SLNY does not own any properties. SLNY leases office space for its sales personnel located in New York City. The lease is scheduled to terminate in 2004. During 2001 and 2002, KBL leased office space in Purchase, New York. This lease was terminated as of December 31, 2002, after completion of the merger with SLNY.
Pursuant to Instruction I(2)(a) to Form 10-K, the Company elects to omit the Management's Discussion and Analysis of Financial Condition and Results of Operations. Below is an analysis of the results of operations explaining material changes in the Statement of Income between the years ended December 31, 2002 and December 31, 2001.
Changes in any of the assumptions that serve to increase or decrease the estimated future gross profits will cause the amortization of DAC to decrease or increase, respectively, in the current period. This will cause fluctuation in earnings from period to period.
Fixed maturities are classified as available-for-sale. The changes in fair value of available-for-sale securities are
The decrease in Wealth Management pretax income was due primarily to decreased fee income, lower net investment income and higher DAC amortization. Fee income is based upon the level of variable account assets. Unfavorable market conditions and increased surrenders during 2002 lowered the value of these assets, resulting in a 31% decrease since December 31, 2001. The decrease in net investment income for the year was due to lower average investment balances due to the declining balances in fixed deposits in the Company's annuity operations. Interest paid to policyholders also decreased due to the lower balances in fixed deposits, partially offsetting the decreased net investment income. DAC amortization increased by $3.1 million as a result of lower projected future earnings.
The following table provides a summary of operations for the Group Protection Segment (in 000's):
The following table provides a summary of operations for the Corporate Segment (in 000's):
Total stockholders' equity of the SLNY at December 31, 2002 and 2001 was $292.1 million and $222.7 million, respectively. No dividends were paid during 2002 or 2001. SLNY's management considers its capital resources to be adequate.
SLNY's primary investment objective is to maximize after-tax returns on the products it issues within acceptable risk parameters. SLNY is exposed to two primary types of investment risk:
SLNY regularly reviews its bond portfolios relative to any change in specific issuer performance, external and internal ratings, industry conditions, financial ratios, and changes in investment value. Such analysis is undertaken to determine that the integrity of SLNY's investments remains sound and to review for other-than-temporary impairments.
The pricing of SLNY's products has embedded provisions for expected default losses over the long term. This expectation is reassessed on a regular basis to determine the adequacy of the provision. However, actual losses may prove to be above or below the expected loss rate. The overall economic environment will also impact the market value of the portfolio through both interest rate changes and the response of credit spreads to changes in the business cycle. SLNY's credit function and capital base generally permits it to pursue a buy and hold strategy that balances assets and liabilities with the intent of withstanding near-term swings in the broader economy.
As of December 31, 2002, the portfolio carried $58.3 million in gross unrealized gains relative to $16.0 million in unrealized losses. As a percent of carrying value, the largest contributors of unrealized losses were found in the Utilities, Transportation, Technology and Consumer Non-Cyclical sectors. Basic Industries and Capital Goods experienced the smallest gross unrealized losses as a percent of total carrying value. A brief discussion concerning the industry segments of SLNY's corporate bond holdings is as follows:
: The Basic Industry sector is composed of the chemicals, metals, and paper and forest products industries. Broadly, these sectors supply commodity products for use as an end product or as input for higher value-added goods. Demand typically fluctuates with the strength of the economy. As would be expected, continued weak demand has led to falling unit prices, lower capacity utilization, and declining profitability for many industry participants. Those companies with highly leveraged balance sheets may have experienced ratings deterioration to below investment grade classifications, or are at risk for such. A rebound in industry profitability may be delayed until the domestic and/or world economies show prolonged strength and capital spending resumes. In the interim, the portfolios are comprised of well-run companies with specialty niches or with dominant industry positions that have allowed them to withstand the market weakness and avoid significant market-value deterioration.
