The Company’s home office is located in Little Rock, Arkansas. Personnel performing services for the Company operate in Transamerica Corporation office space in Cedar Rapids, Iowa and St. Petersburg, Florida. An allocable share of the cost of each of the above mentioned TA Corp premises was paid by the Company through the common cost allocation service agreement. We believe that our existing offices are adequate to meet our current requirements and we anticipate that suitable additional or substitute space will be available, as necessary, upon favorable terms.
The statements contained in this Report that are not historical facts are forward-looking statements as defined in the US Private Securities Litigation Reform Act of 1995. Certain statements in this report may be considered forward-looking, including those about management expectations, anticipated financial results and other similar matters. The words or phrases “expect,” “anticipate,” “should,” “believe,” “estimate,” “intend,” “may,” “predict,” “continue,” “forecast,” “will,” “would,” and similar statements of a future or forward-looking nature that reflect management’s current views with respect to future events or financial performance are meant to identify “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, as amended, and are subject to the safe harbor created by such sections. These forward-looking statements represent management’s beliefs regarding future performance, which is inherently uncertain. There are a variety of factors, many of which are beyond the control of the Company, which affect the Company’s operations, performance, business strategy and results and could cause its actual results and experience to differ materially from the expectations and objectives expressed in any forward-looking statements. Such risks and uncertainties include but are not limited to the following:
Our failure to achieve anticipated levels of earnings or operational efficiencies as well as other cost saving initiatives; and
The political, monetary, economic and operational impacts of the “Brexit” referendum.
The Company does not undertake to update or revise forward-looking statements to reflect the impact of circumstances or events that arise after the dates they are made, except as otherwise may be required by the federal securities laws. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements, which speak to Company expectations only as of the dates on which they are made. Actual results may differ materially from expectations conveyed in forward-looking statements due to changes caused by various risks and uncertainties. The Company will include any required or necessary updates, revisions, or classifications of the forward-looking statements or the disclosures and risks and uncertainties in future filings.
Expenses generally include commissions, premium taxes, and general and administrative expenses for policy administration and related overhead charges.
Credit spreads represent the credit risk premiums required by market participants for a given credit quality, i.e., the additional yield that a debt instrument issued by an AA-rated entity must produce over a risk-free alternative (e.g., U.S. Treasury instruments). Changes in credit spreads have an inverse relationship to the value of interest-sensitive investments.
At December 31, 2017 and 2016, the Company had 7,928 and 9,017 life insurance and annuity contracts in force with interest rate guarantees, respectively. The estimated average rate of interest credited on behalf of contract owners was 3.17% and 3.32% during 2017 and 2016, respectively. Total invested assets supporting these liabilities with interest rate guarantees had an estimated average effective yield of 4.95% and 4.99% during 2017 and 2016, respectively.
The preparation of Financial Statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses and the disclosures of contingent assets and liabilities. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ and such differences could have a material impact on the Financial Statements.
See Notes to Financial Statements, Note 1 Summary of Significant Accounting Policies, for a discussion of newly adopted accounting pronouncements.
The Company’s investments consist principally of fixed maturity and equity securities that are classified as available-for-sale (“AFS”) and are reported at estimated fair value. The fair values of fixed maturity and equity securities are determined by management after taking into consideration several sources of data. When available, the Company uses quoted market prices in active markets to determine the fair value of its investments. The Company’s valuation policy utilizes a pricing hierarchy that dictates that publicly available prices are initially sought from indices and third-party pricing services. In the event that pricing is not available from these sources, those securities are submitted to brokers to obtain quotes. If broker quotes are not available, securities are priced using internal cash flow modeling techniques. These valuation methodologies commonly use reported trades, bids, offers, issuer spreads, benchmark yields, estimated prepayment speeds, and/or estimated cash flows.
Objective evidence of impairment of an investment in an equity instrument classified as AFS includes information about significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the issuer operates, that indicates that the cost of the investment in the equity instrument may not be recovered. As part of an ongoing process, the equity analysts actively monitor earnings releases, company fundamentals, new developments and industry trends for any signs of possible impairment. If an AFS equity security is impaired based upon the Company’s qualitative or quantitative impairment criteria, any further declines in the fair value at subsequent reporting dates are recognized as impairments. Therefore, at each reporting period an impairment is recognized for the difference between the fair value and the original cost basis, less any previously recognized impairments, for an equity security that is determined to be impaired based upon the Company’s impairment criteria.
