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 SEPTEMBER 30, 2007
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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” in Rule 12b-2 of the Exchange.
Large accelerated filer | Accelerated filer | Non-accelerated filer |
o | o | x |
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 November 5, 2007, the registrant had 100,000 common shares, $25 par value, outstanding, all of which are held by Allstate Life Insurance Company.
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
INDEX TO QUARTERLY REPORT ON FORM 10-Q
September 30, 2007
PART 1. | FINANCIAL INFORMATION | Page |
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Item 1. | Financial Statements |
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| Condensed Statements of Operations for the Three-Month and Nine-Month Periods Ended September 30, 2007 and 2006 (unaudited) | 3 |
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| Condensed Statements of Financial Position as of September 30, 2007 (unaudited) and December 31, 2006 | 4 |
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| Condensed Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2007 and 2006 (unaudited) | 5 |
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| Notes to Condensed Financial Statements (unaudited) | 6 |
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| Report of Independent Registered Public Accounting Firm | 15 |
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 |
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Item 4. | Controls and Procedures | 29 |
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PART II. | OTHER INFORMATION |
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Item 1. | Legal Proceedings | 30 |
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Item 1A. | Risk Factors | 30 |
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Item 6. | Exhibits | 30 |
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PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
CONDENSED STATEMENTS OF OPERATIONS
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
($ in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
| (unaudited) |
| (unaudited) |
| ||||||||
Revenues |
|
|
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| ||||
Premiums |
| $ | 17,720 |
| $ | 19,211 |
| $ | 54,135 |
| $ | 53,963 |
|
Contract charges |
| 14,677 |
| 13,740 |
| 43,816 |
| 48,582 |
| ||||
Net investment income |
| 96,994 |
| 92,536 |
| 287,901 |
| 279,256 |
| ||||
Realized capital gains and losses |
| 681 |
| (4,741 | ) | (2,063 | ) | (24,093 | ) | ||||
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| ||||
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| 130,072 |
| 120,746 |
| 383,789 |
| 357,708 |
| ||||
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Costs and expenses |
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| ||||
Contract benefits |
| 45,297 |
| 44,348 |
| 136,835 |
| 137,904 |
| ||||
Interest credited to contractholder funds |
| 44,572 |
| 41,614 |
| 131,470 |
| 124,662 |
| ||||
Amortization of deferred policy acquisition costs |
| 12,049 |
| 8,992 |
| 41,022 |
| 20,819 |
| ||||
Operating costs and expenses |
| 9,335 |
| 10,526 |
| 26,889 |
| 34,887 |
| ||||
|
| 111,253 |
| 105,480 |
| 336,216 |
| 318,272 |
| ||||
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| ||||
Loss on disposition of operations |
| — |
| (215 | ) | (132 | ) | (7,963 | ) | ||||
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| ||||
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| ||||
Income from operations before income tax expense |
| 18,819 |
| 15,051 |
| 47,441 |
| 31,473 |
| ||||
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|
|
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| ||||
Income tax expense |
| 6,434 |
| 4,844 |
| 16,679 |
| 10,409 |
| ||||
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| ||||
Net income |
| $ | 12,385 |
| $ | 10,207 |
| $ | 30,762 |
| $ | 21,064 |
|
See notes to condensed financial statements.
3
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
CONDENSED STATEMENTS OF FINANCIAL POSITION
|
| September 30, |
| December 31, |
| ||
($ in thousands, except par value data) |
| 2007 |
| 2006 |
| ||
|
| (unaudited) |
|
|
| ||
Assets |
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|
|
| ||
Investments |
|
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|
|
| ||
Fixed income securities, at fair value (amortized cost $5,900,261 and $5,542,227) |
| $ | 6,168,835 |
| $ | 5,887,139 |
|
Mortgage loans |
| 708,249 |
| 708,449 |
| ||
Short-term |
| 118,033 |
| 142,334 |
| ||
Policy loans |
| 38,181 |
| 38,168 |
| ||
Other |
| 19 |
| 3,784 |
| ||
|
|
|
|
|
| ||
Total investments |
| 7,033,317 |
| 6,779,874 |
| ||
|
|
|
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|
| ||
Cash |
| 4,920 |
| 7,090 |
| ||
Deferred policy acquisition costs |
| 288,475 |
| 278,625 |
| ||
Accrued investment income |
| 67,643 |
| 63,843 |
| ||
Reinsurance recoverables |
| 393,150 |
| 437,422 |
| ||
Current income taxes receivable |
| — |
| 862 |
| ||
Other assets |
| 44,719 |
| 42,488 |
| ||
Separate Accounts |
| 1,016,547 |
| 1,009,784 |
| ||
|
|
|
|
|
| ||
Total assets |
| $ | 8,848,771 |
| $ | 8,619,988 |
|
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| ||
Liabilities |
|
|
|
|
| ||
Contractholder funds |
| $ | 4,791,262 |
| $ | 4,708,428 |
|
Reserve for life-contingent contract benefits |
| 1,957,763 |
| 1,926,492 |
| ||
Deferred income taxes |
| 29,460 |
| 47,940 |
| ||
Current income taxes payable |
| 1,334 |
| — |
| ||
Other liabilities and accrued expenses |
| 386,354 |
| 243,338 |
| ||
Payable to affiliates, net |
| 9,198 |
| 30,031 |
| ||
Reinsurance payable to parent |
| — |
| 979 |
| ||
Separate Accounts |
| 1,016,547 |
| 1,009,784 |
| ||
|
|
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|
| ||
Total liabilities |
| 8,191,918 |
| 7,966,992 |
| ||
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Commitments and Contingent Liabilities (Note 4) |
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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 |
| ||
Additional capital paid-in |
| 140,000 |
| 140,000 |
| ||
Retained income |
| 462,037 |
| 432,458 |
| ||
Accumulated other comprehensive income: |
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Unrealized net capital gains and losses |
| 52,316 |
| 78,038 |
| ||
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Total accumulated other comprehensive income |
| 52,316 |
| 78,038 |
| ||
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Total shareholder’s equity |
| 656,853 |
| 652,996 |
| ||
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Total liabilities and shareholder’s equity |
| $ | 8,848,771 |
| $ | 8,619,988 |
|
See notes to condensed financial statements.
4
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
CONDENSED STATEMENTS OF CASH FLOWS
|
| Nine Months Ended |
| ||||
|
| 2007 |
| 2006 |
| ||
($ in thousands) |
| (unaudited) |
| ||||
Cash flows from operating activities |
|
|
|
|
| ||
Net income |
| $ | 30,762 |
| $ | 21,064 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
| ||
Amortization and other non-cash items |
| (57,080 | ) | (53,843 | ) | ||
Realized capital gains and losses |
| 2,063 |
| 24,093 |
| ||
Loss on disposition of operations |
| 132 |
| 7,963 |
| ||
Interest credited to contractholder funds |
| 131,470 |
| 124,662 |
| ||
Changes in: |
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|
|
|
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Life-contingent contract benefits and contractholder funds |
| 9,981 |
| 19,131 |
| ||
Deferred policy acquisition costs |
| 6,891 |
| (30,364 | ) | ||
Income taxes payable |
| (1,797 | ) | (36,012 | ) | ||
Other operating assets and liabilities |
| (36,249 | ) | (3,912 | ) | ||
Net cash provided by operating activities |
| 86,173 |
| 72,782 |
| ||
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Cash flows from investing activities |
|
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Proceeds from sales of fixed income securities |
| 339,309 |
| 710,186 |
| ||
Investment collections |
|
|
|
|
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Fixed income securities |
| 84,197 |
| 97,249 |
| ||
Mortgage loans |
| 54,838 |
| 57,960 |
| ||
Investment purchases |
|
|
|
|
| ||
Fixed income securities |
| (598,494 | ) | (775,808 | ) | ||
Mortgage loans |
| (54,542 | ) | (93,832 | ) | ||
Change in short-term investments, net |
| 45,495 |
| 18,952 |
| ||
Disposition of operations |
| (44 | ) | (394,915 | ) | ||
Change in other investments, net |
| (503 | ) | 1,685 |
| ||
Net cash used in investing activities |
| (129,744 | ) | (378,523 | ) | ||
|
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Cash flows from financing activities |
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|
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Contractholder fund deposits |
| 377,809 |
| 668,215 |
| ||
Contractholder fund withdrawals |
| (336,408 | ) | (357,789 | ) | ||
Net cash provided by financing activities |
| 41,401 |
| 310,426 |
| ||
|
|
|
|
|
| ||
Net (decrease) increase in cash |
| (2,170 | ) | 4,685 |
| ||
Cash at beginning of period |
| 7,090 |
| 3,818 |
| ||
Cash at end of period |
| $ | 4,920 |
| $ | 8,503 |
|
See notes to condensed financial statements.
