The Company offers a wide array of annuities, including (1) deferred and immediate variable annuities that are registered with the SEC, including fixed interest rate allocation options that are offered in certain of our variable annuities and are registered because of their market value adjustment feature and (2) fixed rate allocation options in certain of our variable and fixed annuities that are not registered with the SEC. In addition, the Company has in force a relatively small block of variable life insurance policies, but it no longer actively sells such policies. The markets in which the Company operates are subject to regulatory oversight with particular emphasis placed on company solvency and sales practices. These markets are also subject to increasing competitive pressure as the legal barriers, that have historically segregated the markets of the financial services industry, have been changed through both legislative and judicial processes. Regulatory changes have opened the insurance industry to competition from other financial institutions, particularly banks and mutual funds that are positioned to deliver competing investment products through large, stable distribution channels.
our ability to generate favorable investment results through asset liability management and strategic and tactical asset allocation; and
We capitalize costs that vary with and are related primarily to the acquisition of new and renewal annuity contracts. These costs include primarily commissions, costs of policy issuance and other variable expenses. We amortize these deferred policy acquisition costs, or DAC, over the expected lives of the contracts, based on the level and timing of gross profits. As of December 31, 2006 and 2005, DAC was $766.3 million and $528.9 million, respectively.
In addition to DAC, we also recognize assets for capitalized sales inducements and valuation of business acquired (“VOBA”). The deferred sales inducements are amortized using the same methodology and assumptions used to amortize deferred policy acquisition costs. For additional information about our deferred sales inducements, see Note 6 to the Financial Statements. VOBA represents the present value of future profits embedded in acquired businesses. For additional information about VOBA including its bases for amortization, see Note 5 of the financial statements.
A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved upon the occurrence of future events. Under U.S. GAAP, reserves for contingencies are required to be established when the future event is probable and its impact can be reasonably estimated. An example is the establishment of a reserve for losses in connection with an unresolved legal matter. The initial
Policy charges and fee income increased by $105.6 million, from $455.7 million in 2005 to $561.3 million in 2006. Mortality and expense charges increased by $76.5 million as a result of the increase in the inforce business and market appreciation. Generally, annuity fees are asset-based fees, which are dependent on fund balances. Average annuity separate account fund balances have increased as a result of market appreciation and positive net flows, resulting in an increase in policy charges and fee income. Optional benefit charges on our living and death benefit features increased $18.7 million primarily driven by increased sales of our Lifetime Five and Spousal Lifetime Five benefit features. This increase was primarily offset by the change in the value of our embedded derivatives related to the reinsurance of these features included in realized investment losses, net. Additionally, policy charges increased $6.8 million from the prior year due to the change in realized market value adjustments related to the Company’s fixed, market value adjusted investment option (“MVA option”).
Realized investment losses, net, increased by $15.9 million from $32.1 million in 2005 to $48.0 million in 2006. This was driven by increased investment losses on our MVA portfolio due to dispositions of fixed maturities in a rising rate environment to fund outflows. Also contributing to the increased losses was the change in the value of our embedded derivatives related to our living benefit features. This was offset in policy charges and fee income as discussed in the preceding paragraph.