During the first quarter 2005, ML of New York transitioned the policy administration of its inforce life insurance contracts to an unaffiliated third party service provider. ML of New York remains committed to the delivery of high quality services for all life insurance contracts inforce .
Future policy benefits are actuarially determined reserves, which are calculated to meet future obligations and are generally payable over an extended period of time. Principle assumptions used in the establishment of liabilities for future policy benefits are mortality, surrender rates, policy expenses, investment yields and inflation. These estimates and assumptions are influenced by historical experience, current developments and anticipated market trends. At December 31, 2005 and 2004, future policy benefits were $22.5 million and $22.1 million, respectively. Included within future policy benefits are liabilities for GMDB and guaranteed minimum income benefit (“GMIB”) provisions contained in the variable products that ML of New York issues. See Note 6 to the Financial Statements for further discussion of GMDB and GMIB liabilities as well as period-to-period differences in unlocking.
Specific estimates include the realization of dividend-received deductions (“DRD”) and foreign tax credits (“FTC”). A portion of ML of New York’s investment income related to separate accounts business qualifies for the DRD and FTC. Information necessary to calculate these tax adjustments is typically not available until the following year. However, within the current year’s provision, management makes estimates regarding the future tax deductibility of these items. These estimates are primarily based on recent historic experience. See Note 7 to the Financial Statements for period-to-period differences in DRD and FTC adjustments.
In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts.” SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS No. 97. The SOP defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. This SOP is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. ML of New York will adopt SOP 05-1 on January 1, 2007. ML of New York is currently assessing the Financial Statement impact related to the adoption of SOP 05-1.
material impact on ML of New York’s Statements of Earnings for the years ended December 31, 2005 and 2004.
deposits were impacted by a reduction in the number of internal wholesalers. For nearly the first half of 2005, one of the three internal wholesaler positions was vacant.
During 2005, ML of New York experienced contract owner withdrawals that exceeded deposits on all products by $106.4 million. The components of contract owner transactions were as follows:
At December 31, 2005 and 2004, approximately $162.1 million (or 99%) and $179.8 million (or 100%), respectively, of fixed maturity securities were considered investment grade. ML of New York defines investment grade securities as unsecured debt obligations that have a rating equivalent to Standard and Poor’s BBB- or higher (or similar rating agency). Also, at December 31, 2005, approximately $5.7 million (or 3%) of fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by Standard and Poor’s. This compares to $7.5 million (or 4%) of BBB- rated fixed maturity securities at December 31, 2004.
At December 31, 2005, approximately $2.2 million (or 1%) of fixed maturity securities were considered below investment grade. The majority of these below investment grade holdings will mature in January 2006. At December 31, 2004, ML of New York did not hold any fixed maturity securities that were considered below investment grade. Below investment grade securities are speculative and are subject to significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. Current below investment grade holdings are the result of ratings downgrades on existing securities as ML of New York does not purchase below investment grade securities. ML of New York closely monitors such investments.
ML of New York’s investment in collateralized mortgage obligations (“CMO”) and mortgage backed securities (“MBS”) had a carrying value of $2.6 million and $1.4 million at December 31, 2005 and 2004, respectively. At December 31, 2005 and 2004, approximately $0.7 million (or 29%) and $1.0 million (or 71%), respectively, of CMO and MBS holdings were fully collateralized by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. CMO and MBS securities are structured to allow the investor to determine, within certain limits, the amount of interest rate risk, prepayment risk and default risk that the investor is willing to accept. It is this level of risk that determines the degree to which the yields on CMO and MBS securities will exceed the yields that can be obtained from similarly rated corporate securities.
At December 31, 2005, ML of New York had 1,657 life insurance and annuity contracts inforce with interest rate guarantees. The estimated average rate of interest credited on behalf of contract owners was 4.14% and 4.35% during 2005 and 2004, respectively. Total investments and cash and cash equivalents supporting liabilities with interest rate guarantees had an estimated average effective yield of 4.33% and 4.13% during 2005 and 2004, respectively. The number of life insurance and annuity contracts inforce with interest rate guarantees decreased 196 (or 11%) as compared to 2004.
During 2005 asset-based policy fees increased $0.3 million (or 2%) while average variable account balances were relatively unchanged at $944.3 million as compared to 2004.
The impact of changes in medium term interest rates, corporate credit and credit spreads on market valuations for the years ended December 31 were as follows:
ML of New York’s liquidity requirements include the payment of sales commissions and other underwriting expenses and the funding of its contractual obligations for the life insurance and annuity contracts it has inforce. ML of New York has developed and utilizes a cash flow projection system and regularly performs asset / liability duration matching in the management of its asset and liability portfolios. ML of New York anticipates funding all its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. As of December 31, 2005 and 2004, ML of New York’s assets included $172.8 million and $186.4 million, respectively, of cash, short-term investments, and investment grade publicly traded available-for-sale securities that could be liquidated if funds were required.
The following table summarizes ML of New York’s contractual obligations as of December 31, 2005:
The long-term liabilities include the portion of future policy benefits for which ML of New York believes the amount and timing of the payments are essentially fixed and determinable. These amounts primarily relate to contracts where ML of New York is currently making payments to policyholders and will continue to do so until the occurrence of a specific event.
ML of New York receives claims paying ability ratings from Standard and Poors and A.M. Best. At December 31, 2005, ML of New York received ratings from Standard and Poors and A.M. Best of “A+” and “A”, respectively. These ratings were unchanged from the ratings at December 31, 2004.
Despite the reduction in fixed rate contracts inforce, net investment income was favorably impacted by an increase in asset yields during 2005 as compared to 2004.
Amortization of DAC increased $6.2 million to $7.0 million during 2005 as compared to $0.8 million in 2004 primarily as a result of period-to-period differences in DAC unlocking of $6.2 million as noted in the Critical Accounting Policies section above.
Insurance expenses and taxes increased $0.7 million (or 18%) to $4.7 million during 2005 as compared to $4.0 million in 2004. The following table provides the changes in insurance expenses and taxes by type:
Net realized investment gains decreased $0.5 million to $0.1 during 2004 as compared to $0.6 million in 2003. The following table provides the changes in net realized investment gains (losses) by type:
The decrease in interest related net realized gains is primarily due to decreased invested asset sales and decreases to asset market valuations resulting from the increasing interest rate environment during 2004 as compared to 2003.
The decrease in life insurance mortality expense is due to a decrease in net amount at risk per death claim.
Amortization of DAC decreased $4.0 million (or 83%) to $0.8 million during 2004 as compared to $4.8 million in 2003 primarily as a result of period-to-period differences in DAC unlocking as noted in the Critical Accounting Policies section above. Excluding DAC unlocking, amortization of DAC was relatively unchanged during 2004 as compared to 2003.
As noted in the Recent Developments section above, effective January 1, 2004, ML of New York adopted SOP 03-1 and recorded a cumulative change in accounting principle of $2.0 million, net of a federal income tax benefit of $1.1 million.
ML of New York’s operating results are categorized into two business segments: Life Insurance and Annuities. ML of New York’s Life Insurance segment consists of variable life insurance products and interest-sensitive life products. ML of New York’s Annuity segment consists of variable annuities and interest-sensitive annuities. The “Other” earnings category represents earnings on invested assets that do not support contract owner liabilities.
Earnings before change in accounting principle by segment were as follows:
During 2005 and 2004, ML of New York did not incur any OTT impairment losses on investments for either the Life Insurance or Annuity segments. The Annuity segment recorded $0.8 million of OTT impairment losses on investments in 2003.
ML of New York’s operations have not been materially impacted by inflation and changing prices during the preceding three years.