5
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”), a wholly owned subsidiary of The Allstate Corporation (the “Corporation”).
The condensed financial statements and notes as of September 30, 2007 and for the three-month and nine-month periods ended September 30, 2007 and 2006 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, 2006. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.
Adopted accounting standards
Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (“SOP 05-1”)
In October 2005, the American Institute of Certified Public Accountants (“AICPA”) issued SOP 05-1. SOP 05-1 provides accounting guidance for deferred policy acquisition costs associated with internal replacements of insurance and investment contracts other than those already described in Statement of Financial Accounting Standard (“SFAS”) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments”. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement or rider to an existing contract, or by the election of a feature or coverage within an existing contract. In February 2007, the AICPA issued Technical Practice Aids (“TPAs”) that provide interpretive guidance to be used in applying SOP 05-1. The Company adopted the provisions of SOP 05-1 on January 1, 2007 for internal replacements occurring in fiscal years beginning after December 15, 2006. The adoption resulted in a $1.2 million after-tax reduction to retained income to reflect the impact on estimated future gross profits from the changes in accounting for certain costs associated with contract continuations that no longer qualify for deferral under SOP 05-1 and a reduction of deferred acquisition costs (“DAC”) and deferred sales inducements (“DSI”) balances of $1.8 million pre-tax as of January 1, 2007. The ongoing effects of SOP 05-1 are not expected to have a material impact on the Company’s results of operations or financial position.
SFAS No. 155, Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140 (“SFAS No. 155”)
In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, which permits the fair value remeasurement at the date of adoption of any hybrid financial instrument containing an embedded derivative that otherwise would require bifurcation under paragraph 12 or 13 of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”(“SFAS No.133”); clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or hybrid financial instruments that contain embedded derivatives requiring bifurcation; and clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. The Company adopted the provisions of SFAS No. 155 on January 1, 2007, which were effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of the first fiscal year beginning after September 15, 2006. The Company elected not to remeasure existing hybrid financial instruments that contained embedded derivatives requiring bifurcation at the date of adoption pursuant to paragraph 12 or 13 of SFAS No. 133. The adoption of SFAS No. 155 did not have a material effect on the results of operations or financial position of the Company.
6
Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”)
In July 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. FIN 48 requires an entity to recognize the tax benefit of uncertain tax positions only when it is more likely than not, based on the position’s technical merits, that the position would be sustained upon examination by the respective taxing authorities. The tax benefit is measured as the largest benefit that is more than fifty-percent likely of being realized upon final settlement with the respective taxing authorities. On January 1, 2007, the Company adopted the provisions of FIN 48, which were effective for fiscal years beginning after December 15, 2006. No cumulative effect of a change in accounting principle or adjustment to the liability for unrecognized tax benefits was recognized as a result of the adoption of FIN 48. Accordingly, the adoption of FIN 48 did not have an effect on the results of operations or financial position of the Company.
The Company had no liability for unrecognized tax benefits at January 1, 2007 or September 30, 2007, and believes it is reasonably possible that the liability balance will not significantly increase or decrease within the next 12 months.
The Internal Revenue Service (“IRS”) has completed its examination of the Company’s federal income tax returns for 2003-2004. The Company’s tax years prior to 2003 have been examined by the IRS and the statute of limitations has expired on those years.
Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”)
In September 2006, the SEC issued SAB 108 to eliminate the diversity of practice in the process by which misstatements are quantified for purposes of assessing their materiality on the financial statements. SAB 108 is intended to eliminate the potential for the build up of improper amounts on the balance sheet due to the limitations of certain methods of materiality assessment utilized in current practice. SAB 108 establishes a single quantification framework wherein the significance determination is based on the effects of the misstatements on each of the financial statements as well as the related financial statement disclosures. On December 31, 2006, the Company adopted the provisions of SAB 108 which were effective for the first fiscal year ending after November 15, 2006. The adoption of SAB 108 did not have any effect on the results of operations or financial position of the Company.
FASB Staff Position No. FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP FAS 115-1”)
FSP FAS 115-1 nullifies the guidance in paragraphs 10-18 of Emerging Issues Task Force Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” and references existing other-than-temporary impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell the security has not been made, and also provides guidance on the subsequent income recognition for impaired debt securities. The Company adopted FSP FAS 115-1 as of January 1, 2006 on a prospective basis. The effects of adoption did not have a material effect on the results of operations or financial position of the Company.
SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”)
SFAS No. 154 replaces Accounting Principles Board (“APB”) Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS No. 154 requires retrospective application to prior periods’ financial statements for changes in accounting principle, unless determination of either the period specific effects or the cumulative effect of the change is impracticable or otherwise not required. The Company adopted SFAS No. 154 on January 1, 2006. The adoption of SFAS No. 154 did not have any effect on the results of operations or financial position of the Company.
7
Pending accounting standards
SFAS No. 157, Fair Value Measurements (“SFAS No. 157”)
In September 2006, the FASB issued SFAS No. 157 which redefines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. SFAS No. 157 applies where other accounting pronouncements require or permit fair value measurements. Additional disclosures and modifications to current fair value disclosures will be required upon adoption of SFAS No. 157. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effects of adoption of SFAS No. 157 on its results of operations and financial position.
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”)
In February 2007, the FASB issued SFAS No. 159 which provides reporting entities an option to report selected financial assets, including investment securities designated as available for sale, and financial liabilities, including most insurance contracts, at fair value. 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 impact of a reporting entity’s decision to use fair value on its earnings and also 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 is effective as of the beginning of a reporting entity’s first fiscal year beginning after November 15, 2007. Because application of the standard is optional, any impacts are limited to those financial assets and liabilities to which SFAS No. 159 would be applied, which have yet to be determined by the Company.
SOP 07-1, Clarification of the Scope of the Audit and Accounting Guide, Investment Companies (“the Guide”) and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies (“SOP 07- 1”)
In June 2007, the AICPA issued SOP 07-1. Upon adoption of the SOP, the Company must also adopt the provisions of FASB Staff Position No. FIN 46(R)-7, “Application of FASB Interpretation No. 46(R) to Investment Companies”, which permanently exempts investment companies from applying the provisions of Interpretation 46(R) to investments carried at fair value. SOP 07-1 provides guidance for determining whether an entity falls within the scope of the Guide and whether investment company accounting should be retained by a parent company upon consolidation of an investment company subsidiary or by an equity method investor in an investment company. In certain circumstances, SOP 07-1 precludes retention of specialized accounting for investment companies (i.e. fair value accounting), when similar direct investments exist in the consolidated group and are measured on a basis inconsistent with that applied to investment companies. Additionally, SOP 07-1 precludes retention of specialized accounting for investment companies if the reporting entity does not distinguish, through documented policies, the nature and type of investments to be held in the investment companies from those made in the consolidated group where other accounting guidance is being applied. SOP 07-1 was to be effective for fiscal years beginning on or after December 15, 2007, however the FASB voted in October 2007 to delay the effective date. A revised effective date for SOP 07-1 is not yet available. The Company is assessing the current and future implications of this standard on its results of operations and financial position.
FASB Staff Position No. 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 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. The effects of applying FSP FIN 39-1 will be recorded as a change in accounting principle through retrospective application. The adoption of FSP FIN 39-1 is not expected to have a material impact on the company’s results of operations or financial position based on the current level of derivative activity.
8
2. Supplemental Cash Flow Information
Non-cash investment exchanges and modifications, which primarily reflect refinancing of fixed income securities, totaled $162 thousand and $2.6 million for the nine-month periods ended September 30, 2007 and 2006, respectively.
