Premiums and contract charges under generally accepted accounting principles ("GAAP") increased slightly in 1997 and decreased 21.0% in 1996. Under GAAP, revenues exclude deposits on most annuity contracts and premiums on universal life insurance policies, and will vary with the mix of business sold during the period. In 1997, an increase in contract charges on universal life policies and variable annuity contracts was partially offset by a decrease in sales of life-contingent structured settlement annuities. The decrease in 1996 arose primarily from a fluctuation in the level of sales of structured settlement annuities sold with life contingencies. Provision for life and annuity contract benefits increased $7.1 million, or 4.1%, during 1997, and decreased $25.3 million, or 12.8%, during 1996. These changes resulted primarily from fluctuations in the level of sales of structured settlement annuities with life contingencies.
Pretax net investment income increased 10.7% in 1997 and 8.1% in 1996. The increases are due primarily to higher investment balances in each period. Investments, excluding Separate Account assets and unrealized gains on fixed income securities, grew 9.8% and 13.3% in 1997 and 1996, respectively. The increases in net investment income were partially offset by slightly lower portfolio yields. In low interest rate environments as have existed in 1997 and 1996, funds from maturing investments may be invested at substantially lower interest rates than which prevailed when the funds were previously invested, thereby reducing the average portfolio yield.
The composition of the investment portfolio at December 31, 1997 is presented in the table below (see Notes 2 and 4 to the financial statements for investment accounting policies and additional information).
(1) Fixed income securities are carried at fair value. Amortized cost for these securities was $1,510,110 at December 31, 1997.
Total investments increased to $1.91 billion at December 31, 1997 from $1.64 billion at December 31, 1996. The increase in the Company's investments was primarily due to increased unrealized capital gains of $123.5 million on fixed income securities and amounts invested from positive cash flows generated from operations.
At December 31, 1997 and 1996, $228.7 million and $194.2 million, respectively, of the fixed income securities portfolio were invested in mortgage-backed securities ("MBS"). At December 31, 1997, all of the MBS were investment grade and approximately 96% have underlying collateral that is guaranteed by U.S. government entities, thus credit risk was minimal.
The fixed income securities portfolio contained $39.7 million and $31.5 million of asset-backed securities ("ABS") at December 31, 1997 and 1996, respectively. ABS are subject to some of the same risks as MBS, but to a lesser degree because of the nature of the underlying assets. The Company attempts to mitigate these risks by primarily investing in highly-rated, publicly-traded, intermediate term ABS at or below par value. At December 31, 1997, the amortized cost of the ABS portfolio was below par value by $233 thousand. Over 43% of the Company's ABS are invested in securitized credit card receivables. The remainder of the portfolio is backed primarily by securitized manufactured housing, home equity and recreational vehicles.
The Company's $114.6 million investment in mortgage loans at December 31, 1997 is comprised primarily of loans secured by first mortgages on developed commercial real estate. Property type diversification is a key consideration used to manage the Company's mortgage loan risk.
The Company's short-term investment portfolio was $9.5 million and $25.9 million at December 31, 1997 and 1996, respectively. The Company invests available cash balances in taxable short-term securities having a final maturity date or redemption date of one year or less.
Separate Account assets and liabilities increased 18.4% from $260.7 million at December 31, 1996 to $308.6 million at December 31, 1997 due primarily to favorable investment performance of the Separate Account investment portfolios and sales of flexible premium deferred variable annuity contracts, partially offset by variable annuity contract surrenders and withdrawals.
The Company manages the interest rate risk inherent in its assets relative to the interest rate risk inherent in its liabilities. One of the measures the Company uses to quantify this exposure is duration. Duration measures the sensitivity of the fair value of assets and liabilities to changes in interest rates. For example, if interest rates increase 1%, the fair value of an asset with a duration of 5 years is expected to decrease in value by approximately 5%. At December 31, 1997, the difference between the Company's liability and asset duration was approximately 2.8 years. This duration gap indicates that the fair value of the Company's liabilities is more sensitive to interest rate movements than the fair value of its assets.
