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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
_ EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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 24, 2003. Common stock, par value
of $10 per share: 250,000 shares outstanding
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PRUCO LIFE INSURANCE COMPANY
(Registrant)
INDEX
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Page No.
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Cover Page -
Index 2
PART I Item 1. Business 3
Item 2 Properties 6
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of Security Holders 7
PART II Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 8
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial
Position and Results of Operations 8
Item 7a. Quantitative and Qualitative Disclosures About
Market Risk 21
Item 8. Financial Statements and Supplementary Data 25
Item 9. Changes in and Disagreements with Independent
Accountants on Accounting and Financial Disclosure 25
PART III Item 10. Directors and Executive Officers of the Registrant 25
Item 11. Executive Compensation 27
Item 12. Security Ownership of Certain Beneficial Owners
and Management 27
Item 13. Certain Relationships and Related Transactions 27
Item 14. Controls and Procedures 27
PART IV Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 28
Signatures 30
Certifications 31
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," "intends", 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
negative impact of the current economic environment; various domestic or
international military or terrorist activities or conflicts; volatility in the
securities markets; reestimates of our reserves for future policy benefits and
claims; changes in our assumptions related to deferred policy acquisition costs;
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
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Item 1. Business
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Overview
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 interest sensitive 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.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential Insurance"), an insurance company founded in 1875 under the
laws of the state of New Jersey. On December 18, 2001 ("the date of
demutualization") Prudential Insurance converted from a mutual life insurance
company to a stock life insurance company and became an indirect wholly owned
subsidiary of Prudential Financial, Inc. ("Prudential Financial"). 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 Insurance 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 Insurance
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.
The following paragraphs describe the Company's products, marketing and
distribution, and underwriting and pricing.
Products
Variable Life Insurance
We offer a number of individual variable life insurance products that provide a
return linked to an underlying investment portfolio designated by the
policyholder while providing the policyholder with the flexibility to change
both the death benefit and premium payments. Each product provides for the
deduction of charges and expenses from the customer's investment account. We
also offer variable life products targeted to the estate planning and
corporate-owned life insurance markets.
Term Life Insurance
We offer a variety of term life insurance products. Most term products include a
conversion feature that allows the policyholder to convert the policy into
permanent life insurance coverage.
Universal Life Insurance
We offer universal life insurance products that feature a market rate fixed
interest investment account and flexible premiums.
Variable and Fixed Annuities
We offer variable annuities that provide our customers with the opportunity to
invest in proprietary and non-proprietary mutual funds and fixed-rate options.
The investments made by customers in the proprietary and non-proprietary mutual
funds represent separate accounts for which the contractholder bears the
investment risk. The investments made in the fixed rate options are credited
with interest at rates determined by us, subject to certain minimums.
Additionally, our variable annuities products offer certain minimum death
benefit and living benefit guarantee options. We also had offered fixed
annuities that provide a guarantee of principal and a guaranteed interest rate
to be credited to the principal amount for a specified period of time. Fixed
annuities are not currently offered for sale.
3
Guaranteed Investment Contracts ("GICs")
We offer non-participating GICs through which customers deposit funds with us
under contracts that typically provide for a specified rate of interest on the
amount invested through the maturity of the contract. We are obligated to pay
principal and interest according to the contracts' terms. This obligation is
backed primarily by fixed maturities, and we bear all of the investment and
asset/liability management risk on these contracts. As spread products,
non-participating GICs make a profit to the extent that the rate of return on
the investments we make with the invested funds exceeds the promised interest
rate and our expenses. Since 1997, we have offered our credit-enhanced GIC,
which has a triple-A rating, the highest rating possible, as a result of a
guarantee from a financial insurer.
Marketing and Distribution
Prudential Insurance Agents
Agents employed by Prudential Insurance, our Parent company, distribute
variable, universal and term life, variable and fixed annuities, and investment
and protection products with proprietary and non-proprietary investment options
as well as selected insurance products manufactured by others. GICs are
distributed using a small direct sales force. We place most of our GIC business
with clients with whom we have an existing relationship.
The majority of Prudential Insurance Agents are multi-line traditional agents.
Other than certain training allowances or salary paid at the beginning of their
employment, traditional Prudential Insurance Agents are paid on a commission
basis for the products they sell. As described in the Notes to the Financial
Statements, the Company is allocated expenses from Prudential Insurance. These
allocated expenses reflect a market based pricing arrangement.
Third Party Distribution
Our individual life and annuity products are offered through a variety of third
party channels, including independent brokers, general agencies, producer
groups, banks and broker-dealers. We have historically focused on serving the
intermediaries who provide insurance solutions in support of estate and wealth
transfer planning for affluent individuals and corporate-owned life insurance
for businesses. However, we have expanded our target market to include mass
affluent individuals in addition to affluent individuals. The life insurance and
annuity products offered are generally the same as those available through
Prudential Insurance Agents. Our third party efforts are supported by a network
of internal and external wholesalers.
Underwriting and Pricing
Life Insurance
Our life insurance underwriters follow detailed and uniform policies and
procedures to assess and quantify the risk of our individual life insurance
products. We require the applicant to take a variety of underwriting tests, such
as medical examinations, electrocardiograms, blood tests, urine tests, chest
x-rays and consumer investigative reports, depending on the age of the applicant
and the amount of insurance applied for. Our universal life insurance contracts
and the fixed component of our variable life insurance contracts feature
crediting rates which are reset periodically. In resetting these rates, we
consider the returns on our portfolios supporting the interest-sensitive life
insurance business, current interest rates, the competitive environment, and our
profit objectives.
Annuities
We earn investment management fees based upon the average assets of the mutual
funds in our variable annuity products and mortality and expense fees and other
fees for various insurance-related options and features based on average daily
net assets of the value of the annuity separate accounts. We price our fixed
annuities as well as the fixed-rate options of our variable annuities based on
assumptions as to investment returns, expenses and persistency. Competition also
influences our pricing. We seek to maintain a spread between the return on our
general account invested assets and the interest we credit on our fixed
annuities. To encourage persistency, all of our variable annuities have
withdrawal restrictions and declining surrender or withdrawal charges for a
specified number of years.
Guaranteed Investment Contracts
We set our rates for guaranteed products using a proprietary pricing model that
considers the investment environment and our risk, expense and profitability
assumptions. Upon sale of a product, we adjust the duration of our asset
portfolio and lock in the prevailing interest rates. We continuously monitor
cash flow experience and work closely with our Asset Liability and Risk
Management Group to review performance and ensure compliance with our investment
policy.
4
Reserves
We establish reserve and policyholder fund liabilities to recognize our future
benefit obligations for our in force life and annuity policies. For variable and
interest-sensitive life insurance and annuity contracts, we establish
policyholders' account balances that represent cumulative gross premium payments
plus credited interest and/or fund performance, less withdrawals, expenses and
mortality charges.
Our variable annuity products contain a guaranteed minimum death benefit feature
that prescribes a minimum benefit to be paid upon the death of the annuitant.
This minimum death benefit is based on the net deposits paid into the contract,
the net deposits accumulated at a specific rate, the highest historical account
value on a contract anniversary, or more typically the greatest of these values.
To the extent that the guaranteed minimum dearth benefit is higher than the
current account value at the time of death, we incur a cost that results in
increased annuity policy benefits We currently do not record a corresponding
reserve for these future obligations, as current accounting literature does not
prescribe the advanced recognition of expected future net costs associated with
these guarantees. Costs associated with such benefits are recorded as a charge
to earnings in the period in which the death benefit is paid. However, we
consider the expected net costs associated with these guarantees in our
calculations of expected gross profits on the variable annuity business, on
which our periodic evaluations of unamortized policy acquisition costs are
based. A proposed AICPA Statement of Position (SOP), "Accounting and Reporting
by Insurance Enterprises for Certain Non-traditional Long Duration Contracts,"
would require us to establish such a reserve. We are currently evaluating the
impact of this proposed SOP. As of December 31, 2002, the death benefit coverage
in force (representing the amount we would have to pay if all annuitants had
died on that date) was approximately $3.0 billion. The death benefit coverage in
force represents the excess of the guaranteed benefit amount over the fair value
of the underlying mutual fund investments.
We establish policyholder fund liabilities for GICs that represent cumulative
contractholder account balances.
Reinsurance
Since 2000, we have reinsured the majority of the mortality risk we assume under
our new individual life insurance products. The maximum amount of individual
life insurance we may retain on any life is $2.5 million.
Regulatory Environment
In order to continue to market life insurance and annuity products, the Company
must meet or exceed the statutory capital and surplus requirements of the
insurance departments of the states in which it conducts business. Statutory
accounting practices differ from generally accepted accounting principles
("GAAP") in two major respects. First, under statutory accounting practices, the
acquisition costs of new business are charged to expense, while under GAAP they
are initially deferred and amortized over a period of time. Second, under
statutory accounting practices, the required additions to statutory reserves for
new business in some cases may initially exceed the statutory revenues
attributable to such business. These practices result in a reduction of
statutory income and surplus at the time of recording new business.
Insurance companies are subject to Risk-Based Capital ("RBC") guidelines,
monitored by insurance regulatory authorities, that measure the ratio of the
Company's statutory surplus with certain adjustments ("Adjusted Capital") to its
required capital, based on the risk characteristics of its insurance liabilities
and investments. Required capital is determined by statutory formulae that
consider risks related to the type and quality of invested assets,
insurance-related risks associated with the Company's products, interest rate
risks, and general business risks. The RBC calculations are intended to assist
regulators in measuring the adequacy of the Company's statutory capitalization.
The Company considers RBC implications in its asset/liability management
strategies. Each year, the Company conducts a thorough review of the adequacy of
statutory insurance reserves and other actuarial liabilities. The review is
performed to ensure that the Company's statutory reserves are computed in
accordance with accepted actuarial standards, reflect all contractual
obligations, meet the requirements of state laws and regulations and include
adequate provisions for any other actuarial liabilities that need to be
established. All significant reserve changes are reviewed by the Board of
Directors and are subject to approval by the Arizona Department of Insurance and
the New Jersey Department of Banking and Insurance (the "Insurance
Departments"). The Company believes that its statutory capital is adequate for
its currently anticipated levels of risk as measured by regulatory guidelines.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance ("Codification"), which replaced the current Accounting
Practices and Procedures manual as the NAIC's primary guidance on statutory
accounting as of January 1, 2001. The Codification provided guidance for areas
where statutory accounting had been silent and changed current statutory
accounting in certain areas. Certain of the standards had an impact on the
measurement of statutory capital, which, in turn, affected RBC ratios of
insurance companies. The Company adopted the Codification guidance effective
January 1, 2001. As a result of these changes, the Company reported an increase
to statutory surplus of $81 million, primarily as a result of the recognition of
deferred tax assets.
5
The NAIC has developed a set of financial relationships or tests known as the
Insurance Regulatory Information System ("IRIS") to assist state regulators in
monitoring the financial condition of insurance companies and identifying
companies that require special attention or action by insurance regulatory
authorities. Insurance companies generally submit data annually to the NAIC,
which in turn analyzes the data using prescribed financial data ratios, each
with defined "usual ranges." Generally, regulators will begin to investigate or
monitor an insurance company if ratios fall outside the usual ranges for four or
more of the ratios. If an insurance company has insufficient capital, regulators
may act to reduce the amount of insurance it can issue. The Company is not
currently subject to regulatory scrutiny based on these ratios.
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.
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.
Item 2. Properties
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Office space is provided by Prudential Insurance, as is described in the Notes
to the Consolidated Financial Statements.
Item 3. Legal Proceedings
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The Company and Prudential Insurance 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
Insurance and that are typical of the businesses in which the Company and
Prudential Insurance operate. Class action and individual lawsuits involve a
variety of issues and/or allegations, which include sales practices,
underwriting practices, claims payment and procedures, premium charges, policy
servicing and breach of fiduciary duties to customers. We are also subject to
litigation arising out of our general business activities, such as our
investments and third party contracts. In certain of these matters, the
plaintiffs are seeking large and/or indeterminate amounts, including punitive or
exemplary damages.
The Company and Prudential Insurance have been subject to substantial regulatory
actions and civil litigation, including class actions, involving individual life
insurance sales practices from 1982 through 1995. As of January 31, 2003, the
Company and Prudential Insurance have resolved those regulatory actions, its
sales practices class action litigation and virtually all of the individual
sales practices actions filed by policyholders who "opted out" of the sales
practices class action. Prudential Insurance 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.
6
Item 4. Submission of Matters to a Vote of Security Holders
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At the annual meeting of the stockholders held on June 17, 2002, 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-subsequently resigned
Ronald P. Joelson
David R. Odenath, Jr.
7
PART II
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Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters
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The Company is a wholly owned subsidiary of Prudential Insurance. There is no
public market for the Company's common stock.
