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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
COMMISSION FILE NUMBERS 33-26322; 33-46827; 33-52254; 33-60290;
33-58303; 333-33863; 333-34192
MERRILL LYNCH LIFE INSURANCE COMPANY
(Exact name of Registrant as specified in its charter)
<Table>
ARKANSAS 91-1325756
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
</Table>
7 ROSZEL ROAD
PRINCETON, NJ 08540-6205
(Address of Principal Executive Offices)
(609) 627-3950
(Registrant's telephone number including area code)
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 __
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
COMMON 250,000
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.
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PART I Financial Information
Item 1. Financial Statements.
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
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BALANCE SHEETS
(Dollars in thousands) (Unaudited)
================================================================================
September 30, December 31,
ASSETS 2001 2000
- ------ ------------- ------------
INVESTMENTS:
Fixed maturity securities, at estimated fair value
(amortized cost: 2001 - $1,957,663; 2000 - $2,050,333) $ 1,987,232 $ 2,012,016
Equity securities, at estimated fair value
(cost: 2001 - $187,861; 2000 - $229,045) 184,347 215,030
Trading account securities, at estimated fair value 21,080 24,859
Real estate held-for-sale 19,447 19,447
Policy loans on insurance contracts 1,199,237 1,193,690
------------ ------------
Total Investments 3,411,343 3,465,042
CASH AND CASH EQUIVALENTS 216,938 92,730
ACCRUED INVESTMENT INCOME 71,018 71,001
DEFERRED POLICY ACQUISITION COSTS 470,293 494,088
FEDERAL INCOME TAXES - DEFERRED - 10,902
REINSURANCE RECEIVABLES 4,682 3,090
AFFILIATED RECEIVABLES - NET 1,937 667
RECEIVABLES FROM SECURITIES SOLD 14,935 2,578
OTHER ASSETS 40,021 40,614
SEPARATE ACCOUNTS ASSETS 10,423,407 12,362,798
------------ ------------
TOTAL ASSETS $ 14,654,574 $ 16,543,510
============ ============
See accompanying notes to financial statements. (Continued)
1
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
- ------------------------------------------------------------------
BALANCE SHEETS
(Continued) (Dollars in thousands, except common stock par value and shares)
(Unaudited)
================================================================================
September 30, December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 2001 2000
- ------------------------------------ ------------- -------------
LIABILITIES:
POLICYHOLDER LIABILITIES AND ACCRUALS:
Policyholders' account balances $ 3,316,858 $ 3,421,873
Claims and claims settlement expenses 101,038 85,673
------------- -------------
Total policyholder liabilities and accruals 3,417,896 3,507,546
OTHER POLICYHOLDER FUNDS 14,311 17,678
LIABILITY FOR GUARANTY FUND ASSESSMENTS 10,006 10,250
FEDERAL INCOME TAXES - DEFERRED 12,248 -
FEDERAL INCOME TAXES - CURRENT 883 5,134
PAYABLES FOR SECURITIES PURCHASED 66,047 1,328
UNEARNED POLICY CHARGE REVENUE 111,435 101,182
OTHER LIABILITIES 11,355 32,074
SEPARATE ACCOUNTS LIABILITIES 10,417,395 12,356,035
------------- -------------
Total Liabilities 14,061,576 16,031,227
------------- -------------
STOCKHOLDER'S EQUITY:
Common stock ($10 par value; authorized: 1,000,000 shares; issued and
outstanding: 250,000 shares) 2,500 2,500
Additional paid-in capital 347,324 347,324
Retained earnings 258,623 194,808
Accumulated other comprehensive loss (15,449) (32,349)
------------- -------------
Total Stockholder's Equity 592,998 512,283
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 14,654,574 $ 16,543,510
============= =============
See accompanying notes to financial statements.
2
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
- ------------------------------------------------------------------
STATEMENTS OF EARNINGS
(Dollars in thousands) (Unaudited)
================================================================================
Three Months Ended
September 30,
------------------------------
2001 2000
---------- ----------
REVENUES:
Policy charge revenue $ 62,446 $ 74,809
Net investment income 55,334 58,709
Net realized investment gains (losses) (1,525) 775
---------- ----------
Total Revenues 116,255 134,293
---------- ----------
BENEFITS AND EXPENSES:
Interest credited to policyholders' account balances 38,570 41,180
Market value adjustment expense 598 127
Policy benefits (net of reinsurance recoveries: 2001 - $2,960;
2000 - $3,417) 10,204 9,464
Reinsurance premium ceded 5,930 6,061
Amortization of deferred policy acquisition costs 15,623 3,086
Insurance expenses and taxes 20,119 11,394
---------- ----------
Total Benefits and Expenses 91,044 71,312
---------- ----------
Earnings Before Federal Income Tax Provision 25,211 62,981
FEDERAL INCOME TAX PROVISION (BENEFIT):
Current (2,118) 18,179
Deferred 10,941 3,865
---------- ----------
Total Federal Income Tax Provision 8,823 22,044
---------- ----------
NET EARNINGS $ 16,388 $ 40,937
========== ==========
See accompanying notes to financial statements.
