| TENNESSEE | 63-0169720 | ||
|---|---|---|---|
| (State or other jurisdiction | (IRS Employer | ||
| incorporation or organization) | Identificiation No.) |
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No[ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Number of shares of Common Stock, $1.00 par value, outstanding as of May 9, 2003: 5,000,000 shares.
Part I. Financial Information:
Item 1. Financial Statements:
Report of Independent Accountants..............................................
Consolidated Condensed Statements of Income for the Three Months
ended March 31, 2003 and 2002 (unaudited)..................................
Consolidated Condensed Balance Sheets as of March 31, 2003
(unaudited) and December 31, 2002..........................................
Consolidated Condensed Statements of Cash Flows for the
Three Months ended March 31, 2003 and 2002 (unaudited).....................
Notes to Consolidated Condensed Financial Statements (unaudited)...............
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations..........................................................
Item 3. Quantitative and Qualitative Disclosures About Market Risk................
Item 4. Controls and Procedures...................................................
Part II. Other Information:
Item 6. Exhibits and Reports on Form 8-K..........................................
Signature.............................................................................
To the Directors and Share Owner
Protective Life Insurance Company
We have reviewed the accompanying consolidated condensed balance sheet of Protective Life Insurance Company and subsidiaries as of March 31, 2003, and the related consolidated condensed statements of income for each of the three-month periods ended March 31, 2003 and 2002, and the consolidated condensed statements of cash flows for the three-month periods ended March 31, 2003 and 2002. These financial statements are the responsibility of Protective Life’s management.
We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated condensed interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of December 31, 2002, and the related consolidated statements of income, share-owner’s equity, and cash flows for the year then ended (not presented herein), and in our report dated March 19, 2003, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated condensed balance sheet as of December 31, 2002 is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
/s/PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Birmingham, Alabama
May 9, 2003
THREE MONTHS ENDED
MARCH 31
-------------------------
2003 2002
---- ----
REVENUES
Premiums and policy fees $385,211 $380,757
Reinsurance ceded (186,006) (176,683)
--------- ---------
Premiums and policy fees, net of reinsurance ceded 199,205 204,074
Net investment income 248,410 232,472
Realized investment gains (losses)
Derivative financial instruments (9,880) (1,318)
All other investments 5,723 855
Other income 8,934 8,614
--------- ---------
452,392 444,697
--------- ---------
BENEFITS AND EXPENSES
Benefits and settlement expenses (net of reinsurance ceded:
three months: 2003 - $214,783; 2002 - $149,185) 295,943 286,721
Amortization of deferred policy acquisition costs 56,265 52,404
Other operating expenses (net of reinsurance ceded:
three months: 2003 - $28,333; 2002 - $33,574) 43,569 49,598
--------- ---------
395,777 388,723
--------- ---------
INCOME BEFORE INCOME TAX 56,615 55,974
Income tax expense 18,553 16,721
--------- ---------
NET INCOME $ 38,062 $ 39,253
========= =========
See notes to consolidated condensed financial statements
MARCH 31 DECEMBER 31
2003 2002
----------- ------------
(UNAUDITED)
ASSETS
Investments:
Fixed maturities, at market (amortized cost: 2003 - $11,583,801; 2002 - $11,212,765) $12,144,420 $11,655,465
Equity securities, at market (amortized cost: 2003 - $40,059; 2002 - $51,095) 40,536 48,799
Mortgage loans on real estate 2,483,629 2,518,151
Investment in real estate, net of accumulated depreciation 14,346 15,499
Policy loans 536,085 543,161
Other long-term investments 216,340 210,381
Short-term investments 906,196 447,155
------------ ------------
Total investments 16,341,552 15,438,611
Cash 34,092 85,850
Accrued investment income 195,095 180,950
Accounts and premiums receivable, net 50,897 50,544
Reinsurance receivables 2,393,808 2,359,208
Deferred policy acquisition costs 1,705,577 1,680,724
Goodwill 35,143 35,143
Property and equipment, net 41,283 38,878
Other assets 244,897 262,127
Assets related to separate accounts
Variable annuity 1,452,098 1,513,824
Variable universal life 115,591 114,364
Other 4,377 4,330
------------ ------------
$22,614,410 $21,764,553
============ ============
LIABILITIES
Policy liabilities and accruals $ 9,256,947 $ 9,087,340
Stable value investment contract deposits 4,106,685 4,018,552
Annuity account balances 3,714,368 3,697,495
Other policyholders' funds 172,271 174,665
Other liabilities 1,117,696 620,731
Accrued income taxes 60,575 36,859
Deferred income taxes 226,596 206,845
Debt
Notes payable 2,256 2,264
Indebtedness to related parties 2,000 2,000
Liabilities related to separate accounts
Variable annuity 1,452,098 1,513,824
Variable universal life 115,591 114,364
Other 4,377 4,330
------------ ------------
20,231,460 19,479,269
------------ ------------
COMMITMENTS AND CONTINGENT LIABILITIES - NOTE B
SHARE-OWNER'S EQUITY
Preferred Stock, $1.00 par value, shares
authorized and issued: 2,000, liquidation preference $2,000 2 2
Common Stock, $1.00 par value, shares
authorized and issued: 5,000,000 5,000 5,000
Additional paid-in capital 846,619 846,619
Note receivable from PLC Employee Stock Ownership Plan (3,426) (3,838)
Retained earnings 1,237,841 1,201,587
Accumulated other comprehensive income:
Net unrealized gains (losses) on investments (net of income
tax: 2003 - $159,911; 2002 - $128,145) 296,978 237,983
Accumulated loss - hedging (net of income tax: 2003 - $(34); 2002 - $(1,114)) (64) (2,069)
------------ ------------
2,382,950 2,285,284
------------ ------------
$22,614,410 $21,764,553
============ ============
See notes to consolidated condensed financial statements
THREE MONTHS ENDED
MARCH 31
--------------------------------
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 38,062 $ 39,253
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment losses 4,157 463
Amortization of deferred policy acquisition costs 56,265 52,404
Capitalization of deferred policy acquisition costs (92,684) (84,225)
Depreciation expense 2,553 2,662
Deferred income tax (15,104) 18,940
Accrued income tax 23,716 (56,973)
Interest credited to universal life and investment products 142,383 225,670
Policy fees assessed on universal life and investment products (75,558) (94,779)
Change in accrued investment income and other receivables 49,098 (60,973)
Change in policy liabilities and other policyholders' funds
of traditional life and health products 69,871 64,632
Change in other liabilities 496,965 23,775
Other (net) 19,649 (15,143)
------------ -----------
Net cash provided by operating activities 719,373 115,706
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities and principal reductions of investments
Investments available for sale 3,652,795 2,133,427
Other 119,860 51,030
Sale of investments
Investments available for sale 5,553,365 2,563,224
Other 840 0
Cost of investments acquired
Investments available for sale (10,136,785) (5,125,362)
Other (89,039) (85,056)
Purchase of property and equipment (5,874) (1,698)
Sale of property and equipment 0 43
------------ -----------
Net cash used in investing activities (904,838) (464,392)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings under line of credit arrangements and debt 0 1,180,472
Principal payments on line of credit arrangements and debt (8) (1,252,979)
Dividend to share owner (1,808) 0
Investment product deposits and change in universal life deposits 586,860 679,264
Investment product withdrawals (451,337) (307,610)
------------ -----------
Net cash provided by financing activities 133,707 299,147
------------ -----------
(DECREASE)/INCREASE IN CASH (51,758) (49,539)
CASH AT BEGINNING OF PERIOD 85,850 107,166
------------ -----------
CASH AT END OF PERIOD $ 34,092 $ 57,627
============ ===========
See notes to consolidated condensed financial statements
The accompanying unaudited consolidated condensed financial statements of Protective Life Insurance Company and subsidiaries (“Protective Life”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair statement have been included. Operating results for the three month period ended March 31, 2003, are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. The year-end consolidated condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. For further information, refer to the consolidated financial statements and notes thereto included in Protective Life’s annual report on Form 10-K for the year ended December 31, 2002.
