================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
(AMENDMENT NO. 1)
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
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
----------------------------------------------------
(Address of principal executive offices ) (Zip Code)
(973) 802-6000
----------------------------------------------------
(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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of November 11, 2004. Common stock, par
value of $10 per share: 250,000 shares outstanding
PRUCO LIFE INSURANCE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION (H) (1) (A) AND (B) ON FORM 10-Q AND IS THEREFORE FILING
THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.
================================================================================
TABLE OF CONTENTS
Page No.
--------
PART I - FINANCIAL INFORMATION
Explanatory Note 3
Item 1. (Unaudited) Financial Statements:
Consolidated Statements of Financial Position
As of September 30, 2004 and December 31, 2003 4
Consolidated Statements of Operations and Comprehensive Income
Three and nine months ended September 30, 2004 and 2003 5
Consolidated Statements of Stockholder's Equity
Periods ended September 30, 2004 and December 31, 2003 and 2002 6
Consolidated Statements of Cash Flows
nine months ended September 30, 2004 and 2003 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 4. Controls and Procedures 15
PART II - OTHER INFORMATION
Item 6. Exhibits 17
Signatures 18
FORWARD-LOOKING STATEMENTS Certain of the statements included in this Quarterly
Report on Form 10-Q/A, including but not limited to those in the Management's
Discussion and Analysis of Financial Condition and Results of Operations,
constitute forward-looking statements within the meaning of the U.S. Private
Securities Litigation Reform Act of 1995. Words such as "expects," "believes,"
"anticipates," "includes," "plans," "assumes," "estimates," "projects,"
"intends" or variations of such words are generally part of forward-looking
statements. Forward-looking statements are made based on management's current
expectations and beliefs concerning future developments and their potential
effects upon Pruco Life Insurance Company ("the Company"). There can be no
assurance that future developments affecting the Company will be those
anticipated by management. These forward-looking statements are not a guarantee
of future performance and involve risks and uncertainties, and there are certain
important factors that could cause actual results to differ, possibly
materially, from expectations or estimates reflected in such forward-looking
statements, including without limitation: general economic, market and political
conditions, including the performance of financial markets and interest rate
fluctuations; various domestic or international military or terrorist activities
or conflicts; volatility in the securities markets; re-estimates of our reserves
for future policy benefits and claims; changes in our assumptions related to
deferred policy acquisition costs; our exposure to contingent liabilities;
catastrophe losses; investment losses and defaults; changes in our claims-paying
or credit ratings; competition in our product lines and for personnel;
fluctuations in foreign currency exchange rates and foreign securities markets;
risks to our international operations; the impact of changing regulation or
accounting practices; adverse litigation results; and changes in tax law. The
Company is under no obligation to update any particular forward-looking
statement included in this Quarterly Report on Form 10-Q.
2
EXPLANATORY NOTE
During a review and inventory in the fourth quarter of 2004 of the deferred tax
balances of Pruco Life Insurance Company (the "Company") the Company identified
an error in the determination of state tax expense for the three months ended
June 30, 2004. This error resulted in an understatement of income tax expense,
and overstatement of net income, in the amount of $7.4 million for the three and
six months ended June 30, 2004 and the nine months ended September 30, 2004.
Accordingly, the Company is filing this Amendment No. 1 to its Quarterly Report
on Form 10-Q for the quarter ended September 30, 2004 to (1) restate the
unaudited interim financial statements of the Company for the nine months ended
September 30, 2004 contained in Part I, Item 1, (2) amend Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in Part I, Item 2, to reflect such restatement, and (3) amend the
disclosures under Controls and Procedures in Part I, Item 4, to provide
additional information with respect to the error and the status of the Company's
disclosure controls and procedures and internal control over financial
reporting. This Amendment No. 1 also includes as Exhibits certificates of the
Company's Chief Executive Officer and Chief Financial Officer required by
Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 (Items 601(b)(31) and
601(b)(32) of Regulation S-K).
The Company's original Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004 has not been updated except as required to reflect the
effects of the restatement. Except as identified above, no other items included
in the original Form 10-Q have been amended, and such items remain in effect as
of the filing date of the original Form 10-Q. This Amendment No. 1 does not
purport to provide an update or a discussion of any other developments at the
Company subsequent to the filing date of the original Form 10-Q.
See Note 2 to the unaudited interim financial statements included in this
Amendment No. 1 for additional information.
