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UNITED STATES
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, 2001
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
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(State or other jurisdiction, (IRS Employer Identification No.)
incorporation or organization)
213 Washington Street, Newark, New Jersey 07102
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(Address of principal executive offices) (Zip Code)
(973) 802-3274
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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 ___
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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 27, 2002. Common
stock, par value of $10 per share: 250,000 shares outstanding
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PRUCO LIFE INSURANCE COMPANY
(Registrant)
INDEX
Page No.
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Cover Page -
Index 2
PART I Item 1. Business 3
Item 2 Properties 3
Item 3. Legal Proceedings 3
Item 4. Submission of Matters to a Vote of Security Holders 4
PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 5
Item 6. Selected Financial Data 5
Item 7. Management's Discussion and Analysis of Financial Position and Results of Operations 5
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 17
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes in and Disagreements with Independent Accountants on Accounting
and Financial Disclosure 21
PART III Item 10. Directors and Executive Officers of the Registrant 22
Item 11. Executive Compensation 24
Item 12. Security Ownership of Certain Beneficial Owners and Management 24
Item 13. Certain Relationships and Related Transactions 24
PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 25
Exhibit Index 25
Signatures 27
Forward-Looking Statement Disclosure
Certain of the statements included in this Annual Report on Form 10-K, including
but not limited to those in the Management's Discussion and Analysis of
Financial Condition and Results of Operations, constitute forward-looking
statements within the meaning of the U.S. Private Securities Litigation Reform
Act of 1995. Words such as "expects," "believes," "anticipates," "includes,"
"plans," "assumes," "estimates," "projects," or variations of such words are
generally part of forward-looking statements. Forward-looking statements are
made based on management's current expectations and beliefs concerning future
developments and their potential effects upon Pruco Life Insurance Company ("the
Company"). There can be no assurance that future developments affecting the
Company will be those anticipated by management. These forward-looking
statements are not a guarantee of future performance and involve risks and
uncertainties, and there are certain important factors that could cause actual
results to differ, possibly materially, from expectations or estimates reflected
in such forward-looking statements, including without limitation: general
economic, market and political conditions, including the performance of
financial markets, interest rate fluctuations and the continuing impact of the
events of September 11; volatility in the securities markets; reestimates of our
reserves for future policy benefits and claims; our exposure to contingent
liabilities; catastrophe losses; investment losses and defaults; changes in our
claims-paying or credit ratings; competition in our product lines and for
personnel; fluctuations in foreign currency exchange rates and foreign
securities markets; risks to our international operations; the impact of
changing regulation or accounting practices; adverse litigation results; and
changes in tax law. The Company does not intend, and is under no obligation to,
update any particular forward-looking statement included in this document.
2
PART 1
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, term life
insurance, variable and fixed annuities, and a non-participating guaranteed
interest contract ("GIC") called Prudential Credit Enhanced GIC ("PACE") in the
District of Columbia, Guam and in all states except New York. The Company also
had marketed individual life insurance through its branch office in Taiwan. The
branch office was transferred to an affiliated Company on January 31, 2001, as
described in the Notes to the Financial Statements.
The Company has one wholly owned subsidiary, Pruco Life Insurance Company of New
Jersey ("PLNJ"). 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, term life insurance, fixed and variable
annuities only in the states of New Jersey and New York. Another wholly owned
subsidiary, The Prudential Life Insurance Company of Arizona ("PLICA") was
dissolved on September 30, 2000. All assets and liabilities were transferred to
the Company. PLICA had no new business sales in 2000, 1999 or 1998.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential"), an insurance company founded in 1875 under the laws of
the state of New Jersey. On December 18, 2001 ("the date of demutualization")
Prudential converted from a mutual life insurance company to a stock life
insurance company and became an indirect wholly owned subsidiary of Prudential
Financial, Inc. (the "Holding Company"). The demutualization was completed in
accordance with Prudential's Plan of Reorganization, which was approved by the
Commissioner of the New Jersey Department of Banking and Insurance in October
2001.
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 Company's policyholder contracts. During 2000, a capital contribution of
$27.2 million resulted from the forgiveness of an intercompany receivable.
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
Office space is provided by Prudential, as is described in the Notes to the
Consolidated Financial Statements.
Item 3. Legal Proceedings
Prudential and the Company are subject to legal and regulatory actions in the
ordinary course of their businesses, including class actions. Pending legal and
regulatory actions include proceedings relating to aspects of the businesses and
operations that are specific to the Company and Prudential and that are typical
of the businesses in which the Company and Prudential operate. Some of these
proceedings have been brought on behalf of various alleged classes of
complainants. In certain of these matters, the plaintiffs are seeking large
and/or indeterminate amounts, including punitive or exemplary damages.
Beginning in 1995, regulatory authorities and customers brought significant
regulatory actions and civil litigation against the Company and Prudential
involving individual life insurance sales practices. In 1996, Prudential, on
behalf of itself and many of its life insurance subsidiaries including the
Company entered into settlement agreements with relevant insurance regulatory
authorities and plaintiffs in the principal life insurance sales practices class
action lawsuit covering policyholders of individual permanent life insurance
policies issued in the United States from 1982 to 1995. Pursuant to the
settlements, the companies agreed to various changes to their sales and business
practices controls, to a series of fines, and to provide specific forms of
relief to eligible class members. Virtually all claims by class members filed in
connection with the settlements have been resolved and virtually all aspects of
the remediation program have been satisfied. While the approval of the class
action settlement is now final, Prudential and the Company remain subject to
oversight and review by insurance regulators and other regulatory authorities
with respect to its sales practices and the conduct of the remediation program.
The U.S. District Court has also retained jurisdiction as to all matters
relating to the administration, consummation, enforcement and interpretation of
the settlements.
3
As of February 28, 2002, Prudential and/or the Company remained a party to
approximately 44 individual sales practices actions filed by policyholders who
"opted out" of the class action settlement relating to permanent life insurance
policies issued in the United States between 1982 and 1995. In addition, there
were 20 sales practices actions pending that were filed by policyholders who
were members of the class and who failed to "opt out" of the class action
settlement. Prudential and the Company believe that those actions are governed
by the class settlement release and expects them to be enjoined and/or
dismissed. Additional suits may be filed by class members who "opted out" of the
class settlements or who failed to "opt out" but nevertheless seek to proceed
against Prudential and/or the Company. A number of the plaintiffs in these cases
seek large and/or indeterminate amounts, including punitive or exemplary
damages. Some of these actions are brought on behalf of multiple plaintiffs. It
is possible that substantial punitive damages might be awarded in any of these
actions and particularly in an action involving multiple plaintiffs.
Prudential has indemnified the Company for any liabilities incurred in
connection with sales practices litigation covering policyholders of individual
permanent life insurance policies issued in the United States from 1982 to 1995.
The Company's litigation is subject to many uncertainties, and given the
complexity and scope, the outcomes cannot be predicted. It is possible that the
results of operations or the cash flow of the Company in a particular quarterly
or annual period could be materially affected by an ultimate unfavorable
resolution of pending litigation and regulatory matters. Management believes,
however, that the ultimate outcome of all pending litigation and regulatory
matters should not have a material adverse effect on the Company's financial
position.
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of the stockholders held on June 15, 2001, 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.
Vivian L. Banta
Richard J. Carbone
Helen M. Galt
Jean D. Hamilton
Ronald P. Joelson
David R. Odenath, Jr.
4
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
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 Subsidiary
For the Years Ended December 31,
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(In Thousands)
2001 2000 1999 1998 1997
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Revenues
Premiums and other revenue $ 593,912 $ 670,445 $ 575,190 $ 473,975 $ 435,547
Realized investment (losses)
gains, net (60,476) (20,679) (32,545) 44,841 10,974
Net investment income 343,638 337,919 276,821 261,430 259,634
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Total revenues 877,074 987,685 819,466 780,246 706,155
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Benefits and Expenses
Policyholders' benefits and interest
credited to policyholders' account 452,046 419,073 341,894 312,731 310,352
balances
Other expenses 382,701 410,684 392,041 231,320 227,561
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Total benefits and expenses 834,747 829,757 733,935 544,051 537,913
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Income before income tax provision 42,327 157,928 85,531 236,195 168,242
Income tax (benefit) provision (25,255) 54,432 29,936 84,233 61,868
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Net income $ 67,582 $ 103,496 $ 55,595 $ 151,962 $ 106,374
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Total assets at year end $22,093,412 $ 23,059,009 $21,768,508 $ 16,812,781 $12,851,467
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Separate Account liabilities at year end $14,920,584 $ 16,230,264 $16,032,449 $ 11,490,751 $ 7,948,788
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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 sells interest-sensitive individual life insurance and variable life
insurance, term life insurance, individual variable and fixed annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced ("PACE") 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 marketed individual life insurance through its branch office in
Taiwan. The Taiwan branch was transferred to an affiliated Company on January
31, 2001, as described in the Notes to the Financial Statements.
Generally, policyholders who purchase the Company's products have the option of
investing in the Separate Accounts, segregated funds for which investment risks
are borne by the customer, or the Company's portfolio, referred to as the
General Account. The Company earns its profits through policy fees charged to
Separate Account annuity and life policyholders and through the interest spread
for the GIC and General Account annuity and life products. Policy charges and
fee income consist mainly of three types, sales charges or loading fees on new
sales, mortality and expense charges ("M&E") assessed on fund balances, and
mortality and related charges based on total life insurance in-force business.
Policyholder fund values are affected by net sales (sales less withdrawals),
changes in interest rates and investment returns. The interest spread represents
the difference between the investment income earned by the Company on its
investment portfolio and the amount of interest credited to the policyholders'
accounts. Products that generate spread income primarily include the GIC
product, general account life insurance products, fixed annuities and the
fixed-rate option of variable annuities. The majority of the fund balances and
new sales, except for the GIC product, are in the Separate Accounts.
5
In accordance with a profit sharing agreement with Prudential that was in effect
through December 31, 2000, the Company received fee income from policyholder
account balances invested in the Prudential Series Funds ("PSF"). PSF are a
portfolio of mutual fund investments related to the Company's Separate Account
products. These revenues were recorded as "Asset management fees" in the
Consolidated Statements of Operations and Comprehensive Income. The Company was
charged an asset management fee by Prudential Global Asset Management ("PGAM")
and Jennison Associates LLC ("Jennison") for managing the PSF portfolio. These
fees were a component of "general, administrative and other expenses."
On September 29, 2000, the Board of Directors for the Prudential Series Fund,
Inc. ("PSFI") adopted resolutions to terminate the existing management agreement
between PSFI and Prudential, and has appointed another subsidiary of Prudential
as the fund manager for the PSF. The change was approved by the shareholders of
PSFI during early 2001 and was effective as of January 1, 2001. Therefore as of
January 1, 2001, the Company no longer receives fees associated with the PSF or
incurs asset management expenses from PGAM and Jennison associated with the PSF.
This transaction resulted in a decrease in net income from the prior year of $
34.2 million.
On January 31, 2001, the Company transferred all of its assets and liabilities
associated with the Company's Taiwan branch including Taiwan's insurance book of
business to an affiliated Company, Prudential Life Insurance Company of Taiwan
Inc. ("Prudential of Taiwan"), a wholly owned subsidiary of Prudential.
The mechanism used to transfer this block of business in Taiwan is referred to
as a "full acquisition and assumption" transaction. Under this mechanism, the
Company is jointly liable with Prudential of Taiwan for two years from the
giving of notice to all obligees for all matured obligations and for two years
after the maturity date of not-yet-matured obligations. Prudential of Taiwan is
also contractually liable, under indemnification provisions of the transaction,
for any liabilities that may be asserted against the Company. The transfer of
the insurance related assets and liabilities was accounted for as a
long-duration coinsurance transaction under accounting principles generally
accepted in the United States. Under this accounting treatment, the insurance
related liabilities remain on the books of the Company and an offsetting
reinsurance recoverable is established.
As part of this transaction, the Company made a capital contribution to
Prudential of Taiwan in the amount of the net equity of the Company's Taiwan
branch as of the date of transfer. In July 2001, the Company dividended its
interest in Prudential of Taiwan totaling $45.8 million to Prudential.
Beginning February 1, 2001 Taiwan's net income is not included in the Company's
results of operations. The Taiwan branch had net income of $1.8 million ($97.8
million in revenues and $96.0 million in expenses) in 2000.
On December 28, 2001, the Company paid to Prudential an extraordinary dividend
which was approved by the Insurance Department of Arizona. The dividend was $108
million and was paid with cash of $26 million and fixed maturities of $82
million.
In connection with Prudential's demutualization, qualified annuity contract
holders were given increases to their policy values in the form of policy
credits. The policy credits of $128.0 million are reflected as a reduction of
retained earnings.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted
accounting principles ("GAAP") requires the application of accounting policies
that often involve a significant degree of judgment. Management, on an ongoing
basis, reviews critical estimates and assumptions. If management determines, as
a result of its consideration of facts and circumstances, that modifications in
assumptions and estimates are appropriate, results of operations and financial
position as reported in the Consolidated Financial Statements may change
significantly.
The following sections discuss accounting policies applied in preparing our
financial statements that Management believes are most dependent on the
application of estimates and assumptions.
