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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- - EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 33-37587
PRUCO LIFE INSURANCE COMPANY
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Arizona 22-1944557
- ------------------------------ ---------------------------------
(State or other jurisdiction, (IRS Employer
incorporation or organization) Identification No.)
213 Washington Street, Newark, New Jersey 07102
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(Address of principal executive offices) (Zip Code)
(973) 802-2042
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(Registrant's Telephone Number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: NONE
Securities registered pursuant to Section 12 (g) of the Act: NONE
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 ___
State the aggregate market value of the voting stock held by
non-affiliates of the registrant: NONE
Indicate the number of shares outstanding of each of the
registrant's classes of common stock, as of March 15, 2000. Common stock, par
value of $10 per share: 250,000 shares outstanding
PRUCO LIFE INSURANCE COMPANY
(Registrant)
INDEX
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Item No. Page No.
- -------- --------
Cover Page -
Index 2
PART I
1. Business 3
2. Properties 3
3. Legal Proceedings 3
4. Submission of Matters to a Vote of Security Holders 4
PART II
5. Market for Registrant's Common Equity and Related Stockholders' Matters 5
6. Selected Financial Data 5
7. Management's Discussion and Analysis of Financial Position
and Results of Operations 5
7a. Quantitative and Qualitative Disclosures About Market Risk 14
8. Financial Statements and Supplementary Data 19
9. Changes in and Disagreements with Independent Accountants on Accounting
and Financial Disclosure 19
PART III
10. Directors and Executive Officers of the Registrant 20
11. Executive Compensation 21
12. Security Ownership of Certain Beneficial Owners and Management 21
13. Certain Relationships and Related Transactions 21
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 22
Exhibit Index 22
Signatures 24
2
PART I
Item 1. Business
Pruco Life Insurance Company ("the Company") is a stock life insurance company,
organized in 1971 under the laws of the state of Arizona. The Company is
licensed to sell individual life insurance, variable life insurance, variable
annuities, fixed annuities, and a group annuity program ("the Contracts") in the
District of Columbia, Guam and in all states and territories except New York. In
addition, the Company markets individual life insurance through its branch
office in Taiwan. The Company has two wholly owned subsidiaries, Pruco Life
Insurance Company of New Jersey ("PLNJ") and The Prudential Life Insurance
Company of Arizona ("PLICA"). PLNJ is a stock life insurance company organized
in 1982 under the laws of the state of New Jersey. It is licensed to sell
individual life insurance, variable life insurance, fixed annuities, and
variable annuities only in the states of New Jersey and New York. PLICA is a
stock life insurance company organized in 1988 under the laws of the state of
Arizona. PLICA had no new business sales in 1997, 1998 or 1999 and at this time
will not be issuing new business.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential"), a mutual insurance company founded in 1875 under the
laws of the state of New Jersey. Prudential is currently considering
reorganizing itself into a publicly traded stock company through a process known
as "demutualization." On February 10, 1998, Prudential's Board of Directors
authorized management to take the preliminary steps necessary to allow
Prudential to demutualize. On July 1, 1998, legislation was enacted in New
Jersey that would permit this conversion to occur and that specified the process
for conversion. Demutualization is a complex process involving development of a
plan of reorganization, adoption of a plan by Prudential's Board of Directors, a
public hearing, review and approval by two-thirds of the qualified policyholders
who vote on the plan review and approval by the New Jersey Department of
Banking and Insurance. Prudential's management is in the process of developing a
proposed plan of demutualization, although there can be no assurance that
Prudential's Board of Directors will approve such a plan.
Prudential intends to make additional capital contributions to the Company, as
needed, to enable it to comply with its reserve requirements and fund expenses
in connection with its business. Generally, Prudential is under no obligation to
make such contributions and its assets do not back the benefits payable under
the Contracts.
The Company is engaged in a business that is highly competitive because of the
large number of stock and mutual life insurance companies and other entities
engaged in marketing insurance products, and individual and group annuities.
Item 2. Properties
Not applicable.
Item 3. Legal Proceedings
Various lawsuits against the Company have arisen in the course of the Company's
business. In certain of these matters, large and/or indeterminate amounts are
sought.
On October 28, 1996, the Company entered into a Stipulation of Settlement with
attorneys for the plaintiffs in a consolidated class action lawsuit pending in a
Multi-District Litigation proceeding in the U.S. District Court for the District
of New Jersey. The class action suit involved alleged improprieties in
connection with the sale, servicing and operation of permanent life insurance
policies from 1982 through 1995. Pursuant to the settlement, the Company has
participated in a remediation program pursuant to which relief was offered to
policyowners who were misled when they purchased permanent life insurance
policies in the United States from 1982 to 1995. Prudential has agreed to
indemnify the Company for any liability incurred in connection with that
litigation.
The balance of the Company's litigation is subject to many uncertainties, and
given the complexity and scope, the outcomes cannot be predicted with precision.
Management believes that any ultimate liability which could result from such
litigation would not have a material adverse effect on the Company's financial
position.
3
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of the stockholders held on June 18, 1999, the sole
stockholder of the Company appointed the Board of Directors of the Company. The
following are the Directors appointed at such meeting:
James J. Avery, Jr.
William Bethke
Ira J. Kleinman
Esther H. Milnes
David R. Odenath, Jr.
I. Edward Price
Kiyofumi Sakaguchi
4
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholders'
Matters
The Company is a wholly-owned subsidiary of Prudential. There is no public
market for the Company's common stock.
Item 6. Selected Financial Data
Pruco Life Insurance Company and Subsidiaries
------------------------------------------------------------------------
For the Years Ended December 31,
(In Thousands)
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Revenues
Premiums and other revenue $ 575,190 $ 473,975 $ 435,547 $ 397,319 $ 388,087
Realized investment gains
(losses), net (32,545) 44,841 10,974 10,835 13,200
Net investment income 276,821 261,430 259,634 247,328 246,618
------------------------------------------------------------------------
Total revenues 819,466 780,246 706,155 655,482 647,905
Benefits and expenses
Policyholder benefits' and
interest credited to
policyholders' account
balances 341,894 312,731 310,352 305,119 280,913
Other expenses 392,041 231,320 227,561 122,006 134,790
------------------------------------------------------------------------
Total benefits and expenses 733,935 544,051 537,913 427,125 415,703
------------------------------------------------------------------------
Income before income tax provision 85,531 236,195 168,242 228,357 232,202
Income tax provision 29,936 84,233 61,868 79,135 79,558
------------------------------------------------------------------------
Net income $ 55,595 $ 151,962 $ 106,374 $ 149,222 $ 152,644
========================================================================
Total assets at period end $21,791,837 $16,812,781 $12,851,467 $9,710,366 $8,471,638
========================================================================
Separate Account liabilities at
period end $16,032,449 $11,490,751 $ 7,948,788 $5,277,454 $4,263,896
========================================================================
Item 7. Management's Discussion and Analysis of Financial Position and Results
of Operations.
The following analysis should be read in conjunction with the Notes to
Consolidated Financial Statements.
The Company markets individual life insurance, variable life insurance, variable
annuities, fixed annuities, and a group annuity program primarily through
Prudential's sales force in the United States. These markets are subject to
regulatory oversight with particular emphasis placed on company solvency and
sales practices. These markets are also subject to increasing competitive
pressure as the legal barriers which have historically segregated the markets of
the financial services industry have been changed through both legislative and
judicial processes. Regulatory changes have opened the insurance industry to
competition from other financial institutions, particularly banks and mutual
funds that are positioned to deliver competing investment products through
large, stable distribution channels. The Company also markets individual life
insurance through its branch office in Taiwan.
5
The Company's Results of Operations and Changes in Statements of Financial
Position are described below.
1. Results of Operations
Net income for the year ended December 31, 1999 was $55.6 million, a decrease of
$96.4 million or 63.4% from $152.0 million earned in the year ended December 31,
1998. The decrease reflects a $189.9 million increase in expenses, offset in
part by a $39.2 million increase in revenues and a related decrease in income
taxes of $54.3 million. Net income for the year ended December 31, 1997 was
$106.4 million.
(a) 1999 versus 1998
Premiums increased $16.8 million to $99.0 million for the year ended December
31, 1999. The increase was primarily due to continued growth at the Company's
Taiwan branch, which sells traditional life insurance products. New sales for
the Taiwan branch grew by 40% and gross insurance in force increased by 16%. The
premium increase in Taiwan was partially offset by a decrease of $2.4 million in
domestic premiums related to extended term policy conversions. As an option in
the event of a lapse, individual variable life insurance policies provide
policyholders with additional extended term or reduced paid-up life insurance
based on the amount that can be purchased with the remaining cash value of the
contract (if the contractholder does not elect to receive the remaining cash
value as a cash distribution). The application of the remaining cash value to
purchase such coverage is recorded as premium revenue in the Statement of
Operations.
Policy charges and fee income, primarily consisting of expense, mortality,
loading and other insurance charges assessed on policyholder account balances,
increased by $63.8 million to $414.4 million in 1999 from $350.6 million in
1998. The majority of the proceeds from sales of the Company's interest
sensitive, non traditional products are invested in Separate Account funds,
through which the customer has an option to invest in mutual fund investments.
These Separate Account fund balances increased by $4.5 billion from the prior
year. Strong securities market conditions contributed to appreciation in
Separate Account asset values during 1999, and consequently, fee income.
Favorable market conditions also provided a stimulus to investors to purchase
mutual fund shares and annuities, particularly the Discovery Select annuity
product, the Company's most actively sold annuity product, which further
contributed to growth in assets and fees earned. Discovery Select net sales,
defined as sales less withdrawals, increased slightly from $2.573 billion in
1998 to $2.646 billion in 1999, an increase of $73.0 million. This increase can
be attributed to an increase in exchanges as a result of the Exchange Program,
which provides the contractholders of older Prudential or Pruco Life annuity
products an opportunity to convert to the Discovery Select product. Exchanges
were $1.221 billion in 1999 compared to $.925 billion in 1998, an increase of
$296.0 million. New sales declined from $1.647 billion in 1998 to $1.424 billion
in 1999, a decrease of $223.0 million.
Net investment income increased by $15.4 million to $276.8 million in 1999. The
increase was primarily the result of higher income from fixed maturities
(excluding short-term investments) of $12.2 million, as the average assets
increased. Average yields on fixed maturities were modestly lower in 1999.
Investment of cash inflows from the Prudential Credit Enhanced ("PACE") product,
a non-participating guaranteed investment contract ("GIC"), was the primary
cause of the increase in the asset base. The PACE product increased its
investments in fixed maturities by $345.8 million during 1999.
Realized investment losses, net were $32.5 million in 1999 compared to realized
investment gains, net of $44.8 million for the prior year. The decline of $77.3
million was primarily due to the impact of net sales of fixed maturity
securities during a rising interest rate environment for most of 1999. Realized
losses on fixed maturities were $29.1 million in 1999, consisting of losses on
sales of $18.0 million and writedowns for impairments deemed other than
temporary of $11.1 million. In 1998, there were realized gains of $29.8 million
on fixed maturities, net of writedowns for impairments deemed other than
temporary of $2.8 million. In addition, in 1999 the Company realized $1.6
million in losses from U.S. Treasury futures transactions versus a gain of $12.4
million in the prior year.
Asset management fees increased to $60.4 million at December 31, 1999 from $40.2
million at December 31, 1998. These represent fees collected from the Prudential
Series Funds ("PSF"), a portfolio of mutual fund investments related to the
Company's Separate Account products. The increase reflects a $4.5 billion
increase in Separate Account assets in 1999, as discussed above.
Policyholders' benefits were $205.0 million for the year ended December 31,
1999, an increase of $11.3 million from $193.7 million for the year ended
December 31, 1998. The increase was mainly due to increases in reserves of $4.2
million, surrender increases of $3.0 million, and term life conversion credits
of $3.0 million. The reserve increase reflects continued business expansion in
the Company's Taiwan branch. As noted above, the Taiwan branch experienced a 40%
growth in sales in 1999, requiring an increase to their reserves of $12.8
million. This increase was offset by a decline in domestic reserves of $8.9
million resulting from a reduction in extended term insurance activity and a
decrease in year over year sales. The term life conversions of $3.0 million
relate to premium credits provided to policyholders who exercised an option to
convert term life insurance products to variable life insurance.
6
Interest credited to policyholder account balances for the year ended December
31, 1999 was $136.9 million, an increase of $17.9 million from $119.0 million in
1998. Interest credited for the PACE product increased by $15.0 million as PACE
account balances increased to $584.7 million at December 31, 1999 from $231.3
million at December 31, 1998.
General, administrative and other expenses, net of capitalization and
amortization of deferred policy acquisition costs ("DAC"), increased $160.7
million to $392.0 million in 1999 from $231.3 million in 1998. The increase was
primarily the result of the implementation of a new expense allocation
methodology from Prudential. This new allocation process shifts a greater amount
of expenses to products requiring more complex business processes and more
transactions, such as variable products which allow policyholders to make
changes in their investment portfolio. As a result of this change, the Company's
allocation of general and administrative expenses from Prudential increased by
approximately $78.0 million. These allocated expenses include distribution
expenses from Prudential's retail agency network. Beginning in 1999, market
based distribution transfer pricing was the basis for allocating costs to each
product distributed through Prudential's retail agency network. A majority of
these distribution expenses have been capitalized by the Company as DAC.
Other factors contributing to the increase in general, administrative and other
expenses include DAC amortization, Prudential Global Asset Management ("PGAM")
fees and a reserve for unbeknownst modified endowment contracts ("UMEC"). DAC
amortization increased by $46.3 million. In 1998, DAC amortization was reduced
as a result of a change in estimate of gross profit margin related to variable
universal life products and increased profitability of the Discovery Select
product. In addition, beginning in 1999 expenses included an asset based charge
from PGAM for managing Separate Account investment portfolios. These fees were
$25.8 million in 1999. Expenses in 1999 also include $10.2 million for the
establishment of a reserve for UMEC. A modified endowment contract ("MEC") is a
universal life policy in which the money paid into the contract by the
contractholder exceeds the level permitted by the Internal Revenue Service.
Consequently, the contract loses its tax deferred status. The Company had failed
to notify contractholders when they reached this level, and therefore has agreed
to remedy policyholders for any penalties they have incurred. The Company has
established a reserve to cover any tax liability to be paid on behalf of the
policyholder, any enhanced death benefit given to the policyholder as a remedy
and any expected administrative costs.
