| DELAWARE | 95-2492236 | ||
|---|---|---|---|
| (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 [X] No [ ]
Number of shares of Common Stock, $.50 par value, outstanding as of April 23, 2004: 69,310,717 shares.
INDEX
Page Number
Part I. Financial Information:
Item 1. Financial Statements:
Report of Independent Accountants..................................................................
Consolidated Condensed Statements of Income for the
Three Months ended March 31, 2004 and 2003 (unaudited).........................................
Consolidated Condensed Balance Sheets as of March 31, 2004
(unaudited) and December 31, 2003..............................................................
Consolidated Condensed Statements of Cash Flows for the
Three Months ended March 31, 2004 and 2003 (unaudited).........................................
Notes to Consolidated Condensed Financial Statements (unaudited)...................................
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................................
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................
Item 4. Controls and Procedures......................................................................
Part II. Other Information:
Item 2. Changes in Securities and Use of Proceeds....................................................
Item 6. Exhibits and Reports on Form 8-K.............................................................
Signature................................................................................................
To the Directors and
Share Owners
Protective Life Corporation
We have reviewed the accompanying consolidated condensed balance sheet of Protective Life Corporation and its 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 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-owners’ 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 4, 2004
(Dollars in thousands
except per share amounts)
(Unaudited)
THREE MONTHS ENDED
MARCH 31
2004 2003
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REVENUES
Premiums and policy fees $443,796 $387,094
Reinsurance ceded (249,339) (189,417)
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Premiums and policy fees, net of reinsurance ceded 194,457 197,677
Net investment income 264,608 257,701
Realized investment gains (losses):
Derivative financial instruments 5,083 (4,880)
All other investments 16,627 (1,178)
Other income 37,419 25,309
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518,194 474,629
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BENEFITS AND EXPENSES
Benefits and settlement expenses
(net of reinsurance ceded:
three months: 2004 - $241,287; 2003 - $217,771) 287,316 297,273
Amortization of deferred policy acquisition costs 59,794 55,759
Other operating expenses (net of reinsurance ceded:
three months: 2004 - $39,562; 2003 - $29,033) 71,685 65,558
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418,795 418,590
- ---------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX 99,399 56,039
Income tax expense 34,094 18,334
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NET INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE 65,305 37,705
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Cumulative effect of change in accounting principle,
net of income tax (10,128) 0
- ---------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 55,177 $ 37,705
- ---------------------------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE PER
SHARE - BASIC $.93 $.54
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NET INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE PER
SHARE - DILUTED $.92 $.53
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NET INCOME PER SHARE - BASIC $.79 $.54
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NET INCOME PER SHARE - DILUTED $.78 $.53
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DIVIDENDS PAID PER SHARE $.16 $.15
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Average shares outstanding - basic 70,117,634 69,956,505
Average shares outstanding - diluted 70,863,117 70,483,448
See notes to consolidated condensed financial statements
(Dollars in thousands)
MARCH 31 DECEMBER 31
2004 2003
(Unaudited)
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ASSETS
Investments:
Fixed maturities, at market (amortized cost: 2004 - $13,010,864; 2003 - $12,743,213) $13,875,517 $13,355,911
Equity securities, at market (amortized cost: 2004 - $55,192; 2003 - $45,379) 58,362 46,731
Mortgage loans on real estate 2,746,706 2,733,722
Investment in real estate, net 108,098 18,126
Policy loans 492,782 502,748
Other long-term investments 231,161 249,494
Short-term investments 516,988 519,419
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Total investments 18,029,614 17,426,151
Cash 114,972 136,698
Accrued investment income 198,564 189,232
Accounts and premiums receivable, net 95,943 57,944
Reinsurance receivables 2,462,269 2,350,606
Deferred policy acquisition costs 1,867,195 1,861,020
Goodwill 46,619 47,312
Property and equipment, net 45,143 45,640
Other assets 256,894 238,581
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
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$25,417,656 $24,573,991
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LIABILITIES
Policy liabilities and accruals $ 9,960,399 $ 9,732,697
Stable value product account balances 4,923,231 4,676,531
Annuity account balances 3,412,553 3,480,577
Other policyholders' funds 159,458 158,875
Securities sold under repurchase agreements 8,660 0
Other liabilities 814,308 875,652
Accrued income taxes 42,262 (34,261)
Deferred income taxes 415,849 377,990
Liabilities related to variable interest entities 477,128 400,000
Long-term debt 376,457 461,329
Subordinated debt securities 324,743 221,650
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
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23,215,491 22,571,847
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COMMITMENTS AND CONTINGENT LIABILITIES - NOTE B
SHARE-OWNERS' EQUITY
Preferred Stock, $1.00 par value, shares authorized: 3,600,000; Issued: None
Junior Participating Cumulative Preferred Stock, $1.00 par value
shares authorized: 400,000; Issued: None
Common Stock, $.50 par value, shares authorized: 160,000,000
shares issued: 2004 and 2003 - 73,251,960 36,626 36,626
Additional paid-in capital 419,147 418,351
Treasury stock, at cost (2004 - 3,941,243 shares; 2003 - 4,260,259 shares) (13,931) (15,275)
Stock held in trust (2004 - 81,142 shares; 2003 - 97,700 shares) (2,365) (2,788)
Unallocated stock in Employee Stock Ownership Plan
(2004 - 609,735 shares; 2003 - 724,068 shares) (1,989) (2,367)
Retained earnings 1,279,131 1,235,012
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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2,202,165 2,002,144
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$25,417,656 $24,573,991
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See notes to consolidated condensed financial statements
(Dollars in thousands)
(Unaudited)
THREE MONTHS ENDED
MARCH 31
2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 55,177 $ 37,705
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment (gains) losses (13,803) (2,926)
Amortization of deferred policy acquisition costs 59,794 56,265
Capitalization of deferred policy acquisition costs (95,245) (92,518)
