UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
The Registrant meets the conditions set forth in General Instruction H (1)(a) and (b) of Form 10-Q and is therefore filing this Form with the reduced disclosure format.
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2009
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 333-100029
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
(Exact name of registrant as specified in its charter)
New York | 36-2608394 | |
(State of Incorporation) |
| (I.R.S. Employer Identification No.) |
100 Motor Parkway, Suite 132 |
|
|
Hauppauge, New York |
| 11788 |
(Address of principal executive offices) |
| (Zip code) |
Registrant’s telephone number, including area code: 631-357-8920
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o |
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o No o |
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o |
| Accelerated filer o |
| Non-accelerated filer x |
| Smaller reporting company o |
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x |
As of May 12, 2009, the registrant had 100,000 common shares, $25 par value, outstanding, all of which are held by Allstate Life Insurance Company.
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
INDEX TO QUARTERLY REPORT ON FORM 10-Q
March 31, 2009
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PART 1. | FINANCIAL INFORMATION |
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Item 1. | Financial Statements |
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| Condensed Statements of Operations for the Three-Month Periods Ended March 31, 2009 and 2008 (unaudited) | 1 |
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| Condensed Statements of Financial Position as of March 31, 2009 (unaudited) and December 31, 2008 | 2 |
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| Condensed Statements of Cash Flows for the Three-Month Periods Ended March 31, 2009 and 2008 (unaudited) | 3 |
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| Notes to Condensed Financial Statements (unaudited) | 4 |
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| Report of Independent Registered Public Accounting Firm | 20 |
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 21 |
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Item 4. | Controls and Procedures | 47 |
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PART II. | OTHER INFORMATION |
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Item 1. | Legal Proceedings | 48 |
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Item 1A. | Risk Factors | 48 |
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Item 6. | Exhibits | 48 |
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
CONDENSED STATEMENTS OF OPERATIONS
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| Three Months Ended |
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($ in thousands) |
| 2009 |
| 2008 |
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| (unaudited) |
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Revenues |
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Premiums |
| $ | 11,464 |
| $ | 10,011 |
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Contract charges |
| 13,726 |
| 14,671 |
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Net investment income |
| 93,678 |
| 99,746 |
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Realized capital gains and losses |
| 99,218 |
| 1,721 |
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| 218,086 |
| 126,149 |
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Costs and expenses |
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Contract benefits |
| 37,779 |
| 38,805 |
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Interest credited to contractholder funds |
| 56,834 |
| 43,301 |
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Amortization of deferred policy acquisition costs |
| 72,667 |
| 1,451 |
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Operating costs and expenses |
| 12,789 |
| 9,022 |
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| 180,069 |
| 92,579 |
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Loss on disposition of operations |
| — |
| (268 | ) | ||
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Income from operations before income tax expense |
| 38,017 |
| 33,302 |
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Income tax expense |
| 13,348 |
| 11,725 |
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Net income |
| $ | 24,669 |
| $ | 21,577 |
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See notes to condensed financial statements.
1
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
CONDENSED STATEMENTS OF FINANCIAL POSITION
|
| March 31, |
| December 31, |
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($ in thousands, except par value data) |
| 2009 |
| 2008 |
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| (unaudited) |
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Assets |
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Investments |
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Fixed income securities, at fair value (amortized cost $5,478,083 and $5,776,451) |
| $ | 5,031,358 |
| $ | 5,496,365 |
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Mortgage loans |
| 670,446 |
| 700,268 |
| ||
Equity securities, at fair value (cost $80) |
| 72 |
| — |
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Short-term, at fair value (amortized cost $900,839 and $409,737) |
| 900,839 |
| 409,802 |
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Policy loans |
| 40,019 |
| 39,672 |
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Other |
| 2,341 |
| 2,478 |
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Total investments |
| 6,645,075 |
| 6,648,585 |
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Cash |
| 55,319 |
| 4,965 |
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Deferred policy acquisition costs |
| 548,518 |
| 538,248 |
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Reinsurance recoverables |
| 369,854 |
| 367,957 |
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Accrued investment income |
| 59,946 |
| 61,581 |
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Deferred income taxes |
| 54,109 |
| 65,397 |
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Other assets |
| 68,640 |
| 64,440 |
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Separate Accounts |
| 479,091 |
| 533,760 |
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Total assets |
| $ | 8,280,552 |
| $ | 8,284,933 |
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Liabilities |
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Contractholder funds |
| $ | 5,101,455 |
| $ | 5,086,965 |
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Reserve for life-contingent contract benefits |
| 1,806,535 |
| 1,953,157 |
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Current income taxes payable |
| 40,767 |
| 12,769 |
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Other liabilities and accrued expenses |
| 249,262 |
| 172,286 |
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Payable to affiliates, net |
| 7,315 |
| 8,457 |
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Reinsurance payable to parent |
| 4,931 |
| 971 |
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Separate Accounts |
| 479,091 |
| 533,760 |
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Total liabilities |
| 7,689,356 |
| 7,768,365 |
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Commitments and Contingent Liabilities (Note 6) |
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Shareholder’s equity |
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Common stock, $25 par value, 100 thousand shares authorized and outstanding |
| 2,500 |
| 2,500 |
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Additional capital paid-in |
| 140,000 |
| 140,000 |
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Retained income |
| 507,651 |
| 482,982 |
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Accumulated other comprehensive loss: |
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Unrealized net capital gains and losses |
| (58,955 | ) | (108,914 | ) | ||
Total accumulated other comprehensive loss |
| (58,955 | ) | (108,914 | ) | ||
Total shareholder’s equity |
| 591,196 |
| 516,568 |
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Total liabilities and shareholder’s equity |
| $ | 8,280,552 |
| $ | 8,284,933 |
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See notes to condensed financial statements.
2
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
CONDENSED STATEMENTS OF CASH FLOWS
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| Three Months Ended |
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($ in thousands) |
| 2009 |
| 2008 |
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| (unaudited) |
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Cash flows from operating activities |
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Net income |
| $ | 24,669 |
| $ | 21,577 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Amortization and other non-cash items |
| (17,232 | ) | (18,706 | ) | ||
Realized capital gains and losses |
| (99,218 | ) | (1,721 | ) | ||
Loss on disposition of operations |
| — |
| 268 |
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Interest credited to contractholder funds |
| 56,834 |
| 43,301 |
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Changes in: |
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Life-contingent contract benefits and contractholder funds |
| (5,699 | ) | (3,413 | ) | ||
Deferred policy acquisition costs |
| 63,750 |
| (9,648 | ) | ||
Income taxes |
| 12,385 |
| 10,764 |
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Other operating assets and liabilities |
| 3,176 |
| 1,624 |
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Net cash provided by operating activities |
| 38,665 |
| 44,046 |
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Cash flows from investing activities |
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Proceeds from sales of fixed income securities |
| 601,507 |
| 132,449 |
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Investment collections |
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Fixed income securities |
| 96,898 |
| 41,885 |
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Mortgage loans |
| 28,614 |
| 20,253 |
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Investment purchases |
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Fixed income securities |
| (252,394 | ) | (129,725 | ) | ||
Mortgage loans |
| — |
| (5,750 | ) | ||
Change in short-term investments, net |
| (456,381 | ) | (113,731 | ) | ||
Change in other investments, net |
| (521 | ) | 1,345 |
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Net cash provided by (used in) investing activities |
| 17,723 |
| (53,274 | ) | ||
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Cash flows from financing activities |
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Contractholder fund deposits |
| 110,535 |
| 133,749 |
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Contractholder fund withdrawals |
| (116,569 | ) | (124,825 | ) | ||
Net cash (used in) provided by financing activities |
| (6,034 | ) | 8,924 |
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Net increase (decrease) in cash |
| 50,354 |
| (304 | ) | ||
Cash at beginning of period |
| 4,965 |
| 7,356 |
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Cash at end of period |
| $ | 55,319 |
| $ | 7,052 |
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See notes to condensed financial statements.
3
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
1. General
Basis of presentation
The accompanying condensed financial statements include the accounts of Allstate Life Insurance Company of New York (the “Company”), a wholly owned subsidiary of Allstate Life Insurance Company (“ALIC”), which is wholly owned by Allstate Insurance Company (“AIC”). All of the outstanding common stock of AIC is owned by Allstate Insurance Holdings, LLC, a wholly owned subsidiary of The Allstate Corporation (the “Corporation”).
The condensed financial statements and notes as of March 31, 2009 and for the three-month periods ended March 31, 2009 and 2008 are unaudited. The condensed financial statements reflect all adjustments (consisting only of normal recurring accruals) which are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods. These condensed financial statements and notes should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.
To conform to the 2009 presentation, certain amounts in the prior year condensed financial statements and notes have been reclassified.
Premiums and Contract Charges
The following table summarizes premiums and contract charges by product.
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| Three months ended |
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($ in thousands) |
| March 31, |
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| 2009 |
| 2008 |
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Premiums |
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Traditional life insurance (1) |
| $ | 5,590 |
| $ | 5,933 |
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Immediate annuities with life contingencies |
| 3,588 |
| 2,150 |
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Accident and health |
| 2,286 |
| 1,928 |
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Total premiums |
| 11,464 |
| 10,011 |
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Contract charges |
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Interest-sensitive life insurance (1) |
| 12,498 |
| 12,902 |
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Fixed annuities |
| 1,228 |
| 1,769 |
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Total contract charges |
| 13,726 |
| 14,671 |
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Total premiums and contract charges |
| $ | 25,190 |
| $ | 24,682 |
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(1) To conform to the current period presentation, certain amounts in the prior period have been reclassified.
Adopted accounting standards
Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”)
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, which redefines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America (“GAAP”), and expands disclosures about fair value measurements. SFAS No. 157 establishes a three-level hierarchy for fair value measurements based upon the nature of the inputs to the valuation of an asset or liability. SFAS No. 157 applies where other accounting pronouncements require or permit fair value measurements. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which permits the deferral of the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company adopted the provisions of SFAS No. 157 for financial assets and financial liabilities recognized or disclosed at fair value on a recurring or non-recurring basis as of January 1, 2008.
4
Consistent with the provisions of FSP FAS 157-2, the Company adopted SFAS No. 157 for non-financial assets and liabilities measured at fair value on a non-recurring basis on January 1, 2009. In October 2008, the FASB issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP FAS 157-3”), which clarifies the application of SFAS No. 157 in a market that is not active. The Company adopted the provisions of FSP FAS 157-3 as of September 30, 2008. The adoption of SFAS No. 157 and FSP FAS 157-3 did not have a material effect on the Company’s results of operations or financial position (see Note 3).
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133 (“SFAS No. 161”)
In March 2008, the FASB issued SFAS No. 161, which amends and expands the disclosure requirements for derivatives currently accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”). The new disclosures are designed to enhance the understanding of how and why an entity uses derivative instruments and how derivative instruments affect an entity’s financial position, results of operations, and cash flows. The standard requires, on a quarterly basis, quantitative disclosures about the potential cash outflows associated with the triggering of credit-risk-contingent features, if any; tabular disclosures about the classification and fair value amounts of derivative instruments reported in the statement of financial position; disclosure of the location and amount of gains and losses on derivative instruments reported in the statement of operations; and qualitative information about how and why an entity uses derivative instruments and how derivative instruments and related hedged items affect the entity’s financial statements. SFAS No. 161 is effective for fiscal periods beginning after November 15, 2008, and is to be applied on a prospective basis only. SFAS No. 161 affects disclosures and therefore implementation had no impact on the Company’s results of operations or financial position (see Note 4).
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 (“SFAS No. 159”)
In February 2007, the FASB issued SFAS No. 159 which provides reporting entities, on an ongoing basis, an option to report selected financial assets, including investment securities, and financial liabilities, including most insurance contracts, at fair value through earnings. SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement alternatives for similar types of financial assets and liabilities. The standard also requires additional information to aid financial statement users’ understanding of the impacts of a reporting entity’s decision to use fair value on its earnings and requires entities to display, on the face of the statement of financial position, the fair value of those assets and liabilities for which the reporting entity has chosen to measure at fair value. SFAS No. 159 was effective as of the beginning of a reporting entity’s first fiscal year beginning after November 15, 2007. The Company did not apply the fair value option to any existing financial assets or liabilities as of January 1, 2008 and did not elect to apply the option prospectively to any financial assets or liabilities acquired subsequent to the effective date. Consequently, the adoption of SFAS No. 159 had no impact on the Company’s results of operations or financial position.
FSP No. FIN 39-1, Amendment of FASB Interpretation No. 39 (“FSP FIN 39-1”)
In April 2007, the FASB issued FSP FIN 39-1, which amends FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts”. FSP FIN 39-1 replaces the terms “conditional contracts” and “exchange contracts” with the term “derivative instruments” and requires a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement that have been offset in the statement of financial position. FSP FIN 39-1 was effective for fiscal years beginning after November 15, 2007, with early adoption permitted. The adoption of FSP FIN 39-1 did not have a material impact on the Company’s results of operations or financial position.
5
FSP No. FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161 (“FSP FAS 133-1 and FIN 45-4”)
In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, which amends SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), and FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), to both enhance and synchronize the disclosure requirements of the two statements with respect to the potential for adverse effects of changes in credit risk on the financial statements of the sellers of credit derivatives and certain guarantees. SFAS No. 133 was amended to require disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument. FIN 45 was amended to require an additional disclosure about the current status of the payment/performance risk of a guarantee. The FSP clarifies the FASB’s intent that the disclosures required by SFAS No. 161 should be provided for any reporting period (annual or quarterly interim) beginning after November 15, 2008. The provisions of this FASB staff position that amend SFAS No. 133 and FIN 45 are effective for reporting periods ending after November 15, 2008, and the provisions that clarify the effective date of SFAS No. 161 are effective upon the adoption of that statement; therefore, the disclosure requirements, which have no impact to the Company’s results of operations or financial position, were adopted at December 31, 2008.
FSP No. EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20 (“FSP EITF 99-20-1”)
In January 2009, the FASB issued FSP EITF 99-20-1, which amends FASB Emerging Issues Task Force (“EITF”) No. 99-20 “Recognition of Interest Income and Impairment on Purchased Beneficial Interest and Beneficial Interests That Continue to Be Held by a Transferor or in Securitized Financial Assets,” (“EITF 99-20”), to align the impairment guidance in EITF No. 99-20 with the impairment guidance and related implementation guidance in SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities”. The provisions of this FASB staff position are effective for reporting periods ending after December 15, 2008. The adoption of FSP EITF 99-20-1 did not have a material effect on the results of operations or financial position of the Company.
Pending accounting standards
FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS 115-2 and FAS 124-2”)
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2 which amends SFAS No. 115 and SFAS No. 124 “Accounting for Certain Investments Held by Not-for-Profit Organizations”, to provide recognition guidance for debt securities classified as available-for-sale and held-to-maturity and subject to other-than-temporary impairment (“OTTI”) guidance. If the fair value of a debt security is less than its amortized cost basis at the reporting date, an entity shall assess whether the impairment is an OTTI. FSP FAS 115-2 and FAS 124-2 defines the situations under which an OTTI should be considered to have occurred. When an entity intends to sell the security or more likely than not it will be required to sell the security before recovery of its amortized cost basis, an OTTI is recognized in earnings. When the entity does not expect to recover the entire amortized cost basis of the security even if it does not intend to sell the security, the entity must consider a number of factors and use its best estimate of the present value of cash flows expected to be collected from the debt security in order to determine whether a credit loss exists, and the period over which the debt security is expected to recover. The amount of total OTTI related to the credit loss shall be recognized in earnings while the amount of the total OTTI related to other factors shall be recognized in other comprehensive income. Both the statement of operations and the statement of accumulated other comprehensive income are required to display the OTTI related to credit losses and the OTTI related to other factors on the face of each statement.
FSP FAS 115-2 and FAS 124-2 expands the disclosure requirements of SFAS No. 115 (for both debt and equity securities) and requires a more detailed, risk-oriented breakdown of security types and related information, and requires the annual disclosures to be made for interim periods. In addition, new disclosures are required to help users of financial statements understand the significant inputs used in determining a credit loss as well as a rollforward of that amount each period. FSP FAS 115-2 and FAS 124-2 are effective for interim periods ending after June 15, 2009 with early adoption permitted in conjunction with the early adoption of FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). The disclosures are not required
6
for earlier periods presented for comparative purposes. FSP FAS 115-2 and FSP 124-2 shall be applied to existing and new investments held by an entity as of the beginning of the interim period in which it is adopted. A cumulative effect adjustment to the opening balance of retained earnings will be recognized for debt securities with an existing OTTI at the beginning of the interim period in which the FSP is adopted. The Company will adopt the provisions of FSP FAS 115-2 and FAS 124-2 as of April 1, 2009. The specific requirements of the FSP applicable to the Company’s portfolio are being interpreted, studied and assessed. The potential cumulative effect to retained income as of April 1, 2009 is not yet reliably estimable since the Company is still assessing the requirements; however, the Company expects that it will result in an increase to retained income, offset by a decrease to accumulated other comprehensive income by the same amount.
FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”)
In April 2009, the FASB issued FSP FAS 157-4, which amends SFAS No. 157, to provide additional guidance for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased. Guidance on identifying circumstances that indicate a transaction is not orderly is also provided. If it is concluded that there has been a significant decrease in the volume and level of market activity for an asset or liability in relation to normal market activity for an asset or liability, transactions or quoted prices may not be determinative of fair value, and further analysis of the transactions or quoted prices may be needed. A significant adjustment to the transactions or quoted prices may be necessary to estimate fair value which may be determined based on the point within a range of fair value estimates that is most representative of fair value under the current market conditions. Determination of whether the transaction is orderly is based on the weight of the evidence. The disclosure requirements of SFAS No. 157 are increased since disclosures of the inputs and valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques and related inputs during the reporting period are required.
FSP FAS 157-4 defines the disclosures required for major categories by SFAS No. 157 to be the major security types as defined in FASB Statement No. 115. FSP FAS 157-4 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. FSP FAS 157-4 is effective for interim periods ending after June 15, 2009 with early adoption permitted but only in conjunction with the early adoption of FSP FAS 115-2 and FAS 124-2. Revisions resulting from a change in valuation technique or its application shall be accounted for as a change in accounting estimate and disclosed, along with a quantification of the total effect of the change in valuation technique and related inputs, if practicable, by major category. The Company will adopt the provisions of FSP FAS 157-4 as of April 1, 2009. Quantification of the estimated effects of the application of the FSP FAS 157-4 requirements will be based on the market conditions and portfolio holdings at the time of adoption and are therefore not yet reliably estimable; however, the Company does not expect a material impact to its results of operations or financial position upon adoption.
FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”)
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1 which amends FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments”, to require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements; and amends Accounting Principles Board Opinion No. 28, “Interim Financial Reporting”, to require those disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009. The disclosures are not required for earlier periods presented for comparative purposes and earlier adoption is permitted in conjunction with the early adoption of FSP FAS 115-2 and FAS 124-2 and FSP FAS 157-4. The Company will adopt the provisions of FSP FAS 107-1 and APB 28-1 for second quarter 2009. FSP FAS 107-1 and APB 28-1 affects disclosures and therefore implementation will not impact the Company’s results of operations or financial position.
