Item 1. Business
Transamerica Advisors Life Insurance Company (“TALIC” or the “Company”) is a wholly owned subsidiary of AEGON USA, LLC (“AUSA”). AUSA is an indirect wholly owned subsidiary of AEGON N.V., a public limited liability company organized under Dutch law. AEGON N.V. and its subsidiaries and joint ventures have life insurance and pension operations in over twenty-five countries in Europe, the Americas, and Asia and are also active in savings and asset management operations, accident and health insurance, general insurance and to a limited extent banking operations.
The Registrant is a life insurance company, who conducts its business primarily in the annuity markets and to a lesser extent in the life insurance markets of the financial services industry. The Registrant was incorporated under the laws of the State of Washington on January 27, 1986 and redomesticated to the State of Arkansas on August 31, 1991. The Registrant is currently subject to primary regulation by the Arkansas Insurance Department.
The Registrant is currently licensed to conduct business in 49 states, the District of Columbia, the U.S. Virgin Islands, and Guam. During 2014, life insurance and/or annuity deposits on existing policies were made in all states the Registrant was licensed in, with the largest concentration in Florida, 36%, New Jersey, 12%, Texas, 6%, Illinois, 5%, and California, 5%. Currently, the Company is not issuing new life insurance, variable annuity and market value adjusted annuity products. In 2012, the Company began selling a fixed contingent annuity (also sometimes referred to as a contingent deferred annuity (“CDA”)) that includes a stand-alone living benefit (“SALB”). A SALB is essentially a guaranteed lifetime withdrawal benefit which exists independently and is applied to mutual funds and exchange traded funds.
Information pertaining to contract owner deposits, contract owner account balances, and capital contributions can be found in the Registrant’s Financial Statements which are contained herein.
The Registrant makes available, free of charge, annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. This information is available through About Us section under Financial Strength of the Transamerica website at www.transamerica.com. These reports are available through the website as soon as reasonably practicable after the Registrant electronically files such material with, or furnishes it to, the Securities and Exchange Commission.
Item 1A.
Item 1A. Risk Factors
Risk Factors that Could Affect Transamerica Advisors Life Insurance Company
In the course of conducting its business operations, the Company could be exposed to a variety of risks that are inherent to the insurance industry. A summary of some of the significant risks that could affect the Company’s financial condition and results of operations is included below. Some of these risks are managed in accordance with established risk management policies and procedures. Other factors besides those discussed below or elsewhere in this Form 10-K also could adversely affect our business and operations, and the following risk factors should not be considered a complete list of potential risks that may affect the Company.
Our operating environment remains uncertain about the timing and strength of a recovery in the U.S. and global economy. The steps we have taken to realign our business and strengthen our capital position may not be adequate to mitigate the financial and other risks associated with our operating environment which could materially affect our results of operations and financial condition
Uncertainty in the U.S. and global economy continued to affect our operating environment. Our results, financial condition and statutory capital remain sensitive to equity market volatility and performance, and expectations are that market conditions will continue to pressure returns in our investment portfolio. Concerns over Global market conditions and the ability of the U.S.
Government to manage the U.S. deficit have contributed to increased volatility and diminished expectations for the economy and the market going forward. These events may have an adverse effect on us given our equity market exposure and our revenues may decline in such circumstances. In addition, we may experience an elevated instance of claims and lapses or surrenders of our policies. Adverse changes in the economy could affect earnings negatively and could have a material adverse effect on our results of operations and financial condition.
We maintain a level of cash and securities which, combined with expected cash inflows from investments and operations, is believed adequate to meet anticipated short-term and long-term benefit obligations. However, withdrawal and surrender levels may differ from anticipated levels for a variety of reasons, such as changes in economic conditions. In addition, disruptions, uncertainty, or volatility in the capital and credit markets may limit our access to capital required to operate our business. Such market conditions may limit our ability to satisfy statutory capital requirements, fund redemption requests, and generate fee income and market related revenue to meet liquidity needs. As such, we may be forced to utilize available internal resources or bear an unattractive cost of capital, which could decrease our profitability and significantly reduce our financial flexibility and liquidity.
We are exposed to significant financial and capital markets risk, including changes in interest rates, credit spreads, and equity prices that may have a material adverse effect on our results of operations, financial condition and liquidity
We are exposed to significant financial and capital markets risks including changes in interest rates, credit spreads, equity prices, market volatility, performance of the economy, in general, the performance of the specific obligors included in our portfolio and other factors outside our control. Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates will increase the net unrealized loss position of our investment portfolio and sustained increases in interest rates may result in policyholders surrendering their contracts which may require us to liquidate assets in an unrealized loss position. Tax planning strategies can also be adversely affected by a rise in interest rates by limiting the ability to recognize tax benefits associated with operating and capital loss carryforwards. Conversely, due to the long-term nature of some of our liabilities, sustained declines in interest rates may subject us to reinvestment risk, increased hedging costs, spread compression and capital volatility.
The exposure to credit spreads primarily relates to market price variability and reinvestment risk associated with changes in credit spreads. If issuer credit spreads widen or increase significantly over an extended period of time, it would likely result in additional other-than-temporary impairments and increases in the net unrealized loss position in our investment portfolio will likely result. If credit spreads tighten significantly, net investment income associated with new purchases of fixed maturities may be reduced. Credit spread tightening may also cause an increase in the reported value of certain liabilities that are valued using a discount rate that reflects our own credit spread. In addition, market volatility may make it difficult to value certain of our securities if trading becomes less frequent. As such, valuations may include assumptions or estimates that may have significant period-to-period changes from market volatility, which could have a material effect on our results of operations or financial condition.
The exposure to equity risks relates to the potential for lower earnings associated with our equity-based Separate Accounts, where fee income is earned based upon account values. The significant fluctuations in equity markets over the last several years have significantly impacted the account values and related fee income during those years. In addition, certain of our products offer guaranteed benefits which increase our potential benefit exposure and statutory capital exposure should equity markets decline. Sustained declines in equity markets may result in the need to devote significant additional capital to support these products.
The insurance industry is heavily regulated and changes in regulation, including the enactment of, and adoption of regulations under The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), may adversely affect our results of operations and liquidity
The insurance industry is subject to comprehensive state regulation and supervision. We are also impacted by federal legislation and administrative policies in areas such as financial services regulations and federal taxation. The primary purpose of state regulation of the insurance business is to protect policyholders. The laws of the various states establish insurance departments with broad powers to regulate such matters as: licensing companies to transact business, admitting statutory assets, regulating unfair trade and claims practices, establishing statutory reserve requirements and solvency standards, restricting various transactions between affiliates and regulating the types, amounts and valuation of investments. State insurance regulators, federal regulators and the National Association of Insurance Commissioners (“NAIC”) continually reexamine existing laws and regulations, and may impose changes in the future.
State insurance guaranty associations have the right to assess insurance companies doing business in their state for funds to help pay the obligations of insolvent insurance companies to policyholders and claimants. As the amount and timing of an assessment is beyond our control, the liabilities established for these potential assessments may not be adequate.
Recently, there has been an increase in potential federal initiatives that would affect the financial services industry. The Dodd-Frank Act, which was enacted in July 2010, provides for comprehensive changes to the regulation of the financial services industry
by granting existing government agencies and newly created government agencies and bodies (e.g., the Financial Stability Oversight Council and the Federal Insurance Office) authority to promulgate new financial regulations applicable to financial institutions. These new regulations may subject our parent to a number of requirements, including, among others, stress tests and stricter prudential standards, such as stricter requirements and limitations relating to liquidity, credit exposure and risk management. In addition, the Dodd-Frank Act authorizes the Federal Insurance Office, which does not have general authority over the business of insurance, to make recommendations to the Financial Stability Oversight Council that certain insurers be subject to more stringent regulation. Further, as required by the Dodd-Frank Act, the Federal Insurance Office has issued a report with recommendations on how to modernize and improve the system of insurance regulation in the United States. Many of the provisions of this legislation require substantial rulemaking across numerous agencies within the federal government. Although this process has begun, it is proceeding substantially slower than the aggressive schedule contemplated at the time of enactment. Consequently, the ultimate impact of any of these provisions on our results of operations, liquidity or capital resources is currently indeterminable.
Potential changes in federal or state tax laws, including changes impacting the availability of the Separate Accounts dividend received deduction, may adversely affect our business, results of operations, and financial condition
Changes in federal and state tax laws could make certain products the Company has sold less attractive to consumers. For example, enacted reductions in the federal income tax that individual investors are required to pay on dividends and capital gains on stocks and mutual funds provide an incentive for some customers and potential customers to shift assets into mutual funds, and away from variable annuity products. These enacted tax rate reductions may impact the relative attractiveness of annuities as compared to stocks and mutual funds. In addition, the Company benefits from certain tax benefits, such as dividends received deductions and tax credits.
The U.S. Government, as well as state governments, also considers from time to time tax law changes that may increase the amount of taxes that the Company pays. Although the specific form of any such potential legislation is uncertain, it may include lessening or eliminating some or all of the tax advantages currently benefiting the Company or its policyholders. This could occur in the context of deficit reduction or other tax reforms. The effects of any such changes could result in lapses of policies currently held and/or the incurrence of higher corporate taxes which could have a material adverse effect on our financial condition and results of operations.
Changes in equity markets and other factors may significantly affect our financial results
The fee revenue that is earned on equity-based Separate Accounts assets is generally based upon account values. As strong equity markets result in higher account values, strong equity markets positively affect our results of operations through increased policy charge revenue and decreased benefit exposure. Increased fee revenue resulting from strong equity markets increases the expected gross profits (“EGPs”) from variable insurance products as do lower-than-expected lapses, mortality rates, and expenses. As a result, the higher EGPs may improve margins through lower amortized costs related to deferred acquisition costs (“DAC”), deferred sales inducements (“DSI”), and value of business acquired (“VOBA”). Correspondingly, a decrease in the equity markets as well as increases in lapses, mortality rates, and expenses depending upon their significance, may reduce margins through higher net amortized costs associated with DAC, DSI, and VOBA and may have a material adverse effect on our results of operations and capital resources. For more information on DAC, DSI, and VOBA amortization, see Item 7 - Management’s Narrative Analysis of Results of Operations-Critical Accounting Policies and Estimates below.
Changes in equity markets and interest rates affects the profitability of our products with guaranteed benefits, therefore, such changes may have a material adverse effect on our financial results
The valuation of liabilities related to the guaranteed minimum death benefits (“GMDB”) and guaranteed minimum income benefits (“GMIB”) for variable annuities is tied to the difference between the value of the underlying accounts and the guaranteed death or income benefit, calculated using a benefit ratio approach. The GMDB and GMIB liability valuations take into account the present value of total expected GMDB and GMIB payments and the present value of total expected assessments over the life of the contract and claims and assessments to date. Both the level of expected GMDB and GMIB payments and expected total assessments used in calculating the benefit ratio are affected by the equity markets. Accordingly, a decrease in the equity markets will increase the net amount at risk under the GMDB and the GMIB benefits we offer as part of our variable annuity products, which has the effect of increasing the value of GMDB and GMIB liabilities we must record.
The value of liabilities related to the guaranteed minimum withdrawal benefits (“GMWB”) for variable annuities are based on the fair value of the underlying benefit. The liabilities related to GMWB benefits valued at fair value are impacted by changes in equity markets, volatility and interest rates. Accordingly, strong equity markets and increases in interest rates will generally decrease the value of GMWB liabilities. Conversely, a decrease in the equity markets, along with a decrease in interest rates, will result in an increase in the value of GMWB liabilities we must record.
The value of contra liabilities related to the reinsurance of guaranteed minimum income benefits (“GMIB reinsurance”) for variable annuities is based on the fair value of the underlying benefit. The contra liabilities related to the GMIB reinsurance benefits valued at fair value are affected by changes in equity markets, volatility and interest rates. Accordingly, strong equity markets and increases in interest rates will generally decrease the value of the GMIB reinsurance contra liability. Conversely, a decrease in the equity markets, along with a decrease in interest rates, will generally result in an increase in the GMIB reinsurance contra liabilities we must record. Changes in the values of guaranteed benefits would result in a charge to earnings in the quarter in which the liabilities are increased or decreased.
A customized dynamic hedge program is maintained to mitigate the risks associated with income volatility around the change in reserves on GMWB. However, the hedge positions may not be effective to exactly offset the changes in the carrying value of the guarantees due to, among other things, the time lag between changes in their values and corresponding changes in the hedge positions, high levels of volatility in the equity markets and derivatives, extreme swings in interest rates, contract holder behavior that is different than expected, and divergence between the performing of the underlying funds and hedging indices. In addition, a separate hedge program is maintained to mitigate the net equity risk associated with variable annuities and variable universal life products. The program does not hedge any specific product group, but rather provides protection against a portion of the total remaining equity tail risk after existing hedge programs across all products in extreme market decline scenarios.
Our valuations of many of our financial instruments include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations and financial condition
Fixed maturity, equity, free standing and embedded derivatives and Separate Account assets are reported at estimated fair value on our Balance Sheets. The determination of estimated fair value is made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts.
During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the financial environment. In such cases, securities may require more subjectivity and management judgment in determining their fair values and those fair values may differ materially from the value at which the investments may be ultimately sold. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities and period-to-period changes in value could vary significantly. Decreases in value could have a material adverse effect on our results of operations and financial condition.
Defaults in our bonds, private placements and mortgage loan portfolios may adversely affect profitability and shareholder’s equity
For general account products, we typically bear the risk for investment performance (return of principal and interest). We are exposed to credit risk on our fixed income portfolio (e.g. bonds, mortgages, private placements). Some issuers have defaulted on their financial obligations for various reasons, including bankruptcy, lack of liquidity, downturns in the economy, downturns in the real estate values, operational failure, and fraud. Any event reducing the value of the fixed income portfolio other than on a temporary basis could have a material adverse effect on our business, results of operations, and financial condition.
Changes in market interest rates may adversely affect our financial results
The profitability of our fixed life and annuity products depends in part on interest rate spreads, therefore, interest rate fluctuations could negatively affect our financial results. Some of our fixed products have interest rate guarantees that expose us to the risk that changes in interest rates will reduce our “spread” or the difference between the amounts that we are required to pay under the contracts and the amounts we are able to earn on our general account investments intended to support our obligations under the contracts. Declines in our spread or instances where the returns on our general account investments are not enough to support the interest rate guarantees on these products could have a material adverse effect on our financial results.
In periods of increasing interest rates, we may not be able to replace the assets in our general account with higher yielding assets needed to fund the higher crediting rates. We therefore may have to accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts and related assets. In periods of declining interest rates, we have to reinvest the cash we receive as interest or return of principal on our investments in lower yielding instruments then available. Moreover, borrowers may prepay fixed income securities in our general account in order to borrow at lower market rates, which exacerbates this risk. As we are entitled to reset the interest rates on our fixed rate annuities only at limited, pre-established intervals, and since many of our policies have guaranteed minimum interest or crediting rates, our spreads could decrease and potentially become negative.
Increases in interest rates may cause increased surrenders and withdrawals of insurance products. In periods of increasing interest rates, policy loans and surrenders and withdrawals of life insurance policies and annuity contracts may increase as policyholders seek products with perceived higher returns. This process may lead to cash outflows of our existing block of business. These outflows may require investment assets to be sold at a time when the prices of those assets are lower because of the increase in market interest rates, which may result in realized investment losses. A sudden demand among policyholders to change product types or withdraw funds could lead us to sell assets at a loss to meet funding demands.
Business and financial results may be adversely affected by an inability to sell assets to meet maturing obligations
We could be exposed to liquidity risk, which is the risk that we cannot quickly convert invested assets to cash without incurring significant losses. Our liquidity may be impaired due to circumstances that we may be unable to control, such as general market disruptions or an operational problem. Our ability to sell assets may also be impaired if other market participants are seeking to sell similar assets at the same time. The inability to sell assets to meet maturing obligations, a negative change in its credit ratings, or regulatory capital restrictions, may have an adverse effect on financial results.
Our participation in a securities lending program subjects us to potential liquidity and other risks
We participate in a securities lending program whereby fixed income securities are loaned by our agent bank to third parties, primarily major brokerage firms and commercial banks. The borrowers of our securities provide us with collateral, typically in cash, which we separately maintain. We invest such cash collateral in other securities, primarily in commercial paper and money market or other short-term funds.
Almost all securities on loan under the program can be returned to us by the borrower at any time. Returns of loaned securities would require us to return the cash collateral associated with such loaned securities. In addition, in some cases, the maturity of the securities held as invested collateral (e.g. securities that we have purchased with cash received from third parties) may exceed the term of the related securities on loan and/or the market value of these securities may fall below the amount of cash we are obligated to return to the borrower of our loaned securities. If we are required to return significant amounts of cash collateral on short notice and we are forced to sell securities to meet the return obligation, we may have difficulty selling such collateral that is invested in securities in a timely manner, be forced to sell securities in a volatile or illiquid market for less than we otherwise would have been able to realize under normal market conditions, or both. In addition, under stressful capital market and economic conditions, such as those conditions we have experienced recently, liquidity broadly deteriorates, which may further restrict our ability to sell securities.
Differences between actual claims experience and underwriting and reserving assumptions may require liabilities to be increased, which may have a material adverse effect on our financial results
Our earnings depend upon the extent to which actual claims experience is consistent with the assumptions used in setting the prices for products and establishing the technical provisions and liabilities for claims. To the extent that actual claims experience is less favorable than the underlying assumptions used in establishing such liabilities, earnings would be reduced. Furthermore, if these higher claims were part of a trend, we may be required to increase our liabilities, which may also reduce income. In addition, certain acquisition costs related to the sale of new policies and the purchase of policies already in force have been recorded as assets on the balance sheet and are being amortized into earnings over time. If the assumptions relating to the future profitability of these policies (such as future claims, investment income, and expenses) are not realized, the amortization of these costs may be accelerated and may require write-offs due to unrecoverability. This may have a material adverse effect on our financial results.
Environmental liability exposure from our commercial mortgage loan portfolio may adversely affect our results of operations and financial condition
Liability under environmental protection laws resulting from our commercial mortgage loan portfolio may adversely affect our results of operation. Under the laws of several states, contamination of a property may give rise to a lien on the property to secure recovery of the costs of cleanup. In some states, this kind of lien has priority over the lien of an existing mortgage against the property, which would impair our ability to foreclose on the property should the related loan be in default. In addition, we may be liable for costs of addressing releases or threatened releases of hazardous substances that require remedy at a property securing a mortgage loan held by us, which could have an adverse effect on our results of operations and financial condition.
A pandemic, terrorist attack or other catastrophic event may adversely affect our results of operations and liquidity
Our mortality experience may be adversely impacted by a catastrophic event. In addition, a severe catastrophic event may cause significant volatility in global financial markets, disruptions to commerce, and reduced economic activity. The resulting macroeconomic conditions may adversely affect our cash flows as well as the value and liquidity of our invested assets. We may also experience operational disruptions if our employees are unable or unwilling to come to work due to a pandemic or other catastrophe.
A computer system failure, cyber attack or security breach may disrupt our business, damage our reputation and adversely affect our results of operations, financial condition and cash flows
We use computer systems to store, retrieve, evaluate and utilize customer and company data and information. Our business is highly dependent on our ability to access these systems to perform necessary business functions such as providing customer support, administering variable products, making changes to existing policies, filing and paying claims, managing our investment portfolios, and producing financial statements. While we have policies, procedures, automation and backup plans designed to prevent or limit the effect of failure, our computer systems may be vulnerable to disruptions or breaches as a result of natural disasters, man-made disasters, criminal activity, pandemics, data and identity theft, or other events beyond our control. The failure of our computer systems for any reason could disrupt our operations, result in loss of customer business and may adversely affect our profitability.
We retain confidential information on our computer systems, including customer information and proprietary business information. Any compromise of the security of our computer systems that results in the disclosure of personally identifiable customer information could damage our reputation, expose us to litigation, increase regulatory scrutiny and require us to incur significant technical, legal, and other expenses.
If our internal controls are not effective, policyholders could lose confidence in our financial reporting
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to conduct a comprehensive evaluation of our internal control over financial reporting. To comply with this statute, we are required to document and test our internal control over financial reporting and our management is required to assess and issue a report concerning our internal control over financial reporting. We have determined that a material weakness, as described in Part II - Item 9A, Controls and Procedures, of this Annual Report existed as of December 31, 2014. Accordingly, we have concluded that our internal control over financial reporting and disclosure controls and procedures were not effective as of December 31, 2014. This material weakness has existed since December 31, 2013, although not identified until recently.