Depreciation expense 2,736 2,634
Deferred income tax (5,312) (13,497)
Accrued income tax 37,533 21,725
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 (158,539) (50,708)
Change in policy liabilities and other policyholders' funds
of traditional life and health products 208,648 71,229
Net change in trading securities 1,708 0
Change in other liabilities (92,180) (11,995)
Other, net (30,540) 45,501
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 43,422 130,240
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CASH FLOWS FROM INVESTING ACTIVITIES
Investments available for sale, net of short-term investments:
Maturities and principal reductions of investments 454,563 1,375,990
Sale of investments 925,287 3,220,069
Cost of investments acquired (1,620,368) (4,974,504)
(Increase) decrease in mortgage loans, net (12,984) 34,522
Decrease in investment real estate, net 972 1,226
Decrease in policy loans, net 9,966 7,076
Increase in other long-term investments, net (1,910) (5,064)
Decrease in short-term investments, net 40,351 25,400
Purchase of property and equipment (2,239) (5,876)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (206,362) (321,161)
- ---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under line of credit arrangements and long-term debt 2,552,151 152,500
Principal payments on line of credit arrangement and long-term debt (2,628,363) (132,507)
Dividends to share owners (11,058) (10,323)
Issuance of subordinated debt securities 103,093 0
Issuance (purchase) of common stock held in trust 423 (395)
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 141,214 144,798
- ---------------------------------------------------------------------------------------------------------------------------------
DECREASE IN CASH (21,726) (46,123)
CASH AT BEGINNING OF PERIOD 136,698 101,953
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CASH AT END OF PERIOD $ 114,972 $ 55,830
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See notes to consolidated condensed financial statements
NOTE A – BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements of Protective Life Corporation and subsidiaries (the “Company”) 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 the Company’s annual report on Form 10-K for the year ended December 31, 2003.
NOTE B – COMMITMENTS AND CONTINGENT LIABILITIES
The Company’s certificate of incorporation provides indemnification for persons serving as officers and directors of the Company. In addition, agreements with the Company’s directors require the Company, upon certain “change-in-control” contingencies, to obtain a $20 million letter of credit to secure the Company’s indemnification obligations. The letter of credit would provide security for the Company’s obligations up to an aggregate amount of $20 million (after taking into account amounts paid by the Company and amounts paid under the Company’s directors and officers or other insurance policies).
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. The Company 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 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. The Company, 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, the Company 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 the Company.
NOTE C – OPERATING SEGMENTS
The Company 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, the Company 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. The Company 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 the Company 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. |
The Company 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 corporate debt and 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.
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 consitently.
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 reduction in the goodwill balance in the Asset Protection segment relates to the sale of a small subsidiary in the first quarter of 2004.
Operating Segment Income for the
Three Months Ended March 31, 2004
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Life Stable Value
Marketing Acquisitions Annuities Products
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Premiums and policy fees $235,986 $69,469 $7,628
Reinsurance ceded (168,786) (17,101)
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Net of reinsurance ceded 67,200 52,368 7,628
Net investment income 57,940 58,655 51,588 $64,033
Realized investment gains 6,004 3,879
Other income 21,143 717 1,785
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Total revenue 146,283 111,740 67,005 67,912
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Benefits and settlement expenses 72,026 73,020 46,046 49,769
Amortization of deferred policy acquisition costs 21,081 7,849 9,057 761
Other operating expenses 11,575 9,668 6,745 1,804
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Total benefits and expenses 104,682 90,537 61,848 52,334
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Income before income tax 41,601 21,203 5,157 15,578
Less: realized investment gains 6,004 3,879
Add back: related amortization of deferred
policy acquisition costs 3,660
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Operating income 41,601 21,203 2,813 11,699
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Corporate
Asset and Total
Protection Other Adjustments Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees $120,570 $10,143 $443,796
Reinsurance ceded (63,107) (345) (249,339)
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Net of reinsurance ceded 57,463 9,798 194,457
Net investment income 7,917 24,475 264,608
Realized investment gains 11,827 21,710
Other income 9,062 4,712 37,419
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Total revenue 74,442 50,812 518,194
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Benefits and settlement expenses 34,887 11,568 287,316
Amortization of deferred policy acquisition costs 20,069 977 59,794
Other operating expenses 14,926 26,967 71,685
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Total benefits and expenses 69,882 39,512 418,795
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Income before income tax 4,560 11,300 99,399
Less: realized investment gains 11,827
Add back: derivative gains related to corporate
debt and investments 4,875
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Operating income 4,560 4,348
Income tax expense $34,094 34,094
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Net income before cumulative effect of change in
accounting principle 65,305
Cumulative effect of change in accounting principle,
net of income tax (10,128) (10,128)
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Net income $ 55,177
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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)
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Net of reinsurance ceded 62,509 54,437 5,883
Net investment income 56,538 62,296 58,442 $58,532
Realized investment gains (losses) 27 (6,702)
Other income 13,972 905 1,941
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Total revenue 133,019 117,638 66,293 51,830
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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 6,278 12,166 5,910 1,030
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Total benefits and expenses 102,384 94,866 63,282 49,394
