Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 33-37587
PRUCO LIFE INSURANCE COMPANY
(Exact name of Registrant as specified in its charter)
Arizona 22-1944557
------------------------------ ---------------------------------
(State or other jurisdiction, (IRS Employer Identification No.)
incorporation or organization)
213 Washington Street, Newark, New Jersey 07102
------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(973) 802-3274
-----------------------------------------------------
(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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
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 August 14, 2003. Common stock, par value
of $10 per share: 250,000 shares outstanding
Pruco Life Insurance Company meets the conditions set
forth in General Instruction (H) (1) (a) and (b) on Form 10-Q and
is therefore filing this Form with the reduced disclosure format.
================================================================================
PRUCO LIFE INSURANCE COMPANY
INDEX TO FINANCIAL STATEMENTS
Page No.
--------
Cover Page
Index 2
PART I - Financial Information
Item 1. (Unaudited) Financial Statements
Consolidated Statements of Financial Position
As of June 30, 2003 and December 31, 2002 3
Consolidated Statements of Operations and Comprehensive Income
Three and Six months ended June 30, 2003 and 2002 4
Consolidated Statements of Stockholder's Equity
Periods ended June 30, 2003 and December 31, 2002 and 2001 5
Consolidated Statements of Cash Flows
Six months ended June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 4. Controls and Procedures 19
PART II - Other Information
Item 1. Legal proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 22
Forward-Looking Statement Disclosure
Certain of the statements included in this Quarterly Report on Form 10-Q,
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
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Financial Position (Unaudited)
As of June 30, 2003 and December 31, 2002 (in thousands)
- --------------------------------------------------------------------------------
June 30, December 31,
2003 2002
------------- -------------
ASSETS
Fixed maturities available for sale, at fair value
(amortized cost, 2003: $5,354,325; 2002: $4,921,691) $ 5,694,471 $ 5,158,106
Policy loans 865,163 879,506
Short-term investments 170,422 214,342
Other long-term investments 101,029 91,021
------------- -------------
Total investments 6,831,085 6,342,975
Cash and cash equivalents 489,414 436,182
Deferred policy acquisition costs 1,210,526 1,152,997
Accrued investment income 90,448 86,125
Reinsurance recoverable 410,325 393,171
Receivables from Parent and affiliates 34,093 61,099
Other assets 56,436 41,581
Separate account assets 13,817,611 12,696,758
------------- -------------
TOTAL ASSETS $ 22,939,938 $ 21,210,888
============= =============
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $ 5,348,543 $ 4,855,761
Future policy benefits and other policyholder liabilities 985,090 934,546
Cash collateral for loaned securities 295,193 225,518
Securities sold under agreement to repurchase 208,673 400,507
Income taxes payable 339,558 245,252
Other liabilities 143,845 130,411
Separate account liabilities 13,817,611 12,696,758
------------- -------------
Total liabilities 21,138,513 19,488,753
------------- -------------
Contingencies (See Footnote 2)
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 467,072 466,748
Deferred compensation (1,179) -
Retained earnings 1,201,650 1,161,136
Accumulated other comprehensive income 131,382 91,751
------------- -------------
Total stockholder's equity 1,801,425 1,722,135
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 22,939,938 $ 21,210,888
============= =============
See Notes to Consolidated Financial Statements
3
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Operations and Comprehensive Income (Unaudited)
Three and Six Months Ended June 30, 2003 and 2002 (in thousands)
- --------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
REVENUES
Premiums $ 41,449 $ 22,968 $ 82,698 $ 41,266
Policy charges and fee income 139,768 131,715 276,012 258,748
Net investment income 84,195 82,325 168,748 163,796
Realized investment gains (losses), net 5,407 (26,080) (4,252) (32,306)
Asset management fees 3,348 2,880 6,252 5,132
Other income 1,683 6,425 3,892 7,633
------------ ------------ ------------ ------------
Total revenues 275,850 220,233 533,350 444,269
------------ ------------ ------------ ------------
BENEFITS AND EXPENSES
Policyholders' benefits 84,463 59,116 170,924 116,929
Interest credited to policyholders'
account balances 56,587 49,486 108,089 96,672
General, administrative and other
expenses 106,522 137,221 202,903 231,577
------------ ------------ ------------ ------------
Total benefits and expenses 247,572 245,823 481,916 445,178
------------ ------------ ------------ ------------
Income (loss) from operations before
income taxes 28,278 (25,590) 51,434 (909)
------------ ------------ ------------ ------------
Income tax expense (benefit) 6,473 (8,326) 10,917 (3,116)
------------ ------------ ------------ ------------
NET INCOME (LOSS) 21,805 (17,264) 40,517 2,207
------------ ------------ ------------ ------------
Other comprehensive income, net of tax 28,549 31,147 39,631 12,006
------------ ------------ ------------ ------------
TOTAL COMPREHENSIVE INCOME $ 50,354 $ 13,883 $ 80,148 $ 14,213
============ ============ ============ ============
See Notes to Consolidated Financial Statements
4
Pruco Life Insurance Company and Subsidiary
Statements of Stockholder's Equity (Unaudited)
Periods Ended June 30, 2003 and December 31, 2002 and 2001 (in thousands)
- --------------------------------------------------------------------------------
Accumulated
other Total
Common Paid-in- Retained Deferred comprehensive stockholder's
stock capital earnings Compensation income equity
------------- ------------- ------------- ------------- ------------- -------------
Balance, January 1, 2001 $ 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 - - - - 149 149
