Heightened competition, particularly in terms of price, product features, and distribution capability, which could constrain the Company’s growth and profitability;
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), which require the Company to make estimates and assumptions. The Company believes that of its significant accounting policies the following may involve a higher degree of judgment and complexity.
Acquisition costs consist of commissions, underwriting and other costs that vary with and are primarily related to the production of new business. Acquisition costs related to investment-type contracts, primarily deferred annuity contracts, are deferred and amortized with interest in proportion to the present value of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits are composed of net investment income, net realized investment gains and losses, life and variable annuity fees, surrender charges, interest credited, policyholder benefits and direct variable administrative expenses.
DAC amortization is reviewed regularly and adjusted retrospectively when the Company revises the actual profits and its estimate of future gross profits to be realized from investment-type contracts, including realized gains and losses from investments.
DAC is also adjusted for amounts relating to unrealized investment gains and losses. This adjustment, net of tax, is included with unrealized investment gains or losses that are recorded in accumulated other comprehensive income (loss). DAC was (decreased) increased by $(0.5) million and $0.8 million at December 31, 2006 and 2005, respectively, relating to this adjustment.
The Company’s accounting policy for impairment requires recognition of an other-than-temporary impairment write-down on a security if it is determined that the Company will be unable to recover all amounts due under the contractual obligation of the security. Once an impairment charge has been recorded, the Company continues to review the other-than-temporarily impaired securities for additional impairment.
The Company’s net income was $16.2 million and $5.4 million for the years ended December 31, 2006 and 2005, respectively. Income before income taxes and cumulative effect of change in accounting principle was $23.6 million and $7.7 million for the years ended December 31, 2006 and 2005, respectively. This $15.9 million increase was caused primarily from increases in premiums and fee income of $6.1 million and $7.5 million, respectively, along with a decrease in interest credited of $13.2 million offset by a net increase in DAC amortization and other operating expenses of $8.4 million. Income tax expense was $7.4 million and $2.3 million for the years ended December 31, 2006 and 2005, respectively. The results of operations are discussed more fully below.
Total revenues were $150.7 million and $136.0 million for the years ended December 31, 2006 and 2005, respectively. The increase of $14.7 million was primarily due to the following:
Premiums and annuity considerations - were $38.3 million and $32.2 million for the years ended December 31, 2006 and 2005, respectively. The increase of $6.1 million was primarily due to increased in-force business in group disability, group stop loss and group life insurance, with premium increases of $2.8 million, $1.9 million and $1.7 million, respectively.
Net investment income - was $97.4 million and $94.3 million for the years ended December 31, 2006 and 2005, respectively. The increase of $3.1 million was the net result of higher average investment yield, increasing income by $13.1 million, and a volume decline in average invested assets, decreasing income by $10.0 million.
Net realized investment losses - were $6.1 million and $4.1 million for the years ended December 31, 2006 and 2005, respectively. Sales of investments generally are made to maximize total return and take advantage of prevailing market conditions. The Company incurred write-downs of fixed maturities for other-than-temporary impairments of $0.8 million and $5.5 million for the years ended December 31, 2006 and 2005, respectively.
Fee and other income - was $21.1 million and $13.6 million for the years ended December 31, 2006 and 2005, respectively. Fee and other income include separate account fees and similar charges, such as mortality and expense ("M&E") charges earned on variable annuity balances. M&E charges, which are based on the market values of the assets in the separate accounts supporting the contracts, were $10.9 million and $9.0 million for the years ended December 31, 2006 and 2005, respectively. Variable product fees represented 1.50% and 1.37% of the average variable annuity separate account balances for the years ended December 31, and 2005, respectively. Average separate account assets were $726.9 million and $658.0 million for the years ended December 31, 2006 and 2005, respectively.
Total benefits and expenditures were $127.0 million and $128.3 million for the years ended December 31, 2006 and 2005, respectively. The decrease of $1.3 million was due to the following:
Interest credited - to policyholders was $56.4 million and $69.6 million for the years ended December 31, 2006 and 2005, respectively. Of the $13.2 million decrease in interest credited, $5.8 million was the result of a lower average interest credited rate and $7.4 million was due to a decline in average policyholder balances.
Policyholder benefits - were $29.3 million and $25.7 million for the years ended December 31, 2006 and 2005, respectively. The $3.6 million increase was primarily due to an increase in benefits for group health insurance products.
