The accompanying unaudited consolidated condensed financial statements of Protective Life Insurance Company and subsidiaries ("Protective Life") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2000, are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. The year-end consolidated condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. For further information, refer to the consolidated financial statements and notes thereto included in Protective Life's annual report on Form 10-K for the year ended December 31, 1999.
Protective Life is a wholly-owned subsidiary of Protective Life Corporation ("PLC"). NOTE B - COMMITMENTS AND CONTINGENT LIABILITIES Under insurance guaranty fund laws in most states, insurance companies doing business therein can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies. Protective Life does not believe such assessments will be materially different from amounts already provided for in the financial statements. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's own financial strength.
A number of civil jury verdicts have been returned against insurers in the jurisdictions in which Protective Life does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments against the insurers that are disproportionate to the actual damages, including material amounts of punitive damages. In addition, in some class action and other lawsuits involving insurers’ sales practices, insurers have made material settlement payments. In some states, including Alabama (where Protective Life maintains its headquarters), juries have substantial discretion in awarding punitive damages, which creates the potential for unpredictable material adverse judgments in any given lawsuit. Protective Life, like other insurers, in the ordinary course of business, is involved in such litigation or alternatively in arbitration. Although the outcome of any such litigation or arbitration cannot be predicted with certainty, Protective Life believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position, results of operations, or liquidity of Protective Life.
NOTE C - OPERATING SEGMENTS Protective Life operates seven divisions whose principal strategic focuses can be grouped into three general categories: life insurance, specialty insurance products, and retirement savings and investment products. The following table sets forth operating segment income and assets for the periods shown. Adjustments represent the inclusion of unallocated realized investment gains (losses) and the recognition of income tax expense. There are no asset adjustments.
In the 2000 first quarter, certain health insurance lines were transferred from the Dental and Consumer Benefits Division to the Corporate and Other segment in order to reflect management’s current focus. Prior period segment results have been restated to reflect the change.
OPERATING SEGMENT INCOME FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2000
-----------------------------------------------------------------------
(IN THOUSANDS)
SPECIALTY INSURANCE
LIFE INSURANCE PRODUCTS
DENTAL AND
INDIVIDUAL CONSUMER FINANCIAL
LIFE WEST COAST ACQUISITIONS BENEFITS INSTITUTIONS
--------- ---------- ------------ ------- ------------
Premiums and policy fees $297,080 $99,939 $101,803 $198,136 $280,267
Reinsurance ceded (225,465) (78,426) (22,151) (60,069) (121,943)
------- ------ ------- ------- -------
Net of reinsurance ceded 71,615 21,513 79,652 138,067 158,324
Net investment income 44,966 66,999 87,992 6,640 33,692
Realized investment gains (losses)
Other income (2,446) 9 11,028 22,467
------- ------ ------- ------- -------
Total revenues 114,135 88,512 167,653 155,735 214,483
------- ------ ------- ------- -------
Benefits and settlement expenses 62,365 64,670 96,691 100,633 99,674
Amortization of deferred policy
acquisition costs 22,957 10,120 13,179 9,563 35,371
Other operating expenses (665) (12,651) 18,635 30,866 54,053
------- ------ ------- ------- -------
Total benefits and expenses 84,657 62,139 128,505 141,062 189,098
