The most important factors we monitor to evaluate the financial condition and performance of our Company include:
- For financial condition: our financial strength ratings, operating leverage, debt leverage and return on equity.
We are responsible for the determination of fair value and the supporting assumptions and methodologies. We employ independent third party pricing servicers to gather, analyze, and interpret market information and derive fair values based upon relevant assumptions and methodologies for each applicable security. In situations where sufficient market observable information is not available for a particular security through the sources as agreed to with us, no quote is provided by the service providers. For these securities, fair value is determined either by requesting brokers who are knowledgeable about these securities to provide a quote or we internally determine fair values employing widely accepted pricing valuation models. Changing market conditions in the fourth quarter of 2007, were incorporated into valuation assumptions and reflected in the fair values, which were validated by calibration and other analytical techniques to available market observable data.
Third party pricing servicers consolidate market transactions and other key valuation model inputs from multiple sources and provide pricing information in the form of a single fair value for each security for which a fair value request is agreed. Fair values provided are derived from their proprietary pricing models. The sources used by these servicers include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads, currency rates, and other market-observable information as applicable, as well as widely accepted valuation models developed on a proprietary basis. Their proprietary pricing models are based on discounted cashflow methodology and they may take into account, among other things, market observable information as of the measurement date from the sources described above; and the specific attributes of the security being valued including its term, interest rate and credit rating (consistent with those we use to report our holdings by credit rating); industry sector, and where applicable, collateral quality and other issue or issuer specific information. To operate these models effectively requires seasoned professional judgment and experience. In the cases where market transactions or other market observable data is limited, the degree of judgment varies with the availability of market observable information.
The fair value of securities such as privately-placed securities, where our pricing servicers or brokers cannot provide fair value determinations, is determined using widely accepted valuation methods and models. These internally developed models are appropriate for each class of security, involve some degree of judgment, and include inputs that may not be market observable.
The following table identifies those investments carried at fair value as of December 31, 2007 by method of determination:
For investments classified as available for sale, the difference between fair value and amortized cost, net of certain other items and deferred income taxes (as disclosed in Note 6), is reported as a component of accumulated other comprehensive income on the Statements of Financial Position and is not reflected in the operating results of any period until reclassified to net income upon the consummation of a transaction with an unrelated third party or when declines in fair values are deemed other-than-temporary. The assessment of other-than-temporary impairment of a security's fair value is performed on a portfolio review as well as a case-by-case basis considering a wide range of factors.
For our portfolio review evaluations, we ascertain whether there are any approved programs involving the disposition of investments such as changes in duration, revision to strategic asset allocations and liquidity actions, as well as any dispositions anticipated by the portfolio managers. In these instances, we recognize impairment on securities designated as subject to these approved anticipated actions if the security is in an unrealized loss position. There are a number of assumptions and estimates inherent in evaluating impairments and determining if they are other-than-temporary, including 1) our ability and intent to hold the investment for a period of time sufficient to allow for an anticipated recovery in value; 2) the expected recoverability of principal and interest; 3) the length of time and extent to which the fair value has been less than amortized cost; 4) the financial condition, near-term and long-term prospects of the issuer, including relevant industry conditions and trends, and implications of rating agency actions and offering prices; and 5) the specific reasons that a security is in a significant unrealized loss position, including market conditions which could affect liquidity. Additionally, once assumptions and estimates are made, any number of changes in facts and circumstances could cause us to subsequently determine that an impairment is other-than-temporary, including 1) general economic conditions that are worse than previously forecasted or that have a greater adverse effect on a particular issuer or industry sector than originally estimated; 2) changes in the facts and circumstances related to a particular issue or issuer's ability to meet all of its contractual obligations; and 3) changes in facts and circumstances or new information obtained which causes a change in our ability or intent to hold a security to maturity or until it recovers in value. Changes in assumptions, facts and circumstances could result in additional charges to earnings in future periods to the extent that losses are realized. The charge to earnings, while potentially significant to net income, would not have a significant effect on shareholder's equity since the majority of our portfolio is designated as available-for -sale and carried at fair value and as a result, any related net unrealized loss would already be reflected as a component of accumulated other comprehensive income in shareholder's equity.
DAC related to interest-sensitive life and annuities is amortized in proportion to the incidence of the total present value of gross profits, which includes both actual historical gross profits ("AGP") and estimated future gross profits ("EGP") expected to be earned over the estimated lives of the contracts. The amortization is net of interest on the prior period DAC balance using rates established at the inception of the contracts. Actual amortization periods range from 15-30 years; however, incorporating estimates of customer surrender rates, partial withdrawals and deaths generally results in the majority of the DAC being amortized during the surrender charge period. The cumulative DAC amortization is reestimated and adjusted by a cumulative charge or credit to results of operations when there is a difference between the incidence of actual versus expected gross profits in a reporting period or when there is a change in total EGP.
Over the past three years, our most significant DAC assumption updates that resulted in a change to EGP and the amortization of DAC have been revisions to expected future investment returns, expenses, mortality and in-force or persistency assumptions resulting in net DAC amortization acceleration of $5.8 million in 2007, net DAC amortization deceleration of $146 thousand in 2006, and net DAC amortization deceleration of $7.5 million in 2005. The 2005 amortization deceleration included $4.3 million related to our subsequently disposed variable annuity business for which we no longer have any DAC.
For further discussion of these polices, see Note 8 of the financial statements and the Forward-looking Statements and Risk Factors section of this document.
OVERVIEW AND STRATEGY We are a wholly owned subsidiary of Allstate Life Insurance Company ("ALIC"), which is a wholly owned subsidiary of Allstate Insurance Company ("AIC"), a wholly owned subsidiary of The Allstate Corporation (the "Corporation"). We provide life insurance, retirement and investment products, and voluntary accident and health insurance to individual customers. Our mission is to reinvent retirement and protection for the middle market consumer.
To achieve our mission and reach our financial goals, our primary objectives are to deepen financial services relationships with Allstate customers and build consumer-driven innovation capabilities and culture. We will continue to drive scale through non-proprietary distribution channel relationships and leverage future innovations across those channels. We will also enhance our operational excellence. In addition to focusing on higher return markets, products, and distribution channels, we will improve our financial performance through capital efficiency and enterprise risk and return management capabilities and practices.
We plan to continue offering a suite of products that provides financial protection primarily to middle market consumers and help them better prepare for retirement. Our products include fixed annuities, including deferred, and immediate; interest-sensitive, traditional and variable life insurance; and voluntary accident and health insurance. Our products are sold through several distribution channels including Allstate exclusive agencies, which include exclusive financial specialists, independent agents (including master brokerage agencies and workplace enrolling agents), and financial service firms such as banks, broker-dealers and specialized structured settlement brokers.
Summarized financial data for the years ended December 31, is presented in the following table.
ANALYSIS OF REVENUES Total revenues increased 3.2% or $15.8 million in 2007 compared to 2006, due to lower net realized capital losses and higher net investment income, partially offset by lower premiums and contract charges. Total revenues increased 2.7% or $12.9 million in 2006 compared to 2005, due to higher premiums and net investment income, partially offset by higher net realized capital losses and lower contract charges.
(IN THOUSANDS) 2007 2006 2005 -------- -------- -------- PREMIUMS Traditional life $ 24,997 $ 24,298 $ 26,067 Immediate annuities with life contingencies 37,491 54,877 38,322 Accident and health, and other 6,636 5,138 4,149 -------- -------- -------- TOTAL PREMIUMS 69,124 84,313 68,538 CONTRACT CHARGES Interest-sensitive life 51,155 46,448 42,315 Fixed annuities 8,375 8,851 7,237 Variable annuities -- 8,127 16,728 -------- -------- -------- TOTAL CONTRACT CHARGES(1) 59,530 63,426 66,280 -------- -------- -------- TOTAL PREMIUMS AND CONTRACT CHARGES $128,654 $147,739 $134,818 ======== ======== ========
- ---------- (1) Contract charges for 2007, 2006 and 2005 include contract charges related to the cost of insurance totaling $35.2 million, $32.2 million and $33.2 million, respectively.