Amortization of DAC - relates to the costs of acquiring new business, which vary with and are primarily related to the production of new annuity business. Such acquisition costs include commissions, costs of policy issuance, underwriting and selling expenses. Amortization expense was $18.4 million and $9.5 million for the years ended December 31, 2006 and 2005, respectively. The amortization expense included an increase (decrease) in amortization of $4.7 million and ($1.0) million for the years ended December 31, 2006 and 2005, respectively due to the effect of revisions in estimated future gross profits. The most significant assumption changes for the year ended December 31, 2006 related to assumptions regarding lapses, future growth rates of capital markets assumptions, and expense assumptions.
Net investment income - was $82.7 million and $91.1 million for the years ended December 31, 2006 and 2005, respectively. The decrease of $8.4 million was the net result of higher average investment yield, increasing income by $10.0 million, and a volume decline in average invested assets, decreasing income by $18.4 million. Effective January 1, 2006, the Company adopted a new capital allocation methodology for measurement of segment operating results to more closely align with capital requirements. The changes primarily impact the amount of capital and income on capital that is allocated to the Wealth Management Segment from the Corporate Segment. Such allocated income decreased from 2005 to 2006.
Fee and other income - was $16.8 million and $13.7 million for the years ended December 31, 2006 and 2005, respectively. Fee and other income consist primarily of separate account fees and similar charges, including M&E charges earned on variable annuity balances. M&E charges, which are based on the market values of the assets in the separate accounts supporting the contracts, were $10.9 million and $9.0 million for the years ended December 31, 2006 and 2005, respectively. Variable product fees represented 1.50% and 1.37% of the average variable annuity separate account balances for the years ended December 31, 2006 and 2005, respectively. The increase in separate account income was due to an increase in average separate account assets. Average separate account assets were $725.6 million and $657.5 million for the years ended December 31, 2006 and 2005, respectively.
Other income was $3.5 million and $2.4 million for the years ended December 31, 2006 and 2005, respectively. Other income represents primarily administrative service fees.
Total benefits and expenditures were $87.0 million and $94.1 million for the years ended December 31, 2006 and 2005, respectively. The decrease of $7.1 million was primarily due to the following:
Amortization of DAC - relates to the costs of acquiring new business, which vary with and are primarily related to, the production of new annuity business. Such acquisition costs included commissions, costs of policy issuance, underwriting and selling expenses. Amortization expense was $18.7 million and $9.5 million for the years ended December 31, 2006 and 2005, respectively. The amortization expense included an increase (decrease) in amortization of $4.9 million and ($1.0) million for the years ended December 31, 2006 and 2005, respectively due to the effect of revisions in estimated future gross profits. The most significant assumption changes for the year ended December 31, 2006 related to assumptions regarding lapses, future growth rates of capital markets assumptions, and expense assumptions.
The Group Protection Segment markets and administers group life, stop loss and long-term and short-term disability insurance products. These products are sold to companies that provide group benefits for their employees. The Group Protection Segment had pretax income of $4.5 million and $0.3 million for the years ended December 31, 2006 and 2005, respectively.
The Individual Protection Segment products offered by the Company are universal life, variable universal life and conversions from group life products. Pretax income (loss) was $0.6 million and $(0.5) million for the years ended December 31, 2006 and 2005, respectively. Significant growth and sales of universal life insurance account for the growth in revenues, expenditures, income and total assets.
The Corporate Segment includes the unallocated capital of the Company and items not otherwise attributable to the other segments. Pretax income within the Corporate Segment was $8.3 million and $0.2 million for the years ended December 31, and 2005, respectively.
Effective January 1, 2006, the Company adopted a new capital allocation methodology for measurement of segment operating results to more closely align with capital requirements. The changes impact the amount of capital and income on capital that is allocated to the Individual Protection, Group Protection and Wealth Management Segments from the Corporate Segment. Lower allocations of capital and income on capital to the Wealth Management Segment is the primary cause of the increase in income.
As of December 31, 2004, SLC - U.S. Ops Holdings was a direct wholly-owned subsidiary of Sun Life Assurance Company of Canada ("SLOC"). SLOC is a life insurance company incorporated in 1865 and a direct wholly-owned subsidiary of SLF. On January 4, 2005, a reorganization was completed under which most of SLOC’s asset management businesses in Canada and the United States were transferred to Sun Life Financial Corp., a newly incorporated wholly-owned subsidiary of SLF. The Company is now an indirect subsidiary of Sun Life Financial Corp., and continues to be an indirect subsidiary of SLF.