------- ------ ------- ------- -------
Income before income tax 29,478 26,373 39,148 14,673 25,385
RETIREMENT SAVINGS AND
INVESTMENT PRODUCTS
STABLE CORPORATE
VALUE INVESTMENT AND TOTAL
PRODUCTS PRODUCTS OTHER ADJUSTMENTS CONSOLIDATED
-------- -------- ------- ----------- ------------
Premiums and policy fees $ 22,858 $89,110 $1,089,193
Reinsurance ceded (48,394) (556,448)
------ ------ ---------
Net of reinsurance ceded 22,858 40,716 532,745
------ ------ ---------
Net investment income $178,850 95,810 (1,988) 512,961
Realized investment gains (losses) (2,272) 457 $ (5,447) (7,262)
Other income 2,260 5,392 38,710
------- ------- ------ ----- ---------
Total revenues 176,578 121,385 44,120 (5,447) 1,077,154
------- ------- ------ ----- ---------
Benefits and settlement expenses 152,299 78,837 36,460 691,629
Amortization of deferred
acquisition costs 658 18,298 1,720 111,866
Other operating expenses 2,907 13,011 24,684 130,840
------- ------- ------ -------
Total benefits and expenses 155,864 110,146 62,864 934,335
------- ------- ------ -------
Income before income tax 20,714 11,239 (18,744) 142,819
Income tax expense 50,504 50,504
-------
Net income $ 92,315
=======
7
OPERATING SEGMENT INCOME FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 1999
------------------------------------------------------------------------
(IN THOUSANDS)
SPECIALTY INSURANCE
LIFE INSURANCE PRODUCTS
DENTAL AND
INDIVIDUAL CONSUMER FINANCIAL
LIFE WEST COAST ACQUISITIONS BENEFITS INSTITUTIONS
--------- ---------- ------------ ---------- ------------
Premiums and policy fees $200,913 $62,520 $113,527 $159,811 $212,747
Reinsurance ceded (126,454) (42,802) (24,420) (36,960) (132,233)
------- ------ ------- ------- -------
Net of reinsurance ceded 74,459 19,718 89,107 122,851 80,514
Net investment income 45,376 56,779 99,587 8,597 17,382
Realized investment gains (losses)
Other income (1,614) 1,302 (9) 5,023 11,378
------- ------ ------- ------- -------
Total revenues 118,221 77,799 188,685 136,471 109,274
------- ------ ------- ------- -------
Benefits and settlement expenses 55,265 50,471 98,237 90,633 40,586
Amortization of deferred policy
acquisition costs 20,317 5,055 15,309 5,724 18,654
Other operating expenses 18,457 2,839 22,675 27,082 33,615
------ ------ ------- ------- ------
Total benefits and expenses 94,039 58,365 136,221 123,439 92,855
------ ------ ------- ------- ------
Income before income tax 24,182 19,434 52,464 13,032 16,419
RETIREMENT SAVINGS AND
INVESTMENT PRODUCTS
STABLE CORPORATE
VALUE INVESTMENT AND TOTAL
PRODUCTS PRODUCTS OTHER ADJUSTMENTS CONSOLIDATED
-------- -------- --------- ----------- ------------
Premiums and policy fees $17,610 $73,863 $840,991
Reinsurance ceded (20,001) (382,870)
------ ------ -------
Net of reinsurance ceded 17,610 53,862 458,121
-------
Net investment income $155,634 78,712 915 462,982
Realized investment gains (losses) (82) 892 $ (356) 454
Other income 1,587 2,179 19,846
------- ------ ------ --- -------
Total revenues 155,552 98,801 56,956 (356) 941,403
------- ------ ------ --- -------
Benefits and settlement expenses 131,016 64,477 42,911 573,596
Amortization of deferred
acquisition costs 575 14,777 1,904 82,315
Other operating expenses 2,963 11,018 20,677 139,326
------- ------ ------ -------
Total benefits and expenses 134,554 90,272 65,492 795,237
------- ------ ------ -------
Income before income tax 20,998 8,529 (8,536) 146,166
Income tax expense 53,603 53,603
-------
Net income $ 92,563
=======
8
OPERATING SEGMENT ASSETS
SEPTEMBER 30, 2000
-----------------------------------------------------------------------------
(IN THOUSANDS)
SPECIALTY INSURANCE
LIFE INSURANCE PRODUCTS
DENTAL AND
INDIVIDUAL CONSUMER FINANCIAL
LIFE WEST COAST ACQUISITIONS BENEFITS INSTITUTIONS
--------- ---------- ------------ --------- ------------
Investments and other assets $1,204,540 $1,437,714 $1,549,613 $210,889 $1,163,060
Deferred policy acquisition costs
and goodwill 342,829 269,594 228,875 31,879 143,420
--------- --------- --------- ------- ---------
