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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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, 2000
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
(Exact name of Registrant as specified in its charter)
Arizona 22-1944557
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(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) 802-3274
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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 29, 2001. Common
stock, par value of $10 per share: 250,000 shares outstanding
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PRUCO LIFE INSURANCE COMPANY
(Registrant)
INDEX
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Item No. Page No.
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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 4
PART II
5. Market for Registrant's Common Equity and Related
Stockholders' Matters 5
6. Selected Financial Data 5
7. Management's Discussion and Analysis of Financial Position
and Results of Operations 5
7a. Quantitative and Qualitative Disclosures About Market Risk 14
8. Financial Statements and Supplementary Data 19
9. Changes in and Disagreements with Independent Accountants on
Accounting and Financial Disclosure 19
PART III
10. Directors and Executive Officers of the Registrant 20
11. Executive Compensation 22
12. Security Ownership of Certain Beneficial Owners and Management 22
13. Certain Relationships and Related Transactions 22
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 23
Exhibit Index 23
Signatures 25
2
PART 1
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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 is
licensed to sell individual life insurance, variable life insurance, variable
annuities, fixed annuities, and a group annuity program ("the Contracts") in the
District of Columbia, Guam and in all states and territories except New York. In
addition, the Company markets traditional individual life insurance through its
branch office in Taiwan. The Company has one wholly owned subsidiary, Pruco Life
Insurance Company of New Jersey ("PLNJ"). 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. Another wholly
owned subsidiary, The Prudential Life Insurance Company of Arizona ("PLICA") was
dissolved on September 30, 2000. All assets and liabilities were transferred to
the Company. PLICA had no new business sales in 2000, 1999 or 1998.
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 is in the process of reorganizing
itself into a publicly traded stock company through a process known as
"demutualization." On February 10, 1998, Prudential's Board of Directors
authorized management to take the preliminary steps necessary to permit
Prudential to demutualize and become a stock company. On July 1, 1998,
legislation was enacted in New Jersey that would permit this demutualization to
occur and that specified the process for demutualization. On December 15, 2000,
Prudential's Board of Directors unanimously adopted a Plan of Reorganization,
which provides the framework under which Prudential will convert from a mutual
structure to stock ownership. Demutualization is a complex process involving
development of a plan of reorganization, a public hearing, approval by
two-thirds of the qualified policyholders who vote on the plan (with at least
one million qualified policyholders voting) and review and approval by the New
Jersey Commissioner of Banking and Insurance. Prudential is working toward
completing this process in 2001. However, there is no certainty that the
demutualization will be completed in this time frame or that the necessary
approvals will be obtained. It is also possible that after careful review,
Prudential could decide not to demutualize or could decide to delay its plans.
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. Prudential made a capital contribution of $27.2 million during
2000 resulting from the forgiveness of an intercompany receivable.
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.
Item 2. Properties
Office space is provided by Prudential, as is described in the Notes to the
Consolidated Financial Statements.
Item 3. Legal Proceedings
Prudential and the Company are subject to legal and regulatory actions in the
ordinary course of their businesses, including class actions. Pending legal and
regulatory actions include proceedings relating to aspects of the businesses and
operations that are specific to the Company and Prudential and that are typical
of the businesses in which the Company and Prudential operate. Some of these
proceedings have been brought on behalf of various alleged classes of
complainants. In certain of these matters, the plaintiffs are seeking large
and/or indeterminate amounts, including punitive or exemplary damages.
Beginning in 1995, regulatory authorities and customers brought significant
regulatory actions and civil litigation against the Company and Prudential
involving individual life insurance sales practices. In 1996, Prudential, on
behalf of itself and many of its life insurance subsidiaries including the
Company entered into settlement agreements with relevant insurance regulatory
authorities and plaintiffs in the principal life insurance sales practices class
action lawsuit covering policyholders of individual permanent life insurance
policies issued in the United States from 1982 to 1995. Pursuant to the
settlements, the companies agreed to various changes to their sales and business
practices controls, to a series of fines, and to provide specific forms of
relief to eligible class members. Virtually all claims by class members filed in
connection with the settlements have been resolved and virtually all aspects of
the remediation program have been satisfied. While the approval of the class
action settlement is now final, Prudential and the Company remain subject to
oversight and review by insurance regulators and other regulatory authorities
with respect to its sales practices and the conduct of the remediation program.
The U.S. District Court has also retained jurisdiction as to all matters
relating to the administration, consummation, enforcement and interpretation of
the settlements.
3
As of December 31, 2000, Prudential and/or the Company remained a party to
approximately 61 individual sales practices actions filed by policyholders who
"opted out" of the class action settlement relating to permanent life insurance
policies issued in the United States between 1982 and 1995. In addition, there
were 48 sales practices actions pending that were filed by policyholders who
were members of the class and who failed to "opt out" of the class action
settlement. Prudential and the Company believe that those actions are governed
by the class settlement release and expect them to be enjoined and/or dismissed.
Additional suits may be filed by class members who "opted out" of the class
settlements or who failed to "opt out" but nevertheless seek to proceed against
Prudential and/or the Company. A number of the plaintiffs in these cases seek
large and/or indeterminate amounts, including punitive or exemplary damages.
Some of these actions are brought on behalf of multiple plaintiffs. It is
possible that substantial punitive damages might be awarded in any of these
actions and particularly in an action involving multiple plaintiffs.
Prudential has indemnified the Company for any liabilities incurred in
connection with sales practices litigation covering policyholders of individual
permanent life insurance policies issued in the United States from 1982 to 1995.
The balance of the Company's litigation is subject to many uncertainties, and
given the complexity and scope, the outcomes cannot be predicted. It is possible
that the results of operations or the cash flow of the Company in a particular
quarterly or annual period could be materially effected by an ultimate
unfavorable resolution of pending litigation and regulatory matters. Management
believes, however, that the ultimate outcome of all pending litigation and
regulatory matters, should not have a material adverse effect on the Company's
financial position.
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of the stockholders held on June 19, 2000, the sole
stockholder of the Company appointed the Board of Directors of the Company. The
following are the Directors appointed at such meeting:
James J. Avery, Jr.
Ronald P. Joelson
Ira J. Kleinman
Esther H. Milnes
David R. Odenath, Jr.
I. Edward Price
Kiyofumi Sakaguchi
4
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
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)
2000 1999 1998 1997 1996
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Revenues
Premiums and other revenue $ 670,445 $ 575,190 $ 473,975 $ 435,547 $ 397,319
Realized investment
(losses)gains, net (20,679) (32,545) 44,841 10,974 10,835
Net investment income 337,919 276,821 261,430 259,634 247,328
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Total revenues 987,685 819,466 780,246 706,155 655,482
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Benefits and expenses
Policyholders' benefits and
interest credited to
policyholders' account
balances 419,073 341,894 312,731 310,352 305,119
Other expenses 410,684 392,041 231,320 227,561 122,006
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Total benefits and expenses 829,757 733,935 544,051 537,913 427,125
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Income before income tax provision 157,928 85,531 236,195 168,242 228,357
Income tax provision 54,432 29,936 84,233 61,868 79,135
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Net income $ 103,496 $ 55,595 $ 151,962 $ 106,374 $ 149,222
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Total assets at period end $23,059,009 $21,768,508 $16,812,781 $12,851,467 $9,710,366
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Separate Account liabilities at
period end $16,230,264 $16,032,449 $11,490,751 $ 7,948,788 $5,277,454
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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 sells interest-sensitive individual life insurance and variable life
insurance, term life insurance, individual variable and fixed annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced ("PACE") primarily through Prudential's sales force in the United
States. These markets are subject to regulatory oversight with particular
emphasis placed on company solvency and sales practices. These markets are also
subject to increasing competitive pressure as the legal barriers which have
historically segregated the markets of the financial services industry have been
changed through both legislative and judicial processes. Regulatory changes have
opened the insurance industry to competition from other financial institutions,
particularly banks and mutual funds that are positioned to deliver competing
investment products through large, stable distribution channels. The Company
also markets individual life insurance through its branch office in Taiwan. The
Taiwan branch was transferred to an affiliated Company on January 31, 2001, as
described in the Notes to the Financial Statements. The Taiwan branch had net
income of $1.8 million ($97.8 million of revenues and $96.0 million in expenses)
in 2000. Beginning on February 1, 2001, Taiwan's net income will not be included
in the Company's results of operations.
5
Generally, policyholders who purchase the Company's products have the option of
investing in the Separate Accounts, segregated funds for which investment risks
are borne by the customer, or the Company's portfolio, referred to as the
General Account. The Company earns its profits through policy fees and asset
management fees charged to Separate Account annuity and life policyholders and
through the interest spread for the GIC and General Account annuity and life
products. Policy fees and asset management fees are assessed on the policyholder
fund balances. These fund values are affected by net sales (sales less
withdrawals), changes in interest rates and investment returns. The interest
spread represents the difference between the investment income earned by the
Company on its investment portfolio and the amount of interest credited to the
policyholders' accounts. The majority of the fund balances and new sales, except
for the GIC product, are in the Separate Accounts rather than the General
Account.
The Company's Changes in Financial Position and Results of Operations are
described below.
Changes in Financial Position
2000 versus 1999
Total assets increased from $21.8 billion at December 31, 1999 to $23.1 billion
at December 31, 2000, an increase of $1.3 billion, primarily from increases in
investments and cash and cash equivalents of $.9 billion, and Separate Accounts
of $.2 billion. For a discussion of Investments see "Investment Portfolio and
Investment Strategies". A discussion of Separate Account balances and net sales
follows.
Although there were positive Separate Account net sales of $1.2 billion
(contributions of $2.4 billion less withdrawals of $1.2 billion), growth in the
Separate Accounts was minimized by expense disbursements of $.3 billion, and in
particular, investment losses from stock value declines of $.7 billion. This was
in contrast to the prior year which experienced investment gains of $2.1
billion. However, the average Separate Account fund value during the current
year, which is more indicative of fee income, was approximately $3 billion
higher than the prior year, due to beginning of the year 2000 balances being
substantially higher than the prior year. The majority of the net sales were
from the Discovery Select annuity product ("Discovery Select") which had net
sales of $1.115 billion. This was significantly lower than net sales of
Discovery Select of $2.646 billion in 1999 due primarily to the termination of
the Exchange program in May 2000. Surrenders also increased due to the aging of
the business and since exchange assets are not subject to surrender charges. The
Exchange Program had provided the contractholders of older Prudential or Pruco
Life annuity products an opportunity to convert to the Discovery Select product.
Total liabilities increased from $20.1 billion at December 31, 1999 to $21.2
billion at December 31, 2000, an increase of $1.1 billion. The increase was
primarily due to increases to policyholder account balances of $.5 billion,
securities lending liabilities of $.2 billion, Separate Account liabilities of
$.2 billion, and an increase to future policy reserves of $.1 billion. The
increase in policyholders' account balances from $3.1 billion at December 31,
1999 to $3.6 billion at December 31, 2000 was primarily due to increases of $315
million from sales of the PACE product, and an increase of $175 million, mainly
due to exchanges and sales of the Discovery Select product for the General
Account. Future policy benefits increased by $73 million from $630 million at
December 31, 1999 to $703 million at December 31, 2000 primarily the result of
increased sales and in-force business at the Taiwan branch.
1999 versus 1998
Total assets increased from $16.8 billion at December 31, 1998 to $21.8 billion
at December 31, 1999, an increase of $5.0 billion, of which $4.5 billion
represents growth in Separate Account assets. Contributions to Separate Accounts
were $3.5 billion in 1999, withdrawals and expense disbursements were $1.1
billion and investment gains were $2.1 billion. The majority of the Separate
Account increase came from Discovery Select which increased by $3.7 billion due
to net sales of $2.6 billion, including $1.2 billion in exchange sales, and
appreciation. Other increases in 1999 are mainly from growth in investments of
$235.0 million and deferred acquisition costs ("DAC") of $201.0 million.
Total liabilities increased from $15.1 billion at December 31, 1998 to $20.1
billion at December 31, 1999, an increase of $5.0 billion. The increase was
primarily due to higher Separate Account liabilities of $4.5 billion, increases
to policyholder account balances of $423 million and increases to future policy
reserves of $101 million. The increase of $423 million in policyholders' account
balances from $2.7 billion at December 31, 1998 to $3.1 billion at December 31,
1999 was primarily due to the PACE product which increased by $353.0 million in
1999. Annuity General Account balances increased by $70.0 million in 1999,
mainly due to exchanges and sales of Discovery Select. Future policy benefits
increased by $101 million from $528.8 million at December 31, 1998 to $629.5
million at December 31, 1999 as a result of increased sales and in-force
business at the Taiwan branch.
6
Results of Operations
(a) 2000 versus 1999
Net Income
Net income for the year ended December 31,2000 was $103.5 million, an increase
of $47.9 million from $55.6 million earned in the year ended December 31, 1999.
The increase reflects a $168.2 million, or 20.5% increase in revenues, offset in
part by a $95.8 million, 13.1% increase in expenses. Income taxes increased by
$24.5 million corresponding with the income increase.
