The discussion in this Form 10-K may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends these forward-looking statements to be covered by the safe harbor provisions of the federal securities laws relating to forward-looking statements. These include statements relating to trends in, or representing management’s beliefs about, the Company’s future strategies, operations and financial results, as well as other statements including, but not limited to, words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “may,” “should” and other similar expressions. Forward-looking statements are made based upon management’s current expectations and beliefs concerning trends and future developments and their potential effects on the Company. They are not guarantees of future performance. Actual results may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties which include, among others: (i) changes in general economic conditions, including changes in interest rates and the performance of financial markets; (ii) heightened competition, including with respect to pricing, entry of new competitors and the development of new products and services by new and existing competitors; (iii) regulatory, accounting or tax developments that may affect the Company or the cost of, or demand for, its products or services; (iv) downgrades in the financial strength ratings of the Company; (v) discrepancies between actual claims or investment experience and assumptions used in setting prices for the Company’s products and establishing the Company’s liabilities for future policy benefits and claims relating to such products; (vi) movements in the equity markets that affect our investment results, the fees we earn from funds on deposit and the demand for our variable products; (vii) the Company’s continued success in achieving planned expense reductions; (viii) the effects of closing the Company’s affiliated retail brokerage operations; and (ix) other risks and uncertainties described in any of the Company’s filings with the SEC. The Company undertakes no obligation to update or revise publicly any forward-looking statement, whether as a result of new information, future events or otherwise.
We are a manufacturer of insurance and annuity products for the accumulation, preservation and transfer of wealth. We provide products and services to affluent and high-net-worth individuals through their advisors. We offer a broad range of life insurance and annuity products, including universal, variable universal, term life insurance, and a range of variable annuity offerings and services through a variety of distributors. These distributors include independent advisors and financial services firms who make our products and services available to their clients.
Securitized Financial Instruments. Effective April 1, 2001, we adopted Emerging Issues Task Force Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (“EITF 99-20”). This pronouncement requires investors in certain asset-backed securities to record changes in their estimated yield on a prospective basis and to apply specific valuation methods to these securities to determine of there has been an other-than-temporary decline in value. We had no change in net income as a result of this accounting change.
The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The amortization of deferred acquisition costs requires the use of various assumptions, estimates and judgments about the future. Significant assumptions include those concerning expenses, investment performance, mortality and policy cancellations (i.e., lapses, withdrawals and surrenders). These assumptions are reviewed on a regular basis and are generally based on our past experience, industry studies, regulatory requirements and judgments about the future. Changes in estimated gross margins and gross profits based on actual experiences are reflected as an adjustment to total amortization to date resulting in a charge or credit to earnings. Finally, analyses are performed periodically to assess whether there are sufficient gross margins or gross profits to amortize the remaining deferred acquisition cost balances.
See Note 3 to our financial statements in this Form 10-K for more information.
As of December 31, 2005, we had deferred tax assets of $7.9 million related to $22.8 million of net operating losses for federal income tax purposes. The losses are scheduled to expire in 2017.
Our federal income tax returns are routinely audited by the IRS and estimated provisions are routinely provided in the financial statements in anticipation of the results of these audits. The IRS has examined our consolidated group’s federal income tax returns through 2001. The IRS is currently examining our federal income tax returns for 2002 and 2003. While it is often difficult to predict the outcome of these audits, including the timing of any resolution of any particular tax matter, we believe that our reserves, as recorded in other liabilities on the balance sheet, are adequate for all open tax years. Unfavorable resolution of any particular issue could result in additional use of cash to pay liabilities that would be deemed owed to the IRS. Additionally, any unfavorable or favorable resolution of any particular issue
At December 31, 2005, our Total Adjusted Capital level was in excess of 300% of Company Action Level.
$2,789.5 million, represented 99.7% of total general account investments. Public debt securities represented 85.5% of total debt securities, with the remaining 14.5% represented by private debt securities.
months. This analysis is provided for investment grade and non-investment grade securities and closed block and outside of closed block securities. Using this analysis, coupled with our watch list, we review all securities whose fair value is less than 80% of amortized cost (significant unrealized loss) with emphasis on below investment grade securities with a continuous significant unrealized loss in excess of six months. In addition, we review securities that had experienced lesser percentage declines in value on a more selective basis to determine if a security is other-than-temporarily impaired.
