Concurrent with implementing the new Agreement, the Company recaptured the Term reinsurance previously reinsured under a coinsurance treaty with an affiliated offshore captive company, Pruco Re Ltd. The agreement had covered all term policies written on or after October 1, 2002. As a result of this recapture, the Company recognized a net gain of $1.2 million.
The new coinsurance agreement with PARCC also replaces the yearly renewable term agreements with external reinsurers that were previously in effect on this block of business. However, similar yearly renewable term agreements on this block of business have been placed with external reinsurers, through affiliated companies. There was no net cost associated with the initial transaction and initial transactions were accounted for in accordance with FAS 113, “Accounting and Reporting for Reinsurance of Short and Long Duration Contracts”. Reinsurance recoverables related to this transaction were $178.5 million as of September 30, 2004.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Pruco Life Insurance Company meets the conditions set forth in General Instruction H(1)(a) and (b) on Form 10-Q and is therefore filing this form with the reduced disclosure format.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) addresses the consolidated financial condition of Pruco Life Insurance Company as of September 30, 2004, compared with December 31, 2003, and its consolidated results of operations for the three and nine month periods ended September 30, 2004 and September 30, 2003. You should read the following analysis of our consolidated financial condition and results of operations in conjunction with the Company’s MD&A and audited Consolidated Financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, and Consolidated Financial Statements (unaudited) included elsewhere in this Quarterly Report on Form 10-Q.
The Company sells interest-sensitive individual life insurance, variable life insurance, term life insurance, individual variable annuities, and a non-participating guaranteed interest contract (“GIC”) called Prudential Credit Enhanced GIC (“PACE”), primarily through Prudential Insurance’s sales force in the United States. These markets are subject to regulatory oversight with particular emphasis placed on company solvency and sales practices. These markets are also subject to increasing competitive pressure as the legal barriers, which have historically segregated the markets of the financial services industry, have been changed through both legislative and judicial processes. Regulatory changes have opened the insurance industry to competition from other financial institutions, particularly banks and mutual funds that are positioned to deliver competing investment products through large, stable distribution channels. The Company also had marketed individual life insurance through its branch office in Taiwan. The Taiwan branch was transferred to an affiliated Company on January 31, 2001. Beginning February 1, 2001, all insurance activity of the Taiwan branch has been ceded to the affiliated Company. The Company had also marketed a non-participating guaranteed interest contract (“GIC”) called Prudential Credit Enhanced GIC (“PACE”) under an agreement with MBIA (the Insurance and Reimbursement Agreement) that expired June 30,2004. The Company did not seek an extension of the agreement. The termination of sales of this product has no impact on the existing in force contracts of PACE GIC customers.
Generally, policyholders who purchase the Company’s products have the option of investing in the separate accounts, segregated funds for which investment risks are borne by the customer, or the Company’s portfolio, referred to as the “general account”. The Company earns its profits through policy fees charged to separate account annuity and life policyholders and through the interest spread for the GIC and general account annuity and life products. Policy charges and fee income consist mainly of three types, sales charges or loading fees on new sales, mortality and expense charges (“M&E”) assessed on fund balances, and mortality and related charges based on total life insurance in-force business. Policyholder fund values are affected by net sales (sales less withdrawals), changes in interest rates and investment returns. The interest spread represents the difference between the investment income earned by the Company on its investment portfolio and the amount of interest credited to policyholders’ accounts. Products that generate interest spread primarily include the GIC product, general account life insurance products, fixed annuities and the fixed-rate option of variable annuities.
In addition to policy charges and fee income, the Company earns revenues from insurance premiums from term life insurance and asset management fees on the separate account fund balances. The Company’s operating expenses principally consist of insurance benefits provided, general business expenses, commissions and other costs of selling and servicing the various products we sell and interest credited on general account liabilities.
The Company’s Changes in Financial Position and Results of Operations are described below.
| 1. | Analysis of Financial Condition |
From December 31, 2003 to September 30, 2004 total assets increased $1.1 billion, from $25.2 billion to $26.3 billion. Fixed maturities increased by $425 million mainly as a result of the implementation of Statement of Position 03-1 (“SOP 03-1”). SOP 03-1 requires among other things, that certain individual market value adjusted annuity (“MVA”) contracts be accounted for under general account accounting treatment. As a result of the adoption, approximately $400 million of fixed maturities formerly classified as separate account assets were reclassified as general account fixed maturities. Separate account assets increased by $320 million despite the reclassification of approximately $400 million of assets to general account accounting treatment, due to positive market performance of approximately $419 million and positive net sales. Reinsurance recoverables increased $157 million as a result of larger ceded reserves held under the new coinsurance agreement mentioned above. Deferred acquisition costs ("DAC") decreased by $24 million from December 31, 2003 driven by $143 million in capitalization of acquisition expenses, a $23 million DAC increase from the implementation of SOP 03-1 and a decrease in "shadow DAC" of $34 million. This was partially offset by $156 million of amortization. Capitalization in the Life business included ceded DAC of $134 million resulting from capitalization of initial reinsurance ceding allowances that are part of the new coinsurance agreement mentioned above. The $17 million of shadow DAC is shown in the amortization and other non-cash items line on the Statements of Cash Flows.
