The Private Securities Litigation Reform Act of 1995 defines forward-looking statements as statements not based on historical fact. This discussion includes forward-looking statements by the Company. These statements relate to such topics as volume growth, market share, and financial goals. It is important to understand that these forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those that the statements anticipate. These risks and uncertainties may concern, among other things:
The financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"), which require SLNY to make estimates and assumptions (see Note 1 to the financial statements included in Item 8). SLNY believes that of its significant accounting policies (see Note 1 to the financial statements included in Item 8), the following may involve a higher degree of judgement and complexity.
Acquisition costs related to fixed and variable annuities and life insurance products are deferred and amortized, generally in proportion to the ratio of annual gross profits to the estimated total gross profits over the lives of the contracts. Estimated gross profits are reviewed quarterly and adjusted retrospectively when the Company revises its estimates. Estimated gross profits include assumptions related to investment spread, mortality, lapse, expense, and asset growth rates. Although realization of deferred policy acquisition costs ("DAC") is not assured, SLNY believes it is more likely than not that all of these costs will be realized. The amount of DAC considered realizable, however, could be reduced in the near term if the estimates of gross profits or total revenues discussed above are reduced.
SLNY's ability to liquidate positions in privately placed fixed securities and mortgages will be impacted to a significant degree by the lack of an actively traded market. Although SLNY believes its estimates reasonably reflect the fair value of those instruments, its key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral (if any) and other factors may not reflect those of an active market.
SLNY's accounting policy for impairment requires recognition of an other-than-temporary impairment write-down on a security if it is determined that SLNY is unable to recover all amounts due under the contractual obligations of the security. In addition, for securities expected to be sold, an other-than-temporary impairment charge is recognized if SLNY does not expect the fair value of a security to recover to cost or amortized cost prior to the expected date of sale. Once an impairment charge has been recorded, SLNY continues to review the other-than-temporarily impaired securities for additional impairment, if necessary.
During 2002, 2001 and 2000, SLNY incurred realized losses totaling $4.6 million, $0.6 million and $1.5 million respectively, for other-than-temporary impairment of value of some of its fixed maturities after determining that not all of the unrealized losses were temporary in nature. During 2002, $0.2 million of the 2001 losses were recovered and are included in realized gains. During 2001, $0.6 million of the 2000 losses were recovered and were included in realized gains. SLNY has discontinued the accrual of income on several of its holdings for issuers that are in default. The termination of accrual accounting on these holdings reduced income by $98,000, $75,000 and $50,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
SLNY had a net loss of $3.1 million for the year ended December 31, 2002 as compared to net income of $4.6 million for the year ended December 31, 2001. The change in income was directly attributed to losses in the Wealth Management segment.
The following table summarizes the results of operations and total assets as of and for the year ended December 31, 2002 for KBL, Sun NY Predecessor, and the combined entity, SLNY (in 000's):
SLNY's net income from operations reflects the operations of its four business segments: Wealth Management, Individual Protection, Group Protection and Corporate. As a result of the merger at December 31, 2002, KBL's results are included with the Wealth Management segment. For ease of comparison, the results of KBL are discussed separately.
The results of operations and total assets of KBL as of and for the year ended December 31, 2002 and the two month period ended December 31, 2001 is as follows (in 000's):
Pretax income from the Group Protection segment increased by $1.1 million for the year ended December 31, 2002, as compared to 2001 primarily due to increased premiums. Rate increases on renewals and new business together with increased volume associated with the decision to sell stop loss business in New York, effective June, 2001, resulted in increased premiums. An adjustment was made to premiums during the third quarter of 2002 that decreased premium revenue by $1.8 million. The full amount of the under accrual was paid during 2002. Claims were comparable to 2001.
The following table provides a summary of operations for the Individual Protection Segment (in 000's):
The only products available in the Individual Protection segment are those which converted from the Group Protection segment, therefore, there is minimal activity in this segment. During 2001, the Individual Protection segment incurred an increase in reserves due to revised mortality assumptions. This significantly increased total expenditures during 2001. There was no change in mortality assumptions in 2002 that would have had a similar impact, which resulted in improved 2002 earnings.
