We own or lease approximately 360,000 square feet of office space. We lease approximately 260,000 square fee of space for our executive offices, corporate operations and protection products segment operations in Des Moines, Iowa; Woodbury, New York; and Indianapolis, Indiana. We own approximately 100,000 square feet of office space in Topeka, Kansas where our accumulation products operations are conducted. Approximately 45,000 square feet of our owned office space is leased to third parties.
For purposes of computing the ratio of earnings to combined fixed charges and preferred stock dividends, “earnings” consist of income from operations before income taxes and combined fixed charges and preferred stock dividends. “Fixed charges” consist of interest credited on annuity and universal life contracts, interest expense on debt, amortization of debt expense, early extinguishment of debt and preferred stock dividends, including the gross-up for income taxes.
See “Item 1 Business” for information regarding the nature of our operations.
Total assets increased $1.7 billion in 2005 primarily as a result of net cash received from collected premiums and deposits and positive cash flows from operating activities. Liabilities increased $1.6 billion primarily due to policy reserves and policyowner funds which rose due to the higher volume of insurance policies in force and increased annuity sales. Stockholders’ equity increased $78.8 million during 2005 primarily as a result of 2005 net income of $191.2 million, the issuance of preferred stock which resulted in net proceeds of $144.8 million, stock issued under incentive plans amounting to $23.3 million, and the conversion of OCEANs amounting to $10.7 million. The additions to equity were reduced by treasury stock purchases which decreased equity $154.6 million, unrealized gains on available-for-sale investments which declined $118.2 million, and dividends declared on common and preferred stock in the fourth quarter of 2005 which decreased equity $18.3 million. The unrealized gains included in accumulated other comprehensive income are presented after related adjustments to DAC, VOBA, capitalized bonus interest, closed block policyowner dividend obligation, unearned revenue reserves and deferred income taxes.
Unrealized gains and losses on open block options and securities held-for-trading.
These items will fluctuate from period to period depending on the prevailing interest rate and economic environment or are not part of the core insurance operations. As a result, management believes they do not reflect the ongoing earnings capacity of our operating segments.
primarily through IMOs, CMOs, a PPGA distribution system and a New York distribution system. When protection products are sold, we invest the premiums we receive in our investment portfolio and establish a liability representing our commitment to the policyowner. We manage investment spread by seeking to maximize the return on these invested assets, consistent with our asset/liability and credit quality policies. We enter into reinsurance arrangements in order to reduce the effects of mortality risk and the statutory capital strain from writing new business. All income statement line items are presented net of reinsurance amounts. In addition, the protection products segment includes the results of the closed block. Protection products in force totaled $102.5 billion at December 31, 2005, $97.5 billion at December 31, 2004 and $98.6 billion at December 31, 2003. Protection products in force is a performance measure utilized by investors, analysts and the Company to assess the Company’s position in the industry. A summary of our protection products segment operations follows:
Pre-tax operating income from our protection products increased 18% in 2005 and 9% in 2004 compared to the respective prior years. The increase in 2005 was primarily due to the growth in the indexed life business and higher open block product margins. The increase in 2004 was primarily due to higher open block product margins and lower operating expenses. The key drivers of our protection products business include sales, persistency, net investment income, mortality and expenses.
Persistency. Persistency, which we measure in terms of a lapse rate, is a key driver of our business as it refers to the policies which remain in our block of business. A low lapse rate means higher persistency indicating more business is remaining in force to generate future revenues. Annualized lapse rates were 6.2% in 2005 compared to 6.7% in 2004 and 6.5% in 2003. Our persistency experience remained within our pricing assumptions.
Net Investment Income. Net investment income is a key driver of our business as it reflects earnings on our invested assets. Net investment income increased in 2005 and 2004 compared to the respective prior years. The increase in 2005 and 2004 was primarily due to growth in average protection products assets which were approximately $278 and $318 million higher than the respective prior years. The earned rate of the investment portfolio was 6.57% in 2005 compared to 6.44% in 2004 and 6.63% in 2003. Rates increased in 2005 following the prior years’ declining rates associated with the overall lower interest rate environment in 2004 and 2003.
