We undertake no obligation to publicly update or revise any forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which merely reflect Company expectations at the time of the writing. Actual results may differ materially from expectations conveyed in forward-looking statements due to changes caused by various risks and uncertainties. The reader should, however, consult any further disclosures MLLIC may make in future filings of its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K.
On December 28, 2007, the Company and its affiliate, MLLICNY, were acquired by AUSA. The acquisition was accounted for by AUSA using the purchase method of accounting, which required the assets and liabilities of MLLIC to be identified and measured at their estimated fair values as of the acquisition date.
Changes in the fair value of fixed maturity and equity securities are reported as a component of accumulated other comprehensive income (loss), net of taxes on the Balance Sheets and are not reflected in the Statements of Income until a sale transaction occurs or when credit-related declines in estimated fair value are deemed other-than-temporary.
Financial assets that are lent to a third party or that are transferred subject to a repurchase agreement at a fixed price are not derecognized as the Company retains substantially all the risks and rewards of asset ownership. The lent securities are included in fixed maturity available-for-sale securities in the Balance Sheets. A liability is recognized for cash collateral received, required initially at 102%, on which interest is accrued. At December 31, 2009 and 2008, the payable for collateral under securities loaned was $149.1 million and $182.5 million, respectively.
For equity securities, once management determines a decline in the value of an available-for-sale security is other-than-temporary, the cost basis of the equity security is reduced to its fair value, with a corresponding charge to earnings.
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 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 available-for-sale debt securities for which non credit OTTI was previously recognized in OCI in OCI-OTTI.
For the years ended December 31, 2009 and 2008, the Company recorded an OTTI in income, net of value of business acquired amortization, of $9.9 million and $8.3 million, respectively. The Company did not experience any realized investment losses due to other-than-temporary declines in fair value for the year ended December 31, 2007.
The Company’s liability for policyholder account balances represents the contract value that has accrued to the benefit of policyholders as of 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, 2009 and 2008 were $1.6 billion and $1.8 billion, respectively.
The Company regularly evaluates the assumptions used to establish these liabilities, as well as actual experience and adjusts GMDB and GMIB liabilities with a related charge or credit to earnings (“unlocking”), if actual experience or evidence suggests that the assumptions should be revised. For the years ended December 31, 2009, 2008 and 2007, the favorable (unfavorable) impact to pre-tax income related to GMDB and GMIB unlocking was ($10.4) million, ($95.8) million, and $22.0 million, respectively.
MLLIC’s variable universal life insurance product includes a premium load that is higher in early policy years than in later years. The excess of the initial load over the ultimate load is accreted into revenue over time in the same manner that DAC is amortized. In addition, the unearned policy charge revenue liability is subject to the same periodic reassessment as DAC. At December 31, 2007, the UPCR liability was zero as a result of the push down accounting at the acquisition date. For the year ended December 31, 2007, the unfavorable impact on pre-tax income related to UPCR unlocking was $4.8 million. See Note 6 to the Financial Statements for a further discussion.
The valuation allowance for deferred tax assets at December 31, 2009 was $145.5 million. There was no valuation allowance at December 31, 2008. The valuation allowance is related to a net operating loss carryforward and other deferred tax assets that, in the judgment of management, is not more likely than not to be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that all or some of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends on generation of further taxable income during the periods in which those temporary differences are deductible. Management considers the scheduled reversal of deferred tax liabilities, projected taxable income, and tax-planning strategies in making the assessment.
The Company adopted guidance that establishes the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities as of the period ended September 30, 2009. This guidance was formerly known as Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162.
The Company adopted guidance on measuring the fair value of certain alternative investments (i.e., investments in hedge funds, private equity funds, venture capital funds, offshore fund vehicles, funds of funds, and real estate funds) as of the period ended December 31, 2009 (ASU 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)).
The Company adopted guidance requiring disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments as of the period ended December 31, 2008. This guidance was formerly known as FSP No. FAS 133-1 and FASB Interpretation No. 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.
The decrease in variable annuity deposits during 2009 and 2008 was primarily due to volatile equity markets as well as the Company discontinuing the sale of variable annuity products in 2009. All other deposits include deposits on discontinued modified guaranteed annuities and immediate annuities as well as renewal deposits on existing life insurance and fixed annuity contracts. Internal exchanges during 2009, 2008 and 2007 were $10.4 million, $58.2 million and $140.2 million, respectively.
