================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarterly Period Ended September 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ______________ Commission file number 0-19277 THE HARTFORD FINANCIAL SERVICES GROUP, INC. (Exact name of registrant as specified in its charter) DELAWARE 13-3317783 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) HARTFORD PLAZA, HARTFORD, CONNECTICUT 06115-1900 (Address of principal executive offices) (860) 547-5000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No[ ] As of October 31, 2001, there were outstanding 245,173,335 shares of Common Stock, $0.01 par value per share, of the registrant. ================================================================================
INDEX PART I. FINANCIAL INFORMATION - ----------------------------- ITEM 1. FINANCIAL STATEMENTS PAGE Consolidated Statements of Income - Third Quarter and Nine Months Ended September 30, 2001 and 2000 3 Consolidated Balance Sheets - September 30, 2001 and December 31, 2000 4 Consolidated Statements of Changes in Stockholders' Equity - Nine Months Ended September 30, 2001 and 2000 5 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2001 and 2000 6 Notes to Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 30 PART II. OTHER INFORMATION - --------------------------- ITEM 1. LEGAL PROCEEDINGS 30 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30 Signature 31 - 2 -
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS <TABLE> <CAPTION> THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONSOLIDATED STATEMENTS OF INCOME THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- ----------------------------- (IN MILLIONS, EXCEPT FOR PER SHARE DATA) 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ (Unaudited) (Unaudited) <S> <C> <C> <C> <C> REVENUES Earned premiums $ 2,287 $ 2,301 $ 6,954 $ 6,647 Fee income 654 680 1,942 1,869 Net investment income 714 683 2,124 1,980 Other revenue 121 120 362 330 Net realized capital gains (losses) (54) 7 (91) (22) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 3,722 3,791 11,291 10,804 -------------------------------------------------------------------------------------------------------------------------- BENEFITS, CLAIMS AND EXPENSES Benefits, claims and claim adjustment expenses 2,886 2,176 7,435 6,254 Amortization of deferred policy acquisition costs and present value of future profits 556 569 1,630 1,653 Insurance operating costs and expenses 513 534 1,461 1,479 Goodwill amortization 15 11 43 16 Other expenses 178 182 532 481 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 4,148 3,472 11,101 9,883 -------------------------------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES, MINORITY INTEREST AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES (426) 319 190 921 Income tax expense (benefit) (323) 69 (207) 166 Minority interest, net of tax -- -- -- (54) - ------------------------------------------------------------------------------------------------------------------------------------ INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES (103) 250 397 701 Cumulative effect of accounting changes, net of tax -- -- (34) -- - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ (103) $ 250 $ 363 $ 701 -------------------------------------------------------------------------------------------------------------------------- BASIC EARNINGS (LOSS) PER SHARE Income (loss) before cumulative effect of accounting changes $ (0.43) $ 1.11 $ 1.69 $ 3.20 Cumulative effect of accounting changes, net of tax -- -- (0.15) -- - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ (0.43) $ 1.11 $ 1.54 $ 3.20 DILUTED EARNINGS (LOSS) PER SHARE [1] Income (loss) before cumulative effect of accounting changes $ (0.43) $ 1.09 $ 1.66 $ 3.15 Cumulative effect of accounting changes, net of tax -- -- (0.14) -- - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ (0.43) $ 1.09 $ 1.52 $ 3.15 - ------------------------------------------------------------------------------------------------------------------------------------ Weighted average common shares outstanding 238.0 224.4 235.6 218.9 Weighted average common shares outstanding and dilutive potential common shares [1] 238.0 229.3 239.5 222.3 - ------------------------------------------------------------------------------------------------------------------------------------ Cash dividends declared per share $ 0.25 $ 0.24 $ 0.75 $ 0.72 - ------------------------------------------------------------------------------------------------------------------------------------ <FN> [1] In the absence of the third quarter 2001 net loss, 241.7 weighted average common shares and dilutive potential common shares outstanding would have been used in the calculation of diluted earnings per share for the quarter ended September 30, 2001. </FN> </TABLE> SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. - 3 -
<TABLE> <CAPTION> THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, DECEMBER 31, (IN MILLIONS, EXCEPT FOR SHARE DATA) 2001 2000 - -------------------------------------------------------------------------------------------------------------------------------- (Unaudited) <S> <C> <C> ASSETS Investments ----------- Fixed maturities, available for sale, at fair value (amortized cost of $37,643 and $33,856) $ 39,010 $ 34,492 Equity securities, available for sale, at fair value (cost of $1,304 and $921) 1,248 1,056 Policy loans, at outstanding balance 3,715 3,610 Other investments 1,973 1,511 - -------------------------------------------------------------------------------------------------------------------------------- Total investments 45,946 40,669 Cash 325 227 Premiums receivable and agents' balances 2,477 2,295 Reinsurance recoverables 5,091 4,579 Deferred policy acquisition costs and present value of future profits 6,313 5,305 Deferred income tax 461 682 Goodwill 1,683 1,202 Other assets 2,829 2,519 Separate account assets 105,487 114,054 - -------------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 170,612 $ 171,532 ======================================================================================================================== LIABILITIES Future policy benefits, unpaid claims and claim adjustment expenses Property and casualty $ 16,680 $ 15,874 Life 7,931 7,105 Other policyholder funds and benefits payable 19,542 15,848 Unearned premiums 3,458 3,093 Short-term debt 234 235 Long-term debt 2,265 1,862 Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures 1,444 1,243 Other liabilities 4,805 4,754 Separate account liabilities 105,487 114,054 - -------------------------------------------------------------------------------------------------------------------------------- 161,846 164,068 COMMITMENTS AND CONTINGENCIES, NOTE 10 STOCKHOLDERS' EQUITY Common stock - authorized 400,000,000, issued 241,028,707 and 238,645,675 shares, par value $0.01 2 2 Additional paid-in capital 1,945 1,686 Retained earnings 6,072 5,887 Treasury stock, at cost - 2,941,340 and 12,355,414 shares (37) (480) Accumulated other comprehensive income 784 369 - -------------------------------------------------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 8,766 7,464 ------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 170,612 $ 171,532 ======================================================================================================================== </TABLE> SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. - 4 -
<TABLE> <CAPTION> THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2001 Accumulated Other Comprehensive Income (Loss) -------------------------------------------------- Common Unrealized Net Gain on Minimum Stock/ Gain Cash-Flow Pension Outstanding Additional Treasury (Loss) on Hedging Cumulative Liability Shares Paid-in Retained Stock, Securities, Instruments, Translation Adjustment, (In (In millions) (Unaudited) Capital Earnings at Cost net of tax net of tax Adjustments net of tax Total thousands) - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> BALANCE, BEGINNING OF PERIOD $1,688 $5,887 $(480) $497 $-- $(113) $(15) $7,464 226,290 Comprehensive income Net income 363 363 Other comprehensive income, net of tax [1] Cumulative effect of accounting change [2] (1) 24 23 Unrealized gain on securities [3] 334 334 Cumulative translation adj. (10) (10) Net gain on cash-flow hedging instruments [4] 68 68 --------- Total other comprehensive income 415 --------- Total comprehensive income 778 --------- Issuance of shares under incentive and stock purchase plans 76 4 80 1,924 Issuance of common stock in underwritten offering 169 446 615 10,000 Tax benefit on employee stock options and awards 14 14 Treasury stock acquired (7) (7) (127) Dividends declared on common stock (178) (178) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, END OF PERIOD $1,947 $6,072 $(37) $830 $92 $(123) $(15) $8,766 238,087 - ------------------------------------------------------------------------------------------------------------------------------------ NINE MONTHS ENDED SEPTEMBER 30, 2000 Accumulated Other Comprehensive Income (Loss) -------------------------------------------- Common Minimum Stock/ Unrealized Pension Outstanding Additional Treasury Gain (Loss) Cumulative Liability Shares Paid-in Retained Stock, on Securities, Translation Adjustment, (In (In millions) (Unaudited) Capital Earnings at Cost net of tax Adjustments net of tax Total thousands) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, BEGINNING OF PERIOD $1,553 $5,127 $(942) $(198) $(63) $(11) $5,466 217,226 Comprehensive income Net income 701 701 Other comprehensive income, net of tax [1] Unrealized gain on securities [3] 282 282 Cumulative translation adjustments (86) (86) --------- Total other comprehensive income 196 --------- Total comprehensive income 897 --------- Issuance of shares under incentive and stock purchase plans (44) 159 115 3,336 Issuance of common stock from treasury 56 342 398 7,250 Conversion of HLI employee stock options and restricted shares 84 8 92 186 Tax benefit on employee stock options and awards 33 33 Treasury stock acquired (100) (100) (2,832) Dividends declared on common stock (157) (157) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, END OF PERIOD $1,682 $5,671 $(533) $84 $(149) $(11) $6,744 225,166 - ------------------------------------------------------------------------------------------------------------------------------------ <FN> [1] Unrealized gain (loss) on securities is net of tax expense of $180 and $152 for the nine months ended September 30, 2001 and 2000, respectively. Cumulative effect of accounting change is net of tax benefit of $12. Net gain on cash-flow hedging instruments is net of tax expense of $37 for the nine months ended September 30, 2001. There is no tax effect on cumulative translation adjustments. [2] Unrealized gain (loss) on securities, net of tax, includes cumulative effect of accounting change of $(23) to net income and $24 to net gain on cash-flow hedging instruments. [3] Net of reclassification adjustment for gains (losses) realized in net income of $2 and $(9) for the nine months ended September 30, 2001 and 2000, respectively. [4] Net of amortization adjustment of $5 to net investment income. </FN> </TABLE> SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. - 5 -
<TABLE> <CAPTION> THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------- (IN MILLIONS) 2001 2000 - -------------------------------------------------------------------------------------------------------------------------------- (Unaudited) <S> <C> <C> OPERATING ACTIVITIES Net income $ 363 $ 701 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES Change in receivables, payables and accruals (54) (146) Change in reinsurance recoverables and other related assets (527) (32) Amortization of deferred policy acquisition costs and present value of future profits 1,630 1,653 Additions to deferred policy acquisition costs and present value of future profits (2,047) (1,963) Change in accrued and deferred income taxes (210) 263 Increase in liabilities for future policy benefits, unpaid claims and claim adjustment expenses and unearned premiums 1,866 709 Minority interest in consolidated subsidiary -- 54 Net realized capital losses 91 22 Depreciation and amortization 38 46 Cumulative effect of accounting changes, net of tax 34 -- Other, net (125) 341 - -------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 1,059 1,648 ================================================================================================================================ INVESTING ACTIVITIES Purchase of investments (12,512) (11,182) Sale of investments 7,523 9,621 Maturity of investments 2,139 1,409 Purchase of business/affiliate (1,105) (1,393) Sale of affiliates 15 -- Additions to property, plant and equipment (141) (138) - -------------------------------------------------------------------------------------------------------------------------------- NET CASH USED FOR INVESTING ACTIVITIES (4,081) (1,683) ================================================================================================================================ FINANCING ACTIVITIES Short-term debt, net -- 400 Issuance of long-term debt 400 516 Issuance of company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures 200 -- Issuance of common stock in underwritten offering 615 398 Net proceeds from (disbursements for) investment and universal life-type contracts charged against policyholder accounts 2,027 (1,050) Dividends paid (176) (156) Acquisition of treasury stock (7) (100) Proceeds from issuance of shares under incentive and stock purchase plans 61 92 - -------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 3,120 100 - -------------------------------------------------------------------------------------------------------------------------------- Foreign exchange rate effect on cash -- (12) - -------------------------------------------------------------------------------------------------------------------------------- Net increase in cash 98 53 Cash - beginning of period 227 182 - -------------------------------------------------------------------------------------------------------------------------------- CASH - END OF PERIOD $ 325 $ 235 ================================================================================================================================ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: - ------------------------------------------------- NET CASH PAID DURING THE PERIOD FOR: Income taxes $ 37 $ 8 Interest $ 172 $ 151 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. </TABLE> - 6 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in millions except per share data unless otherwise stated) (unaudited) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (A) BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of The Hartford Financial Services Group, Inc. and its consolidated subsidiaries ("The Hartford" or the "Company") have been prepared in accordance with generally accepted accounting principles for interim periods. Less than majority-owned entities in which The Hartford has at least a 20% interest are reported on the equity basis. In the opinion of management, these statements include all normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows for the periods presented. (For a description of accounting policies, see Note 1 of Notes to Consolidated Financial Statements included in The Hartford's 2000 Form 10-K Annual Report.) On April 2, 2001, The Hartford acquired the U.S. individual life insurance, annuity and mutual fund businesses of Fortis, Inc. (operating as "Fortis Financial Group", or "Fortis"). The acquisition was accounted for as a purchase transaction and, as such, the revenues and expenses generated by this business from April 2, 2001 forward are included in the Company's Consolidated Statements of Income. (For further discussion of the Fortis Acquisition, see Note 4.) On June 27, 2000, The Hartford acquired all of the outstanding shares of Hartford Life, Inc. ("HLI") that it did not already own ("The HLI Repurchase"). The accompanying unaudited consolidated financial statements reflect the minority interest in HLI of approximately 19% prior to the acquisition date. (For further discussion on The HLI Repurchase, see Note 2 of Notes to Consolidated Financial Statements included in The Hartford's 2000 Form 10-K Annual Report.) Certain reclassifications have been made to prior year financial information to conform to the current year classification of transactions and accounts. (B) ADOPTION OF NEW ACCOUNTING STANDARDS Effective September 2001, the Company adopted Emerging Issues Task Force ("EITF") Issue 01-10, "Accounting for the Impact of the Terrorist Attacks of September 11, 2001". Under the consensus, costs related to the terrorist act should be reported as part of income from continuing operations and not as an extraordinary item. The Company has recognized and classified all direct and indirect costs associated with the attack of September 11 in accordance with the consensus. (For discussion of the impact of the September 11 terrorist attack, see Note 2.) Effective April 1, 2001, the Company adopted EITF Issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets". Under the consensus, investors in certain asset-backed securities are required to record changes in their estimated yield on a prospective basis and to evaluate these securities for an other than temporary decline in value. If the fair value of the asset-backed security has declined below its carrying amount and the decline is determined to be other than temporary, the security is written down to fair value. Upon adoption of EITF Issue 99-20, the Company recorded an $11 charge in net income as a net of tax cumulative effect of accounting change. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS Nos. 137 and 138. The standard requires, among other things, that all derivatives be carried on the balance sheet at fair value. The standard also specifies hedge accounting criteria under which a derivative can qualify for special accounting. In order to receive special accounting, the derivative instrument must qualify as a hedge of either the fair value or the variability of the cash flow of a qualified asset or liability, or forecasted transaction. Special accounting for qualifying hedges provides for matching the timing of gain or loss recognition on the hedging instrument with the recognition of the corresponding changes in value of the hedged item. The Company's policy prior to adopting SFAS No. 133 was to carry its derivative instruments on the balance sheet in a manner similar to the hedged item(s). Upon adoption of SFAS No. 133, the Company recorded a $23 charge in net income as a net of tax cumulative effect of accounting change. The transition adjustment was primarily comprised of gains and losses on derivatives that had been previously deferred and not adjusted to the carrying amount of the hedged item. Also included in the transition adjustment were gains and losses related to recognizing at fair value all derivatives that are designated as fair-value hedging instruments offset by the difference between the book values and fair values of related hedged items attributable to the hedged risks. The entire transition amount was previously recorded in Accumulated Other Comprehensive Income ("OCI") - Unrealized Gain/Loss on Securities in accordance with SFAS No. 115. Gains and losses on derivatives that were previously deferred as adjustments to the carrying amount of hedged items were not affected by the implementation of SFAS No. 133. Upon adoption, the Company also reclassified $24, net of tax, to Accumulated OCI - - Gain on Cash-Flow Hedging Instruments from Accumulated OCI - Unrealized Gain/Loss on Securities. This reclassification reflects the January 1, 2001 net unrealized gain for all derivatives that are designated as cash-flow hedging instruments. For further discussion of the Company's accounting policies for derivative instruments, see Note 2 of Notes to Consolidated Financial Statements included in The Hartford's March 31, 2001 Form 10-Q. For further discussion of The Hartford's derivative results by hedge category for the quarter and nine months ended September 30, 2001, see Note 3, Derivatives and Hedging Activities below. - 7 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (C) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 establishes an accounting model for long-lived assets to be disposed of by sale that applies to all long-lived assets, including discontinued operations. SFAS No. 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. The provisions of Statement 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001. Adoption of SFAS No. 144 will not have a material impact on the Company's financial condition or results of operations. In June 2001, the FASB issued SFAS No. 141, "Business Combinations". SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations requiring all business combinations to be accounted for under the purchase method. Accordingly, net assets acquired are recorded at fair value with any excess of cost over net assets assigned to goodwill. SFAS No. 141 also requires that certain intangible assets acquired in a business combination be recognized apart from goodwill. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method of accounting for those transactions is prohibited. Adoption of SFAS No. 141 will not have a material impact on the Company's financial condition or results of operations. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". Under SFAS No. 142, amortization of goodwill is precluded; however, its fair value is periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested for impairment in the year of adoption, including an initial test performed within six months. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed within twelve months. SFAS No. 142 requires that useful lives for intangibles other than goodwill be reassessed and remaining amortization periods be adjusted accordingly. The reassessment must be completed prior to the end of the first quarter of 2002. All provisions of SFAS No. 142 will be applied beginning January 1, 2002 to goodwill and other intangible assets. The Company expects goodwill amortization to approximate $52, after-tax, in 2001 and to have approximated $56, after-tax, in 2002. The Company is in the process of assessing the impacts from the implementation of the other provisions of SFAS No. 142. NOTE 2. SEPTEMBER 11 TERRORIST ATTACK As a result of the September 11 terrorist attack, the Company recorded in the third quarter of 2001 a loss amounting to $440, net of taxes and reinsurance: $420 related to property and casualty operations and $20 related to life operations. The property-casualty portion of the estimate includes coverages related to property, business interruption, workers' compensation, and other liability exposures, including those underwritten by the Company's assumed reinsurance operation. The Company based the loss estimate upon a review of insured exposures using a variety of assumptions and actuarial techniques, including estimated amounts for unknown and unreported policyholder losses and costs incurred in settling claims. Also included was an estimate of amounts recoverable under the Company's ceded reinsurance programs, including the cost of additional reinsurance premiums. As a result of the uncertainties involved in the estimation process, final claims settlement may vary from present estimates. NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards and exchange traded futures and options, in order to achieve one of three Company approved objectives: to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity; or to control transaction costs. The Company is considered an "end-user" of derivative instruments and, as such, does not make a market or trade in these instruments for the express purpose of earning trading profits. For a detailed discussion of the Company's use of derivative instruments, see Note 2 of Notes to Consolidated Financial Statements included in The Hartford's March 31, 2001 Form 10-Q. As of September 30, 2001, the Company reported $190 of derivative assets in other invested assets and $182 of derivative liabilities in other liabilities. Cash-Flow Hedges For the quarter and nine months ended September 30, 2001, the Company's gross gains and losses representing the total ineffectiveness of all cash-flow hedges essentially offset, with the net impact reported as realized capital gains or losses. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness. Gains and losses on derivative contracts that are reclassified from OCI to current period earnings are included in the line item in the statement of income in which the hedged item is recorded. As of September 30, 2001, approximately $4 of after-tax deferred net - 8 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED) gains on derivative instruments accumulated in OCI are expected to be reclassified to earnings during the next twelve months. This expectation is based on the anticipated interest payments on hedged investments in fixed maturity securities that will occur over the next twelve months, at which time the Company will recognize the deferred net gains/losses as an adjustment to interest income over the term of the investment cash flows. The maximum term over which the Company is hedging its exposure to the variability of future cash flows (for all forecasted transactions, excluding interest payments on variable-rate debt) is twelve months. As of September 30, 2001, the Company held approximately $2.3 billion in derivative notional value related to strategies categorized as cash-flow hedges. There were no reclassifications from OCI to earnings resulting from the discontinuance of cash-flow hedges during the quarter or nine months ended September 30, 2001. Fair-Value Hedges For the quarter and nine months ended September 30, 2001, the Company's gross gains and losses representing the total ineffectiveness of all fair-value hedges essentially offset, with the net impact reported as realized capital gains or losses. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness. As of September 30, 2001, the Company held approximately $360 in derivative notional value related to strategies categorized as fair-value hedges. Other Risk Management Activities In general, the Company's other risk management activities relate to strategies used to meet the previously mentioned Company-approved objectives. Swap agreements, interest rate cap and floor agreements and option contracts are used to meet these objectives. Changes in the value of all derivatives held for other risk management purposes are reported in current period earnings as realized capital gains or losses. As of September 30, 2001, the Company held approximately $4.8 billion in derivative notional value related to strategies categorized as Other Risk Management Activities. NOTE 4. FORTIS ACQUISITION On April 2, 2001, The Hartford acquired Fortis Financial Group for $1.12 billion in cash. The Company effected the acquisition through several reinsurance agreements with subsidiaries of Fortis, Inc. and the purchase of 100% of the stock of Fortis Advisers, Inc. and Fortis Investors, Inc., wholly-owned subsidiaries of Fortis, Inc. The acquisition was accounted for as a purchase transaction and, as such, the revenues and expenses generated by this business from April 2, 2001 forward are included in the Company's Consolidated Statement of Income. The Company financed the acquisition from the proceeds of the (1) February 16, 2001 issuance of 10 million shares of common stock pursuant to an underwritten offering under its current shelf registration for $615, net, (2) March 1, 2001 issuance of $400 of senior debt securities under HLI's June 1998 shelf registration and (3) March 6, 2001 issuance of $200 of trust preferred securities under HLI's June 1998 shelf registration. The assets and liabilities acquired in this transaction were recorded at values prescribed by applicable purchase accounting rules, which generally represent estimated fair value. In addition, an intangible asset representing the present value of future profits ("PVP") of the acquired business was established in the amount of $605. The PVP is amortized to expense in relation to the estimated gross profits of the underlying insurance contracts, and interest is accreted on the unamortized balance. For the quarter and nine months ended September 30, 2001, amortization of PVP amounted to $10 and $23, respectively. Goodwill of $553, representing the excess of the purchase price over the amount of net assets (including PVP) acquired, has also been recorded and is being amortized on a straight-line basis over a 25 year period. NOTE 5. SALE OF INTERNATIONAL SUBSIDIARIES On February 8, 2001, The Hartford completed the sale of its Spain-based subsidiary, Hartford Seguros. The Hartford received $29 before costs of sale and recorded an after-tax net realized capital loss of $16. In September 2001, The Hartford entered into a memorandum of understanding for the sale of its Singapore-based Hartford Insurance Company (Singapore), Ltd. The Company recorded a net realized capital loss of $9 after-tax related to the sale. On September 7, 2001, HLI completed the sale of its ownership interest in an Argentine subsidiary, Sudamerica Holding S.A. The Company recorded an after-tax net realized capital loss of $21 related to the sale. NOTE 6. DEBT (A) SHORT-TERM DEBT The Hartford's commercial paper ranks equally with its other unsecured and unsubordinated indebtedness. As of December 31, 2000, The Hartford had a $1.5 billion five-year revolving credit facility, which was terminated on June 20, 2001. Effective on that date, The Hartford entered into an amended and restated five-year revolving $1.0 billion credit facility with fourteen banks. This facility is available for general corporate purposes and to provide additional support to the Company's commercial paper program. As of September 30, 2001, there were no outstanding borrowings under the facility. As of September 30, 2001, HLI maintained a $250 five-year revolving credit facility comprised of four participatory banks. This facility, which expires in 2003, is available for general corporate purposes and to provide additional support to HLI's commercial paper program. As of September 30, 2001, there were no outstanding borrowings under the facility. - 9 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (B) LONG-TERM DEBT On March 1, 2001, HLI issued and sold $400 of senior debt securities under its June 1998 shelf registration. The long-term debt was issued in the form of 7.375% thirty-year senior notes due March 1, 2031. Interest on the notes is payable semi-annually on March 1 and September 1, commencing on September 1, 2001. As discussed in Note 4, HLI used the net proceeds from the issuance of the notes to partially fund the Fortis acquisition. (C) SHELF REGISTRATION STATEMENTS On November 9, 2000, The Hartford filed with the Securities and Exchange Commission ("SEC") a shelf registration statement for the potential offering and sale of up to $2.6 billion in debt and equity securities. The registration statement was declared effective on February 12, 2001. As of September 30, 2001, The Hartford had $2.0 billion remaining on the shelf. (For further discussion, see Note 6 of Notes to Consolidated Financial Statements included in The Hartford's 2000 Form 10-K Annual Report.) In October 2001, The Hartford issued both Trust Originated Preferred Securities and common stock as discussed in Note 12 "Subsequent Events". After these issuances, The Hartford had $1.1 billion remaining on its shelf. On May 15, 2001, HLI filed with the SEC a shelf registration statement for the potential offering and sale of up to $1.0 billion in debt and preferred securities. The registration statement was declared effective on May 29, 2001. This registration statement includes an aggregate $150 of HLI securities remaining under the shelf registration filed by HLI with the SEC in June 1998. As of September 30, 2001, HLI had $1.0 billion remaining on its shelf. NOTE 7. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES On March 6, 2001, Hartford Life Capital II, a Delaware statutory business trust formed by HLI, issued 8,000,000, 7.625% Trust Preferred Securities, Series B under its June 1998 shelf registration. The proceeds from the sale of the Series B Preferred Securities were used to acquire $200 of 7.625% Series B Junior Subordinated Debentures issued by HLI. As previously discussed in Note 4, HLI used the proceeds from the offering to partially fund the Fortis acquisition. The Series B Preferred Securities represent undivided beneficial interests in Hartford Life Capital II's assets, which consist solely of the Series B Junior Subordinated Debentures. HLI owns all of the common securities of Hartford Life Capital II. Holders of Series B Preferred Securities are entitled to receive cumulative cash distributions accruing from March 6, 2001, the date of issuance, and payable quarterly in arrears commencing April 15, 2001 at the annual rate of 7.625% of the stated liquidation amount of $25.00 per Series B Preferred Security. The Series B Preferred Securities are subject to mandatory redemption upon repayment of the Series B Junior Subordinated Debentures at maturity or upon earlier redemption. HLI has the right to redeem the Series B Junior Subordinated Debentures on or after March 6, 2006 or earlier upon the occurrence of certain events. Holders of Series B Preferred Securities generally have no voting rights. The Series B Junior Subordinated Debentures mature on February 15, 2050 and bear interest at the annual rate of 7.625% of the principal amount, payable quarterly in arrears commencing April 15, 2001. The Series B Junior Subordinated Debentures are unsecured and rank junior and subordinate in right of payment to all present and future senior debt of HLI and are effectively subordinated to all existing and future obligations of HLI subsidiaries. HLI has the right at any time, and from time to time, to defer payments of interest on the Series B Junior Subordinated Debentures for a period not exceeding 20 consecutive quarters up to the debentures' maturity date. During any such period, interest will continue to accrue and HLI may not declare or pay any cash dividends or distributions on, or purchase, HLI's capital stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank equally with or junior to the Series B Junior Subordinated Debentures. HLI will have the right at any time to dissolve the Trust and cause the Series B Junior Subordinated Debentures to be distributed to the holders of the Series B Preferred Securities. HLI has guaranteed, on a subordinated basis, all of the Hartford Life Capital II obligations under the Series B Preferred Securities including payment of the redemption price and any accumulated and unpaid distributions upon dissolution, winding up or liquidation to the extent Hartford Life Capital II has funds available to make these payments. On October 26, 2001, Hartford Capital III, a Delaware statutory business trust formed by The Hartford, issued 20,000,000, 7.45% Trust Originated Preferred Securities, Series C and received proceeds, before expenses, of $500. For further discussion of this issuance, see Note 12 of Notes to Consolidated Financial Statements. NOTE 8. STOCKHOLDERS' EQUITY On February 16, 2001, The Hartford issued 10 million shares of common stock pursuant to an underwritten offering under its current shelf registration for net proceeds of $615. As discussed in Note 4, the proceeds were used to partially fund the Fortis acquisition. On October 22, 2001, The Hartford issued 7.0 million shares of common stock to Salomon Smith Barney Inc. at a price of $56.82 per share and received proceeds of $400. The shares were then re-offered by Salomon Smith Barney Inc. to investors. For further discussion of this issuance, see Note 12 of Notes to Consolidated Financial Statements. - 10 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 9. EARNINGS PER SHARE The following tables present a reconciliation of income and shares used in calculating basic earnings per share to those used in calculating diluted earnings per share. <TABLE> <CAPTION> Third Quarter Ended Nine Months Ended -------------------------------------- ----------------------------------- Income Per Share Per Share SEPTEMBER 30, 2001 (Loss) Shares Amount Income Shares Amount - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> BASIC EARNINGS (LOSS) PER SHARE Income (loss) available to common shareholders $ (103) 238.0 $ (0.43) $ 363 235.6 $ 1.54 -------------- ---------- DILUTED EARNINGS (LOSS) PER SHARE Options and contingently issuable shares [1] -- -- -- 3.9 ------------------------ ------------------------- Income (loss) available to common shareholders plus assumed conversions [1] $ (103) 238.0 $ (0.43) $ 363 239.5 $ 1.52 - ------------------------------------------------------------------------------------------------------------------------------------ <FN> [1] As a result of the net loss in the quarter ended September 30, 2001, SFAS 128, "Earnings Per Share", requires the Company to use basic weighted average shares outstanding in the calculation of third quarter 2001 diluted earnings per share, as the inclusion of options and contingently issuable shares of 3.7 would have been antidilutive to the earnings per share calculation. In the absence of the net loss, weighted average common shares outstanding and dilutive potential common shares would have totaled 241.7. </FN> </TABLE> <TABLE> <CAPTION> Third Quarter Ended Nine Months Ended -------------------------------------- ------------------------------------ Per Share Per Share SEPTEMBER 30, 2000 Income Shares Amount Income Shares Amount - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> BASIC EARNINGS PER SHARE Income available to common shareholders $ 250 224.4 $ 1.11 $ 701 218.9 $ 3.20 ------------- ----------- DILUTED EARNINGS PER SHARE Options and contingently issuable shares -- 4.9 -- 3.4 ------------------------- ------------------------- Income available to common shareholders plus assumed conversions $ 250 229.3 $ 1.09 $ 701 222.3 $ 3.15 - ------------------------------------------------------------------------------------------------------------------------------------ </TABLE> Basic earnings per share reflects the actual weighted average number of shares outstanding during the period. Diluted earnings per share includes the dilutive effect of outstanding options, using the treasury stock method, and contingently issuable shares. Under the treasury stock method exercise of options is assumed, with the proceeds used to repurchase common stock at the average market price for the period. Contingently issuable shares are included upon satisfaction of certain conditions related to the contingency. NOTE 10. COMMITMENTS AND CONTINGENCIES (A) LITIGATION The Hartford is or may become involved in various legal actions, some of which involve claims for substantial amounts. In the opinion of management, the ultimate liability, if any, with respect to such actual and potential lawsuits, after consideration of provisions made for potential losses and costs of defense, is not expected to be material to the consolidated financial condition, results of operations or cash flows of The Hartford. (B) ENVIRONMENTAL AND ASBESTOS CLAIMS Information regarding environmental and asbestos claims may be found in the Environmental and Asbestos Claims section of Management's Discussion and Analysis of Financial Condition and Results of Operations. (C) TAX MATTERS The Hartford's federal income tax returns are routinely audited by the Internal Revenue Service ("IRS"). In August 2001, the Company recorded a $130 benefit, primarily the result of the favorable treatment of certain tax matters related to separate account investment activity arising during the 1996-2000 tax years. During 2000, the Company recorded a $24 tax benefit as a result of a settlement with the IRS with respect to certain similar tax matters for the 1993-1995 tax years. Management believes that adequate provision has been made in the financial statements for any potential assessments that may result from tax examinations and other tax related matters for all open tax years. NOTE 11. SEGMENT INFORMATION The Hartford is organized into two major operations: Life and Property & Casualty. Within these operations, The Hartford conducts business principally in ten operating segments. Additionally, all activities related to The HLI Repurchase, the minority interest in HLI for pre-acquisition periods and The Hartford Bank, FSB are included in Corporate. Life is organized into four reportable operating segments: Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI"). Investment Products offers individual variable and fixed annuities, mutual funds, retirement plan services and other investment products. Individual - 11 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11. SEGMENT INFORMATION (CONTINUED) Life sells a variety of life insurance products, including variable life, universal life, interest sensitive whole life and term life insurance. Group Benefits sells group insurance products, including group life and group disability insurance as well as other products, including stop loss and supplementary medical coverage to employers and employer sponsored plans, accidental death and dismemberment, travel accident and other special risk coverages to employers and associations. COLI primarily offers variable products used by employers to fund non-qualified benefits or other postemployment benefit obligations as well as leveraged COLI. Life also includes in an Other category its international operations, which are primarily located in Latin America and the Far East, as well as corporate items not directly allocable to any of its reportable operating segments, principally interest expense. The Hartford's Property & Casualty operation was reorganized into six reportable operating segments and, effective January 1, 2001, is reported as the North American underwriting segments of Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance; and the International and Other Operations segment. Business Insurance provides standard commercial business for small accounts (Select Customer) and mid-sized insureds (Key Accounts). This segment also provides commercial risk management products and services to small and mid-sized members of affinity groups in addition to marine coverage. Affinity Personal Lines provides customized products and services to the membership of AARP through a direct marketing operation; and to customers of Sears and Ford as well as customers of financial institutions through an affinity center. Personal Insurance provides automobile, homeowners, home-based business and fire coverages to individuals who prefer local agent involvement through a network of independent agents in the standard personal lines market and through Omni in the non-standard automobile market. Specialty Commercial provides bond and financial products coverages as well as insurance through retailers and wholesalers to large commercial clients and insureds requiring a variety of specialized coverages. The Reinsurance segment assumes reinsurance worldwide and primarily writes treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business. In October 2001, The Hartford's reinsurance segment announced a centralization of all underwriting and claims operations in Hartford, and an exit of all international lines except catastrophe, ART and marine. For further discussion of this restructuring, see Note 12 of Notes to Consolidated Financial Statements. International consisted primarily of The Hartford Insurance Company (Singapore), Ltd. until its sale in September 2001, while Other Operations consists of operations which have ceased writing new business. The measure of profit or loss used by The Hartford's management in evaluating performance is operating income, except for its North American underwriting segments, which are evaluated by The Hartford's management primarily based upon underwriting results. "Operating income" is defined as after-tax operational results excluding, as applicable, net realized capital gains or losses, the cumulative effect of accounting changes and certain other items. While not considered segments, the Company also reports and evaluates operating income results for Life, Property & Casualty and North American, which includes the combined underwriting results of the North American underwriting segments along with income and expense items not directly allocable to these segments, such as net investment income. Property & Casualty includes operating income for North American and the International and Other Operations segment. Certain transactions between segments occur during the year that primarily relate to tax settlements, insurance coverage, expense reimbursements, services provided and capital contributions. Certain reinsurance stop loss agreements exist between the segments which specify that one segment will reimburse another for losses incurred in excess of a predetermined limit. Also, one segment may purchase group annuity contracts from another to fund pension costs and claim annuities to settle casualty claims. In addition, certain intersegment transactions occur in Life. These transactions include interest income on allocated surplus and the allocation of net realized capital gains and losses through net invested income utilizing the duration of the segment's investment portfolios. The following tables present revenues and operating income (loss). Underwriting results are presented for the Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance segments, while operating income is presented for all other segments, along with Life and Property & Casualty, including North American. - 12 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11. SEGMENT INFORMATION (CONTINUED) <TABLE> <CAPTION> REVENUES THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------------------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Life Investment Products $ 622 $ 605 $ 1,869 $ 1,777 Individual Life 236 164 639 475 Group Benefits 617 553 1,871 1,630 COLI 171 239 536 574 Other (41) 26 (25) 18 - ------------------------------------------------------------------------------------------------------------------------------------ Total Life 1,605 1,587 4,890 4,474 - ------------------------------------------------------------------------------------------------------------------------------------ Property & Casualty North American Earned premiums and other revenue Business Insurance 680 577 1,940 1,700 Affinity Personal Lines 480 449 1,404 1,299 Personal Insurance 252 246 753 721 Specialty Commercial 334 357 922 911 Reinsurance 220 202 699 585 Ceded premiums related to the September 11 terrorist attack (114) -- (114) -- - ------------------------------------------------------------------------------------------------------------------------------------ Total North American earned premiums and other revenue 1,852 1,831 5,604 5,216 Net investment income 227 219 679 647 Net realized capital gains (losses) (4) 7 (28) 6 - ------------------------------------------------------------------------------------------------------------------------------------ Total North American 2,075 2,057 6,255 5,869 International and Other Operations 38 143 133 458 - ------------------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty 2,113 2,200 6,388 6,327 - ------------------------------------------------------------------------------------------------------------------------------------ Corporate 4 4 13 3 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES $ 3,722 $ 3,791 $ 11,291 $ 10,804 ==================================================================================================================================== </TABLE> - 13 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11. SEGMENT INFORMATION (CONTINUED) <TABLE> <CAPTION> OPERATING INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------------------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Life Investment Products $ 116 $ 105 $ 344 $ 317 Individual Life 30 19 86 57 Group Benefits 26 23 76 63 COLI 8 9 27 25 Other 102 (4) 86 14 - ------------------------------------------------------------------------------------------------------------------------------------ Total Life 282 152 619 476 - ------------------------------------------------------------------------------------------------------------------------------------ Property & Casualty North American Underwriting results Business Insurance 6 (11) (7) (63) Affinity Personal Lines (7) 6 (13) 5 Personal Insurance (10) (1) (31) (15) Specialty Commercial (18) (19) (56) (62) Reinsurance (47) (28) (109) (52) - ------------------------------------------------------------------------------------------------------------------------------------ Underwriting results excluding September 11 (76) (53) (216) (187) September 11 terrorist attack (647) -- (647) -- - ------------------------------------------------------------------------------------------------------------------------------------ Total North American underwriting results (723) (53) (863) (187) Net servicing and