In addition in 2009 and 2008, personnel performing services for the Registrant occupied office space in Jacksonville, Florida, which is owned by ML&Co. An allocable share of the cost of the above mentioned premise was paid by the Registrant through the transition services agreement between AUSA and ML&Co.
Changes affecting mortality, persistence and other factors that may impact the profitability of our insurance products;
The Company’s investments consist of fixed maturity and equity securities that are classified as available-for-sale (“AFS”) which are reported at estimated fair value. In addition, the Company holds fixed maturity securities which contain a conversion to equity feature, which is considered an embedded derivative. These fixed maturity securities have been classified as trading and are reported at estimated fair value. The fair values of fixed maturity and equity securities are determined by management after taking into consideration several sources of data. The Company’s valuation policy dictates that publicly available prices are initially sought from several third party pricing services. In the event that pricing is not available from these services, those securities are submitted to brokers to obtain quotes. Lastly, securities are priced using internal cash flow modeling techniques. These valuation methodologies commonly use reported trades, bids, offers, issuer spreads, benchmark yields, estimated prepayment speeds, and/or estimated cash flows.
The Company’s portfolio of private placement securities is valued using a matrix pricing methodology. The pricing methodology is obtained from a third party service and indicates current spreads for securities based on weighted average life, credit rating and industry sector. Monthly the Company reviews the matrix to ensure the spreads are reasonable by comparing them to observed spreads for similar securities traded in the market. In order to account for the illiquid nature of these securities, illiquidity premiums are included in the valuation and are determined based upon the pricing of recent transactions in the private placement market as well as comparing the value of the privately offered security to a similar public security. The impact of the illiquidity premium to the overall valuation is less than 1% of the value.
from external sources (i.e. company announcements, ratings agency announcements, or news wire services). For AFS fixed maturity securities, the Company also considers whether it is more likely than not that it will not be required to sell the debt security before its anticipated recovery. The factors that may give rise to a potential OTTI include, but are not limited to, i) certain credit-related events such as default of principal or interest payments by the issuer, ii) bankruptcy of issuer, iii) certain security restructurings, and iv) fair market value less than cost or amortized cost for an extended period of time. In the absence of a readily ascertainable market value, the estimated fair value on these securities represents management’s best estimate and is based on comparable securities and other assumptions as appropriate. Management bases this determination on the most recent information available.
Derivatives are financial instruments in which the value changes in response to an underlying variable, which require little or no net initial investment and are net settled at a future date. The Company has entered into exchange traded derivatives such as futures and variance swaps to hedge the costs of the volatility of the S&P market. Variance swaps are used in the asset/liability management process to mitigate the gamma risk created when the Company has issued minimum guarantee insurance contracts linked to an index. These variance swaps are similar to volatility options where the underlying index provides for the market value movements. All derivatives recognized on the Balance Sheets are carried at fair value with changes in fair value recognized in the Statements of Income. The fair value for exchange traded derivatives, such as futures, are calculated net of the interest accrued to date and is based on quoted market prices. Net settlements on the futures occur daily. The fair value for variance swaps is calculated as the difference between the estimated volatility of the underlying S&P index at maturity to the actual volatility of the underlying S&P index at initiation (i.e. strike) multiplied by the notional value of the swap. At termination the final fair value is
The costs of acquiring business, principally commissions, certain expenses related to policy issuance, and certain variable sales expenses that relate to and vary with the production of new and renewal business, are deferred and amortized based on the estimated future gross profits for a group of contracts. DAC are subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each reporting period. At December 31, 2010 and 2009, variable annuities accounted for the Company’s entire DAC asset of $31.4 million and $26.7 million, respectively.
DAC for variable annuities is amortized with interest over the anticipated lives of the insurance contracts in relation to the present values of estimated future gross profits from asset-based fees, guaranteed benefit rider fees, contract fees, and surrender charges, less a provision for guaranteed death and living benefit expenses, policy maintenance expenses, and non-capitalized commissions. Future gross profit estimates are subject to periodic evaluation with necessary revisions applied against amortization to date. The impact of revisions and assumptions to estimates on cumulative amortization is recorded as a charge or credit to current operations, commonly referred to as “unlocking”. Changes in assumptions can have a significant impact on the amount of DAC reported and the 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 returns and increases in surrender or mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization. For the years ended December 31, 2010, 2009 and 2008, there was a favorable (unfavorable) impact to pre-tax income related to DAC unlocking of $1.1 million, ($2.6) million and ($7.3) million, respectively. See Note 4 to the Financial Statements for a further discussion.