Management, with oversight from the Audit Committee of the Board of Directors, has developed and presented a plan for the completion of remediation measures to address this weakness. Although we believe we are taking appropriate actions to remediate the control deficiencies we have identified, we cannot assure you that we will be successful in remediating the material weakness or that we will not discover other material weaknesses in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in implementation, could cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements, and substantial costs and resources may be required to rectify these or other internal control deficiencies. If we cannot produce reliable financial reports, policyholders could lose confidence in our reported financial information, and our business, financial condition, and reputation could be harmed. We expect to be successful in remediating this material weakness.
Changes in accounting standards may adversely affect our financial statements
Our financial statements are prepared in conformity with United States generally accepted accounting principles (“GAAP”) as prescribed by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). From time to time, we are required to adopt new or revised accounting standards or guidance. It is possible that future accounting standards 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 financial condition and results of operations.
Litigation and regulatory investigations may adversely affect our business, results of operations, and financial condition
The Company, like other life insurance companies, is subject to regulatory and legal proceedings, including class action lawsuits, in the ordinary course of our business. Such legal and regulatory matters include proceedings specific to us and other proceedings generally applicable to business practices in the industry in which the Company operates. In some lawsuits and regulatory proceedings involving insurers, substantial damages have been sought and/or material settlement payments have been made. Although the outcome of any litigation or regulatory proceeding cannot be predicted with certainty, at the present time, the Company believes that there are no pending or threatened proceedings or lawsuits that are reasonably likely to have a material adverse impact on our financial statements or our ability to meet our obligations.
The Company reached an agreement to end a multi-state exam with several state insurance regulators and state controllers’ offices regarding compliance with laws and regulations concerning the identification, reporting and escheatment of unclaimed benefits or abandoned funds. The Company is also the subject of other inquiries and market conduct examinations with a similar focus on the handling of unreported claims and abandoned property. The audits and related examination activity may result in additional payments to beneficiaries, escheatment of funds deemed abandoned, administrative penalties and changes in our procedures for the identification of unreported claims and handling of escheatable property. The Company does not believe that any regulatory actions or agreements that result from these examinations will have a material adverse impact on our financial statements or our ability to meet our obligations. See also Item 3. Legal Proceedings.
We may not be able to protect our intellectual property and may be subject to infringement claims
We may be subject to costly litigation in the event that another party alleges our operations or activities infringe upon another party’s intellectual property rights. Third parties may have, or may eventually be issued, patents that could be infringed by our products, methods, processes or services. Any party that holds such a patent could make a claim of infringement against us. We may also be
subject to claims by third parties for breach of copyright, trademark, trade secret or license usage rights. Any such claims and any resulting litigation could result in significant liability for damages. If we were found to have infringed a third-party patent or other intellectual property rights, we could incur substantial liability, and in some circumstances could be enjoined from providing certain products or services to our customers or utilizing and benefiting from certain methods, processes, copyrights, trademarks, trade secrets or licenses, or alternatively could be required to enter into costly licensing arrangements with third parties, all of which could have a material adverse effect on our business, results of operations and financial condition.
Growth in revenues is dependent on sales of potential new products, if any, along with the market performance of the assets underlying the policies and the policy and rider fees received on the declining number of life insurance, variable annuity and market value adjusted annuity policies in force
The economic environment in recent years presented significant challenges to the Company’s ability to issue certain products at competitive returns leading to the Company’s election to discontinue new sales of life insurance, variable annuity and market value adjusted products. In 2012, the Company launched a new fixed contingent annuity (also sometimes referred to as a CDA) that includes a SALB rider. There is a risk that state regulators could determine that existing actuarial or financial standards are inadequate when applied to CDAs and therefore require more stringent regulations, which could impact the Company’s ability to issue such products, potentially making growth of future revenues limited and uncertain.
The uncertainty of the performance of the securities markets would also mean that where the Company’s revenues are dependent on fees or charges based on market value of investments underlying the policies, the Company’s revenues would also be uncertain. Further, as policyholders surrender their policies and the number of policies in force is reduced, and as policyholders die or otherwise withdraw value from their policies, the revenues that the Company receives for policy and rider administration, and for mortality and expense risks will likely decline over time. However, there remain a significant number of annuity and life insurance policies in force that will continue to be serviced and are expected to continue to generate revenues for the foreseeable future.
Item 1B.
Item 1B. Unresolved Staff Comments
Not Applicable.
Item 2.
Item 2. Properties
The Registrant’s home office is located in Little Rock, Arkansas. Personnel performing services for the Registrant operate in AUSA office space in Cedar Rapids, Iowa and St. Petersburg, Florida. An allocable share of the cost of each of the above mentioned premises was paid by the Registrant through the common cost allocation service agreement.
Item 3.
Item 3. Legal Proceedings
The Company, like other life insurance companies, is subject to regulatory and legal proceedings, including class action lawsuits, in the ordinary course of our business. Such legal and regulatory matters include proceedings specific to us and other proceedings generally applicable to business practices in the industry in which the Company operates. In some lawsuits and regulatory proceedings involving insurers, substantial damages have been sought and/or material settlement payments have been made. Although the outcome of any litigation or regulatory proceeding cannot be predicted with certainty, at the present time, the Company believes that there are no pending or threatened proceedings or lawsuits that are reasonably likely to have a material adverse impact on our financial statements or our ability to meet our obligations.
The Company reached an agreement to end a multi-state exam with several state insurance regulators and state controllers’ offices regarding compliance with laws and regulations concerning the identification, reporting and escheatment of unclaimed benefits or abandoned funds. The Company is also the subject of other inquiries and market conduct examinations with a similar focus on the handling of unreported claims and abandoned property. The audits and related examination activity may result in additional payments to beneficiaries, escheatment of funds deemed abandoned, administrative penalties and changes in our procedures for the identification of unreported claims and handling of escheatable property. The Company does not believe that any regulatory actions or agreements that result from these examinations will have a material adverse impact on our financial statements or our ability to meet our obligations.
Item 4.
Item 4. Mine Safety Disclosures
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) The Registrant is a wholly owned subsidiary of AUSA. There is no public trading market for the Registrant’s common stock.
During 2014, the Registrant paid a $100.0 million dividend to AUSA. During 2013, the Registrant did not pay any dividends to AUSA. During 2014, the Company received $179.0 million in capital contributions from AUSA. During 2013, the Company did not receive any capital contributions from AUSA. No other cash or stock dividends have been declared on Registrant’s common stock at any time during the two most recent fiscal years. Under laws applicable to insurance companies domiciled in the State of Arkansas, the Registrant’s ability to pay extraordinary dividends on its common stock is restricted. See Note 9 to the Registrant’s Financial Statements.
(b) Not applicable.
(c) Not applicable.
Item 6.
Item 6. Selected Financial Data
Information called for by this item is omitted pursuant to General Instruction I. of Form 10-K.
Item 7.
Item 7. Management’s Narrative Analysis of Results of Operations
This Management’s Narrative Analysis of Results of Operations should be read in conjunction with the Financial Statements and Notes to Financial Statements included herein.
Forward Looking Statements
The statements contained in this Report that are not historical facts are forward-looking statements as defined in the US Private Securities Litigation Reform Act of 1995. The following are words that identify such forward-looking statements: aim, believe, estimate, target, intend, may, expect, anticipate, predict, project, counting on, plan, continue, want, forecast, should, would, is confident, will, and similar expressions as they relate to our Company. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Such risks and uncertainties include but are not limited to the following:
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Changes in general economic conditions;
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Changes in the performance of financial markets, including emerging markets, such as with regard to:
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The frequency and severity of defaults by issuers in our fixed income investment portfolios; and
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The effects of corporate bankruptcies and/or accounting restatements on the financial markets and the resulting decline in the value of equity and debt securities we hold;
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The frequency and severity of insured loss events;
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Changes affecting mortality, morbidity, persistence and other factors that may impact the profitability of our insurance products;
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Changes affecting interest rate levels and continuing low or rapidly changing interest rate levels;
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Increasing levels of competition;
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Changes in laws and regulations, particularly those affecting our operations, the products we sell, and the attractiveness of certain products to our customers;
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Regulatory changes relating to the insurance industry in the jurisdictions in which we operate;
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Lowering of one or more of the financial strength ratings and the adverse impact such action may have on the premium writings, policy retention, profitability and liquidity;
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Acts of God, acts of terrorism, acts of war and pandemics;
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Changes in the policies of central banks and/or governments;
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Litigation or regulatory actions that could require us to pay significant damages or change the way we do business;
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Customer responsiveness to both new products and distribution channels;
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Competitive, legal, regulatory or tax changes that affect the distribution cost of or demand for our products;
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The impact of product withdrawals, restructurings and other unusual items; and
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Our failure to achieve anticipated levels of earnings or operational efficiencies as well as other cost saving initiatives.
We undertake no obligation to publicly update or revise any forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which merely reflect Company expectations at the time of the writing. Actual results may differ materially from expectations conveyed in forward-looking statements due to changes caused by various risks and uncertainties. The reader should, however, consult any further disclosures TALIC may make in future filings of its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K.
Overview
During the preparation of the Company’s Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2014, an error in the tax valuation allowance was identified for the year ended December 31, 2013. The error principally relates to the scheduling of certain deferred tax liabilities in the Company’s analysis of the future ability to utilize net operating loss carryforwards in the tax expense calculations and the resulting amount of valuation allowance recognized. Following the identification of the tax-related error, Management initiated a comprehensive internal review of the Company’s historical financial information and determined the error materially impacted the audited financial statements for the year ended December 31, 2013 and the unaudited interim financial statements for March 31, 2014, June 30, 2014 and September 30, 2014. The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission (“SEC”) on April 1, 2015 and a Current Report on Form 8-K/A on April 9, 2015 disclosing its conclusions that the audited financial statements of the Company for the year ended December 31, 2013 and the unaudited interim financial statements for March 31, 2014, June 30, 2014, and September 30, 2014 as contained in its historical Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, respectively, should no longer be relied upon. Consequently, the Company has restated its financial statements for the year ended December 31, 2013 and the unaudited interim financial statements for March 31, 2014, June 30, 2014, and September 30, 2014. In addition, the Company identified, individually and in the aggregate, immaterial out-of-period errors which have been corrected in the periods to which they relate. The impact of the restatement of the Company’s financial statements is detailed in Note 1. “Restatement of Previously Reported Financial Information” and Note 14. “Quarterly Unaudited Financial Information” to the financial statements. The Company’s evaluation of the effectiveness of the Company’s disclosure controls and procedures and the Company’s remediation plans are described in “Item 9A. Controls and Procedures” in Part II of this 2014 Form 10-K.
Business Overview
Transamerica Advisors Life Insurance Company (“TALIC”, “Registrant”, the “Company”, “we”, “our”, or “us”) is a wholly owned subsidiary of AEGON USA, LLC (“AUSA”). AUSA is an indirect wholly owned subsidiary of AEGON N.V., a public limited liability company organized under Dutch law. The Company is domiciled in Arkansas.
TALIC conducts its business primarily in the annuity markets and to a lesser extent in the life insurance markets of the financial services industry. The Company offered the following guaranteed benefits within its variable annuity product suite: guaranteed minimum death benefits (“GMDB”), guaranteed minimum income benefits (“GMIB”) and guaranteed minimum withdrawal benefits (“GMWB”). In addition, the Company sells a fixed contingent annuity (also sometimes referred to as a contingent deferred annuity (“CDA”)), which includes a stand-alone living benefit (“SALB”).
The Company’s gross earnings are principally derived from two sources:
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the charges imposed on variable annuity, CDA and variable life insurance contracts, and
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the net earnings from investment of fixed rate life insurance and annuity contract owner deposits less interest credited to contract owners, commonly known as interest spread.
The costs associated with acquiring contract owner deposits (deferred policy acquisition costs) are amortized over the period in which the Company anticipates holding those funds, as noted in the Critical Accounting Policies and Estimates section below. Insurance expenses and taxes reported in the Statements of Income are net of amounts deferred. In addition, the Company incurs expenses associated with the maintenance of in force contracts.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity to GAAP requires management to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses and the disclosures of contingent assets and liabilities. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ and could have a material impact on the financial statements.
The Company’s critical accounting policies and estimates are discussed below. See Note 2 to the Financial Statements for additional information regarding accounting policies.
Valuation of Fixed Maturity and Equity Securities
The Company’s investments consist principally of fixed maturity and equity securities that are classified as available-for-sale (“AFS”) which are reported at estimated fair value. In addition, the Company held fixed maturity securities which contain a conversion to equity feature, which is considered an embedded derivative. These fixed maturity securities have been classified as trading and are reported at estimated fair value. During 2012, the last of these securities converted so the Company no longer holds any of these securities as of December 31, 2014 and 2013. The fair values of fixed maturity and equity securities are determined by management after taking into consideration several sources of data. When available, the Company uses quoted market prices in active markets to determine the fair value of its investments. The Company’s valuation policy utilizes a pricing hierarchy which dictates that publicly available prices are initially sought from indices and third-party pricing services. In the event that pricing is not available from these sources, those securities are submitted to brokers to obtain quotes. If broker quotes are not available, then securities are priced using internal cash flow modeling techniques. These valuation methodologies commonly use reported trades, bids, offers, issuer spreads, benchmark yields, estimated prepayment speeds, and/or estimated cash flows.
To understand the valuation methodologies used by third-party pricing services, the Company reviews and monitors their applicable methodology documents. Any changes to their methodologies are noted and reviewed for reasonableness. In addition, the Company performs periodic in-depth reviews of prices received from third-party pricing services. The objective for such reviews is to demonstrate that the Company can corroborate detailed information such as assumptions, inputs and methodologies used in pricing individual securities against documented pricing methodologies. Only third-party pricing services and brokers with a substantial presence in the market and with appropriate experience and expertise are used.
Each month, the Company performs an analysis of the information obtained from third-party services and brokers to ensure that the information is reasonable and produces a reasonable estimate of fair value. The Company considers both qualitative and quantitative factors as part of this analysis, including but not limited to, recent transactional activity for similar fixed maturities, review of pricing statistics and trends, and consideration of recent relevant market events. Other controls and procedures over pricing received from indices, third-party pricing services, or brokers include validation checks such as exception reports which highlight significant price changes, stale prices or un-priced securities. In addition, the Company performs back testing on a sample basis. Back testing involves selecting a sample of securities trades and comparing the prices in those transactions to prices used for financial reporting. Significant variances between the price used for financial reporting and the transaction price are investigated to explain the cause of the difference.
The Company’s portfolio of private placement securities is valued using a matrix pricing methodology. The pricing methodology is obtained from a third party service and indicates current spreads for securities based on weighted average life, credit rating and industry sector. Monthly the Company reviews the matrix to ensure the spreads are reasonable by comparing them to observed spreads for similar securities traded in the market. In order to account for the illiquid nature of these securities, illiquidity premiums are included in the valuation and are determined based upon the pricing of recent transactions in the private placement market as well as comparing the value of the privately offered security to a similar public security. The impact of the illiquidity premium to the overall valuation is less than 1% of the fair value. At December 31, 2014 and 2013, approximately $106.4 million (or 6%) and $72.5 million (or 4%), respectively, of the Company’s fixed maturity and equity securities portfolio consisted of private placement securities.
Changes in the fair value of fixed maturity and equity securities deemed AFS are reported as a component of accumulated other comprehensive income (loss), net of taxes on the Balance Sheets and are not reflected in the Statements of Income until a sale transaction occurs or when credit-related declines in estimated fair value are deemed other-than-temporary. Changes in fair value of fixed maturity securities deemed trading are reported as a component of net investment income.
Other-Than-Temporary Impairment (“OTTI”) Losses on Investments
The Company regularly reviews each investment in its fixed maturity and equity AFS securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. Management makes this determination through a series of discussions with the Company’s portfolio managers and credit analysts, and information obtained from external sources (i.e.; company announcements, ratings agency announcements, or news wire services). For fixed maturity AFS securities, the Company also considers whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The factors that may give rise to a potential OTTI include, but are not limited to, i) certain credit-related events such as default of principal or interest payments by the issuer, ii) bankruptcy of issuer, iii) certain security restructurings, and iv) fair market value less than cost or amortized cost for an extended period of time. In the absence of a readily ascertainable market value, the estimated fair value on these securities represents management’s best estimate and is based on comparable securities and other assumptions as appropriate. Management bases this determination on the most recent information available.
For equity securities, once management determines a decline in the value of an AFS security is other-than-temporary, the cost basis of the equity security is reduced to its fair value, with a corresponding charge to earnings. Objective evidence of impairment of an investment in an equity instrument classified as available-for-sale includes information about significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the issuer operates, and indicates that the cost of the investment in the equity instrument may not be recovered. As part of an ongoing process, the equity analysts actively monitor earnings releases, company fundamentals, new developments and industry trends for any signs of possible impairment. If an available-for-sale equity security is impaired based upon the Company’s qualitative or quantitative impairment criteria, any further declines in the fair value at subsequent reporting dates are recognized as impairments. Therefore, at each reporting period, for an equity security that is determined to be impaired based upon the Company’s impairment criteria, an impairment is recognized for the difference between the fair value and the original cost basis, less any previously recognized impairments.
For fixed maturity AFS securities, an OTTI must be recognized in earnings when an entity either: a) has the intent to sell the debt security or b) more likely than not will be required to sell the debt security before its anticipated recovery. If the Company meets either of these criteria, the OTTI is recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For fixed maturity AFS securities in unrealized loss positions that do not meet these criteria, the Company must analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows. If the net present value is less than the amortized cost of the investment, an OTTI is recorded. The OTTI is separated into two pieces: an amount representing the credit loss, where the present value of cash flows expected to be collected is less than the amortized cost basis of the security, and an amount related to all other factors (referred to as the non credit portion). The credit loss is recognized in earnings and the non credit loss is recognized in other comprehensive income (“OCI”), net of applicable taxes and value of business acquired. Management records subsequent changes in the estimated fair value (positive and negative) of fixed maturity AFS securities for which non credit OTTI was previously recognized in OCI in OCI-OTTI.
For the year ended December 31, 2014, the Company recorded an OTTI in income of $0.1 million, with no associated value of business acquired amortization. For the years ended December 31, 2013 and 2012, the Company recorded an OTTI in income of $0.7 million and $0.3 million, respectively, net of value of business acquired amortization.
Mortgage Loans on Real Estate
Mortgage loans on real estate are carried at unpaid principal balances adjusted for amortization of premiums and accretion of discounts and are net of valuation allowances and general reserves. The fair value for mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or similar remaining maturities. Interest income is accrued on the principal balance of the loan based on the loan’s contractual interest rate. Premiums and discounts are amortized using the effective yield method over the life of the loan. Interest income and amortization of premiums and discounts are reported in net investment income along with mortgage loan fees, which are recorded as they are incurred.
Loans are considered impaired when it is probable that based upon current information and events, the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. When the Company determines that a loan is impaired, a valuation allowance is established for the excess carrying value of the loan over its estimated collateral value. Changing economic conditions impact the valuation of mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that the Company performs for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for losses. In addition, the Company continues to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of emphasis are properties that have deteriorating credits or have experienced debt coverage reduction. Where warranted, the Company has established or increased loss reserves based upon this analysis. The Company does not accrue interest on loans ninety days past due. The Company also establishes a general reserve which is calculated by applying a percentage, based on risk rating and maturity, to the outstanding loan balance.
At December 31, 2014 and 2013, there was $66.7 million and $46.4 million, respectively, in mortgage loans on real estate recorded on the Balance Sheets. The estimated fair value of the mortgage loans on real estate at December 31, 2014 and 2013 was $71.4 million and $51.5 million, respectively. There was one impaired mortgage loan during the first quarter of 2014 which was subsequently sold during the third quarter of 2014 for a ($2.0) million realized loss. There were no impaired mortgage loans at December 31, 2014 or 2013. The general reserve at December 31, 2014 and 2013 was less than $0.1 million. The change in the valuation allowance and the general reserve is reflected in net realized investment gains (losses), excluding OTTI losses on securities in the Statements of Income. At December 31, 2014 and 2013, there were no mortgage loans that were two or more payments delinquent. See Note 4 to the Financial Statements for further discussion.