3
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
- ------------------------------------------------------------------
STATEMENTS OF EARNINGS
(Dollars in thousands) (Unaudited)
================================================================================
Nine Months Ended
September 30,
------------------------------
2001 2000
---------- ----------
REVENUES:
Policy charge revenue $ 192,666 $ 202,882
Net investment income 167,927 178,733
Net realized investment gains (losses) (2,152) 2,038
---------- ----------
Total Revenues 358,441 383,653
---------- ----------
BENEFITS AND EXPENSES:
Interest credited to policyholders' account balances 116,185 123,946
Market value adjustment expense 1,555 249
Policy benefits (net of reinsurance recoveries: 2001 - $11,298;
2000 - $12,169) 26,247 29,943
Reinsurance premium ceded 18,538 17,747
Amortization of deferred policy acquisition costs 48,608 36,561
Insurance expenses and taxes 51,082 42,225
---------- ----------
Total Benefits and Expenses 262,215 250,671
---------- ----------
Earnings Before Federal Income Tax Provision 96,226 132,982
FEDERAL INCOME TAX PROVISION:
Current 18,361 41,398
Deferred 14,050 5,146
---------- ----------
Total Federal Income Tax Provision 32,411 46,544
---------- ----------
NET EARNINGS $ 63,815 $ 86,438
========== ==========
See accompanying notes to financial statements.
4
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
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STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands) (Unaudited)
================================================================================
Three Months Ended
September 30,
----------------------------
2001 2000
--------- ---------
NET EARNINGS $ 16,388 $ 40,937
OTHER COMPREHENSIVE INCOME:
Net unrealized gains on available-for-sale securities:
Net unrealized holding gains arising during the period 38,702 31,364
Reclassification adjustment for (gains) losses included in net earnings 1,453 (187)
--------- ---------
Net unrealized gains on investment securities 40,155 31,177
Adjustments for:
Policyholder liabilities (20,513) (8,164)
Deferred policy acquisition costs (8,755) (10,118)
Deferred federal income taxes (3,810) (4,512)
--------- ---------
Total other comprehensive income, net of taxes 7,077 8,383
--------- ---------
COMPREHENSIVE INCOME $ 23,465 $ 49,320
========= =========
See accompanying notes to financial statements.
5
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
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STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands) (Unaudited)
================================================================================
Nine Months Ended
September 30,
----------------------------
2001 2000
--------- ---------
NET EARNINGS $ 63,815 $ 86,438
OTHER COMPREHENSIVE INCOME:
Net unrealized gains on available-for-sale securities:
Net unrealized holding gains arising during the period 74,678 25,744
Reclassification adjustment for (gains) losses included in net earnings 1,957 (1,537)
--------- ---------
Net unrealized gains on investment securities 76,635 24,207
Adjustments for:
Policyholder liabilities (29,370) (6,050)
Deferred policy acquisition costs (21,265) (9,333)
Deferred federal income taxes (9,100) (3,089)
--------- ---------
Total other comprehensive income, net of taxes 16,900 5,735
--------- ---------
COMPREHENSIVE INCOME $ 80,715 $ 92,173
========= =========
See accompanying notes to financial statements.
6
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
STATEMENTS OF STOCKHOLDER'S EQUITY
(Dollars in thousands) (Unaudited)
================================================================================
Accumulated
Additional other Total
Common paid-in Retained comprehensive stockholder's
stock capital earnings loss equity
---------- ---------- ---------- ------------- -------------
BALANCE, JANUARY 1, 2000 $ 2,500 $ 347,324 $ 134,127 $ (50,085) $ 433,866
Cash dividend paid to parent (65,000) (65,000)
Net earnings 125,681 125,681
Other comprehensive income, net of tax 17,736 17,736
---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2000 2,500 347,324 194,808 (32,349) 512,283
Net earnings 63,815 63,815
Other comprehensive income, net of tax 16,900 16,900
---------- ---------- ---------- ---------- ----------
BALANCE, SEPTEMBER 30, 2001 $ 2,500 $ 347,324 $ 258,623 $ (15,449) $ 592,998
========== ========== ========== ========== ==========
See accompanying notes to financial statements.
