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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 September 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
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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
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES X NO
--- ---
State the aggregate market value of the voting stock held by non-affiliates of
the registrant: NONE
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of November 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.
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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 September 30, 2003 and December 31, 2002 3
Consolidated Statements of Operations and Comprehensive Income
Three and Nine months ended September 30, 2003 and 2002 4
Consolidated Statements of Stockholder's Equity
Periods ended September 30, 2003 and December 31, 2002 and 2001 5
Consolidated Statements of Cash Flows
Nine months ended September 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 11
Item 4. Controls and Procedures 21
PART II - Other Information
---------------------------
Item 1. Legal Proceedings 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 24
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 September 30, 2003 and December 31, 2002 (in thousands)
- --------------------------------------------------------------------------------
September 30, December 31,
2003 2002
------------- ------------
ASSETS
Fixed maturities available for sale,
at fair value (amortized cost, 2003: $5,608,017; 2002: $4,921,691) $ 5,909,870 $ 5,158,106
Policy loans 851,822 879,506
Short-term investments 181,014 214,342
Other long-term investments 96,571 91,021
----------- -----------
Total investments 7,039,277 6,342,975
Cash and cash equivalents 241,549 436,182
Deferred policy acquisition costs 1,279,866 1,152,997
Accrued investment income 99,569 86,125
Reinsurance recoverable 470,793 393,171
Receivables from Parent and affiliates 50,263 61,099
Other assets 87,735 41,581
Separate account assets 14,378,264 12,696,758
----------- -----------
TOTAL ASSETS $23,647,316 $21,210,888
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $5,417,933 $4,855,761
Future policy benefits and other policyholder liabilities 1,028,028 934,546
Cash collateral for loaned securities 311,992 225,518
Securities sold under agreement to repurchase 214,848 400,507
Income taxes payable 340,366 245,252
Other liabilities 149,798 130,411
Separate account liabilities 14,378,264 12,696,758
----------- -----------
Total liabilities 21,841,229 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 467,080 466,748
Deferred compensation (907) -
Retained earnings 1,220,820 1,161,136
Accumulated other comprehensive income 116,594 91,751
----------- -----------
Total stockholder's equity 1,806,087 1,722,135
----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $23,647,316 $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 Nine Months Ended September 30, 2003 and 2002 (in thousands)
- --------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
------------ ------------- ------------- -------------
REVENUES
Premiums $ 38,410 $ 35,313 $121,108 $ 76,579
Policy charges and fee income 144,088 128,310 420,100 387,058
Net investment income 86,302 85,488 255,050 249,284
Realized investment gains (losses), net 1,093 (22,788) (3,159) (55,094)
Asset management fees 3,425 2,981 9,677 8,113
Other income 1,883 2,095 5,775 9,728
-------- -------- -------- --------
Total revenues 275,201 231,399 808,551 675,668
-------- -------- -------- --------
BENEFITS AND EXPENSES
Policyholders' benefits 75,019 60,268 245,943 177,197
Interest credited to policyholders'
account balances 58,555 53,783 166,644 150,455
General, administrative and other
expenses 112,629 181,072 315,532 412,649
-------- -------- -------- --------
Total benefits and expenses 246,203 295,123 728,119 740,301
-------- -------- -------- --------
Income (loss) from operations before
income taxes 28,998 (63,724) 80,432 (64,633)
-------- -------- -------- --------
Income tax expense (benefit) 9,827 (35,170) 20,744 (38,286)
-------- -------- -------- --------
NET INCOME (LOSS) 19,171 (28,554) 59,688 (26,347)
-------- -------- -------- --------
Other comprehensive (loss) income, net
of tax (14,788) 32,323 24,843 44,329
-------- -------- -------- --------
TOTAL COMPREHENSIVE (LOSS) INCOME $ 4,383 $ 3,769 $ 84,531 $ 17,982
======== ======== ======== ========
See Notes to Consolidated Financial Statements
4
Pruco Life Insurance Company and Subsidiary
Statements of Stockholder's Equity (Unaudited)
Periods Ended September 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
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
Net income - - 59,688 - - 59,688
Adjustments to policy credits
issued to eligible policyholders - - (4) - - (4)
Stock-based compensation programs - 332 - (907) - (575)
Change in net unrealized investment
gains, net of reclassification
adjustment and taxes - - - - 24,843 24,843
------ -------- ----------- ------- --------- -----------
