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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- - EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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
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(State or other jurisdiction, (IRS Employer Identification No.)
incorporation or organization)
213 Washington Street, Newark, New Jersey 07102
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(Address of principal executive offices) (Zip Code)
(973) 802-6000
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(Registrant's Telephone Number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: NONE
Securities registered pursuant to Section 12 (g) of the Act: NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
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State the aggregate market value of the voting stock held by
non-affiliates of the registrant: NONE
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of March 19, 2004. Common stock, par value
of $10 per share: 250,000 shares outstanding.
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Pruco Life Insurance Company meets the conditions set
forth in General Instruction (I) (1) (a) and (b) on Form 10-K and
is therefore filing this Form with the reduced disclosure format.
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PRUCO LIFE INSURANCE COMPANY
(Registrant)
INDEX
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Page No.
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Cover Page -
Index 2
PART I Item 1. Business 3
Item 2. Properties 6
Item 3. Legal Proceedings 6
PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 7
Item 7. Management's Discussion and Analysis of Financial Position and Results of Operations 7
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 12
Item 8. Financial Statements and Supplementary Data 15
Item 9. Changes in and Disagreements with Independent Accountants on Accounting 15
and Financial Disclosure
Item 9A. Controls and Procedures 15
PART III Item 10. Directors and Executive Officers of the Registrant 16
Item 14. Principal Accountant Fees and Services 16
PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 17
Signatures 19
Forward-Looking Statement Disclosure
Certain of the statements included in this Annual Report on Form 10-K, including
but not limited to those in the Management's Discussion and Analysis of
Financial Condition and Results of Operations, constitute forward-looking
statements within the meaning of the U.S. Private Securities Litigation Reform
Act of 1995. Words such as "expects," "believes," "anticipates," "includes,"
"plans," "assumes," "estimates," "projects," "intends", or variations of such
words are generally part of forward-looking statements. Forward-looking
statements are made based on management's current expectations and beliefs
concerning future developments and their potential effects upon Pruco Life
Insurance Company ("the Company"). There can be no assurance that future
developments affecting the Company will be those anticipated by management.
These forward-looking statements are not a guarantee of future performance and
involve risks and uncertainties, and there are certain important factors that
could cause actual results to differ, possibly materially, from expectations or
estimates reflected in such forward-looking statements, including without
limitation: general economic, market and political conditions, including the
performance of financial markets, interest rate fluctuations and the continuing
negative impact of the current economic environment; various domestic or
international military or terrorist activities or conflicts; volatility in the
securities markets; reestimates of our reserves for future policy benefits and
claims; changes in our assumptions related to deferred policy acquisition costs;
our exposure to contingent liabilities; catastrophe losses; investment losses
and defaults; changes in our claims-paying or credit ratings; competition in our
product lines and for personnel; fluctuations in foreign currency exchange rates
and foreign securities markets; risks to our international operations; the
impact of changing regulation or accounting practices; adverse litigation
results; and changes in tax law. The Company does not intend, and is under no
obligation to, update any particular forward-looking statement included in this
document.
2
PART 1
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Item 1. Business
Overview
Pruco Life Insurance Company is a stock life insurance company, organized in
1971 under the laws of the state of Arizona. Pruco Life Insurance Company is
licensed to sell interest sensitive individual life insurance, variable life
insurance, term life insurance, variable and fixed annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced GIC ("PACE") in the District of Columbia, Guam and in all states except
New York. Pruco Life Insurance Company also had marketed individual life
insurance through its branch office in Taiwan. The branch office was transferred
to an affiliated Company on January 31, 2001, as described in the Notes to the
Financial Statements.
Pruco Life Insurance Company has three subsidiaries, which includes one wholly
owned life insurance subsidiary, Pruco Life Insurance Company of New Jersey
("PLNJ") and two subsidiaries formed in 2003 for the purpose of acquiring
municipal fixed maturities (see related party footnote for more information).
Pruco Life Insurance Company and its subsidiaries are referred to as "the
Company" and all financial information is shown on a consolidated basis
throughout this document.
PLNJ is a stock life insurance company organized in 1982 under the laws of the
state of New Jersey. It is licensed to sell individual life insurance, variable
life insurance, term life insurance, fixed and variable annuities only in the
states of New Jersey and New York.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential Insurance"), an insurance company founded in 1875 under the
laws of the state of New Jersey. On December 18, 2001 ("the date of
demutualization") Prudential Insurance converted from a mutual life insurance
company to a stock life insurance company and became an indirect wholly owned
subsidiary of Prudential Financial, Inc. ("Prudential Financial"). The
demutualization was completed in accordance with Prudential's Plan of
Reorganization, which was approved by the Commissioner of the New Jersey
Department of Banking and Insurance in October 2001.
Prudential Insurance intends to make additional capital contributions to the
Company, as needed, to enable it to comply with its reserve requirements and
fund expenses in connection with its business. Generally, Prudential Insurance
is under no obligation to make such contributions and its assets do not back the
benefits payable under the Company's policyholder contracts.
The Company is engaged in a business that is highly competitive because of the
large number of stock and mutual life insurance companies and other entities
engaged in marketing insurance products, and individual and group annuities.
The following paragraphs describe the Company's products, marketing and
distribution, and underwriting and pricing.
Products
Variable Life Insurance
We offer a number of individual variable life insurance products that provide a
return linked to an underlying investment portfolio designated by the
policyholder while providing the policyholder with the flexibility to change
both the death benefit and premium payments. Each product provides for the
deduction of charges and expenses from the customer's investment account. We
also offer variable life products targeted to the estate planning and
corporate-owned life insurance markets.
Term Life Insurance
We offer a variety of term life insurance products. Most term products include a
conversion feature that allows the policyholder to convert the policy into
permanent life insurance coverage.
Universal Life Insurance
We offer universal life insurance products that feature a market rate fixed
interest investment account and flexible premiums.
Variable and Fixed Annuities
We offer variable annuities that provide our customers with the opportunity to
invest in proprietary and non-proprietary mutual funds and fixed-rate options.
The investments made by customers in the proprietary and non-proprietary mutual
funds represent separate accounts for which the contractholder bears the
investment risk. The investments made in the fixed rate options are credited
with interest at rates determined by us, subject to certain minimums.
Additionally, our variable annuities products offer certain minimum death
benefit and living benefit guarantee options. We also offer a fixed annuity
product that provides a guaranteed rate of interest for a specified maturity
subject to a market value adjustment in the event of early withdrawal. We had
previously offered fixed annuities that provide a guarantee of principal and a
guaranteed interest rate to be credited to the principal amount for a specified
period of time. This type of fixed annuity is no longer offered for sale.
3
Guaranteed Investment Contracts ("GICs")
We offer non-participating GICs through which customers deposit funds with us
under contracts that typically provide for a specified rate of interest on the
amount invested through the maturity of the contract. We are obligated to pay
principal and interest according to the contracts' terms. This obligation is
backed primarily by fixed maturities, and we bear all of the investment and
asset/liability management risk on these contracts. As spread products,
non-participating GICs make a profit to the extent that the rate of return on
the investments we make with the invested funds exceeds the promised interest
rate and our expenses. Since 1997, we have offered our credit-enhanced GIC,
which has a triple-A rating, the highest rating possible, as a result of a
guarantee from a financial insurer.
Marketing and Distribution
Prudential Insurance Agents
Agents employed by Prudential Insurance, our Parent company, distribute
variable, universal and term life, variable and fixed annuities, and investment
and protection products with proprietary and non-proprietary investment options
as well as selected insurance products manufactured by others. GICs are
distributed using a small direct sales force. We place most of our GIC business
with clients with whom we have an existing relationship.
The majority of Prudential Insurance Agents are multi-line traditional agents.
Other than certain training allowances or salary paid at the beginning of their
employment, traditional Prudential Insurance Agents are paid on a commission
basis for the products they sell. As described in the Notes to the Financial
Statements, the Company is allocated expenses from Prudential Insurance. These
allocated expenses reflect a market based pricing arrangement.
Third Party Distribution
Our individual life and annuity products are offered through a variety of third
party channels, including independent brokers, general agencies, producer
groups, banks and broker-dealers. We have historically focused on serving the
intermediaries who provide insurance solutions in support of estate and wealth
transfer planning for affluent individuals and corporate-owned life insurance
for businesses. However, we have expanded our target market to include mass
affluent individuals in addition to affluent individuals. The life insurance and
annuity products offered are generally the same as those available through
Prudential Insurance Agents. Our third party efforts are supported by a network
of internal and external wholesalers.
Underwriting and Pricing
Life Insurance
Our life insurance underwriters follow detailed and uniform policies and
procedures to assess and quantify the risk of our individual life insurance
products. We require the applicant to take a variety of underwriting tests, such
as medical examinations, electrocardiograms, blood tests, urine tests, chest
x-rays and consumer investigative reports, depending on the age of the applicant
and the amount of insurance applied for. Our universal life insurance contracts
and the fixed component of our variable life insurance contracts feature
crediting rates which are reset periodically. In resetting these rates, we
consider the returns on our portfolios supporting the interest-sensitive life
insurance business, current interest rates, the competitive environment, and our
profit objectives.
Annuities
We earn investment management fees based upon the average assets of the mutual
funds in our variable annuity products and mortality and expense fees and other
fees for various insurance-related options and features based on average daily
net assets of the value of the annuity separate accounts. We price the
fixed-rate options of our variable annuities based on assumptions as to
investment returns, expenses and persistency. Competition also influences our
pricing. We seek to maintain a spread between the return on our general account
invested assets and the interest we credit on our fixed annuities. To encourage
persistency, all of our variable annuities have withdrawal restrictions and
declining surrender or withdrawal charges for a specified number of years.
Guaranteed Investment Contracts
We set our rates for guaranteed products using a proprietary pricing model that
considers the investment environment and our risk, expense and profitability
assumptions. Upon sale of a product, we adjust the duration of our asset
portfolio and lock in the prevailing interest rates. We continuously monitor
cash flow experience and work closely with our Asset Liability and Risk
Management Group to review performance and ensure compliance with our investment
policy.
4
Reserves
We establish reserve and policyholder fund liabilities to recognize our future
benefit obligations for our in force life and annuity policies. For variable and
interest-sensitive life insurance and annuity contracts, we establish
policyholders' account balances that represent cumulative gross premium payments
plus credited interest and/or fund performance, less withdrawals, expenses and
mortality charges. We establish policyholder fund liabilities for GICs that
represent cumulative contractholder account balances.
Effective January 1, 2004, we will adopt SOP 03-01, which requires us to record
a liability for minimum guaranteed death benefits as well as other changes. This
is discussed in Item 7, Management's Discussion and Analysis and in Footnote 2
on new accounting pronouncements.
Reinsurance
Since 2000, we have reinsured the majority of the mortality risk we assume under
our new individual life insurance products. The maximum amount of individual
life insurance we may retain on any life is $2.5 million.
Regulatory Environment
In order to continue to market life insurance and annuity products, the Company
must meet or exceed the statutory capital and surplus requirements of the
insurance departments of the states in which it conducts business. Statutory
accounting practices differ from generally accepted accounting principles
("GAAP") in two major respects. First, under statutory accounting practices, the
acquisition costs of new business are charged to expense, while under GAAP they
are initially deferred and amortized over a period of time. Second, under
statutory accounting practices, the required additions to statutory reserves for
new business in some cases may initially exceed the statutory revenues
attributable to such business. These practices result in a reduction of
statutory income and surplus at the time of recording new business.
Insurance companies are subject to Risk-Based Capital ("RBC") guidelines,
monitored by insurance regulatory authorities, that measure the ratio of the
Company's statutory surplus with certain adjustments ("Adjusted Capital") to its
required capital, based on the risk characteristics of its insurance liabilities
and investments. Required capital is determined by statutory formulae that
consider risks related to the type and quality of invested assets,
insurance-related risks associated with the Company's products, interest rate
risks, and general business risks. The RBC calculations are intended to assist
regulators in measuring the adequacy of the Company's statutory capitalization.
The Company considers RBC implications in its asset/liability management
strategies. Each year, the Company conducts a thorough review of the adequacy of
statutory insurance reserves and other actuarial liabilities. The review is
performed to ensure that the Company's statutory reserves are computed in
accordance with accepted actuarial standards, reflect all contractual
obligations, meet the requirements of state laws and regulations and include
adequate provisions for any other actuarial liabilities that need to be
established. All significant reserve changes are reviewed by the Board of
Directors and are subject to approval by the Arizona Department of Insurance and
the New Jersey Department of Banking and Insurance (the "Insurance
Departments"). The Company believes that its statutory capital is adequate for
its currently anticipated levels of risk as measured by regulatory guidelines.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance ("Codification"), which replaced the current Accounting
Practices and Procedures manual as the NAIC's primary guidance on statutory
accounting as of January 1, 2001. The Codification provided guidance for areas
where statutory accounting had been silent and changed current statutory
accounting in certain areas. Certain of the standards had an impact on the
measurement of statutory capital, which, in turn, affected RBC ratios of
insurance companies. The Company adopted the Codification guidance effective
January 1, 2001. As a result of these changes, the Company reported an increase
to statutory surplus of $81 million, primarily as a result of the recognition of
deferred tax assets.
The NAIC has developed a set of financial relationships or tests known as the
Insurance Regulatory Information System ("IRIS") to assist state regulators in
monitoring the financial condition of insurance companies and identifying
companies that require special attention or action by insurance regulatory
authorities. Insurance companies generally submit data annually to the NAIC,
which in turn analyzes the data using prescribed financial data ratios, each
with defined "usual ranges." Generally, regulators will begin to investigate or
monitor an insurance company if ratios fall outside the usual ranges for four or
more of the ratios. If an insurance company has insufficient capital, regulators
may act to reduce the amount of insurance it can issue. The Company is not
currently subject to regulatory scrutiny based on these ratios.
