The results of operations of the Company for 1999 are affected by the acquisition of business from MBL Life on July 1, 1999 (See Note 3 of the accompanying financial statements).
In 2001, the Company adopted EITF 99-20 which was recorded as a cumulative effect of accounting change (See Note 2 of the accompanying financial statements).
The financial position of the Company as of December 31, 1997 has been affected by the acquisition and subsequent merger with John Alden Life Insurance Company of New York effective March 31, 1997.
Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable developments. Some may be national in scope, such as general economic conditions, changes in tax law and changes in interest rates. Some may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation. Others may relate to the Company specifically, such as credit, volatility and other risks associated with the Company's investment portfolio. Investors are also directed to consider other risks and uncertainties discussed in documents filed by the Company with the SEC. The Company disclaims any obligation to update forward-looking information.
VALUATION OF CERTAIN FINANCIAL INSTRUMENTS: Gross unrealized losses on the debt and equity securities available for sale amounted to $21.6 million at December 31, 2001. In determining if and when a decline in fair value below amortized cost is other-than-temporary, we evaluate at each reporting period the market conditions, offering prices, trends of earnings, price multiples, and other key measures for our investments in debt and marketable equity securities. In particular, for debt securities, the Company assesses the probability that all amounts due are collectible according to the contractual terms of the obligation. When such a decline in value is deemed to be other-than-temporary, we recognize an impairment loss in the current period operating results to the extent of the decline.
AMORTIZATION OF DEFERRED ACQUISITION COSTS: We amortize our deferred acquisition costs ("DAC") based on a percentage of our expected gross profits ("EGPs") over the life of the underlying policies. Our estimated EGPs are computed based on assumptions related to the underlying policies written, including the anticipated duration of the underlying policies, growth rate of the assets supporting the liabilities (management currently estimates a rate of 10% in projecting EGP), and level of expenses necessary to maintain the policies over their entire life. We amortize deferred policy acquisition costs by estimating the present value of the EGPs 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 EGPs. That percentage is used to amortize the deferred policy acquisition cost 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 profits.
NET INCOME totaled $8.2 million in 2001, compared with $7.3 million in 2000 and $7.7 million in 1999. On July 1, 1999, the Company acquired the New York individual life business and the individual and group annuity business of MBL Life Assurance Corporation (the "Acquisition"). The Acquisition was accounted for under the purchase method of accounting, and therefore results of operations include those of the Acquisition only from its date of acquisition. Consequently, the operating results for 2001, 2000 and 1999 are not comparable. On a pro forma basis, using the historical financial information of the acquired business and assuming that the Acquisition had been consummated on January 1, 1999, the beginning of the prior-year periods discussed herein, net income would have been $9.4 million for the year ended December 31, 1999.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflects the adoption of EITF 99-20. The Company recorded a loss of $520,000, net of tax, which is recognized in the statement of income and comprehensive income as a cumulative effect of accounting change for the year ended December 31, 2001 (see Note 2 of Notes to Financial Statements).
PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $14.9 million in 2001, compared with $11.6 million in 2000 and $14.3 million in 1999. The 28% year-to-date improvement in 2001 over 2000 primarily resulted from decreased amortization of deferred acquisition costs, partially offset by lower net investment income and fee income. The decline from 1999 to 2000 primarily resulted from increased net realized investment losses, partially offset by increased fee income and decreased amortization of deferred acquisition costs.
NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and universal life contracts, totaled $37.1 million in 2001, $42.1 million in 2000 and $42.8 million in 1999. These amounts equal 2.60% on average invested assets (computed on a daily basis) of $1.43 billion in 2001, 2.49% on average invested assets of $1.69 billion in 2000 and 2.42% on average invested assets of $1.77 billion in 1999. On a pro forma basis, assuming the Acquisition had been consummated on January 1, 1999, net investment income on related average invested assets would have been 2.05% in 1999.
Net investment spreads include the effect of income earned or interest paid on the difference between average invested assets and average interest-bearing liabilities. Average invested assets exceeded average interest-bearing liabilities by $85.6 million in 2001, compared with $79.6 million in 2000 and $89.0 million in 1999. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 2.32% in 2001, 2.27% in 2000 and 2.18% in 1999. On a pro forma basis, assuming the Acquisition had been consummated on January 1, 1999, the Spread Difference would have been 1.87% in 1999 reflecting primarily the effect of the lower-yielding assets received in the Acquisition.
