American Family Life Insurance Company

Report of the Examination of American Family Life Insurance Company Madison, Wisconsin As of December 31, 2006 TABLE OF CONTENTS Page I. INTRODUCTION .................................................................................................................. 2 II. HISTORY AND PLAN OF OPERATION .............................................................................. 4 III. MANAGEMENT AND CONTROL ........................................................................................ 6 IV. AFFILIATED COMPANIES .................................................................................................. 8 V. REINSURANCE ................................................................................................................. 13 VI. FINANCIAL DATA .............................................................................................................. 14 VII. SUMMARY OF EXAMINATION RESULTS ....................................................................... 24 VIII. CONCLUSION.................................................................................................................... 27 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS.............................................. 28 X. ACKNOWLEDGMENT ....................................................................................................... 29 State of Wisconsin / OFFICE OF THE COMMISSIONER OF INSURANCE Jim Doyle, Governor Sean Dilweg, Commissioner Wisconsin.gov September 28, 2007 125 South Webster Street • P.O. Box 7873 Madison, Wisconsin 53707-7873 Phone: (608) 266-3585 • Fax: (608) 266-9935 E-Mail: information@oci.state.wi.us Web Address: oci.wi.gov Honorable Sean Dilweg Commissioner of Insurance State of Wisconsin 125 South Webster Street Madison, Wisconsin 53703 Honorable Alfred W. Gross Chair, Financial Condition (E) Committee, NAIC Commissioner of Insurance Commonwealth of Virginia 1300 East Main Street Richmond, Virginia 23219 Honorable Merle Scheiber Secretary, Midwestern Zone, NAIC Director of Insurance State of South Dakota 445 East Capitol Avenue Pierre, South Dakota 57501-3185 Honorable Morris J. Chavez Secretary, Western Zone, NAIC Superintendent of Insurance State of New Mexico 1120 Paseo de Paralta Santa Fe, New Mexico 87504 Commissioners: In accordance with the instructions of the Wisconsin Commissioner of Insurance, a compliance examination has been made of the affairs and financial condition of: AMERICAN FAMILY LIFE INSURANCE COMPANY Madison, Wisconsin and this report is respectfully submitted. I. INTRODUCTION The previous examination of American Family Life Insurance Company (hereinafter also the company or AFLIC) was conducted in 2002 as of December 31, 2001. The current examination covered the intervening period ending December 31, 2006, and included a review of such 2007 transactions as deemed necessary to complete the examination. The examination consisted of a review of all major phases of the company's operations and included the following areas: History Management and Control Corporate Records Conflict of Interest Fidelity Bonds and Other Insurance Employees' Welfare and Pension Plans Territory and Plan of Operations Affiliated Companies Growth of Company Reinsurance Financial Statements Accounts and Records Data Processing Emphasis was placed on the audit of those areas of the company's operations accorded a high priority by the examiner-in-charge when planning the examination. Special attention was given to the action taken by the company to satisfy the recommendations and comments made in the previous examination report. The company is annually audited by an independent public accounting firm as prescribed by s. Ins 50.05, Wis. Adm. Code. An integral part of this compliance examination was the review of the independent accountant's work papers. Based on the results of the review of these work papers, alternative or additional examination steps deemed necessary for the completion of this examination were performed. The examination work papers contain documentation with respect to the alternative or additional examination steps performed during the course of the examination. Independent Actuary's Review An independent actuarial firm was engaged under a contract with the Office of the Commissioner of Insurance. The actuary reviewed the adequacy of aggregate life and annuity 2 reserves, aggregate accident and health reserves, dividends to policyholders, asset adequacy analysis, and deferred life insurance premiums. The actuary’s results were reported to the examiner-in-charge. As deemed appropriate, reference is made in this report to the actuary's conclusion. 