May 23, 2006 Investor Day The Hartford Financial Services Group Enterprise Risk Management David Johnson Executive Vice President Chief Financial Officer The Hartford Financial Services Group, Inc.
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 Hartford s Quarterly Report on Form 10-Q filed for the quarter ended March 31, 2006, Annual Report on Form 10-K filed for the year ended December 31, 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. The discussion in this presentation of The Hartford s financial performance includes financial measures that are not derived from generally accepted accounting principles, or GAAP. Information regarding these non-gaap and other financial measures is provided in the Investor Financial Supplement for the first quarter of 2006, and in the Investor Relations section of The Hartford s website at www.thehartford.com. The Hartford Financial Services Group, Inc. 2
Enterprise risk management accountability is clearly established at The Hartford David Johnson, Chief Financial Officer Craig Raymond, Enterprise Chief Risk Officer Robert Paiano, Property & Casualty Chief Risk Officer David Braun, Hartford Investment Management Chief Risk Officer Jim Trimble, Life Chief Risk Officer The Hartford Financial Services Group, Inc. 3
May 23, 2006 Investor Day The Hartford Financial Services Group Enterprise Risk Management Craig Raymond Senior Vice President Chief Risk Officer The Hartford Financial Services Group, Inc.
The Hartford has a strong, ingrained, risk management discipline The Hartford Financial Services Group Hartford Property & Casualty Hartford Life Hartford Investment Management Co The Hartford Financial Services Group, Inc. 5
ERM enables aggregation and consistent management of risk across the enterprise The Hartford Financial Services Group Hartford Property & Casualty E R M Hartford Investment Management Co Hartford Life The Hartford Financial Services Group, Inc. 6
ERM has two key objectives: maximize shareholder value with no surprises Create common understanding of risk appetite and tolerances Understand and report on significant risk exposures across enterprise Develop and share risk mitigation/transfer methods Build framework that: Enables business leaders to make appropriate and consistent risk/return decisions Facilitates management of overall enterprise risk profile and capital The Hartford Financial Services Group, Inc. 7
We manage significant exposures and correlated risks across the enterprise Terrorism Equity Markets Hedging Credit / Counterparty Interest Rate Currency Natural Catastrophe Operational Risk The Hartford Financial Services Group, Inc. 8
For terrorism, integrated underwriting processes help to manage our risk aggregations Property & Casualty Operations property losses business interruption worker s compensation general liability Life Operations life and annuity mortality group mortality group disability Single Site Exposure with ERM: Common approach to determining exposure probable maximum loss PML Single database to consolidate single site exposures Policy limits and underwriting processes Exception and conflict resolution Reporting to management and the Board The Hartford Financial Services Group, Inc. 9
Detailed reporting allows management and Board to monitor exposure and compliance Top Ten Managed Landmarks $ In Millions P&C Life Co. Corporate (Life + P&C) Managed Landmarks City PML Chg from Last Month PML Chg from Last Month PML Chg from Last Month A New England - East $917 ($20) $23 $0 $940 ($20) B Middle Atlantic - North $433 $6 $409 $0 $843 $6 C Middle Atlantic - South $776 $17 $2 $2 $779 $19 D Middle Atlantic - South $757 $2 $3 $0 $760 $2 E Middle Atlantic - North $753 $13 $6 $0 $759 $13 F Middle Atlantic - South $751 ($8) $0 $0 $751 ($8) G Middle Atlantic - North $546 ($3) $200 $1 $746 ($2) H Middle West $504 $10 $235 ($1) $738 $9 I Middle Atlantic - North $680 $8 $21 $15 $700 $23 J Middle Atlantic - North $677 $12 $0 $0 $677 $12 Notes A $940 The depopulation plan is developed with a target date of quarters end to be below Corporate Cap and the P&C Company Cap. B $843 A joint depopulation plan is being developed. The Hartford Financial Services Group, Inc. 10
A revised economic capital model is being implemented enterprise-wide Common risk measurement and capital attribution Consistent reporting across the enterprise Capital modeling, analysis and reporting process improvements Automation of financial information used in allocation of capital, capital adequacy modeling and management reporting within the Life and P&C business groups and roll-up to Corporate The Hartford Financial Services Group, Inc. 11
May 23, 2006 Investor Day The Hartford Financial Services Group Catastrophe Risk Management Robert Paiano Senior Vice President Catastrophe Management and Ceded Reinsurance The Hartford Financial Services Group, Inc.
