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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-K
Registrant meets the conditions set forth in General Instruction I (1)(a) and
(b) of Form 10-K and is therefore filing this Form with the reduced disclosure
format.
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
OR
/ / 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
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES
EXCHANGE ACT OF 1934: NONE
INDICATE BY CHECK MARK IF REGISTRANT IS A WELL-KNOWN SEASONED ISSUER, AS DEFINED
IN RULE 405 OF THE SECURITIES ACT. YES / / NO /X/
INDICATE BY CHECK MARK IF THE REGISTRANT IS NOT REQUIRED TO FILE REPORTS
PURSUANT TO SECTION 13 OR SECTION 15(d) OF THE SECURITIES ACT.
YES / / NO /X/
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 / /
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF THE REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR OTHER INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY
AMENDMENT TO THIS FORM 10-K. /X/
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
/ / / / /X/
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN
RULE 12b-2 OF THE EXCHANGE ACT). YES / / NO /X/
NONE OF THE COMMON EQUITY OF THE REGISTRANT IS HELD BY NON-AFFILIATES.
THEREFORE, THE AGGREGATE MARKET VALUE OF COMMON EQUITY HELD BY NON-AFFILIATES OF
THE REGISTRANT IS ZERO.
AS OF MARCH 10, 2006, THE REGISTRANT HAD 100,000 COMMON SHARES, $25 PAR VALUE,
OUTSTANDING, ALL OF WHICH ARE HELD BY ALLSTATE LIFE INSURANCE COMPANY.
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TABLE OF CONTENTS
<Table>
<Caption>
PAGE
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PART I
Item 1. Business 1
Item 1A. Risk Factors 2
Item 2. Properties 2
Item 3. Legal Proceedings 2
Item 4. Submission of Matters to a Vote of Security Holders * N/A
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities 3
Item 6. Selected Financial Data * N/A
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 4
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 33
Item 8. Financial Statements and Supplementary Data 34
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure 69
Item 9A. Controls and Procedures 69
Item 9B. Other Information 69
PART III
Item 10. Directors and Executive Officers of the Registrant * N/A
Item 11. Executive Compensation * N/A
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters* N/A
Item 13. Certain Relationships and Related Transactions * N/A
Item 14. Principal Accountant Fees and Services 70
PART IV
Item 15. Exhibits and Financial Statement Schedules 71
Signatures 74
Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d)
of the Securities Exchange Act of 1934 by Registrants Which Have Not Registered
Securities Pursuant to Section 12 of the Securities Exchange Act of 1934 75
Financial Statement Schedules S-1
</Table>
* Omitted pursuant to General Instruction I(2) of Form 10-K
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PART I
ITEM 1. BUSINESS
Allstate Life Insurance Company of New York ("Allstate Life of New York",
"ALNY", the "Company", "we", "us" or "our") was incorporated in 1967 as a stock
life insurance company under the laws of the State of New York. In 1984, ALNY
was purchased by Allstate Life Insurance Company ("ALIC"). Allstate Life of New
York is a wholly owned subsidiary of ALIC, a stock life insurance company
incorporated under the laws of the State of Illinois. ALIC is a wholly owned
subsidiary of Allstate Insurance Company, a stock property-liability insurance
company organized under the laws of the State of Illinois. All of the
outstanding capital stock of Allstate Insurance Company ("AIC") is owned by The
Allstate Corporation (the "Corporation" or "Allstate"), a publicly owned holding
company incorporated under the laws of the State of Delaware. The Corporation is
the largest publicly held personal lines insurer in the United States. Widely
known through the "You're In Good Hands With Allstate (R)" slogan, Allstate
provides insurance products to more than 17 million households through a
distribution network that utilizes a total of 14,100 exclusive agencies and
exclusive financial specialists in the United States and Canada. Allstate is the
second-largest personal property and casualty insurer in the United States on
the basis of 2004 statutory premiums earned. In addition, it is the nation's
13th largest life insurance business on the basis of 2004 ordinary life
insurance in force and 17th largest on the basis of 2004 statutory admitted
assets.
Our mission is to assist financial services professionals in meeting their
clients' financial protection, retirement and investment needs by providing
top-tier products delivered with reliable and efficient service while generating
acceptable returns on equity.
The Company provides life insurance, retirement and investment products to
individuals. Our principal products include interest-sensitive and traditional
life insurance, variable life insurance, variable and fixed annuities and
supplemental accident and health insurance. Products are sold through a variety
of distribution channels including Allstate exclusive agencies, independent
agents (including master brokerage agencies and workplace enrolling agents), and
financial service firms such as banks, broker/dealers and specialized structured
settlement brokers.
We compete principally on the basis of the scope of our distribution
systems, the breadth of our product offerings, the recognition of our brand, our
financial strength and ratings, our product features and prices, and the level
of customer service that we provide. In addition, with respect to variable
annuity and variable life insurance products in particular, we compete on the
basis of the variety of fund managers and choices of funds for our separate
accounts and the management and performance of those funds within our separate
accounts.
The market for life insurance, retirement and investment products continues
to be highly fragmented and competitive. As of December 31, 2005, there were
approximately 740 groups of life insurance companies in the United States, most
of which offered one or more similar products. In addition, because many of
these products include a savings or investment component, our competition
includes domestic and foreign securities firms, investment advisors, mutual
funds, banks and other financial institutions. Competitive pressure is growing
due to several factors, including cross marketing alliances between unaffiliated
businesses, as well as consolidation activity in the financial services
industry.
Allstate Life of New York is subject to extensive regulation, primarily,
but not exclusively, from the New York State Insurance Department. The method,
extent and substance of such regulation generally has its source in statutes
that establish standards and requirements for conducting the business of
insurance and that delegate regulatory authority to the New York State Insurance
Department. In general, such regulation is intended for the protection of those
who purchase or use our insurance products. These rules have a substantial
effect on our business and relate to a wide variety of matters including
insurance company licensing and examination, agent licensing and compensation,
trade practices, policy forms, accounting methods, the nature and amount of
investments, claims practices, participation in guaranty funds, reserve
adequacy, insurer solvency, transactions with affiliates, the payment of
dividends, and underwriting standards. For a discussion of statutory financial
information, see Note 13 of the Financial Statements. For a discussion of
regulatory contingencies, see Note 11 of the Financial Statements. Notes 11 and
13 are incorporated in this Part I, Item 1 by reference.
In recent years the state insurance regulatory framework has come under
increased federal scrutiny. Legislation that would provide for federal
chartering of insurance companies has been proposed. In addition, state
legislators and insurance regulators continue to examine the appropriate nature
and scope of state insurance regulation. We cannot predict whether any specific
state or federal measures will be adopted to change the nature or scope of the
regulation of the insurance business or what effect any such measures would have
on Allstate Life of New York.
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ITEM 1A. RISK FACTORS
Information required in Item 1A is incorporated by reference to the
discussion under heading "Forward-Looking Statements and Risk Factors" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM 2. PROPERTIES
Allstate Life of New York occupies office space in Hauppauge, New York and
Northbrook, Illinois that is owned or leased by AIC. Expenses associated with
these facilities are allocated to us on both a direct and indirect basis,
depending on the nature and use.
ITEM 3. LEGAL PROCEEDINGS
Information required for Item 3 is incorporated by reference to the
discussion under the headings "Regulation" and "Legal and regulatory proceedings
and inquiries" in Note 11 of our financial statements.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
No established public trading market exists for our common stock. All of
our outstanding common stock is owned by our parent, ALIC. ALIC's outstanding
common stock is owned by AIC. All of the outstanding common stock of AIC is
owned by the Corporation. Within the past three years, we have not sold or
repurchased any of our equity securities.
From January 1, 2003 through March 15, 2006, we paid no dividends on our
common stock to ALIC.
For additional information on dividends, including restrictions on the
payment of dividends, see the discussion under the heading "Dividends" in Note
13 of our financial statements, which is incorporated herein by reference.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 financial statements and
related notes found under Part II Item 8 contained herein. We operate as a
single segment entity based on the manner in which financial information is used
internally to evaluate and determine the allocation of resources.
The most important matters that we monitor to evaluate the financial
condition and performance of our company include:
- For operations: premiums, deposits, gross margin including investment
and benefit margins, the amortization of deferred policy acquisition
costs, expenses, operating income, and invested assets;
- For Investments: credit quality/experience, stability of long-term
returns, cash flows and asset and liability duration;
- For financial condition: our financial strength ratings and statutory
capital levels and ratios; and
- For product distribution: profitably growing distribution partner
relationships and Allstate exclusive agencies sales of all products
and services.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
We have identified four accounting policies that require us to make
assumptions and estimates that are significant to the financial statements. It
is reasonably likely that changes in these assumptions and estimates could occur
from period to period and result in a material impact on our financial
statements. A brief summary of each of these critical accounting policies
follows. For a more detailed discussion of the effect of these policies on our
financial statements, and the judgments and estimates relating to these
policies, see the referenced sections of the MD&A. For a complete summary of our
significant accounting policies see Note 2 of the financial statements.
INVESTMENT VALUATION The fair value of publicly traded fixed income securities
is based on independent market quotations, whereas the fair value of
non-publicly traded securities is based on either widely accepted pricing
valuation models, which use internally developed ratings and independent third
party data as inputs, or independent third party pricing sources. Factors used
in our internally developed models, such as liquidity risk associated with
privately-placed securities, are difficult to independently observe and
quantify. Because of this, judgment is required in developing certain of these
estimates and, as a result, the estimated fair value of non-publicly traded
securities may differ from amounts that would be realized upon an immediate sale
of the securities.
For investments classified as available for sale, the difference between
fair value and amortized cost, net of deferred income taxes, is reported as a
component of accumulated other comprehensive income on the Statements of
Financial Position and is not reflected in the operating results of any period
until reclassified to net income upon the consummation of a transaction with an
unrelated third party, or when declines in fair values are deemed other than
temporary. The assessment of other than temporary impairment of a security's
fair value is performed on a portfolio review as well as a case-by-case basis
considering a wide range of factors. For our portfolio review evaluations, we
ascertain whether there are any approved programs involving the disposition of
investments such as changes in duration, revision to strategic asset allocations
and liquidity actions; and any dispositions planned by the portfolio managers.
In these instances, we recognize impairment on securities being considered for
these approved planned actions if the security is in an unrealized loss
position. There are a number of assumptions and estimates inherent in evaluating
impairments and determining if they are other than temporary, including 1) our
ability and intent to retain the investment for a period of time sufficient to
allow for an anticipated recovery in value; 2) the expected recoverability of
principal and interest; 3) the duration and extent to which the fair value has
been less than amortized cost; 4) the financial condition, near-term and
long-term prospects of the issuer, including relevant industry conditions and
trends, and implications of rating agency actions and offering prices; and 5)
the specific reasons that a security is in a significant unrealized loss
position, including market conditions which could affect liquidity.
Additionally, once assumptions and estimates are made, any number of changes in
facts and circumstances could cause us to later determine that an impairment is
other than temporary, including 1) general economic conditions that are worse
than previously assumed or that have a greater adverse effect on a particular
issuer than originally estimated; 2) changes in the facts and circumstances
related to a particular issuer's ability to meet all of its contractual
obligations; and 3) changes in facts and circumstances or new information
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obtained which causes a change in our ability or intent to hold a security to
maturity or until it recovers in value. Changes in assumptions, facts and
circumstances could result in additional charges to earnings in future periods
to the extent that losses are realized. The charge to earnings, while
potentially significant to net income, would not have a significant effect on
shareholder's equity since the majority of our portfolio is carried at fair
value and as a result, any related unrealized loss, net of deferred acquisition
costs, deferred sales inducement costs and deferred tax, would already be
reflected as a component of accumulated other comprehensive income in
shareholder's equity.
For a more detailed discussion of the risks relating to changes in
investment values and levels of investment impairment, and the potential causes
of such changes, see Note 6 of the financial statements and the Investments,
Market Risk, and Forward-looking Statements and Risk Factors sections of the
MD&A.
DERIVATIVE INSTRUMENT HEDGE EFFECTIVENESS We primarily use derivative financial
instruments to reduce our exposure to market risk and in conjunction with
asset/liability management. The fair value of exchange traded derivative
contracts is based on independent market quotations, whereas the fair value of
non-exchange traded derivative contracts is based on either widely accepted
pricing valuation models which use independent third party data as inputs or
independent third party pricing sources.
When derivatives meet specific criteria, they may be designated as
accounting hedges and accounted for as fair value, cash flow, foreign currency
fair value, or foreign currency cash flow hedges. When designating a derivative
as an accounting hedge, we formally document the hedging relationship, risk
management objective and strategy. The documentation identifies the hedging
instrument, the hedged item, the nature of the risk being hedged and the
assumptions used to assess how effective the hedging instrument is in offsetting
the exposure to changes in the hedged item's fair value attributable to the
hedged risk. In the case of a cash flow hedge, this documentation includes the
exposure to changes in the hedged transaction's variability in cash flows
attributable to the hedged risk. We do not exclude any component of the change
in fair value of the hedging instrument from the effectiveness assessment. At
each reporting date, we confirm that the hedging instrument continues to be
highly effective in offsetting the hedged risk. For further discussion of these
policies and quantification of the impact of these estimates and assumptions,
see Note 7 of the financial statements and the Investments, Market Risk and
Forward-looking Statements and Risk Factors sections of the MD&A.
DEFERRED POLICY ACQUISITION COST ("DAC") AMORTIZATION We incur significant costs
in connection with acquiring business. In accordance with generally accepted
accounting principles ("GAAP"), costs that vary with and are primarily related
to acquiring business are deferred and recorded as an asset on the Statements of
Financial Position.
DAC related to traditional life insurance is amortized over the premium
paying period of the related policies in proportion to the estimated revenues on
such business. Significant assumptions relating to estimated premiums,
investment income and realized capital gains and losses, as well as to all other
aspects of DAC are determined based upon conditions as of the date of policy
issuance and are generally not revised during the life of the policy. Any
deviations from projected business in force resulting from actual policy
terminations differing from expected levels and any estimated premium
deficiencies change the rate of amortization in the period such events occur.
Generally, the amortization period for these contracts approximate the estimated
lives of the policies.
DAC related to interest-sensitive life, fixed and variable annuities and
other investment contracts is amortized in proportion to the incidence of the
total present value of gross profits which includes both actual historical gross
profits ("AGP") and estimated future gross profits ("EGP") earned over the
estimated lives of the contracts. The amortization period ranges from 15-30
years; however, estimates of customer surrender rates, partial withdrawals and
deaths generally result in the majority of the DAC being amortized over the
surrender charge period. AGP and EGP consist of the following components:
benefit margin primarily from mortality, including guaranteed minimum death,
income, withdrawal and accumulation benefits; investment margin including
realized capital gains and losses; and contract administration, surrender and
other contract charges, less maintenance expenses.
DAC amortization for variable annuity and life contracts is estimated using
stochastic modeling and is significantly impacted by the anticipated return on
the underlying funds. Our long-term assumption of separate accounts fund
performance, net of fees, was approximately 7% in 2005 and 8% in 2004 and 2003.
Whenever actual separate accounts fund performance, based on the two most recent
years, varies from the expectation, we project performance levels over the next
five years such that the mean return over a seven-year period equals the
long-term expectation. This process is referred to as "reversion to the mean"
and is commonly used by the life insurance industry. Although the use of a
reversion to the mean assumption is common within the industry, the parameters
used in the methodology are subject to judgment and vary between companies. For
example, when
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applying this assumption we do not allow the future mean rates of return
including fees projected over the five-year period to exceed 12.75% or fall
below 0%. We periodically evaluate the results of utilizing this process to
confirm that it is reasonably possible that variable annuity and life fund
performance will revert to the expected long-term mean within this time horizon.
Revisions to EGPs result in changes in the cumulative amounts expensed as a
component of amortization of DAC in the period in which the revision is made.
This is commonly known as "DAC unlocking".
For quantification of the impact of these estimates and assumptions, see
the Forward-looking Statements and Risk Factors sections of the MD&A and Note 2
and 10 of the financial statements.
RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS ESTIMATION Long-term actuarial
assumptions of future investment yields, mortality, morbidity, policy
terminations and expenses are used when establishing the reserve for
life-contingent contract benefits. These assumptions, which for traditional life
insurance are applied using the net level premium method, include provisions for
adverse deviation and generally vary by such characteristics as type of
coverage, year of issue and policy duration. Future investment yield assumptions
are determined at the time the policy is issued based upon prevailing investment
yields as well as estimated reinvestment yields. Mortality, morbidity and policy
termination assumptions are based on our experience and industry experience
prevailing at the time the policies are issued. Expense assumptions include the
estimated effects of inflation and expenses to be incurred beyond the
premium-paying period.
For further discussion of these policies see Note 8 of the financial
statements and the Forward-looking Statements and Risk Factors section of the
MD&A.
OPERATIONS
OVERVIEW AND STRATEGY We are a wholly owned subsidiary of Allstate Life
Insurance Company ("ALIC"), which is a wholly owned subsidiary of Allstate
Insurance Company ("AIC"), a wholly owned subsidiary of The Allstate Corporation
(the "Corporation"). ALIC, along with ALNY and its other wholly owned
subsidiaries, provide life insurance, retirement and investment products to
individual and institutional customers. Our mission is to assist financial
services professionals in New York in meeting their clients' financial
protection, retirement and investment needs by providing top-tier products
delivered with reliable and efficient service.
We are pursuing the following actions and strategies to improve return on
equity: maintaining and developing focused top-tier products, deepening
distribution partner relationships, improving our cost structure through scale
and efficiencies, advancing our enterprise risk management program and
leveraging the strength of the Allstate brand name across products and
distribution channels. The execution of our business strategies has and may
continue to involve simplifying our business model and focusing on those
products and distribution relationships where we can secure strong leadership
positions while generating acceptable returns. This may require modifying the
number and selection of products marketed (for example, through such actions as
the sale of our direct response distribution business in 2004); terminating
underperforming distribution relationships; reducing policy administration
software systems; and other actions that we may determine are appropriate to
successfully execute our business strategies (see also "Subsequent Event"
in Note 3 to the financial statements).
Our product line includes a wide variety of products designed to meet
the financial protection, retirement and investment needs of our customers.
Our products include traditional life, interest-sensitive life, supplemental
accident and health insurance, variable life and fixed and variable
annuities. Our products are sold through a variety of distribution channels
including Allstate exclusive agencies, independent agents (including master
brokerage agencies and workplace enrolling agents), and financial service
firms such as banks, broker/dealers and specialized structured settlement
brokers.
PREMIUMS AND 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 life,
variable and fixed annuities for which deposits are classified as contractholder
funds or separate accounts liabilities. Contract charges are assessed against
the contractholder account values for maintenance, administration, cost of
insurance and surrender prior to contractually specified dates. As a result,
changes in contractholder funds and separate accounts liabilities are considered
in the evaluation of growth and as indicators of future levels of revenues.
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The following table summarizes premiums and contract charges by product.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
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PREMIUMS
Traditional life $ 26,067 $ 23,786 $ 22,998
Immediate annuities with life contingencies 38,322 49,877 36,371
Accident, health and other 4,149 2,887 8,642
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TOTAL PREMIUMS 68,538 76,550 68,011
CONTRACT CHARGES
Interest-sensitive life 42,315 40,400 38,042
Variable annuities 16,728 13,222 10,084
Fixed annuities 7,237 6,212 4,892
---------- ---------- ----------
TOTAL CONTRACT CHARGES 66,280 59,834 53,018
---------- ---------- ----------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 134,818 $ 136,384 $ 121,029
========== ========== ==========
</Table>
The following table summarizes premiums and contract charges by
distribution channel.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
---------- ---------- ----------
PREMIUMS
Allstate agencies $ 25,569 $ 23,409 $ 22,664
Specialized brokers 38,283 49,768 36,334
Broker dealers 36 107 37
Independent agents 4,650 3,162 1,643
Direct marketing - 104 7,333
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TOTAL PREMIUMS 68,538 76,550 68,011
CONTRACT CHARGES
Allstate agencies 40,741 39,710 38,296
Specialized brokers 2,678 3,802 3,403
Independent agents 478 466 172
Banks 9,664 4,964 2,213
Broker dealers 12,719 10,892 8,934
---------- ---------- ----------
TOTAL CONTRACT CHARGES 66,280 59,834 53,018
---------- ---------- ----------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 134,818 $ 136,384 $ 121,029
========== ========== ==========
</Table>
Total premiums decreased 10.5% in 2005 compared to 2004 as lower premiums
on immediate annuities with life contingencies more than offset higher
traditional life and supplemental accident and health premiums sold through the
workplace. Premiums on immediate annuities with life contingencies declined
primarily as a result of pricing actions taken to improve our returns on new
business and reflect our current expectations of mortality. Higher traditional
life and supplement accident and health premiums were primarily the result of
growth.
Total premiums increased 12.6% in 2004 compared to 2003. The increase was
the result of increased premiums on immediate annuities with life contingencies
and supplemental accident and health insurance sold through the workplace,
partially offset by decreased other premiums resulting from the disposal of
substantially all of our direct response distribution business. Sales of
immediate annuities with life contingencies fluctuate due to consumer preference
as well as market and competitive conditions, which drive the level and mix of
immediate annuities sold with or without life contingencies. Excluding premiums
on immediate annuities with life contingencies and premiums from our disposed
direct response distribution business, premiums increased 9.3% compared to 2003,
due to the expansion of our supplemental accident and health insurance sold
through the workplace.
Contract charges increased 10.8% in 2005 compared to 2004. The increase was
due to higher contract charges on fixed annuities, interest-sensitive life and
variable annuities. Fixed annuity contract charges in 2005 reflect higher
surrender charges compared with the prior year. The increase in the
interest-sensitive life contract charges was attributable to in-force business
growth resulting from deposits and credited interest more than
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offsetting surrenders and benefits. Higher variable annuity contract charges
were primarily the result of higher account values in our separate accounts.
Contract charges increased 12.9% in 2004 compared to 2003. The increase was
primarily attributable to higher contract charges on variable annuities and
interest-sensitive life. The increase in contract charges on variable annuities
was driven by a 21.2% increase in the average separate accounts values in 2004
compared to 2004, which was attributable to net deposits and transfers to the
separate accounts and positive investment performance exceeding the surrenders
and withdrawals. Higher interest-sensitive life contract charges primarily
reflect growth in business in-force.
CONTRACTHOLDER FUNDS represent interest-bearing liabilities arising from the
sale of fixed annuities, interest-sensitive life 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.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
------------ ------------ ------------
CONTRACTHOLDER FUNDS, BEGINNING BALANCE $ 3,802,846 $ 2,658,325 $ 2,051,429
Impact of adoption of SOP 03-1 (1) - 2,031 -
DEPOSITS:
Fixed annuities (immediate and deferred) 726,332 1,182,719 511,824
Interest-sensitive life 100,355 99,182 69,449
Variable annuity and life deposits allocated to fixed
accounts 57,127 103,463 147,515
------------ ------------ ------------
Total deposits 883,814 1,385,364 728,788
INTEREST CREDITED 173,984 129,243 106,020
BENEFITS, WITHDRAWALS AND OTHER ADJUSTMENTS
Benefits (74,923) (46,649) (24,103)
Surrenders and partial withdrawals (364,051) (246,081) (150,102)
Contract charges (41,856) (41,573) (40,554)
Net transfers to separate accounts (39,765) (39,906) (16,944)
Other adjustments 9,346 2,092 3,791
------------ ------------ ------------
TOTAL BENEFITS, WITHDRAWALS AND OTHER ADJUSTMENTS (511,249) (372,117) (227,912)
------------ ------------ ------------
CONTRACTHOLDER FUNDS, ENDING BALANCE $ 4,349,395 $ 3,802,846 $ 2,658,325
============ ============ ============
</Table>
- ----------
(1) The increase in contractholder funds due to the adoption of Statement of
Position No. 03-1, "Accounting and Reporting by Insurance Enterprises for
Certain Nontraditional Long-Duration Contracts and for Separate Accounts"
("SOP 03-1") reflects the reclassification of deferred sales inducements
("DSI") from contractholder funds to other assets and the establishment of
reserves for certain liabilities that are primarily related to income
benefit guarantees provided under variable annuities.
Lower contractholder deposits and increased surrenders and partial
withdrawals contributed to a reduction in the growth rate of contractholder
funds in 2005 compared to 2004. Average contractholder funds increased 26.2% in
2005 compared to a 37.1% increase in 2004.
Contractholder deposits decreased 36.2% in 2005 compared to 2004 due
primarily to lower deposits on fixed annuities. Fixed annuity deposits declined
38.6% in 2005 from reduced consumer demand relative to certificates of deposit
and other short-term investments due to increases in short-term interest rates
without corresponding increases in longer term rates and pricing actions to
increase fixed annuity product returns. A continuation of the current interest
rate environment may limit the level of future fixed annuity deposits.
Contractholder funds deposits increased 90.1% in 2004 compared to 2003 due
to increased fixed annuity and interest-sensitive life deposits, partially
offset by lower variable annuity and life deposits allocated to fixed
8
<Page>
accounts. Fixed annuity deposits increased 131.1% in 2004 compared to 2003 due
to strong consumer demand, competitive pricing and effective distribution
efforts in our bank channel.
Surrenders and partial withdrawals increased 47.9% in 2005 compared to 2004
reflecting a withdrawal rate of 9.6% for 2005 based on the beginning of period
contractholder funds balance. This compares to a withdrawal rate of 9.3% and
7.3% for 2004 and 2003, respectively. Surrenders and withdrawals may vary with
changes in interest rates and equity market conditions and the aging of our
in-force contracts.
SEPARATE ACCOUNTS LIABILITIES represent contractholders' claims to the related
separate accounts assets. Separate accounts liabilities primarily arise from the
sale of variable annuity contracts and variable life insurance policies. The
following table shows the changes in separate accounts liabilities.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
------------ ------------ ------------
SEPARATE ACCOUNTS LIABILITIES, BEGINNING BALANCE $ 792,550 $ 665,875 $ 537,204
Variable annuity and life deposits 179,649 210,601 230,114
Variable annuity and life deposits allocated to
fixed accounts (57,127) (103,463) (147,515)
------------ ------------ ------------
Net deposits 122,522 107,138 82,599
Investment results 59,127 70,960 114,539
Contract charges (13,417) (10,399) (7,894)
Net transfers from fixed accounts 39,765 39,906 16,944
Surrenders and benefits (71,723) (80,930) (77,517)
------------ ------------ ------------
SEPARATE ACCOUNTS LIABILITIES, ENDING BALANCE $ 928,824 $ 792,550 $ 665,875
============ ============ ============
</Table>
Separate accounts liabilities increased 17.2% as of December 31, 2005
compared to December 31, 2004. This is compared to an increase of 19.0% as of
December 31, 2004 compared to December 31, 2003. The decline in the rate at
which separate accounts liabilities increased was primarily attributable to less
favorable market performance, partially offset by higher net deposits. Net
variable annuity and life deposits increased 14.4% in 2005 compared to 2004 and
increased 29.7% in 2004 compared to 2003. Variable product deposits vary with
equity market conditions and consumer preferences related to our product
features. Variable annuity contractholders often allocate a significant portion
of their initial variable annuity contract deposit into a fixed rate investment
option. The level of this activity is reflected above in the deposits allocated
to fixed accounts, while all other transfer activity between the fixed and
separate accounts investment options is reflected in net transfers from fixed
accounts. The liability for the fixed portion of variable annuity contracts is
reflected in contractholder funds.
NET INVESTMENT INCOME increased 17.9% in 2005 compared to 2004 and 14.0% in 2004
compared to 2003. The increase in both periods was the result of higher
portfolio balances, partially offset by lower portfolio yields. Higher portfolio
balances resulted from the investment of cash flows from operating and financing
activities related primarily to deposits from fixed annuities and
interest-sensitive life policies. Investment balances as of December 31, 2005,
increased 8.9% from December 31, 2004 and increased 27.2% as of December 31,
2004 compared to December 31, 2003. The decline in the rate at which investments
increased in 2005 compared to 2004 was the result of a lesser increase in
contractholder funds and a decline in unrealized capital gains on fixed income
securities in 2005 compared with an increase in 2004.