3 II. HISTORY AND PLAN OF OPERATION American Family Mutual Insurance Company (hereinafter also AFMIC) incorporated American Family Life Insurance Company in 1957, as a stock life and disability insurance company. AFLIC is a wholly owned subsidiary of AFMIC through its downstream holding company, AmFam, Incorporated. Collectively, AFMIC and subsidiaries are known as the American Family Mutual Insurance Group. The company is currently licensed in 26 states. During the five-year period under examination, the company obtained its licenses to write business in North Carolina (2002), South Carolina (2002) and Wyoming (2005). In 2006, the company wrote business in all of the jurisdictions in which it was licensed. The distribution of direct premiums written in 2006 by state was as follows: Wisconsin Minnesota Missouri Illinois Colorado Arizona Kansas All others Total $ 83,473,005 49,251,983 48,846,449 43,881,353 29,568,673 27,379,742 23,664,067 105,920,982 $411,986,254* 20.2% 12.0 11.9 10.7 7.2 6.6 5.7 25.7 100.0% * Dividends or refunds applied to purchase paid-up additions and annuities, and premium or annuity considerations waived under disability or other contract provisions, are not included. The company is currently licensed in the following states: Arizona Idaho Iowa Minnesota Nebraska North Carolina Oregon Utah Wisconsin Colorado Illinois Kansas Missouri Nevada North Dakota South Carolina Texas Wyoming California Indiana Michigan Montana New Mexico Ohio South Dakota Washington The products marketed by the company include traditional whole life and term, universal life, and variable universal life insurance products as well as annuity products including variable annuities. All products are marketed through AFMIC’s exclusive agency system. 4 The following chart is a summary of premium income as reported by the company in 2006. The growth of the company is discussed in the “Financial Data” section of this report. Premium Income Direct Premium $168,304,154 129,527,300 84,401,833 3,612,758 1,556,847 53,546,205 $440,949,097 Reinsurance Assumed $ 0 24,191 0 0 0 0 $24,191 Reinsurance Ceded $ 467,425 40,377,347 1,097,577 0 0 0 $41,942,349 Line of Business Ordinary/whole life Term life Universal life Group life Immediate annuities Individual deferred annuities Total All Lines Net Premium $167,836,729 89,174,144 83,304,256 3,612,758 1,556,847 53,546,205 $399,030,939 5 III. MANAGEMENT AND CONTROL Board of Directors The board of directors consists of nine members who are elected annually, each of whom is an officer of AFMIC. Officers are elected at the annual board meetings and are to hold those positions until the earlier of their resignation or removal by the board of directors. As inside directors, they receive no additional compensation for serving on the board. Currently the board of directors consists of the following persons: Name and Residence David Ralph Anderson Madison, WI Michael Jeffrey Bosco Fitchburg, WI Vicki Lee Chvala Madison, WI James Francis Eldridge Sun Prairie, WI Bradley James Gleason Deerfield, WI Alan Edward Meyer Verona, WI Darnell Moore Madison, WI Jack Charles Salzwedel Waunakee, WI Daniel Robert Schultz Monona, WI Principal Occupation Chairman and Chief Executive Officer of the American Family Mutual Insurance Group Vice President – Life/Health of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group Secretary and Chief Legal Officer of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group Executive Vice President of the American Family Mutual Insurance Group President and Chief Operations Officer of the American Family Mutual Insurance Group Treasurer and Chief Financial Officer of the American Family Mutual Insurance Group Term Expires 2008 2008 2008 2008 2008 2008 2008 2008 2008 6 Officers of the Company The officers appointed by the board of directors and serving at the time of this examination are listed below. Listed compensation is total gross earnings for services rendered to the American Family Mutual Insurance Group and includes amounts allocated to all affiliates. 2006 Compensatio n $2,035,621 835,571 1,028,169 653,182 892,983 587,761 803,289 1,030,543 484,765 210,183 776,418 248,259 158,126 Name David Ralph Anderson Jack Charles Salzwedel James Francis Eldridge Daniel Robert Schultz Vicki Lee Chvala Bradley James Gleason Alan Edward Meyer Darnell Moore Michael Jeffrey Bosco Kari Elizabeth Grasee Thomas Syme King James Walter Behrens Ann Marie Demerath Committees of the Board Office Chairman and Chief Executive Officer President and Chief Operations Officer Secretary and Chief Legal Officer Treasurer and Chief Financial Officer Executive Vice President Executive Vice President Executive Vice President Executive Vice President Vice President, Life/Health Vice President, Controller Vice President, Investments Assistant Secretary Assistant Treasurer Article III, Section 8, of the company's bylaws allow for the formation of certain committees by the board of directors. There were no committees appointed by the board at the time of the examination. The committees of the ultimate controlling party, AFMIC, govern the company. 