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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002.
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
Commission file number 333-02491*.
KEMPER INVESTORS LIFE INSURANCE COMPANY
(Exact name of registrant as specified in charter)
ILLINOIS 36-3050975
(State of Incorporation) (I.R.S. Employer
Identification Number)
1600 McCONNOR PARKWAY
SCHAUMBURG, ILLINOIS 60196-6801
(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (847) 874-4000
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 and (2) has been subject to such filing
requirements for the past 90 days. Yes _(check mark) No __.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes __ No _(check mark) .
The aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked price of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter was $0.
* Pursuant to Rule 429 under the Securities Act of 1933, this Form 10-K also
relates to Commission file numbers 333-22389, 333-32632, 333-54252 and
333-86044.
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PART I
Item 1. Business
Corporate structure
Kemper Investors Life Insurance Company, founded in 1947, is incorporated
under the insurance laws of the State of Illinois and is licensed in the
District of Columbia and all states except New York. Zurich Life Insurance
Company of New York ("ZLICONY"), formerly Zurich Kemper Life Insurance Company
of New York, a wholly-owned subsidiary, received its license from the State of
New York early in 2001 and began writing business in May of 2001. Kemper
Investors Life Insurance Company and its subsidiaries (collectively, "KILICO",
"the Company", "we", "our" or "us") are wholly-owned by Kemper Corporation
("Kemper"), a non-operating holding company. Kemper is a wholly-owned
subsidiary of Zurich Holding Company of America ("ZHCA"), a holding company.
ZHCA is a wholly-owned subsidiary of Zurich Group Holding ("ZGH" or "Zurich"),
a Swiss holding company. ZGH is wholly-owned by Zurich Financial Services
("ZFS"), a Swiss holding company.
Strategic initiatives
Our management, operations and strategic directions are integrated with
those of several other Kemper subsidiaries:
. Federal Kemper Life Assurance Company ("FKLA"),
. Zurich Life Insurance Company of America ("ZLICA"), and
. Zurich Direct, Inc. ("ZD").
This integration streamlines management, controls costs, improves
profitability, increases operating efficiencies and productivity, and helps to
expand the companies' distribution capabilities. Headquartered in Schaumburg,
Illinois, FKLA markets term and interest-sensitive life insurance, as well as
certain annuity products, primarily through brokerage general agents and other
independent distributors. ZLICA markets term life insurance products primarily
through ZD. ZD is an affiliated direct marketing life insurance agency
currently marketing term life insurance directly to consumers primarily through
various marketing media. The Company, FKLA, ZLICA and Fidelity Life
Association, A Mutual Legal Reserve Company ("FLA"), collectively operate under
the trade name Zurich Life, formerly Zurich Kemper Life. FLA shares directors,
management, operations and employees with FKLA pursuant to an administrative
and management services agreement. FLA issues policies not issued by FKLA or
KILICO as well as other policies similar to certain FKLA policies.
During 2002, Zurich Life completed a project to optimize the portfolio of
businesses, the distribution channels and the products that Zurich Life sells.
This strategic initiative was named FOCUS and was implemented in two phases.
The objective of phase I of FOCUS was to identify those businesses with the
potential to be significant generators of embedded value through strong present
value of distributable earnings margins and future growth. As a result of this
analysis, the decision was made to exit the individual variable universal life
line of business due to lack of scale and profitability. We also chose not to
build out a separate marketing and wholesaling group to exclusively target the
bank distribution channel.
The objective of phase II of FOCUS was and is to aggressively look at the
operating and cost structures necessary to support those businesses that our
portfolio review determined will deliver the greatest profitability. Zurich
Life dramatically improved its processes and reduced its overall operating
expenses. Phase II work continues today and continues to be about fundamentally
changing Zurich Life's cost structure in order to
1
compete and win in the markets it has chosen. We benefited significantly from
the cost reductions generated by the phase II work and expect to continue to
benefit in future periods.
Over the last several years, we have increased the competitiveness of our
variable annuity portfolio by adding new products with additional benefit
options, adding multiple variable subaccount investment options and adding
investment managers to existing variable annuity products. In 1997, we
introduced a non-registered individual and group variable business-owned life
insurance contract ("BOLI") and a series of individual variable life insurance
contracts. In 1998, we introduced a new registered individual variable annuity
product with thirty-seven variable subaccount investment options and various
investment managers.
