UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 33-37587
PRUCO LIFE INSURANCE COMPANY
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(Exact name of Registrant as specified in its charter)
Arizona 22-1944557
- ------------------------------ ---------------------------------
(State or other jurisdiction, (IRS Employer Identification No.)
incorporation or organization)
213 Washington Street, Newark, New Jersey 07102
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(Address of principal executive offices ) (Zip Code)
(973) 802-2859
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(Registrant's Telephone Number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: NONE
Securities registered pursuant to Section 12 (g) of the Act: NONE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES _X_ NO___
State the aggregate market value of the voting stock held by non-affiliates
of the registrant: NONE
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of March 15, 1999. Common stock, par value of $10
per share: 250,000 shares outstanding
PRUCO LIFE INSURANCE COMPANY
(Registrant)
INDEX
Item No. Page No.
- -------- --------
Cover Page -
Index 2
PART I
1. Business 3
2. Properties 3
3. Legal Proceedings 3
4. Submission of Matters to a Vote of Security Holders 3
PART II
5. Market for Registrant's Common Equity and Related Stockholders' Matters 4
6. Selected Financial Data 4
7. Management's Discussion and Analysis of Financial Position
and Results of Operations 4
7a. Quantitative and Qualitative Disclosures About Market Risk 13
8. Financial Statements and Supplementary Data 18
9. Changes in and Disagreements with Independent Accountants on Accounting
and Financial Disclosure 18
PART III
10. Directors and Executive Officers of the Registrant 19
11. Executive Compensation 20
12. Security Ownership of Certain Beneficial Owners and Management 20
13. Certain Relationships and Related Transactions 20
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 21
Exhibit Index 21
Signatures 23
2
PART I
------
Item 1. Business
- ------------------
Pruco Life Insurance Company (the Company) is a stock life insurance company,
organized in 1971 under the laws of the state of Arizona. The Company markets
individual life insurance, variable life insurance, variable annuities, fixed
annuities, and a group annuity program (the Contracts) in all states and
territories except the District of Columbia and Guam. In addition, the Company
markets individual life insurance through its branch office in Taiwan. The
Company has two wholly owned subsidiaries, Pruco Life Insurance Company of New
Jersey (PLNJ) and The Prudential Life Insurance Company of Arizona (PLICA). PLNJ
is a stock life insurance company organized in 1982 under the laws of the state
of New Jersey. It is licensed to sell individual life insurance, variable life
insurance, fixed annuities, and variable annuities only in the states of New
Jersey and New York. PLICA is a stock life insurance company organized in 1988
under the laws of the state of Arizona. PLICA had no new business sales in 1996,
1997 or 1998 and at this time will not be issuing new business.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America (Prudential), a mutual insurance company founded in 1875 under the laws
of the state of New Jersey. Prudential intends to make additional capital
contributions to the Company, as needed, to enable it to comply with its reserve
requirements and fund expenses in connection with its business. Generally,
Prudential is under no obligation to make such contributions and its assets do
not back the benefits payable under the Contracts.
The Company is engaged in a business that is highly competitive because of the
large number of stock and mutual life insurance companies and other entities
engaged in marketing insurance products, and individual and group annuities.
There are approximately 1,620 stock, mutual and other types of insurers in the
life insurance business in the United States.
Item 2. Properties
- --------------------
Not applicable.
Item 3. Legal Proceedings
- ---------------------------
Based on complaints about sales practices engaged in by Prudential, the Company,
and agents appointed by Prudential and the Company, several actions have been
brought against the Company on behalf of those persons who purchased life
insurance policies. Prudential has agreed to indemnify the Company for any and
all losses resulting from such litigation.
In the normal course of business, the Company is subject to various claims and
assessments. Management believes the settlement of these matters would not have
a material effect on the financial position or results of operations of the
Company.
Item 4. Submission of Matters to a Vote of Security Holders
- -------------------------------------------------------------
At the annual meeting of the stockholders held on June 9, 1998, the sole
stockholder of the Company appointed the Board of Directors of the Company. The
following are the appointed Board of Directors:
James J. Avery, Jr.
William Bethke
Ira J. Kleinman
Esther H. Milnes
Mendel A. Melzer
I. Edward Price
Kiyofumi Sakaguchi
3
PART II
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Item 5. Market for the Registrant's Common Equity and Related Stockholders'
Matters
- --------------------------------------------------------------------------------
The Company is a wholly-owned subsidiary of Prudential. There is no public
market for the Company's common stock.
Item 6. Selected Financial Data
- ---------------------------------
Pruco Life Insurance Company and Subsidiaries
For the Years Ended December 31,
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(In Thousands)
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
Revenues
Premiums and other revenue $ 463,453 $ 413,589 $ 397,319 $ 388,087 $ 344,701
Realized investment gains, net 44,841 10,974 10,835 13,200 (41,074)
Net investment income 261,430 259,634 247,328 246,618 241,132
-------------------------------------------------------------------------------
Total revenues 769,724 684,197 655,482 647,905 544,759
Benefits and expenses
Current and future benefits and
claims 305,462 290,234 305,119 280,913 235,660
Other expenses 228,067 225,721 122,006 134,790 179,173
-------------------------------------------------------------------------------
Total benefits and expenses 533,529 515,955 427,125 415,703 414,833
-------------------------------------------------------------------------------
Income before income tax provision 236,195 168,242 228,357 232,202 129,926
Income tax provision 84,233 61,868 79,135 79,558 48,031
-------------------------------------------------------------------------------
Net income $ 151,962 $ 106,374 $ 149,222 $ 152,644 $ 81,895
===============================================================================
Total assets at period end $16,812,781 $12,851,467 $ 9,710,366 $ 8,471,638 $ 7,713,183
===============================================================================
Separate Account liabilities $11,490,751 $ 7,948,788 $ 5,277,454 $ 4,263,896 $ 3,493,932
===============================================================================
Item 7. Management's Discussion and Analysis of Financial Position and Results
of Operations.
- --------------------------------------------------------------------------------
The following analysis should be read in conjunction with the notes to
Consolidated Financial Statements.
The Company markets individual life insurance, variable life insurance, variable
annuities, fixed annuities, and a group annuity program primarily through
Prudential's sales force in the United States and markets individual life
insurance through its branch office in Taiwan.
The Company markets its products in the life insurance and annuity sectors of
the insurance industry. 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 are being challenged 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.
4
The Company had $16.8 billion in assets at December 31, 1998 compared to $12.9
billion at December 31, 1997, of which $11.5 billion and $7.9 billion were held
in Separate Accounts in 1998 and 1997, respectively, under variable life
insurance policies and variable annuity contracts. The remaining assets
consisted primarily of general account investments in bonds, policy loans and
short-term investments.
1. Results of Operations
Net income for the year ended December 31, 1998 was $152.0 million, an increase
of $45.6 million or 42.9% from $106.4 million earned in the year ended December
31, 1997. Net income for the year ended December 31, 1996 was $149.2 million.
(a) 1998 versus 1997
Total insurance revenues, consisting of premiums and policy charges and fee
income, increased $42.4 million for the year ended December 31, 1998 to $422.2
million from $379.8 million for the year ended December 31, 1997. In response to
customer needs and market trends, the Company markets a product portfolio
utilizing advice-based strategy including highly selective product offerings
from other investment advisors. The Discovery Select Variable Annuity was a
successful new product which generated significant sales. The Company also
introduced a new variable universal life (VUL) insurance product, which provides
an option to the customer to select proprietary or non-proprietary mutual fund
investments. Strong securities market conditions contributed to appreciation in
Separate Account asset values. Favorable market conditions also provided a
stimulus to investors to purchase mutual fund shares and annuities, including
VUL and Discovery Select products, which further contributed to growth in assets
under management and consequently on fees earned. In addition, the Company's
Taiwan branch generated continued growth in premiums for traditional insurance
products.
The Company's consolidated net investment income increased $1.8 million for the
year ended December 31, 1998 to $261.4 from $259.6 million for the year ended
December 31, 1997. Consolidated net realized investment gains increased $33.8
million for the year ended December 31, 1998 to $44.8 from $11.0 million for the
year ended December 31, 1997. Please refer to the section below titled
"Investment Portfolio and Investment Strategies" for a discussion of investment
income and net realized investment gains by asset type.
Other income increased $7.5 million for the year ended December 31, 1998 to
$41.3 million from $33.8 million for the year ended December 31, 1997. The
portfolio of mutual fund investments related to the Company's Separate Account
products are known as The Prudential Series Fund. The Company receives an
allocated portion of investment management fees that Prudential earns from The
Prudential Series Fund and records these fees in "Other income."
Policyholders' benefits increased $7.1 million for the year ended December 31,
1998 to $186.5 million from $179.4 million for the year ended December 31, 1997.
This change is attributable to an increase in death claims in absolute amount
and as a percentage of mean amount of insurance in force reflecting the overall
aging of the business in force.
Interest credited to policyholders' account balances increased by $8.1 million
for the year ended December 31, 1998 to $118.9 million from $110.8 million for
the year ended December 31, 1997. Accounting for more than half of this year's
increase is the introduction of a new non-participating guaranteed investment
contract (GIC) product, Prudential Credit Enhanced (PACE), early in 1998. The
remaining increase is attributable to the rise in policyholder account balances
as well as increased interest credited pertaining to policy loans, partially
offset by declining interest crediting rates for interest-sensitive life
contracts.
Other operating costs and expenses increased $2.4 million for the year ended
December 31, 1998 to $228.1 million compared to $225.7 million for the year
ended December 31, 1997. Increased sales activity of Discovery Select and the
new VUL product noted above resulted in a corresponding increase in expenses. In
addition to the increased sales volume, the Parent company's allocation
methodology for expenses billed to Pruco Life in 1998 changed, resulting in
increased expenses allocated to the Company. Offsetting this increase was a 1997
refinement of estimated gross profit margins which led to an overall decrease in
deferred policy acquisition costs (DAC) amortization relative to 1997.
5
Investment Portfolio and Investment Strategies
The Company's investment portfolio supports its insurance and annuity
liabilities and other obligations to customers for which it assumes investment
related risks. The portfolio was comprised of total investments amounting to
$4.2 billion at December 31, 1998, versus $3.9 billion at December 31, 1997. A
diversified portfolio of publicly traded bonds, private placements, commercial
mortgages and equity investments is managed under strategies intended to
maintain optimal asset mix consistent with current and anticipated cash flow
requirements of the related obligations.
The asset management strategy for the portfolio is in accordance with an
investment policy statement developed and coordinated within the Company by the
Portfolio Management Group, agreed to by senior management, and approved by the
Board of Directors. In managing the investment portfolio, the long term
objective is to generate favorable investment results through asset-liability
management, strategic and tactical asset allocation and asset manager selection.
Asset mix strategies are constrained by the need to match asset structure to
product liabilities, considering the underlying income and return
characteristics of investment alternatives and seeking to closely approximate
the interest rate sensitivity of the asset portfolio with the estimated interest
rate sensitivity of the product liabilities. Asset mix strategies also include
maintenance of broad diversification across asset classes, issuers and sectors;
effective utilization of capital while maintaining liquidity believed to be
adequate to satisfy cash flow requirements; and achievement of competitive
performance. The major categories of invested assets, quality across the
portfolio, and recent activities to manage the portfolio are discussed below.
Fixed Maturities
The fixed maturity portfolio is diversified across maturities, sectors and
issuers. As of December 31, 1998 and 1997, the Company has classified all
publicly traded securities and 63% and 52%, respectively, of privately traded
securities as "available for sale" with the remainder of the privately placed
fixed maturities as "held to maturity. The estimated fair value of fixed
maturities totaled $3.2 billion, an increase of $271.9 million compared to
December 31, 1997. This increase is primarily attributable to the new product,
PACE.
1998 1997
------------------------------------------ ------------------------------------------
Net Net
Amortized Estimated Unrealized Amortized Estimated Unrealized
Cost Fair Value Gains Cost Fair Value Gains
--------- ---------- ---------- ------------- ---------- ----------
(In Thousands)
Fixed maturities -
available for sale
Publicly traded $2,040,592 $2,054,807 $ 14,215 $2,157,525 $2,187,405 $ 29,880
Privately traded 698,062 709,119 11,057 369,029 376,447 7,418
Total Fixed maturities - ---------- ---------- ---------- ---------- ---------- ----------
available for sale 2,738,654 2,763,926 25,272 2,526,554 2,563,852 37,298
---------- ---------- ---------- ---------- ---------- ----------
Fixed maturities -
held to maturity
Privately traded 410,558 421,845 11,287 338,848 350,056 11,208
---------- ---------- ---------- ---------- ---------- ----------
Total $3,149,212 $3,185,771 $ 36,559 $2,865,046 $2,913,908 $ 48,506
========== ========== ========== ========== ========== ==========
At December 31, 1998, the net unrealized capital gains on the "available for
sale" fixed maturity portfolio totaled $25.3 million compared to $37.3 million
at December 31, 1997. The decrease in the net unrealized gain position is
primarily due to the effect of a higher level of sales activity, offset in part
by the effect of lower interest rates.
Based on estimated fair value, the Company's holdings of private placement fixed
maturities constituted 35% and 25% of total fixed maturities at December 31,
1998 and 1997, respectively. These investments generally offer higher yields
than comparable quality public market securities, increase the diversification
of the portfolio, and contain tighter covenant protection than public
securities.
6
Gross investment income from fixed maturities increased by $17.2 million from
1997 to 1998 as a result growth in invested assets, including the addition of
the PACE product. Realized gains increased by $20.0 million from 1997 primarily
due to the sale of fixed maturities during a period of declining interest rates.