Total assets $1,547,369 $1,707,308 $1,778,488 $242,768 $1,306,480
========= ========= ========= ======= =========
RETIREMENT SAVINGS AND
INVESTMENT PRODUCTS
STABLE CORPORATE
VALUE INVESTMENT AND TOTAL
PRODUCTS PRODUCTS OTHER CONSOLIDATED
-------- ----------- -------- ------------
Investments and other assets $3,189,891 $3,904,774 $410,540 $13,071,021
Deferred policy acquisition costs
and goodwill 2,350 124,440 82,314 1,225,701
--------- --------- ------- ----------
Total assets $3,192,241 $4,029,214 $492,854 $14,296,722
========= ========= ======= ==========
OPERATING SEGMENT ASSETS
DECEMBER 31, 1999
-----------------------------------------------------------------------------
(IN THOUSANDS)
SPECIALTY INSURANCE
LIFE INSURANCE PRODUCTS
DENTAL AND
INDIVIDUAL CONSUMER FINANCIAL
LIFE WEST COAST ACQUISITIONS BENEFITS INSTITUTIONS
---------- ---------- ------------ --------- ------------
Investments and other assets $1,205,968 $1,343,517 $1,553,954 $197,673 $727,857
Deferred policy acquisition costs 379,117 200,605 235,903 25,819 51,339
--------- --------- --------- ------- -------
Total assets $1,585,085 $1,544,122 $1,789,857 $223,492 $779,196
========= ========= ========= ======= =======
RETIREMENT SAVINGS AND
INVESTMENT PRODUCTS
STABLE CORPORATE
VALUE INVESTMENT AND TOTAL
PRODUCTS PRODUCTS OTHER CONSOLIDATED
--------- --------- ------- ------------
Investments and other assets $2,766,178 $3,355,863 $418,609 $11,569,619
Deferred policy acquisition costs 1,156 117,577 8 1,011,524
--------- --------- ------- ----------
Total assets $2,767,334 $3,473,440 $418,617 $12,581,143
========= ========= ======= ==========
9NOTE D - STATUTORY REPORTING PRACTICES Financial statements prepared in conformity with generally accepted accounting principles (i.e., GAAP) differ in some respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. At September 30, 2000, and for the nine months then ended, Protective Life and its life insurance subsidiaries had consolidated share-owner’s equity and net income prepared in conformity with statutory reporting practices of $575.3 million and $28.6 million, respectively.
NOTE E - INVESTMENTS As prescribed by Statement of Financial Accounting Standards ("SFAS") No. 115, certain investments are recorded at their market values with the resulting net unrealized gains and losses reduced by a related adjustment to deferred policy acquisition costs, net of income tax, recorded as a component of share-owner’s equity. The market values of fixed maturities increase or decrease as interest rates fall or rise. Therefore, although the application of SFAS No. 115 does not affect Protective Life’s operations, its reported share-owner’s equity will fluctuate significantly as interest rates change.
Protective Life's balance sheets at September 30, 2000 and December 31, 1999, prepared on the basis of reporting investments at amortized cost rather than at market values, are as follows:
September 30 December 31
------------ -----------
(In Thousands)
Total investments $ 9,982,224 $ 8,894,426
Deferred policy acquisition costs 1,186,343 992,518
All other assets 3,251,781 2,918,857
---------- ----------
$14,420,348 $12,805,801
========== ==========
Deferred income taxes $ 60,817 $ 46,243
All other liabilities 13,065,286 11,616,935
---------- ----------
13,126,103 11,663,178
Share-owner's equity 1,294,245 1,142,623
---------- ----------
$14,420,348 $12,805,801
========== ==========
NOTE F - DERIVATIVE FINANCIAL INSTRUMENTS Protective Life has not used derivative financial instruments for trading purposes. Combinations of interest rate swap contracts, options and futures contracts are sometimes used as hedges against changes in interest rates for certain investments, primarily outstanding mortgage loan commitments. Realized investment gains and losses on such contracts are deferred and amortized over the life of the hedged asset or liability. Realized investment losses of $1.2 million were deferred during the first nine months of 2000. No realized investment gains or losses were deferred in the full year of 1999.