6
Valuation of investments
The major portion of our investments are recorded at fair value in the statement
of financial position. Fair values are based on quoted market prices or
estimates from independent pricing services, when available. However, when such
information is not available, for example, with respect to private placement
fixed maturity securities, fair value is estimated, typically by using a
discounted cash flow model, which considers current market credit spreads for
publicly traded issues with similar terms by companies of comparable credit
quality. Consequently, changes in estimated future cash flows or in our
assessment of the issuer 's credit quality will result in changes in carrying
value. For fixed maturities and equity securities classified as available for
sale, the impact of such changes is recorded in "Accumulated other comprehensive
income (loss)," a separate component of equity. However, the carrying value of
these securities is written down to estimated fair value when a decline in value
is considered to be other than temporary, and we record the corresponding
impairment loss in "Realized investment losses, net," in the Consolidated
Statements of Operations and Comprehensive Income. The factors we consider to
determine if an impairment loss is warranted are discussed more fully in Note 2
to the Consolidated Financial Statements. The level of impairment losses can be
expected to increase when economic conditions worsen and decrease when economic
conditions improve.
Policyholder liabilities and deferred policy acquisition costs
The liability for future policy benefits is primarily comprised of the present
value of estimated future payments to holders of life insurance and annuity
products where the timing and amount of payment depends on policyholder
mortality surrender or retirement experience. For life insurance and annuity
products, expected mortality is generally based on the Company 's historical
experience or standard industry tables. Interest rate assumptions are based on
factors such as market conditions and expected investment returns. Although
mortality and interest rate assumptions are "locked-in" upon the issuance of new
insurance or annuity business with fixed and guaranteed terms, significant
changes in experience or assumptions may require us to provide for expected
future losses on a product by establishing premium deficiency reserves.
Our liability for Unpaid claims and claim adjustment expenses includes estimates
of claims that we believe have been incurred, but have not yet been reported
("IBNR"), as of the balance sheet date. These estimates, and estimates of the
amounts of loss we will ultimately incur on reported claims, which are based in
part on our historical experience, are regularly adjusted to reflect actual
claims experience. When actual experience differs from our previous estimate,
the resulting difference will be included in our reported results for the period
of the change in estimate.
For most life insurance and annuity products that we sell, we defer costs that
vary with and are related primarily to the production of new business to the
extent these costs are deemed recoverable from future profits, and we record
these costs as an asset known as deferred policy acquisition costs or "DAC" "in
the statements of financial position. We amortize this DAC asset over the
expected lives of the contracts, based on the level and timing of either
estimated profits or premiums, depending on the type of contract. For products
with amortization based on future premiums, the amortization rate is locked-in
when the product is sold. However, for products with amortization based on
estimated profits, the amortization rate is periodically updated to reflect
current period experience or changes in assumptions that affect future
profitability, such as lapse rates, investment returns, mortality experience,
expense margins and surrender charges. These changes result in adjustments to
DAC balances in the period that we change our assumptions as well as changes in
prospective DAC amortization. For example, adverse market conditions in 2001
resulted in declines in the market values of assets supporting our variable life
insurance and annuity products, which in turn resulted in lower expectations
regarding our estimated future gross profits from fee-based income. As a result,
we recorded a higher level of DAC amortization in 2001 for these products. DAC
is also subject to periodic recoverability testing.
Reserves for contingencies and litigation
A contingency is an existing condition that involves a degree of uncertainty
that will ultimately be resolved upon the occurrence of future events. Under
GAAP, reserves for contingencies are required to be established when the future
event is probable and its impact can be reasonably estimated. An example is the
establishment of a reserve for losses in connection with an unresolved legal
matter. The initial reserve reflects management 's best estimate of the probable
cost of ultimate resolution of the matter and is revised accordingly as facts
and circumstances change and, ultimately, when the matter is brought to closure.
In situations in which the Company is to be indemnified by Prudential, as with
the sales practices actions, a reserve for contingencies would not need to be
established in the Company's financial statements.
7
Other significant estimates
In addition to the items discussed above, the application of GAAP requires
management to make other estimates and assumptions. One example is the
recognition of deferred tax assets, which depends on management's assumption
that future earnings will be sufficient to realize the deferred benefit. This is
discussed in Note 8 to the Consolidated Financial Statements.
The Company's Changes in Financial Position and Results of Operations are
described below.
Changes in Financial Position
2001 versus 2000
From December 31, 2000 to December 31, 2001 there was a decrease of $966 million
in total assets from $23.059 billion to $22.093 billion, the majority of which
relates to a $1.310 billion decrease in Separate Accounts primarily from stock
market declines, as described below. The fixed maturity portfolio increased $139
million resulting from unrealized appreciation from declining interest rates and
from positive cash inflows. The transfer of the Company's Taiwan branch
accounted for using coinsurance accounting required the establishment of
reinsurance recoverable of $260.6 million, and the inclusion of the Taiwan
branch future policy reserve liabilities on the Company's balance sheet. The
Company also reclassified held-to-maturity securities, amounting to $324.5
million at January 1, 2001 to the available-for-sale category.
During the year, liabilities decreased by $784 million from $21.226 billion to
$20.442 billion. Separate account liabilities decreased $1.310 billion as a
result of net investment losses of $1.388 billion, expense disbursements and
other changes of $244 million offset by net sales of $322 million. Current year
net sales of $322 million ($1.540 billion of contributions less $1.218 billion
of surrenders and withdrawals) are $918 million lower than the same period prior
year sales of $1.240 billion ($2.376 billion of contributions less $1.136
billion of surrenders and withdrawals). The primary reason for the decrease is
declines in Discovery Select annuity product ("Discovery Select") exchange sales
resulting from the discontinuation of the Exchange Program on May 1, 2000. The
Exchange Program had provided the contract holders of older Prudential or Pruco
Life annuity products an opportunity to convert to the Discovery Select product.
Annuity product net sales declined $1.118 billion while variable life insurance
sales grew $200 million from the prior year.
Policyholder account balances increased by $301 million from interest credited
and positive cash inflows for the PACE product and the general account life and
annuity products. Future policy benefit liabilities increased by $105 million
resulting from sales of term insurance, additional extended term insurance, and
increases to Taiwan branch reserves. Other liabilities increased by $108 million
as a result of policy credits granted to Separate Account qualified annuity
contract holders related to the demutualization.
Total equity declined $181 million from $1.832 billion at December 31, 2000 to
$1.651 billion at December 31, 2001. The largest factor in this decrease is the
payment of two dividends, which are discussed above, to Prudential totaling
$153.8 million. One dividend consisted of an extraordinary dividend approved by
the Insurance Department of Arizona for $108 million. The other dividend of
$45.8 million represented the Company's net investment in its Taiwan branch,
which was contributed to a sister company, Prudential Life Insurance Company of
Taiwan, and subsequently dividended to Prudential. Refer to Note 14 for more
information on the Taiwan dividend. Equity was also reduced by $128.0 million
for policy credits to be made to eligible policyholders. In connection with
Prudential's demutualization, qualified annuity contract holders were given
increases to their policy values in the form of policy credits. In addition,
equity was increased by net income of $67.6 million, net unrealized investment
gains of $30.0 million and net foreign currency translation adjustments of $3.2
million.
2000 versus 1999
Total assets increased from $21.768 billion at December 31, 1999 to $23.059
billion at December 31, 2000, an increase of $1.291 billion, primarily from
increases in investments and cash and cash equivalents of $945 million, and
Separate Accounts of $198 million. Investments increased due to positive
insurance cash inflows and unrealized appreciation of fixed maturities. A
discussion of Separate Account balances and net sales follows.
8
Although there were positive Separate Account net sales of $1.240 billion
(contributions of $2.376 billion less withdrawals of $1.136 billion), growth in
the Separate Accounts was minimized by expense disbursements and other changes
of $384 million, and in particular, investment losses from stock value declines
of $658 million. This was in contrast to the prior year which experienced
investment gains of $2.164 billion. However, the average Separate Account fund
value during the current year, which is more indicative of fee income, was
approximately $3 billion higher than the prior year, due to beginning of the
year 2000 balances being substantially higher than the prior year. The majority
of the net sales were from the Discovery Select annuity product ("Discovery
Select"), which had net sales of $1.115 billion. This was significantly lower
than net sales of Discovery Select of $2.646 billion in 1999 due primarily to
the termination of the Exchange program in May 2000. Surrenders also increased
due to the aging of the business and since exchange assets are not subject to
surrender charges.
Total liabilities increased from $20.099 billion at December 31, 1999 to $21.226
billion at December 31, 2000, an increase of $1.127 billion. The increase was
primarily due to increases to policyholder account balances of $522 million,
securities lending liabilities of $181 million, Separate Account liabilities of
$198 million, and an increase to future policy reserves of $73 million. The
increase in policyholders' account balances from $3.125 billion at December 31,
1999 to $3.647 billion at December 31, 2000 was primarily due to increases of
$315 million from sales of the PACE product, and an increase of $175 million,
mainly due to exchanges and sales of the Discovery Select product for the
General Account. Future policy benefits increased by $73 million from $630
million at December 31, 1999 to $703 million at December 31, 2000 primarily the
result of increased sales and in-force business at the Taiwan branch.
Results of Operations
2001 versus 2000
Net Income
Consolidated net income was $35.9 million lower for the year ended December 31,
2001 than for the year ended December 31, 2000. Economic and market downturns
resulted in increased realized investment losses for impairments and sales of
fixed maturities of $39.8 million. In addition, there was increased amortization
of deferred policy acquisition costs ("DAC") of $35.2 million for domestic life
and annuity products, resulting from a decline in expected future profits. Net
asset management fee revenue declined $34.2 million ($63.3 million in revenues
less $29.1 million of expenses). The Company ceased receiving fee income or
paying asset management fee expenses related to the Prudential Series Fund
("PSF") as of January 1, 2001, as described in the Notes to Consolidated
Financial Statements. Policyholder benefits were $8.0 million higher as
increases to domestic individual life product reserves, death benefits, and
surrender benefits offset decreases in the Taiwan branch's policyholder
benefits. Tax expense for the current year is lower than the prior year by $79.7
million due to reduced income from operations before income taxes and a
refinement of the estimated benefits from nontaxable investment income.
Revenues
Consolidated revenues decreased by $110.6 million, from $987.7 million to $877.1
million. As discussed above, the elimination of PSF asset management fees
reduced revenues by $63.3 million. Premiums decreased by $31.0 million from the
prior year. The ceding of premiums pursuant to the transfer of the Company's
Taiwan branch caused an $80.6 million decline in premiums. This was partially
offset by higher term insurance sales of the Term Essential and Term Elite
products, as those products were not launched until late 2000, and an increase
in 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 policyholder 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.
Future policy benefit reserves are also increased by the amount of these
premiums.
Realized investment losses increased by $39.8 million from the prior year as
recognized writedowns on fixed maturities with other than temporary impairments
increased by $41.2 million in 2001. In addition, a realized loss of $29.2
million was recorded on the sale of Enron fixed maturities in 2001. Partially
offsetting these investment declines were gains on sales of fixed maturities of
$21.8 million in 2001(excluding Enron) compared to losses of $22.3 million in
2000 as interest rates declined in 2001 increasing the fair value of the bonds.
The sales in 2000 were made in the early part of the year before rates
substantially declined. Derivative instruments and other investment gains were
$13.5 million less than in 2000. This was mainly the result of the Company's net
short position in futures during 2001, versus a net long position in 2000, as
interest rates were generally declining in both years.
These decreases were partially offset by increases in policy charges and fee
income and net investment income. Policy charges and fee income, consisting
primarily of mortality and expense ("M&E"), loading and other insurance charges
assessed on General and Separate Account policyholder fund balances, increased
by $15.3 million. The increase was a result of a $29.0 million increase for
domestic individual life products offset by a $13.7 million decrease for annuity
products. Mortality and sales based loading charges for life products increased
as a result of growth in the in-force business and higher new sales. The
in-force business grew from $53.214 billion at December 31, 2000 to $58.743
billion at December 31, 2001, an increase of 10.3%. In contrast, annuity fees
are mainly asset based fees which are dependent on the fund balances which are
affected by net sales as well as asset depreciation or appreciation on the
underlying investment funds in which the customer has the option to invest.
Annuity fund balances have declined as a result of unfavorable valuation changes
in the securities market and lower sales due to the discontinuation of the
Exchange program.
9
Net investment income increased by $5.7 million from the prior year as income
from fixed maturities rose as a result of a higher average asset base from
reinvestment of proceeds from GIC sales, and general account annuity life
deposits. Partially offsetting this increase was a decline in short term
investments and cash equivalent income mainly as a result of lower interest
rates.
Other income increased $2.5 million due to an increase in the modal premium
charge for policyholders who pay other than annual premiums, as a result of the
growth of the term insurance business.
Benefits and Expenses
Policyholder benefits increased by $8.0 million from increases in domestic
individual life product reserves, death benefits, and surrender benefits; offset
by decreases in Taiwan's policyholder benefits. Death benefits increased $29.0
million due mainly to the increased in force business, with $11.6 million of the
increase specifically related to the September 11 terrorist attacks. Domestic
individual life reserves increased $32.6 million as a result of sales of term
insurance and extended term premiums. There were also increased benefits paid on
surrenders of reduced paid up policies of $8.3 million. Offsetting these were
decreases in reserve provisions and benefits for the Company's Taiwan branch of
$61.6 million.
