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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 33-37587
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Pruco Life Insurance Company
(Exact Name of Registrant as Specified in its Charter)
Arizona 22-1944557
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
213 Washington Street
Newark, New Jersey 07102
(973) 802-6000
(Address and Telephone Number of Registrant's Principal Executive Offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES
REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|
State the aggregate market value of the voting stock held by
non-affiliates of the registrant: N/A
As of February 28, 2005, 250,000 shares of the registrant's common stock
(par value $10) were outstanding.
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 reduced disclosure.
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TABLE OF CONTENTS
Page
Number
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PART I Item 1. Business............................................................................... 2
Item 2. Properties............................................................................. 5
Item 3. Legal Proceedings...................................................................... 5
PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities......................................................... 6
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 6
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................. 12
Item 8. Financial Statements and Supplementary Data............................................ 14
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure... 14
Item 9A. Controls and Procedures................................................................ 14
Item 9B. Other Information...................................................................... 15
Item 10. Directors and Executive Officers of the Registrant..................................... 15
PART III Item 14. Principal Accounting Fees and Services ................................................ 16
PART IV Item 15. Exhibits and Financial Statement Schedules............................................. 16
SIGNATURES................................................................................................. 18
Forward-Looking Statements
Some of the statements included in this Annual Report on Form 10-K, including
but not limited to those in Management's Discussion and Analysis of Financial
Condition and Results of Operations, may 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," "should," "will," "shall" 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 and its subsidiaries. There can be no assurance
that future developments affecting Pruco Life Insurance Company and its
subsidiaries 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, among others: (1) general
economic, market and political conditions, including the performance of
financial markets and interest rate fluctuations; (2) domestic or international
military or terrorist activities or conflicts; (3) volatility in the securities
markets; (4) fluctuations in foreign currency exchange rates and foreign
securities markets; (5) regulatory or legislative changes, including changes in
tax law; (6) changes in statutory or U.S. GAAP accounting principles, practices
or policies; (7) differences between actual experience regarding mortality,
morbidity, persistency, surrender experience, interest rates, or market returns
and the assumptions we use in pricing our products, establishing liabilities and
reserves or for other purposes; (8) re-estimates of our reserves for future
policy benefits and claims; (9) changes in our assumptions related to deferred
policy acquisition costs; (10) events resulting in catastrophic loss of life;
(11) investment losses and defaults; (12) changes in our claims-paying ratings;
(13) competition in our product lines and for personnel; (14) economic,
political, currency and other risks relating to our international operations;
(15) adverse determinations in litigation or regulatory matters and our exposure
to contingent liabilities; and (16) the effects of acquisitions, divestitures
and restructurings, including possible difficulties in integrating and realizing
the projected results of acquisitions. Pruco Life Insurance Company does not
intend, and is under no obligation, to update any particular forward-looking
statement included in this document.
PART 1
Item 1. Business
Overview
Pruco Life Insurance Company is a 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, or GIC, called Prudential Credit Enhanced GIC, or
PACE, in the District of Columbia, Guam and 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.
The Company has three subsidiaries, including one wholly owned life insurance
subsidiary, Pruco Life Insurance Company of New Jersey, or PLNJ, and two
subsidiaries formed in 2003 for the purpose of acquiring municipal fixed
maturities (see Note 13). Pruco Life Insurance Company and its subsidiaries are
together 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
U.S. states of New Jersey and New York.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America or, "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 life insurance company and became an indirect wholly owned
subsidiary of Prudential Financial, Inc. or, "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 policyholders' 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
The Company offers 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
The Company offers 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
The Company offers universal life insurance products that feature a market rate
fixed interest investment account and flexible premiums. In June 2003, we
updated our universal life insurance products and began to offer survivorship
universal life, which covers two individuals on a single policy and provides for
payment of a death benefit upon the death of the other insured individual.
Variable and Fixed Annuities
The Company offers 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 we determine, subject to certain
minimums. Additionally, our variable annuities products offer certain minimum
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death benefit and living benefit guarantee options. We also offer fixed annuity
products that provide a guarantee of principal and a guaranteed interest rate
for a specified period of time.
Guaranteed Investment Contracts ("GICs")
The Company offers 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 of Prudential Insurance, our parent company, distribute variable, term,
and universal life insurance, 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.
Prudential Insurance Agents sell life insurance products primarily to customers
in the U.S. mass and mass affluent markets, as well as small business owners.
The majority of Prudential Insurance Agents are multi-line agents. Other than
certain training allowances or salary paid at the beginning of their employment,
we pay Prudential Insurance Agents on a commission basis for the products they
sell. In addition to commissions, Prudential Insurance Agents receive the
employee benefits that we provide to other Prudential Insurance employees
generally, including medical and disability insurance, an employee savings
program and qualified retirement plans.
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 focus on serving the intermediaries who
provide insurance solutions in support of estate and wealth transfer planning
for affluent and mass affluent individuals. The life insurance products offered
are generally the same as those available through Prudential 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 requested. Our universal life insurance contracts
and the fixed component of our variable life insurance contracts feature
crediting rates, which are periodically reset. 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 asset 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 value of the annuity separate accounts or the amount of guaranteed value.
We price our fixed annuities as well as the fixed-rate options of our variable
annuities based on assumptions as to investment returns, expenses and
persistency. Competition also influences our pricing. We seek to maintain a
spread between the return on our general account invested assets and the
interest we credit on our fixed annuities. To encourage persistency, most of our
variable and fixed 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.
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Reserves
We establish reserve and policyholders' fund liabilities to recognize our future
benefit obligations for our in force life and annuity policies, including the
minimum death benefit and living benefit guarantee features of some of these
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
policyholders' fund liabilities for GICs that represent cumulative
contractholder account balances.
Effective January 1, 2004, we adopted SOP 03-1, "Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts," 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 Note 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 with both affiliated and unaffiliated
companies. As of the end of 2004, all reinsurance arrangements were with
affiliated companies and the maximum amount of individual life insurance we may
retain on any life is $100,000. See Note 13 to the consolidated financial
statements for more information related to these reinsurance arrangements.
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 or,
"GAAP." 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. The Company believes that its statutory capital is adequate for its
currently anticipated levels of risk as measured by regulatory guidelines.
The NAIC has developed a set of financial relationships or tests known as the
Insurance Regulatory Information System or, "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 or, the "Annual Statement," is filed with the Insurance
Departments each year covering the Company's operations for the preceding year
and its financial position as of the end of that year. Regulation by the
Insurance Departments includes periodic examinations to verify the accuracy of
contract liabilities and reserves. The Company's books and accounts are subject
to review by the Insurance Departments at all times. A full examination of the
Company's operations is conducted periodically by the Insurance Departments and
under the auspices of the NAIC.
The Company is subject to regulation under the insurance laws of all
jurisdictions in which it operates. The laws of the various jurisdictions
establish supervisory agencies with broad administrative powers with respect to
various matters, including licensing to transact business, overseeing trade
practices, licensing agents, approving contract forms, establishing reserve
requirements, fixing maximum interest rates on life insurance contract loans and
minimum rates for accumulation of surrender values, prescribing the form and
content of required financial statements and regulating the type and amounts of
investments permitted. The Company is required to file the Annual Statement with
supervisory agencies in each of the jurisdictions in which it does business, and
its operations and accounts are subject to examination by these agencies at
regular intervals.
Our variable life insurance products, as well as our variable annuity products,
generally are "securities" within the meaning of federal securities laws,
registered under the federal securities laws and subject to regulation by the
SEC and the NASD. Federal and some state
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securities regulation affect investment advice, sales and related activities
with respect to these products. In addition, although the federal government
does not comprehensively regulate the business of insurance, federal legislation
and administrative policies in several areas, including taxation, financial
services regulation and pension and welfare benefits regulation, can
significantly affect the insurance industry. Congress also periodically
considers and is considering laws affecting privacy of information and genetic
testing that could significantly and adversely affect the insurance industry.
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, which may include class action lawsuits. 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
may 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 also
may be 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 may seek large and/or indeterminate amounts, including punitive
or exemplary damages.
The Company has received formal requests for information relating to its
variable annuity business and unregistered separate accounts from regulators,
including, among others, the Securities and Exchange Commission and the State of
New York Attorney General's office. The Company is cooperating with all such
inquiries.
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 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.
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PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
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 Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results of
Operations or, "MD&A," addresses the consolidated financial condition of Pruco
Life Insurance Company as of December 31, 2004, compared with December 31, 2003,
and its consolidated results of operations for the years ended December 31, 2004
and 2003.
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 called Prudential Credit
Enhanced, or "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 or, "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 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.
In addition to policy charges and fee income, the Company 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 our ability to manufacture and distribute products and services and
to introduce new products gaining market acceptance on a timely
basis;
o our 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 our mortality and morbidity experience on individual life insurance
and annuity products;
o our persistency experience, which affects our ability to recover the
cost of acquiring new business over the lives of the contracts;
o our cost of administering insurance contracts and providing asset
management products and services;
o our returns on invested assets, net of the amounts we credit to
policyholders' accounts;
o our ability to earn commissions and fees from the distribution and
servicing of annuities, retirement products, and other investment
products at a level that enables us to earn a margin over the
expense of providing such services;
o the amount of our account values and changes in their fair value,
which affect the amount of asset management fees we receive;
o our ability to generate favorable investment results through
asset/liability management and strategic and tactical asset
allocation; and
6
o our ability to maintain our claims paying ratings.
Application of Critical Accounting Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America, or 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 could 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
As prescribed by GAAP, we present our fixed maturity investments classified as
available for sale, at fair value in the statements of financial position. The
fair values for our public fixed maturity securities are based on quoted market
prices or estimates from independent pricing services. However, for our
investments in private securities such as private placement fixed maturity
securities, which comprised 14% of our investments as of December 31, 2004, this
information is not available. For these private fixed maturities, fair value is
determined 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, and an additional spread component for
the reduced liquidity associated with private placements. This additional spread
component is determined based on surveys of various third party financial
institutions.
For our fixed maturity investments classified as available for sale, the impact
of changes in fair value is recorded as an unrealized gain or loss in
"Accumulated other comprehensive income (loss), net," a separate component of
equity. In addition, investments classified as available for sale are subject to
our impairment review to identify when a decline in value is other than
temporary. Factors we consider in determining whether a decline in value is
other than temporary include: the extent (generally if greater than 20%) and
duration (generally greater than six months) of the decline; the reasons for the
decline in value (credit event or interest rate related); our ability and intent
to hold the investment for a period of time that will allow for a recovery of
value; and the financial condition and near-term prospects of the issuer. When
it is determined that a decline in value is other than temporary, the carrying
value of the security is reduced to its fair value, with a corresponding charge
to earnings. This corresponding charge is referred to as an impairment and is
reflected in "Realized investment gains (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.
Future Policy Benefit Reserves
We establish reserves for future policy benefit payments to or on behalf of
policyholders in the same period in which the policy is issued. These reserves
relate primarily to term life and certain annuity products.
