Premiums and contract charges under generally accepted accounting principles ("GAAP") decreased 21.0% in 1996 and increased 67.5% in 1995. Under GAAP, revenues exclude deposits on most annuities and premiums on universal life insurance policies. The changes in premiums and contract charges in 1996 and 1995 primarily reflect fluctuations in the level of sales of structured settlement annuities sold with life contingencies. Provision for policy benefits decreased $25.3 million or 12.8%, during 1996 and increased $60.6 million or 44.1%, during 1995. These changes also result primarily from the fluctuations in the level of sales of structured settlement annuities with life contingencies. GAAP premium and contract charges will vary with the mix of products sold during the period.
In low interest rate environments, funds from maturing investments may be reinvested at substantially lower interest rates than those which prevailed when the funds were previously invested.
Operating expenses were essentially unchanged in 1996. The 15.6% increase in 1995 operating expense resulted from an increase in amortization of deferred acquisition costs. In 1994, the Company recognized an after tax charge of $787 thousand related to the cost of an early retirement program offered to certain home office employees. The program provided one year of salary continuation and related benefits and an enhanced retirement benefit.
Net operating income increased 4.2% in 1996 and 17.0% in 1995. The increase in 1996 is the result of growth in investments partially offset by less favorable mortality experience on structured settlement annuities with life contingencies. The increase in net operating income in 1995 was primarily due to higher margins and growth in revenues.
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. The Company's primary market risk exposure is to changes in interest rates. The Company does not currently have material exposures to equity price, commodity price, or foreign currency exchange risk.
The active management of market risk is integral to the Company's operations. The Company may use the following tools to manage its exposure to market risk within defined tolerance ranges: 1) rebalance its existing asset or liability portfolios, 2) change the character of future investments purchased or 3) use derivatives to modify the interest rate characteristics of existing assets and liabilities or assets expected to be purchased. (See the financial futures contracts section in "Investments" and Note 5 to the financial statements for a more detailed discussion of these products.)
The Company offers a variety of annuities including fixed rate single and flexible premium deferred annuities and single premium immediate annuities, including structured settlement annuities. For such products, the Company invests premiums and deposits to create cash flows that will fund future claims, benefits and expenses, and earn stable margins.
The Company's $84.6 million investment in mortgage loans at December 31, 1996 is comprised primarily of loans secured by first mortgages on developed commercial real estate. Property type diversification is a key consideration used to manage the Company's mortgage loan risk.
The Company closely monitors its commercial mortgage loan portfolio on a loan-by-loan basis. Loans with an estimated collateral value less than the loan balance, as well as loans with other characteristics indicative of a higher than normal credit risk, are reviewed by financial and investment management at least quarterly for purposes of establishing valuation allowances and placing loans on non-accrual status. The underlying collateral values are based upon discounted property cash flow projections, which are updated as conditions change or at least annually.
The Company uses financial futures contracts to reduce its exposure to interest rate risk on its investments as well as to improve asset/liability management. The Company does not hold or issue these instruments for trading purposes. At December 31, 1996, the Company had $6.7 million in notional amount of futures contracts outstanding, all of which mature within one year. The Company is exposed to credit-related losses in the event of nonperformance by counterparties to financial futures contracts. However, such nonperformance is not expected because the Company utilizes highly rated counterparties, establishes risk control limits and maintains ongoing monitoring procedures. In addition, futures contracts have limited off-balance-sheet credit risk as they are executed on organized exchanges and require security deposits, as well as the daily cash settlement of margins.
The reserve for life-contingent contract benefits increased 8.7% to $911.5 million at December 31, 1996, resulting primarily from the sales of structured settlement annuities with life contingencies.
The NAIC has a standard for assessing the solvency of insurance companies, which is referred to as risk-based capital ("RBC"). The requirement consists of a formula for determining each insurer's RBC and a model law specifying regulatory actions if an insurer's RBC falls below specified levels. The RBC formula for life insurance companies establishes capital requirements relating to insurance risk, business risk, asset risk and interest rate risk. At December 31, 1996, RBC for the Company was significantly above levels which would require regulatory action.
Claims-paying ability ratings at December 31, 1996 assigned to the Company include AA+, A+(g) and Aa3 from Standard & Poor's, A.M. Best and Moody's, respectively.
The Company's principal sources of funds are premiums, deposits, and collections of principal and income from the investment portfolio. The primary uses of these funds are to purchase investments and pay policyholder claims, benefits, contract maturities and surrenders, and operating costs.
