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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
Commission File Number: 333-45862
JOHN HANCOCK LIFE INSURANCE COMPANY
Exact name of registrant as specified in charter
MASSACHUSETTS 04-1414660
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
John Hancock Place
Post Office Box 111
Boston, Massachusetts 02117
(Address of principal executive offices)
(617) 572-6000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 3 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
Number of shares outstanding of our only class of common stock as of
August 1, 2003:
1,000
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
JOHN HANCOCK LIFE INSURANCE COMPANY
CONSOLIDATED BALANCE SHEETS
June 30,
2003 December 31,
(unaudited) 2002
-----------------------
(in millions)
Assets
Investments
Fixed maturities:
Held-to-maturity--at amortized cost
(fair value: June 30--$1,624.6; December 31--$1,777.2) .. $ 1,579.9 $ 1,727.0
Available-for-sale--at fair value
(cost: June 30--$45,161.4; December 31--$41,206.5) ...... 47,947.6 42,046.3
Equity securities:
Available-for-sale--at fair value
(cost: June 30--$310.3; December 31--$307.5) ............ 414.2 349.6
Trading securities--at fair value
(cost: June 30--$0.1; December 31--$0.3) ................ 0.4 0.7
Mortgage loans on real estate ............................... 10,586.7 10,296.5
Real estate ................................................. 201.1 255.3
Policy loans ................................................ 2,014.5 2,014.2
Short-term investments ...................................... 200.3 137.3
Other invested assets ....................................... 2,977.2 2,839.1
--------- ---------
Total Investments ................................... 65,921.9 59,666.0
Cash and cash equivalents ................................... 1,012.3 897.0
Accrued investment income ................................... 860.2 743.2
Premiums and accounts receivable ............................ 101.3 114.1
Deferred policy acquisition costs ........................... 3,247.3 3,352.6
Reinsurance recoverable ..................................... 3,654.1 2,958.9
Other assets ................................................ 2,579.4 2,660.3
Separate account assets ..................................... 18,451.1 17,414.9
--------- ---------
Total Assets ........................................ $95,827.6 $87,807.0
========= =========
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
2
JOHN HANCOCK LIFE INSURANCE COMPANY
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
June 30,
2003 December 31,
(unaudited) 2002
------------------------
(in millions)
Liabilities and Shareholder's Equity
Liabilities
Future policy benefits ..................................... $37,047.8 $34,233.8
Policyholders' funds ....................................... 22,453.6 22,571.0
Consumer notes ............................................. 680.1 290.2
Unearned revenue ........................................... 374.4 368.9
Unpaid claims and claim expense reserves ................... 154.5 160.7
Dividends payable to policyholders ......................... 470.1 463.0
Short-term debt ............................................ 51.5 99.5
Long-term debt ............................................. 733.4 703.9
Income taxes ............................................... 1,668.9 925.0
Other liabilities .......................................... 6,076.4 4,397.3
Separate account liabilities ............................... 18,451.1 17,414.9
--------- ---------
Total Liabilities .................................. 88,161.8 81,628.2
Minority interest .......................................... 5.1 7.3
Commitments and contingencies - Note 5
Shareholder's Equity
Common stock, $10,000 par value; 1,000 shares authorized
and outstanding ............................................ 10.0 10.0
Additional paid in capital ................................. 4,763.2 4,763.2
Retained earnings .......................................... 1,384.8 956.1
Accumulated other comprehensive income ..................... 1,502.7 442.2
--------- ---------
Total Shareholder's Equity ......................... 7,660.7 6,171.5
--------- ---------
Total Liabilities and Shareholder's Equity ......... $95,827.6 $87,807.0
========= =========
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
3
JOHN HANCOCK LIFE INSURANCE COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------------------------------------
(in millions)
Revenues
Premiums ...................................................... $ 484.4 $ 500.5 $ 956.7 $ 949.3
Universal life and investment-type product fees ............... 153.1 150.0 308.1 298.3
Net investment income ......................................... 942.3 888.8 1,875.4 1,776.5
Net realized investment and other gains (losses), net of
related amortization of deferred policy acquisition
costs, amounts credited to participating pension
contractholders and the policyholder dividend obligation
($49.3 and $(12.6) for the three months ended June 30,
2003 and 2002 and $(0.5) and $(34.9) for the six months
ended June 30, 2003 and 2002, respectively) ................. 78.3 (125.4) 183.7 (211.5)
Investment management revenues, commissions and other fees .... 122.4 138.9 241.6 281.3
Other revenue ................................................. 55.3 48.9 127.4 119.5
------------------- -------------------
Total revenues .......................................... 1,835.8 1,601.7 3,692.9 3,213.4
Benefits and Expenses
Benefits to policyholders, excluding amounts related to net
realized investment and other gains (losses) credited to
participating pension contractholders and the
policyholder dividend obligation ($28.4 and $(3.7) for
the three months ended June 30, 2003 and 2002 and
$(12.9) and $(10.5) for the six months ended June 30,
2003 and 2002, respectively) .............................. 919.7 964.3 1,869.0 1,868.5
Other operating costs and expenses ............................ 350.8 303.2 669.5 634.4
Amortization of deferred policy acquisition costs, excluding
amounts related to net realized investment and other
gains (losses) ($20.9 and $(8.9) for the three months
ended June 30, 2003 and 2002 and $12.4 and $(24.4) for
the six months ended June 30, 2003 and 2002,
respectively) ............................................. 61.5 64.8 131.3 122.5
Dividends to policyholders .................................... 137.5 143.5 270.0 281.8
------------------- -------------------
Total benefits and expenses ............................. 1,469.5 1,475.8 2,939.8 2,907.2
------------------- -------------------
Income before income taxes ...................................... 366.3 125.9 753.1 306.2
Income taxes .................................................... 108.6 24.3 224.4 72.8
------------------- -------------------
Net income ...................................................... $ 257.7 $ 101.6 $ 528.7 $ 233.4
=================== ===================
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
4
JOHN HANCOCK LIFE INSURANCE COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
AND COMPREHENSIVE INCOME
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Shareholder's Outstanding
Stock Capital Earnings Income (Loss) Equity Shares
-----------------------------------------------------------------------------
(in millions, except for outstanding share amounts)
Balance at April 1, 2002 ....................... $ 10.0 $ 4,763.3 $ 729.0 $ 131.6 $ 5,633.9 1,000
Demutualization transaction .................... (0.1) (0.1)
Comprehensive income:
Net income ................................ 101.6 101.6
Other comprehensive income, net of tax:
Net unrealized gains (losses) ........... 113.4 113.4
Net accumulated gains (losses) on cash
flow hedges ........................... 28.0 28.0
Foreign currency translation
adjustment ............................ 0.1 0.1
Minimum pension liability ............... 1.3 1.3
-----------
Comprehensive income ........................... 244.4
Dividend paid to parent company ................ (100.0) (100.0)
----------------------------------------------------------------------------
Balance at June 30, 2002 ....................... $ 10.0 $ 4,763.2 $ 730.6 $ 274.4 $ 5,778.2 1,000
============================================================================
Balance at April 1, 2003 ....................... $ 10.0 $ 4,763.2 $ 1,227.1 $ 757.1 $ 6,757.4 1,000
Comprehensive income:
Net income ................................ 257.7 257.7
Other comprehensive income, net of tax:
Net unrealized gains (losses) ........... 637.3 637.3
Net accumulated gains (losses) on cash
flow hedges ........................... 106.5 106.5
Foreign currency translation
adjustment ............................ 0.1 0.1
Minimum pension liability ................. 1.7 1.7
-----------
Comprehensive income ........................... 1,003.3
Dividend paid to parent company ................ (100.0) (100.0)
----------------------------------------------------------------------------
Balance at June 30, 2003 ....................... $ 10.0 $ 4,763.2 $ 1,384.8 $ 1,502.7 $ 7,660.7 1,000
============================================================================
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
5
JOHN HANCOCK LIFE INSURANCE COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
AND COMPREHENSIVE INCOME - (CONTINUED)
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Shareholder's Outstanding
Stock Capital Earnings Income (Loss) Equity Shares
-------------------------------------------------------------------------
(in millions, except for outstanding share amounts)
Balance at January 1, 2002 .................... $ 10.0 $ 4,763.4 $ 608.2 $ 225.6 $ 5,607.2 1,000
Demutualization transactions .................. (0.2) (0.2)
Comprehensive income:
Net income ............................... 233.4 233.4
Other comprehensive income, net of tax:
Net unrealized gains (losses) .......... 30.3 30.3
Net accumulated gains (losses) on
cash flow hedges ..................... 15.8 15.8
Foreign currency translation
adjustment ........................... 0.2 0.2
Minimum pension liability .............. 2.5 2.5
----------
Comprehensive income .......................... 282.2
Dividend paid to parent company ............... (111.0) (111.0)
-------------------------------------------------------------------------
Balance at June 30, 2002 ...................... $ 10.0 $ 4,763.2 $ 730.6 $ 274.4 $ 5,778.2 1,000
=========================================================================
Balance at January 1, 2003 .................... $ 10.0 $ 4,763.2 $ 956.1 $ 442.2 $ 6,171.5 1,000
Demutualization transactions
Comprehensive income:
Net income ............................... 528.7 528.7
Other comprehensive income, net of tax:
Net unrealized gains (losses) .......... 944.8 944.8
Net accumulated gains (losses) on
cash flow hedges ..................... 112.3 112.3
Foreign currency translation
adjustment ........................... -- --
Minimum pension liability ................ 3.4 3.4
----------
Comprehensive income .......................... 1,589.2
Dividend paid to parent company ............... (100.0) (100.0)
-------------------------------------------------------------------------
Balance at June 30, 2003 ...................... $ 10.0 $ 4,763.2 $ 1,384.8 $ 1,502.7 $ 7,660.7 1,000
=========================================================================
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
6
JOHN HANCOCK LIFE INSURANCE COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
2003 2002
----------------------
(in millions)
Cash flows from operating activities:
Net income .................................................. $ 528.7 $ 233.4
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of discount - fixed maturities ............... (1.8) (41.3)
Net realized investment and other losses .................. (183.7) 211.5
Change in deferred policy acquisition costs ............... (143.6) (126.4)
Depreciation and amortization ............................. 21.4 27.0
Net cash flows from trading securities .................... 0.3 0.6
Increase in accrued investment income ..................... (117.0) (67.4)
Decrease in premiums and accounts receivable .............. 12.8 9.3
Increase in other assets and other liabilities, net ....... (178.4) (98.1)
Increase in policy liabilities and accruals, net .......... 1,182.8 1,120.9
Increase in income taxes .................................. 175.4 18.3
--------- ---------
Net cash provided by operating activities ............ 1,296.9 1,287.8
Cash flows from investing activities:
Sales of:
Fixed maturities available-for-sale ..................... 6,484.2 1,936.1
Equity securities available-for-sale .................... 87.3 169.4
Real estate ............................................. 63.6 35.9
Home Office properties .................................. 887.6 --
Short-term investments and other invested assets ........ 103.2 61.8
Maturities, prepayments and scheduled redemptions of:
Fixed maturities held-to-maturity ....................... 136.0 84.5
Fixed maturities available-for-sale ..................... 1,779.8 1,583.8
Short-term investments and other invested assets ........ 80.2 73.6
Mortgage loans on real estate ........................... 530.6 605.2
Purchases of:
Fixed maturities held-to-maturity ....................... (2.2) (11.8)
Fixed maturities available-for-sale ..................... (11,245.8) (6,526.1)
Equity securities available-for-sale .................... (87.3) (81.5)
Real estate ............................................. (6.7) (3.2)
Short-term investments and other invested assets ........ (514.2) (341.7)
Mortgage loans on real estate issued ...................... (808.8) (816.7)
Net cash received related to acquisition of business ..... 93.7 --
Other, net ................................................ (180.5) (273.3)
--------- ---------
Net cash used in investing activities .................. $(2,599.3) $(3,504.0)
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
7
JOHN HANCOCK LIFE INSURANCE COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
Six Months Ended
June 30,
2003 2002
----------------------
(in millions)
Cash flows from financing activities:
Dividends paid to parent .................................... $ (100.0) $ (111.0)
Universal life and investment-type contract deposits ........ 4,562.5 4,906.3
Universal life and investment-type contract maturities and
withdrawals ............................................... (3,386.9) (2,898.3)
Issuance of consumer notes .................................. 389.9 --
Issuance of short-term debt ................................. 70.8 9.3
Repayment of short-term debt ................................ (114.5) (91.6)
Repayment of long-term debt ................................. (4.1) (13.6)
--------- ---------
Net cash provided by financing activities ............... 1,417.7 1,801.1
--------- ---------
Net increase (decrease) in cash and cash equivalents .... 115.3 (415.1)
Cash and cash equivalents at beginning of year .......... 897.0 1,025.3
--------- ---------
Cash and cash equivalents at end of period .............. $ 1,012.3 $ 610.2
========= =========
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
8
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- Summary of Significant Accounting Policies
Business
John Hancock Life Insurance Company (the Company) is a diversified financial
services organization that provides a broad range of insurance and investment
products and investment management and advisory services. The Company is a
wholly owned subsidiary of John Hancock Financial Services, Inc. (JHFS, or the
Parent).
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, these unaudited consolidated financial statements contain all
adjustments, consisting of only normal and recurring adjustments, necessary for
a fair presentation of the Company's financial position and results of
operations. Operating results for the three and six month periods ended June 30,
2003 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2003. These unaudited consolidated financial statements
should be read in conjunction with the Company's annual audited financial
statements as of December 31, 2002 included in the Company's Form 10-K for the
year ended December 31, 2002 filed with the United States Securities and
Exchange Commission (hereafter referred to as the Company's 2002 Form 10-K). All
of the Company's United States Securities and Exchange Commission filings are
available on the internet at www.sec.gov, under the name Hancock John Life.
The balance sheet at December 31, 2002, presented herein, has been derived from
the audited financial statements at that date but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
The acquisition described under the table below was recorded under the purchase
method of accounting and, accordingly, the operating results have been included
in the Company's consolidated results of operations from the date of
acquisition. The purchase price was allocated to the assets acquired and the
liabilities assumed based on estimated fair values, with the excess of the
applicable purchase price over the estimated fair values, if any, recorded as
goodwill. This acquisition was made by the Company in execution of its plan to
acquire businesses that have strategic value, meet its earnings requirements and
advance the growth of its current businesses.
The disposal described below was conducted in order to execute the Company's
strategy to focus resources on businesses in which it can have a leadership
position. The table below presents actual and proforma data, for comparative
purposes, of revenue and net income for the periods indicated, to demonstrate
the proforma effect of the acquisition and of the disposal as if they both
occurred on January 1, 2002.
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
Proforma 2003 Proforma 2002 Proforma 2003 Proforma 2002
-------------------------------------------------------------------------------------
(in millions)
Revenue ..... $1,822.1 $1,835.8 $1,573.6 $1,601.7 $3,648.1 $3,692.9 $3,155.3 $3,213.4
Net income .. $ 255.8 $ 257.7 $ 101.2 $ 101.6 $ 525.9 $ 528.7 $ 236.9 $ 233.4
Acquisition:
On December 31, 2002, the Company acquired the fixed universal life insurance
business of Allmerica Financial Corporation (Allmerica) through a reinsurance
agreement for approximately $104.3 million. There was no impact on the Company's
results of operations from the acquired insurance business during 2002.
Disposal:
On June 19, 2003, the Company agreed to sell its group life insurance business
through a reinsurance agreement with Metropolitan Life Insurance Company, Inc
(MetLife). The Company is ceding all activity after May 1, 2003 to MetLife. The
transaction was recorded as of May 1, 2003, and is expected to close later in
2003, subject to regulatory approval.
9
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 1 -- Summary of Significant Accounting Policies - (Continued)
Stock-Based Compensation
The Company has two stock-based compensation plans, which are described more
fully in the Company's 2002 Form 10-K. For the periods covered by this report,
the Company applies the recognition and measurement provisions of Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations in accounting for stock-based
compensation grants made prior to January 1, 2003. No compensation expense is
reflected in net income for stock option grants to employees and non-employee
board members of the Company made prior to January 1, 2003. All options granted
under those plans had an exercise price equal to the market value of JHFS common
stock on the date of grant. Prior to January 1, 2003, the Company recognized
compensation expense at the time of the grant or over the vesting period for
grants of non-vested stock to employees and non-employee board members and
grants of stock options to non-employee general agents and has continued this
practice. The Company adopted the fair value provisions of Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation," as of January 1, 2003 and is utilizing the transition provisions
described in SFAS No. 148, on a prospective basis to awards granted after
December 31, 2002. Adoption of the fair value provisions of SFAS No. 123 will
have a material impact on the Company's net income. The Company has adopted the
disclosure provisions of SFAS No. 148. The following table illustrates the pro
forma effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of SFAS No. 123, to all stock-based employee
compensation.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------------- -------------------
(in millions)
Net income, as reported ......................... $257.7 $101.6 $528.7 $233.4
Add: Stock-based employee compensation expense
included in reported net income, net of
related tax effects .......................... 4.0 1.6 12.1 2.9
Deduct: Total stock-based employee
compensation expense determined under fair
value method for all awards, net of related
tax effects .................................. 9.2 13.7 25.9 27.6
------ ------ ------ ------
Proforma net income ............................. $252.5 $ 89.5 $514.9 $208.7
====== ====== ====== ======
Recent Accounting Pronouncements
Statement of Position 03-1 - Accounting and Reporting by Insurance Enterprises
for Certain Nontraditional Long Duration Contracts and for Separate Accounts
On July 7, 2003, the Accounting Standards Executive Committee (AcSEC) of the
American Institute of Certified Public Accountants (AICPA) issued Statement of
Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long Duration Contracts and for Separate Accounts" (SOP 03-1).
SOP 03-1 provides guidance on a number of topics unique to insurance
enterprises, including: separate account presentation, interest in separate
accounts, gains and losses on the transfer of assets from the general account to
a separate account, liability valuation, returns based on a contractually
referenced pool of assets or index, accounting for contracts that contain death
or other insurance benefit features, accounting for reinsurance and other
similar contracts, accounting for annuitization benefits, and sales inducements
to contract holders.
SOP 03-1 will be effective for the Company's financial statements on January 1,
2004. The Company is currently evaluating the impact of adopting SOP 03-1 on its
consolidated financial position, results of operations or cashflows.
Statement of Financial Accounting Standards No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" (SFAS No. 150).
SFAS No.150 changes the accounting for certain financial instruments that, under
previous guidance, issuers could account for as equity. It requires that certain
financial instruments be classified as liabilities on issuer balance sheets,
including those
10
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 1 -- Summary of Significant Accounting Policies - (Continued)
instruments that are issued in shares and are mandatorily redeemable, those
instruments that are not issued in shares but give the issuer an obligation to
repurchase previously issued equity shares, and certain financial instruments
that give the issuer the option of settling an obligation by issuing more equity
shares. SFAS No. 150 is effective immediately for all financial instruments
entered into or modified after May 31, 2003, and otherwise will be effective for
the Company on July 1, 2003. The adoption of SFAS No. 150 will not have a
material impact on the Company's consolidated financial position, results of
operations or cash flows.
SFAS No. 149 - Amendment of Statement No. 133 on Derivative Instruments and
Hedging Activities
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" (SFAS No. 149). SFAS No. 149 amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities (SFAS No. 133). In particular,
SFAS No. 149 clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative, clarifies when a derivative
contains a financing component, amends the definition of an underlying to
conform it to language used in FASB Interpretation No. 45--"Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", and amends certain other existing
pronouncements. Except for certain implementation guidance that is incorporated
in SFAS No. 149 and already effective, SFAS No. 149 is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The adoption of SFAS No. 149 will have no
material impact on the Company's consolidated financial position, results of
operations or cash flows.
FASB Derivative Implementation Group Issue No. 36--Embedded Derivatives:
Bifurcation of a Debt Instrument that Incorporates Both Interest Rate Risk and
Credit Rate Risk Exposures that are Unrelated or Only Partially Related to the
Creditworthiness of the Issuer of that Instrument
In April 2003, the FASB's Derivative Implementation Group (DIG) released SFAS
No. 133 Implementation Issue No. 36, "Embedded Derivatives: Bifurcation of a
Debt Instrument that Incorporates Both Interest Rate Risk and Credit Rate Risk
Exposures that are Unrelated or Only Partially Related to the Creditworthiness
of the Issuer of that Instrument" (DIG B36). DIG B36 addresses whether SFAS
No.133 requires bifurcation of a debt instrument into a debt host contract and
an embedded derivative if the debt instrument incorporates both interest rate
risk and credit risk exposures that are unrelated or only partially related to
the creditworthiness of the issuer of that instrument. Under DIG B36, modified
coinsurance and coinsurance with funds withheld reinsurance agreements as well
as other types of receivables and payables where interest is determined by
reference to a pool of fixed maturity assets or a total return debt index are
examples of arrangements containing embedded derivatives requiring bifurcation.
The effective date of the implementation guidance is October 1, 2003.
The Company has determined that certain of its reinsurance
receivables/(payables) and certain of its insurance products contain embedded
derivatives requiring bifurcation. The Company has not yet determined the fair
value of the related embedded derivatives in these products. Management believes
that accounting for these embedded derivatives in accordance with DIG B36 will
not have a material impact on the Company's consolidated financial position,
results of operations or cash flows.
FASB Interpretation 46--Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51
In January 2003, the FASB issued Interpretation 46, "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51," (FIN 46) which clarifies
the consolidation accounting guidance in Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," (ARB No. 51) as it applies to certain
entities in which equity investors which do not have the characteristics of a
controlling financial interest, or do not have sufficient equity at risk for the
entities to finance their activities without additional subordinated financial
support from other parties. Such entities are known as variable interest
entities (VIEs).
Controlling financial interests of a VIE are identified by the exposure of a
party to the VIE to a majority of either the expected losses or residual rewards
of the VIE, or both. Such parties are primary beneficiaries of the VIEs and FIN
46 requires that the primary beneficiary of a VIE consolidate the VIE. FIN 46
also requires new disclosures for significant relationships with VIEs, whether
or not consolidation accounting is either used or anticipated. The consolidation
11
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 1 -- Summary of Significant Accounting Policies - (Continued)
requirements of FIN 46 apply immediately to VIEs created after January 31, 2003
and to VIEs in which an enterprise obtains an interest after that date. They
apply in the first fiscal year or interim period beginning after June 15, 2003
to VIEs in which an enterprise holds a variable interest that is acquired before
February 1, 2003.
Additional liabilities recognized as a result of consolidating VIEs with which
the Company is involved would not represent additional claims on the general
assets of the Company; rather, they would represent claims against additional
assets recognized by the Company as a result of consolidating the VIEs.
However, it is possible that if we do consolidate some of the Company-managed
CDOs, we may report lower assets and capital in the short-term. Similarly,
additional assets recognized as a result of consolidating these VIEs would not
represent additional assets which the Company could use to satisfy claims
against its general assets, rather they would be used only to settle additional
liabilities recognized as a result of consolidating the VIEs. Refer to Note 4
below, and Note 1 in the Company's 2002 Form 10-K for a more complete discussion
of the Company's relationships with VIEs, their assets and liabilities, and the
Company's maximum exposure to loss as a result of its involvement with them.
On July 1, 2003, FIN 46 became effective for those VIEs which the Company is the
primary beneficiary. The Company has elected to apply the provisions of FIN 46
prospectively, commencing on July 1, 2003 and is currently estimating the impact
on its consolidated financial position, results of operations and cash flows of
consolidating those VIEs for which the Company is the primary beneficiary.
SFAS No. 148--Accounting for Stock-Based Compensation--Transition and
Disclosure, an amendment of FASB Statement No. 123
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123." SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation which is an optional alternative method of accounting presented in
SFAS No. 123, "Accounting for Stock Based Compensation." In addition, SFAS No.
148 amends the disclosure requirements of SFAS No. 123 to require more prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. SFAS No. 148's amendment of the transition and annual
disclosure provisions of SFAS No. 123 is effective for fiscal years ending after
December 2002. The Company adopted the fair value provisions of SFAS No. 123 on
January 1, 2003 and utilized the transition provisions described in SFAS No.
148, on a prospective basis to awards granted after December 31, 2002 for its
participation in JHFS' stock compensation plans. In the first six months of 2003
JHFS granted 630,000 stock options to senior management of the Company and
recorded $0.6 million, net of tax of $0.2 million, of related compensation
expense. The Company has adopted the disclosure provisions of SFAS No. 148, see
Note 1--Summary of Significant Accounting Policies, Stock-Based Compensation
above.
For the periods prior to January 1, 2003, Accounting Principles Board Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees" was applied. APB No. 25
provides guidance on how to account for the issuance of stock and stock options
to employees. The Company adopted APB No. 25 upon its demutualization and IPO
effective February 1, 2000. Compensation cost for stock options, if any, is
measured as the excess of the quoted market price of the Company's stock at the
date of grant over the amount an employee must pay to acquire the stock.
Compensation cost is recognized over the requisite vesting periods based on
market value on the date of grant. APB No. 25 was amended by SFAS No. 123 to
require pro forma disclosures of net income and earnings per share as if a "fair
value" based method was used.
FASB Interpretation No. 45--Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" (FIN 45). FIN 45 requires certain types of guarantees to
be recorded by the guarantor as liabilities at fair value. This differs from
current practice, which generally requires recognition of a liability only when
a potential loss is deemed to be probable and is reasonably estimable in amount.
FIN 45 does not apply to guarantees that are accounted for under existing
insurance accounting principles. FIN 45 requires more extensive disclosures of
certain other types of guarantees, including certain categories of guarantees
which are already accounted for under specialized accounting principles, such as
SFAS No. 133, even when the likelihood of making any payments under the
guarantee is remote.
12
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 1 -- Summary of Significant Accounting Policies - (Continued)
Disclosure requirements are effective for financial statements for interim or
annual periods ending after December 31, 2002. Refer to the Company's 2002 Form
10-K. Initial recognition and initial measurement provisions are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002. The
adoption of FIN 45 had no impact on the Company's consolidated financial
position, results of operations or cash flows.
SFAS No. 146--Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 requires recognition of a
liability for exit or disposal costs, including restructuring costs, when the
liability is incurred rather than at the date of an entity's commitment to a
formal plan of action. SFAS No. 146 applies to one-time termination benefits
provided to current employees that are involuntarily terminated under the terms
of a one-time benefit arrangement. An ongoing benefit arrangement is presumed to
exist if a company has a past practice of providing similar benefits. SFAS No.
146 is effective for exit or disposal activities that are initiated after
December 31, 2002. The adoption of SFAS No. 146 had no impact on the Company's
consolidated financial position, results of operations or cash flows during the
period ended June 30, 2003.
13
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 2 -- Related Party Transactions
Certain directors of the Company are members or directors of other entities that
periodically perform services for or have other transactions with the Company.
Such transactions are either subject to bidding procedures or are otherwise
entered into on terms comparable to those that would be available to unrelated
third parties and are not material to the Company's results of operations,
financial condition, or liquidity.
The Company provides JHFS, its parent, with personnel, property, and facilities
in carrying out certain of its corporate functions. The Company annually
determines a fee (the parent company service fee) for these services and
facilities based on a number of criteria, which are periodically revised to
reflect continuing changes in the Company's operations. The parent company
service fee is included in other operating costs and expenses within the
Company's income statements. The Company charged JHFS service fees of $4.8
million and $5.0 million for the three month periods ended June 30, 2003 and
2002, respectively, and $11.1 million and $ 11.8 million for the six month
periods ended June 30, 2002 and 2001, respectively. As of June 30, 2003, JHFS
was current in its payments to the Company related to these services.
The Company provides certain administrative and asset management services to its
employee benefit plans (the Plans). Fees paid to the Company by the Plans for
these services were $1.2 million and $1.7 million for the three months ended
June 30, 2003 and 2002, respectively, and $2.6 million and $3.6 million for the
six months ended June 30, 2003 and 2002, respectively.
During the first six months of 2003, the Company paid $24.8 million in premiums
to an affiliate, John Hancock Insurance Company of Vermont (JHIC of Vermont) for
certain insurance services. All of these were in Trust Owned Health Insurance
(TOHI) premiums, a funding vehicle for postretirement medical benefit plans,
which offers customers an insured medical benefit-funding program in conjunction
with a broad range of investment options.
The Company has reinsured certain portions of its long term care insurance and
group pension businesses with John Hancock Reassurance Company, Ltd. of Bermuda
(JHReCo), an affiliate and wholly owned subsidiary of JHFS. The Company entered
into these reinsurance contracts in order to facilitate its capital management
process. These reinsurance contracts are primarily written on a funds withheld
basis where the related financial assets remain invested at the Company. As a
result, the Company recorded a liability for coinsurance amounts withheld from
JHReCo of $2,001.8 million and $1,631.5 million at June 30, 2003 and December
31, 2002, respectively, which are included with other liabilities in the
consolidated balance sheets and recorded reinsurance recoverable from JHReCo of
$2,293.7 million and $2,043.7 million at June 30, 2003 and December 31, 2002,
respectively, which are included with other reinsurance recoverables on the
consolidated balance sheets. Premiums ceded to JHReCo were $166.0 million and
$264.3 for the three month periods ended June 30, 2003 and 2002, respectively,
and $283.3 million and $375.1 million for the six month periods ended June 30,
2003 and 2002, respectively.
In the first quarter of 2002, the Company began reinsuring certain portions of
its group pension businesses with an affiliate, JHIC of Vermont. The Company
entered into these reinsurance contracts in order to facilitate its capital
management process. These reinsurance contracts are primarily written on a funds
withheld basis where the related financial assets remain invested at the
Company. As a result, the Company recorded a liability for coinsurance amounts
withheld from JHIC of Vermont of $137.3 million and $98.6 million as of June 30,
2003 and December 31, 2002, respectively, which is included with other
liabilities in the consolidated balance sheets. At June 30, 2003 and December
31, 2002, the Company had not recorded any reinsurance recoverable from JHIC of
Vermont. Reinsurance recoverable is typically recorded with other reinsurance
recoverables on the consolidated balance sheet. Premiums ceded by the Company to
JHIC of Vermont were $0.2 million and $0.3 million for the three months ended
June 30, 2003 and 2002, respectively, and $0.4 million and $0.4 million for the
six months ended June 30, 2003 and 2002, respectively.
14
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 3 -- Segment Information
In the first quarter of 2003, the Company implemented organizational changes
within the Corporate and Other Segment which resulted in the reclassification of
2002 results for the Federal long-tern care insurance business to the Protection
Segment. The reclassification associated with the Federal long-term care
insurance business has no impact on segment after- tax operating income, or net
income of the business. The reclassification increased Protection Segment
after-tax operating income and decreased Corporate and Other Segment after-tax
operating income by $0.2 million and $0.3 million for the three and six month
periods ended June 30, 2002.
The Company operates in the following five business segments: two segments
primarily serve retail customers, two segments serve institutional customers and
our fifth segment is the Corporate and Other Segment, which includes our
international operations, the corporate account and several run-off businesses.
Our retail segments are the Protection Segment and the Asset Gathering Segment.
Our institutional segments are the Guaranteed and Structured Financial Products
Segment (G&SFP) and the Investment Management Segment. For additional
information about the Company's business segments please refer to the Company's
2002 Form 10-K.
The following table summarizes selected financial information by segment for the
periods and dates indicated, and reconcile segment revenues and segment
after-tax operating income to amounts reported in the unaudited consolidated
statements of income. Included in the Protection Segment for all periods
presented are the assets, liabilities, revenues and expenses of the closed
block. For additional information on the closed block, see Note 6 - Closed Block
in the notes to the unaudited consolidated financial statements and the related
footnote in the Company's 2002 Form 10-K.
Amounts reported as segment adjustments in the tables below primarily relate to:
(i) certain net realized investment and other gains (losses), net of
related amortization adjustment for deferred policy acquisition
costs, amounts credited to participating pension contractholder
accounts and policyholder dividend obligation (the adjustment for
net realized investment and other gains (losses) excludes gains and
losses from mortgage securitizations because management views the
related gains and losses as an integral part of the core business of
those operations),
(ii) restructuring costs related to reducing staff in the home office and
terminating certain operations outside the home office in 2002,
costs of this nature are not reported as a segment adjustment for
2003, and
(iii) benefits to policyholders and expenses incurred relating to the
settlement of a class action lawsuit against the Company involving a
dispute regarding disclosure of costs on various modes of life
insurance premium payment.