Policy and contract surrenders decreased $306.8 million (or 30%) to $722.9 million during 2009 as compared to 2008. Policy and contract surrenders decreased $489.3 million (or 32%) to $1,029.7 million during 2008 as compared to 2007. The decrease is primarily due to the decline in the equity markets in late 2008 and early 2009.
The following schedule identifies MLLIC’s general account invested assets by type at December 31:
The cumulative effect adjustment was calculated for all available-for-sale securities held as of April 1, 2009, for which an OTTI was previously recognized, but as of April 1, 2009, the Company did not intend to sell the security and it was not more likely than not that the Company would be required to sell the security before recovery of its amortized cost, by comparing the present value of cash flows expected to be received as of April 1, 2009, to the amortized cost basis of the available-for-sale securities. The discount rate used to calculate the present value of the cash flows expected to be collected was the rate for each respective available-for-sale security in effect before recognizing any OTTI. In addition, because the carrying amount of VOBA is adjusted for the effects of realized and unrealized gains and losses on available-for-sale securities, the Company recognized a true-up to the VOBA balances for this cumulative effect adjustment.
Five issuers represent more than 5% of the total unrealized loss position, which is comprised of one commercial mortgage-backed security (“CMBS”) holding, one ABS subprime mortgage, one Treasury bond and two residential mortgage-backed securities (“RMBS”). The Company’s largest single issuer unrealized loss is $5.9 million and relates to US Treasuries. The Company’s CMBS unrealized loss is $3.8 million and relates to Citigroup Commercial Mortgage Tranche 2004-C1. This is a CMBS that contains fixed income positions where our holding is rated investment grade. The Company’s ABS subprime mortgage unrealized loss is $3.4 million and relates to Lehman XS Tranche 2007-9, which is a first lien-fixed rate subprime mortgage security that is rated below investment grade. Due to an adverse change in cash flows, Lehman XS Tranche 2007-9 was impaired to discounted cash flows as of December 31, 2009. The Company’s RMBS unrealized loss is $6.4 million and relates to GSR Mortgage Loan Tranche 2005-AR5 and SASCO 2008-03. GSR Mortgage Loan Tranche 2005-AR5 and SASCO 2008-03 are securitized portfolios of RMBS that contain fixed income positions where our holdings are rated below investment grade and investment grade, respectively.
The overall exposure to the banking sub-sector in the Company’s portfolio is of high quality. The unrealized losses in the banking sub-sector primarily reflect low floating rate coupons on some securities, and credit spread widening due to economic weakness and market concerns that deeply subordinated securities will not be supported by the government. Government initiatives put into place during 2008 and 2009 have been largely successful in reopening the funding markets though lending remains cautious in some sectors of the economy. Many banks have benefited from both direct assistance (government capital injections, asset relief plans and government guarantees on debt) and indirect assistance (various government liquidity measures, including short-term funding facilities). Included in the Company’s banking exposure are hybrid securities, which typically have an original maturity of more than thirty years, may be perpetual and were designed to receive enhanced equity credit from rating agencies. In addition, they have other features that may not be consistent across issues such as a cumulative or non-cumulative coupon, capital replacement language and an alternative payment mechanism. The Company’s exposure to hybrid securities in an unrealized loss is all rated investment grade and there is little risk of payment interruption. The Company evaluated the near-term prospects of the issuers in relation to the severity and duration of the unrealized loss and does not consider those investments to be impaired as of December 31, 2009.
There are no individual issuers rated below investment grade in this sub-sector which have an unrealized loss position greater than $2.5 million.
The unrealized loss in the Basic Industries and Capital Goods sector is primarily related to aerospace and defense companies. Business aircraft is currently in the midst of a severe cyclical downturn. The industry is seeing a significant decline in demand for new aircraft, as well as significant delays and renegotiations on previously ordered aircraft. Orders are being deferred by large customers. To combat falling sales, the industry has undertaken various cost reduction efforts. Commercial aircraft demand has been in a cyclical decline as well, however, not to the same degree as business aircraft. Commercial airline traffic trends have stabilized and are expected to follow global economic trends. The Company evaluated the near-term prospects of the issuers in relation to the severity and duration of the unrealized loss and does not consider those investments to be impaired as of December 31, 2009.