Protective Life is a wholly-owned subsidiary of Protective Life Corporation (“PLC”).
Under insurance guaranty fund laws, in most states insurance companies doing business therein can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies. Protective Life does not believe such assessments will be materially different from amounts already provided for in the financial statements. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer’s own financial strength.
A number of civil jury verdicts have been returned against insurers and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives’ relationships with agents or other persons with whom the insurer does business, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges, and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages, which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very little appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. Protective Life, like other financial services companies, in the ordinary course of business is involved in such litigation or, alternatively, arbitration. Protective Life is currently in arbitration with one reinsurer with respect to amounts overpaid, and the reinsurer has indicated the intent to raise defenses and possible counterclaims. Although the outcome of any such litigation or arbitration cannot be predicted, Protective Life believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position, results of operations, or liquidity of Protective Life.
Protective Life operates several business segments. An operating segment is generally distinguished by products and/or channels of distribution. A brief description of each segment follows:
| Life Marketing. The Life Marketing segment markets level premium term and term-like insurance, universal life, and variable universal life products on a national basis primarily through networks of independent insurance agents and brokers, and in the “bank owned life insurance” market. |
| Annuities. The Annuities segment manufactures, sells, and supports fixed and variable annuity products. These products are primarily sold through stockbrokers, but are also sold through financial institutions and the Life Marketing segment's sales force. |
| Acquisitions. The Acquisitions segment focuses on acquiring, converting, and servicing policies acquired from other companies. The segment's primary focus is on life insurance policies sold to individuals. |
| Stable Value Contracts. The Stable Value Contracts segment markets guaranteed investment contracts to 401(k) and other qualified retirement savings plans, and sells funding agreements to special purpose entities that in turn issue notes or certificates in smaller, transferable denominations. The segment also markets fixed and floating rate funding agreements directly to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds. |
| Asset Protection. The Asset Protection segment primarily markets credit life and disability insurance products through banks, consumer finance companies and automobile dealers, and markets vehicle and recreational marine extended service contracts. |
| Corporate and Other. Protective Life has an additional business segment herein referred to as Corporate and Other. The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on unallocated capital). This segment also includes earnings from several lines of business which Protective Life is not actively marketing (mostly cancer insurance and group annuities), various investment-related transactions, and the operations of several small subsidiaries. |
Protective Life uses the same accounting policies and procedures to measure operating segment income and assets as it uses to measure its consolidated net income and assets. Operating segment income is generally income before income tax, adjusted to exclude any pretax minority interest in income of consolidated subsidiaries. Premiums and policy fees, other income, benefits and settlement expenses, and amortization of deferred policy acquisition costs are attributed directly to each operating segment. Net investment income is allocated based on directly related assets required for transacting the business of that segment. Realized investment gains (losses) and other operating expenses are allocated to the segments in a manner which appropriately reflects the operations of that segment. Unallocated realized investment gains (losses) are deemed not to be associated with any specific segment.
Assets are allocated based on policy liabilities and deferred policy acquisition costs directly attributable to each segment.
There are no significant intersegment transactions.
The following table sets forth total operating segment income and assets for the periods shown. Adjustments represent the inclusion of unallocated realized investment gains (losses) and the recognition of income tax expense. Asset adjustments represent the inclusion of assets related to discontinued operations.
OPERATING SEGMENT INCOME FOR THE
THREE MONTHS ENDED MARCH 31, 2003
------------------------------------------------------------------------
LIFE STABLE VALUE
MARKETING ANNUITIES ACQUISITIONS CONTRACTS
--------- --------- ------------ -------------
Premiums and policy fees $186,547 $ 5,883 $ 74,040
Reinsurance ceded (124,038) (18,626)
--------- -------- ---------
Net of reinsurance ceded 62,509 5,883 55,414
Net investment income 56,402 58,441 62,296 $58,532
Realized investment gains (losses) 27 (6,701)
Other income 228 763 905
--------- -------- --------- --------
Total revenues 119,139 65,114 118,615 51,831
--------- -------- --------- --------
Benefits and settlement expenses 72,790 52,986 73,596 47,765
Amortization of deferred policy
acquisition costs 23,071 4,386 10,081 599
Other operating expenses (7,416) 4,912 11,759 1,031
--------- -------- --------- --------
Total benefits and expenses 88,445 62,284 95,436 49,395
--------- -------- --------- --------
Income before income tax 30,694 2,830 23,179 2,436
CORPORATE
ASSET AND TOTAL
PROTECTION OTHER ADJUSTMENTS CONSOLIDATED
---------- --------- ----------- ------------
Premiums and policy fees $107,549 $11,192 $385,211
Reinsurance ceded (40,865) (2,477) (186,006)
--------- -------- ---------
Net of reinsurance ceded 66,684 8,715 199,205
Net investment income 9,827 2,912 248,410
Realized investment gains (losses) $ 2,517 (4,157)
Other income 6,699 339 8,934
--------- -------- --------- ---------
Total revenues 83,210 11,966 2,517 452,392
--------- -------- --------- ---------
Benefits and settlement expenses 40,524 8,282 295,943
Amortization of deferred policy
acquisition costs 17,798 330 56,265
Other operating expenses 24,090 9,193 43,569
--------- -------- ---------
Total benefits and expenses 82,412 17,805 395,777
--------- -------- ---------
Income before income tax 798 (5,839) 56,615
Income tax expense 18,553 18,553
---------
Net income $ 38,062
=========
OPERATING SEGMENT INCOME FOR THE
THREE MONTHS ENDED MARCH 31, 2002
--------------------------------------------------------------------------
LIFE STABLE VALUE
MARKETING ANNUITIES ACQUISITIONS CONTRACTS
--------- --------- ------------ ------------
Premiums and policy fees $149,422 $ 6,609 $ 81,364
Reinsurance ceded (100,015) (18,003)
--------- -------- ----------
Net of reinsurance ceded 49,407 6,609 63,361
Net investment income 50,268 51,944 58,710 $59,507
Realized investment gains (losses) 382 521
Other income 218 892 549
--------- -------- --------- --------
Total revenues 99,893 59,827 122,620 60,028
--------- -------- --------- --------
Benefits and settlement expenses 63,131 42,387 79,244 48,829
Amortization of deferred policy
acquisition costs 16,191 6,994 8,909 565
Other operating expenses (1,218) 5,768 10,878 885