Revenues
Policy charges and fee income, consisting primarily of mortality and expense
("M&E"), loading and other insurance charges assessed primarily on Separate
Account policyholder account balances, increased by $60.4 million to $474.9
million in 2000 from $414.4 million in 1999. In addition, asset management fees,
primarily representing fees collected from the Pru Series Funds ("PSF") , a
portfolio of mutual fund investments related to the Company's Separate account
products, increased by $10.8 million from the prior year. These asset based fee
revenues are dependent on the fund balances which are affected by net sales as
well as asset depreciation or appreciation on the underlying investment funds in
which the customer has the option to invest. Although the Separate Account fund
balances as of December 31, 2000 are only slightly higher than the prior year
end due to stock market declines, (especially in the fourth quarter) the average
fund balance during the year was $3 billion higher than the prior year, as is
described in the "Changes In Financial Position" section. Strong securities
market conditions contributed to significant appreciation in Separate Account
asset values during 1999 which had a carryover effect on 2000 income, as
beginning of the year balances were substantially higher than in the previous
year. Policy charges for annuity and life products were $37.4 million and $23.0
million higher, respectively, than the prior year. Most of the annuity increase
came from higher M&E charges from Discovery Select, the Company's most actively
sold product. Discovery Select net sales, defined as sales less withdrawals,
were $1,115 million. The increase in life policy fees is also due to a higher
average fund balance than in the previous year.
As is described in Note 14 to the Consolidated Financial Statements, beginning
January 1, 2001, the Company will not receive asset management fee revenue or
pay asset management charges related to PSF. For the year ending December 31,
2000, $64.1 million of asset management fee revenue was earned from PSF. Asset
management expenses charged by Prudential Global Asset Management ("PGAM") and
Jennison Associates LLC ("Jennison") to manage the PSF were $29.1 million.
Premiums increased $22.9 million to $121.9 million for the year ended December
31, 2000. The increase was primarily due to continued growth at the Company's
Taiwan branch, which sells traditional life insurance products. New sales for
the Taiwan branch grew by 21% and gross insurance in force increased by 17%.
Premiums from annuitizations of Discovery Select contracts also contributed
somewhat to the growth in premiums. Premiums in 2001 will be substantially less
as Taiwan premiums will be fully ceded to an affiliated company, as described
earlier, beginning February 1, 2001. Taiwan premiums in 2000 were $88 million.
Net investment income increased by $61.1 million to $337.9 million in 2000. The
increase was primarily the result of higher income from fixed maturities of
$45.8 million, and $10.4 from short-term and cash equivalents, as the asset base
increased. Investment of cash inflows from the PACE product was the primary
cause of the increase in the asset base.
Realized investment losses, net were $20.7 million in 2000 compared to realized
losses of $32.5 million for the prior year. This improvement of $11.8 million
came primarily from derivative gains in 2000 of $15.0 million versus losses of
$1.6 million in 1999. Offsetting this somewhat were realized losses on fixed
maturities that were $5.7 million higher than in 1999, as most of the sales were
made in early 2000, when interest rates were higher and writedowns for
impairments deemed other than temporary were $12.3 million, an increase of $1.1
million from 1999.
Benefits and Expenses
Policyholders' benefits including changes in reserves were $248.1 million for
the year ended December 31, 2000, an increase of $43.0 million from the prior
year. Increases to reserves were $31.0 million higher than the prior year of
which $14.8 million is related to continued business expansion in the Company's
Taiwan branch. Discovery Select annuitizations of $7.7 million, and higher life
reserves for extended term insurance and disability reserves of $8.5 million
also contributed to the reserve increases. Policyholder benefits were $12.0
million higher mainly due to an increase in death claims of $9.8 million and
increased annuity and Taiwanese policyholder benefits due to the growth in
business.
Interest credited to policyholder account balances for the year ended December
31, 2000 was $171.0 million, an increase of $34.2 million from 1999. Interest
credited for the PACE product increased by $25.8 million as the PACE
policyholder account balances increased $315 million. Interest credited on
annuity products increased by $7.5 million as the General Account fund balances
increased and there were higher new money rates due to higher incentive rates
for Discovery Select.
7
General, administrative and other expenses, net of capitalization increased
$18.6 million to $410.7 million in 2000. The largest factor in this increase is
amortization of deferred policy acquisition costs ("DAC") of $129.0 million
which is $32.6 million higher than the prior year. Annuity DAC amortization
increased $39.3 million to $72.8 million, due to growth in profitability of
Discovery Select, and accelerated amortization associated with a decline in
expected future gross profits as a result of unfavorable market conditions in
2000. Amortization of life products declined by $10.2 million due to prior year
write-offs of DAC for policies that were rescinded as a result of the Company's
policyholder remediation program, as described in the Notes to the financial
statements. Taiwan DAC amortization increased by $3.5 million due to growth in
the business.
Commission and distribution expenses, net of capitalization are lower by $1.1
million due mainly to two offsetting factors. Growth in trail commissions on
Discovery Select exchanges, which are nondeferable, increased expenses by $8.0
million. This was offset by a change in the allocation of distribution expenses.
As of April 1, 2000, Prudential and the Company agreed to revise the estimate of
allocated distribution expenses to reflect a market based pricing arrangement.
This decreased year over year expenses (net of capitalization) by $8.9 million.
Other general and administrative expenses were down $16.1 million from the prior
year due to decreases in consulting fees, salary expenses, and charges to the
reserve for unbeknownst modified endowment contracts ("UMEC"). Consulting and
external contracted services charges were lower in 2000 by $7.9 million as the
prior year had contracted external programmers for Year 2000 system preparation
and data integrity projects. Decreases in staffing levels from the prior year
resulted in reductions in salary expense and employee benefits of $4.1 million.
Provisions made to UMEC were $6.3 million in 2000 which is $3.9 million less
than the prior year. A modified endowment contract ("MEC") is an insurance
policy in which the money paid into the contract by the contractholder exceeds
the level permitted by the Internal Revenue Service. Consequently, the contract
loses its tax deferred status. The Company had failed to notify contractholders
when they reached this level, and therefore has agreed to remedy policyholders
for any penalties they have incurred. The Company has established a reserve to
cover any tax liability to be paid on behalf of the policyholder, any enhanced
death benefit given to the policyholder as a remedy and any expected
administrative costs. Offsetting these decreases slightly was an increase of
$3.2 million for PGAM fees, asset based charges for managing Separate Account
investment portfolios, due to the increase in the average Separate Account
balance.
(b) 1999 versus 1998
Net Income
Net income for the year ended December 31, 1999 was $55.6 million, a decrease of
$96.4 million from the prior year. The decrease reflects a $189.9 million
increase in expenses, offset in part by a $39.2 million increase in revenues and
a related decrease in income taxes of $54.3 million.
Revenues
Policy charges and fee income, increased by $63.8 million to $414.4 million in
1999 from $350.6 million in 1998, primarily as a result of increased Separate
Account fund balances. These Separate Account fund balances increased by $4.5
billion from the prior year. Strong securities market conditions contributed to
appreciation in Separate Account asset values during 1999, and consequently, an
increase in fee income. Favorable market conditions also provided a stimulus to
investors to purchase mutual fund shares and annuities, particularly the
Discovery Select annuity product, which further contributed to growth in assets
and fees earned. Discovery Select net sales, increased slightly from $2.573
billion in 1998 to $2.646 billion in 1999, an increase of $73.0 million. This
increase can be attributed to an increase in exchanges as a result of the
Exchange Program.
Premiums increased $16.8 million to $99.0 million for the year ended December
31, 1999. The increase was primarily due to continued growth at the Company's
Taiwan branch, which sells traditional life insurance products.
Net investment income increased by $15.4 million to $276.8 million in 1999. The
increase was primarily the result of higher income from fixed maturities of
$12.2 million, as the average assets increased. Average yields on fixed
maturities were modestly lower in 1999. Investment of cash inflows from the PACE
product, was the primary cause of the increase in the asset base. The PACE
product increased its investments in fixed maturities by $345.8 million during
1999.
Realized investment losses, net were $32.5 million in 1999 compared to realized
investment gains, net of $44.8 million for the prior year. The decline of $77.3
million was primarily due to the impact of net sales of fixed maturity
securities during a rising interest rate environment for most of 1999. Realized
losses on fixed maturities were $29.1 million in 1999, consisting of losses on
sales of $18.0 million and writedowns for impairments deemed other than
temporary of $11.1 million. In 1998, there were realized gains of $29.8 million
on fixed maturities, net of writedowns for impairments deemed other than
temporary of $2.8 million. In addition, in 1999 the Company realized $1.6
million in losses from U.S. Treasury futures transactions versus a gain of $12.4
million in the prior year.
8
Asset management fees increased to $60.4 million at December 31, 1999 from $40.2
million at December 31, 1998, due to the increase in the Separate Account fund
balances.
Benefits and Expenses
Policyholders' benefits were $205.0 million for the year ended December 31,
1999, an increase of $11.3 million from $193.7 million for the year ended
December 31, 1998. The increase was mainly due to increases in reserves of $4.2
million, surrender increases of $3.0 million, and term life conversion credits
of $3.0 million. The reserve increase reflects continued business expansion in
the Company's Taiwan branch. As noted above, the Taiwan branch experienced a 40%
growth in sales in 1999, requiring an increase to their reserves of $12.8
million. This increase was offset by a decline in domestic reserves of $8.9
million resulting from a reduction in extended term insurance activity and a
decrease in year over year sales. The term life conversions of $3.0 million
relate to premium credits provided to policyholders who exercised an option to
convert term life insurance products to variable life insurance.
Interest credited to policyholder account balances for the year ended December
31, 1999 was $136.9 million, an increase of $17.9 million from $119.0 million in
1998. Interest credited for the PACE product increased by $15.0 million as PACE
account balances increased to $584.7 million at December 31, 1999 from $231.3
million at December 31, 1998.
General, administrative and other expenses, net of capitalization increased
$160.7 million to $392.0 million in 1999 from $231.3 million in 1998. The
increase was primarily the result of the implementation of a new expense
allocation methodology from Prudential. This new allocation process shifts a
greater amount of expenses to products requiring more complex business processes
and more transactions, such as variable products which allow policyholders to
make changes in their investment portfolio. As a result of this change, the
Company's allocation of general and administrative expenses from Prudential
increased by approximately $78.0 million. These allocated expenses include
distribution expenses from Prudential's retail agency network. A majority of
these distribution expenses have been capitalized by the Company as DAC.
Other factors contributing to the increase in general, administrative and other
expenses include DAC amortization, PGAM fees and UMEC expenses. DAC amortization
is $46.3 million higher than 1998, as DAC amortization in 1998 was reduced as a
result of a change in estimate of gross profit margin related to variable
universal life products. In addition, DAC amortization increased in 1999 as a
result of increased profitability of the Discovery Select product. In addition,
beginning in 1999 expenses included an asset based charge from PGAM for managing
Separate Account investment portfolios. These fees were $25.8 million in 1999.
Expenses in 1999 also include $10.2 million for the establishment of a reserve
for UMEC.
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
$5.0 billion at December 31, 2000, versus $4.4 billion at December 31, 1999. 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 risk tolerance reflects the
Company's aggregate capital position, exposure to business risk, liquidity and
rating agency considerations.
The asset management strategy for the portfolio is in accordance with an
investment policy statement developed and coordinated within the Company by the
Asset Liability and Risk Management Group, agreed to by senior management, and
approved by the Company's 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.
9
Fixed Maturities
The fixed maturity portfolio is diversified across maturities, sectors and
issuers. The Company has classified all publicly traded securities as "available
for sale" or "AFS". As of December 31, 2000 and 1999, approximately 78% and 72%
respectively, of privately traded securities, were classified as AFS. The
remainder of the privately placed fixed maturities were classified as "held to
maturity" or "HTM". AFS securities are carried in the Consolidated Statements of
Financial Position at fair value, with unrealized gains and losses (after
certain related adjustments) recognized by credits or charges to "Accumulated
Other Comprehensive Income", a component of equity capital. HTM securities are
carried at amortized cost, and unrealized gains or losses on these securities
are not recognized in the financial statements. At December 31, 2000, the fixed
maturities portfolio totaled $3.9 billion (AFS fair value of $3.6 billion and
HTM amortized cost of $0.3 billion), an increase of $0.5 billion compared to
December 31, 1999. This increase in fixed maturities was due primarily to cash
inflows from insurance operations, particularly the PACE product, and unrealized
gains due to declining interest rates.
2000 1999
---------------------------------------------- ------------------------------------------
Net Net
Amortized Cost Estimated Unrealized Amortized Estimated Unrealized
Fair Value Gains(Losses) Cost Fair Value Losses
---------------------------------------------- -------------- ---------------------------
(In Thousands)
Fixed maturities
Publicly traded $ 2,385,108 $ 2,393,919 $ 8,811 $2,070,500 $2,004,636 $(65,864)
Privately placed 1,491,682 1,488,236 (3,446) 1,402,547 1,371,548 (30,999)
---------------------------------------------- -------------- ------------- -------------
Total $ 3,876,790 $ 3,882,155 $ 5,365 $3,473,047 $3,376,184 $(96,863)
============================================== ============== ============= =============
At December 31, 2000, net unrealized gains on the AFS fixed maturity portfolio
totaled $9.3 million compared with net unrealized losses of $85.7 million at
December 31, 1999. The change in the net unrealized gain (loss) position
reflects the impact of declining interest rates.
