the amount of benefits potentially payable by the Insurance Group under the enhanced guarantee features offered in certain products, particularly the Accumulator ® series of variable annuity products, has increased substantially, which has increased the level of regulatory capital and reserves that the Insurance Group needs to maintain to support these products. The Insurance Group’s risk management program, which principally utilizes reinsurance and hedging, mitigated, but did not fully offset, the economic effect of these potential benefit increases.
the significant declines in Separate Accounts balances have reduced the fee income earned on such accounts.
the Insurance Group experienced an increase in writedowns of fixed maturities and unrealized losses.
In 2008, management took, and continues to take, actions designed to mitigate the impact or effects of the current economic disruption including, among others, the following:
Reinsurance. As part of its ongoing capital management efforts, AXA Equitable ceded to AXA Bermuda a 100% quota share of all liabilities for variable annuity GMBD and GMIB riders issued on or after January 1, 2006 and in-force on September 30, 2008.
AXA Bermuda Transaction. During fourth quarter 2008, the Company ceded Accumulator variable annuity GMDB and GMIB riders for policies issued from January 1, 2006 through September 30, 2008 to AXA Bermuda. AXA Bermuda, a captive life reinsurance company established by AXA Financial in 2003, reinsures level premium term insurance and lapse protection riders under universal life insurance policies issued by the Company. For the Company, the reinsurance transaction provided capital relief and mitigates the volatility of capital requirements.
AXA Bermuda placed $6.3 billion into a Regulation 114 Trust (the “Trust”), to support the reinsurance reserve credit at the Company. AXA Bermuda intends to hold a combination of assets in the Trust and/or letters of credit equal to the statutory reserves for this business, so that the Company will be permitted to take reserve credit for the reinsurance. AXA Bermuda may make additional deposits to the Trust, and may remove assets from the Trust, subject to quarterly reserve evaluations.
Net earnings for the Company totaled $3.23 billion for 2008, an increase of $1.99 billion from the $1.23 billion reported in 2007. The increase of $2.04 billion in the Insurance segment was offset by the decrease of $43.9 million in the Investment Management segment. Net earnings for 2008 and 2007 included the post-tax results from discontinued operations, detailed in the following schedule. For further information, see Note 16 of Notes to Consolidated Financial Statements included elsewhere herein.
Earnings from continuing operations in 2008 were $3.25 billion, an increase of $2.01 billion from $1.24 billion in 2007. Income taxes totaled $1.70 billion in 2008 as compared to the $759.8 million in 2007. The increase of $1.13 billion reported in the Insurance segment due to higher earnings was partially offset by $191.0 million lower taxes for the Investment Management segment taxes. The Investment Management segment’s taxes in 2008 reflected the impact of the approximately $58.2 million decrease related to the release of deferred taxes related to unremitted foreign earnings. The Company provides Feceral and state income taxes on the undistributed earnings of non-U.S. corporate subsidiaries except to the extent such earnings are permanently invested outside the United States.
Earnings from continuing operations before income taxes and minority interest were $5.42 billion for 2008, an increase of $2.72 billion from the $2.70 billion reported in 2007. The increase resulted from the $3.19 billion increase in the Insurance segment, partially offset by $468.3 million lower earnings in the Investment Management segment.
Total benefits and other deductions were $13.16 billion in 2008, a $4.45 billion increase as compared to $8.71 billion in 2007, the Insurance segment’s increase being partially offset by lower expenses for the Investment Management segment. The Insurance segment increase of $4.99 billion was primarily due to higher benefits paid and higher DAC amortization partially offset by lower compensation and benefits. There was a $550.8 million decrease in the Investment Management segment’s benefits and other deductions principally attributed to declines in compensation and benefits, other operating costs and expenses and distribution plan payments at AllianceBernstein.
Revenues. In 2008, segment revenues increased $8.18 billion over the prior year as higher net investment income and commissions, fees and other income more than offset higher investment losses, net.