taxes
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
Net income - - 40,517 - - 40,517
Adjustments to policy credits
issued to eligible policyholders - - (3) - - (3)
Stock-based compensation - 324 - - - 324
Deferred compensation program - - - (1,179) - (1,179)
Change in net unrealized investment
gains, net of reclassification
adjustment and taxes - - - - 39,631 39,631
------------- ------------- ------------- ------------- ------------- -------------
Balance, June 30, 2003 $ 2,500 $ 467,072 $ 1,201,650 $ (1,179) $ 131,382 $ 1,801,425
============= ============= ============= ============= ============= =============
See Notes to Consolidated Financial Statements
5
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30, 2003 and 2002 (in thousands)
- --------------------------------------------------------------------------------
2003 2002
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 40,517 $ 2,207
Adjustments to reconcile net income to net cash from
(used in) operating activities:
Policy charges and fee income (50,549) (34,645)
Interest credited to policyholders' account balances 108,089 96,672
Realized investment losses, net 4,252 32,306
Amortization and other non-cash items (37,573) (5,284)
Change in:
Future policy benefits and other policyholders'
liabilities 50,544 43,463
Accrued investment income (4,323) (3,527)
Receivables from Parent and affiliates 27,006 (11,980)
Policy loans 14,343 (4,475)
Deferred policy acquisition costs (57,529) (50,199)
Income taxes payable/receivable 94,306 7,430
Other, net (18,575) (54,661)
-------------- --------------
Cash Flows From Operating Activities 170,508 17,307
-------------- --------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities available for sale 1,311,519 932,838
Payments for the purchase of:
Fixed maturities available for sale (1,759,650) (1,332,737)
Cash collateral for loaned securities, net 69,675 30,256
Securities sold under agreement to repurchase, net (191,834) 187,340
Other long-term investments, net (12,900) (11,183)
Short-term investments, net 43,919 90,536
-------------- --------------
Cash Flows Used in Investing Activities (539,271) (102,950)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 986,172 936,679
Withdrawals (563,319) (584,106)
Deferred compensation (1,179) -
Stock- based compensation 324 -
Cash payments to eligible policyholders (3) (115,979)
-------------- --------------
Cash Flows From Financing Activities 421,995 236,594
-------------- --------------
Net increase in Cash and cash equivalents 53,232 150,951
Cash and cash equivalents, beginning of year 436,182 374,185
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 489,414 $ 525,136
============== ==============
See Notes to Consolidated Financial Statements
6
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The unaudited interim consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") on a basis consistent with reporting interim financial
information in accordance with instructions to Form 10-Q and Article 10 of
Regulation S-K of the Securities and Exchange Commission. These interim
financial statements are unaudited but reflect all adjustments which, in the
opinion of management, are necessary to provide a fair presentation of the
consolidated results of operations and financial condition of the Pruco Life
Insurance Company ("the Company") for the interim periods presented. The Company
is a wholly owned subsidiary of The Prudential Insurance Company of America
("Prudential Insurance"), which in turn is a wholly owned subsidiary of
Prudential Financial, Inc. ("Prudential Financial"). All such adjustments are of
a normal recurring nature. The results of operations for any interim period are
not necessarily indicative of results for a full year. Certain amounts in the
Company's prior year consolidated financial statements have been reclassified to
conform with the current year presentation. These financial statements should be
read in conjunction with the consolidated financial statements and notes thereto
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002.
2. 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 is subject to legal and regulatory actions in the ordinary course of
its 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 that are typical of the businesses in which the
Company operates. 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'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.
7
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
3. 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
Many 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 and agency distribution
expenses.
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,
supplies, use of equipment and office space are provided by Prudential
Insurance. Beginning in 2003, general and administrative expenses include
allocations of stock compensation expenses related to a stock option program and
a deferred compensation program issued by Prudential Financial.
The Company is allocated estimated distribution expenses from Prudential
Insurance's agency network for both its domestic life and annuity products. The
estimate of allocated distribution expenses is intended to reflect a market
based pricing arrangement. The Company has capitalized the majority of these
distribution expenses as deferred policy acquisition costs.
Affiliated Asset Management Fee Income
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 Prudential Series Funds ("PSF").
These revenues are recorded as "Asset management fees" in the Consolidated
Statements of Operations and Comprehensive Income.
Corporate Owned Life Insurance
The Company has sold four Corporate Owned Life Insurance ("COLI") policies to
Prudential Insurance. The cash surrender value included in Separate accounts was
$947.6 million and $835.6 million at June 30, 2003 and December 31, 2002,
respectively. Fees related to the COLI policies were $5.9 million and $4.4
million for the periods ended June 30, 2003 and 2002, respectively.