10Protective Life uses interest rate swap contracts, swaptions (options to enter into interest rate swap contracts), caps, and floors to convert certain investments from a variable to a fixed rate of interest and from a fixed rate of interest to a variable rate of interest. Swap contracts are also used to alter the effective durations of assets and liabilities. Protective Life uses foreign exchange contracts in connection with certain stable value contracts denominated in foreign currencies.
At September 30, 2000, contracts with a notional amount of $2.0 billion were in a $10.9 million net unrealized loss position. During the nine months ended September 30, 2000, Protective Life recognized $10.8 million in realized investment losses related to derivative financial instruments. In addition, certain stable value contracts were recorded at market value at September 30, 2000, resulting in a realized investment gain of $11.4 million for the nine months ended September 30, 2000.
NOTE G - COMPREHENSIVE INCOME (LOSS) The following table sets forth Protective Life’s comprehensive income (loss) for the nine month periods ended September 30, 2000 and 1999:
Three Months Ended Nine Months Ended
September 30 September 30
-------------------------- ------------------------
2000 1999 2000 1999
---- ---- ---- ----
Net income $ 31,488 $27,023 $ 92,315 $ 92,563
Increase (decrease) in net unrealized gains
on investments (net of income tax:
three months: 2000 - $39,962; 1999 - $3,072
nine months: 2000 - $32,848; 1999 - $(74,899)) 74,215 5,704 61,003 (139,099)
Reclassification adjustment for amounts
included in net income (net of income tax:
three months: 2000 - $2,048; 1999 - $1,123
nine months: 2000 - $2,542; 1999 - $(159)) 3,804 2,087 4,720 (295)
------- ------ ------- -------
Comprehensive income (loss) $109,507 $34,814 $158,038 $ (46,831)
======= ====== ======= =======
NOTE H - ACQUISITION In January, 2000, Protective Life acquired the Lyndon Insurance Group (“Lyndon”). The transaction has been accounted for as a purchase, and the results of the transaction have been included in the accompanying financial statements since its effective date.
Summarized below are the consolidated results of operations for the nine months ended September 30, 1999, on an unaudited pro forma basis, as if the Lyndon acquisition had occurred as of January 1, 1999. The pro forma information is based on the Protective Life’s consolidated results of operations for the nine months ended September 30, 1999, and on data provided by Lyndon, after giving effect to certain pro forma adjustments. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transaction occurred on the basis assumed above nor are they indicative of results of the future operations of the combined enterprises.
Nine Months Ended
September 30, 1999
------------------
(In Thousands)
(Unaudited)
Total revenues $ 1,014,330
Net income $ 99,381
11NOTE I - RECLASSIFICATIONS Certain reclassifications have been made in the previously reported financial statements and accompanying notes to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on previously reported net income, total assets, or share-owner’s equity.
NOTE J - RECENTLY ISSUED ACCOUNTING STANDARDS The Financial Accounting Standards Board (“FASB”) has issued Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. Effective January 1, 2001, SFAS No. 133, as amended by SFAS No. 138, will require Protective Life to record derivative financial instruments, including certain derivative instruments embedded in other contracts, on its balance sheet and to carry such derivatives at fair value. Derivatives that are not designated to be part of a qualifying hedging relationship must be adjusted to fair value each period through net income. If the derivative is a hedge, its change in fair value is either offset against the change in fair value of the hedged item through net income or recorded in share- owner’s equity until the hedged item is recognized in net income. The fair value of derivatives increase or decrease as interest rates and general economic conditions change. Although the adoption of SFAS No. 133 will not affect Protective Life’s operations, adoption will introduce volatility into Protective Life’s reported net income and share-owner’s equity.
In September 2000 the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinquishments of Liabilities, a replacement of SFAS No. 125". SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. The statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal year ended after December 15, 2000. This Statement is effective for transfers and servicing of financial assets and extinquishments of liabilities occurring after March 31, 2001.
NOTE K - SUBSEQUENT EVENT On November 7, 2000, PLC announced that Protective Life has agreed to coinsure a block of approximately 70,000 individual life policies from Standard Insurance Company. The transaction represents approximately $725 million of life insurance reserves and approximately $80 million of annual premium. The transaction is subject to regulatory approval.