7 IV. AFFILIATED COMPANIES American Family Life Insurance Company is a member of a holding company system referred to as the “American Family Mutual Insurance Group.” The organizational chart below depicts the relationships among the affiliates in the group. A brief description of the affiliates follows the organizational chart. Organizational Chart As of December 31, 2006 American Family Mutual Insurance Company American Family Securities, LLC AmFam, Incorporated American Family Brokerage, Incorporated American Family Life Insurance Company American Standard Insurance Company of Wisconsin American Family Financial Services, Incorporated American Family Insurance Company American Standard Insurance Company of Ohio American Family Mutual Insurance Company American Family Mutual Insurance Company is the parent of the holding company system referenced above. AFMIC was organized in 1927 and writes primarily auto and homeowner’s coverage in 18 states. AFMIC assumes 100% of the business written by its downstream property and casualty subsidiaries. As of December 31, 2006, AFMIC reported assets of $11,009,904,394, liabilities of $6,818,334,833, and policyholders’ surplus of $4,191,569,561. Operations for 2006 produced net loss of $103,568,663. AFMIC was examined concurrently with the AFLIC examination. The results of that examination are described in a separate report. AmFam, Incorporated AmFam, Incorporated, was incorporated in 1981 to serve as a downstream holding company for the American Family Mutual Insurance Group. As of December 31, 2006, the company’s consolidated GAAP basis audited financial statement reported assets of 8 $5,569,851,000, liabilities of $4,417,535,000 and stockholder’s equity of $1,152,316,000. Of that amount, all but approximately $18,950,000 was derived from the value of its insurance subsidiaries. American Family Brokerage, Incorporated American Family Brokerage, Incorporated, was incorporated in 1985 as an insurance agency and operates within the same states as its parent AFMIC. Its primary objective is to assist American Family agents in securing coverage for their clients when the coverage or limits are not available through the American Family Mutual Insurance Group. As of December 31, 2006, the company’s GAAP basis audited financial statement reported assets of $3,961,000, liabilities of $2,449,000, and stockholder’s equity of $1,512,000. Operations for 2006 produced a net income of $982,000. American Family Securities, LLC American Family Securities, LLC, (hereinafter also AFS) was incorporated on July 14, 2000, with a capital contribution of $250,000 from AFMIC, as a limited liability company whose sole member is AFMIC. AFS, a non-clearing, registered broker dealer, is the principal underwriter for American Family Life Insurance Company’s variable life and annuity products. On March 23, 2001, AFS was admitted into the National Association of Securities Dealers (NASD) to sell AFLIC’s variable products. As of December 31, 2006, the company’s GAAP basis audited financial statement reported assets of $292,000, liabilities of $5,000 and member’s equity of $287,000. Operations for 2006 produced a net income of $9,000. American Family Financial Services, Incorporated American Family Financial Services, Incorporated, (hereinafter also AFFS) was acquired by American Family Mutual Insurance Group in 1969. Its original business purpose was to provide direct loans and leases, primarily to policyholders, through AFMIC's multi-line exclusive agency force. However, during the period under examination AFFS’s business environment has changed and so has its purpose. The company has been making fewer loans to policyholders. This was due to the fact that other lenders (banks, credit unions, etc.) could offer lower lending rates than AFFS because they have a lower cost of money. AFFS’s borrowing costs, derived 9 primarily from the issuance of commercial paper and a demand note, is considerably higher than banks which use checking, savings, and certificate of deposit accounts to fund loans. At the same time AFFS expanded its lending to its exclusive agency force, since its agents found it hard to borrow money from other lenders due to their commission-based compensation. These trends are evident when comparing the commercial mortgage loan receivable balance as a ratio to total loans outstanding at year-end 2001 to year-end 2006, which was 7.9% and 35.7%, respectively. At year-end 2006 approximately 80% of AFFS’s commercial mortgage loans were to its agents. As noted above, AFFS finances its loan portfolio primarily through the sale of commercial paper. AFMIC has agreed to guarantee the debt of AFFS, in order to allow the company to receive the best possible interest rates. In 1998 the board of directors of AFMIC authorized an increase in the guarantee limit to $375 million, as approved by this office. As of December 31, 2006, AFFS outstanding guaranteed debt totaled $79,973,206. In addition, AFMIC, American Standard Insurance Company of Wisconsin (hereinafter also ASIC), and AFLIC may lend AFFS additional funds through the use of short-term notes not to exceed at any one time $100,000,000, $10,000,000 and $20,000,000, respectively, as approved by this office. At December 31, 2006, there were no outstanding short-term notes issued by AFFS owed to an affiliate. As of December 31, 2006, the company’s GAAP basis audited financial statement reported assets of $160,215,000, liabilities of $141,526,000, and stockholder’s equity of $18,689,000. Operations for 2006 produced net loss of $43,000. As of November 1, 2007 AFFS