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Smith Barney Annuity & Life Risk Management SeminarSmith Barney Annuity & Life Risk Management Seminar
The Hartford Financial Services Group, Inc.The Hartford Financial Services Group, Inc.
June 7, 2005
Craig R. Raymond Senior VP & Chief Risk Officer
1
Safe Harbor Statement
Certain statements made in this presentation should be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These include statements about The Hartford’s future results of operations. We caution investors that these forward-looking statements are not guarantees of future performance, and actual results may differ materially. Investors should consider the important risks and uncertainties that may cause actual results to differ, including those discussed in the Quarterly Report on Form 10-Q filed on May 2, 2005 and other filings we make with the Securities and Exchange Commission. We assume no obligation to update this presentation, which speaks as of today’s date.
2
Industry Variable Annuity SalesThe Hartford #1 Since 1993
$5,767
$5,948
$6,401
$7,019
$7,674
$8,848
$9,355
$9,552
$13,093
$15,244Hartford Life
TIAA-CREF
Equitable
Metlife
AIG/SunAmerica
ING
Lincoln National
Pacific Life
John Hancock
Prudential
2004 VA Sales ($ Millions)
Industry Variable Annuity Sales 2004Source: VARDS
Rank Company2004
Market Share1 Hartford Life 11.87%2 TIAA-CREF 10.20%3 Equitable 7.44%4 Metlife 7.29%5 AIG/SunAmerica 6.89%6 ING 5.98%7 Lincoln National 5.47%8 Pacific Life 4.99%9 John Hancock 4.63%
10 Prudential 4.49%
4
• Provides customers with basic principal protection at a lower cost• Expands Hartford’s withdrawal benefit product offerings• Product design reduces capital requirements and risk
Withdrawal Rate 7% 5%
Reset Yes, every 5 years No
Revocable No Yes, after 5 years
Required Asset Allocation No No
Transfer Restrictions No Yes, but not currently enforced
Cost 50 bps 20 bps
Introduction Date 8/2002 11/2004
Principal First Preferred
PrincipalFirst
The Hartford’s
The Hartford’s GMWB Products
Advantages of Principal First Preferred
5
Principal First Assets3/31/05 Individual Annuity Assets
$109 Billion
Other VA (Non-Principal First)$67.0 B61.5%
ReinsuredPrincipal First
$11.4 B10.4%
Hedged Principal First & PF Preferred
$19.7 B18.1%
Of the new variable annuity sales in the 1st Q 2005 (based on initial deposits only), 63% elected the Principal First rider while 9% elected PF Preferred
Fixed Annuities$10.9 B10.0%
TotalPrincipal First
& PF Preferred$31.1 B28.5%
6
How We Look at Principal First Risk & Hedging
• Risk is assessed over various time horizons– Short-term– Long-term
• Risk is considered across several financial frameworks– GAAP– Statutory– Economic/cash flow
• Why do we hedge?– Substantial short-term GAAP earnings volatility– Statutory surplus usage and volatility– Claim costs in extreme scenarios
7
• Approach: Use of derivative securities to protect against adverse market movements
• Goal: Change in value of hedge assets ≅ Change in value of liabilities– The GAAP liability under FAS 133 uses option pricing techniques and capital markets assumptions– Our liability hedge target starts with GAAP, but our strategy also contemplates the impacts of hedging
on statutory results
• Desired Benefits– Mitigates GAAP net income volatility– Significantly reduces statutory capital usage -- especially under proposed NAIC C-3 Phase II risk-based
capital requirements
How We Hedge – The Hartford’s Hedging Approach
8
Greek Hedging
Put, Call & Exotic Options
Index Futures & Swaps
Interest Rate Futures & Swaps
“Delta” Sensitivity to Market Movements
“Vega” Sensitivity to Implied Volatility Changes
“Rho” Sensitivity to Interest Rate Changes
In addition to the three base Greeks, we also monitor/manage the Cross-Greeks
(i.e., how do Delta, Vega and Rho behave as the capital markets move)
9
Long-Term RiskRange of Principal First Benefit Costs
The long-term cost of Principal First is less than the 50 bps fee under a vast majority of scenarios
Basis Points on Account Value over Scenario Horizon
-
10.0
20.0
30.0
40.0
50.0
60.0
70.0
0% 4% 7% 10%
13%
16%
20%
23%
26%
29%
32%
36%
39%
42%
45%
48%
52%
55%
58%
61%
64%
68%
71%
74%
77%
80%
84%
87%
90%
93%
96%
Cla
ims
in b
asis
poi
nts
100%
% of 250 Scenarios
10
(200)
(150)
(100)
(50)
-
50
100
150
Mar-95
Mar-96
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
)
No hedgingHedging
Impact of Hedging on GAAP Income Volatility
Based on $10B of Principal First written in the 1st quarter of 1995
#1 #2 #3
1995 Stress Test ScenarioQuarterly GAAP Net Income
With Hedging
GA
AP
Net
Inco
me
($ in
milli
ons)
Hedge significantly reduces GAAP net income volatility
11
(150)
(100)
(50)
-
50
100
150
200
250
300
Stand-alone PF With Hedging
Impact of Hedging on Statutory Capital Usage
Hedging mitigates Statutory impacts Potential benefits of aggregation
Sing
le Y
ear C
apita
l Usa
ge ($
in m
illion
s)
Principal First Annual Statutory Capital Usage$10 billion of Principal First issued on one day
Probability of Capital Usage Event50.0% 25.0% 10.0% 5.0% 2.5%
12
(150)
(100)
(50)
-
50
100
150
200
250
300
Stand-alone PF Stand-alone PFP
Principal First vs. Principal First Preferred without Hedging
Principal First Preferred has less risk due to its key design elements:
•5% withdrawals (vs. 7%)•No reset allowed (vs. every 5 years)
Sing
le Y
ear C
apita
l Usa
ge ($
in m
illion
s)
Principal First vs. Principal First Preferred Annual Statutory Capital Usage(both with no hedging)
$10 billion of Principal First issued on one day
Probability of Capital Usage Event50.0% 25.0% 10.0% 5.0% 2.5%
13
Actual GAAP Volatility
Hedging stabilized monthly results
2004 Volatility of Realized Gain (Loss)
-40
-30
-20
-10
0
10
20
30
40
50
Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04
After tax/DAC Net Gain (Loss) post-hedging Liability Gain (Loss)
$ in
milli
ons
Hedge fit was tight