Liabilities for collateral received in conjunction with securities lending activities are reported in other liabilities and accrued expenses in the Condensed Statements of Financial Position. The associated cash flows are included in cash flows from operating activities in the Condensed Statements of Cash Flows along with the related changes in investments, which are as follows:
|
| Nine months ended |
| ||||
(in thousands) |
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Net change in fixed income securities |
| $ | (131,643 | ) | $ | (100,624 | ) |
Net change in short-term investments |
| (12,218 | ) | (91,285 | ) | ||
Net change in proceeds managed |
| $ | (143,861 | ) | $ | (191,909 | ) |
|
|
|
|
|
| ||
Liabilities for collateral and security repurchase, beginning of year |
| $ | (199,486 | ) | $ | (149,465 | ) |
Liabilities for collateral and security repurchase, end of period |
| (343,347 | ) | (341,374 | ) | ||
Operating cash flow provided |
| $ | 143,861 |
| $ | 191,909 |
|
3. Reinsurance
The effects of reinsurance on premiums and contract charges are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Premiums and contract charges |
|
|
|
|
|
|
|
|
| ||||
Direct |
| $ | 42,381 |
| $ | 42,382 |
| $ | 128,443 |
| $ | 124,815 |
|
Assumed – non-affiliate |
| 220 |
| 318 |
| 905 |
| 1,027 |
| ||||
Ceded |
|
|
|
|
|
|
|
|
| ||||
Affiliate |
| (997 | ) | (992 | ) | (2,981 | ) | (3,620 | ) | ||||
Non-affiliate |
| (9,207 | ) | (8,757 | ) | (28,416 | ) | (19,677 | ) | ||||
Premiums and contract charges, net of reinsurance |
| $ | 32,397 |
| $ | 32,951 |
| $ | 97,951 |
| $ | 102,545 |
|
The effects of reinsurance on contract benefits are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Contract benefits |
|
|
|
|
|
|
|
|
| ||||
Direct |
| $ | 49,025 |
| $ | 46,460 |
| $ | 147,418 |
| $ | 148,188 |
|
Assumed – non-affiliate |
| 119 |
| 108 |
| 608 |
| 605 |
| ||||
Ceded |
|
|
|
|
|
|
|
|
| ||||
Affiliate |
| (346 | ) | (44 | ) | (1,618 | ) | (225 | ) | ||||
Non-affiliate |
| (3,501 | ) | (2,176 | ) | (9,573 | ) | (10,664 | ) | ||||
Contract benefits, net of reinsurance |
| $ | 45,297 |
| $ | 44,348 |
| $ | 136,835 |
| $ | 137,904 |
|
9
The effects of reinsurance on interest credited to contractholder funds are as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Interest credited to contractholder funds |
|
|
|
|
|
|
|
|
| ||||
Direct |
| $ | 47,974 |
| $ | 45,845 |
| $ | 141,855 |
| $ | 130,366 |
|
Assumed – non-affiliate |
| 8 |
| 9 |
| 23 |
| 63 |
| ||||
Ceded– non-affiliate |
| (3,410 | ) | (4,240 | ) | (10,408 | ) | (5,767 | ) | ||||
Interest credited to contractholder funds, net of reinsurance |
| $ | 44,572 |
| $ | 41,614 |
| $ | 131,470 |
| $ | 124,662 |
|
In addition to amounts included in the table above are reinsurance premiums ceded to ALIC of $814 thousand and $771 thousand for the third quarter of 2007 and 2006, respectively, and $2.39 million and $2.26 million for the first nine months of 2007 and 2006, respectively, under the terms of the structured settlement annuity reinsurance agreement. These reinsurance premiums are reflected as a component of realized capital gains and losses on the Condensed Statements of Operations as the treaty under which these amounts are ceded is accounted for as a derivative instrument pursuant to the requirements of SFAS No. 133.
Variable Annuity Business
On June 1, 2006, in accordance with the terms of the definitive Master Transaction Agreement and related agreements (collectively the “Agreement”) the Company, its parent ALIC, and the Corporation, completed the disposal through reinsurance of all of the Company’s variable annuity business to Prudential Financial, Inc. and its subsidiary, The Prudential Insurance Company of America (collectively “Prudential”). For the Company, this disposal achieved the economic benefit of transferring to Prudential the future rights and obligations associated with this business.
The disposal was effected through reinsurance agreements (the “Reinsurance Agreements”) which include both coinsurance and modified coinsurance provisions. Coinsurance and modified coinsurance provisions are commonly used in the reinsurance of variable annuities because variable annuities generally include both separate account and general account liabilities. When contractholders make a variable annuity deposit, they must choose how to allocate their account balances between a selection of variable-return mutual funds that must be held in a separate account and fixed-return funds held in the Company’s general account. In addition, variable annuity contracts include various benefit guarantees that are general account obligations of the Company. The Reinsurance Agreements do not extinguish the Company’s primary liability under the variable annuity contracts.
Variable annuity balances invested in variable-return mutual funds are held in separate accounts, which are legally segregated assets and available only to settle separate account contract obligations. Because the separate account assets must remain with the Company under insurance regulations, modified coinsurance is typically used when parties wish to transfer future economic benefits of such business. Under the modified coinsurance provisions, the separate account assets remain on the Company’s Condensed Statements of Financial Position, but the related results of operations are fully reinsured and presented net of reinsurance on the Condensed Statements of Operations.
The coinsurance provisions of the Reinsurance Agreements were used to transfer the future rights and obligations related to fixed–return fund options and benefit guarantees. $440.0 million of assets supporting general account liabilities were transferred to Prudential, net of consideration, under the coinsurance provisions as of the transaction closing date. General account liabilities of $369.6 million at September 30, 2007 and $415.7 million as of December 31, 2006, however, remain on the Condensed Statements of Financial Position with a corresponding reinsurance recoverable.
10
For purposes of presentation in the Condensed Statements of Cash Flows, the Company treated the reinsurance of its variable annuity business to Prudential as a disposition of operations, consistent with the substance of the transaction which was the disposition of a block of business accomplished through reinsurance. Accordingly, the net consideration transferred to Prudential of $388.4 million (computed as $440.0 million of general account insurance liabilities transferred to Prudential on the closing date less consideration of $51.6 million) and the costs of executing the transaction of $1.2 million, pretax, were classified as a disposition of operations in the cash flows from investing activities section of the Condensed Statements of Cash Flows.
Under the Agreement, the Company, ALIC and the Corporation have indemnified Prudential for certain pre-closing contingent liabilities (including extra-contractual liabilities of the Company and ALIC and liabilities specifically excluded from the transaction) that the Company and ALIC have agreed to retain. In addition, the Company, ALIC and the Corporation 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 limits 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”.
The terms of the Agreement give Prudential the right to be the exclusive provider of its variable annuity products through the Allstate proprietary agency force for three years and a non-exclusive preferred provider for the following two years. During a transition period, the Company and ALIC will continue to issue new variable annuity contracts, accept additional deposits on existing business from existing contractholders on behalf of Prudential and, for a period of twenty-four months or less, service the reinsured business while Prudential prepares for the migration of the business onto its servicing platform.
Pursuant to the Agreement, the consideration was $51.6 million. The disposal resulted in a reinsurance loss of $9.3 million, pretax. This reinsurance loss and other transactional expenses incurred were included as a component of loss on disposition of operations on the Statements of Operations and Comprehensive Income and amounted to $10.7 million, pretax ($7.0 million, after-tax) during 2006. Additional losses totaling $132 thousand were recorded in the first nine months of 2007. DAC and DSI were reduced by $79.7 million and $6.2 million, respectively, as of the effective date of the transaction for balances related to the variable annuity business subject to the Reinsurance Agreements.
The separate account balances related to the modified coinsurance reinsurance were $1.01 billion as of September 30, 2007 and $1.01 billion as of December 31, 2006. Separate account balances totaling approximately $3.8 million as of September 30, 2007 and $2.7 million at December 31, 2006 relate to the variable life business that is being retained. In the first five months of 2006, prior to this disposition, the Company’s variable annuity business generated $8.1 million in contract charges.
4. 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 owed to policyholders and claimants. Amounts assessed to each company are typically related to its proportion of business written in a particular state.
The New York Liquidation Bureau (the “Bureau”) has publicly reported that Executive Life Insurance Company of New York (“Executive Life”), currently under its jurisdiction as part of a 1992 court-ordered rehabilitation plan, may only be able to meet future obligations of its annuity contracts for the next fifteen years due to an estimated $600 million shortfall in assets to fund those obligations. If Executive Life were to be declared insolvent in the future, the Company would likely have exposure to guaranty fund assessments or other costs.
