The Registrant’s home office is located in Little Rock, Arkansas. 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.
In addition, personnel performing services for the Registrant occupy office space in Pennington, New Jersey and Jacksonville, Florida, which is owned by ML&Co. An allocable share of the cost of each of the above mentioned premises was paid by the Registrant through the transition services agreement between AUSA and ML&Co.
risks and uncertainties. The reader should, however, consult any further disclosures MLLIC 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.
The Company made refinements during 2008 to the initial estimated fair values as additional information became available. The following adjustments as of December 31, 2008 were made to the initial purchase price allocation:
In addition, as required by the U.S. Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 54, Push Down Basis of Accounting in Financial Statements of a Subsidiary, the purchase method of accounting applied by AUSA to the acquired assets and liabilities associated with the Company has been “pushed down” to the financial statements of the Company, thereby establishing a new basis of accounting. As a result, the Company follows AUSA’s accounting policies subsequent to the acquisition date. This new basis of accounting is referred to as the “successor basis”, while the historical basis of accounting is referred to as the “predecessor basis’’. In general, all 2008 amounts, as well as Balance Sheet amounts for 2007 are representative of the successor basis of accounting while the Statements of Income, Stockholder's Equity, Comprehensive Income, and Cash Flows amounts for 2007 and 2006 are representative of the predecessor basis of accounting. Financial statements included herein for periods prior and subsequent to the acquisition date are labeled “Predecessor” and “Successor”, respectively.
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 immaterial (less than 1% of the value).
At December 31, 2008 and December 31, 2007, approximately, $166.1 million (or 12%) and, $144.5 million (or 10%), respectively, of the Company’s fixed maturity and equity securities portfolio consisted of non-publicly traded securities. Since significant judgment is required for the valuation of non-publicly traded securities, the estimated fair value of these securities may differ from amounts realized upon an immediate sale.
Financial assets that are lent to a third party or that are transferred subject to a repurchase agreement at a fixed price are not derecognized as the Company retains substantially all the risks and rewards of asset ownership. The lent securities are included in fixed maturities in the Balance Sheets. A liability is recognized for cash collateral received, required initially at 102%, on which interest is accrued. At December 31, 2008, the payable for collateral under securities loaned was $182.5 million. There was no payable for collateral under securities loaned at December 31, 2007.
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, 2008, 2007 and 2006 there was a favorable (unfavorable) impact to pre-tax earnings related to DAC unlocking of ($7.3) million, $26.5 million, and $16.7 million, respectively. See Note 6 to the Financial Statements for a further discussion.
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, MLLIC 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 $581.1 million and $575.0 million, respectively. For the year ended December 31, 2008, the unfavorable impact to pre-tax earnings related to VOBA unlocking was $68.4 million. The unlocking includes an impairment charge of $28.0 million as estimated future gross profits were less than the unamortized balance. See Note 5 to the Financial Statements for a further discussion of VOBA.
“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 MLLIC 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 MLLIC. As a result of this decision, an impairment charge was taken for the majority of the goodwill balance of $139.3 million. The remaining amount relates to MLLIC’s state licenses. See Note 5 to the Financial Statements for a further discussion. At December 31, 2008 and 2007, the Company’s goodwill asset was $2.8 million and $156.9 million, respectively. The entire asset amount has been allocated to annuities.
Included within future policy benefits are liabilities for GMDB and GMIB provisions contained in the variable products that the Company issues. At December 31, 2008 and 2007, GMDB and GMIB liabilities included within future policy benefits were as follows:
MLLIC’s variable universal life insurance product includes a premium load that is higher in early policy years than in later years. The excess of the initial load over the ultimate load is accreted into revenue over time in the same manner that DAC is amortized. In addition, the unearned policy charge revenue liability is subject to the same periodic reassessment as DAC. At December 31, 2007, the UPCR liability was zero as a result of the push down accounting at the acquisition date. For the year ended December 31, 2007, the impact on pre-tax earnings related to UPCR unlocking was $4.8 million unfavorable. See Note 6 to the Financial Statements for a further discussion.
MLLIC adopted the provisions of FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. MLLIC has analyzed all material tax positions under the provisions of FIN No. 48, and has determined that there are no tax benefits that should not be recognized as of December 31, 2008 or as of December 31, 2007. There are no unrecognized tax benefits that would affect the effective tax rate. It is not anticipated that the total amounts of unrecognized tax benefits will significantly increase within twelve months of the reporting date.
