Effective January 2, 2001, we adopted the Accounting Standards Executive Committee's Statement of Position 00-3 "Accounting by Insurance Enterprises for Demutualizations and Formations of Mutual Holdings Companies and for Certain Long-Duration participating Contracts," or SOP 00-3. The provisions of SOP 00-3 resulted in a modification of the presentation of the closed blocks in our consolidated financial statements to no longer show the operations of the closed blocks and the assets and liabilities of the closed blocks as single line items. In addition, SOP 00-3 required the reporting of unrealized gains and losses on closed block investments as a component of the closed block policyholder dividend obligation rather than accumulated other comprehensive income in total stockholders' equity. As a result, unrealized gains (losses) amounting to $6.0 million at December 31, 2000, ($10.7 million) at December 31, 1999, $27.6 million at December 31, 1998 and $31.1 million at December 1997 were reclassified from accumulated other comprehensive income to dividends payable to policyowners.
(C) We did not have common stock until our demutualization on September 20, 2000, therefore, there were no dividends to declare on common stock for the years 1997 through 1999. ALHI, our predecessor to our company did declare dividends on its common stock of $0.40 per share, $0.40 per share, and $0.30 per share for the years ended December 31, 1999, 1998 and 1997, respectively.
(D) Adjusted net operating income reflects net income adjusted to eliminate certain items (net of applicable income taxes and minority interest) which our management believes are not indicative of overall operating trends, including net realized gains or losses on investments. Different items are likely to occur in each period presented and others may have different opinions as to which items may warrant adjustment. The adjusted net operating income shown does not constitute net income computed in accordance with accounting principles generally accepted in the United States (or GAAP). See additional description of Adjusted Net Operating Income included in
In accordance with accounting principles generally accepted in the United States, or GAAP, universal life insurance premiums and annuity deposits that we receive are reflected as increases in liabilities for policyowner account balances and not as revenues. Surrender benefits paid relating to universal life insurance policies and annuity products are reflected as decreases in liabilities for policyowner account balances and not as expenses. Revenues for universal life and annuity products consist of policy charges for the cost of insurance, administration charges and surrender charges assessed against policyowner account balances. Amounts for interest credited to universal life and annuity policyowner account balances and benefit claims in excess of policyowner account balances are reported as expenses in our financial statements. We receive investment income earned from the funds deposited into account balances by universal life and annuity policyowners, the majority of which is passed through to such policyowners in the form of interest credited.
Premium revenues reported for our traditional life insurance products are recognized as revenues when due. Future policy benefits and policy acquisition costs are recognized as expenses over the life of the policy by means of a provision for future policy benefits and amortization of deferred policy acquisition costs.
Policy acquisition costs consist of the costs related to acquiring new life insurance and annuity business, including costs of issuing policies and other variable selling expenses (principally commissions). The method of amortizing deferred policy acquisition costs for life insurance products varies depending upon whether the contract is participating or non-participating. Participating life insurance contracts are those which are expected to pay dividends to policyowners in proportion to their relative contribution to our statutory surplus. Deferred policy acquisition costs for participating policies are amortized as an expense primarily in proportion to expected profits or margins from such policies. The amortization period and amount are adjusted when current or estimated future gross profits or margins on the underlying policies vary from previous estimates. For example, the amortization of deferred policy acquisition costs is accelerated when policy terminations are higher than originally estimated or when investments supporting the policies are sold at a gain prior to their anticipated maturity. Non-participating life insurance deferred policy acquisition costs are amortized over the premium-paying period of the related policies in proportion to the ratio of annual premium revenues to total anticipated premium revenues using assumptions consistent with those used in computing policy benefit reserves. For universal life insurance and annuity products, deferred policy acquisition costs are generally amortized in proportion to the present value of estimated gross margins from surrender charges and investment, mortality and expense margins.