Based on fair value, the Company's holdings of private placement fixed
maturities constituted 38% and 41% of total fixed maturities at December 31,
2000 and 1999, 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.
Gross investment income from fixed maturities increased by $45.8 million to
$263.3 million in 2000 as a result of a higher beginning of the year asset base
and investment of positive cash flows in 2000. Realized losses on fixed
maturities of $34.8 million were $5.7 million higher when compared with realized
losses of $29.1 million in 1999. This variance is attributed to the timing of
turnover, as most of 2000's losses were realized in the beginning of the year
when rates were high. In addition, writedowns for impairments of fixed
maturities which were deemed to be other than temporary increased by $1.1
million from 1999.
10
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 as of December 31, 2000 and 1999:
December 31, 2000 December 31, 1999
------------------------------------------- ------------------------------------------
Standard & Amortized Estimated Amortized Estimated
NAIC Poor's Cost % Fair Value % Cost % Fair Value %
- ------------------------ --------------------- --------------------- ------------------ ----------------------
(In Thousands)
1 AAA to AAA- $1,811,068 46.7% $1,835,642 47.3% $1,369,346 39.4% $1,342,146 39.8%
2 BBB+ to BBB- 1,794,309 46.3% 1,784,694 46.0% 1,847,502 53.2% 1,787,102 52.9%
3 BB+ to BB- 118,652 3.0% 117,793 3.1% 159,896 4.6% 150,994 4.5%
4 B+ to B- 113,050 2.9% 106,699 2.7% 75,843 2.2% 75,239 2.2%
5 CCC or lower 22,093 0.6% 20,067 0.5% 7,718 0.2% 8,061 0.2%
6 In or near
default 17,618 0.5% 17,260 0.4% 12,742 0.4% 12,642 0.4%
---------- ---------- ---------- ----------
Total $3,876,790 100.0% $3,882,155 100.0% $3,473,047 100.0% $3,376,184 100.0%
========== ========== ========== ==========
The fixed maturity portfolio consists largely of investment grade assets (rated
"1" or "2" by the NAIC), with such investments accounting for 93% of the
portfolio at December 31, 2000 and 1999, based on fair value. As of both of
those dates, less than 1% of the fixed maturities portfolio, based on fair
value, 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 maintains separate monitoring processes for public and private fixed
maturities and creates watch lists to highlight securities which require special
scrutiny and management. The Company's fixed maturity asset managers formally
review all public fixed maturity holdings on a monthly basis and more frequently
when necessary to identify potential credit deterioration whether due to ratings
downgrades, unexpected price variances, and/or industry specific concerns. The
Company classifies public fixed maturity securities of issuers that have
defaulted as loans not in good standing and all other public watch list assets
as closely monitored.
Our private fixed maturity asset managers conduct specific servicing tests on
each investment on a quarterly basis to determine whether the investment is in
compliance or should be placed on the watch list or assigned an early warning
classification. The Company assigns early warning classification to those
issuers that have failed a servicing test or experienced a minor covenant
default, and the Company continues to monitor them for improvement or
deterioration. The Company assigns closely monitored status to those investments
that have been recently restructured or for which restructuring is a possibility
due to substantial credit deterioration or material covenant defaults. The
Company classifies as not in good standing securities of issuers that are in
more severe condition, for example, bankruptcy or payment default.
December 31, 2000 December 31, 1999
--------------------------------- --------------------------------
Amortized Amortized
Cost % of Total Cost % of Total
-------------- -------------- -------------- ---------------
(In Thousands)
Performing $ 3,799,529 98.0% $3,428,880 98.8%
Watch List
Closely monitored 56,513 1.5% 31,425 0.9%
Not in good standing 20,748 0.5% 12,742 0.3%
--------------- ---------------
Total $ 3,876,790 100.0% $3,473,047 100.0%
=============== ===============
Writedowns for impairments of fixed maturities which were deemed to be other
than temporary were $12.3 million, $11.2 million and $2.8 million for the years
2000, 1999 and 1998, respectively.
11
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 manufacturing, asset backed securities, and service
issues. The portfolio is summarized below by issuer category:
December 31, 2000
-----------------------------------------------
Amortized Estimated % of
Cost Fair Value Fair Value
---------------- -------------- -------------
(In Thousands)
United States government
securities and obligations $ 309,609 $ 317,479 8.2%
Mortgage backed securities 31,479 31,809 .8%
Asset backed securities (1) 544,447 541,315 14.0%
Foreign government securities 136,133 143,706 3.7%
Manufacturing 791,609 788,188 20.3%
Utilities 634,671 628,657 16.2%
Retail and wholesale 230,303 229,162 5.9%
Energy 1,304 1,359 .0%
Finance 519,690 528,020 13.6%
Services 548,729 544,555 14.0%
Transportation 122,655 121,565 3.1%
Other 6,161 6,340 .2%
---------------- --------------- -------------
Total $ 3,876,790 $ 3,882,155 100.0%
================ =============== =============
December 31, 1999
-----------------------------------------------
Amortized Estimated % of
Cost Fair Value Fair Value
---------------- ------------------------------
(In Thousands)
United States government
securities and obligations $ 113,172 $ 111,122 3.3%
Mortgage backed securities 1,558 1,712 0.1%
Asset backed securities (1) 464,097 453,441 13.4%
Foreign government securities 92,725 92,988 2.8%
Manufacturing 706,866 675,731 20.0%
Utilities 489,207 471,534 14.0%
Retail and wholesale 244,723 238,438 7.1%
Energy 31,392 30,837 0.9%
Finance 635,268 625,321 18.5%
Services 518,040 504,350 14.9%
Transportation 166,108 160,586 4.7%
Other 9,891 10,124 0.3%
---------------- ---------------- --------------
Total $3,473,047 $3,376,184 100.0%
================ ================ =============
(1) Asset backed securities are primarily backed by credit card receivables,
home equity loans, trade receivables and auto loans.
Mortgage Loans on Real Estate
As of December 31, 2000, the Company's mortgage loan portfolio totaled $9.3
million, a reduction of $1.2 million from December 31, 1999, reflecting
maturities and prepayments. The portfolio is comprised of commercial mortgage
loans, with diversification by property type and geographic location. Refer to
Footnote 3 in the Notes to Consolidated Financial Statements. Mortgage
investment income is $1.0 million which is $1.8 million lower than the prior
year as 1999 had loan prepayment income in anticipation of increasing interest
rates.
The Company monitors the mortgage loan portfolio quarterly and through that
process identifies which loans require additional monitoring. Loans with
estimated collateral values less than the outstanding loan balances and loans
demonstrating characteristics indicative of higher than normal credit risks are
reviewed by management. The underlying collateral values are based upon
discounted property cash flow projections or external appraisals.
12
Equity Securities
The Company's equity securities are comprised of common stocks and
non-redeemable preferred stock and are carried at estimated fair value on the
Statements of Financial Position. Based on fair value, equity securities totaled
$10.8 million in 2000 compared to $4.5 million in 1999. The equity securities
portfolio experienced no significant changes in income or realized gains in
2000.
Short-Term Investments
Short-term investments include highly liquid debt instruments other than those
held in "Cash and cash equivalents" with a maturity of twelve months or less
when purchased. These securities are carried at amortized cost, which
approximates fair value. As of December 31, 2000, the Company's short-term
investments totaled $202.8 million, an increase of $118.2 million compared to
$84.6 million at December 31, 1999, primarily due to increased securities
financing activity.
Other Significant Items
Derivatives
The Company uses derivatives primarily to alter mismatches between the duration
of assets in its portfolios and the duration of insurance and annuity
liabilities supported by those assets. During 2000, $5.6 million of gains were
realized in swaps due to favorable 2000 positions in exchange rates and spreads.
Also during 2000, $9.4 million of gains were realized from futures versus a loss
of $1.6 million in 1999. This was the result of the Company being net long in
futures during both years, as interest rates were generally declining in 2000
versus generally increasing in 1999.
2. Liquidity and Capital Resources
The Company's liquidity requirements include the payment of sales commissions,
other underwriting expenses and the funding of its contractual obligations for
the life insurance and annuity contracts 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
(refer to Footnote 14 in the Notes to Consolidated Financial Statements). As of
December 31, 2000, the Company's assets included $2.9 billion of cash and cash
equivalents, 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 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 surplus 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 Insurance and
the New Jersey Department of Banking and Insurance (the "Insurance
Departments"). The Company believes that its statutory capital is adequate for
its currently anticipated levels of risk as measured by regulatory guidelines.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance ("Codification"), which replaces the current Accounting
Practices and Procedures manual as the NAIC's primary guidance on statutory
accounting as of January 1, 2001. The Codification provides guidance for areas
where statutory accounting has been silent and changes current statutory
accounting in certain areas. Certain of the standards could have an impact on
the measurement of statutory capital which, in turn, could affect RBC ratios of
insurance companies. The Company has adopted the Codification guidance effective
January 1, 2001, and has estimated the potential effect of the Codification
guidance to have a favorable impact of at least $60 million on the Company's
surplus position, primarily as a result of the recognition of deferred tax
assets.
13
3. Regulatory Environment
The Company is subject to the laws of 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 as described in the Liquidity and
Capital Resources disclosure. The implementation of these standards has not had
a significant impact on 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.
4. Effective New Accounting Pronouncements
Refer to Footnote 2, "Summary of Significant Accounting Policies," of the Notes
to Consolidated Financial Statements.
5. Information Concerning Forward-Looking Statements
Some of the statements contained in Management's Discussion and Analysis,
including those words such as "believes", "expects", "intends", "estimates",
"assumes", "anticipates" and "seeks", are forward-looking statements. These
forward-looking statements involve risk and uncertainties. Actual results may
differ materially from those suggested by the forward-looking statements for
various reasons. In particular, statements contained in Management's Discussion
and Analysis regarding the Company's business strategies involve risks and
uncertainties, and we can provide no assurance that we will be able to execute
our strategies effectively or achieve our financial and other objectives.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Risk Management, Market Risk, and Derivative Financial Instruments
As an wholly-owned 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 optimizing returns on
the underlying assets or liabilities. 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, and operating risk.
14
Market risk is the risk of change in the value of financial instruments as a
result of absolute or relative changes in interest rates, foreign currency
exchange rates or equity or commodity prices. To varying degrees, the investment
activities supporting all of the Company's products and services generate market
risks. Market risks incurred and the strategies for managing these risks vary by
product.
With respect to non-variable life insurance products, fixed rate annuities and
the fixed rate options in our variable life insurance and annuity products, the
Company incurs market risk primarily in the form of interest rate risk. The
Company manages this risk through asset/liability management strategies that
seek to match the interest rate sensitivity of the assets to that of the
underlying liabilities. The Company's overall objective in these strategies is
to limit the net change in value of assets and liabilities arising from interest
rate movements. While it is more difficult to measure the interest sensitivity
of the Company's insurance liabilities than that of the related assets, to the
extent the Company can measure such sensitivities the Company believes that
interest rate movements will generate asset value changes that substantially
offset changes in the value of the liabilities relating to the underlying
products.
For variable annuities and variable life insurance products, excluding the fixed
rate options in these products, the Company's main exposure is the risk that
asset management fees may decrease as a result of declines in assets under
management due to changes in prices of securities. The Company is also exposed
to the risk that asset management fees calculated by reference to performance
could be lower. For variable annuity and variable life insurance products with
minimum guaranteed death benefits, the Company also faces the indirect risk that
declines in the value of underlying investments as a result of changes in
securities prices may increase the Company's net exposure to death benefits
under these contracts. The Company does not believe that these indirect risks
add significantly to the Company's overall risk. The Company manages its
exposure to equity price risk primarily by seeking to match the risk profile of
equity investments against risk-adjusted equity market benchmarks. The Company
measures benchmark risks level in terms of price volatility in relation to the
market in general.
The Company's exposure to market risk results from "other than trading"
activities in its insurance businesses. 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. These include sensitivity and
Value-at-Risk measures, positions and other limits based on type of risk, and
various hedging methods.
Insurance Asset/Liability Management
The Company's asset/liability management strategies seek to match the interest
rate sensitivity of the assets to that of the underlying liabilities and to
construct asset mixes consonant with product features, such as interest
crediting strategies. The Company also considers risk-based capital implications
in its asset/liability management strategies. The Company seeks to maintain
interest rate and equity exposures within established ranges, which are
periodically adjusted based on market conditions and the design of related
insurance products sold to customers. The Company's risk managers, who work with
portfolio and asset managers but under separate management, establish investment
risk limits for exposures to any issuer, or type of security and oversee efforts
to manage risk within policy constraints set by management and approved by the
Board of Directors.