Balance, September 30, 2003 $2,500 $467,080 $ 1,220,820 $ (907) $ 116,594 $ 1,806,087
====== ======== =========== ======= ========= ===========
See Notes to Consolidated Financial Statements
5
Pruco Life Insurance Company and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30, 2003 and 2002 (in thousands)
- --------------------------------------------------------------------------------
2003 2002
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 59,688 $ (26,347)
Adjustments to reconcile net income to net cash from
(used in) operating activities:
Policy charges and fee income (78,453) (53,458)
Interest credited to policyholders' account balances 166,644 150,455
Realized investment losses, net 3,159 55,094
Amortization and other non-cash items 819 (73,506)
Change in:
Future policy benefits and other policyholders'
liabilities 93,482 56,223
Accrued investment income (13,444) (8,325)
Receivables from Parent and affiliates 10,836 (31,413)
Policy loans 27,684 (6,246)
Deferred policy acquisition costs (126,869) 32,286
Income taxes payable/receivable 95,114 (13,569)
Other, net (104,964) (67,973)
----------- -----------
Cash Flows From Operating Activities 133,696 13,221
----------- -----------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities available for sale 1,865,707 1,253,266
Payments for the purchase of:
Fixed maturities available for sale (2,579,066) (1,815,193)
Cash collateral for loaned securities, net 86,474 77,007
Securities sold under agreement to repurchase, net (185,659) 246,220
Other long-term investments, net (7,713) (9,899)
Short-term investments, net 33,423 132,193
----------- -----------
Cash Flows Used in Investing Activities (786,834) (116,406)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 1,573,209 1,382,000
Withdrawals (1,114,700) (790,967)
Cash payments to eligible policyholders (4) (115,989)
----------- -----------
Cash Flows From Financing Activities 458,505 475,044
----------- -----------
Net (decrease) increase in Cash and cash equivalents (194,633) 371,859
Cash and cash equivalents, beginning of year 436,182 374,185
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 241,549 $ 746,044
=========== ===========
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-X 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. NEW ACCOUNTING POLICIES AND ACCOUNTING PRONOUNCEMENTS
In July 2003, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants ("AICPA") issued Statement of
Position ("SOP") 03-01, "Accounting and Reporting by Insurance Enterprises for
Certain Nontraditional Long-Duration Contracts and for Separate Accounts." AcSEC
has developed the SOP to address the evolution of product designs since the
issuance of SFAS No. 60, "Accounting and Reporting by Insurance Enterprises,"
and SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the Sale of
Investments" and the need for interpretive guidance to be developed in three
areas: separate account presentation and valuation; the accounting recognition
given sales inducements (bonus interest, bonus credits, persistency bonuses);
and the classification and valuation of certain long-duration contract
liabilities.
The most significant accounting implications of the SOP are as follows: (1)
reporting and measuring assets and liabilities of separate account products as
general account assets and liabilities when specified criteria are not met; (2)
reporting and measuring seed money in separate accounts as general account
assets based on the insurer's proportionate beneficial interest in the separate
account's underlying assets; (3) capitalizing sales inducements that meet
specified criteria and amortizing such amounts over the life of the contracts
using the same methodology as used for amortizing deferred acquisition costs,
but immediately expensing those sales inducements accrued or credited if such
criteria are not met; (4) recognizing contractholder liabilities for: (a)
modified guaranteed (market value adjusted) annuities at accreted balances that
do not include the then current market value surrender adjustment, (b) two-tier
annuities at the lower (non-annuitization) tier account value, (c) persistency
bonuses at amounts that are not reduced for expected forfeitures, (d) group
pension participating and similar general account "pass through" contracts that
are not accounted for under SFAS No. 133 at amounts based on the fair value of
the assets or index that determines the investment return pass through; (5)
establishing an additional liability for guaranteed minimum death and similar
mortality and morbidity benefits only for contracts determined to have mortality
and morbidity risk that is other than nominal and when the risk charges made for
a period are not proportionate to the risk borne during that period; and (6) for
contracts containing an annuitization benefits contract feature, if such
contract feature is not accounted for under the provisions of SFAS No. 133
establishing an additional liability for the contract feature if the present
value of expected annuitization payments at the expected annuitization date
exceeds the expected account balance at the expected annuitization date.