The following table reflects net income adjusted to eliminate certain items (net of applicable income taxes and minority interest) which our management believes do not necessarily indicate overall operating trends. For example, net realized capital gains or losses on investments, excluding our gains or losses on convertible preferred stock and bonds which we consider to be core earnings, are eliminated. Net realized capital gains or losses on investments may be realized at the sole discretion of management and are often realized in accordance with tax planning strategies. Therefore, our management believes that our net realized capital gains or losses or investments do not properly reflect earnings capacity for the periods presented below. Different items of adjustment are likely to occur in different periods presented and others may have different opinions as to which items may warrant adjustment. Adjusted net operating income is the basis we use to assess our overall performance. Adjusted net operating income as described by us may not be comparable to similarly titled measures reported by other companies, including insurance companies. The adjusted net operating income shown below does not constitute our net income computed in accordance with GAAP.
(A) Represents total realized gains or losses on investments less core realized gains or losses (defined as gains or losses from the closed block and gains or losses on the convertible preferred stock and bond portfolio) adjusted for income taxes and minority interest on such amounts. Non-core realized gains or losses may vary widely between periods. Such amounts are determined by management's timing of individual transactions and do not necessarily correspond to the underlying operating trends.
(G) Represents the cumulative effect of change in accounting for derivatives, net of income taxes, as of January 1, 2001, resulting from our adoption of SFAS 133. This statement is effective for fiscal years beginning after June 15, 2000.
We have established two closed blocks of policies: (a) the first on June 30, 1996 in connection with the reorganization of our subsidiary, ALIC, to a stock company, and (b) the second on March 31, 2001 in connection with the reorganization of ILIC to a stock company. Each closed block consists of insurance policies issued by ALIC or ILIC which had a dividend scale in effect as of the establishment dates of the closed block. The closed blocks were designed to provide reasonable assurance to the owners of these insurance policies that, after the reorganization of ALIC and ILIC, assets would be available to maintain the dividend scales and interest credits in effect prior to each reorganization, if the experience underlying such scales and credits continues.
We have two reportable operating segments: life insurance and annuities. Products generally distinguish a segment. We use the same accounting policies and procedures to measure operating segment income as we use to measure our consolidated income from operations other than the elimination of certain items which management believes are not necessarily indicative of overall operating trends. These items are explained further under "Adjusted Net Operating Income." Revenues, benefits and expenses are primarily attributed directly to each operating segment. Net investment income and core realized gains and losses on investments are allocated according to the asset portfolios to which they relate. Investment realized gains and losses from the closed block and from convertible preferred stocks and bonds are considered core realized gains and losses. All other gains and losses are considered non-core. Other revenues and expenses which are deemed not to be associated with any specific reportable segment are grouped together in the all other operations category. These items primarily consist of holding company revenues and expenses and the operations of our real estate management subsidiary. We assess the performance of our operating segments before interest expense, income
attributable to the acquisition of ILICO. The increases for 2001, excluding ILICO, and 2000 primarily reflect the increased sales of universal life products and increased cost of insurance charges corresponding with the normal aging and growth of the block of business.
The effective yield on the investment portfolio was 7.32% in 2001 compared to 7.94% in 2000 and 7.90% in 1999. Excluding ILICO, 2001 yields decreased to 7.64%. The decrease in yields in 2001, exclusive of ILICO, primarily resulted from the lower interest rate market. The increase in 2000 yields primarily related to the purchase accounting market value adjustments made to our assets in connection with our reorganization, in the third quarter of 2000.
