Transamerica Advisors Life Insurance Company (“TALIC”, “Registrant”, the “Company”, “we”, “our”, or “us”) is a wholly owned subsidiary of AEGON USA, LLC (“AUSA”). AUSA is an indirect wholly owned subsidiary of AEGON N.V., a limited liability share company organized under Dutch law. The Company is domiciled in Arkansas.
The costs associated with acquiring contract owner deposits (deferred policy acquisition costs) are amortized over the period in which the Company anticipates holding those funds, as noted in the Critical Accounting Policies and Estimates section below. Insurance expenses and taxes reported in the Statements of Income are net of amounts deferred. In addition, the Company incurs expenses associated with the maintenance of in force contracts.
For fixed maturity AFS securities, an OTTI must be recognized in earnings when an entity either: a) has the intent to sell the debt security or b) more likely than not will be required to sell the debt security before its anticipated recovery. If the Company meets either of these criteria, the OTTI is recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For fixed maturity AFS securities in unrealized loss positions that do not meet these criteria, the Company must analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows. If the net present value is less than the amortized cost of the investment, an OTTI is recorded. The OTTI is separated into two pieces: an amount representing the credit loss, where the present value of cash flows expected to be collected is less than the amortized cost basis of the security, and an amount related to all other factors (referred to as the non credit portion). The credit loss is recognized in earnings and the non credit loss is recognized in other comprehensive income (“OCI”), net of applicable taxes and value of business acquired. Management records subsequent changes in the estimated fair value (positive and negative) of fixed maturity AFS securities for which non credit OTTI was previously recognized in OCI in OCI-OTTI.
For the year ended December 31, 2013, the Company recorded an OTTI in income of $0.7 million, net of value of business acquired amortization. For the year ended December 31, 2012, the Company recorded an OTTI in income of $0.3 million, net of value of business acquired amortization. For the year ended December 31, 2011, the Company recorded an OTTI in income of $1.2 million, net of value of business acquired amortization.
Derivatives are financial instruments in which the value changes in response to an underlying variable that require little or no net initial investment and are settled at a future date. The Company has entered into derivatives, such as futures, options, total return swaps and variance swaps to hedge minimum guarantees on variable annuity contracts. These derivatives are recognized on the Balance Sheet and are carried at fair value with changes in fair value recognized as a component of net derivative gains (losses) in the Statements of Income.
In addition, the Company executed total return swaps with exposure to the S&P. These total return swaps are also being used to hedge equity risk.
Put and call options have been utilized by the Company to create equity collars designed to have a zero cost at issue, which serve to hedge the risk of equity market declines by selling a portion of market upside above the Company’s long-term expected return. The equity collars were disposed of in the fourth quarter of 2013.
For further discussion of the Company’s use of derivatives, see the Results of Operations and Note 3 to the Financial Statements.
DAC for variable annuities is amortized with interest over the anticipated lives of the insurance contracts in relation to the present values of estimated future gross profits from asset-based fees, guaranteed benefit rider fees, contract fees, and surrender charges, less a provision for guaranteed death and living benefit expenses, policy maintenance expenses, and non-capitalized commissions. Future gross profit estimates are subject to periodic evaluation with necessary revisions applied against amortization to date. The impact of revisions and assumptions to estimates on cumulative amortization is recorded as a charge or credit to current operations, commonly referred to as “unlocking”. Changes in assumptions can have a significant impact on the amount of DAC reported and the related amortization patterns. In general, increases in the estimated Separate Accounts return and decreases in surrender or mortality assumptions increase the expected future profitability of the underlying business and may lower the rate of DAC amortization. Conversely, decreases in the estimated Separate Accounts returns and increases in surrender or mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization. For the years ended December 31, 2013, 2012, and 2011, there was a favorable (unfavorable) impact to pre-tax net income related to DAC unlocking of ($2.2) million, $1.8 million, and ($3.0) million, respectively. See Note 4 to the Financial Statements for a further discussion.
The expense and the subsequent capitalization and amortization (accretion) are recorded as a component of policy benefits in the Statements of Income. At December 31, 2013 and 2012, variable annuities accounted for the Company’s entire DSI asset of $7.5 million and $10.0 million, respectively. For the years ended December 31, 2013, 2012, and 2011, there was a favorable (unfavorable) impact to pre-tax income related to unlocking of ($0.3) million, $0.5 million, and ($0.6) million, respectively. See Note 4 to the Financial Statements for a further discussion.
The Company’s liability for policyholder account balances represents the contract value that has accrued to the benefit of policyholders at the Balance Sheet date. The liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Policyholder account balances at December 31, 2013 and 2012 were $1.3 billion and $1.4 billion, respectively.
The following outlines the adoption of recent accounting guidance in 2013. See Note 1 to the Financial Statements for a further discussion.
