We occupy office space in Lincoln, Nebraska and Northbrook, Illinois that is owned by AIC. Expenses associated with these facilities are allocated to us on a direct basis.
The following discussion highlights significant factors influencing the financial position and results of operations of Lincoln Benefit Life Company (referred to in this document as "we", "Lincoln Benefit", "our", "us" or the "Company"). It should be read in conjunction with the financial statements and related notes found under Part II Item 8 contained herein. We operate as a single segment entity, based on the manner in which we use financial information to evaluate business performance and to determine the allocation of resources.
a) Quoted prices for similar assets or liabilities in active markets;
To distinguish among the categories, we consider the frequency of completed transactions. If inputs used to measure a financial instrument fall within different levels of the fair value hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the entire instrument. Certain financial assets are not carried at fair value on a recurring basis. Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is subject to remeasurement at fair value after initial recognition and the resulting measurement is reflected in the financial statements.
We are responsible for the determination of the fair value of financial assets and financial liabilities and the supporting assumptions and methodologies. We gain assurance on the overall reasonableness and consistent application of valuation input assumptions, valuation methodologies, and compliance with accounting standards for fair value determination through the execution of various processes and controls designed to ensure that our financial assets and financial liabilities are appropriately valued. We monitor fair values received from third parties and those derived internally on an ongoing basis.
Fair value of our investments comprise an aggregation of numerous, single best estimates for each security in the Statements of Financial Position. Because of this detailed approach there is no single set of assumptions that determine our fair value estimates. Moreover, management does not compile a range of estimates for items reported at fair value because we do not believe that a range would provide meaningful information. In the last 10 years, our quarterly net unrealized capital gains and losses have ranged from an $18.3 million net unrealized capital gain at June 30, 2003 to a $6.8 million net unrealized capital loss at June 30, 2006. The change in net unrealized capital gains and losses by quarter over the 10 year period has averaged $3.5 million and has ranged from a $9.9 million decrease to a $6.9 million increase.
INVESTMENTS --------------------- ($ IN THOUSANDS) FAIR PERCENT VALUE TO TOTAL -------- -------- Fair value based on internal sources $ 1,365 0.4% Fair value based on external sources 308,666 99.6 -------- ----- Total investments $310,031 100.0% ======== =====
IMPAIRMENT OF FIXED INCOME SECURITIES For fixed income securities classified as available for sale, the difference between fair value and amortized cost, net of deferred income taxes (as disclosed in Note 4), is reported as a component of accumulated other comprehensive income on the Statements of Financial Position and is not reflected in the operating results of any period until reclassified to net income upon the consummation of a transaction with an unrelated third party or when the decline in fair value is deemed other than temporary. The assessment of whether the impairment of a security's fair value is other than temporary is performed using a portfolio review as well as a case-by-case review considering a wide range of factors.
Fixed income securities subject to other-than-temporary impairment write-downs continue to earn investment income when future expected payments are both reasonably estimable and probable, and any discount or premium is recognized using the effective yield method over the expected life of the security; otherwise income recognition is discontinued. For a more detailed discussion of the risks relating to changes in investment values and levels of investment impairment as well as the potential causes of such changes, see Note 4 of the financial statements and Market Risk and Risk Factors sections of this document.
OVERVIEW AND STRATEGY We are a wholly owned subsidiary of Allstate Life Insurance Company ("ALIC"), which is a wholly owned subsidiary of Allstate Insurance Company ("AIC"), a wholly owned subsidiary of Allstate Insurance Holdings, LLC, which is wholly owned by The Allstate Corporation (the "Corporation"). Lincoln Benefit provides life insurance, retirement and investment products to individual customers. Our strategic vision is to reinvent protection and retirement for the consumer.
On June 1, 2006, ALIC, its subsidiary Allstate Life Insurance Company of New York, and The Allstate Corporation completed the disposal of substantially all of their variable annuity business pursuant to a definitive agreement with Prudential Financial, Inc. and its subsidiary, The Prudential Insurance Company of America (collectively "Prudential"). The disposal was effected through a combination of coinsurance and modified coinsurance reinsurance agreements. The Company is not a direct participant in this agreement and its reinsurance agreements with ALIC remain unchanged.
NET REALIZED CAPITAL GAINS of $6.0 million were recognized in 2008 compared to net realized capital losses of $417 thousand and $1.3 million in 2007 and 2006, respectively. The realized capital gains and losses in 2008, 2007 and 2006 were related to dispositions of investments. For further discussion of realized capital gains and losses see the Realized Capital Gains and Losses section of the MD&A.