Debt securities are monitored individually for impairments based on our asset specialists' expectations of payment interruption. The probability of interruption is based on assessments of capital markets, funding needs and the liquidity profile of the issuer.
The long-term growth rate assumption for the amortization of VOBA was 8% at December 31, 2017 and 2016. At December 31, 2017 and 2016, the Company’s VOBA asset was $201.3 million and $222.3 million, respectively. For the years ended December 31, 2017, 2016, and 2015, the favorable (unfavorable) impact to pre-tax net income related to VOBA unlocking was ($8.5) million, ($12.9) million and $0.1 million, respectively. There were no impairment charges for the years ended 2017 and 2015. Impairment charges for the year ended 2016 were $0.5 million.
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, long-term volatility, own credit risk, utilization and inflation. The “own credit risk” is the risk that that the company will not fulfill its obligations and is a component in the valuation of future policy benefits. These estimates and assumptions are influenced by historical experience, current developments and anticipated market trends.
The Company’s liability for future policy benefits consists of liabilities for immediate annuities and liabilities for certain guaranteed benefits contained in the variable insurance products the Company manufactures. Liabilities for immediate annuities are equal to the present value of estimated future payments to or on behalf of policyholders, where the timing and amount of payment generally depends on policyholder mortality. Interest rates used in establishing such liabilities were in the range of 0.01% to 8.8% during 2017 and 2016. See Notes to Financial Statements, Note 5 Variable Contracts Containing Guaranteed Benefits, for further discussion.
Specific estimates include the realization of dividend-received deductions (“DRD”) and foreign tax credits (“FTC”). A portion of the Company’s investment income related to Separate Accounts business qualifies for the DRD and FTC. Information necessary to calculate these tax adjustments is typically not available until the following year. However, within the current year’s provision, management makes estimates regarding the future tax deductibility of these items. These estimates are primarily based on recent historic experience. See Notes to Financial Statements, Note 6 Income Taxes for a further discussion.
On December 22, 2017, the Tax Cuts and Jobs Act ("TCJA") (HR 1, Pub. L. 115-97), was signed into law. The TCJA is complex and substantially changes U.S. corporate income tax rates and other provisions in the tax code. We continue to examine the impact the TCJA may have on our business. The TCJA has already had a material impact on our income tax expense and deferred tax balances (most notably a $41.0 million unfavorable impact in the fourth quarter of 2017 related to the remeasurement of net deferred tax assets using the lowered corporate tax rate, along with a corresponding reduction in the valuation allowance.) Despite the beneficial impact in the corporate income tax rate, the full impact is uncertain and our business and financial condition could be adversely affected. The Company had a deferred tax asset at December 31, 2017 and December 31, 2016 for the benefit of net operating loss (“NOL”) carryforwards of $554.6 million (net of an ASC 740 reduction of $12.6 million) and $627.9 million (net of an ASC 740 reduction of $12.5 million), respectively, with a carry forward period of fifteen years that will expire at various dates between 2023 and 2031. At December 31, 2017, the Company had no capital loss carry forward and at December 31, 2016, the Company had a deferred tax asset for a capital loss carry forward of $0.1 million for federal income tax purposes with a carry forward period of five years that will expire in 2018. At December 31, 2017 and December 31, 2016, the Company had a deferred tax asset for foreign tax credit carry forward of $9.8 million and $9.8 million, respectively, with a carry forward period of ten years that will expire at various dates up to 2026. Finally, the Company had a deferred tax asset for an Alternative Minimum Tax credit carry forward for federal income tax purposes of $4.2 million at both December 31, 2017 and December 31, 2016. The Company expects to be refunded $3.9 million of minimum tax credit carryforward by the end of 2021 pursuant to the TCJA. A valuation allowance remains for the remaining balance of $0.3 million.
The valuation allowance for deferred tax assets at December 31, 2017 and December 31, 2016 was $78.7 million and $154.4 million, respectively (this included losses that are anticipated to be used in the consolidated group to reflect the income statement impact of the losses that would not be used if filing separately). The valuation allowance is related to the loss carry forwards, tax credits, and other deferred tax assets that, in the current judgment of management, are not more likely than not to 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 future 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. The amount of deferred tax asset considered realizable, however, could be increased in the near term if estimates of future taxable income during the carry forward period are increased.
