Selected consolidated financial data for the Company are presented below for each of the five years in the period ended December 31, 2002. This data should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto and Item 7, Management's Discussion and Analysis of Results of Operations and Financial Condition.
The Insurance Company is rated "B+ (Very Good)" by A.M. Best as of December 31, 2002.
Total annuity considerations and life insurance premiums decreased to approximately $81.0 million in fiscal 2002 from approximately $111.5 million in fiscal 2001, a decrease of approximately 27.4%. This decrease is attributable to a decrease in sales of the Insurance Company¢ s Single Premium immediate annuities with life contingencies. Annuity considerations decreased to approximately $69.4 million in fiscal 2002 from approximately $97.4 million in fiscal 2001, a decrease of approximately $28.0 million. In accordance with GAAP, sales of single premium deferred annuities are not reported as annuity considerations, but rather as additions to policyholder account balances. Based on statutory accounting, revenue from sales of single premium annuities were approximately $815.8 million, $700.1 million and $350.4 million in fiscal 2002, 2001 and 2000, respectively. Management believes that the increase in annuity considerations is due to the successful expansion of our Marketing Department. Beginning in 1996, the Company added regional sales directors in various states. These regional sales directors have added new general agents, which have generated sales.
Total annuity considerations and life insurance premiums increased to approximately $111.5 million in fiscal 2001 from approximately $62.6 million in fiscal 2000, an increase of approximately 78.1%. Management believes that the increase in annuity considerations is due to the successful expansion of our Marketing Department. Beginning in 1996, the Company added regional sales directors in various states. These regional sales directors have added new general agents, which have generated sales.
Universal life and investment type policy fee income was approximately $.7 million in fiscal 2002, as compared to approximately $.8 million in fiscal 2001 and approximately $.7 million in fiscal 2000. The decrease in 2002 is attributed to a reduced number of life policies surrendered during 2002 that were within the surrender charge period. Policy fee income consists principally of amounts assessed during the period against policyholders' account balances for mortality charges and surrender charges.
Realized investment losses amounted to approximately $146.7 million in fiscal 2002, as compared to approximately $65.1 million of losses in fiscal 2001 and losses of approximately $8.5 million in fiscal 2000. Realized investment losses for years ended December 31, 2002, 2001 and 2000 include realized investment losses of approximately $147.3 million, $50.7 million and $22.8 million, respectively, attributable to writedowns of certain securities contained in the Company's investment portfolio. Investment securities with unrealized losses are placed on an internal watch list and are carefully evaluated to determine whether such losses are other than temporary. Evaluations of watch list securities are monitored on an ongoing basis. Various criteria are utilized in the evaluation of the financial performance of the issuer, including capital structure, debt maturities, earnings trends, asset quality, Industry trends, regional and economic trends and specific events including: a) company specific event, such as missed interest payments, accounting issues, gain or loss of major revenue generating contract(s), significant change in availability and cost of raw material or labor; and, b) specific market- driven events such as dramatic changes in interest rates or geo-political events. The result of this analysis is then evaluated in the context of the Company’s intent to hold to maturity barring any significant adverse change in credit conditions, as well as the Company’s need for liquidity. When issuers are determined to be other than temporary, the Company adjusts the book value to reflect the net realizable value or fair value, as appropriate, on a quarterly basis. Realized investment gains (losses) also result from sales of certain equities and convertible securities, and calls and sales of fixed maturity investments in the Company's investment portfolio.
The following table presents the total gross unrealized losses for fixed maturities where the estimated fair value had declined and remained below amortized cost by December 31, 2002.
Approximately 89% of the securities with an unrealized loss of 20% or more for a period equal to or greater than twelve months are Principal Protected Notes. This structure utilizes AAA collateral such as U.S Treasury Strips, in conjuction with a variable rate coupon. The AAA rated collateral accretes to par at maturity, defeasing the security and thereby insulating the holder from any negative credit events which might interfere with the repayment of principal.
