(4) Statutory data has been derived from the annual statements of our insurance subsidiaries, as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices.
• The volume of our life insurance and annuity business in force, which is driven by the level of our sales, the volume of business assumed through coinsurance agreements and the persistency of the business written.
As described in more detail in Note 1 to our consolidated financial statements, we have recently adopted newly issued accounting rules that require the following accounting changes:
Amortization of deferred policy acquisition costs for participating life insurance and interest sensitive and index products is expected to total $48.7 million for 2004, excluding the impact of new production in 2004. A 10 percent increase in estimated gross profits for 2004 would result in $4.1 million of additional amortization expense. Correspondingly, a 10 percent decrease in estimated gross profits would result in $4.1 million of decreased amortization expense.
Equity income, net of related income taxes, totaled $5.8 million in 2003, $0.2 million in 2002 and $0.3 million in 2001. Equity income includes our proportionate share of gains and losses attributable to our ownership interest in partnerships, joint ventures and certain companies where we exhibit some control but have a minority ownership interest. As a result of our common stock investment in American Equity Investment Life Holding Company (AEHC), the parent company of American Equity, equity income includes $4.4 million in 2003 and $1.4 million in 2002 and 2001, representing our share of its net income. During the fourth quarter of 2003, we discontinued the use of the equity method of accounting for our investment in AEHC due to a decrease in our ownership interest resulting from AEHC’s initial public offering of common stock. Equity income is net of goodwill amortization totaling $0.4 million in 2001. See Note 1 to the consolidated financial statements for a discussion of the accounting for goodwill amortization beginning in 2002.
years at December 31, 2002. Accordingly, the earned rate on the portfolio lags behind changes in market yields. The extent that the portfolio yield lags behind changes in market yields generally depends upon the following factors:
If interest rates were to increase 10% from levels at December 31, 2003 and 2002, our fixed maturity securities and short-term investments would decrease approximately $107.8 million at December 31, 2003 and $68.0 million at December 31, 2002, while the value of our interest rate swaps would increase approximately $1.7 million at December 31, 2003. These hypothetical changes in value do not take into account any offsetting change in the value of insurance liabilities for investment contracts since we estimate such value to be the cash surrender value of the underlying contracts. If interest rates were to decrease 10% from levels at December 31, 2003 and 2002, the fair value of our debt and mandatorily redeemable preferred stock would increase $3.2 million at December 31, 2003 and $2.1 million at December 31, 2002.
Equity price risk is not material to us due to the relatively small equity portfolio held at December 31, 2003. However, we do earn investment management fees (on those investments managed by us) and mortality and expense fee income based on the value of our separate accounts. On an annualized basis, the investment management fee rates range from 0.20% to 0.45% for 2003, 2002 and 2001. The mortality and expense fee rates range from 0.90% to 1.40% for 2003, 2002 and 2001. As a result, revenues from these sources do fluctuate with changes in the market value of the equity, fixed maturity and other securities held by the separate accounts. In addition, we have equity price risk to the extent we may owe amounts under the guaranteed minimum death benefit provisions of our variable annuity contracts. See “Pending Accounting Change” for discussion of this exposure.
In December 2003, we entered into a $60.0 million revolving line of credit agreement with LaSalle Bank National Association and Bankers Trust Company, N.A. This agreement is effective through October 31, 2005 and interest on any borrowings will accrue at a variable rate. Under this agreement, we are required to maintain minimum capital and surplus levels at the Life Companies and meet certain other financial covenants. We are also prohibited from incurring additional indebtedness in excess of $10.0 million while this agreement is in effect. In January 2004, we borrowed $46.0 million on this line of credit to fund the partial redemption of our Series C preferred stock which took place on January 2, 2004.
The Life Companies’ cash inflows consist primarily of premium income, deposits to policyholder account balances, income from investments, sales, maturities and calls of investments and repayments of investment principal. The Life Companies’ cash outflows are primarily related to withdrawals of policyholder account balances, investment purchases, payment of policy acquisition costs, policyholder benefits, income taxes, dividends and current operating expenses. Life insurance companies generally produce a positive cash flow which may be measured by the degree to which cash inflows are adequate to meet benefit obligations to policyholders and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business. The Life Companies’ liquidity positions continued to be favorable in 2003, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
• the feature of a convertible fixed maturity security that allows the conversion of a fixed maturity security into an equity security is considered an embedded derivative,
The unearned revenue reserve reflects the unamortized balance of the excess of first year administration charges over renewal period administration charges (policy initiation fees) on interest sensitive products. These excess charges have been deferred and are being recognized in income over the period benefited using the same assumptions and factors used to amortize deferred policy acquisition costs.
Equity investees distributed to us equity securities with a fair value of less than $0.1 million in 2002 and $2.8 million in 2001. We did not receive any such distributions in 2003.
The call options are designed to fund the index credits owed to contract holders who elect to participate in one or more market indices. Prior to 2003, the options purchased were intended to fund the full amount of the annual index credits. During 2003, the methodology for purchasing options was changed, allowing for a decrease in the cost of the options. New options purchased are intended to fund the amount of the annual index credits in excess of the minimum guaranteed interest on the contracts. On the respective anniversary dates of the index annuity contracts, the market index used to compute the annual index credits is reset and new one-year call options are purchased to fund the next annual index credit. American Equity manages the cost of these purchases through the terms of the index annuities, which permit changes to annual participation rates, asset fees, and/or caps, subject to guaranteed
We share certain office facilities and services with the IFBF, Kansas Farm Bureau Federation and their affiliated companies. These expenses are allocated on the basis of cost and time studies that are updated annually and consist primarily of rent, salaries and related expenses, travel and other operating costs.
(A) Amounts are net of adjustments, as applicable, to amortization of unearned revenue reserves, deferred policy acquisition costs, value of insurance in force acquired and income taxes attributable to gains and losses on investments.
Our investment in equity method investees and the related equity income and interest expense are attributable to the corporate and other segment. Expenditures for long-lived assets were not significant during the periods presented above.