other income [1] 5 4 17 6 Net investment income 227 219 679 647 Other expenses (50) (55) (153) (157) Income tax (expense) benefit 222 (7) 209 (9) - ------------------------------------------------------------------------------------------------------------------------------------ Total North American (319) 108 (111) 300 International and Other Operations -- 5 2 14 - ------------------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty (319) 113 (109) 314 - ------------------------------------------------------------------------------------------------------------------------------------ Corporate (15) (20) (47) (80) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL OPERATING INCOME (LOSS) (52) 245 463 710 Cumulative effect of accounting changes, net of tax -- -- (34) -- Net realized capital gains (losses), after-tax (51) 5 (66) (9) - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ (103) $ 250 $ 363 $ 701 ==================================================================================================================================== <FN> [1] Net of expenses related to service business. </FN> </TABLE> NOTE 12. SUBSEQUENT EVENTS On October 22, 2001, The Hartford issued 7.0 million shares of common stock to Salomon Smith Barney Inc. at a price of $56.82 per share and received proceeds of $400. The shares were then re-offered by Salomon Smith Barney Inc. to investors. On October 26, 2001, Hartford Capital III, a Delaware statutory business trust formed by The Hartford, issued 20,000,000, 7.45% Trust Originated Preferred Securities, Series C and received proceeds, before expenses, of $500. The proceeds from these two issuances will be used for general corporate purposes, which includes planned redemption in part or whole of the 8.35% Cumulative Quarterly Income Preferred Securities, Series B of Hartford Capital II and the replacement of a portion of the reduction in shareholders' equity from the September 11 terrorist attack. In October 2001, The Hartford's reinsurance segment announced a centralization of all underwriting and claims operations in Hartford, and an exit of all international lines except catastrophe, ART and marine. As a result of the reorganization, the Company will record a fourth quarter restructuring charge. Also in the fourth quarter, in connection with the previously mentioned planned redemptions of the 8.35% Cumulative Quarterly Income Preferred Securities, The Hartford will record an extraordinary charge for early retirement of indebtedness. In aggregate, the two charges will be approximately $20, after-tax. - 14 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollar amounts in millions except share data unless otherwise stated) Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the financial condition of The Hartford Financial Services Group, Inc. and its consolidated subsidiaries (collectively, "The Hartford" or the "Company") as of September 30, 2001, compared with December 31, 2000, and its results of operations for the third quarter and nine months ended September 30, 2001, compared with the equivalent 2000 periods. This discussion should be read in conjunction with the MD&A included in The Hartford's 2000 Form 10-K Annual Report. Certain statements made herein, other than statements of historical fact, are forward-looking statements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive and legislative developments. These forward-looking statements are subject to change and uncertainty which are, in many instances, beyond the Company's control and have been made based upon management's expectations and beliefs concerning future developments and their potential effect upon the Company. There can be no assurance that future developments will be in accordance with management's expectations or that the effect of future developments on The Hartford will be those anticipated by management. Actual results could differ materially from those expected by the Company, depending on the outcome of various factors. These factors include: the uncertain nature of damage theories and loss amounts and the development of additional facts related to the September 11 terrorist attack; the response of reinsurance companies under reinsurance contracts and the impact of increasing reinsurance rates; the possibility of more unfavorable loss experience than anticipated; the possibility of general economic and business conditions that are less favorable than anticipated; more frequent or severe catastrophes than anticipated; changes in interest rates or the stock markets; stronger than anticipated competitive activity; unfavorable legislative, regulatory or judicial developments; and other factors described in such forward-looking statements. Certain reclassifications have been made to prior year financial information to conform to the current year presentation. - -------------------------------------------------------------------------------- INDEX - -------------------------------------------------------------------------------- Consolidated Results of Operations: Operating Summary 15 Life 17 Investment Products 18 Individual Life 19 Group Benefits 19 Corporate Owned Life Insurance ("COLI") 20 Property & Casualty 20 Business Insurance 21 Affinity Personal Lines 21 Personal Insurance 22 Specialty Commercial 22 Reinsurance 23 International and Other Operations 23 Environmental and Asbestos Claims 24 Investments 25 Capital Markets Risk Management 27 Capital Resources and Liquidity 28 Regulatory Matters and Contingencies 30 Accounting Standards 30 - -------------------------------------------------------------------------------- CONSOLIDATED RESULTS OF OPERATIONS: OPERATING SUMMARY - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------------------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> TOTAL REVENUES $ 3,722 $ 3,791 $ 11,291 $ 10,804 - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ (103) $ 250 $ 363 $ 701 Less: Cumulative effect of accounting changes, net of tax [1] -- -- (34) -- Net realized capital gains (losses), after-tax (51) 5 (66) (9) - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME (LOSS) $ (52) $ 245 $ 463 $ 710 - ------------------------------------------------------------------------------------------------------------------------------------ <FN> [1] For the nine months ended September 30, 2001, represents the cumulative impact of the Company's adoption of Emerging Issues Task Force ("EITF") Issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" and Statement of Financial Accounting Standards ("SFAS") No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities". </FN> </TABLE> "Operating income (loss)" is defined as after-tax operational results excluding, as applicable, net realized capital gains or losses, the cumulative effect of accounting changes and certain other items. Management believes that this performance measure delineates the results of operations of the Company's ongoing businesses in a manner that allows for a better understanding of the underlying trends in the Company's current business. However, operating income (loss) should only be analyzed in conjunction with, and not in lieu of, net income (loss) and may not be comparable to other performance measures used by the Company's competitors. OPERATING RESULTS Included in the Company's operating results for the third quarter and nine months ended September 30, 2001, were $440 of losses, - 15 -
after-tax and net of reinsurance, related to the September 11 terrorist attack and a $130 tax benefit at Hartford Life, Inc. ("HLI"), primarily the result of the favorable treatment of certain tax matters related to separate account investment activity during the 1996-2000 tax years. Revenues for the third quarter and nine months ended September 30, 2001 decreased $69, or 2%, and increased $487, or 5%, respectively, over the comparable prior year periods. Included in both 2001 periods was a $114 reduction in North American Property & Casualty premiums from additional reinsurance cessions related to the September 11 terrorist attack. Excluding the effects of the September 11 terrorist attack, revenues increased $45, or 1%, and $601, or 6%, for the third quarter and nine months ended September 30, 2001, respectively, as compared to the third quarter and nine months ended September 30, 2000. The increase was related to continued new business growth in Group Benefits, increased fee income in Individual Life primarily as a result of the April 2001 purchase of Fortis, Inc. ("Fortis") and earned premium growth in most of the Property & Casualty underwriting segments. (For further discussion of the Fortis acquisition, see Note 4 of Notes to Consolidated Financial Statements). These increases were partially offset by lower revenues and higher net realized capital losses, reflecting the sale of several of The Hartford's international subsidiaries, including Spain-based Hartford Seguros, Singapore-based Hartford Insurance Company (Singapore), Ltd. and an Argentina-based insurance joint venture. Operating results decreased $297 and $247, respectively, for the third quarter and nine months ended September 30, 2001, from the comparable prior year periods. Excluding the effects of the September 11 terrorist attack and HLI tax benefit, operating income increased $13, or 5%, and $63, or 9%, for the third quarter and nine months ended September 30, 2001, respectively, as compared to the third quarter and nine months ended September 30, 2000. The increases reflect favorable operating performance in the Company's Business Insurance and Group Benefits segments and operating income from Fortis. INCOME TAXES Excluding the impact of the September 11 terrorist attack and the HLI tax benefit, the effective tax rate for the third quarter and nine months ended September 30, 2001 was 18% and 19%, respectively, compared with 22% and 18%, respectively, for the comparable periods in 2000. The decrease in the effective tax rates was primarily the result of the sale of the Company's Spain-based Hartford Seguros and Singapore-based Hartford Insurance Company (Singapore), Ltd. subsidiaries and the sale of the Company's ownership interest in an Argentine subsidiary, Sudamerica Holding S.A. Tax exempt interest earned on invested assets was the principal cause of the effective tax rates being lower than the 35% U.S. statutory rate. SEGMENT RESULTS The Hartford is organized into two major operations: Life and Property & Casualty. Within these operations, The Hartford conducts business principally in ten operating segments. Additionally, all activities related to the June 27, 2000 acquisition of all the outstanding shares of HLI that The Hartford did not already own ("The HLI Repurchase"), the minority interest in HLI for pre-acquisition periods and The Hartford Bank, FSB are included in Corporate. Life is organized into four reportable operating segments: Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI"). Life also includes in an Other category its international operations, which are primarily located in Latin America and the Far East, as well as corporate items not directly allocable to any of its reportable operating segments, principally interest expense. The Hartford's Property & Casualty operation was reorganized into six reportable operating segments and, effective January 1, 2001, is reported as the North American underwriting segments of Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance; and the International and Other Operations segment. The measure of profit or loss used by The Hartford's management in evaluating performance is operating income, except for its North American underwriting segments, which are evaluated by The Hartford's management primarily based upon underwriting results. While not considered segments, the Company also reports and evaluates operating income results for Life, Property & Casualty, and North American, which includes the combined underwriting results of the North American underwriting segments along with income and expense items not directly allocable to these segments, such as net investment income. Property & Casualty includes operating income for North American and the International and Other Operations segment. (For discussion of the Company's intersegment transactions, see Note 11 of Notes to Consolidated Financial Statements.) The following is a summary of North American underwriting results by segment within Property & Casualty. Underwriting results represent premiums earned less incurred claims, claim adjustment expenses and underwriting expenses. <TABLE> <CAPTION> UNDERWRITING RESULTS (BEFORE-TAX) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------------------------------------- North American 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Business Insurance $ 6 $ (11) $ (7) $ (63) Affinity Personal Lines (7) 6 (13) 5 Personal Insurance (10) (1) (31) (15) Specialty Commercial (18) (19) (56) (62) Reinsurance (47) (28) (109) (52) - ------------------------------------------------------------------------------------------------------------------------------------ Underwriting results excluding September 11 (76) (53) (216) (187) September 11 terrorist attack (647) -- (647) -- - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL NORTH AMERICAN UNDERWRITING RESULTS $ (723) $ (53) $ (863) $ (187) ==================================================================================================================================== </TABLE> - 16 -
The following is a summary of operating income (loss) and net income (loss). <TABLE> <CAPTION> OPERATING INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------- -------------- -------------- ----------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Life <S> <C> <C> <C> <C> Investment Products $ 116 $ 105 $ 344 $ 317 Individual Life 30 19 86 57 Group Benefits 26 23 76 63 COLI 8 9 27 25 Other 102 (4) 86 14 - ------------------------------------------------------------------------------------------------------------------------------------ Total Life 282 152 619 476 Property & Casualty North American (319) 108 (111) 300 International and Other Operations -- 5 2 14 - ------------------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty (319) 113 (109) 314 Corporate (15) (20) (47) (80) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL OPERATING INCOME (LOSS) $ (52) $ 245 $ 463 $ 710 ==================================================================================================================================== </TABLE> <TABLE> <CAPTION> NET INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------- -------------- -------------- ----------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Life Investment Products $ 116 $ 105 $ 344 $ 317 Individual Life 30 19 86 57 Group Benefits 26 23 76 63 COLI 8 9 27 25 Other 70 (4) 17 (14) - ------------------------------------------------------------------------------------------------------------------------------------ Total Life 250 152 550 448 Property & Casualty North American (339) 113 (146) 304 International and Other Operations 1 5 6 25 - ------------------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty (338) 118 (140) 329 Corporate (15) (20) (47) (76) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL NET INCOME (LOSS) $ (103) $ 250 $ 363 $ 701 ==================================================================================================================================== </TABLE> An analysis of the operating results summarized above is included on the following pages. Environmental and Asbestos Claims and Investments are discussed in separate sections. - -------------------------------------------------------------------------------- LIFE - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY [1] THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Revenues $ 1,605 $ 1,587 $ 4,890 $ 4,474 Expenses 1,355 1,435 4,314 4,026 Cumulative effect of accounting changes, net of tax [2] -- -- (26) -- - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME [3] 250 152 550 448 Less: Cumulative effect of accounting changes, net of tax [2] -- -- (26) -- Net realized capital losses, after-tax (32) -- (43) (28) - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME [3] $ 282 $ 152 $ 619 $ 476 ==================================================================================================================================== <FN> [1] Life excludes the effect of activities related to The HLI Repurchase, along with minority interest for pre-acquisition periods, both of which are reflected in Corporate. [2] For the nine months ended September 30, 2001, represents the cumulative impact of the Company's adoption of EITF Issue 99-20 and SFAS No. 133. [3] For the third quarter and nine months ended September 30, 2001, includes $130 tax benefit related to separate account investment activity and $20 of after-tax losses related to the September 11 terrorist attack. For the nine months ended September 30, 2000, includes $32 tax benefit related to favorable tax items. </FN> </TABLE> - 17 -
