Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report includes “forward-looking statements” which express expectations of future events and/or results. The words “believe,” “expect,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “plan,” 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 the Company cannot give assurance that such statements will prove to be correct. Please refer to “Known Trends and Uncertainties” and “Other Developments” herein for more information about factors which could affect future results.
CRITICAL ACCOUNTING POLICIES
In the conduct of business, the Company makes certain assumptions regarding the mortality, persistency, expenses and interest rates, (or other factors appropriate to the type of business) it expects to experience in future periods. Similar assumptions are also used to estimate the amounts of deferred policy acquisition costs, policy liabilities and accruals, and various other items. The Company’s actual experience, as well as changes in estimates, are components of the Company’s statements of income.
RESULTS OF CONTINUING OPERATIONS
The Company operates several business segments each having a strategic focus which can be grouped into three general product categories: life insurance, retirement savings and investment products, and specialty insurance products. The Company’s operating segments are Life Marketing, Acquisitions, Stable Value Contracts, Annuities, and Credit Products. The Company also has an additional business segment referred to as Corporate and Other.
PREMIUMS AND POLICY FEES
The following table sets forth for the periods shown the amount of premiums and policy fees, net of reinsurance (premiums and policy fees), and the percentage change from the prior period:
YEAR ENDED AMOUNT PERCENTAGE
DECEMBER 31 (IN THOUSANDS) INCREASE (DECREASE)
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1999 $ 398,730 (3.3)%
2000 489,790 22.8
2001 618,669 26.3
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In 2000, premiums and policy fees increased $91.1 million or 22.8% over 1999. The Life Marketing segment's premiums and policy fees decreased $15.9 million due to a higher amount of reinsurance ceded. Premiums and policy fees in the Acquisitions segment are expected to decline with time (due to the lapsing of policies resulting from deaths of insureds or terminations of coverage) unless new acquisitions are made. No acquisitions were completed in this segment in 1999 or 2000, resulting in a decrease of $11.9 million in premiums and policy fees in 2000. The increase in premiums and policy fees from the Annuities segment was $5.9 million. In January 2000, the Credit Products segment acquired the Lyndon Insurance Group (Lyndon), which resulted in a $97.1 million increase in premiums and policy fees. Premiums and policy fees related to the segment's other businesses increased $15.4 million. Premiums and policy fees relating to various health insurance lines in the Corporate and Other segment increased $0.5 million.
In 2001, premiums and policy fees increased $128.9 million or 26.3% over 2000. Premiums and policy fees in the Life Marketing segment increased $21.2 million due to increased sales. In January 2001, the Acquisitions segment coinsured a block of individual life insurance policies from Standard Insurance Company, and in October 2001, acquired Inter-State Assurance Company and First Variable Life Insurance Company from Ilona Financial Group, Inc. a subsidiary of Irish Life & Permanent plc. These transactions resulted in a $86.8 million increase in premium and policy fees. Premiums and policy fees from older acquired blocks declined $7.2 million in 2001. The decrease in premiums and policy fees from the Annuities segment was $2.0 million. Premiums and policy fees from the Credit Products segment increased $29.6 million. Premiums and policy fees relating to various health insurance lines in the Corporate and Other segment increased $0.6 million.
NET INVESTMENT INCOME
The following table sets forth for the periods shown the amount of net investment income, the percentage change from the prior period, and the percentage earned on average cash and investments:
PERCENTAGE
EARNED
ON AVERAGE
YEAR ENDED AMOUNT PERCENTAGE CASH AND
DECEMBER 31 (IN THOUSANDS) INCREASE INVESTMENTS
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1999 $667,968 6.2% 7.6%
2000 730,149 9.3 7.6
2001 884,041 21.1 7.3
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Net investment income in 2000 increased $62.2 million or 9.3% over 1999, and in 2001 increased $153.9 million or 21.1% over 2000, primarily due to increases in the average amount of invested assets. Invested assets have increased primarily due to acquisitions, receiving stable value and annuity deposits, and the asset growth that results from the sale of various insurance products. The January 2000 Lyndon acquisition increased net investment income $21.8 million. The January 2001 coinsurance arrangement and the October 2001 acquisitions resulted in an increase in investment income of $66.4 million.
The percentage earned on average cash and investments was 7.6% in 2000 and 7.3% in 2001.
REALIZED INVESTMENT GAINS (LOSSES)
The Company generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs.
The following table sets forth realized investment gains (losses) relating to derivative financial instruments and all other investments for the periods shown:
DERIVATIVE
FINANCIAL ALL OTHER
YEAR ENDED INSTRUMENTS INVESTMENTS
DECEMBER 31 (IN THOUSANDS) (IN THOUSANDS)
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1999 $ (2,279) $ 1,222
2000 9,013 (16,056)
2001 (11,431) (8,740)
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Realized investment gains and losses related to derivative financial instruments primarily represent changes in the fair values of certain derivative financial instruments.
The sales of investments that have occurred generally result from portfolio management decisions to maintain proper matching of assets and liabilities. Realized investment losses related to all other investments in 2000 of $31.2 million were largely offset by realized investment gains of $15.1 million. Realized investment losses in 2001 of $85.6 million were largely offset by realized investment gains of $76.9 million. During 2001, the Company recorded other than temporary impairments in its investments of $12.6 million.
OTHER INCOME
The following table sets forth other income for the periods shown:
YEAR ENDED AMOUNT
DECEMBER 31 (IN THOUSANDS)
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1999 $ 89,680
2000 151,833
2001 131,678
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Other income consists primarily of revenues of the Company’s broker-dealer subsidiary, direct response businesses, service contract businesses, investment advisory fees from variable insurance products, and revenues of the Company’s noninsurance subsidiaries.
In 2000, revenues from the Company’s broker-dealer subsidiary, direct response businesses, and service contract businesses increased $14.9 million, $8.7 million, and $15.7 million, respectively. In March 2000, the Company completed the sale of its Hong Kong affiliate, resulting in $24.8 million of other income. Other income from all other sources decreased $1.9 million. In 2001, revenues from the Company’s direct response businesses and service contract businesses increased $10.2 million and $3.3 million, respectively. Revenue from the Company’s broker-dealer subsidiary decreased $9.1 million in 2001 due to the general downturn in the equity markets. Other income from all other sources increased $0.2 million.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(continued)
Income Before Income Tax
The table below sets forth operating income or loss and income or loss before income tax by business segment for the periods shown:
YEAR ENDED DECEMBER 31
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Amount (in thousands) 1999 2000 2001
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Operating Income(1)
LIFE INSURANCE
Life Marketing $ 58,188 $ 76,597 $ 89,574
Acquisitions 63,671 52,762 68,040
RETIREMENT SAVINGS AND INVESTMENT PRODUCTS
Stable Value Contracts 29,465 31,208 33,150
Annuities 12,491 15,171 16,934
SPECIALTY INSURANCE PRODUCTS
Credit Products 21,932 32,191 33,960
Corporate and Other 20,145 11,199 (10,895)
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Total operating income 205,892 219,128 230,763
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Realized investment gains (losses)
Stable Value Contracts (549) (6,556) 7,218
Annuities 1,446 410 1,139
Unallocated (1,954) (897) (28,528)
Related amortization of deferred policy acquisition costs
Annuities (1,446) (410) (996)
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Total realized investment gains (losses), net (2,503) (7,453) (21,167)
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Income Before Income Tax
LIFE INSURANCE
Life Marketing 58,188 76,597 89,574
Acquisitions 63,671 52,762 68,040
RETIREMENT SAVINGS AND INVESTMENT PRODUCTS
Stable Value Contracts 28,916 24,652 40,368
Annuities 12,491 15,171 17,077
Specialty Insurance Products
Credit Products 21,932 32,191 33,960
Corporate and Other 20,145 11,199 (10,895)
Unallocated realized investment gains (losses) (1,954) (897) (28,528)
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Total income from continuing operations before income tax $203,389 $211,675 $209,596
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(1) Income (loss) from continuing operations before income tax excluding realized investment gains and losses and related amortization of deferred policy acquisition costs.
The Life Marketing segment’s 2000 pretax operating income was $76.6 million, $18.4 million above 1999. The segment’s 2001 pretax operating income was $89.6 million, $13.0 million above 2000. The segment has grown through sales. The segment’s results include expenses to develop new distribution channels.
In the ordinary course of business, the Acquisitions segment regularly considers acquisitions of blocks of policies or smaller insurance companies. Policies acquired through the segment are usually administered as “closed” blocks; i.e., no new policies are being marketed. Therefore, earnings from the Acquisitions segment 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 segment did not make an acquisition in 1999 or 2000.
In 2000, the Acquisition segment’s pretax operating income was $52.8 million, $10.9 million below 1999. In 2000, the segment had approximately $13 million less investment income as compared to 1999. Also, the segment’s mortality was approximately $5.8 million better than expected in 2000 as compared to being approximately $8.9 million better than expected in 1999. Additionally, in the fourth quarter of 1999, adjustments were made to the segment’s investment portfolio which had the effect of transferring approximately $10 million of investment income to the Corporate and Other segment during 2000. In 2001, the segment’s pretax operating income was $68.0 million, $15.3 million above 2000. The 2001 coinsurance of a block of life insurance policies and the October 2001 acquisition of two small life insurance companies resulted in a $15.9 million increase in earnings. Earnings on older acquired blocks of policies declined $0.6 million.
The Stable Value Contracts segment had 2000 pretax operating income of $31.2 million, $1.7 million above 1999. The increase was due to higher account balances which was partially offset by lower interest rate spreads. Operating spreads in 2000 were compressed due to higher interest rates and an inverted yield curve. The Stable Value Contracts segment’s 2001 pretax operating income was $33.2 million, $2.0 million above 2000. This increase is due primarily to higher account balances. Operating spreads in 2001 were lower than last year due to lower investment income. Realized investment losses associated with this segment in 2000 were $6.5 million as compared to gains of $7.2 million in 2001. As a result, total pretax income was $24.7 million in 2000 and $40.4 million in 2001. The Annuities segment’s 2000 pretax operating income increased $2.7 million to $15.2 million. The increase reflects the segment’s growth through sales. The Annuities segment’s 2001 pretax operating income was $16.9 million, $1.7 million above 2000. The 2001 results include a tax benefit of approximately $3.0 million related to the segment’s variable annuities which was partially offset by an increase in reserves related to minimum death benefit guarantees. The segment’s future results may also be negatively affected by the slowing economy. Volatile equity markets could negatively affect sales of variable annuities and the fees the segment assesses on variable annuity contracts. Lower interest rates could negatively affect sales of fixed annuities. The segment had no realized investment gains or losses (net of related amortization of deferred policy acquisition costs) in 2000 and a $0.1 million gain in 2001. As a result, total pretax income was $15.2 million in 2000, and $17.1 million in 2001.
The Credit Products segment’s 2000 pretax operating income increased $10.3 million to $32.2 million. Included in the segment’s 2000 results were $16.9 million from the January 2000 Lyndon acquisition. Earnings of the segment’s other businesses were lower than expected due to higher than expected claims. The segment’s 2001 pretax operating income was $34.0 million, $1.8 million above 2000. Incurred credit insurance claims were higher, but were offset by a change in estimate with respect to reserves. The segment’s 2001 results include income of approximately $2.0 million from the sale of a small insurance subsidiary’s charter. The segment’s future results may be negatively affected by the slowing economy. Lower consumer lending and fewer automobile purchases could negatively affect the segment’s sales. Also, the level of claims typically increases in a slowing economy.
The Corporate and Other segment consists primarily of net investment income on unallocated capital, interest expense on substantially all debt, several lines of business which the Company is not actively marketing (mostly health insurance), earnings from various investment-related transactions, and the operations of several small subsidiaries. The segment’s 2000 pretax operating income was $11.2 million. The segment’s 2000 results include $24.8 million of income from the sale of the Company’s Hong Kong affiliate. Earnings from health insurance lines decreased $7.0 million. The segment also had $18.6 million less net investment income as compared to 1999. In 2000, higher short-term interest rates and an inverted yield curve reduced investment income and increased interest expense. In 2001, the segment had pretax operating losses of $10.9 million. Excluding the sale of the Company’s Hong Kong affiliate in 2000, the Corporate and Other business segment had a 2001 pretax operating loss of $10.9 million compared to a loss of $13.6 million in 2000, primarily relating to interest expense and corporate expenses.
INCOME TAX EXPENSE
The following table sets forth the effective income tax rates relating to continuing operations for the periods shown:
YEAR ENDED EFFECTIVE INCOME
DECEMBER 31 TAX RATES
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1999 35.4%
2000 35.1
2001 32.7
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Management’s current estimate of the effective income tax rate for 2002 is approximately 33.2%.
DISCONTINUED OPERATIONS
On December 31, 2001, the Company completed the sale to Fortis, Inc. of substantially all of its Dental Benefits Division (Dental Division) and discontinued certain other remaining Dental Division related operations, primarily other health insurance lines. In 2000, income from discontinued operations, net of income tax, was $16.1 million. In 2001, the loss from discontinued operations was $10.0 million (primarily due to the non-performance of reinsurers) and the loss from sale of discontinued operations was $20.5 million, both net of income tax.
EXTRAORDINARY LOSS
On June 30, 1999, the Company caused PLC Capital L.L.C. (PLC Capital), a special purpose finance subsidiary, to redeem its $55 million of 9% Cumulative Monthly Income Preferred Securities, Series A (MIPS). In a related transaction, the Company redeemed its $69.6 million of Subordinated Debentures which were held by PLC Capital. The redemption resulted in an extraordinary loss of $1.8 million or $0.03 per share on both a basic and diluted basis. The extraordinary loss was comprised primarily of unamortized deferred debt issue costs and losses related to the termination of related interest rate swap agreements, net of an income tax benefit of $0.9 million.
CHANGE IN ACCOUNTING PRINCIPLE
On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." The adoption of SFAS No. 133 resulted in a cumulative after-tax charge to net income, net of income tax, of approximately $7.6 million or $0.11 per share on both a basic and diluted basis.
NET INCOME
The following table sets forth net income from continuing operations before extraordinary loss and cumulative effect of change in accounting principle and related per share information for the periods shown:
PERCENTAGE
YEAR ENDED AMOUNT PER SHARE INCREASE/
DECEMBER 31 (IN THOUSANDS) DILUTED (DECREASE)
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1999 $ 131,448 $1.99 7.6%
2000 137,354 2.08 4.5
2001 141,058 2.01 (3.4)
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Net income from continuing operations before extraordinary loss and cumulative effect of change in accounting principle per share diluted in 2000 increased 4.5% over 1999, reflecting improved operating earnings in the Life Marketing, Stable Value Contracts, Annuities and Credit Products segments, which were partially offset by lower operating earnings in the Acquisitions and Corporate and Other segments, and higher realized investment losses. Income from continuing operations in 2000 includes income of $.24 per share relating to the sale of the Company's Hong Kong affiliate. Excluding the effects of the sale of the Hong Kong affiliate, net income from continuing operations before extraordinary loss and cumulative effect of change in accounting principle per share diluted in 2000 was $1.84. Net income from continuing operations before extraordinary loss and cumulative effect of change in accounting principle per share diluted in 2001 of $2.01 reflects improved operating earnings in all segments partially offset by higher realized investments losses.
KNOWN TRENDS AND UNCERTAINTIES
The operating results of companies in the insurance industry have historically been subject to significant fluctuations. The factors which could affect the Company's future results include, but are not limited to, general economic conditions and the known trends and uncertainties which are discussed more fully below. Please also refer to "Other Developments" herein.
o We are exposed to many types of risks that could negatively affect our business. There are many types of risks that all companies are exposed to in their businesses. For example, companies are exposed to the risks of natural disasters, malicious and terrorist acts, computer viruses, and other perils. While the Company has obtained insurance, implemented risk management and contingency plans, and taken preventive measures and other precautions, no assurance can be given that there are not scenarios that could have an adverse effect on the Company. Additionally, there are scenarios that could have an adverse effect on general economic conditions and mortality and morbidity.
o We operate in a mature, highly competitive industry, which could limit our ability to gain or maintain our position in the industry. Life and health insurance is a mature industry. In recent years, the industry has experienced little growth in life insurance sales, though the aging population has increased the demand for retirement savings products. Life and health insurance is a highly competitive industry. The Company encounters significant competition in all lines of business from other insurance companies, many of which have greater financial resources than the Company, as well as competition from other providers of financial services. Competition could result in, among other things, lower sales or higher lapses of existing products.
The insurance industry is consolidating, with larger, potentially more efficient organizations emerging from consolidation. Also, some mutual insurance companies are converting to stock ownership, which will give them greater access to capital markets. Additionally, commercial banks, insurance companies, and investment banks may now combine, provided certain requirements are satisfied.
