In addition in 2009, personnel performing services for the Registrant occupied office space in Jacksonville, Florida, which is owned by ML&Co. An allocable share of the cost of the above mentioned premise was paid by the Registrant through a transition services agreement between AUSA and ML&Co.
Our failure to achieve anticipated levels of earnings or operational efficiencies as well as other cost saving initiatives.
Each month, the Company performs an analysis of the information obtained from third-party services and brokers to ensure that the information is reasonable and produces a reasonable estimate of fair value. The Company considers both qualitative and quantitative factors as part of this analysis, including but not limited to, recent transactional activity for similar fixed maturities, review of pricing statistics and trends, and consideration of recent relevant market events. Other controls and procedures over pricing received from indices, third-party pricing services, or brokers include validation checks such as exception reports which highlight significant price changes, stale prices or un-priced securities. Additionally, during 2011, the Company began performing back testing on a sample basis. Back testing involves selecting a sample of securities trades and comparing the prices in those transactions to prices used for financial reporting. Significant variances between the price used for financial reporting and the transaction price are investigated to explain the cause of the difference.
The Company’s portfolio of private placement securities is valued using a matrix pricing methodology. The pricing methodology is obtained from a third party service and indicates current spreads for securities based on weighted average life, credit rating and industry sector. Monthly the Company reviews the matrix to ensure the spreads are reasonable by comparing them to observed spreads for similar securities traded in the market. In order to account for the illiquid nature of these securities, illiquidity premiums are included in the valuation and are determined based upon the pricing of recent transactions in the private placement market as well as comparing the value of the privately offered security to a similar public security. The impact of the illiquidity premium to the overall valuation is less than 1% of the value. At December 31, 2011 and 2010, approximately $56.7 million (or 3%) and $51.7 million (or 3%), respectively, of the Company’s fixed maturity and equity securities portfolio consisted of private placement securities.
The Company regularly reviews each investment in its fixed maturity and equity AFS securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. Management makes this determination through a series of discussions with the Company’s portfolio managers and credit analysts, and information obtained from external sources (i.e., company announcements, ratings agency announcements, or news wire services). For fixed maturity AFS securities, the Company also considers whether it is more likely than not that it will not be required to sell the debt security before its anticipated recovery. The factors that may give rise to a potential OTTI include, but are not limited to, i) certain credit-related events such as default of principal or interest payments by the issuer, ii) bankruptcy of issuer, iii) certain security restructurings, and iv) fair market value less than cost or amortized cost for an extended period of time. In the absence of a readily ascertainable market value, the estimated fair value on these securities represents management’s best estimate and is based on comparable securities and other assumptions as appropriate. Management bases this determination on the most recent information available.
Mortgage loans on real estate are carried at unpaid principal balances adjusted for amortization of premiums and accretion of discounts and are net of valuation allowances and generic reserves. The fair value for mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or similar remaining maturities. Interest income is accrued on the principal balance of the loan based on the loan’s contractual interest rate. Premiums and discounts are amortized using the effective yield method over the life of the loan. Interest income and amortization of premiums and discounts are reported in net investment income along with mortgage loan fees, which are recorded as they are incurred.
Loans are considered impaired when it is probable that based upon current information and events, the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. When the Company determines that a loan is impaired, a valuation allowance is established for the excess carrying value of the loan over its estimated collateral value. Changing economic conditions impact the valuation of mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that the Company performs for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for losses. In addition, the Company continues to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of emphasis are properties that have deteriorating credits or have experienced debt coverage reduction. Where warranted, the Company has established or increased loss reserves based upon this analysis. The Company does not accrue interest on loans ninety days past due. The Company also establishes a generic reserve which is calculated by applying a percentage, based on risk rating and maturity, to the outstanding loan balance.
At December 31, 2011 and 2010, there was $55.7 million and $62.9 million, respectively, in mortgage loans on real estate recorded on the Balance Sheets. The estimated fair value of the mortgage loans on real estate at December 31, 2011 and December 31, 2010 was $61.8 million and $66.7 million, respectively. There were no impaired mortgage loans at December 31, 2011. A valuation allowance of $0.6 million was established for an impaired mortgage loan during 2010 which was then sold during the first quarter 2011 resulting in a recovery of $0.2 million. In addition, during the fourth quarter 2010, a mortgage loan
was impaired for $0.6 million and then sold. The general reserve at December 31, 2011 and 2010 was less than $0.1 million. The change in the valuation allowance and the general reserve is reflected in net realized investment gains (losses), excluding OTTI losses on securities in the Statements of Income. At December 31, 2011 and 2010, there were no mortgage loans that were two or more payments delinquent. See Note 3 to the Financial Statements for further discussion.
