The Registrant’s home office is located at 4 Manhattanville Road, Purchase, New York. Personnel performing services for the Registrant operate in AUSA office space in Cedar Rapids, Iowa and St. Petersburg, Florida. An allocable share of the cost of each of the above mentioned premises was paid by the Registrant through the common cost allocation service agreement.
We undertake no obligation to publicly update or revise any forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which merely reflect Company expectations at the time of the writing. Actual results may differ materially from expectations conveyed in forward-looking statements due to changes caused by various risks and uncertainties. The reader should, however, consult any further disclosures MLLICNY may make in future filings of its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K.
On December 28, 2007, the Company and its affiliate, MLLIC, were acquired by AUSA. In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangibles, the acquisition was accounted for by AUSA using the purchase method of accounting, which required the assets and liabilities of MLLICNY to be identified and measured at their estimated fair values as of the acquisition date.
Each month, the Company performs an analysis of the information obtained from third party services and brokers to ensure that the information is reasonable and produces a reasonable estimate of fair value. The Company considers both qualitative and quantitative factors as part of this analysis, including but not limited to, recent transactional activity for similar fixed maturities, review of pricing statistics and trends, and consideration of recent relevant market events.
The Company regularly reviews each investment in its fixed maturity and equity securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary (“OTT”) declines in the fair value of investments. Management makes this determination through a series of discussions with the Company’s portfolio managers and credit analysts, information obtained from external sources (i.e. company announcements, ratings agency announcements, or news wire services) and the Company’s ability and intent to hold the investments for a period of time sufficient for a forecasted market price recovery up to or beyond the amortized cost of the investment. The factors that may give rise to a potential OTT impairment 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 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. Once impaired, the discount or reduced premium recorded for the debt security, based on the new cost basis, is amortized over the remaining life of the debt security in a prospective manner based on the amount and timing of future estimated cash flows. During 2008, the Company recorded an OTT impairment, net of value of business acquired amortization, of $0.5 million. The Company did not experience any realized investment losses due to OTT declines in fair value for the years ended December 31, 2007 and 2006.
The expense and the subsequent capitalization and amortization are recorded as a component of policy benefits in the Statements of Income. At December 31, 2008, variable annuities insurance accounted for the Company’s entire DSI asset of $0.2 million. At December 31, 2007, the DSI balance was zero as a result of push down accounting at the acquisition date. See Note 6 to the Financial Statements for a further discussion of DSI.
VOBA represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the insurance and annuity contracts inforce at the acquisition date. VOBA is based on actuarially determined projections, for each block of business, of future policy and contract charges, premiums, mortality, policyholder behavior, Separate Account performance, operating expenses, investment returns, and other factors. Actual experience on the purchased business may vary from these projections. Revisions in 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 asset and a charge to income if estimated future gross profits are less than the unamortized balance. In addition, MLLICNY utilizes the reversion to the mean assumption, a common industry practice, in its determination of the amortization of VOBA. This practice assumes that the expectations for long-term appreciation in equity markets is not changed by minor short-term market fluctuations, but that it does change when large interim deviations have occurred. At December 31, 2008, the reversion to the mean assumption was 15% gross short-term equity growth rate for five years and thereafter a 9% gross long-term growth rate. At December 31, 2008 and 2007, the Company’s VOBA asset was $41.5 million and $44.0 million, respectively. For the year ended December 31, 2008, the unfavorable impact to pre-tax earnings related
Goodwill is the excess of the purchase price over the estimated fair value of net assets acquired. Under SFAS No. 142, 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. 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 MLLICNY 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. A review was performed at September 30, 2008 and there was no indication of impairment for goodwill or other intangibles. However during the 4th quarter 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 MLLICNY. As a result of this decision, an impairment charge was taken for the majority of the goodwill balance of $3.1 million. The remaining amount relates to MLLICNY’s state licenses. See Note 5 of the Financial Statements for a further discussion. At December 31, 2008 and 2007, the Company’s goodwill asset was $0.5 million and $6.9 million, respectively. The entire asset amount has been allocated to annuities.
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, 2008 and 2007 were $135.1 million and $140.8 million, respectively.
