Changes in the performance of financial markets, including emerging markets, such as with regard to:
The frequency and severity of defaults by issuers in our fixed income investment portfolios; and
Changes affecting mortality and other factors that may impact the profitability of our insurance products;
Changes in laws and regulations, particularly those affecting our operations, the products we sell, and the attractiveness of certain products to our customers;
On December 28, 2007, the Company and its affiliate, MLLIC, were acquired by AUSA. The acquisition was accounted for by AUSA using the purchase method of accounting, which required the assets and liabilities of MLLICNY to be identified and measured at their estimated fair values as of the acquisition date.
This reflects the December 31, 2008 balance before adjustments for unrealized gains (losses) on investments, amortization and/or impairments.
The Company’s critical accounting policies and estimates are discussed below. See Note 1 to the Financial Statements for additional information regarding accounting policies.
The Company regularly reviews each investment in its fixed maturity and equity securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. Management makes this determination through a series of discussions with the Company’s portfolio managers and credit analysts, and information obtained from external sources (i.e. company announcements, ratings agency announcements, or news wire services). For equity securities, the Company also considers 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. The factors that may give rise to a potential OTTI include, but are not limited to, i) certain credit-related events such as default of principal or interest payments by the issuer, ii) bankruptcy of issuer, iii) certain security restructurings, and iv) fair market value less than cost or amortized cost for an extended period of time. In the absence of a readily ascertainable market value, the estimated fair value on these securities represents management’s best estimate and is based on comparable securities and other assumptions as appropriate. Management bases this determination on the most recent information available.
To the extent the Company determines that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized. During the second quarter 2009, the Company adopted new Financial Accounting Standards Board (“FASB”) guidance for the recognition and presentation of OTTI. The recognition provisions apply only to debt securities classified as available-for-sale and held-to-maturity, while the presentation and disclosure requirements apply to both debt and equity securities.
For the years ended December 31, 2009 and 2008, the Company recorded an OTTI in income, net of value of business acquired amortization, of $0.9 million and $0.5 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 most significant assumptions involved in the estimation of future gross profits are future net Separate Accounts performance, surrender rates, mortality rates and reinsurance costs. For variable annuities, the Company generally establishes a long-term rate of net Separate Accounts growth. If returns over a determined historical period differ from the long-term assumption, returns for future determined periods are calculated so that the long-term assumption is achieved. The result is that the long-term rate is assumed to be realized over a specified period. However, the long-term rate may be adjusted if expectations change. This method for projecting market returns is known as reversion to the mean, a standard industry practice. At December 31, 2009, the reversion to the mean assumption was 7.25% gross short-term equity growth rate for five years and thereafter a 9% gross long-term growth rate, while at December 31, 2008, the reversion to the mean assumption was 15% gross short-term equity growth rate for five years and thereafter a 9% gross long-term growth rate. Surrender and mortality rates for all variable contracts are based on historical experience and a projection of future experience.
VOBA represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the insurance and annuity contracts in force at the acquisition date. VOBA is based on actuarially determined projections, for each block of business, of future policy and contract charges, premiums, mortality, policyholder behavior, Separate Account performance, operating expenses, investment returns, and other factors. Actual experience on the purchased business may vary from these projections. Revisions in estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future gross profits are less than the unamortized balance. In addition, MLLICNY utilizes the reversion to the mean assumption, a common industry practice, in its determination of the amortization of VOBA. This practice assumes that the expectations for long-term appreciation in equity markets is not changed by minor short-term market fluctuations, but that it does change when large interim deviations have occurred. At December 31, 2009, the reversion to the mean assumption was 7.25% gross short-term equity growth rate for five years and thereafter a 9% gross long-term growth rate, while at December 31, 2008, the reversion to the mean assumption was 15% gross short-term equity growth rate for five years and thereafter a 9% gross long-term growth rate. At December 31, 2009 and 2008, the Company’s VOBA asset was $31.0 million and $41.5 million, respectively. For the years ended December 31, 2009 and 2008, the unfavorable impact to pre-tax income related to VOBA unlocking was $0.5 million and $2.5 million, respectively. For the years ended December 31, 2009 and 2008, there was an impairment charge of $7.2 million and $4.3 million, respectively. See Note 5 to the Financial Statements for a further discussion.
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 $125.3 million and $135.1 million, respectively.