9
<Page>
NET INCOME analysis is presented in the following table.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
------------ ------------ ------------
Premiums $ 68,538 $ 76,550 $ 68,011
Contract charges (1) 66,274 59,817 53,018
Net investment income 356,162 302,055 264,854
Periodic settlements and accruals on non-hedge
derivative instruments (2) 1,096 372 -
Contract benefits (183,227) (182,150) (167,221)
Interest credited to contractholder funds (3) (159,563) (129,044) (106,020)
------------ ------------ ------------
Gross margin 149,280 127,600 112,642
Amortization of DAC and DSI (40,224) (24,579) (28,273)
Operating costs and expenses (43,497) (42,115) (36,978)
Income tax expense (24,779) (21,845) (17,520)
Realized capital gains and losses, after-tax (3,220) (5,844) (5,240)
DAC and DSI amortization expense on realized
capital gains and losses, after-tax (2,360) (1,342) (1,043)
Reclassification of periodic settlements and
accruals on non-hedge derivative instruments,
after-tax (680) (234) -
Gain (loss) on disposition of operations, after-tax 1 862 (2,898)
Cumulative effect of change in accounting
principle, after-tax - (7,586) -
------------ ------------ ------------
NET INCOME $ 34,521 $ 24,917 $ 20,690
============ ============ ============
</Table>
- ----------
(1) Loads charged to customers at the inception of interest-sensitive life
contracts are deferred and amortized to income in a manner consistent with
DAC. Amortization of deferred loads related to capital gains is excluded
from contract charges for purposes of calculating gross margin.
Amortization of deferred loads related to capital gains totaled $6 thousand
and $17 thousand in 2005 and 2004, respectively. There was no comparable
amount in 2003.
(2) Periodic settlements and accruals of non-hedge derivative instruments are
reflected as a component of realized capital gains and losses on the
Statements of Operations and Comprehensive Income.
(3) Beginning in 2004, amortization of deferred sales inducements ("DSI") is
excluded from interest credited to contractholder funds for purposes of
calculating gross margin. Amortization of DSI totaled $2,373 thousand and
$760 thousand in 2005 and 2004, respectively. Prior periods have not been
restated.
GROSS MARGIN, a non-GAAP measure, represents premiums and contract charges, net
investment income and periodic settlements and accruals on non-hedge derivative
instruments, less contract benefits and interest credited to contractholder
funds excluding amortization of DSI. We reclassify periodic settlements and
accruals on non-hedge derivative instruments into gross margin to report them in
a manner consistent with the economically hedged investments, replicated assets
or product attributes (e.g. net investment income or interest credited to
contractholder funds) and by doing so, appropriately reflect trends in product
performance. We use gross margin as a component of our evaluation of the
profitability of our life insurance and financial product portfolio.
Additionally, for many of our products, including fixed annuities, variable life
and annuities, and interest-sensitive life insurance, the amortization of DAC
and DSI is determined based on actual and expected gross margin. Gross margin is
comprised of three components that are utilized to further analyze the business:
investment margin, benefit margin, and contract charges and fees. We believe
gross margin and its components are useful to investors because they allow for
the evaluation of income components separately and in the aggregate when
reviewing performance. Gross margin, investment margin and benefit margin should
not be considered as a substitute for net income and do not reflect the overall
profitability of the business. Net income is the GAAP measure that is most
directly comparable to these margins. Gross margin is reconciled to GAAP net
income in the previous table.
10
<Page>
The components of gross margin are reconciled to the corresponding
financial statement line items in the following table.
<Table>
<Caption>
2005
---------------------------------------------------------
CONTRACT
INVESTMENT BENEFIT CHARGES AND GROSS
(IN THOUSANDS) MARGIN MARGIN FEES MARGIN
------------ ------------ ------------ ------------
Premiums $ - $ 68,538 $ - $ 68,538
Contract charges (1) - 33,176 33,098 66,274
Net investment income 356,162 - - 356,162
Periodic settlements and
accruals on non-hedge
derivative instruments (2) 1,096 - - 1,096
Contract benefits (100,996) (82,231) - (183,227)
Interest credited to
contractholder funds(3) (159,563) - - (159,563)
------------ ------------ ------------ ------------
$ 96,699 $ 19,483 $ 33,098 $ 149,280
============ ============ ============ ============
</Table>
<Table>
<Caption>
2004(4)
---------------------------------------------------------
CONTRACT
INVESTMENT BENEFIT CHARGES AND GROSS
(IN THOUSANDS) MARGIN MARGIN FEES MARGIN
------------ ------------ ------------ ------------
Premiums $ - $ 76,550 $ - $ 76,550
Contract charges (1) - 30,803 29,014 59,817
Net investment income 302,055 - - 302,055
Periodic settlements and
accruals on non-hedge
derivative instruments (2) 372 - - 372
Contract benefits (98,261) (83,889) - (182,150)
Interest credited to
contractholder funds(3) (129,044) - - (129,044)
------------ ------------ ------------ ------------
$ 75,122 $ 23,464 $ 29,014 $ 127,600
============ ============ ============ ============
</Table>
<Table>
<Caption>
2003(4)
---------------------------------------------------------
CONTRACT
INVESTMENT BENEFIT CHARGES AND GROSS
(IN THOUSANDS) MARGIN MARGIN FEES MARGIN
------------ ------------ ------------ ------------
Premiums $ - $ 68,011 $ - $ 68,011
Contract charges (1) - 27,644 25,374 53,018
Net investment income 264,854 - - 264,854
Contract benefits (93,331) (73,890) - (167,221)
Interest credited to
contractholder funds(3) (106,020) - - (106,020)
------------ ------------ ------------ ------------
$ 65,503 $ 21,765 $ 25,374 $ 112,642
============ ============ ============ ============
</Table>
- ----------
(1) Loads charged to customers at the inception of interest-sensitive life
contracts are deferred and amortized to income in a manner consistent with
DAC. Amortization of deferred loads related to capital gains is excluded
from contract charges for purposes of calculating gross margin.
Amortization of deferred loads related to capital gains totaled $6 thousand
and $17 thousand in 2005 and 2004, respectively. There was no comparable
amount in 2003.
(2) Periodic settlements and accruals of non-hedge derivative instruments are
reflected as a component of realized capital gains and losses on the
Statements of Operations and Comprehensive Income.
(3) Beginning in 2004, amortization of DSI is excluded from interest credited
to contractholder funds for purposes of calculating gross margin.
Amortization of DSI totaled $2,373 thousand and $760 thousand in 2005 and
2004, respectively. Prior periods have not been restated.
(4) 2004 and 2003 have been restated to conform to the current period
presentation. In connection therewith, contract charges related to
guaranteed minimum death, income, accumulation and withdrawal benefits on
variable annuities have been reclassified to benefit margin from
maintenance charges. Additionally, amounts previously presented as
maintenance charges and surrender charges are now presented in the
aggregate as contract charges and fees. These reclassifications did not
result in a change in gross margin.
11
<Page>
Gross margin increased 17.0% in 2005 compared to 2004 and 13.3% in 2004
compared to 2003. The increase in 2005 was the result of higher investment
margin and contract charges and fees, partially offset by lower benefit margin.
Gross margin for 2005 includes additional benefits of $15 million that were
accrued in accordance with a regulatory matter (see Note 11 to the financial
statements). The increase in gross margin in 2004 compared to 2003 was
attributable to higher investment margin, contract charges and fees and benefit
margin.
INVESTMENT MARGIN is a component of gross margin, both of which are
non-GAAP measures. Investment margin represents the excess of net investment
income and periodic settlements and accruals on non-hedge derivative instruments
over interest credited to contractholder funds and the implied interest on
life-contingent immediate annuities included in the reserve for life-contingent
contract benefits. Amortization of DSI is excluded from interest credited to
contractholder funds for purposes of calculating investment margin. We use
investment margin to evaluate our profitability related to the difference
between investment returns on assets supporting certain products and amounts
credited to customers ("spread") during a fiscal period.
Investment margin by product group is shown in the following table.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
--------- --------- ---------
Annuities $ 87,946 $ 64,110 $ 55,541
Life insurance 8,753 11,012 9,962
--------- --------- ---------
Total investment margin $ 96,699 $ 75,122 $ 65,503
========= ========= =========
</Table>
Investment margin increased 28.7% in 2005 compared to 2004 primarily due
to growth in our fixed annuity business, partially offset by lower weighted
average investment spreads on interest-sensitive life and immediate annuities
and additional fixed annuity contract benefits accrued in accordance with a
regulatory matter (see Note 11 to the financial statements). Investment
margin increased 14.7% in 2004 compared to 2003 primarily due to higher
contractholder funds and actions to reduce crediting rates where possible,
partially offset by a decline in the fixed income securities portfolio yield
resulting from lower market interest rates.
The following table summarizes the annualized weighted average investment
yields, interest crediting rates and investment spreads during 2005, 2004 and
2003.
<Table>
<Caption>
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
INVESTMENT YIELD INTEREST CREDITING RATE INVESTMENT SPREADS
---------------- ----------------------- ------------------
2005 2004 2003 2005 2004 2003 2005 2004 2003
---- ---- ---- ---- ---- ---- ---- ---- ----
Interest-sensitive life products 5.7% 6.1% 6.6% 4.6% 4.8% 4.9% 1.1% 1.3% 1.7%
Fixed annuities - deferred
annuities 5.4 5.6 6.1 3.3 3.5 3.8 2.1 2.1 2.3
Fixed annuities - immediate
annuities with and without life
contingencies 7.4 7.6 7.8 6.7 6.8 6.9 0.7 0.8 0.9
Investments supporting capital,
traditional life and other products 6.2 6.0 6.3 N/A N/A N/A N/A N/A N/A
</Table>
The following table summarizes the liabilities as of December 31 for these
contracts and policies.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
------------ ------------ ------------
Fixed annuities - immediate annuities with life contingencies $ 1,502,918 $ 1,442,055 $ 1,376,898
Other life contingent contracts and other 366,957 340,396 306,873
------------ ------------ ------------
Reserve for life-contingent contracts $ 1,869,875 $ 1,782,451 $ 1,683,771
============ ============ ============
Interest-sensitive life $ 427,523 $ 368,608 $ 309,076
Fixed annuities - deferred annuities 3,381,034 2,890,254 1,861,456
Fixed annuities - immediate annuities without life
contingencies and other 540,838 543,984 487,793
------------ ------------ ------------
Contractholder funds $ 4,349,395 $ 3,802,846 2,658,325
============ ============ ============
</Table>
12
<Page>
BENEFIT MARGIN is a component of gross margin, both of which are non-GAAP
measures. Benefit margin represents life and life-contingent immediate annuity
premiums, cost of insurance contract charges and variable annuity contract
charges for contract guarantees less contract benefits. Benefit margin excludes
the implied interest on life-contingent immediate annuities, which is included
in the calculation of investment margin. We use the benefit margin to evaluate
our underwriting performance, as it reflects the profitability of our products
with respect to mortality or morbidity risk during a fiscal period.
Benefit margin by product group is shown in the following table.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 (1) 2003 (1)
------------ ------------ ------------
Life insurance $ 34,558 $ 29,291 $ 25,075
Annuities (15,075) (5,827) (3,310)
------------ ------------ ------------
Total benefit margin $ 19,483 $ 23,464 $ 21,765
============ ============ ============
</Table>
- ----------
(1) 2004 and 2003 have been restated to conform to the current period
presentation.
Benefit margin declined 17.0% in 2005 compared to 2004 due to an
increasingly unfavorable benefit margin on annuities partially offset by a
higher benefit margin on life insurance products. The unfavorable change in
the benefit margin on annuities was primarily attributable to additional
variable annuity contract benefits accrued in accordance with a regulatory
matter (see Note 11 to the financial statements). The improvement in the
benefit margin on life insurance primarily reflects the continued growth of
our in force business.
Benefit margin increased 7.8% in 2004 compared to 2003 as a higher life
insurance benefit margin more than offset a decrease in the benefit margin on
certain immediate annuities. The increase in the benefit margin on life
insurance reflects growth in our interest-sensitive life business in-force and
lower mortality benefits on both interest-sensitive and traditional life
business. In addition, 2003 was impacted by the strengthening of reserves on
certain traditional life policies. These increases were partially offset by the
disposal of substantially all of our direct response distribution business. The
decrease in the benefit margin on annuities was driven by unfavorable mortality
experience on life-contingent immediate annuities, partially offset by an
improved benefit margin from lower contract benefits related to guaranteed
minimum death benefits ("GMDBs") on variable annuities.
As required by SOP 03-1, as of January 1, 2004, a reserve was established
for death and income benefits provided for under variable annuities and other
secondary guarantees. For variable annuities, the reserve includes GMDBs and
guaranteed minimum income benefits ("GMIBs").
Annuity benefit margin will continue to be adversely impacted by
life-contingent immediate annuities for which benefit payments are anticipated
to extend beyond their original pricing expectations. The annuity benefit margin
in future periods will fluctuate based on the timing of annuitant deaths on
these life-contingent immediate annuities and the annual evaluation of
assumptions used in our valuation models for variable and fixed annuity
guarantees.
AMORTIZATION OF DAC AND DSI, excluding amortization related to realized
capital gains and losses, increased 63.7% in 2005 compared to 2004 as a result
of higher gross margin primarily from the growth in our annuity investment
margin.
In the first quarter of 2005, as a result of our annual comprehensive
evaluation of the assumptions used in our valuation models for all investment
products, we recorded DAC and DSI amortization deceleration (commonly referred
to as "DAC and DSI unlocking") of $7.3 million, which included deceleration of
$2.8 million on interest-sensitive and variable life products and deceleration
of $4.5 million for variable annuities. The amortization deceleration on
variable annuities was attributable to better than anticipated gross profits.
In the prior year, the comparable DAC and DSI unlocking was a net
deceleration of amortization of $10.2 million. This deceleration of amortization
was the result of favorable projected mortality on our interest-sensitive life
products.
Amortization of DAC and DSI decreased 13.1% during 2004 compared to 2003.
The decrease was primarily a result of DAC and DSI amortization deceleration in
2004 compared to slight amortization acceleration in 2003. This change in DAC
unlocking was partially offset by higher amortization attributable to increased
gross margins on fixed and variable annuities. The deceleration of amortization
in 2004 was the result of favorable projected mortality on our
interest-sensitive life products.
13
<Page>
The adoption of SOP 03-1 in 2004 required a new modeling approach for
estimating expected future gross profits that are used when determining the
amortization of DAC. Because of this new modeling approach, effective January 1,
2004, the variable annuity DAC and DSI assets were reduced by $10.7 million.
This reduction was recognized as a component of cumulative effect of a change in
accounting principle.
The changes in the DAC asset are summarized in the following tables.
<Table>
<Caption>
AMORTIZATION
(ACCELERATION)
BEGINNING DECELERATION EFFECT OF ENDING
BALANCE IMPACT OF IMPACT OF AMORTIZATION (CHARGED) UNREALIZED BALANCE
DECEMBER 31, ADOPTION OF DISPOSAL ACQUISITION CHARGED TO CREDITED TO CAPITAL GAINS DEC. 31,
(IN THOUSANDS) 2004 SOP 03-1 OF DR COSTS DEFERRED INCOME (3) INCOME (1) AND LOSSES 2005
------------ ----------- --------- -------------- ------------ -------------- ------------- ---------
Traditional life $ 33,480 $ -- $ -- $ 1,713 $ (2,204) $ -- $ -- $ 32,989
Interest-sensitive
life 72,129 -- -- 8,784 (8,435) 3,250 1,580 77,308
Variable annuities 47,725 -- -- 12,095 (11,014) 4,268 15,080 68,154
Investment contracts 82,800 -- -- 43,817 (26,879) 9 37,176 136,923
Accident, health
and other 2,039 -- -- 1,796 (658) -- -- 3,177
------------ ----------- --------- -------------- ------------ -------------- ------------- ---------
Total $ 238,173 $ -- $ -- $ 68,205 $ (49,190) $ 7,527 $ 53,836 $ 318,551
============ =========== ========= ============== ============ ============== ============= =========
</Table>
<Table>
<Caption>
AMORTIZATION
(ACCELERATION)
BEGINNING DECELERATION EFFECT OF ENDING
BALANCE IMPACT OF IMPACT OF AMORTIZATION (CHARGED) UNREALIZED BALANCE
DECEMBER 31, ADOPTION OF DISPOSAL ACQUISITION CHARGED TO CREDITED TO CAPITAL GAINS DEC. 31,
(IN THOUSANDS) 2003 SOP 03-1 (2) OF DR COSTS DEFERRED INCOME (3) INCOME (1) AND LOSSES 2004
------------ ------------ --------- -------------- ------------ -------------- ------------- ---------
Traditional life $ 33,046 $ -- $ -- $ 3,098 $ (2,664) $ -- $ -- $ 33,480
Interest-sensitive
life 60,231 -- -- 6,747 (5,841) 9,259 1,733 72,129
Variable annuities 52,743 (11,140) -- 14,750 (12,801) -- 4,173 47,725
Investment contracts 37,308 -- -- 66,285 (14,399) 954 (7,348) 82,800
Accident, health
and other 4,109 -- (3,213) 1,622 (479) -- -- 2,039
------------ ------------ --------- -------------- ------------ -------------- ------------- ---------
Total $ 187,437 $ (11,140) $ (3,213) $ 92,502 $ (36,184) $ 10,213 $ (1,442) $ 238,173
============ ============ ========= ============== ============ ============== ============= =========
</Table>
- ----------
(1) Included as a component of Amortization of DAC on the Statements of
Operations and Comprehensive Income.
(2) The impact of adoption of SOP 03-1 includes a write-down in variable
annuity DAC of $7.7 million, the reclassification of DSI from DAC to other
assets resulting in a decrease to DAC of $4.1 million and an increase to
DAC of $691 thousand for an adjustment to the effect of unrealized capital
gains and losses.
(3) The amortization of DAC for interest-sensitive life, variable annuities and
investment contracts is proportionate to the recognition of gross profits,
which include realized capital gains and losses. Fluctuations in
amortization for these products may result as actual realized capital gains
and losses differ from the amounts utilized in the determination of
estimated gross profits. Amortization related to realized capital gains and
losses was $3.7 million and $2.1 million in 2005 and 2004, respectively.
14
<Page>
OPERATING COSTS AND EXPENSES increased 3.3% in 2005 compared to 2004 and
increased 13.9% in 2004 compared to 2003. The increase in 2005 was primarily
attributable to higher technology, distribution, and administrative expenses,
which were incurred to support growth in the Company's in-force business. These
increases were partially offset by lower non-deferrable commissions, guaranty
fund assessments, and expenses related to taxes, licenses, and fees.
The increase in 2004 was attributable to higher non-deferrable sales
commissions and employee expenses, partially offset by lower expenses due to the
disposal of substantially all of our direct response distribution business.
REINSURANCE CEDED We enter into reinsurance agreements with ALIC and
unaffiliated carriers to limit our risk of mortality and morbidity losses. As of
December 31, 2005 and 2004, for certain term life insurance policies, we ceded
25-90% of the mortality risk depending on the length of the term, policy premium
guarantees and the date of policy issuance. Mortality risk on policies in excess
of $250 thousand per life is ceded to ALIC. As of December 31, 2005 and 2004,
37.6% and 32.4%, respectively, of our face amount of life insurance in force is
reinsured to non-affiliates and ALIC. We retain primary liability as a direct
insurer for all risks ceded to reinsurers.
The estimation of reinsurance recoverables is impacted by the uncertainties
involved in the establishment of reserves.
Developments in the insurance industry have included consolidation activity
between reinsurers, which has resulted in reinsurance risk across the industry
being concentrated among fewer companies. As a result, we have increased our
percentage of underwriting retention of new term life insurance policies.
Our reinsurance recoverables, summarized by reinsurer as of December 31,
are shown in the following table.
<Table>
<Caption>
REINSURANCE RECOVERABLE
S&P FINANCIAL -----------------------
(IN THOUSANDS) STRENGTH RATING 2005 2004
--------------- ---- ----
Transamerica Financial Life Insurance AA $ 4,861 $ 1,885
RGA Reinsurance Company AA- 2,511 1,181
Triton Insurance Company (1) (2) N/A 1,407 1,453
Allstate Life Insurance Company AA 935 1,062
American United Life AA- 534 330
Security Life of Denver AA 516 350
Generali USA A 511 361
Swiss Re Life and Health America, Inc. AA 478 345
Scottish Re Group (2) A- 409 303
Other (3) 567 1,152
--------- --------
Total $ 12,729 $ 8,422
========= ========
</Table>
- ----------
(1) As of December 31, 2005 and 2004, this company was rated A
(Excellent) by A.M. Best.
(2) Reinsurance recoverables due from Triton Insurance Company and a
small portion of the recoverables due from Scottish Re Group, as
of December 31, 2005 and 2004, reflect reinsurance arrangements
entered into in conjunction with the disposal of substantially
all of our direct response distribution business.
(3) As of December 31, 2005 and 2004, all of the reinsurance
recoverables in the other category are related to companies rated
AA- or better by S&P.
We continuously monitor the creditworthiness of reinsurers in order to
determine our risk of recoverability on an individual and aggregate basis, and a
provision for uncollectible reinsurance is recorded if needed. No amounts have
been deemed unrecoverable in the three-years ended December 31, 2005.
We have a reinsurance treaty through which we cede re-investment related
risk on our structured settlement annuities to ALIC. The terms of this treaty
meet the accounting definition of a derivative under Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities". Accordingly, the treaty is recorded in the Statements
of Financial Position at fair value, and changes in the fair value of the treaty
and premiums paid to ALIC are recognized in realized capital gains and losses.
Effective January 2, 2004, guaranteed minimum accumulation benefits
("GMABs") on variable annuities are 100% ceded to ALIC through a reinsurance
treaty. Effective January 1, 2005, guaranteed minimum withdrawal benefits
("GMWBs") and certain GMDBs on variable annuities are 100% ceded to ALIC through
a reinsurance treaty.
15
<Page>
OUTLOOK
- - We are pursuing strategies intended to improve our return on equity. The
strategies include continuing to proactively manage capital and focus our
product portfolio on products where we can secure market leadership and
achieve acceptable returns.
- - We will continue to manage our expenses and improve our operating
efficiency.
- - We plan to reinvigorate sales through the Allstate exclusive agencies by
further tailoring products for our customers and making it easier for our
agents to distribute the Company's products.
INVESTMENTS
An important component of our financial results is the return on our
investment portfolio. The investment portfolio is managed based upon the nature
of the business and our corresponding liability structure.
OVERVIEW AND STRATEGY The investment strategy focuses on the need for
risk-adjusted spread on the underlying liabilities while maximizing return on
capital. We believe investment spread is maximized by selecting assets that
perform favorably on a long-term basis and by disposing of certain assets to
minimize the effect of downgrades and defaults. We believe this strategy
maintains the investment margin necessary to sustain income over time. The
portfolio management approach employs a combination of recognized market,
analytical and proprietary modeling, including a strategic asset allocation
model, as the primary basis for the allocation of interest sensitive, illiquid
and credit assets as well as for determining overall below investment grade
exposure and diversification requirements. Within the ranges set by the
strategic asset allocation model, tactical investment decisions are made in
consideration of prevailing market conditions. As a result of tactical
decisions, we may sell securities during the period in which fair value has
declined below amortized cost for fixed income securities or cost for equity
securities. Portfolio reviews, which include identifying securities that are
other than temporarily impaired and recognizing impairment on securities in an
unrealized loss position for which we do not have the intent and ability to hold
until recovery, are conducted regularly. For more information, see the Portfolio
Monitoring section of the MD&A.
PORTFOLIO COMPOSITION The composition of the investment portfolio at December
31, 2005 and 2004 is presented in the table below. Also see Notes 2 and 6 to the
financial statements for investment accounting policies and additional
information.
<Table>
<Caption>
DECEMBER 31, 2005 DECEMBER 31, 2004
--------------------------- ---------------------------
CARRYING PERCENT CARRYING PERCENT
(IN THOUSANDS) VALUE OF TOTAL VALUE OF TOTAL
------------ ------------ ------------ ------------
Fixed income securities (1) $ 5,989,263 89.0% $ 5,545,647 89.8%
Mortgage loans 633,789 9.4 480,280 7.8
Short-term 63,057 0.9 111,509 1.8
Policy loans 36,698 0.6 34,948 0.6
Other 3,740 0.1 4,638 -
------------ ------------ ------------ ------------
Total $ 6,726,547 100.0% $ 6,177,022 100.0%
============ ============ ============ ============
</Table>
- ----------
(1) Fixed income securities are carried at fair value. Amortized cost basis for
these securities was $5.54 billion and $5.01 billion at December 31, 2005
and 2004, respectively.
Total investments increased to $6.73 billion at December 31, 2005 from
$6.18 billion at December 31, 2004, primarily due to positive cash flows from
operating and financing activities, partially offset by decreased net unrealized
gains on fixed income securities.
Total investments at amortized cost related to collateral held in
accordance with securities lending transactions, were $149.5 million and $133.4
million at December 31, 2005 and 2004, respectively
We use different methodologies to estimate the fair value of publicly and
non-publicly traded marketable investment securities and exchange traded and
non-exchange traded derivative contracts. For a discussion of these methods, see
the Application of Critical Accounting Policies section of MD&A.
16
<Page>
The following table shows total investments, categorized by the method used
to determine fair value at December 31, 2005.
<Table>
<Caption>
DERIVATIVE
INVESTMENTS CONTRACTS
--------------------------- ------------
FAIR PERCENT FAIR
(IN THOUSANDS) VALUE OF TOTAL VALUE
------------ ------------ ------------
Fair value based on independent market
quotations $ 4,831,201 71.8% $ 24
Fair value based on models and other valuation
methods 1,215,594 18.1 2,567
Mortgage loans, policy loans and other
investments, valued at cost 679,752 10.1 -
------------ ------------ ------------
Total $ 6,726,547 100.0% $ 2,591
============ ============ ============
</Table>
FIXED INCOME SECURITIES
See Note 6 of the financial statements for a table showing the amortized
cost, unrealized gains, unrealized losses and fair value for each type of fixed
income security for the years ended December 31, 2005 and 2004.
U.S. government and agencies of the U.S. government securities were all
rated investment grade at December 31, 2005.
Municipal bonds, including tax-exempt and taxable securities, totaled
$327.6 million, all of which were rated investment grade at December 31, 2005.
Approximately 62.1% of the municipal bond portfolio was insured by five bond
insurers and accordingly have a Moody's equivalent rating of Aaa or Aa. The
municipal bond portfolio at December 31, 2005 consisted of approximately 40
issues from approximately 37 issuers. The largest exposure to a single issuer
was approximately 16.7% of the municipal bond portfolio.
Corporate bonds totaled $3.44 billion and 94.5% were rated investment grade
at December 31, 2005. As of December 31, 2005, the portfolio contained $1.51
billion of privately placed corporate obligations, 43.9% of the total corporate
obligations in the portfolio, compared with $1.39 billion at December 31, 2004.
Approximately $1.48 billion or 98.2% of the privately placed corporate
obligations consisted of fixed rate privately placed securities. The benefits of
fixed rate privately placed securities when compared to publicly issued
securities are generally higher yields, improved cash flow predictability
through pro-rata sinking funds, and a combination of covenant and call
protection features designed to better protect the holder against losses
resulting from credit deterioration, reinvestment risk or fluctuations in
interest rates. A disadvantage of fixed rate privately placed securities when
compared to publicly issued securities is relatively reduced liquidity. At
December 31, 2005 95.0% of privately placed securities were rated investment
grade.
Foreign government securities totaled $306.3 million and all were rated
investment grade at December 31, 2005.
Mortgage-backed securities ("MBS") totaled $563.1 million at December 31,
2005, all of which were investment grade. Approximately 81.4% of the MBS
portfolio consists of securities that were issued by, or have underlying
collateral that is guaranteed by U.S. government agencies or U.S. government
sponsored entities. For the remaining portion of the portfolio not guaranteed by
U.S. government agencies or entities, approximately 79.2% had a Moody's rating
of Aaa or a Standard & Poor's ("S&P") rating of AAA, the highest rating
category. The MBS portfolio is subject to interest rate risk since price
volatility and the ultimate realized yield are affected by the rate of
prepayment of the underlying mortgages.
Commercial Mortgage Backed Securities ("CMBS") totaled $491.8 million at
December 31, 2005. CMBS investments primarily represent pools of commercial
mortgages, broadly diversified across property types and geographical area. The
CMBS portfolio is subject to credit risk, but unlike other structured products,
is generally not subject to prepayment risk due to protections within the
underlying commercial mortgages, whereby borrowers are restricted from prepaying
their mortgages due to changes in interest rates. Credit defaults can result in
credit directed prepayments. Approximately 82.0% of the CMBS portfolio had a
Moody's rating of Aaa or a Standard & Poor's rating of AAA, the highest rating
category, at December 31, 2005.
