agency and its subsidiary offices, which consist of approximately 539,706 square feet in the aggregate. The Company believes that such properties are suitable and adequate for its current and anticipated business operations.
The following discussion addresses the financial condition and results of operations of the Company for the periods indicated. The discussion and analysis of the Company's financial condition and results presented below should be read in conjunction with the "Selected Financial Data" and the Financial Statements and related footnotes and other financial information included elsewhere.
MLOA's primary business is to provide asset accumulation and life insurance products to business owners, growing families, and pre-retirees. The Company's insurance and financial products are marketed and distributed directly to individuals primarily through MONY Life's career agency sales force and its complementary distribution channels. These products are sold in 49 states (not including New York), the District of Columbia, the U.S. Virgin Islands and Puerto Rico.
The Company derives its revenues principally from: (i) insurance, administrative and surrender charges on universal life and annuity products, (ii) asset management fees from separate account products, (iii) premiums on non-participating term life insurance, and (iv) net investment income and realized capital gains on general account assets. The Company's expenses consist of insurance benefits provided to policyholders, interest credited on policyholders' account balances, the cost of selling and servicing the various products sold by the Company, including commissions to sales representatives (net of any deferrals), and general business expenses.
Following is a discussion of the critical accounting policies that, in the Company's view, require significant use of judgment. Refer to Note 2 of the Financial Statements for a complete description of the Company's significant accounting policies.
Accounting for litigation, contingencies and restructuring charges requires the Company to estimate the expected costs of events which have already occurred but which the Company has not completely resolved. As discussed in Note 12 to the Financial Statements, the Company is party to various legal actions and proceedings in connection with its business. The Company records liabilities related to these matters to the extent the losses are probable and reasonably estimable, in accordance with the provisions of FASB 5 and FASB Interpretation 14. Judgements exceeding established loss reserves or changes in the circumstances of the matter requiring management to update its loss estimate may materially affect the Company's financial position and operating results.
As discussed in Note 14 to the Consolidated Financial Statements, in 2001 the Company established reserves related to the reorganization of its business. These reserves are based on the estimated costs of lease abandonments and other costs directly related to the Company's reorganization plan and incremental to the Company's normal operating costs. Although management does not expect significant changes to its reorganization plan, the actual costs related to this plan may differ from management's estimates.
Other Charges consisted of: (i) impairments of certain invested assets and valuation related write-downs of equity securities held in the Company's portfolio, (ii) write-downs of certain information technology assets, and (iii) other miscellaneous items. See Note 14 to the Financial Statements for details of the components of these charges.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
primarily due to increased competition in the marketplace, the introduction by some companies of bonus annuities, which the Company elected not to offer, and the aging of the block of business. The Company continues to take actions to reverse this trend, including: (i) changes in agent compensation plans, (ii) the establishment of a conservation unit, (iii) an exchange program which allows policyholders to exchange their old policies to a new product series, and (iv) increased education and training of the Company's career agency sales force to emphasize the value of the Company's annuity line compared to the competition.
Net realized gains on investments were $5.3 million for 2001, an increase of $10.4 million from a net realized loss of $5.1 million reported for 2000. The following table sets forth the components of net realized gains (losses) by investment category for 2001 and 2000.
Amortization of deferred policy acquisition costs ("DAC") was $62.1 million for 2001, an increase of $13.3 million, or 27.3%, from $48.8 million reported for 2000. The increase was primarily due to $8.1 million higher amortization related to the Company's VUL business as a result of the increased size of the in-force block, partially offset by the recognition of deferred revenue as policy fee income. Amortization of CSVUL was $3.5 million higher as a result of lower death claims and the increased size of the in-force block. In addition, amortization of group universal life ("GUL") and traditional life increased by $4.3 million and $0.7 million respectively,
Other operating costs and expenses were $101.3 million for 2001, an increase of $12.7 million, or 14.3%, from $88.6 million reported for 2000. The increase is due primarily to charges of $12.3 million, and an increase in commissions and expenses related to assumed business from USFL. See Note 14 to the Financial Statements for a discussion of the Reorganization and Other Charges recorded in the forth quarter of 2001.
UL and investment-type product fees were $158.2 million for 2000, an increase of $15.1 million, or 10.6%, from $143.1 million reported for 1999. The principal reasons for the change from year to year are as follows:
The net increase in VUL and UL was partially offset by a decrease in FPVA product fees of $63.1 million for 2000, a decrease of $1.3 million from $64.4 million reported for 1999, due to declines and fund values. The decline in FPVA fees is a result of lower fund values, primarily due to: (i) increased competition in the marketplace, (ii) the introduction by some companies of bonus annuities, which the Company elected not to offer, and (iii) the aging of the block of business. The Company has taken actions to reverse this trend, including: (i) changes in agent compensation plans, (ii) the establishment of a conservation unit, (iii) the introduction of an exchange program which allows policyholders to exchange their old policies to a new product series, and (iv) increased education and training of the Company's career agency sales force to emphasize the value of the Company's annuity line compared to the competition.