The Company's ability to compete is dependent upon, among other things, its ability to attract and retain distribution channels to market its insurance and investment products, its ability to develop competitive and profitable products, its ability to maintain low unit costs, and its maintenance of strong ratings from rating agencies. However, irrational competition from other insurers could adversely affect the Company's competitive position.
o A ratings downgrade could adversely affect our ability to compete. Ratings are an important factor in the Company’s competitive position. Rating organizations periodically review the financial performance and condition of insurers, including the Company’s subsidiaries. A downgrade in the ratings of the Company’s subsidiaries could adversely affect the Company’s ability to sell its products, retain existing business, and compete for attractive acquisition opportunities.
For the past several years, rating downgrades in the industry have exceeded upgrades. Rating organizations assign ratings based upon several factors. While most of the factors relate to the rated company, some of the factors relate to the views of the rating organization, general economic conditions, and circumstances outside the rated company's control. The Company cannot predict what actions the rating organizations may take, or what actions the Company may be required to take in response to the actions of the rating organizations, which could adversely affect the Company.
o Our policy claims fluctuate from year to year. The Company’s results may fluctuate from year to year due to fluctuations in policy claims received by the Company. Certain of the Company’s businesses may experience higher claims if the economy is growing slowly or in recession.
Mortality and morbidity expectations incorporate assumptions about many factors, including for example, how a product is distributed, persistency and lapses, and future progress in the fields of health and medicine. Actual mortality and morbidity could differ from our expectations if actual results differ from those assumptions.
o We could be forced to sell investments at a loss to cover policyholder withdrawals. Many of the products offered by the Company’s insurance subsidiaries allow policyholders and contract holders to withdraw their funds under defined circumstances. The subsidiaries manage their liabilities and configure their investment portfolios so as to provide and maintain sufficient liquidity to support anticipated withdrawal demands and contract benefits and maturities. While the Company’s life insurance subsidiaries own a significant amount of liquid assets, a certain portion of their assets are relatively illiquid. Unanticipated withdrawal or surrender activity could, under some circumstances, compel the Company’s insurance subsidiaries to dispose of assets on unfavorable terms, which could have an adverse effect on the Company.
o Interest-rate fluctuations could negatively affect our spread income or otherwise impact our business. Significant changes in interest rates expose insurance companies to the risk of not earning anticipated spreads between the interest rate earned on investments and the credited interest rates paid on outstanding policies and contracts. Both rising and declining interest rates can negatively affect the Company’s spread income. While the Company develops and maintains asset/liability management programs and procedures designed to preserve spread income in rising or falling interest rate environments, no assurance can be given that changes in interest rates will not affect such spreads.
Changes in interest rates may also impact our business in other ways. Lower interest rates may result in lower sales of certain of the Company's insurance and investment products. In addition, certain of the Company's insurance and investment products guarantee a minimum credited interest rate.
Higher interest rates may create a less favorable environment for the origination of mortgage loans and decrease the investment income we receive in the form of prepayment fees, make-whole payments, and mortgage participation income. Higher interest rates may also increase the cost of debt and other obligations having floating rate or rate reset provisions, and may result in lower sales of variable products. Also, the amount of policy fees received from variable products is affected by the performance of the equity markets.
Additionally, the Company's asset/liability management programs and procedures incorporate assumptions about the relationship between short-term and long-term interest rates (i.e., the slope of the yield curve), relationships between risk-adjusted and risk-free interest rates, market liquidity, and other factors. The effectiveness of the Company's asset/liability management programs and procedures may be negatively affected whenever actual results differ from these assumptions.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(continued)
o Insurance companies are highly regulated. The Company’s insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with many aspects of the insurance business, which may include premium rates, marketing practices, advertising, policy forms, and capital adequacy, and is concerned primarily with the protection of policyholders rather than share owners. From time to time, regulators may raise issues during examinations or audits of the Company’s subsidiaries. Even though such issues are unlikely to result in any material impact on the Company, the Company cannot predict what regulatory actions may be taken or what initiatives may be enacted which could adversely affect the Company.
The Company's insurance subsidiaries may be subject to regulation by the United States Department of Labor when providing a variety of products and services to employee benefit plans governed by the Employment Retirement Income Security Act (ERISA). Severe penalties are imposed for breach of duties under ERISA.
Certain policies, contracts, and annuities offered by the Company's insurance subsidiaries are subject to regulation under the federal securities laws administered by the Securities and Exchange Commission. The federal securities laws contain regulatory restrictions and criminal, administrative, and private remedial provisions.
o Tax law changes could adversely affect our ability to compete with non-insurance products or reduce the demand for certain insurance products. Under the Internal Revenue Code of 1986, as amended, income tax payable by policyholders on investment earnings is deferred during the accumulation period of certain life insurance and annuity products. This favorable tax treatment may give certain of the Company’s products a competitive advantage over other non-insurance products. To the extent that the Internal Revenue Code is revised to reduce the tax-deferred status of life insurance and annuity products, or to increase the tax-deferred status of competing products, all life insurance companies, including the Company’s subsidiaries, would be adversely affected with respect to their ability to sell such products, and, depending upon grandfathering provisions, the surrenders of existing annuity contracts and life insurance policies. In addition, life insurance products are often used to fund estate tax obligations. Legislation has recently been enacted that would over time, reduce and eventually eliminate the estate tax. If the estate tax is significantly reduced or eliminated, the demand for certain life insurance products could be adversely affected. The Company cannot predict what tax initiatives may be enacted which could adversely affect the Company.
o Financial services companies are frequently the targets of litigation, including class action litigation, which could result in substantial judgments. A number of civil jury verdicts have been returned against insurers and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives, relationships with agents or other persons with whom the insurer does business and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges, and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages, which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very little appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. The Company, like other financial services companies, in the ordinary course of business, is involved in such litigation or, alternatively, in arbitration. The Company cannot predict the outcome of any such litigation or arbitration.
o A decrease in sales or persistency could negatively affect our results. The Company’s ability to maintain low unit costs is dependent upon the level of sales and persistency. A decrease in sales or persistency without a corresponding reduction in expenses may result in higher unit costs.
Additionally, a decrease in persistency may result in higher amortization of deferred policy acquisition costs. Although many of the Company's products contain surrender charges, the charges decrease over time and may not be sufficient to cover the unamortized deferred policy acquisition costs with respect to the insurance policy or annuity contract being surrendered. A decrease in persistency may also result in higher claims.
o Our investments are subject to risks. The Company’s invested assets and derivative financial instruments are subject to customary risks of credit defaults and changes in market values. The value of the Company’s commercial mortgage loan portfolio depends in part on the financial condition of the tenants occupying the properties which the Company has financed. Factors that may affect the overall default rate on, and market value of, the Company’s invested assets, derivative financial instruments, and mortgage loans include interest rate levels, financial market performance, and general economic conditions as well as particular circumstances affecting the businesses of individual borrowers and tenants.
o Our growth from acquisitions involves risks.The Company’s acquisitions have increased its earnings in part by allowing the Company to enter new markets and to position itself to realize certain operating efficiencies. There can be no assurance, however, that the Company will realize the anticipated financial results from its acquisitions, or that suitable acquisitions, presenting opportunities for continued growth and operating efficiencies, or capital to fund acquisitions will continue to be available to the Company.
o We are dependent on the performance of others.The Company’s results may be affected by the performance of others because the Company has entered into various arrangements involving other parties. Examples include, but are not limited to, the following: many of the Company’s products are sold through independent distribution channels; and variable annuity deposits are invested in funds managed by third parties. The Company may also use third-party administrators to collect premiums, pay claims, and/or perform customer service functions. Additionally, the Company’s operations are dependent on various technologies some of which are provided and/or maintained by other parties.
As with all financial services companies, our ability to conduct business is dependent upon consumer confidence in the industry and its products. Actions of competitors, and financial difficulties of other companies in the industry, could undermine consumer confidence and adversely affect the Company.
o Our reinsurance program involves risks. The Company’s insurance subsidiaries cede insurance to other insurance companies through reinsurance. However, the Company remains liable with respect to ceded insurance should any reinsurer fail to meet the obligations assumed by it.
The cost of reinsurance is, in some cases, reflected in the premium rates charged by the Company. Under certain reinsurance agreements, the reinsurer may increase the rate it charges the Company for the reinsurance, though the Company does not anticipate increases to occur. Therefore, if the cost of reinsurance were to increase or if reinsurance were to become unavailable, the Company could be adversely affected.
Additionally, the Company assumes policies of other insurers. Any regulatory or other adverse development affecting the ceding insurer could also have an adverse effect on the Company.
RECENTLY ISSUED ACCOUNTING STANDARDS
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125". SFAS No. 140 revises the standards of accounting for securitizations and other transfers of financial assets. This statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The adoption of this accounting standard did not have a material effect on the Company's financial position or results of operations.
In June 2001, the FASB issued SFAS Nos. 141, "Business Combinations" and 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that business combinations initiated after June 30, 2001, be accounted for using the purchase method. SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and effective for any goodwill or intangible asset acquired after June 30, 2001. The Company expects the adoption of SFAS No. 142 to result in the elimination of up to $3.5 million of goodwill amortization in 2002.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to have a material effect on the Company's financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 requires that the same accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, expands the use of discontinued operations accounting to include more types of transactions and changes the timing of when discontinued operation accounting is applied. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of SFAS No. 144 to have a material effect on the Company's financial position or results of operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(continued)
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations usually produce a positive cash flow. This cash flow is used to fund an investment portfolio to finance future benefit payments. Since future benefit payments largely represent medium- and long-term obligations reserved using certain assumed interest rates, the Company's investments are predominantly in medium- and long-term, fixed-rate investments such as bonds and mortgage loans.
INVESTMENTS
The Company generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs. However, the Company may sell any of its investments to maintain proper matching of assets and liabilities. Accordingly, the Company has classified its fixed maturities and certain other securities as "available for sale."
The Company's investments in debt and equity securities are reported at market value, and investments in mortgage loans are reported at amortized cost. At December 31, 2001, the Company's fixed maturity investments (bonds and redeemable preferred stocks) had a market value of $9,838.1 million, which is 1.0% above amortized cost of $9,745.1 million. The Company had $2,512.8 million in mortgage loans at December 31, 2001. While the Company's mortgage loans do not have quoted market values, at December 31, 2001, the Company estimates the market value of its mortgage loans to be $2,671.1 million (using discounted cash flows from the next call date), which is 6.3% above amortized cost. Most of the Company's mortgage loans have significant prepayment penalties. These assets are invested for terms approximately corresponding to anticipated future benefit payments. Thus, market fluctuations are not expected to adversely affect liquidity.
At December 31, 2000, the Company's fixed maturity investments had a market value of $7,415.8 million, which was 1.0% below amortized cost of $7,489.4 million. The Company estimated the market value of its mortgage loans to be $2,385.2 million at December 31, 2000, which was 5.2% above amortized cost of $2,268.2 million.
The following table sets forth the estimated market values of the Company's fixed maturity investments and mortgage loans resulting from a hypothetical immediate 1 percentage point increase in interest rates from levels prevailing at December 31, and the percent change in market value the following estimated market values would represent.
AMOUNT PERCENT
AT DECEMBER 31 (IN MILLIONS) CHANGE
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2000
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Fixed maturities $7,156.3 (3.5)%
Mortgage loans 2,277.9 (4.5)
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2001
--------------------------------------------------------------
Fixed maturities $9,395.4 (4.5)%
Mortgage loans 2,550.9 (4.5)
==============================================================
Estimated market values were derived from the durations of the Company’s fixed maturities and mortgage loans. Duration measures the relationship between changes in market value to changes in interest rates. While these estimated market values generally provide an indication of how sensitive the market values of the Company’s fixed maturities and mortgage loans are to changes in interest rates, they do not represent management’s view of future market changes, and actual market results may differ from these estimates.
For several years the Company has offered a type of commercial mortgage loan under which the Company will permit a slightly higher loan-to-value ratio in exchange for a participating interest in the cash flows from the underlying real estate. As of December 31, 2001, approximately $548.4 million of the Company’s mortgage loans have this participation feature.
At December 31, 2001, delinquent mortgage loans and foreclosed properties were 0.2% of invested assets. Bonds rated less than investment grade were 3.4% of invested assets. The Company does not expect these investments to adversely affect its liquidity or ability to maintain proper matching of assets and liabilities.
Policy loans at December 31, 2001, were $521.8 million, an increase of $291.3 million from December 31, 2000. The January 2001 coinsurance arrangement and the October 2001 acquisitions resulted in an increase in policy loans of $238.6 million. Policy loan rates are generally in the 4.5% to 8.0% range. Such rates at least equal the assumed interest rates used for future policy benefits.
In the ordinary course of its commercial mortgage lending operations, the Company will commit to provide a mortgage loan before the property to be mortgaged has been built or acquired. The mortgage loan commitment is a contractual obligation to fund a mortgage loan when called upon by the borrower. The commitment is not recognized in the Company’s financial statements until the commitment is actually funded. The mortgage loan commitment contains terms, including the rate of interest which may be less than prevailing interest rates.
At December 31, 2001, the Company had outstanding mortgage loan commitments of $406.3 million with an estimated fair value of $429.3 million (using discounted cash flows from the first call date). At December 31, 2000, the Company had outstanding commitments of $308.4 million with an estimated fair value of $319.0 million. The following table sets forth the estimated fair value of the Company’s mortgage loan commitments resulting from a hypothetical immediate 1 percentage point increase in interest rate levels prevailing at December 31, and the percent change in fair value the following estimated fair values would represent.
AMOUNT PERCENT
AT DECEMBER 31 (IN MILLIONS) CHANGE
-----------------------------------------------------------
2000 $305.0 (4.4)%
2001 410.8 (4.3)
-----------------------------------------------------------
The estimated fair values were derived from the durations of the Company’s outstanding mortgage loan commitments. While these estimated fair values generally provide an indication of how sensitive the fair value of the Company’s outstanding commitments are to changes in interest rates, they do not represent management’s view of future market changes, and actual market results may differ from these estimates.
LIABILITIES
Many of the Company’s products contain surrender charges and other features that reward persistency and penalize the early withdrawal of funds. Certain stable value and annuity contracts have market-value adjustments that protect the Company against investment losses if interest rates are higher at the time of surrender than at the time of issue.
At December 31, 2001, the Company had policy liabilities and accruals of $8,859.0 million. The Company’s life insurance products have a weighted average minimum credited interest rate of approximately 4.5%.
At December 31, 2001, the Company had $3,716.5 million of stable value account balances with an estimated fair value of $3,822.0 million (using discounted cash flows), and $3,248.2 million of annuity account balances with an estimated fair value of $3,166.1 million (using surrender values).
At December 31, 2000, the Company had $3,177.9 million of stable value account balances with an estimated fair value of $3,251.0 million, and $1,916.9 million of annuity account balances with an estimated fair value of $1,893.7 million.
The following table sets forth the estimated fair values of the Company’s stable value and annuity account balances resulting from a hypothetical immediate 1 percentage point decrease in interest rates from levels prevailing at December 31, and the percent change in fair value the following estimated fair values would represent.
AMOUNT PERCENT
AT DECEMBER 31 (IN MILLIONS) CHANGE
- --------------------------------------------------------------
2000
- --------------------------------------------------------------
Stable value account balances $3,299.8 1.5%
Annuity account balances 1,975.1 4.3
==============================================================
2001
- --------------------------------------------------------------
Stable value account balances $3,887.0 1.7%
Annuity account balances 3,308.6 4.5
==============================================================
Estimated fair values were derived from the durations of the Company’s stable value and annuity account balances. While these estimated fair values generally provide an indication of how sensitive the fair values of the Company’s stable value and annuity account balances are to changes in interest rates, they do not represent management’s view of future market changes, and actual market results may differ from these estimates.
Approximately 20% of the Company’s liabilities relate to products (primarily whole life insurance), the profitability of which could be affected by changes in interest rates. The effect of such changes in any one year is not expected to be material.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes a risk management strategy that incorporates the use of derivative financial instruments, primarily to reduce its exposure to interest rate risk as well as currency exchange risk.
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 and mortgage-backed securities. Interest rate swap contracts generally involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date. Interest rate futures generally involve exchange traded contracts to buy or sell treasury bonds and notes in the future at specified prices. Interest rate options represent contracts that allow the holder of the option to receive cash or purchase, sell or enter into a financial instrument at a specified price within a specified period of time. The Company used interest rate swap contracts, swaptions (options to enter into interest rate swap contracts), caps, and floors to modify the interest characteristics of certain investments, its Senior Notes, Medium-Term Notes, and TOPrS. Swap contracts are also used to alter the effective durations of assets and liabilities. The Company uses currency swaps to reduce its exposure to currency exchange risk on certain stable value contracts denominated in foreign currencies, primarily the European euro and the British pound.
