U.S. Individual Solutions. Our Individual Annuities business remains focused on helping its customers meet their investment and retirement needs. We remain focused on offering a broad range of solutions that enable us to realize appropriate returns for the current environment and provide a strong value proposition for our customers. As we execute on our product diversification strategy, we expect a natural reduction in average fee rates due to the maturation of the existing block and due to sales of newer products which generally have lower rate structures. Our Individual Life business is continuing to execute on its product diversification strategy in order to maintain a diversified product mix and an attractive risk profile. We continue to deepen relationships with distribution partners while developing a more customer-oriented experience. As we grow our business, we are remaining disciplined in our pricing. In the longer term, we believe our ability to provide additional solutions to the employees of our Workplace Solutions businesses and to other retail customers should increase revenues in our Individual Solutions businesses. We also expect to offer Individual Solutions products on the Assurance IQ platform over time.
of U.S. dollar-denominated products relative to products denominated in other currencies. For additional information on sales within our international insurance operations, see “-International Businesses-Sales Results,” below.
$1,169 million unfavorable variance, on a pre-tax basis, reflecting the net impact from changes in the value of our embedded derivatives and related hedge positions associated with certain variable annuities (see “-Results of Operations by Segment-U.S. Businesses-U.S. Individual Solutions Division-Individual Annuities-Variable Annuity Risks and Risk Mitigants” for additional information);
For certain product guarantees, primarily certain optional living benefit features of the variable annuity products in our Individual Annuities segment including guaranteed minimum accumulation benefits (“GMAB”), guaranteed minimum withdrawal benefits (“GMWB”) and guaranteed minimum income and withdrawal benefits (“GMIWB”), the benefits are accounted for as embedded derivatives using a fair value accounting framework. The fair value of these contracts is calculated as the present value of expected future benefit payments to contractholders less the present value of assessed rider fees attributable to the embedded derivative feature. Under U.S. GAAP, the fair values of these benefit features are based on assumptions a market participant would use in valuing these embedded derivatives. Changes in the fair value of the embedded derivatives are recorded quarterly through a benefit or charge to current period earnings. For additional information regarding the valuation of these embedded derivatives, see Note 6 to the Consolidated Financial Statements.
The increase of $113 million in strategic investments was primarily driven by strong fixed income investment performance.
The following table sets forth the operating results for our U.S. Businesses for the periods indicated.
2019 to 2018 Annual Comparison. Revenues increased $29 million. Excluding the impact from our annual reviews and update of assumptions and other refinements, discussed above, revenues increased $47 million. The increase was driven by higher net investment income primarily reflecting a higher level of invested assets, and higher premiums mostly reflecting an increase in single premium immediate annuity sales, with offsets in policyholders’ benefits as discussed below. These increases were partially offset by lower policy charges and fee income reflecting certain products reaching contractual milestones for fee tier reduction, unfavorable impacts from our living benefit guarantees as a result of declining interest rates, and lower average account values resulting from net outflows which were partially offset by market appreciation. Also contributing to the decrease were lower asset management and service fees and other income primarily due to higher capital hedge costs reflecting the impacts of equity market performance.
Asset Liability Management (“ALM”) Strategy (including fixed income instruments and derivatives):
The Company is exploring strategic options for its Korean insurance business.
Excluding these items, adjusted operating income from our Life Planner operations increased $21 million, primarily reflecting business growth in Japan, higher underwriting results driven by a favorable impact from mortality experience and policyholders’ behavior, and higher net investment spread results driven by higher income on non-coupon investments and higher prepayment fee income. Also contributing to the increase was an unfavorable impact from changes in market conditions on estimates of profitability in the prior period. Beginning in the second quarter of 2019, the impact from this activity is excluded from adjusted operating income (see Note 22 to the Consolidated Financial Statements for additional information). These increases were partially offset by higher expenses driven by updates to legal reserves, as well as higher costs including those related to business growth and business initiatives.
Excluding these items, adjusted operating income from our Gibraltar Life and Other operations decreased $50 million, primarily reflecting higher expenses related to costs associated with business growth and business initiatives, including enhancements to sales processes and distribution. Also contributing to the decrease were lower underwriting results driven by an unfavorable impact from mortality experience and policyholders’ behavior. These decreases were partially offset by the favorable impact from growth of business in force, higher net investment spread results driven by higher income on non-coupon investments and higher prepayment fee income, and higher other income driven by a favorable impact from our joint venture investments.