(b) 1998 versus 1997
Total insurance revenues, consisting of premiums and policy charges and fee
income, increased by $31.0 million for the year ended December 31, 1998 to
$432.7 million from $401.7 million for the year ended December 31, 1997. The
increase was due to higher premium revenues at the Company's Taiwan branch and
higher mortality and expense charges related to increases in policyholder
account balances during 1998. In addition, there was an increase of $4.6 million
in premiums related to extended term policy conversions.
The Company's net investment income increased by $1.8 million for the year ended
December 31, 1998 to $261.4 from $259.6 million for the year ended December 31,
1997. Consolidated net realized investment gains increased $33.8 million in 1998
due to the sale of fixed maturities during a period of declining interest rates.
Policyholders' benefits decreased $5.8 million for the year ended December 31,
1998 to $193.7 million from $199.5 million for the year ended December 31, 1997
due to less surrenders from extended term insurance.
Interest credited to policyholders' account balances increased by $8.1 million
for the year ended December 31, 1998 to $118.9 million from $110.8 million for
the year ended December 31, 1997. Accounting for more than half of this increase
was the introduction of a new non-participating GIC product, PACE, early in
1998. The remaining increase was attributable to the rise in policyholder
account balances as well as increased interest credited pertaining to Separate
Account policy loans, partially offset by declining interest crediting rates for
interest-sensitive life contracts.
General, administrative and other expenses increased by $3.7 million for the
year ended December 31, 1998 to $231.3 million from $227.6 million for the year
ended December 31, 1997. Increased sales activity resulted in a corresponding
increase in expenses. In addition to the increased sales volume, Prudential's
allocation methodology for expenses billed to Pruco Life changed late in 1998,
resulting in increased expenses allocated to the Company. Offsetting this
increase was a 1997 refinement of estimated gross profit margins which led to an
overall decrease in DAC amortization relative to 1997.
7
Changes in Financial Position
1999 versus 1998
Total assets increased from $16.8 billion at December 31, 1998 to $21.8 billion
at December 31, 1999, an increase of $5.0 billion, of which $4.5 billion
represents growth in Separate Account assets. Contributions to Separate Accounts
were $3.5 billion in 1999, withdrawals and expense disbursements were $1.1
billion and net investment income (including realized and unrealized gains) was
$2.1 billion. The majority of the Separate Account increase came from the
Discovery Select annuity product which increased by $3.7 billion due to net
sales and appreciation, including $1.2 billion in exchange sales. Other
increases in 1999 are mainly from growth in investments of $235.0 million and
DAC of $201.0 million. For discussion of Investments see "Investment Portfolio
and Investment Strategies" which follows.
Total liabilities increased from $15.1 billion at December 31, 1998 to $20.1
billion at December 31, 1999, an increase of $5.0 billion. The increase was
primarily due to higher Separate Account liabilities of $4.5 billion in 1999,
increases to policyholder account balances of $414 million and increases to
future policy reserves of $107 million. The increase of $414 million in
policyholders' account balances from $2.7 billion at December 31, 1998 to $3.1
billion at December 31, 1999 was primarily due to the PACE product which
increased by $353.0 million in 1999. Annuity General Account balances increased
by $70.0 million in 1999, mainly due to exchanges and sales of the Discovery
Select product.
Future policy benefits increased by $107.2 million from $528.8 million at
December 31, 1998 to $636.0 million at December 31, 1999. The increase was
primarily the result of increased sales and in-force business at the Taiwan
branch.
Investment Portfolio and Investment Strategies
The Company's investment portfolio supports its insurance and annuity
liabilities and other obligations to customers for which it assumes investment
related risks. The portfolio was comprised of total investments amounting to
$4.5 billion at December 31, 1999, versus $4.2 billion at December 31, 1998. A
diversified portfolio of publicly traded bonds, private placements, commercial
mortgages and equity investments is managed under strategies intended to
maintain optimal asset mix consistent with current and anticipated cash flow
requirements of the related obligations. The risk tolerance reflects the
Company's aggregate capital position, exposure to business risk, liquidity and
rating agency considerations.
The asset management strategy for the portfolio is in accordance with an
investment policy statement developed and coordinated within the Company by the
Portfolio Management Group, agreed to by senior management, and approved by the
Company's Board of Directors. In managing the investment portfolio, the long
term objective is to generate favorable investment results through
asset-liability management, strategic and tactical asset allocation and asset
manager selection. Asset mix strategies are constrained by the need to match
asset structure to product liabilities, considering the underlying income and
return characteristics of investment alternatives and seeking to closely
approximate the interest rate sensitivity of the asset portfolio with the
estimated interest rate sensitivity of the product liabilities. Asset mix
strategies also include maintenance of broad diversification across asset
classes, issuers and sectors; effective utilization of capital while maintaining
liquidity believed to be adequate to satisfy cash flow requirements; and
achievement of competitive performance. The major categories of invested assets,
quality across the portfolio, and recent activities to manage the portfolio are
discussed below.
Fixed Maturities
The fixed maturity portfolio is diversified across maturities, sectors and
issuers. The Company has classified all publicly traded securities as "available
for sale" or "AFS". As of December 31, 1999 and 1998, approximately 72% and 63%
respectively, of privately traded securities, were classified as AFS. The
remainder of the privately placed fixed maturities were classified as "held to
maturity" or "HTM". "Available for sale" securities are carried in the
Consolidated Statements of Financial Position at fair value, with unrealized
gains and losses (after certain related adjustments) recognized by credits or
charges to "Accumulated Other Comprehensive Income", a component of equity
capital. Securities "held to maturity" are carried at amortized cost, and
unrealized gains or losses on these securities are not recognized in the
financial statements. At December 31, 1999 the fixed maturities portfolio
totaled $3.4 billion (AFS fair value of $3.0 billion and HTM amortized cost of
$0.4 billion), an increase of $0.2 billion compared to December 31, 1998. This
increase in fixed maturities was due primarily to cash inflows from the PACE
products of $0.3 billion, offset in part by net unrealized losses due to rising
interest rates.
8
1999 1998
---------------------------------------------- ------------------------------------------
Net Net
Amortized Cost Estimated Unrealized Amortized Estimated Unrealized
Fair Value (Losses) Cost Fair Value Gains
-------------- --------------- --------------- -------------- ------------- -------------
(In Thousands)
Fixed maturities
Publicly traded $2,070,500 $2,004,636 $(65,864) $2,040,592 $2,054,807 $14,215
Privately placed 1,402,547 1,371,548 (30,999) 1,108,620 1,130,964 22,344
-------------- --------------- --------------- -------------- ------------- -------------
Total $3,473,047 $3,376,184 $(96,863) $3,149,212 $3,185,771 $36,559
============== =============== =============== ============== ============= =============
At December 31, 1999, net unrealized losses on the "available for sale" fixed
maturity portfolio totaled $85.7 million compared with net unrealized gains of
$25.3 million at December 31, 1998. The change in the net unrealized gain
position reflects the impact of rising interest rates..
Based on fair value, the Company's holdings of private placement fixed
maturities constituted 41% and 35% of total fixed maturities at December 31,
1999 and 1998, respectively. These investments generally offer higher yields
than comparable quality public market securities, increase the diversification
of the portfolio, and contain tighter covenant protection than public
securities.
Gross investment income from fixed maturities increased by $12.2 million to
$217.5 million in 1999 as a result of a higher average asset base from the
investment of positive cashflows from the PACE products in 1999. Realized losses
were $29.1 million in 1999 compared with realized gains of $29.8 million in
1998. This decrease was attributed to net sales activity during a rising
interest rate environment for most of 1999, as opposed to 1998 when rates were
falling. In addition, writedowns for impairments of fixed maturities which were
deemed to be other than temporary increased by $8.4 million from 1998.
Credit Quality
The following table describes the credit quality of the fixed maturity
portfolio, based on ratings assigned by the National Association of Insurance
Commissioners ("NAIC") or Standard & Poor's Corporation, an independent rating
agency as of December 31, 1999:
December 31, 1999 December 31, 1998
------------------------------------------- ---------------------------------------------
Standard & Amortized Estimated Amortized Estimated
NAIC Poor's Cost % Fair Value % Cost % Fair Value %
- ------------------------ --------------------- --------------------- --------------------- -----------------------
(In Thousands)
1 AAA to AAA- $1,369,346 39.4% $1,342,146 39.8% $1,375,368 43.7% $1,398,678 43.9%
2 BBB+ to BBB- 1,847,502 53.2% 1,787,102 52.9% 1,436,820 45.6% 1,449,072 45.5%
3 BB+ to BB- 159,896 4.6% 150,994 4.5% 240,380 7.6% 244,933 7.7%
4 B+ to B- 75,843 2.2% 75,239 2.2% 68,621 2.2% 66,762 2.1%
5 CCC or lower 7,718 0.2% 8,061 0.2% 27,553 0.9% 26,062 0.8%
6 In or near
default 12,742 0.4% 12,642 0.4% 470 0.0% 264 0.0%
------------- ------------- ------------- --------------
Total $3,473,047 100.0% $3,376,184 100.0% $3,149,212 100.0% $3,185,771 100.0%
============= ============= ============= ==============
The fixed maturity portfolio consists largely of investment grade assets (rated
"1" or "2" by the NAIC), with such investments accounting for 93% and 89% of the
portfolio at December 31, 1999 and 1998, respectively, based on fair value. As
of both of those dates, less than 1% of the fixed maturities portfolio, based on
fair value, was rated "6" by the NAIC, defined as public and private placement
securities which are currently non-performing or believed subject to default in
the near-term.
9
The Company maintains separate monitoring processes for public and private fixed
maturities and creates watch lists to highlight securities which require special
scrutiny and management. The Company's fixed maturity asset managers formally
review all public fixed maturity holdings on a monthly basis and more frequently
when necessary to identify potential credit deterioration whether due to ratings
downgrades, unexpected price variances, and/or industry specific concerns. The
Company classifies public fixed maturity securities of issuers that have
defaulted as loans not in good standing and all other public watch list assets
as closely monitored.
Our private fixed maturity asset managers conduct specific servicing tests on
each investment on a quarterly basis to determine whether the investment is in
compliance or should be placed on the watch list or assigned an early warning
classification. The Company assigns early warning classification to those
issuers that have failed a servicing test or experienced a minor covenant
default, and the Company continues to monitor them for improvement or
deterioration. The Company assigns closely monitored status to those investments
that have been recently restructured or for which restructuring is a possibility
due to substantial credit deterioration or material covenant defaults. The
Company classifies as not in good standing securities of issuers that are in
more severe condition, for example, bankruptcy or payment default.
December 31, 1999 December 31, 1998
--------------------------------- ---------------------------------
Amortized Amortized
Cost % of Total Cost % of Total
--------------- ------------ --------------- --------------
(In Thousands)
Performing $3,428,880 98.8% $3,124,315 99.2%
Watch List
Closely monitored 31,425 0.9% 24,427 0.8%
Not in good standing 12,742 0.3% 470 0.0%
--------------- ---------------
Total $3,473,047 $3,149,212
=============== ===============
Writedowns for impairments of fixed maturities which were deemed to be other
than temporary were $11.2 million, $2.8 million and $0.1 million for the years
1999, 1998 and 1997, respectively.
Portfolio Diversity
The fixed maturity portfolio is broadly diversified by type and industry of
issuer. The greatest industry concentrations within the public portfolio were
finance, utilities, and manufacturing. The greatest concentrations within the
private portfolio were asset backed securities, manufacturing and service
issues. The portfolio is summarized below by issuer category:
December 31, 1999
-----------------------------------------------
Amortized Estimated % of
Cost Fair Value Fair Value
--------------- ----------------- -------------
(In Thousands)
United States government
securities and obligations $ 113,172 $ 111,122 3.3%
Mortgage backed securities 1,558 1,712 0.1%
Asset backed securities (1) 464,097 453,441 13.4%
Foreign government securities 92,725 92,988 2.8%
Manufacturing 706,866 675,731 20.0%
Utilities 489,207 471,534 14.0%
Retail and wholesale 244,723 238,438 7.1%
Energy 31,392 30,837 0.9%
Finance 635,268 625,321 18.5%
Services 518,040 504,350 14.9%
Transportation 166,108 160,586 4.7%
Other 9,891 10,124 0.3%
---------------- --------------- -------------
Total $3,473,047 $3,376,184 100.0%
================ =============== =============
10
December 31, 1998
-----------------------------------------------
Amortized Estimated % of
Cost Fair Value Fair Value
--------------- ----------------- -------------
(In Thousands)
United States government
securities and obligations $ 110,294 $ 110,839 3.5%
Mortgage backed securities 750 906 0.1%
Asset backed securities (1) 428.321 431,182 13.5%
Foreign government securities 87,112 88,419 2.8%
Manufacturing 585,680 589,775 18.5%
Utilities 454,279 463,140 14.5%
Retail and wholesale 166,980 168,837 5.3%
Energy 6,429 6,649 0.2%
Finance 556,850 561,751 17.6%
Services 584,496 594,240 18.7%
Transportation 148,999 151,091 4.8%
Other 19,022 18,942 0.5%
---------------- --------------- -------------
Total $ 3,149,212 $ 3,185,771 100.0%
================ =============== =============
(1) Asset backed securities are primarily backed by credit card receivables,
home equity loans, trade receivables and auto loans.
Mortgage Loans on Real Estate
As of December 31, 1999, the Company's mortgage loan portfolio totaled $10.5
million, a reduction of $6.8 million from December 31, 1998, reflecting
maturities and prepayments. The portfolio is comprised of commercial mortgage
loans, with diversification by property type and geographic location. Refer to
Footnote 3 in the Notes to Consolidated Financial Statements. In 1999,
investment income increased by $1.0 million versus 1998 mainly due to increased
mortgage loan prepayment income in anticipation of increasing interest rates.
The Company monitors the mortgage loan portfolio quarterly and through that
process identifies which loans require additional monitoring. Loans with
estimated collateral values less than the outstanding loan balances and loans
demonstrating characteristics indicative of higher than normal credit risks are
reviewed by management. The underlying collateral values are based upon
discounted property cash flow projections or external appraisals.
Equity Securities
The Company's equity securities are comprised of common stocks and are carried
at estimated fair value on the Statements of Financial Position. Based on fair
value, equity securities totaled $4.5 million in 1999 compared to $2.8 million
in 1998. The equity securities portfolio experienced no significant changes in
income or realized gains in 1999.
Short-Term Investments
Short-term investments include highly liquid debt instruments such as commercial
paper which are purchased with an original maturity of twelve months or less.