Interest credited to policyholder account balances increased by $25.0 million as
policyholder account balances grew by $301.0 million from December 2000 mainly
as a result of GIC and general account life and annuity sales, as mentioned
above.
General, administrative, and other expenses decreased $28.0 million from the
prior year. Commission and distribution expenses after capitalization, excluding
the Taiwan branch, are $33.2 million lower resulting from a change in the
allocation of distribution expenses to a market based pricing arrangement as of
April 1, 2000 and higher capitalization of commissions from new sales. The
elimination of asset management expenses lowered expenses by $29.1 million. The
transfer of the Company's Taiwan branch resulted in an expense reduction of
$25.2 million.
Partially offsetting these decreases was an increase in DAC amortization of
domestic life and annuity products of $35.2 million from increases in deferrable
expenses as a result of sales, and increased amortization associated with a
decline in expected future profits from stock market declines. There was also an
additional $24.3 million of expenses, excluding the Taiwan branch, driven by
higher allocations charged to the Company for salary, consulting, and data
processing costs. The Company is assuming a larger share of allocated costs as
allocations are based on new sales of which the Company has a higher percentage
than in the previous year.
2000 versus 1999
Net Income
Net income for the year ended December 31, 2000 was $103.5 million; an increase
of $47.9 million from $55.6 million earned in the year ended December 31, 1999.
The increase reflects a $168.2 million, or 20.5% increase in revenues, offset in
part by a $95.8 million, 13.1% increase in expenses. Income taxes increased by
$24.5 million corresponding with the income increase.
Revenues
Policy charges and fee income increased by $60.4 million, to $474.9 million in
2000 from $414.4 million in 1999. In addition, asset management fees, primarily
representing fees collected from the Pru Series Funds ("PSF") increased by $10.8
million from the prior year. Although the Separate Account fund balances as of
December 31, 2000 are only slightly higher than the prior year end due to stock
market declines, (especially in the fourth quarter) the average fund balance
during the year was $3 billion higher than the prior year, as is described in
the "Changes In Financial Position" section. Strong securities market conditions
contributed to significant appreciation in Separate Account asset values during
1999 which had a carryover effect on 2000 income, as beginning of the year
balances were substantially higher than in the previous year. Policy charges for
annuity and life products were $37.4 million and $23.0 million higher,
respectively, than the prior year. Most of the annuity increase came from higher
M&E charges from Discovery Select, as net sales of this product were
approximately $1.1 billion. The increase in life policy fees is also due to a
higher average fund balance than in the previous year.
Premiums increased $22.9 million to $121.9 million for the year ended December
31, 2000. 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 21% and gross insurance in force increased by 17%.
Premiums from annuitizations of Discovery Select contracts also contributed
somewhat to the growth in premiums.
10
Net investment income increased by $61.1 million to $337.9 million in 2000. The
increase was primarily the result of higher income from fixed maturities of
$45.8 million, and $10.4 million from short-term and cash equivalents, as the
asset base increased. Investment of cash inflows from the PACE product was the
primary cause of the increase in the asset base.
Realized investment losses, net were $20.7 million in 2000 compared to realized
losses of $32.5 million for the prior year. This improvement of $11.8 million
came primarily from derivative gains in 2000 of $15.0 million versus losses of
$1.6 million in 1999. Partially offsetting this were realized losses on fixed
maturities that were $5.7 million higher than in 1999, as most of the sales were
made in early 2000, when interest rates were higher and writedowns for
impairments deemed other than temporary were $12.3 million, an increase of $1.1
million from 1999.
Benefits and Expenses
Policyholders' benefits including changes in reserves were $248.1 million for
the year ended December 31, 2000, an increase of $43.0 million from the prior
year. Increases to reserves were $31.0 million higher than the prior year of
which $14.8 million is related to continued business expansion in the Company's
Taiwan branch. Discovery Select annuitizations of $7.7 million, and higher life
reserves for extended term insurance and disability reserves of $8.5 million
also contributed to the reserve increases. Policyholder benefits were $12.0
million higher mainly due to an increase in death claims of $9.8 million and
increased annuity and Taiwanese policyholder benefits due to the growth in
business.
Interest credited to policyholder account balances for the year ended December
31, 2000 was $171.0 million, an increase of $34.2 million from 1999. Interest
credited for the PACE product increased by $25.8 million as the PACE
policyholder account balances increased $315 million. Interest credited on
annuity products increased by $7.5 million as the General Account fund balances
increased and there were higher new money rates due to higher incentive rates
for Discovery Select.
General, administrative and other expenses, net of capitalization increased
$18.6 million to $410.7 million in 2000. The largest factor in this increase is
amortization of deferred policy acquisition costs ("DAC") of $129.0 million,
which is $32.6 million higher than the prior year. Annuity DAC amortization
increased $39.3 million to $72.8 million, due to growth in profitability of
Discovery Select, and accelerated amortization associated with a decline in
expected future gross profits as a result of unfavorable market conditions in
2000. Amortization of life products declined by $10.2 million due to prior year
write-offs of DAC for policies that were rescinded as a result of the Company's
policyholder remediation program, as described in the Notes to the financial
statements. The Taiwan branch DAC amortization increased by $3.5 million due to
growth in the business.
Commission and distribution expenses, net of capitalization are lower by $1.1
million due mainly to two offsetting factors. Growth in trail commissions on
Discovery Select exchanges, which are nondeferable, increased expenses by $8.0
million. This was offset by a change in the allocation of distribution expenses
to reflect a market based pricing arrangement. This decreased year over year
expenses (net of capitalization) by $8.9 million.
Other general and administrative expenses were down $16.1 million from the prior
year due to decreases in consulting fees, salary expenses, and charges to the
reserve for unbeknownst modified endowment contracts ("UMEC"). Consulting and
external contracted services charges were lower in 2000 by $7.9 million as the
prior year had contracted external programmers for Year 2000 system preparation
and data integrity projects. Decreases in staffing levels from the prior year
resulted in reductions in salary expense and employee benefits of $4.1 million.
Provisions made to UMEC were $6.3 million in 2000 which is $3.9 million less
than the prior year. Offsetting these decreases slightly was an increase of $3.2
million for asset management fees, asset based charges for managing Separate
Account investment portfolios, due to the increase in the average Separate
Account balance.
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
$5.207 billion at December 31, 2001, versus $5.048 billion at December 31, 2000.
A diversified portfolio of publicly traded bonds, private placements, commercial
loans on real estate and equity investments is managed under strategies intended
to maintain a competitive 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.
11
The asset management strategy for the portfolio is in accordance with an
investment policy statement developed and coordinated within the Company by the
Asset Liability and Risk Management Group, agreed to by senior management, and
approved by the 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 management strategies take into account 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 management
strategies also include 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 ("AFS"). As of December 31, 2001 all privately placed securities were
classified as AFS compared to approximately 78% in 2000. The remainder of
privately placed fixed maturities in 2000 was classified as held to maturity
("HTM"). AFS securities are carried in the Consolidated Statement of Financial
Position at fair value, with unrealized gains and losses (after certain related
adjustments) recognized by credits and charges to equity capital. HTM securities
are carried at amortized cost, and unrealized gains or losses on these
securities are not recognized in the financial statements. At December 31, 2001
the fixed maturities portfolio totaled $4.025 billion, an increase of $143
million, based on fair value, compared to December 31, 2000. This increase in
fixed maturities reflected growth in the overall portfolio due to positive cash
flow from insurance operations during 2000, appreciation arising from a lower
interest rate environment, as well as reinvestment of net investment income,
offset by dividends paid in the form of fixed maturities. The following table
displays a public/private breakout of this year's net unrealized appreciation in
the fixed income portfolio versus during 2001.
2001 2000
-----------------------------------------------------------------------------------------
Net Net
Amortized Estimated Unrealized Amortized Estimated Unrealized
Cost Fair Value Gains Cost Fair Value Gains(Losses)
------------- -------------- ------------- ----------- ----------- ----------------
(In Thousands)
Fixed Maturities
Publicly traded $ 2,638,917 $ 2,695,135 $ 56,218 $ 2,385,108 $ 2,393,919 $ 8,811
Privately placed 1,296,555 1,329,758 33,203 1,491,682 1,488,236 (3,446)
----------- ----------- -------- ----------- ----------- ---------
Total $ 3,935,472 $ 4,024,893 $ 89,421 $ 3,876,790 $ 3,882,155 $ 5,365
=========== =========== ======== =========== =========== =========
At December 31, 2001, the net unrealized capital gains/(losses) on the
"available for sale" fixed maturity portfolio totaled $89.4 million compared to
$9.3 million ($5.4 million including HTM) at December 31, 2000. The increase in
the net unrealized capital gain position is primarily due to the effect of lower
interest rates in 2001 versus 2000.
Gross investment income on fixed maturities increased by $16.1 million from 2000
to 2001 as a result of a higher asset base in 2001, offset by reinvestment and
new purchases at lower rates. Realized losses of $60.9 million were $26.3
million greater than December 31, 2000. This variance is attributed to higher
impairments taken in 2001 of $41.2 million, primarily relating to asset-backed
securities, and losses on sale of Enron holdings of $29.2 million, offset by
higher trading gains of $44.1 million, occurring mainly in the first half of the
year.
The table below summarizes fixed maturity investment results:
Year Ended December 31
------------------------
2001 2002
--------- --------
(In Thousands)
Gross Investment Income $279,477 $263,325
Yield(1) 7.32% 7.53%
Realized Capital Losses ($60,924) ($34,812)
(1) Yields are determined by dividing gross investment income by the average of
year-end asset carrying values, excluding unrealized gains and losses, less
one-half of gross investment income.
12
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 Moody's Corporation, an independent rating agency:
December 31, 2001 December 31, 2000
------------------------------------------- ------------------------------------------
Amortized Estimated Amortized Estimated
NAIC Moody's Cost % Fair Value % Cost % Fair Value %
- ------------------------ --------------------- --------------------- ------------------------------------------
(In Thousands)
1 AAA to AAA- 1,889,567 48.0% 1,930,014 48.0% $1,811,068 46.7% $1,835,642 47.3%
2 BBB+ to BBB- 1,727,161 43.9% 1,778,254 44.2% 1,794,309 46.3% 1,784,694 46.0%
3 BB+ to BB- 198,945 5.1% 201,466 5.0% 118,652 3.0% 117,793 3.1%
4 B+ to B- 81,558 2.1% 77,436 1.9% 113,050 2.9% 106,699 2.7%
5 CCC or lower 20,782 0.5% 20,786 0.5% 22,093 0.6% 20,067 0.5%
6 In or near default 17,459 0.4% 16,937 0.4% 17,618 0.5% 17,260 0.4%
---------- ---------- ---------- ----------
Total $3,935,472 100.0% $4,024,893 100.0% $3,876,790 100.0% $3,882,155 100.0%
========== ========== ========== ==========
The fixed maturity portfolio consists largely of investment grade assets (rated
"1" or "2" by the NAIC). Based on fair value, these investments accounted for
92% and 93% of the portfolio as of December 31, 2001 and 2000, respectively. As
of December 31, 2001 and 2000, less than 1% of the fixed maturities portfolio
was rated "6" by the NAIC, defined as public and private placement securities
which are currently non-performing or believed to be subject to default in the
near-term.
The Company maintains separate monitoring processes for public and private fixed
maturities and create watch lists to highlight securities, which require special
scrutiny and management. Our public 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. We
classify 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 an ongoing basis to determine whether the investment is in
compliance or should be placed on the watch list or assigned an early warning
classification. We assign early warning classification to those issuers that
have failed a servicing test or experienced a minor covenant default, and we
continue to monitor them for improvement or deterioration. We assign closely
monitored status to those investments that have been recently restructured or
for which a restructuring is a possibility due to substantial credit
deterioration or material covenant defaults. We classify as not in good standing
securities of issuers that are in more severe conditions, for example,
bankruptcy or payment default.
December 31, 2001 December 31, 2000
--------------------------------- -------------------------------
Book Value % of Total Book Value % of Total
--------------- ---------------- -------------- ---------------
(In Thousands)
Performing $ 3,903,871 99.2% $ 3,799,529 98.0%
Watch List
Closely monitored 26,230 0.7% 56,513 1.5%
Not in good standing 5,371 0.1% 20,748 0.5%
----------- --------- ----------- ---------
Total $ 3,935,472 100.0% $ 3,876,790 100.0%
=========== ========= =========== =========
Writedowns for impairments of fixed maturities which were deemed to be other
than temporary were $53.5 million, $12.3 million and $11.2 million for the years
2001, 2000 and 1999 respectively.