The following table presents certain information with respect to our gross unrealized losses related to our investments in general account debt securities. Applicable DAC and deferred income taxes reduce the effect of these losses on our comprehensive income.
For debt securities with gross unrealized losses, 87.0% of the unrealized losses after offsets pertain to investment grade securities and 13.0% of the unrealized losses after offsets pertain to below investment grade securities at December 31, 2005.
annuities and deposit funds. These are liabilities in our financial statements prepared in conformity with statutory accounting practices. These amounts are at least equal to the values available to be withdrawn by policyholders.
Individual life insurance policies, other than term life insurance policies, increase in cash values over their lives. Policyholders have the right to borrow an amount generally up to the cash value of their policies at any time. As of December 31, 2005, we had approximately $249.4 million in cash values with respect to which policyholders had rights to take policy loans. The majority of cash values eligible for policy loans are at variable interest rates that are reset annually on the policy anniversary. Policy loans at December 31, 2005 were $8.2 million.
The Connecticut Insurance Holding Company Act limits the maximum amount of annual dividends and other distributions in any 12-month period to stockholders of Connecticut domiciled insurance companies without prior approval of the Insurance Commissioner. Under current law, we cannot make any dividend distribution during 2006 without prior approval.
As of December 31, 2005, we did not have any significant off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K.
Premiums increased 29% in 2005 over 2004 due to higher sales of our term life insurance products.
Insurance and investment product fees increased 31% in 2005 over 2004 due to higher sales of universal life products in 2005. We experienced a significant increase in large estate and business planning cases, some of which involved the use of non-recourse premium financing. In the first quarter of 2006 we affirmed our position that we will not accept sales of policies that employ this type of premium financing and do not contain strong evidence of insurance need and an insurable interest. We believe our vigilance in monitoring this activity, along with regulatory developments in this area,may impact sales but expect the overall trend in life sales to remain positive in 2006.
Amortization of deferred policy acquisition costs increased 79% in 2005 over 2004 due primarily to higher DAC balances, improved investment margins for annuities and the effects of an adjustment or “unlocking” of assumptions. The unlocking was driven by revised assumptions regarding mortality experience offset by interest rate and spread adjustments for annuities.
Other operating expenses increased 42% in 2005 over 2004 as a result of higher commissions, expenses and premium taxes driven by the increase in universal life new business.
Insurance and investment product fees increased 27% in 2004 over 2003 primarily due to growth in fee-based funds on deposit. In addition, fee revenue from our assumed variable universal life and variable annuity blocks of business increased over the prior year.
Premiums increased 33% in 2003 over 2002 due primarily to higher sales of our term life insurance products.
Net investment income increased 44% in 2003 over 2002 primarily due to an increase in invested assets related to the guaranteed interest account portion of our annuity business. See policy benefit discussion below for additional information on average account balances.
Amortization of deferred policy acquisition costs decreased 14% in 2003 from 2002. The decrease resulted from a revision of the long-term market performance assumption and an impairment charge related to the recoverability of the deferred acquisition cost asset of the variable annuity business, both of which occurred in 2002 and did not recur in 2003. This decrease was partially offset by an increase in amortization for universal life and term business from the growth in life insurance inforce.
Premiums decreased 15% in 2002 over 2001 primarily due to a shift in life insurance sales from term products to universal life products.
Other operating expenses increased by 79% for 2002. The increase is primarily due to growth in new business and to lower deferred expenses resulting from lower expected future margins on the guaranteed interest account portion of our annuity business.
The increase in net investment income of 237% in 2001 over 2000 was primarily due to higher average invested assets supporting the growth in variable annuity business.
Amortization of deferred policy acquisition costs decreased 46% in 2001, primarily due to a non-recurring adjustment to deferred policy acquisition costs in 2000 related to term insurance.