¡ The frequency and severity of defaults by issuers in our fixed income investment portfolios; and
The Company’s portfolio of private placement securities is valued using a matrix pricing methodology. The pricing methodology is obtained from a third party service and indicates current spreads for securities based on weighted average life, credit rating and industry sector. Monthly the Company reviews the matrix to ensure the spreads are reasonable by comparing them to observed spreads for similar securities traded in the market. In order to account for the illiquid nature of these securities, illiquidity premiums are included in the valuation and are determined based upon the pricing of recent transactions in the private placement market as well as comparing the value of the privately offered security to a similar public security. The impact of the illiquidity premium to the overall valuation is less than 1% of the value. At December 31, 2013, there were no private placement securities in the Company’s fixed maturity and equity securities portfolio. At December 31, 2012, approximately $2.0 million (or 2%) of the Company’s fixed maturity and equity securities portfolio consisted of private placement securities.
During 2013, the Company entered into total return swaps which are based on the Standard & Poor’s 500 Composite Stock Price Index (“S&P”). The Company uses total return swaps to hedge equity risk. At December 31, 2013, the Company had total return swaps with a notional value of $1.1 million and a net fair value of less than ($0.1) million. The Company recognized less than ($0.1) million of losses from the change in fair value of the total return swaps in net derivative losses in the Statements of Income.
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. At December 31, 2013 and 2012, the Company’s VOBA asset was $24.6 million and $25.2 million, respectively. For the years ended December 31, 2013, 2012 and 2011, the favorable (unfavorable) impact to pre-tax net income related to VOBA unlocking was $0.8 million, $0.2 million and ($0.7) million, respectively. There were no impairment charges in 2013, 2012 and 2011. See Note 4 to the Financial Statements for a further discussion.
The expense and the subsequent capitalization and amortization (accretion) are recorded as a component of policy benefits in the Statements of Income. At December 31, 2013 and 2012, variable annuities accounted for the Company’s entire DSI asset of $0.1 million. See Note 4 to the Financial Statements for a further discussion.
Future policy benefits are actuarially determined liabilities, which are calculated to meet future obligations and are generally payable over an extended period of time. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, surrender rates, policy expenses, equity returns, interest rates, and inflation. These estimates and assumptions are influenced by historical experience, current developments and anticipated market trends. At December 31, 2013 and 2012, future policy benefits were $19.3 million and $16.5 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, 2013, 2012 and 2011, the favorable (unfavorable) impact to pre-tax income related to GMDB and GMIB unlocking was $2.4 million, $2.8 million and ($2.4) million, respectively.
Future policy benefits also include liabilities, which can be either positive or negative, for contracts containing GMWB provisions and for the reinsurance of GMIB provisions (“GMIB reinsurance”) for contracts based on the fair value of the underlying benefit. GMWB and GMIB reinsurance are treated as embedded derivatives and are required to be reported separately from the host contract. The fair value of these guarantees are calculated as the present value of future expected payments to policyholders less
At December 31, 2013 and 2012, GMWB liability and GMIB reinsurance asset included within future policy benefits were as follows:
ASC 944, Financial Services - Insurance - ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts - modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts - adopted January 1, 2012.
Total direct deposits (including internal exchanges) were $0.3 million, $0.3 million and $0.9 million for the years ended December 31, 2013, 2012 and 2011, respectively. During 2013, there were no internal exchanges. Internal exchanges during 2012 and 2011 were $0.1 million and $0.2 million, respectively.
At December 31, 2013, the Company’s assets were $803.7 million or $19.5 million higher than the $784.2 million in assets at December 31, 2012. Assets excluding Separate Accounts assets decreased $5.3 million. Separate Accounts assets, which represent 69% of total assets increased $24.9 million (or 4.7%) to $551.3 million. Changes in Separate Accounts assets were as follows:
There were no fixed contract owner deposits in 2013, 2012 and 2011. During 2013, 2012 and 2011, fixed contract owner withdrawals were $4.9 million, $4.7 million, and $6.7 million, respectively.
The Company maintains a general account investment portfolio comprised primarily of investment grade fixed maturity securities, policy loans, and cash and cash equivalents.
The Company’s $0.7 million of gross unrealized losses within the government and government agencies sector has a fair value of $9.0 million. All of the issuers in this sector continue to make payments in accordance with the original bond agreements. A majority of the unrealized losses in this sector relate to securities issued by the government of the United States of America and is primarily due to rising interest rates during the second half of 2013.
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 72% of Separate Accounts assets were invested in equity-based mutual funds at December 31, 2013. 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 2013, the total average variable account balances decreased $3.4 million (or 0.6%) to $536.9 million as compared to the same period in 2012.
(b) The Company defines credit spreads according to the Merrill Lynch U.S. Corporate Bond Index for BBB-A Rated bonds with three to five year maturities.
At December 31, 2013 and 2012, the Company had 833 and 932 life insurance and annuity contracts in force with interest rate guarantees, respectively. The estimated average rate of interest credited on behalf of contract owners was 3.4% and 3.8% during 2013 and 2012, respectively. Total invested assets supporting these liabilities with interest rate guarantees had an estimated average effective yield of 4.5% and 3.9% during 2013 and 2012, respectively.
For the years ended December 31, 2013 and 2012, the Company recorded net income of $5.7 million and $7.2 million, respectively. The decrease in net income during 2013 as compared to 2012 was primarily due to higher policy benefits, partially offset by lower VOBA amortization and net realized gains.
Amortization of VOBA was $0.8 million and $2.3 million for the years ended December 31, 2013 and 2012, respectively. Included in amortization was favorable unlocking of $0.8 million and $0.2 million for the years ended December 31, 2013 and 2012, respectively.
Policy benefits decreased $5.0 million during 2012 as compared to 2011. The following table provides the changes in policy benefits by type:
Insurance expenses and taxes decreased $0.6 million in 2012 as compared to 2011. The following table provides the changes in insurance expenses and taxes for each respective period:
The Company is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2013, 2012 or 2011.