Mortality and Benefit Expense. Mortality is a key driver of our business as it impacts the amount of our benefit expense. We utilize reinsurance to reduce the effects of mortality risk. Benefit expense was lower in 2005 as compared to 2004 due to favorable mortality in the open block and due to the decline in the in force closed block business. Although we experienced unfavorable mortality in 2004 as compared to 2003, our experience remained within our pricing assumptions. In addition, we had increased reinsurance recoveries in 2004 and 2003, which reduce benefit expense, as a result of additional reinsurance arrangements.
Underwriting, Acquisition and Other Expenses. Underwriting, acquisition and other expenses are a key driver of our business as they are costs of our operations. Expenses increased in 2005 compared to 2004 primarily due to increased state taxes, higher employee benefit costs and additional expenses of moving ILIC post issue policy service and data center activities from Woodbury, New York to Des Moines, Iowa. Expenses decreased in 2004 compared to 2003 primarily due to lower operating expenses resulting from the restructuring activities to integrate the ILICO life operations and also due to increased reimbursement from reinsurers of non-deferrable commission and expense allowances, as more policies were subject to reinsurance.
Our accumulation products segment reflects the operating results primarily from our individual fixed annuities and funding agreements. The fixed annuities are marketed on a national basis primarily through IMOs and independent brokers. Similar to our protection products segment, we invest the premiums we receive from accumulation product deposits in our investment portfolio and establish a liability representing our commitment to the policyowner. We manage product spread by seeking to maximize the return on our invested assets consistent with our asset/liability management and credit quality policies. When appropriate, we periodically reset the interest rates credited to our policyowner liability. Accumulation products reserves totaled $13.5 billion at December 31, 2005, $12.3 billion at December 31, 2004 and $11.7 billion at December 31, 2003. A summary of our accumulation products segment operations follows:
Deposits. Deposits are a key driver of our business as this is a measure which represents collected premiums to be deposited to policyowner accounts for which we will earn a future product spread. Deposits are presented as collected premiums, which are measured in accordance with industry practice, and represent the amount of new business sold during the period. Deposits are a performance metric which we use to measure the productivity of our distribution network and for compensation of sales and marketing employees and agents. As shown in the Deposits by Product table presented in “Item 1. Business - Accumulation Products Segment,” total annuity deposits
increased 43% in 2005 and 5% in 2004 as compared to the respective prior years. The increases in 2005 and 2004 were driven by continued consumer demand for indexed products.
Persistency. Persistency, which we measure in terms of a withdrawal rate, is a key driver of our business as it refers to the policies which remain in our block of business. A low withdrawal rate reflects higher persistency indicating more business is remaining in force to generate future revenues. Withdrawals represent funds taken out of accumulation products by policyowners not including those due to the death of policyowners. Annuity withdrawal rates without internal replacements continued to improve in 2005 as compared to 2004 and 2003 and amounted to 8.3%, 8.5% and 9.5%, respectively. Annuity withdrawals without internal replacements totaled $1,200.4 million in 2005, $1,118.1 million in 2004 and $1,196.9 million in 2003. Our withdrawal experience remained within our pricing assumptions.
Product Spread. Product spread is a key driver of our business as it measures the difference between the income earned on our invested assets and the rate which we credit to policyowners, with the difference reflected as segment operating income. We actively manage product spreads in response to changes in our investment portfolio yields by adjusting liability crediting rates while considering our competitive strategies. Asset earned rates and liability crediting rates were as follows for our annuity products:
The other operations consist of our non-core lines of business outside of protection and accumulation products. These lines of business include holding company revenues and expenses, operations of our real estate management subsidiary, and accident and health insurance. The pre-tax operating loss of our other operations increased in 2005 compared to 2004 primarily due to lower net investment income as a result of lower yielding investments and higher investment expenses. The pre-tax operating loss of our other operations increased in 2004 compared to 2003 primarily due to increased holding company expenses, such as Sarbanes-Oxley internal control regulations, the OCEANs exchange and succession activities in 2004, and lower investment income from our real estate management subsidiary.