15
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 3 -- Segment Information - (Continued)
Asset Investment Corporate
Protection Gathering G&SFP Management and Other Consolidated
----------------------------------------------------------------------
(in millions)
As of or for the three months ended
June 30, 2003
Revenues:
Revenues from external customers ... $ 479.5 $ 139.1 $ 15.5 $ 27.9 $ 161.2 $ 823.2
Net investment income .............. 351.0 176.9 412.3 7.5 (5.4) 942.3
Inter-segment revenues ............. -- 0.3 -- 7.7 (8.0) --
----------------------------------------------------------------------
Segment revenues ................... 830.5 316.3 427.8 43.1 147.8 1,765.5
Net realized investment and
other gains (losses), net ........ 26.5 20.2 11.8 -- 11.8 70.3
----------------------------------------------------------------------
Revenues ........................... $ 857.0 $ 336.5 $ 439.6 $ 43.1 $ 159.6 $ 1,835.8
======================================================================
Net Income:
Segment after-tax operating
income ........................... $ 89.1 $ 51.2 $ 67.5 $ 11.5 $ (7.0) $ 212.3
Net realized investment and
other gains (losses), net ........ 17.0 12.8 8.1 -- 7.5 45.4
----------------------------------------------------------------------
Net income ......................... $ 106.1 $ 64.0 $ 75.6 $ 11.5 $ 0.5 $ 257.7
======================================================================
Supplemental Information:
Equity in net income of investees
accounted for by the equity
method ........................... $ 5.8 $ 3.1 $ 11.8 $ 4.0 $ 1.2 $ 25.9
Carrying value of investments
accounted for by the equity
method ........................... 308.9 201.9 505.8 14.4 688.8 1,719.8
Amortization of deferred policy
acquisition costs, excluding
amounts related to net realized
investment and other gains
(losses) ......................... 41.9 19.1 0.6 -- (0.1) 61.5
Segment assets ..................... 34,790.9 18,204.5 36,927.2 2,579.2 3,325.8 95,827.6
16
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 3 -- Segment Information (Continued)
Asset Investment Corporate
Protection Gathering G&SFP Management and Other Consolidated
--------------------------------------------------------------------------
(in millions)
As of or for the three months ended
June 30, 2002
Revenues:
Revenues from external customers .. $ 473.6 $ 145.5 $ 18.0 $ 22.9 $ 180.1 $ 840.1
Net investment income ............. 326.0 140.5 428.7 3.6 (10.0) 888.8
Inter-segment revenues ............ -- -- -- 6.8 (6.8) --
--------------------------------------------------------------------------
Segment revenues .................. 799.6 286.0 446.7 33.3 163.3 1,728.9
Net realized investment and
other gains (losses), net ....... (28.6) (20.7) (86.7) 0.6 8.2 (127.2)
--------------------------------------------------------------------------
Revenues .......................... $ 771.0 $ 265.3 $ 360.0 $ 33.9 $ 171.5 $ 1,601.7
==========================================================================
Net Income:
Segment after-tax operating
income .......................... $ 79.1 $ 40.6 $ 72.1 $ 7.4 $ 4.8 $ 204.0
Net realized investment and
other gains (losses), net ....... (18.6) (13.2) (55.9) 0.5 5.1 (82.1)
Class action lawsuit .............. (18.7) -- -- -- (0.8) (19.5)
Restructuring charges ............. (0.9) (0.5) (0.2) (0.2) 1.0 (0.8)
--------------------------------------------------------------------------
Net income ........................ $ 40.9 $ 26.9 $ 16.0 $ 7.7 $ 10.1 $ 101.6
==========================================================================
Supplemental Information:
Equity in net income of
investees accounted for by the
equity method ................... $ 5.3 $ 2.4 $ 11.4 $ 0.2 $ 0.4 $ 19.7
Carrying amount of investments
accounted for under the
equity method ................... 149.3 103.9 280.1 8.3 616.7 1,158.3
Amortization of deferred policy
acquisition costs, excluding
amounts related to net
realized investment and other
gains (losses) .................. 35.3 28.8 0.7 -- -- 64.8
Segment assets .................... 29,744.6 $15,294.0 33,463.7 2,089.8 2,566.4 83,158.5
17
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 3 -- Segment Information - (Continued)
Asset Investment Corporate
Protection Gathering G&SFP Management and Other Consolidated
-------------------------------------------------------------------------
(in millions)
As of or for the six months ended
June 30, 2003
Revenues:
Revenues from external customers .... $ 962.4 $ 274.7 $ 33.6 $ 49.9 $ 322.7 $ 1,643.3
Net investment income ............... 694.6 342.9 839.6 11.7 (13.4) 1,875.4
Inter-segment revenues .............. -- 0.6 -- 14.1 (14.7) --
-------------------------------------------------------------------------
Segment revenues .................... 1,657.0 618.2 873.2 75.7 294.6 3,518.7
Net realized investment and
other gains (losses), net ......... (5.5) (17.5) (123.5) -- 320.7 174.2
-------------------------------------------------------------------------
Revenues ............................ $ 1,651.5 $ 600.7 $ 749.7 $ 75.7 $ 615.3 $ 3,692.9
=========================================================================
Net Income:
Segment after-tax operating
income ............................ $ 172.2 $ 91.2 $ 144.4 $ 17.1 $ (8.8) $ 416.1
Net realized investment and
other gains (losses), net ......... (3.5) (11.3) (77.3) -- 204.7 112.6
-------------------------------------------------------------------------
Net income .......................... $ 168.7 $ 79.9 $ 67.1 $ 17.1 $ 195.9 $ 528.7
=========================================================================
Supplemental Information:
Equity in net income of
investees accounted for by
the equity method ................. $ 11.0 $ 5.2 $ 19.7 $ 3.9 $ 1.3 $ 41.1
Carrying amount of investments
accounted for using the
equity method ..................... 308.9 201.9 505.8 14.4 688.8 1,719.8
Amortization of deferred policy
acquisition costs, excluding
amounts related to net
realized investment and other
gains (losses) .................... 77.1 53.0 1.1 -- 0.1 131.3
Segment assets ...................... 34,790.9 18,204.5 36,927.2 2,579.2 3,325.8 95,827.6
18
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 3 -- Segment Information - (Continued)
Asset Investment Corporate
Protection Gathering G&SFP Management and Other Consolidated
--------------------------------------------------------------------------
(in millions)
As of or for the six months ended
June 30, 2002
Revenues:
Revenues from external customers ... $ 935.8 $ 297.3 $ 31.1 $ 39.8 $ 345.4 $ 1,649.4
Net investment income .............. 646.4 271.0 848.2 7.6 3.3 1,776.5
Inter-segment revenues ............. -- -- -- 16.5 (16.5) --
--------------------------------------------------------------------------
Segment revenues ................... 1,582.2 568.3 879.3 63.9 332.2 3,425.9
Net realized investment and
other gains (losses), net ........ (57.5) (44.4) (108.2) 0.6 (3.0) (212.5)
--------------------------------------------------------------------------
Revenues ........................... $ 1,524.7 $ 523.9 $ 771.1 $ 64.5 $ 329.2 $ 3,213.4
==========================================================================
Net Income:
Segment after-tax operating
income ........................... $ 149.9 $ 80.6 $ 136.2 $ 12.3 $ 14.3 $ 393.3
Net realized investment and
other gains (losses), net ........ (37.1) (28.0) (69.4) 0.5 (2.0) (136.0)
Class action lawsuit ............... (18.7) -- -- -- (0.8) (19.5)
Restructuring charges .............. (4.1) (1.9) (0.5) (0.2) 2.3 (4.4)
--------------------------------------------------------------------------
Net income ......................... $ 90.0 $ 50.7 $ 66.3 $ 12.6 $ 13.8 $ 233.4
==========================================================================
Supplemental Information:
Equity in net income of investees
accounted for by the equity
method ........................... $ 9.5 $ 5.1 $ 18.8 $ 0.1 $ 11.4 $ 44.9
Carrying amount of investments
accounted for using the
equity method .................... 149.3 103.9 280.1 8.3 616.7 1,158.3
Amortization of deferred policy
acquisition costs, excluding
amounts related to net
realized investment and other
gains (losses) ................... 71.1 50.4 1.1 -- (0.1) 122.5
Segment assets ..................... 29,744.6 15,294.0 33,463.7 2,089.8 2,566.4 83,158.5
19
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 4 -- Relationships with Variable Interest Entities
The Company has relationships with various types of special purpose entities
(SPEs) and other entities, some of which are variable interest entities (VIEs)
as discussed in Note 1--Summary of Significant Accounting Policies above.
Presented below are discussions of the Company's significant relationships with
and certain summarized financial information for these entities.
As explained in Note 1--Summary of Significant Accounting Policies above,
additional liabilities recognized as a result of consolidating VIEs in which the
Company is involved would not represent additional claims on the general assets
of the Company; rather, they would represent claims against additional assets
recognized by the Company as a result of consolidating the VIEs. These
additional liabilities are non-recourse to the general assets of the Company.
Similarly, additional assets recognized as a result of consolidating these VIEs
would not represent additional assets which the Company could use to satisfy
claims against its general assets, rather they would be used only to settle
additional liabilities recognized as a result of consolidating the VIEs.
Collateralized Debt Obligations (CDOs). The Company acts as investment advisor
to certain asset backed investment vehicles, commonly known as collateralized
debt obligations (CDOs). The Company also invests in the debt and/or equity of
these CDOs, and in the debt and/or equity of CDOs managed by others. CDOs raise
capital by issuing debt and equity securities, and use their capital to invest
in portfolios of interest bearing securities. The returns from a CDO's portfolio
of investments are used by the CDO to finance its operations including paying
interest on its debt and paying advisory fees and other expenses. Any net income
or net loss is shared by the CDO's equity owners and, in certain circumstances
where we manage the CDO, positive investment experience is shared by the Company
through variable performance management fees. Any net losses are borne first by
the equity owners to the extent of their investments, and then by debt owners in
ascending order of subordination or are borne by the issuer of separate account
insurance policies See the Company's 2002 Form 10-K for a discussion of separate
account accounting.
If a CDO does not have sufficient controlling equity capital to finance its
expected losses at its origination, in accordance with FASB Interpretation No.
46--"Consolidation of Variable Interest Entities, an interpretation of ARB No.
51" (FIN 46), the CDO is defined as a VIE for purposes of determining and
evaluating the appropriate consolidation criteria. In accordance with FIN 46,
where the Company is the primary beneficiary of the CDO, including being a
manager of the CDO, and the CDO is a VIE, the Company will consolidate the
financial statements of the CDO into its own financial statements as of July 1,
2003. It should be noted that all CDOs are not VIEs.
In accordance with existing consolidation accounting principles, the Company
currently consolidates a CDO only when the Company owns a majority of the CDO's
equity, and will continue this practice for CDOs which are not considered VIEs.
The Company has not yet finalized its determination of whether each CDO should
be considered a VIE, or if each is a VIE, whether the Company would be the
primary beneficiary of each.
Owners of securities of CDOs advised by the Company have no recourse to the
Company's assets in the event of default by the CDO, unless the Company has
guaranteed such securities directly for investors. The Company's risk of loss
from any CDO it manages, or in which it invests, is limited to its investment in
the CDO and any such guarantees it may have made. All of these guarantees are
accounted for under existing insurance industry accounting principles, and the
guaranteed assets are recorded on the Company's consolidated balance sheets, at
their fair value, as separate account assets. The Company believes it is
reasonably possible that it may consolidate one or more of the CDOs which it
manages, or will be required to disclose information about them, or both, as of
September 30, 2003, as a result of adopting FIN 46.
The tables below present summary financial data for CDOs which the Company
manages, and data relating to the Company's maximum exposure to loss as a result
of its relationships with them. The Company has determined that it is not the
primary beneficiary of any CDO in which it invests but does not manage and thus
will not be required to consolidate any of them. Credit ratings are provided by
credit rating agencies, and relate to the debt issued by the CDOs in which the
Company has invested or guaranteed.
20
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 4 -- Relationships with Variable Interest Entities - (Continued)
June 30, December 31,
2003 2002
------------------------
(in millions)
Total size of Company-Managed CDOs
Total assets ...................................... $5,815.4 $6,089.2
======== ========
Total debt ........................................ $3,538.5 $3,574.1
Total other liabilities ........................... 2,253.9 2,432.7
-------- --------
Total liabilities ................................. 5,792.4 6,006.8
Total equity ...................................... 23.0 82.4
-------- --------
Total liabilities and equity ...................... $5,815.4 $6,089.2
======== ========
Maximum exposure of the Company to losses June 30, December 31,
From Company-Managed CDO'S 2003 2002
----------------------------------
(in millions, except percents)
Investment in tranches of Company-Managed CDO's,
by credit rating (Moody's/Standard & Poors):
Aaa/AAA .................................. $197.6 33.5% $380.2 53.8%
Aa/AA .................................... 81.6 13.8 -- --
A/A ...................................... -- -- 14.5 2.1
Baa/BBB .................................. 217.9 37.0 218.0 30.9
Ba/BB .................................... 7.6 1.3 7.0 1.0
B3/B- .................................... -- -- 6.0 0.9
Caa/CCC .................................. 12.2 2.1 -- --
Ca/C ..................................... -- -- -- --
Not rated (equity) ....................... 72.8 12.3 79.8 11.3
------ ------ ------ ------
Total Company exposure ................... $589.7 100.0% $705.5 100.0%
====== ====== ====== ======
The Company has determined that each of its relationships with any CDO in which
it invests but does not manage is not significant, and therefore is not included
in the preceding schedules.
Other. The Company has a number of relationships with a disparate group of
entities (Other Entities), which result from the Company's direct investment in
the equity and/or debt of the Other Entities. Two are energy investment
partnerships, two are investment funds organized as limited partnerships and
three are operating companies (a ski resort developer/operator, a step-van
manufacturer and a steel spring manufacturing company). Subsequent to the
Company's investment in them, the operating companies underwent corporate
reorganizations. The Company is evaluating whether each is a VIE, but considers
it reasonably possible that it may consolidate each of these entities or be
required to disclose information about them, as a result of adopting FIN 46. The
Company has made no guarantees to any other parties involved with these
entities, and has only one outstanding capital commitment to one of the
investment funds. The Company's maximum exposure to loss as a result of its
relationships with these entities is limited to its investment in them and its
capital commitment.
21
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 4 -- Relationships with Variable Interest Entities - (Continued)
The tables below present summary financial data for the Other Entities, and data
relating to the Company's maximum exposure to loss as a result of its
relationships with the Other Entities.
June 30, December 31,
2003 2002
----------------------
(in millions)
Total size of Other Entities (1)
Total assets ........................................ $291.9 $291.7
====== ======
Total debt .......................................... $306.2 309.3
Total other liabilities ............................. 61.1 61.9
------ ------
Total liabilities ................................... 367.3 371.2
Total equity (2) .................................... (75.4) (79.5)
------ ------
Total liabilities and equity ........................ $291.9 $291.7
====== ======
(1) Certain data is reported with up to a six-month delay, due to the
delayed availability of audited financial statements of the Other
Entities.
(2) The negative equity results primarily from the inclusion of the ski
resort operator mentioned previously. This entity has an accumulated
deficit from operations, but is current on its debt service and is
cash flow positive. The total equity shown above has not been
adjusted to remove the portion attributable to other beneficiaries
of these entities.
June 30, December 31,
2003 2002
---------------------
(in millions)
Maximum exposure of the Company to losses from
Other Entities (1)
Combined equity and debt investments in the Other Entities .. $181.1 $171.0
Outstanding capital commitments to Other Entities ........... 43.2 44.2
====== ======
Total Company exposure ...................................... $224.3 $215.2
====== ======
(1) The Company's maximum exposure to loss is limited to its investments
of debt and equity securities of these entities, which are carried
at fair value on the Company's financial statements and its
commitment to provide additional equity as noted above.
Note 5 -- Contingencies
Harris Trust
Since 1983, the Company has been involved in complex litigation known as Harris
Trust and Savings Bank, as Trustee of Sperry Master Retirement Trust No. 2 v.
John Hancock Mutual Life Insurance Company (S.D.N.Y. Civ. 83-5491). After
successive appeals to the Second Circuit and to the U.S. Supreme Court, the case
was remanded to the District Court and tried by a Federal District Court judge
in 1997. The judge issued an opinion in November 2000.
In that opinion the Court found against the Company and awarded the Trust
approximately $13.8 million in relation to this claim together with unspecified
additional pre-judgment interest on this amount from October 1988. The Court
also found against the Company on issues of liability valuation and ERISA law.
Damages in the amount of approximately $5.7 million, together with
22
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 5 -- Contingencies - (Continued)
unspecified pre-judgment interest from December 1996, were awarded on these
issues. As part of the relief, the judge ordered the removal of Hancock as a
fiduciary to the plan. On April 11, 2001, the Court entered a judgment against
the Company for approximately $84.9 million, which includes damages to the
plaintiff, pre-judgment interest, attorney's fees and other costs.
On May 14, 2001 the Company filed an appeal in this case. On August 20, 2002,
the Second Circuit Court of Appeals issued a ruling, affirming in part,
reversing in part, and vacating in part the District Court's judgment in this
case. The Second Circuit Court of Appeals' opinion overturned substantial
portions of the District Court's opinion, representing the vast majority of the
lower court's award of damages and fees, and sent the matter back to the
District Court for further proceedings. The matter remains in litigation, and no
final judgment has been entered.
Notwithstanding what the Company believes to be the merits of its position in
this case, if unsuccessful, its ultimate liability, including fees, costs and
interest, could have a material adverse impact on net income. However, the
Company does not believe that any such liability would be material in relation
to its financial position or liquidity.
Reinsurance Recoverable
On February 28, 1997, the Company sold a major portion of its group insurance
business to UNICARE Life & Health Insurance Company (UNICARE), a wholly owned
subsidiary of WellPoint Health Networks, Inc. The business sold included the
Company's group accident and health business and related group life business and
Cost Care, Inc., Hancock Association Services Group and Tri-State, Inc., all of
which were indirect wholly-owned subsidiaries of the Company. The Company
retained its group long-term care operations. The insurance business sold was
transferred to UNICARE through a 100% coinsurance agreement. The Company remains
liable to its policyholders to the extent that UNICARE does not meet its
contractual obligations under the coinsurance agreement.
Through the Company's group health insurance operations, the Company entered
into a number of reinsurance arrangements in respect of personal accident
insurance and the occupational accident component of workers compensation
insurance, a portion of which was originated through a pool managed by Unicover
Managers, Inc. Under these arrangements, the Company both assumed risks as a
reinsurer, and also passed 95% of these risks on to other companies. This
business had originally been reinsured by a number of different companies, and
has become the subject of widespread disputes. The disputes concern the
placement of the business with reinsurers and recovery of the reinsurance. The
Company is engaged in certain disputes, including a number of related legal
proceedings, in respect of this business. The risk to the Company is that other
companies that reinsured the business from the Company may seek to avoid their
reinsurance obligations. However, the Company believes that it has a reasonable
legal position in this matter. During the fourth quarter of 1999 and early 2000,
the Company received additional information about its exposure to losses under
the various reinsurance programs. As a result of this additional information and
in connection with global settlement discussions initiated in late 1999 with
other parties involved in the reinsurance programs, during the fourth quarter of
1999 the Company recognized a charge for uncollectible reinsurance of $133.7
million, after tax, as its best estimate of its remaining loss exposure. The
Company believes that any exposure to loss from this issue, in addition to
amounts already provided for as of June 30, 2003, would not be material to the
Company's financial position, results of operation or liquidity.
Reinsurance ceded contracts do not relieve the Company from its obligations to
policyholders. The Company remains liable to its policyholders for the portion
reinsured to the extent that any reinsurer does not meet its obligations for
reinsurance ceded to it under the reinsurance agreements. Failure of the
reinsurers to honor their obligations could result in losses to the Company;
consequently, estimates are established for amounts deemed or estimated to be
uncollectible. To minimize its exposure to significant losses from reinsurance
insolvencies, the Company evaluates the financial condition of its reinsurers
and monitors concentration of credit risk arising from similar characteristics
of the reinsurers.
Other Matters
In the normal course of its business operations, the Company is involved with
litigation from time to time with claimants, beneficiaries and others, and a
number of litigation matters were pending as of June 30, 2003. It is the opinion
of management, after consultation with counsel, that the ultimate liability with
respect to these claims, if any, will not materially affect the financial
position, results of operations or liquidity of the Company.
23
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 6 -- Closed Block
In connection with the Company's plan of reorganization for its demutualization
and initial public offering, the Company created a closed block for the benefit
of policies included therein. Additional information regarding the creation of
the closed block and relevant accounting issues is contained in the notes to
consolidated financial statements of the Company's 2002 Form 10-K. The following
table sets forth certain summarized financial information relating to the closed
block as of the dates indicated.
June 30,
2003 December 31,
(unaudited) 2002
-------------------------
(in millions)
Liabilities
Future policy benefits .............................................. $10,603.7 $10,509.0
Policyholder dividend obligation .................................... 552.7 288.9
Policyholders' funds ................................................ 1,504.9 1,504.0
Policyholder dividends payable ...................................... 438.8 432.3
Other closed block liabilities ...................................... 116.5 111.7
-------------------------
Total closed block liabilities .................................... $13,216.6 $12,845.9
-------------------------
Assets
Investments
Fixed maturities:
Held-to-maturity--at amortized cost
(fair value: June 30--$80.1; December 31--$97.1) ................ $ 75.5 $ 86.0
Available-for-sale--at fair value
(cost: June 30--$5,800.2; December 31--$5,580.2) ................ 6,331.4 5,823.2
Equity securities:
Available-for-sale--at fair value
(cost: June 30--$11.6; December 31--$10.5) ...................... 12.2 12.4
Mortgage loans on real estate ....................................... 1,686.2 1,665.8
Policy loans ........................................................ 1,559.3 1,555.1
Short term investments .............................................. -- 25.2
Other invested assets ............................................... 269.7 212.4
-------------------------
Total investments ................................................. 9,934.3 9,380.1
Cash and cash equivalents ........................................... 111.4 244.0
Accrued investment income ........................................... 158.6 156.3
Other closed block assets ........................................... 324.3 327.6
-------------------------
Total closed block assets ......................................... $10,528.6 $10,108.0
-------------------------
Excess of reported closed block liabilities over assets
designated to the closed block .................................... $ 2,688.0 $ 2,737.9
-------------------------
Portion of above representing other comprehensive income:
Unrealized appreciation (depreciation), net of tax of $(185.9)
million and $(84.0) million at June 30 and December 31,
respectively .................................................... 345.2 155.9
Allocated to the policyholder dividend obligation, net of tax of
$187.7 million and $88.8 million at June 30 and December 31,
respectively .................................................... (348.6) (164.9)
-------------------------
Total ......................................................... (3.4) (9.0)
-------------------------
Maximum future earnings to be recognized from closed block
assets and liabilities ............................................ $ 2,684.6 $ 2,728.9
=========================
24
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 6 -- Closed Block - (Continued)
June 30,
2003 December 31,
(unaudited) 2002
----------------------
(in millions)
Change in the policyholder dividend obligation:
Balance at beginning of period ................. $288.9 $251.2
Impact on net income before income taxes ..... (18.8) (70.8)
Unrealized investment gains (losses) ......... 282.6 108.5
----------------------
Balance at end of period ....................... $552.7 $288.9
======================
The following table sets forth certain summarized financial information relating
to the closed block for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
----------------------------------------
(in millions)
Revenues
Premiums ..................................................... $218.8 $231.6 443.2 $468.0
Net investment income ........................................ 161.7 166.7 326.3 333.2
Net realized investment and other gains (losses), net of
amounts credited to the policyholder dividend obligation
of $23.8 million and $3.8 million for the three months
ended June 30, 2003 and 2002, respectively and $(11.2)
million and $(2.6) million for the six months ended June
30, 2003 and 2002, respectively ........................... (1.1) (1.5) (2.3) (2.7)
Other closed block revenues .................................. 0.1 -- 0.1 --
----------------------------------------
Total closed block revenues ................................ 379.5 396.8 767.3 798.5
Benefits and Expenses
Benefits to policyholders .................................... 230.3 251.1 475.9 509.5
Change in the policyholder dividend obligation ............... (3.2) (17.7) (8.7) (35.7)
Other closed block operating costs and expenses .............. (1.9) (0.7) (4.4) (2.2)
Dividends to policyholders ................................... 120.9 127.5 237.9 253.5
----------------------------------------
Total benefits and expenses ................................ 346.1 360.2 700.7 725.1
----------------------------------------
Closed block revenues, net of closed block benefits and
expenses, before income taxes .............................. 33.4 36.6 66.6 73.4
Income taxes, net of amounts credited to the policyholder
dividend obligation of $0.6 million and $(0.1) million
for the three months ended June 30, 2003 and 2002,
respectively and $1.1 million and $(3.1) million for the
six months ended June 30, 2003 and 2002, respectively ..... 11.9 12.5 23.3 25.0
----------------------------------------
Closed block revenues, net of closed block benefits and
expenses, and income taxes ................................. $ 21.5 $ 24.1 $ 43.3 $ 48.4
========================================
25
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 7 -- Severance
During the three and six month periods ended June 30, 2003, the Company
continued its ongoing Competitive Position Project (the project). This project
was initiated in the first quarter of 1999 to reduce costs and increase future
operating efficiency by consolidating portions of the Company's operations and
is expected to continue through at least 2003. The project consists primarily of
reducing staff in the home office and terminating certain operations outside the
home office.
Since the inception of the project, as well as from similar initiatives such as
our information technology outsourcing, approximately 1,500 employees have been
terminated. Benefits paid since the inception of the project were $103.5 million
through June 30, 2003. As of June 30, 2003 and December 31, 2002, the liability
for employee termination costs, included in other liabilities was $12.8 million
and $12.4 million, respectively. Employee termination costs, net of related
curtailment pension and other post employment benefit related gains, are
included in other operating costs and expenses and were $3.2 million and $1.8
million for the three months ended June 30, 2003 and 2002 and $9.4 million and
$6.8 million for the six months ended June 30, 2003 and 2002, respectively. The
total employee termination costs for the six month period ended June 30, 2003
included an estimated $5.0 million for planned terminations related to our
information technology outsourcing.
26
JOHN HANCOCK LIFE INSURANCE COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Note 8 -- Sale/Lease Back Transactions and Other Lease Obligations
On March 14, 2003, the Company sold three of its Home Office complex properties
to Beacon Capital Partners for $910.0 million. As part of the transaction, the
Company entered into a long-term lease of the space it now occupies in those
buildings and plans on continuing to use them as its corporate headquarters. As
a result of the sales-leaseback transaction, the Company recognized a current
realized gain of $271.4 million and a deferred profit of $209.4 million. A
capital lease obligation of $90.0 million was recorded for one of the
properties, which has a 15 year lease term. The other two properties have
operating leases which range from 5 to 12 years. The Company also provided
Beacon Capital Partners with a long-term sublease on the Company's parking
garage.
The future minimum lease payments by year and in the aggregate, under the
capital lease and under noncancelable operating leases related to those three
properties sold under a sales-leaseback transaction and the future sublease
rental income, consisted of the following for 2003:
Noncancelable Income from
Capital Operating Operating
Lease Leases Sub-lease
------------------------------------
(in millions)
2003 .......................................... $ 6.9 $ 29.3 $ 1.3
2004 .......................................... 8.3 34.3 1.3
2005 .......................................... 8.0 33.5 1.3
2006 .......................................... 7.7 32.8 1.3
2007 .......................................... 7.4 32.2 1.3
Thereafter .................................... 54.5 114.9 78.5
------ ------ ------
Total minimum payment ......................... 92.8 $277.0 $ 85.0
====== ======
Amounts representing interest expense ........ (4.1)
------
Present value of net minimum lease payments ... 88.7
Current portion of capital lease obligations .. (3.0)
------
Total ...................................... $ 85.7
======
Note 9 -- Goodwill and Other Intangible Assets
The carrying values of the Company's goodwill and other purchased intangible
assets are presented in the table below as of the dates presented. These assets
are included in other assets in the unaudited consolidated balance sheets.
Additional information about the Company's purchased intangible assets is
provided in the Notes to the Company's 2002 Form 10-K.
June 30, December 31,
2003 2002
---------------------------
(in millions)
Goodwill ......................................... $108.6 $108.6
Management contracts ............................. $ 5.3 $ 5.2
Value of business acquired ....................... $172.2 $177.2
27
JOHN HANCOCK LIFE INSURANCE COMPANY
ITEM 2. MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS
of OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) addresses the financial condition of John Hancock Life
Insurance Company (John Hancock or the Company), a wholly owned subsidiary of
John Hancock Financial Services, Inc. (JHFS, or the Parent), as of June 30,
2003, compared with December 31, 2002, and its consolidated results of
operations for the three and six month periods ended June 30, 2003 and June 30,
2002, and, where appropriate, factors that may affect future financial
performance. This discussion should be read in conjunction with the Company's
MD&A and annual audited financial statements as of December 31, 2002 included in
the Company's Form 10-K for the year ended December 31, 2002 filed with the
Securities and Exchange Commission (hereafter referred to as the Company's 2002
Form 10-K) and unaudited consolidated financial statements and related notes
included elsewhere in this Form 10-Q. All of the Company's United States
Securities and Exchange Commission filings are available on the internet at
www.sec.gov, under the name Hancock John Life.
Statements, analyses, and other information contained in this report
relating to trends in the Company's operations and financial results, the
markets for the Company's products, the future development of the Company's
business, and the contingencies and uncertainties to which the Company may be
subject, as well as other statements including words such as "anticipate,"
"believe," "plan," "estimate," "intend," "will," "should," "may," and other
similar expressions, are "forward-looking statements" under the Private
Securities Litigation Reform Act of 1995. Such statements are made based upon
management's current expectations and beliefs concerning future events and their
potential effects on the Company. Future events and their effects on the Company
may not be these anticipated by management. The Company's actual results may
differ materially from the results anticipated in these forward-looking
statements. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Forward-Looking Statements" included herein for a
discussion of factors that could cause or contribute to such material
differences.
Critical Accounting Policies
General
We have identified the accounting policies below as critical to our
business operations and understanding of our results of operations. For a
detailed discussion of the application of these and other accounting policies,
see Note 1--Summary of Significant Accounting Policies in the Notes to
Consolidated Financial Statements in the Company's 2002 Form 10-K. Note that the
application of these accounting policies in the preparation of this report
requires management to use judgments involving assumptions and estimates
concerning future results or other developments including the likelihood, timing
or amount of one or more future transactions or events. There can be no
assurance that actual results will not differ from those estimates. These
judgments are reviewed frequently by senior management, and an understanding of
them may enhance the reader's understanding of the Company's financial
statements. We have discussed the identification, selection and disclosure of
critical accounting estimates and policies with the Audit Committee of the Board
of Directors.
Consolidation Accounting
In January 2003, the Financial Accounting Standards Board issued
Interpretation 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51," (FIN 46) which clarifies the consolidation
accounting guidance of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," (ARB No. 51) to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. Such
entities are known as variable interest entities (VIEs). The discussion below
describes those entities which the Company has identified as reasonably possible
candidates for consolidation under FIN 46, which requires consolidation as of
July 1, 2003.
The Investment Management Segment of the Company manages invested assets
for customers under various fee-based arrangements. We use a variety of special
purpose entities (SPEs) to hold assets under management for customers under
these arrangements. These entities include investment vehicles commonly known as
collateralized debt obligations (CDOs). In certain cases various business units
of the Company make investments in the equity and/or debt of these entities to
support their insurance liabilities. Results of one of the CDOs are consolidated
with the Company's financial results, while the remaining CDOs are not
consolidated since the Company's equity interest is minor and the Company does
not guarantee payment of the CDOs' liabilities, except for guarantees made to
investors as part of separate account contracts which are already included in
separate account liabilities in the Company's consolidated balance sheets.
The Company has a number of relationships with a disparate group of
entities, which result from the Company's direct investment in their equity
and/or debt. Two of these entities are energy investment partnerships, two are
investment
28
JOHN HANCOCK LIFE INSURANCE COMPANY
funds organized as limited partnerships and three are operating companies (a ski
resort developer/operator, a stepvan manufacturer and a steel spring
manufacturing company). Subsequent to the Company's investment in them, the
operating companies underwent corporate reorganizations. The Company has made no
guarantees to any other parties involved with these entities, and has only one
outstanding capital commitment to one of the investment funds.
The Company is evaluating whether each of these entities is a VIE, and if
so, whether consolidation accounting should be used for each. The Company is
still estimating the future potential impact of consolidating any potential VIE
with which it is involved. However, additional liabilities recognized as a
result of consolidating any of these entities would not represent additional
claims on the general assets of the Company; rather, they would represent claims
against additional assets recognized by the Company as a result of consolidating
the VIEs. However, it is possible that if we do consolidate some of the Company
managed CDOs, we may report lower assets and capital in the short term.
Conversely, additional assets recognized as a result of consolidation would not
represent additional assets which the Company could use to satisfy claims
against its general assets, rather they would be used only to settle additional
liabilities recognized as a result of consolidation. The Company's maximum loss
in relation to these entities is limited to its investments in them, future
capital commitments made, and where the Company is the issuer of separates
account wrap guarantees to third party investors in these entities, the amount
of wrapped investments. Therefore, the Company believes that these transactions
have no impact on the Company's liquidity and capital resources beyond what is
already presented in the consolidated financial statements and notes thereto. It
is the Company's intent to display any consolidated entities clearly on the face
of the balance sheets with appropriate disclosures.
Amortization of Deferred Acquisition Costs
Costs that vary with, and are related primarily to, the production of new
business have been deferred to the extent that they are deemed recoverable. Such
costs include commissions, certain costs of policy issue and underwriting, and
certain agency expenses. Similarly, any amounts assessed as initiation fees or
front-end loads are recorded as unearned revenue. The Company tests the
recoverability of its deferred policy acquisition costs, or DAC, annually with a
model that uses data such as market performance, lapse rates and expense levels.
At June 30, 2003, the Company's DAC asset was $3,247.3 million, or 3.4% of total
assets. We amortize DAC on term life and long-term care insurance ratably with
premiums. We amortize DAC on our annuity products and retail life insurance,
other than term, based on a percentage of the estimated gross profits over the
life of the policies, which are generally twenty years for annuities and thirty
years for life policies. Our estimated gross profits are computed based on
assumptions related to the underlying policies including mortality, lapse,
expenses, and asset growth rates. We amortize DAC and unearned revenue on these
policies at a constant percentage of gross profits over the life of the
policies.
Estimated gross profits, including net realized investment and other gains
(losses), are adjusted periodically to take into consideration the actual
experience to date and assumed changes in the remaining gross profits. When
estimated gross profits are adjusted, we also adjust the amortization of DAC to
maintain a constant amortization percentage over the life of the policies. Our
current estimated gross profits include certain judgments by our actuaries
concerning mortality, lapse and asset growth that are based on a combination of
actual Company experience and historical market experience of equity and fixed
income returns. Short-term variances of actual results from the judgments made
by management can impact quarter to quarter earnings. Our history has shown us
that the actual results over time for mortality, lapse and the combination of
investment returns and crediting rates (referred in the industry as interest
spread) for the life insurance and annuity products have reasonably followed the
long-term historical trends. In recent years, actual results for market
experience, or asset growth, have fluctuated considerably from historical trends
and the long-term assumptions made in calculating expected gross profits.