The Company uses duration and convexity analyses to estimate the price
sensitivity of assets and liabilities to interest rate changes. Duration is an
estimate of the sensitivity of the fair value of a financial instrument relative
to changes in interest rates. Convexity is an estimate of the rate of change of
duration with respect to changes in interest rate, and is commonly used for
managing assets with prepayment risk, such as mortgage backed securities. The
Company seeks to manage its interest rate exposure by matching the relative
sensitivity of asset and liability values to interest rate changes, or
controlling "duration mismatch" of assets and liabilities. The Company has a
target duration mismatch level of plus or minus 0.6 years. As of December 31,
2000, the difference between the pre-tax duration of assets and the target
duration of liabilities in the Company's duration managed portfolio was less
than 0.1 years.
The Company also performs portfolio stress testing as part of its regulatory
cash flow testing. In this testing, the Company evaluates the impact of altering
its interest-sensitive assumptions under various moderately adverse interest
rate environments. These interest-sensitive assumptions relate to the timing and
amounts of redemptions and pre-payments of fixed-income securities and lapses
and surrenders of insurance products. The Company evaluates any shortfalls that
this cash flow testing reveals to determine if there is a need to increase
statutory reserves or adjust portfolio management strategies.
15
Market Risk Related to Interest Rates
Assets that subject the Company to interest rate risk include fixed maturities,
mortgage loans on real estate, and policy loans. In the aggregate, the carrying
value of these assets represented 70% of consolidated assets, other than assets
that are held in Separate Accounts, as of December 31, 2000 and 73% as of
December 31, 1999. With respect to liabilities, the Company is exposed to
interest rate risk through policyholder account balances relating to
interest-sensitive life insurance and annuity and investment type contracts.
The Company assesses interest rate sensitivity for its financial assets,
financial liabilities and derivatives using hypothetical test scenarios which
assume both upward and downward 100 basis point parallel shifts in the yield
curve from prevailing interest rates. The following tables set forth the
potential loss in fair value from a hypothetical 100 basis point upward shift at
December 31, 2000 and 1999, because this scenario results in the greatest net
exposure to interest rate risk of the hypothetical scenarios tested at those
dates. While the test scenario is for illustrative purposes only and does not
reflect management's expectations regarding future interest rates or the
performance of fixed income markets, it is a near-term, reasonably possible
hypothetical change that illustrates the potential impact of such events. These
test scenarios do not measure the changes in value that could result from
non-parallel shifts in the yield curve, which would be expected to produce
different changes in discount rates for different maturities. As a result, the
actual loss in fair value from a 100 basis point change in interest rates could
be different from that indicated by these calculations.
This presentation does not include $2.587 billion and $2.466 billion of
insurance reserves and deposit liabilities at December 31, 2000 and 1999,
respectively. The Company believes that the interest rate sensitivities of these
insurance liabilities offset, in large measure, the interest rate risk of the
financial assets set forth in the following tables.
December 31, 2000
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(derivatives) Value Shift Fair Value
---------------------------------------------------------------
Financial Assets and Liabilities (In millions)
with Interest Rate Risk:
Financial Assets:
Fixed maturities:
Available for sale - $ 3,562 $ 3,468 $ (94)
Held to maturity - 321 313 (8)
Mortgage loans on real estate - 11 10 (1)
Policy loans - 883 838 (45)
Derivatives:
Futures 202 2 1 (1)
Swaps 9 .3 .1 (.2)
Financial liabilities:
Investment contracts - (1,785) (1,760) 25
----------------
Total estimated potential loss $ (124.2)
================
16
December 31, 1999
---------------------------------------------------------------
Fair Value
After + 100
Basis Point
Notional Estimated Parallel Hypothetical
Value Fair Yield Curve Change in
(derivatives) Value Shift Fair Value
---------------------------------------------------------------
Financial Assets and Liabilities (In millions)
with Interest Rate Risk:
Financial Assets:
Fixed maturities:
Available for sale - $ 2,998 $ 2,897 $ (101)
Held to maturity - 378 367 (11)
Mortgage loans on real estate - 12 12 -
Policy loans - 761 728 (33)
Derivatives:
Futures 122 (2) (9) (7)
Financial liabilities:
Investment contracts - (1,283) (1,268) 15
----------------
Total estimated potential loss $ (137)
================
The estimated changes in fair values of the financial assets shown above relate
to assets invested in support of the Company's insurance liabilities, but do not
include assets associated with products for which investment risk is borne
primarily by the contractholders rather than the Company.
Market Risk Related to Equity Prices
The Company actively manages equity price risk relative to benchmarks in
respective markets. Equity holdings are benchmarked against a blend of leading
market indices, mainly the Standard & Poor's ("S&P") 500 and Russell 2000, and
targets price sensitivities that approximate those of the benchmark indices. The
Company estimates its equity price risk from a hypothetical 10% decline in
equity benchmark market levels and measures this risk in terms of the decline in
the fair value of the equity securities it holds. Using this methodology, the
Company's estimated equity price risk at December 31, 2000 was $1.1 million,
representing a hypothetical decline in fair market value of equity securities
held by the Company at that date from $10.8 million to $9.7 million. The
Company's estimated equity price risk using this methodology at December 31,
1999 was $.4 million, representing a hypothetical decline in fair market value
of equity securities the Company held at that date from $4.5 million to $4.1
million. These amounts exclude equity securities relating to products for which
investment risk is borne primarily by the contractholder rather than by the
Company. While these scenarios are for illustrative purposes only and do not
reflect management's expectations regarding future performance of equity markets
or of the Company's equity portfolio, they represent near term reasonably
possible hypothetical changes that illustrate the potential impact of such
events.
Market Risk Related to Foreign Currency Exchange Rates
The Company is exposed to foreign currency exchange risk in its investment
portfolio and through its operations in Taiwan. The Company generally hedges
substantially all foreign currency-denominated fixed-income investments
supporting its U.S. insurance operations into U.S. dollars, using foreign
exchange currency swaps, in order to mitigate the risk that the fair value of
these investments fluctuates as a result of changes in foreign exchange rates.
The Company generally does not hedge all of the foreign currency risk of its
equity investments in unaffiliated foreign entities.
Foreign currency exchange risk is actively managed within specified limits at
the enterprise (Prudential) level using Value-at-Risk ("VaR") analysis. This
statistical technique estimates, at a specified confidence level, the potential
pretax loss in portfolio market value that could occur over an assumed time
horizon due to adverse market movements. This calculation utilizes a
variance/covariance approach.
The Company calculates VaR estimates of exposure to loss from volatility in
foreign currency exchange for a one month time period. The Company's estimated
VaR at December 31, 2000 for foreign currency assets not hedged to U.S. dollars,
17
measured at the 95% confidence level and using a one month time horizon, was
$2.3 million, representing a hypothetical decline in fair market value of these
foreign currency assets from $133.2 million to $130.9 million. The Company's
estimated VaR at December 31, 1999 for foreign currency assets not hedged to
U.S. dollars, measured at the 95% confidence level and using a one month time
horizon, was $1.2 million, representing a hypothetical decline in fair market
value of these foreign currency assets from $36.1 million to $34.9 million.
These calculations use historical price volatilities and correlation data at a
95% confidence level.
The Company's average monthly VaR from foreign currency exchange rate movements
measured at the 95% confidence level over a one month time horizon was $2.3
million during 2000 and $1.5 million during 1999.
Limitations of VaR Models
Although VaR models represent a recognized tool for risk management, they have
inherent limitations, including reliance on historical data that may not be
indicative of future market conditions or trading patterns. Accordingly VaR
models should not be viewed as a predictor of future results. The Company may
incur losses that could be materially 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. The Company uses these models together with
other risk management tools, including stress testing. The results of these
models and analysis thereof are subject to the judgment of the Company's risk
management personnel.
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, options and forwards contracts. See Footnote 11 of the Notes to
Consolidated Financial Statements as to the Company's derivative positions at
December 31, 2000 and 1999. Under insurance statutes the Company may only use
derivative securities in hedging activities intended to offset changes in the
market value of assets held, obligations, and anticipated transactions. These
statutes prohibit the use of derivatives for speculation. The Company uses
derivative financial instruments to manage 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.
Product Risk is the risk of adverse results due to deviation of experience from
expected levels reflected in pricing. Products are priced to reflect the
expected levels of benefits and expense while allowing 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 some flexibility to respond to changes in
actuarial experience. The Company also considers the competitive environment 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. Expense risk is the risk that actual expenses exceed those assumed
in pricing, relates to all products and varies by volume of business as well as
general price level changes. 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 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. The Company is also exposed to credit risk resulting from
reinsurance transactions.
18
Limits of exposure by counterparty, 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.
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. Like other financial
institutions, the Company is exposed to the risk of misconduct by employees that
are contrary to the internal controls the Company designed to manage those
risks. Legal risk may arise from inadequate control over contract documentation,
marketing processes, or other operations. The Company is subject to internal
controls established by Prudential to manage regulatory, legal, credit, asset
management and other risks at the business unit level for specific lines of
business and at the enterprise level for company-wide processes. Business unit
management personnel, internal auditors and an enterprise level Management
Internal Control unit monitor the Company's controls. The Company's controls are
subject to regulatory review in certain instances.
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 has implemented a business
continuation initiative to address these concerns.
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 Financial Statement Schedules elsewhere in this Annual
Report.
Item 9. Changes in and Disagreements with Independent Accountants on Accounting
and Financial Disclosure
Not applicable.
19
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
Name Position Age
- ---- -------- ---
James J. Avery, Jr. Chairman of the Board and Director 49
I. Edward Price Vice Chairman of the Board and Director 58
Esther H. Milnes President and Director 50
James Drozanowski Senior Vice President 58
Hiroshi Nakajima Senior Vice President 57
Thomas F. Higgins Senior Vice President 46
Ronald P. Joelson Director 42
C. Edward Chaplin Senior Vice President and Treasurer 44
Hwei-Chung Shao Senior Vice President and Chief Actuary 46
William J. Eckert, IV Vice President and Chief Financial Officer 38
David A. Nachman Vice President and Comptroller 53
Clifford E. Kirsch Chief Legal Counsel and Secretary 41
Ira J. Kleinman Director 53
David R. Odenath, Jr. Director 44
Kiyofumi Sakaguchi Director 58
- --------------------------------------------------------------------------------
James J. Avery, Jr., age 49 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 President, Prudential U.S. Consumer Group
since 1998. From 1997 to 1998 he was Senior Vice President, CFO and Chief
Actuary for the Prudential Individual Insurance Group. From 1995 to 1997 he was
President, Prudential Select.
I. Edward Price, age 58, has been Senior Vice President and Actuary of
Prudential U.S. Consumer Group since 1998. From 1995 to 1998 he was Senior Vice
President and Actuary, Prudential U.S. Consumer Group. From 1994 to 1995, he was
Chief Executive Officer of Prudential International Insurance. From 1993 to 1994
he was President, Prudential International Insurance. Prior to 1993, he was
Senior Vice President and Company Actuary of Prudential.
Esther H. Milnes, age 50, has been Vice President and Chief Actuary, Prudential
U.S. Consumer Group since 1999. From 1996 to 1999 she was Vice President and
Actuary of Prudential U.S. Consumer Group. From 1993 to 1996, 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 58, has been Vice President, Operations and Systems,
Prudential U.S. Consumer Group since 1998. From 1996 to 1998 he was Vice
President and Operations Executive, Prudential Individual Insurance Group. 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.
Hiroshi Nakajima, age 57, has been President and Chief Executive Officer of
Pruco Life Insurance Company, Taiwan Branch, since November 1997. Prior to 1997,
he was Senior Managing Director, Prudential Life Insurance Co., Ltd.
20
Thomas F. Higgins, age 46, has been Vice President of Annuity Services and
Prudential U.S. Consumer Group since 1999. From 1998 to 1999 he was Vice
President of Mutual Funds, Prudential Individual Financial Services. Prior to
1998, he was Principal of Mutual Fund Operations, The Vanguard Group.
Ronald P. Joelson, age 42, has been Senior Vice President, Prudential Asset,
Liability and Risk Management since 1999. From 1996 to 1999 he was President of
Guaranteed Products, Prudential Institutional.
C. Edward Chaplin, age 44, has been Senior Vice President and Treasurer of
Prudential Insurance Company of America since 2000. Prior to 2000, he was Vice
President and Treasurer of Prudential Insurance Company of America.
Hwei-Chung Shao, age 46, has been Vice President and Associate Actuary,
Prudential since 1996. Prior to 1996, she was Vice President and Assistant
Actuary, Prudential Corporate Risk Management.
William J. Eckert, IV, age 38, was elected Vice President and Chief Accounting
Officer of the Company in June 2000. Mr. Eckert has been Vice President,
Enterprise Financial Management of Prudential Insurance Company of America since
May 1995. Prior to 1995, he was Senior Manager at Deloitte & Touche, LLP.
David A. Nachman, age 53, 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.