The expense and the subsequent capitalization and amortization are recorded as a component of policy benefits in the Statements of Income. At December 31, 2010 and 2009, variable annuities accounted for the Company’s entire DSI asset of $7.3 million and $6.3 million, respectively. For the years ended December 31, 2010 and 2009, there was a favorable (unfavorable) impact to pre-tax income related to unlocking of $0.3 million, less than $0.1 million and ($2.2) million, respectively. See Note 4 to the Financial Statements for a further discussion.
Other intangible assets were comprised of a distribution agreement, a trade name and a non-compete agreement. At December 31, 2008, the Company made a business decision to commence selling similar products on affiliate companies through the ML&Co distribution channel instead of continuing to sell new variable annuities on the Company. As a result of this decision, an impairment charge was taken for the entire unamortized other intangible balance of $76.1 million at December 31, 2008. Prior to December 31, 2008, the trade name and the non-compete agreements were amortized on a straight-line basis over their useful life of five years. The distribution intangible was amortized over the expected economic benefit period and at a pace consistent with the expected future gross profit streams generated from the distribution agreement, which was thirty years. The entire asset amount had been allocated to annuities. See Note 4 to the Financial Statements for further discussion.
Goodwill is the excess of the purchase price over the estimated fair value of net assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but are subject to impairment tests conducted at least annually. Impairment testing is to be performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit represents the operating segment which is the level at which the financial information is prepared and regularly reviewed by management. The entire asset amount has been allocated to annuities. Goodwill is reviewed for indications of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator, or unanticipated competition would cause the Company to review the carrying amounts of goodwill for impairment. When considered impaired, the carrying amounts are written down to fair value based primarily on discounted cash flows. At December 31, 2008, the Company made a business decision to commence selling similar products on affiliate companies through the ML&Co distribution channel instead of continuing to sell new variable annuities on the Company. As a result of this decision, an impairment charge was taken for the majority of the goodwill balance ($139.3 million) at December 31, 2008. The remaining amount of $2.8 million at December 31, 2010 and 2009 relates to the Company’s state licenses. See Note 4 to the Financial Statements for further discussion.
The Company’s liability for policyholder account balances represents the contract value that has accrued to the benefit of policyholders as of the Balance Sheet date. The liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Policyholder account balances at December 31, 2010 and 2009 were $1.6 billion and $1.6 billion, respectively.
Included within future policy benefits are liabilities for GMDB and GMIB provisions contained in the variable products that the Company issues.
At December 31, 2010 and 2009, GMDB and GMIB liabilities included within future policy benefits were as follows:
The Company regularly evaluates the assumptions used to establish these liabilities, as well as actual experience and adjusts GMDB and GMIB liabilities with a related charge or credit to earnings (“unlocking”), if actual experience or evidence suggests that the assumptions should be revised. For the years ended December 31, 2010, 2009 and 2008, the favorable (unfavorable) impact to pre-tax income related to GMDB and GMIB unlocking was $41.0 million, ($10.4) million and ($95.8) million, respectively.
ASC 310, Receivables, ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses) - guidance requires new and expanded disclosures about the allowance for credit losses, credit quality, impaired loans, modifications, and nonaccrual and past due financing receivables - adopted December 31, 2010.
The following outlines the adoption of accounting guidance in 2009. See Note 1 to the Financial Statements for a further discussion.
ASC 805, Business Combinations - guidance that established the principles and requirements for how the acquirer in a business combination: a) measures and recognizes the identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquired entity, b) measures and recognizes positive goodwill acquired or a gain from bargain purchase (negative goodwill), and c) determines the disclosure information that is decision-useful to users of financial statements in evaluating the nature and financial effects of the business combination - adopted January 1, 2009.
ASU 2010-15, How Investments Held Through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments - clarification that an insurance entity should not consider any separate account interest held for the benefit of policyholders in an investment to be the insurer’s interest and should not combine those interests with its general account interest in the same investment when assessing the investment for consolidation - will be adopted January 1, 2011.
ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts - modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts - will be adopted January 1, 2012.
ASC 350, Intangibles - Goodwill and Other - guidance requires entities with a zero or negative carrying value to perform step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists - will be adopted January 1, 2011.