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Income before income tax 30,635 22,772 3,011 2,436
Less: realized investment gains (losses) 27 (6,702)
Add back: related amortization of deferred
policy acquisition costs 731
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Operating income 30,635 22,772 3,715 9,138
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Corporate
Asset and Total
Protection Other Adjustment Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees $108,677 $12,924 $387,094
Reinsurance ceded (44,179) (2,574) (189,417)
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Net of reinsurance ceded 64,498 10,350 197,677
Net investment income 9,700 12,193 257,701
Realized investment gains (losses) 617 (6,058)
Other income 6,971 1,520 25,309
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Total revenue 81,169 24,680 474,629
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Benefits and settlement expenses 39,302 9,379 297,273
Amortization of deferred policy acquisition costs 18,691 1,118 55,759
Other operating expenses 22,023 18,151 65,558
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Total benefits and expenses 80,016 28,648 418,590
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Income (loss) before income tax 1,153 (3,968) 56,039
Less: realized investment gains (losses) 617
Add back: derivative gains related to corporate
debt and investments 5,634
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Operating income 1,153 1,049
Income tax expense $18,334 18,334
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Net income $ 37,705
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Operating Segment Assets
March 31, 2004
- ---------------------------------------------------------------------------------------------------------------------------------------
Life Stable Value
Marketing Acquisitions Annuities Products
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $5,295,967 $4,200,503 $5,464,463 $4,790,288
Deferred policy acquisition costs 1,220,932 378,596 78,422 11,207
Goodwill 10,354
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Total assets $6,527,253 $4,579,099 $5,542,885 $4,801,495
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- ---------------------------------------------------------------------------------------------------------------------------------------
Corporate
Asset and Total
Protection Other Adjustments Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $ 981,132 $2,711,615 $59,874 $23,503,842
Deferred policy acquisition costs 169,980 8,058 1,867,195
Goodwill 36,182 83 46,619
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Total assets $1,187,294 $2,719,756 $59,874 $25,417,656
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Operating Segment Assets
December 31, 2003
- ---------------------------------------------------------------------------------------------------------------------------------------
Life Stable Value
Marketing Acquisitions Annuities Products
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $4,987,757 $4,356,929 $5,436,619 $4,520,955
Deferred policy acquisition costs 1,185,102 385,042 101,096 7,186
Goodwill 10,354
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Total assets $6,183,213 $4,741,971 $5,537,715 $4,528,141
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- ---------------------------------------------------------------------------------------------------------------------------------------
Corporate
Asset and Total
Protection Other Adjustments Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------------
Investments and other assets $1,014,556 $2,288,582 $60,261 $22,665,659
Deferred policy acquisition costs 173,123 9,471 1,861,020
Goodwill 36,875 83 47,312
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Total assets $1,224,554 $2,298,136 $60,261 $24,573,991
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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, the Company’s 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, the Company discovered that it had overpaid reinsurance premiums to several reinsurance companies of approximately $94.5 million. The Company has received payment from substantially all of the affected reinsurance companies. In the first quarter of 2003, the Company 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, the Company’s pretax income for the first quarter of 2003 increased by $1.8 million.
NOTE F – NET INCOME PER SHARE
Net income per share – basic is net income divided by the average number of shares of Common Stock outstanding including shares that are issuable under various deferred compensation plans.
Net income per share – diluted is adjusted net income divided by the average number of shares outstanding including all dilutive, potentially issuable shares that are issuable under various stock-based compensation plans and stock purchase contracts.
Net income and a reconciliation of basic and diluted average shares outstanding for the three month periods ended March 31, 2004 and 2003 are summarized as follows:
RECONCILIATION OF NET INCOME AND
AVERAGE SHARES OUTSTANDING
- --------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Net income $55,177 $37,705
- --------------------------------------------------------------------------------------------------------------------------------
Average shares issued and outstanding 69,148,942 68,794,968
Stock held in trust (81,142) (96,262)
Issuable under various deferred compensation plans 1,049,834 1,257,799
- --------------------------------------------------------------------------------------------------------------------------------
Average shares outstanding - basic 70,117,634 69,956,505
Stock held in trust 81,142 96,262
Stock appreciation rights 313,583 183,576
Issuable under various other stock-based compensation plans 350,758 247,105
- --------------------------------------------------------------------------------------------------------------------------------
Average shares outstanding - diluted 70,863,117 70,483,448
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NOTE G – 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 the Company. However, FIN 46 guidance required the interpretation to be applied to entities that are considered special-purpose entities no later than as of the end of the first reporting period that ends after December 15, 2003 (December 31, 2003, for the Company). As such, the Company consolidated, as of December 31, 2003, a special-purpose entity whose investments are managed by the Company. The special-purpose entity was consolidated based on the determination that the Company was its primary beneficiary. The Company also consolidated, as of and for the three months ended March 31, 2004, two real estate investment companies that the Company had previously reported as investments. The entities were consolidated based on the determination that the Company was the primary beneficiary. The consolidation resulted in the Company’s reported assets and liabilities increasing by $76.2 million with an immaterial impact on results of operations. Additionally, the Company deconsolidated, as of December 31, 2003, the special-purpose entities PLC Capital Trust III and PLC Capital Trust IV after determining the Company was not the primary beneficiary of these special-purpose entities.