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 2008, the unfavorable impact to pre-tax earnings related to GMDB and GMIB unlocking was $2.3 million. For 2007, the favorable impact to pre-tax earnings related to GMDB and GMIB unlocking was $1.2 million.
At December 31, 2008 and 2007, GMWB and GMIB reinsurance liabilities (assets) included within future policy benefits were as follows:
In January 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. EITF 99-20-1, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20 (“FSP EITF 99-20-1”). The FSP amends the impairment and related interest income measurement guidance in EITF 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, to achieve more consistent determination of whether an other-than-temporary impairment has occurred for debt securities classified as available-for-sale or held-to-maturity. The FSP permits the use of reasonable management judgment about the probability that the company will be able to collect all amounts due while previously EITF 99-20 required the use of market participant assumptions which could not be overcome by management judgment. The FSP also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, and other related guidance. The FSP became effective for interim and annual reporting periods ending after December 15, 2008, and shall be applied prospectively. The Company adopted FSP EITF 99-20-1 on December 31, 2008 and it had no material impact on the Company’s financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, with early adoption permitted provided the entity has not yet issued financial statements for the fiscal year, including any interim periods. The provisions of SFAS No. 157 are to be applied prospectively. The Company adopted SFAS No. 157 on January 1, 2008. The adoption did not have a material impact on the Company’s Financial Statements. See Note 3 to the Financial Statements for additional disclosures.
Total direct deposits decreased $26.8 million to $9.9 million during 2008, as compared to 2007. Total direct deposits (including internal exchanges) were as follows:
The decrease in variable annuity deposits in 2008 was primarily due to volatile equity markets. During 2007, the decrease in variable annuity deposits was primarily due to increased third party competition for similar variable annuity products containing guaranteed living benefit provisions and features.
The amortized cost and estimated fair value of investments in fixed maturity and equity securities at December 31 were:
In accordance with push down accounting, amortized cost was equal to estimated fair value at December 31, 2007.
MLLICNY has exposure to deeply subordinated investment grade securities within the banking sector which have the characteristics of both debt and equity. These bonds, broadly referred to as capital securities, allow the borrower to defer payments without defaulting and are subordinated to traditional bonds in a company’s capital structure. The value of our investments in these securities may be significantly impacted if the issuers of such securities exercise the option to defer payment of optional coupons or dividends, are forced to accept government support or intervention, or grant majority equity stakes to their respective governments. As of December 31, 2008, MLLICNY held capital securities within the banking sector that were either categorized as Hybrid or Upper Tier 2.
The following table highlights MLLICNY’s credit risk to capital securities within the banking sector at December 31:
The unrealized losses in the REIT sub-sector are a result of general spread widening in the Commercial Mortgage-Backed Securities (“CMBS”) market and the REIT unsecured market. Despite real estate values falling and capitalization rates rising, REIT’s operating fundamentals continue to perform at levels sufficient to support their debt structure. However, further fundamental deterioration is expected as unemployment rises, consumer discretionary spending falls, and tenant bankruptcies increase. The majority of REITs have exhibited financial discipline and have focused on maintaining financial flexibility during the difficult financing environment.
The more significant of these sub-sectors from an unrealized loss perspective are retailers, automotive, and entertainment. Retail and entertainment have been negatively impacted by a consumer pull-back in spending, particularly discretionary purchases, as increased unemployment, a weak housing market, credit market tightening and historically low consumer confidence weighed on the consumer. Margins have also been under increased pressure as many retailers have implemented aggressive promotion activity and increased discounts in an effort to drive store traffic, manage inventories and maintain market share.
The underlying fundamentals driving sales and earnings performance of the automotive industry continue to be pressured as a result of a secular shift away from more profitable SUVs and pickups towards more fuel-efficient cars and crossovers. In addition, the combination of weak consumer confidence, tighter credit standards and growing unemployment has negatively impacted auto sales.
The vast majority of the unrealized losses in the consumer non-cyclical sector relate to global macro economic conditions and credit spread widening. There are no individual issuers rated below investment grade in the consumer non-cyclical sub-sector which have unrealized loss positions greater than $0.2 million.
