Our home office is located in Galveston, Texas. We own and occupy approximately 420,000 square feet of office space in this building. We also own the following additional properties that are materially important to our operations:
Due to the recent market and economic turmoil, life insurance companies experienced declining demand for certain products in 2008 and 2009. In response, we developed and began offering in September, 2009 a new Indexed Universal Life product, which we anticipate will be desirable in the current market. Life insurance continues to be a mainstay product for us today, as it has during our long history. We believe that the combination of predictable and decreasing mortality rates, positive cash flow generation for many years after policy issue and favorable persistency characteristics, suggest a viable and profitable future for this line of business. We continue to use a wide variety of marketing channels and plan to expand our traditional distribution models with additional independent agents.
Sales of traditional life insurance products through our Career Sales and Services Division increased in 2009. This coupled with our focus on policy persistency and expense management allowed us to continue to maintain a stable and profitable block of in force business.
Future policy benefit liabilities for participating traditional life insurance policies are calculated consistent with, ASC 944-40 (formerly “FAS 97”), Accounting and Reporting by Insurance Enterprise for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, and are equal to the aggregate of (i) net level premium reserves for death and endowment policy benefits (calculated based upon the non-forfeiture interest rate, ranging from 2.5% to 6.0%, and mortality rates assumed in calculating the cash surrender values described in such contracts); and (ii) the liability for terminal dividends.
Tax regulations require items to be included in the tax return at different times from the items reflected in the financial statements. As a result, the effective tax rate reflected in the financial statements is different than the actual rate applied on the tax return. Some of these differences are permanent such as expenses that are not deductible in our tax return, and some differences are temporary, reversing over time, such as valuation of insurance reserves. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which tax payment has been deferred, or expenditures for which we have already taken a deduction in our tax return but have not yet recognized in our consolidated financial statements.
The following table presents the components of the change in DAC for the years ended December 31, 2009, 2008 and 2007 (in thousands, except percentages):
We use reinsurance to mitigate excessive risk to the Company. Our current retention limit is $700,000 for traditional and universal life. Accidental death benefits and premium waiver benefits are fully retained on new business issued beginning in 2008. Increases in reserves and premium amounts ceded primarily reflect increased use of reinsurance in conjunction with treaties related to universal life products.
The following table details the gain or loss on derivatives related to equity-indexed annuities (in thousands, except percentages):
Premiums for the periods indicated are as follows (in thousands, except percentages):
For the major medical business, we use reinsurance on an excess of loss basis. Our retention limit is $500,000 per claim on these types of policies. Certain amounts of stop-loss and other types of catastrophe health reinsurance programs are also reinsured. We manage these risks by reinsuring over 90% of the risk to highly rated reinsurance companies. We also maintain some reinsurance on a quota share basis for our long-term care and disability income business.
Policy benefits and the loss ratio decreased in 2009 compared to 2008 due to the $40.5 million decrease in catastrophe experience from the prior year and a decline in loss reserves of $17.8 million, offset by a decrease in reinsurance ceded losses from $35.8 million in 2008 to $0.2 million in 2009.
The expense ratio decreased in 2009 due to the litigation expense noted in the “Other Operating Costs and Expenses” discussion above, combined with a greater amount of expenses being deferred through our updated deferral estimates. The increase in 2008 from 2007 was primarily a result of the litigation expense and modest increases in staffing levels.
The combined ratios for 2009 (projected), 2008 and 2007 are comparable to the industry average for the same periods of 97.0%, 96.8% and 94.2%, respectively, per A.M. Best.
For year-end 2005, the $339.2 million deficiency gross of reinsurance was primarily the result of our participation in the National Flood Insurance Program as administered by the Federal Emergency Management Agency. As these losses are 100% reimbursed by the federal government, they do not impact our net reserve calculations or our net loss development patterns. The National Flood Insurance Program had paid losses of $390.0 million for the year ended December 31, 2005 because of the 2005 hurricanes, specifically Hurricane Katrina. Since reserves are not set up for the National Flood Insurance Program, any payments made subsequent to year-end will appear as adverse development on a gross basis. If the flood losses were removed from the gross data, the $339.2 million deficiency would have been a $50.8 million redundancy, gross of reinsurance.