: The Communications sector is made up of media-cable, media-non cable, telecom-wireless, and telecom-wireline. Communications, especially telecommunications, came under severe pressure in 2002. Significant overcapacity in certain business lines, technological substitution, intense competition, general economic weakness, and, accounting scandals led to extreme volatility in bond prices and high-profile defaults. SLNY's portfolio was not immune to these developments. SLNY's overall strategy has been to overweight companies with stronger and improving balance sheets, such as the regional bell operating companies and rural local exchange carriers; wireless companies with better competitive positions; diversified telecommunication and media companies; and the more recession-resistant cable sector. A significant portion of the portfolio is invested at the operating company level, which generally fares better under difficult scenarios. Pressures on these sectors have moderated to a significant extent, and SLNY expects to see further improvements to credit quality from increased free cash flows, further boosted by any improvement in the economy. SLNY intends to hold stressed but performing investments until they recover.
The Energy sector encompasses the oil and gas industries. Higher commodity prices in the second half of 2002 contributed to the earnings of most oil and gas companies - namely exploration and production, integrateds and, to a lesser extent, refineries. Investments in these sectors, in general, provided solid returns during the year. Oil field services, however, did not fare as well due to a redirection by the integrateds towards increasing reserves through acquisition rather than exploration. Political turmoil in Venezuela caused that country's oil production to suffer near complete shutdown after workers went on strike at the oilfields and refineries. Although bond values of Venezuela's national oil company suffered considerable declines, the structure of SLNY's holdings in this entity continues to provide investment protection.
: The Technology sector is comprised of computer hardware manufacturers, makers of mainframe, client/server and personal computers ("PC") as well as computer software and services manufacturers. The fundamentals of the technology sector remained weak as global information technology ("IT") spending remained severely depressed in 2002. Industry analysts have indicated that there is no near term catalyst that could restore sales back to the levels seen in the late 1990s, when strong demand driven by the technological advancement of PC's, cell phones and telecom equipment often outpaced supply growth. Currently, excess supply continues to undermine pricing. Most industry analysts expect a modest improvement in IT spending this year after several years of depressed demand. SLNY remains comfortable with its limited issuer and industry exposure in this sector.
: The Transportation category includes airlines, railroads, trucking and shipping companies. Most of these sectors are experiencing some effects from the cyclical downturn. However, the airline industry has been particularly hard hit with demand reduced by the events of September 11, the weak economy and structural changes to the industry. As such, the domestic airline industry posted a historic loss of $9.0 billion in 2002. Two major airlines, United Airlines and U.S. Airways, filed for Chapter 11 protection. SLNY generally lends to the industry on a secured basis. Thus, the emphasis of recovery values is based on the collateral backing the secured financings. These secured airline financing are of two types, Equipment Trust Certificates ("ETC's") and Enhanced Equipment Trust Certificates ("EETCs"). The ETC's have an initial 80% loan-to-value ratio and the EETC's senior tranches had an initial 40-50% loan-to-value and include a provision for a third party to pay interest for eighteen months from default. Although SLNY has experienced a fair amount of deterioration in the airline component of the transportation portfolio in 2002, SLNY is provided downside protection due to the secured nature of its holdings.
: The Utilities sector includes regulated electric and gas utilities, regulated interstate pipelines, merchant energy companies and independent power projects. The continuation of unresolved California energy crisis issues as well as the fallout from the late 2001 Enron bankruptcy, Federal Energy Regulatory Commission and Securities and Exchange Commission investigations, accounting restatements, accounting rule changes, shareholder litigation, and depressed commodity prices placed unprecedented pressure on the sector. Liquidity became the primary focus for the sector, a situation greatly exacerbated by rapid, and in some cases, multiple level downgrades by the credit rating agencies. SLNY's portfolio is diversified to include many regulated utilities, interstate pipelines and utility holding companies that have been less affected during the year. In the cases where the portfolio's utility holdings have been negatively impacted, ongoing analysis of both firm-specific asset values and projected industry economics drive SLNY's investment conclusions. In fact, SLNY expects the industry may benefit in the intermediate term from a strong focus on balance sheet repair, including reduced capital expenditure, reduced dividends, asset sales and equity issuance. The ongoing progress in industry restructuring supports SLNY's intention to hold its positions until maturity or recovery.