--------- -------- --------- --------
Total benefits and expenses 78,104 55,149 99,031 50,279
--------- -------- --------- --------
Income before income tax 21,789 4,678 23,589 9,749
CORPORATE
ASSET AND TOTAL
PROTECTION OTHER ADJUSTMENTS CONSOLIDATED
---------- ------- ----------- ------------
Premiums and policy fees $130,508 $12,854 $380,757
Reinsurance ceded (55,048) (3,617) (176,683)
--------- -------- ---------
Net of reinsurance ceded 75,460 9,237 204,074
Net investment income 11,095 948 232,472
Realized investment gains (losses) $(1,366) (463)
Other income 6,917 38 8,614
--------- -------- -------- ---------
Total revenues 93,472 10,223 (1,366) 444,697
--------- -------- -------- ---------
Benefits and settlement expenses 45,125 8,005 286,721
Amortization of deferred policy
acquisition costs 19,304 441 52,404
Other operating expenses 20,377 12,908 49,598
--------- -------- ---------
Total benefits and expenses 84,806 21,354 388,723
--------- -------- ---------
Income before income tax 8,666 (11,131) 55,974
Income tax expense 16,721 16,721
---------
Net income $ 39,253
=========
OPERATING SEGMENT ASSETS
MARCH 31, 2003
----------------------------------------------------------------------------
LIFE STABLE VALUE
MARKETING ANNUITIES ACQUISITIONS CONTRACTS
--------- --------- ------------ -------------
Investments and other assets $4,393,631 $4,884,325 $4,511,751 $3,999,666
Deferred policy acquisition costs 1,012,555 95,889 416,606 4,825
Goodwill
----------- ----------- ----------- -----------
Total assets $5,406,186 $4,980,214 $4,928,357 $4,004,491
=========== =========== =========== ===========
CORPORATE
ASSET AND TOTAL
PROTECTION OTHER ADJUSTMENTS CONSOLIDATED
---------- ---------- ----------- ------------
Investments and other assets $1,054,656 $1,906,473 $123,188 $20,873,690
Deferred policy acquisition costs 167,457 8,245 1,705,577
Goodwill 35,143 35,143
----------- ----------- --------- ------------
Total assets $1,257,256 $1,914,718 $123,188 $22,614,410
=========== =========== ========= ============
OPERATING SEGMENT ASSETS
DECEMBER 31, 2002
-----------------------------------------------------------------------------
LIFE STABLE VALUE
MARKETING ANNUITIES ACQUISITIONS CONTRACTS
--------- --------- ------------ -------------
Investments and other assets $4,193,732 $4,821,398 $4,553,955 $3,930,669
Deferred policy acquisition costs 973,631 93,140 435,592 4,908
Goodwill
----------- ----------- ----------- -----------
Total assets $5,167,363 $4,914,538 $4,989,547 $3,935,577
=========== =========== =========== ===========
CORPORATE
ASSET AND TOTAL
PROTECTION OTHER ADJUSTMENTS CONSOLIDATED
---------- ---------- ----------- ------------
Investments and other assets $1,069,341 $1,355,762 $123,829 $20,048,686
Deferred policy acquisition costs 165,751 7,702 1,680,724
Goodwill 35,143 35,143
----------- ----------- --------- ------------
Total assets $1,270,235 $1,363,464 $123,829 $21,764,553
=========== =========== ========= ============
Financial statements prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) differ in some respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. In accordance with statutory accounting reporting practices, at March 31, 2003, and for the three months then ended, Protective Life and its life insurance subsidiaries had combined share-owner’s equity of $831.3 million and a net loss of $12.6 million. The net loss primarily relates to federal income taxes and realized investment losses.
In 2002, Protective Life discovered that it had overpaid reinsurance premiums to several reinsurance companies of approximately $94.6 million. At December 31, 2002, Protective Life had recorded cash and receivables totaling $69.7 million, which reflects the amounts received and Protective Life’s current estimate of amounts to be recovered in the future, based upon the information available. The corresponding increase in premiums and policy fees resulted in $62.5 million of additional amortization of deferred policy acquisition costs in 2002. The amortization of deferred policy acquisition costs takes into account the amortization relating to the increase in premiums and policy fees as well as the additional amortization required should the remainder of the overpayment not be collected.
At March 31, 2003, Protective Life reassessed the amount of the overpayment it expects to recover, and, as a result, increased related receivables by $2.8 million. The corresponding increase in premiums and policy fees resulted in $1.0 million of additional amortization of deferred policy acquisition costs. As a result, Protective Life’s pretax income for the three months ended March 31, 2003, increased by $1.8 million.
In April 2003, the Derivatives Implementation Group of the FASB cleared Issue No. B36, “Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments” (DIG B36). DIG B36 requires the bifurcation of embedded derivatives within modified coinsurance and funds withheld coinsurance arrangements that expose the creditor to credit risk of a company other than the debtor, even if the debtor owns as investment assets the third-party securities to which the creditor is exposed. The effective date of the implementation guidance in DIG B36 is for the first fiscal quarter beginning after September 15, 2003, and should be applied on a prospective basis. Protective Life is currently evaluating the impact of this pronouncement on its financial statements, but does not anticipate a material impact on its financial condition or results of operations.
In April 2003, FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. This Statement is effective for contracts entered into or modified after June 30, 2003, and should be applied prospectively. Protective Life is currently evaluating the impact of this pronouncement on its financial statements, but does not anticipate a material impact on its financial condition or results of operations.
As of March 31, 2003, and during the quarter then ended, Protective Life had no hedging relationships designated as a fair-value hedge.
Protective Life has entered into a foreign currency swap to hedge the risk of changes in the value of interest and principal payments to be made on certain of its foreign-currency-based stable value contracts. Under the terms of the swap, Protective Life pays a fixed U.S.-dollar-denominated rate and receives a fixed foreign-currency-denominated rate. Effective July 1, 2002, Protective Life designated this swap as a cash flow hedge and therefore recorded the change in the fair value of the swap during the period in accumulated other comprehensive income. In the first quarter of 2003, Protective Life recognized income of $0.3 million related to the ineffective portion of the hedging instrument. There were no components of the hedging instrument excluded from the assessment of hedge ineffectiveness. During the first quarter of 2003, a pretax loss of $11.6 million representing the change in fair value of the hedged contracts during the quarter, and a gain of like amount representing the application of hedge accounting to this transaction, were recorded in Realized Investment Gains (Losses) – Derivative Financial Instruments in Protective Life’s consolidated condensed statements of income. Additionally, at March 31, 2003, Protective Life reported a reduction to accumulated other comprehensive income of $0.1 million (net of income tax of $34 thousand) related to its derivatives designated as cash flow hedges. During the next twelve months, Protective Life expects to reclassify out of accumulated other comprehensive income and into earnings, as a reduction of interest expense, approximately $15 thousand.