Asset-backed securities ("ABS") totaled $124.4 million at December 31,
2005. Our ABS portfolio is subject to credit and interest rate risk. Credit risk
is managed by monitoring the performance of the collateral. In addition, many of
the securities in the ABS portfolio are credit enhanced with features such as
over-collateralization, subordinated structures, reserve funds, guarantees
and/or insurance. Approximately 76.0% of
17
<Page>
the ABS portfolio had a Moody's rating of Aaa or a Standard & Poor's ("S&P")
rating of AAA, the highest rating category. A portion of the ABS portfolio is
also subject to interest rate risk since, for example, price volatility and
ultimate realized yield are affected by the rate of prepayment of the underlying
assets. The ABS portfolio includes collateralized debt obligations and other
bonds that are secured by a variety of asset types, predominately home equity
loans.
At December 31, 2005, 96.6% 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 S&P, Fitch
or Dominion; or a comparable internal rating if an externally provided rating is
not available.
The following table summarizes the credit quality of the fixed income
securities portfolio at December 31, 2005.
<Table>
<Caption>
(IN THOUSANDS)
NAIC FAIR PERCENT
RATING MOODY'S EQUIVALENT VALUE OF TOTAL
- -------------- ------------------------------------ ------------ --------
1 Aaa/Aa/A $ 4,211,944 70.3%
2 Baa 1,575,607 26.3
3 Ba 136,021 2.3
4 B 42,572 0.7
5 Caa or lower 5,194 0.1
6 In or near default 17,925 0.3
------------ --------
$ 5,989,263 100.0%
============ ========
</Table>
UNREALIZED GAINS AND LOSSES See Note 6 of the financial statements for further
disclosures regarding unrealized losses on fixed income securities and factors
considered in determining whether they are not other than temporarily impaired.
The unrealized net capital gains on fixed income securities at December 31, 2005
totaled $453.9 million, a decrease of $78.8 million since December 31, 2004.
Gross unrealized gains and losses on fixed income securities are provided in the
table below.
<Table>
<Caption>
GROSS UNREALIZED
AMORTIZED --------------------------- FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
------------ ------------ ------------ ------------
AT DECEMBER 31, 2005
Corporate:
Public utilities $ 639,703 $ 69,523 $ (2,795) $ 706,431
Banking 517,269 21,586 (3,406) 535,449
Consumer goods 445,536 13,824 (5,042) 454,318
Financial services 373,126 8,039 (4,054) 377,111
Communications 228,235 11,551 (2,258) 237,528
Energy 196,775 6,707 (1,318) 202,164
Capital goods 304,831 7,353 (4,434) 307,750
Basic industry 215,734 7,649 (2,446) 220,937
Transportation 169,367 13,868 (646) 182,589
Other 150,768 20,633 (1,245) 170,156
Technology 45,308 1,897 (376) 46,829
------------ ------------ ------------ ------------
Total corporate fixed income portfolio 3,286,652 182,630 (28,020) 3,441,262
U.S. government and agencies 510,362 213,421 - 723,783
Municipal 308,219 20,193 (776) 327,636
Foreign government 236,078 70,433 (176) 306,335
Asset-backed securities 123,981 1,068 (679) 124,370
Mortgage-backed securities 569,712 4,050 (10,712) 563,050
Commercial mortgage-backed securities 490,985 3,999 (3,149) 491,835
Redeemable preferred stock 9,407 1,585 - 10,992
------------ ------------ ------------ ------------
Total fixed income securities $ 5,535,396 $ 497,379 $ (43,512) $ 5,989,263
============ ============ ============ ============
</Table>
18
<Page>
The consumer goods, capital goods, financial services and banking sectors
had the highest concentration of gross unrealized losses in our corporate fixed
income securities portfolio at December 31, 2005. The gross unrealized losses in
these sectors are primarily interest rate related or company specific. All
securities in an unrealized loss position at December 31, 2005 were included in
our portfolio monitoring process wherein it was determined that the declines in
value were not other than temporary.
The following table shows the composition by credit quality of the fixed
income securities with gross unrealized losses at December 31, 2005.
<Table>
<Caption>
(IN THOUSANDS)
NAIC UNREALIZED PERCENT PERCENT
RATING MOODY'S EQUIVALENT LOSS OF TOTAL FAIR VALUE OF TOTAL
----------- ----------- ----------- -----------
1 Aaa/Aa/A $ (26,315) 60.5% $ 1,424,116 68.9%
2 Baa (14,726) 33.8 579,310 28.1
3 Ba (2,263) 5.2 50,648 2.5
4 B (208) 0.5 11,166 0.5
5 Caa or lower - - - -
6 In or near default - - - -
----------- ----------- ----------- -----------
Total $ (43,512) 100.0% $ 2,065,240 100.0%
=========== =========== =========== ===========
</Table>
At December 31, 2005, $41.0 million, or 94.3%, of the gross unrealized
losses were related to investment grade fixed income securities. Unrealized
losses on investment grade securities principally relate to changes in interest
rates or changes in sector-related credit spreads since the securities were
acquired.
As of December 31, 2005, $2.5 million of the gross unrealized losses were
related to below investment grade fixed income securities. Included among the
securities rated below investment grade are both public and privately placed
high-yield bonds and securities that were investment grade when originally
acquired. We mitigate the credit risk of investing in below investment grade
fixed income securities by limiting the percentage of our fixed income portfolio
invested in such securities, through diversification of the portfolio, and
active credit monitoring and portfolio management.
The scheduled maturity dates for fixed income securities in an unrealized
loss position at December 31, 2005 are shown below. Actual maturities may differ
from those scheduled as a result of prepayments by the issuers.
<Table>
<Caption>
UNREALIZED PERCENT PERCENT
(IN THOUSANDS) LOSS OF TOTAL FAIR VALUE OF TOTAL
------------ ------------ ------------ ------------
Due in one year or less $ (9) -% $ 1,989 0.1%
Due after one year through five years (4,506) 10.3 264,148 12.8
Due after five years through ten years (18,519) 42.6 812,655 39.3
Due after ten years (9,087) 20.9 532,730 25.8
Mortgage- and asset- backed securities(1) (11,391) 26.2 453,718 22.0
------------ ------------ ------------ ------------
Total $ (43,512) 100.0% $ 2,065,240 100.0%
============ ============ ============ ============
</Table>
- ----------
(1) Because of the potential for prepayment, mortgage- and asset-backed
securities are not categorized based on their contractual maturities.
PORTFOLIO MONITORING We have a comprehensive portfolio monitoring process to
identify and evaluate, on a case by case basis, fixed income securities for
which 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 for which 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, in addition to other securities for which
we may have a concern, are evaluated based on facts and circumstances for
inclusion on our watch-list. As a result of approved programs involving the
disposition of investments such as changes in duration and revisions to
strategic asset allocations, and certain dispositions anticipated by portfolio
managers, we also conduct a portfolio review to recognize impairment losses on
securities in an unrealized loss position for which we do not have the intent
and ability to hold until recovery. All securities in an unrealized loss
position at December 31, 2005 were included in our portfolio monitoring process
wherein it was determined that the declines in value were not other than
temporary.
19
<Page>
The following table summarizes fixed income securities in a gross
unrealized loss position according to significance, aging and investment grade
classification.
<Table>
<Caption>
December 31, 2005 December 31, 2004
-------------------------------------------- ---------------------------------------
Fixed Income Fixed Income
------------------------------ -------------------------
Below Below
Investment Investment Investment
(in thousands except number of issues) Investment Grade Grade Total Grade Grade Total
---------------- ----------- ----------- ----------- ----------- -----------
Category (i): Unrealized loss less than 20% of amortized cost
Number of Issues 334 34 368 130 28 158
Fair Value $ 1,999,082 $ 61,814 $ 2,060,896 $ 859,644 $ 51,482 $ 911,126
Unrealized $ (39,839) $ (2,471) $ (42,310) $ (10,604) $ (2,260) $ (12,864)
Category (ii): Unrealized loss greater than or equal to 20% of amortized cost for a period of less than 6 consecutive months
Number of Issues 3 - 3 - - -
Fair Value $ 4,344 $ - $ 4,344 $ - $ - $ -
Unrealized $ (1,202) $ - $ (1,202) $ - $ - $ -
---------------- ----------- ----------- ----------- ----------- -----------
Total Number of Issues 337 34 371 130 28 158
================ =========== =========== =========== =========== ===========
Total Fair Value $ 2,003,426 $ 61,814 $ 2,065,240 $ 859,644 $ 51,482 $ 911,126
================ =========== =========== =========== =========== ===========
Total Unrealized Losses $ (41,041) $ (2,471) $ (43,512) $ (10,604) $ (2,260) $ (12,864)
================ =========== =========== =========== =========== ===========
</Table>
Categories (i) and (ii) have generally been adversely affected by overall
economic conditions including interest rate increases and the market's
evaluation of certain sectors. The degree to which and/or length of time that
the securities have been in an unrealized loss position does not suggest that
these securities pose a high risk of being other than temporarily impaired. All
of the securities in these categories are monitored for impairment. We expect
that the fair values of these securities will recover over time.
The following table contains the individual securities with the largest
unrealized losses as of December 31, 2005. No other fixed income security had an
unrealized loss greater than $554 thousand or 1.3% of the total unrealized loss
on fixed income securities.
<Table>
<Caption>
UNREALIZED
UNREALIZED FAIR NAIC LOSS
(IN THOUSANDS) LOSS VALUE RATING CATEGORY
---------- ---------- ---------- ----------
Mortgage Backed Security $ (930) $ 24,137 1 (i)
Construction Product Manufacturer (639) 19,361 2 (i)
Paper Manufacturer and Distributor (636) 6,864 2 (i)
Mortgage Backed Security (584) 17,066 1 (i)
Securitized Property of Auto
Manufacturer (559) 1,988 2 (ii)
Mortgage Backed Security (554) 20,169 1 (i)
---------- ----------
Total $ (3,902) $ 89,585
========== ==========
</Table>
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.
20
<Page>
The following table summarizes problem, restructured and potential problem
fixed income securities at December 31.
<Table>
<Caption>
2005 2004
------------------------------------ ------------------------------------
PERCENT PERCENT
OF TOTAL OF TOTAL
FIXED FIXED
AMORTIZED FAIR INCOME AMORTIZED FAIR INCOME
(IN THOUSANDS) COST VALUE PORTFOLIO COST VALUE PORTFOLIO
---------- ---------- ---------- ---------- ---------- ----------
Problem $ 14,373 $ 17,762 0.3% $ 10,637 $ 10,813 0.2%
Restructured 163 163 - 5,396 6,151 0.1
Potential problem 5,609 5,640 0.1 11,231 10,539 0.2
---------- ---------- ---------- ---------- ---------- ----------
Total net carrying value $ 20,145 $ 23,565 0.4% $ 27,264 $ 27,503 0.5%
========== ========== ========== ========== ========== ==========
Cumulative write-downs
recognized $ 5,455 $ 4,606
========== ==========
</Table>
During 2005, a security classified as restructured as of December 31, 2004
was reclassified to the problem category. The decrease in the potential problem
category as of December 31, 2005 compared to December 31, 2004, was primarily
related to the removal of a security due to improving conditions.
We evaluated each of these securities through our portfolio monitoring
process at December 31, 2005 and recorded write-downs when appropriate. We
further concluded that any remaining unrealized losses on these securities were
temporary in nature and that we have the intent and ability to hold the security
until recovery. While these balances may increase in the future, particularly if
economic conditions are unfavorable, management expects that the total amount of
securities in these categories will remain low relative to the total fixed
income securities portfolio.
NET REALIZED CAPITAL GAINS AND LOSSES The following table presents the
components of realized capital gains and losses and the related tax effect for
the years ended December 31.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
--------- --------- ---------
Investment write-downs $ (1,543) $ (3,402) $ (7,682)
Dispositions (2,053) (2,784) (1,587)
Valuation of derivative instruments (4,469) (5,777) (2,140)
Settlement of derivative instruments 2,873 2,666 2,891
--------- --------- ---------
Realized capital gains and losses, pretax (5,192) (9,297) (8,518)
Income tax benefit 1,972 3,453 3,278
--------- --------- ---------
Realized capital gains and losses, after-tax $ (3,220) $ (5,844) $ (5,240)
========= ========= =========
</Table>
Dispositions in the above table include sales, losses recognized in
anticipation of dispositions and other transactions such as calls and
prepayments. We may sell securities during the period in which fair value has
declined below amortized cost for fixed income securities. In certain situations
new factors such as negative developments, subsequent credit deterioration,
relative value opportunities, market liquidity concerns and portfolio
reallocations can subsequently change our previous intent to continue holding a
security.
For the year ended December 31, 2005, dispositions included net realized
gains on sales of $4.7 million and write-downs recorded in connection with
anticipated dispositions of $6.8 million. The net realized gains on sales were
comprised of gross gains of $12.2 million and gross losses of $7.5 million. The
$7.5 million in gross losses primarily consisted of sales of fixed income
securities.
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 derivative instruments are most appropriately considered in
conjunction with the unrealized gains and losses on the fixed income portfolio.
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<Page>
This approach mitigates the impacts of general interest rate changes to the
overall financial condition of the Company.
Because of an anticipated rise in interest rates, as well as changes in
existing market conditions and long-term asset return assumptions, certain
changes are planned within various portfolios. These include continued
asset-liability management strategies, on-going comprehensive reviews of our
portfolios, changes to our strategic asset allocations, and yield enhancement
strategies. Certain of the securities we identified were in an unrealized loss
position, for which we recognized $6.8 million of losses in anticipation of
dispositions due to a change in our intent to hold the securities until
recovery. At December 31, 2005 the fair value of the securities in these
portfolios was $11.52 million.
The five largest losses from sales of individual securities for the year
ended December 31, 2005 totaled $2.7 million with the largest being $0.7 million
and the smallest being $0.4 million. None of the $2.7 million related to
securities that were in an unrealized loss position greater than or equal to 20%
of amortized cost for fixed income securities.
MORTGAGE LOANS Our mortgage loans portfolio totaled $633.8 million at December
31, 2005 and $480.3 million at December 31, 2004, and was comprised primarily of
loans secured by first mortgages on developed commercial real estate.
Geographical and property type diversification are key considerations used to
manage our mortgage loan risk.
We closely monitor our commercial mortgage loan portfolio on a loan-by-loan
basis. Loans with an estimated collateral value less than the loan balance, as
well as loans with other characteristics indicative of higher than normal credit
risk, are reviewed by financial and investment management at least quarterly for
purposes of establishing valuation allowances and placing loans on non-accrual
status. The underlying collateral values are based upon either discounted
property cash flow projections or a commonly used valuation method that utilizes
a one-year projection of expected annual income divided by an expected rate of
return. We had no realized capital losses related to write-downs on mortgage
loans for the years ended December 31, 2005, 2004 and 2003.
SHORT-TERM INVESTMENTS Our short-term investment portfolio was $63.1 million and
$111.5 million at December 31, 2005 and 2004, respectively. We invest available
cash balances primarily in taxable short-term securities having a final maturity
date or redemption date of less than one year.
We also participate in securities lending, primarily as an investment yield
enhancement, with third parties such as brokerage firms. We obtain collateral in
an amount equal to 102% of the fair value of the securities and monitor the
market value of the securities loaned on a daily basis with additional
collateral obtained as necessary. The cash we receive is invested in short-term
and fixed income investments, and an offsetting liability is recorded in other
liabilities and accrued expense. At December 31, 2005, the amount of securities
lending collateral reinvested in short-term investments had a carrying value of
$46 million. This compares to $66 million at December 31, 2004.
MARKET RISK
Market risk is the risk that we will incur losses due to adverse changes in
interest rates or equity prices. Our primary market risk exposure is to changes
in interest rates, although we also have certain exposures to changes in equity
prices.
The active management of market risk is integral to our results of
operations. We may use the following approaches to manage our exposure to market
risk within defined tolerance ranges: 1) rebalancing existing asset or liability
portfolios, 2) changing the character of investments purchased in the future or
3) using derivative instruments to modify the market risk characteristics of
existing assets and liabilities or assets expected to be purchased. For a more
detailed discussion of our use of derivative financial instruments, see Note 7
of the financial statements.
OVERVIEW We generate substantial investable funds from our business. In
formulating and implementing guidelines for investing funds, we seek to earn
returns that enhance our ability to offer competitive rates and prices to
customers while contributing to attractive and stable profits and long-term
capital growth. Accordingly, our investment decisions and objectives are a
function of our underlying risks and product profiles.
Investment policies define the overall framework for managing market and
other investment risks, including accountability and control over these risk
management activities. These investment activities follow policies that have
been approved by our board of directors. These investment policies specify the
investment limits and
22
<Page>
strategies that are appropriate given our liquidity, surplus, product profile,
and regulatory requirements. Executive oversight of investment activities is
conducted primarily through our board of directors and investment committee. The
asset-liability management ("ALM") policies further define the overall framework
for managing market and investment risks. ALM focuses on strategies to enhance
yields, mitigate investment risks and optimize capital to improve profitability
and returns. The ALM activities follow asset-liability policies that have been
approved by our board of directors. These ALM policies specify limits, ranges
and/or targets for investments that best meet our business objectives in light
of our product liabilities.
We manage our exposure to market risk through the use of asset allocation,
duration and value-at-risk limits, through the use of simulation and, as
appropriate, through the use of stress tests. We have asset allocation limits
that place restrictions on the total funds that may be invested within an asset
class. We have duration limits on our investment portfolio, and, as appropriate,
on individual components of the portfolio. These duration limits place
restrictions on the amount of interest rate risk that may be taken. Our
value-at-risk limits are intended to restrict the potential loss in fair value
that could arise from adverse movements in the fixed income, equity, and
currency markets based on historical volatilities and correlations among market
risk factors. Comprehensive day-to-day management of market risk within defined
tolerance ranges occurs as portfolio managers buy and sell within their
respective markets based upon the acceptable boundaries established by the
investment policies. This day-to-day management is integrated with and informed
by the activities of the ALM organization. This integration results in a
prudent, methodical and effective adjudication of market risk and return,
conditioned by the unique demands and dynamics of our product liabilities and
supported by the application of advanced risk technology and analytics.
INTEREST RATE RISK is the risk that we will incur loss due to adverse changes in
interest rates. This risk arises from many of our primary activities, as we
invest substantial funds in interest-sensitive assets and issue
interest-sensitive liabilities.
We manage the interest rate risk in our assets relative to the interest
rate risk inherent in our liabilities. One of the measures used to quantify this
exposure is duration. Duration measures the price sensitivity of the assets and
liabilities to changes in interest rates. For example, if interest rates
increase by 100 basis points, the fair value of an asset with a duration of 5 is
expected to decrease in value by approximately 5%. At December 31, 2005, the
difference between our asset and liability duration was approximately (0.34),
compared to a (0.26) gap at December 31, 2004. A negative duration gap indicates
that the fair value of our liabilities is more sensitive to interest rate
movements than the fair value of our assets.
We seek to invest premiums, contract charges and deposits to generate
future cash flows that will fund future claims, benefits and expenses, and that
will earn stable margins across a wide variety of interest rate and economic
scenarios. In order to achieve this objective and limit interest rate risk, we
adhere to a philosophy of managing the duration of assets and related
liabilities. This philosophy may include using futures to reduce the interest
rate risk resulting from mismatches between existing assets and liabilities, and
financial futures to hedge the interest rate risk related to anticipated
purchases and sales of investments and product sales to customers.
To calculate the duration gap between assets and liabilities, we project
asset and liability cash flows and calculate their net present value using a
risk-free market interest rate adjusted for credit quality, sector attributes,
liquidity and other specific risks. Duration is calculated by revaluing these
cash flows at alternative interest rates and determining the percentage change
in aggregate fair value. The cash flows used in this calculation include the
expected maturity and repricing characteristics of our derivative financial
instruments, all other financial instruments (as described in Note 7 of the
financial statements), and certain other items including interest-sensitive
liabilities and annuity liabilities. The projections include assumptions (based
upon historical market experience and our experience) that reflect the effect of
changing interest rates on the prepayment, lapse, leverage and/or option
features of instruments, where applicable. Such assumptions relate primarily to
mortgage-backed securities, collateralized mortgage obligations, municipal
housing bonds, callable municipal and corporate obligations, and fixed rate
single and flexible premium deferred annuities.
Based upon the information and assumptions we use in this duration
calculation, and interest rates in effect at December 31, 2005, we estimate that
a 100 basis point immediate, parallel increase in interest rates ("rate shock")
would decrease the net fair value of the assets and liabilities by approximately
$46.8 million, compared to $60.6 million at December 31, 2004. There are $412.3
million of assets supporting life insurance products such as traditional and
interest-sensitive life that are not financial instruments. These assets and the
associated liabilities have not been included in the above estimate. The $412.3
million of assets excluded from the calculation has increased from $383.9
million reported at December 31, 2004 due to increases in policies in-force.
Based on assumptions described above, in the event of a 100 basis point
immediate increase in interest rates, the assets
23
<Page>
supporting life insurance products would decrease in value by $32.2 million,
compared to a decrease of $29.3 million at December 31, 2004. The selection of a
100 basis point immediate parallel change in interest rates should not be
construed as our prediction of future market events, but only as an illustration
of the potential effect of such an event.
To the extent that conditions differ from the assumptions we used in these
calculations, duration and rate shock measures could be significantly impacted.
Additionally, our calculations assume that the current relationship between
short-term and long-term interest rates (the term structure of interest rates)
will remain constant over time. As a result, these calculations may not fully
capture the effect of non-parallel changes in the term structure of interest
rates and/or large changes in interest rates.
EQUITY PRICE RISK is the risk that we will incur economic losses due to
adverse changes in general levels of the equity markets. At December 31, 2005
and 2004, we had separate accounts assets related to variable annuity and
variable life contracts with account values totaling $928.8 million and $792.6
million, respectively. We earn contract charges as a percentage of these account
values. In the event of an immediate decline of 10% in the account values due to
equity market declines, we would have earned approximately $1.5 million and $1.3
million less in fee income at December 31, 2005 and 2004, respectively.
Variable annuity contracts we sell have a GMDB and customers may have
chosen to purchase an enhanced GMDB, a guaranteed minimum income benefits
("GMIB") from 2002 to December 31, 2003, a TrueReturn(SM) guaranteed minimum
accumulation benefit ("GMAB") beginning in 2004, and a SureIncome(SM) guaranteed
minimum withdrawal benefit ("GMWB") beginning in 2005. These guarantees subject
us to additional equity market risk because the beneficiary or contractholder
may receive a benefit that is greater than their corresponding account value.
GMDBs are payable upon death. GMIBs may be exercised on or after the tenth-year
anniversary (not prior to 2012) of the contract if the contractholder elects to
receive a defined stream of payments ("annuitize"). GMABs are credited to the
contractholder account on a contract anniversary date that is pre-determined by
the contractholder, between the eighth and sixteenth year after contract issue
(not prior to 2012). GMABs guarantee an account value of up to 1.6 times (or
160%) of the amount deposited in the contract, depending on the amount of time
the contract is in force and adherence to certain fund allocation requirements.
GMWBs may be payable if the contractholder elects to take partial withdrawals.
GMWBs guarantee that the contractholder can take annual partial withdrawals up
to 8% of the amount deposited in the contract until their withdrawals total the
initial deposit. The GMABs, GMWBs and certain GMDBs are 100% ceded to ALIC under
reinsurance agreements.
In January 2004, we established reserves for GMDBs and GMIBs in conjunction
with the adoption of SOP 03-1. Because of this change in accounting, guarantee
payments are now recognized over future periods rather than expensed as paid.
For more details about this accounting guidance and the calculation of the
related reserves see Note 2 and 8 of the financial statements.
At December 31, 2005 and 2004, the guaranteed value of the death benefits
in excess of account values was estimated to be $38 million and $86 million,
respectively, net of reinsurance. The decrease in this estimate between periods
is attributable to improved equity markets during 2005 and customer surrenders
of contracts with in-the-money GMDBs. In both periods, approximately half of
this exposure is related to the return of deposits guarantee, while the
remaining half is attributable to a death benefit guarantee greater than the
original deposits.
In the event of an immediate decline in account values of 10% due to equity
market declines, payments for guaranteed death benefits at December 31, 2005
would increase by an estimated $0.7 million in 2006. These payments would be
charged against the related reserve rather than directly to earnings as paid.
Contributions to the reserve for GMDBs would increase by a nominal amount in
2006 in the event of an immediate 10% decline in account values. The selection
of a 10% immediate decrease should not be construed as our prediction of future
market events, but only as an example to illustrate the potential effect on
earnings and cash flow of equity market declines as a result of this guarantee.
Also, our actual payment experience in the future may not be consistent with the
assumptions used in the model.
GMIB contracts that we sold provide the contractholder with the right to
annuitize based on the highest account value at any anniversary date or on a
guaranteed earnings rate based on the initial account value over the specified
period. The guaranteed income benefit feature was first offered in our variable
annuity products beginning in 2002, with guaranteed benefits available for
election by contractholders ten years after issue. Accordingly, the earliest
date at which benefits could become payable is 2012. Therefore, in the event of
an immediate decline of 10% in contractholders' account values as of December
31, 2005 due to equity market declines, contributions to the reserve would be
increased by a nominal amount in 2006. The selection of a 10%
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immediate decrease should not be construed as our prediction of future market
events, but only as an example to illustrate the potential effect on earnings
and cash flow of equity market declines as a result of this guarantee.
In the event of an immediate decline of 10% in GMAB and GMWB
contractholders' account values as of December 31, 2005, due to equity market
declines, there would be no net impact on our earnings because these benefits
are fully reinsured, however the reserve for GMABs and GMWBs would be increased
by approximately $1.5 million and $66 thousand, respectively.
We are also exposed to equity risk in DAC. Fluctuations in the value of the
variable annuity and life contract account values due to the equity market
affect DAC amortization, because the expected fee income and guaranteed benefits
payable are components of the EGP for variable annuity and life contracts. For a
more detailed discussion of DAC, see Note 2 of the financial statements and the
Application of Critical Accounting Policies section of the MD&A.
CAPITAL RESOURCES AND LIQUIDITY
CAPITAL RESOURCES consist of shareholder's equity. The following table
summarizes our capital resources at December 31.
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
------------ ------------ ------------
Common stock, additional capital paid-in and
retained income $ 538,465 $ 483,980 $ 394,850
Accumulated other comprehensive income 128,968 155,255 138,724
------------ ------------ ------------
Total shareholder's equity $ 667,433 $ 639,235 $ 533,574
============ ============ ============
</Table>
SHAREHOLDER'S EQUITY increased in 2005 primarily as a result of net income
and a capital contribution from ALIC of $20.0 million, partially offset by lower
unrealized net capital gains on fixed income securities. Shareholder's equity
increased in 2004 when compared to 2003 due to a capital contribution from ALIC
of $64.2 million, net income and increased unrealized net capital gains on fixed
income securities.
FINANCIAL RATINGS AND STRENGTH Our insurance financial strength was rated Aa2,
AA, and A+ by Moody's, Standard & Poor's and A.M. Best, respectively, at
December 31, 2005.
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), risk exposures,
operating leverage, ALIC's ratings, AIC's ratings and other factors.
State laws specify regulatory actions if an insurer's risk-based capital
("RBC"), a measure of an insurer's solvency, falls below certain levels. The
NAIC has a standard formula for annually assessing RBC. The formula for
calculating RBC takes into account factors relating to insurance, business,
asset and interest rate risks. At December 31, 2005, our RBC was above levels
that would require regulatory actions.
The NAIC has also developed a set of financial relationships or tests known
as the Insurance Regulatory Information System to assist state regulators in
monitoring the financial condition of insurance companies and identifying
companies that require special attention or action from insurance regulatory
authorities. The NAIC analyzes data provided by insurance companies using
prescribed ratios, each with defined "usual ranges." Generally, regulators will
begin to monitor an insurance company if its ratios fall outside the usual
ranges for four or more of the ratios. If an insurance company has insufficient
capital, regulators may act to reduce the amount of insurance it can issue. Our
ratios are within these ranges.