The provisions of the SOP are effective for fiscal years beginning after
December 15, 2003, and, as such, the Company 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. The Company is currently
completing an assessment of the impact of the SOP on its operations; however, we
do not believe that the implementation of the SOP will have a material effect on
the Company's consolidated financial position.
7
3. 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.
8
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements (Unaudited)
- ------------------------------------------------------
4. 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
$973.1 million and $835.6 million at September 30, 2003 and December 31, 2002,
respectively. Fees related to the COLI policies were $9.1 million and $4.4
million for the periods ended September 30, 2003 and 2002, respectively.
9
Pruco Life Insurance Company and Subsidiary
Notes to Consolidated Financial Statements (Unaudited)
- ------------------------------------------------------
Reinsurance with Affiliates
Pruco Reinsurance Ltd. reinsurance agreement
During September 2003, the Company implemented an agreement to reinsure its term
life insurance policies known as Term Elite and Term Essential with an
affiliated company, Pruco Reinsurance Ltd. ("Pruco Re"). The Company will
reinsure with Pruco Re ("THE REINSURER") a significant portion of the risks
under such policies through an automatic and facultative coinsurance agreement
("Agreement"). This Agreement covers all significant risks under the policies
reinsured. The Company is not relieved of its primary obligation to the
policyholder as a result of these reinsurance transactions. This coinsurance
agreement replaces the yearly renewable term agreements with external reinsurers
that were previously in effect on this block of business. The initial cost of
this transaction of $7.5 million will be amortized over the life of the
underlying insurance policies. Reinsurance recoverables related to this
transaction are $18.4 million.
Other affiliated reinsurance agreements
In addition, the Company currently has three other 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.
Taiwan branch reinsurance agreement
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 September 30, 2003 and 2002 from the Taiwan
coinsurance agreement were $56.7 million and $56.4 million, respectively.
Benefits ceded for the periods ended September 30, 2003 and 2002 from the Taiwan
coinsurance agreement were $10.2 million and $10.6 million, respectively.
Included in the total reinsurance recoverable balances for both domestic and
Taiwan agreements were affiliated reinsurance recoverables of $413.2 million and
$362.0 million at September 30, 2003 and December 31, 2002, respectively. Of
these affiliated amounts, the reinsurance recoverable related to the Taiwan
coinsurance agreement was $360.9 million and $311.3 million at September 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 September 30, 2003 and December 31, 2002, there
was $527 million and $626 million, respectively, of asset-based financing. There
was no debt outstanding to Prudential Funding, LLC as of September 30, 2003 or
December 31, 2002.
10
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 September 30, 2003, compared with December 31, 2002, and
its consolidated results of operations for the three and nine month periods
ended September 30, 2003 and September 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 September 30, 2003 there was an increase of $2,436
million in total assets from $21,211 million to $23,647 million. The largest
increase was in Separate account assets, which increased by $1,682 million
primarily from market value appreciation as a result of recoveries in the equity
markets and from positive net sales (sales less withdrawals). Fixed maturities
increased by $752 million mainly as a result of investing general account
policyholder deposits and positive cash flows from insurance operations into
fixed maturities. Also contributing to the increase in the fixed maturity
balance was unrealized appreciation and a reallocation of cash and shorter-term
investments into fixed maturities. Deferred acquisition costs ("DAC") increased
by $127 million, as capitalization of distribution expenses from new sales
exceeded the amortization of DAC. Reinsurance recoverable is higher by $78
million due to increases in the Taiwan branch reinsurance recoverable and the
Pruco Re reinsurance recoverable for term insurance. Cash and cash equivalents
are lower by $195 million resulting from lower security lending activities and a
higher allocation of cash into long-term fixed maturities as compared to
shorter-term investments.