Derivative instruments expose the Company to credit and market risk. The Company minimizes its credit risk by entering into transactions with highly rated counterparties. The Company manages the market risk associated with interest rate and foreign exchange contracts by establishing and monitoring limits as to the types and degrees of risk that may be undertaken.
The Company monitors its use of derivatives in connection with its overall asset/liability management programs and procedures. The Company’s asset/liability committee is responsible for implementing various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the Company’s overall interest rate and currency exchange risk management strategies.
In September 2000, the Company entered into a transaction to facilitate the Company’s possible entry into the institutional money management business involving a total return swap with respect to $400 million of a portfolio of approximately $413 million of investments held by an unrelated special purpose vehicle that are managed by the Company. The Company, in effect, has retained the investment risk with respect to the $400 million. The swap is recorded on the Company’s balance sheet at fair value.
At December 31, 2001, contracts with a notional amount of $5,475.1 million were in a $21.9 million net loss position. At December 31, 2000, contracts with a notional amount of $3,134.2 million were in a $12.3 million net loss position. The Company recognized $11.4 million of realized investment losses and $9.0 million of realized investment gains related to derivative financial instruments in 2001 and 2000, respectively.
The following table sets forth the notional amount and fair value of the Company’s derivative financial instruments at December 31, and the estimated gains and losses resulting from a hypothetical immediate plus and minus 1 percentage point change in interest rates from levels prevailing at December 31.
GAIN (LOSS)
RESULTING FROM
AN IMMEDIATE +/-1
FAIR VALUE POINT CHANGE
NOTIONAL AT IN INTEREST RATES
(IN MILLIONS) AMOUNT DECEMBER 31 +1% -1%
- -------------------------------------------------------------------------------
2000
Options
Puts $ 50.0 $ 0.0 $ 0.2 $ 0.0
Futures 100.8 (2.8) 4.0 (9.0)
Fixed to floating
Swaps 1,249.3 (4.7) (42.1) 27.9
Swaptions 310.0 0.4 0.7 8.3
Caps 295.0 0.0 0.3 0.0
Floors 120.0 (0.3) 0.0 (0.8)
Floating to fixed
Swaps 160.0 (2.5) 4.5 (9.4)
Caps 300.0 0.0 0.6 0.0
Floors 300.0 (1.1) 0.0 (3.1)
- -------------------------------------------------------------------------------
$2,885.1 $(11.0) $(31.8) $13.9
- -------------------------------------------------------------------------------
2001
Options
Puts $ 775.0 $ 0.1 $ 1.3 $ 0.0
Calls 1,400.0 0.3 0.0 5.4
Futures 100.0 1.1 6.9 (6.4)
Fixed to floating
Swaps 1,654.3 0.6 (49.7) 15.1
Swaptions 35.0 0.0 0.0 0.0
Caps 175.0 0.0 0.0 0.0
Floating to fixed
Swaps 460.0 (12.8) (4.5) (20.4)
Caps 300.0 0.0 0.0 0.0
Floors 300.0 (1.9) (2.7) (1.1)
- -------------------------------------------------------------------------------
$5,199.3 $(12.6) $(48.7) $(7.4)
- -------------------------------------------------------------------------------
The Company is also subject to foreign exchange risk arising from stable value contracts denominated in foreign currencies and related foreign currency swaps. At December 31, 2001, stable value contracts of $275.8 million had a foreign exchange gain of approximately $7.2 million and the related foreign currency swaps had a net loss of approximately $9.3 million. At December 31, 2000, stable value contracts of $249.2 million had a foreign exchange loss of approximately $4.0 million and the related foreign currency swaps had a net unrealized loss of approximately $1.3 million.
The following table sets forth the notional amount and fair value of the funding agreements and related foreign currency swaps at December 31, and the estimated gains and losses resulting from a hypothetical 10% change in quoted foreign currency exchange rates from levels prevailing at December 31.
GAIN (LOSS)
RESULTING FROM
AN IMMEDIATE +/-10
FAIR VALUE POINT CHANGE
NOTIONAL AT IN INTEREST RATES
(IN MILLIONS) AMOUNT DECEMBER 31 +1% -1%
- ----------------------------------------------------------------------------
2000
Stable Value
Contracts $ 249.2 $ (4.0) $(29.3) $21.3
Foreign Currency
Swaps 249.2 (1.3) 23.7 (26.4)
- ----------------------------------------------------------------------------
$ 498.4 $ (5.3) $ (5.6) $(5.1)
- ----------------------------------------------------------------------------
2001
Stable Value
Contracts $ 275.8 $ 7.2 $(19.6) $ 34.1
Foreign Currency
Swaps 275.8 (9.3) 19.2 (37.8)
- ----------------------------------------------------------------------------
$ 551.6 $ (2.1) $ (0.4) $ (3.7)
- ----------------------------------------------------------------------------
Estimated gains and losses were derived using pricing models specific to derivative financial instruments. While these estimated gains and losses generally provide an indication of how sensitive the Company’s derivative financial instruments are to changes in interest rates and foreign currency exchange rates, they do not represent management’s view of future market changes, and actual market results may differ from these estimates.
The Company is exploring other uses of derivative financial instruments.
ASSET/LIABILITY MANAGEMENT
The Company’s asset/liability management programs and procedures involve the monitoring of asset and liability durations for various product lines; cash flow testing under various interest rate scenarios; and the continuous rebalancing of assets and liabilities with respect to yield, risk, and cash flow characteristics. It is the Company’s policy to generally maintain asset and liability durations within one-half year of one another, although, from time to time, a broader interval may be allowed.
The Company believes its asset/liability management programs and procedures and certain product features provide protection for the Company against the effects of changes in interest rates under various scenarios. Additionally, the Company believes its asset/liability management programs and procedures provide sufficient liquidity to enable it to fulfill its obligation to pay benefits under its various insurance and deposit contracts. However, the Company’s asset/liability management programs and procedures incorporate assumptions about the relationship between short-term and long-term interest rates (i.e., the slope of the yield curve), relationships between risk-adjusted and risk-free interest rates, market liquidity and other factors, and the effectiveness of the Company’s asset/liability management programs and procedures may be negatively affected whenever actual results differ from those assumptions. During 2000, market conditions and an inverted yield curve limited the Company’s ability to offset the effects of rising short-term interest rates. During 2001, the Company benefited from a steepening of the yield curve.
Cash outflows related to stable value contracts (primarily maturing contracts, scheduled interest payments, and expected withdrawals) were approximately $735 million during 2001. Cash outflows related to stable value contracts are estimated to be approximately $1,086 million in 2002. At December 31, 2001, the Company had $30.1 million, $62.6 million, and $12.5 million of stable value contracts which may be terminated by the contract holder upon seven, thirty, and ninety days notice, respectively. The Company’s asset/liability management programs and procedures take into account maturing contracts and expected withdrawals. Accordingly, the Company does not expect stable value contract related cash outflows to have an unusual effect on the future operations and liquidity of the Company.
The life insurance subsidiaries were committed at December 31, 2001, to fund mortgage loans in the amount of $406.3 million. The Company’s subsidiaries held $361.6 million in cash and short-term investments at December 31, 2001. Protective Life Corporation had an additional $2.1 million in cash and short-term investments available for general corporate purposes.
While the Company generally anticipates that the cash flow of its subsidiaries will be sufficient to meet their investment commitments and operating cash needs, the Company recognizes that investment commitments scheduled to be funded may, from time to time, exceed the funds then available. Therefore, the Company has arranged sources of credit for its insurance subsidiaries to use when needed. The Company expects that the rate received on its investments will equal or exceed its borrowing rate. Additionally, the Company may, from time to time, sell short-duration stable value products to complement its cash management practices.
The Company has also used securitization transactions involving its commercial mortgage loans to increase its liquidity. In 1999, the Company sold $263 million of loans, receiving cash of $220 million and securities of approximately $43 million.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(continued)
CAPITAL
At December 31, 2001, Protective Life Corporation had no borrowings outstanding under its $200 million revolving lines of credit.
Protective Life Corporation's cash flow is dependent on cash dividends and payments on surplus notes from its subsidiaries; revenues from investment, data processing, legal and management services rendered to subsidiaries; and investment income. At December 31, 2001, approximately $282.1 million of consolidated share-owners’ equity, excluding net unrealized investment gains and losses, represented net assets of the Company’s insurance subsidiaries that cannot be transferred to Protective Life Corporation. In addition, the states in which the Company’s insurance subsidiaries are domiciled impose certain restrictions on the insurance subsidiaries’ ability to pay dividends to Protective Life Corporation.
The Company plans to retain substantial portions of the earnings of its insurance subsidiaries in those companies primarily to support their future growth. Protective Life Corporation’s cash disbursements have, from time to time, exceeded its cash receipts, and these shortfalls have been funded through various external financings. Therefore, Protective Life Corporation may, from time to time, require additional external financing.
To give the Company flexibility in connection with future acquisitions and other growth opportunities, the Company has registered debt securities, preferred and common stock, and stock purchase contracts of Protective Life Corporation, and additional preferred securities of special purpose finance subsidiaries under the Securities Act of 1933 on a delayed (or shelf) basis.
In March 2000, the Company issued Senior Notes totaling $125 million with 10, 15, and 30 year maturities. Interest rates range from 8.00% to 8.25%. The proceeds were used to repay bank borrowings of which $55 million had been used to redeem the Monthly Income Preferred Securities in 1999.
In December 2000, the Company issued $60 million of 7.5% Senior Notes, with a 15 year maturity. The proceeds were used to repay bank borrowings and to partially fund the January 2001 coinsurance of a block of individual life insurance policies from Standard Insurance Company (Standard).
In February 2001, the Company issued 3.9 million shares of its Common Stock under stock purchase contracts relating to its 6.5% FELINE PRIDES. In the transaction, substantially all of the preferred securities comprising part of the FELINE PRIDES, and the underlying subordinated debt, were redeemed.
In February 2001, the Company issued $100 million of Floating Rate Senior Notes. The proceeds were used to invest in the Company’s insurance subsidiaries, which included completing the funding of the Standard transaction, and for general corporate purposes. The Floating Rate Notes are due February 28, 2003, and bear an interest rate of LIBOR plus .375%, adjusted quarterly.
On August 17, 2001, a special purpose finance subsidiary of the Company, PLC Capital Trust III, issued $100 million of 7.5% Trust Originated Preferred Securities ("TOPrS"). The 7.5% TOPrS are guaranteed on a subordinated basis by the Company. This guarantee, considered together with the other obligations of the Company with respect to the 7.5% TOPrS, constitutes a full and unconditional guarantee by the Company of PLC Capital Trust III’s obligations with respect to the 7.5% TOPrS.
PLC Capital Trust III was formed solely to issue securities and use the proceeds thereof to purchase subordinated debentures of the Company. The sole assets of PLC Capital Trust III are $103.1 million of Protective Life Corporation 7.5% Subordinated Debentures due 2031, Series D. The proceeds of the Company’s subordinated debentures were used to repay outstanding bank indebtedness and the balance was used for general corporate purposes. The Company has the right under the subordinated debentures to extend interest payment periods up to five consecutive years, and, as a consequence, dividends on the 7.5% TOPrS may be deferred (but will continue to accumulate, together with additional dividends on any accumulated but unpaid dividends at the dividend rate) by PLC Capital Trust III during any such extended interest payment period. The 7.5% TOPrS are redeemable by PLC Capital Trust III at any time on or after August 22, 2006.
A life insurance company’s statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners (NAIC), as modified by the insurance company’s state of domicile. Statutory accounting rules are different from accounting principles generally accepted in the United States of America and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The NAIC’s risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The achievement of long-term growth will require growth in the statutory capital of the Company’s insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as retained statutory earnings or equity contributions by the Company.
CONTRACTUAL OBLIGATIONS
The table below sets forth future maturities of long-term debt, guaranteed preferred beneficial interests in the Company’s subordinated debentures (guaranteed preferred beneficial interests), and stable value contracts.
(IN THOUSANDS) 2002 2003-2004 2005-2006 AFTER 2006
-------------------------------------------------------------------
Long-term
debt $ 175,000 $194,241
Guaranteed
preferred
beneficial
interests 175,000
Stable value
contracts $971,536 1,696,120 $979,460 69,414
Securities
sold under
repurchase
agreements 117,000
--------------------------------------------------------------------
OTHER DEVELOPMENTS
Under insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies. The Company does not believe that any such assessments will be materially different from amounts already reflected in the financial statements.
The Company 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 the Company.
The Company is not aware of any pending or threatened regulatory action with respect to the Company or any of its subsidiaries that is reasonably likely to have a material effect on the Company.
The Company believes that the tragic events of September 11, 2001, will have little direct effect on the Company’s operations or financial strength. However, many of the Company’s businesses and the performance of the Company’s investment portfolio are affected by general economic conditions, therefore a downturn in the general economy could have a negative effect on the Company’s operations and financial strength.
In recent years, most financial services companies, including the Company, experienced a decrease in the market price of their common stock. Although the Company believes it has sufficient capital to fund its immediate growth and capital needs, a lower stock price may limit the Company’s ability to raise capital to fund other growth opportunities and acquisitions.
IMPACT OF INFLATION
Inflation increases the need for life insurance. Many policyholders who once had adequate insurance programs may increase their life insurance coverage to provide the same relative financial benefit and protection. Higher interest rates may result in higher sales of certain of the Company’s investment products.
The higher interest rates that have traditionally accompanied inflation could also affect the Company’s operations. Policy loans increase as policy loan interest rates become relatively more attractive. As interest rates increase, disintermediation of stable value and annuity account balances and individual life policy cash values may increase. The market value of the Company’s fixed-rate, long-term investments may decrease, the Company may be unable to implement fully the interest rate reset and call provisions of its mortgage loans, and the Company’s ability to make attractive mortgage loans, including participating mortgage loans, may decrease. In addition, participating mortgage loan income may decrease. The difference between the interest rate earned on investments and the interest rate credited to life insurance and investment products may also be adversely affected by rising interest rates.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Share Owners of Protective Life Corporation
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, share-owners’ equity and of cash flows present fairly, in all material respects, the financial position of Protective Life Corporation and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 of the Notes to the Consolidated Financial Statements, effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”.