Item 6. Selected Financial Data
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Pruco Life Insurance Company and Subsidiary
For the Years Ended December 31,
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(in thousands)
2002 2001 2000 1999 1998
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Revenues
Premiums and other revenue $ 684,343 $ 593,912 $ 670,445 $ 575,190 $ 473,975
Realized investment (losses) gains, net (68,037) (60,476) (20,679) (32,545) 44,841
Net investment income 334,486 343,638 337,919 276,821 261,430
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Total revenues 950,792 877,074 987,685 819,466 780,246
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Benefits and Expenses
Policyholders' benefits and interest
credited to policyholders' account
balances 480,064 452,046 419,073 341,894 312,731
Other expenses 509,733 382,701 410,684 392,041 231,320
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Total benefits and expenses 989,797 834,747 829,757 733,935 544,051
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(Loss) Income before income taxes (39,005) 42,327 157,928 85,531 236,195
Income tax (benefit) expense (52,503) (25,255) 54,432 29,936 84,233
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Net income $ 13,498 $ 67,582 $ 103,496 $ 55,595 $ 151,962
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Total assets at year end $21,210,888 $22,093,412 $23,059,009 $21,768,508 $16,812,781
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Separate account liabilities at year $12,696,758 $14,920,584 $16,230,264 $16,032,449 $11,490,751
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Item 7. Management's Discussion and Analysis of Financial Position and Results
of Operations
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Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the consolidated financial condition of Pruco Life
Insurance Company as of December 31, 2002, compared with December 31, 2001, and
its consolidated results of operations for the years ended December 31, 2002,
2001 and 2000.
The Company sells interest-sensitive individual life insurance and variable life
insurance, term life insurance, individual variable annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced ("PACE") primarily through the Prudential Insurance 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. Beginning
February 1, 2001, all insurance activity of the Taiwan branch has been ceded to
the affiliated Company and is not included in the Company's results of
operations.
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
8
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.
Application of Critical Accounting Policies
The preparation of financial statements in conformity with U.S. 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 estimates and assumptions used in the preparation of
financial statements. If management determines that modifications in assumptions
and estimates are appropriate given current facts and circumstances, results of
operations and financial position as reported in the Consolidated Financial
Statements may change significantly.
The following sections discuss the accounting policies applied in preparing our
financial statements that management believes are most dependent on the
application of estimates and assumptions.
Valuation of investments
A large portion of our investments is reflected at fair value in the statements
of financial position based on quoted market prices or estimates from
independent pricing services. However, when such information is not available,
for example, with respect to private placement fixed maturity securities, which
comprises 18.6% of our investments at December 31, 2002, 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 fair value estimates. 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 reduced,
with a corresponding charge to earnings, when a decline in value is considered
to be other than temporary. Factors we consider in determining whether a decline
in value is other than temporary include: whether the decline is substantial;
the length of time the fair value has been less than cost, generally six months;
and the financial condition and near-term prospects of the issuer. This
corresponding charge is referred to as an impairment and is reflected in
"Realized investment losses, net" in the statements of operations. 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 and other policyholder liabilities"
represents 4.8% of total liabilities as of December 31, 2002. Changes in this
liability are generally reflected in the "Policyholders' benefits" caption in
our statements of operations. This liability 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 or surrender 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 loss recognition reserves.
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 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. However,
for products with amortization based on future premiums, the amortization rate
is locked-in when the product is sold.
For example, expected profitability is a significant estimate in evaluating
deferred acquisition costs related to annuity products. Expected profitability
considers, among other assumptions, our best estimate of future asset returns to
estimate the future fees we expect to earn, the costs associated with minimum
death benefit guarantees we expect to incur and other profitability factors. For
the average remaining life of our variable annuity contracts in force as of
December 31, 2002, our evaluation of deferred policy acquisition costs is based
on a 9.25% annual blended rate of return that reflects an assumed rate of return
of 11.5% for equity type assets. Continuation of current market conditions or
further deterioration in market conditions may result in increases in the
amortization of deferred policy acquisition costs, while a significant
improvement in market conditions may result in a decrease in the amortization of
deferred policy acquisition costs. These changes in DAC balances are included as
a component of "General, administrative and other expenses" in our statements of
operations.
9
See "Results of Operations" for discussion of the impact of DAC amortization on
our results of our life and annuities products, including increased amortization
recorded in 2002 and 2001 reflecting lower estimates of future gross profits.
See "Results of Operations" for a discussion of the proposed AICPA Statement of
Position "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts."
Reserves for contingencies
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 Insurance,
there will be no financial impact on the statement of operations.
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 7 to the Consolidated Financial Statements.
Recently Issued Accounting Pronouncements
See Note 2 to the Consolidated Financial Statements for a discussion of recently
issued accounting pronouncements.
The FASB is currently discussing the accounting related to certain modified
coinsurance ("modco") and funds withheld reinsurance agreements. More
specifically, the discussions relate to whether modco and funds withheld
reinsurance agreements that provide for a total return on a pool of fixed income
securities contain embedded derivatives that would require bifurcation under
SFAS No. 133. The FASB plans to address this issue by combining it with a
portion of the tentative guidance in SFAS No. 133 Implementation Issue No.
B36, "Embedded Derivatives-Bifurcation of Embedded Credit."
If embedded derivative accounting for certain modco and funds withheld
reinsurance agreements is eventually required under Implementation Issue No.
B36, we intend to apply the guidance prospectively, for all existing contracts
and future transactions, in the quarter following final resolution of the Issue.
Based upon our current level of modco and funds withheld reinsurance, we do not
believe application of Implementation Issue No. B36, as we currently understand
it, would have a material impact on our financial condition or results of
operations.
The Company's Changes in Financial Position and Results of Operations are
described below.
Changes in Financial Position
2002 versus 2001
From December 31, 2001 to December 31, 2002 there was a decrease of $882 million
in total assets from $22.093 billion to $21.211 billion. Separate account assets
declined $2.224 billion mainly from market value declines. Fixed maturities
increased by $1.133 billion from investing policyholder deposits and unrealized
market gains. Reinsurance recoverable increased by $92 million due to growth in
reinsurance activity for the transferred Taiwan business and domestic term and
variable life insurance. Cash and cash equivalents increased $62 million from
increased securities lending activities.
During the year, liabilities decreased by $953 million from $20.442 billion to
$19.489 billion. Corresponding with the asset change, separate account
liabilities decreased by $2.224 billion primarily from market value declines of
$2.094 billion, and policy charges and other disbursements of $446 million
offset by net sales of $316 million. Current year net sales of $316 million
consist of $1.639 billion of contributions and policy credit transfers less
$1.323 billion of surrenders, withdrawals and transfers.
Policyholder account balances increased by $908 million primarily from positive
net sales (sales less withdrawals) of annuity products with fixed rate options
and the PACE product. A higher level of securities lending activity increased
liabilities by $355 million. Future policy benefits increased $126 million
mainly due to increases in reserves for the transferred Taiwan business and for
domestic life term and extended term insurance.
Other liabilities decreased by $98 million mainly due to the funding of policy
credits to the separate account policyholders, which had been accrued in other
liabilities at December 31, 2001. This decrease was partially offset by an
increase in payables resulting from purchases of securities that had not yet
been settled.
10
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 Insurance
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 to Prudential Insurance 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 Insurance. 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 the
Prudential Insurance 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.
Results of Operations
2002 versus 2001
Net Income
Despite growth in annuity and life insurance sales and the in-force of our life
insurance products, consolidated net income declined $54.1 million from $67.6
million in 2001 to $13.5 million in 2002. The primary reason for this decline
was the weak equity markets that affected, in particular, the variable annuity
products. The unfavorable market conditions caused a decline in the annuity
separate account fund values, which resulted in lower policy fee income and
higher minimum death benefit guarantees as fund values fell below the guaranteed
minimum death benefits. These factors also affected our estimate of expected
future gross profits, which is the basis on which DAC is amortized. As a result,
DAC amortization was accelerated. DAC amortization, which is included in
"General, Administrative and Other Expenses", increased $112.3 million from the
prior year, with $75.3 million related specifically to annuity products. This
decrease to income was partially offset by higher premiums from term insurance
sales and renewals and higher policy charges from life products due to the
growth of the in-force business. Most of the policy charges associated with life
products such as mortality charges are based on the face amount of the policies
and not the fund value and therefore are not as affected by stock market changes
as are the annuity products. Tax expense for the current year is lower than the
prior year due to reduced income from operations before taxes. Both years
include tax benefits from nontaxable investment income. More details regarding
the components of revenues and expenses are provided below.
Revenues
Consolidated revenues increased by $73.7 million, from $877.1 million to $950.8
million. 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 $39.7 million. The
increase was a result of a $56.9 million increase for domestic individual life
11
products offset by a $17.2 million decrease for annuity products. Mortality and
sales based loading charges for life products increased as a result of growth of
the in-force business. The life insurance in-force (excluding term insurance)
grew to $65.5 billion at December 31, 2002 from $58.7 billion at December 31,
2001. Policy charges from life products were also positively impacted by $12
million in policy fees from a sale to Prudential Insurance in December 2002 of
Corporate Owned Life Insurance ("COLI").
In contrast, annuity fees are mainly asset based fees which are dependent on
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
conditions in the securities market over the past three years, thereby reducing
policy fee income.
Premiums increased by $38.0 million primarily as a result of higher term
insurance sales and renewals of the Term Essential and Term Elite products of
$50.9 million as these are relatively new products launched at the end of 2000.
Partially offsetting this increase is lower extended term premiums of $4.9
million, and lower Taiwan premiums of $7.5 million as all Taiwan premiums are
ceded after January 31, 2001 pursuant to the coinsurance agreement. Extended
term policies represent term insurance the Company issued, under policy
provisions to customers who previously had lapsing variable life insurance with
the Company. The policyholder can purchase 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.
Other income increased $9.2 million primarily from expense allowance recoveries
from a reinsurance agreement associated with the Magnastar contract, a new third
party distribution agreement (described in Note 6) and increased modal premiums.
Modal premiums, service charges for policyholders who pay other than annual
premiums, have grown as term insurance has grown.
Partially offsetting these increases are lower net investment income and higher
realized investment losses. Despite the investment portfolio growth due to
positive cash inflows, net investment income is lower by $9.1 million due to
lower yields available on the reinvestment of fixed maturities and lower
interest rates for short-term investments. Realized investment losses are $7.6
million higher mainly due to increased derivative losses of $10.3 million from
Treasury futures and swaps as the Company is in a net short position in a
declining interest rate environment. Losses on fixed maturities from credit
related sales and impairments were $56.0 million in 2002 compared to $60.9
million in 2001. Although the current year experienced less impairments compared
to the prior year ($27.8 million in 2002 compared to $53.5 million in 2001),
there were higher losses due to credit related sales in 2002 ($28.2 million in
2002 compared to $7.4 million in 2001).
Benefits and Expenses
Policyholder benefits increased by $19.2 million, which consists of increases in
death benefits of $16.1 million and reserve increases of $3.1 million. The
primary reason for the higher death benefits is the increase in guaranteed
minimum death benefits for annuity products, as described below. Guaranteed
minimum death benefits increased from $13.6 million in 2001 to $33.8 million in
2002. Death benefits associated with our life insurance products decreased by
$2.4 million despite an increase in the in-force business and unfavorable
mortality experience due to two factors, which were favorable when compared to
the prior year. The prior year policyholder benefits included the impact of
September 11th claims of $11.6 million, net of reinsurance. In addition, the
current year benefited from reinsurance recoveries from Prudential Insurance and
other insurance carriers. In particular, two large death claims totaling $30
million were reinsured by Prudential Insurance.
The guaranteed minimum death benefit feature provides annuity contract holders
with a guarantee that the benefit received at death will be no less than a
prescribed minimum amount. This minimum amount is based on the net deposits paid
into the contract, the net deposits accumulated at a specified rate, the highest
historical account value on a contract anniversary, or more typically the
greatest of these values, depending on features offered in various contracts and
elected by the contract holders. These contracts generally require payment of
additional charges for guarantees other than those based on net deposits paid
into the contract. To the extent that the guaranteed minimum death benefit is
higher than the current account value at the time of death, the Company incurs a
cost. This results in increased annuity policy benefits in periods of declining
financial markets and in periods of stable financial markets following a
decline. Current accounting literature does not prescribe advance recognition of
the expected future net costs associated with these guarantees, and accordingly
we currently do not record a liability corresponding to these projected future
obligations for death benefits in excess of annuity account values. However, we
consider the expected net costs associated with these guarantees in our
calculations of expected gross profits on variable annuity business, on which
our periodic evaluations of unamortized policy acquisition costs are based. A
proposed AICPA Statement of Position, "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts" (the "Proposed SOP"), would require recording of a liability for the
expected net costs associated with these guarantees under certain circumstances,
if adopted as proposed. We are currently evaluating the impact of the Proposed
SOP. As of December 31, 2002, the death benefit coverage in force (representing
the amount we would have to pay if all annuitants had died on that date) was
approximately $3.0 billion. The death benefit coverage in force represents the
excess of the guaranteed benefit amount over the fair value of the underlying
mutual fund investments.
Reserve increases were $3.2 million higher than the prior year primarily from
increases to term insurance reserves of $23.6 million due to sales and renewals
of the Term Essential and Term Elite products. Partially offsetting this, were
12
decreases to reserves resulting from lower extended term premiums and increased
surrenders of reduced paid up policies. The change in Taiwan reserves was $5.4
million lower in 2002 due to the transfer of the branch as of January 31, 2001,
and the subsequent ceding of the business.