The table below summarizes fixed maturity investment results:
Year Ended December 31,
1998 1997
--------- ---------
(In Thousands)
Gross investment income $205,312 $188,076
Yield(1) 7.08% 7.35%
Realized capital gains $ 29,817 $ 9,860
(1) Yields are determined by dividing gross investment income by the average of
quarter-end asset carrying values, excluding unrealized gains and losses, less
one-half of gross investment income.
Credit Quality
The following table describes the credit quality of the fixed maturity
portfolio, based on ratings assigned by the National Association of Insurance
Commissioners ("NAIC") or Standard & Poor's Corporation, an independent rating
agency:
December 31, 1998 December 31, 1997
------------------------------------------ ---------------------------------------
Standard & Amortized Estimated Amortized Estimated
NAIC Poor's Cost % Fair Value % Cost % Fair Value %
- ----------------- -------------------- -------------------- -------------------- ------------------
(In Thousands)
1 AAA to AA- $1,375,371 43.7 $1,398,678 43.9 $1,507,219 52.6 $1,529,620 52.5
2 BBB+ to BBB- 1,436,820 45.6 1,449,073 45.5 1,175,684 41.0 1,194,461 41.0
3 BB+ to BB- 240,379 7.6 244,932 7.7 100,676 3.5 104,557 3.6
4 B+ to B- 68,620 2.2 66,763 2.1 75,849 2.7 78,953 2.7
5 CCC or lower 27,552 .9 26,061 .8 5,943 .2 6,288 .2
6 In or near 470 -- 264 -- 31 -- 29 --
default
---------- ---------- ---------- ----------
Total $3,149,212 $3,185,771 $2,865,402 $2,913,908
========== ========== ========== ==========
The fixed maturity portfolio consists largely of investment grade assets (rated
"1" or "2" by the NAIC), with such investments accounting for 89% and 94% of the
portfolio at December 31, 1998 and 1997, respectively, based on estimated fair
value. As of both of those dates, less than 1% of the fixed maturities portfolio
was rated "6" by the NAIC, defined as public and private placement securities
which are currently non-performing or believed subject to default in the
near-term.
The Company continually reviews fixed maturities and identifies potential
problem assets which require additional monitoring. The Company defines
"problem" fixed maturities as those for which principal and/or interest payments
are in default. The Company defines "potential problem" fixed maturities as
assets which are believed to present default risk associated with future debt
service obligations and therefore require more active management. At December
31, 1998 management identified $264 thousand of fixed maturity investments as
problem or potential problem. An immaterial amount of problem or potential
problem fixed maturities were identified in 1997.
7
Portfolio Diversity
The fixed maturity portfolio is broadly diversified by type and industry of
issuer. The greatest industry concentrations within the public portfolio were
finance, utilities, and manufacturing. The greatest concentrations within the
private portfolio were asset backed securities and within the service and
manufacturing industries. The total portfolio is summarized below by issuer
category:
December 31, 1998 December 31, 1997
------------------------------- -------------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---------- ---------- ---------- ----------
(In Thousands)
United States government
securities and obligations $ 110,294 $ 110,839 $ 177,334 $ 178,536
Mortgage backed securities 2,257 2,411 3,116 3,260
Asset backed securities (1) 442,272 445,518 320,554 323,744
Manufacturing 585,680 589,775 401,291 409,856
Utilities 469,343 478,262 397,374 406,790
Retail and wholesale 166,979 168,837 97,333 99,993
Energy 6,429 6,648 1,473 1,599
Finance 545,760 550,291 818,532 826,767
Services 584,495 594,240 430,827 441,775
Transportation 148,999 151,091 122,056 124,807
Other 86,704 87,859 95,156 96,345
---------- ---------- ---------- ----------
Total $3,149,212 $3,185,771 $2,865,046 $2,913,472
========== ========== ========== ==========
(1) Asset backed securities are primarily backed by credit card receivables,
home equity loans, trade receivables and auto loans.
Short-Term Investments
Short-term investments include highly liquid debt instruments such as commercial
paper which are purchased with an original maturity of twelve months or less.
These securities are carried at amortized cost, which approximates fair value.
As of December 31, 1998, the Company's short-term investments totaled $240.7
million, a decrease of $75.7 million compared to $316.4 million at December 31,
1997. The decrease in short-term investments was primarily due to decreased
securities lending activity, resulting in lower cash collateral held and
invested in short-term instruments, coupled with a strategic decision to hold
less short-term investments. While income remained relatively unchanged, the
short-term yield decreased 175 basis points primarily due to lower average
interest rates. Investment expenses increased by $10.0 million primarily as a
result of 1998 including a full year's worth of securities lending activity
versus one quarters worth in 1997.
The table below presents summary data with respect to the Company's short-term
investment positions:
Year Ended December 31,
1998 1997
-------- --------
(In Thousands)
Carrying amount at end of period $240,727 $316,355
Net investment income 13,347 19,511
Yield (1) 3.67% 5.42%
(1) Yields are determined by dividing net investment income by the average of
quarter-end asset carrying values, less one-half of net investment income.
8
Derivatives
At the end of 1997 The Company began using derivatives, primarily futures
contracts, to hedge interest-rate risk related to the insurance and annuity
liabilities. During 1998 $12.4 million of gains were realized from derivatives.
The gains are reported in "Realized investment gains, net."
(b) 1997 versus 1996
Total insurance revenues, consisting of premiums and policy charges and fee
income, increased $3.3 million for the year ended December 31, 1997 to $379.8
million from $376.5 million for the year ended December 31, 1996. This increase
in insurance revenues consists of an increase of $5.3 million in policy charges
and fee income partially offset by a decrease in premiums of $2.0 million. These
fluctuations are due to an increased emphasis in the domestic market place on
retirement type investment products rather than life insurance protection
products. Lower domestic premiums were partially offset by an increase in
premiums for traditional insurance products generated from the Company's Taiwan
branch.
The Company's consolidated net investment income increased $12.3 million for the
year ended December 31, 1997 to $259.6 from $247.3 million for the year ended
December 31, 1996. Increase in cash flows from insurance operations and average
assets as well as the asset allocation strategies, produced favorable investment
results in 1997. Fixed maturity income increased in 1997 due to higher
investment returns as a result of a shift to higher yielding securities. Income
from short term investments increased because of higher fixed maturity assets
available to lend to third parties as part of the Company's securities lending
program. Offsetting these increases was a decline in income on the mortgage loan
portfolio, a result of declining asset base.
Other income increased $13.0 million for the year ended December 31, 1997 to
$33.8 million from $20.8 million for the year ended December 31, 1996. This
increase is due to a higher level of advisory fees attributable to the Discovery
Preferred and Discovery Select Separate Account products.
Policyholders' benefits decreased $7.5 million for the year ended December 31,
1997 to $179.4 million from $186.9 million for the year ended December 31, 1996.
This decrease is attributable to better mortality experience associated with the
Company's products.
Interest credited to policyholders' account balances decreased by $7.4 million
for the year ended December 31, 1997 to $110.8 million from $118.2 million for
the year ended December 31, 1996. This decrease is primarily attributable to a
decrease in interest crediting rates, partially offset by increased fund values
due to new sales of Separate Account products.
Other operating costs and expenses increased $103.7 million for the year ended
December 31, 1997 to $225.7 million compared to $122.0 million for the year
ended December 31, 1996. The increase reflects factors including the refinement
of estimated gross profit margins used to amortize DAC. Favorable mortality
experience and reduction in cost of insurance charges contributed to a change in
net amortization. Favorable sales in 1997 were a partial offset. Also, increased
operating costs resulted from higher sales activity of Discovery Select and
Discovery Preferred annuity products, and technological advancements made in
annuity processing, customer service, and product development.
2. Liquidity and Capital Resources
The Company's liquidity requirements include the payment of sales commissions
and other underwriting expenses and the funding of its contractual obligations
for the life insurance and annuity contracts it has in-force. The Company has
developed and utilizes a cash flow projection system and regularly performs
asset/liability duration matching in the management of its asset and liability
portfolios. The Company anticipates funding all its cash requirements utilizing
cash from operations, normal investment maturities and anticipated calls and
repayments or through short term borrowing from its affiliate Prudential Funding
Corporation (see Related Party Transactions). As of December 31, 1998, the
Company's assets included $1.9 billion of cash, short-term investments and
investment grade publicly traded fixed maturity securities that could be
liquidated if funds were required.
In order to continue to market life insurance and annuity products, the Company
must meet or exceed the statutory capital and surplus requirements of the
insurance departments of the states in which it conducts business. Statutory
accounting practices differ from generally accepted accounting principles
("GAAP") in two major respects. First, under statutory accounting practices, the
acquisition costs of new business are charged to expense, while under GAAP they
are initially deferred and amortized over a period of time. Second, under
statutory accounting practices, the required additions to
9
statutory reserves for new business in some cases may initially exceed the
statutory revenues attributable to such business. These practices result in a
reduction of statutory income and surplus at the time of recording new business.
Insurance companies are subject to Risk-Based Capital (RBC) guidelines,
monitored by insurance regulatory authorities, that measure the ratio of the
Company's statutory equity with certain adjustments ("Adjusted Capital") to its
required capital, based on the risk characteristics of its insurance liabilities
and investments. Required capital is determined by statutory formulae that
consider risks related to the type and quality of invested assets,
insurance-related risks associated with the Company's products, interest rate
risks, and general business risks. The RBC calculations are intended to assist
regulators in measuring the adequacy of the Company's statutory capitalization.
The Company considers RBC implications in its asset/liability management
strategies. Each year, the Company conducts a thorough review of the adequacy of
statutory insurance reserves and other actuarial liabilities. The review is
performed to ensure that the Company's statutory reserves are computed in
accordance with accepted actuarial standards, reflect all contractual
obligations, meet the requirements of state laws and regulations and include
adequate provisions for any other actuarial liabilities that need to be
established. All significant reserve changes are reviewed by the Board of
Directors and are subject to approval by the Arizona Department of Banking and
Insurance. The Company believes that its statutory capital is adequate for its
currently anticipated levels of risk as measured by regulatory guidelines.
The National Association of Insurance Commissioners recently approved a series
of codified statutory accounting standards for consideration by the various
state regulators. Certain of the proposed standards, if adopted by insurance
regulatory authorities, could have an impact on the measurement of statutory
capital which, in turn, could affect RBC ratios of insurance companies. At the
present time, the Company cannot estimate the potential impact of these proposed
standards on its RBC position.
3. Regulatory Environment
The Company is subject to the laws of the State of Arizona and to the
regulations of the Department of Insurance of the State of Arizona and the New
Jersey Department of Banking and Insurance (the "Insurance Departments"). A
detailed financial statement in the prescribed form (the "Annual Statement") is
filed with the Insurance Departments each year covering the Company's operations
for the preceding year and its financial position as of the end of that year.
Regulation by the Insurance Departments includes periodic examinations to verify
the accuracy of contract liabilities and reserves. The Company's books and
accounts are subject to review by the Insurance Departments at all times. A full
examination of the Company's operations is conducted periodically by the
Insurance Departments and under the auspices of the NAIC.
The Company is subject to regulation under the insurance laws of all
jurisdictions in which it operates. The laws of the various jurisdictions
establish supervisory agencies with broad administrative powers with respect to
various matters, including licensing to transact business, overseeing trade
practices, licensing agents, approving contract forms, establishing reserve
requirements, fixing maximum interest rates on life insurance contract loans and
minimum rates for accumulation of surrender values, prescribing the form and
content of required financial statements and regulating the type and amounts of
investments permitted. The Company is required to file the Annual Statement with
supervisory agencies in each of the jurisdictions in which it does business, and
its operations and accounts are subject to examination by these agencies at
regular intervals.
The NAIC has adopted several regulatory initiatives designed to improve the
surveillance and financial analysis regarding the solvency of insurance
companies in general. These initiatives include the development and
implementation of a risk-based capital formula for determining adequate levels
of capital and surplus. Insurance companies are required to calculate their
risk-based capital in accordance with this formula and to include the results in
their Annual Statement. It is anticipated that these standards will have no
significant effect upon the Company.
Although the federal government generally does not directly regulate the
business of insurance, federal initiatives often have an impact on the business
in a variety of ways. Certain insurance products of the Company are subject to
various federal securities laws and regulations. In addition, current and
proposed federal measures which may significantly affect the insurance business
include regulation of insurance company solvency, employee benefit regulation,
removal of barriers preventing banks from engaging in the insurance business,
tax law changes affecting the taxation of insurance companies and the tax
treatment of insurance products and its impact on the relative desirability of
various personal investment vehicles.
10
4. The Year 2000 Issue
Pruco Life utilizes many of the same business applications, infrastructure and
business partners as Prudential. Prudential has addressed the Year 2000 issue on
an enterprise-wide basis. Therefore, it is not possible to differentiate Pruco
Life's Year 2000 issue from that of Prudential. The accompanying discussion of
the Year 2000 issue reflects steps taken by Prudential to mitigate the Year 2000
risks.
Many computer systems are programmed to recognize only the last two digits in a
date. As a result, any computer system that has date-sensitive programming may
recognize a date using "00" as the year 1900 rather than the year 2000. This
problem can affect non-information technology systems that include embedded
technology, such as microprocessors included in "infrastructure" equipment used
for telecommunications and other services as well as computer systems. If this
anomaly is not corrected, the year "00" could cause systems to perform date
comparisons and calculations incorrectly, which could in turn affect the
accuracy and compromise the integrity of business records. Business operations
could be interrupted when companies are unable to process transactions, send
invoices, or engage in similar normal business activities.
Prudential established a Company-wide Program Office (CPO) to develop and
coordinate an operating framework for the Year 2000 compliance activities.
Prudential's CPO structured the Year 2000 program into three major components:
Business Applications, Infrastructure and Business Partners. The CPO also
established quality assurance procedures including a certification process to
monitor and evaluate enterprise-wide progress of each component of Prudential's
program for conversion and upgrading of systems for Year 2000 compliance.