7
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
STATEMENTS OF CASH FLOWS
(Dollars in thousands) (Unaudited)
================================================================================
Nine Months Ended
September 30,
------------------------------
2001 2000
---------- ----------
Cash Flows From Operating Activities:
Net earnings $ 63,815 $ 86,438
Noncash items included in earnings:
Amortization of deferred policy acquisition costs 48,608 36,561
Capitalization of policy acquisition costs (46,078) (71,618)
Accretion of investments (1,046) (1,010)
Interest credited to policyholders' account balances 116,185 123,946
Provision for deferred Federal income tax 14,050 5,146
(Increase) decrease in operating assets:
Accrued investment income (17) 169
Reinsurance receivables (1,592) 185
Affiliated receivables (1,270) (4,801)
Other 593 6,335
Increase (decrease) in operating liabilities:
Claims and claims settlement expenses 15,365 16,867
Other policyholder funds (3,367) (7,643)
Liability for guaranty fund assessments (244) (5,063)
Federal income taxes - current (4,251) 8,128
Unearned policy charge revenue 10,253 17,545
Other (20,996) 4,456
Other operating activities:
Net realized investment (gains) losses 2,152 (2,038)
---------- ----------
Net cash and cash equivalents provided by operating activities 192,160 213,603
---------- ----------
Cash Flows From Investing Activities:
Proceeds from (payments for):
Sales of available-for-sale securities 163,038 135,791
Maturities of available-for-sale securities 283,982 200,777
Purchases of available-for-sale securities (258,238) (216,231)
Trading account securities 384 621
Sale of real estate held-for-sale - 1,375
Policy loans on insurance contracts (5,547) (21,895)
Recapture of investments in separate accounts - 665
Investment in separate accounts (1,001) (2,110)
---------- ----------
Net cash and cash equivalents provided by investing activities $ 182,618 $ 98,993
---------- ----------
See accompanying notes to financial statements. (Continued)
8
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
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STATEMENTS OF CASH FLOWS
(Continued) (Dollars in thousands) (Unaudited)
================================================================================
Nine Months Ended
September 30,
----------------------------------
2001 2000
------------ ------------
Cash Flows From Financing Activities:
Proceeds from (payments for):
Policyholder deposits (excludes internal policy replacement deposits) $ 862,222 $ 1,067,651
Policyholder withdrawals (including transfers to / from separate accounts) (1,112,792) (1,328,551)
------------ ------------
Net cash and cash equivalents used by financing activities (250,570) (260,900)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 124,208 51,696
CASH AND CASH EQUIVALENTS:
Beginning of year 92,730 92,181
------------ ------------
End of period $ 216,938 $ 143,877
============ ============
Supplementary Disclosure of Cash Flow Information:
Cash paid for:
Federal income taxes $ 22,612 $ 33,270
Intercompany interest 653 672
See accompanying notes to financial statements.
9
MERRILL LYNCH LIFE INSURANCE COMPANY
(a wholly owned subsidiary of Merrill Lynch Insurance Group, Inc.)
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NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
================================================================================
NOTE 1: BASIS OF PRESENTATION
Merrill Lynch Life Insurance Company (the "Company") is a wholly owned
subsidiary of Merrill Lynch Insurance Group, Inc. ("MLIG"). The Company is an
indirect wholly owned subsidiary of Merrill Lynch & Co., Inc. ("Merrill Lynch &
Co."). The Company sells life insurance and annuity products, including variable
life insurance and variable annuities.
The interim financial statements for the three and nine month periods are
unaudited. In the opinion of management, these unaudited financial statements
include all adjustments (consisting only of normal recurring accruals) necessary
for a fair presentation of the financial position and the results of operations
in accordance with accounting principles generally accepted in the United States
of America. These unaudited financial statements should be read in conjunction
with the audited financial statements included in the Company's Annual Report on
Form 10-K ("2000 10K") for the year ended December 31, 2000. The nature of the
Company's business is such that the results of any interim period are not
necessarily indicative of results for a full year. Certain reclassifications
have also been made to prior period financial statements, where appropriate, to
conform to the current period presentation.
NOTE 2. STATUTORY ACCOUNTING PRACTICES
The Company's statutory financial statements are presented on the basis of
accounting practices prescribed or permitted by the Insurance Department of the
State of Arkansas. The State of Arkansas has adopted the National Association of
Insurance Commissioners' statutory accounting practices as the basis of its
statutory accounting practices.
Statutory capital and surplus at September 30, 2001 and December 31, 2000 were
$262,297 and $252,704, respectively. For the nine month periods ended September
30, 2001 and 2000, statutory net income (loss) was ($14,182) and $56,886,
respectively.
NOTE 3. INVESTMENTS
The Company's investments in fixed maturity and equity securities are classified
as either available-for-sale or trading and are recorded at estimated fair
value. Unrealized gains and losses on available-for-sale securities are included
in stockholder's equity as a component of accumulated other comprehensive loss,
net of tax. Unrealized gains and losses on trading account securities are
included in net realized investment gains (losses). If management determines
that a decline in the value of a security is other-than-temporary, the carrying
value is adjusted to estimated fair value and the decline in value is recorded
as a net realized investment loss.
