The results of operations of the Company for 1997 are affected by the acquisition and subsequent merger with JANY effective March 31, 1997.
The financial position of the Company as of December 31, 1997 has been affected by the acquisition and subsequent merger with JANY effective March 31, 1997.
NET INCOME totaled $7.3 million in 2000, compared with $7.7 million in 1999 and $16.5 million in 1998. On July 1, 1999, the Company acquired the New York individual life business and the individual and group annuity business of MBL Life Assurance Corporation (the "Acquisition"). The Acquisition was accounted for under the purchase method of accounting, and therefore results of operations include those of the Acquisition only from its date of acquisition. Consequently, the operating results for 2000, 1999 and 1998 are not comparable. On a pro forma basis, using the historical financial information of the acquired business and assuming that the Acquisition had been consummated on October 1, 1997, the beginning of the prior-year periods discussed herein, net income would have been $9.4 million and $19.9 million for the years ended December 31, 1999 and September 30, 1998 respectively.
PRETAX INCOME totaled $11.6 million in 2000, $14.3 million in 1999 and $28.6 million in 1998. The 18.9% year-to-date decline in 2000 over 1999 primarily resulted from increased net realized investment losses, partially offset by increased variable annuity fees, decreased general and administrative expenses, and decreased amortization of deferred acquisition costs. The significant decline from 1998 to 1999 was also due to an increase in net realized investment losses.
Investment income (and the related yields on average invested assets) totaled $119.6 million (7.08%) in 2000, $125.4 million (7.10%) in 1999 and $115.9 million (7.46%) in 1998. The decrease in the investment yield in 2000 as compared to 1999 and in 1999 as compared to 1998 principally reflect the effects of lower yielding assets received in the MBL Life acquisition. The invested assets associated with the Acquisition included high-grade corporate, government and government/agency bonds, which are generally lower yielding than a significant portion of the invested assets that comprise the remainder of the Company's portfolio. On a pro forma basis, assuming the Acquisition had been consummated on October 1, 1997, the yield on related average invested assets would have been 6.83% in 1999 and 6.85% in 1998.
Total interest expense equaled $77.5 million in 2000, $82.6 million in 1999 and $80.7 million in 1998. The average rate paid on all interest-bearing liabilities was 4.81% in 2000, compared with 4.92% in 1999 and 5.36% in 1998. Interest-bearing liabilities averaged $1.61 billion during 2000, $1.68 billion during 1999 and $1.51 billion during 1998. The decrease in interest rates paid in 2000 results primarily from the continued reduction of crediting rates on certain closed blocks of business and the effects of the Acquisition. On a pro forma basis, assuming the Acquisition had been consummated on October 1, 1997, the average rate paid on all interest-bearing liabilities would have been 4.96% in 1999 and 5.28% in 1998 and interest-bearing liabilities would have averaged $2.10 billion during 1999 and $2.34 billion in 1998.
VARIABLE ANNUITY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $9.1 million in 2000, $6.6 million in 1999 and $3.6 million in 1998. The increased fees in 2000 reflect growth in average variable annuity assets, principally due to the receipt of variable annuity premiums and net exchanges into the separate accounts from the fixed accounts of variable annuity contracts, partially offset by surrenders and declines in market values. Variable annuity fees represent 1.5% of average variable annuity assets in all periods presented. Variable annuity assets averaged $591.9 million, $417.8 million and $234.1 million during 2000, 1999 and 1998, respectively. Variable annuity premiums, which exclude premiums allocated to the fixed accounts of variable annuity products, totaled $39.6 million, $66.7 million and $80.2 million in 2000, 1999 and 1998, respectively.
At December 31, 2000 the Bond Portfolio (excluding $75,000 of redeemable preferred stocks) included $1.23 billion of bonds rated by Standard & Poor's ("S&P"), Moody's Investors Service ("Moody's), Fitch ("Fitch") or the Securities Valuation Office of the National Association of Insurance Commissioners ("NAIC"), and $9.9 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At December 31, 2000, approximately $1.15 billion of the Bond Portfolio was investment grade, including $557.5 million of U.S. government/agency securities and mortgage-backed securities ("MBSs").
S&P and Fitch rate debt securities in rating categories ranging from AAA (the highest) to D (in payment default). A plus (+) or minus (-) indicates the debt's relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Moody's rates debt securities in rating categories ranging from Aaa (the highest) to C (extremely poor prospects of ever attaining any real investment standing). The number 1,2 or 3 (with 1 the highest and 3 the lowest) indicates the debt's relative standing within the rating category. A security rated Baa3 or higher is considered investment grade. Issues are categorized based on the highest of the S&P, Moody's, and Fitch ratings if rated by multiple agencies.