Protective Life uses certain interest rate swaps, caps, floors, options and futures contracts as economic hedges against the changes in value or cash flows of outstanding mortgage loan commitments and certain owned investments of Protective Life. For the three months ended March 31, 2003, Protective Life recognized total pre-tax losses of $8.9 million representing the change in fair value of these derivative instruments as well as the realized gain or loss on contracts closed during the period.
On its foreign currency swaps, Protective Life recognized a $6.7 million pre-tax gain for the first quarter 2003 while recognizing a $7.6 million foreign exchange pre-tax loss on the related foreign-currency-denominated stable value contracts for the quarter. The net change primarily results from the difference in the forward and spot exchange rates used to revalue the currency swaps and the stable value contracts, respectively. This net change is reflected in Realized Investment Gains (Losses) – Derivative Financial Instruments in Protective Life’s consolidated condensed statements of income.
Protective Life has entered into asset swap arrangements to, in effect, sell the equity options embedded in owned convertible bonds in exchange for an interest rate swap that converts the remaining host bond to a variable rate instrument. For the three months ended March 31, 2003, Protective Life recognized a $0.1 million pre-tax gain for the change in the asset swaps’ fair value and recognized a $0.4 million pre-tax loss to separately record the embedded equity options at fair value.
The following table sets forth Protective Life’s comprehensive income for the periods shown:
THREE MONTHS ENDED
MARCH 31
-------------------------
2003 2002
---- ----
Net income $38,062 $ 39,253
Change in net unrealized gains/losses
on investments (net of income tax:
three months: 2003 - $33,769; 2002 - $(43,261)) 62,715 (80,342)
Change in Accumulated Loss-Hedging (net
of income tax: 2003 - $1,080) 2,005
Reclassification adjustment for amounts
included in net income (net of income tax:
three months: 2003 - $(2,003); 2002 - $(299)) (3,720) (556)
-------- ---------
Comprehensive income (loss) $99,062 $(41,645)
======== =========
The following table sets forth supplemental cash flow information for the periods presented below:
THREE MONTHS ENDED
MARCH 31
---------------------
2003 2002
---- ----
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Reduction of principal on note from ESOP $412 $661
==== ====
Certain reclassifications have been made in the previously reported financial statements and accompanying notes to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on previously reported net income, total assets, or share-owner’s equity.
In June 2002, Protective Life coinsured a block of traditional life and interest-sensitive life insurance policies from Conseco Variable Insurance Company. The transaction has been accounted for as a purchase, and the results of the transaction have been included in the accompanying financial statements since the transaction’s effective date.
Summarized below are the consolidated results of operations for the period presented below on an unaudited pro forma basis, as if the acquisition had occurred as of January 1, 2002. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transaction occurred on the basis assumed above nor are they indicative of results of the future operations of the combined enterprises.
THREE MONTHS ENDED
MARCH 31, 2002
------------------
(UNAUDITED)
Total revenues $460,836
Net income 41,046
Protective Life Insurance Company (“Protective Life”) is a wholly-owned subsidiary of Protective Life Corporation (“PLC”), an insurance holding company whose common stock is traded on the New York Stock Exchange under the symbol “PL”. Founded in 1907, Protective Life provides financial services through the production, distribution, and administration of insurance and investment products. Unless the context otherwise requires, “Protective Life” refers to the consolidated group of Protective Life Insurance Company and its subsidiaries.
For a more complete understanding of Protective Life’s business and its current period results, please read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with Protective Life’s latest annual report on Form 10-K and our other filings with the SEC.
Protective Life operates several business segments each having a strategic focus. An operating segment is generally distinguished by products and/or channels of distribution. Protective Life’s operating segments are Life Marketing, Annuities, Acquisitions, Stable Value Contracts, and Asset Protection. Protective Life also has an additional business segment referred to as Corporate and Other.
This report reviews Protective Life’s financial condition and results of operations including its liquidity and capital resources. Historical information is presented and discussed. Where appropriate, factors that may affect future financial performance are also identified and discussed. Certain statements made in this report include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance or achievements instead of historical facts and may contain words like “believe,” “expect,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “plan,” “will,” “shall,” and other words, phrases, or expressions with similar meanings. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from the results contained in the forward-looking statements, and Protective Life cannot give assurances that such statements will prove to be correct. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Please refer to Exhibit 99(a), incorporated by reference herein, for more information about factors which could affect future results.
Protective Life’s results may fluctuate from period to period due to fluctuations in mortality, persistency, claims, expenses, interest rates, and other factors. Therefore, it is management’s opinion that quarterly operating results for an insurance company are not necessarily indicative of results to be achieved in future periods, and that a review of operating results over a longer period is necessary to assess an insurance company’s performance.
The following table sets forth for the periods shown the amount of premiums and policy fees, net of reinsurance (“premiums and policy fees”):
THREE MONTHS ENDED
MARCH 31
-------------------------
2003 2002
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(IN THOUSANDS)
Premiums and Policy Fees $199,205 $204,074
Premiums and policy fees decreased $4.9 million or 2.4% in the first three months of 2003 as compared to the first three months of 2002. Premiums and policy fees in the Life Marketing segment increased $13.1 million in the first three months of 2003 as compared to the same period in 2002 due to an increase in sales. Premiums and policy fees in the Acquisitions segment are expected to decline with time (due to the lapsing of policies resulting from death of insureds or terminations of coverage) unless new acquisitions are made. In June 2002, Protective Life coinsured a block of insurance policies from Conseco Variable Insurance Company. This acquisition resulted in an increase in premiums and policy fees of $7.7 million during the three months ended March 31, 2003. Premiums and policy fees from older acquired blocks decreased $15.6 million in the first three months of 2003 as compared to the same period last year. The decrease in premiums and policy fees from the Annuities Segment was $0.7 million in the three months ended March 31, 2003, as compared to the same period in 2002. Premiums and policy fees related to the Asset Protection segment decreased $8.8 million in the first three months of 2003 as compared to the first three months of 2002 primarily due to the planned termination of a block of service contracts. Premiums and policy fees relating to various health insurance lines in the Corporate and Other segment decreased $0.5 million.
The following table sets forth for the periods shown the amount of net investment income:
THREE MONTHS ENDED
MARCH 31
-------------------------
2003 2002
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(IN THOUSANDS)
Net Investment Income $248,410 $232,472
Net investment income in the first three months of 2003 was $248.4 million, which was $15.9 million or 6.9% higher than the corresponding period of the preceding year primarily due to an increase in the average amount of invested assets. The June 2002 acquisition resulted in $8.4 million of investment income. The percentage earned on average cash and investments was 6.2% in the first quarter of 2003 compared to 6.9% in the first quarter of 2002. Investment returns have been negatively affected by higher prepayments on mortgage-backed securities and mortgage loans, and lower interest rates.