Interest credited and benefits to policyholders amounted to approximately $276.8 million in fiscal 2002 as compared to approximately $267.4 million in fiscal 2001 and approximately $197.8 million in fiscal 2000. This represents an increase of approximately 3.5% comparing fiscal 2002 to fiscal 2001 and approximately a 35.2% increase comparing fiscal 2001 to fiscal 2000. These increases principally are attributable to a higher level of policyholder account balances as a result of the increase in annuity considerations received during the respective years.
The Insurance Company’s average credited rates for reserves and account balances for the 12 months ended December 31, 2002, 2001 and 2000 were less than the Company’s ratio of net investment income to mean assets for the same periods as noted above under "Net Investment Income." Although management does not currently expect material declines in the spread between the Company’s average credited rate for reserves and account balances and the Company’s ratio of net investment income to mean assets (the "Spread"), there can be no assurance that the spread will not decline in future periods or that such decline will not have a material adverse effect on the Company’s financial condition and results of operations. Depending, in part, upon competitive factors affecting the industry in general, and the Company in particular, the Company may, from time to time, adjust the average credited rates on certain of its products. There can be no assurance that the Company will reduce such rates or that any such reductions will broaden the Spread.
The interest expense on the Company's notes payable amounted to approximately $10.63 million in fiscal 2002, approximately $8.84 million in fiscal 2001 and approximately $9.77 million in fiscal 2000. The increase in interest expense in fiscal 2002 is attributable to the Company's rate lock loss in connection with the issuance of the senior notes due 2009.
General expenses, taxes and commissions to agents totaled approximately $47.2 million in fiscal 2002 as compared to approximately $50.3 million in fiscal 2001 and approximately $29.9 million in fiscal 2000. This represents a decrease of approximately 6.2% comparing fiscal 2002 to fiscal 2001 and an increase of approximately 68.2% comparing fiscal 2001 to fiscal 2000. The decrease in fiscal 2002 compared to fiscal 2001 is attributable to a reduction in the Company’s general expenses due to expense controls initiated in 2002. The increase in fiscal 2001 compared to 2000, principally is attributable to higher costs associated with higher commissions and selling expenses incurred associated with the higher level of sales of single premium annuities offset by the company¢ s general expenses and taxes.
The change in the net DAC for fiscal 2002 resulted in a credit of approximately $30.6 million, as compared to a credit of approximately $23.5 million in fiscal 2001 and a credit of approximately $11.0 million in fiscal 2000. Such changes are due (i) to the increase in costs associated with recent new product sales which have been deferred and are amortized in proportion to the recognition of earned revenue and (ii) to the effect of revisions to estimated gross profits on unamortized deferred acquisition costs which are reflected in the year such estimated gross profits are revised.
For the reasons discussed above, income (loss) before income taxes amounted to approximately $(99.2) million in fiscal 2002, as compared to approximately $(18.6) million in fiscal 2001 and approximately $58.0 million in fiscal 2000.
Income tax expense (benefit) was approximately $(30.0) million for fiscal 2002, as compared to approximately $(10.9) million in fiscal 2001 and approximately $17.1 million in fiscal 2000. The decrease in income taxes in fiscal 2002 is primarily attributable to realized capital losses during fiscal 2002. The Company's strategy was to utilize a carryback of its net capital gains reported in the Company's consolidated tax return in 2000 and 1999.
