Under GAAP, premiums represent revenue generated from life products with significant mortality or morbidity risks. Revenues for interest-sensitive life insurance and other products which are largely investment- related, for which deposits are treated as liabilities, are reflected as contract charges. Immediate annuities may be purchased with a life contingency whereby mortality risk is a significant factor. For this reason the GAAP revenues generated on these contracts are recognized as premiums. The following table summarizes GAAP premiums and contract charges.
Total premiums were $104.3 million in 2000 compared to $63.7 million in 1999 with the increase driven primarily by higher sales of immediate annuities with life contingencies. Immediate annuities with life contingencies increased due to higher sales resulting from a more competitive pricing strategy, introduced in late 1999, and enhanced wholesaling efforts. In 1999, total premiums decreased to $63.7 million compared to $85.8 million in 1998, primarily due to lower sales of immediate annuities with life contingencies. The types of immediate annuities sold may fluctuate significantly from year to year, which impacts premiums reported.
Total contract charges increased 8.4% during 2000 as compared to 1999, and 16.1% as compared to 1998. In both periods, variable annuity contract charges increased primarily due to increases in account value in force. Variable annuity account values increased in 2000 due to sales, partially offset by decreased market performance and benefit payments and fees. During 1999, variable annuity account values increased due to sales and market performance, partially offset by benefit payments and fees. Variable annuity contract charges, which are calculated as a percentage of each annuity account value, will fluctuate as variable account values are impacted directly by market performance. For 2000, contract charges from immediate annuities without life contingencies increased as a result of increased sales during the year. Contract charges on interest-sensitive life products increase primarily as a result of increased mortality charges as policyholders age during both periods.
Realized capital losses, after-tax, were $3.3 million in 2000 compared to $1.3 million in 1999. In both years, realized capital gains and losses were generated primarily from the sale of publicly traded corporate securities. The sales were made to better manage asset and liability duration and facilitate investing in higher yielding securities. Period to period fluctuations in realized capital gains and losses are largely the result of the timing of sales decisions reflecting management's view of individual securities and overall market conditions.
- Consistent with the marketplace, the Company's sales continued to move towards lower profit margin products, such as term life and variable annuities. These lower profit margin products require a higher volume of sales to increase the Company's operating results. The Company achieved this increased volume
- As the Company completes the current program to transition its life specialist agents to an exclusive financial specialist independent contractor status, adverse impacts to premiums could be experienced due to a decline in these agents' productivity. The Company currently expects approximately half of the exclusive agents to become licensed as Personal Financial Representatives ("PFRs") by 2002. PFRs are licensed to sell additional products such as variable annuities and mutual funds. As these agents become licensed to sell additional products, the sales trends and mix of products sold could fluctuate.
The Company has investment guidelines that define the overall framework for managing market and other investment risks, including the accountabilities and controls over these activities. In addition, the Company has specific Board of Directors-approved investment policies that delineate the investment limits and strategies that are appropriate given the Company`s liquidity, surplus, product and regulatory requirements.
The Company manages its exposure to market risk through asset allocation limits, duration limits and, as appropriate, stress tests. Asset allocation limits place restrictions on the aggregate fair value that may be invested within an asset class. Duration limits place restrictions on the amount of interest rate risk that may be taken. Stress tests measure downside risk to fair value and earnings over longer time intervals and/or for adverse market scenarios.
The day-to-day management of market risk within defined tolerance ranges occurs as portfolio managers buy and sell within their respective markets based upon the acceptable boundaries established by the investment guidelines and investment policies. The Company implemented a comprehensive daily measurement process, administered by the Investment Risk Manager, for monitoring compliance to limits established by these governance documents.
In a falling interest rate environment, the risk of pre-payment of some fixed income securities increases, causing funds to be reinvested at lower yields. The Company limits this risk by concentrating the fixed income portfolio on non-callable securities, through careful selection of mortgage-backed securities that are structured to minimize cash volatility and by purchasing securities that provide for make-whole type pre-payment fees. Falling interest rates can also impact demand for the Company's products, as bank certificates of deposits with no surrender charges and higher average returns from equity markets may become more attractive to new and existing customers. Conversely, in a rising interest rate environment, competitive pressures may make it difficult for the Company to sustain spreads between rates credited on fixed rate deferred annuities and interest-sensitive life products and portfolio earnings rates, thereby prompting withdrawals by contractholders. The Company manages this risk by adjusting interest crediting rates, at least on an annual basis, with due regard to the yield of its investment portfolio and pricing assumptions and by prudently managing interest rate risk of assets and liabilities.