PricewaterhouseCoopers LLP
Birmingham, Alabama
March 1, 2002
Year Ended December 31 (Dollars in thousands except per share amounts) 2001 2000 1999 - ---------------------------------------------------------------------------------------------------------------------- Revenues Premiums and policy fees $1,389,820 $1,175,898 $ 861,027 Reinsurance ceded (771,151) (686,108) (462,297) - ---------------------------------------------------------------------------------------------------------------------- Net of reinsurance ceded 618,669 489,790 398,730 Net investment income 884,041 730,149 667,968 Realized investment gains (losses) Derivative financial instruments (11,431) 9,013 (2,279) All other investments (8,740) (16,056) 1,222 Other income 131,678 151,833 89,680 - ---------------------------------------------------------------------------------------------------------------------- Total revenues 1,614,217 1,364,729 1,155,321 - ---------------------------------------------------------------------------------------------------------------------- Benefits and expenses Benefits and settlement expenses (net of reinsurance ceded: 2001 - $609,996; 2000 - $538,291; 1999 - $344,474) 972,624 760,778 629,656 Amortization of deferred policy acquisition costs 147,058 143,180 96,689 Amortization of goodwill 3,555 3,113 316 Other operating expenses (net of reinsurance ceded: 2001 - $167,243; 2000 - $223,498; 1999 - $150,570) 281,384 245,983 225,271 - ---------------------------------------------------------------------------------------------------------------------- Total benefits and expenses 1,404,621 1,153,054 951,932 - ---------------------------------------------------------------------------------------------------------------------- Income from continuing operations before income tax 209,596 211,675 203,389 - ---------------------------------------------------------------------------------------------------------------------- Income tax expense Current 64,667 11,947 43,971 Deferred 3,871 62,374 27,970 - ---------------------------------------------------------------------------------------------------------------------- Total income tax expense 68,538 74,321 71,941 - ---------------------------------------------------------------------------------------------------------------------- Net income from continuing operations before extraordinary loss and cumulative effect of change in accounting principle 141,058 137,354 131,448 Income (loss) from discontinued operations, net of income tax (9,977) 16,122 21,642 Loss from sale of discontinued operations, net of income tax (20,545) - ---------------------------------------------------------------------------------------------------------------------- Net income before extraordinary loss and cumulative effect of change in accounting principle 110,536 153,476 153,090 Extraordinary loss on early extinguishment of debt, net of income tax (1,763) Cumulative effect of change in accounting principle, net of income tax (7,593) - ---------------------------------------------------------------------------------------------------------------------- Net income $ 102,943 $ 153,476 $ 151,327 ====================================================================================================================== Net income from continuing operations before extraordinary loss and cumulative effect of change in accounting principle per share - basic $ 2.02 $ 2.09 $ 2.01 Net income per share - basic $ 1.48 $ 2.33 $ 2.31 Net income from continuing operations before extraordinary loss and cumulative effect of change in accounting principle per share - diluted $ 2.01 $ 2.08 $ 1.99 Net income per share - diluted $ 1.47 $ 2.32 $ 2.29 Cash dividends paid per share $ .55 $ .51 $ .47 ====================================================================================================================== See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS
December 31
(Dollars in thousands) 2001 2000
- --------------------------------------------------------------------------------------------------------------------
Assets
Investments:
Fixed maturities, at market (amortized cost: 2001 - $9,745,057;
2000 - $7,489,361) $ 9,838,091 $ 7,415,769
Equity securities, at market (cost: 2001 - $78,332 ; 2000 - $61,358) 76,774 58,700
Mortgage loans 2,512,844 2,268,224
Investment real estate, net of accumulated depreciation
(2001 - $1,466 ; 2000 - $1,226) 26,349 12,566
Policy loans 521,841 230,527
Other long-term investments 104,624 66,462
Short-term investments 237,155 189,161
- --------------------------------------------------------------------------------------------------------------------
Total investments 13,317,678 10,241,409
Cash 126,558 55,494
Accrued investment income 159,866 122,314
Accounts and premiums receivable, net of allowance for uncollectible amounts
(2001 - $3,025 ; 2000 - $2,195) 64,410 85,223
Reinsurance receivables 2,174,769 1,100,131
Deferred policy acquisition costs 1,532,683 1,189,380
Goodwill 48,162 250,321
Property and equipment 51,307 54,253
Other assets 251,581 138,419
Assets related to separate accounts
Variable annuity 1,910,651 1,841,439
Variable universal life 77,162 63,504
Other 3,997 3,746
- --------------------------------------------------------------------------------------------------------------------
$19,718,824 $15,145,633
====================================================================================================================
See Notes to Consolidated Financial Statements.
December 31
(Dollars in thousands) 2001 2000
- --------------------------------------------------------------------------------------------------------------------
Liabilities
Policy liabilities and accruals
Future policy benefits and claims $6,971,792 $5,031,957
Unearned premiums 904,374 937,516
- --------------------------------------------------------------------------------------------------------------------
Total policy liabilities and accruals 7,876,166 5,969,473
Stable value contract account balances 3,716,530 3,177,863
Annuity account balances 3,248,217 1,916,894
Other policyholders' funds 131,040 125,533
Other liabilities 498,579 393,262
Accrued income taxes 60,897 (35,330)
Deferred income taxes 127,230 79,066
Securities sold under repurchase agreements 117,000
Long-term debt 376,211 306,125
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures
8.25% Trust Originated Preferred Securities 75,000 75,000
7.5% Trust Originated Preferred Securities 100,000
6.5% FELINE PRIDES 115,000
Liabilities related to separate accounts
Variable annuity 1,910,651 1,841,439
Variable universal life 77,162 63,504
Other 3,997 3,746
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 18,318,680 14,031,575
====================================================================================================================
Commitments and contingent liabilities - Note 6
Share-owners' equity
Preferred Stock, $1 par value
Shares authorized: 3,600,000
Issued: none
Junior Participating Cumulative
Preferred Stock, $1 par value
Shares authorized: 400,000
Issued: none
Common Stock, $.50 par value
Shares authorized: 2001 and 2000 - 160,000,000
Issued: 2001 - 73,251,960; 2000 - 69,333,117 36,626 34,667
Additional paid-in capital 405,420 289,819
Treasury stock, at cost (2001 - 4,696,788 shares; 2000 - 4,775,550 shares) (15,895) (12,812)
Stock held in trust (2001 - 55,785 shares; 2000 - 36,210 shares) (1,535) (1,318)
Unallocated stock in Employee Stock Ownership Plan (2001 - 1,001,401 shares;
2000 - 1,112,668 shares) (3,317) (3,686)
Retained earnings 924,517 858,761
Accumulated other comprehensive income
Net unrealized gains (losses) on investments
(net of income tax: 2001 - $ 29,254 ; 2000 - $(27,662)) 54,328 (51,373)
- --------------------------------------------------------------------------------------------------------------------
Total share-owners' equity 1,400,144 1,114,058
- --------------------------------------------------------------------------------------------------------------------
$19,718,824 $15,145,633
====================================================================================================================
CONSOLIDATED STATEMENTS OF SHARE-OWNERS' EQUITY
Additional Stock Unallocated Net Unrealized Total
Common Paid-In Treasury Held In Stock in Retained Gains (Losses)Share-Owners'
(Dollars in thousands) Stock Capital Stock Trust ESOP Earnings on Investments Equity
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $34,667 $254,705 $(13,140) $(4,277) $617,182 $55,057 $ 944,194
--------
Net income for 1999 151,327 151,327
Change in net unrealized
gains/losses on investments
(net of income tax - $(108,675)) (201,825) (201,825)
Reclassification adjustment for
amounts included in net income
(net of income tax - $370) 687 687
--------
Comprehensive loss for 1999 (49,811)
--------
Cash dividends (30,305) (30,305)
Purchase of common stock $ (621) (621)
Stock-based compensation 947 145 1,092
Reissuance of treasury stock
to ESOP 405 35 (440) 0
Allocation of stock to employee
accounts 674 674
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 34,667 256,057 (12,960) (621) (4,043) 738,204 (146,081) 865,223
---------
Net income for 2000 153,476 153,476
Change in net unrealized
gains/losses on investments
(net of income tax - $48,532) 90,130 90,130
Reclassification adjustment for
amounts included in net income
(net of income tax - $2,465) 4,578 4,578
---------
Comprehensive income for 2000 248,184
---------
Cash dividends (32,919) (32,919)
Purchase of common stock (697) (697)
Stock-based compensation 33,535 120 33,655
Reissuance of treasury stock
to ESOP 227 28 (255) 0
Allocation of stock to employee
accounts 612 612
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 34,667 289,819 (12,812) (1,318) (3,686) 858,761 (51,373) 1,114,058
-----------
Net income for 2001 102,943 102,943
Change in net unrealized
gains/losses on investments
(net of income tax - $51,729) 96,069 96,069
Reclassification adjustment for
amounts included in net income
(net of income tax - $3,059) 5,681 5,681
Transition adjustment on derivative
financial instruments
(net of income tax - $2,127) 3,951 3,951
-----------
Comprehensive income for 2001 208,644
-----------
Cash dividends (37,187) (37,187)
Redemption of FELINE PRIDES 1,959 111,455 113,414
Purchase of common stock (217) (217)
Purchase of treasury stock (3,405) (3,405)
Stock-based compensation 3,349 240 3,589
Reissuance of treasury stock
to ESOP 797 82 (879) 0
Allocation of stock to employee
accounts 1,248 1,248
- -----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001
- - Note 7 $36,626 $405,420 $(15,895) $(1,535) $(3,317) $924,517 $54,328 $1,400,144
=======================================================================================================================
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
(Dollars in thousands) 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net income $ 102,943 $ 153,476 $ 151,327
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment losses 20,171 7,043 1,057
Extraordinary loss on early extinguishment of debt 1,763
Amortization of deferred policy acquisition costs 154,384 149,574 104,912
Capitalization of deferred policy acquisition costs (317,627) (338,685) (239,482)
Depreciation expense 12,110 10,421 12,030
Deferred income taxes 6,856 67,949 25,841
Accrued income taxes 98,476 (30,813) 9,499
Amortization of goodwill 9,056 8,525 5,584
Loss from sale of discontinued operations 20,545
Interest credited to universal life and investment products 944,098 766,004 331,746
Policy fees assessed on universal life and investment products (222,415) (197,581) (165,818)
Change in accrued investment income and other receivables (241,517) (149,778) (131,614)
Change in policy liabilities and other policyholders' funds of traditional
life and health products 442,193 500,254 215,556
Change in other liabilities 157,529 (38,674) 77,902
Other, net (5,501) (31,056) (10,729)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,181,301 876,659 389,574
- ----------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Maturities and principal reductions of investments:
Investments available for sale 3,260,107 13,037,876 10,167,542
Other 283,640 135,058 243,280
Sale of investments:
Investments available for sale 9,095,873 810,716 537,343
Other 1,363 5,222 267,892
Cost of investments acquired:
Investments available for sale (14,019,243) (14,523,312) (10,816,652)
Corporate owned life insurance (100,000)
Other (378,520) (464,779) (864,100)
Acquisitions and bulk reinsurance assumptions (124,027) (162,413) 46,508
Sale of discontinued operations, net of cash transferred 216,031
Purchase of property and equipment (12,282) (5,861) (18,741)
Sale of property and equipment 70 417
- ----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,776,988) (1,167,493) (436,511)
- ----------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Borrowings under line of credit arrangements and long-term debt 2,738,763 2,434,879 4,516,977
Principal payments on line of credit arrangements and long-term debt (2,551,677) (2,364,779) (4,451,790)
Payment of guaranteed preferred beneficial interests (55,000)
Dividends to share owners (37,187) (32,919) (30,305)
Issuance of guaranteed preferred beneficial interests 100,000
Purchase of common stock held in trust (217) (697) (621)
Purchase of treasury stock (3,405)
Investment product deposits and change in universal life deposits 1,735,653 1,811,484 1,300,736
Investment product withdrawals (1,315,179) (1,553,282) (1,190,904)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 666,751 294,686 89,093
- ----------------------------------------------------------------------------------------------------------------------
Increase in cash 71,064 3,852 42,156
Cash at beginning of year 55,494 51,642 9,486
- ----------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 126,558 $ 55,494 $ 51,642
======================================================================================================================
See Notes to Consolidated Financial Statements.
Notes to consolidated financial statements
(All dollar amounts in tables are in thousands except per share amounts.)
1 Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements of Protective Life Corporation and subsidiaries (the Company) are prepared on the basis of accounting principles generally accepted in the United States of America. Such accounting principles differ from statutory reporting practices used by insurance companies in reporting to state regulatory authorities. (See also Note 9.)
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make various estimates that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, as well as the reported amounts of revenues and expenses. Actual results could differ from these estimates.
Entities Included
The consolidated financial statements include the accounts, after intercompany eliminations, of Protective Life Corporation and its wholly-owned subsidiaries.
Nature of Operations
Protective Life Corporation is a holding company whose subsidiaries provide financial services through the production, distribution, and administration of insurance and investment products. The Company markets individual life insurance, credit life and disability insurance, guaranteed investment contracts, guaranteed funding agreements, fixed and variable annuities, and extended service contracts throughout the United States. The Company also maintains a separate division devoted to the acquisition of insurance policies from other companies. Founded in 1907, Protective Life Insurance Company (Protective Life) is the Company’s largest operating subsidiary.
The operating results of companies in the insurance industry have historically been subject to significant fluctuations due to changing competition, economic conditions, interest rates, investment performance, insurance ratings, claims, persistency, and other factors.
Recently Issued Accounting Standards
On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133, as amended by SFAS Nos. 137 and 138, requires the Company to record all derivative financial instruments, at fair value on the balance sheet. Changes in fair value of a derivative instrument are reported in net income or other comprehensive income, depending on the designated use of the derivative instrument. The adoption of SFAS No. 133 resulted in a cumulative charge to net income, net of income tax, of $7.6 million ($0.11 per share on both a basic and diluted basis) and a cumulative after-tax increase to other comprehensive income of $4.0 million on January 1, 2001. The charge to net income and increase to other comprehensive income primarily resulted from the recognition of derivative instruments embedded in the Company’s corporate bond portfolio. In addition, the charge to net income includes the recognition of the ineffectiveness on existing hedging relationships including the difference in spot and forward exchange rates related to foreign currency swaps used as an economic hedge of foreign-currency-denominated stable value contracts. Prospectively, the adoption of SFAS No. 133 may introduce volatility into the Company’s reported net income and other comprehensive income depending on future market conditions and the Company’s hedging activities.
In September 2000, the Financial Accounting Standards Board (FASB) issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125". SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets. This statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The adoption of this accounting standard did not have a material effect on the Company’s financial position or results of operations.
In June 2001, the FASB issued SFAS Nos. 141, “Business Combinations”, and 142, “Goodwill and Other Intangible Assets”. SFAS No. 141 requires that business combinations initiated after June 30, 2001, be accounted for using the purchase method. SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. The standard replaces the requirement to amortize goodwill with one that calls for an annual impairment test, among other provisions. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and effective for any goodwill or intangible asset acquired after June 30, 2001. The Company expects the adoption of SFAS No. 142 to result in the elimination of up to $3.5 million of goodwill amortization in 2002.
In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to have a material effect on the Company’s financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 requires that the same accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, expands the use of discontinued operations accounting to include more types of transactions and changes the timing of when discontinued operations accounting is applied. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of SFAS No. 144 to have a material effect on the Company’s financial position or results of operations.
Investments
The Company has classified all of its investments in fixed maturities, equity securities, and short-term investments as “available for sale.”
Investments are reported on the following bases less allowances for uncollectible amounts on investments, if applicable:
o Fixed maturities (bonds and redeemable preferred stocks) at current market value. Where market values are unavailable, the Company obtains estimates from independent pricing services or estimates market value based upon a comparison to quoted issues of the same issuer or issues of other issuers with similar terms and risk characteristics.
o Equity securities (common and nonredeemable preferred stocks)- at current market value.
o Mortgage loans- at unpaid balances, adjusted for loan origination costs, net of fees, and amortization of premium or discount.
o Investment real estate - at cost, less allowances for depreciation computed on the straight-line method. With respect to real estate acquired through foreclosure, cost is the lesser of the loan balance plus foreclosure costs or appraised value.
o Policy loans - at unpaid balances.
o Other long-term investments - at a variety of methods similar to those listed above, as deemed appropriate for the specific investment.
o Short-term investments - at cost, which approximates current market value.
Substantially all short-term investments have maturities of three months or less at the time of acquisition and include approximately $0.6 million in bank deposits voluntarily restricted as to withdrawal.
As prescribed by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” certain investments are recorded at their market values with the resulting unrealized gains and losses reduced by a related adjustment to deferred policy acquisition costs, net of income tax, reported as a component of share-owners’ 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 the Company’s operations, its reported share-owners’ equity will fluctuate significantly as interest rates change.
The Company's balance sheets at December 31, prepared on the basis of reporting investments at amortized cost rather than at market values, are as follows:
2001 2000
- ----------------------------------------------------------------------
Total investments $13,212,993 $10,317,657
Deferred policy acquisition costs 1,553,786 1,192,696
All other assets 4,868,463 3,714,844
- ----------------------------------------------------------------------
$19,635,242 $15,225,197
======================================================================
Deferred income taxes $ 97,976 $ 107,257
All other liabilities 18,191,450 13,952,509
- ----------------------------------------------------------------------
18,289,426 14,059,766
Share-owners' equity 1,345,816 1,165,431
- ----------------------------------------------------------------------
$19,635,242 $15,225,197
======================================================================
Realized gains and losses on sales of investments are recognized in net income using the specific identification basis.
Derivative Financial Instruments
The Company utilizes a risk management strategy that incorporates the use of derivative instruments, primarily to reduce its exposure to interest rate risk as well as currency exchange risk.
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 and mortgage-backed securities. Interest rate swap contracts generally involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date. Interest rate futures generally involve exchange traded contracts to buy or sell treasury bonds and notes in the future at specified prices. Interest rate options represent contracts that allow the holder of the option to receive cash or purchase, sell or enter into a financial instrument at a specified price within a specified period of time. The Company uses interest rate swap contracts, swaptions (options to enter into interest rate swap contracts), caps, and floors to modify the interest characteristics of certain investments, and its Senior Notes, Medium-Term Notes, and TOPrS. Swap contracts are also used to alter the effective durations of assets and liabilities. The Company uses foreign currency swaps to reduce its exposure to currency exchange risk on certain stable value contracts denominated in foreign currencies, primarily the European euro and the British pound.