These securities are carried at amortized cost, which approximates fair value.
As of December 31, 1999, the Company's short-term investments totaled $207.2
million, a decrease of $33.5 million compared to $240.7 million at December 31,
1998. The decrease in short-term investments was primarily due to decreased
securities financing activity. Net investment income was $19.2 million for 1999
and $23.1 million for 1998. The reduction reflects a decrease in the average
asset base.
11
Other Significant Items
Derivatives
The Company uses derivatives primarily to alter mismatches between the duration
of assets in its portfolios and the duration of insurance and annuity
liabilities supported by those assets. During 1999, $1.6 million of losses were
realized from derivatives versus gains of $12.4 million in 1998. The Company was
net long in interest rate futures during both years. However, interest rates
were generally rising in 1999 versus declining in 1998.
2. Liquidity and Capital Resources
The Company's liquidity requirements include the payment of sales commissions,
other underwriting expenses and the funding of its contractual obligations for
the life insurance and annuity contracts in-force. The Company has developed and
utilizes a cash flow projection system and regularly performs asset/liability
duration matching in the management of its asset and liability portfolios. The
Company anticipates funding all its cash requirements utilizing cash from
operations, normal investment maturities and anticipated calls and repayments or
through short term borrowing from its affiliate Prudential Funding Corporation
(refer to Footnote 14 in the Notes to Consolidated Financial Statements). As of
December 31, 1999, the Company's assets included $2.1 billion of cash,
short-term investments and investment grade publicly traded fixed maturity
securities that could be liquidated if funds were required.
In order to continue to market life insurance and annuity products, the Company
must meet or exceed the statutory capital and surplus requirements of the
insurance departments of the states in which it conducts business. Statutory
accounting practices differ from generally accepted accounting principles
("GAAP") in two major respects. First, under statutory accounting practices, the
acquisition costs of new business are charged to expense, while under GAAP they
are initially deferred and amortized over a period of time. Second, under
statutory accounting practices, the required additions to statutory reserves for
new business in some cases may initially exceed the statutory revenues
attributable to such business. These practices result in a reduction of
statutory income and surplus at the time of recording new business.
Insurance companies are subject to Risk-Based Capital ("RBC") guidelines,
monitored by insurance regulatory authorities, that measure the ratio of the
Company's statutory surplus with certain adjustments ("Adjusted Capital") to its
required capital, based on the risk characteristics of its insurance liabilities
and investments. Required capital is determined by statutory formulae that
consider risks related to the type and quality of invested assets,
insurance-related risks associated with the Company's products, interest rate
risks, and general business risks. The RBC calculations are intended to assist
regulators in measuring the adequacy of the Company's statutory capitalization.
The Company considers RBC implications in its asset/liability management
strategies. Each year, the Company conducts a thorough review of the adequacy of
statutory insurance reserves and other actuarial liabilities. The review is
performed to ensure that the Company's statutory reserves are computed in
accordance with accepted actuarial standards, reflect all contractual
obligations, meet the requirements of state laws and regulations and include
adequate provisions for any other actuarial liabilities that need to be
established. All significant reserve changes are reviewed by the Board of
Directors and are subject to approval by the Arizona Department of Insurance and
the New Jersey Department of Banking and Insurance (the "Insurance
Departments"). The Company believes that its statutory capital is adequate for
its currently anticipated levels of risk as measured by regulatory guidelines.
The NAIC has approved a series of codified statutory accounting standards which
will replace the current Accounting Practices and Procedures Manual as the
NAIC's primary guidance on statutory accounting. Certain of the standards could
have an impact on the measurement of statutory capital which, in turn, could
affect RBC ratios of insurance companies. The Insurance Departments have issued
notices requiring adoption of the new Accounting Practices and Procedures Manual
for financial filings with an "as of" date on and after January 1, 2001. The
Company has not estimated the potential effect of the Codification guidance, but
does not believe it will have an adverse impact on the Company's surplus
position.
12
3. Regulatory Environment
The Company is subject to the laws of the Insurance Departments. A detailed
financial statement in the prescribed form (the "Annual Statement") is filed
with the Insurance Departments each year covering the Company's operations for
the preceding year and its financial position as of the end of that year.
Regulation by the Insurance Departments includes periodic examinations to verify
the accuracy of contract liabilities and reserves. The Company's books and
accounts are subject to review by the Insurance Departments at all times. A full
examination of the Company's operations is conducted periodically by the
Insurance Departments and under the auspices of the NAIC.
The Company is subject to regulation under the insurance laws of all
jurisdictions in which it operates. The laws of the various jurisdictions
establish supervisory agencies with broad administrative powers with respect to
various matters, including licensing to transact business, overseeing trade
practices, licensing agents, approving contract forms, establishing reserve
requirements, fixing maximum interest rates on life insurance contract loans and
minimum rates for accumulation of surrender values, prescribing the form and
content of required financial statements and regulating the type and amounts of
investments permitted. The Company is required to file the Annual Statement with
supervisory agencies in each of the jurisdictions in which it does business, and
its operations and accounts are subject to examination by these agencies at
regular intervals.
The NAIC has adopted several regulatory initiatives designed to improve the
surveillance and financial analysis regarding the solvency of insurance
companies in general. These initiatives include the development and
implementation of a risk-based capital formula as described in the Liquidity and
Capital Resources disclosure. The implementation of these standards has not had
a significant impact on the Company.
Although the federal government generally does not directly regulate the
business of insurance, federal initiatives often have an impact on the business
in a variety of ways. Certain insurance products of the Company are subject to
various federal securities laws and regulations. In addition, current and
proposed federal measures which may significantly affect the insurance business
include regulation of insurance company solvency, employee benefit regulation,
removal of barriers preventing banks from engaging in the insurance business,
tax law changes affecting the taxation of insurance companies and the tax
treatment of insurance products and its impact on the relative desirability of
various personal investment vehicles.
4. The Year 2000 Issue
The Company utilizes many of the same business applications, infrastructure and
business partners as Prudential. Prudential addressed the Year 2000 issue on an
enterprise-wide basis. Therefore, it is not possible to differentiate the
Company's Year 2000 issue from that of Prudential. The accompanying discussion
of the Year 2000 issue and its outcome reflects steps taken by Prudential to
mitigate the Year 2000 risks.
The Year 2000 issue is best understood as a computer hardware and software
problem in which computer systems that have date-sensitive programming may
recognize a date using "00" as the year 1900 instead of the year 2000.
Prudential's total cost to address the Year 2000 issue was $225 million, with
$13 million spent in 1996, $64 million in 1997, $104 million in 1998 and $44
million in 1999. These amounts do not include Prudential's share of Year 2000
costs incurred by partnerships or joint ventures in which Prudential
participates but does not have a controlling financial interest. These amounts
also exclude costs for replacement systems that Prudential implemented or
accelerated solely due to potential Year 2000 failures because they were
immaterial. Prudential funded the cost of its Year 2000 program from operations.
During the course of its Year 2000 program, Prudential delayed some
discretionary computer projects to focus on completion of the Year 2000
projects. These delays did not have a material impact on Prudential's or the
Company's financial condition or operations.
To date, neither Prudential nor the Company have experienced material Year 2000
related problems in any of their operations. Prudential believes that it has
mitigated the Year 2000 risk, however Prudential cannot guarantee that it will
not experience a Year 2000 failure that has thus far been undetected. In the
worst case, it is possible that an as yet unknown Year 2000 failure, whether
internal or external, could have a material impact on Prudential or Pruco Life's
results of operations, liquidity or financial condition. Where necessary, we
have enhanced our general business continuation contingency plans to ensure that
they would be effective in responding to a Year 2000 failure. Substantially all
of these plans, as they related to Year 2000 issues, include the ultimate
resolution of any technology failure that we may encounter.
13
5. Effective New Accounting Pronouncements
Refer to Footnote 2, "Summary of Significant Accounting Policies," of the Notes
to Consolidated Financial Statements.
6. Information Concerning Forward-Looking Statements
Some of the statements contained in Management's Discussion and Analysis,
including those words such as "believes", "expects", "intends", "estimates",
"assumes", "anticipates" and "seeks", are forward-looking statements. These
forward-looking statements involve risk and uncertainties. Actual results may
differ materially from those suggested by the forward-looking statements for
various reasons. In particular, statements contained in Management's Discussion
and Analysis regarding the Company's business strategies involve risks and
uncertainties, and we can provide no assurance that we will be able to execute
our strategies effectively or achieve our financial and other objectives.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Risk Management, Market Risk, and Derivative Financial Instruments
As an wholly-owned subsidiary of Prudential, the Company benefits from the risk
management strategies implemented by its parent.
Risk management includes the identification and measurement of various forms of
risk, establishment of acceptable risk thresholds, and creation of processes
intended to maintain risks within these thresholds while optimizing returns on
the underlying assets or liabilities. Prudential considers risk management an
integral part of its core businesses.
The risks inherent in the Company's operations include market risk, product
risk, credit risk, and operating risk.
Market risk is the risk of change in the value of financial instruments as a
result of absolute or relative changes in interest rates, foreign currency
exchange rates or equity or commodity prices. To varying degrees, the investment
activities supporting all of the Company's products and services generate market
risks. Market risks incurred and the strategies for managing these risks vary by
product.
With respect to non-variable life insurance products, fixed rate annuities and
the fixed rate options in our variable life insurance and annuity products, the
Company incurs market risk primarily in the form of interest rate risk. The
Company manages this risk through asset/liability management strategies that
seek to match the interest rate sensitivity of the assets to that of the
underlying liabilities. The Company's overall objective in these strategies is
to limit the net change in value of assets and liabilities arising from interest
rate movements. While it is more difficult to measure the interest sensitivity
of the Company's insurance liabilities than that of the related assets, to the
extent the Company can measure such sensitivities the Company believes that
interest rate movements will generate asset value changes that substantially
offset changes in the value of the liabilities relating to the underlying
products.
For variable annuities and variable life insurance products, excluding the fixed
rate options in these products, the Company's main exposure is the risk that
asset management fees may decrease as a result of declines in assets under
management due to changes in prices of securities. The Company is also exposed
to the risk that asset management fees calculated by reference to performance
could be lower. For variable annuity and variable life insurance products with
minimum guaranteed death benefits, the Company also faces the indirect risk that
declines in the value of underlying investments as a result of changes in
securities prices may increase the Company's net exposure to death benefits
under these contracts. The Company does not believe that these indirect risks
add significantly to the Company's overall risk. The Company manages its
exposure to equity price risk primarily by seeking to match the risk profile of
equity investments against risk-adjusted equity market benchmarks. The Company
measures benchmark risks level in terms of price volatility in relation to the
market in general.
The Company's exposure to market risk results from "other than trading"
activities in its insurance businesses. Market risks in the Company's insurance
business are managed through an investment process that incorporates
asset/liability management techniques and other risk management policies and
limits. Derivatives, as discussed further below, are used for hedging purposes
in the asset/liability management process. These include sensitivity and
Value-at-Risk measures, positions and other limits based on type of risk, and
various hedging methods.
14
Insurance Asset/Liability Management
The Company seeks to maintain interest rate and equity exposures within
established ranges, which are periodically adjusted based on market conditions
and the design of related insurance products sold to customers. The Company's
risk managers, who work with portfolio and asset managers but under separate
management, establish investment risk limits for exposures to any issuer,
geographic region, type of security or industry sector and oversee efforts to
manage risk within policy constraints set by management and approved by the
Board of Directors.
The Company uses duration and convexity analyses to measure price sensitivity to
interest rate changes. Duration measures the relative sensitivity of the fair
value of a financial instrument to changes in interest rates. Convexity measures
the rate of change of duration with respect to changes in interest rate. The
Company seeks to manage its interest rate exposure by matching the relative
sensitivity of asset and liability values to interest rate changes, or
controlling "duration mismatch" of assets and liabilities. The Company has a
target duration mismatch level of plus or minus 0.5 years. As of December 31,
1999, the difference between the pre-tax duration of assets and the target
duration of liabilities in the Company's duration managed portfolio was less
than 0.1 years. The Company also considers risk-based capital implications in
its asset/liability management strategies.
The Company also performs portfolio stress testing as part of its regulatory
cash flow testing. In this testing, the Company evaluates the impact of altering
its interest-sensitive assumptions under various moderately adverse interest
rate environments. These interest-sensitive assumptions relate to the timing and
amounts of redemptions and pre-payments of fixed-income securities and lapses
and surrenders of insurance products. The Company evaluates any shortfalls that
this cash flow testing reveals to determine if there is a need to increase
statutory reserves or adjust portfolio management strategies.
Market Risk Related to Interest Rates
Assets that subject the Company to interest rate risk include fixed maturities,
mortgage loans on real estate, and policy loans. In the aggregate, the carrying
value of these assets represented 73% of consolidated assets, other than assets
that are held in Separate Accounts, as of December 31, 1999 and 74% as of
December 31, 1998. With respect to liabilities, the Company is exposed to
interest rate risk through policyholder account balances relating to
interest-sensitive life insurance and annuity and investment type contracts.
The Company assesses interest rate sensitivity for its financial assets,
financial liabilities and derivatives using hypothetical test scenarios which
assume both upward and downward 100 basis point parallel shifts in the yield
curve from prevailing interest rates. The following tables set forth the
potential loss in fair value from a hypothetical 100 basis point upward shift at
December 31, 1999 and 1998, because this scenario results in the greatest net
exposure to interest rate risk of the hypothetical scenarios tested at those
dates. While the test scenario is for illustrative purposes only and does not
reflect management's expectations regarding future interest rates or the
performance of fixed income markets, it is a near-term, reasonably possible
hypothetical change that illustrates the potential impact of such events. These
test scenarios do not measure the changes in value that could result from
non-parallel shifts in the yield curve, which would be expected to produce
different changes in discount rates for different maturities. As a result, the
actual loss in fair value from a 100 basis point change in interest rates could
be different from that indicated by these calculations.
15
This presentation does not include $2.469 billion and $2.393 billion of
insurance reserves and deposit liabilities at December 31, 1999 and 1998,
respectively. The Company believes that the interest rate sensitivities of these
insurance liabilities offset, in large measure, the interest rate risk of the
financial assets set forth in the following tables.