Derivatives and Hedge Accounting
Derivatives are financial instruments in which the value changes in response to an underlying variable that require little or no net initial investment and are settled at a future date. The Company has entered into derivatives, such as futures, options, total return swaps, and variance swaps to hedge minimum guarantees on variable annuity contracts. These derivatives are recognized on the Balance Sheet and are carried at fair value with changes in fair value recognized as a component of net derivative gains (losses) in the Statements of Income.
Futures contracts are used to hedge the liability risk associated with products providing the policyholder a return based on various global equity market indices. Net settlements on the futures occur daily.
The Company has entered into variance swaps to hedge the costs of the volatility of the Standard and Poor’s 500 Composite Stock Price Index (“S&P”). These variance swaps are similar to volatility options where the underlying index provides for the market value movements. Variance swaps do not accrue interest, and typically, no cash is exchanged at initiation.
In addition, the Company executed total return swaps with exposure to the S&P. These total return swaps are also being used to hedge equity risk.
Put and call options have been utilized by the Company to create equity collars designed to have a zero cost at issue, which serve to hedge the risk of equity market declines by selling a portion of market upside above the Company’s long-term expected return. The equity collar was disposed of in the fourth quarter of 2013.
During the third quarter of 2013, the Company entered into cash flow hedging transactions on Treasury Inflation Protected Securities (“TIPS”) utilizing interest rate swaps to lengthen portfolio duration and to hedge the variability of cash flows due to changes in inflation.
During the fourth quarter of 2014, the Company began writing credit default swaps enabling the Company to change the risk profile of the assets in the portfolio by enhancing the overall yield.
For further discussion of the Company’s use of derivatives, see the Results of Operations and Note 4 to the Financial Statements.
Securities Lending
Financial assets that are lent to a third party or that are transferred subject to a repurchase agreement at a fixed price are not derecognized as the Company retains substantially all the risks and rewards of asset ownership. The loaned securities are included in fixed maturity AFS securities in the Balance Sheets. A liability is recognized for cash collateral received, required initially at 102%, on which interest is accrued. If the fair value of the collateral is at any time less than 102% of the fair value of the loaned securities, the counterparty is mandated to deliver additional collateral, the fair value of which, together with the collateral already held in connection with the lending transaction, is at least equal to 102% of the fair value of the loaned securities.
The following table provides a summary of the securities under securities lending agreements for the years ended December 31:
Reverse Repurchase Agreements
The Company enters into dollar roll repurchase agreement transactions whereby the Company takes delivery of mortgage-backed securities (“MBS”) pools and sells them to a counterparty along with an agreement to repurchase substantially the same pools at some point in the future, typically one month forward. These transactions are accounted for as collateralized borrowings, and the repurchase agreement liability is included in the Balance Sheets in payables for collateral under securities loaned and reverse repurchase agreements.
The following table provides a summary of the securities under reverse repurchase agreements for the years ended December 31:
Value of Business Acquired (“VOBA”), Deferred Policy Acquisition Costs (“DAC”), and Deferred Sales Inducements (“DSI”)
VOBA
VOBA represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the insurance and annuity contracts in force at the acquisition date. VOBA is based on actuarially determined projections, for each block of business, of future policy and contract charges, premiums, mortality, policyholder behavior, Separate Account performance, operating expenses, investment returns, and other factors. Actual experience on the purchased business may vary from these projections. At December 31, 2014 and 2013, the Company’s VOBA asset was $268.1 million and $284.6 million, respectively. For the years ended December 31, 2014, 2013, and 2012, the favorable (unfavorable) impact to pre-tax net income related to VOBA unlocking was $6.6 million, $12.7 million, and ($0.7) million, respectively. There were no impairment charges in 2014, 2013, and 2012.
For acquired annuity and variable life insurance contracts, VOBA is amortized in proportion to gross profits arising principally from investment margins, mortality and expense margins, rider margins, and surrender charges, based on historical and anticipated future experience, which is updated periodically. Revisions in estimates result in changes to the amounts amortized in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future gross profits are less than the unamortized balance. See Note 5 to the Financial Statements for further discussion.
DAC
The costs of acquiring business, principally commissions, certain expenses related to policy issuance, and certain variable sales expenses that relate to and vary with the production of new and renewal business are deferred and amortized based on the estimated future gross profits for a group of contracts. DAC are subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each reporting period. At December 31, 2014 and 2013, variable annuities accounted for the Company’s entire DAC asset of $41.1 million and $34.9 million, respectively.
DAC for variable annuities is amortized with interest over the anticipated lives of the insurance contracts in relation to the present values of estimated future gross profits from asset-based fees, guaranteed benefit rider fees, contract fees, and surrender charges, less a provision for guaranteed death and living benefit expenses, policy maintenance expenses, and non-capitalized commissions. Future gross profit estimates are subject to periodic evaluation with necessary revisions applied against amortization to date. The impact of revisions and assumptions to estimates on cumulative amortization is recorded as a charge or credit to current operations, commonly referred to as “unlocking”. Changes in assumptions can have a significant impact on the amount of DAC reported and the related amortization patterns. In general, increases in the estimated Separate Accounts return and decreases in surrender or mortality assumptions increase the expected future profitability of the underlying business and may lower the rate of DAC amortization. Conversely, decreases in the estimated Separate Accounts returns and increases in surrender or mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization. For the years ended December 31, 2014, 2013, and 2012, there was a favorable (unfavorable) impact to pre-tax net income related to DAC unlocking of $2.4 million, ($2.2) million, and $0.5 million, respectively. See Note 5 to the Financial Statements for further discussion.
DSI
The Company offers a sales inducement whereby the contract owner receives a bonus which increases the initial account balance by an amount equal to a specified percentage of the contract owner’s deposit. This amount may be subject to recapture under certain circumstances. Consistent with DAC, sales inducements for variable annuity contracts are deferred and amortized based on the estimated future gross profits for each group of contracts. These future gross profit estimates are subject to periodic evaluation by the Company, with necessary revisions applied against amortization to date. The impact of these revisions on cumulative amortization is recorded as a charge or credit to current operations, commonly referred to as “unlocking”. It is reasonably possible that estimates of future gross profits could be reduced in the future, resulting in a material reduction in the carrying amount of the DSI asset.
The expense and the subsequent capitalization and amortization (accretion) are recorded as a component of policy benefits in the Statements of Income. At December 31, 2014 and 2013, variable annuities accounted for the Company’s entire DSI asset of $9.4
million and $7.5 million, respectively. For the years ended December 31, 2014, 2013, and 2012, there was a favorable (unfavorable) impact to pre-tax income related to unlocking of $0.9 million, ($0.3) million, and $0.5 million, respectively. See Note 5 to the Financial Statements for a further discussion.
The long-term growth rate assumption for the amortization of VOBA, DAC and DSI was 8% at December 31, 2014 and 2013 and 9% at December 31, 2012.
Goodwill
Goodwill is the excess of the purchase price over the estimated fair value of net assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but are subject to impairment tests conducted at least annually. Impairment testing is to be performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit represents the operating segment which is the level at which the financial information is prepared and regularly reviewed by management. The entire asset amount has been allocated to annuities. Goodwill is reviewed for indications of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator, or unanticipated competition would cause the Company to review the carrying amounts of goodwill for impairment. When considered impaired, the carrying amounts are written down to fair value based primarily on discounted cash flows. The Company performed annual tests of goodwill at December 31, 2014, 2013, and 2012 and determined there was no impairment of goodwill.
Policyholder Account Balances
The Company’s liability for policyholder account balances represents the contract value that has accrued to the benefit of policyholders at the Balance Sheet date. The liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Policyholder account balances at December 31, 2014 and 2013 were $1.2 billion and $1.3 billion, respectively.
Future Policy Benefits
Future policy benefits are actuarially determined liabilities, which are calculated to meet future obligations and are generally payable over an extended period of time. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, surrender rates, policy expenses, equity returns, interest rates, and inflation. These estimates and assumptions are influenced by historical experience, current developments and anticipated market trends. At December 31, 2014 and 2013, future policy benefits were $425.2 million and $408.9 million, respectively.
Included within future policy benefits are liabilities for GMDB and GMIB provisions contained in the variable products that the Company issues.
At December 31, 2014 and 2013, GMDB and GMIB liabilities included within future policy benefits were as follows:
The Company regularly evaluates the assumptions used to establish these liabilities, as well as actual experience, and adjusts GMDB and GMIB liabilities with a related charge or credit to earnings (“unlocking”) if actual experience or evidence suggests that the assumptions should be revised. For the years ended December 31, 2014, 2013 and 2012, the favorable impact to pre-tax income related to GMDB and GMIB unlocking was $16.7 million, $35.9 million, and $41.9 million, respectively.
Future policy benefits also include liabilities, which can be either positive or negative, for contracts containing GMWB and SALB provisions and for the reinsurance of GMIB provisions (“GMIB reinsurance”) for contracts based on the fair value of the underlying benefit. GMWB and GMIB reinsurance are treated as embedded derivatives and are required to be reported separately from the host contract. The fair values of these guarantees are calculated as the present value of future expected payments to policyholders less the present value of assessed fees attributable to the guarantees. Given the complexity and long-term nature of these guarantees, which are unlike instruments available in financial markets, their fair values are determined using stochastic techniques under a variety of market return scenarios. A variety of factors are considered, including expected market rates of return, equity and interest rate volatility, credit spread, correlations of market returns, discount rates and actuarial assumptions. Currently, the Company does not hedge the risks associated with the SALB.
At December 31, 2014 and 2013, GMWB liability and GMIB reinsurance asset included within future policy benefits were as follows:
At December 31, 2014 and 2013, the future policy benefits for the SALB liability was $0.5 million and less than $0.1 million, respectively.
Income Taxes
The Company uses the asset and liability method in providing income taxes on all transactions that have been recognized in the financial statements. The asset and liability method requires that deferred taxes be adjusted to reflect the tax rates at which future taxable amounts will be settled or realized. The Company provides for income taxes based on amounts it believes it will ultimately owe. Inherent in the provision for income taxes are estimates regarding the realization of certain tax deductions and credits.
Specific estimates include the realization of dividend-received deductions (“DRD”) and foreign tax credits (“FTC”). A portion of the Company’s investment income related to Separate Accounts business qualifies for the DRD and FTC. Information necessary to calculate these tax adjustments is typically not available until the following year. However, within the current year’s provision, management makes estimates regarding the future tax deductibility of these items. These estimates are primarily based on recent historic experience. See Note 7 to the Financial Statements for a further discussion.
The valuation allowance for federal deferred tax assets at December 31, 2014 and 2013 (As Restated) was $113.4 million and $139.3 million, respectively (this includes losses that are anticipated to be used in the consolidated group to reflect the income statement impact of the losses that would not be used if filing separately). The valuation allowance is related to loss carryforwards and other deferred tax assets that, in the judgment of management, are not more likely than not to be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that all or some of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends on generation of future taxable income during the periods in which those temporary differences are deductible. Management considers the scheduled reversal of deferred tax liabilities, projected taxable income, and tax-planning strategies in making the assessment. The error that was identified during the preparation of the Company’s 2014 financial statements, which required a restatement of the Company’s financial statements as of the year ended December 31, 2013 and the three quarters of 2014 relate to the complexity of the tax valuation allowance calculation.
The Company filed a separate federal income tax return for the years 2008 through 2012. A consolidated tax return was filed for 2013. An examination by the Internal Revenue Service is in progress for the years 2011 and 2012. The Company believes that there are adequate defenses against or sufficient provisions established related to any open or contested tax positions. A consolidated tax return has not yet been filed for 2014.
Recent Accounting Guidance
The following outlines the adoption of recent accounting guidance in 2013. See Note 2 to the Financial Statements for a further discussion.
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ASC 210, Balance Sheet - Accounting Standards Update (“ASU”) 2011-11, Disclosures about Offsetting Assets and Liabilities - enhances disclosures about financial instruments and derivative instruments that are either offset on the statement of financial position or subject to an enforceable master netting arrangement - adopted January 1, 2013.
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ASC 220, Comprehensive Income - ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, requires an entity to provide information about significant items reclassified out of accumulated other comprehensive income (“AOCI”) by component - adopted January 1, 2013.
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ASC 740, Income Taxes - ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, requires that the liability related to certain unrecognized tax benefits should be offset against a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryfoward if such settlement is required or expected in the event the uncertain tax position is disallowed - early adopted September 30, 2013.
Future Accounting Guidance
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ASC 860, Transfers and Servicing - ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosure - requires repurchase-to-maturity transactions to be accounted for as secured borrowings and amends accounting for repurchase financings. It also requires disclosure for (1) repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings and (2) certain transactions
accounted for as a sale. The guidance will be effective for the Company on January 1, 2015, except for disclosure requirements for certain transactions accounted for as secured borrowings which will be effective on April 1, 2015. The Company is evaluating the impact that adoption will have on the Company’s disclosures.
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ASC 205, Presentation of Financial Statements - ASU 2014-15, Presentation of Financial Statements-Going Concern - requires an entity’s management to evaluate whether there are conditions or events that, considered in the aggregate, raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. It also requires disclosures under certain circumstances. The guidance is effective for annual period ending after December 15, 2016. Early application is permitted. Implementation of the ASC will not affect the Company’s financial position or results of operations. The Company is in the process of reviewing its policies and processes to ensure compliance with the new guidance.
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ASC 606, Revenue from Contracts with Customers - ASU 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09) - requires that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance establishes a five-step process to achieve this core principle. ASU 2014-09 will be effective for the Company on January 1, 2017, using either of two methods: retrospective to each prior reporting period presented with certain practical expedients, or retrospective with the cumulative effect of initial application recognized at the date of initial application subject to certain additional disclosures. The Company has not yet selected a transition method and are evaluating the impact that adoption of this update is expected to have on the Company’s financial statements.
Deposits
Total direct deposits (including internal exchanges) were $21.6 million, $30.4 million, and $35.3 million for the years ended December 31, 2014, 2013 and 2012, respectively. Deposits are currently limited to additions to existing policies which will result in fluctuations period over period. Internal exchanges during 2014, 2013 and 2012 were $6.8 million, $3.8 million, and $6.5 million, respectively.
Financial Condition
At December 31, 2014, the Company’s assets were $10.1 billion or $448.0 million less than the $10.6 billion in assets at December 31, 2013. Assets excluding Separate Accounts assets increased $122.8 million. Separate Accounts assets, which represent 67% of total assets, decreased $570.8 million to $6.8 billion. Changes in Separate Accounts assets were as follows:
During 2014, 2013 and 2012, fixed contract owner deposits were $0.2 million. During 2014, 2013 and 2012, fixed contract owner withdrawals were $71.8 million, $92.1 million, and $104.7 million, respectively.
Investments
The Company maintains a general account investment portfolio comprised primarily of investment grade fixed maturity securities, policy loans, cash and cash equivalents and mortgage loans on real estate.
The following schedule identifies the Company’s general account invested assets by type at December 31:
Fixed Maturity and Equity Securities
The amortized cost/cost and estimated fair value of investments in fixed maturity and equity securities at December 31, 2014 and 2013 were:
(1) Subsequent unrealized gains (losses) on OTTI securities are included in OCI-OTTI.
The Company monitors industry sectors and individual debt securities for evidence of impairment. This evidence may include one or more of the following: 1) deteriorating market to book ratio, 2) increasing industry risk factors, 3) deteriorating financial condition of the issuer, 4) covenant violations of the issuer, 5) high probability of bankruptcy of the issuer, 6) nationally recognized credit rating agency downgrades, and/or 7) intent or requirement to sell before a debt security’s anticipated recovery. Additionally, for structured securities (asset-backed securities (“ABS”), residential mortgage-backed securities (“RMBS”), and commercial mortgage-backed securities (“CMBS”)), cash flow trends and underlying levels of collateral are monitored. A security is impaired if there is objective evidence that a loss event has occurred after the initial recognition of the asset that has a negative impact on the estimated future cash flows. A specific security is considered to be impaired when it is determined that it is probable that not all amounts due (both principal and interest) will be collected as scheduled. For debt securities, an OTTI must be recognized in earnings when an entity either a) has the intent to sell the debt security or b) more likely than not will be required to sell the debt security before its anticipated recovery. If the Company meets either of these criteria, the OTTI is recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For debt securities in unrealized loss positions that do not meet these criteria, the Company must analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The Company has evaluated the near-term prospects of the issuers in relation to the severity and duration of the unrealized loss, and unless otherwise noted, does not consider these investments to be impaired at December 31, 2014.
Four issuers represent more than 5% of the total unrealized loss position, comprised of below investment grade corporate bonds with $4.9 million of unrealized losses at December 31, 2014.
Financial Services Sector
The Company’s $2.3 million of gross unrealized losses within the financial services sector has a fair value of $37.7 million at December 31, 2014. The majority of the unrealized loss in the financial services sector relates to one below investment grade security, Genworth Financial, which can be found within the insurance sub-sector. The $1.9 million of unrealized losses for Genworth Financial relates to the decline in value of its long term care product.
There are no individual issuers rated below investment grade in this sector which have an unrealized loss position greater than $2.5 million.
Industrial Sector
The Company’s $5.2 million of gross unrealized losses within the industrial sector has a fair value of $70.9 million at December 31, 2014. The industrial sector is further subdivided into various sub-sectors with a majority of its gross unrealized loss made up of issuers within the energy and consumer cyclical sub-sectors. Issuers within the energy sub-sector had total unrealized losses of $2.3 million, which relates to declining oil prices during 2014. Within the consumer cyclical sub-sector, there was one issuer that had a $1.6 million unrealized loss. This issuer previously defaulted and just recently restructured its debt.
There are no individual issuers rated below investment grade in this sector which have an unrealized loss position greater than $2.5 million.
Equity Securities
The Company’s $0.5 million of gross unrealized losses classified as equity have a fair value of $9.7 million at December 31, 2014. All of the unrealized loss relates to holdings in the banking sub-sector.
The amortized cost and estimated fair value of fixed maturity AFS securities at December 31, 2014 and 2013 by rating agency equivalent were:
During the fourth quarter of 2014, the Company changed its methodology for determining credit ratings for its fixed maturity AFS securities. The Company changed the rating hierarchy to align more closely with the Credit Name Limit Policy (“CNLP”) as maintained internally by AEGON NV. In previous years the disclosure of ratings followed a hierarchy of S&P, Moody’s, Fitch, Internal and National Association of Insurance Commissioners (“NAIC”). Under the CNLP, a composite rating is used, which is based on a combination of the ratings of the constituents mentioned. The rating used is the lower of the external rating and the internal rating. This change in methodology did not impact net income, total assets or total liabilities.
The Company defines investment grade securities as unsecured debt obligations that have a rating equivalent to S&P’s BBB- or higher (or similar rating agency). At December 31, 2014 and 2013, approximately $107.9 million (or 6%) and $117.5 million (or 7%), respectively, of fixed maturity securities were rated BBB-, which is the lowest investment grade rating given by S&P. Below investment grade securities are speculative and are subject to significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. The Company closely monitors such investments.
Unrealized gains (losses) incurred during 2014 and 2013 were primarily due to price fluctuations resulting from changes in interest rates and credit spreads. If the Company has the intent to sell or it is more likely than not that the Company will be required to sell these securities prior to the anticipated recovery of the amortized cost, securities are written down to fair value. If cash flow models indicate a credit event will impact future cash flows, the security is impaired to discounted cash flows. As the remaining unrealized losses in the portfolio relate to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired.
Details underlying securities in a continuous gross unrealized loss and OTTI position for AFS investment grade securities were as follows:
(1) Subsequent unrealized gains (losses) on OTTI securities are included in OCI-OTTI.
Details underlying securities in a continuous gross unrealized loss and OTTI position for below investment grade AFS securities were as follows:
(1) Subsequent unrealized gains (losses) on OTTI securities are included in OCI-OTTI.
Gross unrealized losses and OTTI on below investment grade AFS securities represented 63% and 6% of total gross unrealized losses and OTTI on all AFS securities at December 31, 2014 and 2013, respectively. Generally, below investment grade securities are more likely than investment grade securities to develop credit concerns. The ratios of estimated fair value to amortized cost reflected in the table below were not necessarily indicative of the market value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to December 31, 2014.