Business Applications
The scope of the Business Applications component includes a wide range of
computer systems that directly support Prudential's business operations and
accounting systems. The entire application portfolio was analyzed in 1996 to
determine appropriate Year 2000 readiness strategies (i.e., renovate, replace or
retire). Rigorous testing standards have been employed for all applications that
will not be retired, including those that are newly developed or purchased.
Application replacement and renovation projects follow a similar path toward
Year 2000 compliance. The key project phases include Year 2000 analysis and
design, programming activities, testing, and implementation. Replacement
projects are also tracked until the existing applications are removed from
production.
Of Prudential's total application portfolio, approximately 70% of the
applications are being renovated, 13% are being replaced by Year 2000 compliant
systems, and the remaining 17% are being retired from production. At December
31, 1998, the percentage of business applications (based on application count)
in the implementation phase for Year 2000 compliance for renovation, replacement
and retirement are 99%, 96% and 99%, respectively. The overall completion date
for Business Applications is June 1999.
Infrastructure
The scope of Prudential's Year 2000 Infrastructure initiatives include mainframe
computer system hardware and operating system software, mid-range systems and
servers, telecommunications equipment, buildings and facilities systems,
personal computers, and vendor hardware and software.
Although there are minor differences among these various components, the
approach to Year 2000 readiness for Infrastructure generally involves phases
identified as inventory, assessment, remediation activities (e.g., upgrading
hardware or software), testing and implementation. The overall completion date
for Infrastructure is June 1999.
Business Partners
Prudential's approach to business partner readiness includes classification of
each partner's status as "highly critical" or "less critical" and the
development of contingency plans to address the potential that a business
partner could experience a Year 2000 failure. Approximately 30% of Prudential's
business partners have been identified as highly critical and the remaining 70%
as less critical. Project phases include inventory, risk assessment, and
contingency planning activities. All project phases for highly critical business
partner readiness were achieved in December 1998; Prudential has an overall
completion date for less critical business partner readiness of June 1999.
11
The Cost of Year 2000 Readiness
Prudential is funding the Year 2000 program from operating cash flows. Some of
the expenses of Prudential's Year 2000 readiness are allocated across its
various businesses and subsidiaries, including Pruco Life. Expenses related to
the Year 2000 initiatives allocated to Pruco Life are part of systems overhead
costs to date and are included in Pruco Life's general and administrative
expenses. The Year 2000 costs allocated to Pruco Life to date are not material
to its operations and financial position. Moreover, the forecasted allocated
Year 2000 costs are not expected to have a material impact on Pruco Life's
ability to meet its contractual commitments.
Year 2000 Risks and Contingency Planning
The major portion of the Prudential's transactions are of such volume that they
can only be effectively processed through the use of automated systems.
Therefore, substantially all of Prudential's contingency plans include the
ultimate resolution of any causative technology failures that may be
encountered.
Prudential believes that the Business Application, Infrastructure and Business
Partners components of the Year 2000 project are substantially on schedule.
While management expects a small number of the projects may not meet their
targeted completion date, it is anticipated that these projects will be
completed by September 1999 so that any delays, if experienced, would not have a
significant impact on the timing of the project as a whole. During the course of
the Year 2000 program, some discretionary technology projects have been delayed
in favor of the completion of Year 2000 projects. However, this impact has been
minimized by Prudential's strategic decision to outsource most of the Year 2000
renovation work.
While Prudential and its subsidiaries believe that they are well positioned to
mitigate its Year 2000 issue, this issue, by its nature, contains inherent
uncertainties, including the uncertainty of Year 2000 readiness of third
parties. Consequently, the Company is unable to determine at this time whether
the consequences of Year 2000 failures will have a material adverse effect on
the Company's results of operations, liquidity or financial position. In the
worst case, it is possible that any technology failure, including an internal or
external Year 2000 failure, could have a material impact on the Company's
results of operations, liquidity, or financial position.
Prudential is enhancing existing business contingency plans to mitigate Year
2000 risk. Current contingency plans include planned responses to the failure of
specific business applications or infrastructure components. These responses are
being reviewed and expected to be finalized by June 1999 to ensure that they are
workable under the special conditions of a Year 2000 failure. The plans are also
being updated to reduce the level of uncertainty about the Year 2000 problem
including readiness of Prudential's Business Partners.
The discussion of the Year 2000 Issue herein, and in particular Prudential's
plans to remediate this issue and the estimated costs thereof, are
forward-looking in nature. See cautionary statement below relating to
forward-looking statements.
5. Effective New Accounting Pronouncements
Refer to Note 2, "Summary of Significant Accounting Policies," of the Notes to
Consolidated Financial Statements.
6. Information Concerning Forward-Looking Statements
Certain of the statements contained in Management's Discussion and Analysis may
be considered forward-looking statements. Words such as "expects," "believes,"
"anticipates," "intends," "plans," or variations of such words are generally
part of forward-looking statements. Forward-looking statements are made based
upon management's current expectations and beliefs concerning future
developments and their potential effects upon the Company. There can be no
assurance that future developments affecting the Company will be those
anticipated by management. There are certain important factors that could cause
actual results to differ materially from estimates or expectations reflected in
such forward-looking statements including without limitation, changes in general
economic conditions, including the performance of financial markets and interest
rates; market acceptance of new products and distribution channels; competitive,
regulatory or tax changes that affect the cost or demand for the Company's
products; and adverse litigation results. While the Company reassesses material
trends and uncertainties affecting its financial position and results of
operations, it does not intend to review or revise any particular
forward-looking statement referenced in this Management's Discussion and
Analysis in light of future events. The information referred to above should be
considered by readers when reviewing any forward-looking statements contained in
this Management's Discussion and Analysis.
12
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------
Risk Management, Market Risk, and Derivative Financial Instruments
As a direct subsidiary of Prudential, the Company benefits from the risk
management strategies implemented by its parent.
Risk management includes the identification and measurement of various forms of
risk, establishment of acceptable risk thresholds, and creation of processes
intended to maintain risks within these thresholds while maximizing returns.
Prudential considers risk management an integral part of its core businesses.
The risks inherent in the Company's operations include market risk, product
risk, credit risk, concentration risk, liquidity risk, and operating risk. These
risk categories, and the Company's strategies relative to each, are discussed
below.
The Company's risk monitoring processes include preparation and review of risk
reports on a regular basis, with frequency based on the purpose of the report.
For example, reports associated with specific strategies or assets are produced
daily, while portfolio level reports are typically semi-monthly or monthly and
high level reports are produced quarterly.
Market risk is the risk of change in the value of financial instruments as a
result of changes in interest rates, currency exchange rates, equity and
commodity prices. To varying degrees, the investment activities supporting all
of the Company's products and services generate market risks. These products and
services include life insurance and annuities. Market risks incurred and the
strategies for managing these risks vary by product.
Insurance products and fixed rate annuities, incur market risk primarily in the
form of interest rate risk. This is controlled through asset/liability
management strategies that seek to match the interest rate sensitivity of the
assets to that of the underlying liabilities, with the objective of insulating
the portfolio's underlying capital from market value changes due to interest
rate movements. If perfectly matched, interest rate movements will generate
asset market value changes that offset changes in the value of the liabilities
relating to the underlying insurance products.
Variable annuities also incur market risk to the Company in part through
interest rate risk but largely through equity price risk. Equity price risk is
controlled primarily by managing the risk profile of equity investments against
the risk profile incorporated in the related variable annuity products.
For fee-based products, including variable contracts and Separate Accounts,
investment risk is borne primarily by the contractholders rather than the
Company (subject to any minimum guarantees). The greatest market-related risk to
the Company for these products is the indirect one that, in the event of sub-par
performance, asset based fee revenues could decline and that competitive factors
could impede the Company's ability to maintain or grow assets under management.
However, since this is primarily an operating risk it is not quantified as part
of the Company's analysis of market risk.
The Company's exposure to market risk results from "other than trading"
activities in its insurance business. Market risks in the Company's insurance
business are managed through an investment process that incorporates
asset/liability management techniques and other risk management policies and
limits. Derivatives, as discussed further below, are used for hedging purposes
in the asset/liability management process.
Insurance Asset/Liability Management
Interest rate and equity exposures are maintained within established ranges,
which are subject to adjustment based on market conditions and the design of
related insurance products sold to customers. Risk managers, independent of
portfolio and asset managers, establish investment risk limits on
asset/liability management and oversee ongoing efforts to manage risk within
policy constraints.
The Company uses duration and convexity analyses to measure price sensitivity to
interest rate changes. Duration measures the relative sensitivity of the fair
value of a financial instrument to changes in interest rates. Convexity measures
the rate of change of duration with respect to changes in yield, recognizing
that the price of a bond is usually expected to fall at a slower rate as yield
increases.
While duration and convexity are useful indicators of asset price sensitivity to
interest rate changes, pricing models used in the portfolio management process
also consider the effects of optionality. This entails a variety of option
pricing model applications.
13
The Company also performs portfolio stress testing as part of its regulatory
cash flow testing in which interest-sensitive assumptions (such as asset calls
and prepayments and insurance product contract persistency) are evaluated under
various severe interest rate environments. Any shortfalls revealed by cash flow
testing are evaluated to determine whether there is a need to increase reserves
or adjust portfolio management strategies.
Interest Rate Related Market Risk on Assets
Assets with interest rate risk include fixed maturities,
mortgage loans and policy loans which, in the aggregate, comprise 94% of the
Company's consolidated invested assets (excluding assets held in Separate
Accounts) as of December 31, 1998.
Interest Rate Related Market Risk on Liabilities
In addition to insurance reserves, which are not measured by the sensitivity
analysis below, the Company has policyholders' account balances relating to
interest-sensitive life and annuity contracts through which it is exposed to
interest rate risk.
Derivatives
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, various financial indices, or the value of
securities or commodities. Derivative financial instruments can be
exchange-traded or contracted in the over-the-counter market and include swaps,
futures, forwards and options contracts. Fixed rate loan commitments may also be
considered similar to derivatives because of their off balance sheet and
option-like characteristics. See Note 10 of Notes to Consolidated Financial
Statements as to the Company's derivative positions at December 31, 1998 and
1997. Insurance statutes applicable to the Company restrict the use of
derivative securities to hedging activities intended to offset changes in the
market value of assets held, obligations, and anticipated transactions and
prohibit the use of derivatives for speculation. The Company uses derivative
financial instruments to reduce market risk from changes in interest rates or
foreign currency exchange rates, and to alter interest rate or currency
exposures arising from mismatches between assets and liabilities.
Interest Rate Sensitivity
Interest rate sensitivity for the indicated classes of financial assets,
financial liabilities, and derivatives is assessed using hypothetical test
scenarios which assume both upward and downward 100 basis point parallel shifts
in the yeld curve from prevailing interest rates at December 31, 1998. The
following table summarizes the potential loss in fair value associated with a
hypothetical 100 basis point upward parallel shift in the yield curve from
prevailing interest rates at December 31, 1998. This scenario results in the
greatest net exposure to interest rate risk of the hypothetical scenarios
tested. The test scenario is for illustrative purposes only and is not intended
to reflect management's expectations regarding future interest rates or
performance of fixed income markets.
14
In addition, this presentation includes only assets, liabilities and derivatives
required by the Rules and does not include $535 million of insurance
liabilities. Management includes the interest rate sensitivities implicit in
these insurance liabilities in its internal measurements and believes these
insurance liabilities substantially offset the interest rate risk summarized in
the following table.
December 31, 1998
--------------------------------------------------------------
Fair Value
After + 100
Notional Basis Point Hypothetical
Value Fair Yield Curve Change in
(derivatives) Value Shift Fair Value
------------- -------- ------------ ------------
(In Millions)
Financial Assets and Liabilities with
Interest Rate Risk:
Financial Assets:
Fixed maturities:
Available for sale -- 2,764 2,666 (98)
Held to maturity -- 422 408 (14)
Mortgage loans on real estate -- 19 19 --
Policy loans -- 806 762 (44)
Derivatives:
Futures 41 -- (2) (2)
Financial Liabilities:
Policyholders' account balances -- (2,704) (2,727) (23)
-----
Total estimated potential loss $(181)
=====
The estimated changes in fair values of financial assets shown above relate to
assets invested in support of the Company's insurance liabilities, and do not
include assets associated with products for which investment risk is borne
primarily by the contractholders rather than the Company.
Equity Price Market Risk
Equity price risk is actively managed relative to benchmarks in respective
markets. Excluding equities relating to products for which investment risk is
borne primarily by the contractholder rather than by the Company, the table
below provides an estimate of the Company's equity risk following a 10% decline
in benchmark equity market prices. Equity holdings are benchmarked against a
blend of leading market indices, including prominently the Standard & Poor's
("S&P") 500 and Russell 2000, and target price sensitivities approximating those
of the benchmark indices. This scenario is not intended to reflect management's
expectations regarding future performance of equity markets.
December 31, 1998
------------------------------------------------------
Fair Value After 10%
Drop in Equity Hypothetical
Fair Market Benchmark Change in
Value (1) Fair Value
-------- -------------------- ------------
(In Millions)
Financial Assets with Equity Price Risk
Equity securities $2.8 $2.5 $(0.3)
(1) The market benchmark used for purposes of this analysis is a blend of
leading equities market indices, including the S&P 500 Index and the
Russell 2000 Index. This benchmark is believed to have broadly similar
characteristics, in terms of price sensitivity, to the Company's
equity securities portfolio.
15
Foreign Currency Exchange Market Risk
The Company is exposed to foreign currency exchange risk in its investment
portfolio and through its operations in Taiwan. The Company's investment policy
dictates that foreign currency exchange rate risk created by fixed income
investments denominated in foreign currencies, in most instances, is to be fully
hedged into U.S. dollars. Investment-related foreign currency exchange rate risk
retained in the portfolio emanates principally from foreign denominated equity
investments for which currency exchange rate volatility is factored into
expected returns when allocating funds to this asset class. Hedging of market
risk associated with changes in foreign currency exchange rates is generally
accomplished through the use of foreign exchange forward contracts and foreign
currency swaps.