Accounting Standards Codification (“ASC”) 210, Balance Sheet - Accounting Standards Update (“ASU”) 2011-11, Disclosures about Offsetting Assets and Liabilities - enhances disclosures about financial instruments and derivative instruments that are either offset on the statement of financial position or subject to an enforceable master netting arrangement - adopted January 1, 2013.
ASC 220, Comprehensive Income - ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, requires an entity to provide information about significant items reclassified out of accumulated other comprehensive income (“AOCI”) by component - adopted January 1, 2013.
ASC 944, Financial Services-Insurance - ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts - modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts - adopted January 1, 2012.
Total direct deposits (including internal exchanges) were $30.4 million, $35.3 million, and $33.5 million for the years ended December 31, 2013, 2012 and 2011, respectively. Deposits are currently limited to additions to existing policies which will result in fluctuations period over period. Internal exchanges during 2013, 2012 and 2011 were $3.8 million, $6.5 million, and $5.9 million, respectively.
At December 31, 2013, the Company’s assets were $10.6 billion or $14.2 million higher than the $10.5 billion in assets at December 31, 2012. Assets excluding Separate Accounts assets decreased $359.2 million. Separate Accounts assets, which represent 70% of total assets, increased $373.4 million to $7.3 billion. Changes in Separate Accounts assets were as follows:
During 2013, 2012 and 2011, fixed contract owner deposits were $0.2 million, $0.2 million, and $0.2 million, respectively. During 2013, 2012 and 2011, fixed contract owner withdrawals were $92.1 million, $104.7 million, and $114.2 million, respectively.
The Company monitors industry sectors and individual debt securities for evidence of impairment. This evidence may include one or more of the following: 1) deteriorating market to book ratio, 2) increasing industry risk factors, 3) deteriorating financial condition of the issuer, 4) covenant violations of the issuer, 5) high probability of bankruptcy of the issuer, 6) nationally recognized credit rating agency downgrades, and/or 7) intent or requirement to sell before a debt security’s anticipated recovery. Additionally, for structured securities (asset-backed securities (“ABS”), residential mortgage-backed securities (“RMBS”), and commercial mortgage-backed securities (“CMBS”)), cash flow trends and underlying levels of collateral are monitored. A security is impaired if there is objective evidence that a loss event has occurred after the initial recognition of the asset that has a negative impact on the estimated future cash flows. A specific security is considered to be impaired when it is determined that it is probable that not all amounts due (both principal and interest) will be collected as scheduled. For debt securities, an OTTI must be recognized in earnings when an entity either a) has the intent to sell the debt security or b) more likely than not will be required to sell the debt security before its anticipated recovery. If the Company meets either of these criteria, the OTTI is recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For debt securities in unrealized loss positions that do not meet these criteria, the Company must analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The Company has evaluated the near-term prospects of the issuers in relation to the severity and duration of the unrealized loss, and unless otherwise noted, does not consider these investments to be impaired at December 31, 2013.
ABS - housing securities are secured by pools of residential mortgage loans primarily those which are categorized as subprime. The unrealized loss is primarily due to decreased liquidity and increased credit spreads in the market combined with significant increases in expected losses on loans within the underlying pools. The Company’s $0.8 million of gross unrealized losses within the ABS - housing sector has a fair value of $17.4 million.
The Company does not currently invest in or originate whole loan residential mortgages. The Company categorizes asset backed securities issued by a securitization trust as having subprime mortgage exposure when the average credit score of the underlying mortgage borrowers in a securitization trust is below 660 at issuance. The Company also categorizes ABS issued by a securitization trust with second lien mortgages as subprime mortgage exposure, even though a significant percentage of second lien mortgage borrowers may not necessarily have credit scores below 660 at issuance.
Loss severity assumptions were determined by observing historical rates from broader market data while being adjusted for specific pool performance, collateral type, mortgage insurance and estimated loan modifications. Prepayments were estimated by examining historical averages of prepayment activity on the underlying collateral. Once the entire pool is modeled, the results are closely analyzed by our internal asset specialists to determine whether or not our particular tranche or holding is at risk for not collecting all contractual cash flows taking into account the seniority and other terms of the tranches held. The unrealized loss is primarily due to decreased liquidity, increased credit spreads in the market, slower prepayments, and increased expected losses on loans within the underlying pools. Expected losses within the underlying pools are generally higher than original expectations, which have led to some rating downgrades in these securities.
Securities are impaired to the net present value of projected future cash flows where holdings are not projected to pay principal and interest in full. As the remaining unrealized losses in the ABS - housing related portfolio relate to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired at December 31, 2013.
CMBS are securitizations of underlying pools of mortgages on commercial real estate. The underlying mortgages have varying risk characteristics and are pooled together and sold in different rated tranches. The Company’s CMBS include conduit, large loan, and single borrower. The Company’s $2.0 million of gross unrealized losses within the CMBS sector has a fair value of $22.7 million.