Included within future policy benefits are liabilities for GMDB and GMIB provisions contained in the variable products that the Company issues. At December 31, 2009 and 2008, GMDB and GMIB liabilities included within future policy benefits were as follows:
Specific estimates include the realization of dividend-received deductions (“DRD”) and foreign tax credits (“FTC”). A portion of the Company’s investment income related to Separate Accounts business qualifies for the DRD and FTC. Information necessary to calculate these tax adjustments is typically not available until the following year. However, within the current year’s provision, management makes estimates regarding the future tax deductibility of these items. These estimates are primarily based on recent historic experience. See Note 8 to the Financial Statements for a further discussion.
On July 1, 2009, the FASB Accounting Standards CodificationTM (“Codification”) was launched as the single source of authoritative nongovernmental GAAP. Accounting guidance promulgated by the FASB is communicated through an Accounting Standards Update (“ASU”). An ASU provides the reason for the update and details the amendments to the Codification. Guidance in the Codification is organized by Topic, each representing a collection of related guidance (e.g., Financial Services-Insurance). Topics are further subdivided into Subtopics (e.g., Insurance Activities), and Sections (e.g., Recognition, Measurement, or Disclosure).
The Company adopted revised guidance for the recognition and presentation of OTTI as of the period ended June 30, 2009. This guidance was formerly known as FASB Staff Position (“FSP”) No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments.
The Company adopted guidance for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased as well as guidance on identifying circumstances that indicate a transaction is not orderly as of the period ended June 30, 2009. This guidance was formerly known as FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly and supersedes guidance formerly known as FSP No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.
On January 1, 2008, the Company adopted guidance providing a fair value option election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. This guidance was formerly known as SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.
On January 1, 2008, the Company adopted guidance that defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. This guidance was formerly known as SFAS No. 157, Fair Value Measurements.
The Company adopted guidance that amends impairment and related interest income measurement guidance to permit the use of reasonable management judgment about the probability that the company will be able to collect all amounts due as of the period ended December 31, 2008. This guidance was formerly known as FSP No. EITF 99-20-1, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20.
On January 1, 2009, the Company prospectively adopted guidance that provides requirements for the accounting and reporting of transactions that represent business combinations to be accounted for under the acquisition method. This guidance was formerly known as SFAS No. 141 (revised 2007), Business Combinations.
On January 1, 2009, the Company adopted guidance that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance was formerly known as FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets.
In addition, the following is recent accounting guidance that will be adopted in the future. See Note 1 to the Financial Statements for a further discussion.
At December 31, 2009, the Company’s assets were $909.8 million or $39.9 million higher than the $869.8 million in assets at December 31, 2008. Assets excluding Separate Accounts assets decreased $5.8 million. Separate Accounts assets, which represent 71% of total assets, increased $45.7 million (or 8%) to $644.1 million. Changes in Separate Accounts assets were as follows:
As permitted by the guidance, the Company recorded an increase of $0.1 million to the opening balance of retained earnings with a corresponding decrease to accumulated OCI on the Statement of Stockholder’s Equity to reclassify the non credit portion of previously other-than-temporarily impaired available-for-sale securities held as of April 1, 2009. The following summarizes the components for this cumulative effect adjustment:
Subsequent unrealized gains (losses) on OTTI securities are included in OCI-OTTI.
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.
ABS Housing Related securities are secured by pools of residential mortgage loans primarily those which are categorized as subprime. The unrealized loss 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.
All ABS housing related securities are monitored and reviewed on a monthly basis with detailed cash flow models using the current collateral pool and capital structure on the portfolio quarterly. Model output is generated under base and several stress-case scenarios. ABS housing asset specialists utilize widely recognized industry modeling software to perform a loan-by-loan, bottom-up approach to modeling. The ABS housing models incorporate external estimates on property valuations, borrower characteristics, propensity of a borrower to default or prepay and the overall security structure. Defaults were estimated by identifying the loans that are in various delinquency buckets and defaulting a certain percentage of them over the near-term and long-term. Recent payment history, a percentage of on-going delinquency rates and a constant prepayment rate are also incorporated into the model. Once the entire pool is modeled, the results are closely analyzed by the asset specialist to determine whether or not our particular tranche or holding is at risk for payment interruption. Holdings are impaired to the net present value of projected future cash flows where loss events have taken place or are projected to take place that would affect future cash flows on our particular tranche.
As the unrealized losses in the ABS housing related 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 as of December 31, 2009.