Foreign currency exchange risk is actively managed within specified limits at
the enterprise level using Value-at-Risk analysis. As previously mentioned, this
statistical technique estimates, at a specified confidence level, the potential
pretax loss in portfolio market value that could occur over an assumed holding
period due to adverse movements in underlying risk factors, which in this case
are foreign currency exchange rates.
Value-at-Risk (VaR) estimates of exposure to loss from volatility in foreign
currency exchange rates are calculated for one day and one month time periods.
Exponentially weighted historical price volatilities and covariance data are
used at a confidence level such that losses are not expected to exceed this VaR
estimate in no more than one in twenty business days.
December 31, 1998
--------------------------------------------------------
Fair Value Less One Hypothetical
Fair Month's Value at Change in
Value Risk (1) Fair Value
------ ------------------- -------------
(In Millions)
Financial Assets with Foreign Currency
Exchange Rate Risk:
Foreign currency denominated assets
not hedged to United States dollars $32.0 $31.5 $(0.5)
(1) Value at risk measured at 95% confidence level.
Limitations of VaR Models
VaR models have inherent limitations, including reliance on historical data that
may not be indicative of future market conditions or trading patterns, and
therefore should not be viewed as a predictor of future results. There can be no
assurance that the Company will not incur losses in excess of the amounts
indicated by the model on a particular trading day or over a period of time. A
VaR model does not estimate the greatest possible loss outside of its confidence
interval. These models are used by the Company in addition to other risk
management tools, including stress testing, and in conjunction with the
experience and judgment of management.
Product Risk is the risk of adverse results due to deviation of experience from
expected levels reflected in pricing. The Company, in its insurance and annuity
operations, sells traditional and interest sensitive individual insurance
products and annuity products. Products are priced to reflect the expected
levels of risk and to allow a margin for adverse deviation. The level of margin
varies with product design and pricing strategy with respect to the targeted
market. The Company seeks to maintain underwriting standards so that premium
charged is consistent with risk assumed on an overall basis. Additionally, most
of the Company's policies and contracts allow the Company to adjust credits (via
interest crediting rates) and/or charges (in contracts where elements such as
mortality and expense charges are not guaranteed), allowing the Company to
respond to changes in actuarial experience. The competitive environment is also
an important element in determining pricing elements including premiums,
crediting rates, and non-guaranteed charges.
Mortality risks, generally inherent in most of the Company's life insurance and
annuity products, are incorporated in pricing based on the Company's experience
(if available and relevant) and/or industry experience. Mortality studies are
performed periodically to compare the actual incidence of death claims in
relation to business in force, to levels assumed in pricing and to industry
experience. Persistency risk represents the risk that the pattern of policy
surrenders will deviate from assumed levels so that policies do not remain in
force long enough to allow the Company to recover its acquisition
16
costs. Certain products are designed, by use of surrender charges and other
features, to discourage early surrenders and thus mitigate this risk to the
Company. Periodic studies are performed to compare actual surrender experience
to pricing assumptions and industry experience.
For fee-based products in which investment risk is borne by the client, the
Company retains the risk that fees charged may not adequately cover
administrative expenses. The ability to earn a spread between these fees and the
associated costs is dependent upon the competitive environment, product
performance, the ability to attract clients and assets, and the Company's
control of expense levels.
Credit Risk is the risk that counterparties or issuers may default or fail to
fully honor contractual obligations and is inherent in investment portfolio
asset positions including corporate bonds and mortgages, private placements and
other lending-type products, certain derivative transactions, and various
investment operations functions. In derivative transactions, the Company follows
an established credit approval process which includes risk control limits and
monitoring procedures.
Limits of exposure by counterparty, country and industry are in place at the
portfolio level, and counterparty concentration risk is also reviewed at the
enterprise level. Credit concentration risks are limited based on credit
quality, and enterprise-level concentrations are reviewed on a quarterly basis.
Business group credit analysis units evaluate creditworthiness of counterparties
and assign internal credit ratings based on data from independent rating
agencies and their own fundamental analysis. Additionally, stress tests and
sensitivity analysis are utilized to estimate the exposure to credit losses from
unusual events.
Liquidity Risk is the risk that the Company will be unable to liquidate
positions at a reasonable price in order to meet cash flow requirements under
various scenarios. As indicated above, the Company's asset/liability management
strategies seek to maintain asset positions that are consistent with the
expected cash flow demands associated with its liabilities under various
possible situations. Liquidity policies are formally managed at the enterprise
level, using various comparisons of asset liquidity to potential liability
outflows. The Company believes that the comparison of its general account net
liquidity to individual policy net cash surrender value is key to the periodic
evaluation of its ability to meet policyholder claim requirements, and stress
tests are utilized to measure the expected liquidity situation under
hypothetical unusual events. The Company believes that its liquidity position is
more than adequate to meet the expected cash flow demands associated with its
liabilities under reasonably possible stress situations.
Operating Risk is the risk of potential loss from internal or external events
such as mismanagement, fraud, systems breakdowns, business interruption, or
failure to satisfy legal or fiduciary responsibilities. All financial
institutions, including the Company, are exposed to the risk of unauthorized
activities by employees that are contrary to the internal controls designed to
manage such risks. Legal risk may arise from inadequate control over contract
documentation, marketing processes, or other operations. Internal controls
responsive to regulatory, legal, credit, asset stewardship and other concerns
are established at the business unit level for specific lines of business and at
the enterprise level for company-wide processes. Controls are monitored by
business unit management, internal and external auditors, and by an enterprise
level Management Internal Control unit, and in certain instances, are subject to
regulatory review.
Following recent revelations and negative publicity surrounding the issue of
sales practices, the Company has implemented a strategy to emphasize ethical
conduct in the recruitment and training of agents and in the sales process. The
Company has also strengthened controls including the establishment of a client
acquisition program, in conjunction with the underwriting process, intended to
ascertain the appropriateness of insurance coverages sold and mitigate the risk
of inappropriate policy replacement activity.
Another aspect of operating risk relates to the Company's ability to conduct
transactions electronically and to gather, process, and disseminate information
and maintain data integrity and uninterrupted operations given the possibility
of unexpected or unusual events. The Company is implementing a business
continuation initiative to address these concerns. Considerations relative to
the potential impact of the Year 2000 on computer operations, infrastructural
support, and other matters are discussed above.
17
Item 8. Financial Statements and Supplementary Data
- -----------------------------------------------------
Information required with respect to this Item 8 regarding Financial Statements
and Supplementary Data is set forth commencing on page F-3 hereof. See Index to
Financial Statements and Schedules elsewhere in this Annual Report.
Item 9. Changes in and Disagreements with Independent Accountants on
Accounting and Financial Disclosure
- --------------------------------------------------------------------------------
Not applicable.
18
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
Name Position Age
- ---- -------- ---
James J. Avery, Jr. Chairman of the Board and Director 47
I. Edward Price Vice Chairman of the Board and Director 56
Esther H. Milnes President and Director 48
James Drozanowski Senior Vice President 56
Frank Marino Senior Vice President 54
Edward A. Minogue Senior Vice President 56
Hwei-Chung Shao Senior Vice President and Chief Actuary 44
Dennis G. Sullivan Principal Financial Officer and
Chief Accounting Officer 43
David A. Nachman Vice President and Comptroller 51
Imants Saksons Vice President 48
William M. Bethke Director 51
Ira J. Kleinman Director 51
Mendel A. Melzer Director 38
Kiyofumi Sakaguchi Director 55
- --------------------------------------------------------------------------------
James J. Avery, Jr., age 47 was elected Chairman of the Board of Directors of
the Company on June 27, 1997. Mr. Avery joined the Prudential Insurance Company
of America in 1988 and has served as the Senior Vice President, CFO and Chief
Actuary for the Prudential Individual Insurance Group since 1997.
I. Edward Price, age 56, has been Senior Vice President and Actuary of
Prudential Individual Insurance since 1995. From 1994 to 1995, he was Chief
Executive Officer of Prudential International Insurance. From 1993 to 1994 he
was President of Prudential International Insurance. Prior to 1993, he was
Senior Vice President and Company Actuary of Prudential.
Esther H. Milnes, age 48, has been Vice President and Actuary of Prudential
Individual Insurance Group since 1996. From 1993 to 1995, she was Senior Vice
President and Chief Actuary of Prudential Insurance and Financial Services.
Prior to 1993, she was Vice President and Associate Actuary of Prudential.
James C. Drozanowski, age 56, has been Vice President and Operations Executive,
Prudential Individual Insurance Group since 1996. From 1995 to 1996, he was
President and Chief Executive Officer of Chase Manhattan Bank, and from 1993 to
1995, he was Vice President, North America Customer Services, Chase Manhattan
Bank. Prior to 1993, he was Operations Executive, Global Securities Services,
Chase Manhattan Bank.
Frank P. Marino, age 54, has been Vice President, Policyowner Relations
Department, Prudential Individual Insurance Group since 1996. Prior to 1996 he
was Senior Vice President, Prudential Mutual Fund Services.
Edward A. Minogue, age 56, was elected a Senior Vice President of the Company on
September 1, 1997. Mr. Minogue has been a Vice President of the Prudential
Insurance Company of America since July, 1997. Prior to 1997, Mr. Minogue was a
director of Merrill Lynch, Pierce & Smith, Inc.
19
Hwei-Chung Shao, age 44, has been Vice President and Associate Actuary,
Prudential.
Dennis G. Sullivan, age 43, was elected Principal Financial Officer and Chief
Accounting Officer of the Company in March, 1999. Mr. Sullivan has been Vice
President and Deputy Controller of Prudential since November 1998. Prior
thereto, from January 1998, Mr. Sullivan was Vice President and Controller of
ContiFinancial Corporation. From 1997 to 1998, Mr. Sullivan was Deputy Corporate
Controller of Salomon Brothers Inc. Prior to 1997, he was a director at Salomon
Brothers Inc.
David A. Nachman, age 51, was elected Vice President and Comptroller of the
Company in March, 1999. Mr. Nachman joined the Prudential Insurance Company of
America in 1973 and has served as Vice President, Accounting, Prudential since
1992.
Imants Saksons, age 48, was elected Vice President, Compliance, Prudential
Individual Financial Services in September, 1998. Prior to 1998, he was Vice
President, Market Conduct, U.S. Operations, Manulife Fiancial.
William M. Bethke, age 51, has been President, Prudential Capital Markets Group
since 1992.
Ira J. Kleinman, age 51, has been Chief Marketing and Product Development
Officer of Prudential Individual Insurance Group since 1995. From 1993 to 1995,
he was President of Prudential Select. From 1992 to 1993, he was Senior Vice
President of Prudential. Prior to 1992, he was Vice President of Prudential.
Mendel A. Melzer, age 38, has been Chief Investment Officer, Mutual Funds and
Annuities, Prudential Investments since 1996; 1995 to 1996: Chief Financial
Officer of the Money Management Group of Prudential; 1993 to 1995: Senior Vice
President and Chief Financial Officer of Prudential Preferred Financial
Services; Prior to 1993: Managing Director, Prudential Investment Corporation.
Kiyofumi Sakaguchi, age 55, has been President, Prudential International
Insurance Group since 1995; 1994 to 1995: Chairman and Chief Executive Officer,
the Prudential Life Insurance Co., Ltd.; Prior to 1994: President and Chief
Executive Officer, Asia Pacific Region-Prudential International Insurance, and
President, the Prudential Life Insurance Co., Ltd.
Item 11. Executive Compensation
- -------------------------------
The following table shows the 1998 annual compensation, paid by Prudential, and
allocated based on time devoted to the duties as an executive of the Company for
services provided to the Company:
Name and Principal Other Annual
Position Year Salary Bonus Compensation
- --------------------- ---- ------- ------- ------------
Esther H. Milnes 1998 $20,769 $26,313 $ 0
President 1997 18,660 21,398 0
1996 18,058 12,136 0
Item 12. Security Ownership of Certain Beneficial Owners and Management
- -----------------------------------------------------------------------
Not applicable.
Item 13. Certain Relationships and Related Transactions
- -------------------------------------------------------
Refer to Note 13 in the Notes to the Consolidated Financial Statements on page
F-24.
20
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------------------------------------------------------------------------
(a) (1) and (2) Financial Statements and Schedules of Registrant and
its subsidiaries are listed in the accompanying "Index to Consolidated
Financial Statements and Financial Statement Schedules" on page F-1
hereof and are filed as part of this Report.
(a) (3) Exhibits
--------
Regulation S-K
--------------
2. Not applicable.
3. Documents Incorporated by Reference
(i) The Articles of Incorporation of Pruco Life, as amended
October 19, 1993, are incorporated herein by reference to Form
S-6, Registration No. 333-07451, filed July 2, 1996 on behalf of
the Pruco Life Variable Appreciable Account; (ii) Bylaws of Pruco
Life, as amended May 6, 1997 are incorporated herein by reference
to Form 10-Q, Registration No. 33-37587, filed August 15, 1997 on
behalf of Pruco Life Insurance Company.
4. Exhibits
Modified Guaranteed Annuity Contract, incorporated by reference
to Registrant's Form S-1 Registration Statement, Registration No.
33-37587, filed November 2, 1990, on behalf of Pruco Life
Insurance Company.
Market-Value Adjustment Annuity Contract, incorporated by
reference to Registrant's Form S-1 Registration Statement,
Registration No. 33-61143, filed November 17, 1995, on behalf of
Pruco Life Insurance Company.