During this nine-month period, liabilities increased by $2,352 million from
$19,489 million to $21,841 million. Corresponding with the asset change,
Separate account liabilities increased by $1,682 million, as described above.
Policyholder account balances increased by $562 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 $95 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 $93 million due to increased reserves for the
transferred Taiwan business and increases to life reserves as a result of sales
and renewals of term insurance. A lower level of securities lending activity
decreased liabilities by $99 million.
11
2. Results of Operations
September 2003 to September 2002 Three Month Comparison
Net Income
Consolidated net income of $19.2 million for the third quarter of 2003 was an
improvement of $47.7 million from the loss of $28.5 million incurred in the
third quarter of 2002. The third quarter of 2002 included higher DAC
amortization of approximately $80.8 million primarily from an additional charge
for DAC amortization for our annuity products that did not recur in the current
quarter. In addition, there were higher realized investment losses of $23.9
million in the third quarter of 2002. The continued growth of the in-force
business resulted in increases in policy charges and fees, offset by increases
in policyholder benefits, expenses and taxes during the current quarter. Further
details regarding the components of revenues and expenses are described in the
following paragraphs.
Revenues
Consolidated revenues increased by $43.8 million, from $231.4 million to $275.2
million. Realized investment gains increased by $23.9 million mainly due to
lower fixed maturity losses of $20.1 million, lower derivative losses of $2.5
million, and a mortgage prepayment gain in 2003 of $1.7 million. The third
quarter of 2002 had fixed maturity impairments and credit related losses of
$20.6 million versus losses of $.5 million in 2003. Policy charges also
increased by $15.8 million, as is described in the following paragraph.
Policy charges and fee income, consisting primarily of mortality and expense
("M&E"), loading and other insurance charges assessed on General and Separate
Account policyholder fund balances, increased by $15.8 million. The increase was
a result of a $13.8 million increase for individual life products and a $2.0
million increase for annuity products. Mortality and sales based loading charges
for life products increased as a result of growth of the in-force business and
the sale of newer interest-sensitive products that generally carry higher
expense charges in the first few years of the contract. The life in-force
business (excluding term insurance) grew to $69.1 billion at September 30, 2003
from $62.5 billion at September 30, 2002 and $65.2 billion at December 31, 2002.
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 increased as a
result of a positive market recovery in the current year.
Premiums increased by $3.1 million primarily as a result of growth in premiums
of $14 million on term products. Partially offsetting this is a decrease in
premiums from customers who previously had lapsing variable life insurance
policies with us ("extended term insurance"). Extended term life insurance
premiums decreased $10.6 million as a result of the favorable market performance
in the previous quarter resulting in fewer lapses.
Benefits and Expenses
Policyholder benefits were higher than the prior year quarter by $14.8 million
resulting from increases to change in reserves of $11.5 million and increases to
death benefits of $3.3 million. Higher reserves for term insurance sales were
mostly offset by lower reserves for extended term insurance. There was also an
increase in the unearned revenue reserve of $11.6 million as a result of higher
deferrals of upfront life insurance charges. More fees are being deferred in the
current quarter, which is recorded as an increase to reserves, than the prior
year quarter due to continued sales of newer interest-sensitive life insurance
products. These products defer substantial charges during the first five years
of the policy. Death claims and surrenders of life insurance products increased
by $7.2 million due to growth of the in force business. Death benefits for
annuity products decreased by $3.9 million primarily from lower guaranteed
minimum death benefits, as described below.
Guaranteed annuity minimum death benefit payments for annuities decreased from
$10.7 million in the third quarter of 2002 to $6.1 million in the third quarter
of 2003 as the equity markets improved. As of September 30, 2003, the annuity
death benefit coverage in force (representing the amount that we would have to
pay if all annuitants had died on that date) was approximately $2.3 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 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
12
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 $4.8 million due
to growth in policyholder account balances, especially for the annuity products.
General, administrative, and other expenses decreased by $68.4 million from the
prior year quarter. The primary reason was a decrease in DAC amortization of
$80.8 million as the prior year quarter included a charge for additional DAC
amortization for our annuity products to reflect our lower estimate of future
gross profits based on asset value declines as of September 30, 2002. Partially
offsetting this was an increase in allocated distribution expenses and general
and administrative expenses, mainly due to increased new business and a growing
in-force.
