Decreases in the availability of reinsurance or the receipt of reinsurance payments;
The Company does not undertake to update or revise forward-looking statements to reflect the impact of circumstances or events that arise after the dates they are made except as otherwise may be required by the federal securities laws. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements, which speak to Company expectations only as of the dates on which they are made. Actual results may differ materially from expectations conveyed in forward-looking statements due to changes caused by various risks and uncertainties. The reader should, however, consult further disclosures the Company 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.
The Company is a life insurance company that conducts its business primarily in the annuity markets and to a lesser extent in the life insurance markets of the financial services industry. The Company’s gross earnings are principally derived from two sources:
the charges imposed by the outstanding variable annuity, CDA and variable life insurance contracts, and
The Company’s financial position and/or results of operations are primarily impacted by the following economic factors: equity market performance, fluctuations in medium-term interest rates, and the corporate credit environment which affects credit quality and causes fluctuations in credit spreads. The following discusses the impact of each of these economic factors.
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, 2016. Since asset-based fees collected on in force 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 2016, average variable Separate Account balances decreased $0.75 billion (or 12%) to $5.7 billion as compared to the same period in 2015, as business continues to decline due to runoff, resulting in a decrease in related fees of $11.9 million.
Fluctuations in the U.S. equity market also directly impact the Company’s exposure to guaranteed benefit provisions contained in the contracts it enters into. Minimal or negative investment performance generally results in greater exposure to guarantee provisions. Prolonged periods of minimal or negative investment performance will result in greater guaranteed benefit costs as compared to assumptions. If the Company determines that it needs to increase its estimated long term cost of guaranteed benefits, it will need to establish higher guaranteed benefit liabilities than it has established in the past.
(c) 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.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses and the disclosures of contingent assets and liabilities. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ and such differences could have a material impact on the financial statements.
The Company’s investments consist principally of fixed maturity and equity securities that are classified as available-for-sale (“AFS”) and are reported at estimated fair value. The fair values of fixed maturity and equity securities are determined by management after taking into consideration several sources of data. When available, the Company uses quoted market prices in active markets to determine the fair value of its investments. The Company’s valuation policy utilizes a pricing hierarchy that dictates that publicly available prices are initially sought from indices and third-party pricing services. In the event that pricing is not available from these sources, those securities are submitted to brokers to obtain quotes. If broker quotes are not available, then securities are priced using internal cash flow modeling techniques. These valuation methodologies commonly use reported trades, bids, offers, issuer spreads, benchmark yields, estimated prepayment speeds, and/or estimated cash flows.
Each month, the Company performs an analysis of the information obtained from third-party services and brokers to ensure that the information is reasonable and produces a reasonable estimate of fair value. The Company considers both qualitative and quantitative factors as part of this analysis, including but not limited to, recent transactional activity for similar fixed maturities, review of pricing statistics and trends, and consideration of recent relevant market events. Other controls and procedures over pricing received from indices, third-party pricing services, or brokers include validation checks such as review of exception reports that highlight significant price changes, stale prices or un-priced securities. In addition, the Company performs back testing on a sample basis. Back testing involves selecting a sample of securities trades and comparing the prices in those transactions to prices used for financial reporting. Significant variances between the price used for financial reporting and the transaction price are investigated to explain the cause of the difference.
The Company regularly reviews each investment in its fixed maturity and equity AFS securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. Management makes this determination through a series of discussions with the Company’s portfolio managers and credit analysts, and information obtained from external sources (i.e. company announcements, ratings agency announcements, or news wire services). For fixed maturity AFS securities, the Company also considers whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The factors that may give rise to a potential OTTI include, but are not limited to, 1) certain credit-related events such as default of principal or interest payments by the issuer, 2) bankruptcy of issuer, 3) certain security restructurings, and 4) fair market value less than cost or amortized cost for an extended period of time. In the absence of a readily ascertainable market value, the estimated fair value on these securities represents management’s best estimate and is based on comparable securities and other assumptions as appropriate. Management bases this determination on the most recent information available.
Debt securities are monitored individually for impairments based on our asset specialists’ expectations of payment interruption. The probability of interruption is based on assessments of capital markets, funding needs and the liquidity profile of the issuer.
To qualify for hedge accounting, the hedge relationship is designated and formally documented at inception, detailing the particular risk management objective and strategy for the hedge (which includes the item and risk that is being hedged), the derivative that is being used and how hedge effectiveness is being assessed. For hedge accounting purposes, a distinction is made between fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation. Currently and during the periods covered by the accompanying financial statements, the Company has only had cash flow hedges.