Total policyowner benefits were $384.2 million in 2001 compared to $308.2 million in 2000 and $301.3 million in 1999. The acquisition of ILICO in 2001 increased life insurance benefits $127.4 million in 2001. Excluding the impact of the ILICO acquisition, total policyowner benefits decreased $51.4 million in 2001 as compared to 2000 and increased $6.9 million in 2000 compared to 1999. The 2001 decrease in traditional life insurance benefits, exclusive of the impact of ILICO, was primarily due to the new reinsurance agreements entered into in 2000 and favorable mortality of the closed block both of which resulted in decreased death benefits and change in liability for future policy benefits. In addition, traditional life insurance benefits decreased due to increased reinsurance recovery benefits of the closed block of $43.2 million in 2001 related to the new reinsurance agreements entered into in 2000. The 2000 increase in traditional life insurance benefits was due to higher death benefits and reserves related to increased persistency as policyholders held their policies awaiting our demutualization distribution. Universal life benefits, excluding ILICO, decreased approximately $1.8 million in 2001 compared to 2000 and $3.8 million in 2000 compared to 1999 due to favorable mortality on closed block policies partially offset by increased interest credited related to more policies in-force as sales have increased. The weighted average crediting rate on universal life policyowner account balances was 5.63% for 2001 (5.64% excluding ILICO) compared to 5.62% for 2000 and 5.67% for 1999. We estimated life insurance benefits from the terrorist attacks in the United States on September 11, 2001 to be approximately $1.2 million.
The amortization of deferred policy acquisition costs and value of business acquired amounted to $57.0 million in 2001 compared to $35.6 million in 2000 and $37.6 million in 1999. Amortization of deferred
policy acquisition costs and value of business acquired (VOBA), exclusive of ILICO, increased $9.7 million in 2001 as compared to 2000 and decreased $2.0 million in 2000 as compared to 1999. Deferred policy acquisition costs and VOBA are generally amortized in proportion to gross margins. The 2001 increase was primarily due to increased amortization associated with higher policy lapses which reduces future margins to amortize such costs resulting in more current year expense. The 2000 decrease was primarily due to reduced amortization consistent with the projected reduction in the gross margins of the closed block as the life insurance in force declines which was partially offset by increased amortization in the open block for higher margins experienced in 2000.
Net investment income was $577.9 million for 2001 compared to $468.4 million for 2000 and $443.4 million for 1999. Approximately $64.0 million of net investment income for 2001 was attributable to the acquisition of ILICO. Excluding ILICO, net investment increased primarily due to higher average invested assets (excluding market value adjustments) and higher effective yields as compared to the respective prior year. Average invested assets (excluding market value adjustments) increased to approximately $468.0 million in 2001 compared to 2000 and $278.9 million in 2000 compared to 1999. The increase was primarily due to the growth of our annuity business.
Annuity benefits were $426.9 million in 2001 compared to $323.6 million in 2000 and $339.1 million in 1999. Approximately $61.1 of the increase in annuity benefits in 2001 was due to the acquisition of ILICO in the second quarter of 2001. Annuity benefits increased approximately $42.2 million in 2001, exclusive of the impact of the ILICO acquisition, and decreased $15.5 million in 2000. Excluding ILICO, interest credited to deferred annuity account balances increased $45.5 million in 2001 compared to 2000 and decreased
$19.1 million in 2000 compared to 1999. In 2001, average deferred fixed annuity account balances, excluding ILICO, increased approximately $304.4 million and the weighted average crediting rate on deferred fixed annuity account balances increased 12 basis points to 5.07%. The 2001 increase in crediting rates reflects the change in product mix and the increase in the investment yields of the deferred fixed annuity portfolio. Overall, spreads on deferred fixed annuities, excluding ILICO, were reduced 1 basis point to 202 basis points in 2001 as compared 2000. In 2000 as compared to 1999, average deferred fixed annuity account balances decreased approximately $15.0 million and the weighted average crediting rate on deferred fixed annuity account balances remained constant at 4.95%. The 2000 decrease in crediting rates reflects the decrease in the investment yields of the deferred fixed annuity portfolio. Overall, spreads on deferred fixed annuities widened 30 basis points to 203 basis points in 2000 as compared 1999. Including ILICO deferred fixed annuity products, the weighted average crediting rate increased to 5.07% and spreads were 200 basis points. Other annuity benefits declined approximately $3.2 million, exclusive of ILICO, in 2001 which corresponds with the decline in immediate annuity and supplementary contract premiums and increased $3.6 million in 2000 due the issuance of two insurance contracts to two commercial paper conduits in mid-1999, one of which was terminated in the fourth quarter of 1999. ILICO added approximately $40.2 million to the 2001 other annuity benefits due to payments made under modified coinsurance agreements.