The Company filed a separate federal income tax return for the years 2008 through 2012. The Company was part of the consolidated tax return for 2013 through 2016. An examination by the Internal Revenue Service is in progress for the years 2011 through 2013. The Company believes that there are adequate defenses against or sufficient provisions established related to any open or contested tax positions. The 2017 return has not yet been filed.
Separate Accounts assets, which represent 67% of total assets, increased $133.9 million to $5.8 billion at December 31, 2017. This was primarily due to growth in account asset values resulting from favorable investment performance of $848.2 million, lower benefit payments and withdrawals, offset by higher surrenders as compared to the previous year as shown in the table below:
The following schedule identifies the Company’s general account invested assets by type at December 31, 2017 and 2016:
The Company 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 of the issuer; 5) high probability of bankruptcy of the issuer; 6) nationally recognized credit rating agency downgrades; and 7) intent or requirement to sell before a debt security’s anticipated recovery. Additionally, we monitor structured securities (asset-backed securities (“ABS”), residential mortgage-backed securities (“RMBS”), and commercial mortgage-backed securities (“CMBS”)), cash flow trends and underlying levels of collateral. 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 at December 31, 2017.
The Company’s $2.0 million of gross unrealized losses within the industrial sector relates to securities with a fair value of $95.3 million. The industrial sector is further subdivided into various sub-sectors with a majority of its gross unrealized loss made up of issuers within the energy, consumer non-cyclical and communications sub-sectors. There was one primary issuer within the energy sub-sector which made up a majority of the $0.7 million gross unrealized loss, resulting from weak oil prices. The two issuers within the communications sub-sector that made up the $0.6 million gross unrealized loss were affected by challenges that affected the entire wireline industry. Entities within the consumer non-cyclical sub-sector had gross unrealized losses of $0.6 million, which was spread evenly among health care, pharmaceutical and tobacco industries.
These factors typically require significant management judgment. The impairment review process has resulted in no other than temporary impairment charges for the year ended December 31, 2017 for the Company.
The Company’s fixed maturity AFS ratings are designated based on the Credit Name Limit Policy, which uses a composite rating from the main rating agencies S&P Global Rating Services (“S&P GRS”), Moody’s, and Fitch Ratings (“Fitch”). The rating used is the lower of the composite rating and the Company’s Internal Rating. The Company defines investment grade securities as unsecured debt obligations that have a rating equivalent to S&P GRS’s BBB- or higher (or similar rating agency). At December 31, 2017 and 2016, approximately $120.7 million (or 7.79%) and $65.7 million (or 4.4%), respectively, of the Company’s fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by S&P GRS. 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.
Unrealized gains (losses) incurred during 2017 and 2016 were primarily due to price fluctuations resulting from changes in interest rates and credit spreads. If the Company has the intent to sell or it is more likely than not that the Company will be required to sell these securities prior to the anticipated recovery of the amortized cost, securities are written down to fair value. If cash flow models indicate a credit event will affect future cash flows, the security is impaired to discounted cash flows. As the remaining unrealized losses in the portfolio relate to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired.
Details underlying securities in a continuous gross unrealized loss and OTTI position for investment grade AFS securities are as follows:
Gross unrealized losses and OTTI on below investment grade AFS securities represented 45% and 32% of total gross unrealized losses and OTTI on all AFS securities at December 31, 2017 and 2016, respectively. Generally, below investment grade securities are more likely than investment grade securities to develop credit concerns. The ratios of estimated fair value to amortized cost reflected in the table below are not necessarily indicative of the market value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to December 31, 2017.
The financial strength rating scales of S&P GRS, A.M. Best Company (“A.M. Best”), and Fitch are characterized as follows:
On May 5, 2017, A.M. Best affirmed the Company’s rating at A+, and changed the outlook from stable to negative. On August 3, 2017, Fitch affirmed the Company’s rating at A+, and maintained the stable outlook. On February 28, 2018, S&P affirmed the Company’s rating at AA-, and maintained the negative outlook.
