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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-------------------------
FORM 10-Q
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(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, 2005
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) 802-6000
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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
----- -----
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 May 13, 2005. 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.
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1
TABLE OF CONTENTS
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Interim Consolidated Statements of Financial Position, As of March 31,
2005 and December 31, 2004 3
Interim Consolidated Statements of Operations and Comprehensive Income,
Three months ended March 31, 2005 and 2004 4
Interim Consolidated Statement of Stockholder's Equity, Three months ended
March 31, 2005 5
Interim Consolidated Statements of Cash Flows, Three months ended
March 31, 2005 and 2004 6
Notes to Interim Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 10
Item 4. Controls and Procedures 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 6. Exhibits 14
Signatures 15
FORWARD-LOOKING STATEMENTS
Some of the statements included in this Annual Report on Form 10-Q, including
but not limited to those in Management's Discussion and Analysis of Financial
Condition and Results of Operations, may 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," "should," "will," "shall" 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 and its subsidiaries. There can be no assurance
that future developments affecting Pruco Life Insurance Company and its
subsidiaries 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, among others: (1) general
economic, market and political conditions, including the performance of
financial markets and interest rate fluctuations; (2) domestic or international
military or terrorist activities or conflicts; (3) volatility in the securities
markets; (4) fluctuations in foreign currency exchange rates and foreign
securities markets; (5) regulatory or legislative changes, including changes in
tax law; (6) changes in statutory or U.S. GAAP accounting principles, practices
or policies; (7) differences between actual experience regarding mortality,
morbidity, persistency, surrender experience, interest rates, or market returns
and the assumptions we use in pricing our products, establishing liabilities and
reserves or for other purposes; (8) re-estimates of our reserves for future
policy benefits and claims; (9) changes in our assumptions related to deferred
policy acquisition costs; (10) events resulting in catastrophic loss of life;
(11) investment losses and defaults; (12) changes in our claims-paying ratings;
(13) competition in our product lines and for personnel; (14) economic,
political, currency and other risks relating to our international operations;
(15) adverse determinations in litigation or regulatory matters and our exposure
to contingent liabilities; and (16) the effects of acquisitions, divestitures
and restructurings, including possible difficulties in integrating and realizing
the projected results of acquisitions. Pruco Life Insurance Company does not
intend, and is under no obligation, to update any particular forward-looking
statement included in this document.
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
AS OF MARCH 31, 2005 AND DECEMBER 31, 2004 (IN THOUSANDS)
- --------------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
2005 2004
------------ ------------
ASSETS
Fixed maturities available for sale,
at fair value (amortized cost, 2005: $6,386,805; 2004: $6,114,020) $ 6,505,847 $ 6,339,103
Policy loans 859,746 856,755
Short-term investments 215,670 122,061
Other long-term investments 77,777 28,258
------------ ------------
Total investments 7,659,040 7,346,177
Cash and cash equivalents 354,591 743,533
Deferred policy acquisition costs 1,523,200 1,429,027
Accrued investment income 109,081 101,432
Reinsurance recoverable 811,348 765,045
Receivables from Parent and affiliates 54,537 50,339
Deferred sales inducements 114,510 112,643
Other assets 263,503 12,225
Separate account assets 17,026,385 17,326,555
------------ ------------
TOTAL ASSETS $ 27,916,195 $ 27,886,976
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
LIABILITIES
Policyholders' account balances $ 6,047,923 $ 6,122,924
Future policy benefits and other policyholder liabilities 1,393,280 1,325,836
Cash collateral for loaned securities 384,808 410,718
Securities sold under agreement to repurchase 172,592 45,254
Income taxes payable 348,743 433,966
Other liabilities 620,290 330,966
Separate account liabilities 17,026,385 17,326,555
------------ ------------
TOTAL LIABILITIES 25,994,021 25,996,219
------------ ------------
CONTINGENCIES (SEE NOTE 2)
STOCKHOLDER'S EQUITY
Common stock, $10 par value;
1,000,000 shares, authorized;
250,000 shares, issued and outstanding 2,500 2,500
Additional paid-in capital 455,786 455,377
Deferred compensation (1,261) (1,173)
Retained earnings 1,408,685 1,359,526
Accumulated other comprehensive income 56,464 74,527
------------ ------------