Protective Life generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash-flow needs.
The following table sets forth realized investment gains (losses) for the periods shown:
REALIZED INVESTMENT THREE MONTHS ENDED
GAINS/(LOSSES) MARCH 31
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2003 2002
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(IN THOUSANDS)
Derivative Financial Instruments $(9,880) $(1,318)
All Other Investments 5,723 855
The sales of investments that have occurred generally result from portfolio management decisions to maintain proper matching of assets and liabilities. Realized investment gains related to all other investments in the first three months of 2003 of $15.9 million were largely offset by realized investment losses of $10.2 million. Realized investment gains related to all other investments in the first three months of 2002 of $29.1 million were largely offset by realized investment losses of $29.0 million. During the first three months of 2003 and 2002, Protective Life recorded other-than-temporary impairments in its investments of $9.0 million and $9.6 million, respectively.
Each quarter Protective Life reviews investments with material unrealized losses and tests for other-than-temporary impairments. Management analyzes various factors to determine if any other-than-temporary asset impairments exist. Once a determination has been made that an other-than-temporary impairment exists, a realized loss is incurred and the cost basis of the impaired asset is adjusted to its fair value. An other-than-temporary impairment loss is recognized based upon all relevant facts and circumstances for each investment. With respect to unrealized losses due to issuer-specific events, Protective Life considers the creditworthiness and financial performance of the issuer and other available information. With respect to unrealized losses that are not due to issuer-specific events, such as losses due to interest rate fluctuations, general market conditions or industry-related events, Protective Life considers its intent and ability to hold the investment to allow for a market recovery or to maturity together with an assessment of the likelihood of full recovery.
The following table sets forth other income for the periods shown:
THREE MONTHS ENDED
MARCH 31
-----------------------
2003 2002
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(IN THOUSANDS)
Other Income $8,934 $8,614
Other income consists primarily of revenues from Protective Life’s direct response business, service contract business, non-insurance subsidiaries and rental of space in its administrative building to PLC. Other income in the first three months of 2003 was $0.3 million higher than the corresponding period of 2002. In the first three months of 2003 as compared to the same period of 2002, revenues from Protective Life’s service contract business decreased $0.6 million. Income from other sources increased $0.9 million.
Management evaluates the results of Protective Life’s segments on a before-income-tax basis as adjusted for certain items which management believes are not indicative of Protective Life’s core operations. Segment operating income (loss) excludes net realized investment gains and losses and the related amortization of deferred policy acquisition costs and gains (losses) on derivative instruments because fluctuations in these items are due to changes in interest rates and other financial market factors instead of mortality and morbidity. Also, segment operating income (loss) excludes any net gains or losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of changes in accounting principles, and any other items, that, in each case, are neither normal nor recurring. Although the items excluded from segment operating income (loss) may be significant components in understanding and assessing Protective Life’s overall financial performance, management believes that segment operating income (loss) enhances an investor’s understanding of Protective Life’s results of operations by highlighting the income (loss) attributable to the normal, recurring operations of the insurance business (i.e., mortality and morbidity), consistent with industry practice. However, Protective Life’s segment operating income (loss) measures may not be comparable to similarly titled measures reported by other companies. Segment operating income (loss) should not be construed as a substitute for net income (loss) determined in accordance with accounting principles generally accepted in the United States of America (GAAP). “Total income before income tax” is a GAAP measure to which the non-GAAP measure “total operating income” may be compared. Unlike total operating income, total income before income tax includes net realized investment gains and losses, the related amortization of deferred policy acquisition costs and gains (losses) on derivative instruments.
The following table sets forth operating income or loss and income or loss before income tax by business segment for the periods shown:
OPERATING INCOME (LOSS) AND INCOME (LOSS) BEFORE INCOME TAX
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31
------------------------
2003 2002
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Operating Income (Loss)(1)
Life Marketing $30,694 $21,789
Annuities 3,534 4,662
Acquisitions 23,179 23,589
Stable Value Contracts 9,137 9,228
Asset Protection 798 8,666
Corporate and Other (5,839) (11,131)
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Total operating income 61,503 56,803
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Realized Investment Gains (Losses)
Annuities 27 382
Stable Value Contracts (6,701) 521
Unallocated Realized Investment Gains (Losses) 2,517 (1,366)
Related Amortization of Deferred Policy
Acquisition Costs
Annuities (731) (366)
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Total net (4,888) (829)
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Income (Loss) Before Income Tax
Life Marketing 30,694 21,789
Annuities 2,830 4,678
Acquisitions 23,179 23,589
Stable Value Contracts 2,436 9,749
Asset Protection 798 8,666
Corporate and Other (5,839) (11,131)
Unallocated Realized Investment Gains (Losses) 2,517 (1,366)
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Total income before income tax $56,615 $55,974
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(1) Income before income tax excluding realized investment gains and losses and related amortization of
deferred policy acquisition costs.
The Life Marketing segment’s pretax operating income was $30.7 million in the first three months of 2003 compared to $21.8 million in the same period of 2002. The increase is primarily attributable to growth in business-in-force due to strong sales in prior periods and lower expense variances. First quarter 2003 earnings include $1.8 million related to an increase in Protective Life’s estimate of amounts to be recovered related to the previously disclosed overpayment of certain reinsurance premiums. Mortality experience during the quarter was approximately $1.4 million worse than pricing and $1.8 million less favorable than in the prior year quarter.
The Annuities segment’s pretax operating income of $3.5 million for the first quarter of 2003 declined from $4.7 million in the first quarter of 2002 primarily because of spread compression and lower sales volume in the fixed annuity lines during the first quarter of 2003 as compared to the first quarter of 2002 and an increase of $0.6 million to the liability for guaranteed minimum death benefits.
Protective Life offers a guaranteed minimum death benefit feature (GMDB) on its variable annuity products. Protective Life’s accounting policy has been to calculate its total exposure to GMDB, and then apply a mortality factor to determine the amount of claims that could be expected to occur in the coming twelve months. Protective Life then accrues to that amount over four quarters. At March 31, 2003, the total GMDB reserve was $6.2 million. At March 31, 2003, the total guaranteed amount payable under the GMDB feature based on variable annuity account balances at March 31, 2003 was $564.0 million.
In accordance with statutory accounting practices prescribed or permitted by regulatory authorities (which require the assumption that equity markets will significantly worsen), Protective Life’s insurance subsidiaries reported GMDB related policy liabilities and accruals of $28.8 million at March 31, 2003.
The Annuities segment’s future results may continue to be negatively affected by a slow economy. Volatile equity markets could negatively affect sales of variable annuities and the fees the segment assesses on variable annuity contracts. Lower interest rates could negatively affect sales of fixed annuities. In this segment, equity market volatility may create uncertainty regarding the level of future profitability in the variable annuity business and the related rate of amortization of deferred policy acquisition costs.