Based on currently available information, the outcome of this situation is uncertain at this time. The Bureau may eventually take actions to address this situation that may lead to guaranty fund assessments or other costs to the Company. 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 market share in New York was approximately 5.5% in 2005 based on industry annuity premium.
11
Guarantees
In the normal course of business, the Company provides standard indemnifications to counterparties in contracts 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 were 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 September 30, 2007.
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 and, in some cases, the timing of their resolutions relative to other similar matters involving other companies; 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 on 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 our 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.
12
• 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.
• 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 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.
• 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 of the trial court’s summary judgment order is now pending in the United States Court of Appeals for the Eighth Circuit.
• AIC is also defending a certified class action filed by former employee agents who terminated their employment prior to the agency program reorganization. These plaintiffs have asserted breach of contract and ERISA claims. The court approved the form of class notice in October 2007 and set a December 2007 deadline for filing dispositive motions.
• 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.
13
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, 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.
5. Other Comprehensive Income
The components of other comprehensive income (loss) on a pretax and after-tax basis are as follows:
|
| Three months ended September 30, |
| ||||||||||||||||
|
| 2007 |
| 2006 |
| ||||||||||||||
(in thousands) |
| Pretax |
| Tax |
| After- |
| Pretax |
| Tax |
| After- |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Unrealized holding gains arising during the period, net of related offsets |
| $ | 23,124 |
| $ | (8,094 | ) | $ | 15,030 |
| $ | 71,794 |
| $ | (25,127 | ) | $ | 46,667 |
|
Less: reclassification adjustment of realized capital gains and losses |
| 3,025 |
| (1,059 | ) | 1,966 |
| (2,965 | ) | 1,038 |
| (1,927 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Other comprehensive income |
| $ | 20,099 |
| $ | (7,035 | ) | 13,064 |
| $ | 74,759 |
| $ | (26,165 | ) | 48,594 |
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net income |
|
|
|
|
| 12,385 |
|
|
|
|
| 10,207 |
| ||||||
Comprehensive income |
|
|
|
|
| $ | 25,449 |
|
|
|
|
| $ | 58,801 |
|
|
| Nine months ended September 30, |
| ||||||||||||||||
|
| 2007 |
| 2006 |
| ||||||||||||||
(in thousands) |
| Pretax |
| Tax |
| After- |
| Pretax |
| Tax |
| After- |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Unrealized holding losses arising during the period, net of related offsets |
| $ | (35,430 | ) | $ | 12,400 |
| $ | (23,030 | ) | $ | (86,786 | ) | $ | 30,376 |
| $ | (56,410 | ) |
Less: reclassification adjustment of realized capital gains and losses |
| 4,142 |
| (1,450 | ) | 2,692 |
| (25,896 | ) | 9,064 |
| (16,832 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Other comprehensive loss |
| $ | (39,572 | ) | $ | 13,850 |
| (25,722 | ) | $ | (60,890 | ) | $ | 21,312 |
| (39,578 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net income |
|
|
|
|
| 30,762 |
|
|
|
|
| 21,064 |
| ||||||
Comprehensive income (loss) |
|
|
|
|
| $ | 5,040 |
|
|
|
|
| $ | (18,514 | ) |
14
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 September 30, 2007, and the related condensed statements of operations for the three-month and nine-month periods ended September 30, 2007 and 2006, and the condensed statements of cash flows for the nine-month periods ended September 30, 2007 and 2006. 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, 2006, and the related statements of operations and comprehensive income, shareholder’s equity, and cash flows for the year then ended, not presented herein. In our report dated March 9, 2007, which report includes an explanatory paragraph relating to a change in the Company’s method of accounting for certain nontraditional long-duration contracts and for separate accounts in 2004, 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, 2006 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
November 2, 2007
15
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2007 AND 2006
OVERVIEW
The following discussion highlights significant factors influencing the 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 2006. We operate as a single segment entity, based on the manner in which we use financial information to evaluate performance and determine the allocation of resources.
OPERATIONS
Effective June 1, 2006, we disposed of our variable annuity business through reinsurance with Prudential Financial Inc. (“Prudential”). The following table presents the results of operations attributable to the variable annuity business for the period of 2006 prior to the disposition.
(in thousands) |
| Nine Months Ended |
| |
|
|
|
|
|
Contract charges |
| $ | 8,103 |
|
Net investment income |
| 8,789 |
| |
Realized capital gains and losses |
| (4,079 | ) | |
Total revenues |
| 12,813 |
| |
|
|
|
| |
Contract benefits |
| (2,117 | ) | |
Interest credited to contractholder funds |
| (6,408 | ) | |
Amortization of deferred policy acquisition costs |
| 7,277 |
| |
Operating costs and expenses |
| (3,394 | ) | |
Total costs and expenses |
| (4,642 | ) | |
|
|
|
| |
Loss on disposition of operations |
| (7,748 | ) | |
|
|
|
| |
Income from operations before income tax expense (1) |
| $ | 423 |
|
(1) |
| For the nine months ended September 30, 2006, income from operations before income tax expense on the variable annuity business reinsured to Prudential included an investment spread and benefit spread of $2.4 million and $(1.1) million, respectively. |
16
The Company’s results of operations for the three months and nine months ended September 30 are presented in the following table.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Revenues |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums |
| $ | 17,720 |
| $ | 19,211 |
| $ | 54,135 |
| $ | 53,963 |
|
Contract charges |
| 14,677 |
| 13,740 |
| 43,816 |
| 48,582 |
| ||||
Net investment income |
| 96,994 |
| 92,536 |
| 287,901 |
| 279,256 |
| ||||
Realized capital gains and losses |
| 681 |
| (4,741 | ) | (2,063 | ) | (24,093 | ) | ||||
Total revenues |
| 130,072 |
| 120,746 |
| 383,789 |
| 357,708 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Contract benefits |
| (45,297 | ) | (44,348 | ) | (136,835 | ) | (137,904 | ) | ||||
Interest credited to contractholder funds |
| (44,572 | ) | (41,614 | ) | (131,470 | ) | (124,662 | ) | ||||
Amortization of DAC |
| (12,049 | ) | (8,992 | ) | (41,022 | ) | (20,819 | ) | ||||
Operating costs and expenses |
| (9,335 | ) | (10,526 | ) | (26,889 | ) | (34,887 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Total costs and expenses |
| (111,253 | ) | (105,480 | ) | (336,216 | ) | (318,272 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Loss on disposition of operations |
| — |
| (215 | ) | (132 | ) | (7,963 | ) | ||||
Income tax expense |
| (6,434 | ) | (4,844 | ) | (16,679 | ) | (10,409 | ) | ||||
Net income |
| $ | 12,385 |
| $ | 10,207 |
| $ | 30,762 |
| $ | 21,064 |
|
Net Income increased $2.2 million to $12.4 million in the third quarter of 2007 and increased $9.7 million to $30.8 million in the first nine months of 2007 compared to the same periods in 2006. The increase in the third quarter was mostly the result of higher revenues, partially offset by higher amortization of deferred policy acquisition costs (“DAC”) and interest credited to contractholder funds. Higher net income in the first nine months of 2007 was primarily attributable to increased revenues, lower operating costs and expenses, and the recognition in the prior year of losses relating to the disposition of our variable annuity business, partially offset by higher amortization of DAC and interest credited to contractholder funds.
Analysis of Revenues Total revenues increased 7.7% and 7.3% in the third quarter and first nine months of 2007, respectively, compared to the same periods in the prior year. The increases in both periods were mostly driven by improved realized capital gains and losses and higher net investment income. In the third quarter, these changes were partially offset by lower premiums. In the nine-month period, these changes were partially offset by lower contract charges.
Premiums represent revenues generated from traditional life, immediate annuities with life contingencies, accident and health and other insurance products that have significant mortality or morbidity risk.
Contract charges are revenues generated from interest-sensitive and variable life, fixed annuities and variable 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. Subsequent to the close of our reinsurance transaction with Prudential on June 1, 2006, variable annuity contract charges on the business subject to the transaction are fully reinsured to Prudential and presented net of reinsurance on the Condensed Statements of Operations (see Note 3 to the Condensed Financial Statements).
