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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
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
- ------------------------------ ---------------------------------
(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 May 11, 2001. Common stock, par value of $10 per share:
250,000 shares outstanding
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PRUCO LIFE INSURANCE COMPANY
INDEX TO FINANCIAL STATEMENTS
Page No.
Cover Page -
Index 2
PART I - Financial Information
Item 1. (Unaudited) Financial Statements
Consolidated Statements of Financial Position
As of March 31, 2001 and December 31, 2000 3
Consolidated Statements of Operations and Comprehensive Income
Three months ended March 31, 2001 and 2000 4
Consolidated Statements of Changes in Stockholder's Equity
Periods ended March 31, 2001 and December 31, 2000 and 1999 5
Consolidated Statements of Cash Flows
Three months ended March 31, 2001 and 2000 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
PART II - Other Information
Item 2. Changes in Securities and Use of Proceeds 16
Item 6. Exhibits and Reports on Form 8-K 17
Signature Page 18
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Financial Position
As of March 31, 2001 and December 31, 2000 (In Thousands)
- --------------------------------------------------------------------------------
(Unaudited)
March 31, December 31,
2001 2000
-----------------------------------
ASSETS
Fixed maturities
Available for sale, at fair value (amortized cost,
2001: $3,854,661; 2000: $3,552,244) $ 3,907,070 $ 3,561,521
Held to maturity, at amortized cost (fair value, 2000: $320,634) - 324,546
Equity securities - available for sale, at fair value
(cost, 2001: $241 ; 2000: $13,446) 362 10,804
Investment in affiliate 51,071 -
Mortgage loans on real estate 9,071 9,327
Policy loans 846,549 855,374
Short-term investments 22,387 202,815
Other long-term investments 91,780 83,738
-----------------------------------
Total investments 4,928,290 5,048,125
Cash and cash equivalents 524,354 453,071
Deferred policy acquisition costs 1,064,979 1,132,653
Deferred ceding commissions 72,705 -
Accrued investment income 79,006 82,297
Reinsurance recoverable 186,772 31,568
Receivables from affiliates 46,274 51,586
Other assets 34,139 29,445
Separate Account assets 14,861,519 16,230,264
-----------------------------------
TOTAL ASSETS $ 21,798,038 $ 23,059,009
===================================
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities
Policyholders' account balances $ 3,736,621 $ 3,646,668
Future policy benefits and other policyholder liabilities 717,073 702,862
Cash collateral for loaned securities 225,014 185,849
Securities sold under agreement to repurchase 25,172 104,098
Income taxes payable 246,581 235,795
Other liabilities 104,907 120,891
Separate Account liabilities 14,861,519 16,230,264
-----------------------------------
Total liabilities 19,916,887 21,226,427
-----------------------------------
Contingencies (See Footnote 2)
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 466,748 466,748
Retained earnings 1,390,563 1,361,924
Accumulated other comprehensive income
Net unrealized investment gains 21,340 4,730
Foreign currency translation adjustments - (3,320)
-----------------------------------
Accumulated other comprehensive income 21,340 1,410
-----------------------------------
Total stockholder's equity 1,881,151 1,832,582
-----------------------------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 21,798,038 $ 23,059,009
===================================
See Notes to Consolidated Financial Statements
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income (Unaudited)
Three Months Ended March 31, 2001 and 2000 (In Thousands)
- --------------------------------------------------------------------------------
Three months ended
March 31,
2001 2000
---------------- -----------------
REVENUES
Premiums $ 23,418 $ 27,251
Policy charges and fee income 119,104 114,881
Net investment income 90,310 84,474
Realized investment gains(losses), net 10,877 (10,311)
Asset management fees 2,153 16,521
Other income 670 203
---------------- -----------------
Total revenues 246,532 233,019
---------------- -----------------
BENEFITS AND EXPENSES
Policyholders' benefits 56,905 62,332
Interest credited to policyholders' account balances 48,808 38,163
General, administrative and other expenses 103,539 111,859
---------------- -----------------
Total benefits and expenses 209,252 212,354
---------------- -----------------
Income from operations before income taxes 37,280 20,665
---------------- -----------------
Income tax provision 8,641 7,232
---------------- -----------------
NET INCOME 28,639 13,433