• Diligent monitoring of risk & rebalancing
• Markets were not extremely volatile
• No major dislocations
• No qtr. had after tax/DAC>$2 M
• Hedge cost after tax/DAC was 3-4 BPS
14
Hedging Principle First
• Under a wide range of market conditions, the replication hedge will perform very well
• Cannot perfectly hedge the Principal First potential claim stream using the available universe of derivatives
• We understand the potential for hedging Gain/Loss and provide for this risk in the product pricing
• Proactive strategies to address challenges– Strong consideration of the Cross-Greeks when managing the hedge portfolio– Continually pursue more structured options to better match the liability– Constant communication with Street to follow supply/demand dynamics
15
Daily Hedging Process
• Overnight: – Liability models run over 100,000 scenarios to produce Greeks, Market Value
(MV) and attribution of MV change– Uses closing capital market data and prior day inforce file
• Start of Business Day:– Liability files are sent from Life Co. to Hartford Investment Management– Asset statistics are compared with Liability statistics
• Trades needed to rebalance the Greeks are identified and executed– Trade to get Delta, Vega and Rho neutral
• P&L for prior day is produced• Throughout the Business Day:
– As market conditions change, Cross-Greeks may create the need to rebalance– The Asset and Liability Greeks are monitored on a “real time” basis– Trades needed to rebalance the Greeks are identified and executed
16
Principal First Contractholder Experience
• Characteristics of current Principal First contractholders are similar to the rest of the variable annuity book (age, fund selection, etc)
• Contractholder experience studies– Available data
• 1.4 million inforce variable annuity contracts• 300,000 Principal First contacts• We perform experience studies using 15+ years of experience• Over 20 million contract years of experience• Our experience data includes varying market environments the bull market of the
late 1990’s through the market drops in 2000-2002― Tracking of data
• Daily inforce and behavior snapshots• Monthly experience trend analysis• Sorting and tracking of behavior across many characteristics age, contract type,
contract year, GMDB, fund mix, qualified status, use of auto-income and others
17
Risk Management and Hedging Recap
• We have a very good understanding of our Principal First business
• We diligently monitor our policyholder experience and use this information to improve our estimates
• We assess and measure risk across a variety of metrics and time horizons, which is factored into our hedging program
• Our hedging program has performed extremely well thus far. Given the growing size of our book and the potential for more volatile market conditions, we would expect more GAAP Gain/Loss than seen previously
18
C3 Phase II
• NAIC Initiative– Reserves and Risk-Based Capital (RBC)– Applies to Variable Annuity contracts and associated guarantees– RBC is expected to be implemented for year-end 2005– Reserves expected to be implemented for year-end 2006
• Model Based Methodology– Model business over a broad range of stochastically generated scenarios– Uses Prudent Best Estimate assumptions– Include all revenue, benefits, and expenses– Include currently held assets, including hedge assets– Include impact of reinsurance and future hedge strategy
19
C3 Phase II
• CTE Measurement– Conditional Tail Expectation measures “Tail Risk”– CTE 90 for RBC means average of the results for the worst 10% of
scenarios– CTE 65 for Reserves means average of the results for the worst 35% of
scenarios
• Advantages – Aligns measurement of reserves and RBC to underlying risks– Rewards risk management such as reinsurance, hedging, and product
design
• The Hartford’s View – Actively involved in the development and analysis of the NAIC proposal– Already pricing and managing capital based on this approach
20
Risk Management Technology
Hartford’s Analytical Computing Facts
From 35 CPU’s in our original Hedging release, the platform has grown to > 350
We have the capacity to process hundreds of millions of calculations per second
Newly optimized version of the hedging analytics runs 10‐20 times faster than before
Hedging process alone consumes enough data monthly to fill the Library of Congress
Analytics can run on any desktop, any server, any operating system at the same time ensuring massive expandability
Grid computing environment runs seamlessly across multiple data centers, ensuring business continuity
Exploring expansion to public grid centers with major technology companies
Hartford’s Analytical Computing Facts
From 35 CPU’s in our original Hedging release, the platform has grown to > 350
We have the capacity to process hundreds of millions of calculations per second
Newly optimized version of the hedging analytics runs 10‐20 times faster than before
Hedging process alone consumes enough data monthly to fill the Library of Congress
Analytics can run on any desktop, any server, any operating system at the same time ensuring massive expandability
Grid computing environment runs seamlessly across multiple data centers, ensuring business continuity
Exploring expansion to public grid centers with major technology companies
• Grid Computing works like a ‘virtual supercomputer’– Ties together servers and desktops into one big processing engine– Allows us to make use of our latent computing power– Enables tremendous scalability and resiliency
Analytical Capability Growth
0
50
100
150
200
250
300
350
400
3/2003 3/2004 3/2005
Date
Num
ber o
f CPU
's
Grid Computing Introduced
Grid Computing Introduced
Hedging Program
Starts
Hedging Program
Starts
• Risk management technology is all about enabling massive computation• Hartford Life deployed Grid Computing in 2004
– Pioneers in the Life Insurance Industry