The most significant assumptions underlying the valuation of the Company’s pension valuation are the expected future rate of return on Plan assets and the discount rate which, at January 1, 2003, were determined to be 8.0% and 6.125%, respectively. Each 1% increment in the return on assets lowers the future expected annual GAAP expense for 2005 and later by approximately $700,000, while each 1% decrease in the discount rate adds approximately $9.6 million to annual expense.
Below is a summary of the changes in the Company’s commercial mortgage portfolio for the years ended December 31, 2003, 2002 and 2001, respectively.
The following tables present certain information by type of investment with respect to securities sold which resulted in a loss for the year ended December 31, 2003 and the year ended December 31, 2002, including: (i) the number of positions sold that comprise the aggregate gross realized loss for the period; (ii) the aggregate fair value of such securities at the date of their sale, (iii) the aggregate carrying value of such securities at the date of sale; (iv) the aggregate gross amount of the realized loss recorded from the sale of such securities during the period;, and (v) the gross realized losses reported for each period sorted in descending order by percentage of sales price to carrying value at date of sale. Excludes amounts relating to certain invested assets held pursuant to a reinsurance arrangement whereby all the experience from such assets is passed to the reinsurer.
The following sets forth certain summarized financial information relating to the Group Pension Transaction for the periods indicated, including information regarding the components of revenue and expense comprising the Group Pension Profits. In accordance with GAAP, the Group Pension Transaction did not constitute a sale because the Company retained substantially all the risks and rewards associated with the business transferred to Aegon. Accordingly, over the life of the transaction the Company was required to reflect the transferred assets and liabilities on its balance sheet under separate captions entitled “Assets transferred in Group Pension Transaction” and “Liabilities transferred in Group Pension Transaction”. As a result of the expiration of the transaction at December 31, 2002 and the recognition of earnings from the Final Value Payment from Aegon, the Company has no further interest in the transferred assets and liabilities and, accordingly, such assets and liabilities are no longer reflected on the Company’s balance sheet.
Other income (net) and its related decrease of approximately $55.5 million, to $24.8 million for the year ended December 31, 2003 from $80.3 million for the year ended December 31, 2002, primarily consisted of the following:
For the year ended December 31, 2003 commissions and expense allowances on reinsurance ceded were $7.7 million, a decrease of $92.4 million from $100.1 million reported for the year ended December 31, 2002. The decrease is primarily due to a decrease of $91.7 million in profits on the transferred group pension business (see Group Pension Transaction).
The change in deferred income taxes during 2003 was $(4.2) million. There was no change reported during 2002 as the net deferred tax was established as of December 31, 2002 (see New Statutory Accounting Practices).
In connection with the Group Pension Transaction, on December 31, 1993, the Company made a $200 million capital investment in AEGON USA by purchasing $150 million of Series A and $50 million of Series B notes. The Series A notes paid interest at 6.44% and the Series B notes paid interest at 6.24% per annum. The Series A notes matured on April 7, 2003 and the Series B notes matured on December 31, 2002.
Mortgage loans, consisting of commercial, agricultural and residential loans, comprised 10.3% and 11.1% of total invested assets in the Closed Block at December 31, 2003 and 2002, respectively. As of December 31, 2003 and 2002, commercial mortgage loans comprised $558.2 million and $593.1 million, or 91.0% and 93.3% of total mortgage loan investments, respectively. Agricultural loans comprised $44.5 million and $42.5 million, or 7.4% and 6.7% of total mortgage loans, and residential mortgages comprised $0.2 million and $0.2 million of total mortgage loan investments at the dates indicated, respectively.
Real estate investments meeting the following criteria are classified as “real estate to be disposed of” in the Company’s consolidated balance sheets and the results therefrom are reported as “discontinued operations” in the Company’s consolidated statement of income and comprehensive income as a result of the Company’s adoption in 2002 of Financial Accounting Standard Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”):
• The property is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets;
Policyholders’ account balances for universal life and investment-type contracts represent an accumulation of gross premium payments plus credited interest less expense and mortality charges and withdrawals. The weighted average interest crediting rate for universal life products was approximately 5.5%, 5.6% and 5.9% for the years ended December 31, 2003, 2002, and 2001, respectively. The weighted average interest crediting rate for investment-type products was approximately 4.2%, 4.3% and 4.5% for the years ended December 31, 2003, 2002, and 2001, respectively.
The following table presents the amortized cost, gross unrealized gains and losses, and estimated fair value of fixed maturity securities, including the DSCA Sub-account OB (see Note 21) and amounts relating to certain invested assets held pursuant to a reinsurance arrangement whereby all the experience from such assets is passed to the reinsurer, as of December 31, 2003 and 2002.