($ IN THOUSANDS) 2008 2007 ----------- ----------- Fixed income securities (1) $ 229,328 $ 273,144 Short-term (2) 80,703 28,057 ----------- ----------- Total investments $ 310,031 $ 301,201 =========== ===========
- ---------- (1) Fixed income securities are carried at fair value. Amortized cost basis for these securities was $229.7 million and $266.8 million at December 31, 2008 and 2007, respectively.
Total investments increased to $310.0 million at December 31, 2008 from $301.2 million at December 31, 2007 due to purchases of short-term investments partially offset by negative operating cash flows and net unrealized capital losses on fixed income securities at December 31, 2008 compared to net unrealized capital gains at December 31, 2007.
FIXED INCOME SECURITIES See Note 4 of the financial statements for a table showing the amortized cost, unrealized gains, unrealized losses and fair value for each type of fixed income security for the years ended December 31, 2008 and 2007.
MUNICIPAL BONDS totaled $499 thousand at December 31, 2008, all of which are tax exempt. The municipal bond portfolio was insured by one bond insurer and accordingly has a Moody's equivalent rating of Aa.
COMMERCIAL MORTGAGE-BACKED SECURITIES ("CMBS") totaled $19.0 million and reflected 8.3% of the fixed income securities portfolio at December 31, 2008. The CMBS portfolio is subject to credit risk, but unlike other structured securities, is generally not subject to prepayment risk due to protections within the underlying commercial mortgages whereby borrowers are effectively restricted from prepaying their mortgages due to changes in interest rates. All of the CMBS investments are structured securities collateralized by pools of commercial mortgages, broadly diversified across property types and geographical area.
ASSET-BACKED SECURITIES ("ABS") totaled $7.0 million and reflected 3.1% of the fixed income securities portfolio at December 31, 2008. Credit risk is managed by monitoring the performance of the collateral. In addition, many of the securities in the ABS portfolio are credit enhanced with features such as over-collateralization, subordinated structures, reserve funds, guarantees and/or insurance. A portion of the ABS portfolio is also subject to interest rate risk since ultimate realized yields are affected by the rate of prepayment of the underlying assets.
SHORT-TERM INVESTMENTS Our short-term investment portfolio was $80.7 million and $28.1 million at December 31, 2008 and 2007, respectively. We invest available cash balances primarily in taxable short-term securities having a final maturity date or redemption date of less than one year.
UNREALIZED GAINS AND LOSSES See Note 4 of the financial statements for further disclosures regarding unrealized losses on fixed income securities and factors considered in determining whether securities are other-than-temporarily impaired. The unrealized net capital losses totaled $341 thousand at December 31, 2008, compared to unrealized net capital gains of $6.4 million at December 31, 2007 as a result of significantly widening credit spreads.
The net unrealized loss for the fixed income portfolio of $339 thousand comprised $6.0 million of gross unrealized gains and $6.3 million of gross unrealized losses at December 31, 2008. This is compared to a net unrealized gain for the fixed income portfolio totaling $6.4 million at December 31, 2007, comprised of $7.7 million of gross unrealized gains and $1.3 million of gross unrealized losses.
The banking, consumer goods, financial services and transportation sectors had the highest concentration of gross unrealized losses in our corporate fixed income securities portfolio at December 31, 2008. The gross unrealized losses in these sectors were primarily the result of significantly widening credit spreads. Credit spreads are the additional yield on fixed income securities above the risk-free rate (typically defined as the yield on U.S. Treasury securities) that market participants require to compensate them for assuming credit, liquidity and/or prepayment risks for fixed income securities with consistent terms. Credit spreads vary with the market's perception of risk and liquidity in specific issuer or specific sectors. Credit spreads can widen (increase) or tighten (decrease) and may offset or add to the effects of risk-free interest rate changes in the valuation of fixed income securities from period to period.
For fixed income securities, 21.8% of the gross unrealized losses at December 31, 2008 were from $623 thousand of CMBS with a fair value below 70% of amortized cost, or 0.3% of our fixed income portfolio, at December 31, 2008. The percentage of fair value to amortized cost for fixed income securities with gross unrealized losses at December 31, 2008 are shown in the following table.