---------------- -----------------
Other comprehensive income, net of tax:
Unrealized gains on securities, net of
Reclassification adjustment 16,610 6,489
Foreign currency translation adjustments 3,320 34
---------------- -----------------
Other comprehensive income 19,930 6,523
---------------- -----------------
TOTAL COMPREHENSIVE INCOME $ 48,569 $ 19,956
================ =================
See Notes to Consolidated Financial Statements
4
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Changes in Stockholder's Equity (Unaudited)
Periods Ended March 31, 2001 and December 31, 2000 and 1999 (In Thousands)
- --------------------------------------------------------------------------------
Accumulated
other Total
Common Paid-in- Retained comprehensive stockholder's
stock capital earnings income (loss) equity
------- --------- ----------- ------------- -------------
Balance, January 1, 1999 $ 2,500 $ 439,582 $ 1,202,833 $ 8,317 $ 1,653,232
Net income - - 55,595 - 55,595
Change in foreign currency
translation adjustments,
net of taxes - - - (742) (742)
Change in net unrealized
investment losses, net of
reclassification adjustment
and taxes - - - (38,266) (38,266)
------- --------- ----------- ---------- -----------
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,
net of taxes - - - (993) (993)
Change in net unrealized
investment losses, net of
reclassification
adjustment and taxes - - - 33,094 33,094
------- --------- ----------- ---------- -----------
Balance, December 31, 2000 $ 2,500 $ 466,748 $1,361,924 $ 1,410 $ 1,832,582
Net income - - 28,639 - 28,639
Change in foreign currency
translation adjustments,
net of taxes - - - 3,320 3,320
Change in net unrealized
investment gains, net of
reclassification adjustment
and taxes - - - 16,610 16,610
------- --------- ----------- ---------- -----------
Balance, March 31, 2001 $ 2,500 $ 466,748 $ 1,390,563 $ 21,340 $ 1,881,151
======= ========= =========== ========== ===========
See Notes to Consolidated Financial Statements
5
Pruco Life Insurance Company and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31, 2001 and 2000 (In Thousands)
- --------------------------------------------------------------------------------
2001 2000
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 28,639 $ 13,433
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Policy charges and fee income (19,687) (16,900)
Interest credited to policyholders' account balances 48,808 38,163
Realized investment (gains) losses, net (10,877) 10,311
Amortization and other non-cash items (28,103) 1,291
Change in:
Future policy benefits and other policyholders'
liabilities 14,211 23,746
Accrued investment income 3,291 (5,189)
Receivables from affiliates 5,312 51,262
Policy loans (13,129) (18,424)
Deferred policy acquisition costs and ceding
commissions (5,031) (25,413)
Income taxes payable 23,487 30,216
Other, net (23,270) (16,945)
----------- -----------
Cash Flows From Operating Activities 23,651 85,551
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities:
Available for sale 1,132,680 651,540
Held to maturity -- 12,189
Equity securities 204 251
Mortgage loans on real estate 256 281
Payments for the purchase of:
Fixed maturities:
Available for sale (1,209,152) (745,783)
Equity securities (106) (2,772)
Cash collateral for loaned securities, net 39,165 25,184
Securities sold under agreement to repurchase, net (78,926) 43,896
Other long-term investments (5,540) (8,710)
Short-term investments, net 180,428 (3,050)
----------- -----------
Cash Flows From(Used In) Investing Activities 59,009 (26,974)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 370,993 649,345
Withdrawals (307,878) (594,205)
Cash provided to affiliate (74,492) --
----------- -----------
Cash Flows (Used in)From Financing Activities (11,377) 55,140
----------- -----------
Net increase in Cash and cash equivalents 71,283 113,717
Cash and cash equivalents, beginning of year 453,071 198,994
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 524,354 $ 312,711
=========== ===========
See Notes to Consolidated Financial Statements
6
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The accompanying interim consolidated financial statements have been prepared
pursuant to the rules and regulations for reporting on Form 10-Q on the basis of
accounting principles generally accepted in the United States. These interim
financial statements are unaudited but reflect all adjustments which, in the
opinion of management, are necessary to provide a fair presentation of the
consolidated results of operations and financial condition of the Pruco Life
Insurance Company ("the Company"), a wholly owned subsidiary of The Prudential
Insurance Company of America ("Prudential"), for the interim periods presented.