Commissions, fees and other income increased $1.52 billion to $2.40 billion in 2008 as compared to $883.6 million in 2007 principally due to an increase in the fair value of the GMIB reinsurance contracts partially offset by a $45.3 million decrease in gross investment management and distribution fees received from EQAT and VIP Trust due to a lower asset base. As required by SFAS No. 133, the GMIB reinsurance contracts are considered derivatives and are reported at fair value. In 2008, the fair value of these contracts increased $1.56 billion, including the $210.6 million initial impact of adopting SFAS No. 157 on January 1, 2008, as compared to the $6.9 million increase recorded in 2007.
Benefits and Other Deductions. Total benefits and other deductions for the Insurance segment increased $4.99 billion to $10.63 billion in 2008 as compared to $5.64 billion in 2007. The increase was principally the result of a $2.70 billion increase in policyholders’ benefits, the $2.38 billion increase in DAC amortization and $325.2 million lower DAC capitalization offset by $307.1 million lower commission expense and a $85.8 million decrease in compensation and benefits.
Policyholders’ benefits were $4.70 billion in 2008, a $2.70 billion increase from $2.00 billion in 2007. The increase was principally due to a $2.70 billion increase in the GMDB/GMIB benefits and reserves due to changes in market conditions, reductions in interest rates, changes in market conditions and the growth of the business, of which $20.2 million relates to the Bermuda reinsurance transaction, a $272.6 million increase in the GWBL reserve, higher death claims and a $7.0 million increase in policyholder dividends.
For universal life products and investment-type products, DAC is amortized over the expected total life of the contract group as a constant percentage of estimated gross profits arising principally from investment results, Separate Account fees, mortality and expense margins and surrender charges based on historical and anticipated future experience, updated at the end of each accounting period. When estimated gross profits are expected to be negative for multiple years of a contract life, DAC is amortized using the present value of estimated assessments. The effect on the amortization of DAC of revisions to estimated gross profits or assessments is reflected in earnings in the period such estimated gross profits or assessments are revised. A decrease in expected gross profits or assessments would accelerate DAC amortization. Conversely, an increase in expected gross profits or assessments would slow DAC amortization. The effect on the DAC asset that would result from realization of unrealized gains (losses) is recognized with an offset to accumulated comprehensive income in consolidated shareholder’s equity as of the balance sheet date.
A significant assumption in the amortization of DAC on variable and interest-sensitive life insurance and variable annuities relates to projected future Separate Account performance. Management sets estimated future gross profit assumptions related to Separate Account performance using a long-term view of expected average market returns by applying a reversion to the mean approach. In applying this approach to develop estimates of future returns, it is assumed that the market will return to an average gross long-term return estimate, developed with reference to historical long-term equity market performance and subject to assessment of the reasonableness of resulting estimates of future return assumptions. For purposes of making this reasonableness assessment, management has set limitations as to maximum and minimum future rate of return assumptions, as well as a limitation on the duration of use of these maximum or minimum rates of return. At December 31, 2008, the average gross short-term and long-term annual return estimate is 9.0% (6.7% net of product weighted average Separate Account fees), and the gross maximum and minimum short-term annual rate of return limitations are 15.0% (12.7% net of product weighted average Separate Account fees) and 0.0% ((2.3%) net of product weighted average Separate Account fees), respectively. The maximum duration over which these rate limitations may be applied is 5 years. This approach will continue to be applied in future periods. If actual market returns continue at levels that would result in assuming future market returns of 15.0% for more than 5 years in order to reach the average gross long-term return estimate, the application of the 5 year maximum duration limitation would result in an acceleration of DAC amortization. Conversely, actual market returns resulting in assumed future market returns of 0.0% for more than 5 years would result in a required deceleration of DAC amortization. As of December 31, 2008, current projections of future average gross market returns assume a 9% return for 2009 through 2013, which is within the maximum and minimum limitations. To demonstrate the sensitivity of variable annuity DAC amortization, a 1% increase in the assumption for future Separate Account rate of return would result in an approximately $29.0 million net increase in DAC amortization due primarily to a projected decrease in the fair values of derivatives used to hedge certain risks related to these products and a 1% decrease in the assumption for future Separate Account rate of return would result in an approximately $75.7 million net decrease in DAC amortization. This information considers only the effect of changes in the future Separate Account rate of return and not changes in any other assumptions used in the measurement of the DAC balance.