The effects on the amortization of DAC and unearned revenues of revisions
to estimated gross margins and profits are reflected in earnings in the period
such revisions are made. Expected gross profits or expected gross margins are
discounted at periodically revised interest rates and are applied to the
remaining benefit period. At both June 30, 2003 and December 31, 2002, the
average discount rate was 8.4%, for participating traditional life insurance
products and 6.0% and 6.2% respectively, for universal life products. The total
amortization period was 30 years for both participating traditional life
insurance products and universal life products.
The Company's future assumptions with respect to the expected gross
profits in its variable life insurance business in the Protection Segment and
variable annuity business in the Asset Gathering Segment are 8%, gross of fees
(which are approximately 1% to 2%), for the long-term growth rate assumption and
13% gross of fees on average for the next five years.
29
JOHN HANCOCK LIFE INSURANCE COMPANY
Sensitivity of Deferred Acquisition Costs Amortization. The level of DAC
amortization in the third quarter of 2003 will vary if separate account growth
rates vary from our current assumptions. The table below shows the estimated
increased (decreased) quarterly DAC amortization that will result if actual
separate account growth rates are different than the rates assumed in our DAC
models.
Asset
Protection Gathering Total
---------- --------- -----
(in millions)
18% ........................................ $(0.3) $(1.7) $(2.0)
13% ........................................ -- -- --
8% ........................................ 0.3 1.8 2.1
Benefits to Policyholders
The liability for "future policy benefits" is the largest liability
included in our consolidated balance sheets, 42.0% of total liabilities as of
June 30, 2003. Changes in this liability are generally reflected in the
"benefits to policyholders" caption in our consolidated statements of income.
This liability is primarily comprised of the present value of estimated future
payments to holders of life insurance and annuity products based on certain
management judgments. Reserves for future policy benefits of certain insurance
products are calculated using management's judgments of mortality, morbidity,
lapse, investment performance and expense levels that are based primarily on the
Company's past experience and are therefore reflective of the Company's proven
underwriting and investing abilities. Once these assumptions are made for a
given policy or group of policies, they will not be changed over the life of the
policy unless the Company recognizes a loss on the entire line of business. The
Company periodically reviews its policies for loss recognition and, based on
management's judgment, the Company from time to time may recognize a loss on
certain lines of business. Short-term variances of actual results from the
judgments made by management are reflected in current period earnings and can
impact quarter to quarter earnings.
Investment in Debt and Equity Securities
Impairments on our investment portfolio are recorded as a charge to income
in the period when the impairment is judged by management to occur. See the
General Account Investments section of this document and "Quantitative and
Qualitative Information About Market Risk--Credit Risk" section of this document
for a more detailed discussion of the investment officers' professional
judgments involved in determining impairments and fair values.
Certain of our fixed income securities classified as held-to-maturity and
available-for-sale are not publicly traded, and quoted market prices are not
available from brokers or investment bankers on these securities. The change in
the fair value of the available-for-sale securities is recorded in other
comprehensive income as an unrealized gain or loss. We calculate the fair value
of these securities ourselves through the use of pricing models and discounted
cash flows calling for a substantial level of professional investment management
judgments. Our approach is based on currently available information, including
information obtained by reviewing similarly traded securities in the market, and
we believe it to be appropriate and fundamentally sound. However, different
pricing models or assumptions or changes in relevant current information could
produce different valuation results. The Company's pricing model takes into
account a number of factors based on current market conditions and trading
levels of similar securities. These include current market based factors related
to credit quality, country of issue, market sector and average investment life.
The resulting prices are then reviewed by the pricing analysts and members of
the Controller's Department. Our pricing analysts take appropriate action to
reduce valuation of securities where an event occurs which negatively impacts
the securities' value. Certain events that could impact the valuation of
securities include issuer credit ratings, business climate, management changes,
litigation and government actions, among others.
As part of the valuation process we attempt to identify securities which
may have experienced an other than temporary decline in value, and thus require
the recognition of an impairment. To assist in identifying impairments, at the
end of each quarter our Investment Review Committee reviews all securities where
market value is less than ninety percent of amortized cost for three months or
more to determine whether impairments need to be taken. This committee includes
the head of workouts, the head of each industry team, the head of portfolio
management, the Chief Investment Officer, and the Corporate Risk Officer who
reports to the Chief Financial Officer. The analysis focuses on each company's
or project's ability to service its debts in a timely fashion and the length of
time the security has been trading below cost. The results of this analysis are
reviewed by the Life Company's Committee of Finance, a subcommittee of the Life
Company's Board of Directors, quarterly. To supplement this process, a quarterly
review is made of the entire fixed maturity portfolio to assess credit quality,
including a review of all impairments with the Life Company's Committee of
Finance. See "Management's
30
JOHN HANCOCK LIFE INSURANCE COMPANY
Discussion and Analysis of Financial Condition and Analysis of Financial
Condition and Results of Operations--General Account Investments" section of
this document for a more detailed discussion of this process and the judgments
used therein.
Benefit Plans
The Company annually reviews its pension and other post-employment benefit
plan assumptions for the discount rate, the long-term rate of return on plan
assets, and the compensation increase rate. All assumptions are reviewed with
the Audit Committee.
The assumed discount rate is set in the range of (a) the rate from the
December daily weighted average of long-term corporate bond yields (as published
by Moody's Investor Services for rating categories A, Aa, Aaa, and Baa) less a
5% allowance for expenses and default and (b) the rate from the rounded average
of the prior year's discount rate and the rate in (a) above. The discount rate
in effect for 2003 is 6.75%. A 0.25% increase in the discount rate would
decrease pension benefits Projected Benefit Obligation (PBO) and 2003 Net
Periodic Pension Cost (NPPC) by approximately $65.1 million and $4.9 million
respectively. A 0.25% increase in the discount rate would decrease other post-
employment benefits Accumulated Postretirement Benefit Obligation (APBO) and
2003 Net Periodic Benefit Cost (NPBC) by approximately $18.1 million and $1.2
million, respectively.
The assumed long-term rate of return on plan assets is generally set at
the long-term rate expected to be earned (based on the Capital Asset Pricing
Model and similar tools) based on the long-term investment policy of the plans
and the various classes of the invested funds. For 2003, net periodic pension
(and benefit) cost, an 8.75% long term rate of return assumption is being used.
A 0.25% increase in the long-term rate of return would decrease 2003 NPPC by
approximately $4.6 million and 2003 NPBC by approximately $0.5 million. The
expected return on plan assets is based on the fair market value of the plan
assets as of December 31, 2002. The target asset mix of the plan is: 50%
domestic stock, 15% international stock, 10% private equity, and 25% fixed
income.
The compensation rate increase assumption is generally set at a rate
consistent with current and expected long-term compensation and salary policy;
including inflation. A change in the compensation rate increase assumption can
be expected to move in the same direction as a change in the discount rate. A
0.25% decrease in the salary scale would decrease pension benefits PBO and NPPC
by approximately $8.3 million and $1.2 million respectively. Post employment
benefits are independent of compensation.
The Company uses a 5% corridor for the amortization of actuarial
gains/losses. Actuarial gains/losses are amortized over approximately 13 years
for pension costs and over approximately 13 years for other benefit costs.
Prior service costs are amortized over approximately 9 years for pension
costs and over approximately 17 years for benefit costs.
Income Taxes
Our reported effective tax rate on net income was 29.6% and 29.8% for the
three and six months ended June 30, 2003 compared to 19.3% and 23.8% for the
three and six months ended June 30, 2002. Our effective tax rate is based on
expected income, statutory tax rates and tax planning opportunities available to
us. Significant judgment is required in determining our effective tax rate and
in evaluating our tax positions. We establish reserves when, despite our belief
that our tax return positions are fully supportable, we believe that certain
positions are likely to be challenged and that we may not succeed. We adjust
these reserves in light of changing facts and circumstances, such as the
progress of a tax audit. Our effective tax rate includes the impact of reserve
provisions and changes to reserves that we consider appropriate, as well as
related interest. This rate is then applied to our year-to-date operating
results.
Tax regulations require certain items to be included in the tax return at
different times than those items are reflected in the financial statements. As a
result, our effective tax rate reflected in our financial statements is
different than that reported in our tax return. Some of these differences are
permanent, such as affordable housing tax credits, and some are temporary
differences, such as depreciation expense. Temporary differences create deferred
tax assets and liabilities. Deferred tax assets generally represent items that
can be used as a tax deduction or credit in our tax return in future years for
which we have already recorded the tax benefit in our income statement. Our
policy is to establish valuation allowances for deferred tax
31
JOHN HANCOCK LIFE INSURANCE COMPANY
assets when the amount of expected future taxable income is not likely to
support the use of the deduction or credit. Deferred tax liabilities generally
represent tax expense recognized in our financial statements for which payment
has been deferred or expense for which we have already taken a deduction on our
tax return, but have not yet recognized as expense in our financial statements.
A number of years may elapse before a particular matter, for which we have
established a reserve, is audited and finally resolved. The Internal Revenue
Service is currently examining our tax returns for 1996 through 1998.
While it is often difficult to predict the final outcome or the timing of
resolution of any particular tax matter, we believe that our reserves reflect
the probable outcome of known tax contingencies. Our tax reserves are presented
in the balance sheet within other liabilities.
Reinsurance
We reinsure portions of the risks we assume for our protection products.
The maximum amount of individual ordinary life insurance retained by us on any
life is $10 million under an individual policy and $20 million under a
second-to-die policy. As of January 1, 2001, we established additional
reinsurance programs, which limit our exposure to fluctuations in life claims
for individuals for whom the net amount at risk is $3 million or more. As of
January 1, 2001, the Company entered into an agreement with two reinsurers
covering 50% of its closed block business. The treaties are structured so they
will not affect policyholder dividends or any other financial items reported
within the closed block, which was established at the time of the Life Company's
demutualization to protect the reasonable dividend expectations of certain
participating life insurance policyholders.
In addition, the Company has entered into reinsurance agreements to
specifically address insurance exposure to multiple life insurance claims as a
result of a catastrophic event. The Company has put into place, effective July
1, 2002, catastrophic reinsurance covering both individual and group policies
written by all of its U.S. life insurance subsidiaries. Effective July 1, 2003,
the deductible for individual and group coverages combined was reduced from $25
million to $17.5 million per occurrence and the limit of coverage is $40 million
per occurrence. Both the deductible and the limit apply to the combined U.S.
insurance subsidiaries. The Company has supplemented this coverage by reinsuring
all of its accidental death exposures in excess of $100,000 per life under its
group life insurance coverages, and 50% of such exposures below $100,000. Should
catastrophic reinsurance become unavailable to the Company in the future, the
absence of, or further limitations on, reinsurance coverage, could adversely
affect the Company's future net income and financial position.
By entering into reinsurance agreements with a diverse group of highly
rated reinsurers, we seek to control our exposure to losses. Our reinsurance,
however, does not discharge our legal obligations to pay policy claims on the
policies reinsured. As a result, we enter into reinsurance agreements only with
highly rated reinsurers. Nevertheless, there can be no assurance that all our
reinsurers will pay the claims we make against them. Failure of a reinsurer to
pay a claim could adversely affect our business, financial condition or results
of operations.
Our long-term care business units reinsure with John Hancock Reassurance
Company, LTD (JHReCo), a wholly owned subsidiary of JHFS. Group Long Term Care
ceded 50% of their inforce business prior to 1997 to JHReC0 in 2001 (up from 40%
in 2000 and 30% in 1999) and 50% of all new business effective in 1997 and
later. Retail Long-Term Care also cedes business to JHReCo; 50% of all new
business 1997 and later is ceded to JHReCo and 50% of business assumed from
Fortis in retro-ceded to JHReCo.
Our non-traditional life insurance business reinsures with JHReCo 100% of
the risk associated with the no lapse guarantee benefit present in the
protection universal life insurance products. This reinsurance agreement was
effective in 2001 and includes policies issued in years 2001 and later. In
addition, the traditional life insurance business entered into a reinsurance
agreement with JHReCo to reinsure 50% of its retained level premium term
business written by the Company's subsidiary, John Hancock Variable Life
Insurance Company. The agreement was effective in 2002 and includes inforce
policies.
Economic Trends
Economic trends impact profitability and sales of the Company's by
products. The impact of economic trends on the Company's profitability are
similar to their impact on the financial markets. The Company estimates that a
1% increase (decrease) in interest rates occurring evenly over a twelve month
period, or an estimated 8 basis points per month, would increase (decrease)
segment after tax operating income by approximately $4 million, and a 5%
increase (decrease) in equity markets occurring evenly over a twelve month
period, or an estimated 42 basis points per month, would increase (decrease)
segment after tax operating income by approximately $10 million.
32
JOHN HANCOCK LIFE INSURANCE COMPANY
The sales and other financial results of our retail business over the last
several years have been affected by general economic and industry trends.
Variable products, including variable life insurance and variable annuities,
until 2001 had accounted for the majority of recent increases in total premiums
and deposits for the insurance industry as a result of the strong equity market
growth in those years and the "baby boom" generation reaching its high-earnings
years and seeking tax-advantaged investments to prepare for retirement. This
trend has changed due to fluctuations in stock market performance and we have
seen investors return to fixed income products. Our diverse distribution network
and product offerings will assist in the maintenance of assets and provide for
sales growth. Although sales of traditional whole life insurance products have
experienced continued declines, sales of fixed annuity products and corporate
owned life insurance have increased. Universal life sales have also increased
for the Company and for the industry as a whole, due in part to the market's
demand for products of a fixed nature. Term life sales have increased over the
past few years, as consumer continue to seek lower cost options to solving their
protection needs. With respect to our long-term care insurance products,
premiums have increased due to the aging of the population and the expected
inability of government entitlement programs to meet their medical needs in
retirement.
Premiums and deposits of our individual annuity products decreased from a
strong prior year by 13.5% to $750.7 million for the three months ended June 30,
2003. Annuity premiums and deposits increased 2.0% to $1,829.3 million for the
six month period ended June 30, 2003. Premiums and deposits on our long-term
care insurance increased 9.2%, to $129.2 million and 16.0%, to $255.1 million
for the three and six month periods ended June 30, 2003 due to strong growth in
the business and increasing renewal premiums, while our variable life insurance
product deposits in 2003 decreased 14.1%, to $211.6 million and 17.7%, to $439.2
million, for the same time periods. The average policyholder account value in
the universal life insurance product line increased $878.8 million, or 32.2% and
$1,186.0, or 42.0% for the three and six month period ended June 30, 2003 from
the comparable periods, due to underlying growth and the December 31, 2002
acquisition of Allmerica's fixed universal life insurance business. Despite
continued volatility in the equity markets during 2003, mutual fund deposits
increased $608.6 million or 65.1% to $1,543.4 million and $707.7 million or
39.0% to $2,524.5 million for the three and six month periods ended June 30,
2003, respectively, due to sales of the John Hancock Preferred Income series of
closed end funds. However, redemptions increased $504.4 million, or 41.4%, to
$1,723.6 million and $318.5 million, or 13.4% to $2,691.9 million for the three
and six month periods ended June 30, 2003. The increase was primarily due to the
redemption of a large institutional advisory account in the second quarter,
partially offset by declines in redemptions of mutual funds. We have reduced
operating expenses to protect profit margins as we work to stabilize and grow
assets under management in the mutual funds business. However, our mutual fund
operations are impacted by general market trends, and a continued downturn in
the mutual fund market may negatively affect our future operating results.
Recent economic and industry trends also have affected the sales and
financial results of our institutional business. Sales of fund-type products
decreased 56.4% or $486.7 million and 47.6% or $1,129.9 million for the three
and six months ended June 30, 2003. The decrease was driven by decreasing demand
for GICs and increased market competition. Premiums on group annuity products
were down due to market competition and the low level of interest rates. We
continue to look for opportunistic sales in the single premium group annuity
market where our pricing standards are met. Partially offsetting the decrease in
sales was the introduction of SignatureNotes, a new product launched in late
2002 which generated sales of $405.2 million in 2003. SignatureNotes is designed
to generate sales from the conservative retail investor looking for protection
of principal and stable returns. The investment management services we provide
to domestic and international institutions include services and products such as
investment advisory client portfolios, individually managed and pooled separate
accounts, registered investment company funds, bond and mortgage
securitizations, collateralized bond obligation funds and mutual fund management
capabilities. Assets under management of our Investment Management Segment
increased to $29,485.2 million as of June 30, 2003 from $27,491.4 million as of
December 31, 2002.
33
JOHN HANCOCK LIFE INSURANCE COMPANY
Transactions Affecting Comparability of Results of Operations
The acquisition described under the table below was recorded under the
purchase method of accounting and, accordingly, the operating results have been
included in the Company's consolidated results of operations from the date of
acquisition. The purchase price was allocated to the assets acquired and the
liabilities assumed based on estimated fair values, with the excess of the
applicable purchase price over the estimated fair values, if any, recorded as
goodwill. This acquisition was made by the Company in execution of its plan to
acquire businesses that have strategic value, meet its earnings requirements and
advance the growth of its current businesses.
The disposal described below was conducted in order to execute the
Company's strategy to focus resources on business in which it can have a
leadership position. The table below presents actual and proforma data, for
comparative purposes, of revenue, net income and earnings per share for the
periods indicated, to demonstrate the proforma effect of the acquisition and of
the disposal as if it occurred on January 1, 2002.
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
Proforma 2003 Proforma 2002 Proforma 2003 Proforma 2002
----------------------------------------- -----------------------------------------
(in millions)
Revenue ..... $1,822.1 $1,835.8 $1,573.6 $1,601.7 $3,648.1 $3,692.9 $3,155.3 $3,213.4
Net income .. $ 255.8 $ 257.7 $ 101.2 $ 101.6 $ 525.9 $ 528.7 $ 236.9 $ 233.4
Acquisition:
On December 31, 2002, the Company acquired the fixed universal life
insurance business of Allmerica Financial Corporation (Allmerica) through a
reinsurance agreement for approximately $104.3 million. There was no impact on
the Company's results of operations from the acquired insurance business during
2002.
Disposal:
On June 19, 2003, the Company agreed to sell its group life insurance
business through a reinsurance agreement with Metropolitan Life Insurance
Company, Inc (MetLife). The Company is ceding all activity after May 1, 2003 to
MetLife. The transaction was recorded as of May 1, 2003 and is expected to close
later in 2003, subject to regulatory approval.
34
JOHN HANCOCK LIFE INSURANCE COMPANY
Results of Operations
The table below presents the consolidated results of operations for the
periods presented.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------------- -------------------
(in millions)
Revenues
Premiums ........................................................... $ 484.4 $ 500.5 $ 956.7 $ 949.3
Universal life and investment-type product fees .................... 153.1 150.0 308.1 298.3
Net investment income .............................................. 942.3 888.8 1,875.4 1,776.5
Net realized investment and other gains (losses), net of
related amortization of deferred policy acquisition costs,
amounts credited to participating pensions contractholders and
the policyholder dividend obligation (1) ........................ 78.3 (125.4) 183.7 (211.5)
Investment management revenues, commissions, and other fees ........ 122.4 138.9 241.6 281.3
Other revenue ...................................................... 55.3 48.9 127.4 119.5
------------------- -------------------
Total revenues ........................................... 1,835.8 1,601.7 3,692.9 3,213.4
Benefits and expenses
Benefits to policyholders, excluding amounts related to net
realized investment and other gains (losses) credited
to participating pension contractholders and the
policyholder dividend obligation (2) ............................ 919.7 964.3 1,869.0 1,868.5
Other operating costs and expenses ................................. 350.8 303.2 669.5 634.4
Amortization of deferred policy acquisition costs, excluding
amounts related to net realized investment and other gains
(losses) (3) .................................................... 61.5 64.8 131.3 122.5
Dividends to policyholders ......................................... 137.5 143.5 270.0 281.8
------------------- -------------------
Total benefits and expenses .............................. 1,469.5 1,475.8 2,939.8 2,907.2
Income before taxes ................................................ 366.3 125.9 753.1 306.2
Income taxes ....................................................... 108.6 24.3 224.4 72.8
------------------- -------------------
Net income ............................................... $ 257.7 $ 101.6 $ 528.7 $ 233.4
=================== ===================
(1) Net of related amortization of deferred policy acquisition costs, amounts
credited to participating pension contractholders and the policyholder
dividend obligation of $49.3 million and $(12.6) million for the three
months ended June 30, 2003 and 2002, and $(0.5) million and $(34.9)
million for the six months ended June 30, 2003 and 2002, respectively.
(2) Excluding amounts related to net realized investment and other gains
(losses) credited to participating pension contractholders and the
policyholder dividend obligation of $28.4 million and $(3.7) million for
the three months ended June 30, 2003 and 2002, and $(12.9) million and
$(10.5) million for the six months ended June 30, 2003 and 2002,
respectively.
(3) Excluding amounts related to net realized investment and other gains
(losses) of $20.9 million and $(24.4) million for the three months ended
June 30, 2003 and 2002, and $12.4 million and $(8.9) million for the six
months ended June 30, 2003, respectively.
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
During the first quarter of 2003, the Company implemented an
organizational change within the Corporate and Other Segment which resulted in
the reclassification of the 2002 results for the Federal long-term care
insurance business to the Protection Segment. The following discussion presents
the results of our segments on a basis consistent across periods with the new
organization structure. The reclassification associated with the Federal
long-term care insurance business has no impact on segment after-tax operating
income, or net income of the business. The reclassification increased Protection
Segment after-tax
35
JOHN HANCOCK LIFE INSURANCE COMPANY
operating income and decreased Corporate and Other Segment after-tax operating
income by $0.2 million for the three month period ended June 30, 2002.
Consolidated income before income taxes increased 190.9%, or $240.4
million, from the prior year. The increase was driven by growth in income before
income taxes of $91.2 in the Protection Segment, $90.1 million in the Guaranteed
and Structured Financial Products (G&SFP) Segment, $56.9 million in the Asset
Gathering Segment and $6.9 million in the Investment Management Segment.
Partially offsetting these increases was a decrease of $4.7 million in the
Corporate and Other Segment. The increase in the consolidated income before
income taxes was driven by a $203.7 million improvement in net realized
investment and other gains and losses compared to the prior year. The
improvement in net realized investment gains and losses was driven by the $98.6
million increase in the G&SFP Segment, $55.2 million in the Protection Segment,
and $40.8 million in the Asset Gathering Segment.
Revenues increased 14.6%, or $234.1 million, from the prior year. The
increase in revenues was driven by the aforementioned increase in net realized
investment and other gains and losses compared to the prior year. Consolidated
net realized investment and other gains increased 162.4%, or $203.7 million,
from the prior year. See detail of current period net realized investment and
other gains (losses) in table below. The change in net realized investment and
other gains is the result of gains on disposal of fixed maturity securities of
$259.3 million and gains on disposals of equity securities of $8.7 million. The
net realized investment and other gains on the sale of fixed maturity securities
was partially offset by other than temporary declines in value of other fixed
maturity securities of $91.4 million and equity securities of $7.7 million. The
largest impairments were $25.0 million relating to a toll road, $13.6 million
relating to an Australian mining company, and $11.0 million relating to a
utility brought into the bankruptcy of its parent. For additional analysis
regarding net realized investment and other gains (losses), see General Account
Investments in the MD&A.
Net Realized
Gross Gain Gross Loss Hedging Investment
For the Three Months Ended June 30, 2003 Impairment on Disposal on Disposal Adjustments and Other Gain (Loss)
-------------------------------------------------------------------------
(in millions)
Fixed maturity securities (1) (2) ..... $ (91.4) $ 259.3 $ (10.1) $(79.7) $ 78.1
Equity securities ..................... (7.7) 8.7 -- -- 1.0
Mortgage loans on real estate ......... -- 16.4 (3.8) (12.0) 0.6
Real estate ........................... -- (5.7) (2.8) -- (8.5)
Other invested assets ................. (1.1) 0.1 (5.8) -- (6.8)
Derivatives ........................... -- -- -- 63.2 63.2
-------------------------------------------------------------------------
Subtotal $(100.2) $ 278.8 $ (22.5) $(28.5) $ 127.6
=========================================================================
Amortization adjustment for deferred policy acquisition costs ................. (20.9)
Amounts credited to participating pension contractholders ..................... (4.8)
Amounts credited to the policyholder dividend obligation ...................... (23.6)
---------------------
Total .................................................................... $ 78.3
=====================
(1) Fixed Maturities gain on disposals includes $48.7 million of gains from
previously impaired securities.
(2) Fixed Maturities loss on disposals includes $5.7 million of credit related
losses.
The hedging adjustments in the fixed maturities and mortgage loans asset
classes are non-cash adjustments representing the amortization or reversal of
prior fair value adjustments on assets in those classes that were or are
designated as hedged items in a fair value hedge. When an asset or liability is
so designated, its cost basis is adjusted in response to movements in interest
rates. These adjustments are non-cash and reverse with the passage of time as
the asset or liability and derivative mature. The hedging adjustments on the
derivatives represent non-cash adjustments on derivative instruments and on
assets and liabilities designated as hedged items reflecting the change in fair
value of those items.
Premiums decreased 3.2%, or $16.1 million, from the prior year. The
decrease in premiums was driven by the Corporate and Other Segment which
declined 18.8%, or $23.4 million, driven by the sale of the group life business.
Premiums also decreased in the G&SFP Segment 41.0%, or $2.5 million, driven by
lower fee-based product premiums. In addition, premiums in the Protection
Segment decreased $0.2 million, driven the run off of the closed block partially
offset by growth in the long-term care business. These declines in premiums were
partially offset by an increase in the Asset Gathering Segment of $10.0 million
driven by the fixed annuity business.
Universal life and investment-type product fees increased 2.1%, or $3.1
million. The increase in product fees was driven by the Protection Segment,
where product fees improved 3.5%, or $3.8 million. Protection Segment product
fees increased due to the non-traditional life insurance business where product
fees increased of 59.9%, or $11.5 million, driven by growth
36
JOHN HANCOCK LIFE INSURANCE COMPANY
of the existing business and the acquisition of the Allmerica fixed universal
life insurance business as of December 31, 2002. Average account balance in the
non-traditional life insurance business increased 11.2%, or $958.7 million, also
due to the underlying growth and the Allmerica acquisition, partially offset by
the effect of poor 2002 separate account performance. In G&SFP product fees
increased 5.2%, or $0.6 million, due to higher asset-based fees. Partially
offsetting these increases in product fees was a decline in Asset Gathering
Segment's product fees. Asset Gathering Segment's product fees declined 4.2%, or
$1.3 million, on lower variable annuity account balances. Average account
balances in the variable annuity business decreased by 11.5%, or $683.0 million.
Net investment income increased 6.0%, or $53.5 million, from the prior
year. The growth in net investment income was driven by the Asset Gathering
Segment which increased 25.9%, or $36.4 million, on growth on the fixed annuity
business. Average invested assets in the fixed annuity business increased 35.7%,
or $2,728.5 million, while earned rates decreased by approximately 56 basis
points. See additional analysis in the Asset Gathering Segment MD&A. In
addition, net investment income increased in the Protection Segment by 7.7%, or
$25.0 million, driven by the non-traditional life insurance business.
Non-traditional life insurance net investment income increased 25.8%, or $15.7
million, driven by growth of the existing business and the acquisition of the
Allmerica fixed universal life insurance business as of December 31, 2002. Net
investment income increased $3.9 million in the Investment Management Segment.
In addition, net investment income improved in the Corporate and Other Segment
driven by a decrease in the lease residual management investments. These
increases in net investment income were partially offset by a decline in the
G&SFP Segment. G&SFP Segment net investment income declined by 3.8%, or $16.4
million, due to a decline in the average investment yield on invested assets to
5.82% for the current period. The decline in yield is impacted by the
fluctuation of the return on approximately $12 billion of the G&SFP Segment
asset portfolio which floats with market rates. The floating rate exposure on
our asset portfolio is managed to match the floating rate exposure on our
liability portfolio. For additional analysis of net investment income and yields
see the General Account Investments section of this MD&A.
Advisory fees decreased 11.9%, or $16.5 million, from the prior year. The
decrease in fees was driven by the Asset Gathering Segment which decreased
13.0%, or $14.3 million, driven by the mutual funds business. The mutual funds
business management advisory fees declined $12.4 million driven by a decline in
average assets under management of 3.4%, or $935.5 million. Advisory fees as
percentage of assets under management decreased 5 basis points due to an
increase in institutional and closed-end fund assets under management as a
percent of total asset under management. Institutional and closed-end fund
assets are generally charged lower fees than retail assets.
Other revenue increased 13.1%, or $6.4 million, from the prior year. The
Company's other revenue is largely made up of Signature Fruit in the Corporate
and Other Segment. The increase in other revenue is driven by the $6.3 million
increase at Signature Fruit which generated revenue of $52.8 million in the
current period. Other revenue also increased in the Protection Segment by $2.3
million due to the Federal long-term care insurance business which officially
began operation on October 1, 2002. The Federal long-term care insurance
business is a fee business where the Company administers and supports employee
long-term care insurance benefits offered by the Federal Government to its
employees.
Benefits to policyholders decreased 4.6%, or $44.6 million, from the prior
year. The decrease in benefits to policyholders was driven by the Corporate and
Other Segment which declined 33.1%, or $38.4 million, driven by the sale of the
group life business. In addition, the G&SFP Segment declined 10.5%, or
$31.4 million. Lower benefits to policyholders in the G&SFP Segment were driven
by the spread-based business where interest credited decreased $19.7 million due
to a decline in the average crediting rate on account balances resulting from
the reset on floating rate liabilities.
Partially offsetting these decreases in benefits to policyholders was an
increase in the Asset Gathering Segment. The Asset Gathering Segment benefits to
policyholders increased 23.2%, or $24.8 million, due to growth in the fixed
annuity business. The growth in the fixed annuity business was driven by
increased benefits reserves and increased interest credited. The increase in
fixed benefit reserves were driven by a $10.0 million increase in premiums. The
increase in interest credited was driven by a 33.1%, or $2,445.4 million, growth
in average invested assets despite a decrease in the crediting rate of 79 basis
points. The Protection Segment increased $0.4 million driven by the growth in
reserves due to premium growth in the long-term care insurance business. This
increase was partially offset by the inclusion of $30.0 million in benefits to
policyholders from the settlement of the modal premiums class action lawsuit in
the prior year.
Operating costs and expenses increased 15.7%, or $47.6 million. Included
in the Company's operating costs and expenses are all the operating expenses of
Signature Fruit in the Corporate and Other Segment. The increase in operating
costs and expenses was driven by the Corporate and Other Segment, which
increased 47.0%, or $29.6 million, due to increases in the corporate account and
Signature Fruit. The corporate account increases in expenses were driven by a
$12.8 million increase in deficiency interest and $7.3 million increase in the
net periodic pension costs. Signature Fruit expenses increased $4.0 million to
$53.8 million. In addition, operating costs and expenses increased 63.2%, or
$21.1 million in the
37
JOHN HANCOCK LIFE INSURANCE COMPANY
G&SFP Segment due to an increased level of reinsurance arrangements combined
with compensation costs. Operating costs and expenses increased $2.4 million in
the Investment Management Segment due to higher compensation costs. Also
included in other operating costs and expenses is $5.0 million for planned
terminations related to the information technology outsourcing as well as other
initiatives and curtailment and other post employment benefit related gains of
$3.2 million compared to $1.8 million in the prior year. See Note 7 - Severance
to the unaudited consolidated financial statements. Partially offsetting these
increase in operating costs and expenses was a decline in the Protection Segment
of $4.5 million or 4.8% due to lower selling expenses. Asset Gathering Segment
operating costs and expenses declined by 1.1%, or $1.0 million, driven by the
mutual funds business due to cost control measures and decreased amortization of
deferred selling commissions due to lower mutual fund redemptions. In addition,
Signator and Essex, two of the Company's distribution subsidiaries in the Asset
Gathering Segment, experienced lower commission expense on lower load mutual
fund sales compared to the prior year.
Amortization of deferred policy acquisition costs decreased 5.1%, or $3.3
million, from the prior year. The decrease in amortization of deferred policy
acquisition costs was driven by the Asset Gathering Segment which decreased
33.7%, or $9.7 million from the prior year. Our variable annuity businesses
experienced lower amortization of deferred policy acquisition costs of
approximately 107.5%, or $14.4 million. Amortization in the variable annuity
business decreased due to improved separate account performance during the
period. Amortization increased in the fixed annuity business by $4.6 million due
to account growth on the business compared to the prior year, interest spreads
improved compared to the prior year. Partially offsetting the declines in
amortization of deferred policy acquisition costs was an increase in
amortization in the Protection Segment of $6.6 million, or 18.7% driven by
growth in the long-term care and non-traditional life insurance businesses.
Dividends to policyholders decreased 4.2%, or $6.0 million, from the prior
year. The decrease in dividends to policyholders was driven by the Protection
Segment, which declined 5.7%, or $7.6 million, due to a decrease in the dividend
scale on traditional life insurance products effective the beginning of this
year.
Income taxes were $108.6 million in 2003, compared to $24.3 million for
2002. Our effective tax rate was 29.6% in 2003, compared to 19.3% in 2002. The
higher effective tax rate was primarily due to increased capital gains,
partially offset by increased affordable housing tax credits.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
During the first quarter of 2003, the Company implemented an
organizational change within the Corporate and Other Segment which resulted in
the reclassification of the 2002 results for the Federal long-term care
insurance business to the Protection Segment. The following discussion presents
the results of our segments on a basis consistent across periods with the new
organization structure. The reclassification associated with the Federal
long-term care insurance business has no impact on segment after-tax operating
income, or net income of the business. The reclassification increased Protection
Segment after-tax operating income and decreased Corporate and Other Segment
after-tax operating income by $0.3 million for the six month period ended June
30, 2002.
Consolidated income before income taxes increased 146.0%, or $446.9
million, from the prior year. The increase was driven by growth in income before
income taxes of $286.9 million in the Corporate and Other Segment, $114.6
million in the Protection Segment, $45.0 million in the Asset Gathering Segment,
and $8.2 million in the Investment Management Segment. The increase in the
Corporate and Other Segment was driven by growth in net realized investment and
other gains of $323.5 million due to a gain of $233.8 million (and a deferred
profit of $247.7 million) on the sale of the Company's home office properties
during the first quarter of 2003. See Note 8 -- Sales / Lease-back Transactions
in the notes to the unaudited consolidated financial statements.