13ITEM 2. MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS
OF OPERATIONS
Protective Life Insurance Company ("Protective Life") is a wholly-owned subsidiary of Protective Life Corporation ("PLC"), an insurance holding company whose common stock is traded on the New York Stock Exchange under the symbol “PL”. Founded in 1907, Protective Life provides financial services through the production, distribution, and administration of insurance and investment products. Unless the context otherwise requires "Protective Life" refers to the consolidated group of Protective Life Insurance Company and its subsidiaries.
In accordance with General Instruction H(2)(a), Protective Life includes the following analysis with the reduced disclosure format.
Protective Life operates seven divisions whose principal strategic focuses can be grouped into three general categories: life insurance, specialty insurance products, and retirement savings and investment products. The life insurance divisions are: Individual Life, West Coast, Acquisitions, Dental and Consumer Benefits (Dental), Financial Institutions, Stable Value Products, and Investment Products. Protective Life also has an additional business segment which is Corporate and Other.
This report includes "forward-looking statements" which express expectations of future events and/or results. The words "believe", "expect", "anticipate" and similar expressions identify forward-looking statements which are based on future expectations rather than on historical facts and are therefore subject to a number of risks and uncertainties, and Protective Life cannot give assurance that such statements will prove to be correct. Please refer to Exhibit 99 herein for more information about factors which could affect future results.
Revenues The following table sets forth revenues by source for the period shown, and the percentage change from the prior period:
Nine Months Percentage
Ended Increase/
September 30 (Decrease)
-------------------------- -------------
(In Thousands)
2000 1999
---- ----
Premiums and policy fees $ 532,745 $458,121 16.3%
Net investment income 512,961 462,982 10.8
Realized investment gains (losses) (7,262) 454 1,699.6
Other income 38,710 19,846 95.1
--------- -------
$1,077,154 $941,403
========= =======
Premiums and policy fees, net of reinsurance ceded, increased $74.6 million or 16.3% in the first nine months of 2000 over the first nine months of 1999. Premiums and policy fees in the Individual Life Division decreased $2.8 million in the first nine months of 2000 as compared to the same period in 1999 primarily due to a higher amount of reinsurance ceded. Premiums and
14policy fees in the West Coast Division increased $1.8 million in the first nine months of 2000 as compared to the same period in 1999. Premiums and policy fees in the Acquisitions Division are expected to decline with time unless new acquisitions are made. No transactions were completed in this Division in 1999 or the first nine months of 2000. As a result, decreases in older acquired blocks resulted in a $9.5 million decrease in premiums and policy fees. In the Dental Division premiums and policy fees related to dental indemnity insurance increased $13.6 million in the first nine months of 2000 as compared to the same period in 1999. Premiums and policy fees related to the Dental Division’s other businesses increased $1.6 million in the first nine months of 2000 as compared to the same period in 1999. Premiums and policy fees from the Financial Institutions Division increased $77.8 million in the first nine months of 2000 as compared to the first nine months of 1999. On January 20, 2000, the Financial Institutions Division acquired the Lyndon Insurance Group (“Lyndon”) which resulted in a $69.6 million increase in premiums and policy fees. Premiums and policy fees related to the Financial Institutions Division’s other businesses increased $8.2 million in the first nine months of 2000 as compared to the same period in 1999. The increase in premiums and policy fees from the Investment Products Division was $5.2 million. Premiums and policy fees relating to various health insurance lines in the Corporate and Other segment decreased $13.1 million.
Net investment income in the first nine months of 2000 increased by $50.0 million over the corresponding period of the preceding year primarily due to an increase in the average amount of invested assets and due to acquisitions. The Lyndon acquisition resulted in a $12.8 million increase in investment income.
Protective Life generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash-flow needs. However, Protective Life may sell any of its investments to maintain proper matching of assets and liabilities. Accordingly, Protective Life has classified its fixed maturities and certain other securities as "available for sale." The sales of investments that have occurred have resulted principally from portfolio management decisions to maintain approximate matching of assets and liabilities.