Investment income (and the related yields on average invested assets) totaled $100.2 million (7.02%) in 2001, compared with $119.6 million (7.08%) in 2000 and $125.4 million (7.10%) in 1999. The decrease in the investment yield in 2001 compared to 2000 primarily reflects a lower interest rate environment in 2001. The decrease in the investment yield in 2000 compared to 1999 principally reflect the effects of lower yielding assets received in the MBL Life acquisition. The invested assets associated with the Acquisition included high-grade corporate, government and government/agency bonds, which are generally lower yielding than a significant portion of the invested assets that comprise the remainder of the Company's portfolio. On a pro forma basis, assuming the Acquisition had been consummated on January 1, 1999, the yield on related average invested assets would have been 6.83% in 1999.
Expenses incurred to manage the investment portfolio amounted to $2.0 million in 2001, $2.0 million in 2000 and $1.9 million in 1999. These expenses are included as a reduction to investment income in the statement of income and comprehensive income.
VARIABLE ANNUITY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $8.0 million in 2001, $9.1 million in 2000 and $6.6 million in 1999. The decreased fees in 2001 reflect the recent state of the equity markets which have been in decline throughout much of 2001, partially offset by net exchanges into the separate accounts from the fixed accounts of variable annuity contracts. The increased fees in 2000 reflect growth in average variable annuity assets, principally due to the receipt of variable annuity deposits and net exchanges into the separate accounts from the fixed accounts of variable annuity contracts, partially offset by surrenders and declines in market values. Variable annuity fees represent 1.5% of average variable annuity assets in all periods presented. Variable annuity assets averaged $517.1 million, $591.9 million and $417.8 million during 2001, 2000 and 1999, respectively. Variable annuity deposits, which exclude deposits allocated to the fixed accounts of variable annuity products, totaled $34.6 million in 2001, $39.6 million in 2000 and $66.7 million in 1999. These amounts represent 6%, 7% and 19% of variable annuity reserves at the beginning of the respective periods. The decrease in variable annuity deposits in 2001 reflected lower demand for the variable account options of the Company's variable annuity products due to the unfavorable equity market conditions discussed above. Transfers from the fixed accounts of the Company's variable annuity products to the separate accounts (see "Change in Average Invested Assets") are not classified as variable annuity deposits. Accordingly, changes in variable annuity deposits are not necessarily indicative of the ultimate allocation by customers among fixed and variable account options of the Company's variable annuity products.
UNIVERSAL LIFE INSURANCE FEES, NET amounted to $3.4 million, $2.2 million and $1.1 million in 2001, 2000 and 1999, respectively. Universal life insurance fees consist of mortality charges, up-front fees earned on deposits received and administrative fees, net of excess mortality expense on these contracts. The administrative fees are assessed based on the number of policies in force as of the end of each month. The Company acquired its universal life contracts as part of the Acquisition and does not actively market such contracts. Such fees represent 1.39%, 0.84% and 0.83% of average reserves for universal life insurance contracts in the respective periods, with the increase in 2001 resulting principally from improved mortality experience, which cannot necessarily be expected to continue in future periods. (See Note 3 of the accompanying financial statements.)
SURRENDER CHARGES on fixed and variable annuity contracts and universal life contracts totaled $2.1 million in 2001, $3.8 million in 2000 and $3.3 million in 1999. Surrender charges generally are assessed on withdrawals at declining rates during the first seven years of a contract. Withdrawal payments, which exclude claims and lump-sum annuity benefits, totaled $257.3 million in 2001, compared with $409.2 million in 2000 and $392.4 million in 1999. These payments, when expressed as a percentage of average fixed and variable annuity and universal life reserves, represent 14.2%, 19.1% and 19.0% for 2001, 2000 and 1999, respectively. Withdrawal rates were higher in 2000 and 1999 principally due to the higher level of surrenders on certain closed blocks of fixed annuity business during those periods. Withdrawals include variable annuity payments from the separate accounts totaling $38.6 million (7.5% of average variable annuity reserves), $36.6 million (6.2% of average variable annuity reserves) and $28.6 million (6.9% of average variable annuity reserves) in 2001, 2000 and 1999, respectively. Management does not anticipate significant increases in the level of withdrawal payments relative to fixed and variable annuity and universal life reserves.
AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $11.6 million in 2001, compared with $19.4 million in 2000 and $22.7 million in 1999. The decrease in amortization in 2001 is principally due to the impact of net realized investment losses.
SHAREHOLDER'S EQUITY increased to $193.6 million at December 31, 2001 from $187.6 million at December 31, 2000, due principally to a $10.7 million increase in accumulated other comprehensive income and $8.2 million of net income recorded in 2001, partially offset by a $12.9 million dividend paid to its Parent on April 2, 2001.