Revenues increased 14.9%, or $479.5 million, from the prior year. The
increase in revenues was driven by the Corporate and Other Segment where net
realized investment and other gains increased $323.5 million due to a gain of
$233.8 million (and a deferred profit of $247.7 million) on the sale of the
Company's home office properties. Consolidated net realized investment and other
gains increased 186.9%, or $395.2 million from the prior year. See detail of
current period net realized investment and other gains (losses) in table below.
The change in net realized investment and other gains is the result of gain on
the sale of the Company's home office properties. The net realized investment
and other gains were partially offset by other than temporary declines in value
of fixed maturity securities of $312.7 million and equity securities of $25.3
million. The largest impairments were $37.6 million relating to a large,
national farmer-owned diary co-operative, $27.3 million relating to a large,
North American transportation provider, $25.9 million relating to a special
purpose company created to sublease aircraft, $25.0 million relating to a toll
road, $14.1 million related to a subordinated holding company structure
comprised of ownership interests in three power generation facilities, $13.6
million related to an Australian mining company, and $11.0 million relating to a
utility brought into bankruptcy by its parent. For additional analysis regarding
net realized investment and other gains (losses), see General Account
Investments in the MD&A.
38
JOHN HANCOCK LIFE INSURANCE COMPANY
Net Realized
Gross Gain Gross Loss Hedging Investment
For the Six Months Ended June 30, 2003 Impairment on Disposal on Disposal Adjustments and Other Gain (Loss)
--------------------------------------------------------------------------
(in millions)
Fixed maturity securities (1) (2) ..... $ (312.7) $311.3 $(42.8) $(154.2) $(198.4)
Equity securities ..................... (25.3) 31.9 (2.0) -- 4.6
Mortgage loans on real estate ......... -- 20.8 (11.9) (32.8) (23.9)
Real estate ........................... -- 278.1 (2.8) -- 275.3
Other invested assets ................. (10.3) 9.3 (1.4) -- (2.4)
Derivatives ........................... -- -- -- 128.0 128.0
--------------------------------------------------------------------------
Subtotal ............... $ (348.3) $651.4 $(60.9) $ (59.0) $ 183.2
==========================================================================
Amortization adjustment for deferred policy acquisition costs .................... (12.4)
Amounts charged to participating pension contractholders ......................... 1.5
Amounts charged to the policyholder dividend obligation ......................... 11.4
---------------------
Total ....................................................................... $ 183.7
=====================
(1) Fixed Maturities gain on disposals includes $49.3 million of gains
from previously impaired securities.
(2) Fixed Maturities loss on disposals includes $22.9 million of credit
related losses.
The hedging adjustments in the fixed maturities and mortgage loans asset
classes are non-cash adjustments representing the amortization or reversal of
prior fair value adjustments on assets in those classes that were or are
designated as hedged items in a fair value hedge. When an asset or liability is
so designated, its cost basis is adjusted in response to movements in interest
rates. These adjustments are non-cash and reverse with the passage of time as
the asset or liability and derivative mature.
Premiums increased 0.8%, or $7.4 million, from the prior year. The
increase in premiums was due to growth in the Asset Gathering Segment where
growth in the fixed annuity business drove premiums up 254.2%, or $21.1 million
and the Protection Segment which increased $15.1 million driven by the long-term
care insurance business. Partially offsetting these increases were declines in
premiums of $27.4 million in Corporate and Other Segment and $1.4 million in the
G&SFP Segment. Premiums declined in the Corporate and Other Segment reflecting
the sale of the group life business.
Universal life and investment-type product fees increased 3.3%, or $9.8
million from the prior year. The growth in product fees was driven by the
Protection Segment, where product fees increased 3.7%, or $8.0 million. This
increase was due to the non-traditional life insurance business, driven by
growth of the existing business and the acquisition of the Allmerica fixed
universal life insurance business as of December 31, 2002. In addition, the
G&SFP Segment increased $4.2 million, or 19.6%, primarily due to higher
asset-based fees. Partially offsetting the growth in product fees in the
Protection and G&SFP Segments is a decline of $2.4 million in product fees in
the Asset Gathering Segment. Asset Gathering Segment product fees earned in the
variable annuity business decreased 12.4%, or $7.1 million, due to a 10.5%
decline in average fund values. Declines in variable annuity product fees were
partially offset by growth in the fixed annuity business where product fees
increased $4.7 million due to a 22.4% increase in the number of contract
inforce.
Net investment income increased 5.6%, or $98.9 million, from the prior
year. The growth in net investment income was driven by the Asset Gathering
Segment which increased 26.5%, or $71.9 million, from the prior year on growth
on the fixed annuity business. Average invested assets in the fixed annuity
business increased 36.0%, or $2,609.4 million, while earned rates decreased. See
additional analysis in the Asset Gathering Segment MD&A. In addition, net
investment income increased in the Protection Segment by 7.5%, or $48.2 million,
from the prior year driven by the universal life insurance business.
Non-traditional life insurance net investment income increased 25.8%, or $30.7
million, driven by the growth of the business and the acquisition of the
Allmerica fixed universal life insurance business as of December 31, 2002.
Partially offsetting these increases in net investment income was a decline of
$16.6 million in the Corporate and Other Segment. The Corporate and Other
Segment net investment income declined as a result of increased surplus
requirements in other business lines. G&SFP Segment net investment income
decreased $8.6 million or 1.0% due to the decline in the average investment
yield on invested assets to 6.00% in the current period. The decline in yield is
impacted by the fluctuation of market rates driving the return on approximately
$12 billion of the G&SFP Segment asset portfolio which floats with market rates.
The portfolio float is designed to match the interest exposure on our asset
portfolio to the exposure on our liabilities. For additional analysis of net
investment income and yields see the General Account Investments section of this
MD&A.
39
JOHN HANCOCK LIFE INSURANCE COMPANY
Advisory fees decreased 14.1%, or $39.7 million, from the prior year. The
decrease in fees was driven by the Asset Gathering Segment which decreased
17.6%, or $39.9 million, driven by the mutual funds business. The mutual funds
business management advisory fees declined $30.2 million driven by a decline in
average assets under management of 7.5%, or $2,133.7 million. Advisory fees as
percentage of average assets under management decreased 4 basis points due to an
increase in institutional and closed-end fund assets under management as a
percent of total asset under management. Institutional and closed-end fund
assets are generally charged lower fees than retail assets.
Other revenue increased 6.6%, or $7.9 million, from the prior year. The
Company's other revenue is largely made up of Signature Fruit in the Corporate
and Other Segment. Signature Fruit increased $6.7 million to $122.6 million for
the current period. In addition, other revenue increased $3.5 million in the
Protection Segment driven by the Federal long-term care insurance business which
officially began operation on October 1, 2002. The Federal long-term care
insurance business is a fee business where the Company administers and supports
employee long-term care insurance benefits offered by the Federal Government to
its employees. Partially offsetting these increases in other revenue was a
decline of $5.3 million in the Corporate and Other Segment.
Benefits to policyholders increased $0.5 million from the prior year.
Driving the increase in benefits to policyholders was growth in the Asset
Gathering Segment's fixed annuity business, where benefits to policyholders
increased 25.0%, or $51.7 million. The growth in fixed annuity benefits to
policyholders was driven by an increase of $21.1 million in premiums and an
increase in interest credited on higher policyholder account balances. Average
account balances in the fixed annuity business increased 34.1%, or $2,393.8
million, while credited rates decreased 82 basis points from the prior year. In
addition, the Protection Segment increased 4.1%, or $36.0 million, due to growth
in the long-term care insurance business. The long term care insurance business
experienced growth in new premiums and strong persistency during the period. The
Protection Segment increased despite the inclusion of $30.0 million in benefits
to policyholders in the prior year from the settlement of the modal premiums
class action lawsuit.
Partially offsetting these increases in benefits to policyholders was a
decrease in the G&SFP Segment of 8.2%, or $48.9 million. Lower benefits to
policyholders in the G&SFP Segment were primarily due to lower interest credited
on account balances for spread-based products. The decrease in spread-based
interest credited was 7.1%, or $36.1 million, due to a decline in the average
interest crediting rate on account balances driven by the reset on floating rate
liabilities. Corporate and Other Segment benefits to policyholders declined
$38.4 million from the prior year driven by the sale of the group life business.
Operating costs and expenses increased 5.5%, or $35.1 million. Included in
the Company's operating cost and expense are all the operating expenses of
Signature Fruit in the Corporate and Other Segment. The increase in the
Company's operating costs and expenses were driven by the Corporate and Other
Segment, which increased 21.2%, or $31.6 million, due to an increase in the
corporate account and Signature Fruit. The Corporate account increases in
expenses were driven by a $14.8 million increase in deficiency interest and
$17.0 million increase in the net periodic pension costs. Signature Fruit's
operating expenses increased $6.4 million to $124.2 million in the current
period. In addition, operating costs and expenses increased $2.9 million in the
Investment Management Segment and $35.4 million in the G&SFP Segment due to
higher compensation costs. Partially offsetting these increases was a decrease
in operating cost and expenses in the Asset Gathering Segment driven by
reductions in the mutual funds business on lower distribution and selling
expenses. In addition, Protection Segment operating costs and expenses decreased
6.8%, or $12.3 million, driven by the deferral of expenses in the long-term care
insurance business. Also included in other operating costs and expenses is $9.4
million for planned terminations related to the information technology
outsourcing as well as other initiatives and curtailment and other post
employment benefit related gains compared to $6.8 million in the prior year. See
Note 7 -- Severance to the unaudited consolidated financial statements.
Amortization of deferred policy acquisition costs increased 7.2%, or $8.8
million, from the prior year. The increase in amortization of deferred policy
acquisition costs was driven by the Protection Segment which increased 8.2%, or
$6.0 million from the prior year driven by growth in the long-term care and
non-traditional life insurance businesses. In addition, the Asset Gathering
Segment amortization of deferred policy acquisition costs increased 5.2%, or
$2.6 million. Amortization in the fixed annuity businesses increased 42.4%, or
$11.7 million, on growth of the business demonstrated by a 32.9% increases in
average reserves. Amortization in the variable annuity business decreased 39.6%,
or $9.0 million, due to improved separate account performance during the period
compared to the prior year.
Dividends to policyholders decreased 4.2%, or $11.8 million, from the
prior year. The decrease in dividends to policyholders was driven by the
Protection Segment, which declined 6.6%, or $17.4 million, due to a decrease in
the dividend scale on traditional life insurance products effective the
beginning of this year.
Income taxes were $224.4 million in 2003, compared to $72.8 million for
2002. Our effective tax rate was 29.8% in 2003, compared to 23.8% in 2002. The
higher effective tax rate was primarily due to increased capital gains,
partially offset
40
JOHN HANCOCK LIFE INSURANCE COMPANY
by increased affordable housing tax credits.
Results of Operations by Segment and Adjustments to GAAP Reported Net Income
In the first quarter of 2003, the Company implemented organizational
changes within the Corporate and Other Segment which resulted in the
reclassification of 2002 results for the Federal long-tern care insurance
business to the Protection Segment. The reclassification associated with the
Federal long-term care insurance business has no impact on segment after- tax
operating income, or net income of the business. The reclassification increased
Protection Segment after-tax operating income and decreased Corporate and Other
Segment after-tax operating income by $0.2 million and $0.3 million for the
three and six month periods ended June 30, 2002.
We operate our business in five segments: two segments primarily serve
retail customers, two segments serve institutional customers and our fifth
segment is the Corporate and Other Segment, which includes our international
operations, the corporate account and several run-off businesses. Our retail
segments are the Protection Segment and the Asset Gathering Segment. Our
institutional segments are the Guaranteed and Structured Financial Products
(G&SFP) Segment and the Investment Management Segment. For additional
information about the Company's business segments, please refer to the Company's
2002 Form 10-K.
We evaluate segment performance and base some of management's incentives
on segment after-tax operating income, which excludes the effect of net realized
investment and other gains and losses and other identified transactions. Total
segment after-tax operating income, which is a non-GAAP financial measure, is
determined by adjusting GAAP net income for net realized investment and other
gains and losses, extraordinary items, and certain other items, which we believe
are not indicative of overall operating trends. While these items may be
significant components in understanding and assessing our consolidated financial
performance, we believe that the presentation of segment after-tax operating
income enhances the understanding of our results of operations by highlighting
net income attributable to the normal, recurring operations of the business.
However, segment after-tax operating income is not a substitute for net income
determined in accordance with GAAP.
A discussion of the adjustments to GAAP reported income, many of which
affect each operating segment, follows the table below. A reconciliation of
segment after-tax operating income, as adjusted, to GAAP reported net income
precedes each segment discussion.
Three Months Ended Six Months Ended,
June 30, June 30,
2003 2002 2003 2002
---------------------------------------
(in millions)
Segment Data:
Segment after-tax operating income:
Protection Segment .................................. $ 89.1 $ 79.1 $172.2 $149.9
Asset Gathering Segment ............................. 51.2 40.6 91.2 80.6
---------------- ----------------
Total Retail Segments ............................. 140.3 119.7 263.4 230.5
Guaranteed and Structured Financial Products
Segment ........................................... 67.5 72.1 144.4 136.2
Investment Management Segment ....................... 11.5 7.4 17.1 12.3
---------------- ----------------
Total Institutional Segments ...................... 79.0 79.5 161.5 148.5
Corporate and Other Segment ......................... (7.0) 4.8 (8.8) 14.3
---------------- ----------------
Total segment after-tax operating income .......... 212.3 204.0 416.1 393.3
After-tax adjustments:
Net realized investment and other gains (losses) .. 45.4 (82.1) 112.6 (136.0)
Class action lawsuit .............................. -- (19.5) -- (19.5)
Restructuring charges ............................. -- (0.8) -- (4.4)
---------------- ----------------
Total after-tax adjustments ....................... 45.4 (102.4) 112.6 (159.9)
---------------- ----------------
GAAP Reported:
Net income ........................................ $257.7 $101.6 $528.7 $233.4
================ ================
(1) In 2002, during its start-up phase, the Federal long-term care insurance
business was reported in the Corporate and Other Segment. Effective
January 1, 2003, the program and its prior year results were reclassified
from the Corporate and Other Segment to the Protection Segment.
41
JOHN HANCOCK LIFE INSURANCE COMPANY
Our GAAP reported net income was significantly affected by net realized
investment and other gains and losses and other identified transactions
presented above as after-tax adjustments. A description of these adjustments
follows.
In all periods, net realized investment and other gains (losses), except
for gains and losses from mortgage securitizations, have been excluded from
segment after-tax operating income because such data are often excluded by
analysts and investors when evaluating the overall financial performance of
insurers. Net realized investment and other gains and losses from mortgage
securitizations were not excluded from segment after-tax operating income
because we view the related gains and losses as an integral part of the core
business of those operations.
Net realized investment and other gains have been reduced by: (1)
amortization of deferred policy acquisition costs to the extent that such
amortization results from net realized investment and other gains (losses), (2)
the portion of net realized investment and other gains (losses) credited to
certain participating contractholder accounts and (3) the portion of net
realized investment and other gains (losses) credited to the policyholder
dividend obligation. We believe presenting net realized investment and other
gains (losses) in this format provides information useful in evaluating our
operating performance. This presentation may not be comparable to presentations
made by other insurers. Summarized below is a reconciliation of (a) net realized
investment and other gains (losses) per the consolidated financial statements
and (b) the adjustment made for net realized investment and other gains (losses)
to calculate segment after-tax operating income for periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------------------------------------
(in millions)
Net realized investment and other gains (losses) ............... $127.6 $(138.0) $183.2 $(246.4)
Add amortization of deferred policy acquisition costs related
to net realized investment and other gains (losses) ....... (20.9) 8.9 (12.4) 24.4
Add (less) amounts credited to participating pension
contractholder accounts ................................... (4.8) 7.5 1.5 7.9
Add (less) amounts credited to policyholder dividend
obligation ................................................ (23.6) (3.8) 11.4 2.6
--------------------------------------
Net realized investment and other gains (losses), net of
related amortization of deferred policy acquisition costs
and amounts credited to participating pension
contractholders per unaudited consolidated financial
statements ................................................. 78.3 (125.4) 183.7 (211.5)
Add net realized investment and other (gains) losses
attributable to mortgage securitizations .................. (8.0) (1.8) (9.5) (1.0)
--------------------------------------
Net realized investment and other gains (losses) net -
pre-tax adjustment to calculate segment operating income .. 70.3 (127.2) 174.2 (212.5)
Less income tax effect ......................................... (24.9) 45.1 (61.6) 76.5
--------------------------------------
Net realized investment and other gains (losses) - after-tax
adjustment to calculate segment operating income .......... $ 45.4 $ (82.1) $112.6 $(136.0)
======================================
The Company incurred after-tax restructuring charges to reduce costs and
increase future operating efficiency by consolidating portions of our
operations. Additional information regarding restructuring costs is included in
Note 7 -- Severance in the notes to the unaudited consolidated financial
statements. After-tax restructuring costs, net of related pension curtailment
and other post employment benefit related gains, were $1.2 million and $4.4
million for the three and six month periods ended June 30, 2002 and were
excluded from segment after-tax operating income. The Company incurred after-tax
restructuring costs of $2.1 million (pre-tax $3.2 million) and $6.1 million
(pre-tax $9.4 million) for the three and six month periods ended June 30, 2003
which are included in segment after-tax operating income. Therefore, segment
after-tax operating income decreased in 2003 due to the Company's change in
treatment of this adjustment to segment after-tax operating income. Therefore,
if restructuring charges were treated similarly in the prior year, 2002
after-tax operating
42
JOHN HANCOCK LIFE INSURANCE COMPANY
income as presented would have been lower by $0.8 million and $4.4 million for
the three and six month periods ended June 30, 2002, respectively.
In 2002, the Company incurred a $19.5 million after-tax charge related to the
settlement of the Modal Premium class action lawsuit. The settlement agreement
involves policyholders who paid premiums on a monthly, quarterly, or semi-annual
basis rather than annually. The settlement costs are intended to provide for
relief to class members and for legal and administrative costs associated with
the settlement. In entering into the settlement, the Company specifically denied
any wrongdoing.
43
JOHN HANCOCK LIFE INSURANCE COMPANY
Protection Segment
The following table presents certain summary financial data relating to
the Protection Segment for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------------------------------------------
Operating Results: (in millions)
Revenues
Premiums ...................................................... $ 366.2 $ 366.4 $ 735.0 $ 719.9
Universal life and investment-type product fees ............... 111.2 107.4 223.7 215.7
Net investment income ......................................... 351.0 326.0 694.6 646.4
Other revenues ................................................ 2.1 (0.2) 3.7 0.2
------------------- -------------------
Total revenues ............................................ 830.5 799.6 1,657.0 1,582.2
Benefits and expenses
Benefits to policyholders ..................................... 443.1 428.5 906.4 856.2
Other operating costs and expenses ............................ 89.2 77.6 167.0 158.3
Amortization of deferred policy acquisition costs, excluding
amounts related to net realized investment and other gains
(losses) .................................................... 41.9 35.3 77.1 71.1
Dividends to policyholders .................................... 126.0 133.6 247.7 265.1
------------------- -------------------
Total benefits and expenses ............................... 700.2 675.0 1,398.2 1,350.7
Segment pre-tax operating income (1) ............................... 130.3 124.6 258.8 231.5
Income taxes ....................................................... 41.2 45.5 86.6 81.6
------------------- -------------------
Segment after-tax operating income (1) ............................. 89.1 79.1 172.2 149.9
------------------- -------------------
After-tax adjustments: (1)
Net realized investment and other gains (losses) .............. 17.0 (18.6) (3.5) (37.1)
Restructuring charges ......................................... -- (0.9) -- (4.1)
Class action lawsuit .......................................... -- (18.7) -- (18.7)
------------------- -------------------
Total after-tax adjustments ............................... 17.0 (38.2) (3.5) (59.9)
GAAP Reported:
Net income ......................................................... $ 106.1 $ 40.9 $ 168.7 $ 90.0
=================== ====================
Other Data:
Segment after-tax operating income (loss):
Non-traditional life (variable and universal life) ............ $ 37.2 $ 30.7 $ 66.3 $ 57.4
Traditional life .............................................. 27.8 27.6 51.6 57.0
Long-term care ................................................ 20.7 22.1 49.6 37.1
Federal long-term care ........................................ 1.6 0.2 3.1 0.3
Other ......................................................... 1.8 (1.5) 1.6 (1.9)
------------------- -------------------
Segment after-tax operating income (1) ............................. $ 89.1 $ 79.1 $ 172.2 $ 149.9
(1) See "Results of Operations by Segment and Adjustments to GAAP Reported Net
Income" included in this MD&A.
(2) In 2002, during its start-up phase, the Federal long-term care insurance
business was reported in the Corporate and Other Segment. Effective
January 1, 2003, the program and its prior year results were reclassified
from the Corporate and Other Segment to the Protection Segment.
44
JOHN HANCOCK LIFE INSURANCE COMPANY
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
Segment after-tax operating income increased 12.7%, or $10.0 million, from
the prior year. Non-traditional life insurance business after-tax operating
income increased 21.2%, or $6.5 million, primarily due to increases in universal
life and investment-type product fees and net investment income, partially
offset by higher expenses. Traditional life insurance business after-tax
operating income increased 0.7%, or $0.2 million. Federal long-term care
insurance business after-tax operating income increased $1.3 million as the mass
enrollment did not begin until the third quarter of 2002. Long-term care
insurance business after-tax operating income decreased approximately 6.3%, or
$1.4 million, resulting from increased expenses, lower portfolio yields and
continued low lapse rates.
Revenues increased 3.9%, or $30.9 million. Premiums decreased $0.2
million. Traditional life insurance business premiums decreased 4.5%, or $11.0
million, due to the run off of the closed block. This was offset by a $10.8
million increase in long-term care insurance premiums driven by business growth
from higher sales and lower lapses. Universal life and investment-type product
fees increased 3.5%, or $3.8 million, due primarily to cost of insurance fees of
$5.6 million resulting from growth in the existing business and the addition of
the Allmerica block of business assumed as of December 31, 2002. Segment net
investment income increased 7.7%, or $25.0 million, primarily due to a 16.3%
increase in average asset balances, partially offset by a 57 basis point
decrease in yields.
Benefits and expenses increased 3.7%, or $25.2 million. Benefits to
policyholders increased 3.4%, or $14.6 million, due primarily to growth in
long-term care insurance business. Long-term care insurance business benefits
and expenses increased 23.0%, or $29.2 million, primarily due to additions to
reserves for premium growth and higher claim volume on growth of the business
during the period. The long-term care insurance business claims are being
incurred at a rate lower than assumed in pricing the product. Long-term care
insurance business policies have increased to 653.2 thousand from 568.2 thousand
in the prior year. Amortization of deferred policy acquisition costs increased
18.7% or $6.6 million, primarily due to a $6.7 million increase in the
non-traditional life insurance business for experience true-ups and growth and
$3.3 million from growth in the long-term care insurance business. These
increases were partially offset by a $3.5 million decrease in amortization of
deferred policy acquisition costs in the traditional life insurance business due
to lower contributions from the closed block. Dividends to policyholders
decreased 5.7%, or $7.6 million, primarily due to a dividend scale cut for the
traditional life insurance business. Other operating costs and expenses
increased 14.9%, or $11.6 million primarily due to severance, increase in
benefit plan expenses, and the addition of the Allmerica block assumed. The
Segment's effective tax rate on operating income was 31.6% compared to 36.5% for
the prior year. The decrease was primarily due to an increase in affordable
housing credits, a decrease in deficiency charge, and a net change in other
permanent differences.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Segment after-tax operating income increased 14.9%, or $22.3 million, from
the prior year. Non-traditional life insurance business after-tax operating
income increased 15.5%, or $8.9 million, primarily due to increases in universal
life and investment-type product fees and net investment income, partially
offset by higher expenses and higher benefits to policyholders. Long-term care
insurance business after-tax operating income increased approximately 33.7%, or
$12.5 million, resulting from growth of the business. Federal long-term care
insurance business after-tax operating income increased $2.8 million as the mass
enrollment did not begin until the third quarter of 2002. Traditional life
insurance business after-tax operating income decreased 9.4%, or $5.4 million,
primarily resulting from decreases in premiums and net investment income
partially offset by a decrease in total benefit and expenses, driven by lower
dividends.
Revenues increased 4.7%, or $74.8 million. Premiums increased 2.1%, or
$15.1 million, primarily due to long-term care insurance premiums, which
increased 16.0%, or $35.2 million, driven by business growth from higher sales
and continued lower lapses. This increase was partially offset by a 4.0%, or
$20.0 million decrease in the traditional life insurance business premiums
primarily due to the run off of the closed block and the lower dividend scale
causing purchase of fewer paid up additions. Universal life and investment-type
product fees increased 3.7%, or $8.0 million, due primarily to cost of insurance
fees of $12.6 million resulting from growth in the existing business and the
addition of the Allmerica block of business assumed as of December 31, 2002.
Segment net investment income increased 7.5%, or $48.2 million, primarily due to
a 15.6% increase in average asset balances, partially offset by a 54 basis point
decrease in yields.
Benefits and expenses increased 3.5%, or $47.5 million. Benefits to
policyholders increased 5.9%, or $50.2 million, due primarily to growth in
long-term care insurance business. Long-term care insurance business benefits
and expenses increased 17.8%, or $44.1 million, primarily due to additions to
reserves for premium growth and higher claim volume on growth of the business
during the period. The long-term care insurance business claims are being
incurred at a rate lower than assumed in pricing the product. Long-term care
insurance business policies have increased to 653.2 thousand from 568.2 thousand
in the prior year. The non-traditional life insurance business had an increase
in benefits to policyholders of $2.9 million, which was driven by a $25.1
million increase in interest credited on higher current year account balances
and the addition of the Allmerica business. These increases were partially
offset by lower death claims paid net of reserves released and reinsurance
45
JOHN HANCOCK LIFE INSURANCE COMPANY
ceded of $11.2 million due to not repeating higher mortality experienced in the
prior year, and an $11.0 million decrease in policy benefit reserves and other
benefits due primarily to lower enhanced cash value reserves. The traditional
life insurance line of business benefits to policyholders increased 1.2%, or
$6.1 million due to higher death claims, net of reserves released and
reinsurance ceded. Dividends to policyholders decreased 6.6%, or $17.4 million,
primarily due to a dividend scale cut for the traditional life insurance
business. Total operating costs and expenses increased 5.5%, or $8.7 million,
primarily due to severance, increase in benefit plan expenses, and the addition
of the Allmerica block assumed. The Segment's effective tax rate on operating
income was 33.5% compared to 35.3% for the prior year. The decrease was
primarily due to an increase in affordable housing credits, a decrease in
deficiency charge, and a net change in other permanent differences.
46
JOHN HANCOCK LIFE INSURANCE COMPANY
Asset Gathering Segment
The following table presents certain summary financial data relating to
the Asset Gathering Segment for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------------------------------------------
Operating Results: (in millions)
Revenues
Premiums ...................................................... $ 13.8 $ 3.8 $ 29.4 $ 8.3
Investment-type product fees .................................. 29.7 31.0 58.8 61.2
Net investment income ......................................... 176.9 140.5 342.9 271.0
Investment management revenues, commissions
and other fees .............................................. 96.0 110.3 187.0 226.9
Other revenues ................................................ (0.1) 0.4 0.1 0.9
---------------------- -----------------------
Total revenues ............................................ 316.3 286.0 618.2 568.3
Benefits and expenses
Benefits to policyholders ..................................... 131.8 107.0 258.2 206.5
Other operating costs and expenses ............................ 90.6 90.8 174.2 193.6
Amortization of deferred policy acquisition costs, excluding
amounts related to net realized investment and other gains
(losses) .................................................... 19.1 28.8 53.0 50.4
---------------------- -----------------------
Total benefits and expenses ............................... 241.5 226.6 485.4 450.5
Segment pre-tax operating income (1) ............................... 74.8 59.4 132.8 117.8
Income taxes ....................................................... 23.6 18.8 41.6 37.2
---------------------- -----------------------
Segment after-tax operating income (1) ............................. 51.2 40.6 91.2 80.6
---------------------- -----------------------
After-tax adjustments: (1)
Net realized investment and other gains (losses), net ......... 12.8 (13.2) (11.3) (28.0)
Restructuring charges ......................................... -- (0.5) -- (1.9)
---------------------- -----------------------
Total after-tax adjustments ............................... 12.8 (13.7) (11.3) (29.9)
GAAP Reported:
Net income ......................................................... $ 64.0 $ 26.9 $ 79.9 $ 50.7
====================== ======================
Other Data:
Segment after-tax operating income:
Annuity(fixed and variable) ................................... $ 40.0 $ 23.4 $ 67.5 $ 48.3
Mutual funds .................................................. 11.2 14.5 20.5 27.0
Other ......................................................... -- 2.7 3.2 5.3
Mutual fund assets under management, end of period ................. 27,544.4 26,227.4 27,544.4 26,227.4
(1) See "Results of Operations by Segment and Adjustments to GAAP Reported Net
Income" included in this MD&A.
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
Segment after-tax operating income was $51.2 million, an increase of
26.1%, or $10.6 million, from the prior year. Fixed annuity after-tax operating
income increased 40.8%, or $8.0 million, due to account balance growth and
higher spreads. In addition to the increase in the fixed annuity business there
was an increase of $8.6 million in after-tax operating income in the variable
annuity business due to strong separate account performance. Offsetting the
increase in segment after-
47
JOHN HANCOCK LIFE INSURANCE COMPANY
tax operating income in the annuity businesses was a decrease in the mutual fund
segment's after-tax operating income of 22.8% or $3.3 million primarily due to a
15.2%, or $12.4 million, decrease in management advisory fees, partially offset
by a 12.1%, or $7.2 million decrease in operating expenses. Signature Services
after-tax operating income decreased $1.5 million, driven by an increase in
operating expenses. After-tax operating income for Essex, a distribution
subsidiary primarily serving the financial institution channel, decreased $1.0
million and Signator Investors after-tax operating income decreased $0.1
million.
Revenues increased 10.6%, or $30.3 million, from the prior year period.
The rise in revenue was due to a $36.4 million increase in net investment income
and a $10.0 million increase in premiums, driven by the fixed annuity business.
The increase in net investment income was primarily due to increases in invested
assets backing fixed annuity products, partially offset by lower earned yields
in the portfolio. Average invested assets backing fixed annuity products
increased 35.7% to $10,361.4 million while the average investment yield
decreased from the prior year. These increases in revenue were partially offset
by a decrease in investment management revenues, primarily from the mutual fund
business, of 13.0%, or $14.3 million and a $1.3 million decrease in
investment-type product fees, primarily in the variable annuity business on
lower average fund values. Investment-type product fees decreased mostly due to
a decline in the average variable annuity fund values of 11.5%, or $683.0
million, to $5,280.2 million. The decrease in the assets under management was
due to poor separate account returns in the prior year. For variable annuities
the mortality and expense fees as a percentage of average account balances were
1.32% and 1.35% for the current and prior year periods.
Investment management revenues, commissions, and other fees decreased
13.0%, or $14.3 million from the prior year. Average mutual fund assets under
management were $26,570.1 million, a decrease of $935.4 million, or 3.4% from
the prior year period. The decrease in average mutual fund assets under
management was primarily due to market depreciation of $1,444.3 million from
June 30, 2002 to March 31, 2003. Ending mutual fund assets under management
increased by $1,317.0 million or 5.0% from the prior year period due to $2,242.0
million in market appreciation during the current quarter. The mutual fund
business experienced net redemptions of $224.1 million during the second quarter
of 2003, as compared to net redemptions of $346.2 million in the prior year, a
change of $122.1 million. This change was primarily due to an increase in
deposits of $608.6 million, partially offset by an increase in redemptions of
$504.4 million. The increase in deposits was driven by $675.0 million in sales
of the John Hancock Preferred Income series of closed-end funds, partially
offset by the $126.9 million acquisition of the U.S. Global Leaders Growth Fund
in the prior period. The increase in redemptions was primarily due to the
redemption of a large institutional advisory account, partially offset by lower
retail mutual fund redemptions. Investment advisory fees decreased 10.7%, or
$4.3 million, to $35.9 million, from the prior period and were 0.54% and 0.59%
of average mutual fund assets under management for the three months ended June
30, 2003 and 2002. Underwriting and distribution fees decreased 18.0%, $10.0
million, to $45.6 million compared to the prior year period. Asset based 12b-1
fees declined by $5.8 million due to a decline in average retail mutual fund
assets under management. Commission revenue declined by $4.2 million primarily
due to lower contingent deferred sales charges on lower mutual fund redemptions.
Shareholder service and other fees were $14.3 million compared to $11.0 million
in the prior year.
Benefits and expenses increased 6.6%, or $14.9 million from the prior year
period. Benefits to policyholders increased 23.2%, or $24.8 million, primarily
due to a $13.3 million increase in interest credited on fixed annuity account
balances due to higher average account balances and $14.1 million higher reserve
provisions for life-contingent immediate fixed annuity fund values on higher
sales of these contract types. Partially offsetting the increase in benefits to
policyholders was a decline in amortization of deferred policy acquisition costs
of 33.7%, or $9.7 million, from the prior year period primarily due to a $14.4
million decrease in the variable annuity business due to strong separate account
performance in the current quarter. The Segment's effective tax rate on
operating income was 31.6% for both the three months ended June 30, 2003 and
2002.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Segment after-tax operating income was $91.2 million, an increase of
13.2%, or $10.6 million from the prior year period. Fixed annuity after-tax
operating income increased 47.8%, or $17.8 million from June 30, 2002. The fixed
annuity business grew due to higher net investment income, partially offset by
higher interest credited on account balance growth. The variable annuity
business after-tax operating income increased 12.6%, or $1.4 million to $12.5
million for the six month period ended June 30, 2003 compared to the prior year.