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003 (IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- -------------
(RESTATED)
ASSETS
Fixed maturities available for sale,
at fair value (amortized cost, 2004:
$6,083,488; 2003: $5,682,043) $ 6,379,266 $ 5,953,815
Policy loans 852,305 848,593
Short-term investments 120,961 160,635
Other long-term investments 31,093 89,478
------------- -------------
Total investments 7,383,625 7,052,521
Cash and cash equivalents 462,066 253,564
Deferred policy acquisition costs 1,356,699 1,380,710
Accrued investment income 108,323 96,790
Reinsurance recoverable 674,081 517,410
Receivables from Parent and affiliates 67,170 53,138
Deferred sales inducements and other assets 133,182 88,736
Separate account assets 16,092,475 15,772,262
------------- -------------
TOTAL ASSETS $ 26,277,621 $ 25,215,131
============= =============
LIABILITIES AND STOCKHOLDER'S EQUITY
LIABILITIES
Policyholders' account balances $ 6,073,222 $ 5,582,633
Future policy benefits and other policyholder liabilities 1,238,308 1,068,977
Cash collateral for loaned securities 331,529 431,571
Securities sold under agreement to repurchase 93,507 97,102
Income taxes payable 407,282 335,665
Other liabilities 192,155 111,865
Separate account liabilities 16,092,475 15,772,262
------------- -------------
TOTAL LIABILITIES 24,428,478 23,400,075
------------- -------------
CONTINGENCIES (SEE FOOTNOTE 3)
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 454,343 459,654
Deferred compensation (1,474) (850)
Retained earnings 1,316,115 1,246,065
Accumulated other comprehensive income 77,659 107,687
------------- -------------
TOTAL STOCKHOLDER'S EQUITY 1,849,143 1,815,056
------------- -------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 26,277,621 $ 25,215,131
============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
(RESTATED)
REVENUES
Premiums $ 13,588 $ 38,410 $ 70,202 $ 121,108
Policy charges and fee income 163,350 144,088 477,393 420,100
Net investment income 94,227 86,302 279,607 255,050
Realized investment gains (losses), net (1,654) 1,093 (1,268) (3,159)
Asset management fees 3,996 3,425 11,611 9,677
Other income 5,964 1,883 22,931 5,775
---------- ---------- ---------- ----------
TOTAL REVENUES 279,471 275,201 860,476 808,551
---------- ---------- ---------- ----------
BENEFITS AND EXPENSES
Policyholders' benefits 60,067 75,019 201,630 245,943
Interest credited to policyholders'
account balances 63,554 58,555 188,488 166,644
General, administrative and other
expenses 125,602 112,629 379,260 315,532
---------- ---------- ---------- ----------
TOTAL BENEFITS AND EXPENSES 249,223 246,203 769,378 728,119
---------- ---------- ---------- ----------
Income from operations before income
taxes and cumulative effect of change in
accounting principle 30,248 28,998 91,098 80,432
Income tax expense 1,259 9,827 11,898 20,744
---------- ---------- ---------- ----------
NET INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE 28,989 19,171 79,200 59,688
Cumulative effect of change in
accounting principle, net of tax - - (9,150) -
---------- ---------- ---------- ----------
NET INCOME 28,989 19,171 70,050 59,688
---------- ---------- ---------- ----------
Change in net unrealized investment
gains, net of taxes 30,393 (14,788) (34,057) 24,843
Cumulative effect of accounting change,
net of taxes - - 4,030 -
---------- ---------- ---------- ----------
Other comprehensive income (loss), net
of tax 30,393 (14,788) (30,027) 24,843
---------- ---------- ---------- ----------
TOTAL COMPREHENSIVE INCOME $ 59,382 $ 4,383 $ 40,023 $ 84,531
========== ========== ========== ==========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (UNAUDITED)
PERIODS ENDED SEPTEMBER 30, 2004 AND DECEMBER 31, 2003 AND 2002 (IN THOUSANDS)
ACCUMULATED
OTHER TOTAL
COMMON PAID-IN- RETAINED DEFERRED COMPREHENSIVE STOCKHOLDER'S
STOCK CAPITAL EARNINGS COMPENSATION INCOME (LOSS) EQUITY
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, JANUARY 1, 2002 $ 2,500 $ 466,748 $ 1,147,665 $ - $ 34,566 $ 1,651,479
Net income - - 13,498 - - 13,498
Adjustments to policy credits
issued to eligible policyholders - - (27) - - (27)
Change in foreign currency
translation adjustments, net of
taxes - - - - 149 149
Change in net unrealized investment
gains, net of taxes - - - - 57,036 57,036
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 2,500 466,748 1,161,136 - 91,571 1,722,135
Net income - - 84,933 - - 84,933
Adjustments to policy credits
issued to eligible policyholders - - (4) - - (4)
Purchase of fixed maturities from
an affiliate, net of taxes - (7,557) - - 7,557 -
Stock-based compensation programs - 463 - (850) - (387)
Change in net unrealized investment
gains, net of taxes - - - - 8,379 8,379
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2003 2,500 459,654 1,246,065 (850) 107,687 1,815,056
Net income (restated) - - 70,050 - - 70,050
Purchase of Fixed Maturities from
an affiliate, net of taxes (5,744) 5,744 -
Stock-based compensation programs - 433 - (624) - (191)
Cumulative effect of change in
accounting principle, net of taxes - - - - 4,030 4,030
Change in net unrealized investment
gains, net of taxes - - - - (39,802) (39,802)
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, SEPTEMBER 30, 2004 $ 2,500 $ 454,343 $ 1,316,115 $ (1,474) $ 77,659 $ 1,849,143
============= ============= ============= ============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
6
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (IN THOUSANDS)