9. None.
10. None.
11. Not applicable.
12. Not applicable.
13. Not applicable.
16. Not applicable.
18. None.
21. Pruco Life Insurance Company of New Jersey, a stock life
insurance company organized under the laws of the state of New
Jersey, is a wholly owned subsidiary of Pruco Life. It is
licensed to sell life insurance and annuities only in the States
of New Jersey and New York.
The Prudential Life Insurance Company of Arizona, a stock life
insurance company organized under the laws of the State of
Arizona, is a wholly owned subsidiary of Pruco Life. It is
licensed to sell life insurance and annuities only in the State
of Arizona.
22. None.
23. Not applicable.
24. Powers of Attorney for I. Edward Price, Esther H. Milnes, William
M. Bethke, Ira Kleinman and Mendel Melzer are incorporated by
reference to Form 10-K, Registration No. 33-867880, filed March
21
28, 1997, on behalf of Pruco Life Variable Contract Real Property
Account. A Power of Attorney for Kiyofumi Sakaguchi is
incorporated by reference to Post Effective Amendment No. 8 to
Form S-6, Registration No. 33-49994, filed April 28, 1997 on
behalf of the Pruco Life PRUvider Variable Appreciable Account. A
Power of Attorney for James J. Avery, Jr. is incorporated by
reference to Post-Effective Amendment No. 9 to Form S-1,
Registration No. 33-20018, filed June 25, 1997 on behalf of the
Pruco Life of New Jersey Variable Contract Real Property Account.
27. Exhibit 27, Financial Data Schedule appended to this form in
accordance with EDGAR instructions.
99. The following table presents sales and related expenses of the
Flexible Premium Variable Annuity Account since July 19, 1995,
the effective date of the registration statement (SEC file number
3331-61143).
For the account(s)
For the account of the
of the Company contractholder(s)
------------------------ ------------------
Aggregate
offering
price of
amount
registered Amount sold Amount sold
---------- ----------- ------------------
(000's)
Flexible Premium Variable Annuity Account* $ 500,000 $ 196,882 $ 13,309
Underwriting discounts and commissions ** (6,891)
Other expenses *** (9,943)
---------
Total (16,834)
---------
Net offering proceeds $ 180,048
=========
* Securities are not issued or sold in predetermined units.
** Amount represents estimated commissions paid to affiliated parties.
*** Amount represents estimated general administrative expenses paid to
the parent under service and lease agreement.
22
SIGNATURES
----------
Pursuant to the requirements of Section 13, or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PRUCO LIFE INSURANCE COMPANY
(Registrant)
Date: March 15, 1999 By: /s/ESTHER H. MILNES
-------------- --------------------------------
Esther H. Milnes
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
* Chairman of the Board March 15, 1999
- ------------------------------
James J. Avery, Jr.
* Vice Chairman of the Board March 15, 1999
- ------------------------------ and DirectoR
I. Edward Price
* President and Director March 15, 1999
- ------------------------------
Esther H. Milnes
/s/DENNIS G. SULLIVAN Principal Financial Officer and March 15, 1999
- ------------------------------ Chief Accounting Officer
Dennis G. Sullivan
* Director March 15, 1999
- ------------------------------
William M. Bethke
* Director March 15, 1999
- ------------------------------
Ira J. Kleinman
* Director March 15, 1999
- ------------------------------
Mendel A. Melzer
* Director March 15, 1999
- ------------------------------
Kiyofumi Sakaguchi
* By: /s/THOMAS C. CASTANO
--------------------------
Thomas C. Castano
(Attorney-in-Fact)
23
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997, and 1996
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
24
PRUCO LIFE INSURANCE COMPANY
INDEX TO FINANCIAL STATEMENTS
Financial Statements Page No.
- -------------------- --------
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
Report of Independent Accountants F-2
Consolidated Financial Statements:
Statements of Financial Position -
December 31, 1998 and 1997 F-3
Statements of Operations - Years ended
December 31, 1998, 1997 and 1996 F-4
Statements of Changes in Stockholder's Equity -
Years ended December 31, 1998, 1997 and 1996 F-5
Statements of Cash Flows - Years ended
December 31, 1998, 1997, and 1996 F-6
Notes to the Consolidated Financial Statements -
December 31, 1998, 1997, and 1996 F-7
F-1
Report of Independent Accountants
---------------------------------
To the Board of Directors of
Pruco Life Insurance Company
In our opinion, the accompanying consolidated statements of financial position
and the related consolidated statements of operations, of changes in
stockholder's equity and of cash flows present fairly, in all material respects,
the financial position of Pruco Life Insurance Company and its subsidiaries at
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. 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
generally accepted auditing standards 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 the opinion expressed
above.
PricewaterhouseCoopers LLP
New York, New York
February 26, 1999
F-2
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Financial Position
December 31, 1998 and 1997 (In Thousands)
- --------------------------------------------------------------------------------
1998 1997
------------ ------------
ASSETS
Fixed maturities
Available for sale, at fair value (amortized cost, 1998: $2,738,654;
1997: $2,526,554) $ 2,763,926 $ 2,563,852
Held to maturity, at amortized cost (fair value, 1998: $421,845; 1997:
$350,056) 410,558 338,848
Equity securities - available for sale, at fair value (cost, 1998: $2,951; 2,847 1,982
1997: $1,289)
Mortgage loans on real estate 17,354 22,787
Policy loans 766,917 703,955
Short-term investments 240,727 316,355
Other long-term investments 1,047 1,317
------------ ------------
Total investments 4,203,376 3,949,096
Cash 89,679 71,358
Deferred policy acquisition costs 861,713 655,242
Accrued investment income 61,114 67,000
Other assets 65,145 86,692
Separate Account assets 11,531,754 8,022,079
------------ ------------
TOTAL ASSETS $ 16,812,781 $ 12,851,467
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $ 2,696,191 $ 2,380,460
Future policy benefits and other policyholder liabilities 534,599 472,460
Cash collateral for loaned securities 73,336 143,421
Securities sold under agreement to repurchase 49,708 --
Income taxes payable 44,524 71,703
Net deferred income tax liability 148,834 138,483
Payable to affiliate 66,568 70,375
Other liabilities 55,038 120,260
Separate Account liabilities 11,490,751 7,948,788
------------ ------------
Total liabilities 15,159,549 11,345,950
------------ ------------
Contingencies (See Note 11)
Stockholder's Equity
Common stock, $10 par value;
1,000,000 shares, authorized;
250,000 shares, issued and outstanding at
December 31, 1998 and 1997 2,500 2,500
Paid-in-capital 439,582 439,582
Retained earnings 1,202,833 1,050,871
Accumulated other comprehensive income
Net unrealized investment gains 9,902 17,129
Foreign currency translation adjustments (1,585) (4,565)
------------ ------------
Accumulated other comprehensive income 8,317 12,564
------------ ------------
Total stockholder's equity 1,653,232 1,505,517
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 16,812,781 $ 12,851,467
============ ============
See Notes to Consolidated Financial Statements
F-3
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31, 1998, 1997 and 1996 (In Thousands)
- --------------------------------------------------------------------------------
1998 1997 1996
--------- --------- ---------
REVENUES
Premiums $ 57,467 $ 49,496 $ 51,525
Policy charges and fee income 364,719 330,292 324,976
Net investment income 261,430 259,634 247,328
Realized investment gains, net 44,841 10,974 10,835
Other income 41,267 33,801 20,818
--------- --------- ---------
Total revenues 769,724 684,197 655,482
--------- --------- ---------
BENEFITS AND EXPENSES
Policyholders' benefits 186,527 179,419 186,873
Interest credited to policyholders' account balances 118,935 110,815 118,246
General, administrative and other expenses 228,067 225,721 122,006
--------- --------- ---------
Total benefits and expenses 533,529 515,955 427,125
--------- --------- ---------
Income from operations before income taxes 236,195 168,242 228,357
--------- --------- ---------
Income taxes
Current 69,768 73,326 60,196
Deferred 14,465 (11,458) 18,939
--------- --------- ---------
Total income taxes 84,233 61,868 79,135
--------- --------- ---------
NET INCOME 151,962 106,374 149,222
--------- --------- ---------
Other comprehensive income, net of tax:
Unrealized gains on securities, net of
reclassification adjustment (7,227) 3,025 (17,952)
Foreign currency translation adjustments 2,980 (2,863) (482)
--------- --------- ---------
Other comprehensive income (4,247) 162 (18,434)
--------- --------- ---------
TOTAL COMPREHENSIVE INCOME $ 147,715 $ 106,536 $ 130,788
========= ========= =========
See Notes to Consolidated Financial Statements
F-4
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Changes in Stockholder's Equity
Years Ended December 31, 1998, 1997, and 1996 (In Thousands)
- --------------------------------------------------------------------------------
Accumulated
other Total
Common Paid-in- Retained comprehensive stockholder's
stock capital earnings income equity
----------- ----------- ----------- ------------- -------------
Balance, January 1, 1996 $ 2,500 $ 439,582 $ 795,275 $ 30,836 $ 1,268,193
Net income -- -- 149,222 -- 149,222
Change in foreign currency
translation adjustments -- -- -- (482) (482)
Change in net unrealized
investment gains, net of
reclassification adjustment -- -- -- (17,952) (17,952)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1996 2,500 439,582 944,497 12,402 1,398,981
Net income -- -- 106,374 -- 106,374
Change in foreign currency
translation adjustments -- -- -- (2,863) (2,863)
Change in net unrealized
investment gains, net of
reclassification adjustment -- -- -- 3,025 3,025
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1997 2,500 439,582 1,050,871 12,564 1,505,517
Net income -- -- 151,962 -- 151,962
Change in foreign currency
translation adjustments -- -- -- 2,980 2,980
Change in net unrealized
investment gains, net of
reclassification adjustment -- -- -- (7,227) (7,227)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1998 $ 2,500 $ 439,582 $ 1,202,833 $ 8,317 $ 1,653,232
=========== =========== =========== =========== ============
See Notes to Consolidated Financial Statements
F-5
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 1998, 1997, and 1996 (In Thousands)
- --------------------------------------------------------------------------------
1998 1997 1996
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 151,962 $ 106,374 $ 149,222
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Policy charges and fee income (47,230) (40,783) (50,286)
Interest credited to policyholders' account balances 118,935 110,815 118,246
Realized investment gains, net (44,841) (10,974) (10,835)
Amortization and other non-cash items 18,611 (31,181) 29,334
Change in:
Future policy benefits and other policyholders' liabilities 62,139 39,683 54,176
Accrued investment income 5,886 (4,890) (2,248)
Separate Accounts 32,288 (13,894) (38,025)
Payable to affiliate (3,807) 20,547 16,519
Policy loans (62,962) (64,173) (70,509)
Deferred policy acquisition costs (206,471) (22,083) (66,183)
Income taxes payable (27,179) 78,894 (816)
Deferred income tax liability 10,351 (10,477) 7,912
Other, net (43,675) 34,577 7,814
----------- ----------- -----------
Cash Flows (Used In) From Operating Activities (35,993) 192,435 144,321
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities:
Available for sale 5,429,396 2,828,665 3,886,254
Held to maturity 74,767 138,626 138,127
Equity securities 4,101 6,939 7,527
Mortgage loans on real estate 5,433 24,925 19,226
Other long-term investments 1,140 3,276 288
Investment real estate -- -- 4,488
Payments for the purchase of:
Fixed maturities:
Available for sale (5,617,208) (3,141,785) (4,008,810)
Held to maturity (145,919) (70,532) (114,494)
Equity securities (2,274) (4,594) (4,697)
Other long-term investments (409) (51) (657)
Cash collateral for loaned securities, net (70,085) 143,421 -
Securities sold under agreement to repurchase, net 49,708 - -
Short-term investments, net 75,771 (147,030) 58,186
----------- ----------- -----------
Cash Flows Used In Investing Activities (195,579) (218,140) (14,562)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 3,098,721 2,099,600 536,370
Withdrawals (2,848,828) (2,076,303) (633,798)
----------- ----------- -----------
Cash Flows From (Used in) Financing Activities 249,893 23,297 (97,428)
----------- ----------- -----------
Net increase (decrease) in Cash 18,321 (2,408) 32,331
Cash, beginning of year 71,358 73,766 41,435
----------- ----------- -----------
CASH, END OF PERIOD $ 89,679 $ 71,358 $ 73,766
=========== =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes paid (received) $ 99,810 $ (7,904) $ 61,760
=========== =========== ===========
See Notes to Consolidated Financial Statements
F-6
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. BUSINESS
Pruco Life Insurance Company (the Company) is a stock life insurance company,
organized in 1971 under the laws of the state of Arizona. The Company markets
individual life insurance, variable life insurance, variable annuities, fixed
annuities, and a group annuity program (the Contracts) in all states and
territories except the District of Columbia and Guam. In addition, the Company
markets individual life insurance through its branch office in Taiwan. The
Company has two wholly owned subsidiaries, Pruco Life Insurance Company of New
Jersey (PLNJ) and The Prudential Life Insurance Company of Arizona (PLICA). PLNJ
is a stock life insurance company organized in 1982 under the laws of the state
of New Jersey. It is licensed to sell individual life insurance, variable life
insurance, fixed annuities, and variable annuities only in the states of New
Jersey and New York. PLICA is a stock life insurance company organized in 1988
under the laws of the state of Arizona. PLICA had no new business sales in 1997
or 1998 and at this time will not be issuing new business.
The Company is a wholly owned subsidiary of The Prudential Insurance Company of
America (Prudential), a mutual insurance company founded in 1875 under the laws
of the state of New Jersey. Prudential intends to make additional capital
contributions to the Company, as needed, to enable it to comply with its reserve
requirements and fund expenses in connection with its business. Generally,
Prudential is under no obligation to make such contributions and its assets do
not back the benefits payable under the Contracts.
