| 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No[ ]
Indicate by check mark 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 7, 2004: 5,000,000 shares.
INDEX
Page Number
Part I. Financial Information:
Item 1. Financial Statements (unaudited):
Report of Independent Accountants.................................................................
Consolidated Condensed Statements of Income for the
Three Months ended March 31, 2004 and 2003....................................................
Consolidated Condensed Balance Sheets as of March 31, 2004
and December 31, 2003.........................................................................
Consolidated Condensed Statements of Cash Flows for the
Three Months ended March 31, 2004 and 2003....................................................
Notes to Consolidated Condensed Financial Statements..............................................
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, 2004, and the related consolidated condensed statements of income for each of the three-month periods ended March 31, 2004 and 2003, and the consolidated condensed statements of cash flows for the three-month periods ended March 31, 2004 and 2003. These interim financial statements are the responsibility of the Company's’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 generally accepted auditing standards, 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, 2003, 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 11, 2004, 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, 2003 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
14, 2004
(Dollars in thousands)
(Unaudited)
THREE MONTHS ENDED
MARCH 31
2004 2003
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REVENUES
Premiums and policy fees $ 439,229 $ 384,234
Reinsurance ceded (244,867) (186,006)
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Premiums and policy fees, net of reinsurance ceded 194,362 198,228
Net investment income 251,023 245,551
Realized investment gains (losses)
Derivative financial instruments (1,626) (7,021)
All other investments 16,627 5,723
Other income 13,939 8,934
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474,325 451,415
- --------------------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES
Benefits and settlement expenses
(net of reinsurance ceded:
three months: 2004 - $237,659; 2003 - $214,783) 281,506 297,398
Amortization of deferred policy acquisition costs 59,794 55,759
Other operating expenses (net of reinsurance ceded:
three months: 2004 - $38,845; 2003 - $28,333) 35,253 41,643
- --------------------------------------------------------------------------------------------------------------------------------
376,553 394,800
- --------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX 97,772 56,615
Income tax expense 33,937 18,553
- --------------------------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 63,835 38,062
- --------------------------------------------------------------------------------------------------------------------------------
Cumulative effect of change in accounting principle,
net of income tax (10,128) 0
- --------------------------------------------------------------------------------------------------------------------------------
NET INCOME $53,707 $38,062
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See notes to consolidated condensed financial statements
(Dollars in thousands)
(Unaudited)
MARCH 31 DECEMBER 31
2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Fixed maturities, at market (amortized cost: 2004 - $12,606,641; 2003 - $12,314,822) $13,467,294 $12,927,520
Equity securities, at market (cost: 2004 - $27,279; 2003 - $29,169) 30,449 30,521
Mortgage loans on real estate 2,746,706 2,733,722
Investment in real estate, net 82,064 13,152
Policy loans 492,782 502,748
Other long-term investments 225,759 244,913
Short-term investments 494,621 510,635
- --------------------------------------------------------------------------------------------------------------------------------
Total investments 17,539,675 16,963,211
Cash 84,721 111,059
Accrued investment income 193,721 184,439
Accounts and premiums receivable, net 85,614 43,095
Reinsurance receivables 2,419,069 2,308,153
Deferred policy acquisition costs 1,869,853 1,863,568
Goodwill 36,182 35,143
Property and equipment, net 42,782 43,156
Other assets 215,220 198,581
Assets related to separate accounts
Variable annuity 2,113,413 2,045,038
Variable universal life 182,665 171,408
Other 4,365 4,361
- --------------------------------------------------------------------------------------------------------------------------------
$24,787,280 $23,971,212
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LIABILITIES
Policy liabilities and accruals $ 9,920,681 $ 9,693,818
Stable value product account balances 4,923,231 4,676,531
Annuity account balances 3,412,553 3,480,577
Other policyholders' funds 158,960 158,359
Securities sold under repurchase agreements 8,660 0
Other liabilities 709,518 764,097
Accrued income taxes 80,559 5,718
Deferred income taxes 376,453 339,273
Notes payable 2,226 2,234
Liabilities related to variable interest entities 55,102 0
Liabilities related to separate accounts
Variable annuity 2,113,413 2,045,038
Variable universal life 182,665 171,408
Other 4,365 4,361
- --------------------------------------------------------------------------------------------------------------------------------
21,948,386 21,341,414
- --------------------------------------------------------------------------------------------------------------------------------
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 865,805 863,819
Note receivable from PLC Employee Stock Ownership Plan (2,984) (3,426)
Retained earnings 1,485,525 1,431,818
Accumulated other comprehensive income:
Net unrealized gains on investments (net of income tax:
2004 - $258,871; 2003 - $177,642) 480,761 329,907
Accumulated gain - hedging (net of income tax: 2004 - $2,577; 2003 - $1,442) 4,785 2,678
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2,838,894 2,629,798
- --------------------------------------------------------------------------------------------------------------------------------
$24,787,280 $23,971,212
- --------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated condensed financial statements
(Dollars in thousands)
(Unaudited)
THREE MONTHS ENDED
MARCH 31
2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 53,707 $ 38,062
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment (gains) losses (9,823) (234)
Amortization of deferred policy acquisition costs 59,794 55,759
Capitalization of deferred policy acquisition costs (95,355) (92,178)
Depreciation expense 2,613 2,553
Deferred income tax (5,729) (15,104)
Accrued income tax 27,667 23,716
Interest credited to universal life and investment products 161,309 142,383
Policy fees assessed on universal life and investment products (87,864) (75,558)
Change in accrued investment income and other receivables (162,480) (49,098)
Change in policy liabilities and other policyholders' funds of traditional
life and health products 208,648 69,871
Change in other liabilities (89,665) 6,965
Other, net (28,449) 22,232
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 34,373 129,369
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investments available for sale, net of short-term investments:
Maturities and principal reductions of investments 454,223 1,375,990
Sale of investments 925,049 3,220,069
Cost of investments acquired (1,608,409) (4,974,578)
(Increase) decrease in mortgage loans, net (12,984) 34,522
Decrease in investment in real estate, net 931 1,153
Decrease in policy loans, net 9,966 7,076
Increase in other long-term investments, net (1,269) (5,959)
Decrease in short-term investments, net 42,134 30,959
Purchase of property and equipment (3,972) (5,874)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (194,331) (316,642)
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under line of credit arrangements and long-term debt 2,484,551 0
Principal payments on line of credit arrangement and debt (2,475,899) (8)
Investment product deposits and change in universal life deposits 597,697 586,860
Investment product withdrawals (472,729) (451,337)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 133,620 135,515
- --------------------------------------------------------------------------------------------------------------------------------
DECREASE IN CASH (26,338) (51,758)
CASH AT BEGINNING OF PERIOD 111,059 85,850
- --------------------------------------------------------------------------------------------------------------------------------
CASH AT END OF PERIOD $ 84,721 $ 34,092
- --------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated condensed financial statements
NOTE A – BASIS OF PRESENTATION
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, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. 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, 2003.
Protective Life is a wholly-owned subsidiary of Protective Life Corporation (“PLC”).
NOTE B – COMMITMENTS AND CONTINGENT LIABILITIES
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 and in arbitration. 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.
