THE FOLLOWING DISCUSSION HIGHLIGHTS SIGNIFICANT FACTORS INFLUENCING RESULTS OF OPERATIONS AND CHANGES IN FINANCIAL POSITION OF ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK (THE "COMPANY"). IT SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND RELATED NOTES. TO CONFORM WITH THE 2000 PRESENTATION, CERTAIN PRIOR YEAR AMOUNTS HAVE BEEN RECLASSIFIED.
The Company, 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 ("Corporation"), markets life and investment products in the state of New York through a combination of exclusive and independent agencies, securities firms, banks, specialized brokers and direct response marketing. Life products consist of traditional products, including term and whole life, interest-sensitive life and immediate annuities with life contingencies. Investment products include deferred annuities and immediate annuities without life contingencies. Deferred annuities include fixed rate, market value adjusted and variable annuities.
The assets and liabilities related to variable annuity contracts are legally segregated and reflected as Separate Accounts. The assets of the Separate Accounts are carried at fair value. Separate Accounts liabilities represent the contractholders' claims to the related assets and are carried at the fair value of the assets. In the event that the asset value of certain contractholder accounts are projected to be below the value guaranteed by the Company, a liability is established through a charge to earnings. Investment income and realized capital gains and losses of the Separate Accounts accrue directly to the contractholders and therefore, are not included in the Company's statements of operations.
(2) Realized capital gains and losses, after-tax is presented net of the effects of the Company's deferred policy acquisition cost amortization and additional future policy benefits to the extent that such effects resulted from the recognition of realized capital gains and losses.
Statutory premiums and deposits, which include premiums and deposits for all products, are used to analyze sales trends. The following table summarizes statutory premiums and deposits by product line.
Net investment income increased 19.0% and 10.4% in 2000 and 1999, respectively. Increases in both years were due to higher investment balances, lower expenses and increased investment yields. Investments, excluding Separate Accounts assets and unrealized gains on fixed income securities, grew 21.7% and 10.7% in 2000 and 1999, respectively. The increase in both years was due primarily to positive cash flows from operations.
Operating income increased 22.7% or $6.3 million in 2000 to $34.3 million. The increase was due to increased net investment income and premiums and contract charges partially offset by higher contract benefits. Mortality margin was impacted favorably by $1.7 million as mortality results on immediate annuities with life contingencies were positive in 2000 compared to a loss in 1999. Increased expenses during 2000 are due primarily to additional investments in technology, distribution and marketing. Net investment margin increased by $700 thousand primarily due to lower investment expenses and a larger asset base coupled with slightly higher yielding assets. Operating income increased 11.5% or $2.9 million in 1999 to $27.9 million as favorable mortality experience and increased contract charges were partially offset by higher expenses.
- The Company's contract charge revenue is dependent upon sustaining balances in assets of the Separate Accounts supporting its variable annuity products. These balances may increase in 2001 with sales volume increases, but such increases may be offset by fluctuating stock performance during the year. Sales could also be adversely impacted by declines in market conditions.
in 2000 and expects product growth to continue partially due to new product offerings, as well as increases in wholesaling activities.
- Investments in technology distribution and marketing are expected to impact profitability.
- The Company is experiencing increased competition. In order to compete with larger traditional insurance companies, as well as non-traditional competitors, such as banks and securities firms, the Company will have to reduce distribution costs and increase economies of scale.
The Company administers and oversees its investment risk management processes primarily through its Board of Directors, Investment Committee and the Credit and Risk Management Committee ("CRMC"). The Board of Directors and Investment Committee provide executive oversight of investment activities. The CRMC is a senior management committee consisting of the Chief Investment Officer, the Investment Risk Manager, and other investment officers who are responsible for the day-to-day management of investment risk. The CRMC meets at least monthly to provide detailed oversight of investment risk, including market risk.
The Company manages the interest rate risk inherent in its assets relative to the interest rate risk inherent in its liabilities. One of the measures the Company uses to quantify this exposure is duration. Duration measures the sensitivity of the fair value of assets and liabilities to changes in interest rates. For example, if interest rates increase 1%, the fair value of an asset with a duration of 5 is expected to decrease in value by approximately 5%. At December 31, 2000, the difference between the Company's liability and asset duration was approximately 1.5 versus a 1.4 gap at December 31, 1999. This duration gap indicates that the fair value of the Company's liabilities is more sensitive to interest rate movements than the fair value of its assets.
The Company's principal sources of funds are premiums and contract charges; deposits; receipts of principal, interest from the investment portfolio; and capital contributions from ALIC, its parent. The primary uses of these funds are to purchase investments and pay policyholder claims, benefits, contract maturities, contract surrenders and withdrawals and operating costs.
The maturity structure of the Company's fixed income securities, which represent 89.3% of the Company's total investments, is managed to meet the anticipated cash flow requirements of the underlying liabilities. A portion of the Company's diversified product portfolio, primarily fixed deferred annuity and interest-sensitive life insurance products, is subject to discretionary surrender and withdrawal by contractholders. Total surrenders and withdrawal amounts were $99.2 million, $62.1 million, and $56.5 million in 2000, 1999, and 1998, respectively. As the Company's interest-sensitive life policies and annuity contracts in force grow and age, the dollar amount of surrenders and withdrawals will likely increase. While the overall amount of surrenders may increase in the future, a significant increase in the level of surrenders relative to total contractholder account balances is not anticipated.
(1) Fixed income securities are carried at fair value. Amortized cost for these securities was $2,260,087 at December 31, 2000.