The Company is engaged in a business that is highly competitive because of the
large number of stock and mutual life insurance companies and other entities
engaged in marketing insurance products, and individual and group annuities.
There are approximately 1,620 stock, mutual and other types of insurers in the
life insurance business in the United States.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP"). All significant intercompany
balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the period. Actual results could differ from those estimates.
Investments
Fixed maturities classified as "available for sale" are carried at estimated
fair value. Fixed maturities that the Company has both the intent and ability to
hold to maturity are stated at amortized cost and classified as "held to
maturity". The amortized cost of fixed maturities is written down to estimated
fair value if a decline in value is considered to be other than temporary.
Unrealized gains and losses on fixed maturities "available for sale", including
the effect on deferred policy acquisition costs and participating annuity
contracts that would result from the realization of unrealized gains and losses,
net of income taxes, are included in a separate component of equity,
"Accumulated other comprehensive income."
Equity securities, available for sale, comprised of common and non-redeemable
preferred stock, are carried at estimated fair value. The associated unrealized
gains and losses, net of income tax, the effects on deferred policy acquisition
costs and on participating annuity contracts that would result from the
realization of unrealized gains and losses, are included in a separate component
of equity, "Accumulated other comprehensive income."
Mortgage loans on real estate are stated primarily at unpaid principal balances,
net of unamortized discounts and allowance for losses. The allowance for losses
is based upon a loan specific review and management's consideration of past
results, current trends, the estimated value of the underlying collateral,
composition of the loan portfolio, current economic conditions and other
relevant factors. Impaired loans are identified by management as loans in which
a probability exists that all amounts due according to the contractual terms of
the loan agreement will not be collected.
F-7
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Impaired loans are measured based on the present value of expected future cash
flows discounted at the loan's effective interest rate, or the fair value of the
collateral if the loan is collateral dependent.
Interest received on impaired loans, including loans that were previously
modified in a troubled debt restructuring, is either applied against the
principal or reported as revenue, according to management's judgment as to the
collectibility of principal. Management discontinues the accrual of interest on
impaired loans after the loans are 90 days delinquent as to principal or
interest, or earlier when management has serious doubts about collectibility.
When a loan is recognized as impaired, any accrued but unpaid interest
previously recorded on such loan is reversed against interest income of the
current period. Generally, a loan is restored to accrual status only after all
delinquent interest and principal are brought current and, in the case of loans
where interest has been interrupted for a substantial period, a regular payment
performance has been established.
Policy loans are carried at unpaid principal balances.
Short-term investments, consists primarily of highly liquid debt instruments
purchased with an original maturity of twelve months or less and are carried at
amortized cost, which approximates fair value.
Other long-term investments primarily represent the Company's investments in
joint ventures and partnerships in which the Company does not have control.
These investments are recorded using the equity method of accounting, reduced
for other than temporary declines in value.
Realized investment gains, net are computed using the specific identification
method. Costs of fixed maturity and equity securities are adjusted for
impairments considered to be other than temporary.
Cash
Cash includes cash on hand, amounts due from banks, and money market
instruments.
Deferred Policy Acquisition Costs
The costs which vary with and that are related primarily to the production of
new insurance business are deferred to the extent that they are deemed
recoverable from future profits. Such costs include certain commissions, costs
of policy issuance and underwriting, and certain variable field office expenses.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing at the end of each accounting
period. Deferred policy acquisition costs are adjusted for the impact of
unrealized gains or losses on investments as if these gains or losses had been
realized, with corresponding credits or charges included in "Accumulated other
comprehensive income."
Acquisition costs related to interest-sensitive life products and
investment-type contracts are deferred and amortized in proportion to total
estimated gross profits arising principally from investment results, mortality
and expense margins and surrender charges based on historical and anticipated
future experience. Amortization periods range from 15 to 30 years. For
participating life insurance, deferred policy acquisition costs are amortized
over the expected life of the contracts in proportion to estimated gross margins
based on historical and anticipated future experience, which is updated
periodically. Deferred policy acquisition costs are analyzed to determine if
they are recoverable from future income, including investment income. If such
costs are determined to be unrecoverable, they are expensed at the time of
determination. The effect of revisions to estimated gross profits on unamortized
deferred acquisition costs is reflected in earnings in the period such estimated
gross profits are revised.
Securities loaned
Securities loaned are treated as financing arrangements and are recorded at the
amount of cash received as collateral. The Company obtains collateral in an
amount equal to 102% of the fair value of the securities. The Company monitors
the market value of securities loaned on a daily basis with additional
collateral obtained as necessary. Non-cash collateral received is not reflected
in the consolidated statements of financial position. Substantially all of the
Company's securities loaned are with large brokerage firms.
F-8
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase are treated as financing
arrangements and are carried at the amounts at which the securities will be
subsequently reacquired, including accrued interest, as specified in the
respective agreements. The Company's policy is to take possession of securities
purchased under agreements to resell. The market value of securities to be
repurchased is monitored and additional collateral is requested, where
appropriate, to protect against credit exposure.
Securities lending and securities repurchase agreements are used to generate net
investment income and facilitate trading activity. These instruments are
short-term in nature (usually 30 days or less). Securities loaned are
collateralized principally by U.S. Government and mortgage-backed securities.
Securities sold under repurchase agreements are collateralized principally by
cash. The carrying amounts of these instruments approximate fair value because
of the relatively short period of time between the origination of the
instruments and their expected realization.
Separate Account Assets and Liabilities
Separate Account assets and liabilities are reported at estimated fair value and
represent segregated funds which are invested for certain policyholders and
other customers. Separate Account assets include common stocks, fixed
maturities, real estate related securities, and short-term investments. The
assets of each account are legally segregated and are not subject to claims that
arise out of any other business of the Company. Investment risks associated with
market value changes are borne by the customers, except to the extent of minimum
guarantees made by the Company with respect to certain accounts. The investment
income and gains or losses for Separate Accounts generally accrue to the
policyholders and are not included in the Consolidated Statement of Operations.
Mortality, policy administration and surrender charges on the accounts are
included in "Policy charges and fee income."
Separate Accounts represent funds for which investment income and investment
gains and losses accrue directly to, and investment risk is borne by, the
policyholders, with the exception of the Pruco Life Modified Guaranteed Annuity
Account. The Pruco Life Modified Guaranteed Annuity Account is a non-unitized
separate account, which funds the Modified Guaranteed Annuity Contract and the
Market Value Adjustment Annuity Contract. Owners of the Pruco Life Modified
Guaranteed Annuity and the Market Value Adjustment Annuity Contracts do not
participate in the investment gain or loss from assets relating to such
accounts. Such gain or loss is borne, in total, by the Company.
Insurance Revenue and Expense Recognition
Premiums from insurance policies are generally recognized when due. Benefits are
recorded as an expense when they are incurred. For traditional life insurance
contracts, a liability for future policy benefits is recorded using the net
level premium method. For individual annuities in payout status, a liability for
future policy benefits is recorded for the present value of expected future
payments based on historical experience.
Premiums from non-participating group annuities with life contingencies are
generally recognized when due. For single premium immediate annuities, premiums
are recognized when due with any excess profit deferred and recognized in a
constant relationship to insurance in-force or, for annuities, the amount of
expected future benefit payments.
Amounts received as payment for interest-sensitive life, individual annuities,
and guaranteed investment contracts are reported as deposits to "Policyholders'
account balances." Revenues from these contracts reflected as "Policy charges
and fee income" consist primarily of fees assessed during the period against the
policyholders' account balances for mortality charges, policy administration
charges and surrender charges. In addition, interest earned from the investment
of these account balances is reflected in "Net investment income." Benefits and
expenses for these products include claims in excess of related account
balances, expenses of contract administration, interest credited and
amortization of deferred policy acquisition costs.
Foreign Currency Translation Adjustments
Assets and liabilities of the Taiwan branch are translated to U.S. dollars at
the exchange rate in effect at the end of the period. Revenues, benefits and
other expenses are translated at the average rate prevailing during the period.
Cumulative translation adjustments arising from the use of differing exchange
rates from period to period are charged or credited directly to "Other
comprehensive income." The cumulative effect of changes in foreign exchange
rates are included in "Accumulated other comprehensive income."
F-9
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Other Income
Other income consists primarily of asset management fees which are received by
the Company from Prudential for services Prudential provides to the Prudential
Series Fund, an underlying investment option of the Separate Accounts.
Derivative Financial Instruments
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, various financial indices, or the value of
securities or commodities. Derivative financial instruments used by the Company
include futures, currency swaps, and options contracts and can be
exchange-traded or contracted in the over-the-counter market. The Company uses
derivative financial instruments to hedge market risk from changes in interest
rates or foreign currency exchange rates, and to alter interest rate or currency
exposures arising from mismatches between assets and liabilities. All
derivatives used by the Company are for other than trading purposes.
To qualify as a hedge, derivatives must be designated as hedges for existing
assets, liabilities, firm commitments, or anticipated transactions which are
identified and probable to occur, and effective in reducing the market risk to
which the Company is exposed. The effectiveness of the derivatives must be
evaluated at the inception of the hedge and throughout the hedge period.
When derivatives qualify as hedges, the changes in the fair value or cash flows
of the derivatives and the hedged items are recognized in earnings in the same
period. If the Company's use of other than trading derivatives does not meet the
criteria to apply hedge accounting, the derivatives are recorded at fair value
in "Other liabilities" in the Consolidated Statements of Financial Position, and
changes in their fair value are recognized in earnings in "Realized investment
gains, net" without considering changes in the hedged assets or liabilities.
Cash flows from other than trading derivative assets and liabilities are
reported in the operating activities section in the Consolidated Statements of
Cash Flows.
Income Taxes
The Company and its subsidiaries are members of the consolidated federal income
tax return of Prudential and files separate company state and local tax returns.
Pursuant to the tax allocation arrangement with Prudential, total federal income
tax expense is determined on a separate company basis. Members with losses
record tax benefits to the extent such losses are recognized in the consolidated
federal tax provision. Deferred income taxes are generally recognized, based on
enacted rates, when assets and liabilities have different values for financial
statement and tax reporting purposes. A valuation allowance is recorded to
reduce a deferred tax asset to that portion that is expected to be realized.
New Accounting Pronouncements
In June 1996, the Financial Accounting Standards Board ("FASB") issued the
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("SFAS 125"). The statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities
and provides consistent standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. SFAS 125
became effective January 1, 1997 and is to be applied prospectively. Subsequent
to June 1996, FASB issued SFAS No. 127 "Deferral of the Effective Date of
Certain Provisions of SFAS 125" ("SFAS 127"). SFAS 127 delays the implementation
of SFAS 125 for one year for certain transactions, including repurchase
agreements, dollar rolls, securities lending and similar transactions. Adoption
of SFAS 125 did not have a material impact on the Company's results of
operations, financial position and liquidity.
During 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income,"
which was issued by the FASB in June 1997. This statement defines comprehensive
income and establishes standards for reporting and displaying comprehensive
income and its components in financial statements. The statement requires that
the Company classify items of other comprehensive income by their nature and
display the accumulated balance of other comprehensive income separately from
retained earnings in the equity section of the Statement of Financial Position.
Application of this statement did not change recognition or measurement of net
income and, therefore, did not affect the Company's financial position or
results of operations.
F-10
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
On January 1, 1999, the Company adopted the American Institute of Certified
Public Accountants ("AICPA") Statement of Position 97-3, "Accounting by
Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP 97-3").
This statement provides guidance for determining when an insurance company or
other enterprise should recognize a liability for guaranty-fund assessments as
well as guidance for measuring the liability. The adoption of SOP 97-3 is not
expected to have a material effect on the Company's financial position or
results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires that companies recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. SFAS No. 133 provides, if certain conditions
are met, that a derivative may be specifically designated as (1) a hedge of the
exposure to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment (fair value hedge), (2) a hedge of the exposure to
variable cash flows of a forecasted transaction (cash flow hedge), or (3) a
hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security or a
foreign-currency-denominated forecasted transaction (foreign currency hedge).
SFAS No. 133 does not apply to most traditional insurance contracts. However,
certain hybrid contracts that contain features which can affect settlement
amounts similarly to derivatives may require separate accounting for the "host
contract" and the underlying "embedded derivative" provisions. The latter
provisions would be accounted for as derivatives as specified by the statement.
Under SFAS No. 133, the accounting for changes in fair value of a derivative
depends on its intended use and designation. For a fair value hedge, the gain or
loss is recognized in earnings in the period of change together with the
offsetting loss or gain on the hedged item. For a cash flow hedge, the effective
portion of the derivative's gain or loss is initially reported as a component of
other comprehensive income and subsequently reclassified into earnings when the
forecasted transaction affects earnings. For a foreign currency hedge, the gain
or loss is reported in other comprehensive income as part of the foreign
currency translation adjustment. For all other derivatives not designated as
hedging instruments, the gain or loss is recognized in earnings in the period of
change. The Company is required to adopt this Statement no later than January 1,
2000 and is currently assessing the effect of the new standard.
In October, 1998, the AICPA issued Statement of Position 98-7, "Deposit
Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not
Transfer Insurance Risk," ("SOP 98-7"). This statement provides guidance on how
to account for insurance and reinsurance contracts that do not transfer
insurance risk. SOP 98-7 is effective for fiscal years beginning after June 15,
1999. The adoption of this statement is not expected to have a material effect
on the Company's financial position or results of operations.
Reclassifications
Certain amounts in the prior years have been reclassified to conform to current
year presentation.
