may differ materially from expectations conveyed in forward-looking statements due to changes caused by various risks and uncertainties. The reader should, however, consult any further disclosures TALICNY may make in future filings of its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K.
The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the reported amounts of revenues and expenses. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ and could have a material impact on the financial statements, and it is possible that such changes could occur in the near term.
To understand the valuation methodologies used by third-party pricing services, the Company reviews and monitors their applicable methodology documents. Any changes to their methodologies are noted and reviewed for reasonableness. In addition, the Company performs in-depth reviews of prices received from third-party pricing services on a sample basis. The objective for such reviews is to demonstrate that the Company can corroborate detailed information such as assumptions, inputs and methodologies used in pricing individual securities against documented pricing methodologies. Only third-party pricing services and brokers with a substantial presence in the market and with appropriate experience and expertise are used.
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, 2012 and 2011, approximately $2.0 million (or 2%) and $1.8 million (or 1%), respectively, of the Company’s fixed maturity and equity securities portfolio consisted of private placement securities.
VOBA represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the insurance and annuity contracts in force at the acquisition date. VOBA is based on actuarially determined projections, for each block of business, of future policy and contract charges, premiums, mortality, policyholder behavior, Separate Account performance, operating expenses, investment returns, and other factors. Actual experience on the purchased business may vary from these projections. Revisions in estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future gross profits are less than the unamortized balance. At December 31, 2012 and 2011, the Company’s VOBA asset was $25.2 million and $27.6 million, respectively. For the years ended December 31, 2012, 2011 and 2010, the favorable (unfavorable) impact to pre-tax net income related to VOBA unlocking was $0.2 million, ($0.7) million and $0.6 million, respectively. There were no impairment charges in 2012, 2011 and 2010. See Note 4 to the Financial Statements for a further discussion.
The costs of acquiring business, principally commissions, certain expenses related to policy issuance, and certain variable sales expenses that relate to and vary with the production of new and renewal business are deferred and amortized based on the estimated future gross profits for a group of contracts. DAC are subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each reporting period. At December 31, 2012 and 2011, variable annuities accounted for the Company’s entire DAC asset of $0.3 million and $0.5 million, respectively.
Future policy benefits are actuarially determined liabilities, which are calculated to meet future obligations and are generally payable over an extended period of time. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, surrender rates, policy expenses, equity returns, interest rates, and inflation. These estimates and assumptions are influenced by historical experience, current developments and anticipated market trends. At December 31, 2012 and 2011, future policy benefits were $16.5 million and $19.1 million, respectively.
Included within future policy benefits are liabilities for GMDB and GMIB provisions contained in the variable products that the Company issued. At December 31, 2012 and 2011, GMDB and GMIB liabilities included within future policy benefits were as follows:
At December 31, 2012 and 2011, the Company did not have a tax valuation allowance for deferred tax assets. A tax valuation allowance was not deemed necessary as management determined that it is more likely than not that the deferred tax assets will 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.
ASU 2011-05, Presentation of Comprehensive Income - requires an entity to report components of comprehensive income in either a single continuous statement of comprehensive income or two separate but consecutive statements - adopted January 1, 2012.
The following outlines the adoption of recent accounting guidance in 2011. See Note 1 to the Financial Statements for a further discussion.
ASC 820, Fair Value Measurements and Disclosure - ASU 2010-06, Improving Disclosures about Fair Value Measurement - requires separate presentation of information about purchases, sales, issuances, and settlements in the Level 3 reconciliation for fair value measurements using significant unobservable inputs - adopted January 1, 2011.
Total direct deposits (including internal exchanges) were $0.3 million, $0.9 million and $1.0 million for the years ended December 31, 2012, 2011 and 2010, respectively. The decrease in deposits was primarily due to the Company ceasing to issue new variable annuity and market value adjusted annuity products in 2009. Internal exchanges during 2012, 2011 and 2010 were $0.1 million $0.2 million and $0.4 million, respectively.
There were no fixed contract owner deposits in 2012, 2011 and 2010. During 2012, 2011 and 2010, fixed contract owner withdrawals were $4.7 million, $6.7 million, and $8.1 million, respectively.
The amortized cost/cost and estimated fair value of investments in fixed maturity and equity AFS securities at December 31, 2012 and 2011 were:
As of December 31, 2012, there are no industry sectors with significant unrealized losses.
The amortized cost and estimated fair value of fixed maturity AFS securities at December 31, 2012 and 2011 by rating agency equivalent were:
The Company defines investment grade securities as unsecured debt obligations that have a rating equivalent to S&P’s BBB- or higher (or similar rating agency). At December 31, 2012 and 2011, approximately $2.4 million (or 2%) and $4.1 million (or 3%), respectively, of fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by S&P. Below investment grade securities are speculative and are subject to significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. The Company closely monitors such investments.
(1) Subsequent unrealized gains/losses on OTTI securities are included in OCI-OTTI.
The estimated fair value and amortized cost of the subprime mortgage investments at December 31, 2011 was $1.6 million, consisting entirely in first lien - fixed rate, AAA quality and vintages prior to 2004.
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, 2012 and 2011, the Company’s assets included $185.1 million and $174.1 million, respectively, of cash, short-term investments and investment grade publicly traded AFS securities that could be liquidated if funds were required.
the net earnings from investment of fixed rate life insurance and annuity contract owner deposits less interest credited to contract owners, commonly known as interest spread
Policy charge revenue decreased $1.1 million (or 7.9%) to $12.9 million during 2012, as compared to $14.0 million in 2011. The following table provides the changes in policy charge revenue by type for each respective period:
(a) The decrease in asset-based policy charge revenue for 2012 was principally due to a decrease in average variable account balances.
Policy benefits decreased $4.9 million during 2012 as compared to 2011. The following table provides the changes in policy benefits by type:
(a) The decrease in interest related gains in 2011 as compared to 2010 is primarily due to a decrease in gains on sales of fixed maturity securities in 2011.
Policy benefits increased $2.8 million during 2011 as compared to 2010. The following table provides the changes in policy benefits by type:
(c) Life insurance mortality expense decreased in 2011 as compared to 2010 primarily due to 2010 claims with a high net amount at risk.
Amortization of VOBA was $1.6 million for the year ended December 31, 2011, which included unfavorable unlocking of $0.7 million. Amortization of VOBA was $1.2 million for the year ended December 31, 2010, which included favorable unlocking of $0.6 million. 2011 was impacted by unfavorable equity markets and long-term interest rate assumption changes during the third quarter resulting in lower amortization expense and unfavorable unlocking as compared to 2010.
Insurance expenses and taxes decreased $0.7 million in 2011 as compared to 2010. The following table provides the changes in insurance expenses and taxes for each respective period:
(a) The decline in general insurance expenses is primarily due to lower transition and system conversion related expenses in 2011 as compared to 2010.