TOTAL STOCKHOLDER'S EQUITY 1,922,174 1,890,757
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 27,916,195 $ 27,886,976
============ ============
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2005 AND 2004 (IN THOUSANDS)
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
---------------------------
2005 2004
--------- ---------
REVENUES
Premiums $ 8,642 $ 27,825
Policy charges and fee income 145,552 155,835
Net investment income 101,349 92,484
Realized investment gains, net 3,945 5,969
Asset management fees 3,936 3,827
Other income 2,611 1,988
--------- ---------
TOTAL REVENUES 266,035 287,928
--------- ---------
BENEFITS AND EXPENSES
Policyholders' benefits 37,626 68,045
Interest credited to policyholders' account balances 59,289 61,161
General, administrative and other expenses 120,672 118,806
--------- ---------
TOTAL BENEFITS AND EXPENSES 217,587 248,012
--------- ---------
Income from operations before income tax (benefit) expense and
cumulative effect of accounting change 48,448 39,916
Income tax (benefit) expense (711) 8,377
--------- ---------
NET INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 49,159 31,539
Cumulative effect of accounting change, net of taxes - (9,150)
--------- ---------
NET INCOME 49,159 22,389
--------- ---------
Change in net unrealized investment gains, net of taxes (18,063) 14,690
Cumulative effect of accounting change, net of taxes - 4,030
--------- ---------
Other comprehensive income (loss), net of taxes (18,063) 18,720
--------- ---------
TOTAL COMPREHENSIVE INCOME $ 31,096 $ 41,109
========= =========
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2005 (IN THOUSANDS)
- --------------------------------------------------------------------------------
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED DEFERRED COMPREHENSIVE STOCKHOLDER'S
STOCK CAPITAL EARNINGS COMPENSATION INCOME (LOSS) EQUITY
-------- ---------- -------- ------------ ------------- -------------
BALANCE, DECEMBER 31, 2004 $ 2,500 $ 455,377 $ 1,359,526 $ (1,173) $ 74,527 $ 1,890,757
Net income - - 49,159 - - 49,159
Stock-based compensation programs - 175 - (88) - 87
Contributed Capital - 234 - - - 234
Change in net unrealized investment
gains, net of taxes - - - - (18,063) (18,063)
------- --------- ----------- --------- ---------- -----------
BALANCE, MARCH 31, 2005 $ 2,500 $ 455,786 $ 1,408,685 $ (1,261) $ 56,464 $ 1,922,174
======= ========= =========== ========= ========== ===========
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2005 AND 2004 (IN THOUSANDS)
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
------------------------------
2005 2004
-------- --------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income $ 49,159 $ 22,389
Adjustments to reconcile net income to net cash from
(used in) operating activities:
Policy charges and fee income (53,469) (31,906)
Interest credited to policyholders' account balances 59,289 61,161
Realized investment gains, net (3,945) (5,969)
Amortization and other non-cash items 77,729 (74,365)
Cumulative effect of accounting change, net of taxes - 9,150
Change in:
Future policy benefits and other policyholders' liabilities 67,444 72,111
Reinsurance recoverable (46,303) (40,885)
Accrued investment income (7,649) (5,483)
Receivables from Parent and affiliates (4,198) 9,292
Policy loans (2,991) (2,423)
Deferred policy acquisition costs (94,173) 26,961
Income taxes payable/receivable (85,223) 18,974
Deferred sales inducements (1,867) (13,948)
Other, net 38,044 (33,609)
----------- ---------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES (8,153) 11,450
----------- ---------
CASH FLOWS (USED IN) FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities available for sale 1,751,774 480,139
Payments for the purchase of:
Fixed maturities available for sale (2,028,426) (512,180)
Other long-term investments, net (46,305) 5,527
Short-term investments, net (93,529) (5,879)
----------- ---------
CASH FLOWS USED IN INVESTING ACTIVITIES (416,486) (32,393)
----------- ---------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Policyholders' account balances:
Deposits 212,806 590,904
Withdrawals (278,858) (549,108)
Cash collateral for loaned securities, net (25,910) (9,409)
Securities sold under agreement to repurchase, net 127,338 (33,611)
Contributed capital 234 -
Deferred compensation (88) (1,145)
Stock-based compensation 175 125
----------- ---------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES 35,697 (2,244)
----------- ---------
Net (decrease) in cash and cash equivalents (388,942) (23,187)
Cash and cash equivalents, beginning of year 743,533 253,564
----------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 354,591 $ 230,377
=========== =========
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
6
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO INTERIM 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,
or "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 Pruco Life Insurance Company, or the
"Company," for the interim periods presented. The Company is a wholly owned
subsidiary of The Prudential Insurance Company of America, or "Prudential
Insurance," which in turn is a wholly owned subsidiary of Prudential Financial,
Inc., or "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, 2004.