Derivative instruments expose the Company to credit and market risk. The Company minimizes its credit risk by entering into transactions with highly rated counterparties. The Company manages the market risk associated with interest rate and foreign exchange contracts by establishing and monitoring limits as to the types and degrees of risk that may be undertaken.
The Company monitors its use of derivatives in connection with its overall asset/liability management programs and procedures. The Company’s asset/liability committee is responsible for implementing various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the Company’s overall interest rate and currency exchange risk management strategies.
All derivatives are recognized on the balance sheet (other long-term investments or other liabilities) at their fair value (primarily estimates from independent pricing services). On the date the derivative contract is entered into, the Company designates the derivative as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value” hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge), or (3) as a derivative either held for investment purposes or held as a natural hedging instrument designed to act as an economic hedge against the changes in value or cash flows of a hedged item (“other” derivative). Changes in the fair value of a derivative that is highly effective as and that is designated and qualifies as a fair-value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk (including losses or gains on firm commitments), are recorded in current-period earnings. Changes in the fair value of a derivative that is highly effective as and that is designated and qualified as a cash-flow hedge are recorded in other comprehensive income, until earnings are affected by the variability of cash flows. Changes in the fair value of other derivatives are recognized in current earnings and reported in Realized Investment Gains (Losses) Derivative Financial Instruments in the Company’s consolidated condensed statements of income.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair-value or cash-flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is dedesignated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; (4) because a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, the derivative will continue to be carried on the balance sheet at its fair value, and the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the derivative will continue to be carried on the balance sheet at its fair value, and any asset or liability that was recorded pursuant to recognition of the firm commitment will be removed from the balance sheet and recognized as a gain or loss in current-period earnings. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will remain therein until such time as they are reclassified to earnings as originally forecasted to occur. In all situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current-period earnings.
o Fair-Value Hedges. The Company has designated, as a fair value hedge, callable interest rate swaps used to modify the interest characteristics of certain callable Medium-Term Notes and stable value contracts. In assessing hedge effectiveness, the Company excludes the embedded call option’s time value component from each derivative’s total gain or loss. In 2001, total measured ineffectiveness for the fair value hedging relationships was insignificant while the excluded time value component resulted in a pre-tax gain of $1.3 million. Both the measured ineffectiveness and the excluded time value component are reported in Realized Investment Gains (Losses) Derivative Financial Instruments in the Company’s consolidated condensed statements of income.
o Cash-Flow Hedges. The Company has not designated any hedging relationships as a cash flow hedge.
o Other Derivatives. The Company uses certain interest rate swaps, caps, floors, swaptions, options and futures contracts as economic hedges against the changes in value or cash flows of outstanding mortgage loan commitments and certain owned investments as well as certain debt and preferred security obligations of the Company. In 2001, the Company recognized total pre-tax losses of $10.8 million representing the change in fair value of these derivative instruments.
On its foreign currency swaps, the Company recognized a $8.2 million pre-tax loss in 2001 while recognizing a $11.2 million foreign exchange pre-tax gain on the related foreign-currency-denominated stable value contracts. The net gain primarily results from the difference in the forward and spot exchange rates used to revalue the currency swaps and the stable value contracts, respectively. This net gain is reflected in Realized Investment Gains (Losses) Derivative Financial Instruments in the Company’s consolidated condensed statements of income.
The Company has entered into asset swap arrangements to effectively sell the equity options embedded in owned convertible bonds in exchange for an interest rate swap that converts the remaining host bond to a variable rate instrument. In 2001, the Company recognized a $12.2 million pre-tax gain for the change in the asset swaps’ fair value and recognized a $16.9 million pre-tax loss to separately record the embedded equity options at fair value.
The Company has also entered into a total return swap with respect to $400 million of a portfolio of approximately $413 million of investments held by an unrelated special purpose vehicle that are managed by the Company. The Company recognized a $0.3 million pre-tax loss in 2001 for the change in the total return swap’s fair value.
At December 31, 2001, contracts with a notional amount of $5,475.1 million were in a $21.9 million net loss position. At December 31, 2000, contracts with a notional amount of $3,134.2 million were in a $12.3 million net loss position. The Company recognized $9.0 million in realized investment gains related to derivative financial instruments in 2000.
The Company’s derivative financial instruments are with highly rated counterparties.
Cash
Cash includes all demand deposits reduced by the amount of outstanding checks and drafts. The Company has deposits with certain financial institutions which exceed federally insured limits. The Company has reviewed the credit worthiness of these financial institutions and believes there is minimal risk of a material loss.
Deferred Policy Acquisition Costs
Commissions and other costs of acquiring traditional life and health insurance, credit insurance, universal life insurance, and investment products that vary with and are primarily related to the production of new business, have been deferred. Traditional life and health insurance acquisition costs are amortized over the premium-payment period of the related policies in proportion to the ratio of annual premium income to the present value of the total anticipated premium income. Credit insurance acquisition costs are being amortized in proportion to earned premium. Acquisition costs for universal life and investment products are amortized over the lives of the policies in relation to the present value of estimated gross profits before amortization. Under SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments,” the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates (equal to the rate used to compute liabilities for future policy benefits; currently 3.0% to 9.4%) it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from that assumed. Additionally, relating to SFAS No. 115, these costs have been adjusted by an amount equal to the amortization that would have been recorded if unrealized gains or losses on investments associated with the Company’s universal life and investment products had been realized.
The cost to acquire blocks of insurance representing the present value of future profits from such blocks of insurance is also included in deferred policy acquisition costs. The Company amortizes the present value of future profits over the premium payment period, including accrued interest of up to approximately 8%. The unamortized present value of future profits for all acquisitions was approximately $523.4 million and $343.6 million at December 31, 2001 and 2000, respectively. During 2001, $221.9 million of present value of future profits was capitalized, and $42.1 million was amortized. During 2000, $47.3 million of present value of future profits was capitalized (relating to acquisitions made during the year) and $44.3 million was amortized.
Goodwill
Goodwill is being amortized straight-line over periods ranging from 10 to 40 years. Goodwill at December 31 is as follows:
2001 2000
- ---------------------------------------------------------------------
Goodwill $55,246 $270,250
Accumulated amortization 7,084 19,929
- ---------------------------------------------------------------------
$48,162 $250,321
=====================================================================
The Company periodically evaluates the recoverability of its goodwill by comparing expected future cash flows to the amount of unamortized goodwill. If this evaluation were to indicate the unamortized goodwill is impaired, the goodwill would be reduced to an amount representing the present value of applicable estimated future cash flows. A substantial portion of goodwill was disposed of in connection with the 2001 sale of the Company��s Dental Benefits Division.
Property and Equipment
Property and equipment are reported at cost. The Company primarily uses the straight-line method of depreciation based upon the estimated useful lives of the assets. Major repairs or improvements are capitalized and depreciated over the estimated useful lives of the assets. Other repairs are expensed as incurred. The cost and related accumulated depreciation of property and equipment sold or retired are removed from the accounts, and resulting gains or losses are included in income.
Property and equipment consisted of the following at December 31:
2001 2000
- ------------------------------------------------------------------------
Home Office building $ 45,845 $ 41,184
Data processing equipment 34,100 34,626
Other, principally furniture
and equipment 40,055 38,573
- ------------------------------------------------------------------------
120,000 114,383
Accumulated depreciation 68,693 60,130
- ------------------------------------------------------------------------
$ 51,307 $ 54,253
========================================================================
Separate Accounts
The assets and liabilities related to separate accounts in which the Company does not bear the investment risk are valued at market and reported separately as assets and liabilities related to separate accounts in the accompanying consolidated financial statements.
Stable Value Contracts Account Balances
The Company markets guaranteed investment contracts to 401(k) and other qualified retirement savings plans, and fixed and floating rate funding agreements to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds. The Company also sells funding agreements to special purpose entities that in turn issue notes or certificates in smaller, transferrable denominations. In a structured program, the Company issues funding agreements to a special purpose trust or entity formed solely to purchase the funding agreements and simultaneously issue certificates or notes having terms substantially identical to the underlying funding agreements. Stable value contract account balances include guaranteed investment contracts and funding agreements issued by the Company, and the obligations of consolidated special purpose trusts or entities formed to purchase funding agreements issued by the Company. At December 31, 2001 and 2000 the Company had $1.7 billion and $1.0 billion of stable value contract account balances marketed through structured programs.
Revenues and Benefits Expense
o Traditional Life, Health, and Credit Insurance Products. Traditional life insurance products consist principally of those products with fixed and guaranteed premiums and benefits, and include whole life insurance policies, term and term-like life insurance policies, limited payment life insurance policies, and certain annuities with life contingencies. Life insurance and immediate annuity premiums are recognized as revenue when due. Health and credit insurance premiums are recognized as revenue over the terms of the policies. Benefits and expenses are associated with earned premiums so that profits are recognized over the life of the contracts. This is accomplished by means of the provision for liabilities for future policy benefits and the amortization of deferred policy acquisition costs.
Liabilities for future policy benefits on traditional life insurance products have been computed using a net level method including assumptions as to investment yields, mortality, persistency, and other assumptions based on the Company’s experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation. Reserve investment yield assumptions are graded and range from 2.5% to 7.0%. The liability for future policy benefits and claims on traditional life, health, and credit insurance products includes estimated unpaid claims that have been reported to the Company and claims incurred but not yet reported. Policy claims are charged to expense in the period in which the claims are incurred.
Activity in the liability for unpaid claims is summarized as follows:
2001 2000 1999
- --------------------------------------------------------------------------
Balance beginning of year $110,064 $122,346 $ 93,966
Less reinsurance 25,830 47,661 20,019
- --------------------------------------------------------------------------
Net balance beginning
of year 84,234 74,685 73,947
- --------------------------------------------------------------------------
Incurred related to:
Current year 383,371 323,222 331,380
Prior year (1,080) (4,880) (4,997)
- --------------------------------------------------------------------------
Total incurred 382,291 318,342 326,383
- --------------------------------------------------------------------------
Paid related to:
Current year 312,748 252,209 283,219
Prior year 81,220 61,925 44,093
- --------------------------------------------------------------------------
Total paid 393,968 314,134 327,312
- --------------------------------------------------------------------------
Other changes:
Acquisitions and reserve
transfers (6,257) 5,341 1,667
- --------------------------------------------------------------------------
Net balance end of year 66,300 84,234 74,685
Plus reinsurance 33,723 25,830 47,661
- --------------------------------------------------------------------------
Balance end of year $100,023 $110,064 $122,346
==========================================================================
o Universal Life and Investment Products. Universal life and investment products include universal life insurance, guaranteed investment contracts, deferred annuities, and annuities without life contingencies. Premiums and policy fees for universal life and investment products consist of fees that have been assessed against policy account balances for the costs of insurance, policy administration, and surrenders. Benefit reserves for universal life and investment products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized in income over the term of the policies. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances and interest credited to policy account balances. Interest rates credited to universal life and investment products ranged from 3.0% to 9.4% in 2001.
The Company’s accounting policies with respect to variable universal life and variable annuities are identical except that policy account balances (excluding account balances that earn a fixed rate) are valued at market and reported as components of assets and liabilities related to separate accounts.
Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Income tax provisions are generally based on income reported for financial statement purposes. Deferred federal income taxes arise from the recognition of temporary differences between the basis of assets and liabilities determined for financial reporting purposes and the basis determined for income tax purposes. Such temporary differences are principally related to the deferral of policy acquisition costs and the provision for future policy benefits and expenses.
Discontinued Operations
On December 31, 2001, the Company completed the sale to Fortis, Inc. of substantially all of its Dental Benefits Division (Dental Division), and discontinued other remaining Dental Division related operations, primarily other health insurance lines.
The operating results and charges related to the sale of the Dental division at December 31 are as follows:
2001 2000 1999
- -----------------------------------------------------------------------------
Total revenues $350,916 $369,239 $378,561
- -----------------------------------------------------------------------------
Income (loss) before
income taxes from
discontinued operations $ (12,797) $ 27,718 $ 36,132
Income tax (expense)
benefit 2,820 (11,596) (14,490)
- -----------------------------------------------------------------------------
Income (loss) from
discontinued operations $ (9,977) $ 16,122 $ 21,642
- -----------------------------------------------------------------------------
Gain from sale of
discontinued operations
before income tax $ 22,927
Income tax expense
related to sale (43,472)
- -----------------------------------------------------------------------------
Loss from sale of
discontinued operations $ (20,545)
- -----------------------------------------------------------------------------
Income (loss) from
discontinued operations -
per share
(diluted and basic) $ (.14) $ .24 $ .33
Loss from sale of
discontinued operations -
per share
(diluted and basic) $ (.29)
- -----------------------------------------------------------------------------
Remaining assets and liabilities at December 31, 2001 related to the business sold to Fortis, Inc. consist of reinsurance receivables and policy liabilities and accruals of approximately $51.2 million. Assets and liabilities related to the other discontinued lines of business of approximately $11.1 million and $14.3 million, respectively, remain at December 31, 2001.
Net Income Per Share
Net income per share - basic is net income divided by the average number of shares of Common Stock outstanding including shares that are issuable under various deferred compensation plans.
Net income per share - diluted is adjusted net income divided by the average number of shares outstanding including all diluted, potentially issuable shares that are issuable under various stock-based compensation plans and stock purchase contracts.
A reconciliation of net income and adjusted net income, and basic and diluted average shares outstanding for the years ended December 31 is summarized as follows:
2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------
Net income $ 102,943 $ 153,476 $ 151,327
Dividends on FELINE PRIDES __(1) __(1)
- --------------------------------------------------------------------------------------------------------------------
Adjusted net income $ 102,943 $ 153,476 $ 151,327
====================================================================================================================
Average shares issued and outstanding 68,037,410 64,544,140 64,481,997
Stock held in trust (47,759) (41,797) (13,030)
Issuable under various deferred compensation plans 1,420,874 1,330,006 1,135,344
- --------------------------------------------------------------------------------------------------------------------
Average shares outstanding - basic 69,410,525 65,832,349 65,604,311
Stock held in trust 47,759 41,797 13,030
Stock appreciation rights 266,132 131,443 183,996
Issuable under various other stock-based compensation plans 225,757 275,539 360,030
FELINE PRIDES stock purchase contracts __(1) __(1)
- --------------------------------------------------------------------------------------------------------------------
Average shares outstanding - diluted 69,950,173 66,281,128 66,161,367
====================================================================================================================
(1) Excluded because the effect is anti-dilutive.
Supplemental Cash Flow Information
The following table sets forth supplemental cash flow information for the years ended December 31:
2001 2000 1999
- -----------------------------------------------------------------------------------------------
Cash paid during the year:
Interest on debt $ 36,095 $ 37,660 $ 34,756
Income taxes 31,795 55,798 42,367
- -----------------------------------------------------------------------------------------------
Noncash investing and financing activities:
Reissuance of treasury stock to ESOP $ 879 $ 255 $ 440
Change in unallocated stock in ESOP 369 357 234
Stock-based compensation 3,589 33,655 1,092
Redemption of FELINE PRIDES 113,414
Acquisitions and related reinsurance transactions:
Assets acquired $2,554,202 $ 533,869 $ 12,502
Liabilities assumed (2,430,175) (371,456) (12,502)
- -----------------------------------------------------------------------------------------------
Net $124,027 $ 162,413 $ 0
===============================================================================================
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-owners' equity.