The Company has a qualified pension plan covering substantially all of MONY Life’s salaried employees. The provisions of the plan provide both (a) defined benefit accruals based on: (i) years of service, (ii) the employee’s final average annual compensation and (iii) wage bases or benefits under Social Security, and (b) defined contribution accruals based on a Company matching contribution equal to 100% of the employee’s elective deferrals under the incentive savings plan for employees up to 3% of the employee’s eligible compensation and an additional 2% of eligible compensation for each active participant. Effective June 15, 1999, prospective defined contribution accruals in the defined benefit plan ceased and were redirected to the Investment Plan Supplement for Employees of MONY Life. The Company did not make any contribution in the current or prior year under Section 404 of the Internal Revenue Code (“IRC”) because the plan was fully funded under Section 412 of the IRC.
Assumed health care cost trend rates typically have a significant effect on the amounts reported for health care plans, however, under the Company’s postretirement healthcare plan, there is a per capita limit on the Company’s healthcare costs. As a result, a one-percentage point change in the assumed healthcare cost trend rates would have an immaterial effect on amounts reported.
(1) Expenses of approximately $6.0 million relating to the Final Value Payment are recorded in “other operating costs and expenses” on the Company’s consolidated statement of income and comprehensive income for 2002.
At the effective date of the initial grants of options pursuant to the 1998 SIP, the Company elected to apply the accounting prescribed by APB 25 to option grants to employees and, accordingly, make the required pro forma disclosures of net income and earnings per share as if the fair value accounting prescribed by SFAS 123 had been adopted (see Note 4). Pursuant to the requirements of APB 25, the options granted by the Company under the 1998 SIP and the 2002 SOP to employees qualify as non-compensatory. Accordingly, the Company is not required to recognize any compensation expense with respect to such option grants. Based on the definition of an “employee” prescribed in the Internal Revenue Code, the Company’s career financial professionals do not qualify as employees. Accordingly, with respect to grants of options under both the SIP and the SOP to career financial professionals, the Company adopted the accounting provisions of SFAS 123. Pursuant to the guidance in SFAS 123 and related interpretations, vesting provisions attached to stock based compensation issued to non-employees constitute a performance based condition which requires variable plan accounting. Under variable plan accounting, the fair value of the option grant must be re-measured at the end of each accounting period, until the options are 100 percent vested. Accordingly, the compensation cost charged to expense during any particular accounting period represents the difference between the vested percentage of the fair value of the options at the end of the accounting period and the cumulative compensation cost charged to expense in prior periods. Compensation cost is determined based on the fair value of such options using a Black-Scholes option-pricing model (see below for further discussion regarding how fair value is determined). Such compensation cost is required to be recognized over the vesting period. The compensation expense related to options granted to career financial professionals varies with and primarily relates to the production of business and as such is recognized as DPAC and is amortized on a basis consistent with how earnings emerge from the underlying products that gave rise to such DPAC. The deferred expense amount relating to options granted to career financial professionals which were outstanding was $0.5 million and $0.0 million for the years ended December 31, 2003 and 2002, respectively.
MONY Holdings’ cash inflows principally consist of investment income from its invested assets and dividends from MONY Life, if declared and paid. MONY Holdings’ cash outflows principally consist of expenses incurred in connection with the administration of MONY Holdings’ affairs, interest expense on its outstanding indebtedness and dividends to MONY Group, if declared and paid. The amount of dividends from MONY Holdings to MONY Group is largely dependent upon the amount of dividends available to MONY Holdings from MONY Life in excess of that attributable to the CBB. The payment of dividends from MONY Life to MONY Holdings is regulated under state insurance law. In 2003, MONY Life paid a dividend to MONY Holdings in the amount of $25.0 million, of which $13.8 million was retained by MONY Holdings in its DSCA Sub-account CBB (see Note 22) and $11.2 million was paid by MONY Holdings in the form of a dividend to MONY Group. In 2002, MONY Life paid a dividend to MONY Holdings in the amount of $90.0 million, of which $15.6 million was retained by MONY Holdings in its DSCA Sub-account CBB and $74.4 million was paid by MONY Holdings in the form of a dividend to MONY Group.
The following tables summarize the components of the aforementioned charges recorded in 2003, 2002 and 2001, respectively. None of the charges referred to below as “Reorganization Charges” have been allocated to the Company’s operating segments, however, the charges in 2001 referred to as “Other Charges” have been allocated to the Company’s operating segments. All Reorganization Charges incurred in 2003, 2002 and 2001 are reported as reconciling items.