The future policy benefit reserves at December 31, 2004 represented 5% of our
total liabilities and relate primarily to term life products and are determined
in accordance with GAAP as the present value of expected future benefits to or
on behalf of policyholders plus the present value of future expenses less the
present value of future net premiums. The expected future benefits are based on
mortality, lapse, maintenance expense and, interest rate assumptions, and also
consider the risk of adverse deviation in our actual results from the results
assumed in establishing our reserves. Our mortality assumptions are generally
based on the Company's historical experience or standard industry tables, as
applicable. Our interest rate assumptions are based on factors such as market
conditions and expected investment returns. Collectively, these assumptions are
"locked-in" upon the issuance of new policies and continue to be used in
subsequent periods to establish the reserves. We review our assumptions to
determine whether the reserves together with the expected future premiums are
sufficient to provide for the expected future benefit payments and expenses. In
particular, we review our mortality assumptions annually and conduct full
actuarial studies every three years. Generally, we do not expect our mortality
trends to change significantly in the short-term and to the extent these trends
may change we expect such changes to be gradual over the long-term. If, based on
our review, there have been significant adverse changes in actual experience
compared to the experience we assumed at the time the policy was issued we may
be required to provide for expected future losses by establishing premium
deficiency reserves. The assumptions used to establish premium deficiency
reserves represent our current best estimate of experience with no provision for
adverse deviation. Once established, premium deficiency reserves are not reduced
for subsequent improvement in experience but may be increased for subsequent
adverse deviations in experience. As of December 31, 2004, we do not have
material premium deficiency reserves related to these products.
Deferred Policy Acquisition Costs
We capitalize costs that vary with and are related primarily to the acquisition
of new and renewal insurance and annuity contracts. These costs include
primarily commissions, costs of policy issuance and underwriting, and variable
field office expenses. We amortize
7
these deferred policy acquisition costs, or DAC, over the expected lives of the
contracts, based on the level and timing of either gross margins, gross profits,
or gross premiums, depending on the type of contract. As of December 31, 2004,
DAC in our life business was $1.031 billion and DAC in our annuity business was
$398 million.
DAC associated with the term life policies of our domestic individual life
insurance business is amortized in proportion to gross premiums. We evaluate the
recoverability of our DAC related to these policies as part of our premium
deficiency testing. If a premium deficiency exists, we reduce DAC by the amount
of the deficiency or to zero through a charge to current period earnings. If the
deficiency is more than the DAC balance, we then increase the reserve for future
policy benefits by the excess by means of a charge to current period earnings.
Generally, we do not expect significant short-term deterioration in experience,
and therefore do not expect significant writedowns of the related DAC.
DAC associated with the variable and universal life policies of our domestic
individual life insurance and international insurance businesses and the
variable and fixed annuity contracts of our individual annuities business is
amortized over the expected life of these policies in proportion to gross
profits. In calculating gross profits, we consider mortality, persistency, and
other elements as well as rates of return on investments associated with these
contracts. We regularly evaluate and adjust the related DAC balance with a
corresponding charge or credit to current period earnings for the effects of our
actual gross profits and changes in our assumptions regarding estimated future
gross profits. Our evaluation of DAC related to variable annuity contracts
considers expected gross profits that would be generated within a
pre-established reasonably possible range, or corridor, of future rate of return
scenarios. Adjustments to DAC are made only when our long-term view of
investment returns considered in our estimates of future gross profits results
in a DAC balance outside of the corridor. However, notwithstanding our corridor
approach, we may determine that a revision of our expected gross profits and a
related adjustment to our DAC is necessary if changes in additional factors,
such as policyholder activity, suggest that our current view of expected gross
profits may no longer represent our best estimate. For variable annuity
contracts, DAC is more sensitive to the effects of changes in our estimates of
gross profits due primarily to the significant portion of gross profits that is
dependent upon the total rate of return on assets held in separate account
investment options, and the shorter average life of the contracts. This rate of
return influences the fees we earn, costs we incur associated with minimum death
benefit and other contractual guarantees specific to our variable annuity
contracts, as well as other sources of profit. This is also true, to a lesser
degree, for our variable life policies; however, the variable life policies
derive a significant portion of their gross profits from margins in the cost of
insurance charge.
In evaluating the DAC for our domestic variable life insurance and annuity
products, future rate of return assumptions are evaluated using a reversion to
mean approach, a common industry practice. Under this approach, we consider
actual returns over a period of time and project returns for the future period
so that the assets grow at the expected rate of return for the entire period. If
the projected future rate of return is greater than our maximum future rate of
return, we use our maximum reasonable future rate of return. For variable
annuities products, our expected rate of return is 8% per annum, which reflects
an expected rate of return of 8.9% per annum for equity type assets. The future
equity rate of return used varies by product, but was under 8.9% per annum for
all of our variable annuity products for our evaluation of deferred policy
acquisition costs as of December 31, 2004.
To demonstrate the sensitivity of our variable annuity DAC balance relative to
our future rate of return, increasing or decreasing our future rate of return by
100 basis points would have required us to consider adjustments, subject to our
application of the corridor approach, to that DAC balance as follows. The
information provided in the table below considers only the effect of changes in
our future rate of return and not changes in any other assumptions such as
persistency, mortality, or expenses included in our evaluation of DAC.
Increase/(Reduction)
in DAC
------------------------
(in thousands)
Increase in projected rate of return by 100 basis points $ 10,516
Decrease in projected rate of return by 100 basis points $(10,856)
See "Results of Operations" for a discussion of the impact of DAC amortization
on our results of the life and annuities products.
Taxes on Income
Tax regulations require items to be included in the tax return at different
times than the items are reflected in the financial statements. As a result, the
effective tax rate reflected in the financial statements is different than the
actual rate applied on the tax return. Some of these differences are permanent
such as expenses that are not deductible in our tax return, and some differences
are temporary,
8
reversing over time, such as valuation of insurance reserves. Timing differences
create deferred tax assets and liabilities. Deferred tax assets generally
represent items that can be used as a tax deduction or credit in future years
for which we have already recorded the tax benefit in our income statement.
Deferred tax liabilities generally represent tax expense recognized in our
financial statements for which payment has been deferred, or expenditures for
which we have already taken a deduction in our tax return but have not yet
recognized in our financial statements. The application of GAAP requires us to
evaluate the recoverability of our deferred tax assets and establish a valuation
allowance if necessary to reduce our deferred tax asset to an amount that is
more likely than not to be realized. Realization of certain deferred tax assets
is dependent upon generating sufficient taxable income in the appropriate
jurisdiction prior to the expiration of the carry-forward periods. Although
realization is not assured, management believes it is more likely than not the
deferred tax assets, net of valuation allowances, will be realized.
Our accounting represents management's best estimate of future events that can
be appropriately reflected in the accounting estimates. Certain changes or
future events, such as changes in tax legislation, geographic mix of earnings
and completion of tax audits could have an impact on our estimates and effective
tax rate.
To the extent our effective tax rate increases or decreases by one percent of
income from operations before income taxes and cumulative effect of accounting
change, consolidated income from operations before cumulative effect of
accounting change would have increased or declined by $1.5 million in 2004.
The amount of income taxes paid by the Company is subject to ongoing audits in
various jurisdictions. We reserve for our best estimate of potential
payments/settlements to be made to the Internal Revenue Service and other taxing
jurisdictions for audits on-going or not yet commenced. We anticipate that the
Internal Revenue Service will complete its examination of 1997 through 2001
during the first half of 2005. Although the results of these audits are not
final, based on currently available information, we believe that the outcome
will not have an adverse effect on our financial position, cash flows or results
of operations.
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.
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 Condition and Results of Operations are
described below.
Effective New Accounting Policies Adopted
See Note 2, "Summary of Significant Accounting Policies," of the Notes to
Consolidated Financial Statements.
Changes in Financial Condition
2004 versus 2003
From December 31, 2003 to December 31, 2004 there was an increase of $2.672
billion in total assets from $25.215 billion to $27.887 billion. The largest
increase was in separate account assets, which increased by $1.554 billion
primarily from market value appreciation of $1.659 billion as a result of
continued strength in the equity markets, positive net sales (sales less
withdrawals) and partially offset by the implementation of Statement of Position
03-1 or, "SOP 03-1," in 2004. SOP 03-1 requires among other things, that certain
individual market value adjusted annuity or, "MVA," contracts be accounted for
under general account accounting treatment. As a result of the adoption,
approximately $400 million of fixed maturities formerly classified as separate
account assets were reclassified as general account fixed maturities.
Fixed maturities increased by $385 million mainly as a result of the
implementation of SOP 03-1 described above, and investing positive cash flows
into fixed maturities. Offsetting overall growth in fixed maturities was a
decline in the level of unrealized gains resulting from an increasing interest
rate environment and in increased cash position as of December 31,2004.
Deferred acquisition costs increased by $48 million from December 31, 2003
driven by $221 million in net capitalization of acquisition expenses, largely
offset by $187 million of amortization. Capitalization in the Life business
reflects a $151 million reduction as a result of a new coinsurance agreement
with Prudential Arizona Reinsurance Captive Company or, "PARCC." DAC also
increased $14 million from the implementation of SOP 03-1 and a change in
unrealized gains. These amounts are shown in the amortization and other non-cash
items line on the Statements of Cash Flows.
9
Reinsurance recoverable is higher by $248 million as a result of larger ceded
reserves held under the PARCC agreement, and is mentioned in more detail in
"Premiums" below. Deferred sales inducements and other assets are higher by $36
million, driven by a $31 million 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 higher by $451 million
resulting from accumulated portfolio cash flows and, in part from asset sales,
in anticipation of redeployment.
During the year, liabilities increased by $2,596 million from $23,400 million to
$25,996 million. Corresponding with the asset change, Separate account
liabilities increased by $1,554 million, as described above. Policyholder
account balances increased by $540 million due primarily to the reclassification
of MVA contracts as described above and by positive net sales of annuity
products with fixed rate options and life general account products. Future
policy benefits increased by $257 million due to increased reserves for the
Taiwan business, the establishment of guaranteed minimum death and income
benefits in the annuity business and increases to life reserves as a result of
sales and renewals of term and the newer universal life products. Income taxes
payable, net, were higher by $98 million as a result of income tax expense and a
tax refund received in 2003 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 $73 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
2004 to 2003 Annual Comparison
Net Income
Consolidated net income of $113 million for 2004 improved $28 million from $85
million earned for 2003. Policy charges and fee income increased $72 million
from last year as a result of increased sales and growth in the separate
accounts from continued strength in the financial markets. DAC amortization in
2004 is $56 million higher than in 2003 due to increased amortization in the
current year from higher gross profits in both the life and annuity businesses
and growth in the term life in force. Further details regarding the components
of revenues and expenses are described in the following paragraphs.
Revenues
Consolidated revenues increased by $53 million, from $1.077 billion in 2003 to
$1.130 billion. Policy charges and fee income, consisting primarily of mortality
and expense, loading and other insurance charges assessed on general and
separate account policyholders' fund balances, increased by $72 million. The
increase was the result of a $37 million increase for individual life products
and a $35 million increase 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 gross variable life
in force business grew in excess of 8% to $77 billion at December 31, 2004 from
$71 billion at December 31, 2003. Annuity fees are mainly asset based fees which
are dependent on the fund balances that are affected by net sales as well as
asset depreciation or appreciation on the underlying investment funds in which
the customer has the option to invest. Average annuity separate account fund
balances are nearly 17% higher than in the prior year as a result of favorable
market performance and positive net sales.
Net premiums decreased by $59 million from $142 million in 2003, due to
increased reinsurance premiums resulting from the coinsurance agreement with
PARCC, an affiliate, to reinsure 90% of the entire term book of business. This
agreement replaced the previous coinsurance with Pruco Reinsurance Ltd., which
reinsured only certain term business. The new agreement covers 90% of all term
policies written by both the Company and its wholly owned subsidiary, Pruco Life
Insurance Company of New Jersey. All term business not previously covered by the
Pruco Re Coinsurance agreement was reinsured with yearly renewable term
reinsurance carrying lower premiums than coinsurance. In addition, extended term
premiums decreased by $13 million due to lower policy lapses from better market
performance.