The Company has recorded certain adjustments to deferred policy acquisition
costs and policyholders' account balances in connection with unrealized holding
gains or losses on investments classified as available-for-sale. The Company
adjusts those assets and liabilities as if the unrealized holdings gains or
losses had actually been realized, with corresponding credits or charges
reported in accumulated other comprehensive loss, net of taxes. The components
of net unrealized gains (losses) included in accumulated other comprehensive
loss were as follows:
September 30, December 31,
2001 2000
------------- ------------
Assets:
Fixed maturity securities $ 29,569 $ (38,317)
Equity securities (3,514) (14,015)
Deferred policy acquisition costs (2,008) 19,257
Federal income taxes - deferred - 17,419
Separate Accounts assets (2,105) (353)
--------- ---------
21,942 (16,009)
--------- ---------
Liabilities:
Federal income taxes - deferred (8,319) -
Policyholders' account balances 45,710 16,340
--------- ---------
37,391 16,340
--------- ---------
Stockholder's equity:
Accumulated other comprehensive loss $ (15,449) $ (32,349)
========= =========
10
Net realized investment gains (losses), including changes in valuation
allowances for the nine months ended September 30 were as follows:
September 30, September 30,
2001 2000
------------- -------------
Available-for-sale securities $ 1,243 $ (2,313)
Trading account securities:
Net realized investment gains (losses) (1,478) 5,587
Net unrealized holding losses (1,917) (1,998)
Real estate held-for-sale - 750
Investment in Separate Accounts - 12
-------- --------
Total net realized investment gains (losses) $ (2,152) $ 2,038
======== ========
NOTE 4. ACCOUNTING PRONOUNCEMENTS
On January 1, 2001, the Company adopted the provisions of SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133").
SFAS No.133 requires the Company to recognize all derivatives as either assets
or liabilities in the balance sheet and measure those instruments at fair value.
The accounting treatment for changes in fair value for derivatives is dependent
upon whether the derivative qualifies for hedge accounting. As defined by SFAS
No. 133, the Company does not have any derivatives that qualify for hedge
accounting and, as such, changes in fair value of the Company's derivatives
instruments are recorded in earnings. At September 30, 2001, the change in fair
value of derivatives did not have a material impact on earnings.
NOTE 5. SEGMENT INFORMATION
In reporting to management, the Company's operating results are categorized into
two business segments: Life Insurance and Annuities. The Company's Life
Insurance segment consists of variable life insurance products and
interest-sensitive life insurance products. The Company's Annuity segment
consists of variable annuities and interest sensitive annuities. The accounting
policies of the business segments are the same as those for the Company's
financial statements included herein. All revenue and expense transactions are
recorded at the product level and accumulated at the business segment level for
review by management. The "Other" category, presented in the following segment
financial information, represents net revenues and earnings on assets that do
not support life or annuity contract owner liabilities.
The following table summarizes each business segment's contribution to
consolidated net revenues and net earnings for the three and nine month periods
ended September 30:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
NET REVENUES (a):
Annuities $ 45,730 $ 48,799 $ 138,219 $ 142,200
Life Insurance 31,324 40,843 101,793 108,793
Other 631 3,471 2,244 8,714
--------- --------- --------- ---------
Total Net Revenues $ 77,685 $ 93,113 $ 242,256 $ 259,707
========= ========= ========= =========
NET EARNINGS:
Annuities $ 9,931 $ 14,597 $ 39,312 $ 39,300
Life Insurance 6,046 24,084 23,044 41,474
Other 411 2,256 1,459 5,664
--------- --------- --------- ---------
Total Net Earnings $ 16,388 $ 40,937 $ 63,815 $ 86,438
========= ========= ========= =========
(a) Management considers investment income net of interest credited to
policyholders' account balances in evaluating results.
11
ITEM 2 MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
This Management's Narrative Analysis of the Results of Operations addresses
changes in revenues and expenses for the three and nine month periods ended
September 30, 2001 and 2000. This discussion should be read in conjunction with
the accompanying unaudited financial statements and notes thereto, in addition
to the 2000 Financial Statements and Notes to Financial Statements and the
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the 2000 10K.
In addition to providing historical information, the Company may make or publish
forward-looking statements about management expectations, strategic objectives,
business prospects, anticipated financial performance, and other similar
matters. A variety of factors, many of which are beyond the Company's control,
affect the operations, performance, business strategy, and results of the
Company and could cause actual results and experience to differ materially from
the expectations expressed in these statements. These factors include, but are
not limited to, the factors listed in the Economic Environment section below, as
well as actions and initiatives taken by both current and potential competitors
and the effect of current, pending, and future legislation and regulation. THE
COMPANY UNDERTAKES NO RESPONSIBILITY TO UPDATE OR REVISE ANY FORWARD-LOOKING
STATEMENTS.
