The Registrant’s home office is located at 4 Manhattanville Road, Purchase, New York. After March 31, 2010, the Registrant’s home office will be located at 440 Mamaroneck Avenue, Harrison, New York 10528. Personnel performing services for the Registrant operate in AUSA office space in Cedar Rapids, Iowa and St. Petersburg, Florida. An allocable share of the cost of each of the above mentioned premises was paid by the Registrant through the common cost allocation service agreement.
In addition, personnel performing services for the Registrant occupy office space in Jacksonville, Florida, which is owned by ML&Co. An allocable share of the cost of each of the above mentioned premises was paid by the Registrant through the transition services agreement between AUSA and ML&Co.
MLLICNY conducts its business primarily in the annuity markets and to a lesser extent in the life insurance markets of the financial services industry. As of September 30, 2009, the Company, in addition to no longer issuing life insurance products, is no longer issuing variable annuity and market value adjusted annuity products. The Company offered the following guaranteed benefits within its variable annuity product suite: guaranteed minimum death benefits (“GMDB”), guaranteed minimum income benefits (“GMIB”) and guaranteed minimum withdrawal benefits (“GMWB”).
In addition, the purchase method of accounting applied by AUSA to the acquired assets and liabilities associated with the Company has been “pushed down” to the financial statements of the Company, thereby establishing a new basis of accounting. As a result, the Company follows AUSA’s accounting policies subsequent to the acquisition date. This new basis of accounting is referred to as the “successor basis”, while the historical basis of accounting is referred to as the “predecessor basis’’. In general, all 2009 and 2008 amounts are representative of the successor basis of accounting while the Statements of Income, Stockholder’s Equity, Comprehensive Income, and Cash Flows amounts for 2007 are representative of the predecessor basis of accounting. Financial statements included herein for periods prior and subsequent to the acquisition date are labeled “Predecessor” and “Successor”, respectively.
At December 31, 2009 and 2008, approximately, $9.2 million (or 8%) and $7.7 million (or 7%), respectively, of the Company’s fixed maturity and equity securities portfolio consisted of non-publicly traded securities. Since significant judgment is required for the valuation of non-publicly traded securities, the estimated fair value of these securities may differ from amounts realized upon an immediate sale.
Derivatives are financial instruments in which the value changes in response to an underlying variable, that require little or no net initial investment and are settled at a future date. All derivatives recognized on the Balance Sheets are carried at fair value. All changes in fair value are recognized in the Statements of Income. The fair value for exchange traded derivatives, such as futures, are calculated net of the interest accrued to date and is based on quoted market prices. Net settlements on the futures occur daily. As of December 31, 2009, the Company had 20 outstanding short futures contracts with a notional amount of $5.6 million. As of December 31, 2008, the Company had 10 outstanding short futures contracts with a notional amount of $2.3 million.
For debt securities, an OTTI must be recognized in earnings when an entity either a) has the intent to sell the debt security or b) more likely than not will be required to sell the debt security before its anticipated recovery. If the Company meets either of these criteria, the OTTI is recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For debt securities in unrealized loss positions that do not meet these criteria, the Company must analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows. If the net present value is less than the amortized cost of the investment, an OTTI is recorded. The OTTI is separated into two pieces: an amount representing the credit loss, where the present value of cash flows expected to be collected is less than the amortized cost basis of the security, and an amount related to all other factors (referred to as the non credit portion). The credit loss is recognized in earnings and the non credit loss is recognized in other comprehensive income (“OCI”), net of applicable taxes and value of business acquired. Management records subsequent changes in the estimated fair value (positive and negative) of available-for-sale debt securities for which non credit OTTI was previously recognized in OCI in OCI-OTTI.
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, 2009 and 2008, variable annuities accounted for the Company’s entire DAC asset of $0.4 million and $0.4 million, respectively.
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 benefit 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, 2009 and 2008 there was less than $0.1 million of DAC unlocking impacting pre-tax income. For the year ended December 31, 2007, there was a favorable impact to pre-tax income related to DAC unlocking of $1.8 million. See Note 6 to the Financial Statements for a further discussion.