2 Investment Operations
Major categories of net investment income for the years ended December 31 are summarized as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Fixed maturities $586,305 $536,550 $470,458
Equity securities 32,334 2,955 1,949
Mortgage loans 208,830 177,917 172,027
Investment real estate 4,632 3,132 2,655
Policy loans 31,763 14,977 15,994
Other, principally short-term investments 37,281 12,113 20,761
- --------------------------------------------------------------------------------
901,145 747,644 683,844
Investment expenses 17,104 17,495 15,876
- --------------------------------------------------------------------------------
$884,041 $730,149 $667,968
================================================================================
Realized investment gains (losses) for all other investments for the years ended December 31 are summarized as follows:
2001 2000 1999
- ---------------------------------------------------------------------
Fixed maturities $(7,311) $(14,793) $ 8,215
Equity securities 2,462 1,685 (3,371)
Mortgage loans and
other investments (3,891) (2,948) (3,622)
- ---------------------------------------------------------------------
$(8,740) $(16,056) $ 1,222
=====================================================================
In 2001, gross gains on the sale of investments available for sale (fixed maturities, equity securities, and short-term investments) were $64.3 million, and gross losses were $72.9 million. In 2000, gross gains were $8.7 million, and gross losses were $28.4 million. In 1999, gross gains were $44.1 million, and gross losses were $32.4 million. Realized investment gains (losses) for derivative financial instruments for the years ended December 31 are summarized as follows:
2001 2000 1999
- -----------------------------------------------------------------------------
Derivative financial
instruments $(11,431) $9,013 $(2,279)
=============================================================================
The amortized cost and estimated market value of the Company's investments classified as available for sale at December 31 are as follows:
AMORTIZED GROSS UNREALIZED GROSS UNREALIZED ESTIMATED
COST GAINS LOSSES MARKET VALUE
2001
- ------------------------------------------------------------------------------------------------------------------------
Fixed maturities:
Bonds:
Mortgage-backed securities $ 3,709,118 $ 84,965 $ 33,759 $ 3,760,324
United States Government and authorities 98,967 4,088 0 103,055
States, municipalities, and political subdivisions 94,022 4,009 0 98,031
Public utilities 807,773 19,763 4,860 822,676
Convertibles and bonds with warrants 96,951 7,423 6,184 98,190
All other corporate bonds 4,936,614 117,092 99,500 4,954,206
Redeemable preferred stocks 1,612 0 3 1,609
- ------------------------------------------------------------------------------------------------------------------------
9,745,057 237,340 144,306 9,838,091
Equity securities 78,332 3,565 5,123 76,774
Short-term investments 237,155 0 0 237,155
- ------------------------------------------------------------------------------------------------------------------------
$10,060,544 $240,905 $149,429 $10,152,020
========================================================================================================================
2000
- ------------------------------------------------------------------------------------------------------------------------
Fixed maturities:
Bonds:
Mortgage-backed securities $ 2,915,836 $ 49,373 $ 33,197 $ 2,932,012
United States Government and authorities 95,567 2,662 0 98,229
States, municipalities, and political subdivisions 88,223 3,407 0 91,630
Public utilities 631,703 7,804 5,596 633,911
Convertibles and bonds with warrants 69,014 11,277 12,145 68,146
All other corporate bonds 3,687,250 49,533 146,704 3,590,079
Redeemable preferred stocks 1,768 0 6 1,762
- ------------------------------------------------------------------------------------------------------------------------
7,489,361 124,056 197,648 7,415,769
Equity securities 61,358 2,761 5,419 58,700
Short-term investments 189,161 0 0 189,161
- ------------------------------------------------------------------------------------------------------------------------
$ 7,739,880 $126,817 $203,067 $ 7,663,630
========================================================================================================================
The amortized cost and estimated market value of fixed maturities at December 31, 2001, by expected maturity, are shown as follows. Expected maturities are derived from rates of prepayment that may differ from actual rates of prepayment.
ESTIMATED
AMORTIZED MARKET
COST VALUE
- --------------------------------------------------------------------------------
Due in one year or less $ 896,159 $ 899,666
Due after one year
through five years 3,253,264 3,318,537
Due after five years
through ten years 2,199,562 2,228,012
Due after ten years 3,396,072 3,391,876
- --------------------------------------------------------------------------------
$9,745,057 $9,838,091
================================================================================
At December 31, 2001 and 2000, the Company had bonds which were rated less than investment grade of $447.3 million and $252.5 million, respectively, having an amortized cost of $524.1 million and $332.0 million, respectively. At December 31, 2001, approximately $63.3 million of the bonds rated less than investment grade were securities issued in Company-sponsored commercial mortgage loan securitizations. Approximately $1,788.2 million of bonds are not publicly traded.
The change in unrealized gains (losses), net of income tax, on fixed maturity and equity securities for the years ended December 31 is summarized as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Fixed maturities $108,307 $109,626 $(227,568)
Equity securities 715 (820) 973
================================================================================
At December 31, 2001, all of the Company’s mortgage loans were commercial loans of which 75% were retail, 10% were apartments, 7% were office buildings, 7% were warehouses, and 1% were other. The Company specializes in making mortgage loans on either credit-oriented or credit-anchored commercial properties, most of which are strip shopping centers in smaller towns and cities. No single tenant’s leased space represents more than 3.5% of mortgage loans. Approximately 76% of the mortgage loans are on properties located in the following states listed in decreasing order of significance: Texas, Tennessee, Georgia, Alabama, North Carolina, South Carolina, Florida, Virginia, California, Mississippi, Washington, Kentucky, and Ohio.
Many of the mortgage loans have call provisions between 3 and 10 years. Assuming the loans are called at their next call dates, approximately $153.4 million would become due in 2002, $560.4 million in 2002 to 2006, $392.5 million in 2007 to 2011, and $46.7 million thereafter.
At December 31, 2001, the average mortgage loan was $2.1 million, and the weighted average interest rate was 7.6%. The largest single mortgage loan was $18.8 million.
For several years the Company has offered a type of commercial mortgage loan under which the Company will permit a slightly higher loan-to-value ratio in exchange for a participating interest in the cash flows from the underlying real estate. As of December 31, 2001 and 2000, approximately $548.4 million and $572.2 million respectively, of the Company’s mortgage loans have this participation feature.
At December 31, 2001 and 2000, the Company’s problem mortgage loans (over ninety days past due) and foreclosed properties totaled $29.6 million and $20.6 million, respectively. Since the Company’s mortgage loans are collateralized by real estate, any assessment of impairment is based upon the estimated fair value of the real estate. Based on the Company’s evaluation of its mortgage loan portfolio, the Company does not expect any material losses on its mortgage loans.
At December 31, 2001 and 2000, the Company had investments related to retained beneficial interests of mortgage loan securitizations of $286.4 million and $309.0 million, respectively.
Certain investments with a carrying value of $62.5 million, were non-income producing for the twelve months ended December 31, 2001.
Policy loan interest rates generally range from 4.0% to 8.0%.
On December 31, 2001, Protective Life Insurance Company had $117.0 million of securities sold under repurchase agreements with an interest rate of 2.0%. The agreement to repurchase liability is recorded as securities sold under repurchase agreements.
3 Income Taxes
The Company’s effective income tax rate related to continuing operations varied from the maximum federal income tax rate as follows:
2001 2000 1999
- ------------------------------------------------------------------------
Statutory federal income
tax rate applied to pretax
income 35.0% 35.0% 35.0%
Amortization of
nondeductible goodwill 0.1 0.1
State income taxes 0.7 0.6 0.4
Dividends received
deduction and
tax-exempt interest (1.8) (0.4)
Low-income housing credit (0.5) (0.3) (0.3)
Other (0.8) 0.1 0.3
- ------------------------------------------------------------------------
32.7% 35.1% 35.4%
========================================================================
The provision for federal income tax differs from amounts currently payable due to certain items reported for financial statement purposes in periods which differ from those in which they are reported for income tax purposes.
Details of the deferred income tax provision for the years ended December 31 are as follows:
2001 2000 1999
- --------------------------------------------------------------------------
Deferred policy
acquisition
costs $ 81,947 $30,250 $ 45,671
Benefit and other
policy liability
changes (75,422) 34,986 (22,660)
Temporary
differences of
investment income 6,285 (2,590) 6,655
Other items (8,939) (272) (1,696)
- --------------------------------------------------------------------------
$ 3,871 $62,374 $ 27,970
==========================================================================
The components of the Company's net deferred income tax liability as of December 31 were as follows:
2001 2000
- ------------------------------------------------------------------------
Deferred income tax assets:
Policy and policyholder
liability reserves $276,071 $195,767
Other 15,381 6,442
- ------------------------------------------------------------------------
291,452 202,209
========================================================================
Deferred income tax liabilities:
Deferred policy acquisition costs 379,072 302,629
Unrealized gains (losses) on
investments 39,610 (21,354)
- ------------------------------------------------------------------------
418,682 281,275
- ------------------------------------------------------------------------
Net deferred income tax liability $127,230 $ 79,066
========================================================================
Under pre-1984 life insurance company income tax laws, a portion of the Company's gain from operations which was not subject to current income taxation was accumulated for income tax purposes in a memorandum account designated as Policyholders' Surplus. The aggregate accumulation in this account at December 31, 2001, was approximately $70.5 million. Should the accumulation in the Policyholders' Surplus account of the life insurance subsidiaries exceed certain stated maximums, or should distributions including cash dividends be made to Protective Life Corporation in excess of approximately $971.8 million, such excess would be subject to federal income taxes at rates then effective. Deferred income taxes have not been provided on amounts designated as Policyholders' Surplus. Under current income tax laws, the Company does not anticipate paying income tax on amounts in the Policyholders' Surplus accounts.
4 Debt and Guaranteed Preferred Beneficial Interests
Long-term debt at December 31 is summarized as follows:
2001 2000
- ---------------------------------------------------------------------------
Long-term debt (year of issue):
7.95% Senior Notes (1994),
due 2004 $75,000 $75,000
7.45% Medium-Term Notes
(1996), due 2011 9,852 9,938
7.45% Medium-Term Notes
(1996), due 2011, callable 2001 9,867
7.10% Medium-Term Notes
(1996), due 2011, callable 2001 12,238
7.00% Medium-Term Notes
(1996), due 2011, callable 2001 12,182
8.00% Senior Notes (2000),
due 2010, callable 2003 49,873 49,905
8.10% Senior Notes (2000),
due 2015, callable 2003 39,853 39,890
8.25% Senior Notes (2000),
due 2030, callable 2005 34,719 34,790
7.50% Senior Notes (2000),
due 2016, callable 2004 59,944 60,000
Floating Rate Senior Notes
(2001), due 2003 100,000
Mortgage notes on
investment real estate 6,970 2,315
- ---------------------------------------------------------------------------
$376,211 $306,125
===========================================================================
Under revolving line of credit arrangements with several banks, the Company can borrow up to $200 million on an unsecured basis. No compensating balances are required to maintain the line of credit. At December 31, 2001 and 2000, the Company had no borrowings outstanding under these credit arrangements.
The aforementioned revolving line of credit arrangements contain, among other provisions, requirements for maintaining certain financial ratios and restrictions on indebtedness incurred by the Company and its subsidiaries. Additionally, the Company, on a consolidated basis, cannot incur debt in excess of 40% of its total capital.
Except for the 7.95% Senior Notes, limited amounts of the Senior and Medium-Term Notes may be redeemed upon the death of the beneficial owner of the notes.
At December 31, 2001, future maturities of long-term debt are $100.0 million in 2003, $75.0 million in 2004 and $194.2 million in years after 2005.
In 1994, a special purpose finance subsidiary of the Company, PLC Capital L.L.C. (PLC Capital), issued $55 million of 9% Cumulative Monthly Income Preferred Securities, Series A (MIPSSM). In 1999, the Company caused PLC Capital to redeem the MIPS. In a related transaction the Company redeemed its subordinated debentures which were held by PLC Capital. The redemption of the subordinated debentures resulted in an extraordinary loss of $1.8 million ($0.03 per share on both a diluted and basic basis). The extraordinary loss was comprised primarily of unamortized deferred debt issue costs and losses related to the termination of related interest rate swap agreements, net of an income tax benefit of $0.9 million.
In 1997, another special purpose finance subsidiary, PLC Capital Trust I, issued $75 million of 8.25% Trust Originated Preferred Securities (TOPrSSM). The 8.25% TOPrS are guaranteed on a subordinated basis by the Company. This guarantee, considered together with the other obligations of the Company with respect to the 8.25% TOPrS, constitutes a full and unconditional guarantee by the Company of PLC Capital Trust I’s obligations with respect to the 8.25% TOPrS.
PLC Capital Trust I was formed solely to issue securities and use the proceeds thereof to purchase subordinated debentures of the Company. The sole assets of PLC Capital Trust I are $77.3 million of Protective Life Corporation 8.25% Subordinated Debentures due 2027, Series B. The Company has the right under the subordinated debentures to extend interest payment periods up to five consecutive years, and, as a consequence, dividends on the 8.25% TOPrS may be deferred (but will continue to accumulate, together with additional dividends on any accumulated but unpaid dividends at the dividend rate) by PLC Capital Trust I during any such extended interest payment period. The 8.25% TOPrS are redeemable by PLC Capital Trust I at any time on or after April 29, 2002.
Also in 1997, another special purpose finance subsidiary, PLC Capital Trust II, issued $115 million of FELINE PRIDES which are comprised of stock purchase contracts and a beneficial ownership of 6.5% TOPrS. The sole assets of PLC Capital Trust II were $118.6 million of Protective Life Corporation 6.5% Subordinated Debentures due 2003, Series C. In February 2001, the Company issued 3,918,843 shares of its Common Stock under the stock purchase contracts. In the transaction, substantially all of the 6.5% TOPrS and the underlying subordinated debt were redeemed. The dividend rate on the TOPrS that remained outstanding after February 2001 was reset to 6.77% under a formula specified in the agreement. The remaining outstanding TOPrS and underlying subordinated debt were redeemed in April 2001.
In August 2001, a third special purpose finance subsidiary of the Company, PLC Capital Trust III, issued $100 million of 7.5% TOPrS. The 7.5% TOPrS are guaranteed on a subordinated basis by the Company. This guarantee, considered together with the other obligations of the Company with respect to the 7.5% TOPrS, constitutes a full and unconditional guarantee by the Company of PLC Capital Trust III’s obligations with respect to the 7.5% TOPrS.
PLC Capital Trust III was formed solely to issue securities and use the proceeds thereof to purchase subordinated debentures of the Company. The sole assets of PLC Capital Trust III are $103.1 million of Protective Life Corporation 7.5% Subordinated Debentures due 2031, Series D. The Company has the right under the subordinated debentures to extend interest payment periods up to five consecutive years, and, as a consequence, dividends on the 7.5% TOPrS may be deferred (but will continue to accumulate, together with additional dividends on any accumulated but unpaid dividends at the dividend rate) by PLC Capital Trust III during any such extended interest payment period. The 7.5% TOPrS are redeemable by PLC Capital Trust III at any time on or after August 22, 2006.
The MIPS, TOPrS, and FELINE PRIDES (collectively, “preferred securities”) are reported in the accompanying balance sheets as “guaranteed preferred beneficial interests”.
The Company uses interest rate swap agreements to convert a portion of its debt and preferred securities from a fixed interest or dividend rate to a floating rate. Interest expense on all debt, including dividends on preferred securities and the effect of interest rate swap agreements, totaled $32.9 million, $34.2 million, and $32.1 million in 2001, 2000, and 1999, respectively.
5 Recent Acquisitions
In September 1999, the Company recaptured a block of credit life and disability policies which it had previously ceded.
In January 2000, the Company acquired the Lyndon Insurance Group (Lyndon). The assets acquired included $47.3 million of present value of future profits and $41.4 million of goodwill.
In January 2001, the Company coinsured a block of individual life policies from Standard Insurance Company. In October 2001, the Company completed the acquisition of the stock of Inter-State Assurance Company (Inter-State) and First Variable Life Insurance Company (First Variable) from ILona Financial Group, Inc., a subsidiary of Irish Life & Permanent plc of Dublin, Ireland. The purchase price was approximately $250 million. The assets acquired included $132.7 million of present value of future profits.
These transactions have been accounted for as purchases, and the results of the transactions have been included in the accompanying financial statements since their respective effective dates.
Summarized below are the consolidated results of operations for 2001 and 2000, on an unaudited pro forma basis, as if the Inter-State and First Variable acquisitions had occurred as of January 1, 2000. The pro forma information is based on the Company’s consolidated results of operations for 2001 and 2000, and on data provided by the acquired companies, 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.
(unaudited) 2001 2000 - ----------------------------------------------------------------- Total revenues $1,683,536 $1,457,155 Net income 111,718 165,176 Net income per share-basic 1.61 2.51 Net income per share-diluted 1.60 2.49 =================================================================
6 Commitments and Contingent Liabilities
The Company is contingently liable to obtain a $20 million letter of credit under indemnity agreements with its directors. Such agreements provide insurance protection in excess of the directors’ and officers’ liability insurance in force at the time up to $20 million. Should certain events occur constituting a change in control of the Company, the Company must obtain the letter of credit upon which directors may draw for defense or settlement of any claim relating to performance of their duties as directors. The Company has similar agreements with certain of its officers providing up to $10 million in indemnification which are not secured by the obligation to obtain a letter of credit.
The Company leases administrative and marketing office space in approximately 30 cities including Birmingham, with most leases being for periods of three to ten years. The aggregate annualized rent is approximately $8.7 million.
The Company has financed the construction of a third building contiguous to its existing home office complex under an operating lease arrangement. Approximately $38 million of construction costs had been incurred at December 31, 2001. The Company has an option to purchase the building from the lessor at the end of the lease term.
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. The Company 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 and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives relationships with agents or persons with whom the insurer does business, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very little appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. The Company, like other financial service companies, 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, the Company 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 the Company.