has discontinued writing new loans of any kind and is considering various options for the servicing and run-off of its existing loan portfolio. American Standard Insurance Company of Wisconsin American Standard Insurance Company of Wisconsin was incorporated in 1961. The company is currently licensed in 23 states and is limited to providing insurance for motorcycles and for nonstandard private passenger automobile risks. ASIC’s direct writings are 100% ceded to AFMIC under a quota share agreement approved by this office. As of December 31, 2006, 10 ASIC reported assets of $355,217,394, liabilities of $116,618,918, and surplus of $238,598,476. Operations for 2006 produced net income of $11,767,890. ASIC was examined concurrently with the AFMIC examination. The results of the examination are described within a separate report. American Family Insurance Company American Family Insurance Company (hereinafter also AFIC) was incorporated in Ohio in 1995 and writes business only in that state. AFIC was founded for the purposes of operating efficiencies and state tax savings. AFIC cedes 100% of its direct writings to AFMIC under a quota share agreement approved by this office. AFIC writes lines of business identical to American Family Mutual Insurance Company and markets its business through AFMIC’s agents. As of December 31, 2006, AFIC reported assets of $73,695,175, liabilities of $62,659,779 and surplus of $11,035,396. Operations for 2006 produced net income of $996,245. AFIC was examined concurrently with AFMIC as of December 31, 2006, and the results of that examination were expressed in a separate report issued by the Ohio Department of Insurance. American Standard Insurance Company of Ohio American Standard Insurance Company of Ohio (hereinafter also ASICO) was incorporated in 1995 and writes business only in Ohio. ASICO was founded for the purposes of operating efficiencies and state tax savings. ASICO writes lines of business identical to ASIC’s and cedes 100% of these direct writings to AFMIC under a quota share agreement approved by this office. Insurance is sold through AFMIC’s agents. As of December 31, 2006, ASICO reported assets of $17,113,493, liabilities of $11,373,899 and surplus of $5,739,594. Operations for 2006 produced a net income of $360,817. ASICO was examined concurrently with AFMIC as of December 31, 2006, and the results of that examination were expressed in a separate report issued by the Ohio Department of Insurance. Agreements with Affiliates AFLIC has no employees of its own. All operations are conducted by employees of AFMIC, in accordance with the business practices and internal controls of that organization. In addition to ongoing common management and control by this upstream affiliate, various written 11 agreements and undertakings affect the company’s relationship to its affiliates. A brief summary of these agreements follows: Effective December 12, 1995, AFMIC developed an inter-company cost allocation agreement for the reimbursement of expenses paid by AFMIC on behalf of its affiliates. Allocated cost is based on the actual cost of providing the service multiplied by the affiliate’s proportionate share of the benefit conferred. All cost allocations are determined by the group’s Controller Division and are considered final. All parties to this agreement are allowed to express their opinion to the group’s Controller Division of the allocation affecting each of them and the Controller Division is to consider such opinions carefully in determining cost allocation. Effective April 29, 2002, AFMIC and its affiliates entered into a restated tax allocation agreement for the purpose of filing federal income tax returns on a consolidated basis. Under this agreement, AFMIC prepares and files a consolidated U.S. federal income tax return that includes all affiliates of the holding company group. The agreement sets forth the rights and obligations of the parties to the agreement with respect to the determination and settlement of federal income tax liabilities as well as the allocation of American Family Mutual Insurance Group’s consolidated U.S. federal income tax liability and tax benefits in accordance with a rational, systematic formula. The agreement provides for computation of tax, settlement of balances between affiliates, tax sharing, filing the return, audits and other adjustments, and other administrative requirements. The agreement calls for the settling of estimated U.S. federal tax payments within 30 days of filing of those payments. Final settlement is due within 30 days of the filing of the consolidated U.S. federal tax return. The agreement has a provision for members entering or departing the group and provides for successors. 