Realized investment losses for the first nine months of 2000 were $7.3 million as compared to $0.5 millions of realized investment gains in the corresponding period of 1999. Protective Life could experience significant realized investment losses were it to make adjustments to its existing fixed maturity portfolio.
Other income consists primarily of fees from the sale of service contracts, administrative-services-only types of group accident and health insurance contracts, and from rental of space in its administrative building to PLC and affiliates. Other income from all sources increased $18.9 million in the first nine months of 2000 as compared with the first nine months of 1999. Revenues from Protective Life’s service contract business and consumer direct dental business increased $13.8 million and $7.2 million, respectively, in the first nine months of 2000 as compared to the same period of 1999.
15Income Before Income Tax In the 2000 first quarter, certain health insurance lines were transferred from the Dental and Consumer Benefits Division to the Corporate and Other segment. Prior period segment results have been restated to reflect the change.
The following table sets forth operating income or loss and income or loss before income tax by business segment for the periods shown:
Operating Income (Loss) and Income (Loss) Before Income Tax
Nine Months Ended September 30
(In Thousands)
2000 1999
Operating Income (Loss)1 ---- ----
Life Insurance
Individual Life $ 29,478 $ 24,182
West Coast 26,373 19,434
Acquisitions 39,148 52,464
Specialty Insurance Products
Dental and Consumer Benefits 14,673 13,032
Financial Institutions 25,385 16,419
Retirement Savings and Investment Products
Stable Value Products 22,986 21,080
Investment Products 11,239 8,529
Corporate and Other (18,744) (8,536)
------- -------
Total operating income 150,538 146,604
------- -------
Realized Investment Gains (Losses)
Stable Value Products (2,272) (82)
Investment Products 457 892
Unallocated Realized Investment Gains (Losses) (5,447) (356)
Related Amortization of Deferred Policy Acquisition Costs
Investment Products (457) (892)
------- -------
Total net (7,719) (438)
------- -------
Income (Loss) Before Income Tax
Life Insurance
Individual Life 29,478 24,182
West Coast 26,373 19,434
Acquisitions 39,148 52,464
Specialty Insurance Products
Dental and Consumer Benefits 14,673 13,032
Financial Institutions 25,385 16,419
Retirement Savings and Investment Products
Stable Value Products 20,714 20,998
Investment Products 11,239 8,529
Corporate and Other (18,744) (8,536)
Unallocated Realized Investment Gains (Losses) (5,447) (356)
------- -------
Total income before income tax $142,819 $146,166
======= =======
1 Income before income tax excluding realized investment gains and losses and related
amortization of deferred acquisition costs.
16 The Individual Life Division’s pretax operating income was $29.5 million in the first nine months of 2000 compared to $24.2 million in the same period of 1999. The Division has grown through sales. The Division’s mortality experience was $3.8 million better than expected in the first nine months of 2000 as compared to being $2.9 million better than expected in the first nine months of 1999.
West Coast had pretax operating income of $26.4 million for the first nine months of 2000 compared to $19.4 million for the same period last year. The increase reflects the Division’s growth through sales.
Pretax operating income from the Acquisitions Division was $39.1 million in the first nine months of 2000 as compared to $52.5 million in the same period of 1999. The Division’s mortality experience was approximately $2.9 million better than expected in the first nine months of 2000 as compared to being approximately $6.4 million better than expected in the first nine months of 1999. Additionally, in the fourth quarter of 1999, adjustments were made to the Division’s investment portfolio which had the effect of transferring in the first nine months of 2000 approximately $10.0 million of investment income to the Corporate and Other segment. Earnings from the Acquisitions Division are normally expected to decline over time (due to the lapsing of policies resulting from deaths of insureds or terminations of coverage) unless new acquisitions are made. The Division has not made an acquisition in 1999 or the first nine months of 2000.
The Dental Division’s pretax operating income was $14.7 million in the first nine months of 2000 compared to $13.0 million in the same period last year. Claims returned to more normal levels in the 2000 second and third quarters after having been higher than normal in the first quarter.