Details underlying AFS securities below investment grade and in an unrealized loss were as follows:
Subprime Mortgage Investments
Subprime mortgages are loans to homebuyers who have weak or impaired credit histories. Through 2008, the market for these loans had expanded rapidly. During that time, however, lending practices and credit assessment standards grew steadily weaker. As a result, the market experienced a sharp increase in the number of loan defaults. Investors in subprime mortgage assets include not only mortgage lenders, but also brokers, hedge funds, and insurance companies. The Company does not currently invest in or originate whole loan residential mortgages. The Company categorizes ABS issued by a securitization trust as having subprime mortgage exposure when the average credit score of the underlying mortgage borrowers in a securitization trust is below 660 at issuance. The Company also categorizes ABS issued by a securitization trust with second lien mortgages as subprime mortgage exposure, even though a significant percentage of second lien mortgage borrowers may not necessarily have credit scores below 660 at issuance.
The following tables provide the ABS subprime mortgage exposure by rating and estimated fair value by vintage at December 31, 2014 and 2013:
(a) Second lien collateral primarily composed of loans to prime and Alt A borrowers.
Mortgage Loans on Real Estate
The following summarizes key information on mortgage loans on real estate:
The fair value for mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or similar remaining maturities. The estimated fair value of the mortgage loans on real estate at December 31, 2014 and 2013 was $71.4 million and $51.5 million, respectively.
All mortgage loans that are impaired have an established allowance for loss. Changing economic conditions impact our valuation of mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that the Company performs for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for losses. In addition, the Company continues to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of emphasis are properties that have deteriorating credits or have experienced debt coverage reduction. Where warranted, the Company has established or increased loss reserves based upon this analysis. There was one impaired mortgage loan during the first quarter of 2014 which was subsequently sold during the third quarter of 2014 for a ($2.0) million realized loss. There were no impaired mortgage loans at December 31, 2014 and 2013. At December 31, 2014 and 2013, there were no commercial mortgage loans that were two or more payments delinquent. See Note 4 to the Financial Statements for further discussion.
Business Environment
The Company’s financial position and/or results of operations are primarily impacted by the following economic factors: equity market performance, fluctuations in medium term interest rates, and the corporate credit environment via credit quality and fluctuations in credit spreads. The following discusses the impact of each economic factor.
Equity Market Performance
The investment performance of the underlying U.S. equity-based mutual funds supporting the Company’s variable products do not replicate the returns of any specific U.S. equity market index. However, investment performance will generally increase or decrease with corresponding increases or decreases of the overall U.S. equity market. There are several standard indices published on a daily basis that measure performance of selected components of the U.S. equity market. Examples include the Dow Jones Industrial Average (“Dow”), the NASDAQ Composite Index (“NASDAQ”) and the S&P. The Dow, NASDAQ and S&P ended 2014 with increases of 8%, 13% and 11%, respectively, from 2013. The Dow, NASDAQ and S&P ended 2013 with increases of 27%, 38% and 30%, respectively, from 2012.
Changes in the U.S. equity market directly affect the values of the underlying U.S. equity-based mutual funds supporting Separate Accounts assets and, accordingly, the values of variable contract owner account balances. Approximately 75% of Separate Accounts assets were invested in equity-based mutual funds at December 31, 2014. Since asset-based fees collected on in force variable contracts represent a significant source of revenue, the Company’s financial condition will be impacted by fluctuations in investment performance of equity-based Separate Accounts assets. During 2014, the total average variable account balances decreased $0.1 billion (or 1%) to $7.0 billion as compared to the same period in 2013.
Fluctuations in the U.S. equity market also directly impact the Company’s exposure to guaranteed benefit provisions contained in the variable contracts it manufactures. Minimal or negative investment performance generally results in greater exposure to guarantee provisions. Prolonged periods of minimal or negative investment performance will result in greater guaranteed benefit costs as compared to assumptions. If the Company determines that it needs to increase its estimated long term cost of guaranteed benefits, it will result in establishing greater guaranteed benefit liabilities as compared to current practice.
Medium Term Interest Rates, Corporate Credit and Credit Spreads
Changes in interest rates affect the value of investments, primarily fixed maturity securities and preferred equity securities, as well as interest-sensitive liabilities. Changes in interest rates have an inverse relationship to the value of investments and interest-sensitive liabilities. Also, since the Company has certain fixed products that contain guaranteed minimum crediting rates, decreases in interest rates can decrease the amount of interest spread earned.
Changes in the corporate credit environment directly impact the value of the Company’s investments, primarily fixed maturity securities. The Company primarily invests in investment-grade corporate debt to support its fixed rate product liabilities.
Credit spreads represent the credit risk premiums required by market participants for a given credit quality, i.e., the additional yield that a debt instrument issued by an AA-rated entity must produce over a risk-free alternative (e.g., U.S. Treasury instruments). Changes in credit spreads have an inverse relationship to the value of interest sensitive investments.
The impact of changes in medium term interest rates, corporate credit and credit spreads on market valuations were as follows:
(a) The Company defines medium term interest rates as the average interest rate on U.S. Treasury securities with terms of one to five years.
(b) The Company defines credit spreads according to the Merrill Lynch U.S. Corporate Bond Index for BBB-A Rated bonds with three to five year maturities.
At December 31, 2014 and 2013, the Company had 10,197 and 10,926 life insurance and annuity contracts in force with interest rate guarantees, respectively. The estimated average rate of interest credited on behalf of contract owners was 3.37% and 3.18% during 2014 and 2013, respectively. Total invested assets supporting these liabilities with interest rate guarantees had an estimated average effective yield of 5.2% and 5.1% during 2014 and 2013, respectively.
Liquidity and Capital Resources
Liquidity
The Company’s liquidity requirements include the payment of sales commissions and other underwriting expenses and the funding of its contractual obligations for the life insurance and annuity contracts it has in force. The Company has developed and utilizes a cash flow projection system and regularly performs asset/liability duration matching in the management of its asset and liability portfolios. The Company anticipates funding its cash requirements utilizing cash from operations, normal investment maturities and anticipated calls and repayments, consistent with prior years. At December 31, 2014 and 2013, the Company’s assets included $2.2 billion and $2.1 billion, respectively, of cash, short-term investments and investment grade publicly traded AFS securities that could be liquidated if funds were required.
Capital Resources
During 2014, the Company received capital contributions from AUSA of $179.0 million and the Company paid a $100.0 million cash dividend to AUSA. During 2013, the Company did not receive a capital contribution from AUSA and the Company did not pay a cash dividend to AUSA.
Statutory Principles and Risk-Based Capital (“RBC”)
In order to continue to issue annuity products, the Company must meet or exceed the statutory capital and surplus requirements of the insurance departments of the states in which it conducts business. Statutory accounting principles differ from GAAP in multiple major respects. Under statutory accounting principles, the acquisition costs of new business are charged to expense, while under GAAP they are amortized over a period of time. Under statutory accounting principles, the required additions to statutory reserves are calculated under different rules than under GAAP. In addition, the valuation of investments and accounting for deferred taxes differs between the two bases of accounting.
The National Association of Insurance Commissioners utilizes the RBC adequacy monitoring system. The RBC calculates the amount of adjusted capital that a life insurance company should have based upon that company’s risk profile. At December 31, 2014 and 2013, based on the RBC formula, the Company’s total adjusted capital levels were well in excess of the minimum amount of capital required to avoid regulatory action.
Ratings
Ratings are an important factor in establishing the competitive position in the insurance and financial services marketplace. Rating agencies rate insurance companies based on financial strength and the ability to pay claims, factors more relevant to contract holders than investors.
The financial strength rating scales of S&P, A.M. Best, and Fitch Ratings (“Fitch”) are characterized as follows:
•
S&P - AAA to R
•
A.M. Best - A++ to S
•
Fitch - AAA to C
The following table summarizes the Company’s ratings at April 15, 2015:
S&P
AA-
(4th out of 21)
A.M. Best
A +
(2nd out of 16)
Fitch
AA-
(4th out of 19)
A downgrade of our financial strength rating could affect our competitive position in the insurance industry as customers may select companies with higher financial strength ratings. These ratings are not a recommendation to buy or hold any of the Company’s securities and they may be revised or revoked at any time at the sole discretion of the rating organization.
Commitments and Contingencies
The following table summarizes the Company’s policyholders’ obligations at December 31, 2014:
(a) The policyholder liabilities include benefit and claim liabilities of which a significant portion represents policies and contracts that do not have a stated contractual maturity. The projected cash benefit payments in the table above are based on management’s best estimates of the expected gross benefits and expenses, partially offset by the expected gross premiums, fees and charges relating to the existing business in force. Estimated cash benefit payments are based on mortality and lapse assumptions comparable with the Company’s historical experience, modified for recently observed trends. Actual payment obligations may differ if experience varies from these assumptions. The cash benefit payments are presented on an undiscounted basis and are before deduction of tax and before reinsurance. The liability amounts in the Company’s financial statements reflect the discounting for interest as well as adjustments for the timing of other factors as described above. As a result, the sum of the cash benefit payments shown for all years in the table above exceeds the corresponding policyholder liability amounts.
The Company has utilized public information to estimate the future assessments it will incur as a result of life insurance company insolvencies. At December 31, 2014 and 2013, the Company’s estimated liability for future guaranty fund assessments was $0.1 million and $0.2 million, respectively. In addition, the Company has a receivable for future premium tax deductions of $4.5 million and $4.6 million at December 31, 2014 and 2013, respectively. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
In the normal course of business, the Company is subject to various claims and assessments. Management believes the settlement of these matters would not have a material effect on the financial position, results of operations or cash flows of the Company.
Results of Operations
The Company’s gross earnings are principally derived from two sources:
•
the charges imposed on variable annuity and variable life insurance contracts, and
•
the net earnings from investment of fixed rate life insurance and annuity contract owner deposits less interest credited to contract owners, commonly known as interest spread.
The costs associated with acquiring contract owner deposits (DAC) are amortized based on the estimated gross profits for a group of contracts, as noted in the Critical Accounting Policies and Estimates section above. Insurance expenses and taxes reported in the Statements of Income are net of amounts deferred. In addition, the Company incurs expenses associated with the maintenance of in force contracts.
2014 compared to 2013 (As Restated)
For the years ended December 31, 2014 and 2013 (As Restated), the Company recorded net income (loss) of $33.5 million and ($214.3) million, respectively. The change in net income during 2014 as compared to 2013 was primarily due to higher realized derivative losses related to the equity collar hedge and the addition of a tax valuation allowance in 2013.
Policy charge revenue decreased $2.3 million to $183.3 million during 2014, as compared to $185.6 million in 2013. The following table provides the changes in policy charge revenue by type for each respective period:
Net derivative losses decreased $183.8 million to $76.1 million during 2014 as compared to $259.9 million in 2013. The following table provides the changes in net derivative gains (losses) by type:
(a) The equity collar was disposed of in the fourth quarter of 2013 which is driving the decrease in losses. The 2013 losses were driven by the increase in the S&P index. This was a zero cost at inception macro equity hedge to protect against a portion of the unhedged equity tail risk by selling a portion of the market upside above the Company’s long term expected return and buying protection against extreme market declines. As a result, when equity markets increase, the equity collar declines in value. When markets decrease, the equity collar increases in value.
(b) The Company had a large notional amount of short positions in total return swaps in 2014, and the increase in the S&P gave rise to losses. The total return swap gains in 2013 were the result of long exposure to the S&P.
(c) Short futures result in losses when equity markets increase and long futures result in gains as equity markets increase. The Company no longer holds long futures. Short futures performance was driven by the 11% and 30% increases in the S&P for the periods ended December 31, 2014 and 2013, respectively.
(d) During 2014 the Company entered into credit default swaps and the losses were driven by widening credit spreads at the time of sale.
Policy benefits increased $31.0 million during 2014 as compared to 2013. The following table provides the changes in policy benefits by type:
(a) See the Critical Accounting Policies and Estimates section above for further discussion of annuity benefit unlocking.
(b) The increase in annuity benefit expense was primarily driven by the increase in fair value reserves in 2014 as compared to 2013.
(c) During 2014 there was a decrease in gross profits resulting in accretion compared with 2013 which saw an increase in gross profits leading to increased amortization.
Amortization (accretion) of DAC was ($6.1) million and $12.9 million for 2014 and 2013, respectively, which included favorable (unfavorable) unlocking of $2.4 million and ($2.2) million, respectively. The change in 2014 was primarily driven by updated policyholder assumptions and underperforming Separate Accounts during the year which resulted in accretion and favorable unlocking as compared to 2013.
Amortization of VOBA was $10.8 million and $4.8 million for the years ended December 31, 2014 and 2013, respectively, which included favorable unlocking of $6.6 million and $12.7 million, respectively. The change in 2014 was impacted by lower equity market performance and updated policyholder assumptions resulting in increased amortization and favorable unlocking as compared to 2013.
Insurance expenses and taxes decreased $5.7 million in 2014 as compared to 2013. The following table provides the changes in insurance expenses and taxes for each respective period:
(a) The decrease in general insurance expense is primarily related to a change in guaranty fund assessments when compared to 2013.
2013 (As Restated) compared to 2012
For the years ended December 31, 2013 (As Restated) and 2012, the Company recorded net income (loss) of ($214.3) million and $164.3 million, respectively. The decrease in income during 2013 as compared to 2012 was primarily due to realized derivative losses related to the equity collar hedge, the addition of a tax valuation allowance, higher policy benefits expense offset by lower VOBA amortization expense in 2013.
Policy charge revenue decreased $2.1 million to $185.6 million during 2013, as compared to $187.7 million in 2012. The following table provides the changes in policy charge revenue by type for each respective period:
Net realized derivative losses increased $211.5 million to $259.9 million during 2013 as compared to $48.4 million in 2012. The following table provides the changes in net realized derivative losses by type:
(a) The equity collar losses were driven by the increase in the S&P index which grew 30% for the period ended December 31, 2013. This is a zero cost at inception macro equity hedge to protect against a portion of the unhedged equity tail risk by selling a portion of the market upside above the Company’s long term expected return and buying protection against extreme market declines. As a result, when equity markets increase, the equity collar will decline in value. When equity markets decrease, the equity collar will increase in value.
(b) The total return swaps were entered into during 2013 and are based on the return of the S&P.
(c) Short futures result in losses when equity markets increase and long futures result in gains as equity markets increase. The 2013 performance from these futures positions was driven by the increase in the S&P.
Policy benefits increased $27.9 million during 2013 as compared to 2012. The following table provides the changes in policy benefits by type:
(a) See the Critical Accounting Policies and Estimates section above for further discussion of annuity benefit unlocking.
(b) The increase in annuity benefit expense was primarily due to benefits paid exceeding the release of fair value reserves in 2013 as compared to 2012.
Amortization of DAC was $12.9 million and $4.9 million for 2013 and 2012, respectively, which included favorable (unfavorable) unlocking of ($2.2) million and $0.5 million, respectively. The increase in 2013 was primarily driven by positive gross profits resulting in increased amortization as compared to 2012.
Amortization of VOBA was $4.8 million and $27.8 million for the years ended December 31, 2013 and 2012, respectively, which included favorable (unfavorable) unlocking of $12.7 million and ($0.7) million, respectively. 2013 was impacted by favorable equity markets and positive gross profits as compared to 2012.
Insurance expenses and taxes increased $1.2 million in 2013 as compared to 2012. The following table provides the changes in insurance expenses and taxes for each respective period:
(a) The increase in general insurance expense is primarily related to a change in guaranty fund assessments when compared to 2012.
Segment Information
The Company’s operating results are categorized into two business segments: Annuity and Life Insurance. The Company’s Annuity segment consists of variable annuity and interest-sensitive annuity contracts. The Company’s Life Insurance segment consists of variable life insurance and interest-sensitive life insurance contracts. The accounting policies of the business segments are the same as those described in the summary of significant accounting policies. All revenue and expense transactions are recorded at the contract level and accumulated at the business segment level for review by management.
Select financial information by segment for the years ended December 31 is as follows:
(a) Net revenues include total revenues net of interest credited to policyholder liabilities.
The Company is not dependent upon any single customer, and no single customer accounted for more than 10% of its revenues during 2014, 2013, or 2012.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk
As an insurance company, the Company is in the “risk” business and as a result is exposed to a variety of risks. A description of our risk management and control systems is given below on the basis of significant identified risks for us. Our largest exposures are to changes in the financial markets (e.g; interest rate, credit and equity market risks) that affect the value of the investments, liabilities from products that we sold, deferred expenses, and value of business acquired.
Results of the Company’s sensitivity analyses are presented to show the estimated sensitivity of net income to various scenarios. For each type of market risk, the analysis shows how net income would have been affected by changes in the relevant risk variables that were reasonably possible at the reporting date. For each sensitivity test, the impact of a reasonably possible change in a single factor (or shock) is shown. The analysis considers the interdependency between interest rates and lapse behavior for products sold where there is clear evidence of dynamic lapse behavior. Management action is taken into account to the extent that it is part of the Company’s regular policies and procedures. However, incidental management actions that would require a change in policies and procedures are not considered.
Each sensitivity analysis reflects the extent to which the shock tested would affect management’s critical accounting estimates and judgment in applying the Company’s accounting policies (See Note 2 of the Financial Statements for a description of the critical accounting estimates and judgments). The shock may affect the measurement of assets and liabilities based on assumptions that are not observable in the market as well as market consistent assumptions. For example, a shock in interest rates may lead to changes in the amortization schedule of DAC or to increased impairment losses on equity investments. Although management’s short-term assumption may change if there is a reasonable change in a risk factor, long-term assumptions will generally not be revised unless there is evidence that the movement is permanent. This fact is reflected in the sensitivity analyses provided below.
The sensitivities do not reflect what the net income for the period would have been if risk variables had been different because the analysis is based on the exposures in existence at the reporting date rather than on those that actually occurred during the year. Nor are the results of the sensitivities intended to be an accurate prediction of the Company’s future income. The analysis does not consider all methods available to management to respond to changes in the financial environment, such as changing investment portfolio allocations or adjusting crediting rates. Furthermore, the results of the analyses cannot be extrapolated for wider variations since effects do not tend to be linear. No risk management process can clearly predict future results.
Interest Rate Risk
Interest rate risk arises from the possibility that changes in interest rates will affect the value of investments, primarily fixed maturity securities and preferred equity securities. Changes in interest rates have an inverse relationship to the value of investments. The Company manages interest rate risk as part of its asset/liability management strategy. For each portfolio, management monitors the expected changes in assets and liabilities, as produced by the Company’s model, resulting from various interest rate scenarios. Based on these results, management closely matches the duration of insurance liabilities to the duration of assets supporting those liabilities.
The table below shows the interest rates at the end of the last five years:
The sensitivity analysis in the table below shows an estimate of the effect of a parallel shift in the yield curve on net income and equity. Increases in interest rates have a negative effect on GAAP equity and net income in the current year because it results in unrealized losses on investments that are carried at fair value. The offsetting economic gain on the insurance contracts is however, not fully reflected in the sensitivities because many of these liabilities are not measured at fair value. Over time, the short-term reduction in net income due to rising interest rates would be offset by higher net income in later years, all else being equal.
The sensitivity analysis above reflects the assets and liabilities held at year-end. This does not necessarily reflect the risk exposure during the year as significant events do not necessarily occur on January 1. The selection of a 100 basis point immediate, parallel increase or decrease in interest rates is a hypothetical rate scenario used to demonstrate potential risk. While a 100 basis point immediate, parallel increase does not represent the Company’s view of future market changes, it is a near term reasonably possible hypothetical change that illustrates the potential impact of such events. While the income and equity impacts provide a presentation of interest rate sensitivity, they are based on the portfolio exposures at a point in time and may not be representative of future market results. These exposures will change as a result of ongoing portfolio transactions in response to management’s assessment of changing market conditions and available investment opportunities.
Credit Risk
Credit risk represents the loss that the Company would incur if an issuer fails to perform its contractual obligations and the value of the security held has been impaired or is deemed worthless. The Company manages its credit risk by setting investment policy guidelines that assure diversification with respect to investment, issuer, geographic location and credit quality. Management regularly monitors compliance of each investment portfolio’s status with the investment policy guidelines, including timely updates of credit-related securities.
Equity Market Risk
Fluctuations in the equity markets have affected the Company’s profitability, capital position and sales of equity related products in the past and may continue to do so. Exposure to equity markets exists in both assets and liabilities. Asset exposure exists through direct equity investment, where the Company bears all or most of the volatility in returns and investment performance risk. Equity market exposure is also present in insurance contracts for account of policyholders where funds are invested in equities such as variable annuities and life insurance. Although most of the risk remains with the policyholder, lower investment returns can reduce the asset management fee earned by the Company on the asset balance in these products. In addition, some of this business has minimum guarantees.