The Company seeks to invest premiums and deposits on universal life policies and investment contracts to create future cash flows that will fund future claims, benefits and expenses, and earn stable margins across a wide variety of interest rate and economic scenarios. In order to achieve this objective and limit its exposure to interest rate risk, the Company adheres to a philosophy of managing the duration of assets and related liabilities, and uses financial futures to hedge the interest rate risk related to anticipatory purchases and sales of investments and product sales to customers.
Based upon the information and assumptions the Company uses in its duration calculation and in effect at December 31, 1997, management estimates that a 100 basis point immediate, parallel increase in interest rates ("rate shock") would decrease the net fair value of its assets and liabilities identified above by approximately $16.8 million. The selection of a 100 basis point immediate rate shock should not be construed as a prediction by the Company's management of future market events; but rather, to illustrate the potential impact of such an event.
The NAIC has a standard for assessing the solvency of insurance companies, which is referred to as risk-based capital ("RBC"). The requirement consists of a formula for determining each insurer's RBC and a model law specifying regulatory actions if an insurer's RBC falls below specified levels. The RBC formula for life insurance companies establishes capital requirements relating to insurance, business, asset and interest rate risks. At December 31, 1997, RBC for the Company was significantly above a level that would require regulatory action.
The Company's principal sources of funds are collections of principal and interest from the investment portfolio and the receipt of premiums and deposits. The primary uses of these funds are to purchase investments and pay policyholder claims, benefits, contract maturities and surrenders, and operating costs.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive Income" and SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 130 requires the presentation of comprehensive income in the financial statements. Comprehensive income is a measurement of all changes in equity that result from transactions and other economic events other than transactions with stockholders. The requirements of this statement will be adopted effective January 1, 1998.
In December 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." The SOP provides guidance concerning when to recognize a liability for insurance-related assessments and how those liabilities should be measured. Specifically, insurance-related assessments should be recognized as liabilities when all of the following criteria have been met: a) an assessment has been imposed or it is probable that an assessment will be imposed, b) the event obligating an entity to pay an assessment has occurred and c) the amount of the assessment can be reasonably estimated. The requirements of this standard will be adopted in 1999 and are not expected to have a material impact on the results of operations, cash flows or financial position of the Company. The SOP is expected to be adopted in 1999.
Statements of Operations for the Years Ended December 31, 1997, 1996 and 1995.........................F-3
Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995.........................F-5
Schedule IV - Reinsurance for the Years Ended December 31, 1997, 1996 and 1995.........................F-22
We have audited the accompanying Statements of Financial Position of Allstate Life Insurance Company of New York (the "Company") as of December 31, 1997 and 1996, and the related Statements of Operations, Shareholder's Equity and Cash Flows for each of the three years in the period ended December 31, 1997. Our audits also included Schedule IV - Reinsurance and Schedule V - Valuation and Qualifying Accounts. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK STATEMENTS OF CASH FLOWS
Basis of presentation The accompanying financial statements include the accounts of Allstate Life Insurance Company of New York (the "Company"). The Company is wholly owned by a wholly owned subsidiary ("Parent") of Allstate Insurance Company ("AIC"), a wholly owned subsidiary of The Allstate Corporation (the "Corporation"). On June 30, 1995, Sears, Roebuck and Co. ( "Sears") distributed its 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend (the "Distribution"). These financial statements have been prepared in conformity with generally accepted accounting principles.
To conform with the 1997 presentation, certain amounts in the prior years' financial statements and notes have been reclassified.
Nature of operations The Company markets a broad line of life insurance and annuity products in the State of New York. Life insurance includes traditional products such as whole life and term life insurance, as well as universal life and other interest-sensitive life products. Annuities include deferred annuities, such as variable annuities and fixed rate single and flexible premium annuities, and immediate annuities such as structured settlement annuities. The Company distributes its products using a combination of Allstate agents which include life specialists, banks, independent agents, brokers and direct response marketing.
Structured settlement annuity contracts issued by the Company are long-term in nature and involve fixed guarantees relating to the amount and timing of benefit payments. Single and flexible premium deferred annuity contracts issued by the Company are subject to discretionary withdrawal or surrender by the customers, subject to applicable surrender charges. In a low interest rate environment, funds from maturing investments, particularly those supporting long-term structured settlement annuity obligations, may be reinvested at substantially lower interest rates than those which prevailed when the funds were previously invested.
