Hartford Insurance Group Inc (HIG) 2008 Q4 法說會逐字稿

Good morning. My name is Felicia and I will be your conference operator today. At this time, I would like to welcome everyone to The Hartford fourth-quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Mr. Rick Costello, you may begin your conference.

Thank you, Felicia. Good morning and thank you for joining us for today's fourth-quarter 2008 financial results conference call. As you know, our earnings release and financial supplement were issued yesterday. To help you follow our discussion, a slide presentation is available on our website at www.thehartford.com.

Ramani Ayer, Chairman and CEO; Greg McGreevey, our Chief Investment officer; and Liz Zlatkus, CFO, will provide prepared remarks today. We will conclude with a question-and-answer session. Also participating on today's call are Tom Marra, President and COO; John Walters, President and CEO of our Life company; Neal Wolin, President and COO of the P&C company; and Alan Kreczko, General Counsel.

Turning to the presentation, on slide 2, please note that we will make certain statements during the call that 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 our press release issued yesterday, our quarterly report on Form 10-Q for the quarter ended September 30, 2008 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.

Today's discussion 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, including reconciliations to the most directly comparable GAAP financial measure, is provided in the investor financial supplement for the fourth quarter of 2008, in the press release we issued yesterday and in the Investor Relations section of The Hartford's website at www.thehartford.com. Now I would ask you to move to slide 3 as I turn the call over to The Hartford's Chairman and CEO, Ramani Ayer.

Thank you, Rick. Good morning, everyone and thank you for joining us. 2008 was one of the toughest years in The Hartford's history. We all know that the financial markets saw some of the worst declines since the Great Depression and the global slowdown affected virtually every sector of the economy.

In this landscape, The Hartford finished 2008 well-capitalized on solid financial footing. To achieve this position, we undertook a number of important initiatives in the fourth quarter. Early in October, we announced a $2.5 billion capital investment from Allianz. We reduced our annual dividend by 40% in October. Throughout the second half of '08, we enhanced our liquidity position and at the end of the year, we had almost $14 billion held in cash, short-term investments and treasuries.

We began a process to reduce risk in our investment portfolio, which Greg McGreevey will address in detail. We initiated a review of our global variable annuity business and lastly, we implemented a corporate-wide expense and efficiency program that will yield a reduction in our run rate expenses of at least $250 million by the end of the year.

Turning to the numbers on slide 3, we are not happy with our fourth-quarter or full-year results. We recorded a net loss of $806 million, or $2.71 a share in the fourth quarter. Contributing to the loss were realized losses of $610 million. Losses on our hedge program and impairments were the primary sources there. We also recorded a $597 million write-off of goodwill associated with our annuity business.

Core earnings in the fourth quarter were a negative $208 million, or $0.72 per diluted share. In addition to the goodwill charge, core earnings were hurt by a $152 million charge related to our 3 Win variable annuity product in Japan, negative returns on alternative investments and lower yields on our fixed income portfolio. As I mentioned earlier, we have intentionally enhanced our liquidity position. One effect of this action has been lower net investment income as we have increased our holdings of lower yielding assets.

Our property and casualty operations performed exceptionally well in the fourth quarter, as well as the full year. For the quarter, our outstanding underwriting results received a boost from net favorable prior period development.

Please turn to slide 4. Fourth quarter P&C core earnings were $452 million, 9% above the prior year period. These strong results were driven by a remarkable 77.6 combined ratio. The quarter benefited from current and prior accident year net reserve releases totaling $187 million after tax.

On an ex-cat current accident year basis, our ongoing operations' combined ratio was 85.3. This is an excellent result and reflects favorable claim frequency and the underwriting discipline we are exercising.

Net investment income in property and casualty was down 62% in the quarter, driven by a $167 million pretax loss from limited partnerships and alternative investments, as well as lower yields on our fixed maturity portfolio. Total net written premiums were $2.5 billion, flat to the 2007 level. As markets remain competitive, we continue to balance underwriting profitability with growth.

In personal lines, we generated an impressive 79.5 combined ratio in the fourth quarter. This result reflects in part favorable current and prior accident year reserve releases on auto liability claims. On an accident year ex-cat basis, the combined ratio was 86.8. Although top-line challenges persist, AARP continues to grow with written premium improving 3% over the prior year quarter.

New business trends are positive as well with fourth-quarter new business premium 9% above the prior year as the rollout of our new Dimensions product gained strength and traction. Small commercial delivered a phenomenal 75.4 combined ratio for the quarter, bolstered in part by favorable current and prior accident year development, largely related to workers' compensation.

On an accident year basis, the ex-cat combined ratio was 76.8, the 12th consecutive quarter below 90. The written premium was down 4% for the quarter, but pricing trended positive, increasing 1%, four points better than prior year quarter and three points better than the third quarter.

Now please turn to slide 5 for our Life results. Our Life businesses were heavily impacted by the quarter's market turbulence. Total assets under management ended the year at $298 billion, a 20% decline from the end of 2007, primarily driven by the impact of equity market declines on account values.

With AUM down, fee-based revenues fell, negative returns on alternative investments, lower investment income and the write-off of goodwill in our annuity businesses also contributed to a $261 million loss in core earnings.

Sales of our variable annuity products were challenged, both in the US and in Japan. Market volatility has slowed the pace of industry sales, which we have seen both in lower sales and deposits, as well as reduced surrender levels.

Our mutual funds business slowed in the fourth quarter as you would expect, but still generated over $2.5 billion of deposits. We believe that we continue to take marketshare in the fourth quarter.

Our protection businesses continue to perform quite well. Life insurance in force increased 9% over the past 12 months. Strong growth in term life fueled the year-over-year improvement with modest growth also recorded in variable and universal life.

In group benefits, we continue to generate positive results in a very competitive market. Fully insured premiums were up 4% over the fourth quarter of 2007. Strong sales and persistency in both group life and disability contributed to the steady premium growth.

As we pivot from our 2008 results, I would like to share some of our thinking about 2009. Looking forward, uncertainty about the global economy and the capital markets has increased. In the absence of healthy and functioning credit markets, we are concerned that the recession, both in the US and abroad, may be deeper and longer than initially expected.