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LIQUIDITY SOURCES AND USES Our potential sources of funds principally include
the following activities:
- Receipt of insurance premiums
- Contractholder fund deposits
- Reinsurance recoveries
- Receipts of principal and interest on investments
- Sales of investments
- Funds from securities lending
- Inter-company loans
- Capital contributions from parent
Our potential uses of funds principally include the following activities:
- Payment of contract benefits, surrenders and withdrawals
- Reinsurance cessions and payments
- Operating costs and expenses
- Purchase of investments
- Repayment of securities lending
- Payment or repayment of inter-company loans
- Tax payments/settlements
- Dividends to parent
As reflected in our Statements of Cash Flows, higher operating cash flows
in 2005, compared to 2004, primarily related to increased interest received on
investments and lower expenses paid, partially offset by lower premiums
received. Higher cash flows from operating activities in 2004 compared to 2003,
were primarily due to higher interest received on fixed income securities and
mortgage loans and increased premium collections, partially offset by higher
contract benefits and expenses paid.
Cash flows used in investing activities decreased in 2005, compared to
2004, due to lower cash provided by financing activities partially offset by the
investment of higher operating cash flows. Higher investing cash flows in 2004
compared to 2003 reflect the investment of increased financing and operating
cash flows.
Lower cash flows provided by financing activities in 2005, compared to
2004, were primarily due to lower deposits on fixed annuities and higher fixed
annuity withdrawals. Increased financing cash flows during 2004 were primarily
the result of higher deposits on fixed annuities and interest-sensitive life
products, partially offset by lower variable life and annuity deposits to fixed
accounts and benefits and withdrawals paid.
To ensure we have the appropriate level of liquidity, we perform actuarial
tests on the impact to cash flows of policy surrenders and other actions under
various scenarios. Depending upon the years in which certain policy types were
sold with specific surrender provisions, our cash flow could vary due to higher
surrender of policies exiting their surrender charge periods.
We have entered into an inter-company loan agreement with the Corporation.
The amount of inter-company loans available to us is at the discretion of the
Corporation. The maximum amount of loans the Corporation will have outstanding
to all its eligible subsidiaries at any given point in time is limited to $1.00
billion. We had no amounts outstanding under the inter-company loan agreement at
December 31, 2005 or 2004. The Corporation uses commercial paper borrowings and
bank lines of credit to fund inter-company borrowings.
Certain remote events and circumstances could constrain our or the
Corporation's liquidity. Those events and circumstances include, for example, a
catastrophe resulting in extraordinary losses, a downgrade in the Corporation's
long-term debt rating of A1, A+ and a (from Moody's, Standard & Poor's and A.M.
Best, respectively) to non-investment grade status of below Baa3/BBB-/bb, a
downgrade in AIC's financial strength rating from Aa2, AA and A+ (from Moody's,
Standard & Poor's and A.M. Best, respectively) to below Baa/BBB/A-, or a
downgrade in our financial strength ratings from Aa2, AA and A+ (from Moody's,
Standard & Poor's and A.M. Best, respectively) to below Aa3/AA-/A-. The rating
agencies also consider the interdependence of the Corporation's individually
rated entities, therefore, a rating change in one entity could potentially
affect the ratings of other related entities.
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CONTRACTUAL OBLIGATIONS AND COMMITMENTS Our contractual obligations as of
December 31, 2005 and the payments due by period are shown in the following
table.
<Table>
<Caption>
Less Than Over 5
($ IN THOUSANDS) Total 1 year 1-3 years 4-5 years years
------------ ------------ ------------ ------------ ------------
Securities lending (1) $ 149,465 $ 149,465 $ - $ - $ -
Contractholder funds(2) 5,786,335 366,557 1,259,424 1,012,722 3,147,632
Reserve for life-contingent contract benefits(3) 5,490,273 120,974 399,360 278,632 4,691,307
Payable to affiliates, net 5,249 5,249 - - -
Reinsurance payable to parent 971 971 - - -
Other liabilties and accrued expenses(4)(5) 22,778 21,108 553 502 615
------------ ------------ ------------ ------------ ------------
Total Contractual Cash Obligations $ 11,455,071 $ 664,324 $ 1,659,337 $ 1,291,856 $ 7,839,554
============ ============ ============ ============ ============
</Table>
- ----------
(1) Securities lending transactions are typically fully secured with cash or
marketable securities. We manage our short-term liquidity position to ensure the
availability of a sufficient amount of liquid assets to extinguish short-term
liabilities as they come due in the normal course of business.
(2) Contractholder funds represent interest-bearing liabilities arising from the
sale of products such as interest-sensitive life and fixed annuities, including
immediate annuities without life contingencies. These amounts reflect estimated
cash payments to be made to policyholders and contractholders. Certain of these
contracts, such as immediate annuities without life contingencies, involve
payment obligations where the amount and timing of the payment is essentially
fixed and determinable. These amounts relate to (i) policies or contracts where
we are currently making payments and will continue to do so and (ii) contracts
where the timing of payments has been determined by the contract. Other
contracts, such as interest-sensitive life and fixed deferred annuities, involve
payment obligations where the amount and timing of future payments is uncertain.
For these contracts, the Company is not currently making payments and will not
make payments until (i) the occurrence of an insurable event, such as death, or
(ii) the occurrence of a payment triggering event, such as the surrender of or
partial withdrawal on a policy or deposit contract, which is outside of the
control of the Company. We have estimated the timing of payments related to
these contracts based on historical experience and our expectation of future
payment patterns. Uncertainties relating to these liabilities include mortality,
customer lapse and withdrawal activity, and estimated additional deposits for
interest-sensitive life contracts, which may significantly impact both the
timing and amount of future payments. Such cash outflows reflect adjustments for
the estimated timing of mortality, retirement, and other appropriate factors,
but are undiscounted with respect to interest. As a result, the sum of the cash
outflows shown for all years in the table of $5.79 billion exceeds the
corresponding liability amounts of $4.35 billion included in the Statements of
Financial Position as of December 31, 2005 for contractholder funds. The
liability amount in the Statements of Financial Position reflects the
discounting for interest as well as adjustments for the timing of other factors
as described above.
(3) The reserve for life-contingent contract benefits relates primarily to
traditional life and immediate annuities with life contingencies and reflects
the present value of estimated cash payments to be made to policyholders and
contractholders. Immediate annuities with life contingencies include (i)
contracts where we are currently making payments and will continue to do so
until the occurrence of a specific event such as death and (ii) contracts where
the timing of a portion of the payments has been determined by the contract.
Other contracts, such as traditional life and supplemental accident and health
insurance, involve payment obligations where the amount and timing of future
payments is uncertain. For these contracts, the Company is not currently making
payments and will not make payments until (i) the occurrence of an insurable
event, such as death or illness, or (ii) the occurrence of a payment triggering
event, such as a surrender of a policy or contract, which is outside of the
control of the Company. We have estimated the timing of cash outflows related to
these contracts based on historical experience and our expectation of future
payment patterns. Uncertainties relating to these liabilities include mortality,
morbidity, expenses, customer lapse and withdrawal activity, and renewal premium
for life policies, which may significantly impact both the timing and amount of
future payments. Such cash outflows reflect adjustments for the estimated timing
of mortality, retirement, and other appropriate factors, but are undiscounted
with respect to interest. As a result, the sum of the cash outflows shown for
all years in the table of $5.49 billion exceeds the corresponding liability
amounts of $1.87 billion included in the Statements of Financial Position as of
December 31, 2005 for reserve for life-contingent contract benefits. The
liability amount in the Statements of Financial Position reflects the
discounting for interest as well as adjustments for the timing of other factors
as described above.
(4) Other liabilities and accrued expenses primarily include accrued expenses
and claim payments.
(5) Balance sheet liabilities not included in the table above include unearned
and advance premiums of $466 thousand and deferred income taxes of $73 million.
These items were excluded as they do not meet the definition of a contractual
liability as we are not contractually obligated to pay these amounts to third
parties. Rather, they represent an accounting mechanism that allows us to
present our financial statements on an accrual basis of accounting. In addition,
other liabilities of $16 million were not included in the table above because
they did not represent a contractual obligation or the amount and timing of
their eventual payment was sufficiently uncertain.
At December 31, 2005, we had $28 million in contractual conditional
commitments to invest in private placements and mortgage loans.
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REGULATION AND LEGAL PROCEEDINGS
We are subject to extensive regulation and we are involved in various
legal and regulatory actions, all of which have an effect on specific aspects of
our business. For a detailed discussion of the legal and regulatory actions in
which we are involved, see Note 11 of the financial statements.
PENDING ACCOUNTING STANDARDS
As of December 31, 2005, there are several pending accounting standards
that we have not implemented either because the standard had not been finalized
or the implementation date had not yet occurred. For a discussion of these
pending standards, see Note 2 of the financial statements.
The effect of implementing certain accounting standards on our financial
results and financial condition is often based in part on market conditions at
the time of implementation of the standard and other factors we are unable to
determine prior to implementation. For this reason, we are sometimes unable to
estimate the effect of certain pending accounting standards until the relevant
authoritative body finalizes these standards or until we implement them.
FORWARD-LOOKING STATEMENTS AND 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. 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) and in our public filings with
the SEC.
In addition to the normal risks of business, we are subject to significant
risks and uncertainties, including those listed below, which apply to us as an
insurer and a provider of other financial services.
CHANGES IN UNDERWRITING AND ACTUAL EXPERIENCE COULD MATERIALLY AFFECT
PROFITABILITY
Our product pricing includes long-term assumptions regarding investment
returns, mortality, morbidity, persistency and operating costs and expenses of
the business. Management establishes target returns for each product based upon
these factors and the average amount of capital that the Company must hold to
support in-force contracts, satisfy rating agencies and meet regulatory
requirements. We monitor and manage our pricing and overall sales mix to achieve
target returns on a portfolio basis. Profitability from new business emerges
over a period of years depending on the nature and life of the product and is
subject to variability as actual results may differ from pricing assumptions.
Our profitability depends on the adequacy of investment margins, the
management of market and credit risks associated with investments, our ability
to maintain premiums and contract charges at a level adequate to cover mortality
and morbidity benefits, the adequacy of contract charges on variable contracts
to cover the costs of various product features, the persistency of policies to
ensure recovery of acquisition expenses, and the management of operating costs
and expenses within anticipated pricing allowances. Legislation and regulation
of the insurance marketplace and products could also affect our profitability.
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CHANGES IN RESERVE ESTIMATES MAY REDUCE PROFITABILITY
Reserve for life-contingent contract benefits is computed on the basis of
long-term actuarial assumptions of future investment yields, mortality,
morbidity, policy terminations and expenses. We periodically review the adequacy
of these reserves on an aggregate basis and if future experience differs
significantly from assumptions, adjustments to reserves may be required which
could have a material adverse effect on our operating results and financial
condition.
CHANGES IN MARKET INTEREST RATES MAY LEAD TO A SIGNIFICANT DECREASE IN THE SALES
AND PROFITABILITY OF SPREAD-BASED PRODUCTS
Our ability to manage our investment margin for spread-based products, such
as fixed annuities, is dependent upon maintaining profitable spreads between
investment yields and interest crediting rates. As interest rates decrease or
remain at low levels, proceeds from investments that have matured, prepaid or
been sold may be reinvested at lower yields, reducing investment margin.
Lowering interest crediting rates can offset decreases in investment margin on
some products. However, these changes could be limited by market conditions,
regulatory or contractual minimum rate guarantees on many contracts and may not
match the timing or magnitude of changes in asset yields. Decreases in the rates
offered on products could make those products less attractive, leading to lower
sales and/or changes in the level of surrenders and withdrawals for these
products. Non-parallel shifts in interest rates, such as increases in short-term
rates without accompanying increases in medium- and long-term rates, can
influence customer demand for fixed annuities, which could impact the level and
profitability of new customer deposits. Increases in market interest rates can
also have negative effects, for example by increasing the attractiveness of
other investments to our customers, which can lead to higher surrenders at a
time when the fixed income investment asset values are lower as a result of the
increase in interest rates. For certain products, principally fixed annuity and
interest-sensitive life products, the earned rate on assets could lag behind
market yields. We may react to market conditions by increasing crediting rates,
which could narrow spreads. Unanticipated surrenders could result in DAC
unlocking or affect the recoverability of DAC and thereby increase expenses and
reduce profitability.
DECLINING EQUITY MARKETS MAY REDUCE BOTH SALES OF PRODUCTS AND INCOME FROM
CONTRACT CHARGES AND MAY ADVERSELY AFFECT OPERATING RESULTS AND FINANCIAL
CONDITION
Conditions in the domestic and international stock markets affect the sale
and profitability of our variable annuities. In general, sales of variable
annuities decrease when stock markets are declining over an extended period of
time. The effect of decreasing separate accounts balances resulting from
volatile equity markets, lower underlying fund performance or declining consumer
confidence could cause contract charges earned to decrease. In addition, it is
possible that the assumptions and projections we use to establish prices for
GMDB, GMIB, GMAB and GMWB products, particularly assumptions and projections
about investment performance, do not accurately reflect the level of costs that
we will ultimately incur in providing those benefits, resulting in adverse
margin trends. These factors may result in accelerated DAC amortization and
require increases in reserves, which would reduce statutory capital and surplus
and/or our net income. Poor fund performance could also result in higher partial
withdrawals of account value which, for some contracts, do not reduce the GMDB
by a proportional amount.
CHANGES IN ESTIMATES OF PROFITABILITY ON INTEREST-SENSITIVE LIFE, FIXED AND
VARIABLE ANNUITIES AND OTHER INVESTMENT CONTRACTS MAY HAVE AN ADVERSE EFFECT ON
RESULTS THROUGH INCREASED AMORTIZATION OF DAC
DAC related to interest-sensitive life, fixed and variable annuities and
other investment contracts is amortized in proportion to AGP and EGP over the
estimated lives of the contracts. Assumptions underlying EGP, including those
relating to margins from mortality, investment margin, contract administration,
surrender and other contract charges, are updated from time to time in order to
reflect actual and expected experience and its potential effect on the valuation
of DAC. Updates to these assumptions could result in DAC unlocking, which in
turn could adversely affect our operating results and financial condition.
A LOSS OF KEY PRODUCT DISTRIBUTION RELATIONSHIPS COULD MATERIALLY AFFECT SALES
Certain products are distributed under agreements with other members of the
financial services industry that are not affiliated with us. Termination of one
or more of these agreements due to, for example, a change in control of one of
these distributors, could have a detrimental effect on sales.
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CHANGES IN TAX LAWS MAY DECREASE SALES AND PROFITABILITY OF PRODUCTS
Under current federal and state income tax law, certain products we offer,
primarily life insurance and annuities, receive favorable tax treatment. This
favorable treatment may give certain of our products a competitive advantage
over noninsurance products. Congress from time to time considers legislation
that would reduce or eliminate the favorable policyholder tax treatment
currently applicable to life insurance and annuities. Congress also considers
proposals to reduce the taxation of certain products or investments that may
compete with life insurance and annuities. Legislation that increases the
taxation on insurance products or reduces the taxation on competing products
could lessen the advantage or create a disadvantage for certain of our products
making them less competitive. Such proposals, if adopted, could have a material
adverse effect on our financial position or ability to sell such products and
could result in the surrender of some existing contracts and policies. In
addition, changes in the federal estate tax laws could negatively affect the
demand for the types of life insurance used in estate planning.
ACTIONS TAKEN TO SIMPLIFY OUR BUSINESS MODEL AND IMPROVE PROFITABILITY MAY NOT
BE SUCCESSFUL AND MAY RESULT IN LOSSES AND COSTS
We are pursuing strategies intended to improve return on equity. Actions
that we have taken and may continue to take include changing the number and
selection of products being marketed, terminating underperforming distribution
relationships, reducing policy administration software systems, and other
actions that we may determine are appropriate to successfully execute our
business strategies. The actions that we have taken and may take in the future
may not achieve their intended outcome and could result in lower premiums and
contract charges, restructuring costs, losses on disposition or losses related
to the discontinuance of individual products or distribution relationships.
RISKS RELATING TO THE INSURANCE INDUSTRY
OUR FUTURE RESULTS ARE DEPENDENT IN PART ON OUR ABILITY TO SUCCESSFULLY OPERATE
IN AN INSURANCE INDUSTRY THAT IS HIGHLY COMPETITIVE
The insurance industry is highly competitive. Our competitors include other
insurers and, because many of our products include a savings or investment
component, securities firms, investment advisers, mutual funds, banks and other
financial institutions. Many of our competitors have well-established national
reputations and market similar products. Because of the competitive nature of
the insurance industry, including competition for producers such as exclusive
and independent agents, there can be no assurance that we will continue to
effectively compete with our industry rivals, or that competitive pressure will
not have a material adverse effect on our business, operating results or
financial condition. The ability of banks to affiliate with insurers may have a
material adverse effect on all of our product lines by substantially increasing
the number, size and financial strength of potential competitors. Furthermore,
certain competitors operate using a mutual insurance company structure and
therefore, may have dissimilar profitability and return targets.
WE ARE SUBJECT TO MARKET RISK AND DECLINES IN CREDIT QUALITY
We are subject to market risk, the risk that we will incur losses due to
adverse changes in interest rates and equity prices. Our primary market risk
exposures are to changes in interest rates and equity prices and, to a lesser
degree, changes in foreign currency exchange rates. For additional information
on market risk, see the "Market Risk" section of MD&A.
A decline in market interest rates could have an adverse effect on our
investment income as we invest cash in new investments that may yield less than
the portfolio's average rate. In a declining interest rate environment,
borrowers may prepay or redeem securities more quickly than expected as they
seek to refinance at lower rates. A decline could also cause the purchase of
longer-term assets in order to obtain adequate investment yields resulting in a
duration gap when compared to the duration of liabilities. An increase in market
interest rates could have an adverse effect on the value of our investment
portfolio. Increases in interest rates also may lead to an increase in policy
loans, surrenders and withdrawals that generally would be funded at a time when
fair values of fixed income securities are lower. A decline in the quality of
our investment portfolio as a result of adverse economic conditions or otherwise
could cause additional realized losses on securities, including realized losses
relating to derivative strategies not adequately addressing portfolio risks.
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CONCENTRATION OF OUR INVESTMENT PORTFOLIO IN ANY PARTICULAR SEGMENT OF THE
ECONOMY MAY HAVE ADVERSE EFFECTS
The concentration of our investment portfolio in any particular industry,
group of related industries or geographic sector could have an adverse effect on
our investment portfolio and consequently on our results of operations and
financial position. While we seek to mitigate this risk by having a broadly
diversified portfolio, events or developments that have a negative impact on any
particular industry, group of related industries or geographic region may have a
greater adverse effect on the investment portfolio to the extent that the
portfolio are concentrated rather than diversified.
WE MAY SUFFER LOSSES FROM LITIGATION
As is typical for a large Company, we are involved in a substantial amount
of litigation, including class action litigation challenging a range of company
practices. 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 our operating results or cash flows for a particular
quarter or annual period. For a description of our current legal proceedings,
see Note 11 of the financial statements.
In some circumstances, we, or others in the Allstate Group, may be able to
collect on third-party insurance that we carry to recover all or part of the
amounts that we pay in judgments, settlements and litigation expenses. However,
we, or others in the Allstate Group, may not be able to resolve issues
concerning the availability, if any, or the ability to collect such insurance
concurrently with the underlying litigation. Consequently, the timing of the
resolution of a particular piece of litigation and the determination of our
insurance recovery with respect to that litigation may not coincide and,
therefore, may be reflected in our financial statements in different fiscal
quarters.
WE ARE SUBJECT TO EXTENSIVE REGULATION AND POTENTIAL FURTHER RESTRICTIVE
REGULATION MAY INCREASE OUR OPERATING COSTS AND LIMIT OUR GROWTH
As insurance companies, broker-dealers, investment advisers and/or
investment companies, we are subject to extensive laws and regulations. These
laws and regulations are complex and subject to change. Moreover, they are
administered and enforced by a number of different governmental authorities,
including state insurance regulators, state securities administrators, the SEC,
the National Association of Securities Dealers, the U.S. Department of Justice,
and state attorneys general, each of which exercises a degree of interpretive
latitude. Consequently, we are subject to the risk that compliance with any
particular regulator's or enforcement authority's interpretation of a legal
issue may not result in compliance with another regulator's or enforcement
authority's interpretation of the same issue, particularly when compliance is
judged in hindsight. In addition, there is risk that any particular regulator's
or enforcement authority's interpretation of a legal issue may change over time
to our detriment, or that changes in the overall legal environment may, even
absent any particular regulator's or enforcement authority's interpretation of a
legal issue changing, cause us to change our views regarding the actions we need
to take from a legal risk management perspective, thus necessitating changes to
our practices that may, in some cases, limit our ability to grow and improve the
profitability of our business. Furthermore, in some cases, these laws and
regulations are designed to protect the interests of a specific constituency
rather than a range of constituencies. For example, state insurance laws and
regulations are generally intended to protect purchasers or users of insurance
products. In many respects, these laws and regulations limit our ability to grow
and improve the profitability of our business.
In recent years, the state insurance regulatory framework has come under
public scrutiny and members of Congress have discussed proposals to provide for
optional federal chartering of insurance companies. We can make no assurances
regarding the potential impact of state or federal measures that may change the
nature or scope of insurance regulation.
REINSURANCE MAY BE UNAVAILABLE AT CURRENT LEVELS AND PRICES, WHICH MAY LIMIT OUR
ABILITY TO WRITE NEW BUSINESS
Market conditions beyond our control determine the availability and cost of
the reinsurance we purchase. No assurances can be made that reinsurance will
remain continuously available to us to the same extent and on the same terms and
rates as are currently available. If we were unable to maintain our current
level of reinsurance or purchase new reinsurance protection in amounts that we
consider sufficient and at prices that we consider acceptable, we would have to
either accept an increase in our exposure risk, reduce our insurance writings,
or develop or seek other alternatives.
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<Page>
REINSURANCE SUBJECTS US TO THE CREDIT RISK OF OUR REINSURERS AND MAY NOT BE
ADEQUATE TO PROTECT US AGAINST LOSSES ARISING FROM CEDED INSURANCE
The collectibility of reinsurance recoverables is subject to uncertainty
arising from a number of factors, including whether insured losses meet the
qualifying conditions of the reinsurance contract and whether reinsurers, or
their affiliates, have the financial capacity and willingness to make payments
under the terms of a reinsurance treaty or contract. Our inability to collect a
material recovery from a reinsurer could have a material adverse effect on our
operating results and financial condition.
THE CONTINUED THREAT OF TERRORISM AND ONGOING MILITARY ACTIONS MAY ADVERSELY
AFFECT THE LEVEL OF CLAIM LOSSES WE INCUR AND THE VALUE OF OUR INVESTMENT
PORTFOLIO
The continued threat of terrorism, both within the United States and
abroad, and ongoing military and other actions and heightened security measures
in response to these types of threats, may cause significant volatility and
losses from declines in the equity markets and from interest rate changes in the
United States, Europe and elsewhere, and may result in loss of life, property
damage, additional disruptions to commerce and reduced economic activity. Some
of the assets in our investment portfolio may be adversely affected by declines
in the equity markets and reduced economic activity caused by the continued
threat of terrorism. We seek to mitigate the potential impact of terrorism on
our commercial mortgage portfolio by limiting geographical concentrations in key
metropolitan areas and by requiring terrorism insurance to the extent that it is
commercially available. Additionally, in the event that a terrorist act occurs,
our operating results may be adversely affected, depending on the nature of the
event.
ANY DECREASE IN OUR FINANCIAL STRENGTH RATINGS MAY HAVE AN ADVERSE EFFECT ON OUR
COMPETITIVE POSITION
Financial strength ratings are important factors in establishing the
competitive position of insurance companies and generally have an effect on an
insurance company's business. On an ongoing basis, rating agencies review the
financial performance and condition of insurers and could downgrade or change
the outlook on an insurer's ratings due to, for example, a change in an
insurer's statutory capital; a change in a rating agency's determination of the
amount of risk-adjusted capital required to maintain a particular rating; an
increase in the perceived risk of an insurer's investment portfolio; a reduced
confidence in management or a host of other considerations that may or may not
be under the insurer's control. The insurance financial strength ratings of
ALNY, ALIC and AIC are A+, AA and Aa2 from A.M. Best, Standard & Poor's and
Moody's, respectively. Because all of these ratings are subject to continuous
review, the retention of these ratings cannot be assured. A multiple level
downgrade in any of these ratings could have a material adverse effect on our
sales, our competitiveness, the marketability of our product offerings, and our
liquidity, operating results and financial condition.
CHANGES IN ACCOUNTING STANDARDS ISSUED BY THE FINANCIAL ACCOUNTING STANDARDS
BOARD ("FASB") OR OTHER STANDARD-SETTING BODIES MAY ADVERSELY AFFECT OUR
FINANCIAL STATEMENTS
Our financial statements are subject to the application of GAAP, which is
periodically revised and/or expanded. Accordingly, we are required to adopt new
or revised accounting standards from time to time issued by recognized
authoritative bodies, including the FASB. It is possible that future changes we
are required to adopt could change the current accounting treatment that we
apply to our financial statements and that such changes could have a material
adverse effect on our results and financial condition. For a description of
potential changes in accounting standards that could affect us currently, see
Note 2 of the financial statements.
THE OCCURRENCE OF EVENTS UNANTICIPATED IN OUR DISASTER RECOVERY SYSTEMS AND
MANAGEMENT CONTINUITY PLANNING COULD IMPAIR OUR ABILITY TO CONDUCT BUSINESS
EFFECTIVELY
In the event of a disaster such as a natural catastrophe, an industrial
accident, a terrorist attack or war, events unanticipated in our disaster
recovery systems could have an adverse impact on our ability to conduct business
and on our results of operations and financial condition, particularly if those
events affect our computer-based data processing, transmission, storage and
retrieval systems. In the event that a significant number of our managers could
be unavailable in the event of a disaster, our ability to effectively conduct
our business could be severely compromised.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required for Item 7A is incorporated by reference to the material
under the caption "Market Risk" in Part II, 9B
Item 7 of this report.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------------
(IN THOUSANDS) 2005 2004 2003
--------- --------- ---------
REVENUES
Premiums (net of reinsurance ceded of $16,046, $16,133 and $8,021) $ 68,538 $ 76,550 $ 68,011
Contract charges 66,280 59,834 53,018
Net investment income 356,162 302,055 264,854
Realized capital gains and losses (5,192) (9,297) (8,518)
--------- --------- ---------
485,788 429,142 377,365
--------- --------- ---------
COSTS AND EXPENSES
Contract benefits (net of reinsurance recoveries of $8,510, $7,536 and $5,219) 183,227 182,150 167,221
Interest credited to contractholder funds 161,936 129,804 106,020
Amortization of deferred policy acquisition costs 41,663 25,971 29,969
Operating costs and expenses 43,497 42,115 36,978
--------- --------- ---------
430,323 380,040 340,188
GAIN (LOSS) ON DISPOSITION OF OPERATIONS 1 1,326 (4,458)
--------- --------- ---------
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE AND CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE, AFTER-TAX 55,466 50,428 32,719
Income tax expense 20,945 17,925 12,029
--------- --------- ---------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, AFTER-TAX 34,521 32,503 20,690
Cumulative effect of change in accounting principle, after-tax - (7,586) -
--------- --------- ---------
NET INCOME 34,521 24,917 20,690
--------- --------- ---------
OTHER COMPREHENSIVE (LOSS) INCOME, AFTER TAX
Change in unrealized net capital gains and losses (26,287) 16,531 (30,931)
--------- --------- ---------
COMPREHENSIVE INCOME (LOSS) $ 8,234 $ 41,448 $ (10,241)
========= ========= =========
</Table>
See notes to financial statements.