13
Portfolio Diversity
The fixed maturity portfolio is broadly diversified by type and industry of
issuer. As of December 31, 2001, the greatest industry concentrations within the
public portfolio were finance, utilities, and manufacturing. The greatest
industry concentrations within the private portfolio were asset-backed
securities, manufacturing and service. The fixed maturities portfolio is
summarized below by issuer category:
December 31, 2001
------------------------------------------------
Amortized Estimated % of
Cost Fair Value Fair Value
------------------------------------------------
(In Thousands)
United States Government
Securities and Obligations $ 303,606 $ 303,453 7.5%
Mortgage Backed Securities 10,148 10,247 0.3%
Asset Backed Securities (1) 577,528 590,245 14.7%
Foreign Government Securities 27,331 29,454 0.7%
Manufacturing 782,944 803,155 19.9%
Utilities 646,628 663,645 16.5%
Retail and Wholesale 223,373 230,162 5.7%
Energy 5,223 5,173 0.1%
Finance 688,064 711,932 17.7%
Services 557,311 565,654 14.1%
Transportation 106,687 104,716 2.6%
Other 6,629 7,057 0.2%
----------- ----------- --------
Total $ 3,935,472 $ 4,024,893 100.0%
=========== =========== ========
December 31, 2000
------------------------------------------------
Amortized Estimated % of
Cost Fair Value Fair Value
------------------------------------------------
(In Thousands)
United States Government
Securities and Obligations $ 309,609 $ 317,479 8.2%
Mortgage Backed Securities 31,479 31,809 0.8%
Asset Backed Securities (1) 544,447 541,315 14.0%
Foreign Government Securities 136,133 143,706 3.7%
Manufacturing 791,609 788,188 20.3%
Utilities 634,671 628,657 16.2%
Retail and Wholesale 230,303 229,162 5.9%
Energy 1,304 1,359 0%
Finance 519,690 528,020 13.6%
Services 548,729 544,555 14.0%
Transportation 122,655 121,565 3.1%
Other 6,161 6,340 0.2%
----------- ----------- --------
Total $ 3,876,790 $ 3,882,155 100.0%
=========== =========== ========
(1) Asset backed securities are primarily backed by credit card receivables,
home equity loans, trade receivables and auto loans.
14
Commercial Loans on Real Estate
As of December 31, 2001, the Company's portfolio of commercial loans on real
estate portfolio totaled $8.2 million, a reduction of $1.1 million from December
31, 2000, reflecting maturities and prepayments. The portfolio is comprised of
commercial loans on real estate, with diversification by property type and
geographic location. Refer to Footnote 3 in the Notes to Consolidated Financial
Statements. Mortgage investment income is $0.9 million, which is $0.1 million
lower than the prior year due to a lower asset base.
The Company evaluates its loans on a quarterly basis for watch list status based
on compliance with various financial ratios and other covenants set forth in the
loan agreements, borrower credit quality, property condition and other factors.
The Company may place loans on early warning status in cases where it detects
that the physical condition of the property, the financial situation of the
borrower or tenant, or other factors could lead to a loss of principal or
interest. The Company classifies as closely monitored those loans that have
experienced material covenant defaults or substantial credit or collateral
deterioration. Not in good standing loans are those for which there is a high
probability of loss of principal, such as when the borrower is in bankruptcy or
the loan is in foreclosure. An experienced staff of workout professionals
actively manages the loans in the closely monitored and not in good standing
categories.
Equity Securities
The Company's equity securities are comprised of common and non-redeemable
preferred stock and are carried at estimated fair value on the Statement of
Financial Position. Based on fair value, equity securities totaled $0.4 million
in 2001 compared to $10.8 million in 2000. At December 31, 2001, the unrealized
capital gains on the equity portfolio totaled $0.2 million compared to $2.6
million of losses at December 31, 2000. The equity securities' asset base
declined due to the transfer of stocks in connection with the transfer of the
Taiwan branch.
Short-Term Investments
Short-term investments include liquid debt instruments that have maturities
between 3 - 12 months from date of purchase. These securities are carried at
amortized cost, which approximates fair value. As of December 31, 2001, the
Company's short-term investments totaled $215.6 million, an increase of $12.8
million compared to $202.8 million at December 31, 2000. Short-term yields
decreased due to lower rates in 2001, partially offset by greater spread income
earned on securities lending activity.
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. These derivative contracts do not qualify
for hedge accounting and, consequently, we recognize the changes in fair value
of such contracts from period to period in current earnings. During 2001, $2.9
million of gains were realized in swaps versus a gain of $5.6 million in 2000.
This was due to favorable 2001 and 2000 trends in exchange rates and spreads.
During 2001, $4.3 million of losses were realized from futures versus gains of
$9.4 million in 2000. This was the result of the Company's net short position in
futures during 2001, versus a net long position in 2000, as interest rates were
generally declining in both years.
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, 2001, the Company's assets included $3.0 billion of cash and cash
equivalents, 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.
15
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.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance ("Codification"), which replaces the current Accounting
Practices and Procedures manual as the NAIC's primary guidance on statutory
accounting as of January 1, 2001. The Codification provides guidance for areas
where statutory accounting has been silent and changes current statutory
accounting in certain areas. 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 Company has adopted the Codification guidance effective
January 1, 2001. As a result of these changes, the Company reported an increase
to statutory surplus of $88 million, primarily as a result of the recognition of
deferred tax assets.
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 formulae 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.
Effective New Accounting Pronouncements
Refer to Footnote 2, "Summary of Significant Accounting Policies," of the Notes
to Consolidated Financial Statements.
16
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Risk Management, Market Risk, and Derivative Financial Instruments
As a 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 to alter interest rate
or currency exposures arising from mismatches between assets and liabilities.
These include sensitivity and Value-at-Risk measures, positions and other limits
based on type of risk, and various hedging methods.
Insurance Asset/Liability Management
The Company's asset/liability management strategies seek to match the interest
rate sensitivity of the assets to that of the underlying liabilities and to
construct asset mixes consonant with product features, such as interest
crediting strategies. The Company also considers risk-based capital implications
in its asset/liability management strategies. 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, or type of security 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 estimate the price
sensitivity of assets and liabilities to interest rate changes. Duration is an
estimate of the sensitivity of the fair value of a financial instrument relative
to changes in interest rates. Convexity is an estimate of the rate of change of
duration with respect to changes in interest rate, and is commonly used for
managing assets with prepayment risk, such as mortgage backed securities. 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 0.6 years. As of December 31,
2001, the difference between the pre-tax duration of assets and the target
duration of liabilities in the Company's duration managed portfolio was 0.2
years.
17
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,
commercial loans on real estate, and policy loans. In the aggregate, the
carrying value of these assets represented 68% of consolidated assets, other
than assets that are held in Separate Accounts, as of December 31, 2001 and 70%
as of December 31, 2000. With respect to liabilities, the Company is exposed to
interest rate risk through policyholder account balances relating to life
insurance and annuity 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, 2001 and 2000, 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.
This presentation does not include $2.753 billion and $2.587 billion of
insurance reserves and deposit liabilities at December 31, 2001 and 2000,
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, 2001
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(Derivatives) Value Shift Fair Value
---------------------------------------------------------------
(In millions)
Financial Assets and Liabilities
with Interest Rate Risk:
Financial Assets:
Fixed Maturities:
Available for Sale - $ 4,025 $ 3,902 $ (123)
Held to Maturity - - - -
Commercial Loans on Real Estate - 10 10 -
Policy Loans - 934 880 (54)
Derivatives:
Futures (128) - 6 6
Swaps 9 1 1 -
Financial Liabilities:
Investment Contracts - (2,053) (2,028) 25
-------
Total Estimated Potential Loss $ (146)
=======
18
December 31, 2000
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(Derivatives) Value Shift Fair Value
---------------------------------------------------------------
(In millions)
Financial Assets and Liabilities
with Interest Rate Risk:
Financial Assets:
Fixed Maturities:
Available for Sale - $ 3,562 $ 3,468 $ (94)
Held to Maturity - 321 313 (8)
Commercial Loans on Real Estate - 11 10 (1)
Policy Loans - 883 838 (45)
Derivatives:
Futures 202 2 1 (1)
Swaps 9 .3 .1 (.2)
Financial Liabilities:
Investment Contracts - (1,785) (1,760) 25
--------
Total Estimated Potential Loss $(124.2)
=======
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 contract holders rather than the Company.
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, 2001 was $.038 million,
representing a hypothetical decline in fair market value of equity securities
held by the Company at that date from $.375 million to $.338 million. The
Company's estimated equity price risk using this methodology at December 31,
2000 was $1.1 million, representing a hypothetical decline in fair market value
of equity securities the Company held at that date from $10.8 million to $9.7
million. These amounts exclude equity securities relating to products for which
investment risk is borne primarily by the contract holder 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.
19
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, 2001 for foreign currency assets not hedged to U.S. dollars,
measured at the 95% confidence level and using a one month time horizon, was
$0.8 million, representing a hypothetical decline in fair market value of these
foreign currency assets from $17.6 million to $16.8 million. The Company's
estimated VaR at December 31, 2000 for foreign currency assets not hedged to
U.S. dollars, measured at the 95% confidence level and using a one month time
horizon, was $2.3 million, representing a hypothetical decline in fair market
value of these foreign currency assets from $133.2 million to $130.9 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 $1.33
million during 2001 and $2.3 million during 2000.
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.
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, 2001 and 2000. Under insurance statutes the Company may only use
derivative securities in 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 manage 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.
20
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 commercial loans on real estate,
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, 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.
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.
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.
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 elsewhere in this Annual Report.
Item 9. Changes in and Disagreements with Independent Accountants on Accounting
and Financial Disclosure
Not applicable.
21
PART III
Item 10. Directors and Executive Officers of the Registrant
Name Position Age
- ---- -------- ---
Vivian L. Banta Chairman of the Board and President 51
James J. Avery, Jr. Vice Chairman of the Board and Director
50
Richard J. Carbone Director 54
Helen M. Galt Director 54
Jean D. Hamilton Director 54
Ronald P. Joelson Director 43
David R. Odenath, Jr. Director 45
Andrew J. Mako Executive Vice President 45
C. Edward Chaplin Senior Vice President and Treasurer 45
Hwei-Chung Shao Senior Vice President and Chief Actuary 47
William J. Eckert, IV Vice President and Chief Accounting Officer 39
Charles A. McGee Vice President and Comptroller 53
Clifford E. Kirsch Chief Legal Counsel and Secretary 42
Shaun M. Byrnes Senior Vice President 40
James Drozanowski Senior Vice President 59
Thomas F. Higgins Senior Vice President 47
Esther H. Milnes Senior Vice President 51
James B. O'Connor Senior Vice President 46
Vivian L. Banta, age 51, is President and Chairman of the Board of Directors of
the Company. She has been Executive Vice President, Individual Financial
Services, U.S. Consumer Group since 2000. From 1998 to 1999 she was a Consultant
for Individual Financial Services. From 1997 to 1998, Ms. Banta was a Consultant
for Morgan Stanley and prior to 1997 she was Executive Vice President, Global
Investor Service, Chase Manhattan Bank.
James J. Avery, Jr., age 50, is Vice Chairman of the Board of Directors of the
Company. Mr. Avery has been President, Prudential U.S. Consumer Group since
1998. From 1997 to 1998 he was Senior Vice President, Chief Financial Officer
and Chief Actuary for the Prudential Individual Insurance Group. From 1995 to
1997 he was President, Prudential Select.
Richard J. Carbone, age 54, has been Senior Vice President and Chief Financial
Officer since 1997. Prior to 1997 he was the Controller for Salomon Brothers.
Helen M. Galt, age 54, has been a Company Actuary for Prudential since 1993.
Jean D. Hamilton, age 54, has been Executive Vice President, Prudential
Institutional since 1998. Prior to 1998 she was President of Diversified Group.
Ronald P. Joelson, age 43, has been Senior Vice President, Prudential Asset,
Liability and Risk Management since 1999. From 1996 to 1999 he was President of
Guaranteed Products, Prudential Institutional.
22
David R. Odenath, Jr., age 45, 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 Paine
Webber.
Andrew J. Mako, age 45, is Executive Vice President of the Company. Mr. Mako has
been Vice President, Finance, U.S. Consumer Group since 1999. From 1996 to 1998,
he was Vice President for the Business Performance Management Group of
Prudential. Prior to 1996, he held various positions in Prudential since joining
Prudential in 1978.
C. Edward Chaplin, age 45, has been Senior Vice President and Treasurer of
Prudential Insurance Company of America since 2000. Prior to 2000, he was Vice
President and Treasurer of Prudential Insurance Company of America.
Hwei-Chung Shao, age 47, has been Vice President and Associate Actuary,
Prudential since 1996. Prior to 1996, she was Vice President and Assistant
Actuary, Prudential Corporate Risk Management.
William J. Eckert, IV, age 39, was elected Vice President and Chief Accounting
Officer of the Company in June 2000. Mr. Eckert has been Vice President,
Enterprise Financial Management of Prudential Insurance Company of America since
May 1995. Prior to joining Prudential in 1995, he was Senior Manager at Deloitte
& Touche, LLP.
Charles A. McGee, age 53, was elected Vice President and Controller of the
Company in June 2001. Mr. McGee has been Vice President, Financial Reporting of
Prudential since June 2001. He has held a variety of assignments in his 30 years
with Prudential.
Clifford E. Kirsch, age 42, 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.