The expense and the subsequent capitalization and amortization are recorded as a component of policy benefits in the Statements of Income. At December 31, 2009 and 2008, variable annuities accounted for the Company’s entire DSI asset of $0.1 million and $0.2 million, respectively. See Note 6 to the Financial Statements for a further discussion.
Other intangibles that were acquired at the acquisition date include a distribution agreement, a tradename, and a non-compete agreement. At December 31, 2008, the Company made a business decision to commence selling similar products on affiliate companies through the ML&Co. distribution channel instead of continuing to sell new variable annuities on the Company. As a result of this decision, an impairment charge of $6.8 million was taken for the entire unamortized other intangible balance at December 31, 2008. Prior to December 31, 2008, the tradename and the non-compete agreements were amortized on a straight-line basis over their useful life of five years. The distribution intangible was amortized over the expected economic benefit period and at a pace consistent with the expected future gross profit streams generated from the distribution agreement, which was thirty years. The entire asset amount had been allocated to annuities. See Note 5 to the Financial Statements for a further discussion.
Goodwill is the excess of the purchase price over the estimated fair value of net assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but are subject to impairment tests conducted at least annually. Impairment testing is to be performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit represents the operating segment which is the level at which the financial information is prepared and regularly reviewed by management. The entire asset amount has been allocated to annuities. Goodwill is reviewed for indications of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator, or unanticipated competition would cause MLLICNY to review the carrying amounts of goodwill for impairment. When considered impaired, the carrying amounts are written down to fair value based primarily on discounted cash flows. At December 31, 2008, the Company made a business decision to commence selling similar products on affiliate companies through the ML&Co. distribution channel instead of continuing to sell new variable annuities on the Company. As a result of this decision, an impairment charge was taken for the majority of the goodwill balance ($3.1 million) at December 31, 2008. The remaining amount of $0.5 million at December 31, 2009 and 2008 relates to MLLICNY’s state licenses. See Note 5 to the Financial Statements for a further discussion.
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.
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, 2009, 2008, and 2007, the favorable (unfavorable) impact to pre-tax income related to GMDB and GMIB unlocking was ($0.2) million, ($2.3) million, and $1.2 million, respectively.
The Company files a return in the U.S. federal tax jurisdiction and various state tax jurisdictions. As a result of the Company’s election for federal income tax purposes of Internal Revenue Code Section 338, the predecessor is responsible for any uncertain tax positions that existed prior to the acquisition date.
On January 1, 2009, the Company adopted guidance that amends and expands the disclosure requirements related to derivative instruments and hedging activities. This guidance was formerly known as SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133.
The Company’s marketing emphasis, prior to September 30, 2009, had been on the sale of variable annuity products. These products were designed to address the retirement planning needs of ML&Co. clients. Each variable annuity product was designed to provide tax-deferred retirement savings with the opportunity for diversified investing in a wide selection of underlying mutual fund portfolios.
Total direct deposits decreased $7.0 million during 2009 as compared to 2008. Total direct deposits (including internal exchanges) were as follows:
Policy and contract surrenders decreased $19.1 million (or 24%) to $59.4 million during 2009 as compared to 2008. Policy and contract surrenders decreased $46.5 million (or 37%) to $78.5 million during 2008 as compared to 2007. The decrease is primarily due to the decline in the equity markets in late 2008 and early 2009.
There were no fixed contract owner deposits in 2009, 2008 and 2007. During 2009, 2008 and 2007, fixed contract owner withdrawals were $8.2 million, $9.4 million and $3.0 million, respectively.
The following schedule identifies MLLICNY’s general account invested assets by type at December 31:
The Company adopted revised guidance for the recognition and presentation of OTTI effective as of June 30, 2009. The prior requirement for management to assert that it has the intent and ability to hold an impaired debt security until recovery was replaced with the requirement that management assert if it either has the intent to sell the debt security or if it is more likely than not the entity will be required to sell the debt security before recovery of its amortized cost basis.