We also conduct a portfolio review to recognize impairment on securities in an unrealized loss position for which we do not have the intent and ability to hold until recovery as a result of approved programs involving the disposition of investments for reasons such as negative developments that would change the view of long term investors and their intent to continue to hold the investment, subsequent credit deterioration of an issuer or holding, subsequent further deterioration of capital markets (i.e. debt) and of economic conditions, subsequent further deterioration in the financial services and real estate industries, changes in duration, revisions to strategic asset allocations, liquidity needs, unanticipated federal income tax situations involving capital gains and capital loss carrybacks and carryforwards with specific expiration dates, investment risk mitigation actions, and other new facts and circumstances that would cause a change in our previous intent to hold a security to recovery or maturity.
We also monitor the quality of our fixed income portfolio by categorizing certain investments as "problem", "restructured" or "potential problem". Problem fixed income securities are in default with respect to principal or interest and/or are investments issued by companies that have gone into bankruptcy subsequent to our acquisition or loan. Restructured fixed income securities have rates and terms that are not consistent with market rates or terms prevailing at the time of the restructuring. Potential problem fixed income securities are current with respect to contractual principal and/or interest, but because of other facts and circumstances, we have concerns regarding the borrower's ability to pay future principal and interest, which causes us to believe these investments may be classified as problem or restructured in the future.
As of December 31, 2008 and 2007, we did not have any fixed income securities categorized as problem, restructured or potential problem.
($ IN THOUSANDS) 2008 2007 2006 ------- ------- ------- Fixed income securities $13,302 $13,533 $13,495 Short-term and other investments 992 1,117 762 ------- ------- ------- Investment income, before expense 14,294 14,650 14,257 Investment expense (354) (393) (309) ------- ------- ------- Net investment income $13,940 $14,257 $13,948 ======= ======= =======
We may sell or change our intent to hold a security until recovery for impaired fixed income securities that were in an unrealized loss position at the previous reporting date, or other investments where the fair value has declined below the amortized cost, in situations where significant unanticipated new facts and circumstances emerge or existing facts and circumstances increase in significance and are anticipated to adversely impact a security's future valuations more than previously expected; including negative developments that would change the view of long term investors and their intent to continue to hold the investment, subsequent credit deterioration of an issuer or holding, subsequent further deterioration in capital markets (i.e. debt) and of economic conditions, subsequent further deterioration in the financial services and real estate industries, liquidity needs, unanticipated federal income tax situations involving capital gains and capital loss carrybacks and carryforwards with specific expiration dates, investment risk mitigation actions, and other new facts and circumstances that would cause a change in our previous intent to hold a security to recovery or maturity.
REINSURANCE RECOVERABLE, CONTRACTHOLDER FUNDS AND RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS Under GAAP, when reinsurance contracts do not relieve the ceding company of legal liability to contractholders, the ceding company is required to report reinsurance recoverables arising from these contracts separately as assets. The liabilities for the contracts are reported as contractholder funds, reserve for life-contingent contract benefits, or separate accounts liabilities depending on the characteristics of the contracts. We reinsure all reserve liabilities with ALIC or other non-affiliated reinsurers. Reinsurance recoverables and the related reserve for life-contingent contract benefits and contractholder funds are reported separately in the Statements of Financial Position, while the assets which support the separate accounts liabilities are reflected as separate accounts assets.
At December 31, 2008, contractholder funds decreased to $17.79 billion from $17.82 billion at December 31, 2007 as a result of new and additional deposits on fixed annuities and interest-sensitive life policies and interest credited to contractholder funds being more than offset by surrenders, withdrawals, benefit payments and related contract charges. The reserve for life-contingent contract benefits increased to $2.58 billion at December 31, 2008 from $2.35 billion as of December 31, 2007 due primarily to sales of traditional life and other insurance products, partially offset by benefits paid and policy lapses. Reinsurance recoverables from ALIC and reinsurance recoverables from non-affiliates increased by $13.9 million and $190.8 million, respectively.
At December 31, 2008, approximately 97% of reinsurance recoverables due from non-affiliated companies were reinsured under uncollateralized reinsurance agreements with companies that had a financial strength rating of A or above, as measured by S&P. In certain cases, these ratings refer to the financial strength of the affiliated group or parent company of the reinsurer.
We continuously monitor the creditworthiness of reinsurers in order to determine our risk of recoverability on an individual and aggregate basis and a provision for uncollectible reinsurance is recorded if needed. No amounts have been deemed unrecoverable in the three years ended December 31, 2008.
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES The following table provides additional details regarding Level 1, 2 and 3 financial assets and financial liabilities by their classification in the Statement of Financial Position at December 31, 2008.