The table that follows sets forth the closing levels of certain major indices at the end of the last five years:
The sensitivity analysis of net income to change in equity prices is presented in the table below. The sensitivity of net income to changes in equity markets reflects changes in the market value of the Company’s portfolio, changes in DAC amortization and the strengthening of the guaranteed minimum benefits, where applicable. The results of equity sensitivity tests are non-linear. The main reason for this is due to equity options sold to clients that are embedded in some of these products and the more severe scenarios could cause accelerated DAC amortization and guaranteed minimum benefits provisioning, while moderate scenarios may not.
The selection of a 10% and 20% change in the equity markets should not be construed as a prediction of future market events, but rather as an illustration of the potential impact of such an event. The Company’s exposure can change as a result of changes in the Company’s mix of business.
Liquidity Risk
Liquidity risk is inherent in much of the Company businesses. Each asset purchased and liability sold has liquidity characteristics that are unique. Some liabilities are surrenderable while some assets, such as private placements, mortgages loans and limited partnerships have low liquidity. If the Company requires significant amounts of cash on short notice in excess of normal cash requirements, the Company may have difficulty selling these investments at attractive prices, in a timely manner or both.
Underwriting Risk
The Company’s earnings depend significantly upon the extent to which actual claims experience is consistent with the assumptions used in setting the prices for products and establishing the technical liabilities and liabilities for claims. To the extent that actual claims experience is less favorable than the underlying assumptions used in establishing such liabilities, income would be reduced. Furthermore, if these higher claims were part of a permanent trend, the Company may be required to increase liabilities, which could reduce income. In addition, certain acquisition costs related to the sale of new policies and the purchase of policies already in force have been recorded as assets on the balance sheet and are being amortized into income over time. If the assumptions relating to the future profitability of these policies (such as future claims, investment income and expenses) are not realized, the amortization of these costs could be accelerated and may even require write offs due to unrecoverability. This could have a materially adverse effect on the Company’s business, results of operations and financial condition.
Sources of underwriting risk include policy lapses and policy claims such as mortality and expenses. In general, the Company is at risk if policy lapses increase as sometimes the Company is unable to fully recover up front expenses in selling a product despite the presence of commission recoveries or surrender charges and fees. Within variable annuity contracts with certain guarantee benefits, the Company is at risk if policy lapses decrease, as more contracts would remain in force until guaranteed payments are made. For mortality risk, the Company sells certain types of policies that are at risk if mortality increases, such as term life insurance or guaranteed minimum death benefits, and sells certain types of policies that are at risk if mortality decreases (longevity risk) such as certain annuity products. The Company is also at risk if expenses are higher than assumed by management.
The Company monitors and manages its underwriting risk by underwriting risk type. Attribution analysis is performed on earnings and reserve movements in order to understand the source of any material variation in actual results from what was expected. The Company’s units also perform experience studies for underwriting risk assumptions, comparing the
Company’s experience to industry experience as well as combining the Company’s experience and industry experience based on the depth of the history of each source to the Company’s underwriting assumptions. The Company also has the ability to reduce expense levels over time, thus mitigating unfavorable expense variation.
Sensitivity analysis of net income to various underwriting risks is shown in the table that follows. The sensitivities represent an increase or decrease of mortality rates over 2014. Increases in mortality rates lead to an increase in the level of benefits and claims on most business. The impact on net income of sales transactions of investments required to meet the higher cash outflow from lapses or deaths are reflected in the sensitivities.
A shock in mortality rates will generally not lead to a change in the assumptions underlying the measurement of the insurance liabilities as management will recognize that the shock is temporary. Life insurers are also exposed to longevity risk.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financials statements of Registrant are set forth in Part IV hereof and are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
No information is required to be disclosed under this item.
Item 9A.
Item 9A. Controls and Procedures
a) Evaluation of disclosure controls and procedures
The term “disclosure controls and procedures” (defined in the Securities Exchange Act of 1934 Rule 13a-15(e)) generally refers to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rule and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by TALIC in the reports that it files or submits under the Exchange Act is accumulated and communicated to TALIC’s management, including TALIC’s principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. TALIC’s management, with the participation of the President and Chief Financial Officer, have evaluated the effectiveness of TALIC’s disclosure controls and procedures as of December 31, 2014, the end of the period covered by this annual report (the “Evaluation Date”). Based on that evaluation, TALIC’s President and Chief Financial Officer have concluded that, as of the Evaluation Date, such disclosure controls and procedures were not effective because of the material weakness described below under “Management’s Annual Report on Internal Control Over Financial Reporting.” As a result of this material weakness, management has concluded that the Company’s disclosure controls and procedures as of December 31, 2013 were not effective.
b) Management’s annual report on internal control over financial reporting
The term “internal control over financial reporting” (defined in Exchange Act Rule 13a-15(f)) generally refers to the process of a company that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
TALIC’s management, with the participation of the President and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting. TALIC’s management, with the participation of the President and Chief Financial Officer, conducted an evaluation of the effectiveness of TALIC’s internal control over financial reporting as of December 31, 2013 based on the criteria related to internal control over financial reporting described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission and previously concluded that internal control over financial reporting was effective as of December 31, 2013, as reported in its previously filed Annual Report on Form 10-K. However, as a result of the restatement, TALIC’s management identified a material weakness in internal control over financial reporting as further described below and has now concluded that internal control over financial reporting was not effective as of December 31, 2013 and, because remediation is not yet completed, internal control over financial reporting was also not effective as of December 31, 2014.
A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness described below resulted in adjustments during the preparation of the Company’s 2014 financial statements and restatement of the Company’s financial statements as of and for the year ended 2013 and the interim periods in 2014, as outlined in Notes 1 and 14 to the financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K, and affected the tax-related financial statement line items and disclosures and until remediation is complete could result in misstatements in future interim or annual reporting periods. The Company did not have effective controls surrounding the evaluation and review related to non-routine technical tax accounting matters, specifically with regards to the valuation allowance on deferred tax assets.
This annual report does not include an attestation report of TALIC’s registered public accounting firm regarding internal control over financial reporting because TALIC is a non-accelerated filer.
Remediation plan
Management has been actively engaged in developing remediation plans to address the above material weakness. The remediation efforts expected to be implemented include the following:
Re-designing processes, procedures, and controls to identify, research, evaluate and review the appropriate accounting related to non-routine technical tax accounting matters, specifically with regards to the valuation allowance on deferred tax assets to ensure greater oversight and evaluation of income tax conclusions prior to the issuance of the financial statements.
The Company believes that the controls that will be implemented will improve the effectiveness of our internal control over financial reporting. As the Company continues to evaluate and work to improve the internal control over financial reporting, the Company may take additional measures to address the material weakness or determine to supplement or modify certain of the remediation measures described above.
c) Changes in internal control over financial reporting
As of the fiscal quarter ended December 31, 2014, there have been no changes in TALIC’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, TALIC’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
The client-auditor relationship between the Company and Ernst & Young LLP (“EY”) ceased upon the completion of the 2013 annual audit for the Company’s fiscal year ended December 31, 2013.
In connection with the audits of the Company’s financial statements for each of the two fiscal years ended December 31, 2013 and 2012, there were no disagreements with EY on any matters of accounting principles or practices, financial statement disclosure or auditing scope and procedures which, if not resolved to the satisfaction of EY would have caused EY to make reference to the matter in their report.
PART III
Information called for by items 10 through 13 of this part is omitted pursuant to General Instruction I. of Form 10-K.
Item 14.
Item 14. Principal Accountant Fees and Services
Fees Paid to the Registrant’s Independent Auditor
The aggregate fees for professional services rendered by PricewaterhouseCoopers LLP (“PwC”), the Company’s principal accountants, for 2014 were:
(a) Audit fees consist of fees for the annual financial statement audit (including required quarterly reviews) and other procedures required to be performed by the independent auditor to be able to form an opinion on TALIC’s financial statements. These other procedures include information systems and procedural reviews and testing performed in order to understand and place reliance on the systems of internal control, and consultations relating to the audit or quarterly review. They also include fees billed for other audit services, which are those services that only the external auditor reasonably can provide, and include statutory audits, comfort letters, services associated with SEC registration statements, periodic reports and other documents filed with the SEC.
Audit Committee Pre-approval Policies and Procedures
TALIC’s Audit Committee is responsible, among other matters, for the oversight of the external auditor. Consistent with SEC rules regarding auditor independence, the Audit Committee has adopted a policy regarding pre-approval of audit and permissible non-audit services provided by our independent auditors (the “Pre-approval Policy”).
Under the Pre-approval Policy, proposed services either:
(i) may be pre-approved by the Audit Committee without consideration of specific case-by-case services (“general pre-approval”); or
(ii) require the specific pre-approval of the Audit Committee (“specific pre-approval”). Appendices to the Pre-approval Policy (that are adopted each year) set out the audit, audit-related, tax, and other services that have received the general pre-approval of the Audit Committee. All other audit, audit-related, tax and other services must receive specific pre-approval from the Audit Committee.
During 2014, all services provided to TALIC by PwC were pre-approved by the Audit Committee in accordance with the Pre-approval policy.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Financial Statements and Exhibits
(1) The following financial statements of the Registrant are filed as part of this report
a. Independent Registered Public Accounting Firm Report dated April 15, 2015 (PricewaterhouseCoopers LLP).
b. Independent Registered Public Accounting Firm Report dated April 15, 2015 (Ernst & Young LLP).
c. Balance Sheets at December 31, 2014 and 2013 (As Restated).
d. Statements of Income for the Years Ended December 31, 2014, 2013 (As Restated) and 2012.
e. Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 (As Restated) and 2012.
f. Statements of Stockholder’s Equity for the Years Ended December 31, 2014, 2013 (As Restated) and 2012.
g. Statements of Cash Flows for the Years Ended December 31, 2014, 2013 (As Restated) and 2012.
h. Notes to Financial Statements for the Years Ended December 31, 2014, 2013 (As Restated) and 2012.
(2) Not applicable.
(3) The following exhibits are filed as part of this report:
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting for TALIC to provide reasonable assurance regarding the reliability of the financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the receipts and expenditures are being made only in accordance with authorizations of Management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of internal control over financial reporting effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Management assessed the internal control over financial reporting as of December 31, 2013 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and the overall control environment. Based on the assessment, Management had previously concluded that internal control over financial reporting was effective as of December 31, 2013 as reported in its previously filed Annual Report on Form 10-K. However, as a result of the restatement, TALIC’s management identified a material weakness in internal control over financial reporting as further described below and has now concluded that internal control over financial reporting was not effective as of December 31, 2013 and, because remediation is not yet completed, internal control over financial reporting was also not effective as of December 31, 2014.
A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected on a timely basis. The material weakness described below resulted in adjustments during the preparation of the Company’s 2014 financial statements and restatement of the Company’s financial statements as of and for the year ended 2013 and the interim periods in 2014 as outlined in Note 1 and Note 14 to the financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K, and affected the tax-related financial statement line items and disclosures and until remediation is complete could result in misstatements in future interim or annual reporting periods. The Company did not have effective controls surrounding the evaluation and review related to non-routine technical tax accounting matters, specifically with regards to the valuation allowance on deferred tax assets.
Management has been actively engaged in developing remediation plans to address the above material weakness. The remediation efforts expected to be implemented include the following:
Re-designing processes, procedures, and controls to identify, research, evaluate and review the appropriate accounting related to non-routine technical tax accounting matters, specifically with regards to the valuation allowance on deferred tax assets to ensure greater oversight and evaluation of income tax conclusions prior to the issuance of the financial statements.
The Company believes that the controls that will be implemented will improve the effectiveness of the internal control over financial reporting. As the Company continues to evaluate and work to improve the internal control over financial reporting, the Company may take additional measures to address the material weakness or determine to supplement or modify certain of the remediation measures described above.
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm - PricewaterhouseCoopers LLP
Report of Independent Registered Public Accounting Firm - Ernst & Young LLP
Balance Sheets at December 31, 2014 and 2013 (As Restated)
Statements of Income for the Years Ended December 31, 2014, 2013 (As Restated) and
Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 (As Restated) and 2012
Statements of Stockholder’s Equity for the Years Ended December 31, 2014, 2013 (As Restated) and 2012
Statements of Cash Flows for the Years Ended December 31, 2014, 2013(As Restated) and
Notes to Financial Statements for the Years Ended December 31, 2014, 2013 (As Restated) and
[PricewaterhouseCoopers LLP]
Report of Independent Registered Public Accounting Firm
To the Board of Directors
In our opinion, the accompanying balance sheet and the related statements of income, comprehensive income, stockholder’s equity and cash flows present fairly, in all material respects, the financial position of Transamerica Advisors Life Insurance Company at December 31, 2014, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements 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. An audit 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, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
April 15, 2015
[Ernst & Young LLP]
Report of Independent Registered Public Accounting Firm
The Board of Directors
Transamerica Advisors Life Insurance Company
We have audited the accompanying balance sheets of Transamerica Advisors Life Insurance Company as of December 31, 2013 and 2012, and the related statements of income, comprehensive income, stockholder’s equity, and cash flows for each of the two years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits 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, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Transamerica Advisors Life Insurance Company at December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the financial statements, the 2013 financial statements have been restated to correct an error in the determination of the deferred tax asset valuation allowance.
/s/ Ernst & Young LLP
Des Moines, Iowa
March 27, 2014, except for Note 1, which is as of April 15, 2015
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
BALANCE SHEETS
See Notes to Financial Statements
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
BALANCE SHEETS - Continued
See Notes to Financial Statements
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
STATEMENTS OF INCOME
See Notes to Financial Statements
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
STATEMENTS OF COMPREHENSIVE INCOME
See Notes to Financial Statements
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
STATEMENTS OF STOCKHOLDER’S EQUITY
See Notes to Financial Statements
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
STATEMENTS OF CASH FLOWS
See Notes to Financial Statements
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
STATEMENTS OF CASH FLOWS - Continued
(1) Included in net decrease in cash and cash equivalents is interest received (2014 - $31; 2013 - $29; 2012 - $0); interest paid (2014 - $5; 2013 - $4; 2012 - $7); income taxes paid ( 2014 - $0; 2013 - $136; 2012 - $10,140); and income taxes received (2014 - $719; 2013 - $8,491; 2012 - $478)
See Notes to Financial Statements
TRANSAMERICA ADVISORS LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF AEGON USA, LLC)
NOTES TO FINANCIAL STATEMENTS
(Dollars in Thousands)
Note 1. Restatement of Previously Reported Financial Statements
During the preparation of the Company’s Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2014, an error in the tax valuation allowance was identified for the year ended December 31, 2013. The error principally relates to the scheduling of certain deferred tax liabilities in the Company’s analysis of the future ability to utilize net operating loss carryforwards in the tax expense calculations and the resulting amount of valuation allowance recognized. Following the identification of the tax- related error, management initiated a comprehensive internal review of the Company’s historical financial information and determined the error materially impacted the audited financial statements for the year ended December 31, 2013 and the unaudited interim financial statements for March 31, 2014, June 30, 2014 and September 30, 2014. Consequently, the Company has restated its financial statements for the year ended December 31, 2013 and the unaudited interim financial statements for March 31, 2014, June 30, 2014 and September 30, 2014. The restated unaudited interim financial statements for March 31, 2014, June 30, 2014 and September 30, 2014 are presented in Note 14 to the Financial Statements. In addition, the following out-of-period errors and reclassifications have been made to the financial statements:
•
Other out-of-period errors - The Company identified, individually and in the aggregate, immaterial out-of-period errors which have been corrected in the periods to which they relate. These corrections primarily relate to actuarial modelling reserving errors and state tax calculations. These corrections had the combined effect on income and equity as noted below. The impact to individual financial statement line items for these corrections is reflected in the below section “Comparison of previously issued financial statements to restated financial statements for the year ended December 31, 2013”.
•
Balance Sheet reclassifications - there was no effect on net income or stockholder’s equity as a result of these changes
o A liability balance representing outstanding checks was moved from the “Cash and cash equivalents” line to a new line item called “Checks not yet presented for payment”.
o “Policyholder account balances” of $20,282, was reclassified to “Future policy benefits” as of December 31, 2013.
•
Statements of Income reclassifications - “Interest credited to policyholder liabilities” of $4,541 and $6,915 was reclassified to “Policy benefits” for the years ended December 31, 2013 and 2012, respectively. There was no effect on net income or stockholder’s equity as a result of this change.
•
Statements of Cash Flows reclassifications - there was no effect on net income or stockholder’s equity as a result of these changes
o “Change in payables for collateral under securities loaned and reverse repurchase agreements” was reclassified from “Cash Flows from Investing Activities” to “Cash Flows from Financing Activities” for the years ended December 31, 2013 and 2012.
o “Interest credited to policyholder liabilities” of $4,541 and $6,915 was reclassified to “Change in benefit reserves” for the years ended December 31, 2013 and 2012, respectively in “Cash Flows from Operating Activities”.
o Outstanding checks liability has been moved from “Cash and cash equivalents” to “Checks not yet presented for payment”, a new line in “Cash Flows from Operating Activities”.
Comparison of previously issued financial statements to restated financial statements for the year ended December 31, 2013
The following tables compare the previously reported Balance Sheet as of December 31, 2013 and the previously reported Statements of Income, Comprehensive Income (Loss), Stockholder’s Equity, and Cash Flows for the year ended December 31, 2013 to the corresponding restated financial statements.
Transamerica Advisors Life Insurance Company
Balance Sheet
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Balance Sheet - Continued
(1) Consists of out-of-period errors and reclassifications.
(2) Included in Other Adjustments is a reclassification of $20,282 from “Policyholder account balances” to “Future policy benefits”.
Transamerica Advisors Life Insurance Company
Statement of Income
(1) Consists of out-of-period errors and reclassifications.
(2) Included in Other Adjustments is a reclassification of $4,541 from “Interest credited to policyholder liabilities” to “Policy benefits”.
Transamerica Advisors Life Insurance Company
Statement of Comprehensive Income
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Stockholder’s Equity
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Cash Flows
(1) Consists of out-of-period errors and reclassifications.
(2) Included in Other Adjustments is a reclassification of $4,541 from “Interest credited to policyholder liabilities” to “Change in benefit reserves”.
(3) Included in net decrease in cash and cash equivalents is interest received - $29; interest paid - $4; income taxes paid - $136; and income taxes received - $8,491
Note 2. Summary of Significant Accounting Policies and Estimates
Basis of Presentation
Transamerica Advisors Life Insurance Company (“TALIC” or the “Company”) is a wholly owned subsidiary of AEGON USA, LLC (“AUSA”). AUSA is an indirect wholly owned subsidiary of AEGON N.V., a public limited liability company organized under Dutch law. AEGON N.V. and its subsidiaries and joint ventures have life insurance and pension operations in over twenty-five countries in Europe, the Americas, and Asia and are also active in savings and asset management operations, accident and health insurance, general insurance and to a limited extent banking operations.
The Company is a life insurance company, who conducts its business primarily in the annuity markets and to a lesser extent in the life insurance markets of the financial services industry. The Company is domiciled in the State of Arkansas and is currently licensed to sell insurance and annuities in forty-nine states, the District of Columbia, the U.S. Virgin Islands and Guam. Currently, the Company is not issuing new life insurance, variable annuity and market value adjusted annuity products. In 2012, the Company began selling a fixed contingent annuity (also sometimes referred to as a contingent deferred annuity (“CDA”)) that includes a stand-alone living benefit (“SALB”). A SALB is essentially a guaranteed lifetime withdrawal benefit which exists independently and is applied to mutual funds and exchange traded funds.
Basis of Reporting
The accompanying financial statements have been prepared in conformity with United States generally accepted accounting principles (“GAAP”). The Company also submits financial statements to insurance industry regulatory authorities, which are prepared on the basis of statutory accounting principles (“SAP”). The significant accounting policies and related judgments underlying the Company’s financial statements are summarized below.
Accounting Estimates and Assumptions
The preparation of financial statements in conformity to GAAP requires management to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses and the disclosures of contingent assets and liabilities. Those estimates are inherently subject to change and actual results could differ from those estimates. Included among the material (or potentially material) reported amounts and disclosures that require extensive use of estimates are: fair value of certain invested assets, asset valuation allowances, deferred policy acquisition costs, deferred sales inducements, value of business acquired, goodwill, policyholder liabilities, income taxes, and potential effects of unresolved litigated matters.