Contract charges decreased 4.3% in 2006 compared to 2005. Excluding contract charges on variable annuities, contract charges increased 11.6% in 2006 compared to 2005. The increase was due to higher contract charges on interest-sensitive life products resulting from growth of business in force, and increased contract charges on fixed annuities due to increased surrender charges.
Contractholder deposits decreased 33.2% in 2007 compared to 2006 due to lower deposits on fixed annuities and the classification of the net change in variable annuity contractholder funds as "other adjustments" subsequent to the effective date of our reinsurance agreement with Prudential. The decline of 37.8% in fixed annuity deposits in 2007 compared to 2006 was due to our strategy to raise new business returns for these products combined with lower industry-wide fixed annuity sales. The decline in variable annuity and life deposits allocated to fixed accounts was due to the reinsured variable annuity business. Subsequent to the reinsurance of our variable annuity business effective June 1, 2006, the net change in contractholder funds attributable to variable annuities is included as a component of the "other adjustments" line in the table above.
Contractholder deposits decreased 8.9% in 2006 compared to 2005 due primarily to lower variable annuity and life deposits allocated to fixed accounts due to the reinsured variable annuity business. Also contributing to the decline were lower deposits on fixed annuities due to lower deposits on traditional deferred annuities and market value adjusted annuities, partially offset by a $42.2 million increase in deposits on Allstate(R) Treasury-Linked Annuity contracts. Lower deposits on traditional deferred annuities and market value adjusted annuities were primarily attributable to our actions to improve new business returns and reduced consumer demand. Consumer demand for fixed annuities is influenced by market interest rates on short-term deposit products and equity market conditions, which can increase the relative attractiveness of competing investment alternatives.
Surrenders and partial withdrawals decreased 12.5% in 2007 compared to 2006. This decline was due to the classification of the net change in variable annuity contractholder funds as "other adjustments" subsequent to the effective date of our reinsurance agreements with Prudential and, to a lesser extent, a decline in surrenders and partial withdrawals on fixed annuities. Surrenders and partial withdrawals for 2006 include $30.5 million related to the reinsured variable annuity business. The surrender and partial withdrawal rate on deferred fixed annuities and interest-sensitive life insurance products, based on the beginning of period contractholder funds, was 8.5% in 2007 compared to 10.1% in 2006.
Surrenders and partial withdrawals increased 33.9% in 2006 compared to 2005, while the surrender and partial withdrawal rate increased to 10.1% for 2006 from 8.3% for 2005. The increase in the surrender rate in 2006 was influenced by multiple factors, including the relatively low interest rate environment during the preceding years, which reduced reinvestment opportunities and increased the number of policies with little or no surrender charge protection. Also influencing the increase were our crediting rate strategies related to renewal business implemented to improve investment spreads on selected contracts.
NET INVESTMENT INCOME increased 3.7% in 2007 compared to 2006 and 4.7% in 2006 compared to 2005. The increase in both periods was primarily due to higher average portfolio balances. Higher average portfolio balances in both years resulted from the investment of cash flows from operating and financing activities related primarily to deposits on fixed annuities and interest-sensitive life policies.
REALIZED CAPITAL GAINS AND LOSSES reflected net losses of $831 thousand, $22.1 million and $5.2 million in 2007, 2006 and 2005, respectively. For further discussion of realized capital gains and losses, see the Investments section of MD&A.
ANALYSIS OF COSTS AND EXPENSES Total costs and expenses increased 3.3% or $14.4 million in 2007 compared to 2006 due to higher amortization of DAC and interest credited to contractholder funds, partially offset by lower contract benefits and operating costs and expenses. Total costs and expenses increased 1.3% or $5.6 million in 2006 compared to 2005 due to higher contract benefits, interest credited to contractholder funds and operating costs and expenses, partially offset by lower amortization of DAC.
Contract benefits increased 4.0% or $7.3 million in 2006 compared to 2005 due primarily to higher sales of immediate annuities with life contingencies as well as higher implied interest on immediate annuities with life contingencies, partially offset by the accrual in 2005 of additional variable annuity contract benefits related to a regulatory matter and the absence in 2006 of contract benefits related to the reinsured variable annuity business in the period subsequent to the effective date of the reinsurance agreement. The implied interest on immediate annuities with life contingencies totaled $103.9 million and $101.0 million in 2006 and 2005, respectively.
(IN THOUSANDS) 2007 2006 2005 ------- ------- -------- Life insurance $28,820 $27,536 $ 34,558 Annuities 1,243 2,338 (15,075) ------- ------- -------- Total benefit spread $30,063 $29,874 $ 19,483 ======= ======= ========
- ---------- (1) Amortization of DAC before amortization relating to realized capital gains and losses and changes in assumptions for 2006 and 2005 includes $(4.6) million and $(9.8) million, respectively, relating to the reinsured variable annuity business.
(2) Amortization relating to realized capital gains and losses for 2006 and 2005 includes $11.9 million and $(1.2) million, respectively, relating to the reinsured variable annuity business.
The increase of 68.7% in the amortization of DAC in 2007 compared to 2006 was in part due to the impact of the reinsured variable annuity business. Excluding the impact of the reinsured variable annuity business, amortization of DAC increased 37.2% or $14.5 million in 2007 compared to 2006 due primarily to an increase in amortization acceleration on fixed annuities resulting from our annual comprehensive review of DAC assumptions (commonly referred to as "DAC unlocking") and higher gross profits on fixed annuities.
The decrease in amortization of DAC in 2006 compared to 2005 was due to the impact of the reinsured variable annuity business, which for 2006 reflected a credit to income of $7.3 million compared to a charge to income of $6.7 million for 2005. Excluding the impact of the reinsured variable annuity business, DAC amortization increased 11.6% or $4.0 million in 2006 compared to 2005 due to higher gross profits on fixed annuities.
The DAC asset was reduced by $79.7 million in 2006 as a result of the disposition of our variable annuity business. The changes in the DAC asset are summarized in the following tables.
- ---------- (1) The adoption of 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"), resulted in a $1.0 million after-tax adjustment to unamortized DAC related to the impact on future estimated gross profits from the changes in accounting for certain costs associated with contract continuations that no longer qualify for deferral under SOP 05-1. The adjustment was recorded as a reduction of retained income at January 1, 2007 and a reduction of the DAC balance of $1.6 million, pretax.
(2) Included as a component of amortization of DAC on the Statements of Operations and Comprehensive Income.
OPERATING COSTS AND EXPENSES decreased 19.2% or $9.0 million in 2007 compared to 2006. This decrease was attributable to the absence in 2007 of expenses related to the reinsured variable annuity business, lower restructuring and employee benefit related expenses, decreased insurance department assessments and lower non-deferrable commissions, partially offset by an increased investment in technology. Subsequent to the effective date of the reinsurance agreement for the variable annuity business, operating costs and expenses benefited from a servicing fee paid by Prudential for our servicing of the business during a 24 month or less transition period following the effective date of the reinsurance agreement.
Operating costs and expenses increased 7.1% or $3.1 million in 2006 compared to 2005. The increase in 2006 was attributable to higher guaranty fund assessments, restructuring charges and employee benefit expenses, partially offset by the absence of expenses related to the reinsured variable annuity business in the period subsequent to the effective date of the reinsurance agreement, and lower technology related expenses.
INCOME TAX EXPENSE increased by 28.4% or $5.0 million in 2007 compared to 2006 and decreased by 15.2% or $3.2 million in 2006 compared to 2005. The increase in 2007 compared to 2006 was due to increased income from operations before income tax expense and, to a lesser extent, an increase in the effective tax rate. The decrease in 2006 compared to 2005 was due to a decline in the effective tax rate and lower income from operations before income tax expense.
REINSURANCE CEDED We enter into reinsurance agreements with ALIC and unaffiliated reinsurers to limit our risk of mortality and morbidity losses and re-investment risk. In addition, the Company has used reinsurance to effect the acquisition or disposition of certain blocks of business. We retain primary liability for all risks reinsured.
