State regulators also use NAIC IRIS ratios to monitor capital adequacy requirements. The NAIC ratios cover 12 categories of financial data with defined “usual” ranges for each such category. The ratios are intended to provide insurance regulators with “early warnings” as to when a given company might warrant special attention. An insurance company may fall outside of the usual range for one or more ratios, and such variances may result from specific transactions that are, by themselves, immaterial or eliminated at the consolidation level. In certain states, insurers with more than three IRIS ratios outside of the NAIC usual ranges may be subject to increased regulatory oversight. For 2004, each of the Company’s insurance subsidiaries had six IRIS ratios outside of the usual ranges. However, for 2005 Family Life had five ratios and Investors Life had two ratios which were outside the usual ranges. For Family Life, the ratios outside the usual ranges were primarily related to changes in capital and surplus, net income, investment income, and non-admitted assets. For Investors Life, the ratios outside the usual ranges were primarily related to investment income and changes in premium. Despite the IRIS ratio results for 2005, both Family Life and Investors Life continue to maintain capital and surplus positions which significantly exceed RBC and other regulatory requirements.
During 2004, the Company and its investment manager developed asset-liability (“ALM”) models for the investment portfolios of FIC’s two insurance companies. These models focus on comparing the respective durations of the assets and liabilities of each company. Since duration is a direct measure of the sensitivity of an asset or liability to a change in interest rates, these ALM models are designed to allow the Company’s management to deploy investment assets in ways expected to moderate the impact of changes in interest rates on the equity of each of the insurance companies.
In 2005, FIC’s net loss was affected by the following items:
Significant auditing, actuarial, accounting, consulting, and legal fees continued to be incurred in 2005, although reduced from the level of 2004, as a result of the audit of the company’s financial accounts and resulting restatement of prior years’ consolidated financial statements included in its 2004 Form 10-K filing, along with various litigation matters continuing into 2005. These fees totaled $7.3 million in 2005, reflecting a $1.4 million decrease from 2004.
In 2004, FIC’s net loss was affected by the following items:
Significant auditing, actuarial, accounting, consulting, and legal fees were incurred in 2004, much of which was associated with the internal review of the Company’s financial accounts and resulting restatement of prior years’ consolidated financial statements as reported in its 2003 Form 10-K filing. The total for all these expenses and fees, much of which related to the internal review, restatement and litigation matters, was approximately $8.7 million for 2004. Comparative expenses and fees for 2003 and 2002 totaled approximately $5.1 million and $2.1 million, respectively.
In 2003, FIC’s net loss was affected by the following items:
$5.2 million in charges related to other than temporary impairment of securities. This adjustment resulted from an analysis of the investment portfolio that was made by the Company in connection with their regular and periodic analysis.
The above described items need to be taken into consideration in drawing comparisons between the operating results in 2005 and other periods.
The Company’s revenues and net loss for years 2005, 2004, and 2003 are shown in the following table.
Premium revenues reported for traditional life insurance products are recognized when due. Typically, both renewal premiums and first-year premiums have declined from year to year throughout the period of 2003 through 2005, as shown in the following table.
The decline in renewal premiums reflects the run-off in the Company’s existing book of business, as previously noted. The decrease in first-year premiums for Investors Life is attributable to the decrease in the number and value of new policies that were issued in 2004 and 2003. Also, Investors Life historically has focused less on sales of traditional life insurance products, placing more emphasis on annuity and universal life insurance products. Conversely, Family Life product marketing has concentrated on sales of mortgage protection insurance which are traditional life insurance products. During 2003 and 2004, the sales organization of Family Life was restructured to lower overall policy acquisition costs. Family Life also upgraded its product portfolio in 2004 to offer more competitive features and benefits. These developments were key to the increase in first year premiums in Family Life during 2004. During 2005, these trends continued with renewal premiums continuing to run-off in the Company’s existing book of business. While Investors Life maintained its first-year premiums, the restructuring and upgrades to the product portfolio contributed to Family Life’s increase in first-year premiums.
In accordance with GAAP, deposits received by FIC in connection with annuity contracts and premiums received for universal life (“UL”) insurance policies are reflected in FIC’s consolidated financial statements as increases in liabilities for contractholder deposit funds and not as revenues. Annual charges made against these deposits are reported as revenue. For the years 2003-2005, the table below reflects the amounts of such annuity deposits and UL premiums.