Total direct deposits (including internal exchanges) were $46.0 million, $295.3 million, and $447.6 million for the years ended December 31, 2010, 2009 and 2008, respectively. The decrease in deposits was primarily due to the Company ceasing to issue new variable annuity and market value adjusted annuity products in 2009, as well as the volatile equity markets during 2008 and 2009. Internal exchanges during 2010, 2009, and 2008 were $5.2 million, $10.4 million, and $58.2 million, respectively.
Policy and contract surrenders were $756.5 million, $722.9 million and $1,029.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. The decrease from 2008 to 2009 was primarily due to the decline in the equity markets in late 2008 and early 2009.
At December 31, 2010, the Company’s assets were $11.5 billion or $121.3 million lower than the $11.6 billion in assets at December 31, 2009. Assets excluding Separate Accounts assets increased $29.5 million. Separate Accounts assets, which represent 71% of total assets, decreased $150.8 million to $8.2 billion.
The Company maintains a conservative general account investment portfolio comprised primarily of investment grade fixed maturity securities, policy loans, cash and cash equivalents and mortgage loans on real estate.
The amortized cost/cost and estimated fair value of investments in fixed maturity and equity securities at December 31, 2010 and 2009 were:
Eight issuers represent more than 5% of the total unrealized loss position, comprised of four subprime housing ABS holdings, two corporate bonds, one U.S. Treasury bond, and one RMBS holding. The Company’s ABS - subprime housing unrealized loss is $4.9 million on holdings that have been impaired to discounted cash flows and $2.6 million on holdings that have never been impaired. The Company’s subprime housing ABS consist of four below investment grade deals whereby the collateral is comprised of 2006-2007 fixed rate, first lien subprime mortgages. The Company owns two investment grade corporate non-convertible securities, one that was issued by USB Capital and one that was issued by AT&T Inc. with combined unrealized losses of $2.1 million. The Company’s unrealized loss on U.S. Treasuries is $1.7 million. The Company’s RMBS unrealized loss is $2.1
million and relates to a securitized portfolio of prime hybrid mortgages that contain fixed income positions where our holding is rated below investment grade and was previously impaired to discounted cash flows.
The Company’s $0.4 million of gross unrealized losses within the financial services sector has a fair value of $12.8 million. The majority of the unrealized loss in the financial services sector relates to the banking sub-sector which has just under $0.4 million of gross unrealized losses on securities with a fair value of $9.9 million. Companies within the Company’s financial services sector are high in credit quality and, as a whole, represent a large portion of the corporate debt market. The extreme stress on the capital base of banks and other financial institutions within the sector was significantly reduced due to unprecedented liquidity and capital support from major governments in 2008 and 2009.
The Company’s $2.7 million of gross unrealized losses within the industrial sector has a fair value of $63.6 million. The majority of the unrealized loss in the industrial sector relates to two sub-sectors, communications and consumer cyclical. The communications sub-sector has of $1.3 million of gross unrealized losses with a fair value of $25.2 million. The consumer cyclical sub-sector has of $0.7 million of gross unrealized losses with a fair value of $13.0 million.
The communications sub-sector can be further divided into the media non-cable, wireless and wirelines industries. The media non-cable category, which had experienced weakness in 2009, rebounded in 2010 as the overall advertising environment strengthened. The wireless and wirelines categories continue to be stable. The Company evaluated the near-term prospects of the issuers in relation to the severity and duration of the unrealized loss and does not consider those investments to be impaired at December 31, 2010.
The more significant of these industries from an unrealized loss perspective are retailers and gaming. Retail has been negatively impacted by a consumer pull-back in spending, particularly discretionary purchases, as high unemployment, credit market tightening, and household deleveraging have weighed on the consumer. Signs of improvement have begun to emerge as residential real estate prices have begun to turn positive, although prices are still considered very affordable. Equity prices
have increased and consumer confidence has come off its historical lows. Margins have also strengthened on tight inventory controls, cost cutting activities and the lapping of easy year-over-year comparisons. Promotional activity and discounts continue to be used as tools to drive traffic and maintain market share.