There are no individual issuers rated below investment grade in the basic industries and capital goods sector which have unrealized loss positions greater than $2.5 million.
The Consumer Cyclical sector has been negatively impacted by the combination of global economic weakness, weak consumer confidence, tight credit standards and high unemployment. The most significant sub-sector from an unrealized loss perspective is gaming.
Where issuers are not projected to pay principal and interest in full, securities were impaired to the net present value of projected future cash flows. The Company evaluated the near-term prospects of the issuers in relation to the severity and duration of the remaining unrealized loss and does not consider those investments to be impaired as of December 31, 2009.
There are no individual issuers rated below investment grade in the consumer cyclical sector which have unrealized loss positions greater than $2.5 million.
The Energy sector includes several sub-sectors. The most significant sub-sector from an unrealized loss perspective is integrated energy (companies that are active in both exploration/production and refining).
Over the past year, the fundamental picture for integrated companies has improved with commodity prices positively impacting cash flow generation. These are mostly very large, geographically diverse names with multi-billion dollars in liquidity and are not highly leveraged. As such they are able to absorb commodity volatility better than the smaller exploration and production companies. The Company evaluated the near-term prospects of the issuers in relation to the severity and duration of the remaining unrealized loss and does not consider those investments to be impaired as of December 31, 2009.
The Transportation sector includes transportation services companies and airlines. Transportation services is a diversified sub-sector including issuers ranging from rental car companies to rail car manufacturers. These companies have all been impacted by the economic slowdown in varying degrees. Rental car companies have experienced weakness in end market demand, especially within the corporate travel segment. A weak used car market rebounded dramatically during 2009 and the capital markets have opened back up for the more leveraged names in the sub-sector. Parcel delivery companies have also experienced weak demand for their services, which has pressured pricing. Balance sheets generally remain strong and the recent strength in industrial production should help fundamentals for this sector.
Airline fundamentals continue to be pressured as business travel demand remains soft. Airlines have resorted to cutting capacity and fares to keep their aircraft full, which has resulted in high load factors, but much weaker yields. This has translated into significant pressure on the top-line. Liquidity concerns have abated for the foreseeable future given the sizable amounts of cash that have been raised across the sector via the capital markets. Concerns over input costs have increased as jet fuel costs have risen to 52 week highs.
There are no individual issuers rated below investment grade in the transportation sector which have unrealized loss positions greater than $2.5 million.
ABS Housing Related securities are secured by pools of residential mortgage loans primarily those which are categorized as subprime. The unrealized loss and OTTI 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. Expected losses within the underlying pools are generally higher than original expectations, primarily in certain later-vintage adjustable rate mortgage loan pools, which has led to some rating downgrades in these securities. While most of the Company’s ABS housing related positions are secured by pools of subprime residential mortgages, the Company has exposure to one ABS collateralized by manufactured housing loans. The market value of this security is $3.3 million with an amortized cost balance of $4.1 million. The security has a vintage of 2001.
There is one individual issuer rated below investment grade in the ABS housing sector which has an unrealized loss position greater than $2.5 million, Lehman XS TR 2007-09. The market value of this security is $5.4 million with an unrealized loss of $3.4 million, with the position being first lien - senior CCC rated. For this holding, the collateral pool has experienced higher than expected delinquencies and losses, and the unrealized loss is further exacerbated by the impact of declining home values on borrowers using affordability products. The credit spread widening is further impacting the unrealized losses due to illiquidity as well as increased extension risk due to slower than expected prepayments. Cash flow models did not indicate full recovery of principal and interest for the Company’s particular holding above and it was impaired to the net present value of projected future cash flows as of December 31, 2009.
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 includes conduit and single borrower securities, with the majority of these positions being AAA-senior rated securities.
The following tables summarize the Company’s CMBS exposure by rating and vintage at December 31:
All 2004 & Prior AAA’s are classified as ‘AAA - Senior’. This was prior to the market convention of Credit Enhanced tiering within AAA’s, which started in 2005.