The Company is subject to state insurance laws. A detailed financial statement
in the prescribed form (the "Annual Statement") is filed with the Insurance
Departments each year covering the Company's operations for the preceding year
and its financial position as of the end of that year. Regulation by the
Insurance Departments includes periodic examinations to verify the accuracy of
contract liabilities and reserves. The Company's books and accounts are subject
to review by the Insurance Departments at all times. A full examination of the
Company's operations is conducted periodically by the Insurance Departments and
under the auspices of the NAIC.
5
The Company is subject to regulation under the insurance laws of all
jurisdictions in which it operates. The laws of the various jurisdictions
establish supervisory agencies with broad administrative powers with respect to
various matters, including licensing to transact business, overseeing trade
practices, licensing agents, approving contract forms, establishing reserve
requirements, fixing maximum interest rates on life insurance contract loans and
minimum rates for accumulation of surrender values, prescribing the form and
content of required financial statements and regulating the type and amounts of
investments permitted. The Company is required to file the Annual Statement with
supervisory agencies in each of the jurisdictions in which it does business, and
its operations and accounts are subject to examination by these agencies at
regular intervals.
Although the federal government generally does not directly regulate the
business of insurance, federal initiatives often have an impact on the business
in a variety of ways. Certain insurance products of the Company are subject to
various federal securities laws and regulations. In addition, current and
proposed federal measures which may significantly affect the insurance business
include regulation of insurance company solvency, employee benefit regulation,
removal of barriers preventing banks from engaging in the insurance business,
tax law changes affecting the taxation of insurance companies and the tax
treatment of insurance products and its impact on the relative desirability of
various personal investment vehicles.
Item 2. Properties
Office space is provided by Prudential Insurance, as is described in the Notes
to the Consolidated Financial Statements.
Item 3. 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.
6
PART II
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Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company is a wholly owned subsidiary of Prudential Insurance. There is no
public market for the Company's common stock.
Item 7. Management's Discussion and Analysis of Financial Position and Results
of Operations
Pruco Life Insurance Company meets the conditions set forth in General
Instruction I(1)(a) and (b) on Form 10-K 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 December 31, 2003, compared with December 31, 2002, and
its consolidated results of operations for the years ended December 31, 2003 and
2002.
Overview
The Company sells interest-sensitive individual life insurance and variable life
insurance, term life insurance, individual variable annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced ("PACE") primarily through the Prudential Insurance sales force in the
United States. These markets are subject to regulatory oversight with particular
emphasis placed on company solvency and sales practices. These markets are also
subject to increasing competitive pressure as the legal barriers, which have
historically segregated the markets of the financial services industry, have
been changed through both legislative and judicial processes. Regulatory changes
have opened the insurance industry to competition from other financial
institutions, particularly banks and mutual funds that are positioned to deliver
competing investment products through large, stable distribution channels. The
Company also marketed individual life insurance through its branch office in
Taiwan. The Taiwan branch was transferred to an affiliated Company on January
31, 2001, as described in the Notes to the Financial Statements. Beginning
February 1, 2001, all insurance activity of the Taiwan branch has been ceded to
the affiliated Company.
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.
Besides policy charges and fee income, the Company also earns revenues from
insurance premiums from term life insurance and asset management fees on the
Separate Account fund balances. The Company's operating expenses principally
consist of insurance benefits provided, general business expenses, commissions
and other costs of selling and servicing the various products we sell and
interest credited on general account liabilities.
The Company's profitability depends principally on its ability and Prudential
Insurance's ability to price and manage risk on insurance products, to attract
and retain customer assets, and to manage expenses. Specific drivers of our
profitability include:
o the ability of the Company and Prudential Insurance to manufacture
and distribute products and services and to introduce new products
gaining market acceptance on a timely basis;
o the ability to price our insurance products at a level that enables
us to earn a margin over the cost of providing benefits and the
expense of acquiring customers and administering those products;
o the mortality and morbidity experience on individual life insurance
and annuity products;
o persistency experience, which affects our ability to recover the cost
of acquiring new business over the lives of the contracts;
o the cost of administering insurance contracts and providing asset
management products and services;
o the returns on invested assets, net of the amounts we credit to
policyholders' accounts;
o the amount of our assets under management and changes in their fair
value, which affect the amount of asset management fees we receive;
and
o the ability to generate favorable investment results through
asset-liability management and strategic and tactical asset
allocation.
7
Application of Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP") requires the
application of accounting policies that often involve a significant degree of
judgment. Management, on an ongoing basis, reviews estimates and assumptions
used in the preparation of financial statements. If management determines that
modifications in assumptions and estimates are appropriate given current facts
and circumstances, results of operations and financial position as reported in
the Consolidated Financial Statements may change significantly.
The following sections discuss the accounting policies applied in preparing our
financial statements that management believes are most dependent on the
application of estimates and assumptions.
Valuation of investments
A large portion of our investments is reflected at fair value in the statements
of financial position based on quoted market prices or estimates from
independent pricing services. However, when such information is not available,
for example, with respect to private placement fixed maturity securities, which
comprises 16.2% of our investments at December 31, 2003, fair value is
estimated, typically by using a discounted cash flow model, which considers
current market credit spreads for publicly traded issues with similar terms by
companies of comparable credit quality. Consequently, changes in estimated
future cash flows or in our assessment of the issuer's credit quality will
result in changes in fair value estimates. For fixed maturities and equity
securities classified as available for sale, the impact of such changes is
recorded in "Accumulated other comprehensive income (loss)," a separate
component of equity. However, the carrying value of these securities is reduced,
with a corresponding charge to earnings, when a decline in value is considered
to be other than temporary. Factors we consider in determining whether a decline
in value is other than temporary include: whether the decline is substantial;
the length of time the fair value has been less than cost, generally six months;
and the financial condition and near-term prospects of the issuer. This
corresponding charge is referred to as an impairment and is reflected in
"Realized investment losses, net" in the statements of operations. The level of
impairment losses can be expected to increase when economic conditions worsen
and decrease when economic conditions improve.
Policyholder liabilities
The liability for "Future policy benefits and other policyholder liabilities"
represents 4.6% of total liabilities as of December 31, 2003. Changes in this
liability are generally reflected in the "Policyholders' benefits" caption in
our statements of operations. This liability is primarily comprised of the
present value of estimated future payments to holders of life insurance and
annuity products where the timing and amount of payment depends on policyholder
mortality or surrender experience. For life insurance and annuity products,
expected mortality is generally based on the Company's historical experience or
standard industry tables. Interest rate assumptions are based on factors such as
market conditions and expected investment returns. Although mortality and
interest rate assumptions are "locked-in" upon the issuance of new insurance or
annuity business with fixed and guaranteed terms, significant changes in
experience or assumptions may require us to provide for expected future losses
on a product by establishing loss recognition reserves.
Deferred policy acquisition costs
For most life insurance and annuity products that we sell, we defer costs that
vary with and are related primarily to the production of new business to the
extent these costs are deemed recoverable from future profits, and we record
these costs as an asset known as deferred policy acquisition costs or "DAC" ",
which is 5.5% of total assets as of December 31, 2003. We amortize this DAC
asset over the expected lives of the contracts, based on the level and timing of
either estimated profits or premiums, depending on the type of contract. For
products with amortization based on future premiums, the amortization rate is
locked-in when the product is sold. For products with amortization based on
estimated profits, the amortization rate is periodically updated to reflect
current period experience or changes in assumptions that affect future
profitability, such as lapse rates, investment returns, mortality experience,
expense margins and surrender charges.
For example, expected profitability is a significant estimate in evaluating
deferred acquisition costs related to annuity products. Expected profitability
considers, among other assumptions, our best estimate of future asset returns to
estimate the future fees we expect to earn, the costs associated with minimum
death benefit guarantees we expect to incur and other profitability factors. For
the average remaining life of our variable annuity contracts in force as of
December 31, 2003, our evaluation of deferred policy acquisition costs is based
on a 7.7% annual blended rate of return that reflects an assumed rate of return
of 8.9% for equity type assets. Continuation of current market conditions or
further deterioration in market conditions may result in increases in the
amortization of deferred policy acquisition costs, while a significant
improvement in market conditions may result in a decrease in the amortization of
deferred policy acquisition costs. These changes in DAC balances are included as
a component of "General, administrative and other expenses" in our statements of
operations.
See "Results of Operations" for a discussion of the impact of DAC amortization
on our results of our life and annuities products, including decreased
amortization in 2003 and increased amortization recorded in 2002 reflecting
higher estimates of future gross profits in 2003 and lower estimates of future
gross profits in 2002.
8
Reserves for contingencies
A contingency is an existing condition that involves a degree of uncertainty
that will ultimately be resolved upon the occurrence of future events. Under
GAAP, reserves for contingencies are required to be established when the future
event is probable and its impact can be reasonably estimated. An example is the
establishment of a reserve for losses in connection with an unresolved legal
matter. The initial reserve reflects management's best estimate of the probable
cost of ultimate resolution of the matter and is revised accordingly as facts
and circumstances change and, ultimately, when the matter is brought to closure.
In situations in which the Company is to be indemnified by Prudential Insurance,
there will be no financial impact on the statement of operations.
Other significant estimates
In addition to the items discussed above, the application of GAAP requires
management to make other estimates and assumptions. One example is the
recognition of deferred tax assets, which depends on management's assumption
that future earnings will be sufficient to realize the deferred benefit. This is
discussed in Note 7 to the Consolidated Financial Statements.
Recently Issued Accounting Pronouncements
See Note 2 to the Consolidated Financial Statements for a discussion of recently
issued accounting pronouncements.
The Company's Changes in Financial Position and Results of Operations are
described below.
Changes in Financial Position
2003 versus 2002
From December 31, 2002 to December 31, 2003 there was an increase of $4,004
million in total assets from $21,211 million to $25,215 million. The largest
increase was in Separate account assets, which increased by $3,076 million
primarily from market value appreciation of $2,842 million as a result of
recoveries in the equity markets. Positive net sales (sales less withdrawals)
also contributed to the increase in Separate account assets. Fixed maturities
increased by $796 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 $228 million, as capitalization of distribution expenses from new sales
exceeded the amortization of DAC. Reinsurance recoverable is higher by $117
million due to increases in the Taiwan branch reinsurance recoverable and the
Pruco Re reinsurance recoverable for term insurance. Other assets are higher by
$47 million due to an increase in deferred expenses related to sales inducements
for annuity products as the Company has sold more annuity contracts that contain
these features. Cash and cash equivalents and short-term investments are lower
by $236 million resulting from lower security lending activities and a higher
investment into long-term fixed maturities as compared to shorter-term
investments, as mentioned above.
During the year, liabilities increased by $3,911 million from $19,489 million to
$23,400 million. Corresponding with the asset change, Separate account
liabilities increased by $3,076 million, as described above. Policyholder
account balances increased by $727 million due primarily to positive net sales
of annuity products with fixed rate options and life general account products.
Future policy benefits increased by $134 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. Income taxes payable, which is a net
number comprised of payables and receivables, increased by $90 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. There was a decrease in total securities
lending activity of $97 million and a change in the mix between cash collateral
for loaned securities and securities sold under agreements to repurchase, as
there are less treasury securities in the portfolio. Treasury securities are
commonly used for lending activities, especially in the securities sold under
agreements to repurchase category.
Results of Operations
2003 versus 2002
Net Income
Consolidated net income of $84.9 million for 2003 was an improvement of $71.4
million from the $13.5 million earned for 2002. DAC amortization in 2003 is
$138.5 million lower than in 2002 due primarily to an additional charge of $117
million in the prior year and a benefit to net income of $15 million in the
current year for our annuity products. Realized investment losses are lower by
$65.3 million due to an improving credit environment in 2003. 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 and premiums as a result of
growth of the business. The increase in taxes for the year of $86.6 million is
primarily related to the increase in income from operations before taxes, and a
decrease in the dividends received deduction. Further details regarding the
components of revenues and expenses are described in the following paragraphs.
Revenues
Consolidated revenues increased by $131.8 million, from $950.8 million to
$1,082.6 million. Realized investment losses decreased by $65.3 million as a
result of an improving credit environment in 2003. Fixed maturity losses were
lower by $57.6 million, derivative losses were lower by $5.1 million, and there
9
was a mortgage prepayment gain in 2003 of $1.7 million. The prior year had fixed
maturity losses of $56.0 million consisting of $27.8 million of impairments and
$28.2 million of credit related losses. The current year had fixed maturity
gains of $1.6 million consisting of $12.4 million of impairments offset by $14.0
million of gains on sales.
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 $40.3 million. The increase was
a result of a $44.6 million increase for individual life products offset
partially by a $4.3 million decrease for annuity products. Policy charges for
life products increased as a result of growth in the in-force business, the
favorable impact of increases in the market value of variable life insurance
assets, 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 $71.1 billion at December 31, 2003
from $65.2 billion at December 31, 2002. In contrast, annuity fees are mainly
asset-based fees, which are dependent on the fund balances. Annuity separate
account fund balances have increased during the current year as a result of
favorable market performance and positive net sales. However, the average
balance for the current year is lower than the prior year average balance as the
favorable 2003 market performance did not completely offset the unfavorable
performance during 2002.
Premiums increased by $13.3 million mainly from higher term insurance sales and
renewals of $34.4 million partially offset by lower extended term premiums. Term
insurance gross premiums increased by $74.1 million due to increased sales and a
growing renewal base offset by an increase of $39.7 million in ceded premiums
driven by the coinsurance agreement with an affiliate, Pruco Re Ltd. This
contract became effective at the end of the 3rd quarter of 2003. Extended term
insurance premiums decreased by $19.4 million from decreased policy lapses as a
result of favorable market conditions in 2003. Extended term policies represent
term insurance the Company issued under policy provisions to customers who
previously had lapsing variable life insurance with the Company. The
policyholder can purchase extended term or reduced paid-up life insurance based
on the amount that can be purchased with the remaining cash value of the
contract (if the policyholder does not elect to receive the remaining cash value
as a cash distribution). The application of the remaining cash value to purchase
such coverage is recorded as premium revenue in the Statement of Operations.
Future policy benefit reserves are also increased by the amount of these
premiums.