In looking at the property and casualty market, we believe 2009 will remain competitive. We expect pricing declines in commercial lines to moderate in 2009. Loss cost growth should remain controlled. The macroeconomic issues are likely to pressure the top line as our customers seem to shed expenses by reducing payrolls and coverage. We are already seeing some of this as new business formations have dropped and midterm cancellations have picked up slightly.

The Hartford's outlook for 2009 reflects all of these factors. We expect to see modest margin compression with a relatively flat top line. Contributing to the margin compression will be the overhang of pricing pressures already in the market, combined with a modest uptick in lost cause.

The outlook for the life industry is heavily tied to the performance of the credit and equity markets. The capital markets are likely to see modest improvements, but the timing is uncertain. Global sales of variable annuities and retail mutual funds could be pressured as consumers seek relatively safer investment vehicles for their retirement assets.

Sales and deposits in our equity-linked businesses are expected to be challenged. This is reflected in our deposits and flows guidance for our global VA business in particular. Our guidance also reflects lower ROAs and after-tax margins due to lower net investment income and affects the falling AUM levels.

Now this morning, Moody's took action on The Hartford's ratings. We are disappointed with their decision. The Hartford is well-capitalized and in this environment, we have already commenced a number of actions aimed at protecting our statutory capital and reducing risk.

As we reported last night, we will propose to The Hartford Board that we reduce our dividend to $0.05 per share to enhance our capital flexibility. While we finished the year well-capitalized, we believe reducing the dividend is a smart approach in light of the risks around the economy and capital markets.

It is too early to exactly -- to tell you exactly how the VA industry is going to change in terms of pricing and products, but The Hartford is moving forward to reduce the risk in its product portfolio. Price increases on our variable annuity guarantees are reflective on new business this month. And we are revising our product set from the perspectives of customer value, capital efficiency and enterprise risk.

Finally, as Liz will discuss in more detail, we are shifting our VA hedging program to better protect statutory capital. With that, I will turn it over to Greg McGreevey who will discuss our investment results. Greg?

Thank you, Ramani and good morning. I look forward to speaking with you about our investment portfolio. Many of my comments will be similar to those provided at Investor Day, so I will try to move quickly through my slides.

I wanted to first cover our unrealized loss position at the end of the year. As you can see on slide 6, and as you know, significant spread widening in the fourth quarter across all asset classes caused our net unrealized loss position to grow to $13.2 billion. The graphic on this slide illustrates the key sources of the unrealized loss -- CMBS and corporate securities, which were further broken out between financials and all other corporates. Our unrealized loss position increased by about $1.6 billion from the end of October, which was the position I discussed at our Investor Day. While we saw an improvement in gross in unrealized losses across many areas of our portfolio in December, the year-end level still reflected substantial market stress and illiquidity.

Before discussing the specific asset classes, I wanted to first talk about our fourth-quarter impairments. Please turn to slide 7. We had total pretax impairments of $419 million, which was at the low end of the guidance provided at Investor Day. Of this amount and of importance, we only had $73 million of new impairments taken for credit reasons. We also had roughly $100 million of impairments due to mark to market changes on previously impaired securities. The majority of our total impairments, about $250 million, were taken on securities where you do not want to (inaudible) the [hold] until recovery. Given current market conditions, we wanted the flexibility to potentially trade these assets at a future date. Such actions would be congruent with our desire to derisk our portfolio in a manner that balances risk, return on capital consistent with our economic view and the expectations of price performance for specific securities.

Now let's discuss some individual asset classes, if you could please turn to slide 8. Our CMBS holdings have been a major contributor to our unrealized loss. They represent about 10% of total invested assets, but over 40% of the unrealized loss. As you know, fourth-quarter pricing was heavily influenced by the continued downturn in the economy, changing fundamentals in commercial real estate and a general lack of liquidity and capital in this asset class. These factors led to significant price declines in our CMBS bond portfolio. At the end of 2008, the average holding in our portfolio had a market to book value ratio of about 60%, even though 90% of our holdings were rated AAA or AA.

The market pricing on these assets at year-end implies cumulative losses over 40%, which is five times the first worst loss experience in the US commercial real estate market. We continue to stress test the entire CMBS portfolio under a severe recession scenario and have done an extensive bottom-up analysis on each security and its underlying collateral to examine loss potential and future performance. We believe that our impairments to date have reflected both our stress scenario and our bottom-up analysis.

In the intermediate term, we expect that opportunities to sell CMBS assets at reasonable values will be limited given the current pricing levels are so out of alignment with the likely ultimate value of these assets. That being said, our long-term plan is to reduce overall exposure to CMBS relative to our entire portfolio, as well as to align our holdings to only the most senior part of the capital structure. This will take some time to accomplish and in the interim, we will continue to explore hedging opportunities at the security, property type and portfolio level.

As you know in the third quarter, we further stressed the loss of modeling assumptions for the severe recession scenario we used for CMBS and will continue to use these assumptions in modeling our cash flows for determining impairments going forward. When we round the cash flows underlying our CMBS holdings through the severe recession model in the fourth quarter, only a few securities failed for the first time.

Our impairment testing assumes 20% to 30% plus peak to trough declines in commercial property values depending on geography and type, declines in rental rates and sharp increase to vacancies. In total, the assumptions we are using for defaults and severities are close to the levels experienced in the 1986 cohort. The severe recession scenario is consistent with our view of the commercial real estate market based upon declining valuations and deteriorating market fundamentals. We do not expect prices to recover much over the intermediate-term, barring government intervention. That said, we still expect to receive principal and interest payments on the majority of holdings moving forward.

Now if you could please turn to slide 9. The financial service sector remains in today's headlines on a daily basis. Market uncertainty about the future of this sector has re-intensified in the past few weeks, with speculation ranging from nationalization to the establishment of bad bank government entities. We have remained quite cautious on this sector for some time, given the challenging economic backdrop that has resulted in increased losses and reduced capital adequacy for many of these organizations.

Included in our financial exposure of $7.9 billion is about $2.6 billion of market value exposure to Tier 1 capital, including preferreds. This exposure is diversified among leading worldwide financial institutions including banks, insurers and finance companies. We saw significant price volatility across the hybrid sector globally in January, driven by increased concerns over expected losses and potential restructuring events.

Our Tier 1 capital exposure to European banks is about $900 million, which is roughly 1% of our total invested asset portfolio. Our European bank exposure is primarily to large universal banks that are integral to the financial system. Included in this number is around $100 million of European perpetual preferred exposure.

