Tax Matters Agreement. As a consequence of our separation from GE, and our election jointly made with GE to treat that separation as an asset sale under section 338 of the Internal Revenue Code, we became entitled to additional tax deductions for post-IPO periods. For further discussion of our Tax Matters Agreement, see note 14 to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data.”
development and policy cancellations. These assumptions are based on our historical experience and our expectations of future performance, which are highly dependent on assumptions as to long-term macroeconomic conditions including interest rates, home price appreciation and the rate of unemployment. We periodically review our expected pattern of risk emergence and make adjustments based on actual experience and changes in our expectation of future performance with any adjustments reflected in current period income. For the years ended December 31, 2006 and 2005, increases to international mortgage insurance earned premiums as a result of adjustments made to our expected pattern of risk emergence and policy cancellations were $74 million and $21 million, respectively.
Acquisition and operating expenses, net of deferrals. Acquisition and operating expenses, net of deferrals, increased primarily due to a $153 million increase in our Protection segment, a $27 million increase in our Mortgage Insurance segment and a $21 million increase in Corporate and Other. The increase in our Protection segment was primarily attributable to an increase in commissions and other expenses in our payment protection insurance runoff block and higher non-deferrable acquisition costs in our long-term care and life businesses. The increase in our Mortgage Insurance segment was primarily attributable to increased costs in our existing international platforms and continued investments in potential new international mortgage insurance platforms. The increase in Corporate and Other is attributable to an increase in stand-alone costs as we transition towards full independence from GE and increased equity based compensation expense. These increases were partially offset by a $123 million decrease in our Affinity segment due to our corporate formation in 2004.
The effective tax rate decreased to 35.8% for the year ended December 31, 2005 from 36.7% for the year ended December 31, 2004. This decrease in effective tax rate was primarily attributable to a reduction in excess foreign tax credits and a favorable examination development in 2005.
The following table sets forth selected operating performance measures regarding our fee-based products as of or for the dates indicated:
The decrease in net operating income for the year ended December 31, 2005 was primarily attributable to higher impairments on fixed maturities and a decrease in policy fees and other income associated with a $25 million after-tax gain recognized in 2004 related to our waiver of contractual rights under an outsourcing services agreement with our global outsourcing provider, increases in stand-alone public company costs and interest expense as a result of changes to our debt structure as a result of our IPO, as well as, higher short-term interest rates on our short-term borrowings and the decreased benefit for income taxes due to nonrecurring IPO-related tax benefits recognized in 2004.
The total investment portfolio increased $3.2 billion. The increase was primarily due to cash generated from operating activities, net of cash used for financing activities, which was invested in fixed maturities and commercial mortgage loans compounded by an increase in the securities lending program. This was partially offset by lower net unrealized gains as a result of a higher interest rate environment and the derecognition of restricted investments held by securitization entities from our consolidated statement of financial position.
For the years ended December 31, 2006, 2005 and 2004, we recognized impairments of $8 million, $71 million and $26 million, respectively. We generally intend to hold securities in unrealized loss positions until they recover. However, from time to time, we sell securities in the ordinary course of managing our portfolio to meet diversification, credit quality, yield and liquidity requirements. The aggregate fair value of securities sold at a loss during twelve months ended December 31, 2006 was $4,352 million, which was approximately 97.4% of book value.
In connection with our corporate formation, we assumed ¥60 billion in Yen Notes from GEFAHI. In the third quarter of 2004, we retired the ¥3 billion of Yen Notes that were transferred to us. We entered into arrangements to swap our obligations under the Yen Notes to a U.S. dollar obligation with a principal amount of $478 million and bearing interest at a rate of 4.84% per annum.
In general, our business as a whole is not seasonal in nature. However, in our Mortgage Insurance segment, the level of delinquencies, which increases the likelihood of losses, tends to decrease in the first and second quarters of the calendar year and increase in the third and fourth quarters. As a result, we have experienced lower levels of losses resulting from delinquencies in the first and second quarters, as compared with the third and fourth quarters.
Mortgage Insurance. In the U.S., Canada, Australia, New Zealand, Mexico, Japan and multiple European countries, we offer mortgage insurance products that enable borrowers to buy homes with low-down-payments. We also provide mortgage insurance on a structured, or bulk basis, that aids in the sale of mortgages to the capital markets, and which helps lenders manage capital and risks. Additionally, we offer services, analytical tools and technology that enable lenders to operate more efficiently and more effectively manage risk.