Net investment income increased by $10.1 million as a result of increased income
from fixed maturities due to an increase in the portfolio balance from the
investment of positive operating and financing cash flows into the fixed
maturity portfolio. This was significantly offset by the effect of lower
reinvestment rates for fixed maturities and short-term investments due to the
lower interest rate environment.
Benefits and Expenses
Policyholder benefits increased by $56.9 million primarily from increased
reserve provisions of $29.0 million mainly for life insurance reserves and
higher death claims primarily from life products of $27.9 million.
The change in reserves increased $29.0 million from the prior year primarily as
a result of an increase of $34.1 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 contributed $17.1
million to the increase in reserves, whereas the decrease in extended term
premiums provided a decrease of $20.1 million.
Benefits increased by $27.9 million primarily from higher death claims on
variable, universal life, and term life insurance policies due to the growth of
the in force business. Included in this change is a decrease of $2.4 million for
annuity guaranteed minimum death benefits from $33.8 million in 2002 to $31.4
million in 2003 due to favorable market performance during 2003.
The guaranteed minimum death benefit (GMDB) 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. Previously, accounting literature did not
prescribe the recognition of a liability for the expected future net costs
associated with GMDB provisions. However, effective January 1, 2004, we will
adopt SOP 03-01 which requires us to record such a liability based on
application of an expected loss ratio to "cumulative assessments" through the
balance sheet date, and then subtracting "cumulative excess payments" from that
date. We currently estimate this liability to be approximately $45 million.
However, in our periodic evaluation of unamortized deferred policy acquisition
costs associated with our variable annuity business, we considered the expected
net costs associated with the guaranteed minimum death benefits in our
calculation of expected gross profits from this business. Accordingly, the
effect of establishing the guaranteed minimum death benefit reserve related to
this business will be partially offset by an estimated increase of approximately
$23 million in unamortized deferred policy acquisition costs, resulting in
higher future amortization.
In addition to establishing a liability associated with the guaranteed minimum
death benefit feature, SOP 03-01 requires a change in valuation and presentation
of our liability associated with the market value adjustment ("MVA") feature
contained in certain annuity contracts. The MVA feature requires the Company to
pay to the contract holder upon surrender the accreted value of the fund as well
as a market value adjustment based on the crediting rates on the contract
surrendered compared to crediting rates on newly issued contracts. Currently,
this liability is reflected at market value, which considers the effects of
unrealized gains and losses in contract value resulting from changes in
10
crediting rates. Upon adoption of SOP 03-01, the Company will reclassify this
liability from "Separate Account Liabilities" to "Policyholders' Account
Balances" and reduce it to reflect accreted value, which excludes the effect of
unrealized gains and losses in contract value resulting from changes in
crediting rates. We currently estimate the impact of the reduction in liability
associated with the MVA feature to be a benefit of approximately $7 million.
Interest credited to policyholder account balances increased by $23.2 million
due to growth in policyholders' account balances, especially for the annuity
products, which accounted for $20.2 million of the increase. Life general
account policyholder balances also increased providing a $4.4 million increase
in interest credited. GIC policyholder account balances decreased during 2003
due to scheduled withdrawals causing a decrease of $1.4 million in interest
credited. Overall net interest spread revenue, representing net investment
income less interest credited, has declined from last year as investment yields
on general account assets have declined as described above.
General, administrative, and other expenses decreased by $106.2 million from the
prior year. The primary reason was a decrease in DAC amortization of $138.5
million. DAC amortization for annuity products was $118.7 million less as the
prior year included an additional charge of $117 million for DAC amortization
while the current year had a benefit to net income of $15 million. The charge in
2002 reflected our lower estimates of future gross profits from greater expected
costs from minimum death benefit guarantees and lower expected fees under these
contracts due to declines in asset values and decreased future asset returns
during 2002. In 2003, the benefit reflected our higher estimates of future gross
profits from favorable market performance during the current year. In addition,
there was an increase in annuity DAC amortization in 2003 of approximately $13
million related to increased capital gains. DAC amortization on life insurance
products was lower by $19.8 million due to the favorable fund performance
partially offset by the increasing amortization on the growing term and
universal life business.
Deferred acquisition costs related to annuity products are evaluated quarterly
by comparing our actual profitability to our expectations. Expected
profitability considers, among other assumptions, our estimate of future asset
returns that determine the future fees we will earn, the costs we expect to
incur associated with minimum death benefit or other contractual guarantees, and
other profitability factors. If actual asset returns do not differ significantly
from our expectations, they do not result in a change in the rate of
amortization of deferred acquisition costs. Where actual asset returns differ
significantly from expectations, future asset return assumptions are evaluated
using a reversion to mean approach. Under the reversion to mean approach, we
consider historical returns over a period of time and project returns for a
future four-year period so that the investments underlying the annuities grow at
a targeted return for the entire period. A calculated rate of return over the
four future years, which we refer to as the look-forward period, is determined
so that this calculated rate, together with the actual rate of return for the
historical period, produces the targeted return for the entire period. If the
calculated rate of return is consistent with our range of expectations in light
of market conditions, we use it to project the asset growth for the next four
years. If the calculated rate of return is not supported by our current
expectations, we adjust the rate of return for purposes of these computations.
For contract years after the look-forward period, we project asset growth using
our long-term rate, currently an 8% annual blended rate of return, which
reflects an assumed rate of return of 8.85% for equity type assets. Beginning in
the second quarter of 2002 and continuing throughout 2002, we utilized a rate of
return lower than the calculated return, which contributed to our additional
amortization of deferred acquisition costs during the second and third quarters
of 2002. The equity rate of return used in the immediate four-year look-forward
period varies by product, but was under 10% for all of our variable annuity
products for our evaluation of deferred policy acquisition costs as of December
31, 2003. For the average remaining life of our variable annuity contracts in
force as of December 31, 2003, our evaluation of deferred policy acquisition
costs is based on a 7.7% annual blended rate of return that reflects an assumed
rate of return of 8.9% for equity type assets. Deterioration in market
conditions may result in increases in the amortization of deferred policy
acquisition costs, while further improvement in market conditions may result in
a decrease in the amortization of deferred policy acquisition costs.
General, administrative and other expenses, excluding DAC amortization,
increased $32.3 million from the prior year due to an increase in distribution
expenses of $8.3 million and allocated operating expenses of $24 million.
Distribution expenses, net of capitalization increased $8.3 million, as renewal
commissions on term insurance, which have been growing due to the increasing
renewal base, are not fully capitalizable. Operating expenses, in particular
salary related expenses, are higher as a result of new business and the growing
in-force business.
Effective New Accounting Pronouncements
Refer to Footnote 2, "Summary of Significant Accounting Policies," of the Notes
to Consolidated Financial Statements.
11
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Risk Management, Market Risk, and Derivative Financial Instruments
As a wholly-owned subsidiary of Prudential Insurance, the Company benefits from
the risk management strategies implemented by its parent. Risk management
includes the identification and measurement of various forms of risk,
establishment of acceptable risk thresholds, and creation of processes intended
to maintain risks within these thresholds while optimizing returns on the
underlying assets or liabilities. Prudential Insurance considers risk management
an integral part of its core businesses.
Market risk is the risk of change in the value of financial instruments as a
result of absolute or relative changes in interest rates, foreign currency
exchange rates or equity or commodity prices. To varying degrees, the investment
activities supporting all of the Company's products and services generate market
risks. Market risks incurred and the strategies for managing these risks vary by
product.
With respect to non-variable life insurance products, fixed rate annuities and
the fixed rate options in our variable life insurance and annuity products, the
Company incurs market risk primarily in the form of interest rate risk. The
Company manages this risk through asset/liability management strategies that
seek to match the interest rate sensitivity of the assets to that of the
underlying liabilities. The Company's overall objective in these strategies is
to limit the net change in value of assets and liabilities arising from interest
rate movements. While it is more difficult to measure the interest sensitivity
of the Company's insurance liabilities than that of the related assets, to the
extent the Company can measure such sensitivities the Company believes that
interest rate movements will generate asset value changes that substantially
offset changes in the value of the liabilities relating to the underlying
products.
For variable annuities and variable life insurance products, excluding the fixed
rate options in these products, the Company's main exposure is the risk that
asset-based fees may decrease as a result of declines in assets under management
due to changes in market performance. For variable annuity and variable life
insurance products with minimum guaranteed death and living benefits, the
Company also faces the risk that declines in the value of underlying investments
as a result of changes in securities prices may increase the Company's net
exposure to death and living benefits under these contracts.
The Company manages its exposure to equity price risk primarily by seeking to
match the risk profile of equity investments against risk-adjusted equity market
benchmarks. The Company measures benchmark risks level in terms of price
volatility in relation to the market in general.
The Company's exposure to market risk results from "other than trading"
activities in its insurance businesses. Market risks in the Company's insurance
business are managed through an investment process that incorporates
asset/liability management techniques and other risk management policies and
limits. Derivatives, as discussed further below, are used to alter interest rate
or currency exposures arising from mismatches between assets and liabilities.
These include sensitivity and Value-at-Risk measures, positions and other limits
based on type of risk, and various hedging methods.
Insurance, Annuities, and Guaranteed Products Asset/Liability Management
The Company seeks to maintain interest rate and equity exposures within
established ranges, which we periodically adjust based on market conditions and
the design of related products sold to customers. Our risk managers establish
investment risk limits for exposures to issuers, type of security or industry
sector and oversee efforts to manage risk within policy constraints set by
management and approved by the Board of Directors.
The Company uses duration and convexity analyses to measure price sensitivity to
interest rate changes. Duration measures the relative sensitivity of the fair
value of a financial instrument to changes in interest rates. Convexity measures
the rate of change of duration with respect to changes in interest rates. We
seek to manage our interest rate exposure by matching the relative sensitivity
of asset and liability values to interest rate changes, or controlling "duration
mismatch" of assets and liabilities. The Company has a target duration mismatch
level. As of December 31, 2003 and 2002, the difference between the pre-tax
duration of assets and the target duration of liabilities in our
duration-managed portfolios was within constraint limits. The Company considers
risk-based capital implications in its asset/liability management strategies.
The Company also performs portfolio stress testing as part of its regulatory
cash flow testing. In this testing, the Company evaluates the impact of altering
the interest-sensitive assumptions under various moderately adverse interest
rate environments. These interest-sensitive assumptions relate to the timing and
amount of redemptions and prepayments of fixed-income securities and lapses and
surrenders of insurance products. The Company evaluates any shortfalls that this
cash flow testing reveals to determine whether it needs to increase statutory
reserves or adjust portfolio management strategies.
12
Market Risk Related to Interest Rates
Assets that subject the Company to interest rate risk include fixed maturities
and policy loans. In the aggregate, the carrying value of these assets
represented 72% of consolidated assets, other than assets that are held in
Separate accounts, as of December 31, 2003 and 71% as of December 31, 2002. With
respect to liabilities, the Company is exposed to interest rate risk through
policyholder account balances relating to life insurance and annuity investment
type contracts.
The Company assesses interest rate sensitivity for its financial assets,
financial liabilities and derivatives using hypothetical test scenarios which
assume both upward and downward 100 basis point parallel shifts in the yield
curve from prevailing interest rates. The following tables set forth the
potential loss in fair value from a hypothetical 100 basis point upward shift at
December 31, 2003 and 2002, because this scenario results in the greatest net
exposure to interest rate risk of the hypothetical scenarios tested at those
dates. While the test scenario is for illustrative purposes only and does not
reflect management's expectations regarding future interest rates or the
performance of fixed income markets, it is a near-term, reasonably possible
hypothetical change that illustrates the potential impact of such events. These
test scenarios do not measure the changes in value that could result from
non-parallel shifts in the yield curve, which would be expected to produce
different changes in discount rates for different maturities. As a result, the
actual loss in fair value from a 100 basis point change in interest rates could
be different from that indicated by these calculations.
The below presentation excludes $3.213 billion and $2.961 billion of insurance
reserves and deposit liabilities at December 31, 2003 and 2002, respectively.
The Company believes that the interest rate sensitivities of these insurance
liabilities offset, in large measure, the interest rate risk of the financial
assets set forth in the following tables.
13
December 31, 2003
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(Derivatives) Value Shift Fair Value
---------------------------------------------------------------
Financial Assets with Interest Rate (In millions)
Risk:
Fixed Maturities Available for Sale $ - $ 5,954 $ 5,759 $ (195)
Policy Loans 967 918 (49)
Derivatives:
Futures 6 - - -
Swaps 31 (4) (4) -
Financial Liabilities with Interest
Rate Risk:
Investment Contracts - (3,506) (3,484) 22
----------------
Total Estimated Potential Loss $ (222)
================
December 31, 2002
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(Derivatives) Value Shift Fair Value
---------------------------------------------------------------
Financial Assets with Interest Rate (In millions)
Risk:
Fixed Maturities Available for $ - $ 5,158 $ 5,007 $ (151)
Sale
Policy Loans - 1,031 967 (64)
Derivatives:
Futures 12 - - -
Swaps 36 2 1 (1)
Financial Liabilities with Interest
Rate Risk:
Investment Contracts - (2,907) (2,875) 32
----------------
Total Estimated Potential Loss $(184)
================
The estimated changes in fair values of the financial assets shown above relate
to assets invested in support of the Company's insurance liabilities, but do not
include assets associated with products for which investment risk is borne
primarily by the contract holders rather than the Company.
Market Risk Related to Equity Prices
The Company does not have a significant general account investment in equity
securities. For equity investments within the Separate Accounts, the investment
risk is borne primarily by the contract holder rather than by the Company.
Market Risk Related to Foreign Currency Exchange Rates
The Company is exposed to foreign currency exchange risk in its investment
portfolio and previously through its operations in Taiwan. The Company generally
hedges substantially all foreign currency-denominated fixed-income investments
supporting its U.S. insurance operations into U.S. dollars, using foreign
exchange currency swaps, in order to mitigate the risk that the fair value of
these investments fluctuates as a result of changes in foreign exchange rates.