The Company's fixed income securities portfolio consists of privately-placed securities, U.S. government bonds, publicly traded corporate bonds, , mortgage-backed securities, municipal bonds, foreign government bonds, and asset-backed securities. The Company generally holds its fixed income securities to maturity, but has classified all of these securities as available for sale to allow maximum flexibility in portfolio management. At December 31, 2000, unrealized net capital gains on the fixed income securities portfolio totaled $216.0 million compared to $54.3 million at December 31, 1999. The increase in the unrealized gain position is primarily attributable to interest rate fluctuations from year to year.
At December 31, 2000 and 1999, $381.0 million and $288.7 million, respectively, of the fixed income securities portfolio were invested in mortgage-backed securities ("MBS"). The MBS portfolio consists primarily of securities which were issued by or have underlying collateral that is guaranteed by U.S. government agencies or sponsored entities. Therefore the MBS portfolio has relatively low credit risk.
In June 1999, the Financial Accounting Standards Board ("FASB") delayed the effective date of Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 replaces existing pronouncements and practices with a single, integrated accounting framework for derivatives and hedging activities. The delay in implementation was effected through the issuance of SFAS No. 137, which extends the SFAS No. 133 requirements to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, which amends the accounting and reporting standards of SFAS 133 for certain derivative instruments and certain hedging activities. As required, the Company has prospectively adopted the provisions of SFAS No. 133 and SFAS No. 138 ("statements") as of January 1, 2001. The cumulative impact of adoption is not material to either the financial position or results of operations of the Company.
Upon adoption, assets and liabilities pertaining to derivatives (some previously off balance sheet), certain embedded derivatives and hedged risks are carried at fair value. In connection with adopting the statements, all hedging relationships were designated anew. The Company's economic hedging strategies did not change as a result of adopting the statements, however, the accounting for most strategies did change. The fair value of the derivative and the hedged risk in economic hedging strategies which qualify for hedge accounting will be matched together in Net income. For derivatives in economic hedging strategies which do not qualify as accounting hedges, the current settlement portion of the derivative will be classified in Net income together with the risk being economically hedged while the change in value of the final settlement portion of the derivative will be classified as a component of Realized capital gains and losses.
Hedge ineffectiveness for open accounting hedges will be reported in realized capital gains and losses. Additionally, the market value changes of embedded derivatives reported separately will be classified in realized capital gains and losses, provided the item is not economically hedged. Separation of the convertible feature from fixed maturity securities results in a discounted security and a new basis for accretion of discount.
Forward-looking statements do not relate strictly to historical or current facts and may be identified by their use of words like "plans," "expects," "will," "anticipates," "estimates," "intends," "believes," "likely," and other words with similar meanings. These statements may address, among other things, our strategy for growth, product development, regulatory approvals, market position, expenses, financial results and reserves. Forward-looking statements are based on management's current expectations of future events. We cannot guarantee that any forward-looking statement will be accurate. However, we believe that our forward-looking statements are based on reasonable, current expectations and assumptions. We assume no obligation to update any forward-looking statements as a result of new information or future events or developments.
- - Changes in market interest rates can have adverse effects on the Company's investment portfolio, investment income, product sales and results of operations. Increases in market interest rates have an adverse impact on the value of the investment portfolio by decreasing unrealized capital gains on fixed income securities. Declining market interest rates could have an adverse impact on the Company's investment income as the Company invests proceeds from positive cash flows from operations and reinvests proceeds from maturing and called investments into new investments that could be yielding less than the portfolio's average rate. Changes in market rates of interest, as compared to rates offered on some of the Company's products, could make those products less attractive if competitive investment margins are not maintained. This could lead to lower sales and/or changes in the level of surrenders on these products. The Company seeks to limit its exposure in this area by offering a diverse group of products, periodically reviewing and revising crediting rates and providing for surrender charge in the event of early withdrawal.
- - In order to meet the anticipated cash flow requirements of its obligations to policyholders, from time to time the Company adjusts the effective duration of the assets and liabilities of the Company's investment portfolio. Those adjustments may have an impact on the value of the investment portfolio and on investment income.
- - Management believes the reserves for life-contingent contract benefits are adequate to cover ultimate policy benefits, despite the underlying risks and uncertainties associated with their determination when payments will not occur until well into the future. The Company periodically reviews and revises its estimates. If future experience differs from assumptions, it may have a material impact on results of operations.
- - The Company distributes some of its products under agreements with other members of the financial services industry that are not affiliated with the Company. Termination of one or more these agreements due to changes in control of any of these entities or other factors could have a detrimental effect on the Company's sales. This risk may be exacerbated due to the enactment of the Gramm-Leach-Bliley Act of 1999, which eliminates many federal and state law barriers to affiliations among banks, securities firms, insurers and other financial service providers.
- In addition, state insurance regulators are reexamining the regulatory framework that currently governs the United States insurance business. They are engaged in an effort to determine the proper role of state insurance regulation in the United States financial services industry following the enactment of the Gramm-Leach-Bliley Act. The Company cannot predict whether any state or federal measures will be adopted to change the nature or scope of the regulation of the insurance business or what affect any such measures would have on the Company.
- - Financial strength ratings have become an increasingly important factor in establishing the competitive position of insurance companies and, generally, may be expected to have an effect on an insurance company's sales. On an ongoing basis, rating agencies review the financial performance and condition of insurers. A downgrade, while not expected, could have a material adverse effect on the Company's business, financial condition and results of operations.
- - Additional risk factors regarding market risk are incorporated by reference to the discussion of "Market Risk" beginning on page 8.