ABS - housing securities are secured by pools of residential mortgage loans primarily those which are categorized as subprime. The unrealized loss is primarily due to decreased liquidity and increased credit spreads in the market combined with significant increases in expected losses on loans within the underlying pools. Expected losses within the underlying pools are generally higher than original expectations, primarily in certain later-vintage adjustable rate mortgage loan pools, which has led to some rating downgrades in these securities. The Company’s $7.6 million of gross unrealized losses within the ABS - housing sector has a fair value of $17.8 million.
are in various delinquency buckets and defaulting a certain percentage of them over the near-term and long-term. Assumed defaults on delinquent loans are dependent on the specific security’s collateral attributes and historical performance. Loss severity assumptions were determined by observing historical rates from broader market data while being adjusted for specific pool performance, collateral type, mortgage insurance and estimated loan modifications. Prepayments were estimated by examining historical averages of prepayment activity on the underlying collateral. Once the entire pool is modeled, the results are closely analyzed by our internal asset specialists to determine whether or not our particular tranche or holding is at risk for not collecting all contractual cash flows taking into account the seniority and other terms of the tranches held. The Company impaired its particular tranche to the net present value of discounted cash flows where it would not be able to receive all contractual cash flows. Remaining ABS subprime mortgage positions are not considered impaired at December 31, 2010. The unrealized loss is primarily due to decreased liquidity, increased credit spreads in the market, slower prepayments, and increased expected losses on loans within the underlying pools. Expected losses within the underlying pools are generally higher than original expectations, which have led to some rating downgrades in these securities.
For this holding in the ABS - housing portfolio, the underlying collateral pool has experienced higher than expected delinquencies and losses, which is further exacerbated by the impact of declining home values on borrowers using affordability products. This has led to the underlying collateral pool having reduced cash flows in comparison to expectations at origination. Increased losses have eroded the subordination in this transaction, which in turn has led to a decline in the level of protection to our tranche within the collateral pool. Due to an adverse change in cash flows, the Company’s holding above was re-impaired to the net present value of projected future cash flows in the first quarter of 2010. There are no other individual issuers rated below investment grade in the ABS - housing sector which have unrealized loss positions greater than $2.5 million.
Where holdings are not projected to pay principal and interest in full, securities were impaired to the net present value of projected future cash flows. As the remaining unrealized losses in the ABS - housing portfolio relate to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired at December 31, 2010.
Loss severity assumptions were determined by obtaining historical rates from broader market data and by adjusting those rates for vintage, specific pool performance, collateral type, mortgage insurance and estimated loan modifications. Prepayments were estimated by examining historical averages of prepayment activity on the underlying collateral. Once the entire pool is modeled, the results are closely analyzed by our internal asset specialists to determine whether or not our particular tranche or holding is at risk for not collecting all contractual cash flows taking into account the seniority and other terms of the tranches held. The Company impaired its particular tranche to the net present value of discounted cash flows where it would not be able to receive all
As the remaining unrealized losses in the RMBS portfolio relate to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired at December 31, 2010.
At December 31, 2010 and 2009, approximately $85.8 million (or 35%) and $98.4 million (or 36%), respectively, of RMBS and CMBS holdings were fully collateralized by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. RMBS and CMBS securities are structured to allow the investor to determine, within certain limits, the amount of interest rate risk, prepayment risk and default risk that the investor is willing to accept. It is this level of risk that determines the degree to which the yields on RMBS and CMBS will exceed the yields that can be obtained from corporate securities with similar credit ratings.
The Company’s $1.7 million of gross unrealized losses within the government sector has a fair value of $31.5 million. All of the unrealized loss in the government sector AFS portfolio relates to U.S. Treasuries. U.S. Treasury interest rates rose during the second half of 2010, largely in response to market perceptions of improved economic prospects and lingering inflation fears. These factors decreased prices for U.S. Treasury and Agency securities at December 31, 2010. The Company evaluated the near-term prospects of the issuer in relation to the severity and duration of the unrealized loss and does not consider the position to be impaired at December 31, 2010.
Unrealized gains (losses) incurred during the years ended December 31, 2010 and 2009 were primarily due to price fluctuations resulting from changes in interest rates and credit spreads. As the Company does not have the intent to sell and it is not more likely than not that the Company will be required to sell these securities prior to the anticipated recovery of the amortized cost, the Company did not consider these securities to be other-than-temporarily impaired.
Gross unrealized losses and OTTI on available-for-sale below investment grade securities represented 71% and 32% of total gross unrealized losses and OTTI on all available-for-sale securities at December 31, 2010 and 2009, respectively. Generally, below investment grade securities are more likely than investment grade securities to develop credit concerns. The ratios of estimated fair value to amortized cost reflected in the table below were not necessarily indicative of the market value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to December 31, 2010.
