the amount of our assets under management and changes in their fair value, which affect the amount of asset management fees we receive; and
Commercial loans, which comprised nearly 2% of our investments as of December 31, 2005, are carried primarily at unpaid principal balances, net of unamortized premiums or discounts and an allowance for losses. This allowance includes a loan specific portion as well as a portfolio reserve for probable incurred but not specifically identified losses. The loan specific portion is based on management’s judgment as to ultimate collectibility of loan principal. The portfolio reserve is based on a number of factors, such as historical experience and portfolio diversification. Adjustments to the allowance are reflected in “Realized investment gains (losses), net,” in our statements of operations. Similar to impairment losses discussed above, the allowance for losses can be expected to increase when economic conditions worsen and decrease when economic conditions improve.
Future rate of return assumptions used in evaluating DAC for our domestic annuity and variable life insurance products, are derived using a reversion to the mean approach, a common industry practice. Under this approach, we consider actual returns over a period of time and project returns for the future period so that the assets grow at the expected rate of return for the entire period. If the projected future rate of return is greater than our maximum future rate of return, we use our maximum reasonable future rate of return. As part of our approach for variable annuity contracts, if the estimated gross profits under the previously projected rate of returns are greater than or less than a range of estimated gross profits determined by statistically generated rate of returns, we change our future assumption to reflect the result of the reversion to the mean approach. For variable annuities products, our expected rate of return is 8% per annum, which reflects an expected rate of return of 8.9% per annum for equity type assets. The future equity rate of return used varies by product, but was under 8.9% per annum for all of our variable annuity products for our evaluation of deferred policy acquisition costs as of December 31, 2005.
See “-Results of Operations” for a discussion of the impact of DAC amortization on our results of the life and annuities products.
Refer to Note 2, “Summary of Significant Accounting Policies,” of the Notes to Financial Statements.
From December 31, 2004 to December 31, 2005, total assets increased by $344 million from $3.621 billion to $3.965 billion. Fixed maturities increased by $92 million, from $904 million to $996 million, as a result of investing positive operating and financing cash flows, partly offset by a $20 million investment in commercial loans and a decline in the level of unrealized gains resulting from an increasing interest rate environment. Separate account assets increased by $175 million, from $2.113 billion at December 31, 2004 to $2.288 billion at December 31, 2005, due to positive cash flows (sales less withdrawals) and market performance in the current year. Reinsurance recoverable increased by $25 million, from $67 million at December 31, 2004, largely as a result of increased ceded reserves held under the PARCC agreement (see Note 13 to the Financial Statements). Deferred acquisition costs, or “DAC,” increased $42 million driven by higher capitalization from new sales and a $12 million increase in the shadow DAC adjustment due to lower unrealized gains.
From December 31, 2004 to December 31, 2005, total liabilities increased by $317 million, from $3.303 billion to $3.620 billion. Corresponding with the asset change, separate account liabilities increased by $175 million from $2.113 billion at December 31, 2004, as described above. The Company had short-term borrowings from an affiliate of $53 million at December 31, 2005 to provide short-term working capital. There were no such borrowings outstanding at December 31, 2004. Policyholders’ account balances increased by $25 million, from $816 million in 2004, primarily due to positive net sales in the life business. Future policy benefits and other policyholder liabilities increased by $34 million, from $170 million at December 31, 2004, as a result of growth in the term insurance business. Income taxes payable, net of receivables, decreased by $4 million, primarily as a result of a $12 million tax payment made in the first quarter of 2005.
Policy charges and fee income, consisting primarily of mortality and expense charges, loading and other insurance charges assessed on general and separate account policyholders’ fund balances, decreased by $15 million, from $75 million in 2004 to $60 million in 2005. The decrease resulted from a $17 million decrease, from $65 million in 2004 for individual life products while annuity products increased $2 million, from $11 million in 2004. Although mortality and sales-based loading charges for life products increased as a result of continued growth in the in force business, reinsurance policy charges on variable and universal life products increased even more. The gross variable and universal life in force business grew more than 1% to $11.6 billion at December 31, 2005, from $11.5 billion at December 31, 2004. Reinsurance ceded policy charges increased on variable and universal life due to the excess of loss reinsurance agreement (see Note 13 to the Financial Statements) and are reflected within policy charges. Annuity fees are mainly asset-based fees, which are dependent on fund balances that are affected by net sales as well as asset depreciation or appreciation on the underlying investment funds in which customers may invest. Average annuity fund balances have increased more than 10% over last year primarily as a result of favorable market performance.
Net investment income increased by $8 million, from $52 million in 2004 to $60 million in 2005, as a result of increased income from fixed maturities due to an increase in the portfolio balance from proceeds of short-term borrowings and the investment of positive cash flows into the fixed maturity portfolio, reinvestment in net investment income and higher yields from improved reinvestment rates.
DAC amortization of $9 million in 2005 was $14 million lower than in 2004 as increases in the annuity business from higher gross profits were more than offset by lower amortization in the life business. Amortization in the life business decreased by $16 million, primarily due to the update of assumptions discussed above. Amortization in the annuity business increased by $1 million as a result of higher gross profits from increased spread revenues and fees from market appreciation.