All CMBS securities of the Company are monitored and modeled under base and several stress-case scenarios by asset specialists. For conduit securities a widely recognized industry modeling software is used to perform a loan-by-loan, bottom-up approach. For non-conduit securities, a CMBS asset specialist works closely with AEGON USA Realty Advisors’ real estate valuation group to determine underlying asset valuation and risk. Both methodologies incorporate external estimates on the property market, capital markets, property cash flows, and loan structure. Results are then closely analyzed by the asset specialist to determine whether or not a principal or interest loss is expected to occur. If cash flow models indicate a credit event will impact future cash flows, the security is impaired to the net present value of projected future cash flows.
There are no individual issuers rated below investment grade in this sector which have an unrealized loss position greater than $2.5 million.
The amortized cost and estimated fair value of fixed maturity securities by rating agency equivalent were:
Unrealized gains (losses) incurred during 2009 and 2008 were primarily due to price fluctuations resulting from changes in interest rates and credit spreads. The Company has the ability and intent to hold the investments for a period of time sufficient for a forecasted market price recovery up to or beyond the amortized cost of the investment.
Gross unrealized losses and OTTI on available-for-sale below investment grade securities represented 32% and 14% of total gross unrealized losses and OTTI on all available-for-sale securities at December 31, 2009 and 2008, respectively. Generally, below investment grade securities are more likely than investment grade securities to develop credit concerns. The ratios of estimated fair value to amortized cost reflected in the table below were not necessarily indicative of the market value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to December 31, 2009.
The majority of assets depressed over 20% as well as over 40% and greater than one year are primarily related to ABS subprime mortgages, CMBS and RMBS. As there has been no impact to expected future cash flows, the Company does not consider the underlying investments to be impaired as of December 31, 2009.
Second lien collateral primarily composed of loans to prime and Alt A borrowers.
Twenty-two unique issuers accounted for the remaining gross impairment losses of $9.5 million with no single issuer accounting for more than $1.0 million. During 2008, the Company impaired its holdings of FBG Finance and State Street Capital for $1.9 million and $1.0 million, respectively, due to a lack of intent to hold these issuers. Additionally, the Company recorded a $2.2 million gross impairment on Lehman Brothers Holdings due to a bankruptcy filing of the issuer. Forty-seven unique issuers accounted for the remaining gross impairment losses of $9.1 million with no single issuer accounting for more than $1.0 million.
The Company adopted revised guidance on the recognition and presentation of OTTI as of June 30, 2009. The gross cumulative effect of this adoption was a $12.6 million adjustment to retained earnings and amortized cost for fixed maturity securities and cost for equity securities for the non credit related portion of previously recorded impairments on securities still in inventory at April 1, 2009. Of this, $3.5 million related to non credit impairments previously recorded in income during the first quarter of 2009.
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, 2009 and 2008. At December 31, 2009 and 2008, there were no commercial mortgage loans that were two or more payments delinquent. See Note 4 to the Financial Statements for further discussion.
Changes in the U.S. equity market directly affect the values of the underlying U.S. equity-based mutual funds supporting Separate Accounts assets and, accordingly, the values of variable contract owner account balances. Approximately 75% of Separate Accounts assets were invested in equity-based mutual funds at December 31, 2009. Since asset-based fees collected on in force variable contracts represent a significant source of revenue, the Company’s financial condition will be impacted by fluctuations in investment performance of equity-based Separate Accounts assets.
At December 31, 2009 and 2008, MLLIC had 15,498 and 17,284 life insurance and annuity contracts inforce with interest rate guarantees, respectively. The estimated average rate of interest credited on behalf of contract owners was 3.49% and 4.08% during 2009 and 2008, respectively. Total invested assets supporting these liabilities with interest rate guarantees had an estimated average effective yield of 2.49% and 5.65% during 2009 and 2008, respectively. In 2009 the number of life insurance and annuity contracts inforce with interest rate guarantees decreased 1,786 (or 10%) as compared to 2008.
During 2009, the Company did not pay any cash dividends to AUSA or receive any capital contributions from AUSA. During 2008, the Company received a $250.0 million capital contribution from AUSA.
The National Association of Insurance Commissioners utilizes the RBC adequacy monitoring system. The RBC calculates the amount of adjusted capital that a life insurance company should have based upon that company’s risk profile. As of December 31, 2009 and 2008, based on the RBC formula, the Company’s total adjusted capital levels were above the minimum amount of capital required to avoid regulatory action.
On March 31, 2009, S&P downgraded the Company’s insurance financial strength rating from AA to AA-. The ratings outlook is negative.