Life has the following reportable segments: Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI"). The Company reports corporate items not directly allocable to any of its segments, principally interest expense, as well as its international operations in "Other". On April 2, 2001, The Hartford acquired the U.S. individual life insurance, annuity and mutual fund businesses of Fortis, Inc. (operating as "Fortis Financial Group" or "Fortis"). (For further discussion, see "Fortis Acquisition" in the Capital Resources and Liquidity section.) This transaction was accounted for as a purchase and, as such, the revenues and expenses generated by this business from April 2, 2001 forward are included in Life's consolidated results of operations. Revenues increased $18, or 1%, and $416, or 9%, for the third quarter and nine months ended September 30, 2001, respectively, as Life experienced growth in Investment Products, Individual Life and Group Benefits, which were partially offset by a decrease in COLI. Most notably, Group Benefits experienced higher earned premiums resulting from strong sales and solid persistency, and Individual Life earned higher fee income and net investment income due primarily to the business acquired from Fortis. Expenses decreased $80, or 6%, for the third quarter primarily associated with the lower levels of revenue in the COLI segment and a decrease in income tax expense, primarily due to a $130 benefit associated with a tax item related to separate account investment activity. For the nine months ended September 30, 2001, expenses increased $288, or 7%, primarily as a result of the growth in Life revenues, which was partially offset by the $130 favorable tax item and the COLI operation, as described above. Operating income increased $130, or 86%, and $143, or 30%, for the third quarter and nine months ended September 30, 2001, respectively. Included in the results for the third quarter of 2001 are the $130 favorable tax item discussed above and a $20 loss associated with the impact of the September 11 terrorist attack. In addition, for the nine months ended September 30, 2000, Life recorded a benefit of $32 also related to favorable tax items. Excluding the favorable tax items and the impact of the September 11 terrorist attack, operating income increased $20, or 13%, and $65, or 15%, for the third quarter and nine months ended September 30, 2001, respectively, as each of Life's operating segments experienced growth in operating income from a year ago. - -------------------------------------------------------------------------------- INVESTMENT PRODUCTS - -------------------------------------------------------------------------------- <TABLE> <CAPTION> THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Revenues $ 622 $ 605 $ 1,869 $ 1,777 Expenses 506 500 1,525 1,460 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME $ 116 $ 105 $ 344 $ 317 - ------------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------------ Individual variable annuity account values $ 68,545 $ 83,009 Other individual annuity account values 9,421 8,955 Other investment products account values 17,638 17,368 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ACCOUNT VALUES 95,604 109,332 Mutual fund assets under management 14,380 9,868 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENT PRODUCTS ASSETS UNDER MANAGEMENT $ 109,984 $ 119,200 ==================================================================================================================================== </TABLE> Revenues in the Investment Products segment increased $17, or 3%, and $92, or 5%, for the third quarter and nine months ended September 30, 2001, respectively, driven primarily by the other investment products operation. Fee income in other investment products increased $12, or 16%, and $46, or 22%, for the third quarter and nine months ended September 30, 2001, principally due to growth in Life's mutual fund assets, which increased $4.5 billion, or 46%, to $14.4 billion as of September 30, 2001, due to strong sales and the business acquired from Fortis. Net investment income in other investment products increased $27, or 19%, and $84, or 21%, due mostly to growth in the institutional business, where related assets increased $1.2 billion, or 16%, from a year ago. The increases in other investment products were partially offset by individual annuity revenues, which decreased $22, or 6%, and $38, or 3%, for the third quarter and nine months ended September 30, 2001. Fee income and net investment income from the business acquired from Fortis helped to partially offset lower revenues associated with decreased account values resulting from the lower equity markets as compared to the prior year. Individual annuity account values decreased $14.0 billion, or 15%, from September 30, 2000. Expenses increased $6, or 1%, and $65, or 4%, for the third quarter and nine months ended September 30, 2001, respectively, driven by higher interest credited and higher insurance expenses and other in other investment products associated with the revenue growth described above. For the respective third quarter and nine month periods, interest credited in other investment products operations increased $22, or 19%, and $63, or 19%, while insurance expenses and other increased $8, or 9%, and $45, or 18%. Also, individual annuity interest credited increased $13, or 23%, and $10, or 5%, principally due to the business acquired from Fortis. Partially offsetting these increases were decreases in individual annuity expenses, including amortization of deferred acquisition costs and present value of future profits, which decreased $29, or 23%, and $47, or 13%, for the respective periods. Additionally, individual annuity income tax expense decreased $19, or 46%, and $35, or 28%, for the respective - 18 -
periods, due to lower pre-tax operating income and the ongoing tax impact associated with separate account investment activity. Operating income increased $11, or 10%, and $27, or 9%, for the third quarter and nine months ended September 30, 2001, respectively, as compared to the equivalent periods in 2000. These increases were driven by the growth in revenues in other investment products described above, the favorable impact of the Fortis Financial Group acquisition and the lower effective tax rate related to the individual annuity business.
- -------------------------------------------------------------------------------- INDIVIDUAL LIFE - -------------------------------------------------------------------------------- <TABLE> <CAPTION> THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Revenues $ 236 $ 164 $ 639 $ 475 Expenses 206 145 553 418 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME $ 30 $ 19 $ 86 $ 57 - ------------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------------ Variable life account values $ 3,460 $ 3,019 Total account values $ 7,322 $ 5,879 - ------------------------------------------------------------------------------------------------------------------------------------ Variable life insurance in force $ 59,466 $ 30,787 Total life insurance in force $ 118,510 $ 72,651 ==================================================================================================================================== </TABLE> Revenues in the Individual Life segment increased $72, or 44%, and $164, or 35%, for the third quarter and nine months ended September 30, 2001, respectively, primarily due to the business acquired from Fortis, Inc. Fee income, including cost of insurance charges, increased $50, or 43%, and $115, or 34%, respectively, driven principally by growth in the variable life business where account values increased $441, or 15%, and life insurance in force increased $28.7 billion, or 93% from a year ago. In addition, net investment income on general account business (universal life, interest sensitive whole life and term life) increased $20, or 43%, and $43, or 32%, for the respective third quarter and nine months, consistent with the growth in related account values. Expenses increased $61, or 42%, and $135, or 32%, for the respective third quarter and nine-month periods, due principally to the growth in revenues described above. Year-to-date mortality experience (expressed as death claims as a percentage of net amount at risk) for 2001 was higher than the same period of the prior year, however, 2001 year-to-date mortality experience was within pricing assumptions and is favorable to full year 2000 levels. Operating income increased $11, or 58%, and $29, or 51%, for the third quarter and nine months ended September 30, 2001, respectively. Individual Life incurred an after-tax loss of $3 related to the September 11 terrorist attack. Excluding this loss, operating income increased $14, or 74%, and $32, or 56%, for the third quarter and nine months ended September 30, 2001, respectively, primarily due to the growth factors described above. - -------------------------------------------------------------------------------- GROUP BENEFITS - -------------------------------------------------------------------------------- <TABLE> <CAPTION> THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Revenues $ 617 $ 553 $ 1,871 $ 1,630 Expenses 591 530 1,795 1,567 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME $ 26 $ 23 $ 76 $ 63 ==================================================================================================================================== </TABLE> Revenues in the Group Benefits segment increased $64, or 12%, and $241, or 15%, and excluding buyouts, increased $68, or 12%, and $203, or 13%, for the third quarter and nine months ended September 30, 2001, respectively. These increases were driven by growth in premiums which, excluding buyouts, increased $62, or 13%, and $183, or 13%, for the respective third quarter and nine month periods, due to solid persistency of the in force block of business and strong sales to new customers. Fully insured ongoing sales for the third quarter and nine months ended September 30, 2001 were $110 and $424, 4% and 16% higher, respectively, than the equivalent 2000 periods. Additionally, net investment income increased $6, or 11%, and $20, or 12%, for the third quarter and nine-month periods, respectively, due to the growth in the overall business described above. Expenses, excluding buyouts, increased $65, or 12%, and $190, or 12%, for the third quarter and nine months ended September 30, 2001, respectively, driven primarily by higher benefits and claims which increased $48, or 12%, and $148, or 12%, respectively. These increases are consistent with the growth in the business described above as the loss ratios (defined as benefits and claims as a percentage of premiums and other considerations) have remained relatively flat with the comparable prior year periods. In addition, expenses other than benefits and claims increased $17, or 14%, and $42, or 12%, excluding buyouts, for the respective third quarter and nine-month periods. Operating income increased $3, or 13%, and $13, or 21%, for the third quarter and nine months ended September 30, 2001, respectively. Group Benefits incurred an after-tax loss of $2 - 19 -
related to the September 11 terrorist attack. Excluding this loss, operating income increased $5, or 22%, and $15, or 24%, for the third quarter and nine months ended September 30, 2001, respectively, principally due to the revenue growth described above as the segment's loss and expense ratios have remained relatively consistent with prior year. The Group Benefits segment currently offers Medicare supplement insurance to members of The Retired Officers Association, an organization consisting of retired military officers. Congress recently passed legislation, effective in the fourth quarter of 2001, whereby retired military officers age 65 and older will receive full medical insurance, eliminating the need for Medicare supplement insurance. This legislation is expected to reduce Group Benefits annualized premium revenues by approximately $169. - -------------------------------------------------------------------------------- CORPORATE OWNED LIFE INSURANCE (COLI) - -------------------------------------------------------------------------------- <TABLE> <CAPTION> THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Revenues $ 171 $ 239 $ 536 $ 574 Expenses 163 230 509 549 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME $ 8 $ 9 $ 27 $ 25 - ------------------------------------------------------------------------------------------------------------------------------------ Variable COLI account values $ 16,915 $ 15,497 Leveraged COLI account values 4,835 4,998 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ACCOUNT VALUES $ 21,750 $ 20,495 ==================================================================================================================================== </TABLE> COLI revenues decreased $68, or 28%, and $38, or 7%, for the third quarter and nine months ended September 30, 2001, respectively, mostly due to lower fee income and net investment income. Fee income decreased $59, or 42%, and $47, or 16%, for the third quarter and nine month periods, due to a decline in variable COLI sales from the respective prior year periods. In addition, net investment income decreased $12, or 12% for the third quarter due primarily to lower interest rates, as well as a slight decline in leveraged COLI account values. Year-to-date net investment income was consistent with 2000 levels. Expenses decreased $67, or 29%, and $40, or 7%, associated with the decreased revenue discussed above. Operating income decreased $1, or 11%, and increased $2, or 8%, for the third quarter and nine months ended September 30, 2001. COLI incurred an after-tax charge of $2 related to the September 11 terrorist attack. Excluding this charge, operating income increased $1, or 11%, and $4, or 16%, for the third quarter and nine months ended September 30, 2001, respectively, due principally to a $1.4 billion, or 9%, increase in variable COLI account values. - -------------------------------------------------------------------------------- PROPERTY & CASUALTY - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> TOTAL REVENUES $ 2,113 $ 2,200 $ 6,388 $ 6,327 - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) [1] $ (338) $ 118 $ (140) $ 329 Less: Cumulative effect of accounting change, net of tax [2] -- -- (8) -- Net realized capital gains (losses), after-tax (19) 5 (23) 15 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME (LOSS) [1] $ (319) $ 113 $ (109) $ 314 ==================================================================================================================================== <FN> [1] 2001 includes $420 of after-tax losses related to the September 11 terrorist attack. [2] Represents the cumulative impact of the Company's adoption of EITF Issue 99-20. </FN> </TABLE> Revenues for Property & Casualty decreased $87, or 4%, for the third quarter and increased $61, or 1%, for the nine months ended September 30, 2001, as compared with the same periods in 2000. Included in both 2001 periods was a $114 reduction in premium from additional reinsurance cessions related to the September 11 terrorist attack. Excluding the impact of the September 11 terrorist attack, revenues increased $27, or 1%, and $175, or 3%, for the third quarter and nine month periods, respectively. The increases for both periods were primarily a result of earned premium growth in North American Property & Casualty operations due to price increases, strong business growth and improved premium renewal retention, primarily within the Business Insurance segment. Partially offsetting the increases for both periods were revenue declines in International operations as a result of the sales of Zwolsche in December 2000 and Hartford Seguros in February 2001. Operating income decreased $432 for the third quarter and $423 for the nine months ended September 30, 2001, as compared with the same prior year periods. Excluding the $420 impact of the September 11 terrorist attack, operating income decreased $12, or 11%, and $3, or 1%, for the third quarter and nine month periods, respectively. The decreases for both periods were primarily due to adverse loss development in the auto lines of business and Reinsurance, as well as the sales of International subsidiaries. Partially offsetting the decreases were favorable pricing and loss cost trends in Business Insurance as well as North American Property & Casualty expense ratio improvements. - 20 -