Net investment income increased by $29 million, up from $345 million in 2003,
driven by increased income in fixed maturities due to an increase in the
portfolio balance from the above-mentioned reclassification resulting from the
adoption of SOP 03-1 in 2004, reinvestment of income, and positive cash flows.
This was partially offset by a lower yields, increased transfers from fixed fund
annuities to separate accounts and lower income from declining fund balances in
the retirement business.
Realized investment gains (losses) improved by $8 million, from realized losses
of $3 million in 2003 to realized gains in 2004 of $5 million, largely as a
result of continued improvement in the credit environment in 2004. The current
year fixed maturity net realized gains resulted primarily from a $10 million
decline in impairments partly offset by a slight decline in realized gains on
sales.
Benefits and Expenses
10
Total policyholders' benefits decreased by $57 million from $332 million in 2003
to $ 275 million in 2004, as a result of lower total benefits for the life and
annuity businesses of $52 million and $5 million, respectively.
The change in reserves for life products decreased $25 million from $84 million
in 2003 to $59 million in 2004, primarily as a result of a decrease in term life
reserves, net of reinsurance. The net change in term reserves is lower due to
the new coinsurance treaty with PARCC, which generated higher reinsurance
reserves than last year. The change in reserves for annuity products increased
$5 million to $7 million in 2004, due to guaranteed minimum death benefit or,
"GMDB," and guaranteed minimum income benefit "GMIB" reserves that were
established as of January 1, 2004. The GMDB feature provides annuity
contractholders 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 contractholders. Prior to adoption of SOP
03-1 a liability for the expected future net costs associated with GMDB
provisions was not established for the annuity business.
Policyholders' benefits for life insurance products decreased by $27 million,
down from $205 million in 2003, driven by lower net death benefits of $18
million and lower surrenders of reduced paid up policies of $9 million. While
net term death benefits rose $15 million from a 50% increase in the term in
force, net variable and universal death benefits were $33 million lower than the
prior year, due to lower mortality and an increase in the ceded in force for
these products in 2004. Annuity death benefits of $32 million in 2004 were lower
by $10 million, primarily due to lower guaranteed minimum death benefits driven
by higher fund values as a result of market appreciation.
Interest credited to policyholders' account balances increased by $23 million,
from $228 million in 2003 to $251 million in 2004, due to growth in
policyholders' account balances, especially for the annuity fixed rate option
products. Overall net interest spread revenue, representing net investment
income less interest credited, increased from last year as general account
assets have increased as described above.
General, administrative, and other expenses increased by $61 million from $398
million in 2003 to $459 million in 2004. The primary reason was increased DAC
amortization of $56 million, up from $130 million in 2003. DAC amortization for
life and annuity products was higher by $39 million and $17 million,
respectively. The increase in amortization in the life business was driven by
growth in the term and universal in force and less favorable fund performance
compared to 2003 partly offset by reduced amortization resulting from ceded DAC
associated with the new coinsurance treaty with PARCC described in note 13
below. The increase in amortization in the annuity business was driven by higher
gross profits from higher spread revenue and lower guaranteed minimum death
benefits in 2004 as compared to 2003, partly offset by a lower deferred bonus
unlocking in 2004.
General, administrative and other expenses, excluding DAC amortization,
increased $5 million from the prior year as a result of more new business and
the growing in force. Partly offsetting the growth in general and administrative
expenses are lower net distribution costs resulting from increased reinsurance
expense allowances, net of capitalization, in the life business as a result of
the PARCC coinsurance agreement mentioned above. These allowances are included
in net distribution expense within operating expenses.
11
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Risk Management, Market Risk and Derivative Instruments
Risk management includes the identification and measurement of various forms of
risk, the establishment of risk thresholds and the creation of processes
intended to maintain risks within these thresholds while optimizing returns on
the underlying assets or liabilities. We consider risk management an integral
part of our core business.
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
and trading activities supporting all of our products and services generate
market risks. The market risks incurred and our 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, we
incur market risk primarily in the form of interest rate risk. We manage this
risk through asset/liability management strategies that seek to match the
interest rate sensitivity of the assets to that of the underlying liabilities.
Our 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 our insurance liabilities than
that of the related assets, to the extent that we can measure such sensitivities
we believe 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, and most separate accounts, our main exposure to
the market is the risk that asset management fees decrease as a result of
declines in assets under management due to changes in prices of securities. We
also run the risk that asset management fees calculated by reference to
performance could be lower. For variable annuity and variable life insurance
products with minimum guaranteed death and other benefits, we also face the risk
that declines in the value of underlying investments as a result of changes in
prices of securities may increase our net exposure to these death and other
benefits under these contracts. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Result of Operations" for
payments made under the guaranteed minimum death benefit provision of certain
individual annuity contracts.
We manage our exposure to equity price risk relating to our general account
primarily by seeking to match the risk profile of equity investments against
risk-adjusted equity market benchmarks. We measure benchmark risk levels in
terms of price volatility in relation to the market in general.
The source of our exposure to market risk is related to "other than trading"
activities conducted primarily in our insurance, annuity and guaranteed products
operations.
Other Than Trading Activities
We hold the majority of our assets for "other than trading" activities in our
insurance, annuities and guaranteed products. We incorporate asset/liability
management techniques and other risk management policies and limits into the
process of investing our assets. We use derivatives for hedging purposes in the
asset/liability management process.
Insurance, Annuities, and Guaranteed Products Asset/Liability Management
We seek 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 any issuer, geographic region, type of security or
industry sector and oversee efforts to manage risk within policy constraints set
by management and approved by the Investment Committee of Prudential Financial
and the Board of Directors.
We use 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 legal entity by matching the relative
sensitivity of asset and liability values to interest rate changes, or
controlling "duration mismatch" of assets and liabilities. We have target
duration mismatch constraints for each entity. As of December 31, 2004 and 2003,
the difference between the duration of assets and the target duration of
liabilities in our duration managed portfolios was within our constraint limits.
We consider risk-based capital implications in our asset/liability management
strategies.
We also perform portfolio stress testing as part of our regulatory cash flow
testing. In this testing, we evaluate the impact of altering our
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 and the potential impact of any guaranteed
minimum interest rates. We evaluate any shortfalls that this cash flow testing
reveals to determine if we need to increase statutory reserves or adjust
portfolio management strategies.
Market Risk Related to Interest Rates
12
Our "other than trading" assets that subject us to interest rate risk include
primarily fixed maturity securities and policy loans. In the aggregate, the
carrying value of these assets represented 68% of our consolidated assets, other
than assets that we held in separate accounts, as of December 31, 2004 and 72%
as of December 31, 2003.
With respect to "other than trading" liabilities, we are exposed to interest
rate risk through policyholders' account balances relating to interest-sensitive
life insurance, annuity and investment-type contracts.
We assess interest rate sensitivity for "other than trading" financial assets,
financial liabilities and derivatives using hypothetical test scenarios that
assume either upward or 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 as
of December 31, 2004 and 2003, 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 our 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 we would expect 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.
December 31, 2004
-------------------------------------------------------------------
Hypothetical
Fair Value
After + 100
Notional Basis Point Hypothetical
Value of Fair Parallel Change in
Derivatives Value Yield Curve Fair Value
Shift
-------------------------------------------------------------------
Financial Assets with Interest Rate Risk: (In millions)
Fixed maturities, available for sale $6,339 $6,132 $ (207)
Policy loans 960 895 (65)
Mortgage Loans 2 2 --
Derivatives:
Futures $(137) -- 6 6
Swaps 68 (5) -- 5
Financial Liabilities with Interest Rate
Risk:
Investment Contracts (3,773) (3,761) 12
------
Total Estimated Potential Loss $ (249)
======
December 31, 2003
-------------------------------------------------------------------
Hypothetical
Fair Value
After + 100
Notional Basis Point Hypothetical
Value of Fair Parallel Change in
Derivatives Value Yield Curve Fair Value
Shift
-------------------------------------------------------------------
Financial Assets with Interest Rate Risk: (In millions)
Fixed maturities, available for sale $5,954 $ 5,759 $(195)
Policy loans 993 936 (57)
Derivatives:
Futures $ 6 -- -- --
Swaps 31 (4) (4) --
Financial Liabilities with Interest Rate
Risk:
Investment Contracts -- (3,506) (3,484) 22
-----
Total Estimated Potential Loss $(230)
=====
13
The tables above do not include approximately $3,750 billion of insurance
reserve and deposit liabilities as of December 31, 2004 and $3.213 billion as of
December 31, 2003. We believe that the interest rate sensitivities of these
insurance liabilities offset, in large measure, the interest rate risk of the
financial assets set forth in these tables.
The estimated changes in fair values of our financial assets shown above relate
primarily to assets invested to support our insurance liabilities, but do not
include assets associated with products for which investment risk is borne
primarily by the contractholders rather than by us.
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 in order to mitigate
the risk that the fair value of these investments fluctuates as a result of
changes in foreign exchange rates.
Foreign currency exchange risk is actively managed within specified limits at
the enterprise (Prudential Insurance) level using Value-at-Risk ("VaR")
analysis. This statistical technique estimates, at a specified confidence level,
the potential pre-tax 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.
Limitations of VaR Models
Although VaR models are 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, you
should not view VaR models as a predictor of future results. We may incur losses
that could be materially in excess of the amounts indicated by the models on a
particular trading day or over a period of time, and there have been instances
when results have fallen outside the values generated by our VaR models. A VaR
model does not estimate the greatest possible loss. The results of these models
and analysis thereof are subject to the judgment of our risk management
personnel.
Derivatives
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, financial indices, or the prices of securities or
commodities. Derivative financial instruments may be exchange-traded or
contracted in the over-the-counter market and include swaps, futures, options
and forward contracts. See Note 10 to the Consolidated Financial Statements for
a description of our derivative activities as of December 31, 2004 and 2003.
Under insurance statutes, our insurance companies may use derivative financial
instruments to hedge actual or anticipated changes in their assets or
liabilities, to replicate cash market instruments or for certain
income-generating activities. These statutes generally prohibit the use of
derivatives for speculative purposes. We use derivative financial instruments
primarily to seek to reduce market risk from changes in interest rates or
foreign currency exchange rates, and to alter interest rate or foreign 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 on Form 10-K.
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
SEC 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 Rule 13a-15(e), as of
December 31, 2004. Based on such evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that, as of December 31, 2004, our
disclosure controls and procedures were effective in timely alerting them to
material information relating to us (and our consolidated subsidiaries) required
to be included in our periodic SEC filings.
14
In determining the Company's state tax expense for the three months ended June
30, 2004, an error was made relating to the treatment of state net operating
loss carryforwards. This error resulted in an understatement of tax expense, and
corresponding overstatement of net income, for the three and six months ended
June 30, 2004 and the nine months ended September 30, 2004. The error was
identified by the Company in the course of a review and inventory by the Company
of its deferred tax balances undertaken during the fourth quarter of 2004.
Restated unaudited interim financial statements of the Company reflecting the
correction of this error were included in Amendment No. 1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and amendment
No. 1 to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004.