Although the Company currently benefits from agreements with financial services entities who market and distribute its products, consolidation within that industry and specifically, a change in control of those entities with which the Company partners, could affect the Company's sales.
Mortgage loans are carried at outstanding principal balance, net of unamortized premium or discount and valuation allowances. Valuation allowances are established for impaired loans when it is probable that contractual principal and interest will not be collected. Valuation allowances for impaired loans reduce the carrying value to the fair value of the collateral or the present value of the loan's expected future repayment cash flows discounted at the loan's original effective interest rate. Valuation allowances on loans not considered to be impaired are established based on consideration of the underlying collateral, borrower financial strength, current and expected future market conditions, and other factors.
Investment income consists primarily of interest, which is recognized on an accrual basis. Interest income on mortgage-backed and asset-backed securities is determined on the effective yield method, based on estimated principal repayments. Accrual of income is suspended for fixed income securities and mortgage loans that are in default or when the receipt of interest payments is in doubt.
Realized capital gains and losses are determined on a specific identification basis.
Derivative financial instruments The Company utilizes futures contracts which are derivative financial instruments. When futures meet specific criteria they may be designated as accounting hedges and accounted for on a deferral basis, depending upon the nature of the hedge strategy and the method used to account for the hedged item.
If, subsequent to entering into a hedge transaction, the futures contract becomes ineffective (including if the hedged item is sold or otherwise extinguished or the occurrence of a hedged anticipatory transaction is no longer probable), the Company terminates the derivative position. Gains and losses on these terminations are reported in realized capital gains and losses in the period they occur. The Company may also terminate derivatives as a result of other events or circumstances. Gains and losses on these terminations are either deferred and amortized over the remaining life of either the hedge or the hedged item, whichever is shorter, or are reported in shareholder's equity, consistent with the accounting for the hedged item. Futures contracts must reduce the primary market risk exposure on an enterprise basis in conjunction with the hedge strategy; be designated as a hedge at the inception of the transaction; and be highly correlated with the fair value of, or interest income or expense associated with, the hedged item at inception and throughout the hedge period.
Recognition of premium revenues and contract charges Premiums for traditional life insurance are recognized as revenue when due. Accident and disability premiums are earned on a pro rata basis over the policy period. Revenues on interest-sensitive life insurance policies are comprised of contract charges and fees, and are recognized when assessed against the policyholder account balance. Revenues on most annuities, which are considered investment contracts, include contract charges and fees for contract administration and surrenders. These revenues are recognized when levied against the contract balance. Gross premium in excess of the net premium on limited payment contracts, primarily structured settlement annuities when sold with life contingencies, are deferred and recognized over the contract period.
Income taxes The income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are insurance reserves and deferred acquisition costs. Deferred income taxes also arise from unrealized capital gains and losses on fixed income securities carried at fair value.
Contractholder funds Contractholder funds arise from the issuance of individual or group policies and contracts that include an investment component, including most annuities and universal life policies. Payments received are recorded as interest-bearing liabilities. Contractholder funds are equal to deposits received and interest credited to the benefit of the contractholder less withdrawals, mortality charges and administrative expenses. Credited interest rates on contractholder funds ranged from 3.30% to 9.75% for those contracts with fixed interest rates and from 3.25% to 7.75% for those with flexible rates during 1997.
Reinsurance The Company cedes business to the Parent under reinsurance treaties to limit aggregate and single exposures on large risks. Premiums and policy benefits ceded totaled $2,171 and $327 in 1997, $1,383 and $1,662 in 1996, and $1,259 and $278 in 1995, respectively. Included in the reinsurance recoverable at December 31, 1997 and 1996 are amounts due from the Parent of $342 and $965, respectively.
The Company had no impaired loans at December 31, 1997 and 1996. The net carrying value of impaired loans at December 31, 1995 was $9,647, measured at the fair value of the collateral. The total investment in impaired mortgage loans before valuation allowance at December 31, 1995 was $11,581 and the related allowance on these impaired loans was $1,934.