2. 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.
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 AND REGULATORY MATTERS
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 payments 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 and regulatory matters are subject to many
uncertainties, and given their 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.
7
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ADOPTION OF STATEMENT OF POSITION 03-1
In July 2003, the Accounting Standards Executive Committee, or "AcSEC," of the
American Institute of Certified Public Accountants, or "AICPA," issued Statement
of Position, or "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 $9.2 million, reported as a
cumulative effect of accounting change in the results of operations for the
three months ended March 31, 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, or
"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, or "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, or "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.
The cumulative effect of the adoption of this SOP is shown in the statement of
cash flows under "Cumulative Effect of Accounting Change" and includes increases
in fixed maturities of $403 million and policyholders' account balances of $387
million related to the reclassifications of annuity contracts from the separate
account to the general account. This activity also includes the establishment of
the GMDB reserves of approximately $45 million and the increase in DAC of $23
million. Other balance sheet accounts that were affected include other long-term
investments and deferred taxes payable.
STOCK OPTIONS
In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 (R), "Share-Based Payment," which
replaces FASB Statement No. 123, "Accounting for Stock-Based Compensation." SFAS
No. 123 (R) requires all entities to apply the fair value based measurement
method in accounting for share-based payment transactions with employees, except
for equity instruments held by employee share ownership plans. Under this
method, compensation costs of awards to employees, such as stock options, are
measured at fair value and expensed over the period during which an employee is
required to provide service in exchange for the award (the vesting period). The
Company had previously adopted the fair value recognition provision of the
original SFAS No. 123, prospectively for all new stock options issued to
employees on or after January 1, 2003. As issued SFAS No. 123 (R) is effective
for interim and annual periods beginning after June 15, 2005. However, the SEC
has recently deferred the effective date and as a result the Company will adopt
SFAS No. 123 (R) on January 1, 2006. By that date, there will be no unvested
stock options issued prior to January 1, 2003.
RECLASSIFICATIONS
Certain amounts in the prior year have been reclassified to conform to the
current year presentation.
8
4. 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 account
liabilities was $1.1 billion at March 31, 2005 and December 31, 2004.
PURCHASE OF FIXED MATURITIES FROM AN AFFILIATE
In 2004, the Company purchased certain of fixed maturities from Prudential
Insurance 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 Company also sold $31 million of fixed maturities securities,
recorded at an amortized cost of $29 million, to Prudential Arizona Reinsurance
Captive Company, or "PARCC." The difference between the historical amortized
cost and the fair value, net of taxes, was reflected as a reduction to
additional paid-in capital. The fixed maturity investments are categorized in
the Company's consolidated statements of financial position as available for
sale fixed maturities, 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.
REINSURANCE WITH AFFILIATES
During the third quarter of 2004, the Company entered into an agreement to
reinsure its term life insurance policies known as Term Elite and Term
Essential, or "Term," with PARCC, an affiliated company. The Company reinsured
with PARCC, 90 percent of the risks under such policies through an automatic and
facultative coinsurance agreement. The Company is not relieved of its primary
obligation to the policyholder as a result of these reinsurance transactions.
Concurrently with implementing the new Agreement, the Company recaptured the
term reinsurance previously reinsured under a coinsurance treaty with an
affiliated offshore captive company, Pruco Reinsurance, 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 replaces the yearly renewable term
agreements with external reinsurers that were previously in effect on this block
of business. 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 SFAS No. 113, "Accounting and Reporting
for Reinsurance of Short-Duration and Long-Duration Contracts." Reinsurance
recoverables related to this transaction were $251 million as of March 31, 2005.