REINSURANCE S&P FINANCIAL RECOVERABLE ON PAID (IN THOUSANDS) STRENGTH RATING AND UNPAID CLAIMS --------------- ------------------- 2007 2006 -------- -------- Prudential Insurance Company of America AA $353,948 $415,709 Transamerica Financial Life Insurance AA 13,335 9,321 RGA Reinsurance Company AA- 5,082 4,262 Allstate Life Insurance Company AA 3,649 2,437 Triton Insurance Company NR 950 1,614 Security Life of Denver AA 780 638 Generali USA A 763 722 Canada Life AA 745 549 Swiss Re Life and Health America, Inc. AA- 743 713 American United Life AA- 675 634 Scottish Re Group BB+ 461 531 Minnesota Mutual AA- 96 87 Cologne Re AAA 88 130 Metropolitan Life AA 64 75 Mutual of Omaha AA- 52 -- -------- -------- Total $381,431 $437,422 ======== ========
We continuously monitor the creditworthiness of reinsurers in order to determine our risk of recoverability on an individual and aggregate basis, and a provision for uncollectible reinsurance is recorded if needed. No amounts have been deemed unrecoverable in the three years ended December 31, 2007.
- - We expect operating costs and expenses to increase over the prior year as a result of increased spending for the development of innovative products, additional marketing and growth of our Allstate exclusive agency distribution channel as well as a reduction in the variable annuity servicing fee from Prudential. We expect that these expense increases will be partially mitigated by our continuing focus on operating efficiency.
- - We plan to balance targeted new business return improvement with investments in growth initiatives and sales. Initially, investments in growth are expected to slow the improvement of returns and may reduce the price competitiveness of certain products, such as our fixed annuities, and slow or reduce the growth in sales and net income.
Our investment strategy has historically focused on the need for risk-adjusted spread to support the underlying liabilities to achieve return on capital and profitable growth. We believe investment spread is maximized by selecting assets that perform favorably on a long-term basis and by disposing of certain assets to minimize the effect of downgrades and defaults. We believe this strategy maintains the investment spread necessary to sustain income over time. The portfolio management approach employs a combination of recognized market, analytical and proprietary modeling, including a strategic asset allocation model, as the primary basis for the allocation of interest sensitive, illiquid and credit assets as well as for determining overall below investment grade exposure and diversification requirements. Within the ranges set by the strategic asset allocation model, tactical investment decisions are made in consideration of prevailing market conditions. We will be adding a total return framework to the management of our assets to further enhance long-term returns and leverage our active management capabilities.
- ---------- (1) Fixed income securities are carried at fair value. Amortized cost basis for these securities was $5.93 billion.
Total investments increased to $7.06 billion at December 31, 2007 from $6.78 billion at December 31, 2006, primarily due to positive cash flows from operating and financing activities.
During 2007, certain financial markets experienced decreased liquidity. This was particularly evident in the markets for securities collateralized by sub-prime residential mortgages. We experienced this illiquidity particularly in our asset-backed residential mortgage-backed securities ("ABS RMBS") and Alt-A residential mortgage-backed securities ("Alt-A") and commercial real estate collateralized debt obligations ("CRE CDO") portfolios. These portfolios totaled $138.0 million or less than 2% of our total investments at December 31, 2007. Certain other asset-backed and real estate-backed securities markets experienced illiquidity, but to a lesser degree.
The fair values of securities comprising the illiquid portfolios are obtained from our contracted third-party pricing servicers and brokers. We evaluated the reasonableness of the fair value of these portfolios as of December 31, 2007 by comparing vendor prices to alternative third-party pricing and valuation servicers, both of which consider available market information including, but not limited to, collateral quality, anticipated cash flows, credit enhancements, default rates, loss severities, and credit ratings from rating agencies. In addition, we also considered the reasonableness of security values based upon the securities' relative position within their respective capital structures in determining the reasonableness of fair values, on a portfolio basis, for the above referenced securities as of December 31, 2007.
of our ARS holdings as of March 13, 2008 for which we are currently receiving the maximum rate. We anticipate that failed auctions may persist. Auctions will continue to be conducted as scheduled for each of the securities. While these developments continue in the market, par value of these holdings may not be representative of the fair value of these securities. Accordingly, subsequent auctions could be more successful resulting in interest rates being more in line with the 7, 28 or 35 day reset periods.
The Company's portfolio of privately placed securities are broadly diversified by issuer, industry sector, and by country. The portfolio is made up of approximately 210 issues with an average security value of approximately $7.2 million. Privately placed corporate obligations generally benefit from increased yields and structural security features such as financial covenants and call protections that provide investors greater protection against credit deterioration, reinvestment risk or fluctuations in interest rates than those typically found in publicly registered debt securities. Additionally, investments in these securities are made after extensive due diligence of the issuer, typically including direct discussions with senior management and on-site visits to company facilities. Ongoing monitoring includes direct periodic dialog with senior management of the issuer and continuous monitoring of operating performance and financial position. Every issue is internally rated with a formal rating affirmation once a year.
FOREIGN GOVERNMENT securities totaled $333.5 million and all were rated investment grade at December 31, 2007.
FAIR % TO TOTAL (IN THOUSANDS) VALUE INVESTMENTS AAA -------- ----------- ----- MBS U.S. Agency $341,446 4.8% 100.0% Prime 49,334 0.7 100.0 Alt-A 28,837 0.4 100.0 -------- --- Total MBS $419,617 5.9% ======== ===
The following table shows CMBS by type and Moody's equivalent rating at December 31, 2007.
CRE CDO are investments secured primarily by commercial mortgage-backed securities and other commercial mortgage debt obligations. These securities are generally less liquid and have a higher risk profile than other commercial mortgage-backed securities. Fair value represents 97.6% of the amortized cost of these securities. At December 31, 2007, CRE CDO had gross unrealized losses of $5.2 million and no gross unrealized gains. In addition to the quality of the loans and securities collateralizing the CRE CDOs, influential factors in our analysis are the adequacy of subordination and strength of the CRE CDO management team.
ASSET-BACKED SECURITIES ("ABS") totaled $106.9 million and 99.6% were rated investment grade at December 31, 2007. Credit risk is managed by monitoring the performance of the collateral. In addition, many of the securities in the ABS portfolio are credit enhanced with features such as over-collateralization, subordinated structures, reserve funds, guarantees and/or insurance. A portion of the ABS portfolio is also subject to interest rate risk since, for example, price volatility and ultimate realized yields are affected by the rate of prepayment of the underlying assets.
(IN THOUSANDS) FAIR % TO TOTAL VALUE INVESTMENTS ------- ----------- ABS RMBS FIRST LIEN: FIXED RATE (1) $13,779 0.2% VARIABLE RATE (1) 38,138 0.5 ------- --- TOTAL FIRST LIEN (2) 51,917 0.7 SECOND LIEN: INSURED 17,109 0.3 OTHER 7,083 0.1 ------- --- TOTAL SECOND LIEN (3) 24,192 0.4 ------- --- TOTAL ABS RMBS $76,109 1.1% ======= ===
- ---------- (1) Fixed rate and variable rate refer to the primary interest rate characteristic of the underlying mortgages at the time of issuance.
(3) The credit ratings of the second lien ABS RMBS were 86.4% Aaa, 7.1% A and 6.5% Ba at December 31, 2007.
ABS RMBS portfolio includes securities that are collateralized by mortgage loans issued to borrowers that cannot qualify for prime or alternative financing terms due in part to an impaired or limited credit history. It also includes securities that are collateralized by certain second lien mortgages regardless of the borrower's credit profile. Fair value represents 91.5% of the amortized cost of these securities. As of December 31, 2007, the ABS RMBS portfolio had gross unrealized losses of $7.1 million and no gross unrealized gains.
At December 31, 2007, $72.3 million or 95.0% of the total ABS RMBS securities that are rated Aaa are currently insured by 4 bond insurers. $67.8 million or 89.0% of the portfolio consisted of securities that were issued during 2005, 2006 and 2007. At December 31, 2007, 94.3% of these securities were rated Aaa, 0.8% rated Aa, 2.6% were rated A and 2.3% were rated Ba.