Investment income on mortgage-backed and asset-backed securities is initially based upon yield, cash flow, and prepayment assumptions at the date of purchase. Subsequent revisions in those assumptions are recorded using the retrospective or prospective method. Under the retrospective method, used for mortgage-backed and asset-backed securities of high credit quality (ratings equal to or greater than AA or that are U.S. Agency backed) which cannot be contractually prepaid, amortized cost of the security is adjusted to the amount that would have existed had the revised assumptions been in place at the date of purchase. The adjustments to amortized cost are recorded as a charge or credit to net investment income. Under the prospective method, which is used for all other mortgage-backed and asset-backed securities, future cash flows are estimated and interest income is recognized going forward using the new internal rate of return. As of December 31, 2006, all our mortgage-backed and asset-backed securities that have had subsequent revisions in yield, cash flow or prepayment assumptions are accounted for under the retrospective method.
servicers, using assumptions of claim rates for loans in default and the average amount paid for loans that result in a claim. As is common accounting practice in the mortgage insurance industry and in accordance with U.S. GAAP, loss reserves are not established for future claims on insured loans that are not currently in default. During the fourth quarter of 2006, we performed a periodic update of our Australian loss reserve factors which resulted in a $34 million increase in our reserves for losses and loss adjustment expenses.
Adjustments are the result of a $69 million reclassification from future annuity and contract benefits, partially offset by a $44 million decrease related to the reclassification of certain reinsurance assumed determined to be deposit method of accounting.
The following table sets forth the effects of reinsurance on premiums written and earned for the years ended December 31:
(b) Principally modifications of the 1965-70 or 1975-80 Select and Ultimate Tables, 1958 and 1980 Commissioner’s Standard Ordinary Tables, 1980 Commissioner’s Extended Term table and (IA) Standard Table 1996 (modified).
Net operating loss carryforwards (“NOL”) amounted to $684 million as of December 31, 2006 and, if unused, will expire beginning in 2020. The benefits of the NOL carryforwards have been recognized in our consolidated financial statements, except to the extent of the valuation allowances described above relating to state and foreign taxes.
As a consequence of our separation from GE, and our joint election with GE to treat that separation as an asset sale under section 338 of the Internal Revenue Code, we became entitled to additional tax deductions in post-IPO periods. We have recorded on our Consolidated Balance Sheets, at $656 million and $659 million, our estimates of the remaining deferred tax benefits (reducing net deferred income tax liabilities) associated with these deductions as of December 31, 2006 and 2005, respectively. We are obligated, pursuant to our Tax Matters Agreement with GE, to make fixed payments to GE, over the next 16 years, on an after-tax basis and subject to a cumulative cap of $640 million, 80% of the projected tax savings associated with the section 338 deductions. We recorded net interest expense of $22 million, $25 million and $10 million for the years ended December 31, 2006, 2005 and 2004, respectively, reflecting accretion of our liability at the Tax Matters Agreement rate of 5.72%. We have recorded the estimated $380 million and $379 million present value of our remaining obligation
For awards issued prior to January 1, 2006, stock-based compensation expense is recognized on a graded vesting attribution method over the awards’ respective vesting schedule. For awards issued after January 1, 2006, stock-based compensation expense is recognized evenly on a straight-line attribution method over the awards’ respective vesting period.
A summary of stock option activity for the years ended December 31, 2006 and 2005 is presented below:
Our holding companies received dividends from our domestic insurance subsidiaries of $587 million ($231 million of which are deemed “extraordinary”), $639 million ($76 million of which are deemed “extraordinary”) and $2,111 million ($1,244 million of which are deemed “extraordinary”), during 2006, 2005 and 2004, respectively.
Statutory net income (losses) from our captive life reinsurance subsidiaries relate to their assumption reinsurance of statutorily required term and universal life insurance reserves from our U.S. domiciled life insurance companies. These reserves are, in turn, funded through the issuance of surplus notes (non-recourse funding obligations) to third parties. Accordingly, the life insurance subsidiaries combined statutory net income and distributable earnings are not affected by the statutory net income (losses) of the captives, except to the extent dividends are received from the captives. The combined statutory capital and surplus of our life insurance subsidiaries does not include the capital and surplus of our captive life reinsurance subsidiaries of $1,175 million and $521 million as of December 31, 2006 and 2005, respectively. Capital and surplus of our captive life reinsurance subsidiaries includes surplus notes (non-recourse funding obligations) as further described in note 13.
We currently conduct our operations in three operating business segments: (1) Protection, which includes our life insurance, long-term care insurance, linked benefit products, Medicare supplement insurance, group life and health insurance and payment protection insurance business; (2) Retirement Income and Investments, which includes our fixed annuities, individual variable annuities, group variable annuities designed for retirement plans, single premium immediate annuities, variable life insurance, specialized products, including GICs, funding agreements, and FABNs, and asset management products and services; (3) Mortgage Insurance, which includes our mortgage insurance products and mortgage-related services that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages business. Prior to our corporate formation we also conducted operations in a fourth business segment, Affinity, which included life and health insurance and other financial products and services offered directly to consumers through affinity marketing arrangements with a variety of organizations, an institutional asset management business and several other small businesses that are not part of our core ongoing business. The lines of business and assets and liabilities of our Affinity segment were not transferred to us in our corporate formation, therefore the results or operations of the Affinity segment are only included in our results until May 24, 2004. We also have Corporate and Other activities, which include interest and other debt financing expenses and other corporate income and expenses not allocated to the segments, as well as the results of a small, non-core business that is managed outside of our operating segments.
As of December 31, 2006, we were committed to fund $298 million in U.S. commercial mortgage loans and $208 million to fund interests in limited partnerships.