FAIR VALUE AS FAIR VALUE AS A FAIR A PERCENTAGE PERCENTAGE OF ($ IN THOUSANDS) VALUE OF PAR VALUE AMORTIZED COST ------ ------------- --------------- Corporate $1,307 100.4% 100.0% ABS 6,002 100.0 100.3 ------ TOTAL LEVEL 3 INVESTMENTS $7,309 100.1 100.3 ======
OVERVIEW In formulating and implementing guidelines for investing funds, we seek to earn returns that enhance our ability to offer competitive rates and prices to customers while contributing to attractive and stable profits and long-term capital growth. Accordingly, our investment decisions and objectives are a function of the underlying risks and our product profiles.
INTEREST RATE RISK is the risk that we will incur a loss due to adverse changes in interest rates relative to the interest rate characteristics of interest bearing assets. This risk arises from our investment in interest-sensitive assets. Interest rate risk includes risks related to changes in U.S. Treasury yields and other key risk-free reference yields.
Based upon the information and assumptions used in the duration calculation, and interest rates in effect at December 31, 2008, we estimate that a 100 basis point immediate, parallel increase in interest rates ("rate shock") would decrease the net fair value of the assets by approximately $8.5 million, compared to $11.1 million at December 31, 2007. The selection of a 100 basis point immediate parallel change in interest rates should not be construed as our prediction of future market events, but only as an illustration of the potential effect of such an event.
Spread duration is calculated similarly to interest rate duration. At December 31, 2008, the spread duration of assets was 3.4. Based upon the information and assumptions we use in this spread duration calculation, and spreads in effect at December 31, 2008, we estimate that a 100 basis point immediate, parallel increase in spreads across all asset classes, industry sectors and credit ratings ("spread shock") would decrease the net fair value of the assets by approximately $7.2 million, compared to $10.6 million at December 31, 2007. The selection of a 100 basis point immediate parallel change in spreads should not be construed as our prediction of future market events, but only as an illustration of the potential effect of such an event.
($ IN THOUSANDS) 2008 2007 2006 -------- -------- -------- Common stock, additional capital paid-in and retained income $298,783 $285,809 $276,804 Accumulated other comprehensive income (222) 4,129 (178) -------- -------- -------- Total shareholder's equity $298,561 $289,938 $276,626 ======== ======== ========
FINANCIAL RATINGS AND STRENGTH We share the insurance financial strength ratings of our parent, ALIC, as our business is reinsured to ALIC. The following table summarizes ALIC's financial strength ratings.
On February 2, 2009, A.M. Best affirmed ALIC's A+ financial strength rating. On January 29, 2009, S&P downgraded ALIC's financial strength rating to AA- from AA. The outlook for the rating remained negative. In October 2008, the outlook had been revised to negative from stable. On January 29, 2009, Moody's downgraded ALIC's financial strength rating to A1 from Aa3. The outlook for the rating was revised to stable from negative. In October 2008, Moody's downgraded ALIC's financial strength rating to Aa3 from Aa2.
State laws specify regulatory actions if an insurer's risk-based capital ("RBC"), a measure of an insurer's solvency, falls below certain levels. The NAIC has a standard formula for annually assessing RBC. The formula for calculating RBC for life insurance companies takes into account factors relating to insurance, business, asset and interest rate risks. At December 31, 2008, our RBC was within the range that we target.
CASH FLOWS As reflected in our Statements of Cash Flows, net cash used in operating activities was $5.9 million in 2008 compared to net cash provided by operating activities of $14.0 million and $23.0 million in 2007 and 2006, respectively. Fluctuations in net cash provided by operating activities primarily occur as a result of changes in net investment income and differences in the timing of reinsurance payments to and from ALIC.
Our ability to pay dividends is dependent on business conditions, income, cash requirements and other relevant factors. The payment of shareholder dividends without the prior approval of the state insurance regulator is limited by Nebraska law to formula amounts based on statutory surplus and statutory net income, as well as the timing and amount of dividends paid in the preceding twelve months. The maximum amount of dividends that we can distribute during 2009 without prior approval of the Nebraska Department of Insurance is $27.9 million.
