In addition to information presented in the consolidated financial statements, the Company uses information other than that determined using accounting principles generally accepted in the United States ("GAAP") to analyze and report its financial position and results of operations. Management believes that these non-GAAP and operating measures, when used in conjunction with the consolidated financial statements, can improve the understandability of the financial statements and allow investors to evaluate the information used by management to analyze company performance.
The following table illustrates where Premiums and deposits are reflected in the consolidated financial statements.
- - Total consolidated revenues decreased 1.4% in 2002 compared to 2001. Excluding realized capital losses, revenues increased 3.3% in 2002 to $4.86 billion primarily due to increased investment income. - - Premiums and deposits increased 7.3% to $10.97 billion in 2002 due to increased sales of fixed annuities, including sales of the Allstate(R) Treasury - Linked Annuity of $762 million. Sales of variable annuities declined 17.5% in 2002 compared to 2001. (Further information and a reconciliation of Premiums and deposits to the Consolidated financial statements appears in the Definitions of Non-GAAP and Operating Measures section of the MD&A). - - Net income decreased $123 million as a result of increased realized capital losses. - - Operating income was comparable in 2002 to 2001 due to an increase in the investment margin and an adjustment for prior year tax liabilities offset by accelerated amortization of DAC and higher operating costs and expenses. (Further information and a reconciliation of Operating income to Net income appear in the Definitions of Non-GAAP and Operating Measures section of the MD&A.) - - Separate Accounts assets decreased 18.1% due to declines in account balances related to poor equity market performance during the year.
The Company writes down to fair value a fixed income or equity security that is classified as other than temporarily impaired in the period the security is deemed to be other than temporarily impaired. The assessment of other than temporary impairment is performed on a case-by-case basis considering a wide range of factors. Inherent in the Company's evaluation of a particular security are assumptions and estimates about the operations of the issuer and its future earnings potential. Some of the factors considered in evaluating whether a decline in fair value is other than temporary are:
the years ended December 31, 2002 and 2001, the hedge ineffectiveness reported as Realized capital gains and losses amounted to losses of $15 million and gains of $6 million, respectively.
Products sold to Retail customers include retirement solutions such as variable annuities and fixed annuities, and financial protection products such as interest-sensitive life and traditional life insurance. Retail products are sold through a variety of distribution channels including Allstate exclusive agencies, independent agents (including master brokerage agencies), financial services firms (financial institutions and broker/dealers) and direct marketing.
Operating income for the Structured Financial Products segment increased 17.5% in 2002 compared to 2001 due to growth in the investment margin partially offset by a decline in the mortality margin and increased operating costs and expenses. In 2001, Operating income increased 24.1% over 2000 as a result of increased investment margin partly offset by higher income tax expense on operations and a decline in the mortality margin.
The Company's asset/liability strategy includes swap transactions for certain products that can have the effect of reducing portions of Net investment income as well as interest credited to Contractholder funds while preserving the spread on those products. The following table summarizes the weighted average investment yield and the weighted average interest crediting rates during 2002, 2001 and 2000.
The following table presents the amortized cost, gross unrealized gains and losses and fair value for fixed income and equity securities.
Corporate obligations that are publicly issued totaled $13.78 at December 31, 2002 compared to $10.71 at December 31, 2001. At December 31, 2002, 89.7% of these obligations were rated as investment grade. As of December 31, 2002, the fixed income securities portfolio contained $12.36 billion of privately placed corporate obligations or 47.3% of the total corporate obligations in the portfolio, compared with $11.36 billion at December 31, 2001. The benefits of privately placed securities as compared to public securities are generally higher yields, improved cash flow predictability through pro-rata sinking funds on many bonds, and a combination of covenant and call protection features designed to better protect the holder against losses resulting from credit deterioration, reinvestment risk and fluctuations in interest rates. A relative disadvantage of privately placed securities when compared to public securities is reduced liquidity. At December 31, 2002, 84.1% of the privately placed securities were rated as investment grade.
(1) Because of the potential for prepayment, mortgage- and asset-backed securities have not been reflected based on their contractual maturities.
These risks and uncertainties could result in a charge to earnings in future periods to the extent that losses are realized. The charge to earnings, while potentially significant to Net income, would not have a significant impact on Shareholder's equity since the majority of the portfolio is held at fair value and as a result, the related unrealized gain (loss), net of tax, would already be reflected as Accumulated other comprehensive income in Shareholder's equity.
The unrealized loss balance for fixed income and equity securities can be further segmented into the following four categories of securities:
OVERSIGHT The Company generates substantial investable funds from its primary business operations. In formulating and implementing policies for investing funds, the Company seeks to earn returns that enhance its ability to offer competitive rates and prices to customers while contributing to attractive and stable profits and long-term capital growth for the Company. Accordingly, the Company's investment decisions and objectives are a function of the underlying risks and product profiles.
To calculate duration, the Company projects asset and liability cash flows and discounts them to a net present value basis using a risk-free market rate adjusted for credit quality, sector attributes, liquidity and other specific risks. Duration is calculated by revaluing these cash flows at alternative levels of interest rates and determining the percentage change in fair value from the base case. The cash flows used in the model reflect the expected maturity and repricing characteristics of the Company's derivative financial instruments, all other financial instruments (as described in Note 7 to the consolidated financial statements), and certain non-financial instruments including interest-sensitive liabilities and annuity liabilities. The projections include assumptions (based upon historical market experience and Company specific experience) reflecting the impact of changing interest rates on the prepayment, lapse, leverage and/or option features of financial instruments, where applicable. Such assumptions relate primarily to mortgage-backed securities, collateralized mortgage obligations, callable corporate and municipal obligations, and fixed rate single and flexible premium deferred annuities.
FINANCIAL RATINGS AND STRENGTH The Company's insurance financial strength ratings are influenced by many factors including operating and financial performance, asset quality, asset/liability management, overall portfolio mix, the amount of financial leverage (i.e. debt), exposure to risks, current level of operating leverage as well as the relationship of ALIC's rating to that of its parent, AIC. Insurance financial strength ratings have become an increasingly important factor in establishing the competitive position of insurance companies and, generally, may be expected to have an effect on an insurance company's sales. On an ongoing basis, rating agencies review the financial performance and condition of insurers. A downgrade, while not expected, could have a material adverse effect on the Company's business, financial condition and results of operations. ALIC's current insurance financial strength ratings are listed below:
The Company is also exposed to interest rate risk on certain insurance liabilities. Decreases in interest rates can lead contractholders to surrender their contracts.
In June 2001, the FASB issued Statement of Financial Accounting Standard ("SFAS") No. 143, "Accounting for Asset Retirement Obligations", which changes the measurement of an asset retirement obligation from a cost-accumulation measurement to a fair value measurement, where the fair value of an asset retirement obligation is recognized as a liability when incurred rather than over the useful life of the related asset. Accretion expense is recognized using the credit-adjusted risk-free interest rate in effect when the liability is initially recognized and asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and subsequently amortized into expense. The adoption of SFAS No. 143 on January 1, 2003 is not expected to have a material impact on either the consolidated financial position or results of operations of the Company.