The Company regularly monitors industry sectors and individual debt securities for evidence of impairment. This evidence may include one or more of the following: 1) deteriorating market to book ratio, 2) increasing industry risk factors, 3) deteriorating financial condition of the issuer, 4) covenant violations, 5) high probability of bankruptcy of the issuer, 6) nationally recognized credit rating agency downgrades, and/or 7) intent and ability to hold to recovery. Additionally, for asset-backed securities (“ABS”), cash flow trends and underlying levels of collateral are monitored. A security is impaired if there is objective evidence that a loss event has occurred after the initial recognition of the asset that has a negative impact on the estimated future cash flows. A specific security is considered to be impaired when it is determined that it is probable that not all amounts due (both principal and interest) will be collected as scheduled. For debt securities, an OTTI must be recognized in earnings when an entity either a) has the intent to sell the debt security or b) more likely than not will be required to sell the debt security before its anticipated recovery. If the Company meets either of these criteria, the OTTI is recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For debt securities in unrealized loss positions that do not meet these criteria, the Company must analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The Company has evaluated the near-term prospects of the issuers in relation to the severity and duration of the unrealized loss, and unless otherwise noted, does not consider these investments to be impaired as of December 31, 2009.
Nine issuers represent more than 5% of the total unrealized loss position, comprised of three commercial mortgage-backed securities (“CMBS”) holdings, two capital securities within the financial services sector, two government securities, one ABS subprime mortgage and one residential mortgage-backed security (“RMBS”). The Company‘s CMBS unrealized loss is $0.6 million and relates to LBUBS Commercial Mortgage Tranche 2006-C7, Morgan Stanley Capital I 2005- HQ6 and Morgan Stanley Capital I 2006-HQ9. These are CMBS that contain fixed income positions where our holdings are all rated investment grade. The Company’s RMBS unrealized loss is $0.2 million and relates to GSR Mortgage Loan Tranche 2005-AR5. GSR Mortgage Loan Tranche 2005-AR5 is a securitized portfolio of RMBS that contains fixed income positions where our holding is rated below investment grade. The Company’s ABS subprime mortgage unrealized loss is $0.2 million and relates to Conseco Fin Sec Corp 2001-C, which is a fixed rate first lien subprime mortgage security that is rated investment grade. The Company‘s investment grade capital securities have an unrealized loss of $0.3 million and were issued by Wells Fargo & Company and JP Morgan Chase & Co. The Company’s government and government agencies securities which have an unrealized loss of $0.2 million, were issued in Venezuela and Quebec, and are rated below investment grade and investment grade, respectively.
Fundamentals remain somewhat weakened by the global recession and some companies remain dependent on government support. However, funding concerns have largely abated as capital markets have reopened and investor confidence is returning to the sector. In addition, the sector has raised a significant amount of capital, creating a large buffer to help absorb rising credit losses. Following the unprecedented global market turmoil, regulators are likely to strengthen capital requirements for the sector as a whole as well as implement additional regulatory controls and oversight. All of the securities in an unrealized loss position are rated investment grade.
The Company does not currently invest in or originate whole loan residential mortgages. The Company categorizes ABS issued by a securitization trust as having subprime mortgage exposure when the average credit score of the underlying mortgage borrowers in a securitization trust is below 660 at issuance. The Company also categorizes ABS issued by a securitization trust with second lien mortgages as subprime mortgage exposure, even though a significant percentage of second lien mortgage borrowers may not necessarily have credit scores below 660 at issuance.
CMBS are securitizations of underlying pools of mortgages on commercial real estate. The underlying mortgages have varying risk characteristics and are pooled together and sold in different rated tranches. All of the Company’s CMBS holdings are conduit securities. Over 96% of the Company’s exposure to CMBS is AAA rated, with the majority of these positions being AAA - senior rated securities. The following tables summarize the Company’s CMBS exposure by rating and vintage at December 31:
Results are then closely analyzed by the asset specialist to determine whether or not a principal or interest loss is expected to occur. If cash flow models indicate a credit event will impact future cash flows, the security is impaired to the net present value of projected future cash flows.
There are no other individual issuers rated below investment grade in the RMBS sector which have unrealized loss positions greater than $0.2 million.
Government and Government Agencies exposure relates to government issued securities including Venezuelan and Canadian government bonds and US Treasury bonds. Global economic concerns have adversely affected the market values on all but the strongest rated government debt. All of the issuers in the government and government agencies sector continue to make payments in accordance with the original bond agreements. 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 the positions to be impaired as of December 31, 2009.