Fixed income securities represent 91.7% of the Company's total investments. The maturity structure of these securities is managed to meet the anticipated cash flow requirements of the underlying liabilities. A portion of the Company's product portfolio, primarily fixed deferred annuities and universal life insurance policies, is subject to discretionary surrender and withdrawal by customers. Management believes its assets are sufficiently liquid to meet future obligations to its life and annuity policyholders, under various interest rate scenarios.
The initial draft of the NAIC's codification of statutory accounting practices will be distributed in March 1997 for a six-month public exposure period. Finalization of the codification is expected to occur in late 1997 or early 1998, with implementation tentatively planned for January 1, 1999. Due to the possible changes resulting from the public exposure of the codification, the potential impact to statutory surplus is not determinable at this time.
In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers of Financial Assets and Extinguishments of Liabilities." This standard distinguishes between transfers of financial assets as sales versus financing transactions based upon relinquishment of control and addresses the accounting for securitizations, securities lending, repurchase agreements and insubstance defeasance transactions. The requirements of this statement that were effective on January 1, 1997 were adopted and are not expected to have a material impact on the results of operations or financial position of the Company.
In our opinion, such financial statements present fairly, in all material respects, the financial position of Allstate Life Insurance Company of New York as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, Schedule IV--Reinsurance and Schedule V--Valuation and Qualifying Accounts, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
The Company markets a broad line of life insurance and annuity products in the State of New York. Life insurance includes traditional products such as whole life and term life insurance, as well as universal life and other interest-sensitive life products. Annuities include deferred annuities, such as variable annuities and fixed rate single and flexible premium annuities, and immediate annuities such as structured settlement annuities. The Company distributes its products using a combination of Allstate agents, banks and other financial institutions, brokers and direct response marketing.
Mortgage loans are carried at outstanding principal balance, net of unamortized premium or discount and valuation allowances. Valuation allowances are established for impaired loans when it is probable that contractual principal and interest will not be collected. Valuation allowances for impaired loans reduce the carrying value to the fair value of the collateral or the present value of the loan's expected future repayment cash flows discounted at the loan's original effective interest rate. Valuation allowances on loans not considered to be impaired are established based on consideration of the underlying collateral, borrower financial strength, current and expected future market conditions and other factors.
Investment income consists primarily of interest, which is recognized on an accrual basis. Interest income on mortgage-backed and asset-backed securities is determined on the effective yield method, based on estimated principal repayments. Accrual of income is suspended for fixed income securities and mortgage loans that are in default or when the receipt of interest payments is in doubt. Realized capital gains and losses are determined on a specific identification basis.
When the Company uses futures as hedging instruments, the derivative must reduce the primary market risk exposure on an enterprise basis in conjunction with the hedge strategy; be designated as a hedge at the inception of the transaction; and be highly correlated with the fair value of, or interest income or expense associated with, the hedged item at inception and throughout the hedge period.
Under deferral accounting, gains and losses on derivatives are deferred on the statement of financial position and recognized in earnings in conjunction with earnings on the hedged item. The Company accounts for interest rate futures as hedges using deferral accounting for anticipatory investment purchases and sales when the criteria discussed above are met. In addition, anticipated transactions must be probable of occurrence and their significant terms and characteristics identified.
Changes in fair values of these derivatives are initially deferred as other liabilities and accrued expenses. Once the anticipated transaction occurs, the deferred gains or losses are considered part of the cost basis of the asset and reported net of tax in shareholder's equity or recognized as a gain or loss from disposition of the asset, as appropriate. The Company reports initial margin deposits on futures in short-term investments. Fees and commissions paid on these derivatives are also deferred as an adjustment to the carrying value of the hedged item.
The Company issues flexible premium deferred variable annuity contracts, the assets and liabilities of which are legally segregated and reflected in the accompanying statements of financial position as assets and liabilities of the Separate Accounts. Assets and liabilities of the Separate Accounts represent funds of Allstate Life of New York Variable Annuity Account, Allstate Life of New York Variable Annuity Account II and Allstate Life of New York Separate Account A ("Separate Accounts"), unit investment trusts registered with the Securities and Exchange Commission.
Contractholder funds arise from the issuance of individual or group contracts that include an investment component, including most annuities and interest- sensitive life insurance contracts. Payments received are recorded as interest- bearing liabilities. Contractholder funds are equal to deposits received and interest credited to the benefit of the contractholder less withdrawals, mortality charges and administrative expenses. Credited interest rates on contractholder funds ranged from 3.1% to 9.75% for those contracts with fixed interest rates and from 3.55% to 8.42% for those with flexible rates during 1996.
