Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the consolidated financial condition of American Skandia Life Assurance Corporation as of December 31, 2004, compared with December 31, 2003, and its consolidated results of operations for the years ended December 31, 2004 and 2003.
For purposes of MD&A, no explicit distinction is made between the pre-purchase accounting periods and the post purchase accounting periods.
Besides policy charges and fee income, the Company also earns revenues from asset management fees calculated on the average separate account fund balances. The Company's operating expenses principally consist of insurance benefits provided, general business expenses, commissions and other costs of selling and servicing the various products we sell.
o our persistency experience, which affects our ability to recover the cost of acquiring new business over the lives of the contracts;
As of the date of acquisition, the Company changed its classification of equity securities held in support of a deferred compensation plan from available -for sale to trading. New management made this decision to align with Prudential Financial's accounting policy. These equity securities were fair valued on May 1, 2003 under purchase accounting and therefore there was no income statement impact for the change in classification. Such investments are now carried at fair value with changes in unrealized gains and losses reported in the Consolidated Statements of Operations and Comprehensive Income, as a component of "Other income."
In evaluating the DAC for our annuity products future rate of return assumptions are evaluated using a reversion to mean approach, a common industry practice. Under this approach, we consider actual returns over a period of time and project returns for the future period so that the assets grow at the expected rate of return for the entire period. If the projected future rate of return is greater than our maximum future rate of return, we use our maximum reasonable future rate of return. For variable annuities products, our expected rate of return is 8% per annum, which reflects an expected rate of return of 8.9% per anum for equity type assets. The future equity rate of return used varies by annuity product, but was under 8.9% per annum for all of our variable annuity products for our evaluation of deferred policy acquisition costs as of December 31, 2004.
In connection with these sales, ASI, through special purpose trusts, issued collateralized notes in private placements, which were secured by the rights to receive future fees and charges purchased from the Company. As part of the Acquisition, the notes issued by ASI were repaid.
Under the terms of the securitization purchase agreements, the rights sold provide for ASI to receive a percentage (60%, 80% or 100% depending on the underlying commission option) of future mortality and expense charges and contingent deferred sales charges, after reinsurance, expected to be realized over the remaining surrender charge period of the designated contracts (generally 6 to 8 years). As a result of purchase accounting, the liability was reduced to reflect the discounted estimated future payments to be made and has been subsequently reduced by amortization according to a revised schedule. If actual mortality and expense charges and contingent deferred sales charges are less than those projected in the original amortization schedules, calculated on a transaction by transaction basis, ASI has no recourse against the Company.
Reserves for contingencies A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved upon the occurrence of future events. Under U.S. GAAP, reserves for contingencies are required to be established when the future event is probable and its impact can be reasonably estimated. An example is the establishment of a reserve for losses in connection with an unresolved legal matter. The initial reserve reflects management's best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as facts and circumstances change and, ultimately, when the matter is brought to closure. In situations in which the Company is to be indemnified by SICL, there will be no financial impact on the Consolidated Statements of Operations and Comprehensive Income. See Note 12 to the Consolidated Financial Statements for a further discussion of indemnification agreements.
Other significant estimates In addition to the items discussed above, the application of U.S. GAAP requires management to make other estimates and assumptions.
Asset management fees increased by $17.9 million from December 31, 2003 to December 31, 2004 as a result of higher average assets under management compared to last year. Asset management fees are asset-based fees, which are dependent on the amount of assets under management.
As of December 31, 2004, the death benefit coverage in force (representing the amount that we would have to pay if all annuitants had died on that date) was approximately $2.9 billion. The death benefit coverage in force represents the excess of the guaranteed benefit amount over the account value. The GMDB feature provides annuity contract holders with a guarantee that the benefit received at death will be no less than a prescribed minimum amount. This minimum amount is generally based on the net deposits paid into the contract and, for greater than 80% of the business in force as of December 31, 2004, this minimum guarantee is applicable only for the first ten contract years or until a specified attained age. To the extent that the GMDB is higher than the current account value at the time of death, the Company incurs a cost. This results in increased annuity policy benefits in periods of declining financial markets and in periods of stable financial markets following a decline. Effective January 1, 2004, the Company adopted SOP 03-1, which requires us to record such a liability based on application of an expected benefit ratio to "cumulative assessments" through the balance sheet date, and then subtracting "cumulative excess payments" through that date. The GMDB reserve as of December 31, 2004 amounted to $26.4 million.
Interest credited to policyholder account balances increased by $61.7 million primarily due to the adoption of SOP 03-1, which accounted for $68.2 million of the increase. As discussed above, prior to January 1, 2004, interest credited was recorded within net investment income. This increase was partially offset by decreased amortization of deferred purchase credits of $2.3 million consistent with decreased amortization of DAC, primarily as a result of purchase accounting.