The Company believes that the error was attributable to a material weakness in
the Company's internal control over financial reporting. The Company has
implemented enhancements to its internal control over financial reporting to
provide reasonable assurance that errors of this type will not recur. These
steps include the completion of the Company's comprehensive review and inventory
of deferred tax assets and liabilities. The Company is in the process of
implementing definitive standards for detailed documentation supporting deferred
tax balances and expects to complete this implementation in 2005. The Company is
also in the process of implementing an automated application to further enhance
control with respect to the collection of detailed deferred tax information, and
it expects to fully implement such application in 2005.
As described above, management has implemented improvements to the Company's
internal control over financial reporting to address the material weakness
described above. Except for such changes, no change in the Company's internal
control over financial reporting occurred during the quarter ended December
31,2004 that has materially affected or is reasonably likely to materially
affect our internal control over financial reporting, as defined in Exchange Act
Rule 13a-15(f).
Item 9B. Other Information
None.
Item 10. Directors and Executive Officers of the Registrant
We have adopted a code of business conduct and ethics, known as "Making the
Right Choices," which applies to our Chief Executive Officer, Chief Financial
Officer, as well as to our directors and other employees. Making the Right
Choices is posted on our website at www.investor.prudential.com. Our code of
business conduct and ethics, any amendments and any waiver granted to any of our
directors or executive officers are available free of charge on our website at
www.investor.prudential.com.
15
PART III
Item 14. Principal Accounting Fees and Services
The Audit Committee of the Board of Directors of Prudential Financial has
appointed PricewaterhouseCoopers LLP as the independent auditor of Prudential
Financial and certain of its domestic and international subsidiaries, including
the Registrant. 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 7, 2005, to
be filed with the Securities and Exchange Commission pursuant to Regulation 14A
within 120 days after the year ended December 31, 2004.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(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
Registrant on August 15, 1997.
4. Exhibits
4(a) Modified Guaranteed Annuity Contract is incorporated by reference
to the Registrant'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 Registrant'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 Registrant'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.
16
10. None.
11. Not applicable.
12. Not applicable.
13. Not applicable.
16. Not applicable.
18. None.
22. None.
23. Not applicable.
24. Powers of Attorney.
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.
17
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 30th day of March 2005.
PRUCO LIFE INSURANCE COMPANY
(Registrant)
By: /s/ Bernard J. Jacob
------------------------------------
Bernard J. Jacob
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 30, 2005.
Name Title
- ---- -----
James J. Avery, Jr. * Director
- ------------------------------
James J. Avery, Jr.
/s/ Bernard J. Jacob Director and President
- ------------------------------ (Principal Executive Officer)
Bernard J. Jacob
Ronald Paul Joelson * Director
- ------------------------------
Ronald Paul Joelson
Andrew J. Mako* Director
- ------------------------------
Andrew J. Mako
C. Edward Chaplin * Director
- ------------------------------
C. Edward Chaplin
- -----------------
Helen M. Galt * Director
- ------------------------------
Helen M. Galt
David R. Odenath, Jr. * Director
- ------------------------------
David R. Odenath, Jr.
/s/ John Chieffo Chief Financial and Accounting Officer
- ------------------------------ (Principal Accounting and Financial Officer)
John Chieffo
* By: /s/ Thomas C. Castano
------------------------------
Thomas C. Castano
(Attorney-in-Fact)
18
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Financial Statements and
Report of Independent Registered Public Accounting Firm
December 31, 2004 and 2003
29
PRUCO LIFE INSURANCE COMPANY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements Page No.
- -------------------- --------
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm F - 2
Consolidated Financial Statements:
Consolidated Statements of Financial Position - December 31, 2004 and 2003 F - 3
Consolidated Statements of Operations and Comprehensive Income
Years ended December 31, 2004, 2003 and 2002 F - 4
Consolidated Statements of Stockholder's Equity
Years ended December 31, 2004, 2003 and 2002 F - 5
Consolidated Statements of Cash Flows
Years ended December 31, 2004, 2003 and 2002 F - 6
Notes to the Consolidated Financial Statements F - 7
F-1
Report of Independent Registered Public Accounting Firm
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, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004, 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 the standards of the
Public Company Accounting Oversight Board (United States). Those standards
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 American Institute of Certified
Public Accountants Statement of Position 03-1, "Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts" as of January 1, 2004, and the fair value provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" as of January 1, 2003.
PricewaterhouseCoopers LLP
New York, New York
March 25, 2005
F-2
Pruco Life Insurance Company and Subsidiaries
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Financial Position
As of December 31, 2004 and December 31, 2003 (in thousands, except share
amounts)
- --------------------------------------------------------------------------------
2004 2003
----------------------------
ASSETS
Fixed maturities available for sale,
at fair value (amortized cost, 2004 - $6,114,020; 2003 - $5,682,043) $ 6,339,103 $ 5,953,815
Policy loans 856,755 848,593
Short-term investments 122,061 160,635
Other long-term investments 28,258 89,478
----------------------------
Total investments 7,346,177 7,052,521
Cash and cash equivalents 743,533 253,564
Deferred policy acquisition costs 1,429,027 1,380,710
Accrued investment income 101,432 96,790
Reinsurance recoverables 765,045 517,410
Receivables from Parent and affiliates 50,339 53,138
Deferred sales inducements and other assets 124,868 88,736
Separate account assets 17,326,555 15,772,262
----------------------------
TOTAL ASSETS $ 27,886,976 $ 25,215,131
============================
LIABILITIES AND STOCKHOLDER'S EQUITY
LIABILITIES
Policyholders' account balances $ 6,122,924 $ 5,582,633
Future policy benefits and other policyholder liabilities 1,325,836 1,068,977
Cash collateral for loaned securities 410,718 431,571
Securities sold under agreement to repurchase 45,254 97,102
Income taxes payable 433,966 335,665
Other liabilities 330,966 111,865
Separate account liabilities 17,326,555 15,772,262
----------------------------
Total liabilities 25,996,219 23,400,075
----------------------------
CONTINGENCIES (See Note 12)
STOCKHOLDER'S EQUITY
Common stock, ($10 par value;
1,000,000 shares, authorized;
250,000 shares, issued and outstanding) 2,500 2,500
Additional paid-in capital 455,377 459,654
Deferred compensation (1,173) (850)
Accumulated other comprehensive income 74,527 107,687
Retained earnings 1,359,526 1,246,065
----------------------------
Total stockholder's equity 1,890,757 1,815,056
----------------------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 27,886,976 $ 25,215,131
============================
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, 2004, 2003 and 2002 (in thousands)
- --------------------------------------------------------------------------------
2004 2003 2002
----------- ----------- -----------
REVENUES
Premiums $ 83,287 $ 142,140 $ 128,854
Policy charges and fee income 642,021 570,158 529,887
Net investment income 373,552 344,628 334,486
Realized investment gains (losses), net 5,011 (2,770) (68,037)
Asset management fees 15,747 13,218 11,397
Other income 10,514 9,595 9,536
----------- ----------- -----------
Total revenues 1,130,132 1,076,969 946,123
----------- ----------- -----------
BENEFITS AND EXPENSES
Policyholders' benefits 275,378 332,114 275,251
Interest credited to policyholders' account
balances 250,675 227,992 204,813
General, administrative and other expenses 458,590 397,881 505,064
----------- ----------- -----------
Total benefits and expenses 984,643 957,987 985,128
----------- ----------- -----------
Income from operations before income taxes and
cumulative effect of accounting change 145,489 118,982 (39,005)
Income taxes:
Current 59,682 (69,617) (64,656)
Deferred (36,804) 103,666 12,153
----------- ----------- -----------
Total income tax expense (benefit) 22,878 34,049 (52,503)
----------- ----------- -----------
Net Income from Operations Before Cumulative
Effect of Accounting Change 122,611 84,933 13,498
Cumulative effect of accounting change, net of
taxes (9,150) -- --
----------- ----------- -----------
NET INCOME 113,461 84,933 13,498
----------- ----------- -----------
Change in net unrealized investment gains, net (41,944) 8,379 57,036
of taxes
Cumulative effect of accounting change,
net of taxes 4,030 -- --
Foreign currency translation adjustments -- -- 149
----------- ----------- -----------
Other comprehensive income (loss), net of taxes (37,914) 8,379 57,185
----------- ----------- -----------
COMPREHENSIVE INCOME $ 75,547 $ 93,312 $ 70,683
=========== =========== ===========
See Notes to Consolidated Financial Statements
F-4
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Stockholder's Equity
Periods Ended December 30, 2004, 2003 and 2002 (in thousands)
- -------------------------------------------------------------
Accumulated
Other Total
Common Paid-in- Retained Deferred Comprehensive Stockholder's
Stock Capital Earnings Compensation Income (Loss) Equity
----------- ----------- ----------- ------------ ------------- -------------
Balance, January 1, 2002 $ 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
Net income -- -- 113,461 -- -- 113,461
Purchase of fixed maturities from an
affiliate, net of taxes -- (4,754) -- -- 4,754 --
Stock-based compensation programs -- 477 -- (323) -- 154
Cumulative effect of accounting change,
net of taxes -- -- -- -- 4,030 4,030
Change in net unrealized investment
gains, net of taxes -- -- -- -- (41,944) (41,944)
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 2004 $ 2,500 $ 455,377 $ 1,359,526 $ (1,173) $ 74,527 $ 1,890,757
=========== =========== =========== =========== =========== ===========
See Notes to Consolidated Financial Statements
F-5
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended December 31, 2004, 2003 and 2002 (in thousands)
- --------------------------------------------------------------------------------
2004 2003 2002
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 113,461 $ 84,933 $ 13,498
Adjustments to reconcile net income to net cash from
(used in) operating activities:
Policy charges and fee income (140,240) (108,731) (74,117)
Interest credited to policyholders' account balances 250,675 227,992 204,813
Realized investment (gains) losses, net (5,011) 2,770 68,037
Amortization and other non-cash items 710 51,685 (78,452)
Cumulative effect of accounting change 9,150 -- --
Change in:
Future policy benefits and other policyholders' liabilities 212,121 134,431 126,316
Reinsurance recoverable (247,635) (116,739) (99,974)
Accrued investment income 1,638 (10,665) (8,692)
Receivables from Parent and affiliates 2,799 461 (28,025)
Policy loans (8,162) 30,913 (5,441)
Deferred policy acquisition costs (25,213) (227,713) 6,833
Income taxes payable 103,447 90,413 (20,844)
Deferred sales inducements and other assets (36,136) (47,100) (20,071)
Other, net
216,484 (18,601) 23,912
----------- ----------- -----------
Cash Flows From Operating Activities 448,088 94,049 107,793
----------- ----------- -----------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities available for sale 2,293,944 2,506,887 1,834,129
Payments for the purchase of:
Fixed maturities available for sale (2,266,074) (3,303,651) (2,884,673)
Other long-term investments, net 36,763 (2,873) (10,202)
Short-term investments, net
47,709 53,705 1,256
----------- ----------- -----------
Cash Flows From (Used in) Investing Activities 112,342 (745,932) (1,059,490)
----------- ----------- -----------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 2,093,835 2,196,543 1,789,307
Withdrawals (2,086,995) (1,621,978) (1,014,901)
Cash payments to eligible policyholders -- (4) (116,000)
Cash collateral for loaned securities, net (20,853) 206,053 35,496
Securities sold under agreement to repurchase, net (51,848) (303,405) 319,792
Paid in capital transaction associated with the purchase of fixed
maturities from an affiliate (4,754) (7,557) --
Deferred compensation (323) (850) --
Stock-based compensation 477 463 --
----------- ----------- -----------
Cash Flows From (Used in) Financing Activities (70,461) 469,265 1,013,694
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 489,969 (182,618) 61,997
Cash and cash equivalents, beginning of year 253,564 436,182 374,185
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 743,533 $ 253,564 $ 436,182
=========== =========== ===========
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 or "the 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 or, "GIC,"
called Prudential Credit Enhanced GIC or, "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 Note 13.