All CMBS securities of the Company are monitored and modeled under base and several stress-case scenarios by asset specialists. A widely recognized industry modeling software is used to perform a loan-by-loan, bottom-up approach. This methodology also incorporates external estimates on the property market, capital markets, property cash flows, and loan structure.
The gross unrealized loss on CMBS is $0.6 million. Over the past 18 months, the commercial real estate market has continued to soften. As property fundamentals deteriorate, CMBS loan delinquencies have been climbing at the same time. The introduction of the 20% and 30% credit enhanced classes within the 2005-2008 vintage deals provide some offset to these negative fundamentals. While the CMBS sector is beginning to show signs of improvement, the lending market remains limited as lenders have become more conservative with underwriting standards, property transactions have diminished greatly, and higher mortgage spreads have curtailed borrowing. A lack of liquidity in the market combined with a broad re-pricing of risk has led to increased credit spreads across the credit classes. As the unrealized losses in the CMBS 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 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 $0.2 million.
RMBS are securitizations of underlying pools of non-commercial mortgages on real estate. The underlying residential mortgages have varying credit ratings and are pooled together and sold in tranches. The majority of the Company’s RMBS unrealized losses relate to whole loan passthroughs.
The unrealized loss on RMBS is $0.2 million and is attributed to the B rated generic shelf name, GSR MTGE LN TR 2005-AR5 (“GSR”). The Company’s amortized cost in GSR is $1.1 million and the deal contains its own unique pool of collateral and represents a separate and distinct trust. The combination of low floating-rate reset margins, slow prepayment speeds, severe illiquidity in the market for near-prime securities, and the unprecedented level of mortgage-related credit spread widening have pushed the overall market value as a percent of amortized cost on all RMBS bonds in an unrealized loss position to 80%.
As the unrealized losses in the RMBS portfolio relates to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired as of December 31, 2009.
At December 31, 2009 and 2008, approximately $8.2 million (or 24%) and $9.8 million (or 32%), respectively, of RMBS and CMBS holdings were fully collateralized by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. RMBS and CMBS securities are structured to allow the investor to determine, within certain limits, the amount of interest rate risk, prepayment risk and default risk that the investor is willing to accept. It is this level of risk that determines the degree to which the yields on RMBS and CMBS will exceed the yields that can be obtained from corporate securities with similar credit ratings.
The Company’s impairment losses were $0.9 million for the year ended December 31, 2009 with no VOBA amortization. For the year ended December 31, 2008, impairment losses were $0.5 million, net of VOBA amortization. There were no impairment losses for the year ended December 31, 2007. During 2009, the Company impaired its holdings of preferred stock in CIT Group, Inc. for $0.3 million and its holding in Harrah’s Entertainment Inc. (“Harrah’s) to fair value for $0.3 million. Five unique issuers accounted for the remaining gross impairment of $0.3 million during 2009. During 2008, the Company impaired its holding in Harrah’s to fair value for $0.3 million. Six unique issuers accounted for the remaining gross impairments of $0.3 million during 2008.
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 74% 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.
During 2009, average variable account balances decreased $171.7 million (or 22%) to $601.1 million as compared to the same period in 2008. The decrease in average variable account balances contributed $2.8 million to the decrease in asset-based policy charge revenue during 2009, as compared to the same period in 2008.
The Company defines medium term interest rates as the average interest rate on U.S. Treasury securities with terms of one to five years.
At December 31, 2009 and 2008, MLLICNY had 1,151 and 1,232 life insurance and annuity contracts inforce with interest rate guarantees, respectively. The estimated average rate of interest credited on behalf of contract owners was 4.03% and 4.11% during 2009 and 2008, respectively. Total invested assets supporting these liabilities with interest rate guarantees had an estimated average effective yield of 3.63% and 5.34% during 2009 and 2008, respectively. In 2009, the number of life insurance and annuity contracts inforce with interest rate guarantees decreased 81 (or 7%) as compared to 2008.
During 2009, the Company did not receive a capital contribution from AUSA nor did the Company pay a dividend to AUSA. During 2008, the Company paid an ordinary cash dividend of $7.0 million to AUSA.
The Company and AUSA are parties to a “keepwell” agreement which, subject to its terms, commits AUSA to maintain MLLICNY at a minimum net worth.
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. At December 31, 2009 and 2008, based on the RBC formula, the Company’s total adjusted capital levels were well in excess of the minimum amount of capital required to avoid regulatory action.
The insurer financial strength rating scales of S&P, A.M. Best, Moody’s Investors Service (“Moody’s”), and Fitch Ratings (“Fitch”) are characterized as follows:
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.