I would like to reiterate the following points on financials. First, our preferred and hybrid holdings are in large institutions that have strong current ratings, on average AA and AA minus. Second, this portfolio was constructed primarily to match longer dated liabilities, which allows us to hold these securities to maturity from an ALM perspective. And finally, while we do not see imminent risk of nonpayment or nationalization for the vast majority of our portfolio, we remain concerned about price performance against the economic backdrop.

To that end, we continue to pursue a host of risk mitigation and hedging strategies for specific financial exposures where we have an elevated degree of concern. As part of this analysis, we have reduced our financial services exposure by over $500 million in the fourth quarter.

As you will recall, in the third quarter, we spent a fair amount of time discussing the fact that we had recognized about $1.5 billion of impairments on financial holdings where we were not able to assert that they would substantially recover their value within two years. At Investor Day, we said we plan to move away from the two-year period based on evolving guidance on impairments.

Beginning in the fourth quarter, we began to evaluate the potential for price recovery over a longer period, up to and including maturity. We continue to employ what we believe is a conservative impairment process that immediately reflects all credit-specific concerns, as well as decisions to preserve trading flexibility in order to actively manage portfolio risk.

If you could now please turn to slide 10, we have included a slide on nonfinancial corporates primarily to demonstrate the diversification and defensive positions within our portfolio. This asset class has not come under the pricing pressures we have seen in other sectors. Trading at just under $0.90 on the dollar in aggregate, these holdings have benefited from our underweight to both high-yield bonds and consumer cyclical sectors.

We hedge certain risks within our portfolio by buying protection on names that we believe could have challenges in the current market environment. Some of these would include names in the retail, lodging and a lot of our BBB rated credits.

If you could now turn to slide 11. As we position our portfolio for 2009 and beyond, it is difficult to predict when and how the global economy will emerge from this significant downturn. However, our current view is the domestic and global economy will remain weak for some time despite continued government stimulus packages here in the US and abroad. The potential also exists for government purchases of distressed securities, combined with some form of recapitalization and asset protection loss sharing for financial institutions, which could be an important first step in the long process of unfreezing the credit markets.

In this backdrop, we expect to continue to incrementally reduce our risk exposure in a prudent manner that is focused on value and capital preservation. We will move towards a portfolio that will take both a long-term view and short-term economic realities into consideration.

Finally, and moving forward, we will put on new risk only when we reduce risk in other parts of our portfolio. We believe there are very strong liquidity positions critical in these types of market conditions and are employing the prudent action-oriented approach to investing. With that, I will turn it over to Liz.

Thank you, Greg and good morning. I would like to begin by discussing our year-end capital position. I am working from slide 12. The Hartford enters 2009 well-capitalized. Our property and casualty operations are capitalized above levels that have historically been associated with a AA rating. The preliminary year-end 2008 RBC ratio for our Life operation stands at 385%. And we have $1.9 billion of excess capital at the holding and property casualty company. Finally, we continued to maintain $2.4 billion of available capital resources in the form of our pre-funded $500 million contingent capital facility and our $1.9 billion credit facility.

While we enter the year well-capitalized, our preliminary year-end numbers came in lower than our December Investor Day estimates. I will take a few minutes to walk you through the differences. Please move to slide 13.

On December 5, management's best estimate for year-end additional capital resources at the holding company and the P&C companies was $1.1 billion. In fact, we ended the year with $1.9 billion. There are a couple of reasons for this difference. First, rather than downstreaming all of the proceeds from our Allianz capital rate at the Life company, we retained $1 billion at the holding company, providing us with greater flexibility going forward.

Second, the decline in interest rates in December resulted in a smaller benefit than anticipated from the discounting of our longtailed P&C reserves in certain rating agency capital models. This decline reduced our excess capital position by roughly $400 million. Partially offsetting this were other changes to surplus, including higher fourth-quarter statutory income. All in, we entered 2009 with $1.9 billion of excess capital in the holding company and P&C operations.

Please turn to slide 14. In December, we provided estimated year-end Life RBC ratios at different market levels. Given the fact that the market ended the year at 903, I will focus on the comparison to Investor Day projections at a 900 S&P. As the slide shows, our preliminary 2008 year-end RBC ratio is 385%. That compares to a December projection of 535%. Again, the 535% reflected all of the Allianz capital being contributed to the Life company. Retaining $1 billion at the holding company results in a 70 point reduction in the RBC ratio. So the apples-to-apples comparison is to 465%. That leaves an 80 point difference in the RBC ratios. Generally, the reasons for this decline fall in two categories, what I will describe as market changes and forecast variance.

One important estimate that was impacted by both market changes and forecast variance was cash flow testing required under AG39. You may recall that, on Investor Day, we believe AG39 would not impact our year-end reserve requirements. In preparing our capital projections in late November, we did not perform full-blown cash flow testing as this is done annually in the first quarter of the year with actual year-end data. Instead, we made a number of assumptions about our year-end book of business, projected market conditions and other reserve valuation inputs.

Having now conducted the actual cash flow testing on our year-end in force business, using 12/31 capital market input, it resulted in a net reserve increase of about $600 million. We think this result is unduly conservative. With that perspective, we have requested AG39 relief from our year-end reserve calculation from the Connecticut Department of Insurance. If relief is granted, the benefit will be included in our actual year-end RBC ratio. But we have not reflected any potential benefit in our preliminary 385% RBC.

A different market change that contributed to the 80 point difference was the yen strengthening in December. This increase in required reserves for the Japan annuity business resulted in a $150 million reduction in surplus. Finally, other factors netted to a benefit of about $50 million. The sum of these three impacts totaled the $700 million, which you see on the slide.

Another market change unrelated to VA was the effect of spread widening and certain investments holding. This reduced surplus by about $450 million and was largely related to the surplus required in the market value adjusted fixed annuity. Again, this amount was more than the amount that we had forecasted. To be clear, these are not impairments, but rather the impact of marking to market the assets supporting the fixed annuity liability. To the extent that credit markets recover, we expect to recapture that capital.

Before we move off the subject of year-end 2008 capital, as I mentioned earlier, we submitted a permitted practice request relating to AG39 with the Connecticut DOI. We have also submitted a permitted practice request related to the admissibility of deferred tax assets. If both requests are approved, they could provide a benefit of as much as 75 RBC points.