Shaun M. Byrnes, age 40, has been Senior Vice President, Director of Mutual
Funds, Annuities & UITs, Prudential Investments (PI) since 2001. From 2000 to
2001 he was Senior Vice President, Director of Research, Prudential Investments.
From 1999 to 2000 Mr. Byrnes was Senior Vice President, Director of Mutual
Funds, Prudential Investments, and from 1997 to 1999 he was Vice President,
Mutual Funds, Prudential Investments. Prior to joining Prudential in 1997, he
was Vice President, SIB Portfolio Advisors, Inc.
James C. Drozanowski, age 59, has been Vice President, Operations and Systems,
Prudential U.S. Consumer Group 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.
Thomas F. Higgins, age 47, has been Vice President of Annuity Services and
Prudential U.S. Consumer Group since 1999. From 1998 to 1999 he was Vice
President of Mutual Funds, Prudential Individual Financial Services. Prior to
1998, he was Principal of Mutual Fund Operations, The Vanguard Group.
Esther H. Milnes, age 51, has been Vice President and Chief Actuary, Prudential
U.S. Consumer Group since 1999. From 1996 to 1999 she was Vice President and
Actuary of Prudential U.S. Consumer 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 B. O'Connor, age 46, is Senior Vice President and Actuary for the Company.
Mr. O'Connor has been Vice President, Guaranteed Products since 2001. From 1998
to 2000 he was Corporate Vice President of Guaranteed Products. Prior to 1998 he
was Corporate Actuary for Prudential Investments.
23
Item 11. Executive Compensation
The following table shows the 2001 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
- ---------------------------- ------------------- ----------------- ----------------- -----------------
Vivian L. Banta, President 2001 $ 35,084 $ 213,904 $ 0
Esther H. Milnes, President 2000 21,533 3,132 0
Esther H. Milnes, President 1999 20,782 23,238 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.
24
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (2) Financial Statements of the Registrant and its
subsidiary are listed in the accompanying "Index to Consolidated
Financial Statements" 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
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, which was a wholly owned subsidiary of Pruco Life
Insurance, was dissolved on September 30, 2000.
22. None.
23. Not applicable.
25
24. A Power of Attorney for James J. Avery, Jr. is incorporated
by reference to Post-Effective Amendment No. 2 to Form S-6,
Registration No. 333-07451, filed June 25, 1997 on behalf of
the Pruco Life Variable Appreciable Account. Powers of
attorney for David R. Odenath, Jr., Ronald P. Joelson, and
William J. Eckert, IV may be incorporated by reference to Form
N-4, Registration No. 333-52754, filed December 26, 2000 on
behalf of the Pruco Life Flexible Premium Variable Annuity
Account. Powers of attorney for Vivian L Banta, Richard J.
Carbone, Helen M. Galt, and Jean D. Hamilton may be
incorporated by reference to Post-Effective Amendment No. 5 to
Form S-6, Registration No. 333-85115, filed June 28, 2001 on
behalf of the Pruco Life Variable Universal Account.
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 account(s)
For the account of the contract
of the Company holder(s)
------------------------------ ------------------
Aggregate
offering price Amount sold Amount sold
of amount
registered
--------------- --------------- ------------------
(In Thousands)
Flexible Premium Variable Annuity Account * $ 500,000 $ 375,342 $ 91,489
Underwriting discounts and commissions ** (10,797)
Other expenses *** (21,412)
---------
Total (32,209)
---------
Net offering proceeds $ 343,133
=========
* 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.
26
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 27, 2002 By: ______________________________
--------------
Andrew J. Mako
Executive Vice 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 and President March 27, 2002
Vivian L. Banta
*
_____________________________ Vice Chairman of the Board March 27, 2002
James J. Avery, Jr. and Director
*
_____________________________ Director March 27, 2002
Jean D. Hamilton
*
_____________________________ Director March 27, 2002
Ronald Paul Joelson
*
_____________________________ Director March 27, 2002
Richard J. Carbone
*
_____________________________ Director March 27, 2002
Helen M. Galt
*
_____________________________ Director March 27, 2002
David R. Odenath, Jr.
______________________________ Vice President and March 27, 2002
William J. Eckert, IV Chief Accounting Officer
* By: ___________________________
Thomas C. Castano
(Attorney-in-Fact)
27
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARY
Consolidated Financial Statements and
Report of Independent Accountants
December 31, 2001 and 2000
28
PRUCO LIFE INSURANCE COMPANY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements Page No.
- -------------------- --------
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARY
Report of Independent Accountants F - 2
Consolidated Financial Statements:
Consolidated Statements of Financial Position - December 31, 2001 and 2000 F - 3
Consolidated Statements of Operations and Comprehensive Income
Years ended December 31, 2001, 2000 and 1999 F - 4
Consolidated Statements of Changes in Stockholder's Equity
Years ended December 31, 2001, 2000 and 1999 F - 5
Consolidated Statements of Cash Flows
Years ended December 31, 2001, 2000 and 1999 F - 6
Notes to the Consolidated Financial Statements F - 7
F-1
Report of Independent Accountants
To the Board of Directors and Stockholder of
Pruco Life Insurance Company
In our opinion, the consolidated financial statements listed in the
accompanying index 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 subsidiary at December 31,
2001 and 2000, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001, in conformity
with accounting principles generally accepted in the United States of
America. 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
of America, 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 our opinion.
PricewaterhouseCoopers LLP
New York, New York
February 21, 2002
F-2
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Financial Position
December 31, 2001 and 2000 (In Thousands)
- --------------------------------------------------------------------------------
2001 2000
----------------- -----------------
ASSETS
Fixed maturities
Available for sale, at fair value (amortized cost, 2001: $3,935,472;
2000:$3,552,244) $ 4,024,893 $ 3,561,521
Held to maturity, at amortized cost (fair value, 2000: $320,634) - 324,546
Equity securities - available for sale, at fair value (cost, 2001: $173;
2000: $13,446) 375 10,804
Commercial loans on real estate 8,190 9,327
Policy loans 874,065 855,374
Short-term investments 215,610 202,815
Other long-term investments 84,342 83,738
---------- ------------
Total investments 5,207,475 5,048,125
Cash and cash equivalents 374,185 453,071
Deferred policy acquisition costs 1,159,830 1,132,653
Accrued investment income 77,433 82,297
Reinsurance recoverable 300,697 31,568
Receivables from affiliates 33,074 51,586
Other assets 20,134 29,445
Separate Account assets 14,920,584 16,230,264
---------- ------------
TOTAL ASSETS $22,093,412 $ 23,059,009
=========== ============
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $ 3,947,690 $ 3,646,668
Future policy benefits and other policyholder liabilities 808,230 702,862
Cash collateral for loaned securities 190,022 185,849
Securities sold under agreements to repurchase 80,715 104,098
Income taxes payable 266,096 235,795
Other liabilities 228,596 120,891
Separate Account liabilities 14,920,584 16,230,264
---------- ------------
Total liabilities 20,441,933 21,226,427
---------- ------------
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 466,748 466,748
Retained earnings 1,147,665 1,361,924
Accumulated other comprehensive income (loss):
Net unrealized investment gains 34,718 4,730
Foreign currency translation adjustments (152) (3,320)
---------- ------------
Accumulated other comprehensive income 34,566 1,410
---------- ------------
Total stockholder's equity 1,651,479 1,832,582
---------- ------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $22,093,412 $ 23,059,009
=========== ============
See Notes to Consolidated Financial Statements
F-3
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Operations and Comprehensive Income
Years Ended December 31, 2001, 2000 and 1999 (In Thousands)
- --------------------------------------------------------------------------------
2001 2000 1999
-------------- --------------- ---------------
REVENUES
Premiums $ 90,868 $ 121,921 $ 98,976
Policy charges and fee income 490,185 474,861 414,425
Net investment income 343,638 337,919 276,821
Realized investment losses, net (60,476) (20,679) (32,545)
Asset management fees 7,897 71,160 60,392
Other income 4,962 2,503 1,397
---------- ----------- -----------
Total revenues 877,074 987,685 819,466
---------- ----------- -----------
BENEFITS AND EXPENSES
Policyholders' benefits 256,080 248,063 205,042
Interest credited to policyholders' account balances 195,966 171,010 136,852
General, administrative and other expenses 382,701 410,684 392,041
---------- ----------- -----------
Total benefits and expenses 834,747 829,757 733,935
---------- ----------- -----------
Income from operations before income taxes 42,327 157,928 85,531
---------- ----------- -----------
Income tax (benefit) provision (25,255) 54,432 29,936
---------- ----------- -----------
NET INCOME 67,582 103,496 55,595
---------- ----------- -----------
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities, net of
reclassification adjustment 29,988 33,094 (38,266)
Foreign currency translation adjustments 3,168 (993) (742)
---------- ----------- -----------
Other comprehensive income (loss) 33,156 32,101 (39,008)
---------- ----------- -----------
TOTAL COMPREHENSIVE INCOME $ 100,738 $ 135,597 $ 16,587
=========== ============ ===========
See Notes to Consolidated Financial Statements
F-4
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Changes in Stockholder's Equity
Years Ended December 31, 2001, 2000 and 1999 (In Thousands)
- --------------------------------------------------------------------------------
Accumulated
other Total
Common Paid-in- Retained comprehensive stockholder's
Common stock capital earnings income (loss) equity
------------ -------- -------- ------------- --------------
Balance, January 1, 1999 $ 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
Net income - - 103,496 - 103,496
Contribution from Parent - 27,166 - - 27,166
Change in foreign
currency translation
adjustments, net of taxes - - - (993) (993)
Change in net unrealized
investment losses, net of
reclassification adjustment and
taxes - - - 33,094 33,094
--------- ---------- ------------ ------------ -------------
Balance, December 31, 2000
2,500 466,748 1,361,924 1,410 1,832,582
Net income - - 67,582 - 67,582
Policy credits issued to eligible
policyholders - - (128,025) - (128,025)
Dividends to Parent - - (153,816) - (153,816)
Change in foreign currency
translation adjustments, net of
taxes - - - 3,168 3,168
Change in net unrealized investment
gains, net of reclassification
adjustment and taxes - - - 29,988 29,988
--------- ---------- ------------ ------------ -------------
Balance, December 31, 2001 $ 2,500 $ 466,748 $ 1,147,665 $ 34,566 $ 1,651,479
========= ========== ============ ============ =============
See Notes to Consolidated Financial Statements
F-5
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 31, 2001, 2000 and 1999 (In Thousands)
- --------------------------------------------------------------------------------
2001 2000 1999
-------------- ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 67,582 $ 103,496 $ 55,595
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Policy charges and fee income (54,970) (72,275) (83,961)
Interest credited to policyholders' account balances 195,966 171,010 136,852
Realized investment losses, net 60,476 20,679 32,545
Amortization and other non-cash items (49,594) (48,141) 75,037
Change in:
Future policy benefits and other policyholders' 105,368 73,340 100,743
liabilities
Accrued investment income 4,864 (13,380) (7,803)
Receivable from/Payable to affiliate 18,512 (24,907) (66,081)
Policy loans (40,645) (63,022) (25,435)
Deferred policy acquisition costs (100,281) (69,868) (201,072)
Income taxes payable/receivable 38,839 90,195 (47,758)
Other, net (38,114) 51,011 18,974
-------------- ----------- ------------
Cash Flows From (Used in) Operating Activities 208,003 218,138 (12,364)
-------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities:
Available for sale 2,653,798 2,273,789 3,076,848
Held to maturity - 64,245 45,841
Equity securities 482 1,198 5,209
Commercial loans on real estate 1,137 1,182 6,845
Other long-term investments - 15,039 385
Payments for the purchase of:
Fixed maturities:
Available for sale (2,961,861) (2,782,541) (3,452,289)
Held to maturity - - (24,170)
Equity securities (184) (11,134) (5,110)
Other long-term investments (130) (6,917) (39,094)
Cash collateral for loaned securities, net 4,174 98,513 14,000
Securities sold under agreement to repurchase, net (23,383) 82,947 (28,557)
Short-term investments, net (12,766) (118,418) 92,199
-------------- ----------- ------------
Cash Flows Used In Investing Activities (338,733) (382,097) (307,893)
-------------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account deposits 1,456,668 2,409,399 3,457,158
Policyholders' account withdrawals (1,313,300) (1,991,363) (3,091,565)
Cash dividend to Parent (26,048) - -
Cash provided to affiliate (65,476) - -
-------------- ----------- ------------
Cash Flows (Used in) From Financing Activities 51,844 418,036 365,593
-------------- ----------- ------------
Net increase in Cash and cash equivalents (78,886) 254,077 45,336
Cash and cash equivalents, beginning of year 453,071 198,994 153,658
-------------- ----------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 374,185 $ 453,071 $ 198,994
============== =========== ============
SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes (received) paid $ (46,021) $ (14,832) $ 55,144
-------------- ----------- ------------
NON-CASH TRANSACTIONS DURING THE YEAR
Dividend paid with fixed maturities $ 81,952 $ - $ -
-------------- ----------- ------------
Taiwan branch dividend paid with net assets/liabilities $ 45,816 $ - $ -
-------------- ----------- ------------
Policy credits issued to eligible policyholders $ 128,025 $ - $ -
-------------- ----------- ------------
Contribution from Parent $ - $ 27,166 $ -
-------------- ----------- ------------
See Notes to Consolidated Financial Statements
F-6
Pruco Life Insurance Company and Subsidiary
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, term life
insurance, variable and fixed annuities, and a non-participating guaranteed
interest contract ("GIC") called Prudential Credit Enhanced GIC ("PACE") in the
District of Columbia, Guam and in all states and territories except New York.