September 2003 to September 2002 Nine Month Comparison
Net Income
Consolidated net income of $59.7 million for the nine months of 2003 was an
improvement of $86.0 million from the $26.3 million loss for the nine months of
2002. The nine months of 2002 included additional DAC amortization of
approximately $119.7 million and higher realized investment losses of $51.9
million. The current year continued to show increases to policyholder benefits,
interest credited and general and administrative expenses (other than DAC
amortization) offset partially by higher policy charges and fee income as a
result of growth of the business. Income tax expense also increased by $59.0
million due to the increase in income. Further details regarding the components
of revenues and expenses are described in the following paragraphs.
Revenues
Consolidated revenues increased by $132.9 million, from $675.7 million to $808.6
million. Realized investment losses decreased by $51.9 million mainly due to
lower fixed maturity losses of $43.4 million, lower derivative losses of $7.2
million, and a mortgage prepayment gain in 2003 of $1.7 million. The prior year
had fixed maturity losses of $44.3 million consisting of $20.5 million of
impairments and $23.8 million of credit related losses. The current year has
fixed maturity losses of $.9 million consisting of $12.4 million of impairments
and $11.5 million of gains on sales.
Premiums increased by $44.5 million mainly from higher term insurance sales and
renewals of approximately $41 million. Extended term insurance premiums also
increased by $3 million.
Policy charges and fee income increased by $33.0 million. The increase was a
result of a $42.6 million increase for individual life products offset partially
by a $9.6 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 the sale of newer interest-sensitive products that
generally carry higher expense charges in the first few years of the contract.
In contrast, annuity fees are mainly asset-based fees, which are dependent on
the fund balances. Although Annuity separate account fund balances have
increased during the current year as a result of favorable market performance,
the average balance for the current year is lower than the prior year average
balance resulting in a decrease in policy charges and fee income for annuity
products.
Net investment income increased by $5.8 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 $4.0 million as the prior year contained an expense
allowance from a reinsurance agreement which did not recur in the current year.
Benefits and Expenses
Policyholder benefits increased by $68.7 million primarily from increased
reserve provisions of $39.4 million mainly for life insurance reserves and
higher death claims for life and annuity products of $29.3 million.
13
The change in reserves increased $39.4 million from the prior year primarily as
a result of an increase of $23.5 million in the change in the unearned revenue
reserve compared to the prior year. The increase is primarily due to higher
deferrals of upfront policy charges partially offset by increased amortization.
Deferrals are higher than last year due to continued sales of newer variable
life insurance products, which defer substantial charges during the first five
years of the policy. The growth in term insurance sales also contributed to the
increase in reserves.
Benefits increased by $29.3 million primarily from a higher volume of death
claims on interest-sensitive products and increased surrenders of life policies
due to the growth of the in force business. Guaranteed minimum death benefit
payments for annuity products increased slightly by $1.7 million from $24.3
million in 2002 to $26.0 million for 2003.
Interest credited to policyholder account balances increased by $16.2 million
due to growth in policyholders' account balances, especially for the annuity
products.
General, administrative, and other expenses decreased by $97.1 million from the
prior year. The primary reason was a decrease in DAC amortization of $119.7
million as the prior year included an additional charge for DAC amortization due
to lower estimated future profits as a result of the equity markets as of
September 30, 2002. Partially offsetting this was an increase in allocated
distribution and general and administrative expenses, mainly due to increased
new business and a growing in-force.
14
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
$7,039.3 million at September 30, 2003, versus $6,343.0 million at December 31,
2002. A diversified portfolio of publicly traded bonds, private placements, and
other long-term investments is managed under strategies intended to maintain a
competitive asset mix consistent with current and anticipated cash flow
requirements of the related obligations. The risk tolerance reflects the
Company's aggregate capital position, exposure to business risk, liquidity and
rating agency considerations.