F-11
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS
Fixed Maturities and Equity Securities:
The following tables provide additional information relating to fixed maturities
and equity securities as of December 31,:
1998
----------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
(In Thousands)
Fixed maturities available for sale
U.S. Treasury securities and obligations of
U.S. government corporations and agencies 110,294 864 318 110,840
Foreign government bonds 87,112 2,003 696 88,419
Corporate securities 2,540,498 30,160 6,897 2,563,761
Mortgage-backed securities 750 156 -- 906
---------- ---------- ---------- ----------
Total fixed maturities available for sale $2,738,654 $ 33,183 $ 7,911 $2,763,926
========== ========== ========== ==========
Equity securities available for sale $ 2,951 $ 168 $ 272 $ 2,847
========== ========== ========== ==========
Fixed maturities held to maturity
Corporate securities $ 410,558 $ 11,287 $ -- $ 421,845
---------- ---------- ---------- ----------
Total fixed maturities held to maturity $ 410,558 $ 11,287 $ -- $ 421,845
========== ========== ========== ==========
1997
----------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
(In Thousands)
Fixed maturities available for sale
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 177,691 $ 1,231 $ 20 $ 178,902
Foreign government bonds 83,889 1,118 19 84,988
Corporate securities 2,263,898 36,857 2,017 2,298,738
Mortgage-backed securities 1,076 180 32 1,224
---------- ---------- ---------- ----------
Total fixed maturities available for sale $2,526,554 $ 39,386 $ 2,088 $2,563,852
========== ========== ========== ==========
Equity securities available for sale $ 1,289 $ 802 $ 109 $ 1,982
========== ========== ========== ==========
Fixed maturities held to maturity
Corporate securities $ 338,848 $ 11,427 $ 219 $ 350,056
---------- ---------- ---------- ----------
Total fixed maturities held to maturity $ 338,848 $ 11,427 $ 219 $ 350,056
========== ========== ========== ==========
F-12
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The amortized cost and estimated fair value of fixed maturities, categorized by
contractual maturities at December 31, 1998 are shown below:
Available for Sale Held to Maturity
-------------------------------- ---------------------------------
Amortized Estimated Fair Amortized Estimated Fair
Cost Value Cost Value
--------- -------------- ---------- --------------
(In Thousands) (In Thousands)
Due in one year or less $ 72,931 $ 73,254 $ 3,036 $ 3,064
Due after one year through five years 1,050,981 1,059,389 193,749 201,136
Due after five years through ten years 1,142,507 1,156,664 155,568 158,801
Due after ten years 471,485 473,713 58,205 58,844
Mortgage-backed securities 750 906 -- --
---------- ---------- ---------- ----------
Total $2,738,654 $2,763,926 $ 410,558 $ 421,845
========== ========== ========== ==========
Actual maturities will differ from contractual maturities because, in certain
circumstances, issuers have the right to call or prepay obligations.
Proceeds from the sale of fixed maturities available for sale during 1998, 1997,
and 1996 were $5,327.3 million, $2,796.3 million, and $3,667.1 million,
respectively. Gross gains of $46.3 million, $18.6 million, and $22.1 million and
gross losses of $14.1 million, $7.9 million, and $17.6 million were realized on
those sales during 1998, 1997, and 1996, respectively.
Proceeds from the maturity of fixed maturities available for sale during 1998,
1997, and 1996 were $102.1 million, $32.4 million, and $219.2 million,
respectively. During the years ended December 31, 1998, 1997, and 1996, there
were no securities classified as held to maturity that were sold.
Writedowns for impairments of fixed maturities which were deemed to be other
than temporary were $2.8 million, $.1 million and $.1 million for the years
1998, 1997 and 1996, respectively.
F-13
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The following table describes the credit quality of the fixed maturity
portfolio, based on ratings assigned by the National Association of Insurance
Commissioners ("NAIC") or Standard & Poor's Corporation, an independent rating
agency as of December 31, 1998:
Available for Sale Held to Maturity
------------------------------ -------------------------------------
Amortized Estimated Fair Amortized Estimated Fair
Cost Value Cost Value
---------- -------------- ---------- --------------
(In Thousands) (In Thousands)
NAIC Standard & Poor's
1 AAA to AA- $1,195,301 $1,211,995 $ 180,070 $ 186,683
2 BBB+ to BBB- 1,254,522 1,263,656 182,298 185,417
3 BB+ to BB- 201,033 204,278 39,346 40,654
4 B+ to B- 59,799 57,695 8,821 9,068
5 CCC or lower 27,552 26,061 -- --
6 In or near default 447 241 23 23
---------- ---------- ---------- ----------
Total $2,738,654 $2,763,926 $ 410,558 $ 421,845
========== ========== ========== ==========
The fixed maturity portfolio consists largely of investment grade assets (rated
"1" or "2" by the NAIC), with such investments accounting for 89% and 94% of the
portfolio at December 31, 1998 and 1997, respectively, based on fair value. As
of both of those dates, less than 1% of the fixed maturities portfolio was rated
"6" by the NAIC, defined as public and private placement securities which are
currently non-performing or believed subject to default in the near-term.
The Company continually reviews fixed maturities and identifies potential
problem assets which require additional monitoring. The Company defines
"problem" fixed maturities as those for which principal and/or interest payments
are in default. The Company defines "potential problem" fixed maturities as
assets which are believed to present default risk associated with future debt
service obligations and therefore require more active management. At December
31, 1998 management identified $264.0 thousand of fixed maturity investments as
problem or potential problem. An immaterial amount of problem or potential
problem fixed maturities were identified in 1997.
Mortgage Loans on Real Estate
The Company's mortgage loans were collateralized by the following property types
at December 31, 1998 and 1997.
1998 1997
------------------ -------------------
(In Thousands)
Office buildings $ -- -- $ 4,607 20%
Retail stores 7,356 42% 8,090 35%
Apartment complexes 5,988 35% 6,080 27%
Industrial buildings 4,010 23% 4,010 18%
------------------ ------------------
Net carrying value $17,354 100% $22,787 100%
================== ==================
F-14
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
The largest concentration of mortgage loans are in the states of Pennsylvania
(35%), Washington (34%), and New Jersey (23%).
Special Deposits
Fixed maturities of $8.6 million and $8.3 million at December 31, 1998 and 1997,
respectively, were on deposit with governmental authorities or trustees as
required by certain insurance laws.
Other Long-Term Investments
The Company's "Other long-term investments" of $1.0 million and $1.3 million as
of December 31, 1998 and 1997, respectively, are comprised of joint ventures and
limited parterships. The Company's share of net income from these entities was
$.1 million, $2.2 million and $1.4 million for the years ended December 31,
1998, 1997 and 1996, respectively, and is reported in "Net investment income."
Investment Income and Investment Gains and Losses
Net investment income arose from the following sources for the years ended
December 31:
1998 1997 1996
--------- --------- ---------
(In Thousands)
Fixed maturities - available for sale $ 179,184 $ 161,140 $ 152,445
Fixed maturities - held to maturity 26,128 26,936 33,419
Equity securities 14 76 44
Mortgage loans on real estate 1,818 2,585 5,669
Policy loans 40,928 37,398 33,449
Short-term investments 23,110 22,011 16,780
Other 6,886 14,920 10,051
--------- --------- ---------
Gross investment income 278,068 265,066 251,857
Less: investment expenses (16,638) (5,432) (4,529)
--------- --------- ---------
Net investment income $ 261,430 $ 259,634 $ 247,328
========= ========= =========
Realized investment gains ,net including charges for other than temporary
reductions in value, for the years ended December 31, were from the following
sources:
1998 1997 1996
--------- --------- ---------
(In Thousands)
Fixed maturities - available for sale $ 29,330 $ 9,039 $ 9,036
Fixed maturities - held to maturity 487 821 --
Equity securities 3,489 8 781
Mortgage loans on real estate -- 797 1,677
Derivative instruments 12,414 -- --
Other (879) 309 (659)
--------- --------- ---------
Realized investment gains, net $ 44,841 $ 10,974 $ 10,835
========= ========= =========
F-15
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. INVESTMENTS (continued)
Net Unrealized Investment Gains
Net unrealized investment gains on securities available for sale are included in
the Consolidated Statement of Financial Position as a component of "Accumulated
other comprehensive income." Changes in these amounts include reclassification
adjustments to avoid double-counting in "Comprehensive income," items that are
included as part of "Net income" for a period that also have been part of "Other
comprehensive income" in earlier periods. The amounts for the years ended
December 31, net of tax, are as follows:
1998 1997 1996
-------- -------- --------
(In Thousands)
Net unrealized investment gains, beginning of year $ 17,129 $ 14,104 $ 32,056
Changes in net unrealized investment gains attributable to:
Investments:
Net unrealized gains on investments arising during the period 14,593 13,880 (20,405)
Reclassification adjustment for gains included in net income 22,799 6,680 6,165
-------- -------- --------
Change in net unrealized gains on investments, net of adjustments (8,206) 7,200 (26,570)
Impact of net unrealized investment gains on:
Policyholder's account balances (1,063) 1,293 (2,467)
Deferred policy acquisition costs 2,042 (5,468) 11,085
-------- -------- --------
Change in net unrealized investment gains (7,227) 3,025 (17,952)
-------- -------- --------
Net unrealized investment gains, end of year $ 9,902 $ 17,129 $ 14,104
======== ======== ========
Unrealized gains (losses) on investments arising during the periods reported in
the above table are net of income tax (benefit) expense of $(8.2) million,
$(7.6) million and $12.1 million for the years ended December 31, 1998, 1997 and
1996, respectively.
Reclassification adjustments reported in the above table for the years ended
December 31, 1998, 1997 and 1996 are net of income tax expense of $12.8 million,
$3.6 million and $3.8 million, respectively.
Policyholder's account balances reported in the above table are net of income
tax (benefit) expense of $(.2) million, $.0 million and $1.4 million for the
years ended December 31, 1998, 1997 and 1996, respectively.
Deferred policy acquisition costs in the above tables for the years ended
December 31, 1998, 1997 and 1996 are net of income tax (benefit) expense of
$(1.1) million, $2.9 million and $(6.2) million, respectively.
4. POLICYHOLDERS' LIABILITIES
Future policy benefits and other policyholder liabilities at December 31 are as
follows:
1998 1997
-------- --------
(In Thousands)
Life insurance $506,249 $444,737
Annuities 28,350 27,723
-------- --------
$534,599 $472,460
======== ========
F-16
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
4. POLICYHOLDERS' LIABILITIES (continued)
Life insurance liabilities include reserves for death benefits. Annuity
liabilities include reserves for immediate annuities.
The following table highlights the key assumptions generally utilized in
calculating these reserves:
Product Mortality Interest Rate Estimation Method
- ------------------------------ ------------------------- ------------- -----------------------
Life insurance - Domestic Generally rates 2.5% to 7.5% Net level premium based
guaranteed in on non-forfeiture
calculating cash interest rate
surrender values
Life insurance - International Generally rates 6.25% to 6.5% Net level premium based
guaranteed in on the expected
calculating cash investment return
surrender values
Individual immediate annuities 1983 Individual Annuity 6.25% to 11.0% Present value of
Mortality Table with expected future payment
certain modifications based on historical
experience
Policyholders' account balances at December 31, are as follows:
1998 1997
---------- ----------
(In Thousands)
Interest-sensitive life contracts $1,386,829 $1,345,089
Individual annuities 1,077,996 1,035,371
Guaranteed investment contracts 231,366 --
---------- ----------
$2,696,191 $2,380,460
========== ==========
Policyholders' account balances for interest-sensitive life, individual
annuities, and guaranteed investment contracts are equal to policy account
values plus unearned premiums. The policy account values represent an
accumulation of gross premium payments plus credited interest less withdrawals,
expenses, mortality charges.
Certain contract provisions that determine the policyholder account balances are
as follows:
Product Interest Rate Withdrawal / Surrender Charges
- --------------------------------- -------------- ----------------------------------
Interest sensitive life contracts 4.0% to 6.5% Various up to 10 years
Individual annuities 3.0% to 5.6% 0% to 8% for up to 8 years
Guaranteed investment contracts 5.02% to 6.23% Subject to market value withdrawal
provisions for any funds withdrawn
other than for benefit responsive
and contractual payments
F-17
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. REINSURANCE
The Company participates in reinsurance, with Prudential and other companies, in
order to provide greater diversification of business, provide additional
capacity for future growth and limit the maximum net loss potential arising from
large risks. Reinsurance ceded arrangements do not discharge the Company or the
insurance subsidiaries as the primary insurer, except for cases involving a
novation. Ceded balances would represent a liability to the Company in the event
the reinsurers were unable to meet their obligations to the Company under the
terms of the reinsurance agreements. The likelihood of a material reinsurance
liability reassumed by the Company is considered to be remote.
Reinsurance amounts included in the Consolidated Statement of Operations for the
year ended December 31 are below.
1998 1997 1996
-------- -------- --------
(In Thousands)
Direct Premiums $ 65,423 $ 51,851 $ 53.776
Reinsurance assumed 1,395 1,369 1,128
Reinsurance ceded - affiliated (6,532) (686) (254)
Reinsurance ceded - unaffiliated (2,819) (3,038) (3,125)
-------- -------- --------
Premiums $ 57,467 $ 49,496 $ 51,525
======== ======== ========
Policyholders' benefits ceded $ 27,991 $ 25,704 $ 26,796
======== ======== ========
Reinsurance recoverables, included in "Other assets" in the Company's
Consolidated Statements of Financial Position, at December 31 include amounts
recoverable on unpaid and paid losses and were as follows:
1998 1997
------- -------
(In Thousands)
Life insurance - affiliated $ 6,481 $ 2,618
Other reinsurance - affiliated 21,650 23,243
------- -------
$28,131 $25,861
======= =======
F-18
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. EMPLOYEE BENEFIT PLANS
Pension and Other Postretirement Plans
The Company has a non-contributory defined benefit pension plan which covers
substantially all of its Taiwanese employees. This plan was established as of
September 30, 1997 and the projected benefit obligation and related expenses at
September 30, 1998 was not material to the Consolidated Statements of Financial
Position or results of operations for the years presented. All other employee
benefit costs are allocated to the Company from Prudential in accordance with
the service agreement described in Note 13.