In 2006, the Company established SLNY Private Placement Investment Company I, LLC, a non-insurer investment limited liability corporation.
Income on investments is recorded on the accrual basis. Investments are placed in a non-accrual status when management believes that the borrower’s financial condition, after giving consideration to economic and business conditions and collection efforts, is such that collection of principal and interest is doubtful. When an investment is placed in non-accrual status, all interest previously accrued is reversed against current period interest income. Interest accruals are resumed on such investments only when the investments have performed on a sustained basis for a reasonable period of time, and when, in the judgment of management, the investments are estimated to be fully collectible as to both principal and interest.
Operating expenses primarily represent allocated compensation and general and administrative expenses. Management believes intercompany expenses are calculated on a reasonable basis; however, these amounts may not necessarily be indicative of the costs that would be incurred if the Company operated on a stand-alone basis.
In November of 2005, the FASB issued FASB Staff Position ("FSP") 115-1 and 124-1 "The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments." This FSP is effective for reporting periods beginning after December 15, 2005. The FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of the impairment loss. The statement also includes accounting guidance for periods subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. Adoption of this FSP did not impact the methodology used by the Company to determine and measure impaired investments. See disclosure in Note 4.
On January 1, 2004, the Company adopted SOP 03-1. The major provisions of SOP 03-1 that affect the Company require:
See Footnote 13 for additional information regarding the impact of adoption of SOP 03-1.
In January 2007, the FASB provided a scope exception under SFAS No. 155 for securitized interests that only contain an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets, and for which the investor does not control the right to accelerate the settlement. If a securitized interest contains any other embedded derivative (for example, an inverse floater), then it would be subject to the bifurcation tests in SFAS No. 133, as would securities purchased at a significant premium. Following the issuance of the scope exception by the FASB, changes in the market value of the Company’s investment securities would continue to be made through other comprehensive income, a component of stockholders’ equity. The Company does not expect that the January 1, 2007 adoption of SFAS No. 155 will have a material impact on the Company’s financial position, results of operations or cash flows. However, to the extent that certain of the Company’s future investments in securitized financial assets do not meet the scope exception adopted by the FASB, the Company’s future results of operations may exhibit volatility if such investments are required to be bifurcated or marked to market value in their entirety through the income statement, depending on the election made by the Company.
In September of 2005, the AICPA issued Statement of Position 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 provides guidance on accounting by insurance companies for DAC on internal replacements other than those specifically described in FASB Statement 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 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The adoption of SOP 05-1 did not have an impact the Company’s consolidated financial statements.
Goodwill represents the difference between the purchase price paid and the fair value of the net assets acquired in connection with the Company’s acquisition of Keyport Benefit Life Insurance Company ("KBL"), which was a wholly-owned subsidiary of Keyport Life Insurance Company. KBL was merged into the Company on December 31, 2002. Goodwill is allocated in total to the Wealth Management Segment. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," goodwill and indefinite-lived assets are tested for impairment on an annual basis. The Company completed the required impairment tests during the second quarter of 2006 and concluded that these assets were not impaired.
The Company has agreements with Sun Life U.S. and certain affiliates, under which the Company receives, as requested, certain investment and administrative services on a cost reimbursement basis. Expenses under these agreements amounted to approximately $14.5 million, $16.0 million and $11.5 million for the years ended December 31, 2006, 2005 and 2004, respectively.
The Company had $1.0 million and $17.9 million due to related parties at December 31, 2006 and 2005, respectively, and $5.6 million and $0.6 million due from related parties at December 31, 2006 and 2005, respectively.
During 2006, 2005 and 2004, the Company paid $1.4 million, $1.0 million and $1.0 million, respectively, in commission fees to an affiliate, Sun Life Financial Distributors, Inc.
During 2006, 2005 and 2004, the Company paid $1.5 million, $2.8 million and $2.5 million, respectively, in commission fees to Independent Financial Marketing Group, Inc., an affiliate.
During 2006, 2005 and 2004, the Company paid $1.3 million, $1.5 million and 1.4 million, respectively, in investment advisory fees to Sun Capital Advisers LLC, a registered investment adviser and affiliate.