12 V. REINSURANCE AFLIC’s reinsurance program for whole life, universal life, and variable universal life policies consists primarily of ceding large risks ($750,000 or more on standard risks) to several different reinsurance companies. Ceding contracts are either coinsurance or yearly renewable term. Since January 1997, AFLIC has ceded 100% of the excess above $750,000 on whole life, universal life and variable universal life policies. AFLIC normally does not write many risks over the retention of $750,000. AFLIC’s reinsurance for term life policies is a coinsurance program under which the company retains 95% of each policy issued under $250,000, 50% of each policy issued between $250,000 and $499,999, and 10% of each policy issued for $500,000 or above. The reinsurance treaties are with Generali USA Life Reassurance Company, RGA Reinsurance Company and Swiss Re Life & Health America Inc. for varying percentages of the total reinsurance. Ceded reinsurance premium for 2006 was approximately 10% of gross premium. This percentage of premium ceded has increased from approximately 7.5% of gross premium in 2002. Reinsurance assumed in 2006 represents less than 0.01% of gross writings. This amount pertains to a canceled contract, in run-off, that was reviewed during the prior examination. All coverages are placed with reinsurers directly by AFLIC. A review of the reinsurers participating under these agreements showed that all are companies licensed or authorized to do business in Wisconsin. It was also found that the company adequately reviews security rankings of all reinsurers it directly places business with. All contracts reviewed contain proper insolvency provisions. 13 VI. FINANCIAL DATA The following financial statements reflect the financial condition of the company as reported to the Commissioner of Insurance in the December 31, 2006, annual statement. Also included in this section are schedules which reflect the growth of the company, NAIC Insurance Regulatory Information System (IRIS) ratio results for the period under examination, and the compulsory and security surplus calculation. Adjustments made as a result of the examination are noted at the end of this section in the area captioned "Reconciliation of Surplus per Examination." 14 American Family Life Insurance Company Assets As of December 31, 2006 Net Admitted Assets $2,802,912,510 95,103,073 280,460,625 43,801,457 202,060,603 5,919,000 2,377,387 31,679,780 1,980,000 37,356,521 25,706 1,644,733 0 0 122 Assets Bonds Stocks: Common stocks Mortgage loans on real estate: First liens Cash, cash equivalents, and short-term investments Contract loans Other invested assets Receivables for securities Investment income due and accrued Reinsurance: Amounts recoverable from reinsurers Net deferred tax asset Guaranty funds receivable or on deposit Receivable from parent, subsidiaries and affiliates Write-ins for other than invested assets: Returned checks Advanced commissions Miscellaneous receivable Total assets excluding separate accounts, segregated accounts and protected cell assets From separate accounts, segregated accounts and protected cell assets Total Assets $2,802,912,510 95,103,073 280,460,625 43,801,457 202,927,726 5,919,000 2,888,117 31,679,780 1,980,000 161,176,468 25,706 1,712,571 (2,410) 7,345,317 122 Nonadmitted Assets $ 0 0 0 0 867,123 0 510,730 0 0 123,819,947 0 67,838 (2,410) 7,345,317 0 3,637,930,062 179,738,716 $3,817,668,778 132,608,545 0 $132,608,545 3,505,321,517 179,738,716 $3,685,060,233 15 American Family Life Insurance Company Liabilities, Surplus, and Other Funds As of December 31, 2006 Aggregate reserve for life contracts Liability for deposit-type contracts Contract claims: Life Provision for policyholders’ dividends and coupons payable in following calendar year: Apportioned for payment to December 31, 2007 Not yet apportioned Premiums and annuity considerations received in advance Contract liabilities not included elsewhere: Interest maintenance reserve Commissions to agents due or accrued General expenses due or accrued Transfers to separate accounts due or accrued (net) Taxes, licenses, and fees due or accrued, excluding federal income taxes Unearned investment income Amounts withheld or retained by company as agent or trustee Remittances and items not allocated Miscellaneous liabilities: Asset valuation reserve Payable to parent, subsidiaries and affiliates Write-ins for liabilities: Liability for checks charged off Reserve for retired lives Payable for reinsurance Reserve for clearing accounts Litigation settlements payable Interest due on death benefit payable Total liabilities excluding separate accounts business From separate accounts statement Total liabilities Common capital stock Gross paid in and contributed surplus Unassigned funds (surplus) Total capital and surplus Total Liabilities, Capital and Surplus $ 2,500,000 1,000,000 428,727,367 432,227,367 $3,685,060,233 $2,619,929,292 336,318,456 10,074,196 40,096,394 1,719,888 345,413 4,944,612 3,279,863 34,157,498 (25,542,210) 1,613,901 5,995,033 498,612 1,561,867 31,994,501 5,024,457 163,478 542,605 18,627 292,667 55,000 10,000 3,073,094,150 179,738,716 3,252,832,866 16 American Family Life Insurance Company Summary of Operations For the Year 2006 Premiums and annuity considerations for life and accident and health contracts Considerations for supplementary contracts with life contingencies Net investment income Amortization of interest maintenance reserve Commissions and expense allowances on reinsurance ceded Miscellaneous