December 31, 1999
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(derivatives) Value Shift Fair Value
---------------------------------------------------------------
Financial Assets and Liabilities (In millions)
with Interest Rate Risk:
Financial Assets:
Fixed maturities:
Available for sale - $ 2,998 $ 2,897 $ (101)
Held to maturity - 378 367 (11)
Mortgage loans on real estate - 12 12 -
Policy loans - 761 728 (33)
Derivatives
Futures 122 (2) (9) (7)
Financial liabilities
Investment contracts - (1,277) (1,262) 15
----------------
Total estimated potential loss $ (137)
================
December 31, 1998
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(derivatives) Value Shift Fair Value
---------------------------------------------------------------
Financial Assets and Liabilities (In millions)
with Interest Rate Risk:
Financial Assets:
Fixed maturities:
Available for sale - $ 2,764 $ 2,666 $ (98)
Held to maturity - 422 408 (14)
Mortgage loans on real estate - 19 19 -
Policy loans - 806 762 (44)
Derivatives
Futures 41 - (2) (2)
Financial liabilities
Investment contracts - (839) (832) 7
----------------
Total estimated potential loss $ (151)
================
The estimated changes in fair values of the financial assets shown above relate
to assets invested in support of the Company's insurance liabilities, but do not
include assets associated with products for which investment risk is borne
primarily by the contractholders rather than the Company.
16
Market Risk Related to Equity Prices
The Company actively manages equity price risk relative to benchmarks in
respective markets. Equity holdings are benchmarked against a blend of leading
market indices, mainly the Standard & Poor's ("S&P") 500 and Russell 2000, and
targets price sensitivities that approximate those of the benchmark indices. The
Company estimates its equity price risk from a hypothetical 10% decline in
equity benchmark market levels and measures this risk in terms of the decline in
the fair value of the equity securities it holds. Using this methodology, the
Company's estimated equity price risk at December 31, 1999 was $.4 million,
representing a hypothetical decline in fair market value of equity securities
held by the Company at that date from $4.5 million to $4.1 million. The
Company's estimated equity price risk using this methodology at December 31,
1998 was $.3 million, representing a hypothetical decline in fair market value
of equity securities the Company held at that date from $2.8 million to $2.5
million. These amounts exclude equity securities relating to products for which
investment risk is borne primarily by the contractholder rather than by the
Company. While these scenarios are for illustrative purposes only and do not
reflect management's expectations regarding future performance of equity markets
or of the Company's equity portfolio, they represent near term reasonably
possible hypothetical changes that illustrate the potential impact of such
events.
Market Risk Related to Foreign Currency Exchange Rates
The Company is exposed to foreign currency exchange risk in its investment
portfolio and through its operations in Taiwan. The Company generally hedges
substantially all foreign currency-denominated fixed-income investments
supporting its U.S. insurance operations into U.S. dollars, using foreign
exchange currency swaps, in order to mitigate the risk that the fair value of
these investments fluctuates as a result of changes in foreign exchange rates.
The Company generally does not hedge all of the foreign currency risk of its
equity investments in unaffiliated foreign entities.
Foreign currency exchange risk is actively managed within specified limits at
the enterprise (Prudential) level using Value-at-Risk ("VaR") analysis. This
statistical technique estimates, at a specified confidence level, the potential
pretax loss in portfolio market value that could occur over an assumed time
horizon due to adverse market movements. This calculation utilizes a
variance/covariance approach.
The Company calculates VaR estimates of exposure to loss from volatility in
foreign currency exchange for a one month time period. The Company's estimated
VaR at December 31, 1999 for foreign currency assets not hedged to U.S. dollars,
measured at the 95% confidence level and using a one month time horizon, was
$1.2 million, representing a hypothetical decline in fair market value of these
foreign currency assets from $36.1 million to $34.9 million. The Company's
estimated VaR at December 31, 1998 for foreign currency assets not hedged to
U.S. dollars, measured at the 95% confidence level and using a one month time
horizon, was $0.5 million, representing a hypothetical decline in fair market
value of these foreign currency assets from $32.0 million to $31.5 million.
These calculations use historical price volatilities and correlation data at a
95% confidence level.
The Company's average monthly VaR from foreign currency exchange rate movements
measured at the 95% confidence level over a one month time horizon was $1.5
million during 1999 and $1.6 million during 1998.
Limitations of VaR Models
Although VaR models represent a recognized tool for risk management, they have
inherent limitations, including reliance on historical data that may not be
indicative of future market conditions or trading patterns. Accordingly VaR
models should not be viewed as a predictor of future results. The Company may
incur losses that could be materially in excess of the amounts indicated by the
model on a particular trading day or over a period of time. A VaR model does not
estimate the greatest possible loss. The Company uses these models together with
other risk management tools, including stress testing. The results of these
models and analysis thereof are subject to the judgment of the Company's risk
management personnel.
17
Derivatives
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, various financial indices, or the value of
securities or commodities. Derivative financial instruments can be
exchange-traded or contracted in the over-the-counter market and include swaps,
futures, options and forwards contracts. See Footnote 11 of the Notes to
Consolidated Financial Statements as to the Company's derivative positions at
December 31, 1999 and 1998. Under insurance statutes the Company may only use
derivative securities in hedging activities intended to offset changes in the
market value of assets held, obligations, and anticipated transactions. These
statutes prohibit the use of derivatives for speculation. The Company uses
derivative financial instruments to seek to reduce market risk from changes in
interest rates or foreign currency exchange rates, and to alter interest rate or
currency exposures arising from mismatches between assets and liabilities.
Product Risk is the risk of adverse results due to deviation of experience from
expected levels reflected in pricing. Products are priced to reflect the
expected levels of benefits and expense while allowing a margin for adverse
deviation. The level of margin varies with product design and pricing strategy
with respect to the targeted market. The Company seeks to maintain underwriting
standards so that premium charged is consistent with risk assumed on an overall
basis. Additionally, most of the Company's policies and contracts allow the
Company to adjust credits (via interest crediting rates) and/or charges (in
contracts where elements such as mortality and expense charges are not
guaranteed), allowing the Company some flexibility to respond to changes in
actuarial experience. The Company also considers the competitive environment in
determining pricing elements including premiums, crediting rates, and
non-guaranteed charges.
Mortality risks, generally inherent in most of the Company's life insurance and
annuity products, are incorporated in pricing based on the Company's experience
(if available and relevant) and/or industry experience. Mortality studies are
performed periodically to compare the actual incidence of death claims in
relation to business in force, to levels assumed in pricing and to industry
experience. Expense risk is the risk that actual expenses exceed those assumed
in pricing, relates to all products and varies by volume of business as well as
general price level changes. Persistency risk represents the risk that the
pattern of policy surrenders will deviate from assumed levels so that policies
do not remain in force long enough to allow the Company to recover its
acquisition costs. Certain products are designed, by use of surrender charges
and other features, to discourage early surrenders and thus mitigate this risk
to the Company. Periodic studies are performed to compare actual surrender
experience to pricing assumptions and industry experience.
For fee-based products in which investment risk is borne by the client, the
Company retains the risk that fees charged may not adequately cover
administrative expenses. The ability to earn a spread between these fees and the
associated costs is dependent upon the competitive environment, product
performance, the ability to attract clients and assets, and the Company's
control of expense levels.
Credit Risk is the risk that counterparties or issuers may default or fail to
fully honor contractual obligations and is inherent in investment portfolio
asset positions including corporate bonds and mortgages, private placements and
other lending-type products, certain derivative transactions, and various
investment operations functions. In derivative transactions, the Company follows
an established credit approval process which includes risk control limits and
monitoring procedures. The Company is also exposed to credit risk resulting from
reinsurance transactions.
Limits of exposure by counterparty, country and industry are in place at the
portfolio level, and counterparty concentration risk is also reviewed at the
enterprise level. Credit concentration risks are limited based on credit
quality, and enterprise-level concentrations are reviewed on a quarterly basis.
Business group credit analysis units evaluate creditworthiness of counterparties
and assign internal credit ratings based on data from independent rating
agencies and their own fundamental analysis. Additionally, stress tests and
sensitivity analysis are utilized to estimate the exposure to credit losses from
unusual events.
Operating Risk is the risk of potential loss from internal or external events
such as mismanagement, fraud, systems breakdowns, business interruption, or
failure to satisfy legal or fiduciary responsibilities. Like other financial
institutions, the Company is exposed to the risk of misconduct by employees that
are contrary to the internal controls the Company designed to manage those
risks. Legal risk may arise from inadequate control over contract documentation,
marketing processes, or other operations. The Company is subject to internal
controls established by Prudential to manage regulatory, legal, credit, asset
management and other risks at the business unit level for specific lines of
business and at the enterprise level for company-wide processes. Business unit
management personnel, internal auditors and an enterprise level Management
Internal Control unit monitor the Company's controls. The Company's controls are
subject to regulatory review in certain instances.
18
Another aspect of operating risk relates to the Company's ability to conduct
transactions electronically and to gather, process, and disseminate information
and maintain data integrity and uninterrupted operations given the possibility
of unexpected or unusual events. The Company has implemented a business
continuation initiative to address these concerns. The potential impact of the
Year 2000 on computer operations, infrastructural support, and other matters is
discussed above.
Item 8. Financial Statements and Supplementary Data
Information required with respect to this Item 8 regarding Financial Statements
and Supplementary Data is set forth commencing on page F-3 hereof. See Index to
Financial Statements and Financial Statement Schedules elsewhere in this Annual
Report.
Item 9. Changes in and Disagreements with Independent Accountants on Accounting
and Financial Disclosure
Not applicable.
19
PART III
Item 10. Directors and Executive Officers of the Registrant
Name Position Age
- ---- -------- ---
James J. Avery, Jr. Chairman of the Board and Director 48
I. Edward Price Vice Chairman of the Board and Director 57
Esther H. Milnes President and Director 49
James Drozanowski Senior Vice President 57
Hiroshi Nakajima Senior Vice President 56
Hwei-Chung Shao Senior Vice President and Chief Actuary 45
Dennis G. Sullivan Principal Financial Officer and Chief Accounting Officer 44
David A. Nachman Vice President and Comptroller 52
Clifford E. Kirsch Chief Legal Counsel and Secretary 40
William M. Bethke Director 52
Ira J. Kleinman Director 52
David R. Odenath, Jr. Director 43
Kiyofumi Sakaguchi Director 57
- --------------------------------------------------------------------------------------------------------------
James J. Avery, Jr., age 48 was elected Chairman of the Board of Directors of
the Company on June 27, 1997. Mr. Avery joined the Prudential Insurance Company
of America in 1988 and has served as President, Prudential Individual Life
Insurance since 1998. From 1997 to 1998 he was Senior Vice President, CFO and
Chief Actuary for the Prudential Individual Insurance Group. From 1995 to 1997
he was President, Prudential Select.
I. Edward Price, age 57, has been Senior Vice President and Actuary of
Prudential Individual Life Insurance since 1998. From 1995 to 1998 he was Senior
Vice President and Actuary, Prudential Individual Insurance Group. From 1994 to
1995, he was Chief Executive Officer of Prudential International Insurance. From
1993 to 1994 he was President, Prudential International Insurance. Prior to
1993, he was Senior Vice President and Company Actuary of Prudential.
Esther H. Milnes, age 49, has been Vice President and Chief Actuary, Prudential
Individual Life Insurance since 1999. From 1996 to 1999 she was Vice President
and Actuary of Prudential Individual Insurance Group. From 1993 to 1996, she was
Senior Vice President and Chief Actuary of Prudential Insurance and Financial
Services. Prior to 1993, she was Vice President and Associate Actuary of
Prudential.
James C. Drozanowski, age 57, has been Vice President, Operations and Systems,
Prudential Individual Financial Services since 1998. From 1996 to 1998 he was
Vice President and Operations Executive, Prudential Individual Insurance Group.
From 1995 to 1996, he was President and Chief Executive Officer of Chase
Manhattan Bank, and from 1993 to 1995, he was Vice President, North America
Customer Services, Chase Manhattan Bank. Prior to 1993, he was Operations
Executive, Global Securities Services, Chase Manhattan Bank.
Hiroshi Nakajima, age 56, has been President and Chief Executive Officer of
Pruco Life Insurance Company, Taiwan Branch, since November 1997.
Hwei-Chung Shao, age 45, has been Vice President and Associate Actuary,
Prudential since 1996. Prior to 1996, she was Vice President and Assistant
Actuary, Prudential Corporate Risk Management.
20
Dennis G. Sullivan, age 44, was elected Principal Financial Officer and Chief
Accounting Officer of the Company in March, 1999. Mr. Sullivan has been Vice
President and Deputy Controller of Prudential since November 1998. Prior
thereto, from January 1998, Mr. Sullivan was Vice President and Controller of
ContiFinancial Corporation. From 1997 to 1998, Mr. Sullivan was Deputy Corporate
Controller of Salomon Brothers Inc. Prior to 1997, he was a director at Salomon
Brothers Inc.
David A. Nachman, age 52, was elected Vice President and Comptroller of the
Company in March, 1999. Mr. Nachman joined the Prudential Insurance Company of
America in 1973 and has served as Vice President, Accounting, Prudential since
1992.
Clifford E. Kirsch, age 40, has been Chief Legal Counsel and Secretary of the
Company since 1995. Mr. Kirsch joined Prudential Insurance Company of America in
1995 as Chief Counsel, Variable Products. From 1994 to 1995 he was Associate
General Counsel of Paine Webber, Inc. Prior to 1994 he was an Assistant Director
at the United States Securities and Exchange Commission.
William M. Bethke, age 52, has been Chief Investment Officer, Prudential since
1997. Prior to 1997 he was President, Prudential Capital Markets Group.
Ira J. Kleinman, age 52, has been Executive Vice President, Prudential
International Insurance Group since 1997. From 1995 to 1997 he was Chief
Marketing and Product Development Officer of Prudential Individual Insurance
Group. From 1993 to 1995, he was President of Prudential Select. From 1992 to
1993, he was Senior Vice President of Prudential. Prior to 1992, he was Vice
President of Prudential.
David R. Odenath, Jr., age 43, has been President of Prudential Investments
since 1999. Prior to joining Prudential in 1999, Mr. Odenath was Senior Vice
President and Director of Sales for the Investment Consulting Group at
PaineWebber.
Kiyofumi Sakaguchi, age 57, has been Executive Vice President, International
Insurance since 1998. From 1995 to 1998 he was President, Prudential
International Insurance Group. From 1994 to 1995 he was Chairman and Chief
Executive Officer, the Prudential Life Insurance Co., Ltd., Japan. Prior to 1994
he was President and Chief Executive Officer, Asia Pacific Region-Prudential
International Insurance, and President, the Prudential Life Insurance Co., Ltd.