7
2. Supplemental Cash Flow Information
Non-cash investment exchanges and modifications, which primarily reflect refinancings of fixed income securities, totaled $1.4 million for the three-month period ended March 31, 2009.
Liabilities for collateral received in conjunction with the Company’s securities lending business activities are reported in other liabilities and accrued expenses in the Condensed Statements of Financial Position. The accompanying cash flows are included in cash flows from operating activities in the Condensed Statements of Cash Flows along with the activities resulting from management of the proceeds, which are as follows:
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| Three months ended |
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($ in thousands) |
| 2009 |
| 2008 |
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Net change in proceeds managed |
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|
|
| ||
Net change in fixed income securities |
| $ | — |
| $ | (13,009 | ) |
Net change in short-term investments |
| (33,796 | ) | (178,581 | ) | ||
Operating cash flow used |
| $ | (33,796 | ) | $ | (191,590 | ) |
|
|
|
|
|
| ||
Net change in liabilities |
|
|
|
|
| ||
Liabilities for collateral, beginning of year |
| $ | (117,297 | ) | $ | (198,138 | ) |
Liabilities for collateral, end of period |
| (151,093 | ) | (389,728 | ) | ||
Operating cash flow provided |
| $ | 33,796 |
| $ | 191,590 |
|
3. Fair Value of Assets and Liabilities
The Company adopted the provisions of SFAS No. 157 as of January 1, 2008 for its financial assets and liabilities that are measured at fair value and as of January 1, 2009 for its non-financial assets and liabilities measured at fair value on a non-recurring basis. SFAS No. 157 established a hierarchy for inputs used in determining fair value that maximize the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available.
Assets and liabilities recorded on the Condensed Statements of Financial Position at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:
Level 1 Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company can access.
Level 2 Assets and liabilities whose values are based on the following:
a) Quoted prices for similar assets or liabilities in active markets;
b) Quoted prices for identical or similar assets or liabilities in non-active markets; or
c) Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability.
Level 3 Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the assets and liabilities.
The availability of observable inputs varies by instrument. In situations where fair value is based on internally developed pricing models or inputs that are unobservable in the market, the determination of fair value requires more judgment. The degree of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3. In many instances, valuation inputs used to measure fair value fall into different levels of the fair value hierarchy. The category level in the fair value hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level 3.
8
Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans and policy loans. Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is subject to remeasurement at fair value after initial recognition and the resulting remeasurement is reflected in the condensed financial statements. As of March 31, 2009, 77.5% of total assets are measured at fair value and 0.6% of total liabilities are measured at fair value.
The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of March 31, 2009:
|
| Quoted prices |
| Significant |
| Significant |
| Counterparty |
| Balance as of |
| |||||
($ in thousands) |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| netting(1) |
| 2009 |
| |||||
Assets: |
|
|
|
|
|
|
|
|
|
|
| |||||
Fixed income securities |
| $ | 153,073 |
| $ | 3,555,964 |
| $ | 1,322,321 |
|
|
| $ | 5,031,358 |
| |
Equity securities |
| — |
| 72 |
| — |
|
|
| 72 |
| |||||
Short-term investments |
| 28,945 |
| 871,894 |
| — |
|
|
| 900,839 |
| |||||
Other investments: |
|
|
|
|
|
|
|
|
|
|
| |||||
Free-standing derivatives |
| — |
| 1,677 |
| 670 |
| $ | (6 | ) | 2,341 |
| ||||
Separate account assets |
| 479,091 |
| — |
| — |
|
|
| 479,091 |
| |||||
Other assets |
| — |
| — |
| (2,503 | ) |
|
| (2,503 | ) | |||||
Total recurring basis assets |
| 661,109 |
| 4,429,607 |
| 1,320,488 |
| (6 | ) | 6,411,198 |
| |||||
Non-recurring basis (2) |
| — |
| — |
| 9,206 |
|
|
| 9,206 |
| |||||
Total assets at fair value |
| $ | 661,109 |
| $ | 4,429,607 |
| $ | 1,329,694 |
| $ | (6 | ) | $ | 6,420,404 |
|
% of total assets at fair value |
| 10.3 | % | 69.0 | % | 20.7 | % | — | % | 100.0 | % | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Liabilities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Contractholder funds: |
|
|
|
|
|
|
|
|
|
|
| |||||
Derivatives embedded in annuity contracts |
| $ | — |
| $ | — |
| $ | (33,368 | ) |
|
| $ | (33,368 | ) | |
Other liabilities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Free-standing derivatives |
| — |
| (10,579 | ) | (5,637 | ) | $ | 6 |
| (16,210 | ) | ||||
Total liabilities at fair value |
| $ | — |
| $ | (10,579 | ) | $ | (39,005 | ) | $ | 6 |
| $ | (49,578 | ) |
% of total liabilities at fair value |
| — | % | 21.3 | % | 78.7 | % | — | % | 100.0 | % |
(1) In accordance with FSP FIN 39-1, the Company nets all fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral executed with the same counterparty under a master netting agreement. At March 31, 2009, the right to reclaim cash collateral was offset by securities held, and there was no obligation to return collateral.
(2) Includes mortgage loans written-down to fair value in connection with recognizing other-than-temporary impairments.
9
The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2008:
|
| Quoted prices |
| Significant |
| Significant |
| Balance as of |
| ||||
($ in thousands) |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| 2008 |
| ||||
Assets: |
|
|
|
|
|
|
|
|
| ||||
Fixed income securities |
| $ | 154,119 |
| $ | 4,007,707 |
| $ | 1,334,539 |
| $ | 5,496,365 |
|
Short-term investments |
| 33,315 |
| 376,487 |
| — |
| 409,802 |
| ||||
Other investments: |
|
|
|
|
|
|
|
|
| ||||
Free-standing derivatives |
| — |
| 1,764 |
| 714 |
| 2,478 |
| ||||
Separate account assets |
| 533,760 |
| — |
| — |
| 533,760 |
| ||||
Other assets |
| — |
| — |
| (1,829 | ) | (1,829 | ) | ||||
Total recurring basis assets |
| 721,194 |
| 4,385,958 |
| 1,333,424 |
| 6,440,576 |
| ||||
Non-recurring basis (1) |
| — |
| — |
| 10,589 |
| 10,589 |
| ||||
Total assets at fair value |
| $ | 721,194 |
| $ | 4,385,958 |
| $ | 1,344,013 |
| $ | 6,451,165 |
|
% of total assets at fair value |
| 11.2 | % | 68.0 | % | 20.8 | % | 100.0 | % | ||||
|
|
|
|
|
|
|
|
|
| ||||
Liabilities: |
|
|
|
|
|
|
|
|
| ||||
Contractholder funds: |
|
|
|
|
|
|
|
|
| ||||
Derivatives embedded in annuity contracts |
| $ | — |
| $ | — |
| $ | (30,051 | ) | $ | (30,051 | ) |
Other liabilities: |
|
|
|
|
|
|
|
|
| ||||
Free-standing derivatives |
| — |
| (20,849 | ) | (5,450 | ) | (26,299 | ) | ||||
Total liabilities at fair value |
| $ | — |
| $ | (20,849 | ) | $ | (35,501 | ) | $ | (56,350 | ) |
% of total liabilities at fair value |
| — | % | 37.0 | % | 63.0 | % | 100.0 | % |
(1) Includes mortgage loans written-down to fair value in connection with recognizing other-than-temporary impairments.
As required by SFAS No. 157, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3).
10
The following table provides a summary of changes in fair value during the three months ended March 31, 2009 of Level 3 assets and liabilities held at fair value on a recurring basis. Net transfers in and/or out of Level 3 are reported as having occurred at the beginning of the quarter the transfer occurred; therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| gains (losses) |
| |||||||
|
|
|
| Total realized and |
|
|
|
|
|
|
| included in |
| |||||||||
|
|
|
| unrealized gains (losses) |
| Purchases, |
|
|
|
|
| Net income |
| |||||||||
|
|
|
| included in: |
| sales, |
|
|
|
|
| for financial |
| |||||||||
|
|
|
|
|
| OCI on |
| issuances |
| Net |
|
|
| instruments |
| |||||||
|
| Balance as of |
|
|
| Statement |
| and |
| transfers in |
| Balance as of |
| still held at |
| |||||||
|
| December 31, |
| Net |
| of Financial |
| settlements, |
| and/or (out) |
| March 31, |
| March 31, |
| |||||||
($ in thousands) |
| 2008 |
| income (1) |
| Position |
| net |
| of Level 3 |
| 2009 |
| 2009 (3) |
| |||||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Fixed income securities |
| $ | 1,334,539 |
| $ | (3,219 | ) | $ | (24,123 | ) | $ | (37,896 | ) | $ | 53,020 |
| $ | 1,322,321 |
| $ | (3,071 | ) |
Other investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Free-standing derivatives, net |
| (4,736 | ) | (405 | ) | — |
| 174 |
| — |
| (4,967 | )(2) | 48 |
| |||||||
Other assets |
| (1,829 | ) | (674 | ) | — |
| — |
| — |
| (2,503 | ) | (674 | ) | |||||||
Total recurring Level 3 assets |
| $ | 1,327,974 |
| $ | (4,298 | ) | $ | (24,123 | ) | $ | (37,722 | ) | $ | 53,020 |
| $ | 1,314,851 |
| $ | (3,697 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Contractholder funds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Derivatives embedded in annuity contracts |
| $ | (30,051 | ) | $ | (3,242 | ) | $ | — |
| $ | (75 | ) | $ | — |
| $ | (33,368 | ) | $ | (3,242 | ) |
Total recurring Level 3 liabilities |
| $ | (30,051 | ) | $ | (3,242 | ) | $ | — |
| $ | (75 | ) | $ | — |
| $ | (33,368 | ) | $ | (3,242 | ) |
(1) The effect to net income totals $(7.5) million and is reported in the Condensed Statements of Operations as follows: $(7.1) million in realized capital gains and losses; $2.8 million in net investment income; and $(3.2) million in contract benefits.
(2) Comprises $670 thousand of assets and $(5.6) million of liabilities.
(3) The amounts represent gains and losses included in net income for the period of time that the asset or liability was determined to be in Level 3. These gains and losses total $(6.9) million and are reported in the Condensed Statements of Operations as follows: $(6.5) million in realized capital gains and losses; $2.8 million in net investment income; and $(3.2) million in contract benefits.
11
The following table provides a summary of changes in fair value during the three months ended March 31, 2008 of Level 3 assets and liabilities held at fair value on a recurring basis. Net transfers in and/or out of Level 3 are reported as having occurred at the beginning of the quarter the transfer occurred; therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| gains (losses) |
| |||||||
|
|
|
| Total realized and |
|
|
|
|
|
|
| included in |
| |||||||||
|
|
|
| unrealized gains (losses) |
| Purchases, |
|
|
|
|
| Net income |
| |||||||||
|
|
|
| included in: |
| sales, |
|
|
|
|
| for financial |
| |||||||||
|
|
|
|
|
| OCI on |
| issuances |
| Net |
|
|
| instruments |
| |||||||
|
| Balance as of |
|
|
| Statement of |
| and |
| transfers in |
| Balance as of |
| still held at |
| |||||||
|
| January 1, |
| Net |
| Financial |
| settlements, |
| and/or (out) |
| March 31, |
| March 31, |
| |||||||
($ in thousands) |
| 2008 |
| income (1) |
| Position |
| net |
| of Level 3 |
| 2008 |
| 2008 (3) |
| |||||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Fixed income securities |
| $ | 1,469,898 |
| $ | 7,998 |
| $ | (21,870 | ) | $ | 3,451 |
| $ | 26,133 |
| $ | 1,485,610 |
| $ | 388 |
|
Other investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Free-standing derivatives, net |
| (980 | ) | (2,472 | ) | — |
| 126 |
| — |
| (3,326 | )(2) | 20 |
| |||||||
Other assets |
| (1,733 | ) | 2,239 |
| — |
| — |
| — |
| 506 |
| 2,239 |
| |||||||
Total recurring Level 3 assets |
| $ | 1,467,185 |
| $ | 7,765 |
| $ | (21,870 | ) | $ | 3,577 |
| $ | 26,133 |
| $ | 1,482,790 |
| $ | 2,647 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Contractholder funds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Derivatives embedded in annuity contracts |
| $ | 174 |
| $ | (1,428 | ) | $ | — |
| $ | 1 |
| $ | — |
| $ | (1,253 | ) | $ | (1,428 | ) |
Total recurring Level 3 liabilities |
| $ | 174 |
| $ | (1,428 | ) | $ | — |
| $ | 1 |
| $ | — |
| $ | (1,253 | ) | $ | (1,428 | ) |
(1) The effect to net income totals $6.3 million and is reported in the Condensed Statements of Operations as follows: $6.3 million in realized capital gains and losses; $1.4 million in net investment income; and $(1.4) million in contract benefits.
(2) Comprises $897 thousand of assets and $(4.2) million of liabilities.
(3) The amounts represent gains and losses included in net income for the period of time that the asset or liability was determined to be in Level 3. These gains and losses total $1.2 million and are reported in the Condensed Statements of Operations as follows: $1.2 million in realized capital gains and losses; $1.4 million in net investment income; and $(1.4) million in contract benefits.
4. Derivative Financial Instruments
The Company primarily uses derivatives for risk reduction. In addition, the Company has derivatives embedded in non-derivative “host” contracts, which are required to be separated from the host contract and accounted for at fair value as derivative instruments. With the exception of non-hedge embedded derivatives, all of the Company’s derivatives are evaluated for their ongoing effectiveness as either accounting hedge or non-hedge derivative financial instruments on at least a quarterly basis. The Company does not use derivatives for trading purposes. Non-hedge accounting is generally used for “portfolio” level hedging strategies where the terms of the individual hedged items do not meet the strict homogeneity requirements prescribed in SFAS No. 133 to permit the application of SFAS No. 133’s hedge accounting model.
Asset-liability management is a risk management strategy that is principally employed to balance the respective interest-rate sensitivities of the Company’s assets and liabilities. Depending upon the attributes of the assets acquired and liabilities issued, derivative instruments such as interest rate swaps and caps are acquired to change the interest rate characteristics of existing assets and liabilities to ensure the relationship is maintained within specified ranges and to reduce exposure to rising or falling interest rates.
The Company uses foreign currency swaps primarily to reduce the foreign currency risk associated with holding foreign currency denominated investments. The Company also has a reinsurance treaty that is recorded as a derivative instrument, under which it primarily cedes re-investment related risk on its structured settlement annuities to ALIC.
When derivatives meet specific criteria, they may be designated as accounting hedges and accounted for as fair value, cash flow, foreign currency fair value or foreign currency cash flow hedges. The Company designates its foreign currency swap contracts as cash flow hedges when the hedging instrument is highly effective in offsetting the exposure of variations in cash flows for the hedged risk that could affect net income. Amounts are reclassified to net investment income as the hedged item affects net income.
12
The Company’s primary embedded derivatives are guaranteed minimum accumulation and withdrawal benefits related to the Company’s variable annuity business, which is fully reinsured.
The notional amounts specified in the contracts are used to calculate the exchange of contractual payments under the agreements and are generally not representative of the potential for gain or loss on these agreements.
Fair value, which is equal to the carrying value, is the estimated amount that the Company would receive (pay) to terminate the derivative contracts at the reporting date. The carrying value amounts for over-the-counter (“OTC”) free-standing derivatives have been further adjusted for the effects, if any, of legally enforceable master netting agreements and are presented on a net basis in the Condensed Statements of Financial Position in accordance with FASB Interpretation No. 39.
The net impact to pre-tax income for derivatives includes valuation and settlements of derivatives which are reported in net income. For cash flow hedges, gains and losses amortized from accumulated other comprehensive income are reported in net income.
The following table provides a summary of the volume and fair value positions of derivative instruments as well as their reporting location in the Condensed Statements of Financial Position at March 31, 2009.
|
| Asset derivatives |
| ||||||||||||
($ in thousands, except number of contracts) |
| Balance sheet location |
| Volume- |
| Fair |
| Gross |
| Gross |
| ||||
Derivatives designated as accounting hedging instruments |
|
|
|
|
|
|
|
|
|
|
| ||||
Foreign currency contracts |
| Other investments |
| $ | 7,500 |
| $ | 1,677 |
| $ | 1,677 |
| $ | — |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Derivatives not designated as accounting hedging instruments |
|
|
|
|
|
|
|
|
|
|
| ||||
Interest rate contracts |
| Other investments |
| 52,000 |
| 664 |
| 664 |
| — |
| ||||
Structured settlement annuity reinsurance agreement |
| Other assets |
| — |
| (2,503 | ) | (2,503 | ) | — |
| ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total derivative assets |
|
|
| $ | 59,500 |
| $ | (162 | ) | $ | (162 | ) | $ | — |
|
|
| Liability derivatives |
| ||||||||||||
|
| Balance sheet location |
| Volume- |
| Fair |
| Gross |
| Gross |
| ||||
Derivatives not designated as accounting hedging instruments |
|
|
|
|
|
|
|
|
|
|
| ||||
Interest rate contracts |
| Other liabilities & accrued expenses |
| $ | 691,700 |
| $ | (16,210 | ) | $ | 6 |
| $ | (16,216 | ) |
Embedded derivatives |
| Contractholder funds |
| 181,073 |
| (33,368 | ) | — |
| (33,368 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total derivative liabilities |
|
|
| $ | 872,773 |
| $ | (49,578 | ) | $ | 6 |
| $ | (49,584 | ) |
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total derivatives |
|
|
| $ | 932,273 |
| $ | (49,740 | ) |
|
|
|
|
13
The following table provides a summary of the impacts of the Company’s foreign currency contracts in cash flow hedging relationships in the Condensed Statements of Operations and the Condensed Statements of Financial Position for the three month period ended March 31, 2009. Amortization of net gains from accumulated other comprehensive income related to cash flow hedges is expected to be $50 thousand during the next twelve months.
($ in thousands) |
|
|
| ||||
|
|
|
| ||||
Location of loss reclassified from accumulated OCI into income (effective portion) |
| Net investment income |
| ||||
|
|
|
| ||||
Amount of loss recognized in OCI on derivatives during the period (effective portion) |
| $ | (79) |
|
| ||
|
|
|
|
|
| ||
Amount of gain recognized in OCI on derivatives during the term of the hedging relationship (effective portion) |
| $ | 1,670 |
|
| ||
|
|
|
|
|
| ||
Amount of gain reclassified from accumulated OCI into income (effective portion) |
| $ | 12 |
|
| ||
|
|
|
|
|
| ||
Location of gain recognized in income on derivative (ineffective portion and amount excluded from effectiveness testing) |
| Realized capital gains and losses |
| ||||
|
|
|
| ||||
Amount of gain recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing) |
| $ | — |
|
| ||
The following table presents gains and losses from valuation and settlements reported on derivatives not designated as accounting hedging instruments in the Condensed Statements of Operations for the three month period ended March 31, 2009.