As of September 30, As of December 31,
---------------------------------------------------------
(1) 2003 % of Total 2002 % of Total
---------------------------- ---------------------------
($ in thousands)
Fixed maturities:
Public, available for sale, at fair value $4,809,207 68.3% $3,977,441 62.7%
Private, available for sale, at fair value 1,100,663 15.6% 1,180,665 18.6%
Policy loans, at outstanding balance 851,822 12.1% 879,506 13.9%
Short-term investments 181,014 2.6% 214,342 3.4%
Other long-term investments (1) 96,571 1.4% 91,021 1.4%
------------ --------- ---------- ------
Total investments $7,039,277 100.0% $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 September 30, 2003, our investment portfolio consisted primarily of
$5,909.9 million of fixed maturity securities (84% of the total portfolio at
September 30, 2003 versus 81% at December 31, 2002). The remaining investment
portfolio, comprised of policy loans, short-term investments and other long-term
investments, represents 16% of the total portfolio at September 30, 2003 versus
19% at December 31, 2002.
Investment Results
The following table sets forth the income yield and investment income, excluding
realized investment losses and gains, net for each major asset category of the
Company for the periods indicated.
For the three months ended September 30,
--------------------------------------------------------------
2003 2002
--------------------------------------------------------------
(1) Yield Amount Yield Amount
--------------------------------------------------------------
($ in thousands)
Fixed maturities 5.54% $74,223 6.70% $70,055
Policy loans 5.61 11,957 5.60 12,723
Short-term investments 2.44 1,509 2.94 3,695
Other long-term investments 6.30 1,534 9.06 2,561
---------- ----------- -------- -----------
Investment income before investment 5.49 89,223 6.40 89,034
expenses
Investment expenses (0.10) (2,921) (0.11) (3,546)
---------- ----------- -------- -----------
Total after investment expenses 5.39% $86,302 6.29% $85,488
========== =========== ======== ===========
- -----------------
(1) Yields are based on quarterly average carrying values except for fixed
maturities and securities lending activity. Yields for fixed maturities are
based on amortized cost. Yields for securities lending activity are
calculated net of corresponding liabilities and rebate expenses. Yields for
prior year are presented on a basis consistent with our current reporting
practices.
15
The overall income yield on our invested assets after investment expenses,
excluding realized investment losses, net was 5.39% and 6.29% for the third
quarter of 2003 and 2002, respectively. The change in yield between periods is
primarily attributable to reinvestment activities and investment of new funds in
a declining interest rate environment.
For the nine months ended September 30,
--------------------------------------------------------------
2003 2002
--------------------------------------------------------------
(2) Yield Amount Yield Amount
--------------------------------------------------------------
($ in thousands)
Fixed maturities 5.75% $218,093 6.45% $205,424
Policy loans 5.49 34,949 5.83 36,132
Short-term investments 2.19 6,137 3.22 10,155
Other long-term investments 7.91 5,490 10.80 6,417
------- ---------- ------ ----------
Investment income before investment
expenses 5.65 264,669 6.31 258,128
Investment expenses (0.11) (9,619) (0.10) (8,844)
------- ---------- ------ ----------
Total after investment expenses 5.54% $255,050 6.21% $249,284
======= ========== ====== ==========
- -----------------
(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 5.54% and 6.21% for the first nine
months of 2003 and 2002, respectively. The change in yield between periods is
primarily due to reinvestment activities and investment of new funds in a
declining interest rate environment.