In December 2004, the Company recaptured the excess of loss reinsurance
agreement with The Prudential Insurance Company of America, or "Prudential
Insurance," and replaced it with a revised agreement to reinsure all risks not
otherwise reinsured. Reinsurance recoverables related to this agreement were $49
million as of March 31, 2005. The Company is not relieved of its primary
obligation to the policyholder as a result of this agreement.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PRUCO LIFE INSURANCE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(A) AND (B) ON FORM 10-Q AND IS THEREFORE FILING THIS FORM IN
REDUCED DISCLOSURE FORMAT.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations, or "MD&A," addresses the consolidated financial condition of Pruco
Life Insurance Company as of March 31 2005, compared with December 31, 2004, and
its consolidated results of operations for the three month periods ended March
31, 2005 and March 31, 2004. 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, 2004, and
Interim 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 and individual variable annuities, 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 GIC called
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 customers.
Generally, the Company's products offer the option of investing in 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 from
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 to policyholders' account balances.
The Company's Changes in Financial Position and Results of Operations are
described below.
1. ANALYSIS OF FINANCIAL CONDITION
From December 31, 2004 to March 31, 2005 total assets increased $29 million,
from $27.887 billion to $27.916 billion. Fixed maturities and short-term
investments combined increased by $260 million mainly as a result of investing
positive cash flows, expansion of the securities lending program and
reinvestment of investment income. Offsetting overall growth in fixed maturities
was a decline in the level of unrealized gains resulting from an increasing
interest rate environment as of March 31, 2005. Other long-term investments
increased $50 million during the current year as additional funds were invested
in commercial loans.
Deferred policy acquisition costs increased by $94 million from $1.429 billion
at December 31, 2004, to $1.523 billion at March 31, 2005, driven by an $81
million increase in the shadow DAC adjustment from lower unrealized gains and
$72 million in net capitalization of acquisition expenses, partially offset by
$59 million of amortization. Capitalization in the Life business reflects a
reduction in capitalization of $16 million related to ceded costs due to cost
reimbursements under the new coinsurance agreement with Prudential Arizona
Reinsurance Captive Company or, "PARCC." (See Note 4)
10
Reinsurance recoverable increased by $46 million, largely as a result of
increased ceded reserves held under the PARCC agreement (see Note 4) and
increased recoverables for the Taiwan business. Other assets increased by $251
million, driven by a $250 million increase in investment receivables due to the
timing of trade settlements as of March 31, 2005.
Cash and cash equivalents declined by $389 million, from $744 million at
December 31, 2004 to $355 million at March 31, 2005, due to the accumulated
portfolio cash flows early in the current quarter.
Separate account assets decreased $301 million, from $17.327 billion at December
31, 2004 to $17.026 billion at March 31, 2005, primarily due to a decline in
market value during the quarter.
During the first quarter of 2005, total liabilities decreased by $2 million.
Corresponding with the asset change, separate account liabilities decreased by
$301 million, as described above. Other liabilities increased $289 million,
primarily due to increased investment payables on unsettled trades. Policyholder
account balances decreased by $75 million, due primarily to increased maturities
of retirement contracts during the quarter. Future policy benefits increased by
$67 million, due to increased reserves for the Taiwan business, increased
guaranteed minimum death and income benefits in the annuity business from higher
revenues and increases to life reserves as a result of sales and renewals of
term and the newer universal life products. Income taxes payable, net, declined
by $85 million primarily due to a $76 million tax payment made in the first
three months of 2005. Total securities lending activity increased by $101
million. The relative amounts of cash collateral for loaned securities and
securities sold under agreements to repurchase decreased $26 million and
increased $127 million, respectively.
2. RESULTS OF OPERATIONS
MARCH 2005 TO MARCH 2004 THREE MONTH COMPARISON
NET INCOME
Consolidated net income of $49 million for the three months ended March 31, 2005
improved $27 million, from $22 million in the same period in 2004. Driving the
increase are a charge to income in 2004 of $9 million for the adoption of SOP
03-1 and a low effective tax rate in 2005 due to a reduction of tax reserves of
approximately $11 million reflecting the resolution of certain items with the
Internal Revenue Service. Net investment income increased $9 million over the
last year, primarily due to a collection in 2005 of investment income on a
previously defaulted bond.