All other operating costs and expenses totaled $722.6 million in 2008, a decrease of $31.0 million from the $753.6 million reported in 2007. The 2008 decrease was primarily due to lower EQAT and VIP Trust subadvisory fees partially offset by higher consulting expenses.
Premiums and Deposits. Total premiums and deposits for life insurance and annuity products in 2008 were $17.13 billion, a decrease of $2.49 billion from prior year’s level of $19.62 billion, as total first year premiums and deposits decreased $2.44 billion to $12.39 billion from $14.83 billion. First year premiums and deposits for annuity products decreased by $2.14 billion to $11.87 billion in 2008 from $14.01 billion in 2007 with lower first year sales of $1.73 billion and $416.7 million in the wholesale and retail channels, respectively, due to the difficult economic and market environment. First year premiums and deposits for the life products decreased $290.4 million to $510.2 million from $800.6 million primarily due to $287.4 million lower sales of interest sensitive life products in the wholesale channel.
In July 2007, AXA Equitable launched two new universal life insurance products. These new universal life products are currently available for new sales in place of the prior product. The prior universal life product accounted for 17.4% and 68.7% of first year life premiums and deposits for the Insurance segment for 2008 and 2007, respectively. The new universal life products are expected to be more competitive at certain issue ages. They are less competitive for older issue ages. Since a substantial portion of AXA Equitable’s life insurance sales came from sales of the prior universal life product to customers at older issue ages, the introduction of the new products has reduced total universal life sales while increasing overall margins on sales of the new products as compared to the prior product. As a result of the severe decline and volatility in the equity markets and the continued decline of interest rates in 2008, AXA Equitable has revised and/or eliminated the sale of certain annuity and life insurance products, taking into account customer needs and preferences, competitive market considerations, risk management and capital utilization. Potential changes to the guarantee features, pricing and/or Separate Account investment options may make annuity and life insurance products offered by AXA Equitable less competitive versus similar products in the marketplace or less attractive relative to other financial products, which could adversely affect the sales of AXA Equitable’s annuity and life insurance products. AXA Equitable may offer new and/or different products, and it may also further revise, suspend or discontinue one or more of its product offerings as conditions in the marketplace and capital markets develop.
Surrenders and Withdrawals. Surrenders and withdrawals decreased $2.04 billion to $8.04 billion during 2008 compared to $10.07 billion in 2007. There was a $2.06 billion decrease in individual annuities surrenders and withdrawals of which $223 million was due to lower surrenders of fixed annuities sold five years ago ($486 million in 2008 as compared to $709.2 million in the prior year). Overall, the annualized annuities surrender rate decreased to 7.9% in 2008 from 9.6% in 2007. In 2008, variable and interest-sensitive life insurance surrenders and withdrawals increased by $14.0 million to $832.1 million from $818.1 million while traditional life surrenders and withdrawals were $278.1 million, $8.7 million higher than the $269.4 million in 2007. The individual life surrender rates increased to 4.0% in 2008 from 3.7% in 2007. The surrender and withdrawal rates excluding fixed annuities described above continue to fall within the range of expected experience.
Included fees earned by AllianceBernstein totaling $29.7 million and $31.8 million in 2008 and 2007, respectively, for services provided to the Insurance Group.
Included invested assets of the Company not managed by AllianceBernstein, principally cash and short-term investments and policy loans, totaling approximately $22.60 billion and $10.92 billion at December 31, 2008 and 2007, respectively, as well as mortgages and equity real estate totaling $4.21 billion and $4.28 billion at December 31, 2008 and 2007, respectively.
Liquidity Requirements. AXA Equitable’s liquidity requirements principally relate to the liabilities associated with its various life insurance, annuity and group pension products in its continuing operations; the liabilities of the discontinued Wind-up Annuities operations; shareholder dividends to AXA Financial; and operating expenses, including debt service. AXA Equitable’s liabilities include, among other things, the payment of benefits under life insurance, annuity and group pension products, as well as cash payments in connection with policy surrenders, withdrawals and loans.