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 L for discussion of the Company’s adoption of SOP 03-1.
On December 31, 2003, the Company 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 the Company’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
- --------------------------------------------------------------------------------------------------------------------------------
The Company 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.
In addition to pension benefits, the Company 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 H – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Fair-Value Hedges
As of March 31, 2004 and 2003, and during the three month periods then ended, the Company had no hedging relationships designated as a fair-value hedge.
Cash-Flow Hedges
The Company 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, the Company pays a fixed U.S.-dollar-denominated rate and receives a fixed foreign-currency-denominated rate. Effective July 1, 2002, the Company 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 the Company related to the ineffective portion of the hedging instrument was immaterial. In the first quarter of 2003, the income recognized by the Company 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 the Company’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, the Company 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, the Company expects to reclassify out of accumulated other comprehensive income and into earnings approximately $36 thousand.
Other Derivatives
The Company 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 as well as certain debt and subordinated debt securities of the Company. For the three months ended March 31, 2004 and 2003, the Company recognized total pretax gains of $1.1 million and pretax losses of $4.2 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, the Company 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.
The Company 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, the Company 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, the Company 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 I – COMPREHENSIVE INCOME
The following table sets forth the Company’s comprehensive income for the periods presented below:
- --------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Net income $ 55,177 $37,705
Change in net unrealized gains/losses on
investments (net of income tax:
2004 - $87,049; 2003 - $31,354) 161,662 58,229
Change in accumulated gain-hedging (net of income
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 - $412) (10,808) 766
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $208,138 $98,705
- --------------------------------------------------------------------------------------------------------------------------------
NOTE J – 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-owners’ equity.
NOTE K – SUBORDINATED DEBT SECURITIES AND SENIOR NOTES
On January 27, 2004, a special-purpose entity, PLC Capital Trust V, issued $100 million of 6.125% Trust Originated Preferred Securities (TOPrS). The 6.125% TOPrS are guaranteed on a subordinated basis by the Company. This guarantee, considered together with the other obligations of the Company with respect to the 6.125% TOPrS, constitutes a full and unconditional guarantee by the Company of PLC Capital Trust V’s obligations with respect to the 6.125% TOPrS.
PLC Capital Trust V was formed solely to issue securities and use the proceeds thereof to purchase subordinated debt securities of the Company. The sole assets of PLC Capital Trust V are $103.1 million of Protective Life Corporation 6.125% Subordinated Debentures due 2034, Series F. The Company has the right under the subordinated debt securities to extend interest payment periods up to five consecutive years, and as a consequence, dividends on the 6.125% TOPrS may be deferred (but will continue to accumulate, together with additional dividends on any accumulated but unpaid dividends at the dividend rate) by PLC Capital Trust V during any such extended interest payment period. The 6.125% TOPrS are redeemable by PLC Capital Trust V at any time on or after January 27, 2009.
The majority of the proceeds of the 6.125% TOPrS was used to pay down outstanding bank debt, including $59.9 million incurred to redeem the Company’s outstanding 7.50% 15-year Senior Notes on January 1, 2004. In addition, the Company repaid the $25 million outstanding as of December 31, 2003, on its $200 million line of credit. The balance of the proceeds will be used for general corporate purposes, affording the Company additional financial flexibility.
NOTE L – CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
In January 2004, the Company 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 ($0.14 per share on both a basic and diluted basis). 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, the Company recorded a $0.1 million adjustment related to guaranteed minimum death benefits (GMDB) on its variable annuity products.
The Company issues variable universal life and variable annuity products through its separate accounts for which the investment risk is borne by the contract holder. The Company 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 reserve 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 the Company’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, the Company maintains a reserve for all interest credits earned to date. The Company 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.
Prospectively, the Company currently anticipates that the adoption of SOP 03-1 may negatively impact pretax income by $0 to $2.0 million per quarter. However, the Company will continue to review and refine its estimates and monitor the relevant regulatory bodies for further implementation guidance and interpretations of this standard.
Protective Life Corporation is a holding company whose subsidiaries provide financial services through the production, distribution, and administration of insurance and investment products. Founded in 1907, Protective Life Insurance Company is the Company’s principal operating subsidiary. Unless the context otherwise requires, the “Company” refers to the consolidated group of Protective Life Corporation and its subsidiaries.
For a more complete understanding of the Company’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 the Company’s latest annual report on Form 10-K and other filings with the SEC.
The Company operates several business segments each having a strategic focus. An operating segment is generally distinguished by products and/or channels of distribution. The Company’s operating segments are Life Marketing, Acquisitions, Annuities, Stable Value Products, and Asset Protection. The Company also has an additional segment referred to as Corporate and Other.
This report reviews the Company’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 the Company 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.
The Company’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 $194,457 $197,677
----------------------------------------------------------------------------------------------------------------------------
Premiums and policy fees decreased $3.2 million or 1.6% 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, the Company 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 $7.0 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 $264,608 $257,701
----------------------------------------------------------------------------------------------------------------------------
Net investment income in the first three months of 2004 was $264.6 million, which was $6.9 million or 2.7% 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 5.9% in the first three months of 2004, compared to 6.4% in the first three months of 2003. Participating mortgage loan income decreased $1.9 million in the first three months of 2004 as compared to the first three months of 2003.