($ in thousands) |
| Realized |
| Contract |
| Total gain |
| |||
Interest rate contracts |
| $ | 9,864 |
| $ | — |
| $ | 9,864 |
|
Embedded derivative financial instruments |
| — |
| (3,317 | ) | (3,317 | ) | |||
Structured settlement annuity reinsurance agreement |
| (1,510 | ) | — |
| (1,510 | ) | |||
Total |
| $ | 8,354 |
| $ | (3,317 | ) | $ | 5,037 |
|
The Company manages its exposure to credit risk by utilizing highly rated counterparties, establishing risk control limits, executing legally enforceable master netting agreements (“MNAs”) and obtaining collateral where appropriate. The Company uses master netting agreements for OTC derivative transactions, including interest rate swap, foreign currency swap and interest rate cap agreements. These agreements permit either party to net payments due for transactions covered by the agreements. Under the provisions of the agreements, collateral is either pledged or obtained when certain predetermined exposure limits are exceeded. As of March 31, 2009, the Company pledged $13.1 million in securities to counterparties. The Company has not incurred any losses on derivative financial instruments due to counterparty nonperformance.
Counterparty credit exposure represents the Company’s potential loss if all of the counterparties concurrently fail to perform under the contractual terms of the contracts and all collateral, if any, becomes worthless. This exposure is measured by the fair value of OTC free-standing derivative contracts with a positive fair value at the reporting date reduced by the effect, if any, of legally enforceable master netting agreements.
The following table summarizes the counterparty credit exposure by counterparty credit rating as it relates to interest rate swap, foreign currency swap, and interest rate cap agreements.
($ in thousands) |
| March 31, 2009 |
| December 31, 2008 |
| ||||||||||||||||||
Rating (1) |
| Number |
| Notional |
| Credit |
| Exposure, |
| Number |
| Notional |
| Credit |
| Exposure, |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
A |
| 1 |
| $ | 59,500 |
| $ | 2,342 |
| $ | 2,342 |
| 1 |
| $ | 59,500 |
| $ | 2,478 |
| $ | 2,478 |
|
(1) Rating is the lower of Standard and Poor’s (“S&P”) or Moody’s ratings.
(2) Only OTC derivatives with a net positive fair value are included for each counterparty.
14
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. Market risk exists for all of the derivative financial instruments the Company currently holds, as these instruments may become less valuable due to adverse changes in market conditions. To limit this risk, the Company’s senior management has established risk control limits. In addition, changes in fair value of the derivative financial instruments that the Company uses for risk management purposes are generally offset by the change in the fair value or cash flows of the hedged risk component of the related assets, liabilities or forecasted transactions.
Certain of the Company’s derivative instruments contain credit-risk-contingent termination events, cross-default provisions and credit support annex agreements. Credit-risk-contingent termination events allow the counterparties to terminate the derivative on certain dates if the Company’s financial strength credit ratings by Moody’s or S&P fall below a certain level or in the event the Company is no longer rated by both Moody’s and S&P. Credit-risk-contingent cross-default provisions allow the counterparties to terminate the derivative instruments if the Company defaults by pre-determined threshold amounts on certain debt instruments. Credit-risk-contingent credit support annex agreements specify the amount of collateral the Company must post to counterparties based on the Company’s financial strength credit ratings by Moody’s or S&P, or in the event the Company is no longer rated by both Moody’s and S&P.
The maximum amount of additional exposure for contracts with credit-risk contingent features if all features were triggered is $100 thousand.
5. Reinsurance
The effects of reinsurance on premiums and contract charges are as follows:
($ in thousands) |
| Three months ended |
| ||||
|
| 2009 |
| 2008 |
| ||
Premiums and contract charges |
|
|
|
|
| ||
Direct |
| $ | 36,314 |
| $ | 34,053 |
|
Assumed — non-affiliate |
| 200 |
| 286 |
| ||
Ceded |
|
|
|
|
| ||
Affiliate |
| (4,418 | ) | (992 | ) | ||
Non-affiliate |
| (6,906 | ) | (8,665 | ) | ||
Premiums and contract charges, net of reinsurance |
| $ | 25,190 |
| $ | 24,682 |
|
The effects of reinsurance on contract benefits are as follows:
($ in thousands) |
| Three months ended |
| ||||
|
| 2009 |
| 2008 |
| ||
Contract benefits |
|
|
|
|
| ||
Direct |
| $ | 53,826 |
| $ | 45,846 |
|
Assumed — non-affiliate |
| 197 |
| 276 |
| ||
Ceded |
|
|
|
|
| ||
Affiliate |
| (2,430 | ) | (1,494 | ) | ||
Non-affiliate |
| (13,814 | ) | (5,823 | ) | ||
Contract benefits, net of reinsurance |
| $ | 37,779 |
| $ | 38,805 |
|
15
The effects of reinsurance on interest credited to contractholder funds are as follows:
($ in thousands) |
| Three months ended |
| ||||
|
| 2009 |
| 2008 |
| ||
Interest credited to contractholder funds |
|
|
|
|
| ||
Direct |
| $ | 59,161 |
| $ | 46,295 |
|
Assumed — non-affiliate |
| — |
| 9 |
| ||
Ceded — non-affiliate |
| (2,327 | ) | (3,003 | ) | ||
Interest credited to contractholder funds, net of reinsurance |
| $ | 56,834 |
| $ | 43,301 |
|
In addition to amounts included in the tables above are reinsurance premiums ceded to ALIC of $836 thousand and $819 thousand for the three months ended March 31, 2009 and 2008, respectively, under the terms of the structured settlement annuity reinsurance agreement. These amounts are reflected as a component of realized capital gains and losses on the Condensed Statements of Operations as the treaty is recorded as a derivative instrument pursuant to the requirements of SFAS No. 133.
6. Guarantees and Contingent Liabilities
Guaranty funds
Under state insurance guaranty fund laws, insurers doing business in a state can be assessed, up to prescribed limits, for certain obligations of insolvent insurance companies to policyholders and claimants. Amounts assessed to each company are typically related to its proportion of business written in each state. The Company’s policy is to accrue a guaranty fund assessment when the entity for which the insolvency relates has been declared financially insolvent by a court of competent jurisdiction and, in certain states, that is also a final order of liquidation, and the amount of loss is reasonably estimable.
The New York Liquidation Bureau (the “Bureau”) has publicly reported that Executive Life Insurance Company of New York (“Executive Life”) is currently under its jurisdiction as part of a 1992 court-ordered rehabilitation plan and may only be able to meet future obligations of its annuity contacts for the next fifteen years. However, Executive Life does not have a liquidity problem at this time, and an order of liquidation has not been sought by the Bureau. The shortfall was estimated by the Bureau to be $1.27 billion at October 29, 2008.
If Executive Life were to be declared insolvent in the future, the Company may have exposure to future guaranty fund assessments. The Company’s exposure will ultimately depend on the level of guaranty fund system participation, as well as the viability of a plan of the Bureau to obtain voluntary contributions, primarily from the original insurance companies that acquired structured settlement annuity contracts from Executive Life. Under current law, the Company may be allowed to recoup a portion of the amount of any additional guaranty fund assessment in periods subsequent to the recognition of the assessment by offsetting future premium taxes. The Company’s New York market share was approximately 4.1% in 2007 based on industry annuity premium.
Guarantees
Related to the disposal through reinsurance of our variable annuity business to Prudential Financial, Inc. and its subsidiary in 2006, the Company and ALIC, have agreed to indemnify Prudential for certain pre-closing contingent liabilities (including extra-contractual liabilities of the Company and ALIC and liabilities specifically excluded from the transaction) that Company and ALIC have agreed to retain. In addition, the Company and ALIC will each indemnify Prudential for certain post-closing liabilities that may arise from the acts of the Company and ALIC and their agents, including in connection with the Company’s and ALIC’s provision of transition services. The Reinsurance Agreements contain no limitations or indemnifications with regard to insurance risk transfer, and transferred all of the future risks and responsibilities for performance on the underlying variable annuity contracts to Prudential, including those related to benefit guarantees, in accordance with the provisions of SFAS No. 113 “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts”. Management does not believe this agreement will have a material adverse effect on results of operations, cash flows or financial position of the Company.
16
In the normal course of business, the Company provides standard indemnifications to contractual counterparties in connection with numerous transactions, including acquisitions and divestures. The types of indemnifications typically provided include indemnifications for breaches of representations and warranties, taxes and certain other liabilities, such as third party lawsuits. The indemnification clauses are often standard contractual terms and are entered into in the normal course of business based on an assessment that the risk of loss would be remote. The terms of the indemnifications vary in duration and nature. In many cases, the maximum obligation is not explicitly stated and the contingencies triggering the obligation to indemnify have not occurred and are not expected to occur. Consequently, the maximum amount of the obligation under such indemnifications is not determinable. Historically, the Company has not made any material payments pursuant to these obligations.
The aggregate liability balance related to all guarantees was not material as of March 31, 2009.
Regulation
The Company is subject to changing social, economic and regulatory conditions. From time to time regulatory authorities or legislative bodies seek to impose additional regulations regarding agent and broker compensation and otherwise expand overall regulation of insurance products and the insurance industry. The ultimate changes and eventual effects of these initiatives on the Company’s business, if any, are uncertain.
Legal and regulatory proceedings and inquiries
Background
The Company and certain affiliates are involved in a number of lawsuits, regulatory inquiries, and other legal proceedings arising out of various aspects of its business. As background to the “Proceedings” subsection below, please note the following:
· These matters raise difficult and complicated factual and legal issues and are subject to many uncertainties and complexities, including the underlying facts of each matter; novel legal issues; variations between jurisdictions in which matters are being litigated, heard or investigated; differences in applicable laws and judicial interpretations; the length of time before many of these matters might be resolved by settlement, through litigation or otherwise; the fact that some of the lawsuits are putative class actions in which a class has not been certified and in which the purported class may not be clearly defined; the fact that some of the lawsuits involve multi-state class actions in which the applicable law(s) for the claims at issue is in dispute and therefore unclear; and the current challenging legal environment faced by large corporations and insurance companies.
· The outcome of these matters may also be affected by decisions, verdicts, and settlements, and the timing of such decisions, verdicts, and settlements, in other individual and class action lawsuits that involve the Company, other insurers, or other entities and by other legal, governmental, and regulatory actions that involve the Company, other insurers, or other entities.
· In the lawsuits, plaintiffs seek a variety of remedies including equitable relief in the form of injunctive and other remedies and monetary relief in the form of contractual and extra-contractual damages. In some cases, the monetary damages sought include punitive damages. Often specific information about the relief sought, such as the amount of damages, is not available because plaintiffs have not requested specific relief in their pleadings. In the Company’s experience, when specific monetary demands are made in pleadings, they bear little relation to the ultimate loss, if any, to the Company.
· In connection with regulatory examinations and proceedings, government authorities may seek various forms of relief, including penalties, restitution and changes in business practices. The Company may not be advised of the nature and extent of relief sought until the final stages of the examination or proceeding.
· For the reasons specified above, it is often not possible to make meaningful estimates of the amount or range of loss that could result from the matters described below in the “Proceedings” subsection. The Company reviews these matters on an ongoing basis and follows the provisions of SFAS No. 5, “Accounting for Contingencies”, when making accrual and disclosure decisions. When assessing reasonably possible and probable outcomes, the Company bases its decisions on its assessment of the ultimate outcome following all appeals.
17
· Due to the complexity and scope of the matters disclosed in the “Proceedings” subsection below and the many uncertainties that exist, the ultimate outcome of these matters cannot be reasonably predicted. In the event of an unfavorable outcome in one or more of these matters, the ultimate liability may be in excess of amounts currently reserved, if any, and may be material to the Company’s operating results or cash flows for a particular quarterly or annual period. However, based on information currently known to it, management believes that the ultimate outcome of all matters described below, as they are resolved over time, is not likely to have a material adverse effect on the financial position of the Company.
Proceedings
Legal proceedings involving Allstate agencies and AIC may impact the Company, even when the Company is not directly involved, because the Company sells its products through a variety of distribution channels including Allstate agencies. Consequently, information about the more significant of these proceedings is provided in the following paragraph.
AIC is defending certain matters relating to its agency program reorganization announced in 1999. These matters are in various stages of development.
· These matters include a lawsuit filed in 2001 by the U.S. Equal Employment Opportunity Commission (“EEOC”) alleging retaliation under federal civil rights laws (the “EEOC I” suit) and a class action filed in 2001 by former employee agents alleging retaliation and age discrimination under the Age Discrimination in Employment Act (“ADEA”), breach of contract and ERISA violations (the “Romero I” suit). In 2004, in the consolidated EEOC I and Romero I litigation, the trial court issued a memorandum and order that, among other things, certified classes of agents, including a mandatory class of agents who had signed a release, for purposes of effecting the court’s declaratory judgment that the release is voidable at the option of the release signer. The court also ordered that an agent who voids the release must return to AIC “any and all benefits received by the [agent] in exchange for signing the release.” The court also stated that, “on the undisputed facts of record, there is no basis for claims of age discrimination.” The EEOC and plaintiffs have asked the court to clarify and/or reconsider its memorandum and order and in January 2007, the judge denied their request. In June 2007, the court granted AIC’s motions for summary judgment. Following plaintiffs’ filing of a notice of appeal, the Third Circuit issued an order in December 2007 stating that the notice of appeal was not taken from a final order within the meaning of the federal law and thus not appealable at this time. In March 2008, the Third Circuit decided that the appeal should not summarily be dismissed and that the question of whether the matter is appealable at this time will be addressed by the Court along with the merits of the appeal.
· The EEOC also filed another lawsuit in 2004 alleging age discrimination with respect to a policy limiting the rehire of agents affected by the agency program reorganization (the “EEOC II” suit). In EEOC II, in 2006, the court granted partial summary judgment to the EEOC. Although the court did not determine that AIC was liable for age discrimination under the ADEA, it determined that the rehire policy resulted in a disparate impact, reserving for trial the determination on whether AIC had reasonable factors other than age to support the rehire policy. AIC’s interlocutory appeal from the partial summary judgment was granted. In June 2008, the Eighth Circuit Court of Appeals affirmed summary judgment in the EEOC’s favor. In September 2008, the Court of Appeals granted AIC’s petition for rehearing en banc and vacated its earlier decision affirming the trial court’s grant of summary judgment in favor of the EEOC. The Court of Appeals then dismissed the appeal, determining that it lacked jurisdiction to consider the appeal at this stage in the litigation.
· A putative nationwide class action has also been filed by former employee agents alleging various violations of ERISA, including a worker classification issue. These plaintiffs are challenging certain amendments to the Agents Pension Plan and are seeking to have exclusive agent independent contractors treated as employees for benefit purposes. This matter was dismissed with prejudice by the trial court, was the subject of further proceedings on appeal, and was reversed and remanded to the trial court in 2005. In June 2007, the court granted AIC’s motion to dismiss the case. Following plaintiffs’ filing of a notice of appeal, the Third Circuit issued an order in December 2007 stating that the notice of appeal was not taken from a final order within the meaning of the federal law and thus not appealable at this time. In March 2008, the Third Circuit decided that the appeal should not summarily be dismissed and that the question of whether the matter is appealable at this time will be addressed by the Court along with the merits of the appeal.
18
In all of these various matters, plaintiffs seek compensatory and punitive damages, and equitable relief. AIC has been vigorously defending these lawsuits and other matters related to its agency program reorganization.
Other matters
Various other legal, governmental, and regulatory actions, including state market conduct exams, and other governmental and regulatory inquiries are currently pending that involve the Company and specific aspects of its conduct of business. Like other members of the insurance industry, the Company is the target of a number of lawsuits and proceedings, some of which involve claims for substantial or indeterminate amounts. These actions are based on a variety of issues and target a range of the Company’s practices. The outcome of these disputes is currently unpredictable.
One or more of these matters could have an adverse effect on the Company’s operating results or cash flows for a particular quarterly or annual period. However, based on information currently known to it, management believes that the ultimate outcome of all matters described in this “Other matters” subsection, in excess of amounts currently reserved, if any, as they are resolved over time is not likely to have a material effect on the operating results, cash flows or financial position of the Company.
7. Other Comprehensive Income (Loss)
The components of other comprehensive income (loss) on a pre-tax and after-tax basis are as follows:
|
| Three months ended March 31, |
| ||||||||||||||||
|
| 2009 |
| 2008 |
| ||||||||||||||
|
|
|
|
|
| After- |
|
|
|
|
| After- |
| ||||||
($ in thousands) |
| Pre-tax |
| Tax |
| tax |
| Pre-tax |
| Tax |
| tax |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Unrealized holding gains and losses arising during the period, net of related offsets |
| $ | 169,060 |
| $ | (59,171 | ) | $ | 109,889 |
| $ | (34,671 | ) | $ | 12,134 |
| $ | (22,537 | ) |
Less: reclassification adjustment of realized capital gains and losses |
| 92,200 |
| (32,270 | ) | 59,930 |
| 973 |
| (341 | ) | 632 |
| ||||||
Unrealized net capital gains and losses |
| 76,860 |
| (26,901 | ) | 49,959 |
| (35,644 | ) | 12,475 |
| (23,169 | ) | ||||||
Other comprehensive income (loss) |
| $ | 76,860 |
| $ | (26,901 | ) | 49,959 |
| $ | (35,644 | ) | $ | 12,475 |
| (23,169 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net income |
|
|
|
|
| 24,669 |
|
|
|
|
| 21,577 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Comprehensive income (loss) |
|
|
|
|
| $ | 74,628 |
|
|
|
|
| $ | (1,592 | ) |
19
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
Allstate Life Insurance Company of New York:
We have reviewed the accompanying condensed statement of financial position of Allstate Life Insurance Company of New York (the “Company”), an affiliate of The Allstate Corporation, as of March 31, 2009, and the related condensed statements of operations, and cash flows for the three-month periods ended March 31, 2009 and 2008. These interim financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the statement of financial position of Allstate Life Insurance Company of New York as of December 31, 2008, and the related statements of operations and comprehensive income, shareholder’s equity, and cash flows for the year then ended (not presented herein); and in our report dated March 17, 2009, which report includes an explanatory paragraph relating to a change in the Company’s method of accounting for uncertainty in income taxes and accounting for deferred acquisition costs associated with internal replacements in 2007, we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying condensed statement of financial position as of December 31, 2008 is fairly stated, in all material respects, in relation to the statement of financial position from which it has been derived.
/s/ Deloitte & Touche LLP
Chicago, Illinois
May 11, 2009
20
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 2009 AND 2008
OVERVIEW
The following discussion highlights significant factors influencing the condensed financial position and results of operations of Allstate Life Insurance Company of New York (referred to in this document as “we”, “ALNY”, “our”, “us” or the “Company”). It should be read in conjunction with the condensed financial statements and notes thereto found under Part I. Item 1. contained herein, and with the discussion, analysis, financial statements and notes thereto in Part I. Item 1. and Part II. Item 7. and Item 8. of the Allstate Life Insurance Company of New York Annual Report on Form 10-K for 2008. We operate as a single segment entity based on the manner in which we use financial information to evaluate business performance and determine the allocation of resources.
OPERATIONS
Summarized financial data is presented in the following table.