There are no individual issuers rated below investment grade in this sector which have an unrealized loss position greater than $0.2 million.
Details underlying securities in a continuous gross unrealized loss and OTTI position for investment grade securities were as follows:
The Company adopted revised guidance on the recognition and presentation of OTTI as of June 30, 2009. The gross cumulative effect of this adoption was a $0.2 million adjustment to retained earnings and amortized cost for the non credit related portion of previously recorded impairments on securities still in inventory at April 1, 2009. Of this, $0.1 million related to non credit impairments recorded in income during the first quarter of 2009. The current balance in OCI relating to OTTI at December 31, 2009 is zero as all “previously impaired” assets with OTTI in OCI were sold during 2009.
The investment performance of the underlying U.S. equity-based mutual funds supporting the Company’s variable products do not replicate the returns of any specific U.S. equity market index. However, investment performance will generally increase or decrease with corresponding increases or decreases of the overall U.S. equity market.
There are several standard indices published on a daily basis that measure performance of selected components of the U.S. equity market. Examples include the Dow Jones Industrial Average (“Dow”), the NASDAQ Composite Index (“NASDAQ”) and the Standard & Poor’s 500 Composite Stock Price Index (“S&P”). The Dow, NASDAQ and S&P ended 2009 with increases of 19%, 44% and 23%, respectively, from 2008. The Dow, NASDAQ and S&P ended 2008 with decreases of 34%, 41% and 38%, respectively, from 2007.
The following table summarizes the Company’s policyholders’ obligations as of December 31, 2009:
The change in equity related gains (losses) principally relates to net losses on futures contracts during 2009 compared to net gains on futures contracts during 2008.
Policy benefits increased $0.7 million during 2009 as compared to 2008. The following table provides the changes in policy benefits by type:
Reinsurance premiums ceded decreased $1.0 million during 2009 as compared to 2008. Effective second quarter of 2008, the Company began to recapture the majority of its reinsurance resulting in the decreased reinsurance premiums, which is expected to be finalized in the first half of 2010.
The increase in commissions is primarily related to an increase in trail commissions in 2009.
Policy charge revenue decreased $2.3 million (or 11%) to $18.5 million during 2008 as compared to $20.8 million in 2007. The following table provides the changes in policy charge revenue by type for each respective period:
Policy benefits increased $0.5 million during 2008, as compared to 2007. The following table provides the changes in policy benefits by type:
The decrease in annuity benefit expense was primarily due to the decrease in the guaranteed minimum benefit amounts as a result of volatile equity markets effect on reinsurance reserves.
Amortization of deferred policy acquisition costs was immaterial in 2008. The DAC balance was zero as of December 31, 2007 as a result of push down accounting at the acquisition date. Amortization of deferred policy acquisition costs was $2.2 million for 2007.
Insurance expenses and taxes increased $1.6 million in 2008 as compared to 2007. The following table provides the changes in insurance expenses and taxes for each respective period:
The increase in taxes, licenses, and fees is primarily due to lower New York State Franchise tax in 2007.
The “Other” category, presented in the following segment financial information, represents net revenues and income on invested assets that do not support life or annuity policyholder liabilities. Subsequent to the acquisition date, management no longer considers “Other” a category for segment reporting purposes. It is impracticable to restate the prior period segment information as well as disclosing the information under both the old basis and the new basis of reporting. Therefore, the predecessor information is shown under the old basis, three segments - Annuity, Life Insurance and Other, while the successor information is shown under the new basis, two segments - Annuity and Life Insurance.
Results of MLLICNY’s sensitivity analyses are presented to show the estimated sensitivity of net income to various scenarios. For each type of market risk, the analysis shows how net income would have been affected by changes in the relevant risk variables that were reasonably possible at the reporting date. For each sensitivity test, the impact of a reasonably possible change in a single factor (or shock) is shown. The analysis considers the interdependency between interest rates and lapse behavior for products sold where there is clear evidence of dynamic lapse behavior. Management action is taken into account to the extent that it is part of MLLICNY’s regular policies and procedures. However, incidental management actions that would require a change in policies and procedures are not considered.