Pretax operating income of the Financial Institutions Division was $25.4 million in the first nine months of 2000 as compared to $16.4 million in the same period of 1999. Included in the Division’s 2000 results were $12.4 million of earnings from the Lyndon acquisition. Earnings of the Division’s other business decreased due to higher than expected claims in most lines in the 2000 first quarter.
The Stable Value Products Division had pretax operating income of $23.0 million in the first nine months of 2000 and $21.1 million in the corresponding period of 1999. This increase was primarily due to higher account balances which was partially offset by lower interest rate spreads. Operating spreads in the 2000 third quarter were compressed due to higher interest rates and an inverted yield curve. Realized investment losses associated with this Division in the first nine months of 2000 were $2.3 million as compared to losses of $0.1 million in the same period last year. As a result, total pretax earnings were $20.7 million in the first nine months of 2000 compared to $21.0 million for the same period last year.
The Investment Products Division pretax operating income was $11.2 million in the first nine months of 2000 compared to $8.5 million in the same period of 1999. The increase reflects the Division’s growth through sales. The Division had no realized investment gains (net of related amortization of deferred policy acquisition costs) in the first nine months of 2000 or the full year of 1999.
17 The Corporate and Other segment consists primarily of net investment income on unallocated capital and other operating expenses not identified with the preceding operating divisions (including management fees paid to PLC and interest on substantially all debt), several lines of business which Protective Life is not actively marketing (mostly health insurance), and the operations of a small noninsurance subsidiary. The pretax loss for this segment was $18.7 million in the first nine months of 2000 compared to a loss of $8.5 million in the first nine months of 1999. Earnings from health insurance lines decreased $6.4 million in the first nine months of 2000 as compared to the same period last year. The segment also had approximately $3.8 million higher expenses in the third quarter of 2000 as compared to the same period in 1999.
Income Taxes
The following table sets forth the effective tax rates for the periods shown:
Nine Months
Ended Estimated Effective
September 30 Income Tax Rates
------------ -------------------
1999 36.7 %
2000 35.4
The effective income tax rate for the full year of 1999 was 36.7%. Management’s estimate of the effective income tax rate for 2000 is approximately 35.8%.
Net Income The following table sets forth net income for the periods shown, and the percentage change from the prior period:
NET INCOME
-----------------------------------------
NINE MONTHS PERCENTAGE
ENDED TOTAL INCREASE/
SEPTEMBER 30 (IN THOUSANDS) (DECREASE)
------------ -------------- ---------
1999 $92,563 6.5 %
2000 92,315 (0.3)
Compared to the same period in 1999, net income in the first nine months of 2000 decreased $0.2 million, reflecting improved operating earnings in the Individual Life, West Coast, Dental, Financial Institutions, Stable Value and Investment Products Divisions and higher realized investment gains (net of related amortization of deferred policy acquisition costs) which were offset by lower operating earnings in the Acquisitions and the Corporate and Other segment.
Recently Issued Accounting Standards The Financial Accounting Standards Board (“FASB”) has issued Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. Effective January 1, 2001, SFAS No. 133, as amended, will require Protective Life to record derivative financial instruments, including certain derivative instruments embedded in
18other contracts, on its balance sheet and to carry such derivatives at fair value. Derivatives that are not designated to be part of a qualifying hedging relationship must be adjusted to fair value each period through net income. If the derivative is a hedge, its change in fair value is either offset against the change in fair value of the hedged item through net income or recorded in share- owner’s equity until the hedged item is recognized in net income. The fair value of derivatives increase or decrease as interest rates and general economic conditions change. Although the adoption of SFAS No. 133 will not affect Protective Life’s operations, adoption will introduce volatility into Protective Life’s reported net income and share-owner’s equity.
The FASB and the Derivatives Implementation Group (“DIG”), a task force specifically created to assist the FASB in addressing SFAS No. 133 implementation issues, are continuing to issue guidance with respect to SFAS No. 133. Protective Life is in the process of completing its assessment of the application of SFAS No. 133. This assessment includes a review of Protective Life’s insurance and investment product contracts and financial instruments with respect to SFAS No. 133’s definitions of derivative and embedded derivative instruments, as further clarified by the FASB and DIG. The assessment also includes an evaluation of existing hedging relationships to determine if such relationships meet the specific hedging criteria of SFAS No. 133.