The composition by credit quality of the securities with gross unrealized losses in SLNY's fixed maturity securities portfolio is as follows at December 31, 2002 (in 000's):
Securities that have been triggered for the impairment review process may either be determined to be impaired or placed on a watchlist for monitoring. Should it be determined that a security is impaired SLNY may sell the security and realize a loss or hold the security following an appropriate adjustment in carrying value to reflect expected recovery. During 2002, 2001 and 2000, SLNY incurred write-downs of fixed maturities totaling $4.6 million, $0.5 million and $1.5 million, respectively, for other-than-temporary impairment. The 2002 write-downs reflect impairments primarily relating to the Utilities, Transportation and Communications sectors. Gross realized losses on the voluntary sales of fixed maturity securities totaled $8.5 million in 2002, compared to $2.9 million in 2001.
The carrying value of fixed maturity securities with unrealized losses by maturity date is as follows at December 31, 2002 (in 000's):
Sun Life Insurance and Annuity Company of New York ("Sun NY Predecessor") and Keyport Benefit Life Insurance Company ("KBL") were merged on December 31, 2002, with Sun NY Predecessor as the surviving company ("SLNY"). As terms of the merger, SLNY issued 4,001 additional shares of common stock in exchange for all the assets and liabilities of KBL. Total book value of assets acquired and liabilities assumed were $1,869.3 million and $1,652.8 million, respectively, at December 31, 2002. These financial statements give effect to this transaction as of November 1, 2001.
The financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for stock life insurance companies.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. The most significant estimates are those used in determining deferred policy acquisition costs ("DAC"), investment allowances and the liabilities for future policyholder benefits. Actual results could differ from those estimates.
SLNY accounts for its investments in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." At the time of purchase, fixed maturity securities are classified based on intent, as held-to-maturity or available-for-sale. In order for the securities to be classified as held-to-maturity, SLNY must have positive intent and ability to hold the securities to maturity. Securities held-to-maturity are stated at cost, adjusted for amortization of premiums, and accretion of discounts. Securities that do not meet this criteria are classified as available-for-sale. Available-for-sale securities are carried at estimated fair value with changes in unrealized gains or losses reported net of policyholder related amounts and deferred income taxes in a separate component of other comprehensive income. Fair values for publicly traded securities are obtained from external market quotations. For privately placed fixed maturities, fair values are estimated by taking into account prices for publicly traded securities of similar credit risk, maturities, repayment, and liquidity characteristics. SLNY does not engage in trading activities. All of SLNY's fixed maturity securities are classified as available-for-sale. All security transactions are recorded on a trade-date basis.
SLNY's accounting policy for impairment requires recognition of an other-than-temporary impairment charge on a security if it is determined that SLNY is unable to recover all amounts due under the contractual obligations of the security. In addition, for securities expected to be sold, an other-than-temporary impairment charge is recognized if SLNY does not expect the fair value of a security to recover to cost or amortized cost prior to the expected date of sale. Once an impairment charge has been recorded, SLNY then continues to review the other-than-temporarily impaired securities for additional impairment, if necessary.
Deferred acquisition costs for each product are reviewed to determine if they are recoverable from future income, including investment income. If such costs are determined to be unrecoverable, they are expensed at the time of determination. Although realization of DAC is not assured, SLNY believes it is more likely than not that all of these costs will be realized. The amount of DAC considered realizable, however, could be reduced in the near term if the estimates of gross profits discussed above are reduced.
Future contract and policy benefits are liabilities for traditional life, health and annuity products. Such liabilities are established in amounts adequate to meet the estimated future obligations of policies in force. The liabilities associated with traditional life insurance, annuity and disability insurance products are computed using the net level premium method based on assumptions about future investment yields, mortality, morbidity and persistency. The assumptions used are based upon SLNY's experience and industry standards.