All media companies, but especially newspaper and directory companies, are suffering from a tepid advertising environment related to the weak economy. This has made it difficult for companies to offset declining revenues with sufficient cost cutting initiatives, leading to significantly lower profits. In addition, this space had been a focus for activist shareholders and private equity firms, forcing management to respond by increasing financial leverage, performing consolidations or divesting assets. The net effect of this was a weaker credit profile for many companies just as the market started to slow down.
The subprime mortgage collapse, followed by tightened credit conditions and subsequent failures among firms in the bank and finance sectors has driven the US and many developed nations into a recession. These global economic concerns have adversely affected the market values on all but the strongest rated sovereign debt, and US Treasuries were one of the few asset classes with positive returns in 2008. Of the issuers in an unrealized loss, 73% of the unrealized losses relates to Republic of Venezuela. Venezuela depends largely on oil to support its economy and, despite recent declines, current prices provide adequate cash flows to support debt service. In fact, the government has enough reserves to pay their debt off as of year end. All of the issuers in this sector continue to make payments in accordance with the original bond agreements. There are no individual issuers rated below investment grade in this sector which have an unrealized loss position greater than $0.2 million.
The unrealized loss on asset-backed securities (“ABS”) - credit cards is $0.5 million. The unrealized loss in the ABS credit card sector is primarily a function of decreased liquidity and increased credit spreads in the structured finance and financial institution market. While the credit card ABS portfolios with large subprime segments may be negatively impacted by the slowing domestic economy and housing market, there has been little rating migration of the bonds held by MLLICNY. All of the ABS credit card bonds held by MLLICNY are rated investment grade.
CMBS are securitizations of underlying pools of mortgages on commercial real estate. The underlying mortgages have varying risk characteristics and are pooled together and sold in different rated tranches. All of MLLICNY’s CMBS holdings are conduit securities. The following tables summarize MLLICNY’s CMBS exposure by rating and vintage at December 31:
All CMBS securities are monitored and modeled under base and several stress-case scenarios by asset specialists. For conduit securities, a widely recognized industry modeling software is used to perform a loan-by-loan, bottom-up approach. This methodology incorporates external estimates on the property market, capital markets, property cash flows, and loan structure. Results are then closely analyzed to determine whether or not a principal or interest loss is expected to occur. If cash flow models indicate a credit event will impact future cash flows, the security is impaired to fair value.
The unrealized loss on CMBS is $5.0 million. The fundamentals of the CMBS market are, on average, strong but are starting to show some signs of deterioration in some markets. The introduction of the 20% and 30% credit enhanced, super senior AAA classes provide an offset to these negative fundamentals. The lending market has become virtually frozen as lenders have become more conservative with underwriting standards, property transactions have diminished greatly, and higher mortgage spreads have curtailed lending. A lack of liquidity in the market combined with a broad re-pricing of risk has led to increased credit spreads across the credit classes.
Residential mortgage-backed securities (“RMBS”) are securitizations of underlying pools of non-commercial mortgages on real estate. The underlying residential mortgages have varying credit ratings and are pooled together and sold in tranches. MLLICNY’s RMBS includes collateralized mortgage obligations (CMOs) and government sponsored enterprise (GSE) guaranteed passthroughs.
The unrealized loss on RMBS is $0.6 million. The combination of low floating-rate reset margins, slow prepayment speeds, severe illiquidity in the market for near-prime securities, and the unprecedented level of mortgage-related credit spread widening have pushed the overall market value as a percent of book on those RMBS bonds in an unrealized loss position to 80%. As the 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 as of December 31, 2008.
The amortized cost and estimated fair value of fixed maturity securities at December 31 by rating agency equivalent were:
The Company defines investment grade securities as unsecured debt obligations that have a rating equivalent to Standard and Poor’s BBB- or higher (or similar rating agency). At December 31, 2008, approximately $2.6 million (or 2%) of fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by Standard and Poor’s. This compares to $0.9 million (or 1%) of BBB- rated fixed maturity securities at December 31, 2007. Below investment grade securities are speculative and are subject to significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. The Company closely monitors such investments.