The Company also had marketed individual life insurance through its branch
office in Taiwan. The branch office was transferred to an affiliated Company on
January 31, 2001, as described in Footnote 14.
The Company has one wholly owned subsidiary, Pruco Life Insurance Company of New
Jersey ("PLNJ"). 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, term life insurance, fixed and variable
annuities only in the states of New Jersey and New York. Another wholly owned
subsidiary, The Prudential Life Insurance Company of Arizona ("PLICA") was
dissolved on September 30, 2000. All assets and liabilities were transferred to
the Company. PLICA had no new business sales in 2000 or 1999.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential"), an insurance company founded in 1875 under the laws of
the state of New Jersey. On December 18, 2001 ("the date of demutualization")
Prudential converted from a mutual life insurance company to a stock life
insurance company and became an indirect wholly owned subsidiary of Prudential
Financial, Inc. (the "Holding Company"). The demutualization was completed in
accordance with Prudential's Plan of Reorganization, which was approved by the
Commissioner of the New Jersey Department of Banking and Insurance in October
2001.
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 Company's policyholder contracts. During 2000, a capital contribution of
$27.2 million resulted from the forgiveness of an intercompany receivable.
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 of America
("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.
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
are included in a separate component of equity, "Accumulated other comprehensive
income (loss)", net of income taxes.
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, 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 (loss)", net of income taxes.
F-7
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Commercial 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 it is probable 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, consisting of highly liquid debt instruments other than
those held in "Cash and cash equivalents," with a maturity of twelve months or
less when purchased, 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 exercise control,
derivatives held for purposes other than trading, and investments in the
Company's own Separate Accounts. Joint ventures and partnerships are recorded
using the equity method of accounting, reduced for other than temporary declines
in value. The Company's investment in the Separate Accounts is carried at
estimated fair value. The Company's net income from investments in joint
ventures and partnerships is generally included in "Net investment income."
Realized investment losses, 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. Impairment adjustments are
included in "Realized investment gains (losses), net." Factors considered in
evaluating whether a decline in value is other than temporary are: 1) whether
the decline is substantial; 2) the Company's ability and intent to retain the
investment for a period of time sufficient to allow for an anticipated recovery
in value; 3) the duration and extent to which the market value has been less
than cost; and 4) the financial condition and near-term prospects of the issuer.
Cash and cash equivalents include cash on hand, amounts due from banks, money
market instruments, and other debt issues with a maturity of three months or
less when purchased.
Deferred policy acquisition costs
The costs that vary with and that are related primarily to the production of new
insurance and annuity business are deferred to the extent that they are deemed
recoverable from future profits. Such costs include commissions, costs of policy
issuance and underwriting, and variable field office expenses. Deferred policy
acquisition costs are subject to recognition testing at the time of policy issue
and recoverability and premium deficiency testing at the end of each accounting
period. Deferred policy acquisition costs, for certain products, 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 (loss)."
Policy acquisition costs related to interest-sensitive and variable life
products and certain investment-type products are deferred and amortized over
the expected life of the contracts (periods ranging from 25 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 Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Deferred policy acquisition costs related to non-participating term insurance
are amortized over the expected life of the contracts in proportion to premium
income. For guaranteed investment contracts, acquisition costs are expensed as
incurred.
Prudential and the Company have offered programs under which policyholders, for
a selected product or group of products, can exchange an existing policy or
contract issued by Prudential or the Company for another form of policy or
contract. These transactions are known as internal replacements. If the new
policies have terms that are substantially similar to those of the earlier
policies, the DAC is retained with respect to the new policies and amortized
over the life of the new policies. If the terms of the new policies are not
substantially similar to those of the former policy, the unamortized DAC on the
surrendered policies is immediately charged to expense.
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. The assets consist of 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 and Comprehensive
Income. 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.
Contingencies
Amounts related to contingencies are accrued if it is probable that a liability
has been incurred and an amount is reasonably estimable. Management evaluates
whether there are incremental legal or other costs directly associated with the
ultimate resolution of the matter that are reasonably estimable and, if so, they
are included in the accrual.
F-9
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
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. 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.
Premiums, benefits and expenses are stated net of reinsurance ceded to other
companies. Estimated reinsurance recoverables and the cost of reinsurance are
recognized over the life of the reinsured policies using assumptions consistent
with those used to account for the underlying policies.
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 (loss)." The cumulative effect of changes in foreign
exchange rates are included in "Accumulated other comprehensive income (loss)".
Asset Management Fees
Through December 31, 2000, the Company received asset management fee income from
policyholder account balances invested in The Prudential Series Funds ("PSF"),
which are a portfolio of mutual fund investments related to the Company's
Separate Account products (refer to Note 14). In addition, the Company receives
fees from policyholder account balances invested in funds managed by companies
other than Prudential. Asset management fees are recognized as income as earned.
Derivative Financial Instruments
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, financial indices, or the value of securities or
commodities. Derivative financial instruments used by the Company include swaps,
futures, forwards and option contracts and may be exchange-traded or contracted
in the over-the-counter market. See Note 11 for a discussion of the Company's
use of derivative financial instruments and the related accounting and reporting
treatment for such instruments.
Income Taxes
The Company and its subsidiary are members of the consolidated federal income
tax return of Prudential and file 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.
New Accounting Pronouncements
In September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities--a replacement of FASB Statement No. 125." The Company has adopted
the provisions of SFAS No. 140 relating to transfers and extinguishments of
liabilities which are effective for periods occurring after March 31, 2001. The
adoption did not have an effect on the results of operations of the Company.
F-10
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No.
142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the
Company account for all business combinations in the scope of the statement
using the purchase method. SFAS No. 142 requires that an intangible asset
acquired either individually or with a group of other assets shall initially be
recognized and measured based on fair value. An intangible asset with a finite
life is amortized over its useful life to the reporting entity; an intangible
asset with an indefinite useful life, including goodwill, is not amortized. All
intangible assets shall be tested for impairment in accordance with the
statement. SFAS No. 142 is effective for fiscal years beginning after December
15, 2001; however, goodwill and intangible assets acquired after June 30, 2001
are subject immediately to the nonamortization and amortization provisions of
this statement. As of December 31, 2001, The Company does not have any goodwill
or intangible assets.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 eliminated the requirement that
discontinued operations be measured at net realizable value or that entities
include losses that have not yet occurred. SFAS No. 144 eliminated the exception
to consolidation for a subsidiary for which control is likely to be temporary.
SFAS No. 144 requires that long-lived assets that are to be disposed of by sale
be measured at the lower of book value or fair value less cost to sell. An
impairment for assets that are not considered to be disposed of is recognized
only if the carrying amounts of long-lived assets are not recoverable and exceed
their fair values. Additionally, SFAS No. 144 expands the scope of discontinued
operations to include all components of an entity with operations and cash flows
that (1) can be distinguished from the rest of the entity and (2) will be
eliminated from the ongoing operations of the entity in a disposal transaction.
SFAS No. 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001 and, generally, its provisions are to be
applied prospectively.
Reclassifications
Certain amounts in the prior years have been reclassified to conform to the
current year presentation.
F-11
Pruco Life Insurance Company and Subsidiary
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:
2001
---------------------------------------------------------------
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 $ 303,606 $ 1,496 $ 1,648 $ 303,454
Foreign Government Bonds 27,332 2,122 - 29,454
Corporate Securities 3,594,386 116,186 28,834 3,681,738
Mortgage-backed Securities 10,148 160 61 10,247
---------- --------- -------- ----------
Total Fixed Maturities Available For Sale $3,935,472 $ 119,964 $ 30,543 $4,024,893
========== ========= ======== ==========
Equity Securities Available For Sale $ 173 $ 220 $ 18 $ 375
========== ========= ======== ==========
2000
--------------------------------------------------------------
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 $ 309,609 $ 7,888 $ 17 $ 317,480
Foreign Government Bonds 136,133 8,093 520 143,706
Corporate Securities 3,075,023 43,041 49,538 3,068,526
Mortgage-backed Securities 31,479 330 0 31,809
---------- ------- ------- ----------
Total Fixed Maturities Available For Sale $3,552,244 $59,352 $50,075 $3,561,521
========== ======= ======= ==========
Fixed Maturities Held To Maturity
Corporate Securities $ 324,546 $ 1,500 $ 5,412 $ 320,634
---------- ------- ------- ----------
Total Fixed Maturities Held To Maturity $ 324,546 $ 1,500 $ 5,412 $ 320,634
========== ======= ======= ==========
Equity Securities Available For Sale $ 13,446 $ 197 $ 2,839 $ 10,804
========== ======= ======= ==========
F-12
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The amortized cost and estimated fair value of fixed maturities, by contractual
maturities at December 31, 2001 is shown below:
Available For Sale
--------------------------------------
Amortized Estimated Fair
Cost Value
--------------- -------------------
(In Thousands)
Due in one year or less $ 802,235 $ 821,790
Due after one year through five years 1,841,097 1,885,535
Due after five years through ten years 1,026,709 1,045,693
Due after ten years 255,283 261,628
Mortgage-backed securities 10,148 10,247
----------- -----------
Total $ 3,935,472 $ 4,024,893
=========== ===========
Actual maturities may differ from contractual maturities because issuers have
the right to call or prepay obligations.
Proceeds from the sale of fixed maturities available for sale during 2001, 2000,
and 1999, were $2,380.4 million, $2,103.6 million, and $2,950.4 million,
respectively. Gross gains of $40.3 million, $15.3 million, $13.1 million, and
gross losses of $47.7 million, $33.9 million, and $31.1 million, were realized
on those sales during 2001, 2000, and 1999, respectively.
Proceeds from the maturity of fixed maturities available for sale during 2001,
2000, and 1999, were $273.4 million, $170.2 million, and $126.5 million,
respectively.
Writedowns for impairments which were deemed to be other than temporary for
fixed maturities were $53.5 million, $12.3 million, and $11.2 million, for the
years 2001, 2000 and 1999, respectively.
Due to the adoption of FAS 133, "Accounting for Derivative Instruments and
Hedging Activities", on January 1, 2001, the entire portfolio of fixed
maturities classified as held to maturity were transferred to the available for
sale category. The aggregate amortized cost of the securities was $324.5
million. Unrealized investment losses of $2.5 million, net of tax were recorded
in "Accumulated Other Comprehensive income (loss)" at the time of transfer.
During 2000, certain securities classified as held to maturity were transferred
to the available for sale portfolio. These actions were taken as a result of a
significant deterioration in credit worthiness. The aggregate amortized cost of
the securities transferred was $6.6 million. Gross unrealized investment losses
of $0.3 million were recorded in "Accumulated Other Comprehensive income (loss)"
at the time of transfer. Prior to transfer, impairments related to these
securities, if any, were included in "realized investment losses, net". During
the year ended December 31, 1999, there were no securities classified as held to
maturity that were transferred. During the years ended December 31, 2001, 2000,
and 1999, there were no securities classified as held to maturity that were
sold.
Commercial Loans on Real Estate
The Company's commercial loans on real estate were collateralized by the
following property types at December 31:
2001 2000
-------------------------- -------------------------
(In Thousands)
Retail Stores $ 4,623 56.4% $ 5,615 60.2%
Industrial Buildings 3,567 43.6% 3,712 39.8%
-------------------------- -------------------------
Net Carrying Value $ 8,190 100.0% $ 9,327 100.0%
========================== =========================
The concentration of commercial loans are in the states of Washington (47%), New
Jersey (44%), and North Dakota (9%).
F-13
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
Special Deposits and Restricted Assets
Fixed maturities of $2.9 million and $8.0 million at December 31, 2001 and 2000,
respectively, were on deposit with governmental authorities or trustees as
required by certain insurance laws. Equity securities restricted as to sale were
$.2 million at December 31, 2001 and 2000, respectively.
Other Long-Term Investments
The Company's "Other long-term investments" of $84.3 million and $83.7 million
as of December 31, 2001 and 2000, respectively, are comprised of joint ventures
and limited partnerships, the Company's investment in the Separate Accounts and
certain derivatives for other than trading. Joint ventures and limited
partnerships totaled $35.8 million and $34.3 million at December 31, 2001 and
2000, respectively. The Company's share of net income from the joint ventures
was $1.6 million, $.9 million, and $.3 million, for the years ended December 31,
2001, 2000 and 1999, respectively, and is reported in "Net investment income."
The Company's investment in the Separate Accounts was $44.0 million and $46.9
million at December 31, 2001 and 2000, respectively.