In 2000, as part of our plan to sharpen our focus on the group retirement
market, we purchased PMG Securities Corporation, PMG Asset Management, Inc.,
PMG Marketing, Inc., and PMG Life Agency, Inc. (collectively "PMG"). The total
cost was $8.2 million, resulting in the recording of definite-lived intangible
assets in the amount of $7.6 million. PMG is a well-respected broker-dealer
located primarily in the eastern part of the country. We own 100 percent of the
stock of PMG.
Also in 2000, we transferred $63.3 million in fixed maturity securities and
cash to fund the operations of ZLICONY.
Throughout 2001 and 2000, we introduced a number of new annuity and life
insurance products, all designed to meet the demands of our customers in an
ever-changing marketplace. In addition, in 2002 we introduced two new variable
annuity products. However, with the continued turbulent equity markets, we
focused more in 2002 on sales of our fixed annuity products, which provide
investors a more stable return on their investment.
Narrative description of business
We offer both individual and group fixed-rate (general account) and variable
(separate account) annuity contracts, as well as individual and group term life
and group variable (separate account) life insurance products through various
distribution channels. We offer investment-oriented products, guaranteed
returns or a combination of both, to help policyholders meet multiple insurance
and financial objectives. Financial institutions, securities brokerage firms,
insurance agents and financial planners are important distribution channels for
our products. Our sales mainly consist of deposits received on certain long
duration fixed and variable annuities and BOLI contracts.
Our fixed and variable annuities generally have surrender charges that are a
specified percentage of policy values or premiums and decline as the policy
ages. General account annuity and interest-sensitive life policies are
guaranteed to accumulate at specified interest rates but allow for periodic
crediting rate changes.
Over the last several years, in part reflecting the equity market
environment, we have increased our emphasis on marketing our existing and new
separate account products. Unlike the fixed-rate annuity business where we
manage spread revenue, we receive administrative fee revenue on variable
products, which compensates us for providing death benefits potentially in
excess of cash surrender values. In addition, on variable life insurance
contracts, cost of insurance charges are designed to compensate us for
providing death benefit coverage substantially in excess of surrender values.
As a result of this strategy, our separate account assets have increased
over the last few years, despite a decrease in sales of our DESTINATIONS/SM/
product (discussed below) in 2002 due the discontinuation of the
2
guaranteed retirement income benefit ("GRIB") option in November 2001. Our
separate account assets and variable product sales were as follows (in
millions):
December 31,
-----------------------------
2002 2001 2000
--------- --------- ---------
Separate account assets............ $13,547.4 $13,108.8 $11,179.6
========= ========= =========
Year Ended December 31,
-----------------------------
2002 2001 2000
--------- --------- ---------
Variable annuity sales (1)......... $ 979.3 $ 2,547.5 $ 1,160.5
Variable life sales, primarily BOLI 881.4 544.9 856.1
--------- --------- ---------
Total variable product sales....... $ 1,860.7 $ 3,092.4 $ 2,016.6
========= ========= =========
- --------
(1) Includes the fixed account option of the variable contracts totaling $172.9
million, $536.8 million and $339.6 million in 2002, 2001 and 2000,
respectively. The fixed account option has been primarily used for dollar
cost averaging into the separate account investment options. This allows
contractholders the option to allocate amounts to the fixed account option
and authorize pro-rated amounts to be automatically transferred into the
separate account investment options over a specified period of time.
Theoretically, this reduces the effects of significant market fluctuations.
However, this result is not guaranteed.
In 2002, with the continued turbulent equity markets, sales of our fixed
annuity products increased significantly. However, these sales occurred during
a period of declining interest rates which makes managing spread revenue more
difficult.
Our fixed annuity sales were as follows (in millions):
Year Ended December 31,
-----------------------
2002 2001 2000
------ ------ ------
Fixed annuity sales $370.3 $142.0 $168.6
====== ====== ======
Our fixed annuity sales increased $228.3 million in 2002, compared with
2001. This increase is primarily the result of investors seeking a more stable
return on their investments during a time of stock market volatility.
In 2002, several new products were introduced. Archway/SM/ and Scudder ZS4
are registered individual and group variable and market value adjusted deferred
annuities. Archway/SM/ offers contractholders 26 different variable subaccount
investment options with various investment managers while Scudder ZS4 offers a
total of 39 different variable subaccount investment options with various
investment managers. These products have a four-year surrender charge period
and a 10% free withdrawal option. In addition, there are two optional death
benefit riders that allow contractholders to allocate contract value to the
equity market, while still providing valuable family protection. In addition,
modifications were made to certain existing annuity products in 2002 to either
enhance their attractiveness to the marketplace or improve their profitability.