Clifford E. Kirsch, age 41, has been Chief Legal Counsel and Secretary of the
Company since 1995. Mr. Kirsch joined Prudential Insurance Company of America in
1995 as Chief Counsel, Variable Products. From 1994 to 1995 he was Associate
General Counsel of Paine Webber, Inc. Prior to 1994 he was an Assistant Director
at the United States Securities and Exchange Commission.
Ira J. Kleinman, age 53, has been Executive Vice President, Prudential
International Insurance Group since 1997. From 1995 to 1997 he was Chief
Marketing and Product Development Officer of Prudential Individual Insurance
Group. 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.
David R. Odenath, Jr., age 44, has been President of Prudential Investments
since 1999. Prior to joining Prudential in 1999, Mr. Odenath was Senior Vice
President and Director of Sales for the Investment Consulting Group at Paine
Webber.
Kiyofumi Sakaguchi, age 58, has been Executive Vice President, International
Insurance since 1998. From 1995 to 1998 he was President, Prudential
International Insurance Group. From 1994 to 1995 he was Chairman and Chief
Executive Officer, the Prudential Life Insurance Co., Ltd., Japan. Prior to 1994
he was President and Chief Executive Officer, Asia Pacific Region-Prudential
International Insurance, and President, the Prudential Life Insurance Co., Ltd.
21
Item 11. Executive Compensation
The following table shows the 2000 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 2000 $ 21,533 $ 3,132 $ 0
President 1999 20,782 23,238 0
1998 20,769 26,313 0
Item 12. Security Ownership of Certain Beneficial Owners and Management
Not applicable.
Item 13. Certain Relationships and Related Transactions
Refer to Footnote 14 in the Notes to the Consolidated Financial Statements.
22
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 Insurance
Company, 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 Insurance
Company. 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, which was a wholly owned subsidiary of Pruco Life
Insurance, was dissolved on September 30, 2000.
22. None.
23. Not applicable.
23
24. Powers of Attorney for I. Edward Price, Esther H. Milnes, and
Ira Kleinman are incorporated by reference to Form 10-K,
Registration No. 33-867880, filed March 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. Powers of
attorney for David Odenath and Ronald Joelson may be
incorporated by reference to Form N-4, Registration No.
333-52754, filed December 26, 2000 on behalf of the Pruco Life
Flexible Premium Variable Annuity Account.
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
For the account account(s) of the
of the Company contractholder(s)
------------------------------ -----------------
Aggregate
offering
price of
amount
registered Amount sold Amount sold
--------------- -------------- ------------------
(in thousands)
Flexible Premium Variable Annuity
Account* $ 500,000 $ 356,833 $ 57,499
Underwriting discounts and commissions ** (9,455)
Other expenses *** (18,896)
---------------
Total (28,351)
---------------
Net offering proceeds $ 328,482
===============
* 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.
24
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 29, 2001 By: ______________________________
-------------- 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 29, 2001
- -----------------------
James J. Avery, Jr.
* Vice Chairman of the Board March 29, 2001
- ----------------------- and Director
I. Edward Price
* President and Director March 29, 2001
- -----------------------
Esther H. Milnes
* Principal Financial Officer and March 29, 2001
- ----------------------- Chief Accounting Officer
William J. Eckert, IV
* Director March 29, 2001
- -----------------------
Ronald Paul Joelson
* Director March 29, 2001
- -----------------------
Ira J. Kleinman
* Director March 29, 2001
- -----------------------
Kiyofumi Sakaguchi
* By: ___________________________
Thomas C. Castano
(Attorney-in-Fact)
25
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT
CONSOLIDATED FINANCIAL STATEMENTS
For the fiscal year ended December 31, 2000
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
26
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:
Consolidated Statements of Financial Position
Years ended December 31, 2000 and 1999 F - 3
Consolidated Statements of Operations and Comprehensive Income
Years ended December 31, 2000, 1999 and 1998 F - 4
Consolidated Statements of Changes in Stockholder's Equity
Years ended December 31, 2000, 1999 and 1998 F - 5
Consolidated Statements of Cash Flows
Years ended December 31, 2000, 1999 and 1998 F - 6
Notes to the Consolidated Financial Statements F - 7
F-1
Report of Independent Accountants
---------------------------------
To the Board of Directors and Stockholder of
Pruco Life Insurance Company
In our opinion, the accompanying consolidated statements of financial
position and the related consolidated statements of operations and
comprehensive income, of changes in stockholder's equity and of cash flows
present fairly, in all material respects, the financial position of Pruco
Life Insurance Company (a wholly-owned subsidiary of the Prudential Insurance
Company of America) and its subsidiaries at December 31, 2000 and 1999, and
the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
March, 13, 2001
F-2
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Financial Position
December 31, 2000 and 1999 (In Thousands)
- -------------------------------------------------------------------------------------------------------------------
2000 1999
------------ ------------
ASSETS
Fixed maturities
Available for sale, at fair value (amortized cost, 2000: $3,552,244; $ 3,561,521 $ 2,998,362
1999:$3,084,057)
Held to maturity, at amortized cost (fair value, 2000: $320,634 ; 324,546 388,990
1999: $377,822)
Equity securities - available for sale, at fair value (cost, 2000: $13,446; 10,804 4,532
1999: $3,238)
Mortgage loans on real estate 9,327 10,509
Policy loans 855,374 792,352
Short-term investments 202,815 84,621
Other long-term investments 83,738 77,769
----------------- -----------------
Total investments 5,048,125 4,357,135
Cash and cash equivalents 453,071 198,994
Deferred policy acquisition costs 1,132,653 1,062,785
Accrued investment income 82,297 68,917
Receivables from affiliates 51,586 -
Other assets 61,013 48,228
Separate Account assets 16,230,264 16,032,449
----------------- -----------------
TOTAL ASSETS $ 23,059,009 $ 21,768,508
================= =================
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $ 3,646,668 $ 3,125,049
Future policy benefits and other policyholder liabilities 702,862 629,522
Cash collateral for loaned securities 185,849 87,336
Securities sold under agreements to repurchase 104,098 21,151
Income taxes payable 235,795 145,600
Payables to affiliates - 487
Other liabilities 120,891 57,095
Separate Account liabilities 16,230,264 16,032,449
----------------- -----------------
Total liabilities 21,226,427 20,098,689
----------------- -----------------
Contingencies (See Footnote 12)
Stockholder's Equity
Common stock, $10 par value;
1,000,000 shares, authorized;
250,000 shares, issued and outstanding 2,500 2,500
Paid-in-capital 466,748 439,582
Retained earnings 1,361,924 1,258,428
Accumulated other comprehensive income (loss):
Net unrealized investment gains (losses) 4,730 (28,364)
Foreign currency translation adjustments (3,320) (2,327)
----------------- -----------------
Accumulated other comprehensive income (loss) 1,410 (30,691)
----------------- -----------------
Total stockholder's equity 1,832,582 1,669,819
----------------- -----------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 23,059,009 $ 21,768,508
================= =================
See Notes to Consolidated Financial Statements
F-3
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
Years Ended December 31, 2000, 1999 and 1998 (In Thousands)
- -------------------------------------------------------------------------------------------------------------------
2000 1999 1998
-------------- --------------- ---------------
REVENUES
Premiums $ 121,921 $ 98,976 $ 82,139
Policy charges and fee income 474,861 414,425 350,569
Net investment income 337,919 276,821 261,430
Realized investment (losses) gains, net (20,679) (32,545) 44,841
Asset management fees 71,160 60,392 40,200
Other income 2,503 1,397 1,067
-------------- --------------- ---------------
Total revenues 987,685 819,466 780,246
-------------- --------------- ---------------
BENEFITS AND EXPENSES
Policyholders' benefits 248,063 205,042 193,739
Interest credited to policyholders' account balances 171,010 136,852 118,992
General, administrative and other expenses 410,684 392,041 231,320
-------------- --------------- ---------------
Total benefits and expenses 829,757 733,935 544,051
-------------- --------------- ---------------
Income from operations before income taxes 157,928 85,531 236,195
-------------- --------------- ---------------
Income tax provision 54,432 29,936 84,233
-------------- --------------- ---------------
NET INCOME 103,496 55,595 151,962
-------------- --------------- ---------------
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities, net of
reclassification adjustment 33,094 (38,266) (7,227)
Foreign currency translation adjustments (993) (742) 2,980
-------------- --------------- ---------------
Other comprehensive income (loss) 32,101 (39,008) (4,247)
-------------- --------------- ---------------
TOTAL COMPREHENSIVE INCOME $ 135,597 $ 16,587 $ 147,715
============== =============== ===============
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, 2000, 1999 and 1998 (In Thousands)
- -------------------------------------------------------------------------------------------------------------------
Accumulated
other Total
Common stock Paid-in- Retained comprehensive stockholder's
capital earnings income (loss) equity
-------------- -------------- -------------- ----------------- ------------------
Balance, January 1, 1998 $ 2,500 $ 439,582 $ 1,050,871 $ 12,564 $ 1,505,517
Net income - - 151,962 - 151,962
Change in foreign currency - - - 2,980 2,980
translation adjustments,
net of taxes
Change in net unrealized (7,227) (7,227)
investment gains, net of - - -
reclassification adjustment
and taxes
-------------- -------------- -------------- ----------------- ------------------
Balance, December 31, 1998 2,500 439,582 1,202,833 8,317 1,653,232
Net income - - 55,595 - 55,595
Change in foreign currency - - - (742) (742)
translation adjustments,
net of taxes
Change in net unrealized
investment losses, net of - - - (38,266) (38,266)
reclassification adjustment
and taxes
-------------- -------------- -------------- ----------------- ------------------
Balance, December 31, 1999 2,500 439,582 1,258,428 (30,691) 1,669,819
Net income - 103,496 103,496
Contribution from Parent 27,166 27,166
Change in foreign currency
translation adjustments, - - - (993) (993)
net of taxes
Change in net unrealized
investment gains, net of - - - 33,094 33,094
reclassification adjustment
and taxes
-------------- -------------- -------------- ----------------- ------------------
Balance, December 31, 2000 $ 2,500 $ 466,748 $ 1,361,924 $ 1,410 $ 1,832,582
============== ============== ============== ================= ==================
See Notes to Consolidated Financial Statements
F-5
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2000, 1999 and 1998 (In Thousands)
- -------------------------------------------------------------------------------------------------------------------
2000 1999 1998
----------------- ------------------ ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 103,496 $ 55,595 $151,962
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Policy charges and fee income (72,275) (83,961) (29,827)
Interest credited to policyholders' account balances 171,010 136,852 118,992
Realized investment losses (gains), net 20,679 32,545 (44,841)
Amortization and other non-cash items (48,141) 75,037 19,655
Change in:
Future policy benefits and other policyholders' 73,340 100,743 61,095
liabilities
Accrued investment income (13,380) (7,803) 5,886
Receivable from/Payable to affiliate (52,073) (66,081) (3,807)
Policy loans (63,022) (25,435) (62,962)
Deferred policy acquisition costs (69,868) (201,072) (206,471)
Income taxes payable 90,195 (47,758) (16,828)
Contribution from Parent 27,166 - -
Other, net 51,011 18,974 (43,675)
----------------- ----------------------------------
Cash Flows From (Used in) Operating Activities 218,138 (12,364) (50,821)
----------------- ----------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities:
Available for sale 2,273,789 3,076,848 5,429,396
Held to maturity 64,245 45,841 74,767
Equity securities 1,198 5,209 4,101
Mortgage loans on real estate 1,182 6,845 5,433
Other long-term investments 15,039 385 33,428
Payments for the purchase of:
Fixed maturities:
Available for sale (2,782,541) (3,452,289) (5,617,208)
Held to maturity - (24,170) (145,919)
Equity securities (11,134) (5,110) (2,274)
Other long-term investments (6,917) (39,094) (409)
Cash collateral for loaned securities, net 98,513 14,000 (70,085)
Securities sold under agreement to repurchase, net 82,947 (28,557) 49,708
Short-term investments, net (118,418) 92,199 103,791
----------------- ----------------------------------
Cash Flows Used In Investing Activities (382,097) (307,893) (135,271)
----------------- ----------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 2,409,399 3,457,158 3,098,764
Withdrawals (1,991,363) (3,091,565) (2,866,331)
----------------- ----------------------------------
Cash Flows From Financing Activities 418,036 365,593 232,433
----------------- ----------------------------------
Net increase in Cash and cash equivalents 254,077 45,336 46,341
Cash and cash equivalents, beginning of year 198,994 153,658 107,317
----------------- ----------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 453,071 $198,994 $ 153,658
================= ==================================
SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes (received) paid $ (14,832) $55,144 $99,810
================= ==================================
See Notes to Consolidated Financial Statements
F-6
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 is
licensed to sell individual life insurance, variable life insurance, variable
annuities, fixed annuities, and a group annuity program ("the Contracts") in the
District of Columbia, Guam and in all states and territories except New York. In
addition, the Company markets traditional individual life insurance through its
branch office in Taiwan. The Company has one wholly owned subsidiary, Pruco Life
Insurance Company of New Jersey ("PLNJ"). 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. Another wholly
owned subsidiary, The Prudential Life Insurance Company of Arizona ("PLICA") was
dissolved on September 30, 2000. All assets and liabilities were transferred to
the Company. PLICA had no new business sales in 2000, 1999 or 1998.