7 Share-Owners' Equity and Restrictions and Stock-based Compensation
Activity in the Company's issued and outstanding common stock is summarized as follows:
ISSUED TREASURY OUTSTANDING
SHARES SHARES SHARES
- -------------------------------------------------------------------------------
Balance, December 31, 1998 69,333,117 4,898,100 64,435,017
Reissuance of treasury stock (67,075) 67,075
- -------------------------------------------------------------------------------
Balance, December 31, 1999 69,333,117 4,831,025 64,502,092
Reissuance of treasury stock (55,475) 55,475
- -------------------------------------------------------------------------------
Balance, December 31, 2000 69,333,117 4,775,550 64,557,567
Reissuance of treasury stock (78,762) 78,762
Redemption of FELINE PRIDES 3,918,843 3,918,843
- -------------------------------------------------------------------------------
Balance, December 31, 2001 73,251,960 4,696,788 68,555,172
===============================================================================
The Company has a Rights Agreement that provides rights to owners of the Company’s Common Stock to purchase Series A Junior Participating Cumulative Preferred Stock, or in certain circumstances, either Common Stock or common stock of an acquiring company at one half the market price of such Common Stock or common stock, as the case may be. The rights will become exercisable if certain events occur with respect to the Company, including the acquisition by a person or group of 15% or more of the Company’s Common Stock. The Company can redeem the rights at $.01 per right in certain circumstances, including redemption until ten business days following a public announcement that 15% or more of the Company’s Common Stock has been acquired by a person or group.
Share owners have authorized 4,000,000 shares of Preferred Stock, $1.00 par value. Other terms, including preferences, voting, and conversion rights, may be established by the Board of Directors. In connection with the Rights Agreement, 400,000 of these shares have been designated as Series A Junior Participating Cumulative Preferred Stock, $1.00 par value, and were unissued at December 31, 2001. The remaining 3,600,000 shares of Preferred Stock, $1.00 par value, were also unissued at December 31, 2001.
The Company sponsors a deferred compensation plan for certain of its agents. A trust was established to aid the Company in meeting its obligations under the plan. Company Common Stock owned by the trust is accounted for as treasury stock.
The Company has an Employee Stock Ownership Plan (ESOP). The stock is used to match employee contributions to the Company’s 401(k) and Stock Ownership Plan (401(k) Plan) and to provide other employee benefits. The stock held by the ESOP that has not yet been used is the unallocated stock shown as a reduction to share-owners’ equity. The ESOP shares are dividend-paying and are considered outstanding for earnings per share calculations. Dividends on the shares are used to pay the ESOP’s note to Protective Life. If certain events associated with a change in control of the Company occur, any unallocated shares held by the ESOP will become allocable to employee 401(k) accounts.
The Company may, from time to time, reissue treasury shares or buy in the open market additional shares of Common Stock to complete its 401(k) obligations. Accordingly, in 2000, the Company reissued from treasury 14,126 shares of Common Stock to the 401(k) Plan and reissued from treasury another 30,721 shares during 2001.
Since 1973, the Company has had stock-based incentive plans to motivate management to focus on the Company’s long-range performance through the awarding of stock-based compensation. Under plans approved by share owners in 1997 and 1998, up to 5,000,000 shares may be issued in payment of awards.
The criteria for payment of performance awards is primarily based upon a comparison of the Company’s average return on average equity and total rate of return over a four year award period (earlier upon the death, disability, or retirement of the executive, or in certain circumstances, of a change in control of the Company) to that of a comparison group of publicly held life and multiline insurance companies. If the Company’s results are below the median of the comparison group, no portion of the award is earned. If the Company’s results are at or above the 90th percentile, the award maximum is earned.
In 1999, 99,380 performance shares were awarded, having an estimated fair value on the grant date of $3.4 million. In 2000, 3,330 performance shares and 513,618 stock appreciation rights (SARs) were awarded, having a combined estimated fair value on the grant date of $3.7 million. In 2001, 153,490 performance shares and 40,000 SARs were awarded having a combined estimated fair value on the grant date of $4.9 million. The SARs, if earned, expire after ten years.
A performance share is equivalent in value to one share of Company Common Stock. With respect to SARs, the Company will pay an amount equal to the difference between the specified base price of the Company’s Common Stock and the market value at the exercise date. Awards are paid in shares of Company Common Stock. At December 31, 2001, outstanding awards measured at maximum payouts were 423,362 performance shares and 853,236 SARs.
During 1996, 2000, and 2001, SARs were granted to certain officers of the Company to provide long-term incentive compensation based solely on the performance of the Company’s Common Stock. The SARs are exercisable after five years (earlier upon the death, disability, or retirement of the officer, or in certain circumstances, of a change in control of the Company) and expire after ten years or upon termination of employment. In 2000, 217,500 SARs were awarded, having an estimated fair value on the grant date of $1.5 million. In 2001, 62,500 SARs were awarded, having an estimated fair value on the grant date of $0.6 million. The number of SARs granted in 1996, 2000 and 2001, outstanding at December 31, 2001, was 660,000, 215,000, and 62,500, respectively.
The 1996 SARs have a base price of $17.4375. The 2000 SARs have a base price of $22.31. The 2001 SARs have a base price of $31.26 and $31.29. The fair value of the 2001 SARs was estimated using a Black-Scholes option pricing model. Assumptions used in the model were as follows: expected volatility of 26.4% (approximately equal to that of the S&P Life Insurance Index), a risk-free interest rate of 4.7%, a dividend rate of 1.9%, and an expected exercise date of 2007.
The expense recorded by the Company for its stock-based compensation plans was $5.6 million, $4.1 million, and $4.0 million in 2001, 2000, and 1999, respectively. The Company’s obligations of its stock-based compensation plans that are expected to be settled in shares of the Company’s Common Stock are reported as a component of share-owners’ equity.
The Company has established deferred compensation plans for directors, officers, and others. Compensation deferred is credited to the participants in cash, Common Stock equivalents, or a combination thereof. The Company may, from time to time, reissue treasury shares or buy in the open market shares of Common Stock to fulfill its obligation under the plans. At December 31, 2001, the plans had 1,406,692 shares of Common Stock equivalents credited to participants.
At December 31, 2001, approximately $282.1 million of consolidated share-owners’ equity, excluding net unrealized gains on investments, represented net assets of the Company’s insurance subsidiaries that cannot be transferred to Protective Life Corporation. In addition, the Company’s insurance subsidiaries are subject to various state statutory and regulatory restrictions on the insurance subsidiaries’ ability to pay dividends to Protective Life Corporation. In general, dividends up to specified levels are considered ordinary and may be paid thirty days after written notice to the insurance commissioner of the state of domicile unless such commissioner objects to the dividend prior to the expiration of such period. Dividends in larger amounts are considered extraordinary and are subject to affirmative prior approval by such commissioner. The maximum amount that would qualify as ordinary dividends to the Company by its insurance subsidiaries in 2002 is estimated to be $99.0 million.
8 Related Party Matters
Certain corporations with which the Company’s directors were affiliated paid the Company premiums and policy fees or other amounts for various types of insurance and investment products. Such premiums, policy fees, and other amounts totaled $19.6 million, $50.9 million, and $70.3 million in 2001, 2000, and 1999, respectively. The Company paid commissions, interest on debt and investment products, and fees to these same corporations totaling $5.9 million, $28.2 million, and $16.7 million in 2001, 2000, and 1999, respectively. In addition, the Company has a swap contract with a related party having a notional amount of $443.2 million, which to the Company was in a $24.8 million gain position at December 31, 2001.
9 Reconciliation with Statutory Reporting Practices and Other Regulatory Matters
Financial statements prepared in conformity with accounting principles generally accepted in the United States of America differ in some respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. The most significant differences are as follows: (a) acquisition costs of obtaining new business are deferred and amortized over the approximate life of the policies rather than charged to operations as incurred; (b) benefit liabilities are computed using a net level method and are based on realistic estimates of expected mortality, interest, and withdrawals as adjusted to provide for possible unfavorable deviation from such assumptions; (c) deferred income taxes are provided for temporary differences between financial and taxable earnings; (d) the Asset Valuation Reserve and Interest Maintenance Reserve are restored to share-owners’ equity; (e) furniture and equipment, agents’ debit balances, and prepaid expenses are reported as assets rather than being charged directly to surplus (referred to as nonadmitted assets); (f) certain items of interest income, such as mortgage and bond discounts, are amortized differently; and (g) bonds are recorded at their market values instead of amortized cost. The National Association of Insurance Commissioners (NAIC) has adopted the Codification of Statutory Accounting Principles (Codification). Codification changed statutory accounting rules in several areas and was effective January 1, 2001. The adoption of Codification did not have a material effect on the Company’s insurance subsidiaries’ statutory capital.
The reconciliations of net income and share-owners’ equity prepared in conformity with statutory reporting practices to that reported in the accompanying consolidated financial statements are as follows:
Net Income Share-Owners' Equity
-----------------------------------------------------------------------------
2001 2000 1999 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
In conformity with statutory
reporting practices1 $163,181 $69,927 $83,656 $775,138 $628,274 $598,655
Additions (deductions)
by adjustment:
Deferred policy acquisition
costs, net of amortization 163,243 157,617 120,644 1,532,683 1,189,380 1,011,524
Deferred income tax (3,871) (62,374) (27,970) (127,230) (79,066) 37,828
Asset Valuation Reserve 108,062 103,853 41,104
Interest Maintenance Reserve (10,444) (3,540) (226) 16,959 9,715 19,328
Nonadmitted items 184,310 97,447 51,350
Noninsurance affiliates (23,356) 28,100 2,584 819,950 790,975 904,762
Dividends paid on Guaranteed
Preferred Beneficial Interests (5,766) (9,461) (10,606)
Discontinued operations (193,688)
Consolidation elimination (2,207,562) (1,859,279) (1,411,392)
Other valuation and timing differences 13,644 (26,793) (16,755) 297,834 232,759 (387,936)
- -----------------------------------------------------------------------------------------------------------------------
In conformity with generally
accepted accounting principles $102,943 $153,476 $151,327 $1,400,144 $1,114,058 $865,223
=======================================================================================================================
(1) Consolidated
As of December 31, 2001, the Company’s insurance subsidiaries had on deposit with regulatory authorities, fixed maturity and short-term investments with a market value of approximately $81.9 million.
10 Operating Segments
The Company operates business segments each having a strategic focus which can be grouped into three general categories: life insurance, retirement savings and investment products, and specialty insurance products. An operating segment is generally distinguished by products and/or channels of distribution. A brief description of each segment follows.
Life Insurance
o The Life Marketing segment markets level premium term and term-like insurance, universal life, and variable universal life products on a national basis primarily through networks of independent insurance agents and brokers, and in the “bank owned life insurance” market.
o The Acquisitions segment focuses on acquiring, converting, and servicing policies acquired from other companies. The segment’s primary focus is on life insurance policies sold to individuals.
Retirement Savings and Investment Products
o The Stable Value Contracts segment markets guaranteed investment contracts to 401(k) and other qualified retirement savings plans. The segment also markets fixed and floating rate funding agreements to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds.
o The Annuities segment manufactures, sells, and supports fixed and variable annuity products. These products are primarily sold through stockbrokers, but are also sold through financial institutions and the Life Marketing segment’s sales force.
Specialty Insurance Products
o The Credit Products segment markets credit life and disability insurance products through banks, consumer finance companies, and automobile dealers, and markets vehicle and recreational marine extended service contracts.
Corporate and Other
The Company has an additional business segment herein referred to as Corporate and Other. The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on unallocated capital and interest on substantially all debt). This segment also includes earnings from several lines of business which the Company is not actively marketing (mostly cancer insurance and group annuities), various investment-related transactions, and the operations of several small subsidiaries.
The Company uses the same accounting policies and procedures to measure operating segment income and assets as it uses to measure its consolidated net income and assets. Operating segment income is generally income before income tax, adjusted to exclude any pretax minority interest in income of consolidated subsidiaries. Premiums and policy fees, other income, benefits and settlement expenses, and amortization of deferred policy acquisition costs are attributed directly to each operating segment. Net investment income is allocated based on directly related assets required for transacting the business of that segment. Realized investment gains (losses) and other operating expenses are allocated to the segments in a manner which most appropriately reflects the operations of that segment. Unallocated realized investment gains (losses) are deemed not to be associated with any specific segment.
Assets are allocated based on policy liabilities and deferred policy acquisition costs directly attributable to each segment.
There are no significant intersegment transactions.
The following table sets forth total operating segment income and assets for the periods shown. Adjustments represent the inclusion of unallocated realized investment gains (losses), the recognition of income tax expense, income from discontinued operations, extraordinary loss, and cumulative effect of change in accounting principle. Asset adjustments represent the inclusion of assets related to discontinued operations.
In December 2001, the Company sold substantially all of its Dental Division and discontinued other Dental related operations. Additionally, other adjustments were made to combine its life insurance marketing operations into a single segment, and to reclassify certain smaller businesses. Prior period segment results have been restated to reflect these changes.
LIFE INSURANCE
--------------------------------------
LIFE
OPERATING SEGMENT INCOME MARKETING ACQUISITIONS
- --------------------------------------------------------------------------------------------------------------------
2001
Premiums and policy fees $ 542,406 $ 243,915
Reinsurance ceded (421,411) (61,482)
- --------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 120,995 182,433
Net investment income 179,346 187,535
Realized investment gains (losses)
Other income 70,913 682
- --------------------------------------------------------------------------------------------------------------------
Total revenues 371,254 370,650
- --------------------------------------------------------------------------------------------------------------------
Benefits and settlement expenses 190,538 238,877
Amortization of deferred policy acquisition costs and goodwill 41,868 20,501
Other operating expenses 49,274 43,232
- --------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 281,680 302,610
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income tax 89,574 68,040
Income tax expense
Discontinued operations, net of income tax
Change in Accounting Principle, net of income tax
- --------------------------------------------------------------------------------------------------------------------
Net income
====================================================================================================================
2000
Premiums and policy fees $ 487,720 $ 134,099
Reinsurance ceded (387,907) (31,102)
- --------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 99,813 102,997
Net investment income 152,511 116,940
Realized investment gains (losses)
Other income 70,335 (4)
- --------------------------------------------------------------------------------------------------------------------
Total revenues 322,659 219,933
- --------------------------------------------------------------------------------------------------------------------
Benefits and settlement expenses 149,430 125,151
Amortization of deferred policy acquisition costs and goodwill 49,111 17,081
Other operating expenses 47,521 24,939
- --------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 246,062 167,171
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income tax 76,597 52,762
Income tax expense
Discontinued operations, net of income tax
- --------------------------------------------------------------------------------------------------------------------
Net income
====================================================================================================================
1999
Premiums and policy fees $ 361,824 $ 148,620
Reinsurance ceded (246,111) (33,754)
- --------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 115,713 114,866
Net investment income 138,198 129,806
Realized investment gains (losses)
Other income 47,780 (9)
- --------------------------------------------------------------------------------------------------------------------
Total revenues 301,691 244,663
- --------------------------------------------------------------------------------------------------------------------
Benefits and settlement expenses 147,631 129,581
Amortization of deferred policy acquisition costs and goodwill 29,538 19,444
Other operating expenses 66,334 31,967
- --------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 243,503 180,992
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income tax 58,188 63,671
Income tax expense
Discontinued operations, net of income tax
Extraordinary loss, net of income tax
- --------------------------------------------------------------------------------------------------------------------
Net income
====================================================================================================================
Operating Segment Assets
2001
Investments and other assets $3,433,099 $4,087,470
Deferred policy acquisition costs and goodwill 839,375 418,268
- --------------------------------------------------------------------------------------------------------------------
Total assets $4,272,474 $4,505,738
====================================================================================================================
2000
Investments and other assets $2,846,551 $1,602,352
Deferred policy acquisition costs and goodwill 710,468 222,620
- --------------------------------------------------------------------------------------------------------------------
Total assets $3,557,019 $1,824,972
====================================================================================================================
(1)Adjustments to net income represent the inclusion of unallocated realized investment gains (losses), and the recognition of income tax expense, income from discontinued operations, extraordinary loss, and cumulative effect of change in Accounting Principle. Asset adjustments represent the inclusion of assets related to discontinued operations.