In 2002 and 2001, after extensive reviews of our product portfolio, we
exited the high net worth business and the individual variable universal life
product line due to lack of scale and profitability. In addition, we chose not
to build out a separate marketing and wholesaling group to exclusively target
the bank distribution channel. We have in the past and we will continue to
assess the various markets in which we operate as well as our product offerings
in each such market.
In 2001, several new products were also introduced. Zurich Classic II, an
individual and group fixed annuity, offers contractholders a number of
guaranteed interest periods from which to choose. Zurich Preferred Plus, an
individual and group variable annuity and market value adjusted deferred
annuity, offers contractholders twenty-seven different variable subaccount
investment options with various investment managers and offers a four percent
bonus on all premiums paid. Also in 2001, ZLICONY introduced two new term life
insurance products in the State of New York.
3
In 2000, several new products were also introduced. Zurich Preferred, a
registered individual and group variable and market value adjusted deferred
annuity, offers contractholders twenty-seven different variable subaccount
investment options with various investment managers. Zurich Kemper
Lifeinvestor, a registered flexible premium variable universal life product,
permits policyholders to allocate premiums among forty-one different subaccount
investment options with various investment managers. We also introduced a new
individual and group fixed annuity, Zurich Classic.
During mid-1998, we introduced DESTINATIONS/SM/, a registered individual and
group variable, fixed and market value adjusted deferred annuity product.
DESTINATIONS/SM/ currently offers forty-two variable subaccount investment
options with various investment managers, ten guarantee periods, a fixed
account option, dollar cost averaging and, prior to November 2001, a GRIB
option. The GRIB is an optional benefit to the DESTINATIONS/SM/ variable
annuity, for an additional asset-based fee. It allows for a proxy account
value, called the GRIB Base, to be applied to the guaranteed annuity factors
(settlement option purchase rates) in the contract. The GRIB Base prior to
attained age 80 is the greatest of:
. the contract value (account value),
. the greatest anniversary value before the exercise (annuitization) date, or
. purchase payments minus previous withdrawals, accumulated at 5 percent
interest per year to the annuitization date.
In the fourth quarter of 2001, we discontinued offering the GRIB option with
the DESTINATIONS/SM/ product due to the continued decline in the stock market,
particularly in the wake of the tragedy of September 11th and in the first
quarter of 2003 we discontinued all sales of DESTINATIONS/SM/. While we
continued to receive renewal premiums and Section 1035 premium (tax-free
exchange of certain insurance policies) during 2002, sales of the
DESTINATIONS/SM/ product will continue to be substantially lower in future
years because of these decisions.
During mid-1997, we introduced variable BOLI, a group variable life
insurance contract that is primarily marketed to banks and other large
corporate entities. Also in 1997, we issued a series of non-registered variable
individual universal life insurance contracts that were marketed primarily to
high net worth individuals. Significant fluctuations in our sales of the
variable life products are due mainly to the nature of the BOLI product--high
dollar volume per sale, low frequency of sales.
Investors Brokerage Services, Inc., ("IBS"), our wholly-owned subsidiary,
and our affiliated broker-dealer, BFP Securities, LLC, are the principal
underwriters of our registered variable annuity and variable life products. BFP
Securities, LLC, is also the primary wholesaling distributor of our BOLI
products.
NAIC ratios
The National Association of Insurance Commissioners (the "NAIC") annually
calculates certain statutory financial ratios for most insurance companies in
the United States. These calculations are known as the Insurance Regulatory
Information System ("IRIS") ratios. Currently, thirteen IRIS ratios are
calculated. The primary purpose of the ratios is to provide an "early warning"
of potential negative developments. The NAIC reports a company's ratios to
state regulators who may then contact the company if three or more ratios fall
outside the NAIC's "usual ranges".
Based on statutory financial data as of December 31, 2002, we had six ratios
outside the usual ranges: the net change in capital and surplus ratio, the net
income to total income (including realized capital gains and losses) ratio, the
adequacy of investment income ratio, the change in premium ratio, the change in
product mix ratio and the change in reserving ratio.