Interest credited to policyholder account balances increased by $8.8 million as
a result of growth in policyholder account balances of approximately $900
million. Interest credited increased by $7.0 million for PACE guaranteed
investment contracts and $3.5 million for life funds. Annuity interest credited
declined by $1.7 million despite growth of approximately $600 million in
policyholder account balances due to a reduction in annuity interest rates.
Annuity interest crediting rates were reduced in reaction to the declining
investment portfolio yields. Overall net interest spread revenue has declined
from last year as investment income and yields on general account assets have
declined as described above.
General, administrative, and other expenses increased $127.0 million from the
prior year, primarily the result of increased DAC amortization of $112.3
million. The majority of the DAC amortization increase, $75.3 million, was
related to our annuity products. These charges reflect our lower estimates of
future gross profits from greater expected costs from minimum death benefit
guarantees and lower expected fees under these contracts due to declines in
asset values and decreased future asset returns. The remaining increase in DAC
amortization is associated with our life products and is primarily due to the
growth of the in-force, less favorable market performance, and the reduction in
prior year amortization due to claims from the September 11th terrorist attack
on the United States. In addition, general, administrative, and other expenses
increased by $14.7 million as a result of the growth of the business.
Deferred acquisition costs related to annuity products are evaluated quarterly
by comparing our actual profitability to our expectations. Expected
profitability considers, among other assumptions, our best estimate of future
asset returns to estimate the future fees we expect to earn, the costs
associated with minimum death benefit guarantees we expect to incur and other
profitability factors. If actual asset returns do not differ significantly from
our expectations, they do not result in a change in the rate of amortization of
deferred acquisition costs. Where actual asset returns differ more significantly
from expectations, future asset return assumptions are evaluated using a
reversion to mean approach. Under the reversion to mean approach we consider
historical returns over a period of time and project returns for a future
four-year period so that the investments underlying the annuities grow at a
targeted return for the entire period. We evaluate returns over a historical
period beginning January 1, 2000 giving higher weighting to the returns
experienced during the most recent two-year period. A calculated rate of return
over the four future years, which we refer to as the look-forward period, is
determined so that this calculated rate, together with the actual rate of return
for the historical period, produces the targeted return for the entire period.
If the calculated rate of return is consistent with our range of expectations in
light of market conditions, we will use it to project the asset growth for the
next four years. If the calculated rate of return is not supported by our
current expectations, we adjust our rate of return for purposes of these
computations. For contract years after the look-forward period, we project asset
growth using our long-term rate, currently an 8% annual blended rate of return,
which reflects an assumed rate of return of 8.85% for equity type assets.
Beginning in the second quarter and continuing throughout the year, we utilized
a rate of return lower than the calculated return, which contributed to
additional amortization of deferred acquisition costs during the second and
third quarter. The equity rate of return used in the immediate four-year
look-forward period varies by product, but is under 15% for all of our variable
annuity products for our evaluation of deferred policy acquisition costs as of
December 31, 2002. For the average remaining life of our variable annuity
contracts in force as of December 31, 2002, our evaluation of deferred policy
acquisition costs is based on a 9.25% annual blended rate of return, which
reflects an assumed rate of return of 11.5% for equity type assets. Continuation
of current market conditions or further deterioration in market conditions may
result in increases in the amortization of deferred policy acquisition costs,
while a significant improvement in market conditions may result in a decrease in
the amortization of deferred policy acquisition costs.
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 gross 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, and an increase in premiums related to extended term policy
conversions.
13
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 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 $53.2 billion at December 31, 2000 to $58.7 billion
at December 31, 2001, an increase of 10.3%. In contrast, annuity fees which are
mainly asset-based fees, have declined as a result of unfavorable valuation
changes in the securities market and lower sales due to the discontinuation of
the Exchange program.
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 and 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 charges due to the growth in term insurance.
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 deposits, 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.
General Account Investments
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
$6,343.0 million at December 31, 2002, versus $5,207.5 million at December 31,
2001. A diversified portfolio of publicly traded bonds, private placements,
commercial mortgages and equity investments is managed under strategies intended
to maintain a competitive asset mix consistent with current and anticipated cash
flow requirements of the related obligations. The risk tolerance reflects the
Company's aggregate capital position, exposure to business risk, liquidity and
rating agency considerations.
As of December 31,
----------------------------------------------------------
2002 % of Total 2001 % of Total
---------------------------- ----------------------------
($ in thousands)
Fixed maturities
Public, available for sale, at fair value $3,977,441 62.7% $2,695,135 51.8%
Private, available for sale, at fair value 1,180,665 18.6% 1,329,758 25.5%
Equity securities, at fair value 199 -% 375 -%
Commercial loans, at book value 6,966 0.1% 8,190 0.2%
Other long term investments (1) 83,856 1.3% 84,342 1.6%
Policy loans, at outstanding balance 879,506 13.9% 874,065 16.8%
Short-term investments 214,342 3.4% 215,610 4.1%
-------------- ------------- -------------- -------------
Total investments $6,342,975 100.0% $5,207,475 100.0%
============== ============= ============== =============
14
- ------------
(1) Other long-term investments consist of real estate and non-real
estate related investments in joint ventures and partnerships, our
interest in separate account investments and other miscellaneous
investments.
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, the related quality of the
portfolio, and recent activities to manage the portfolio are discussed below.
As of December 31, 2002, our investment portfolio consisted primarily of
$5,158.1 million of fixed maturity securities versus $4,024.9 in 2001 (81% of
the total portfolio in 2002 versus 77% in 2001), $7.0 million of commercial
loans versus $8.2 million in 2001, $0.2 million of equity securities versus $0.4
million in 2001 and $1,177.7 million of other investments (19% of the total
portfolio in 2002 versus 23% in 2001). The commercial loan portfolio consists of
loans secured mainly by commercial buildings, which are concentrated in the
United States. The equity securities portfolio in 2002 consists of $0.2 million
of publicly traded equity securities. The equity securities portfolio in 2001
consists of $0.2 million of publicly traded equity securities and $0.2 million
of privately traded equity securities. The remaining $1,177.7 million of other
investments were comprised of other long-term investments, policy loans and
short-term investments as compared to $1,174.0 million in 2001.
Investment Results
The overall income yield on our invested assets after investment expenses,
excluding realized investment gains (losses), was 6.26% for the year ended
December 31, 2002 and 6.88% for 2001. The decline in yield on the portfolio in
2002 from 2001 is primarily attributable to reinvestment activities over the
last two years in a declining interest rate environment.
Continuation of the low interest rate environment will result in our
reinvestment of maturing securities at lower rates and would reduce the yield we
are able to earn on our investments, which support our obligations for certain
products, including fixed annuities, and guaranteed investment contracts. This
reduction in yield would also have a corresponding impact on the "spread," the
difference between the yield on our investments and the amounts that we are
required to pay our customers related to these products, which would have a
negative impact on our future profitability.
The following table sets forth the income yield and investment income, excluding
realized investment gains/(losses), for each major asset category of the Company
for the periods indicated.
For the year ended December 31,
----------------------------------------------------------
2002 2001
----------------------------------------------------------
(1) Yield Amount Yield Amount
----------------------------------------------------------
($ in thousands)
Fixed maturities 6.58% $275,843 7.42% $279,477
Equity securities 8.87 266 1.37 71
Commercial loans 11.00 791 10.87 905
Policy loans 5.79 49,436 5.75 48,149
Short-term investments 3.32 13,540 5.02 24,253
Other investments 8.15 7,071 6.79 6,021
--------- ------------- ---------- -------------
Investment income before investment
expenses 6.37 346,947 6.99 358,876
Investment expenses (0.11) (12,461) (0.11) (15,238)
--------- ------------- ---------- -------------
Total after investment expenses 6.26% $334,486 6.88% $343,638
========= ============= ========== =============
- ------------
(1) Yields are based on quarterly average carrying values except
for fixed maturities, equity securities and securities lending
activity. Yields for fixed maturities are based on amortized cost.
Yields for equity securities are based on cost. Yields for
securities lending activity are calculated net of corresponding
liabilities and rebate expenses. Yields for prior year are
presented on a basis consistent with our current reporting
practices.
15
Fixed Maturity Securities
Investment Mix
We manage our public portfolio to a risk profile directed by the Asset Liability
and Risk Management Group. We seek to employ relative value analysis both in
credit selection and in purchasing and selling securities. To the extent that we
actively purchase and sell securities as part of portfolio selection and
portfolio rebalancing, the total return that we earn on the portfolio will be
reflected both as investment income and also as realized gains or losses on
investments.
We use our private placement and asset-backed portfolios to enhance the
diversification and yield of our overall fixed maturity portfolio. Our
investment staff directly originates approximately half of all of our private
placements. Our origination capability offers the opportunity to lead
transactions and gives us the opportunity for better terms, including covenants
and call protection, and to take advantage of innovative deal structures.
The Company has classified all private placements and publicly traded securities
as available for sale. "Available for sale" 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. At December 31, 2002 the fixed maturities portfolio
totaled $5,158.1 million, an increase of $1,133.2 million compared to December
31, 2001. This increase in fixed maturities reflected growth in the overall
portfolio due to positive cash flow from insurance operations during 2002,
appreciation arising from a lower interest rate environment, as well as
reinvestment of net investment income.
Our fixed maturity securities portfolio consists principally of public and
private fixed maturities across an array of industry categories. As of December
31, 2002, we held approximately 81% of assets in fixed maturity securities
(versus 77% as of December 31, 2001) with a total amortized cost of $4,921.7
million and an estimated fair value of $5,158.1 million, compared to an
amortized cost of $3,935.5 million and estimated fair value of $4,024.9 million
as of December 31, 2001. Our investments in public fixed maturities as of
December 31, 2002 were $3,793.0 million at amortized cost and $3,977.4 million
at estimated fair value compared to $2,638.9 million at amortized cost and
$2,695.1 million at estimated fair value as of December 31, 2001. Our
investments in private fixed maturities as of December 31, 2002 were $1,128.7
million at amortized cost and $1,180.7 million at estimated fair value compared
to $1,296.6 million at amortized cost and $1,329.8 million at estimated fair
value as of December 31, 2001.
Fixed Maturity Securities and Unrealized Gains and Losses by Industry Category
The following table sets forth the composition of our fixed maturity securities
portfolio by industry category as of the dates indicated and the associated
gross unrealized gains and losses.
As of December 31,
-------------------------------------------------------------------------------------------------------
2002 2001
------------------------------------------------- ---------------------------------------------------
(1) Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
Cost Gains Losses Fair Value Cost Gains Losses Fair Value
-------------------------------------------------------------------------------------------------------
(in thousands)
Industry
- --------
U.S. Government $600,385 $11,906 $1 $612,290 $303,605 $2,015 $2,169 $303,451
Manufacturing 1,029,622 59,334 4,476 1,084,480 743,208 23,300 4,550 761,958
Utilities 509,444 29,199 6,128 532,515 617,646 21,994 5,722 633,918
Finance 705,019 52,722 724 757,017 688,330 25,158 1,330 712,158
Services 538,604 25,344 2,827 561,121 385,550 9,987 8,808 386,729
Mortgage Backed 120,425 3,242 14 123,653 10,148 160 61 10,247
Foreign
Government 45,981 4,707 44 50,644 27,332 2,130 8 29,454
Retail and
Wholesale 279,750 20,093 477 299,366 217,332 7,556 598 224,290
Securities 642,771 14,667 2,096 655,342 577,527 15,444 2,727 590,244
Transportation 218,649 12,303 390 230,562 183,148 5,689 4,681 184,156
Energy 218,269 19,224 35 237,458 175,017 6,628 418 181,227
Other 12,772 886 - 13,658 6,629 554 122 7,061
----------- ----------- ---------- ------------- ------------- ----------- ------------- -------------
Total $4,921,691 $253,627 $17,212 $5,158,106 $3,935,472 $120,615 $31,194 $4,024,893
=========== =========== ========== ============= ============= =========== ============= =============
- ------------
(1) Investment data for 2002 has been classified based on industry
accepted Lehman categorizations for public holdings and similar
classifications by industry for all other holdings. Prior year data
has been reclassified to conform to current year presentation. This
table includes redeemable preferred stock.
As a percentage of amortized cost, fixed maturity investments as of December 31,
2002 consist primarily of 21% manufacturing sector, 14% finance sector, 13%
asset-backed securities, 12% U.S. Government, and 11% services sector compared
to 19% manufacturing sector, 17% finance sector, 15% asset-backed securities, 8%
16
U.S. Government, and 10% services sector as of December 31, 2001. Nearly 100% of
the mortgage-backed securities were publicly traded agency pass-through
securities. Collateralized mortgage obligations represented less than 1% of
total mortgage-backed securities.