Underwriting, acquisition and other expenses were $60.9 million in 2001 compared to $52.6 million in 2000 and $37.2 million in 1999. Approximately $3.3 million of such expenses was due to the ILICO acquisition. Excluding these ILICO expenses, underwriting, acquisition and insurance expenses increased approximately $5.1 million in 2001 compared to 2000 and increased $15.4 million in 2000 compared to 1999. The increase between the reporting years primarily reflects increased employee and agent costs and expenses related to the new independent marketing organizations acquired in January 2001 and April 2000. These increases are partially offset by a reduction in expenses from the consolidation of annuity operations in Topeka. The increase in expenses due to the new independent marketing organizations was offset by the increase in other income from the independent marketing organizations previously discussed.
Adjusted pre-tax operating income from our annuity operations was $95.9 million in 2001 compared to $88.2 million in 2000 and $89.2 million in 1999. The acquisition of ILICO contributed $7.2 million in 2001. Excluding this contribution from ILICO, our annuity operating income increased $0.5 million in 2001 compared to 2000 and decreased $1.0 million in 2000 compared to 1999. The slight increase in 2001 was primarily due to increased net independent marketing organizations' operating income offset by increased employee and agent costs.
Adjusted pre-tax operating income from our other operations was $8.1 million in 2001 compared to $12.0 million in 2000 and $7.6 million in 1999. Other operations primarily consist of holding company revenues and expenses and operations of our real estate management subsidiary. Revenues declined in 2001 as compared to prior years primarily from the reduction in holding company cash equivalents of approximately $340 million. The cash equivalents were generated primarily from the sale of our discontinued operations in mid-1998 and were carried as invested assets until October 2000, when we distributed the funds to our former members in connection with our demutualization. Additionally, revenues declined in 2001 from the reduction of properties under management. Accordingly, the expenses associated with these properties declined in 2001 as well. We began decreasing our properties under management in 1999 as this business was not a part of our core strategy of life insurance and annuity operations.
A summary of our adjusted pre-tax operating income by segment and the remaining line items of our consolidated statements of income follows:
Total adjusted pre-tax operating income was $198.0 million in 2001 compared to $159.3 million in 2000 and $148.1 million in 1999. The acquisition of ILICO contributed $39.8 million to 2001 adjusted pre-tax operating income. The increase in 2000 adjusted pre-tax operating income as compared to 1999 was primarily from the life insurance segment and other operations, as previously discussed.
Interest expense was $26.0 million in 2001 compared to $29.7 million in 2000 and $29.0 million in 1999. The decreased interest expense in 2001 was primarily due to lower borrowing rates in 2001 as compared to 2000 and the maturity of the adjustable conversion-rate equity security units in July 2001. The 2001 interest expense also included approximately $1.3 million of interest expense from ILIC. ILIC has a $25 million, 8.66% surplus note, due on April 1, 2011. The increased interest expense in 2000 was primarily due to higher average outstanding borrowings during 2000 compared to 1999. The additional borrowings in 2000 were primarily used to support insurance company operations, affordable housing investments, fund the acquisition of a new independent marketing organization, and fund a portion of the initial investment in IL Group.
Income tax expense was $39.5 million in 2001 compared to $42.5 million in 2000 and $33.7 million in 1999. The effective tax rate was 33.2% for 2001, 36.9% for 2000 and 34.4% for 1999. The decrease in the effective tax rate in 2001 reflected the decline in nondeductible expenses associated with our demutualization and increased tax exempt income from the COLI investment. The increase in the effective tax rate in 2000 was due to the nondeductible expenses associated with our demutualization combined with lower tax credits from affordable housing and historic rehabilitation investments.
Minority interest represents the minority stockholders ownership percentage share of net income of ALHI prior to our acquisition of this minority interest. The minority shareholder ownership percentage was 42% through September 20, 2000, the date at which the minority interest was acquired. As a result of our acquisition of the minority interest there is no net income applicable to the minority interest in 2001.