16
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 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 September 30, 2003 the fixed maturities portfolio
totaled $5,909.9 million, an increase of $751.8 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 September
30, 2003, we held approximately 84% of assets in fixed maturity securities
(versus 81% as of December 31, 2002) with a total amortized cost of $5,608.0
million and an estimated fair value of $5,909.9 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
September 30, 2003 were $4,568.0 million at amortized cost and $4,809.2 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 September 30, 2003 were $1,040.0
million at amortized cost and $1,100.7 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 September 30, 2003 As of December 31, 2002
------------------------------------------------ ----------------------------------------------------
(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 $ 256,247 $ 5,589 $ 7 $ 261,829 $ 600,385 $ 11,906 $ 1 $ 612,290
Manufacturing 1,216,330 73,598 2,389 1,287,539 1,029,622 59,334 4,476 1,084,480
Utilities 653,728 44,497 2,452 695,773 509,444 29,199 6,128 532,515
Finance 1,130,618 67,020 303 1,197,335 705,019 52,722 724 757,017
Services 818,821 50,235 860 868,196 538,604 25,344 2,827 561,121
Mortgage Backed 95,280 2,302 5 97,577 120,425 3,242 14 123,653
Foreign
Government 44,198 5,816 31 49,983 45,981 4,707 44 50,644
Retail and
Wholesale 331,145 20,079 767 350,457 279,750 20,093 477 299,366
Asset-Backed
Securities 756,609 18,216 1,064 773,761 642,771 14,667 2,096 655,342
Transportation 186,986 14,231 65 201,152 218,649 12,303 390 230,562
Energy 111,483 8,133 491 119,125 218,269 19,224 35 237,458
Other 6,572 571 - 7,143 12,772 886 - 13,658
---------- --------- ------- ---------- ---------- -------- ------- ----------
Total $5,608,017 $ 310,287 $ 8,434 $5,909,870 $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.
17
As a percentage of amortized cost, fixed maturity investments as of September
30, 2003 consist primarily of the following sectors: 22% manufacturing, 20%
finance, 15% services, 13% asset-backed securities and 12% utilities compared to
21% manufacturing, 14% finance, 13% asset-backed securities, 12% U.S.
Government, and 11% services as of December 31, 2002. Approximately 95% of the
mortgage-backed securities were publicly traded agency pass-through securities.
Collateralized mortgage obligations represented less than 5% of total
mortgage-backed securities.
The gross unrealized losses related to our fixed maturity portfolio were $8.4
million as of September 30, 2003 compared to $17.2 million as of December 31,
2002. The gross unrealized losses as of September 30, 2003 were concentrated
primarily in the utilities, manufacturing, asset-backed securities and services
sectors while gross unrealized losses as of December 31, 2002 were concentrated
in the utilities, manufacturing, and services sectors. Non-investment grade
securities represented 28% of the gross unrealized losses as of September 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 $503.5 million, or 9%, of the total fixed maturities as of
September 30, 2003, compared to $526.8 million, or 11%, of total fixed
maturities as of December 31, 2002.
Public Fixed Maturities - Credit Quality
The following table sets forth our public fixed maturity portfolios by NAIC
rating as of the dates indicated.
---------------------------------------------- ---------------------------------------------
As of September 30, 2003 As of December 31, 2002
---------------------------------------------- ---------------------------------------------
(1) Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
Cost Gains Losses Fair Value Cost Gains Losses Fair Value
---------------------------------------------- ---------------------------------------------
($ in thousands)
NAIC Rating Agency
Designation Equivalent
- ---------------------------
1 Aaa, Aa, A $ 2,544,783 $ 127,732 $2,100 $2,670,415 $2,377,674 $116,244 $ 438 $2,493,480
2 Baa 1,731,887 99,619 3,012 1,828,494 1,152,329 71,903 4,152 1,220,080
3 Ba 165,883 10,084 680 175,287 162,210 5,224 2,201 165,233
4 B 111,552 7,579 1,415 117,716 75,167 2,381 2,987 74,561
5 C and lower 8,594 3,060 151 11,503 10,391 412 2,057 8,746
6 In or near
default 5,310 575 93 5,792 15,195 481 335 15,341
----------- --------- ------ ---------- ---------- -------- ------- ----------
Public Fixed Maturities $ 4,568,009 $ 248,649 $7,451 $4,809,207 $3,792,966 $196,645 $12,170 $3,977,441
=========== ========= ====== ========== ========== ======== ======= ==========
(1) Includes, as of September 30, 2003 and December 31, 2002, respectively, 36
securities with amortized cost of $19 million (fair value, $20 million) and
6 securities with amortized cost of $3 million (fair value, $3 million) that
have been categorized based on expected NAIC designations pending receipt of
SVO ratings.
18
Private Fixed Maturities - Credit Quality
The following table sets forth our private fixed maturity portfolios by NAIC
rating as of the dates indicated.