The gross unrealized losses related to our fixed maturity portfolio were $17.2
million as of December 31, 2002 compared to $31.2 million as of December 31,
2001. The gross unrealized losses in 2002 were concentrated primarily in the
utilities, manufacturing and services sectors while gross unrealized losses in
2001 were concentrated in the services, utilities, transportation and
manufacturing sectors. Non-investment grade securities represented 65% of the
gross unrealized losses in 2002 versus 40% of gross unrealized losses in 2001.
The following table sets forth the breakdown of our fixed maturity securities
portfolio by contractual maturity as of the dates indicated.
As of December 31,
---------------------------------------------------------------
2002 2001
--------------------------------- --------------------------
Amortized Cost % of Total Amortized Cost % of Total
---------------------------------------------------------------
($ in thousands)
Maturing in 2002 $ - -% $ 252,387 6.3%
Maturing in 2003 600,515 12.2% 538,311 13.7%
Maturing in 2004 473,559 9.6% 401,340 10.2%
Maturing in 2005 815,282 16.5% 544,405 13.8%
Maturing in 2006 791,361 16.1% 640,036 16.3%
Maturing in 2007 455,987 9.3% 255,314 6.5%
Maturing in 2008 418,960 8.5% 273,746 7.0%
Maturing in 2009 261,160 5.3% 243,565 6.2%
Maturing in 2010 163,023 3.3% 139,190 3.5%
Maturing in 2011 274,863 5.6% 289,852 7.4%
Maturing in 2012 and
Beyond 666,981 13.6% 357,326 9.1%
----------------- ----------- ----------------- --------------
Total Fixed Maturities $4,921,691 100.0% $3,935,472 100.0%
================= =========== ================= ==============
Fixed Maturity Securities Credit Quality
The NAIC evaluates the investments of insurers for regulatory reporting purposes
and assigns fixed maturity securities to one of six categories called "NAIC
Designations." NAIC designations of "1" or "2" include fixed maturities
considered investment grade, which include securities rated Baa3 or higher by
Moody's or BBB- or higher by S&P. NAIC Designations of "3" through "6" are
referred to as below investment grade, which include securities rated Ba1 or
lower by Moody's and BB+ or lower by S&P. The fixed maturity securities
designated as NAIC 6 include securities that are not rated.
The amortized cost of our public and private below-investment grade fixed
maturities totaled $526.8 million, or 11%, of the total fixed maturities as of
December 31, 2002, compared to $318.7 million, or 8%, of total fixed maturities
as of December 31, 2001. The increase in the amount of below-investment grade
fixed maturities at December 31, 2002 from a year earlier came primarily from
negative credit migration over the period.
Public Fixed Maturities - Credit Quality
The following table sets forth our public fixed maturity portfolios by NAIC
rating as of the dates indicated.
As of December 31,
-------------------------------------------------------------------------------------------------------
2002 2001
------------------------------------------------- ---------------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
Cost Gains Losses Fair Value Cost Gains Losses Fair Value
-------------------------------------------------------------------------------------------------------
(in thousands)
NAIC Rating Agency
Designation Equivalent
- ------------ ---------------
1 Aaa, Aa, A $2,377,674 $116,244 $438 $2,493,480 $1,441,230 $40,582 $4,309 $1,477,503
2 Baa 1,152,329 71,903 4,152 1,220,080 973,831 32,391 6,279 999,943
3 Ba 162,210 5,224 2,201 165,233 120,796 2,730 3,862 119,664
4 B 75,167 2,381 2,987 74,561 76,702 2,516 6,674 72,544
5 C and lower 10,391 412 2,057 8,746 14,158 776 1,159 13,775
6 In or near
default 15,195 481 335 15,341 12,201 74 569 11,706
------------- ----------- ---------- ------------- ----------- ------------- ------------ ------------
Public Fixed Maturities $3,792,966 $196,645 $12,170 $3,977,441 $2,638,918 $79,069 $22,852 $2,695,135
============= =========== ========== ============= =========== ============= ============ ============
17
Private Fixed Maturities - Credit Quality
The following table sets forth our private fixed maturity portfolios by NAIC
rating as of the dates indicated. As of December 31,
As of December 31,
-------------------------------------------------------------------------------------------------------
2002 2001
------------------------------------------------- ---------------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
Cost Gains Losses Fair Value Cost Gains Losses Fair Value
-------------------------------------------------------------------------------------------------------
(in thousands)
NAIC Rating Agency
Designation Equivalent
- ------------ ---------------
1 Aaa, Aa, A $338,539 $12,348 $1,351 $349,536 $448,333 $10,762 $6,590 $452,505
2 Baa 526,384 34,430 45 560,769 753,331 26,445 1,463 778,313
3 Ba 212,917 9,197 3,089 219,025 78,149 3,793 140 81,802
4 B 9,637 - 196 9,441 4,857 39 2 4,894
5 C and lower 39,616 1,007 253 40,370 6,624 507 120 7,011
6 In or near
default 1,632 - 108 1,524 5,260 - 27 5,233
------------- ----------- ---------- ------------- ----------- ------------- ------------ ------------
Private Fixed Maturities $1,128,725 $56,982 $5,042 $1,180,665 $1,296,554 $41,546 $8,342 $1,329,758
============= =========== ========== ============= =========== ============= ============ ============
Unrealized Losses from Fixed Maturity Securities
The following table sets forth the amortized cost and gross unrealized losses of
fixed maturity securities where the estimated fair value had declined and
remained below amortized cost by 20% or more for the following timeframes:
As of December 31,
------------------------------------------------------------------------
2002 2001
----------------------------------- ------------------------------------
Gross Unrealized Gross Unrealized
Amortized Cost Losses Amortized Cost Losses
------------------------------------------------------------------------
(in thousands)
Less than six months $9,605 $3,488 $11,753 $3,914
Greater than six months but less than nine months 982 424 - -
Greater than nine months but less than
twelve months - - 377 111
Greater than twelve months - - - -
---------------- ----------------- ----------------- -------------------
Total $10,587 $3,912 $12,130 $4,025
================ ================= ================= ===================
Gross unrealized losses of fixed maturity securities where estimated fair value
has been 20% or more below amortized cost were $3.9 million as of December 31,
2002, compared to $4.0 million as of December 31, 2001. The gross unrealized
losses in 2002 were primarily concentrated in the utilities, manufacturing, and
transportation sectors while the gross unrealized losses in 2001 were
concentrated in the transportation, services, and manufacturing sectors.
Impairments of Fixed Maturity Securities
Our credit and portfolio management processes help ensure prudent controls over
valuation and management of the private portfolio. We have separate pricing and
authorization processes to establish "checks and balances" for new investments.
We apply consistent standards of credit analysis and due diligence for all
transactions, whether they originate through our own in-house origination staff
or through agents. Our regional offices closely monitor the portfolios in their
regions. We set all valuation standards centrally, and we assess the fair value
of all investments quarterly.
18
We maintain 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
securities 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 classifications 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. In certain
situations, the Company benefits from negotiated rate increases or fees
resulting from a covenant breach. We assign closely monitored status to those
investments that have been recently restructured or for which restructuring is a
possibility due to substantial credit deterioration or material covenant
defaults. We classify as not in good standing securities of issuers that are in
more severe conditions, for example, bankruptcy or payment default.
We classify our fixed maturity securities as available for sale. As a result, we
record unrealized gains and losses to the extent that amortized cost is
different from estimated fair value. All available for sale securities with
unrealized losses are subject to our review to identify other-than-temporary
impairments in value. In evaluating whether a decline in value is
other-than-temporary, we consider several factors including, but not limited to,
the following:
1. whether the decline is substantial;
2. the duration (generally greater than six months);
3. the reasons for the decline in value (credit event or interest rate
related);
4. our ability and intent to hold our investment for a period of time to allow
for a recovery of value; and
5. the financial condition of and near-term prospects of the issuer.
When we determine that there is an other-than-temporary impairment, we record a
writedown to estimated fair value which reduces the cost basis. The new cost
basis of an impaired security is not adjusted for subsequent increases in
estimated fair value. Estimated fair values for fixed maturities, other than
private placement securities are based on quoted market prices or prices
obtained from independent pricing services. Estimated fair values for private
placement fixed maturities are determined primarily by 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 type of issue, its
current credit quality and its remaining average life. The estimated fair value
of certain non-performing private placement fixed maturities is based on amounts
estimated by management.
Impairments of fixed maturity securities totaled $27.8 million in 2002 and $53.5
million in 2001.
Liquidity and Capital Resources
Consolidated Liquidity and Capital Management
We manage our liquidity and capital resources on a company-wide basis, as well
as by legal entity and business, recognizing regulatory restrictions on
transfers of funds among entities engaged in the insurance and other businesses.
We seek to manage our consolidated liquidity position so that we have, on a
cost-effective basis, adequate resources to satisfy operating cash requirements
and investment objectives, as well as to fund business growth. We also seek to
manage our liquidity so that we have adequate sources of funding to support our
needs under stress scenarios so that we can meet our obligations without
materially disrupting our operating and investing activities.
Insurance, Annuities and Guaranteed Products Liquidity
Our principal cash flow sources are premiums and fund deposits, investment and
fee income and investment maturities and sales. These cash inflows may be
supplemented by financing activities either directly through asset-based
financing or through borrowing from other Prudential Insurance affiliates. We
actively use our balance sheet capacity for financing activities on a secured
basis through securities lending and repurchase transactions to earn additional
spread income.
Cash outflow requirements principally relate to benefits, claims, and payments
to contract holders as well as amounts paid to policyholders and contract
holders in connection with surrenders, withdrawals, and net policy loan
activity. Uses of cash also include commissions, general and administrative
expenses, and purchase of investments. We regularly monitor our liquidity
requirements associated with our policyholder and contract holder obligations so
that we manage cash inflows to match anticipated cash outflow requirements. We
utilize a cash flow projection system and regularly perform asset/liability
duration matching in the management of our asset and liability portfolios.
19
Gross account withdrawals, amounted to $1,015 million in the year ended December
31, 2002 and $1,313 million in the year ended December 31, 2001. These
withdrawals include contractually scheduled maturities of traditional guaranteed
investment contracts totaling $183 million in the year ended December 31, 2002
and $171 million in the year ended December 31, 2001. Since these contractual
withdrawals as well as the level of surrenders experienced, were consistent with
our assumptions in asset liability management, the associated cash outflows did
not have an adverse impact on our overall liquidity.
Interest rate fluctuations can affect the timing of cash flows associated with
our insurance and annuity liabilities as well as the value of assets supporting
these obligations. Changes in interest rates and other market conditions can
also expose us to the risk of accelerated surrenders as policyholders and
contract holders are attracted to alternative products. We seek to maintain an
appropriate match between our assets and liabilities so that we can satisfy the
changing cash flow requirements associated with interest rate fluctuations. In
response to interest rate changes, we can alter our strategies for investment of
new cash flows, adjust interest credited interest rates if and to the extent
permitted by contracts, and adjust the pricing of new products.
We closely monitor surrenders and withdrawals for our life insurance and annuity
contracts. Upon policy surrender, life insurance policyholders are surrendering
the life insurance protection in addition to their investment in the contract,
which would typically require new underwriting and acquisition costs to replace.
Therefore, our exposure to increased surrenders is considerably less for life
insurance policies than for annuities. In addition, many of our contracts
contain provisions that discourage early surrender. Market value adjustment
features in some contracts provide for adjustments of the amount available in
the event of surrender to reflect changes in the value of the underlying
investments. We deduct policy loans, which we report as assets, from amounts
available on surrender. Some contracts impose surrender charges that we deduct
in the event of surrender before specified dates.
We use surrender charges and other contract provisions to mitigate the extent,
timing and profitability impact of withdrawals of funds by customers from
annuity contracts. The following table sets forth withdrawal characteristics of
our general account annuity reserves and deposit liabilities (based on statutory
liability values) as of the dates indicated.
As of December 31,
----------------------------------------------------------------------
2002 2001
----------------------------------- ----------------------------------
Amount % of Total Amount % of Total
---------------- ------------------ ----------------- ----------------
($ in millions)
Not subject to discretionary withdrawal provisions $ 39 2.4% $ 37 3.7%
Subject to discretionary withdrawal, with adjustment:
With market value adjustment - -% - -%
At contract value, less surrender charge of 5% or
more 646 39.9% 271 27.0%
---------------- ------------------ ----------------- ----------------
Subtotal 685 42.3% 308 30.7%
Subject to discretionary withdrawal at contract value
with no surrender charge or surrender charge of
less than 5% 934 57.7% 695 69.3%
---------------- ------------------ ----------------- ----------------
Total annuity reserves and deposit liabilities $1,619 100.0% $1,003 100.0%
================ ================== ================= ================
We sell variable life insurance products that contain both general and separate
account components, with the bulk of account balances in separate accounts. The
principal product of this type, Variable Appreciable Life, also imposes
surrender charges for the first ten years after issuance. In addition to the
right to surrender, policyholders may transfer account balances between the
general account and the separate account components, subject to limitations on
the amount transferred and only within a 30-day period following each
anniversary of the policy. As of December 31, 2002 and 2001, general account
balances for variable life insurance products were $1.677 billion and $1.539
billion, respectively, while separate account balances were $5.620 billion and
$6.080 billion, respectively.