14
Foreign currency exchange risk is actively managed within specified limits at
the enterprise (Prudential Insurance) level using Value-at-Risk ("VaR")
analysis. This statistical technique estimates, at a specified confidence level,
the potential pretax loss in portfolio market value that could occur over an
assumed time horizon due to adverse market movements. This calculation utilizes
a variance/covariance approach. As of December 31, 2003 and December 31, 2002
foreign currency exposure was hedged.
Limitations of VaR Models
Although VaR models represent a recognized tool for risk management, they have
inherent limitations, including reliance on historical data that may not be
indicative of future market conditions or trading patterns. Accordingly VaR
models should not be viewed as a predictor of future results. The Company may
incur losses that could be materially in excess of the amounts indicated by the
model on a particular trading day or over a period of time. A VaR model does not
estimate the greatest possible loss. The Company uses these models together with
other risk management tools, including stress testing. The results of these
models and analysis thereof are subject to the judgment of the Company's risk
management personnel.
Derivatives
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, various financial indices, or the value of
securities or commodities. Derivative financial instruments can be
exchange-traded or contracted in the over-the-counter market and include swaps,
futures, options and forwards contracts. See Footnote 10 of the Notes to
Consolidated Financial Statements as to the Company's derivative positions at
December 31, 2003 and 2002. Under insurance statutes the Company may only use
derivative securities in activities intended to offset changes in the market
value of assets held, obligations, and anticipated transactions. These statutes
prohibit the use of derivatives for speculation. The Company uses derivative
financial instruments to manage market risk from changes in interest rates or
foreign currency exchange rates, and to alter interest rate or currency
exposures arising from mismatches between assets and liabilities.
Item 8. Financial Statements and Supplementary Data
Information required with respect to this Item 8 regarding Financial Statements
and Supplementary Data is set forth commencing on page F-3 hereof. See Index to
Financial Statements elsewhere in this Annual Report.
Item 9. Changes in and Disagreements with Independent Accountants on Accounting
and Financial Disclosure
None.
Item 9A. 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 December 31, 2003. Based on such
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that, as of December 31, 2003, our disclosure controls and procedures
were effective in timely alerting them to material information relating to us
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 December
31, 2003, that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
15
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
We have adopted a code of conduct, known as Making the Right Choices, which
applies to our chief executive officer, chief financial officer and controller,
as well as to our directors. Making the Right Choices contains a code of ethics,
which is posted on the Prudential website at www.investor.prudential.com. Our
code of ethics, any amendments and any waiver under our code of ethics granted
to any of our directors or executive officers will be available free of charge
on the Prudential website at www.investor.prudential.com.
Item 14. Principal Accounting Fees and Services
The Audit Committee of the Board of Directors of Prudential Financial (the
"Audit Committee") has appointed PricewaterhouseCoopers LLP as the independent
auditors of Prudential Financial and certain of its domestic and international
subsidiaries, including the Company. The Audit Committee has established a
policy requiring its pre-approval of all audit and permissible non-audit
services provided by the independent auditor. The specific information called
for by this item is hereby incorporated by reference to the section entitled
"Item 2 - Ratification of the Appointment of Independent Auditors" in Prudential
Financial's definitive proxy statement for the Annual Meeting of Shareholders to
be held on June 8, 2004, to be filed with the Securities and Exchange Commission
pursuant to Regulation 14A within 120 days after the year ended December 31,
2003.
16
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (2) Financial Statements of the Registrant and its
subsidiary are listed in the accompanying "Index to Consolidated
Financial Statements" on page F-1 hereof and are filed as part of this
Report.
(a) (3) Exhibits
Regulation S-K
--------------
2. Not applicable.
3(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.
3b. Reports on Form 8-K
None
4. Exhibits
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.
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.
9. None.
10. None.
11. Not applicable.
12. Not applicable.
13. Not applicable.
17
16. Not applicable.
18. None.
22. None.
23. Not applicable.
24. Powers of attorney are filed herewith.
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
18
SIGNATURES
- ----------
Pursuant to the requirements of Section 13, or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the city of Newark, and
state of New Jersey on the 19th day of March 2004.
PRUCO LIFE INSURANCE COMPANY
(Registrant)
By: /s/ Andrew J. Mako
-------------------
Andrew J. Mako
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on March 19, 2004.
Name Title
- ---- -----
Vivian L. Banta * Chairman of the Board and Director
- -----------------------------
Vivian L. Banta
James J. Avery, Jr. * Vice Chairman of the Boardand Director
- -----------------------------
James J. Avery, Jr.
/s/ Andrew J. Mako Director and Chief Executive Officer
- -----------------------------
Andrew J. Mako
Ronald Paul Joelson * Director
- -----------------------------
Ronald Paul Joelson
Richard J. Carbone * Director
- -----------------------------
Richard J. Carbone
Helen M. Galt * Director
- -----------------------------
Helen M. Galt
David R. Odenath, Jr. * Director
- -----------------------------
David R. Odenath, Jr.
/s/ William J. Eckert, IV Vice President and
- ----------------------------- Chief Financial Officer
William J. Eckert, IV
(Principal Accounting and Financial Officer)
* By: /s/ Thomas C. Castano
---------------------
Thomas C. Castano
(Attorney-in-Fact)
19
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Financial Statements and
Report of Independent Auditors
December 31, 2003 and 2002
PRUCO LIFE INSURANCE COMPANY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements Page No.
- -------------------- --------
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
Report of Independent Auditors F - 2
Consolidated Financial Statements:
Consolidated Statements of Financial Position - December 31, 2003 and 2002 F - 3
Consolidated Statements of Operations and Comprehensive Income
Years ended December 31, 2003, 2002 and 2001 F - 4
Consolidated Statements of Stockholder's Equity
Years ended December 31, 2003, 2002 and 2001 F - 5
Consolidated Statements of Cash Flows
Years ended December 31, 2003, 2002 and 2001 F - 6
Notes to the Consolidated Financial Statements F - 7
F-1
Report of Independent Auditors
------------------------------
To the Board of Directors and Stockholder of
Pruco Life Insurance Company
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Pruco
Life Insurance Company (a wholly-owned subsidiary of The Prudential Insurance
Company of America) and its subsidiaries at December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As described in Note 2, the Company adopted the fair value recognition
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" as of January 1, 2003.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 10, 2004
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Financial Position
December 31, 2003 and 2002 (in thousands)
- --------------------------------------------------------------------------------
2003 2002
------------ ------------
ASSETS
Fixed maturities available for sale,
at fair value (amortized cost, 2003: $5,682,043, 2002: $4,921,691) $ 5,953,815 $ 5,158,106
Policy loans 848,593 879,506
Short-term investments 160,635 214,342
Other long-term investments 89,478 91,021
------------ ------------
Total investments 7,052,521 6,342,975
Cash and cash equivalents 253,564 436,182
Deferred policy acquisition costs 1,380,710 1,152,997
Accrued investment income 96,790 86,125
Reinsurance recoverable 517,410 400,671
Receivables from Parent and affiliates 53,138 53,599
Other assets 88,736 41,581
Separate account assets 15,772,262 12,696,758
------------ ------------
TOTAL ASSETS $ 25,215,131 $ 21,210,888
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $ 5,582,633 $ 4,855,761
Future policy benefits and other policyholder liabilities 1,068,977 934,546
Cash collateral for loaned securities 431,571 225,518
Securities sold under agreements to repurchase 97,102 400,507
Income taxes payable 335,665 245,252
Other liabilities 111,865 130,411
Separate account liabilities 15,772,262 12,696,758
------------ ------------
Total liabilities 23,400,075 19,488,753
------------ ------------
Contingencies (See Footnote 11)
Stockholder's Equity
Common stock, $10 par value;
1,000,000 shares, authorized;
250,000 shares, issued and outstanding 2,500 2,500
Paid-in-capital 459,654 466,748
Deferred compensation (850) -
Retained earnings 1,246,065 1,161,136
Accumulated other comprehensive income:
Net unrealized investment gains 107,690 91,754
Foreign currency translation adjustments (3) (3)
------------ ------------
Accumulated other comprehensive income 107,687 91,751
------------ ------------
Total stockholder's equity 1,815,056 1,722,135
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 25,215,131 $ 21,210,888
============ ============
See Notes to Consolidated Financial Statements
F-3
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
Years Ended December 31, 2003, 2002 and 2001 (in thousands)
- --------------------------------------------------------------------------------
2003 2002 2001
--------- ---------- ----------
REVENUES
Premiums $ 142,140 $ 128,854 $ 90,868
Policy charges and fee income 570,158 529,887 490,185
Net investment income 344,628 334,486 343,638
Realized investment losses, net (2,770) (68,037) (60,476)
Asset management fees 13,218 11,397 7,897
Other income 15,229 14,205 4,962
--------- ---------- ----------
Total revenues 1,082,603 950,792 877,074
--------- ---------- ----------
BENEFITS AND EXPENSES
Policyholders' benefits 332,114 275,251 256,080
Interest credited to policyholders' account balances 227,992 204,813 195,966
General, administrative and other expenses 403,515 509,733 382,701
--------- ---------- ----------
Total benefits and expenses 963,621 989,797 834,747
--------- ---------- ----------
Income (loss) from operations before income taxes 118,982 (39,005) 42,327
--------- ---------- ----------
Income Taxes:
Current (69,617) (64,656) (98,956)
Deferred 103,666 12,153 73,701
--------- ---------- ----------
Total income tax expense (benefit) 34,049 (52,503) (25,255)
--------- ---------- ----------
NET INCOME 84,933 13,498 67,582
--------- ---------- ----------
Other comprehensive income, net of tax:
Change in net unrealized investment gains 8,379 57,036 29,988
Foreign currency translation adjustments - 149 3,168
--------- ---------- ----------
Other comprehensive income 8,379 57,185 33,156
--------- ---------- ----------
TOTAL COMPREHENSIVE INCOME $ 93,312 $ 70,683 $ 100,738
========= ========== ==========
See Notes to Consolidated Financial Statements
F-4
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Stockholder's Equity
Years Ended December 31, 2003, 2002 and 2001 (in thousands)
Accumulated
other Total
Common Paid-in- Retained Deferred comprehensive stockholder's
stock capital earnings Compensation income (loss) 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 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 taxes - - - - 57,036 57,036
------- --------- ----------- ------- --------- -----------
Balance, December 31, 2002 2,500 466,748 1,161,136 - 91,751 1,722,135
Net income - - 84,933 - - 84,933
Adjustments to policy credits
issued to eligible policyholders - - (4) - - (4)
Purchase of fixed maturities from
an affiliate, net of taxes - (7,557) - - 7,557 -
Stock-based compensation programs - 463 - (850) - (387)
Change in net unrealized investment
gains, net of taxes - - - - 8,379 8,379
------- --------- ----------- ------- --------- -----------
Balance, December 31, 2003 $ 2,500 $ 459,654 $ 1,246,065 $ (850) $ 107,687 $ 1,815,056
======= ========= =========== ======= ========= ===========
See Notes to Consolidated Financial Statements
F-5
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2003, 2002 and 2001 (in thousands)
- --------------------------------------------------------------------------------
2003 2002 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 84,933 $ 13,498 $ 67,582
Adjustments to reconcile net income to net cash
provided by operating activities:
Policy charges and fee income (108,731) (74,117) (54,970)
Interest credited to policyholders' account balances 227,992 204,813 195,966
Realized investment losses, net 2,770 68,037 60,476
Amortization and other non-cash items 51,685 (78,452) (49,594)
Change in:
Future policy benefits and other policyholders'
liabilities 134,431 126,316 105,368
Reinsurance recoverable (116,739) (99,974) (269,129)
Accrued investment income (10,665) (8,692) 4,864
Receivables from Parent and affiliates 461 (28,025) 18,512
Policy loans 30,913 (5,441) (40,645)
Deferred policy acquisition costs (227,713) 6,833 (100,281)
Income taxes payable/receivable 90,413 (20,844) 38,839
Deferred sales inducements (47,100) (20,071) (12,143)
Payable for policy credits to Separate Account
policyholders - - 115,973
Other, net (18,988) 23,912 127,185
------------ ------------ ------------
Cash Flows From Operating Activities 93,662 107,793 208,003
------------ ------------ ------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities available for sale 2,506,887 1,834,129 2,653,798
Payments for the purchase of:
Fixed maturities available for sale (3,303,651) (2,884,673) (2,961,861)
Cash collateral for loaned securities, net 206,053 35,496 4,174
Securities sold under agreement to repurchase, net (303,405) 319,792 (23,383)
Other long-term investments, net (2,873) (10,202) 1,305
Short-term investments, net 53,705 1,256 (12,766)
------------ ------------ ------------
Cash Flows Used In Investing Activities (843,284) (704,202) (338,733)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account deposits 2,196,543 1,789,307 1,456,668
Policyholders' account withdrawals (1,621,978) (1,014,901) (1,313,300)
Cash dividend to Parent - - (26,048)
Cash provided to affiliate - - (65,476)
Paid in capital transaction associated with the purchase
of fixed maturities from an affiliate (7,557) - -
Cash payments made to eligible policyholders (4) (116,000) -
------------ ------------ ------------
Cash Flows From Financing Activities 567,004 658,406 51,844
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (182,618) 61,997 (78,886)
Cash and cash equivalents, beginning of year 436,182 374,185 453,071
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 253,564 $ 436,182 $ 374,185
============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes (received) paid $ (51,570) $ 546 $ (46,021)
------------ ------------ ------------
NON-CASH TRANSACTIONS DURING THE YEAR
Dividend paid with fixed maturities $ - $ - $ 81,952
------------ ------------ ------------
Taiwan branch dividend paid with net assets/liabilities $ - $ - $ 45,816
------------ ------------ ------------
Policy credits issued to eligible policyholders $ - $ - $ 128,025
------------ ------------ ------------
See Notes to Consolidated Financial Statements
F-6
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. BUSINESS
Pruco Life Insurance Company is a stock life insurance company, organized in
1971 under the laws of the state of Arizona. Pruco Life Insurance Company is
licensed to sell interest sensitive individual life insurance, variable life
insurance, term life insurance, variable and fixed annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced GIC ("PACE") in the District of Columbia, Guam and in all states except
New York. Pruco Life Insurance Company also had marketed individual life
insurance through its branch office in Taiwan. The branch office was transferred
to an affiliated Company on January 31, 2001, as described in Footnote 12 to the
Financial Statements.