So we finished 2008 well-capitalized. Our P&C operations are capitalized above historical AA standards. We have excess capital at the combined P&C holding companies of $1.9 billion and our preliminary Life company RBC ratio is 385%. Of course, we also maintain the $2.4 billion of capital resources related to our contingent capital and credit facility.

Please move to slide 15. Now I want to make a few comments about 2009 capital. Our P&C operations are expected to generate capital in excess of that required to maintain AA type capital levels and to support the cash requirement of the holding company.

As to Life, given the significant uncertainty in the markets today, year-end RBC projections are extremely volatile and inherently imprecise. Therefore, we are not providing specific year-end RBC ratio projections. However, to provide some context, isolating just the impact of equity market declines, we estimate that in an S&P of 700, we have capital within our enterprise today sufficient to maintain an RBC ratio of 325%.

This assessment does not include a provision for credit or other market effects, which, of course, will occur. That said, a few additional things should be considered when looking into '09. First, while we are disappointed with the impact of AG39 on 2008, having a high VA reserve starting point actually reduces the expected incremental capital impact of lower equity markets in 2009.

Second, we purchased additional equity protection to further mitigate the tail. Third, we are evaluating offshore and captive structures, which we believe will allow for better alignment between our hedging program with the reserves we would need to hold.

Finally, we have announced our intent to reduce the dividend. We are revamping our VA product and derisking the investment portfolio and again, we have $2.4 billion of additional resources available from our contingent capital credit facility.

In summary, given our current capital position and other capital resources, we enter 2009 able to absorb further market deterioration.

Now please turn to slide 16 to discuss changes to our hedging program. An important step we took in the fourth quarter was to modify our VA hedging program to better protect statutory capital. We began to reduce volatility in interest rate protection in our program during the quarter.

From a GAAP perspective, the effects of these changes were roughly offsetting. The changes did, however, benefit our year-end capital position. Going forward, we will continue to tune our hedging program to tilt the balance towards protecting statutory surplus, recognizing that this will increase the potential for GAAP volatility.

In the fourth quarter, the GMWB hedging program managed through the tremendous volatility of the markets reasonably well. We finished with an after-tax loss of $384 million. This was driven mostly by our underhedged vega position, basis risk and intraday market volatility.

Finally, I will conclude on slide 17. I want to quickly hit upon our 2009 guidance. For 2009, our plans imply full-year core earnings per share of between $5.80 and $6.20. There are a number of assumptions underlying these estimates, including our assumption of the S&P starting at 900 and growing to 965.

I am not going to go through all of them, but I would like to draw your attention to the DAC assumptions. Our 2009 guidance assumes no effect from DAC unlock. As you know, we completed our annual DAC unlock at the end of the third quarter in 2008. The S&P at the end of September was 1165. If the first quarter were to end at an S&P level of 830 or lower, we would likely perform an offcycle DAC unlock at that time. Based on the sensitivities provided in the third quarter 10-Q, the unlock could be in the range of $670 million custody to $1.3 billion after-tax at that level. And I would guide you towards the higher end of that range. With that, I will turn the call over to Ramani.

Thank you, Liz. Operator, I would like to open the call now for questions and answers.

(Operator Instructions). Jeff Schuman, KBW.

Good morning. A couple questions. First of all, I was wondering -- it looks like the margin guidance for the annuity business is relatively high for '09. I was wondering if you would talk a little bit about that. And then secondly, I was wondering -- given the relatively modest levels of annuity production at this point, what is being done to kind of keep -- I guess keep the wholesalers fed and kind of keep the wholesalers, then the distribution partners kind of in place and keep the franchise together?

Thank you, Jeff. I will turn it over to Tom.

I will start. Obviously, we have taken a lot of expense action on the annuity side already and that is one aspect. Another fact is that the DRD benefit is a relatively stable number. So that, on a lower asset base, is going to obviously lever up the ROA. John has done a number of things on the wholesaler front and I will turn it over to him to cover that part of it.

Thanks, Tom. As you know, in the fourth quarter, we did resize our wholesale force on the variable annuity side and while we are pleased with that, I think that, at current sales levels, we are going to have to continue to manage our expenses aggressively and we are making product changes as we have described, both increase in the fees on our product, which go into effect in February and then other product changes that we are considering for May. As we roll those out and assess the competitive environment, if we need to make additional changes to the expense structure, we are prepared to do that and we are going to view that in a very fluid market as we go forward.

But relative to retaining wholesalers, we have put in some temporary subsidies to keep them in a good comp perspective.

Yes.

Okay, thank you very much.

Jay Cohen, Banc of America.

Operator, you are very choppy. So if you could speak into the mic, I would appreciate it. Thank you.

Hey, can you hear me okay?

Yes, very well.

It's actually Banc of America-Merrill Lynch. They keep getting that wrong, but that's the name of the firm.

I think that is Jay Cohen, right?

I guess a kind of boring question on operations in the property casualty side. Your accident year loss ratio for the fourth quarter -- in fact, for the full year -- proved to be exceptionally good at a time when prices, by everyone's account, are coming down. So clearly, it seems in the quarter and throughout the year, you took a different view of loss costs and I guess it is based partly on your look back and looking how reserves have developed. But if you could flesh that out, what are you seeing in the numbers that is allowing you to book a lower loss ratio accident year ex-cats in '08 versus '07?

I am going to have Neal start this answer if you don't mind.

Jay, I mean we do not look at -- or make any assumption about prior development when we do our loss picks for '08, but we obviously look at our book of business. We look at how loss costs are developing in '08 and make judgments on that. I think what you see in our accident year combined is really what we have been talking about for a long time now, which is disciplined pricing, a product suite where we think we can match price and risk in a very sophisticated way and where we see pockets of profitability, we will dig harder and work on our retentions harder. But where we don't, we will let it go. And all that I think, from our perspective, contributes to what we feel like our current accident year combines in '08 that we are very pleased with.

Two things also that I would like to add, Jay, is one is the frequency in our business has been very, very favorable. That is something that we are naturally reflecting in our loss costs. The second thing I believe investors should note is our carried reserves are actually 3.8% higher than the actuarial estimates compared to say 2.7% last year. So from the standpoint of the reserve position, we are in a very good place.

