•“Results of Operations” begins with a discussion of our “Annual Actuarial Review.” Annual actuarial review (the “AAR”) describes the changes in key assumptions applied in 2020 and 2019, respectively, resulting in an unfavorable impact on net income (loss) available to shareholders in each period.
We provide for federal and state income taxes currently payable, as well as those deferred due to temporary differences between the financial reporting and tax bases of assets and liabilities. Our accounting for income taxes represents our best estimate of various events and transactions. Tax laws are often complex and may be subject to differing interpretations by the taxpayer and the relevant governmental taxing authorities. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various taxing jurisdictions.
The provision for income tax, expressed as a percentage of income (loss) before provision for income tax, resulted in an effective tax rate of 26% in the current period compared to 29% in the prior period. The decrease in the effective tax rate in the current period is driven by lower pre-tax adjusted earnings, discussed in greater detail below. Our effective tax rate differs from the statutory tax rate primarily due to the impacts of the dividends received deduction and tax credits.
◦interest expense recognized in the prior period on a tax liability associated with our separation from MetLife.
The provision for income tax, expressed as a percentage of pre-tax adjusted earnings, resulted in an effective tax rate of 19% in both the current and prior periods. Our effective tax rate differs from the statutory tax rate primarily due to the impacts of the dividends received deduction.
Adjusted earnings were $148 million for the current period, a decrease of $83 million.
Adjusted earnings were a loss of $294 million for the current period, a higher loss of $88 million.
(1)Excludes living benefit fees, included as a component of adjusted earnings, of $58 million and $64 million for the years ended December 31, 2020 and 2019, respectively.
There has also been an increased market focus on retail sector investments as a result of the COVID-19 pandemic and uncertainty regarding its duration and severity. Our exposure to retail sector corporate fixed maturity securities was $1.9 billion, of which 97% were investment grade, with net unrealized gains (losses) of $265 million at December 31, 2020.
The estimated fair value of CMBS rated Aaa using rating agency ratings was $5.0 billion, or 73.4% of total CMBS, and designated NAIC 1 was $6.5 billion, or 95.0% of total CMBS, at December 31, 2020. The estimated fair value of CMBS Aaa rating agency ratings was $4.3 billion, or 74.9% of total CMBS, and designated NAIC 1 was $5.6 billion, or 97.5% of total CMBS, at December 31, 2019.
See Note 8 of the Notes to the Consolidated Financial Statements for information about embedded derivatives measured at estimated fair value on a recurring basis and their corresponding fair value hierarchy.
See Note 10 of the Notes to the Consolidated Financial Statements for information on preferred stock issuances.
Brighthouse Life Insurance Company is a member of the Federal Home Loan Bank (“FHLB”) of Atlanta, where we maintain an active funding agreement program, along with inactive funding agreement programs with certain other regional banks in the FHLB system. Brighthouse Life Insurance Company had obligations outstanding under funding agreements of $595 million at both December 31, 2020 and 2019, respectively, which are reported in policyholder account balances. On April 2, 2020, Brighthouse Life Insurance Company issued funding agreements for an aggregate collateralized borrowing of $1.0 billion to provide a readily available source of contingent liquidity, which were repaid during the second half of 2020. During each of the years ended December 31, 2019 and 2018, there were no issuances or repayments under this funding agreement program. See Note 3 of the Notes to the Consolidated Financial Statements for additional information on FHLB funding agreements.
The total amount presented for insurance liabilities of $70.4 billion exceeds the sum of the liability amounts for future policy benefits and of $47.9 billion presented on the consolidated balance sheet principally due to (i) the time value of money, which accounts for a substantial portion of the difference; and (ii) differences in assumptions, most significantly mortality, between the date the liabilities were initially established and the current date; and are partially offset by liabilities related to accounting conventions (such as interest reserves and unearned revenue), or which are not contractually due, which are excluded.
Actual cash payments on policyholder account balances may differ significantly from the liabilities as presented on the consolidated balance sheet and the estimated cash payments as presented in the table above due to differences between actual experience and the assumptions used in the establishment of the liabilities and the estimation of the cash payments. All estimated cash payments are presented gross of any reinsurance recoverable.
The total amount presented for long-term debt differs from the total amount presented on the consolidated balance sheet as the amounts presented herein do not include unamortized premiums or discounts and debt issuance costs incurred upon issuance and include future interest on such obligations for the period from January 1, 2021 through maturity. Future interest on variable rate debt was computed using prevailing rates at December 31, 2020 and, as such, does not consider the impact of future rate movements. Future interest on fixed rate debt was computed using the stated rate on the obligations.
