The Hartford 2013 Annual Report Download - page 97

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To calculate duration, convexity, and key rate durations, projections of asset and liability cash flows are discounted to a present value
using interest rate assumptions. These cash flows are then revalued at alternative interest rate levels to determine the percentage change
in fair value due to an incremental change in the entire yield curve for duration and convexity, or a particular point on the yield curve for
key rate duration. Cash flows from corporate obligations are assumed to be consistent with the contractual payment streams on a yield to
worst basis. Yield to worst is a basis that represents the lowest potential yield that can be received without the issuer actually defaulting.
The primary assumptions used in calculating cash flow projections include expected asset payment streams taking into account
prepayment speeds, issuer call options and contract holder behavior. Mortgage-backed and asset-backed securities are modeled based on
estimates of the rate of future prepayments of principal over the remaining life of the securities. These estimates are developed by
incorporating collateral surveillance and anticipated future market dynamics. Actual prepayment experience may vary from these
estimates.
The Company is also exposed to interest rate risk based upon the discount rate assumption associated with the Company’s pension and
other postretirement benefit obligations. The discount rate assumption is based upon an interest rate yield curve comprised of bonds
rated AA with maturities primarily between zero and thirty years. For further discussion of discounting pension and other postretirement
benefit obligations, refer to Note 18 - Employee Benefit Plans of Notes to Consolidated Financial Statements. In addition, management
evaluates performance of certain Talcott Resolution products based on net investment spread which is, in part, influenced by changes in
interest rates. For further discussion, see the Talcott Resolution section of the MD&A.
The investments and liabilities primarily associated with interest rate risk are included in the following discussion. Certain product
liabilities, including those containing GMWB, GMIB, GMAB, or GMDB, expose the Company to interest rate risk but also have
significant equity risk. These liabilities are discussed as part of the Equity Risk section below.
Fixed Maturity Investments
The Company’s investment portfolios primarily consist of investment grade fixed maturity securities. The fair value of these investments
was $63.2 billion and $87.0 billion at 2013 and 2012, respectively. The fair value of these and other invested assets fluctuates depending
on the interest rate environment and other general economic conditions. The weighted average duration of the portfolio, including fixed
maturities, commercial mortgage loans, derivatives, and cash equivalents, was approximately 5.3 and 5.6 years as of 2013 and 2012,
respectively. As of December 31, 2012, the weighted average duration of the portfolio, excluding the Retirement Plans and Individual
Life businesses, was approximately 5.4 years.
Liabilities
The Company’s investment contracts and certain insurance product liabilities, other than non-guaranteed separate accounts, include asset
accumulation vehicles such as fixed annuities, guaranteed investment contracts, other investment and universal life-type contracts and
certain insurance products such as long-term disability.
Asset accumulation vehicles primarily require a fixed rate payment, often for a specified period of time, such as fixed rate annuities with
a market value adjustment feature. The term to maturity of these contracts generally range from less than one year to ten years. In
addition, certain products such as corporate owned life insurance contracts and the general account portion of Talcott Resolutions’s
variable annuity products, credit interest to policyholders subject to market conditions and minimum interest rate guarantees. The term to
maturity of the asset portfolio supporting these products may range from short to intermediate.
While interest rate risk associated with many of these products has been reduced through the use of market value adjustment features and
surrender charges, the primary risk associated with these products is that the spread between investment return and credited rate may not
be sufficient to earn targeted returns.
The Company also manages the risk of certain insurance liabilities similarly to investment type products due to the relative predictability
of the aggregate cash flow payment streams. Products in this category may contain significant reliance upon actuarial (including
mortality and morbidity) pricing assumptions and do have some element of cash flow uncertainty. Product examples include structured
settlement contracts, on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon) and short-term and long-term
disability contracts. The cash outflows associated with these policy liabilities are not interest rate sensitive but do vary based on the
timing and amount of benefit payments. The primary risks associated with these products are that the benefits will exceed expected
actuarial pricing and/or that the actual timing of the cash flows will differ from those anticipated, or interest rate levels may deviate from
those assumed in product pricing, ultimately resulting in an investment return lower than that assumed in pricing. The average duration
of the liability cash flow payments can range from less than one year to in excess of fifteen years.