Investments
Fixed maturity and equity securities
The Company’s investments consist principally of fixed maturity and equity securities that are classified as available-for-sale (“AFS”) which are reported at estimated fair value. The fair values of fixed maturity and equity securities are determined by management after taking into consideration several sources of data. When available, the Company uses quoted market prices in active markets to determine the fair value of its investments. The Company’s valuation policy utilizes a pricing hierarchy which dictates that publicly available prices are initially sought from indices and third-party pricing services. In the event that pricing is not available from these sources, those securities are submitted to brokers to obtain quotes. If broker quotes are not available, securities are priced using internal cash flow modeling techniques. These valuation methodologies commonly use reported trades, bids, offers, issuer spreads, benchmark yields, estimated prepayment speeds, and/or estimated cash flows.
To understand the valuation methodologies used by third-party pricing services, the Company reviews and monitors their applicable methodology documents. Any changes to their methodologies are noted and reviewed for reasonableness. In addition, the Company performs periodic in-depth reviews of prices received from third-party pricing services. The objective for such reviews is to demonstrate that the Company can corroborate detailed information such as assumptions, inputs and methodologies used in pricing individual securities against documented pricing methodologies. Only third-party pricing services and brokers with a substantial presence in the market and with appropriate experience and expertise are used.
Each month, the Company performs an analysis of the information obtained from third-party services and brokers to ensure that the information is reasonable and produces a reasonable estimate of fair value. The Company considers both qualitative and quantitative factors as part of this analysis, including but not limited to, recent transactional activity for similar fixed maturities, review of pricing statistics and trends, and consideration of recent relevant market events. Other controls and procedures over pricing received from indices, third-party pricing services, or
brokers include validation checks such as exception reports which highlight significant price changes, stale prices or un-priced securities. Additionally, the Company performs back testing on a sample basis. Back testing involves selecting a sample of securities trades and comparing the prices in those transactions to prices used for financial reporting. Significant variances between the price used for financial reporting and the transaction price are investigated to explain the cause of the difference.
The Company’s portfolio of private placement securities is valued using a matrix pricing methodology. The pricing methodology is obtained from a third party service and indicates current spreads for securities based on weighted average life, credit rating and industry sector. Monthly, the Company reviews the matrix to ensure the spreads are reasonable by comparing them to observed spreads for similar securities traded in the market. In order to account for the illiquid nature of these securities, illiquidity premiums are included in the valuation and are determined based upon the pricing of recent transactions in the private placement market, as well as comparing the value of the privately offered security to a similar public security. The impact of the illiquidity premium to the overall valuation is less than 1% of the fair value.
For fixed maturity securities, premiums are amortized to the earlier of the call or maturity date, discounts are accreted to the maturity date, and interest income is accrued daily. For equity securities, dividends are recognized on the ex-dividend date. Investment transactions are recorded on the trade date. Realized gains and losses on the sale or maturity of investments are determined on the basis of specific identification.
Changes in the fair value of fixed maturity and equity securities deemed AFS are reported as a component of accumulated other comprehensive income (loss), net of taxes on the Balance Sheets and are not reflected in the Statements of Income until a sale transaction occurs or when credit-related declines in estimated fair value are deemed other-than-temporary. Changes in fair value of fixed maturity securities deemed trading are reported as a component of net investment income.
Other-than-temporary impairments (“OTTI”)
The Company regularly reviews each investment in its fixed maturity and equity AFS securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. Management makes this determination through a series of discussions with the Company’s portfolio managers and credit analysts, and information obtained from external sources (i.e., company announcements, ratings agency announcements, or news wire services). For fixed maturity AFS securities, the Company also considers whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The factors that may give rise to a potential OTTI include, but are not limited to, i) certain credit-related events such as default of principal or interest payments by the issuer, ii) bankruptcy of issuer, iii) certain security restructurings, and iv) fair market value less than cost or amortized cost for an extended period of time. In the absence of a readily ascertainable market value, the estimated fair value on these securities represents management’s best estimate and is based on comparable securities and other assumptions as appropriate. Management bases this determination on the most recent information available. For equity securities, once management determines a decline in the value of an AFS security is other-than-temporary, the cost basis of the equity security is reduced to its fair value, with a corresponding charge to earnings.
For fixed maturity AFS securities, an OTTI must be recognized in earnings when an entity either a) has the intent to sell the debt security or b) more likely than not will be required to sell the debt security before its anticipated recovery. If the Company meets either of these criteria, the OTTI is recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For fixed maturity AFS securities in unrealized loss positions that do not meet these criteria, the Company must analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows. If the net present value is less than the amortized cost of the investment, an OTTI is recorded. The OTTI is separated into two pieces: an amount representing the credit loss, where the present value of cash flows expected to be collected is less than the amortized cost basis of the security, and an amount related to all other factors (referred to as the non credit portion). The credit loss is recognized in earnings and the non credit loss is recognized in other comprehensive income (“OCI”), net of applicable taxes and value of business acquired. Management records subsequent changes in the estimated fair value (positive and negative) of fixed maturity AFS securities for which non credit OTTI was previously recognized in OCI in OCI-OTTI.
Limited partnerships
At December 31, 2014, the Company had investments in two limited partnerships that were not publicly traded. Both partnerships are carried at estimated fair value for which one is derived from management’s review of the underlying financial statements that were prepared on a GAAP basis and the other from which management is able to determine that observable market inputs have been used. At December 31, 2013, the Company had an investment in one limited partnership that was not publicly traded. This partnership was carried at estimated fair value which is derived from management’s review of the underlying financial statements that were prepared on a GAAP basis. The valuation utilizing the underlying financial statements is on a one quarter lag.
Mortgage loans on real estate
Mortgage loans on real estate are carried at unpaid principal balances adjusted for amortization of premiums and accretion of discounts and are net of valuation allowances and general reserves. The fair value for mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or similar remaining maturities. Interest income is accrued on the principal balance of the loan based on the loan’s contractual interest rate. Premiums and discounts are amortized using the effective yield method over the life of the loan. Interest income and amortization of premiums and discounts are reported in net investment income along with mortgage loan fees, which are recorded as they are incurred.
Loans are considered impaired when it is probable that based upon current information and events, the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. When the Company determines that a loan is impaired, a valuation allowance is established for the excess carrying value of the loan over its estimated collateral value. Changing economic conditions impact the Company’s valuation of mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that the Company performs for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for losses. In addition, the Company continues to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of emphasis are properties that have deteriorating credits or have experienced debt coverage reduction. Where warranted, the Company has established or increased loss reserves based upon this analysis. The Company does not accrue interest on loans ninety days past due. The Company also establishes a general reserve which is calculated by applying a percentage, based on risk rating and maturity, to the outstanding loan balance.
Policy loans
Policy loans on insurance contracts are stated at unpaid principal balances. The fair value of policy loans approximates their book value. Policy loans are fully collateralized by the account value of the associated insurance contracts, and the spread between the policy loan interest rate and the interest rate credited to the account value held as collateral is fixed.
Derivatives and hedge accounting
Derivatives are primarily used by the Company to manage risk associated with interest rate or equity market risk or volatility. Freestanding derivatives are carried in the Balance Sheets at fair value. If a derivative is not designated as an accounting hedge or its use in managing risk does not qualify for hedge accounting, changes in the fair value of the derivatives are reported in net derivative gains (losses) in the Statements of Income.
To qualify for hedge accounting, the hedge relationship is designated and formally documented at inception, detailing the particular risk management objective and strategy for the hedge (which includes the item and risk that is being hedged), the derivative that is being used and how hedge effectiveness is being assessed. For hedge accounting purposes, a distinction is made between fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation. Currently, the Company only has cash flow hedges.
A cash flow hedge is the hedge of the exposure to variability of cash flows to be received or paid related to a recognized asset or liability. For derivatives that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of OCI and reclassified into the Statements of Income when the Company’s earnings are affected by the variability of the hedged item. Any hedge ineffectiveness is recognized as a component of net derivative gains (losses) in the Statements of Income.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and on deposit and short-term investments with original maturities of three months or less. Cash and cash equivalents are primarily valued at amortized cost, which approximates fair value.
Checks Not Yet Presented for Payment
The Company’s checks not yet presented for payment consists of checks written that have not yet cleared the Company’s bank accounts. The majority of the Company’s bank accounts are zero balance accounts that are funded at the time items clear against the account; therefore, the outstanding checks represent immediately payable liabilities. As the recipients of these checks have generally not yet received payment, the Company classifies the outstanding checks as a liability. Checks not yet presented for payment are classified in the cash flows from operating activities section of the Company’s Statement of Cash Flows.
Securities Lending
Financial assets that are lent to a third party or that are transferred subject to a repurchase agreement at a fixed price are not derecognized as the Company retains substantially all the risks and rewards of asset ownership. The loaned securities are included in fixed maturity AFS securities in the Balance Sheets. A liability is recognized for cash collateral received, required initially at 102%, on which interest is accrued. If the fair value of the collateral is at any time less than 102% of the fair value of the loaned securities, the counterparty is mandated to deliver additional collateral, the fair value of which, together with the collateral already held in connection with the lending transaction, is at least equal to 102% of the fair value of the loaned securities.
Reverse Repurchase Agreements
The Company enters into dollar roll repurchase agreement transactions whereby the Company takes delivery of mortgage-backed securities (“MBS”) pools and sells them to a counterparty along with an agreement to repurchase substantially the same pools at some point in the future, typically one month forward. These transactions are accounted for as collateralized borrowings and the repurchase agreement liability is included in the Balance Sheets in payables for collateral under securities loaned and reverse repurchase agreements.
Value of Business Acquired (“VOBA”), Deferred Policy Acquisition Costs (“DAC”) and Deferred Sales Inducements (“DSI”)
VOBA
VOBA represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the insurance and annuity contracts in force at the acquisition date. VOBA is based on actuarially determined projections, for each block of business, of future policy and contract charges, premiums, mortality, policyholder behavior, Separate Account performance, operating expenses, investment returns, and other factors. Actual experience on the purchased business may vary from these projections.
For acquired annuity and variable life insurance contracts, VOBA is amortized in proportion to gross profits arising principally from investment margins, mortality and expense margins, rider margins, and surrender charges, based on historical and anticipated future experience, which is updated periodically. Revisions in estimates result in changes to the amounts amortized in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future gross profits are less than the unamortized balance. See Note 5 to the financial statements for further discussion.
DAC
The costs of acquiring business, principally commissions, certain expenses related to policy issuance, and certain variable sales expenses that relate to and vary with the production of new and renewal business are deferred and amortized based on the estimated future gross profits for a group of contracts. DAC are subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each reporting period.
DAC for variable annuities is amortized with interest over the anticipated lives of the insurance contracts in relation to the present values of estimated future gross profits from asset-based fees, guaranteed benefit rider fees, contract fees, and surrender charges, less a provision for guaranteed death and living benefit expenses, policy maintenance expenses, and non-capitalized commissions. Future gross profit estimates are subject to periodic evaluation with necessary revisions applied against amortization to date. The impact of revisions and assumptions to estimates on cumulative amortization is recorded as a charge or credit to current operations, commonly referred to as
“unlocking”. Changes in assumptions can have a significant impact on the amount of DAC reported and the related amortization patterns. In general, increases in the estimated Separate Accounts return and decreases in surrender or mortality assumptions increase the expected future profitability of the underlying business and may lower the rate of DAC amortization. Conversely, decreases in the estimated Separate Accounts returns and increases in surrender or mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization.
At December 31, 2014 and 2013, variable annuities accounted for the Company’s entire DAC asset. See Note 5 to the Financial Statements for further discussion.
DSI
The Company offers a sales inducement whereby the contract owner receives a bonus which increases the initial account balance by an amount equal to a specified percentage of the contract owner’s deposit. This amount may be subject to recapture under certain circumstances. Consistent with DAC, sales inducements for variable annuity contracts are deferred and amortized based on the estimated future gross profits for each group of contracts. These future gross profit estimates are subject to periodic evaluation by the Company, with necessary revisions applied against amortization to date. The impact of these revisions on cumulative amortization is recorded as a charge or credit to current operations, commonly referred to as “unlocking”. It is reasonably possible that estimates of future gross profits could be reduced in the future, resulting in a material reduction in the carrying amount of the DSI asset.
The expense and the subsequent capitalization and amortization (accretion) are recorded as a component of policy benefits in the Statements of Income. At December 31, 2014 and 2013, variable annuities accounted for the Company’s entire DSI asset. See Note 5 to the Financial Statements for further discussion.
Goodwill
Goodwill is the excess of the purchase price over the estimated fair value of net assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but are subject to impairment tests conducted at least annually. Impairment testing is to be performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit represents the operating segment which is the level at which the financial information is prepared and regularly reviewed by management. The entire asset amount has been allocated to annuities. Goodwill is reviewed for indications of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator, or unanticipated competition would cause the Company to review the carrying amounts of goodwill for impairment. When considered impaired, the carrying amounts are written down to fair value based primarily on discounted cash flows. The Company performed annual tests of goodwill at December 31, 2014, 2013, and 2012 and determined there was no impairment of goodwill.
Separate Accounts
The Company’s Separate Accounts consist of variable annuities and variable life insurance contracts, of which the assets and liabilities are legally segregated and reported as separate captions in the Balance Sheets. Separate Accounts are established in conformity with Arkansas State Insurance Law and are generally not chargeable with liabilities that arise from any other business of the Company. Separate Accounts assets may be subject to claims of the Company only to the extent the value of such assets exceeds Separate Accounts liabilities. The assets of the Separate Accounts are carried at the daily net asset value of the mutual funds in which they invest.
Absent any contract provision wherein the Company guarantees either a minimum return or account value upon death or annuitization, the net investment income and net realized and unrealized gains and losses attributable to Separate Accounts assets supporting variable annuities and variable life contracts accrue directly to the contract owner and are not reported as revenue in the Statements of Income. Mortality, guaranteed benefit fees, policy administration, maintenance, and withdrawal charges associated with Separate Accounts products are included in policy charge revenue in the Statements of Income.
Policyholder Account Balances
The Company’s liability for policyholder account balances represents the contract value that has accrued to the benefit of the policyholder as of the Balance Sheet dates. The liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Interest-crediting rates for the Company’s fixed rate products are as follows:
These rates may be changed at the option of the Company after initial guaranteed rates expire, unless contracts are subject to minimum interest rate guarantees.
Future Policy Benefits
The Company’s liability for future policy benefits consists of liabilities for immediate annuities and liabilities for certain guaranteed benefits contained in the variable insurance products the Company manufactures. Liabilities for immediate annuities are equal to the present value of estimated future payments to or on behalf of policyholders, where the timing and amount of payment generally depends on policyholder mortality. Interest rates used in establishing such liabilities were in the range of 0.01% to 7.44% during 2014 and 2013. See Note 6 to the Financial Statements for further discussion.
Revenue Recognition
Revenues for variable annuity contracts consist of policy charges for i) mortality and expense risks, ii) certain guaranteed benefits selected by the contract owner, iii) administration fees, iv) annual contract maintenance charges, and v) withdrawal charges assessed on contracts surrendered during the withdrawal charge period. Revenues for variable annuity contracts are recognized when policy charges are assessed or earned.
Revenues for variable life insurance contracts consist of policy charges for i) mortality and expense risks, ii) cost of insurance fees, iii) amortization of front-end and deferred sales charges, and iv) withdrawal charges assessed on contracts surrendered during the withdrawal charge period. Revenues for variable life insurance contracts are recognized when policy charges are assessed or earned.
Revenues for interest-sensitive annuity contracts (market value adjusted annuities, immediate annuities, and single premium deferred annuities) and interest-sensitive life insurance contracts (single premium whole life insurance) consist of i) investment income, ii) gains (losses) on the sale of invested assets, and iii) withdrawal charges assessed on contracts surrendered during the withdrawal charge period. Revenues for interest-sensitive annuity and life insurance contracts are recognized when investment income and investment sales are earned while revenues for contract charges are recognized when assessed or earned.
Revenues for CDAs consist of fees assessed based on a percentage of the participants covered asset pool, which are assets that are not internally managed by the Company. Fees on CDAs are recognized as they are assessed or earned.
Claims and Claims Settlement Expenses
Liabilities for claims and claims settlement expenses equal the death benefit (plus accrued interest) for claims that have been reported to the Company but have not settled and an estimate, based upon prior experience, for unreported claims.
Income Taxes
The Company provides for income taxes on all transactions that have been recognized in the financial statements in accordance with GAAP guidance. Accordingly, deferred taxes are adjusted to reflect the tax rates at which future taxable amounts will likely be settled or realized. The effects of tax rate changes on future deferred tax liabilities and deferred tax assets, as well as other changes in income tax laws, are recognized in net income (loss) in the year during which such changes are enacted.
The Company is subject to taxes on premiums and is exempt from state income taxes in most states.
Subsequent Events
The financial statements are adjusted to reflect events that occurred between the balance sheet date and the date when the financial statements are issued, provided they give evidence of conditions that existed at the balance sheet date. See Note 15 to the Financial Statements for further discussion.
Events that are indicative of conditions that arose after the balance sheet date are disclosed, but do not result in an adjustment of the financial statements themselves.
Recent Accounting Guidance
Accounting Guidance Adopted in 2013
Accounting Standards Codification (“ASC”) 210, Balance Sheet
In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-11, Disclosures about Offsetting Assets and Liabilities, which enhances disclosures about financial instruments and derivative instruments that are either offset on the statement of financial position or subject to an enforceable master netting arrangement or similar agreement. Entities are required to provide both net and gross information for these assets and liabilities in order to enhance comparability between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards (“IFRS”). The guidance is effective for annual reporting periods, and interim periods within those years, beginning on or after January 1, 2013. The disclosures required by this guidance should be applied retrospectively for all comparative periods presented. The Company adopted the guidance on January 1, 2013, which affects disclosures but did not impact the Company’s results of operations or financial position.
ASC 220, Comprehensive Income
In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which requires an entity to provide information about significant items reclassified out of accumulated other comprehensive income (“AOCI”) by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The guidance is effective prospectively for annual reporting periods, and interim periods within those years, beginning after December 15, 2012. The Company adopted the guidance on January 1, 2013, which affects disclosures but did not impact the Company’s results of operations or financial position.
ASC 740, Income Taxes
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The guidance requires that the liability related to certain unrecognized tax benefits should be offset against a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. The guidance is effective prospectively for annual reporting periods, and interim periods within those years, beginning after December 15, 2013, with early application permitted. The Company early adopted the guidance in the third quarter of 2013, which affects disclosures but did not impact the Company’s results of operations or financial position. See Note 7 to the Financial Statements for further discussion.
Future Accounting Guidance
ASC 860, Transfers and Servicing
In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The guidance requires repurchase-to-maturity transactions to be accounted for as secured borrowings and amends accounting for repurchase financings. It also requires disclosure for (1) repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings and (2) certain transactions accounted for as a sale. The guidance will be effective for the Company on January 1, 2015, except for disclosure requirements for certain transactions accounted for as secured borrowings which will be effective on April 1, 2015. The Company does not expect the new accounting requirements to impact the Company’s results of operations or financial position and is evaluating the impact that adoption will have on the Company’s disclosures.
ASC 205, Presentation of Financial Statements
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern (ASC Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This guidance requires an entity’s management to evaluate whether there are conditions or events that, considered in the aggregate, raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. It also requires disclosures under certain circumstances. The guidance is effective for annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. Implementation of the ASC will not affect the Company’s financial position or results of operations. The Company is in the process of reviewing its policies and processes to ensure compliance with the new guidance.
ASC 606, Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers: Topic 606. The guidance in this update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance unless the contracts are within the scope of other standards (for example, financial instruments, insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance establishes a five-step process to achieve this core principle. ASU 2014-09 will be effective for the Company on January 1, 2017, using either of two methods: retrospective to each prior reporting period presented with certain practical expedients, or retrospective with the cumulative effect of initial application recognized at the date of initial application subject to certain additional disclosures. The Company has not yet selected a transition method and is evaluating the impact that adoption of this update is expected to have on the Company’s financial statements.
Note 3. Fair Value of Financial Instruments
Fair Value Measurements
ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements.
Fair Value Hierarchy
The Company has categorized its financial instruments into a three level hierarchy which is based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.
Assets and liabilities recorded at fair value on the Balance Sheets are categorized as follows:
Level 1. Unadjusted quoted prices for identical assets or liabilities in an active market.
Level 2. Quoted prices in markets that are not active or inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:
a) Quoted prices for similar assets or liabilities in active markets
b) Quoted prices for identical or similar assets or liabilities in non-active markets
c) Inputs other than quoted market prices that are observable
d) Inputs that are derived principally from or corroborated by observable market data through correlation or other means
Level 3. Prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. They reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.