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During this nine-month period, liabilities increased by $1.0 billion, from $23.4 billion to $24.4 billion. Policyholder account balances increased by $491 million due primarily to the reclassification of MVA contracts as described above and positive net sales. Future policy benefits increased by $169 million due to increased Taiwan reserves and the establishment of guaranteed minimum death benefit reserves (“GMDB”) of $45 million on January 1, 2004. Corresponding with the asset change, separate account liabilities increased by $320 million, as described above.
September 2004 to September 2003 Three Month Comparison
Net Income
Consolidated net income of $29 million for the third quarter of 2004 was $10 million higher than the third quarter of 2003. Increases in fees from higher sales and asset based revenues in the current quarter, higher net investment income from an increased asset base and a more favorable effective tax rate from the impact of increased dividends received deductions. Partially offsetting the above are increased DAC amortization, higher general and administrative expense levels and realized capital losses. Further details regarding the components of revenues and expenses are described in the following paragraphs.
Revenues
Consolidated revenues increased by $4 million, from $275 million in the prior year quarter to $279 million. Policy charges and fee income, consisting primarily of mortality and expense, loading and other insurance charges assessed on general and separate account policyholder fund balances, increased by $19 million. The increase was a result of a $11 million increase for individual life products and an $8 million increase for annuity products. Policy charges for life products increased as a result of growth in the in-force business, the favorable impact of increases in the market value of variable life insurance assets, and the sale of newer interest-sensitive products that generally carry higher expense charges in the first few years of the contract. The gross variable life in-force business grew to $75 billion at September 30, 2004 from $69 billion at September 30, 2003 and $71 billion at December 31, 2003. Annuity fees are mainly asset based fees which are dependent on the fund balances that are affected by net sales as well as asset depreciation or appreciation on the underlying investment funds in which the customer has the option to invest. Annuity separate account fund balances are higher than in the prior year quarter as a result of favorable market performance and positive net sales.
Net premiums decreased $25 million from the prior year quarter due to increases reinsurance premiums resulting from the coinsurance agreement with PARCC to reinsure the entire term business. This agreement replaced the previous coinsurance with Pruco Re Ltd. which reinsured only certain term business of the Company. The new agreement covers all term policies written by both the Company and its wholly owned subsidiary, Pruco Life Insurance Company of New Jersey. All term business not previously covered by the Pruco Re Coinsurance agreement was reinsured with yearly renewable term reinsurance carrying lower premiums than coinsurance. Extended term premiums increased by $1 million due to more policy lapses. Premiums for annuity contracts with life contingencies were essentially unchanged from the prior year quarter.
Net investment income increased by $8 million as a result of increased income from fixed maturities due to an increase in the annuity portfolio balance from the reclassification of fixed maturities from the separate account to the general account, reinvestment of income, and positive cash flows. This was partially offset by lower income from lower fund balances in retirement business.
Other income increased by $4 million due to higher expense recovery allowances received from the PARCC term coinsurance agreement.
Benefits and Expenses
Total policyholder benefits, including changes in reserves, decreased by $15 million, compared to the prior year quarter, mainly due to a $16.0 million net decrease in life reserves from the PARCC Agreement described above. Increases in gross term reserves from increased sales and a growing in-force were more than offset by increased ceded reserves.
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The change in annuity reserves increased by under $1 million, primarily due to increased annuitizations. There was relatively no change during the current quarter in the GMDB reserves established as of January 1, 2004. Increases to GMDB reserves based on gross profits were mostly offset by decreases due to benefit payments described below.
Policyholder benefits for life insurance products, net of reinsurance, were essentially unchanged from the prior year quarter.
Interest credited to policyholder account balances increased by $5 million over the prior year quarter due to growth in policyholder account balances, primarily from the reclassification of the MVA annuity products from separate account to policyholder account balances. Partially offsetting this increase was a decrease of $2 million in interest credited for GICs as the associated policyholder account balances decreased during 2004 due to scheduled withdrawals and large sales in the prior year period not repeated in the current year period and the termination of sales of the product effective July 1, 2004.