Pruco Life Insurance Company has three subsidiaries, which include one wholly
owned life insurance subsidiary, Pruco Life Insurance Company of New Jersey or,
"PLNJ," and two subsidiaries formed in 2003 for the purpose of acquiring and
investing in municipal fixed maturities from an affiliated company (see Note
13). 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 or, "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. or "Prudential Financial."
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 Note 13. 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,
investments, future policy benefits, provision for income taxes, disclosure of
contingent 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 Options
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 years ended December
31, 2004 and 2003, include costs of $0.3 million and $0.9 million, respectively,
associated with employee stock options issued by Prudential Financial to certain
employees of the Company. 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
equal to the market value of Prudential Financial's Common Stock on the date of
grant.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," which
replaces FASB Statement No. 123. SFAS 123R requires all entities to apply the
fair value based measurement method in accounting for share-based payment
transactions with employees except for equity instruments held by employee share
ownership plans. As described above Prudential Financial had previously adopted
the fair value recognition provisions of the original SFAS 123 for all new
awards granted to employees on or after January 1, 2003. SFAS 123R is effective
for interim and annual periods beginning after June
F-7
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
15, 2005. Prudential Financial will adopt the fair value recognition provisions
of this statement on July 1, 2005 for those awards issued prior to January 1,
2003. By that date, the unvested stock options issued prior to January 1, 2003,
will be recognized over the remaining vesting period of approximately six
months.
Prudential Financial and the Company account for non-employee stock options
using the fair value method of SFAS No. 123 in accordance with Emerging Issues
Task Force Issue ("EITF") No. 96-18 "Accounting for Equity Instruments That Are
Issued to Other Than Employees" and related interpretations in accounting for
its non-employee stock options.
Investments
Fixed maturities classified as "available for sale" are carried at fair value.
The amortized cost of fixed maturities is written down to 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)."
Policy loans are carried at unpaid principal balances.
Securities repurchase and resale agreements and securities borrowed and loaned
transactions are used to generate income, to borrow funds, or to facilitate
trading activity. Securities repurchase and resale agreements are generally
short-term in nature, and therefore, the carrying amounts of these instruments
approximate fair value. Securities repurchase and resale agreements are
collateralized principally by U.S. government and government agency securities.
Securities borrowed or loaned are collateralized principally by cash or U.S.
government securities. For securities repurchase agreements and securities
loaned transactions used to generate income, the cash received is typically
invested in cash equivalents, short-term investments or fixed maturities.
Securities repurchase and resale agreements that satisfy certain criteria are
treated as collateralized financing arrangements. These agreements are carried
at the amounts at which the securities will be subsequently resold or
reacquired, as specified in the respective agreements. For securities purchased
under agreements to resell, the Company's policy is to take possession or
control of the securities and to value the securities daily. Securities to be
resold are the same, or substantially the same, as the securities received. For
securities sold under agreements to repurchase, the market value of the
securities to be repurchased is monitored, and additional collateral is obtained
where appropriate, to protect against credit exposure. Securities to be
repurchased are the same, or substantially the same as those sold. Income and
expenses related to these transactions executed within the general account and
it's insurance subsidiary used to generate income are reported as "Net
investment income," however, for transactions used to borrow funds, the
associated borrowing cost is reported as interest expense (included in "General
and administrative expenses").
Securities borrowed and securities loaned transactions are treated as financing
arrangements and are recorded at the amount of cash advanced or received. With
respect to securities loaned transactions, 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 the
securities borrowed and loaned on a daily basis with additional collateral
obtained or provided as necessary. Substantially all of the Company's securities
borrowed transactions are with brokers and dealers, commercial banks and
institutional clients. Substantially all of the Company's securities loaned
transactions are with large brokerage firms. Income and expenses associated with
securities borrowing transactions are reported as "Net investment income."
Income and expenses associated with securities loaned transactions used to
generate income are generally reported as "Net investment income;" however, for
securities loaned transactions used for funding purposes the associated rebate
is reported as interest expense (included in "General and administrative
expenses").
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 limited partnerships in which the Company does not exercise
control, as well as investments in the Company's own separate accounts, which
are carried at estimated fair value, and investment real estate. Joint venture
and partnership interests are generally accounted for using the equity method of
accounting, except in instances in which the Company's interest is so minor that
it exercises virtually no influence over operating and financial policies. In
such instances, the Company applies the cost method of accounting. The Company's
net income from investments in joint ventures and partnerships is generally
included in "Net investment income."
F-8
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Realized investment gains (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) the extent (generally if greater than 20%) and the duration
(generally if greater than six months); (2) the reasons for the decline in value
(credit event, interest related or market fluctuation); (3) the Company's
ability and intent to hold the investments for a period of time to allow for a
recovery of value; and (4) the financial condition of and near-term prospects of
the issuer.
There are a number of significant risks and uncertainties inherent in the
process of monitoring impairments and determining if an impairment is other than
temporary. These risks and uncertainties include, but are not limited to: (1)
the risk that our assessment of an issuer's ability to meet its obligations
could change, (2) the risk that the economic outlook could be worse than
expected or have more of an impact on the issuer than anticipated, (3) the risk
that we are making decisions based on fraudulent or misstated information in the
financial statements provided by issuers and (4) the risk that new information
obtained by us or changes in other facts and circumstances, including those not
related to the issuer, could lead us to change our intent to hold the security
to maturity or until it recovers in value. Any of these situations could result
in a change in our impairment determination, and hence a charge to earnings in a
future period.
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 policy acquisition costs
The Company is charged distribution expenses from Prudential Insurance'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 Insurance'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.
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.
Reinsurance recoverables and payables
Reinsurance recoverables and payables include receivables and corresponding
payables associated with reinsurance arrangements with affiliates. See Note 13
for additional information about these arrangements.
F-9
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Separate account assets and liabilities
Separate account assets and liabilities are reported at fair value and represent
segregated funds which are invested for certain policyholders, pension funds and
other customers. The assets consist of common stocks, fixed maturities, real
estate related investments, real estate mortgage loans 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. See Note 12 for additional information regarding
separate account arrangements with contractual guarantees. 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. Mortality,
policy administration and surrender charges assessed against the accounts are
included in "Policy charges and fee income." Asset management fees charged to
the accounts are included in "Asset management fees."
Deferred sales inducements and other assets, and other liabilities
The Company provides sales inducements to contractholders, which primarily
include an up-front bonus added to the contractholder's initial deposit 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
to policyholders' account balances. As of December 31, 2004 and 2003, deferred
sales inducement costs included in other assets were $110 million and $79
million, respectively.
Other assets consist primarily of deferred sales inducements costs, premiums
due, 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.
Policyholders' Account Balances
The Company's liability for policyholders' account balances represents the
contract value that has accrued to the benefit of the policyholder as of the
balance sheet date. This liability is generally equal to the accumulated account
deposits plus interest credited less policyholders' withdrawals and other
charges assessed against the account balance. These policyholders' account
balances also include provision for benefits under non-life contingent payout
annuities.
Future Policy Benefits
The Company's liability for future policy benefits is primarily comprised of the
present value of estimated future payments to or on behalf of policyholders,
where the timing and amount of payment depends on policyholder mortality, less
the present value of future net premiums. For life insurance, expected mortality
is generally based on the Company's historical experience or standard industry
tables. Interest rate assumptions are based on factors such as market conditions
and expected investment returns. Although mortality and interest rate
assumptions are "locked-in" upon the issuance of new insurance or annuity
business with fixed and guaranteed terms, significant changes in experience or
assumptions may require us to provide for expected future losses on a product by
establishing premium deficiency reserves. The Company's liability for future
policy benefits is also inclusive of liabilities for guarantee benefits related
to certain non-traditional long duration life and annuity contracts, which are
discussed more fully in Note 8.
Unpaid Claims
Unpaid claims include estimates of claims that the Company believes have been
incurred, but have not yet been reported ("IBNR") as of the balance sheet date.
Consistent with industry accounting practice, we do not establish loss reserves
until a loss has occurred. These IBNR estimates, and estimates of the amounts of
loss we will ultimately incur on reported claims, which are based in part on our
historical experience, are regularly adjusted to reflect actual claims
experience. When actual experience differs from our previous estimate, the
resulting difference will be included in our reported results for the period of
the change in estimate in the "Policyholders' benefits" caption in our
statements of operations. On an ongoing basis, trends in actual experience are a
significant factor in the determination of claim reserve levels.
Contingencies
Amounts related to contingencies are accrued if it is probable that a liability
has been incurred and an amount is reasonably estimable. Management evaluates
whether there are incremental legal or other costs directly associated with the
ultimate resolution of the matter that are reasonably estimable and, if so, they
are included in the accrual.
F-10
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Insurance Revenue and Expense Recognition
Premiums from life insurance policies, excluding interest-sensitive life
contracts, are recognized when due. Benefits are recorded as an expense when
they are incurred. A liability for future policy benefits is recorded when
premiums are recognized using the net level premium method.
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. These contracts are discussed in further detail in
Note 8. Also, as more fully discussed in Note 8, the liability for the
guaranteed minimum death benefit under these contracts is determined each period
end by estimating the accumulated value of a percentage of the total assessments
to date less the accumulated value of death benefits in excess of the account
balance.
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 to policyholders' account balances 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 policyholders' account balances invested in The Prudential Series Funds or,
"PSF," which are a portfolio of mutual fund investments related to the Company's
separate account products (see Note 13). In addition, the Company receives fees
from policyholders' account balances invested in funds managed by companies
other than Prudential Insurance. Asset management fees are recognized as income
when earned.
Derivative Financial Instruments
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, financial indices, or the value of securities or
commodities. Derivative financial instruments used by the Company include swaps
and futures, and may be exchange-traded or contracted in the over-the-counter
market. Derivative positions are carried at 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, manage the interest rate and currency characteristics of
assets or liabilities. Additionally, derivatives may be used to seek to reduce
exposure to interest rate 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 fair value 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, 2004, none of the Company's derivatives qualify
for hedge accounting treatment.
F-11
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
If a derivative does not qualify for hedge accounting, all changes in its fair
value, including net receipts and payments, are included in "Realized investment
gains (losses), net" without considering changes in the fair value of the
economically associated assets or liabilities.
The Company is a party to financial instruments that may contain derivative
instruments that are "embedded" in the financial instruments. 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 gains (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 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
the amount expected to be realized.
New Accounting Pronouncements
In March 2004, the EITF of the FASB reached a final consensus on Issue 03-1,
"The Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments." This Issue establishes impairment models for determining whether
to record impairment losses associated with investments in certain equity and
debt securities. It also requires income to be accrued on a level-yield basis
following an impairment of debt securities, where reasonable estimates of the
timing and amount of future cash flows can be made. The Company's policy is
generally to record income only as cash is received following an impairment of a
debt security. In September 2004, the FASB issued FASB Staff Position ("FSP")
EITF 03-1-1, which defers the effective date of a substantial portion of EITF
03-1, from the third quarter of 2004, as originally required by the EITF, until
such time as FASB issues further implementation guidance, which is expected
sometime in 2005. The Company will continue to monitor developments concerning
this Issue and is currently unable to estimate the potential effects of
implementing EITF 03-1 on the Company's consolidated financial position or
results of operations.