Net investment income was $92.7 million for 2000, a decrease of $2.0 million, or 2.1%, from $94.7 million reported for 1999. The decrease was primarily related to lower invested assets of $31.9 million, partially offset by a 2 basis point increase in portfolio yields.
For the Years Ended --------------------- December 31, --------------------- 2000 1999 --------- --------- Fixed maturities $(5.3) $(0.2) Mortgage loans 0.1 (0.3) Real estate 0.1 (0.5) Other 0.0 0.7 ----- ----- $(5.1) $(0.3) ===== =====
Other income was $12.1 million for 2000 compared to $7.6 million for December 31, 1999, an increase of $4.5 million, or 59.2%. The increase is primarily due to higher fees received on supplemental contracts in 2000.
The Company's cash inflows are provided mainly from annuity considerations and deposit funds, investment income, maturities and sales of invested assets, and term life insurance premiums. Cash outflows primarily relate to the liabilities associated with its various life insurance and annuity products, operating expenses and income taxes. The life insurance and annuity liabilities relate to the Company's obligation to make benefit payments under its insurance and annuity contracts, as well as the need to make payments in connection with policy surrenders, withdrawals and loans. The Company develops an annual cash flow projection which shows expected asset and liability cash flows on a monthly basis. At the end of each quarter actual cash flows are compared to projections, projections for the balance of the year are adjusted in light of the actual results, if appropriate, and investment strategies are also changed, if appropriate. The quarterly cash flow reports contain relevant information on all of the following: new product sales and deposits versus projections, existing liability cash flow versus projections and asset portfolio cash flow versus projections. An interest rate projection is a part of the initial annual cash flow projections for both assets and liabilities. Actual changes in interest rates during the year and, to a lesser extent, changes in rate expectations will impact the changes in projected asset and liability cash flows during the course of the year. When the Company is formulating its cash flow projections it considers, among other things, its expectations about sales of the Company's products, its expectations concerning customer behavior in light of current and expected economic conditions, its expectations concerning competitors and the general outlook for the economy and interest rates.
The following table sets forth the withdrawal characteristics and the surrender and withdrawal experience of the Company's total annuity reserves and deposit liabilities at December 31, 2001 and 2000.
(1) Excludes approximately $176.9 million and $767.1 million in 2001 and 2000, respectively, relating to surrenders associated with an exchange program offered by the Company wherein contract holders surrendered old FPVA contracts and reinvested the proceeds in a new enhanced FPVA product offered by the Company.
Annuity surrenders have decreased for the years ended December 31, 2001 and 2000 as compared to 1999 primarily due to the aging of the block of business and a consequent decrease in surrender charge rates, as well as an increase in competition. In July 1999, the Company responded to these factors by offering new investment fund choices with its variable annuity products. The Company has also embarked on a conservation program, and has established a special conservation unit that offers policyholders the opportunity to exchange their contracts for a new product series. These positive efforts are reflected in the decrease in surrender activity in 2001 and 2000, as compared to 1999.
During 2001, the Company reported cash used in operations of $14.1 million, as compared to $94.2 million during 2000, a decrease of $80.1 million between the periods. The increase in net cash flow from operations was primarily due to charges taken in the fourth quarter and the timing of payments of liabilities. See Note 14 to the financial statements. In 2001, net cash flow provided by financing activities was $128.0 million, an increase of $49.8 million from $78.3 million in 2000. This increase is primarily due to lower surrenders, as noted in the table and discussion above.
Fixed maturities ............ $1,220.9 78.7% $1,014.7 77.2% Mortgage loans on real estate .................... 132.8 8.6 116.1 8.8 Policy loans ................ 71.6 4.6 69.4 5.3 Other invested assets ....... 22.4 1.5 8.8 0.7 Cash and cash equivalents ... 102.6 6.6 104.8 8.0 -------- ----- -------- ----- Total invested assets .. $1,550.3 100.0% $1,313.8 100.0% ======== ===== ======== =====
Fixed maturities consist of publicly traded and privately placed debt securities which represented 78.7% and 77.2% of total invested assets at December 31, 2001 and 2000, respectively.
The Securities Valuation Office of the NAIC evaluates the bond investments of insurers for regulatory reporting purposes and assigns securities to one of six investment categories ("NAIC Designations"). The NAIC Designations closely mirror the Nationally Recognized Securities Rating Organizations' credit ratings for marketable bonds. NAIC Designations 1 and 2 include bonds considered investment grade ("Baa" or higher by Moody's, or "BBB" or higher by S&P) by such rating organizations. NAIC Designations 3 through 6 are referred to as below investment grade ("Ba" or lower by Moody's, or "BB" or lower by S&P).