- -------------------------------------------------------------------------------- BUSINESS INSURANCE - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> Written premiums [1] $ 703 $ 603 $ 2,119 $ 1,787 Underwriting results excluding September 11 6 (11) (7) (63) September 11 terrorist attack (245) -- (245) -- - ------------------------------------------------------------------------------------------------------------------------------------ Underwriting results $ (239) $ (11) $ (252) $ (63) Combined ratio excluding September 11 97.5 100.2 98.3 102.2 Combined ratio 134.2 100.2 111.0 102.2 ==================================================================================================================================== <FN> [1] 2001 includes $15 of reinsurance cessions related to the September 11 terrorist attack. </FN> </TABLE> Business Insurance written premiums increased $100, or 17%, for the third quarter and $332, or 19%, for the nine months ended September 30, 2001, as compared to the same periods in 2000. Select Customer increased $53, or 20%, for the quarter and $161, or 20%, for the nine month period. These increases continue to be driven by pricing increases, strong premium renewal retention and the success of product, marketing, technology and service growth initiatives. The increase in Key Accounts of $44, or 17%, for the third quarter and $133, or 17%, for the nine month period continues to be attributable primarily to significant pricing increases and improved premium renewal retention as well as strong new business growth. These increases were partially offset by $15 of reinsurance cessions related to the September 11 terrorist attack. Excluding the impact of the September 11 terrorist attack, underwriting results improved $17, with a corresponding 2.7 point decrease in the combined ratio, for the third quarter and $56, or 3.9 point combined ratio decrease, for the nine month period. The improvement for both periods was primarily due to strong pricing and minimal loss costs as well as an improved expense ratio. The favorable expense ratio was the result of the benefits of last year's field office reorganization and reorganization costs not recurring in 2001. - -------------------------------------------------------------------------------- AFFINITY PERSONAL LINES - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Written premiums $ 475 $ 425 $ 1,380 $ 1,251 Underwriting results excluding September 11 (7) 6 (13) 5 September 11 terrorist attack (3) -- (3) -- - ------------------------------------------------------------------------------------------------------------------------------------ Underwriting results $ (10) $ 6 $ (16) $ 5 Combined ratio excluding September 11 102.3 99.4 101.9 100.1 Combined ratio 103.0 99.4 102.1 100.1 ==================================================================================================================================== </TABLE> Written premiums increased $50, or 12%, for the third quarter and $129, or 10%, for the nine months ended September 30, 2001, as compared to the same periods in 2000. The increase in both periods continues to be driven by growth in the AARP program and Affinity business unit. AARP increased primarily as a result of strong new business growth and continued steady premium renewal retention. The improvement in Affinity continues to reflect increased new business from the Ford and Sears accounts, partially offset by lower financial institution written premiums. Excluding the impact of the September 11 terrorist attack, underwriting results decreased $13, with a 2.9 point increase in the combined ratio, for the third quarter and $18, or a 1.8 point increase in the combined ratio, for the nine month period. Higher personal automobile losses continue to adversely impact underwriting results and the combined ratios. In addition, the loss adjustment expense ratios for both periods increased primarily as a result of higher losses and increased litigation costs. Although underwriting expenses increased in both periods primarily as a result of increased written premiums, the expense ratios improved slightly as compared to prior year primarily as a result of prudent expense management. - 21 -
- -------------------------------------------------------------------------------- PERSONAL INSURANCE - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Written premiums $ 267 $ 261 $ 767 $ 740 Underwriting results excluding September 11 (10) (1) (31) (15) September 11 terrorist attack (6) -- (6) -- - ------------------------------------------------------------------------------------------------------------------------------------ Underwriting results $ (16) $ (1) $ (37) $ (15) Combined ratio excluding September 11 102.1 98.5 102.6 100.9 Combined ratio 104.1 98.5 103.2 100.9 ==================================================================================================================================== </TABLE> Written premiums increased $6, or 2%, and $27, or 4%, for the third quarter and nine months ended September 30, 2001, respectively, as compared to the same prior year periods. The increase in written premiums was primarily due to premium growth in the standard automobile and homeowners lines as a result of pricing increases and strong premium renewal retention. Premium declines in non-standard auto reflect decreased business, the result of significant price increases to address loss cost issues. Excluding the impact of the September 11 terrorist attack, underwriting results decreased $9, with a 3.6 point increase in the combined ratio, for the third quarter and $16, or a 1.7 point combined ratio increase, for the nine month period. Increased automobile losses in both standard and non-standard, primarily due to unfavorable loss development, adversely impacted the quarter and nine month period underwriting results and combined ratios. In addition, an increase in the loss adjustment expense ratios for both periods resulted primarily from higher losses and increased litigation costs. Partially offsetting the combined ratio increase for both periods was improvement in the expense ratios, primarily as a result of lower commissions and prudent expense management. - -------------------------------------------------------------------------------- SPECIALTY COMMERCIAL - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Written premiums [1] $ 264 $ 370 $ 775 $ 874 Underwriting results excluding September 11 (18) (19) (56) (62) September 11 terrorist attack (167) -- (167) -- - ------------------------------------------------------------------------------------------------------------------------------------ Underwriting results $ (185) $ (19) $ (223) $ (62) Combined ratio excluding September 11 107.6 104.7 106.4 105.3 Combined ratio 169.2 104.7 128.4 105.3 ==================================================================================================================================== <FN> [1] 2001 includes $7 of reinsurance cessions related to the September 11 terrorist attack. </FN> </TABLE> Specialty Commercial written premiums decreased $106, or 29%, for the third quarter and $99, or 11%, for the nine months ended September 30, 2001, as compared to the same prior year periods. The variances for both periods were primarily due to a decrease in written premiums from sold or exited business lines which include farm, public entity ("PENCO") and Canada. The decrease for the quarter was also due to The Hartford's purchase, in the third quarter of 2000, of the in force, new and renewal financial products business as well as the majority of the excess and surplus lines business of Reliance which resulted in $93 of additional premium for the third quarter of 2000. Also contributing to the decrease was $7 of reinsurance cessions related to the September 11 terrorist attack. Partially offsetting the decrease for the quarter were increases in written premiums in the property, casualty and bond lines. For the nine month period, the decrease was partially offset by an increase in written premiums in the casualty, bond and professional liability lines of business. Excluding the impact of the September 11 terrorist attack, underwriting results improved $1, with a 2.9 point increase in the combined ratio, for the third quarter and $6, or a 1.1 point combined ratio increase, for the nine month period. Underwriting results for both periods primarily reflect increased losses in the risk management division, offset by favorable results in the property lines of business and lower underwriting expenses as a result of ceding commissions in the professional liability line. The increase in the combined ratio for both periods was due primarily to increased loss ratios in the risk management division and professional liability line, partially mitigated by favorable results in the property line. - 22 -
- -------------------------------------------------------------------------------- REINSURANCE - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Written premiums [1] $ 89 $ 190 $ 657 $ 645 Underwriting results excluding September 11 (47) (28) (109) (52) September 11 terrorist attack (226) -- (226) -- - ------------------------------------------------------------------------------------------------------------------------------------ Underwriting results $ (273) $ (28) $ (335) $ (52) Combined ratio excluding September 11 122.1 116.4 115.3 108.7 Combined ratio 324.8 116.4 154.5 108.7 ==================================================================================================================================== <FN> [1] 2001 includes $92 of reinsurance cessions related to the September 11 terrorist attack. </FN> </TABLE> Reinsurance written premiums decreased $101, or 53%, for the third quarter and increased $12, or 2%, for the nine months ended September 30, 2001, as compared with the same prior year periods. Written premiums decreased in the third quarter primarily due to $92 of reinsurance cessions related to the September 11 terrorist attack. The increase in premiums for the nine month period was primarily attributable to growth in Alternative Risk Transfer ("ART") written premiums, primarily driven by a significant first quarter ART transaction, partially offset by the reinsurance cessions related to September 11. The achievement of double-digit pricing increases in traditional reinsurance was mitigated by higher terminations to maintain profitability targets. Excluding the impact of the September 11 terrorist attack, underwriting results decreased $19 for the third quarter, with a corresponding 5.7 point increase in the combined ratio, and $57, or an increase of 6.6 combined ratio points, for the nine month period. The decrease in underwriting results and corresponding increase in the combined ratios for both periods continued to be attributable to the adverse loss development on prior underwriting years. In October 2001, Reinsurance announced a centralization of all underwriting and claims operations in Hartford, and an exit of all international lines except catastrophe, ART and marine. - -------------------------------------------------------------------------------- INTERNATIONAL AND OTHER OPERATIONS - -------------------------------------------------------------------------------- <TABLE> <CAPTION> OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> TOTAL REVENUES $ 38 $ 143 $ 133 $ 458 - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 1 $ 5 $ 6 $ 25 Less: Net realized capital gains, after-tax 1 -- 4 11 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING INCOME $ -- $ 5 $ 2 $ 14 ==================================================================================================================================== </TABLE> INTERNATIONAL International revenues for the third quarter ended September 30, 2001 decreased $111, or 97%, over the comparable period in 2000 while operating income decreased $5. Both decreases were primarily due to the sale of Zwolsche in December 2000. In September 2001, The Hartford entered into a memorandum of understanding related to the sale of its Singapore-based Hartford Insurance Company (Singapore), Ltd. and recorded in its third quarter results a net realized capital loss of $9, after tax, which was reported in the 2001 investment results of North American Property & Casualty. On February 8, 2001, The Hartford completed the sale of its Spain-based subsidiary Hartford Seguros. The Hartford received $29, before costs of sale and recorded a $16, after-tax, net realized capital loss, which also was reported in the 2001 investment results of North American Property & Casualty. OTHER OPERATIONS Other Operations consist of property and casualty operations of The Hartford which have discontinued writing new business. Other Operations revenues increased $6, or 21%, for the third quarter and increased $6, or 6%, for the nine months ended September 30, 2001 compared to the same prior year period. Operating income was flat compared to third quarter, but decreased $1 for the nine months ended September 30, 2001 and 2000, respectively. - 23 -
- -------------------------------------------------------------------------------- ENVIRONMENTAL AND ASBESTOS CLAIMS - -------------------------------------------------------------------------------- The Hartford continues to receive claims that assert damages from environmental exposures and for injuries from asbestos and asbestos-related products, both of which affect the Property & Casualty operation. Environmental claims relate primarily to pollution and related clean-up costs. With regard to these claims, uncertainty exists which impacts the ability of insurers and reinsurers to estimate the ultimate reserves for unpaid losses and related settlement expenses. The Hartford finds that conventional reserving techniques cannot estimate the ultimate cost of these claims because of inadequate development patterns and inconsistent emerging legal doctrine. The majority of environmental claims and many types of asbestos claims differ from any other type of contractual claim because there is almost no agreement or consistent precedent to determine what, if any, coverage exists or which, if any, policy years and insurers or reinsurers may be liable. Further uncertainty arises with environmental claims since claims are often made under policies, the existence of which may be in dispute, the terms of which may have changed over many years, which may or may not provide for legal defense costs, and which may or may not contain environmental exclusion clauses that may be absolute or allow for fortuitous events. Courts in different jurisdictions have reached disparate conclusions on similar issues and in certain situations have broadened the interpretation of policy coverage and liability issues. In light of the extensive claim settlement process for environmental and asbestos claims, which involves comprehensive fact gathering, subject matter expertise and intensive litigation, The Hartford established an environmental claims facility in 1992 to defend itself aggressively against unwarranted claims and to minimize costs. Within the property and casualty insurance industry in the mid-1990's, progress was made in developing sophisticated, alternative methodologies utilizing company experience and supplemental databases to assess environmental and asbestos liabilities. Consistent with The Hartford's practice of using the best techniques to estimate the Company's environmental and asbestos exposures, a study was initiated in April 1996 based on known cases. The Hartford, utilizing internal staff supplemented by outside legal and actuarial consultants, completed the study in October 1996. (For further discussion on the study, see the MD&A section "Environmental and Asbestos Claims" in The Hartford's 2000 Form 10-K Annual Report.) Reserve activity for both reported and