The Company has one reportable operating segment with two primary lines of business; individual annuities and individual life insurance. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Premiums shown on the Company's consolidated financial statements in accordance with GAAP consist of premiums received for whole or term life insurance products, as well as that portion of the Company's single premium immediate annuities, which have life contingencies. With respect to that portion of single premium annuity contracts without life contingencies, as well as single premium deferred annuities and universal life insurance products, premiums collected by the Company are not reported as premium revenues, but rather are reported as additions to policyholders' account balances. With respect to products that are accounted for as policyholders' account balances, revenues are recognized over time in the form of policy fee income, surrender charges and mortality and other charges deducted from the policyholders' account balances. The Company's operating earnings are derived primarily from these revenues, plus the Company's investment results, including realized gains (losses), less interest credited, benefits to policyholders and expenses.
Certain costs related to the sale of new business are deferred as "deferred policy acquisition costs" ("DAC") and amortized into expenses in proportion to the recognition of earned revenues. Costs deferred include principally commissions, certain expenses of the policy issue and underwriting departments and certain variable sales expenses. Under certain circumstances, DAC will be expensed earlier than originally estimated, including those circumstances where the policy terminations are higher than originally estimated with respect to certain annuity products. Most of the Company's annuity products have surrender charges that are designed to discourage and mitigate the effect of early terminations.
Comparison of Fiscal Year 2002 to Fiscal Year 2001 and Fiscal Year 2001 to Fiscal Year 2000.
Of this amount, annuity considerations increased to approximately $97.4 million in fiscal 2001 from approximately $55.2 million in fiscal 2000, an increase of approximately $42.2 million.
Net investment income totaled approximately $267.6 million in fiscal 2002, as compared to approximately $234.1 million in fiscal 2001 and approximately $225.2 million in fiscal 2000. This represents approximately a 14.3% increase comparing fiscal 2002 to fiscal 2001 and approximately 4.0% increase comparing fiscal 2001 to fiscal 2000. The increases are attributable principally to an increase in fixed maturities as a result of our increase in sales. Investment income from "other invested assets" totaled approximately $21.9 million in fiscal 2002, $40.3 million in fiscal 2001 and $36.8 million in fiscal 2000. In fiscal 2002, 2001 and 2000, the Insurance Company participated in "dollar roll" transactions (i.e., the sale of a mortgage-backed security and a simultaneous agreement to purchase a similar security at a later date at a lower price) to enhance investment income. The proceeds from the sale are invested in short-term securities at a positive spread until the settlement date of the similar security. During this period, the holding institution receives all income and prepayments for the security. During 2002, the Company recorded approximately $1.6 million of additional investment income on these transactions. The Company's ratio of net investment income to average cash and invested assets less net investment income for the years ended December 31, 2002, 2001 and 2000 was approximately 7.56%, 8.19% and 9.21%, respectively. For additional information, please refer to "Note 2 of the Notes to Consolidated Financial Statements."
Total benefits and expenses for fiscal 2002 aggregated approximately $304.0 million, as compared to approximately $303.0 million for fiscal 2001 and approximately $226.5 million for fiscal 2000. This represents an increase of approximately .3% comparing fiscal 2002 to fiscal 2001 and an increase of approximately 33.8% comparing fiscal 2001 to fiscal 2000. The reasons for these changes will be discussed under the respective components below.
For the reasons discussed above, the Company had net loss of approximately $(69.3) million in fiscal 2002, net loss of approximately $(7.7) million in fiscal 2001 and net income of approximately $40.9 million in fiscal 2000.
The guidelines, among other things, focus on the insurer's overall financial condition and profitability under statutory accounting practices. Management of the Company cannot provide assurance that the Insurance Company will have statutory earnings to support payment of dividends to the Company in an amount sufficient to fund its cash requirements and pay cash dividends or that the Superintendent will not disapprove any dividends that the Insurance Company must submit for the Superintendent's
on the payment of dividends to their respective parent companies. To preserve capital, the Insurance Company paid no dividends in fiscal 2002 and in 2001 and 2000, the Insurance Company paid dividends of $27.7 million and $49.6 million, respectively, to the Company.
The Company is an insurance holding company and its primary uses of cash are debt service obligations, operating expenses and dividend payments. The Company's principal sources of cash are dividends from the Insurance Company, sales of and interest on the Company's investments and rent from its real estate. During 2002, the Company's Board of Directors maintained the quarterly dividend rate of $.10 per share. During 2002 and 2001, the Company purchased and retired 0 and 26,000 shares of common stock, respectively. At December 31, 2002, the Company was authorized to purchase approximately 385,000 additional shares of common stock.
The indenture governing the Senior Notes contains covenants relating to limitations on liens and sale or issuance of capital stock of the Insurance Company. In the event the Company violates such covenants as defined in the indenture, the Company may be obligated to offer to repurchase all of the outstanding principal amount of such notes. As of December 31, 2002, the Company believes that it is in compliance with all of the covenants.