income: Income from fees associated with investment management, administration, and contract guarantees from separate accounts Write-ins for miscellaneous income: Other Brokerage income Asset management fees Total income items Death benefits Matured endowments Annuity benefits Disability benefits and benefits under accident and health contracts Surrender benefits and withdrawals for life contracts Group conversions Interest and adjustments on contract- or deposit-type contract funds Payments on supplementary contracts with life contingencies Increase in aggregate reserves for life and accident and health contracts Subtotal Commissions on premiums, annuity considerations, and deposit-type contract funds (direct business only) General insurance expenses Insurance taxes, licenses, and fees excluding federal income taxes Net transfers to or (from) separate accounts net of reinsurance Write-in for deductions: Litigation settlements Interest expense on federal income tax Total deductions Net gain (loss) from operations before dividends to policyholders and federal income taxes Dividends to policyholders $ 73,576,563 276,122 8,352,447 2,627,431 105,594,693 1,364,654 17,313,230 1,338,078 101,158,935 311,602,153 $399,030,939 551,306 197,453,494 750,644 18,052,668 1,593,464 124,904 26,029 139,758 617,723,206 30,142,882 93,424,097 10,059,419 40,887,377 (62,183) 140,032 486,193,777 131,529,429 40,950,387 17 Net gain (loss) from operations after dividends to policyholders and before federal income taxes Federal and foreign income taxes incurred (excluding tax on capital gains) Net gain (loss) from operations after dividends to policyholders and federal income taxes and before realized capital gains or losses Net realized capital gains or (losses) Net Income 90,579,042 31,290,526 59,288,516 1,843,437 $ 61,131,953 18 American Family Life Insurance Company Cash Flow For the Year 2006 Premiums collected net of reinsurance Net investment income Miscellaneous income Total Benefit- and loss-related payments Net transfers to separate, segregated accounts and protected cell accounts Commissions, expenses paid, and aggregate write-ins for deductions Dividends paid to policyholders Federal and foreign income taxes paid (recovered) Total deductions Net cash from operations Proceeds from investments sold, matured, or repaid: Bonds Stocks Mortgage loans Total investment proceeds Cost of investments acquired (long-term only): Bonds Stocks Mortgage loans Miscellaneous applications Total investments acquired Net increase (or decrease) in contract loans and premium notes Net cash from investments Cash from financing and miscellaneous sources: Net deposits on deposit-type contracts and other insurance liabilities Other cash provided (applied) Net cash from financing and miscellaneous sources Reconciliation: Net change in cash, cash equivalents, and short-term investments Cash, cash equivalents, and short-term investments: Beginning of year End of Year $ 399,580,234 197,397,462 19,936,823 616,914,519 $212,006,775 50,022,387 131,807,195 39,999,112 38,117,579 471,953,048 144,961,471 $307,460,452 19,701,608 15,649,947 342,812,007 354,665,451 19,030,673 88,348,975 3,920,037 465,965,136 8,514,187 (131,667,316) 4,905,045 100,594 5,005,639 18,299,794 25,501,663 $ 43,801,457 19 American Family Life Insurance Company Compulsory and Security Surplus Calculation December 31, 2006 Assets Less security surplus of insurance subsidiaries Less liabilities Adjusted surplus Annual premium: Individual life and health Factor Total Group life and health Factor Total Greater of 7.5% of consideration or 2% of reserves for annuities and deposit administration funds Compulsory surplus (subject to a $2,000,000 minimum) Compulsory Surplus Excess or (Deficit) $3,685,060,233 0 3,252,832,866 432,227,367 $301,395,318 15% $45,209,297 2,531,446 10% 253,144 7,215,537 52,677,978 $ 379,549,389 Adjusted surplus (from above) Security surplus: (140% of compulsory surplus, factor reduced 1% for each $33 million in premium written in excess of $10 million, with a minimum of 110%) Security Surplus Excess or (Deficit) $ 432,227,367 68,481,371 $ 363,745,996 20 American Family Life Insurance Company Reconciliation and Analysis of Surplus For the Five-Year Period Ending December 31, 2006 The following schedule is a reconciliation of total capital and surplus during the period under examination as reported by the company in its filed annual statements: 2006 Capital and surplus, beginning of year Net income Change in net unrealized capital gains/losses Change in net deferred income tax Change in nonadmitted assets and related items Change in asset valuation reserve Capital and Surplus, End of Year 2005 2004 2003 2002 $364,416,236 61,131,953 $314,686,943 57,904,698 $264,950,525 51,733,326 $237,895,841 8,278,033 $243,103,025 3,876,040 5,925,276 2,193,286 1,084,149 (2,429,315) 6,165,755 1,910,451 16,062,396 11,084,432 (14,329,116) 5,537,455 3,041,293 (4,480,677) 1,950,721 (8,780,960) (2,359,516) (7,713,598) (3,537,008) (4,833,169) (10,689,388) 10,397,825 $432,227,367 $364,416,236 $314,686,943 $264,950,525 $237,895,841 American Family Life Insurance