8
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
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 June 30, 2003 or 2002 is reflected in the statement of operations.
The fourth agreement is described below.
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, Inc.
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 Insurance.
Premiums ceded for the periods ended June 30, 2003 and 2002 from the Taiwan
coinsurance agreement were $37.7 million and $37.6 million, respectively.
Benefits ceded for the periods ended June 30, 2003 and 2002 from the Taiwan
coinsurance agreement were $6.9 million and $7.1 million, respectively.
Included in the reinsurance recoverable balances were affiliated reinsurance
recoverables of $365.7 million and $362.0 million at June 30, 2003 and December
31, 2002, respectively. Of these affiliated amounts, the reinsurance recoverable
related to the Taiwan coinsurance agreement was $337.7 million and $311.3
million at June 30, 2003 and December 31, 2002, respectively.
Debt Agreements
The Company has a revolving line of credit facility of up to $800 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 $800 million. As of June 30, 2003 and December 31, 2002, there was
$504 million and $626 million, respectively, of asset-based financing. There was
no debt outstanding to Prudential Funding, LLC as of June 30, 2003 or December
31, 2002.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Pruco Life Insurance Company meets the conditions set forth in General
Instruction H(1)(a) and (b) on Form 10-Q and is filing this form with reduced
disclosure.
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 June 30, 2003, compared with December 31, 2002, and its
consolidated results of operations for the three and six month periods ended
June 30, 2003 and June 30, 2002. You should read the following analysis of our
consolidated financial condition and results of operations in conjunction with
the Company's MD&A and audited Consolidated Financial statements included in the
Company's Report on Form 10-K for the year ended December 31, 2002.
The Company sells interest-sensitive individual life insurance, variable life
insurance, term life insurance, individual variable annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced GIC ("PACE") primarily through Prudential Insurance's sales force in
the United States. These markets are subject to regulatory oversight with
particular emphasis placed on company solvency and sales practices. These
markets are also subject to increasing competitive pressure as the legal
barriers, which have historically segregated the markets of the financial
services industry, have been changed through both legislative and judicial
processes. Regulatory changes have opened the insurance industry to competition
from other financial institutions, particularly banks and mutual funds that are
positioned to deliver competing investment products through large, stable
distribution channels. The Company also had 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 of the premiums and
benefits of the Taiwan branch are ceded to an affiliated company.
Generally, policyholders who purchase the Company's products have the option of
investing in the Separate accounts, segregated funds for which investment risks
are borne by the customer, or the Company's portfolio, referred to as the
General account. The Company earns its profits through policy fees charged to
Separate account annuity and life policyholders and through the interest spread
for the GIC and General account annuity and life products. Policy charges and
fee income consist mainly of three types, sales charges or loading fees on new
sales, mortality and expense charges ("M&E") assessed on fund balances, and
mortality and related charges based on total life insurance in-force business.
Policyholder fund values are affected by net sales (sales less withdrawals)
changes in interest rates and investment returns. The interest spread represents
the difference between the investment income earned by the Company on its
investment portfolio and the amount of interest credited to the policyholders'
accounts. Products that generate spread income primarily include the GIC
product, general account life insurance products, fixed annuities and the
fixed-rate option of variable annuities.
The Company's Changes in Financial Position and Results of Operations are
described below.
1. Analysis of Financial Condition
From December 31, 2002 to June 30, 2003 there was an increase of $1,729 million
in total assets from $21,211 million to $22,940 million. The largest increase
was in Separate account assets, which increased by $1,121 million primarily from
market value appreciation as a result of recoveries in the equity markets in the
current quarter and from positive net sales (sales less withdrawals). Fixed
maturities increased by $536 million as a result of unrealized appreciation and
from investing general account policyholder deposits and positive cash flows
from insurance operations into fixed maturities. Deferred acquisition costs
("DAC") increased by $58 million, as capitalization of commissions from new
sales exceeded the amortization of DAC.
During this six-month period, liabilities increased by $1,650 million from
$19,489 million to $21,139 million. Corresponding with the asset change,
Separate account liabilities increased by $1,121 million, as described above.
Policyholder account balances increased by $493 million due primarily to
positive net sales of annuity products with fixed rate options and life general
account products. Income taxes payable, which is a net number comprised of
payables and receivables, increased by $94 million as a result of income tax
expense and a tax refund received from Prudential Financial. In accordance with
the tax sharing agreement with Prudential Financial, the Company was reimbursed
for operating losses utilized in the consolidated federal tax return. Future
policy benefits increased by $51 million due to increased reserves for the
transferred Taiwan business and increases to life reserves as a result of sales
of term insurance. A lower level of securities lending activity decreased
liabilities by $122 million.
10
2. Results of Operations
June 2003 to June 2002 Three Month Comparison
Net Income
Consolidated net income of $21.8 million for the second quarter of 2003 was an
improvement of $39.1 million from the loss of $17.3 million incurred in the
second quarter of 2002. The second quarter of 2002 had realized investment
losses of $26.1 million and a charge for additional DAC amortization of
approximately $40 million, which did not recur in the current quarter. The
current quarter continued to show increases in premiums and policy charges
offset by increases to policyholder benefits and general and administrative
expenses due to the growth of the business. Further details regarding the
components of revenues and expenses are described in the following paragraphs.