In October 2008, the FASB issued FSP No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The FSP clarifies the application of SFAS No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The key considerations illustrated in the FSP FAS No. 157-3 example include the use of an entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates, appropriate risk adjustments for nonperformance and liquidity risks, and the reliance that an entity should place on quotes that do not reflect the result of market transactions. The FSP became effective upon issuance. The FSP adoption did not have a 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.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”). This statement replaces SFAS No. 141, Business Combinations and establishes 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. SFAS No. 141(R) is effective for and shall be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with earlier adoption prohibited. Assets and liabilities that arose from business combinations with acquisition dates prior to the SFAS No. 141(R) effective date shall not be adjusted upon adoption of SFAS No. 141(R) with certain exceptions for acquired deferred tax assets and acquired income tax positions. The Company expects to adopt SFAS No. 141(R) and will apply its requirements to acquisitions occurring on or after January 1, 2009, and does not expect the adoption to have a material impact on the results of operation or financial position.
MLLIC’s marketing emphasis has been on the sale of variable annuity products through the retail network of MLPF&S. These products were designed to address the retirement planning needs of ML&Co.’s clients. Each variable annuity product was designed to provide tax-deferred retirement savings with the opportunity for diversified investing in a wide selection of underlying mutual fund portfolios. MLLIC competes for ML&Co.’s clients’ retirement planning business with i) unaffiliated insurers whose products are also sold through ML&Co.’s retail network, ii) insurers who solicit this business directly, and iii) other investment products sold through ML&Co.’s retail network. MLLIC competes in this market segment by integrating its products into ML&Co.’s planning-based financial management program.
The decrease in variable annuity deposits in 2008 was primarily due to volatile equity markets. During 2007, variable annuity deposits were relatively unchanged as compared to 2006.
During 2008, the Company experienced contract owner withdrawals that exceeded deposits by $891.9 million. The components of contract owner transactions were as follows:
The following schedule identifies MLLIC’s general account invested assets by type for the years ended December 31:
credit losses and weak earning prospects that are associated with a recessionary environment and this is adding pressure to subordinated and longer duration holdings.
The Basic and Capital Goods industries encompass various sub-sectors ranging from aerospace defense to packaging. Building materials continue to be impacted by the slowdown in the US housing market which has been further impacted by declines in consumer spending. Chemicals have been impacted by concerns of a slowing domestic economy, slower global demand, volatility in raw material costs and increasing competition from global competitors. Paper and forest products continue to be under pressure due to higher input costs, lower housing starts and lack of demand for paper related shipping
and writing products. Additionally, lack of market liquidity and volatile credit markets have further impacted bond prices. There are no individual issuers rated below investment grade in the basic industries and capital goods sub-sector which have unrealized loss positions greater than $2.5 million.
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 $2.5 million.
The bonds of the underlying companies have seen price declines consistent with the overall market and concerns over the effect lower commodity prices will have on cash flow. There are no individual issuers rated below investment grade in the energy sub-sector which have unrealized loss positions greater than $2.5 million.
The Communications sector can be further divided into the media cable, media non-cable, wireless and wirelines sub-sectors.
Many companies in the wirelines sector continue to focus on increasing shareholder returns. This has escalated event risk within the sector and caused concern that companies may increase financial leverage. There are no individual issuers rated below investment grade in the communications sub-sector which have unrealized loss positions greater than $2.5 million.
The Electric Utility sector is generally viewed as a defensive sector during weak economic environments. While defensive in nature, there are several issues which present challenges, including growing capital expenditures programs, the possibility of CO2 legislation, a renewed interest in expanding riskier unregulated generation projects, and increasingly uncertain state regulatory environments driven by rising energy prices and a slowing economy. There are no individual issuers rated below investment grade in this sub-sector which have unrealized loss positions greater than $2.5 million.
The Natural Gas sector includes natural gas pipeline and distribution companies. The underlying fundamentals for pipelines are adversely affected by the decline in commodity prices, weak end user demand, and higher financing costs. Capital expenditures remained at elevated levels as the industry addresses the country’s infrastructure needs. As a result, pipelines will need continued access to the capital markets. The distributors remain well capitalized with increasing focus on reducing exposure to bad debts and weather related volatility. There are no individual issuers rated below investment grade in this sub-sector which have unrealized loss positions greater than $2.5 million.
All ABS-housing securities are monitored and reviewed on a monthly basis with detailed cash flow models using the current collateral pool and capital structure on each portfolio quarterly. Model output is generated under base and several stress-case
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. MLLIC’s CMBS includes conduit and single borrower securities. Over 88% of MLLIC’s exposure to CMBS is AAA rated, with the majority of these positions being AAA - senior rated securities. The following tables summarize MLLIC’s CMBS exposure by rating and vintage at December 31:
For the RMBS holdings in an unrealized loss, the collateral pools have experienced higher than expected delinquencies and losses, and the unrealized loss is further exacerbated by the impact of declining home values on borrowers using affordability products. Further impacting the unrealized losses is spread widening due to illiquidity as well as increased extension risk due to slower than expected prepayments. Despite the continued decline in the margin of safety on these securities during 2008, cash flow models indicate full recovery of principal and interest for each of MLLIC’s particular holdings in an unrealized loss position. As the
At December 31, 2008 and 2007, approximately $108.9 million (or 29%) and $151.3 million (or 73%), respectively, of CMO and CMBS holdings were fully collateralized by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. CMO 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 CMO and MBS securities will exceed the yields that can be obtained from corporate securities with similar credit ratings.
