The Company’s administrative offices are located at MONY Life’s corporate office, located at 1740 Broadway, New York, New York and consists of approximately 267,000 square feet. MONY Life also has office facilities in Syracuse, New York for use in its insurance operations, which consist of approximately 578,000 square feet in the aggregate. MONY Life also leases all 217 of its agency and its subsidiary offices, which consist of approximately 1,388,000 square feet in the aggregate. The Company believes that such properties are suitable and adequate for its current and anticipated business operations.
MONY Life Insurance Company of America (the “Company” or “MLOA”), an Arizona stock life insurance company, is a wholly-owned subsidiary of MONY Life Insurance Company (“MONY Life”), formerly The Mutual Life Insurance Company of New York, which converted from a mutual life insurance company to a stock life insurance company on November 16, 1998. MONY Life is a wholly-owned subsidiary of MONY Holdings, LLC (“MONY Holdings”), a downstream holding company formed by The MONY Group Inc. (the “MONY Group”) on February 27, 2002. On April 30, 2002, MONY Group transferred all of its ownership interest in MONY Life to MONY Holdings.
The Company’s primary business is to provide life insurance, annuities and corporate-owned and bank-owned life insurance (“COLI and BOLI”) to business owners, growing families, and pre-retirees. The Company distributes its products and services through Retail and Wholesale distribution channels. The Company’s Retail distribution channels are comprised of (i) the career agency sales force operated by MONY Life and (ii) Trusted Securities Advisors Corporation (“Trusted Advisors”), now a division of MONY Securities Corporation (“MSC”), which is a wholly-owned subsidiary of MONY Life. The Company’s Wholesale distribution channel is comprised of: (i) MONY Partners, a division of MONY Life and (ii) MONY Life’s corporate marketing team which markets COLI and BOLI products. These products are sold in 49 states (not including New York), the District of Columbia and Puerto Rico.
On September 17, 2003, MONY Group entered into an Agreement and Plan of Merger with AXA Financial, Inc. (“AXA Financial”) and AIMA Acquisition Co., which was subsequently amended on February 22, 2004 (hereafter referred to collectively as the “AXA Agreement”), pursuant to which MONY Group will become a wholly owned subsidiary of AXA Financial in a cash transaction valued at approximately $1.5 billion. Under the terms of the AXA Agreement, which has been approved by the boards of directors of AXA Financial and MONY Group, MONY Group’s shareholders will receive $31.00 for each share of MONY Group’s common stock. The acquisition contemplated by the AXA Agreement is subject to various regulatory approvals and other customary conditions, including the approval of MONY Group’s shareholders. A special meeting of MONY Group’s shareholders is scheduled for May 18, 2004 to vote on the proposed acquisition of MONY Group by AXA Financial. The transaction is expected to close in the second quarter of 2004. See Note 14 to the Financial Statements for further information regarding MONY Group’s pending merger transaction with AXA Financial.
The Company’s profitability depends in large part upon: (i) price movements and trends in the securities markets, (ii) the amount of its assets under management, (iii) the adequacy of its product pricing (which is primarily a function of competitive conditions, management’s ability to assess and manage trends in mortality and morbidity experience as compared to the level of benefit payments, and its ability to maintain expenses within pricing assumptions), (iv) supply and demand for the kinds of products offered by the Company, (v) the maintenance of the Company’s target spreads between credited rates on policyholders’ account balances and the
In addition, the Company has a service agreement with MONY Life whereby MONY Life provides personnel services to the Company to conduct its business. A failure of the proposed merger with AXA Financial could have significant negative effects on MONY Life’s staff and agents. As to staff, many employees may have found other jobs by the time of the shareholder vote, in anticipation of losing their positions with MONY Life after the closing. In addition, the perceived instability of MONY Group and its subsidiaries if the proposed transaction does not close could lead to additional employee and agent turnover.
Declines in Securities Market Prices Could Reduce the Value of Certain Intangible Assets on the Company’s Balance Sheet. The Company Might Have to Write-Off Deferred Policy Acquisition Costs Sooner Than Planned.