NOTE C – OPERATING SEGMENTS
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, stockbrokers, and in the “bank owned life insurance” market. |
| 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. |
| 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. |
| Stable Value Products. The Stable Value Products 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. During the fourth quarter of 2003, Protective Life registered a funding agreement-backed notes program with the SEC. |
| Asset Protection. The Asset Protection segment markets extended service contracts and credit life and disability insurance to protect consumers’ investments in automobiles and watercraft. |
| Corporate and Other. Protective Life has an additional 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 and interest on substantially all debt). This segment also includes earnings from several lines of business which Protective Life is not actively marketing (mostly cancer insurance, surety insurance, and group annuities), various investment-related transactions, and the operations of several small subsidiaries. A small surety line of business was moved from the Asset Protection segment to Corporate and Other in the quarter, and prior period segment data was restated to reflect the change. |
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, net realized investment gains and losses, the related amortization of deferred policy acquisition costs, and the cumulative effect of change in accounting principle. Periodic settlements of interest rate swaps associated with certain investments are included in realized gains and losses but are considered part of operating income because the interest rate swaps are hedging items affecting operating income. 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 directly attributable to each segment and deferred policy acquisition costs and goodwill are shown in the segments to which they are attributable. A reclassification adjustment has been made to the December 31, 2003 segment asset information in the Annuities and Corporate and Other segments to reflect segment asset groupings consistently.
There are no significant intersegment transactions.
The following table sets forth total operating segment income and assets for the periods shown. Adjustments represent the cumulative effect of change in accounting principle and the recognition of income tax expense. Asset adjustments represent the inclusion of assets related to discontinued operations. The increase in the goodwill balance in the Asset Protection segment relates to the merger of an affiliated company with an insurance subsidiary of Protective Life and the sale of a small subsidiary in the first quarter of 2004.
Operating Segment Income for the
Three Months Ended March 31, 2004
- ---------------------------------------------------------------------------------------------------------------------------------------
Life Stable Value
Marketing Acquisitions Annuities Products
- ---------------------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees $235,986 $ 69,469 $ 7,628
Reinsurance ceded (168,786) (17,101)
- ---------------------------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 67,200 52,368 7,628
Net investment income 57,718 58,655 51,588 $64,033
Realized investment gains 6,004 3,879
Other income 182 717 1,523
- ---------------------------------------------------------------------------------------------------------------------------------------
Total revenue 125,100 111,740 66,743 67,912
- ---------------------------------------------------------------------------------------------------------------------------------------
Benefits and settlement expenses 72,025 73,020 46,046 49,769
Amortization of deferred policy acquisition costs 21,081 7,849 9,057 761
Other operating expenses (8,935) 9,754 6,925 1,804
- ---------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 84,171 90,623 62,028 52,334
- ---------------------------------------------------------------------------------------------------------------------------------------
Income before income tax 40,929 21,117 4,715 15,578
Less: realized investment gains 6,004 3,879
Add back: related amortization of deferred
policy acquisition costs 3,660
- ---------------------------------------------------------------------------------------------------------------------------------------
Operating income 40,929 21,117 2,371 11,699
---------------------------------------------------------------------------------------------------------------------------------------
Asset Corporate Total
Protection and Other Adjustments Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees $116,003 $10,143 $ 439,229
Reinsurance ceded (58,635) (345) (244,867)
- ---------------------------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 57,368 9,798 194,362
Net investment income 7,889 11,140 251,023
Realized investment gains 5,118 15,001
Other income 9,244 2,273 13,939
- ---------------------------------------------------------------------------------------------------------------------------------------
Total revenue 74,501 28,329 474,325
- ---------------------------------------------------------------------------------------------------------------------------------------
Benefits and settlement expenses 29,076 11,570 281,506
Amortization of deferred policy acquisition costs 20,069 977 59,794
Other operating expenses 15,141 10,564 35,253
- ---------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 64,286 23,111 376,553
- ---------------------------------------------------------------------------------------------------------------------------------------
Income before income tax 10,215 5,218 97,772
Less: realized investment gains 5,117
Add back: derivative gains related to investments 1,947
- ---------------------------------------------------------------------------------------------------------------------------------------
Operating income 10,215 2,048
Income tax expense $33,937 33,937
- ---------------------------------------------------------------------------------------------------------------------------------------
Net income before cumulative effect of change in
accounting principle 63,835
Cumulative effect of change in accounting principle,
net of income tax (10,128) (10,128)
- ---------------------------------------------------------------------------------------------------------------------------------------
Net income $ 53,707
- ---------------------------------------------------------------------------------------------------------------------------------------
Operating Segment Income for the
Three Months Ended March 31, 2003
- ---------------------------------------------------------------------------------------------------------------------------------------
Life Stable Value
Marketing Acquisitions Annuities Products
- ---------------------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees $186,547 $ 73,063 $ 5,883
Reinsurance ceded (124,038) (18,626)
- ---------------------------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 62,509 54,437 5,883
Net investment income 56,402 62,296 58,441 $58,532
Realized investment gains (losses) 27 (6,701)
Other income 228 905 763
- ---------------------------------------------------------------------------------------------------------------------------------------
Total revenue 119,139 117,638 65,114 51,831
- ---------------------------------------------------------------------------------------------------------------------------------------
Benefits and settlement expenses 75,222 72,619 52,986 47,765
Amortization of deferred policy acquisition costs 20,884 10,081 4,386 599
Other operating expenses (7,661) 11,759 4,912 1,031
- ---------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 88,445 94,459 62,284 49,395
- ---------------------------------------------------------------------------------------------------------------------------------------
Income before income tax 30,694 23,179 2,830 2,436
Less: realized investment gains (losses) 27 (6,702)
Add back: related amortization of deferred
policy acquisition costs 731
- ---------------------------------------------------------------------------------------------------------------------------------------
Operating income 30,694 23,179 3,534 9,138
---------------------------------------------------------------------------------------------------------------------------------------
Asset Corporate Total
Protection and Other Adjustments Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees $105,817 $12,924 $ 384,234
Reinsurance ceded (40,768) (2,574) (186,006)
- ---------------------------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 65,049 10,350 198,228
Net investment income 9,693 187 245,551
Realized investment gains (losses) 5,376 (1,298)
Other income 6,699 339 8,934
- ---------------------------------------------------------------------------------------------------------------------------------------
Total revenue 81,441 16,252 451,415
- ---------------------------------------------------------------------------------------------------------------------------------------
Benefits and settlement expenses 39,428 9,378 297,398
Amortization of deferred policy acquisition costs 18,691 1,118 55,759
Other operating expenses 22,229 9,373 41,643
- ---------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 80,348 19,869 394,800
- ---------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income tax 1,093 (3,617) 56,615
Less: realized investment gains (losses) 5,376
Add back: derivative gains related to investments 2,859
- ---------------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 1,093 (6,134)
Income tax expense $18,553 18,553
- ---------------------------------------------------------------------------------------------------------------------------------------
Net income $ 38,062
- ---------------------------------------------------------------------------------------------------------------------------------------
Operating Segment Assets
March 31, 2004
- ---------------------------------------------------------------------------------------------------------------------------------------
Life Stable Value
Marketing Acquisitions Annuities Products
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $5,290,122 $4,200,503 $5,461,959 $4,790,287
Deferred policy acquisition costs 1,220,931 378,596 78,422 11,207
Goodwill
- ---------------------------------------------------------------------------------------------------------------------------------------
Total assets $6,511,053 $4,579,099 $5,540,381 $4,801,494
- ---------------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------------
Asset Corporate Total
Protection and Other Adjustments Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $ 935,406 $2,146,257 $56,711 $22,881,245
Deferred policy acquisition costs 172,224 8,473 1,869,853
Goodwill 36,182 36,182
- ---------------------------------------------------------------------------------------------------------------------------------------
Total assets $1,143,812 $2,154,730 $56,711 $24,787,280
- ---------------------------------------------------------------------------------------------------------------------------------------
Operating Segment Assets
December 31, 2003
- ---------------------------------------------------------------------------------------------------------------------------------------
Life Stable Value
Marketing Acquisitions Annuities Products
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $4,983,336 $4,356,929 $5,433,465 $4,520,955
Deferred policy acquisition costs 1,185,102 385,042 101,096 7,186
Goodwill
- ---------------------------------------------------------------------------------------------------------------------------------------
Total assets $6,168,438 $4,741,971 $5,534,561 $4,528,141
- ---------------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------------
Asset Corporate Adjustments Total
Protection and Other Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $ 958,219 $1,762,503 $57,094 $22,072,501
Deferred policy acquisition costs 176,524 8,618 1,863,568
Goodwill 35,143 35,143
- ---------------------------------------------------------------------------------------------------------------------------------------
Total assets $1,169,886 $1,771,121 $57,094 $23,971,212
- ---------------------------------------------------------------------------------------------------------------------------------------
NOTE D – STATUTORY REPORTING PRACTICES
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 reporting practices, at March 31, 2004, and for the three months then ended, Protective Life and its insurance subsidiaries had combined share-owners’ equity of $1,091.5 million and net income of $30.4 million.