2004 2003
------------ ------------
(RESTATED)
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income $ 70,050 $ 59,688
Adjustments to reconcile net income to net cash from
(used in) operating activities:
Policy charges and fee income (101,421) (78,453)
Interest credited to policyholders' account balances 188,487 166,644
Realized investment (gains) losses, net 1,268 3,159
Amortization and other non-cash items 46,051 819
Cumulative effect of accounting change 9,150 -
Change in:
Future policy benefits and other policyholders' 124,593 93,482
liabilities
Reinsurance recoverable (156,671) (70,122)
Accrued investment income (5,253) (13,444)
Receivables from Parent and affiliates (14,032) 10,836
Policy loans (3,712) 27,684
Deferred policy acquisition costs 47,115 (126,869)
Income taxes payable/receivable 76,763 95,114
Deferred sales inducements and other assets (44,449) (46,154)
Other, net 77,483 11,312
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES 315,422 133,696
------------ ------------
CASH FLOWS (USED IN) FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities available for sale 1,316,701 1,865,707
Payments for the purchase of:
Fixed maturities available for sale (1,399,196) (2,579,066)
Cash collateral for loaned securities, net (100,042) 86,474
Securities sold under agreement to repurchase, net (3,595) (185,659)
Other long-term investments, net 33,657 (7,713)
Short-term investments, net 47,946 33,423
------------ ------------
CASH FLOWS USED IN INVESTING ACTIVITIES (104,529) (786,834)
------------ ------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 1,626,314 1,573,209
Withdrawals (1,622,961) (1,114,700)
Cash payments to eligible policyholders - (4)
Paid in capital transaction associated with the purchase
of fixed maturities from an affiliate (5,744) -
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES (2,391) 458,505
------------ ------------
Net increase (decrease) in cash and cash equivalents 208,502 (194,633)
Cash and cash equivalents, beginning of year 253,564 436,182
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD 462,066 $ 241,549
============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
7
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The unaudited interim consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
("GAAP") on a basis consistent with reporting interim financial information in
accordance with instructions to Form 10-Q and Article 10 of Regulation S-X of
the Securities and Exchange Commission. These interim financial statements are
unaudited but reflect all adjustments that, 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") for the interim periods presented. The Company is a wholly owned
subsidiary of The Prudential Insurance Company of America ("Prudential
Insurance"), which in turn is a wholly owned subsidiary of Prudential Financial,
Inc. ("Prudential Financial"). 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 current year presentation.
The Company has extensive transactions and relationships with Prudential
Insurance 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. 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, 2003.
2. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
The Company has restated its previously issued unaudited interim financial
statements for the nine months ended September 30, 2004. During a review and
inventory of its deferred tax balances in the fourth quarter of 2004, the
Company identified an error in the determination of its state income tax expense
for the nine months ended September 30, 2004. The error related to the treatment
of net operating loss carryforwards for state income tax purposes.
The impact of the restatement on the financial statements for the nine months
ended September 30, 2004 is shown below:
Consolidated Statement of Operations and Comprehensive Income:
CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
NINE MONTHS ENDED
SEPTEMBER 30, 2004
-------------------------
PREVIOUSLY
REPORTED RESTATED
----------- -----------
Income from operations before income taxes
and cumulative effect of change in
accounting principle $ 91,098 $ 91,098
Income tax expense 4,498 11,898
----------- -----------
Net income before cumulative effect of change
in accounting principle 86,600 79,200
----------- -----------
Net Income $ 77,450 $ 70,050
----------- -----------
CONSOLIDATED STATEMENT OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30, 2004
-------------------------
PREVIOUSLY
REPORTED RESTATED
----------- -----------
Net Income $ 77,450 $ 70,050
Income taxes payable / receivable 69,363 76,763
----------- -----------
Cash flows from operating activities 315,422 315,422
----------- -----------
8
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
SEPTEMBER 30, 2004
-----------------------------
PREVIOUSLY
REPORTED RESTATED
------------- -------------
Income taxes payable $ 399,882 $ 407,282
Retained earnings 1,323,515 1,316,115
Total liabilities and stockholder's equity 26,277,621 26,277,621
3. CONTINGENCIES AND LITIGATION
CONTINGENCIES
On an ongoing basis, our internal supervisory and control functions review the
quality of our sales, marketing and other customer interface procedures and
practices and may recommend modifications or enhancements. In certain cases, if
appropriate, we may offer customers remediation and may incur charges, including
the cost of such remediation, administrative costs and regulatory fines.
