This excerpt taken from the ALL 10-Q filed Oct 31, 2007.
Net income analysis The following discussion should be read in conjunction with the Condensed Consolidated Statements of Operations which can be found under Part I. Item 1. This analysis provides supplemental information and should not be considered a replacement for the Condensed Consolidated Statements of Operations which are presented in accordance with GAAP.
Variability in net income may be caused by changes in net investment results, underwriting results, realized capital gains and losses, expenses (including the amortization of DAC), gain (loss) on the disposition of operations, and income tax expense. We have developed a supplemental analysis of net income to facilitate analysis of and provide greater insight into our results, which we call gross margin.
Gross margin, a non-GAAP measure, includes:
Life and annuity premiums,
Net investment income,
Interest credited to contractholder funds, excluding amortization of DSI reported in interest credited to contractholder funds. DSI is aggregated with DAC amortization expense in the analysis since it impacts net income in a consistent manner, and
Periodic settlements and accruals on certain non-hedge derivative instruments (see additional discussion under investment margin) reported as realized capital gains and losses.
Gross margin is further divided into three components, investment margin, benefit margin, and contract charges and fees margin, in order to reveal trends that are otherwise difficult to observe in the Condensed Consolidated Statement of Operations. Each is a non-GAAP measure.
We use gross margin, its components, and other analysis presented below, to more effectively analyze changes in net income and to reveal more of the underlying financial performance of our business, including each of our major product groups. This analysis enables investors to also observe trends and variability in net investment results, underwriting results, and contract charges which would not otherwise be determinable. This analysis:
Assists investors in understanding the sources of earnings and causes of periodic variability between periods;
Provides insights into changes in profitability due to changes in revenues and related incurred benefits;
Highlights operating trends that might otherwise not be transparent;
Helps reveal the reasonableness of our pricing assumptions; and
Facilitates a better understanding of our financial performance.
Gross margin measures the excess of life and annuity premiums, contract charges and net investment income over the cost of contract benefits and interest credited to reserves and contractholder funds. This excess amount is available to cover our expenses (including the amortization of DAC) and income taxes. We believe it is important for investors and other users of our financial statements to effectively analyze and determine if our revenues are sufficient to cover expenses.
Investment margin is our measure of net investment results. The contribution of net investment results are difficult to observe in the Condensed Consolidated Statement of Operations. Net investment income is earned on invested assets supporting both the reserves for life-contingent contract benefits and contractholder funds and related capital. Net investment income supports the increases in the reserves for life-contingent contract benefits and contractholder funds that relate to interest credited to policyholders, which are reported on the Condensed Consolidated Statements of Operations in contract benefits and interest credited to contractholder funds, respectively. The implied interest on life-contingent contract benefits is reported in contract benefits and must be
calculated to determine its charge to net investment results. Furthermore, since net investment income and interest credited to contractholder funds fluctuate with changes in market interest rates, they should be evaluated together, with implied interest credited to life-contingent contracts, so that their impact on net income can be more fully understood. The net effect of these items results in the impact of investment margin on net income.