All such adjustments are of a normal recurring nature. The results of operations
for any interim period are not necessarily indicative of results for a full
year. Certain amounts in the Company's prior year consolidated financial
statements have been reclassified to conform with the 2001 presentation. These
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto contained in the Company's Annual Report
on Form 10-K for the year ended December 31, 2000.
2. 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 March 31, 2001, 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 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.
7
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. CONTINGENCIES AND LITIGATION (continued)
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.
3. 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.
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, 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 that was in effect
through December 31, 2000, the Company received fee income from policyholder
account balances invested in the Prudential Series Funds ("PSF"). These revenues
were recorded as "Asset management fees" in the Consolidated Statements of
Operations and Comprehensive Income. The Company was 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, 2001, the Company no longer
receives 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 $ 651.2
million and $685.9 million at March 31, 2001 and December 31, 2000,
respectively. The fees received related to the COLI policies were $2.2 million
for the period ending March 31, 2001.
8
Pruco Life Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Reinsurance
The Company currently has four reinsurance agreements in place with Prudential
and affiliates. Specifically, the Company has 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. In addition there are 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 March 31, 2001 or 2000. The fourth agreement which is new for 2001
is described below.
On January 31, 2001, the Company transferred all of its assets and liabilities
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 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 was accounted for as a
long-duration coinsurance transaction under accounting principles generally
accepted in the United States. Under this accounting treatment, the insurance
related liabilities remain on the books of the Company and an offsetting
reinsurance recoverable is established.
As part of this transaction, the Company made a capital contribution to
Prudential of Taiwan in the amount of the net equity of the Company's Taiwan
branch as of the date of transfer. As of March 31, 2001, the Company retains an
ownership interest of 12% in the stock of Prudential of Taiwan. The Company
plans to dividend its interest in Prudential of Taiwan to Prudential in the
second quarter of 2001.
Premiums and benefits ceded for the period ending March 31, 2001 from the Taiwan
coinsurance agreement were $20.1 million and $2.9 million, respectively.
This transaction reduced the Company's 2001 effective tax rate due to a decrease
in the deferred tax liability which had previously been established relating to
the Taiwan branch.
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 was no outstanding debt relating to this credit facility as of
March 31, 2001 or December 31, 2000.
4. RECENT 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 has adopted disclosures about collateral and for
recognition and reclassification of collateral required under the statement for
fiscal years ending after December 15, 2000.
9
5. DERIVATIVE INSTRUMENTS
Adoption of Statement of Financial Accounting Standards (SFAS) No. 133
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", on January 1, 2001. In accordance with SFAS 133, the
Company recorded a net-of-tax cumulative adjustment to earnings to recognize at
fair value all derivatives. This adjustment 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.
Accounting for Derivatives and Hedging Activities
A derivative is a financial instrument whose 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 derivatives are recognized on the balance sheet at fair value. On the date
the derivative contract is entered into the Company designates the derivative 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, or a
foreign-currency-denominated asset, liability or forecasted transaction (foreign
currency hedge). 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 has the following types of derivative instruments:
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 recognized in current earnings or comprehensive income
depending on the hedge type as described above for qualifying fair value or cash
flow hedges. 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.
10
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
reported in current earnings or other comprehensive income depending on the
hedge type as described above for qualifying fair value or cash flow hedges.