Further details regarding the components of revenues and expenses are described
in the following paragraphs.
REVENUES
Consolidated revenues decreased by $22 million, from $288 million for the three
months ended March 31, 2004 to $266 million in the same period in 2005. Premiums
of $9 million, decreased by $19 million, from $28 million in the three months
ended March 31, 2004, due to increased ceded reinsurance premiums resulting from
the coinsurance agreement with PARCC, an affiliate, to reinsure 90% of the
entire term book of business (See Note 4).
Policy charges and fee income, consisting primarily of mortality and expense,
loading and other insurance charges assessed on general and separate account
policyholders' fund balances, decreased by $10 million. The decrease was the
result of a $15 million decrease for individual life products and a $5 million
increase for annuity products. Policy charges for life products decreased as a
result of a new reinsurance agreement resulting in higher ceded variable
premiums, partly offset by 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 nearly 2% from $77.1 billion at December 31, 2004 to $78.4 billion
at March 31, 2005. Annuity fees are mainly asset based fees which are dependent
on fund balances that are affected by net sales as well as asset depreciation or
appreciation on the underlying investment funds in which customers may invest.
Average annuity separate account fund balances are more than 9% higher than in
the prior year as a result of favorable market performance and positive net
sales.
Net investment income increased by $9 million for the three months ended March
31, 2005, from $92 million in the same period in 2004, driven by more than $6
million of income resulting from the collection of investment income in 2005, on
a previously defaulted bond and increased income in fixed maturities due to an
increase in the portfolio balance from the deployment of funds accumulated as of
December 31, 2004. This was partially offset by declining fund balances in the
retirement business, which decreased due to greater contract maturities during
the current quarter.
11
BENEFITS AND EXPENSES
Total benefits and expenses decreased $30 million, from $248 million for the
three months ended March 31, 2004 to $218 million for the current period, driven
by a $30 million decrease in policyholders' benefits, including changes in
reserves, in 2005. Policyholder benefits, including changes in reserves, in the
life business declined $33 million but increased $3 million in the annuity
business.
Policyholders' benefits, excluding changes in reserves, for life insurance
products decreased by $35 million, from $50 million in the three months ended
March 31, 2004, driven by lower net death benefits of $35 million. While net
term death benefits were essentially unchanged from 2004, net variable and
universal death benefits combined were $33 million lower than the prior year,
due to lower mortality and an increase in the ceded in force for these products
in December 2004. The Company entered into a new excess of loss reinsurance
agreement in the fourth quarter of 2004 with an affiliate (see Note 4),
resulting in a significant increase in reinsured variable and universal life
business. Annuity policyholder benefits of $7 million in 2005 were slightly
lower than in the prior year period, primarily due to lower guaranteed minimum
death benefits, or "GMDB," driven by higher average fund values in the current
year as a result of market appreciation.
The change in reserves for life products increased $2 million, from $10 million
in the three months ended March 31, 2004 to $12 million in the three months
ended March 31, 2005. The increase was primarily the result of an increase in
variable and universal reserves, which were $4 million higher primarily due to
increased sales of variable and universal products and the new excess of loss
reinsurance agreement mentioned above, partly offset by a $2 million decrease in
net term reserves due to the new coinsurance treaty with PARCC, which generated
higher reinsurance reserves than last year. The change in reserves for annuity
products increased $4 million in 2005, due to the establishment of a GMDB
feature as of January 1, 2004. The GMDB feature provides annuity contractholders
with a guarantee that the benefit received at death will be no less than a
prescribed minimum amount. This minimum amount is based on the net deposits paid
into the contract, the net deposits accumulated at a specified rate, the highest
historical account value on a contract anniversary, or more typically, the
greatest of these values, depending on features offered in various contracts and
elected by the contractholders.
Tax benefit for the three months ended March 31, 2005 benefited from a reduction
of reserves of approximately $11 million reflecting the resolution of certain
items with the Internal Revenue Service.