SLNY held $1.59 billion and $1.08 billion in invested assets at December 31, 2002 and 2001, respectively. SLNY pursues a high-quality, well-diversified portfolio strategy that is appropriate for its general fund obligations. The investment function is a critical component of SLNY's business given the role invested assets play in supporting SLNY's product lines and the direct impact of investment results on profitability.
The composition of the investments in SLNY's general account portfolio is as follows at December 31 (in 000's):
The fixed maturity portion of the portfolio consists of publicly traded and privately placed debt securities. SLNY diversifies its fixed maturities by industry sectors, government (domestic and foreign), and mortgaged-back and asset-backed securities. Asset-backed securities include structured equipment and receivable investments. The composition of SLNY's fixed maturity portfolio by sector and the unrealized gains and losses contained therein as of December 31, 2002 is as follows (in 000's):
: Capital Goods is a large, diverse industrial sector encompassing the aerospace and defense, building material, construction machinery, diversified manufacturing, and environmental sectors. In 2002, aerospace continued to be negatively effected by the events of September 11 further exacerbated by weak economic conditions. Defense, on the other hand, benefited from the recent military buildup and increased budgets for homeland defense. Building materials was weaker due to reduced commercial construction. Although construction machinery demand had been underperforming, in general, SLNY has seen improved balance sheets and operational efficiencies as these firms position for market recovery. In the environmental service sector poor economic conditions have affected volume and revenue growth, yet companies in this sector continue to apply strong free cash flow to improve their financial flexibility. While the capital goods subsectors have had varying operating histories, SLNY is comfortable with issuer concentration and prospects.
: Consumer Cyclicals is a large diverse industrial category comprising the automotive, entertainment, gaming, home construction, service and textile sectors. In 2002, the automotive sector experienced significant pricing pressures, reduced earnings and balance sheet problems. Automotive companies suffered significant balance sheet deterioration from underfunded pension plans resulting from declining capital markets. Although auto demand in 2003 is expected to be similar to 2002, improvement is expected for 2004. Many retailers experienced a particularly challenging environment due to industry consolidation, guarded consumer spending, increased competition, and limited pricing power. Entertainment and gaming sectors had a relatively strong year. SLNY has no exposure to the textile industry and limited exposure to the services industry. SLNY continues to closely watch sector performance and has positioned the portfolio to focus on industry leaders or bond issues with attractive collateral.
- The Consumer Non-cyclical sector is comprised of consumer product, food and beverage, healthcare, pharmaceutical, and supermarket companies. In a year of economic weakness and record debt defaults, the consumer products sector continued to be characterized as one of a safe haven, and, thus outperformed most sectors in 2002. SLNY's analysis suggests that the broad sector will continue to be a good relative performer under most economic scenarios. Sector weakness was concentrated in the supermarket sub sector for 2002. Supermarkets suffered from both a weaker economy and a change in the competitive structure of the industry. As consumers have become price sensitive in weak economic times, many have turned away from traditional grocers and turned to non-traditional food retailers such as supercenters and membership clubs. Yet, healthy free cash flow levels provide supermarket operators with financial flexibility and support investment stability.
The Finance sector encompasses banks, independent and captive finance companies, insurance companies, broker-dealers and real estate investment trusts ("REIT"). With a few notable exceptions, bonds in this broad sector performed well in 2002. Banks benefited from near historic low interest rates, which served to improve net interest margins. Banks continued to show restraint in commercial lending, focusing on consumer lending for growth. Deteriorating credit quality, especially in commercial and industrial portfolios, led to marked increases in provisioning and charge-offs. Bonds of independent finance companies were quite volatile in 2002, owing mostly to the on-again, off-again divestiture of one large commercial finance company and to the myriad of negative headlines of one large consumer finance company. Bond prices rallied in the latter part of 2002. Finance companies exposed to aircraft leasing suffered the effects of the downturn in air travel and the bankruptcies of major airlines. The performance of the captive finance bonds largely followed that of their parents. The bonds of life insurance companies underperformed in 2002 owing mostly to the dismal stock market performance that eroded variable annuity sales and account values. Life insurers were forced to accelerate deferred costs and to increase reserves for guaranteed minimum death benefits. Life insurers were also affected by lower interest rates, which lowered the yield on bond portfolios, and by the wave of downgrades and defaults of corporate bonds. Property-casualty insurers benefited from a hardening of prices, tempered somewhat by renewed asbestos headline risk, lower interest rates which lowered bond portfolio yields, and downgrades and defaults of corporate bond portfolios.