On July 17, 2008, AXA Equitable was accepted as members of the Federal Home Loan Bank of New York (“FHLBNY”) which provides AXA Equitable with access to collateralized borrowings and other FHLBNY products. As membership requires the ownership of member stock, AXA Equitable purchased stock to meet its membership requirement for $13.5 million. The credit facility provided by FHLBNY will supplement existing liquidity sources and provide a diverse and reliable source of funds. Any borrowings from the FHLBNY will require the purchase of FHLBNY activity based stock in an amount equal to 4.5% of the borrowings. AXA Equitable’s borrowing capacity with FHLBNY is $1.00 billion. As a member of FHLBNY, AXA Equitable can receive advances for which it would be required to pledge qualified mortgage-backed assets and government securities as collateral. At December 31, 2008, there were no outstanding borrowings from FHLBNY.
Sources of Liquidity. The principal sources of AXA Equitable’s cash flows are premiums, deposits and charges on policies and contracts, investment income, repayments of principal and sales proceeds from its fixed maturity portfolios, sales of other General Account Investment Assets, borrowings from third parties and affiliates and dividends and distributions from subsidiaries.
AllianceBernstein’s primary sources of liquidity have been cash flows from operations, proceeds from sales of investments, the issuance of commercial paper and additional investments by AllianceBernstein Holding using proceeds from exercises of compensatory options to buy AllianceBernstein Holding units. AllianceBernstein requires financial resources to fund distributions to its General Partner and Unitholders, capital expenditures, net repayments of commercial paper, purchases of investments and purchases of Holding units to fund deferred compensation plans. AllianceBernstein currently has $200.0 million available under a shelf registration statement for future issuances.
AllianceBernstein has a $1.00 billion five-year revolving credit facility with a group of commercial banks and other lenders that expires in 2011. It is intended to provide back-up liquidity for AllianceBernstein’s $1.00 billion commercial paper program, although AllianceBernstein borrows directly under the facility from time to time. Under the revolving credit facility, the interest rate, at AllianceBernstein’s option, is a floating rate generally based upon a defined prime rate, a rate related to LIBOR or the Federal Funds rate. The revolving credit facility contains covenants that, among other things, require AllianceBernstein to meet certain financial ratios. AllianceBernstein was in compliance with the covenants at December 31, 2008. At December 31, 2008, $284.8 million in commercial paper was outstanding; no amounts were outstanding under any other program at that date.
In January 2008, SCB LLC entered into a $950.0 million three-year revolving credit agreement with a group of commercial banks to fund its obligations resulting from engaging in certain securities trading and customer activities. Under the revolving credit facility, the interest rate, at the option of SCB LLC, is a floating rate generally based upon a defined prime rate, a rate related to LIBOR or the Federal Funds rate. In January 2008, AllianceBernstein and AXA executed guarantees related to SCB LLC’s credit facility. In the event SCB LLC is unable to meet its obligations, AllianceBernstein or AXA will pay the obligations when due on demand. AllianceBernstein will reimburse AXA to the extent AXA must pay on its guarantee. This agreement is continuous and remains in effect until the later of payment in full of any obligation under the credit facility has been made or the maturity date.
Certain of AllianceBernstein’s deferred compensation plans provide for the election by participants to have their deferred compensation awards notionally invested in AllianceBernstein Holding units or AllianceBernstein sponsored investment services. From time to time, AllianceBernstein will fund participant elections. In 2008 and 2007, respectively, subsidiaries of AllianceBernstein purchased AllianceBernstein Holding units totaling $2.4 million and $50.9 million for such plans.