On April 23, 2009, A.M. Best downgraded the Company’s insurance financial strength rating from A+ to A. The ratings outlook remains stable.
The following table summarizes the Company’s ratings as of March 25, 2010:
The policyholder liabilities include benefit and claim liabilities of which a significant portion represents policies and contracts that do not have a stated contractual maturity. The projected cash benefit payments in the table above are based on management’s best estimates of the expected gross benefits and expenses, partially offset by the expected gross premiums, fees and charges relating to the existing business in force. Estimated cash benefit payments are based on mortality and lapse assumptions comparable with the Company’s historical experience, modified for recently observed trends. Actual payment obligations may differ if experience varies from these assumptions. The cash benefit payments are presented on an undiscounted basis and are before deduction of tax and before reinsurance. The liability amounts in the Company’s financial statements reflect the discounting for interest as well as adjustments for the timing of other factors as described above. As a result, the sum of the cash benefit payments shown for all years in the table above exceeds the corresponding policyholder liability amounts.
The Company has utilized public information to estimate the future assessments it will incur as a result of life insurance company insolvencies. At December 31, 2009 and 2008, the Company’s estimated liability for future guaranty fund assessments was $5.0 million and $5.7 million, respectively. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
The costs associated with acquiring contract owner deposits (DAC) are amortized over the period in which the Company anticipates holding those funds, as noted in the Critical Accounting Policies section above. 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 the years ended December 31, 2009 and 2008, MLLIC recorded a net loss of $203.1 million and $138.3 million, respectively. The decrease in income during 2009 as compared to 2008 was primarily due to the 2009 valuation allowance on deferred tax assets, increased VOBA amortization and impairments, and the 2009 net realized investment losses partially offset by the 2008 goodwill and other intangibles impairment charge and lower policy benefit expenses.
Net realized investment gains (losses) decreased $86.0 million to ($58.3) million during 2009 as compared to $27.7 million in 2008. The following table provides the changes in net realized investment gains (losses) by type:
Policy benefits decreased $139.5 million during 2009 as compared to 2008. The following table provides the changes in policy benefits by type:
See the Critical Accounting Policies and Estimates section above for further discussion of annuity benefit unlocking.
Reinsurance premiums ceded decreased $15.5 million during 2009 as compared to 2008. Effective second quarter of 2008, the Company began to recapture the majority of its reinsurance resulting in the decreased reinsurance premiums, which is expected to be finalized in the first half of 2010.
Amortization (accretion) of DAC was $10.6 million and ($0.7) million for 2009 and 2008, respectively. For 2009 and 2008, there was an unfavorable impact to pre-tax income related to DAC unlocking of $2.6 million and $7.4 million, respectively. Equity market improvements in 2009 caused higher amortization expense as a result of increasing gross profits. During 2008, the Company experienced lower than expected gross profits as a result of market losses which reduced amortization expense and unlocking.
The decrease in commissions is primarily due to the Company no longer issuing variable annuity products during the latter part of 2009, as well as a decline in trail commissions as a result of decreased average variable account balances in 2009 as compared to 2008.
MLLIC recorded a net income (loss) of ($138.3) million and $110.5 for 2008 and 2007, respectively.
The decrease in non-asset based policy charge revenue was primarily due to unfavorable UPCR amortization in 2007 resulting from high mortality. The UPCR balance was zero as of December 31, 2007 as a result of push down accounting at the acquisition date.
Net realized investment gains increased $25.6 million to $27.7 million during 2008 as compared to $2.1 million in 2007. The following table provides the changes in net realized investment gains by type:
The decrease in interest related gains during 2008 were primarily due to the recording of OTT impairments in 2008.
The increase in annuity benefit expense was primarily due to the increase in guaranteed minimum benefit amounts due to increased market volatility.
The increase in life insurance mortality expense during 2008 was due to fewer claims on policies that had a higher net amount at risk.
Reinsurance premiums ceded decreased $5.5 million during 2008 as compared to 2007. Effective second quarter of 2008, the Company began to recapture the majority of its reinsurance resulting in the decreased reinsurance premiums.
The increase in general insurance expenses is primarily due to increased system-related expenses.
MLLIC is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2009, 2008, or 2007.