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 is in the process of reorganizing
itself into a publicly traded stock company through a process known as
"demutualization." On February 10, 1998, Prudential's Board of Directors
authorized management to take the preliminary steps necessary to permit
Prudential to demutualize and become a stock company. On July 1, 1998,
legislation was enacted in New Jersey that would permit this demutualization to
occur and that specified the process for demutualization. On December 15, 2000,
Prudential's Board of Directors unanimously adopted a Plan of Reorganization,
which provides the framework under which Prudential will convert from a mutual
structure to stock ownership. Demutualization is a complex process involving
development of a plan of reorganization, a public hearing, approval by
two-thirds of the qualified policyholders who vote on the plan (with at least
one million qualified policyholders voting) and review and approval by the New
Jersey Commissioner of Banking and Insurance. Prudential is working toward
completing this process in 2001. However, there is no certainty that the
demutualization will be completed in this time frame or that the necessary
approvals will be obtained. It is also possible that after careful review,
Prudential could decide not to demutualize or could decide to delay its plans.
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. Prudential made a capital contribution of $27.2 million during
2000 resulting from the forgiveness of an intercompany receivable.
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The Company has extensive transactions and relationships with
Prudential and other affiliates, as more fully described in Footnote 14. Due to
these relationships, it is possible that the terms of these transactions are not
the same as those that would result from transactions among wholly unrelated
parties. All significant intercompany transactions and balances have been
eliminated in consolidation.
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, in particular deferred policy acquisition costs ("DAC")
and future policy benefits, 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 policyholders' account
balances 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."
F-7
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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, the effects on deferred policy acquisition costs and on
policyholders' account balances, net of income tax, that would result from the
realization of unrealized gains and losses, are included in a separate component
of equity, "Accumulated other comprehensive income (loss)."
Mortgage loans on real estate are stated primarily at unpaid principal balances,
net of unamortized discounts and an allowance for losses. The allowance for
losses includes a loan specific reserve for impaired loans and a portfolio
reserve for incurred but not specifically identified losses. Impaired loans
include those loans for which it is probable that all amounts due according to
the contractual terms of the loan agreement will not be collected. Impaired
loans are measured at the present value of expected future cash flows discounted
at the loan's effective interest rate, or at 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 accruing
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
uncollectible interest 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 the payment of interest has been interrupted for a substantial period, a
regular payment performance has been established. The portfolio reserve for
incurred but not specifically identified losses considers the Company's past
loan loss experience, the current credit composition of the portfolio,
historical credit migration, property type diversification, default and loss
severity statistics and other relevant factors.
Policy loans are carried at unpaid principal balances.
Short-term investments, consisting of highly liquid debt instruments other than
those held in "Cash and cash equivalents," with a maturity of twelve months or
less when purchased, are carried at amortized cost, which approximates fair
value.
Other long-term investments represent the Company's investments in joint
ventures and partnerships in which the Company does not exercise control,
derivatives held for purposes other than trading, and investments in the
Company's own Separate Accounts. Joint ventures and partnerships are recorded
using the equity method of accounting, reduced for other than temporary declines
in value. The Company's investment in the Separate Accounts is carried at
estimated fair value. The Company's net income from investments in joint
ventures and partnerships is generally included in "Net investment income."
Realized investment (losses) 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 and cash equivalents
Includes cash on hand, amounts due from banks, money market instruments, and
other debt issues with a maturity of three months or less when purchased.
Deferred Policy Acquisition Costs
The costs that vary with and that are related primarily to the production of new
insurance and annuity business are deferred to the extent that they are deemed
recoverable from future profits. Such costs include commissions, costs of policy
issuance and underwriting, and variable field office expenses. Deferred policy
acquisition costs are subject to recognition testing at the time of policy issue
and recoverability and premium deficiency testing at the end of each accounting
period. Deferred policy acquisition costs, for certain products, 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 (loss)."
Policy acquisition costs related to interest-sensitive and variable life
products and certain investment-type products are deferred and amortized over
the expected life of the contracts (periods ranging from 25 to 30 years) in
proportion to estimated gross profits arising principally from investment
results, mortality and expense margins, and surrender charges based on
historical and anticipated future experience, which is updated periodically. The
effect of changes to estimated gross profits on unamortized deferred acquisition
costs is reflected in "General and administrative expenses" in the period such
estimated gross profits are revised.
F-8
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Prudential and the Company have offered programs under which policyholders, for
a selected product or group of products, can exchange an existing policy or
contract issued by Prudential or the Company for another form of policy or
contract. These transactions are known as internal replacements. If the new
policies have terms that are substantially similar to those of the earlier
policies, the DAC is retained with respect to the new policies and amortized
over the life of the new policies. If the terms of the new policies are not
substantially similar to those of the former policy, the unamortized DAC on the
surrendered policies is immediately charged to expense.
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% and 105% of the fair value of the domestic and foreign
securities, respectively. 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 because the debtor typically has the right to redeem the
collateral on short notice. Substantially all of the Company's securities loaned
are with large brokerage firms.
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. Assets to be repurchased are the same, or substantially
the same, as the assets transferred and the transferor, through right of
substitution, maintains the right and ability to redeem the collateral on short
notice. The market value of securities to be repurchased is monitored and
additional collateral is obtained, 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. The assets consist of 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 Statements of Operations and Comprehensive
Income. 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.
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. 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.
F-9
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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".
Asset Management Fees
The Company receives asset management fee income from policyholder account
balances invested in The Prudential Series Fund ("PSF"), which are a portfolio
of mutual fund investments related to the Company's Separate Account products.
In addition, the Company receives fees from policyholder account balances
invested in funds managed by companies other than Prudential. Asset management
fees are recognized as income as earned.
Derivative Financial Instruments
Derivatives are financial instruments whose values are derived from interest
rates, foreign exchange rates, financial indices, or the value of securities or
commodities. Derivative financial instruments used by the Company include swaps,
futures, forwards and option contracts and may be exchange-traded or contracted
in the over-the-counter market. The Company uses derivative financial
instruments to seek 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.
To qualify for hedge accounting treatment, 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 is evaluated at the inception of the hedge and throughout the
hedge period. All derivatives used by the Company are for other than trading
purposes.
Derivatives held for purposes other than trading are primarily used to seek to
reduce exposure to interest rate and foreign currency risks associated with
assets held or expected to be purchased or sold, and liabilities incurred or
expected to be incurred. Additionally, other than trading derivatives are used
to change the characteristics of the Company's asset/liability mix as part of
the Company's risk management activities.
See Note 11 for a discussion of the accounting treatment of derivatives that
qualify for hedge accounting treatment. 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 long-term investments" or
"Other liabilities" in the Consolidated Statements of Financial Position, and
changes in their fair value are included in "Realized investment (losses)gains,
net" without considering changes in fair value of the hedged assets or
liabilities. Cash flows from other than trading derivatives are reported in the
investing 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 file 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 September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -
a replacement of FASB Statement No. 125". The Company is currently evaluating
the effect of adopting the provisions of SFAS No. 140 relating to transfers and
extinguishments of liabilities which are effective for periods occurring after
March 31, 2001. The Company had adopted in these financial statements
disclosures about securitizations and collateral and for recognition and
reclassification of collateral required under the statement for fiscal years
ending after December 15, 2000.
F-10
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" and, in June 2000, SFAS No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities - an amendment
of FASB Statement No. 133". SFAS No. 133, as amended by SFAS No. 138
(collectively "SFAS No. 133"), 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 does not apply to most traditional
insurance contracts. However, certain hybrid contracts that contain features
which may 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.
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). 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. The accounting for a fair value hedge described
above applies to a derivative designated as a hedge of the foreign currency
exposure of an unrecognized firm commitment or an available-for-sale security.
Similarly, the accounting for a cash flow hedge described above applies to a
derivative designated as a hedge of the foreign currency exposure of a
foreign-currency-denominated forecasted transaction. For all other derivatives
not designated as hedging instruments, the gain or loss is recognized in
earnings in the period of change.
The Company adopted SFAS No. 133, as amended, as of January 1, 2001. The
adoption of this statement did not have a material impact on the results of
operations of the Company. As part of the implementation, the Company
reclassified held-to-maturity securities, amounting to approximately $324.5
million at January 1, 2001, to the available-for-sale category. This
reclassification resulted in the recognition of a net unrealized loss of
approximately $2.5 million, net of tax, which was recorded as a component of
"Accumulated other comprehensive income/(loss)" on the implementation date.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101, " Revenue Recognition in Financial Statements"
("SAB No. 101"). SAB No. 101 provides guidance for revenue recognition and
related disclosure in the financial statements. The Company adopted SAB No. 101,
and its related interpretations, as of October 1, 2000. The adoption of SAB No.
101 did not 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 the
current year presentation.
F-11
3. INVESTMENTS
Fixed Maturities and Equity Securities:
The following tables provide additional information relating to fixed maturities
and equity securities as of December 31:
2000
---------------------------------------------------------------
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 $ 309,609 $ 7,888 $ 17 $ 317,480
agencies
Foreign government bonds 136,133 8,093 520 143,706
Corporate securities 3,075,023 43,041 49,538 3,068,526
Mortgage-backed securities 31,479 330 0 31,809
------------- -------------- -------------- --------------
Total fixed maturities available for sale $3,552,244 $ 59,352 $ 50,075 $3,561,521
============= ============== ============== ==============
Fixed maturities held to maturity
Corporate securities $ 324,546 $ 1,500 $ 5,412 320,634
------------- -------------- -------------- --------------
Total fixed maturities held to maturity $ 324,546 $ 1,500 $ 5,412 320,634
============= ============== ============== ==============
Equity securities available for sale $ 13,446 $ 197 $ 2,839 $ 10,804
============== ============== ============== ==============
1999
--------------------------------------------------------------
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 $ 113,172 $ 2 $ 2,052 $ 111,122
agencies
Foreign government bonds 92,725 1,718 1,455 92,988
Corporate securities 2,876,602 8,013 92,075 2,792,540
Mortgage-backed securities 1,558 157 3 1,712
-------------- ------------ -------------- --------------
Total fixed maturities available for sale $ 3,084,057 $ 9,890 $95,585 $2,998,362
============== ============ ============== ==============
Fixed maturities held to maturity
Corporate securities $ 388,990 $ 1,832 $13,000 $ 377,822
-------------- ------------- -------------- -------------
Total fixed maturities held to maturity $ 388,990 $ 1,832 $13,000 $ 377,822
============== ============= ============== =============
Equity securities available for sale $ 3,238 $ 1,373 $ 79 $ 4,532
============== ============= ============== =============
F-12
3. INVESTMENTS (continued)
The amortized cost and estimated fair value of fixed maturities, by contractual
maturities at December 31, 2000 is 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 $ 128,804 $ 128,419 $ 77,682 $ 78,475
Due after one year through five 1,529,597 1,533,899 101,033 100,395
years
Due after five years through ten 1,409,156 1,415,736 135,960 132,080
years
Due after ten years 453,209 451,658 9,871 9,684
Mortgage-backed securities 31,478 31,809 - -
---------------- ------------------- ----------------- ----------------
Total $ 3,552,244 $ 3,561,521 $ 324,546 $ 320,634
================ =================== ================= ================
Actual maturities may differ from contractual maturities because issuers have
the right to call or prepay obligations.
Proceeds from the sale of fixed maturities available for sale during 2000, 1999,
and 1998 were $2,103.6 million, $2,950.4 million, and $5,327.3 million,
respectively. Gross gains of $15.3 million, $13.1 million, and $46.3 million,
and gross losses of $33.9 million, $31.1 million, and $14.1 million, were
realized on those sales during 2000, 1999, and 1998, respectively.
Proceeds from the maturity of fixed maturities available for sale during 2000,
1999, and 1998, were $170.2 million, $126.5 million, and $102.1 million,
respectively.
Writedowns for impairments which were deemed to be other than temporary for
fixed maturities were $12.3 million, $11.2 million, and $2.8 million for the
years 2000, 1999 and 1998, respectively.
During 2000, certain securities classified as held to maturity were transferred
to the available for sale portfolio. These actions were taken as a result of a
significant deterioration in credit worthiness. The aggregate amortized cost of
the securities transferred was $6.6 million . Gross unrealized investment losses
of $.3 million were recorded in "Accumulated Other Comprehensive income (loss)"
at the time of transfer. Prior to transfer, impairments related to these
securities, if any, were included in "realized investment losses, net". During
the years ended December 31, 2000, 1999, and 1998, there were no securities
classified as held to maturity that were sold. During the years ended December
31, 1999, and 1998, there were no securities classified as held to maturity that
were transferred.