The Insurance Company is subject to various regulatory restrictions on the maximum amount of payments, including loans or cash advances that it may make to the Company without obtaining prior regulatory approval. Under the New York Insurance Law, the Insurance Company is permitted without prior insurance regulatory clearance to pay a stockholder dividend to the Company as long as the aggregate amount of all such dividends in any calendar year does not exceed the lesser of (i) 10% of its surplus as of the immediately preceding calendar year and (ii) its net gain from operations for the immediately preceding calendar year (excluding realized capital gains and losses). The Insurance Company will be permitted to pay a stockholder dividend to the Company in excess of the lesser of such two amounts only if it files notice of its intention to declare such a dividend and the amount thereof with the Superintendent and the Superintendent does not disapprove the distribution. Under the New York Insurance Law, the Superintendent has broad discretion in determining whether the financial condition of a stock life insurance company would support the payment of such dividends to its stockholders. The NYSID has established informal guidelines for such determinations.
consideration. The Company's other insurance subsidiary is also subject to restrictions
Principal sources of funds at the Insurance Company are premiums and other considerations paid, net investment income received and proceeds from investments called, redeemed or sold. The principal uses of these funds are the payment of benefits on annuity contracts and life insurance policies (including withdrawals and surrender payments), the payment of policy acquisition costs, operating expenses and the purchase of investments.
Given the Insurance Company's historic cash flow and current financial results, management believes that, for the next twelve months and for the reasonably foreseeable future, the Insurance Company's cash flow from operating activities will provide sufficient liquidity for the operations of the Insurance Company.
For purposes of the Company's consolidated statements of cash flows, financing activities relate primarily to "dollar roll" repurchase transactions, and to sales and surrenders of the Company's annuity and universal life insurance products. The payment of dividends by the Company to its stockholders also is considered to be a financing activity. Net cash provided by the Company's financing activities amounted to approximately $668.9 million, $711.9 million and $189.5 million in fiscal 2002, 2001 and 2000, respectively. These fluctuations primarily are attributable to higher policyholder account balances (as a result of increased sales), the new line of credit established in 2001, partially offset by the payment of dividends to the Company's shareholders during fiscal year 2002.
Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates, and other relevant market rate or price changes. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded. The following is a discussion of the Company's primary market risk exposures and how those exposures are currently managed as of December 31, 2002.
The primary market risk to the Company's investment portfolio is interest rate
The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety.
Based on market values and prevailing interest rates as of December 31, 2002, a hypothetical instantaneous increase of 100 basis points would produce a loss in fair value of fixed maturity assets of approximately $242.8 million. Since the Company is able to hold its fixed maturity securities to maturity, it does not expect to realize significant losses under such a hypothetical scenario.
The Company maintains a portfolio which includes below investment grade securities which were purchased to achieve a more favorable investment yield, all of which are classified as available for sale and reported at estimated market value. As of December 31, 2002 and 2001, the carrying value of these securities was approximately $271.3 million and $275.0 million, respectively (representing approximately 6.1% and 7.3%, respectively, of the Company's total assets).
As of December 31, 2002, approximately 6.7% of the Insurance Company's total invested assets were invested in limited partnerships and equity securities. Pursuant to NYSID regulations, the Company's investments in equity securities, including limited partnership interests, may not exceed 20% of the Insurance Company's invested assets. Investments in limited partnerships are included in the Company's consolidated balance sheet under the heading "Other invested assets." See "Note 2 to the Notes to Consolidated Financial Statements." The Company is committed, if called upon during a specified period, to contribute an aggregate of approximately $122.4 million of additional capital to certain of these limited partnerships. $7.7 million in commitments will expire in 2003, $30.4 million in 2004, $28.1 million in 2005, $21.4 million in 2006 and $34.7 in 2007. The Company may make selective investments in additional limited partnerships as opportunities arise. In general, risks associated with such limited partnerships include those related to their underlying investments (i.e., equity securities, debt securities and real estate), plus a level of illiquidity, which is mitigated by the ability of the Company to take annual distributions of partnership earnings. There can be no assurance that the Company will continue to achieve the same level of returns on its investments in limited partnerships as it has historically or that the Company will achieve any returns on such investments at all. Further, there can be no assurance that the Company will receive a return of all or any portion of its current or future capital investments in limited partnerships. The failure of the Company to receive the return of a material portion of its capital investments in limited partnerships, or to achieve historic levels of return on such investments, could have a material adverse effect on the Company's financial condition and results of operations.