Item 11. Executive Compensation
The following table shows the 1999 annual compensation, paid by Prudential, and
allocated based on time devoted to the duties as an executive of the Company for
services provided to the Company:
Name and Principal Other Annual
Position Year Salary Bonus Compensation
- ---------------------------- ------------------- ----------------- ----------------- -----------------
Esther H. Milnes 1999 $20,782 $23.238 $0
President 1998 20,769 26,313 0
1997 18,660 21,398 0
Item 12. Security Ownership of Certain Beneficial Owners and Management
Not applicable.
Item 13. Certain Relationships and Related Transactions
Refer to Footnote 14 in the Notes to the Consolidated Financial Statements.
21
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (2) Financial Statements and Schedules of Registrant and
its subsidiaries are listed in the accompanying "Index to Consolidated
Financial Statements and Financial Statement Schedules" on page F-1
hereof and are filed as part of this Report.
(a) (3) Exhibits
Regulation S-K
2. Not applicable.
3. Documents Incorporated by Reference
(i) The Articles of Incorporation of Pruco Life Insurance
Company, as amended October 19, 1993, are incorporated herein
by reference to Form S-6, Registration No. 333-07451, filed
July 2, 1996 on behalf of the Pruco Life Variable Appreciable
Account; (ii) Bylaws of Pruco Life, as amended May 6, 1997 are
incorporated herein by reference to Form 10-Q, Registration
No. 33-37587, filed August 15, 1997 on behalf of Pruco Life
Insurance Company.
4. Exhibits
Modified Guaranteed Annuity Contract, incorporated by
reference to Registrant's Form S-1 Registration Statement,
Registration No. 33-37587, filed November 2, 1990, on behalf
of Pruco Life Insurance Company.
Market-Value Adjustment Annuity Contract, incorporated by
reference to Registrant's Form S-1 Registration Statement,
Registration No. 33-61143, filed November 17, 1995, on behalf
of Pruco Life Insurance Company.
9. None.
10. None.
11. Not applicable.
12. Not applicable.
13. Not applicable.
16. Not applicable.
18. None.
21. Pruco Life Insurance Company of New Jersey, a stock life
insurance company organized under the laws of the state of New
Jersey, is a wholly owned subsidiary of Pruco Life Insurance
Company. It is licensed to sell life insurance and annuities
only in the States of New Jersey and New York.
The Prudential Life Insurance Company of Arizona, a stock life
insurance company organized under the laws of the State of
Arizona, is a wholly owned subsidiary of Pruco Life Insurance
Company. It is licensed to sell life insurance and annuities
only in the State of Arizona.
22. None.
23. Not applicable.
22
24. Powers of Attorney for I. Edward Price, Esther H. Milnes,
William M. Bethke and Ira Kleinman are incorporated by
reference to Form 10-K, Registration No. 33-867880, filed
March 28, 1997, on behalf of Pruco Life Variable Contract Real
Property Account. A Power of Attorney for Kiyofumi Sakaguchi
is incorporated by reference to Post Effective Amendment No. 8
to Form S-6, Registration No. 33-49994, filed April 28, 1997
on behalf of the Pruco Life PRUvider Variable Appreciable
Account. A Power of Attorney for James J. Avery, Jr. is
incorporated by reference to Post-Effective Amendment No. 9 to
Form S-1, Registration No. 33-20018, filed June 25, 1997 on
behalf of the Pruco Life of New Jersey Variable Contract Real
Property Account.
27. Exhibit 27, Financial Data Schedule appended to this form in
accordance with EDGAR instructions.
99. The following table presents sales and related expenses of the
Flexible Premium Variable Annuity Account since July 19, 1995,
the effective date of the registration statement (SEC file
number 3331-61143).
For the
For the account account(s) of the
of the Company contractholder(s)
------------------------------- ------------------
Aggregate
offering
price of
amount
registered Amount sold Amount sold
--------------- --------------- ------------------
(in thousands)
Flexible Premium Variable Annuity Account * $ 500,000 $ 270,227 $ 29,062
Underwriting discounts and commissions ** (9,458)
Other expenses *** (13,435)
---------------
Total (22,893)
---------------
Net offering proceeds $ 247,334
===============
* Securities are not issued or sold in predetermined units.
** Amount represents estimated commissions paid to affiliated parties.
*** Amount represents estimated general administrative expenses paid to the parent under
service and lease agreement.
23
SIGNATURES
Pursuant to the requirements of Section 13, or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PRUCO LIFE INSURANCE COMPANY
(Registrant)
Date: March 21, 2000 By: ______________________________
-------------- Esther H. Milnes
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
*
______________________________ Chairman of the Board March 21, 2000
James J. Avery, Jr.
*
______________________________ Vice Chairman of the Board March 21, 2000
I. Edward Price and Director
*
______________________________ President and Director March 21, 2000
Esther H. Milnes
______________________________ Principal Financial Officer and March 21, 2000
Dennis G. Sullivan Chief Accounting Officer
*
______________________________ Director March 21, 2000
William M. Bethke
*
______________________________ Director March 21, 2000
Ira J. Kleinman
*
______________________________ Director March 21, 2000
Kiyofumi Sakaguchi
* By: ___________________________
Thomas C. Castano
(Attorney-in-Fact)
24
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT
CONSOLIDATED FINANCIAL STATEMENTS
For the fiscal year ended December 31, 1999
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
25
PRUCO LIFE INSURANCE COMPANY
INDEX TO FINANCIAL STATEMENTS
Financial Statements Page No.
- -------------------- --------
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
Report of Independent Accountants F - 2
Consolidated Financial Statements:
Consolidated Statements of Financial Position
Years ended December 31, 1999 and 1998 F - 3
Consolidated Statements of Operations and Comprehensive Income
Years ended December 31, 1999, 1998 and 1997 F - 4
Consolidated Statements of Changes in Stockholder's Equity
Years ended December 31, 1999, 1998, and 1997 F - 5
Consolidated Statements of Cash Flows
Years ended December 31, 1999, 1998, and 1997 F - 6
Notes to the Consolidated Financial Statements
Years ended December 31, 1999, 1998, and 1997 F - 7
F-1
Report of Independent Accountants
---------------------------------
To the Board of Directors and Stockholder of
Pruco Life Insurance Company
In our opinion, the accompanying consolidated statements of financial
position and the related consolidated statements of operations, of changes in
stockholder's equity and of cash flows present fairly, in all material
respects, the financial position of Pruco Life Insurance Company (a
wholly-owned subsidiary of the Prudential Insurance Company of America) and
its subsidiaries at December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted
our audits of these statements in accordance with auditing standards
generally accepted in the United States which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
New York, New York
March 21, 2000
F-2
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Financial Position
December 31, 1999 and 1998 (In Thousands)
- ----------------------------------------------------------------------------------------------------------------
1999 1998
----------------- -----------------
ASSETS
Fixed maturities
Available for sale, at fair value (amortized cost, 1999: $3,084,057;
1998: $2,738,654) $2,998,362 $2,763,926
Held to maturity, at amortized cost (fair value, 1999: $377,822; 1998:
$421,845) 388,990 410,558
Equity securities - available for sale, at fair value (cost, 1999: $3,238;
1998: $2,951) 4,532 2,847
Mortgage loans on real estate 10,509 17,354
Policy loans 792,352 766,917
Short-term investments 207,219 240,727
Other long-term investments 77,769 42,050
----------------- -----------------
Total investments 4,479,733 4,244,379
Cash 76,396 89,679
Deferred policy acquisition costs 1,062,785 861,713
Accrued investment income 68,917 61,114
Receivables from affiliate 23,329 -
Other assets 48,228 65,145
Separate Account assets 16,032,449 11,490,751
----------------- -----------------
TOTAL ASSETS $21,791,837 $16,812,781
================= =================
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $3,116,261 $2,702,011
Future policy benefits and other policyholder liabilities 635,978 528,779
Cash collateral for loaned securities 87,336 73,336
Securities sold under agreement to repurchase 21,151 49,708
Income taxes payable 145,600 193,358
Payables to affiliate - 66,568
Other liabilities 83,243 55,038
Separate Account liabilities 16,032,449 11,490,751
----------------- -----------------
Total liabilities 20,122,018 15,159,549
----------------- -----------------
Contingencies (See Footnote 12)
Stockholder's Equity
Common stock, $10 par value;
1,000,000 shares, authorized;
250,000 shares, issued and outstanding 2,500 2,500
Paid-in-capital 439,582 439,582
Retained earnings 1,258,428 1,202,833
Accumulated other comprehensive (loss) income
Net unrealized investment (losses) gains (28,364) 9,902
Foreign currency translation adjustments (2,327) (1,585)
----------------- -----------------
Accumulated other comprehensive (loss) income (30,691) 8,317
----------------- -----------------
Total stockholder's equity 1,669,819 1,653,232
----------------- -----------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 21,791,837 $16,812,781
================= =================
See Notes to Consolidated Financial Statements
F-3
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
Years Ended December 31, 1999, 1998 and 1997 (In Thousands)
- -------------------------------------------------------------------------------------------------------------------
1999 1998 1997
-------------- --------------- ---------------
REVENUES
Premiums $ 98,976 $ 82,139 $ 69,614
Policy charges and fee income 414,425 350,569 332,132
Net investment income 276,821 261,430 259,634
Realized investment (losses) gains, net (32,545) 44,841 10,974
Asset management fees 60,392 40,200 33,310
Other income 1,397 1,067 491
-------------- --------------- ---------------
Total revenues 819,466 780,246 706,155
-------------- --------------- ---------------
BENEFITS AND EXPENSES
Policyholders' benefits 205,042 193,739 199,537
Interest credited to policyholders' account balances 136,852 118,992 110,815
General, administrative and other expenses 392,041 231,320 227,561
-------------- --------------- ---------------
Total benefits and expenses 733,935 544,051 537,913
-------------- --------------- ---------------
Income from operations before income taxes 85,531 236,195 168,242
-------------- --------------- ---------------
Income tax provision 29,936 84,233 61,868
-------------- --------------- ---------------
NET INCOME 55,595 151,962 106,374
-------------- --------------- ---------------
Other comprehensive (loss) income, net of tax:
Unrealized gains (losses) on securities, net of
reclassification adjustment (38,266) (7,227) 3,025
Foreign currency translation adjustments (742) 2,980 (2,863)
-------------- --------------- ---------------
Other comprehensive (loss) income (39,008) (4,247) 162
-------------- --------------- ---------------
TOTAL COMPREHENSIVE INCOME $ 16,587 $147,715 $106,536
============== =============== ===============
See Notes to Consolidated Financial Statements
F-4
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Changes in Stockholder's Equity
Years Ended December 31, 1999, 1998, and 1997 (In Thousands)
- -------------------------------------------------------------------------------------------------------------------
Accumulated
other Total
Common Paid-in- Retained comprehensive stockholder's
stock capital earnings income (loss) equity
------------- ------------ ---------------- ---------------- -------------------
Balance, January 1, 1997 $ 2,500 $ 439,582 $ 944,497 $ 12,402 $1,398,981
Net income - - 106,374 - 106,374
Change in foreign currency
translation adjustments,
net of taxes - - - (2,863) (2,863)
Change in net unrealized
investment gains, net
of reclassification
adjustment and taxes - - - 3,025 3,025
------------- ------------ ---------------- ---------------- -------------------
Balance, December 31, 1997 2,500 439,582 1,050,871 12,564 1,505,517
Net income - - 151,962 - 151,962
Change in foreign currency
translation adjustments,
net of taxes - - - 2,980 2,980
Change in net unrealized
investment losses,
net of reclassification
adjustment and taxes - - - (7,227) (7,227)
------------- ------------ ---------------- ---------------- -------------------
Balance, December 31, 1998 2,500 439,582 1,202,833 8,317 1,653,232
Net income - - 55,595 - 55,595
Change in foreign currency
translation adjustments,
net of taxes - - - (742) (742)
Change in net unrealized
investment losses, net of
reclassification
adjustment and taxes - - - (38,266) (38,266)
------------- ------------ ---------------- ----------------- ------------------
Balance, December 31, 1999 $ 2,500 $ 439,582 $ 1,258,428 $ (30,691) $1,669,819
============= ============ ================ ================= ==================
See Notes to Consolidated Financial Statements
F-5
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 1999, 1998, and 1997 (In Thousands)
- ----------------------------------------------------------------------------------------------------------------
1999 1998 1997
----------------- ----------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 55,595 $151,962 $106,374
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Policy charges and fee income (83,961) (29,827) (40,783)
Interest credited to policyholders' account balances 136,852 118,992 110,815
Realized investment (gains) losses, net 32,545 (44,841) (10,974)
Amortization and other non-cash items 75,037 19,655 (26,405)
Change in:
Future policy benefits and other policyholders'
liabilities 107,199 61,095 34,907
Accrued investment income (7,803) 5,886 (4,890)
Payable to affiliate (89,897) (3,807) 20,547
Policy loans (25,435) (62,962) (64,173)
Deferred policy acquisition costs (201,072) (206,471) (22,083)
Income taxes payable (47,758) (16,828) 68,417
Other, net 45,122 (43,675) 34,577
----------------- ----------------- ----------------
Cash Flows (Used In) From Operating Activities (3,576) (50,821) 206,329
----------------- ----------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities:
Available for sale 3,076,848 5,429,396 2,828,665
Held to maturity 45,841 74,767 138,626
Equity securities 5,209 4,101 6,939
Mortgage loans on real estate 6,845 5,433 24,925
Other long-term investments 385 33,428 (10,618)
Payments for the purchase of:
Fixed maturities:
Available for sale (3,452,289) (5,617,208) (3,141,785)
Held to maturity (24,170) (145,919) (70,532)
Equity securities (5,110) (2,274) (4,594)
Other long-term investments (39,094) (409) (51)
Cash collateral for loaned securities, net 14,000 (70,085) 143,421
Securities sold under agreement to repurchase, net (28,557) 49,708 -
Short-term investments, net 33,580 75,771 (147,030)
----------------- ----------------- ----------------
Cash Flows Used In Investing Activities (366,512) (163,291) (232,034)
----------------- ----------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 3,448,370 3,098,764 2,099,600
Withdrawals (3,091,565) (2,866,331) (2,076,303)
----------------- ----------------- ----------------
Cash Flows From (Used in) Financing Activities 356,805 232,433 23,297
----------------- ----------------- ----------------
Net increase (decrease) in Cash (13,283) 18,321 (2,408)
Cash, beginning of year 89,679 71,358 73,766
----------------- ----------------- ----------------
CASH, END OF PERIOD $76,396 $89,679 $71,358
================= ================= ================
SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes paid (received) $55,144 $99,810 $(7,904)
================= ================= ================
See Notes to Consolidated Financial Statements
F-6
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. BUSINESS
Pruco Life Insurance Company ("the Company") is a stock life insurance company,
organized in 1971 under the laws of the state of Arizona. The Company is
licensed to sell individual life insurance, variable life insurance, variable
annuities, fixed annuities, and a group annuity program ("the Contracts") in the
District of Columbia, Guam and in all states and territories except New York. In
addition, the Company markets individual life insurance through its branch
office in Taiwan. The Company has two wholly owned subsidiaries, Pruco Life
Insurance Company of New Jersey ("PLNJ") and The Prudential Life Insurance
Company of Arizona ("PLICA"). PLNJ is a stock life insurance company organized
in 1982 under the laws of the state of New Jersey. It is licensed to sell
individual life insurance, variable life insurance, fixed annuities, and
variable annuities only in the states of New Jersey and New York. PLICA is a
stock life insurance company organized in 1988 under the laws of the state of
Arizona. PLICA had no new business sales in 1997, 1998 or 1999 and at this time
will not be issuing new business.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential"), a mutual insurance company founded in 1875 under the
laws of the state of New Jersey. Prudential is currently considering
reorganizing itself into a publicly traded stock company through a process known
as "demutualization." On February 10, 1998, Prudential's Board of Directors
authorized management to take the preliminary steps necessary to allow
Prudential to demutualize. On July 1, 1998, legislation was enacted in New
Jersey that would permit this conversion to occur and that specified the process
for conversion. Demutualization is a complex process involving development of a
plan of reorganization, adoption of a plan by Prudential's Board of Directors, a
public hearing, review and approval by two-thirds of the qualified policyholders
who vote on the plan and review and approval by the New Jersey Department of
Banking and Insurance. Prudential's management is in the process of developing a
proposed plan of demutualization, although there can be no assurance that
Prudential's Board of Directors will approve such a plan.