We believe that cash flows from operating and investing activities of our
insurance, annuity and guaranteed products operations are adequate to satisfy
liquidity requirements of these operations based on our current liability
structure and considering a variety of reasonably foreseeable stress scenarios.
The continued adequacy of this liquidity will depend upon factors including
future securities market conditions, changes in interest rate levels and
policyholder perceptions of our financial strength, which could lead to reduced
cash inflows or increased cash outflows. As of December 31, 2002 and 2001, on a
consolidated basis, we had cash and short-term investments of approximately
$650.5 million and $589.8 million, respectively, and fixed maturity investments
classified as "available for sale" with fair values of $5.158 billion and $4.025
billion at those dates, respectively.
Financing Activities
Our financing principally consists of an affiliated revolving line of credit
with Prudential Funding LLC, a wholly owned subsidiary of Prudential Insurance,
and asset-based or secured forms of financing. Our total capacity to borrow is
$700 million, which includes both the asset-based financing and borrowings from
Prudential Funding LLC. There was no outstanding debt relating to the Prudential
Funding LLC credit facility as of December 31, 2002 or December 31, 2001. The
secured financing arrangements include transactions such as securities lending
and repurchase agreements, which we generally use to finance portfolios of
liquid securities and earn additional spread income.
20
As of December 31,
----------------------
2002 2001
---------- ----------
Borrowings: (in millions)
General obligations $ - $ -
Total asset-based financing 626 271
---------- ----------
Total borrowings and asset-based financings $ 626 $ 271
========== ==========
Non-Insurance Contractual Obligations
As of December 31, 2002, the Company has a commitment to fund private placement
fixed maturities in the amount of $10.7 million.
Deferred Policy Acquisition Costs
We capitalize costs that vary with and are related primarily to the production
of new insurance and annuity business. These costs include commissions, costs to
issue and underwrite the policies and certain variable field office expenses.
The capitalized amounts are known as deferred policy acquisition costs, or DAC.
Our total DAC, including the impact of unrealized investment gains and losses,
amounted to $1.153 billion and $1.160 billion as of December 31, 2002 and 2001,
respectively.
If we were to experience a significant increase in lapse or surrender rates on
policies for which we amortize DAC based on estimated gross margins or gross
profits, such as variable life insurance and variable annuities, we would expect
acceleration of the write-off of DAC for the affected blocks of policies.
Additionally, for all policies on which we have outstanding DAC, we would be
required to evaluate whether this experience called into question our ability to
recover all or a portion of the DAC, and we would be required to write off some
or all of the DAC if we concluded that we could not recover it. While an
accelerated write-off of DAC would not affect our cash flow or liquidity, it
would negatively affect our reported earnings and level of capital under
generally accepted accounting principles.
Effective New Accounting Pronouncements
Refer to Footnote 2, "Summary of Significant Accounting Policies," of the Notes
to Consolidated Financial Statements.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
Risk Management, Market Risk, and Derivative Financial Instruments
As a wholly-owned subsidiary of Prudential Insurance, 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 Insurance considers risk management
an integral part of its core businesses.
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-based fees may decrease as a result of declines in assets under management
due to changes in market performance. For variable annuity and variable life
insurance products with minimum guaranteed death benefits, the Company also
faces the 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 has assessed this risk, as described
in "Results of Operations."
21
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, Annuities, and Guaranteed Products 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,
2002, the difference between the pre-tax duration of assets and the target
duration of liabilities in the Company's duration managed portfolio was minus
0.2 years.
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 71% of consolidated assets, other
than assets that are held in Separate accounts, as of December 31, 2002 and 68%
as of December 31, 2001. 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, 2002 and 2001, 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.
22
This presentation does not include $2.961 billion and $2.753 billion of
insurance reserves and deposit liabilities at December 31, 2002 and 2001,
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, 2002
-----------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(Derivatives) Value Shift Fair Value
-----------------------------------------------------------------
Financial Assets and Liabilities with (In millions)
Interest Rate Risk:
Financial Assets:
Fixed Maturities:
Available for Sale $ - $ 5,158 $ 5,007 $ (151)
Commercial Loans on Real Estate - 9 9 -
Policy Loans - 1,031 967 (64)
Derivatives:
Futures 12 - - -
Swaps 36 2 1 (1)
Financial Liabilities:
Investment Contracts - (2,907) (2,875) 32
----------------
Total Estimated Potential Loss $ (184)
================
December 31, 2001
-----------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(Derivatives) Value Shift Fair Value
-----------------------------------------------------------------
Financial Assets and Liabilities with (In millions)
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)
================
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.
23
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, 2002 was $.020 million,
representing a hypothetical decline in fair market value of equity securities
held by the Company at that date from $.199 million to $.179 million. The
Company's estimated equity price risk using this methodology at December 31,
2001 was $.038 million, representing a hypothetical decline in fair market value
of equity securities the Company held at that date from $.375 million to $.338
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 previously 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.
Foreign currency exchange risk is actively managed within specified limits at
the enterprise (Prudential Insurance) level using Value-at-Risk ("VaR")
analysis. This statistical technique estimates, at a specified confidence level,
the potential pretax loss in portfolio market value that could occur over an
assumed time horizon due to adverse market movements. This calculation utilizes
a variance/covariance approach.
The Company calculates VaR estimates of exposure to loss from volatility in
foreign currency exchange for a one month time period. The Company's estimated
VaR at December 31, 2002 for foreign currency assets not hedged to U.S. dollars,
measured at the 95% confidence level and using a one month time horizon, was
$0.9 million, representing a hypothetical decline in fair market value of these
foreign currency assets from $21.2 million to $20.3 million. 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.
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 $0.96
million during 2002 and $1.33 million during 2001.
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 10 of the Notes to
Consolidated Financial Statements as to the Company's derivative positions at
December 31, 2002 and 2001. Under insurance statutes the Company may only use
24
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.
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
- --------------------------------------------------------------------------------
None.
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
Name Position Age
- ---- -------- ---
Vivian L. Banta Chairman of the Board and Director 52
James J. Avery, Jr. Vice Chairman of the Board and Director 51
Andrew J. Mako Director and President 46
Richard J. Carbone Director 55
Helen M. Galt Director 55
Ronald P. Joelson Director 44
David R. Odenath, Jr. Director 46
C. Edward Chaplin Senior Vice President and Treasurer 46
Hwei-Chung Shao Senior Vice President and Chief Actuary 48
William J. Eckert, IV Vice President and Chief Accounting Officer 40
Charles A. McGee Vice President and Comptroller 54
Clifford E. Kirsch Chief Legal Counsel and Secretary 43
Shaun M. Byrnes Senior Vice President 41
Thomas F. Higgins Senior Vice President 48
Melody C. McDaid Senior Vice President 53
Esther H. Milnes Senior Vice President 52
James M. O'Connor Senior Vice President 47
Vivian L. Banta, age 52, is Chairman of the Board of Directors of the Company.
She was President of the Company through February 11, 2003. She has been
Executive Vice President, of the Prudential Insurance Division 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 51, is Vice Chairman of the Board of Directors of the
Company. Mr. Avery has been President, Prudential Insurance Division 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.
25
Andrew J. Mako, age 46, is Director and President of the Company as of February
12, 2003. Mr. Mako has been Vice President, Finance, Prudential Insurance
Division 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.
Richard J. Carbone, age 55, has been Senior Vice President and Chief Financial
Officer of Prudential since 1997. Prior to 1997 he was the Controller for
Salomon Brothers.
Helen M. Galt, age 55, has been a Company Actuary for Prudential since 1993.
Ronald P. Joelson, age 44, 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.
David R. Odenath, Jr., age 46, 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.
C. Edward Chaplin, age 46, 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 48, 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 40, was elected Vice President and Chief Accounting
Officer of the Company in June 2000. Mr. Eckert has been Vice President,
Prudential Insurance Division Controllers since May 1995. Prior to joining
Prudential in 1995, he was Senior Manager at Deloitte & Touche, LLP.
Charles A. McGee, age 54, 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 43, 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 41, 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.
Thomas F. Higgins, age 48, has been Vice President of Annuity Services in the
Prudential Insurance Division 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.
Melody C. McDaid, age 53, is Senior Vice President of the Company and Vice
President and Site Executive, Prudential Financial Services Customer Service
Office since 1995.
Esther H. Milnes, age 52, has been Vice President and Chief Actuary, Prudential
Insurance Division 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 M. O'Connor, age 47, 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.
26
Item 11. Executive Compensation
- --------------------------------
The following table shows the 2002, 2001, and 2000 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 2002 $ 35,084 $105,000 $165
Vivian L. Banta, President 2001 35,084 213,904 -
Esther H. Milnes, President 2000 21,533 3,132 -
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
Not applicable.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
Refer to Footnote 12 in the Notes to the Consolidated Financial Statements.
Item 14. Controls and Procedures
- ---------------------------------
Within the 90-day period prior to the filing of this report, an evaluation was
carried out under the supervision and with the participation of the Company's
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rule 13a-14(c) under the Securities Exchange Act of
1934. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the design and operation of these disclosure
controls and procedures were effective. No significant changes were made in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
27
PART IV
Item 15. 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.
3b. Reports on Form 8-K
Form 8-Ks, Commission file number 33-37587, filed on
August 16, 2002 and November 14, 2002.
4. Exhibits
Market-Value Adjustment Annuity Contract, incorporated by
reference to Registrant's Form S-1 Registration Statement,
Registration No. 333-89530, filed December 9, 2002, 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.
28
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, and Helen M. Galt, 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
of amount
registered Amount sold Amount sold
--------------- ---------------- ------------------
(in thousands)
Flexible Premium Variable Annuity Account* $ 500,000 $ 393,213 $ 130,757
Underwriting discounts and commissions ** (11,314)
Other expenses *** (22,438)
----------------
Total (33,752)
----------------
Net offering proceeds $ 359,461
================
* 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.
29
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, in the city of Newark, and
state of New Jersey on the 24th day of March 2003.
PRUCO LIFE INSURANCE COMPANY
(Registrant)
By: /s/ Andrew J. Mako
-------------------
Andrew J. Mako
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 indicated on March 24, 2003.
Name Title
- ---- -----
Vivian L. Banta * Chairman of the Board and Director
- ---------------------------
Vivian L. Banta
James J. Avery, Jr. * Vice Chairman of the Boardand Director
- ---------------------------
James J. Avery, Jr.
/s/ Andrew J. Mako Director and President
- ---------------------------
Andrew J. Mako
Ronald Paul Joelson * Director
- ---------------------------
Ronald Paul Joelson
Richard J. Carbone * Director
- ---------------------------
Richard J. Carbone
Helen M. Galt * Director
- ---------------------------
Helen M. Galt
David R. Odenath, Jr. * Director
- ---------------------------
David R. Odenath, Jr.