Realized Investment Gains/(Losses)
The Company generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash-flow needs.
The following table sets forth realized investment gains (losses) for the periods shown:
----------------------------------------------------------------------------------------------------------------------------
REALIZED INVESTMENT THREE MONTHS ENDED
GAINS/(LOSSES) MARCH 31
2004 2003
----------------------------------------------------------------------------------------------------------------------------
($ in thousands)
Derivative Financial Instruments $ 5,083 $(4,880)
All Other Investments 16,627 (1,178)
----------------------------------------------------------------------------------------------------------------------------
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 $17.1 million were largely offset by realized investment gains of $15.9 million. During the first three months of 2004, the Company recorded no other-than-temporary impairments in its investments, compared to $15.9 million of impairments that were included in realized investment losses related to all other investments in the first three months of 2003.
Each quarter the Company reviews its 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, the Company 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, the Company 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 gains related to derivative financial instruments were $5.1 million in the three months ended March 31, 2004, compared to net losses of $4.9 million in the three months ended March 31, 2003. For the three months ended March 31, 2004 and 2003, the net derivative gains (losses) were primarily due to adjustments from derivative instruments entered into to reduce the Company’s exposure to interest rate risk. (See also Note H to the Company’s Consolidated Condensed Financial Statements included herein.)
Other Income
The following table sets forth other income for the periods shown:
----------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
----------------------------------------------------------------------------------------------------------------------------
($ in thousands)
Other Income $37,419 $25,309
----------------------------------------------------------------------------------------------------------------------------
Other income consists primarily of investment advisory fees from variable insurance products, and revenues from unaffiliated parties relating to the Company’s broker-dealer subsidiary, direct response businesses, service contract businesses, and the Company’s other non-insurance subsidiaries. Other income increased to $37.4 million in the first three months of 2004 from $25.3 million in the first nine months of 2003. Revenues from the Company’s broker-dealer subsidiary increased $3.2 million in the first three months of 2004 as compared to the same period in 2003. Revenues from the Company’s direct response businesses and service contract businesses increased $1.8 million and $2.2 million, respectively, in the first three months of 2004 as compared to the first three months of 2003. Due to the consolidation of variable interest entities, revenues from real estate holdings increased $4.3 million. Other income from all other sources increased $0.6 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 the Company’s segment reporting in the Notes to Consolidated Condensed Financial Statements, management evaluates the results of the Company’s segments on a before-income-tax basis as adjusted for certain items which management believes are not indicative of the Company’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 corporate debt and 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 the Company’s overall financial performance, management believes that operating segment income (loss) enhances an investor’s understanding of the Company’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, the Company’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 corporate debt and investments.
The following table sets forth operating income and income or loss before income tax by business segment for the periods shown:
OPERATING INCOME AND INCOME (LOSS) BEFORE INCOME TAX
- ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
- ------------------------------------------------------------------------------------------------------------------------------
($ in thousands)
Operating income 1
Life Marketing $41,601 $30,635
Acquisitions 21,203 22,772
Annuities 2,813 3,715
Stable Value Products 11,699 9,138
Asset Protection 4,560 1,153
Corporate and Other 4,348 1,049
- ------------------------------------------------------------------------------------------------------------------------------
Realized investment gains (losses)
Annuities 6,004 27
Stable Value Products 3,879 (6,702)
Corporate and Other 11,827 617
Less derivative gains related to corporate debt
and investments 2
Corporate and Other (4,875) (5,634)
Related amortization of deferred policy
acquisition costs
Annuities (3,660) (731)
- ------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income tax
Life Marketing 41,601 30,635
Acquisitions 21,203 22,772
Annuities 5,157 3,011
Stable Value Products 15,578 2,436
Asset Protection 4,560 1,153
Corporate and Other 11,300 (3,968)
- ------------------------------------------------------------------------------------------------------------------------------
Total income before income tax $99,399 $56,039
- ------------------------------------------------------------------------------------------------------------------------------
| 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 corporate debt and certain investments included in realized investment gains and considered a part of operating income |
The Life Marketing segment’s pretax operating income was $41.6 million in the first three months of 2004 compared to $30.6 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 $12.8 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 $21.2 million in the first three months of 2004, a decrease of $1.6 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 $2.8 million in the first three months of 2004, a decrease from the $3.7 million of operating income for the first three months of 2003. The decrease in pretax operating income is primarily attributable to lower sales of annuities caused by lower interest rates and an unfavorable expense variance as compared to pricing allowances.
The Company 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 the Company 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), the Company’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 the Company 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 $4.6 million in pretax operating income in the first three months of 2004, compared to $1.2 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 the Company 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 a loss of $0.1 million in the first three months of 2004, compared to a loss of $0.5 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, the Company 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, interest expense on substantially all debt, and several lines of business that the Company 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 $4.3 million in the first three months of 2004, compared to income of $1.0 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, a $1.1 million charge from the early extinguishment of debt, and other increases in corporate expenses.