Three keys to understanding catastrophe risk management at The Hartford The Hartford has a demonstrated catastrophe risk management discipline Catastrophe risk management is integrated with underwriting and product management Approach to risk transfer continues to evolve The Hartford Financial Services Group, Inc. 13
The Hartford has a demonstrated discipline related to catastrophe risk management Catastrophe risk management is administered centrally including allocation of capacity and risk transfer decisions. Annual Catastrophe Loss Ratios 15.0% 12.0% The Hartford Ongoing Operations U.S. P&C Industry * (Estimate) 9.0% 6.0% 3.0% 0.0% 5.6% 4.5% 2.4% 2.6% 2.6% 1.7% 2.0% 1.2% 1.4% 0.6% 0.4% 0.6% The Hartford 1985-2005 Average 8.1% 3.6% 3.1% 1.0% 1.7% 2.8% 2.0% 2.2% 1.4% 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2.4% * U.S. P&C Industry data sources: ISO, A.M. Best, Insurance Information Institute. The Hartford Financial Services Group, Inc. 14
Catastrophe risk management is fully integrated with underwriting and product management Aggregations are managed across the P/C operations Expected catastrophe losses are factored into the assessment of profitability Required capital reflects cat volatility Capacity is allocated by geographic zone to individual business lines The Hartford Financial Services Group, Inc. 15
The Hartford s approach to risk transfer continues to evolve Utilizing both traditional reinsurance and other products Added additional coverage Risk-linked securities Second-event covers Collateralized reinsurance 28% of $150 million Millions $2,250 $2,000 $1,750 $1,500 $1,250 $1,000 $750 $500 $250 $125 National Catastrophe Programs 90% of $600mm xs $100mm Retention of $100mm Reinsurance 26% of $400 xs $1.3B Retention of $175mm 2003 2006 Reinsurance 45% of $400 xs $1.3B Collateralized reinsurance 88% of $675mm xs $175mm The Hartford Financial Services Group, Inc. 16
May 23, 2006 Investor Day The Hartford Financial Services Group Investment Risk Management David Braun Senior Vice President Hartford Investment Management Company The Hartford Financial Services Group, Inc.
The Hartford has a dedicated team focusing on investment risk management Dedicated team works closely with lines of business, corporate actuarial, ERM, portfolio management, sector analysts and traders 12 professionals with diverse backgrounds (investments, Life/P&C actuarial, economics, quantitative finance, computer programming) Focus of today s discussion will primarily be interest rate risk management (asset/liability management) Brief comments on portfolio composition & credit risk management Other responsibilities include: equity hedging, liquidity management, asset allocation (portfolio benchmarks), risk policies and limits. The Hartford Financial Services Group, Inc. 18
Credit risk framework facilitates risk communication and active risk management Diversified, liquid, high quality portfolio Experienced and talented fundamental credit analysis team 42 analysts with an average of 13 years of experience Quantitative credit modeling complements fundamental analysis Uses: risk adjusted returns on assets and liabilities, economic capital, early warnings, risk/return optimization and risk reporting ERM integration of investment and insurance business credit risk The Hartford Financial Services Group, Inc. 19
Diversified, high quality general account investment portfolio Commercial MBS, 17% Corporate, 42% US Gov't/Agency, 1% Foreign Govt., 2% Risk Management sets strategic asset allocation and quality targets, with upper and lower tolerances around that target. Equity/Partnerships, 2% Municipals, 15% ABS, 10% Commercial Mtgs., 3% Short Term, 3% MBS/CMO, 5% AAA, 32% AA, 12% Equities/Partnership, 2% B & Below, 1% BB, 3% BBB, 23% A, 27% Percentages are based on 3/31/06 General Account and Guaranteed Separate Account Assets The Hartford Financial Services Group, Inc. 20
Asset liability management: very tight interest rate management process for fixed liabilities Tight duration and key rate duration matching for fixed liabilities Examples: GIC or MVA Fixed Annuity New money rate philosophy - reduces risk but results in sales volatility Thorough interest rate risk management is embedded in the quoting process Group Benefits quotes on large cases where the premium may not be received for up to 6-36 months Quoted premium reflects forward interest rates We execute an anticipatory hedge where we lock in the forward interest rates today (i.e., forward commit), thus reducing interest rate risk The Hartford Financial Services Group, Inc. 21
Asset liability management: dynamic duration management leads to proactive risk taking Built infrastructure to dynamically manage duration for non-fixed liabilities (e.g., Fixed Bucket of VA) Stochastically model financials under alternative investment strategies Sample Analytics Risk/Reward Trade-Off by Duration Strategy Fully informs the duration decision based on risk/return trade-off Update for changes in the level of rates, shape of the yield curve and liability composition Incorporates all embedded liability optionality Return LOW - - - - - - - - - HIGH 0 0 3 years 4 years 2 years 5 years Risk LOW - - - - - - - - - - - - - HIGH 6 years # in box is the Duration Target for that run The Hartford Financial Services Group, Inc. 22
Holistic approach to interest rate risk improves transparency and optimizes action Monitor enterprise-wide interest rate risk under three measuring sticks: Statutory, GAAP and Economic Value Evaluate/manage risk in the aggregate, not in silos Identify concentrations and offsets. For example, if rates rise: Negatives: Increased unrealized loss hits BV per share (offset by a lower liability on an economic basis) Potential surrenders Convexity induced duration mismatches Positives: Reduced variable annuity hedging costs Over-funded pension plan Increased marketability of new money credited rate products Reduced risk of spread compression The Hartford Financial Services Group, Inc. 23
May 23, 2006 Investor Day The Hartford Financial Services Group Life Operations Risk Management Jim Trimble Sr. Vice President and Chief Actuary Hartford Life The Hartford Financial Services Group, Inc.