The bonds of broker-dealers fared well despite a very difficult operating environment characterized by a drought of equity initial public offerings ("IPO"), equity underwriting, and merger and acquisition activity. Broker-dealers were also plagued by negative headlines concerning biased research reports, conflicts of interest and IPO allocation processes. The recent performance of REITs has been strong, due to the defensive nature of the underlying assets and the sector's adherence to conservative credit covenants and policies. While real estate fundamentals may continue to weaken, it is anticipated that REIT debt will continue to be insulated from any significant credit or market value deterioration.
The Securities Valuation Office ("SVO") of the National Association of Insurance Commissioners evaluates all public and private bonds purchased as investments by insurance companies. The SVO assigns one of six investment categories to each security it reviews. Category 1 is the highest quality rating, and Category 6 is the lowest. Categories 1 and 2 are the equivalent of investment grade debt as defined by rating agencies such as Standard & Poor's ("S&P") and Moody's (i.e., BBB-/Baa3 or higher), while Categories 3-6 are the equivalent of below-investment grade securities.
The majority of SLNY's fixed maturity investments are investment grade, with 98% of fixed maturity securities classified as Category 1 and 2 by the SVO as of December 31, 2002. Below investment grade bonds were 2.0% of fixed maturity investments and 1.9 % of total invested assets as of December 31, 2002. The following table provides the SVO ratings for SLNY's bond portfolio along with an equivalent S&P rating designation as of December 31, 2002 (in 000's):
SLNY has a comprehensive process in place to identify potential problem securities that could have an impairment that is other-than-temporary. At the end of each quarter, all securities with a market value below 80% of amortized cost are reviewed. An analysis is undertaken to determine whether this decline in market value is other-than- temporary. SLNY's process focuses on issuer operating performance as well as overall industry and market conditions. Any deterioration in operating performance is assessed relative to the impact on financial ratios including leverage and coverage measures specific to an industry and relative to any investment covenants. Additionally, SLNY's analysis assesses each issuer's ability to service its debts in a timely fashion, the length of time the security has been trading below 80% of amortized cost, rating agency actions, and any other key developments. The Chief Investment Officer and the Chief Financial Officer review the results of the impairment analysis.
Adjustments to reconcile net (loss) income to net cash provided by
Cash acquired from acquisition through merger of Keyport Benefit Life Insurance Company
On October 9, 2002, Sun Life Insurance and Annuity Company of New York ("Sun NY Predecessor"), which was a wholly-owned subsidiary of Sun Life Assurance Company of Canada (U.S.) ("Sun Life U.S."), and Keyport Benefit Life Insurance Company ("KBL"), which was a wholly-owned subsidiary of Keyport Life Insurance Company ("Keyport"), an affiliate, filed an Agreement and Plan of Merger ("Merger Agreement") with the New York State Insurance Department. On December 31, 2002 at 5:00 p.m., Sun NY Predecessor and KBL completed the merger. Pursuant to the Merger Agreement, KBL merged with and into Sun NY Predecessor, with Sun NY Predecessor as the surviving company ("SLNY"), and SLNY issued 4,001 additional shares of common stock to Keyport in exchange for the assets and liabilities of KBL. As a result of the additional common stock issuance, SLNY is now a subsidiary of both Keyport and Sun Life U.S., with Keyport owning 67% of the common stock of SLNY. SLNY is licensed and authorized to write all the business that was previously being written by KBL and SLNY. The merger has no effect on the existing rights and benefits of policyholders or contract holders from either company. Keyport, KBL, Sun Life U.S., Sun NY Predecessor, and SLNY are, and at all times relevant to the merger were, indirectly wholly-owned subsidiaries of Sun Life Assurance Company of Canada ("SLOC"). SLOC is an indirect wholly-owned subsidiary of Sun Life Financial Services of Canada Inc. ("SLF"), a reporting company under the Securities Exchange Act of 1934. SLNY is engaged in the sale of fixed and variable annuity contracts, group life, stop loss and group health insurance contracts. These contracts are sold by insurance agents, some of who are registered representatives of national and regional stock brokerage firms and brokers.