Prudential Insurance and its affiliates have received formal requests for
information relating to their variable annuity business from regulators and
governmental authorities. The regulators and authorities include, among others,
the Securities and Exchange Commission, the NASD and the State of New York
Attorney General's Office. Prudential Insurance and its affiliates are
cooperating with all such inquiries and are conducting their own internal
review.
It is possible that the results of operations or the cash flow of the Company in
a particular quarterly or annual period could be materially affected as a result
of payments in connection with the matters discussed above, depending, in part,
upon the results of operations or cash flow for such period. Management
believes, however, that the ultimate payments in connection with these matters
should not have a material adverse effect on the Company's financial position.
LITIGATION
The Company is subject to legal and regulatory actions in the ordinary course of
its businesses, including class actions. Pending legal and regulatory actions
include proceedings relating to aspects of the businesses and operations that
are specific to the Company and that are typical of the businesses in which the
Company operates. Class action and individual lawsuits involve a variety of
issues and/or allegations, which include sales practices, underwriting
practices, claims payment and procedures, premium charges, policy servicing and
breach of fiduciary duties to customers. We are also subject to litigation
arising out of our general business activities, such as our investments and
third party contracts. In certain of these matters, the plaintiffs are seeking
large and/or indeterminate amounts, including punitive or exemplary damages.
The Company's litigation is subject to many uncertainties, and given the
complexity and scope, the outcomes cannot be predicted. It is possible that the
results of operations or the cash flow of the Company in a particular quarterly
or annual period could be materially affected by an ultimate unfavorable
resolution of pending litigation and regulatory matters. Management believes,
however, that the ultimate outcome of all pending litigation and regulatory
matters should not have a material adverse effect on the Company's financial
position.
9
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4. ADOPTION OF STATEMENT OF POSITION 03-1
In July 2003, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants ("AICPA") issued Statement of
Position ("SOP") 03-1, "Accounting and Reporting by Insurance Enterprises for
Certain Nontraditional Long-Duration Contracts and for Separate Accounts". AcSEC
issued the SOP to address the need for interpretive guidance to be developed in
three areas: separate account presentation and valuation; the accounting
recognition given sales inducements (bonus interest, bonus credits, persistency
bonuses); and the classification and valuation of certain long-duration contract
liabilities.
The Company adopted the SOP effective January 1, 2004. The effect of initially
adopting SOP 03-1 was a net of tax charge of $9.1 million, reported as a
cumulative effect of accounting change in the results of operations for nine
months ended September 30, 2004. This charge reflects primarily the net impact
of converting certain individual market value adjusted annuity contracts from
separate account accounting treatment to general account accounting treatment
and the effect of establishing reserves for guaranteed minimum death benefit
("GMDB") provisions of the Company's variable annuity contracts. In addition,
the Company recorded an increase in other comprehensive income of $4.0 million
after tax related to recording the cumulative unrealized investment gains, net
of shadow deferred acquisition costs ("DAC"), on fixed maturities reclassified
from the separate account to the general account as of January 1, 2004.
In June 2004, the FASB issued FASB Staff Position ("FSP") 97-1, "Situations in
Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting
by Insurance Enterprises for Certain Long-Duration Contracts and for Realized
Gains and Losses from the Sale of Investments, Permit or Require an Accrual of
an Unearned Revenue Liability." FSP 97-1 clarifies the accounting for unearned
revenue liabilities of certain universal-life contracts under SOP 03-1. The
Company's adoption of FSP 97-1 on July 1, 2004 did not change the accounting for
unearned revenue liabilities and, therefore, had no impact on the Company's
results of operations.
On the Statement of Cash Flows, the cumulative effect of the SOP is shown on one
line rather than on the individual asset and liability lines that were affected.
The major components of this line are increases in fixed maturities of $403
million and policyholder account balances of $387 million related to the
reclassifications of annuity contracts from the separate account to the general
account. In addition, the establishment of the GMDB reserves of approximately
$45 million and the increase in DAC of $23 million are also shown on this line.
Other balance sheet accounts that were affected include other long-term
investments and deferred taxes payable.
5. RELATED PARTY TRANSACTIONS
CORPORATE OWNED LIFE INSURANCE
Prudential Insurance owns Corporate Owned Life Insurance Policies issued by the
Company. The cash surrender value of these policies included in separate
accounts was $1.1 billion at September 30, 2004.
PURCHASE OF FIXED MATURITIES FROM AN AFFILIATE
In May of 2004, the Company invested $110 million in certain fixed maturities
owned by Prudential Insurance.