The following table summarizes the Company’s ratings at March 29, 2018:
The policyholder liabilities include benefit and claim liabilities of which a significant portion represents policies and contracts that do not have a stated contractual maturity. The projected cash benefit payments in the table above are based on management’s best estimates of the expected gross benefits and expenses, partially offset by the expected gross premiums, fees and charges relating to the existing business in force. Estimated cash benefit payments are based on mortality and lapse assumptions comparable with the Company’s historical experience, modified for recently observed trends. Actual payment obligations may differ if experience varies from these assumptions. The cash benefit payments are presented on an undiscounted basis and before the deduction of taxes and before reinsurance. The liability amounts in the Company’s Financial Statements reflect the discounting for interest as well as adjustments for the timing of other factors as described above. As a result, the sum of the cash benefit payments shown for all years in the table above exceeds the corresponding policyholder liability amounts.
The Company has utilized public information to estimate the future assessments it will incur as a result of insolvencies of life insurance companies that are members of a life insurance guaranty association in which the Company is also a member. When a member becomes insolvent, the guaranty association assesses the remaining members of the association an amount sufficient to satisfy an insolvent insurer’s contract owner obligations, within specified limitations. At December 31, 2017 and 2016, the Company’s estimated liability for future guaranty fund assessments was $0.1 million and $0.1 million, respectively. In addition, the Company has a receivable for future premium tax deductions of $3.8 million and $4.0 million at December 31, 2017 and 2016, respectively. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
For the years ended December 31, 2017 and 2016, the Company recorded net income (loss) of $99.4 million and ($20.5) million, respectively. The increase in net earnings during 2017 as compared to 2016 was driven by $62.6 million lower policy benefit expense and $41.1 million lower derivative losses and $8.0 million higher realized investment gains, offset by lower amortization of VOBA.
Net derivative losses decreased $41.1 million from $90.2 million in 2016. The following table provides the components of net derivative gains (losses) by type:
Long positions on bond futures contracts produced $2.6 million in realized gains during 2017 as rates were generally down on the long end of the rate curve in relation to when positions were rolled throughout the year.
Put options produced $33.6 million of loss during 2017, driven by normal amortization of $24.2 million primarily on fourth quarter 2016 and second quarter 2017 acquisitions, in addition to realized losses of $5.9 million and mark to market losses of $3.5 million.
Policy benefits decreased $62.6 million compared to 2016, largely due to the favorable impact from reserve unlocking along with a decrease in life insurance mortality expense. The unlocking of $71.5 million was driven by valuation model assumption changes based on strong equity market performance experience in 2017. Lower mortality experience in 2017 as compared to the prior year led to fewer claims, resulting in lower life insurance mortality expense. The following table provides the components of policy benefits by type:
Amortization of VOBA decreased $16.6 million in 2017 compared to 2016. The decrease was primarily due to lower amortization expense of $12.1 million, driven by favorable equity returns and higher future gross profit projections along with run rate effects of model change assumptions for strong market performance and lower mortality experience. Unlocking adjustments resulted in an additional $4.5 million decrease in expense as a result of improved mortality experience as compared to 2016. See Notes to Financial Statements, Note 4 VOBA, DAC, and DSI, for further discussion.
For the year ended December 31, 2017, the $89.7 million increase in net income for the annuity segment was primarily due to lower derivative losses, higher net realized gains and lower policy benefit expenses. The $41.3 million lower derivative losses resulted primarily from lower losses on short positions in equity total return swaps and equity futures related to positional activity and improving equity market performance in the current year. These positive impacts were offset by increased amortization and the impact of improving equity market performance on put option positions acquired in late 2016 and midyear 2017. The $5.3 million increase in net realized gains were due primarily to the sale of $118.0 million in mortgage loans to affiliates in the third quarter of 2017, generating $4.2 million. The $44.2 million lower policy benefits expense was primarily driven by the higher release of reserves in the current year resulting from higher equity market performance and a lower interest rate environment as compared to the prior year.
For the year ended December 31, 2017, the $30.2 million increase in net income for the life insurance segment was primarily driven by lower policy benefits expense and lower amortization of VOBA. The $18.3 million lower policy benefits expense was primarily driven by improved mortality claims experience in the current year as compared to the prior year. The $13.9 million lower amortization of VOBA resulted from a combination of decreased amortization of $8.7 million due to improved mortality experience, higher fund performance and an update to expected future gross profits due to model assumption changes and actual experience along with a lower third quarter annual unlocking adjustment of $5.2 million as compared to prior year due to model assumption updates.