NOTE E – REINSURANCE RECEIVABLE
In 2002, Protective Life discovered that it had overpaid reinsurance premiums to several reinsurance companies of approximately $94.5 million. Protective Life has received payment from substantially all of the affected reinsurance companies. In the first quarter of 2003, Protective Life increased premiums and policy fees $2.8 million as a result of cash received and changes in expected receipts at that time. The 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 first quarter of 2003 increased by $1.8 million.
NOTE F – RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued FASB Interpretation No. (FIN) 46 “Consolidation of Variable Interest Entities,” which was revised in December 2003. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from the other parties. The effective date of FIN 46 is March 31, 2004, for Protective Life. As such, Protective Life consolidated, as of and for the three months ended March 31, 2004, a real estate investment company that Protective Life had previously reported as an investment. The entity was consolidated based on the determination that Protective Life was the primary beneficiary. The consolidation resulted in Protective Life’s reported assets and liabilities increasing by $54.5 million with an immaterial impact on results of operations.
In July 2003, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.” SOP 03-1 is effective for fiscal years beginning after December 15, 2003. See Note J for discussion of Protective Life’s adoption of SOP 03-1.
On December 31, 2003, PLC adopted SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” as revised by the FASB in December 2003.
The following table sets forth the amount of net periodic benefit cost recognized for PLC’s defined benefit pension plan and unfunded excess benefits plan:
- ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
- ------------------------------------------------------------------------------------------------------------------------------
Service cost $ 2,012 $ 1,700
Interest cost 2,325 1,991
Expected return on plan assets (2,280) (1,903)
Amortization of prior service cost 92 78
Amortization of net loss 470 397
- ------------------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 2,619 $ 2,263
- ------------------------------------------------------------------------------------------------------------------------------
PLC previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $6.4 million to its pension plan in 2004. There has been no change in this estimate. As of March 31, 2004, no contributions have been made.
PLC’s defined benefit pension plan covers substantially all of its employees, including Protective Life employees. The plan is not separable by affiliates participating in the plan.
In addition to pension benefits, PLC provides limited healthcare benefits and life insurance benefits to eligible retirees. The cost of these plans for the three months ended March 31, 2004 and 2003 was immaterial.
NOTE G – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Fair-Value Hedges
As of March 31, 2004 and 2003, and during the three month periods then ended, Protective Life had no hedging relationships designated as a fair-value hedge.
Cash-Flow Hedges
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 2004, the income recognized by Protective Life related to the ineffective portion of the hedging instrument was immaterial. In the first quarter of 2003, the income recognized by Protective Life related to the ineffective portion of the hedging instrument was $0.3 million. There were no components of the hedging instrument excluded from the assessment of hedge ineffectiveness. During the three months ended March 31, 2004, a pretax gain of $12.6 million, representing the change in fair value of the hedged contracts during the period, and a loss 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. During the three months ended March 31, 2003, a pretax loss of $11.6 million, representing the change in fair value of the hedged contracts during the period, and a gain of like amount representing the application of hedge accounting were recorded. Additionally, at March 31, 2004 and 2003, Protective Life reported an increase of $4.8 million and a reduction of $0.1 million, respectively, in accumulated other comprehensive income (net of income tax of $2.6 million and $34 thousand, respectively) related to its derivative designated as a cash flow hedge. During the next twelve months, Protective Life expects to reclassify out of accumulated other comprehensive income and into earnings approximately $36 thousand.
Other Derivatives
Protective Life uses certain interest rate swaps, caps, floors, swaptions, options and futures contracts to mitigate or eliminate certain financial and market risks, including those related to changes in interest rates, fair value, and cash flows, of outstanding mortgage loan commitments and certain owned investments. For the three months ended March 31, 2004 and 2003, Protective Life recognized total pretax losses of $5.8 million and $6.1 million, respectively, 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 $9.6 million pretax loss and a $6.7 million pretax gain for the first three months of 2004 and 2003, respectively, while recognizing a $9.9 million foreign exchange pretax gain and $7.6 million foreign exchange pretax loss on the related foreign-currency-denominated stable value contracts in the same periods, respectively. 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.
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, 2004, Protective Life recognized a $0.2 million pretax loss for the change in the asset swaps’ fair value and recognized a $4.0 million pretax gain to separately record the embedded equity options at fair value. For the three months ended March 31, 2003, Protective Life recognized a $0.1 million pretax gain for the change in the asset swaps’ fair value and recognized a $0.4 million pretax loss to separately record the embedded equity options at fair value.
NOTE H – COMPREHENSIVE INCOME
The following table sets forth Protective Life’s comprehensive income for the periods shown:
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THREE MONTHS ENDED
MARCH 31
2004 2003
-----------------------------------------------------------------------------------------------------------------------------
Net income $ 53,707 $38,062
Change in net unrealized gains/losses on
investments (net of income tax:
2004 - $87,049; 2003 - $33,769 161,662 62,715
Change in accumulated gain-hedging (net of
tax: 2004 - $1,135; 2003 - $1,080) 2,107 2,005
Reclassification adjustment for amounts included
in net income (net of income tax:
2004 - $(5,819); 2003 - $(2,003)) (10,808) (3,720)
-----------------------------------------------------------------------------------------------------------------------------
Comprehensive income $206,668 $99,062
-----------------------------------------------------------------------------------------------------------------------------
NOTE I –RECLASSIFICATIONS
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 or share-owner’s equity.