Traditional life insurance, property and casualty insurance, and variable annuity products are excluded from the definition of a derivative instrument. However, non-traditional forms of such products may include embedded derivative instruments, as defined in SFAS No. 133, that must be accounted for separately in financial statements at fair value. With the possible exception of variable life insurance as discussed below, Protective Life has determined that its insurance and investment products do not contain such terms that meet the definition of an embedded derivative instrument.
The FASB and the DIG are in the process of evaluating variable life insurance products with respect to the embedded derivative provisions of SFAS No. 133. Protective Life expects that its variable life insurance products will ultimately be excluded from the provisions of SFAS No. 133. However, Protective Life will not be able to complete its assessment until the issue is resolved by the FASB in the fourth quarter.
Within its investment portfolio, Protective Life owns various forms of remarketable put bond securities, with an aggregate par value of approximately $140 million. Each security includes a call option at par ultimately held by a third party unrelated to the debt issuer. Depending on the legal structure of the security and call option, the call option may represent an attached freestanding derivative subject to separate accounting under SFAS No. 133. Protective Life is currently reviewing each security’s specific structure as well as its ability to designate the attached call option as a qualifying hedge of the embedded put option held by Protective Life.
Protective Life also owns convertible bond securities, which include embedded equity options that must be separately accounted for under SFAS No. 133. Concurrent with the purchase of each security, Protective Life entered into a derivative contract (“asset swap”) with an investment banker that provides the banker with a call option on the security in exchange for a favorable interest rate swap. The asset swaps effectively offset much of the change in fair value of the equity options but do not meet the specific hedging criteria of SFAS No. 133. As of September 30, 2000, the asset swaps’ aggregate fair value was a loss of $21.7 million. The aggregate market and carrying values of the convertible bonds were $116.3 million and $95.9
19million, respectively, representing an unrealized gain of $20.4 million. Protective Life is in the process of valuing the embedded equity options in the bond securities for purposes of determining the necessary transition adjustment on January 1, 2001.
Under existing GAAP, Protective Life is currently accounting for certain derivative instruments as a hedge of the interest rate risk associated with specific mortgage loan commitments and fixed-rate guaranteed investment contracts. The Company has determined that the specific hedge criteria of SFAS No. 133 will not be met for certain of these derivative contracts. The net unrealized loss related to non-qualifying contracts was less than $0.5 million at September 30, 2000. The qualifying contracts will be accounted for as fair value hedges under SFAS No. 133 and, as a result, the earnings impact of the derivative instruments is expected to be offset by the adjustment of the hedged items’ change in fair value attributable to interest rate risk.
Protective Life has issued foreign-currency-denominated funding agreements that provide for a variable interest rate. Concurrent with their issuance, Protective Life entered into foreign currency swaps with dual floating legs as a compound hedge of the foreign exchange risk and the interest rate risk associated with the foreign currencies. Under SFAS No. 133, the relationship is expected to qualify as a foreign currency, fair value hedge.
Protective Life is not able to estimate the effect of adoption of SFAS No. 133 on its financial statements until it completes its assessment as noted above. In addition, the FASB and DIG continue to address implementation issues, including insurance-related issues, for which the ultimate resolution may effect Protective Life’s assessment. Furthermore, the actual transition adjustment to be recorded at January 1, 2001 will depend on the nature, purpose and fair value of the derivatives held by Protective Life on that date.
In September 2000 the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinquishments of Liabilities, a replacement of SFAS No. 125". SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. The statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal year ended after December 15, 2000. This Statement is effective for transfers and servicing of financial assets and extinquishments of liabilities occurring after March 31, 2001.
20PART IIItem 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule
Exhibit 99 - Safe Harbor for Forward-Looking Statements
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| Date: | November 14, 2000 | /s/ Jerry W. Defoor |
| | Jerry W. DeFoor |
| | Vice President and Controller |
| | and Chief Accounting Officer |
| | (Duly authrorized officer) |