----------------------------------------------- -------------------------------------------
As of September 30, 2003 As of December 31, 2002
----------------------------------------------- -------------------------------------------
(1) Gross Gross Gross Gross
Amortized Unrealized Unrealized Amortized Unrealized Unrealized
Cost Gains Losses Fair Value Cost Gains Losses Fair Value
----------------------------------------------- -------------------------------------------
($ in thousands)
NAIC Rating Agency
Designation Equivalent
- ---------------------------
1 Aaa, Aa, A $ 391,796 $15,589 $521 $ 406,864 $ 338,539 $12,348 $1,351 $ 349,536
2 Baa 436,093 27,580 427 463,246 526,384 34,430 45 560,769
3 Ba 136,260 14,379 9 150,630 212,917 9,197 3,089 219,025
4 B 16,561 2,198 12 18,747 9,637 - 196 9,441
5 C and lower 23,163 1,303 - 24,466 39,616 1,007 253 40,370
6 In or near
default 36,135 589 14 36,710 1,632 - 108 1,524
---------- ------- ---- ---------- ---------- ------- ------ ----------
Private Fixed Maturities $1,040,008 $61,638 $983 $1,100,663 $1,128,725 $56,982 $5,042 $1,180,665
========== ======= ==== ========== ========== ======= ====== ==========
(1) Includes, as of September 30, 2003 and December 31, 2002, respectively, 45
securities with amortized cost of $152 million (fair value, $156 million)
and 10 securities with amortized cost of $21 million (fair value, $22
million) that have been categorized based on expected NAIC designations
pending receipt of SVO ratings.
Unrealized Losses from Fixed Maturity Securities
The following table sets forth the amortized cost and gross unrealized losses of
fixed maturity securities where the estimated fair value had declined and
remained below amortized cost by 20% or more for the following timeframes:
---------------------------------- ----------------------------------
As of September 30, 2003 As of December 31, 2002
---------------------------------- ----------------------------------
Gross Gross
Unrealized Unrealized
Amortized Cost Losses Amortized Cost Losses
---------------------------------- ----------------------------------
($ in thousands)
Less than six months $2,479 $726 $9,605 $3,488
Greater than six months but less than nine
months - - 982 424
Greater than nine months 9 5 - -
--------- ------ --------- ----------
Total $2,488 $731 $10,587 $3,912
========= ====== ========= ==========
Gross unrealized losses of fixed maturity securities where estimated fair value
has been 20% or more below amortized cost were $.7 million as of September 30,
2003, compared to $3.9 million as of December 31, 2002. The gross unrealized
losses at September 30, 2003 were primarily concentrated in the manufacturing,
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.
19
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 $12.4 million for the first
nine months of 2003 and $20.5 million for the first nine 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 distribution expenses, 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 September 30, 2003 and December
31, 2002 we had cash and short-term investments of approximately $422.6 million
and $650.5 million, respectively, and fixed maturity investments classified as
"available for sale" with fair values of $5.910 billion and $5.158 billion at
those dates, respectively.
20
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 September 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.
September 30, December 31,
2003 2002
------------------------------
(in millions)
Borrowings:
General obligations $ - $ -
Total asset-based financing 527 626
----- -----
Total borrowings and asset-based financings $ 527 $ 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 September 30, 2003. Based on such
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that, as of September 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 September 30, 2003, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
21
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 5. Other Information
- -------------------------
Recently, the Company received a formal request for information from the New
York Attorney General's Office in connection with its variable annuity business.
The Company is cooperating with this inquiry and is conducting its own internal
review.
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 3 variable annuity) is
incorporated by reference to the Company's registration
statement on Form S-3, Registration No. 333-103474, filed
February 27, 2003.
22
4(g) Market-Value Adjustment Annuity Contract (Strategic Partners
FlexElite variable annuity) is incorporated by reference to
Post-Effective Amendment No. 1 to Form N-4, Registration No.
333-75702, filed February 14, 2003, on behalf of the Pruco
Life Flexible Premium Variable Annuity Account.
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
-------------------
None
23
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 November 14, 2003
- --------------------- (Authorized Signatory)
Andrew J. Mako
/s/ William J. Eckert, IV Vice President and November 14, 2003
- -------------------------- Chief Financial Officer
William J. Eckert, IV (Principal Accounting Officer)
24