particular issuer than originally estimated; 2) changes in the facts and circumstances related to a particular issuer's ability to meet all of its contractual obligations; and 3) changes in facts and circumstances or new information obtained which causes a change in our ability or intent to hold a security to maturity or until it recovers in value. Changes in assumptions, facts and circumstances could result in additional charges to earnings in future periods to the extent that losses are realized. The charge to earnings, while potentially significant to net income, would not have a significant effect on shareholder's equity since the majority of our portfolio is carried at fair value and as a result, any related unrealized loss would already be reflected as a component of accumulated other comprehensive income in shareholder's equity.
The following table summarizes the annualized weighted average investment yields, interest crediting rates and investment spreads during 2006, 2005 and 2004.
AMORTIZATION OF DAC AND DSI, excluding amortization related to realized capital gains and losses, increased 27.4% in 2006 compared to 2005. Lower variable annuity amortization in 2006 due to the disposition of the business effective June 1, 2006 through reinsurance was more than offset by the recognition of amortization acceleration (commonly referred to as DAC and DSI "unlocking") totaling $544 thousand in 2006 compared to the recognition of amortization deceleration of $7.3 million in 2005, and higher amortization on investment contracts due to improved gross margin. DAC and DSI amortization related to realized capital gains and losses, after-tax, changed by a favorable $11.9 million in 2006 compared to 2005. The impact of realized capital gains and losses on amortization of DAC and DSI is dependent upon the relationship between the assets that give rise to the gain or loss and the product liability supported by the assets. Fluctuations result from changes in the impact of realized capital gains and losses on actual and expected gross profits.
NAIC FAIR PERCENT RATING MOODY'S EQUIVALENT VALUE OF TOTAL - -------------- ------------------ ---------- -------- 1 Aaa/Aa/A $4,266,674 72.5% 2 Baa 1,433,572 24.4 3 Ba 149,943 2.5 4 B 29,478 0.5 5 Caa or lower 639 -- 6 In or near default 6,833 0.1 ---------- ----- Total $5,887,139 100.0% ========== =====
The utilities, consumer goods, banking, capital goods and financial services sectors had the highest concentration of gross unrealized losses in our corporate fixed income securities portfolio at December 31, 2006. The gross unrealized losses in these sectors are primarily interest rate related or company specific. As of December 31, 2006, $32.1 million or 91.5% of the gross unrealized losses in the corporate fixed income portfolio, and all of the remaining fixed income securities with gross unrealized losses, were rated investment grade. Unrealized losses on investment grade securities are principally related to rising interest rates or changes in credit spreads since the securities were acquired. All securities in an unrealized loss position at December 31, 2006
MORTGAGE LOANS Our mortgage loans portfolio was $708.4 million at December 31, 2006 and $633.8 million at December 31, 2005, and was comprised primarily of loans secured by first mortgages on developed commercial real estate. Geographical and property type diversification are key considerations used to manage our mortgage loan risk.
We manage our exposure to market risk through the use of asset allocation, duration and value-at-risk limits, through the use of simulation and, as appropriate, through the use of stress tests. We have asset allocation limits that place restrictions on the total funds that may be invested within an asset class. We have duration limits on our investment portfolio, and, as appropriate, on individual components of the portfolio. These duration limits place restrictions on the amount of interest rate risk that may be taken. Our value-at-risk limits are intended to restrict the potential loss in fair value that could arise from adverse movements in the fixed income, equity, and currency markets based on historical volatilities and correlations among market risk factors. Comprehensive day-to-day management of market risk within defined tolerance ranges occurs as portfolio managers buy and sell within their respective markets based upon the acceptable boundaries established by the investment policies. This day-to-day management is integrated with and informed by the activities of the ALM organization. This integration results in a prudent, methodical and effective adjudication of market risk and return, conditioned by the unique demands and dynamics of our product liabilities and supported by the application of advanced risk technology and analytics.
Cash flows used in investing activities decreased in both 2006 and 2005, compared to the respective prior years, due to decreased net cash provided by financing activities, partially offset by the investment of higher operating cash flows. Cash flows used in investing activities in 2006 also include the settlements related to the disposition through reinsurance of our variable annuity business.
At December 31, 2006, we had $14.7 million in contractual conditional commitments to invest in private placements and mortgage loans.
Short-term investments are carried at cost or amortized cost that approximates fair value, and include the investment of collateral received in connection with securities lending business activities. For these transactions, the Company records an offsetting liability in other liabilities and accrued expenses for the Company's obligation to return the collateral or funds received. We also purchase securities under agreements to resell.
Separate accounts assets and liabilities are carried at fair value. The assets of the separate accounts are legally segregated and available only to settle separate account contract obligations. Separate accounts liabilities represent the contractholders' claims to the related assets. Investment income and realized capital gains and losses of the separate accounts accrue directly to the contractholders and therefore, are not included in the Company's Statements of Operations and Comprehensive Income. Deposits to, and surrenders and withdrawals from, the separate accounts are not included in cash flows.
On January 1, 2004, the Company adopted SOP 03-1. The major provisions of the SOP that affected the Company at the time of adoption are listed below. The provisions were primarily applicable to the business that was subsequently reinsured on June 1, 2006 (see Note 3 for more information):
In September 2004, the staff of the AICPA, aided by industry experts, issued a set of technical questions and answers on financial accounting and reporting issues related to SOP 03-1. The TPA addresses a number of issues related to SOP 03-1 including when it was necessary to establish a liability in addition to the account balance for certain contracts such as single premium and universal life that meet the definition of an insurance contract and have amounts assessed against the contractholder in a manner that is expected to result in profits in earlier years and losses in subsequent years from the insurance benefit function. The impact of adopting the provisions of the TPAs did not have a material effect on the results of operations or financial position of the Company.
(IN THOUSANDS) 2006 2005 2004 -------- ------- ------- Fixed income securities $(25,398) $(6,596) $(7,666) Mortgage loans 3,572 3,000 1,480 Other (259) (1,596) (3,111) -------- ------- ------- Realized capital gains and losses, pre-tax (22,085) (5,192) (9,297) Income tax benefit 8,216 1,972 3,453 -------- ------- ------- Realized capital gains and losses, after-tax $(13,869) $(3,220) $(5,844) ======== ======= =======
A mortgage loan is impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Interest income for impaired loans is recognized on an accrual basis if payments are expected to continue to be received; otherwise a cash basis is used. The Company had no impaired loans in 2006 or 2005.
The following table summarizes the notional amount, fair value and carrying value of the Company's derivative financial instruments at December 31, 2006.
The Company offers various guarantees to variable annuity contractholders including a return of no less than (a) total deposits made on the contract less any customer withdrawals, (b) total deposits made on the contract less any customer withdrawals plus a minimum return or (c) the highest contract value on a specified anniversary date minus any customer withdrawals following the contract anniversary. These guarantees include benefits that are payable in the event of death (death benefits), upon annuitization (income benefits), upon periodic withdrawal (withdrawal benefits), or at specified dates during the accumulation period (accumulation benefits). Liabilities for variable contract guarantees related to death benefits are included in reserve for life-contingent contract benefits and the liabilities related to the income, withdrawal and accumulation benefits are included in contractholder funds in the Statements of Financial Position. All liabilities for variable contracts guarantees are reported on a
In addition to amounts included in the table above are reinsurance premium ceded to ALIC of $3.0 million, $2.9 million and $2.7 million of premiums and contract charges ceded to ALIC during 2006, 2005 and 2004, respectively, under the terms of the structured settlement annuity reinsurance agreement (See Note 5).