Realized and Unrealized Gains (Losses) on Assets and Liabilities. Realized gains (losses) on open block investments will fluctuate from period to period depending on the prevailing interest rates, the economic environment and the timing of investment sales and credit events. As part of managing our invested assets, we routinely sell securities and realize gains and losses. During 2004, we sold our Indianapolis, Indiana office building. We had previously listed this building with a real estate broker in 2003 as part of our restructuring plan and recorded a pre-tax impairment loss of $7.7 million at that time (see further discussion in Restructuring Costs). The sale of the building in 2004 resulted in an additional pre-tax loss of $11.8 million. Realized gains on open block investments in 2003 included $12.1 million of gains on sales of investments previously impaired and written-down in 2002 or 2003, primarily American Airlines, Dynegy Holdings, Intermedia Communications and NRG Northeast Generating.
Restructuring Costs. Restructuring costs relate to our consolidation of various functions in connection with a restructuring of our protection products’ and accumulation products’ operations and investment activities which began in the third quarter of 2001. The objective of the restructuring plan was to eliminate duplicative functions for all business units and to reduce on-going operating costs. Corporate administrative functions were transitioned so they are performed primarily in Des Moines, Iowa. Protection products administration processes were transitioned so they are performed in Des Moines; Woodbury, New York; or outsourced. Accumulation products functions were transitioned to Topeka, Kansas. Investment activities were restructured to eliminate certain real estate management services which have been outsourced.
Interest Expense. Interest expense in 2005 was comparable to 2004. Interest expense increased in 2004 as compared to 2003 primarily due to interest associated with the PRIDES securities of $143.8 million issued in the second quarter of 2003.
Income Tax Expense. The effective income tax rate for 2005 and 2004 varied from the prevailing corporate rate primarily as a result of tax exempt income, reductions in the income tax accrual and reductions in the deferred tax valuation allowance.
The effective income tax rate for 2005 also varied from the prevailing corporate rate due to additional income tax expense of $6.6 million incurred in the restructuring of our joint venture interest with Ameritas in which our interest in AVLIC was sold to Ameritas. The additional tax expense related to the reversal of taxable temporary differences during 2005 without the benefit of previously anticipated dividends received deductions.
issued to us by ALIC), investment income on our assets and fees which we charge our subsidiaries, offset by the expenses incurred for debt service, salaries and other expenses.
The payment of dividends by our insurance subsidiaries is regulated under various state laws. Generally, under the various state statutes, our insurance subsidiaries’ dividends may be paid only from the earned surplus arising from their respective businesses and must receive the prior approval of the respective state regulator to pay any dividend that would exceed certain statutory limitations. The current statutes generally limit any dividend, together with dividends paid out within the preceding 12 months, to the greater of (i) 10% of the respective company’s policyowners’ statutory surplus as of the preceding year end or (ii) the statutory net gain from operations for the previous calendar year. Generally, the various state laws give the state regulators discretion to approve or disapprove requests for dividends in excess of these limits. Based on these limitations and 2004 results, our life insurance subsidiaries could have paid us an estimated $186 million in dividends in 2005 without obtaining regulatory approval. Our insurance subsidiaries paid us approximately $62 million in 2005. Based on 2005 results, our insurance subsidiaries can pay an estimated $143 million in dividends without obtaining regulatory approval during 2006. We also consider risk-based capital levels, capital and liquidity operating needs, and other factors prior to paying dividends from the insurance subsidiaries.
On July 12, 2005, we filed a $1.5 billion shelf registration statement on Form S-3 with the Securities and Exchange Commission (the Shelf Registration), which was declared effective on July 15. The Shelf Registration will allow us to issue a variety of debt and/or equity securities when market opportunities and the need for financing arise. We utilized the shelf to issue senior notes and preferred stock in the third quarter of 2005. We have $1.05 billion of shelf capacity remaining.
