The statements contained in this Report that are not historical facts are forward-looking statements as defined in the US Private Securities Litigation Reform Act of 1995. The following are words that identify such forward-looking statements: aim, believe, estimate, target, intend, may, expect, anticipate, predict, project, counting on, plan, continue, want, forecast, should, would, is confident, will, and similar expressions as they relate to our Company. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Such risks and uncertainties include but are not limited to the following:
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
the net earnings from investment of fixed rate life insurance and annuity contract owner deposits less interest credited to contract owners, commonly known as interest spread.
For equity securities, once management determines a decline in the value of an AFS 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 the years ended December 31, 2012, 2011 and 2010, the Company recorded an OTTI in income, with no value of business acquired amortization, of less than $0.1 million, less than $0.1 million, and less than $0.1 million, respectively.
Derivatives are financial instruments in which the value changes in response to an underlying variable, that require little or no net initial investment and are settled at a future date. All derivatives recognized on the Balance Sheets are carried at fair value. All changes in fair value are recognized in the Statements of Income. The fair value for exchange traded derivatives, such as futures, are calculated net of the interest accrued to date and is based on quoted market prices. Net settlements on the futures occur daily. At December 31, 2012, the Company had 10 outstanding short futures contracts with a notional amount of $3.6 million. At December 31, 2011, the Company had 20 outstanding short futures contracts with a notional amount of $6.3 million.
In addition, in order to trade futures, the Company is required to post collateral to an exchange (sometimes referred to as margin). The fair value of collateral posted in relation to the futures margin was $0.3 million and $0.7 million as of December 31, 2012 and 2011, respectively.
The expense and the subsequent capitalization and amortization are recorded as a component of policy benefits in the Statements of Income. At December 31, 2012 and 2011, variable annuities accounted for the Company’s entire DSI asset of $0.1 million and $0.2 million, respectively. See Note 4 to the Financial Statements for a further discussion.
The long-term and short-term growth rate assumption for the amortization of VOBA, DAC and DSI was 9% at December 31, 2012, 2011 and 2010.
Goodwill is the excess of the purchase price over the estimated fair value of net assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but are subject to impairment tests conducted at least annually. Impairment testing is to be performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit represents the operating segment which is the level at which the financial information is prepared and regularly reviewed by management. The entire asset amount has been allocated to annuities. Goodwill is reviewed for indications of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator, or unanticipated competition would cause the Company to review the carrying amounts of goodwill for impairment. When considered impaired, the carrying amounts are written down to fair value based primarily on discounted cash flows. The Company performed the annual test of goodwill at December 31, 2012, 2011 and 2010 and determined there was no impairment of goodwill.
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, 2012 and 2011 were $104.1 million and $105.2 million, 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, 2012, 2011 and 2010, the favorable (unfavorable) impact to pre-tax income related to GMDB and GMIB unlocking was $2.8 million, ($2.4) million and $2.3 million, respectively.
The following outlines the adoption of recent accounting guidance in 2012. See Note 1 to the Financial Statements for a further discussion.
At December 31, 2012, the Company’s assets were $784.8 million or $7.6 million lower than the $792.4 million in assets at December 31, 2011. Assets excluding Separate Accounts assets decreased $7.7 million. Separate Accounts assets, which represent 67% of total assets, decreased $15.3 million (or 2.8%) to $526.4 million. Changes in Separate Accounts assets were as follows:
Unrealized gains (losses) incurred during the years ended 2012 and 2011 were primarily due to price fluctuations resulting from changes in interest rates and credit spreads. If the Company has the intent to sell or it is more likely than not that the Company will be required to sell these securities prior to the anticipated recovery of the amortized cost, securities are written down to fair value. If cash flow models indicate a credit event will impact future cash flows, the security is impaired to discounted cash flows. As the remaining unrealized losses in the portfolio relate to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired.