/s/ William J. Eckert, IV Vice President and
- --------------------------- Chief Accounting Officer
William J. Eckert, IV
* By: /s/ Thomas C. Castano
-----------------------
Thomas C. Castano
(Attorney-in-Fact)
30
CERTIFICATIONS
I, Andrew J. Mako certify that:
1. I have reviewed this annual report on Form 10-K of Pruco Life Insurance
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 24, 2003
/s/ Andrew J. Mako
------------------
Andrew J. Mako
Chief Executive Officer
31
I, William J. Eckert, IV, certify that:
1. I have reviewed this annual report on Form 10-K of Pruco Life Insurance
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 24, 2003
/s/ William J. Eckert
---------------------
William J. Eckert, IV
Chief Financial Officer
32
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, 2002 and 2001
33
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, 2002 and 2001 F - 3
Consolidated Statements of Operations and Comprehensive
Income Years ended December 31, 2002, 2001 and 2000 F - 4
Consolidated Statements of Stockholder's Equity
Years ended December 31, 2002, 2001 and 2000 F - 5
Consolidated Statements of Cash Flows
Years ended December 31, 2002, 2001 and 2000 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,
2002 and 2001, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2002, 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.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 11, 2003
F-2
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Financial Position
December 31, 2002 and 2001 (in thousands)
- -------------------------------------------------------------------------------------------------------------------------------
2002 2001
----------------- -----------------
ASSETS
Fixed maturities available for sale,
at fair value (amortized cost, 2002: $4,921,691, 2001: $3,935,472) $ 5,158,106 $ 4,024,893
Equity securities available for sale, at fair value (cost, 2002: $100; 2001: $173) 199 375
Commercial loans on real estate 6,966 8,190
Policy loans 879,506 874,065
Short-term investments 214,342 215,610
Other long-term investments 83,856 84,342
----------------- -----------------
Total investments 6,342,975 5,207,475
Cash and cash equivalents 436,182 374,185
Deferred policy acquisition costs 1,152,997 1,159,830
Accrued investment income 86,125 77,433
Reinsurance recoverable 393,171 300,697
Receivables from Parent and affiliates 61,099 33,074
Other assets 41,581 20,134
Separate account assets 12,696,758 14,920,584
----------------- -----------------
TOTAL ASSETS $ 21,210,888 $ 22,093,412
================= =================
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $ 4,855,761 $ 3,947,690
Future policy benefits and other policyholder liabilities 934,546 808,230
Cash collateral for loaned securities 225,518 190,022
Securities sold under agreements to repurchase 400,507 80,715
Income taxes payable 245,252 266,096
Other liabilities 130,411 228,596
Separate account liabilities 12,696,758 14,920,584
----------------- -----------------
Total liabilities 19,488,753 20,441,933
----------------- -----------------
Contingencies (See Footnote 11)
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 1,161,136 1,147,665
Accumulated other comprehensive income:
Net unrealized investment gains 91,754 34,718
Foreign currency translation adjustments (3) (152)
----------------- -----------------
Accumulated other comprehensive income 91,751 34,566
----------------- -----------------
Total stockholder's equity 1,722,135 1,651,479
----------------- -----------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 21,210,888 $ 22,093,412
================= =================
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, 2002, 2001 and 2000 (in thousands)
- -------------------------------------------------------------------------------------------------------------------
2002 2001 2000
-------------- ---------------- --------------
REVENUES
Premiums $ 128,854 $ 90,868 $ 121,921
Policy charges and fee income 529,887 490,185 474,861
Net investment income 334,486 343,638 337,919
Realized investment losses, net (68,037) (60,476) (20,679)
Asset management fees 11,397 7,897 71,160
Other income 14,205 4,962 2,503
-------------- --------------- ---------------
Total revenues 950,792 877,074 987,685
-------------- --------------- ---------------
BENEFITS AND EXPENSES
Policyholders' benefits 275,251 256,080 248,063
Interest credited to policyholders' account balances 204,813 195,966 171,010
General, administrative and other expenses 509,733 382,701 410,684
-------------- --------------- ---------------
Total benefits and expenses 989,797 834,747 829,757
-------------- --------------- ---------------
(Loss) income from operations before income taxes (39,005) 42,327 157,928
-------------- --------------- ---------------
Income Taxes:
Current (64,656) (98,956) 8,661
Deferred 12,153 73,701 45,771
-------------- --------------- ---------------
Total income tax (benefit) expense (52,503) (25,255) 54,432
-------------- --------------- ---------------
NET INCOME 13,498 67,582 103,496
-------------- --------------- ---------------
Other comprehensive income, net of tax:
Unrealized gains on securities, net of
reclassification adjustment 57,036 29,988 33,094
Foreign currency translation adjustments 149 3,168 (993)
-------------- --------------- ---------------
Other comprehensive income 57,185 33,156 32,101
-------------- --------------- ---------------
TOTAL COMPREHENSIVE INCOME $ 70,683 $ 100,738 $ 135,597
============== =============== ===============
See Notes to Consolidated Financial Statements
F-4
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Stockholder's Equity
Years Ended December 31, 2002, 2001 and 2000 (in thousands)
- ----------------------------------------------------------------------------------------------------------------------------
Accumulated
other Total
Common Paid-in- Retained comprehensive stockholder's
stock capital earnings income (loss) equity
------------ ------------- ---------------- ----------------- -------------------
Balance, January 1, 2000 $ 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
Net income - - 13,498 - 13,498
Adjustments to policy credits issued to
eligible policyholders - - (27) - (27)
Change in foreign currency translation
adjustments, net of taxes - - - 149 149
Change in net unrealized investment
gains, net of reclassification adjustment
and taxes - - - 57,036 57,036
------------ ------------- ---------------- ----------------- -------------------
Balance, December 31, 2002 $ 2,500 $ 466,748 $ 1,161,136 $ 91,751 $ 1,722,135
============ =========== ================ ================= ===================
See Notes to Consolidated Financial Statements
F-5
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000 (in thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
---------------- ------------------ -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,498 $ 67,582 $ 103,496
Adjustments to reconcile net income to net cash
provided by operating activities:
Policy charges and fee income (74,117) (54,970) (72,275)
Interest credited to policyholders' account balances 204,813 195,966 171,010
Realized investment losses, net 68,037 60,476 20,679
Amortization and other non-cash items (78,452) (49,594) (48,141)
Change in:
Future policy benefits and other policyholders' liabilities 126,316 105,368 73,340
Accrued investment income (8,692) 4,864 (13,380)
Receivables from Parent and affiliates (28,025) 18,512 (24,907)
Policy loans (5,441) (40,645) (63,022)
Deferred policy acquisition costs 6,833 (100,281) (69,868)
Income taxes payable/receivable (20,844) 38,839 90,195
Other, net (96,133) (38,114) 51,011
---------------- ------------------ -----------------
Cash Flows From Operating Activities 107,793 208,003 218,138
---------------- ------------------ -----------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities:
Available for sale 1,834,129 2,653,798 2,273,789
Held to maturity - - 64,245
Equity securities 4 482 1,198
Commercial loans on real estate 1,224 1,137 1,182
Payments for the purchase of:
Fixed maturities:
Available for sale (2,884,673) (2,961,861) (2,782,541)
Equity securities (9) (184) (11,134)
Cash collateral for loaned securities, net 35,496 4,174 98,513
Securities sold under agreement to repurchase, net 319,792 (23,383) 82,947
Other long-term investments, net (11,421) (130) 8,122
Short-term investments, net 1,256 (12,766) (118,418)
---------------- ------------------ -----------------
Cash Flows Used In Investing Activities (704,202) (338,733) (382,097)
---------------- ------------------ -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account deposits 1,789,307 1,456,668 2,409,399
Policyholders' account withdrawals (1,014,901) (1,313,300) (1,991,363)
Cash dividend to Parent - (26,048) -
Cash provided to affiliate - (65,476) -
Cash payments made to eligible policyholders (116,000) - -
---------------- ------------------ -----------------
Cash Flows From Financing Activities 658,406 51,844 418,036
---------------- ------------------ -----------------
Net increase in cash and cash equivalents 61,997 (78,886) 254,077
Cash and cash equivalents, beginning of year 374,185 453,071 198,994
---------------- ------------------ -----------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 436,182 $ 374,185 $ 453,071
================ ================== =================
SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes paid (received) $ 546 $ (46,021) $ (14,832)
---------------- ------------------ -----------------
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 previously 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 12.
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.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential Insurance"), an insurance company founded in 1875 under the
laws of the state of New Jersey. On December 18, 2001 ("the date of
demutualization") Prudential Insurance converted from a mutual life insurance
company to a stock life insurance company and became an indirect wholly owned
subsidiary of Prudential Financial, Inc. ("Prudential Financial"). The
demutualization was completed in accordance with Prudential Insurance's Plan of
Reorganization, which was approved by the Commissioner of the New Jersey
Department of Banking and Insurance in October 2001.
Prudential Insurance 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 Insurance
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 include the accounts of the Company and
its wholly owned subsidiary, PLNJ. 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 Insurance and other affiliates, as more fully
described in Footnote 12. 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. 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. See
the discussion below on realized investment gains and losses for a description
of the accounting for impairment adjustments. 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 "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 "Accumulated other comprehensive
income (loss)", net of income taxes. The cost of equity securities is written
down to estimated fair value when a decline in value is considered to be other
than temporary. See the discussion below on realized investment gains and losses
for a description of the accounting for impairment adjustments.
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 non-performing loans
and a portfolio reserve for incurred but not specifically identified losses.
Non-performing 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. These 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
non-performing 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 non-performing 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 non-performing, 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. There is no valuation allowance for commercial loans on real estate at
December 31, 2002 or 2001.
Policy loans are carried at unpaid principal balances.
Short-term investments consist of highly liquid debt instruments with a maturity
of greater than three months and less than twelve months when purchased. These
investments are carried at amortized cost, which because of their short term
approximates fair value.
Other long-term investments consist of 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, which are carried at estimated fair value.
Joint ventures and partnership interests are generally accounted for using the
equity method of accounting, reduced for other than temporary declines in 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 maturities and equity securities are adjusted for
impairments, which are declines in value that are considered to be other than
temporary. Impairment adjustments are included in "Realized investment losses,
net." In evaluating whether a decline in value is other than temporary, the
Company considers several factors including, but not limited to the following:
(1) whether the decline is substantial; (2) the duration (generally greater than
six months); (3) the reasons for the decline in value (credit event, interest
related or market fluctuation); (4) the Company's ability and intent to hold the
investments for a period of time to allow for a recovery of value; and (5) the
financial condition of and near-term prospects of the issuer.
Cash and cash equivalents
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 such costs 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 ("DAC") are subject to recoverability testing at the end of
each accounting period. DAC, for applicable 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 administrative and other 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)
DAC 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.
The Company and Prudential Insurance have offered programs under which
policyholders, for a selected product or group of products, can exchange an
existing policy or contract issued by the Company or Prudential Insurance for
another form of policy or contract. These transactions are known as internal
replacements. 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. 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.
Securities loaned
Securities loaned are treated as collateralized 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. 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 generally 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". Asset
management fees charged to the accounts are included in "Asset management fees".
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.
Other assets and other liabilities
Other assets consist primarily of prepaid expenses, certain restricted assets,
and receivables resulting from sales of securities that had not yet settled at
the balance sheet date. Other liabilities consist primarily of accrued expenses,
technical overdrafts, demutualization consideration not yet paid to
policyholders, and payables resulting from purchases of securities that had not
yet been settled at the balance sheet date.
F-9
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.
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 life insurance policies, excluding interest-sensitive life
contracts, 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.
Certain annuity contracts provide the holder a guarantee that the benefit
received upon death will be no less than a minimum prescribed amount that is
based upon a combination of net deposits to the contract, net deposits to the
contract accumulated at a specified rate or the highest historical account value
on a contract anniversary. To the extent the guaranteed minimum death benefit
exceeds the current account value at the time of death, the Company incurs a
cost that is recorded as "Policyholders' benefits" for the period in which death
occurs.
Amounts received as payment for interest-sensitive life, deferred 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 DAC.
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, and again beginning on February 1, 2002, 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
12). In addition, the Company receives fees from policyholder account balances
invested in funds managed by companies other than Prudential Insurance. Asset
management fees are recognized as income as earned.
Derivative Financial Instruments
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" as amended, on January 1, 2001. Except as noted below, the
adoption of this statement did not have a material impact on the results of
operations of the Company.
Upon its adoption of FAS 133, the Company reclassified "held to maturity"
securities with a fair value of approximately $320.6 million to "available for
sale" as permitted by the new standard. This reclassification resulted in
unrealized gains of $2.5 million, net of tax, which were recorded in
"Accumulated Other Comprehensive income (loss)."
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
and futures, and may be exchange-traded or contracted in the over-the-counter
market. Derivative positions are carried at estimated fair value, generally by
obtaining quoted market prices or through the use of pricing models. Values can
be affected by changes in interest rates, foreign exchange rates, credit
spreads, market volatility and liquidity. Values can also be affected by changes
in estimates and assumptions used in pricing models.
F-10
Derivatives are used to manage the characteristics of the Company's
asset/liability mix, and to manage the interest rate and currency
characteristics of invested assets. Additionally, derivatives 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.
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The Company designates derivatives 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
entered into as an economic hedge that does not qualify for hedge accounting. As
of December 31, 2002, none of the Company's derivatives qualify for hedge
accounting treatment.
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. Changes in fair value are
included in "Realized investment losses, net" without considering changes in
fair value of the hedged assets or liabilities.
Income Taxes
The Company and its subsidiary are members of the consolidated federal income
tax return of Prudential Financial and file separate company state and local tax
returns. Pursuant to the tax allocation arrangement with Prudential Financial,
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 June 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS
No. 142, "Goodwill and Other Intangible Assets." 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. As of December 31, 2002, the Company does not
have any goodwill or intangible assets.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 requires that a liability for
costs associated with an exit or disposal activity be recognized and measured
initially at fair value only when a liability is incurred. Prior to the adoption
of SFAS No. 146, such amounts were recorded upon the Company's commitment to a
restructuring plan. SFAS No. 146 is effective for exit or disposal activities
that are initiated after December 31, 2002. Accordingly, the Company will adopt
this statement for applicable transactions occurring on or after January 1,
2003.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 expands existing accounting
guidance and disclosure requirements for certain guarantees and requires the
recognition of a liability for the fair value of certain types of guarantees
upon issuance. FIN No. 45 is applicable to guarantees issued or modified after
December 31, 2002. The January 1, 2003 adoption of the Interpretation's guidance
did not have a material effect on the Company's financial position. The Company
did not have any guarantees to disclose in accordance with the disclosure
requirements of the Interpretation.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities." FIN No. 46 addresses whether certain types of entities, referred to
as variable interest entities ("VIEs"), should be consolidated in a company's
financial statements. A VIE is an entity that either (1) has equity investors
that lack certain essential characteristics of a controlling financial interest
(including the ability to control the entity, the obligation to absorb the
entity's expected losses or the right to receive the entity's expected residual
returns); or (2) lacks sufficient equity to finance its own activities without
financial support provided by other parties, which in turn would be expected to
F-11
absorb at least some of the expected losses of the VIE. An entity should
consolidate a VIE if it stands to absorb a majority of the VIE's expected losses
or residual returns. The Company adopted the Interpretation for relationships
with VIEs that began on or after February 1, 2003. For VIEs with which an entity
became involved in prior to February 1, 2003, the consolidation guidance is
required to be implemented by July 1, 2003. Accordingly, the Company is in the
process of determining whether it will need to consolidate previously
unconsolidated VIEs or to deconsolidate previously consolidated VIEs.
