The Registrant’s home office is located at 222 Broadway, 14th Floor, New York, New York. This office space is leased from MLPF&S. In addition, personnel performing services for the Registrant pursuant to its Management Services Agreement operate in MLIG office space. MLIG occupies certain office space in Pennington, New Jersey through Merrill Lynch & Co. An allocable share of the cost of each of these premises is paid by the Registrant through the service agreement with MLIG. Merrill Lynch Insurance Group Services, Inc. (“MLIGS”), an affiliate of MLIG owns office space in Jacksonville, Florida. MLIGS also leases certain office space in Springfield, Massachusetts from Picknelly Family Limited Partnership. During 2001, MLIGS consolidated operations into the Jacksonville, Florida location. MLIGS continues to lease the office space in Springfield, Massachusetts, although there are no personnel at that location.
ML of New York conducts its business in the life insurance and annuity markets of the financial services industry. These markets are highly regulated with particular emphasis on company solvency and sales practice monitoring. Demographically, the population is aging, which favors life insurance and annuity products.
Changes in the corporate credit environment directly impact the value of ML of New York’s investments, primarily fixed maturity securities. ML of New York primarily invests in investment-grade corporate debt to support its fixed rate product liabilities.
ML of New York defines credit spreads according to the Merrill Lynch U.S. Corporate Bond Index for BBB-A Rated bonds with three to five year maturities. During 2003, credit spreads contracted approximately 113 basis points and ended the year at 85 basis points. During 2002, credit spreads widened approximately 20 basis point and ended the year at 198 basis points.
DAC for variable annuities is amortized with interest over the lives of the policies in relation to the present values of estimated future gross profits from asset-based fees, contract fees, and surrender charges, less a provision for guaranteed minimum death benefit expenses, policy maintenance expenses, and non-capitalized commissions.
Future gross profit estimates are subject to periodic evaluation by ML of New York, with necessary revisions applied against amortization to date. The impact of revisions to estimates on cumulative amortization is recorded as a charge or benefit to current operations (“DAC unlocking”). During 2003 and 2002, ML of New York reduced earnings by $1.0 million and $1.5 million, respectively, via an increase in amortization of deferred policy acquisition costs. Changes in assumptions can have a significant impact on the amount of DAC reported for variable annuities and variable life insurance products and their 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 return and increases in surrender or mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization.
ML of New York sells variable and interest sensitive annuity products through the retail network of Merrill Lynch, Pierce, Fenner & Smith, Incorporated, a wholly owned broker-dealer subsidiary of Merrill Lynch & Co. ML of New York competes for Merrill Lynch & Co.’s clients’ annuity business with unaffiliated insurers whose products are also sold through Merrill Lynch & Co.’s retail network, and with insurers who solicit this business
ML of New York’s financial management is based on conservative investment and liability management and regular monitoring of its risk profile. ML of New York also seeks to provide superior customer service and financial management to promote the competitiveness of its products. ML of New York’s customer service center has established standards of performance that are monitored on a regular basis. Managers and employees in the customer service center are periodically evaluated based on their performance in meeting these standards.
ML of New York has strategically placed its marketing emphasis on the sale of variable annuity products. These products are designed to address the retirement planning needs of Merrill Lynch & Co.’s clients. ML of New York issues three types of variable annuity products. These products are differentiated by the degree of liquidity afforded to the contract owner. The B-Share variable annuity contains a seven year surrender charge period, the L-Share variable annuity contains a three year surrender charge period, and the C-Share variable annuity has no surrender charge period. Each variable annuity product provides tax-deferred retirement savings with the opportunity for diversified investing in a wide selection of underlying mutual fund portfolios. In addition, ML of New York issues a modified guaranteed annuity product. The modified guaranteed annuity product also provides tax-deferred retirement savings through a guaranteed fixed interest rate for a period selected by the contract owner, but imposes a market value adjustment for withdrawals prior to the expiration of the guarantee period. Total direct premiums by product type for the three years ended December 31 were as follows:
ML of New York’s L-Share variable annuity product was introduced in the fourth quarter 2001.
During 2003, ML of New York’s total direct premiums decreased $4.1 million (or 6%) to $60.4 million as compared to 2002. Variable annuity premiums increased $10.2 million (or 21%) to $58.2 million during 2003 as compared to 2002. Management attributes the increase in variable annuity premiums primarily to the introduction of a new B-Share variable annuity product during the third quarter of 2003. Sales of the new B-Share variable annuity product were $20.8 million during 2003. The new B-Share variable annuity product is designed for the tax-qualified IRA market and includes a guaranteed living benefit provision. Also, during the second quarter 2003 ML of New York added a guaranteed living benefit provision to its existing B-Share variable annuity. Living benefit provisions have increased in popularity due to consumers’ increasing demand for guaranteed benefits. Management believes that the generally decreasing equity markets over the past three
Modified guaranteed annuity sales decreased $15.0 million (or 99%) to $0.2 million during 2003 as compared to 2002. During 2003, ML of New York stopped offering certain guarantee periods because required spreads could not be realized due to the combination of lower interest rates and regulatorily mandated guaranteed minimum crediting rates.