At December 31, 2003 the carrying value of the Company’s DPAC was $758.1 million. Approximately $145.4 million of this amount pertains to the Company’s variable annuity in force business. The profit margins from this business, over which the related DPAC is amortized, are particularly sensitive to changes in assumed investment returns and asset valuations. With respect to the investment return assumptions which underlie the amortization of its variable annuity DPAC, the accounting policy followed by the Company, which is referred to as the “reversion to the mean” method, assumes a rate of return over the life of the business of 8.0%. In applying this method, the future assumed rate of return assumption is adjusted based on actual returns to date so that the ultimate rate of return over the expected life of the business is always 8.0%. However, the Company’s policy is to never exceed a future rate of return assumption in excess of 10.0%. Accordingly, the ultimate rate of return over the life of such business may be less than 8.0%. In addition, in applying the “reversion to the mean” method, the Company’s policy does not provide for a floor on the assumed future rate of return. Accordingly, actual returns to date sufficiently in excess of the ultimate assumed rate of return of 8.0% may result in a future rate of return assumption that could actually be negative.
The Company’s calculation of variable annuity product DPAC asset balances as of December 31, 2003 incorporated an assumption of 9.6% in 2004, gradually decreasing to 8.0% thereafter, for all funds underlying variable annuity products. This assumption is consistent with the “reversion to the mean” method described above. The assumption of future returns impacts the Company’s expectation of both future fee income and future expenses, including the cost of guaranteed minimum death benefits.
Management’s assessment of whether an investment in a debt or equity security is “other than temporarily impaired” is primarily based on the following factors:
Changes in the factors discussed above (particularly, a sustained or continuing decline in the prices of securities, or a deterioration in the credit quality of issuers, or a deterioration in industry or issuer fundamentals or in the macro economic outlook) may significantly affect the Company’s determination of whether a security is “other than temporarily impaired”, which may require the Company to recognize an “other than temporary impairment” charge that could be material to its results of operations and financial position. See - Investments - Other Than Temporary Impairment Charges on Investments in Fixed Maturity Securities and Common Stocks.
Certain of the Company’s annuity products have contractual provisions which guarantee minimum death benefits. These provisions require the Company to pay the beneficiary any excess of the guaranteed minimum benefit over the fund value of the annuity contract in addition to the payment of the fund value. It is the Company’s practice to establish reserves for the payment of any guaranteed minimum death benefit claims on the basis of its outlook for mortality experience and the amount at risk on the annuity contracts. At December 31, 2003, the Company’s net amount at risk (or the aggregate amount by which the guaranteed values exceeded the cash values of its in force annuity contracts) totaled approximately $360.7 million. At December 31, 2003, the Company carried a reserve of approximately $3.5 million with respect to such claims. However, additional reserves for such claims may need to be established, particularly if there is a sustained deterioration in the securities markets. In addition, the American Institute of Certified Public Accountants (“AICPA”) has issued guidance concerning the establishment of such reserves. This guidance requires the Company to change its methodology for determining the amount of reserves that should be established for such claims. Accordingly, upon the adoption of the new guidance issued by the AICPA, effective for fiscal years beginning after December 15, 2003, the Company will have to establish additional reserves. The Company estimates that under the new AICPA guidance it will have to establish additional reserves of approximately $0.6 million at December 31, 2003.
As discussed above under the caption “- General Discussion of Factors Affecting Profitability,” revenues from the Company’s separate account and mutual fund products depend, in large part, upon the amount of assets it has under management. Accordingly, a sustained deterioration in the securities markets can adversely affect the Company’s revenues which could be material to its results of operations and financial position.
Although the Company has no employees, under a service agreement with MONY Life, the Company pays for services provided by MONY Life employees (see Note 4 to the Financial Statements). Pension costs for such employees are based in part, on the rate of return assumption and the discount rate used to determine pension liabilities. As required under GAAP, both the expected rate of return assumption for 2004 on assets funding MONY Life’s pension liabilities and other post-retirement benefits and the discount rate used to determine those liabilities were established at December 31, 2003. MONY Life made these assumptions on the basis of historical returns on such assets, its outlook for future returns, the long-term outlook for such returns in the marketplace, and yields on high-quality corporate bonds. Due to the continuing decline in the market yield on high-quality
corporate bonds, MONY Life lowered the discount rate assumption for 2004 to 6.125% from 6.625% in 2003, which will cause an increase in MONY Life’s net periodic expense in 2004 and thereafter. However, while the expected rate of return assumption for 2004 of 8.0% was not changed from that assumed in 2003, the fair value of plan assets grew more than anticipated during 2003, and accordingly, earnings on plan assets during 2004 attributable to such growth are expected to more than offset the increase in pension expense resulting from the use in 2004 of a lower discount rate assumption.