In December 2003, the FASB issued FIN No. 46(R), "Consolidation of Variable
Interest Entities," which revised the original FIN No. 46 guidance issued in
January 2003. FIN No. 46(R) 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, as the primary beneficiary, it stands to absorb a
majority of the VIE's expected losses or to receive a majority of the VIE's
expected residual returns. On December 31, 2003, the Company adopted FIN No.
46(R) for all special purpose entities ("SPEs") and for relationships with all
VIEs that began on or after February 1, 2003. On March 31, 2004, the Company
implemented FIN No. 46(R) for relationships with potential VIEs that are not
SPEs. The transition to FIN No. 46(R) did not have a material effect on the
Company's consolidated financial position or results of operations.
In July 2003, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants ("AICPA") issued Statement of
Position ("SOP") 03-1, "Accounting and Reporting by Insurance Enterprises for
Certain Nontraditional Long-Duration Contracts and for Separate Accounts." AcSEC
issued this SOP to address the need for interpretive guidance in three areas:
separate account presentation and valuation; the classification and valuation of
certain long-duration contract liabilities; and the accounting recognition given
sales inducements (bonus interest, bonus credits and persistency bonuses).
F-12
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The effect of adopting SOP 03-1 was a charge of $9 million, net of $5 million of
taxes, which was reported as a "Cumulative effect of accounting change, net of
taxes" in the results of operations for the year ended December 31, 2004. This
charge reflects the net impact of converting certain individual market value
adjusted annuity contracts from separate account accounting treatment to general
account accounting treatment, including carrying the related liabilities at
accreted value, and the effect of establishing reserves for guaranteed minimum
death benefit provisions of the Company's variable annuity and variable life
contracts. The Company also recognized a cumulative effect of accounting change
related to unrealized investment gains within "Other comprehensive income, net
of taxes" of $4 million, net of $3 million of taxes, for the year ended December
31, 2004. Upon adoption of SOP 03-1, approximately $400 million in "Separate
account assets" were reclassified resulting in an increase in "Fixed maturities,
available for sale", as well as changes in other non-separate account assets.
Similarly, upon adoption, approximately $400 million in "separate account
liabilities" were reclassified resulting in increases in "Policyholders' account
balances" as well as changes in other non-separate account liabilities.
In June 2004, the FASB issued FSP No. 97-1, "Situations in Which Paragraphs
17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments, Permit or Require Accrual of an Unearned
Revenue Liability." FSP 97-1 clarifies the accounting for unearned revenue
liabilities of certain universal-life type contracts under SOP 03-1. The
Company's adoption of FSP 97-1 on July 1, 2004 did not change the accounting for
unearned revenue liabilities and, therefore, had no impact on the Company's
consolidated financial position or results of operations. In September 2004, the
AICPA SOP 03-1 Implementation Task Force issued a Technical Practice Aid ("TPA")
to clarify certain aspects of SOP 03-1. The implementation of this TPA during
the third quarter of 2004 had no impact on the Company's consolidated financial
position or results of operations.
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 in 2003 had no impact 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 a material effect on the
Company's consolidated financial position or results of operations.
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.
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:
2004
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
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 $ 87,013 $ 778 $ 109 $ 87,682
States, municipalities and political subdivisions 173,129 8,627 191 181,565
Foreign government bonds 30,005 3,982 9 33,978
Mortgage-backed securities 333,720 1,685 440 334,965
Public utilities 848,762 40,036 1,710 887,088
All other corporate bonds 4,641,391 181,494 9,060 4,813,825
Redeemable preferred stock -- -- -- --
------------ ------------ ------------ ------------
Total fixed maturities, available for sale $ 6,114,020 $ 236,602 $ 11,519 $ 6,339,103
============ ============ ============ ============
2003
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
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
============ ============ ============ ============
- --------------------------------------------------------------------------------
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, 2004 is shown below:
Available for sale
------------------------
Amortized Fair
Cost Value
---------- ----------
(in thousands)
Due in one year or less $ 809,242 $ 816,443
Due after one year through five years 2,644,613 2,726,406
Due after five years through ten years 1,650,713 1,749,571
Due after ten years 675,732 711,718
Mortgage-backed securities 333,720 334,965
---------- ----------
Total $6,114,020 $6,339,103
========== ==========
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 2004, 2003,
and 2002, were $1,500 million, $1,957 million and $1,607 million respectively.
Proceeds from the maturity of fixed maturities available for sale during 2004,
2003, and 2002, were $794 million, $550 million, and $227 million, respectively.
Gross gains of $27 million, $21 million, and $20 million and gross losses of $17
million, $7 million, and $48 million were realized on those sales during 2004,
2003, and 2002, respectively.
Writedowns for impairments, which were deemed to be other than temporary for
fixed maturities were $1 million, $12 million, and $28 million for the years,
ended December 31, 2004, 2003 and 2002, respectively.
Other Long-Term Investments
The following table provides information relating to other long-term investments
as of December 31:
2004 2003
-------- --------
(in thousands)
Joint ventures and limited partnerships $ 184 $ 37,321
Company's investment in Separate accounts 29,993 55,214
Derivatives for other than trading (4,683) (3,585)
Commercials loans on real estate 2,286 249
Equity securities 478 279
-------- --------
Total other long- term investments $ 28,258 $ 89,478
======== ========
The Company's share of net income from the joint ventures was $1 million, $2
million, and $1 million, for the years ended December 31, 2004, 2003, and 2002,
respectively, and is reported in "Net investment income." Mortgage interest on
commercial loans on real estate was $1.4 million, $0.9 million, and $0.8 million
for the years ended December 31, 2004, 2003 and 2002, 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:
2004 2003 2002
--------- --------- ---------
(in thousands)
Fixed maturities, available for sale $ 327,899 $ 295,357 $ 275,843
Policy loans 46,935 46,750 49,436
Short-term investments and cash equivalents 7,685 7,357 13,540
Other 3,981 7,821 8,128
--------- --------- ---------
Gross investment income 386,500 357,285 346,947
Less: investment expenses (12,948) (12,657) (12,461)
--------- --------- ---------
Net investment income $ 373,552 $ 344,628 $ 334,486
========= ========= =========
Realized investment gains (losses), net including charges for other than
temporary reductions in value, for the years ended December 31, were from the
following sources:
2004 2003 2002
-------- -------- --------
(in thousands)
Fixed maturities, available for sale $ 9,034 $ 1,567 $(56,039)
Derivatives (5,801) (6,629) (11,746)
Other 1,778 2,292 (252)
-------- -------- --------
Realized investment gains (losses), net $ 5,011 $ (2,770) $(68,037)
======== ======== ========
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 taxes, 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
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, 2002 $ 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 affiliate 11,659 -- -- (4,102) 7,557
(see Note 13)
Reclassification adjustment for gains
included in net income (2,177) -- -- 784 (1,393)
Impact of net unrealized investment gains
(losses) on deferred policy acquisition costs -- (13,999) -- 5,040 (8,959)
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
Net investment gains on investments arising
during the period (51,357) -- -- 20,442 (30,915)
Purchase of fixed maturities from an affiliate
(see Note 13) 7,314 -- -- (2,560) 4,754
Cumulative effect of change in accounting
principle 6,297 -- -- (2,267) 4,030
Reclassification adjustment for gains included in
net income (8,888) -- -- 3,111 (5,777)
Impact of net unrealized investment gains
(losses) on deferred policy acquisition costs -- (9,616) -- 2,152 (7,464)
Impact of net unrealized investment gains
(losses) on policyholders' account balances -- -- 3,130 (918) 2,212
------------- ------------- ------------- ------------- -------------
Balance, December 31, 2004 $ 225,155 $ (130,981) $ 20,891 $ (40,535) $ 74,530
============= ============= ============= ============= =============
F-17
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The table below presents net unrealized gains on investments by asset class at
December 31,
2004 2003 2002
-------- -------- --------
(in thousands)
Fixed maturities $225,083 $271,772 $236,415
Other long-term investments 72 17 98
-------- -------- --------
Unrealized gains on investments $225,155 $271,789 $236,513
======== ======== ========
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, 2004:
Less than twelve Twelve months
months or 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 $ 104,487 $ 300 $ -- $ -- $ 104,487 $ 300
Foreign government bonds 2,656 9 -- -- 2,656 9
Corporate securities 1,113,346 8,943 50,766 1,827 1,164,112 10,770
Mortgage-backed securities 80,097 438 41 2 80,138 440
---------- ---------- ---------- ---------- ---------- ----------
Total $1,300,586 $ 9,690 $ 50,807 $ 1,829 $1,351,393 $ 11,519
========== ========== ========== ========== ========== ==========
As of December 31, 2004, gross unrealized losses on fixed maturities totaled $12
million comprising 250 issuers. Of this amount, there was $10 million in the
less than twelve months category comprising 238 issuers and $2 million in the
greater than twelve months category comprising 12 issuers. There were no
individual issuers with gross unrealized losses greater than $1.1 million. The
$10 million of gross unrealized losses of less than twelve months is comprised
of investment grade securities. The $2 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, 2004.
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 $377 thousand
and a gross unrealized loss of $24 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, 2004 and 2003,
the carrying value of fixed maturities available for sale pledged to third
parties as reported in the Consolidated Statements of Financial Position were
$437 million and $509 million, respectively.
Fixed maturities of $4 million at December 31, 2004 and 2003 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:
2004 2003 2002
----------- ----------- -----------
(in thousands)
Balance, beginning of year $ 1,380,710 $ 1,152,997 $ 1,159,830
Capitalization of commissions, sales and issue expenses 221,237 371,650 328,658
Amortization (186,408) (129,938) (268,438)
Change in unrealized investment gains 11,592 (13,999) (67,053)
Impact of adoption of SOP 03-1 1,896 -- --
----------- ----------- -----------
Balance, end of year $ 1,429,027 $ 1,380,710 $ 1,152,997
=========== =========== ===========
Deferred acquisition costs in 2004 include reductions in capitalization and
amortization related to the reinsurance expense allowances resulting from the
coinsurance treaty with Prudential Reinsurance Captive Company or "PARCC,"
discussed in Note 13 below. Ceded capitalization and amortization relating to
this treaty included in the above table amounted to $151 million and $10
million, respectively, in 2004.
F-19
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. POLICYHOLDERS' LIABILITIES
Future policy benefits at December 31, are as follows:
2004 2003
---------- ----------
(in thousands)
Life insurance - domestic $ 761,195 $ 646,953
Life insurance - Taiwan 467,332 376,033
Individual annuities 85,761 33,598
Group annuities 11,548 12,393
---------- ----------
Total future policy benefits $1,325,836 $1,068,977
========== ==========
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 4.75% to 14.75%,
with approximately 15% 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:
2004 2003
---------- ----------
(in thousands)
Interest-sensitive life contracts $2,542,797 $2,270,703
Individual annuities 2,679,322 2,244,314
Guaranteed investment contracts 900,805 1,067,616
---------- ----------
Total policyholders' account balances $6,122,924 $5,582,633
========== ==========
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, if applicable. Interest crediting rates range from 1.50% to 5.90% for
interest-sensitive life contracts. Interest crediting rates for individual
annuities range from 1.50% to 14.00%, 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 Prudential Insurance, Prudential
of Taiwan, PARCC and other companies, in order to provide greater
diversification of business, provide additional capacity for future growth and
limit the maximum net loss potential arising from large risks. Life reinsurance
is accomplished through various plans of reinsurance, primarily yearly renewable
term and coinsurance. Reinsurance ceded arrangements do not discharge the
Company as the primary insurer. Ceded balances would represent a liability of
the Company in the event the reinsurers were unable to meet their obligations to
the Company under the terms of the reinsurance agreements. The likelihood of a
material reinsurance liability reassumed by the Company is considered to be
remote.