At December 31, 2011 and 2010, the Company had 630 and 360 outstanding short futures contracts with a notional amount of $197.3 million and $112.8 million, respectively. At December 31, 2011 and 2010, the Company had variance swaps with a notional value of $5.0 thousand and $7.0 thousand, respectively, and a net fair value of ($1.3) million and ($0.4) million, respectively, which is presented as a liability on the Balance Sheets. The Company recognized $1.0 million and $0.4 million of losses from the change in fair value of the variance swaps in net investment income in the Statements of Income during the years ended December 31, 2011 and 2010, respectively.
Financial assets that are lent to a third party or that are transferred subject to a repurchase agreement at a fixed price are not derecognized as the Company retains substantially all the risks and rewards of asset ownership. The lent securities are included in fixed maturity AFS securities in the Balance Sheets. A liability is recognized for cash collateral received, required initially at 102%, on which interest is accrued. If the fair value of the collateral is at any time less than 102% of the fair value of the loaned securities, the counterparty is mandated to deliver additional collateral, the fair value of which, together with the collateral already held in connection with the lending transaction, is at least equal to 102% of the fair value of the loaned securities. At December 31, 2011 and 2010, the payable for collateral under securities loaned was $244.0 million and $160.4 million, respectively.
DAC for variable annuities is amortized with interest over the anticipated lives of the insurance contracts in relation to the present values of estimated future gross profits from asset-based fees, guaranteed benefit rider fees, contract fees, and surrender charges, less a provision for guaranteed death and living benefit expenses, policy maintenance expenses, and non-capitalized commissions. Future gross profit estimates are subject to periodic evaluation with necessary revisions applied against amortization to date. The impact of revisions and assumptions to estimates on cumulative amortization is recorded as a charge or credit to current operations, commonly referred to as “unlocking”. Changes in assumptions can have a significant impact on the amount of DAC reported and the related amortization patterns. In general, increases in the estimated Separate Accounts return and decreases in surrender or mortality assumptions increase the expected future profitability of the underlying business and may lower the rate of DAC amortization. Conversely, decreases in the estimated Separate Accounts returns and increases in surrender or mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization. For the years ended December 31, 2011, 2010 and 2009, there was a favorable (unfavorable) impact to pre-tax income related to DAC unlocking of ($3.0) million, $1.1 million and ($2.6) million, respectively. See Note 4 to the Financial Statements for a further discussion.
The expense and the subsequent capitalization and amortization (accretion) are recorded as a component of policy benefits in the Statements of Income. At December 31, 2011 and 2010, variable annuities accounted for the Company’s entire DSI asset of $10.4 million and $7.3 million, respectively. For the years ended December 31, 2011, 2010 and 2009, there was a favorable (unfavorable) impact to pre-tax income related to unlocking of ($0.6) million, $0.3 million and less than $0.1 million, respectively. See Note 4 to the Financial Statements for a further discussion.
The Company’s liability for policyholder account balances represents the contract value that has accrued to the benefit of policyholders at the Balance Sheet date. The liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Policyholder account balances at December 31, 2011 and 2010 were $1.5 billion and $1.6 billion, respectively.
The Company regularly evaluates the assumptions used to establish these liabilities, as well as actual experience and adjusts GMDB and GMIB liabilities with a related charge or credit to earnings (“unlocking”), if actual experience or evidence suggests that the assumptions should be revised. For the years ended December 31, 2011, 2010 and 2009, the favorable (unfavorable) impact to pre-tax income related to GMDB and GMIB unlocking was ($70.0) million, $41.0 million and ($10.4) million, respectively.
The valuation allowance for deferred tax assets at December 31, 2011 and 2010 was $90.4 million and $93.0 million, respectively. The valuation allowance is related to a net operating loss carryforward and other deferred tax assets that, in the judgment of management, is not more likely than not to be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that all or some of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends on generation of future taxable income during the periods in which those temporary differences are deductible. Management considers the scheduled reversal of deferred tax liabilities, projected taxable income, and tax-planning strategies in making the assessment.
ASC 350, Intangibles-Goodwill and Other - ASU 2010-28, When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts - requires entities with a zero or negative carrying value to perform step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists - adopted January 1, 2011.
ASC 210, Balance Sheet - ASU 2011-11, Disclosures about Offsetting Assets and Liabilities - enhances disclosures about financial instruments and derivative instruments that are either offset on the statement of financial position or subject to an enforceable master netting arrangement - will be adopted January 1, 2013.