NOTE J – CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
In January 2004, Protective Life adopted SOP 03-1 “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts”. SOP 03-1 provides guidance related to the establishment of reserves for benefit guarantees provided under certain long-duration contracts, as well as the accounting for mortality benefits provided in certain universal life products. In addition, it addresses the capitalization and amortization of sales inducements to contract holders. The adoption of SOP 03-1 resulted in a cumulative charge to net income of $10.1 million, net of income tax of $5.5 million. The charge to net income includes a $10.0 million charge to recognize additional liabilities, including an adjustment to deferred policy acquisition costs, on certain universal life contracts. These additional liabilities are required due to a change in the pattern of recognition of mortality benefits called for by the SOP. In addition, Protective Life recorded a $0.1 million adjustment related to guaranteed minimum death benefits (GMDB) on its variable annuity products.
Protective Life issues variable universal life and variable annuity products through its separate accounts for which the investment risk is borne by the contract holder. Protective Life also offers, for its variable annuity products, various account value guarantees upon death. The most significant of these guarantees involve (a) return of the highest anniversary date account value, or (b) return of the greater of the highest anniversary date account value or the last anniversary date account value compounded at 5% interest. The GMDB reserve is calculated by applying a benefit ratio, equal to the present value of total expected GMDB claims divided by the present value of total expected contract assessments, to cumulative contract assessments. This amount is then adjusted by the amount of cumulative GMDB claims paid and accrued interest. Assumptions used in the calculation of the GMDB reserve were as follows: mean investment performance of 9%, mortality at 60% of the 1994 MGDB Mortality Table, lapse rates ranging from 1%-20% (depending on product type and duration), and an average discount rate of 7%.
Separate account balances are valued at market and reported separately as assets and liabilities related to separate accounts in the accompanying consolidated balance sheets. Amounts assessed against policy account balances for the costs of insurance, policy administration, and other services are included in premiums and policy fees in the accompanying statements of income. Changes in the GMDB accrual are included in benefits and settlement expenses in the accompanying statements of income.
The variable annuity separate account balances subject to GMDB were $2.1 billion at March 31, 2004. The total guaranteed amount payable based on variable annuity account balances at March 31, 2004, was $295.3 million (including $262.0 million in the Annuities segment and $33.3 million in the Acquisitions segment), with a GMDB reserve of $5.7 million (including $5.2 million in the Annuities segment and $0.5 million in the Acquisitions segment). The average attained age of contract holders at March 31, 2004 was 64. For the three months ended March 31, 2004, the total incurred and paid GMDB claims were $0.8 million and $1.0 million, respectively. For the three months ended March 31, 2003, the total incurred and paid GMDB claims were $3.7 million and $3.1 million, respectively.
Account balances of variable annuities with guarantees were invested in variable annuity separate accounts as follows:
- -------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2004 DECEMBER 31, 2003
- -------------------------------------------------------------------------------------------------------------------------
Equity mutual funds $1,906.6 $1,846.0
Fixed income mutual funds 206.8 199.0
- -------------------------------------------------------------------------------------------------------------------------
Total $2,113.4 $2,045.0
- -------------------------------------------------------------------------------------------------------------------------
Certain of Protective Life’s universal life products have a sales inducement in the form of a retroactive interest credit (RIC). In addition, certain variable annuity contracts provide a sales inducement in the form of a bonus interest credit. In accordance with SOP 03-1, Protective Life maintains a reserve for all interest credits earned to date. Protective Life defers the expense associated with the RIC and bonus interest credits each period and amortizes these costs in a manner similar to that used for deferred policy acquisition costs. The amount of the total unamortized deferred asset at March 31, 2004 and December 31, 2003 was $27.4 million and $27.7 million, respectively. The amount of costs deferred and amortized in the first three months of 2004 was $2.3 million and $3.0 million, respectively. The amount of costs deferred and amortized in the first three months of 2003 was $1.5 million and $3.7 million, respectively.
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 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, Acquisitions, Annuities, Stable Value Products, and Asset Protection. Protective Life also has an additional 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,” “may,” 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, 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.
Premiums and Policy Fees
The following table sets forth for the periods shown the amount of premiums and policy fees, net of reinsurance ceded (“premiums and policy fees”):
------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
(In thousands)
------------------------------------------------------------------------------------------------------------------------
Premiums and Policy Fees $194,362 $198,228
------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees decreased $3.9 million or 2.0% in the first three months of 2004 as compared to the first three months of 2003. Premiums and policy fees in the Life Marketing segment increased $4.7 million in the first three months of 2004 as compared to the same period in 2003. In the first three months of 2003, Protective Life recorded $2.8 million of additional premiums related to recoveries of overpaid reinsurance; no increase was recorded in the first three months of 2004. (See Note E in the Notes to Consolidated Condensed Financial Statements.) The growth of the face value of in-force policies resulted in an increase of $7.5 million in net premiums and policy fees in the first three months of 2004 as compared to the same period of 2003. Premiums and policy fees in the Acquisitions segment decreased $2.1 million in the first three months of 2004, as compared to the first three months of 2003. 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. The increase in premiums and policy fees from the Annuities segment was $1.7 million in the first three months of 2004 as compared to the first three months of 2003 primarily due to increased fees on variable account values. Premiums and policy fees related to the Asset Protection segment fell $7.7 million for the first three months of 2004 compared to the first three months of 2003. The segment’s decrease primarily relates to the termination of non-core lines of business. Premiums and policy fees relating to various insurance lines in the Corporate and Other segment decreased $0.6 million in the first three months of 2004 as compared to the first three months of 2003. Premiums and policy fees on these lines are expected to decline as they continue to run off.
Net Investment Income
The following table sets forth for the periods shown the amount of net investment income:
------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
(In thousands)
------------------------------------------------------------------------------------------------------------------------
Net Investment Income $251,023 $245,551
------------------------------------------------------------------------------------------------------------------------
Net investment income in the first three months of 2004 was $251.0 million, which was $5.5 million or 2.2% higher than the corresponding period of the preceding year. The increase is a result of an increase in average invested assets partially offset by lower interest rates on new investments. The percentage earned on average cash and investments was 5.7% in the first three months of 2004, compared to 6.1% in the first three months of 2003. Participating mortgage income decreased $1.9 million in the first three months of 2004 as compared to the first three months of 2003.
Realized Investment Gains/(Losses)
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
2004 2003
(In thousands)
------------------------------------------------------------------------------------------------------------------------
Derivative Financial Instruments $(1,626) $(7,021)
All Other Investments 16,627 5,723
------------------------------------------------------------------------------------------------------------------------
The sales of investments that have occurred generally have resulted 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 2004 of $20.2 million were partially offset by realized investment losses of $3.6 million. Realized investment losses related to all other investments in the first three months of 2003 of $15.9 million were largely offset by realized investment gains of $10.2 million. During the first three months of 2004, Protective Life recorded no other-than-temporary impairments in its investments, compared to $9.0 million of impairments that were included in realized investment losses related to all other investments in the first three months of 2003.
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 recognized 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.
Realized investment gains and losses related to derivative financial instruments represent changes in the fair values of certain derivative financial instruments and gains or losses on contracts closed during the period. Net realized investment losses related to derivative financial instruments were $1.6 million in the three months ended March 31, 2004, compared to net losses of $7.0 million in the three months ended March 31, 2003. For the three months ended March 31, 2004 and 2003, the net derivative losses were primarily due to adjustments from derivative instruments entered into to reduce Protective Life’s exposure to interest rate risk. (See also Note G to Protective Life’s Consolidated Condensed Financial Statements included herein.)