The Company records investments in fixed maturity securities available-for-sale, equity securities, and investments in limited partnership interests accounted for at fair value in the balance sheet. In most cases, the Company determines fair values using quoted market prices. However, valuation of certain investments, such as private placement fixed maturity securities, requires the use of assumptions and estimates related to interest rates, default rates and the timing of cash flows because quoted market prices are not available. At December 31, 2003, the carrying value of private placement fixed maturity securities was $765.8 million.
The Company records changes in the fair values of investments in fixed maturity and equity securities available-for-sale that are not considered to be “other than temporarily impaired” in other comprehensive income. For investments the Company considers to be “other than temporarily impaired”, the Company records an impairment loss, which is reflected in realized gains and (losses) on investments. See - Investments - Other Than Temporary Impairment Charges on Investments in Fixed Maturity Securities and Common Stocks. Determining whether a security is “other than temporarily impaired” requires the use of estimates and significant
The assumption with respect to the future return on pension plan assets is made by management after taking into consideration historic returns on such assets (generally the geometric annual rate of return over at least a ten year period), the actual mix of the pension plan’s invested assets at the valuation date (which is assumed to be consistent in future periods), managements outlook for future returns on such asset types, and the long-term outlook for such returns in the marketplace.
The assumption as to the appropriate discount rate to be used to determine the present value of the pension liabilities is made by management after taking into consideration the Moody’s AA rate index.
• Public and Private Fixed Maturity Securities - The estimated fair values of public fixed maturity securities are based upon quoted market prices, where available. The fair values of private fixed maturity securities or public fixed maturity securities which are not actively traded are estimated using values obtained from independent pricing services or, in the case of private placements, by discounting expected future cash flows using a current market interest rate commensurate with the credit quality and term of the investments.
• Public common stock - The fair value of public common stock investments are determined based on quoted market prices.
In addition to the items discussed above, the application of GAAP requires management to make other estimates and assumptions. For example, the recognition of deferred tax assets, which depends upon management’s assumptions with respect to the Company’s ability to realize deferered tax benefits. See Note 10 to the Financial Statements.
During 2003 the Company was allocated charges from MONY Life aggregating approximately $1.1 million representing reorganization charges taken in connection with MONY Life’s reorganization of certain of its lines of business. These charges consisted of losses relating to the abandonment of leased office space and the write-off of unused furniture and equipment. All of these reorganization charges represented “costs associated with exit
The following table presents the Company’s results of operations for the years ended December 31, 2003 and 2002. The financial information herein is presented in accordance with GAAP unless otherwise noted.
Universal life and investment type product fees were $166.2 million for 2003, an increase of $12.4 million, or 8.1%, from $153.8 million reported for 2002. The increase was primarily attributable to an $18.1 million increase in fees earned on life insurance products, primarily VUL, UL and CSVUL, offset by a $5.7 million decrease in fees earned on the FPVA products. The increase in life insurance product fees was primarily attributable to growth in the in-force block on these products. The decrease in FPVA fees was primarily due to lower surrender charges, attributable to a negative market value adjustment and lower surrender rates, and a decrease in mortality and expense charges as a result of lower average separate account assets under management. Further contributing to the decrease in FPVA fees was an increase in fees ceded to certain reinsurers.
Net realized gains on investments were $17.3 million for 2003, an increase of $27.5 million from net realized losses of $10.2 million reported for 2002. The increase was primarily due to significant losses recorded in 2002 relating to “other than temporary impairment” charges on fixed maturity securities. The following table sets forth the components of net realized gains and (losses) by investment category for the periods presented.
Other income was $27.0 million for 2003, an increase of $10.2 million, or 60.7%, compared to $16.8 million for 2002. The increase was primarily attributable to increased advisory fee income and supplementary contract sales.
Amortization of DPAC was $55.2 million for 2003, a decrease of $26.6 million, or 32.5%, from $81.8 million reported for 2002. The decreased amortization was primarily attributable to increased future margins as a result of higher revenue from underlying funds and an increase in future profitability due to improved market returns. The market upturn in 2003 triggered a decrease in amortization of $10.0 million for the year ended December 31, 2003 compared to the prior year when the deterioration of the markets triggered accelerated DPAC amortization of approximately $17.2 million for the year ended December 31, 2002. The increased revenue from underlying funds resulted in decreased DPAC amortization of approximately $7.4 million. These decreases were partially offset by increased DPAC amortization on life insurance products, primarily the VUL, UL and term product lines, as a result of growth in these lines of business.