Revenues
Consolidated revenues increased by $55.6 million, from $220.2 million to $275.8
million. Realized investment gains increased by $31.5 million mainly due to
lower fixed maturity losses of $24.5 million and lower derivative losses of $7.0
million. The second quarter of 2002 had fixed maturity impairments and credit
related losses of $16.7 million versus gains on sales of fixed maturities of
$7.8 million in 2003.
Premiums increased by $18.5 million from higher term insurance sales and
renewals of the Term Essential and Term Elite products of $13.4 million and
higher premiums on term insurance we issued, under policy provisions, to
customers who previously had lapsing variable life insurance policies with us
("extended term insurance"). Extended term life insurance increased as a result
of less favorable market performance in previous quarters, which caused an
increase in lapses. Annuity premiums decreased by $ 1.7 million as a result of
lower annuitizations.
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 $8.0 million. The increase was
a result of a $13.3 million increase for individual life products offset by a
$5.3 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. The in-force business (excluding term insurance) grew to $67.8 billion
at June 30, 2003 from $61.7 billion at June 30, 2002 and $65.2 billion at
December 31, 2002. In contrast, annuity fees are mainly asset-based fees, which
are dependent on the fund balances. Fund balances 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 Separate account fund
balances have declined as a result of unfavorable valuation changes in the
securities market over the past several years. There was a positive market
recovery in the current quarter, but annuity Separate account fund values are
lower than the same period last year.
Other income decreased by $4.7 million as the prior year quarter contained a
reinsurance expense allowance of approximately $5 million not repeated in the
current quarter.
Net investment income increased by $1.9 million as a result of increased income
from fixed maturities due to an increase in the portfolio size, partially offset
by the effect of lower reinvestment rates on fixed maturities and short-term
investments.
Benefits and Expenses
Policyholder benefits increased by $25.3 million primarily from increased
reserve provisions for life insurance reserves and less favorable mortality
experience. The change in reserves for life products increased $12.5 million
from the prior year quarter primarily as a result of higher term and extended
term insurance, as discussed in the premium section. The change in reserves for
annuity products decreased by $2.6 million due to lower annuitizations, as is
also described in the premium section. Life and annuity death benefits increased
by $15.5 million primarily from a higher volume of death claims on variable life
products and a slight increase in guaranteed minimum death benefits for annuity
products.
Guaranteed minimum death benefit payments increased from $7.5 million in the
second quarter of 2002 to $8.0 million in the second quarter of 2003. As of June
30, 2003, the death benefit coverage in force (representing the amount that we
would have to pay if all annuitants had died on that date) was approximately
$2.5 billion. The death benefit coverage in force represents the excess of the
guaranteed benefit amount over the account value. 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
11
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, we incur 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
deferred policy acquisition costs are based. AICPA Statement of Position 03-01,
"Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts." (the "SOP"), will require
the recording of a liability for the expected net costs associated with these
guarantees under certain circumstances. The provisions of the SOP are effective
for financial statements for fiscal years beginning after December 15, 2003,
and, as such, we will adopt the SOP effective January 1, 2004. The effect of
initially adopting this SOP will be reported as a cumulative effect of a change
in accounting principle with restatement of prior financial statements
prohibited. We are currently evaluating the impact of the SOP.
Interest credited to policyholder account balances increased by $7.1 million due
to growth in policyholder account balances, especially for the annuity products.
General, administrative, and other expenses decreased by $30.7 million from the
prior year quarter. The primary reason was a decrease in DAC amortization of
$42.5 million as the prior year quarter had a charge for additional DAC
amortization of approximately $40 million to reflect our lower estimate of
future gross profits on annuities based on asset value declines and expected
equity market returns as of June 30, 2002. Partially offsetting this was an
increase in allocated commission and general and administrative expenses, mainly
due to increased new business and a growing in-force.
June 2003 to June 2002 Six Month Comparison
Net Income
Consolidated net income of $40.5 million for the six months of 2003 was an
improvement of $38.3 million from the $2.2 million earned for the six months of
2002. The six months of 2002 had higher realized investment losses of $28.1
million and an additional charge for DAC amortization of approximately $40
million, which did not recur in the current year. The current year continued to
show increases in premiums and policy charges offset by increases to
policyholder benefits and general and administrative expenses as a result of
growth of the business. Further details regarding the components of revenues and
expenses are described in the following paragraphs.
Revenues
Consolidated revenues increased by $89.1 million, from $444.3 million to $533.4
million. Realized investment losses decreased by $28.1 million mainly due to
lower fixed maturity losses of $23.4 million and lower derivative losses of $4.6
million. The prior year had fixed maturity losses of $23.7 million consisting of
$5.4 million of impairments and $18.3 million of credit related losses. The
current year has fixed maturity losses of $.4 million consisting of $12.2
million of impairments and $11.8 million of gains on sales.