On August 5, 2005, we issued $300.0 million of senior notes under the Shelf Registration. The senior notes bear interest at 5.95% per year payable semi-annually on February 15 and August 15 of each year, commencing on February 15, 2006. The senior notes mature on August 15, 2015 and may be redeemed at our option at any time, in whole or in part, subject to payment of a redemption premium. The net proceeds from the offering were primarily utilized to repay revolving credit borrowings, repurchase common stock and convert the $185.0 million aggregate principal OCEANs described below.
On September 26, 2005, we issued 6.0 million shares of Series A Non-Cumulative Perpetual Preferred Stock (Shares) with no par value under the Shelf Registration. Net proceeds amounted to $144.8 million after the related underwriting discount and other costs. Dividends on the preferred stock are non-cumulative and are payable
quarterly, when, as and if declared by the board of directors, in whole or in part out of legally available funds. Dividends on the preferred stock accrued from September 26, 2005 with the first dividend payable on December 15, 2005 at a fixed rate of 7.25% per annum of the liquidation preference of $25 per share. Subject to certain restrictions, the Company may redeem the preferred stock at any time in whole, prior to September 15, 2010, at a cash redemption price equal to the greater of $25 per share or the sum of the present values of $25 per share plus any declared and unpaid dividends to the redemption date, without accumulation of any undeclared dividends, and any undeclared dividends for the dividend periods from the redemption date to and including the dividend payment date on September 15, 2010. On or after the dividend payment date in September 2010, the shares may be redeemed at a price of $25 per share or $150.0 million in the aggregate plus declared and unpaid dividends to the redemption date without accumulation of any undeclared dividends.
In connection with our issuance of the Shares, we entered into a declaration of covenant (Declaration) in which we agreed to redeem or repurchase the Shares only if and to the extent that the total redemption or repurchase price is equal to or less than the proceeds we or our subsidiaries have received during the six months prior to the date of such redemption or repurchase from the sale of certain qualifying securities that, among other things, are (i) with limited exceptions, pari passu with or junior to the Shares upon our liquidation or dissolution, or our winding up, (ii) perpetual, or have a mandatory redemption or maturity date that is not less than sixty years after the date of initial issuance of such securities and (iii) provide for dividends or other distributions that are either non-cumulative or, if cumulative, are subject to certain optional or mandatory deferral provisions.
The preferred stock has no stated maturity and is not convertible into any other security. The proceeds from the Series A Perpetual Preferred Stock were used to repay borrowings under the Revolving Credit Agreement and for general corporate purposes.
The Company has several options for deploying excess capital, including supporting higher sales growth, reducing debt levels, pursuing acquisitions and purchasing common stock. Our Board of Directors approved a stock purchase program effective June 24, 2005, under which we may purchase up to six million shares of our common stock at such times and under such conditions, as we deem advisable. The purchases may be made in the open market or by such other means as we determine to be appropriate, including privately negotiated purchases. The purchase program supercedes all prior purchase programs. We plan to fund the purchase program from a
We manage liquidity on a continuing basis. One way is to minimize our need for capital. We accomplish this by attempting to use our capital as efficiently as possible and by developing capital-efficient products in our insurance subsidiaries. We also manage our mix of sales by focusing on the more capital-efficient products. In addition, we use reinsurance agreements, where cost-effective, to reduce capital strain in the insurance subsidiaries. We also focus on optimizing the consolidated capital structure to properly balance the levels and sources of borrowing and the issuance of equity securities.
Our insurance subsidiaries’ sources of cash consist primarily of premium receipts; deposits to policyowner account balances; and income from investments, sales, maturities and calls of investments and repayments of investment principal. The uses of cash are primarily related to withdrawals of policyowner account balances, investment purchases, payment of policy acquisition costs, payment of policyowner benefits, repayment of debt, income taxes and current operating expenses. Insurance companies generally produce a positive cash flow from operations, as measured by the amount by which cash flows are adequate to meet benefit obligations to policyowners and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business.