Income Taxes
The following table sets forth the effective tax rates for the periods shown:
- ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
- ------------------------------------------------------------------------------------------------------------------------------
Effective Income Tax Rates 34.3% 32.7%
- ------------------------------------------------------------------------------------------------------------------------------
The effective income tax rate for the full year of 2003 was approximately 33.3%. Management’s estimate of the effective income tax rate for the full year 2004 is approximately 34.3%. The expected increase is primarily due to the expiration of certain tax credits and an increase in state income taxes.
Net Income
The following table sets forth net income before cumulative effect of change in accounting principle and related per share information for the periods shown:
- ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31
2004 2003
- ------------------------------------------------------------------------------------------------------------------------------
($ in thousands, except
per-share amounts)
Net income before cumulative effect of change in
accounting principle $65,305 $37,705
Per share-basic .93 .54
Per share-diluted .92 .53
- ------------------------------------------------------------------------------------------------------------------------------
Compared to the same period in 2003, net income before cumulative effect of change in accounting principle per share-diluted in the first three months of 2004 increased 73.6%, reflecting higher realized investment gains and higher operating earnings in the Life Marketing, Asset Protection, Stable Value Products, 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 the Company’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 the Company 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 the Company 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 the Company. However, FIN 46 guidance required the interpretation to be applied to entities that are considered special-purpose entities no later than as of the end of the first reporting period that ends after December 15, 2003 (December 31, 2003, for the Company). As such, the Company consolidated, as of December 31, 2003, a special-purpose entity whose investments are managed by the Company. The special-purpose entity was consolidated based on the determination that the Company was its primary beneficiary. The Company also consolidated, as of and for the three months ended March 31, 2004, two real estate investment companies that the Company had previously reported as investments. The entities were consolidated based on the determination that the Company was the primary beneficiary. The consolidation resulted in the Company’s reported assets and liabilities increasing by $76.2 million with an immaterial impact on results of operations. Additionally, the Company deconsolidated, as of December 31, 2003, the special-purpose entities PLC Capital Trust III and PLC Capital Trust IV after determining the Company was not the primary beneficiary of these special-purpose entities.
In January 2004, the Company 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 ($0.14 per share on both a basic and diluted basis). 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, the Company recorded a $0.1 million adjustment related to guaranteed minimum death benefits (GMDB) on its variable annuity products. (See also Note L to the Company’s Consolidated Condensed Financial Statements included herein.)
Review by Independent Accountants
With respect to the unaudited consolidated condensed financial information of Protective Life Corporation 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 4, 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.
The Company’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, the Company’s investments are predominantly in medium- and long-term, fixed-rate investments such as bonds and mortgage loans.
INVESTMENTS
Portfolio Description
The Company’s investment portfolio consists primarily of fixed maturity securities (bonds and redeemable preferred stocks) and commercial mortgage loans. The Company generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs. However, the Company may sell any of its investments to maintain proper matching of assets and liabilities. Accordingly, the Company has classified $13.5 billion of its fixed maturities and certain other securities as “available for sale.”
As of December 31, 2003, the Company consolidated a special-purpose entity, in accordance with FIN 46, whose investments are managed by the Company. These investments with a market value of $425.1 million at March 31, 2004, have been classified as “trading” securities by the Company.
The Company’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, the Company’s fixed maturity investments had a market value of $13.9 billion, which is 6.6% above amortized cost of $13.0 billion. The Company had $2.7 billion in mortgage loans at March 31, 2004. While the Company’s mortgage loans do not have quoted market values, at March 31, 2004, the Company estimates the market value of its mortgage loans to be $3.0 billion (using discounted cash flows from the next call date), which is 9.5% above amortized cost. Most of the Company’s mortgage loans have significant prepayment fees. These assets are invested for terms approximately corresponding to anticipated future benefit payments. Thus, market fluctuations are not expected to adversely affect liquidity.
The following table shows the carrying values of the Company’s invested assets.
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March 31, 2004 December 31, 2003
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($ in thousands)
Publicly-issued bonds $11,944,952 66.2% $11,377,474 65.3%
Privately issued bonds 1,927,272 10.7 1,975,273 11.3
Redeemable preferred stock 3,293 0.0 3,164 0.0
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Fixed maturities 13,875,517 76.9 13,355,911 76.6
Equity securities 58,362 0.3 46,731 0.3
Mortgage loans 2,746,706 15.3 2,733,722 15.7
Investment real estate 108,098 0.6 18,126 0.1
Policy loans 492,782 2.7 502,748 2.9
Other long-term investments 231,161 1.3 249,494 1.4
Short-term investments 516,988 2.9 519,419 3.0
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Total investments $18,029,614 100.0% $17,426,151 100.0%
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Included in the above table are $407.0 million of fixed maturities and $18.1 million of short term investments at March 31, 2004 and $420.1 million of fixed maturities and $4.8 million of short term investments at December 31, 2003, classified by the Company as trading securities.
Risk Management and Impairment Review
The Company monitors the overall credit quality of the Company’s portfolio within general guidelines. The following table shows the Company’s available for sale fixed maturities by credit rating at March 31, 2004.
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S&P or Equivalent Percent of
Designation Market Value Market Value
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($ 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
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Investment grade 12,482,076 92.8
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BB 639,192 4.7
B 326,710 2.4
CCC or lower 12,628 0.1
In or near default 4,590 0.0
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Below investment grade 983,120 7.2
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Redeemable preferred stock 3,293 0.0
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Total $13,468,489 100.0%
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Not included in the table above are $396.0 million of investment grade and $11.0 million of less than investment grade fixed maturities classified by the Company as trading securities.
