The Registrant's home office is located at 100 Church Street, 11th Floor, New York, New York. This office space is leased from MLPF&S. In addition, personnel performing services for the Registrant pursuant to its Management Services Agreement operate in MLIG office space. MLIG occupies certain office space in Princeton, New Jersey through Merrill Lynch & Co. An allocable share of the cost of each of these premises is paid by the Registrant through the service agreement with MLIG. Merrill Lynch Insurance Group Services, Inc. ("MLIGS"), an affiliate of MLIG owns office space in Jacksonville, Florida. MLIGS also leases certain office space in Springfield, Massachusetts from Picknelly Family Limited Partnership. During 2001, MLIGS consolidated operations into the Jacksonville, Florida location. MLIGS continues to lease the office space in Springfield, Massachusetts, although there are no personnel at that location.
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Financial Statements and Notes to Financial Statements included herein.
In addition to providing historical information, ML of New York may make or publish forward-looking statements about management expectations, strategic objectives, business prospects, anticipated financial performance, and other similar matters. A variety of factors, many of which are beyond ML of New York's control, affect the operations, performance, business strategy, and results of ML of New York and could cause actual results and experience to differ materially from the expectations and objectives expressed in these statements. These factors include, but are not limited to, the factors listed in the Business Environment and Economic Environment sections listed below, as well as actions and initiatives taken by both current and potential competitors and the effect of current, pending, and future legislation and regulation. ML OF NEW YORK UNDERTAKES NO RESPONSIBILITY TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS.
ML of New York has determined that its financial exposure related to the events and aftermath of the terrorist attacks ("Attacks") on September 11, 2001 can be characterized into the following risk categories: mortality risk, equity price risk, and credit risk. The following discusses each type of risk in greater detail and its impact, either actual or potential, on ML of New York.
- - Reductions in separate accounts assets. Asset based fees collected on separate accounts assets are a primary source of earnings for ML of New York, thus lower asset balances will result in lower fee income. During the month of September 2001, ML of New York's separate accounts assets decreased $64.6 million, or 7% as compared to August 2001. A decrease of approximately $66.1 million was due to negative investment performance in the underlying mutual funds supporting variable products. Although investment performance rebounded during the fourth quarter 2001, earnings have been negatively impacted due to this reduction in separate accounts assets. - - Increased exposure to guaranteed minimum death benefits. Due to decreasing variable contract owner account values, there is an increasing number of contracts, and amounts per contract, in which guaranteed minimum death benefits exceed those contract owner account values. This may result in greater future mortality expense given the current reduced level of variable account balances.
Credit Risk - Airline, insurance, and hotel & tourism sectors have been particularly impacted by the Attacks. As such, credit quality within those sectors has been negatively affected. ML of New York monitors its credit exposure to these sectors on a daily basis. ML of New York has not incurred any realized losses due to the sale or book value writedown of any securities in the sectors noted above.
ML of New York conducts its business in the life insurance and annuity markets of the financial services industry. These markets are highly regulated with particular emphasis on company solvency and sales practice monitoring.
The financial services industry continues to be affected by the intensifying competitive environment as demonstrated by consolidation through mergers and acquisitions, competition from new entrants, and traditional competitors using the internet or other technology to establish or expand their businesses. In addition, the Gramm-Leach-Bliley Act, passed in 1999, represented a significant accomplishment in the effort to modernize the financial services industry in the U.S. by repealing Depression-era barriers between commercial banking, investment banking, and insurance activities. This legislation, together with other changes in the financial services industry made possible by previous reforms, has increased the number of companies competing for a similar customer base.
ML of New York's financial position and/or results of operations are primarily impacted by the following economic factors:
ML of New York sells variable and interest sensitive life insurance and annuity products through Merrill Lynch & Co.'s retail network of Financial Advisors. ML of New York competes for Merrill Lynch & Co.'s clients' life insurance and annuity business with unaffiliated insurers whose products are also sold through Merrill Lynch & Co.'s retail network, and with insurers who solicit this business directly. The product lines that ML of New York offers are focused in the highly competitive market segment of retirement and death benefit planning. ML of New York competes in this market segment by integrating its products into Merrill Lynch & Co.'s planning-based financial management program.
ML of New York's financial management is based on conservative investment and liability management and regular monitoring of its risk profile. ML of New York also seeks to provide superior customer service and financial management to promote the competitiveness of its products. ML of New York's customer service centers have established standards of performance that are monitored on a regular basis. Managers and employees in the customer service centers are periodically evaluated based on their performance in meeting these standards.
ML of New York's total sales increased 39% during 2001, as compared to a 5% decrease during 2000. Variable annuity sales increased $34.9 million (or 47%) during 2001 and continue to dominate overall sales by comprising 95%, 90%, and 89% of total direct premiums during 2001, 2000, and 1999, respectively. During 2001, variable annuity sales were favorably impacted by the introduction of the C-Share variable annuity product.
Management believes that variable annuity sales are impacted by the performance of the equity markets, therefore future variable annuity sales could be negatively impacted by the continuation of:
During 2001, ML of New York experienced contract owner deposits that exceeded withdrawals by $25.3 million. The components of contract owner transactions were as follows:
ML of New York'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 inforce. ML of New York 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. ML of New York anticipates funding all its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. As of December 31, 2001, ML of New York's assets included $164.4 million of cash, short-term investments and investment grade publicly traded available-for-sale securities that could be liquidated if funds were required.
ML of New York believes that it will be able to fund the capital and surplus requirements of projected new business from current statutory earnings and existing statutory capital and surplus. If sales of new business significantly exceed projections, ML of New York may have to look to its parent and other affiliated companies to provide the capital or borrowings necessary to support its current marketing efforts. ML of New York's future marketing efforts could be hampered should its parent and/or affiliates be unwilling to commit additional funding.
ML of New York's gross earnings are principally derived from two sources:
The costs associated with acquiring contract owner deposits are amortized over the period in which ML of New York anticipates holding those funds. In addition, ML of New York incurs expenses associated with the maintenance of inforce contracts.
Net earnings derived from interest spread decreased $1.8 million during 2001 as compared to 2000. The decrease in interest spread is primarily a result of ML of New York's $35.0 million dividend payment to MLIG during the fourth quarter 2000, as well as the reduction in invested assets resulting from the decline in fixed rate contracts inforce.
Insurance expenses and taxes increased $0.7 million (or 16%) during 2001 as compared to 2000. The increase in insurance expenses and taxes is primarily due to $1.0 million of costs related to the consolidation of ML of New York's policy administration service centers.
ML of New York's effective federal income tax rate increased to 45% for 2001 from 32% for 2000. During 2001, ML of New York recorded a $0.8 million (net of tax) adjustment for interest expense. Excluding this interest expense adjustment, ML of New York's effective federal income tax rate was 34% for 2001.
Policy benefits increased $1.2 million (or 183%) during 2000 as compared to 1999 due to significantly increased mortality for interest sensitive life insurance products.
Reinsurance premium ceded increased $0.2 million (or 10%) to $2.0 million during 2000. This increase is attributable to the combined effect of the increasing age of contract owners and increased insurance inforce.
The decrease in annuity net earnings during 2001 as compared to 2000 is primarily due to the increase in net realized investment losses, as noted above.
ML of New York's operations have not been materially impacted by inflation and changing prices during the preceding three years.