FINANCIAL EXPOSURE RELATED TO THE EVENTS OF SEPTEMBER 11, 2001
The Company has determined that its financial exposure related to the events and
aftermath of the terrorist attacks ("Attacks") on September 11, 2001 can be
characterized into the following risk categories: mortality risk, equity price
risk, and credit risk. The following discusses each type of risk in greater
detail and its impact, either actual or potential, on the Company.
Mortality Risk - In quantifying mortality risk directly associated with the
Attacks, the Company has not experienced a material financial impact due to
reported death claims and does not anticipate a material financial impact of
death claims incurred but not reported. Mitigating factors of direct mortality
risk include i) the Company is not licensed to sell individual or group life
insurance and annuities in the State of New York, where the largest
concentration of mortality risk exists, and ii) the Company does not assume
mortality risks of other life insurance companies.
Equity Price Risk - The significant decrease in the U.S. equity market that
occurred after the Attacks has negatively impacted the Company's earnings and
future earnings via the following:
- - Reductions in separate accounts assets. Asset-based fees collected on
separate accounts assets are a primary source of earnings for the Company,
thus lower asset balances will result in lower fee income. During the month
of September, the Company's separate accounts assets decreased $819
million, or 7% as compared to August. Approximately $801 million of this
decrease was due to negative investment performance in the underlying
mutual funds supporting variable products.
- - Reductions in trading account assets. The Company's trading account is
carried at market value with changes in market value included in earnings.
The trading account is subject to equity price risk because the portfolio
is invested in convertible debt and convertible preferred stocks. The
valuations of these types of securities are impacted by changes in value of
the underlying equity security. Trading account losses for the month of
September were $1.2 million.
- - Increased exposure to guaranteed minimum death benefits. Due to decreasing
variable account balances there is an increasing number of contracts, and
amounts per contract, in which guaranteed minimum death benefits exceed
contract owner account values. This will result in greater future mortality
expense given the current reduced level of variable account balances.
Credit Risk - Airline, insurance, and hotel & tourism sectors have been
particularly impacted by the Attacks. As such, credit quality within those
sectors has been negatively effected. The following table summarizes the
Company's holdings at book value for these sectors:
(In millions) Airline Insurance Hotels & Tourism
------- --------- ----------------
Holdings $43.1 (1) $125.3 (2) $28.4 (3)
(1) Includes $9.3 million in lower tranche debt of weaker airlines
(2) Includes $26.2 million in insurance companies with a significant New York
City presence in property & casualty insurance and workers compensation
insurance
(3) Includes $10.2 million in non-investment grade holdings
The Company monitors these investments on a daily basis, however the Company has
not incurred any realized losses due to the sale or book value writedown of any
securities in the sectors noted above.
Technology - The Company's policy administration systems were not impacted by
the Attacks and contract owner processing for all fixed product transactions
continued as normal. Variable product processing was suspended during the
closure of the stock exchanges
12
and resumed on Monday, September 17. Also, the Company relocated certain
financial systems to a designated disaster recovery location in accordance with
Company policy.
Expenses - Expenses incurred by Merrill Lynch & Co. associated with the Attacks
include costs related to i) the write-off of damaged assets, ii) the purchase
of replacement equipment, and iii) employee relocation, which required
arranging alternative office facilities and reconfiguring technology,
telecommunications, and transportation. Amounts allocated to the Company due to
these expenses have not had a material impact on earnings. Additional expenses
related to the Attacks continue to be incurred, however the full financial
impact cannot be currently determined. Management does not believe that these
expenses will have a material impact on earnings.
DISCONTINUANCE OF ESTATE PLANNING LIFE INSURANCE
Effective August 20, 2001, the Company discontinued manufacturing and marketing
estate planning life insurance products. Given both limited resources and market
potential, the Company could not justify the investments necessary to compete
against carriers who have the scale required to make frequent improvements to
their products. These factors combined with recent estate tax legislation (see
below) also contributed to the decision. The Company's product manufacturing and
marketing resources will be committed to products with outstanding growth
prospects, those products where the Company has strategic advantages relative to
other manufacturers within the Merrill Lynch & Co. distribution system, and
those that leverage the tremendous marketing and distribution capabilities of
Merrill Lynch & Co.'s U.S. Private Client Division. The Company will continue to
issue its single premium variable life insurance product that was introduced in
March 2001. Also, the Company remains committed to servicing all life insurance
contracts in force.
The decision to discontinue manufacturing and marketing estate planning life
insurance products is not expected to have a material impact on earnings.
Pre-tax earnings related to these products have historically contributed less
than 6% of the Company's total pre-tax earnings.