unreported environmental and asbestos claims, including reserves for legal defense costs, for the nine months ended September 30, 2001 and the year ended December 31, 2000, was as follows (net of reinsurance): <TABLE> <CAPTION> ENVIRONMENTAL AND ASBESTOS CLAIMS AND CLAIM ADJUSTMENT EXPENSES - ------------------------------------------------------------------------------------------------------------------------------------ NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, 2001 DECEMBER 31, 2000 ---------------------------------------- --------------------------------------- Environmental Asbestos Total Environmental Asbestos Total - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> Beginning liability $ 911 $ 572 $ 1,483 $ 995 $ 625 $ 1,620 Claims and claim adjustment expenses incurred [1] 12 23 35 8 8 16 Claims and claim adjustment expenses paid (146) (63) (209) (92) (61) (153) - ------------------------------------------------------------------------------------------------------------------------------------ ENDING LIABILITY [2] $ 777 $ 532 $ 1,309 $ 911 $ 572 $ 1,483 ==================================================================================================================================== <FN> [1] For the nine months ended September 30, 2001, environmental and asbestos include $2 and $19, respectively, of incurred expenses related to the assumption of previously ceded reserves from commutations of reinsurance contracts. [2] The ending liabilities are net of reinsurance on reported and unreported claims of $1,285 and $1,506 for September 30, 2001 and December 31, 2000, respectively. Gross of reinsurance as of September 30, 2001 and December 31, 2000, reserves for environmental and asbestos were $1,282 and $1,312 and $1,483 and $1,506, respectively. </FN> </TABLE> The Hartford believes that the environmental and asbestos reserves reported at September 30, 2001 are a reasonable estimate of the ultimate remaining liability for these claims based upon known facts, current assumptions and The Hartford's methodologies. Future social, economic, legal or legislative developments may alter the original intent of policies and the scope of coverage. The Hartford will continue to evaluate new methodologies and developments, such as the increasing level of asbestos claims being tendered under the comprehensive general liability operations (non-product) section of policies, as they arise in order to supplement the Company's ongoing analysis and review of its environmental and asbestos exposures. These future reviews may result in a change in reserves, impacting The Hartford's results of operations in the period in which the reserve estimates are changed. While the impact of these changes could have a material effect on future results of operations, The Hartford does not expect such changes would have a material effect on its liquidity or financial condition. - 24 -
- -------------------------------------------------------------------------------- INVESTMENTS - -------------------------------------------------------------------------------- An important element of the financial results of The Hartford is return on invested assets. The Hartford's investment portfolios are divided between Life and Property & Casualty. The investment portfolios are managed based on the underlying characteristics and nature of each operation's respective liabilities and managed within established risk parameters. (For further discussion on The Hartford's approach to managing risks, see the Capital Markets Risk Management section.) Please refer to The Hartford's 2000 Form 10-K Annual Report for a description of the Company's investment objectives and policies. LIFE The following table identifies invested assets by type held in the Life general account as of September 30, 2001 and December 31, 2000. <TABLE> <CAPTION> COMPOSITION OF INVESTED ASSETS - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2001 DECEMBER 31, 2000 FAIR VALUE PERCENT FAIR VALUE PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Fixed maturities, at fair value $ 22,505 80.4% $ 18,248 79.6% Equity securities, at fair value 412 1.5% 171 0.7% Policy loans, at outstanding balance 3,715 13.3% 3,610 15.7% Other investments 1,341 4.8% 910 4.0% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENTS $ 27,973 100.0% $ 22,939 100.0% ==================================================================================================================================== </TABLE> Policy loans are secured by the cash value of the life policy and do not mature in a conventional sense, but expire in conjunction with the related policy liabilities. The following table identifies fixed maturities by type held in the Life general account as of September 30, 2001 and December 31, 2000. <TABLE> <CAPTION> FIXED MATURITIES BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2001 DECEMBER 31, 2000 FAIR VALUE PERCENT FAIR VALUE PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Corporate $ 10,512 46.7% $ 7,663 42.0% Asset-backed securities (ABS) 3,436 15.3% 3,070 16.8% Commercial mortgage-backed securities (CMBS) 2,919 13.0% 2,776 15.2% Municipal - tax-exempt 1,514 6.7% 1,390 7.6% Mortgage-backed securities (MBS) - agency 974 4.3% 602 3.3% Collateralized mortgage obligations (CMO) 782 3.5% 928 5.1% Government/Government agencies - United States 482 2.1% 244 1.3% Government/Government agencies - Foreign 386 1.7% 321 1.8% Municipal - taxable 47 0.2% 83 0.5% Short-term 1,394 6.2% 975 5.3% Redeemable preferred stock 59 0.3% 196 1.1% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL FIXED MATURITIES $ 22,505 100.0% $ 18,248 100.0% ==================================================================================================================================== </TABLE> Fixed maturity investments increased by $4.3 billion primarily as a result of the Fortis acquisition, increased cash flow and an increase in fair value due to a lower interest rate environment. The securities acquired as part of the Fortis transaction were principally corporate and ABS. INVESTMENT RESULTS The table below summarizes Life's results. <TABLE> <CAPTION> THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- (before-tax) 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Net investment income - excluding policy loan income $ 368 $ 324 $ 1,085 $ 944 Policy loan income 79 84 235 230 -------------------------------------------------------- Net investment income - total $ 447 $ 408 $ 1,320 $ 1,174 Yield on average invested assets [1] 6.7% 7.4% 7.0% 7.0% Net realized capital losses $ (50) $ -- $ (67) $ (43) ==================================================================================================================================== <FN> [1] Represents annualized net investment income (excluding net realized capital gains (losses)) divided by average invested assets at cost (fixed maturities at amortized cost). </FN> </TABLE> For the third quarter and nine months ended September 30, 2001 net investment income, excluding policy loans, increased 14% and 15% compared to the respective prior year periods. The increases were primarily due to income earned on the previously - 25 -
discussed increase in fixed maturity investments from the Fortis acquisition, partially offset by lower yields in the third quarter ended September 30, 2001. Yields on average invested assets for the third quarter ended September 30, 2001 decreased to 6.7% compared to 7.4% in the prior year period, primarily the result of lower yields on fixed maturities in 2001. Yields on average invested assets for the nine months ended September 30, 2001 were essentially flat. Net realized capital losses for the third quarter and nine months ended September 30, 2001 increased by $50 and $24 compared to the respective prior year periods. Included in net realized capital losses for the third quarter ended September 30, 2001 was a $35 loss recognized on the sale of the Company's interest in an Argentine insurance joint venture. Also, included in 2001 net realized capital losses were losses associated with the credit deterioration of certain investments in which the Company has an indirect economic interest. PROPERTY & CASUALTY The following table identifies invested assets by type as of September 30, 2001 and December 31, 2000. <TABLE> <CAPTION> COMPOSITION OF INVESTED ASSETS - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2001 DECEMBER 31, 2000 FAIR VALUE PERCENT FAIR VALUE PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Fixed maturities, at fair value $ 16,501 91.8% $ 16,239 91.6% Equity securities, at fair value 836 4.7% 885 5.0% Other investments 632 3.5% 601 3.4% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENTS $ 17,969 100.0% $ 17,725 100.0% ==================================================================================================================================== </TABLE> The following table identifies fixed maturities by type as of September 30, 2001 and December 31, 2000. <TABLE> <CAPTION> FIXED MATURITIES BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2001 DECEMBER 31, 2000 FAIR VALUE PERCENT FAIR VALUE PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Municipal - tax-exempt $ 8,441 51.2% $ 8,527 52.5% Corporate 3,970 24.1% 3,105 19.1% Commercial mortgage-backed securities (CMBS) 1,127 6.8% 1,141 7.0% Asset-backed securities (ABS) 761 4.6% 760 4.7% Government/Government agencies - Foreign 549 3.3% 682 4.2% Mortgage-backed securities (MBS) - agency 393 2.4% 315 1.9% Collateralized mortgage obligations (CMO) 139 0.8% 236 1.5% Government/Government agencies - United States 73 0.5% 63 0.4% Municipal - taxable 48 0.3% 46 0.3% Short-term 894 5.4% 1,120 6.9% Redeemable preferred stock 106 0.6% 244 1.5% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL FIXED MATURITIES $ 16,501 100.0% $ 16,239 100.0% ==================================================================================================================================== </TABLE> Total fixed maturities increased slightly from December 31, 2000, as an increase in fair value due to a lower interest rate environment was partially offset by a decline due to sales of international subsidiaries. Corporate fixed maturities increased primarily due to a reallocation from municipal tax-exempt and short-term investments. INVESTMENT RESULTS The table below summarizes Property & Casualty's results. <TABLE> <CAPTION> THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Net investment income, before-tax $ 263 $ 271 $ 791 $ 802 Net investment income, after-tax [1] $ 205 $ 212 $ 616 $ 626 -------------------------------------------------------- Yield on average invested assets, before-tax [2] 6.1% 6.2% 6.2% 6.2% Yield on average invested assets, after-tax [1] [2] 4.8% 4.9% 4.8% 4.8% Net realized capital gains (losses), before-tax $ (4) $ 7 $ (24) $ 22 ==================================================================================================================================== <FN> [1] Due to the significant holdings in tax-exempt investments, after-tax net investment income and after-tax yield are also included. [2] Represents annualized net investment income (excluding net realized capital gains (losses)) divided by average invested assets at cost (fixed maturities at amortized cost). </FN> </TABLE> For the third quarter ended September 30, 2001, before- and after-tax net investment income and yields decreased slightly compared to the prior year period. The decreases were due to a reduction in investment income in International operations resulting from the sales of Zwolsche and Hartford Seguros, partially offset by higher income on taxable fixed maturities in the North American Property and Casualty operations. For the nine months ended September 30, 2001, before- and after-tax net investment income - 26 -
decreased slightly as improved earnings in North American Property & Casualty's fixed maturity investments were more than offset by the decline in earnings from the previously mentioned sale of International operations. Yields on average invested assets for the nine months ended September 30, 2001 were flat. Net realized capital losses for the third quarter and nine months ended September 30, 2001 were $4 and $24 compared to net realized capital gains of $7 and $22 for the respective prior year periods. The 2001 net realized losses include losses generated from the sales of international subsidiaries, which were partially offset by gains from the sale of fixed maturities and equities. Also, included in 2001 net realized losses were losses associated with the credit deterioration of certain investments in which the Company has an indirect economic interest. CORPORATE In connection with The HLI Repurchase, the carrying value of the purchased fixed maturity investments was increased to fair market value as of the date of the repurchase. This adjustment was reported in Corporate. The amortization benefit of the increase to the fixed maturity investments' carrying values is reported in Corporate's net investment income. The total amount of amortization benefit for the third quarter and nine months ended September 30, 2001 was $4 and $13, respectively, before-tax. Also reported in Corporate were $4 of fixed maturity investments for The Hartford Bank, FSB. - -------------------------------------------------------------------------------- CAPITAL MARKETS RISK MANAGEMENT - -------------------------------------------------------------------------------- The Hartford has a disciplined approach to managing risks associated with its capital markets and asset/liability management activities. Investment portfolio management is organized to focus investment management expertise on specific classes of investments while asset/liability management is the responsibility of separate and distinct risk management units supporting the Life and Property & Casualty operations. The Company is exposed to two primary sources of investment and asset/liability management risk: credit risk, relating to the uncertainty associated with the ability of an obligor or counterparty to make timely payments of principal and/or interest, and market risk, relating to the market price and/or cash flow variability associated with changes in interest rates, securities prices, market indices, yield curves or currency exchange rates. The Company does not hold any financial instruments purchased for trading purposes. Please refer to The Hartford's 2000 Form 10-K Annual Report for a description of the Company's objectives, policies and strategies. CREDIT RISK The Company invests primarily in securities rated investment grade and has established exposure limits, diversification standards and review procedures for all credit risks including borrower, issuer or counterparty. Creditworthiness of specific obligors is determined by an internal credit assessment and ratings assigned by nationally recognized ratings agencies. Obligor, asset sector and industry concentrations are subject to established limits and are monitored on a regular interval. The Hartford is not exposed to any significant credit concentration risk of a single issuer. The following tables identify fixed maturity securities for Life, including guaranteed separate accounts, and Property & Casualty, by credit quality. The ratings referenced in the tables are based on the ratings of a nationally recognized rating organization or, if not rated, assigned based on the Company's internal analysis of such securities. LIFE As of September 30, 2001 and December 31, 2000, over 96% of the fixed maturity portfolio was invested in securities rated investment grade. <TABLE> <CAPTION> FIXED MATURITIES BY CREDIT QUALITY - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2001 DECEMBER 31, 2000 FAIR VALUE PERCENT FAIR VALUE PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> United States Government/Government agencies $ 2,819 8.7% $ 2,329 8.4% AAA 5,005 15.5% 4,896 17.6% AA 3,551 11.0% 3,546 12.7% A 11,127 34.4% 9,675 34.7% BBB 7,359 22.8% 5,633 20.2% BB & below 1,017 3.2% 708 2.5% Short-term 1,425 4.4% 1,085 3.9% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL FIXED MATURITIES $ 32,303 100.0% $ 27,872 100.0% ==================================================================================================================================== </TABLE> - 27 -
