Benefit reserves for traditional life products are determined according to the provisions of Statement of Financial Accounting Standards (SFAS) No. 60, Accounting and Reporting by Insurance Enterprises. The methodology used requires that the present value of future benefits to be paid to or on behalf of policyholders less the present value of future net premiums (that portion of the gross premiums required to provide for all future benefits and expenses) be determined. Such determination uses assumptions, including provision for adverse deviation, for expected investment yields, mortality, terminations and maintenance expenses applicable at the time the insurance contracts are issued. These assumptions determine the level and the sufficiency of reserves. The Company annually tests the validity of these assumptions.
Alliance, a new subsidiary of the Company, was added as a 2% participant in the pool with AIC’s and AGI’s participation decreasing 1% each. The Company maintained its overall 65% participation.
in the direct mail product. The policies inforce and inforce annualized premium growth for annuities is due to new product offerings in 2006. Inforce annualized premium growth was 5.2%, with the largest increase in traditional life at 12.9%, or $5.4 million.
Net realized investment gains, net of tax, decreased $2.9 million during 2007 to a net realized investment loss, net of tax, of $717 thousand as a result of increased writedowns on fixed maturities and equity securities and losses on tax credit partnerships offset by increased gains on sales of fixed maturities and equity securities. On a pretax basis, writedowns increased from $2.9 million in 2006 to $25.4 million in 2007. The increase in writedowns is due to other than temporary impairments in fixed maturities, including collateralized debt obligations (CDOs), and equity securities. Net realized investment gains, net of tax, declined $1.7 million, or 43.8%, for 2006 as a result of increased losses on tax credit partnerships. On a pretax basis, writedowns increased from $2.1 million in 2005 to $2.9 million in 2006.
Net realized investment gains (losses), net of tax, increased $3.4 million during 2007 as a result of increased gains on fixed maturities and equity securities offset by losses on tax credit partnerships and increased writedowns on fixed maturities and equity securities. Pretax net realized investment gains increased $3.1 million and $5.0 million for fixed maturities and equity securities, respectively. On a pretax basis, writedowns increased from $796 thousand in 2006 to $3.2 million in 2007.
AIC and AGI contributed $16.9 million of earned premiums growth during 2006. The growth from AIC and AGI is related to increases in personal lines. During 2006, earned premiums for homeowner and manufactured home increased $10.5 million, or 7.1%, automobile increased $5.5 million, or 1.8%, farmowner increased $1.6 million, or 6.1%. In addition, there was a slight increase in other lines offset by increases in ceded catastrophe premiums and working cover premiums of $1.6 million.
Life insurance premiums increased $4.9 million, or 10.6%, in 2007 compared to $4.9 million, or 11.9%, in 2006. This growth is attributable to increases in term life premiums of $4.8 million in 2007 and an increase of 6.4% in term life policies inforce year to date. During January 2006, Life began offering a return of premium level term product which contributed the majority of the increase in life insurance premiums during 2007 and 2006.
On a statutory accounting basis, issued annualized new business premiums increased by 29.0% to $17.8 million with a total volume of $3.4 billion of insurance being issued in 2006. The new product offerings for 2006 contributed as follows: return of premium level term - 6,329 policies issued, $4.6 million of issued annualized new business premiums and volume of $1.1 billion of insurance issued; annuities - 57 policies issued and $1.4 million of issued annualized new business premium.
The Company’s 1.7% increase in net investment income for 2007 compares favorably to a decline of 1.8% in net investment income for 2006 due to increases in interest income on fixed maturities, short-term investments and partnership income. Offsetting these increases is a decrease of $8.7 million in equity in net earnings (after internal capital charge) of MidCountry for 2007. Alliance contributed $2.1 million to the increase in net investment income during 2007. The decline in 2006 was the result of the write-off of loans in Financial’s portfolio, increased borrowing costs, reduced income from the equity-method investment in MidCountry and lower partnership earnings. These items were partially offset by increased earnings on fixed maturities, equity securities and short-term investments.
The majority of the Company’s investment portfolio consists of fixed maturities that are diverse as to both industry and geographic concentration. In 2007, the overall mix of investments shifted due to the purchase of Alliance and additional investments in short-term investments from the sales of fixed maturities and equity securities.
At December 31, 2007, all securities in the fixed maturity portfolio, with the exception of a single investment of $3.0 million, were rated by an outside rating service. The Company considers bonds with a quality rating of BB+ and below to be below investment grade or high yield bonds (also called junk bonds).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the Company’s result of their operations and their cash flows for the year ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
The consolidated financial statements include, after intercompany eliminations, Alfa Corporation and its wholly-owned subsidiaries:
On January 1, 2007, the Company adopted SOP 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. This statement provides guidance on accounting for deferred acquisition costs on an internal replacement. Transactions are accounted for as an internal replacement, as defined by this statement, when a policyholder requests a change not within the terms of the original contract and the change is deemed by the Company to be significant and integrated. For internal replacements of insurance products, the unamortized balance of acquisition costs previously deferred under the original contract is extinguished and charged to income. The new acquisition costs associated with the replacement are deferred and amortized to income.
The Company issued a variable-rate $70 million long-term obligation maturing on June 1, 2017 in the second quarter of 2002 as a means of funding the collateral loan and commercial lease portfolios. The interest rates on this obligation were 5.01% and 5.55% at December 31, 2007 and 2006, respectively. Refer to Note 1 - Summary of Significant Accounting Policies for discussions about the Company’s cash flow hedge which expired on April 30, 2007.
The following table shows total share-based compensation expense included in the Consolidated Statements of Income:
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provision of SFAS No. 123 to all awards of share-based employee compensation in 2005.
The total intrinsic value of options exercised during 2007, 2006 and 2005, was $2.4 million, $1.7 million and $2.5 million, respectively. Intrinsic value is measured using the fair market value at the date of exercise (for shares exercised) or at December 31, 2007 (for outstanding options), less the applicable exercise price. Cash received from option exercises totaled $3.3 million, $2.8 million and $3.0 million during 2007, 2006 and 2005, respectively. The tax benefit realized from stock options exercised during the same periods was $791 thousand, $533 thousand and $795 thousand, respectively, based on deductions from earnings of $2.3 million, $1.5 million and $2.3 million, respectively.
The Company’s finance subsidiary leases certain equipment to Marshall Creek, Ltd., a joint real estate venture with Mutual (refer to Note 3 - Related-Party Transactions). These equipment leases have various expiration dates through 2010.
For the three months ended December 31, 2007, net realized investment gains, net of tax, decreased $2.8 million when compared to the same period in 2006. This decline resulted from increased writedowns on fixed maturities and equity securities offset by increased gains on sales of fixed maturities and equity securities. On a pre-tax basis, writedowns increased from $788 thousand in the three months ended December 31, 2006 to $19.0 million in the same period in 2007. The increase in writedowns is due to other than temporary impairments in fixed maturities, including CDOs, and equity securities.