Reinsurance premiums, commissions, expense reimbursements, benefits and reserves
related to reinsured long-duration contracts are accounted for over the life of
the underlying reinsured contracts using assumptions consistent with those used
to account for the underlying contracts. Amounts recoverable from reinsurers,
for both long and short duration reinsurance arrangements, 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 Taiwan business as of February 1, 2001, are
described further in Note 13.
Reinsurance amounts included in the Statement of Operations and Comprehensive
Income for the years ended December 31 are below.
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:
2004 2003 2002
----------- ----------- -----------
(in thousands)
Direct premiums and policy charges and fee income $ 1,033,174 $ 878,669 $ 862,723
Reinsurance ceded (307,866) (166,371) (203,982)
----------- ----------- -----------
Premiums and policy charges and fee income $ 725,308 $ 712,298 $ 658,741
----------- ----------- -----------
Policyholders' benefits ceded $ 129,125 $ 99,229 $ 70,327
----------- ----------- -----------
Reinsurance premiums 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:
2004 2003
-------- --------
(in thousands)
Domestic life insurance - affiliated $272,999 $ 66,837
Domestic life insurance - unaffiliated 13,166 62,147
Other reinsurance - affiliated 11,548 12,393
Taiwan life insurance-affiliated 467,332 376,033
-------- --------
$765,045 $517,410
======== ========
During 2004, the Company entered into reinsurance contracts with affiliates
covering the entire domestic life in force. As a result, all related reinsurance
contracts are with affiliates as of December 31, 2004. These contracts are
described further in Note 13, below.
The gross and net amounts of life insurance in force at December 31, were as
follows:
2004 2003 2002
------------- ------------- -------------
(in thousands)
Life insurance face amount in force $ 204,016,616 $ 158,488,681 $ 118,381,408
Ceded to other companies (179,108,664) (81,095,301) (49,113,635)
------------- ------------- -------------
Net amount of life insurance in force $ 24,907,952 $ 77,393,380 $ 69,267,773
============= ============= =============
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:
2004 2003 2002
--------- --------- --------
(in thousands)
Current tax (benefit) expense benefit:
U.S $ 61,801 $ (69,836) $(65,004)
State and local (2,119) 219 309
Foreign -- -- 39
--------- --------- --------
Total 59,682 (69,617) (64,656)
--------- --------- --------
Deferred tax expense (benefit):
U.S (31,944) 102,685 15,709
State and local (4,860) 981 (3,556)
--------- --------- --------
Total (36,804) 103,666 12,153
--------- --------- --------
Total income tax expense (benefit) $ 22,878 $ 34,049 $(52,503)
========= ========= ========
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 and cumulative effect of accounting change for
the following reasons:
2004 2003 2002
--------- --------- --------
(in thousands)
Expected federal income tax (benefit) expense $ 50,921 $ 41,644 $(13,652)
State and local income taxes (4,537) 781 (2,111)
Non taxable investment income (21,908) (12,165) (41,745)
Incorporation of Taiwan branch 172 443 7,545
Other (1,770) 3,346 (2,540)
--------- --------- --------
Total income tax expense (benefit) $ 22,878 $ 34,049 $(52,503)
========= ========= ========
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
2004 2003
-------- --------
(in thousands)
Deferred tax assets
Insurance reserves $ 48,116 $ 14,875
Tax loss carry forwards -- 12,731
Investments 5,652 --
Other 4,743 6,419
-------- --------
Deferred tax assets 58,511 34,025
-------- --------
Deferred tax liabilities
Deferred acquisition costs 366,155 383,712
Net unrealized gains on securities 74,984 96,998
Investments -- 24,804
Other 24,390 --
-------- --------
Deferred tax liabilities 465,529 505,514
-------- --------
Net deferred tax liability $407,018 $471,489
======== ========
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 the Company had
state operating loss carryforwards of $826 million.
The Internal Revenue Service (the "Service") has completed all examinations of
the consolidated federal income tax returns through 1996. Tax years 1997 through
2001 are currently under examination. Management believes sufficient provisions
have been made for potential adjustments.
8. CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS
The Company issues traditional variable annuity contracts through its separate
accounts for which investment income and investment gains and losses accrue
directly to, and investment risk is borne by, the contractholder. The Company
also issues variable annuity contracts with general and separate account options
where the Company contractually guarantees to the contractholder a return of no
less than (a) total deposits made to the contract less any partial withdrawals
("return of net deposits"), (b) total deposits made to the contract less any
partial withdrawals plus a minimum return ("minimum return"), or (c) the highest
contract value on a specified anniversary date minus any withdrawals following
the contract anniversary ("anniversary contract value"). These guarantees
include benefits that are payable in the event of death or annuitization.
The Company also issues annuity contracts with market value adjusted investment
options ("MVAs"), which provide for a return of principal plus a fixed rate of
return if held to maturity, or, alternatively, a "market adjusted value" if
surrendered prior to maturity. The market value adjustment may result in a gain
or loss to the Company, depending on crediting rates or an indexed rate at
surrender, as applicable.
In addition, the Company issues variable life, variable universal life and
universal life contracts where the Company contractually guarantees to the
contractholder a death benefit even when there is insufficient value to cover
monthly mortality and expense charges, whereas otherwise the contract would
typically lapse ("no lapse guarantee"). Variable life and variable universal
life contracts are offered with general and separate account options.
The assets supporting the variable portion of both traditional variable
annuities and certain variable contracts with guarantees are carried at fair
value and reported as "Separate account assets" with an equivalent amount
reported as "Separate account liabilities." Amounts assessed against the
contractholders for mortality, administration, and other services are included
within revenue in "Policy charges and fee income" and changes in liabilities for
minimum guarantees are generally included in "Policyholders' benefits." In 2004
there were no gains or losses on transfers of assets from the general account to
a separate account.
For those guarantees of benefits that are payable in the event of death, the net
amount at risk is generally defined as the current guaranteed minimum death
benefit in excess of the current account balance at the balance sheet date. For
guarantees of benefits that are payable at annuitization, the net amount at risk
is generally defined as the present value of the minimum guaranteed annuity
payments available to the contractholder determined in accordance with the terms
of the contract in excess of the current account balance. The Company's
contracts with guarantees may offer more than one type of guarantee in each
contract; therefore, the amounts listed may not be mutually exclusive. As of
December 31, 2004, the Company had the following guarantees associated with
these contracts, by product and guarantee type:
F-23
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS (continued)
December 31, 2004
-----------------------------------------------
In the Event of At Annuitization /
Death Accumulation
-----------------------------------------------
Variable Annuity Contracts (dollars in thousands)
Return of net deposits
Account value $2,241,327 N/A
Net amount at risk $ 7,373 N/A
Average attained age of contractholders 62 years N/A
Minimum return or anniversary contract value
Account value $9,704,195 $2,034,671
Net amount at risk $1,456,702 $ 1,122
Average attained age of contractholders 65 years 59 years
Average period remaining until earliest expected annuitization N/A 6.3years
Unadjusted Value Adjusted Value
Market value adjusted annuities
-----------------------------------------------
Account value $328,951 $345,342
December 31, 2004
-------------------------
In the Event of Death
-------------------------
Variable Life, Variable Universal Life and Universal Life Contracts (dollars in thousands)
No Lapse Guarantees
Separate account value $ 1,625,520
General account value $ 393,712
Net amount at risk $32,294,429
Average attained age of contractholders 45 years
Account balances of variable annuity contracts with guarantees were invested in
separate account investment options as follows:
December 31, 2004
-------------------
(in thousands)
Equity funds 8,144,114
Bond funds 763,261
Balanced funds 320,966
Money market funds 267,668
Specialty funds 13,006
----------
Total $9,509,015
==========
The total amount of funds invested in separate account investment options for
variable life, variable universal life and universal life contracts with
guarantees was $1,626 million at December 31, 2004.
In addition to the above mentioned amounts invested in separate account
investment options, $2,437 million of account balances of variable annuity
contracts with guarantees (inclusive of contracts with MVA features) were
invested in general account investment options.
F-24
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS (continued)
Liabilities For Guarantee Benefits
The table below summarizes the changes in general account liabilities for
guarantees on variable contracts. The liabilities for guaranteed minimum death
benefits ("GMDB") and guaranteed minimum income benefits ("GMIB") are included
in "Future policy benefits" and the related changes in the liabilities are
included in "Policyholders' benefits."
Guaranteed Guaranteed
Minimum Death Minimum Income
Benefit (GMDB) Benefit (GMIB) Totals
--------------------------------------------
(in thousands)
Balance as of January 1, 2004 . $ 42,194 $ 2,211 $ 44,405
Incurred guarantee benefits . 24,700 5,100 29,800
Paid guarantee benefits ..... (23,057) -- (23,057)
--------------- --------------- ---------
Balance as of December 31, 2004 $ 43,837 $ 7,311 $ 51,148
=============== =============== =========
The GMDB liability is determined each period end by estimating the accumulated
value of a percentage of the total assessments to date less the accumulated
value of the death benefits in excess of the account balance. The percentage of
assessments used is chosen such that, at issue, the present value of expected
death benefits in excess of the projected account balance and the percentage of
the present value of total expected assessments over the lifetime of the
contracts are equal. The Company regularly evaluates the estimates used and
adjusts the GMDB liability balance, with a related charge or credit to earnings,
if actual experience or other evidence suggests that earlier assumptions should
be revised. The GMIB liability was determined at December 31, 2004 by estimating
the accumulated value of a percentage of the total assessments to date less the
accumulated value of the projected income benefits in excess of the account
balance.
The present value of death benefits in excess of the projected account balance
and the present value of total expected assessments for GMDB's were determined
over a reasonable range of stochastically generated scenarios. For variable
annuities and variable universal life, 5,000 scenarios were stochastically
generated and, from these, 200 scenarios were selected using a sampling
technique. For variable life, various scenarios covering a reasonable range were
weighted based on a statistical lognormal model. For universal life, 10,000
scenarios were stochastically generated and, from these, 100 were selected.
Sales Inducements
The Company defers sales inducements and amortizes them over the anticipated
life of the policy using the same methodology and assumptions used to amortize
deferred policy acquisition costs. These deferred sales inducements are included
in "Other assets." The Company offers various types of sales inducements. These
inducements include: (i) a bonus whereby the policyholder's initial account
balance is increased by an amount equal to a specified percentage of the
customer's initial deposit and (ii) additional interest credits after a certain
number of years a contract is held. Changes in deferred sales inducements are as
follows:
Sales Inducements
-----------------
(in thousands)
Balance as of January 1, 2004 ............................ $ 79,143
Capitalization ......................................... 43,286
Amortization ........................................... (11,969)
---------
Balance as of December 31, 2004 .......................... $ 110,460
=========
F-25
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. 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 loss for the Company amounted to $4 million, $141 million, and
$239 million for the years ended December 31, 2004, 2003, and 2002,
respectively. Statutory surplus of the Company amounted to $572 million and $517
million at December 31, 2004 and 2003, 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. During late 2003 and
in 2004, the Company obtained reinsurance on the term life business from a
captive affiliate, mitigating the surplus strain on that business. The agreement
is discussed further in Note 13, below.