There were no significant unrealized losses at December 31, 2012. Gross unrealized losses and OTTI on below investment grade AFS securities represented 25% of total gross unrealized losses and OTTI on all AFS securities at December 31, 2011. 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, 2012.
There were no assets depressed over 20% at December 31, 2012. Details underlying AFS securities below investment grade and in an unrealized loss and OTTI position were as follows:
During 2012, 2011 and 2010, there was less than $0.1 million, less than $0.1 million, and $0.1 million, respectively, of investment income on fixed maturity trading securities recorded in net investment income in the Statements of Income. During 2012, 2011, and 2010 there was less than $0.1 million, less than ($0.1) million, and less than ($0.1) million, respectively, of income (losses) recognized from the change in the fair value on fixed maturity trading securities recorded in net investment income in the Statements of Income. The Company recognized gains (losses) of less than ($0.1) million and less than $0.1 million during the years ended 2012 and 2011, respectively, on the conversion of fixed maturity trading securities to preferred stock. There were no conversions of fixed maturity trading securities to preferred stock in 2010.
The following tables provide the ABS subprime mortgage exposure by rating and estimated fair value by vintage at December 31, 2012:
The Company’s impairment losses were less than $0.1 million, less than $0.1 million, and less than $0.1 million for the years ended December 31, 2012, 2011 and 2010, respectively, with no associated VOBA amortization. The 2012, 2011, and 2010 impairment losses were principally the result of the Company impairing its holding of a 2005 vintage RMBS due to adverse changes in cash flows.
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 67% of Separate Accounts assets were invested in equity-based mutual funds at December 31, 2012. 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. During 2012, average variable account balances decreased $66.3 million (or 10.9%) to $540.3 million as compared to the same period in 2011.
Changes in interest rates affect the value of investments, primarily fixed maturity securities and preferred equity securities, as well as interest-sensitive liabilities. Changes in interest rates have an inverse relationship to the value of investments and interest-sensitive liabilities. Also, since the Company has certain fixed products that contain guaranteed minimum crediting rates, decreases in interest rates can decrease the amount of interest spread earned.
During 2012 and 2011, the Company did not receive a capital contribution from AUSA. In 2012, the Company did not pay a cash dividend to AUSA. In 2011, the Company paid a cash dividend of $25.0 million to AUSA.
In order to continue to issue annuity products, the Company must meet or exceed the statutory capital and surplus requirements of the insurance departments of the states in which it conducts business. Statutory accounting principles differ from GAAP in two major
respects. First, under statutory accounting principles, the acquisition costs of new business are charged to expense, while under GAAP they are amortized over a period of time. Second, under statutory accounting principles, the required additions to statutory reserves are calculated under different rules than under GAAP.
On September 21, 2012, Fitch reduced the Company’s outlook from stable to negative. The Company’s financial strength rating remained the same.
The following table summarizes the Company’s ratings at March 28, 2013:
(a) 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, 2012 and 2011, the Company’s estimated liability for future guaranty fund assessments was less than $0.1 million and $0.3 million, respectively. In addition, the Company has a receivable for future premium tax deductions of less than $0.1 million and $0.1 million at December 31, 2012 and 2011, respectively. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
Net realized investment gains decreased $1.6 million to ($1.0) million during 2012 as compared to $0.6 million in 2011. The following table provides the changes in net realized investment gains (losses) by type:
(a) The decrease in interest related gains in 2012 as compared to 2011 is primarily a result of higher fixed maturity securities sales in 2011.
Amortization of VOBA was $2.3 and $1.6 million for the year ended December 31, 2012 and 2011, respectively. Included in amortization was favorable (unfavorable) unlocking of $0.2 million and ($0.7) million for the years ended December 31, 2012 and 2011, respectively. 2012 was impacted by favorable equity markets and higher gross profits as compared to 2011.
Net realized investment gains decreased $0.3 million to $0.6 million during 2011 as compared to $0.9 million in 2010. The following table provides the changes in net realized investment gains (losses) by type:
The Company is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2012, 2011 or 2010.