Other than DAC, benefits and expenses related to traditional life, annuity, and disability contracts, including group policies, are recognized when incurred in a manner designed to match them with related premium revenue and spread income recognition over expected policy lives. For investment-type contracts, benefits include death benefits in excess of account values, which are recognized as incurred.
Fees from investment advisory services are recognized as revenues when services are provided. Revenues from fixed and variable annuities and single-premium whole life policies include mortality charges, surrender charges, policy fees, and contract fees and are recognized when earned.
In July 2002, the American Institute of Certified Public Accountants ("AICPA") issued a proposed Statement of Position ("SOP"), "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Separate Accounts." This SOP provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts. SLNY is in the process of evaluating the provisions of this SOP and its impact to SLNY's financial position and results of operations.
In November 2002, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others ("FIN 45"). FIN 45 requires entities to establish liabilities for certain types of guarantees and expands financial statement disclosures for others. This interpretation has no impact on SLNY.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities," to improve financial reporting by enterprises involved with variable interest entities. This interpretation states that if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise. This interpretation has no impact on SLNY because it does not maintain any involvement with variable interest entities.
Management believes intercompany expenses are calculated on a reasonable basis, however, these amounts may not necessarily be indicative of the costs that would be incurred if SLNY operated on a stand-alone basis.
During December 2002, SLNY received $14.9 million of additional capital contributions from Sun Life U.S. and $30.2 million of additional capital contributions from Keyport.
SLNY had $30.6 million due to related parties at December 31, 2002, and $0.6 million due from related parties as of December 31, 2002.
Gross gains of $5.6 million, and $3.3 million and gross losses of $8.5 million, and $2.9 million were realized on the voluntary sale of fixed maturities for the years ended December 31, 2002 and 2001, respectively.
As of December 31, 2002, 98% of SLNY's fixed maturities were investment grade. Investment grade securities are those that are rated "BBB" or better by nationally recognized rating agencies. During 2002, 2001 and 2000 SLNY incurred realized losses totaling $4.6 million, $0.6 million and $1.5 million, respectively, for other-than-temporary impairment of value of some of its fixed maturities after determining that not all of the unrealized losses were temporary in nature. During 2002, $0.2 million of the 2001 losses were recovered and are included in realized gains. During 2001, $0.6 million of the 2000 losses were recovered and were included in realized gains. SLNY has discontinued the accrual of income on several of its holdings for issuers that are in default. The termination of accrual accounting on these holdings reduced income by $98,000, $75,000 and $50,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
SLNY monitors the condition of the mortgage loans in its portfolio. In those cases where mortgages have been restructured, appropriate allowances for losses have been made. In those cases where, in management's judgement, the mortgage loan's value has been impaired, appropriate losses are recorded. SLNY had no restructured or impaired mortgage loans at December 31, 2002 and 2001, respectively.
At December 31, 2002, scheduled mortgage loan maturities were as follows (in 000's):
SLNY has made commitments of mortgage loans on real estate and other loans into the future. The outstanding commitments for these mortgages amount to $0.7 million and $0.5 million at December 31, 2002 and 2001, respectively. The fair value of the outstanding commitments is not material to the Company.
The following table presents the carrying amounts and estimated fair values of SLNY's financial instruments at December 31, 2002 and 2001 (in 000's):
SLNY is contingently liable for the portion of the policies reinsured under each of its existing reinsurance agreements in the event the reinsurance companies are unable to pay their portion of any reinsured claim. Management believes that any liability from this contingency is unlikely. However, to limit the possibility of such losses, SLNY periodically evaluates the financial condition of its reinsurers and monitors concentration of credit risk.