($ in thousands) |
| Three months ended |
| ||||
|
| 2009 |
| 2008 |
| ||
Revenues |
|
|
|
|
| ||
Premiums |
| $ | 11,464 |
| $ | 10,011 |
|
Contract charges |
| 13,726 |
| 14,671 |
| ||
Net investment income |
| 93,678 |
| 99,746 |
| ||
Realized capital gains and losses |
| 99,218 |
| 1,721 |
| ||
Total revenues |
| 218,086 |
| 126,149 |
| ||
|
|
|
|
|
| ||
Costs and expenses |
|
|
|
|
| ||
Contract benefits |
| (37,779 | ) | (38,805 | ) | ||
Interest credited to contractholder funds |
| (56,834 | ) | (43,301 | ) | ||
Amortization of DAC |
| (72,667 | ) | (1,451 | ) | ||
Operating costs and expenses |
| (12,789 | ) | (9,022 | ) | ||
Total costs and expenses |
| (180,069 | ) | (92,579 | ) | ||
|
|
|
|
|
| ||
Loss on disposition of operations |
| — |
| (268 | ) | ||
Income tax expense |
| (13,348 | ) | (11,725 | ) | ||
Net income |
| $ | 24,669 |
| $ | 21,577 |
|
|
|
|
|
|
| ||
Investments at March 31 |
| $ | 6,645,075 |
| $ | 7,244,411 |
|
Net income in the first quarter of 2009 of $24.7 million compared to $21.6 million in the same period of 2008. The increase in net income of $3.1 million was primarily the result of higher realized capital gains, partially offset by deferred policy acquisition costs (“DAC”) and deferred sales inducement costs (“DSI”) amortization acceleration for changes in assumptions and lower net investment income.
Analysis of Revenues Total revenues increased 72.9% or $91.9 million in the first quarter of 2009 compared to the same period of 2008 due to higher net realized capital gains, partially offset by lower net investment income and contract charges.
Premiums represent revenues generated from traditional life insurance, immediate annuities with life contingencies, and accident and health insurance products that have significant mortality or morbidity risk.
Contract charges are revenues generated from interest-sensitive and variable life insurance, and fixed annuities for which deposits are classified as contractholder funds or separate accounts liabilities. Contract charges are assessed against the contractholder account values for maintenance, administration, cost of insurance and surrender prior to the contractually specified dates. As a result, changes in contractholder funds are considered in the evaluation of growth and as indicators of future levels of revenues.
21
The following table summarizes premiums and contract charges by product.
($ in thousands) |
| Three months ended |
| ||||
|
| 2009 |
| 2008 |
| ||
Premiums |
|
|
|
|
| ||
Traditional life insurance (1) |
| $ | 5,590 |
| $ | 5,933 |
|
Immediate annuities with life contingencies |
| 3,588 |
| 2,150 |
| ||
Accident and health |
| 2,286 |
| 1,928 |
| ||
Total premiums |
| 11,464 |
| 10,011 |
| ||
|
|
|
|
|
| ||
Contract charges |
|
|
|
|
| ||
Interest-sensitive life insurance (1) |
| 12,498 |
| 12,902 |
| ||
Fixed annuities |
| 1,228 |
| 1,769 |
| ||
Total contract charges (2) |
| 13,726 |
| 14,671 |
| ||
Premiums and contract charges |
| $ | 25,190 |
| $ | 24,682 |
|
(1) To conform to the current period presentation, certain amounts in the prior period have been reclassified.
(2) Total contract charges for the first quarter of 2009 and 2008 include contract charges related to the cost of insurance totaling $8.0 million and $9.6 million, respectively.
Total premiums increased 14.5% in the first quarter of 2009 compared to the same period of 2008 due primarily to higher sales of immediate annuities with life contingencies, partially offset by lower traditional life insurance premiums. The decline in premiums on traditional life insurance was the result of higher premiums ceded to ALIC due to a greater utilization of reinsurance.
Total contract charges decreased 6.4% in the first quarter of 2009 compared to the same period of 2008 due to lower contract charges on fixed annuities and interest-sensitive life insurance policies. The decline in contract charges on fixed annuities was primarily the result of lower surrender charges. The decline in contract charges on interest-sensitive life insurance policies was the result of higher cost of insurance contract charges ceded to ALIC due to a greater utilization of reinsurance, partially offset by increased contract charge rates.
22
Contractholder funds represent interest-bearing liabilities arising from the sale of fixed annuities, interest-sensitive life insurance policies and variable annuity and life deposits allocated to fixed accounts. The balance of contractholder funds is equal to the cumulative deposits received and interest credited to the contractholder less cumulative contract maturities, benefits, surrenders, withdrawals and contract charges for mortality or administrative expenses. The following table shows the changes in contractholder funds.
|
| Three months ended |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Contractholder funds, beginning balance |
| $ | 5,086,965 |
| $ | 4,848,461 |
|
|
|
|
|
|
| ||
Deposits |
|
|
|
|
| ||
Fixed annuities |
| 77,097 |
| 92,125 |
| ||
Interest-sensitive life insurance |
| 25,774 |
| 25,982 |
| ||
Variable life deposits allocated to fixed accounts |
| 13 |
| 11 |
| ||
Total deposits |
| 102,884 |
| 118,118 |
| ||
|
|
|
|
|
| ||
Interest credited |
| 47,629 |
| 45,116 |
| ||
|
|
|
|
|
| ||
Benefits, withdrawals and other adjustments |
|
|
|
|
| ||
Benefits |
| (42,276 | ) | (41,213 | ) | ||
Surrenders and partial withdrawals |
| (74,276 | ) | (83,607 | ) | ||
Contract charges |
| (13,775 | ) | (12,837 | ) | ||
Net transfers to separate accounts |
| (17 | ) | (5 | ) | ||
Other adjustments (1) |
| (5,679 | ) | (7,805 | ) | ||
Total benefits, withdrawals and other adjustments |
| (136,023 | ) | (145,467 | ) | ||
Contractholder funds, ending balance |
| $ | 5,101,455 |
| $ | 4,866,228 |
|
(1) The table above illustrates the changes in contractholder funds, which are presented gross of reinsurance recoverables on the Condensed Statements of Financial Position. The table above is intended to supplement our discussion and analysis of revenues, which are presented net of reinsurance on the Condensed Statements of Operations. As a result, the net change in contractholder funds associated with products reinsured to third parties is reflected as a component of the other adjustments line.
Contractholder funds increased 0.3% and 0.4% in the first quarter of 2009 and 2008, respectively. Average contractholder funds increased 4.9% in the first quarter of 2009 compared to the first quarter of 2008.
Contractholder deposits decreased 12.9% in the first quarter of 2009 compared to the same period of 2008 due primarily to lower deposits on fixed annuities. Deposits on fixed annuities decreased 16.3% in the first quarter of 2009 compared to the same period of 2008 due to pricing actions relating to our efforts to improve returns on new business and reduce our concentration in spread based products as well as highly competitive market conditions.
Surrenders and partial withdrawals on deferred fixed annuities and interest-sensitive life insurance products decreased 11.2% to $74.3 million in the first quarter of 2009 from $83.6 million in the same period of 2008 due to a 12.6% reduction in surrenders and partial withdrawals on fixed annuities. The annualized surrender and partial withdrawal rate on deferred fixed annuities and interest-sensitive life products, based on the beginning of period contractholder funds, was 7.1% in the first quarter of 2009 compared to 8.5% in the first quarter of 2008.
Net investment income decreased 6.1% or $6.1 million to $93.7 million in the first quarter of 2009 compared to $99.7 million in the same period of 2008. For further discussion of net investment income, see the Investments section of the MD&A.
Net realized capital gains and losses reflected net gains of $99.2 million and $1.7 million in the first quarters of 2009 and 2008, respectively. For further discussion of realized capital gains and losses, see the Investments section of the MD&A.
Analysis of Costs and Expenses Total costs and expenses increased 94.5% or $87.5 million in the first quarter of 2009 compared with the same period of 2008 due to higher amortization of DAC, interest credited to contractholder funds and operating costs and expenses, partially offset by lower contract benefits.
23
Contract benefits decreased 2.6% in the first quarter of 2009 compared to the same period of 2008 due primarily to improved mortality experience on life insurance products.
We analyze our mortality and morbidity results using the difference between premiums and contract charges earned for the cost of insurance and contract benefits excluding the portion related to the implied interest on immediate annuities with life contingencies (“benefit spread”). This implied interest totaled $27.7 million and $27.3 million in the first quarter of 2009 and 2008, respectively. The benefit spread by product group is disclosed in the following table.
|
| Three months ended |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Life insurance |
| $ | 9,229 |
| $ | 8,246 |
|
Annuities |
| 91 |
| (987 | ) | ||
Total benefit spread |
| $ | 9,320 |
| $ | 7,259 |
|
Benefit spread increased 28.4% in the first quarter of 2009 compared to the same period of 2008 due primarily to improved mortality experience on life insurance products and growth in life insurance business in force.
Interest credited to contractholder funds increased 31.3% or $13.5 million in the first quarter of 2009 compared to the same period of 2008 due primarily to the acceleration of amortization of DSI due to changes in assumptions, an unfavorable change in amortization of DSI relating to realized capital gains and losses, and higher average contractholder funds. The acceleration of amortization of DSI due to changes in assumptions increased interest credited to contractholder funds by $6.7 million in the first quarter of 2009 compared to amortization deceleration which decreased interest credited to contractholder funds by $2.1 million in the first quarter of 2008.
In order to analyze the impact of net investment income and interest credited to contractholders on net income, we monitor the difference between net investment income and the sum of interest credited to contractholder funds and the implied interest on immediate annuities with life contingencies, which is included as a component of contract benefits on the Condensed Statements of Operations (“investment spread”).
The investment spread by product group is shown in the following table.
|
| Three months ended |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Annuities |
| $ | (11 | ) | $ | 17,276 |
|
Life insurance |
| 32 |
| 1,038 |
| ||
Net investment income on investments supporting capital |
| 9,157 |
| 10,850 |
| ||
Total investment spread |
| $ | 9,178 |
| $ | 29,164 |
|
Investment spread declined 68.5% in the first quarter of 2009 compared to the same period of 2008 due primarily to the acceleration of amortization of DSI due to changes in assumptions and lower net investment income.
24
To further analyze investment spreads, the following table summarizes the weighted average investment yield on assets supporting product liabilities and capital, interest crediting rates and investment spreads for the three months ended March 31.
|
| Weighted average |
| Weighted average |
| Weighted average |
| ||||||
|
| 2009 |
| 2008 |
| 2009 |
| 2008 |
| 2009 |
| 2008 |
|
Interest-sensitive life insurance |
| 5.1 | % | 5.8 | % | 4.9 | % | 4.4 | % | 0.2 | % | 1.4 | % |
Deferred fixed annuities |
| 5.1 |
| 5.6 |
| 3.4 |
| 3.4 |
| 1.7 |
| 2.2 |
|
Immediate fixed annuities with and without life contingencies |
| 6.5 |
| 7.3 |
| 6.5 |
| 6.6 |
| — |
| 0.7 |
|
Investments supporting capital, traditional life and other products |
| 5.2 |
| 6.2 |
| N/A |
| N/A |
| N/A |
| N/A |
|
The following table summarizes our product liabilities and indicates the account value of those contracts and policies in which an investment spread is generated.
|
| March 31, |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Immediate fixed annuities with life contingencies |
| $ | 1,654,405 |
| $ | 1,625,280 |
|
Other life contingent contracts and other |
| 152,130 |
| 402,161 |
| ||
Reserve for life-contingent contract benefits |
| $ | 1,806,535 |
| $ | 2,027,441 |
|
|
|
|
|
|
| ||
Interest-sensitive life |
| $ | 585,160 |
| $ | 542,361 |
|
Deferred fixed annuities |
| 3,883,565 |
| 3,737,663 |
| ||
Immediate fixed annuities without life contingencies and other |
| 632,730 |
| 586,204 |
| ||
Contractholder funds |
| $ | 5,101,455 |
| $ | 4,866,228 |
|
Amortization of DAC increased $71.2 million in the first quarter of 2009 compared to the same period of 2008. The increase in the first quarter of 2009 was primarily attributable to amortization acceleration for changes in assumptions for our annuities and an unfavorable change in (amortization) accretion relating to realized capital gains and losses. The components of amortization of DAC are summarized in the following table.
|
| Three months ended |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Amortization of DAC before amortization relating to realized capital gains and losses and changes in assumptions |
| $ | (14,238 | ) | $ | (10,919 | ) |
Amortization (acceleration) deceleration for changes in assumptions (“DAC unlocking”) |
| (41,924 | ) | 8,764 |
| ||
(Amortization) accretion relating to realized capital gains and losses (1) |
| (16,505 | ) | 704 |
| ||
Total amortization of DAC |
| $ | (72,667 | ) | $ | (1,451 | ) |
(1) |
| The impact of realized capital gains and losses on amortization of DAC is dependent upon the relationship between the assets that give rise to the gain or loss and the product liability supported by the assets. Fluctuations result from changes in the impact of realized capital gains and losses on actual and expected gross profits. |
During the first quarter of 2009, we completed our annual comprehensive review of the profitability of investment products to determine DAC balances for our interest-sensitive life insurance and annuity contracts. The review covered assumptions for investment returns, including capital gains and losses, interest crediting rates to policyholders, the effect of any hedges, persistency, mortality and expenses in all product lines. This review resulted in an acceleration of DAC amortization (charge to income) totaling $41.9 million pre-tax, including amortization acceleration of $45.2 million related to fixed annuities, partially offset by amortization deceleration of
25
$3.3 million related to interest-sensitive life insurance. The principal assumption impacting estimated future gross profits and the related DAC amortization for fixed annuities was an increase in the level of expected realized capital losses in 2009 and 2010 and, to a lesser extent, reduced investment spread. Reduced estimated future gross profits for fixed annuities resulted in accelerated DAC amortization. For our interest-sensitive life insurance products, the amortization deceleration was due to higher estimated future gross profits due to a favorable change in our mortality assumptions, partially offset by increased expected capital losses and, to a lesser extent, reduced investment spread.
In the first quarter of 2008, our annual comprehensive review of the profitability of investment products resulted in the deceleration of DAC amortization (credit to income) for changes in assumptions of $8.8 million, including $6.5 million related to fixed annuities and $2.3 million related to interest-sensitive life insurance. The first quarter 2008 net amortization deceleration of $6.5 million on fixed annuities was due primarily to higher than expected investment spreads partially offset by increased expenses. The first quarter 2008 net amortization deceleration of $2.3 million on interest-sensitive life insurance was due to higher than expected benefit spreads partially offset by increased expenses.
The following table provides the effect on DAC amortization of changes in assumptions relating to the gross profit components of investment margin, benefit margin and expense margin.
|
| Three months ended |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Investment margin |
| $ | (50,219 | ) | $ | 8,497 |
|
Benefit margin |
| 7,483 |
| 4,029 |
| ||
Expense margin |
| 812 |
| (3,762 | ) | ||
Net (acceleration) deceleration |
| $ | (41,924 | ) | $ | 8,764 |
|
Operating costs and expenses increased 41.8% or $3.8 million in the first quarter of 2009 compared to the same period of 2008 due primarily to higher restructuring expenses and increased assessments from the New York State Insurance Department for administrative costs. Restructuring expenses in the first quarter of 2009 were recorded in connection with our previously announced plan to improve efficiency and narrow our focus of product offerings.
Income tax expense increased 13.8% or $1.6 million in the first quarter of 2009 compared to the same period in the prior year due to higher income from operations before income tax expense.
INVESTMENTS
We continue to make progress on strategic risk mitigation efforts toward reducing portfolio risk and overall exposure to commercial real estate. Commercial real estate exposure was reduced by $60.2 million through targeted dispositions and principal repayments from borrowers. Additionally, through ongoing asset liability management practices, we reduced the duration gap between our fixed income portfolio and our liabilities to lessen our exposure to increases in interest rates.
The composition of the investment portfolio at March 31, 2009 is presented in the table below.
($ in thousands) |
| Investments |
| Percent |
| |
Fixed income securities (1) |
| $ | 5,031,358 |
| 75.7 | % |
Mortgage loans |
| 670,446 |
| 10.1 |
| |
Equity securities (2) |
| 72 |
| — |
| |
Short-term (3) |
| 900,839 |
| 13.6 |
| |
Policy loans |
| 40,019 |
| 0.6 |
| |
Other |
| 2,341 |
| — |
| |
Total |
| $ | 6,645,075 |
| 100.0 | % |
(1) Fixed income securities are carried at fair value. Amortized cost basis for these securities was $5.48 billion.
(2) Equity securities are carried at fair value. Cost basis for these securities was $80 thousand.
(3) Short-term investments are carried at fair value. Amortized cost basis for these investments was $900.8 million.
26
Total investments at March 31, 2009 were slightly lower than at December 31, 2008 as increased unrealized net capital losses were almost entirely offset by positive operating cash flows and increased funds associated with collateral received in connection with securities lending.
Total investments at amortized cost related to collateral received in connection with securities lending business activities increased to $151.1 million at March 31, 2009, from $117.3 million at December 31, 2008. These investments are included as a component of short-term investments.
Fixed income securities are listed in the table below.
($ in thousands) |
| Fair value at |
| Percent to |
| Fair value at |
| Percent to |
| ||
U.S. government and agencies |
| $ | 529,808 |
| 8.0 | % | $ | 917,731 |
| 13.8 | % |
Municipal |
| 402,410 |
| 6.1 |
| 385,381 |
| 5.8 |
| ||
Corporate |
| 2,765,299 |
| 41.6 |
| 2,887,137 |
| 43.4 |
| ||
Foreign government |
| 312,765 |
| 4.7 |
| 371,542 |
| 5.6 |
| ||
Mortgage-backed securities (“MBS”) |
| 506,969 |
| 7.6 |
| 396,177 |
| 6.0 |
| ||
Commercial mortgage-backed securities (“CMBS”) |
| 454,935 |
| 6.8 |
| 468,868 |
| 7.0 |
| ||
Asset-backed securities (“ABS”) |
| 53,838 |
| 0.8 |
| 64,070 |
| 1.0 |
| ||
Redeemable preferred stock |
| 5,334 |
| 0.1 |
| 5,459 |
| 0.1 |
| ||
Total fixed income securities |
| $ | 5,031,358 |
| 75.7 | % | $ | 5,496,365 |
| 82.7 | % |
At March 31, 2009, 96.7% of the fixed income securities portfolio was rated investment grade, which is defined as a security having a rating from the National Association of Insurance Commissioners (“NAIC”) of 1 or 2; a rating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from Standard and Poor’s (“S&P”), Fitch or Dominion or a rating of aaa, aa, a or bbb from A.M. Best; or a comparable internal rating if an externally provided rating is not available.
Municipal Bonds totaled $402.4 million at March 31, 2009, substantially all of which are taxable. The following table summarizes the municipal bond portfolio by Moody’s equivalent rating as of March 31, 2009.