Benefit Base A notional amount (not actual cash value) used to calculate the owner’s guaranteed benefits within an annuity contract. The death benefit and living benefit within the same contract may not have the same Benefit Base.
An optional benefit (available for an additional cost) where an annuitant is entitled to annuitize the policy and receive a minimum payment stream based on the Benefit Base, which could be greater than the underlying account value.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2021, expressed an unqualified opinion on the Company’s internal control over financial reporting.
The Company sells index-linked annuities and variable annuity products with guaranteed minimum benefits, some of which are embedded derivatives that are required to be bifurcated from the host contract, separately accounted for, and measured at fair value. As of December 31, 2020, the fair value of the embedded derivative liability associated with certain of the Company’s annuity contracts was $7.2 billion. Management utilizes various assumptions in order to measure the embedded liability including expectations concerning policyholder behavior, mortality and risk margins, as well as changes in the Company’s own nonperformance risk. These assumptions are reviewed at least annually by management, and if they change significantly, the estimated fair value is adjusted by a cumulative charge or credit to net income.
•With the assistance of our actuarial specialists, we evaluated the appropriateness of the significant assumptions, tested the completeness and accuracy of the underlying data and the mathematical accuracy of the Company’s valuation model.
For term and non-participating whole life insurance, assumptions for mortality and persistency are based upon the Company’s experience. Interest rate assumptions for the aggregate future policy benefit liabilities range from 3% to 9%. The liability for single premium immediate annuities is based on the present value of expected future payments using the Company’s experience for mortality assumptions, with interest rate assumptions used in establishing such liabilities ranging from 0% to 8%.
For its life products, the Company has historically reinsured the mortality risk primarily on an excess of retention basis or on a quota share basis. In addition to reinsuring mortality risk as described above, the Company reinsures other risks, as well as specific coverages. Placement of reinsurance is done primarily on an automatic basis and also on a facultative basis for risks with specified characteristics. On a case-by-case basis, the Company may retain up to $20 million per life and reinsure 100% of amounts in excess of the amount the Company retains. The Company also reinsures 90% of the risk associated with participating whole life policies to a former affiliate and assumes certain term life policies and universal life policies with secondary death benefit guarantees issued by a former affiliate. The Company evaluates its reinsurance programs routinely and may increase or decrease its retention at any time.
The changes in the allowance for credit losses by portfolio segment were as follows:
(1)The related loaned security could be returned to the Company on the next business day which would require the Company to immediately return the cash collateral.
As described in Note 1, the Company generally records its share of earnings in its equity method investments using a three-month lag methodology and within net investment income. Aggregate net investment income from these equity method investments exceeded 10% of the Company’s consolidated pre-tax income (loss) for each of the years ended December 31, 2020, 2019 and 2018. This aggregated summarized financial data does not represent the Company’s proportionate share of the assets, liabilities or earnings of such entities.
NELICO sponsors both a qualified and a non-qualified defined benefit pension plan, a postretirement plan and other unfunded benefit plans. These pension and other unfunded benefit plans were amended to cease benefit accruals and are closed to new entrants. The qualified defined benefit pension plan had an accumulated benefit obligation of $182 million and $164 million at December 31, 2020 and 2019, respectively. This plan was fully funded at December 31, 2020 and 2019 with assets in excess of the accumulated benefit obligation of $8 million and $7 million, respectively. The Company did not make any employer contributions to this qualified plan during 2020 or 2019.
The following table sets forth the net operating loss carryforwards for tax purposes at December 31, 2020.
For the periods prior to the Separation, Brighthouse Financial filed a consolidated federal life and non-life income tax return in accordance with the provisions of the Tax Code. Current taxes (and the benefits of tax attributes such as losses) are allocated to Brighthouse Financial, Inc., and its includable subsidiaries, under the consolidated tax return regulations and a tax sharing agreement with MetLife. This tax sharing agreement states that federal taxes will be computed on a modified separate return basis with benefits for losses.
(1)Includes unamortized debt issuance costs, discounts and premiums, as applicable, totaling net $35 million and $42 million for the senior notes and junior subordinated debentures on a combined basis at December 31, 2020 and 2019, respectively.
All of the transactions reported as related party activity occurred prior to the MetLife Divestiture (see Note 1). For the year ended December 31, 2018, reinsurance ceded and assumed included related party transactions for life insurance premiums of $201 million and $6 million, respectively.