The amortized cost and fair value by maturity periods for fixed maturities are shown below (in 000’s). Actual maturities may differ from contractual maturities on asset-backed securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Gross gains of $3.4 million, $4.6 million and $17.5 million, and gross losses of $10.2 million, $3.2 million and $7.5 million were realized on the sale of fixed maturities for the years ended December 31, 2006, 2005 and 2004, respectively.
As of December 31, 2006, 96.2% of the Company’s fixed maturities were investment grade. Investment grade securities are those that are rated "BBB" or better by nationally recognized statistical rating organizations. In 2006, $1.5 million of the prior years’ impairment losses were recovered through disposition and are included in net realized losses. In 2005, no prior years’ losses were recovered through disposition. In 2004, $0.1 million of the prior years’ impairment losses were recovered through disposition and are included in net realized gains.
The gross unrealized losses and fair value of investments, which have been deemed to be temporarily impaired, aggregated by investment category, number of securities and length of time that securities have been in an unrealized loss position at December 31, 2005 are as follows (dollar amounts in 000’s):
The Company has a comprehensive process in place to identify potential problem securities that could have an impairment that is other-than-temporary. At the end of each quarter, all securities with an unrealized loss are reviewed. An analysis is undertaken to determine whether this decline in market value is other-than-temporary. The Company’s process focuses on issuer operating performance and overall industry and market conditions. Any deterioration in operating performance is assessed relative to the impact on issuer financial ratios, including leverage and coverage measures specific to an industry and relative to any investment covenants. Additionally, the Company’s analysis assesses each issuer’s ability to service its debts in a timely fashion, the length of time the security has been in an unrealized loss position, rating agency actions, and any other key developments as well the Company’s ability and intention, if any, to dispose of its position prior to the fair value increasing so as to allow recovery of the Company’s cost. The Company has a Credit Committee that includes members from its investment, finance and actuarial functions. The Credit Committee meets and reviews the results of the Company’s impairment analysis on a quarterly basis.
Mortgage loans are collateralized by the related properties and generally are no more than 75% of each property’s value at the time that the original loan is made.
Mortgage loans comprised the following property types and geographic regions (in 000’s):
Fixed maturities and equity securities: The fair values of publicly traded fixed maturities are based upon market prices or dealer quotes. For privately-placed fixed maturities, fair values are estimated by taking into account prices for publicly-traded securities of similar credit risk, maturity, repayment and liquidity characteristics. The fair value of equity securities are based on quoted market prices. Equity securities are included within other invested assets within the consolidated balance sheet.
Mortgage: The fair values of mortgage and other loans are estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Separate accounts, assets and liabilities: The estimated fair value of assets held in separate accounts is based on quoted market prices. The fair value of liabilities related to separate accounts is the amount payable on demand, which excludes surrender charges.
The Company had an agreement with SLOC whereby SLOC reinsured morbidity risks of a block of the Company’s group long-term disability contracts. The treaty was commuted effective December 31, 2004.
The Company has an agreement with an unrelated company whereby the unrelated company reinsures the morbidity risks of the Company’s group long-term disability contracts. Under this agreement, certain long-term disability benefits are reinsured on a yearly-renewable term basis. The agreement provides that the unrelated company will reinsure amounts above $4,000 per claim per month for long-term disability contracts ceded by the Company. The retention limit was raised to $9,000 per claim per month for claims incurred on or after January 1, 2006.
Cash collateral received on securities lending transactions is reflected in other invested assets with an offsetting liability recognized in other liabilities for the obligation to return the collateral. The fair value of collateral held and included in other invested assets was $65.8 million at December 31, 2006. Fee income earned on securities lending transactions was $0.1 million for the year ended December 31, 2006.
The Company participates in a plan sponsored by Sun Life U.S. that provides certain health, dental and life insurance benefits ("post-retirement benefits") for retired employees and dependents. Substantially all employees of the participating companies may become eligible for these benefits if they reach normal retirement age, or retire early upon satisfying an alternate age-plus-service condition. Life insurance benefits are generally set at a fixed amount. The Company is allocated a portion of these post-retirement benefit plan expenses. The allocated expenses were $13,000, $8,000 and $13,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
In June 2006, the FASB issued FIN 48. FIN 48 establishes a comprehensive reporting model which addresses how a business entity should recognize, measure, present and disclose uncertain tax positions that the entity has taken or plans to take on a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact, if any, of FIN 48 on its consolidated financial statements.