($ in thousands) |
| Par |
| Amortized |
| Fair |
| Unrealized |
| Fair value |
| ||||
Rating |
|
|
|
|
|
|
|
|
|
|
| ||||
Aaa |
| $ | 139,240 |
| $ | 114,129 |
| $ | 100,098 |
| $ | (14,031 | ) | 87.7 | % |
Aa |
| 204,111 |
| 123,309 |
| 112,919 |
| (10,390 | ) | 91.6 |
| ||||
A (2) |
| 163,131 |
| 131,690 |
| 109,241 |
| (22,449 | ) | 83.0 |
| ||||
Baa (3) |
| 194,245 |
| 99,987 |
| 78,852 |
| (21,135 | ) | 78.9 |
| ||||
Ba or lower (3) |
| 2,000 |
| 2,071 |
| 1,300 |
| (771 | ) | 62.8 |
| ||||
Total (1) |
| $ | 702,727 |
| $ | 471,186 |
| $ | 402,410 |
| $ | (68,776 | ) | 85.4 |
|
(1) |
| Includes auction rate securities (“ARS”) with par value of $105.6 million, amortized cost of $105.6 million, fair value of $92.8 million and unrealized capital losses of $12.8 million. For a more detailed discussion on ARS, see the Allstate Life Insurance Company of New York Annual Report on Form 10-K for 2008. |
|
|
|
(2) |
| Includes pre-refunded municipals with fair values of $2.5 million at March 31, 2009. Pre-refunded municipals are generally escrowed by Aaa rated securities, such as U.S. government or governmental agency securities. |
|
|
|
(3) |
| On April 13, 2009, one of the bond insurers, Ambac Assurance Corporation, was downgraded by Moody’s from a rating of Baa to Ba. We estimate that this will impact the classification of the Moody’s equivalent rating for approximately $17.0 million of fair value of insured municipal bonds. |
The unrealized net capital loss of $68.8 million at March 31, 2009 in our municipal bond portfolio is driven primarily by higher yields, including widening credit spreads, since the time of initial purchase.
Corporate bonds totaled $2.77 billion of March 31, 2009. As of March 31, 2009, $1.25 billion or 45.2% consisted of privately placed corporate securities, compared to $1.33 billion or 45.9% at December 31, 2008. Privately placed securities primarily consist of corporate issued senior debt securities that are in unregistered form or are directly
27
negotiated with the borrower. Privately placed corporate securities are rated by the NAIC in instances when information is provided to them. Approximately 33.9% of the privately placed corporate securities in our portfolio are rated by an independent rating agency.
The following table summarizes the corporate fixed income portfolio by Moody’s equivalent rating as of March 31, 2009.
|
| Corporate-Public |
| Corporate-Private |
| Total Corporate |
| ||||||||||||
($ in thousands) |
| Fair |
| Unrealized |
| Fair |
| Unrealized |
| Fair |
| Unrealized |
| ||||||
Rating (1) |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Aaa |
| $ | — |
| $ | — |
| $ | 96,568 |
| $ | 1,191 |
| $ | 96,568 |
| $ | 1,191 |
|
Aa |
| 93,662 |
| 448 |
| 90,949 |
| (2,261 | ) | 184,611 |
| (1,813 | ) | ||||||
A |
| 605,007 |
| (31,263 | ) | 347,248 |
| (16,227 | ) | 952,255 |
| (47,490 | ) | ||||||
Baa |
| 727,902 |
| (89,133 | ) | 602,073 |
| (75,142 | ) | 1,329,975 |
| (164,275 | ) | ||||||
Ba or lower |
| 87,555 |
| (25,293 | ) | 114,335 |
| (43,740 | ) | 201,890 |
| (69,033 | ) | ||||||
Total |
| $ | 1,514,126 |
| $ | (145,241 | ) | $ | 1,251,173 |
| $ | (136,179 | ) | $ | 2,765,299 |
| $ | (281,420 | ) |
The unrealized net capital loss of $281.4 million at March 31, 2009 was driven primarily by widening credit spreads since the time of initial purchase resulting from deteriorating macro economic conditions and continued credit market deterioration.
Collateralized MBS, CMBS and ABS securities are detailed in the following table by Moody’s equivalent rating as of March 31, 2009.
($ in thousands) |
| Fair value |
| Percent to total |
| Aaa |
| Aa |
| A |
| Baa (1) |
| Ba or |
| |
MBS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
U.S. government sponsored entities (“U.S. Agency”) |
| $ | 442,479 |
| 6.7 | % | 100.0 | % | — |
| — |
| — |
| — |
|
Prime residential mortgage-backed securities (“Prime”) |
| 41,616 |
| 0.6 |
| 100.0 |
| — |
| — |
| — |
| — |
| |
Alt-A residential mortgage-backed securities (“Alt-A”) |
| 22,874 |
| 0.3 |
| 100.0 |
| — |
| — |
| — |
| — |
| |
Total MBS |
| $ | 506,969 |
| 7.6 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
CMBS |
| $ | 454,935 |
| 6.8 | % | 88.2 |
| 4.8 | % | 5.6 | % | 1.4 | % | — |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
ABS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Asset-backed residential mortgage-backed securities (“ABS RMBS”) non-insured |
| $ | 28,131 |
| 0.4 |
| 29.1 |
| 36.8 |
| 1.8 |
| 4.5 |
| 27.8 | % |
ABS RMBS insured |
| 6,973 |
| 0.1 |
| — |
| 3.2 |
| 2.2 |
| 46.5 |
| 48.1 |
| |
Total ABS RMBS |
| 35,104 |
| 0.5 |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Other collateralized debt obligations (“other CDO”) |
| 18,734 |
| 0.3 |
| 26.9 |
| — |
| 58.7 |
| — |
| 14.4 |
| |
Total ABS |
| $ | 53,838 |
| 0.8 | % |
|
|
|
|
|
|
|
|
|
|
(1) On April 13, 2009, one of the bond insurers, Ambac Assurance Corporation, was downgraded by Moody’s from a rating of Baa to Ba. We estimate that this will impact the classification for the Moody’s equivalent rating for approximately $3.2 million of carrying value of insured ABS RMBS.
During the first quarter of 2009, certain financial markets continued to experience depressed prices due to market and liquidity disruptions. We experienced this illiquidity and disruption in certain of our MBS, CMBS and ABS fixed income securities, particularly in our Prime, Alt-A, CMBS, ABS RMBS, and other CDO portfolios. These portfolios totaled $573.3 million, or 8.6% of our total investments at March 31, 2009.
We determine the fair values of securities comprising these illiquid portfolios by obtaining information from an independent third-party valuation service provider and brokers. We confirmed the reasonableness of the fair value of these portfolios as of March 31, 2009 by analyzing available market information including, but not limited to, collateral quality, anticipated cash flows, credit enhancements, default rates, loss severities, securities’ relative position within their respective capital structures, and credit ratings from statistical rating agencies.
28
The following table summarizes our illiquid portfolios as of March 31, 2009.
($ in thousands) |
| Par |
| Amortized |
| Amortized cost |
| Fair |
| Fair value as a |
| Unrealized |
| ||||
MBS |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Prime |
| $ | 46,081 |
| $ | 46,270 |
| 100.4 | % | $ | 41,616 |
| 90.3 | % | $ | (4,654 | ) |
Alt-A |
| 30,000 |
| 29,629 |
| 98.8 |
| 22,874 |
| 76.2 |
| (6,755 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
CMBS |
| 752,781 |
| 715,891 |
| 95.1 |
| 454,935 |
| 60.4 |
| (260,956 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
ABS |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
ABS RMBS |
| 62,555 |
| 55,383 |
| 88.5 |
| 35,104 |
| 56.1 |
| (20,279 | ) | ||||
Other CDO |
| 28,725 |
| 28,725 |
| 100.0 |
| 18,734 |
| 65.2 |
| (9,991 | ) | ||||
Total |
| $ | 920,142 |
| $ | 875,898 |
| 95.2 |
| $ | 573,263 |
| 62.3 |
| $ | (302,635 | ) |
(1) The difference between par value and amortized cost of $44.2 million is primarily attributable to write-downs. Both amounts have been reduced by principal payments.
(2) Amortized cost includes other-than-temporary impairment charges, as applicable.
The following table presents realized capital gains and losses and principal transactions relating to our illiquid portfolios for the three months ended March 31, 2009.
|
| Realized capital gains and losses |
| Principal transactions |
| |||||||||||
($ in thousands) |
| Sales |
| Impairment |
| Change in |
| Sold |
| Principal |
| |||||
MBS |
|
|
|
|
|
|
|
|
|
|
| |||||
Prime |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | 670 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
CMBS |
| (1,024 | ) | (2,248 | ) | (1,478 | ) | 623 |
| 721 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
ABS |
|
|
|
|
|
|
|
|
|
|
| |||||
ABS RMBS |
| — |
| — |
| (253 | ) | 13 |
| 3,335 |
| |||||
Other CDO |
| — |
| — |
| — |
| — |
| 63 |
| |||||
Total |
| $ | (1,024 | ) | $ | (2,248 | ) | $ | (1,731 | ) | $ | 636 |
| $ | 4,789 |
|
Securities included in our illiquid portfolios with a fair value less than 70% of amortized cost as of March 31, 2009 are shown in the following table.
($ in thousands) |
| Fair |
| Unrealized |
| ||
CMBS |
| $ | 100,745 |
| $ | (210,222 | ) |
ABS RMBS |
| 10,509 |
| (15,347 | ) | ||
Other CDO |
| 13,689 |
| (9,148 | ) | ||
Total |
| $ | 124,943 |
| $ | (234,717 | ) |
We continue to believe that the unrealized losses on these securities are not predictive of the ultimate performance of the underlying collateral. In the absence of further deterioration in the collateral relative to our positions in the securities’ respective capital structures, which could be other than temporary, the unrealized losses should reverse over the remaining lives of the securities.
The cash flows of the underlying mortgages or collateral for MBS, CMBS and ABS are generally applied in a pre-determined order and are designed so that each security issued qualifies for a specific original rating. The security issue is typically referred to as the “class”. For example, the “senior” portion or “top” of the capital structure which would originally qualify for a rating of Aaa is referred to as the “Aaa class” and typically has priority in receiving the principal repayments on the underlying mortgages. In a sequential structure, underlying collateral principal repayments are
29
directed to the most senior rated Aaa class in the structure until paid in full, after which principal repayments are directed to the next most senior Aaa class in the structure until it is paid in full. Senior Aaa classes generally share any losses from the underlying collateral on a pro-rata basis after losses are absorbed by classes with lower original ratings including other “junior” or “subordinate” Aaa securities. For certain senior Aaa classes of CMBS, the losses may be shared pro-rata. The underlying mortgages have fixed interest rates, variable interest rates (such as adjustable rate mortgages (“ARM”)) or are hybrid, meaning that they contain features of both fixed and variable rate mortgages.
CMBS totaled $454.9 million, all of which were rated investment grade at March 31, 2009. The CMBS portfolio is subject to credit risk, but unlike other structured securities, is generally not subject to prepayment risk due to protections within the underlying commercial mortgages whereby borrowers are effectively restricted from prepaying their mortgages due to changes in interest rates. Of the CMBS investments, 97.7% are traditional conduit transactions collateralized by pools of commercial mortgages, broadly diversified across property types and geographical area. The remainder consists of non-traditional CMBS such as large loan pools and single borrower transactions.
The following table shows our CMBS portfolio at March 31, 2009 by vintage year, based upon our participation in the capital structure.
($ in thousands) |
|
|
|
|
|
|
|
|
| ||||
Capital structure |
| Par |
| Amortized |
| Fair |
| Unrealized |
| ||||
Aaa |
|
|
|
|
|
|
|
|
| ||||
2007: |
|
|
|
|
|
|
|
|
| ||||
Super senior (3) |
| $ | 60,000 |
| $ | 60,497 |
| $ | 39,071 |
| $ | (21,426 | ) |
Subordinated senior (5) |
| 28,000 |
| 27,068 |
| 6,327 |
| (20,741 | ) | ||||
Subtotal |
| 88,000 |
| 87,565 |
| 45,398 |
| (42,167 | ) | ||||
2006: |
|
|
|
|
|
|
|
|
| ||||
Super senior (3) |
| 28,000 |
| 28,105 |
| 20,308 |
| (7,797 | ) | ||||
Mezzanine senior (4) |
| 37,338 |
| 36,242 |
| 18,123 |
| (18,119 | ) | ||||
Subordinated senior (5) |
| 42,081 |
| 40,291 |
| 11,251 |
| (29,040 | ) | ||||
Subtotal |
| 107,419 |
| 104,638 |
| 49,682 |
| (54,956 | ) | ||||
2005: |
|
|
|
|
|
|
|
|
| ||||
Super senior (3) |
| 51,400 |
| 51,390 |
| 43,982 |
| (7,408 | ) | ||||
Subordinated senior (5) |
| 10,000 |
| 9,871 |
| 4,143 |
| (5,728 | ) | ||||
Subtotal |
| 61,400 |
| 61,261 |
| 48,125 |
| (13,136 | ) | ||||
Pre-2005 (6) |
| 288,996 |
| 289,089 |
| 251,305 |
| (37,784 | ) | ||||
Aaa total |
| 545,815 |
| 542,553 |
| 394,510 |
| (148,043 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Aa |
| 153,307 |
| 152,195 |
| 45,632 |
| (106,563 | ) | ||||
A |
| 53,659 |
| 21,143 |
| 14,793 |
| (6,350 | ) | ||||
Total CMBS |
| $ | 752,781 |
| $ | 715,891 |
| $ | 454,935 |
| $ | (260,956 | ) |
(1) |
| Capital structure classification reflects original ratings which may not be consistent with current ratings due to upgrades and downgrades. |
|
|
|
(2) |
| Amortized cost includes other-than-temporary impairment charges, as applicable. |
|
|
|
(3) |
| Most senior of the Aaa rated tranches, typically has a high level of credit enhancement of approximately 30%, meaning actual losses in the deal have to reach 30% before incurring a first dollar loss. |
|
|
|
(4) |
| Middle Aaa rated tranche, typically having credit enhancement of approximately 20%, are subordinate only to the Super senior bonds. |
|
|
|
(5) |
| Lowest Aaa rated tranche, typically with credit enhancement in the low teens. This bond is subordinate to the Super senior and Mezzanine senior tranches, but still senior to all tranches rated below Aaa. |
|
|
|
(6) |
| Prior to 2005, the Aaa bonds in a transaction were generally not divided into Super senior, Mezzanine senior, or Subordinated senior (with the exception of a few deals structured very late in 2004); therefore all 2004 and prior Aaa-rated securities are grouped into this category. |
30
The unrealized net capital loss of $261.0 million at March 31, 2009 on our CMBS portfolio was a result of widening of credit spreads due to deteriorating macro economic conditions and continued credit market deterioration. Credit spread widening since the time of initial purchase occurred in all rating classes but was particularly evident in our subordinated senior Aaa and lower rated securities. These holdings accounted for $206.2 million, or 79.0%, of the unrealized net capital loss. Our analysis suggests that the vast majority of our CMBS portfolio is well insulated from a severe rise in commercial mortgage default rates.
ABS RMBS includes securities that are collateralized by mortgage loans issued to borrowers that cannot qualify for Prime or Alt-A financing terms due in part to weak or limited credit history. It also includes securities that are collateralized by certain second lien mortgages regardless of the borrower’s credit history. $29.7 million or 84.6% of the ABS RMBS portfolio consisted of securities that were issued during 2005, 2006 and 2007. At March 31, 2009, 20.3% of securities issued during 2005, 2006 and 2007 were rated Aaa, 35.6% rated Aa, 2.3% rated A, 4.2% rated Baa and 37.6% rated Ba or lower.
The following table presents additional information about our ABS RMBS portfolio including a summary by first and second lien collateral at March 31, 2009.
($ in thousands) |
| Fair Value |
| Percent to |
| |
First lien: |
|
|
|
|
| |
Fixed rate (1) |
| $ | 9,908 |
| 0.2 | % |
Variable rate (1) |
| 15,699 |
| 0.2 |
| |
Total first lien (2) |
| 25,607 |
| 0.4 |
| |
Second lien: |
|
|
|
|
| |
Insured |
| 6,436 |
| 0.1 |
| |
Other |
| 3,061 |
| — |
| |
Total second lien (3) |
| 9,497 |
| 0.1 |
| |
Total ABS RMBS |
| $ | 35,104 |
| 0.5 | % |
(1) |
| Fixed rate and variable rate refer to the primary interest rate characteristics of the underlying mortgages at the time of issuance. |
(2) |
| The credit ratings of the first lien ABS RMBS were 23.5% Aaa, 40.4% Aa, 2.6% A, 4.9% Baa and 28.6% Ba or lower at March 31, 2009. |
(3) |
| The credit ratings of the second lien ABS RMBS were 22.7% Aaa, 2.3% Aa, 34.2% Baa and 40.8% Ba or lower at March 31, 2009. |
The following table includes first lien non-insured ABS RMBS by vintage year and the interest rate characteristics of the underlying mortgage product.
|
| Fair value |
|
|
|
|
| |||||||||
($ in thousands) |
| Variable |
| Fixed |
| Total |
| Amortized |
| Unrealized |
| |||||
2007 |
| $ | 2,969 |
| $ | 8,051 |
| $ | 11,020 |
| $ | 15,146 |
| $ | (4,126 | ) |
2006 |
| 12,193 |
| 1,857 |
| 14,050 |
| 18,950 |
| (4,900 | ) | |||||
Total |
| $ | 15,162 |
| $ | 9,908 |
| $ | 25,070 |
| $ | 34,096 |
| $ | (9,026 | ) |
(1) Amortized cost includes other-than-temporary impairment charges, as applicable.
We also own $3.1 million of second lien ABS RMBS non-insured securities, representing 64.9% of amortized cost. $900 thousand, or 29.4%, of this portfolio are 2006 and 2007 vintage years. Together with the first lien non-insured ABS RMBS in the table above, this comprises our $28.1 million of non-insured ABS RMBS.
31
At March 31, 2009, $7.0 million or 19.9% of the total ABS RMBS securities are insured by 4 bond insurers and 51.9% of these insured securities were rated investment grade. The following table shows our insured ABS RMBS portfolio at March 31, 2009 by vintage year for the first lien and second lien collateral.
|
| Vintage year |
| Fair |
| Amortized |
| Unrealized |
| |||||||||||||
($ in thousands) |
| 2007 |
| 2006 |
| 2005 |
| Pre-2005 |
| value |
| cost (1) |
| gain/(loss) |
| |||||||
First lien |
| $ | 381 |
| $ | 156 |
| $ | — |
| $ | — |
| $ | 537 |
| $ | 837 |
| $ | (300 | ) |
Second lien |
| 3,107 |
| — |
| 85 |
| 3,244 |
| 6,436 |
| 15,730 |
| (9,294 | ) | |||||||
Total insured ABS RMBS (2) |
| $ | 3,488 |
| $ | 156 |
| $ | 85 |
| $ | 3,244 |
| $ | 6,973 |
| $ | 16,567 |
| $ | (9,594 | ) |
(1) |
| Amortized cost includes other-than-temporary impairment charges, as applicable. |
|
|
|
(2) |
| The evaluation for other-than-temporary impairment through our portfolio monitoring process considers the current claims paying resources of the individual bond insurers. |
Mortgage Loans Our mortgage loan portfolio was $670.4 million at March 31, 2009 and comprised primarily loans secured by first mortgages on developed commercial real estate. Geographical and property type diversification are key considerations used to manage our exposure. The portfolio is diversified across several property types. Our exposure to any metropolitan area is also highly diversified, with the largest exposure not exceeding 12.2% of the portfolio. The average debt service coverage ratio represents the amount of cash flows available from the property available by the borrower to meet its principal and interest payment obligations. The average debt service coverage ratio of the portfolio as of March 31, 2009 was 1.8, and only 4.0% of the mortgage loan portfolio had a debt service coverage ratio under 1.0.