The Company cedes business to the Parent under reinsurance treaties to limit aggregate and single exposures on large risks. Premiums and policy benefits ceded totaled $1,383 and $1,662 in 1996, $1,259 and $278 in 1995, and $1,181 and $1,877 in 1994, respectively. Included in the reinsurance recoverable at December 31, 1996 and 1995 are amounts due from the Parent of $965 and $1,212.
AIC, through an affiliate, purchased $15,610, $11,243, and $7,568 of structured settlement annuities from the Company in 1996, 1995 and 1994, respectively. Of these amounts, $8,517, $4,164 and $1,221
NOTES TO FINANCIAL STATEMENTS--(CONTINUED) ($ IN THOUSANDS) relate to structured settlement annuities with life contingencies and are included in premium income in 1996, 1995 and 1994, respectively. Additionally, the reserve for life-contingent contract benefits was increased by approximately 94% of such premium received in each of these years.
The scheduled maturities for fixed income securities are as follows at December 31, 1996:
NOTES TO FINANCIAL STATEMENTS--(CONTINUED) ($ IN THOUSANDS) PROCEEDS FROM SALES OF FIXED INCOME SECURITIES
Proceeds from sales of investments in fixed income securities were $28,454, $13,526 and $49,903 in 1996, 1995 and 1994, respectively. Gross gains of $480, $172 and $1,743 and gross losses of $2,308, $105 and $973 were realized on sales of fixed income securities during 1996, 1995 and 1994, respectively.
Activity in the valuation allowance for all mortgage loans for the years ended December 31, 1996 and 1995 is summarized as follows:
The Company's mortgage loans are collateralized by a variety of commercial real estate property types located throughout the United States. Substantially all of the commercial mortgage loans are non-recourse
NOTES TO FINANCIAL STATEMENTS--(CONTINUED) ($ IN THOUSANDS) The fair value of contractholder funds on investment contracts is based on the terms of the underlying contracts. Reserves on investment contracts with no stated maturities (single premium and flexible premium deferred annuities) are valued at the account balance less surrender charges. The fair value of immediate annuities and annuities without life contingencies with fixed terms is estimated using discounted cash flow calculations based on interest rates currently offered for contracts with similar terms and durations. Separate Accounts liabilities are carried at the fair value of the underlying assets.
The contract or notional amounts are used to calculate the exchange of contractual payments under the agreements and are not representative of the potential for gain or loss on these agreements.
Financial futures are commitments to either purchase or sell designated financial instruments at a future date for a specified price or yield. They may be settled in cash or through delivery. As part of its
NOTES TO FINANCIAL STATEMENTS--(CONTINUED) ($ IN THOUSANDS) asset/liability management, the Company generally utilizes futures contracts to manage its market risk related to fixed income securities and anticipatory investment purchases and sales. Futures used as hedges of anticipatory transactions pertain to identified transactions which are probable to occur and are generally completed within ninety days. Futures contracts have limited off- balance-sheet credit risk as they are executed on organized exchanges and require security deposits, as well as the daily cash settlement of margins.
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. Market risk exists for all of the derivative financial instruments that the Company currently holds, as these instruments may become less valuable due to adverse changes in market conditions. The Company mitigates this risk through established risk limits set by senior management. In addition, the change in the value of the Company's derivative financial instruments designated as hedges are generally offset by the change in the value of the related assets.
Commitments to extend mortgage loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. The Company enters these agreements to commit to future loan fundings at a predetermined interest rate. Commitments generally have fixed expiration dates or other termination clauses. Commitments to extend mortgage loans, which are secured by the underlying properties, are valued based on estimates of fees charged by other institutions to make similar commitments to similar borrowers. At December 31, 1996, the Company had $6,190 in mortgage loan commitments which had a fair value of $62. No such commitments existed at December 31, 1995.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED) ($ IN THOUSANDS) Prior to January 1, 1984, the Company was entitled to exclude certain amounts from taxable income and accumulate such amounts in a "policyholder surplus" account. The balance in this account at December 31, 1996, approximately $389, will result in taxes payable of $136 if distributed by the Company to the Parent. No provision for taxes has been made as the Company has no plan to distribute amounts from this account. No further additions to the account are allowed under the Tax Reform Act of 1984.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED) ($ IN THOUSANDS) PERMITTED STATUTORY ACCOUNTING PRACTICES
The Company prepares its statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the New York Department of Insurance. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company does not follow any permitted statutory accounting practices that have a material effect on statutory surplus or risk-based capital.
The ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company and other relevant factors. Under New York Insurance Law, a notice of intention to distribute any dividend must be filed with the New York Superintendent of Insurance not less than 30 days prior to the distribution. Such proposed declaration is subject to the Superintendent's disapproval.