Premiums increased by $41.4 million from higher term insurance sales and
renewals of the Term Essential and Term Elite products of $27.2 million and
higher premiums on term insurance we issued, under policy provisions, to
customers who previously had lapsing variable life insurance policies with us
("extended term insurance").
Policy charges and fee income increased by $17.3 million. The increase was a
result of a $28.8 million increase for individual life products offset partially
by an $11.5 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. In contrast, annuity fees are mainly asset-based fees, which
are dependent on the fund balances. Annuity Separate account fund balances have
declined as a result of unfavorable valuation changes in the securities market
over the past several years resulting in a decrease in policy charges and fee
income for annuity products.
Net investment income increased by $5.0 million as a result of increased income
from fixed maturities due to an increase in the portfolio balance, partially
offset by the effect of lower reinvestment rates on fixed maturities and
short-term investments.
Other income decreased by $3.7 million as the prior year contained a reinsurance
expense allowance recovery of approximately $5 million. This was offset
partially by higher modal premium fees in the current year due to the increase
in the in-force business.
12
Benefits and Expenses
Policyholder benefits increased by $54.0 million primarily from increased
reserve provisions for life insurance reserves and less favorable mortality
experience for life and annuity products. The change in reserves for life
products increased $28.5 million from the prior year primarily as a result of
higher term and extended term insurance, as discussed in the premium section.
Life benefits increased by $16.5 million primarily from a higher volume of death
claims on variable products of $12 million and increased surrenders of reduced
paid up policies in the current year. Annuity death benefits increased by $9.4
million primarily as a result of an increase in guaranteed minimum death
benefits. Guaranteed minimum death benefit payments increased from $13.6 million
in 2002 to $20.0 million for 2003.
Interest credited to policyholder account balances increased by $11.4 million
due to growth in policyholders' account balances, especially for the annuity
products.
General, administrative, and other expenses decreased by $28.7 million from the
prior year. The primary reason was a decrease in DAC amortization of $38.9
million as the prior year had an additional charge for DAC amortization of
approximately $40 million for the annuity products, as described previously.
Partially offsetting this was an increase in allocated commission and general
and administrative expenses, mainly due to increased new business and a growing
in-force.
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
$6,831.1 million at June 30, 2003, versus $6,343.0 million at December 31, 2002.
A diversified portfolio of publicly traded bonds, private placements, and other
long-term investments is managed under strategies intended to maintain a
competitive asset mix consistent with current and anticipated cash flow
requirements of the related obligations. The risk tolerance reflects the
Company's aggregate capital position, exposure to business risk, liquidity and
rating agency considerations.
As of June 30, As of December 31,
----------------------------- -----------------------------
2003 % of Total 2002 % of Total
------------- ------------- ------------- -------------
($ in thousands)
Fixed maturities:
Public, available for sale, at fair value $ 4,600,174 67.3% $ 3,977,441 62.7%
Private, available for sale, at fair value 1,094,297 16.0% 1,180,665 18.6%
Policy loans, at outstanding balance 865,163 12.7% 879,506 13.9%
Short-term investments 170,422 2.5% 214,342 3.4%
Other long-term investments (1) 101,029 1.5% 91,021 1.4%
------------- ------------- ------------- -------------
Total investments $ 6,831,085 100.0% $ 6,342,975 100.0%
============= ============= ============= =============
- ----------
(1) Other long-term investments consist of investments in joint ventures
and partnerships, our interest in separate account investments,
mortgage loans, equity securities 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 quality of the
portfolio, and recent activities to manage the portfolio are discussed below.
As of June 30, 2003, our investment portfolio consisted primarily of $5,694.5
million of fixed maturity securities (83% of the total portfolio at June 30,
2003 versus 81% at December 31, 2002), and $1,136.6 million of other investments
(17% of the total portfolio at June 30, 2003 versus 19% at December 31, 2002).
The other investments were comprised of other long-term investments, policy
loans and short-term investments.
13
Investment Results
The following table sets forth the income yield and investment income, excluding
realized investment losses, net for each major asset category of the Company for
the periods indicated.
For the three months ended June 30,
----------------------------------------------
2003 2002
--------------------- --------------------
Yield Amount Yield Amount
-------- -------- -------- --------
($ in thousands)
Fixed maturities 5.49% $ 71,528 6.57% $ 68,234
Policy loans 5.27 11,374 5.46 11,916
Short-term investments 1.77 2,270 3.01 3,170
Other long-term investments 9.11 2,180 7.33 1,823
-------- -------- -------- --------
Investment income before investment
expenses 5.43 87,352 6.26 85,143
Investment expenses (0.10) (3,157) (0.09) (2,818)
-------- -------- -------- --------
Total after investment expenses 5.33% $ 84,195 6.17% $ 82,325
======== ======== ======== ========
- ----------
(1) Yields are based on quarterly average carrying values except for fixed
maturities and securities lending activity. Yields for fixed maturities
are based on amortized 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.
The overall income yield on our invested assets after investment expenses,
excluding realized investment losses, net was 5.33% and 6.17% for the second
quarter of 2003 and 2002, respectively. The change in yield between periods is
primarily attributable to reinvestment in a declining interest rate environment.