For the years ended December 31, 2009 and 2008, MLLICNY recorded a net loss of ($6.2) million and ($2.2) million, respectively. The decrease in income during 2009 as compared to 2008 was primarily due to the 2009 net realized investment losses, increased VOBA amortization and impairments, and the 2009 valuation allowance on deferred tax assets partially offset by the 2008 goodwill and other intangibles impairment charge.
The decrease in non-asset based policy charge revenue was primarily due to the run-off of the life business as well as less paid up additions during 2009 as a result of poor equity market performance in 2008.
Insurance expenses and taxes increased $0.5 million as compared to 2008. The following table provides the changes in insurance expenses and taxes for each respective period:
The decrease in taxes, licenses and fees is primarily due to a tax refund related to NY franchise taxes.
MLLICNY recorded net income (loss) of ($2.2) million and $10.6 million for 2008 and 2007, respectively.
Net realized investment gains decreased $0.3 million (or 32%) to $0.8 million during 2008 as compared to 2007. The following table provides the changes in net realized investment gains by type:
The increase in credit related losses during 2008 were primarily due to one credit impairment in the third quarter of 2008 and a large credit related gain in 2007.
MLLICNY’s operating results are categorized into two business segments: Annuity and Life Insurance. MLLICNY’s Annuity segment consists of variable annuity and interest-sensitive annuity contracts. MLLICNY’s Life Insurance segment consists of variable life insurance and interest-sensitive life insurance contracts. The accounting policies of the business segments are the same as those described in the summary of significant accounting policies. All revenue and expense transactions are recorded at the contract level and accumulated at the business segment level for review by management.
As an insurance company, the Company is in the “risk” business and as a result is exposed to a variety of risks. A description of our risk management and control systems is given below on the basis of significant identified risks for us. Our largest exposures are to changes in the financial markets (e.g. interest rate, credit and equity market risks) that affect the value of the investments, liabilities from products that we sold, deferred expenses, and value of business acquired.
Interest rate risk arises from the possibility that changes in interest rates will affect the value of investments, primarily fixed maturity securities and preferred equity securities. Changes in interest rates have an inverse relationship to the value of investments. MLLICNY manages interest rate risk as part of its asset/liability management strategy. For each portfolio, management monitors the expected changes in assets and liabilities, as produced by MLLICNY’s model, resulting from various interest rate scenarios. Based on these results, management closely matches the duration of insurance liabilities to the duration of assets supporting those liabilities.
The sensitivity analysis in the table below shows an estimate of the effect of a parallel shift in the yield curve on net income and equity. Increases in interest rates have a negative effect on GAAP equity and net income in the current year because it results in unrealized losses on investments that are carried at fair value. The offsetting economic gain on the insurance contracts is however, not fully reflected in the sensitivities because many of these liabilities are not measured at fair value. Over time, the short-term reduction in net income due to rising interest rates would be offset by higher net income in later years, all else being equal.
The sensitivity analysis above reflects the assets and liabilities held at year-end. This does not necessarily reflect the risk exposure during the year as significant events do not necessarily occur on January 1. The selection of a 100 basis point immediate, parallel increase or decrease in interest rates is a hypothetical rate scenario used to demonstrate potential risk. While a 100 basis point immediate, parallel increase does not represent the Company’s view of future market changes, it is a near term reasonably possible hypothetical change that illustrates the potential impact of such events. While the income and equity impacts provide a presentation of interest rate sensitivity, they are based on the portfolio exposures at a point in time and may not be representative of future market results. These exposures will change as a result of ongoing portfolio transactions in response to management’s assessment of changing market conditions and available investment opportunities.
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 MLLICNY’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.
MLLICNY 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. MLLICNY’s units also perform experience studies for underwriting risk assumptions, comparing MLLICNY’s experience to industry experience as well as combining MLLICNY’s experience and industry experience based on the depth of the history of each source to MLLICNY’s underwriting assumptions. MLLICNY also has the ability to reduce expense levels over time, thus mitigating unfavorable expense variation.
MLLICNY’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. MLLICNY’s management, with the participation of the President and Chief Financial Officer, has conducted an evaluation of the effectiveness of MLLICNY’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, MLLICNY’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 MLLICNY’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the MLLICNY’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit MLLICNY to provide only management’s report in this annual report.
During the fiscal quarter ended December 31, 2009, there have been no changes in MLLICNY’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, MLLICNY’s internal control over financial reporting.