YEAR ENDED DECEMBER 31, ($ IN THOUSANDS) ----------------------------- 2008 2007 2006 ------- ------- ------- REVENUES Net investment income $13,940 $14,257 $13,948 Realized capital gains and losses 5,952 (417) (1,255) ------- ------- ------- INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE 19,892 13,840 12,693 Income tax expense 6,918 4,835 4,433 ------- ------- ------- NET INCOME 12,974 9,005 8,260 ------- ------- ------- OTHER COMPREHENSIVE (LOSS) INCOME, AFTER-TAX Change in unrealized net capital gains and losses (4,351) 4,307 (885) ------- ------- -------
The Company has exposure to market risk as a result of its investment portfolio. Market risk is the risk that the Company will incur realized and unrealized net capital losses due to adverse changes in interest rates, credit spreads and, to a limited extent, equity prices. The Company's primary market risk exposure is to changes in interest rates, although we also have certain exposures to changes in equity prices in our equity-indexed annuities and separate accounts liabilities. This risk is transferred to ALIC in accordance with our reinsurance agreements. Interest rate risk is the risk that the Company will incur a loss due to adverse changes in interest rates relative to the interest rate characteristics of its interest bearing assets. This risk arises from our investment in interest-sensitive assets. Interest rate risk includes risks related to changes in U.S. Treasury yields and other key risk-free reference yields, as well as changes in interest rates resulting from widening credit spreads and credit exposure.
Realized capital gains and losses include gains and losses on investment sales and write-downs in value due to other-than-temporary declines in fair value. Realized capital gains and losses on investment sales include calls and prepayments and are determined on a specific identification basis.
The Company recognizes other-than-temporary impairment losses on fixed income securities and short-term investments when the decline in fair value is deemed other than temporary including when the Company cannot assert a positive intent to hold an impaired security until recovery (see Note 4). Fixed income securities subject to change in intent write-downs continue to earn investment income (other than discussed above), and any discount or premium is recognized using the effective yield method over the expected life of the security.
The Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS No. 157"), as of January 1, 2008 for its financial assets and financial liabilities that are measured at fair value. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, and establishes a framework for measuring fair value. The adoption did not have a material effect on the Company's determination of fair value.
Financial assets and financial liabilities recorded on the Statements of Financial Position at fair value as of December 31, 2008 are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:
- FIXED INCOME SECURITIES: U.S. Treasuries are in Level 1 and valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access. - SHORT-TERM: Comprise primarily actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access. - SEPARATE ACCOUNT ASSETS: Comprise actively traded mutual funds that have daily quoted net asset values for identical assets that the Company can access. Net asset values for the actively traded mutual funds in which the separate account assets are invested are obtained daily from the fund managers.
MORTGAGE-BACKED SECURITIES ("MBS"); ASSET-BACKED SECURITIES ("ABS")-CREDIT CARD: Valued based on inputs including quoted prices for identical or similar assets in markets that are not active.
- CONTRACTHOLDER FUNDS: Derivatives embedded in certain annuity contracts are valued based on internal models that rely on inputs such as interest rate yield curves and equity index volatility assumptions that are market
CORPORATE: These securities are categorized as Level 3 as a result of the significance of non-market observable inputs. The securities are valued based on internal ratings, which are not observable in the market.
Prior to the adoption of SFAS No. 157 on January 1, 2008, the fair value of fixed income securities was based upon observable market quotations, other market observable data or was derived from such quotations and market observable data. The fair value of privately placed fixed income securities was generally based on widely accepted pricing valuation models, which were developed internally. The valuation models used security specific information such as the credit rating of the issuer, industry sector of the issuer, maturity, estimated duration, call provisions, sinking fund requirements, coupon rate, quoted market prices of comparable securities and estimated liquidity premiums to determine the overall spread for the specific security.
Immediate annuities with life contingencies provide insurance protection over a period that extends beyond the period during which premiums are collected. Premiums from these products are recognized as revenue when received at the inception of the contract. Benefits and expenses are recognized in relation to premiums. Profits from these policies come from investment income, which is recognized over the life of the contract.
assessed against the contractholder account balance for maintenance, administration and surrender of the contract prior to contractually specified dates, and are recognized when assessed against the contractholder account balance.
The income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are unrealized capital gains and losses on investments and differences in tax bases of investments. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized (see Note 9).
The reserve for life-contingent contract benefits payable under insurance policies, including traditional life insurance and life-contingent immediate annuities, is computed on the basis of long-term actuarial assumptions of future investment yields, mortality, morbidity, policy terminations and expenses (see Note 6). These assumptions, which for traditional life insurance are applied using the net level premium method, include provisions for adverse deviation and generally vary by characteristics such as type of coverage, year of issue and policy duration.