TAX LEGISLATION
During June 2001, Congress passed the Economic Growth and Tax Relief
Reconciliation Act of 2001 (the "Act"). The primary provision in the Act that
directly impacts the Company's business is the reform and eventual repeal of the
estate tax. Under the new tax law, the annual estate tax exemption will increase
from $0.675 million in 2001 to $3.5 million in 2009, with a complete repeal of
the estate tax in 2010. During the third quarter 2001, the Company decided to
discontinue marketing its estate planning life insurance products.
SERVICE CENTER INTEGRATION
During the second quarter 2001, the Company announced plans to consolidate its
life and annuity policy administration service centers into one location. The
objective of this initiative is to provide high quality service with a single
point of contact for all of the Company's touchpoints, including contract
owners, Financial Advisors, District Annuity Specialists, and Wealth Management
Specialists. In addition, the consolidation is consistent with Merrill Lynch &
Co.'s goals of integrating for efficiency, minimizing business risk, and
maximizing the client experience. The consolidation was completed during the
third quarter 2001. Costs incurred related to the consolidation were $7.8
million, with the majority of these costs reported in the third quarter. The
Company anticipates future annual expense savings of approximately $5.5 million.
BUSINESS OVERVIEW
The Company's gross earnings are principally derived from two sources:
- - the charges imposed on variable life insurance and variable annuity
contracts, and
- - the net earnings from investment of fixed rate life insurance and annuity
contract owner deposits less interest credited to contract owners, commonly
known as interest spread
The costs associated with acquiring contract owner deposits are amortized over
the period in which the Company anticipates holding those funds. In addition,
the Company incurs expenses associated with the maintenance of inforce
contracts.
ECONOMIC ENVIRONMENT
13
The Company's financial position and/or results of operations are primarily
impacted by the following economic factors:
- - fluctuations in medium term interest rates
- - fluctuations in credit spreads
- - equity market performance
The Company defines medium term interest rates as the average interest rate on
U.S. Treasury securities with terms of 1 to 10 years. During the current nine
month period, medium term interest rates decreased approximately 139 basis
points as compared to December 2000 and decreased approximately 218 basis points
as compared to September 2000.
The Company defines credit spreads as the interest rate spread between the
5-year U.S. Treasury Bond Index and the 5-year Corporate Industrial Bond Index.
During the first nine months of 2001, credit spreads contracted approximately 20
basis points to end the period at 158 basis points. During the first nine months
of 2000, credit spreads widened approximately 39 basis points to end the period
at 150 basis points.
There are several standard indices published on a daily basis that measure
performance of selected components of the U.S. equity market. Examples include
the Dow Jones Industrial Average ("Dow"), NASDAQ Composite Index ("NASDAQ") and
the Standard & Poor's 500 Composite Stock Price Index ("S&P Index"). During the
first nine months of 2001, the Dow, NASDAQ and S&P Index decreased 18%, 39% and
21%, respectively. Prior to September 11, 2001, the Dow, NASDAQ and S&P Index
decreased 11%, 31% and 17%, respectively. The investment performance in the
underlying mutual funds supporting the Company's variable products do not
replicate the returns on any specific U.S. equity market index. However,
investment performance will generally increase or decrease with corresponding
increases or decreases in the overall U.S. equity market.
NEW BUSINESS
Life insurance premiums and annuity deposits decreased $131.3 million (or 29%)
to $323.0 million and $178.8 million (or 16%) to $964.3 million during the
current three and nine month periods ended September 30, 2001, respectively, as
compared to the same periods in 2000. Variable annuity deposits continue to
dominate the Company's overall sales by comprising 91% and 90% of total direct
premiums for the three and nine month periods ended September 30, 2001,
respectively. Life insurance premiums and annuity deposits by type of product
were as follows:
Premiums % Change
--------------------------- ----------------------------
Third Quarter Nine Months Third Quarter Nine Months
2001 2001 2001-2000 2001-2000
------------- ----------- ------------- -----------
($ In Millions)
Variable Annuities:
Without surrender charge provision $ 153.2 $ 469.6 -12% 74%
With surrender charge provision 140.9 401.3 -41% -45%
------- ------- ------- -------
294.1 870.9 -29% -13%
------- ------- ------- -------
Variable Life Insurance:
Estate Planning 12.7 45.2 -47% -32%
Cash Value Accumulation 4.6 16.5 -53% -54%
------- ------- ------- -------
17.3 61.7 -49% -40%
------- ------- ------- -------
Modified Guaranteed Annuities 8.4 22.9 14% -27%
Other 3.2 8.8 113% 110%
------- ------- ------- -------
Total Direct Premiums $ 323.0 $ 964.3 -29% -16%
======= ======= ======= =======
During the current three and nine month periods, variable annuity deposits
decreased $117.3 million (or 29%) and $134.4 million (or 13%), respectively, as
compared to the same periods in 2000. Management believes that variable annuity
sales have been impacted by equity market volatility related to the general
economic slowdown, as well as the Attacks of September 11. In addition, third
quarter 2001 sales were directly impacted by the business shutdown and general
business uncertainty in the aftermath of the Attacks. However, for the current
nine month period declines in the Company's variable annuity deposits have been
less severe as compared to
14
sales declines by other variable annuity carriers ("non-proprietary") within the
Merrill Lynch & Co. distribution system and for the industry in general.