(2) Bonds and short-term promissory instruments are divided into six quality categories for NAIC rating purposes, ranging from 1 (highest) to 5 (lowest) for nondefaulted bonds plus one category, 6, for bonds in or near default. These six categories correspond with the S&P/Moody's/Fitch rating groups listed above, with categories 1 and 2 considered investment grade. The NAIC categories include $9.9 million of assets that were rated by the Company pursuant to applicable NAIC rating guidelines.
While the trading market for the Company's privately traded Secured Loans is more limited than for publicly traded issues, management believes that participation in these transactions has enabled the Company to improve its investment yield. As a result of restrictive financial covenants, these Secured Loans involve greater risk of technical default than do publicly traded investment-grade securities. However, management believes that the risk of loss upon default for these Secured Loans is mitigated by such financial covenants and the collateral values underlying the Secured Loans. The Company's Secured Loans are rated by S&P, Moody's, Fitch, the NAIC or by the Company, pursuant to comparable statutory ratings guidelines established by the NAIC.
OTHER INVESTED ASSETS aggregated $39.9 million at December 31, 2000, compared with $42.6 million at December 31, 1999, and consist principally of policy loans.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, default rates, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company's fixed-rate products incorporate surrender charges or other restrictions in order to encourage persistency. Approximately 77% of the Company's fixed annuity and universal life reserves had surrender penalties or other restrictions at December 31, 2000.
As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-rate assets and liabilities under commonly used stress-test interest rate scenarios. With the results of these computer simulations, the Company can measure the potential gain or loss in fair value of its interest-rate sensitive instruments and seek to protect its economic value and achieve a predictable spread between what it earns on its invested assets and what it pays on its liabilities by designing its fixed-rate products and conducting its investment operations to closely match the duration of the fixed-rate assets to that of its fixed-rate liabilities. The Company's fixed-rate assets include: cash and short-term investments; bonds, notes and redeemable preferred stocks; common stocks; mortgage loans; and policy loans. At December 31, 2000, these assets had an aggregate fair value of $1.6 billion with a duration of 3.7. The Company's fixed-rate liabilities are its fixed annuity and universal life insurance contracts. At December 31, 2000, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $1.4 billion with a duration of 2.5. The Company's potential exposure due to a relative 10% increase in prevailing interest rates from their December 31, 2000 levels is a loss of approximately $11.7 million, representing an increase in the fair value of its fixed-rate assets that is not offset by an increase in the fair value of its fixed-rate liabilities. Because the Company actively manages its assets and liabilities and has strategies in place to minimize its exposure to loss as interest rate changes occur, it expects that actual losses would be less than the estimated potential loss.
Duration is a common option-adjusted measure for the price sensitivity of a fixed-maturity portfolio to changes in interest rates. It measures the approximate percentage change in the market value of a portfolio if interest rates change by 100 basis points, recognizing the changes in cash flows resulting from embedded options such as policy surrenders, investment prepayments and bond calls. It also incorporates the assumption that the Company will continue to utilize its existing strategies of pricing its fixed annuity and universal life products, allocating its available cash flow amongst its various investment portfolio sectors and maintaining sufficient levels of liquidity. Because the calculation of duration involves estimation and incorporates assumptions, potential changes in portfolio value indicated by the portfolio's duration will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material.
There are risks associated with some of the techniques the Company uses to provide liquidity, enhance its spread income and match its assets and liabilities. The primary risk associated with the Company's Reverse Repos is counterparty risk. The Company believes, however, that the counterparties to its Reverse Repos are financially responsible and that the counterparty risk associated with those transactions is minimal. It is the Company's policy that these agreements are entered into with counterparties who have a debt rating of A/A2 or better from both S&P and Moody's. The Company continually monitors its credit exposure with respect to these agreements. The primary risk associated with MBSs is that a changing interest rate environment might cause prepayment of the underlying obligations at speeds slower or faster than anticipated at the time of their purchase. As part of its decision to purchase an MBS, the Company assesses the risk of prepayment by analyzing the security's projected performance over an array of interest-rate scenarios. Once an MBS is purchased, the Company monitors its actual prepayment experience monthly to reassess the relative attractiveness of the security with the intent to maximize total return.
CONTINGENT LIABILITIES are discussed in Note 9 of the accompanying financial statements.