34
<Page>
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
STATEMENTS OF FINANCIAL POSITION
<Table>
<Caption>
DECEMBER 31,
---------------------------
(IN THOUSANDS, EXCEPT PAR VALUE DATA) 2005 2004
------------ ------------
ASSETS
Investments
Fixed income securities, at fair value (amortized cost $5,535,396 and $5,012,977) $ 5,989,263 $ 5,545,647
Mortgage loans 633,789 480,280
Short-term 63,057 111,509
Policy loans 36,698 34,948
Other 3,740 4,638
------------ ------------
Total investments 6,726,547 6,177,022
Cash 3,818 8,624
Deferred policy acquisition costs 318,551 238,173
Accrued investment income 62,452 55,821
Reinsurance recoverables 12,729 8,422
Current income taxes receivable - 367
Other assets 35,760 17,665
Separate Accounts 928,824 792,550
------------ ------------
TOTAL ASSETS $ 8,088,681 $ 7,298,644
============ ============
LIABILITIES
Reserve for life-contingent contract benefits $ 1,869,875 $ 1,782,451
Contractholder funds 4,349,395 3,802,846
Deferred income taxes 73,399 90,760
Other liabilities and accrued expenses 188,123 180,904
Payable to affiliates, net 5,249 8,831
Current income tax payable 5,412 -
Reinsurance payable to parent 971 1,067
Separate Accounts 928,824 792,550
------------ ------------
TOTAL LIABILITIES 7,421,248 6,659,409
------------ ------------
COMMITMENTS AND CONTINGENT LIABILITIES (NOTE 11)
SHAREHOLDER'S EQUITY
Common stock, $25 par value, 100 thousand shares authorized,
issued and outstanding 2,500 2,500
Additional capital paid-in 140,000 120,000
Retained income 395,965 361,480
Accumulated other comprehensive income:
Unrealized net capital gains and losses 128,968 155,255
------------ ------------
Total accumulated other comprehensive income 128,968 155,255
------------ ------------
TOTAL SHAREHOLDER'S EQUITY 667,433 639,235
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 8,088,681 $ 7,298,644
============ ============
</Table>
See notes to financial statements.
35
<Page>
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
STATEMENTS OF SHAREHOLDER'S EQUITY
<Table>
<Caption>
DECEMBER 31,
---------------------------------
(IN THOUSANDS) 2005 2004 2003
--------- --------- ---------
COMMON STOCK $ 2,500 $ 2,500 $ 2,500
--------- --------- ---------
ADDITIONAL CAPITAL PAID IN
Balance, beginning of year 120,000 55,787 55,787
Capital contribution 20,000 64,213 -
--------- --------- ---------
Balance, end of year 140,000 120,000 55,787
--------- --------- ---------
RETAINED INCOME
Balance, beginning of year 361,480 336,563 315,873
Net income 34,521 24,917 20,690
Dividends (36) - -
--------- --------- ---------
Balance, end of year 395,965 361,480 336,563
--------- --------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of year 155,255 138,724 169,655
Change in unrealized net capital gains and losses (26,287) 16,531 (30,931)
--------- --------- ---------
Balance, end of year 128,968 155,255 138,724
--------- --------- ---------
TOTAL SHAREHOLDER'S EQUITY $ 667,433 $ 639,235 $ 533,574
========= ========= =========
</Table>
See notes to financial statements.
36
<Page>
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------------------------
(IN THOUSANDS) 2005 2004 2003
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 34,521 $ 24,917 $ 20,690
Adjustments to reconcile net income to net cash provided by operating activities
Amortization and other non-cash items (58,887) (51,544) (49,547)
Realized capital gains and losses 5,192 9,297 8,518
(Gain) loss on disposition of operations (1) (1,326) 4,458
Cumulative effect of change in accounting principle - 7,586 -
Interest credited to contractholder funds 161,936 129,804 106,020
Changes in:
Reserve for life-contingent contract benefits and contractholder funds 36,533 32,492 21,200
Deferred policy acquisition costs (26,542) (66,532) (28,937)
Income taxes 2,591 12,091 (3,715)
Other operating assets and liabilities (15,285) (7,442) (11,917)
----------- ----------- -----------
Net cash provided by operating activities 140,058 89,343 66,770
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of fixed income securities 481,745 485,522 251,569
Investment collections
Fixed income securities 160,281 184,317 210,569
Mortgage loans 54,795 26,714 24,345
Investments purchases
Fixed income securities (1,086,370) (1,758,452) (1,027,047)
Mortgage loans (205,389) (119,953) (87,889)
Change in short-term investments, net 29,687 (29,248) 9,866
Change in other investments, net 2,305 2,678 291
Change in policy loans (1,750) (841) (349)
----------- ----------- -----------
Net cash used in investing activities (564,696) (1,209,263) (618,645)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Capital contribution 20,000 64,213 -
Contractholder fund deposits 878,614 1,385,364 728,788
Contractholder fund withdrawals (478,782) (331,764) (187,868)
----------- ----------- -----------
Net cash provided by financing activities 419,832 1,117,813 540,920
----------- ----------- -----------
NET DECREASE IN CASH (4,806) (2,107) (10,955)
CASH AT BEGINNING OF YEAR 8,624 10,731 21,686
----------- ----------- -----------
CASH AT END OF YEAR $ 3,818 $ 8,624 $ 10,731
=========== =========== ===========
</Table>
See notes to financial statements.
37
<Page>
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
NOTES TO FINANCIAL STATEMENTS
1. GENERAL
BASIS OF PRESENTATION
The accompanying 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"). These financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America
("GAAP"). Management has identified the Company as a single segment entity.
To conform to the 2005 presentation, certain amounts in the prior years'
financial statements and notes have been reclassified.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
NATURE OF OPERATIONS
The Company sells life insurance, retirement and investment products to
individual customers through several distribution channels. The principal
products are deferred and immediate fixed annuities, variable annuities,
interest-sensitive and traditional life insurance, variable life insurance and
supplemental accident and health insurance.
The Company is authorized to sell life insurance, retirement and investment
products in the state of New York. The Company distributes its products to
individuals through multiple intermediary distribution channels, including
Allstate exclusive agencies, independent agencies, banks, broker-dealers, and
specialized structured settlement brokers. The Company sells products through
independent agencies affiliated with master brokerage agencies. Independent
workplace enrolling agencies and Allstate exclusive agencies also sell the
Company's supplemental accident and health insurance products to employees of
small and medium size firms. Although the Company currently benefits from
agreements with financial services entities that market and distribute its
products, change in control of these non-affiliated entities could negatively
impact the Company's sales. Approximately 56% of 2005 sales of structured
settlement annuities were sold through four specialized structured settlement
brokers.
The Company monitors economic and regulatory developments that have the
potential to impact its business. The ability of banks to affiliate with
insurers may have a material adverse effect on all of the Company's product
lines by substantially increasing the number, size and financial strength of
potential competitors. Furthermore, state and federal laws and regulations
affect the taxation of insurance companies and life insurance and annuity
products. Congress and various state legislatures have considered proposals
that, if enacted, could impose a greater tax burden on the Company or could have
an adverse impact on the tax treatment of some insurance products offered by the
Company, including favorable policyholder tax treatment currently applicable to
life insurance and annuities. Legislation that reduced the federal income tax
rates applicable to certain dividends and capital gains realized by individuals,
or other proposals, if adopted, that reduce the taxation, or permit the
establishment, of certain products or investments that may compete with life
insurance or annuities could have an adverse effect on the Company's financial
position or ability to sell such products and could result in the surrender of
some existing contracts and policies. In addition, changes in the federal estate
tax laws have negatively affected the demand for the types of life insurance
used in estate planning.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INVESTMENTS
Fixed income securities include bonds, mortgage-backed, commercial
mortgage-backed and asset-backed securities, and redeemable preferred stocks.
Fixed income securities may be sold prior to their contractual maturity
("available for sale") and are carried at fair value. The fair value of publicly
traded fixed income securities is based upon independent market quotations. The
fair value of non-publicly traded securities is based on either widely accepted
pricing valuation models which use internally developed ratings and independent
third party data (e.g., term structures and current publicly traded bond prices)
as inputs or independent third party pricing sources. The valuation models use
indicative information such as ratings, industry, coupon, and maturity along
with related third party data and publicly traded bond prices to determine
security specific spreads. These
38
<Page>
spreads are then adjusted for illiquidity based on historical analysis and
broker surveys. The difference between amortized cost and fair value, net of
deferred income taxes, certain life and annuity deferred policy acquisition
costs, certain deferred sales inducement costs, and certain reserves for
life-contingent contract benefits, are reflected as a component of accumulated
other comprehensive income. Cash received from calls, principal payments and
make-whole payments is reflected as a component of proceeds from sales. Cash
received from maturities and pay-downs is reflected as a component of investment
collections.
Mortgage loans are carried at outstanding principal balances, net of
unamortized premium or discount and valuation allowances, if any. Valuation
allowances are established for impaired loans when it is probable that
contractual principal and interest will not be collected. Valuation allowances
for impaired loans reduce the carrying value to the fair value of the collateral
or the present value of the loan's expected future repayment cash flows
discounted at the loan's original effective interest rate.
Short-term investments are carried at cost or amortized cost that
approximates fair value, and include the reinvestment of collateral received in
connection with securities lending activities. For these transactions, the
Company records an offsetting liability in other liabilities and accrued
expenses for the Company's obligation to return the collateral.
Policy loans are carried at the unpaid principle balances. Other
investments consist primarily of derivative financial instruments.
Investment income consists primarily of interest and is recognized on an
accrual basis. Interest income on mortgage-backed, commercial mortgage-backed
and asset-backed securities is determined using the effective yield method,
considering estimated principal repayments. Accrual of income is suspended for
fixed income securities and mortgage loans that are in default or when the
receipt of interest payments is in doubt.
Realized capital gains and losses include gains and losses on investment
dispositions, write-downs in value due to other than temporary declines in fair
value and changes in the fair value of certain derivatives. Dispositions include
sales, losses recognized in anticipation of dispositions and other transactions
such as calls and prepayments. Realized capital gains and losses on investment
dispositions are determined on a specific identification basis.
The Company recognizes other-than-temporary impairment losses on fixed
income securities when the decline in fair value is deemed other than temporary
(see Note 6).
DERIVATIVE AND EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments include foreign currency swaps, interest
rate caps, interest rate futures, and reinvestment related and equity market
risk transfer reinsurance agreements with ALIC that meet the accounting
definition of a derivative (see Note 4). Foreign currency swaps involve the
future exchange or delivery of foreign currency on terms negotiated at the
inception of the contract. Interest rate cap agreements give the holder the
right to receive at a future date, the amount, if any, by which a specified
market interest rate exceeds the fixed cap, applied to a notional amount.
Interest rate futures are defined as commitments to buy or sell designated
financial instruments based on specified prices or yields. Derivatives that are
required to be separated from the host instrument and accounted for as
derivative financial instruments ("subject to bifurcation") are embedded in
certain variable life and annuity contracts.
All derivatives are accounted for on a fair value basis and reported as
other investments, reinsurance recoverables, other assets, other liabilities and
accrued expenses or contractholder funds. Embedded derivative instruments
subject to bifurcation are also accounted for on a fair value basis and are
reported together with the host contracts. The change in the fair value of
derivatives embedded in liabilities and subject to bifurcation is reported in
contract benefits or realized capital gains and losses. When derivatives meet
specific criteria, they may be designated as accounting hedges and accounted for
as fair value, cash flow, foreign currency fair value or foreign currency cash
flow hedges. The hedged item may be either all or a specific portion of a
recognized asset, liability or an unrecognized firm commitment attributable to a
particular risk. At the inception of the hedge, the Company formally documents
the hedging relationship and risk management objective and strategy. The
documentation identifies the hedging instrument, the hedged item, the nature of
the risk being hedged and the methodology used to assess how effective the
hedging instrument is in offsetting the exposure to changes in the hedged item's
fair value attributable to the hedged risk, or in the case of a cash flow hedge,
the exposure to changes in the hedged item's or transaction's variability in
cash flows attributable to the hedged risk. The Company does not exclude any
component of the change in fair value of the hedging instrument from the
effectiveness assessment. At each reporting date, the Company confirms that the
hedging instrument continues to be highly effective in offsetting the hedged
risk. Ineffectiveness in fair value hedges and cash flow hedges is reported in
realized capital gains and losses.
39
<Page>
CASH FLOW HEDGES The Company designates certain of its foreign currency
swap contracts as cash flow hedges when the hedging instrument is highly
effective in offsetting the exposure of variations in cash flows for the hedged
risk that could affect net income. The Company's cash flow exposure may be
associated with an existing asset, liability, or a forecasted transaction.
Anticipated transactions must be probable of occurrence and their significant
terms and specific characteristics must be identified.
For hedging instruments used in cash flow hedges, the changes in fair value
of the derivatives are reported in accumulated other comprehensive income as
unrealized net capital gains and losses. Amounts are reclassified to net
investment income or realized capital gains and losses as the hedged transaction
affects net income or when the forecasted transaction affects net income.
Accrued periodic settlements on derivatives used in cash flow hedges are
reported in net investment income. The amount reported in accumulated other
comprehensive income for a hedged transaction is limited to the lesser of the
cumulative gain or loss on the derivative less the amount reclassified to net
income; or the cumulative gain or loss on the derivative needed to offset the
cumulative change in the expected future cash flows on the hedged transaction
from inception of the hedge less the derivative gain or loss previously
reclassified from accumulated other comprehensive income to net income. If the
Company expects at any time that the loss reported in accumulated other
comprehensive income would lead to a net loss on the combination of the hedging
instrument and the hedged transaction which may not be recoverable, a loss is
recognized immediately in realized capital gains and losses. If an impairment
loss is recognized on an asset or an additional obligation is incurred on a
liability involved in a hedge transaction, any offsetting gain in accumulated
other comprehensive income is reclassified and reported together with the
impairment loss or recognition of the obligation.
TERMINATION OF HEDGE ACCOUNTING If, subsequent to entering into a hedge
transaction, the derivative becomes ineffective (including if the hedged item is
sold or otherwise extinguished, the occurrence of a hedged forecasted
transaction is no longer probable, or the hedged asset becomes impaired), the
Company may terminate the derivative position. The Company may also terminate
derivative instruments or redesignate them as non-hedge as a result of other
events or circumstances. If the derivative financial instrument is not
terminated when a fair value hedge is no longer effective, the future gains and
losses recognized on the derivative are reported in realized capital gains and
losses. When a fair value hedge is no longer effective, is redesignated as a
non-hedge, or when the derivative has been terminated, the gain or loss
recognized on the item being hedged and used to adjust the book value of the
asset, liability or portion thereof is amortized over the remaining life of the
hedged item to net investment income or interest credited to contractholder
funds beginning in the period that hedge accounting is no longer applied. If the
hedged item of a fair value hedge is an asset, which has become impaired, the
adjustment made to the book value of the asset is subject to the accounting
policies applied to impaired assets. When a derivative financial instrument used
in a cash flow hedge of an existing asset or liability is no longer effective or
is terminated, the gain or loss recognized on the derivative is reclassified
from accumulated other comprehensive income to net income as the hedged risk
impacts net income, beginning in the period hedge accounting is no longer
applied or the derivative instrument is terminated. If the derivative financial
instrument is not terminated when a cash flow hedge is no longer effective, the
future gains and losses recognized on the derivative are reported in realized
capital gains and losses. When a derivative financial instrument used in a cash
flow hedge of a forecasted transaction is terminated because the forecasted
transaction is no longer probable, the gain or loss recognized on the derivative
is immediately reclassified from accumulated other comprehensive income to
realized capital gains and losses in the period that hedge accounting is no
longer applied. If the cash flow hedge is no longer effective, the gain or loss
recognized on the derivative is reclassified from accumulated other
comprehensive income to net income as the remaining hedged item affects net
income.
NON-HEDGE DERIVATIVE FINANCIAL INSTRUMENTS The Company also has certain
derivatives that are used in interest rate and equity price risk management
strategies for which hedge accounting is not applied. These derivatives consist
of interest rate caps, financial futures contracts, and reinvestment related and
equity market risk transfer reinsurance agreements with ALIC that meet the
accounting definition of a derivative.
Based upon the type of derivative instrument and strategy, the income
statement effects of these derivatives are reported in a single line item, with
the results of the associated risk. Therefore, the derivatives' fair value gains
and losses and accrued periodic settlements are recognized together in one of
the following during the reporting period: realized capital gains and losses or
contract benefits. Cash flows from embedded derivatives requiring bifurcation
and derivatives receiving hedge accounting are reported consistently with the
host contracts and hedged risks respectively within the Statements of Cash
Flows. Cash flows from other derivatives are reported in cash flows from
investing activities within the Statements of Cash Flows.
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<Page>
SECURITIES LOANED
Securities lending transactions are used primarily to generate net
investment income. The Company receives collateral for securities loaned in an
amount generally equal to 102% of the fair value of fixed income securities and
records the related obligations to return the collateral in other liabilities
and accrued expenses. The carrying value of these obligations approximates fair
value because of their relatively short-term nature. The Company monitors the
market value of securities loaned on a daily basis and obtains additional
collateral as necessary to mitigate counterparty credit risk. The Company
maintains the right and ability to redeem the securities loaned on short notice.
Substantially all of the Company's securities loaned are placed with large
brokerage firms.
RECOGNITION OF PREMIUM REVENUES AND CONTRACT CHARGES, AND RELATED BENEFITS
AND INTEREST CREDITED
Traditional life insurance products consist principally of products with
fixed and guaranteed premiums and benefits, primarily term and whole life
insurance products. Premiums from these products are recognized as revenue when
due from policyholders. Benefits are recognized in relation to such revenue so
as to result in the recognition of profits over the life of the policy and are
reflected in contract benefits.
Immediate annuities with life contingencies, including certain structured
settlement annuities, provide insurance protection over a period that extends
beyond the period during which premiums are collected. Premiums from these
products are recognized as revenue when received at the inception of the
contract. Benefits and expenses are recognized in relation to such revenue such
that profits are recognized over the lives of the contracts.
Interest-sensitive life contracts, such as universal life and single
premium life, are insurance contracts whose terms are not fixed and guaranteed.
The terms that may be changed include premiums paid by the contractholder,
interest credited to the contractholder account balance and any amounts assessed
against the contractholder account balance. Premiums from these contracts are
reported as contractholder fund deposits. Contract charges consist of fees
assessed against the contractholder account balance for cost of insurance
(mortality risk), contract administration and early surrender. These revenues
are recognized when assessed against the contractholder account balance.
Contract benefits include life-contingent benefit payments in excess of the
contractholder account balance.
Contracts that do not subject the Company to significant risk arising from
mortality or morbidity are referred to as investment contracts. Fixed annuities,
including market value adjusted annuities and immediate annuities without life
contingencies are considered investment contracts. Consideration received for
such contracts is reported as contractholder fund deposits. Contract charges for
investment contracts consist of fees assessed against the contractholder account
balance for maintenance, administration, and surrender of the contract prior to
contractually specified dates, and are recognized when assessed against the
contractholder account balance.
Interest credited to contractholder funds represents interest accrued or
paid on interest-sensitive life contracts and investment contracts. Crediting
rates for certain fixed annuities and interest-sensitive life contracts are
adjusted periodically by the Company to reflect current market conditions
subject to contractually guaranteed minimum rates. Pursuant to the adoption of
Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises
for Certain Nontraditional Long-Duration Contracts and for Separate Accounts"
("SOP 03-1") in 2004, interest credited also includes amortization of deferred
sales inducement ("DSI") expenses. DSI is amortized into interest credited using
the same method used to amortize deferred policy acquisition costs ("DAC").
Separate account products include variable annuities and variable life
insurance contracts. The assets supporting these products are legally segregated
and available only to settle separate account contract obligations. Deposits
received are reported as separate accounts liabilities. Contract charges for
these products consist of fees assessed against the contractholder account
values for contract maintenance, administration, mortality, expense and early
surrender. Contract benefits incurred include guaranteed minimum death, income,
withdrawal and accumulation benefits incurred on variable annuity and life
insurance contracts.
DEFERRED POLICY ACQUISITION AND SALES INDUCEMENT COSTS
Costs that vary with and are primarily related to acquiring life
insurance and investment contracts are deferred and recorded as DAC. These
costs are principally agents' and brokers' remuneration and certain
underwriting costs. DSI costs, which are deferred and recorded as other
assets, related to sales inducements offered on sales to new customers,
principally on fixed and variable annuities and primarily in the form of
additional credits to the customer's account value or enhancements to
interest credited for a specified period, which are beyond amounts currently
being credited to existing contracts. All other
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acquisition costs are expensed as incurred and included in operating costs and
expenses on the Statements of Operations and Comprehensive Income. DAC is
amortized to income and included in amortization of deferred policy acquisition
costs on the Statements of Operations and Comprehensive Income. DSI is amortized
to income using the same methodology and assumptions as DAC and is included in
interest credited to contractholder funds on the Statements of Operations and
Comprehensive Income. DAC and DSI are periodically reviewed for recoverability
and written down when necessary.
For traditional life insurance and other premium paying contracts, DAC is
amortized in proportion to the estimated revenues on such business. Assumptions
used in amortization of DAC and reserve calculations are determined based upon
conditions as of the date of policy issuance and are generally not revised
during the life of the policy. Any deviations from projected business in force
resulting from actual policy terminations differing from expected levels and any
estimated premium deficiencies change the rate of amortization in the period
such events occur. Generally, the amortization period for these contracts
approximates the estimated lives of the policies.
For internal exchanges of traditional life insurance, the unamortized
balance of costs previously deferred under the original contracts are charged to
income. The new costs associated with the exchange are deferred and amortized to
income.
For interest-sensitive life, fixed and variable annuities and other
investment contracts, DAC and DSI are amortized in proportion to the incidence
of the total present value of gross profits, which includes both actual
historical gross profits ("AGP") and estimated future gross profits ("EGP")
earned over the estimated lives of the contracts. The amortization periods range
from 15-30 years; however, estimates of customer surrender rates, partial
withdrawals and deaths generally result in the majority of deferred costs being
amortized over the surrender charge period. The rate of amortization during this
term is matched to the pattern of total gross profits. AGP and EGP consist of
the following components: benefit margins, primarily from mortality, including
guaranteed minimum death, income, withdrawal and accumulation benefits;
investment margin including realized capital gains and losses; and contract
administration, surrender and other contract charges, less maintenance
expenses.
DAC and DSI amortization for variable annuity and life contracts is
estimated using stochastic modeling and is significantly impacted by the
anticipated return on the underlying funds. The Company's long-term expectation
of separate accounts fund performance, net of fees, was approximately 7% in 2005
and 8% in 2004 and 2003. Whenever actual separate accounts fund performance
based on the two most recent years varies from the expectation, the Company
projects performance levels over the next five years such that the mean return
over a seven-year period equals the long-term expectation. This approach is
commonly referred to as "reversion to the mean" and is commonly used by the life
insurance industry as an appropriate method for amortizing variable annuity and
life DAC and DSI. In applying the reversion to the mean process, the Company
does not allow the future mean rates of return including fees projected over the
five-year period to exceed 12.75% or fall below 0%. The Company periodically
evaluates the results of utilization of this process to confirm that it is
reasonably possible that variable annuity and life fund performance will revert
to the expected long-term mean within this time horizon.
Changes in the amount or timing of EGP result in adjustments to the
cumulative amortization of DAC and DSI. All such adjustments are reflected in
the current results of operations.
The Company performs quarterly reviews of DAC and DSI recoverability for
interest-sensitive life, variable annuities and investment contracts in the
aggregate using current assumptions. If a change in the amount of EGP is
significant, it could result in the unamortized DAC and DSI not being
recoverable, resulting in a charge which is included as a component of
amortization of deferred policy acquisition costs or interest credited to
contractholder funds, respectively, on the Statements of Operations and
Comprehensive Income.
Any amortization of DAC or DSI that would result from changes in unrealized
gains or losses had those gains or losses actually been realized during the
reporting period is recorded net of tax in other comprehensive income.
REINSURANCE
In the normal course of business, the Company seeks to limit aggregate and
single exposure to losses on large risks by purchasing reinsurance from
reinsurers (see Note 9). The amounts reported in the Statements of Financial
Position as reinsurance recoverables include amounts billed to reinsurers on
losses paid as well as estimates of amounts expected to be recovered from
reinsurers on incurred losses that have not yet been paid. Reinsurance
recoverables on unpaid losses are estimated based upon assumptions consistent
with those used in establishing the liabilities related to the underlying
reinsured contract. Insurance liabilities are reported gross of reinsurance
recoverables. Reinsurance premiums are generally reflected in income in a manner
consistent with
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the recognition of premiums on the reinsured contracts. Reinsurance does not
extinguish the Company's primary liability under the policies written.
Therefore, the Company regularly evaluates the financial condition of the
reinsurers and establishes allowances for uncollectible reinsurance recoverables
as appropriate.
The Company has reinsurance treaties through which it cedes primarily
re-investment related risk on its structured settlement annuities, guaranteed
minimum accumulation benefits ("GMABs"), guaranteed minimum withdrawal benefits
("GMWBs") and certain guaranteed minimum death benefits ("GMDBs") to ALIC. The
terms of the treaties related to the structured settlement annuities, GMABs and
GMWBs meet the accounting definition of a derivative under Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities". Accordingly, these items are recorded in
the Statement of Financial Position at fair value. For the treaty pertaining to
the re-investment related risk on structured settlement annuities, changes in
the fair value of the treaty and premiums paid to ALIC are recognized in
realized capital gains and losses (see Note 4). For the treaty pertaining to the
GMABs and GMWBs, changes in the fair value of the treaty are recognized in
contract benefits.
INCOME TAXES
The income tax provision is calculated under the liability method. Deferred
tax assets and liabilities are recorded based on the difference between the
financial statement and tax bases of assets and liabilities at the enacted tax
rates. The principal assets and liabilities giving rise to such differences are
unrealized capital gains and losses on fixed income securities, insurance
reserves and deferred policy acquisition costs. A deferred tax asset valuation
allowance is established when there is uncertainty that such assets would be
realized.
RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS
The reserve for life-contingent contract benefits, which relates to
traditional life and supplemental accident and health insurance and immediate
annuities with life contingencies, is computed on the basis of long-term
actuarial assumptions as to future investment yields, mortality, morbidity,
policy terminations and expenses (see Note 8). These assumptions, which for
traditional life insurance are applied using the net level premium method,
include provisions for adverse deviation and generally vary by such
characteristics as type of coverage, year of issue and policy duration. To the
extent that unrealized gains on fixed income securities would result in a
premium deficiency had those gains actually been realized, the related increase
in reserves for certain immediate annuities with life contingencies is recorded
net of tax as a reduction of the unrealized net capital gains included in
accumulated other comprehensive income.
CONTRACTHOLDER FUNDS
Contractholder funds represent interest-bearing liabilities arising from
the sale of products, such as interest-sensitive life, fixed annuities, and
variable annuity and life deposits allocated to fixed accounts. Contractholder
funds are comprised primarily of deposits received and interest credited to the
benefit of the contractholder less surrenders and withdrawals, mortality charges
and administrative expenses (see Note 8). Contractholder funds also include
reserves for secondary guarantees on variable annuities.
SEPARATE ACCOUNTS
The Company issues variable annuities and variable life insurance
contracts, the assets and liabilities of which are legally segregated and
recorded as assets and liabilities of the separate accounts. The assets of the
separate accounts are carried at fair value. Separate accounts liabilities
represent the contractholders' claims to the related assets and are carried at
the fair value of the assets. Investment income and realized capital gains and
losses of the separate accounts accrue directly to the contractholders and
therefore, are not included in the Company's Statements of Operations and
Comprehensive Income. Revenues to the Company from the separate accounts consist
of contract charges for maintenance, administration, cost of insurance and
surrender of the contract prior to the contractually specified dates and are
reflected in contract charges. Deposits to the separate accounts are not
included in cash flows.
Absent any contract provision wherein the Company guarantees either a
minimum return or account value upon death, a specified contract anniversary
date, partial withdrawal or annuitization, variable annuity and variable life
insurance contractholders bear the investment risk that the separate accounts'
funds may not meet their stated investment objectives. The account balances of
variable annuities contracts' separate accounts with
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guarantees included $882.2 million and $758.4 million of equity, fixed income
and balanced mutual funds and $44.0 million and $32.3 million of money market
mutual funds at December 31, 2005 and 2004, respectively.
LIABILITIES FOR VARIABLE CONTRACT GUARANTEES
The Company offers various guarantees to variable annuity contractholders
including a return of no less than (a) total deposits made on the contract less
any customer withdrawals, (b) total deposits made on the contract less any
customer withdrawals plus a minimum return or (c) the highest contract value on
a specified anniversary date minus any customer withdrawals following the
contract anniversary. These guarantees include benefits that are payable in the
event of death (death benefits), upon annuitization (income benefits), upon
periodic withdrawal (withdrawal benefits), or at specified dates during the
accumulation period (accumulation benefits). Liabilities for variable contract
guarantees related to death benefits are included in reserve for life-contingent
contract benefits and the liabilities related to the income, withdrawal and
accumulation benefits are included in contractholder funds in the Statements of
Financial Position (see Note 8).