In the ordinary course of business, the Acquisitions segment regularly considers acquisitions of blocks of policies or smaller insurance companies. Policies acquired through the segment are usually administered as “closed” blocks; i.e., no new policies are being marketed. Therefore, earnings from the Acquisitions segment are normally expected to decline over time (due to the lapsing of policies resulting from deaths of insureds or terminations of coverage) unless new acquisitions are made.
Pretax operating income from the Acquisitions segment was $23.2 million in the first three months of 2003, a decrease of $0.4 million from the first three months of 2002. This decrease was primarily attributable to a correction in our investment income allocation process, which had the effect of transferring $2.1 million of investment income in the quarter from this segment to the Corporate and Other segment, and to $1.1 million of higher expenses incurred during the quarter. These declines were partially offset by $2.8 million of earnings related to the coinsurance of a block of policies from Conseco.
The Stable Value Contracts segment had pretax operating income of $9.1 million in the first three months of 2003 as compared to $9.2 million in the corresponding period of 2002. The decrease is primarily due to a narrowing of average spreads from 98 basis points in the first quarter of 2002, to 93 basis points in the first quarter of 2003.
The Asset Protection segment had pretax operating income of $0.8 million in the first three months of 2003 as compared to $8.7 million for the same period in 2002. The segment’s core operating lines had pretax operating income of $3.2 million in the first quarter of 2003 as compared to $7.1 million in the first quarter of 2002. Non-core and ancillary lines had a loss of $0.7 million in the first quarter of 2003 compared to a loss of $1.1 million in the first quarter of 2002. Included in the segment’s pretax income for 2002 was $2.7 million of income related to the sale of the inactive charter of a small subsidiary. In addition, the Company recorded a charge of $1.7 million related to certain uncollectible balances from a third party contract administrator in the first quarter of 2003.
Protective Life continues to closely monitor the effects that declines in used vehicle values might have on residual value reserves in the Asset Protection segment. Protective Life expects that if recent declines in used vehicle values persist, additional increases to these reserves may be required.
Protective Life continues to actively market two inactive charters held in the Asset Protection segment. Protective Life has entered into a definitive agreement for the sale of one of the charters and subject to regulatory approval and other customary closing conditions, expects to receive proceeds from the sale of approximately $6.8 million in either the second or third quarter of 2003.
The Corporate and Other segment consists primarily of net investment income on capital and various other items not associated with the other segments. The segment had a pretax operating loss of $5.8 million in the first three months of 2003 as compared to a pretax operating loss of $11.1 million in the first three months of 2002. An increase of $2.1 million came from additional investment income related to the previously discussed correction in the Company’s investment allocation process.
The following table sets forth the effective tax rates for the periods shown:
THREE MONTHS ENDED
MARCH 31
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2003 2002
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Effective Income Tax Rates 32.8% 29.9%
The effective income tax rate for the full year of 2002 was 34.9%. Management’s estimate of the effective income tax rate for the full year 2003 is approximately 32.8%.
The following table sets forth net income for the periods shown:
THREE MONTHS ENDED
NET INCOME MARCH 31
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2003 2002
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Total (in thousands) $38,062 $39,253
Compared to the same period in 2002, net income in the first three months of 2003 decreased $1.2 million, reflecting lower operating results in the Annuities, Acquisitions, Stable Value Contracts, and Asset Protection segments partially offset by improved operating earnings in the Life Marketing and Corporate and Other segments and higher realized investment gains.
The factors which could affect Protective Life’s future results include, but are not limited to, general economic conditions and the following known trends and uncertainties: we are exposed to the risks of natural disasters, malicious and terrorist acts that could adversely affect our operations; we operate in a mature, highly competitive industry, which could limit our ability to gain or maintain our position in the industry; a ratings downgrade could adversely affect our ability to compete; our policy claims fluctuate from period to period, and actual results could differ from our expectations; our results may be negatively affected should actual experience differ from management’s assumptions and estimates; the use of reinsurance introduces variability in our statement of income; we could be forced to sell investments at a loss to cover policyholder withdrawals; interest rate fluctuations could negatively affect our spread income or otherwise impact our business; equity market volatility could negatively impact our business; a deficiency in our systems could result in over-or-underpayments of amounts owed to or by Protective Life and/or errors in our critical assumptions or reported financial results; insurance companies are highly regulated; changes to tax law or interpretations of existing tax law could adversely affect Protective Life and its ability to compete with non-insurance products or reduce the demand for certain insurance products; financial services companies are frequently the targets of litigation, including class action litigation, which could result in substantial judgments; our ability to maintain low unit costs is dependent upon the level of new sales and persistency of existing business; our investments are subject to market and credit risks; we may not realize our anticipated financial results from our acquisitions strategy; we are dependent on the performance of others; our reinsurers could fail to meet assumed obligations, increase rates or be subject to adverse developments that could affect us; and computer viruses could affect our data processing systems or those of our business partners. Please refer to Exhibit 99(a), incorporated by reference herein, about these factors that could affect future results.
In April 2003, the Derivatives Implementation Group of the FASB cleared Issue No. B36, “Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments” (DIG B36). DIG B36 requires the bifurcation of embedded derivatives within modified coinsurance and funds withheld coinsurance arrangements that expose the creditor to credit risk of a company other than the debtor, even if the debtor owns as investment assets the third-party securities to which the creditor is exposed. The effective date of the implementation guidance in DIG B36 is for the first fiscal quarter beginning after September 15, 2003, and should be applied on a prospective basis. Protective Life is currently evaluating the impact of this pronouncement on its financial statements, but does not anticipate a material impact on its financial condition or results of operations.
In April 2003, FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. This Statement is effective for contracts entered into or modified after June 30, 2003, and should be applied prospectively. Protective Life is currently evaluating the impact of this pronouncement on its financial statements, but does not anticipate a material impact on its financial condition or results of operations.
With respect to the unaudited consolidated condensed financial information of Protective Life Insurance Company for the three-month periods ended March 31, 2003 and 2002. PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”) reported that they have applied limited procedures in accordance with professional standards for a review of such information. However, their separate report dated May 9, 2003, appearing herein, stated that they did not audit and they do not express an opinion on that unaudited consolidated condensed financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited consolidated condensed financial information because that report is not a “report” or a “part” of a registration statement prepared or certified by PricewaterhouseCoopers into which this Form 10-Q may be incorporated by reference within the meaning of Sections 7 and 11 of the Act.
Protective Life’s operations usually produce a positive cash flow. This cash flow is used to fund an investment portfolio to finance future benefit payments. Since future benefit payments largely represent medium- and long-term obligations reserved using certain assumed interest rates, Protective Life’s investments are predominantly in medium- and long-term, fixed-rate investments such as bonds and mortgage loans.
Protective Life generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs. However, Protective Life may sell any of its investments to maintain proper matching of assets and liabilities. Accordingly, Protective Life has classified its fixed maturities and certain other securities as “available for sale.”