The Hartford s life risk management starts with a view of enterprise risk Represent primary risks Retail Products Group Institutional Solutions Group Individual Life Division Group Benefits Division International Division Equity Interest & Credit Mortality Morbidity Currency The Hartford Financial Services Group, Inc. 25
Our risk management approach applies multiple risk frameworks and tools Risk Drivers Equity Interest rates and credit Mortality Morbidity Currency Risk Frameworks Economic GAAP Statutory Risk Management Tools Product design and product portfolio mix Pricing & underwriting Reinsurance Hedging The Hartford Financial Services Group, Inc. 26
Product design, reinsurance and hedging are used to manage the risk profile for US VAs 03/31/06 U.S. Variable Annuity Data GMDB Net Amount at Risk Total NAR of $5.3B GMDB NAR reinsured No Living Benefits Living Benefits Profile* AUM of $109B 84% 62% 16% 27% 11% GMDB NAR retained Hedged Living Benefits Reinsured Principal First * 72% of US Living Benefits was more than 10% out of the money The Hartford Financial Services Group, Inc. 27
Risk management in Japan has been primarily product design driven with some reinsurance Adagio V2 and V3 GMIB 03/31/06 Japan Variable Annuity Assets Under Management $27 Billion 70% 30% Adagio V1 MAV Japanese variable annuities have embedded risk management Guarantee of principal only - no step ups 10-15 year deferral before guaranteed income begins Required asset allocation Adagio V3 uses foreign equity funds with currency hedges 35% of the MAV product is reinsured Hedging is being evaluated as part of global risk aggregation The Hartford Financial Services Group, Inc. 28
The Hartford s GAAP hedging program has performed well and continues to evolve $ Millions 60 40 2005-2006 Volatility of Realized Gain (Loss) GAAP hedge effectiveness continues to be very good Expect more quarter-toquarter volatility going forward 20 0-20 Jan- 05 Feb- 05 Mar- 05 Apr- 05 May- 05 Jun- 05 Jul- 05 Aug- 05 Sep- 05 Oct- 05 Nov- 05 Dec- 05 Jan- 06 Feb- 06 Mar- 06 Evolving enhancements to global hedging and risk management approach: -40-60 -80 After tax/dac Net Gain (Loss) post hedging Liability Gain (Loss) Optimize tradeoffs between transaction costs and GAAP volatility Aggregate global risks Increase weighting of statutory hedge targets The Hartford Financial Services Group, Inc. 29
The Hartford s proprietary tools help us to manage C3 Phase 2 volatility Range* of Year-end of C3P2 Year-end Capital for C3 NewBusinesswith Phase 2 a Capital for New Business GMWB with GMWB Range of Year-end C3P2 Capital for NewBusiness with a GMWB We have created tools that allow us to understand the future volatility of C3P2 for all in force and projected new sales This proprietary tool enhances decisions on product, hedging, reinsurance and capital planning C3P2 is more volatile than prior capital standards since it focuses on the tail (i.e., worst 10%) Guaranteed benefits tend to have more exposure in the tail *250 scenarios ranked from lowest to highest required capital The volatility of required capital under C3P2 impacts surplus and the ability to pay dividends or buy back stock The Hartford Financial Services Group, Inc. 30
The Hartford s risk management capabilities are growing with our book of business Risk management is woven into our culture Risk management is built from the ground up, looking at drivers of risk, relevant financial frameworks and metrics, and utilizing tools appropriately to manage risk Grid computing technology supports all run-time intensive analysis, and allows us to create supercomputer-like speed but also maintain flexibility Various risk management tools are utilized Inter-company and third party reinsurance programs are continuously being evaluated Hedging programs are evolving to address aggregate global risks, transaction costs, and potentially greater weighting of statutory hedge targets Product design addresses risk correlation and diversification benefits across the U.S. and Japan The Hartford Financial Services Group, Inc. 31
May 23, 2006 Investor Day The Hartford Financial Services Group Capital Management David Johnson Executive Vice President Chief Financial Officer The Hartford Financial Services Group, Inc.
A strong balance sheet provides capacity for prudent risk-taking 35% 30% 25% 20% 15% Financial Leverage X-AOCI [1] 29.5% 28.1% 23.5% 20.0% Enterprise Goal Low 20 s 19.4% 2002 2003 2004 2005 1Q 2006 We have achieved our target capital margin and leverage ratio Capital margin is now $1 billion in excess of rating agency minimums Rating agency models in flux We expect to generate an additional $500 million of capital resources in excess of needs in 2006 [1] Includes 75% equity credit on the equity units. 2003 excludes the impact of the CNA transaction. The Hartford Financial Services Group, Inc. 33