Other Income
The following table sets forth other income for the periods shown:
------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
(In thousands)
------------------------------------------------------------------------------------------------------------------------
Other Income $13,939 $8,934
------------------------------------------------------------------------------------------------------------------------
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 increased to $13.9 million in the first three months of 2004 from $8.9 million in the first three months of 2003. Due to the consolidation of variable interest entities, revenues from real estate holdings increased $3.4 million. Other income from all other sources increased $1.6 million in the first three months of 2004 as compared to the first three months of 2003.
Income Before Income Tax and Operating Income
Consistent with Protective Life’s segment reporting in the Notes to Consolidated Condensed Financial Statements, 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 because fluctuations in these items are due to changes in interest rates and other financial market factors instead of mortality and morbidity. Periodic settlements of interest rate swaps associated with certain investments are included in realized gains and losses but are considered part of operating income because the interest rate swaps are hedging items affecting operating income. Also, segment operating income (loss) excludes any net gains or losses on disposals of businesses and the cumulative effect of changes in accounting principles. 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 operating segment 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, and the related amortization of deferred policy acquisition costs. In the Annuities and Stable Value Products segments operating income excludes realized investment gains and losses and related amortization. In the Corporate and Other segment operating income excludes realized investment gains and losses and includes derivative gains related to certain investments.
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
2004 2003
- ----------------------------------------------------------------------------------------------------------------------------
Operating income (Loss) 1
Life Marketing $40,929 $30,694
Acquisitions 21,117 23,179
Annuities 2,371 3,534
Stable Value Products 11,699 9,138
Asset Protection 10,215 1,093
Corporate and Other 2,048 (6,134)
- ----------------------------------------------------------------------------------------------------------------------------
Realized investment gains (losses)
Annuities 6,004 27
Stable Value Products 3,879 (6,702)
Corporate and Other 5,117 5,376
Less derivative gains related to investments 2
Corporate and Other (1,947) (2,859)
Related amortization of deferred policy
acquisition costs
Annuities (3,660) (731)
- ----------------------------------------------------------------------------------------------------------------------------
Income (loss) before income tax
Life Marketing 40,929 30,694
Acquisitions 21,117 23,179
Annuities 4,715 2,830
Stable Value Products 15,578 2,436
Asset Protection 10,215 1,093
Corporation and Other 5,218 (3,617)
- ----------------------------------------------------------------------------------------------------------------------------
Total income before income tax $97,772 $56,615
- ----------------------------------------------------------------------------------------------------------------------------
| 1 | Income before income tax excluding realized investment gains and losses and related amortization of deferred policy acquisition costs |
| 2 | Periodic settlement of interest rate swaps associated with certain investments included in realized investment gains and considered a part of operating income |
The Life Marketing segment’s pretax operating income was $40.9 million in the first three months of 2004 compared to $30.7 million in the same period of 2003. 2003 earnings include $1.8 million related to recoveries of overpaid reinsurance premiums, (See Note E in the Notes to Consolidated Condensed Financial Statements). Excluding earnings from recoveries from overpayments, operating income increased by $12.0 million. The increase is primarily attributable to growth in business-in-force due to strong sales in prior periods and favorable mortality experience. Mortality experience during the first three months of 2004 was approximately $2.3 million better than pricing, $3.7 million more favorable than in the same period of 2003. The increase in earnings was offset by expenses exceeding pricing allowances, reducing income by $7.1 million in the first three months of 2004.
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.
The Acquisitions segment’s pretax operating income was $21.1 million in the first three months of 2004, a decrease of $2.1 million from the first three months of 2003. Pretax operating income declined due to less favorable mortality experience than in the same period of 2003 and the expected decline in earnings from older acquisitions. Mortality experience was $1.1 million better than pricing in the first three months of 2004, compared to $1.7 million better than pricing in the first three months of 2003.
The Annuities segment’s pretax operating income was $2.4 million in the first three months of 2004, a decrease from the $3.5 million of operating income for the first three months of 2003. The decrease is primarily attributable to lower sales of annuities caused by lower interest rates and an unfavorable expense variance as compared to pricing allowances.
Protective Life offers a guaranteed minimum death benefit feature (GMDB) on its variable annuity products. At March 31, 2004, the total GMDB reserve for the Annuities segment was $5.2 million, $0.1 million higher than Protective Life reported at December 31, 2003. The total guaranteed amount payable under this feature based on variable annuity account balances at March 31, 2004, was $262.0 million, a decrease of $25.0 million from December 31, 2003, caused by an improvement in the equity markets.
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 $12.0 million at March 31, 2004, a decrease of $0.1 million from December 31, 2003.
Although positive performance in the equity markets in 2003 and 2004 allowed Protective Life to decrease its GMDB related policy liabilities, the Annuities segment’s future results may 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.
The Stable Value Products segment’s pretax operating income was $11.7 million in the first three months of 2004, an increase of $2.6 million from the first three months of 2003. The increase is attributable to an increase of average spreads from 93 basis points in the first three months of 2003, to 100 basis points in the first three months of 2004 and a $771.1 million increase in average account balances.
The Asset Protection segment had $10.2 million in pretax operating income in the first three months of 2004, compared to $1.1 million pretax operating income in the first three months of 2003. The segment has several lines of business that are not considered core to the operations of Protective Life and, therefore, the segment is exiting those lines. Core operations contributed $3.7 million to income in the first three months of 2004, compared to $3.4 million in the first three months of 2003. The increase resulted from increased earnings in the service contract lines partially offset by losses in the credit insurance lines of business. Non-core and ancillary lines had pretax operating income of $5.5 million in the first three months of 2004, compared to a loss of $0.6 million in the first three months of 2003. The Asset Protection segment sold an inactive charter in the first quarter of 2004, resulting in an increase in pretax operating income of $1.0 million. In the first quarter of 2003, the segment recorded a charge of $1.7 million related to uncollectible balances from a third party contract administrator. During the quarter, Protective Life determined that its surety line was not core to the Asset Protection business and reclassified it to the Corporate and Other segment for reporting purposes.
The Corporate and Other segment consists primarily of net investment income on unallocated capital, several lines of business that Protective Life is not actively marketing, earnings from various investment-related transactions, and various other items not associated with the other segments. The segment had pretax operating income of $2.0 million in the first three months of 2004, compared to a loss of $6.1 million in the first three months of 2003. The increase in pretax operating income resulted from an increase in net investment income for the segment, partially offset by a $2.2 million decrease in operating income from the surety insurance line of business and other increases in corporate expenses.
Income Taxes
The following table sets forth the effective tax rates for the periods shown:
------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
(In thousands)
------------------------------------------------------------------------------------------------------------------------
Effective Income Tax Rates 34.7% 32.8%
------------------------------------------------------------------------------------------------------------------------
The effective income tax rate for the full year of 2003 was approximately 33.7%. Management’s estimate of the effective income tax rate for the full year 2004 is approximately 34.7%. The expected increase is primarily due to the expiration of certain tax credits and an increase in state income taxes.
Net Income
The following table sets forth net income before cumulative effect of change in accounting principle for the periods shown:
------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
------------------------------------------------------------------------------------------------------------------------
(In thousands)
Net income before cumulative effect
of change in accounting principle $63,835 $38,062
------------------------------------------------------------------------------------------------------------------------
Compared to the same period in 2003, net income before cumulative effect of change in accounting principle in the first three months of 2004 increased $25.8 million, reflecting higher realized investment gains and higher operating earnings in the Life Marketing, Stable Value Products, Asset Protection, and Corporate and Other segments offset by decreases in operating results in the Annuities and Acquisitions segments.