In addition to the interest-sensitive products, our insurance subsidiaries have issued funding agreements totaling $986.2 million outstanding as of December 31, 2005, consisting of one to ten year maturity fixed rate insurance contracts. The assets backing the funding agreements are legally segregated and are not subject to claims that arise out of any other business of the insurance subsidiaries. The funding agreements are further backed by the general account assets of the insurance subsidiaries. The segregated assets and liabilities are included with general
We also have variable separate account assets and liabilities representing funds that are separately administered, principally for variable annuity contracts, and for which the contractholder bears the investment risk. Separate account assets and liabilities are reported at fair value and amounted to $221.7 million at December 31, 2005. Separate account contractholders generally have no claim against the assets of the general account, except with respect to certain insurance benefits. The operations of the separate accounts are not included in the accompanying consolidated financial statements.
Through their respective memberships in the Federal Home Loan Banks (FHLB) of Des Moines, Topeka, and Indianapolis; ALIC, American and ILIC are eligible to borrow under variable-rate short term fed funds arrangements to provide additional liquidity. These borrowings are secured and interest is payable based on current rates at the time of each advance. There were no borrowings outstanding under these arrangements at December 31, 2005. In addition, ALIC has long-term fixed rate advances from the FHLB outstanding of $12.0 million at December 31, 2005.
We participate in a securities lending program whereby certain fixed maturity securities from the investment portfolio are loaned to other institutions for a short period of time. We receive a fee in exchange for the loan of securities and require initial collateral equal to 102 percent, with an on-going level of 100 percent, of the market value of the loaned securities to be separately maintained. Securities with a market value of approximately $458.8 million and $342.6 million were on loan under the program and we were liable for cash collateral under our control of approximately $474.6 million and $351.7 million at December 31, 2005 and 2004, respectively. The collateral held under the securities lending program has been included in cash and cash equivalents in the consolidated balance sheet and the obligation to return the collateral upon the return of the loaned securities has been included in accrued expenses and other liabilities.
At December 31, 2005, the statutory capital and surplus of the insurance subsidiaries was approximately $1,157 million. Management believes that each insurance company has statutory capital which provides adequate risk based capital that exceeds required levels.
Certain partnership investments provide for commitments of future capital, loans or guarantees. We have obligations to make future capital contributions to various partnerships of up to $20.1 million at December 31, 2005. We also have commitments to extend credit for mortgages totaling $57.4 million at December 31, 2005. In addition, at December 31, 2005, we had loan guarantees which totaled $1.3 million.
The obligation is included in other investments on the consolidated balance sheet.
The obligation is included in accrued expenses and other liabilities on the consolidated balance sheet.
Payments for future life and annuity policy benefits and policyowner funds represent management’s estimate of surrenders, mortality and morbidity activity associated with the policies.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. The valuation of financial instruments, accounting for derivatives and amortization of DAC, VOBA and deferred sales inducements are considered our critical accounting policies due to their subjective nature and significance to the financial statements.
A significant portion of our assets are carried at fair value, primarily securities available-for-sale, securities held for trading purposes and derivative financial instruments. Market values are based on quoted market prices where available.
risk premiums, performance of underlying collateral (if any), and other factors may not be realized in the event of an actual sale.
Investments in mortgage loans, real estate, policy loans and other investments are monitored for possible impairment. If it is determined that collection of all amounts due under the contractual terms is doubtful or carrying values exceed the fair value of underlying collateral, such investments are considered impaired and the asset carrying value is adjusted or a valuation allowance is established.
We hold derivative financial instruments to hedge growth in policyowner liabilities for certain protection and accumulation products and to hedge market risk for fixed income investments. These derivatives qualify for hedge accounting, are economic hedges but not designated as hedging instruments, or are derivatives used to replicate a security and are utilized as discussed in detail in notes 1 and 4 to our consolidated financial statements.
To hedge equity market risk, we primarily use S&P 500 Index call options to hedge the growth in interest credited to the customer as provided by our indexed products. We may also use interest rate swaps or options to manage our fixed products’ risk profile. Generally, credit default swaps are coupled with a bond to synthetically create an instrument cheaper than an equivalent investment traded in the cash market.