Company Insurance Regulatory Information System For the Five-Year Period Ending December 31, 2006 The company’s NAIC Insurance Regulatory Information System (IRIS) results for the period under examination are summarized below. There were no unusual results. Ratio #1 #2 #3 #4 #5 #6 #7 #8 #9 #10 #11 #12 Net change in capital and surplus Gross change in capital and surplus Net income to total income Adequacy of investment income Nonadmitted to admitted assets Total real estate and mortgage loans to cash and invested assets Total affiliated investments to capital and surplus Surplus relief Change in premium Change in product mix Change in asset mix Change in reserving ratio 2006 19% 19 10 190 4 8 0 4 5 0.1 0.4 (5) 2005 16% 16 10 188 4 6 1 4 1 0.2 0.1 (3) 2004 19% 19 9 195 4 6 1 3 8 0.1 0.1 (7) 2003 11% 11 2 206 5 6 1 7 3 0.2 0.1 (1) 2002 (2%) (2) 1 207 5 7 1 7 8 1.5 0.4 3 21 Growth of American Family Life Insurance Company Year 2006 2005 2004 2003 2002 2001 Admitted Assets $3,685,060,233 3,454,057,751 3,228,193,581 2,996,479,187 2,769,804,022 2,632,922,439 Liabilities $3,252,832,866 3,089,641,515 2,913,506,638 2,731,528,662 2,531,908,181 2,389,819,414 Capital and Surplus $432,227,367 364,416,236 314,686,943 264,950,525 237,895,841 243,103,025 Net Life Premiums, Annuity Considerations, and Deposits Life Insurance Premiums $343,925,876 328,215,613 329,856,577 303,881,821 295,880,941 293,406,867 Annuity Considerations $55,103,052 51,481,124 48,025,746 45,642,490 40,618,490 16,542,549 Deposit-type Contract Funds $3,055,684 2,848,780 2,570,697 1,962,963 3,983,478 4,346,607 Year 2006 2005 2004 2003 2002 2001 Life Insurance In Force (in thousands) Gross Risk In Force $76,857,050 71,889,606 68,476,060 65,280,484 62,086,202 57,568,136 Year 2006 2005 2004 2003 2002 2001 Ceded $24,071,529 21,070,021 19,105,569 18,741,533 13,968,275 7,535,238 Net $52,785,521 50,819,585 49,370,491 46,538,951 48,117,927 50,032,898 The company has experienced surplus growth over the past five years of 77.8% and is primarily attributable to profitable business and unrealized investment gains over this period. 2002 was the only year during the examination period where the company incurred a decrease in surplus from the previous year, which was due to net realized capital losses of $21.2 million attributable to the downturn in the stock market. The company also incurred significant net realized capital losses in 2003 of $31.1 million due to the aforementioned downturn in the stock market, which contributed to significantly lower net income in 2003 compared to the 2004 results. 2004 net income was positively affected by lower increases in reserves from the prior year and lower dividends to policyholders. Gross premium growth has been fairly steady for the five-year 22 period beginning 2002 across all life products except for deposit-type contracts (including structured settlements), which declined from 2001 to 2002. AFLIC’s business includes writing structured settlement business for AFMIC on a competitive basis—AFMIC compares AFLIC to its competitors in this market and AFMIC picks the writer with the most advantageous rates. The reason for the differences in the deposits between years is likely due to the competitiveness in the market in each of the respective years. Ceded premiums in 2002 increased by 75% from the previous year primarily due to the 86% growth in reinsured term policies in force. Reconciliation of Surplus per Examination No adjustments were made to surplus as a result of the examination. The amount of surplus of $432,227,367 reported by the company as of December 31, 2006, is accepted. 23 VII. SUMMARY OF EXAMINATION RESULTS Compliance with Prior Examination Report Recommendations There were five specific comments and recommendations in the previous examination report. Comments and recommendations contained in the last examination report and actions taken by the company are as follows: 1. Schedule Y—It is recommended that the company report in Schedule Y of its statutory annual statements all transactions among affiliates relating to the cost sharing and income tax allocation agreements in compliance with s. Ins 40.03 (5), Wis. Adm. Code. Action—Compliance 2. Invested Assets—It is recommended that the company amend the custodial agreement to include the language recommended by the NAIC’s Financial Condition Examiners Handbook, to replace references to Midwest Securities with the current trust company, and to replace the custodian with the current one. Action—Compliance 3. Amounts Withheld or Retained by Company for Account of Others—It is recommended that the company comply with the NAIC’s Accounting Practices and Procedures Manual SSAP No. 67 and the NAIC’s Annual Statement Instructions – Life, Accident and Health for the reporting of cash receipts that cannot be identified for a specific purpose. Action—Compliance 4. Disabled Lives Reserve—It is recommended that the company address the coding errors found during the examination so that the benefit amount is the annual premium for all policyholders on waiver of premium, and that all claimants are properly recognized. Action—Compliance 