Protective Life’s investments in debt and equity securities are reported at market value, and investments in mortgage loans are reported at amortized cost. At March 31, 2003, the fixed maturity investments (bonds and redeemable preferred stocks) had a market value of $12,144.4 million, which is 4.8% above amortized cost of $11,583.8 million. Protective Life had $2,483.6 million in mortgage loans at March 31, 2003. While Protective Life’s mortgage loans do not have quoted market values, at March 31, 2003, Protective Life estimates the market value of its mortgage loans to be $2,731.6 million (using discounted cash flows from the next call date), which is 10.0% above amortized cost. Most of Protective Life’s mortgage loans have significant prepayment fees. These assets are invested for terms approximately corresponding to anticipated future benefit payments. Thus, market value fluctuations are not expected to adversely affect liquidity.
At March 31, 2003 and December 31, 2002, Protective Life had gross unrealized losses of $114.9 million and $182.8 million, respectively. Unrealized losses related to below investment grade securities that had been in an unrealized loss position for more than twelve months were $22.9 million and $34.3 million, at March 31, 2003, and December 31, 2002, respectively.
For several years, Protective Life has offered a type of commercial loan under which Protective Life will permit a slightly higher loan-to-value ratio in exchange for a participating interest in the cash flows from the underlying real estate. As of March 31, 2003, approximately $348.1 million of Protective Life’s mortgage loans have this participation feature.
At March 31, 2003, delinquent mortgage loans and foreclosed properties were 0.1% of invested assets. Bonds rated less than investment grade were 6.0% of invested assets. Protective Life does not expect these investments to adversely affect its liquidity or ability to maintain proper matching of assets and liabilities.
Policy loans at March 31, 2003, were $536.1 million, a decrease of $7.1 million from December 31, 2002. Policy loan rates are generally in the 4.0% to 8.0% range. Such rates at least equal the assumed interest rates used for future policy benefits.
In the ordinary course of its commercial mortgage lending operations, Protective Life will commit to provide a mortgage loan before the property to be mortgaged has been built or acquired. The mortgage loan commitment is a contractual obligation to fund a mortgage loan when called upon by the borrower. The commitment is not recognized in Protective Life’s financial statements until the commitment is actually funded. The mortgage loan commitment contains terms, including the rate of interest which may become less than prevailing interest rates. At March 31, 2003, Protective Life had outstanding mortgage loan commitments of $542.9 million.
Many of Protective Life’s products contain surrender charges and other features that reward persistency and penalize the early withdrawal of funds. Certain stable value and annuity contracts have market-value adjustments that protect Protective Life against investment losses if interest rates are higher at the time of surrender than at the time of issue.
At March 31, 2003, Protective Life had policy liabilities and accruals of $9.3 billion. Protective Life’s interest-sensitive life insurance policies have a weighted average minimum credited interest rate of approximately 4.5%.
At March 31, 2003, Protective Life had $4.1 billion of stable value contract account balances and $3.7 billion of annuity account balances.
Protective Life utilizes a risk management strategy that incorporates the use of derivative financial instruments, primarily to reduce its exposure to interest rate risk as well as currency exchange risk.
Combinations of interest rate swap contracts, options and futures contracts are sometimes used as hedges against changes in interest rates for certain investments, primarily outstanding mortgage loan commitments and mortgage-backed securities. Interest rate swap contracts generally involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date. Interest rate futures generally involve exchange traded contracts to buy or sell treasury bonds and notes in the future at specified prices. Interest rate options represent contracts that allow the holder of the option to receive cash or purchase, sell or enter into a financial instrument at a specified price within a specified period of time. Protective Life used interest rate swap contracts, swaptions (options to enter into interest rate swap contracts), caps, and floors to modify the interest characteristics of certain investments. Swap contracts are also used to alter the effective durations of assets and liabilities. Protective Life uses foreign currency swaps to reduce its exposure to currency exchange risk on certain stable value contracts denominated in foreign currencies, primarily the European euro and the British pound.
Derivative instruments expose Protective Life to credit and market risk. Protective Life minimizes its credit risk by entering into transactions with highly rated counterparties. Protective Life manages the market risk associated with interest rate and foreign exchange contracts by establishing and monitoring limits as to the types and degrees of risk that may be undertaken.
Protective Life monitors its use of derivatives in connection with its overall asset/liability management programs and procedures. Protective Life’s asset/liability committee is responsible for implementing various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into Protective Life’s overall interest rate and currency exchange risk management strategies.
Protective Life’s asset/liability management programs and procedures involve the monitoring of asset and liability durations for various product lines; cash flow testing under various interest rate scenarios; and the continuous rebalancing of assets and liabilities with respect to yield, risk, and cash flow characteristics. It is Protective Life’s policy to generally maintain asset and liability durations within one-half year of one another, although, from time to time, a broader interval may be allowed.
Protective Life believes its asset/liability management programs and procedures and certain product features provide protection for Protective Life against the effects of changes in interest rates under various scenarios. Additionally, Protective Life believes its asset/liability management programs and procedures provide sufficient liquidity to enable it to fulfill its obligation to pay benefits under its various insurance and deposit contracts. However, Protective Life’s asset/liability management programs and procedures incorporate assumptions about the relationship between short-term and long-term interest rates (i.e., the slope of the yield curve), relationships between risk-adjusted and risk-free interest rates, market liquidity and other factors, and the effectiveness of Protective Life’s asset/liability management programs and procedures may be negatively affected whenever actual results differ from those assumptions.
Approximately 20% of Protective Life’s liabilities relate to products (primarily whole life insurance) the profitability of which may be affected by changes in interest rates. The effect of such changes in any one year is not expected to be material.
Cash outflows related to stable value contracts (primarily maturing contracts, scheduled interest payments and expected withdrawals) were approximately $1,047.0 million during 2002. Cash outflows related to stable value contracts are estimated to be approximately $1,091.5 million in 2003. Protective Life’s asset/liability management programs and procedures take into account maturing contracts and expected withdrawals. Accordingly, Protective Life does not expect stable value contract related cash outflows to have an unusual effect on the future operations and liquidity of Protective Life.
Protective Life was committed at March 31, 2003, to fund mortgage loans in the amount of $542.9 million. Protective Life held $940.3 million in cash and short-term investments at March 31, 2003.
While Protective Life generally anticipates that the cash flows of its subsidiaries will be sufficient to meet their investment commitments and operating cash needs, Protective Life recognizes that investment commitments scheduled to be funded may, from time to time, exceed the funds then available. Therefore, Protective Life has arranged sources of credit for its insurance subsidiaries to use when needed. Protective Life expects that the rate received on its investments will equal or exceed its borrowing rate. Additionally, Protective Life may, from time to time, sell short-duration stable value products to complement its cash management practices.
Protective Life has also used securitization transactions involving its commercial mortgage loans to increase its liquidity.
At March 31, 2003, PLC had $150.0 million outstanding under its $200.0 million revolving line of credit due October 1, 2005, at an interest rate of 1.81%.