Net income from continuing operations was $79.3 million in 2001 compared to $51.1 million in 2000 and $35.9 million in 1999. Approximately $17.7 million of the increase in 2001 was from the ILICO acquisition. The remainder was primarily due to the lower effective tax rate and the reduction in net income applicable to the minority interest. The 2000 increase was primarily due to the results of our life insurance operations previously discussed and the reduction in net income applicable to the minority interest.
Net income was $72.9 million in 2001 compared to $51.8 million in 2000 and $38.4 million in 1999. The acquisition of ILICO increased net income approximately $17.7 million in 2001. In addition, the lower effective tax rate and reduction in net income applicable to minority interest also increased net income in 2001 as compared to 2000. The adoption of SFAS No. 133 in 2001 had a one-time cumulative effect of reducing net income by $8.2 million.
We intend to rely primarily on dividends, interest income and fee income from our life insurance subsidiaries in order to make dividend payments to our shareholders. The payment of dividends by our life insurance subsidiaries is regulated under various state laws. Generally, under the various state statutes, our life insurance subsidiaries dividends may be paid only from the earned surplus arising from their respective businesses and must receive the prior approval of the respective state regulator to pay any dividend that would exceed certain statutory limitations. The current statutes generally limit any dividend, together with dividends paid out within the preceding 12 months, to the greater of (i) 10% of the respective company's policyowners' surplus as of the preceding year end or (ii) the net gain from operations for the previous calendar year. Generally, the various state laws give the state regulators broad discretion to approve or disapprove requests for dividends in excess of these limits. Based on these limitations and 2001 results, our life insurance subsidiaries could pay us an estimated $80.5 million in dividends in 2002 without obtaining regulatory approval.
We generated cash flows from operating activities of $97.1 million, $373.3 million and $741.2 million for the years ended December 31, 2001, 2000 and 1999, respectively. Operating cash flows were primarily used to increase our investment portfolio.
On March 6, 2002, we issued $185 million of optionally convertible equity-linked accreting notes due in 2032. The notes will be convertible into shares of common stock if the sale price of the common stock exceeds specified levels and in certain other circumstances. The notes are senior subordinated debt, subordinated in right of payment to all existing and future senior debt and senior to all existing and future junior subordinated debt. The net proceeds of the offering will be used to repay approximately $120 million existing debt under the Revolving Credit Agreement, repurchase approximately $59 million of common stock and other corporate purposes.
Management anticipates that funds to meet short-term and long-term capital expenditures, cash dividends to shareholders and operating cash needs will come from existing capital and internally generated funds. Management believes that the current level of cash and available-for-sale and short-term securities, combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on mortgage-backed securities and its insurance products, will be adequate to meet the anticipated short-term cash obligations of the life insurance subsidiaries.
Matching the investment portfolio maturities to the cash flow demands of the type of insurance being provided is an important consideration for each type of life insurance product and annuity. We continuously monitor benefits and surrenders to provide projections of future cash requirements. As part of this monitoring process, we perform cash flow testing of assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing investment strategy, we establish a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage-backed securities, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations. There can be no assurance that future experience regarding benefits and surrenders will be similar to historic experience since withdrawal and surrender levels are influenced by such factors as the interest rate environment and the claims-paying and financial strength ratings of the life insurance subsidiaries.
- --------------- (A) Includes $834.4 million of statutory liabilities with a contractual surrender charge of less than five percent of the account balance.
ALIC is a party to a $250 million fixed separate funding agreement. Under this agreement, a five-year floating rate insurance contract is issued to a commercial paper conduit. The funding agreement is secured by segregated assets and is further backed by the general account assets of ALIC. The assets are legally segregated and are not subject to claims that arise out of any other business of ALIC. The segregated assets and liabilities are included with general account assets in the financial statements. The funding agreement may not be cancelled by the commercial paper conduit unless there is a default under the agreement, but ALIC may terminate the agreement at any time.