The Company recognizes transfers between levels at the beginning of the quarter.
The following table presents the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis:
(a) Securities are classified as Level 1 if the fair value is determined by observable inputs that reflect quoted prices for identical assets in active markets that the Company has the ability to access at the measurement date. Level 1 securities primarily include highly liquid U.S. Treasury and U.S. government agency securities. Securities are classified as Level 2 if the fair value is determined by observable inputs, other than quoted prices included in Level 1, for the asset or prices for similar assets. Securities are classified as Level 3 if the valuations are derived from techniques in which one or more of the significant inputs are unobservable. Level 3 consists principally of fixed maturity securities whose fair value is estimated based on non-binding broker quotes and internal models. These internal models primarily use projected cash flows discounted using relevant risk spreads and market interest rate curves. At December 31, 2014 and 2013, less than 0.5% of fixed maturity AFS securities were valued using internal models.
(b) Cash equivalents are primarily valued at amortized cost, which approximates fair value. Operating cash is not included in the above table.
(c) Limited partnership investments in which management is able to determine that observable market inputs have been used and can be redeemed at the net asset value in 90 days or less are considered Level 2. The Company has an investment in a limited partnership for which the fair value is derived from management’s review of the underlying financial statements that were prepared on a GAAP basis and is considered a Level 3 measurement. The valuation utilizing these financial statements is on a one quarter lag.
(d) Separate Accounts assets are carried at the net asset value provided by the fund managers.
(e) The Company issued contracts containing guaranteed minimum withdrawal benefit riders (“GMWB”) and obtained reinsurance on guaranteed minimum income benefit riders (“GMIB reinsurance”). GMWB and GMIB reinsurance are treated as embedded derivatives and are required to be reported separately from the host contract. In addition, the Company issues SALB contracts which are required to be reported at fair value. The fair value of these guarantees is calculated as the present value of future expected payments to policyholders less the present value of assessed fees attributable to the guarantees. Given the complexity and long-term nature of these guarantees, their fair values are determined using stochastic techniques under a variety of market return, discount rates and actuarial assumptions. Since many of the assumptions are unobservable and are considered to be significant inputs to the liability valuation, the liability included in future policy benefits has been reflected within Level 3 of the fair value hierarchy.
(f) Level 2 derivatives include inflation swaps, variance swaps, total return swaps, and credit default swaps for which the Company utilized readily accessible quoted index levels and broker quotes. The fair value for inflation swaps is calculated as the difference between the consumer price index (or related readily accessible quoted inflation index level) at the reporting date from the last reset date, multiplied by the notional value of the swap. The fair value for the variance swaps is calculated as the difference between the estimated volatility of the underlying Standard and Poor’s 500 Composite Stock Price Index (“S&P”) at maturity to the actual volatility of the underlying S&P index at initiation (i.e., strike) multiplied by the notional value of the swap. Total return swaps are valued based on the change in the underlying equity index as of the last reset date. Credit default swaps are valued using a discounted cash flow model where future premium payments and protection payments are corrected for the probability of default which is modeled using an arbitrage free credit spread model.
During 2014 and 2013, there were no transfers between level 1 and 2, respectively.
The following table provides a summary of the change in fair value of the Company’s Level 3 assets at December 31, 2014 and 2013:
(a) Recorded as a component of limited partnerships and fixed maturity AFS securities in the Balance Sheets.
(b) Recorded as a component of other comprehensive income (loss).
(c) Recorded as a component of net investment income in the Statements of Income.
In certain circumstances, the Company will obtain non-binding quotes from brokers to assist in the determination of fair value. If those quotes can be corroborated by other market observable data, the investments will be classified as Level 2. If not, the investments are classified as Level 3 due to the unobservable nature of the brokers’ valuation processes. The increase in Level 3 fixed maturity AFS securities at December 31, 2014 was due to a security transferring from Level 2 to Level 3 due to the unavailability of market observable data. The increase was partially offset by a security transferring from Level 3 to Level 2 due to the availability of market observable data. The increase in Level 3 fixed maturity AFS securities at December 31, 2013 was driven by the purchase of five securities at Level 3 within the period. The increase was partially offset by two securities transferring from Level 3 to Level 2 due to the availability of market observable data from an external source.
The Company’s Level 3 liabilities (assets) consist of provisions for GMWB, SALB and GMIB reinsurance. The fair value of these guarantees is calculated as the present value of future expected payments to policyholders less the present value of assessed fees attributable to the guarantees. Given the complexity and long-term nature of these guarantees which are unlike instruments available in financial markets, their fair values are determined using stochastic techniques under a variety of market return scenarios. A variety of factors are considered, including expected market rates of return, equity and interest rate volatility, credit spread, correlations of market returns,
discount rates and actuarial assumptions. For GMWB and SALB, an increase (decrease) in credit spread in isolation would result in a lower (higher) fair value measurement and increases (decreases) in volatility in isolation would result in a higher (lower) fair value measurement. Changes in the Company’s credit spread and volatility assumption have an inverse reaction for GMIB reinsurance, due to this reserve being an asset.
The expected returns are based on risk-free rates, such as the current London Inter-Bank Offered Rate (“LIBOR”) forward curve. The credit spread, which is the most significant unobservable input, is set by using the credit default swap (“CDS”) spreads of a reference portfolio of life insurance companies, adjusted to reflect the subordination of senior debt holders at the holding company level to the position of policyholders at the operating company level (who have priority in payments to other creditors). The credit spread was 30 basis points (“bps”) and 45 bps at December 31, 2014 and 2013, respectively.
For equity volatility, the Company uses a term structure assumption with market-based implied volatility inputs for the first five years and a long-term forward rate assumption of 25% thereafter. The volume of observable option trading from which volatilities are derived generally declines as the contracts’ term increases, therefore, the volatility curve grades from implied volatilities for five years to the ultimate rate. The resulting volatility assumption in year 20 for the S&P (expressed as a spot rate) was 24.3% and 23.9% at December 31, 2014 and 2013, respectively. Correlations of market returns across underlying indices are based on historical market returns and their inter-relationships over a number of years preceding the valuation date. Assumptions regarding policyholder behavior, such as lapses, included in the models are derived in the same way as the assumptions used to measure insurance liabilities. These assumptions are reviewed at each valuation date and updated based on historical experience and observable market data as required.
The following table provides a summary of the changes in fair value of the Company’s Level 3 liabilities (assets) at December 31, 2014 and 2013:
(a) Recorded as a component of policy benefits in the Statements of Income.
(b) Recorded as a component of future policy benefits in the Balance Sheets.
During 2014, the change in GMWB and GMIB reinsurance reserves was primarily driven by declining interest rates and updated policyholder behavior assumptions. During 2013, the change in GMWB and GMIB reinsurance reserves was primarily driven by increased interest rates, updated policyholder behavior assumptions and better than expected equity market performance. During 2014, the change in the SALB reserve was due to an increase in fees collected.
The following table provides a summary of the quantitative inputs and assumptions of the Company’s Level 3 assets and liabilities at December 31, 2014 and 2013:
(1) The Company has an investment in a limited partnership for which the fair value is derived from management’s review of the underlying financial statements that were prepared on a GAAP basis. Management did not make any adjustments to the valuation from the underlying financial statements. As a result, inputs are not developed by management to determine the fair value measurement for this investment.
(2) The SALB is a relatively new product with fewer than 150 policies. Due to the small size of this block the liability was determined based on fees earned.
The following table provides the estimated fair value of the Company’s assets not carried at fair value on the Balance Sheets at December 31, 2014 and 2013:
(a) The fair value of mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or remaining maturities.
(b) Policy loans are stated at unpaid principal balance. The fair value of policy loans approximates their book value.
Note 4. Investments
Fixed Maturity and Equity Securities
The amortized cost/cost and estimated fair value of investments in fixed maturity and equity AFS securities at December 31, 2014 and 2013 were:
(1) Represents other than temporary impairments (“OTTI”) in Accumulated Other Comprehensive Income (“AOCI”), which were not included in earnings. Amount excludes $3,202 and $922 of unrealized gains at December 31, 2014 and 2013, respectively.
Excluding investments in U.S. government and government agencies, the Company is not exposed to any significant concentration of credit risk in its fixed maturity securities portfolio.
The amortized cost and estimated fair value of fixed maturity AFS securities by investment grade at December 31, 2014 and 2013 were:
At December 31, 2014 and 2013 the estimated fair value of fixed maturity securities rated BBB- were $107,865 and $117,465, respectively, which is the lowest investment grade rating given by S&P. Below investment grade securities are speculative and are subject to significantly greater risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. The Company closely monitors such investments.
The amortized cost and estimated fair value of fixed maturity AFS securities at December 31, 2014 and 2013 by contractual maturities were:
In the preceding table fixed maturity securities not due at a single maturity date have been included in the year of final maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company did not hold any trading securities during the years ended 2014 and 2013. During 2012, there was $101 of investment income on fixed maturity trading securities recorded in net investment income in the Statements of Income. During 2012 there was $1,069 of income recognized from the change in the fair value on fixed maturity trading securities recorded in net investment income in the Statements of Income. The Company recognized losses of $960 during 2012 on the conversion of fixed maturity trading securities to preferred stock.
The Company had investment securities with an estimated fair value of $20,484 and $21,007 that were deposited with insurance regulatory authorities at December 31, 2014 and 2013, respectively.
Unrealized Gains (Losses) on Fixed Maturity and Equity Securities
The Company’s investments in fixed maturity and equity securities classified as AFS are carried at estimated fair value with unrealized gains and losses included in stockholder’s equity as a component of accumulated other comprehensive income (loss), net of taxes.
The estimated fair value and gross unrealized losses and OTTI of fixed maturity and equity AFS securities aggregated by length of time that individual securities have been in a continuous unrealized loss position at December 31, 2014 and 2013 were as follows:
(1) Subsequent unrealized gains (losses) on OTTI securities are included in OCI-OTTI.
The total number of securities in an unrealized loss position was 95 and 113 at December 31, 2014 and 2013, respectively.
There were two securities in a continuous unrealized loss position where fair value had declined below amortized cost by greater than 20% at December 31, 2014. The securities had an estimated fair value of $3,221 with an unrealized loss of $2,665. At December 31, 2013 there was one security in a continuous unrealized loss position where fair value had declined below amortized cost by greater than 20%. The security had an estimated fair value of $1,695 with an unrealized loss of $461.
Unrealized gains (losses) incurred during the years ended December 31, 2014 and 2013 were primarily due to price fluctuations resulting from changes in interest rates and credit spreads. If the Company has the intent to sell or it is more likely than not that the Company will be required to sell these securities prior to the anticipated recovery of the amortized cost, securities are written down to fair value. If cash flow models indicate a credit event will impact future cash flows, the security is impaired to discounted cash flows. As the remaining unrealized losses in the portfolio relate to holdings where the Company expects to receive full principal and interest, the Company does not consider the underlying investments to be impaired.
The components of net unrealized gains (losses) and OTTI included in accumulated other comprehensive income (loss), net of taxes, at December 31, 2014 and 2013 were as follows:
The Company records certain adjustments to policyholder account balances in conjunction with the unrealized holding gains or losses on investments classified as available-for-sale. The Company adjusts a portion of these liabilities as if the unrealized holding gains or losses had actually been realized, with corresponding credits or charges reported in accumulated other comprehensive income (loss), net of taxes. At December 31, 2014 and 2013, there were no adjustments to policyholder account balances in conjunction with the unrealized holding gains or losses on investments classified as available-for-sale.
Mortgage Loans on Real Estate
Mortgage loans on real estate consist entirely of mortgages on commercial real estate. Prepayment premiums are collected when borrowers elect to prepay their debt prior to the stated maturity, and are included in net realized investment gains (losses), excluding OTTI on securities in the Statements of Income. There were no prepayment premiums for the years ended December 31, 2014 and 2013.
Loans are considered impaired when it is probable that based upon current information and events, the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. A valuation allowance is established when a loan is impaired for the excess carrying value of the loan over its estimated collateral value. In addition to the valuation allowance for specific loans, a general reserve is estimated based on a percent of the outstanding loan balance. The general reserve at December 31, 2014 and 2013 was $36 and $27, respectively. The change in the reserve is reflected in net realized investment gains (losses), excluding OTTI on securities in the Statements of Income. There were no impaired mortgage loans at December 31, 2104 or 2013. The change in the credit loss allowances on mortgage loans by type of property for the years ended December 31 was as follows:
The commercial mortgages are geographically diversified throughout the United States with the largest concentrations in Pennsylvania, New Hampshire, California, Washington, Minnesota, and Oregon which account for approximately 78% of mortgage loans at December 31, 2014.
The credit quality of mortgage loans by type of property for the years ended December 31 was as follows:
The credit quality for the commercial mortgage loans was determined based on an internal credit rating model which assigns a letter rating to each mortgage loan in the portfolio as an indicator of the quality of the mortgage loan. The internal credit rating model was designed based on rating agency methodology, then modified for credit risk associated with the Company’s mortgage lending process, taking into account such factors as projected future cash flows, net operating income, and collateral value. The model produces a rating score and an associated letter rating which is intended to align with S&P ratings as closely as possible. Information supporting the risk rating process is updated at least annually. While mortgage loans with a lower rating carry a higher risk of loss, adequate reserves for loan losses have been established to cover those risks.
Policy Loans
Policy loans on insurance contracts are stated at unpaid principal balances. Policy loans are fully collateralized by the account value of the associated insurance contracts, and the spread between the policy loan interest rate and the interest rate credited to the account value held as collateral is fixed.
Securities Lending
The following table provides a summary of the securities under securities lending agreements for years ended December 31:
Derivatives and Hedge Accounting
The Company uses several types of derivatives to manage the capital market risk associated with the GMWB.
S&P futures contracts are used to hedge the equity risk associated with these types of variable guaranteed products, in particular the claim and/or revenue risks of the liability portfolio. Net settlements on the futures occur daily. The realized gains (losses) on settlement of these futures have been recorded in net derivative losses in the Statements of Income.
The Company uses variance swaps to hedge equity risk. During 2013, the Company also entered into total return swaps which are based on the S&P. The Company recognizes gains (losses) from the change in fair value of the variance swaps and total return swaps in net derivative losses in the Statements of Income.
The Company also uses equity collars to hedge equity risk. These derivatives were purchased in the fourth quarter of 2012 as part of a hedging program which, with a zero cost at issue, hedges a portion of equity market decline by selling a portion of market upside above the Company’s long-term expected return. The Company recognizes gains (losses) from the change in fair value of the equity collars in net derivative losses in the Statements of Income. The equity collar was disposed of during the fourth quarter of 2013 due to changing market conditions and business needs.
During the third quarter of 2013, the Company entered into cash flow hedging transactions on Treasury Inflation Protected Securities (“TIPS”) utilizing interest rate swaps to lengthen portfolio duration and to hedge the variability of cash flows due to changes in inflation.
During the fourth quarter of 2014, the Company began writing credit default swaps enabling the Company to change the risk profile of the assets in the portfolio by enhancing the overall yield. As a writer of credit default swaps, the Company actively monitors the underlying asset, being careful to note any events (default or similar credit event) that would require the Company to perform on the credit default swap. If such events would take place, the Company has recourse provisions from the proceeds of the bankruptcy settlement of the underlying entity or by the sale of the underlying bond. In the event the representative issuer defaults on its debt obligation referenced in the contract, a payment equal to the notional amount of the contract will be made by the Company and recognized in net derivative gains (losses) on the Statement of Income.
The following table presents the notional and fair value for hedging instruments as of December 31, 2014 and 2013:
The following table presents the net derivative gains (losses) recognized in the Statements of Income:
The following table presents the maximum potential amount of future payments, credit rating, and maturity dates for the credit default swaps as of December 31, 2014:
The following tables present the components of the gain or loss on derivatives that qualify as cash flow hedges:
All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.
As of December 31, 2014, the before-tax deferred net losses on derivatives recorded in AOCI that are expected to be reclassified to the Statements of Income during the next twelve months are ($761). This expectation is based on the anticipated interest payments on the hedged investments in TIPS that will occur over the next twelve months, at which time the Company will recognize the deferred gains (losses) as an adjustment to interest income over the term of the investment cash flows.
The Company receives or pledges collateral related to these derivative transactions. The credit support agreement contains a fair value threshold of $1,000 over which collateral needs to be pledged by the Company or its counterparty. At December 31, 2014 and 2013, the Company has pledged securities in the amount of $27,862 and $31,213, respectively, to counterparties. The Company did not receive cash collateral from counterparties at December 31, 2014 and 2013.
In addition, in order to trade futures, the Company is required to post collateral to an exchange (sometimes referred to as margin). The fair value of collateral posted in relation to the futures margin was $3,235 and $8,452 as of December 31, 2014 and 2013, respectively.
Offsetting of Financial Instruments
The Company has derivative instruments that are subject to master netting agreements. These agreements include provisions to setoff positions with the same counterparties in the event of default by one of the parties. The following tables present the offsetting of derivative assets for the periods ended December 31, 2014 and 2013:
The following tables present the offsetting of derivative liabilities for the periods ended December 31, 2014 and 2013:
There were no other financial assets or financial liabilities as of December 31, 2014 and 2013 that were subject to offsetting.
Net Investment Income
Net investment income by source for the years ended December 31 was as follows:
Realized Investment Gains (Losses)
The Company considers fair value at the date of sale to be equal to proceeds received. Proceeds and gross realized investment gains (losses) from the sale of AFS securities for the years ended December 31 were as follows:
During the first quarter of 2014 the Company impaired a mortgage loan which was subsequently sold during the third quarter of 2014 for a ($1,997) realized loss. There were no impaired mortgage loans in periods ended December 31, 2013 and 2012.
OTTI
If management determines that a decline in the value of an AFS equity security is other-than-temporary, the cost basis is adjusted to estimated fair value and the decline in value is recorded as a net realized investment loss. For debt securities, the manner in which an OTTI is recorded depends on whether management intends to sell a security or it is more likely than not that it will be required to sell a security in an unrealized loss position before its anticipated recovery. If management intends to sell or more likely than not will be required to sell the debt security before recovery, the OTTI is recognized in earnings for the difference between amortized cost and fair value. If these criteria are not met, the OTTI is bifurcated into two pieces: a credit loss is recognized in earnings at an amount equal to the difference between the amortized cost of the debt security and the present value of the security’s anticipated cash flows, and a non credit loss is recognized in OCI for any difference between the fair value and the net present value of the debt security at the impairment measurement date.
The following table sets forth the amount of credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in OCI, and the corresponding changes in such amounts for the years ended December 31:
The components of OTTI reflected in the Statements of Income for the years ended December 31 were as follows:
During 2014 the Company impaired its holding of a previously OCI impaired 2006 vintage residential mortgage backed security (“RMBS”) and a previously OCI impaired 2007 vintage RMBS due to adverse changes in cash flows.
During 2013, the Company had an intent to sell impaired corporate bond, two previously OCI impaired 2007 vintage RMBS and one 2006 vintage RMBS due to adverse changes in cash flows.
During 2012, the Company impaired several RMBS due to adverse changes in cash flows.
Note 5. VOBA, DAC, and DSI
VOBA
VOBA reflects the estimated fair value of in force contracts acquired and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the life insurance and annuity contracts in force at the acquisition date. VOBA is based on actuarially determined projections, for each block of business, of future policy and contract charges, premiums, mortality, Separate Accounts performance, surrenders, operating expenses, investment returns and other factors. Actual experience on the purchased business may vary from these projections. If estimated gross profits or premiums differ from expectations, the amortization of VOBA is adjusted to reflect actual experience. The long-term growth rate assumption for the amortization of VOBA, DAC and DSI was 8% at December 31, 2014 and 2013 and 9% at December 31, 2012.
The change in the carrying amount of VOBA for the years ended December 31 was as follows:
During 2014, the decrease in VOBA was primarily driven by amortization expense from lower favorable equity market performance and a decrease in adjustments related to unrealized (gains) losses and OTTI on investments resulting from increased unrealized gains during the year. The change in unlocking was driven by lower favorable equity market performance resulting in amortization and favorable unlocking.
The estimated future amortization of VOBA from 2015 to 2019 is as follows:
DAC and DSI
The change in the carrying amount of DAC and DSI for the years ended December 31 was as follows:
The increase in DAC and DSI in 2014 was primarily driven by updated policyholder assumptions and underperforming Separate Accounts during the year which resulted in accretion and favorable unlocking as compared to 2013.