Investment Income and Investment Gains and Losses
Net investment income arose from the following sources for the years ended
December 31:
2001 2000 1999
---------------- ----------------- ----------------
(In Thousands)
Fixed Maturities - Available For Sale $ 279,477 $ 237,042 $ 188,236
Fixed Maturities - Held To Maturity - 26,283 29,245
Equity Securities - Available For Sale 71 18 -
Commercial Loans On Real Estate 905 1,010 2,825
Policy Loans 48,149 45,792 42,422
Short-Term Investments and Cash Equivalents 24,253 29,582 19,208
Other 6,021 16,539 4,432
---------------- ----------------- ----------------
Gross Investment Income 358,876 356,266 286,368
Less: Investment Expenses (15,238) (18,347) (9,547)
---------------- ----------------- ----------------
Net Investment Income $ 343,638 $ 337,919 $ 276,821
================ ================= ================
Realized investment losses, net including charges for other than temporary
reductions in value, for the years ended December 31, were from the following
sources:
2001 2000 1999
---------------- ----------------- -----------------
(In Thousands)
Fixed Maturities - Available For Sale $ (60,924) $ (34,600) $ (29,192)
Fixed Maturities - Held To Maturity - (212) 102
Equity Securities - Available For Sale (56) 271 392
Derivatives (1,396) 15,039 (1,557)
Other 1,900 (1,177) (2,290)
---------------- ----------------- -----------------
Realized Investment Losses, Net $ (60,476) $ (20,679) $ (32,545)
================ ================= =================
Securities Pledged to Creditors
The Company pledges investment securities it owns to unaffiliated parties
through certain transactions including securities lending, securities sold under
agreements to repurchase, and futures contracts. At December 31, 2001 and 2000,
the carrying value of fixed maturities available for sale pledged to third
parties as reported in the Consolidated Statements of Financial Position were
$265.2 million and $287.8 million, respectively.
F-14
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
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 (loss)." Changes in these amounts
include reclassification adjustments to exclude from "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, 1999 $ 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)
Reclassification adjustment for
gains(losses) included in net income 28,698 - - (9,970) 18,728
Impact of net unrealized investment
gains(losses) on deferred policy
acquisition costs - 53,407 - (16,283) 37,124
Impact of net unrealized investment
gains(losses) on policyholders' account - - (5,712) 2,077 (3,635)
balances
--------------- ------------ ----------- ---------- ------------
Balance, December 31, 1999 (84,401) 40,292 (3,032) 18,777 (28,364)
Net investment gains(losses) on
investments arising during the period 56,707 - - (21,539) 35,168
Reclassification adjustment for
gains(losses) included in net income 34,329 - - (13,039) 21,290
Impact of net unrealized investment
gains(losses) on deferred policy
acquisition costs - (39,382) - 14,177 (25,205)
Impact of net unrealized investment
gains(losses) on policyholders' account - - 2,877 (1,036) 1,841
balances
--------------- ------------ ----------- ---------- ------------
Balance, December 31, 2000 6,635 910 (155) (2,660) 4,730
Net investment gains(losses) on
investments arising during the period 22,007 - - (7,922) 14,085
Reclassification adjustment for
gains(losses) included in net income 60,980 - - (21,953) 39,027
Impact of net unrealized investment
gains(losses) on deferred policy
acquisition costs - (41,223) - 14,840 (26,383)
Impact of net unrealized investment
gains(losses) on policyholders' account
balances - - 5,092 (1,833) 3,259
--------------- ------------ ----------- ---------- ------------
Balance, December 31, 2001 $ 89,622 $ (40,313) $ 4,937 $ (19,528) $ 34,718
=============== ============ ============ ========== =============
F-15
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
4. DEFERRED POLICY ACQUISITION COSTS
The balances of and changes in deferred policy acquisition costs as of and for
the years ended December 31, are as follows:
2001 2000 1999
(In Thousands)
Balance, Beginning of Year $ 1,132,653 $ 1,062,785 $ 861,713
Capitalization of Commissions, Sales and Issue Expenses 295,823 242,322 242,373
Amortization (156,092) (129,049) (96,451)
Change In Unrealized Investment (Gains) Losses (41,223) (39,382) 53,407
Foreign Currency Translation 1,773 (4,023) 1,743
Transfer of Taiwan branch balance to an affiliated company (73,104) - -
------------ --------------- --------------
Balance, End of Year $ 1,159,830 $ 1,132,653 $ 1,062,785
============ =============== ==============
5. POLICYHOLDERS' LIABILITIES
Future policy benefits and other policyholder liabilities at December 31, are as
follows:
2001 2000
-------- ----------
(In Thousands)
Life Insurance - Domestic $500,974 $ 429,825
Life Insurance - Taiwan 260,632 226,272
Individual Annuities 32,423 31,817
Group Annuities 14,201 14,948
-------- ----------
$808,230 $ 702,862
======== ==========
Life insurance liabilities include reserves for death benefits. Annuity
liabilities include reserves for annuities that are in payout status.
The following table highlights the key assumptions generally utilized in
calculating these reserves:
Product Mortality Interest Rate Estimation Method
- -------------------------------- ---------------------------- ---------------- --------------------------
Life Insurance - Domestic Generally rates guaranteed 2.5% to 11.25% Net level premium based
Variable and Interest-Sensitive in calculating cash on non-forfeiture
surrender values interest rate
Life Insurance - Domestic Term Best estimate plus a 6.5% to 6.75% Net level premium plus a
Insurance provision for adverse provision for adverse
deviation deviation
Life Insurance - International Generally the Taiwan 6.25% to 7.5% Net level premium plus a
standard table plus a provision for adverse
provision for adverse deviation.
deviation
Individual Annuities Mortality table varies 6.25% to 11.0% Present value of
based on the issue year of expected future payments
the contract. Current based on historical
table (for 1998 & later experience
issues) is the Annuity
2000 Mortality Table with
certain modifications
Group Annuities 1950 & 1971 Group Annuity 14.75% Present value of
Mortality Table with expected future payments
certain modifications based on historical
experience
F-16
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Policyholders' account balances at December 31, are as follows:
2001 2000
------------------- -------------------
(In Thousands)
Interest-Sensitive Life Contracts $ 1,976,710 $ 1,886,714
Individual Annuities 976,237 859,996
Guaranteed Investment Contracts 994,743 899,958
------------ ------------
$ 3,947,690 $ 3,646,668
============ ============
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 3.0% to 6.75% Various up to 10 years
Individual Annuities 3.0% to 16.0% 0% to 7% for up to 9 years
Guaranteed Investment Contracts 4.32% to 8.03% Subject to market value withdrawal
provisions for any funds withdrawn
other than for benefit responsive
and contractual payments
F-17
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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 subsidiary as the primary insurer. 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. The affiliated reinsurance agreements, including the
Company's reinsurance of all its Taiwanese business, are described further in
Note 14.
Reinsurance amounts included in the Consolidated Statements of Operations and
Comprehensive Income for the year ended December 31, are as follows:
2001 2000 1999
---------------- ---------------- ----------------
(In Thousands)
Domestic:
Reinsurance premiums ceded - affiliated $ (9,890) $ (7,641) $ (5,630)
Reinsurance premiums ceded - unaffiliated (13,399) (2,475) -
Policyholders' benefits ceded 10,803 3,558 3,140
Taiwan after the transfer:
Reinsurance premiums ceded -affiliated (82,433) - -
Policyholders' benefits ceded-affiliated 12,859 - -
Taiwan before the transfer:
Reinsurance premiums ceded - affiliated (107) (1,573) (1,252)
Reinsurance premiums ceded -unaffiliated (167) (2,830) (1,745)
Policyholders' benefits ceded 71 1,914 1,088
Reinsurance premiums assumed 162 1,671 1,778
Reinsurance recoverables, included in the Company's Consolidated Statements of
Financial Position at December 31, were as follows:
2001 2000
------------------- -----------------
(In Thousands)
Domestic Life Insurance - $ 11,014 $ 8,765
affiliated
Domestic Life Insurance - 14,850 2,037
unaffiliated
Other Reinsurance - affiliated 14,201 14,948
Taiwan Life Insurance-affiliated 260,632 -
Taiwan Life Insurance-unaffiliated - 5,818
----------- ----------
$ 300,697 $ 31,568
=========== ==========
The gross and net amounts of life insurance in force at December 31, were as
follows:
2001 2000 1999
---- ---- ----
(In Thousands)
Life Insurance Face Amount In Force $ 84,317,628 $ 66,327,999 $ 54,954,680
Ceded To Other Companies (25,166,264) (7,544,363) (2,762,319)
------------- ------------ ------------
Net Amount of Life Insurance In Force $ 59,151,364 $ 58,783,636 $ 52,192,361
============= ============ ============
F-18
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. EMPLOYEE BENEFIT PLANS
Pension and Other Postretirement Plans
The Company had a non-contributory defined benefit pension plan that covered
substantially all of its Taiwanese employees. The pension plan was transferred
to an affiliate on January 31, 2001 as described in Note 14. This plan was
established as of September 30, 1998 and the projected benefit obligation and
related expenses at December 31, 2000 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.
8. INCOME TAXES
The components of income taxes for the years ended December 31, are as follows:
2001 2000 1999
----------- ------------ -----------
(In Thousands)
Current Tax Expense (Benefit):
U.S. $ (100,946) $ 8,588 $ (14,093)
State and Local 1,866 38 378
Foreign 124 35 15
---------- --------- ----------
Total (98,956) 8,661 (13,700)
---------- --------- ----------
Deferred Tax Expense (Benefit):
U.S. 76,155 43,567 42,320
State and Local (2,454) 2,204 1,316
---------- --------- ----------
Total 73,701 45,771 43,636
---------- --------- ----------
Total Income Tax Expense $ (25,255) $ 54,432 $ 29,936
========== ========== ==========
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:
2001 2000 1999
------------ ----------- -----------
(In Thousands)
Expected Federal Income Tax Expense $ 14,814 $ 55,275 $ 29,936
State and Local Income Taxes (382) 1,457 1,101
Non taxable investment income (38,693) (6,443) (1,010)
Incorporation of Taiwan Branch (1,774) - -
Other 780 4,143 (91)
----------- ----------- -----------
Total Income Tax Expense $ (25,255) $ 54,432 $ 29,936
=========== =========== ===========
F-19
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. INCOME TAXES (continued)
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
2001 2000
---------- ----------
(In Thousands)
Deferred Tax Assets
Insurance Reserves $ 43,317 $ 100,502
State Net Operating Losses 5,642 1,400
Other 9,309 8,610
---------- ----------
Deferred Tax Assets 58,268 110,512
---------- ----------
Deferred Tax Liabilities
Deferred Acquisition Costs 324,082 324,023
Net Unrealized Gains on Securities 32,264 2,389
Investments 20,644 19,577
---------- ----------
Deferred Tax Liabilities 376,990 345,989
---------- ----------
Net Deferred Tax Liability $ 318,722 $ 235,477
========== ==========
Management believes that based on its historical pattern of taxable income, the
Company and its subsidiary will produce sufficient income in the future to
realize its deferred tax assets. 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, 2001 and 2000, the
Company and its subsidiary had no federal operating loss carryforwards for tax
purposes. At December 31, 2001 and December 31, 2000, the Company had state
operating loss carryforwards for tax purposes of $369 million and $91 million,
which expire by 2021 and 2020, respectively.
The Internal Revenue Service (the "Service") has completed all examinations of
the consolidated federal income tax returns through 1992. The Service has
examined the years 1993 through 1995. Discussions are being held with the
Service with respect to proposed adjustments. Management, however, believes
there are adequate defenses against, or sufficient reserves to provide for such
adjustments. The Service has completed its examination of 1996 and has begun its
examination of 1997 through 2000.
9. STATUTORY NET INCOME AND SURPLUS
The Company is required to prepare statutory financial statements in accordance
with accounting practices prescribed or permitted by the Arizona Department of
Insurance and the New Jersey Department of Banking and Insurance. Statutory
accounting practices primarily differ from GAAP by charging policy acquisition
costs to expense as incurred, establishing future policy benefit liabilities
using different actuarial assumptions and valuing investments, deferred taxes,
and certain assets on a different basis.
Statutory net income (loss) of the Company amounted to $71.5 million, $(50.5)
million, and $(82.3) million for the years ended December 31, 2001, 2000, and
1999, respectively. Statutory surplus of the Company amounted to $728.7 million
and $849.6 million at December 31, 2001 and 2000, respectively.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance ("Codification"), which replaces the current Accounting
Practices and Procedures manual as the NAIC's primary guidance on statutory
accounting as of January 1, 2001. Codification provides guidance for areas where
statutory accounting has been silent and changes current statutory accounting in
certain areas. The Company has adopted the Codification guidance effective
January 1, 2001. As a result of these changes, the Company reported an increase
to statutory surplus of $88 million, primarily relating to the recognition of
deferred tax assets.
F-20
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values presented below have been determined using available
market information and by applying valuation methodologies. Considerable
judgment is applied in interpreting data to develop the estimates of fair value.
Estimated fair values 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. Generally, 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.
Commercial loans on real estate
The estimated fair value of the portfolio of commercial loans on real estate is
primarily based upon the present value of the expected future cash flows
discounted at the appropriate U.S. Treasury rate, adjusted for the current
market spread for a similar quality loan.
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 repayment
patterns.
Investment contracts
For guaranteed investment contracts, estimated fair values are derived 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. For individual deferred annuities and other deposit
liabilities, fair value approximates carrying value.
Derivative financial instruments
Refer to Note 11 for the disclosure of fair values on these instruments.
