The following table illustrates where Structured Financial Products Premiums and deposits are reflected in the consolidated financial statements.
DERIVATIVE INSTRUMENTS Derivative financial instruments include swaps, futures, options, interest rate caps and floors, warrants, synthetic guaranteed investment contracts, certain forward contracts for purchases of to-be-announced mortgage securities, certain investment risk transfer reinsurance agreements and certain fixed income security forward purchase commitments. Derivatives that are required to be separated from the host instrument and accounted for as derivative financial instruments ("subject to bifurcation") are embedded in convertible and other fixed income securities, equity indexed life and annuity contracts, and certain variable life and annuity contracts.
Total Retail Premiums and deposits increased 20.3% to $8.31 billion in 2002 from $6.91 billion in 2001. The increase in 2002 was due to growth in sales of fixed annuities, including $762 million of the Allstate(R) Treasury -Linked Annuity sales, partly offset by declines in variable annuity sales. The Allstate(R) Treasury-Linked Annuity is the first flexible premium deferred fixed annuity that provides a competitive underlying guaranteed rate for five years plus annual renewal rates linked to movement in five-year U.S. Treasury rates. The decline in variable annuity sales was caused by poor equity market performance during the period.
The factors causing a change in DAC asset balances for the year ended December 31 are summarized in the following tables.
(1) Included as a component of amortization of deferred policy acquisition costs on the Consolidated Statements of Operations and Comprehensive Income.
- - The Company is undertaking various expense-saving initiatives to increase profitability. These initiatives will include creating greater efficiencies, a simplification of operations and focusing on distribution among the current channels. The efficacy of these expense-saving initiatives is difficult to predict due to external factors and technology costs. - - In order to compete with major insurance company competitors, as well as non-traditional competitors such as banks, financial service firms and securities firms, the Company will have to provide products that are considered competitive by its distribution channels and customers. Additionally, to meet its return targets, the Company must distribute its products within its pricing parameters. The Company plans to focus its efforts by deepening relationships with its more productive and more profitable distribution partners.
- - Net income decreased $58 million to a net loss in 2002 as a result of increased realized capital losses, higher operating costs and expenses and lower mortality margin, partly offset by an increase in the investment margin. - - Premiums and deposits decreased 19.8% in the Structured Financial Products segment due to unfavorable market conditions for sales of funding agreements ("FAs").
Total Premiums and deposits in 2002 decreased 19.8% compared to 2001 due to declining sales of funding agreements and GICs partly offset by an increase in sales of structured settlement and immediate annuities. Period to period fluctuations in sales of FAs and GICs will occur as the sales of these products are primarily made based on management's assessment of market opportunities. The 28.4% decline in FAs compared to 2001 is primarily a result of lower sales in the latter part of 2002. Management determined that economic conditions during that period were adverse to earning targeted spreads on this product.
As of December 31, 2002, the key assumptions used to estimate the fair value of privately placed corporate obligations included the following:
The MBS portfolio is subject to interest rate risk since the price volatility and ultimate realized yield are affected by the rate of repayment of the underlying mortgages. The Company attempts to limit interest rate risk on these securities by investing a portion of the portfolio in securities that provide prepayment protection. At December 31, 2002, approximately 53.2% of the MBS portfolio was invested in planned amortization class bonds or the equivalent.
Common and non-redeemable preferred stocks and real estate investment trust equity investments are classified as available for sale and are carried at fair value if independent market quotations are available. If independent market quotations are not available, these securities are carried at cost. The difference between cost and fair value, net of deferred income taxes, is reflected as a component of Accumulated other comprehensive income.
MORTGAGE LOANS The Company's $5.88 billion investment in mortgage loans at December 31, 2002 and $5.45 billion at December 31, 2001, is comprised primarily of loans secured by first mortgages on developed commercial real estate. Geographical and property type diversification are key considerations used to manage the Company's mortgage loan risk.
As of December 31, 2002 $156.51 billion or 41.7% of life insurance inforce was ceded to third parties.
CAPITAL RESOURCES consist of shareholder's equity. The following table summarizes the Company's capital resources at December 31.
eligible subsidiaries at any given point in time is limited to $1.00 billion. No amounts were outstanding for the Company under the inter-company loan agreement at December 31, 2002 or 2001.
avoiding the payment of employee benefits. A putative nationwide class action filed by former employee agents also includes a worker classification issue; these agents are challenging certain amendments to the Agents Pension Plan and are seeking to have exclusive agent independent contractors treated as employees for benefit purposes. AIC has been vigorously defending these and various other worker classification lawsuits. The outcome of these disputes is currently uncertain.
features. A provision requires the establishment of a liability in addition to the account balance for contracts and contract features that provide guaranteed death or other insurance benefits. The Company does not currently hold liabilities for GMDB features covered by the SOP or GMIBs. However, these benefits are included in the EGP calculation used when evaluating DAC. If the SOP is adopted, the Company's establishment of these liabilities could have a material impact on the Consolidated Statement of Operations and Comprehensive Income depending on the market conditions at the time of adoption, but it is not expected to have a material impact on the Company's Consolidated Statements of Financial Position. - - Portions of the non-publicly traded marketable investment securities and non-exchange traded derivative contracts are accounted for at fair value using internally developed widely accepted valuation models and independent third party data as model inputs. Changes in the fair value of any security or derivative contract could negatively impact the Company's net income, assets, liabilities and shareholder's equity. - - In recent years, the state insurance regulatory framework has come under increased federal scrutiny and legislation that would provide for optional federal chartering of insurance companies has been introduced in Congress. In addition state legislators and insurance regulators continue to examine the appropriate nature and scope of state insurance regulation. The Company cannot predict whether any state or federal measures will be adopted to change the nature or scope of the regulation of the insurance business or what effect any such measures would have on the Company. - - The Gramm-Leach-Bliley Act of 1999 permits mergers that combine commercial banks, insurers and securities firms under one holding company. Until passage of the Gramm-Leach-Bliley Act of 1999, the Glass Steagall Act of 1933 had limited the ability of banks to engage in securities-related businesses and the Bank Holding Company Act of 1956 had restricted banks from being affiliated with insurers. With the passage of the Gramm-Leach-Bliley Act of 1999, bank holding companies may acquire insurers and insurance holding companies may acquire banks. In addition, grandfathered unitary thrift holding companies, including the Corporation, may engage in activities that are not financial in nature. The ability of banks to affiliate with insurers may materially adversely affect all of the Company's product lines by substantially increasing the number, size and financial strength of potential competitors. - - Like other members of the insurance industry, the Company is the target of an increasing number of class action lawsuits and other types of litigation, some of which involve claims for substantial and/or indetermine amounts (including punitive and treble damages) and the outcomes of which are unpredictable. This litigation is based on a variety of issues including insurance and claim settlement practices. GAAP prescribes when a company has a contingent liability and may reserve for particular risks, including litigation exposures. Therefore, results for a given period could be significantly adversely affected when a reserve is established for litigation. - - The design of any system of controls and procedures, including internal controls and disclosure controls and procedures, is based in part upon assumptions about the likelihood of future events. Therefore, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. - - The impact of The Sarbanes-Oxley Act of 2002 on the business of the Company is being evaluated but cannot be completely determined at this time.