Pruco Life Insurance Company has three subsidiaries, which include one wholly
owned life insurance subsidiary, Pruco Life Insurance Company of New Jersey
("PLNJ") and two subsidiaries formed in 2003 for the purpose of acquiring
municipal fixed maturities from an affiliated company (refer to related party
footnote12). Pruco Life Insurance Company and its subsidiaries are referred to
as "the Company" and all financial information is shown on a consolidated basis
throughout this document.
PLNJ is a stock life insurance company organized in 1982 under the laws of the
state of New Jersey. It is licensed to sell individual life insurance, variable
life insurance, term life insurance, fixed and variable annuities only in the
states of New Jersey and New York.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America ("Prudential Insurance"), an insurance company founded in 1875 under the
laws of the state of New Jersey. On December 18, 2001 ("the date of
demutualization") Prudential Insurance converted from a mutual life insurance
company to a stock life insurance company and became an indirect wholly owned
subsidiary of Prudential Financial, Inc. ("Prudential Financial"). The
demutualization was completed in accordance with Prudential Insurance's Plan of
Reorganization, which was approved by the Commissioner of the New Jersey
Department of Banking and Insurance in October 2001.
Prudential Insurance intends to make additional capital contributions to the
Company, as needed, to enable it to comply with its reserve requirements and
fund expenses in connection with its business. Generally, Prudential Insurance
is under no obligation to make such contributions and its assets do not back the
benefits payable under the Company's policyholder contracts.
The Company is engaged in a business that is highly competitive because of the
large number of stock and mutual life insurance companies and other entities
engaged in marketing insurance products, and individual and group annuities.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of Pruco Life
Insurance Company and its subsidiaries. The consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP"). The Company has extensive transactions
and relationships with Prudential Insurance and other affiliates, as more fully
described in Footnote 12. Due to these relationships, it is possible that the
terms of these transactions are not the same as those that would result from
transactions among wholly unrelated parties.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, in particular deferred policy acquisition costs ("DAC")
and future policy benefits, and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and
expenses during the period. Actual results could differ from those estimates.
Stock Based Compensation
In 2003, Prudential Financial issued stock-based compensation including stock
options, restricted stock, restricted stock units and performance shares.
Effective January 1, 2003, Prudential Financial changed its accounting for
employee stock options to adopt the fair value recognition provisions of SFAS
No. 123, "Accounting for stock Based Compensation" as amended, prospectively for
all new awards granted to employees on or after January 1, 2003. Accordingly,
results of operations of the Company for the year ended December 31, 2003,
include costs of $1.0 million associated with stock-based compensation issued by
Prudential Financial to certain employees and non-employees of the Company and
the statement of financial position at December 31, 2003, includes a reduction
in equity for deferred compensation. Prior to January 1, 2003, Prudential
Financial accounted for employee stock options using the intrinsic value method
of APB No. 25 "Accounting for Stock Issued to Employees," and related
interpretations. Under this method, Prudential Financial and the Company did not
recognize any stock-based compensation costs as all options granted had an
exercise price equaled to the market value of Prudential Financial's Common
Stock on the date of grant.
F-7
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Investments
Fixed maturities classified as "available for sale" are carried at estimated
fair value. The amortized cost of fixed maturities is written down to estimated
fair value if a decline in value is considered to be other than temporary. See
the discussion below on realized investment gains and losses for a description
of the accounting for impairment adjustments. Unrealized gains and losses on
fixed maturities "available for sale", including the effect on deferred policy
acquisition costs and policyholders' account balances that would result from the
realization of unrealized gains and losses are included in "Accumulated other
comprehensive income (loss)", net of income taxes.
Policy loans are carried at unpaid principal balances.
Short-term investments consist of highly liquid debt instruments with a maturity
of greater than three months and less than twelve months when purchased. These
investments are carried at amortized cost, which because of their short-term
nature approximates fair value.
Other long-term investments consist of the Company's investments in joint
ventures and partnerships in which the Company does not exercise control,
derivatives held for purposes other than trading, investments in the Company's
own separate accounts, commercial loans on real estate, and equity securities
available for sale. Joint ventures and partnership interests are generally
accounted for using the equity method of accounting, reduced for other than
temporary declines in value. The Company's net income from investments in joint
ventures and partnerships is generally included in "Net investment income."
Separate accounts are carried at estimated fair value. Commercial loans on real
estate are stated primarily at unpaid principal balances. Equity securities
available for sale, comprised of common and non-redeemable preferred stock, are
carried at estimated fair value. The cost of equity securities is written down
to estimated fair value when a decline in value is considered to be other than
temporary.
Realized investment losses, net are computed using the specific identification
method. Costs of fixed maturities and equity securities are adjusted for
impairments, which are declines in value that are considered to be other than
temporary. Impairment adjustments are included in "Realized investment losses,
net." In evaluating whether a decline in value is other than temporary, the
Company considers several factors including, but not limited to the following:
(1) whether the decline is substantial; (2) the duration (generally greater than
six months); (3) the reasons for the decline in value (credit event, interest
related or market fluctuation); (4) the Company's ability and intent to hold the
investments for a period of time to allow for a recovery of value; and (5) the
financial condition of and near-term prospects of the issuer.
Cash and cash equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, money
market instruments, and other debt issues with maturities of three months or
less when purchased.
Deferred sales inducement costs
The company provides sales inducements to contract holders, which primarily
include an up-front bonus added to the contract holder's initial deposit and an
enhanced crediting rate over the first year of the contract, for certain annuity
contracts. These costs are deferred and recognized on the statement of financial
position in other assets. They are amortized using the same methodology and
assumptions used to amortized deferred policy acquisition costs. The
amortization expense is included as a component of interest credited. As of
December 31, 2003 and 2002, deferred sales inducement costs included in other
assets were $82.1 million and $35.0 million, respectively.
Deferred policy acquisition costs
The Company is charged distribution expenses from Prudential's agency network
for both its domestic life and annuity products through a transfer pricing
agreement, which is intended to reflect a market based pricing arrangement.
These costs include commissions and variable field office expenses. The Company
is also allocated costs of policy issuance and underwriting from Prudential's
general and administrative expense allocation system. The Company also is
charged commissions from third parties, which are primarily capitalized.
The costs that vary with and that are related primarily to the production of new
insurance and annuity business are deferred to the extent such costs are deemed
recoverable from future profits. For annuity products, the entire
transfer-pricing fee is deemed to be related to the production of new annuity
business and is capitalized. For life products, there is a look-through into the
expenses incurred by the Prudential agency network and expenses that are
considered to be related to the production of new insurance business are
deferred. The cost of policy issuance and underwriting are also considered to be
related primarily to the production of new insurance and annuity business and
are fully capitalized.
F-8
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Deferred policy acquisition costs ("DAC") are subject to recoverability testing
at the end of each accounting period. DAC, for applicable products, are adjusted
for the impact of unrealized gains or losses on investments as if these gains or
losses had been realized, with corresponding credits or charges included in
"Accumulated other comprehensive income (loss)."
Policy acquisition costs related to interest-sensitive and variable life
products and certain investment-type products are deferred and amortized over
the expected life of the contracts (periods ranging from 25 to 30 years) in
proportion to estimated gross profits arising principally from investment
results, mortality and expense margins, and surrender charges based on
historical and anticipated future experience, which is updated periodically. The
effect of changes to estimated gross profits on unamortized deferred acquisition
costs is reflected in "General administrative and other expenses" in the period
such estimated gross profits are revised.
DAC related to non-participating term insurance are amortized over the expected
life of the contracts in proportion to premium income. For guaranteed investment
contracts, acquisition costs are expensed as incurred.
The Company and Prudential Insurance have offered programs under which
policyholders, for a selected product or group of products, can exchange an
existing policy or contract issued by the Company or Prudential Insurance for
another form of policy or contract. These transactions are known as internal
replacements. If the terms of the new policies are not substantially similar to
those of the former policy, the unamortized DAC on the surrendered policies is
immediately charged to expense. If the new policies have terms that are
substantially similar to those of the earlier policies, the DAC is retained with
respect to the new policies and amortized over the life of the new policies.
Securities loaned
Securities loaned are treated as collateralized financing arrangements and are
recorded at the amount of cash received as collateral. The Company obtains
collateral in an amount equal to 102% and 105% of the fair value of the domestic
and foreign securities, respectively. The Company monitors the market value of
securities loaned on a daily basis with additional collateral obtained as
necessary. Non-cash collateral received is not reflected in the consolidated
statements of financial position because the debtor typically has the right to
redeem the collateral on short notice. Substantially all of the Company's
securities loaned are with large brokerage firms.
Securities sold under agreements to repurchase
Securities sold under agreements to repurchase are treated as financing
arrangements and are carried at the amounts at which the securities will be
subsequently reacquired, including accrued interest, as specified in the
respective agreements. Assets to be repurchased are the same, or substantially
the same, as the assets transferred and the transferor, through right of
substitution, maintains the right and ability to redeem the collateral on short
notice. The market value of securities to be repurchased is monitored and
additional collateral is obtained, where appropriate, to protect against credit
exposure.
Securities lending and securities repurchase agreements are used to generate net
investment income. These instruments are short-term in nature (usually 30 days
or less) and are collateralized by cash. The carrying amounts of these
instruments approximate fair value because of the relatively short period of
time between the origination of the instruments and their expected realization.
Separate account assets and liabilities
Separate account assets and liabilities are reported at estimated fair value and
represent segregated funds which are invested for certain policyholders and
other customers. The assets consist of common stocks, fixed maturities, real
estate related securities, and short-term investments. The assets of each
account are legally segregated and are generally not subject to claims that
arise out of any other business of the Company. Investment risks associated with
market value changes are borne by the customers, except to the extent of minimum
guarantees made by the Company with respect to certain accounts. The investment
income and gains or losses for separate accounts generally accrue to the
policyholders and are not included in the Consolidated Statements of Operations
and Comprehensive Income. Mortality, policy administration and surrender charges
on the accounts are included in "Policy charges and fee income". Asset
management fees charged to the accounts are included in "Asset management fees".
Separate accounts represent funds for which investment income and investment
gains and losses accrue directly to, and investment risk is borne by, the
policyholders, with the exception of the Pruco Life Modified Guaranteed Annuity
Account. The Pruco Life Modified Guaranteed Annuity Account is a non-unitized
separate account, which funds the Modified Guaranteed Annuity Contract and the
Market Value Adjustment Annuity Contract. Owners of the Pruco Life Modified
Guaranteed Annuity and the Market Value Adjustment Annuity Contracts do not
participate in the investment gain or loss from assets relating to such
accounts. Such gain or loss is borne, in total, by the Company. Upon adoption of
SOP 03-01 (described below) on January 1, 2004, the Company will reclassify this
liability from Separate Account Liabilities to Policyholders' Account Balances.
F-9
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Other assets and other liabilities
Other assets consist primarily of deferred sales inducements costs (described
previously), premiums due and deferred, certain restricted assets, and
receivables resulting from sales of securities that had not yet settled at the
balance sheet date. Other liabilities consist primarily of accrued expenses,
technical overdrafts, and payables resulting from purchases of securities that
had not yet been settled at the balance sheet date.
Contingencies
Amounts related to contingencies are accrued if it is probable that a liability
has been incurred and an amount is reasonably estimable.
Insurance Revenue and Expense Recognition
Premiums from life insurance policies, excluding interest-sensitive life
contracts, are generally recognized when due. Benefits are recorded as an
expense when they are incurred. For traditional life insurance contracts, a
liability for future policy benefits is recorded using the net level premium
method. For individual annuities in payout status, a liability for future policy
benefits is recorded for the present value of expected future payments based on
historical experience.
Certain annuity contracts provide the holder a guarantee that the benefit
received upon death will be no less than a minimum prescribed amount that is
based upon a combination of net deposits to the contract, net deposits to the
contract accumulated at a specified rate or the highest historical account value
on a contract anniversary. To the extent the guaranteed minimum death benefit
exceeds the current account value at the time of death, the Company incurs a
cost that is recorded as "Policyholders' benefits" for the period in which death
occurs.
Amounts received as payment for interest-sensitive life, deferred annuities and
guaranteed investment contracts are reported as deposits to "Policyholders'
account balances". Revenues from these contracts reflected as "Policy charges
and fee income" consist primarily of fees assessed during the period against the
policyholders' account balances for mortality charges, policy administration
charges and surrender charges. Benefits and expenses for these products include
claims in excess of related account balances, expenses of contract
administration, interest credited and amortization of DAC.
Premiums, benefits and expenses are stated net of reinsurance ceded to other
companies. Estimated reinsurance recoverables and the cost of reinsurance are
recognized over the life of the reinsured policies using assumptions consistent
with those used to account for the underlying policies.
Foreign currency translation adjustments
Assets and liabilities of the Taiwan branch are translated to U.S. dollars at
the exchange rate in effect at the end of the period. Revenues, benefits and
other expenses are translated at the average rate prevailing during the period.
Cumulative translation adjustments arising from the use of differing exchange
rates from period to period are charged or credited directly to "Other
comprehensive income (loss)." The cumulative effect of changes in foreign
exchange rates are included in "Accumulated other comprehensive income (loss)".
Asset management fees
Beginning on February 1, 2002, the Company received asset management fee income
from policyholder account balances invested in The Prudential Series Funds
("PSF"), which are a portfolio of mutual fund investments related to the
Company's separate account products (refer to Note 12). In addition, the Company
receives fees from policyholder account balances invested in funds managed by
companies other than Prudential Insurance. Asset management fees are recognized
as income as earned.
Derivative Financial Instruments
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" as amended, on January 1, 2001. Except as noted below, the
adoption of this statement did not have a material impact on the results of
operations of the Company.