The following summarizes the results of operations and total assets as of and for the year ended December 31, 2002 (in 000's):
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of November 1, 2001 (in thousands):
In the normal course of business, SLNY may enter into transactions involving various types of financial instruments, including cash and cash equivalents, investments such as fixed maturities, mortgage loans and equity securities, debt, loan commitments and financial guarantees. These instruments involve credit risk and also may be subject to risk of loss due to interest rate fluctuation. SLNY evaluates and monitors each financial instrument individually and, when appropriate, obtains collateral or other security to minimize losses.
Mortgage loans are stated at unpaid principal balances, net of provisions for estimated losses. Mortgage loans acquired at a premium or discount are carried at amortized values net of provisions for estimated losses. Loans include commercial first mortgage loans and are diversified by property type and geographic area throughout the United States. Mortgage loans are collateralized by the related properties and generally are no more than 70% of the properties' value at the time that the original loan is made.
Investment income is recognized on an accrual basis. Realized gains and losses on the sales of investments are recognized in operations at the date of sale and are determined using the specific cost identification method. When an impairment of a specific investment or a group of investments is determined to be other-than-temporary, a realized investment loss is recorded. Changes in the provision for estimated losses on mortgage loans are included in net realized investment gains and losses.
Acquisition costs consist of commissions, underwriting and other costs that vary with and are primarily related to the production of new business. Acquisition costs related to investment-type contracts, primarily deferred annuity and guaranteed investment contracts, are deferred and amortized with interest in proportion to the present value of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits are composed of net investment income, net realized investment gains and losses, life and variable annuity fees, surrender charges and direct variable administrative expenses. This amortization is reviewed quarterly and adjusted retrospectively by a cumulative charge or credit to current operations when SLNY revises its estimate of current or future gross profits to be realized from this group of products, including realized and unrealized gains and losses from investments.
Property, equipment, and leasehold improvements, which are included in other assets, are stated at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight-line or accelerated method over the estimated useful lives of the related assets, which generally range from 3 to 10 years.
Operating expenses primarily represent compensation, general and administrative expenses. Management believes intercompany expenses are calculated on a reasonable basis, however, these amounts may not necessarily be indicative of the costs that would be incurred if SLNY operated on a stand-alone basis.
SLNY has established separate accounts applicable to various classes of contracts providing for variable benefits and they are generally not chargeable with liabilities that arise from any other business of SLNY. Separate account assets are subject to general account claims only to the extent the value of such assets exceeds the separate account liabilities. Contracts for which funds are invested in separate accounts include individual qualified and non-qualified variable annuity contracts. Assets and liabilities of the separate accounts, representing net deposits and accumulated net investment earnings, less fees, held primarily for the benefit of contractholders, are shown as separate captions in the financial statements. Assets held in the separate accounts are carried at market value and the investment risk of such securities is retained by the policyholder.
SLNY adopted SFAS No. 133, as amended by SFAS No. 137 and SFAS No. 138, on January 1, 2001. SLNY did not use derivative contracts during the years ended December 31, 2002, 2001 and 2000, and therefore adoption had no effect on SLNY's financial position or results of operations.
SLNY has agreements with SLOC, Sun Life U.S. and its affiliates, which provide that SLOC and Sun Life U.S. will furnish to SLNY, as requested, personnel as well as certain investment and administrative services on a cost reimbursement basis. Expenses under these agreements amounted to approximately $4.4 million, $3.8 million and $3.3 million for the years ended December 31, 2002, 2001 and 2000, respectively.