Non-proprietary variable annuity sales have decreased approximately 23% during
the current nine month period as compared to the same period in 2000. Similarly,
variable annuity sales for the industry have decreased approximately 21% during
the same time period. Management attributes the Company's relative success
within its distribution system to the strength of its wholesaling force and in
particular their distribution of the Company's "no surrender charge" variable
annuity product, which was introduced during April 2000. In a relatively short
period of time, sales of this product have surpassed the sales of the Company's
other "more traditional" variable annuity product.
As noted above, management believes that variable annuity sales are impacted by
the performance of the equity markets. Therefore, future variable annuity sales
could be negatively impacted by:
- - increased equity market volatility, or
- - a continuation in the decline in the equity markets from what was
experienced during 2000
During the current three and nine months periods, variable life insurance
premiums decreased $16.9 million (or 49%) and $40.6 (or 40%), respectively, as
compared to the same periods in 2000. The decreases in variable life insurance
premiums were attributable to two factors. First, uncertainty regarding
potential changes in estate tax legislation negatively impacted sales of the
Company's estate planning product. Sales of this product decreased $21.3 million
(or 32%) as compared to the same period in 2000 and as noted above were
discontinued. Second, marketing efforts for the Company's cash accumulation
product were de-emphasized as the Company developed a new single premium
variable life product ("SPVL") that was designed to replace the existing single
premium and multi-premium cash accumulation products. The new SPVL product was
introduced in March 2001.
During the current three and nine months periods, modified guaranteed annuity
deposits increased $1.0 million (or 14%) and decreased $8.4 million (or 27%),
respectively, as compared to the same periods in 2000. Modified guaranteed
annuity products offer a fixed interest crediting rate reflective of the current
interest rate environment, thus increases or decreases in sales tend to have a
direct relationship to changes in interest rates.
FINANCIAL CONDITION
During the first nine months of 2001, separate accounts assets decreased $1.9
billion (or 16%) to $10.4 billion primarily due to unfavorable investment
performance associated with the general decline in the equity market. Changes in
separate accounts assets for the current three and nine month periods ended
September 30, 2001 were as follows:
Third Nine
Quarter Months
2001 2001
----------- -----------
(In Millions)
Investment performance - variable products $ (1,309.0) $ (1,863.8)
Net cash outflow - variable products (66.3) (74.9)
Net change in seed money (1.1) (0.7)
----------- -----------
$ (1,376.4) $ (1,939.4)
=========== ===========
As of September 30, 2001, approximately $86.8 million (or 4%) of the Company's
fixed maturity securities were considered non-investment grade. The Company
defines non-investment grade as unsecured debt obligations that do not have a
rating equivalent to Standard and Poor's BBB- or higher (or similar rating
agency). Non-investment grade securities are speculative and are subject to
significantly greater risks related to the creditworthiness of the issuers and
the liquidity of the market for such securities. The Company carefully selects,
and closely monitors, such investments.
The Company has exposure to selected emerging markets that include securities
issued by sovereigns or corporations of Asia (excluding Japan), Latin America
and Mexico. At September 30, 2001, the Company held $84.5 million in emerging
market securities with an approximate unrealized loss of $3.4 million.
LIQUIDITY
15
To fund all business activities, the Company maintains a high quality and liquid
investment portfolio. As of September 30, 2001, the Company's assets included
$1.9 billion of cash, short-term investments and investment grade publicly
traded available-for-sale securities that could be liquidated if funds were
required.
RESULTS OF OPERATIONS
For the three month periods ended September 30, 2001 and 2000, the Company
reported net earnings of $16.4 million and $40.9 million, respectively. For the
nine month periods ended September 30, 2001 and 2000, the Company reported net
earnings of $63.8 million and $86.4 million, respectively.
Policy charge revenue decreased $12.4 million (or 17%) and $10.2 million (or 5%)
during the three and nine month periods ended September 30, 2001, respectively,
as compared to the same periods in 2000. The decreases in policy charge revenue
are attributable to the decrease in average variable account balances. Average
variable account balances decreased $2.0 billion (or 15%) and $1.3 billion (or
10%) during the current three and nine month periods as compared to the same
periods in 2000. During the same periods, asset based policy charges decreased
$6.6 million (or 14%) and $11.5 million (or 9%). During the current three month
period, non-asset based policy charges decreased $5.8 million (or 20%) as
compared to the same period in 2000. The decrease is primarily due to a $4.1
million decrease in deferred policy load amortization.