The Company purchased fixed maturity investments for $110 million, the fair
market value plus accrued interest at the acquisition date, but reflected the
investments at historical amortized cost of $99 million. The difference between
the historical amortized cost and the fair value, net of taxes, was reflected as
a reduction to paid in capital. The fixed maturity investments are categorized
in the Company's consolidated balance sheet as available for sale debt
securities, and are therefore carried at fair value, with the difference between
amortized cost and fair value reflected in accumulated other comprehensive
income. Gains and losses will be realized upon disposition of the investment to
an entity not under common control.
10
REINSURANCE WITH AFFILIATES
During the quarter ended September 2004, the Company entered into an agreement
to reinsure its term life insurance policies known as Term Elite and Term
Essential ("Term") with an affiliated company, Prudential Arizona Reinsurance
Captive Company ("PARCC"). The Company will reinsure with PARCC ("the
reinsurer") 90 percent of the risks under such policies through an automatic and
facultative coinsurance agreement ("Agreement"). The Company is not relieved of
its primary obligation to the policyholder as a result of these reinsurance
transactions.
Concurrent with implementing the new Agreement, the Company recaptured the Term
reinsurance previously reinsured under a coinsurance treaty with an affiliated
offshore captive company, Pruco Re Ltd. The agreement had covered all term
policies written on or after October 1, 2002. As a result of this recapture, the
Company recognized a net gain of $1.2 million.
The new coinsurance agreement with PARCC also replaces the yearly renewable term
agreements with external reinsurers that were previously in effect on this block
of business. However, similar yearly renewable term agreements on this block of
business have been placed with external reinsurers, through affiliated
companies. There was no net cost associated with the initial transaction and
initial transactions were accounted for in accordance with FAS 113, "Accounting
and Reporting for Reinsurance of Short and Long Duration Contracts". Reinsurance
recoverables related to this transaction were $178.5 million as of September 30,
2004.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PRUCO LIFE INSURANCE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(A) AND (B) ON FORM 10-Q AND IS THEREFOREFILING THIS FORM WITH
THE REDUCED DISCLOSURE FORMAT.
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the consolidated financial condition of Pruco Life
Insurance Company as of September 30, 2004, compared with December 31, 2003, and
its consolidated results of operations for the three and nine month periods
ended September 30, 2004 and September 30, 2003. Comparisons discussed in this
MD&A reflect the effects of the restatements described in footnote 2 of the
unaudited financial statements above. You should read the following analysis of
our consolidated financial condition and results of operations in conjunction
with the Company's MD&A and audited Consolidated Financial statements included
in the Company's Annual Report on Form 10-K for the year ended December 31,
2003, and Consolidated Financial Statements (unaudited) included elsewhere in
this Quarterly Report on Form 10-Q.
The Company sells interest-sensitive individual life insurance, variable life
insurance, term life insurance, individual variable annuities, and a
non-participating guaranteed interest contract ("GIC") called Prudential Credit
Enhanced GIC ("PACE"), primarily through Prudential Insurance's sales force in
the United States. These markets are subject to regulatory oversight with
particular emphasis placed on company solvency and sales practices. These
markets are also subject to increasing competitive pressure as the legal
barriers, which have historically segregated the markets of the financial
services industry, have been changed through both legislative and judicial
processes. Regulatory changes have opened the insurance industry to competition
from other financial institutions, particularly banks and mutual funds that are
positioned to deliver competing investment products through large, stable
distribution channels. The Company also had marketed individual life insurance
through its branch office in Taiwan. The Taiwan branch was transferred to an
affiliated Company on January 31, 2001. Beginning February 1, 2001, all
insurance activity of the Taiwan branch has been ceded to the affiliated
Company. The Company had also marketed a non-participating guaranteed interest
contract ("GIC") called Prudential Credit Enhanced GIC ("PACE") under an
agreement with MBIA (the Insurance and Reimbursement Agreement) that expired
June 30,2004. The Company did not seek an extension of the agreement. The
termination of sales of this product has no impact on the existing in force
contracts of PACE GIC customers.
Generally, policyholders who purchase the Company's products have the option of
investing in the separate accounts, segregated funds for which investment risks
are borne by the customer, or the Company's portfolio, referred to as the
"general account". The Company earns its profits through policy fees charged to
separate account annuity and life policyholders and through the interest spread
for the GIC and general account annuity and life products. Policy charges and
fee income consist mainly of three types, sales charges or loading fees on new
sales, mortality and expense charges ("M&E") assessed on fund balances, and
mortality and related charges based on total life insurance in-force business.
Policyholder fund values are affected by net sales (sales less withdrawals),
changes in interest rates and investment returns. The interest spread represents
the difference between the investment income earned by the Company on its
investment portfolio and the amount of interest credited to policyholders'
accounts. Products that generate interest spread primarily include the GIC
product, general account life insurance products, fixed annuities and the
fixed-rate option of variable annuities.