Prudential intends to make additional capital contributions to the Company, as
needed, to enable it to comply with its reserve requirements and fund expenses
in connection with its business. Generally, Prudential is under no obligation to
make such contributions and its assets do not back the benefits payable under
the Contracts.
The Company is engaged in a business that is highly competitive because of the
large number of stock and mutual life insurance companies and other entities
engaged in marketing insurance products, and individual and group annuities.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States ("GAAP"). The
Company has extensive transactions and relationships with Prudential and other
affiliates, as more fully described in Footnote 14. Due to these relationships,
it is possible that the terms of these transactions are not the same as those
that would result from transactions among wholly unrelated parties. All
significant intercompany transactions and balances have been eliminated in
consolidation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, in particular deferred policy acquisition costs ("DAC")
and future policy benefits, and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and
expenses during the period. Actual results could differ from those estimates.
Investments
Fixed maturities classified as "available for sale" are carried at estimated
fair value. Fixed maturities that the Company has both the intent and ability to
hold to maturity are stated at amortized cost and classified as "held to
maturity". The amortized cost of fixed maturities is written down to estimated
fair value if a decline in value is considered to be other than temporary.
Unrealized gains and losses on fixed maturities "available for sale", including
the effect on deferred policy acquisition costs and policyholders' account
balances that would result from the realization of unrealized gains and losses,
net of income taxes, are included in a separate component of equity,
"Accumulated other comprehensive income."
F-7
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Equity securities, available for sale, comprised of common and non-redeemable
preferred stock, are carried at estimated fair value. The associated unrealized
gains and losses, net of income tax, the effects on deferred policy acquisition
costs and on policyholders' account balances that would result from the
realization of unrealized gains and losses, are included in a separate component
of equity, "Accumulated other comprehensive income."
Mortgage loans on real estate are stated primarily at unpaid principal balances,
net of unamortized discounts and an allowance for losses. The allowance for
losses includes a loan specific reserve for impaired loans and a portfolio
reserve for incurred but not specifically identified losses. Impaired loans
include those loans for which a probability exists that all amounts due
according to the contractual terms of the loan agreement will not be collected.
Impaired loans are measured at the present value of expected future cash flows
discounted at the loan's effective interest rate, or at the fair value of the
collateral if the loan is collateral dependent. Interest received on impaired
loans, including loans that were previously modified in a troubled debt
restructuring, is either applied against the principal or reported as revenue,
according to management's judgment as to the collectibility of principal.
Management discontinues accruing interest on impaired loans after the loans are
90 days delinquent as to principal or interest, or earlier when management has
serious doubts about collectibility. When a loan is recognized as impaired, any
accrued but uncollectible interest is reversed against interest income of the
current period. Generally, a loan is restored to accrual status only after all
delinquent interest and principal are brought current and, in the case of loans
where the payment of interest has been interrupted for a substantial period, a
regular payment performance has been established. The portfolio reserve for
incurred but not specifically identified losses considers the Company's past
loan loss experience, the current credit composition of the portfolio,
historical credit migration, property type diversification, default and loss
severity statistics and other relevant factors.
Policy loans are carried at unpaid principal balances.
Short-term investments, including highly liquid debt instruments purchased with
an original maturity of twelve months or less, are carried at amortized cost,
which approximates fair value.
Other long-term investments represent the Company's investments in joint
ventures and partnerships in which the Company does not have control. These
investments are recorded using the equity method of accounting, reduced for
other than temporary declines in value. The Company's investment in the Separate
Accounts are included on this line.
Realized investment gains, net are computed using the specific identification
method. Costs of fixed maturity and equity securities are adjusted for
impairments considered to be other than temporary.
Cash
Cash includes cash on hand, amounts due from banks, and money market
instruments.
Deferred Policy Acquisition Costs
The costs which vary with and that are related primarily to the production of
new insurance business are deferred to the extent that they are deemed
recoverable from future profits. Such costs include certain commissions, costs
of policy issuance and underwriting, and certain variable field office expenses.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing at the end of each accounting
period. Deferred policy acquisition costs are adjusted for the impact of
unrealized gains or losses on investments as if these gains or losses had been
realized, with corresponding credits or charges included in "Accumulated other
comprehensive income".
Policy acquisition costs related to interest-sensitive products and certain
investment-type products are deferred and amortized over the expected life of
the contracts (periods ranging from 15 to 30 years) in proportion to estimated
gross profits arising principally from investment results, mortality and expense
margins, and surrender charges based on historical and anticipated future
experience, which is updated periodically. The effect of changes to estimated
gross profits on unamortized deferred acquisition costs is reflected in "General
and administrative expenses" in the period such estimated gross profits are
revised.
F-8
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Securities loaned
Securities loaned are treated as financing arrangements and are recorded at the
amount of cash received as collateral. The Company obtains collateral in an
amount equal to 102% and 105% of the fair value of the domestic and foreign
securities, respectively. The Company monitors the market value of securities
loaned on a daily basis with additional collateral obtained as necessary.
Non-cash collateral received is not reflected in the consolidated statements of
financial position because the debtor typically has the right to redeem the
collateral on short notice. Substantially all of the Company's securities loaned
are with large brokerage firms.
Securities sold under agreements to repurchase
Securities sold under agreements to repurchase are treated as financing
arrangements and are carried at the amounts at which the securities will be
subsequently reacquired, including accrued interest, as specified in the
respective agreements. Assets to be repurchased are the same, or substantially
the same, as the assets transferred and the transferor, through right of
substitution, maintains the right and ability to redeem the collateral on short
notice. The market value of securities to be repurchased is monitored and
additional collateral is obtained, where appropriate, to protect against credit
exposure.
Securities lending and securities repurchase agreements are used to generate net
investment income and facilitate trading activity. These instruments are
short-term in nature (usually 30 days or less). Securities loaned are
collateralized principally by U.S. Government and mortgage-backed securities.
Securities sold under repurchase agreements are collateralized principally by
cash. The carrying amounts of these instruments approximate fair value because
of the relatively short period of time between the origination of the
instruments and their expected realization.
Separate Account Assets and Liabilities
Separate Account assets and liabilities are reported at estimated fair value and
represent segregated funds which are invested for certain policyholders and
other customers. Separate Account assets include common stocks, fixed
maturities, real estate related securities, and short-term investments. The
assets of each account are legally segregated and are not subject to claims that
arise out of any other business of the Company. Investment risks associated with
market value changes are borne by the customers, except to the extent of minimum
guarantees made by the Company with respect to certain accounts. The investment
income and gains or losses for Separate Accounts generally accrue to the
policyholders and are not included in the Consolidated Statements of Operations.
Mortality, policy administration and surrender charges on the accounts are
included in "Policy charges and fee income".
Separate Accounts represent funds for which investment income and investment
gains and losses accrue directly to, and investment risk is borne by, the
policyholders, with the exception of the Pruco Life Modified Guaranteed Annuity
Account. The Pruco Life Modified Guaranteed Annuity Account is a non-unitized
Separate Account, which funds the Modified Guaranteed Annuity Contract and the
Market Value Adjustment Annuity Contract. Owners of the Pruco Life Modified
Guaranteed Annuity and the Market Value Adjustment Annuity Contracts do not
participate in the investment gain or loss from assets relating to such
accounts. Such gain or loss is borne, in total, by the Company.
Insurance Revenue and Expense Recognition
Premiums from insurance policies are generally recognized when due. Benefits are
recorded as an expense when they are incurred. For traditional life insurance
contracts, a liability for future policy benefits is recorded using the net
level premium method. For individual annuities in payout status, a liability for
future policy benefits is recorded for the present value of expected future
payments based on historical experience.
Premiums from non-participating group annuities with life contingencies are
generally recognized when due. For single premium immediate annuities, premiums
are recognized when due with any excess profit deferred and recognized in a
constant relationship to insurance in-force or, for annuities, the amount of
expected future benefit payments.
F-9
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Amounts received as payment for interest-sensitive life, individual annuities
and guaranteed investment contracts are reported as deposits to "Policyholders'
account balances". Revenues from these contracts reflected as "Policy charges
and fee income" consist primarily of fees assessed during the period against the
policyholders' account balances for mortality charges, policy administration
charges and surrender charges. In addition, interest earned from the investment
of these account balances is reflected in "Net investment income". Benefits and
expenses for these products include claims in excess of related account
balances, expenses of contract administration, interest credited and
amortization of deferred policy acquisition costs.
Foreign Currency Translation Adjustments
Assets and liabilities of the Taiwan branch are translated to U.S. dollars at
the exchange rate in effect at the end of the period. Revenues, benefits and
other expenses are translated at the average rate prevailing during the period.
Cumulative translation adjustments arising from the use of differing exchange
rates from period to period are charged or credited directly to "Other
comprehensive income". The cumulative effect of changes in foreign exchange
rates are included in "Accumulated other comprehensive income".
Asset Management Fees
The Company receives asset management fee income from policyholder account
balances invested in The Prudential Series Fund ("PSF"), which are a portfolio
of mutual fund investments related to the Company's Separate Account products.
Derivative Financial Instruments
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, various financial indices or the value of
securities or commodities. Derivative financial instruments used by the Company
include futures, currency swaps and options contracts and can be
exchange-traded or contracted in the over-the-counter market. The Company uses
derivative financial instruments to seek to reduce market risk from changes in
interest rates or foreign currency exchange rates, and to alter interest rate or
currency exposures arising from mismatches between assets and liabilities. All
derivatives used by the Company are for other than trading purposes.
To qualify as a hedge, derivatives must be designated as hedges for existing
assets, liabilities, firm commitments or anticipated transactions which are
identified and probable to occur, and effective in reducing the market risk to
which the Company is exposed. The effectiveness of the derivatives must be
evaluated at the inception of the hedge and throughout the hedge period.
When derivatives qualify as hedges, the changes in the fair value or cash flows
of the derivatives and the hedged items are recognized in earnings in the same
period. If the Company's use of derivatives does not meet the criteria to apply
hedge accounting, the derivatives are recorded at fair value in "Other
liabilities" in the Consolidated Statements of Financial Position, and changes
in their fair value are recognized in earnings in "Realized investment gains,
net" without considering changes in the hedged assets or liabilities. Cash flows
from derivative assets and liabilities are reported in the operating activities
section in the Consolidated Statements of Cash Flows.
Income Taxes
The Company and its subsidiaries are members of the consolidated federal income
tax return of Prudential and files separate company state and local tax returns.
Pursuant to the tax allocation arrangement with Prudential, total federal income
tax expense is determined on a separate company basis. Members with losses
record tax benefits to the extent such losses are recognized in the consolidated
federal tax provision. Deferred income taxes are generally recognized, based on
enacted rates, when assets and liabilities have different values for financial
statement and tax reporting purposes. A valuation allowance is recorded to
reduce a deferred tax asset to that portion that is expected to be realized.
F-10
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires that companies recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. SFAS No. 133 does not apply to most traditional
insurance contracts. However, certain hybrid contracts that contain features
which may affect settlement amounts similarly to derivatives may require
separate accounting for the "host contract" and the underlying "embedded
derivative" provisions. The latter provisions would be accounted for as
derivatives as specified by the statement.
SFAS No. 133 provides, if certain conditions are met, that a derivative may be
specifically designated as (1) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment
(fair value hedge), (2) a hedge of the exposure to variable cash flows of a
forecasted transaction (cash flow hedge), or (3) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security or a foreign-currency-denominated
forecasted transaction (foreign currency hedge).
Under SFAS No. 133, the accounting for changes in fair value of a derivative
depends on its intended use and designation. For a fair value hedge, the gain or
loss is recognized in earnings in the period of change together with the
offsetting loss or gain on the hedged item. For a cash flow hedge, the effective
portion of the derivative's gain or loss is initially reported as a component of
other comprehensive income and subsequently reclassified into earnings when the
forecasted transaction affects earnings. For a foreign currency hedge, the gain
or loss is reported in other comprehensive income as part of the foreign
currency translation adjustment. For all other derivatives not designated as
hedging instruments, the gain or loss is recognized in earnings in the period of
change. The Company is required to adopt this Statement, as amended, as of
January 1, 2001 and is currently assessing the effect of the new standard.
In October 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk" ("SOP
98-7"). This statement provides guidance on how to account for insurance and
reinsurance contracts that do not transfer insurance risk. SOP 98-7 is effective
for fiscal years beginning after June 15, 1999. The adoption of this statement
is not expected to have a material effect on the Company's financial position or
results of operations.