Pursuant to the adoption of SOP 03-1 in 2004, the liability for death and
income benefit guarantees is established equal to a benefit ratio multiplied by
the cumulative contract charges earned, plus accrued interest less contract
benefit payments. The benefit ratio is calculated as the estimated present value
of all expected contract benefits divided by the present value of all expected
contract charges. The establishment of reserves for these guarantees requires
the projection of future separate account fund performance, mortality,
persistency and customer benefit utilization rates. These assumptions are
periodically reviewed and updated. For guarantees related to death benefits,
benefits represent the current guaranteed minimum death benefit payments in
excess of the current account balance. For guarantees related to income
benefits, benefits represent the present value of the minimum guaranteed
annuitization benefits in excess of the current account balance.
Projected benefits and contract charges used in determining the liability
for certain guarantees are developed using models and stochastic scenarios that
are also used in the development of estimated future gross profits. Underlying
assumptions for the liability related to income benefits include assumed future
annuitization elections based on factors such as the extent of benefit to the
potential annuitant, eligibility conditions and the annuitant's attained age.
The liability for guarantees is re-evaluated periodically, and adjustments are
made to the liability balance through a charge or credit to contract benefits.
Guarantees related to accumulation benefits are considered to be derivative
financial instruments; therefore, the liability for these benefits is
established based on its fair value.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
Commitments to extend mortgage loans and purchase private placement
securities have off-balance-sheet risk because their contractual amounts are not
recorded in the Company's Statements of Financial Position (see Note 7).
ADOPTED ACCOUNTING STANDARDS
SOP 03-1, "ACCOUNTING AND REPORTING BY INSURANCE ENTERPRISES FOR CERTAIN
NONTRADITIONAL LONG-DURATION CONTRACTS AND FOR SEPARATE ACCOUNTS" ("SOP 03-1")
On January 1, 2004, the Company adopted SOP 03-1. The major provisions of
the SOP affecting the Company require:
- Establishment of reserves primarily related to death benefit and
income benefit guarantees provided under variable annuity contracts;
- Deferral of sales inducements that meet certain criteria, and
amortization using the same method used for DAC.
The cumulative effect of the change in accounting principle from
implementing SOP 03-1 was a loss of $7.6 million, after-tax ($11.7 million,
pre-tax). It was comprised of an increase in benefit reserves (primarily for
variable annuity contracts) of $942 thousand, pre-tax, and a reduction in DAC
and DSI of $10.7 million, pre-tax.
The SOP requires consideration of a range of potential results to estimate
the cost of variable annuity death benefits and income benefits, which generally
necessitates the use of stochastic modeling techniques. To maintain consistency
with the assumptions used in the establishment of reserves for variable annuity
guarantees, the Company utilized the results of this stochastic modeling to
estimate expected gross profits, which form the basis for determining the
amortization of DAC and DSI. This new modeling approach resulted in a lower
estimate of expected gross profits, and therefore resulted in a write-down of
DAC and DSI.
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In 2005 and 2004, DSI and related amortization is classified within the
Statements of Financial Position and Operations and Comprehensive Income as
other assets and interest credited to contractholder funds, respectively (See
Note 10).
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS ("AICPA") TECHNICAL PRACTICE
AID ("TPA") RE. SOP 03-1
In September 2004, the staff of the AICPA, aided by industry experts,
issued a set of technical questions and answers on financial accounting and
reporting issues related to SOP 03-1 that will be included in the AICPA's TPAs.
The TPA addresses a number of issues related to SOP 03-1 including when it is
necessary to establish a liability in addition to the account balance for
certain contracts such as single premium and universal life that meet the
definition of an insurance contract and have amounts assessed against the
contractholder in a manner that is expected to result in profits in earlier
years and losses in subsequent years from the insurance benefit function. The
impact of adopting the provisions of the TPA did not have a material effect on
the results of operations or financial position of the Company.
PENDING ACCOUNTING STANDARDS
FINANCIAL ACCOUNTING STANDARDS BOARD STAFF POSITION NO. FAS 115-1, "THE MEANING
OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS"
("FSP FAS 115-1")
In November 2005, the Financial Accounting Standards Board ("FASB") issued
FSP FAS 115-1, which nullifies the guidance in paragraphs 10-18 of EITF 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 accounting for an impaired debt
security. FSP FAS 115-1 is effective for reporting periods beginning after
December 15, 2005. The adoption of FSP FAS 115-1 may have a material impact on
the Company's Statements of Operations and Comprehensive Income but is not
expected to have a material impact on the Company's Statements of Financial
Position as fluctuations in fair value are already recorded in accumulated other
comprehensive income.
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 AICPA issued SOP 05-1. SOP 05-1 provides accounting
guidance for deferred policy acquisition costs on internal replacements of
insurance and investment contracts other than those specifically described in
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 a
contract for a new contract, or by amendment, endorsement or rider to a
contract, or by the election of a feature or coverage within a contract.
Internal replacement contracts are those that are substantially changed from the
replaced contract and are accounted for as an extinguishment of the replaced
contract. Nonintegrated contract features are accounted for as separately issued
contracts. Modifications resulting from the election of a feature or coverage
within a contract or from an integrated contract feature generally do not result
in an internal replacement contract subject to SOP 05-1 provided certain
conditions are met. The provisions of SOP 05-1 are effective for internal
replacements occurring in fiscal years beginning after December 15, 2006. The
Company's accounting policy for internal replacements is generally consistent
with the accounting guidance prescribed in SOP 05-1. The Company is currently
assessing the impact of SOP 05-1 on the results of operations and financial
position of the Company.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 154, ACCOUNTING CHANGES AND
ERROR CORRECTIONS ("SFAS NO. 154")
In May 2005, the FASB issued SFAS No. 154, which replaces Accounting
Principles Board ("APB") Opinion No. 20, "Accounting Changes", and FASB
Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements".
SFAS No. 154 requires retrospective application to prior periods' financial
statements for
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changes in accounting principle, unless determination of either
the period specific effects or the cumulative effect of the change is
impracticable or otherwise promulgated. SFAS No. 154 is effective for fiscal
years beginning after December 15, 2005. SFAS No. 154, upon adoption, is not
expected to have a material effect on the results of operations or financial
position of the Company.
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 FASB issued SFAS No. 155, which resolves issues
addressed in Statement 133 Implementation Issue No. D1, "Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets." SFAS No.
155, among other things, permits the fair value remeasurement of any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation; clarifies which interest-only strips and principal-only
strips are not subject to the requirements of Statement 133; and establishes a
requirement to evaluate interests in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation. SFAS No.
155 is effective for all financial instruments acquired or issued in a fiscal
year beginning after September 15, 2006. The Company is currently assessing the
impact of SFAS No. 155 on its results of operations and financial position.
3. DISPOSITIONS
In 2003, the Company announced its intention to exit the direct response
distribution business and, based on its decision to sell the business, reached a
measurement date that resulted in the recognition of an estimated loss on the
disposition of $4.5 million ($2.9 million, after-tax). In 2004, the Company
disposed of substantially all of the direct response distribution business
pursuant to reinsurance transactions with a subsidiary of Citigroup and Scottish
Re (U.S.) Inc. In connection with the disposal activities, the Company recorded
a gain on disposition of $1 thousand ($1 thousand after-tax) and $1.3 million
($862 thousand after-tax) in 2005 and 2004, respectively (see Notes 9 and 10).
SUBSEQUENT EVENT
On March 8, 2006, the Company, its parent, ALIC, and the Corporation,
entered into a definitive agreement ("Agreement") with Prudential Financial,
Inc. and its subsidiary The Prudential Insurance Company of America
(collectively, "Prudential") for the sale pursuant to a combination of
coinsurance and modified coinsurance reinsurance of substantially all of its
variable annuity business. Total consideration is expected to be approximately
$581 million, subject to adjustment for changes in equity markets and interest
rates between the effective date of the Agreement and the closing of the
transaction. ALIC has entered into an economic hedge that it believes will
substantially reduce its economic exposure to the variability of this
arrangement from the period between the effective date of the Agreement and
closing. As a result of the modified coinsurance reinsurance, the separate
account assets and liabilities will remain on the Company's statements of
financial position, but the related results of operations will be fully
reinsured to Prudential. The sale is expected to result in the recognition of a
small gain, which will be amortized into earnings over the life of the
Agreement. A level of cash or cash equivalents in an amount equal to the fixed
(general) account liabilities of approximately $410 million, net of the
consideration, will be needed to settle our obligation to Prudential at closing
under the coinsurance portion of the Agreement. An evaluation will occur in the
first quarter of 2006 regarding available sources of funds for settlements,
which may include such items as cash flows from operations, sales of existing
investments or borrowings.
Under the Agreement, the Company, ALIC and the Corporation will each
indemnify Prudential for certain pre-closing contingent liabilities (including
extra-contractual liabilities of the Company and ALIC and liabilities
specifically excluded from the transaction) that 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, ALIC and their agents, including in connection with the
Company's and ALIC's provision of transition services.
The terms of the Agreement will 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. The Company and ALIC have also agreed to continue
to issue variable annuity contracts in the financial institutions channel for a
period of at least thirty-three months and cede them to Prudential. The
Agreement is subject to regulatory approval and is expected to be completed by
the end of the second quarter of 2006.
In 2005, the Company's variable annuity business generated
approximately $17 million in contract charges on separate account balances of
$927 million and general account balances of $501 million as of
December 31, 2005. Separate account balances totaling approximately
$1 million related to the variable life business continue to be retained
by the Company.
4. RELATED PARTY TRANSACTIONS
BUSINESS OPERATIONS
The Company utilizes services performed by its affiliates, AIC, ALIC and
Allstate Investments LLC, and business facilities owned or leased and operated
by AIC in conducting its business activities. In addition, the Company shares
the services of employees with AIC. The Company reimburses its affiliates for
the operating expenses incurred on its behalf. The Company is charged for the
cost of these operating expenses based on the level of services provided.
Operating expenses, including compensation, retirement and other benefit
programs, allocated to the Company were $53.8 million, $44.8 million and $37.2
million in 2005, 2004 and 2003, respectively. A portion of these expenses relate
to the acquisition of business and is deferred and amortized over the contract
periods.
STRUCTURED SETTLEMENT ANNUITIES
The Company issued $16.0 million, $19.4 million and $19.2 million of
structured settlement annuities, a type of immediate annuity, in 2005, 2004
and 2003, respectively, at prices based upon interest rates in effect at the
time of issuance, to fund structured settlement annuities in matters
involving AIC. Of these amounts, $2.0 million, $5.4 million and $3.9 million
relate to structured settlement annuities with life contingencies and are
included in premium income in 2005, 2004 and 2003, respectively. In most
cases, these annuities were issued under a "qualified assignment," whereby
prior to July 1, 2001 Allstate Settlement Corporation ("ASC"), and on and
subsequent to July 1, 2001 Allstate Assignment Corporation ("AAC") both
wholly owned subsidiaries of ALIC, purchased annuities from the Company and
assumed AIC's obligation to make future payments.
Reserves recorded by the Company for annuities issued to ASC and AAC,
including annuities to fund structured settlement annuities in matters
involving AIC were $1.78 billion and $1.69 billion at December 31, 2005 and
2004, respectively.
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BROKER/DEALER AGREEMENTS
The Company has a service agreement with Allstate Distributors, L.L.C.
("ADLLC"), a broker-dealer company owned by ALIC, whereby ADLLC promotes and
markets the fixed and variable annuities sold by the Company to unaffiliated
financial services firms. In addition, ADLLC also acts as the underwriter of
variable annuities sold by the Company. In return for these services, the
Company recorded commission expense of $7.1 million, $5.6 million and $4.8
million for the years ended December 31, 2005, 2004 and 2003, respectively.
The Company receives underwriting and distribution services from Allstate
Financial Services, LLC ("AFS"), an affiliated broker/dealer company, for
certain variable annuity and variable life insurance contracts sold by Allstate
exclusive agencies. The Company recorded commission expense of $1.3 million,
$1.4 million and $455 thousand for the years ended December 31, 2005, 2004 and
2003, respectively.
REINSURANCE TRANSACTIONS
The Company has reinsurance agreements with unaffiliated reinsurers and
ALIC in order to limit aggregate and single exposure on large risks. A portion
of the Company's premiums and policy benefits are ceded to ALIC and reflected
net of such reinsurance in the Statements of Operations and Comprehensive
Income. Reinsurance recoverables and the related reserve for life-contingent
contract benefits and contractholder funds are reported separately in the
Statements of Financial Position. The Company continues to have primary
liability as the direct insurer for risks reinsured (see Note 9).
Additionally, the Company entered into a reinsurance treaty through which
it primarily cedes re-investment related risk on its structured settlement
annuities to ALIC. Under the terms of the treaty, the Company pays a premium to
ALIC that varies with the aggregate structured settlement annuity statutory
reserve balance. In return, ALIC guarantees that the yield on the portion of the
Company's investment portfolio that supports structured settlement annuity
liabilities will not fall below contractually determined rates. The Company
ceded premium related to structured settlement annuities to ALIC of $2.9
million, $2.7 million and $2.6 million for the years ended December 31, 2005,
2004 and 2003, respectively. At December 31, 2005 and 2004, the carrying value
of the structured settlement reinsurance treaty was $(1.5) million and $(995)
thousand, respectively, which is recorded in other assets. The premiums ceded
and changes in the fair value of the reinsurance treaty are reflected as a
component of realized capital gains and losses on the Statements of Operations
and Comprehensive income as the treaty is recorded as a derivative instrument
pursuant to the requirements of SFAS No. 133.
Beginning in 2004, the Company has a reinsurance treaty through which it
cedes variable annuity GMABs to ALIC. At December 31, 2005 and 2004, the
carrying value of the GMAB treaty, which is recorded as a component of
reinsurance recoverables, was $(553) thousand and $(141) thousand, respectively.
Additionally, beginning in 2005, the treaty was updated to included variable
annuity GMWBs and certain GMDBs. At December 31, 2005, the carrying values
related to GMWBs and GMDBs, which are also reflected as a component of
reinsurance recoverables, were $2 thousand and $104 thousand, respectively.
CAPITAL CONTRIBUTION
The Company received cash capital contributions from ALIC of $20.0 million
and $64.2 million in 2005 and 2004, respectively, which were recorded as
additional capital paid-in on the Statements of Financial Position.
DEBT
The Company has entered into an intercompany loan agreement with the
Corporation. The amount of inter-company loans available to the Company is at
the discretion of the Corporation. The maximum amount of loans the Corporation
will have outstanding to all its eligible subsidiaries at any given point in
time is limited to $1.00 billion. The Company had no amounts outstanding under
the inter-company loan agreement at December 31, 2005 and 2004. The Corporation
uses commercial paper borrowings, bank lines of credit and repurchase agreements
to fund inter-company borrowings.
INCOME TAXES
The Company is a party to a federal income tax allocation agreement with
the Corporation (see Note 12).
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5. SUPPLEMENTAL CASH FLOW INFORMATION
Non-cash investment modifications, which reflect refinancings of fixed
income securities, totaled $4.5 million and $1.7 million for 2005 and 2004,
respectively. There were no non-cash investment modifications in 2003.
Liabilities for collateral received in conjunction with securities lending
activities were $149.5 million, $133.4 million and $134.5 million at December
31, 2005, 2004 and 2003, respectively, and are reported as a component of other
liabilities and accrued expenses in Statements of Financial Position. The
accompanying cash flows are included in cash flows from operating activities in
the Statements of Cash Flows along with the related changes in investments which
for the years ended December 31 are as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
-------------- -------------- --------------
Net change in fixed income securities $ (36,652) $ 59,856 $ (46,447)
Net change in short-term investments 20,555 (58,735) 71,908
-------------- -------------- --------------
Operating cash flow (used) provided $ (16,097) $ 1,121 $ 25,461
============== ============== ==============
Liabilities for collateral, beginning of year $ (133,368) $ (134,489) $ (159,950)
Liabilities for collateral, end of year (149,465) (133,368) (134,489)
-------------- -------------- --------------
Operating cash flow provided (used) $ 16,097 $ (1,121) $ (25,461)
============== ============== ==============
</Table>
6. INVESTMENTS
FAIR VALUES
The amortized cost, gross unrealized gains and losses, and fair value for
fixed income securities are as follows:
<Table>
<Caption>
(IN THOUSANDS) GROSS UNREALIZED
AMORTIZED --------------------------------- FAIR
COST GAINS LOSSES VALUE
-------------- ---------------- -------------- ---------------
AT DECEMBER 31, 2005
U.S. government and agencies $ 510,362 $ 213,421 $ - $ 723,783
Municipal 308,219 20,193 (776) 327,636
Corporate 3,286,652 182,630 (28,020) 3,441,262
Foreign government 236,078 70,433 (176) 306,335
Mortgage-backed securities 569,712 4,050 (10,712) 563,050
Commercial mortgage-backed securities 490,985 3,999 (3,149) 491,835
Asset-backed securities 123,981 1,068 (679) 124,370
Redeemable preferred stock 9,407 1,585 - 10,992
-------------- ---------------- -------------- ---------------
Total fixed income securities $ 5,535,396 $ 497,379 $ (43,512) $ 5,989,263
============== =============== ============== ===============
AT DECEMBER 31, 2004
U.S. government and agencies $ 506,971 $ 197,639 $ - $ 704,610
Municipal 262,683 12,714 (1,422) 273,975
Corporate 2,950,439 246,775 (6,660) 3,190,554
Foreign government 214,508 62,839 - 277,347
Mortgage-backed securities 566,367 8,719 (2,623) 572,463
Commercial mortgage-backed securities 446,354 13,357 (838) 458,873
Asset-backed securities 56,215 1,732 (1,321) 56,626
Redeemable preferred stock 9,440 1,759 - 11,199
-------------- --------------- ------------- ---------------
Total fixed income securities $ 5,012,977 $ 545,534 $ (12,864) $ 5,545,647
============== =============== ============== ===============
</Table>
48
<Page>
SCHEDULED MATURITIES
The scheduled maturities for fixed income securities are as follows at
December 31, 2005:
<Table>
<Caption>
AMORTIZED FAIR
(IN THOUSANDS) COST VALUE
----------------- -----------------
Due in one year or less $ 50,709 $ 51,095
Due after one year through five years 641,927 655,538
Due after five years through ten years 1,817,454 1,886,834
Due after ten years 2,331,613 2,708,376
----------------- -----------------
4,841,703 5,301,843
Mortgage- and asset-backed securities 693,693 687,420
----------------- -----------------
Total $ 5,535,396 $ 5,989,263
================= =================
</Table>
Actual maturities may differ from those scheduled as a result of
prepayments by the issuers. Because of the potential for prepayment on mortgage-
and asset-backed securities, they are not categorized by contractual maturity.
The commercial mortgage-backed securities are categorized by contractual
maturity because they generally are not subject to prepayment risk.
NET INVESTMENT INCOME
Net investment income for the years ended December 31 is as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
---------- ---------- ----------
Fixed income securities $ 330,567 $ 278,522 $ 243,684
Mortgage loans 33,373 27,198 24,026
Other 6,723 4,039 3,592
---------- ---------- ----------
Investment income, before expense 370,663 309,759 271,302
Investment expense 14,501 7,704 6,448
---------- ---------- ----------
Net investment income $ 356,162 $ 302,055 $ 264,854
========== ========== ==========
</Table>
REALIZED CAPITAL GAINS AND LOSSES, AFTER-TAX
Realized capital gains and losses by security type for the years ended
December 31 are as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
---------- ---------- ----------
Fixed income securities $ (6,596) $ (7,666) $ (8,156)
Mortgage loans 3,000 1,480 (1,113)
Other (1,596) (3,111) 751
---------- ---------- ----------
Realized capital gains and losses, pre-tax (5,192) (9,297) (8,518)
Income tax benefit 1,972 3,453 3,278
---------- ---------- ----------
Realized capital gains and losses, after-tax $ (3,220) $ (5,844) $ (5,240)
========== ========== ==========
</Table>
Realized capital gains and losses by transaction type for the years ended
December 31 are as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
---------- ---------- ----------
Write-downs $ (1,543) $ (3,402) $ (7,682)
Dispositions (1) (2,053) (2,784) (1,587)
Valuation of derivative instruments (4,469) (5,777) (2,140)
Settlement of derivative instruments 2,873 2,666 2,891
---------- ---------- ----------
Realized capital gains and losses, pre-tax (5,192) (9,297) (8,518)
Income tax benefit 1,972 3,453 3,278
---------- ---------- ----------
Realized capital gains and losses, after-tax $ (3,220) $ (5,844) $ (5,240)
========== ========== ==========
</Table>
- ----------
(1) Dispositions include sales, losses recognized in anticipation of
dispositions and other transactions such as calls and prepayments. The
Company may sell fixed income securities during the period in which fair
value has declined below amortized cost. In certain situations new factors
such as negative developments, subsequent credit deterioration, relative
value opportunities, market liquidity concerns and portfolio reallocations
can subsequently change our previous intent to continue holding a security.
The Company recognized losses of $6.8 million due to a change in intent to
hold certain securities during 2005.
49
<Page>
Gross gains of $5.8 million, $5.2 million and $4.0 million and gross losses
of $7.4 million, $13.3 million and $6.9 million were realized on sales of fixed
income securities during 2005, 2004 and 2003, respectively.
UNREALIZED NET CAPITAL GAINS AND LOSSES
Unrealized net capital gains and losses included in accumulated other
comprehensive income are as follows:
<Table>
<Caption>
GROSS UNREALIZED
(IN THOUSANDS) FAIR ------------------------- UNREALIZED
AT DECEMBER 31, 2005 VALUE GAINS LOSSES NET GAINS
----------- ----------- ----------- -----------
Fixed income securities $ 5,989,263 $ 497,379 $ (43,512) 453,867
Derivative instruments and other investments (154) - (154) (154)
-----------
Total 453,713
Amounts recognized for: (1)
Premium deficiency reserve (257,473)
Deferred policy acquisition and sales inducements costs 2,172
-----------
Total (255,301)
Deferred income taxes (69,444)
-----------
Unrealized net capital gains and losses $ 128,968
===========
</Table>
<Table>
<Caption>
GROSS UNREALIZED
(IN THOUSANDS) FAIR ------------------------- UNREALIZED
AT DECEMBER 31, 2004 VALUE GAINS LOSSES NET GAINS
----------- ----------- ----------- -----------
Fixed income securities $ 5,545,647 $ 545,534 $ (12,864) $ 532,670
Derivative instruments and other investments 4 4 (724) (720)
-----------
Total 531,950
Amounts recognized for: (1)
Premium deficiency reserve (240,410)
Deferred policy acquisition and sales inducement costs (52,686)
-----------
Total (293,096)
Deferred income taxes (83,599)
-----------
Unrealized net capital gains and losses $ 155,255
===========
</Table>
- ----------
(1) See Note 2, Summary of Significant Accounting Policies for deferred policy
acquisition and sales inducement costs and reserves for life contingent
contract benefits.
CHANGE IN UNREALIZED NET CAPITAL GAINS AND LOSSES
The change in unrealized net capital gains and losses for the years ended
December 31 is as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
----------- ----------- -----------
Fixed income securities $ (78,803) $ 52,790 $ 26,738
Derivative instruments and other investments 566 (720) -
----------- ----------- -----------
Total (78,237) 52,070 26,738
Amounts recognized for:
Premium deficiency reserve (17,063) (25,011) (65,900)
Deferred policy acquisition and sales inducement
costs 54,858 (1,627) (8,424)
----------- ----------- -----------
Total 37,795 (26,638) (74,324)
Deferred income taxes 14,155 (8,901) 16,655
----------- ----------- -----------
(Decrease) increase in unrealized net capital
gains and losses $ (26,287) $ 16,531 $ (30,931)
=========== =========== ===========
</Table>
50
<Page>
PORTFOLIO MONITORING
Inherent in the Company's evaluation of a particular security are
assumptions and estimates about the operations of the issuer and its future
earnings potential. Some of the factors considered in evaluating whether a
decline in fair value is other than temporary are: 1) the Company's ability and
intent to retain the investment for a period of time sufficient to allow for an
anticipated recovery in value; 2) the recoverability of principal and interest;
3) the duration and extent to which the fair value has been less than amortized
cost; 4) the financial condition, near-term and long-term prospects of the
issuer, including relevant industry conditions and trends, and implications of
rating agency actions and offering prices; and 5) the specific reasons that a
security is in a significant unrealized loss position, including market
conditions which could affect access to liquidity.
The following table summarizes the gross unrealized losses and fair value
of fixed income securities by the length of time that individual securities have
been in a continuous unrealized loss position.
<Table>
<Caption>
LESS THAN 12 MONTHS 12 MONTHS OR MORE
----------------------------------- ----------------------------------- TOTAL
NUMBER OF FAIR UNREALIZED NUMBER OF FAIR UNREALIZED UNREALIZED
($ IN THOUSANDS) ISSUES VALUE LOSSES ISSUES VALUE LOSSES LOSSES
---------- ----------- ---------- ----------- --------- ----------- ------------
AT DECEMBER 31, 2005
Fixed income securities
Municipal 12 $ 80,350 $ (776) - $ - $ - $ (776)
Corporate 227 1,078,813 (20,810) 27 159,782 (7,210) (28,020)
Foreign government 2 10,186 (176) - - - (176)
Mortgage-backed securities 32 313,090 (7,089) 11 101,796 (3,623) (10,712)
Commercial mortgage-backed
securities 46 282,391 (3,149) - - - (3,149)
Asset-backed securities 13 33,085 (427) 1 5,747 (252) (679)
---------- ----------- ---------- ----------- --------- ----------- ------------
Total 332 $ 1,797,915 $ (32,427) 39 $ 267,325 $ (11,085) $ (43,512)
========== =========== ========== =========== ========= =========== ============
Investment grade fixed
income securities 300 1,746,340 (30,717) 37 257,086 (10,324) (41,041)
Below investment grade fixed
income securities 32 51,575 (1,710) 2 10,239 (761) (2,471)
---------- ----------- ---------- ----------- --------- ----------- ------------
Total fixed income
securities 332 $ 1,797,915 $ (32,427) 39 $ 267,325 $ (11,085) $ (43,512)
========== =========== ========== =========== ========== =========== ============
AT DECEMBER 31, 2004
Fixed income securities
Municipal 18 $ 81,432 $ (1,238) 1 $ 9,816 (184) $ (1,422)
Corporate 81 369,511 (4,159) 17 84,321 (2,501) (6,660)
Mortgage-backed securities 23 224,914 (2,148) 2 30,398 (475) (2,623)
Commercial mortgage-backed
securities 10 82,850 (445) 1 9,650 (393) (838)
Asset-backed securities 5 18,234 (1,321) - - - (1,321)
---------- ----------- ---------- ----------- --------- ----------- ------------
Total 137 $ 776,941 $ (9,311) 21 $ 134,185 $ (3,553) $ (12,864)
========== =========== ========== =========== ========= =========== ============
Investment grade fixed income
securities 114 746,621 (7,585) 16 113,024 (3,019) (10,604)
Below investment grade fixed
income securities 23 30,320 (1,726) 5 21,161 (534) (2,260)
---------- ----------- ---------- ----------- --------- ----------- ------------
Total fixed income
securities 137 $ 776,941 $ (9,311) 21 $ 134,185 $ (3,553) $ (12,864)
========== =========== ========== =========== ========= =========== ============
</Table>
As of December 31, 2005, $42 .3 million of the unrealized losses related to
securities with an unrealized loss position less than 20% of amortized cost, the
degree of which suggests that these securities do not pose a high risk of being
other than temporarily impaired. Of the $42.3 million, $39.8 million related to
unrealized losses on investment grade securities. Investment grade 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 ("S&P"), Fitch or Dominion;
or a comparable internal rating if an externally provided rating is not
available. Unrealized losses on investment grade securities are principally
related to changes in interest rates or changes in issuer and sector related
credit spreads since the securities were acquired.
As of December 31, 2005, the remaining $1.2 million of unrealized losses
related to securities in unrealized loss positions greater than or equal to 20%
of amortized cost and all related to investment grade securities.
The total $2.5 million of unrealized losses from below investment grade
securities includes $2.3 million of corporate fixed income securities and $228
thousand of asset-backed securities.
51
<Page>
As of December 31, 2005, the Company had the intent and ability to hold the
fixed income securities with unrealized losses for a period of time sufficient
for them to recover.
MORTGAGE LOAN IMPAIRMENT
A mortgage loan is impaired when it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. The Company had no impaired loans at December 31, 2005 or 2004.