In the first quarter of 2009, $6.2 million of commercial mortgage loans were contractually due. Of these, 63% were paid as due and 37.0% were extended generally for less than one year. In addition, $8.9 million that were not contractually due in the first quarter of 2009 were paid in full.
The net carrying value of impaired loans at March 31, 2009 and December 31, 2008 was $9.2 million and $3.4 million, respectively. We recognized $637 thousand of realized capital losses related to valuation allowances on mortgage loans for the quarter ended March 31, 2009. Total valuation allowances of $1.1 million were held at March 31, 2009. Realized capital losses due to changes in intent to hold mortgage loans to maturity totaled $686 thousand for the quarter ended March 31, 2009.
32
Unrealized net capital losses totaled $445.1 million as of March 31, 2009, compared to unrealized net capital losses of $278.3 million as of December 31, 2008 as a result of widening credit spreads on certain fixed income securities, increasing risk-free interest rates and realized capital gains through sales. The following table presents unrealized net capital gains and losses, pre-tax and after-tax.
($ in thousands) |
| March 31, 2009 |
| December 31, 2008 |
| ||
U.S. government and agencies |
| $ | 108,695 |
| $ | 241,076 |
|
Municipal |
| (68,776 | ) | (77,283 | ) | ||
Corporate |
| (281,420 | ) | (271,451 | ) | ||
Foreign government |
| 86,652 |
| 109,235 |
| ||
MBS |
| 3,295 |
| (2,001 | ) | ||
CMBS |
| (260,956 | ) | (252,839 | ) | ||
ABS |
| (30,270 | ) | (22,992 | ) | ||
Redeemable preferred stock |
| (3,945 | ) | (3,831 | ) | ||
Fixed income securities |
| (446,725 | ) | (280,086 | ) | ||
Equity securities |
| (8 | ) | — |
| ||
Short-term investments |
| — |
| 65 |
| ||
Derivatives |
| 1,670 |
| 1,749 |
| ||
|
|
|
|
|
| ||
Unrealized net capital gains and losses, pre-tax |
| (445,063 | ) | (278,272 | ) | ||
|
|
|
|
|
| ||
Amounts recognized for: |
|
|
|
|
| ||
Insurance reserves (1) |
| — |
| (155,935 | ) | ||
DAC and DSI (2) |
| 354,363 |
| 266,647 |
| ||
Total |
| 354,363 |
| 110,712 |
| ||
|
|
|
|
|
| ||
Deferred income taxes |
| 31,745 |
| 58,646 |
| ||
Unrealized net capital gains and losses, after-tax |
| $ | (58,955 | ) | $ | (108,914 | ) |
(1) |
| The insurance reserves adjustment represents the amount by which the reserve balance would increase if the net unrealized gains in the applicable product portfolios were realized and reinvested at current lower interest rates, resulting in a premium deficiency. Although we evaluate premium deficiencies on the combined performance of our life insurance and immediate annuities with life contingencies, the adjustment primarily relates to structured settlement annuities with life contingencies, in addition to certain payout annuities with life contingencies. The insurance reserves adjustment changed to zero as of March 31, 2009 due to decreases in unrealized gains in the applicable product portfolios. The change in the unrealized balance resulted from realizing prior unrealized gains upon the sale of certain securities issued or guaranteed by the U.S. government in the first quarter of 2009. |
|
|
|
(2) |
| The DAC and DSI adjustment represents the amount by which the amortization of DAC and DSI would increase or decrease if the unrealized gains or losses in the respective product portfolios were realized. Recapitalization of the DAC and DSI balances is limited to the originally deferred costs plus interest. |
The net unrealized loss for the fixed income portfolio totaled $446.7 million, comprised of $265.2 million of gross unrealized gains and $711.9 million of gross unrealized losses at March 31, 2009. This is compared to a net unrealized loss for the fixed income portfolio totaling $280.1 million, comprised of $420.1 million of gross unrealized gains and $700.2 million of gross unrealized losses at December 31, 2008.
33
Gross unrealized gains and losses as of March 31, 2009 on fixed income securities by type and sector are provided in the table below.
|
|
|
|
|
|
|
|
|
|
|
| Amortized |
|
|
| |||||
|
|
|
|
|
|
|
|
|
|
|
| cost as a |
| Fair value |
| |||||
|
| Par |
| Amortized |
| Gross unrealized |
|
|
| percent of |
| as a percent |
| |||||||
($ in thousands) |
| value (1) |
| cost |
| Gains |
| Losses |
| Fair value |
| par value |
| of par value |
| |||||
Corporate: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Banking |
| $ | 396,057 |
| $ | 385,516 |
| $ | 1,035 |
| $ | (110,604 | ) | $ | 275,947 |
| 97.3 | % | 69.7 | % |
Financial services |
| 340,885 |
| 330,902 |
| 518 |
| (51,996 | ) | 279,424 |
| 97.1 |
| 82.0 |
| |||||
Utilities |
| 634,514 |
| 626,739 |
| 23,183 |
| (40,544 | ) | 609,378 |
| 99.8 |
| 96.0 |
| |||||
Consumer goods (cyclical and non-cyclical) |
| 450,599 |
| 450,123 |
| 6,272 |
| (23,718 | ) | 432,677 |
| 99.9 |
| 96.0 |
| |||||
Other |
| 244,531 |
| 148,356 |
| 2,575 |
| (10,970 | ) | 139,961 |
| 60.7 |
| 57.2 |
| |||||
Capital goods |
| 333,956 |
| 325,876 |
| 6,179 |
| (28,859 | ) | 303,196 |
| 97.6 |
| 90.8 |
| |||||
Basic industry |
| 127,496 |
| 128,428 |
| 670 |
| (13,332 | ) | 115,766 |
| 100.7 |
| 90.8 |
| |||||
Transportation |
| 188,569 |
| 190,352 |
| 3,314 |
| (21,735 | ) | 171,931 |
| 100.9 |
| 91.2 |
| |||||
Energy |
| 195,064 |
| 197,455 |
| 1,412 |
| (15,814 | ) | 183,053 |
| 101.2 |
| 93.8 |
| |||||
Communications |
| 181,430 |
| 179,965 |
| 3,180 |
| (10,994 | ) | 172,151 |
| 99.2 |
| 94.9 |
| |||||
Technology |
| 82,333 |
| 83,007 |
| 2,103 |
| (3,295 | ) | 81,815 |
| 100.8 |
| 99.4 |
| |||||
Total corporate fixed income portfolio |
| 3,175,434 |
| 3,046,719 |
| 50,441 |
| (331,861 | ) | 2,765,299 |
| 95.9 |
| 87.1 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
ABS |
| 91,280 |
| 84,108 |
| — |
| (30,270 | ) | 53,838 |
| 92.1 |
| 59.0 |
| |||||
CMBS |
| 752,781 |
| 715,891 |
| — |
| (260,956 | ) | 454,935 |
| 95.1 |
| 60.4 |
| |||||
Municipal |
| 702,727 |
| 471,186 |
| 4,698 |
| (73,474 | ) | 402,410 |
| 67.1 |
| 57.3 |
| |||||
MBS |
| 502,371 |
| 503,674 |
| 14,709 |
| (11,414 | ) | 506,969 |
| 100.3 |
| 100.9 |
| |||||
Foreign government |
| 416,553 |
| 226,113 |
| 86,652 |
| — |
| 312,765 |
| 54.3 |
| 75.1 |
| |||||
Redeemable preferred stock |
| 8,500 |
| 9,279 |
| — |
| (3,945 | ) | 5,334 |
| 109.2 |
| 62.8 |
| |||||
U.S. government and agencies |
| 645,427 |
| 421,113 |
| 108,695 |
| — |
| 529,808 |
| 65.2 |
| 82.1 |
| |||||
Total fixed income securities |
| $ | 6,295,073 |
| $ | 5,478,083 |
| $ | 265,195 |
| $ | (711,920 | ) | $ | 5,031,358 |
| 87.0 |
| 79.9 |
|
(1) |
| Included in par value are zero-coupon securities that are generally purchased at a deep discount to the par value that is received at maturity. These included corporate, municipal, foreign government and U.S. government and agencies zero-coupon securities with par value of $192.2 million, $384.0 million, $404.6 million and $485.7 million, respectively. |
The banking, financial services, utilities and capital goods sectors had the highest concentration of gross unrealized losses in our corporate fixed income securities portfolio at March 31, 2009. The gross unrealized losses in these sectors were generally the result of widening credit spreads since the time of initial purchase. As of March 31, 2009, $276.2 million or 83.2% of the gross unrealized losses in the corporate fixed income portfolio and $367.8 million or 96.8% of the gross unrealized losses on the remaining fixed income securities related to securities rated investment grade.
For fixed income securities, 62.5% of the gross unrealized losses at March 31, 2009 were from $361.7 million of securities with a fair value below 70% of amortized cost, or 7.2% of our fixed income portfolio. The percentage of fair value to amortized cost for fixed income securities with gross unrealized losses at March 31, 2009 are shown in the following table.
($ in thousands) |
| Par |
| Amortized |
| Unrealized |
| Fair |
| Percent to |
| ||||
> 80% of amortized cost |
| $ | 2,221,124 |
| $ | 2,168,355 |
| $ | (184,095 | ) | $ | 1,984,260 |
| 39.4 | % |
70% to 80% of amortized cost |
| 337,049 |
| 337,428 |
| (83,069 | ) | 254,359 |
| 5.1 |
| ||||
< 70% of amortized cost (2) |
| 1,012,678 |
| 806,412 |
| (444,756 | ) | 361,656 |
| 7.2 |
| ||||
Gross unrealized losses on fixed income securities |
| 3,570,851 |
| 3,312,195 |
| (711,920 | ) | 2,600,275 |
| 51.7 |
| ||||
Gross unrealized gains on fixed income securities |
| 2,724,222 |
| 2,165,888 |
| 265,195 |
| 2,431,083 |
| 48.3 |
| ||||
Net unrealized gains and losses on fixed income securities |
| $ | 6,295,073 |
| $ | 5,478,083 |
| $ | (446,725 | ) | $ | 5,031,358 |
| 100.0 | % |
(1) |
| Included in par value are $384.0 million of zero-coupon securities as of March 31, 2009 that are generally purchased at a deep discount to the par value that is received at maturity. |
|
|
|
(2) |
| Illiquid portfolios represent $234.7 million of net unrealized losses and $124.9 million of fair value as of March 31, 2009. |
|
|
|
(3) |
| Illiquid portfolios represent $302.6 million of net unrealized losses and $573.3 million of fair value as of March 31, 2009. |
34
The following table presents gross unrealized losses by type of fixed income security with a fair value below 70% of amortized cost at March 31, 2009.
($ in thousands) |
| Fair value |
| Gross unrealized |
| ||
Corporate |
| $ | 176,036 |
| $ | (166,778 | ) |
ABS |
| 24,198 |
| (24,495 | ) | ||
CMBS |
| 100,745 |
| (210,222 | ) | ||
Municipal |
| 55,343 |
| (39,316 | ) | ||
Redeemable preferred stock |
| 5,334 |
| (3,945 | ) | ||
Total fixed income securities |
| $ | 361,656 |
| $ | (444,756 | ) |
We continue to believe that the unrealized losses on these securities are not predictive of the ultimate performance. The unrealized losses should reverse over the remaining lives of the securities. As of March 31, 2009, we have the intent and ability to hold these securities to recovery. Our ability to hold to recovery is substantially enhanced by our liquidity position, which cushions us from the need to liquidate securities with significant unrealized losses to meet cash obligations. During the first quarter of 2009, our fixed income securities portfolio provided approximately $165.4 million in principal and interest cash flows, of which substantially all have been received in accordance with the contractual terms.
We have a comprehensive portfolio monitoring process to identify and evaluate, on a case-by-case basis, fixed income and equity securities whose carrying value may be other-than-temporarily impaired. The process includes a quarterly review of all securities using a screening process to identify situations where the fair value, compared to amortized cost for fixed income securities and cost for equity securities, is below established thresholds for certain time periods, or which are identified through other monitoring criteria such as ratings, ratings downgrades or payment defaults. The securities identified, in addition to other securities for which we may have a concern, are evaluated based on facts and circumstances for inclusion on our watch-list. All investments in an unrealized loss position at March 31, 2009 were included in our portfolio monitoring process for determining whether declines in value were other than temporary.
We also conduct a portfolio review to recognize impairment on securities in an unrealized loss position for which we do not have the intent and ability to hold until recovery as a result of approved programs involving the disposition of investments for reasons such as negative developments that would change the view of long term investors and their intent to continue to hold the investment, subsequent credit deterioration of an issuer or holding, subsequent further deterioration of capital markets (i.e. debt and equity) and of economic conditions, subsequent further deterioration in the financial services and real estate industries, changes in duration, revisions to strategic asset allocations, liquidity needs, unanticipated federal income tax situations involving capital gains and capital loss carrybacks and carryforwards with specific expiration dates, investment risk mitigation actions, and other new facts and circumstances that would cause a change in our previous intent to hold a security to recovery or maturity.
35
The following table summarizes fixed income and equity securities in a gross unrealized loss position according to significance, aging and investment grade classification.
|
| March 31, 2009 |
| December 31, 2008 |
| |||||||||||||||||
($ in thousands except number of |
| Investment |
| Below |
| Equity |
| Total |
| Investment |
| Below |
| Total |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Category (I): Unrealized loss less than 20% of amortized cost (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Number of issues |
| 387 |
| 49 |
| 1 |
| 437 |
| 448 |
| 38 |
| 486 |
| |||||||
Fair value |
| $ | 1,881,363 |
| $ | 102,897 |
| $ | 72 |
| $ | 1,984,332 |
| $ | 2,105,319 |
| $ | 70,192 |
| $ | 2,175,511 |
|
Unrealized |
| $ | (170,943 | ) | $ | (13,152 | ) | $ | (8 | ) | $ | (184,103 | ) | $ | (187,983 | ) | $ | (8,707 | ) | $ | (196,690 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Category (II): Unrealized loss greater than or equal to 20% of amortized cost for a period of less than 6 consecutive months |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Number of issues |
| 133 |
| 32 |
| — |
| 165 |
| 150 |
| 30 |
| 180 |
| |||||||
Fair value |
| $ | 516,828 |
| $ | 41,876 |
| $ | — |
| $ | 558,704 |
| $ | 557,986 |
| $ | 46,428 |
| $ | 604,414 |
|
Unrealized |
| $ | (336,283 | ) | $ | (44,078 | ) | $ | — |
| $ | (380,361 | ) | $ | (431,954 | ) | $ | (26,145 | ) | $ | (458,099 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Category (III): Unrealized loss greater than or equal to 20% of amortized cost for a period of 6 or more consecutive months, but less than 12 consecutive months |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Number of issues |
| 17 |
| 4 |
| — |
| 21 |
| 13 |
| 2 |
| 15 |
| |||||||
Fair value |
| $ | 34,981 |
| $ | 4,052 |
| $ | — |
| $ | 39,033 |
| $ | 23,013 |
| $ | 612 |
| $ | 23,625 |
|
Unrealized |
| $ | (98,306 | ) | $ | (7,839 | ) | $ | — |
| $ | (106,145 | ) | $ | (41,789 | ) | $ | (757 | ) | $ | (42,546 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Category (IV): Unrealized loss greater than or equal to 20% of amortized cost for 12 or more consecutive months |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Number of issues |
| 11 |
| 2 |
| — |
| 13 |
| — |
| 1 |
| 1 |
| |||||||
Fair value |
| $ | 15,333 |
| $ | 2,945 |
| $ | — |
| $ | 18,278 |
| $ | — |
| $ | 2,562 |
| $ | 2,562 |
|
Unrealized |
| $ | (38,451 | ) | $ | (2,868 | ) | $ | — |
| $ | (41,319 | ) | $ | — |
| $ | (2,884 | ) | $ | (2,884 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Total number of issues |
| 548 |
| 87 |
| 1 |
| 636 |
| 611 |
| 71 |
| 682 |
| |||||||
Total fair value (2) |
| $ | 2,448,505 |
| $ | 151,770 |
| $ | 72 |
| $ | 2,600,347 |
| $ | 2,686,318 |
| $ | 119,794 |
| $ | 2,806,112 |
|
Total unrealized losses |
| $ | (643,983 | ) | $ | (67,937 | ) | $ | (8 | ) | $ | (711,928 | ) | $ | (661,726 | ) | $ | (38,493 | ) | $ | (700,219 | ) |
(1) |
| For fixed income securities, cost represents amortized cost. |
|
|
|
(2) |
| At March 31, 2009, 94.2% of the fixed income securities portfolio was rated investment grade compared to 95.7% at December 31, 2008. |
The largest individual unrealized loss was $2.9 million for category (I), $14.7 million for category (II), $14.5 million for category (III), and $8.7 million for category (IV) as of March 31, 2009.
Categories (I) and (II) have generally been adversely affected by overall economic conditions including interest rate increases and the market’s evaluation of certain sectors. The degree to which and/or length of time that the securities have been in an unrealized loss position does not suggest that these securities pose a high risk of being other-than-temporarily impaired.
Categories (III) and (IV) have historically been affected by industry and issue specific, or issuer specific conditions. All of the securities in these categories are monitored for other-than-temporary impairment.
At March 31, 2009, Category (III) for fixed income was comprised of $23.0 million of CMBS, $10.7 million of corporate bonds and $5.3 million of ABS RMBS, for a total of $39.0 million with unrealized losses of $87.2 million, $10.4 million and $8.5 million, respectively, for a total of $106.1 million of unrealized losses.
At March 31, 2009, Category (IV) for below investment grade fixed income securities was comprised of $2.8 million of corporate private and $123 thousand of ABS RMBS, for a total of $2.9 million with unrealized losses of $2.6 million and $287 thousand, respectively, for a total of $2.9 million of unrealized losses.
We continue to believe that the unrealized losses on these securities are not predictive of the ultimate performance.
36
Whenever our initial analysis indicates that a fixed income security’s unrealized loss of 20% or more for at least 36 months or any equity security’s unrealized loss of 20% or more for at least 12 months is temporary, additional evaluations and management approvals are required to substantiate that a write-down is not appropriate. As of March 31, 2009, no securities met these criteria.
