You should read the following analysis of the Company’s financial condition and results of operations in conjunction with the Forward-Looking Statements disclosure included below the Table of Contents, “Risk Factors,” and Financial statements included in this Annual Report on Form 10-K.
The Company sells individual interest-sensitive life insurance, variable life insurance, term insurance, and individual variable annuities in New Jersey and New York through Prudential Insurance’s sales force. These markets are subject to regulatory oversight with particular emphasis placed on company solvency and sales practices. These markets are also subject to increasing competitive pressures as the legal barriers which have historically segregated the markets of the financial services industry have been changed through both legislative and judicial processes. Regulatory changes have opened the insurance industry to competition from other financial institutions, particularly banks and mutual funds that are positioned to deliver competing investment products through large, stable distribution channels.
our ability to generate favorable investment results through asset/liability management and strategic and tactical asset allocation.
See “Risk Factors” for a discussion of risks that could materially affect the business, results of operations or financial condition, or cause the actual results to differ materially from those expected or those expressed in any forward looking statements made by or on behalf of the Company.
We capitalize costs that vary with and are related primarily to the acquisition of new and renewal insurance and annuity contracts. These costs include primarily commissions, costs of policy issuance and underwriting, and variable field office expenses. We amortize these deferred policy acquisition costs, or DAC, over the expected lives of the contracts, based on the level and timing of either gross profits, or gross premiums, depending on the type of contract. As of December 31, 2006, DAC in our life business was $208 million and DAC in our annuity business was $48 million.
DAC associated with the variable and universal life policies of our domestic individual life insurance and the variable and fixed annuity contracts of our individual annuities business is amortized over the expected life of these policies in proportion to gross profits. In calculating gross profits, we consider mortality, persistency, and other elements as well as rates of return on investments associated with these contracts. We regularly evaluate and adjust the related DAC balance with a corresponding charge or credit to current period earnings for the effects of our actual gross profits and changes in our assumptions regarding estimated future gross profits. For the variable and universal life policies a significant portion of our gross profits is derived from mortality margins. As a result, our estimates of future gross profits are significantly influenced by our mortality assumptions. Our mortality assumptions represent our expected claims experience over the life of these policies and are developed based on experience. We review and update our mortality assumptions annually and perform full actuarial studies every five years. Updates to our mortality assumptions in future periods could have a significant adverse or favorable effect on our results of operations.
An increase or decrease in our effective tax rate by one percent of income from operations before income taxes and cumulative effect of accounting change, would have resulted in a decline or increase in income from continuing operations before cumulative effect of accounting change in 2006 of $0.5 million.
From December 31, 2005 to December 31, 2006, total liabilities increased by $275 million, from $3.620 billion to $3.895 billion. Corresponding with the asset change, separate account liabilities increased by $332 million from $2.288 billion at December 31, 2005, as described above. The Company’s short-term borrowings from an affiliate decreased by $28 million from $53 million at December 31, 2005 due to repayments. Future policy benefits and other policyholder liabilities increased by $47 million, from $203 million at December 31, 2005 to $250 million at December 31, 2006, as a result of growth in the term insurance business. Total securities lending position at December 31, 2006 decreased by $56 million from December 31, 2005. The relative amounts of cash collateral for loaned securities and securities sold under agreements to repurchase decreased $58 million and increased $2 million, respectively.
Stockholder’s equity increased by $42 million, from $345 million at December 31, 2005, to $387 million at December 31, 2006, mainly as a result of higher net income.
Net income of $39 million in 2006 was relatively unchanged from the prior year. A detailed discussion of the results of operation follows below.
Revenues decreased by $9 million, from $138 million in 2005 to $129 million in 2006. Realized investment losses of $14 million in 2006 increased as a result of losses from sales of fixed maturities in a rising interest rate environment. Partially offsetting this realized loss was an increase in investment income of $5 million primarily due to higher yields resulting from investment activities in a rising interest rate environment compared to 2005. Policy charges and fee income decreased $1 million from the prior year, driven by lower amortization of unearned policy charges and fee income, partially offset by higher fees of $2 million from higher assets under management as a result of market appreciation.
DAC amortization in 2006 was relatively unchanged from 2005. Lower amortization resulting from favorable fund performance was offset by a lower current year benefit from an increased estimate of total gross profits used as a basis for amortizing deferred policy acquisitions and other costs.
Tax expense in 2006 decreased $3 million, from $14 million in 2005 to $11 million in 2006. The decrease was primarily due to a lower effective tax rate in 2006 and lower income before taxes. These benefits were offset by a favorable adjustment of $3 million in 2005 of substantially all issues relating to the “IRS” examination of the federal income tax returns for the 1997 to 2001 periods.