For the six months ended June 30,
----------------------------------------------
2003 2002
--------------------- ---------------------
Yield Amount Yield Amount
-------- --------- -------- ---------
($ in thousands)
Fixed maturities 5.68% $ 143,870 6.71% $ 135,369
Policy loans 5.34 22,992 5.41 23,409
Short-term investments 2.08 4,628 3.04 6,460
Other long-term investments 8.52 3,956 7.90 3,856
-------- --------- -------- ---------
Investment income before investment
expenses 5.613 175,446 6.35 169,094
Investment expenses (0.11) (6,698) (0.10) (5,298)
-------- --------- -------- ---------
Total after investment expenses 5.50% $ 168,748 6.25% $ 163,796
======== ========= ======== =========
- ----------
(2) Yields are based on quarterly average carrying values except for fixed
maturities and securities lending activity. Yields for fixed maturities
are based on amortized 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.
The overall income yield on our invested assets after investment expenses,
excluding realized investment losses, net was 5.50% and 6.25% for the first six
months of 2003 and 2002, respectively. The change in yield between periods is
primarily due to reinvestment activities 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. On
products with crediting rates that do not fully reflect changes in yields
currently available in fixed income markets, 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.
14
Fixed Maturity Securities
Investment Mix
We manage our public portfolio to a risk profile directed by the Asset Liability
and Risk Management Group, consistent with the investment policy statement
agreed to by senior management and approved by the Board of Directors. 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 credit 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 June 30, 2003 the fixed maturities portfolio
totaled $5,694.5 million, an increase of $536.4 million compared to December 31,
2002.
Our fixed maturity securities portfolio consists principally of public and
private fixed maturities across an array of industry categories. As of June 30,
2003, we held approximately 83% of assets in fixed maturity securities (versus
81% as of December 31, 2002) with a total amortized cost of $5,354.3 million and
an estimated fair value of $5,694.5 million, compared to an amortized cost of
$4,921.7 million and estimated fair value of $5,158.1 million as of December 31,
2002. Our investments in public fixed maturities as of June 30, 2003 were
$4,325.5 million at amortized cost and $4,600.2 million at estimated fair value
compared to $3,793.0 million at amortized cost and $3,977.4 million at estimated
fair value as of December 31, 2002. Our investments in private fixed maturities
as of June 30, 2003 were $1,028.9 million at amortized cost and $1,094.3 million
at estimated fair value compared to $1,128.7 million at amortized cost and
$1,180.7 million at estimated fair value as of December 31, 2002.
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 June 30, 2003 As of December 31, 2002
----------------------------------------------------- ----------------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
(1) Cost Gains Losses Fair Value Cost Gains Losses Fair Value
-------------------------------------------------------- ----------------------------------------------------
(in thousands)
Industry
U.S. Government $ 314,526 $ 8,890 $ 63 $ 323,353 $ 600,385 $ 11,906 $ 1 $ 612,290
Manufacturing 1,160,007 80,900 1,681 1,239,226 1,029,622 59,334 4,476 1,084,480
Utilities 565,345 48,948 1,766 612,527 509,444 29,199 6,128 532,515
Finance 1,066,140 78,296 244 1,144,192 705,019 52,722 724 757,017
Services 605,931 40,601 584 645,948 538,604 25,344 2,827 561,121
Mortgage Backed 94,910 2,630 25 97,515 120,425 3,242 14 123,653
Foreign
Government 49,179 6,387 26 55,540 45,981 4,707 44 50,644
Retail and
Wholesale 296,412 21,505 413 317,504 279,750 20,093 477 299,366
Asset-Backed
Securities 723,095 18,520 1,100 740,515 642,771 14,667 2,096 655,342
Transportation 209,550 16,294 0 225,844 218,649 12,303 390 230,562
Energy 261,431 22,494 230 283,695 218,269 19,224 35 237,458
Other 7,799 814 1 8,612 12,772 886 - 13,658
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Total $ 5,354,325 $ 346,279 $ 6,133 $ 5,694,471 $ 4,921,691 $ 253,627 $ 17,212 $ 5,158,106
=========== =========== =========== =========== =========== =========== =========== ===========
- ----------
(1) Investment data for 2003 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.
15
As a percentage of amortized cost, fixed maturity investments as of June 30,
2003 consist primarily of the following sectors: 22% manufacturing, 20% finance,
14% asset-backed securities, 11% services and 11% utilities compared to 21%
manufacturing, 14% finance, 13% asset-backed securities, 12% U.S. Government,
and 11% services as of December 31, 2002. Nearly 94% of the mortgage-backed
securities were publicly traded agency pass-through securities. Collateralized
mortgage obligations represented less than 6% of total mortgage-backed
securities.
The gross unrealized losses related to our fixed maturity portfolio were $6.1
million as of June 30, 2003 compared to $17.2 million as of December 31, 2002.
The gross unrealized losses as of June 30, 2003 were concentrated primarily in
the utilities, manufacturing and asset-backed securities sectors while gross
unrealized losses as of December 31, 2002 were concentrated in the utilities,
manufacturing, and services sectors. Non-investment grade securities represented
55% of the gross unrealized losses as of June 30, 2003 versus 65% of gross
unrealized losses as of December 31, 2002.