Net investment income for the year ended December 31, 2005, was $31.1 million as compared to $30.7 million for the year ended December 31, 2004, and $35.3 million for the year ended December 31, 2003. The increase in net investment income from 2004 to 2005 was primarily attributable to the reinvestment of cash and short-term investments and real estate sales proceeds into higher-yielding fixed maturity investments during 2005 consistent with the revised investment policies of the Company under Conning’s investment management. This increase in income was also achieved during a period when total investments, including cash and cash equivalents, declined by 4.5% from year end 2004 to year end 2005, primarily due to net run-off of insurance business as previously described. The decrease in net investment income from 2003 to 2004 was primarily attributable to 1) a decline in the income received from the Company’s interest-bearing investments, resulting from decreasing interest rates during 2003 and 2004 and 2) significant reinvestment of investment proceeds from sales, maturities, and mortgage-backed security prepayments in lower-yielding securities during this period. The Company’s holdings of fixed maturities, trading securities, and short-term investments (including cash equivalents) are its primary interest bearing securities. Additionally, the holdings of these securities declined approximately 4.4% from 2003 to 2004 contributing to the lower net investment income. Components of net investment income by investment type are detailed below:
Real estate revenue was primarily earned from the leases on the buildings at the Company’s River Place Pointe office complex in Austin, Texas. Net real estate income (revenues from leases less associated operating expenses and depreciation) totaled $.6 million, $1.8 million, and $2.4 million for the years ended December 31, 2005, 2004, and 2003, respectively. The decrease in real estate income from 2003 to 2004 was primarily due to higher depreciation, operating expenses and real estate taxes, as gross rental income was substantially the same between years. The decrease in real estate income from 2004 to 2005 was primarily due to the reduction in the space available for rental due to the sale of the River Place Point office complex in June, 2005. Due to this sale, the Company will no longer have significant real estate-related income subsequent to this date as the sales proceeds were reinvested primarily in fixed maturity securities.
For the year ended December 31, 2005, FIC had $9.2 million net realized gains on real estate sales, compared to a $1.7 million net realized gain in 2004. No real estate was sold in 2003. The realized gains on real estate for 2005 includes $8.5 million in gains recognized on the sale of the River Place Pointe property and $761,000 of gains recognized on the sale of three properties included in real estate held for sale. The net realized gains on real estate for 2004 includes $1.7 million in gains on sales of two of the Company’s real estate properties classified as held for sale.
For the year ended December 31, 2005, FIC had $386,000 net realized losses on fixed maturities and other investments, compared to net realized gains of $1.1 million in 2004 and net realized losses of $403,000 in 2003. In the third quarter of 2005, a bond was classified as temporarily impaired, resulting in a writedown of $1 million. This bond was called in the fourth quarter of 2005. In 2003, eight bonds were classified as other than temporarily impaired, resulting in writedowns totaling approximately $5.2 million. These bonds were subsequently sold in the fourth quarter of 2003, resulting in a small additional loss subsequent to the writedowns. Various other bonds were called or sold by the Company throughout 2005 and 2003 for net gains that largely offset the previously described write-downs.
Policyholder benefits and expenses, which consist primarily of death benefit claims, totaled $40.4 million, $47.5 million, and $47.4 million for the years ended December 31, 2005, 2004, and 2003, respectively. The decrease in 2005 from 2004 is primarily due to decreases in death benefits and declines in the surrenders of policies. The increase in 2004 from 2003 is primarily due to higher surrenders of traditional life insurance policies and other benefits, partially offset by lower policyholder dividends. Death benefits for 2003 and 2004 were at relatively comparable levels.
Interest expense on contractholder deposit funds represents interest paid or credited to contractholders on cash values accumulated in their universal life insurance and annuity accounts. Interest expense totaled $22.1 million in 2005, $23.2 million in 2004, and $25.8 million in 2003. The decrease in interest expense in 2005 from 2004 was primarily due to the continuing decline in the number of universal life insurance and annuity policies in-force. The decrease in interest expense in 2004 from 2003 was primarily attributable to reductions in interest rates credited to policyholders, as the Company managed its interest spread in response to the low and declining interest rates that characterized 2004. Also contributing to the lower interest expense was a decline in universal life insurance and annuity policies in force, as the liability for contractholder deposit funds decreased from $593.9 million at year-end 2003 to $572.1 million at year-end 2004.
Amortization of deferred policy acquisition costs (“DAC”) increased from $9.8 million in 2003 to $10.5 million in 2004 but decreased slightly to $10.0 million in 2005. These expenses represent the amortization of the costs of producing new business, which consist primarily of agents’ commissions and certain policy issuance and underwriting costs. DAC is amortized over the premium-paying period of the policies in proportion to estimated annual premium revenue for traditional life insurance business. For interest sensitive products, these costs are amortized in relation to the estimated annual gross profits of the policies. The level of policy lapses and surrenders can also have a significant impact on the amount of amortization in any reporting period. The amortization in 2004 and 2005 is reflective of continued pressure on estimated future margins, due to the low market interest rate environment and its impact on the Company’s interest spread as previously described.
Present value of future profits on acquired businesses (“PVFP”) is amortized in a similar manner as DAC, as previously described, for traditional and interest sensitive business. Amortization of PVFP totaled $2.7 million, $3.2 million, and $4.5 million for the years ended December 31, 2005, 2004, and 2003, respectively. The amortization is consistent with the run-off of the acquired blocks of business. However, the amount for 2004 included reduced amortization due to assumption changes related to two acquired universal life insurance blocks of business.
Although many cost reduction steps were implemented in 2004, with additional steps taken in 2005, the savings were largely offset by the extraordinary auditing, actuarial, accounting and other consulting, and legal expenses associated with the reexamination of the Company’s financial accounts and restatement of prior years’ consolidated financial statements as reported in its 2003 Form 10-K filing on July 29, 2005. Significant legal fees were also incurred in 2004 related to litigation matters as previously described in
Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm, dated January 11, 2007.
Consolidated Statements of Operations for the years ended December 31, 2005, 2004, and 2003.
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004, and 2003.