The DAC related to universal life products and deferred annuities is amortized in relation to the actual and expected gross profits from investment, mortality and expense margins and surrender charges of the policies over a specified period of time. This period is 30 years for universal life and 20 years for deferred annuities. Both historical and anticipated investment returns, including realized gains and losses, are considered in determining the amortization of DAC. GAAP requires that changes in expected future gross profits as well as replacing previously projected gross profits with actual gross profits for the current accounting period on the annuity and universal life products cause the DAC amortization rate to be revised retroactively, or “unlocked”, to the date of policy issuance. The cumulative change in DAC related to prior periods is recognized as a component of the current period’s DAC amortization, along with DAC amortization associated with the actual gross profits of the current period. Lower actual gross profits in a period resulting from lower margins on investments, mortality, and/or expenses would typically result in less DAC amortization in that period, whereas higher actual gross profits would result in more amortization in the period. However, if lower gross profits were expected to continue into the future, additional amortization of the existing DAC asset may occur. See the “ DAC amortization” section that follows for a discussion on the unlocking adjustment in 2004.
Interest expense incurred on deposits increased $1.0 million, or 1.9% in 2005 and $2.5 million, or 5.1%, in 2004. This increase can be attributed to the growth of annuities on deposit offset by slightly lower credited rates on annuity deposits. The balance of annuity deposits increased 3.7% at December 31, 2005, to slightly over $1 billion, from $984.9 million at December 31, 2004. In 2004 the annuity deposit balance increased 5.6%, from $932.6 million at December 31, 2003. Interest was credited on annuity and universal life deposits in 2005 and 2004 at the following rates:
The liability for future life policy benefits is computed considering various factors such as anticipated mortality, future investment yields, withdrawals and anticipated credit for reinsurance ceded. The increase in future life policy benefits net of reinsurance ceded totaled $13.1 million in 2005 compared to $7.3 million and $7.2 million in 2004 and 2003, respectively. In 2005 the Company also implemented new valuation software to estimate insurance liability balances for its traditional life insurance products in accordance with FAS 60. These new valuation systems also use more refined methods and calculations to estimate reserve amounts. For FAS 60, the new valuation system calculates individual policy reserves, an improvement over the previous system, which calculated reserves on a grouped basis. The individual reserve calculations recognize the face amount, issue age, and premium mode of each policy resulting in improved estimates of liability. The new system also features improved estimates for two additional components of
Cash flow sources from investing activities includes proceeds from the sales, calls and maturities of fixed maturity positions. These proceeds totaled $274.5 million, $223.5 million and $340.0 million in 2005, 2004 and 2003, respectively. Sales increased in 2005 due to appealing market opportunities in the fixed income market. Maturities and calls of fixed income securities also increased in 2005.
Annuity and universal life deposits, which do not appear as revenue on the financial statements, are a source of funds from financing activities. Net cash provided by annuity and universal life deposits in 2005, 2004 and 2003 were $46.7 million, $65.5 million and $143.7 million, respectively. These deposits do not involve a mortality or morbidity risk and are accounted for using methods applicable to comparable interest-bearing obligations of other types of financial institutions.
In 2004, the Company established an agent bonus program. The bonus is calculated based on various factors including levels of life commissions paid to an agency and an agency’s property/casualty insurance production levels. The bonuses are paid to the agents by EIC. The Company in turn reimburses EIC. Cash payments to EIC relating to these bonuses totaled $2.0 million in 2005. There were no payments relating to this bonus program made to EIC in 2004.