The Hartford 2015 Annual Report Download - page 145

Table of Contents THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Significant Accounting Policies (continued)
F-14
Embedded Derivatives
The Company purchases and has previously issued financial instruments and products that contain embedded derivative instruments.
When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the
economic characteristics of the host contract and (2) a separate instrument with the same terms would qualify as a derivative instrument,
the embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative, which is reported with the
host instrument in the Consolidated Balance Sheets, is carried at fair value with changes in fair value reported in net realized capital
gains and losses.
Credit Risk
Credit risk is defined as the risk of financial loss due to uncertainty of an obligor’s or counterparty’s ability or willingness to meet its
obligations in accordance with agreed upon terms. Credit exposures are measured using the market value of the derivatives, resulting in
amounts owed to the Company by its counterparties or potential payment obligations from the Company to its counterparties. The
Company generally requires that OTC derivative contracts, other than certain forward contracts, be governed by International Swaps and
Derivatives Association ("ISDA") agreements which are structured by legal entity and by counterparty, and permit right of offset. These
agreements require daily collateral settlement based upon agreed upon thresholds. For purposes of daily derivative collateral
maintenance, credit exposures are generally quantified based on the prior business day’s market value and collateral is pledged to and
held by, or on behalf of, the Company to the extent the current value of the derivatives exceed the contractual thresholds. For the
Company’s domestic derivative programs, the maximum uncollateralized threshold for a derivative counterparty for a single legal entity
is $10. The Company also minimizes the credit risk of derivative instruments by entering into transactions with high quality
counterparties primarily rated A or better, which are monitored and evaluated by the Company’s risk management team and reviewed by
senior management. OTC-cleared derivatives are governed by clearing house rules. Transactions cleared through a central clearing house
reduce risk due to their ability to require daily variation margin, monitor the Company's ability to request additional collateral in the event
of a counterparty downgrade, and act as an independent valuation source. In addition, the Company monitors counterparty credit exposure
on a monthly basis to ensure compliance with Company policies and statutory limitations.
Cash
Cash represents cash on hand and demand deposits with banks or other financial institutions.
Reinsurance
The Company cedes insurance to affiliated and unaffiliated insurers in order to limit its maximum losses and to diversify its exposures
and provide statutory surplus relief. Such arrangements do not relieve the Company of its primary liability to policyholders. Failure of
reinsurers to honor their obligations could result in losses to the Company. The Company also assumes reinsurance from other insurers
and is a member of and participates in reinsurance pools and associations. Assumed reinsurance refers to the Company’ s acceptance of
certain insurance risks that other insurance companies or pools have underwritten.
Reinsurance accounting is followed for ceded and assumed transactions that provide indemnification against loss or liability relating to
insurance risk (i.e. risk transfer). To meet risk transfer requirements, a reinsurance agreement must include insurance risk, consisting of
underwriting, investment, and timing risk, and a reasonable possibility of a significant loss to the reinsurer. If the ceded and assumed
transactions do not meet risk transfer requirements, the Company accounts for these transactions as financing transactions.
Premiums, benefits, losses and loss adjustment expenses reflect the net effects of ceded and assumed reinsurance transactions. Included
in other assets are prepaid reinsurance premiums, which represent the portion of premiums ceded to reinsurers applicable to the
unexpired terms of the reinsurance contracts. Included in reinsurance recoverables are balances due from reinsurance companies for paid
and unpaid losses and loss adjustment expenses and are presented net of an allowance for uncollectible reinsurance. Changes in the
allowance for uncollectible reinsurance are reported in benefits, losses and loss adjustment expenses in the Company's Consolidated
Statements of Operations.
The Company evaluates the financial condition of its reinsurers and concentrations of credit risk. Reinsurance is placed with reinsurers
that meet strict financial criteria established by the Company. The Company entered into two reinsurance transactions upon completion
of the sales of its Retirement Plans and Individual Life businesses in 2013. For further discussion of these transactions, see Note 18 -
Discontinued Operations and Business Dispositions and Note 5 - Reinsurance of Notes to Consolidated Financial Statements.
Deferred Policy Acquisition Costs
Deferred policy acquisition costs ("DAC") represent costs that are directly related to the acquisition of new and renewal insurance
contracts and incremental direct costs of contract acquisition that are incurred in transactions with either independent third parties or
employees. Such costs primarily include commissions, premium taxes, costs of policy issuance and underwriting, and certain other
expenses that are directly related to successfully issued contracts.