Upon its adoption of FAS 133, the Company reclassified "held to maturity"
securities with a fair value of approximately $320.6 million to "available for
sale" as permitted by the new standard. This reclassification resulted in
unrealized gains of $2.5 million, net of tax, which were recorded in
"Accumulated Other Comprehensive income (loss)."
F-10
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, financial indices, or the value of securities or
commodities. Derivative financial instruments used by the Company include swaps
and futures, and may be exchange-traded or contracted in the over-the-counter
market. Derivative positions are carried at estimated fair value, generally by
obtaining quoted market prices or through the use of pricing models. Values can
be affected by changes in interest rates, foreign exchange rates, credit
spreads, market volatility and liquidity. Values can also be affected by changes
in estimates and assumptions used in pricing models.
Derivatives are used to manage the characteristics of the Company's
asset/liability mix, and to manage the interest rate and currency
characteristics of invested assets. Additionally, derivatives are used to seek
to reduce exposure to interest rates and foreign currency risks associated with
assets held or expected to be purchased or sold, and liabilities incurred or
expected to be incurred.
The Company designates derivatives as either (1) a hedge of the fair value of a
recognized asset or liability or unrecognized firm commitment ("fair value"
hedge), (2) a hedge of a forecasted transaction or the variability of cash flows
to be received or paid related to a recognized asset or liability ("cash flow"
hedge), (3) a foreign currency or cash flow hedge ("foreign currency" hedge),
(4) a hedge of a net investment in a foreign operation, or (5) a derivative
entered into as an economic hedge that does not qualify for hedge accounting. As
of December 31, 2003, none of the Company's derivatives qualify for hedge
accounting treatment.
If a derivative does not qualify for hedge accounting, it is recorded at fair
value in "Other long-term investments" in the Consolidated Statements of
Financial Position. All changes in fair value, including net receipts and
payments are included in "Realized investment losses, net" without considering
changes in the fair value of the economically associated assets or liabilities.
The Company occasionally is a party to a financial instrument that contains a
derivative instrument that is "embedded" in the financial instrument. At
inception, the Company assesses whether the economic characteristics of the
embedded derivative are clearly and closely related to the economic
characteristics of the remaining component of the financial instrument (i.e.,
the host contract) and whether a separate instrument with the same terms as the
embedded instrument would meet the definition of a derivative instrument. When
it is determined that (1) the embedded derivative possesses economic
characteristics that are not clearly and closely related to the economic
characteristics of the host contract, and (2) a separate instrument with the
same terms would qualify as a derivative instrument, the embedded derivative is
separated from the host contract, carried at fair value, and changes in its fair
value are included in "Realized investment losses, net."
Income Taxes
The Company and its subsidiaries are members of the consolidated federal income
tax return of Prudential Financial and file separate company state and local tax
returns. Pursuant to the tax allocation arrangement with Prudential Financial,
total federal income tax expense is determined on a separate company basis.
Members with losses record tax benefits to the extent such losses are recognized
in the consolidated federal tax provision. Deferred income taxes are generally
recognized, based on enacted rates, when assets and liabilities have different
values for financial statement and tax reporting purposes. A valuation allowance
is recorded to reduce a deferred tax asset to that portion that is expected to
be realized.
New Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board ("FASB") revised
Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities",
which was originally issued in January 2003. FIN No. 46 addresses whether
certain types of entities, referred to as variable interest entities ("VIEs"),
should be consolidated in a company's financial statements. A VIE is an entity
that either (1) has equity investors that lack certain essential characteristics
of a controlling financial interest (including the ability to control the
entity, the obligation to absorb the entity's expected losses and the right to
receive the entity's expected residual returns), or (2) lacks sufficient equity
to finance its own activities without financial support provided by other
entities, which in turn would be expected to absorb at least some of the
expected losses of the VIE. An entity should consolidate a VIE if it stands to
absorb a majority of the VIE's expected losses or to receive a majority of the
VIE's expected residual returns. The Company adopted the Interpretation for
relationships with VIEs that began on or after February 1, 2003, and on December
31, 2003 adopted the revised guidance for all relationships with VIEs that are
special purpose entities ("SPEs"). The Company will implement the revised
guidance to relationships with potential VIEs that are not SPEs as of March 31,
2004. The transition to the revised guidance for SPEs as of December 31, 2003
did not have a material effect on the Company's consolidated financial position,
results of operations or cash flows. The Company does not believe the transition
to the revised guidance on March 31, 2004, will have a material effect on the
Company's consolidated financial position or results of operations.
F-11
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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 Statement of Financial Accounting Standards ("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 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 in the 2004 results of operations, which the Company
expects to be a charge of approximately $15 million before taxes or
approximately $10 million, net of taxes. This charge is caused primarily by an
increase in reserves for guaranteed minimum death benefits relating to our
individual variable annuity contracts and the impact of converting certain
individual market value adjusted annuity (MVA) contracts from separate account
accounting treatment to general account accounting treatment.
In April 2003, the FASB issued Statement No. 133 Implementation Issue No. B36,
"Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments
That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially
Related to the Creditworthiness of the Obligor Under Those Instruments."
Implementation Issue No. B36 indicates that a modified coinsurance arrangement
("modco"), in which funds are withheld by the ceding insurer and a return on
those withheld funds is paid based on the ceding company's return on certain of
its investments, generally contains an embedded derivative feature that is not
clearly and closely related to the host contract and should be bifurcated in
accordance with the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." Effective October 1, 2003, the Company
adopted the guidance prospectively for existing contracts and all future
transactions. As permitted by SFAS No. 133, all contracts entered into prior to
January 1, 1999, were grandfathered and are exempt from the provisions of SFAS
No. 133 that relate to embedded derivatives. The application of Implementation
Issue No. B36 did not have a material effect on the consolidated financial
position or results of operations of the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
generally applies to instruments that are mandatorily redeemable, that represent
obligations that will be settled with a variable number of company shares, or
that represent an obligation to purchase a fixed number of company shares. For
instruments within its scope, the statement requires classification as a
liability with initial measurement at fair value. Subsequent measurement depends
upon the certainty of the terms of the settlement (such as amount and timing)
and whether the obligation will be settled by a transfer of assets or by
issuance of a fixed or variable number of equity shares. The Company's adoption
of SFAS No. 150, as of July 1, 2003, did not have an effect on the Company's
consolidated financial position or results of operations.
F-12
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 requires that a liability for
costs associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. Prior to the
adoption of SFAS No. 146, such amounts were recorded upon the Company's
commitment to a restructuring plan. The Company has adopted this statement for
applicable transactions occurring on or after January 1, 2003.
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN No. 45 expands existing accounting guidance and
disclosure requirements for certain guarantees and requires the recognition of a
liability for the fair value of certain types of guarantees issued or modified
after December 31, 2002. The January 1, 2003 adoption of the Interpretation's
guidance did not have a material effect on the Company's financial position.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 requires that an intangible asset acquired either
individually or with a group of other assets shall initially be recognized and
measured based on fair value. An intangible asset with a finite life is
amortized over its useful life to the reporting entity; an intangible asset with
an indefinite useful life, including goodwill, is not amortized. All indefinite
lived intangible assets shall be tested for impairment in accordance with the
statement. The Company adopted SFAS No. 142 as of January 1, 2002.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 eliminated the requirement that
discontinued operations be measured at net realizable value or that entities
include losses that have not yet occurred. SFAS No. 144 eliminated the exception
to consolidation for a subsidiary for which control is likely to be temporary.
The implementation of this provision was not material to the Company's financial
position. SFAS No. 144 requires that long-lived assets that are to be disposed
of by sale be measured at the lower of book value or fair value less cost to
sell. An impairment for assets that are not to be disposed of is recognized only
if the carrying amounts of long-lived assets are not recoverable and exceed
their fair values. Additionally, SFAS No. 144 expands the scope of discontinued
operations to include all components of an entity with operations and cash flows
that (1) can be distinguished from the rest of the entity and (2) will be
eliminated from the ongoing operations of the entity in a disposal transaction.
The Company adopted SFAS No. 144 effective January 1, 2002.
Reclassifications
Certain amounts in the prior years have been reclassified to conform to the
current year presentation.
F-13
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS
Fixed Maturities:
The following tables provide additional information relating to fixed maturities
as of December 31:
2003
---------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair value
----------- -------------- -------------- --------------
(in thousands)
Fixed maturities available for sale
Bonds:
U.S. Treasury securities and obligations of
U.S. government corporations and
agencies $ 215,305 $ 12,204 $ 10 $ 227,499
States, municipalities and political
subdivisions 47,603 961 - 48,564
Foreign government bonds 44,018 5,345 13 49,350
Mortgage-backed securities 93,730 1,929 19 95,640
Public utilities 702,793 41,312 2,985 741,120
All other corporate bonds 4,577,918 220,845 8,021 4,790,742
Redeemable preferred stock 676 224 - 900
----------- -------- ------- ----------
Total fixed maturities available for sale $5,682,043 $282,820 $11,048 $5,953,815
=========== ======== ======= ==========
2002
---------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Estimated
cost gains losses fair value
------------- -------------- -------------- --------------
(in thousands)
Fixed maturities available for sale
Bonds:
U.S. Treasury securities and obligations of
U.S. government corporations and
agencies $ 600,128 $ 11,898 $ 1 $ 612,025
States, municipalities and political
subdivisions 257 8 - 265
Foreign government bonds 45,981 4,707 44 50,644
Mortgage-backed securities 120,425 3,242 14 123,653
Public utilities 508,456 28,955 5,826 531,585
All other corporate bonds 3,643,436 204,542 11,022 3,836,956
Redeemable preferred stock 3,008 275 305 2,978
---------- -------- ------- ----------
Total fixed maturities available for sale $4,921,691 $253,627 $17,212 $5,158,106
========== ======== ======= ==========
F-14
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The amortized cost and estimated fair value of fixed maturities, by contractual
maturities at December 31, 2003 is shown below:
Available for sale
--------------------------------------
Amortized Estimated fair
cost value
--------------- -------------------
(in thousands)
Due in one year or less $ 391,557 $ 396,985
Due after one year through five years 2,966,656 3,104,194
Due after five years through ten years 1,602,296 1,698,945
Due after ten years 627,804 658,051
Mortgage-backed securities 93,730 95,640
--------- -----------
Total $5,682,043 $ 5,953,815
========== ===========
Actual maturities may differ from contractual maturities because issuers have
the right to call or prepay obligations.
Proceeds from the sale of fixed maturities available for sale during 2003, 2002,
and 2001, were $1,956.5 million, $1,607.1 million and $2,380.4 million
respectively. Proceeds from the maturity of fixed maturities available for sale
during 2003, 2002, and 2001, were $550.4 million, $227.0 million, and $273.4
million, respectively. Gross gains of $20.8 million, $20.0 million, and $40.3
million and gross losses of $6.8 million, $48.2 million, and $47.7 million were
realized on those sales during 2003, 2002, and 2001, respectively.
Writedowns for impairments, which were deemed to be other than temporary for
fixed maturities were $12.4 million, $27.8 million, and $53.5 million for the
years, ended December 31, 2003, 2002 and 2001, respectively.
Other Long-Term Investments
The following table provides information relating to other long-term investments
as of December 31:
2003 2002
------- -------
(in thousands)
Joint ventures and limited partnerships $37,321 $ 36,502
Company's investment in Separate
accounts 55,214 45,370
Derivatives for other than trading (3,585) 1,984
Commercials loans on real estate 249 6,966
Equity securities 279 199
-------- --------
Total other long- term investments $ 89,478 $ 91,021
======== ========
The Company's share of net income from the joint ventures was $2.4 million, $1.4
million, and $1.6 million, for the years ended December 31, 2003, 2002, and
2001, respectively, and is reported in "Net investment income." Mortgage
interest on commercial loans on real estate was $0.9 million, $0.8 million, and
$0.9 million for the years ended December 31, 2003, 2002 and 2001, respectively,
and is also reported in "Net investment income."
F-15
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
Investment Income and Investment Gains and Losses
Net investment income arose from the following sources for the years ended
December 31:
2003 2002 2001
---------- ---------- ------------
(in thousands)
Fixed maturities available for sale $ 295,357 $ 275,843 $ 279,477
Policy loans 46,750 49,436 48,149
Short-term investments and cash equivalents 7,357 13,540 24,253
Other 7,821 8,128 6,997
---------- ---------- ------------
Gross investment income 357,285 346,947 358,876
Less: investment expenses (12,657) (12,461) (15,238)
---------- ---------- ------------
Net investment income $ 344,628 $ 334,486 $ 343,638
========== ========== ============
Realized investment losses, net including charges for other than temporary
reductions in value, for the years ended December 31, were from the following
sources:
2003 2002 2001
---------- ---------- ------------
(in thousands)
Fixed maturities available for sale $ 1,567 $ (56,039) $ (60,924)
Derivatives (6,629) (11,746) (1,396)
Other 2,292 (252) 1,844
---------- ---------- ------------
Realized investment losses, net $ (2,770) $ (68,037) $ (60,476)
========== ========== ============
Net Unrealized Investment Gains (Losses)
Net unrealized investment gains (losses) on securities available for sale are
included in the Consolidated Statements of Financial Position as a component of
"Accumulated other comprehensive income (loss)." Changes in these amounts
include reclassification adjustments to exclude from "Other Comprehensive income
(loss)," those items that are included as part of "Net income" for a period that
also had been part of "Other Comprehensive income (loss)" in earlier periods.