Reclassifications
Certain amounts in the prior years have been reclassified to conform to current
year presentation.
F-11
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS
Fixed Maturities and Equity Securities:
The following tables provide additional information relating to fixed maturities
and equity securities as of December 31,:
1999
---------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------- -------------- -------------- --------------
(In Thousands)
Fixed maturities available for sale
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 113,172 $ 2 $ 2,052 $ 111,122
Foreign government bonds 92,725 1,718 1,455 92,988
Corporate securities 2,876,602 8,013 92,075 2,792,540
Mortgage-backed securities 1,558 157 3 1,712
------------- -------------- -------------- -------------
Total fixed maturities available for sale $3,084,057 $9,890 $95,585 $2,998,362
============= ============== ============== =============
Fixed maturities held to maturity
Corporate securities $ 388,990 $1,832 $13,000 377,822
------------- -------------- -------------- -------------
Total fixed maturities held to maturity $ 388,990 $1,832 $13,000 $ 377,822
============= ============== ============== ==============
Equity securities available for sale $ 3,238 $1,373 $ 79 $ 4,532
============= ============= ============== ==============
1998
---------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------- -------------- -------------- --------------
(In Thousands)
Fixed maturities available for sale
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 110,294 $ 864 $ 319 $ 110,839
Foreign government bonds 87,112 2,003 696 88,419
Corporate securities 2,540,498 30,160 6,896 2,563,762
Mortgage-backed securities 750 156 - 906
------------- -------------- -------------- -------------
Total fixed maturities available for sale $2,738,654 $33,183 $ 7,911 $2,763,926
============== ============= ============== =============
Fixed maturities held to maturity
Corporate securities $ 410,558 $11,287 $ - $ 421,845
------------- -------------- -------------- -------------
Total fixed maturities held to maturity $ 410,558 $11,287 $ - $ 421,845
============== ============= ============== =============
Equity securities available for sale $ 2,951 $ 168 $ 272 $ 2,847
============== ============= ============== =============
F-12
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The amortized cost and estimated fair value of fixed maturities, categorized by
contractual maturities at December 31, 1999 are shown below:
Available for Sale Held to Maturity
------------------------------------ ------------------------------------
Amortized Estimated Fair Amortized Estimated Fair
Cost Value Cost Value
------------------------------------ ----------------- -------------------
(In Thousands) (In Thousands)
Due in one year or less $ 178,298 $ 175,638 $ 18,369 $ 18,296
Due after one year through five
years 1,144,552 1,118,150 178,893 178,624
Due after five years through ten
years 1,326,637 1,283,515 175,549 165,341
Due after ten years 433,012 419,347 16,179 15,561
Mortgage-backed securities 1,558 1,712 - -
---------------- ------------------- ----------------- ------------------
Total $3,084,057 $2,998,362 $ 388,990 $ 377,822
================ =================== ================= ==================
Actual maturities will differ from contractual maturities because, in certain
circumstances, issuers have the right to call or prepay obligations.
Proceeds from the sale of fixed maturities available for sale during 1999, 1998,
and 1997 were $2,950.4 million, $5,327.3 million, and $2,796.3 million,
respectively. Gross gains of $13.1 million, $46.3 million, and $18.6 million and
gross losses of $31.1 million, $14.1 million, and $7.9 million were realized on
those sales during 1999, 1998, and 1997, respectively. During the years ended
December 31, 1999, 1998, and 1997, there were no securities classified as held
to maturity that were sold.
Proceeds from the maturity of fixed maturities available for sale during 1999,
1998, and 1997 were $126.5 million, $102.1 million, and $32.4 million,
respectively
Writedowns for impairments of fixed maturities which were deemed to be other
than temporary were $11.2 million, $2.8 million and $0.1 million for the years
1999, 1998 and 1997, respectively.
Mortgage Loans on Real Estate
The Company's mortgage loans were collateralized by the following property types
at December 31, 1999 and 1998.
1999 1998
---------------------------- ---------------------------
(In Thousands)
Retail stores $ 6,518 62.0% $ 7,356 42.4%
Apartment complexes - - 5,988 34.5%
Industrial buildings 3,991 38.0% 4,010 23.1%
---------------------------- ---------------------------
Net carrying value $10,509 100.0% $17,354 100.0%
============================ ===========================
The largest concentration of mortgage loans are in the states of Washington
(51%), New Jersey (38%), and North Dakota (11%).
Special Deposits and Restricted Assets
Fixed maturities of $8.2 million and $8.6 million at December 31, 1999 and 1998,
respectively, were on deposit with governmental authorities or trustees as
required by certain insurance laws. Equity securities restricted as to sale were
$.3 million and $2.5 million at December 31, 1999 and 1998, respectively.
F-13
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
Other Long-Term Investments
The Company's "Other long-term investments" of $77.8 million and $42.0 million
as of December 31, 1999 and 1998, respectively, are comprised of joint ventures,
limited partnerships, and the Company's investment in the Separate Accounts.
Joint ventures, limited partnerships and other totaled $32.8 million and $1.0
million at December 31, 1999 and 1998, respectively. The Company's share of net
income from the joint ventures was $0.3 million, $0.1 million and $2.2 million
for the years ended December 31, 1999, 1998 and 1997, respectively, and is
reported in "Net investment income." The Company's investment in the Separate
Accounts was $45.0 million and $41.0 million at December 31, 1999 and 1998,
respectively.
Investment Income and Investment Gains and Losses
Net investment income arose from the following sources for the years ended
December 31:
1999 1998 1997
---------------- ----------------- -----------------
(In Thousands)
Fixed maturities - available for sale $188,236 $179,184 $161,140
Fixed maturities - held to maturity 29,245 26,128 26,936
Equity securities - 14 76
Mortgage loans on real estate 2,825 1,818 2,585
Policy loans 42,422 40,928 37,398
Short-term investments 19,208 23,110 22,011
Other 4,432 6,886 14,920
---------------- ----------------- ----------------
Gross investment income 286,368 278,068 265,066
Less: investment expenses (9,547) (16,638) (5,432)
---------------- ----------------- ----------------
Net investment income $276,821 $261,430 $259,634
================ ================= ================
Realized investment gains (losses), net including charges for other than
temporary reductions in value, for the years ended December 31, were from the
following sources:
1999 1998 1997
---------------- ----------------- -----------------
(In Thousands)
Fixed maturities - available for sale $(29,192) $29,330 $9,039
Fixed maturities - held to maturity 102 487 821
Equity securities 392 3,489 8
Mortgage loans on real estate - - 797
Derivative instruments (1,557) 12,414 -
Other (2,290) (879) 309
---------------- ----------------- -----------------
Realized investment (losses) gains, net $(32,545) $44,841 $10,974
================ ================= =================
F-14
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Net Unrealized Investment Gains (Losses)
Net unrealized investment gains (losses) on securities available for sale are
included in the Consolidated Statements of Financial Position as a component of
"Accumulated other comprehensive income". Changes in these amounts include
reclassification adjustments to avoid including in "Other Comprehensive income
(loss)", those items that are included as part of "Net income" for a period that
also had been part of "Other Comprehensive income (loss)" in earlier periods.
The amounts for the years ended December 31, net of tax, are as follows:
Accumulated
other
comprehensive
income (loss)
Deferred Deferred related to net
Unrealized policy Policyholders' income tax unrealized
gains(losses) acquisition Account (liability) investment
on investments costs Balances benefit gains(losses)
----------------- -------------------------------------------------------------
(In Thousands)
Balance, January 1, 1997 $ 26,930 $ (7,893) $ 2,451 $ (7,384) $ 14,104
Net investment gains (losses) on
investments arising during the period 21,338 - - (7,445) 13,893
Reclassifications adjustment for
gains included in net income (10,277) - - 3,585 (6,692)
Impact of net unrealized investment
gains on deferred policy acquisition
costs - (8,412) - 2,944 (5,468)
Impact of net unrealized investment
gains on policyholders' account
balances - - 1,292 - 1,292
---------------- ------------- ---------------- -------------- ----------------
Balance, December 31, 1997 37,991 (16,305) 3,743 (8,300) 17,129
Net investment gains (losses) on
investments arising during the period 22,801 - - (7,588) 15,213
Reclassifications adjustment for
gains included in net income (35,623) - - 11,855 (23,768)
Impact of net unrealized investment
gains on deferred policy acquisition
costs - 3,190 - (1,048) 2,142
Impact of net unrealized investment
gains on policyholders' account
balances - - (1,063) 249 (814)
---------------- ------------- ---------------- -------------- ----------------
Balance, December 31, 1998 25,169 (13,115) 2,680 (4,832) 9,902
Net investment gains (losses) on
investments arising during the period (138,268) - - 47,785 (90,483)
Reclassifications adjustment for
gains included in net income 28,698 - - (9,970) 18,728
Impact of net unrealized investment
gains on deferred policy acquisition
costs - 53,407 - (16,283) 37,124
Impact of net unrealized investment
gains on policyholders' account
balances - - (5,712) 2,077 (3,635)
---------------- ------------- ---------------- ------------- ----------------
Balance, December 31, 1999 $ (84,401) $ 40,292 $(3,032) $18,777 $ (28,364)
================ ============= ================ ============= ================
F-15
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
4. DEFERRED POLICY ACQUISITION COSTS
The balances of and changes in deferred policy acquisition costs for the year
ended December 31, 1999, are as follows:
1999
-----------------
(In Thousands)
Balance, beginning of year $ 861,713
Capitalization on commissions, sales and issue expenses 242,373
Amortization (96,451)
Change in unrealized investment gains 53,407
Foreign currency translation 1,743
-----------------
Balance, end of year $1,062,785
=================
5. POLICYHOLDERS' LIABILITIES
Future policy benefits and other policyholder liabilities at December 31 are as
follows:
1999 1998
------------------- -------------------
(In Thousands)
Life insurance $ 587,162 $ 500,429
Annuities 48,816 28,350
------------------- -------------------
$ 635,978 $ 528,779
=================== ===================
Life insurance liabilities include reserves for death benefits. Annuity
liabilities include reserves for immediate annuities.
The following table highlights the key assumptions generally utilized in
calculating these reserves:
Product Mortality Interest Rate Estimation Method
- ------------------------------- ------------------------- -------------------- -------------------------
Life insurance - Domestic Generally rates 2.5% to 7.5% Net level premium based
guaranteed in on non-forfeiture
calculating cash interest rate
surrender values
Life insurance - International Generally rates 2.5% to 7.5% Net level premium based
guaranteed in on the expected
calculating cash investment return
surrender values
Individual immediate annuities 1983 Individual Annuity 3.5% to 11.0% Present value of
Mortality Table with expected future payment
certain modifications based on historical
experience
F-16
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. POLICYHOLDERS' LIABILITIES (continued)
Policyholders' account balances at December 31, are as follows:
1999 1998
------------------- -------------------
(In Thousands)
Interest-sensitive life contracts $1,383,795 $1,392,649
Individual annuities 1,147,722 1,077,996
Guaranteed investment contracts 584,744 231,366
------------------- -------------------
$3,116,261 $2,702,011
=================== ===================
Policyholders' account balances for interest-sensitive life, individual
annuities, and guaranteed investment contracts are equal to policy account
values plus unearned premiums. The policy account values represent an
accumulation of gross premium payments plus credited interest less withdrawals,
expenses and mortality charges.
Certain contract provisions that determine the policyholder account balances are
as follows:
Product Interest Rate Withdrawal / Surrender Charges
- --------------------------------- ------------------------------------ ------------------------------------
Interest sensitive life
contracts 4.0% to 6.5% Various up to 10 years
Individual annuities 3.0% to 5.6% 0% to 8% for up to 8 years
Guaranteed investment contracts 5.02% to 7.32% Subject to market value withdrawal
provisions for any funds withdrawn
other than for benefit responsive
and contractual payments
6. REINSURANCE
The Company participates in reinsurance, with Prudential and other companies, in
order to provide greater diversification of business, provide additional
capacity for future growth and limit the maximum net loss potential arising from
large risks. Reinsurance ceded arrangements do not discharge the Company or the
insurance subsidiaries as the primary insurer, except for cases involving a
novation. Ceded balances would represent a liability of the Company in the event
the reinsurers were unable to meet their obligations to the Company under the
terms of the reinsurance agreements. The likelihood of a material reinsurance
liability reassumed by the Company is considered to be remote.
F-17
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. REINSURANCE (continued)
Reinsurance amounts included in the Consolidated Statements of Operations for
the year ended December 31 are below.
1999 1998 1997
----------------- ----------------- ----------------
(In Thousands)
Reinsurance premiums assumed 1,778 1,395 1,369
Reinsurance premiums ceded - affiliated (6,882) (6,532) (686)
Reinsurance premiums ceded - unaffiliated (1,744) (2,819) (3,038)
================ ================ ================
Policyholders' benefits ceded $ 4,228 $ 4,044 $ 3,912
================ ================ ================
Reinsurance recoverables, included in "Other assets" in the Company's
Consolidated Statements of Financial Position, at December 31 include amounts
recoverable on unpaid and paid losses and were as follows:
1999 1998
------------------- -----------------
(In Thousands)
Life insurance - affiliated $ 6,653 $ 4,155
Life insurance - unaffiliated 2,625 2,326
Other reinsurance - affiliated 15,600 21,650
------------------- -----------------
$24,878 $28,131
=================== =================
7. EMPLOYEE BENEFIT PLANS
Pension and Other Postretirement Plans
The Company has a non-contributory defined benefit pension plan which covers
substantially all of its Taiwanese employees. This plan was established as of
September 30, 1998 and the projected benefit obligation and related expenses at
December 31, 1999 were not material to the Consolidated Statements of Financial
Position or results of operations for the years presented. All other employee
benefit costs are allocated to the Company by Prudential in accordance with the
service agreement described in Footnote 14.
