The Registrant's home office is located in Little Rock, Arkansas. In addition, personnel performing services for the Registrant pursuant to its Management Services Agreement operate in MLIG office space. MLIG occupies certain office space in Princeton, New Jersey through Merrill Lynch & Co. An allocable share of the cost of each of these premises is paid by the Registrant through the service agreement with MLIG. Merrill Lynch Insurance Group Services, Inc. ("MLIGS"), an affiliate of MLIG, owns office space in Jacksonville, Florida. MLIGS also leases certain office space in Springfield, Massachusetts from Picknelly Family Limited Partnership. During 2001, MLIGS consolidated operations into the Jacksonville, Florida location. MLIGS continues to lease the office space in Springfield, Massachusetts, although there are no personnel at that location.
In addition to providing historical information, Merrill Lynch Life may make or publish forward-looking statements about management expectations, strategic objectives, business prospects, anticipated financial performance, and other similar matters. A variety of factors, many of which are beyond Merrill Lynch Life's control, affect the operations, performance, business strategy, and results of Merrill Lynch Life and could cause actual results and experience to differ materially from the expectations and objectives expressed in these statements. These factors include, but are not limited to, the factors listed in the Business Environment and Economic Environment sections listed below, as well as actions and initiatives taken by both current and potential competitors and the effect of current, pending, and future legislation and regulation. MERRILL LYNCH LIFE UNDERTAKES NO RESPONSIBILITY TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS.
Merrill Lynch Life has determined that its financial exposure related to the events and aftermath of the terrorist attacks ("Attacks") on September 11, 2001 can be characterized into the following risk categories: mortality risk, equity price risk, and credit risk. The following discusses each type of risk in greater detail and its impact, either actual or potential, on Merrill Lynch Life.
Mortality Risk - In quantifying mortality risk directly associated with the Attacks, Merrill Lynch Life has not experienced a material financial impact due to reported death claims and does not anticipate a material financial impact of death claims incurred but not reported. Mitigating factors of direct mortality risk include i) Merrill Lynch Life is not licensed to sell individual or group life insurance and annuities in the State of New York, where the largest concentration of mortality risk exists, and ii) Merrill Lynch Life does not assume mortality risks of other life insurance companies.
- - Reductions in separate accounts assets. Asset based fees collected on separate accounts assets are a primary source of earnings for Merrill Lynch Life, thus lower asset balances will result in lower fee income. During the month of September 2001, Merrill Lynch Life's separate accounts assets decreased $819 million, or 7% as compared to August 2001. Approximately $801 million of this decrease was due to negative investment performance in the underlying mutual funds supporting variable products. Although investment performance rebounded during the fourth quarter 2001, earnings have been negatively impacted due to this reduction in separate accounts assets.
Credit Risk - Airline, insurance, and hotel & tourism sectors have been particularly impacted by the Attacks. As such, credit quality within those sectors has been negatively affected. Merrill Lynch Life monitors its credit exposure to these sectors on a daily basis. Merrill Lynch Life has not incurred any realized losses due to the sale or book value writedown of any securities in these sectors.
Technology - Merrill Lynch Life's policy administration systems were not impacted by the Attacks and contract owner processing for all fixed product transactions continued as normal. Variable product processing was suspended during the closure of the stock exchanges and resumed on Monday, September 17. Also, Merrill Lynch Life relocated certain financial systems to a designated disaster recovery location in accordance with Merrill Lynch & Co. policy.
Demographically, the population is aging, which favors life insurance and annuity products. During June 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "Act"). The primary provision in the Act that directly impacts Merrill Lynch Life's business is the reform and eventual repeal of the estate tax. Under the new tax law, the annual estate tax exemption will increase from $0.675 million in 2001 to $3.5 million in 2009, with an anticipated complete repeal of the estate tax in 2010. During the third quarter 2001, Merrill Lynch Life decided to discontinue marketing its estate planning life insurance products (discussed below).
Merrill Lynch Life sells variable and interest-sensitive life insurance and annuity products through Merrill Lynch & Co.'s retail network of Financial Advisors. Merrill Lynch Life competes for Merrill Lynch & Co.'s clients' life insurance and annuity business with unaffiliated insurers whose products are also sold through Merrill Lynch & Co.'s retail network, and with insurers who solicit this business directly. The product lines that Merrill Lynch Life offers are focused in the highly competitive market segment of retirement and death benefit planning. Merrill Lynch Life competes in this market segment by integrating its products into Merrill Lynch & Co.'s planning-based financial management program.
Merrill Lynch Life's total sales decreased 24% during 2001, as compared to a 25% increase during 2000. During 2001, variable annuity sales decreased $320.0 million (or 23%) as compared to 2000, but continued to dominate overall sales by comprising 90%, 89%, and 86% of total direct premiums for 2001, 2000, and 1999, respectively. Management believes that variable annuity sales have been impacted by equity market volatility related to both the general economic slowdown, as well as the aftermath of the Attacks of September 11.
Merrill Lynch & Co. offers for sale numerous non-proprietary variable annuity products issued by unaffiliated insurers. Merrill Lynch Life's market share of variable annuity sales within the Merrill Lynch & Co. distribution system was 40%, 43% and 37% for 2001, 2000 and 1999, respectively.