Total direct deposits (including internal exchanges) were $33.5 million, $46.0 million and $295.3 million for the years ended December 31, 2011, 2010 and 2009, respectively. Deposits are currently limited to additions to existing policies which will result in fluctuations period over period. The decrease in deposits was primarily due to the Company ceasing to issue new variable annuity and market value adjusted annuity products in the latter part of 2009. Internal exchanges during 2011, 2010 and 2009 were $5.9 million, $5.2 million and $10.4 million, respectively.
At December 31, 2011, the Company’s assets were $10.5 billion or $976.1 million lower than the $11.5 billion in assets at December 31, 2010. Assets excluding Separate Accounts assets increased $179.5 million. Separate Accounts assets, which represent 67% of total assets, decreased $1.2 billion to $7.0 billion. Changes in Separate Accounts assets were as follows:
The amortized cost/cost and estimated fair value of investments in fixed maturity and equity securities at December 31, 2011 and 2010 were:
(1) Subsequent unrealized gains (losses ) on OTTI securities are included in OCI-OTTI.
The Company’s $1.9 million of gross unrealized losses within the financial services sector has a fair value of $37.2 million. The majority of the unrealized loss in the financial services sector relates to the banking sub-sector which has $1.7 million of gross unrealized losses on securities with a fair value of $33.2 million. Companies within the Company’s financial services sector are high in credit quality and, as a whole, represent a large portion of the corporate debt market.
The Company evaluated the near-term prospects of the issuers in relation to the severity and duration of the unrealized loss and does not consider those investments to be impaired at December 31, 2011. There are no individual issuers rated below investment grade in this sub-sector which have an unrealized loss position greater than $2.5 million.
There are no individual issuers rated below investment grade in the communications sub-sector which have unrealized loss positions greater than $2.5 million.
There are no individual issuers rated below investment grade in the ABS - housing related sector which have unrealized loss positions greater than $2.5 million.
Loss severity assumptions were determined by obtaining historical rates from broader market data and by adjusting those rates for vintage, specific pool performance, collateral type, mortgage insurance and estimated loan modifications. Prepayments were estimated by examining historical averages of prepayment activity on the underlying collateral. Once the entire pool is modeled, the results are closely analyzed by our asset specialists to determine whether or not our particular tranche or holding is at risk for not collecting all contractual cash flows taking into account the seniority and other terms of the tranches held. The Company impaired its particular tranche to the net present value of projected future cash flows when we expect that we will not receive all contractual cash flows on our tranches.
The Company’s $3.5 million of gross unrealized losses within the RMBS sector has a fair value of $14.6 million. The unrealized loss in the sector is primarily a result of the housing downturn the United States has experienced since 2007. Even with the stabilization over the past two years, fundamentals in RMBS continue to be weak, which impacts the magnitude of the unrealized loss. Delinquencies and severities in property liquidations remain at an elevated level, while prepayments remain at historically low levels. Due to the weak fundamental situation, reduced liquidity, and the requirement for higher yields due to market uncertainty, credit spreads remain elevated across the asset class.
For this holding in the RMBS portfolio, the underlying collateral pool has experienced higher than expected delinquencies and losses, which is further exacerbated by the impact of declining home values on borrowers using affordability products. This has led to the underlying collateral pool having reduced cash flows in comparison to expectations at origination. Increased losses have eroded the subordination in this security, which in turn has led to a decline in the level of protection to our tranche within the collateral pool. Due to an adverse change in cash flows, the Company’s holding above was last impaired to the net present value of projected future cash flows in 2010.
There are no other individual issuers rated below investment grade in the RMBS sector which have unrealized loss positions greater than $2.5 million.
Gross unrealized losses and OTTI on below investment grade AFS securities represented 68% and 71% of total gross unrealized losses and OTTI on all AFS securities at December 31, 2011 and 2010, respectively. Generally, below investment grade securities are more likely than investment grade securities to develop credit concerns. The ratios of estimated fair value to amortized cost reflected in the table below were not necessarily indicative of the market value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to December 31, 2011.
The assets depressed over 20% as well as over 40% and greater than one year at December 31, 2011 are related to RMBS, ABS backed by subprime mortgages and preferred stock (ABN AMRO) with exposure to the banking sector. With respect to RMBS, this holding is below investment grade and has been impaired to discounted cash flows with the remaining unrealized loss being reflected in OCI-OTTI. In regards to the ABS backed by subprime mortgages, as there has been no impact to expected future cash flows, the Company does not consider the underlying investments to be impaired at December 31, 2011. The drop in price for the ABN AMRO preferred stock was primarily due to high illiquidity in the markets in general due to the European debt crisis.