The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity dates, (excluding scheduled sinking funds) as of December 31, 2001 and 2000 are as follows:
The Company held approximately $212.9 million and $219.7 million of mortgage-backed and asset-backed securities as of December 31, 2001 and 2000, respectively. Of such amounts, $39.9 million and $59.3 million, or 18.8% and 27.0%, respectively, represented agency-issued pass-through and collateralized mortgage obligations ("CMOs") secured by the Federal National Mortgage Association ("FNMA"), the FHLMC and the Government National Mortgage Association ("GNMA"). The balance of such amounts was comprised of other types of mortgage-backed and asset-backed securities. The Company believes that its active monitoring of its portfolio of mortgage-backed securities and the limited extent of its holdings of more volatile types of mortgage-backed securities mitigate the Company's exposure to losses from prepayment risk associated with interest rate fluctuations for this portfolio. At December 31, 2001 and 2000, 76.5% and 75.3%, respectively, of the Company's mortgage-backed and asset-backed securities were assigned an NAIC Designation 1. In addition, the Company believes that it holds a relatively low percentage of CMOs compared to other life insurance companies.
As of December 31, ------------------ 2001 2000 ------- ------- ($ in millions)
CMOs ....................................... $ 77.9 $ 103.4 Asset-backed securities .................... 126.1 111.7 Commercial MBSs ............................ 8.7 4.6 Pass-through securities .................... 0.2 0.0 ------- ------- Total MBSs and asset-backed securities ... $ 212.9 $ 219.7 ======= =======
The prepayment and extension risk associated with a sequential tranche can vary as interest rates fluctuate, since this tranche is not supported by other tranches.
The underlying properties supporting the commercial mortgage loans at December 31, 2001 and 2000, respectively, consisted of 47.8% and 85.6% in office buildings, 29.3% and 0.0% in hotels, 15.9% and 4.9% in industrial buildings, and 7.0% and 9.5% in other categories, none of which exceeded 10.0% of total commercial mortgage loans.
The Company's commercial mortgage loan portfolio is managed by a group of experienced real estate professionals. These professionals monitor the performance of the loan collateral, physically inspect properties, collect financial information from borrowers and keep in close contact with borrowers and the local broker communities to assess the market conditions and evaluate the impact of such conditions on property cash flows. The Company's real estate professionals identify problem and potential problem
Commercial mortgage loans are stated at their unpaid principal balances, net of valuation allowances and writedowns for impairment. The Company provides valuation allowances for commercial mortgage loans considered impaired. Mortgage loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When the Company determines that a loan is impaired, a valuation allowance for loss is established for the excess of the carrying value of the mortgage loan over its estimated fair value. Estimated fair value is based on either the present value of expected future cash flows discounted at the loan's original effective interest rate, the loan's observable market price or the fair value of the collateral. The provision for loss is reported as a realized loss on investment.
The Company reviews its mortgage loan portfolio and analyzes the need for a valuation allowance for any loan which is delinquent for 60 days or more, in process of foreclosure, restructured, on "watchlist", or which currently has a valuation allowance. Loans which are delinquent and loans in process of foreclosure are categorized by the Company as "problem" loans. Loans with valuation allowances, but which are not currently delinquent, and loans which are on the watchlist are categorized by the Company as "potential problem" loans. Loans for which the original terms of the mortgages have been modified or for which interest or principal payments have been deferred are categorized by the Company as "restructured" loans.
At December 31, 2001, the carrying value of restructured loans was $5.8 million, net of valuation allowances of $0.0 million. There were no problem or potential problem loans at December 31, 2001.
Gross interest income on restructured commercial mortgage loan balances that would have been recorded in accordance with the loans' original terms was approximately $0.6 million and $0.8 million at December 31, 2001 and 2000. As a result of the restructurings, the gross interest income recognized in net income at December 31, 2001 and 2000 was $0.5 million and $0.7 million.
In addition to valuation allowances and impairment writedowns recorded on specific agricultural mortgage loans classified as problem, potential problem, and restructured mortgages, the Company records a non-specific estimate of expected losses on all other agricultural mortgage loans based on its historical loss experience for such investments. As of December 31, 2001 and 2000, such reserves were $0.7 million and $0.6 million, respectively.
The cumulative asset specific impairment adjustments and provisions for valuation allowances recorded as of December 31, 2001 and 2000 are shown in the table below.
Cumulative Impairment Adjustments and Provisions For Valuation Allowances on Investments For the Year Ended December 31,
impairment adjustments with respect to real estate held for investment will not need to be made. Any such adjustments may have a material adverse effect on the Company's financial position and results of operations.