Fixed Maturity Securities Credit Quality
The Securities Valuation Office (SVO) of 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. As a
result of time lags between the funding of investments, finalization of legal
documents, and completion of the SVO filing process, the fixed maturity
portfolio generally includes securities that have not yet been rated by the SVO
as of each balance sheet date. Pending receipt of SVO ratings, the
categorization of these securities by NAIC designation is based on the expected
ratings indicated by internal analysis.
The amortized cost of our public and private below-investment grade fixed
maturities totaled $498.0 million, or 9%, of the total fixed maturities as of
June 30, 2003, compared to $526.8 million, or 11%, of total fixed maturities as
of December 31, 2002.
Public Fixed Maturities - Credit Quality
The following table sets forth our public fixed maturity portfolios by NAIC
rating as of the dates indicated.
-----------------------------------------------------------------------------------------------------
As of June 30, 2003 As of December 31, 2002
------------------------------------------------- -------------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
Cost Gains Losses Fair Value Cost Gains Losses Fair Value
-----------------------------------------------------------------------------------------------------
($ in thousands)
NAIC Rating Agency
Designation Equivalent
- ----------- --------------
1 Aaa, Aa, A $2,460,300 $ 149,323 $ 767 $2,608,856 $2,377,674 $ 116,244 $ 438 $2,493,480
2 Baa 1,568,501 107,829 942 1,675,388 1,152,329 71,903 4,152 1,220,080
3 Ba 164,025 10,497 940 173,582 162,210 5,224 2,201 165,233
4 B 106,651 7,427 705 113,373 75,167 2,381 2,987 74,561
5 C and lower 10,172 2,862 96 12,938 10,391 412 2,057 8,746
6 In or near
default 15,814 1,014 791 16,037 15,195 481 335 15,341
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Public Fixed Maturities $4,325,463 $ 278,952 $ 4,241 $4,600,174 $3,792,966 $ 196,645 $ 12,170 $3,977,441
========== ========== ========== ========== ========== ========== ========== ==========
(1) Includes, as of June 30, 2003 and December 31, 2002, respectively, 34
securities with amortized cost of $47 million (fair value, $52 million)
and 6 securities with amortized cost of $3 million (fair value, $3
million) that have been categorized based on expected NAIC designations
pending receipt of SVO ratings.
16
Private Fixed Maturities - Credit Quality
The following table sets forth our private fixed maturity portfolios by NAIC
rating as of the dates indicated.
------------------------------------------------- -------------------------------------------------
As of June 30, 2003 As of December 31, 2002
------------------------------------------------- -------------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
Cost Gains Losses Fair Value Cost Gains Losses Fair Value
-----------------------------------------------------------------------------------------------------
($ in thousands)
NAIC Rating Agency
Designation Equivalent
- ----------- -------------
1 Aaa, Aa, A $ 363,038 $ 17,594 $ 686 $ 379,946 $ 338,539 $ 12,348 $ 1,351 $ 349,536
2 Baa 464,502 34,501 365 498,638 526,384 34,430 45 560,769
3 Ba 132,703 13,023 115 145,611 212,917 9,197 3,089 219,025
4 B 5,538 549 0 6,087 9,637 - 196 9,441
5 C and lower 34,235 1,505 11 35,729 39,616 1,007 253 40,370
6 In or near
default 28,846 155 715 28,286 1,632 - 108 1,524
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Private Fixed Maturities $1,028,862 $ 67,327 $ 1,892 $1,094,297 $1,128,725 $ 56,982 $ 5,042 $1,180,665
========== ========== ========== ========== ========== ========== ========== ==========
(1) Includes, as of June 30, 2003 and December 31, 2002, respectively, 23
securities with amortized cost of $105 million (fair value, $108
million) and 10 securities with amortized cost of $21 million (fair
value, $22 million) that have been categorized based on expected NAIC
designations pending receipt of SVO ratings.
Unrealized Losses from Fixed Maturity Securities
The following table sets forth the amortized cost and gross unrealized losses of
fixed maturity securities where the estimated fair value had declined and
remained below amortized cost by 20% or more for the following timeframes:
-------------------------------------------------
As of June 30, 2003 As of December 31, 2002
----------------------- -----------------------
Gross Gross
Amortized Unrealized Amortized Unrealized
Cost Losses Cost Losses
---------- ---------- ---------- ----------
($ in thousands)
Less than six months $ 76 $ 27 $ 9,605 $ 3,488
Greater than six months but less
than nine months 7 3 982 424
Greater than nine months - - - -
---------- ---------- ---------- ----------
Total $ 83 $ 30 $ 10,587 $ 3,912
========== ========== ========== ==========
Gross unrealized losses of fixed maturity securities where estimated fair value
has been 20% or more below amortized cost were $.03 million as of June 30, 2003,
compared to $3.9 million as of December 31, 2002. The gross unrealized losses at
June 30, 2003 were primarily concentrated in the finance, retail and wholesale,
and utilities sectors while the gross unrealized losses at December 31, 2002
were concentrated in the utilities, manufacturing, and transportation 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.