The results for the net change in capital and surplus ratio and the net
income to total income ratio were primarily caused by the $84.9 million
statutory net loss reported that was caused by the significant downturn in the
stock market during 2002. The result for the adequacy of investment income
ratio was primarily due to
4
compressed spread income due to the current low interest rate environment and
the use of conservative tabular interest rates. The result for the change in
premium ratio and the change in the product mix ratio was primarily caused by a
decrease in sales of our DESTINATIONS/SM/ product in 2002 due to the
discontinuation of the GRIB option in November 2001. The result for the change
in the reserving ratio was primarily due to the level of individual variable
universal life premiums, which carry marginal reserves in the general account,
versus the change in reserves which primarily reflects a matured block of
universal life policies with minimal premium volume.
Based on statutory financial data as of December 31, 2002, ZLICONY had three
ratios outside the usual ranges: the adequacy of investment income ratio, the
change in premium ratio and the change in reserving ratio. The result for the
adequacy of investment income ratio was due to ZLICONY's small amount of
reserves relative to its total invested assets. The result for the change in
premium ratio is due to the relatively significant increase in premium in 2002
over 2001 as ZLICONY began writing business in 2001. The result for the change
in reserving ratio reflects the fact that ZLICONY began writing business in
2001 and had no single premiums in either 2001 or 2002 and had negligible
renewal premiums in 2001.
Other than certain states requesting routine quarterly financial reporting
and/or explanations of the underlying causes for certain ratios, no state
regulators have taken any action due to our IRIS ratios for 2002 or earlier
years.
Risk-based capital, asset adequacy and codification
Under Illinois' and New York's asset adequacy and risk-based capital rules,
state regulators may mandate remedial action for inadequately reserved or
inadequately capitalized companies. The asset adequacy rules are designed to
assure that assets supporting reserves are adequate to cover liabilities under
a variety of economic scenarios. The focus of risk-based capital rules is a
risk-based formula that applies prescribed factors to various risk elements in
an insurer's business and investments to develop a minimum capital requirement
designed to be proportional to the amount of risk assumed by the insurer. We
have capital levels exceeding any that would mandate action under the
risk-based capital rules and are in compliance with applicable asset adequacy
rules.
As of January 1, 2001, the Company adopted the Codification of Statutory
Accounting Principles ("Codification") guidance. The NAIC Accounting Practices
and Procedures Manual is the NAIC's primary guidance on statutory accounting.
Codification provides guidance for areas where statutory accounting had been
silent and changes current statutory accounting in some areas. The Illinois
Insurance Department adopted Codification, effective January 1, 2001. The
Company's statutory surplus was positively impacted by $16.7 million upon
adoption as a result of the net effect of recording a deferred tax asset, of
nonadmitting non-operating system software, of nonadmitting net affiliated
receivables and other changes caused by Codification.
The New York Insurance Department has adopted Codification as a component of
prescribed or permitted practices. The State had adopted certain prescribed
accounting practices that are at variance from those found in Codification.
Specifically, in 2001 deferred tax assets and deferred tax liabilities were not
recognized. In 2002, the State adopted the prescribed accounting practices of
the NAIC for deferred tax assets and deferred tax liabilities. The New York
Superintendent of Insurance has the right to permit other specific practices
that deviate from prescribed practices.
Reserves and reinsurance
The following table provides a breakdown of our reserves for future policy
benefits by product type (in millions):
December 31, December 31,
2002 2001
------------ ------------
General account annuities.................. $3,063 $2,767
Interest-sensitive life insurance and other 615 627
Ceded future policy benefits............... 434 240
------ ------
Total............................... $4,112 $3,634
====== ======
5
Ceded future policy benefits shown above reflect coinsurance (indemnity
reinsurance) transactions where we insured liabilities of approximately $516
million in 1992 and $416 million in 1991 with FLA and ceded benefits related to
our BOLI reinsurance discussed below. At December 31, 2002 and 2001, our
reinsurance reserve credit from FLA relating to these coinsurance transactions
totaled approximately $215.3 million and $230.1 million, respectively.
Utilizing FKLA's employees, we are the servicing company for this coinsured
business and we are reimbursed by FLA for the related servicing expenses. The
increase in ceded future policy benefits in 2002, compared with 2001, is
primarily due to BOLI ceded benefits in 2002 that were classified as a funds
withheld account ("FWA") liability in 2001, as discussed below.