Fixed maturity securities included in Level 3 in our fair value hierarchy are generally priced based on internally-developed valuations or indicative broker quotes. For certain private fixed maturity and equity securities, the internal valuation models use significant unobservable inputs and, accordingly, such securities are included in Level 3 in our fair value hierarchy. Level 3 fixed maturity securities for PFI excluding the Closed Block division included approximately $1.8 billion of public fixed maturities as of December 31, 2019 with values primarily based on indicative broker quotes, and approximately $2.8 billion of private fixed maturities, with values primarily based on internally-developed models. Significant unobservable inputs used in their valuation included: issue specific spread adjustments, material non-public financial information, management judgment, estimation of future earnings and cash flows, default rate assumptions, liquidity assumptions and indicative quotes from market makers. Separate account assets included in Level 3 in our fair value hierarchy primarily include corporate securities and commercial mortgage loans.
The Investment Committee of our Board of Directors (“Board”) oversees our proprietary investments, including our general account portfolios, and regularly reviews performance and risk positions. Our Chief Investment Officer Organization (“CIO Organization”) develops investment policies subject to risk limits proposed by our Enterprise Risk Management (“ERM”) group for the general account portfolios of our domestic and international insurance subsidiaries and directs and oversees management of the general account portfolios within risk limits and exposure ranges approved annually by the Investment Committee.
The table above provides ratings as assigned by nationally recognized rating agencies as of December 31, 2019, including S&P, Moody’s, Fitch and Morningstar.
Our workout and special servicing professionals manage the loans on the watch list.
Excludes fixed maturities designated as held-to-maturity. Credit quality is based on NAIC or equivalent rating.
The estimated payments due by period for operating leases reflect the future minimum lease payments under non-cancelable operating leases, as disclosed in Note 11 to the Consolidated Financial Statements.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of DAC related to universal life and variable life products and fixed and variable deferred annuity products and DSI related to fixed and variable deferred annuity products, including controls over the development of the significant assumptions. These procedures also included, among others, evaluating the appropriateness of management’s models, evaluating the reasonableness of the significant assumptions used in the valuation based on industry knowledge and data as well as historical Company data and experience, testing the completeness and accuracy of data used to develop the assumptions, testing that the assumptions are accurately reflected in the model, and testing the mathematical accuracy of management’s model. Professionals with specialized skill and knowledge were used to assist in evaluating the reasonableness of these significant assumptions.
Excludes available-for-sale notes with amortized cost of $4,751 million (fair value, $4,757 million) and held-to-maturity notes with amortized cost of $4,998 million (fair value, $5,401 million), which have been offset with the associated debt under a netting agreement.
“Other,” for the periods ended December 31, 2019 and 2018, primarily represent deconsolidation of VIE, reclassifications of certain assets between reporting categories and foreign currency translation.
Includes notes with fair value of $10,158 million (carrying amount of $9,749 million) and $9,095 million (carrying amount of $9,095 million) as of December 31, 2019 and 2018, respectively, which have been offset with the associated receivables under a netting agreement.
The following table provides VOBA balances for the year ended December 31, 2019.
The Company tests goodwill for impairment annually, as of December 31, and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, as discussed in further detail in Note 2. The Company’s reporting units, except Assurance IQ, each performed their annual goodwill impairment test using the quantitative two-step approach at December 31, 2019 and 2018. The Assurance IQ segment performed a qualitative assessment at December 31, 2019 considering the October 2019 acquisition date. There are no impairments or accumulated impairment losses recorded in the periods presented above for goodwill.
The Company occupies leased office space and other facilities in many locations under various long-term leases and has entered into numerous leases covering the long-term use of computers and other equipment. The leases, depending on their specific terms, are classified as either operating or finance with the vast majority of leases falling under the operating classification. The leases in the Company’s portfolio have remaining lease terms from less than one year to 29 years, some of which include options to extend the leases for up to 17 years, and some of which include options to terminate the leases within 8 years. An analysis of all economic and non-economic factors associated with leases containing certain options, including factors such as the existence of cancellation penalties, leasehold improvements made to the underlying assets and location of the underlying assets, is conducted to determine whether those leases are reasonably certain to renew, and hence, should be included in the lease term that is used to establish the right-of-use assets and lease liabilities for those arrangements.