At December 31, 2002, approximately $1,384.0 million of consolidated share-owner’s equity, excluding net unrealized investment gains and losses, represented net assets of Protective Life that cannot be transferred to PLC. In addition, the states in which Protective Life’s insurance subsidiaries are domiciled impose certain restrictions on the insurance subsidiaries’ ability to pay dividends to Protective Life. Protective Life plans to retain substantial portions of its earnings to support future growth.
A life insurance company’s statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners (“NAIC”), as modified by the insurance company’s state of domicile. Statutory accounting rules are different from GAAP and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The NAIC’s risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The achievement of long-term growth will require growth in the statutory capital of Protective Life and its insurance subsidiaries. Protective Life may secure additional statutory capital through various sources, such as retained statutory earnings or equity contributions by PLC.
The table below sets forth future maturities of stable value contracts, notes payable, indebtedness to PLC, operating lease obligation, and mortgage loan commitments.
(IN THOUSANDS) 2003 2004-2005 2006-2007 After 2007
-------------- ---- --------- --------- ----------
Stable value contracts $686,527 $1,695,194 $1,648,069 $76,895
Notes payable 2,256
Indebtedness to PLC 2,000
Operating lease obligation 1,166 3,110 68,740
Mortgage loan commitments 542,875
Under insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies. Protective Life does not currently believe that any such assessments will be materially different from amounts already reflected in the financial statements.
A number of civil jury verdicts have been returned against insurers and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives’ relationships with agents or other persons with whom the insurer does business, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges, and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages, which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very little appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. Protective Life, like other financial services companies, in the ordinary course of business is involved in such litigation and in arbitration. Protective Life is currently in arbitration with one reinsurer with respect to reinsurance premium amounts overpaid, and the reinsurer has indicated the intent to raise defenses and possible counterclaims. Although the outcome of any such litigation or arbitration cannot be predicted, Protective Life believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position, results of operations, or liquidity of Protective Life.
Protective Life from time to time is subject to examination, review, and investigation by regulatory authorities, including insurance and securities regulators, and tax authorities. Among other actions, a state insurance department is currently investigating Protective Life’s management of a small block of the health insurance business in a discontinued line of business, apparently as part of a larger inquiry related to the overall health insurance industry. Although Protective Life cannot predict what actions may be taken by any regulatory authority, Protective Life does not believe that this or any other matter currently under examination, review, or investigation or any other pending or threatened regulatory or tax-related action with respect to Protective Life or any of its subsidiaries is reasonably likely to have a material effect on Protective Life.
Legislation has been enacted that permits commercial banks, insurance companies and investment banks to combine, provided certain requirements are satisfied. While Protective Life cannot predict the impact of this legislation, it could cause Protective Life to experience increased competition as larger, potentially more efficient organizations emerge from such combinations.
Under the Internal Revenue Code of 1986, as amended (the “Code”), income tax payable by policyholders on investment earnings is deferred during the accumulation period of certain life insurance and annuity products. This favorable tax treatment may give certain of Protective Life’s products a competitive advantage over other non-insurance products. To the extent that the Code is revised to reduce the tax-deferred status of life insurance and annuity products, all life insurance companies, including Protective Life and its subsidiaries, would be adversely affected with respect to their ability to sell such products, and, depending upon grandfathering provisions, would be affected by the surrenders of existing annuity contracts and life insurance policies. For example, changes in laws or regulations could restrict the ability of some companies to purchase certain corporate or bank-owned life insurance products. Additionally, changes in tax law based on recent proposals to reduce or eliminate federal income tax on corporate dividends and to establish new tax advantaged retirement and life savings plans could, if enacted, reduce the tax advantage of investing in certain life insurance or annuity products.
Legislation has been enacted that would, over time, reduce and ultimately eliminate the estate tax. Life insurance products are often used to fund estate tax obligations. If the estate tax is significantly reduced or eliminated, the demand for certain life insurance products would be adversely affected.
Protective Life’s Life Marketing segment is currently developing and implementing a more sophisticated administrative system capable of facilitating the calculation of more precise estimates of the segment’s deferred policy acquisition costs, policy liabilities and accruals, and various other components of the segment’s balance sheet. The segment’s future results may be affected, positively or negatively, by changes in such estimates arising from the implementation of this system.
Protective Life’s ability to grow depends in large part upon the continued availability of capital. Protective Life has recently deployed significant amounts of capital to support its sales and acquisitions efforts. Capital has also been consumed as Protective Life has incurred realized and unrealized losses on its invested assets, and to increase its GMDB related policy liabilities and accruals in accordance with statutory accounting practices. In recent years, most financial services companies, including PLC, experienced a decrease in the market price of their common stock. A lower stock price for PLC may limit Protective Life’s ability to raise capital to fund other growth opportunities and acquisitions. Although Protective Life believes it has sufficient capital to fund its immediate growth and capital needs, the amount of capital available can vary significantly from period to period due to a variety of circumstances, some of which are neither predictable or foreseeable, nor within Protective Life’s control. A lack of sufficient capital could impair Protective Life’s ability to grow.
Protective Life had previously disclosed that in connection with a review of a Registration Statement, the staff of the SEC had commented on several matters including a request for information concerning certain below investment grade securities having unrealized losses and Protective Life’s determination that these securities did not have other than temporary impairments. In response to comments from the SEC we have expanded our disclosures related to unrealized losses on investments. The staff of the SEC has advised us that it has completed its review of Protective Life’s periodic reports and has no further comments on these filings.
Protective Life previously discontinued the issuance of certificates under a group association health insurance policy. A small number of certificates remain in force under that group policy. (This line of business is accounted for as discontinued operations.) A recently passed law in the State of Florida provides additional rights to persons insured under group association policies to receive coverage under individual conversion policies. Protective Life is currently reviewing the adequacy of its reserves in light of this new law.
There has been no material change from the disclosures in Protective Life’s Annual Report on Form 10-K for the year ended December 31, 2002.
Protective Life’s Chief Executive Officer and Chief Financial Officer have, within the 90-day period preceding the filing of the report, evaluated Protective Life’s disclosure controls and procedures and believe them to be operating effectively to make known to them on a timely basis any material information required to be included in Protective Life’s periodic filings with the Securities and Exchange Commission. There have been no significant changes in the internal controls, or in other factors that could significantly affect internal controls, subsequent to the date this evaluation was completed.
(a) Exhibit 99(a) - Safe Harbor for Forward-Looking Statements
Exhibit 99(b) - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 99(c) - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| PROTECTIVE LIFE INSURANCE COMPANY | |||
|---|---|---|---|
| Date: | May 15, 2003 | /s/ Jerry W. DeFoor | |
| Jerry W. DeFoor | |||
| Vice President and Controller | |||
| and Chief Accounting Officer | |||
| (Duly authrorized officer) |
I, John D. Johns, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Protective Life Insurance Company;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
| /s/ John D. Johns | |||
| Title: President and Chief Executive Officer |
I, Allen W. Ritchie, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Protective Life Insurance Company;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
| /s/ Allen W. Ritchie | |||
| Title: Executive Vice President and Chief Financial Officer |