The following tables provide the ABS subprime mortgage exposure by rating and estimated fair value by vintage at December 31, 2010 and 2009:
For the year ended December 31, 2010, the Company’s impairment losses were $0.6 million, net of VOBA amortization. The gross impairment losses recognized in the Statements of Income were primarily driven by the impairment of a 2005 vintage RMBS for $0.7 million and a 2007 vintage ABS subprime mortgage for $0.3 million due to adverse changes in cash flows. A corporate bond was also impaired for $0.4 million due to the intent to sell or being more likely than not required to sell. In addition, the Company impaired its holding of a 2007 vintage subprime mortgage ABS for $0.4 million.
The fair value for mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or similar remaining maturities. The estimated fair value of the mortgage loans on commercial real estate at December 31, 2010 and 2009 was $66.7 million and $67.7 million, respectively.
The investment performance of the underlying U.S. equity-based mutual funds supporting the Company’s variable products do not replicate the returns of any specific U.S. equity market index. However, investment performance will generally increase or decrease with corresponding increases or decreases of the overall U.S. equity market. There are several standard indices published on a daily basis that measure performance of selected components of the U.S. equity market. Examples include the Dow Jones Industrial Average (“Dow”), the NASDAQ Composite Index (“NASDAQ”) and the Standard & Poor’s 500 Composite Stock Price Index (“S&P”). The Dow, NASDAQ and S&P ended 2010 with increases of 11%, 17% and 13%, respectively, from 2009. The Dow, NASDAQ and S&P ended 2009 with increases of 19%, 44% and 23%, respectively, from 2008.
Fluctuations in the U.S. equity market also directly impact the Company’s exposure to guaranteed benefit provisions contained in the variable contracts it manufactures. Minimal or negative investment performance generally results in greater exposure to guarantee provisions. Prolonged periods of minimal or negative investment performance will result in greater guaranteed benefit
The Company’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 in force. The Company 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. The Company anticipates funding its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. At December 31, 2010 and 2009, the Company’s assets included $1.9 billion and $1.8 billion, respectively, of cash, short-term investments and investment grade publicly traded AFS securities that could be liquidated if funds were required.
The following table summarizes the Company’s ratings at March 25, 2011:
A downgrade of our financial strength rating could affect our competitive position in the insurance industry and make it more difficult for us to market our products, as potential customers may select companies with higher financial strength ratings. These ratings are not a recommendation to buy or hold any of the Company’s securities and they may be revised or revoked at any time at the sole discretion of the rating organization.
The Company has utilized public information to estimate the future assessments it will incur as a result of life insurance company insolvencies. At December 31, 2010 and 2009, the Company’s estimated liability for future guaranty fund assessments was $5.1 million and $5.0 million, respectively, with an offsetting receivable for future premium tax deductions of $4.0 million and $4.0 million, respectively. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
(b) The change in equity related gains (losses) principally relates to the decrease in the net losses on futures contracts during 2010. Short future contracts fluctuate relative to the volatility in the S&P 500.
Policy benefits decreased $20.5 million during 2010 as compared to 2009. The following table provides the changes in policy benefits by type:
(a) See the Critical Accounting Policies and Estimates section above for further discussion of annuity benefit unlocking.
For the years ended December 31, 2009 and 2008, TALIC recorded a net loss of $203.1 million and $138.3 million, respectively. The decrease in income during 2009 as compared to 2008 was primarily due to the 2009 valuation allowance on deferred tax assets, increased VOBA amortization and impairments, and the 2009 net realized investment losses partially offset by the 2008 goodwill and other intangibles impairment charge and lower policy benefit expenses.
(b) The decrease in non-asset based policy charge revenue is primarily due to the run-off of the life business as well as less paid up additions in the first quarter 2009 as a result of poor equity market performance in 2008.
(a) The increase in credit related losses as compared to 2008 was primarily due to losses on securities whereby the Company had the intent to sell as of the balance sheet date, as well as securities of issuers that had filed for bankruptcy during the year.
(c) The change in equity related gains (losses) principally relates to increases in net losses on futures contracts during 2009 as compared to net gains on futures contracts in 2008.
(c) The increase in amortization of deferred sales inducements is principally due to increasing gross profits resulting from improved equity markets.
Reinsurance premiums ceded decreased $15.5 million during 2009 as compared to 2008. Effective second quarter of 2008, the Company began to recapture the majority of its reinsurance resulting in the decreased reinsurance premiums, which is expected to be finalized in 2010.