MLLIC’s bond impairment losses were $14.2 million for the year ended December 31, 2008. No one issuer accounted for impairment losses exceeding $2.5 million.
The following summarizes key information on mortgage loans on real estate:
During 2008, average variable account balances decreased $2.0 billion (or 17%) to $9.5 billion as compared to 2007. The decrease in average variable account balances contributed $29.1 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.
At December 31, 2008 and 2007, MLLIC had 17,284 and 19,388 life insurance and annuity contracts inforce with interest rate guarantees, respectively. The estimated average rate of interest credited on behalf of contract owners was 4.08% and 4.17% during 2008 and 2007, respectively. Total invested assets supporting these liabilities with interest rate guarantees had an estimated average effective yield of 5.65% and 5.20% during 2008 and 2007, respectively. In 2008 the number of life insurance and annuity contracts inforce with interest rate guarantees decreased 2,104 (or 11%) as compared to 2007.
MLLIC’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. MLLIC 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. MLLIC 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, MLLIC’s assets included $1.7 billion and $1.5 billion, respectively, of cash, short-term investments and investment grade publicly traded available-for-sale securities that could be liquidated if funds were required.
MLLIC and AUSA are parties to a “keepwell” agreement which, subject to its terms, commits AUSA to maintain MLLIC at a minimum net worth. Prior to the acquisition date, MLLIC and ML&Co. were parties to a “keepwell” agreement which obligated ML&Co. to maintain a level of capital in MLLIC in excess of minimum regulatory requirements.
The National Association of Insurance Commissioners utilizes the RBC adequacy monitoring system. The RBC calculates the amount of adjusted capital that a life insurance company should have based upon that company’s risk profile. As of December 31,
2008 and 2007, based on the RBC formula, MLLIC’s total adjusted capital levels were well in excess of the minimum amount of capital required to avoid regulatory action.
The insurer financial strength rating scales of S&P, A.M.Best, Moody’s Investors Service (“Moody’s”), and Fitch Ratings (“Fitch”) are characterized as follows:
The policyholder liabilities include benefit and claim liabilities of which a significant portion represents policies and contracts that do not have a stated contractual maturity. The projected cash benefit payments in the table above are based on management’s best estimates of the expected gross benefits and expenses, partially offset by the expected gross premiums, fees and charges relating to the existing business inforce. Estimated cash benefit payments are based on mortality and lapse assumptions comparable with the Company’s historical experience, modified for recently observed trends. Actual payment obligations may differ if experience varies from these assumptions. The cash benefit payments are presented on an undiscounted basis and are before deduction of tax and before reinsurance. The liability amounts in the Company’s financial statements reflect the discounting for interest as well as adjustments for the timing of other factors as described above. As a result, the sum of the cash benefit payments shown for all years in the table above exceeds the corresponding policyholder liability amounts.
The costs associated with acquiring contract owner deposits (DAC) are amortized over the period in which MLLIC 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, MLLIC incurs expenses associated with the maintenance of inforce contracts.
Negative amortization of deferred policy acquisition costs was $0.7 million in 2008. Included in the amortization for 2008 was $7.4 million of unfavorable DAC unlocking. During 2008, the Company experienced lower than expected gross profits as a result of market losses which reduced amortization expense and unlocking. The DAC balance was zero as of December 31, 2007 as a result of push down accounting at the acquisition date. Amortization of deferred policy acquisition costs was $22.1 million for 2007.
Amortization of other intangibles was $3.8 million in 2008. There was no amortization of other intangibles in 2007. Impairment charges were recorded in the fourth quarter of 2008 for other intangibles and goodwill of $76.1 million and $139.3 million, respectively.
MLLIC recorded net income of $110.5 million and $94.7 million for 2007 and 2006, respectively.
See the Critical Accounting Policies section above for a further discussion of UPCR unlocking.
Net realized investment gains increased $0.9 million (or 75%) to $2.1 million during 2007 as compared to $1.2 million in 2006. The following table provides the changes in net realized investment gains by type:
The increase in variable annuity benefit expense is primarily due to net unfavorable market valuation adjustments to GMWB and GMIB liabilities. See the Critical Accounting Policies section above for a further discussion of variable annuity guaranteed benefit liabilities.
Select financial information by segment for the years ended December 31 is as follows:
Management considers interest credited to policyholder liabilities in evaluating net revenues.
MLLIC is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2008, 2007, or 2006.