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 2001. The GAAP accounting treatment
for this transaction is discussed in Note 13.
The Company is subject to Arizona law, which limits the amount of dividends that
insurance companies can pay to stockholders without approval of the Arizona
Department of Insurance. 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 2005. There have been no dividend payments to the parent in
2004, 2003 or 2002.
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values presented below have been determined by using available market
information and by applying valuation methodologies. Considerable judgment is
applied in interpreting data to develop the estimates of fair value. These 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 fair values. The methods and assumptions discussed below were used in
calculating the fair values of the instruments. See Note 11 for a discussion of
derivative instruments.
Fixed maturities
The fair values of public fixed maturity securities are based on quoted market
prices or estimates from independent pricing services. However, for investments
in private placement fixed maturity securities, this information is not
available. For these private investments, the fair value is determined 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, and an additional spread component for the reduced liquidity
associated with private placements. This additional spread component is
determined based on surveys of various third party financial institutions.
Historically, changes in estimated future cash flows or the assessment of an
issuer's credit quality have been the more significant factors in determining
fair values.
Policy loans
The 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, income annuities and other similar
contracts without life contingencies, fair values are derived using discounted
projected cash flows based on interest rates being offered for similar contracts
with maturities consistent with those of the contracts being valued. For
individual deferred annuities and other deposit liabilities, carrying value
approximates fair value.
Derivative financial instruments
Refer to Note 11 for the disclosure of fair values on these instruments.
F-26
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
The following table discloses the carrying amounts and fair values of the
Company's financial instruments at December 31:
2004 2003
--------------------------- ---------------------------
Carrying Carrying
Value Fair Value Value Fair Value
------------ ------------ ------------ ------------
(in thousands)
Financial assets:
Fixed maturities, available for sale $ 6,339,103 $ 6,339,103 $ 5,953,815 $ 5,953,815
Policy loans 856,755 960,391 848,593 992,687
Short-term investments 122,061 122,061 160,635 160,635
Cash and cash equivalents 743,533 743,533 253,564 253,564
Separate account assets 17,326,555 17,326,555 15,772,262 15,772,262
Financial liabilities:
Investment contracts 3,749,639 3,772,610 3,438,721 3,505,697
Cash collateral for loaned securities 410,718 410,718 431,571 431,571
Securities sold under repurchase agreements 45,254 45,254 97,102 97,102
Separate account liabilities 17,326,555 17,326,555 15,772,262 15,772,262
11. DERIVATIVE INSTRUMENTS
Types of Derivative Instruments
Interest rate swaps are used by the Company to manage interest rate exposures
arising from mismatches between assets and liabilities (including duration
mismatches) and to hedge against changes in the value of assets it anticipates
acquiring and other anticipated transactions and commitments. Swaps may be
specifically attributed to specific assets or liabilities or may be based on a
portfolio basis. 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 upon
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.
Exchange-traded futures and options are used by the Company to reduce market
risks from changes in interest rates, to alter mismatches between the duration
of assets in a portfolio and the duration of liabilities supported by those
assets, and to hedge against changes in the value of securities it owns or
anticipates acquiring or selling. In exchange-traded futures transactions, the
Company agrees to purchase or sell a specified number of contracts, the values
of which are determined by the values 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 and options with regulated futures commissions merchants
who are members of a trading exchange.
Futures typically are used to hedge duration mismatches between assets and
liabilities. 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 derivatives, including exchange-traded currency futures and currency
swaps, are used by the Company to reduce market risks from changes in currency
exchange rates with respect to investments denominated in foreign currencies
that the Company either holds or intends to acquire or sell. The Company also
uses currency forwards to hedge the currency risk associated with net
investments in foreign operations and anticipated earnings of its foreign
operations.
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.
F-27
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
11. DERIVATIVE INSTRUMENTS (continued)
The table below summarizes the Company's outstanding positions by derivative
instrument types as of December 31, 2004 and 2003. All of the derivatives are
carried on the Consolidated Statements of Financial Position at estimated fair
value.
Derivatives
2004 2003
-------------------------- -------------------------
Estimated Estimated
Notional fair value Notional fair value
-------------------------- -------------------------
(in thousands)
Non-Hedge Accounting
Swap instruments:
Interest rate $ 54,750 $ (212) $ 13,750 $ 258
Currency 13,278 (4,414) 16,818 (3,851)
Future contracts:
US Treasury futures (137,400) (240) 5,600 (3)
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
over-the-counter derivative 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 and options 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 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.
12. COMMITMENTS, CONTINGENCIES AND LITIGATION AND REGULATORY MATTERS
Commitments
The Company has made commitments to fund $49 million of commercial loans in
2005.
Contingencies
On an ongoing basis, our internal supervisory and control functions review the
quality of our sales, marketing and other customer interface procedures and
practices and may recommend modifications or enhancements. In certain cases, if
appropriate, we may offer customers remediation and may incur charges, including
the cost of such remediation, administrative costs and regulatory fines.
It is possible that the results of operations or the cash flow of the Company in
a particular quarterly or annual period could be materially affected as a result
of payments in connection with the matters discussed above depending, in part,
upon the results of operations or cash flow for such period. Management
believes, however, that the ultimate payments in connection with these matters
should not have a material adverse effect on the Company's financial position.
F-28
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. COMMITMENTS, CONTINGENCIES AND LITIGATION AND REGULATORY MATTERS (continued)
Litigation and Regulatory Proceedings
The Company is subject to legal and regulatory actions in the ordinary course of
their businesses, which may include class action lawsuits. 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
may 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 may
also be 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 may seek large and/or indeterminate amounts, including punitive
or exemplary damages.
The Company has received formal requests for information relating to its
variable annuity business and unregistered separate accounts from regulators,
including, among others, the Securities and Exchange Commission and the State of
New York Attorney General's office. The Company is cooperating with all such
inquiries.
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 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.
13. 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 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 Insurance'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
policyholders' 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 or, "COLI," policies to
Prudential Insurance. The cash surrender value included in separate accounts for
the COLI policies was $1.101 billion and $1.018 billion at December 31, 2004 and
December 31, 2003, respectively. Fees related to the COLI policies were $13
million, $12 million and $21 million for the years ending December 31, 2004,
2003, and 2002.
F-29
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
13. RELATED PARTY TRANSACTIONS (continued)
Reinsurance with affiliates
Pruco Reinsurance Ltd reinsurance agreement
During September 2003, the Company implemented an agreement to reinsure its term
life insurance policies with an affiliated company, Pruco Reinsurance Ltd. or,
"Pruco Re." The Company reinsured with Pruco Re a significant portion of the
risks under such policies through an automatic and facultative coinsurance
agreement. This Agreement covered 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 replaced 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 $8 million was deferred and would be amortized over the life
of the underlying insurance policies; $1 million was amortized in 2003 less than
$1 million in 2004 and was recorded in other income. Reinsurance recoverables
related to this transaction were $29 million at December 31, 2003, including the
unamortized portion of the initial cost of $7 million. Premiums and benefits
ceded in 2003 were $31 million and $7 million, respectively.
During September 2004, this transaction was recaptured by the Company and
replaced with a new coinsurance with PARCC, described in more detail below.
Premiums ceded in 2004 were $58 million prior to the recapture.
PARCC
In September 2004, the Company entered into an agreement to reinsure its term
life insurance policies with an affiliated company, PARCC. The Company reinsures
with PARCC 90 percent of the risks under such policies through an automatic and
facultative coinsurance agreement. The Company is not relieved of its primary
obligation to the policyholder as a result of these reinsurance transactions.
Concurrent with implementing this new agreement, the Company recaptured the
policies previously reinsured under a coinsurance treaty with an affiliated
offshore captive company, Pruco Re Ltd. The agreement had covered all term
policies written on or after October 1, 2002.
The coinsurance agreement with PARCC also replaces the yearly renewable term
agreements with external reinsurers that were previously in effect on this block
of business. There was no net cost associated with the initial transaction and
initial transactions. Reinsurance recoverables related to this transaction were
$226 million as of December 31, 2004. Premiums and benefits ceded in 2004 were
$102 million and $52 million, respectively.
Prudential Insurance
In December 2004, the Company recaptured the excess of loss reinsurance
agreement with Prudential Insurance and replaced it with a revised agreement to
reinsure all risks, not otherwise reinsured. Reinsurance recoverables related to
this agreement were $47 million as of December 31, 2004. The Company is not
relieved of its primary obligation to the policyholder as a result of these
reinsurance transactions.
Other affiliated reinsurance agreements
In addition, the Company currently has two 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 and policy charges ceded from domestic life reinsurance
agreements for the periods ended December 31, 2004, 2003, and 2002 were $13
million, $12 million, and $11 million respectively. Affiliated benefits ceded
for the periods ended December 31, 2004, 2003, and 2002 from domestic life
reinsurance agreements are $21 million, $38 million, and $33 million.
Group annuities affiliated benefits ceded were $2 million in 2004, $3 million in
2003, and $3 million in 2002.
F-30
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
13. 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.
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, 2004, 2003 and 2002
from the Taiwan coinsurance agreement were $85 million, $84 million and $80
million, respectively. Affiliated benefits ceded for the periods ended December
31, 2004, 2003 and 2002; from the Taiwan coinsurance agreement were $12 million,
$13 million and $14 million, respectively.
Included in the total reinsurance recoverable balances for both domestic
(including PARCC and Pruco Re) and Taiwan agreements were affiliated reinsurance
recoverables of $752 million and $455 million at December 31, 2004 and December
31, 2003, respectively. Of these affiliated amounts, the reinsurance recoverable
related to the Taiwan coinsurance agreement was $467 million and $376 million at
December 31, 2004 and December 31, 2003, respectively.
Purchase of fixed maturities from an affiliate
During 2003, the Company invested $112 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 $112 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, the Company also purchased corporate fixed maturities with a fair
value of $52 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 $8 million.
During 2004, the Company invested an additional $110 million in fixed maturities
owned by Prudential Insurance, but reflected these investments at amortized cost
of $99 million. The Company also sold $31 million of fixed maturities
securities, recorded at an amortized cost of $29 million, to PARCC. The net
difference between the historic amortized cost and the fair value, net of taxes
for both of these transactions was $5 million and was recorded as a decrease to
paid in capital as described above.
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, 2004 and 2003, there was $456
million and $529 million, respectively, of asset-based financing. There was no
debt outstanding to Prudential Funding, LLC as of December 31, 2004 or 2003.
F-31
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The unaudited quarterly results of operations for the years ended December 31,
2004 and 2003 are summarized in the table below:
Three months ended (in thousands)
----------------------------------------------------
March 31 June 30 September 30 December 31
----------------------------------------------------
2004 (restated)
Total revenues $287,928 $280,195 $275,712 $286,297
Total benefits and expenses 248,012 259,261 245,464 231,906
Income from operations before income taxes before
Cumulative effect of accounting change 39,916 20,934 30,248 54,391
Net income 22,389 18,672 28,989 43,411
----------------------------------------------------
----------------------------------------------------
2003
Total revenues $257,396 $275,715 $274,742 $269,116
Total benefits and expenses 234,240 247,437 245,744 230,566
Income from operations before income taxes before
Cumulative effect of accounting change 23,156 28,278 28,998 38,550
Net income 18,712 21,805 19,171 25,245
F-32