Known Trends and Uncertainties
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 and subject to numerous legal restrictions and regulations; 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; computer viruses or network security breaches could affect our data processing systems or those of our business partners; our ability to grow depends in large part upon the continued availability of capital; and new accounting rules or changes to existing accounting rules could negatively impact our reported financial results. Please refer to Exhibit 99, incorporated by reference herein, about these factors that could affect future results.
Recently Issued Accounting Standards
In January 2003, the FASB issued FASB Interpretation No. (FIN) 46 “Consolidation of Variable Interest Entities,” which was revised in December 2003. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from the other parties. The effective date of FIN 46 is March 31, 2004, for Protective Life. As such, Protective Life consolidated, as of and for the three months ended March 31, 2004, a real estate investment company that Protective Life had previously reported as an investment. The entity was consolidated based on the determination that Protective Life was the primary beneficiary. The consolidation resulted in Protective Life’s reported assets and liabilities increasing by $54.5 million with an immaterial impact on results of operations.
In January 2004, Protective Life adopted Statement of Position (SOP) 03-1 “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts”. SOP 03-1 provides guidance related to the establishment of reserves for benefit guarantees provided under certain long-duration contracts, as well as the accounting for mortality benefits provided in certain universal life products. In addition, it addresses the capitalization and amortization of sales inducements to contract holders. The adoption of SOP 03-1 resulted in a cumulative charge to net income of $10.1 million, net of income tax of $5.5 million. The charge to net income includes a $10.0 million charge to recognize additional liabilities, including an adjustment to deferred policy acquisition costs, on certain universal life contracts. These additional liabilities are required due to a change in the pattern of recognition of mortality benefits called for by the SOP. In addition, Protective Life recorded a $0.1 million adjustment related to guaranteed minimum death benefits (GMDB) on its variable annuity products. (See also Note J to the Company’s Consolidated Condensed Financial Statements included herein.)
Prospectively, Protective Life currently anticipates that the adoption of SOP 03-1 may negatively impact pretax income by $0 to $2.0 million per quarter. However, Protective Life will continue to review and refine its estimates and monitor the relevant regulatory bodies for further implementation guidance and interpretations of this standard.
Review by Independent Accountants
With respect to the unaudited consolidated condensed financial information of Protective Life Insurance Company for the three-month periods ended March 31, 2004 and 2003, 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 14, 2004, 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.
INVESTMENTS
Portfolio Description
Protective Life’s investment portfolio consists primarily of fixed maturity securities (bonds and redeemable preferred stocks) and commercial 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, 2004, Protective Life’s fixed maturity investments had a market value of $13.5 billion, which is 6.9% above amortized cost of $12.6 billion. Protective Life had $2.7 billion in mortgage loans at March 31, 2004. While Protective Life’s mortgage loans do not have quoted market values, at March 31, 2004, Protective Life estimates the market value of its mortgage loans to be $3.0 billion (using discounted cash flows from the next call date), which is 9.5% 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 fluctuations are not expected to adversely affect liquidity.
The following table shows the carrying values of Protective Life’s invested assets.
--------------------------------------------------------------------------------------------------------------------
MARCH 31, 2004 DECEMBER 31, 2003
(In thousands)
--------------------------------------------------------------------------------------------------------------------
Publicly-issued bonds $11,566,640 65.9% $10,967,622 64.7%
Privately issued bonds 1,897,361 10.8 1,956,734 11.5
Redeemable preferred stock 3,293 0.0 3,164 0.0
--------------------------------------------------------------------------------------------------------------------
Fixed maturities 13,467,294 76.7 12,927,520 76.2
--------------------------------------------------------------------------------------------------------------------
Equity securities 30,449 0.2 30,521 0.2
Mortgage loans 2,746,706 15.7 2,733,722 16.1
Investment real estate 82,064 0.5 13,152 0.1
Policy loans 492,782 2.8 502,748 3.0
Other long-term investments 225,759 1.3 244,913 1.4
Short-term investments 494,621 2.8 510,635 3.0
--------------------------------------------------------------------------------------------------------------------
Total investments $17,539,675 100.0% $16,963,211 100.0%
--------------------------------------------------------------------------------------------------------------------
Risk Management and Impairment Review
Protective Life monitors the overall credit quality of its portfolio within general guidelines. The following table shows Protective Life’s fixed maturities by credit rating at March 31, 2004.
--------------------------------------------------------------------------------------------------------------------
S&P or Equivalent Market Value Percent of
Designation Market Value Market Value
--------------------------------------------------------------------------------------------------------------------
(In thousands)
AAA $ 5,063,737 37.6%
AA 802,010 6.0
A 2,930,907 21.8
BBB 3,685,422 27.4
--------------------------------------------------------------------------------------------------------------------
Investment Grade 12,482,076 92.8
--------------------------------------------------------------------------------------------------------------------
BB 637,997 4.7
B 326,710 2.4
CCC or lower 12,628 0.1
In or near default 4,590 0.0
--------------------------------------------------------------------------------------------------------------------
Below Investment Grade 981,925 7.2
--------------------------------------------------------------------------------------------------------------------
Redeemable preferred stock 3,293 0.0
--------------------------------------------------------------------------------------------------------------------
Total $13,467,294 100.0%
--------------------------------------------------------------------------------------------------------------------
Limiting bond exposure to any creditor group is another way Protective Life manages credit risk. The following table summarizes Protective Life’s ten largest fixed maturity exposures to an individual creditor group as of March 31, 2004.
---------------------------------------------------------------------------------------------
Creditor Market Value
---------------------------------------------------------------------------------------------
(In millions)
Wachovia $75.5
Berkshire Hathaway 73.6
Goldman Sachs 73.0
FPL Group 71.4
Citigroup 70.4
Verizon 66.0
Progress Energy 63.1
Public Service Enterprise Group 61.9
Constellation Energy Group 61.7
American Electric Power 61.1
---------------------------------------------------------------------------------------------
During the first three months of 2004, Protective Life recorded no pretax other-than-temporary impairments in its investments as compared to $9.0 million in the first three months of 2003.
Protective Life’s management considers a number of factors when determining the impairment status of individual securities. These include the economic condition of various industry segments and geographic locations and other areas of identified risks. Although it is possible for the impairment of one investment to affect other investments, Protective Life engages in ongoing risk management to safeguard against and limit any further risk to its investment portfolio. Special attention is given to correlated risks within specific industries, related parties and business markets.
Once management has determined that a particular investment has suffered an other-than-temporary impairment, the asset is written down to its estimated fair value. Protective Life generally considers a number of factors in determining whether the impairment is other than temporary. These include, but are not limited to: 1) actions taken by rating agencies, 2) default by the issuer, 3) the significance of the decline, 4) the intent and ability of Protective Life to hold the investment until recovery, 5) the time period during which the decline has occurred, 6) an economic analysis of the issuer’s industry, and 7) the financial strength, liquidity, and recoverability of the issuer. Management performs a security-by-security review each quarter in evaluating the need for any other-than-temporary impairments. Although no set formula is used in this process, the investment performance, collateral position and continued viability of the issuer are significant measures.
Protective Life generally considers a number of factors relating to the issuer in determining the financial strength, liquidity, and recoverability of an issuer. These include but are not limited to: available collateral, tangible and intangible assets that might be available to repay debt, operating cash flows, financial ratios, access to capital markets, quality of management, market position, exposure to litigation or product warranties, and the effect of general economic conditions on the issuer.
