The Hartford 2013 Annual Report Download - page 105

105
Financial Risk on Statutory Capital
Statutory surplus amounts and risk-based capital (“RBC”) ratios may increase or decrease in any period depending upon a variety of
factors and may be compounded in extreme scenarios or if multiple factors occur at the same time. At times the impact of changes in
certain market factors or a combination of multiple factors on RBC ratios can be counterintuitive. Factors include:
• In general, as equity market levels and interest rates decline, the amount and volatility of both our actual potential obligation, as
well as the related statutory surplus and capital margin for death and living benefit guarantees associated with U.S. variable
annuity contracts can be materially negatively affected, sometimes at a greater than linear rate. Other market factors that can
impact statutory surplus, reserve levels and capital margin include differences in performance of variable subaccounts relative to
indices and/or realized equity and interest rate volatilities. In addition, as equity market levels increase, generally surplus levels
will increase. RBC ratios will also tend to increase when equity markets increase. However, as a result of a number of factors and
market conditions, including the level of hedging costs and other risk transfer activities, reserve requirements for death and living
benefit guarantees and RBC requirements could increase with rising equity markets, resulting in lower RBC ratios. Non-market
factors, which can also impact the amount and volatility of both our actual potential obligation, as well as the related statutory
surplus and capital margin, include actual and estimated policyholder behavior experience as it pertains to lapsation, partial
withdrawals, and mortality.
• For guaranteed benefits (GMDB, GMIB, and GMWB) reinsured from our international operations to our U.S. insurance
subsidiaries, or guaranteed by our U.S. insurance subsidiaries, the Company hedges its aggregate economic exposure to the
various risks arising out of the product guarantees, with a focus on the underlying economics of the exposure to the entire
Company, rather than the direct liability of the underlying issuer of the related products. The Company believes that hedging
economic exposure in this manner is consistent with certain intercompany reinsurance agreements and guarantees, results in
increased capital efficiency and results in a better risk profile than taking alternative approaches to hedging that might emphasize
statutory or GAAP measures or considerations. The amount and volatility of both our actual potential obligation, as well as the
related statutory surplus and capital margin can be materially affected by a variety of factors, both market and non-market. Market
factors include declines in various equity market indices and interest rates, changes in value of the yen versus other global
currencies, difference in the performance of variable subaccounts relative to indices, and increases in realized equity, interest rate,
and currency volatilities. Non-market factors include actual and estimated policyholder behavior experience as it pertains to
lapsation, withdrawals, mortality, and annuitization. Risk mitigation activities, such as hedging, may also result in material and
sometimes counterintuitive impacts on statutory surplus and capital margin. Notably, as changes in these market and non-market
factors occur, both our potential obligation and the related statutory reserves and/or required capital can increase or decrease at a
greater than linear rate.
• As the value of certain fixed-income and equity securities in our investment portfolio decreases, due in part to credit spread
widening, statutory surplus and RBC ratios may decrease.
• As the value of certain derivative instruments that do not qualify for hedge accounting decreases, statutory surplus and RBC ratios
may decrease.
• The life insurance subsidiaries’ exposure to foreign currency exchange risk exists with respect to non-U.S. dollar denominated
assets and liabilities. Assets and liabilities denominated in foreign currencies are accounted for at their U.S. dollar equivalent
values using exchange rates at the balance sheet date. As foreign currency exchange rates vary in comparison to the U.S. dollar,
the remeasured value of those non-dollar denominated assets or liabilities will also vary, causing an increase or decrease to
statutory surplus.
• Our statutory surplus is also impacted by widening credit spreads as a result of the accounting for the assets and liabilities in our
fixed MVA annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In
determining the statutory reserve for the fixed MVA annuities, we are required to use current crediting rates in the U.S. and
Japanese LIBOR in Japan. In many capital market scenarios, current crediting rates in the U.S. are highly correlated with market
rates implicit in the fair value of statutory separate account assets. As a result, the change in statutory reserve from period to
period will likely substantially offset the change in the fair value of the statutory separate account assets. However, in periods of
volatile credit markets, such as we have experienced, actual credit spreads on investment assets may increase sharply for certain
sub-sectors of the overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads
are not fully reflected in the current crediting rates in the U.S. or Japanese LIBOR in Japan, the calculation of statutory reserves
will not substantially offset the change in fair value of the statutory separate account assets resulting in reductions in statutory
surplus. This has resulted and may continue to result in the need to devote significant additional capital to support the product.
• With respect to our fixed annuity business, sustained low interest rates may result in a reduction in statutory surplus and an
increase in NAIC required capital.