In 1996, we assumed, on a yearly renewable term basis, approximately $14.4
billion (face amount) of term life insurance from FKLA. Effective September 30,
2000, this reinsurance agreement with FKLA was terminated. Upon termination, we
returned $7.7 million of premiums to FKLA, representing consideration for the
recaptured reserves. Due to the difference in the generally accepted accounting
principles basis and the statutory accounting basis of the reserves related to
this recaptured business, we recorded a deemed dividend distribution to Kemper
of $16.3 million in 2000. (See the note captioned "Reinsurance" in the Notes to
Consolidated Financial Statements.)
In the fourth quarter of 2000, we assumed from FKLA $100.0 million in
premium deposits related to a Funding Agreement. Funding Agreements are
insurance contracts similar to structured settlements, immediate annuities and
guaranteed investment contracts ("GICs"). The contracts qualify as insurance
under state laws and are sold as non-surrenderable immediate annuities to
trusts established by a securities firm. The securities firm sold interests in
these trusts to institutional investors. This Funding Agreement has a variable
rate of interest, is an obligation of our general account and is recorded as
future policy benefits. (See the note captioned "Reinsurance" in the Notes to
Consolidated Financial Statements.)
Effective December 31, 2001, the Company entered into a quota-share
reinsurance agreement with a ZFS affiliated company, Zurich Insurance Company,
Bermuda Branch ("ZICBB"). Under the terms of this agreement, the Company cedes
100 percent of the net amount at risk of the guaranteed minimum death benefit
and guaranteed retirement income benefit portions of a small number of specific
variable annuity contracts. As consideration for this reinsurance coverage, the
Company cedes 100 percent of all charges to policyholders and all revenue
sharing income received from fund managers related to such reinsured policies.
In 2001, the Company received $7.9 million of ceding commissions and expense
allowances, and paid $1.2 million of ceded premiums, related to this
reinsurance agreement. The account values related to these policies are held in
the Company's separate account during the accumulation period of the contracts.
The reserve credits under this treaty are secured by a trust agreement that
requires the fair market value of assets therein to be at least equal to 102
percent of such reserve credits.
In January 2003, the specific annuities that comprised the block of business
ceded to ZICBB were surrendered. Approximately $5.0 million in surrender
charges collected on these specific annuities was paid to ZICBB at the end of
February, 2003, as the final settlement payment related to this reinsurance
agreement.
The net amount at risk of the guaranteed minimum death benefit and
guaranteed retirement income benefit on certain new variable annuity contracts
issued between March 1, 1997 and April 30, 2000 were ceded to outside
reinsurers. As of December 31, 2002 and 2001, the reinsurance recoverable
related to reinsuring the net amount at risk on these contracts amounted to
$24.7 million and $8.3 million, respectively.
We are party to a reinsurance agreement with ZICBB. Under the terms of this
agreement, we cede, on a yearly renewable term basis, 100 percent of the net
amount at risk (death benefit payable to the insured less the insured's
separate account cash surrender value) related to BOLI. As consideration for
this reinsurance coverage, we cede separate account fees (cost of insurance
charges) to ZICBB. Until January 25, 2002, we retained a portion of such funds
under the terms of a reinsurance agreement in a FWA, which was included as a
component of benefits and funds payable in the accompanying 2001 consolidated
balance sheet.
6
During the first quarter of 2002, we amended our BOLI reinsurance agreement
with ZICBB. Under the amended agreement, the balance in the FWA was transferred
to a trust account that acts as security for the reinsurance agreement. On
January 25, 2002, approximately $222.5 million in cash was transferred to the
trust account. The trust account is not reflected in our consolidated financial
statements but is included in ZICBB's financial statements. At December 31,
2002, reserve credits totaling $237.6 million were secured by the trust
agreement which was supported by cash and invested assets with a fair value of
approximately $252.6 million.
The following table contains amounts related to the BOLI reinsurance
agreement with ZICBB (in millions):
Business Owned Life Insurance (BOLI)
(in millions)
Year Ended December 31,
----------------------------
2002 2001 2000
-------- -------- --------
Face amount in force........... $ 85,592 $ 85,564 $ 85,358
======== ======== ========
Net amount at risk ceded....... $(76,288) $(76,283) $(78,169)
======== ======== ========
Cost of insurance charges ceded $ 156.5 $ 168.1 $ 173.8
======== ======== ========
Funds withheld account......... $ -- $ 236.1 $ 228.8
======== ======== ========
As previously mentioned, the trust account at ZICBB acts as security for the
reinsurance agreement. In 2001, and until January 25, 2002, the FWA supported
reserve credits on reinsurance ceded on the BOLI product.