7. INCOME TAXES
The components of income taxes for the years ended December 31, are as follows:
1998 1997 1996
-------- -------- --------
(In Thousands)
Current tax expense (benefit):
U.S $ 67,272 $ 71,989 $ 59,489
State and local 2,496 1,337 703
Foreign -- -- 4
-------- -------- --------
Total 69,768 73,326 60,196
-------- -------- --------
Deferred tax expense (benefit):
U.S 14,059 (11,458) 18,413
State and local 406 -- 526
-------- -------- --------
Total 14,465 (11,458) 18,939
-------- -------- --------
Total income tax expense $ 84,233 $ 61,868 $ 79,135
======== ======== ========
The income tax expense for the years ended December 31, differs from the amount
computed by applying the expected federal income tax rate of 35% to income from
operations before income taxes for the following reasons:
1998 1997 1996
-------- -------- --------
(In Thousands)
Expected federal income tax expense $ 82,668 $ 58,885 $ 79,925
State and local income taxes 1,886 869 799
Other (321) 2,114 (1,589)
-------- -------- --------
Total income tax expense $ 84,233 $ 61,868 $ 79,135
======== ======== ========
F-19
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. INCOME TAXES (continued)
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
1998 1997
-------- --------
(In Thousands)
Deferred tax assets
Insurance reserves $ 93,564 $ 52,144
-------- --------
Deferred tax assets 93,564 52,144
-------- --------
Deferred tax liabilities
Deferred acquisition costs 224,179 167,128
Net investment gains 12,241 16,068
Other 5,978 7,431
-------- --------
Deferred tax liabilities 242,398 190,627
-------- --------
Net deferred tax liability $148,834 $138,483
======== ========
Management believes that based on its historical pattern of taxable income, the
Company and its subsidiaries will produce sufficient income in the future to
realize its deferred tax assets after valuation allowance. Adjustments to the
valuation allowance will be made if there is a change in management's assessment
of the amount of the deferred tax asset that is realizable. At December 31, 1998
and 1997, respectively, the Company and its subsidiaries had no federal or state
operating loss carryforwards for tax purposes.
The Internal Revenue Service (the "Service") has completed examinations of all
consolidated federal income tax returns through 1989. The Service has examined
the years 1990 through 1992. Discussions are being held with the Service with
respect to proposed adjustments. However, management believes there are adequate
defenses against, or sufficient reserves to provide for, such adjustments. The
Service has begun their examination of the years 1993 through 1995.
F-20
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. EQUITY
Reconciliation of Statutory Surplus and Net Income
Accounting practices used to prepare statutory financial statements for
regulatory purposes differ in certain instances from GAAP. The following table
reconciles the Company's statutory net income and surplus as of and for the
years ended December 31, determined in accordance with accounting practices
prescribed or permitted by the Arizona and New Jersey Departments of Banking and
Insurance with net income and equity determined using GAAP.
1998 1997 1996
--------- --------- ---------
(In Thousands)
Statutory net income $ (33,097) $ 12,778 $ 48,846
Adjustments to reconcile to net
income on a GAAP basis:
Statutory income of subsidiaries 18,953 18,553 25,001
Deferred acquisition costs 202,375 38,003 48,862
Deferred premium 2,625 1,144 1,295
Insurance liabilities (24,942) 26,517 28,662
Deferred taxes (14,465) 11,458 (18,939)
Valuation of investments 20,077 506 365
Other, net (19,564) (2,585) 15,130
--------- --------- ---------
GAAP net income $ 151,962 $ 106,374 $ 149,222
========= ========= =========
1998 1997
----------- -----------
(In Thousands)
Statutory surplus $ 931,164 $ 853,130
Adjustments to reconcile to equity
on a GAAP basis:
Valuation of investments 117,254 97,787
Deferred acquisition costs 861,713 655,242
Deferred premium (15,625) (14,817)
Insurance liabilities (133,811) (107,525)
Deferred taxes (148,834) (138,483)
Other, net 41,371 160,183
----------- -----------
GAAP stockholder's equity $ 1,653,232 $ 1,505,517
=========== ===========
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values presented below have been determined using available
information and valuation methodologies. Considerable judgment is applied in
interpreting data to develop the estimates of fair value. Accordingly, such
estimates presented may not be realized in a current market exchange. The use of
different market assumptions and/or estimation methodologies could have a
material effect on the estimated fair values. The following methods and
assumptions were used in calculating the estimated fair values (for all other
financial instruments presented in the table, the carrying value approximates
estimated fair value).
F-21
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
Fixed maturities and Equity securities
Estimated fair values for fixed maturities and equity securities, other than
private placement securities, are based on quoted market prices or estimates
from independent pricing services. Fair values for private placement securities
are estimated using a discounted cash flow model which considers the current
market spreads between the U.S. Treasury yield curve and corporate bond yield
curve, adjusted for the type of issue, its current credit quality and its
remaining average life. The estimated fair value of certain non-performing
private placement securities is based on amounts estimated by management.
Mortgage loans on real estate
The estimated fair value of the mortgage loan portfolio is primarily based upon
the present value of the scheduled future cash flows discounted at the
appropriate U.S. Treasury rate, adjusted for the current market spread for a
similar quality mortgage.
Policy loans
The estimated fair value of policy loans is calculated using a discounted cash
flow model based upon current U.S. Treasury rates and historical loan
repayments.
Policyholders' account balances
Estimated fair values of policyholders' account balances are derived by using
discounted projected cash flows, based on interest rates being offered for
similar contracts, with maturities consistent with those remaining for the
contracts being valued.
Derivative financial instruments
The fair value of futures is estimated based on market quotes for a transactions
with similar terms.
The following table discloses the carrying amounts and estimated fair values of
the Company's financial instruments at December 31,:
1998 1997
------------------------------- ---------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
----------- ----------- ------------- -----------
(In Thousands)
Financial Assets:
Fixed maturities:
Available for sale $ 2,763,926 $ 2,763,926 $ 2,563,852 $ 2,563,852
Held to maturity 410,558 421,845 338,848 350,056
Equity securities 2,847 2,847 1,982 1,982
Mortgage loans 17,354 19,465 22,787 24,994
Policy loans 766,917 806,099 703,955 703,605
Short-term investments 240,727 240,727 316,355 316,355
Cash 89,679 89,679 71,358 71,358
Separate Account assets 11,531,754 11,531,754 8,022,079 8,022,079
Financial Liabilities:
Policyholders'
account balances $ 2,696,191 $ 2,703,725 $ 2,380,460 $ 2,374,040
Cash collateral for loaned
securities 123,044 123,044 143,421 143,421
Separate Account liabilities 11,490,751 11,490,751 7,948,788 7,948,788
Derivatives 1,723 2,374 653 653
F-22
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTUMENTS
Futures & Options
The Company uses exchange-traded Treasury futures and options to reduce market
risks from changes in interest rates, to alter mismatches between the duration
of assets in a portfolio and the duration of liabilities supported by those
assets, and to hedge against changes in the value of securities it owns or
anticipates acquiring. The Company enters into exchange-traded futures and
options with regulated futures commissions merchants who are members of a
trading exchange. The fair value of futures and options is estimated based on
market quotes for a transaction with similar terms.
Under exchange-traded futures, the Company agrees to purchase a specified number
of contracts with other parties and to post variation margin on a daily basis in
an amount equal to the difference in the daily market values of those contracts.
Futures are typically used to hedge duration mismatches between assets and
liabilities by replicating Treasury performance. Treasury futures move
substantially in value as interest rates change and can be used to either
generate new or hedge existing interest rate risk. This strategy protects
against the risk that cash flow requirements may necessitate liquidation of
investments at unfavorable prices resulting from increases in interest rates.
This strategy can be a more cost effective way of temporarily reducing the
Company's exposure to a market decline than selling fixed income securities and
purchasing a similar portfolio when such a decline is believed to be over.
For futures that meet hedge accounting criteria, changes in their fair value are
deferred and recognized as an adjustment to the carrying value of the hedged
item. Deferred gains or losses from the hedges for interest-bearing financial
instruments are amortized as a yield adjustment over the remaining lives of the
hedged item. Futures that do not qualify as hedges are carried at fair value
with changes in value reported in current period earnings. The notional value of
futures contracts was $40.8 million and $115.7 million at December 31, 1998 and
1997, respectively. The fair value of futures contracts was immaterial at
December 31, 1998 and 1997.
When the Company anticipates a significant decline in the stock market which
will correspondingly affect its diversified portfolio, it may purchase put index
options where the basket of securities in the index is appropriate to provide a
hedge against a decrease in the value of the equity portfolio or a portion
thereof. This strategy effects an orderly sale of hedged securities. When the
Company has large cash flows which it has allocated for investment in equity
securities, it may purchase call index options as a temporary hedge against an
increase in the price of the securities it intends to purchase. This hedge
permits such investment transactions to be executed with the least possible
adverse market impact.
Option premium paid or received is reported as an asset or liability and
amortized into income over the life of the option. If options meet the criteria
for hedge accounting, changes in their fair value are deferred and recognized as
an adjustment to the hedged item. Deferred gains or losses from the hedges for
interest-bearing financial instruments are recognized as an adjustment to
interest income or expense of the hedged item. If the options do not meet the
criteria for hedge accounting, they are fair valued, with changes in fair value
reported in current period earnings. The fair value of options was immaterial at
December 31, 1998, and there were no options in 1997.
Currency Derivatives
The Company uses currency swaps to reduce market risks from changes in currency
values of investments denominated in foreign currencies that the Company either
holds or intends to acquire and to alter the currency exposures arising from
mismatches between such foreign currencies and the US Dollar.
Under currency swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between one currency and another at a
forward exchange rate and calculated by reference to an agreed principal amount.
Generally, the principal amount of each currency is exchanged at the beginning
and termination of the currency swap by each party. These transactions are
entered into pursuant to master agreements that provide for a single net payment
to be made by one counterparty for payments made in the same currency at each
due date.
If currency derivatives are effective as hedges of foreign currency translation
and transaction exposures, gains or losses are recorded in "Foreign currency
translation adjustments". If currency derivatives do not meet hedge accounting
criteria, gains or losses from those derivatives are recognized in current
period earnings.
As of December 31, 1998, the notional value of the swaps was $40.5 million with
a fair value of ($2.3) million. There were no currency swaps at year end 1997.
F-23
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
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10. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTUMENTS (continued)
Credit Risk
The current credit exposure of the Company's derivative contracts is limited to
the fair value at the reporting date. Credit risk is managed by entering into
transactions with creditworthy counterparties and obtaining collateral where
appropriate and customary. The Company also attempts to minimize its exposure to
credit risk through the use of various credit monitoring techniques. As of
December 31, 1998, 47% of notional consisted of interest rate derivatives, 47%
of notional consisted of foreign currency derivatives, and 6% of notional
consisted of equity derivatives.
11. CONTINGENCIES
Several actions have been brought against the Company on behalf of those persons
who purchased life insurance policies based on complaints about sales practices
engaged in by Prudential, the Company and agents appointed by Prudential and the
Company. Prudential has agreed to indemnify the Company for any and all losses
resulting from such litigation.
In the normal course of business, the Company is subject to various claims and
assessments. Management believes the settlement of these matters would not have
a material effect on the financial position or results of operations of the
Company.
12. DIVIDENDS
The Company is subject to Arizona law which limits the amount of dividends that
insurance companies can pay to stockholders. The maximum dividend which may be
paid in any twelve month period without notification or approval is limited to
the lesser of 10% of statutory surplus as of December 31 of the preceding year
or the net gain from operations of the preceding calendar year. Cash dividends
may only be paid out of surplus derived from realized net profits. Based on
these limitations and the Company's surplus position at December 31, 1998, the
Company would not be permitted a dividend distribution in 1998.
13. RELATED PARTY TRANSACTIONS
Service Agreements
Prudential and Pruco Life operate under service and lease agreements whereby
services of officers and employees (except for those agents employed by the
Company in Taiwan), supplies, use of equipment and office space are provided by
Prudential. The net cost of these services allocated to the Company were $269.9
million, $139.5 million and $101.7 million for the years ended December 31,
1998, 1997, and 1996, respectively. These costs are treated in a manner
consistent with the Company's policy on deferred acquisition costs.
Prudential and Pruco Life have an agreement with respect to administrative
services for the Prudential Series Fund. The Company invests in the various
portfolios of the Series Fund through the Separate Accounts. Under this
agreement, Prudential pays compensation to Pruco Life in the amount equal to a
portion of the gross investment advisory fees paid by the Prudential Series
Fund. The Company received from Prudential its allocable share of such
compensation in the amount of $40.1 million, $29.4 million and $19.1 million
during 1998, 1997 and 1996, respectively, recorded in other income.
Reinsurance
The Company currently has three reinsurance agreements in place with Prudential
(the reinsurer). Specifically a reinsurance Group Annuity Contract, whereby the
reinsurer, in consideration for a single premium payment by the Company,
provides reinsurance equal to 100% of all payments due under the contract, and
two yearly renewable term agreements in which the Company may offer and the
reinsurer may accept reinsurance on any life in excess of the Company's maximum
limit of retention. The Company is not relieved of its primary obligation to the
policyholder as a result of these reinsurance transactions. These agreements had
no material effect on net income for the years ended December 31, 1998, 1997,
and 1996.
F-24
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
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13. RELATED PARTY TRANSACTIONS (continued)
Debt Agreements
In July 1998, the Company established a revolving line of credit facility of up
to $300 million with Prudential Funding Corporation, a wholly owned subsidiary
of Prudential. There is no outstanding debt relating to this credit facility as
of December 31, 1998.
F-25