AXA Financial, AXA Equitable and AllianceBernstein, along with other AXA affiliates, participate in certain cost sharing and servicing agreements, which include technology and professional development arrangements. Payments by AXA Equitable and AllianceBernstein to AXA under such agreements totaled approximately $45.3 million, $32.9 million and $30.1 million in 2008, 2007 and 2006, respectively. Payments by AXA and AXA affiliates to the Company under such agreements totaled approximately $28.1 million, $27.7 million and $27.9 million in 2008, 2007 and 2006, respectively. Included in the payments by AXA and AXA affiliates to the Company were $12.9 million, $13.5 million and $12.6 million from AXA Tech for 2008, 2007 and 2006, respectively. AXA Equitable provided and paid for certain services at cost on behalf of AXA Tech; these costs which totaled $117.6 million, $110.7 million and $98.4 million for 2008, 2007 and 2006, respectively, offset the amounts AXA Financial Group were charged in those years for services provided by AXA Tech.
See Notes 11 and 18 of Notes to the Consolidated Financial Statements contained elsewhere herein and AllianceBernstein’s Report on Form 10-K for the year ended December 31, 2008 for information on related party transactions.
A schedule of future payments under certain of the Company’s consolidated contractual obligations follows:
Interest on long-term debt will be approximately $15.4 million per annum in years 2009 through 2013, while interest on loans from affiliates will be approximately $90.5 million per annum in years 2009 through 2013.
In December 2008, AXA Financial increased the capital of AXA Bermuda by $2.8 billion through a contribution of $2.0 billion in cash and approximately $800.0 million in fair value of AllianceBernstein Units.
DAC- For universal life and investment-type contracts and participating traditional life policies, DAC amortization may be affected by changes in estimated gross profits or assessments and margins principally related to investment results, Separate Account performance, Separate Account fees, mortality and expense margins, lapse rates and anticipated surrender charges. The effect on amortization of DAC of revisions to estimated gross profits or assessments is reflected in earnings in the period such estimated gross profits or assessments are revised. Additionally, the level of deferrable Insurance Group operating expenses is another significant factor in that business’ reported profitability in any given period.
Commissions paid to financial intermediaries in connection with the sale of shares of open-end mutual funds sold without a front-end sales charge are capitalized as deferred sales commissions and are amortized over periods not exceeding five and one-half years, the periods of time during which the deferred sales commissions are generally recovered from distribution fees received from those funds and from contingent deferred sales commissions received from shareholders of those funds upon redemption of their shares. The recoverability of these commissions is estimated based on management’s assessment of these future revenue flows.
Benefit Plan Costs - Net periodic pension cost is the aggregation of the compensation cost of benefits promised, interest cost resulting from deferred payment of those benefits, and investment results of assets dedicated to fund those benefits. Each cost component is based on the Company’s best estimate of long-term actuarial and investment return assumptions. Actual experience different from that assumed generally is recognized prospectively over future periods; however, significant variances could result in immediate recognition if they exceed certain prescribed thresholds or in conjunction with a reconsideration of the related assumptions.
Share-based and Other Compensation Programs - Prior to the adoption of SFAS No. 123(R) on January 1, 2006, equity settled stock option awards only resulted in compensation expense if the current market price of the underlying stock exceeded the option strike price at the grant date. Compensation expense for cash settled award programs, such as tandem Stock Appreciation Rights and Performance Units, was recorded based upon changes in the fair value of the AXA ADRs or AXA shares. In connection with the adoption of SFAS No. 123(R), the Company began recognizing compensation expense for the unvested portion of awards outstanding on January 1, 2006 over the balance of the vesting period and for new awards after January 1, 2006, for the fair values of the option awards over the vesting period. Significant factors that could affect results include, but are not limited to, assumptions incorporated in the option pricing models, changes in the market price of AXA ADRs and AXA ordinary shares and grants of additional awards.
Significant management judgment is required in determining the provision for income taxes and deferred tax assets and liabilities and in evaluating the Company’s tax positions including evaluating uncertainties under FIN 48, “Accounting for Uncertainty in Income Taxes”. Under FIN 48, the Company determines whether it is more-likely-than-not that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. Tax positions are then measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement.
The Company’s tax positions are reviewed quarterly and the balances are adjusted as new information becomes available.