A cash flow hedge is the hedge of the exposure to variability of cash flows to be received or paid related to a recognized asset or liability. For derivatives that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of Other Comprehensive Income (“OCI”) and reclassified into the Statements of Income (Loss) when the Company’s earnings are affected by the variability of the hedged item. Any hedge ineffectiveness is recognized as a component of net derivative gains (losses) in the Statements of Income (Loss).
S&P futures contracts and interest rate futures contracts are used to hedge the equity risk and interest rate risk, respectively, associated with these types of variable guaranteed products, in particular the claim and/or revenue risks of the liability portfolio. Net settlements on the futures occur daily. The realized gains (losses) on settlement of these futures are recorded in net derivative gains (losses) in the Statements of Income (Loss).
VOBA reflects the estimated fair value of in force contracts acquired and 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. Annually, the Company performs a comprehensive review of actuarial
The Company filed a separate federal income tax return for the years 2008 through 2012. A consolidated tax return was filed for 2013 through 2015. An examination by the Internal Revenue Service is in progress for the years 2011 through 2013. The Company believes that there are adequate defenses against or sufficient provisions established related to any open or contested tax positions.
Separate Accounts assets, which represent 65% of total assets, decreased $280.7 million to $5.7 billion at December 31, 2016, mainly due to policyholder withdrawals and surrenders of $551.9 million as business continues to run-off, offset by growth in account asset values due to favorable investment performance of $395.3 million as shown in the table below:
The following schedule identifies the Company’s general account invested assets by type at:
The Company’s $0.4 million of gross unrealized losses within the utility services sector relates to securities with a fair value of $9.1 million, largely due to merger and acquisition activity within the electric sub-sector.
The Company’s $0.7 million of gross unrealized losses within the residential MBS sector relates to securities with a fair value of $57.3 million, as the housing market has continued to improve as evidenced by rising home prices and sales volumes. The pace of improvement has slowed considerably from the rapid pace seen post-financial crisis.
The Company’s $0.5 million of gross unrealized losses classified as equity relates to securities with a fair value of $9.8 million. All of the unrealized loss relates to preferred non-convertible holdings in the banking sub-sector. The impairment review process has resulted in no OTTI charges for the year ended December 31, 2016 for the Company. The amortized cost and estimated fair value of fixed maturity AFS securities at December 31, 2016 and 2015 by rating agency equivalent were:
The Company’s fixed maturity AFS ratings are designated based on the Credit Name Limit Policy (“CNLP”), which uses a composite rating from the main rating agencies (S&P, Moody’s, and Fitch). The rating used is the lower of the composite rating and the Company’s Internal Rating. The Company defines investment grade securities as unsecured debt obligations that have a rating equivalent to S&P’s BBB- or higher (or similar rating agency). At December 31, 2016 and 2015, approximately $65.7 million (or 4.4%) and $80.0 million (or 5%), respectively, of the Company’s fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by S&P. Below investment grade securities are speculative and are subject to significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. The Company closely monitors such investments.
(a) Subsequent unrealized gains (losses) on OTTI securities are included in OCI-OTTI.
Gross unrealized losses and OTTI on below investment grade AFS securities represented 32% and 45% of total gross unrealized losses and OTTI on all AFS securities at December 31, 2016 and 2015, respectively. Generally, below investment grade securities are more likely than investment grade securities to develop credit concerns. The ratios of estimated fair value to amortized cost reflected in the table below are not necessarily indicative of the market value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to December 31, 2016.
Mortgage loans on real estate consist entirely of mortgages on commercial real estate. The Company does not accrue interest on loans ninety days past due. At December 31, 2016 and 2015, there were no commercial mortgage loans that had two or more payments delinquent. Mortgage loans by property type and geographic region remained relatively consistent from 2015 to 2016, however, investments in mortgage loans on real estate increased from $92.9 million to $116.2 million at December 31, 2015 to 2016, respectively, due to an increase in new loan originations in 2016.
The following table provides a summary of the dollar roll reverse repurchase agreements at:
The Company’s liquidity requirements include the payment of sales commissions and other underwriting expenses and the funding of its contractual obligations for the life insurance and annuity contracts it has in force. The Company has developed and utilizes a cash flow projection system and regularly performs asset/liability duration matching in the management of its asset and liability portfolios. The Company anticipates funding its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. At December 31, 2016 and 2015, the Company’s assets included $1.6 billion and $2.0 billion of cash, short-term investments and investment grade publicly traded AFS securities that could be liquidated if funds were required.