During 2011, 2010 and 2009, there was $0.6 million, $1.7 million and $1.7 million, respectively, of investment income on fixed maturity trading securities recorded in net investment income in the Statements of Income. During 2011 and 2010, there was $0.4 million and ($1.5) million, respectively, of income (loss) recognized from the change in the fair value on fixed maturity trading securities recorded in net investment income in the Statements of Income. The Company recognized losses of $0.1 million during 2011 on the conversion of fixed maturity trading securities to preferred stock. There were no conversions of fixed maturity trading securities to preferred stock in 2010 or 2009.
The Company adopted revised guidance for the recognition and presentation of OTTI effective at June 30, 2009. As permitted by the guidance, the Company recorded an increase of $3.5 million to the opening balance of retained earnings with a corresponding decrease to accumulated OCI on the Statement of Stockholder’s Equity to reclassify the non credit portion of previously other-than-temporarily impaired AFS securities held at April 1, 2009.
The fair value for mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or similar remaining maturities. The estimated fair value of the mortgage loans on commercial real estate at December 31, 2011 and 2010 was $61.8 million and $66.7 million, respectively.
The Company’s liquidity requirements include the payment of sales commissions and other underwriting expenses and the funding of its contractual obligations for the life insurance and annuity contracts it has in force. The Company has developed and utilizes a cash flow projection system and regularly performs asset/liability duration matching in the management of its asset and liability portfolios. The Company anticipates funding its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. At December 31, 2011 and 2010, the Company’s assets included $2.3 billion and $1.9 billion, respectively, of cash, short-term investments and investment grade publicly traded AFS securities that could be liquidated if funds were required.
During 2011 and 2010, the Company did not receive a capital contribution from AUSA nor did the Company pay a dividend to AUSA.
The financial strength rating scales of S&P, A.M. Best, and Fitch Ratings (“Fitch”) are characterized as follows:
The following table summarizes the Company’s policyholders’ obligations at December 31, 2011:
(a) The policyholder liabilities include benefit and claim liabilities of which a significant portion represents policies and contracts that do not have a stated contractual maturity. The projected cash benefit payments in the table above are based on management’s best estimates of the expected gross benefits and expenses, partially offset by the expected gross premiums, fees and charges relating to the existing business in force. Estimated cash benefit payments are based on mortality and lapse assumptions comparable with the Company’s historical experience, modified for recently observed trends. Actual payment obligations may differ if experience varies from these assumptions. The cash benefit payments are presented on an undiscounted basis and are before deduction of tax and before reinsurance. The liability amounts in the Company’s financial statements reflect the discounting for interest as well as adjustments for the timing of other factors as described above. As a result, the sum of the cash benefit payments shown for all years in the table above exceeds the corresponding policyholder liability amounts.
The Company has utilized public information to estimate the future assessments it will incur as a result of life insurance company insolvencies. At December 31, 2011 and 2010, the Company’s estimated liability for future guaranty fund assessments was $0.6 million and $5.1 million, respectively. In addition, the Company has a receivable for future premium tax deductions of $3.8 million and $4.0 million at December 31, 2011 and 2010, respectively. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
Policy charge revenue decreased $2.4 million to $202.2 million during 2011, as compared to $204.6 million in 2010. The following table provides the changes in policy charge revenue by type for each respective period:
(a) The change in credit related losses as compared to 2010 is primarily due to a decrease in OTTI impairments.
Accretion of DAC was $13.1 million and $3.7 million for 2011 and 2010, respectively, which included favorable (unfavorable) unlocking of ($3.0) million and $1.1 million, respectively. The increase in DAC in 2011 as compared to 2010 was principally driven by unfavorable equity markets and the long-term interest rate assumption change resulting in an increase in accretion and unfavorable unlocking.
(a) The decline in general insurance expenses is primarily due to a reduction in the future guaranty fund assessment liability and lower transition and system conversion related expenses in 2011 as compared to 2010.
For the years ended December 31, 2010 and 2009, the Company recorded net income (loss) of $137.9 million and ($203.1) million, respectively. The increase in income during 2010 as compared to 2009 was primarily due to the 2009 VOBA impairment, the change in the valuation allowance on deferred tax assets, unfavorable 2009 VOBA unlocking, a decrease in net realized investment losses and a decrease in insurance expenses and taxes.
(a) Asset-based policy charge revenue for 2010 was positively impacted by the increase in average variable account balances.
(b) The increase in annuity benefit expense was primarily driven by the relative change in the minimum guarantee reserves year over year and by risk neutral rate fluctuations in 2010 as compared to 2009.
Reinsurance premiums ceded increased $7.1 million during 2010 as compared to 2009 principally due to refined calculations related to a system conversion. At December 31, 2010, the Company has recaptured the majority of its life reinsurance which had started in second quarter of 2008.
The Company is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2011, 2010, or 2009.
The financials statements of Registrant are set forth in Part IV hereof and are incorporated herein by reference.