During 2007, we sold $679 thousand of ABS RMBS, recognizing a loss of $3 thousand. We also collected $26.4 million of principal repayments consistent with the expected cash flows. These repayments represent approximately 36.1% of the amortized cost of our outstanding portfolio at December 31, 2006.
We continue to believe that the unrealized losses on these securities are not necessarily predictive of the performance of the underlying collateral. In the absence of further deterioration in the collateral relative to our positions in the securities' respective capital structures, which could require other-than-temporary impairments, the unrealized losses should reverse over the remaining lives of the securities.
OTHER COLLATERALIZED DEBT OBLIGATIONS totaled $30.8 million and all were rated investment grade at December 31, 2007. Other collateralized debt obligations consist primarily of obligations secured by high yield and investment grade corporate credits including $5.8 million of collateralized loan obligations; $9.4 million of primarily bank trust preferred CDOs; $8.6 million of project finance bonds; $3.9 million of market value CDOs and $3.1 million of collateralized bond obligations. As of December 31, 2007, net unrealized losses on the other collateralized debt obligations were $1.2 million.
SHORT-TERM INVESTMENTS Our short-term investment portfolio was $22.7 million and $142.3 million at December 31, 2007 and 2006, respectively. We invest available cash balances primarily in taxable short-term securities having a final maturity date or redemption date of less than one year.
POLICY LOANS Our policy loan portfolio was $38.5 million and $38.2 million at December 31, 2007 and 2006, respectively. Policy loans are carried at the unpaid principal balances.
UNREALIZED GAINS AND LOSSES See Note 6 of the financial statements for further disclosures regarding unrealized losses on fixed income securities and factors considered in determining whether the securities are not other-than-temporarily impaired. The unrealized net capital gains on fixed income securities at December 31, 2007 totaled $342.2 million, a decrease of $2.7 million since December 31, 2006. The decrease in net unrealized capital gains was related primarily to increased unrealized losses on investment grade fixed income securities, resulting from widening credit spreads and credit exposure related to collateralized securities, which more than offset the effects of declining interest rates.
The banking, financial services and capital goods sectors had the highest concentration of gross unrealized losses in our corporate fixed income securities portfolio at December 31, 2007. The gross unrealized losses in these sectors were primarily company specific and the result of widening credit spreads. As of December 31, 2007, $41.9 million or 79.5% of the gross unrealized losses in the corporate fixed income portfolio and $42.0 million or 98.6% of the gross unrealized losses on the remaining fixed income securities, related to securities rated investment grade. Unrealized losses on investment grade securities are principally related to rising interest rates or changes in credit spreads since the securities were acquired.
All securities in an unrealized loss position at December 31, 2007 were included in our portfolio monitoring process for determining which declines in value are other-than-temporary.
(IN THOUSANDS) NAIC UNREALIZED PERCENT PERCENT RATING MOODY'S EQUIVALENT LOSS OF TOTAL FAIR VALUE OF TOTAL ---------- -------- ---------- -------- 1 Aaa/Aa/A $(59,445) 62.4% $1,491,424 69.5% 2 Baa (24,514) 25.7 545,215 25.4 -------- ----- ---------- ----- Investment grade (83,959) 88.1 2,036,639 94.9 3 Ba (9,821) 10.3 84,675 3.9 4 B (1,355) 1.4 22,517 1.1 5 Caa or lower (212) 0.2 1,298 0.1 -------- ----- ---------- ----- Below investment grade (11,388) 11.9 108,490 5.1 -------- ----- ---------- ----- Total $(95,347) 100.0% $2,145,129 100.0% ======== ===== ========== =====
The following table summarizes fixed income securities in a gross unrealized loss position according to significance, aging and investment grade classification.
Whenever our initial analysis indicates that a fixed income security's unrealized loss of 20% or more for at least 36 months is temporary, additional evaluations and management approvals are required to substantiate that a write-down is not appropriate. As of December 31, 2007, no security met this criteria.
UNREALIZED (IN THOUSANDS) UNREALIZED FAIR NAIC LOSS LOSS VALUE RATING CATEGORY ---------- ------- ------ ---------- Financial Services $ (2,474) $ 7,335 2 II Commercial Mortgage Backed Security (2,157) 3,727 2 II Financial Services (2,050) 2,950 3 II Commercial Mortgage Backed Security (1,694) 13,238 1 I Financial Services (1,594) 8,054 1 I Commercial Mortgage Backed Security (1,489) 8,321 1 I Construction Supply Company (1,463) 4,148 2 II Cash Flow CBO (1,451) 8,549 1 I Commercial Mortgage Backed Security (1,223) 8,827 1 I -------- ------- Total $(15,595) $65,149 ======== =======
(IN THOUSANDS) 2007 2006 -------- -------- Fixed income securities $358,547 $343,115 Mortgage loans 40,916 38,576 Short-term and other 14,487 14,763 -------- -------- Investment income, before expense 413,950 396,454 Investment expense (27,212) (23,390) -------- -------- Net investment income $386,738 $373,064 ======== ========
(IN THOUSANDS) 2007 2006 2005 ------- -------- ------- Investment write-downs $ -- $ (258) $(1,543) Dispositions 3,528 (21,568) (2,053) Valuation of derivative instruments (8,166) (5,429) (4,469) Settlement of derivative instruments 3,807 5,170 2,873 ------- -------- ------- Realized capital gains and losses, pretax (831) (22,085) (5,192) Income tax benefit 308 8,216 1,972 ------- -------- ------- Realized capital gains and losses, after-tax $ (523) $(13,869) $(3,220) ======= ======== =======
Dispositions in the above table include sales, losses recognized in anticipation of dispositions and other transactions such as calls and prepayments. We may sell impaired fixed income securities that were in an unrealized loss position at the previous reporting date, or other investments where the fair value has declined below the carrying value, in situations where new factors such as negative developments, subsequent credit deterioration, changing liquidity needs, and newly identified market opportunities cause a change in our previous intent to hold a security to recovery or maturity.
Dispositions in 2006 included net realized losses on sales and other transactions such as calls and prepayments of $5.1 million and losses recorded in connection with anticipated dispositions of $16.5 million. The net realized losses on sales and other transactions were comprised of gross gains of $13.9 million and gross losses of $19.0 million.
For the year ended December 31, 2007, we recognized $6.8 million of losses related to a change in our intent to hold certain securities with unrealized losses until they recover in value. The change in our intent was primarily related to strategic asset allocation decisions and ongoing comprehensive reviews of our portfolio. At December 31, 2007, the fair value of securities for which we did not have the intent to hold until recovery totaled $86.4 million.
For the year ended December 31, 2006, we recognized $16.5 million of losses related to a change in our intent to hold certain securities with unrealized losses until they recover in value. The change in our intent was driven by certain approved programs, including funding for the disposition through reinsurance of our variable annuity business reinsurance agreement. These programs were completed during 2006. Additionally, ongoing comprehensive reviews of our portfolio resulted in the identification of anticipated dispositions by the portfolio managers. At December 31, 2006, the fair value of securities for which we did not have the intent to hold until recovery totaled $13.7 million.
The ten largest losses from sales of individual securities for the year ended December 31, 2007 totaled $5.0 million with the largest loss being $1 million and the smallest loss being $283 thousand.
Investment policies define the overall framework for managing market and other investment risks, including accountability and control over these risk management activities. These investment activities follow policies that have been approved by our board of directors. These investment policies specify the investment limits and strategies that are appropriate given our liquidity, surplus, product profile, and regulatory requirements. Executive oversight of investment activities is conducted primarily through our board of directors and investment committee. Asset-liability management ("ALM") policies further define the overall framework for managing market and investment risks. ALM focuses on strategies to enhance yields, mitigate market risks and optimize capital to improve profitability and returns.
ALM activities follow asset-liability policies that have been approved by our board of directors. These ALM policies specify limits, ranges and/or targets for investments that best meet our business objectives in light of our product liabilities.