In addition, there are variable separate account assets and liabilities representing funds that are separately administered, principally for variable annuity contracts, and for which the contractholder bears the investment risk. Separate account assets and liabilities are reported at fair value and amounted to $328 million at December 31, 2001. Separate account contractholders have no claim against the asset of the general account. The operations of the separate accounts are not included in the accompanying consolidated financial statements.
In the future, in addition to cash flows from operations and borrowing capacity, the life insurance subsidiaries would anticipate obtaining their required capital from AmerUs Group Co. as we have access to the public debt and equity markets.
We have obligations to make future capital contributions to various partnerships of up to $7.1 million, to loan funds up to $6.9 million to partnerships and to fund private placement investments of $25.0 million
ALIC and its joint venture partner are contingently liable in the event the joint venture, AVLIC, cannot meet its obligations. At December 31, 2001, AVLIC had statutory assets of $2,226.5 million, liabilities of $2,166.0 million and surplus of $60.5 million.
We maintain a diversified portfolio of investments, including public and private fixed maturity securities and commercial mortgage loans. Our objective is to maintain a high-quality, diversified fixed maturity securities portfolio that produces a yield and total return that supports the various product line liabilities and our earnings goals.
The following table summarizes the composition of the fixed maturity securities by category as of December 31, 2001 and 2000:
The portfolio of investment grade fixed maturity securities is diversified by number and type of issuer. As of December 31, 2001, investment grade fixed maturity securities included the securities of over 672 issuers, with 2,225 different issues of securities. No non-government/agency issuer represents more than 1% of investment grade fixed maturity securities.
As of December 31, 2001, 82% of total invested assets were investment grade fixed maturity securities. The following table sets forth the credit quality, by NAIC designation and Standard & Poor's rating equivalents, of fixed maturity securities as of December 31, 2001:
Interest rate swaps and options are used to reduce exposure to changes in interest rates and to manage duration mismatches. Call options are used to hedge equity-indexed annuities. Credit default swaps are coupled with a bond to synthetically create an investment cheaper than the equivalent instrument traded in the cash market. Although we are subject to the risk that counterparties will fail to perform, credit standings of counterparties are monitored regularly. We only enter into transactions with highly rated counterparties. We are also subject to the risk associated with changes in the value of contracts. However, such adverse changes in value generally are offset by changes in the value of the items being hedged. The notional principal amounts of the swaps and options, which represent the extent of our involvement in such contracts but not the risk of loss, at December 31, 2001, amounted to $1,141.3 million. The interest rate swaps had a carrying value of a net payable position of $10.3 million at December 31, 2001. The credit default swaps had a carrying value of a net payable position of $0.2 million at December 31, 2001. The carrying value of options amounted to $72.1 million at December 31, 2001. For each of these derivatives, the carrying value is equal to fair value as of December 31, 2001. The derivatives are reflected as other investments on the consolidated financial statements as of December 31, 2001. The net amount payable or receivable from interest rate and credit default swaps are accrued as an adjustment to interest income. Effective January 1, 2001, we adopted SFAS 133. See note 4 to the consolidated financial statements for further discussion of the impact of adopting SFAS 133.
As of December 31, 2001, six loans in the loan portfolio with a principal balance of $4.9 million were classified as delinquent and no loans were in foreclosure. As of the same date, only one loan aggregating $1.1 million, or 0.1%, of the loan portfolio (as measured by principal balance) was classified as restructured. During 2001, we had one foreclosure with a principal balance of $2.0 million.
We held $321.2 million of other invested assets (including short-term investments and real estate) on December 31, 2001. Other invested assets consist primarily of various joint venture and limited partnership investments and derivatives.
Interest rate changes may have temporary effects on the sale and profitability of the annuities and life insurance products offered. For example, if interest rates rise, competing investments (such as annuities or life insurance products offered by competitors, certificates of deposit, mutual funds, and similar instruments) may become more attractive to potential purchasers of our products until we increase the interest rate credited to owners of our annuities and life insurance products. In contrast, as interest rates fall, we attempt to adjust credited rates to compensate for the corresponding decline in reinvestment rates. We monitor interest rates and sell annuities and life insurance policies that permit flexibility to make interest rate changes as part of management of interest spreads. However, the profitability of our products is based upon persistency, mortality and expenses, as well as interest rate spreads.