The Company's deferred annuity products are designed to encourage persistency by incorporating surrender charges. An annuitant may not terminate or withdraw substantial funds for a period of generally seven years without incurring significant penalties in the form of surrender charges. Approximately 24.9%, 30.5% and 42.0% of the Company's deferred annuity contracts in force (measured by reserves) as of December 31, 2002, 2001, and 2000 are surrenderable without charge. The decrease since December 31, 2000 is attributable to the increase in deferred annuity contracts inforce as a result of the increase in annuity considerations received.
invests a portion of its total assets in short-term investments (approximately 6.46%, 8.13% and 8.77% as of December 31, 2002, 2001 and 2000, respectively). The weighted average duration of the Company's bond portfolio was approximately five and three quarter years as of December 31, 2002. The Company's fixed maturity investments are all classified as available for sale and include those securities available to be sold in response to, among other things, changes in market interest rates, changes in the security's prepayment risk, the Company's need for liquidity and other similar factors.
These investments are carried at market value, and unrealized gains (losses), net of federal income taxes and deferred policy acquisition costs, if any, are charged directly to shareholders' equity, unless a decline in market value is considered to be other than temporary, in which event the Company recognizes a loss throught the income statement. Equity securities include common stocks and non-redeemable preferred stocks and are carried at market, with the related unrealized gains and losses, net of federal income taxes, if any, charged or credited directly to shareholders' equity, unless a decline in market value is considered to be other than temporary, in which event the Company recognizes a loss.
Investments in below investment grade debt securities have different risks than investments in corporate debt securities rated investment grade. Risk of loss upon default by the borrower is significantly greater with respect to below investment grade debt securities than with respect to other corporate debt securities because below investment grade debt securities generally are unsecured and often are subordinated to other creditors of the issuer. Also, issuers of below investment grade debt securities usually have high levels of indebtedness and often are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. Typically, there is only a thinly traded market for such securities and recent market quotations may not be available for some of these securities. Market quotes generally are available only from a limited number of dealers and may not represent firm bids of such dealers or prices for actual sales. The Company attempts to reduce the overall risk in its below investment grade portfolio, as in all of its investments, through careful credit analysis, investment policy limitations, and diversification by company and by industry. Below investment grade debt investments, as well as other investments, are being monitored on an ongoing basis.
In certain situations, the terms of some fixed maturity assets are restructured or modified. There were no restructured fixed maturity assets at December 31, 2002.
environment, the Company has attempted to maintain its credited rates at competitive levels which are designed to discourage surrenders and which may be considered attractive to purchasers of new annuity products. In addition, because the level of prevailing interest rates impacts the Company as well as its competition, management does not believe that the current interest rate environment has materially affected the Company's competitive position vis a vis other life insurance companies that emphasize the sale of annuity products. Notwithstanding the foregoing, if interest rates continue at current levels or decline, there can be no assurance that this segment of the life insurance industry, including the Company, would not experience increased levels of surrenders and reduced sales and thereby be materially adversely affected. Conversley, if interest rates rise, competing investments (such as annuity or life insurance products offered by the Company’s competitors, certificates of deposit, mutual funds and similar investments) may become more attractive to potential purchasers of the Company’s products until the Company increases it’s credited rates.
Effective April 1, 2001, the Company adopted certain additional accounting and reporting requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125, relating to the derecognition of transferred assets and extinguished liabilities and the reporting of servicing assets and liabilities. The initial adoption of these requirements did not have an impact on the Company¢ s consolidated financial statements.
In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires that ratable amortization of goodwill be replaced with periodic tests of the goodwill's impairment and identifiable intangible assets other that goodwill be amortized over their useful lives. SFAS No. 141 is effective for acquisitions made after June 30, 2001. The provisions of SFAS No. 142 were effective for fiscal years beginning after December 15, 2001. Adoption of SFAS 141 and SFAS 142 did not have an impact on the Company's consolidated financial statements for 2001 and 2002.
In July 2001, the SEC released Staff Accounting Bulletin 102, Selected Loan Loss Allowance and Documentation Issues ("SAB 102"). SAB 102 summarizes certain of the SEC's views on the development, documentation and application of a systematic methodology for determining allowances for loan and lease losses. Adoption of SAB 102 by the Company did not have an impact on the Company's consolidated financial statements.
In October 2001, the FASB issued SFAS No.144, Accounting for the Impairment of Disposal of Long-Lived Assets ("SFAS 144"). SFAS provides a single model for accounting for long-lived assets to be disposed by superceding SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ("SFAS 121"), and the accounting and reporting provisions of Accounting Principles Board Opinion No.30, Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently occurring Events and Transactions ("APB 30"). Under SFAS 144, discontinued operations are measured at the lower of carrying value or fair value less cost to sell rather than on a net realizable value basis. Future operating losses relating to discontinued operations are also no longer recognized before they occur. SFAS 144 broadens the definition of a discontinued operation to include a component of an entity (rather than a segment of a business.) SFAS 144 also requires long-lived assets to be disposed of other than by sale to be considered held and used until disposed. SFAS 144 retains the basic provisions of (i) APB 30 regarding the presentation of discontinued operations in the income statement, (ii) SFAS 121 relating to recognition and measurement of impaired long-lived assets classified as held for sale. SFAS 144 was effective beginning January 1, 2002. The adoption of SFAS 144 by the Company did not have an impact on the Company's consolidated financial statements.