To calculate the duration gap between assets and liabilities, we project asset and liability cash flows and calculate their net present value using a risk-free market interest rate adjusted for credit quality, sector attributes, liquidity and other specific risks. Duration is calculated by revaluing these cash flows at alternative interest rates and determining the percentage change in aggregate fair value. The cash flows used in this calculation include the expected maturity and repricing characteristics of our derivative financial instruments, all other financial instruments (as described in Note 7 of the financial statements) and certain other items including interest-sensitive liabilities and annuity liabilities. The projections include assumptions (based upon historical market experience and our experience) that reflect the effect of changing interest rates on the prepayment, lapse, leverage and/or option features of instruments, where applicable. The preceding assumptions relate primarily to mortgage-backed securities, collateralized mortgage obligations, municipal housing bonds, callable municipal and corporate obligations, and fixed rate single and flexible premium deferred annuities.
EQUITY PRICE RISK is the risk that we will incur losses due to adverse changes in general levels of the equity markets. At December 31, 2007 and 2006, we had separate accounts assets related to variable annuity and variable life contracts with account values totaling $948.4 million and $1.01 billion, respectively. Equity risk exists for contract charges based on separate account balances and guarantees for death and/or income benefits provided by our variable products. In 2006, we disposed of all of the variable annuity business through a reinsurance agreement with Prudential as described in Note 3 of the financial statements, and therefore mitigated this aspect of our risk. Equity risk of our variable life business relates to contract charges and policyholder benefits. Total variable life contract charges for 2007 and 2006 were $1.2 million and $830 thousand, respectively. Separate account liabilities related to variable life contracts were $4.1 million and $2.7 million in December 31, 2007 and 2006, respectively.
RATING AGENCY RATING ------------- ------ Moody's Investors Service, Inc. Aa2 ("Excellent") Standard & Poor's Ratings Services AA ("Very Strong") A.M. Best Company, Inc. A+ ("Superior")
Our ratings are influenced by many factors including our operating and financial performance, asset quality, liquidity, asset/liability management, overall portfolio mix, financial leverage (i.e., debt), risk exposures, operating leverage, ALIC's ratings, AIC's ratings and other factors. There were no changes to the ratings listed above during 2007.
Decreased cash flows used in investing activities in 2007, compared to 2006, were the result of lower cash provided by financing activities and, to a lesser extent, operating activities. Lower cash flows used in investing activities in 2006, compared to 2005, were due to lower cash provided by financing activities, partially offset by increased cash provided by operating activities. Cash flows used in investing activities in 2006 also included the settlements related to the disposition through reinsurance of our variable annuity business.
Cash flows from financing activities decreased in 2007, compared to 2006, as a result of lower contractholder fund deposits, partially offset by lower contractholder fund withdrawals. Lower cash flows provided by financing activities in 2006, compared to 2005, were the result of lower contractholder fund deposits and higher withdrawals. For quantification of the changes in contractholder funds, see the Operations section of MD&A.
A portion of our product portfolio, including fixed annuities and interest-sensitive life insurance, is subject to surrender and withdrawal at the discretion of contractholders. As of December 31, 2007, contractholder funds totaling $585.1 million were not subject to discretionary withdrawal, $3.80 billion were subject to discretionary withdrawal with adjustments and $466.6 million were subject to discretionary withdrawal without adjustment. Of the contractholder funds subject to discretionary withdrawal with adjustments, $1.78 billion had a contractual surrender charge of less than 5% of the accounts balance.
We have an inter-company loan agreement with The Allstate Corporation. The amount of inter-company loans available to us is at the discretion of The Allstate Corporation. The maximum amount of loans The Allstate Corporation will have outstanding to all its eligible subsidiaries at any given point in time is limited to $1.00 billion. We had no amounts outstanding under the inter-company loan agreement at December 31, 2007 or 2006. The Allstate Corporation uses commercial paper borrowings and bank lines of credit to fund inter-company borrowings.
(3) Other liabilities primarily include accrued expenses and certain benefit obligations and claim payments and other checks outstanding.
The effect of implementing certain accounting standards on our financial results and financial condition is often based in part on market conditions at the time of implementation of the standard and other factors we are unable to
The Company sells life insurance, retirement and investment products and voluntary accident and health insurance products to individual customers in the state of New York. The principal products are traditional, interest-sensitive and variable life insurance, voluntary accident and health insurance, and fixed annuities. The following table summarizes premiums and contract charges by product.
($ IN THOUSANDS) 2007 2006 2005 -------- -------- -------- PREMIUMS Traditional life insurance $ 24,997 $ 24,298 $ 26,067 Immediate annuities with life contingencies 37,491 54,877 38,322 Other 6,636 5,138 4,149 -------- -------- -------- TOTAL PREMIUMS 69,124 84,313 68,538
CONTRACT CHARGES Interest-sensitive life insurance 51,155 46,448 42,315 Fixed annuities 8,375 8,851 7,237 Variable annuities -- 8,127 16,728 -------- -------- -------- TOTAL CONTRACT CHARGES 59,530 63,426 66,280 -------- -------- -------- TOTAL PREMIUMS AND CONTRACT $128,654 $147,739 $134,818 ======== ======== ========
The Company distributes its products to individuals through multiple distribution channels, including Allstate exclusive agencies, independent agents (including master brokerage agencies and workplace enrolling agents), and financial services firms, such as broker-dealers and specialized structured settlement brokers.
The Company monitors economic and regulatory developments that have the potential to impact its business. The ability of banks to affiliate with insurers may have a material adverse effect on all of the Company's product lines by substantially increasing the number, size and financial strength of potential competitors. The Company currently benefits from agreements with financial services entities that market and distribute its products; change in control of these non-affiliated entities could negatively impact the Company's sales. Furthermore, federal and state laws and regulations affect the taxation of insurance companies and life insurance and annuity products. Congress and various state legislatures have considered proposals that, if enacted, could impose a greater tax burden on the Company or could have an adverse impact on the tax treatment of some insurance products offered by the Company, including favorable policyholder tax treatment currently applicable to life insurance and annuities. Legislation that reduced the federal income tax rates applicable to certain dividends and capital gains realized by individuals, or other proposals, if adopted, that reduce the taxation, or permit the establishment, of certain products or investments that may compete with life insurance or annuities could have an adverse effect on the Company's financial position or ability to sell such products and could result in the surrender of some existing contracts and policies. In addition, changes in the federal estate tax laws could negatively affect the demand for the types of life insurance used in estate planning.
In connection with Company's securities lending business activities, funds received in connection with securities repurchase agreements are invested and classified as short-term investments or fixed income securities available for sale as applicable. For the Company's securities lending business activities, the Company records an offsetting liability in other liabilities and accrued expenses for the Company's obligation to return the collateral or funds received.
When derivatives meet specific criteria, they may be designated as accounting hedges and accounted for as fair value, cash flow, foreign currency fair value or foreign currency cash flow hedges. The hedged item may be either all or a specific portion of a recognized asset, liability or an unrecognized firm commitment attributable to a particular risk. At the inception of the hedge, the Company formally documents the hedging relationship and risk management objective and strategy. The documentation identifies the hedging instrument, the hedged item, the nature of the risk being hedged and the methodology used to assess the effectiveness of the hedging instrument in offsetting the exposure to changes in the hedged item's fair value attributable to the hedged risk. In the case of a cash flow hedge, this documentation includes the exposure to changes in the hedged item's or transaction's variability in cash flows attributable to the hedged risk. The Company does not exclude any component of the change in fair value of the hedging instrument from the effectiveness assessment. At each reporting date, the Company confirms that the hedging instrument continues to be highly effective in offsetting the hedged risk. Ineffectiveness in fair value hedges and cash flow hedges is reported in realized capital gains and losses. There was no hedge ineffectiveness in 2007, 2006 or 2005.