We do not believe we are exposed to more than a nominal amount of credit risk in our interest rate or equity hedges as the counterparties are established, well-capitalized financial institutions. Information about the fair values and notional amounts of these instruments can be found in note 4 to our consolidated financial statements and the section titled “Quantitative and Qualitative Disclosures About Market Risk.”
DAC for non-participating traditional life insurance is amortized over the premium-paying period of the related policies in proportion to the ratio of annual premium revenues to total anticipated premium revenues using assumptions consistent with those used in computing policy benefit reserves. We generally amortize DAC and deferred sales inducements for participating traditional life, universal life and annuity products based on a
percentage of our expected gross margins (EGMs) over the life of the policies. Our estimated EGMs are computed based on assumptions related to the underlying policies written, including the lives of the underlying policies, growth rate of the assets supporting the liabilities, and level of expenses necessary to maintain the policies over their entire life. We amortize DAC and deferred sales inducements by estimating the present value of the EGMs over the lives of the insurance policies and then calculate a percentage of the policy acquisition cost deferred as compared to the present value of the EGMs. That percentage is used to amortize the DAC and deferred sales inducements such that the amount amortized over the life of the policies results in a constant percentage of amortization when related to the actual and future gross margins.
We amortize VOBA based on the incidence of the EGMs from insurance contracts using the interest rate credited to the underlying policies. The EGMs are based on actuarially determined projections of future premium receipts, mortality, surrenders, operating expenses, changes in insurance liabilities, investment yields on the assets retained to support the policy liabilities and other factors. These projections take into account all factors known or expected by management. The actual gross margins may vary from expected levels due to differences in renewal premium, investment spread, investment gains or losses, mortality and morbidity costs and other factors.
The total DAC, VOBA and deferred sales inducements asset balances at December 31, 2005 amounted to $2.4 billion. Based upon these balances, the impact of changes in significant EGM assumptions would result in the following one-time adjustments in DAC, VOBA, deferred sales inducements and unearned revenue reserves amortization expense:
We maintain a diversified portfolio of investments which is supervised by an experienced in-house staff of investment professionals. Sophisticated asset/liability management techniques are employed in order to achieve competitive yields, while maintaining risk at acceptable levels. The asset portfolio is segmented by liability type, with tailored investment strategies for specific product lines. Investment policies are subject to approval by the Board of Directors and are overseen by the Investment and Risk Management Committee of our Board of Directors. Management regularly monitors individual assets and asset groups, in addition to monitoring the overall asset mix. In addition, the Investment and Risk Management Committee reviews investment guidelines and monitors internal controls.
Our investment philosophy is to employ an integrated asset/liability management approach with separate investment portfolios for specific product lines, such as traditional life, universal life, indexed life, traditional annuities, indexed annuities, variable annuities and funding agreements to generate attractive risk-adjusted returns on capital. Essential to this philosophy is coordinating investments in the investment portfolio with product strategies, focusing on risk-adjusted returns and identifying and evaluating associated business risks.
MBS investments are mortgage-related securities including collateralized mortgage obligations (CMOs) and pass-through mortgage securities. Asset-backed securities are both residential and non-residential including exposure to home equity loans, home improvement loans, manufactured housing loans as well as securities backed by loans on automobiles, credit cards, and other collateral or collateralized bond obligations. As of December 31, 2005, asset-backed residential mortgages totaled $161.6 million or 0.8% of total invested assets. As of December 31, 2005, residential mortgage pass-through and CMOs totaled $2,121.3 million or 10.6% of total invested assets. As of December 31, 2005, $1,805.2 million or 85.1% of MBS were from government sponsored enterprises. Other MBS were $316.1 million or 14.9% of MBS as of December 31, 2005. Management believes that the quality of assets in the MBS portfolio is generally high, with 98.3% of such assets representing agency backed or “AAA” rated securities. Collateralized mortgage backed securities (or CMBS) totaled $1,204.9 million or 6.0% of total invested assets as of December 31, 2005.