Each sensitivity analysis reflects the extent to which the shock tested would affect management’s critical accounting estimates and judgment in applying MLLICNY’s accounting policies (See Note 1 of the Financial Statements for a description of the critical accounting estimates and judgments). The shock may affect the measurement of assets and liabilities based on assumptions that are not observable in the market as well as market consistent assumptions. For example, a shock in interest rates may lead to changes in the amortization schedule of DAC or to increased impairment losses on equity investments. Although management’s short-term assumption may change if there is a reasonable change in a risk factor, long-term assumptions will generally not be revised unless there is evidence that the movement is permanent. This fact is reflected in the sensitivity analyses provided below.
The sensitivities do not reflect what the net income for the period would have been if risk variables had been different because the analysis is based on the exposures in existence at the reporting date rather than on those that actually occurred during the year.
Nor are the results of the sensitivities intended to be an accurate prediction of MLLICNY’s future income. The analysis does not consider all methods available to management to respond to changes in the financial environment, such as changing investment portfolio allocations or adjusting crediting rates. Furthermore, the results of the analysis cannot be extrapolated for wider variations since effects do not tend to be linear. No risk management process can clearly predict future results.
The table below shows the interest rates at the end of the last five years:
Credit risk represents the loss that MLLICNY would incur if an issuer fails to perform its contractual obligations and the value of the security held has been impaired or is deemed worthless. MLLICNY manages its credit risk by setting investment policy guidelines that assure diversification with respect to investment, issuer, geographic location and credit quality. Management regularly monitors compliance of each investment portfolio’s status with the investment policy guidelines, including timely updates of credit-related securities.
Fluctuations in the equity markets have affected MLLICNY’s profitability, capital position and sales of equity related products in the past and may continue to do so. Exposure to equity markets exists in both assets and liabilities. Asset exposure exists through direct equity investment, where MLLICNY bears all or most of the volatility in returns and investment performance risk.
The selection of a 10% and 20% change in the equity markets should not be construed as a prediction of future market events, but rather as an illustration of the potential impact of such an event. The Company’s exposure can change as a result of changes in the Company’s mix of business.
Liquidity risk is inherent in much of MLLICNY businesses. Each asset purchased and liability sold has liquidity characteristics that are unique. Some liabilities are surrenderable while some assets, such as private placements, mortgages loans and limited partnerships have low liquidity. If MLLICNY requires significant amounts of cash on short notice in excess of normal cash requirements, MLLICNY may have difficulty selling these investments at attractive prices, in a timely manner or both.
Sources of underwriting risk include policy lapses and policy claims such as mortality and expenses. In general, MLLICNY is at risk if policy lapses increase as sometimes MLLICNY is unable to fully recover up front expenses in selling a product despite the presence of commission recoveries or surrender charges and fees. Within variable annuity contracts with certain guarantee benefits, MLLICNY is at risk if policy lapses decrease, as more contracts would remain in force until guaranteed payments are made.
For mortality risk, MLLICNY sells certain types of policies that are at risk if mortality increases, such as term life insurance or guaranteed minimum death benefits, and sells certain types of policies that are at risk if mortality decreases (longevity risk) such as certain annuity products. MLLICNY is also at risk if expenses are higher than assumed by management.
Sensitivity analysis of net income to various underwriting risks is shown in the table that follows. The sensitivities represent an increase or decrease of mortality rates over 2009. Increases in mortality rates lead to an increase in the level of benefits and claims on most business. The impact on net income and equity of sales transactions of investments required to meet the higher cash outflow from lapses or deaths are reflected in the sensitivities.
The term “disclosure controls and procedures” (defined in the Securities Exchange Act of 1934 Rule 13a-15(e)) generally refers to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within required time periods. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by MLLICNY in the reports that it files or submits under the Exchange Act is accumulated and communicated to MLLICNY’s management, including MLLICNY’s principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. MLLICNY’s management, with the participation of the President and Chief Financial Officer, have evaluated the effectiveness of the MLLICNY’s disclosure controls and procedures as of the end of the period covered by this annual report (the “Evaluation Date”). Based on that evaluation, MLLICNY’s President and Chief Financial Officer have concluded that, as of the Evaluation Date, such disclosure controls and procedures were effective.