Non-investment-grade securities generally provide higher yields and involve greater risks than investment-grade securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment-grade issuers. In addition, the trading market for these securities is usually more limited than for investment-grade securities. These non-investment-grade securities are comprised of bonds spanning 25 industries with 19% of these assets concentrated in media cable, 18% concentrated in telecommunications, and 9% concentrated in transportation services. No other industry concentration constituted more than 5% of these assets.
The table on the following page summarizes the Company's rated bonds by rating classification as of December 31, 2001.
Senior secured loans ("Secured Loans") are included in the Bond Portfolio and aggregated $41.6 million at December 31, 2001. Secured Loans are senior to subordinated debt and equity and are secured by assets of the issuer. At December 31, 2001, Secured Loans consisted of $12.9 million of publicly traded securities and $28.7 million of privately traded securities. These Secured Loans are composed of loans to borrowers spanning 6 industries, with 36% of these assets concentrated in energy, 30% concentrated in utilities, 12% concentrated in finance companies and 9% concentrated in leisure and gaming. No other industry concentration constituted more than 7% of these assets.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, default rates, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company's fixed-rate products incorporate surrender charges or other restrictions in order to encourage persistency. Approximately 66% of the Company's fixed annuity and universal life reserves had surrender penalties or other restrictions at December 31, 2001.
As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-rate assets and liabilities under commonly used stress-test interest rate scenarios. With the results of these computer simulations, the Company can measure the potential gain or loss in fair value of its interest-rate sensitive instruments and seek to protect its economic value and achieve a predictable spread between what it earns on its invested assets and what it pays on its liabilities by designing its fixed-rate products and conducting its investment operations to closely match the duration of the fixed-rate assets to that of its fixed-rate liabilities. The Company's fixed-rate assets include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans; and policy loans. At December 31, 2001, these assets had an aggregate fair value of $1.37 billion with a duration of 3.9. The Company's fixed-rate liabilities include fixed annuity and universal life insurance contracts. At December 31, 2001, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $1.26 billion with a duration of 3.0. The Company's potential exposure due to a relative 10% increase in prevailing interest rates from their December 31, 2001 levels is a loss of approximately $6.8 million, representing the decrease in fair value of its fixed rate assets that is not offset by a decrease in fair value of its fixed rate liabilities. Because the Company actively manages its assets and liabilities and has strategies in place to minimize its exposure to loss as interest rate changes occur, it expects that actual losses would be less than the estimated potential loss.
INVESTED ASSETS EVALUATION is routinely conducted by the Company. Management identifies monthly those investments that require additional monitoring and carefully reviews the carrying values of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. In making these reviews for bonds, management principally considers the adequacy of any collateral, compliance with contractual covenants, the borrower's recent financial performance, news reports and other externally generated information concerning the creditor's affairs. In the case of publicly traded bonds, management also considers market value quotations, if available. For mortgage loans, management generally considers information concerning the mortgaged property and, among other things, factors impacting the current and expected payment status of the loan and,if available, the current fair value of the underlying collateral.
The carrying values of investments that are determined to have declines in value that are other than temporary are reduced to net realizable value and, in the case of bonds, no further accruals of interest are made. The provisions for impairment on mortgage loans are based on losses expected by management to be realized on transfers of mortgage loans to real estate, on the disposition and settlement of mortgage loans and on mortgage loans that management believes may not be collectible in full. Accrual of interest is suspended when principal and interest payments on mortgage loans are past due more than 90 days. With the adoption of EITF 99-20, the Company recognizes impairment losses on securitized assets if discounted cash flows are less than its carrying value. The adoption of EITF 99-20 resulted in a loss of $0.5 million, net of tax, which is being recognized and reported in the statement of income and comprehensive income as a cumulative effect of an accounting change (see Note 2 of Notes to financial statements).
If a substantial portion of the Company's bond portfolio diminished significantly in value and/or defaulted, the Company would need to liquidate other portions of its investment portfolio and/or arrange financing. Such events that may cause such a liquidity strain could be the result of economic collapse or terrorist acts.
GUARANTEES AND OTHER COMMITMENTS: In the ordinary course of business, the Company is obligated to purchase approximately $11.0 million of asset backed securities as of December 31, 2001. The expiration dates of these commitments are as follows: $7.0 million in 2003 and $4.0 million in 2004.
RECENTLY ISSUED ACCOUNTING STANDARDS are discussed in Note 2 of the accompanying financial statements.