17
The following table summarizes premiums and contract charges by product.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Premiums |
|
|
|
|
|
|
|
|
| ||||
Traditional life |
| $ | 6,575 |
| $ | 6,044 |
| $ | 18,937 |
| $ | 16,869 |
|
Immediate annuities with life contingencies |
| 9,395 |
| 11,862 |
| 30,382 |
| 33,354 |
| ||||
Accident and health and other |
| 1,750 |
| 1,305 |
| 4,816 |
| 3,740 |
| ||||
Total premiums |
| 17,720 |
| 19,211 |
| 54,135 |
| 53,963 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Contract charges |
|
|
|
|
|
|
|
|
| ||||
Interest-sensitive life |
| 12,985 |
| 11,692 |
| 37,821 |
| 34,292 |
| ||||
Fixed annuities |
| 1,692 |
| 2,038 |
| 5,995 |
| 6,177 |
| ||||
Variable annuities |
| — |
| 10 |
| — |
| 8,113 |
| ||||
Total contract charges (1) |
| 14,677 |
| 13,740 |
| 43,816 |
| 48,582 |
| ||||
Premiums and contract charges |
| $ | 32,397 |
| $ | 32,951 |
| $ | 97,951 |
| $ | 102,545 |
|
(1) | Contract charges for the three months ended September 30, 2007 and 2006 include contract charges related to the cost of insurance totaling $9.2 million and $7.9 million, respectively. Contract charges for the nine months ended September 30, 2007 and 2006 include contract charges related to the cost of insurance totaling $25.9 million and $24.4 million, respectively. |
Total premiums declined 7.8% in the third quarter of 2007 compared to the third quarter of 2006 and increased 0.3% in the first nine months of 2007 compared to the same period of 2006. The decline in the third quarter of 2007 was due primarily to lower sales of immediate annuities with life contingencies. In the nine month period, lower sales of immediate annuities with life contingencies were more than offset by higher sales of traditional life insurance products and accident and health insurance products.
Contract charges increased 6.8% in the third quarter of 2007 and declined 9.8% in first nine months of 2007 compared to the same periods of 2006. In the third quarter, the increase was the result of higher contract charges on interest-sensitive life insurance policies due to growth in business in force, partially offset by lower contract charges on fixed annuities. The decline in contract charges in the nine month period was due to the disposal of our variable annuity business through reinsurance effective June 1, 2006. Excluding contract charges on variable annuities, contract charges increased 8.3% in the first nine months of 2007 compared to the same period of 2006. This increase also reflects higher contract charges on interest-sensitive life insurance policies due to growth in business in force, partially offset by lower contract charges on fixed annuities.
18
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 |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Contractholder funds, beginning balance |
| $ | 4,711,868 |
| $ | 4,599,676 |
| $ | 4,708,428 |
| $ | 4,349,395 |
|
|
|
|
|
|
|
|
|
|
| ||||
Deposits: |
|
|
|
|
|
|
|
|
| ||||
Fixed annuities |
| 134,811 |
| 204,649 |
| 293,832 |
| 585,058 |
| ||||
Interest-sensitive life |
| 25,922 |
| 23,050 |
| 76,196 |
| 70,889 |
| ||||
Variable annuity and life deposits allocated to fixed accounts |
| 13 |
| 12 |
| 42 |
| 15,505 |
| ||||
Total deposits |
| 160,746 |
| 227,711 |
| 370,070 |
| 671,452 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Interest credited |
| 45,042 |
| 44,869 |
| 133,598 |
| 133,397 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Benefits, withdrawals and other adjustments |
|
|
|
|
|
|
|
|
| ||||
Benefits |
| (35,329 | ) | (34,114 | ) | (110,496 | ) | (105,757 | ) | ||||
Surrenders and partial withdrawals |
| (65,248 | ) | (67,359 | ) | (225,911 | ) | (233,905 | ) | ||||
Contract charges |
| (12,317 | ) | (11,322 | ) | (35,911 | ) | (33,129 | ) | ||||
Net transfers from (to) separate accounts |
| — |
| 2 |
| — |
| (18,127 | ) | ||||
Other adjustments |
| (13,500 | ) | (17,111 | ) | (48,516 | ) | (20,974 | ) | ||||
Total benefits, withdrawals and other adjustments |
| (126,394 | ) | (129,904 | ) | (420,834 | ) | (411,892 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Contractholder funds, ending balance |
| $ | 4,791,262 |
| $ | 4,742,352 |
| $ | 4,791,262 |
| $ | 4,742,352 |
|
Contractholder funds increased 1.7% and 3.1% in the third quarter of 2007 and 2006, respectively, and increased 1.8% and 9.0% in the first nine months of 2007 and 2006, respectively. Average contractholder funds increased 1.7% and 4.5% in the third quarter and first nine months of 2007, respectively, compared to the same periods in 2006. This is compared to an increase in average contractholder funds of 11.7% and 13.2% in the third quarter and first nine months of 2006, respectively, compared to the same periods in 2005.
Contractholder deposits declined 29.4% and 44.9% in the third quarter and first nine months of 2007, respectively, compared to the same periods of 2006. These declines were primarily due to lower deposits on fixed annuities. The declines of 34.1% and 49.8% in fixed annuity deposits in the third quarter and first nine months of 2007, respectively, compared to the same periods in the prior year, are indicative of lower industry-wide fixed annuity sales and our strategy to raise new business returns on capital for these products.
Surrenders and partial withdrawals declined 3.1% and 3.4% in the third quarter of 2007 and first nine months of 2007, respectively, compared to the same periods of 2006. The decrease in surrenders and partial withdrawals in the first nine months of 2007 was due to the absence in 2007 of surrenders and partial withdrawals related to the variable annuity business that was reinsured effective June 1, 2006. Subsequent to the effective date of that transaction, the net change in contractholder funds attributable to the reinsured variable annuity business is included as a component of the other adjustments line in the table above. Surrenders and partial withdrawals for the first nine months of 2006 include $30.5 million related to the reinsured variable annuity business. 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 8.1% and 8.2% for the first nine months of 2007 and 2006, respectively.
19
Net investment income increased 4.8% in the third quarter and 3.1% in the first nine months of 2007 compared to the same periods in 2006. The increase in both periods was primarily due to higher average portfolio balances. Higher average portfolio balances resulted primarily from the investment of operating cash flows. See the Investments section of MD&A for further detail of net investment income.
Realized capital gains and losses reflected net gains of $681 thousand in the third quarter of 2007 and net losses of $2.1 million in first nine months of 2007. This compares to net losses of $4.7 million and $24.1 million in the third quarter and first nine months of 2006, respectively. For further discussion of realized capital gains and losses, see the Investments section of MD&A.
Analysis of Costs and Expenses Total costs and expenses increased 5.5% or $5.8 million and 5.6% or $17.9 million in the third quarter and first nine months of 2007, respectively, compared to the same periods in the prior year. The increases in both periods were mostly driven by higher amortization of DAC and interest credited to contractholder funds, partially offset by lower operating costs and expenses.
Contract benefits increased 2.1% or $949 thousand in the third quarter of 2007 and decreased 0.8% or $1.1 million in the first nine months of 2007 compared to the same periods in the prior year. The increase in the third quarter of 2007 was driven primarily by higher contract benefits for the implied interest on life-contingent immediate annuities. The decrease in the first nine months of 2007 was due to the absence in 2007 of contract benefits on the reinsured variable annuity business, which totaled $2.1 million in the nine months ended September 31, 2006. Excluding the impact of the reinsured variable annuity business, contract benefits increased 0.8% compared to the prior year as a result of higher contract benefits for the implied interest on life-contingent immediate annuities, partially offset by improved mortality experience on immediate annuities with life contingencies.
Contract benefits include the implied interest on life-contingent immediate annuities. This implied interest totaled $27.1 million and $26.2 million in the third quarter of 2007 and 2006, respectively, and totaled $80.5 million and $77.5 million in the first nine months of 2007 and 2006, respectively.