As previously discussed, in fiscal 2002 and 2001 the Company participated in "dollar roll" repurchase agreement transactions. Amounts outstanding to repurchase securities under such agreements were approximately $262.5 million and $260.6 million at December 31, 2002 and 2001, respectively. The Company may engage in selected "dollar roll" transactions as market opportunities arise.
is engaged. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's solvency. The amount of these assessments in current and prior years has not been material, however, the amount and timing of any future assessment on the Insurance Company under these laws cannot be reasonably estimated and are beyond the control of the Company and the Insurance Company. Recent failures of substantially larger insurance companies could result in future assessments in material amounts.
Interest rate changes also may have temporary effects on the sale and profitability of the universal life and annuity products offered by the Company. For example, if interest rates rise, competing investments (such as annuity or life insurance products offered by the Company's competitors, certificates of deposit, mutual funds and similar instruments) may become more attractive to potential purchasers of the Company's products until the Company increases the rates credited to holders of its universal life and annuity products. In contrast, as interest rates fall, the Company attempts to lower its credited rates to compensate for the corresponding decline in its net investment income. As a result, changes in interest rates could materially adversely effect the financial condition and results of operations of the Company depending on the attractiveness of alternative investments available to the Company's customers. In that regard, in the current interest rate
The Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the SEC. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "expect", "anticipate", "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company's beliefs concerning future levels of sales and redemptions of the Company's products, investment spreads and yields, or the earnings and profitability of the Company's activities.
In June 2000, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities-an Amendment of FASB Statement No. 137, Accounting for Derivative Instruments and Hedging Activities-Deferral of Effective Date of FASB Statement No. 133 ("SFAS 137"). SFAS 137 deferred the provisions of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") until January 1, 2001. SFAS 133, as amended by SFAS 138, requires, among other things, that all derivatives be recognized in the consolidated balance sheets as either assets or liabilities and measured at fair value. The corresponding derivative gains and losses should be reported based upon the hedge relationship, if such a relationship exists. Changes in the fair value of derivatives that are not designated as hedges or that do not meet the hedge accounting criteria in SFAS 133 and SFAS 138 are required to be reported in income. The impact of adopting SFAS 133 and 138 was for the Company to record, as a transition adjustment to accumulated comprehensive income, effective January 1, 2001, an unrealized loss of $5.5 million. In July 2002, the Financial Accounting Standards Board ("FASB") issued certain additional guidance relating to the identification of embedded derivatives under SFAS 133 and SFAS 138. The Financial Accounting Standards Board ("FASB") continues to issue additional guidance relating to the accounting for derivatives under SFAS 133 and SFAS 138. Adoption of the additional guidance of SFAS 133 and SFAS 138 did not have an impact on the Company’s consolidated financial statements for 2002.
In September 2001, the Emerging Issues Task Force issued No. 01-10, "Accounting for the Impact of the Terrorist Attack of September 11, 2001" (EITF 01-10 requires that losses or cost resulting from the September 11th events be classified as part of income from continuing operations in the statement of operations. Application of EITF 01-10 did not have an impact on the Company's consolidated financial statements.
In August 2002, the FASB issued SFAS No.146, Accounting for Costs Associated with Exit or Disposal Activities (² SFAS 146² ). The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Previous accounting guidance was provided by EITF 94-3, ² Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)² . SFAS 146 replaces EITF 94-3. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002.
The Company incurs significant costs in connection with acquiring new business. These costs, which vary with and are primarily related to the production of new business, are deferred. The recovery of such costs is dependent upon the future profitability of the related product, which in turn is dependent mainly on investment returns in excess of interest credited, as well as, persistency and expenses. These factors enter into management¢ s estimate of future gross profits, which generally are used to amortize such costs. Changes in these estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the deferred acquisition asset and a charge to income if estimated future gross profits are less than amounts deferred.