(1) Excludes approximately $29.4 million, $61.9 million and $176.9 million in 2003, 2002 and 2001, respectively, relating to surrenders associated with an exchange program offered by the Company wherein contract holders surrendered old FPVA contracts and reinvested the proceeds in a new enhanced FPVA product offered by the Company.
The Company’s principal sources of liquidity to meet cash outflows are its portfolio of liquid assets, capital contributions and loans received from MONY Life, MONY Holdings, and/or MONY Group. During 2003, the Company reported net cash outflows from operations of $28.2 million, a $43.9 million increase from net cash outflows of $72.1 million in 2002.
At December 31, 2003, the adjusted Risk Based Capital (“RBC”) capital ratios of the Company were in excess of minimum capital requirements of the RBC guidelines.
The yield on general account invested assets (including net realized gains and losses on investments) was 6.4%, 5.6% and 6.9% for the years ended December 31, 2003, 2002, and 2001 respectively.
The Company utilizes its investments in privately placed fixed maturity securities to enhance the overall value of its portfolio, increase diversification and obtain higher yields than are possible with comparable quality public market securities. These privately placed securities are also used to enhance cash flow as a result of sinking fund payments. Generally, private placements provide the Company with broader access to management information, strengthened negotiated protective covenants, call protection features and, where applicable, a higher level of collateral. They are, however, generally not freely tradable because of restrictions imposed by federal and state securities laws and illiquid trading markets.
At December 31, 2003, the percentage, based on estimated fair value, of total public and private placement fixed maturity securities that were investment grade (NAIC Designation 1 or 2) was 88.8% compared to 84.1% for December 31, 2002. At December 31, 2003, the fixed maturity securities portfolio was comprised, based on estimated fair value, of 96.0% in public fixed maturity securities, and 79.8% in private fixed maturity securities, compared to 53.6% in public fixed maturity securities and 46.4% in private fixed maturity securities at December 31, 2002.
Within its fixed maturity securities portfolio, the Company identifies “problem fixed maturity securities”, “potential problem fixed maturity securities” and “restructured fixed maturity securities”. See Note 6 to the Financial Statements for a discussion of the criteria used in these identifications.
The Company has a well-diversified portfolio of fixed maturity securities. The portfolio at December 31, 2003 included 20.0% in consumer goods and services, 14.2% in government and agency securities, and the remaining 65.8% in other sectors, none of which exceeded 10.0% of the total fixed maturity securities portfolio. At December 31, 2002, the portfolio included 22.9% in consumer goods and services, 13.2% in government and agency securities, 10.2% in non-government asset and mortgage backed securities, and the remaining 53.7% in other sectors, none of which exceeded 10.0% of the total fixed maturity securities portfolio.
The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity dates (excluding scheduled sinking funds), as of December 31, 2003 and 2002 are as follows:
At December 31, 2003, the Company’s largest unaffiliated single concentration of fixed maturity securities consisted of $59.0 million of carrying value of Federal Home Loan Mortgage Corporation (“FHLMC”) fixed maturity securities which represented approximately 2.4% of total invested assets at December 31, 2003. The largest non-government issuer represented approximately 0.9% of total invested assets at December 31, 2003. See Note 13 to the Financial Statements. No other individual non-government issuer represents more than 0.8% of invested assets.
29.5% and 10.0%, respectively, represented agency-issued pass-through and collateralized mortgage obligations (“CMOs”) secured by the Federal National Mortgage Association (“FNMA”), the FHLMC and the Government National Mortgage Association (“GNMA”). The balance of such amounts was comprised of other types of mortgage-backed and asset-backed securities. The Company believes that its active monitoring of its portfolio of mortgage-backed securities and the limited extent of its holdings of more volatile types of mortgage-backed securities mitigate the Company’s exposure to losses from prepayment risk associated with interest rate fluctuations for this portfolio. At December 31, 2003 and 2002, 68.7% and 66.3%, respectively, of the Company’s mortgage-backed and asset-backed securities were assigned NAIC Designation 1.
The underlying properties supporting the commercial mortgage loans at December 31, 2003 and 2002, respectively, consisted of 59.0% and 63.6% in office buildings, 7.9% and 6.4% in hotels, 11.4% and 13.6% in industrial buildings, 13.5% and 13.3% in office warehouse and 8.2% and 3.1% in other categories.