5. Policy and Contract Claims—It is recommended that the company review its methodology on setting the IBNR liability of Life Policy and Contract Claims in future valuations to ensure continued adequacy. Action—Compliance 24 Summary of Current Examination Results This section contains comments and elaboration on those areas where adverse findings were noted or where unusual situations existed. Comment on the remaining areas of the company's operations is contained in the examination work papers. Affiliated Agreements Each of AFMIC's subsidiary companies, including AFLIC, do not have any employees; all day-to-day operations of those companies are performed by AFMIC's employees as described in section IV of this report titled “Affiliated Companies.” It was discovered during the review of the group's affiliated agreements that there were no service agreements executed by each of the affiliate’s boards allowing for the delegation of duties to AFMIC in regards to their day-to-day operations in accordance with s. 611.67 (2), Wis. Stat. The group establishes a fair allocation of expenses between affiliates, including those expenses created by services provided by AFMIC on behalf of its affiliates, through an affiliated cost-sharing agreement, which was not disapproved by this office. It is recommended that the company create and execute a service agreement with its ultimate parent company that describes the delegation of its board's management authority over day-to-day operations in accordance with s. 611.67 (2), Wis. Stat. Aggregate Reserve for Life Contracts Testing of disability-disabled lives reserve detail uncovered that the claim incurred date used in the calculation of the reserve is incorrect in certain cases, which affects the reserve calculation. Out of a sample size of 18 traditional life disability claims tested, there were four instances where the claim incurred date was incorrect and actually reflected the date of a more recent related transaction. This issue was conveyed to the company. The company performed their own testing and found that 3 claims out of a sample of 50 reported incorrect incurred dates. The company estimated the reserve understatement due to this issue to be $250,000. This office’s contracted actuary reviewed the company’s methodology for estimating the reserve understatement and noted that it was reasonable and conservative. The company does not yet know the cause of the reporting problem but is in the process of investigating and correcting it. It is recommended that the company correct its computer system problem so the proper disability 25 claim incurred dates are used when calculating its disability-disabled lives reserves. As the amount of the estimated reserve understatement of $250,000 is not considered material for examination purposes, no adjustment is deemed necessary. 26 VIII. CONCLUSION Reported surplus has increased from $243,103,025 as of year-end 2001 to $432,227,367 as of year-end 2006. This represents an increase of 77.8% during the period under examination. Net premium growth was steady during the period under examination, which was an average increase in net writing of 5.1% per year. Operating earnings were profitable for each of the years under examination due to profitable business and investment income. The examination of American Family Life Insurance Company resulted in two recommendations, none of which were repeat recommendations, no adjustments to surplus, and no reclassifications of account balances. The examination recommendations pertain to not having a formal written service agreement with its ultimate parent company for services provided and not calculating its reserves relating to disability-disabled lives using proper disability claim incurred dates. 27 IX. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. Page 25 - Affiliated Agreements—It is recommended that the company create and execute a service agreement with its ultimate parent company that describes the delegation of its board's management authority over day-to-day operations in accordance with s. 611.67 (2), Wis. Stat. Page 25 - Aggregate Reserve for Life Contracts—It is recommended that the company correct its computer system problem so the proper disability claim incurred dates are used when calculating its disability-disabled lives reserves. 2. 28 X. ACKNOWLEDGMENT The courtesy and cooperation extended during the course of the examination by the officers and employees of the company are acknowledged. In addition to the undersigned, the following representatives of the Office of the Commissioner of Insurance, State of Wisconsin, participated in the examination: Name Rick H. Anderson Jerry C. DeArmond Andy M. Fell David A. Grinnell Thomas R. Houston Randy F. Milquet Frederick H. Thornton Title Insurance Financial Examiner Insurance Financial Examiner Advanced Loss Reserve Specialist Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Insurance Financial Examiner Advanced Data Processing Audit Specialist Insurance Financial Examiner Advanced Exam Planning & Quality Control Specialist Respectfully submitted, John E. Litweiler Examiner-in-Charge 29