Mortgage Loans on Real Estate
The Company's mortgage loans were collateralized by the following property types
at December 31:
2000 1999
-------------------------- -------------------------
(In Thousands)
Retail stores $ 5,615 60.2% $ 6,518 62.0%
Industrial buildings 3,712 39.8% 3,991 38.0%
-------------------------- -------------------------
Net carrying value $ 9,327 100.0% $ 10,509 100.0%
========================== =========================
The concentration of mortgage loans are in the states of Washington (50%), New
Jersey (40%), and North Dakota (10%).
Special Deposits and Restricted Assets
Fixed maturities of $7.5 million and $8.2 million at December 31, 2000 and 1999,
respectively, were on deposit with governmental authorities or trustees as
required by certain insurance laws. Equity securities restricted as to sale were
$.2 million and $.3 million at December 31, 2000 and 1999, respectively.
F-13
Other Long-Term Investments
The Company's "Other long-term investments" of $83.7 million and $77.8 million
as of December 31, 2000 and 1999, respectively, are comprised of joint ventures
and limited partnerships, the Company's investment in the Separate Accounts and
certain derivatives for other than trading. Joint ventures and limited
partnerships totaled $34.3 million and $35.8 million at December 31, 2000 and
1999, respectively. The Company's share of net income from the joint ventures
was $.9 million, $.3 million, and $.1 million for the years ended December 31,
2000, 1999 and 1998, respectively, and is reported in "Net investment income."
The Company's investment in the Separate Accounts was $46.9 million and $45.0
million at December 31, 2000 and 1999, respectively.
Investment Income and Investment Gains and Losses
Net investment income arose from the following sources for the years ended
December 31:
2000 1999 1998
---------------- ----------------- ----------------
(In Thousands)
Fixed maturities - available for sale $ 237,042 $ 188,236 $ 179,184
Fixed maturities - held to maturity 26,283 29,245 26,128
Equity securities - available for sale 18 - 14
Mortgage loans on real estate 1,010 2,825 1,818
Policy loans 45,792 42,422 40,928
Short-term investments and cash equivalents 29,582 19,208 23,110
Other 16,539 4,432 6,886
---------------- ----------------- ----------------
Gross investment income 356,266 286,368 278,068
Less: investment expenses (18,347) (9,547) (16,638)
---------------- ----------------- ----------------
Net investment income $ 337,919 $ 276,821 $ 261,430
================ ================= ================
Realized investment gains (losses), net including charges for other than
temporary reductions in value, for the years ended December 31, were from the
following sources:
2000 1999 1998
---------------- ----------------- -----------------
(In Thousands)
Fixed maturities - available for sale $ (34,600) $ (29,192) $ 29,330
Fixed maturities - held to maturity (212) 102 487
Equity securities - available for sale 271 392 3,489
Derivatives 15,039 (1,557) 12,414
Other (1,177) (2,290) (879)
---------------- ----------------- -----------------
Realized investment (losses) gains, net $ (20,679) $ (32,545) $ 44,841
================ ================= =================
Securities Pledged to Creditors
The Company pledges investment securities it owns to unaffiliated parties
through certain transactions including securities lending, securities sold under
agreements to repurchase, and futures contracts. At December 31, 2000, the
carrying value of fixed maturities available for sale pledged to third parties
as reported in the Consolidated Statements of Financial Position are $287.8
million.
F-14
Net Unrealized Investment Gains (Losses)
Net unrealized investment gains (losses) on securities available for sale are
included in the Consolidated Statements of Financial Position as a component of
"Accumulated other comprehensive income (loss)". Changes in these amounts
include reclassification adjustments to exclude from "Other Comprehensive income
(loss)", those items that are included as part of "Net income" for a period that
also had been part of "Other Comprehensive income (loss)" in earlier periods.
The amounts for the years ended December 31, net of tax, are as follows:
Accumulated
other
comprehensive
income
Deferred Deferred (loss)
Unrealized policy Policyholders' income tax related to
gains(losses) acquisition Account (liability) net
on investments costs Balances benefit unrealized
investment
gains(losses)
------------------ -------------------------------------------------------------
(In Thousands)
Balance, December 31, 1997 $ 37,991 $ (16,305) $ 3,743 $ (8,300) $ 17,129
Net investment gains (losses) on
investments arising during the period 22,801 - - (7,588) 15,213
Reclassifications adjustment for gains
included in net income (35,623) - - 11,855 (23,768)
Impact of net unrealized investment
gains on deferred policy acquisition
costs - 3,190 - (1,048) 2,142
Impact of net unrealized investment
gains on policyholders' account
balances - - (1,063) 249 (814)
------------------ -------------------------------------------------------------
Balance, December 31, 1998 25,169 (13,115) 2,680 (4,832) 9,902
Net investment gains (losses) on
investments arising during the period (138,268) - - 47,785 (90,483)
Reclassifications adjustment for gains
included in net income 28,698 - - (9,970) 18,728
Impact of net unrealized investment
gains on deferred policy acquisition
costs - 53,407 - (16,283) 37,124
Impact of net unrealized investment
gains on policyholders' account
balances - - (5,712) 2,077 (3,635)
------------------ -------------------------------------------------------------
Balance, December 31, 1999 (84,401) 40,292 (3,032) 18,777 (28,364)
Net investment gains (losses) on
investments arising during the period 56,707 (21,539) 35,168
Reclassifications adjustment for gains
included in net income 34,329 (13,039) 21,290
Impact of net unrealized investment
gains on deferred policy acquisition
costs (39,382) 14,177 (25,205)
Impact of net unrealized investment 2,877 (1,036) 1,841
gains on policyholders' account
balances
------------------ -------------------------------------------------------------
Balance, December 31, 2000 $ 6,635 $ 910 $ (155) $ (2,660) $ 4,730
================== =============================================================
F-15
4. DEFERRED POLICY ACQUISITION COSTS
The balances of and changes in deferred policy acquisition costs as of and for
the years ended December 31, are as follows:
2000 1999
-----------------------------------
(In Thousands)
Balance, beginning of year $ 1,062,785 $ 861,713
Capitalization of commissions, sales and issue expenses 242,322 242,373
Amortization (129,049) (96,451)
Change in unrealized investment gains (39,382) 53,407
Foreign currency translation (4,023) 1,743
-----------------------------------
Balance, end of year $ 1,132,653 $ 1,062,785
===================================
5. POLICYHOLDERS' LIABILITIES
Future policy benefits and other policyholder liabilities at December 31, are as
follows:
2000 1999
------------------- ------------------
(In Thousands)
Life insurance $ 656,097 $ 587,162
Annuities 46,765 42,360
------------------- ------------------
$ 702,862 $ 629,522
=================== ==================
Life insurance liabilities include reserves for death benefits. Annuity
liabilities include reserves for annuities that are in payout status.
The following table highlights the key assumptions generally utilized in
calculating these reserves:
Product Mortality Interest Rate Estimation Method
- -------------------------------- ---------------------------- ---------------- --------------------------
Life insurance - Domestic Generally rates guaranteed 2.5% to 7.5% Net level premium based
variable and interest-sensitive in calculating cash on non-forfeiture
surrender values interest rate
Life insurance - Domestic term Best estimate plus a 6.75% Net level premium plus
insurance provision for adverse a provision for adverse
deviation deviation.
Life insurance - International Generally the Taiwan 6.25% to 7.5% Net level premium plus
standard table plus a a provision for adverse
provision for adverse deviation.
deviation
Individual annuities Mortality table varies 6.25% to 11.0% Present value of
based on the issue year of expected future payments
the contract. Current based on historical
table (for 1998 & later experience
issues) is the Annuity
2000 Mortality Table with
certain modifications
Group annuities 1950 & 1971 Group Annuity 14.75% Present value of
Mortality Table with expected future payments
certain modifications based on historical
experience
F-16
5. POLICYHOLDERS' LIABILITIES (continued)
Policyholders' account balances at December 31, are as follows:
2000 1999
------------------- -----------------
(In Thousands)
Interest-sensitive life contracts $ 1,886,714 $ 1,838,377
Individual annuities 859,996 701,928
Guaranteed investment contracts 899,958 584,744
------------------- -----------------
$ 3,646,668 $ 3,125,049
=================== =================
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 and 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 16.0% 0% to 7% for up to 9 years
Guaranteed investment contracts 5.02% to 8.03% Subject to market value withdrawal
provisions for any funds withdrawn
other than for benefit responsive
and contractual payments
6. 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. Ceded balances would represent a
liability of 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 Statements of Operations and
Comprehensive Income for the year ended December 31, are as follows:
2000 1999 1998
---------------- ---------------- ----------------
(In Thousands)
Reinsurance premiums assumed $ 1,671 $ 1,778 $ 1,395
Reinsurance premiums ceded - affiliated (9,214) (6,882) (6,532)
Reinsurance premiums ceded - unaffiliated (5,305) (1,744) (2,819)
Policyholders' benefits ceded 5,472 4,228 4,044
F-17
6. REINSURANCE (continued)
Reinsurance recoverables, included in "Other assets" in the Company's
Consolidated Statements of Financial Position at December 31, were as follows:
2000 1999
------------------- --------------
(In Thousands)
Life insurance - affiliated $ 8,765 $ 6,653
Life insurance - unaffiliated 7,855 2,625
Other reinsurance - affiliated 14,948 15,600
------------------- --------------
$ 31,568 $24,878
=================== ==============
7. 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, 1998 and the projected benefit obligation and related expenses at
December 31, 2000 were 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 by Prudential in accordance with the
service agreement described in Footnote 14.
F-18
8. INCOME TAXES
The components of income taxes for the years ended December 31, are as follows:
2000 1999 1998
---------------- ----------------- -----------------
Current tax expense (benefit):
U.S. $ 8,588 $ (14,093) $ 67,272
State and local 38 378 2,496
Foreign 35 15 -
---------------- ----------------- -----------------
Total $ 8,661 (13,700) 69,768
---------------- ----------------- -----------------
Deferred tax expense (benefit):
U.S. 43,567 42,320 14,059
State and local 2,204 1,316 406
---------------- ----------------- -----------------
Total 45,771 43,636 14,465
---------------- ----------------- -----------------
Total income tax expense $ 54,432 $ 29,936 $ 84,233
================ ================= =================
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:
2000 1999 1998
---------------- ----------------- -----------------
(In Thousands)
Expected federal income tax expense $ 55,275 $ 29,936 $ 82,668
State and local income taxes 1,457 1,101 1,886
Dividends received deduction (6,443) (1,010) (199)
Other 4,143 (91) (122)
---------------- ----------------- -----------------
Total income tax expense $ 54,432 $ 29,936 $ 84,233
================ ================= =================
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
2000 1999
---------------- -----------------
(In Thousands)
Deferred tax assets
Insurance reserves $ 102,923 $ 93,949
Net unrealized (gains)
losses on securities (2,389) 31,132
Other 15,222 2,502
---------------- -----------------
Deferred tax assets 115,756 127,583
---------------- -----------------
Deferred tax liabilities
Deferred acquisition costs 325,211 299,683
Net investment gains 19,584 110
Other 6,438 -
---------------- -----------------
Deferred tax liabilities 351,233 299,793
---------------- -----------------
Net deferred tax liability $ 235,477 $ 172,210
================ =================
F-19
8. INCOME TAXES (continued)
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, 2000
and 1999, 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 all examinations of
the consolidated federal income tax returns through 1995. The Service has begun
their examination of the 1996 year.
9. STATUTORY NET INCOME AND SURPLUS
Accounting practices used to prepare statutory financial statements for
regulatory purposes differ in certain instances from GAAP. The following tables
reconcile the Company's statutory net (loss) and surplus determined in
accordance with accounting practices prescribed or permitted by the Arizona
Department of Insurance and the New Jersey Department of Banking and Insurance,
to net income and equity determined using GAAP:
2000 1999 1998
---------------- ---------------- ----------------
(In Thousands)
Statutory net (loss) income $ (50,506) $ (82,291) $ (33,097)
Adjustments to reconcile to net income on a GAAP basis:
Statutory income of subsidiaries 21,268 20,221 18,953
Amortization and capitalization of deferred
acquisition costs 113,273 145,922 202,375
Deferred premium 1,096 639 2,625
Insurance revenue and expenses 73,978 45,915 (24,942)
Income taxes (36,766) (43,644) (21,805)
Valuation of investments (14,552) (24,908) 20,077
Asset management fees (13,662) (13,503) -
Other, net 9,367 7,244 (12,224)
---------------- ---------------- ----------------
GAAP net income $ 103,496 $ 55,595 $ 151,962
================ ================ ================
2000 1999
----------------- -----------------
(In Thousands)
Statutory surplus $ 849,567 $ 889,186
Adjustments to reconcile to equity on a GAAP basis:
Valuation of investments 71,506 (38,258)
Deferred acquisition costs 1,132,653 1,062,785
Deferred premium (15,443) (16,539)
Insurance liabilities (401) (54,927)
Income taxes (214,329) (150,957)
Asset management fees - (13,503)
Other, net 9,029 (7,968)
----------------- -----------------
GAAP stockholder's equity $ 1,832,582 $ 1,669,819
================= =================
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance ("Codification"), which replaces the current Accounting
Practices and Procedures manual as the NAIC's primary guidance on statutory
accounting as of January 1, 2001. The Codification provides guidance for areas
where statutory accounting has been silent and changes current statutory
accounting in certain areas. The Company has adopted the Codification guidance
effective January 1, 2001, and has estimated the potential effect of the
Codification guidance to have a favorable impact of at least $60 million on the
Company's surplus position, primarily as a result of the recognition of deferred
tax assets.