General, administrative, and other expenses increased $13 million from the prior year period, largely due to higher DAC amortization of $8 million. DAC amortization for life products increased by $4 million as a result of the growing in-force business and comparatively less favorable fund performance in the current quarter. DAC amortization for annuity products was higher by $4 million due to increased gross profits. There was also an increase in commission expense and general and administrative expenses, net of capitalization, of $5 million due to growth in both the annuity and life businesses.
September 2004 to September 2003 Nine Month Comparison
Net Income
Consolidated net income of $77 million for the nine months of 2004 was $18 million higher than for the first nine months of 2003. Net income before the cumulative change in accounting principle related to the adoption of SOP 03-1 was $27 million higher than the prior year. The effect of the cumulative change in accounting principle was a charge to income of $9 million after tax in the first quarter of 2004. This charge is caused primarily by an increase in reserves for guaranteed minimum death benefits relating to our individual variable annuity contracts offset by the impact of converting certain MVA contracts from separate account accounting treatment to general account accounting treatment. Increases in fees from asset-based revenues, higher net investment income from an increased asset base and a non-recurring favorable adjustment to our state income tax liabilities and lower effective tax rate were offset by higher interest credited to policyholders’ accounts and general and administrative levels. Further details regarding the components of revenues and expenses are described below.
Revenues
Consolidated revenues increased $52 million, from $809 million in the first nine months of 2003 to $860 million in the current year period. Policy charges and fee income, consisting primarily of mortality and expense, loading and other insurance charges assessed on general and separate account policyholder fund balances, increased by $57 million. The increase was a result of a $30 million and $27 million increase in the individual life and annuity businesses, respectively. Policy charges for life products increased as a result of growth in the in-force business, the favorable impact of increases in the market value of variable life insurance assets, and the sale of newer interest-sensitive products that generally carry higher expense charges in the first few years of the contract. The variable life in-force business grew to $75 billion at September 30, 2004 from $69 billion at September 30, 2003 and $71 billion at December 31, 2003. Annuity fees are mainly asset based fees which are dependent on the fund balances that are affected by net sales as well as asset depreciation or appreciation on the underlying investment funds in which the customer has the option to invest. Annuity separate account fund balances are higher than in the prior year quarter as a result of favorable market performance and positive net sales.
Net investment income increased by $25 million as a result of increased income in fixed maturities due to an increase in the portfolio balance from the reclassification of fixed maturities from the annuity separate accounts to the general account, reinvestment of income, and positive cash flows. This was partially offset by lower income from lower fund balances in retirement business and the effect of a lower asset base in the life business.
Other income increased by $17 million due to higher expense recovery allowances received from the PARCC and Pruco Re Ltd. term coinsurance agreements mentioned above.
Net premiums decreased by $51 million from the prior year period due to increased reinsurance premiums resulting from the coinsurance agreement with PARCC to reinsure the entire term business. This agreement replaced the previous coinsurance with Pruco Re Ltd., which reinsured only certain term business with the Company. The new agreement covers all term policies written by both the Company and its wholly owned subsidiary, Pruco Life Insurance Company of New Jersey. All term business not previously covered by the Pruco Re Coinsurance agreement was reinsured with yearly renewable term reinsurance carrying lower premiums than coinsurance.
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Extended term premiums decreased by $13 million due to lower policy lapses from better market performance in the current year. Premiums for annuity contracts with life contingencies were essentially unchanged from the prior year quarter.
Benefits and Expenses
Total policyholder benefits decreased by $44 million from the prior year period,primarily as a result of lower benefits for the annuity and life businesses of $10 million and $32 million, respectively.
The change in reserves for life products decreased $27 million from the prior year period,primarily as a result of a decrease in term life, net of reinsurance. Decreases from lower extended term insurance were mostly offset by an increase in deferred policy charge revenue resulting from increased sales of variable and universal life products. The change in annuity reserves increased slightly, due to increased annuitizations. There was relatively no change during the first nine months in the GMDB reserves that were established as of January 1, 2004. Increases to GMDB reserves based on gross profits were mostly offset by decreases due to benefit payments described below.
Annuity death benefits were lower by $10 million, primarily due to lower guaranteed minimum death benefits driven by higher fund values as a result of market appreciation. Policyholder benefits for life insurance products decreased by $7 million, driven by lower surrenders of reduced paid up policies of $9 million, partly offset by higher net death benefits of $2 million due to an increasing in-force.
Interest credited to policyholder account balances increased by $22 million due to growth in average policyholder account balances in the life and annuity business including the reclassification of the MVA annuity products from separate account to policyholder account balances. Partially offsetting the increase from the annuity products was a decrease of $8 million in interest credited for GICs as the associated policyholder account balances declined during 2004 due to scheduled withdrawals and the termination of sales of the product effective July 1, 2004.