We also monitor the quality of our fixed income portfolio by categorizing certain investments as “problem”, “restructured” or “potential problem.” Problem fixed income securities are in default with respect to principal or interest and/or are investments issued by companies that have gone into bankruptcy subsequent to our acquisition. Restructured fixed income securities have rates and terms that are not consistent with market rates or terms prevailing at the time of the restructuring. Potential problem fixed income securities are current with respect to contractual principal and/or interest, but because of other facts and circumstances, we have concerns regarding the borrower’s ability to pay future principal and interest according to the original terms, which causes us to believe these investments may be classified as problem or restructured in the future.
The following table summarizes problem, restructured and potential problem fixed income securities.
|
| March 31, 2009 |
| |||||||||||||
($ in thousands) |
| Par |
| Amortized |
| Amortized |
| Fair |
| Fair value as |
| Percent of |
| |||
Problem |
| $ | 14,912 |
| $ | 5,698 |
| 38.2 | % | $ | 5,745 |
| 38.5 | % | 0.1 | % |
Potential problem |
| 81,627 |
| 49,932 |
| 61.2 |
| 35,494 |
| 43.5 |
| 0.7 |
| |||
Total net carrying value |
| $ | 96,539 |
| $ | 55,630 |
| 57.6 |
| $ | 41,239 |
| 42.7 |
| 0.8 | % |
Cumulative write-downs recognized (2) |
|
|
| $ | 25,624 |
|
|
|
|
|
|
|
|
|
|
| December 31, 2008 |
| |||||||||||||
|
| Par |
| Amortized |
| Amortized |
| Fair |
| Fair value as |
| Percent of |
| |||
Problem |
| $ | 30,000 |
| $ | 18,824 |
| 62.7 | % | $ | 13,593 |
| 45.3 | % | 0.2 | % |
Potential problem |
| 56,942 |
| 22,118 |
| 38.8 |
| 22,080 |
| 38.8 |
| 0.4 |
| |||
Total net carrying value |
| $ | 86,942 |
| $ | 40,942 |
| 47.1 |
| $ | 35,673 |
| 41.0 |
| 0.6 | % |
Cumulative write-downs recognized (2) |
|
|
| $ | 41,423 |
|
|
|
|
|
|
|
|
|
(1) |
| The difference between par value and amortized cost of $40.9 million at March 31, 2009 and $46.0 million at December 31, 2008 is primarily attributable to write-downs. Par value has been reduced by principal payments. |
|
|
|
(2) |
| Cumulative write-downs recognized only reflects impairment write-downs related to investments within the problem, potential problem and restructured categories. |
At March 31, 2009, amortized cost for the problem category was $5.7 million and was comprised of corporates (primarily privately placed). The decrease of $13.1 million over December 31, 2008 is attributable to the disposal of corporates, partially offset by the addition of fixed income holdings that are either in default with respect to principal or interest and/or are investments issued by companies that went into bankruptcy during the period. There were no investments in the problem category with a fair value less than 70% of amortized cost.
At March 31, 2009, amortized cost for the potential problem category was $49.9 million and was comprised of $40.5 million of corporates (primarily privately placed), $4.0 million of other CDO, $3.0 million of ABS RMBS, and $2.4 million of CMBS. The increase over December 31, 2008 is primarily attributable to the additions of corporates (primarily privately placed) and CMBS. The amortized cost of potential problem investments with a fair value less than 70% of amortized cost totaled $26.9 million, with unrealized losses of $14.3 million and fair value of $12.6 million.
37
We evaluated each of these investments through our portfolio monitoring process at March 31, 2009 and recorded write-downs when appropriate. We further concluded that any remaining unrealized losses on these investments were temporary in nature and that we have the intent and ability to hold the securities until recovery.
Net Investment Income The following table presents net investment income.
|
| Three months ended |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Fixed income securities |
| $ | 84,299 |
| $ | 91,556 |
|
Equity securities |
| 3 |
| — |
| ||
Mortgage loans |
| 9,977 |
| 10,519 |
| ||
Short-term and other |
| 1,684 |
| 2,613 |
| ||
Investment income, before expense |
| 95,963 |
| 104,688 |
| ||
Investment expense |
| (2,285 | ) | (4,942 | ) | ||
Net investment income |
| $ | 93,678 |
| $ | 99,746 |
|
Net investment income decreased 6.1% or $6.1 million to $93.7 million in the first quarter of 2009 compared to $99.7 million in the same period of 2008. This decline is due to lower investment yields from decreased market interest rates, carrying a greater amount of short-term investments in connection with tactically positioning greater liquidity, and lower funds associated with securities lending.
Total investment expenses decreased $2.7 million in the first quarter of 2009 compared to the first quarter of 2008. The decrease was primarily due to lower expenses associated with a lower amount of collateral received in connection with securities lending transactions. The average amount of collateral held in connection with securities lending was $143.9 million in the first quarter of 2009 compared to $312.9 million in the first quarter of 2008, as a result of actions to reduce our securities lending balances.
Net Realized Capital Gains and Losses The following tables present the components of realized capital gains and losses and the related tax effect.
|
| Three months ended |
| ||||
($ in thousands) |
| 2009 |
| 2008 |
| ||
Sales (1) |
| $ | 98,291 |
| $ | 5,543 |
|
Impairment write-downs (2) |
| (4,636 | ) | (633 | ) | ||
Change in intent write-downs (1) (3) |
| (2,791 | ) | (3,532 | ) | ||
Valuation of derivative instruments |
| 8,354 |
| (240 | ) | ||
Settlements of derivative instruments |
| — |
| 583 |
| ||
Realized capital gains and losses, pre-tax |
| 99,218 |
| 1,721 |
| ||
Income tax expense |
| (34,727 | ) | (602 | ) | ||
Realized capital gains and losses, after-tax |
| $ | 64,491 |
| $ | 1,119 |
|
(1) |
| To conform to the current period presentation, certain amounts in the prior periods have been reclassified. |
|
|
|
(2) |
| Impairment write-downs reflect issue specific other-than-temporary declines in fair value, including instances where we could not reasonably assert that the recovery period would be temporary. |
|
|
|
(3) |
| Change in intent write-downs reflect instances where we cannot assert a positive intent to hold until recovery. |
Sales generated $98.3 million of net realized gains for the three months ended March 31, 2009 and were primarily due to $90.5 million of gains on sales of governmental securities.
Impairment write-downs totaled $4.6 million in 2009 and included write-downs on fixed income securities and mortgage loans of $4.0 million and $637 thousand, respectively.
$2.2 million or 56.2% of the fixed income security write-downs for the three months ended March 31, 2009 related to impaired securities that were performing in line with anticipated or contractual cash flows but were written down primarily because of expected deterioration in the performance of the underlying collateral or our assessment
38
of the probability of future default. As of March 31, 2009, there have been no defaults or defaults impacting classes lower in the capital structure. $1.7 million of the fixed income security write-downs for the three months ended March 31, 2009 related to securities experiencing a significant departure from anticipated cash flows; however, we believe they retain economic value. $45 thousand related to securities for which future cash flows are very uncertain.
Impairment write-downs on these investments are presented in the following table. Notwithstanding our intent and ability to hold these securities with impairment write-downs, we concluded that we could not reasonably assert that the recovery period would be temporary.
($ in thousands) |
| Three months ended |
| |
Performing in accordance with anticipated or contractual cash flows (1) |
|
|
| |
CMBS |
| $ | (2,248 | ) |
|
|
|
| |
Departure from anticipated or contractual cash flows |
|
|
| |
Future cash flows expected – |
|
|
| |
Corporate |
|
|
| |
Entertainment |
| (1,610 | ) | |
Telecommunications |
| (46 | ) | |
Subtotal (2) |
| (1,656 | ) | |
Future cash flows very uncertain - |
|
|
| |
Corporate-Gaming |
| (45 | ) | |
Investments disposed |
| (50 | ) | |
Total fixed income securities (3) |
| $ | (3,999 | ) |
Total commercial mortgage write-downs |
| $ | (637 | ) |
(1) Written down primarily because of expected deterioration in the performance of the underlying collateral or our assessment of the probability of future default. As of March 31, 2009, for the securities with direct interest in the lender, there have been no defaults. For securities supported by collateral, there have been no defaults or defaults that have occurred in classes lower in the capital structure.
(2) Experienced a significant departure from anticipated residual cash flows. While these fixed income security write-downs were valued at a significant discount to cost, we believe these securities retain economic value.
(3) Impairment write-downs on our illiquid portfolios were $2.2 million for the three months ended March 31, 2009.
Change in intent write-downs totaling $2.8 million for the three months ended March 31, 2009 included $2.1 million for fixed income securities, $14 thousand for equity securities and $686 thousand for mortgage loans compared to $3.5 million for fixed income securities for the same period of the prior year. The change in intent write-downs in the first quarter of 2009 were a result of our risk mitigation and return optimization programs and ongoing comprehensive reviews of our portfolios resulting in write-downs of individually identified securities.
Investments for which we had changed our intent to hold to recovery totaled $18.3 million and $37.7 million as of March 31, 2009 and December 31, 2008, respectively. The primary drivers of the change were as follows:
· $1.9 million in additions of individually identified fixed income securities as a result of ongoing reviews of our portfolios.
· We sold approximately $1.7 million, recognizing net capital losses of $1.0 million. The sales included approximately $541 thousand from risk mitigation and return optimization programs which recognized $1.1 million in net realized capital losses.
· We re-designated approximately $15.9 million of investments to intent to hold to recovery due to our inability to dispose of them for values equal to or greater than our view of their intrinsic value. Of these assets $2.7 million were related to risk mitigation and return optimization programs and $13.2 million were related to individual identification.
· Valuation adjustments and other charges, including change in intent write-downs, totaled $2.7 million.
39
Valuation and settlement of derivative instruments net realized capital gains totaled $8.4 million for the three months ended March 31, 2009. For the three months ended March 31, 2008, net realized capital losses on the valuation and settlement of derivative instruments totaled $343 thousand and included $240 thousand of losses on the valuation of derivative instruments and $583 thousand of gains on the settlement of derivative instruments.
A changing interest rate environment will drive changes in our portfolio duration targets at a tactical level. A duration target and range is established with an economic view of liabilities relative to a long-term investment portfolio view. Tactical duration management is accomplished through both cash market transactions including new purchases and derivative activities that generate realized gains and losses. As a component of our approach to managing portfolio duration, realized gains and losses on certain derivative instruments are most appropriately considered in conjunction with the unrealized gains and losses on the fixed income portfolio. This approach mitigates the impacts of general interest rate changes to the overall financial condition of the Company.
Fair Value of Assets and Liabilities
We employ independent third-party valuation service providers, broker quotes and internal pricing methods to determine fair values, which provide a single quote or price for each financial instrument. We obtain or calculate only one quote or price per instrument.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For the majority of the Company’s financial assets, all significant inputs are based on market observable data and significant management judgment does not affect the periodic determination of fair value. The determination of fair value using discounted cash flow models involves management judgment when significant model inputs are not based on market observable data. However, where market observable data is available, it takes precedence, and as a result, no range of reasonably likely inputs exists, from which the basis of a sensitivity analysis could be constructed.
There are two situations where discounted cash flow models are used, each of which utilizes a significant input that is not market observable. In the first situation, internal models use internally assigned credit ratings as inputs in the valuation of privately placed securities. Our internal ratings are developed at a more finite level than NAIC ratings (e.g., an NAIC rating of 1 includes securities rated triple, double and single A by a nationally recognized statistical rating organization (“NRSRO”)). We believe these internal ratings provide for a more reliable estimate of fair value since we can more precisely match these ratings to other market observable valuation inputs, such as credit and liquidity spreads, for performing these valuations. The second situation where a discounted cash flow model utilizes a significant input that is not market observable relates to the determination of fair value for our ARS backed by student loans. The assumption is the anticipated date liquidity will return to this market (i.e., when auction failures will cease). Determination of this assumption allows for matching to market observable inputs when performing these valuations.
The following table displays the sensitivity of reasonably likely changes in these assumptions as of March 31, 2009. The selection of these hypothetical scenarios should not be construed as an indication that it would be reasonably likely that all securities would be similarly affected or as our prediction of future events, but only as an illustration of the estimated potential proportional effect of alternative assumptions.
($ in thousands) |
|
|
| |
Privately placed securities with internally assigned credit ratings |
| $ | 864,652 |
|
Percentage change in fair value resulting from: |
|
|
| |
Increase in internal ratings one rating notch |
| 2.6 | % | |
Decrease in internal ratings one rating notch |
| (5.0 | )% | |
|
|
|
| |
ARS backed by student loans at fair value |
| $ | 92,804 |
|
Percentage change in fair value resulting from: |
|
|
| |
Decrease in assumption by five months for the anticipated date liquidity will return to this market |
| 1.4 | % | |
Increase in assumption by five months for the anticipated date liquidity will return to this market |
| (1.4 | )% |
40
The following table provides additional details regarding Level 1, 2 and 3 assets and liabilities by their classification in the Condensed Statement of Financial Position at March 31, 2009. For further discussion of Level 1, 2 and 3 assets and liabilities, see Note 3 of the Condensed Financial Statements.
($ in thousands) |
| Quoted prices in |
| Significant |
| Significant |
| Counterparty |
| Balance as of |
| |||||
Assets |
|
|
|
|
|
|
|
|
|
|
| |||||
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
| |||||
U.S. government and agencies |
| $ | 153,073 |
| $ | 376,735 |
| $ | — |
|
|
| $ | 529,808 |
| |
Municipal |
| — |
| 309,606 |
| — |
|
|
| 309,606 |
| |||||
Municipal - ARS |
| — |
| — |
| 92,804 |
|
|
| 92,804 |
| |||||
Corporate - public |
| — |
| 1,487,706 |
| 26,420 |
|
|
| 1,514,126 |
| |||||
Corporate privately placed securities |
| — |
| 222,864 |
| 1,028,309 |
|
|
| 1,251,173 |
| |||||
Foreign government |
| — |
| 312,765 |
| — |
|
|
| 312,765 |
| |||||
MBS |
| — |
| 473,608 |
| 10,487 |
|
|
| 484,095 |
| |||||
Alt-A |
| — |
| — |
| 22,874 |
|
|
| 22,874 |
| |||||
CMBS |
| — |
| 367,346 |
| 87,589 |
|
|
| 454,935 |
| |||||
ABS RMBS |
| — |
| — |
| 35,104 |
|
|
| 35,104 |
| |||||
Other CDO |
| — |
| — |
| 18,734 |
|
|
| 18,734 |
| |||||
Preferred stock |
| — |
| 5,334 |
| — |
|
|
| 5,334 |
| |||||
Total fixed income securities |
| 153,073 |
| 3,555,964 |
| 1,322,321 |
|
|
| 5,031,358 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Equity securities |
| — |
| 72 |
| — |
|
|
| 72 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Short-term investments: |
|
|
|
|
|
|
|
|
|
|
| |||||
Commercial paper and other |
| — |
| 871,894 |
| — |
|
|
| 871,894 |
| |||||
Money market funds |
| 28,945 |
| — |
| — |
|
|
| 28,945 |
| |||||
Total short-term investments |
| 28,945 |
| 871,894 |
| — |
|
|
| 900,839 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Other investments: |
|
|
|
|
|
|
|
|
|
|
| |||||
Free-standing derivatives |
| — |
| 1,677 |
| 670 |
| $ | (6 | ) | 2,341 |
| ||||
Total other investments |
| — |
| 1,677 |
| 670 |
| (6 | ) | 2,341 |
| |||||
Separate account assets |
| 479,091 |
| — |
| — |
|
|
| 479,091 |
| |||||
Other assets |
| — |
| — |
| (2,503 | ) |
|
| (2,503 | ) | |||||
Total recurring basis assets |
| 661,109 |
| 4,429,607 |
| 1,320,488 |
| (6 | ) | 6,411,198 |
| |||||
Non-recurring basis (2) |
| — |
| — |
| 9,206 |
|
|
| 9,206 |
| |||||
Total assets at fair value |
| $ | 661,109 |
| $ | 4,429,607 |
| $ | 1,329,694 |
| $ | (6 | ) | $ | 6,420,404 |
|
% of total assets at fair value |
| 10.3 | % | 69.0 | % | 20.7 | % | — | % | 100.0 | % | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
| |||||
Contractholder funds: |
|
|
|
|
|
|
|
|
|
|
| |||||
Derivatives embedded in annuity contracts |
| $ | — |
| $ | — |
| $ | (33,368 | ) |
|
| $ | (33,368 | ) | |
Other liabilities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Free-standing derivatives |
| — |
| (10,579 | ) | (5,637 | ) | $ | 6 |
| (16,210 | ) | ||||
Total liabilities at fair value |
| $ | — |
| $ | (10,579 | ) | $ | (39,005 | ) | $ | 6 |
| $ | (49,578 | ) |
% of total financial liabilities at fair value |
| — | % | 21.3 | % | 78.7 | % | — | % | 100.0 | % |
(1) In accordance with Financial Accounting Standards Board (“FASB”) Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39, we net all fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral executed with the same counterparty under a master netting agreement. At March 31, 2009, the right to reclaim cash collateral was offset by securities held, and there was no obligation to return collateral.
(2) Includes mortgage loans written-down to fair value in connection with recognizing other-than-temporary impairments.
41
The following table provides additional details regarding Level 1, 2 and 3 assets and liabilities by their classification as of December 31, 2008.
($ in thousands) |
| Quoted prices |
| Significant |
| Significant |
| Balance as of |
| ||||
Financial assets |
|
|
|
|
|
|
|
|
| ||||
Fixed income securities: |
|
|
|
|
|
|
|
|
| ||||
U.S. government and agencies |
| $ | 154,119 |
| $ | 763,612 |
| $ | — |
| $ | 917,731 |
|
Municipal |
| — |
| 287,597 |
| — |
| 287,597 |
| ||||
Municipal - ARS |
| — |
| — |
| 97,784 |
| 97,784 |
| ||||
Corporate - public |
| — |
| 1,533,704 |
| 27,927 |
| 1,561,631 |
| ||||
Corporate privately placed securities |
| — |
| 261,318 |
| 1,064,188 |
| 1,325,506 |
| ||||
Foreign government |
| — |
| 371,542 |
| — |
| 371,542 |
| ||||
MBS |
| — |
| 361,843 |
| 10,741 |
| 372,584 |
| ||||
Alt-A |
| — |
| — |
| 23,593 |
| 23,593 |
| ||||
CMBS |
| — |
| 422,632 |
| 46,236 |
| 468,868 |
| ||||
ABS RMBS |
| — |
| — |
| 43,868 |
| 43,868 |
| ||||
Other CDO |
| — |
| — |
| 20,202 |
| 20,202 |
| ||||
Preferred stock |
| — |
| 5,459 |
| — |
| 5,459 |
| ||||
Total fixed income securities |
| 154,119 |
| 4,007,707 |
| 1,334,539 |
| 5,496,365 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Short-term investments: |
|
|
|
|
|
|
|
|
| ||||
Commercial paper and other |
| — |
| 376,487 |
| — |
| 376,487 |
| ||||
Money market funds |
| 33,315 |
| — |
| — |
| 33,315 |
| ||||
Total short-term investments |
| 33,315 |
| 376,487 |
| — |
| 409,802 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Other investments: |
|
|
|
|
|
|
|
|
| ||||
Free-standing derivatives |
| — |
| 1,764 |
| 714 |
| 2,478 |
| ||||
Total other investments |
| — |
| 1,764 |
| 714 |
| 2,478 |
| ||||
Separate account assets |
| 533,760 |
| — |
| — |
| 533,760 |
| ||||
Other assets |
| — |
| — |
| (1,829 | ) | (1,829 | ) | ||||
Total recurring basis assets |
| 721,194 |
| 4,385,958 |
| 1,333,424 |
| 6,440,576 |
| ||||
Non-recurring basis (1) |
| — |
| — |
| 10,589 |
| 10,589 |
| ||||
Total assets at fair value |
| $ | 721,194 |
| $ | 4,385,958 |
| $ | 1,344,013 |
| $ | 6,451,165 |
|
% of total assets at fair value |
| 11.2 | % | 68.0 | % | 20.8 | % | 100.0 | % | ||||
|
|
|
|
|
|
|
|
|
| ||||
Liabilities |
|
|
|
|
|
|
|
|
| ||||
Contractholder funds: |
|
|
|
|
|
|
|
|
| ||||
Derivatives embedded in annuity contracts |
| $ | — |
| $ | — |
| $ | (30,051 | ) | $ | (30,051 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Other liabilities: |
|
|
|
|
|
|
|
|
| ||||
Free-standing derivatives |
| — |
| (20,849 | ) | (5,450 | ) | (26,299 | ) | ||||
Total liabilities at fair value |
| $ | — |
| $ | (20,849 | ) | $ | (35,501 | ) | $ | (56,350 | ) |
% of total liabilities at fair value |
| — | % | 37.0 | % | 63.0 | % | 100.0 | % |
(1) Includes mortgage loans written-down to fair value in connection with recognizing other-than-temporary impairments.