The variable annuity business increased due to strong separate account
performance in the current quarter. Mutual fund segment after-tax operating
income was $20.5 million, declining 24.1% or $6.5 million primarily due to an
18.3%, or $30.2 million decrease in management advisory fees, partially offset
by a 16.3%, or $20.2 million decrease in operating expenses. Signature Services
after-tax operating income decreased $0.1 million to $1.8 million, driven by an
increase in operating expenses from 2002. After-tax operating income for Essex,
a distribution subsidiary primarily serving the financial institution channel,
decreased $1.8 million from $2.3 million in the prior year due to lower sales.
Signator Investors after-tax operating income increased $0.1 million.
Revenues increased 8.8% or $49.9 million, from the prior year. The rise in
revenue was due to a $71.9 million increase
48
JOHN HANCOCK LIFE INSURANCE COMPANY
in net investment income and a $21.1 million increase in premiums, driven by the
fixed annuity business. The increase in net investment income was primarily due
to increases in invested assets backing fixed annuity products, partially offset
by lower earned yields in the portfolio. Average invested assets backing fixed
annuity products increased 36.0% to $9,865.7 million and the average investment
yield decreased from the prior year. These increases in revenue were partially
offset by a decrease in investment management revenues, primarily from the
mutual fund business, of 17.6%, or $39.9 million and a $2.4 million decrease in
investment-type product fees, primarily in the variable annuity business on
lower average fund values. Investment-type product fees decreased mostly due to
a decline in the average variable annuity fund values of 10.5%, or $630.6
million, to $5,372.4 million from the prior year period. The decrease in assets
under management was due to poor long-term separate account returns in the prior
year. For variable annuities the mortality and expense fees as a percentage of
average account balances were 1.29% and 1.33% for the current and prior year
periods.
Investment management revenues, commissions, and other fees decreased
17.6%, or $39.9 million from the prior year. Average mutual fund assets under
management were $26,136.5 million, a decrease of $2,133.7 million, or 7.5% from
the prior year period. The decrease in average mutual fund assets under
management is primarily due to market depreciation of $1,318.4 million from June
30, 2002 to December 31, 2002. Ending mutual fund assets under management
increased by $1,317.0 million or 5.0% from the prior year period due to $2,242.0
million in market appreciation during the current quarter. The mutual fund
business experienced net redemptions of $247.0 million during the first six
months of 2003, as compared to net redemptions of $663.8 million in the prior
year, a change of $416.8 million. This change was primarily due to an increase
in deposits of $707.7 million, partially offset by an increase in redemptions of
$318.5 million. The increase in deposits was driven by $974.6 million in sales
of the John Hancock Preferred Income series of closed-end funds, partially
offset by a $158.6 million decrease in retail open-end mutual fund sales and the
acquisition of the $126.9 million U.S. Global Leaders Growth Fund in the prior
period. The increase in redemptions was primarily due to large institutional
advisory account redemptions, partially offset by a decrease in retail open end
mutual fund redemptions of $502.0 million, caused by declined in redemptions
across a number of funds. Investment advisory fees decreased 14.0%, or $11.4
million, to $70.2 million, from the prior period and were 0.54% and 0.58% of
average mutual fund assets under management for the six months ended June 30,
2003 and 2002, respectively. Underwriting and distribution fees decreased 22.6%,
or $25.7 million, to $87.8 million compared to the prior year period. Asset
based 12b-1 fees declined by $14.2 million due to a decline in average retail
mutual fund assets under management. Commission revenue declined by $11.5
million primarily due to lower load mutual fund sales and lower contingent
deferred sales charges due to lower mutual fund redemptions. Shareholder service
and other fees were $29.0 million compared to $22.0 million in the prior year.
Benefits and expenses increased 7.7%, or $34.9 million from the prior year
period. Benefits to policyholders increased 25.0%, or $51.7 million, primarily
due to a $29.3 million increase in interest credited on fixed annuity account
balances due to higher average account balances and $25.1 million higher reserve
provisions for life-contingent immediate fixed annuity fund values on higher
sales of these contract types. Partially offsetting the increase in benefits to
policyholders was a decline in other operating costs and expenses of 10.0% or
$19.4 million, from the prior year period, primarily due to cost savings and
lower distribution and selling expenses in the mutual fund business.
Amortization of deferred policy acquisition costs increased 5.2%, or $2.6
million, due to an $11.7 million increase in the fixed annuity business driven
by account balance growth, offset by a $9.0 million decrease in the variable
annuity business due to strong separate account performance in the current
period. The Segment's effective tax rate on operating income was 31.3% compared
to 31.6% for the prior year period.
49
JOHN HANCOCK LIFE INSURANCE COMPANY
Guaranteed and Structured Financial Products Segment
The following table presents certain summary financial data relating to
the Guaranteed and Structured Financial Products Segment for the periods
indicated.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------------------------------------
(in millions)
Operating Results:
Revenues
Premiums ................................................... $ 3.6 $ 6.1 $ 7.9 $ 9.3
Investment-type product fees ............................... 12.2 11.6 25.6 21.4
Net investment income ...................................... 412.3 428.7 839.6 848.2
Other revenue .............................................. (0.3) 0.3 0.1 0.4
---------------- ---------------
Total revenues ......................................... 427.8 446.7 873.2 879.3
Benefits and expenses
Benefits to policyholders .................................. 266.8 298.2 546.7 595.6
Other operating costs and expenses ......................... 54.4 33.1 99.8 63.7
Amortized of deferred policy acquisition costs, excluding
amounts related to net realized investment and other
gains .................................................. 0.6 0.7 1.1 1.1
Dividends .................................................. 8.3 8.3 16.6 16.6
---------------- ---------------
Total benefits and expenses ........................... 330.1 340.3 664.2 677.0
Segment pre-tax operating income (1) ........................... 97.7 106.4 209.0 202.3
Income taxes ................................................... 30.2 34.3 64.6 66.1
---------------- ---------------
Segment after-tax operating income (1) ......................... 67.5 72.1 144.4 136.2
---------------- ---------------
After-tax adjustments: (1)
Net realized investment and other gains (losses) ........... 8.1 (55.9) (77.3) (69.4)
Restructuring charges ...................................... -- (0.2) -- (0.5)
Total after-tax adjustments .................................... 8.1 (56.1) (77.3) (69.9)
---------------- ---------------
GAAP Reported:
Net income ..................................................... $ 75.6 $ 16.0 $ 67.1 $ 66.3
================ ================
Other Data:
Segment after-tax operating income: (1)
Spread-based products ...................................... $ 62.7 $ 66.6 $135.2 $125.0
Fee-based products ......................................... 4.8 5.5 9.2 11.2
---------------- ---------------
Segment after-tax operating income (1) ......................... $ 67.5 $ 72.1 $144.4 $136.2
================ ================
(1) See "Results of Operations by Segment and Adjustments to GAAP Reported Net
Income" included in this MD&A.
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
Segment after-tax operating income decreased 6.4 % or $4.6 million from
the prior year. Spread-based products after-tax operating income decreased 5.9%
or $3.9 million due to the increased level of reinsurance arrangements,
partially
50
JOHN HANCOCK LIFE INSURANCE COMPANY
offset by growth in investment spreads of 7.8% or $9.0 million. The growth in
investment spreads was a result of a higher average invested asset base, which
increased 10.1% or $2.3 billion over the prior year, partially offset by a 10
basis point decrease in the interest rate margin. Fee-based products after-tax
operating income decreased 12.7% or $0.7 million from the prior year, primarily
due to lower general account risk charges and lower earnings on risk-based
capital.
Revenues decreased 4.2% or $18.9 million from the prior year, primarily as
a result of lower net investment income. Premiums decreased 41.0% or $2.5
million from the prior year, reflecting reduced activity of fee-based products.
Investment-type product fees increased 5.2% or $0.6 million from the prior year,
primarily due to higher asset-based fees. Driven by declining interest rates,
net investment income decreased 3.8% or $16.4 million despite growth in the
average invested assets backing spread-based products. The average yield on
invested assets decreased to 5.82%, reflecting the lower interest rate
environment in the current period. Net investment income varies with market
interest rates as the return on approximately $12 billion of the asset portfolio
floats with market rates. Matching the interest rate exposure on our asset
portfolio to the exposure on our liabilities is a central feature of our
asset/liability management process.
Benefits and expenses decreased 3.0% or $10.2 million from the prior year.
The decrease was driven by lower benefits to policyholders largely offset by
higher operating expenses and costs. Benefits to policyholders decreased 10.5%
or $31.4 million primarily due to lower interest credited on account balances
for spread-based products. Spread-based interest credited decreased 7.7% or
$19.7 million from the prior year. The decrease in interest credited was due to
a decline in the average interest credited rate on account balances for
spread-based products, as liabilities with floating rates reset. The average
crediting rate fell to 4.25%. The decrease in benefits to policyholders was
offset by an increase in other operating costs and expenses of 64.4% or $21.3
million from the prior year. The increase was primarily due to an increased
level of reinsurance arrangements combined with higher pension and compensation
costs. Dividends to contractholders were $8.3 million for both periods. The
segment's effective tax rate on operating income was 30.9% compared to 32.2% in
the prior year. The decrease was primarily due to increased affordable housing
tax credits.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Segment after-tax operating income increased 6.0% or $8.2 million from the
prior year. Spread-based products after-tax operating income increased 8.2% or
$10.2 million which was attributable to an increase in investment spreads of
16.5% or $37.3 million from the prior year, partially offset by higher
reinsurance expenses. The growth in investment spreads was a result of a higher
average invested asset base, which increased 11.1% or $2.5 billion over the
prior year, combined with a 6 basis point increase in the interest rate margin.
Fee-based products after-tax operating income decreased 17.9% or $2.0 million
from the prior year, primarily due to lower general account risk charges and
lower earnings on risk-based capital.
Revenues decreased 0.7% or $6.1 million from the prior year, primarily as
a result of lower net investment income. Premiums decreased 15.1% or $1.4
million from the prior year, reflecting reduced activity of fee-based products.
Investment-type product fees increased 19.6% or $4.2 million from the prior
year, primarily due to higher asset-based fees. Driven by declining interest
rates, net investment income decreased 1.0% or $8.6 million despite the growth
in the average invested assets backing spread-based products. The average yield
on invested assets decreased to 6.00%, reflecting the lower interest rate
environment in the current period. Net investment income varies with market
interest rates as the return on approximately $12 billion of the asset portfolio
floats with market rates. Matching the interest rate exposure on our asset
portfolio to the exposure on our liabilities is a central feature of our
asset/liability management process.
Benefits and expenses decreased 1.9% or $12.8 million from the prior year.
The decrease was driven by lower benefits to policyholders largely offset by
increased operating expenses and costs. Benefits to policyholders decreased 8.2%
or $48.9 million primarily due to lower interest credited on account balances
for spread-based products. Spread-based interest credited decreased 7.1% or
$36.1 million from the prior year. The decrease in interest credited was due to
a decline in the average interest credited rate on account balances for
spread-based products, as liabilities with floating rates reset. The average
crediting rate fell to 4.29%. Partially offsetting the decrease in benefits to
policyholders was an increase in other operating costs and expenses of 56.7% or
$36.1 million from the prior year. The increase was primarily due to an
increased level of reinsurance arrangements combined with higher pension and
compensation costs. Dividends to contractholders were $16.6 million for both
periods. The segment's effective tax rate on operating income was 30.9% compared
to 32.7% in the prior year. The decrease was primarily due to increased
affordable housing tax credits.
51
JOHN HANCOCK LIFE INSURANCE COMPANY
Investment Management Segment
The following table presents certain summary financial data relating to
the Investment Management Segment for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
----------------------------------------------
Operating Results: ......................... (in millions)
Revenues
Net investment income .................. $ 7.5 $ 3.6 $ 11.7 $ 7.6
Net realized investment and other
gains (losses) (1) ..................... 8.0 1.7 9.5 1.0
Investment management revenues,
commissions and other fees ......... 27.6 27.8 54.4 55.3
Other revenue .......................... -- 0.2 0.1 --
--------------------- ---------------------
Total revenues .................... 43.1 33.3 75.7 63.9
Benefits and expenses
Other operating costs and expenses ..... 24.2 21.5 47.7 44.6
--------------------- ---------------------
Total benefits and expenses ....... 24.2 21.5 47.7 44.6
Segment pre-tax operating income (1) ....... 18.9 11.8 28.0 19.3
Income taxes ............................... 7.4 4.4 10.9 7.0
--------------------- ---------------------
Segment after-tax operating income (1) ..... 11.5 7.4 17.1 12.3
--------------------- ---------------------
After-tax adjustments: (1)
Net realized investment and other
gains (losses) (1) ................ -- 0.5 -- 0.5
Restructuring charges .................. -- (0.2) -- (0.2)
--------------------- ---------------------
Total after-tax adjustments ....... -- 0.3 -- 0.3
GAAP Reported:
Net income ................................. $ 11.5 $ 7.7 $ 17.1 $ 12.6
===================== =====================
Other Data:
Segment assets under management, end
of period (2) ........................ $29,872.1 $27,977.4 $29,872.1 $27,977.4
(1) See "Results of Operations by Segment and Adjustments to GAAP Reported Net
Income" included in this MD&A.
(2) Includes general account cash and invested assets of $371.6 million and
$350.0 million at June 30, 2003 and 2002, respectively.
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
Segment after-tax operating income increased $4.1 million, or 55.4%, from
the prior year. The increase was primarily due to $6.3 million in higher net
realized investment gains on mortgage securitizations and $3.9 million in higher
net investment income, partially offset by $2.7 million in higher operating
expenses.
Revenues increased $9.8 million, or 29.4%, from the prior year. Net
realized investment gains on mortgage securitizations increased $6.3 million, to
a gain of $8.0 million, from a gain of $1.7 million in the prior year at John
Hancock Real Estate Finance. The increase in securitization gains resulted from
higher profitability on two securitizations this quarter. Net investment income
was up $3.9 million, primarily resulting from increases in equity method income
on limited partnership energy investments at John Hancock Energy Resources
Management due to the required adoption of fair value accounting at the limited
partnerships. Investment management revenues, commissions, and other fees were
relatively flat overall. Fee income increased $2.4 million at the Hancock
Natural Resource Group (HNRG) from a $1.7 million increase in property
management fees at the new northwest property management division established in
December of 2002, and $0.7 million in higher investment management fees on
higher assets under management. One of HNRG's strategies is to vertically
integrate the timber business and the establishment of the northwest property
management division is another step
52
JOHN HANCOCK LIFE INSURANCE COMPANY
to implement that strategy. Commercial mortgage origination fees at John Hancock
Real Estate Finance increased $0.7 million from higher loan originations for the
Company's General Account. These increases in fee revenue were offset by a
decrease in advisory fees at the Company's institutional advisor, Independence
Investment LLC, of $1.2 million, or 13.0%. Average assets under management this
year at Independence Investment LLC were $0.6 billion less in spite of a $1.2
billion increase in actual assets under management since the end of the prior
year period. The lower fees at Independence Investment LLC reflect the lower
average assets under management, and a shift towards fixed income assets which
have lower fee rates, a one-time performance fee in the prior year period and
lower ongoing performance fees on CBO funds under management this year. Fee
income declined $1.0 million at John Hancock Realty Advisors mostly due to lower
acquisition activity. Fee income declined $0.5 million at the Company's Bond and
Corporate Finance Group on lower assets under management. Investment management
revenue, commissions and other fees were 0.39% of average advisory assets under
management for both the current and prior year quarters.
Total benefits and expenses increased $2.7 million, or 12.6%, from the
prior year. Operating expenses increased $2.9 million, or 13.7%. The increase
was primarily due to $2.1 million, or 46.7%, in higher operating expenses at the
Hancock Natural Resource Group, which included $1.0 million of expenses
associated with the new northwest property management division established in
December of 2002 as discussed earlier, and $1.5 million of increased incentive
compensation plan expenses. Operating expenses at Independence Investment LLC
increased $0.9 million, or 8.0%, based on $0.6 million of increased incentive
compensation plan expenses and $0.4 million of increased severance costs
associated with the closing down of their high net worth management group. At
John Hancock Realty Advisors, operating expenses declined $0.3 million, or
27.3%, due to lower acquisition activity. Operating expenses were 0.34% and
0.30% of average advisory assets under management for the current and prior year
quarters, respectively. Commission expenses at the Hancock Natural Resource
Group were $0.2 million, down from $0.4 million, based on significant new
timberland investors signed in the prior year.
The Segment's effective tax rate on operating income rose to 39.2% from
36.2% for the prior year, primarily due to lower operating income at
Independence Investment, LLC which has a lower state tax liability form of
business organization. The effective tax rate for the Investment Management
Segment remains higher than for our other business segments due to state taxes
on certain investment management subsidiaries, and fewer tax benefits from
portfolio holdings in this segment.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Segment after-tax operating income increased $4.8 million, or 39.0%, from
the prior year. The increase was primarily due to $8.5 million in higher net
realized investment gains on mortgage securitizations, $4.1 in higher net
investment income and $0.9 million in lower commission expenses, partially
offset by $4.1 million in higher operating expenses and $0.9 million in lower
fee income.
Revenues increased $11.8 million, or 18.5%, from the prior year. Net
realized investment gains on mortgage securitizations increased $8.5 million, to
a gain of $9.5 million, from a gain of $1.0 million in the prior year at John
Hancock Real Estate Finance. The increase in securitization gains resulted from
higher profitability on two securitizations in the second quarter of 2003. Net
investment income increased $4.1 million, to $11.7 million, from $7.6 million in
the prior year, primarily resulting from increases in equity method income of
$3.9 million on limited partnership energy investments at John Hancock Energy
Resources Management due to the required adoption of fair value accounting at
the limited partnership. Investment management revenues, commissions, and other
fees decreased $0.9 million, or 1.6%, from the prior year. At the Company's
institutional advisor, Independence Investment LLC, advisory fees were down $3.8
million, or 13.1%, from the prior year. Average assets under management this
year at Independence Investment LLC were $0.3 billion less than in the prior
year period, in spite of a $1.2 billion increase in actual assets under
management since the end of the prior year period. The lower fees at
Independence Investment LLC reflect the lower average assets under management,
and a shift towards fixed income assets which have lower fee rates, a one-time
performance fee in the prior year period and lower ongoing performance fees on
CBO funds under management this year. Fees declined $1.6 million at the
Company's Bond and Corporate Finance Group on lower assets under management
compared to the prior year. These declines in fee revenue were offset by
increases in property management fee income of $3.2 million at the Hancock
Natural Resource Group from the new northwest property management division
established in December of 2002 and $1.0 million in higher management fee income
on higher assets under management. One of HNRG's strategies is to vertically
integrate the timber business and the establishment of the northwest property
management division is another step to implement that strategy. Management fee
income was up $0.4 million at John Hancock Realty Advisors on higher assets
under management. Investment management revenue, commissions and other fees were
0.39% of average advisory assets under management for both the current and prior
year periods.
Total benefits and expenses increased $3.1 million, or 7.0%, from the
prior year. Operating expenses increased $4.1 million, or 9.4%, from the prior
year. The increase was primarily due to $3.9 million in higher operating
expenses at the
53
JOHN HANCOCK LIFE INSURANCE COMPANY
Hancock Natural Resource Group, which included $2.1 million of increased
incentive compensation plan expenses, $1.9 million of expenses associated with
the new northwest property management division established in December of 2002
and recovery of amounts expensed in the prior year period of $0.8 million offset
by $0.9 million in operating expense savings due to ongoing cost reduction
efforts. Operating expenses at Independence Investment LLC increased $0.6
million, or 2.5%, resulting from increased compensation expense, severance costs
associated with the closing down of their high net worth management group and
non-recurring prior period reductions, offset by operating expense savings from
ongoing cost reduction efforts. Operating expenses at the other investment
management business units were relatively flat, declining $0.4 million, or 3.7%
from the prior year. Operating expenses were 0.34% and 0.30% of average advisory
assets under management for the current and prior year periods, respectively.
Commission expenses at the Hancock Natural Resource Group declined $0.9 million
from $1.2 million in the prior year, based on significant new timberland
investors signed in the prior year.
The Segment's effective tax rate on operating income rose to 38.9% from
36.3% for the prior year, primarily due to lower operating income at
Independence Investment, LLC which has a lower state tax liability form of
business organization. The effective tax rate for the Investment Management
Segment remains higher than for our other business segments due to state taxes
on certain investment management subsidiaries, and fewer tax benefits from
portfolio holdings in this segment.
54
JOHN HANCOCK LIFE INSURANCE COMPANY
Corporate and Other Segment
The following table presents certain summary financial data relating to the
Corporate and Other Segment for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------------------------------------
(in millions)
Operating Results:
Segment after-tax operating income(1)
International operations .......................... $ 2.6 $ 2.3 $ 3.2 $ 3.2
Corporate operations .............................. (10.3) 1.3 (14.0) 8.1
Non-core businesses ............................... 0.7 1.2 2.0 3.0
---------------- ----------------
Total ........................................ (7.0) 4.8 (8.8) 14.3
After-tax adjustments: (1)
Net realized investment and other gains (losses),
net .............................................. 7.5 5.1 204.7 (2.0)
Restructuring charges .............................. -- 1.0 -- 2.3
Class action lawsuit ............................... -- (0.8) -- (0.8)
---------------- ----------------
Total after-tax adjustments .................. 7.5 5.3 204.7 (0.5)
GAAP Reported:
Net income ............................................ $ 0.5 $ 10.1 $195.9 $ 13.8
================ ================
(1) See "Adjustments to GAAP Reported Net Income" included in this MD&A.
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
Segment after-tax operating income from international operations increased
$0.3 million from the prior year. Results from our International Group Program
were $0.6 million higher due to higher earned retention income. This was
partially offset by $0.3 million lower operating results in our Indonesia
subsidiary.
Segment after-tax operating loss from corporate operations increased $11.6
million from the prior year. Net investment income on corporate surplus was $6.1
million lower due to increased surplus requirements in our other business lines.
Group Life after-tax operating income was $2.6 million lower reflecting a sale
transaction of the Group Life business to MetLife effective May 1, 2003.
Signature Fruit after-tax operating loss was $1.8 million lower due to increased
case volume and lower overhead costs. The cash surrender value of our corporate
owned life insurance program increased $9.7 million primarily from the improved
performance of the assets supporting the program and an increase in the asset
base. Expense increases in our corporate account were driven by an $8.2 million
increase in the provision for deficiency interest, a $2.7 million increase for
employee costs, a $4.7 million increase for pension costs and a $1.0 million
increase for benefits. A non-recurring prior year gain causes a $1.6 million of
the after-tax decrease. The $3.8 million balance is driven primarily by lower
expenses due to operational savings.
Segment after tax operating income from non-core businesses decreased $0.5
million from the prior year. We continue with the orderly run-off of business
within this group.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Segment after-tax operating income from international operations was
unchanged from the prior year. Results from our International Group Program were
$0.6 million higher due to higher earned retention income offset by lower
operating results in our Indonesia subsidiary.
Segment after-tax operating loss from corporate operations increased $22.1
million from the prior year. Net investment income on corporate surplus was
$21.9 million lower due to $5.1 million lower net investment income as a result
of increased surplus requirements in our other business lines. Group Life
after-tax operating income was $1.1 million lower reflecting a sale transaction
of the Group Life business to MetLife effective May 1, 2003. The cash surrender
value of our corporate owned life insurance program increased $16.3 million
primarily from the improved performance of the assets supporting the program and
an increase in the asset base. Expense increases in our corporate account were
driven by a $9.6 million increase in the provision for deficiency interest, an
$11.0 million increase for pension costs and a $1.4 million increase for
benefits. The $6.6 million balance is driven primarily by lower expenses due to
operational savings.
55
JOHN HANCOCK LIFE INSURANCE COMPANY
Segment after tax operating income from non-core businesses decreased $1.0
million from the prior year. We continue with the orderly run-off of business
within this group.
56
JOHN HANCOCK LIFE INSURANCE COMPANY
General Account Investments
We manage our general account assets in investment segments that support
specific classes of product liabilities. These investment segments permit us to
implement investment policies that both support the financial characteristics of
the underlying liabilities, and also provide returns on our invested capital.
The investment segments also enable us to gauge the performance and
profitability of our various businesses.
Asset/Liability Risk Management
Our primary investment objective is to maximize after-tax returns within
acceptable risk parameters. We are exposed to two primary types of investment
risk:
o Interest rate risk, meaning changes in the market value of fixed maturity
securities as interest rates change over time, and
o Credit risk, meaning uncertainties associated with the continued ability
of an obligor to make timely payments of principal and interest.
We use a variety of techniques to control interest rate risk in our
portfolio of assets and liabilities. In general, our risk management philosophy
is to limit the net impact of interest rate changes on our assets and
liabilities. Assets are invested predominantly in fixed income securities, and
the asset portfolio is matched with the liabilities so as to eliminate the
Company's exposure to changes in the overall level of interest rates. Each
investment segment holds bonds, mortgages, and other asset types that will
satisfy the projected cash needs of its underlying liabilities. Another
important aspect of our asset-liability management efforts is the use of
interest rate derivatives. We selectively apply derivative instruments, such as
interest rate swaps and futures, to reduce the interest rate risk inherent in
combined portfolios of assets and liabilities. For a more complete discussion of
our interest rate risk management practices, please see the Interest Rate Risk
section in the Quantitative and Qualitative Disclosures about Market Risk
section of this document.
Management of credit risk is central to our business and we devote
considerable resources to the credit analysis underlying each investment
acquisition. Our corporate bond management group includes a staff of highly
specialized, experienced, and well-trained credit analysts. We rely on these
analysts' ability to analyze complex private financing transactions and to
acquire the investments needed to profitably fund our liability requirements. In
addition, when investing in private fixed maturity securities, we rely upon
broad access to proprietary management information, negotiated protective
covenants, call protection features and collateral protection.
Our bond portfolio is reviewed on a continuous basis to assess the
integrity of current quality ratings. As circumstances warrant, specific
investments are "re-rated" with the adjusted quality ratings reflected in our
investment system. All bonds are evaluated regularly against the following
criteria:
o material declines in the issuer's revenues or margins;
o significant management or organizational changes;
o significant uncertainty regarding the issuer's industry;
o debt service coverage or cash flow ratios that fall below
industry-specific thresholds;
o violation of financial covenants; and
o other business factors that relate to the issuer.
Insurance product prices are impacted by investment results. Accordingly,
incorporated in insurance products prices are assumptions of expected default
losses over the long-term. Actual losses therefore vary above and below this
average, and the market value of the portfolio as a whole also changes as market
credit spreads move up and down during an economic cycle.
John Hancock is able to hold to this investment strategy over the long
term, both because of its strong capital position, the fixed nature of its
liabilities and the matching of those liabilities with assets and because of the
experience gained through many decades of a consistent investment philosophy. We
generally intend to hold all of our fixed maturity investments to maturity to
meet liability payments, and to ride out any unrealized gains and losses over
the long term. However, we do sell bonds under certain circumstances, such as
when new information causes us to change our assessment of whether a bond will
recover or perform according to its contractual terms, in response to external
events (such as a merger or a downgrade) that result in investment guideline
violations (such as single issuer or overall portfolio credit quality limits),
in response to extreme catastrophic events (such as September 11, 2001) that
result in industry or market wide disruption, or to take advantage of tender
offers.
57
JOHN HANCOCK LIFE INSURANCE COMPANY
Overall Composition of the General Account
Invested assets, excluding separate accounts totaled $66.9 billion and
$60.6 billion as of June 30, 2003 and December 31, 2002, respectively. Although
the portfolio composition has not significantly changed at June 30, 2003 as
compared to December 31, 2002, invested assets have grown 10.5%. The following
table shows the composition of investments in the general account portfolio.
As of June 30, As of December 31,
2003 2002
--------------------------------------------------------------
Carrying % of Carrying % of
Value Total Value Total
--------------------------------------------------------------
(in millions) (in millions)
Fixed maturity securities (1)............ $49,527.5 74.0% $ 43,773.3 72.3%
Mortgage loans (2)....................... 10,586.7 15.8 10,296.5 17.0
Real estate.............................. 201.1 0.3 255.3 0.4
Policy loans (3)......................... 2,014.5 3.0 2,014.2 3.3
Equity securities........................ 414.6 0.6 350.3 0.6
Other invested assets (4)................ 2,977.2 4.5 2,839.1 4.7
Short-term investments................... 200.3 0.3 137.3 0.2
Cash and cash equivalents (5)............ 1,012.3 1.5 897.0 1.5
--------------------------------------------------------------
Total invested assets.................... $66,934.2 100.0% $ 60,563.0 100.0%
==============================================================
(1) In addition to bonds, the fixed maturity security portfolio contains
redeemable preferred stock with a carrying value of $585.7 million and
$590.2 million as of June 30, 2003 and December 31, 2002, respectively.
The total fair value of the fixed maturity security portfolio was
$49,572.2 million and $43,823.5 million, at June 30, 2003 and December 31,
2002 respectively.
(2) The fair value for the mortgage loan portfolio was $11,676.8 million and
$11,220.7 million as of June 30, 2003 and December 31, 2002, respectively.
(3) Policy loans are secured by the cash value of the underlying life
insurance policies and do not mature in a conventional sense, but expire
in conjunction with the related policy liabilities.
(4) Other invested assets as of December 31, 2002 contains a receivable of
$471.1 million from Allmerica Financial Corporation pursuant to the
Company's agreement to reinsure Allmerica's fixed universal life insurance
business. At June 30, 2003, the acquisition accounting was finalized and
these assets are reflected in the proper line items in the portfolio
detail above.
(5) Cash and cash equivalents are included in total invested assets in the
table above for the purposes of calculating yields on the income producing
assets for the Company.
Consistent with the nature of the Company's product liabilities, assets
are heavily oriented toward fixed maturity securities. The Company determines
the allocation of assets primarily on the basis of cash flow and return
requirements of its products and by the level of investment risk.
Fixed Maturity Securities. The fixed maturity securities portfolio is
predominantly comprised of low risk, investment grade, publicly and privately
traded corporate bonds and senior tranches of asset-backed securities (ABS) and
mortgage-backed securities (MBS). The fixed maturity securities portfolio also
includes redeemable preferred stock. As of June 30, 2003, fixed maturity
securities represented 74.0% of general account invested assets with a carrying
value of $49.5 billion, comprised of 59.3% public securities and 40.7% private
securities. Each year, the Company directs the majority of net cash inflows into
investment grade fixed maturity securities. Typically, between 5% and 15% of
funds allocated to fixed maturity securities are invested in
below-investment-grade bonds while maintaining a policy to limit the overall
level of these bonds to no more than 10% of invested assets and the majority of
that balance in the BB category. The Company has established a long-term target
of limiting investments in below investment grade bonds to 8% of invested assets
by 2005 for its U.S. life insurance companies on a statutory accounting basis.
Allocations are based on an assessment of relative value and the likelihood of
enhancing risk-adjusted portfolio returns. While the Company has profited from
the below-investment-grade asset class in the past, care is taken to manage its
growth strategically by limiting its size relative to the Company's total
assets.
The Securities Valuation Office (SVO) of the National Association of
Insurance Commissioners evaluates all public and private bonds purchased as
investments by insurance companies. The SVO assigns one of six investment
categories to each security it reviews. Category 1 is the highest quality
rating, and Category 6 is the lowest. Categories 1 and 2 are the
58
JOHN HANCOCK LIFE INSURANCE COMPANY
equivalent of investment grade debt as defined by rating agencies such as S&P
and Moody's (i.e., BBB /Baa3 or higher), while Categories 3-6 are the equivalent
of below-investment grade securities. SVO ratings are reviewed and may be
revised at least once a year.
The following table shows the composition by credit quality of the fixed
maturity securities portfolio.
Fixed Maturity Securities -- By Credit Quality
-------------------------------------------------------------
As of June 30, As of December 31,
2003 2002
-------------------------------------------------------------
SVO S&P Equivalent Carrying % of Carrying % of
Rating (1) Designation (2) Value (3)(4)(5) Total Value (3)(4)(5) Total
- ----------------------------------------------------------------------------------------------------------
(in millions) (in millions)
1 AAA/AA/A....................... $20,254.8 41.4% $17,590.5 40.7%
2 BBB............................ 22,976.1 46.9 20,406.6 47.3
3 BB............................. 2,296.1 4.7 2,574.9 6.0
4 B.............................. 1,691.7 3.5 1,215.3 2.8
5 CCC and lower.................. 1,149.1 2.3 775.8 1.8
6 In or near default............. 574.0 1.2 620.0 1.4
-------------------------------------------------------------
Subtotal....................... 48,941.8 100.0% 43,183.1 100.0%
Redeemable preferred stock..... 585.7 590.2
-------------------------------------------------------------
Total Fixed Maturities.... .... $49,527.5 $43,773.3
=============================================================
(1) For securities that are awaiting an SVO rating, the Company has assigned a
rating based on an analysis that it believes is equivalent to that used by
the SVO.
(2) Comparisons between SVO and S&P ratings are published by the National
Association of Insurance Commissioners.
(3) Includes 168 securities that are awaiting an SVO rating, with a carrying
value of $3,499.0 million as of June 30, 2003. Due to lags between the
funding of an investment, the processing of final legal documents, the
filing with the SVO, and the rating by the SVO, there will always be a
number of unrated securities at each statement date.
(4) Includes the effect of $50.0 million invested in the Company's
credit-linked note program, $30.0 million of written credit default swaps
on fixed maturity securities in the AAA/AA/A category and $20.0 million of
written credit default swaps on fixed maturity securities in the BBB
category. As of December 31, 2002 the Company had $55.0 million invested
in the Company's credit linked program, $10.0 million of written credit
default swaps on fixed maturity securities in the AAA/AA/A category and
$45.0 million of written credit default swaps on fixed maturity securities
in the BBB category.