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.
If options meet the criteria for hedge accounting, changes in their fair value
are reported in current earnings or other comprehensive income depending on the
hedge type as described above for qualifying fair value or cash flow hedges. 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.
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 current earnings or other
comprehensive income depending on the hedge type as described above for
qualifying fair value or cash flow hedges. If currency swaps do not meet hedge
accounting criteria, gains or losses from those derivatives are recognized in
"Realized investment (losses) gains, net."
11
The table below summarizes the Company's outstanding positions by derivative
instrument types as of March 31, 2001 and December 31, 2000. As of March 31,
2001 none of the Company's derivatives qualify for hedge accounting.
Derivative Instruments
(in thousands)
March 31, December 31,
2001 2000
------------- --------------
Estimated Carrying Estimated Carrying
Notional Fair Value Value Notional Fair Value Value
Non-Hedge
Accounting
- ---------------------
Swap Instruments
Interest rate $ 9,470 $ 523 $ 523 $ 9,470 $ 327 $ 327
Currency 27,440 4,750 4,750 - - -
Future contracts
US Treasury Futures 168,100 (740) (740) 201,700 2,463 2,463
Hedge Accounting
- ---------------------
Swap Instruments
Currency - - - 28,326 1,633 2,155
12
Item 2. Management's Discussion and Analysis of Financial Condition 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 had marketed 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. Beginning February 1,
2001, Taiwan's net income is not included in the Company's results of
operations.
Generally, policyholders who purchase the Company's products have the option of
investing in the Separate Accounts, segregated funds for which investment risks
are borne by the customer, or the Company's portfolio, referred to as the
General Account. The Company earns its profits through policy fees charged to
Separate Account annuity and life policyholders and through the interest spread
for the GIC and General Account annuity and life products. Policy 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.
1. Analysis of Financial Condition
From December 31, 2000 to March 31, 2001 there was a decrease of $1,261 million
in total assets from $23,059 million to $21,798 million, the majority of which
relates to a $1,369 million decrease in Separate Accounts primarily from stock
market declines, as described below. Excluding the Separate Accounts, total
assets increased by $108 million primarily due to fixed maturity appreciation
resulting from declining interest rates and from positive cash inflows. The
transfer of Pruco Taiwan assets to an affiliated company as part of the
coinsurance agreement (described in the Notes to Consolidated Financial
Statements), reduced total investments by $90 million and other assets by $20
million but is offset by the establishment of a reinsurance recoverable. The
Company also reclassified held-to-maturity securities, amounting to $324.5
million at January 1, 2001 to the available-for-sale category.
During this three-month period, liabilities also decreased by $1,309 million
from $21,226 million to $19,917 million. Corresponding with the asset change,
Separate Account liabilities decreased by $1,369 million due to net investment
losses of $1,385 million, expense disbursements of $36 million, offset slightly
by positive net sales (contributions less surrenders and withdrawals). Current
year net sales of $52 million ($398 contributions less $346
surrenders/withdrawals) are $402 million lower than the prior year first quarter
net sales of $454 ($719 contributions less $265 surrenders and withdrawals) due
primarily to the decrease in Discovery Select annuity product exchange sales due
to discontinuation of the Exchange Program on May 1, 2000. Policyholder account
balances increased by $90 million due to interest credited of $49 million and
positive cash inflows from the Pace GIC and from the Variable Universal Life
(VUL) product. Future policy benefit liabilities increased by $14 million due to
sales of term insurance, additional extended term insurance, and increases to
Taiwan premium reserves. A reduced level of securities lending activity
decreased liabilities by $40 million. Taxes payable increased by $11 million due
to first quarter current and deferred tax expense offset somewhat by the
transfer of the Taiwan branch tax liability to the Taiwan affiliate. Other
liabilities decreased by $16 million mainly due to the transfer to the Taiwan
affiliate.