These factors typically require significant management judgment. The impairment review process has resulted in no other than temporary impairment charges for the year ended December 31, 2013 for the Company.
The Company defines investment grade securities as unsecured debt obligations that have a rating equivalent to S&P’s BBB- or higher (or similar rating agency). At December 31, 2013 and 2012, approximately $117.5 million (or 7%) and $96.1 million (or 5%), respectively, of fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by S&P. Below investment grade securities are speculative and are subject to significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. The Company closely monitors such investments.
(a) Second lien collateral primarily composed of loans to prime and Alt A borrowers.
All mortgage loans that are impaired have an established allowance for loss. Changing economic conditions impact our valuation of mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that the Company performs for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for losses. In addition, the Company continues to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of emphasis are properties that have deteriorating credits or have experienced debt coverage reduction. Where warranted, the Company has established or increased loss reserves based upon this analysis. There were no impaired mortgage loans at December 31, 2013 and 2012. At December 31, 2013 and 2012, there were no commercial mortgage loans that were two or more payments delinquent. See Note 3 to the Financial Statements for further discussion.
The investment performance of the underlying U.S. equity-based mutual funds supporting the Company’s variable products do not replicate the returns of any specific U.S. equity market index. However, investment performance will generally increase or decrease with corresponding increases or decreases of the overall U.S. equity market. There are several standard indices published on a daily basis that measure performance of selected components of the U.S. equity market. Examples include the Dow Jones Industrial Average (“Dow”), the NASDAQ Composite Index (“NASDAQ”) and the S&P. The Dow, NASDAQ and S&P ended 2013 with increases of 27%, 38% and 30%, respectively, from 2012. The Dow, NASDAQ and S&P ended 2012 with increases of 7%, 16% and 13%, respectively, from 2011.
Fluctuations in the U.S. equity market also directly impact the Company’s exposure to guaranteed benefit provisions contained in the variable contracts it manufactures. Minimal or negative investment performance generally results in greater exposure to guarantee provisions. Prolonged periods of minimal or negative investment performance will result in greater guaranteed benefit costs as compared to assumptions. If the Company determines that it needs to increase its estimated long term cost of guaranteed benefits, it will result in establishing greater guaranteed benefit liabilities as compared to current practice.
The Company’s liquidity requirements include the payment of sales commissions and other underwriting expenses and the funding of its contractual obligations for the life insurance and annuity contracts it has in force. The Company has developed and utilizes a cash flow projection system and regularly performs asset/liability duration matching in the management of its asset and liability portfolios. The Company anticipates funding its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. At December 31, 2013 and 2012, the Company’s assets included $2.1 billion and $2.4 billion, respectively, of cash, short-term investments and investment grade publicly traded AFS securities that could be liquidated if funds were required.
In order to continue to issue annuity products, the Company must meet or exceed the statutory capital and surplus requirements of the insurance departments of the states in which it conducts business. Statutory accounting principles differ from GAAP in two major respects. First, under statutory accounting principles, 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 principles, the required additions to statutory reserves are calculated under different rules than under GAAP.
The following table summarizes the Company’s ratings at March 27, 2014:
The following table summarizes the Company’s policyholders’ obligations at December 31, 2013:
For the years ended December 31, 2013 and 2012, the Company recorded net income (loss) of ($254.5) million and $165.9 million, respectively. The decrease in income during 2013 as compared to 2012 was primarily due to realized derivative losses related to the equity collar hedge, the addition of a tax valuation allowance, higher policy benefits expense, offset by lower VOBA amortization expense in 2013.
(c) The decrease in life insurance mortality expense relates to the decrease in reinsurance recoverables.
Amortization of DAC was $12.0 million and $0.8 million for 2013 and 2012, respectively, which included favorable (unfavorable) unlocking of ($2.2) million and $1.8 million, respectively. The increase in 2013 was primarily driven by positive gross profits resulting in increased amortization as compared to 2012.
Policy charge revenue decreased $14.5 million to $187.7 million during 2012, as compared to $202.2 million in 2011. The following table provides the changes in policy charge revenue by type for each respective period:
(a) The decrease in asset-based policy charge revenue for 2012 was principally due to the decrease in average variable account balances.
Amortization of VOBA was $19.9 million and $12.2 million for the years ended December 31, 2012 and 2011, respectively, which included favorable (unfavorable) unlocking of $4.3 million and ($11.6) million, respectively. 2012 was impacted by favorable equity markets and positive gross profits in the fourth quarter as compared to 2011.
(a) Decrease in Commissions in 2012 due to lower trail commissions as a direct result of a declining block of business.
(b) The increase in general insurance expense is primarily related to a change in guaranty fund assessments when compared to 2011.