No dividends were declared or paid during 2002 or 2001. SLNY declared and paid dividends in the amount of $4.7 million to Sun Life U.S. during 2000. See Note 14 for dividend restrictions information.
As more fully described in Note 7, SLNY has been involved in several reinsurance transactions with SLOC.
As more fully described in Note 8, SLNY participates in a pension plan and other post-retirement benefits sponsored by Sun Life U.S.
The amortized cost and fair value of fixed maturities were as follows (in 000's):
The amortized cost and estimated fair value by maturity periods for fixed maturities are shown below (in 000's). Actual maturities may differ from contractual maturities on asset-backed securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or SLNY may have the right to put or sell the obligations back to the issuers.
Fixed maturities with an amortized cost of approximately $1.0 million and $0.4 million at December 31, 2002 and 2001, respectively, were on deposit with governmental authorities as required by law.
SLNY invests in commercial first mortgage loans throughout the United States. Investments are diversified by property type and geographic area. Mortgage loans are collateralized by the related properties and generally are no more than 70% of the properties' value at the time that the original loan is made.
The fair values of cash and cash equivalents are estimated to be cost plus accrued interest. The fair values of short-term bonds are estimated to be amortized cost. The fair values of publicly traded fixed maturities are based upon market prices or dealer quotes. For privately placed fixed maturities, fair values are estimated by taking into account prices for publicly traded securities of similar credit risk, maturity, repayment and liquidity characteristics. The fair values of mortgage loans are estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
SLNY has an agreement with SLOC whereby SLOC reinsures the mortality risks of SLNY's group life insurance contracts. Under this agreement, certain death benefits are reinsured on a yearly renewable term basis. The agreement provides that SLOC will reinsure the mortality risks in excess of $50,000 per claim for group life contracts ceded by SLNY.
SLNY participates in a non-contributory defined benefit pension plan that is sponsored by Sun Life U.S., which is directly liable for the related obligations. Benefits under all plans are based on years of service and employees' average compensation. SLNY is allocated a portion of the pension plan expenses. The allocated expenses were $14,000, $13,000 and $52,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
SLNY conducts business principally in three operating segments and maintains a corporate segment to provide for the capital needs of the various operating segments and to engage in other financing-related activities. Each segment was defined consistent with the way results are evaluated by the chief operating decision-maker. Net investment income is allocated based on segmented assets by line of business. SLNY does not materially depend on one or a few customers, brokers or agents for a significant portion of its operations.
The Corporate segment includes the unallocated capital of SLNY and items not otherwise attributable to the other segments. Management evaluates the results of the operating segments on an after-tax basis.
SLNY is required to file quarterly and annual statements with the Insurance Department of the State of New York prepared on an accounting basis prescribed or permitted by the State of New York (statutory basis). Statutory net income and capital stock and surplus differ from net income and shareholder's equity reported in accordance with GAAP for stock life insurance companies primarily because, under statutory basis accounting, policy acquisition costs are expensed when incurred, reserves are based on different assumptions, investments are valued differently, post-retirement benefit costs are based on different assumptions and reflect a different method of adoption, and income tax expense reflects only taxes paid or currently payable.
Effective January 1, 2001, the Insurance Department of the State of New York required that insurance companies domiciled in the State of New York prepare their statutory financial statements in accordance with the National Association of Insurance Commissioners' ("NAIC") Accounting Practices and Procedures manual, version effective January 1, 2001, subject to any deviation prescribed or permitted by the State of New York Superintendent of Insurance.
Total rental expense for the years ended December 31, 2002, 2001 and 2000 was $1.1 million, $0.5 million and $0.4 million, respectively.
To the Board of Directors and Stockholders of Sun Life Insurance and Annuity Company of New York:
We have audited the accompanying balance sheet of Sun Life Insurance and Annuity Company of New York as of December 31, 2002, and the related statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years then ended. 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.