The Company’s commercial mortgage loan portfolio is managed by a group of experienced real estate professionals. These professionals monitor the performance of the loan collateral, physically inspect properties, collect financial information from borrowers and keep in close contact with borrowers and the local broker communities to assess the market conditions and evaluate the impact of such conditions on property cash flows.
There were no problem, potential problem or restructured commercial mortgage loans at December 31, 2003.
In addition to valuation allowances and impairment writedowns recorded on specific commercial mortgage loans classified as problem and restructured mortgage loans, the Company records a non-specific estimate of expected losses on all other such mortgage loans based on its historical loss experience for such investments. As of December 31, 2003 and 2002, such reserves were $3.9 million and $3.2 million, respectively.
The carrying value of the Company’s agricultural mortgage loans was $103.2 million and $85.7 million, which is net of valuation allowances representing 24.6% and 23.9% of total mortgage assets at December 31, 2003 and 2002, respectively. The agricultural mortgage loan portfolio is diversified both geographically and by type of product. The security for these loans includes row crops, permanent plantings, dairies, ranches and timber tracts. Due to strong agricultural markets and advantageous yields, the Company expects to continue to invest in agricultural mortgage investments. Approximately 0.1% and 0.7% of total agricultural loans outstanding at both December 31, 2003 and 2002, respectively, were delinquent or in process of foreclosure.
Management’s assessment of whether an investment by the Company in a fixed maturity security is “other than temporarily impaired” is primarily based on the following factors:
The Company’s accounting policy provides that the Company, at the end of each reporting period, review all securities where the fair value thereof has declined below 80 percent of its current cost basis to determine whether such securities are “other than temporarily impaired”. In addition, pursuant to this policy, management
reviews securities that have experienced lesser percentage declines in value on a more selective basis using many of the previously discussed factors that the Company considers in making a determination that a security is “other than temporarily impaired.”
In determining that the securities giving rise to the aforementioned unrealized losses were not “other than temporarily impaired”, the Company evaluated the factors cited above, which it considers when assessing whether a security is “other than temporarily impaired”. In making these evaluations, the Company must exercise considerable judgment. Accordingly, there can be no assurance that actual results will not differ from the Company’s judgments and that such differences may require the future recognition of “other than temporary
All of the Company’s fixed maturity securities are classified as available for sale and, accordingly, are marked to market, with unrealized gains and losses excluded from earnings and reported as a separate component of accumulated other comprehensive income. Securities whose value is deemed “other than temporarily impaired” are written down to fair value at the date the determination of impairment is made. The writedowns are recorded as realized losses and included in earnings. The cost basis of such securities is adjusted to fair value and the new cost basis is not changed for subsequent recoveries in value. For the years ended December 31, 2003, 2002 and 2001 such writedowns aggregated $8.6 million, $12.5 million and $3.0 million, respectively.
The carrying value of real estate held for investment is generally adjusted for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Such impairment adjustments are recorded as realized investment losses and, accordingly, are reflected in the Company’s results of operations. There were no impairment adjustments for the years ended December 31, 2003, 2002 and 2001. At December 31, 2003 and 2002, the carrying value of real estate held for investment was $2.2 million and $2.3 million, or 0.1% and 0.1%, respectively, of invested assets at such dates. The aforementioned carrying values are net of cumulative impairments of $0.1 million and $0.1 million, respectively, and net of accumulated depreciation of $1.9 million and $1.7 million, respectively, as of December 31, 2003 and 2002. There can be no assurance that additional provisions for impairment adjustments with respect to real estate held for investment will not need to be made.
Statements of cash flows for the years ended December 31, 2003, 2002 and 2001
Mortgage loans on real estate are stated at their unpaid principal balances, net of valuation allowances. Valuation allowances are established for the excess of the carrying value of a mortgage loan over its estimated fair value when the loan is considered to be impaired. Mortgage loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Estimated fair value is based on either the present value of expected future cash flows discounted at the loan’s original effective interest rate, or the loan’s observable market price (if considered to be a practical expedient), or the fair value of the collateral if the loan is collateral dependent and if foreclosure of the loan is considered probable. The provision for loss is reported as a realized loss on investment. Loans in foreclosure and loans considered to be impaired, other than restructured loans, are placed on non-accrual status. Interest received on non-accrual status mortgage loans is included in investment income in the period received. Interest income on restructured mortgage loans is accrued at the restructured loans’ interest rate.
statement of income and comprehensive income as a result of the Company’s adoption in 2002 of the Financial Accounting Standard Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”):
• Management, having the authority to approve the action, commits the organization to a plan to sell the property.