RETIREMENT SAVINGS AND SPECIALTY INSURANCE
INVESTMENT PRODUCTS PRODUCTS
- -------------------------------------------------------------------------------------------------------------------
STABLE VALUE CREDIT CORPORATE TOTAL
CONTRACTS ANNUITIES PRODUCTS AND OTHER ADJUSTMENTS(1) CONSOLIDATED
- -------------------------------------------------------------------------------------------------------------------
$ 28,145 $ 524,281 $ 51,073 $ 1,389,820
(274,220) (14,038) (771,151)
- -------------------------------------------------------------------------------------------------------------------
28,145 250,061 37,035 618,669
$ 261,079 167,905 48,940 39,236 884,041
7,218 1,139 $ (28,528) (20,171)
10,547 46,636 2,900 131,678
- -------------------------------------------------------------------------------------------------------------------
268,297 207,736 345,637 79,171 1,614,217
- -------------------------------------------------------------------------------------------------------------------
222,306 137,204 154,893 28,806 972,624
1,662 24,021 60,756 1,805 150,613
3,961 29,434 96,028 59,455 281,384
- -------------------------------------------------------------------------------------------------------------------
227,929 190,659 311,677 90,066 1,404,621
- -------------------------------------------------------------------------------------------------------------------
40,368 17,077 33,960 (10,895) 209,596
68,538 68,538
(30,522) (30,522)
(7,593) (7,593)
- -------------------------------------------------------------------------------------------------------------------
102,943
===================================================================================================================
$ 30,127 $ 479,352 $ 44,600 $ 1,175,898
(258,931) (8,168) (686,108)
- -------------------------------------------------------------------------------------------------------------------
30,127 220,421 36,432 489,790
$ 243,132 132,314 47,029 38,223 730,149
(6,556) 410 $ (897) (7,043)
11,486 41,325 28,691 151,833
- -------------------------------------------------------------------------------------------------------------------
236,576 174,337 308,775 103,346 1,364,729
- -------------------------------------------------------------------------------------------------------------------
207,143 109,607 135,494 33,953 760,778
900 24,156 52,893 2,152 146,293
3,881 25,403 88,197 56,042 245,983
- -------------------------------------------------------------------------------------------------------------------
211,924 159,166 276,584 92,147 1,153,054
- -------------------------------------------------------------------------------------------------------------------
24,652 15,171 32,191 11,199 211,675
74,321 74,321
16,122 16,122
- -------------------------------------------------------------------------------------------------------------------
$ 153,476
===================================================================================================================
$ 24,248 $ 284,897 $ 41,438 $ 861,027
(176,928) (5,504) (462,297)
- -------------------------------------------------------------------------------------------------------------------
24,248 107,969 35,934 398,730
$ 210,208 106,645 24,506 58,605 667,968
(549) 1,446 (1,954) (1,057)
9,628 27,456 4,825 89,680
- ------------------------------------------------------------------------------------------------------------------
209,659 141,967 159,931 99,364 1,155,321
- ------------------------------------------------------------------------------------------------------------------
175,290 88,642 55,899 32,613 629,656
744 19,820 24,966 2,493 97,005
4,709 21,014 57,134 44,113 225,271
- ------------------------------------------------------------------------------------------------------------------
180,743 129,476 137,999 79,219 951,932
- ------------------------------------------------------------------------------------------------------------------
28,916 12,491 21,932 20,145 203,389
71,941 71,941
21,642 21,642
1,763 1,763
- ------------------------------------------------------------------------------------------------------------------
$ 151,327
==================================================================================================================
$3,872,636 $4,507,289 $1,060,967 $1,063,373 $113,145 $18,137,979
6,375 128,488 179,606 8,733 1,580,845
- ------------------------------------------------------------------------------------------------------------------
$3,879,011 $4,635,777 $1,240,573 $1,072,106 $113,145 $19,718,824
==================================================================================================================
$3,340,099 $3,842,656 $1,232,950 $ 623,796 $217,527 $13,705,931
2,144 126,636 152,964 10,100 214,770 1,439,702
- ------------------------------------------------------------------------------------------------------------------
$3,342,243 $3,969,292 $1,385,914 $ 633,896 $432,297 $15,145,633
==================================================================================================================
11 Employee Benefit Plans
The Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee’s highest thirty-six consecutive months of compensation. The Company’s funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements of ERISA plus such additional amounts as the Company may determine to be appropriate from time to time. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.
The actuarial present value of benefit obligations and the funded status of the plan at December 31 are as follows:
2001 2000
- ------------------------------------------------------------------------------------------------------------------
Projected benefit obligation, beginning of the year $45,538 $36,530
Service cost - benefits earned during the year 3,739 3,338
Interest cost - on projected benefit obligation 3,531 3,195
Actuarial gain (loss) (357) 1,968
Plan amendment 1,162 833
Divestiture (2,165)
Benefits paid (579) (326)
- ------------------------------------------------------------------------------------------------------------------
Projected benefit obligation, end of the year 50,869 45,538
- ------------------------------------------------------------------------------------------------------------------
Fair value of plan assets beginning of the year 40,822 34,420
Actual return on plan assets (1,440) (148)
Employer contribution 5,221 6,876
Benefits paid (579) (326)
- ------------------------------------------------------------------------------------------------------------------
Fair value of plan assets end of the year 44,024 40,822
- ------------------------------------------------------------------------------------------------------------------
Plan assets less than the projected benefit obligation (6,845) (4,716)
Unrecognized net actuarial loss from past experience different from that assumed 10,213 7,766
Unrecognized prior service cost 2,026 1,226
- ------------------------------------------------------------------------------------------------------------------
Net pension asset (liability) recognized in balance sheet $ 5,394 $ 4,276
==================================================================================================================
Net pension cost of the defined benefit pension plan includes the following components for the years ended December 31:
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Service cost $ 3,739 $3,338 $3,270
Interest cost 3,531 3,195 2,779
Expected return on plan assets (3,669) (3,049) (2,348)
Amortization of prior service cost 176 176 115
Amortization of transition asset (17) (17)
Amortization of losses 141
Recognized net actuarial loss 494
Cost of divestiture 186
- ------------------------------------------------------------------------------------------------------------------
Net pension cost $ 4,104 $3,643 $4,293
==================================================================================================================
Assumptions used to determine the benefit obligations as of December 31 were as follows:
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Weighted average discount rate 7.25% 7.50% 8.00%
Rates of increase in compensation level 5.00 5.25 5.75
Expected long-term rate of return on assets 8.50 8.50 8.50
==================================================================================================================
At December 31, 2001, approximately $7.2 million of the assets of the pension plan were in a group annuity contract with Protective Life and therefore are included in the general assets of Protective Life. Approximately $36.8 million of the assets of the pension plan are invested in a collective trust managed by Northern Trust Corporation.
Prior to July 1999, upon retirement, the amount of pension plan assets vested in the retiree were used to purchase a single premium annuity from Protective Life in the retiree’s name. Therefore, amounts presented above as plan assets exclude assets relating to such retirees. Beginning July 1999, retiree obligations are being fulfilled from pension plan assets.
The Company also sponsors an unfunded excess benefits plan, which is a nonqualified plan that provides defined pension benefits in excess of limits imposed on qualified plans by federal tax law. At December 31, 2001 and 2000, the projected benefit obligation of this plan totaled $15.9 million and $14.4 million, respectively, of which $13.8 million and $10.5 million, respectively, have been recognized in the Company’s financial statements.
Net pension costs of the excess benefits plan includes the following components for the years ended December 31:
2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------
Service cost $ 686 $ 736 $ 695
Interest cost 1,121 1,067 887
Amortization of prior service cost 19 19 113
Amortization of transition asset 37 37 37
Recognized net actuarial loss 233 194 265
Cost of divestiture and special termination benefits 1,807
- -----------------------------------------------------------------------------------------------------------------
Net pension cost $3,903 $2,053 $1,997
=================================================================================================================
In addition to pension benefits, the Company provides limited healthcare benefits to eligible retired employees until age 65. The postretirement benefit is provided by an unfunded plan. At December 31, 2001 and 2000, the liability for such benefits was approximately $1.2 million. The expense recorded by the Company was approximately $0.1 million in 2001, 2000, and 1999. The Company’s obligation is not materially affected by a 1% change in the healthcare cost trend assumptions used in the calculation of the obligation.
Life insurance benefits for retirees are provided through the purchase of life insurance policies upon retirement from $10,000 up to a maximum of $75,000. This plan is partially funded at a maximum of $50,000 face amount of insurance.
The Company sponsors a defined contribution retirement plan which covers substantially all employees. Employee contributions are made on a before-tax basis as provided by Section 401(k) of the Internal Revenue Code. The Company has established an Employee Stock Ownership Plan (ESOP) to match voluntary employee contributions to the Company’s 401(k) Plan. In 1994, a stock bonus was added to the 401(k) Plan for employees who are not otherwise under a bonus or sales incentive plan. Expense related to the ESOP consists of the cost of the shares allocated to participating employees plus the interest expense on the ESOP’s note payable to the Company less dividends on shares held by the ESOP. All shares held by the ESOP are treated as outstanding for purposes of computing earnings per share. At December 31, 2001, the Company had committed approximately 166,861 shares to be released to fund employee benefits. The expense recorded by the Company for these employee benefits was less than $0.1 million in 2001, 2000, and 1999.
12 Reinsurance
The Company reinsures certain of its risks with, and assumes risks from, other insurers under yearly renewable term, coinsurance, and modified coinsurance agreements. Under yearly renewable term agreements, the Company generally pays specific premiums to the reinsurer and receives specific amounts from the reinsurer as reimbursement for certain expenses. Coinsurance agreements are accounted for by passing a portion of the risk to the reinsurer. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of all benefit payments. Modified coinsurance is accounted for similarly to coinsurance except that the liability for future policy benefits is held by the original company, and settlements are made on a net basis between the companies. A substantial portion of the Company’s new life insurance and credit insurance sales is being reinsured. The Company reviews the financial condition of its reinsurers and monitors the amount of reinsurance it has with its reinsurers.
The Company has reinsured approximately $169.5 billion, $126.0 billion, and $93.5 billion in face amount of life insurance risks with other insurers representing $565.1 million, $496.4 million, and $364.7 million of premium income for 2001, 2000, and 1999, respectively. The Company has also reinsured accident and health risks representing $122.7 million, $125.8 million, and $97.1 million of premium income for 2001, 2000, and 1999, respectively. In 2001 and 2000, policy and claim reserves relating to insurance ceded of $2,059.0 million and $988.4 million, respectively, are included in reinsurance receivables. Should any of the reinsurers be unable to meet its obligation at the time of the claim, obligation to pay such claim would remain with the Company. At December 31, 2001 and 2000, the Company had paid $46.4 million and $33.5 million, respectively, of ceded benefits which are recoverable from reinsurers. In addition, at December 31, 2001, the Company had receivables of $69.3 million related to insurance assumed. Included in these receivables are $51.2 million related to the sale of the Company’s Dental Division, and $783.9 million related to fixed annuities that were ceded in conjunction with the October 2001 acquisition of two small insurers.
13 Estimated Fair Values of Financial Instruments
The carrying amounts and estimated fair values of the Company’s financial instruments at December 31 are as follows:
2001 2000
------------------------------------------------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNTS VALUES AMOUNTS VALUE
- ------------------------------------------------------------------------------------------------------------------
Assets (see Notes 1 and 2):
Investments:
Fixed maturities $9,838,091 $9,838,091 $7,415,769 $7,415,769
Equity securities 76,774 76,774 58,700 58,700
Mortgage loans on real estate 2,512,844 2,671,074 2,268,224 2,385,174
Short-term investments 237,155 237,155 189,161 189,161
Cash 126,558 126,558 55,494 55,494
Liabilities (see Notes 1 and 4):
Stable value contract account balances 3,716,530 3,821,955 3,177,863 3,250,991
Annuity account balances 3,248,217 3,166,052 1,916,894 1,893,749
Debt:
Senior and Medium-Term Notes 369,241 378,418 303,810 305,987
8.25% Trust Originated Preferred Securities 75,000 74,400 75,000 73,890
7.5% Trust Originated Preferred Securities 100,000 96,960
6.5% FELINE PRIDES 115,000 118,450
Other (see Note 1):
Derivative Financial Instruments (21,865) (21,865) (7,334) (12,296)
==================================================================================================================
Except as noted below, fair values were estimated using quoted market prices.
The Company estimates the fair value of its mortgage loans using discounted cash flows from the next call date.
The Company believes the fair value of its short-term investments and notes payable to banks approximates book value due to being either short-term or having a variable rate of interest.
The Company estimates the fair value of its guaranteed investment contracts and annuities using discounted cash flows and surrender values, respectively.
The Company believes it is not practicable to determine the fair value of its policy loans since there is no stated maturity, and policy loans are often repaid by reductions to policy benefits.
The Company estimates the fair value of its derivative financial instruments using market quotes or derivative pricing models. The fair values represent the net amount of cash the Company would have received (or paid) had the contracts been terminated on December 31.
14 Consolidated Quarterly Results - Unaudited
Protective Life Corporation’s unaudited consolidated quarterly operating data for the years ended December 31, 2001 and 2000, are presented below. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of quarterly results have been reflected in the data which follow. It is also management’s opinion, however, that quarterly operating data for insurance enterprises are not indicative of results to be achieved in succeeding quarters or years. In order to obtain a more accurate indication of performance, there should be a review of operating results, changes in share-owners’ equity, and cash flows for a period of several quarters.
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
- ---------------------------------------------------------------------------------------------------------------------
2001
Premiums and policy fees $311,545 $324,597 $332,739 $420,939
Reinsurance ceded (143,716) (176,689) (184,629) (266,117)
- ---------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 167,829 147,908 148,110 154,822
Net investment income 206,505 212,970 222,759 241,807
Realized investment gains (losses) 9,091 (7,520) (752) (20,990)
Other income 28,412 29,020 37,205 37,041
- ---------------------------------------------------------------------------------------------------------------------
Total revenues 411,837 382,378 407,322 412,680
Benefits and expenses 348,240 333,625 349,827 372,929
- ---------------------------------------------------------------------------------------------------------------------
Income from continuing operations
before income tax 63,597 48,753 57,495 39,751
Income tax expense 21,921 15,751 18,419 12,447
- ---------------------------------------------------------------------------------------------------------------------
Net income from continuing operations 41,676 33,002 39,076 27,304
Discontinued Operations 3,964 (5,855) 3,548 (32,179)
Change in Accounting Principle (7,593)
- ---------------------------------------------------------------------------------------------------------------------
Net income $38,047 $27,147 $42,624 $(4,875)
=====================================================================================================================
Net income from continuing operations
per share - basic $ .61 $ .47 $ .56 $ .38
Net income per share - basic $ .56 $ .39 $ .61 $ (.08)
Average shares outstanding - basic 67,824,547 69,978,779 69,954,622 69,855,582
Operating income1 per share - diluted $ .52 $ .54 $ .56 $ .59
Net income from continuing operations
per share - diluted $ .61 $ .46 $ .56 $ .38
Net income per share - diluted $ .56 $ .38 $ .61 $ (.08)
Average shares outstanding - diluted 68,315,388 70,507,398 70,459,522 70,488,901
====================================================================================================================
2000
Premiums and policy fees $269,669 $305,647 $289,711 $310,871
Reinsurance ceded (144,572) (175,646) (163,360) (202,530)
- --------------------------------------------------------------------------------------------------------------------
Net of reinsurance ceded 125,097 130,001 126,351 108,341
Net investment income 171,432 182,753 185,795 190,169
Realized investment gains (losses) 2,696 (3,106) (4,646) (1,987)
Other income 55,863 34,877 31,028 30,065
- --------------------------------------------------------------------------------------------------------------------
Total revenues 355,088 344,525 338,528 326,588
Benefits and expenses 289,304 292,136 293,967 277,647
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations
before income tax 65,784 52,389 44,561 48,941
Income tax expense 23,289 18,307 15,618 17,107
- --------------------------------------------------------------------------------------------------------------------
Net income from continuing operations 42,495 34,082 28,943 31,834
Discontinued Operations 540 5,220 5,036 5,326
- --------------------------------------------------------------------------------------------------------------------
Net income $43,035 $39,302 $33,979 $37,160
====================================================================================================================
Net income from continuing operations
per share - basic $ .64 $ .52 $ .45 $ .48
Net income per share - basic $ .65 $ .60 $ .52 $ .56
Average shares outstanding - basic 65,717,818 65,761,522 65,912,449 65,935,592
Operating income1 per share - diluted $ .63 $ .54 $ .48 $ .50
Net income from continuing operations
per share - diluted $ .64 $ .51 $ .45 $ .48
Net income per share - diluted $ .65 $ .59 $ .52 $ .56
Average shares outstanding - diluted 66,148,004 66,277,100 66,350,622 66,347,295
====================================================================================================================
(1) Net income from continuing operations excluding realized investment gains and losses and related amortization, extraordinary loss, and change in Accounting Principle.