Fluctuations in the equity markets have affected MLLIC’s profitability, capital position and sales of equity related products in the past and may continue to do so. Exposure to equity markets exists in both assets and liabilities. Asset exposure exists through direct equity investment, where MLLIC bears all or most of the volatility in returns and investment performance risk. Equity market exposure is also present in insurance contracts for account of policyholders where funds are invested in equities such as variable annuities and life insurance. Although most of the risk remains with the policyholder, lower investment returns can reduce the asset management fee earned by MLLIC on the asset balance in these products. In addition, some of this business has minimum guarantees.
The sensitivity analysis of net income to change in equity prices is presented in the table below. The sensitivity of net income to changes in equity markets reflects changes in the market value of MLLIC’s portfolio, changes in DAC amortization and the strengthening of the guaranteed minimum benefits, where applicable. The results of equity sensitivity tests are non-linear. The main reason for this is due to equity options sold to clients that are embedded in some of these products and the more severe scenarios could cause accelerated DAC amortization and guaranteed minimum benefits provisioning, while moderate scenarios may not.
Liquidity risk is inherent in much of MLLIC businesses. Each asset purchased and liability sold has liquidity characteristics that are unique. Some liabilities are surrenderable while some assets, such as private placements, mortgages loans and limited partnerships have low liquidity. If MLLIC requires significant amounts of cash on short notice in excess of normal cash requirements, MLLIC may have difficulty selling these investments at attractive prices, in a timely manner or both.
The Company’s earnings depend significantly upon the extent to which actual claims experience is consistent with the assumptions used in setting the prices for products and establishing the technical liabilities and liabilities for claims. To the extent that actual claims experience is less favorable than the underlying assumptions used in establishing such liabilities, income would be reduced. Furthermore, if these higher claims were part of a permanent trend, MLLIC may be required to increase liabilities, which could reduce income. In addition, certain acquisition costs related to the sale of new policies and the purchase of policies already in force have been recorded as assets on the balance sheet and are being amortized into income over time. If the assumptions relating to the future profitability of these policies (such as future claims, investment income and expenses) are not realized, the amortization of these costs could be accelerated and may even require write offs due to unrecoverability. This could have a materially adverse effect on MLLIC’s business, results of operations and financial condition.
MLLIC monitors and manages its underwriting risk by underwriting risk type. Attribution analysis is performed on earnings and reserve movements in order to understand the source of any material variation in actual results from what was expected. MLLIC’s units also perform experience studies for underwriting risk assumptions, comparing MLLIC’s experience to industry experience as well as combining MLLIC’s experience and industry experience based on the depth of the history of each source to MLLIC’s underwriting assumptions. MLLIC also has the ability to reduce expense levels over time, thus mitigating unfavorable expense variation.
Sensitivity analysis of net income to various underwriting risks is shown in the table that follows. The sensitivities represent an increase or decrease of mortality rates over 2009. Increases in mortality rates lead to an increase in the level of benefits and claims on most business. The impact on net income of sales transactions of investments required to meet the higher cash outflow from lapses or deaths are reflected in the sensitivities.
The term “disclosure controls and procedures” (defined in the Securities Exchange Act of 1934 Rule 13a-15(e)) generally refers to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within required time periods. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by MLLIC in the reports that it files or submits under the Exchange Act is accumulated and communicated to MLLIC’s management, including MLLIC’s principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. MLLIC’s management, with the participation of the President and Chief Financial Officer, have evaluated the effectiveness of the MLLIC’s disclosure controls and procedures as of the end of the period covered by this annual report (the “Evaluation Date”). Based on that evaluation, MLLIC’s President and Chief Financial Officer have concluded that, as of the Evaluation Date, such disclosure controls and procedures were effective.
The term “internal control over financial reporting” (defined in Exchange Act Rule 13a-15(f)) generally refers to the process of a company that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
MLLIC’s management, with the participation of the President and Chief Financial Officer, is responsible for establishing and maintaining an adequate system of internal control over financial reporting. MLLIC’s management, with the participation of the President and Chief Financial Officer, has conducted an evaluation of the effectiveness of MLLIC’s internal control over financial reporting as of December 31, 2009 based on the criteria related to internal control over financial reporting described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, MLLIC’s management concluded that the internal control over financial reporting was effective as of December 31, 2009.
This annual report does not include an attestation report of MLLIC’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the MLLIC’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit MLLIC to provide only management’s report in this annual report.