Contractholder funds represent interest-bearing liabilities arising from the sale of products, such as interest-sensitive life and fixed annuities, and variable annuity and life deposits allocated to fixed accounts. Contractholder funds are comprised primarily of deposits received and interest credited to the benefit of the contractholder less surrenders and withdrawals, mortality charges and administrative expenses (see Note 6). Contractholder funds also include reserves for secondary guarantees on interest-sensitive life insurance and certain fixed annuity contracts and reserves for certain guarantees on variable annuity contracts.
Separate accounts assets are carried at fair value. The assets of the separate accounts are legally segregated and available only to settle separate account contract obligations. Separate accounts liabilities represent the contractholders' claims to the related assets and are carried at an amount equal to the separate accounts assets. Investment income and realized capital gains and losses of the separate accounts accrue directly to the contractholders and therefore, are not included in the Company's Statements of Operations and Comprehensive Income. Deposits to and surrenders and withdrawals from the separate accounts are reflected in separate accounts liabilities and are not included in cash flows. Revenues to the Company from the separate accounts consist of contract charges for maintenance, administration, cost of insurance and surrender of the contract prior to the contractually specified date and are ceded to ALIC.
In February 2007, the FASB issued SFAS No. 159 which provides reporting entities, on an ongoing basis, an option to report selected financial assets, including investment securities, and financial liabilities, including most insurance contracts, at fair value through earnings. SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement alternatives for similar types of financial assets and liabilities. The standard also requires additional information to aid financial statement users' understanding of the impacts of a reporting entity's decision to use fair value on its earnings and requires entities to display, on the face of the statement of financial position, the fair value of those assets and liabilities for which the reporting entity has chosen to measure at fair value. SFAS No. 159 was effective as of the beginning of a reporting entity's first fiscal year beginning after November 15, 2007. The Company did not apply the fair value option to any existing financial assets or liabilities as of January 1, 2008 and did not elect to apply the option prospectively to any financial assets or liabilities acquired during 2008. Consequently, the adoption of SFAS No. 159 had no impact on the Company's results of operations or financial position.
FSP FAS 115-1/124-1 nullified the guidance in paragraphs 10-18 of Emerging Issues Task Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" and references existing other-than-temporary impairment guidance. FSP FAS 115-1/124-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell the security has not been made, and also provides guidance on the subsequent income recognition for impaired debt securities. The Company adopted FSP FAS 115-1/124-1 as of January 1, 2006 on a prospective basis. The effects of adoption did not have a material effect on the results of operations or financial position of the Company.
level of services provided. Operating expenses, including compensation, retirement and other benefit programs, allocated to the Company were $227.0 million, $202.2 million and $192.3 million in 2008, 2007 and 2006, respectively. Of these costs, the Company retains investment related expenses on the invested assets of the Company. All other costs are ceded to ALIC under the reinsurance agreements.
The Company has a service agreement with Allstate Distributors, LLC ("ADLLC"), a broker-dealer affiliate of the Company, whereby ADLLC promotes and markets the fixed and variable annuities sold by the Company to unaffiliated financial services firms. In addition, ADLLC acts as the underwriter of variable annuities sold by the Company. In return for these services, the Company recorded commission expense of $5.1 million, $3.4 million and $1.1 million for the years ended December 31, 2008, 2007 and 2006, respectively, that was ceded to ALIC under the terms of the reinsurance agreements.
The Company receives distribution services from Allstate Financial Services, LLC ("AFS"), an affiliated broker-dealer company, for certain variable annuity and variable life insurance contracts sold by Allstate exclusive agencies. For these services, the Company incurred $18.4 million, $25.5 million and $42.7 million of commission and other distribution expenses for the years ending December 31, 2008, 2007 and 2006, respectively, that were ceded to ALIC under the terms of the reinsurance agreements.