During 2016, the Company paid a $75.0 million dividend and $88.3 million return of capital to TA Corp. During 2015, the Company received a $68.5 million capital contribution from AUSA and paid a $100.0 million return of capital to AUSA.
To maintain the ability to issue annuity products, the Company must meet or exceed the statutory capital and surplus requirements of the insurance departments of the states in which it conducts business. The Company’s application of Statutory accounting principles differ from GAAP in the following major respects: under statutory accounting principles, the acquisition costs of new business are charged to expense, while under GAAP they are amortized over a period of time; under statutory accounting principles, the required additions to statutory reserves are calculated under different rules than under GAAP; and, the valuation of investments and accounting for deferred taxes differs between the two bases of accounting.
The following table summarizes the Company’s obligations to policyholders at December 31, 2016 related to the indicated accounts:
satisfy an insolvent insurer’s contract owner obligations, within specified limitations. At December 31, 2016 and 2015, the Company’s estimated liability for future guaranty fund assessments was $0.1 million and $0.1 million, respectively. In addition, the Company has a receivable for future premium tax deductions of $4.0 million and $4.2 million at December 31, 2016 and 2015, respectively. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
(a) Short equity-linked futures positions produced realized losses of $4.6 million for the year due to overall improved equity market performance across the board.
(c) The Company realized maturity losses of $2.7 million on variance swaps during the year, in addition to mark-to-market losses of $1.0 million.
(d) Short positions on equity-linked total return swaps produced losses of $79.0 million for 2016, primarily made up of $68.3 million in realized losses and $15.0 million in unrealized losses, driven by improving equity market performance and varying reset dates.
(f) Receive fixed vanilla interest rate swaps generated $0.6 million in mark-to-market losses resulting from the upward shift in the rate curve during the year.
Policy benefits decreased $40.1 million during 2016 largely due to the favorable impact from reserve unlocking of $62.4 million due to the annual review of valuation model assumptions, offset by an increase in benefit expenses of $22.4 million due to claims. The following table provides the changes in policy benefits by type:
Insurance, general and administrative expenses decreased $9.8 million compared to 2015 due to a decline in commissions of $4.3 million related to the decline in business due to run-off and a decline in general insurance expenses of $5.3 million related to a change in internal expense allocation methodology. The following table provides the changes in insurance, general and administrative expenses for each respective period:
For the years ended December 31, 2015 and 2014, the Company recorded net income of $13.7 million and 33.5 million, respectively. The decrease in net earnings during 2015 as compared to 2014 was primarily due to higher policy benefits expense and an increase in VOBA and DAC amortization. The increase in expenses was partially offset by lower derivative losses.
(a) Lower Separate Account balances during 2015 due to the declining block of business resulted in lower asset-based policy charge revenue.
Net derivative losses decreased $38.6 million to ($37.5) million during 2015 as compared to ($76.1) million in 2014. The following table provides the changes in net derivative gains (losses) by type:
(a) Short futures result in losses when equity markets increase. The decrease in losses was driven by mixed S&P performance (gains in the first and fourth quarter and losses in the second and third quarter) in 2015 when compared to the 11% increase in the S&P for the period ended December 31, 2014.
Amortization of VOBA was $22.4 million and $10.8 million for the years ended December 31, 2015 and 2014, respectively, which included favorable unlocking of $0.1 million and $6.6 million, respectively. The change in 2015 was primarily driven by positive gross profits due to favorable performance of Separate Accounts and updated policyholder assumptions during the year which resulted in amortization and less favorable unlocking as compared to 2014.
Insurance, general and administrative expenses increased $2.8 million in 2015 as compared to 2014. The following table provides the changes in insurance, general and administrative expenses for each respective period:
The Company’s operating results are categorized into two operating segments: Annuity and Life Insurance. The Company’s Annuity segment consists of variable annuity and interest-sensitive annuity contracts. The Company’s Life Insurance segment consists of variable life insurance and interest-sensitive life insurance contracts. The accounting policies of the business segments are the same as those for the Company’s Financial Statements described in the Notes to Financial Statements, Note 1 Summary of Significant Accounting Policies. All revenue and expense transactions are recorded at the contract level and accumulated at the business segment level for review by management.