Cash flows from financing activities increased $505.8 million from 2008 to 2009, and $557.8 million from 2007 to 2008 resulting from net increases in annuity sales and a decrease in policyholders’ withdrawals during both years compared to the previous one. Refer to the Results of Operations - Annuity for further discussion.
The RBC formula for life companies establishes capital requirements relating to insurance, business, asset and interest rate risks, and effective for 2005 it addresses the equity, interest rate and expense recovery risks associated with variable annuities and group annuities that contain death benefits or certain living benefits.
As of December 31, 2009, 100% of our common stock investments are considered Level 1 securities with fair values determinable from observable market prices.
In order to identify and evaluate investments, which may be other-than-temporarily impaired, we have various quarterly processes in place. For our securities investments, we review the entire portfolio of investments which have unrealized losses. We use various techniques to determine which securities need further review to determine if the impairment is other-than-temporary. The criteria include the amount by which our amortized cost exceeds the market value, the length of time the market value has been below our cost, any public information about the issuer that would indicate the security could be impaired and our intent and ability to hold the security until its value recovers. Furthermore, we review current ratings, rating downgrades and exposure to continued deterioration in the financial and credit markets.
As of December 31, 2009, we invested $970.5 million, or 5.8% of our invested assets, in a well-diversified equity investment portfolio. Of these equity securities, 96.3% are invested in publicly traded (on a national U.S. stock exchange) common stock. The remaining 3.7% of the equity portfolio is invested in publicly traded preferred stock. As of December 31, 2008, we had $902.4 million, or 6.2% of our invested assets, in our equity investment portfolio. Of these equity securities, 94.6% were invested in publicly traded common stock, and the remaining 5.4% were invested in publicly traded preferred stock. The increase in the fair value of our equity securities during the year ended December 31, 2009 is primarily the result of improved market conditions.
We maintain a well-diversified equity portfolio. Our equity portfolio is summarized below by market sector distribution:
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), American National Insurance Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 11, 2010, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Costs deferred on universal life, limited pay and investment type contracts are amortized as a level percentage of the present value of anticipated gross profits from investment yields, mortality, and surrender charges. The effect on the deferred policy acquisition costs that would result from realization of unrealized gains (losses) is recognized with an offset to accumulated other comprehensive income (loss) in the consolidated statement of changes in stockholders’ equity as of the statement of financial position date. It is possible that a change in interest rates could have a significant impact on the deferred policy acquisition costs calculated for these contracts.
In September 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-12, “Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)”, (“ASU 2009-12”) which amended ASC 820. ASU 2009-12 provided additional guidance on using the net asset value per share, as provided by an investee, when estimating the fair value of an alternate investment that does not have a readily determinable fair value as well as enhanced the disclosures concerning these investments. Examples of alternate investments, within the scope of ASU 2009-12, included investments in hedge funds and private equity, real estate, and venture capital partnerships. ASU 2009-12 was effective for interim and annual periods ending after December 15, 2009. Accordingly, American National adopted ASU 2009-12 on December 31, 2009. The adoption of ASU 2009-12 did not have a material effect on American National’s consolidated financial statements.
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2008, are summarized as follows (in thousands):
Policyholder account balances relate to investment-type contracts and universal life-type policies. Investment-type contracts principally include traditional individual fixed annuities in the accumulation phase and non-variable group annuity contracts. Policyholder account balances are equal to (i) policy account values, which consist of an accumulation of gross premium payments; (ii) credited interest, ranging from 2.5% to 5.5% (some annuities also offer a first year bonus ranging from 1% to 8%), less expenses, mortality charges, and withdrawals; and (iii) fair value adjustments relating to business combinations.
The Annuity segment develops sells and supports fixed, equity-indexed, and variable annuity products. These products are primarily sold through independent agents and brokers, but are also sold through financial institutions, multiple line agents and employee agents.
Realized gains or losses on investments are allocated to Corporate and Other.
American National utilizes third-party pricing services to estimate fair value measurements of their pension plan assets. Please refer to Note 5 for further information concerning the valuation methodologies and related inputs utilized by the third-party pricing services. The pension plans have no level 3 assets.