GROSS UNREALIZED ($ IN THOUSANDS) AMORTIZED ---------------- FAIR COST GAINS LOSSES VALUE --------- ------- ------- -------- AT DECEMBER 31, 2008 U.S.government and agencies $ 75,374 $3,700 $ (258) $ 78,816 Corporate 77,192 603 (2,092) 75,703 Municipal 502 -- (3) 499 Mortgage-backed securities 46,720 1,680 (49) 48,351 Commercial mortgage-backed securities 22,896 -- (3,936) 18,960 Asset-backed securities 6,983 20 (4) 6,999 -------- ------ ------- -------- Total fixed income securities $229,667 $6,003 $(6,342) $229,328 ======== ====== ======= ========
AMORTIZED FAIR ($ IN THOUSANDS) COST VALUE --------- -------- Due in one year or less $ 25,080 $ 25,421 Due after one year through five years 88,898 88,627 Due after five years through ten years 34,519 35,392 Due after ten years 27,467 24,538 -------- -------- 175,964 173,978 Mortgage and asset-backed securities 53,703 55,350 -------- -------- Total $229,667 $229,328 ======== ========
($ IN THOUSANDS) 2008 2007 2006 ------- ------ ------- Realized capital gains and losses, pre-tax $ 5,952 $(417) $(1,255) Income tax (expense) benefit (2,083) 146 438 ------- ----- ------- Realized capital gains and losses, after-tax $ 3,869 $(271) $ (817) ======= ===== =======
Inherent in the Company's evaluation of a particular security are assumptions and estimates about the financial condition of the issue or issuer and its future earnings potential. Some of the factors considered in evaluating whether a decline in fair value is other than temporary are: 1) the Company's ability and intent to retain the investment for a period of time sufficient to allow for an anticipated recovery in value; 2) the expected recoverability of principal and interest; 3) the length of time and extent to which the fair value has been less than amortized cost; 4) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry conditions and trends, and implications of rating agency actions and offering prices; and 5) the specific reasons that a security is in a significant unrealized loss position, including market conditions which could affect access to liquidity.
Unrealized losses on mortgage-backed, asset-backed and commercial mortgage-backed holdings were evaluated based on credit ratings, as well as the performance of the underlying collateral relative to the securities' positions in the securities' respective capital structure. The unrealized losses on asset-backed securities that had credit enhancements from bond insurers were evaluated on the quality of the underlying security. These investments were determined to have adequate resources to fulfill contractual obligations.
At December 31, 2008, fixed income securities and short-term investments with a carrying value of $10.6 million were on deposit with regulatory authorities as required by law.
In the normal course of business, the Company invests in various financial assets and incurs various financial liabilities.
As required by SFAS No. 157, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3). Gains and losses for such assets and liabilities categorized within Level 3 may include changes in fair value that are attributable to both observable inputs (Level 1 and Level 2) and unobservable inputs (Level 3).
Presented below are the fair value estimates of financial instruments including those reported at fair value and discussed above and those reported using other methods for which a description of the method to determine fair value appears below the following tables.
- ---------- (1) Carried at fair value in the Statements of Financial Position.
The following table summarizes the notional amount, fair value and carrying value of the Company's embedded derivative financial instruments.
There were no off-balance-sheet financial instruments at December 31, 2008 or 2007.
The Company has reinsurance agreements under which it reinsures all of its business to ALIC or other non-affiliated reinsurers. Under the agreements, premiums, contract charges, interest credited to contractholder funds, contract benefits and substantially all expenses are reinsured. The Company purchases reinsurance to limit aggregate and single losses on large risks. The Company cedes a portion of the mortality risk on certain life policies with a pool of twelve non-affiliated reinsurers. The Company continues to have primary liability as the direct insurer for risks reinsured.
The Company is subject to changing social, economic and regulatory conditions. From time to time, regulatory authorities or legislative bodies seek to impose additional regulations regarding agent and broker compensation and otherwise expand overall regulation of insurance products and the insurance industry. The ultimate changes and eventual effects of these initiatives on the Company's business, if any, are uncertain.
- - These matters include a lawsuit filed in 2001 by the U.S. Equal Employment Opportunity Commission ("EEOC") alleging retaliation under federal civil rights laws (the "EEOC I" suit) and a class action filed in 2001 by former employee agents alleging retaliation and age discrimination under the Age Discrimination in
- - The EEOC also filed another lawsuit in 2004 alleging age discrimination with respect to a policy limiting the rehire of agents affected by the agency program reorganization (the "EEOC II" suit). In EEOC II, in 2006, the court granted partial summary judgment to the EEOC. Although the court did not determine that AIC was liable for age discrimination under the ADEA, it determined that the rehire policy resulted in a disparate impact, reserving for trial the determination on whether AIC had reasonable factors other than age to support the rehire policy. AIC's interlocutory appeal from the partial summary judgment was granted. In June 2008, the Eighth Circuit Court of Appeals affirmed summary judgment in the EEOC's favor. In September 2008, the Court of Appeals granted AIC's petition for rehearing EN BANC and vacated its earlier decision affirming the trial court's grant of summary judgment in favor of the EEOC. The Court of Appeals then dismissed the appeal, determining that it lacked jurisdiction to consider the appeal at this stage in the litigation.