On December 8, 2017, PICA’s Board of Directors acted to decrease the dividends payable on Closed Block policies for 2018. On December 7, 2018, PICA’s Board of Directors approved a continuation of the dividends payable on Closed Block policies for 2019. On December 6, 2019, PICA’s Board of Directors acted to decrease the dividends payable on Closed Block policies for 2020. These actions resulted in a decrease of approximately $86 million for both years ending December 31, 2017 and 2018 and a decrease of approximately $79 million for the year ended December 31, 2019 in the liability for policyholders’ dividends recognized.
Consistent with the Tax Act of 2017, the Company provides applicable U.S. income tax for all unremitted earnings of the Company’s foreign affiliates. For certain foreign affiliates organized in withholding tax jurisdictions, the Company considers the unremitted foreign earnings of those affiliates to be indefinitely reinvested, and therefore does not provide for the withholding tax when calculating its current and deferred tax obligations. For certain other foreign affiliates organized in withholding tax jurisdictions, the Company does not consider unremitted earnings indefinitely reinvested, and therefore provides for foreign withholding tax when calculating its current and deferred tax obligations. The following table summarizes the Company’s indefinite reinvestment assertions for jurisdictions in which the Company operates that impose a withholding tax on dividends or may be subject to other foreign country tax upon a remittance:
Under each of the above transactions for the captive reinsurance subsidiaries, because valid rights of set-off exist, interest and principal payments on the surplus notes and on the related credit-linked notes are settled on a net basis, and the surplus notes are reflected in the Company’s total consolidated borrowings on a net basis. The surplus notes for the captive reinsurance subsidiaries described above are subordinated to policyholder obligations, and for certain applicable surplus notes, the repayment of principal may only be made with prior approval of the Arizona Department of Insurance. The payment of interest on the surplus notes has been approved by the Arizona Department of Insurance, subject to its ability to withdraw that approval.
The Company has funded and non-funded non-contributory defined benefit pension plans (“Pension Benefits”), which cover substantially all of its employees. For some employees, benefits are based on final average earnings and length of service, while benefits for other employees are based on an account balance that takes into consideration age, service and earnings during their career.
In addition to the plan assets above, the Company in 2007 established an irrevocable trust, commonly referred to as a “rabbi trust,” for the purpose of holding assets of the Company to be used to satisfy its obligations with respect to certain non-qualified retirement plans ($1,301 million and $1,208 million benefit obligation at December 31, 2019 and 2018, respectively). Assets held in the rabbi trust are available to the general creditors of the Company in the event of insolvency or bankruptcy. The Company may from time to time in its discretion make contributions to the trust to fund accrued benefits payable to participants in one or more of the plans, and, in the case of a change in control of the Company, as defined in the trust agreement, the Company will be required to make contributions to the trust to fund the accrued benefits, vested and unvested, payable on a pre-tax basis to participants in the plans. The Company did not make any discretionary payments to the trust in 2019 and 2018. As of December 31, 2019 and 2018, the assets in the trust had a carrying value of $986 million and $861 million, respectively.
The Company applied the same approach to the determination of the expected rate of return on plan assets in 2020. The expected rate of return for 2020 is 6.00% and 6.75% for pension and postretirement, respectively.
Registered Investment Companies (Mutual Funds)-Securities are priced at the NAV of shares.
The fair market value of restricted stock units, performance shares and performance units released under the Omnibus Incentive Plan for the years ended December 31, 2019, 2018 and 2017 was $255 million, $238 million and $196 million, respectively. For the Acquisition related awards there were no restricted stock units or performance shares released for the year ended December 31, 2019.
Individual Annuities segment results reflect DAC as if the individual annuity business is a stand-alone operation. The elimination of intersegment costs capitalized in accordance with this policy is included in consolidating adjustments within Corporate and Other operations.
Represents adjustments not included in the above reconciling items. “Other adjustments” include certain components of the consideration for the Assurance IQ acquisition, which are recognized as compensation expense over the requisite service periods, as well as changes in the fair value of contingent consideration.
In March 2015, defendants filed a motion to dismiss the amended complaint. In March 2016, the court issued a decision involving BONYM’s motion to dismiss: (i) denying the motion to dismiss the Pooling and Servicing Agreement (“PSA”) trust claims for lack of jurisdiction; (ii) denying the motion regarding claims for violations of the Trust Indenture Act of 1939 and breach of contract; and (iii) granting the motion regarding claims for negligence and breach of fiduciary duty. In October 2019, the federal court action was dismissed with prejudice. This matter is now closed.