Note 6. Variable Contracts Containing Guaranteed Benefits
Variable Annuity Contracts Containing Guaranteed Benefits
Prior to 2009, the Company issued variable annuity contracts in which the Company may have contractually guaranteed to the contract owner a guaranteed minimum death benefit (“GMDB”) and/or an optional guaranteed living benefit provision. The living benefit provisions offered by the Company included a guaranteed minimum income benefit (“GMIB”) and a GMWB. Information regarding the general characteristics of each guaranteed benefit type is provided below:
•
In general, contracts containing GMDB provisions provide a death benefit equal to the greater of the GMDB or the contract value. Depending on the type of contract, the GMDB may equal: i) contract deposits accumulated at a specified interest rate, ii) the contract value on specified contract anniversaries, iii) return of contract deposits, or iv) some combination of these benefits. Each benefit type is reduced for contract withdrawals.
•
In general, contracts containing GMIB provisions provide the option to receive a guaranteed future income stream upon annuitization. There is a waiting period of ten years from contract issue that must elapse before the GMIB provision can be exercised.
•
Contracts containing GMWB provisions provide the contract owner the ability to withdraw minimum annual payments regardless of the impact of market performance on the contract owner’s account value. In general, withdrawal percentages are based on the contract owner’s age at the time of the first withdrawal.
The Company had the following variable annuity contracts containing guaranteed benefits at December 31:
(a) Net amount at risk for GMDB is defined as the current GMDB in excess of the contract owners’ account balance at the Balance Sheet date. Net amount at risk for GMIB is defined as the present value of the minimum guaranteed annuity payments available to the contract owner in excess of the contract owners’ account balance at the Balance Sheet date. Net amount at risk for GMWB is defined as the difference between the maximum amount payable under the guarantee and the contract owners’ account balance at the Balance Sheet date.
The Company records liabilities for contracts containing GMDB and GMIB as a component of future policy benefits in the Balance Sheets and changes in the liabilities are included as a component of policy benefits in the Statements of Income. The GMDB and GMIB liabilities are determined by projecting future expected guaranteed benefits under multiple scenarios for returns on Separate Accounts assets. The Company uses estimates for mortality and policyholder behavior assumptions based on actual and projected experience for each contract type. These estimates are consistent with the estimates used in the calculation of DAC. The Company regularly evaluates the estimates used and adjusts the GMDB and/or GMIB liability balances with a related charge or credit to earnings (“unlocking”), if actual experience or evidence suggests that earlier assumptions should be revised.
The changes in the variable annuity GMDB and GMIB liabilities for the years ended December 31 were as follows:
The change in reserves was primarily driven by a decrease in interest rates and updated policyholder assumptions during 2014 when compared to 2013.
At December 31, contract owners’ account balances by mutual fund class by guaranteed benefit provisions were comprised as follows:
Variable Life Contracts Containing Guaranteed Benefits
The Company has issued variable life contracts in which the Company contractually guarantees to the contract owner a GMDB. In general, contracts containing GMDB provisions provide a death benefit equal to the amount specified in the contract regardless of the level of the contract’s account value.
At December 31, contract owners’ account balances by mutual fund class for contracts containing GMDB provisions were distributed as follows:
Note 7. Income Taxes
The following is a reconciliation of the provision for income taxes based on income (loss) before federal income taxes, computed using the federal statutory rate versus the reported provision for income taxes for the years ended December 31:
The effective tax rate was not meaningful for the twelve months ended December 31, 2014, 2013, and 2012. Differences between the effective rate and the U.S. statutory rate of 35% principally were the result of Separate Accounts dividends-received deduction (“DRD”) and the valuation allowance on net operating loss carryforward.
The Company provides for deferred income taxes resulting from temporary differences that arise from recording certain transactions in different years for income tax reporting purposes than for financial reporting purposes. The asset and liability method requires that deferred taxes be adjusted to reflect the tax rates at which future taxable amounts will be settled or realized. The Company provides for federal income taxes based on amounts it believes it will ultimately owe. Inherent in the provision for federal income taxes are estimates regarding the realization of certain tax deductions and credits.
Deferred tax assets and liabilities at December 31 were as follows:
The provision for income tax expense (benefit) consists of the following for the years ended:
The provision for income tax receivable (payable) consists of the following for the periods ending December 31:
At December 31, 2014 and 2013 (As Restated), the Company had a tax valuation allowance for deferred tax assets of $113,406 and $139,295, respectively (this includes losses that are anticipated to be used in the consolidated group to reflect the income statement impact of the losses that wouldn’t be used if filing separately). At December 31, 2013, management determined that deferred tax assets on the loss carryforwards and other assets are not more likely than not to be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that all or some of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends on generation of future taxable income during the periods in which those temporary differences are deductible. Management considers the scheduled reversal of deferred tax liabilities, projected taxable income, and tax-planning strategies in making the assessment. The error that was identified during the preparation of the Company’s 2014 financial statements, which required a restatement of the Company’s financial statements as of the year ended December 31, 2013 and the three quarters of 2014 relate to the complexity of the tax valuation allowance calculation.
The Company has analyzed all material tax positions under the guidance of ASC 740, Income Taxes, related to the accounting for uncertainty in income tax, and determined there were tax benefits of $3,041 (gross $8,689) and $2,931 (gross $8,374) that should not be recognized at December 31, 2014 and 2013, respectively, which primarily relate to uncertainty regarding the sustainability of certain deductions taken on the 2013, 2012, 2011, 2010, 2009 and 2008 U.S. Federal income tax returns. To the extent these unrecognized tax benefits are ultimately recognized, they will not impact the effective tax rate in a future period. It is not anticipated that the total amounts of unrecognized tax benefits will significantly increase within twelve months of the reporting date.
The components of the change in the unrecognized tax benefits were as follows:
At December 31, 2014 and 2013, the Company had an operating loss carryforward for federal income tax purposes of $505,102 (net of the ASC 740 reduction of $8,689) and $459,738 (net of the ASC 740 reduction of $8,374), respectively, with a carryforward period of fifteen years that expire at various dates up to 2029. At December 31, 2014 and 2013, the Company had a capital loss carryforward of $2,468 and $4,127, respectively, for federal income
tax purposes with a carryforward period of five years that will expire in 2018. At December 31, 2014 and 2013, the Company had a foreign tax credit carryforward of $8,574 and $8,093, respectively, with a carryforward period of ten years that will expire at various dates up to 2024. Also, the Company has an Alternative Minimum Tax credit carryforward for federal income tax purposes of $4,216 at December 31, 2014 and 2013, with an indefinite carryforward period.
The Company classifies interest and penalties related to income taxes as interest expense and penalty expense, respectively. These amounts are included in insurance expenses and taxes on the Statements of Income. The Company did not incur or recognize any penalties in its financial statements at December 31, 2014, 2013, and 2012. The Company recognized interest income of ($1), less than ($1), and ($30) at December 31, 2014, 2013, and 2012 respectively.
The Company records taxes on a separate company basis. Effective January 1, 2013 for federal income tax purposes the Company joined the Transamerica Corporation consolidated income tax group. The method of allocation between the companies is subject to a written tax allocation agreement. Under the terms of the agreement, taxes are payable to or receivable from Transamerica Corporation in amounts that would result had the company filed a separate tax return with taxing authorities. Any tax differences between the Company’s separately calculated provision and cash flows attributable to benefits from consolidation have been recognized as capital contributions from Transamerica Corporation. As of December 31, 2014, the Company recognized capital contributions from Transamerica Corporation in connection with the tax allocation agreement in the amount of $179,029. There were no capital contributions or return of capital in 2013. Intercompany income tax balances are settled within thirty days of payment to or filing with the Internal Revenue Service.
The Company filed a separate federal income tax return for the years 2008 through 2012. A consolidated tax return was filed for 2013. An examination by the Internal Revenue Service is in progress for the years 2011 and 2012. The Company believes that there are adequate defenses against or sufficient provisions established related to any open or contested tax positions. A consolidated tax return has not yet been filed for 2014.
Note 8. Accumulated Other Comprehensive Income
The following table presents the change in accumulated other comprehensive income by component for the years ended December 31:
(a) All amounts are net of tax.
The following table presents the reclassifications out of accumulated other comprehensive income for the years ended December 31:
Note 9. Stockholder’s Equity and Statutory Accounting Principles
The Company’s statutory financial statements are presented on the basis of accounting practices prescribed or permitted by the Insurance Department of the State of Arkansas. The State of Arkansas has adopted the National Association of Insurance Commissioners’ (“NAIC”) statutory accounting principles as the basis of its statutory accounting principles.
The Company’s statutory net income (loss) for the years ended December 31, 2014, 2013, and 2012 was $201,479, $196,612, and $178,189, respectively.
Statutory capital and surplus at December 31, 2014 and 2013 was $912,090 and $733,415, respectively. At December 31, 2014 and 2013, approximately $309,501 and $438,112, respectively, of stockholder’s equity was available for dividend distribution that would not require approval by the Arkansas Insurance Department, subject to the availability of unassigned surplus. During 2014, the Company paid a $100,000 dividend and received $179,029 in capital contributions to or from AUSA. During 2013, the Company did not pay any dividends or receive any capital contributions to or from AUSA.
The NAIC utilizes the Risk Based Capital (“RBC”) adequacy monitoring system. The RBC calculates the amount of adjusted capital that a life insurance company should have based upon that company’s risk profile. At December 31, 2014 and 2013, based on the RBC formula, the Company’s total adjusted capital level was significantly above the minimum amount of capital required to avoid regulatory action.
The Company has been given a verbal notification by the Insurance Department of the State of Arkansas of a financial examination for the period January 1, 2010 through December 31, 2014. The examination is expected to start during the second quarter of 2015.
Note 10. Reinsurance
In the normal course of business, the Company seeks to limit its exposure to loss on any single insured life and to recover a portion of benefits paid by ceding mortality risk to other insurance enterprises or reinsurers under indemnity reinsurance agreements, primarily quota share coverage and coinsurance agreements. The maximum amount of mortality risk retained by the Company is approximately $1,000 on single and joint life policies.
Indemnity reinsurance agreements do not relieve the Company from its obligations to contract owners. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company regularly evaluates the financial condition of its reinsurers so as to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 2014 and 2013, net reinsurance payable was ($49) and ($249), respectively. The Company did not have a reinsurance reserve at December 31, 2014 and 2013.
At December 31, 2014, the Company had the following life insurance in force:
In addition, the Company seeks to limit its exposure to guaranteed benefit features contained in certain variable annuity contracts. Specifically, the Company reinsures certain GMIB and a GMDB provision to the extent reinsurance capacity is available in the marketplace. At December 31, 2014, 36% and 5% of the account value for variable annuity contracts containing GMIB and GMDB provisions, respectively, were reinsured. At December 31, 2013, 36% and 6% of the account value for variable annuity contracts containing GMIB and GMDB provisions, respectively, were reinsured.
Note 11. Related Party Transactions
At December 31, 2014, the Company had the following related party agreements in effect:
The Company is party to a common cost allocation service agreement between AUSA companies in which various affiliated companies may perform specified administrative functions in connection with the operation of the Company, in consideration of reimbursement of actual costs of services rendered. During 2014, 2013 and 2012, the Company incurred $9,690, $10,751, and $11,514, respectively, in expenses under this agreement. Charges attributable to this agreement are included in insurance expenses and taxes, net of amounts capitalized.
The Company is party to intercompany short-term note receivable arrangements with its parent and affiliates at various times during the year. On June 27, 2014, the Company entered into an intercompany short-term note receivable with AUSA for $50,000 with an interest rate of 0.11% that was paid off in December 2014. On May 21, 2013, the Company entered into an intercompany short-term note receivable of $50,000 with an interest rate of 0.10% that was paid off in December 2013. During 2014, 2013 and 2012, the Company accrued and/or received $27, $29, and $0 of interest, respectively. Interest related to these arrangements is included in net investment income.
AEGON USA Realty Advisors, LLC acts as the manager and administrator for the Company’s mortgage loans on real estate under an administrative and advisory agreement with the Company. Charges attributable to this agreement are included in net investment income. During 2014, 2013 and 2012, the Company incurred $89, $90, and $86, respectively, under this agreement. Mortgage loan origination fees are amortized into net investment income over the life of the mortgage loans. There were no mortgage loan origination fees during 2014, 2013 and 2012, respectively.
AEGON USA Investment Management, LLC acts as a discretionary investment manager under an investment management agreement with the Company. During 2014, 2013 and 2012, the Company incurred $1,770, $1,673, and $1,625, respectively, in expenses under this agreement. Charges attributable to this agreement are included in net investment income.
Transamerica Capital, Inc. provides underwriting and distribution services for the Company under an underwriting agreement. During 2014, 2013 and 2012, the Company incurred $30,836, $32,414, and $32,546, respectively, in expenses under this agreement. Charges attributable to this agreement are included in insurance expenses and taxes, net of amounts capitalized.
Transamerica Asset Management, Inc. acts as the investment advisor for certain related party funds in the Company’s Separate Accounts under multiple service agreements. During 2014, 2013 and 2012, the Company incurred $406, $410 and $405, respectively, in expenses under this agreement. Charges attributed to these agreements are included in insurance expenses and taxes, net of amounts capitalized.
The Company has a participation agreement with Transamerica Series Trust to offer certain funds in the Company’s Separate Accounts. Transamerica Capital, Inc. acts as the distributor for said related party funds. The Company has entered into a distribution and shareholder services agreement for certain of the said funds. During 2014, 2013 and 2012, the Company received $2,584, $1,873, and $1,737, respectively, in revenue under these agreements. Revenue attributable to this agreement is included in policy charge revenue.
The Company is party to the purchasing and selling of investments between various affiliated companies. The investments are purchased and sold using the fair value on the date of the acquisition or disposition. The purchasing and selling of investments between affiliated companies for the years ended December 31, was as follows:
While management believes that the service agreements referenced above are calculated on a reasonable basis, they may not necessarily be indicative of the costs that would have been incurred with an unrelated third party. Affiliated agreements generally contain reciprocal indemnity provisions pertaining to each party’s representations and contractual obligations thereunder.
Note 12. Commitments and Contingencies
State insurance laws generally require that all life insurers who are licensed to transact business within a state become members of the state’s life insurance guaranty association. These associations have been established for the protection of contract owners from loss (within specified limits) as a result of the insolvency of an insurer. At the time an insolvency occurs, the guaranty association assesses the remaining members of the association an amount sufficient to satisfy the insolvent insurer’s contract owner obligations (within specified limits). The Company has utilized public information to estimate the future assessments it will incur as a result of life insurance company insolvencies. At December 31, 2014 and 2013, the Company’s estimated liability for future guaranty fund assessments was $144 and $202, respectively. In addition, the Company has a receivable for future premium tax
deductions of $4,473 and $4,588 at December 31, 2014 and 2013, respectively. If future insolvencies occur, the Company’s estimated liability may not be sufficient to fund these insolvencies and the estimated liability may need to be adjusted. The Company regularly monitors public information regarding insurer insolvencies and adjusts its estimated liability as appropriate.
In the normal course of business, the Company is subject to various claims and assessments. Management believes the settlement of these matters would not have a material effect on the financial position, results of operations or cash flows of the Company.
Note 13. Segment Information
In reporting to management, the Company’s operating results are categorized into two business segments: Annuity and Life Insurance. The Company’s Annuity segment consists of variable annuity and interest-sensitive annuity contracts. The Company’s Life Insurance segment consists of variable life insurance and interest-sensitive life insurance contracts. The accounting policies of the business segments are the same as those for the Company’s financial statements included herein. All revenue and expense transactions are recorded at the contract level and accumulated at the business segment level for review by management. The following tables summarize each business segment’s contribution to select Statements of Income information for the years ended December 31:
(a) Net revenues include total revenues net of interest credited to policyholder liabilities.
The following tables represent select Balance Sheet information at December 31:
Note 14. Quarterly Unaudited Financial Information
As a result of the tax error related to the scheduling of certain deferred tax liabilities, identified in the period ended December 31, 2013, the Company has restated the unaudited interim financial statements for March 31, 2014, June 30, 2014, and September 30, 2014. The impact of the tax adjustments by period are shown below. Additionally, other out-of-period errors have been corrected in the periods to which they relate. These adjustments are not material, individually or in the aggregate, to either the 2014 quarterly periods or any previously issued financial statements. In addition, “Policyholder account balances” of $5,577, $10,989, and $15,235 was reclassified on the Balance Sheet to “Future policy benefits” as of March 31, 2014, June 30, 2014 and September 30, 2014, respectively. The following tables compare the previously reported Balance Sheets as of March 31, 2014, June 30, 2014 and September 30, 2014 and the previously reported Statements of Income, Comprehensive Income (Loss), Stockholder’s Equity, and Cash Flows for the periods ended March 31, 2014, June 30, 2014 and September 30, 2014 to the corresponding restated financial statements.
Transamerica Advisors Life Insurance Company
Balance Sheet (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Balance Sheet - Continued (unaudited)
(1) Consists of out-of-period errors and reclassifications.
(2) Included in Other Adjustments is a reclassification of $5,577 from “Policyholder account balances” to “Future policy benefits”.
Transamerica Advisors Life Insurance Company
Balance Sheet (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Balance Sheet - Continued (unaudited)
(1) Consists of out-of-period errors and reclassifications.
(2) Included in Other Adjustments is a reclassification of $10,989 from “Policyholder account balances” to “Future policy benefits”.
Transamerica Advisors Life Insurance Company
Balance Sheet (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Balance Sheet - Continued (unaudited)
(1) Consists of out-of-period errors and reclassifications.
(2) Included in Other Adjustments is a reclassification of $15,235 from “Policyholder account balances” to “Future policy benefits”.
Transamerica Advisors Life Insurance Company
Statement of Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Comprehensive Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Comprehensive Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Comprehensive Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Comprehensive Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Comprehensive Income (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Stockholder’s Equity (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Stockholder’s Equity (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Stockholder’s Equity (unaudited)
(1) Consists of out-of-period errors and reclassifications.
Transamerica Advisors Life Insurance Company
Statement of Cash Flows (unaudited)
(1) Consists of out-of-period errors and reclassifications.
(2) Included in net decrease in cash and cash equivalents is interest received - $0; interest paid - $5; income taxes paid - $0; and income taxes received - $505.
Transamerica Advisors Life Insurance Company
Statement of Cash Flows (unaudited)
(1) Consists of out-of-period errors and reclassifications.
(2) Included in net decrease in cash and cash equivalents is interest received - $4; interest paid - $1; income taxes paid - $0; and income taxes received - $505.
Transamerica Advisors Life Insurance Company
Statement of Cash Flows (unaudited)
(1) Consists of out-of-period errors and reclassifications.
(2) Included in net decrease in cash and cash equivalents is interest received - $18; interest paid - $2; income taxes paid - $0; and income taxes received - $505.
Note 15. Subsequent Events
Late Filings
On April 1, 2015, the Company filed a Notification of Late Filing on Form 12b-25 with the Securities and Exchange Commission (“SEC”) disclosing the inability to file the 2014 Form 10-K on or before the prescribed due date and the intent to file the 2014 Form 10-K as soon as practicable.
Restatement
The Company filed a Current Report on Form 8-K (“Form 8-K”) with the SEC on April 1, 2015 disclosing that the Company’s Audit Committee concluded that the Company’s previously issued audited financial statements for the year ended December 31, 2013 should no longer be relied upon due to an error in the tax valuation allowance in the fourth quarter of the year ended December 31, 2013.
On April 9, 2015, the Company filed an amended Form 8-K disclosing that the Audit Committee had concluded that the financial statements contained in the Company’s Quarterly Reports on Form 10-Q for the quarters ended March 31, 2014, June 30, 2014 and September 30, 2014 should no longer be relied upon due to an error in the recognition of the tax valuation allowance, similar to the error which affected the Company’s audited financial statements for the year ended December 31, 2013.
SIGNATURES
Pursuant to the requirements of 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.
Transamerica Advisors Life Insurance Company
(Registrant)
Date: April 15, 2015
By:
*
Eric J. Martin
Chief Financial Officer, Vice President, Treasurer, and Controller
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.
*By: Alison Ryan - Attorney-in-Fact pursuant to Powers of Attorney.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
No annual report covering the Registrant’s last fiscal year or proxy materials has been or will be sent to Registrant’s security holder.
EXHIBIT INDEX