• The sale of the asset is probable, and transfer of the asset is expected to qualify for recognition as a completed sale, within one year.
• The asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value.
The Company conducts programs from time to time that allow annuity contract holders to exchange older annuity contracts for new annuity products sold at no cost. The Company has determined that the old and new products are substantially similar and, as such, the Company retains previously recorded DPAC related to the exchanged contract.
DPAC is subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each accounting period. The effect on the amortization of DPAC of revisions in estimated experience is reflected in earnings in the period such estimates are revised. In addition, the effect on the DPAC asset that would result from the realization of unrealized gains (losses) is recognized through an offset to Other Comprehensive Income as of the balance sheet date.
Policyholders’ account balances for universal life and investment-type contracts represent an annuity of gross premium payments plus credited interest less expense and mortality charges and withdrawals. The weighted average interest crediting rate for universal life products was approximately 5.5%, 5.6% and 5.9% for the years ended December 31, 2003, 2002 and 2001, respectively. The weighted average interest crediting rate for investment-type products was approximately 4.7%, 4.9% and 5.0% for each of the years ended December 31, 2003, 2002 and 2001, respectively.
The method of allocation between the companies is subject to written agreement, approved by the Board of Directors. The allocation of federal income taxes will be based upon separate return calculations with current credit for losses and other federal income tax credits provided to the life insurance members of the affiliated group. Intercompany balances are settled annually in the fourth quarter of the year in which the return is filed.
The reinsurer’s investment in a reinsurance contract consists of amounts paid to the ceding company at the inception of the contract (e.g. expense allowances and the excess of liabilities assumed by the reinsurer over the assets transferred to the reinsurer under the contract) plus the amount of capital required to support such business consistent with prudent business practices, regulatory requirements, and the reinsurer’s credit rating. The Company estimates the capital required to support such business based on what it considers to be an appropriate level of risk-based capital in light of regulatory requirements and prudent business practices.
On January 1, 2002 the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). SFAS 142 provides that goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment. This Statement provides specific guidance for testing the impairment of goodwill and intangible assets. The adoption of SFAS 142 did not have a material effect on the Company’s results of operations or financial position.
In April 2003, the FASB issued SFAS 133 Implementation Issue B36, Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments (“DIG B36”). DIG B36 addresses the need to separately account for an embedded derivative within a reinsurer’s receivable and ceding company’s payable arising from modified coinsurance or similar arrangements. Paragraph 12(a) of SFAS 133 indicates that an embedded derivative must be separated from the host contract (“bifurcated”) if the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract. DIG B36 concludes that bifurcation is necessary in a modified coinsurance arrangement because the yield on the receivable and payable is based on a specified proportion of the ceding company’s return on either its general account assets or a specified block of those assets, rather than the overall creditworthiness of the ceding company. The effective date of implementation was the first day of the first fiscal quarter beginning after September 15, 2003, with earlier application as of the beginning of a fiscal quarter permitted. The adoption of DIG B36 on October 1, 2003 resulted in the recognition of a realized gain of $7.1 million and a corresponding SWAP asset of $7.1 million. For the year ended December 31, 2003 a realized gain of $6.5 million is recorded in the Company’s statement of income and comprehensive income under the caption “net realized gains/(losses) on investments” and a corresponding SWAP asset of $5.5 million is recorded in the Company’s balance sheet for 2003 under the caption “other invested assets”.
In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (“SFAS 150”). SFAS 150 changes the accounting for certain financial instruments that, under previous guidance, could be classified as equity or “mezzanine” equity, by now
requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position. Further, SFAS 150 requires disclosure regarding the terms of those instruments and settlement alternatives. SFAS 150 affects an entity’s classification of the following free-standing instruments: (i) mandatory redeemable instruments, (ii) financial instruments to repurchase an entity’s own equity instruments, and (iii) financial instruments embodying obligations that the issuer must or could choose to settle by issuing a variable number of its shares or other equity instruments based solely on (a) a fixed monetary amount known at inception or (b) something other than changes in its own equity instruments. SFAS 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. The guidance in SFAS 150 was generally effective for all financial instruments entered into or modified after May 31, 2003, and was otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 did not have a material impact on the Company’s results of operations and financial position.