Reclassifications
Certain amounts in the prior years have been reclassified to conform to the
current year presentation.
F-12
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:
2002
---------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair value
------------- -------------- -------------- -------------
(in thousands)
Fixed maturities available for sale
Bonds:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 600,128 $ 11,898 $ 1 $ 612,025
States, municipalities and political
subdivisions 257 8 - 265
Foreign government bonds 45,981 4,707 44 50,644
Mortgage-backed securities 120,425 3,242 14 123,653
Public utilities 508,456 28,955 5,826 531,585
All other corporate bonds 3,643,436 204,542 11,022 3,836,956
Redeemable preferred stock 3,008 275 305 2,978
------------- -------------- -------------- -------------
Total fixed maturities available for sale $4,921,691 $ 253,627 $ 17,212 $5,158,106
============= ============== ============== =============
Equity securities available for sale $ 100 $ 101 $ 2 $ 199
============= ============== ============== =============
2001
---------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair value
------------- -------------- -------------- -------------
(in thousands)
Fixed maturities available for sale
Bonds:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 303,350 $ 2,015 $ 2,158 $ 303,207
States, municipalities and political
subdivisions 255 - 11 244
Foreign government bonds 27,332 2,130 8 29,454
Mortgage-backed securities 10,148 160 61 10,247
Public utilities 614,762 21,357 5,666 630,453
All other corporate bonds 2,971,740 94,215 23,235 3,042,720
Redeemable preferred stock 7,885 738 55 8,568
------------- -------------- -------------- -------------
Total fixed maturities available for sale $3,935,472 $ 120,615 $ 31,194 $4,024,893
============= ============== ============== =============
Equity securities available for sale $ 173 $ 220 $ 18 $ 375
============= ============== ============== =============
F-13
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, 2002 is shown below:
Available for sale
--------------------------------------
Amortized Estimated fair
cost value
--------------- ----------------
(in thousands)
Due in one year or less $ 600,515 $ 609,204
Due after one year through five years 2,536,189 2,654,137
Due after five years through ten years 1,337,353 1,423,935
Due after ten years 327,209 347,177
Mortgage-backed securities 120,425 123,653
-------------- -------------------
Total $ 4,921,691 $ 5,158,106
============== ===================
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 2002, 2001,
and 2000, were $1,607.1 million $2,380.4 million, and $2,103.6 million,
respectively. Proceeds from the maturity of fixed maturities available for sale
during 2002, 2001, and 2000, were $227.0 million, $273.4 million, and $170.2
million, respectively. Gross gains of $20.0 million, $40.3 million, and $15.3
million, and gross losses of $48.2 million, $47.7 million, and $33.9 million
were realized on those sales during 2002, 2001, and 2000, respectively.
Writedowns for impairments which were deemed to be other than temporary for
fixed maturities were $27.8 million, $53.5 million, and $12.3 million, for the
years ended December 31, 2002, 2001 and 2000, respectively.
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, 2000, 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:
2002 2001
--------------------- ---------------------
(in thousands)
Retail stores $ 3,556 51.0% $ 4,623 56.4%
Industrial buildings 3,410 49.0% 3,567 43.6%
--------------------- ----------------------
Net carrying value $ 6,966 100.0% $ 8,190 100.0%
===================== ======================
The concentration of commercial loans is in the states of New Jersey (49%),
Washington (43%), and North Dakota (8%). As of December 31, 2002 and 2001, there
were no non-performing loans and no allowance for losses.
F-14
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
Other Long-Term Investments
The Company's "Other long-term investments" of $83.9 million and $84.3 million
as of December 31, 2002 and 2001, 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 $36.5 million and $35.8 million at December 31, 2002 and
2001, respectively. The Company's share of net income from the joint ventures
was $1.4 million, $1.6 million, and $.9 million, for the years ended December
31, 2002, 2001 and 2000, respectively, and is reported in "Net investment
income." The Company's investment in the separate accounts was $45.4 million and
$44.0 million at December 31, 2002 and 2001, respectively.
Investment Income and Investment Gains and Losses
Net investment income arose from the following sources for the years ended
December 31:
2002 2001 2000
---------------- ----------------- -----------------
(in thousands)
Fixed maturities - available for sale $ 275,843 $ 279,477 $ 237,042
Fixed maturities - held to maturity - - 26,283
Equity securities - available for sale 266 71 18
Commercial loans on real estate 791 905 1,010
Policy loans 49,436 48,149 45,792
Short-term investments and cash equivalents 13,540 24,253 29,582
Other 7,071 6,021 16,539
---------------- ----------------- -----------------
Gross investment income 346,947 358,876 356,266
Less: investment expenses (12,461) (15,238) (18,347)
---------------- ----------------- -----------------
Net investment income $ 334,486 $ 343,638 $ 337,919
================ ================= =================
Realized investment losses, net including charges for other than temporary
reductions in value, for the years ended December 31, were from the following
sources:
2002 2001 2000
---------------- ----------------- -----------------
(in thousands)
Fixed maturities $ (56,039) $ (60,924) $ (34,812)
Equity securities - available for sale (78) (56) 271
Derivatives (11,746) (1,396) 15,039
Other (174) 1,900 (1,177)
---------------- ----------------- -----------------
Realized investment losses, net $ (68,037) $ (60,476) $ (20,679)
================ ================= =================
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:
F-15
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
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, 2000 $ (84,401) $ 40,292 $ (3,032) $ 18,777 $ (28,364)
Net investment gains on investments
arising during the period 56,707 - - (21,539) 35,168
Reclassification adjustment for 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
balances - - 2,877 (1,036) 1,841
---------------- -------------- ---------------- ------------- ---------------
Balance, December 31, 2000 6,635 910 (155) (2,660) 4,730
Net investment gains on investments
arising during the period 22,007 - - (7,922) 14,085
Reclassification adjustment for 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
Net investment gains on investments
arising during the period 90,774 - - (32,679) 58,095
Reclassification adjustment for losses
included in net income 56,117 - - (20,202) 35,915
Impact of net unrealized investment
gains(losses) on deferred policy
acquisition costs - (67,053) - 24,139 (42,914)
Impact of net unrealized investment
gains(losses) on policyholders' account
balances - - 9,281 (3,341) 5,940
---------------- -------------- ---------------- ------------- ---------------
Balance, December 31, 2002 $ 236,513 $ (107,366) $ 14,218 $ (51,611) $ 91,754
================ ============== -=============== ============= ===============
F-16
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The table below presents unrealized gains (losses) on investments by asset class
at December 31,
2002 2001 2000
------------ ---------- ----------
(in thousands)
Fixed maturities $ 236,414 $ 89,420 $ 9,277
Equity securities 99 202 (2,642)
------------ ---------- ----------
Unrealized gains/losses on investments $ 236,513 $ 89,622 $ 6,635
============ ========== ==========
Securities Pledged, Restricted Assets and Special Deposits
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, 2002 and 2001,
the carrying value of fixed maturities available for sale pledged to third
parties as reported in the Consolidated Statements of Financial Position were
$613.6 million and $265.2 million, respectively.
Fixed maturities of $2.9 million at December 31, 2002 and 2001, respectively,
were on deposit with governmental authorities or trustees as required by certain
insurance laws. Equity securities restricted as to sale were $.1 million and $.2
million at December 31, 2002 and 2001, respectively.
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:
2002 2001 2000
--------------- ---------------- -----------------
(in thousands)
Balance, beginning of year $ 1,159,830 $ 1,132,653 $ 1,062,785
Capitalization of commissions, sales and issue expenses 328,658 295,823 242,322
Amortization (268,438) (156,092) (129,049)
Change in unrealized investment (gains) losses (67,053) (41,223) (39,382)
Foreign currency translation - 1,773 (4,023)
Transfer of Taiwan branch balance to an affiliated company - (73,104) -
--------------- ---------------- -----------------
Balance, end of year $ 1,152,997 $ 1,159,830 $ 1,132,653
=============== ================ =================
5. POLICYHOLDERS' LIABILITIES
Future policy benefits and other policyholder liabilities at December 31, are as
follows:
2002 2001
-------------- --------------
(in thousands)
Life insurance - domestic $ 578,211 $500,974
Life insurance - Taiwan 311,300 260,632
Individual annuities 31,830 32,423
Group annuities 13,205 14,201
-------------- --------------
Total future policy benefits $ 934,546 $808,230
============== ==============
F-17
Life insurance liabilities include reserves for death benefits and other policy
benefits. Annuity liabilities include reserves for annuities that are in payout
status.
Future policy benefits for domestic and Taiwan traditional life insurance are
based on the net level premium method, calculated using the guaranteed mortality
and nonforfeiture rates which range from 2.50% to 8.75% for domestic insurance
and 6.25% to 7.50% for Taiwan reserves. Less than 1% of the reserves are based
on interest rates in excess of 8%.
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. POLICYHOLDERS' LIABILITIES (continued)
Future policy benefits for individual and group annuities are equal to the
aggregate of 1) the present value of expected future payments on the basis of
actuarial assumptions established at issue, and 2) premium deficiency reserves.
Assumptions as to mortality are based on the Company's experience when the basis
of the reserve is established. The interest rates used in the determination of
the individual annuities reserves range from 6.25% to 11.00%, with less than 14%
of the reserves based on an interest rate in excess of 8%. The interest rate
used in the determination of group annuities reserves is 14.75%.
Policyholders' account balances at December 31, are as follows:
2002 2001
-------------- --------------
(in thousands)
Interest-sensitive life contracts $ 2,102,179 $ 1,976,710
Individual annuities 1,593,703 976,237
Guaranteed investment contracts 1,159,879 994,743
-------------- --------------
Total policyholders' account balances $ 4,855,761 $ 3,947,690
============== ==============
Policyholders' account balances for interest-sensitive life, individual
annuities, and guaranteed investment contracts represent an accumulation of
account deposits plus credited interest less withdrawals, expenses and mortality
charges. Interest crediting rates range from 4.00% to 6.75% for
interest-sensitive life contracts. Interest crediting rates for individual
annuities range from 3.00% to 16.00%, with less than 1% of policyholders'
account balances with interest crediting rates in excess of 8%. Interest
crediting rates for guaranteed investment contracts range from 3.50% to 8.03%,
with less than 1% of policyholders' account balances with interest crediting
rates in excess of 8%.
6. REINSURANCE
The Company participates in reinsurance, with Prudential Insurance and an
affiliate 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. Life reinsurance is accomplished
through various plans of reinsurance, primarily yearly renewable term and
coinsurance. Reinsurance ceded arrangements do not discharge the Company 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.
Reinsurance premiums, commissions, expense reimbursements, benefits and reserves
related to reinsured long-duration contracts are accounted for over the life of
the underlying reinsured contracts using assumptions consistent with those used
to account for the underlying contracts. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liabilities and policy benefits
associated with the reinsured policies. The affiliated reinsurance agreements,
including the Company's reinsurance of all its Taiwanese business as of February
1, 2001, are described further in Note 12.
During 2002, a new product, referred to as Magnastar was introduced. The
Magnastar product is a proprietary variable universal life product developed by
the M Life Insurance Company. The Company has entered into modified coinsurance
and yearly renewal term reinsurance agreements related to this product. Premiums
ceded for the Magnastar product for 2002 were approximately $88 million.
F-18
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. REINSURANCE (Continued)
Reinsurance amounts included in the Consolidated Statements of Operations and
Comprehensive Income for the year ended December 31, are as follows:
2002 2001 2000
----------- ----------- ------------
(in thousands)
Direct premiums and policy charges and fee $862,723 $686,887 $609,630
income
Reinsurance assumed - 162 1,671
Reinsurance ceded (203,982) (105,996) (14,519)
----------- ----------- ------------
Premiums and policy charges and fee income $658,741 $581,053 $596,782
Policyholders' benefits ceded $70,327 $23,733 $ 5,472
Reinsurance ceded for interest-sensitive life products is accounted for as a
reduction of policy charges and fee income. Reinsurance ceded for term insurance
products is accounted for as a reduction of premiums.