That was good disclosure. I appreciate that. And then just to follow up, as the economy continues to deteriorate, what is your expectation for claims expenses?

I think, Jay, that there is a lot of puts and takes in how you think about the effects of the challenging macroeconomy or real economy on loss cost experience and in the aggregate, I think we sort of view loss costs as developing in '09 in a reasonably moderate fashion. So for example, probably less frequency in certain ways on account of the real economy and some of the slowdowns. And so really I think when you net it all out and there are lots of different pieces of it by line and by segment, moderate loss cost development for '09 is what we are calling.

Great. Thanks, gentlemen and congratulations on your new role in the administration.

Thanks, Jay.

Randy Binner, FBR Capital Markets.

Hi, thank you. More of a question from the holding company perspective. The new RBC ratio that has been estimated of 385% does not include excess capital, particularly $1.5 billion in excess cash that sits at the holding company. Although I guess I read the 700 level S&P RBC ratio as potentially including that cash. So could you, one, share why that capital was held at the holding company and not put to the Life subsidiary and if I am correct on the 700 level sensitivity, can you just --

Yes, good morning, Randy. It was not included in the year-end 2008 number. We wanted to hold it at the holding company because it provides more capital flexibility. As we speak about the 700 levels in 2009, yes, we are looking to avail ourselves of that capital.

And if I may, could you expand please just more on the capital flexibility? I mean is it because you are relying on the Connecticut regulator to potentially give your relief so you are closer to 450 or is there potentially another reason why you would hold the capital there because obviously optically it makes the Life company RBC look low?

Randy, this is Ramani. Two things, right? One is we believe that 385% Life RBC is a very good RBC. The second thing is better off maintaining capital flexibility at the holding company level and you use it when needed and that is a discipline, that is a wise discipline. So those are just the two reasons. There is nothing more than that.

Okay. So there is no readthrough to potential debt covenant issues or collateral call issues with rating agencies?

No, not at all. And remember, at any point in time, we can downstream that capital if needed.

Okay. So you feel that it is fungible, it is ready for downstream if necessary?

That is correct.

Thank you very much.

Dan Johnson, Citadel.

Thank you. I have got a couple. In the December presentation, there was some discussion about not taking the full value of the vega hedge, although (inaudible) volatility hedge should definitely help improve the RBC from where we had talked about it in the third-quarter earnings release. At the time in early December, volatility was extremely elevated and came down during the month of December. Can you tell us how you are utilizing that vega hedge today in terms of using the 385% RBC estimate? And I have got a couple more.

Yes, Dan, so in terms of how we look at the 385% RBC, after the call, we did sell out of some of our vega positions and this did actually help our statutory capital ending reserve valuation. In the reserve calculation, for example, it does (inaudible) a lot of scenarios and assumes that the hedge itself can degrade and so that has a negative impact or an increase in the reserve you have to hold. So in fact by, selling out of some of our vega position, we not only helped preserve the fact that, as you said, volatilities did come down, but it also helps in terms of the year-end statutory net reserve calculation.

And are you still -- are you taking the full benefit of that hedge today?

Well, remember, the hedged asset itself, of course, goes into surplus, so it is mark to market at the end of the year. That hedged asset was about $4 billion at the end of the year. That goes into statutory surplus. That is the combination of hedged asset and the amount that we sold and so that fully goes into surplus. The calculation for reserves though actually increases the reserve because it assumes in the future that the hedged asset can come down. So that is where you get the negative impact.

Tell you what, I will follow up later on that one. It is beyond me. But let me move to something that I do understand, you talked about your T1 securities or your Tier 1 securities. What does the Tier 2 balance look like across the board and for European financials?

Greg, do you want to take that?

Yes, so let me just give you -- so for -- these would be total exposure -- I am going to give you total exposure overall by subordination levels. We have got about, let's call it, $1 billion in lower and upper Tier 2 and that would be in total. And the unrealized loss position that we had at the end of the year on that $1 billion is roughly about $100 million in total. And then you have about 10 -- 12% of that total would be in European lower and upper tier subordinated debentures.

You said 12%?

Exact -- correct.

Okay, great. And then finally, on the last question, in the 8-K, you walked through a lot of the -- I believe you have already covered a lot of it, but I want to go back to the $450 million component, which talked about spread widening. At the beginning of December -- excuse me -- at the beginning of November, CMBS pricing was probably 90-ish. At the end of November, it was down to 70 and so we will call it around the Analyst Day and then at the end of the year, it was higher. Also during the month of December, AA and most corporate spreads improved by well over 100 points in line with the decline in the VICs, which you have already referenced.

What timeframe was being used on December 5 to make the observation on volatility? Because it would appear that we used an estimate of -- I'm sorry -- not volatility, but on the spreads -- it appears we were using spreads that were more like from the beginning of November than something that would have been a little more timely as of the beginning of December?

Okay. So on Investor Day, we tried to have us updated assumptions as we could. There are certain securities that we get, particularly in the latter half of November, and particularly those that are illiquid that we did not have in our assumptions. So it was both a spread widening on those certain assets that back our fixed annuity products that occurred at the end of November and some of those asset classes actually -- some of those assets widened a bit further in December that caused the variance versus our projections.

Is that mainly the commercial real estate investments that you reference here?

That is correct.

But the CMBS market very publicly fell apart in the middle of November. So I am confused as to why we would be using something that looked like rather stale information.

Well, the one thing I would say is on this fixed annuity product where we have to mark the assets to market in that particular product, so for assets backing that, including whole loan commercial mortgages, we had to estimate a market value. So some of that is just trying to estimate a market value for the whole loans also.

Okay, great. You are carrying those whole loans at what sort of discount?

We don't have the specific numbers on that here, Dan. So why don't you take that offline.

Typically those are not mark to market, as you know, for statutory -- (multiple speakers)

Right, which is why I'm really interested in how you are valuing them on a fair value basis.

Right. Why don't you take that off-line with Greg.

Do you have a rough estimate?

Nope.

Thank you very much.

Thank you. And I would just request that you keep your questions to two questions because there are several people in queue. So I just want to be sure we give everybody an opportunity to air their questions. Thank you. Operator, next question.

John Nadel, Sterne Agee.