13
2. Results of Operations
Net Income
Consolidated net income of $28.6 million for the first quarter of 2001 was $15.2
million higher than for the first quarter of 2000. The main driver in the rise
in net income was an increase from the prior year in realized gains of $21.2
million from the sale of fixed maturities in 2001 in a declining interest rate
environment. Somewhat offsetting this increase, was a decline in net asset
management fee revenue of $7.8 million ($14.4 million in revenues less $6.6
million of expenses) as the Company ceased receiving fee income or paying asset
management fee expenses related to the Pru Series Fund as of January 1, 2001, as
described in the Notes to Consolidated Financial Statements. In addition, as
also described in the Notes to Consolidated Financial Statements, the Company
did not receive net income from the Taiwan branch after January 31, 2001. Net
income for Taiwan for the first quarter of 2000 was $.9 million compared to a
loss of $.3 million in 2001. Variances by income statement line item are
described in the following paragraphs.
Revenues
Consolidated revenues increased by $13.5 million, from $233.0 million to $246.5
million. As discussed above, realized gains increased revenues by $21.2 million
while the absence of Pru Series Fund asset management fees reduced revenues by
$14.4 million. Policy charges and fee income, consisting primarily of mortality
and expense (M&E), loading and other insurance charges assessed on General and
Separate Account policyholder fund balances, increased by $4.2 million,
consisting of a $4.5 million increase for the domestic life business and a
decline of $.3 million for the individual annuity business. Although life
product policyholder account balances declined somewhat from December 31, 2000,
the average balance was higher in first quarter 2001 than in first quarter 2000.
Annuity fund balances are substantially lower than December 31, 2000, as
described in the "Analysis of Financial Condition", however most of the decline
happened in March 2001 therefore first quarter M&E was not fully impacted.
Premiums decreased by $3.8 million due to the transfer of the Taiwan branch as
of January 31, 2001 causing an $11.9 million decline in premiums which is offset
somewhat by higher term insurance and extended term premiums. Net investment
income increased by $5.8 million from the prior year. Income from fixed
maturites increased by $9 million as the fixed maturity investment balance grew
approximately $439 million since March 31 2000, mainly due to GIC sales.
Offsetting this was a decrease in Separate Account seed money gains.
Benefits and Expenses
Policyholder benefits decreased by $5.4 million mainly due to decreases in
reserve provisions and benefits for Taiwan of $8.0 million due to the transfer.
Domestic life had an increase in reserves of $3.8 million from term insurance
and extended term premiums, while annuity reserves decreased due to lower
premiums from annuitizations. Interest credited to policyholder account balances
increased by $10.6 million as policyholder account balances grew by $536 million
from March 2000 mainly due to the increase in GIC policyholder account balances
from sales as mentioned above. In addition, annuity fund balances increased by $
162 million which contributed to the increase in interest credited.
General, administrative, and other expenses decreased $8.3 million from the
prior year. Commission and distribution expenses after capitalization are $ 22.3
million lower due to a change in the allocation of distribution expenses to a
market based pricing arrangement as of April 1, 2000, which lowered expenses by
$11.5 million. In addition annuity distribution expenses are lower due to a
decrease in sales and fund values that drive the transfer pricing fee. Another
contributor to the decrease was the discontinuation of asset management fees
paid to PGAM for managing the Separate Account Portfolios, which amounted to
$6.6 million in 2000. Deferred acquisition cost (DAC) amortization increased by
$7.7 million due to increases in deferrable expenses as a result of sales and
increased amortization associated with a decline in expected future profits from
stock market declines. The remaining rise in expenses of $12.9 million is due to
increases in salary, consulting, and data processing costs.
3. Liquidity and Capital Resources
Principal cash flow sources are investment and fee income, investment maturities
and sales, and premiums and fund deposits. These cash inflows may be
complemented by financing activities through other Prudential affiliates.
