The Registrant’s home office is located at 222 Broadway, 2nd Floor, New York, New York. This office space is leased from MLPF&S. In addition, personnel performing services for the Registrant pursuant to its Management Services Agreement operate in MLIG office space. MLIG occupies certain office space in Pennington, New Jersey through Merrill Lynch & Co. An allocable share of the cost of each of these premises is paid by the Registrant through the service agreement with MLIG. Merrill Lynch Insurance Group Services, Inc. (“MLIGS”), an affiliate of MLIG, owns office space in Jacksonville, Florida.
Certain statements contained in this Report may be considered forward-looking, including statements about management expectations, strategic objectives, business prospects, anticipated financial performance, and other similar matters. These forward-looking statements are not statements of historical fact and represent only management’s beliefs regarding future events, which are inherently uncertain. There are a variety of factors,
many of which are beyond ML of New York’s control, which affect its operations, performance, business strategy, and results and could cause its actual results and experience to differ materially from the expectations and objectives expressed in any forward-looking statements. These factors include, but are not limited to, actions and initiatives taken by current and potential competitors, general economic conditions, the effects of current, pending and future legislation, regulation and regulatory actions, and the other risks and uncertainties detailed in this report. See Risk Factors that Could Affect ML of New York. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the dates on which they are made. ML of New York does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the dates the forward-looking statements are made. The reader should, however, consult any further disclosures ML of New York may make in future filings of its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.
ML of New York conducts its business primarily in the annuity markets and to a lesser extent in the life insurance markets of the financial services industry. These markets are highly regulated with particular emphasis on company solvency and sales practice monitoring. Demographically, the population is aging and there is a growing number of individuals preparing for retirement, which favors life insurance and annuity products. ML of New York currently offers the following guaranteed benefits within its variable annuity product suite: guaranteed minimum death benefits (GMDB’s), guaranteed minimum income benefits (GMIB’s) and guaranteed minimum withdrawal benefits (GMWB’s). ML of New York believes that the demand for retirement products containing guarantee features will continue to increase in the future. ML of New York believes it is well positioned to continue meeting these demands for guaranteed benefits.
ML of New York’s principal investments are available-for-sale fixed maturity and equity securities as defined by SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The fair value of publicly traded fixed maturity and equity securities are based on independently quoted market prices. For non-publicly traded fixed maturity and equity securities, ML of New York utilizes pricing services and broker quotes to determine fair value. Since significant judgment is required for the valuation of non-publicly traded securities, the estimated fair value of these securities may differ from amounts realized upon an immediate sale. At December 31, 2006 and December 31, 2005, approximately, $19.7 million (or 15%) and $27.2 million (or 17%), respectively, of ML of New York’s fixed maturity and equity securities portfolio consisted of non-publicly traded securities.
The costs of acquiring business, principally commissions, certain expenses related to policy issuance, and certain variable sales expenses that relate to and vary with the production of new and renewal business, are deferred and amortized in accordance with SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. Deferred policy acquisition costs (“DAC”) are subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each reporting period. At December 31, 2006, variable annuities and variable life insurance accounted for $16.1 million (or 71%) and $6.4 million (or 29%), respectively, of ML of New York’s DAC asset. At December 31, 2005, variable annuities and variable life insurance accounted for $15.4 million (or 67%) and $7.6 million (or 33%), respectively, of ML of New York’s DAC asset.
Future gross profit estimates are subject to periodic evaluation with necessary revisions applied against amortization to date. The impact of revisions and assumptions to estimates on cumulative amortization is recorded as a charge or benefit to current operations, commonly referred to as “unlocking”. Changes in assumptions can have a significant impact on the amount of DAC reported and their related amortization patterns. In general, increases in the estimated separate accounts return and decreases in surrender or mortality assumptions increase the expected future profitability of the underlying business and may lower the rate of DAC amortization. Conversely, decreases in the estimated separate accounts returns and increases in surrender or mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization. For the years ended December 31, 2006, 2005 and 2004 the favorable (unfavorable) impact on pretax earnings related to DAC unlocking was $0.9 million, ($3.2) million and $3.0 million respectively. See Note 4 to the Financial Statements for a further discussion of period-to-period differences in DAC unlocking.
ML of New York’s liability for policyholder account balances represents the contract value that has accrued to the benefit of the policyholder 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, 2006 and 2005 were $152.8 million and $168.9 million, respectively.
Future policy benefits are actuarially determined reserves, 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, investment yields and inflation. These estimates and assumptions are influenced by historical experience, current developments and anticipated market trends. At December 31, 2006 and 2005, future policy benefits were $22.3 million and $22.5 million, respectively. Included within future policy benefits are liabilities for GMDB and GMIB provisions contained in the variable products that ML of New York issues. ML of New York regularly evaluates the assumptions used to establish these liabilities, as well as actual experience and adjusts the GMDB and/or GMIB liability balances 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, 2006 and 2005 the favorable impact on pre-tax earnings related to GMDB and GMIB liability unlocking was $0.5 million and $0.2 million respectively. There was no unlocking during 2004. See Note 6 to the Financial Statements for a further discussion of GMDB and GMIB liabilities.
On January 1, 2007 ML of New York adopted Statement of Position (“SOP”) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS No. 97. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. Since ML of New York’s practice of accounting for deferred acquisition costs, in connection with modifications or exchanges, substantially meets the provisions prescribed within SOP 05-1, the adoption of SOP 05-1 did not have a material impact on ML of New York’s Financial Statements.
In September 2006, the FASB issued SFAS No. 157 Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for Financial Statements issued for fiscal years beginning after November 15, 2007 with early adoption permitted. ML of New York intends to early adopt SFAS No. 157 as of the first quarter of fiscal 2007. The adoption is not expected to have a material impact on ML of New York’s Financial Statements.