Competition
We are in a highly competitive business. We compete with a large number of
other stock and mutual life insurance companies, many of which are larger
financially, although none is truly dominant in the industry. KILICO, with its
emphasis on annuity products, also competes for savings dollars with securities
brokerage and investment advisory firms as well as other institutions that
manage assets, produce financial products or market other types of investment
products.
Our principal methods of competition continue to be innovative products,
often designed for selected distribution channels and economic conditions, as
well as appropriate product pricing, careful underwriting, expense control and
the quality of services provided to policyholders and agents.
To address our competition, we have adopted certain business strategies.
These include:
. customer segmentation and focus,
. continued focus on existing and new variable and fixed annuities and BOLI
products,
. distribution through diversified channels,
. systematic review of investment risk and our capital position,
. ongoing efforts to continue as a low-cost provider of insurance products
and high-quality services to agents and policyholders through the use of
technology,
. high quality, efficient operations, and
. rigorous expense management.
Rankings and ratings
According to Best's Insurance Reports, 2002, as of December 31, 2001, we
ranked 47th by admitted assets, 50th by net premiums written and 173rd by
capital and surplus out of the top 250 life insurers.
7
Our December 31, 2002 ratings were as follows:
Rating
--------------
A.M. Best Company........ A (Excellent)
Moody's Investors Service A2 (Good)
Standard & Poor's........ A+ (Strong)
Our Standard & Poor's ("S&P") rating was coupled with ZFS through December
31, 2001, due to the perceived financial strength of ZFS and Zurich Life and
the designation of Zurich Life as one of ZFS' core businesses. In September
2001, S&P announced that it was downgrading several insurance groups based on
the potential catastrophic losses from the September 11, 2001 terrorist attacks
on the United States of America, and the subsequent fall in equity markets. At
that time, ZFS was placed on CreditWatch with negative implications and its
rating, and therefore ours, was downgraded from "AA+" to "AA". In February
2002, ZFS received another downgrade to "AA-" and remained on CreditWatch with
negative implications. During 2001, ZFS considered the divestiture of Zurich
Life. Although ZFS made the decision to retain Zurich Life in December 2001,
S&P decided to uncouple Zurich Life's ratings from ZFS in March 2002, primarily
due to ZFS's consideration of the Zurich Life divestiture. At that time, we
received a rating of "A+", S&P's fifth highest rating, reflecting the
non-supported strength of Zurich Life and were taken off CreditWatch. In August
2002, the outlook for ZFS, our parent, was revised from stable to negative and
concurrently our A+ rating was placed on negative outlook.
We share our A.M. Best rating with ZFS. In the fall of 2001, A.M. Best
placed ZFS under review with developing implications but did not change its
ratings. In March 2002, ZFS's A.M. Best A+ (Superior) financial strength rating
was affirmed, removed from under review and assigned a negative outlook. In
September 2002, A.M. Best announced that it was downgrading ZFS to "A"
(Excellent) from "A+" (Superior). In December 2002, A.M. Best affirmed the "A"
rating of ZFS and its core operating subsidiaries and placed ZFS on a
positive outlook.
Our Moody's Investors Service ("Moody's") Aa3 rating was reviewed in March
2002 and placed under review for possible downgrade. In June 2002, Moody's
lowered our rating to A2, its sixth highest rating out of nineteen.
Employees
At December 31, 2002, we used the services of approximately 959 employees of
FKLA, which are also shared with FLA and ZLICA.
Regulation
We are generally subject to regulation and supervision by the insurance
departments of Illinois and other jurisdictions where we are licensed to do
business. These departments enforce laws and regulations designed to assure
that insurance companies maintain adequate capital and surplus, manage
investments according to prescribed character, standards and limitations and
comply with a variety of operational standards. The departments also make
periodic examinations of individual companies and review annual and other
reports on the financial condition of each company operating within their
respective jurisdictions. Regulations, which often vary from state to state,
cover most aspects of the life insurance business, including market practices,
policy forms and accounting and financial reporting procedures.
Insurance holding company laws enacted in many states grant additional
powers to state insurance commissioners to regulate acquisitions of and by
domestic insurance companies, to require periodic disclosure of relevant
information and to regulate certain transactions with related companies. These
laws also impose prior approval requirements for certain transactions with
affiliates and generally regulate dividend distributions by an insurance
subsidiary to its holding company parent.
8
In addition, certain of our variable life insurance and variable annuity
products, and the related separate accounts, are subject to regulation by the
Securities and Exchange Commission (the "SEC").