To calculate duration, the Company projects asset and liability cash flows, and discounts them to a net present value basis using a risk-free market rate adjusted for credit quality, sector attributes, liquidity and other specific risks. Duration is calculated by revaluing these cash flows at an alternative level of interest rates, and determining the percentage change in fair value from the base case. The cash flows used in the model reflect the expected maturity and repricing characteristics of the Company's derivative financial instruments, all other financial instruments (as depicted in Note 5 to the financial statements), and certain non-financial instruments including interest-sensitive annuity liabilities. The projections include assumptions (based upon historical market experience and Company specific experience) reflecting the impact of changing interest rates on the prepayment, lapse, leverage and/or option features of instruments, where applicable. Such assumptions relate primarily to mortgage-backed securities, collateralized mortgage obligations, callable corporate and municipal obligations, and fixed rate single and flexible premium deferred annuities.
Based upon the information and assumptions the Company uses in its duration calculation and interest rates in effect at December 31, 2000, management estimates that a 100 basis point immediate, parallel increase in interest rates ("rate shock") would decrease the net fair value of its assets and liabilities identified above by approximately $25.2 million, versus a decrease of $31.9 million at December 31, 1999. The selection of a 100 basis point immediate parallel increase in interest rates should not be construed as a prediction by the Company's management of future market events, but only as an illustration of the potential impact of such an event.
The NAIC has a standard for assessing the solvency of insurance companies, which is referred to as risk-based capital ("RBC"). The standard is based on a formula for determining each insurer's RBC and a model law specifying the regulatory actions if an insurer's RBC falls below specified levels. The RBC formula for life insurance companies establishes capital requirements relating to insurance, business, asset and interest rate risks. At December 31, 2000, RBC for the Company was significantly above a level that would require regulatory action.
Total investments were $2.8 billion at December 31, 2000 compared to $2.2 billion at December 31, 1999. The increase was due to positive cash flows generated from operations and increases in unrealized gains on fixed income securities.
At December 31, 2000, substantially all of the Company's fixed income securities portfolio was rated investment grade, which is defined by the Company as a security having a National Association of Insurance Commissioners ("NAIC") rating of 1 or 2, a Moody's rating of Aaa, Aa, A or Baa, or a comparable Company internal rating. The quality mix of the Company's fixed income securities portfolio at December 31, 2000 is presented in the following table:
As of December 31, 2000, the fixed income securities portfolio contained $712.0 million of privately-placed corporate obligations compared to $529.8 million at December 31, 1999. The benefits of privately-placed securities as compared to public securities are generally higher yields, improved cash flow predictability through pro-rata sinking funds on many bonds, and a combination of covenant and call protection features designed to better protect the holder against losses resulting from credit deterioration, reinvestment risk and fluctuations in interest rates. A relative disadvantage of privately-placed securities as compared to public securities is reduced liquidity. At December 31, 2000, substantially all of the privately-placed securities were rated as investment grade by either the NAIC or the Company's internal ratings. The Company determines the fair value of privately-placed fixed income securities based on discounted cash flows using current interest rates for similar securities.
The fixed income securities portfolio contained $39.4 million and $34.2 million of asset-backed securities ("ABS") at December 31, 2000 and 1999, respectively. The ABS portfolio is subject to credit and interest rate risk. Credit risk is mitigated by monitoring the performance of the collateral. Approximately 13.4% of all securities are rated in the highest rating category by one or more credit rating agencies. The ABS portfolio is subject to interest rate risk since the price volatility and ultimate realized yield area affected by the rate of repayment of the underlying assets. Over 34.5% of the Company's ABS are invested in securitized credit card receivables. The remainder of the portfolio is backed primarily by securitized home equity, manufactured housing, and auto loans.