ML of New York seeks to provide superior customer service and financial management to promote the competitiveness of its products. ML of New York’s customer service center has established standards of performance that are monitored on a regular basis. Managers and employees in the customer service center are periodically evaluated based on their performance in meeting these standards.
ML of New York has strategically placed its marketing emphasis on the sale of variable annuity products. These products are designed to address the retirement planning needs of Merrill Lynch & Co.’s clients. Each variable annuity product is designed to provide tax-deferred retirement savings with the opportunity for diversified investing in a wide selection of underlying mutual fund portfolios. During March 2005, ML of New York introduced a new variable annuity product line called Merrill Lynch Investor Choice Annuity (“ICA”), which replaced all new sales of existing variable annuity products. ICA provides the ability to customize variable annuity products with specific contract features including guaranteed minimum death, income and withdrawal benefits, charge structures, and investment options. ICA is offered in B-Share, C-Share and L-Share classes similar to previous variable annuity products. These classes are differentiated by the surrender charge period and the types of contract fees charged to the contract owner. Additionally, ICA offers a bonus class in which a specified amount is added to the contract value with each deposit.
Total direct deposits increased 18.3 million (or 43%) to $61.3 million for the period ended December 31, 2006, as compared to the period ended December 31, 2005. During 2006, variable annuity deposits increased $18.8 million (or 45%) to $60.9 million as compared to 2005. The increase is primarily due to a full year of ICA sales, as well as post-launch enhancements to the product line. In addition, management believes that deposits were favorably impacted by the continuing client demand for guaranteed benefit provisions.
At December 31, 2006, ML of New York had 1,496 life insurance and annuity contracts inforce with interest rate guarantees. The estimated average rate of interest credited on behalf of contract owners was 4.36% and 4.18% during 2006 and 2005, respectively. Total invested assets supporting these liabilities with interest rate guarantees had an estimated average effective yield of 4.65% and 4.30% during 2006 and 2005, respectively. The number of life insurance and annuity contracts inforce with interest rate guarantees decreased 196 (or 10%) as compared to 2005.
During 2006 average variable account balances increased $5.8 million (or 1%) to $950.1 million as compared to 2005. The increase in average variable account balances contributed to a $0.8 million (or 7%) increase in asset-based policy charge revenue during the period ended December 31, 2006 as compared to the same period in 2005.
ML of New York has developed a comprehensive capital management plan that will continue to provide appropriate levels of capital for the risks that assumed, but will allow ML of New York to reduce its absolute level of statutory surplus. In implementing this plan, ML of New York paid an ordinary cash dividend during 2006 of $4.1 million to MLIG. ML of New York did not pay a dividend during 2005. ML of New York paid an ordinary cash dividend during 2004 of $2.5 million to MLIG. Pending regulatory approval, ML of New York intends to pay a cash dividend to MLIG during 2007.
The National Association of Insurance Commissioners utilizes 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. As of December 31, 2006 and 2005, based on the RBC formula, ML of New York’s total adjusted capital level was well in excess of the minimum amount of capital required to avoid regulatory action.
The following table summarizes ML of New York’s contractual obligations as of December 31, 2006:
The costs associated with acquiring contract owner deposits (DAC) are amortized over the period in which ML of New York anticipates holding those funds, as noted in the Critical Accounting Policies section above. Insurance expenses and taxes reported in the statements of earnings are net of amounts deferred. In addition, ML of New York incurs expenses associated with the maintenance of inforce contracts.
Policy charge revenue increased 1.2 million (or 7%) to $19.6 million during 2006 as compared to $18.4 million in 2005. The following table provides the changes in policy charge revenue by type for each respective period:
Net realized investment gains decreased $1.9 million during 2006 as compared to 2005 primarily due to one large credit related gain in the third quarter 2005.
Insurance expenses and taxes decreased $0.3 million (or 6%) to $4.4 million during 2006 as compared to $4.7 million in 2005 primarily due to period-to-period differences in State of New York Insurance Department administrative assessments.
ML of New York recorded earnings before change in accounting principle of $5.5 million and $7.9 million for 2005 and 2004, respectively.
Policy benefits decreased $0.5 million (or 17%) to $2.5 million during 2005 as compared to $3.0 million in 2004. The following table provides the changes in policy benefits by type:
The decrease in life insurance benefit expense is due to a decrease in net amount at risk per death claim.
The decrease in variable annuity guaranteed benefit expense is due to favorable GMDB liability unlocking during 2005 as noted in the Critical Accounting Policies section above.
Amortization of DAC increased $6.2 million to $7.0 million during 2005 as compared to $0.8 million in 2004 primarily as a result of period-to-period differences in DAC unlocking as noted in the Critical Accounting Policies section above. Excluding DAC unlocking, amortization of DAC was relatively unchanged during 2005 as compared to 2004.
The increase in general insurance expenses is primarily due to new product development expenses.
ML of New York’s effective federal income tax rate decreased to 24% for 2005 from 29% for 2004 primarily due to period-to-period differences in DRD and FTC adjustments as noted in the Critical Accounting Policies section above.
ML of New York’s operating results are categorized into two business segments: Annuities and Life Insurance. ML of New York’s Annuity segment consists of variable annuities and interest-sensitive annuities. ML of New York’s Life Insurance segment consists of variable life insurance products and interest-sensitive life products. The “Other” earnings category represents earnings on invested assets that do not support contract owner liabilities. ML of New York’s net earnings by segment as a percentage of the total were as follows:
During 2006, 2005 and 2004, ML of New York did not incur any OTT impairment losses on investments for either the Life Insurance or Annuity segments.