(5) The Company entered into a credit enhancement agreement in the form of a
guaranty from a AAA rated financial guarantor in 1996. To reflect the
impact of this guaranty on the overall portfolio, the Company has
presented securities covered in aggregate by the guaranty at rating levels
provided by the SVO and Moody's that reflect the guaranty. As a result,
$97.9 million of SVO Rating 2, $589.6 million of SVO Rating 3, and $211.8
million of SVO Rating 4 underlying securities are included as $685.3
million of SVO Rating 1, $160.5 million of SVO Rating 2 and $53.5 million
of SVO Rating 3 as of June 30, 2003 and $94.0 million of SVO Rating 2,
$718.0 million of SVO Rating 3, and $141.3 million of SVO Rating 4
underlying securities are included as $753.2 million of SVO Rating 1,
$150.1 million of SVO Rating 2 and $50.0 million of SVO Rating 3 as of
December 31, 2002. The guaranty also contains a provision that the
guarantor can recover from the Company certain amounts paid over the
history of the program in the event a payment is required under the
guaranty. As of June 30, 2003 and December 31, 2002, the maximum amount
that can be recovered under this provision was $82.3 million.
The table above sets forth the SVO ratings for the bond portfolio along
with an equivalent S&P rating agency designation. The majority of the fixed
maturity investments are investment grade, with 88.3% and 88.0% of fixed
maturity investments invested in Category 1 and 2 securities as of June 30, 2003
and December 31, 2002, respectively. Below investment grade bonds were 11.7% and
12.0% of fixed maturity investments and 8.5% and 8.6% of total invested assets
as of June 30, 2003 and December 31, 2002, respectively. This allocation
reflects the Company strategy of avoiding the unpredictability of interest rate
risk in favor of relying on the Company's bond analysts' ability to better
predict credit or
59
JOHN HANCOCK LIFE INSURANCE COMPANY
default risk. The bond analysts operate in an industry-based, team-oriented
structure that permits the evaluation of a wide range of below investment grade
offerings in a variety of industries resulting in a well-diversified high yield
portfolio.
Valuation techniques for the bond portfolio vary by security type and the
availability of market data. Pricing models and their underlying assumptions
impact the amount and timing of unrealized gains and losses recognized, and the
use of different pricing models or assumptions could produce different financial
results. External pricing services are used where available, broker dealer
quotes are used for thinly traded securities, and a spread pricing matrix is
used when price quotes are not available, which typically is the case for our
private placement securities. The spread pricing matrix is based on credit
quality, country of issue, market sector and average investment life and is
created for these dimensions through brokers' estimates of public spreads
derived from their respective publications. When utilizing the spread pricing
matrix, securities are valued through a discounted cash flow method where each
bond is assigned a spread that is added to the current U.S. Treasury rates to
discount the cash flows of the security. The spread assigned to each security is
changed from month to month based on changes in the market. Certain market
events that could impact the valuation of securities include issuer credit
ratings, business climate, management changes, litigation, and government
actions among others. The resulting prices are then reviewed by the pricing
analysts and members of the Controller's Department. The Company's pricing
analysts take appropriate actions to reduce valuations of securities where such
an event occurs that negatively impacts the securities' value. Although the
Company believes its estimates reasonably reflect the fair value of those
securities, the key assumptions about risk premiums, performance of underlying
collateral (if any) and other factors involve significant assumptions and may
not reflect those of an active market. To the extent that bonds have longer
maturity dates, management's estimate of fair value may involve greater
subjectivity since they involve judgment about events well into the future.
Then, every quarter, there is a comprehensive review of all impaired securities
and problem loans by a group consisting of the Chief Investment Officer and the
Bond Investment Committee, including the Corporate Risk Officer who reports to
the Chief Financial Officer The valuation of impaired bonds for which there is
no quoted price is typically based on the present value of the future cash flows
expected to be received. If the company is likely to continue operations, the
estimate of future cash flows is typically based on the expected operating cash
flows of the company that are available to make payments on the bonds. If the
company is likely to liquidate, the estimate of future cash flows is based on an
estimate of the liquidation value of its net assets.
As of June 30, 2003 and December 31, 2002, 40.2% and 49.7% of our below
investment grade bonds are in Category 3, the highest quality below investment
grade. Category 6 bonds, those in or near default, represent securities that
were originally acquired as long-term investments, but subsequently became
distressed. The carrying value of bonds in or near default was $574.0 million
and $620.0 million as of June 30, 2003 and December 31, 2002, respectively. As
of June 30, 2003 and December 31, 2002, $8.5 million and $10.7 million,
respectively of interest on bonds near default was included in accrued
investment income. Unless the Company reasonably expects to collect investment
income on bonds in or near default, the accrual will be ceased and any accrued
income reversed. Management judgment is used and the actual results could be
materially different.
Bonds rated Category 5 by the SVO increased by $551.3 million for the
quarter and $373.3 million for the six month period ended June 30, 2003.
Approximately $159 million of the increase for the quarter was due to upgrades
of Category 6 bonds and market appreciation of existing bonds in this category.
The remaining increase is due primarily to the downgrade by the SVO of $435.2
million of bonds whose public ratings did not change during the quarter. These
bonds were either split rated or rated higher by the major rating agencies and
the SVO moved them to the lower level during the quarter. We do not believe that
these downgrades represent a deterioration in the credit of these securities and
we are appealing approximately $250 million of these downgrades with the SVO and
expect to see upgrades in the coming quarters.
In keeping with the investment philosophy of tightly managing interest
rate risk, the Company's MBS & ABS holdings are heavily concentrated in
commercial MBS where the underlying loans are largely call protected, which
means they are not pre-payable without penalty prior to maturity at the option
of the issuer. By investing in MBS and ABS securities with relatively
predictable repayments, the Company adds high quality, liquid assets to our
portfolios without incurring the risk of cash flow variability. The Company
believes the portion of its MBS/ABS portfolio subject to prepayment risk as of
June 30, 2003 and December 31, 2002 was limited to approximately $1,479 million
and $988 million, respectively, or 17.3% and
60
JOHN HANCOCK LIFE INSURANCE COMPANY
13.1%, respectively, of our total MBS/ABS portfolio and 3.0% and 2.3%,
respectively, of our total fixed maturity securities holdings, at each period
end.
The following table shows the composition by our internal industry
classification of the fixed maturity securities portfolio and the unrealized
gains and losses contained therein.
Fixed Maturity Securities -- By Industry Classification
As of June 30, 2003
------------------------------------------------------------------------------
Carrying Carrying
Value of Value of
Securities Securities
Net with Gross Gross with Gross Gross
Total Unrealized Unrealized Unrealized Unrealized Unrealized
Carrying Value Gain (Loss) Gains Gains Losses Losses
------------------------------------------------------------------------------
(in millions)
Corporate securities:
Banking and finance ............. $ 6,237.5 $ 423.8 $ 5,496.3 $ 438.3 $ 741.2 $ (14.5)
Communications .................. 3,237.7 260.8 2,975.5 289.6 262.2 (28.8)
Government ...................... 2,998.1 147.3 1,571.3 164.4 1,426.8 (17.1)
Manufacturing ................... 7,743.9 506.5 6,543.8 602.8 1,200.1 (96.3)
Oil & gas ....................... 4,925.2 367.3 4,321.6 445.6 603.6 (78.3)
Services/trade .................. 2,655.5 223.2 2,466.7 236.0 188.8 (12.8)
Transportation .................. 2,970.7 98.6 2,166.2 217.0 804.5 (118.4)
Utilities ....................... 9,120.7 437.0 6,937.4 636.4 2,183.3 (199.4)
Other ........................... -- -- -- -- -- --
-----------------------------------------------------------------------------
Total corporate securities ........ 39,889.3 2,464.5 32,478.8 3,030.1 7,410.5 (565.6)
Asset-backed and mortgage-
backed securities ................ 8,541.3 304.6 6,700.0 497.7 1,841.3 (193.1)
U.S. Treasury securities and
obligations of U.S. government
agencies ......................... 178.8 7.7 139.7 7.8 39.1 (0.1)
Debt securities issued by foreign
governments ...................... 258.5 24.9 153.5 30.2 105.0 (5.3)
Obligations of states and political
subdivisions ..................... 659.6 29.2 441.7 30.5 217.9 (1.3)
-----------------------------------------------------------------------------
Total ........................... $49,527.5 $ 2,830.9 $39,913.7 $ 3,596.3 $ 9,613.8 $ (765.4)
=============================================================================
61
JOHN HANCOCK LIFE INSURANCE COMPANY
Fixed Maturity Securities -- By Industry Classification
As of December 31, 2002
------------------------------------------------------------------------------
Carrying Carrying
Value of Value of
Securities Securities
Net with Gross Gross with Gross Gross
Total Unrealized Unrealized Unrealized Unrealized Unrealized
Carrying Value Gain (Loss) Gains Gains Losses Losses
------------------------------------------------------------------------------
(in millions)
Corporate securities:
Banking and finance ............. $ 5,469.0 $ 213.2 $ 4,361.7 $ 264.0 $ 1,107.3 $ (50.8)
Communications .................. 2,204.5 86.4 1,815.8 137.6 388.7 (51.2)
Government ...................... 2,570.5 120.7 1,805.1 139.7 765.4 (19.0)
Manufacturing ................... 7,211.3 202.4 5,502.8 384.6 1,708.5 (182.2)
Oil & gas ....................... 4,318.1 85.0 3,305.7 274.4 1,012.4 (189.4)
Services / trade ................ 2,422.5 118.9 2,088.6 135.4 333.9 (16.5)
Transportation .................. 2,740.5 28.9 2,044.4 158.2 696.1 (129.3)
Utilities ....................... 8,482.3 (168.3) 5,426.7 354.0 3,055.6 (522.3)
Other ........................... 0.1 -- -- -- 0.1 --
-----------------------------------------------------------------------------
Total corporate securities ........ 35,418.8 687.2 26,350.8 1,847.9 9,068.0 (1,160.7)
Asset-backed and mortgage-
backed securities ................ 7,523.1 138.0 5,858.9 414.0 1,664.2 (276.0)
U.S. Treasury securities and
obligations of U.S. government
agencies ......................... 184.4 8.7 183.3 8.7 1.1 --
Debt securities issued by foreign
governments ...................... 325.0 33.5 316.9 36.0 8.1 (2.5)
Obligations of states and political
subdivisions ..................... 322.0 22.6 318.7 22.6 3.3 --
------------------------------------------------------------------------------
Total ........................... $43,773.3 $ 890.0 $33,028.6 $ 2,329.2 $10,744.7 $(1,439.2)
==============================================================================
As of June 30, 2003 and December 31, 2002, there are gross unrealized
gains of $3,596.3 million and $2,329.2 million, and gross unrealized losses of
$765.4 million and $1,439.2 million on the fixed maturities portfolio. As of
June 30, 2003 gross unrealized losses of $765.4 million include $685.5 million,
or 89.6%, of gross unrealized losses concentrated in the utilities,
manufacturing, oil and gas, transportation, and asset-backed and mortgage-backed
securities. The tables above show gross unrealized losses before amounts that
are allocated to the closed block policyholders or participating pension
contractholders. Of the $765.4 million of gross unrealized losses in the
portfolio at June 30, 2003, $97.3 million was in the closed block and $33.3
million has been allocated to participating pension contractholders, leaving
$634.8 million of gross unrealized losses after such allocations. The 2002 gross
unrealized losses of $1,439.2 million included $1,299.2 million, or 90.3%, of
gross unrealized losses concentrated in the utilities, manufacturing, oil and
gas, transportation, and asset-backed and mortgage-backed securities. Only the
utilities sector has net unrealized losses. The tables above show gross
unrealized losses before amounts that were allocated to the closed block
policyholders or participating pension contractholders. Of the $1,439.2 million
of gross unrealized losses in the portfolio at December 31, 2002, $191.0 million
was in the closed block and $62.6 million was allocated to participating pension
contractholders, leaving $1,185.6 million of gross unrealized losses after such
allocations.
Manufacturing: Manufacturing is a large, diverse sector encompassing
cyclical industries. Low commodity prices continue to pressure the subsectors of
mining, chemicals, metals, and forest products. When the U.S. economy recovers,
these cyclical subsectors should recover and the bonds of companies in these
subsectors should recover as well. We have financed these subsectors though
several economic cycles and will typically hold our investments until they
recover in value or mature. Our portfolio also benefits from our underwriting
process where we stress test each company's financial performance
62
JOHN HANCOCK LIFE INSURANCE COMPANY
through a recession scenario.
Oil & Gas: In the Oil & Gas industry, much of our unrealized loss arises
from companies in emerging markets, primarily Latin America and particularly in
Venezuela. Our philosophy in emerging markets is to generally lend to those
companies with dollar based export products such as oil companies. Emerging
markets continue to experience significant stress and bond prices across most
emerging market countries are down. However, our oil & gas investments are
faring well as these companies have dollar based revenues to pay their debts and
have continued to do so. In many cases, deals are structured so that all export
revenues first pass through an offshore trust and our debt service is then paid
before any dollars are released back to the company. This type of transaction is
known as an export receivables deal. All of our Venezuelan transactions are
structured in this manner. The strike in Venezuela raised the risk profile of
our oil transactions in this country, because the investments we have in
Venezuela require oil production in order for these deals to produce payments.
The gross unrealized loss on our Venezuelan oil and gas holdings was $64.4
million and $105.5 million as of June 30, 2003 and December 31, 2002,
respectively. The improvement in the gross unrealized loss is largely due to the
end of the Venezuelan old strike and the increase in oil production to
approximately 80% of pre-strike levels. We expect further price recovery in
these bonds as the market becomes comfortable that these production levels will
continue.
Transportation: The Transportation sector consists largely of air, rail,
and automotive manufacturers and service companies. All of these subsectors are
experiencing cyclical downturns, particularly the airline industry, having been
hit both by the recession and the fallout from September 11, 2001. While most
airlines are losing money, we lend to this industry almost exclusively on a
secured basis (approximately 99% of our loans are secured). These secured
airline financings are of two types: Equipment Trust Certificates (ETC's) and
Enhanced Equipment Trust Certificates (EETC's). The ETC's initially have an 80%
loan-to-value ratio and the EETC senior tranches initially have a 40-50%
loan-to-value and include a provision for a third party to pay interest for
eighteen months from a default. For us to lose money on an ETC, three things
must happen: the airline must default, the airline must decide it does not want
to fly our aircraft, and the aircraft must be worth less than our loan. When
lending to this industry, we underwrite both the airline and the aircraft. We've
been lending to this industry in this fashion for 25 years through several
economic cycles and have seen values on our secured airline bonds fall and
recover thorough these cycles. EETC's are classified as asset-backed securities
and they account for $113.5 million and $180.1 million of the $193.1 million and
$276.0 million of gross unrealized loss in the asset-backed and mortgage-backed
securities category as of June 30, 2003 and December 31, 2002, respectively.
While the airline industry is making positive strides in reducing its cost
structure, a significant recovery in this sector requires a growing economy and
a pick up in business travel. We do still expect that the senior secured nature
of our loans to this industry will protect our holdings through this difficult
time.
Utilities: The Utility sector has faced a number of challenges over the
past few years including the California Power Crisis, the Enron bankruptcy and
the recession which slowed the growth in demand. More recently, there have been
issues around energy trading activities and the financial liquidity of some
large merchant industry players. These events caused a general widening in
utility and project finance bond spreads over the course of 2002. We expect some
continued stress in this sector as owners of merchant plants work through their
liquidity issues with the banks. Investors are likely to see continued
restructurings and/or bankruptcy filings from those companies unable to reach
agreement with the banks. Longer term, we believe the reduction in power supply
from reduced capital expenditures and the shutting of inefficient plants will
support a gradual rise in power prices that will help this sector recover. Thus
far this year, there are a number of positive signs in this sector as power
prices have increased and, most importantly, banks are more willing to refinance
their maturing lines, albeit often on a secured basis. As a result, prices in
power sector bonds have improved significantly, as shown by the reduction in
gross unrealized loss on our utility sector bonds from $522.3 million as of
December 31, 2002 to $199.4 million as of June 30, 2003.
Asset-backed and mortgage-backed securities: As described above, as of
June 30, 2003 and December 31, 2002, the main driver of the unrealized loss in
this category is $113.5 million and $180.1 million of gross unrealized loss on
EETC's with a GAAP book value of $695.0 million and $745.8 million,
respectively. This $113.5 million and $180.1 million of gross unrealized loss
represents 59% and 65% of the total gross unrealized loss in this category.
EETC's are financings secured by a pool of aircraft. The vast majority of our
EETC holdings ($687.9 million and $713.1 million of the $695.0 million and
$745.8 million) are the most senior tranches in the EETC structure. The most
senior tranches are generally structured to have an initial loan-to-value of
40-50%. Given the drop in airline passenger traffic and the financial
difficulties of most of the major carriers, aircraft values have dropped
significantly and hence EETC's have declined in price. We still expect, however,
that most of the senior tranche EETC have enough subordination and asset
coverage to ensure full and timely repayment. The major risk to this portfolio
is a further decline in passenger traffic due to an extended war or increased
terrorist activity, further depressing aircraft values. Thus far, we have never
lost money on a senior tranche EETC even though some of aircraft
63
JOHN HANCOCK LIFE INSURANCE COMPANY
backing our transactions have been leased to airlines that have gone out of
business. As airlines emerge from bankruptcy and it becomes clear that most
senior tranche EETC's have ample asset coverage, we expect these bonds' prices
will recover.
64
JOHN HANCOCK LIFE INSURANCE COMPANY
The following table shows the composition by credit quality of the
securities with gross unrealized losses in our fixed maturity securities
portfolio. Bonds rated Category 5 by the SVO increased by $124.2 million for the
six month period ended June 30, 2003, but the unrealized losses on these
securities decreased by $44.2 million over the same period. For the quarter,
bonds with gross unrealized losses rated Category 5 increased by $299.6 million
while the unrealized losses on these securities increased $30.4 million. The
change for the quarter is caused primarily by upgrades of Category 6 bonds and
downgrades by the SVO of securities that had split ratings or higher ratings by
the major rating agencies. We do not believe that these downgrades represent a
deterioration in the credit of these securities and we are appealing several of
these downgrades with the SVO and expect to see upgrades in the coming quarters.
Unrealized Losses on Fixed Maturity Securities -- By Quality
As of June 30, 2003
--------------------------------------------------------------
Carrying Value of
Securities with
SVO S&P Equivalent Gross Unrealized % of Gross Unrealized % of
Rating (1) Designation (2) Losses (3) Total Losses (3) Total
- -------------------------------------------------------------------------------------------------------
(in millions) (in millions)
1 AAA/AA/A.................... $ 4,212.3 44.7% ($111.0) 14.7%
2 BBB......................... 2,100.9 22.3 (131.5) 17.4
3 BB.......................... 1,079.3 11.4 (131.1) 17.3
4 B........................... 1,088.5 11.6 (195.2) 25.9
5 CCC and lower............... 665.4 7.1 (149.4) 19.8
6 In or near default.......... 270.4 2.9 (36.9) 4.9
--------------------------------------------------------------
Subtotal.................... 9,416.8 100.0% (755.1) 100.0%
Redeemable preferred stock.. 197.0 (10.3)
--------------------------------------------------------------
Total....................... $ 9,613.8 ($765.4)
==============================================================
(1) With respect to securities that are awaiting rating, the Company has
assigned a rating based on an analysis that it believes is equivalent to
that used by the SVO.
(2) Comparisons between SVO and S&P ratings are published by the National
Association of Insurance Commissioners.
(3) Includes 53 securities with gross unrealized losses are awaiting an SVO
rating with a carrying value of $1,698.4 million and unrealized losses of
$37.8 million. Due to lags between the funding of an investment, the
processing of final legal documents, the filing with the SVO, and the
rating by the SVO, there will always be a number of unrated securities at
each statement date. Unrated securities comprised 17.7% and 4.9% of the
total carrying value and total gross unrealized losses of securities in a
loss position, including redeemable preferred stock, respectively.
65
JOHN HANCOCK LIFE INSURANCE COMPANY
Unrealized Losses on Fixed Maturity Securities -- By Quality
As of December 31, 2002
---------------------------------------------------------------
Carrying Value of
Securities with
SVO S&P Equivalent Gross Unrealized % of Gross Unrealized % of
Rating (1) Designation (2) Losses (3) Total Losses (3) Total
- ---------------------------------------------------------------------------------------------------------
(in millions) (in millions)
1 AAA/AA/A.................... $ 3,134.5 29.9% $ (148.2) 10.4%
2 BBB......................... 4,109.8 39.2 (376.7) 26.4
3 BB.......................... 1,622.1 15.5 (410.3) 28.7
4 B........................... 708.5 6.8 (218.4) 15.3
5 CCC and lower............... 541.2 5.2 (193.6) 13.6
6 In or near default.......... 362.4 3.4 (80.5) 5.6
---------------------------------------------------------------
Subtotal................. 10,478.5 100.0% (1,427.7) 100.0%
Redeemable preferred stock.. 266.2 (11.5)
---------------------------------------------------------------
Total....................... $10,744.7 $(1,439.2)
===============================================================
(1) With respect to securities that are awaiting rating, the Company has
assigned a rating based on an analysis that it believes is equivalent to
that used by the SVO.
(2) Comparisons between SVO and S&P ratings are published by the National
Association of Insurance Commissioners.
(3) Includes 59 securities with gross unrealized losses are awaiting an SVO
rating with a carrying value of $1,658.1 million and unrealized losses of
$62.7 million. Due to lags between the funding of an investment, the
processing of final legal documents, the filing with the SVO, and the
rating by the SVO, there will always be a number of unrated securities at
each statement date. Unrated securities comprised 15.4% and 4.4% of the
total carrying value and total gross unrealized losses of securities in a
loss position, including redeemable preferred stock, respectively.
Unrealized Losses on Fixed Maturity Securities -- By Investment Grade and Age
As of June 30, 2003
-------------------------------------------------------------------------------------
Investment Grade Below Investment Grade
-------------------------------------------------------------------------------------
Carrying Carrying
Value of Value of
Securities Securities
with Gross with Gross
Unrealized Hedging Market Unrealized Hedging Market
Losses Adjustments Depreciation Losses Adjustments Depreciation
- -----------------------------------------------------------------------------------------------------------------------------------
(in millions) (in millions)
Three months or less ........................ $2,058.5 $ (4.5) $ (45.2) $ 336.8 $ (8.3) $ (43.6)
Greater than three months to six months ..... 912.4 (9.8) (10.5) 284.0 (4.0) (13.1)
Greater than six months to nine months ...... 938.2 (10.8) (11.0) 279.0 (4.0) (13.4)
Greater than nine months to twelve months ... 233.3 (12.8) (10.0) 169.4 (4.5) (33.9)
Greater than twelve months .................. 2,170.8 (87.0) (40.9) 2,034.4 (109.0) (278.8)
-------------------------------------------------------------------------------------
Subtotal ............................... 6,313.2 (124.9) (117.6) 3,103.6 (129.8) (382.8)
-------------------------------------------------------------------------------------
Redeemable preferred stock .................. 197.0 -- (10.3) -- -- --
-------------------------------------------------------------------------------------
Total .................................. $6,510.2 $ (124.9) $ (127.9) $3,103.6 $ (129.8) $ (382.8)
=====================================================================================
66
JOHN HANCOCK LIFE INSURANCE COMPANY
Unrealized Losses on Fixed Maturity Securities -- By Investment Grade and Age
As of December 31, 2002
---------------------------------------- ------------------------------------------
Investment Grade Below Investment Grade
---------------------------------------- ------------------------------------------
Carrying Carrying
Value of Value of
Securities Securities
with Gross with Gross
Unrealized Hedging Market Unrealized Hedging Market
Losses Adjustments Depreciation Losses Adjustments Depreciation
- --------------------------------------------------------------------------------------- ------------------------------------------
(in millions) (in millions)
Three months or less ....................... $2,159.6 $ (19.3) $ (46.9) $ 272.5 $ (2.2) $ (12.9)
Greater than three months to six months .... 868.6 (15.7) (31.6) 398.2 (6.9) (110.3)
Greater than six months to nine months ..... 914.3 (36.3) (23.9) 561.3 (14.3) (77.8)
Greater than nine months to twelve months .. 293.3 (9.7) (23.6) 388.9 (4.7) (59.6)
Greater than twelve months ................. 3,008.5 (69.8) (248.1) 1,613.3 (75.3) (538.8)
---------------------------------------- ------------------------------------------
Subtotal .............................. 7,244.3 (150.8) (374.1) 3,234.2 (103.4) (799.4)
---------------------------------------- ------------------------------------------
Redeemable preferred stock ................. 266.2 -- (11.5) -- -- --
---------------------------------------- ------------------------------------------
Total ................................. $7,510.5 $ (150.8) $ (385.6) $3,234.2 $ (103.4) $ (799.4)
======================================== ==========================================
The tables above shows the Company's investment grade and below investment
grade securities that were in a loss position at June 30, 2003 and December 31,
2002 by the amount of time the security has been in a loss position. Gross
unrealized losses from hedging adjustments represent the amount of the
unrealized loss that results from the security being designated as a hedged item
in a fair value hedge. When a security is so designated, its cost basis is
adjusted in response to movements in interest rates. These adjustments, which
are non-cash and reverse with the passage of time as the asset and derivative
mature, impact the amount of unrealized loss on a security. The remaining
portion of the gross unrealized loss represents the impact of interest rates on
the non-hedged portion of the portfolio and unrealized losses due to
creditworthiness on the total fixed maturity portfolio.
As of June 30, 2003 and December 31, 2002, respectively, the fixed
maturity securities had a total gross unrealized loss of $510.7 million and
$1,185.0 million, excluding basis adjustments related to hedging relationships.
Of these totals, $363.6 million and $870.1 million, respectively, are due to
securities that have had various amounts of unrealized loss for more than nine
months. Of this, $50.9 million and $271.7 million, respectively comes from
securities rated investment grade. Unrealized losses on investment grade
securities principally relate to changes in interest rates or changes in credit
spreads since the securities were acquired. Credit rating agencies statistics
indicate that investment grade securities have been found to be less likely to
develop credit concerns.
As of June 30, 2003 and December 31, 2002, $312.7 million and $598.4
million, respectively, of the $510.7 million and $1,185.0 million resided in
below investment grade securities with various amounts of unrealized loss for
over nine months. At June 30, 2003, all of these securities were current as to
the payments of principal and interest with the exception of 4 securities with a
carrying value of $9.6 million and an unrealized loss of $17.1 million. Of the
total $312.7 million, $135.4 million traded above 80% of amortized cost at June
30, 2003 and an additional $45.6 million traded above 80% of amortized cost
within the last nine months, for a total of $181.0 million. Of the total $181.0
million in this category, utility related bonds made up $66.4 million. As
described earlier, the utility sector suffered from oversupply and slower than
expected demand last year. This led to many credit quality downgrades in the
sector and corresponding price declines. We have seen evidence of improvement in
the utility sector recently as companies have curtailed expansion plans and sold
assets to conserve cash flow and strengthen their balance sheets. On the other
hand, $69.5 million of this $181.0 million total comes from airline related
bonds and this sector has continued to deteriorate thus far in 2003. While, as
described earlier, we expect the secured nature of our positions to protect our
value, the increased stress in this industry is of concern.
Unrealized Losses As of June 30, 2003
As of June 30, 2003, the remaining portion of the unrealized loss, $131.7
million, arises from below investment grade securities that have traded below 80
percent of amortized cost for over nine months. All of these bonds are current
on payments of principal and interest and we believe, based on currently
available information that it is probable that these securities will continue to
pay based on their original terms. We carefully track these investments to
ensure our continued belief that their prices will recover. More detail on the
most significant securities is contained below:
67
JOHN HANCOCK LIFE INSURANCE COMPANY
o $22.0 million on a fertilizer plant that sources its natural gas from
PDVSA, the Venezuelan oil company. While the cost of the natural gas is
very inexpensive, there are concerns about the reliability of the supply.
Furthermore, the plant that has experienced operating problems. Its equity
sponsors, however, have supported the project with additional
contributions of equity and based on our review of this credit we expect
their continued support. While there is risk the equity sponsors could
drop their support, their past actions, strong capital positions, their
large investment and the low cost nature of this project due to its
inexpensive gas supply give us comfort in their continued support. Hence,
we expect the price to continue to recover.
o $18.6 million from a structured investment based on oil and gas payments
to an Argentine province. This transaction benefits from (1) rights to 80%
of the royalty payments received by the province, (2) a six month debt
service reserve located in the U.S., and (3) a political risk insurance
policy from a major reinsurer that will take over payments in the event
the government imposes transfer or currency conversion limitations.
Currently, the major risk is that the local oil and gas companies are
making payments to the province based on a fixed exchange rate rather than
the market exchange rate. While the province is working to correct this,
if it does not change we will need to dip into the debt service reserve
account for a portion of the debt service payments this year and we will
ultimately need to restructure our rights to royalty payments to extend
beyond the maturity of our notes, so a restructuring would likely extend
the term of our note with interest.
o $3.9 million arises from a structured receivables transaction based on the
export of soybeans from a major soybean producer in Argentina. The
international buyers of the soybeans make payment to an offshore trust
with our debt service paid before any dollars flow back to the Argentine
company. We expect this structure to continue to protect our debt service
payments.
o $5.0 million on a producer of manufactured homes. Overcapacity has hurt
this industry and much of the production and retailing capacity has been
removed over the past several years. This company is a leader in this
industry and thus has been able to weather the downturn. As the industry
recovers due to the reduction of capacity, so should the value of these
bonds.
o $11.6 million on loan secured by a power plant in Mississippi. The plant
is owned by a company currently in bankruptcy, but this asset has not been
pulled into the bankruptcy and hence our loan is current. Our loan
benefits from a 6 month debt service reserve with sufficient cash flow to
cover debt service. We expect the equity in this project to be sold out of
the bankrupt power company and the bond price to recover at that time.
o $8.2 million on a large copper producer based in Mexico. This company has
suffered from the cyclical downturn in copper prices over the past two
years and insufficient capital expenditures to keep its costs competitive.
The company's owners have addressed the latter issue by recently injecting
fresh capital into the company to improve the efficiency of its
operations. The expected improvement in copper prices due to the improving
U.S. economy should also help the company and hence the bond price.
o $3.3 million on a senior tranche franchise loan asset backed security. The
underlying franchise loans are primarily to the gas/convenience sector
that has experienced stress from the large new entrants such as Walmart.
Nevertheless, this senior tranche is current and, based on historical and
projected delinquencies, we still expect to be paid in full and expect its
price to recover.
o $45.4 million on five secured airline bonds. Three of the bonds account
for the majority, $39.8 million, of the loss. These 3 bonds are all senior
tranche, EETC's of an airline currently in bankruptcy. These EETC's,
however, are all current due to the 18 month liquidity facility with which
to make interest payments. In all three cases, the total loan balance of
the senior tranche is still less than the current appraised value of the
underlying aircraft. Accordingly, we expect the market price of this bond
to recover. Another $3.6 million is on an ETC with a major US airline that
we do not expect to file for bankruptcy and hence expect the bond to
recover. The remaining $2.0 million loss is on a subordinated tranche of
an EETC for a major US airline not in bankruptcy. We do not expect this
airline to file for bankruptcy and hence expect the bond to recover.
68
JOHN HANCOCK LIFE INSURANCE COMPANY
o $6.3 million on the bond of a major telecommunications company. A major
portion of the value of this company is derived from its local exchange
business. The company has taken steps to de-leverage and is expected to be
in a positive cash flow position this year. As the company continues to
reduce leverage through cost cutting and asset dispositions, we expect
these securities to continue to recover in value.
The Company's investment grade and below investment grade bonds trading at
less than 80% of amortized cost for more than one year amounted to $76.7 million
in June 30, 2003 down $77.0 million or 50.1% from December 31, 2002. Three
quarters of that amount is associated with U.S. dollar denominated structured
receivables in Venezuela and Argentina, some of which are analyzed above.
The Company believes, however, that after its comprehensive review of each
borrower's ability to meet the obligations of the notes, and based on
information available at this time, these securities will continue to pay as
scheduled, and the Company has the ability and the intent to hold these
securities until they recover in value or mature. The scheduled maturity dates
for securities in an unrealized loss position at June 30, 2003 and December 31,
2002 is shown below.
Unrealized Losses on Fixed Maturity Securities -- By Maturity
June 30, 2003 December 31, 2002
---------------------- ----------------------
Carrying Carrying
Value of Value of
Securities Securities
with Gross Gross with Gross Gross
Unrealized Unrealized Unrealized Unrealized
Loss Loss Loss Loss
----------------------- ------------------------
(in millions) (in millions)
Due in one year or less ................. $ 411.4 $ (14.5) $ 554.9 $ (35.5)
Due after one year through five years ... 1,831.3 (113.4) 2,473.7 (268.4)
Due after five years through ten years .. 1,627.2 (199.5) 2,478.4 (418.6)
Due after ten years ..................... 3,902.6 (244.9) 3,573.5 (440.7)
----------------------- -----------------------
7,772.5 (572.3) 9,080.5 (1,163.2)
Asset-backed and mortgage-backed
securities ............................ 1,841.3 (193.1) 1,664.2 (276.0)
----------------------- -----------------------
Total ................................... $ 9,613.8 $ (765.4) $10,744.7 $(1,439.2)
======================= =======================
69
JOHN HANCOCK LIFE INSURANCE COMPANY
As of June 30, 2003 we had 85 securities representing 17 credit exposures
that had an unrealized loss of $10 million or more. They include:
Description of Issuer Amortized Cost Unrealized Loss
- -------------------------------------------------------------------------------------------------------------
(in millions)
Notes secured by leases on a pool of aircraft ........................... $ 52.6 $ (18.5)
Notes secured by leases on a pool of aircraft ........................... 77.7 (11.4)
Major US airline ........................................................ 150.6 (10.6)
Secured financings to large US airline .................................. 121.0 (23.2)
Large US based merchant energy generator ................................ 99.4 (12.2)
Joint venture with a Venezuelan oil company ............................. 41.5 (19.4)
Finance subsidiary of US paper/wood products manufacturer ............... 207.0 (10.3)
Notes secured by leases on a pool of aircraft ........................... 35.1 (22.7)
US natural gas fired power generator .................................... 84.5 (20.9)
Securitized investment of aircraft ...................................... 186.3 (12.2)
Major US airline ........................................................ 118.6 (11.9)
US power generator with multiple plants ................................. 100.3 (12.3)
Venezuelan oil company with US dollar based flows ....................... 156.8 (24.5)
Joint venture with a Venezuelan oil company and a large US oil company .. 62.9 (12.6)
US merchant energy generator ............................................ 73.7 (12.6)
Argentinean trust holding rights to oil and gas royalty ................. 44.0 (22.0)
Major US airline ........................................................ 84.4 (23.7)
-----------------------------
Total .............................................................. $1,696.4 $ (281.0)
Unrealized losses improved during the second quarter of 2003. As of March
31, 2003, there were 122 securities with an unrealized loss of $10 million or
more with an amortized cost of $2,521.4 million and unrealized loss of $610.1
million. A major driver in the valuation of the fixed income portfolio at June
30, 2003 and December 31, 2002 was the recent reduction in traded or quoted bond
prices across most industries, especially in the below investment grade
categories where, in the current environment, bond market investors are very
risk averse and have severely penalized issues where there is any uncertainty.