In addition to policy charges and fee income, the Company earns revenues from
insurance premiums from term life insurance and asset management fees on the
separate account fund balances. The Company's operating expenses principally
consist of insurance benefits provided, general business expenses, commissions
and other costs of selling and servicing the various products we sell and
interest credited on general account liabilities.
The Company's Changes in Financial Position and Results of Operations are
described below.
1. ANALYSIS OF FINANCIAL CONDITION
From December 31, 2003 to September 30, 2004 total assets increased $1.1
billion, from $25.2 billion to $26.3 billion. Fixed maturities increased by $425
million mainly as a result of the implementation of Statement of Position 03-1
("SOP 03-1"). SOP 03-1 requires among other things, that certain individual
market value adjusted annuity ("MVA") contracts be accounted for under general
account accounting treatment. As a result of the adoption, approximately $400
million of fixed maturities formerly classified as separate account assets were
reclassified as general account fixed maturities. Separate account assets
increased by $320 million despite the reclassification of approximately $400
million of assets to general account accounting treatment, due to positive
market performance of approximately $419 million and positive net sales.
Reinsurance recoverables increased $157 million as a result of larger ceded
reserves held under the new coinsurance agreement mentioned above. Deferred
acquisition costs ("DAC") decreased by $24 million from December 31, 2003 driven
by $143 million in capitalization of acquisition expenses, a $23 million DAC
increase from the implementation of SOP 03-1 and a decrease in "shadow DAC" of
$34 million. This was partially offset by
12
$156 million of amortization. Capitalization in the Life business included ceded
DAC of $134 million resulting from capitalization of initial reinsurance ceding
allowances that are part of the new coinsurance agreement mentioned above. The
$17 million of shadow DAC is shown in the amortization and other non-cash items
line on the Statements of Cash Flows.
During this nine-month period, liabilities increased by $1.0 billion, from $23.4
billion to $24.4 billion. Policyholder account balances increased by $491
million due primarily to the reclassification of MVA contracts as described
above and positive net sales. Future policy benefits increased by $169 million
due to increased Taiwan reserves and the establishment of guaranteed minimum
death benefit reserves ("GMDB") of $45 million on January 1, 2004. Corresponding
with the asset change, separate account liabilities increased by $320 million,
as described above.
2. RESULTS OF OPERATIONS
SEPTEMBER 2004 TO SEPTEMBER 2003 THREE MONTH COMPARISON
NET INCOME
Consolidated net income of $29 million for the third quarter of 2004 was $10
million higher than the third quarter of 2003. Increases in fees from higher
sales and asset based revenues in the current quarter, higher net investment
income from an increased asset base and a more favorable effective tax rate from
the impact of increased dividends received deductions. Partially offsetting the
above are increased DAC amortization, higher general and administrative expense
levels and realized capital losses. Further details regarding the components of
revenues and expenses are described in the following paragraphs.
REVENUES
Consolidated revenues increased by $4 million, from $275 million in the prior
year quarter to $279 million. Policy charges and fee income, consisting
primarily of mortality and expense, loading and other insurance charges assessed
on general and separate account policyholder fund balances, increased by $19
million. The increase was a result of a $11 million increase for individual life
products and an $8 million increase for annuity products. Policy charges for
life products increased as a result of growth in the in-force business, the
favorable impact of increases in the market value of variable life insurance
assets, and the sale of newer interest-sensitive products that generally carry
higher expense charges in the first few years of the contract. The gross
variable life in-force business grew to $75 billion at September 30, 2004 from
$69 billion at September 30, 2003 and $71 billion at December 31, 2003. Annuity
fees are mainly asset based fees which are dependent on the fund balances that
are affected by net sales as well as asset depreciation or appreciation on the
underlying investment funds in which the customer has the option to invest.
Annuity separate account fund balances are higher than in the prior year quarter
as a result of favorable market performance and positive net sales.
Net premiums decreased $25 million from the prior year quarter due to increases
reinsurance premiums resulting from the coinsurance agreement with PARCC to
reinsure the entire term business. This agreement replaced the previous
coinsurance with Pruco Re Ltd. which reinsured only certain term business of the
Company. The new agreement covers all term policies written by both the Company
and its wholly owned subsidiary, Pruco Life Insurance Company of New Jersey. All
term business not previously covered by the Pruco Re Coinsurance agreement was
reinsured with yearly renewable term reinsurance carrying lower premiums than
coinsurance. Extended term premiums increased by $1 million due to more policy
lapses. Premiums for annuity contracts with life contingencies were essentially
unchanged from the prior year quarter.