Details underlying securities in a continuous gross unrealized loss position for below investment grade securities were as follows:
The majority of assets depressed over 30% as well as over 60% for up to 180 consecutive days are primarily related to the industrial sector. MLLICNY 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 as of December 31, 2008.
Subprime mortgages are loans to homebuyers who have weak or impaired credit histories. In recent years, the market for these loans has expanded rapidly. During that time, however, lending practices and credit assessment standards grew steadily weaker. As a result, the market is now experiencing a sharp increase in the number of loan defaults. Investors in subprime assets include not only mortgage lenders, but also brokers, hedge funds, and insurance companies. The Company does not currently invest in or originate whole loan residential mortgages. The Company categorizes asset backed securities issued by a securitization trust as having subprime mortgage exposure when the average credit score of the underlying mortgage borrowers in a securitization trust is below 660 at issuance. The Company also categorizes asset backed securities issued by a securitization trust with second lien mortgages as subprime mortgage exposure, even though a significant percentage of second lien mortgage borrowers may not necessarily have credit scores below 660 at issuance. The entire subprime exposure ($2.8 million) is first lien - fixed rate, AAA quality and in vintages 2004 and prior.
Changes in the U.S. equity market directly affect the values of the underlying U.S. equity-based mutual funds supporting Separate Accounts assets and, accordingly, the values of variable contract owner account balances. Approximately 73% of Separate Accounts assets were invested in equity-based mutual funds at December 31, 2008. Since asset-based fees collected on inforce variable contracts represent a significant source of revenue, the Company’s financial condition will be impacted by fluctuations in investment performance of equity-based Separate Accounts assets.
During 2008, average variable account balances decreased $188.4 million (or 20%) to $772.8 million as compared to 2007. The decrease in average variable account balances contributed $2.8 million to the decrease in asset-based policy charge revenue during the period ended December 31, 2008, as compared to the same period in 2007.
MLLICNY’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. MLLICNY 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. MLLICNY anticipates funding its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. As of December 31, 2008 and 2007, MLLICNY’s assets included $140.4 million and $161.8 million, respectively, of cash, short-term investments and investment grade publicly traded available-for-sale securities that could be liquidated if funds were required.
During 2008, the Company paid an ordinary cash dividend of $7.0 million to AUSA. During 2007 and 2006, the Company paid ordinary cash dividends of $5.5 million and $4.1 million, respectively, to MLIG.
MLLICNY and AUSA are parties to a “keepwell” agreement which, subject to its terms, commits AUSA to maintain MLLICNY at a minimum net worth. Prior to the acquisition date, MLLICNY and ML&Co. were parties to a “keepwell” agreement which obligated ML&Co. to maintain a level of capital in MLLICNY in excess of minimum regulatory requirements.
On March 6, 2009, Fitch downgraded the Company’s insurance financial strength rating from AA+ to AA. The ratings outlook is negative.
The costs associated with acquiring contract owner deposits (DAC) are amortized over the period in which MLLICNY anticipates holding those funds, as noted in the Critical Accounting Policies section above. Insurance expenses and taxes reported in the Statements of Income are net of amounts deferred. In addition, MLLICNY incurs expenses associated with the maintenance of inforce contracts.
The increase in commissions is primarily due to commission expense paid to Transamerica Capital, Inc., a related party during 2008.
The increase in taxes, license, and fees is primarily due to lower New York State Franchise tax in 2007.
The increase in guaranteed benefit based policy charge revenue is due to the increase in inforce variable annuity contracts containing guaranteed benefit riders.
The decrease in non-asset based policy charge revenue is primarily due to unfavorable policy adjustments for certain variable life insurance contracts.
Net realized investment gains increased $1.1 million during 2007 as compared to 2006 primarily due to one large credit related gain earned in the second quarter 2007.
Amortization of DAC decreased $1.1 million (or 33%) to $2.2 million during 2007 as compared to $3.3 million in 2006 primarily as a result of period-to-period differences in DAC unlocking as noted in the Critical Accounting Policies section above.
The decrease in taxes, licenses, and fees is primarily due to lower New York State Franchise tax expense.
MLLICNY is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2008, 2007, or 2006.