We held $357.6 million of other invested assets (including short-term investments) on December 31, 2005. Other invested assets consist of various joint ventures and limited partnership investments and derivatives.
The list of securities identified is subject to a formal assessment to determine if an impairment is other than temporary. Management makes certain assumptions or judgments in its assessment of potentially impaired securities including but not limited to:
Financial factors such as earnings trends, asset quality, liquidity, subsequent events, enterprise valuation, fair value and volatility (among others).
There are no securities that were in more than a 50% loss position at December 31, 2005.
The following table lists material securities with unrealized losses exceeding $3 million. There were no individual material securities with unrealized losses exceeding $3 million at December 31, 2004.
company. These securities along with the securities in the above listing of unrealized losses did not meet the criteria as described in our other-than-temporary process for impairment determination. As a result, there was no realized loss for these securities.
Unrealized gains or losses may not represent future gains or losses that will be realized. These unrealized gains or losses are subject to fluctuation, reflective of such things as volatile financial markets, interest rate movements, credit spread changes and sale decisions.
Generally, AmerUs Group and our nonlife subsidiaries file a consolidated federal income tax return. The life insurance subsidiaries file separate federal income tax returns, except for ILIC and Bankers Life which together began filing a consolidated tax return in 2002. Beginning in 2006, ALIC, American and FBL intend to join AmerUs Group in the filing of a consolidated life-nonlife tax return. ILIC and Bankers will be eligible to join the consolidated life-nonlife tax return in 2007. Deferred income tax assets and liabilities are determined based on differences among the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws.
of a Security Whose Cost Exceeds Fair Value.” FSP FAS 115-1 will be applied prospectively and is effective for reporting periods beginning after December 15, 2005. Our existing policies for recognizing an OTTI are consistent with the guidance in FASP FAS 115-1. As a result, we do not expect the adoption of FSP FAS 115-1 to have a material effect on our consolidated financial condition and results of operations.
In December 2004, the FASB issued a revision to SFAS 123, “Share-Based Payment,” which is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” (SFAS 123). SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on fair values. Pro forma disclosure of fair value information is no longer an alternative. The statement is effective in the first interim or annual period beginning after June 15, 2005. In April 2005, the SEC announced the adoption of a new rule that delays our required effective date of SFAS 123R to January 1, 2006. In August 2005, the FASB issued FASB Staff Position (FSP) No. 123(R)-1, “Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R)” (FSP 123R-1), which indefinitely defers the requirement of SFAS 123-R that a freestanding financial instrument originally subject to SFAS 123R becomes subject to other applicable GAAP when the rights conveyed by the instrument to the holder are no longer dependent on the holder being an employee of the entity. In October 2005, the FASB issued FSP No. 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R)” (FSP 123R-2), which allows the grant date of an award to be the date the award is approved in accordance with an entity’s corporate governance provisions, so long as the approved grant is communicated to employees within a relatively short time period from the date of approval, which is consistent with our current policy.
Adoption of SFAS 123R is to be made using either the modified prospective method or the modified retrospective method. The modified prospective method recognizes cost based on the requirements for all share-based payments granted after the effective date and for awards granted prior to the effective date that remain unvested prior to the effective date. The modified retrospective method includes the requirements of the modified prospective method but also permits restatement of financial statements based on pro forma amounts previously recognized under SFAS 123. Restatement can either be for all prior periods presented or prior interim periods of the year of adoption. Early adoption is permitted. We will adopt SFAS 123R effective January 1, 2006, using the modified prospective method. The pro forma impacts of recognizing fair value, as permitted by SFAS 123, are disclosed in note 1 to the consolidated financial statements. That disclosure reflects our estimate of 2005 additional expense for share-based payments of approximately $2.6 million (after-tax). The implementation of more sophisticated modeling techniques may affect this expense amount.
In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) issued Statement of Position 05-1 (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 Statement of Financial Accounting Standards (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”. 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. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. Retrospective application of SOP 05-1 to previously issued financial statements is not permitted. We do not believe the adoption of this pronouncement will have a material effect on our consolidated financial condition and results of operations.