The Company files a stand-alone federal income tax return. A summary of the components of federal income tax expense (benefit) in the statements of income for the years ended December 31, is as follows (in 000’s):
Federal income taxes attributable to operations are different from the amounts determined by multiplying income before federal income taxes by the statutory federal income tax rate of 35%. The Company’s effective rate differed from the statutory federal income tax rate as follows (in 000’s):
The Company’s federal income tax returns are routinely audited by the Internal Revenue Service ("IRS"), and provisions are made in the consolidated financial statements in anticipation of the results of these audits. In August of 2006, the Company was issued an Revenue Agent’s Report for the tax years 2001 through 2002. The IRS is currently conducting a federal income tax audit of the Company for the tax years 2003 and 2004. In the Company’s opinion, adequate tax liabilities have been established for all years and any adjustments that might be required for the years under audit will not have a material effect on the Company’s consolidated financial statements. However, the amounts of these tax liabilities are estimates and could be revised in the future.
As a result of changes in estimates of insured events in prior years, the liability for unpaid claims and claims adjustment expense decreased by $1,294 and $3,143 in 2006 and 2005, respectively. The favorable development experienced in both years was driven mainly by better than expected loss experience in group life.
On January 1, 2004, the Company adopted the AICPA’s SOP 03-1. The major provisions of SOP 03-1 that affect the Company require:
Reporting and measuring the Company’s interest in its separate accounts as investments.
Upon adoption of SOP 03-1 in 2004, the cumulative effect, reported after tax and net of related effects on DAC, decreased net income and stockholder’s equity by $0.9 million. The reduction in net income was comprised of an increase in benefit reserves (primarily for variable annuity contracts) of $0.9 million, pretax, and a decrease in DAC of $0.5 million, pretax.
(a) Net amount at risk represents the difference between the guaranteed benefit and account balance.
The table below represents information regarding the Company’s variable annuity contracts with guarantees at December 31, 2005 (in 000’s):
(A Wholly-Owned Subsidiary of Sun Life Assurance Company of Canada (U.S.))
The following roll-forward summarizes the reserve for the GMDB for the years ended December 31, (in 000’s):
Because the Company has not issued products that contain a guaranteed minimum income benefit ("GMIB"), there is no requirement for a GMIB reserve as of December 31, 2006 or December 31, 2005.
GMABs or GMWBs are considered to be derivatives under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and are recorded at fair value through earnings. The fair value of the embedded derivatives is calculated stochastically using risk neutral scenarios over a fifty-year projection. Policyholder assumptions are based on experience studies. The GMAB’s or GMWB’s constituted an asset (a liability) in the amount of $0.4 million and $(0.1) million at December 31, 2006 and December 31, 2005, respectively.
Net investment income is allocated based on segmented assets, including allocated capital, by line of business. Allocation of operating expenses are made using both standard rates and actual expenses incurred. Management evaluates the results of the operating segments on an after-tax basis. The Company does not materially depend on one or a few customers, brokers or agents for a significant portion of its operations.
Effective January 1, 2006, the Company adopted a new capital allocation methodology for measurement of segment operating results to be more closely aligned with rating agency standards. The changes impact the amount of capital and income on capital that is allocated to Individual Protection, Group Protection and Wealth Management from the Corporate Segment.
The Group Protection Segment markets, sells and administers group life, stop loss, long-term disability and short-term disability insurance products. These products are sold to employers that provide group benefits for their employees.
The following amounts pertained to the various business segments (in 000’s):
As described earlier, effective January 1, 2006, the Company adopted a new capital allocation methodology for measurement of segment operating results to be more closely aligned with rating agency standards. The following provides a summary of the amounts allocated from the Corporate Segment to the other segments related to the allocation of income on capital for the years presented (in 000’s):
The Company is required to file quarterly and annual statements with the New York State Insurance Department prepared on a statutory accounting basis prescribed or permitted by the State of New York. Statutory net income and capital stock and surplus differ from net income and stockholder’s equity reported in accordance with GAAP for stock life insurance companies primarily because, under statutory basis accounting, policy acquisition costs are expensed when incurred, reserves are based on different assumptions, investments are valued differently, and income tax expense reflects only taxes paid or currently payable.
The Company leases various facilities and equipment under non-cancelable operating leases with terms of up to 10 years. As of December 31, 2006, minimum future lease payments under such leases were as follows (in 000’s):