At December 31, 2003, ML of New York’s assets were $1,251.8 million, or $122.6 million higher than the $1,129.2 million in assets at December 31, 2002 primarily due to a increase in separate accounts assets. Separate accounts assets increased $132.8 million (or 16%) to $943.2 million. Changes in separate accounts assets during each quarter of 2003 were as follows:
During 2003, ML of New York experienced contract owner withdrawals that exceeded deposits by $42.5 million. The components of contract owner transactions were as follows:
significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. Current non-investment grade holdings are the result of ratings downgrades on ML of New York’s portfolio as ML of New York does not purchase non-investment grade securities. Also, as of December 31, 2003, approximately $3.5 million (or 2%) of ML of New York’s fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by Standard and Poor’s, compared to $10.9 million (or 7%) of fixed maturity securities as of December 31, 2002. ML of New York closely monitors such investments. The reductions in non-investment grade and BBB- holdings are attributable to management actions taken during 2003 to improve the overall credit quality of the fixed maturity security portfolio.
ML of New York’s liquidity requirements include the payment of sales commissions and other underwriting expenses and the funding of its contractual obligations for the life insurance and annuity contracts it has inforce. ML of New York has developed and utilizes a cash flow projection system and regularly performs asset / liability duration matching in the management of its asset and liability portfolios. ML of New York anticipates funding all its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. As of December 31, 2003, ML of New York’s assets included $190.4 million of cash, short-term investments, and investment grade publicly traded available-for-sale securities that could be liquidated if funds were required.
The National Association of Insurance Commissioners utilizes the Risk Based Capital (“RBC”) adequacy monitoring system. The RBC calculates the amount of adjusted capital that a life insurance company should have based upon that company’s risk profile. As of December 31, 2003 and 2002, based on the RBC formula, ML of New York’s total adjusted capital level was well in excess of the minimum amount of capital required to avoid regulatory action.
ML of New York receives claims paying ability ratings from Standard and Poors and A.M. Best. At December 31, 2003, ML of New York received ratings from Standard and Poors and A.M. Best of “A+” and “A”, respectively.
ML of New York recorded net earnings of $4.4 million and $3.2 million for 2003 and 2002, respectively.
Policy benefits decreased $0.5 million (or 10%) to $4.0 million during 2003 as compared to $4.5 million in 2002 primarily due to decreased variable annuity death benefit payments incurred under GMDB provisions.
Reinsurance premium ceded decreased $0.1 million (or 10%) to $1.6 million during 2003 as compared to $1.7 million in 2002. The decrease is attributable to the decrease in life insurance inforce.
Insurance expenses and taxes increased $0.2 million (or 6%) to $3.5 million during 2003 as compared to $3.3 million in 2002. The increase in insurance expenses and taxes is primarily due to increased New York State Insurance Department assessments.
ML of New York recorded net earnings of $3.2 million and $4.3 million for 2002 and 2001, respectively.
Policy charge revenue decreased $0.7 million (or 4%) to $18.0 million during 2002 as compared to $18.7 million in 2001. The decrease in policy charge revenue is primarily attributable to reductions in asset-based policy charge revenue collected on variable account balances. Variable annuity and variable life asset-based policy charge revenue decreased $0.4 million (or 4%) and $0.3 million (or 12%), respectively, generally consistent with decreases in average variable account balances for those products. Asset-based policy charge revenue was favorably impacted by increases in rates charged to unaffiliated fund investment managers for administrative services.
Net earnings derived from interest spread decreased $1.0 million (or 20%) to $4.0 million during 2002 as compared to $5.0 million in 2001. The decrease in interest spread is primarily a result of the reduction in yields on invested assets resulting from the lower interest rate environment as compared to 2001.
ML of New York experienced net realized investment losses of $3.2 million and $2.5 million during 2003 and 2002, respectively. The increase in net realized investment losses is due to an increase in credit related losses primarily losses on investments in fixed maturity securities issued by WorldCom Inc.
Amortization of deferred policy acquisition costs increased $2.0 million (or 56%) to $5.5 million during 2002 as compared to $3.5 million in 2001 primarily due to period-to-period differences in DAC unlocking as noted in the Critical Accounting Policies section above.
Insurance expenses and taxes decreased $1.5 million (or 31%) to $3.3 million during 2002 as compared to $4.8 million in 2001. The decrease in insurance expenses and taxes is primarily due to i) cost savings resulting from ML of New York’s consolidation of its life and annuity policy administration service centers, which was completed during the third quarter 2001, and ii) reductions in employee compensation expense.
ML of New York’s effective federal income tax rate decreased to 16% for 2002 from 45% for 2001. The changes in the effective federal income tax rate during the respective periods are due to an increase in certain permanent adjustments recorded during 2002 as compared to 2001. Also, during 2002, ML of New York’s current and deferred tax components have been significantly impacted by fluctuations in GMDB tax reserves. The reserve fluctuations have resulted in an increased current tax benefit and an increased deferred tax expense during 2002 as compared to 2001.