Interest income for impaired loans is recognized on an accrual basis if
payments are expected to continue to be received; otherwise a cash basis is
used. No interest income was earned on impaired loans in 2005 or 2004. In 2003,
the Company recognized interest income on impaired loans of $134 thousand. The
average balance of impaired loans was $3.9 million in 2003.
INVESTMENT CONCENTRATION FOR MUNICIPAL BOND AND COMMERCIAL MORTGAGE PORTFOLIOS
The Company maintains a diversified portfolio of municipal bonds. The
following table shows the principal geographic distribution of municipal bond
issuers represented in the Company's portfolio. No other state represented more
than 5% of the portfolio at December 31, 2005 and 2004.
<Table>
<Caption>
(% OF MUNICIPAL BOND PORTFOLIO CARRYING VALUE) 2005 2004
------- ------
California 35.4% 41.7%
Texas 9.0 10.2
Missouri 8.8 -
Oregon 7.3 7.4
Illinois 6.1 0.8
Virginia 5.1 4.0
Delaware 0.5 5.4
</Table>
The Company's mortgage loans are collateralized by a variety of commercial
real estate property types located throughout the United States. Substantially
all of the commercial mortgage loans are non-recourse to the borrower. The
following table shows the principal geographic distribution of commercial real
estate represented in the Company's mortgage portfolio. No other state
represented more than 5.0% of the portfolio at December 31, 2005 and 2004.
<Table>
<Caption>
(% OF COMMERCIAL MORTGAGE PORTFOLIO CARRYING VALUE) 2005 2004
------- ------
California 23.4% 19.8%
Illinois 11.5 12.2
Pennsylvania 8.2 7.2
New Jersey 7.1 12.3
New York 6.5 9.5
Ohio 6.0 6.3
Texas 5.9 6.1
Arizona 3.4 5.5
</Table>
The types of properties collateralizing the commercial mortgage loans at
December 31 are as follows:
<Table>
<Caption>
(% OF COMMERCIAL MORTGAGE PORTFOLIO CARRYING VALUE) 2005 2004
------- ------
Warehouse 31.3% 30.1%
Office buildings 29.0 24.2
Retail 17.4 23.7
Apartment complex 17.2 16.6
Industrial 2.2 1.5
Other 2.9 3.9
------- ------
100.0% 100.0%
======= ======
</Table>
52
<Page>
The contractual maturities of the commercial mortgage loan portfolio as of
December 31, 2005 for loans that were not in foreclosure are as follows:
<Table>
<Caption>
NUMBER OF CARRYING
($ IN THOUSANDS) LOANS VALUE PERCENT
--------------- ---------------- -----------
2006 3 $ 13,429 2.1%
2007 5 14,498 2.3
2008 3 18,914 3.0
2009 13 49,987 7.9
2010 23 105,922 16.7
Thereafter 91 431,039 68.0
--------------- ---------------- -----------
Total 138 $ 633,789 100.0%
=============== ================ ===========
</Table>
In 2005, $5.9 million of commercial mortgage loans became contractually due
and were paid as due. None were foreclosed or in the process of foreclosure, and
none were in the process of refinancing or restructuring discussions.
CONCENTRATION OF CREDIT RISK
The Company is not exposed to any credit concentration of risk of a single
issuer and its affiliates greater than 10% of the Company's shareholder's equity
other than certain U.S. government and government agencies.
SECURITIES LENDING
The Company participates in securities lending programs with third parties,
mostly large brokerage firms. At December 31, 2005 and 2004, fixed income
securities with a carrying value of $143.2 million and $130.8 million,
respectively, were on loan under these agreements. In return, the Company
receives cash that it invests and includes in short-term investments and fixed
income securities, with an offsetting liability recorded in other liabilities
and accrued expenses to account for the Company's obligation to return the
collateral. Interest income on collateral, net of fees, was $430 thousand, $300
thousand and $324 thousand, for the years ending December 31, 2005, 2004 and
2003, respectively.
OTHER INVESTMENT INFORMATION
Included in fixed income securities are below investment grade assets
totaling $201.7 million and $209.3 million at December 31, 2005 and 2004,
respectively.
At December 31, 2005, fixed income securities with a carrying value of $2.6
million were on deposit with regulatory authorities as required by law.
At December 31, 2005, the carrying value of investments that were
non-income producing was $5.4 million.
7. FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets, incurs various financial liabilities and enters into agreements
involving derivative financial instruments and other off-balance-sheet financial
instruments. The fair value estimates of financial instruments presented below
are not necessarily indicative of the amounts the Company might pay or receive
in actual market transactions. Potential taxes and other transaction costs have
not been considered in estimating fair value. The disclosures that follow do not
reflect the fair value of the Company as a whole since a number of the Company's
significant assets (including DAC and DSI and reinsurance recoverables) and
liabilities (including reserve for life-contingent contract benefits and
deferred income taxes) are not considered financial instruments and are not
carried at fair value. Other assets and liabilities considered financial
instruments such as accrued investment income and cash are generally of a
short-term nature. Their carrying values are deemed to approximate fair value.
53
<Page>
FINANCIAL ASSETS
<Table>
<Caption>
DECEMBER 31, 2005 DECEMBER 31, 2004
------------------------ ------------------------
CARRYING FAIR CARRYING FAIR
(IN THOUSANDS) VALUE VALUE VALUE VALUE
----------- ----------- ----------- -----------
Fixed income securities $ 5,989,263 $ 5,989,263 $ 5,545,647 $ 5,545,647
Mortgage loans 633,789 647,068 480,280 505,890
Short-term investments 63,057 63,057 111,509 111,509
Policy loans 36,698 36,698 34,948 34,948
Separate accounts 928,824 928,824 792,550 792,550
</Table>
Fair values of publicly traded fixed income securities are based upon
quoted market prices or dealer quotes. The fair value of non-publicly traded
securities, primarily privately placed corporate obligations, is based on either
widely accepted pricing valuation models, which use internally developed ratings
and independent third party data (e.g., term structures and current publicly
traded bond prices) as inputs, or independent third party pricing sources.
Mortgage loans are valued based on discounted contractual cash flows. Discount
rates are selected using current rates at which similar loans would be made to
borrowers with similar characteristics, using similar properties as collateral.
Loans that exceed 100% loan-to-value are valued at the estimated fair value of
the underlying collateral. Short-term investments are highly liquid investments
with maturities of one year or less whose carrying values are deemed to
approximate fair value. The carrying value of policy loans is deemed to
approximate fair value. Separate accounts assets are carried in the Statements
of Financial Position at fair value based upon quoted market prices.
FINANCIAL LIABILITIES
<Table>
<Caption>
DECEMBER 31, 2005 DECEMBER 31, 2004
------------------------ ------------------------
CARRYING FAIR CARRYING FAIR
(IN THOUSANDS) VALUE VALUE VALUE VALUE
----------- ----------- ----------- -----------
Contractholder funds on investment contracts $ 3,921,872 $ 3,815,608 $ 3,434,238 $ 3,367,458
Liability for collateral 149,465 149,465 133,368 133,368
Separate accounts 928,824 928,824 792,550 792,550
</Table>
Contractholder funds include interest-sensitive life insurance contracts
and investment contracts. Interest-sensitive life insurance contracts are not
considered financial instruments subject to fair value disclosure requirements.
The fair value of investment contracts is based on the terms of the underlying
contracts. Fixed annuities are valued at the account balance less surrender
charges. Immediate annuities without life contingencies are valued at the
present value of future benefits using current interest rates. Market value
adjusted annuities' fair value is estimated to be the market adjusted surrender
value. The liability for collateral is valued at carrying value due to its
short-term nature. Separate accounts liabilities are carried at the fair value
of the underlying assets.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company primarily uses derivatives for risk reduction. With the
exception of embedded derivatives, all of the Company's derivatives are
evaluated for their on-going effectiveness as either accounting or non-hedge
derivative financial instruments on at least a quarterly basis (see Note 2). The
Company does not use derivatives for trading purposes. Non-hedge accounting is
used for "portfolio" level hedging strategies where the terms of the individual
hedged items do not meet the strict homogeneity requirements prescribed in SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133") to permit the application of SFAS 133's hedge accounting model. The
principal benefit of a "portfolio" level strategy is in its cost savings through
its ability to use fewer derivatives with larger notional amounts while hedging
on a macro basis.
Asset-liability management is a risk management strategy that is employed
to align the respective interest-rate sensitivities of assets and liabilities.
Depending upon the attributes of the assets acquired and liabilities issued,
derivative instruments such as interest rate caps are acquired to change the
interest rate characteristics of existing assets and liabilities to ensure a
proper matched relationship is maintained and to reduce exposure to rising or
falling interest rates. The Company uses financial futures for macro-hedging
related primarily to anticipated asset and liability purchases.
54
<Page>
The following table summarizes the notional amount, fair value and
carrying value of the Company's derivative financial instruments at December 31,
2005.
<Table>
<Caption>
CARRYING CARRYING
NOTIONAL FAIR VALUE VALUE
(IN THOUSANDS) AMOUNT VALUE ASSETS (1) (LIABILITIES)(1)
-------------- -------------- -------------- ----------------
AT DECEMBER 31, 2005
Financial futures contracts $ 169,100 $ 25 $ 71 $ (46)
Interest rate cap agreements 186,300 2,721 2,912 (191)
-------------- -------------- -------------- ----------------
Total interest rate contracts $ 355,400 $ 2,746 $ 2,983 $ (237)
============== ============== ============== ================
Foreign currency swap agreements $ 7,500 $ (154) $ - $ (154)
============== ============== ============== ================
Structured settlement annuity
reinsurance agreement $ - $ (1,473) $ (1,473) $ -
============== ============== ============== ================
Guaranteed accumulation benefits $ 194,098 $ 553 $ - $ 553
============== ============== ============== ================
Guaranteed accumulation benefits
reinsurance agreement $ 194,098 $ (553) $ (553) $ -
============== ============== ============== ================
Guaranteed withdrawal benefits $ 21,746 $ (2) $ - $ (2)
============== ============== ============== ================
Guaranteed withdrawal benefits
reinsurance agreement $ 21,746 $ 2 $ 2 $ -
============== ============== ============== ================
Other embedded derivative financial
instruments $ 1,762 $ (3) $ - $ (3)
============== ============== ============== ================
</Table>
- ----------
(1) Carrying value includes the effects of legally enforceable master netting
agreements. Fair value and carrying value of the assets and liabilities
exclude accrued periodic settlements, which are reported in accrued
investment income or other invested assets.
The following table summarizes the notional amount, fair value and carrying
value of the Company's derivative financial instruments at December 31, 2004.
<Table>
<Caption>
CARRYING CARRYING
NOTIONAL FAIR VALUE VALUE
(IN THOUSANDS) AMOUNT VALUE ASSETS (1) (LIABILITIES)(1)
-------------- -------------- -------------- ----------------
AT DECEMBER 31, 2004
Financial futures contracts $ 179,200 $ 80 $ 280 $ (200)
Interest rate cap agreements 152,000 3,628 4,262 (634)
-------------- -------------- -------------- ----------------
Total interest rate contracts $ 331,200 $ 3,708 $ 4,542 $ (834)
============== ============== ============== ================
Foreign currency swap agreements $ 7,500 $ (724) $ - $ (724)
============== ============== ============== ================
Structured settlement annuity
reinsurance agreement $ - $ (995) $ (995) $ -
============== ============== ============== ================
Guaranteed accumulation benefits $ 93,507 $ 141 $ - $ 141
============== ============== ============== ================
Guaranteed accumulation benefits
reinsurance agreement $ 93,507 $ (141) $ (141) $ -
============== ============== ============== ================
Other embedded derivative financial
instruments $ 1,743 $ (3) $ - $ (3)
============== ============== ============== ================
</Table>
- ----------
(1) Carrying value includes the effects of legally enforceable master netting
agreements. Fair value and carrying value of the assets and liabilities
exclude accrued periodic settlements, which are reported in accrued
investment income or other invested assets.
55
<Page>
The notional amounts specified in the contracts are used to calculate the
exchange of contractual payments under the agreements, and are not
representative of the potential for gain or loss on these agreements.
Fair value, which is equal to the carrying value, is the estimated amount
that the Company would receive (pay) to terminate the derivative contracts at
the reporting date. For exchange traded derivative contracts, the fair value is
based on dealer or exchange quotes. The fair value of non-exchange traded
derivative contracts is based on either independent third party pricing sources,
including dealer quotes, or widely accepted pricing and valuation models which
use independent third party data as inputs.
The Company manages its exposure to credit risk primarily by establishing
risk control limits. The Company uses master netting agreements for
over-the-counter derivative transactions, including foreign currency swap and
interest rate cap agreements. These agreements permit either party to net
payments due for transactions covered by the agreements. Under the provisions of
the agreements, collateral is either pledged or obtained when certain
predetermined exposure limits are exceeded. The Company has not incurred any
losses on derivative financial instruments due to counterparty nonperformance.
Futures contracts are traded on organized exchanges, which require margin
deposits and guarantee the execution of trades, thereby mitigating any
associated potential credit risk.
Market risk is the risk that the Company will incur losses due to adverse
changes in market rates and prices. Market risk exists for all of the derivative
financial instruments that the Company currently holds, as these instruments may
become less valuable due to adverse changes in market conditions. To limit this
risk, the Company's senior management has established risk control limits. In
addition, changes in fair value of the derivative financial instruments that the
Company uses for risk management purposes are generally offset by the change in
the fair value or cash flows of the hedged risk component of the related assets,
liabilities or forecasted transactions.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
The contractual amounts and fair values of off-balance-sheet financial
instruments at December 31 are as follows:
<Table>
<Caption>
2005 2004
-------------------------------- ------------------------------
CONTRACTUAL CONTRACTUAL
(IN THOUSANDS) AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------------- ------------- ------------- --------------
Commitments to extend mortgage loans $ 12,516 $ 125 $ 20,031 $ 200
Private placement commitments 15,000 - - -
</Table>
The contractual amounts represent the amount at risk if the contract is
fully drawn upon, the counterparty defaults and the value of any underlying
security becomes worthless. Unless noted otherwise, the Company does not require
collateral or other security to support off-balance-sheet financial instruments
with credit risk.
Commitments to extend mortgage loans are agreements to lend to a borrower
provided there is no violation of any condition established in the contract. The
Company enters into these agreements to commit to future loan fundings at a
predetermined interest rate. Commitments generally have fixed expiration dates
or other termination clauses. Commitments to extend mortgage loans, which are
secured by the underlying properties, are valued based on estimates of fees
charged by other institutions to make similar commitments to similar borrowers.
Private placement commitments represent conditional commitments to purchase
private placement debt and equity securities at a specified future date. The
Company regularly enters into these agreements in the normal course of business.
The fair value of these commitments generally cannot be estimated on the date
the commitment is made as the terms and conditions of the underlying private
placement securities are not yet final.
56
<Page>
8. RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS AND CONTRACTHOLDER FUNDS
At December 31, the reserve for life-contingent contract benefits consists
of the following:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004
-------------- --------------
Immediate annuities:
Structured settlement annuities $ 1,752,386 $ 1,674,902
Other immediate annuities 7,998 7,529
Traditional life 105,393 95,585
Other 4,098 4,435
-------------- -------------
Total reserve for life-contingent contract benefits $ 1,869,875 $ 1,782,451
============== ==============
</Table>
The following table highlights the key assumptions generally used in
calculating the reserve for life-contingent contract benefits:
<Table>
<Caption>
PRODUCT MORTALITY INTEREST RATE ESTIMATION METHOD
Structured settlement U.S. population with projected Interest rate Present value of
annuities calendar year improvements; assumptions range contractually specified
mortality rates adjusted for from 4.6% to 9.5% future benefits
each impaired life based on
reduction in life expectancy
and nature of impairment
Other immediate annuities 1983 group annuity mortality Interest rate Present value of expected
table assumptions range future benefits based on
1983 individual annuity from 2.4% to 11.5% historical experience
mortality table
Traditional life Actual company experience plus Interest rate Net level premium reserve
loading assumptions range method using the
from 4.0% to 8.0% Company's withdrawal
experience rates
Other:
Variable annuity 90% of 1994 group annuity 7% Projected benefit ratio
guaranteed minimum mortality table with internal applied to cumulative
death benefits modifications assessments
Supplemental Actual company experience plus Unearned premium;
accident and health loading additional contract
reserves for traditional
life
</Table>
To the extent that unrealized gains on fixed income securities would result
in a premium deficiency had those gains actually been realized, a premium
deficiency reserve has been recorded for certain immediate annuities with life
contingencies. A liability of $257.5 million and $240.3 million is included in
the reserve for life-contingent contract benefits with respect to this
deficiency as of December 31, 2005 and 2004, respectively. The offset to this
liability is recorded as a reduction of the unrealized net capital gains
included in accumulated other comprehensive income.
At December 31, contractholder funds consists of the following:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004
------------- -------------
Interest-sensitive life $ 427,523 $ 368,608
Investment contracts:
Fixed annuities 3,381,034 2,890,254
Immediate annuities and other 540,838 543,984
------------- -------------
Total contractholder funds $ 4,349,395 $ 3,802,846
============= =============
</Table>
57
<Page>
The following table highlights the key contract provisions relating to
contractholder funds:
<Table>
<Caption>
PRODUCT INTEREST RATE WITHDRAWAL/SURRENDER CHARGES
Interest-sensitive life Interest rates credited range Either a percentage of account balance or
from 4.0% to 5.25% dollar amount grading off generally over 20
years
Fixed and immediate Interest rates credited range Either a declining or a level percentage
annuities from 1.9% to 11.5% for charge generally over nine years or less.
immediate annuities and 0.0% Additionally, approximately 4.9% of fixed
to 10.3% for fixed annuities annuities are subject to a market value
adjustment for discretionary withdrawals
Other:
Variable guaranteed Interest rates used in Withdrawal and surrender charges are based on
minimum income establishing reserves range the terms of the related variable annuity
benefit and secondary from 1.75% to 10.3% contract
guarantees on
variable annuities
</Table>
Contractholder funds activity for the years ended December 31 is as
follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004
--------------- -----------------
BALANCE, BEGINNING OF YEAR $ 3,802,846 $ 2,658,325
Impact of adoption of SOP 03-1 (1) - 2,031
Deposits 883,814 1,385,364
Interest credited 173,984 129,243
Benefits (74,923) (46,649)
Surrenders and partial withdrawals (364,051) (246,081)
Contract charges (41,856) (41,573)
Net transfers to separate accounts (39,765) (39,906)
Other adjustments 9,346 2,092
--------------- -----------------
BALANCE, END OF YEAR $ 4,349,395 $ 3,802,846
=============== =================
</Table>
- ----------
(1) The increase in contractholder funds due to the adoption of SOP 03-1
reflects the establishment of reserves for certain liabilities that are
primarily related to income benefit guarantees provided under variable
annuities and the reclassification of deferred sales inducements ("DSI")
from contractholder funds to other assets.
58
<Page>
The table below presents information regarding the Company's variable
annuity contracts with guarantees. The Company's variable annuity contracts may
offer more than one type of guarantee in each contract; therefore, the sum of
amounts listed exceeds the total account balances of variable annuity contracts'
separate accounts with guarantees.
<Table>
<Caption>
DECEMBER 31,
--------------------------
($ IN MILLIONS) 2005 2004
----------- -----------
IN THE EVENT OF DEATH
Separate account value $ 926.3 $ 790.7
Net amount at risk (1) $ 38.2 $ 85.5
Average attained age of contractholders 66.5 years 62.9 years
AT ANNUITIZATION
Separate account value $ 41.8 $ 40.1
Net amount at risk (2) $ - $ -
Weighted average waiting period until annuitization options available 7.5 years 8.5 years
FOR CUMULATIVE PERIODIC WITHDRAWALS
Separate account value $ 19.8 $ -
Net amount at risk (3) $ - $ -
ACCUMULATION AT SPECIFIED DATES
Separate account value $ 188.9 $ 86.7
Net amount at risk (4) $ - $ -
Weighted average waiting period until guarantee date 10.5 years 11 years
</Table>
- ----------
(1) Defined as the estimated current guaranteed minimum death benefit in excess
of the current account balance at the balance sheet date.
(2) Defined as the estimated present value of the guaranteed minimum annuity
payments in excess of the current account balance.
(3) Defined as the estimated current guaranteed minimum withdrawal balance
(initial deposit) in excess of the current account balance at the balance
sheet date.
(4) Defined as the estimated present value of the guaranteed minimum
accumulation balance in excess of the current account balance.
The following summarizes the liabilities for guarantees:
<Table>
<Caption>
LIABILITY FOR
GUARANTEES
LIABILITY FOR LIABILITY FOR RELATED TO
GUARANTEES GUARANTEES ACCUMULATION
RELATED TO RELATED TO AND
DEATH INCOME WITHDRAWAL
(IN THOUSANDS) BENEFITS BENEFITS BENEFITS TOTAL
-------------- -------------- -------------- --------------
Balance at December 31, 2004 $ 662 $ 81 $ (141) $ 602
Less reinsurance recoverables - - 141 141
-------------- -------------- -------------- --------------
Net balance at December 31, 2004 662 81 - 743
Incurred guaranteed benefits 1,582 28 - 1,610
Paid guarantee benefits (2,084) (4) - (2,088)
-------------- -------------- -------------- --------------
Net change (502) 24 - (478)
Net balance at December 31, 2005 160 105 - 265
Plus reinsurance recoverables 104 - (551) (447)
-------------- -------------- -------------- --------------
Balance, December 31, 2005(1) $ 264 $ 105 $ (551) $ (182)
============== ============== ============== ==============
</Table>
- ----------
(1) Included in the total liability balance are reserves for variable annuity
death benefits of $264 thousand, variable annuity income benefits of $46
thousand, variable annuity accumulation benefits of $(553) thousand,
variable annuity withdrawal benefits of $2 thousand and other guarantees of
$59 thousand.
59
<Page>
In 2004, incurred guaranteed benefits were $1.8 million and $7 thousand for
death benefits and income benefits, respectively. There were no incurred
guaranteed accumulation benefits in 2004. Paid guarantee benefits were $2.0
million in 2004 for death benefits. There were no paid guarantee benefits in
2004 related to income and accumulation benefits. Further, the Company did not
offer withdrawal benefits in 2004.
9. REINSURANCE
The Company reinsures certain of its risks to unaffiliated reinsurers and
ALIC under yearly renewable term and coinsurance agreements. These agreements
result in a passing of the agreed-upon percentage of risk to the reinsurer in
exchange for negotiated reinsurance premium payments.
Mortality risk on policies in excess of $250 thousand per life is ceded to
ALIC. In addition, we used reinsurance to effect the disposal of substantially
all of our direct response distribution business. In 2005 and 2004, the Company
ceded $1.4 million and $5.5 million, respectively, to a subsidiary of Citigroup
and Scottish Re (U.S.) Inc. in connection with the disposal of the direct
response business.
As of December 31, 2005 and 2004, 37.6% and 32.4%, respectively, of our
face amount of life insurance in force was reinsured to non-affiliates and ALIC.
We retain primary liability as a direct insurer for all risks ceded to
reinsurers. Amounts recoverable from reinsurers are estimated based upon
assumptions consistent with those used in establishing the liabilities related
to the underlying reinsured contracts. No single reinsurer had a material
obligation to the Company nor is the Company's business substantially dependent
upon any reinsurance contract. See Note 4 for discussion of reinsurance
agreements with ALIC. The effects of reinsurance on premiums and contract
charges for the years ended December 31 are as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
-------------- -------------- ---------------
PREMIUMS AND CONTRACT CHARGES
Direct $ 150,749 $ 151,799 $ 128,713
Assumed - non-affiliate 950 719 337
Ceded
Affiliate (4,795) (4,329) (4,530)
Non-affiliate (12,086) (11,805) (3,491)
-------------- -------------- ---------------
Premiums and contract charges, net of reinsurance $ 134,818 $ 136,384 $ 121,029
============== ============== ===============
</Table>
The effects of reinsurance on contract benefits and interest credited to
contractholder funds for the years ended December 31 are as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
-------------- -------------- ---------------
CONTRACT BENEFITS AND INTEREST CREDITED TO CONTRACTHOLDER FUNDS
Direct $ 353,277 $ 319,217 $ 278,321
Assumed - non-affiliate 396 273 139
Ceded
Affiliate (1,154) (985) (1,590)
Non-affiliate (7,356) (6,551) (3,629)
-------------- -------------- ---------------
Contract benefits and interest credited to contractholder
funds, net of reinsurance $ 345,163 $ 311,954 $ 273,241
============== =============== ===============
</Table>
Included in reinsurance recoverables at December 31, 2005 and 2004 are the
amounts due from ALIC of $935 thousand and $1.1 million, respectively. The table
above excludes $2.9 million, $2.7 million and $2.6 million of premiums and
contract charges ceded to ALIC during 2005, 2004 and 2003, respectively, under
the terms of the structured settlement reinsurance treaty (See Note 4).
60
<Page>
10. DEFERRED POLICY ACQUISITION AND SALES INDUCEMENT COSTS
Deferred policy acquisitions costs for the years ended December 31 are as
follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
------------- ------------- -------------
BALANCE, BEGINNING OF YEAR $ 238,173 $ 187,437 $ 166,925
Impact of adoption of SOP 03-1 (1) - (11,140) -
Disposition of operations (2) - (3,213) -
Acquisition costs deferred 68,205 92,502 58,905
Amortization charged to income (41,663) (25,971) (29,969)
Effect of unrealized gains and losses 53,836 (1,442) (8,424)
------------- ------------- -------------
BALANCE, END OF YEAR $ 318,551 $ 238,173 $ 187,437
============= ============= =============
</Table>
- ----------
(1) In 2004, the impact of adoption of SOP 03-1 includes a write-down in
variable annuity DAC of $7.7 million, the reclassification of DSI from DAC
to other assets resulting in a decrease to DAC of $4.1 million and an
increase to DAC of $691 thousand for an adjustment to the effect of
unrealized capital gains and losses.
(2) In 2004, DAC was reduced by $3.2 million related to the disposition of
substantially all of our direct response distribution business
(see Note 3).
Net amortization charged to income includes $3.7 million, $2.1 million and
$1.7 million in 2005, 2004 and 2003, respectively, due to realized capital gains
and losses.
In 2005 and 2004, DSI and related amortization is classified within the
Statements of Financial Position and Operations and Comprehensive Income as
other assets and interest credited to contractholder funds, respectively.
Deferred sales inducement activity for the twelve months ended December 31 was
as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004
------------- -------------
BALANCE, BEGINNING OF YEAR (1) $ 2,955 $ 2,369
Sales inducements deferred 16,923 1,531
Amortization charged to income (2,373) (760)
Effect of unrealized gains and losses 1,022 (185)
------------- -------------
BALANCE, END OF YEAR $ 18,527 $ 2,955
============= =============
</Table>
- ----------
(1) The January 1, 2004 balance includes a $3.0 million write-down of DSI due
to the adoption of SOP 03-1 (see Note 2).
11. COMMITMENTS, GUARANTEES AND CONTINGENT LIABILITIES
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 breach 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 December 31, 2005.
61
<Page>
REGULATION
The Company is subject to changing social, economic and regulatory
conditions. From time to time regulatory authorities 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" sub-section below, please
note the following:
- These matters raise difficult and complicated factual and legal issues
and are subject to many uncertainties and complexities, including but
not limited to, 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.
- 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.
- For the reasons specified above, it is not possible at this time 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 on-going 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 quarter 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.
62
<Page>
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 include a lawsuit filed in
December 2001 by the U.S. Equal Employment Opportunity Commission ("EEOC")
alleging retaliation under federal civil rights laws, a class action filed in
August 2001 by former employee agents alleging retaliation and age
discrimination under the Age Discrimination in Employment Act, breach of
contract and ERISA violations, and a lawsuit filed in October 2004 by the EEOC
alleging age discrimination with respect to a policy limiting the rehire of
agents affected by the agency program reorganization. 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 and are seeking actual damages
including benefits under Allstate employee benefit plans and payments provided
in connection with the reorganization, as well as punitive damages. In late
March 2004, in the first EEOC lawsuit and class action lawsuit, 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 "concluded
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. The case otherwise remains pending. 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 April 2005. In these 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. The outcome of these disputes is currently uncertain.
The Company is currently undergoing a periodic market conduct
examination by state insurance regulators. Regulators are focusing, as they
have with other insurers, on the Company's compliance with the state's
replacement sales and record-keeping processes with regard to life insurance
and annuities among other issues. They have alleged that the Company failed
to meet the requirements of applicable regulations. In relation to this
examination the Company accrued $15 million of additional contractholder
benefits in 2005. The ultimate outcome of this examination including
potential customer remediation related to replacement sales is currently
under discussion with the New York State Department of Insurance.