Cash outflows consist principally of benefits, claims and amounts paid to
policyholders in connection with policy surrenders, withdrawals and net policy
loan activity. Uses of cash also include commissions, general and administrative
expenses, and purchases of investments. Liquidity requirements associated with
policyholder obligations are monitored regularly so that the Company can manage
cash inflows to match anticipated cash outflow requirements.
14
The Company believes that cash flow from operations together with proceeds from
scheduled maturities and sales of fixed maturity investments, are adequate to
satisfy liquidity requirements based on the Company's current liability
structure.
The Company had $21.8 billion of assets at March 31, 2001 compared to $23.1
billion at December 31, 2000, of which $14.9 billion and $16.2 billion were held
in Separate Accounts at March 31, 2001 and December 31, 2000, respectively,
under variable life insurance policies and variable annuity contracts. The
remaining assets consisted primarily of investments and deferred policy
acquisition costs.
4. 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 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's exposure to market risks and the way these risks are managed, are
summarized in Item 7a of the 2000 Form 10K.
15
PART II
Item 2. Changes in Securities and Use of Proceeds.
(d) Information required by Item 701(f) of Regulation S-K:
The information below pertains to modified guaranteed annuity contracts
issued by the Company in two distinct variable annuity products,
Discovery Preferred Variable Annuity and Discovery Select Variable
Annuity. However, because the modified guaranteed annuity option of
each of these products is identical, the Company has aggregated the
registration of these securities.
(1) The original effective date of the Registration Statement of
the Company for the Discovery Preferred Variable Annuity on
Form S-1 was declared effective on November 27, 1995
(Registration No. 33-61143). The Discovery Select prospectus
was added through filings under Rule 424 of the Securities Act
of 1993. The registration statement continues to be effective
through annual amendments, the most recent filed April 16,
1999 and declared effective April 30, 1999.
(2) Offering commenced immediately upon effectiveness of the
registration statement.
(3) Not applicable.
(4) (i) The offering has not been terminated.
(ii) The managing underwriter of the offering is
Prudential Investment Management Services LLC.
(iii) Market-Value Adjustment Annuity Contracts (also known
as modified guaranteed annuity contracts).
(iv) Securities registered and sold for the account of the
Company:
Amount registered*: $ 500,000,000
Aggregate price of the offering amount registered: $ 500,000,000
Amount sold*: $ 360,936,498
Aggregate offering price of amount sold to date: $ 360,936,498
* Securities not issued in predetermined units
No securities have been registered for the account of
any selling security holder.
(v) Expenses associated with the issuance of the securities:
Underwriting discounts and commissions** $ 9,784,737
Other expenses** $ 19,537,393
--------------
Total $ 29,322,130
** Amounts are estimated and are paid to affiliated parties.
(vi) Net offering proceeds: $ 331,614,368
(vii) Not applicable.
(viii) Not applicable.
16
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3(i)(a) The Articles of Incorporation of Pruco Life Insurance Company
(as amended through October 19, 1993) are incorporated by
reference to the initial Registration Statement on Form S-6 of
Pruco Life Variable Appreciable Account as filed July 2, 1996,
Registration No. 333-07451.
3(ii) By-Laws of Pruco Life Insurance Company (as amended through
May 6, 1997) are incorporated by reference to Form 10-Q as
filed by the Company on August 15, 1997.
4(a) Modified Guaranteed Annuity Contract is filed herewith
(previously filed as an exhibit to the Company's Registration
Statement on Form S-1 as filed November 2, 1990, Registration
No. 33-37587).
4(b) Market-Value Adjustment Annuity Contract is incorporated by
reference to the Company's registration statement on Form S-1,
Registration No. 333-18053, as filed November 17, 1995.
(b) Reports on Form 8K
None
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf of the
undersigned, thereunto duly authorized.
PRUCO LIFE INSURANCE COMPANY
(Registrant)
Signature Title Date
President and Director May 14, 2001
- --------------------------
Esther H. Milnes
Principal Financial Officer and May 14, 2001
- -------------------------- Chief Accounting Officer
William J. Eckert, IV
18