SLNY participates in a 401(K) plan sponsored by Sun Life U.S. for which substantially all employees of at least age 21 are eligible at date of hire. Under the plan, employer contributions are matched up to a specified amount of the employee's contributions to the plan. The SLNY portion of this employer contribution was $15,700, $6,200 and $8,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
In addition to pension benefits, Sun Life U.S. sponsors a plan that provides certain health, dental and life insurance benefits ("post-retirement benefits") for retired employees and dependents. Substantially all employees of the participating companies may become eligible for these benefits if they reach normal retirement age while working for SLNY, or retire early upon satisfying an alternate age plus service condition. Life insurance benefits are generally set at a fixed amount. SLNY is allocated a portion of other post-retirement benefit plans expenses. The allocated expenses were $11,000, $10,000 and $11,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
Sun NY Predecessor is included in the consolidated federal income tax return of SLOC U.S. Operations Holdings, and KBL is included as a part of Keyport's consolidated federal income tax return, as previously described in Note 1. Federal income taxes are calculated as if SLNY was filing a separate federal income tax return. A summary of the components of federal income tax expense in the statements of income for the years ended December 31, was as follows (in 000's):
Federal income taxes attributable to the operations are different from the amounts determined by multiplying income before federal income taxes by the expected federal income tax rate of 35%. SLNY's effective rate differs from the federal income tax rate as follows (in 000's):
SLNY makes payments under certain tax sharing agreements. Sun NY Predecessor had cash payments to Sun Life U.S. for federal income taxes of approximately $3.3 million and $0.3 million, for the years ended December 31, 2002 and 2001, respectively. Similarly, KBL had cash payments to Keyport for federal income taxes of approximately $0.6 million and $0 for the years ended December 31, 2002 and 2001, respectively.
SLNY's federal income tax returns are routinely audited by the Internal Revenue Service ("IRS"), and provisions are made in the consolidated financial statements in anticipation of the results of these audits. Sun NY Predecessor and KBL are currently under audit by the IRS for the years 1998 through 2000 and 1999 through October 31, 2001, respectively. In SLNY's opinion, adequate tax liabilities have been established for all years and any adjustments that might be required for the years under audit will not have a material effect on SLNY's financial statements. However, the amounts of these tax liabilities could be revised in the future if estimates of SLNY's ultimate liability are revised.
The following illustrates the changes to the DAC asset (in 000's):
The Wealth Management segment markets and administers both individual fixed and variable annuity products.
The Group Protection segment markets and administers group life insurance, stop loss insurance, long-term disability and short-term disability products. These products are sold to employers that provide group benefits for their employees.
The only Individual products offered are conversions from the group life products.
SLNY's statutory surplus and net income (loss) were as follows (in thousands):
The State of New York has adopted certain prescribed accounting practices that differ from those found in the NAIC Accounting Practices and Procedures manual, version effective January 1, 2001. Specifically, paragraphs 5 through 11 and paragraphs 17 through 19 of Statement of Statutory Accounting Principle ("SSAP") No. 10, Income Taxes, were not adopted. In addition, all requirements related to deferred tax assets and deferred tax liabilities in paragraphs 20 and 21 of SSAP No. 10 were not adopted. The impact of not applying SSAP No. 10 in its entirety was a decrease in SLNY's statutory surplus of $2.1 million and $1.7 million for the years ended December 31, 2002 and 2001, respectively.
Accounting changes adopted to conform to the provisions of the NAIC Accounting Practices and Procedures manual, version effective January 1, 2001, are reported as changes in accounting principles in the statutory financial statements. The cumulative effect of changes in accounting principles is reported as an adjustment to unassigned funds (surplus) in the period of the change in accounting principle. The cumulative effect is the difference between the amount of capital and surplus at the beginning of the year and the amount of capital and surplus that would have been reported at that date if the new accounting principles had been applied retroactively for all prior periods. As a result of these changes, SLNY reported a change in accounting principle in its statutory financial statements, as an adjustment that increased unassigned funds (surplus), of $62,400 as of January 1, 2001. This adjustment is due to the valuation of SLNY's obligation for post-retirement benefits other than pensions on a NAIC basis as of January 1, 2001.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 2002 financial statements present fairly, in all material respects, the financial position of Sun Life Insurance and Annuity Company of New York as of December 31, 2002, and the results of its operations and its cash flows for the years ended December 31, 2002, 2001 and 2000, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, 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 following is a tabulation of the unaudited quarterly results of operations (in 000's). The results have been restated to give effect to the merger as of November 1, 2001.