Thank you, good morning. I guess I have two questions if I could. One is I just wanted to understand and get the specifics behind the relief that you guys have contacted the Department of Insurance in Connecticut for. I understand from Liz's comments, 75 RBC points, I am not sure if that was the DTA, the deferred tax asset only, or if that also included the AG39 relief you were requesting.

So John, that number is a rough estimate of both of them, but they are interrelated. So the AG39 additional reserves actually causes the DTA benefit to go up. So if we get one or we get both of them, that is the right number. But if you get one or the other, it is hard to give you that unless we know which one we get.

Okay. And then just related to that one, before my second question, based on your understanding of your conversations with the rating agencies, do you expect them to look at that as incremental capital or do you expect them to -- are they discounting that? I guess with one state maybe moving one way, another state maybe moving another way or not moving at all, I guess I am sort of confused as to whether the rating agencies in your view will view that as incremental or not?

I would say a couple things. First of all, I can't speak for the rating agencies and you know that they are all different. They have their own capital models in addition to looking at RBC. So while they may not count this, they also may have a different capital model in the first place. We do think that this particular added test of cash flow testing that required this reserve is redundant and so that is how I would look at it.

Okay. On the 325 RBC ratio for the S&P 700 scenario now, I guess a couple things there. How much capital does that assume gets injected from the holding company to the Life company?

It is important to note I am not giving a pinpoint estimate.

Understood, understood.

So it is very variable and what we are really saying is with available capital, excluding or not including our contingent capital or bank lines, we have the ability to maintain a 325 for changes in equity markets.

Okay. And then lastly, when you think about that $1.5 billion of excess cash that you guys talk about at the holding company, is that really excess? I mean what are your holding company cash needs during 2009? Is that over and above those cash needs to meet that service, your lowered common dividend and other --

Yes. The holding company cash needs are about $400 million with a reduction of the dividend and when we talk about excess, it means excess of those requirements.

Okay. And then one more thing on the --

Hey, John?

Sorry, sorry, just real quick on the 325, just a quick or like a ballpark figure, what is $100 million of capital equal RBC points?

The RBC ratio for 2008, the denominator is about $1.3 billion. I don't have that number for 2009.

Okay. Thank you very much.

And I really request that we not have two questions with eight parts to it. I just want to honor everybody's opportunity to ask questions. So I just want to be disciplined about that if you don't mind. Thank you.

Eric Berg, Barclays Capital.

Good morning, Ramani and to your team. Here are my two questions. First, I fully empathize with you folks with respect to this whole issue of the difficulty of balancing the hedging of GAAP versus stat versus economics. I understand that it is all different. However, GAAP -- it is my opinion that GAAP is closer to economics than stat is and I am just wondering why would you be reducing paring back your vega and rho hedge if -- understanding that that is going to improve this accounting thing and I realize it is an important accounting thing, but by doing so, aren't you exposing the Company to real economic risk that, in the end, should matter above all?

So Eric, this is Liz. I would not say that. First of all, we have sold out of some of our vega position, but we have also added protection for further equity market declines. So I would look at it as refining the hedge, adding protection, for example, for other risks like the death benefit in Japan and selling out of some of our vega position. I mean volatility is at all-time highs and at the end of the day, what we have to do here is ultimately pay claims if people are in the money and the claim comes due. So when we look at balancing economics and GAAP and stat, we think the actions we have taken have been prudent. They have helped our statutory capital at the end of the year and we will continue to make those balances and trade-offs throughout 2009.

Okay. Thank you. Here is my second and final question and it is for Greg. Greg, you have provided a breakdown in the past and today of your CMBS by ratings category. Yesterday, I am sure you know, Moody said it is going to take a fresh look at the whole world of CMBS and we will be downgrading junior AAA securities. At least that was the strong suggestion. Some work we did yesterday looking at a sample of your bonds from schedule D would suggest that you have quite a bit of exposure to the junior AAA. Is that conclusion that we reached from a sample correct or would you put it differently? Thank you.

Yes, Eric, thanks for your question. I don't know -- I mean, first of all, just to back up. I think we are well aware of, at least, what the rating agencies and kind of anticipated that the rating agencies would probably be looking at taking action, in this case, in the CMBS portfolio. So I don't know exactly what your relative point is, but I guess I would say that the things that we are focused on and the things that we are most concerned about in our portfolio at least as it relates to downgrades would be in certainly those things that are lower down in the capital structure and from a ratings standpoint, the AJs, as you pointed out, which we do have a decent amount of exposure to.

So with that, there are a couple of things that we have done in looking at our portfolio. One is to potentially look at some hedging opportunities specific to that area of the capital structure in AJs and we have also looked at, if all these things did downgraded under different stress scenarios, what the impact of that capital would be. Now I am not prepared to tell you exactly what that capital number is, but I can tell you that the impact of that we think is not material over the course of 2009, depending on what we expect the severity of those downgrades to be at present.

Thank you.

Darin Arita, Deutsche Bank.

Good morning. Thank you, Ramani. Just two questions here. The first one, it seems like it is difficult for many insurance companies to calculate their statutory capital and reserves in real time. With that backdrop, just wondering how effectively can insurance companies hedge statutory capital for the VAs?

So you are right; it is a challenging exercise. I would say a few things. Number one, 2008 was particularly challenging because these cash flow tests that typically are used just to determine sufficiency of the reserve actually were utilized to determine excess reserves that you have to hold. So we had to try to model both reserves plus the impact of these additional cash flow tests.

In 2009, we are going to be moving to a new methodology, which is called VA CRVM that should make it somewhat easier to determine. But I think the point really is how do we manage our capital, are we making wise decisions, do we understand how our capital moves and the answer to that is yes, we do and so we do feel that we are making the right decisions for those trade-offs.

Thank you. The second question, in terms of the variable annuities, if we think about the lower base of assets and so we will have lower fees in 2009, we are also having lower sales. I am just wondering, in terms of the actual cash flow or statutory earnings, how does that change -- what is the delta there for '09 versus '08?

Darin, on that, we are not forecasting or giving you specifics on it, but as Liz was giving you an impression of how we think about '09 capital, it clearly has expectations around the cash flows in our various businesses. So to the best of our ability, modeling from this point to the end of the year is very, very challenging, so [path] independent, but we certainly have made an attempt to give investors an impression of how we think about it.

Thank you.

Josh Shanker, Citi.