F-18
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. INCOME TAXES
The components of income taxes for the years ended December 31, are as follows:
1999 1998 1997
---------------- ----------------- -----------------
(In Thousands)
Current tax expense (benefit):
U.S. $ (14,093) $67,272 $ 71,989
State and local 378 2,496 1,337
Foreign 15 - -
---------------- ----------------- -----------------
Total (13,700) 69,768 73,326
---------------- ----------------- -----------------
Deferred tax expense (benefit):
U.S. 42,320 14,059 (11,458)
State and local 1,316 406 -
---------------- ----------------- -----------------
Total 43,636 14,465 (11,458)
---------------- ----------------- -----------------
Total income tax expense $29,936 $84,233 $61,868
================ ================= =================
The income tax expense for the years ended December 31, differs from the amount
computed by applying the expected federal income tax rate of 35% to income from
operations before income taxes for the following reasons:
1999 1998 1997
---------------- ----------------- -----------------
(In Thousands)
Expected federal income tax expense $29,936 $82,668 $58,885
State and local income taxes 1,101 1,886 869
Dividends received deduction (1,010) (199) -
Other (91) (122) 2,114
---------------- ----------------- -----------------
Total income tax expense $29,936 $84,233 $61,868
================ ================= =================
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
1999 1998
------------------ -------------------
(In Thousands)
Deferred tax assets
Insurance reserves $93,949 $ 93,564
Net unrealized (gains) losses on
securities 31,132 (9,061)
Other 2,502 -
------------------ -------------------
Deferred tax assets 127,583 84,503
------------------ -------------------
Deferred tax liabilities
Deferred acquisition costs 299,683 224,179
Net investment gains 110 3,180
Other - 5,978
------------------ -------------------
Deferred tax liabilities 299,793 233,337
------------------ -------------------
Net deferred tax liability $172,210 $148,834
================== ===================
F-19
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. INCOME TAXES (continued)
Management believes that based on its historical pattern of taxable income, the
Company and its subsidiaries will produce sufficient income in the future to
realize its deferred tax assets after valuation allowance. Adjustments to the
valuation allowance will be made if there is a change in management's assessment
of the amount of the deferred tax asset that is realizable. At December 31, 1999
and 1998, respectively, the Company and its subsidiaries had no federal or state
operating loss carryforwards for tax purposes.
The Internal Revenue Service (the "Service") has completed all examinations of
the consolidated federal income tax returns through 1992. The Service has begun
their examination of the years 1993 through 1995.
9. EQUITY
Reconciliation of Statutory Surplus and Net Income
Accounting practices used to prepare statutory financial statements for
regulatory purposes differ in certain instances from GAAP. The following table
reconciles the Company's statutory net income and surplus as of and for the
years ended December 31, determined in accordance with accounting practices
prescribed or permitted by the Arizona Department of Insurance and the New
Jersey Department of Banking and Insurance with net income and equity determined
using GAAP.
1999 1998 1997
---------------- ---------------- ----------------
(In Thousands)
Statutory net (loss) income $ (82,291) $ (33,097) $ 12,778
Adjustments to reconcile to net income on a GAAP basis:
Statutory income of subsidiaries 20,221 18,953 18,553
Amortization and capitalization of deferred
acquisition costs 145,921 202,375 38,003
Deferred premium 639 2,625 1,144
Insurance revenue and expenses 45,915 (24,942) 26,517
Income taxes (43,644) (21,805) 11,956
Valuation of investments (24,908) 20,077 506
Asset management fees (13,503) - -
Other, net 7,245 (12,224) (3,083)
---------------- ---------------- ----------------
GAAP net income $ 55,595 $151,962 $106,374
================ ================ ================
1999 1998
----------------- -----------------
(In Thousands)
Statutory surplus $889,186 $931,164
Adjustments to reconcile to equity on a GAAP basis:
Valuation of investments (38,258) 117,254
Deferred acquisition costs 1,062,785 861,713
Deferred premium (16,539) (15,625)
Insurance liabilities (54,927) (133,811)
Income taxes (150,957) (123,343)
Asset management fees (13,503) -
Other, net (7,968) 15,880
----------------- -----------------
GAAP stockholder's equity $1,669,819 $1,653,232
================= =================
F-20
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values presented below have been determined using available
information and valuation methodologies. Considerable judgment is applied in
interpreting data to develop the estimates of fair value. Accordingly, such
estimates presented may not be realized in a current market exchange. The use of
different market assumptions and/or estimation methodologies could have a
material effect on the estimated fair values. The following methods and
assumptions were used in calculating the estimated fair values (for all other
financial instruments presented in the table, the carrying value approximates
estimated fair value).
Fixed maturities and Equity securities
Estimated fair values for fixed maturities and equity securities, other than
private placement securities, are based on quoted market prices or estimates
from independent pricing services. Fair values for private placement securities
are estimated using a discounted cash flow model which considers the current
market spreads between the U.S. Treasury yield curve and corporate bond yield
curve, adjusted for the type of issue, its current credit quality and its
remaining average life. The estimated fair value of certain non-performing
private placement securities is based on amounts estimated by management.
Mortgage loans on real estate
The estimated fair value of the mortgage loan portfolio is primarily based upon
the present value of the scheduled future cash flows discounted at the
appropriate U.S. Treasury rate, adjusted for the current market spread for a
similar quality mortgage.
Policy loans
The estimated fair value of policy loans is calculated using a discounted cash
flow model based upon current U.S. Treasury rates and historical loan
repayments.
Investment contracts
For guaranteed investment contracts, estimated fair values are derived by using
discounted projected cash flows based on interest rates being offered for
similar contracts, with maturities consistent with those remaining for the
contracts being valued. Estimated fair values for individual deferred annuities
are derived using the policyholder's account balance.
Derivative financial instruments
The fair value of futures is estimated based on market quotes for transactions
with similar terms.
The following table discloses the carrying amounts and estimated fair values of
the Company's financial instruments at December 31:
1999 1998
---------------------------------- -------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
---------------- ---------------- --------------- ---------------
(In Thousands)
Financial Assets:
Fixed maturities: Available for sale $2,998,362 $2,998,362 $2,763,926 $2,763,926
Fixed maturities: Held to maturity 388,990 377,822 410,558 421,845
Equity securities 4,532 4,532 2,847 2,847
Mortgage loans on real estate 10,509 11,550 17,354 19,465
Policy loans 792,352 761,232 766,917 806,099
Short-term investments 207,219 207,219 240,727 240,727
Cash 76,396 76,396 89,679 89,679
Separate Account assets 16,032,449 16,032,449 11,490,751 11,490,751
Derivatives 38 38 - -
Financial Liabilities:
Investment contracts $1,282,964 $1,277,317 $ 835,034 $ 839,105
Cash collateral for loaned securities 87,336 87,336 73,336 73,336
Securities sold under repurchase 21,151 21,151 49,708 49,708
agreements
Separate Account liabilities 16,032,449 16,032,449 11,490,751 11,490,751
Derivatives 5,012 5,243 1,723 2,374
F-21
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
11. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
Futures & Options
The Company uses exchange-traded Treasury futures and options to reduce market
risk from changes in interest rates and to manage the duration of assets and the
duration of liabilities supported by those assets. The Company enters into
exchange-traded futures and options with regulated futures commissions merchants
who are members of a trading exchange. The fair value of futures and options is
estimated based on market quotes for a transaction with similar terms.
Under exchange-traded futures, the Company agrees to purchase a specified number
of contracts with other parties and to post variation margin on a daily basis in
an amount equal to the difference in the daily market values of those contracts.
Treasury futures move substantially in value as interest rates change and can be
used to either modify or hedge existing interest rate risk. This strategy
protects against the risk that cash flow requirements may necessitate
liquidation of investments at unfavorable prices resulting from increases in
interest rates. This strategy can be a more cost effective way of temporarily
reducing the Company's exposure to a market decline than selling fixed income
securities and purchasing a similar portfolio when such a decline is believed to
be over.
If futures meet hedge accounting criteria, changes in their fair value are
deferred and recognized as an adjustment to the carrying value of the hedged
item. Deferred gains or losses from the hedges for interest-bearing financial
instruments are amortized as a yield adjustment over the remaining lives of the
hedged item. Futures that do not qualify as hedges are carried at fair value
with changes in value reported in current period earnings. The notional value of
futures contracts was $122.1 million and $40.8 million at December 31, 1999 and
1998, respectively. The fair value of futures contracts was $(2.0) million at
December 31, 1999 and immaterial at December 31, 1998.
When the Company anticipates a significant decline in the stock market which
will correspondingly affect its diversified portfolio, it may purchase put index
options where the basket of securities in the index is appropriate to provide a
hedge against a decrease in the value of the equity portfolio or a portion
thereof. This strategy effects an orderly sale of hedged securities. When the
Company has large cash flows which it has allocated for investment in equity
securities, it may purchase call index options as a temporary hedge against an
increase in the price of the securities it intends to purchase. This hedge
permits such investment transactions to be executed with the least possible
adverse market impact.
Option premium paid or received is reported as an asset or liability and
amortized into income over the life of the option. If options meet the criteria
for hedge accounting, changes in their fair value are deferred and recognized as
an adjustment to the hedged item. Deferred gains or losses from the hedges for
interest-bearing financial instruments are recognized as an adjustment to
interest income or expense of the hedged item. If the options do not meet the
criteria for hedge accounting, they are fair valued, with changes in fair value
reported in current period earnings. The fair value of options was immaterial at
December 31, 1999 and 1998.
Currency Derivatives
The Company uses currency swaps to reduce market risk from changes in currency
values of investments denominated in foreign currencies that the Company either
holds or intends to acquire and to manage the currency exposures arising from
mismatches between such foreign currencies and the US Dollar.
Under currency swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between one currency and another at a
forward exchange rate and calculated by reference to an agreed principal amount.
Generally, the principal amount of each currency is exchanged at the beginning
and termination of the currency swap by each party. These transactions are
entered into pursuant to master agreements that provide for a single net payment
to be made by one counterparty for payments made in the same currency at each
due date.
If currency swaps are effective as hedges of foreign currency translation and
transaction exposures, gains or losses are recorded in "Accumulated Other
Comprehensive Income". If currency swaps do not meet hedge accounting criteria,
gains or losses from those derivatives are recognized in current period
earnings.
The notional value and fair value of the currency swaps $31.0 million and $(3.2)
million and $40.5 million and $(2.3) million, respectively, at December 31, 1999
and 1998.
F-22
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
11. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (continued)
Credit Risk
The current credit exposure of the Company's derivative contracts is limited to
the fair value at the reporting date. Credit risk is managed by entering into
transactions with creditworthy counterparties and obtaining collateral where
appropriate and customary. The Company also attempts to minimize its exposure to
credit risk through the use of various credit monitoring techniques. All of the
net credit exposure for the Company from derivative contracts are with
investment grade counterparties. As of December 31, 1999, 80% of notional
consisted of interest rate derivatives, and 20% of notional consisted of foreign
currency derivatives.
12. CONTINGENCIES
Various lawsuits against the Company have arisen in the course of the Company's
business. In certain of these matters, large and/or indeterminate amounts are
sought.
On October 28, 1996, the Company entered into a Stipulation of Settlement with
attorneys for the plaintiffs in a consolidated class action lawsuit pending in a
Multi-District Litigation proceeding in the U.S. District Court for the District
of New Jersey. The class action suit involved alleged improprieties in
connection with the sale, servicing and operation of permanent life insurance
policies from 1982 through 1995. Pursuant to the settlement, the Company has
participated in a remediation program pursuant to which relief was offered to
policyowners who were misled when they purchased permanent life insurance
policies in the United States from 1982 to 1995. Prudential has agreed to
indemnify the Company for any liability incurred in connection with that
litigation.
The balance of the Company's litigation is subject to many uncertainties, and
given the complexity and scope, the outcomes cannot be predicted with precision.
Management believes that any ultimate liability which could result from such
litigation would not have a material adverse effect on the Company's financial
position.
13. DIVIDENDS
The Company is subject to Arizona law which limits the amount of dividends that
insurance companies can pay to stockholders. The maximum dividend which may be
paid in any twelve month period without notification or approval is limited to
the lesser of 10% of statutory surplus as of December 31 of the preceding year
or the net gain from operations of the preceding calendar year. Cash dividends
may only be paid out of surplus derived from realized net profits. Based on
these limitations and the Company's surplus position at December 31, 1999, the
Company would not be permitted a non-extraordinary dividend distribution in
2000.
14. RELATED PARTY TRANSACTIONS
Service Agreements
Prudential and the Company operate under service and lease agreements whereby
services of officers and employees (except for those agents employed directly by
the Company in Taiwan), supplies, use of equipment and office space are provided
by Prudential. Prudential periodically reviews its methods for determining the
level of administrative expenses charged to the Company. Late in 1998,
Prudential revised its allocation methodology to more closely align allocations
based on business processes, resulting in increased allocations from 1998
levels. Management believes that the updated methodology is reasonable and
better reflects actual costs incurred by Prudential to process transactions on
behalf of the Company. The net cost of these services allocated to the Company
were $317.4 million, $269.9 million and $139.5 million for the years ended
December 31, 1999, 1998, and 1997, respectively.
In addition, the Company received allocated distribution expenses from
Prudential's retail agency network. Beginning in 1999, market based distribution
transfer pricing was the basis for allocating costs to each product line that
distributes products through Prudential's retail agency channels. A majority of
these distribution expenses have been capitalized by the Company as deferred
policy acquisition costs (" DAC").
The Company receives asset management fee income from policyholder account
balances invested in the Prudential Series Fund ("PSF"). These amounts are shown
as asset management fees on the statement of operations. The Company also
collects these fees on behalf of Prudential. The amounts due to Prudential
related to PSF fees were $0.1 million and $22.6 million at December 31, 1999 and
December 31, 1998, respectively.
F-23
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
14. RELATED PARTY TRANSACTIONS (continued)
The Company pays an asset management fee to Prudential Global Asset Management
("PGAM") for managing the Separate Account investment portfolio. The expense for
the year was $25.9 million, which is shown in general, administrative and other
expenses.
The Company has sold three Corporate Owned Life Insurance ("COLI") policies to
Prudential. The cash surrender value included in Separate Accounts was $725.3
million and $362.3 million at December 31, 1999, and 1998, respectively. The
fees received in 1999 related to the COLI policies were $4.0 million.
Reinsurance
The Company currently has three reinsurance agreements in place with Prudential
(the reinsurer). Specifically a reinsurance Group Annuity Contract, whereby the
reinsurer, in consideration for a single premium payment by the Company,
provides reinsurance equal to 100% of all payments due under the contract, and
two yearly renewable term agreements in which the Company may offer and the
reinsurer may accept reinsurance on any life in excess of the Company's maximum
limit of retention. The Company is not relieved of its primary obligation to the
policyholder as a result of these reinsurance transactions. These agreements had
no material effect on net income for the years ended December 31, 1999, 1998,
and 1997.
Debt Agreements
In July 1998, the Company established a revolving line of credit facility of up
to $500 million with Prudential Funding Corporation, a wholly owned subsidiary
of Prudential. There is no outstanding debt relating to this credit facility as
of December 31, 1999.
F-24