The adoption of SFAS 146 is not expected to have a material impact on the Company¢ s consolidated financial statements.
In October 2002, the FASB issued SFAS No.147, Acquisitions of Certain Financial Institutions (² SFAS 147² ). This statement, which provides guidance on the accounting for the acquisition of a financial institution, applies to all acquisitions except those between two or more mutual enterprises. The standard is effective for acquisitions for which the date of acquisition is on or after October 1, 2002. The adoption of SFAS 147 did not have an impact on the Company¢ s consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others (² FIN 45² ). FIN 45 requires entities to establish liabilities for certain types of guarantees, and expands financial statement disclosures for others. Disclosure requirements under FIN 45 are effective for financial statements of annual periods ending after December 15, 2002 and are applicable to all guarantees issued by the guarantor subject to the provisions of FIN 45. The intial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company does not expect the adoption of FIN 45 to have a significant impact on the Company’s consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (² FIN 46² ). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company is in the process of assessing the impact of FIN 46 on its consolidated financial statements.
In March 1999, the National Association of Insurance Commissioner ("NAIC") adopted the Codification of Statutory Accounting Principles (the "Codification"). The Codification, which is intended to standardize regulatory accounting and reporting to state insurance departments, was effective January 1, 2002. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. The New York State Insurance Department ("NYSID") required adoption of the Codification with certain modifications, for the preparation of statutory financial statements, effective January 1, 2001. On October 1, 2002 NYSID modified its orginal adoption of Codification to allow for the recognition of Deferred
Tax Assets (² DTA² ) and Deferred Tax Liabilities (² DTL² ), with certain restrictions. This change allowed the Insurance Company to recognize a DTA of approximately $22.4 million at December 31, 2002 for statutory reporting purposes. The adoption of Codification by the NAIC and the Codification as modified by the NYSID, as currently interpreted, did not adversely affect statutory capital and surplus as of December 31, 2002 or 2001.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (² GAAP² ) requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the consolidated financial statements. The critical accounting policies, estimates and related judgments underlying the Company¢ s consolidated financial statements are summarized below. In applying these accounting policies, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company¢ s business and operations.
The Company¢ s principal investments are in fixed maturities, all of which are exposed to at least one of three primary sources of investment risk: credit, interest rate and market valuation. The financial statement risks are those associated with the recognition of impairments and income, as well as the determination of fair values. Management evaluates whether impairments have occurred case- by- case. Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause and decline in the estimated fair value of the security and in assessing the prospects for near- term recovery. Inherent in management¢ s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the market value has been below amortized cost; (ii) the potential for impairments of securities when the issuer is experiencing significant financial difficulties; (iii) the potential for impairments in an entire industry sector or sub- sector; (iv) the potential for impairments in certain economically depressed geographic locations; (v) the potential for impairments of securities where the issuer, series of issuers or industry has a catastrophic type of loss or has exhausted natural resources; and (vi) other subjective factors, including concentrations and information obtained from regulators and rating agencies. In addition, the earnings on certain investments are dependent upon market conditions, which could result in prepayments and changes in amounts to be earned due to changing interest rates or equity markets. The determination of fair values in the absence of quoted market values is based on valuation methodologies, securities the Company deems to be comparable and assumptions deemed appropriate given the circumstances. The use of different methodologies and assumptions may have a material effect of the estimated fair value amounts.
The Company establishes liabilities for amounts payable under life and health insurance policies and annuity contracts. Generally, these amounts are payable over a long period of time and the profitabiltiy of the products is dependent on the pricing. Principal assumptions used in pricing policies and in the establishment of liabilities for future policy benefits are investment returns, mortality, expenses and persistency.
The Company sponsors a defined benefit plan covering employees who meet specified eligibility requirements. The reported expense and liability associated with these plans requires use of assumptions which include the discount rate, expected return on plan assets and rate of future compensation increases as determined by the Company. Management determines these assumptions based upon currently available market and industry data, historical performance of the plans and its assets. The actuarial assumptions used by the Company may differ materially from actual assets due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of the participants. These differences may have a significant effect on the Company¢ s consolidated financial statements.
The actuarial assumptions used in the calculation of the Company’s projected benefit obligation include the expected rate of compensation increases of 3.00%, a discount rate of 6.50% and an expected return on assets of 7.50%. The projected benefit obligation at December 31, 2002 is $8.7 million.