When a derivative financial instrument used in a cash flow hedge of an existing asset or liability is no longer effective or is terminated, the gain or loss recognized on the derivative is reclassified from accumulated other comprehensive income to net income as the hedged risk impacts net income, beginning in the period hedge accounting is no longer applied or the derivative instrument is terminated. If the derivative financial instrument is not terminated when a cash flow hedge is no longer effective, the future gains and losses recognized on the derivative are reported in realized capital gains and losses. When a derivative financial instrument used in a cash flow hedge of a forecasted transaction is terminated because the forecasted transaction is no longer probable, the gain or loss recognized on the derivative is immediately reclassified from accumulated other comprehensive income to realized capital gains and losses in the period that hedge accounting is no longer applied. If the cash flow hedge is no longer effective, the gain or loss recognized on the derivative is reclassified from accumulated other comprehensive income to net income as the remaining hedged item affects net income.
Based upon the type of derivative instrument and strategy, the income statement effects of these derivatives are reported in a single line item with the results of the associated risk. Therefore, the derivatives' fair value gains and losses and accrued periodic settlements are recognized together in one of the following line items during the reporting period: realized capital gains and losses or contract benefits. Cash flows from embedded derivatives requiring bifurcation and derivatives receiving hedge accounting are reported consistently with the host contracts and hedged risks respectively within the Statements of Cash Flows. Cash flows from other derivatives are reported in cash flows from investing activities within the Statements of Cash Flows.
The Company receives collateral for securities loaned in an amount generally equal to 102% of the fair value of securities and records the related obligations to return the collateral in other liabilities and accrued expenses. The carrying value of these obligations approximates fair value because of their relatively short-term nature. The Company monitors the market value of securities loaned on a daily basis and obtains additional collateral as necessary under the terms of the agreements to mitigate counterparty credit risk. The Company maintains the right and ability to redeem the securities loaned on short notice. Substantially all of the Company's securities loaned are placed with large brokerage firms.
Interest-sensitive life contracts, such as universal life and single premium life, are insurance contracts whose terms are not fixed and guaranteed. The terms that may be changed include premiums paid by the contractholder, interest credited to the contractholder account balance and contract charges assessed against the contractholder account balance. Premiums from these contracts are reported as contractholder fund deposits. Contract charges consist of fees assessed against the contractholder account balance for cost of insurance (mortality risk), contract administration and early surrender. These contract charges are recognized as revenues when assessed against the contractholder account balance. Contract benefits include life-contingent benefit payments in excess of the contractholder account balance.
Contracts that do not subject the Company to significant risk arising from mortality or morbidity are referred to as investment contracts. Fixed annuities, including market value adjusted annuities and immediate annuities
without life contingencies are considered investment contracts. Consideration received for such contracts is reported as contractholder fund deposits. Contract charges for investment contracts consist of fees assessed against the contractholder account balance for maintenance, administration, and surrender of the contract prior to contractually specified dates, and are recognized when assessed against the contractholder account balance.
Interest credited to contractholder funds represents interest accrued or paid on interest-sensitive life contracts and investment contracts. Crediting rates for certain fixed annuities and interest-sensitive life contracts are adjusted periodically by the Company to reflect current market conditions subject to contractually guaranteed minimum rates. Interest credited also includes amortization of deferred sales inducement ("DSI") expenses. DSI is amortized into interest credited using the same method used to amortize deferred policy acquisition costs ("DAC").
Contract charges for variable life and variable annuity products consist of fees assessed against the contractholder account values for contract maintenance, administration, mortality, expense and early surrender. Contract benefits incurred include guaranteed minimum death, income, withdrawal and accumulation benefits. Subsequent to our disposal of all of our variable annuity business through reinsurance agreements with Prudential in 2006 (see Note 3), the contract charges and contract benefits related thereto are reported net of reinsurance ceded.
Costs that vary with and are primarily related to acquiring life insurance and investment contracts are deferred and recorded as DAC. These costs are principally agents' and brokers' remuneration and certain underwriting costs. DSI costs, which are deferred and recorded as other assets, relate to sales inducements offered on sales to new customers, principally on annuities and primarily in the form of additional credits to the customer's account value or enhancements to interest credited for a specified period, which are in excess of the rates currently being credited to similar contracts without sales inducements. All other acquisition costs are expensed as incurred and included in operating costs and expenses on the Statements of Operations and Comprehensive Income. DAC is amortized to income and included in amortization of deferred policy acquisition costs on the Statements of Operations and Comprehensive Income. DSI is reported in other assets and amortized to income using the same methodology and assumptions as DAC and is included in interest credited to contractholder funds on the Statements of Operations and Comprehensive Income. DAC and DSI are periodically reviewed for recoverability and adjusted if necessary.
For interest-sensitive life, annuities and other investment contracts, DAC and DSI are amortized in proportion to the incidence of the total present value of gross profits, which includes both actual historical gross profits ("AGP") and estimated future gross profits ("EGP") expected to be earned over the estimated lives of the contracts. The amortization is net of interest on the prior DAC balance and uses rates established at the inception of the contracts. Actual amortization periods generally range from 15-30 years; however, incorporating estimates of customer surrender rates, partial withdrawals and deaths generally result in the majority of DAC being amortized over the surrender charge period. The rate of amortization during this term is matched to the pattern of total gross profits.
included as a component of amortization of deferred policy acquisition costs or interest credited to contractholder funds, respectively, on the Statements of Operations and Comprehensive Income.
In February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 155, which permits the fair value remeasurement at the date of adoption of any hybrid financial instrument containing an embedded
FASB STAFF POSITION NO. FAS 115-1, THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS ("FSP FAS 115-1")
FSP FAS 115-1 nullifies the guidance in paragraphs 10-18 of Emerging Issues Task Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" and references existing other-than-temporary impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell the security has not been made, and also provides guidance on the subsequent income recognition for impaired debt securities. The Company adopted FSP FAS 115-1 as of January 1, 2006 on a prospective basis. The effects of adoption did not have a material effect on the results of operations or financial position of the Company.
SFAS NO. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS- A REPLACEMENT OF APB OPINION NO.20 AND FASB STATEMENT NO.3 ("SFAS NO. 154")
SFAS No. 154 replaces Accounting Principles Board ("APB") Opinion No. 20, "Accounting Changes", and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements". SFAS No. 154 requires retrospective application to prior periods' financial statements for changes in accounting principle, unless determination of either the period specific effects or the cumulative effect of the change is impracticable or otherwise not required. The Company adopted SFAS No. 154 on January 1, 2006. The adoption of SFAS No.
154 did not have any effect on the results of operations or financial position of the Company.
In September 2006, the FASB issued SFAS No. 157, which redefines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Specifically, SFAS No. 157 establishes a three-level hierarchy for fair value measurements based upon the nature of the inputs to the valuation of an asset or liability. SFAS No. 157 applies where other accounting pronouncements require or permit fair value measurements. Additional disclosures and modifications to current fair value disclosures will be required upon adoption of SFAS No. 157. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position No. 157-2, "Effective Date of FASB Statement No. 157", which permits the deferral of the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company plans to utilize the deferral for non-financial assets and liabilities. The adoption of SFAS No. 157 is not expected to have a material effect on the Company's results of operations or financial position.
In February 2007, the FASB issued SFAS No. 159 which provides reporting entities an option to report selected financial assets, including investment securities designated as available for sale, and financial liabilities, including most insurance contracts, at fair value. SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement alternatives for similar types of financial assets and liabilities. The standard also requires additional information to aid financial statement users' understanding of the impact of a reporting entity's decision to use fair value on its earnings and requires entities to display, on the face of the statement of financial position, the fair value of those assets and liabilities for which the reporting entity has chosen to measure at fair value. SFAS No. 159 is effective as of the beginning of a reporting entity's first fiscal year beginning after November 15, 2007. The Company does not expect to apply the fair value option to any existing financial assets or liabilities as of January 1, 2008. Consequently, the initial adoption of SFAS No. 159 is expected to have no impact on the Company's results of operations or financial position.