We analyze our mortality and morbidity results using the difference between premiums, contract charges earned for the cost of insurance and contract benefits excluding the portion related to the implied interest on life-contingent immediate annuities (“benefit spread”). The benefit spread by product group is disclosed in the following table.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Life insurance |
| $ | 8,863 |
| $ | 7,767 |
| $ | 21,226 |
| $ | 18,920 |
|
Annuities |
| (207 | ) | 1,179 |
| 2,412 |
| (971 | ) | ||||
Total benefit spread |
| $ | 8,656 |
| $ | 8,946 |
| $ | 23,638 |
| $ | 17,949 |
|
Interest credited to contractholder funds increased 7.1% or $3.0 million in the third quarter and 5.5% or $6.8 million in the first nine months of 2007 compared to the same periods in the prior year. The increase in both periods was the result of growth in contractholder funds and higher weighted average interest crediting rates on deferred fixed annuities. In the first nine months of 2007, the impact of these items was partially offset by the absence in 2007 of interest credited related to the reinsured variable annuity business. Interest credited to contractholder funds related to the reinsured variable annuity business totaled $6.4 million in the first nine months of 2006.
In order to analyze the impact of net investment income and interest credited to policyholders on net income, we review the difference between net investment income and the sum of interest credited to contractholder funds and the implied interest on life-contingent immediate annuities which is included as a component of contract benefits on the Condensed Statements of Operations (“investment spread”).
20
The investment spread by product group is shown in the following table.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Annuities |
| $ | 14,577 |
| $ | 15,244 |
| $ | 45,554 |
| $ | 49,021 |
|
Life insurance |
| 809 |
| 480 |
| 2,267 |
| 1,969 |
| ||||
Net investment income on investments supporting capital |
| 9,953 |
| 9,029 |
| 28,142 |
| 26,077 |
| ||||
Total investment spread |
| $ | 25,339 |
| $ | 24,753 |
| $ | 75,963 |
| $ | 77,067 |
|
The following table summarizes the weighted average investment yield, interest crediting rates and investment spreads for the three months ended September 30.
|
| Weighted Average |
| Weighted Average |
| Weighted Average |
| ||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
|
Interest-sensitive life |
| 5.7 | % | 5.6 | % | 4.6 | % | 4.6 | % | 1.1 | % | 1.0 | % |
Deferred fixed annuities |
| 5.7 |
| 5.6 |
| 3.5 |
| 3.4 |
| 2.2 |
| 2.2 |
|
Immediate fixed annuities with and without life contingencies |
| 7.3 |
| 7.4 |
| 6.6 |
| 6.6 |
| 0.7 |
| 0.8 |
|
Investments supporting capital, traditional life and other products |
| 6.1 |
| 6.1 |
| N/A |
| N/A |
| N/A |
| N/A |
|
The following table summarizes the weighted average investment yield, interest crediting rates and investment spreads for the nine months ended September 30.
|
| Weighted Average |
| Weighted Average |
| Weighted Average |
| ||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
|
Interest-sensitive life |
| 5.7 | % | 5.6 | % | 4.6 | % | 4.5 | % | 1.1 | % | 1.1 | % |
Deferred fixed annuities |
| 5.6 |
| 5.6 |
| 3.4 |
| 3.2 |
| 2.2 |
| 2.4 |
|
Immediate fixed annuities with and without life contingencies |
| 7.4 |
| 7.5 |
| 6.6 |
| 6.7 |
| 0.8 |
| 0.8 |
|
Investments supporting capital, traditional life and other products |
| 5.9 |
| 6.2 |
| N/A |
| N/A |
| N/A |
| N/A |
|
The following table summarizes the liabilities for these contracts and policies.
|
| Nine Months Ended |
| ||||
(in thousands) |
| 2007 |
| 2006 |
| ||
Immediate fixed annuities with life contingencies |
| $ | 1,607,719 |
| $ | 1,544,636 |
|
Other life contingent contracts and other |
| 350,044 |
| 360,978 |
| ||
Reserve for life-contingent contract benefits |
| $ | 1,957,763 |
| $ | 1,905,614 |
|
|
|
|
|
|
| ||
Interest-sensitive life |
| $ | 515,037 |
| $ | 464,148 |
|
Deferred fixed annuities |
| 3,705,304 |
| 3,724,117 |
| ||
Immediate fixed annuities without life contingencies and other |
| 570,921 |
| 554,087 |
| ||
Contractholder funds |
| $ | 4,791,262 |
| $ | 4,742,352 |
|
21
Amortization of DAC increased 34.0% or $3.1 million in the third quarter of 2007 and 97.0% or $20.2 million in the first nine months of 2007 compared to the same periods of 2006. The components of amortization of DAC are shown in the following table.
(in thousands) |
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Amortization of DAC before amortization relating to realized capital gains and losses and changes in assumptions (1) |
| $ | (11,958 | ) | $ | (11,244 | ) | $ | (35,413 | ) | $ | (35,784 | ) |
Amortization relating to realized capital gains and losses (2) |
| (91 | ) | 2,252 |
| 209 |
| 14,819 |
| ||||
Changes in assumptions (“unlocking”) |
| — |
| — |
| (5,818 | ) | 146 |
| ||||
Total amortization of DAC |
| $ | (12,049 | ) | $ | (8,992 | ) | $ | (41,022 | ) | $ | (20,819 | ) |
(1) Amortization of DAC before amortization relating to realized capital gains and losses and changes in assumptions for the nine months ended September 30, 2006 includes $(4.6) million relating to the reinsured variable annuity business.
(2) Amortization relating to realized capital gains and losses for the nine months ended September 30, 2006 includes $11.9 million of amortization relating to the reinsured variable annuity business.
The increase in amortization of DAC in the third quarter of 2007 compared to the third quarter of the prior year was primarily the result of an unfavorable change in amortization relating to realized capital gains and losses. The increase in amortization in the first nine months of 2007 compared to the same period in the prior year was primarily due to the absence in 2007 of amortization on the variable annuity business that was reinsured effective June 1, 2006. Amortization on the reinsured variable annuity business in the first nine months of 2006 reflected a credit to income of $7.3 million. Excluding amortization relating to the reinsured variable annuity business, amortization of DAC increased 46.0% in the first nine months of 2007 compared to the same period in the prior year. This increase was due primarily to an unfavorable impact totaling $6.0 million relating to our annual comprehensive review of DAC assumptions (commonly referred to as “unlocking”) and higher gross profits.
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.
Operating costs and expenses declined 11.3% and 22.9% in the third quarter and first nine months of 2007 compared to the same periods of 2006. The decline in both periods was primarily due to lower restructuring and employee benefit related expenses, decreased insurance department assessments and lower non-deferrable commissions, partially offset by an increased investment in technology. Additionally, the decline in the nine-month period was also impacted by the absence in 2007 of expenses related to the reinsured variable annuity business. Excluding the impact of the reinsured variable annuity business, expenses declined 14.6% in the first nine months of 2007.
Gain (loss) on disposition of operations changed by a favorable $215 thousand and $7.8 million in the third quarter and first nine months of 2007, respectively, compared to the same periods in the prior year. This improvement was due to the recognition in the prior year of losses relating to the disposition of our variable annuity business.
Income tax expense increased by $1.6 million and $6.3 million in the third quarter and first nine months of 2007, respectively, compared to the same periods in the prior year. These increases primarily reflect the proportional impact of higher income before taxes.
22
INVESTMENTS
An important component of our financial results is the return on our investment portfolio. The composition of the investment portfolio at September 30, 2007 is presented in the table below.
|
| Carrying |
| Percent |
| |
(in thousands) |
| value |
| of total |
| |
|
|
|
|
|
| |
Fixed income securities (1) |
| $ | 6,168,835 |
| 87.7 | % |
Mortgage loans |
| 708,249 |
| 10.1 |
| |
Short-term |
| 118,033 |
| 1.7 |
| |
Policy loans |
| 38,181 |
| 0.5 |
| |
Other |
| 19 |
| — |
| |
Total |
| $ | 7,033,317 |
| 100.0 | % |
(1) Fixed income securities are carried at fair value. Amortized cost basis for these securities was $5.90 billion.
Total investments increased to $7.03 billion at September 30, 2007, from $6.78 billion at December 31, 2006, primarily due to positive cash flows from operating and financing activities, including increased funds associated with securities lending, partially offset by the decreased net unrealized gains on fixed income securities.
Total investments at amortized cost related to collateral received in connection with securities lending business activities increased to $343.3 million at September 30, 2007, from $199.5 million at December 31, 2006.