There are certain risks and uncertainties associated with determining whether declines in market values are other than temporary. These include significant changes in general economic conditions and business markets, trends in certain industry segments, interest rate fluctuations, rating agency actions, changes in significant accounting estimates and assumptions, commission of fraud and legislative actions. Protective Life continuously monitors these factors as they relate to the investment portfolio in determining the status of each investment. Provided below are additional facts concerning the potential effect upon Protective Life’s earnings should circumstances lead management to conclude that some of the current declines in market value are other-than-temporary.
Market values for private, non-traded securities are determined as follows: 1) Protective Life obtains estimates from independent pricing services or 2) Protective Life estimates market value based upon a comparison to quoted issues of the same issuer or issues of other issuers with similar terms and risk characteristics. The market value of private, non-traded securities was $1,897.4 million at March 31, 2004, representing 10.8% of Protective Life’s total invested assets.
Unrealized Gains and Losses
The majority of unrealized losses can be attributed to interest rate fluctuations and have been deemed temporary. As indicated above, when Protective Life’s investment management deems an investment’s market value decline as other-than-temporary, it is written down to estimated market value. In all cases, management will continue to carefully review and monitor each security.
The information presented below relates to investments at a certain point in time and is not necessarily indicative of the status of the portfolio at any time after March 31, 2004, the balance sheet date. Furthermore, since the timing of recognizing realized gains and losses is largely based on management’s decisions as to the timing and selection of investments to be sold, the tables and information provided below should be considered within the context of the overall unrealized gain (loss) position of the portfolio. At March 31, 2004, Protective Life had an overall pretax net unrealized gain of $863.8 million.
For traded and private fixed maturity and equity securities held by Protective Life that are in an unrealized loss position at March 31, 2004, the estimated market value, amortized cost, unrealized loss and total time period that the security has been in an unrealized loss position are presented in the table below.
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Estimated % Market Amortized % Amortized Unrealized % Unrealized
Market Value Value Cost Cost Loss Loss
(In thousands)
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‹= 90 days $274,579 30.2 % $276,572 29.1% $ (1,993) 4.7%
›90 days but ‹= 180 days 146,313 16.1 149,453 15.7 (3,140) 7.4
›180 days but ‹= 270 days 171,233 18.9 173,509 18.3 (2,276) 5.4
›270 days but ‹= 1 year 188,705 20.8 194,084 20.4 (5,379) 12.7
›1 year but ‹= 2 years 29,638 3.3 33,495 3.5 (3,857) 9.1
›2 years but ‹= 3 years 35,071 3.9 39,423 4.2 (4,352) 10.3
›3 years but ‹= 4 years 2,245 0.2 2,475 0.3 (230) 0.6
›4 years but ‹= 5 years 15,009 1.7 16,578 1.7 (1,569) 3.7
›5 years 44,841 4.9 64,315 6.8 (19,474) 46.1
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Total $907,634 100.0% $949,904 100.0% $(42,270) 100.0%
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At March 31, 2004, $21.9 million of securities in an unrealized loss position were securities issued in Company sponsored commercial mortgage loan securitizations, including $18.7 million in an unrealized loss position greater than five years. Protective Life does not consider these unrealized positions to be other-than-temporary, because the underlying mortgage loans continue to perform consistently with Protective Life’s original expectations.
Protective Life has no material concentrations of issuers or guarantors of fixed maturity securities. The industry segment composition of all securities in an unrealized loss position held by Protective Life at March 31, 2004, is presented in the following table.
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Estimated % Market Amortized % Amortized Unrealized % Unrealized
Market Value Value Cost Cost Loss Loss
(In thousands)
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Agency Mortgages $ 24,431 2.7% $ 24,452 2.6% $ (21) 0.0%
Banking 51,084 5.6 51,641 5.4 (557) 1.3
Basic Industrial 53,383 5.9 54,126 5.7 (743) 1.8
Brokerage 10,833 1.2 10,911 1.1 (78) 0.2
Capital Goods 504 0.1 506 0.1 (2) 0.0
Communications 65,639 7.2 68,006 7.2 (2,367) 5.6
Consumer Cyclical 12,833 1.4 12,947 1.4 (114) 0.3
Consumer Noncyclical 39,803 4.4 40,406 4.3 (603) 1.4
Electric 165,026 18.2 172,231 18.1 (7,205) 17.0
Energy 43,131 4.8 43,969 4.6 (838) 2.0
Insurance 44,656 4.9 44,903 4.7 (247) 0.6
Natural Gas 66,607 7.3 67,516 7.1 (909) 2.2
Non-Agency Mortgages 197,171 21.7 213,480 22.4 (16,309) 38.5
Other Finance 56,491 6.2 63,290 6.7 (6,799) 16.1
Other Industrial 2,400 0.3 2,422 0.3 (22) 0.1
Other Utility 21 0.0 44 0.0 (23) 0.1
Technology 124 0.0 143 0.0 (19) 0.0
Transportation 69,926 7.7 75,309 7.9 (5,383) 12.7
U. S. Government 3,571 0.4 3,602 0.4 (31) 0.1
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Total $907,634 100.0% $949,904 100.0% $(42,270) 100.0%
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The range of maturity dates for securities in an unrealized loss position at March 31, 2004 varies, with 6.4% maturing in less than 5 years, 24.1% maturing between 5 and 10 years, and 69.5% maturing after 10 years. The following table shows the credit rating of securities in an unrealized loss position at March 31, 2004.
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S&P or Equivalent Estimated % Market Amortized % Amortized Unrealized Unrealized
Designation Market Value Value Cost Cost Loss Loss
(In thousands)
- ------------------------------------------------------------------------------------------------------------------------------
AAA/AA/A $508,307 56.0% $517,696 54.5% $ (9,389) 22.2%
BBB 223,564 24.6 229,127 24.1 (5,563) 13.2
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Investment grade 731,871 80.6 746,823 78.6 (14,952) 35.4
BB 82,732 9.1 88,077 9.3 (5,345) 12.6
B 78,498 8.7 85,189 9.0 (6,691) 15.8
CCC or lower 14,533 1.6 29,815 3.1 (15,282) 36.2
Near default 0 0.0 0 0.0 (0) 0.0
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Below investment grade 175,763 19.4 203,081 21.4 (27,318) 64.6
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Total $907,634 100.0% $949,904 100.0% $(42,270) 100.0%
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At March 31, 2004, 80.6% of total securities in an unrealized loss position were rated as investment grade. Total bonds rated less than investment grade were 5.6% of invested assets.
At March 31, 2004, securities in an unrealized loss position that were rated as below investment grade represented 19.4% of the total market value and 64.6% of the total unrealized loss. Unrealized losses related to below investment grade securities that had been in an unrealized loss position for more than twelve months were $25.9 million. Bonds in an unrealized loss position rated less than investment grade were 1.0% 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.
The following table shows the estimated market value, amortized cost, unrealized loss and total time period that the security has been in an unrealized loss position for all below investment grade securities.
