HIG

Business Context and Reporting Period

Company: The Hartford Financial Services Group, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2006
Business Overview: The Hartford is a diversified insurance and financial services company organized into two major operations: Life and Property & Casualty. The Life operation includes segments such as Retail, Retirement Plans, Institutional, Individual Life, Group Benefits, and International. The Property & Casualty operation includes Business Insurance, Personal Lines, Specialty Commercial, and Other Operations (runoff business including asbestos and environmental claims).

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income: Increased by $62 million (9%) primarily driven by higher net income across all Life operating segments and an increase in Property & Casualty Ongoing Operations, partially offset by a decrease in Other Operations.
• Revenues: Increased by $541 million (9%). Key drivers included a $333 million increase in earned premiums (driven by Institutional and Group Benefits growth) and a $288 million increase in net investment income (driven by a $233 million increase in income from trading securities).
• Realized Capital Gains/Losses: Shifted from a net gain of $139 million in Q1 2005 to a net loss of $121 million in Q1 2006. This $260 million swing was primarily due to losses on Japanese fixed annuity contract hedges, GMWB derivatives, and sales of fixed maturity securities at reduced prices due to rising interest rates.
• Accumulated Other Comprehensive Income (AOCI): Decreased by $547 million, turning from a positive balance of $90 million to a negative balance of $(457) million. This was primarily due to unrealized losses on securities of $475 million and losses on hedging instruments of $88 million.
• Underwriting Results: Ongoing Operations underwriting results remained relatively flat at $287 million. The combined ratio before catastrophes and prior accident year development increased slightly to 87.4% from 87.1%.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

• Life Segment: Management expects continued growth in assets under management. However, increased competition in the variable annuity market is expected to result in net outflows for 2006. Full-year projections include variable annuity sales of $11.5 billion to $12.5 billion and retail mutual fund net sales of $4.5 billion to $5.5 billion.
• Property & Casualty: Management expects mid-single-digit written premium growth for Business Insurance and Personal Lines. Specialty Commercial written premium is expected to decrease due to the non-renewal of a captive insurance program. The combined ratio before catastrophes and prior accident year development is expected to be in the high 80s for 2006.
• Interest Rates: The Federal Reserve increased the federal funds rate to 4.75% in March 2006. The Company anticipates further increases, which may result in lower fixed maturity valuations and potential realized losses if assets are sold.

Risks and Contingencies

• Regulatory Investigations: The Company is subject to multiple investigations by the SEC and various Attorneys General regarding broker compensation, market timing, directed brokerage, and single premium group annuities. A reserve of $102 million (after-tax) was established in 2005, with an additional $7 million (after-tax) charge recorded in Q1 2006. Management believes further action is likely and ultimate costs could exceed current reserves.
• Asbestos and Environmental Claims: Significant uncertainty exists regarding ultimate liabilities. Net reserves as of March 31, 2006, were $2.6 billion, within an estimated range of $1.9 billion to $3.0 billion. Further developments could materially affect financial condition.
• Reinsurance Litigation: The Company is engaged in litigation regarding the Blanket Casualty Treaty (BCT) concerning asbestos and pollution claims. If the Company is unable to collect recoveries, it could have a material adverse effect on results.
• Equity Market Risk: The Company faces exposure to equity market volatility through variable annuity guarantees (GMDB, GMWB, GMIB). While hedging strategies are in place, hedge ineffectiveness and policyholder behavior can impact net income.

Unusual Items

• Japanese Fixed Annuity Hedges: Net realized capital losses of $44 million were recognized due to rising Japanese interest rates and the mixed attribute accounting model.
• Leveraged COLI Settlements: The Company achieved favorable settlements in cases regarding leveraged corporate owned life insurance policies, resulting in an after-tax benefit of $34 million recorded in insurance operating costs.

Important Facts for Investor Verification

• Regulatory Reserve Adequacy: Verify the sufficiency of the $109 million (after-tax) reserve for regulatory matters (market timing, broker compensation) given ongoing investigations by the SEC and NYAG.
• Asbestos Reserve Range: Monitor the $1.9 billion to $3.0 billion estimated range for asbestos and environmental liabilities and any updates to the $2.6 billion recorded net reserve.
• Reinsurance Recoverability: Assess the outcome of the Blanket Casualty Treaty litigation, which impacts the collectibility of $586 million in gross reinsurance recoveries.
• Investment Portfolio Impairments: Review the $23 million in other-than-temporary impairments recorded in Q1 2006 and the $1.3 billion in gross unrealized losses on fixed maturities, particularly in the CMBS and corporate sectors.
• Variable Annuity Flows: Track net outflows in the U.S. variable annuity business ($828 million in Q1 2006) against management's full-year outflow projections of $2.7 billion to $3.7 billion.