PROPERTY & CASUALTY As of September 30, 2001 and December 31, 2000, over 94% of the fixed maturity portfolio was invested in securities rated investment grade. <TABLE> <CAPTION> FIXED MATURITIES BY CREDIT QUALITY - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2001 DECEMBER 31, 2000 FAIR VALUE PERCENT FAIR VALUE PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> United States Government/Government agencies $ 556 3.4% $ 516 3.2% AAA 6,186 37.5% 6,414 39.5% AA 3,204 19.4% 3,414 21.0% A 3,037 18.4% 2,664 16.4% BBB 1,760 10.7% 1,442 8.9% BB & below 864 5.2% 669 4.1% Short-term 894 5.4% 1,120 6.9% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL FIXED MATURITIES $ 16,501 100.0% $ 16,239 100.0% ==================================================================================================================================== </TABLE> MARKET RISK The Hartford has material exposure to both interest rate and equity market risk. The Company analyzes interest rate risk using various models including multi-scenario cash flow projection models that forecast cash flows of the liabilities and their supporting investments, including derivative instruments. There have been no material changes in market risk exposures from December 31, 2000. DERIVATIVE INSTRUMENTS The Hartford utilizes a variety of derivative instruments, including swaps, caps, floors, forwards and exchange traded futures and options, in accordance with Company policy and in order to achieve one of three Company approved objectives: to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity; or to control transaction costs. The Company does not make a market or trade derivatives for the express purpose of earning trading profits. (For further discussion on The Hartford's use of derivative instruments, refer to Note 3 of Notes to Consolidated Financial Statements.) - -------------------------------------------------------------------------------- CAPITAL RESOURCES AND LIQUIDITY - -------------------------------------------------------------------------------- Capital resources and liquidity represent the overall financial strength of The Hartford and its ability to generate strong cash flows from each of the business segments and borrow funds at competitive rates to meet operating and growth needs. The capital structure of The Hartford consists of debt and equity summarized as follows: <TABLE> <CAPTION> SEPTEMBER 30, 2001 DECEMBER 31, 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> Short-term debt $ 234 $ 235 Long-term debt 2,265 1,862 Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures (trust preferred securities) 1,444 1,243 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL DEBT $ 3,943 $ 3,340 ----------------------------------------------------------------------------------------------------------------------------- Equity excluding unrealized gain on securities and other, net of tax [1] $ 7,844 $ 6,967 Unrealized gain on securities and other, net of tax [1] 922 497 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY $ 8,766 $ 7,464 ----------------------------------------------------------------------------------------------------------------------------- TOTAL CAPITALIZATION [2] $ 11,787 $ 10,307 ----------------------------------------------------------------------------------------------------------------------------- Debt to equity [2] [3] 50% 48% Debt to capitalization [2] [3] 33% 32% ==================================================================================================================================== <FN> [1] Other represents the net gain on cash-flow hedging instruments as a result of the Company's adoption of SFAS No. 133. [2] Excludes unrealized gain on securities and other, net of tax. [3] Excluding trust preferred securities, the debt to equity ratio was 32% and 30% and the debt to capitalization ratio was 21% and 20% as of September 30, 2001 and December 31, 2000, respectively. </FN> </TABLE> FORTIS ACQUISITION On April 2, 2001, The Hartford acquired Fortis Financial Group for $1.12 billion in cash. The Company effected the acquisition through several reinsurance agreements with subsidiaries of Fortis, Inc. and the purchase of 100% of the stock of Fortis Advisers, Inc. and Fortis Investors, Inc., wholly-owned subsidiaries of Fortis, Inc. The acquisition was accounted for as a purchase transaction. The Company financed the acquisition from the proceeds of the (1) February 16, 2001 issuance of 10 million shares of common stock pursuant to an underwritten offering under its current shelf registration for $615, net, (2) March 1, 2001 issuance of $400 of senior debt securities under HLI's June 1998 shelf registration and (3) March 6, 2001 issuance of $200 of trust preferred securities under HLI's June 1998 shelf registration. - 28 -
CAPITALIZATION The Hartford's total capitalization, excluding unrealized gain on securities and other, net of tax, increased by $1.5 billion as of September 30, 2001 compared to December 31, 2000. This increase was primarily the result of financing activities related to the Fortis acquisition along with earnings partially offset by dividends declared. DEBT On March 1, 2001, HLI issued and sold $400 of senior debt securities from its June 1998 shelf registration to partially finance the Fortis acquisition. Effective June 20, 2001, The Hartford entered into an amended and restated five-year revolving $1.0 billion credit facility with fourteen banks. This facility is available for general corporate purposes and to provide additional support to the Company's commercial paper program. As of September 30, 2001, there were no outstanding borrowings under the facility. As of September 30, 2001, HLI maintained a $250 five-year revolving credit facility comprised of four participatory banks. As of September 30, 2001, there were no outstanding borrowings under the facility. For further discussion of the debt, see Note 6 of Notes to Consolidated Financial Statements. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES Issuance of trust preferred securities-Fortis acquisition - On March 6, 2001, HLI issued and sold $200 of trust preferred securities from its June 1998 shelf registration to partially finance the Fortis acquisition. (For further discussion of the company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures, see Note 7 of Notes to Consolidated Financial Statements.) Subsequent event - On October 26, 2001, Hartford Capital III, a Delaware statutory business trust formed by The Hartford, issued 20,000,000, 7.45% Trust Originated Preferred Securities, Series C and received proceeds before underwriting expenses of $500. For further discussion of this issuance, see Note 12 of Notes to Consolidated Financial Statements. STOCKHOLDERS' EQUITY Issuance of common stock-Fortis acquisition - On February 16, 2001, The Hartford issued 10 million shares of common stock pursuant to an underwritten offering for net proceeds of $615 to partially fund the Fortis acquisition. Subsequent event - On October 22, 2001, The Hartford issued 7.0 million shares of common stock pursuant to an underwritten offering for net proceeds of $400. For further discussion of this issuance, see Note 12 of Notes to Consolidated Financial Statements. Dividends - On July 19, 2001, The Hartford declared a dividend on its common stock of $0.25 per share payable on October 1, 2001 to shareholders of record as of September 4, 2001. On October 18, 2001, The Hartford's Board of Directors declared an increased quarterly dividend of $0.26 per share that will be payable on January 2, 2002 to shareholders of record as of December 3, 2001. Treasury stock - On the first two trading days following the September 11 terrorist attack, The Hartford repurchased 0.1 million shares of its common stock in the open market at a total cost of $7. For the nine months ended September 30, 2000, The Hartford repurchased 2.8 million shares of its common stock in the open market at a total cost of $100 under the Company's $1.0 billion repurchase program authorized in October 1999. Since the inception of the 1999 repurchase program, The Hartford has repurchased 6.1 million shares at a total cost of $250. CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, -------------------------- 2001 2000 - ------------------------------------------------------------------ Cash provided by operating activities $ 1,059 $ 1,648 Cash used for investing activities $ (4,081) $ (1,683) Cash provided by financing activities $ 3,120 $ 100 Cash - end of period $ 325 $ 235 ================================================================== The decrease in cash provided by operating activities was primarily due to lower cash flow in Life operations, as a result of the timing of settlement of receivables and payables, partially offset by increased cash flow in North American Property & Casualty. The increase in cash from financing activities was primarily the result of current period proceeds on investment type contracts versus the prior period disbursements for investment type contracts. The increase in cash from financing activities accounted for the majority of the change in cash for investing activities. Operating cash flows in both periods have been more than adequate to meet liquidity requirements. RATINGS As a result of the September 11 terrorist attack and subsequent reviews by major independent rating agencies, all insurance financial strength and debt ratings of The Hartford were reaffirmed. However, negative outlooks were placed upon the debt ratings of the Company by Moody's and the property and casualty financial strength rating by Standard & Poor's. All other ratings were reaffirmed with stable outlooks. - 29 -
- -------------------------------------------------------------------------------- REGULATORY MATTERS AND CONTINGENCIES - -------------------------------------------------------------------------------- NAIC CODIFICATION The National Association of Insurance Commissioners ("NAIC") adopted the Codification of Statutory Accounting Principles ("Codification") in March 1998. The effective date for the statutory accounting guidance was January 1, 2001. Each of The Hartford's domiciliary states has adopted Codification, and the Company has made the necessary changes in its statutory reporting required for implementation. As of September 30, 2001, the impact of applying the new guidance resulted in a benefit of approximately $400 in statutory surplus. DEPENDENCE ON CERTAIN THIRD PARTY RELATIONSHIPS The Company distributes its annuity, life and certain property and casualty insurance products through a variety of distribution channels, including broker-dealers, banks, wholesalers, its own internal sales force and other third party organizations. The Company periodically negotiates provisions and renewals of these relationships and there can be no assurance that such terms will remain acceptable to the Company or such third parties. An interruption in the Company's continuing relationship with certain of these third parties could materially affect the Company's ability to market its products. OTHER For information on other contingencies, please refer to The Hartford's 2000 Form 10-K Annual Report, Note 15 of Notes to Consolidated Financial Statements. - -------------------------------------------------------------------------------- ACCOUNTING STANDARDS - -------------------------------------------------------------------------------- For a discussion of accounting standards, see Note 1 of Notes to Consolidated Financial Statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information contained in the Capital Markets Risk Management section of Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Hartford is or may become involved in various legal actions, some of which involve claims for substantial amounts. In the opinion of management, the ultimate liability, if any, with respect to such actual and potential lawsuits, after consideration of provisions made for potential losses and costs of defense, is not expected to be material to the consolidated financial condition, results of operations or cash flows of The Hartford. The Hartford is involved in claims litigation arising in the ordinary course of business and accounts for such activity through the establishment of policy reserves. As further discussed in the MD&A under the Environmental and Asbestos Claims section, The Hartford continues to receive environmental and asbestos claims that involve significant uncertainty regarding policy coverage issues. Regarding these claims, The Hartford continually reviews its overall reserve levels, methodologies and reinsurance coverages. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - See Exhibit Index. (b) Reports on Form 8-K: During the quarterly period ended September 30, 2001 or between such date and the filing of this Form 10-Q, the Company filed the following Current Reports on Form 8-K: o dated November 9, 2001 to incorporate by reference into Registration Statement No. 333-49666 (the "Registration Statement") the Underwriting Agreement dated October 17, 2001 between the Company and Salomon Smith Barney Inc. for the issuance and sale of certain of the Company's equity securities; to incorporate by reference into the Registration Statement the Underwriting Agreement dated October 19, 2001 between the Company and Merrill Lynch, Pierce, Fenner & Smith Incorporated and UBS Warburg LLC for the issuance and sale of 20,000,000 Preferred Securities designated the 7.45% Trust Originated Preferred Securities, Series C, of Hartford Capital Trust III (the "Trust Preferred Securities"); and to incorporate by reference into the Registration Statement the tax opinion of Debevoise & Plimpton rendered in connection with the issuance and sale of the Trust Preferred Securities. No financial statements were required to be or were filed with this Form 8-K. o dated October 18, 2001, Item 9, Regulation FD Disclosure, to report that the Company had filed a prospectus for the offering of 7,042,253 shares of common stock. No financial statements were required to be or were filed with this Form 8-K. o dated October 16, 2001, Item 9, Regulation FD Disclosure, to report the Recent Developments section contained in a preliminary prospectus filed by the Company with the Securities and Exchange Commission. No financial statements were required to be or were filed with this Form 8-K. - 30 -
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The Hartford Financial Services Group, Inc. (Registrant) /s/ John N. Giamalis ------------------------------------------- John N. Giamalis Senior Vice President and Controller NOVEMBER 13, 2001 - 31 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC. FORM 10-Q EXHIBIT INDEX EXHIBIT # 4.01 Certificate of Trust of Hartford Capital III was filed as Exhibit 4.13 to the Registration Statement on Form S-3 (Registration No. 33-98014) of ITT Hartford Group, Inc., Hartford Capital I, Hartford Capital II, Hartford Capital III and Hartford Capital IV and is incorporated herein by reference. 4.02 Junior Subordinated Indenture, dated October 30, 1996, between ITT Hartford Group, Inc. and Wilmington Trust Company, as Trustee, was filed as Exhibit 4.16 to ITT Hartford Group, Inc.'s Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by reference. 4.03 Form of Supplemental Indenture between The Hartford Financial Services Group, Inc. and Wilmington Trust Company, as Trustee, was filed as Exhibit 4.03 to The Hartford's Form 8-A dated October 25, 2001, and is incorporated herein by reference. 4.04 Trust Agreement of Hartford Capital III was filed as Exhibit 4.14 to the Registration Statement on Form S-3 (Registration No. 33-98014) of ITT Hartford Group, Inc., Hartford Capital I, Hartford Capital II, Hartford Capital III and Hartford Capital IV and is incorporated herein by reference. 4.05 Form of Amended and Restated Trust Agreement of Hartford Capital III was filed as Exhibit 4.15 to the Registration Statement on Form S-3 (Registration No. 333-12167) of The Hartford Financial Services Group, Inc., Hartford Capital II, Hartford Capital III and Hartford Capital IV and is incorporated herein by reference. 4.06 Form of Preferred Security Certificate for Hartford Capital III was included as Exhibit E of Exhibit 4.05 incorporated herein by reference. 4.07 Form of Guarantee Agreement in respect of Hartford Capital III was filed as Exhibit 4.17 to the Registration Statement on Form S-3 (Registration No. 333-12167) of The Hartford Financial Services Group, Inc., Hartford Capital II, Hartford Capital III and Hartford Capital IV and is incorporated herein by reference. - 32 -