The amounts for the years ended December 31, net of tax, are as follows:
F-16
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
Accumulated
other
comprehensive
income (loss)
Deferred Deferred related to net
Unrealized policy Policyholders' income tax unrealized
gains (losses) acquisition account (liability) investment
on investments costs balances benefit gains (losses)
---------------- ---------------- -------------- ------------ --------------
(in thousands)
Balance, January 1, 2001 $ 6,635 $ 910 $ (155) $ (2,660) $ 4,730
Net investment gains on investments
arising during the period 22,007 - - (7,922) 14,085
Reclassification adjustment for losses
included in net income 60,980 - - (21,953) 39,027
Impact of net unrealized investment
gains(losses) on deferred policy - (41,223) - 14,840 (26,383)
acquisition costs
Impact of net unrealized investment gains
(losses) on policyholders' account balances - - 5,092 (1,833) 3,259
--------- ---------- --------- --------- ---------
Balance, December 31, 2001 89,622 (40,313) 4,937 (19,528) 34,718
Net investment gains on investments
arising during the period 90,774 - - (32,679) 58,095
Reclassification adjustment for losses
included in net income 56,117 - - (20,202) 35,915
Impact of net unrealized investment
gains(losses) on deferred policy
acquisition costs - (67,053) - 24,139 (42,914)
Impact of net unrealized investment gains
(losses) on policyholders' account balances - - 9,281 (3,341) 5,940
--------- ---------- --------- --------- ---------
Balance, December 31, 2002 236,513 (107,366) 14,218 (51,611) 91,754
Net investment gains on investments
arising during the period 25,794 - - (9,330) 16,464
Purchase of fixed maturities from an 11,659 - - (4,102) 7,557
affiliate (see Note 12)
Reclassification adjustment for gains
included in net income (2,177) - - 784 (1,393)
Impact of net unrealized investment gains
(losses) on deferred policy acquisition - (13,999) - 5,040 (8,959)
costs
Impact of net unrealized investment gains
(losses) on policyholders' account balances - - 3,543 (1,276) 2,267
--------- ---------- --------- --------- ---------
Balance, December 31, 2003 $ 271,789 $ (121,365) $ 17,761 $ (60,495) $ 107,690
========= ========== ========= ========= =========
F-17
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The table below presents unrealized gains (losses) on investments by asset class
at December 31,
2003 2002 2001
--------- --------- ---------
(in thousands)
Fixed maturities $ 271,772 $ 236,415 $ 89,420
Other long-term investments 17 98 202
--------- --------- ---------
Unrealized gains/losses on investments $ 271,789 $ 236,513 $ 89,622
========= ========= =========
Included in other long-term investments are equity securities.
Duration of Gross Unrealized Loss Positions for Fixed Maturities
The following table shows the fair value and gross unrealized losses aggregated
by investment category and length of time that individual fixed maturity
securities have been in a continuous unrealized loss position, as of December
31, 2003:
Less than twelve Twelve months or
months more Total
----------------------- ---------------------- -----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------------------- ---------------------- -----------------------
(in thousands)
Fixed maturities:
U.S. Treasury securities and obligations
of U.S. government corporations and agencies $ 6,153 $ 10 $ - $ - $ 6,153 $ 10
Foreign government bonds 288 13 - - 288 13
US Corporate securities 668,497 10,622 39,571 383 708,068 11,005
Mortgage-backed securities 15,060 20 - - 15,060 20
-------- -------- ------- ------ -------- --------
Total $689,998 $ 10,665 $39,571 $ 383 $729,569 $ 11,048
======== ======== ======= ====== ======== ========
As of December 31, 2003, gross unrealized losses on fixed maturities totaled
$11.0 million comprising 180 issuers. Of this amount, there was $10.6 million in
the less than twelve months category comprising 161 issuers and $.4 million in
the greater than twelve months category comprising 19 issuers. There were no
individual issuers with gross unrealized losses greater than $1.2 million. The
$11.0 million of gross unrealized losses is comprised of investment grade
securities. The $.4 million of gross unrealized losses of twelve months or more
were concentrated in the finance sector. Based on a review of the above
information in conjunction with other factors as outlined in our policy
surrounding other than temporary impairments (see Note 2), we have concluded
that an adjustment for other than temporary impairments is not warranted at
December 31, 2003.
Included in other long-term investments are equity securities, which have been
in a loss position for less than 12 months with a fair value of $191 thousand
and a gross unrealized loss of $65 thousand.
F-18
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
Securities Pledged, Restricted Assets and Special Deposits
The Company pledges investment securities it owns to unaffiliated parties
through certain transactions including securities lending, securities sold under
agreements to repurchase, and futures contracts. At December 31, 2003 and 2002,
the carrying value of fixed maturities available for sale pledged to third
parties as reported in the Consolidated Statements of Financial Position were
$508.6 million and $613.6 million, respectively.
Fixed maturities of $3.9 million at December 31, 2003 and $2.9 million at
December 31, 2002, respectively, were on deposit with governmental authorities
or trustees as required by certain insurance laws.
4. DEFERRED POLICY ACQUISITION COSTS
The balances of and changes in deferred policy acquisition costs as of and for
the years ended December 31, are as follows:
2003 2002 2001
----------- ----------- -----------
(in thousands)
Balance, beginning of year $1,152,997 $1,159,830 $ 1,132,653
Capitalization of commissions, sales and issue expenses 371,650 328,658 295,823
Amortization (129,938) (268,438) (156,092)
Change in unrealized investment gains (13,999) (67,053) (41,223)
Foreign currency translation - - 1,773
Transfer of Taiwan branch balance to an affiliated company - - (73,104)
----------- ---------- -----------
Balance, end of year $ 1,380,710 $1,152,997 $ 1,159,830
=========== ========== ===========
F-19
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. POLICYHOLDERS' LIABILITIES
Future policy benefits and other policyholder liabilities at December 31, are as
follows:
2003 2002
----------- ---------
(in thousands)
Life insurance - domestic $ 646,953 $ 578,211
Life insurance - Taiwan 376,033 311,300
Individual annuities 33,598 31,830
Group annuities 12,393 13,205
----------- ---------
Total future policy benefits $ 1,068,977 $ 934,546
=========== =========
Life insurance liabilities include reserves for death benefits and other policy
benefits. Annuity liabilities include reserves for annuities that are in payout
status.
Future policy benefits for domestic and Taiwan traditional life insurance are
based on the net level premium method, calculated using the guaranteed mortality
and nonforfeiture rates which range from 2.50% to 8.75% for domestic insurance
and 6.25% to 7.50% for Taiwan reserves. Less than 1% of the reserves are based
on interest rates in excess of 8%.
Future policy benefits for individual and group annuities are equal to the
aggregate of 1) the present value of expected future payments on the basis of
actuarial assumptions established at issue, and 2) any premium deficiency
reserves. Assumptions as to mortality are based on the Company's experience when
the basis of the reserve is established. The interest rates used in the
determination of the individual annuities reserves range from 6.00% to 11.00%,
with less than 12% of the reserves based on an interest rate in excess of 8%.
The interest rate used in the determination of group annuities reserves is
14.75%.
Policyholders' account balances at December 31, are as follows:
2003 2002
---------- ----------
(in thousands)
Interest-sensitive life contracts $2,270,703 $2,102,179
Individual annuities 2,244,314 1,593,703
Guaranteed investment contracts 1,067,616 1,159,879
---------- ----------
Total policyholders' account balances $5,582,633 $4,855,761
========== ==========
Policyholders' account balances for interest-sensitive life, individual
annuities, and guaranteed investment contracts represent an accumulation of
account deposits plus credited interest less withdrawals, expenses and mortality
charges. Interest crediting rates range from 4.00% to 6.10% for
interest-sensitive life contracts. Interest crediting rates for individual
annuities range from 1.50% to 12.00%, with less than 1% of policyholders'
account balances with interest crediting rates in excess of 8%. Interest
crediting rates for guaranteed investment contracts range from 3.02% to 8.03%,
with less than 1% of policyholders' account balances with interest crediting
rates in excess of 8%.
6. REINSURANCE
The Company participates in reinsurance with affiliated companies, Prudential
Insurance, Prudential of Taiwan, and Pruco Re Ltd., and other unaffiliated
companies, in order to provide greater diversification of business, provide
additional capacity for future growth and limit the maximum net loss potential
arising from large risks. Life reinsurance is accomplished through various plans
of reinsurance, primarily yearly renewable term and coinsurance. Reinsurance
ceded arrangements do not discharge the Company as the primary insurer. Ceded
balances would represent a liability of the Company in the event the reinsurers
were unable to meet their obligations to the Company under the terms of the
reinsurance agreements. The likelihood of a material reinsurance liability
reassumed by the Company is considered to be remote.
Reinsurance premiums, commissions, expense reimbursements, benefits and reserves
related to reinsured long-duration contracts are accounted for over the life of
the underlying reinsured contracts using assumptions consistent with those used
to account for the underlying contracts. Cost of reinsurance is amortized over
the life of the underlying reinsured contracts also using assumptions consistent
with those used to account for the underlying contracts. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim liabilities
and policy benefits associated with the reinsured policies. The affiliated
reinsurance agreements, including the Company's reinsurance of all its Taiwanese
business as of February 1, 2001, are described further in Note 12.
F-20
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. REINSURANCE (continued)
Reinsurance amounts included in the Consolidated Statements of Operations and
Comprehensive Income for the year ended December 31, are as follows:
2003 2002 2001
-------- -------- --------
(in thousands)
Direct premiums and policy charges and fee income $878,669 $862,723 $686,887
Reinsurance assumed - - 162
Reinsurance ceded (166,371) (203,982) (105,996)
-------- -------- --------
Premiums and policy charges and fee income $712,298 $658,741 $581,053
Policyholders' benefits ceded $ 99,229 $ 70,327 $ 23,733
Reinsurance ceded for interest-sensitive life products is accounted for as a
reduction of policy charges and fee income. Reinsurance ceded for term insurance
products is accounted for as a reduction of premiums.
Reinsurance recoverables, included in the Company's Consolidated Statements of
Financial Position at December 31, were as follows:
2003 2002
--------- ---------
(in thousands)
Domestic life insurance - affiliated $ 66,837 $ 45,029
Domestic life insurance - unaffiliated 62,147 31,137
Other reinsurance - affiliated 12,393 13,205
Taiwan life insurance-affiliated 376,033 311,300
--------- ---------
$ 517,410 $ 400,671
========= =========
The gross and net amounts of life insurance in force at December 31, were as
follows:
2003 2002 2001
------------- ------------- ------------
(in thousands)
Life insurance face amount in force $ 158,488,681 $ 118,381,408 $ 84,317,628
Ceded to other companies (81,095,301) (49,113,635) (25,166,264)
------------- ------------- ------------
Net amount of life insurance in force $ 77,393,380 $ 69,267,773 $ 59,151,364
============= ============= ============
F-21
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. INCOME TAXES
The components of income tax expense (benefit) for the years ended December 31,
are as follows:
2003 2002 2001
--------- --------- ----------
(in thousands)
Current tax (benefit) expense:
U.S. (69,836) $ (65,004) $ (100,946)
State and local 219 309 1,866
Foreign - 39 124
--------- --------- ----------
Total (69,617) (64,656) (98,956)
--------- --------- ----------
Deferred tax expense (benefit):
U.S. 102,685 15,709 76,155
State and local 981 (3,556) (2,454)
--------- --------- ----------
Total 103,666 12,153 73,701
--------- --------- ----------
Total income tax expense (benefit) $ 34,049 $ (52,503) $ (25,255)
========= ========= ==========
The income tax expense for the years ended December 31, differs from the amount
computed by applying the expected federal income tax rate of 35% to income from
operations before income taxes for the following reasons:
2003 2002 2001
--------- --------- ----------
(in thousands)
Expected federal income tax (benefit) expense $ 41,644 $ (13,652) $ 14,814
State and local income taxes 781 (2,111) (382)
Non taxable investment income (12,165) (41,745) (38,693)
Incorporation of Taiwan branch 443 7,545 (1,774)
Other 3,346 (2,540) 780
--------- --------- ----------
Total income tax expense (benefit) $ 34,049 $ (52,503) $ (25,255)
========= ========= ==========
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
2003 2002
--------- ---------
(in thousands)
Deferred tax assets
Insurance reserves $ 14,875 $ 24,976
Tax loss carry forwards 12,731 23,706
Other 6,419 3,871
--------- ---------
Deferred tax assets 34,025 52,553
--------- ---------
Deferred tax liabilities
Deferred acquisition costs 383,712 312,150
Net unrealized gains on securities 96,998 85,145
Investments 24,804 18,299
--------- ---------
Deferred tax liabilities 505,514 415,594
--------- ---------
Net deferred tax liability $ 471,489 $ 363,041
========= =========
F-22
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. INCOME TAXES (continued)
Management believes that based on its historical pattern of taxable income, the
Company and its subsidiaries will produce sufficient income in the future to
realize its deferred tax assets. Adjustments to the valuation allowance will be
made if there is a change in management's assessment of the amount of the
deferred tax asset that is realizable. At December 31, 2003 and 2002,
respectively, the Company had state operating loss carryforwards of $826 million
and $592 million, which expire by 2018. At December 31, 2002 the Company had
federal and state capital loss carryforwards of $40 million.
The Internal Revenue Service (the "Service") has completed all examinations of
the consolidated federal income tax returns through 1996. The Service has begun
its examination of 1997 through 2001. Management believes sufficient provisions
have been made for potential adjustments.
8. STATUTORY NET INCOME AND SURPLUS AND DIVIDEND RESTRICTIONS
The Company is required to prepare statutory financial statements in accordance
with accounting practices prescribed or permitted by the Arizona Department of
Insurance. Statutory accounting practices primarily differ from GAAP by charging
policy acquisition costs to expense as incurred, establishing future policy
benefit liabilities using different actuarial assumptions and valuing
investments, deferred taxes, and certain assets on a different basis.
Statutory net income (loss) for the Pruco Life Insurance Company of Arizona
amounted to $(140.7) million, $(238.8) million, and $71.5 million for the years
ended December 31, 2003, 2002, and 2001, respectively. Statutory surplus of
Pruco Life Insurance Company of Arizona amounted to $517.4 million and $471.0
million at December 31, 2003 and 2002, respectively. The statutory losses in
2003 and 2002 were primarily attributed to the surplus strain from new business,
which results from higher commissions and selling expenses that are not deferred
under statutory accounting, and from increases to reserves.