Net earnings derived from interest spread decreased $0.8 million and $3.0
million for the three and nine month periods ended September 30, 2001,
respectively, as compared to the same periods in 2000. Overall, net investment
income and interest credited to policyholders' account balances continue to
decline due to the reduction in fixed rate contracts inforce. The reduction in
interest spread during the current nine month period is primarily due to a $1.1
million reduction in real estate income, as well as the reduction in invested
assets resulting from the Company's fourth quarter 2000 stockholder dividend
payment.
Net realized investment gains decreased $2.3 million and $4.2 million during the
current three and nine month periods ended September 30, 2001, respectively, as
compared to the same periods during 2000. The following table provides the
changes in net realized investment gains (losses) by type for each respective
period:
Three Months Nine Months
Realized Gain (Loss) 2001 - 2000 2001 - 2000
- ------------------------------ ----------- -----------
(In Millions)
Interest related $ 2.0 $ 2.7 (1)
Credit related (0.5) 0.9
Trading account (3.8) (7.0) (2)
Real estate - (0.8) (3)
------- -------
$ (2.3) $ (4.2)
======= =======
(1) The increases in interest related gains are primarily attributable to
increases in invested asset market valuations as compared to the same
periods in 2000. The increases in invested asset market valuations are
primarily due to period-to-period decreases in interest rates and credit
spreads.
(2) The trading account is comprised of convertible debt and convertible
preferred equity securities. The valuations of these securities will
generally fluctuate in a direct relationship to changes in the valuations
of the underlying common equity.
(3) The Company sold one property during the first quarter 2000 that resulted
in a $0.8 million gain.
The market value adjustment expense is attributable to the Company's modified
guaranteed annuity products. This contract provision results in a market value
adjustment to the cash surrender value of those contracts that are surrendered
before the expiration of their interest rate guarantee period. During the
current three and nine month periods ended September 30, 2001, the market value
adjustment expense increased $0.5 million and $1.3 million, respectively, as
compared to the same periods in 2000. The increases are primarily due to the
lower interest rate environment during 2001 as compared to 2000. The market
value adjustment expense has an inverse relationship to changes in interest
rates.
16
Policy benefits increased $0.7 million (or 8%) and decreased $3.7 million (or
12%) during the current three and nine month periods ended September 30, 2001,
respectively, as compared to the same periods in 2000. The decrease in the
current nine month period is primarily due to a $3.7 million reduction in
mortality benefit accrual accumulations as compared to the prior period.
Amortization of deferred policy acquisition costs increased $12.5 million and
$12.0 million during the current three and nine month periods ended September
30, 2001, as compared to the same periods in 2000. During the third quarter
2000, the Company revised its future gross profit assumptions on certain life
insurance business. The retrospective adjustment of the Company's deferred
policy acquisition costs resulted in a $15.6 million decrease in amortization of
deferred policy acquisition costs. Excluding this adjustment, amortization of
deferred policy acquisition costs decreased $3.1 million and $3.6 million during
the current three and nine month periods, respectively, as compared to the same
periods in 2000. These decreases are primarily due to the decrease in asset
based variable annuity policy charge revenue.
Insurance expenses and taxes increased $8.7 million (or 77%) and $8.9 million
(or 21%) during the current three and nine month periods ended September 30,
2001, as compared to the same periods in 2000. During the third quarter 2000,
the Company recorded a $5.8 million reduction in its guaranty fund assessment
liability. Excluding this adjustment, insurance expenses and taxes increased
$2.9 million and $3.1 million during the current three and nine month periods
ended September 30, 2001, as compared to the same periods in 2000. During the
current three and nine month periods, general expenses increased $6.9 million
and $7.8 million, respectively, due to costs related to the consolidation of the
Company's policy administration service centers. Offsetting these increases
during the current three and nine month periods was a decrease in certain
employee related expense allocations from Merrill Lynch & Co., and a decrease in
expenditures related to financial systems enhancements.
SEGMENT INFORMATION
The products that comprise the Life Insurance and Annuity segments generally
possess similar economic characteristics. As such, the financial condition and
results of operations of each business segment are generally consistent with the
Company's consolidated financial condition and results of operations presented
herein.
The decreases in other net revenues and other net earnings during the current
three and nine month periods are primarily due to trading account losses
incurred during 2001.
17
PART II Other Information
Item 1. Legal Proceedings.
Nothing to report.
Item 5. Other Information.
Nothing to report.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
None.
(b) Reports on Form 8-K.
None.
SIGNATURES
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.
MERRILL LYNCH LIFE INSURANCE COMPANY
/s/ MATTHEW J. RIDER
-----------------------------------------
Matthew J. Rider
Senior Vice President,
Chief Financial Officer and Treasurer
Date: November 12, 2001