The Company has a service agreement with MONY Life whereby MONY Life provides personnel services, employee benefits, facilities, supplies and equipment to the Company to conduct its business. The associated costs related to the service agreement are allocated to the Company based on methods that management believes are reasonable, including a review of the nature of such costs and time studies analyzing the amount of employee compensation costs incurred by the Company. For the years ended December 31, 2003, 2002 and 2001, the Company incurred expenses of $73.8 million, $61.8 million and $67.9 million, as a result of such allocations. At December 31, 2003 and 2002 the Company had a payable to MONY Life in connection with this service agreement of $13.1 million and $17.2 million, respectively, which is reflected in “Accounts Payable and Other Liabilities” on the Company’s balance sheet.
In addition to the agreements discussed above, the Company has various other service and investment advisory agreements with MONY Life and affiliates of the Company. The amount of expenses incurred by the Company related to these agreements was $4.5 million, $3.2 million and $3.6 million for the years ended December 31, 2003, 2002, and 2001, respectively. In addition, the Company recorded an intercompany payable of $0.4 million and $0.4 million at December 31, 2003 and 2002, respectively, related to these agreements, which is included in “Accounts Payable and Other Liabilities” on the Company’s balance sheet.
In 1997, the Company entered into a 17-year lease with the New York City Industrial Development Agency (“NY IDA”). NY IDA issued bonds to the Company, for the benefit of MONY Life’s consolidation of site locations to New York City. Debt service under the bonds is funded by lease payments by MONY Life to the bond trustee for the benefit of the bondholder. At December 31,2003, the carrying value of IDA bonds outstanding was $1.2 million. Lease payments for NY IDA were $0.1 million, $0.2 million and $0.2 million for the years ended, December 31, 2003, 2002 and 2001.
The Company recorded capital contributions from MONY Life of $100.0 million, $150.0 million and $100.0 million for the years ended December 31, 2003, 2002 and 2001, respectively.
On March 5, 1999, the Company borrowed $50.5 million from MONY Benefits Management Corp. (“MBMC”), an affiliate, in exchange for a note payable in the same amount. The note bears interest at 6.75% per annum and matures on March 5, 2014. Principal and interest are payable quarterly to MBMC. The carrying value of the note as of December 31, 2003 is $39.6 million.
On May 29, 2002, the Company borrowed $121.0 million from the MONY Group in exchange for a demand note payable in the same amount. The note bore interest at a floating rate equal to Federal Funds Rate +0.15% per annum and had an original maturity date of May 28, 2003. The Company repaid the entire principal outstanding on the demand note plus interest of $1.2 million during the fourth quarter of 2002.
On August 30, 2002, the Company purchased eleven commercial mortgage loans from MONY Life. The purchase price for the mortgages was determined based on fair market value aggregating $148.6 million, which consisted of $146.8 million in principal and $1.8 million in premium. These mortgage loans are included in “Mortgage Loans on Real Estate” on the Company’s balance sheet.
5. Investment Income, Realized and Unrealized Investment Gains/(Losses), and Other Comprehensive Income:
The net change in unrealized investment gains/(losses) represents the only component of other comprehensive income for the years ended December 31, 2003, 2002 and 2001. Following is a summary of the change in unrealized investment gains/(losses) net of related deferred income taxes and adjustment for deferred policy acquisition costs (see Note 3), which are reflected in Accumulated Other Comprehensive Income for the periods presented:
Reclassification adjustments reported in the above table for the years ended December 31, 2003, 2002 and 2001 are net of income tax expense/(benefit) of $2.3 million, $(1.7) million, and $(0.7) million, respectively, and $(2.3) million, $2.5 million, and $2.8 million, respectively, relating to the effect of such amounts on DPAC.
At December 31, 2003 and 2002, there were no fixed maturity securities which were non-income producing for the twelve months preceding such dates.
Impaired mortgage loans that do not have valuation allowances are loans where the net present value of the expected future cash flows related to the loan or the fair value of the collateral equals or exceeds the recorded investment in the loan. Such loans primarily consist of restructured loans or loans on which impairment writedowns were taken prior to the adoption of SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”.
The Company files a consolidated federal income tax return with MONY Life and MONY Life’s other subsidiaries. Federal income taxes have been calculated in accordance with the provisions of the Internal Revenue Code of 1986, as amended. A summary of the income tax expense/(benefit) is presented below:
Federal income taxes reported in the statements of income may be different from the amounts determined by multiplying the earnings before federal income taxes by the statutory federal income tax rate of 35.0%. The sources of the difference and the tax effects of each are as follows:
The Company is required to establish a valuation allowance for any portion of the deferred tax assets that management believes will not be realized. In the opinion of management, it is more likely than not that it will realize the benefit of the deferred tax assets and, therefore, no such valuation allowance has been established.