OTHER MATTERS
The Corporation and some of its subsidiaries, including the Company, have
received interrogatories and demands for information from regulatory and
enforcement authorities relating to various insurance products and practices.
The areas of inquiry include variable annuity market timing and late trading.
The Corporation and some of its subsidiaries, including the Company, have also
received interrogatories and demands for information from authorities seeking
information relevant to on-going investigations into the possible violation of
antitrust or insurance laws by unnamed parties and, in particular, seeking
information as to whether any person engaged in activities for the purpose of
price fixing, market allocation, or bid rigging. The Company believes that these
inquiries are similar to those made to many financial services companies as part
of industry-wide investigations by various authorities into the practices,
policies and procedures relating to insurance and financial services products.
The Corporation and its subsidiaries have responded and will continue to respond
to these inquiries.
63
<Page>
Various other legal and regulatory actions 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 quarter 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.
12. INCOME TAXES
The Company joins the Corporation and its other eligible domestic
subsidiaries (the "Allstate Group") in the filing of a consolidated federal
income tax return and is party to a federal income tax allocation agreement (the
"Allstate Tax Sharing Agreement"). Under the Allstate Tax Sharing Agreement, the
Company pays to or receives from the Corporation the amount, if any, by which
the Allstate Group's federal income tax liability is affected by virtue of
inclusion of the Company in the consolidated federal income tax return.
Effectively, this results in the Company's annual income tax provision being
computed, with adjustments, as if the Company filed a separate return.
The Internal Revenue Service ("IRS") has completed its review of the
Allstate Group's federal income tax returns through the 2002 tax year. Any
adjustments that may result from IRS examinations of tax returns are not
expected to have a material impact on the financial position, liquidity or
results of operations of the Company.
The components of the deferred income tax assets and liabilities at
December 31 are as follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004
---------------- ---------------
DEFERRED ASSETS
Life and annuity reserves $ 80,180 $ 77,104
Other assets 1,376 4,839
---------------- ---------------
Total deferred assets 81,556 81,943
---------------- ---------------
DEFERRED LIABILITIES
Deferred policy acquisition costs (78,316) (73,583)
Unrealized net capital gains (69,444) (83,599)
Difference in tax bases of investments (6,011) (11,299)
Other liabilities (1,184) (4,222)
---------------- ---------------
Total deferred liabilities (154,955) (172,703)
---------------- ---------------
Net deferred liability $ (73,399) $ (90,760)
================ ===============
</Table>
Although realization is not assured, management believes it is more likely than
not that the deferred tax assets will be realized based on the assumption that
certain levels of income will be achieved.
The components of income tax expense for the years ended December 31 are as
follows:
<Table>
<Caption>
(IN THOUSANDS) 2005 2004 2003
----------- ------------ ------------
Current $ 24,132 $ 13,640 $ 8,488
Deferred (3,187) 4,285 3,541
----------- ------------ ------------
Total income tax expense $ 20,945 $ 17,925 $ 12,029
=========== ============ ============
</Table>
The Company paid income taxes of $18.4 million, $5.8 million and $15.7
million in 2005, 2004 and 2003, respectively.
64
<Page>
A reconciliation of the statutory federal income tax rate to the effective
income tax rate on income from operations for the years ended December 31 is as
follows:
<Table>
<Caption>
2005 2004 2003
-------------- ------------- -------------
Statutory federal income tax rate 35.0% 35.0% 35.0%
State income tax expense 3.0 2.1 4.0
Other (0.2) (1.6) (2.2)
-------------- ------------- -------------
Effective income tax rate 37.8% 35.5% 36.8%
============== ============= =============
</Table>
Prior to January 1, 1984, the Company was entitled to exclude certain
amounts from taxable income and accumulate such amounts in a "policyholder
surplus" account. Pursuant to the American Jobs Creation Act of 2004 ("the 2004
Act"), the Company can reduce the policyholder surplus account in 2005 and 2006
without incurring any tax liability. The remaining balance in this account at
December 31, 2005, was $389 thousand, which prior to the 2004 Act would have
resulted in federal income taxes payable of $136 thousand if such amounts had
been distributed or deemed distributed from the policyholder surplus account. No
provision for taxes has ever been made for this item since the Company had no
prior intention of incurring such tax liability. The Company expects to utilize
the 2004 Act provision in 2006, thereby eliminating this remaining potential tax
liability.
13. STATUTORY FINANCIAL INFORMATION
The Company prepares its statutory-basis financial statements in conformity
with accounting practices prescribed or permitted by the State of New York. The
State of New York requires insurance companies domiciled in its state to prepare
statutory-basis financial statements in conformity with the NAIC Accounting
Practices and Procedures Manual, subject to any deviations prescribed or
permitted by the State of New York Insurance Superintendent. Prescribed
statutory accounting practices include a variety of publications of the NAIC, as
well as state laws, regulations and general administrative rules. Permitted
statutory accounting practices encompass all accounting practices not so
prescribed.
Statutory accounting practices primarily differ from GAAP since they
require charging policy acquisition and certain sales inducement costs to
expense as incurred, establishing life insurance reserves based on different
actuarial assumptions, and valuing investments and establishing deferred taxes
on a different basis.
Statutory net income for 2005, 2004 and 2003 was $35.9 million, $13.6
million and $36.8 million, respectively. Statutory capital and surplus as of
December 31, 2005 and 2004 was $410.3 million and $356.8 million, respectively.
DIVIDENDS
The ability of the Company to pay dividends is dependent on business
conditions, income, cash requirements of the Company and other relevant factors.
The payment of shareholder dividends by the Company without prior approval of
the state insurance regulator in any calendar year is limited to formula amounts
based on statutory surplus and statutory net gain from operations, determined in
conformity with statutory accounting practices, for the immediately preceding
calendar year. The maximum amount of dividends that the Company can distribute
during 2006 without prior approval of the New York State Insurance Department is
$41.0 million. In the twelve-month period beginning January 1, 2005, the Company
did not pay any dividends.
65
<Page>
14. BENEFIT PLANS
PENSION AND OTHER POSTRETIREMENT PLANS
The Company utilizes the services of AIC employees. AIC provides various
benefits, described in the following paragraphs, to its employees. The Company
is allocated an appropriate share of the costs associated with these benefits in
accordance with a service and expenses agreement.
Defined pension plans, sponsored by AIC, cover most full-time employees and
certain part-time employees. Benefits under the pension plans are based upon the
employee's length of service and eligible annual compensation. The Company uses
the accrual method for its defined benefit plans in accordance with accepted
actuarial methods. AIC's funding policy for the pension plans is to make annual
contributions at a minimum level that is at least in accordance with regulations
under the Internal Revenue Code and in accordance with generally accepted
actuarial principles. The allocated cost to the Company included in net income
was $1.8 million, $1.5 million and $1.4 million for the pension plans in 2005,
2004 and 2003, respectively. AIC also provides certain health care and life
insurance subsidies for employees hired before January 1, 2003 when they retire
("Postretirement benefits"). Qualified employees may become eligible for these
benefits if they retire in accordance with AIC's established retirement policy
and are continuously insured under AIC's group plans or other approved plans in
accordance with the plan's participation requirements. AIC shares the cost of
the retiree medical benefits with retirees based on years of service, with AIC's
share being subject to a 5% limit on annual medical cost inflation after
retirement. AIC's postretirement benefit plans are not funded. AIC has the right
to modify or terminate these plans. The allocated cost to the Company included
in net income was $543 thousand, $588 thousand and $431 thousand for
postretirement benefits other than pension plans in 2005, 2004 and 2003,
respectively.
PROFIT SHARING PLAN
Employees of AIC are eligible to become members of The Savings and Profit
Sharing Fund of Allstate Employees ("Allstate Plan"). The Corporation's
contributions are based on the Corporation's matching obligation and
performance.
The Company's allocation of profit sharing expense from the Corporation was
$764 thousand, $1.3 million and $1.1 million in 2005, 2004 and 2003,
respectively.
66
<Page>
15. OTHER COMPREHENSIVE INCOME
The components of other comprehensive (loss) income on a pretax and
after-tax basis for the years ended December 31 are as follows:
<Table>
<Caption>
2005
---------------------------------------
After-
(IN THOUSANDS) Pretax Tax tax
----------- ----------- -----------
UNREALIZED CAPITAL GAINS AND LOSSES:
Unrealized holding losses arising during the
period $ (46,529) $ 16,285 $ (30,244)
Less: reclassification adjustments (6,087) 2,130 (3,957)
----------- ----------- -----------
Unrealized net capital gains and losses (40,442) 14,155 (26,287)
----------- ----------- -----------
Other comprehensive loss $ (40,442) $ 14,155 $ (26,287)
=========== =========== ===========
</Table>
<Table>
<Caption>
2004
---------------------------------------
After-
(IN THOUSANDS) Pretax Tax tax
----------- ----------- -----------
UNREALIZED CAPITAL GAINS AND LOSSES:
Unrealized holding gains arising during the
period $ 20,221 $ (7,077) $ 13,144
Less: reclassification adjustments (5,211) 1,824 (3,387)
----------- ----------- -----------
Unrealized net capital gains and losses 25,432 (8,901) 16,531
----------- ----------- -----------
Other comprehensive income $ 25,432 $ (8,901) $ 16,531
=========== =========== ===========
</Table>
<Table>
<Caption>
2003
---------------------------------------
After-
(IN THOUSANDS) Pretax Tax tax
----------- ----------- -----------
UNREALIZED CAPITAL GAINS AND LOSSES:
Unrealized holding losses arising during the
period $ (53,362) $ 18,677 $ (34,685)
Less: reclassification adjustments (5,776) 2,022 (3,754)
----------- ----------- -----------
Unrealized net capital gains and losses (47,586) 16,655 (30,931)
----------- ----------- -----------
Other comprehensive loss $ (47,586) $ 16,655 $ (30,931)
=========== =========== ===========
</Table>
67
<Page>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND SHAREHOLDER OF
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
We have audited the accompanying Statements of Financial Position of Allstate
Life Insurance Company of New York (the "Company", an affiliate of The Allstate
Corporation) as of December 31, 2005 and 2004, and the related Statements of
Operations and Comprehensive Income, Shareholder's Equity, and Cash Flows for
each of the three years in the period ended December 31, 2005. Our audits also
included the financial statement schedules listed in the Index at Item 15. These
financial statements and financial statement schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on the
financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2005 and
2004, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2005, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, such financial statement schedules, when considered in relation to the
basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.
As discussed in Note 2 to the financial statements, the Company changed its
method of accounting for certain nontraditional long-duration contracts and
separate accounts in 2004.
/s/ Deloitte & Touche LLP
Chicago, Illinois
March 10, 2006
68
<Page>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. We maintain disclosure
controls and procedures as defined in Rule 15d-15(e) under the Securities
Exchange Act of 1934. Under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this report.
Based upon this evaluation, the principal executive officer and the principal
financial officer concluded that our disclosure controls and procedures are
effective in providing reasonable assurance that material information required
to be disclosed in our reports filed with or submitted to the Securities and
Exchange Commission under the Securities Exchange Act is made known to
management, including the principal executive officer and the principal
financial officer, as appropriate to allow timely decisions regarding required
disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. During the fiscal
quarter ended December 31, 2005, 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.
ITEM 9B. OTHER INFORMATION
On March 8, 2006, the Corporation issued a press release announcing that
it, the Company and ALIC had entered into a definitive agreement
("Agreement") with Prudential Financial, Inc. and its subsidiary The
Prudential Insurance Company of America (collectively "Prudential") for the
sale pursuant to a combination of coinsurance and modified coinsurance
reinsurance of substantially all of its variable annuity business.
Total consideration is expected to be approximately $581 million,
subject to adjustment for changes in equity markets and interest rates
between the effective date of the Agreement and the closing of the
transaction. ALIC has entered into an economic hedge that it believes will
substantially reduce its economic exposure to the variability of this
arrangement from the period between the effective date of the Agreement and
closing. As a result of the modified coinsurance reinsurance, the separate
account assets and liabilities will remain on the Company's statements of
financial position, but the related results of operations will be fully
reinsured to Prudential. The sale is expected to result in the recognition of
a small gain, which will be amortized into earnings over the life of the
Agreement. A level of cash or cash equivalents in an amount equal to the
fixed (general) account liabilities of approximately $410 million, net of the
consideration, will be needed to settle our obligation to Prudential at
closing under the coinsurance portion of the Agreement. An evaluation will
occur in the first quarter of 2006 regarding available sources of funds for
settlements, which may include such items as cash flows from operations,
sales of existing investments or borrowings.
Under the Agreement, the Company, ALIC and the Corporation will each
indemnify Prudential for certain pre-closing contingent liabilities
(including extra-contractual liabilities of the Company and ALIC and
liabilities specifically excluded from the transaction) that 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 terms of the Agreement will 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. The Company and ALIC have also agreed
to continue to issue variable annuity contracts in the financial institutions
channel for a period of at least thirty-three months and cede them to
Prudential. The Agreement is subject to regulatory approval and is expected
to be completed by the end of the second quarter of 2006.
In 2005, the Company's variable annuity business generated approximately
$17 million in contract charges on separate account balances of $927 million
and general account balances of $501 million as of December 31, 2005.
Separate account balances totaling approximately $1 million related to the
variable life business continue to be retained by the Company.
69
<Page>
PART III
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
(1), (2), (3) AND (4) DISCLOSURE OF FEES -
The following fees have been, or are anticipated to be billed by Deloitte &
Touche LLP, the member firms of Deloitte & Touche Tohmatsu, and their respective
affiliates, for professional services rendered to us for the fiscal years ending
December 31, 2005 and 2004.
<Table>
<Caption>
2005 2004
------------ ------------
Audit fees (a) $ 360,599 $ 330,824
------------ ------------
TOTAL FEES $ 360,599 $ 330,824
============ ============
</Table>
(a) Fees for audits of annual financial statements including financial
statements for the separate accounts, reviews of quarterly financial
statements, statutory audits, attest services, comfort letters, consents
and review of documents filed with the Securities and Exchange Commission.
(5)(i) AND (ii) AUDIT COMMITTEE'S PRE-APPROVAL POLICIES AND PROCEDURES -
The Audit Committee of The Allstate Corporation has established
pre-approval policies and procedures for itself and its consolidated
subsidiaries, including Allstate Life of New York. Those policies and
procedures are incorporated into this Item 14 (5) by reference to Exhibit
99(ii) - The Allstate Corporation Policy Regarding Pre-Approval of
Independent Auditors' Services (the "Pre-Approval Policy"). In addition, in
2005 the Board of Directors of Allstate Life of New York adopted the
Pre-Approval Policy, as it may be amended from time to time by the Audit
Committee or the Board of Directors of the Corporation, as its own policy,
provided that the Designated Member referred to in such policy need not be
independent because the New York Stock Exchange corporate governance
standards do not apply to Allstate Life of New York and provided that
references to the "audit committee" would mean Allstate Life of New York's
Board. All of the services provided by Deloitte and Touche LLP to Allstate
Life of New York in 2005 were pre-approved by The Allstate Corporation Audit
Committee and the Allstate Life of New York Board and all of the services
provided in 2004 were pre-approved by The Allstate Corporation Audit
Committee.
70
<Page>
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) The following financial statements, notes thereto and related
information of Allstate Life of New York are included in Item 8.
Statements of Operations and Comprehensive Income
Statements of Financial Position
Statements of Shareholder's Equity
Statements of Cash Flows
Notes to Financial Statements
Report of Independent Registered Public Accounting Firm
(2) The following additional financial statement schedules are
furnished herewith pursuant to the requirements of Form 10-K.
<Table>
<Caption>
Allstate Life Insurance Company of New York Page
------------------------------------------- ----
Schedules required to be filed under provisions of Regulation S-X Article 7:
Schedule I - Summary of Investments - Other Than Investments in Related Parties S-1
Schedule IV - Reinsurance S-2
Schedule V - Valuation and Qualifying Accounts S-3
</Table>
All other schedules have been omitted because they are not applicable
or required or because the required information is included in the
financial statements or notes thereto.
(3) The following is a list of the exhibits filed as part of this
Form 10-K. The SEC file number for the exhibits incorporated by
reference is 033-47245 except as otherwise noted.
<Table>
<Caption>
Exhibit
No. Description
---------- -----------
3(i) Restated Certificate of Incorporation of Allstate Life
Insurance Company of New York dated December 2, 2003.
Incorporated herein by reference to Exhibit 3(i) to
Allstate Life Insurance Company of New York's Annual
Report on Form 10-K for 2003.
3(ii) Amended By-Laws of Allstate Life Insurance Company of
New York dated December 16, 1998. Incorporated herein
by reference to Exhibit 3(ii) to Allstate Life
Insurance Company of New York's Annual Report on Form
10-K for 1998.
10.1 Amended and Restated Service and Expense Agreement
between Allstate Insurance Company, The Allstate
Corporation and certain affiliates, effective January
1, 2004, and effective March 5, 2005 with respect to
Allstate Life Insurance Company of New York.
Incorporated herein by reference to Exhibit 10.1 to
Allstate Life Insurance Company's Quarterly Report on
Form 10-Q for quarter ended June 30, 2005.
10.2 New York Insurer Supplement to Amended and Restated
Service and Expense Agreement between Allstate
Insurance Company, The Allstate Corporation, Allstate
Life Insurance Company of New York and Intramerica Life
Insurance Company, effective March 5, 2005.
Incorporated herein by reference to Exhibit 10.2 to
Allstate Life Insurance Company's Quarterly Report on
Form 10-Q for quarter ended June 30, 2005.
</Table>
71
<Page>
<Table>
10.3 Investment Advisory Agreement and Amendment to Service
Agreement as of January 1, 2002 between Allstate
Insurance Company, Allstate Investments, LLC and
Allstate Life Insurance Company of New York.
Incorporated herein by reference to Exhibit 10.2 to
Allstate Life Insurance Company of New York's Quarterly
Report on Form 10-Q for quarter ended March 31, 2002.
10.4 Tax Sharing Agreement dated as of November 12, 1996
among The Allstate Corporation and certain affiliates.
Incorporated herein by reference to Exhibit 10.36 to
Allstate Life Insurance Company's Form 10 filed on
April 24, 2002. (SEC File No. 000-31248)
10.5 Underwriting Agreement between Allstate Life Insurance
Company of New York and ALFS, Inc., effective October
1, 1996. Incorporated herein by reference to Exhibit
10.1 to Allstate Life Insurance Company of New York's
Quarterly Report on Form 10-Q for quarter ended June
30, 2002.
10.6 Principal Underwriting Agreement between Allstate Life
Insurance Company of New York and Allstate
Distributors, L.L.C., effective May 1, 2000.
Incorporated herein by reference to Exhibit 10.2 to
Allstate Life Insurance Company of New York's Quarterly
Report on Form 10-Q for quarter ended June 30, 2002.
10.7 Selling Agreement between Allstate Life Insurance
Company of New York, ALFS, Inc. and Allstate Financial
Services, LLC effective May 1, 2005. Incorporated
herein by reference to Exhibit 10.7 to Allstate Life
Insurance Company's Annual Report on Form 10-K for
2003. (SEC File No. 000-31248)
10.8 Reinsurance Agreement between Allstate Life Insurance
Company and Allstate Life Insurance Company of New York
effective January 1, 1984 as amended by Amendment No. 1
effective September 1, 1984, Amendment No.2 effective
January 1, 1987, Amendment No.3 effective October 1,
1988, Amendment No.4 effective January 1, 1994 and
Amendment No.5 effective December 31, 1995.
Incorporated herein by reference to Exhibit 10.6 to
Allstate Life Insurance Company of New York's Quarterly
Report on Form 10-Q for quarter ended June 30, 2002.
10.9 Assumption Reinsurance Agreement between Allstate Life
Insurance Company and Allstate Life Insurance Company
of New York effective July 1, 1984. Incorporated herein
by reference to Exhibit 10.7 to Allstate Life Insurance
Company of New York's Quarterly Report on Form 10-Q for
quarter ended June 30, 2002.
10.10 Reinsurance Agreement between Allstate Life Insurance
Company and Allstate Life Insurance Company of New
York, effective January 1, 1986, as amended by
Amendment No.1 effective December 31, 1995 and
Amendment No. 2 effective December 1, 1995.
Incorporated herein by reference to Exhibit 10.8 to
Allstate Life Insurance Company of New York's Quarterly
Report on Form 10-Q for quarter ended June 30, 2002.
10.11 Reinsurance Agreement between Allstate Life Insurance
Company and Allstate Life Insurance Company of New
York, effective January 1, 1991, as amended by
Amendment No.1 effective December 31, 1995.
Incorporated herein by reference to Exhibit 10.9 to
Allstate Life Insurance Company of New York's Quarterly
Report on Form 10-Q for quarter ended June 30, 2002.
10.12 Stop Loss Reinsurance Agreement between Allstate Life
Insurance Company and Allstate Life Insurance Company
of New York effective December 31, 2001. Incorporated
herein by reference to Exhibit 10.16 to Allstate Life
Insurance Company of New York's Annual Report on Form
10-K for 2003.
</Table>
72
<Page>
<Table>
10.13 Automatic Annuity Reinsurance Agreement between
Allstate Life Insurance Company of New York and
Allstate Life Insurance Company, effective January 2,
2004. Incorporated herein by reference to Exhibit 10.2
to Allstate Life Insurance Company of New York's
Quarterly Report on Form 10-Q for quarter ended June
30, 2004.
10.14 Amendment No. 1 to Automatic Annuity Reinsurance
Agreement between Allstate Life Insurance Company of
New York and Allstate Life Insurance Company, effective
January 1, 2005. Incorporated herein by reference to
Exhibit 10.1 to Allstate Life Insurance Company of New
York's Quarterly Report on Form 10-Q for quarter ended
March 31, 2005.
23 Consent of Independent Registered Public Accounting
Firm
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
99(i) Press release dated March 8, 2006 issued by The
Allstate Corporation.
99(ii) The Allstate Corporation Policy Regarding Pre-Approval
of Independent Auditors' Services effective November
10, 2003. Incorporated herein by reference to Exhibit
99(ii) to Allstate Life Insurance Company of New York's
Annual Report on Form 10-K for 2004.
</Table>
(b) The exhibits are listed in Item 15. (a) (3) above.
(c) The financial statement schedules are listed in Item 15. (a) (2)
above.
73
<Page>
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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)
March 13, 2006 /s/ Samuel H. Pilch
-------------------
By: Samuel H. Pilch
(chief accounting officer and duly
authorized officer of the registrant)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Casey J. Sylla Chairman of the Board, March 13, 2006
- ------------------ President and a Director
Casey J. Sylla (Principal Executive Officer)
/s/ John C. Pintozzi Vice President, Chief March 13, 2006
- -------------------- Financial Officer and a
John C. Pintozzi Director
(Principal Financial Officer)
/s/ Marcia D. Alazraki Director March 5, 2006
- ----------------------
Marcia D. Alazraki
/s/ Vincent A. Fusco Director March 13, 2006
- --------------------
Vincent A. Fusco
/s/ Cleveland Johnson, Jr. Director March 3, 2006
- --------------------------
Cleveland Johnson, Jr.
/s/ John C. Lounds Director March 13, 2006
- ----------------------
John C. Lounds
/s/ Kenneth R. O'Brien Director March 7, 2006
- ----------------------
Kenneth R. O'Brien
/s/ John R. Raben, Jr. Director March 6, 2006
- ----------------------
John R. Raben, Jr.
/s/ Phyllis Hill Slater Director March 13, 2006
- -----------------------
Phyllis Hill Slater
/s/ Kevin R. Slawin Director March 13, 2006
- ----------------------
Kevin R. Slawin
/s/ Michael J. Velotta Director March 13, 2006
- ----------------------
Michael J. Velotta
/s/ Douglas B. Welch Director March 13, 2006
- ----------------------
Douglas B. Welch
/s/ Patricia W. Wilson Director March 13, 2006
- ----------------------
Patricia W. Wilson
</Table>
74
<Page>
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED
PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 BY REGISTRANTS
WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12
OF THE SECURITIES EXCHANGE ACT OF 1934
All of the outstanding common stock of the Company is owned by Allstate
Life Insurance Company. The Company has not provided any of the following items
to security holders:
(1) annual reports to security holders covering the registrant's last
fiscal year; or
(2) proxy statements, forms of proxy or other proxy soliciting
materials.
75
<Page>
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS
IN RELATED PARTIES
DECEMBER 31, 2005
<Table>
<Caption>
AMOUNTS AT
WHICH
SHOWN ON
BALANCE
(IN THOUSANDS) COST FAIR VALUE SHEET
---- ---------- -----
TYPE OF INVESTMENT
Fixed Maturities:
Bonds:
United States government, government agencies and authorities... $ 510,362 $ 723,783 $ 723,783
States, municipalities and political subdivisions .............. 308,219 327,636 327,636
Foreign governments ............................................ 236,078 306,335 306,335
Public utilities ............................................... 639,702 706,431 706,431
All other corporate bonds ...................................... 2,646,950 2,734,831 2,734,831
Mortgage-backed securities ........................................ 569,712 563,050 563,050
Commercial mortgage-backed securities ............................. 490,985 491,835 491,835
Asset-backed securities ........................................... 123,981 124,370 124,370
Redeemable preferred stocks ....................................... 9,407 10,992 10,992
------------ ------------ ------------
Total fixed maturities ......................................... 5,535,396 $ 5,989,263 5,989,263
============ ============ ============
Mortgage loans on real estate ........................................ 633,789 633,789
Policy loans ......................................................... 36,698 36,698
Short-term investments ............................................... 63,057 63,057
Derivative instruments ............................................... 3,740 3,740
Other ................................................................ - -
------------ ------------
Total investments .............................................. $ 6,272,680 $ 6,726,547
============ ============
</Table>
S-1
<Page>
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
SCHEDULE IV--REINSURANCE
<Table>
<Caption>
PERCENTAGE
OF AMOUNT
GROSS NET ASSUMED
(IN THOUSANDS) AMOUNT CEDED ASSUMED AMOUNT TO NET
------------- ------------- ------------- ------------- -------------
YEAR ENDED DECEMBER 31, 2005
Life insurance in force $ 25,508,599 $ 9,806,717 $ 540,025 $ 16,241,907 3.3%
============= ============= ============= =============
Premiums and contract charges:
Life and annuities $ 142,091 $ 12,372 $ 950 $ 130,669 0.7%
Accident and health 8,658 4,509 - 4,149 -
------------- ------------- ------------- -------------
$ 150,749 $ 16,881 $ 950 $ 134,818 0.7%
============= ============= ============= =============
YEAR ENDED DECEMBER 31, 2004
Life insurance in force $ 23,151,807 $ 7,605,444 $ 302,905 $ 15,849,268 1.9%
============= ============= ============= =============
Premiums and contract charges:
Life and annuities $ 142,729 $ 9,952 $ 382 $ 133,159 0.3%
Accident and health 9,070 6,182 337 3,225 10.4%
------------- ------------- ------------- -------------
$ 151,799 $ 16,134 $ 719 $ 136,384 0.5%
============= ============= ============= =============
YEAR ENDED DECEMBER 31, 2003
Life insurance in force $ 20,491,517 $ 4,772,371 $ 58,002 $ 15,777,148 0.4%
============= ============= ============= =============
Premiums and contract charges:
Life and annuities $ 119,247 $ 7,196 $ 336 $ 112,387 0.3%
Accident and health 9,467 825 - 8,642 -
------------- ------------- ------------- -------------
$ 128,714 $ 8,021 $ 336 $ 121,029 0.3%
============= ============= ============= =============
</Table>
S-2
<Page>
ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
<Table>
<Caption>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
(IN THOUSANDS) OF PERIOD EXPENSES DEDUCTIONS PERIOD
------------ ------------ ------------ ------------
YEAR ENDED DECEMBER 31, 2005
Allowance for estimated losses
on mortgage loans $ - $ - $ - $ -
============ ============ ============ ============
YEAR ENDED DECEMBER 31, 2004
Allowance for estimated losses
on mortgage loans $ - $ - $ - $ -
============ ============ ============ ============
YEAR ENDED DECEMBER 31, 2003
Allowance for estimated losses
on mortgage loans $ - $ 982 $ 982 $ -
============ ============ ============ ============
</Table>
S-3