The Company, a wholly owned subsidiary of Allstate Life Insurance Company ("ALIC"), which is a wholly owned subsidiary of Allstate Insurance Company ("AIC"), a wholly owned subsidiary of The Allstate Corporation ("Corporation"), markets a broad line of life insurance and savings products in the state of New York through a combination of exclusive agencies, securities firms, banks, specialized brokers and direct response marketing. Life insurance consists of traditional products, including term and whole life, interest-sensitive life and immediate annuities with life contingencies. Savings products include deferred annuities and immediate annuities without life contingencies. Deferred annuities include fixed rate, market value adjusted and variable annuities. Group pension savings products include immediate annuities also referred to as retirement annuities.
(1) The supplemental operating information presented above allows for a more complete analysis of results of operations. The net effects of gains and losses have been excluded due to its volatility between periods and because such data is often excluded when evaluating the overall financial performance of insurers. Operating income should not be considered as a substitute for any GAAP measure of performance. Our method of calculating operating income may be different from the method used by other companies and therefore comparability may be limited. (2) Net of the effect of related amortization of deferred policy acquisition costs in 1999 and 1998.
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(1) Fixed income securities are carried at fair value. Amortized cost for these securities was $1,858,216 at December 31, 1999.
Total investments were $2.16 billion at December 31, 1999 compared to $2.22 billion at December 31, 1998. Positive cash flows generated from operations were more than offset by lower unrealized gains on fixed income securities.
FIXED INCOME SECURITIES The Company's fixed income securities portfolio consists of privately-placed securities, publicly traded corporate bonds, U.S. government bonds, mortgage-backed securities, foreign government bonds, asset-backed securities and tax-exempt municipal bonds. The Company generally holds its fixed income securities to maturity, but has classified all of these securities as available for sale to allow maximum flexibility in portfolio management. At December 31, 1999, unrealized net capital gains on the fixed income securities portfolio totaled $54.3 million compared to $317.1 million at December 31, 1998. The decrease in the unrealized gain position is primarily attributable to an increase in interest rates.
At December 31, 1999, substantially all of the Company's fixed income securities portfolio was rated investment grade, which is defined by the Company as a security having a National Association of Insurance Commissioners ("NAIC") rating of 1 or 2, a Moody's rating of Aaa, Aa, A or Baa, or a comparable Company internal rating. The quality mix of the Company's fixed income securities portfolio at December 31, 1999 is presented in the following table:
As of December 31, 1999, the fixed income securities portfolio contained $529.8 million of privately-placed corporate obligations compared to $555.9 million at December 31, 1998. The benefits of privately-placed securities as compared to public securities are generally higher yields, improved cash flow predictability through pro-rata sinking funds on many bonds, and a combination of covenant and call protection features designed to better protect the holder against losses resulting from credit deterioration, reinvestment risk and fluctuations in interest rates. A relative disadvantage of privately-placed securities as compared to
public securities is reduced liquidity. At December 31, 1999, substantially all of the privately-placed securities were rated as investment grade by either the NAIC or the Company's internal ratings. The Company determines the fair value of privately-placed fixed income securities based on discounted cash flows using current interest rates for similar securities.
The MBS portfolio is subject to interest rate risk since the price volatility and ultimate realized yield are affected by the rate of repayment of the underlying mortgages. The Company attempts to limit interest rate risk on these securities by investing a portion of the portfolio in securities that provide prepayment protection. At December 31, 1999, over 36% of the MBS portfolio was invested in planned amortization class bonds.
The fixed income securities portfolio contained $34.2 million and $34.5 million of asset-backed securities ("ABS") at December 31, 1999 and 1998, respectively. ABS are subject to credit and interest rate risk. Credit risk is mitigated by monitoring the performance of the collateral. Approximately 35% of all securities are rated in the highest rating category by one or more credit rating agencies. Interest rate risk is similar to the risk posed by MBS, however to a lesser degree because of the nature of the underlying assets. Over 53% of the Company's ABS are invested in securitized credit card receivables. The remainder of the portfolio is backed primarily by securitized home equity, manufactured housing, and auto loans.
CORPORATE OVERSIGHT The Company administers and oversees its investment risk management processes primarily through the Board of Directors and the Credit and Risk Management Committee ("CRMC") of the Corporation. The Board of Directors provide executive oversight of investment activities. The Corporation's CRMC is a senior management committee consisting of the Chief Investment Officer, the Investment Risk Manager, and other investment officers who are responsible for the day-to-day management of market risk. The CRMC meets at least monthly to provide detailed oversight of investment risk, including market risk.
The Company has investment guidelines that define the overall framework for managing market and other investment risks, including the accountabilities and controls over these activities. In addition, the Company has specific investment policies that delineate the investment limits and strategies that are appropriate given the Company`s liquidity, surplus, product and regulatory requirements.
