The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Consolidated Financial Statements included elsewhere herein.
As noted above, as of September 30, 2002, the Company increased its assumptions related to the long-term cost of GMDB for variable annuity products. The GMDB feature provides annuity contract holders with a guarantee that the benefit received at death will be no less than a prescribed minimum amount. This minimum amount is based on the net deposits paid into the contract, the net deposits accumulated at a specified rate, the highest historical account value on a contract anniversary, or more typically the greatest of these values. To the extent that the GMDB is higher than the current account value at the time of death, the Company incurs
The Company also recognized $29.8 million of asset impairments related to technology used in its variable annuity and variable universal life business, reflected in other operating expenses. Of this amount, $29.1 million relates to capitalized software development costs. The remaining $0.7 million relates to technology hardware. During the past five years, the Company has incurred costs to develop technology platforms for its variable products. This includes the technology used to underwrite, issue and maintain customer accounts, incorporating disparate and complex product attributes. As a result of the ratings downgrades (see Rating Agency Actions), and the Company's decision to cease new sales of proprietary life insurance and annuity products, the Company determined that expected future cash flows do not support continued capitalization of the entire cost of the technology assets. Accordingly, the Company recognized the aforementioned permanent impairment in other operating expenses.
The following table summarizes the results of operations for the Allmerica Financial Services segment for the quarter ended December 31, 2002 compared to the quarter ended December 31, 2001. As previously mentioned, the factors that affect this segment's results of operations after September 27, 2002 are substantially different from those in effect prior to that date. Accordingly, the Company believes that the results of operations for the last three months of the year are more indicative of results of operations to be expected in 2003.
The Company's financing obligations generally include debt, minority interest on and repayment of the Company's Capital Securities, operating lease payments, trust instruments supported by funding obligations and funding agreements. The following table represents the Company's annual payments related to the principal payments of these financing obligations as of December 31, 2002 and operating lease payments reflect expected cash payments based upon lease terms:
As a result of the rating downgrades in 2002 of the life insurance companies, the Company is no longer able to generate new sales of proprietary products in its AFS segment and experienced increased surrender rates in the life insurance and annuity business in the fourth quarter. In addition, the Company is no longer able to sell its GIC products. These downgrades have also caused counterparties to terminate certain swap agreements, which have been replaced with alternative derivative instruments.
The consolidated financial statements of Allmerica Financial Corporation ("AFC" or the "Company") include the accounts of Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); First Allmerica Financial Life Insurance Company ("FAFLIC"); The Hanover Insurance Company ("Hanover"); Citizens Insurance Company of America ("Citizens"), and other insurance and non-insurance subsidiaries. These legal entities conduct their operations through several business segments discussed in Note 16. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
FAFLIC established and began operating a closed block (the "Closed Block") for the benefit of the participating policies included therein, consisting of certain individual life insurance participating policies, individual deferred annuity contracts and supplementary contracts not involving life contingencies which were in force as of FAFLIC's demutualization on October 16, 1995; such policies constitute the "Closed Block Business". The purpose of the Closed Block is to protect the policy dividend expectations of such FAFLIC dividend paying policies and contracts. Unless the Commonwealth of Massachusetts Insurance Commissioner consents to an earlier termination, the Closed Block will continue to be in effect until the date none of the Closed Block policies are in force. FAFLIC allocated to the Closed Block assets in an amount that is expected to produce cash flows which, together with future revenues from the Closed Block Business, are reasonably sufficient to support the Closed Block Business, including provision for payment of policy benefits, certain future expenses and taxes and for continuation of policyholder dividend scales payable in 1994 so long as the experience underlying such dividend scales continues. The Company expects that the factors underlying such experience will fluctuate in the future and policyholder dividend scales for Closed Block Business will be set accordingly. Although the assets and cash flow generated by the Closed Block inure solely to the benefit of the holders of policies included in the Closed Block, the excess of Closed Block liabilities over Closed Block assets as measured on a GAAP basis represent the expected future post-tax income from the Closed Block which may be recognized in income over the period the policies and contracts in the Closed Block remain in force. If the actual income from the Closed Block in any given period equals or exceeds the expected income for such period as determined at the inception of the Closed Block, the expected income would be recognized in income for that period. Further, cumulative actual Closed Block income in excess of the expected income would not inure to the shareholders and would be recorded as an additional liability for policyholder dividend obligations. This accrual for future dividends effectively limits the actual Closed Block income recognized in income to the Closed Block income expected to emerge from operation of the Closed Block as determined at inception. If, over the period the policies and contracts in the Closed Block remain in force, the actual income from the Closed Block is less than the expected income from the Closed Block, only such actual income (which could reflect a loss) would be recognized in income. If the actual income from the Closed Block in any given period is less than the expected income for that period and changes in dividend scales are inadequate to offset the negative performance in relation to the expected performance, the income inuring to shareholders of the Company will be reduced. If a policyholder dividend liability had been previously established in the Closed Block because the actual income to the relevant date had exceeded the expected income to such date, such liability would be reduced by this reduction in income (but not below zero) in any periods in which the actual income for that period is less than the expected income for such period.