42
The following table provides a summary of changes in fair value during the three-month period ended March 31, 2009 of Level 3 assets and liabilities held at fair value on a recurring basis.
|
|
|
| Total realized and unrealized |
|
|
|
|
|
|
| Total |
| |||||||||
($ in thousands) |
| Balance as of |
| Net income (1) |
| OCI on |
| Purchases, |
| Net |
| Balance as of |
| instruments |
| |||||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Municipal - ARS |
| $ | 97,784 |
| $ | — |
| $ | (1,730 | ) | $ | (550 | ) | $ | (2,700 | ) | $ | 92,804 |
| $ | — |
|
Corporate - public |
| 27,927 |
| — |
| (1,482 | ) | (25 | ) | — |
| 26,420 |
| — |
| |||||||
Corporate privately |
| 1,064,188 |
| 771 |
| (3,698 | ) | (32,952 | ) | — |
| 1,028,309 |
| (189 | ) | |||||||
MBS |
| 10,741 |
| (10 | ) | 77 |
| (321 | ) | — |
| 10,487 |
| (9 | ) | |||||||
Alt-A |
| 23,593 |
| 5 |
| (724 | ) | — |
| — |
| 22,874 |
| 5 |
| |||||||
CMBS |
| 46,236 |
| (4,442 | ) | (9,288 | ) | (637 | ) | 55,720 |
| 87,589 |
| (3,335 | ) | |||||||
ABS RMBS |
| 43,868 |
| 457 |
| (5,873 | ) | (3,348 | ) | — |
| 35,104 |
| 457 |
| |||||||
Other CDO |
| 20,202 |
| — |
| (1,405 | ) | (63 | ) | — |
| 18,734 |
| — |
| |||||||
Total fixed income |
| 1,334,539 |
| (3,219 | ) | (24,123 | ) | (37,896 | ) | 53,020 |
| 1,322,321 |
| (3,071 | ) | |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Other investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Free-standing |
| (4,736 | ) | (405 | ) | — |
| 174 |
| — |
| (4,967 | )(2) | 48 |
| |||||||
Other assets |
| (1,829 | ) | (674 | ) | — |
| — |
| — |
| (2,503 | ) | (674 | ) | |||||||
Total recurring Level 3 |
| $ | 1,327,974 |
| $ | (4,298 | ) | $ | (24,123 | ) | $ | (37,722 | ) | $ | 53,020 |
| $ | 1,314,851 |
| $ | (3,697 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Contractholder funds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Derivatives embedded in |
| $ | (30,051 | ) | $ | (3,242 | ) | $ | — |
| $ | (75 | ) | $ | — |
| $ | (33,368 | ) | $ | (3,242 | ) |
Total recurring Level 3 liabilities |
| $ | (30,051 | ) | $ | (3,242 | ) | $ | — |
| $ | (75 | ) | $ | — |
| $ | (33,368 | ) | $ | (3,242 | ) |
(1) The effect to net income totals $(7.5) million and is reported in the Condensed Statements of Operations as follows: $(7.1) million in realized capital gains and losses; $2.8 million in net investment income; and $(3.2) million in contract benefits.
(2) Comprises $670 thousand of assets and $(5.6) million of liabilities.
(3) The amounts represent gains and losses included in net income for the period of time that the asset or liability was determined to be in Level 3. These gains and losses total $(6.9) million and are reported in the Condensed Statements of Operations as follows: $(6.5) million in realized capital gains and losses; $2.8 million in net investment income; and $(3.2) million in contract benefits.
43
The following table provides a summary of changes in fair value during the three-month period ended March 31, 2008 of Level 3 assets and liabilities held at fair value on a recurring basis.
|
|
|
| Total realized and unrealized |
|
|
|
|
|
|
| Total |
| |||||||||
($ in thousands) |
| Balance as of |
| Net income (1) |
| OCI on |
| Purchases, |
| Net |
| Balance as of |
| instruments |
| |||||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Municipal - ARS |
| $ | 33,200 |
| $ | — |
| $ | — |
| $ | (2,450 | ) | $ | 15,600 |
| $ | 46,350 |
| $ | — |
|
Corporate - public |
| 38,270 |
| 6,795 |
| (9,242 | ) | (25 | ) | — |
| 35,798 |
| — |
| |||||||
Corporate privately |
| 1,211,628 |
| 1,600 |
| 1,059 |
| 14,136 |
| 10,533 |
| 1,238,956 |
| 1,111 |
| |||||||
MBS |
| 14,292 |
| (37 | ) | (181 | ) | (1,334 | ) | — |
| 12,740 |
| (37 | ) | |||||||
Alt-A |
| 28,836 |
| 5 |
| (2,238 | ) | — |
| — |
| 26,603 |
| 4 |
| |||||||
CMBS |
| 36,794 |
| (2 | ) | (4,976 | ) | (8 | ) | — |
| 31,808 |
| (2 | ) | |||||||
ABS RMBS |
| 76,110 |
| (632 | ) | (4,382 | ) | (3,872 | ) | — |
| 67,224 |
| (632 | ) | |||||||
Other CDO |
| 30,768 |
| 269 |
| (1,910 | ) | (2,996 | ) | — |
| 26,131 |
| (56 | ) | |||||||
Total fixed income |
| 1,469,898 |
| 7,998 |
| (21,870 | ) | 3,451 |
| 26,133 |
| 1,485,610 |
| 388 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Other investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Free-standing |
| (980 | ) | (2,472 | ) | — |
| 126 |
| — |
| (3,326 | )(2) | 20 |
| |||||||
Other assets |
| (1,733 | ) | 2,239 |
| — |
| — |
| — |
| 506 |
| 2,239 |
| |||||||
Total recurring Level 3 |
| $ | 1,467,185 |
| $ | 7,765 |
| $ | (21,870 | ) | $ | 3,577 |
| $ | 26,133 |
| $ | 1,482,790 |
| $ | 2,647 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Contractholder funds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Derivatives embedded in |
| $ | 174 |
| $ | (1,428 | ) | $ | — |
| $ | 1 |
| $ | — |
| $ | (1,253 | ) | $ | (1,428 | ) |
Total recurring Level 3 |
| $ | 174 |
| $ | (1,428 | ) | $ | — |
| $ | 1 |
| $ | — |
| $ | (1,253 | ) | $ | (1,428 | ) |
(1) The effect to net income totals $6.3 million and is reported in the Condensed Statements of Operations as follows: $6.3 million in realized capital gains and losses; $1.4 million in net investment income; and $(1.4) million in contract benefits.
(2) Comprises $897 thousand of assets and $(4.2) million of liabilities.
(3) The amounts represent gains and losses included in net income for the period of time that the asset or liability was determined to be in Level 3. These gains and losses total $1.2 million and are reported in the Condensed Statements of Operations as follows: $1.2 million in realized capital gains and losses; $1.4 million in net investment income; and $(1.4) million in contract benefits.
Net transfers in and/or out of Level 3 are reported as having occurred at the beginning of the quarter the transfer occurred; therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the table above.
We have two different situations where we have classified investments as Level 3. The first is where quotes continue to be received from independent third-party valuation service providers, as all significant inputs are market observable, but there has been a significant decrease in the volume and level of activity for the asset when compared to normal market activity such that the degree of market observability has declined to a point where categorization as a Level 3 measurement is considered appropriate. Among the indicators we consider in determining whether a significant decrease in the volume and level of activity for a specific asset has occurred include the following:
· Level of new issuances in the primary market;
· Trading volume in the secondary market;
· Level of credit spreads over historical levels;
· Bid-ask spread, and
· Price consensus among market participants and sources.
When transferring these securities into Level 3 due to a significant decrease in the volume and level of activity, we do not change the source of fair value estimates or modify the estimates received from independent third-party valuation service providers. Accordingly, for securities included within this group, there was no change in fair value for a change in model resulting in a gain or loss.
44
The second situation where we have classified securities in Level 3 is where specific inputs to our fair value estimation models which are considered significant are not market observable. This has occurred in three principal categories. The first is for certain of our privately placed securities for which we utilize internally developed ratings. The second is broker quotes. Privately placed securities valued using internally developed ratings and securities valued using broker quotes were assigned to Level 3 when we initially assigned the hierarchy in the first quarter of 2008. The third is our ARS backed by student loans for which a principal assumption, the anticipated date liquidity will return to this market, is not market observable.
Transfers into Level 3 involving a change in valuation method during the year ended December 31, 2008 included ARS in the second quarter of 2008 when our independent third-party valuation service provider could no longer provide quotes due to the failure of auctions caused by the absence of institutional investors and broker-dealers participating in this market. We migrated from the use of market prices for completed transactions to a discounted cash flow model which resulted in the recognition of an unrealized capital loss of $3.5 million as of June 30, 2008. In addition, transfers into Level 3 of individual instruments occur when a specific input is not market observable such as situations where a fair value quote is not provided by our independent third-party valuation service provider and as a result the price is stale or has been replaced with a broker quote resulting in the security being classified as Level 3. A quote utilizing the new pricing source is not available as of the prior period, and any gains or losses related to the change in valuation source for individual securities, while included in the table above, are not ascertainable and are not significant.
Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market, all ABS RMBS, Alt-A, ARS and certain CMBS are categorized as Level 3. Transfers into and out of Level 3 during the three months ended March 31, 2009 are attributable to a change in the availability of market observable information for individual securities within the respective categories.
The following table presents fair value as a percent of amortized cost for Level 3 investments at March 31, 2009.
($ in thousands) |
| Fair |
| Fair value |
| Fair value |
| |
Fixed income securities: |
|
|
|
|
|
|
| |
Municipal - ARS |
| $ | 92,804 |
| 87.9 | % | 87.9 | % |
Corporate - public |
| 26,420 |
| 72.2 |
| 72.5 |
| |
Corporate privately placed securities |
| 1,028,309 |
| 85.4 |
| 94.4 |
| |
MBS |
| 10,487 |
| 99.9 |
| 97.3 |
| |
Alt-A |
| 22,874 |
| 76.2 |
| 77.2 |
| |
CMBS |
| 87,589 |
| 27.1 |
| 30.7 |
| |
ABS RMBS |
| 35,104 |
| 56.1 |
| 63.4 |
| |
Other CDO |
| 18,734 |
| 65.2 |
| 65.2 |
| |
Total fixed income securities |
| 1,322,321 |
| 73.4 |
| 80.6 |
| |
Other investments: |
|
|
|
|
|
|
| |
Free-standing derivatives |
| 670 |
| N/A |
| 100.0 |
| |
Total other investments |
| 670 |
| N/A |
| 100.0 |
| |
Sub-total recurring Level 3 investments |
| 1,322,991 |
| 73.4 |
| 80.6 |
| |
Non-recurring basis |
| 9,206 |
| N/A |
| 100.0 |
| |
Total Level 3 investments |
| $ | 1,332,197 |
| 74.0 |
| 80.7 |
|
Non-recurring investments include certain mortgage loans remeasured at fair value due to our change in intent write-downs and other-than-temporary impairments at March 31, 2009.
45
DEFERRED TAXES
We evaluate whether a valuation allowance for our deferred tax assets is required each reporting period. A valuation allowance is established if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred income tax asset will not be realized. In determining whether a valuation allowance is needed, all available evidence is considered. This includes the potential for capital and ordinary loss carryback, future reversals of existing taxable temporary differences, tax planning strategies and future taxable income exclusive of reversing temporary differences.
With respect to our evaluation of the need for a valuation allowance related to the deferred tax asset on unrealized losses on fixed income securities, we rely on our assertion that we have the intent and ability to hold the securities to recovery. As a result, the unrealized losses on these securities would not be expected to materialize and no valuation allowance on the associated deferred tax asset is needed.
With respect to our evaluation of the need for a valuation allowance related to other capital losses that have not yet been recognized for tax purposes, we utilize prudent and feasible tax planning strategies. These include strategies that optimize the Corporation’s ability to carry back capital losses as well as the ability to offset capital losses with capital gains that could be recognized for tax purposes. No valuation allowance was needed at March 31, 2009.
CAPITAL RESOURCES AND LIQUIDITY
Capital Resources consist of shareholder’s equity, representing funds deployed or available to be deployed to support business operations. The following table summarizes our capital resources.
($ in thousands) |
| March 31, |
| December 31, |
| ||
Common stock, additional capital paid-in and retained income |
| $ | 650,151 |
| $ | 625,482 |
|
Accumulated other comprehensive income |
| (58,955 | ) | (108,914 | ) | ||
Total shareholder’s equity |
| $ | 591,196 |
| $ | 516,568 |
|
Shareholder’s equity increased in the first three months of 2009 due to decreased unrealized net capital losses on fixed income securities and net income.
Financial Ratings and Strength Our ratings are influenced by many factors including our operating and financial performance, asset quality, liquidity, asset/liability management, overall portfolio mix, financial leverage (i.e., debt), exposure to risks, the current level of operating leverage, ALIC’s ratings and AIC’s ratings.
On February 2, 2009, A.M. Best affirmed our A+ financial strength rating. On January 29, 2009, S&P downgraded our financial strength rating to AA- from AA. The outlook for the rating remained negative. On January 29, 2009, Moody’s downgraded our financial strength rating to A1 from Aa3. The outlook for the rating was revised to stable from negative.
Liquidity Sources and Uses As reflected in our Condensed Statements of Cash Flows, lower operating cash flows in the first three months of 2009 compared to the first three months of 2008 were primarily related to lower net investment income and higher contract benefit payments, partially offset by higher premiums received.
Cash flows from investing activities shifted to a source of cash in the first quarter of 2009 from a use of cash in the first quarter of 2008 due primarily to higher proceeds from sales of fixed income securities and, to a lesser extent, increased collections on fixed income securities, partially offset by increased purchases of short-term investments and higher purchases of fixed income securities.
Cash flows from financing activities shifted to a use of cash in the first quarter of 2009 compared to a source of cash in the first quarter of 2008. The change was the result of lower contractholder fund deposits partially offset by decreased contractholder fund withdrawals. For quantification of the changes in contractholder funds, see the Operations section of MD&A.
46
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon this evaluation, the principal executive officer and the principal financial officer concluded that our disclosure controls and procedures are effective in providing reasonable assurance that material information required to be disclosed in our reports filed with or submitted to the Securities and Exchange Commission under the Securities Exchange Act is made known to management, including the principal executive officer and the principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting. During the fiscal quarter ended March 31, 2009, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
47
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Information required for this Part II, Item 1, is incorporated by reference to the discussion under the heading “Regulation” and under the heading “Legal and regulatory proceedings and inquiries” in Note 5 of the Company’s Condensed Financial Statements in Part I, Item 1, of this Form 10-Q.
Item 1A. Risk Factors
This document contains “forward-looking statements” that anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These statements are made subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. We assume no obligation to update any forward-looking statements as a result of new information or future events or developments.
These forward-looking statements do not relate strictly to historical or current facts and may be identified by their use of words like “plans,” “seeks,” “expects,” “will,” “should,” “anticipates,” “estimates,” “intends,” “believes,” “likely,” “targets” and other words with similar meanings. These statements may address, among other things, our strategy for growth, product development, regulatory approvals, market position, expenses, financial results, litigation and reserves. We believe that these statements are based on reasonable estimates, assumptions and plans. However, if the estimates, assumptions or plans underlying the forward-looking statements prove inaccurate or if other risks or uncertainties arise, actual results could differ materially from those communicated in these forward-looking statements. Risk factors which could cause actual results to differ materially from those suggested by such forward-looking statements include but are not limited to those discussed or identified in this document (including the risk described below), in our public filings with the Securities and Exchange Commission, and those incorporated by reference in Part I, Item 1A of Allstate Life Insurance Company of New York Annual Report on Form 10-K for 2008.
A large scale pandemic, the continued threat of terrorism, and ongoing military actions may adversely affect the level of claim losses we incur and the value of our investment portfolio
A global pandemic and the continued threat of terrorism, both within the United States and abroad, and ongoing military and other actions and heightened security measures in response to these types of threats, may cause significant volatility and losses from declines in the equity markets and from interest rate changes in the United States, Europe and elsewhere, and result in loss of life, disruptions to commerce and reduced economic activity. Some of the assets in our investment portfolio may be adversely affected by declines in the equity markets and reduced economic activity caused by a global pandemic or the continued threat of terrorism. We seek to mitigate the potential impact of terrorism on our commercial mortgage portfolio by limiting geographical concentrations in key metropolitan areas and by requiring terrorism insurance to the extent that it is commercially available. Additionally, in the event that a global pandemic or a terrorist act occurs, we could be adversely affected, depending on the nature of the event.
Item 6. Exhibits
(a) Exhibits
An Exhibit Index has been filed as part of this report on page E-1.
48
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Allstate Life Insurance Company of New York | ||
| (Registrant) | ||
|
|
| |
May 12, 2009 | By | /s/ Samuel H. Pilch |
|
| Samuel H. Pilch | ||
| Controller | ||
| (chief accounting officer and duly | ||
| authorized officer of Registrant) |
49
Exhibit No. |
| Description | |
15 |
|
| Acknowledgement of awareness from Deloitte & Touche LLP dated May 11, 2009, concerning unaudited interim financial information. |
|
|
|
|
31 (i) |
|
| Rule 15d-14(a) Certification of Principal Executive Officer |
|
|
|
|
31 (i) |
|
| Rule 15d-14(a) Certification of Principal Financial Officer |
|
|
|
|
32 |
|
| Section 1350 Certifications |
E-1