- - AIC is also defending a certified class action filed by former employee agents who terminated their employment prior to the agency program reorganization. Plaintiffs allege that they were constructively discharged so that AIC could avoid paying ERISA and other benefits offered under the reorganization. They claim that the constructive discharge resulted from the implementation of agency standards, including mandatory office hours and a requirement to have licensed staff available during business hours. The court approved the form of class notice which was sent to approximately 1,800 potential class members in November 2007. Fifteen individuals opted out. AIC's motions for judgment on the pleadings were partially granted. In May 2008, the court granted summary judgment in AIC's favor on all class claims. Plaintiffs moved for reconsideration and in the alternative to decertify the class. AIC opposed this motion and filed a motion for summary judgment with respect to the remaining non-class claim. In August 2008, the court denied plaintiffs' motion to reconsider and to decertify the class. In February 2009, plaintiffs moved to dismiss the sole remaining claim with prejudice which the court promptly granted ending this litigation in the trial court.
- - A putative nationwide class action has also been filed by former employee agents alleging various violations of ERISA, including a worker classification issue. These plaintiffs are challenging certain amendments to the Agents Pension Plan and are seeking to have exclusive agent independent contractors treated as employees for benefit purposes. This matter was dismissed with prejudice by the trial court, was the subject of further proceedings on appeal, and was reversed and remanded to the trial court in 2005. In June 2007, the court granted AIC's motion to dismiss the case. Following plaintiffs' filing of a notice of appeal, the Third Circuit issued an order in December 2007 stating that the notice of appeal was not taken from a final order within the meaning of the federal law and thus not appealable at this time. In March 2008, the Third Circuit decided that the appeal should not summarily be dismissed and that the question of whether the matter is appealable at this time will be addressed by the Court along with the merits of the appeal.
agreements with ALIC, management believes that the ultimate outcome of all matters described in this "Other Matters" subsection, in excess of amounts currently reserved, as they are resolved over time is not likely to have a material effect on the operating results, cash flows or financial position of the Company.
The Company joins the Corporation and its other domestic subsidiaries (the "Allstate Group") in the filing of a consolidated federal income tax return and is party to a federal income tax allocation agreement (the "Allstate Tax Sharing Agreement"). Under the Allstate Tax Sharing Agreement, the Company pays to or receives from the Corporation the amount, if any, by which the Allstate Group's federal income tax liability is affected by virtue of inclusion of the Company in the consolidated federal income tax return. The Company also has a supplemental tax sharing agreement with respect to reinsurance ceded to ALIC to allocate the tax benefits and costs related to such reinsurance. Effectively, these agreements result in the Company's annual income tax provision being computed, with adjustments, as if the Company filed a separate return, adjusted for the reinsurance ceded to ALIC.
The Internal Revenue Service is currently examining the Allstate Group's 2005 and 2006 federal income tax returns. The statute of limitations has expired on years prior to 2005. Any adjustments that may result from IRS examinations of tax returns are not expected to have a material effect on the results of operations, cash flows or financial position of the Company.
($ IN THOUSANDS) 2008 2007 ----- ------- DEFERRED ASSETS Unrealized net capital losses $ 119 $ -- Other assets 20 -- ----- ------- Total deferred assets 139 -- ----- ------- DEFERRED LIABILITIES Unrealized net capital gains -- (2,223) Difference in tax bases of investments (139) (254) Other liabilities -- (2) ----- ------- Total deferred liabilities (139) (2,479) ----- ------- Net deferred liabilities $ -- $(2,479) ===== =======
The Company paid income taxes of $4.9 million, $4.4 million and $4.8 million in 2008, 2007 and 2006, respectively.
The ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company and other relevant factors. The payment of shareholder dividends by the Company without the prior approval of the state insurance regulator is limited to formula amounts based on net income and capital and surplus, determined in conformity with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. The maximum amount of dividends that the Company can distribute during 2009 without prior approval of the Nebraska Department of Insurance is $27.9 million. In the twelve-month period beginning January 1, 2008, the Company did not pay any dividends.
We have audited the accompanying Statements of Financial Position of Lincoln Benefit Life Company (the "Company", an affiliate of The Allstate Corporation) as of December 31, 2008 and 2007, and the related Statements of Operations and Comprehensive Income, Shareholder's Equity, and Cash Flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.