FOR THE YEARS ENDED DECEMBER 31 - ---------------------------------------------------------------------------- (In millions) Proceeds from Gross Gross 2002 Voluntary Sales Gains Losses - ---------------------------------------------------------------------------- Fixed maturities $ 3,128.9 $ 152.7 $ 40.4 Equity securities $ 13.4 $ 13.0 $ 0.1 ============================================================================
FOR THE YEARS ENDED DECEMBER 31 2002 2001 2000 - ------------------------------------------------------------------------------- (In millions)
The following table provides share information used in the calculation of the Company's basic and diluted earnings per share:
Massachusetts, New Hampshire and Michigan have enacted laws governing the payment of dividends to stockholders by insurers. Massachusetts' laws affect the dividend paying ability of AFLIAC and FAFLIC, while New Hampshire and Michigan laws affect the dividend paying ability of Hanover and Citizens, respectively. Massachusetts' statute limits the dividends a life insurer may pay in any twelve month period, without the prior permission of the Commonwealth of Massachusetts Insurance Commissioner, to the greater of (i) 10% of its statutory policyholder surplus as of the preceding December 31 or (ii) the individual company's statutory net gain from operations for the preceding calendar year. In addition, under Massachusetts law, no domestic insurer may pay a dividend or make any distribution to its shareholders from other than unassigned funds unless the Commissioner has approved such dividend or distribution. Effective December 30, 2002, AFLIAC, previously a Delaware domiciled life insurance company, became a Massachusetts domiciled life insurance company. On December 31, 2002, AFLIAC became a direct subsidiary of AFC as well as the immediate parent of FAFLIC, which remains a Massachusetts domiciled life insurance company. As a result of this transaction, and in consideration of the decision not to write new business, AFC agreed with the Massachusetts Insurance Commissioner to maintain total adjusted capital levels at a minimum of 100% of AFLIAC's Company Action Level, which was $197.2 million at December 31, 2002. Total adjusted capital for life insurance companies is defined as capital and surplus, plus asset valuation reserve, plus 50% of dividends apportioned for payment and was $481.9 million at December 31, 2002 for AFLIAC. The Company Action Level is the first level in which the Massachusetts Insurance Commissioner would mandate regulatory involvement based solely upon levels of risk based capital. There can be no assurance that AFLIAC would not require additional capital contributions from AFC. No dividends were declared by FAFLIC or AFLIAC to their parent during 2002, 2001, or 2000. AFLIAC and FAFLIC cannot pay dividends to their parent without prior approval from the Commissioner for the forseeable future. Pursuant to New Hampshire's statute, the maximum dividends and other distributions that an insurer may pay in any twelve month period, without prior approval of the New Hampshire Insurance Commissioner, is limited to 10% of such insurer's statutory policyholder surplus as of the preceding December 31. Hanover declared dividends to its parent totaling $92.1 million, $100.0 million and $108 million in 2002, 2001 and 2000, respectively. Prior to July 2003, Hanover cannot declare dividends to its parent without prior approval of the New Hampshire Insurance Commissioner. The allowable dividend without prior approval will increase to approximately $83.0 million on July 11, 2003. Pursuant to Michigan's statute, the maximum dividends and other distributions that an insurer may pay in any twelve month period, without prior approval of the Michigan Insurance Commissioner, is limited to the greater of 10% of policyholders' surplus as of December 31 of the immediately preceding year or the statutory net income less realized gains, for the immediately preceding calendar year. Citizens declared dividends to its parent totaling $48.2 million, $50.0 million and $55 million in 2002, 2001, and 2000, respectively. Prior to July 2003, Citizens cannot declare dividends to its parent without prior approval of the Michigan Insurance Commissioner. The allowable dividend without prior approval will increase to approximately $48.5 million on July 11, 2003.