F-20
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values presented below have been determined using available
market information and by applying valuation methodologies. Considerable
judgment is applied in interpreting data to develop the estimates of fair value.
Estimated fair values 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).
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. Generally, 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 expected 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 repayment
patterns.
Investment contracts
For guaranteed investment contracts, estimated fair values are derived 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. For individual deferred annuities and other deposit
liabilities, fair value approximates carrying value.
Derivative financial instruments
Refer to Note 11 for the disclosure of fair values on these instruments.
The following table discloses the carrying amounts and estimated fair values of
the Company's financial instruments at December 31:
2000 1999
---------------------------------- -------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
---------------- ---------------- --------------- ---------------
(In Thousands)
Financial Assets:
Fixed maturities: Available for sale $3,561,521 $3,561,521 $2,998,362 $2,998,362
Fixed maturities: Held to maturity 324,546 $320,634 388,990 377,822
Equity securities 10,804 10,804 4,532 4,532
Mortgage loans on real estate 9,327 10,863 10,509 11,550
Policy loans 855,374 883,460 792,352 761,232
Short-term investments 202,815 202,815 84,621 84,621
Cash and cash equivalents 453,071 453,071 198,994 198,994
Separate Account assets 16,230,264 16,230,264 16,032,449 16,032,449
Financial Liabilities:
Investment contracts 1,762,794 1,784,767 $1,289,003 $ 1,283,356
Cash collateral for loaned securities 185,849 185,849 87,336 87,336
Securities sold under repurchase
agreements 104,098 104,098 21,151 21,151
Separate Account liabilities 16,230,264 16,230,264 16,032,449 16,032,449
F-21
11. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
A derivative is a financial instrument who's price, performance or cash flow is
based upon the actual or expected price, level, performance, value or cash flow
of some external benchmark, such as interest rates, foreign exchange rates,
securities, commodities, or various financial indices. Derivative financial
instruments can be exchange-traded or contracted in the over-the-counter market
and include swaps, futures, forwards and options contracts. All of the Company's
derivatives are classified as other than trading.
Interest Rate Swaps
The Company uses interest rate swaps to reduce market risk from changes in
interest rates and to manage interest rate exposures arising from mismatches
between assets and liabilities. Under interest rate swaps, the Company agrees
with other parties to exchange, at specified intervals, the difference between
fixed-rate and floating-rate interest amounts calculated by reference to an
agreed notional principal amount. Generally, no cash is exchanged at the outset
of the contract and no principal payments are made by either party. Cash is paid
or received based on the terms of the swap. These transactions are entered into
pursuant to master agreements that provide for a single net payment to be made
by one counterparty at each due date. The fair value of swap agreements is
estimated based on proprietary pricing models or market quotes.
If swap agreements meet the criteria for hedge accounting, net interest receipts
or payments are accrued and recognized over the life of the swap agreements as
an adjustment to interest income or expense of the hedged item. Any unrealized
gains or losses are not recognized until the hedged item is sold or matures.
Gains or losses on early termination of interest rate swaps are deferred and
amortized over the remaining period originally covered by the swaps. If the
criteria for hedge accounting are not met, the swap agreements are accounted for
at fair value with changes in fair value reported in current period earnings.
Futures & Options
The Company uses exchange-traded Treasury futures and options to reduce market
risk from changes in interest rates, and to manage the duration of assets and
the duration of liabilities supported by those assets. In exchange-traded
futures transactions, the Company agrees to purchase or sell a specified number
of contracts, the value of which are determined by the value of designated
classes of Treasury securities, and to post variation margin on a daily basis in
an amount equal to the difference in the daily market values of those contracts
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 based on market quotes.
Treasury futures move substantially in value as interest rates change and can be
used to either modify 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.
If futures 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
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.
F-22
Currency Derivatives
The Company uses currency swaps to reduce market risk from changes in currency
values of investments denominated in foreign currencies that the Company either
holds or intends to acquire and to manage 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 swaps are effective as hedges of foreign currency translation and
transaction exposures, gains or losses are recorded in a manner similar to the
hedged item. If currency swaps do not meet hedge accounting criteria, gains or
losses from those derivatives are recognized in "Realized investment (losses)
gains, net."
The table below summarizes the Company's outstanding positions by derivative
instrument types as of December 31, 2000 and 1999. All amounts presented have
been classified as other than trading based on management's intent at the time
of contract and throughout the life of the contract.
Other than Trading Derivatives
December 31, 2000 and 1999
(in thousands)
2000 1999
------------- -----------
Estimated Carrying Estimated Carrying
Notional Fair Value Value Notional Fair Value Value
Non-Hedge Accounting
- ---------------------------
Swap Instruments
Interest rate
Asset $ 9,470 $ 327 $ 327 $ 0 $ 0 $ 0
Liability 0 0 0 0 0 0
Future contracts
US Treasury Futures
Asset 139,800 3,530 3,530 2,300 39 39
Liability 61,900 (1,067) (1,067) 119,800 (2,017) (2,017)
Option contracts
Interest rate
Asset 0 0 0 0 0 0
Liability 0 0 0 235 (5) (5)
Hedge Accounting
- ---------------------------
Swap Instruments
Currency
Asset 28,326 1,633 2,155 0 0 0
Liability 0 0 0 30,981 (3,220) (2,990)
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. All of the
net credit exposure for the Company from derivative contracts are with
investment grade counterparties. As of December 31, 2000, 88% of notional
consisted of interest rate derivatives, and 12% of notional consisted of foreign
currency derivatives.
F-23
12. CONTINGENCIES AND LITIGATION
Prudential and the Company are subject to legal and regulatory actions in the
ordinary course of their businesses, including class actions. Pending legal and
regulatory actions include proceedings relating to aspects of the businesses and
operations that are specific to the Company and Prudential and that are typical
of the businesses in which the Company and Prudential operate. Some of these
proceedings have been brought on behalf of various alleged classes of
complainants. In certain of these matters, the plaintiffs are seeking large
and/or indeterminate amounts, including punitive or exemplary damages.
Beginning in 1995, regulatory authorities and customers brought significant
regulatory actions and civil litigation against the Company and Prudential
involving individual life insurance sales practices. In 1996, Prudential, on
behalf of itself and many of its life insurance subsidiaries including the
Company entered into settlement agreements with relevant insurance regulatory
authorities and plaintiffs in the principal life insurance sales practices class
action lawsuit covering policyholders of individual permanent life insurance
policies issued in the United States from 1982 to 1995. Pursuant to the
settlements, the companies agreed to various changes to their sales and business
practices controls, to a series of fines, and to provide specific forms of
relief to eligible class members. Virtually all claims by class members filed in
connection with the settlements have been resolved and virtually all aspects of
the remediation program have been satisfied. While the approval of the class
action settlement is now final, Prudential and the Company remain subject to
oversight and review by insurance regulators and other regulatory authorities
with respect to its sales practices and the conduct of the remediation program.
The U.S. District Court has also retained jurisdiction as to all matters
relating to the administration, consummation, enforcement and interpretation of
the settlements.
As of December 31, 2000, Prudential and/or the Company remained a party to
approximately 61 individual sales practices actions filed by policyholders who
"opted out" of the class action settlement relating to permanent life insurance
policies issued in the United States between 1982 and 1995. In addition, there
were 48 sales practices actions pending that were filed by policyholders who
were members of the class and who failed to "opt out" of the class action
settlement. Prudential and the Company believed that those actions are governed
by the class settlement release and expects them to enjoined and/or dismissed.
Additional suits may be filed by class members who "opted out" of the class
settlements or who failed to "opt out" but nevertheless seek to proceed against
Prudential and/or the Company. A number of the plaintiffs in these cases seek
large and/or indeterminate amount, including punitive or exemplary damages. Some
of these actions are brought on behalf of multiple plaintiffs. It is possible
that substantial punitive damages might be awarded in any of these actions and
particularly in an action involving multiple plaintiffs.
Prudential has indemnified the Company for any liabilities incurred in
connection with sales practices litigation covering policyholders of individual
permanent life insurance policies issued in the United States from 1982 to 1995.
The balance of the Company's litigation is subject to many uncertainties, and
given the complexity and scope, the outcomes cannot be predicted. It is possible
that the results of operations or the cash flow of the Company in a particular
quarterly or annual period could be materially effected by an ultimate
unfavorable resolution of pending litigation and regulatory matters. Management
believes, however, that the ultimate outcome of all pending litigation and
regulatory matters, should not have a material adverse effect on the Company's
financial position.
13. 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, 2000, the
Company would not be permitted a non-extraordinary dividend distribution in
2001.
14. RELATED PARTY TRANSACTIONS
The Company has extensive transactions and relationships with Prudential and
other affiliates. It is possible that the terms of these transactions are not
the same as those that would result from transactions among wholly unrelated
parties.
Expense Charges and Allocations
All of the Company's expenses are allocations or charges from Prudential or
other affiliates. These expenses can be grouped into the following categories:
general and administrative expenses, retail distribution expenses and asset
management fees.
F-24
The Company's general and administrative expenses are charged to the Company
using allocation methodologies based on business processes. Management believes
that the methodology is reasonable and reflects costs incurred by Prudential to
process transactions on behalf of the Company. Prudential and the Company
operate under service and lease agreements whereby services of officers and
employees (except for those agents employed directly by the Company in Taiwan),
supplies, use of equipment and office space are provided by Prudential.
The Company is allocated estimated distribution expenses from Prudential's
retail agency network for both its domestic life and annuity products. The
Company has capitalized the majority of these distribution expenses as deferred
policy acquisition costs. Beginning April 1, 2000, Prudential and the Company
agreed to revise the estimate of allocated distribution expenses to reflect a
market based pricing arrangement.
In accordance with a profit sharing agreement with Prudential, the Company
receives fee income from policyholder account balances invested in the
Prudential Series Funds ("PSF"). These revenues are recorded as "Asset
management fees" in the Consolidated Statements of Operations and Comprehensive
Income. The Company also collects these fees on behalf of Prudential and records
a Payable to affiliate in the Consolidated Statements of Financial Position. The
Company is charged an asset management fee by Prudential Global Asset Management
("PGAM") and Jennison Associates LLC ("Jennison") for managing the PSF
portfolio. These fees are a component of "general, administrative and other
expenses."
On September 29, 2000, the Board of Directors for the Prudential Series Fund,
Inc. ("PSFI") adopted resolutions to terminate the existing management agreement
between PSFI and Prudential, and has appointed another subsidiary of Prudential
as the fund manager for the PSF. The change was approved by the shareholders of
PSF during early 2001 and effective January 1, 2000, the Company will no longer
receive fees associated with the PSF. In addition, the Company will no longer
incur the asset management expense from PGAM and Jennison associated with the
PSF.
Corporate Owned Life Insurance
The Company has sold three Corporate Owned Life Insurance ("COLI") policies to
Prudential. The cash surrender value included in Separate Accounts was $685.9
million and $725.3 million at December 31, 2000 and December 31, 1999,
respectively. The fees received related to the COLI policies were $9.6 million
for the year ending December 31, 2000.
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 periods ended December 31, 2000,
December 31, 1999, and December 31, 1998.
Debt Agreements
In July 1998, the Company established a revolving line of credit facility of up
to $500 million with Prudential Funding LLC, a wholly owned subsidiary of
Prudential. There is no outstanding debt relating to this credit facility as of
December 31, 2000 or December 31, 1999.
15. Subsequent Events - Transfer of Taiwan Business
On January 31, 2001, the Company transferred all of its assets, liabilities, and
net equity associated with The Company's Taiwan branch including Taiwan's
insurance book of business, to an affiliated company, Prudential Life Insurance
Company of Taiwan Inc. ("Prudential of Taiwan"), a Taiwan, Republic of China
wholly owned subsidiary of Prudential .
The mechanism used to transfer this block of business in Taiwan is referred to
as a "full acquisition and assumption" transaction. Under this mechanism, the
Company is jointly liable with Prudential of Taiwan for two years from the
giving of notice to all obligees for all matured obligations and for two years
after the maturity date of not-yet-matured obligations. Prudential of Taiwan is
also contractually liable, under indemnification provisions of the transaction,
for any liabilities that may be asserted against the Company. The transfer of
the insurance related assets and liabilities will be accounted for as a
long-duration coinsurance transaction under generally accepted accounting
principles. Under this accounting treatment, the insurance related liabilities
will remain on the books of the Company and an offsetting reinsurance
recoverable will be established.
The net equity transfer will be reflected as a capital contribution from the
Company to Prudential of Taiwan and will also be dividended by the Company to
Prudential. The dividend is expected to occur in the second quarter of 2001.
F-25