F-21
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
The following table discloses the carrying amounts and estimated fair values of
the Company's financial instruments at December 31:
2001 2000
----------------------------------- -------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
---------------- ----------------- --------------- ---------------
(In Thousands)
Financial Assets:
Fixed Maturities: Available For Sale $ 4,024,893 $ 4,024,893 $ 3,561,521 $ 3,561,521
Fixed Maturities: Held To Maturity - - 324,546 320,634
Equity Securities 375 375 10,804 10,804
Commercial Loans on Real Estate 8,190 10,272 9,327 10,863
Policy Loans 874,065 934,203 855,374 883,460
Short-Term Investments 215,610 215,610 202,815 202,815
Cash and Cash Equivalents 374,185 374,185 453,071 453,071
Separate Account Assets 14,920,584 14,920,584 16,230,264 16,230,264
Financial Liabilities:
Investment Contracts 2,003,265 2,053,259 1,762,794 1,784,767
Cash Collateral for Loaned Securities 190,022 190,022 185,849 185,849
Securities Sold Under Repurchase 80,715 80,715 104,098 104,098
Agreements
Separate Account Liabilities 14,920,584 14,920,584 16,230,264 16,230,264
11. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
Adoption of Statement of Financial Accounting Standards No. 133
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" as amended, on January 1, 2001. The adoption of this
statement did not have a material impact on the results of operations of the
Company.
Accounting for Derivatives and Hedging Activities
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, financial indices, or the value of securities or
commodities. Derivative financial instruments used by the Company include swaps,
futures, forwards and option contracts and may be exchange-traded or contracted
in the over-the-counter market. Derivatives may be held for trading purposes or
held for purposes other than trading. All of the Company's derivatives are held
for purposes other than trading.
Derivatives held for purposes other than trading are used to seek to reduce
exposure to interest rates and foreign currency risks associated with assets
held or expected to be purchased or sold, and liabilities incurred or expected
to be incurred. Other than trading derivatives are also used to manage the
characteristics of the Company's asset/liability mix, and to manage the interest
rate and currency characteristics of invested assets.
Derivatives held for purposes other than trading are recognized on the
Consolidated Statements of Financial Position at their fair value. On the date
the derivative contract is entered into, the Company designates the derivative
as either (1) a hedge of the fair value of a recognized asset or liability or
unrecognized firm commitment ("fair value" hedge), (2) a hedge of a forecasted
transaction or the variability of cash flows to be received or paid related to a
recognized asset or liability ("cash flow" hedge), (3) a foreign currency or
cash flow hedge ("foreign currency" hedge), (4) a hedge of a net investment in a
foreign operation, or (5) a derivative that does not qualify for hedge
accounting. As of December 31, 2001, none of the Company's derivatives qualify
for hedge accounting treatment.
F-22
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
11. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (continued)
If a derivative does not qualify for hedge accounting, it is recorded at fair
value in "Other long-term investments" or "Other liabilities" in the
Consolidated Statements of Financial Position, and changes in fair value are
included in earnings without considering changes in fair value of the hedged
assets or liabilities. See "Types of Derivative Instruments" for further
discussion of the classification of derivative activity in current earnings.
Types of Derivative Instruments
Interest Rate Swaps
The Company uses interest rate swaps to reduce market risk from changes in
interest rates and to manage interest rate exposures arising from mismatches
between assets and liabilities. Under interest rate swaps, the Company agrees
with other parties to exchange, at specified intervals, the difference between
fixed-rate and floating-rate interest amounts calculated by reference to an
agreed notional principal amount. Generally, no cash is exchanged at the outset
of the contract and no principal payments are made by either party. Cash is paid
or received based on the terms of the swap. These transactions are entered into
pursuant to master agreements that provide for a single net payment to be made
by one counterparty at each due date. The fair value of swap agreements is
estimated based on proprietary pricing models or market quotes.
If the criteria for hedge accounting are not met, the swap agreements are
accounted for at fair value with changes in fair value reported in "Realized
investment losses, net" in the Consolidated Statement of Operations. During the
period that interest rate swaps are outstanding, net receipts or payments are
include in" Net investment income" in the Consolidated Statement of Operations.
Futures and 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. In exchange-traded
futures transactions, the Company agrees to purchase or sell a specified number
of contracts, the value of which are determined by the value of designated
classes of Treasury securities, and to post variation margin on a daily basis in
an amount equal to the difference in the daily market values of those contracts.
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 based on market quotes.
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 "Realized investment losses, net."
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.
F-23
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
11. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (continued)
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 a manner similar to the
hedged item. If currency swaps do not meet hedge accounting criteria, gains or
losses from those derivatives are recognized in "Realized investment (losses)
gains, net."
The table below summarizes the Company's outstanding positions by derivative
instrument types as of December 31, 2001 and 2000. All amounts presented have
been classified as other than trading based on management's intent at the time
of contract and throughout the life of the contract.
Other than Trading Derivatives
December 31, 2001 and 2000
(In Thousands)
2001 2000
--------------------------------------------------------------------------------------------
Estimated Carrying Estimated Carrying
Notional Fair Value Value Notional Fair Value Value
Non-Hedge Accounting
- ---------------------------
Swap Instruments
Interest Rate
Asset $ 9,470 $ 638 $ 638 $ 9,470 $ 327 $ 327
Liability - - - - - -
Currency
Asset 24,785 3,858 3,858 - - -
Liability - - - - - -
Future Contracts
US Treasury Futures
Asset 76,800 394 394 139,800 3,530 3,530
Liability 64,500 238 238 61,900 1,067 1,067
Hedge Accounting
- ---------------------------
Swap Instruments
Currency
Asset - - - 28,326 1,633 2,155
Liability - - - - - -
F-24
Pruco Life Insurance Company and Subsidiary
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, 2001, 86% of notional
consisted of interest rate derivatives, and 14% of notional consisted of foreign
currency derivatives.
12. CONTINGENCIES AND LITIGATION
Prudential and the Company are subject to legal and regulatory actions in the
ordinary course of their businesses, including class actions. Pending legal and
regulatory actions include proceedings relating to aspects of the businesses and
operations that are specific to the Company and Prudential and that are typical
of the businesses in which the Company and Prudential operate. Some of these
proceedings have been brought on behalf of various alleged classes of
complainants. In certain of these matters, the plaintiffs are seeking large
and/or indeterminate amounts, including punitive or exemplary damages.
Beginning in 1995, regulatory authorities and customers brought significant
regulatory actions and civil litigation against the Company and Prudential
involving individual life insurance sales practices. In 1996, Prudential, on
behalf of itself and many of its life insurance subsidiaries including the
Company entered into settlement agreements with relevant insurance regulatory
authorities and plaintiffs in the principal life insurance sales practices class
action lawsuit covering policyholders of individual permanent life insurance
policies issued in the United States from 1982 to 1995. Pursuant to the
settlements, the companies agreed to various changes to their sales and business
practices controls, to a series of fines, and to provide specific forms of
relief to eligible class members. Virtually all claims by class members filed in
connection with the settlements have been resolved and virtually all aspects of
the remediation program have been satisfied. While the approval of the class
action settlement is now final, Prudential and the Company remain subject to
oversight and review by insurance regulators and other regulatory authorities
with respect to its sales practices and the conduct of the remediation program.
The U.S. District Court has also retained jurisdiction as to all matters
relating to the administration, consummation, enforcement and interpretation of
the settlements.
As of December 31, 2001, Prudential and/or the Company remained a party to
approximately 44 individual sales practices actions filed by policyholders who
"opted out" of the class action settlement relating to permanent life insurance
policies issued in the United States between 1982 and 1995. In addition, there
were 19 sales practices actions pending that were filed by policyholders who
were members of the class and who failed to "opt out" of the class action
settlement. Prudential and the Company believe that those actions are governed
by the class settlement release and expects them to be enjoined and/or
dismissed. Additional suits may be filed by class members who "opted out" of the
class settlements or who failed to "opt out" but nevertheless seek to proceed
against Prudential and/or the Company. A number of the plaintiffs in these cases
seek large and/or indeterminate amounts, including punitive or exemplary
damages. Some of these actions are brought on behalf of multiple plaintiffs. It
is possible that substantial punitive damages might be awarded in any of these
actions and particularly in an action involving multiple plaintiffs.
Prudential has indemnified the Company for any liabilities incurred in
connection with sales practices litigation covering policyholders of individual
permanent life insurance policies issued in the United States from 1982 to 1995.
The Company's litigation is subject to many uncertainties, and given the
complexity and scope, the outcomes cannot be predicted. It is possible that the
results of operations or the cash flow of the Company in a particular quarterly
or annual period could be materially affected by an ultimate unfavorable
resolution of pending litigation and regulatory matters. Management believes,
however, that the ultimate outcome of all pending litigation and regulatory
matters should not have a material adverse effect on the Company's financial
position.
F-25
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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, the Company would not be permitted a dividend distribution
until December 29, 2002.
During 2001, the Company received approval from the Arizona Department of
Insurance to pay an extraordinary dividend to Prudential of $108 million.
14. RELATED PARTY TRANSACTIONS
The Company has extensive transactions and relationships with Prudential and
other affiliates. It is possible that the terms of these transactions are not
the same as those that would result from transactions among wholly unrelated
parties.
Expense Charges and Allocations
All of the Company's expenses are allocations or charges from Prudential or
other affiliates. These expenses can be grouped into the following categories:
general and administrative expenses, retail distribution expenses and asset
management fees.
The Company's general and administrative expenses are charged to the Company
using allocation methodologies based on business processes. Management believes
that the methodology is reasonable and reflects costs incurred by Prudential to
process transactions on behalf of the Company. 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. The
Company is allocated estimated distribution expenses from Prudential's retail
agency network for both its domestic life and annuity products. The Company has
capitalized the majority of these distribution expenses as deferred policy
acquisition costs. Beginning April 1, 2000, Prudential and the Company agreed to
revise the estimate of allocated distribution expenses to reflect a market based
pricing arrangement.
In accordance with a profit sharing agreement with Prudential that was in effect
through December 31, 2000, the Company received fee income from policyholder
account balances invested in the Prudential Series Funds ("PSF"). These revenues
were recorded as "Asset management fees" in the Consolidated Statements of
Operations and Comprehensive Income. The Company was charged an asset management
fee by Prudential Global Asset Management ("PGAM") and Jennison Associates LLC
("Jennison") for managing the PSF portfolio. These fees are a component of
"general, administrative and other expenses."
On September 29, 2000, the Board of Directors for the Prudential Series Fund,
Inc. ("PSFI") adopted resolutions to terminate the existing management agreement
between PSFI and Prudential, and has appointed another subsidiary of Prudential
as the fund manager for the PSF. The change was approved by the shareholders of
PSF during early 2001 and effective January 1, 2001. The Company no longer
receives fees associated with the PSF. In addition, the Company will no longer
incur the asset management expense from PGAM and Jennison associated with the
PSF.
Corporate Owned Life Insurance
The Company has sold three Corporate Owned Life Insurance ("COLI") policies to
Prudential. The cash surrender value included in Separate Accounts was $647.2
million and $685.9 million at December 31, 2001 and December 31, 2000,
respectively. The fees received related to the COLI policies were $7.0 million
and $9.6 million for the years ending December 31, 2001 and 2000.
F-26
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
14. RELATED PARTY TRANSACTIONS (continued)
Reinsurance
The Company currently has four reinsurance agreements in place with Prudential
and affiliates. Specifically, the Company has 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. In addition, there are 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
periods ended December 31, 2001 or 2000. The fourth agreement, which is new for
2001, is described in the following paragraphs.
On January 31, 2001, the Company transferred all of its assets and liabilities
associated with the Company's Taiwan branch including Taiwan's insurance book of
business to an affiliated Company, Prudential Life Insurance Company of Taiwan
Inc. ("Prudential of Taiwan"), a wholly owned subsidiary of the Holding Company.
The mechanism used to transfer this block of business in Taiwan is referred to
as a "full acquisition and assumption" transaction. Under this mechanism, the
Company is jointly liable with Prudential of Taiwan for two years from the
giving of notice to all obligees for all matured obligations and for two years
after the maturity date of not-yet-matured obligations. Prudential of Taiwan is
also contractually liable, under indemnification provisions of the transaction,
for any liabilities that may be asserted against the Company. The transfer of
the insurance related assets and liabilities was accounted for as a
long-duration coinsurance transaction under accounting principles generally
accepted in the United States. Under this accounting treatment, the insurance
related liabilities remain on the books of the Company and an offsetting
reinsurance recoverable is established.
As part of this transaction, the Company made a capital contribution to
Prudential of Taiwan in the amount of the net equity of the Company's Taiwan
branch as of the date of transfer. In July 2001, the Company dividended its
interest in Prudential of Taiwan to Prudential.
Premiums and benefits ceded for the period ending December 31, 2001 from the
Taiwan coinsurance agreement were $82.4 million and $12.9 million, respectively.
Debt Agreements
In July 1998, the Company established a revolving line of credit facility of up
to $500 million with Prudential Funding LLC, a wholly owned subsidiary of
Prudential. There is no outstanding debt relating to this credit facility as of
December 31, 2001 or December 31, 2000.
F-27