Net investment income increased by $8 million as a result of increased income
from fixed maturities due to an increase in the annuity portfolio balance from
the reclassification of fixed maturities from the separate account to the
general account, reinvestment of income, and positive cash flows. This was
partially offset by lower income from lower fund balances in retirement
business.
Other income increased by $4 million due to higher expense recovery allowances
received from the PARCC term coinsurance agreement.
BENEFITS AND EXPENSES
Total policyholder benefits, including changes in reserves, decreased by $15
million, compared to the prior year quarter, mainly due to a $16.0 million net
decrease in life reserves from the PARCC Agreement described above.
13
Increases in gross term reserves from increased sales and a growing in-force
were more than offset by increased ceded reserves.
The change in annuity reserves increased by under $1 million, primarily due to
increased annuitizations. There was relatively no change during the current
quarter in the GMDB reserves established as of January 1, 2004. Increases to
GMDB reserves based on gross profits were mostly offset by decreases due to
benefit payments described below.
Policyholder benefits for life insurance products, net of reinsurance, were
essentially unchanged from the prior year quarter.
Interest credited to policyholder account balances increased by $5 million over
the prior year quarter due to growth in policyholder account balances, primarily
from the reclassification of the MVA annuity products from separate account to
policyholder account balances. Partially offsetting this increase was a decrease
of $2 million in interest credited for GICs as the associated policyholder
account balances decreased during 2004 due to scheduled withdrawals and large
sales in the prior year period not repeated in the current year period and the
termination of sales of the product effective July 1, 2004.
General, administrative, and other expenses increased $13 million from the prior
year period, largely due to higher DAC amortization of $8 million. DAC
amortization for life products increased by $4 million as a result of the
growing in-force business and comparatively less favorable fund performance in
the current quarter. DAC amortization for annuity products was higher by $4
million due to increased gross profits. There was also an increase in commission
expense and general and administrative expenses, net of capitalization, of $5
million due to growth in both the annuity and life businesses.
SEPTEMBER 2004 TO SEPTEMBER 2003 NINE MONTH COMPARISON
NET INCOME
Consolidated net income of $70 million for the nine months of 2004 was $10
million higher than for the first nine months of 2003. Net income before the
cumulative change in accounting principle related to the adoption of SOP 03-1
was $19 million higher than the prior year. The effect of the cumulative change
in accounting principle was a charge to income of $9 million after tax in the
first quarter of 2004. This charge is caused primarily by an increase in
reserves for guaranteed minimum death benefits relating to our individual
variable annuity contracts offset by the impact of converting certain MVA
contracts from separate account accounting treatment to general account
accounting treatment. Increases in fees from asset-based revenues, higher net
investment income from an increased asset base and a lower effective tax rate
were offset by higher interest credited to policyholders' accounts and general
and administrative levels. Further details regarding the components of revenues
and expenses are described below.
REVENUES
Consolidated revenues increased $52 million, from $809 million in the first nine
months of 2003 to $860 million in the current year period. Policy charges and
fee income, consisting primarily of mortality and expense, loading and other
insurance charges assessed on general and separate account policyholder fund
balances, increased by $57 million. The increase was a result of a $30 million
and $27 million increase in the individual life and annuity businesses,
respectively. Policy charges for life products increased as a result of growth
in the in-force business, the favorable impact of increases in the market value
of variable life insurance assets, and the sale of newer interest-sensitive
products that generally carry higher expense charges in the first few years of
the contract. The variable life in-force business grew to $75 billion at
September 30, 2004 from $69 billion at September 30, 2003 and $71 billion at
December 31, 2003. Annuity fees are mainly asset based fees which are dependent
on the fund balances that are affected by net sales as well as asset
depreciation or appreciation on the underlying investment funds in which the
customer has the option to invest. Annuity separate account fund balances are
higher than in the prior year quarter as a result of favorable market
performance and positive net sales.
Net investment income increased by $25 million as a result of increased income
in fixed maturities due to an increase in the portfolio balance from the
reclassification of fixed maturities from the annuity separate accounts to the
general account, reinvestment of income, and positive cash flows. This was
partially offset by lower income from lower fund balances in retirement business
and the effect of a lower asset base in the life business.
Other income increased by $17 million due to higher expense recovery allowances
received from the PARCC and Pruco Re Ltd. term coinsurance agreements mentioned
above.
Net premiums decreased by $51 million from the prior year period due to
increased reinsurance premiums resulting from the coinsurance agreement with
PARCC to reinsure the entire term business. This agreement replaced the previous
coinsurance with Pruco Re Ltd., which reinsured only certain term business with
the Company. The new agreement covers all term policies written by both the
Company and its wholly owned subsidiary, Pruco Life Insurance
14
Company of New Jersey. All term business not previously covered by the Pruco Re
Coinsurance agreement was reinsured with yearly renewable term reinsurance
carrying lower premiums than coinsurance.