The estimated fair values of the Company’s financial instruments approximate their carrying amounts except for mortgage loans and investment-type contracts. The methods and assumptions utilized in estimating the fair values of the Company’s financial instruments are summarized as follows:
discounting expected future cash flows using a current market interest rate commensurate with the credit quality and term of the investments.
The following table summarizes the effect of reinsurance for the years indicated:
Pursuant to a securities lending agreement with a major financial institution, the Company from time to time lends securities to approved borrowers. At December 31, 2003 and 2002, securities loaned by the Company under this agreement had a carrying value of approximately $107.7 million and $186.8 million, respectively. The minimum collateral on securities loaned is 102% of the market value of the loaned securities. Such securities are marked to market on a daily basis and the collateral is correspondingly increased or decreased.
The Company has investments in commercial and agricultural mortgage loans. The locations of properties collateralizing mortgage loans at December 31, 2003 and 2002 are as follows:
As of December 31, 2003 and 2002, the mortgage loan portfolio by property type is as follows:
(v) Recently, there has been a significant increase in federal and state regulatory activity in the financial services industry relating to numerous issues, including market timing and late trading of mutual fund and
variable insurance products. The Company, like many others in the financial services industry, has received requests for information from the SEC seeking documentation and other information relating to these issues. In addition, the SEC recently advised the Company of its plan to conduct an on-site examination of the Company’s variable annuities separate account. The Company has been responding to these requests and continues to cooperate fully with the regulators.
(vi) It is possible that the results of operations or the cash flow of the Company in a particular quarterly or annual period could be materially affected as a result of the settlement, or re-evaluation of, the matters discussed above. Management believes, however, that the ultimate payments in connection with such matters should not have a material adverse effect on the Company’s financial statements. In addition to the matters discussed above, the Company is involved in various other legal actions and proceedings (some of which involve demands for unspecified damages) in connection with its business. In the opinion of management of the Company, resolution of contingent liabilities, income taxes and other matters will not have a material adverse effect on the Company’s financial position or results of operations.
During the fourth quarter of 2002 and 2001, the Company was allocated reorganization and other charges aggregating approximately $1.6 million and $20.7 million, respectively, in connection with MONY Life’s initiative to enhance operating efficiency and more efficiently allocate resources and capital. Of these charges, $1.6 million and $6.8 million, respectively, met the definition of “restructuring charges” as defined by Emerging Issues Task Force Consensus 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” (“EITF 94-3”). The 2002 reorganization charge consisted of severance and related benefits resulting from headcount reductions in MONY Life’s home office and career agency system, as well as losses from abandonment of certain leased offices and equipment. The 2001 reorganization charge consisted of severance and related benefits of $7.4 million resulting
from headcount reductions in MONY Life’s home office and career agency system, and $7.4 million of other miscellaneous items. The remaining restructuring reserves primarily relate to lease abandonment costs and are expected to run-off through 2007. The balance of the charge in 2001, $5.9 million, was unrelated to the reorganization activities and consisted of: (i) impairments of certain invested assets and valuation related write-downs of private equity securities held in the Company’s equity method venture capital portfolio, (ii) write-downs of certain information technology assets, and (iii) other miscellaneous items.
The following tables summarize the components of the aforementioned charges allocated during 2003, 2002 and 2001, respectively:
(1) All of the reorganization charges allocated in 2003 are “costs associated with exit or disposal activities” as described in SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities.
(1) All of the reorganization charges allocated in 2002 meet the definition of “restructuring charges” as defined by EITF 94-3.
(1) Severance benefits aggregating $5.4 million and lease abandonment charges aggregating $1.4 million meet the definition of “restructuring charges” as defined by EITF 94-3.
All charges referred to as Reorganization Charges included in the table above, except $3.5 million related to deferred policy acquisition costs in 2001, are included in “Other Operating Costs and Expenses” in the Company’s income statement for the year ended December 31, 2001.
Set forth below is certain information regarding the liability recorded in connection with the restructuring actions during 2003 and 2002, as well as the changes therein. Such liability is reflected in Accounts Payable and Other Liabilities on the Company’s statements of financial position.
(1) Cash payments include in 2003 the non-cash write-off of $0.4 million in unused equipment in certain abandoned leased offices.