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Estimated % Market Amortized % Amortized Unrealized Unrealized
Market Value Value Cost Cost Loss Loss
(In thousands)
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‹= 90 days $ 30,783 17.5% $ 31,544 15.5% $ (761) 2.8%
›90 days but ‹= 180 days 9,730 5.5 9,858 4.9 (128) 0.5
›180 days but ‹= 270 days 4,298 2.5 4,483 2.2 (185) 0.7
›270 days but ‹= 1 year 24,031 13.7 24,345 12.0 (314) 1.1
›1 year but ‹= 2 years 22,373 12.7 25,858 12.7 (3,485) 12.7
›2 years but ‹= 3 years 28,292 16.1 31,673 15.6 (3,381) 12.4
›3 years but ‹= 4 years 1,941 1.1 2,042 1.0 (101) 0.4
›4 years but ‹= 5 years 9,823 5.6 10,306 5.1 (483) 1.8
›5 years 44,492 25.3 62,972 31.0 (18,480) 67.6
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Total $175,763 100.0% $203,081 100.0% $(27,318) 100.0%
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At March 31, 2004, $17.8 million of below investment grade securities in an unrealized loss position were securities issued in Protective Life-sponsored commercial mortgage loan securitizations, all of which are in an unrealized loss position greater than five years. Protective Life does not consider these unrealized positions to be other-than-temporary, because the underlying mortgage loans continue to perform consistently with Protective Life’s original expectations.
Realized Losses
Realized losses are comprised of both write-downs on other-than-temporary impairments and actual sales of investments.
During the three months ended March 31, 2004, Protective Life recorded no pretax other-than-temporary impairments in its investments, as compared to $9.0 million in the three months ended March 31, 2004.
As discussed earlier, Protective Life’s management considers several factors when determining other-than-temporary impairments. Although Protective Life generally intends to hold securities until maturity, Protective Life may change its positions as a result of a change in circumstances. Any such decision is consistent with Protective Life’s classification of its investment portfolio as available for sale. During the three months ended March 31, 2004, Protective Life sold securities in an unrealized loss position with a market value of $30.8 million resulting in a realized loss of $3.1 million. For such securities, the proceeds, realized loss and total time period that the security had been in an unrealized loss position are presented in the table below.
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Proceeds % Proceeds Realized Loss % Realized Loss
(In thousands)
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‹= 90 days $ 9,992 32.5% $(1,500) 48.7%
›90 days but ‹= 180 days 0 0.0 0 0.0
›180 days but ‹= 270 days 20,077 65.2 (1,571) 51.1
›270 days but ‹= 1 year 0 0.0 0 0.0
› 1 year 711 2.3 (6) 0.2
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Total $30,780 100.0% $(3,077) 100.0%
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Mortgage Loans
Protective Life records mortgage loans net of an allowance for credit losses. This allowance is calculated through analysis of specific loans that are believed to be at a higher risk of becoming impaired in the near future. At March 31, 2004 and December 31, 2003, Protective Life’s allowance for mortgage loan credit losses was $4.7 million.
For several years Protective Life has offered a type of commercial mortgage 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, 2004, approximately $403.1 million of Protective Life’s mortgage loans have this participation feature.
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, 2004, Protective Life had outstanding mortgage loan commitments of $700.4 million.
Liabilities
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, 2004, Protective Life had policy liabilities and accruals of $9.9 billion. Protective Life’s interest-sensitive life insurance policies have a weighted average minimum credited interest rate of approximately 4.5%.
At March 31, 2004, Protective Life had $4.9 billion of stable value contract account balances and $3.4 billion of annuity account balances.
Derivative Financial Instruments
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, futures contracts, and option contracts are sometimes used to mitigate or eliminate certain financial and market risks, including those related to 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 and could result in material changes from quarter-to-quarter. 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 strategies to mitigate or eliminate certain financial and market risks. These strategies are developed through the committee’s analysis of data from financial simulation models and other internal and industry sources and are then incorporated into Protective Life’s overall interest rate and currency exchange risk management strategies.
Asset/Liability Management
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.
Cash outflows related to stable value contracts (primarily maturing contracts, scheduled interest payments and expected withdrawals) were approximately $1,100.1 million during 2003. Cash outflows related to stable value contracts are estimated to be approximately $1,106.1 million in 2004. 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, 2004, to fund mortgage loans in the amount of $700.4 million. Protective Life held $579.3 million in cash and short-term investments at March 31, 2004.
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. At March 31, 2004, Protective Life had $8.7 million of securities sold under repurchase agreements with an interest rate of 1.12%. 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.
Capital
At March 31, 2004, PLC had no borrowings under its $200.0 million revolving line of credit due October 1, 2005.
At December 31, 2003, approximately $1,386.9 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.
Contractual Obligations
The table below sets forth future maturities of stable value products, notes payable, operating lease obligation, other property lease obligations, mortgage loan commitments, and liabilities related to variable interest entities.
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(in thousands) 2004 2005-2006 2007-2008 After 2008
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Stable value products $977,991 $2,074,564 $1,380,016 $490,660
Note payable 2,226
Operating lease obligation 1,119 2,983 66,249
Other property lease obligations 5,730 9,459 5,646 9,313
Mortgage loan commitments 700,395
Liabilities related to variable interest entities 585 6,519 47,998
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The table above excludes liabilities related to separate accounts of $2,300.4 million. Separate account liabilities represent funds maintained for contract holders who bear the related investment risk. These liabilities are supported by assets that are legally segregated and are not subject to claims that arise from other business activities of Protective Life. These assets and liabilities are separately identified on the consolidated balance sheets of Protective Life. The table also excludes future cash flows related to certain insurance liabilities due to the uncertainty with respect to the timing of the cash flows.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
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, 2003.
Item 4. Controls and Procedures
Under the direction our President and Chief Financial Officer, we evaluated our disclosure controls and procedures and internal control over financial reporting and concluded that (i) our disclosure controls and procedures were effective as of March 31, 2004, and (ii) no change in internal control over financial reporting occurred during the quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 12 – Consolidated Earnings Ratios.
Exhibit 15 — Letter re: unaudited interim financial information.
Exhibit 31(a) – Certification Pursuant to § 302 of the Sarbanes-Oxley Act of 2003.
Exhibit 31(b) – Certification Pursuant to § 302 of the Sarbanes-Oxley Act of 2003.
Exhibit 32(a) — Certification Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to § 906 of the Sarbanes-Oxley Act of 2003.
Exhibit 32(b) — Certification Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to § 906 of the Sarbanes-Oxley Act of 2003.
Exhibit 99 – Safe Harbor for Forward-Looking Statements.
(b) The following Forms 8-K were filed with the Securities and Exchange Commission during the three months ended March 31, 2004:
A Form 8-K was filed under Item 7 with the Securities and Exchange Commission on January 22, 2004.
A Form 8-K was filed under Item 7 with the Securities and Exchange Commission on January 28, 2004.
A Form 8-K was filed under Item 7 with the Securities and Exchange Commission on February 3, 2004.
A Form 8-K was filed under Item 7 with the Securities and Exchange Commission on March 3, 2004.
A Form 8-K was filed under Item 7 with the Securities and Exchange Commission on March 10, 2004.
A Form 8-K was filed under Item 7 with the Securities and Exchange Commission on March 17, 2004.
A Form 8-K was filed under Item 7 with the Securities and Exchange Commission on March 24, 2004.
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 17, 2004 | /s/ Steven G. Walker | |
| Steven G. Walker | |||
| Vice President, Controller and | |||
| Chief Accounting Officer | |||
| (Duly authorized officer) |