In force reserves and the assets allocated to each segment are modeled on a regular basis to analyze projected cash flows under a variety of economic scenarios. The result of this modeling is used to modify asset allocation, investment portfolio duration and renewal crediting strategies. We invest in CMOs as part of our basic portfolio strategy, but use other types of derivatives to hedge against the effects of interest rate fluctuations or to hedge growth in policyowner liabilities for certain annuity products and a funding agreement. For a further discussion and disclosure of the nature and extent of the use of derivatives, see note 4 to the consolidated financial statements.
In determining if and when a decline in market value below amortized cost is other-than-temporary, we evaluate the market conditions, offering prices, trends of earnings, price multiples, and other key measures for our investments in marketable equity securities and debt instruments. When such a decline in value is deemed to be other-than-temporary, we recognize an impairment loss in the current period operating results to the extent of the decline.
Securities in our portfolio with a carrying value of approximately $1,350 million at December 31, 2001 do not have readily determinable market prices. For these securities, we estimate their fair value by comparison to similar securities with quoted prices when possible. Otherwise, we use our most recent purchases and sales of similar unquoted securities, independent broker quotes, or internally prepared valuations (including those based on estimates of future profitability) to estimate the fair value of those securities. All such investments are classified as available for sale. Our ability to liquidate our positions in these securities will be impacted to a significant degree by the lack of an actively traded market, and we may not be able to dispose of these investments in a timely manner. Although we believe our estimates reasonably reflect the fair value of those securities, our key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral (if any), and other factors may not be realized in the event of an actual sale.
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS AND VALUE OF BUSINESS ACQUIRED
We amortize the value of business acquired based on the incidence of the expected cash flows from insurance contracts using the interest rate credited to the underlying policies. The expected future cash flows are based on actuarially determined projections of future premium receipts, mortality, surrenders, operating expenses, changes in insurance liabilities, investment yields on the assets retained to support the policy liabilities and other factors. These projections take into account all factors known or expected by management. The actual cash flows may vary from expected levels due to differences in renewal premium, investment spread, investment gains or losses, mortality and morbidity costs and other factors.
We followed the purchase method of accounting for our acquisition of ILICO in May 2001 and the acquisition of the 42% minority interest of ALHI in September 2000. Under the purchase method, we were required to determine the fair value of the acquired assets and liabilities. The fair value of the assets and liabilities were determined as follows:
Investments -- based on quoted market prices, or in cases where quoted market prices were not available, by using discounted cash flow or other valuation techniques.
The excess of the purchase price over the fair value of the net assets acquired for ILICO was recorded as goodwill amounting to $21 million in 2001. The excess of the fair value of the net assets over the purchase price of the minority interest of ALHI was recorded as a reduction of goodwill amounting to $34 million in 2000.
We adopted the Accounting Standards Executive Committee's Statement of Position 00-3, "Accounting by Insurance Enterprises for Demutualizations and Formations of Mutual Holding Companies and for Certain Long-Duration Participating Contracts," in 2001. SOP 00-3 modified the presentation of the closed block in the consolidated financial statement and reporting of unrealized gains and losses on closed block investments. As a result, unrealized gains (losses), net of deferred income taxes, amounting to $6.0 million at December 31, 2000 and ($10.7) million at December 31, 1999 were reclassified from accumulated other comprehensive income to dividends payable to policyowners. There was no net income effect of adopting SOP 00-3. See note 2 to the consolidated financial statements for additional information.
accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business acquisition must meet to be recognized apart from goodwill. SFAS 142 will require goodwill and intangible assets with indefinite useful lives to no longer be amortized but instead tested for impairment at least annually. In addition, a reassessment of useful lives and residual values of all intangible assets will be required. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the consolidated statement of income as of January 1, 2002.