MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Explanatory Statement
The accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations gives effect to the restatement of the consolidated financial statements for the years ended December 31, 2003 and 2002 as described in Note 12 to such financial statements included in Item 8, of Part II, of this Form 10-K. The restatement is due to the Corporation’s determination that the issuers of certain principal protected notes purchased by the Corporation are required to be consolidated with the Corporation’s results from the dates that such notes were purchased by the Insurance Company. As a result of the consolidation, the principal protected notes previously recorded by the corporation are eliminated and the Corporation records the individual assets of the issuers of the principal protected notes (the underlying variable rate income notes and U.S. Treasury Strips or similar instruments) and applies applicable accounting standards to these underlying assets, including the provisions of EITF 99-20 with respect to the variable income notes. In addition, in connection with the restatement the Corporation has applied the provisions of EITF 99-20 to other principal protected note investments whose issuers are not required to be consolidated. Although the Corporation has a demonstrated ability and intention to hold these instruments to maturity until recovery of fair value at or above cost and does not have the ability to cause the liquidation of the issuers of those instruments, the Corporation has deemed it appropriate to apply the provisions of EITF 99-20 in accounting for these instruments to present consistent accounting treatment for all of its principal protected note investments, regardless of whether consolidation is required. The effect of the restatement on the Corporation’s financial statements is summarized as follows:
The aforementioned other than temporary impairment charges and amortization of discount on the treasury strips impact gross profits in each of the affected years and, therefore, affect deferred policyholder acquisition cost amortization and deferred tax amounts in such years.
(1) The impairment of the variable rate income notes is treated as a realized loss as of the date the Corporation determined they were other than temporarily impaired. In most instances, that occurred during 2001. This resulted in a cumulative increase in realized capital loss at December 31, 2001 in the amount of $137.8 million and such cumulative capital loss was recorded as a reduction of retained earnings as of January 1, 2002. This was offset substantially by a reduction of unrealized losses as of the same dates and a corresponding increase in other comprehensive income. (See Selected Financial Data on page 18).
The short-term notes payable relates to a line of credit issued by The Bank of New York in the amount of $50,000,000. The line of credit provides for interest on borrowings based on the 30, 60 and 90-day LIBOR rate depending on the duration of the Corporation’s periodic renewals. At December 31, 2004 the Corporation had the full $50,000,000 outstanding. The line of credit renews annually and is up for renewal on April 22, 2005. If the bank chooses not to renew the line of credit, the Corporation would be forced to pay-down the $50,000,000 in April 2005 or seek alternative financing options. The Corporation does not believe that there would be a material adverse impact on its liquidity or cash flow position if the line of credit were called in April 2005
In March 2004, the Emerging Issues Task Force (“EITF”) reached further consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (“EITF 03-1”). EITF 03-1 provides
The Insurance Company incurs significant costs in connection with acquiring new business. These costs, which vary with and are primarily related to the production of newbusiness, are deferred. The recovery of such costs is dependent upon the future profitability of the related product, which in turn is dependent mainly on investment returns in excess of interest credited, as well as, persistency and expenses. These factors enter into management¢s estimate of future gross profits, which generally are used to amortize such costs. Changes in these estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the deferred acquisition cost asset and a charge to income if estimated future gross profits are less than amounts deferred.