Reinsurance recoverables, included in the Company's Consolidated Statements of
Financial Position at December 31, were as follows:
2002 2001
------------ -------------
(in thousands)
Domestic life insurance - $ 37,529 $ 11,014
affiliated
Domestic life insurance - 31,137 14,850
unaffiliated
Other reinsurance - affiliated 13,205 14,201
Taiwan life insurance-affiliated 311,300 260,632
------------ -------------
$393,171 $ 300,697
============ =============
The gross and net amounts of life insurance in force at December 31, were as
follows:
2002 2001 2000
---------------- --------------- ---------------
(in thousands)
Life insurance face amount in force $ 118,381,408 $ 84,317,628 $ 66,327,999
Ceded to other companies (49,113,635) (25,166,264) (7,544,363)
---------------- --------------- ---------------
Net amount of life insurance in force $ 69,267,773 $ 59,151,364 $ 58,783,636
================ =============== ===============
F-19
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. INCOME TAXES
The components of income tax (benefit) expense for the years ended December 31,
are as follows:
2002 2001 2000
---------------- --------------- ---------------
(in thousands)
Current tax (benefit) expense:
U.S. $ (65,004) $ (100,946) $ 8,588
State and local 309 1,866 38
Foreign 39 124 35
---------------- --------------- ---------------
Total (64,656) (98,956) 8,661
---------------- --------------- ---------------
Deferred tax expense (benefit):
U.S. 15,709 76,155 43,567
State and local (3,556) (2,454) 2,204
---------------- --------------- ---------------
Total 12,153 73,701 45,771
---------------- --------------- ---------------
Total income tax (benefit) expense $ (52,503) $ (25,255) $ 54,432
================ =============== ===============
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:
2002 2001 2000
---------------- --------------- ---------------
(in thousands)
Expected federal income tax (benefit) expense $ (13,652) $ 14,814 $ 55,275
State and local income taxes (2,111) (382) 1,457
Non taxable investment income (41,745) (38,693) (6,443)
Incorporation of Taiwan branch 7,545 (1,774) -
Other (2,540) 780 4,143
---------------- --------------- ---------------
Total income tax (benefit) expense $ (52,503) $ (25,255) $ 54,432
================ =============== ===============
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
2002 2001
------------ -------------
(in thousands)
Deferred tax assets
Insurance reserves $ 24,976 $ 43,317
Tax loss carry forwards 23,706 5,642
Other 3,871 9,309
------------ -------------
Deferred tax assets 52,553 58,268
------------ -------------
Deferred tax liabilities
Deferred acquisition costs 312,150 324,082
Net unrealized gains on securities 85,145 32,264
Investments 18,299 20,644
------------ -------------
Deferred tax liabilities 415,594 376,990
------------ -------------
Net deferred tax liability $ 363,041 $ 318,722
============ =============
F-20
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. INCOME TAXES (continued)
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, 2002 and 2001, the
Company and its subsidiary had federal capital loss carryforwards for tax
purposes of $40 million and $0 million, respectively, which expire by 2007. At
December 31, 2002 the Company had state operating loss carryforwards of $592
million and capital loss carryforwards of $40 million, which expire by 2017 and
2007, respectively. At December 31, 2001, the Company had state operating loss
carryforwards of $369 million, which expire by 2016.
The Internal Revenue Service (the "Service") has completed all examinations of
the consolidated federal income tax returns through 1992 as well as 1996. The
Service has examined the years 1993 through 1995 and the Company is in the
process of finalizing an agreement with the Service with respect to proposed
adjustments for those tax years. The Service has begun its examination of 1997
through 2001. Management believes sufficient provisions have been made for
potential adjustments.
8. STATUTORY NET INCOME AND SURPLUS AND DIVIDEND RESTRICTIONS
The Company is required to prepare statutory financial statements in accordance
with accounting practices prescribed or permitted by the Arizona Department of
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 $(238.8) million, $71.5
million, and $(50.5) million, for the years ended December 31, 2002, 2001, and
2000, respectively. Statutory surplus of the Company amounted to $471.0 million
and $728.7 million at December 31, 2002 and 2001, respectively.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance ("Codification"), which replaced the current Accounting
Practices and Procedures manual as the NAIC's primary guidance on statutory
accounting as of January 1, 2001. Codification provided guidance for areas where
statutory accounting had been silent and changed current statutory accounting in
certain areas. The Company adopted the Codification guidance effective January
1, 2001. As a result of these changes, the Company reported an increase to
statutory surplus of $81 million, primarily relating to the recognition of
deferred tax assets.
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
without prior approval in 2003.
During 2001, the Company received approval from the Arizona Department of
Insurance to pay an extraordinary dividend to Prudential Insurance of $108
million.
F-21
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. 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 and other similar contracts without life
contingencies, 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.
The following table discloses the carrying amounts and estimated fair values of
the Company's financial instruments at December 31:
2002 2001
---------------------------------- -------------------------------
Carrying Estimated Carrying Estimated
value fair value value fair value
--------------- ----------------- --------------- ---------------
(in thousands)
Financial assets:
Fixed maturities available for sale $ 5,158,106 $ 5,158,106 $ 4,024,893 $ 4,024,893
Equity securities 199 199 375 375
Commercial loans on real estate 6,966 8,894 8,190 10,272
Policy loans 879,506 1,031,169 874,065 934,203
Short-term investments 214,342 214,342 215,610 215,610
Cash and cash equivalents 436,182 436,182 374,185 374,185
Separate account assets 12,696,758 12,696,758 14,920,584 14,920,584
Financial liabilities:
Investment contracts 2,830,511 2,906,692 2,003,265 2,053,259
Cash collateral for loaned securities 225,518 225,518 190,022 190,022
Securities sold under repurchase
agreements 400,507 400,507 80,715 80,715
Separate account liabilities 12,696,758 12,696,758 14,920,584 14,920,584
F-22
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
Types of Derivative Instruments
Interest Rate Swaps
Interest rate swaps are used by the Company to manage interest rate exposures
arising from mismatches between assets and liabilities (including duration
mismatches). 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.
Futures
Exchange-traded treasury futures are used by the Company to reduce market risks
from changes in interest rates and, to alter mismatches between the duration of
assets in a portfolio and the duration of liabilities supported by those assets.
As an example, 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 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 with regulated futures commissions merchants
who are members of a trading exchange.
Treasury futures are used to hedge duration mismatches between assets and
liabilities by replicating Treasury performance. 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 that selling fixed income securities and purchasing a similar
portfolio when such a decline is believed to be over.
Currency Swaps
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.
The table below summarizes the Company's outstanding positions by derivative
instrument types as of December 31, 2002 and 2001. All of the derivatives are
carried on the Consolidated Statements of Financial Position at estimated fair
value.
Derivatives
2002 2001
----------------------- -----------------------
Estimated Estimated
Notional fair value Notional fair value
------------ ----------- ----------- -----------
(in thousands)
Non-Hedge Accounting
Swap instruments:
Interest rate $14,405 $ 414 $ 9,470 $ 638
Currency 21,244 1,571 24,785 3,858
Future contracts:
US Treasury futures 12,400 (407) 141,300 632
F-23
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (continuted)
Credit Risk
The Company is exposed to credit-related losses in the event of nonperformance
by counterparties to derivative financial instruments. Generally, the current
credit exposure of the Company's derivative contracts is limited to the fair
value at the reporting date. The credit exposure of the Company's swaps
transactions is represented by the fair value (market value) of contracts with a
positive fair value (market value) at the reporting date. Because
exchange-traded futures are effected through regulated exchanges, and positions
are marked to market on a daily basis, the Company has little exposure to
credit-related losses in the event of nonperformance by counterparties to such
financial instruments. The credit exposure of exchange-traded instruments is
represented by the negative change, if any, in the fair value (market value) of
contracts from the fair value (market value) at the reporting date.
The Company manages credit risk by entering into transactions with creditworthy
counterparties and obtaining collateral where appropriate and customary. In
addition, the Company enters into over-the-counter swaps pursuant to master
agreements that provide for a single net payment to be made by one counterparty
to another at each due date and upon termination. Likewise, the Company effects
exchange-traded futures and options through regulated exchanges and these
positions are marked to market on a daily basis.
11. CONTINGENCIES AND LITIGATION
Contingencies
On an ongoing basis, our internal supervisory and control functions review the
quality of our sales, marketing and other customer interface procedures and
practices and may recommend modifications or enhancements. In certain cases, if
appropriate, we may offer customers remediation and may incur charges, including
the cost of such remediation, administrative costs and regulatory fines.
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 as a result
of payments in connection with the matters discussed above depending, in part,
upon the results of operations or cash flow for such period. Management
believes, however, that the ultimate payments in connection with these matters
should not have a material adverse effect on the Company's financial position.
Litigation
The Company and Prudential Insurance 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
Insurance and that are typical of the businesses in which the Company and
Prudential Insurance operate. Class action and individual lawsuits involve a
variety of issues and/or allegations, which include sales practices,
underwriting practices, claims payment and procedures, premium charges, policy
servicing and breach of fiduciary duties to customers. We are also subject to
litigation arising out of our general business activities, such as our
investments and third party contracts. In certain of these matters, the
plaintiffs are seeking large and/or indeterminate amounts, including punitive or
exemplary damages.
The Company and Prudential Insurance have been subject to substantial regulatory
actions and civil litigation, including class actions, involving individual life
insurance sales practices from 1982 through 1995. As of January 31, 2003, the
Company and Prudential Insurance have resolved those regulatory actions, its
sales practices class action litigation and virtually all of the individual
sales practices actions filed by policyholders who "opted out" of the sales
practices class action. Prudential Insurance 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-24
Pruco Life Insurance Company and Subsidiary
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
12. RELATED PARTY TRANSACTIONS
The Company has extensive transactions and relationships with Prudential
Insurance 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
Insurance or other affiliates. These expenses can be grouped into the following
categories: general and administrative expenses, agency 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
Insurance to process transactions on behalf of the Company. The Company operates
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 Insurance. The
Company is allocated estimated distribution expenses from Prudential's agency
distribution 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, the Company and Prudential
Insurance 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 Insurance 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 Insurance, and appointed another subsidiary of
Prudential Financial as the fund manager for the PSF. The change was approved by
the shareholders of PSF during early 2001 and became effective January 1, 2001.
From January 1, 2001 through January 31, 2002 the Company did not receive fees
associated with the PSF. In addition, the Company did not incur the asset
management expense from PGAM and Jennison associated with the PSF, during that
period.
In accordance with a revenue sharing agreement with Prudential Investments LLC,
which began on February 1, 2002, the Company receives fee income from
policyholder account balances invested in the PSF. These revenues are recorded
as "Asset management fees" in the Consolidated Statements of Operations and
Comprehensive Income. There are no asset management expenses charged under the
agreement.
Corporate Owned Life Insurance
The Company has sold four Corporate Owned Life Insurance ("COLI") policies to
Prudential Insurance. The fourth policy was issued in December 2002 and has a
cash surrender value of $180.8 million at December 31, 2002. Income earned for
the year on this policy is $7.1 million consisting of $12.0 million in policy
fees offset by $2.4 million in reserves and $2.5 million in DAC amortization.
The cash surrender value included in separate accounts for all COLI policies was
$835.6 million and $647.2 million at December 31, 2002 and December 31, 2001,
respectively. Fees related to all of the COLI policies were $21.0 million, $7.0
million and $9.6 million for the years ending December 31, 2002, 2001, and 2000.
Reinsurance with affiliates
The Company currently has four reinsurance agreements in place with Prudential
Insurance 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. The effect these agreements had on net income for the
periods ended December 31, 2002 or 2001 is reflected in the statement of
operations. Information regarding these agreements is provided below and in Note
6. The fourth agreement, which became effective in 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 Prudential
Financial.
F-25
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. RELATED PARTY TRANSACTIONS (Continued)
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 Financial.
Affiliated premiums ceded for the periods ended December 31, 2002 and 2001 from
the Taiwan coinsurance agreement were $79.6 million and $82.5 million,
respectively. Affiliated benefits ceded for the periods ended December 31, 2002
and 2001, from the Taiwan coinsurance agreement were $14.2 and $12.9 million,
respectively. As mentioned above, this agreement did not go into effect until
January 31, 2001.
Affiliated premiums ceded from domestic life reinsurance agreements for the
periods ended December 31, 2002, 2001, and 2000 were $11.1 million, $9.9
million, and $7.6 million, respectively. Affiliated benefits ceded for the
periods ended December 31, 2002, 2001, and 2000 from domestic life reinsurance
agreements are $32.5 million in 2002, and $0 in 2001 and 2000.
Group annuities affiliated benefits ceded were $2.9 million in 2002 and $3.0
million in 2001 and 2000.
Debt Agreements
The Company has a revolving line of credit facility of up to $700 million with
Prudential Funding LLC, a wholly owned subsidiary of Prudential Insurance. The
total of asset-based financing and borrowing under this credit facility cannot
be more than $700 million. There is no outstanding debt relating to this credit
facility as of December 31, 2002 or December 31, 2001.
13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The unaudited quarterly results of operations for the years ended December 31,
2002 and 2001 are summarized in the table below:
Three months ended
---------------------------------------------------------------
March 31 June 30 September 30 December 31
---------------------------------------------------------------
2002 (in thousands)
- ----
Total revenues $ 224,036 $ 220,233 $ 231,399 $ 275,124
Total benefits and expenses 199,355 245,823 295,123 249,496
Income (loss) from operations before income taxes 24,681 (25,590) (63,724) 25,628
Net income (loss) 19,471 (17,264) (28,554) 39,845
2001
- ----
Total revenues $ 246,532 $ 220,871 $ 190,515 $ 219,156
Total benefits and expenses 209,252 205,332 220,648 199,515
Income (loss) from operations before income taxes 37,280 15,539 (30,133) 19,641
Net income (loss) 28,639 12,894 (21,768) 47,817
F-26