(% of municipal bond portfolio carrying value) 1997 1996 ---- ----
(% of commercial mortgage portfolio carrying value) 1997 1996 ---- ----
The types of properties collateralizing the commercial mortgage loans at December 31, are as follows:
The contractual maturities of the commercial mortgage loan portfolio as of December 31, 1997, for loans that were not in foreclosure are as follows:
Number of Loans Carrying Value Percent --------------- --------------- ------- 1999 3 $ 5,302 4.6% 2000 4 7,927 6.9 2001 5 7,340 6.4 2002 2 6,385 5.6 Thereafter 23 87,673 76.5 ----- --------------- ------ Total 37 $ 114,627 100.0% ===== =============== ======
In 1997, $7.3 million of commercial mortgage loans were contractually due. Of these, 20.9% were paid as due and 79.1% were refinanced at prevailing market terms.
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK NOTES TO FINANCIAL STATEMENTS--(CONTINUED) ($ IN THOUSANDS)
Carrying value and fair value include the effects of derivative financial instruments where applicable.
The following table summarizes the contract or notional amount, credit exposure, fair value and carrying value of the Company's derivative financial instruments:
The Company manages its exposure to credit risk by utilizing highly rated counterparties, establishing risk control limits, executing legally enforceable master netting agreements and obtaining collateral where appropriate. To date, the Company has not incurred any losses on derivative financial instruments due to counterparty nonperformance.
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. Market risk exists for all of the derivative financial instruments that the Company currently holds, as these instruments may become less valuable due to adverse changes in market conditions. The Company mitigates this risk through established risk limits set by senior management. In addition, the change in the value of the Company's derivative financial instruments designated as hedges are generally offset by the change in the value of the related assets and liabilities.
The components of income tax expense for the year ended December 31, are as follows:
The Company paid income taxes of $13,350, $11,968 and $12,096 in 1997, 1996 and 1995, respectively. The Company had an income tax payable of $1,419 at December 31, 1997 and an income tax recoverable of $105 at December 31, 1996.
The following tables reconcile net income for the year ended December 31, and shareholder's equity at December 31, as reported herein in conformity with generally accepted accounting principles with statutory net income and capital and surplus, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities:
Balance per generally accepted accounting principles $ 22,716 $ 20,561 $ 19,522 Deferred acquisition costs (10,782) (6,858) (5,537) Deferred income taxes (1,578) 257 (2,677) Statutory reserves 7,749 6,101 11,380 Other postretirement and postemployment benefits (36) (34) 71 Other 522 (1,882) 441 -------- -------- -------- Balance per statutory accounting practices $ 18,591 $ 18,145 $ 23,200 ======== ======== ========
Pension plans Defined benefit pension plans, sponsored by the Corporation, cover domestic full-time employees and certain part-time employees. Benefits under the pension plans are based upon the employee's length of service, average annual compensation and estimated social security retirement benefits. The Corporation's funding policy for the pension plans is to make annual contributions in accordance with accepted actuarial cost methods. The costs to the Company included in net income were $597, $490 and $446 for the pension plans in 1997, 1996 and 1995, respectively.
Postretirement benefits other than pensions The Corporation provides certain health care and life insurance benefits for retired employees. Qualified employees may become eligible for these benefits if they retire in accordance with the Corporation's established retirement policy and are continuously insured under the Corporation's group plans or other approved plans for 10 or more years prior to retirement. The Corporation shares the cost of the retiree medical benefits with retirees based on years of service, with the Corporation's share being subject to a 5% limit on annual medical cost inflation after retirement. The Corporation's postretirement benefit plans currently are not funded. The Corporation has the right to modify or terminate these plans.
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK SCHEDULE IV--REINSURANCE ($ IN THOUSANDS)
Gross Net Year Ended December 31, 1997 Amount Ceded Amount - ---------------------------- ------ ----- ------
Life insurance in force $11,339,990 $ 721,040 $10,618,950 =========== =========== ===========
Gross Net Year Ended December 31, 1996 Amount Ceded Amount - ---------------------------- ------ ----- ------
Life insurance in force $ 8,513,295 $ 398,025 $ 8,115,270 =========== =========== ===========
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS ($ IN THOUSANDS)
By /s/ MICHAEL J. VELOTTA ---------------------- Michael J. Velotta Vice President, Secretary and General Counsel
By */s/ MARLA G. FRIEDMAN ---------------------- Marla G. Friedman Vice President and Director
By */s/ TIMOTHY H. PLOHG ---------------------- Timothy H. Plohg Vice President and Director