Interest credited to policyholders' account balances decreased by $2 million,
from $61 million in the three months ended March 31, 2004 to $59 million in the
three months ended March 31, 2005. Interest credited in the retirement business
was nearly $4 million lower due to increased maturities and withdrawals in the
current year, partly offset by growth in policyholders' account balances in the
life business which were higher due to increased deposits.
General, administrative, and other expenses increased by $2 million from $119
million in the three months ended March 31, 2004 to $121 million in the same
period in 2005. The primary reason was an increase in DAC amortization of $4
million, from $55 million in 2004, driven by higher gross profits from higher
spread revenue and fees in the annuity business. General, administrative and
other expenses, excluding DAC amortization, decreased $2 million from the prior
year as a result of lower net distribution costs resulting from increased
reinsurance expense allowances, net of capitalization, in the life business
resulting from the PARCC coinsurance agreement mentioned above. These allowances
are reflected as a deduction within operating expenses.
ITEM 4. CONTROLS AND PROCEDURES
In order to ensure that the information we must disclose in our filings with the
Securities and Exchange Commission, or "SEC" is recorded, processed, summarized,
and reported on a timely basis, the Company's management, including our Chief
Executive Officer and Chief Financial Officer, have reviewed and evaluated the
effectiveness of our disclosure controls and procedures, as defined in Exchange
Act Rule 13a-15(e) and 15d-15(e), as of March 31, 2005. Based on such
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that, as of March 31, 2005, our disclosure controls and procedures
were effective in timely alerting them to material information relating to us
(and our consolidated subsidiaries) required to be included in our periodic SEC
filings. Other than as discussed in the following paragraphs, no change in the
Company's internal control over financial reporting, as defined in Exchange Act
Rule 13a-15(f) and 15d-15(f), occurred during the quarter ended March 31, 2005
that has materially affected or is reasonably likely to materially affect our
internal control over financial reporting.
12
As previously reported, 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, for the three and
six months ended June 30, 2004 and 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 were included in Amendment No. 1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and amendment
No. 1 to the Company's Quarterly Report on 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 has
implemented 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. The Company is in the process of
implementing definitive standards for detailed documentation supporting deferred
tax balances and expects to complete this implementation in 2005. The Company is
also in the process of implementing an automated application to further enhance
control with respect to the collection of detailed deferred tax information, and
it expects to fully implement such application in 2005.
Effective January 1, 2005, we implemented a new general ledger and financial
reporting platform. The new platform is intended to improve efficiencies through
the use of more current technology. Although the implementation of the new
platform resulted in changes in certain of our internal controls over financial
reporting, we do not believe that the implementation or the related changes in
internal controls materially affect the effectiveness of our internal control
over financial reporting.
13
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to legal and regulatory actions in the ordinary course of
its businesses, which may include class action lawsuits. 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
may 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 also
may be 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 may seek large and/or indeterminate amounts, including punitive
or exemplary damages.
The Company has received formal requests for information relating to its
variable annuity business and unregistered separate accounts from regulators,
including, among others, the Securities and Exchange Commission and the State of
New York Attorney General's office. The Company is cooperating with all such
inquiries.
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 litigation and regulatory matters. Management believes, however,
that the ultimate outcome of all pending litigation and regulatory matters
should not have a material adverse effect on the Company's financial position.
ITEM 6. EXHIBITS
31.1 Section 302 Certification of the Chief Executive Officer,
31.2 Section 302 Certification of the Chief Financial Officer,
32.1 Section 906 Certification of the Chief Executive Officer,
32.2 Section 906 Certification of the Chief Financial Officer.
14
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 in the City of Newark and State of New
Jersey on the 13th day of May 2005.
PRUCO LIFE INSURANCE COMPANY
By: /s/ John Chieffo
-----------------------------------------------------------
John Chieffo
(Authorized Signatory and Principal Accounting and Financial
Officer)
Date: May 13, 2005
15
EXHIBIT INDEX
EXHIBIT NUMBER AND DESCRIPTION
31.1 Section 302 Certification of the Chief Executive Officer,
31.2 Section 302 Certification of the Chief Financial Officer,
32.1 Section 906 Certification of the Chief Executive Officer,
32.2 Section 906 Certification of the Chief Financial Officer.
16