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
17
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 $12.2 million for the first six
months of 2003 and $5.4 million for the first six months of 2002.
3. Liquidity and Capital Resources
Sources and Uses of 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 an affiliated company, Prudential Funding,
LLC. 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.
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 June 30, 2003 and December 31,
2002 we had cash and short-term investments of approximately $659.8 million and
$650.5 million, respectively, and fixed maturity investments classified as
"available for sale" with fair values of $5.694 billion and $5.158 billion at
those dates, respectively.
18
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
$800 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 June 30, 2003 or December 31, 2002.
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.
June 30, December 31,
2003 2002
------------ --------------
(in millions)
Borrowings:
General obligations $ - $ -
Total asset-based financing 504 626
---------- -------------
Total borrowings and asset-based financings $ 504 $ 626
========== =============
Item 4. Controls and Procedures
In order to ensure that the information we must disclose in our filings with the
Securities and Exchange Commission is recorded, processed, summarized, and
reported on a timely basis, the Company's management, including our Chief
Executive Officer and Chief Financial Officer, have reviewed and evaluated the
effectiveness of our disclosure controls and procedures, as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e), as of June 30, 2003. Based on such
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that, as of June 30, 2003, our disclosure controls and procedures were
effective in timely alerting them to material information relating to us (and
our consolidated subsidiaries) required to be included in our periodic SEC
filings. There has been no change in our internal control over financial
reporting during the quarter ended June 30, 2003, that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
19
PART II OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to legal and regulatory actions in the ordinary course of
its 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 that are typical of the businesses in which the
Company operates. 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's litigation is subject to many uncertainties, and given the
complexity and scope, the outcomes cannot be predicted. It is possible that the
results of operations or the cash flow of the Company in a particular quarterly
or annual period could be materially affected by an ultimate unfavorable
resolution of pending litigation and regulatory matters. Management believes,
however, that the ultimate outcome of all pending litigation and regulatory
matters should not have a material adverse effect on the Company's financial
position.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3(i)(a) The Articles of Incorporation of Pruco Life Insurance Company
(as amended through October 19, 1993) are incorporated by
reference to the initial Registration Statement on Form S-6 of
Pruco Life Variable Appreciable Account as filed July 2, 1996,
Registration No. 333-07451.
3(ii) By-Laws of Pruco Life Insurance Company (as amended through
May 6, 1997) are incorporated by reference to Form 10-Q as
filed by the Company on August 15, 1997.
4(a) Modified Guaranteed Annuity Contract is incorporated by
reference to the Company's Registration Statement on Form S-1
as filed November 2, 1990, Registration No. 33-37587.
4(b) Market-Value Adjustment Annuity Contract (Discovery Preferred
Select variable annuity) is incorporated by reference to Form
N-4, Registration No. 33-61125, filed July 19, 1995, on behalf
of the Pruco Life Flexible Premium Variable Annuity Account.
4(c) Market-Value Adjustment Annuity Contract (Discovery Select
variable annuity) is incorporated by reference to Form N-4,
Registration No. 333-06701, filed June 24, 1996, on behalf of
the Pruco Life Flexible Premium Variable Annuity Account.
4(d) Market-Value Adjustment Contract (Strategic Partners Select
variable annuity) is 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.
4(e) Market-Value Adjustment Annuity Contract (Strategic Partners
Horizon annuity) is incorporated by reference to the Company's
registration statement on Form S-3, Registration No.
333-104036, filed March 26, 2003.
4(f) Market-Value Adjustment Annuity Contract Endorsement
(Strategic Partners Annuity One variable annuity) is
incorporated by reference to the Company's registration
statement on Form S-3, Registration No. 333-103474, filed
April 23, 2003.
4(g) Market-Value Adjustment Annuity Contract (Strategic Partners
FlexElite variable annuity) is incorporated by reference to
Post-Effective Amendment No. 2 to Form N-4, Registration No.
333-75702, filed April 23, 2003, on behalf of the Pruco Life
Flexible Premium Variable Annuity Account.
20
31.1 Section 302 Certification of the Chief Executive Officer
31.2 Section 302 Certification of the Chief Financial Officer
32.1 Section 906 Certification of the Chief Executive Officer
32.2 Section 906 Certification of the Chief Financial Officer
(b) Reports on Form 8-K
Current Report on Form 8-K, May 14, 2003, attaching (i) and
(ii) the certifications of Chief Executive Officer and Chief
Financial Officer, required pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf of the
undersigned, thereunto duly authorized.
PRUCO LIFE INSURANCE COMPANY
(Registrant)
By: /s/ Andrew J. Mako
------------------------
Andrew J. Mako
President
Signature Title Date
- --------- ----- ------
/s/ Andrew J. Mako President August 14, 2003
- ----------------------------- (Authorized Signatory)
Andrew J. Mako
/s/ William J. Eckert, IV Vice President and August 14, 2003
- ----------------------------- Chief Financial Officer
William J. Eckert, IV (Principal Accounting Officer)
22