As of December 31, 2001, Merrill Lynch Life had 34,892 life insurance and annuity contracts inforce with interest rate guarantees. The estimated average rate of interest credited on behalf of contract owners was 4.75% during 2001. Invested assets supporting liabilities with interest rate guarantees had an estimated effective yield of 6.45% during 2001. The number of life insurance and annuity contracts inforce with interest rate guarantees decreased 10% as compared to 2000.
In order to continue to issue life insurance and annuity products, Merrill Lynch Life must meet or exceed the statutory capital and surplus requirements of the insurance departments of the states in which it conducts business. Statutory accounting practices differ from generally accepted accounting principles ("GAAP") in two major respects. First, under statutory accounting practices, the acquisition costs of new business are charged to expense, while under GAAP they are amortized over a period of time. Second, under statutory accounting practices, the required additions to statutory reserves for new business in some cases may initially exceed the statutory revenues attributable to such business. These practices result in a reduction of statutory income and surplus at the time of recording new business.
Merrill Lynch Life has developed a comprehensive capital management plan that will continue to provide appropriate levels of capital for the risks Merrill Lynch Life assumes, but will allow Merrill Lynch Life to reduce its absolute level of surplus. In implementing this plan, Merrill Lynch Life paid cash dividends to MLIG of $65.0 million and $135.0 million during 2000 and 1999, respectively. Merrill Lynch Life also paid a $0.5 million stock dividend during 1999. No dividends were paid during 2001.
- - the charges imposed on variable life insurance and variable annuity contracts, and
The costs associated with acquiring contract owner deposits are amortized over the period in which Merrill Lynch Life anticipates holding those funds. In addition, Merrill Lynch Life incurs expenses associated with the maintenance of inforce contracts.
Policy charge revenue decreased $14.4 million (or 5%) during 2001 as compared to 2000. The decrease in policy charge revenue is primarily attributable to the decrease in average variable account balances. During 2001, average variable account balances decreased $1.4 billion (or 11%) as compared to 2000. During the same time period, asset based policy charges decreased $15.3 million (or 9%).
(1) The increase in interest related gains is primarily attributable to increases in invested asset market valuations as compared to the same period in 2000. The increases in invested asset market valuations are primarily due to period-to-period decreases in interest rates and credit spreads.
(4) Merrill Lynch Life sold one property during 2000 that resulted in a $0.8 million gain.
The market value adjustment expense is attributable to Merrill Lynch Life's modified guaranteed annuity products. This contract provision results in a market value adjustment to the cash surrender value of those contracts that are surrendered before the expiration of their interest rate guarantee period. During 2001, the market value adjustment expense increased $1.8 million as compared to 2000. The increase is primarily due to the lower interest rate environment during 2001 as compared to 2000. The market value adjustment expense has an inverse relationship to changes in interest rates.
Policy benefits increased $16.2 million (or 75%) during 2001 as compared to 2000. The increase in policy benefits is primarily due to a $15.2 million increase in variable annuity death benefit expense incurred under guaranteed minimum death benefit provisions.
Insurance expenses and taxes increased $8.1 million (or 14%) during 2001 as compared to 2000. The increase in insurance expenses and taxes is primarily due to $10.7 million in costs related to the consolidation of Merrill Lynch Life's policy administration service centers.
Merrill Lynch Life recorded net earnings of $125.7 million and $96.1 million for 2000 and 1999, respectively.
Policy charge revenue increased $35.2 million (or 15%) during 2000 as compared to 1999. The increase in policy charge revenue is primarily attributable to the increase in average variable account balances. During 2000, average variable account balances increased $1.6 billion (or 14%) as compared to 1999. During the same time period, asset based policy charges increased $25.1 million (or 16%) consistent with the growth in the average variable account balances. Non-asset based policy charges increased $10.1 million (or 13%) during 2000 as compared to 1999 primarily due to an increase in cost of insurance charges collected on variable life insurance contracts.
Net earnings derived from interest spread decreased $3.0 million during 2000 as compared to 1999. The reduction in net earnings derived from interest spread is primarily attributable to stockholder dividend payments and the reduction in fixed rate contracts inforce.
Merrill Lynch Life experienced net realized investment gains of $0.1 million and $8.9 million during 2000 and 1999, respectively. The following table provides net realized investment gains (losses) by type:
(3) The trading account is comprised of convertible debt and convertible preferred equity securities. The valuations of these securities will generally fluctuate in a direct relationship to changes in the valuations of the underlying common equity.
(4) Merrill Lynch Life sold one property during 1999 that resulted in a $7.4 million gain.
Reinsurance premium ceded increased $2.2 million (or 10%) during 2000. The increase is attributable to the combined effect of the increasing age of contract owners and increased insurance inforce.
The decrease in other net earnings during 2001 as compared to 2000 is primarily due to the reduction of invested assets resulting from the stockholder dividend payment in 2000, as well as a $3.7 million increase in realized losses on trading account assets.
Merrill Lynch Life is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2001.
Merrill Lynch Life's operations have not been materially impacted by inflation and changing prices during the preceding three years.