We believe we are in compliance, in all known material respects, with all
applicable regulations. For information on regulatory and other dividend
restrictions, see ITEM 5(c).
Investments
A changing marketplace has affected the life insurance industry. To
accommodate customers' increased preference for safety over higher yields, we
have systematically reduced our investment risk and strengthened our capital
position. During 2002, because of continued poor economic conditions, which
resulted in both write-downs and credit-related losses in our fixed income
portfolio, we repositioned this portfolio. The losses noted above were largely
offset by realized gains on sales in the portfolio and the proceeds were
primarily reinvested in higher quality, less risky investments at the expense
of reducing our portfolio yield. This should result in less volatility in our
fixed income portfolio in the future.
Our cash flow is carefully monitored and our investment program is regularly
and systematically planned to provide funds to meet all obligations and to
optimize investment return. For investment securities, portfolio management is
handled by Deutsche Investment Management Americas, Inc. ("DIM"), formerly
Zurich Scudder Investments, Inc. ("ZSI"), a subsidiary of Zurich at December
31, 2001. DIM provides investment services including purchases and sales of
securities, under the supervision of the Investment Operating Committee of the
Company. On September 24, 2001, ZFS announced that it would sell 100% of its
ownership in ZSI to Deutsche Bank in a transaction valued at $2.5 billion. The
sale was completed on April 5, 2002. This transaction did not included
Scudder's United Kingdom operations, Threadneedle Investments.
Our real estate-related investments are handled by a minority-owned Kemper
real estate subsidiary. Investment policy is directed by our board of
directors. Our investment strategies take into account the nature of each
annuity and life insurance product, the respective crediting rates and the
estimated future policy benefit maturities.
Forward-looking statements
All statements, trend analyses and other information contained in this
report and elsewhere (such as in other filings by KILICO with the SEC, press
releases, presentations by KILICO or its management or oral statements) about
markets for our products and trends in our operations or financial results, as
well as other statements including words such as "anticipate," "believe,"
"plan," "estimate," "expect," "intend," and other similar expressions,
constitute forward-looking statements under the Private Securities Litigation
Reform Act of 1995. These forward-looking statements are subject to known and
unknown risks, uncertainties and other factors which may cause actual results
to be materially different from those contemplated by the forward-looking
statements. These factors include, among other things:
(i) general economic conditions and other factors, including prevailing
interest rate levels and stock market performance, which may affect the
ability of KILICO to sell its products, the market value of our investments
and the lapse rate and profitability of our contracts,
(ii) our ability to achieve anticipated levels of operational
efficiencies through certain cost-saving initiatives,
(iii) customer response to new products, distribution channels and
marketing initiatives,
(iv) mortality, morbidity, and other factors which may affect the
profitability of our insurance products,
(v) changes in the federal income tax laws and regulations which may
affect the relative tax advantages of some of our products,
9
(vi) increasing competition which could affect the sale of our products,
(vii) regulatory changes or actions, including those relating to
regulation of financial services affecting (among other things) bank sales
and underwriting of insurance products, and regulations relating to the sale
and underwriting and pricing of insurance products, and
(viii) the risk factors or uncertainties listed from time to time in our
other filings with the SEC.
Item 2. Properties
We share 307,804 square feet of office space leased by Zurich North America,
an affiliate, from Wells Real Estate Funds, located in Schaumburg, Illinois.
FKLA makes payments for its share of lease expense per terms of the agreement.
Item 3. Legal Proceedings
We have been named as defendant in certain lawsuits incidental to our
insurance business. Based upon the advice of legal counsel, our management
believes that the resolution of these various lawsuits will not result in any
material adverse effect on our consolidated financial position.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
(a) There is no established public trading market for KILICO's common stock.
(b) Kemper owns all of the common stock of KILICO as of the date of this filing.
(c) A cash dividend of $20.0 million was declared and paid to Kemper on June
29, 2000. During 2000, we also reported a deemed dividend distribution of
$16.3 million to Kemper. Cash dividends of $10.0 million and $3.0 million
were declared and paid to Kemper on June 28, 2001 and September 27, 2001,
respectively. No dividends were paid by the Company in 2002 and no
additional dividends have been declared or paid through the date of filing
this Form 10-K.
On September 20, 2002, Kemper contributed $30 million of capital to KILICO.
In addition, on December 31, 2002, Kemper forgave a $7.3 million tax
receivable from KILICO, which was recorded as a capital contribution on
KILICO's books.