In April 2007, the FASB issued FSP FIN 39-1, which amends FASB Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts". FSP FIN 39-1 replaces the terms "conditional contracts" and "exchange contracts" with the term "derivative instruments" and requires a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement that have been offset in the statement of financial position. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. The effects of applying FSP FIN 39-1 will be recorded as a change in accounting principle through retrospective application unless such application is
On June 1, 2006, in accordance with the terms of the definitive Master Transaction Agreement and related agreements (collectively the "Agreement") the Company, its parent ALIC, and the Corporation, completed the disposal through reinsurance of all of the Company's variable annuity business to Prudential Financial, Inc. and its subsidiary, The Prudential Insurance Company of America (collectively "Prudential"). For the Company, this disposal achieved the economic benefit of transferring to Prudential the future rights and obligations associated with this business.
The disposal was effected through reinsurance agreements (the "Reinsurance Agreements") which include both coinsurance and modified coinsurance provisions. Coinsurance and modified coinsurance reinsurance are commonly used in the reinsurance of variable annuities because variable annuities generally include both separate account and general account liabilities. When contractholders make a variable annuity deposit, they must choose how to allocate their account balances between a selection of variable-return mutual funds that must be held in a separate account and fixed-return funds held in the Company's general account. In addition, variable annuity contracts include various benefit guarantees that are general account obligations of the Company. The Reinsurance Agreements do not extinguish the Company's primary liability under the variable annuity contracts.
Variable annuity balances invested in variable-return mutual funds are held in separate accounts, which are legally segregated assets and available only to settle separate account contract obligations. Because the separate account assets must remain with the Company under insurance regulations, modified coinsurance is typically used when parties wish to transfer future economic benefits of such business. Under the modified coinsurance provisions, the separate account assets remain on the Company's Statements of Financial Position, but the related results of operations are fully reinsured and presented net of reinsurance on the Statements of Operations and Comprehensive Income.
For purposes of presentation in the Statements of Cash Flows, the Company treated the reinsurance of its variable annuity business to Prudential as a disposition of operations, consistent with the substance of the transaction which was the disposition of a block of business accomplished through reinsurance. Accordingly, the net consideration transferred to Prudential of $388.4 million (computed as $440.0 million of general account insurance liabilities transferred to Prudential on the closing date less consideration of $51.6 million) and the costs of executing the transaction of $1.2 million, pre-tax, were classified as a disposition of operations in the cash flows from investing activities section of the Statements of Cash Flows.
Under the Agreement, the Company, ALIC and the Corporation have indemnified Prudential for certain pre-closing contingent liabilities (including extra-contractual liabilities of the Company and ALIC and liabilities specifically excluded from the transaction) that the Company and ALIC have agreed to retain. In addition, the Company, ALIC and the Corporation will each indemnify Prudential for certain post-closing liabilities that may arise from the acts of the Company and ALIC, and their agents, including in connection with the Company's and ALIC's provision of transition services. The Reinsurance Agreements contain no limits or indemnifications with regard to insurance risk transfer, and transferred all of the future risks and responsibilities for performance on the underlying variable annuity contracts to Prudential, including those related to benefit guarantees, in accordance with the provisions of SFAS No. 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts".
Pursuant to the Agreement, the Consideration was $51.6 Million. The disposal resulted in a reinsurance loss of $9.3 million, pretax. This reinsurance loss and other transactional expenses incurred were included as a
component of loss on disposition of operations on the statements of operations and comprehensive income and amounted to $10.7 million, pretax ($7.0 million, after-tax) during 2006. DAC and DSI were reduced by $79.7 million and $6.2 million, respectively, as of the effective date of the transaction for balances related to the variable annuity business subject to the Reinsurance Agreements.
Liabilities for collateral received in conjunction with the Company's securities lending business activities were $198.1 million, $199.5 million and $149.5 million at December 31, 2007, 2006 and 2005, respectively, and are reported as a component of other liabilities and accrued expenses in Statements of Financial Position. The accompanying cash flows are included in cash flows from operating activities in the Statements of Cash Flows along with the activities resulting from management of the proceeds, which for the years ended December 31 are as follows:
The Company issued $12.7 million, $15.0 million and $16.0 million of structured settlement annuities, a type of immediate annuity, in 2007, 2006 and 2005, respectively, at prices based upon interest rates in effect at the time of issuance, to fund structured settlements in matters involving AIC. Of these amounts, $1.5 million, $1.5 million and $2.0 million relate to structured settlement annuities with life contingencies and are included in premium income for 2007, 2006 and 2005, respectively. In most cases, these annuities were issued under a "qualified assignment," whereby prior to July 1, 2001 Allstate Settlement Corporation ("ASC"), and subsequent to July 1, 2001 Allstate Assignment Corporation ("AAC"), both wholly owned subsidiaries of ALIC, purchased annuities from the Company and assumed AIC's obligation to make future payments.
The Company receives distribution services from Allstate Financial Services, LLC ("AFS"), an affiliated broker-dealer company, for certain variable annuity and variable life insurance contracts sold by Allstate exclusive agencies. The Company incurred $971 thousand, $1.4 million and $1.3 million of commission and other distribution expenses for the years ended December 31, 2007, 2006 and 2005, respectively.
Additionally, the Company entered into a reinsurance treaty through which it primarily cedes re-investment related risk on its structured settlement annuities to ALIC. Under the terms of the treaty, the Company pays a premium to ALIC that varies with the aggregate structured settlement annuity statutory reserve balance. In return, ALIC guarantees that the yield on the portion of the Company's investment portfolio that supports structured settlement annuity liabilities will not fall below contractually determined rates. The Company ceded premium related to structured settlement annuities to ALIC of $3.2 million, $3.0 million and $2.9 million for the years ended December 31, 2007, 2006 and 2005, respectively. At December 31, 2007 and 2006, the carrying value of the structured settlement reinsurance treaty was $(1.7) million and $(1.9) million, respectively, which is recorded in other assets. The premiums ceded and changes in the fair value of the reinsurance treaty are reflected as a component of realized capital gains and losses on the Statements of Operations and Comprehensive Income as the treaty is recorded as a derivative instrument pursuant to the requirements of SFAS No. 133.
Prior to the Company's disposition of the variable annuity business through reinsurance with Prudential effective June 1, 2006 (see Note 3), the Company had a reinsurance treaty through which it ceded contract benefits on its GMABs, GMWBs and certain GMDBs to ALIC. The reinsurance treaty was recaptured in 2006 and, in accordance therewith, the Company received cash in excess of the liabilities subject to the treaty resulting in a pre-tax gain of $3.3 million. The after-tax gain of $2.2 million was recorded as an adjustment to retained income since the transaction was between affiliates under common control.
The Company has an intercompany loan agreement with The Allstate Corporation. The amount of intercompany loans available to the Company is at the discretion of The Allstate Corporation. The maximum amount of loans The Allstate Corporation will have outstanding to all its eligible subsidiaries at any given point in time is limited to $1.00 billion. The Company had no amounts outstanding under the inter-company loan agreement at December 31, 2007 and 2006. The Allstate Corporation uses commercial paper borrowings, bank lines of credit and repurchase agreements to fund inter-company borrowings.
($ IN THOUSANDS) 2007 2006 2005 ------- -------- ------- Fixed income securities $ 3,614 $(25,398) $(6,596) Mortgage loans (86) 3,572 3,000 Derivatives (4,359) (259) (1,596) ------ ---- ------ Realized capital gains and losses, pre-tax (831) (22,085) (5,192) Income tax benefit 308 8,216 1,972 ------ ---- ------ Realized capital gains and losses, after-tax $ (523) $(13,869) $(3,220) ======= ======== =======
- ---------- (1) See Note 2 for Deferred policy acquisition and sales inducement costs and Reserves for life-contingent contract benefits.
Inherent in the Company's evaluation of a particular security are assumptions and estimates about the financial condition of the issue or issuer and its future earnings potential. Some of the factors considered in evaluating whether a decline in fair value is other-than-temporary are: 1) the Company's ability and intent to retain the investment for a period of time sufficient to allow for an anticipated recovery in value; 2) the recoverability of principal and interest; 3) the length of time and extent to which the fair value has been less than amortized cost; 4) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry conditions and trends, and implications of rating agency actions and offering prices; and 5) the specific reasons that a security is in a significant unrealized loss position, including market conditions which could affect access to liquidity.