Thank you very much. Quickly, one question would be what is your competitiveness in the life insurance business as a single-A rated company and two, how would that affect your impressions to seek out potentially strategic alternatives?

I'm sorry. What was the second --

You broke up on the last part. This is Tom.

I'm sorry, your desire to seek out strategic alternatives with the single A.

Well, I will have John comment on specific businesses, but as we have watched the last few weeks, there are a number of really household named life companies that are now single A as well. Not to say that this is going to be easy, but I think we will hold up reasonably well and again, I think that there are some good companies that are also in the same category now. John, do you want to talk about specific businesses that might be more affected than others?

Yes, so as you look at our portfolio of businesses, I think different ones have different rating sensitivities. Our sense is that, in general, we have a very good reputation with our distributors and a reputation as a company that they can count on over time and that everyone is aware that the ratings levels are changing kind of across the industry in this economic environment. So to some extent, we are in with a pack of firms that are getting challenged from a ratings standpoint.

That said, it will present a headwind that we will have to work our way through. I would say that some of our institutional businesses may be most affected by it and then in other businesses, like our mutual fund businesses, ratings are not an issue at all. And in other businesses, I would say we are more in the middle of the pack relatives to ratings. So I think it's a very rating-specific issue, but I do think it will present some top-line headwind as we go through the year and we are prepared to work through that and get out and be very active in explaining to people why they should be completely comfortable putting new business with The Hartford.

One thing, Darin, I would just remind you is we had some real headwinds in the fourth quarter and our people work very hard and I just think we are going to have to work hard and that is how we think about this. So that is our answer to that.

Okay, thank you.

Tom Gallagher, Credit Suisse.

Good morning, it's Tom. My two questions are, first, I guess for Liz. How much protection did Hartford purchase to reduce VA tail risk or was that more of a prospective comment? And is that going to materially reduce your RBC sensitivity that you gave out at Investor Day? For instance, at Investor Day, you showed a move from S&P 900 to 700 moved your RBC by 255. Is that sensitivity or delta going to be meaningfully lower? And then my follow-up is, Ramani, can you comment on how you are thinking about the VA business longer term? Is this a business you are committed to or would you consider divesting it given the issues right now? Thanks.

So Tom, to your first question, yes, it did reduce some of the convexity. Obviously, we're starting the year at 900 with less capital than we had projected. But some of the protection that we put on did reduce the convexity. And in addition to that, because you are starting off with higher reserves in 2009, as you go down into the lower S&P levels, it is not as convex because you are starting off with a higher reserve level. So all in, we think that is probably worth, and I am giving you a wide range here, in the $1 billion range of reduced convexity between 900 and 700.

So the question on our annuity business, we believe that, first of all, globally, the need for income and retirement is really a customer need that is not going away. One of the things that Tom Marra, and I will let Tom comment on this, is working with John and the team to do is to figure out how to constrain the annuity risk in a way where we are balancing enterprise risk with policyholder benefits, as well as value to our distributors. So Tom, do you want to comment on how we are thinking about it?

I won't get into specifics, but we will have a new product coming out in May, which will be significantly derisked, but we also are coupling it with some other products that we are excited about, the whole notion of payout or lifetime income. And I think as you saw, our fixed annuity business has really done extremely well. Fourth quarter was up handily and somewhat interest rate-dependent, so we may not be quite as robust, at least in the first part of this year. But we have a number of moves to make, but with the derisk variable annuity, it kind of anchors the whole retirement income for individual space that complements our other products.

This is John. I would just add a couple of things. I think you're seeing the industry go in kind of a couple of different directions. You are seeing some people keep very robust features and benefits and just push price up more aggressively and you are seeing other folks, which is more the camp that we are going to be in, trying to constrain the features and benefits to a level that we think is the right balance for us and try to keep costs more in line. And so I think it is to be determined which way investors and which way advisers feel more comfortable with, but we are going to go down a path of trying to keep costs in line and keeping the product more simple rather than trying to compete on a feature by feature basis with some of the other products that are out there that will, because of this environment, have to go much higher in terms of their expense structures. We just think that there is a total expense structure beyond which these products are not as attractive for individuals.

The last point I would make, Tom, is balancing customer value, enterprise risk and marketplace behaviors, etc. is top of mind for our management team and we are just constantly working this issue. This will evolve throughout the year. So we have to observe and take actions accordingly.

Okay. And then just one request actually for Liz. If the convexity is dropping that much, and that is a material change in the convexity, maybe by the time your K comes out, if you can give us an update on the 900 to 700 RBC impact, that would be very helpful.

The key there is -- that is something I would be very reluctant to do principally because it is so (inaudible) dependent, Tom. We have debated this a lot about what to do and how you get from here to the end of the year, what happens with many, many variables embedded in this that makes it very challenging for us to give you a lot of explicit guidance and that is a reason why we wanted to give you some rough impressions of how we think about this rather than get into a lot of specifics at different levels.

Understood. Thanks.

Andrew Kligerman, UBS.

Hey, good morning. First question, the S&P 500 closed around 1164 at the end of the third quarter. So where would the S&P need to be in order to avoid another prospective DAC unlocking in the third quarter of '09? And if there were an unlocking, what kind of magnitude would we look at?

Okay, Liz did cover it in her comments, but I just think it bears repeating, so why don't I have Liz cover that one more time.

In order to not have a DAC unlocking, technically, you have to take the 1165 and grow it in that 9% range by --

Okay, sorry.

-- third quarter. So we gave you the estimate assuming you are starting at 900 to 965 and certainly, you have the sensitivities in the Q. So as we sit here today, we would expect a DAC unlock.

Okay. And then with respect to the NAIC, I understand that they are going to be phasing AG39 cash flow testing out and implementing the new VA CRVM rules in 2009. How much could this statutory accounting help Hartford's results in '09 when that gets implemented?

Andrew, there are a lot of moving pieces. That is correct. AG39 standalone cash flow testing, which is what we think was redundant, is going away. The whole system, so to speak, is being replaced by VA CRVM. It is hard to try to assume how that would change, but what I would say is that there is an AG34 test that we also had to do at the end of the year and that looks at the total -- it kind of requires you to hold reserves for all of your living benefits and death benefits and really looks at your entire contract and that's more consistent with the new VA CRVM rules. So I would just say AG39 is redundant and will go away in '09.

Okay, thank you.