Extended term premiums decreased by $13 million due to lower policy lapses from
better market performance in the current year. Premiums for annuity contracts
with life contingencies were essentially unchanged from the prior year quarter.
BENEFITS AND EXPENSES
Total policyholder benefits decreased by $44 million from the prior year
period,primarily as a result of lower benefits for the annuity and life
businesses of $10 million and $32 million, respectively.
The change in reserves for life products decreased $27 million from the prior
year period,primarily as a result of a decrease in term life, net of
reinsurance. Decreases from lower extended term insurance were mostly offset by
an increase in deferred policy charge revenue resulting from increased sales of
variable and universal life products. The change in annuity reserves increased
slightly, due to increased annuitizations. There was relatively no change during
the first nine months in the GMDB reserves that were established as of January
1, 2004. Increases to GMDB reserves based on gross profits were mostly offset by
decreases due to benefit payments described below.
Annuity death benefits were lower by $10 million, primarily due to lower
guaranteed minimum death benefits driven by higher fund values as a result of
market appreciation. Policyholder benefits for life insurance products decreased
by $7 million, driven by lower surrenders of reduced paid up policies of $9
million, partly offset by higher net death benefits of $2 million due to an
increasing in-force.
Interest credited to policyholder account balances increased by $22 million due
to growth in average policyholder account balances in the life and annuity
business including the reclassification of the MVA annuity products from
separate account to policyholder account balances. Partially offsetting the
increase from the annuity products was a decrease of $8 million in interest
credited for GICs as the associated policyholder account balances declined
during 2004 due to scheduled withdrawals and the termination of sales of the
product effective July 1, 2004.
General, administrative, and other expenses increased $64 million from the prior
year period. The primary reason for the increase was an increase in DAC
amortization of $43 million. DAC amortization for life products increased by $27
million as a result of the growing term life in-force business and comparatively
less favorable fund performance in the current quarter. DAC amortization for
annuity products was higher by $16 million due to increased gross profits. There
was also an increase in commission expense and general and administrative
expenses of $21 million due to growth in both the annuity and life businesses.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
provide reasonable assurance that information required to be disclosed in our
filings with the Securities and Exchange Commission is recorded, processed,
summarized and reported within the periods specified in the Commission's rules
and forms and is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Accounting Officer, as
appropriate to allow timely decisions regarding required disclosure.
In determining the Company's state tax expense for the three months ended June
30, 2004, an error was made relating to the treatment of state net operating
loss carryforwards. This error resulted in an understatement of tax expense, and
corresponding overstatement of net income, of $7.4 million for the nine months
ended September 30, 2004. The error was identified by the Company in the course
of a review and inventory by the Company of its deferred tax balances undertaken
during the fourth quarter of 2004. Restated unaudited interim financial
statements of the Company reflecting the correction of this error are included
in this Amendment No. 1 to the Company's Quarterly Report of Form 10-Q for the
quarter ended September 30, 2004.
The Company believes that the error was attributable to a material weakness in
the Company's internal control over financial reporting. The Company is
implementing enhancements to its internal control over financial reporting to
provide reasonable assurance that errors of this type will not recur. These
steps include the completion of the Company's comprehensive review and inventory
of deferred tax assets and liabilities. In addition, the Company is implementing
definitive standards for detailed documentation supporting deferred tax
balances. This includes the implementation of an automated application to
further enhance control with respect to the collection of detailed deferred tax
information. The Company expects to complete these enhancements in conjunction
with the preparation and reporting of its results of operations for the year
ending December 31, 2004.
15
Based upon the foregoing, the Company's Chief Executive Officer and Chief
Accounting Officer have concluded that the Company's disclosure controls and
procedures were not effective at the reasonable assurance level as of September
30, 2004. However, management believes that the unaudited interim financial
statements included in this Amendment No. 1 fairly present in all material
respects the Company's financial condition, results of operations and cash flows
for the fiscal periods presented.
There were no changes in the Company's internal control over financial reporting
during the quarter ended September 30, 2004 that materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. However, as described above, management is implementing improvements
to the Company's internal control over financial reporting to address the
material weakness.
16
PART II OTHER INFORMATION
ITEM 6. EXHIBITS
- ------- ----------------------------------------------------------
31.1 Section 302 Certification of the Chief Executive Officer.
31.2 Section 302 Certification of the Chief Accounting Officer.
32.1 Section 906 Certification of the Chief Executive Officer.
32.2 Section 906 Certification of the Chief Accounting Officer.
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 by the
undersigned, thereunto duly authorized.
PRUCO LIFE INSURANCE COMPANY
By: /s/ John Chieffo
----------------------------
John Chieffo
Chief Accounting Officer
(Authorized Signatory and
Principal Financial Officer)
Date: January 3, 2005
18