Fixed income securities by type are listed in the table below.
|
| September 30, |
| % to Total |
| December 31, |
| % to Total |
| ||
($ in thousands) |
|
|
|
|
|
|
|
|
| ||
U.S. government and agencies |
| $ | 757,151 |
| 10.8 | % | $ | 729,111 |
| 10.8 | % |
Municipal |
| 451,536 |
| 6.4 |
| 323,003 |
| 4.8 |
| ||
Corporate |
| 3,300,431 |
| 46.9 |
| 3,304,762 |
| 48.7 |
| ||
Asset-backed securities |
| 116,966 |
| 1.7 |
| 109,022 |
| 1.6 |
| ||
Commercial mortgage-backed securities |
| 798,515 |
| 11.4 |
| 673,179 |
| 9.9 |
| ||
Mortgage-backed securities |
| 418,074 |
| 5.9 |
| 433,196 |
| 6.4 |
| ||
Foreign government |
| 316,722 |
| 4.5 |
| 304,947 |
| 4.5 |
| ||
Redeemable preferred stock |
| 9,440 |
| 0.1 |
| 9,919 |
| 0.1 |
| ||
Total fixed income securities |
| $ | 6,168,835 |
| 87.7 | % | $ | 5,887,139 |
| 86.8 | % |
At September 30, 2007, 96.5% 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 or a rating of AAA, AA, A or BBB from Standard & Poor’s, 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.
During the third quarter of 2007, the financial markets experienced liquidity declines, primarily in the residential mortgage and asset-backed commercial paper markets. Certain other asset-backed and real estate investment markets experienced similar illiquidity, but to a much lesser degree. After gaining assurance as to the reasonableness of our vendor pricing services, we have been able to continue to value our portfolio of these securities based upon independent market quotations.
23
Asset-backed and mortgage-backed fixed income securities by type are listed in the table below.
($ in thousands) |
| Aaa |
| Aa |
| A |
| Baa |
| Fair value at |
| % toTotal |
| |
Asset-backed securities |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Asset-backed securities collateralized by sub- prime residential mortgage-backed loans (“ABS RMBS”) |
| 95.6 | % | 4.4 | % | — |
| — |
| $ | 85,425 |
| 1.2 | % |
Other collateralized debt obligations |
| 49.9 | % | 12.4 | % | 27.9 | % | 9.8 | % | 31,541 |
| 0.5 | % | |
Total Asset-backed securities |
|
|
|
|
|
|
|
|
| $ | 116,966 |
| 1.7 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Mortgage-backed securities |
|
|
|
|
|
|
|
|
|
|
|
|
| |
U.S. Agency |
| 100 | % | — |
| — |
| — |
| $ | 340,249 |
| 4.8 | % |
Prime |
| 100 | % | — |
| — |
| — |
| 48,877 |
| 0.7 |
| |
Alt-A |
| 100 | % | — |
| — |
| — |
| 28,948 |
| 0.4 |
| |
Total Mortgage-backed securities |
|
|
|
|
|
|
|
|
| $ | 418,074 |
| 5.9 | % |
Certain of our asset-backed and mortgage-backed securities are collateralized by residential mortgage loans that are characterized by borrowers of differing levels of creditworthiness: U.S. agency, prime, Alt-A and sub-prime. Our practice for acquiring and monitoring ABS RMBS (also known as “sub prime RMBS”) and Alt-A mortgage-backed securities takes into consideration the quality of the originator, quality of the servicer, security credit rating, underlying characteristics of the mortgages, borrower characteristics, level of credit enhancement in the transaction, and bond insurer strength, where applicable. The originators and servicers of the underlying mortgage loans are primarily subsidiaries of large banks and broker/dealers. These securities are structured to experience losses according to the seniority level of each tranche, with the least senior tranche taking the first loss.
At September 30, 2007, we did not record any investment write-downs related to our ABS RMBS or Alt-A residential mortgage-backed securities. Although we do not currently anticipate other-than-temporary impairments in these securities, a deterioration of future market conditions could cause us to alter that outlook. In addition, based on our analysis and the seniority of our securities’ claim on the underlying collateral, we currently expect to receive all payments on these securities in accordance with their original contractual terms.
The following table presents additional information about our ABS RMBS portfolio including a summary by first and second lien collateral.
($ in thousands) |
| Fair value at |
| % to Total |
| |
ABS RMBS |
|
|
|
|
| |
First lien: |
|
|
|
|
| |
Fixed rate (1) |
| $ | 14,852 |
| 0.2 | % |
Variable rate (1) |
| 42,790 |
| 0.6 |
| |
Total first lien (2) |
| 57,642 |
| 0.8 |
| |
Second lien: |
|
|
|
|
| |
Insured |
| 18,254 |
| 0.3 |
| |
Other |
| 9,529 |
| 0.1 |
| |
Total second lien (3) |
| 27,783 |
| 0.4 |
| |
Total ABS RMBS |
| $ | 85,425 |
| 1.2 | % |
(1) Fixed rate and variable rate refer to the primary interest rate characteristic of the underlying mortgages at the time of issuance.
(2) The credit ratings of the first lien ABS RMBS were 100% Aaa, at September 30, 2007.
(3) The credit ratings of the second lien ABS RMBS were 86.6% Aaa, and 13.4% Aa at September 30, 2007.
ABS RMBS includes securities that are collateralized by mortgage loans issued to borrowers that cannot qualify for prime or alternative financing terms due in part to an impaired or limited credit history. It also includes securities that are collateralized by certain second lien mortgages regardless of the borrower’s credit profile. As of September 30, 2007, the ABS RMBS portfolio had gross unrealized losses of $2.0 million. This is compared to net unrealized losses of $613 thousand, which were comprised of $14 thousand of unrealized gains and $627 thousand of unrealized losses at June 30, 2007. During the third quarter of 2007, two second lien ABS RMBS with a value of
24
$3.7 million were downgraded within the investment grade ratings. Since September 30, 2007, one tranche with a value of $734 thousand was downgraded within the investment grade rating. During the third quarter of 2007, we collected $6.3 million of principal repayments consistent with the expected cash flows. These repayments represent more than 6% of the amortized cost of our outstanding ABS RMBS portfolio at June 30, 2007.
At September 30, 2007, $20.8 million or 24.3% of the total ABS RMBS securities that are rated Aaa are currently insured by 4 bond insurers. $74.7 million or 87.5% of the portfolio consisted of securities that were issued during 2006 and 2007. At September 30, 2007, 95.0% of these securities were rated Aaa and 5.0% rated Aa. The expected weighted average life of our 2006 and 2007 ABS RMBS portfolio was estimated to be approximately 3.0 to 3.50 years at origination. As the underlying mortgages are repaid, the weighted average life at origination of the remaining positions will lengthen.
Other collateralized debt obligations consist of investments secured primarily by portfolios of credit card loans, auto loans, student loans and other consumer and corporate obligations.
Alt-A mortgage-backed securities are included in our mortgage-backed fixed income securities and reflect securities that are collateralized by residential mortgage loans issued to borrowers with stronger credit profiles than sub-prime borrowers, but who do not qualify for prime financing terms due to high loan-to-value ratios or limited supporting documentation. All of the Alt-A portfolio was at a fixed rate at the time of issue. At September 30, 2007, the Alt-A portfolio had net unrealized losses of $650 thousand, which were comprised of $139 thousand of unrealized gains and $789 thousand of unrealized losses. At June 30, 2007, these securities had net unrealized losses of $982 thousand, which were comprised of $1.4 million of unrealized gains and $2.4 million of unrealized losses. None of these securities were issued during 2006 and 2007.
Unrealized net capital gains on fixed income securities at September 30, 2007 were $268.6 million, a decrease of $76.3 million or 22.1% since December 31, 2006. The net unrealized gain was comprised of $360.6 million of unrealized gains and $92.1 million of unrealized losses at September 30, 2007. This is compared to net unrealized gains totaling $344.9 million at December 31, 2006, comprised of $399.2 million of unrealized gains and $54.3 million of unrealized losses.
Of the gross unrealized losses in the fixed income portfolio at September 30, 2007, $85.8 million or 93.2% were related to investment grade securities and are believed to be primarily interest rate related. All of the remaining $6.3 million of losses were in the corporate fixed income portfolio and were primarily comprised of securities in the consumer goods, utilities, capital goods, and communications sectors. The gross unrealized losses in these sectors were primarily company specific and interest rate related.