Limiting bond exposure to any creditor group is another way the Company manages credit risk. The following table summarizes the Company’s ten largest fixed maturity exposures to an individual creditor group as of March 31, 2004.
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Creditor Market Value
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($ in millions)
Wachovia $75.5
Berkshire Hathaway 73.6
Goldman Sachs 73.0
FPL Group 71.4
Citigroup 70.4
Duke Energy 68.3
Verizon 66.0
Bank of America 63.5
Progress Energy 63.1
Public Service Enterprise Group 61.9
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During the first three months of 2004, the Company recorded no pretax other-than-temporary impairments in its investments, as compared to $15.9 million in the first three months of 2003.
The Company’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, the Company 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. The Company 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 the Company 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 considered.
The Company 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. The Company 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 the Company’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) the Company obtains estimates from independent pricing services or 2) the Company 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 $1,927.3 million at March 31, 2004, representing 10.7% of the Company’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 the Company’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, the Company had an overall pretax net unrealized gain of $867.8 million.
For traded and private fixed maturity and equity securities held by the Company that are in an unrealized loss position at March 31, 2004, the estimated market value, amortized cost, unrealized loss and total time period that the security has been in an unrealized loss position are presented in the table below.
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Estimated % Market Amortized % Amortized Unrealized % Unrealized
Market Value Value Cost Cost Loss Loss
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($ in thousands)
‹= 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 $18.7 million in an unrealized loss position greater than five years. The Company does not consider these unrealized positions to be other-than-temporary, because the underlying mortgage loans continue to perform consistently with the Company’s original expectations.
The Company has no material concentrations of issuers or guarantors of fixed maturity securities. The industry segment composition of all securities in an unrealized loss position held by the Company at March 31, 2004, is presented in the following table.
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Estimated % Market Amortized % Amortized Unrealized % Unrealized
Market Value Value Cost Cost Loss Loss
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($ in thousands)
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% $(42,270) 100.0%
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The range of maturity dates for securities in an unrealized loss position at March 31, 2004 varies, with 6.4% maturing in less than 5 years, 24.1% maturing between 5 and 10 years, and 69.5% maturing after 10 years. The following table shows the credit rating of securities in an unrealized loss position at March 31, 2004.
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S&P or Equivalent Estimated % Market Amortized % Amortized Unrealized % Unrealized
Designation Market Value Value Cost Cost Loss Loss
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($ 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
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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 5.5% 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 $25.9 million. Bonds in an unrealized loss position rated less than investment grade were 1.0% of invested assets. The Company does not expect these investments to adversely affect its liquidity or ability to maintain proper matching of assets and liabilities.
The following table shows the estimated market value, amortized cost, unrealized loss and total time period that the security has been in an unrealized loss position for all below investment grade securities.
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Estimated % Market Amortized % Amortized Unrealized % Unrealized
Market Value Value Cost Cost Loss Loss
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($ in thousands)
‹= 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 the Company-sponsored commercial mortgage loan securitizations, all of which are in an unrealized loss position greater than five years. The Company does not consider these unrealized positions to be other-than-temporary, because the underlying mortgage loans continue to perform consistently with the Company’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, the Company recorded no pretax other-than-temporary impairments in its investments, as compared to $15.9 million in the three months ended March 31, 2004.
As discussed earlier, the Company’s management considers several factors when determining other-than-temporary impairments. Although the Company generally intends to hold securities until maturity, the Company may change its positions as a result of a change in circumstances. Any such decision is consistent with the Company’s classification of all but a specific portion of its investment portfolio as available for sale. During the three months ended March 31, 2004, the Company sold securities in an unrealized loss position with a market value of $30.8 million resulting in a realized loss of $3.1 million. For such securities, the proceeds, realized loss and total time period that the security had been in an unrealized loss position are presented in the table below.
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Proceeds % Proceeds Realized Loss % Realized Loss
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($ in thousands)
‹= 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
The Company 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, the Company’s allowance for mortgage loan credit losses was $4.7 million.
For several years the Company has offered a type of commercial mortgage loan under which the Company 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 the Company’s mortgage loans have this participation feature.
In the ordinary course of its commercial mortgage lending operations, the Company 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 the Company’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, the Company had outstanding mortgage loan commitments of $700.4 million.
Liabilities
Many of the Company’s products contain surrender charges and other features that reward persistency and penalizes the early withdrawal of funds. Certain stable value and annuity contracts have market-value adjustments that protect the Company against investment losses if interest rates are higher at the time of surrender than at the time of issue.
At March 31, 2004, the Company had policy liabilities and accruals of $10.0 billion. The Company’s interest-sensitive life insurance policies have a weighted average minimum credited interest rate of approximately 4.5%.
At March 31, 2004, the Company had $4.9 billion of stable value product account balances and $3.4 billion of annuity account balances.
Derivative Financial Instruments
The Company 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. The Company 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, its Senior Notes, Medium-Term Notes, and subordinated debt securities. Swap contracts are also used to alter the effective durations of assets and liabilities. The Company 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 the Company to credit and market risk and could result in material changes from quarter-to-quarter. The Company minimizes its credit risk by entering into transactions with highly rated counterparties. The Company 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.