This effect was most pronounced in the reduction in the traded or quoted prices
of the bonds of many energy companies with merchant exposure. In the third and
fourth quarters of2002, the rating agencies downgraded a number of companies
that have exposure to the merchant energy sector. These downgrades in turn
created liquidity issues for a few companies and uncertainty at many others.
This market sentiment, which we believe to be temporary, has led to significant
reductions in the prices of virtually every energy company that has any merchant
exposure, including some in our portfolio and 4 on the list above. We believe
many of these issuers are taking the right steps to strengthen their balance
sheets through a combination of actions such as reducing capital expenditures,
scaling back trading operations, reducing dividends, and issuing equity. Thus
far this year, prices in power sector bonds have improved significantly, as
shown by the reduction in the gross unrealized loss on our utility bonds from
$522.3 million as of December 31, 2002 to $199.4 million as of June 30, 2003.
Airlines are another sector under pressure and they represent 8 names on this
list. Unlike the power sector, the airline sector continues to struggle as it
deals with the continued drop in traffic due to the war in Iraq and SARS. We
continue to believe, however, that the secured nature of our investments will
enable them to recover as the industry recovers. All of the above securities
have undergone thorough analysis by our investment professionals, and at this
time we believe that the borrowers have the financial capacity to make all
required contractual payments on the notes when due, and we intend to hold these
securities until they either mature or recover in value.
Mortgage Loans. As of June 30, 2003 and December 31, 2002, the Company
held mortgage loans with a carrying value of $10.6 billion and $10.3 billion,
including $2.8 billion and $2.6 billion respectively, of agricultural loans at
each period end and $7.8 billion and $7.7 billion, respectively, of commercial
loans. Impaired loans comprised 1.3% and 0.4% of the mortgage portfolio as of
June 30, 2003 and December 31, 2002, respectively. The Company's average
historical impaired loan percentage during the period of 1997 through 2002 is
1.5%. This historical percentage is higher than the current 1.3% because the
historical percentage includes some remaining problem assets of the 1990's real
estate downturn, some of which are still held.
70
JOHN HANCOCK LIFE INSURANCE COMPANY
The following table shows the Company's agricultural mortgage loan
portfolio by its three major sectors: agri-business, timber and production
agriculture.
As of June 30, 2003 As of December 31, 2002
---------------------------------------- -----------------------------------------
Amortized Carrying % of Total Amortized Carrying % of Total
Cost Value Carrying Value Cost Value Carrying Value
---------------------------------------- -----------------------------------------
(in millions) (in millions)
Agri-business ............ $1,708.1 $1,705.2 60.5% $1,526.8 $1,520.8 57.7%
Timber ................... 1,113.2 1,092.9 38.7 1,090.4 1,086.7 41.3
Production agriculture ... 22.7 22.6 0.8 25.3 25.1 1.0
---------------------------------------- -----------------------------------------
Total ................ $2,844.0 $2,820.7 100.0% $2,642.5 $2,632.6 100.0%
======================================== =========================================
The following table shows the distribution of our mortgage loan portfolio
by property type as of the dates indicated. Our commercial mortgage loan
portfolio consists primarily of non-recourse fixed-rate mortgages on fully, or
nearly fully, leased commercial properties.
Mortgage Loans - By Property Type
As of June 30, 2003 As of December 31, 2002
---------------------------------------------------------------
Carrying % of Carrying % of
Value Total Value Total
---------------------------------------------------------------
(in millions) (in millions)
Apartment.......................... $ 1,357.4 12.8% $ 1,408.4 13.7%
Office Buildings................... 2,733.9 25.8 2,779.9 27.0
Retail............................. 1,864.7 17.6 1,779.3 17.3
Agricultural....................... 2,820.7 26.7 2,632.6 25.6
Industrial......................... 939.9 8.9 916.5 8.9
Hotels............................. 444.5 4.2 447.3 4.3
Multi-Family....................... 1.1 -- 1.4 --
Mixed Use.......................... 244.9 2.3 155.2 1.5
Other.............................. 179.6 1.7 175.9 1.7
---------------------------------------------------------------
Total......................... $10,586.7 100.0% $10,296.5 100.0%
===============================================================
The following table shows the distribution of our mortgage loan portfolio
by geographical region, as defined by the American Council of Life Insurers
(ACLI).
Mortgage Loans -- By ACLI Region
---------------------------------------------------------------------------
As of June 30, 2003 As of December 31, 2002
---------------------------------------------------------------------------
Number Carrying % of Carrying % of
Of Loans Value Total Value Total
---------------------------------------------------------------------------
(in millions) (in millions)
East North Central....... 180 $ 1,136.1 10.7% $ 1,102.0 10.7%
East South Central....... 66 422.8 4.0 430.5 4.2
Middle Atlantic.......... 144 1,466.7 13.9 1,447.4 14.1
Mountain................. 112 506.8 4.8 488.5 4.7
New England.............. 117 770.8 7.3 794.7 7.7
Pacific.................. 366 2,205.8 20.8 2,134.5 20.7
South Atlantic........... 289 2,428.1 22.9 2,229.5 21.7
West North Central....... 89 450.7 4.3 450.5 4.4
West South Central....... 172 912.5 8.6 952.2 9.2
Canada................... 12 286.4 2.7 266.7 2.6
---------------------------------------------------------------------------
Total............... 1,547 $10,586.7 100.0% $10,296.5 100.0%
===========================================================================
71
JOHN HANCOCK LIFE INSURANCE COMPANY
The following table shows the carrying values of our mortgage loan
portfolio that are delinquent but not in foreclosure, delinquent and in
foreclosure, restructured and foreclosed. The table also shows the respective
ratios of these items to the total carrying value of our mortgage loan
portfolio. Mortgage loans are classified as delinquent when they are 60 days or
more past due as to the payment of interest or principal. Mortgage loans are
classified as restructured when they are in good standing, but the basic terms,
such as interest rate or maturity date, have been modified as a result of a
prior actual delinquency or an imminent delinquency. All foreclosure decisions
are based on a thorough assessment of the property's quality and location and
market conditions. The decision may also reflect a plan to invest additional
capital in a property to make tenant improvements or renovations to secure a
higher resale value at a later date. Following foreclosure, we rely on our real
estate investment group's ability to manage foreclosed real estate for eventual
return to investment real estate status or outright sale.
Mortgage Loan Comparisons
As of June 30, As of December 31,
2003 2002
------------------------------------ -----------------------------------
Carrying % of Total Carrying % of Total
Value Mortgage Loans (1) Value Mortgage Loans (1)
------------------------------------ -----------------------------------
(in millions) (in millions)
Delinquent, not in foreclosure.... $ 0.1 --% $ 6.1 0.1%
Delinquent, in foreclosure........ 57.2 0.5 44.4 0.4
Restructured...................... 59.5 0.6 54.8 0.5
Loans foreclosed during period.... -- -- 25.8 0.3
Other loans with valuation
allowance (2)................... 77.9 0.7 5.5 0.1
-------------------------------------------------------------------------
Total.......................... 194.7 1.8 136.6 1.4
-------------------------------------------------------------------------
Valuation allowance............... $ 63.8 0.6% $ 61.7 0.6%
=========================================================================
(1) As of June 30, 2003 and December 31, 2002 the Company held mortgage loans
with a carrying value of $10.6 billion and $10.3 billion, respectively.
(2) Increase as of June 30, 2003 is from a U.S. based forest products company
that filed for bankruptcy in June 2003.
Valuation allowance is maintained at a level that is adequate enough to
absorb estimated probable credit losses. Management's periodic evaluation of the
adequacy of the allowance for losses is based on past experience, known and
inherent risks, adverse situations that may affect the borrower's ability to
repay (including the timing of future payments), the estimated value of the
underlying security, the general composition of the portfolio, current economic
conditions and other factors. This evaluation is inherently subjective and is
susceptible to significant changes and no assurance can be given that the
allowances taken will in fact be adequate to cover all losses or that additional
valuation allowances or asset write-downs will not be required in the future.
The valuation allowance for the mortgage loan portfolio was $63.8 million, or
0.6% of the carrying value of the portfolio as of June 30, 2003.
72
JOHN HANCOCK LIFE INSURANCE COMPANY
Investment Results
Net Investment Income. The following table summarizes the Company's investment
results for the periods indicated:
Three Months Ended Six Months Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
----------------------------------------------------------------------------------
Yield Amount Yield Amount Yield Amount Yield Amount
----------------------------------------------------------------------------------
(in millions) (in millions) (in millions) (in millions)
General account assets-excluding
Policy loans
Gross income 5.99% $ 950.7 6.87% $ 907.8 6.17% $ 1,905.1 6.90% $ 1,822.1
Ending assets-excluding policy
loans (1) 64,919.7 54,298.5 64,919.7 54,298.5
Policy loans
Gross income 5.94% 29.9 6.19% 29.9 6.04% 60.9 6.09% 58.8
Ending assets 2,014.5 1,937.3 2,014.5 1,937.3
Total gross income 5.99% 980.6 6.85% 937.7 6.17% 1,965.9 6.87% 1,880.9
Less: investment expenses (38.3) (48.9) (90.5) (104.4)
---------- ---------- ---------- ----------
Net investment income 5.75% $ 942.3 6.49% $ 888.8 5.88% $ 1,875.4 6.49% $ 1,776.5
========== ========== ========== ==========
(1) Cash and cash equivalents are included in invested assets in the table
above for the purposes of calculating yields on income producing assets
for the Company.
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
Net investment income increased $53.5 million from the comparable prior
year period. The increase was primarily the result of asset growth and lower
investment expenses which were partially offset by the acquisition of lower
yielding assets. Overall, the yield for the three months ended June 30, 2003,
net of investment expenses, on the general account portfolio decreased to 5.75%
from 6.49% for the three months ended June 30, 2002. The lower portfolio yield
was driven primarily by lower yields on investment acquisitions. The continued
drop in short-term interest rates during the year, which affects the rate reset
on floating rate assets, also contributed to the declining yield. The change in
yields was impacted by the following drivers:
o As of June 30, 2003 and June 30, 2002, the Company's asset portfolio had
approximately $13 billion and $12 billion of floating-rate exposure
(primarily LIBOR). This exposure was created mostly through interest rate
swaps designed to match our floating-rate liability portfolio. As of June
30, 2003, approximately 87% of this floating rate exposure, excluding the
portion that is attributable to cash and short-term investments, was
directly offset by exposure to floating-rate liabilities. Most of the
remaining 13% of exposure is in floating rate assets acquired for their
relative value and is incorporated into the portfolio's interest rate risk
management plan.
o Certain of our tax-preferenced investments (lease residual management and
affordable housing limited partnerships) dilute the Company's net
portfolio yield on a pre-tax basis. For the three month period ended June
30, 2003, this dilutive effect was 10 basis points, compared to 13 basis
points in the comparable prior year period. Adjusting for taxes, net
income on these investments declined by $0.1 million for the three month
period ended June 30, 2003 compared to the three month period ended June
30, 2002.
o The inflow of new cash for the three month period ending June 30, 2003 was
invested at rates that were below the portfolio rate for the prior year
period. In addition, maturing assets rolling over into new investments at
rates less favorable than those available in 2002 also contributed to the
decline in yields.
Offsetting the effects of these decreases to yields on investments was an
increase in invested assets and a reduction in investment expenses. In the three
month period ended June 30, 2003, average invested assets increased $10,724.9
million, or 19.6%, from the prior year period. In addition, investment expenses
were reduced $10.6 million in the three month period ended June 30, 2003
compared to the prior year. Included are reductions in expenses associated with
the sale of the Company's home office real estate properties.
73
JOHN HANCOCK LIFE INSURANCE COMPANY
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Net investment income increased $98.9 million from the comparable prior
year period. The increase was primarily the result of asset growth and lower
investment expenses which were partially offset by the acquisition of lower
yielding assets. Overall, the yield for the six months ended June 30, 2003, net
of investment expenses, on the general account portfolio decreased to 5.88% from
6.49% for the six months ended June 30, 2002. The lower portfolio yield was
driven primarily by lower yields on investment acquisitions. The continued drop
in short-term interest rates during the year, which affects the rate reset on
floating rate assets, also contributed to the declining yield. The change in
yields was impacted by the following drivers:
o As of June 30, 2003 and June 30, 2002, the Company's asset portfolio had
approximately $13 billion and $12 billion of floating-rate exposure
(primarily LIBOR). This exposure was created mostly through interest rate
swaps designed to match our floating-rate liability portfolio. As of June
30, 2003, approximately 87% of this floating rate exposure, excluding the
portion that is attributable to cash and short-term investments, was
directly offset by exposure to floating-rate liabilities. Most of the
remaining 13% of exposure is in floating rate assets acquired for their
relative value and is incorporated into the portfolio's interest rate risk
management plan.
o Certain of our tax-preferenced investments (lease residual management and
affordable housing limited partnerships) dilute the Company's net
portfolio yield on a pre-tax basis. For the six month period ended June
30, 2003, this dilutive effect was 9 basis points, compared to 11 basis
points in the comparable prior year period. However, adjusting for taxes,
these investments increased the Company's net income by $2.4 million for
the six month period ended June 30, 2003 compared to the six month period
ended June 30, 2002.
o The inflow of new cash for the six month period ending June 30, 2003 was
invested at rates that were below the portfolio rate for the prior year
period. In addition, maturing assets rolling over into new investments at
rates less favorable than those available in 2002 also contributed to the
decline in yields.
Offsetting the effects of these decreases to yields on investments was an
increase in invested assets and a reduction in investment expenses. In the six
month period ended June 30, 2003, average invested assets increased $8,973.5
million, or 16.4%, from the prior year period. In addition, investment expenses
were reduced $13.9 million in the six month period ended June 30, 2003 compared
to the prior year. Included are reductions in corporate complex expenses and
expenses associated with the sale of the Company's home office real estate
properties.
74
JOHN HANCOCK LIFE INSURANCE COMPANY
Net Realized Investment and Other Gain/(Loss)
The following table shows the Company's net realized investment and other
gains (losses) by asset class for the periods presented:
Net Realized
Gross Gain Gross Loss Hedging Investment
For the Three Months Ended June 30, 2003 Impairment On Disposal on Disposal Adjustments and Other Gain/(Loss)
----------------------------------------------------------------------------
(in millions)
Fixed maturity securities (1) (2)....... $ (91.4) $259.3 $(10.1) $(79.7) $ 78.1
Equity securities....................... (7.7) 8.7 -- -- 1.0
Mortgage loans on real estate........... -- 16.4 (3.8) (12.0) 0.6
Real estate............................. -- (5.7) (2.8) -- (8.5)
Other invested assets................... (1.1) 0.1 (5.8) -- (6.8)
Derivatives............................. -- -- -- 63.2 63.2
----------------------------------------------------------------------------
Subtotal................. $(100.2) $278.8 $(22.5) $(28.5) $127.6
============================================================================
Amortization adjustment for deferred policy acquisition costs...................... (20.9)
Amounts credited to participating pension contractholders.......................... (4.8)
Amounts credited to the policyholder dividend obligation........................... (23.6)
----------------------
Total......................................................................... $ 78.3
======================
(1) Fixed Maturities gain on disposals includes $48.7 million of gains
from previously impaired securities.
(2) Fixed Maturities loss on disposals includes $5.7 million of credit
related losses.
Net Realized
Gross Gain Gross Loss Hedging Investment
For the Six Months Ended June 30, 2003 Impairment On Disposal on Disposal Adjustments and Other Gain/(Loss)
---------------------------------------------------------------------------
(in millions)
Fixed maturity securities (1) (2)...... $(312.7) $311.3 $(42.8) $(154.2) $(198.4)
Equity securities....................... (25.3) 31.9 (2.0) -- 4.6
Mortgage loans on real estate........... -- 20.8 (11.9) (32.8) (23.9)
Real estate............................. -- 278.1 (2.8) -- 275.3
Other invested assets................... (10.3) 9.3 (1.4) -- (2.4)
Derivatives............................. -- -- -- 128.0 128.0
---------------------------------------------------------------------------
Subtotal................. $(348.3) $651.4 $(60.9) $ (59.0) $ 183.2
===========================================================================
Amortization adjustment for deferred policy acquisition costs...................... (12.4)
Amounts credited to participating pension contractholders.......................... 1.5
Amounts credited to the policyholder dividend obligation........................... 11.4
---------------------
Total......................................................................... $ 183.7
=====================
(1) Fixed Maturities gain on disposals includes $49.3 million of gains
from previously impaired securities.
(2) Fixed Maturities loss on disposals includes $22.9 million of credit
related losses.
The hedging adjustments in the fixed maturities and mortgage loans asset
classes are non-cash adjustments representing the amortization or reversal of
prior fair value adjustments on assets in those classes that were or are
designated as hedged items in fair value hedge. When an asset or liability is so
designated, its cost basis is adjusted in response to movements in interest
rates. These adjustments are non-cash and reverse with the passage of time as
the asset or liability and derivative mature. The hedging adjustments on the
derivatives represent non-cash adjustments on derivative instruments and on
assets and liabilities designated as hedged items reflecting the change in fair
value of those items.
For the three and six month periods ended June 30, 2003, net realized
investment and other gains was $78.3 million and $183.7 million, respectively.
For the same time periods, gross losses on impairments and on disposal of
investments - including bonds, equities, mortgages and other invested assets was
$122.7 million and $409.2 million, respectively, excluding hedging adjustments.
For the three and six month periods ended June 30, 2003, we realized
$259.3 million and $311.3 million of gains on disposal of fixed maturities
excluding hedging adjustments, respectively. These gains resulted from managing
our portfolios for tax optimization and ongoing portfolio positioning, as well
as $5.7 million and $22.9 million, respectively, of prepayments and
approximately $48.7 million and $49.3 million, respectively, from recoveries on
sales of previously impaired securities.
75
JOHN HANCOCK LIFE INSURANCE COMPANY
For the three and six month periods ended June 30, 2003, we realized $10.1
million and $42.8 million, respectively, of losses upon disposal of bonds
excluding hedging adjustments. We generally intend to hold securities in
unrealized loss positions until they mature or recover. However, we do sell
bonds under certain circumstances such as when new information causes us to
change our assessment of whether a bond will recover or perform according to its
contractual terms, in response to external events (such as a merger or a
downgrade) that result in investment guideline violations (such as single issuer
or overall portfolio credit quality limits), in response to extreme catastrophic
events (such as September 11, 2001) that result in industry or market wide
disruption, or to take advantage of tender offers. Sales generate both gains and
losses.
The Company has a process in place to identify securities that could
potentially have an impairment that is other than temporary. This process
involves monitoring market events that could impact issuers' credit ratings,
business climate, management changes, litigation and government actions, and
other similar factors. This process also involves monitoring late payments,
downgrades by rating agencies, key financial ratios, financial statements,
revenue forecasts and cash flow projections as indicators of credit issues.
At the end of each quarter, our Investment Review Committee reviews all
securities where market value is less than ninety percent of amortized cost for
three months or more to determine whether impairments need to be taken. This
committee includes the head of workouts, the head of each industry team, the
head of portfolio management, the Chief Investment Officer and the Corporate
Risk Officer who reports to the Chief Financial Officer. The analysis focuses on
each company's or project's ability to service its debts in a timely fashion and
the length of time the security has been trading below cost. The results of this
analysis are reviewed by both our external auditors and the Life Company's
Committee of Finance, a subcommittee of the Life Company's Board of Directors,
quarterly. This quarterly process includes a fresh assessment of the credit
quality of each investment in the entire fixed maturities portfolio.
The Company considers relevant facts and circumstances in evaluating
whether the impairment of a security is other than temporary. Relevant facts and
circumstances considered include (1) the length of time the fair value has been
below cost; (2) the financial position of the issuer, including the current and
future impact of any specific events; and (3) the Company's ability and intent
to hold the security to maturity or until it recovers in value. To the extent
the Company determines that a security is deemed to be other than temporarily
impaired, the difference between amortized cost and fair value would be charged
to earnings.
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 (1) the risk that our
assessment of an issuer's ability to meet all of its contractual obligations
will change based on changes in the credit characteristics of that issuer, (2)
the risk that the economic outlook will be worse than expected or have more of
an impact on the issuer than anticipated, (3) information, or fraudulent
financial statements, could be provided to our investment professionals who
determine the fair value estimates and other than temporary impairments, and (4)
the risk that new information obtained by us or changes in other facts and
circumstances 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 charge to
earnings in a future period.
As disclosed in our discussion of the Results of Operations in this MD&A,
the Company recorded losses due to other than temporary impairments of fixed
maturity securities for the three month period ended June 30, of $100.6 million
(including impairment losses of $91.4 million and $9.2 million of previously
recognized gains where the bond was part of a hedging relationship). The
following list shows the largest losses recognized during the quarter, the
related circumstances giving rise to the loss and a discussion of how those
circumstances impacted other material investments held. Unless noted otherwise,
all of the items shown are impairments of securities held at June 30, 2003,
including hedging adjustments.
Impairments and Losses on Disposals - Three Months Ended June 30, 2003
o $25.0 million on private fixed maturity securities (including an
impairment loss of $19.8 million and $5.2 million in previously
recognized gains where the bond was part of a hedging relationship)
on a toll road where a new competing road has decreased the traffic
on the toll road, as a result the project has been unable to
service its debt. We have no other holdings affected by this
situation.
o $13.6 million on private fixed maturity securities (including an
impairment loss of $13.5 million and $0.1 million in previously
recognized gain where the bond was part of a hedging relationship)
on an Australian mining company. Due to weaker commodity prices,
operational difficulties, and losses on currency transactions, the
company is looking to restructure its debts or sell the company.
While lower commodity prices affect a broad range of credits, the
unique circumstances of this company are not present in our other
investments.
76
JOHN HANCOCK LIFE INSURANCE COMPANY
o $11.0 million on public fixed maturity securities (including an
impairment loss of $9.2 million and $1.8 million in previously
recognized gains where the bond was part of a hedging relationship)
on a utility brought into the bankruptcy of its parent that suffered
from a significant amount of merchant energy exposure. Our bonds are
secured by a pump storage facility. We have $42.6 million carrying
value of bonds at the parent that were already impaired in a prior
quarter.
The $10.1 million of realized losses on sales of fixed maturity securities
for the three months ended June 30, 2003 almost entirely arose from the sale of
certain securities with $1.0 million or more of realized loss. Of these
securities, the only significant credit loss was $4.8 million related to a power
provider with a large exposure to the merchant energy markets. As we became more
concerned that the banks would not renew their bank lines to this company, we
sold most of our position and impaired the remaining position that was
subsequently sold in early July. The remaining sales detailed below relate to
general portfolio management (excluding asset/liability interest rate risk
management), including the sale of below investment grade bonds to maintain our
exposure below 10% of invested assets on a statutory basis. The following are
the largest drivers of the losses on sales over $1.0 million:
o $4.8 million credit loss on the sale of public bonds of a power
provider referred to in the above paragraph
o $3.3 million on the sale of public bonds of a utility holding
company where our position exceeded our single credit limits due to
a downgrade of the company. This sale brought our holdings of this
company in compliance within our limits.
o $1.1 million on the sale of public bonds of another power provider
with significant exposure to the merchant energy markets and our
concern over their ability to renew their bank lines.
Impairments and Losses on Disposals - Six Months Ended June 30, 2003
As disclosed in our discussion of the Results of Operations in this MD&A,
the Company recorded losses due to other than temporary impairments of fixed
maturity securities for the first six months of 2003 of $331.2 million
(including impairment losses of $312.7 million, and $18.5 million of previously
recognized gains where the bond was part of a hedging relationship). The
following list shows the largest losses recognized year to date, the related
circumstances giving rise to the loss and a discussion of how those
circumstances impacted other material investments held. Unless noted otherwise,
all of the items shown are impairments of securities held at June 30, 2003,
including hedging adjustments.
o $37.6 million (including an impairment loss of $37.3 million and
$0.3 million in previously recognized gains where the bonds were
part of a hedging relationship) on public fixed maturity securities
relating to a large, national farmer-owned diary co-operative.
Margins have been squeezed due to a supply/demand imbalance, high
input costs and high leverage, due in part to a recent acquisition.
Despite a large favorable outcome on a lawsuit, depressed commodity
prices in this environment have continued to put pressure on the
company to rationalize their operations as was evident in their
recently released annual financial statements. Given our
subordinated position in the capital structure, and unlikely
improvement near term, we have impaired the security to the market
level. We have no other loans to dairy companies that are impacted
by this same combination of factors.
o $27.3 million on public fixed maturity securities relating to a
large North American transportation provider to a variety of
industries that has struggled to emerge from bankruptcy due to
litigation with a subsidiary, tax claims by the IRS, and most
recently, a claim by a regulatory agency. We have further impaired
the security and anticipate reorganization out of bankruptcy within
the next two quarters. These circumstances are unique to this
issuer.
o $25.9 million (including an impairment loss of $23.2 million and
$2.7 million in previously recognized gains where the bonds were
part of a hedging relationship) on public fixed maturity securities
relating to a special purpose company created to sublease aircraft
to two major US airlines. This investment is the subordinated
tranche in a multi-tier structure of an Enhanced Equipment Trust
Certificate (EETC). One of the airlines has recently indicated that
it will not honor the original lease rates on the aircraft in this
investment. Hence, with the loan exceeding the current value of the
securities, we have impaired the security to the market level. While
we do have an investment in the senior tranche of this EETC, the
senior tranche exposure is still less than the current market value
of the underlying planes and the senior tranche has an 18 month
liquidity facility. Therefore, we do not anticipate a loss on the
senior tranche.
o $25.0 million on private fixed maturity securities (including an
impairment loss of $19.8 million and $5.2 million in previously
recognized gains where the bond was part of a hedging relationship)
on a toll road where a new
77
JOHN HANCOCK LIFE INSURANCE COMPANY
competing road has decreased the traffic on the toll road, as a
result the project has been unable to service its debt. We have no
other holdings affected by this situation.
o $14.1 million on public fixed maturity securities relating to a
subordinated holding company structure comprised of ownership
interests in three power generation facilities in the western US.
Due to the severe overcapacity in the power markets and the lack of
an offtake provider for the potential power generated from the
plants, this subordinated interest in the facilities is unlikely to
be able to be refinanced at its maturity date in the second quarter
and hence we have fully impaired these securities, accordingly these
securities have no remaining carrying value. The overcapacity in the
power markets have put stress on all power producers as we discuss
in our sector commentary.
o $13.6 million on private fixed maturity securities relating to an
Australian mining company. Due to weaker commodity prices,
operational difficulties, and losses on currency transactions, the
company is looking to restructure its debts or sell the company.
While lower commodity prices affect a broad range of credits, the
unique circumstances of this company are not present in our other
investments.
o $11.0 million on public fixed maturity securities (including an
impairment loss of $9.2 million and and $1.8 million in previously
recognized gains where the bond was part of a hedging relationship)
of a utility brought into the bankruptcy of its parent that suffered
from a significant amount of merchant energy exposure. Our bonds are
secured by a pump storage facility. We have $42.6 million carrying
value of bonds at the parent that were already impaired in a prior
quarter.
o $11.0 million on private fixed maturity securities secured by
aircraft leased by a large U.S. airline. This airline is seeking to
reduce its lease rates as a small part of its larger efforts to
reduce costs to avoid bankruptcy. This impairment is based on the
expected reduction in the lease rates. We have $53.2 million of
other ETC's backed by leases to this airline. The airline has not
requested a change in the lease rates on the aircraft backing these
investments.
o $9.7 million on public fixed maturity securities relating to a
manufacturer of composite and building materials. This company has
struggled to emerge from bankruptcy due to numerous lawsuits and a
disagreement between the banks and noteholders. Hence the price of
these securities has declined and we are further impairing them down
to current market levels. These circumstances are unique to this
issuer.
o $9.6 million on public fixed maturity securities relating to an
unregulated power and pipeline energy company that became insolvent
due to a fall in profitability in its merchant energy business,
downgrades from the rating agencies, and a lack of liquidity due to
the call on cash collateral requirements after the downgrades. We
have impaired the security to market levels. The overcapacity in the
power markets have put stress on all power producers as we discuss
in our sector commentary.
o $9.4 million on public fixed maturity securities relating to a
special purpose financing company which owns an interest in a gas
fired power plant in the UK with long-term fixed price contracts
that are significantly above market in today's depressed pricing
environment. In early 2003, the banks decided to pursue a firesale
of the power plant. We have impaired this loan to the discounted
value of our likely recovery from such a sale. We have two other
loans with a total carrying value of $99.6 million to companies
participating in the UK power market. $59.3 million is backed by a
UK pump storage facility investment where debt service coverages
have been reduced by the weak environment for power in the U.K., but
we continue to anticipate positive debt service coverages for this
investment. $40.3 million is a loan to the owner of a UK regional
electric company. Regional electric companies have monopolies to
distribute and supply power to their regions thus are less affected
by the over supply of power.
o $9.4 million (including an impairment loss of $7.5 million and $1.9
million in previously recognized gains where the bonds were part of
a hedging relationship) on public fixed maturity securities relating
to an asset backed pool of franchise loans primarily focused in the
gas/convenience store sector. This sector has been hit hard by
rising delinquencies by franchisees and significant declines in
operating margins. During the first quarter of 2003,
78
JOHN HANCOCK LIFE INSURANCE COMPANY
delinquencies increased by almost 50% from previous reports thus we
have impaired the security according to EITF 99-20. We have $151.0
million of other exposure to franchise loan ABS, all of which are
senior tranches, and none of which currently require impairment
under EITF 99-20.
Of the $42.8 million of realized losses on sales of fixed maturity
securities for the six months ended June 30, 2003, $22.9 million was credit
related, $37.9 million arose from the sale of 8 securities with $1.0 million or
more of realized loss. The only significant realized losses year to date were
$16.7 million on the sale of the bonds of a major healthcare service provider
(late in the first quarter, the SEC announced that they had discovered massive
accounting fraud at that company and thus its bond and stock prices plummeted;
due to this significant event and the uncertainty over the future of the company
due to the ongoing SEC investigation, we sold our position), and $4.8 million on
the sale of bonds of a power provider with a large exposure to the merchant
energy markets. As we became more concerned that the banks would not renew their
bank lines to this company, we sold most of our position and impaired the
remaining position that was subsequently sold in early July. These were the only
sales of significance that we consider credit losses, i.e. sold at less than 80%
of amortized cost. All other sales were related to general portfolio management,
including the sale of a number of below investment grade bonds to maintain our
exposure below 10% of invested assets on a statutory basis. The following are
the losses on sales over $1.0 million:
o $16.7 million credit loss on the sale of public bonds of a major
healthcare service provider as referred to in above paragraph
o $4.8 million credit loss on the sale of public bonds of a power
provider referred to in the above paragraph.
o $4.6 million on US Treasuries that were sold as part of our ongoing
asset/liability interest rate risk management.
o $3.3 million on the sale of public bonds of a utility holding
company where our position exceeded our single credit limits due to
a downgrade of the company. This sale brought our holdings of this
company in compliance within our limits.
o $3.1 million on the sale of public bonds of an oil & gas company's
bonds by one of subsidiary managers. This manager sold this position
to reduce its below investment grade exposure.
o $2.2 million on the sale of public bonds of an oil & gas pipeline
company in order to maintain our below investment grade holdings
below 10% of invested assets on a Statutory basis.
o $2.1 million on the sale of public bonds of an unregulated power
generating company. This bond was sold after a downgrade created a
credit limit violation.
o $1.1 million on the sale of public bonds of another power provider
with a significant exposure to the merchant energy markets and our
concern over their ability to renew their bank lines.
There were no other sales with losses more than $1 million and no other
sales of bonds at less than 80% of amortized cost, which we would consider as
credit losses. These sales helped reduce our below investment grade holdings and
accomplished other portfolio objectives.
The Company recorded losses due to other than temporary impairments of CDO
equity and other invested assets of $1.1 million and $10.3 million for the three
and six month periods ended June 30, 2003, respectively. Equity in these CDOs
take the first loss risk in a pool of high yield debt and hence underperform in
a high yield default environment. These impairments were recognized using the
guidance in EITF 99-20. We have a total remaining carrying value of $44.1
million and $48.7 million of CDO equity as of June 30, 2003 and December 31,
2002, which is currently supported by expected cash flows.
The Company also recognized losses on other than temporary impairments of
common stock of $7.7 million and $25.3 million for the three and six month
periods ended June 30, 2003, respectively, as the result of market values
falling below cost for more than six months.