As of December 31, 2007, $82.9 million of the unrealized losses are related to securities with an unrealized loss position less than 20% of amortized cost, the degree of which suggests that these securities do not pose a high risk of being other than temporarily impaired. Of the $95.3 million of unrealized losses on fixed income securities, $84.0 million are related to unrealized losses on investment grade securities. Investment grade is defined as a security having a rating from the National Association of Insurance Commissioners ("NAIC") of 1 or 2; a rating of Aaa, Aa, A or Baa from Moody's or a rating of AAA, AA, A or BBB from Standard & Poor's ("S&P"), Fitch or Dominion, or a rating of aaa, aa, a or bbb from A.M. Best; or a comparable internal rating if an externally provided rating is not available. Unrealized losses on investment grade securities are principally related to rising interest rates or changes in credit spreads since the securities were acquired.
As of December 31, 2007, the Company had the intent and ability to hold the fixed income securities with unrealized losses for a period of time sufficient for them to recover.
(% OF MUNICIPAL BOND PORTFOLIO CARRYING VALUE) 2007 2006 ----- ----- California 30.6% 30.2% Texas 14.3 10.9 Delaware 8.5 1.3 Oregon 5.8 7.2 Virginia 5.0 6.3 New York 4.1 5.8 Missouri 4.0 5.4 Connecticut 0.8 5.0
In 2007, $9.8 million of commercial mortgage loans were contractually due. Of these, 74.6% were paid as due and 25.4% were refinanced at prevailing market terms. None were foreclosed or are in the process of foreclosure, and none were in the process of refinancing or restructuring discussions.
Included in fixed income securities are below investment grade assets totaling $198.6 million and $186.9 million at December 31, 2007 and 2006, respectively.
Fair values of fixed income securities are based upon observable market quotations, observable market data or are derived from such quotations or data. The fair value of privately placed fixed income securities is generally based on widely accepted pricing valuation models, which are developed internally. Mortgage loans are valued based on discounted contractual cash flows. Discount rates are selected using current rates at which similar loans would be made to borrowers with similar characteristics, using similar properties as collateral. Loans that exceed 100% loan-to-value are valued at the estimated fair value of the underlying collateral. Short-term investments are highly liquid investments with maturities of one year or less whose carrying values are deemed to approximate fair value. The carrying value of policy loans is deemed to approximate fair value. The fair value of reinsurance recoverables on investment contracts is determined based on the fair value of the underlying annuity contract account liabilities, adjusted for credit risk. Separate accounts assets are carried in the Statements of Financial Position at fair value based on observable market prices.
Contractholder funds include interest-sensitive life insurance contracts and investment contracts. Interest-sensitive life insurance contracts are not considered financial instruments subject to fair value disclosure requirements. The fair value of investment contracts is based on the terms of the underlying contracts. Fixed annuities are valued at the account balance less surrender charges. Immediate annuities without life contingencies are valued at the present value of future benefits using current interest rates. Market value adjusted annuities' fair value is estimated to be the market adjusted surrender value. Liability for collateral is valued at carrying value due to its short-term nature. Separate accounts liabilities are carried at the account values, which are equal to the carrying value of the assets.
instruments due to counterparty nonperformance. Futures contracts are traded on organized exchanges, which require margin deposits and guarantee the execution of trades, thereby mitigating any potential credit risk associated with transactions executed on organized exchanges.
($ IN THOUSANDS) 2007 2006 ---------- ---------- Immediate fixed annuities: Structured settlement annuities $1,870,663 $1,793,706 Other immediate fixed annuities 10,987 9,815 Traditional life 127,994 117,419 Other 7,327 5,552 ---------- ---------- Total reserve for life-contingent contract benefits $2,016,971 $1,926,492 ========== ==========
- ---------- (1) In 2006, the Company disposed its variable annuity business through reinsurance agreements with Prudential (see Note 3).
Guarantees related to withdrawal and accumulation benefits are considered to be derivative financial instruments: therefore, the liability for these benefits is established based on its fair value.
- ---------- (1) Included in the total liability balance at December 31, 2005 are reserves for variable annuity death benefits of $264 thousand, variable annuity income benefits of $46 thousand, variable annuity accumulation benefits of $(553) thousand, variable annuity withdrawal benefits of $2 thousand and other guarantees of $59 thousand.
In addition to amounts included in the table above are reinsurance premium ceded to ALIC of $3.2 million, $3.0 million and $2.9 million during 2007, 2006 and 2005, respectively, under the terms of the structured settlement annuity reinsurance agreement (See Note 5).
DSI activity, which primarily relates to fixed annuities, for the twelve months ended December 31 was as follows:
- In connection with regulatory examinations and proceedings, government authorities may seek various forms of relief, including penalties, restitution and changes in business practices. The Company may not be advised of the nature and extent of relief sought until the final stages of the examination or proceeding.
than age to support the rehire policy. AIC's interlocutory appeal of the trial court's summary judgment order is now pending in the United States Court of Appeals for the Eighth Circuit.
- AIC is also defending a certified class action filed by former employee agents who terminated their employment prior to the agency program reorganization. These plaintiffs have asserted breach of contract and ERISA claims. The court approved the form of class notice which was sent to approximately 1,800 potential class members in November 2007. Fifteen individuals opted out. AIC has moved for judgment on the pleadings and summary judgment.
Various other legal, governmental, and regulatory actions, including state market conduct exams, and other governmental and regulatory inquiries are currently pending that involve the Company and specific aspects of its conduct of business. Like other members of the insurance industry, the Company is the target of a number of lawsuits and proceedings, some of which involve claims for substantial or indeterminate amounts. These actions are based on a variety of issues and target a range of the Company's practices. The outcome of these disputes is currently unpredictable. One or more of these matters could have an adverse effect on the Company's operating results or cash flows for a particular quarterly or annual period. However, based on information currently known to it, management believes that the ultimate outcome of all matters described in this "Other Matters" subsection in excess of amounts currently reserved, as they are resolved over time is not likely to have a material effect on the operating results, cash flows or financial position of the Company.
2007 2006 --------- --------- (IN THOUSANDS) DEFERRED ASSETS Life and annuity reserves $ 65,519 $ 67,529 Other assets 2,564 1,924 --------- --------- Total deferred assets 68,083 69,453 --------- ---------
Although realization is not assured, management believes it is more likely than not that the deferred tax assets will be realized based on the assumption that certain levels of income will be achieved. The components of income tax expense for the years ended December 31 are as follows:
The Company paid income taxes of $22.7 million, $23.2 million and $18.4 million in 2007, 2006 and 2005, respectively.
The ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company and other relevant factors. The payment of shareholder dividends by the Company without prior approval of the state insurance regulator is limited to formula amounts based on net income and capital and surplus, determined in conformity with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. The maximum amount of dividends that the Company can distribute during 2008 without prior approval of the New York State Insurance Department is $30.6 million. In the twelve-month period beginning January 1, 2007, the Company did not pay any dividends.
------------------------------ After- Pretax Tax tax --------- ------- -------- Unrealized holding losses arising during the period $(15,895) $ 5,563 $(10,332) Less: reclassification adjustment 3,874 (1,356) 2,518 -------- ------- -------- Unrealized net capital gains and losses (19,769) 6,919 (12,850) -------- ------- -------- Other comprehensive loss $(19,769) $ 6,919 $(12,850) ======== ======= ========
($ IN THOUSANDS) ------------------------------ After- Pretax Tax tax --------- ------- -------- Unrealized holding losses arising during the period $(102,314) $35,810 $(66,504) Less: reclassification adjustment (23,960) 8,386 (15,574) --------- ------- -------- Unrealized net capital gains and losses (78,354) 27,424 (50,930) --------- ------- -------- Other comprehensive loss $ (78,354) $27,424 $(50,930) ========= ======= ========
In our opinion, such financial statements present fairly, in all material respects, the financial position of Allstate Life Insurance Company of New York as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 2 to the financial statements, the Company changed its method of accounting for uncertainty in income taxes and accounting for deferred acquisition costs associated with internal replacements in 2007.