The Company manages its exposure to market risk through asset allocation limits, duration limits and, as appropriate, stress tests. Asset allocation limits place restrictions on the aggregate fair value which may be invested within an asset class. The Company has duration limits on its investment portfolios, and, as appropriate, on individual components of these portfolios. These duration limits place restrictions on the amount of interest rate risk which may be taken. Stress tests measure downside risk to fair value and earnings over longer time intervals and/or for adverse market scenarios.
To calculate duration, the Company projects asset and liability cash flows, and discounts them to a net present value basis using a risk-free market rate adjusted for credit quality, sector attributes, liquidity and other specific risks. Duration is calculated by revaluing these cash flows at an alternative level of interest rates, and determining the percentage change in fair value from the base case. The cash flows used in the model reflect the expected maturity and repricing characteristics of the Company's derivative financial instruments, all other financial instruments (as depicted in Note 5 to the financial statements), and certain non-financial instruments including interest-sensitive annuity liabilities. The projections include assumptions (based upon historical market and Company specific experience) reflecting the impact of changing interest rates on the prepayment, lapse, leverage and/or option features of instruments, where applicable. Such assumptions relate primarily to mortgage-backed securities, collateralized mortgage obligations, callable corporate obligations, and fixed rate single and flexible premium deferred annuities.
Based upon the information and assumptions the Company uses in its duration calculation and interest rates in effect at December 31, 1999, management estimates that a 100 basis point immediate, parallel increase in interest rates ("rate shock") would decrease the net fair value of its assets and liabilities identified above by approximately $13.8 million, versus an increase of $16.0 million at December 31,
1998. In addition, there are $287.3 million of assets supporting life insurance products which are not financial instruments and have not been included in the above analysis. This amount is slightly greater than the $260.6 million at December 31, 1998. According to the duration calculation, in the event of a 100 basis point immediate increase in interest rates, these assets would decrease in value by $18.0 million, up from the $12.2 million at December 31, 1998. The selection of a 100 basis point immediate parallel increase in interest rates should not be construed as a prediction by the Company's management of future market events, but rather, is intended to illustrate the potential impact of such an event.
EQUITY PRICE RISK Equity price risk is the risk that the Company will incur economic losses due to adverse changes in a particular stock, stock fund or stock index. At December 31, 1999, the Company had variable annuity funds with balances totaling $443.7 million. This is an increase over the $366.2 million of variable annuity funds at December 31, 1998. The Company earns mortality and expense fees as a percentage of fund balance. In the event of an immediate decline of 10% in the fund balances due to equity market declines, the Company would earn approximately $555 thousand less in annualized fee income. This is a slight increase over the $500 thousand amount determined at December 31, 1998. The contractholder of a variable annuity product may elect to purchase a minimum death benefit guarantee, generally at the time of purchase. This guarantee may subject the Company to additional equity price risk, as the beneficiary may receive their benefit for an amount greater than the fund balance under contractually defined circumstances and terms. The Company recorded actuarially determined reserves as of December 31, 1999 for this exposure. In addition, for certain exposures the Company purchases third party reinsurance. The Company expects growth in its variable annuity products in the future, stemming from both new sales as well as market value appreciation, which will increase its exposure to equity price risk.
The maturity structure of the Company's fixed income securities, which represent 88.7% of the Company's total investments, is managed to meet the anticipated cash flow requirements of the underlying liabilities. A portion of the Company's diversified product portfolio, primarily fixed deferred annuity and interest-sensitive life insurance products, is subject to discretionary surrender and withdrawal by contractholders. Total surrenders and withdrawal amounts were $62.1 million, $56.5 million, and $63.0 million in 1999, 1998, and 1997, respectively. As the Company's interest-sensitive life policies and annuity contracts in force grow and age, the dollar amount of surrenders and withdrawals could increase. While the overall amount of surrenders may increase in the future, a significant increase in the level of surrenders relative to total contractholder account balances is not anticipated. Management believes its assets are sufficiently liquid to meet future obligations to its life and annuity contractholders under various interest rate scenarios.
The Company is dependent upon certain service provided for it by the Corporation including computer-related systems, and systems and equipment that are not typically thought of as computer-related (referred to as "non-IT"). For this reason, the Company is reliant upon the Corporation for the establishment and maintenance of its computer-related systems and non-IT.
The NAIC's codification initiative has produced a comprehensive guide of statutory accounting principles which the Company will implement in January 2001. The Company's state of domicile, New York, continues to review codification and existing statutory accounting requirements for desired revisions to existing state laws and regulations. The requirements are not expected to have a material impact on the statutory surplus of the Company.