On February 27, 2002, MONY Group formed a downstream holding company, MONY Holdings. On April 30, 2002, MONY Group transferred all its ownership interests in MONY to MONY Holdings, and MONY Holdings, through a structured financing tied to the performance of the Closed Block Business within MONY Life, issued $300 million of floating rate insured debt securities in a private placement. The Closed Block Business consists of MONY Life’s regulatory Closed Block and surplus and related assets within MONY Life that support the business in the regulatory Closed Block. Other than activities related to servicing the notes in accordance with the indenture and it’s ownership of MONY Life, MONY Holdings has no operations and engages in no other activity.
The New York State Insurance Department recognizes only statutory accounting practices prescribed or permitted by the State of New York for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under New York Insurance Law. The National Association of Insurance Commissioners’ (“NAIC”) Accounting Practices and Procedures manual [effective January 1, 2001] as of March 2003, (“NAIC SAP”) has been adopted as a component of prescribed or permitted practices by the State of New York. The NAIC Accounting Practices and Procedures manual is composed of the Preamble, the Statements of Statutory Accounting Principles (“SSAPs”), and Appendices. New York State has adopted certain prescribed accounting practices that differ from those found in NAIC SAP. Specifically, goodwill arising from the purchase of a subsidiary, controlled or affiliated entity is written off directly to surplus in the year it originates by New York domiciled companies. In NAIC SAP, goodwill in amounts not exceeding 10% of an insurer’s capital and surplus may be capitalized and all amounts of goodwill are amortized to unrealized gains and losses on investments over periods not to exceed 10 years.
The Company amortizes electronic data processing equipment (EDP) on a straight-line basis over a three-year period. The Company recorded EDP depreciation expense of $2.7 million and $3.3 million for the years ended December 31, 2003 and 2002, respectively. EDP equipment totaled $21.9 million, accumulated depreciation was $17.8 million, and the net admitted asset was $4.1 million at December 31, 2003.
Due and accrued income was excluded from surplus for all investment income due and accrued with amounts that are 90 days past due with the exception of mortgage loans in default. Investment income due and accrued that was excluded from surplus as a non-admitted asset was $4.3 million and $7.8 million at December 31, 2003 and 2002, respectively.
Net realized capital gains (losses) on investments for the years ended December 31, 2003 and 2002 are summarized as follows (in millions):
Unaffiliated equity securities primarily consist of investments in common stocks and limited partnership interests. The fair value of the Company’s investments in common stocks are determined based on quoted market prices, where available. The fair value of the Company’s investments in limited partnership interests are based on amounts reported by such partnerships to the Company.
(iii) In July 2002, pursuant to a jury verdict, the Company was found liable and ordered to pay a former joint venture partner some of the proceeds distributed to the Company from the disposition of a real estate asset in 1999, which was formerly owned by the joint venture. As a result of the verdict, which the Company appealed, the Company recorded a charge aggregating $12.9 million pre-tax in its results of operations, for the quarter ended June 30, 2002. Approximately, $6.4 million of this charge was reflected in the statement of operations caption entitled “net realized capital losses” because it represents the return of proceeds originally included in the determination of the realized gain recognized by the Company in 1999 upon receipt of the aforementioned distribution. The balance of the charge, which is reflected in the statement of operations under the caption entitled “other income (net)” represented management’s best estimate of the interest that the court will require the Company to pay its former joint venture partner, as well as legal costs. In the first quarter of 2003, the Company settled the litigation for approximately $4.1 million less than the provision previously recorded. Accordingly, during the first quarter of 2003, the Company reversed such overaccrual to income, approximately
relating to the accuracy and/or completeness of information provided by MONY Group in such proxy statement. Thereafter, plaintiffs requested a hearing on their motion for a preliminary injunction to enjoin the stockholder vote which had been scheduled to occur at the special meeting on February 24, 2004. A hearing on plaintiffs’ motion for a preliminary injunction was held on February 13, 2004. By order dated March 1, 2004, and an opinion released on February 17, 2004, Vice Chancellor Lamb granted plaintiffs’ motion to the limited extent of enjoining MONY Group from proceeding with the special meeting until MONY Group provides supplemental disclosure to its stockholders relating to the amount of the benefits that the MONY Group executives would receive under the CIC agreements relative to the amounts received by executives in the other transactions the independent directors and their advisors had considered at least ten days before the special meeting. Vice Chancellor Lamb otherwise rejected plaintiffs’ arguments in support of an injunction based on the directors’ purported breach of fiduciary duty, the associated aiding and abetting claims and plaintiffs’ other disclosure claims.