Operator, we don't want to overstay our welcome here. We will take two more questions, bring the call to a close.

Tamara Kravec, NWQ Investment Management.

Thank you, good morning. I have a question, then Jon Bosse has a follow-up. I just want to touch back on the RBC ratio and make sure that I conceptually understand this. At your December Investor Day, you started at 585. You are now, and you are stress scenario was down to 330 ex impairment. Now you are at 465 and that is with a full deployment of the Allianz proceeds. So I guess in your stress scenario, there is a difference there of 120 points and I am understanding that that is -- you feel comfortable with your downside stress scenario because of the further protection that you have purchased.

And then also there is potentially the capital relief coming, but I guess on the negative side, you could have more credit impairments, there are more asset classes being reviewed by the rating agencies, so we could be looking at more downgrade. So you talked about that, but I just want to make sure I conceptually understand that you feel comfortable that your stress scenario is only 5% lower, down to 325 now at 700, just with the further protection that you've purchased. Is that correct?

I will be frank and say that I didn't quite follow all of that. Let me just say a few things. At Investor Day, when you are seeing a 535, we are saying the best way to look at that is to compare -- to start with 465 because we did not downstream $1 billion into the Life company. So the apples-to-apples comparison is 385 to 465, which is an 80 point difference. That is where you should start.

Okay. But it is just getting from 465 -- I am assuming that what you laid out you're going to downstream the proceeds with your stress scenario. So I guess when you are getting down to your stress scenario, your assumptions actually fall to the same level because you are assuming -- in both cases, I think you were assuming that those proceeds would be downstreamed completely.

That's correct. So here's how I would think about it. You start out somewhat -- we start out less, right, at the beginning of the year as you mentioned and then all we are saying is rather than just kind of taking that and assuming that you are -- that that stays constant throughout the 700 levels, again, for equity market declines only, we are saying we have kind of reduced some of that convexity both because the starting level reserves are higher and secondly, because we have purchased additional protection for equity market declines.

To your point, I think you're also saying, well, what about credit market impacts, which we are not including in our estimate. We were trying to isolate equity market levels only. We do expect that -- I mean we do see that this market is very turbulent, so we would expect to have impacts to our statutory capital because of credit and there, I would say, first of all, we have the contingent capital in bank lines, but as importantly, as you said, we are looking for the permitted practice. We will continue to look at our hedging program. We are looking at captive or offshore solutions, which we think could mitigate -- could provide some additional relief and at a minimum, help us line up our hedging program better. So we have some -- we will continue and are continuing to do things to protect statutory capital.

Okay. And Jon has a follow-up.

Hey, it's Jon. We spent the entire call on half of your business. Could you, Ramani, articulate what is the synergy between the Life and the PC and your perspective on why or if these companies have to be together?

Well, Jon, thank you for the question. I think the way to think about this is when it comes to the Hartford brand and the end customer, I believe that the ability to provide protection products, as well as investment products under this brand has been very well-recognized by our customers and distributors as having extreme value. So that is the principal reason besides the diversification benefits that we have seen over time. In both sides of the house, having a combined platform does help us diversify risk. So those were the two things. The Hartford culture and Hartford management discipline are similar across the board and that is something that is brought to bear in everything we do. Tom, did you want to add --

Yes, I did. One thing we rolled out, Jon, in '08 that has been going very well is a cross-sell program where we are getting property casualty agents to sell 401(k) and group benefits products and even high-end individual life. That has been an exciting development and we plan to extend it into '09 and beyond.

I mean just a quick comment. In terms of I mean your mission to protect and enhance shareholder value, you have got one business that is not impaired and based on alternatives, you have -- it would seem you have an opportunity to utilize that value or capital to have the most bulletproof Life company and even use that strength to take advantage of the disarray and opportunities in the market as opposed to holding an asset and then hoping the markets are working toward a long-term solution in a turbulent time. So I mean it is pretty unprecedented times and so I think kind of options really need to be viewed.

Thank you, Jon, for the suggestion and comment.

Thank you.

Tisha Jackson, Columbia Management.

Good morning. Thanks for taking my call. I guess two quick questions. I have a ton of questions, but my two are what is the duration of the protection you have bought in the fourth quarter, i.e., is this a short-term fix or a permanent fix on the convexity issue? And then back to being downgraded to single A, does this affect or at what point might it affect your property and casualty businesses? For example, are there any rating triggers in your AARP relationship or does it limit your ability to compete in the specialty commercial business, the professional liability, etc.?

Tisha, thanks for the question. I will take the second one first and I will turn the question on the protection to Liz. Basically on the property casualty issue as far as ratings -- one, is clearly, from a property casualty competitive landscape standpoint, there are a lot of good property casualty companies that are rated A or even below and so I believe that A is an excellent rating. We will compete vigorously.

At the same time, there will be areas where we are going to have to work harder in which we will. And the larger end of the business, the financial products end of the business, we are going to have to work and sell The Hartford's benefits and sell The Hartford's strength. As you think about it, this is one that we have grown to understand how to do and we will keep fighting out there in the marketplace, I am pretty confident we will do that.

On the AARP business, there are no rating triggers and therefore, this will not be a material issue from an AARP standpoint. At the same time, I would rather have a AA and that is how I have attempted throughout my life to position the Company over time. We will have to work hard through both earnings generation and risk management to try to work our way back and that is something that will take time, but we will work very hard to do that. So let me have Liz answer the first half of your question.

Yes, Tisha, in terms of the protection that we purchased, particularly in December, it was shorter dated, including some futures. But I will remind you that 27% of our book is covered by reinsurance, of our GMWB book and about 27% is covered by very long dated customized derivatives. So we have a lot of long dated protection and of course, we are going to continue to manage the book looking over the length of the guarantees.

So I want to bring this call to a close. I thank you all for joining us today. I also want to thank Neal Wolin who will be departing from The Hartford. He has given us many good years and he has really done a very good job of managing our property casualty company, focused intensely on strategy and driving for performance, which shows in our results. I believe the country gains in his capacity as Deputy White House Counsel working on economic policy given the times that we are all going through and I wish Neal and the administration great good fortune because this will certainly affect us and our business. So I want to thank Neal for his service and I want to thank you all for joining us on the call and we will be talking to you.

This concludes today's conference. You may now disconnect at this time.