The Company recorded a gain of $0.6 million and a loss $23.9 million on
mortgage loans for the three and six month periods ended June 30, 2003 (of which
$12.0 million and $32.8 million, respectively were losses on hedging
adjustments). Included are losses of $8.0 million and $20.1 million,
respectively, for the three and six months ended June 30, 2003, associated with
losses on agriculture mortgages.
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JOHN HANCOCK LIFE INSURANCE COMPANY
There were also gains of $8.7 million and $31.9 million on the sale of
equity securities as part of our overall investment strategy of using gains to
minimize credit losses in the long term, gains of $0.1 million and $9.3 million
from the sale of other invested assets, and a loss of $5.7 million and gain of
$278.1 million resulting from the sale of real estate for the three and six
month periods ended June 30, 2003, respectively. Net derivative activity
resulted in a gain $63.2 million for the three months ended June 30, 2003 and
$128.0 million for the six months ended June 30, 2003, resulting from a slightly
larger impact from interest rate changes on the Company's fair value of hedged
and non-hedged items in comparison to the changes in fair value of its
derivatives.
For the three and six month period ended June 30, 2002, net realized
investment and other losses were $125.4 million and $211.5 million,
respectively. Gross losses on impairments and on disposal of investments -
including bonds, equities, mortgages, real estate, and other invested assets
were $262.3 million and $376.3 million, respectively, excluding hedging
adjustments.
The Company recorded losses due to other than temporary impairments of
fixed maturities of $194.5 million and $279.3 million for the three and six
months periods ended June 30, 2002, excluding hedging adjustments. The primary
other than temporary impairments on fixed maturities for the six months ended
June 30, 2002 were $45.5 million on securities issued by the holding company of
a large domestic power producer that was downgraded to below investment grade
status in July 2002 due to liquidity concerns, $18.4 million on securities of an
Australian power project that failed to produce benefits expected from the
deregulation of that country's power industry, $22.2 million on structured
financings due as a result of ongoing negotiations with a borrower to
restructure debt, $15.0 million on a redeemable preferred stock of a large
domestic farm cooperative due to the cyclical nature of the business and a heavy
debt load, $19.2 million on redeemable preferred stock of a technology based
manufacturer of engineering products with a tight liquidity position, $14.4
million on a large energy company that filed for bankruptcy in late 2001, and
$10.1 million on a water supply and distribution system in Argentina.
Write-downs of CBO/CDO fixed maturity investments were $37.2 million recorded in
the first quarter of 2002.
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JOHN HANCOCK LIFE INSURANCE COMPANY
Liquidity & Capital Resources
Liquidity describes the ability of a company to generate sufficient cash
flows to meet the immediate capital needs to facilitate business operations. The
assets of the Company consist of a diversified investment portfolio and
investments in operating subsidiaries. The Company's cash flow consists
primarily of premiums, deposits, investment income, results of its operating
subsidiaries and proceeds from the Company's debt offerings offset by benefits
paid to contractholders, operating expenses, policyholder dividends to its
participating policyholders and shareholder dividends to it parent company. All
of the outstanding common stock of John Hancock Life Insurance Company is owned
by its Parent, an insurance holding company, John Hancock Financial Services,
Inc.
State insurance laws generally restrict the ability of insurance companies
to pay cash dividends in excess of prescribed limitations without prior
approval. The Company's limit is the greater of 10% of the statutory surplus at
prior year-end or the prior calendar year's statutory net gain from operations
of the Company. The ability of the Company to pay shareholder dividends is and
will continue to be subject to restrictions set forth in the insurance laws and
regulations of Massachusetts, it domiciliary state. The Massachusetts insurance
law limits how and when the Company can pay shareholder dividends. The Company,
in the future could also be viewed as being commercially domiciled in New York.
If so, dividend payments may also be subject to New York's holding company act
as well as Massachusetts' law. The Company currently does not expect such
regulatory requirements to impair its ability to meet its liquidity and capital
needs. During the first six months of 2003, the Company paid $100 million in
dividends to its parent, John Hancock Financial Services, Inc.
Sources of cash for the Company include premiums, deposits and charges on
policies and contracts, investment income, maturing investments, and proceeds
from sales of investment assets. In addition to the need for cash flow to meet
operating expenses, our liquidity requirements relate principally to the
liabilities associated with various life insurance, annuity, and structured
investment products, and to the funding of investments in new products,
processes, and technologies. Product liabilities include the payment of benefits
under life insurance, annuity and structured investment products and the payment
of policy surrenders, withdrawals and policy loans. The Company periodically
adjusts its investment policy to respond to changes in short-term and long-term
cash requirements and provide adequate funds to pay benefits without forced
sales of investments.
The liquidity of our insurance operations is also related to the overall
quality of our investments. As of June 30, 2003, $43,231.0 million, or 88.3% of
the fixed maturity securities held by us and rated by Standard & Poor's Ratings
Services, a division of the McGraw-Hill Companies, Inc. (S&P) or the National
Association of Insurance Commissioners were rated investment grade (BBB or
higher by S&P or 1 or 2 by the National Association of Insurance Commissioners).
The remaining $5,710.8 million, or 11.7%, of fixed maturity investments were
rated non-investment grade. For additional discussion of our investment
portfolio see the General Account Investments section in this Management's
Discussion and Analysis of Financial Condition and Results of Segment
Operations.
We employ an asset/liability management approach tailored to the specific
requirements of each of our product lines. Each product line has an investment
strategy based on the specific characteristics of the liabilities in the product
line. As part of this approach, we develop investment policies and operating
guidelines for each portfolio based upon the return objectives, risk tolerance,
liquidity, and tax and regulatory requirements of the underlying products and
business segments.
Net cash provided by operating activities was $1,296.9 million and
$1,287.8 million for the six month period ended June 30, 2003 and 2002,
respectively. Cash flows from operating activities are affected by the timing of
premiums received, fees received and investment income. The modest $9.1 million
increase in the six month period ended June 30, 2003 compared to 2002 resulted
primarily from increased investment income and policy liabilities and accruals
offset by increased operating expenses and net other assets.
Net cash used in investing activities was $2,599.3 million compared to
$3,504.0 million for the six month period ended June 30, 2003 and 2002,
respectively. Changes in the cash provided by investing activities primarily
relate to the management of the Company's investment portfolios and the
investment of excess capital generated by operating and financing activities.
The $904.7 million decrease in cash used in the six month period ended June 30,
2003 as compared to 2002 is primarily due to the sale of the Home Office
properties.
Net cash provided by financing activities was $1,417.7 million and
$1,801.1 million for the six month period ended June 30, 2003 and 2002,
respectively. The $383.4 million decrease in net cash provided by financing
activities for the six month period ended June 30, 2003 as compared to 2002 was
driven by a decrease in deposits and an increase in cash payments made
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JOHN HANCOCK LIFE INSURANCE COMPANY
on withdrawals of universal life insurance and investment-type contracts
somewhat offset by a $389.9 million increase in funds from the issuance of
consumer notes, a program initiated in the second half of 2002. Deposits on such
universal life insurance and investment-type contracts exceeded withdrawals by
$1,175.6 million and $2,008.0 million for the six months ended June 30, 2003 and
June 30, 2002, respectively.
Cash flow requirements also are supported by a committed line of credit of
$1.0 billion, through a syndication of banks including Fleet National Bank,
JPMorgan Chase, Citicorp USA, Inc., The Bank of Nova Scotia, Fleet Securities,
Inc., and J.P. Morgan Securities Inc. The line of credit agreement provides for
two facilities: one for $500 million pursuant to a 364-day commitment (renewed
effective July 25, 2003) and a second for $500 million (renewable in 2005). The
line of credit is available for general corporate purposes. The line of credit
agreement contains various covenants, among these being that statutory total
capital and surplus plus asset valuation reserve meet certain requirements. To
date, we have not borrowed any amounts under the line of credit.
As of June 30, 2003, we had $512.3 million of principal amounts of debt
outstanding consisting of $447.5 million of surplus notes and $64.8 million of
other notes payable (excluding $131.6 million in non-recourse debt for Signature
Fruit and a Signature Funding CDO). Also not included here is the $137.9 million
SFAS 133 fair value adjustment to interest rate swaps held for the Surplus
Notes. A commercial paper program has been established at John Hancock Financial
Services, Inc., the Company's parent, that has replaced the commercial paper
program that was in place at John Hancock Capital Corporation, the Company's
subsidiary. As of May 1, 2002, all commercial paper issued by John Hancock
Capital Corporation had been retired.
The risk-based capital standards for life insurance companies, as
prescribed by the National Association of Insurance Commissioners, establish a
risk-based capital ratio comparing adjusted surplus to required surplus for the
Company and each of our United States domiciled insurance subsidiaries. If the
risk-based capital ratio falls outside of acceptable ranges, regulatory action
may be taken ranging from increased information requirements to mandatory
control by the domiciliary insurance department. The risk-based capital ratios
are reported annually and monitored continuously. The Company's the risk-based
capital ratios of all our insurance subsidiaries as of year end were
significantly above the ranges that would require regulatory action.
The following table summarizes the Company's information about contractual
obligations by due date and expiration date as of June 30, 2003. Contractual
obligations of the Company are those obligations fixed by agreement as to dollar
amount and date of payment. These obligations are inputs into the Company's
asset liability management system described elsewhere in this document. Other
commercial commitments are those commitments entered into by the Company with
known expiration dates. No such other commercial commitments existed at June 30,
2003.
Contractual Obligations as of June 30, 2003
Payments due by period
-----------------------------------------------------------------
Less than 1 After
Total year 1-3 years 4-5 years 5 years
-----------------------------------------------------------------
(in millions)
Debt ..................................... $ 512.3 $ 465.4 $ 32.4 $ 5.1 $ 9.4
Consumer notes ........................... 1,250.3 16.1 99.4 152.3 982.5
GIC's .................................... 6,212.5 808.4 2,700.2 1,186.7 1,517.2
Funding agreements ....................... 14,072.5 1,060.6 4,864.1 3,516.8 4,631.0
Institutional structured settlements ..... 1,671.9 17.5 36.7 38.7 1,579.0
Annuity certain contracts ................ 1,316.8 175.3 401.3 206.3 533.9
Investment commitments ................... 1,906.6 1,906.6 -- -- --
Operating lease obligations .............. 875.7 50.5 181.7 165.8 477.7
-----------------------------------------------------------------
Total contractual cash obligations .. $27,818.6 $ 4,500.4 $ 8,315.8 $ 5,271.7 $ 9,730.7
=================================================================
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JOHN HANCOCK LIFE INSURANCE COMPANY
We maintain reinsurance programs designed to protect against large or
unusual losses. Based on our review of our reinsurers' financial statements and
reputations in the reinsurance marketplace, we believe that our reinsurers are
financially sound, and, therefore, that we have no significant exposure to
uncollectible reinsurance in excess of uncollectible amounts already recognized
in our unaudited consolidated financial statements.
Given the historical cash flow of our subsidiaries and current financial
results, management believes that the cash flow from the operating activities
over the next year will provide sufficient liquidity for our operations, as well
as to satisfy debt service obligations and to pay other operating expenses.
Although we anticipate that we will be able to meet our cash requirements, we
can give no assurances in this regard.
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JOHN HANCOCK LIFE INSURANCE COMPANY
Forward-Looking Statements
The statements, analyses, and other information contained herein relating
to trends in the John Hancock Life Insurance Company's (the Company's)
operations and financial results, the markets for the Company's products, the
future development of the Company's business, and the contingencies and
uncertainties to which the Company may be subject, as well as other statements
including words such as "anticipate," "believe," "plan," "estimate," "expect,"
"intend," "will," "should," "may," and other similar expressions, are
"forward-looking statements" under the Private Securities Litigation Reform Act
of 1995. Such statements are made based upon management's current expectations
and beliefs concerning future events and their effects on the Company. Future
events and their potential effects on the Company may not be those anticipated
by management. The Company's actual results may differ materially from the
results anticipated in these forward-looking statements.
These forward-looking statements are subject to risks and uncertainties
including, but not limited to, the risks that (1) a significant downgrade in our
ratings for claims-paying ability and financial strength may lead to policy and
contract withdrawals and materially harm our ability to market our products; (2)
new laws and regulations, including the recently enacted Sarbanes-Oxley Act of
2002, or changes to existing laws or regulations, (including, but not limited
to, those relating to the Federal Estate Tax Laws and the proposed Bush
Administration tax and savings initiatives), and the applications and
interpretations given to these laws and regulations, may adversely affect the
Company's sales of insurance and investment advisory products; (3) Massachusetts
insurance law may restrict the ability of John Hancock Variable Life Insurance
Company to pay dividends to us; (4) we face increasing competition in our retail
businesses from mutual fund companies, banks and investment management firms as
well as from other insurance companies; (5) declines or increased volatility in
the securities markets, and other economic factors, may adversely affect our
business, particularly our variable life insurance, mutual fund, variable
annuity and investment business; (6) due to acts of terrorism or other
hostilities, there could be business disruption, economic contraction, increased
mortality, morbidity and liability risks, generally, or investment losses that
could adversely affect our business; (7) our life insurance sales are highly
dependent on a third party distribution relationship; (8) customers may not be
responsive to new or existing products or distribution channels; (9) interest
rate volatility may adversely affect our profitability; (10) our net income and
revenues will suffer if customers surrender annuities and variable and universal
life insurance policies or redeem shares of our open-end mutual funds; (11) the
independent directors of our variable series trusts and of our mutual funds
could reduce the compensation paid to us or could terminate our contracts to
manage the funds; (12) under our Plan of Reorganization, we were required to
establish the closed block, a special arrangement for the benefit of a group of
our policyholders. We may have to fund deficiencies in our closed block, and any
over-funding of the closed block will benefit only the holders of policies
included in the closed block, not our sole shareholder; (13) we will face losses
if the claims on our insurance products, or reductions in rates of mortality on
our annuity products, are greater than we projected; (14) we face investment and
credit losses relating to our investment portfolio, including, without
limitation, the risk associated with the evaluation and determination by our
investment professionals of the fair values of investments as well as whether or
not any investments have been impaired on an other than temporary basis; (15) we
may experience volatility in net income due to changes in standards for
accounting of derivatives, consolidations and other changes or from new
interpretations of accounting standards that must be applied retroactively; (16)
we are subject to risk-based capital requirements and possible guaranty fund
assessments; (17) the National Association of Insurance Commissioners'
codification of statutory accounting practices will adversely affect our
statutory surplus; (18) future interpretations of NAIC Actuarial Guidelines may
require us to establish additional statutory reserves for guaranteed minimum
death benefits under variable annuity contracts; (19) we may be unable to retain
personnel who are key to our business; (20) we may incur losses from assumed
reinsurance business in respect of personal accident insurance and the
occupational accident component of workers compensation insurance; (21)
litigation and regulatory proceedings may result in financial losses, harm our
reputation and divert management resources; (22) we face unforeseen liabilities
arising from our acquisitions and dispositions of businesses; (23) we face
unforeseen liabilities arising from our acquisitions and dispositions of
businesses and (24) we may incur multiple life insurance claims as a result of a
catastrophic event which, because of higher deductibles and lower limits under
our reinsurance arrangements, could adversely affect the Company's future net
income and financial position.
Readers are also directed to other risks and uncertainties discussed, as
well as to further discussion of the risks described above, in other documents
that may be filed by the Company with the United States Securities and Exchange
Commission from time to time. The Company specifically disclaims any obligation
to update or revise any forward-looking information, whether as a result of new
information, future developments, or otherwise.
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JOHN HANCOCK LIFE INSURANCE COMPANY
ITEM 3. QUANTITATIVE and QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Capital Markets Risk Management
The Company maintains a disciplined, comprehensive approach to managing
capital market risks inherent in its business and investment operations.
To mitigate capital market risks, and effectively support Company
objectives, investment operations are organized and staffed to focus investment
management expertise on specific classes of investments, with particular
emphasis placed on private placement markets. In addition, a dedicated unit of
asset/liability risk management (ALM) professionals centralizes the Life
Insurance Company's and its U.S. Life Insurance subsidiaries' implementation of
the interest rate risk management program. As an integral component of its ALM
program, derivative instruments are used in accordance with risk reduction
techniques established through Company policy and with formal approval granted
from the New York Insurance Department. The Company's use of derivative
instruments is monitored on a regular basis by the Company's Investment
Compliance Department and reviewed quarterly with senior management and the
Committee of Finance of the Company's wholly-owned subsidiary, John Hancock Life
Insurance Company, (the Company's Committee of Finance).
The Company's principal capital market exposures are credit and interest
rate risk, which includes the impact of inflation, although we have certain
exposures to changes in equity prices and foreign currency exchange rates.
Credit risk pertains to the uncertainty associated with the ability of an
obligor or counterparty to continue to make timely and complete payments of
contractual principal and interest. Interest rate risk pertains to the change in
fair value that occurs within fixed maturity securities or liabilities as market
interest rates move. Equity and foreign currency risk pertain to price
fluctuations, associated with the Company's ownership of equity investments or
non-US dollar denominated investments and liabilities, driven by dynamic market
environments.
Credit Risk
The Company manages the credit risk inherent in its fixed maturity
securities by applying strict credit and underwriting standards, with specific
limits regarding the proportion of permissible below-investment-grade holdings.
We also diversify our fixed maturity securities with respect to investment
quality, issuer, industry, geographical, and property-type concentrations. Where
possible, consideration of external measures of creditworthiness, such as
ratings assigned by nationally recognized rating agencies such as Moody's and
Standard & Poor's, supplement our internal credit analysis. The Company uses
simulation models to examine the probability distribution of credit losses to
ensure that it can readily withstand feasible adverse scenarios. In addition,
the Company periodically examines, on various levels of aggregation, its actual
default loss experience on significant asset classes to determine if the losses
are consistent with the (1) levels assumed in product pricing, and (2) rating
agencies' quality-specific cohort default data. These tests have generally found
the Company's aggregate experience to be favorable relative to the external
benchmarks and consistent with priced-for-levels.
The Company has a process in place that attempts to identify securities
that could potentially have an impairment that is other than temporary. This
process involves monitoring market events that could impact issuers' credit
ratings, business climate, management changes, acquisition, litigation and
government actions, and other similar factors. This process also involves
monitoring late payments, downgrades by rating agencies, key financial ratios,
financial statements, revenue forecasts and cash flow projections as indicators
of credit issues.
At the end of each quarter, our Investment Review Committee reviews all
securities where market value is less than ninety percent of amortized cost for
three months or more to determine whether impairments need to be taken. This
committee includes the head of workouts, the head of each industry team, and the
head of portfolio management, the Chief Investment Officer, and the Corporate
Risk Officer who reports to the Chief Financial Officer. The analysis focuses on
each company's or project's ability to service its debts in a timely fashion and
the length of time the security has been trading below cost. The results of the
analysis are reviewed by the Life Company's Committee of Finance, a subcommittee
of the Life Company's Board of Directors, quarterly. To supplement this process,
a quarterly review is made of the entire fixed maturity portfolio to assess
credit quality, including a review of all impairments with the Life Company's
Committee of Finance.
The Company considers and documents relevant facts and circumstances in
evaluating whether the impairment of a security is other than temporary.
Relevant facts and circumstances considered include (1) the length of time the
fair value has
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JOHN HANCOCK LIFE INSURANCE COMPANY
been below cost; (2) the financial position of the issuer, including the current
and future impact of any specific events; and (3) the Company's ability and
intent to hold the security to maturity or until it recovers in value. To the
extent the Company determines that a security is deemed to be other than
temporarily impaired, the difference between amortized cost and fair value would
be charged to earnings.
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 (1) the risk that our
assessment of an issuer's ability to meet all of its contractual obligations
will change based on changes in the credit characteristics of that issuer, (2)
the risk that the economic outlook will be worse than expected or have more of
an impact on the issuer than anticipated, (3) information, or fraudulent
financial statements, could be provided to our investment professionals who
determine the fair value estimates and other than temporary impairments and (4)
the risk that new information obtained by us or changes in other facts and
circumstances 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 charge to earnings in a future
period to the extent of the impairment charge recorded. Because the majority of
our portfolio is classified as available-for-sale and held at fair value with
the related unrealized gains (losses) recorded in shareholders' equity, the
charge to earnings should not have a significant impact on shareholders' equity.
As of June 30, 2003 and December 31, 2002, the Company's fixed maturity
portfolio was comprised of 88.3% and 88.0% investment grade securities and 11.7%
and 12.0% below-investment-grade securities, respectively. These percentages are
consistent with recent experience and indicative of the Company's long-standing
investment philosophy of pursuing moderate amounts of credit risk in return for
higher expected returns. We believe that credit risk can be successfully managed
given our proprietary credit evaluation models and experienced personnel.
Interest Rate Risk
The Company maintains a tightly controlled approach to managing its
potential interest rate risk. Interest rate risk arises from many of our primary
activities, as we invest substantial funds in interest-sensitive assets to
support the issuance of our various interest-sensitive liabilities, primarily
within our Protection, Asset Gathering and Guaranteed and Structured Financial
Products Segments.
We manage interest rate sensitive segments of our business, and their
supporting investments, under one of two broadly defined risk management methods
designed to provide an appropriate matching of assets and liabilities. For
guaranteed rate products, where contractual liability cash flows are highly
predictable (e.g., GICs or immediate annuities) we apply sophisticated
duration-matching techniques to manage the segment's exposure to both parallel
and non-parallel yield curve movements. Typically this approach involves a
targeted duration mismatch of zero, with an operational tolerance of less than
+/- 18 days, with other techniques used for limiting exposure to non-parallel
risk. Duration measures the sensitivity of the fair value of assets and
liabilities to changes in interest rates. For example, should interest rates
increase by 100 basis points, the fair value of an asset with a 5-year duration
is expected to decrease in value by approximately 5.0%. For non-guaranteed rate
products we apply scenario-modeling techniques to develop investment policies
with what we believe to be the optimal risk/return tradeoff given our risk
constraints. Each scenario is based on near term reasonably possible
hypothetical changes in interest rates that illustrate the potential impact of
such events.
We project asset, liability and derivatives cash flows on guaranteed rate
products and then discount them against credit-specific interest rate curves to
attain fair values. Duration is then calculated by re-pricing these cash flows
against a modified or "shocked" interest rate curve and evaluating the change in
fair value versus the base case. As of June 30, 2003 and December 31, 2002, the
fair value of fixed maturity securities and mortgage loans supporting duration
managed liabilities was approximately $33,230.4 million and $31,645.9 million,
respectively. Based on the information and assumptions we use in our duration
calculations in effect as of June 30, 2003, we estimate that a 100 basis point
immediate, parallel increase in interest rates ("rate shock") would have no
effect on the net fair value, or surplus, of our duration managed segments
(including derivatives), based on our targeted mismatch of zero, but could be
- -/+ $16.6 million based on our operational tolerance of 18 days.
The risk management method for non-guaranteed rate products, such as whole
life insurance or single premium deferred annuities, is less formulaic, but more
complex, due to the less predictable nature of the liability cash flows. For
these
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JOHN HANCOCK LIFE INSURANCE COMPANY
products, we manage interest rate risk based on scenario-based portfolio
modeling that seeks to identify the most appropriate investment strategy given
probable policyholder behavior and liability crediting needs under a wide range
of interest rate environments. As of June 30, 2003 and December 31, 2002, the
fair value of fixed maturity securities and mortgage loans supporting
liabilities managed under this modeling was approximately $31,115.2 million and
$28,003.8 million, respectively. A rate shock (as defined above) as of June 30,
2003 would decrease the fair value of these assets by $1,256.6 million, which we
estimate would be offset by a comparable change in the fair value of the
associated liabilities, thus minimizing the impact on surplus.
Derivative instruments such as futures contracts and interest rate swaps are
used to hedge interest rate risk in our asset and liability portfolios, in
support of our duration management programs. Under both interest rate risk
management methods described above, we perform comprehensive quarterly
assessments of interest rate risk and compare those results to our investment
guidelines. Any deviations outside of operational tolerances are immediately
correct using derivative instruments. Additionally, we monitor duration mismatch
on an effective "real time" basis and apply derivatives as needed to eliminate
deviations from our target duration mismatches.
Derivative Instruments
The Company uses a variety of derivative financial instruments, including
swaps, caps, floors, and exchange traded futures contracts, in accordance with
Company investment policy. Permissible derivative applications include the
reduction of economic risk (i.e., hedging) related to changes in yields, prices,
cash flows, and currency exchange rates. In addition, certain limited
applications of income generation are allowed. Examples of this type of use
include the purchase of call options to offset the sale of embedded options in
Company liability issuance or the purchase of swaptions to offset the purchase
of embedded put options in certain investments. The Company does not make a
market or trade derivatives for speculative purposes.
As of January 1, 2001, the Company adopted SFAS No. 133, which became
effective for all companies reporting under GAAP in the United States. Briefly
stated, SFAS No. 133 requires that all derivative instruments must be recorded
as either assets or liabilities on the Company's balance sheet, with quarterly
recognition thereafter of changes in derivative fair values through its income
statement. The income effect of derivatives that meet all requirements of a
"qualified hedge" under SFAS No. 133 guidance may be offset, in part or in its
entirety, by recognition of changes in fair value on specifically identified
underlying hedged-items. These hedged-items must be identified at the inception
of the hedge and may consist of assets, liabilities, firm commitments or
forecasted transactions. Depending upon the designated form of the hedge (i.e.,
fair value or cash flow), changes in fair value must either be recorded
immediately through income or through shareholders' equity (other comprehensive
income) for subsequent amortization into income.
The Company's Investment Compliance Unit monitors all derivatives activity
for consistency with internal policies and guidelines. All derivatives trading
activity is reported monthly to the Company's Committee of Finance for review,
with a comprehensive governance report provided jointly each quarter by the
Company's Derivatives Supervisory Officer and Chief Investment Compliance
Officer. The table below reflects the Company's derivative positions hedging
interest rate risk as of June 30, 2003. The notional amounts in the table
represent the basis on which pay or receive amounts are calculated and are not
reflective of credit risk. These fair value exposures represent only a point in
time and will be subject to change as a result of ongoing portfolio and risk
management activities.
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JOHN HANCOCK LIFE INSURANCE COMPANY
As of June 30, 2003
----------------------------------------------------------------------------------------
Fair Value
-----------------------------------------------------
Weighted
Notional Average Term -100 Basis Point As of +100 Basis Point
Amount (Years) Change (2) 6/30/03 Change (2)
----------------------------------------------------------------------------------------
(in millions, except for weighted average term)
Interest rate swaps............... $23,990.4 9.5 $(1,025.5) $(872.8) $(708.2)
CMT swaps......................... 53.4 0.9 1.1 1.0 1.0
Futures contracts (1)............. 223.2 7.1 (7.2) 0.5 8.8
Interest rate caps................ 1,069.2 5.4 19.1 24.1 34.0
Interest rate floors.............. 4,593.0 6.9 263.1 136.7 67.0
Swaptions......................... 30.0 21.9 (9.0) (4.4) (1.6)
------------------ -----------------------------------------------------
Totals......................... $29,959.2 8.9 $ (758.4) $(714.9) $(599.0)
================== =====================================================
(1) Represents the notional value on open contracts as of June 30, 2003.
(2) The selection of a 100 basis point immediate change in interest rates
should not be construed as a prediction by us of future market events but
rather as an illustration of the potential impact of such an event.
Our non-exchange-traded derivatives are exposed to the possibility of loss
from a counterparty failing to perform its obligations under terms of the
derivative contract. We believe the risk of incurring losses due to
nonperformance by our counterparties is remote. To manage this risk, Company
procedures include (a) the on-going evaluation of each counterparty's credit
ratings, (b) the application of credit limits and monitoring procedures based on
an internally developed, scenario-based risk assessment system, (c) quarterly
reporting of each counterparty's "potential exposure", (d) master netting
agreements, and (e) the use of collateral agreements. Futures contracts trade on
organized exchanges and have effectively no credit risk.
Equity Risk
Equity risk is the possibility that we will incur economic losses due to
adverse changes in a particular common stock or warrant that we hold in our
portfolio. In order to reduce our exposure to market fluctuations on some of our
common stock portfolio, we use equity collar agreements. These equity collar
agreements limit the market value fluctuations on their underlying equity
securities. Our equity collars are comprised of an equal number of purchased put
options and written call options, each with strike rates equidistant from the
stock price at the time the contract is established. As of June 30, 2003 and
December 31, 2002, the fair value of our equity securities portfolio was $168.1
million and $149.7 million. The fair value of our equity collar agreements as of
June 30, 2003 and December 31, 2002 was $3.6 million and $12.4 million. A
hypothetical 15% decline in the June 30, 2003 value of the equity securities
would result in an unrealized loss of approximately $19.4 million. The selection
of a 15% immediate change in the value of equity securities should not be
construed as a prediction by us of future market events but rather as an
illustration of the potential impact of such an event. The fair value of any
unhedged common stock holdings will rise or fall with equity market and
company-specific trends. In certain cases the Company classifies its equity
holdings as trading securities. Gains and losses, both realized and unrealized,
on equity securities classified as trading, are part of investment returns
related to equity indexed universal life insurance policies sold at Maritime
Life and are included in benefits to policyholders. These holdings are
marked-to-market through the income statement, creating investment income
volatility that is effectively neutralized by changes in corresponding liability
reserves.
Foreign Currency Risk
Foreign currency risk is the possibility that we will incur economic
losses due to adverse changes in foreign currency exchange rates. This risk
arises in part from our international operations and the issuance of certain
foreign currency-denominated funding agreements sold to non-qualified
institutional investors in the international market. We do not hedge the
exposure from out international operations. We apply currency swap agreements to
hedge the exchange risk inherent in our funding agreements denominated in
foreign currencies. We also have exposure that arises from owning fixed maturity
securities that are denominated in foreign currencies. We use currency swap
agreements to hedge the foreign currency risk of these securities (both interest
and principal payments). At June 30, 2003 and December 31, 2002, the fair value
of our foreign currency denominated fixed maturity securities was approximately
$954.6 million and $775.2 million. The fair value of our currency swap
agreements at June 30, 2003 and December 31, 2002 supporting foreign denominated
bonds was $(179.7) million and $(21.9) million.
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JOHN HANCOCK LIFE INSURANCE COMPANY
We estimate that as of June 30, 2003, a hypothetical 10% immediate change
in each of the foreign currency exchange rates to which we are exposed,
including the currency swap agreements, would result in no material change to
the net fair value of our foreign currency-denominated instruments identified
above. The selection of a 10% immediate change in all currency exchange rates
should not be construed as a prediction by us of future market events but rather
as an illustration of the potential impact of such an event. Our largest
individual currency exposure is to the Canadian dollar.
The modeling technique we use to calculate our exposure does not take into
account correlation among foreign currency exchange rates or correlation among
various markets. Our actual experience may differ from the results noted above
due to the correlation assumptions utilized or if events occur that were not
included in the methodology, such as significant illiquidity or other market
events.
Effects of Inflation
Inflation has not been a material factor in our operations during the past
decade in terms of our investment performance, expenses, or product sales.
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JOHN HANCOCK LIFE INSURANCE COMPANY
ITEM 4. CONTROLS and PROCEDURES
Our Chief Executive Officer and Chief Financial Officer have concluded,
based on their evaluation as of the ended of the period covered by this report
that our disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information we are required to disclose in our
reports filed under the Securities Exchange Act of 1934.
PART II - OTHER INFORMATION
Any exhibit not included with this Form 10-Q when furnished to any
shareholder of record will be furnished to such shareholder upon written request
and payment of up to $.25 per page plus postage (except no payment will be
required for the financial statements and schedules included in Exhibit 13 if
not included). Such requests should be directed to John Hancock Financial
Services, Inc., Investor Relations, John Hancock Place, Post Office Box 111,
Boston, Massachusetts 02117.
ITEM 6. EXHIBITS and REPORTS on FORM 8-K
a) Exhibits
Exhibit
Number Description
- ------ -----------
10.1 Third Amendment dated as of July 25, 2003 to the $1,000,000,000
Credit Agreement dated as of August 3, 2000, as amended, among John
Hancock Financial Services, Inc., John Hancock Life Insurance
Company, The Banks listed therein, Fleet National Bank, as
Co-Administrative Agent, JPMorgan Chase Bank, as Co-Administrative
Agent, Citicorp USA, Inc., as Syndication Agent, The Bank of New
York, as Documentation Agent (364-Day Revolver) and Wachovia Bank,
National Association as Documentation Agent (364-Day Revolver),
Fleet Securities, Inc., and J.P. Morgan Securities, Inc., as Joint
Bookrunners and Joint Lead Arrangers *
10.2 Employment Continuation Agreement between John Hancock Life
Insurance Company, John Hancock Financial Services, Inc. and James
M. Benson dated April 1, 2003. * +
31.1 Chief Executive Officer Certification Pursuant to Rules 13a-14 and
15d-14 of the Securities Exchange Act of 1934 @
31.2 Chief Financial Officer Certification Pursuant to Rules 13a-14 and
15d-14 of the Securities Exchange Act of 1934 @
32.1 Chief Executive Officer certification pursuant to 18 U.S.C. Section
1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002 @
32.2 Chief Financial Officer certification pursuant to 18 U.S.C. Section
1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002 @
================================================================================
* Previously filed as an exhibit to the John Hancock Financial Services,
Inc. quarterly report on Form 10-Q for the quarter ended June 30, 2003,
and incorporated by reference herein.
+ Management contract or compensatory plan or arrangement.
@ Filed herewith.
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JOHN HANCOCK LIFE INSURANCE COMPANY
b) Reports on Form 8-K.
During the Second Quarter of 2003 the Company filed the following Current
Reports on Form 8-K:
On May 2, 2003, the Company filed a Current Report on Form 8-K, dated May
1, 2003 reporting under Item 5 and Item 7 thereof the Company's operating and
financial results for the first quarter of 2003.
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JOHN HANCOCK LIFE INSURANCE COMPANY
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.
JOHN HANCOCK LIFE INSURANCE COMPANY
Date: August 11, 2003 By: /s/ Thomas E. Moloney
---------------------
Thomas E. Moloney
Senior Executive Vice President and
Chief Financial Officer
92