The following table summarizes information with respect to the operations of the Company: (in thousands) For the Year Ended December 31, 2000 1999 1998 1997 1996 STATEMENT OF OPERATIONS DATA
Average assets under management totaled $31,413,809,000 in 2000 and $21,984,759,000 in 1999, representing an increase of 43%. As a result of the growth in sales and average assets under management, annuity and life insurance charges and fees increased 46% in 2000 and 56% in 1999. Fee income generated from transfer agency-type and investment support activities increased 57% in 2000 and 64% in 1999.
Net investment income increased 12% in 2000 compared to 1999 and decreased 6% in 1999 compared to 1998. The increase in 2000 is primarily due to a higher level of investments, partially offset by $6,939,000 of amortization of premiums paid on derivative instruments. The decrease in 1999 was primarily the result of $1,036,000 of amortization of the premium paid on a derivative instrument purchased during 1999. See Note 2D to the consolidated financial statements for information related to derivative instruments used to hedge the guaranteed minimum death benefit ("GMDB") reserve fluctuations. Excluding the derivative amortization, net investment income increased 62% in 2000 and increased 3% in 1999 as a result of increased bond holdings that support the Company's risk-based capital objectives.
Premium income represents premiums earned on the sale of ancillary contracts such as immediate annuities with life contingencies, supplementary contracts with life contingencies and certain life insurance products. Increased sales of these products led to an increase in premium income in 2000. The increase in 2000 and 1999 was primarily due to higher sales of supplementary contracts. Management expects supplementary contracts to grow over time with the maturing of core business lines.
The change in annuity policy reserves includes changes in reserves related to annuity contracts with mortality risks as well as the Company's GMDB liability. In 2000, equity markets declined and the underlying fund performance was lower than the prior year. In contrast, the equity markets and underlying fund performance were up significantly in 1999 compared to 1998. The combination of these events resulted in an increase in GMDB reserves of $39,866,000 in 2000. This compares to an increase in GMDB reserves of $2,323,000 in 1999.
In 1999, the Company began to develop a program utilizing equity put options to manage the risks embedded in the GMDB in annuity contracts that would result from significant declines in the equity markets. Prior to the implementation of the hedge strategies utilizing equity put options, the Company had reinsured substantially all of its exposure on the GMDB liability. The reinsurance was terminated during the second quarter of 1999 as the reinsurer had exited this market.
Return credited to contractowners consists of revenues on the variable and market value adjusted annuities and variable life insurance, offset by the benefit payments and changes in reserves required on this business. Market value adjusted annuity activity has the largest impact on this benefit. In 2000 and 1999, the Separate Account investment returns on the market value adjusted annuities were less than the expected returns as calculated in the reserves, contributing to the significant increase in the return credited to contractholders benefit. In addition, this benefit increased as a result of the amortization of unearned Performance Advantage target value credits, which increased $6,826,000 in 2000 over 1999. Other significant contributors to the change from 1999 to 2000 include guaranteed minimum death benefit payments on variable annuities which were driven up due to the market declines in 2000 as well as increased costs associated with processing of backdated financial transactions. These increased costs were partially offset by a 2000 experience refund on certain reinsurance treaties in the amount of $4,339,000.
Underwriting, acquisition and other insurance expenses for 2000, 1999 and 1998 were as follows:
Acquisition costs amortized during the year 184,616 83,861 86,628 --------- --------- ---------
Net capitalization of deferred acquisition costs (310,487) (366,198) 174,804) ---------- ----------- ---------
Interest expense increased $16,496,000 in 2000 and $28,498,000 in 1999 as a result of additional securitized financing transactions, which consist of the transfer of rights to receive future fees to the Parent ("securitization transactions"). In addition, the Company retired surplus notes on December 10, 2000 and December 31, 1999 of $20,000,000 and $14,000,000, respectively. Surplus notes outstanding as of December 31, 2000 and 1999 totaled $159,000,000 and $179,000,000, respectively.
The effective income tax rates for the years ended December 31, 2000, 1999 and 1998 were 32%, 28% and 19%, respectively. The effective rate is lower than the corporate rate of 35% due to permanent differences, with the most significant item being the dividend received deduction. Management believes that based on the taxable income produced in the past two years, as well as the continued growth in annuity sales, the Company will produce sufficient taxable income in future years to realize its deferred tax assets.
The Company generated net income after tax of $64,817,000, $76,169,000 and $34,767,000 in 2000, 1999 and 1998, respectively. Revenue increases in 2000 were more than offset by higher benefits and expenses driven primarily from the increase in the reserve requirement related to the GMDB as a result of the decline in the equity markets. Investments in new product development and technology also contributed to the increase in expenses. These factors resulted in the 15% decline in net income. Net income increased 119% in 1999 due to strong sales growth and favorable market conditions which led to higher asset-based revenue. The Company considers Mexico an emerging market and has invested in the Skandia Vida operations with the expectation of generating profits from long-term savings products in future years. As such, Skandia Vida has generated net losses of $2,540,000, $2,523,000 and $2,514,000 for the years ended December 31, 2000, 1999 and 1998, respectively. The Company expects to transfer ownership of Skandia Vida to an upstream affiliate during 2001.
On March 22, 2001, the Company announced that it will begin an aggressive operating expense reduction program to better align its operating infrastructure with the current investment environment. The planned moves include a reduction of approximately 150 positions, representing 13% of the Company's workforce, reductions in the compensation and benefit programs and the curtailment of certain discretionary expenses.
Total assets grew 3% in 2000 partially as a result of the modest increase in separate account assets reflecting the impact of strong sales which were almost entirely offset by the decline in equity markets. Increased deferred acquisition costs also contributed to the increase in assets. Liabilities grew 2% in 2000 due to higher reserves required to support the increase in annuity and life insurance business, and increased financing activity related to the transfer of rights to receive future fees and charges.
The majority of the operating cash outflow resulted from the sale of variable annuity and variable life products that carry a contingent deferred sales charge. This type of product causes a temporary cash strain in that 100% of the proceeds are invested in separate accounts supporting the product leaving a cash (but not capital) strain caused by the acquisition cost for the new business. This cash strain required the Company to look beyond the cash made available by insurance operations and investments of the Company to financing in the form of surplus notes, capital contributions, securitization transactions and modified coinsurance reinsurance arrangements:
The Company expects the continued use of reinsurance and securitization transactions to fund the cash strain anticipated from the acquisition costs on the coming years' sales volume.
As of December 31, 2000 and 1999, shareholder's equity totaled $496,911,000 and $359,434,000, respectively. The increases were driven by the previously mentioned capital contributions received from ASI and net income from operations.
The Gramm-Leach-Bliley Act of 1999 (the Financial Services Modernization Act) permits affiliation among banks, securities firms and insurance companies. This legislative change has created opportunities for continued consolidation in the financial services industry and increased competition as large companies offer a wide array of financial products and services.
Various other legislative initiatives could impact the Company such as pension reform, capital gains and estate tax changes, privacy standards and internet regulation. Pension reform may change current tax deferral rules and allow increased contributions to retirement plans, which may lead to higher investments in tax-deferred products and create growth opportunities for the Company. A capital gains tax reduction may cause tax-deferred products to be less attractive to consumers, which could adversely impact the Company. New privacy standards and internet regulation may impact the Company's strategic initiatives especially related to potential partnerships with web-based technology providers.
See index to Consolidated Financial Statements and Supplementary Data on page 13.