In March 1998, the National Association of Insurance Commissioners (NAIC)
adopted the Codification of Statutory Accounting Principles guidance
("Codification"), which replaced the current Accounting Practices and Procedures
manual as the NAIC's primary guidance on statutory accounting as of January 1,
2001. Codification provided guidance for areas where statutory accounting had
been silent and changed current statutory accounting in certain areas. The
Company adopted the Codification guidance effective January 1, 2001. As a result
of these changes, the Company reported an increase to statutory surplus of $81
million, primarily relating to the recognition of deferred tax assets.
As mentioned above, the Company prepares its statutory financial statements in
accordance with accounting practices prescribed or permitted by the Arizona
Department of Insurance. Prescribed statutory accounting practices include
publications of the NAIC, state laws, regulations, and general administrative
rules. Permitted statutory accounting practices encompass all accounting
practices not so prescribed.
In 2001, the Company received approval from the Arizona Department of Insurance
to treat, as assumption reinsurance, the transfer of Pruco Life of Taiwan (Pruco
Taiwan) business to a sister company Prudential Life Insurance Company of
Taiwan, Inc. (Prudential of Taiwan). According to Statement of Statutory
Accounting Principles #61, Life, Deposit-Type and Accident and Health
Reinsurance of the NAIC Accounting Practices and Procedures Manual, this type of
transfer of business would be treated as indemnity reinsurance rather than
assumption reinsurance because there is no concept of novation under Taiwanese
law. However, other than not meeting the strict requirements for a novation, the
transfer of Pruco Taiwan's business has the other elements of assumption
reinsurance. The effect of this permitted practice was an increase to statutory
capital of $113.7 million as of December 31, 2003, 2002, and 2001. The GAAP
accounting treatment for this transaction is discussed in Note 12.
The Company is subject to Arizona law, which limits the amount of dividends that
insurance companies can pay to stockholders. The maximum dividend, which may be
paid in any twelve-month period without notification or approval, is limited to
the lesser of 10% of statutory surplus as of December 31 of the preceding year
or the net gain from operations of the preceding calendar year. Cash dividends
may only be paid out of surplus derived from realized net profits. Based on
these limitations, the Company would not be permitted a dividend distribution
without prior approval in 2004.
During 2001, the Company received approval from the Arizona Department of
Insurance to pay an extraordinary dividend to Prudential Insurance of $108
million.
F-23
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values presented below have been determined using available
market information and by applying valuation methodologies. Considerable
judgment is applied in interpreting data to develop the estimates of fair value.
Estimated fair values may not be realized in a current market exchange. The use
of different market assumptions and/or estimation methodologies could have a
material effect on the estimated fair values. The following methods and
assumptions were used in calculating the estimated fair values (for all other
financial instruments presented in the table, the carrying value approximates
estimated fair value).
Fixed maturities
Estimated fair values for fixed maturities, other than private placement
securities, are based on quoted market prices or estimates from independent
pricing services. Generally, fair values for private placement securities are
estimated using a discounted cash flow model which considers the current market
spreads between the U.S. Treasury yield curve and corporate bond yield curve,
adjusted for the type of issue, its current credit quality and its remaining
average life. The estimated fair value of certain non-performing private
placement securities is based on amounts estimated by management.
Policy loans
The estimated fair value of policy loans is calculated using a discounted cash
flow model based upon current U.S. Treasury rates and historical loan repayment
patterns.
Investment contracts
For guaranteed investment contracts and other similar contracts without life
contingencies, estimated fair values are derived using discounted projected cash
flows, based on interest rates being offered for similar contracts with
maturities consistent with those remaining for the contracts being valued. For
individual deferred annuities and other deposit liabilities, fair value
approximates carrying value.
Derivative financial instruments
Refer to Note 10 for the disclosure of fair values on these instruments.
The following table discloses the carrying amounts and estimated fair values of
the Company's financial instruments at December 31:
2003 2002
---------------------------------- -------------------------------
Carrying Estimated Carrying Estimated
value fair value value fair value
--------------- ----------------- --------------- ---------------
(in thousands)
Financial assets:
Fixed maturities available for sale $5,953,815 $5,953,815 $ 5,158,106 $ 5,158,106
Policy loans 848,593 967,547 879,506 1,031,169
Short-term investments 160,635 160,635 214,342 214,342
Cash and cash equivalents 253,564 253,564 436,182 436,182
Separate account assets 15,772,262 15,772,262 12,696,758 12,696,758
Financial liabilities:
Investment contracts 3,438,721 3,505,697 2,830,511 2,906,692
Cash collateral for loaned securities 431,571 431,571 225,518 225,518
Securities sold under repurchase
agreements 97,102 97,102 400,507 400,507
Separate account liabilities 15,772,262 15,772,262 12,696,758 12,696,758
F-24
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
Types of Derivative Instruments
Interest Rate Swaps
Interest rate swaps are used by the Company to manage interest rate exposures
arising from mismatches between assets and liabilities (including duration
mismatches). Under interest rate swaps, the Company agrees with other parties to
exchange, at specified intervals, the difference between fixed rate and floating
rate interest amounts calculated by reference to an agreed notional principal
amount. Generally, no cash is exchanged at the outset of the contract and no
principal payments are made by either party. Cash is paid or received based on
the terms of the swap. These transactions are entered into pursuant to master
agreements that provide for a single net payment to be made by one counterparty
at each due date.
Futures
Exchange-traded treasury futures are used by the Company to reduce market risks
from changes in interest rates and, to alter mismatches between the duration of
assets in a portfolio and the duration of liabilities supported by those assets.
As an example, the Company agrees to purchase or sell a specified number of
contracts, the value of which are determined by the value of designated classes
of securities, and to post variation margin on a daily basis in an amount equal
to the difference in the daily market values of those contracts. The Company
enters into exchange-traded futures with regulated futures commissions merchants
who are members of a trading exchange.
Treasury futures are used to hedge duration mismatches between assets and
liabilities. Treasury futures move substantially in value as interest rates
change and can be used to either modify or hedge existing interest rate risk.
This strategy protects against the risk that cash flow requirements may
necessitate liquidation of investments at unfavorable prices resulting from
increases in interest rates. This strategy can be a more cost effective way of
temporarily reducing the Company's exposure to a market decline than selling
fixed income securities and purchasing a similar portfolio when such a decline
is believed to be over.
Currency Swaps
Under currency swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between one currency and another at a
forward exchange rate and calculated by reference to an agreed principal amount.
Generally, the principal amount of each currency is exchanged at the beginning
and termination of the currency swap by each party. These transactions are
entered into pursuant to master agreements that provide for a single net payment
to be made by one counterparty for payments made in the same currency at each
due date.
The table below summarizes the Company's outstanding positions by derivative
instrument types as of December 31, 2003 and 2002. All of the derivatives are
carried on the Consolidated Statements of Financial Position at estimated fair
value.
Derivatives
2003 2002
---------------------------- ------------------------
Estimated Estimated
Notional fair value Notional fair value
---------------------------- ------------------------
(in thousands)
Non-Hedge Accounting
Swap instruments:
Interest rate $13,750 $258 $14,405 $ 414
Currency 16,818 (3,851) 21,244 1,571
Future contracts:
US Treasury futures 5,600 (3) 12,400 (407)
F-25
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (continued)
Credit Risk
The Company is exposed to credit-related losses in the event of nonperformance
by counterparties to derivative financial instruments. Generally, the current
credit exposure of the Company's derivative contracts is limited to the fair
value at the reporting date. The credit exposure of the Company's swaps
transactions is represented by the fair value (market value) of contracts with a
positive fair value (market value) at the reporting date. Because
exchange-traded futures are effected through regulated exchanges, and positions
are marked to market on a daily basis, the Company has little exposure to
credit-related losses in the event of nonperformance by counterparties to such
financial instruments. The credit exposure of exchange-traded instruments is
represented by the negative change, if any, in the fair value (market value) of
contracts from the fair value (market value) at the reporting date.
The Company manages credit risk by entering into transactions with creditworthy
counterparties and obtaining collateral where appropriate and customary. In
addition, the Company enters into over-the-counter swaps pursuant to master
agreements that provide for a single net payment to be made by one counterparty
to another at each due date and upon termination. Likewise, the Company effects
exchange-traded futures and options through regulated exchanges and these
positions are marked to market on a daily basis.
11. CONTINGENCIES AND LITIGATION
Contingencies
On an ongoing basis, our internal supervisory and control functions review the
quality of our sales, marketing and other customer interface procedures and
practices and may recommend modifications or enhancements. In certain cases, if
appropriate, we may offer customers remediation and may incur charges, including
the cost of such remediation, administrative costs and regulatory fines.
Prudential Insurance and its affiliates have received formal requests for
information relating to their variable annuity business from regulators and
governmental authorities. The regulators and authorities include, among others,
the Securities and Exchange Commission, the NASD and the State of New York
Attorney General's Office. Prudential Insurance and its affiliates are
cooperating with all such inquiries and are conducting their own internal
review.
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
their businesses, including class actions. Pending legal and regulatory actions
include proceedings relating to aspects of the businesses and operations that
are specific to the Company and 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.
F-26
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. RELATED PARTY TRANSACTIONS
The Company has extensive transactions and relationships with Prudential
Insurance and other affiliates. It is possible that the terms of these
transactions are not the same as those that would result from transactions among
wholly unrelated parties.
Expense Charges and Allocations
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 also includes
allocations of stock compensation expenses related to a stock option program and
a deferred compensation program issued by Prudential Financial.
The Company is charged distribution expenses from Prudential's agency network
for both its domestic life and annuity products through a transfer pricing
agreement, which is intended to reflect a market based pricing arrangement.
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 for
the COLI policies was $1,018.3 million and $835.6 million at December 31, 2003
and December 31, 2002, respectively. Fees related to the COLI policies were
$12.2 million, $21.0 million and $7.0 million for the years ending December 31,
2003, 2002, and 2001.
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 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 was deferred and will be amortized over the life of the underlying
insurance policies; $.9 million was amortized in 2003 and is recorded in other
income. Reinsurance recoverables related to this transaction are $28.6 million,
which includes the unamortized portion of the initial cost of $6.6 million.
Premiums and benefits ceded in 2003 were $30.9 million and $5.7 million,
respectively.
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.
Affiliated premiums ceded from domestic life reinsurance agreements, excluding
Pruco Re for the periods ended December 31, 2003, 2002, and 2001 were $12.4
million, $11.1 million, and $9.9 million respectively. Affiliated benefits
ceded, excluding Pruco Re, for the periods ended December 31, 2003, 2002, and
2001 from domestic life reinsurance agreements are $38.0 million, $32.5 million,
and $0.
Group annuities affiliated benefits ceded were $2.6 million in 2003, $2.9
million in 2002, and $3.0 million in 2001.
F-27
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. RELATED PARTY TRANSACTIONS (Continued)
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 Financial.
Affiliated premiums ceded for the periods ended December 31, 2003, 2002 and 2001
from the Taiwan coinsurance agreement were $83.7 million, $79.6 million and
$82.5 million, respectively. Affiliated benefits ceded for the periods ended
December 31, 2003, 2002 and 2001; from the Taiwan coinsurance agreement were
$13.5 million, $14.2 million and $12.9 million, respectively.
Included in the total reinsurance recoverable balances for both domestic
(including Pruco Re) and Taiwan agreements were affiliated reinsurance
recoverables of $455.3 million and $369.5 million at December 31, 2003 and
December 31, 2002, respectively. Of these affiliated amounts, the reinsurance
recoverable related to the Taiwan coinsurance agreement was $376.0 million and
$311.3 million at December 31, 2003 and December 31, 2002, respectively.
Purchase of fixed maturities from an affiliate
During 2003, Pruco Life Insurance Company invested $111.7 million in the
preferred stock of two Delaware corporations (the "DE Subs"), which were created
to acquire municipal fixed maturity investments from an affiliate of the
Company. The DE Subs are included in the Company's consolidated financial
statements. Prudential Financial, Inc., the Company's ultimate parent company,
owns a nominal common stock investment in each of the DE Subs.
The DE Subs purchased municipal fixed maturity investments for $111.7 million,
the acquisition-date fair value, but reflected the investments at historic
amortized cost of the affiliate. The difference between the historic amortized
cost and the fair value, net of taxes was reflected as a reduction to
paid-in-capital. The fixed maturity investments are categorized in the Company's
consolidated balance sheet as available-for-sale debt securities, and are
therefore carried at fair value, with the difference between amortized cost and
fair value reflected in accumulated other comprehensive income.
In addition, Pruco Life Insurance Company also purchased corporate fixed
maturities with a fair value of $52.3 million from the same affiliate. These
investments were reflected in the same manner as is described above, with the
difference between the historic amortized cost and the fair value, net of taxes
reflected as a reduction of paid-in-capital with an offsetting increase to
accumulated other comprehensive income. The difference between the historic
amortized cost and the fair value, net of taxes for both the municipal
securities and the corporate securities was $7.6 million.
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 December 31, 2003 and 2002, there was $529
million and $626 million, respectively, of asset-based financing. There was no
debt outstanding to Prudential Funding, LLC as of December 31, 2003 or December
31, 2002.
F-28
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The unaudited quarterly results of operations for the years ended December 31,
2003 and 2002 are summarized in the table below:
Three months ended
---------------------------------------------------------------
March 31 June 30 September 30 December 31
---------------------------------------------------------------
2003 (in thousands)
Total revenues $ 257,500 $275,850 $ 275,201 $ 274,052
Total benefits and expenses 234,344 247,572 246,203 235,502
Income (loss) from operations before income
taxes 23,156 28,278 28,998 38,550
Net income (loss) 18,712 21,805 19,171 25,245
---------------------------------------------------------------
---------------------------------------------------------------
2002 (in thousands)
Total revenues $ 224,036 $ 220,233 $ 231,399 $ 275,124
Total benefits and expenses 199,355 245,823 295,123 249,496
Income (loss) from operations before income taxes 24,681 (25,590) (63,724) 25,628
Net income (loss) 19,471 (17,264) (28,554) 39,845
F-29