The Company closely monitors its commercial mortgage loan portfolio on a loan-by-loan basis. Loans with an estimated collateral value less than the loan balance, as well as loans with other characteristics indicative of higher than normal credit risk, are reviewed by financial and investment management at least quarterly for purposes of establishing valuation allowances and placing loans on non-accrual status. The underlying collateral values are based upon discounted property cash flow projections, which are updated as conditions change or at least annually.
The Company's short-term investment portfolio was $58.2 million and $46.0 million at December 31, 2000 and 1999, respectively. The Company invests available cash balances primarily in taxable short-term securities having a final maturity date or redemption date of one year or less.
The Company's business is subject to the effects of a changing social, economic and regulatory environment. Public and regulatory initiatives have varied and have included employee benefit regulations, removal of barriers preventing banks from engaging in the securities and insurance business, tax law changes affecting the taxation of insurance companies and the tax treatment of insurance products and its impact on the relative desirability of various personal investment vehicles. The ultimate changes and eventual effects, if any, of these initiatives are uncertain.
In the normal course of its business, the Company is involved in pending and threatened litigation and regulatory actions in which claims for monetary damages are asserted. At this time, based on their present status, it is in the opinion of management, that the ultimate liability, if any, in one or more of these actions in excess of amounts currently reserved is not expected to have a material effect on the results of operations, liquidity or financial position of the Company.
The NAIC has approved a January 1, 2001 implementation date for newly developed statutory accounting principles ("codification"). The Company's state of domicile, New York, has rejected certain accounting principles, specifically Statement of Statutory Accounting Principle ("SSAP") No. 10 Accounting for Taxes and continues to review codification and existing statutory accounting requirements to align existing state laws and regulations as necessary. The Company currently estimates it will record an increase to surplus of approximately $4.5 million at implementation. The increase to surplus is primarily due to favorable treatment investment write-downs receive within the asset valuation reserve and the reclassification of private placement prepayment penalties and mortgage loan make-whole fees from the interest maintenance reserve to investment income. The NAIC has installed a formal maintenance process to develop and propose new guidance, as well as on-going clarification and interpretation of issues. The impact of any future changes will be recorded as they are approved.
If the expectations or assumptions underlying our forward-looking statements prove inaccurate or if risks or uncertainties arise, actual results could differ materially from those communicated in our forward-looking statements. In addition to the normal risks of business, the Company is subject to significant risk factors, including those listed below which apply to it as an insurance business.
- - The impact of decreasing Separate Accounts balances as a result of fluctuating market conditions could cause contract charges realized by the Company to decrease.
- - The Company's policy acquisition costs related to contractholder funds are amortized in proportion to gross profits over the estimated lives of the contract periods. Assumptions underlying the gross profits, which include estimated fees, investment and expense margins, are periodically updated to reflect actual experience resulting in adjustments to the cumulative amortization of these costs. These adjustments may have a material effect on results of operations.
- - State insurance regulatory authorities require insurance companies to maintain specified levels of statutory capital and surplus. In addition, competitive pressures require the Company to maintain financial strength or claims-paying ability ratings. These restrictions affect the Company's ability to use its capital in other ways.
- At the federal level, these measures include the Gramm-Leach-Bliley Act of 1999, which eliminates many federal and state law barriers to affiliations among banks, securities firms, insurers and other financial service providers.
- At the state level, these measures include legislation to permit mutual insurance companies to convert to a hybrid structure known as a mutual holding company, thereby allowing insurance companies owned by their policyholders to become stock insurance companies owned (through one or more intermediate holding companies) more than 50% by their policyholders and potentially up to 49% by stockholders. Also several large mutual life insurers have used or are expected to use existing state laws and regulations governing the conversion of mutual insurance companies into stock insurance companies (demutualization).
- - Deferred annuities and interest-sensitive life insurance products receive favorable policyholder taxation under current tax laws and regulations. Any legislative or regulatory changes that adversely alter this treatment are likely to negatively affect the demand for these products. Additionally, the demand for life insurance products that are used to address a customer's estate planning needs may be impacted to the extent any legislative changes to the current estate tax laws occur.