The Company monitors its use of derivatives in connection with its overall asset/liability management programs and procedures. The Company’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 the Company’s overall interest rate and currency exchange risk management strategies.
Asset/Liability Management
The Company’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 the Company’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.
The Company believes its asset/liability management programs and procedures and certain product features provide protection for the Company against the effects of changes in interest rates under various scenarios. Additionally, the Company 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, the Company’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 the Company’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. The Company’s asset/liability management programs and procedures take into account maturing contracts and expected withdrawals. Accordingly, the Company does not expect stable value contract related cash outflows to have an unusual effect on the future operations and liquidity of the Company.
The life insurance subsidiaries were committed at March 31, 2004, to fund mortgage loans in the amount of $700.4 million. The Company’s subsidiaries held $629.2 million in cash and short-term investments at March 31, 2004. The Company had an additional $2.7 million in cash and short-term investments available for general corporate purposes.
While the Company generally anticipates that the cash flows of its subsidiaries will be sufficient to meet their investment commitments and operating cash needs, the Company recognizes that investment commitments scheduled to be funded may, from time to time, exceed the funds then available. Therefore, the Company has arranged sources of credit for its insurance subsidiaries to use when needed. At March 31, 2004, Protective Life Insurance Company had $8.7 million of securities sold under repurchase agreements with an interest rate of 1.12%. The Company expects that the rate received on its investments will equal or exceed its borrowing rate. Additionally, the Company may from time to time sell short-duration stable value products to complement its cash management practices.
The Company has also used securitization transactions involving its commercial mortgage loans to increase its liquidity.
Capital
At March 31, 2004, the Company had no borrowings under its $200.0 million revolving line of credit due October 1, 2005.
Protective Life Corporation’s cash flow is dependent on cash dividends and payments on surplus notes from its subsidiaries, revenues from investment, data processing, legal and management services rendered to the subsidiaries, and investment income. At December 31, 2003, approximately $529.8 million of consolidated share-owners’ equity, excluding net unrealized investment gains and losses, represented net assets of the Company’s insurance subsidiaries that cannot be transferred to the Company. In addition, the states in which the Company’s insurance subsidiaries are domiciled impose certain restrictions on the insurance subsidiaries’ ability to pay dividends to the Company.
The Company plans to retain substantial portions of the earnings of its life insurance subsidiaries in those companies primarily to support their future growth. The Company’s cash disbursements have from time to time exceeded its cash receipts, and these shortfalls have been funded through various external financings. Therefore, the Company may, from time to time, require additional external financing.
To give the Company flexibility in connection with future acquisitions and other growth opportunities or for other corporate purposes, the Company has registered debt securities, preferred and common stock, and stock purchase contracts of Protective Life Corporation, and additional preferred securities of special purpose finance subsidiaries under the Securities Act of 1933 on a delayed (or shelf) basis.
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 the Company’s insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as retained statutory earnings or equity contributions by the Company.
Contractual Obligations
The table below sets forth future maturities of debt, subordinated debt securities, 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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2004 2005-2006 2007-2008 After 2008
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($ in thousands)
Long-term debt $ 75,000 $299,231
Subordinated debt securities 324,743
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 400,803 12,437 48,495 15,393
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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 the Company. These assets and liabilities are separately identified on the consolidated balance sheets of the Company. 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
Item 4. Controls and Procedures
Under the direction our Chief Executive Officer 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 2. Changes in Securities and Use of Proceeds
During the quarter ended March 31, 2004, the Company issued the following securities in transactions which were not registered under the Securities Act of 1933, as amended (the “Act”).
| (a) | On March 11, 2004, the Company issued 9 shares of Common Stock, par value $.50 per share. |
| (b) | No underwriters participated. The shares were issued to a nonemployee Director of the Company: Thomas L. Hamby. |
| (c) | The shares were issued in partial payment of the Directors’ retainer fee. |
| (d) | Exemption from registration under the Act was claimed based upon Section 4(2) as a sale by an issuer not involving a public offering. |
Item 6. Exhibits and Reports on Form 8-K
| (a) | Exhibit 10(a) – Employment Continuation Agreement (Executives) |
| Exhibit 10(b) – Employment Continuation Agreement (Senior Officers) |
| Exhibit 15 — Letter re: unaudited interim financial information. |
| Exhibit 31(a) – Certification Pursuant to §302 of the Sarbanes-Oxley Act of 2002. |
| Exhibit 31(b) – Certification Pursuant to §302 of the Sarbanes-Oxley Act of 2002. |
| Exhibit 32(a) — Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| Exhibit 32(b) — Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| Exhibit 99 – Safe Harbor for Forward-Looking Statements. |
| (b) | The following Forms 8-K were filed or furnished to the Securities and Exchange Commission during the three months ended March 31, 2004: |
| A Form 8-K was filed under Items 5 and 7 with the Securities and Exchange Commission on January 28, 2004. |
| A Form 8-K was furnished under Item 12 to the Securities and Exchange Commission on February 11, 2004. |
| A Form 8-K/A was furnished under Item 12 to the Securities and Exchange Commission on February 11, 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 CORPORATION | |||
|---|---|---|---|
| Date: | May 10, 2004 | /s/ Steven G. Walker | |
| Steven G. Walker | |||
| Senior Vice President, Controller | |||
| and Chief Accounting Officer | |||
| (Duly authrorized officer) |