General, administrative, and other expenses increased $64 million from the prior year period. The primary reason for the increase was an increase in DAC amortization of $43 million. DAC amortization for life products increased by $27 million as a result of the growing term life in-force business and comparatively less favorable fund performance in the current quarter. DAC amortization for annuity products was higher by $16 million due to increased gross profits. There was also an increase in commission expense and general and administrative expenses of $21 million due to growth in both the annuity and life businesses.
Item 4.Controls and Procedures
In order to ensure that the information we must disclose in our filings with the Securities and Exchange Commission is recorded, processed, summarized, and reported on a timely basis, the Company’s management, including our Chief Executive Officer and Chief Financial Officer, have reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of September 30, 2004. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2004, our disclosure controls and procedures were effective in timely alerting them to material information relating to us required to be included in our periodic SEC filings. There has been no change in our internal control over financial reporting during the quarter ended September 30, 2004, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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| Item 1. Legal Proceedings |
The Company is subject to legal and regulatory actions in the ordinary course of its businesses, including class actions. Pending legal and regulatory actions include proceedings relating to aspects of the businesses and operations that are specific to the Company and that are typical of the businesses in which the Company operates. Class action and individual lawsuits involve a variety of issues and/or allegations, which include sales practices, underwriting practices, claims payment and procedures, premium charges, policy servicing and breach of fiduciary duties to customers. The Company is also subject to litigation arising out of its general business activities, such as its investments and third party contracts. In certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages.
The Company’s litigation is subject to many uncertainties, and given the complexity and scope, the outcomes cannot be predicted. It is possible that the results of operations or the cash flow of the Company in a particular quarterly or annual period could be materially affected by an ultimate unfavorable resolution of pending litigation and regulatory matters. Management believes, however, that the ultimate outcome of all pending litigation and regulatory matters should not have a material adverse effect on the Company’s financial position.
| 3(i) | | | Articles of Incorporation of the registrant (incorporated by reference to Exhibit A(6)(a) to the Registration Statement on Form S-6 of Pruco Life Variable Appreciable Account (File No. 333-07451)).* | |
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| 3(ii) | | | By-Laws of the registrant incorporated by reference to Exhibit 3(ii) to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 20, 1997 (File No. 033-37587).* | |
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| 4(a) | | | Modified Guaranteed Annuity Contract incorporated by reference to the registrant’s Registration Statement on Form S-1 as filed November 2, 1990, Registration No. 33-37587.* | |
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| 4(b) | | | Market-Value Adjustment Annuity Contract incorporated by reference to Exhibit 4(a) to the Registration Statement on Form N-4 of Pruco Life Flexible Premium Variable Annuity Account (Discovery Preferred Variable Annuity) (File No. 33-61125).* | |
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| 4(c) | | | Market-Value Adjustment Annuity Contract incorporated by reference to Exhibit 4(a) to the Registration Statement on Form N-4 of Pruco Life Flexible Premium Variable Annuity Account (Discovery Select Variable Annuity) (File No. 333-06701).* | |
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| 4(d) | | | Market-Value Adjustment Contract incorporated by reference to Exhibit 4 to the Registration Statement on Form N-4 of Pruco Life Flexible Premium Variable Annuity Account (Strategic Partners Select Variable Annuity) (File No. 333-52754).* | |
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| 4(e) | | | Market-Value Adjustment Annuity Contract incorporated by reference to Exhibit 4 to the registrant’s Registration Statement on Form S-1(Strategic Partners Horizon Annuity) (File No. 333-§89530).* | |
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| 4(f) | | | Market-Value Adjustment Annuity Contract Endorsement incorporated by reference to Exhibit 4(c) to the Registration Statement on Form N-4 of Pruco Life Flexible Premium Variable Annuity Account (Strategic Partners Annuity One 3 Variable Annuity) (File No. 333-103474).* | |
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| 4(g) | | | Market-Value Adjustment Annuity Contract incorporated by reference to Exhibit 4(b) to the Registration Statement on Form N-4 of Pruco Life Flexible Premium Variable Annuity Account (Strategic Partners FlexElite Variable Annuity) (File No. 333-75702).* | |
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| 31.1 | | | Section 302 Certification of the Chief Executive Officer. | |
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| 31.2 | | | Section 302 Certification of the Chief Financial Officer. | |
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| 32.1 | | | Section 906 Certification of the Chief Executive Officer. | |
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| 32.2 | | | Section 906 Certification of the Chief Financial Officer. | |
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| * Filed previously. | |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | PRUCO LIFE INSURANCE COMPANY |
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| | By: | /s/ John Chieffo |
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| | | John Chieffo |
| | | Vice President and Chief Accounting Officer |
| | | (Authorized Signatory and Principal Financial Officer) |
Date: November 11, 2004
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