Our portfolio monitoring process identifies and evaluates, on a case-by-case basis, fixed income 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 those securities whose fair value compared to amortized cost is below established thresholds for certain time periods, or which are identified through other monitoring criteria such as ratings downgrades or payment defaults. The securities identified, and other securities for which we may have a concern, are evaluated based on facts and circumstances for inclusion on our watch-list. 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 such as changes in duration, revisions to strategic asset allocations and liquidity actions, as well as certain dispositions anticipated by portfolio managers. All securities in an unrealized loss position at September 30, 2007 were included in our portfolio monitoring process for determining which declines in value were not other-than-temporary.
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 securities in default with respect to principal or interest and/or securities issued by companies that have gone into bankruptcy subsequent to our acquisition of the security. 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, which causes us to believe these securities may be classified as problem or restructured in the future.
25
The Company had no problem, restructured or potential problem fixed income securities at September 30, 2007. The following table summarizes problem, restructured and potential problem fixed income securities at December 31, 2006.
(in thousands) |
| December 31, 2006 |
| ||||||
|
| Amortized |
| Fair |
| Percent |
| ||
Problem |
| $ | 3,444 |
| $ | 6,883 |
| 0.1 | % |
Restructured |
| — |
| — |
| — |
| ||
Potential problem |
| 2 |
| — |
| — |
| ||
Total net carrying value |
| $ | 3,446 |
| $ | 6,883 |
| 0.1 | % |
Cumulative write-downs recognized |
| $ | 2,491 |
|
|
|
|
|
The fixed income securities categorized as problem and potential problem as of December 31, 2006 were disposed in 2007.
Net Investment Income The following table presents net investment income for the three months and nine months ended September 30.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Fixed income securities |
| $ | 90,369 |
| $ | 84,977 |
| $ | 266,657 |
| $ | 256,028 |
|
Mortgage loans |
| 10,317 |
| 9,595 |
| 30,370 |
| 28,634 |
| ||||
Short-term and other |
| 3,444 |
| 4,316 |
| 11,722 |
| 11,302 |
| ||||
Investment income, before expense |
| 104,130 |
| 98,888 |
| 308,749 |
| 295,964 |
| ||||
Investment expense |
| (7,136 | ) | (6,352 | ) | (20,848 | ) | (16,708 | ) | ||||
Net investment income |
| $ | 96,994 |
| $ | 92,536 |
| $ | 287,901 |
| $ | 279,256 |
|
Net investment income increased 4.8% and 3.1% in the three months and nine months ended September 30, 2007 as compared to the same periods in the prior year.
26
Net Realized Capital Gains and Losses The following table presents the components of realized capital gains and losses and the related tax effect.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
(in thousands) |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Investment write-downs |
| $ | — |
| $ | — |
| $ | — |
| $ | (258 | ) |
Dispositions |
| 3,310 |
| (1,716 | ) | 3,857 |
| (24,083 | ) | ||||
Valuation of derivative instruments |
| (3,524 | ) | (3,964 | ) | (5,497 | ) | (3,325 | ) | ||||
Settlement of derivative instruments |
| 895 |
| 939 |
| (423 | ) | 3,573 |
| ||||
Realized capital gains and losses, pretax |
| 681 |
| (4,741 | ) | (2,063 | ) | (24,093 | ) | ||||
Income tax benefit (expense) |
| (257 | ) | 1,739 |
| 768 |
| 9,058 |
| ||||
Realized capital gains and losses, after-tax |
| $ | 424 |
| $ | (3,002 | ) | $ | (1,295 | ) | $ | (15,035 | ) |
Dispositions in the above table include sales, losses recognized in anticipation of dispositions and other transactions such as calls and prepayments. We may sell impaired fixed income securities that were in an unrealized loss position at the previous reporting date in situations where new factors such as negative developments, subsequent credit deterioration, changing liquidity needs, and newly identified market opportunities cause a change in our previous intent to hold a security until recovery or maturity.
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 portfolio view. Tactical duration adjustments within management’s approved ranges are accomplished through both cash market transactions and derivative activities that generate realized gains and losses and through new purchases. 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.
In the third quarter of 2007, we recognized $220 thousand of losses related to a change in our intent to hold certain securities with unrealized losses until they recover in value. The change in our intent is primarily related to strategic asset allocation decisions and ongoing comprehensive reviews of our portfolio. We identified $108.0 million of securities which we did not have the intent to hold until recovery.
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) |
| September 30, |
| December 31, |
| ||
|
|
|
|
|
| ||
Common stock, additional capital paid-in and retained income |
| $ | 604,537 |
| $ | 574,958 |
|
Accumulated other comprehensive income |
| 52,316 |
| 78,038 |
| ||
Total shareholder’s equity |
| $ | 656,853 |
| $ | 652,996 |
|
Shareholder’s equity increased in the first nine months of 2007 due primarily to net income, partially offset by lower unrealized net capital gains on fixed income securities.
27
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, Allstate Life Insurance Company’s and Allstate Insurance Company’s ratings and other factors. There have been no changes to our insurance financial strength ratings since December 31, 2006.
Liquidity Sources and Uses As reflected in our Condensed Statements of Cash Flows, higher operating cash flows in the first nine months of 2007, compared to the first nine months of 2006, were primarily the result of lower income tax payments and policy acquisition expenses and higher investment income, partially offset by the settlement of an intercompany obligation in 2007 and lower contract charges due to the disposition of the variable annuity business in 2006.
Decreased cash flows used in investing activities were due to a decline in net cash provided by financing activities partially offset by higher net cash provided by operating activities. Also, cash flows used in investing activities in the prior year include the settlement of the disposal of our variable annuity business.
Cash flows from financing activities declined in the first nine months of 2007 compared to the same period in the prior year due to lower contractholder deposits partially offset by lower contractholder withdrawals. For quantification of the changes in contractholder funds, see the Operations section of MD&A.
We have an inter-company loan agreement with The Allstate Corporation. The amount of inter-company loans available to us is at the discretion of The Allstate Corporation. The maximum amount of loans the Allstate Corporation will have outstanding to all its eligible subsidiaries at any given point in time is limited to $1.00 billion. We had no amounts outstanding under the inter-company loan agreement at September 30, 2007 or December 31, 2006. The Allstate Corporation uses commercial paper borrowings and bank lines of credit to fund intercompany borrowings
As described in Note 1 to the Condensed Financial Statements, in accordance with Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), the Company had no liability for unrecognized tax benefits at January 1 or September 30, 2007. We believe it is reasonably possible that the liability balance will not significantly increase or decrease within the next 12 months.
28
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 15(d)-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 September 30, 2007, 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.
29
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 4 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 risks 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 2006.
Based on our analysis and the seniority of our securities’ claim on the underlying collateral, we currently do not anticipate other-than-temporary impairments and we expect to receive all payments on our asset-backed residential mortgage-backed securities (“ABS RMBS”), and Alt-A mortgage-backed securities portfolios in accordance with their original contractual terms.
Changes in the actual or expected performance of mortgage-related securities, the actual or perceived financial strength and claims paying ability of bond insurers, or the valuation and market for these types of securities could lead us to reconsider our payment outlook and determine that write-downs are appropriate in the future.
The change in our unrecognized tax benefit during the next 12 months is subject to uncertainty.
As required by Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which was adopted as of January 1, 2007, we have disclosed our estimate of net unrecognized tax benefits and the reasonably possible increase or decrease in its balance during the next 12 months. We believe that this estimate has been appropriately established based on available facts and information, however, actual results may differ from our estimate for reasons such as changes in our position on specific issues, developments with respect to the governments’ interpretations of income tax laws or changes in judgment resulting from new information obtained in audits or the appeals process.
Item 6. Exhibits
(a) Exhibits
An Exhibit Index has been filed as part of this report on page E-1.
30
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) | ||
|
|
| ||
November 5, 2007 |
| By | /s/ Samuel H. Pilch |
|
|
| Samuel H. Pilch | ||
|
| Controller | ||
|
| (chief accounting officer and duly | ||
|
| authorized officer of Registrant) |
31
Exhibit No. |
| Description | |
15 |
|
| Acknowledgement of awareness from Deloitte & Touche LLP dated November 2, 2007, concerning unaudited interim financial information. |
|
|
|
|
31.1 |
|
| Rule 15d-14(a) Certification of Principal Executive Officer |
|
|
|
|
31.2 |
|
| Rule 15d-14(a) Certification of Principal Financial Officer |
|
|
|
|
32 |
|
| Section 1350 Certifications |
E-1