Restrictions on dividends
Dividend distributions from us to our stockholder are restricted by state
insurance laws. In Illinois, where we are domiciled, if a proposed dividend,
together with other distributions during the 12 preceding months, would exceed
the greater of (a) ten percent of our statutory surplus as regards
policyholders as of the preceding December 31, or (b) our statutorily adjusted
net income for the preceding calendar year, then the proposed dividend must be
reported to the director of insurance at least 30 days prior to the proposed
payment date. The dividend then may be paid only if not disapproved. The
Illinois insurance laws also permit payment of dividends only out of earned
surplus, exclusive of most unrealized capital gains. During 2001, the Company
paid dividends to Kemper in the amount of $13.0 million, which were approved by
the Illinois Department of Insurance. In 2002, the Company did not pay any
dividends. The Company cannot pay any dividends in 2003 without Illinois
Department of Insurance approval.
10
Item 6. Selected Financial Data
The following table sets forth selected financial information for KILICO for
the five years ended December 31, 2002. Such information should be read in
conjunction with our consolidated financial statements and notes thereto,
included in ITEM 8 of this Annual Report on Form 10-K. All amounts are shown in
millions.
December 31, December 31, December 31, December 31, December 31,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
Total revenue........................ $ 380.8 $ 398.3 $ 360.9 $ 363.4 $ 419.7
========= ========= ========= ========= =========
Net income (loss) excluding realized
investment results................. $ (168.5) $ 38.2 $ 53.7 $ 51.1 $ 31.4
========= ========= ========= ========= =========
Net income before goodwill impairment
and cumulative effect of accounting
change............................. $ 9.4 $ 51.6 $ 48.3 $ 44.9 $ 65.1
========= ========= ========= ========= =========
Net income (loss).................... $ (169.0) $ 51.6 $ 48.3 $ 44.9 $ 65.1
========= ========= ========= ========= =========
Financial summary
Total separate account assets........ $13,547.4 $13,108.8 $11,179.6 $ 9,778.1 $ 7,099.2
========= ========= ========= ========= =========
Total assets......................... $18,666.3 $18,089.8 $16,006.6 $14,655.7 $12,239.7
========= ========= ========= ========= =========
Future policy benefits, net of
reinsurance........................ $ 3,677.9 $ 3,393.6 $ 3,278.0 $ 3,409.1 $ 3,561.6
========= ========= ========= ========= =========
Stockholder's equity................. $ 723.8 $ 818.0 $ 730.1 $ 630.0 $ 853.9
========= ========= ========= ========= =========
As further discussed in ITEM 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations, we wrote down our goodwill asset
as of January 1, 2002, in accordance with Statement of Financial Accounting
Standard No. 142, Goodwill and Other Intangible Assets, issued in July 2001.
The write-down totaled $178.4 million.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
We recorded a net loss of $169.0 million in 2002, compared with net income
of $51.6 million and $48.3 million in 2001 and 2000, respectively. The net loss
was attributable to the write-off of the goodwill asset and lower operating
earnings for 2002, compared with 2001. The increase in net income in 2001,
compared with 2000, was due to an increase in net realized investment gains
somewhat offset by a decrease in operating earnings before amortization of
goodwill and other intangibles.
The following table reflects the components of net income (loss):
Net income (loss)
(in millions)
Year Ended December 31,
-----------------------
2002 2001 2000
------- ------ ------
Operating earnings before amortization of goodwill and other intangibles $ 10.7 $ 51.9 $ 66.8
Goodwill impairment..................................................... (156.5) -- --
Amortization of goodwill and other intangibles.......................... (.8) (13.7) (13.1)
Net realized investment gains (losses).................................. (.5) 13.4 (5.4)
Cumulative effect of accounting change, net of tax...................... (21.9) -- --
------- ------ ------
Net income (loss)................................................ $(169.0) $ 51.6 $ 48.3
======= ====== ======
11
Net realized investment results, after tax
(in millions)
Year Ended December 31,
---------------------
2002 2001 2000
------ ------ -----
Fixed maturity securities. $ 22.0 $ 12.9 $ (.5)
Fixed maturity write-downs (12.0) (10.1) (7.4)
Real estate-related gains. .6 10.4 1.1
Other gains (losses), net. (11.1) .2 1.4
------ ------ -----
Total.............. $ (.5) $ 13.4 $(5.4)
====== ====== =====
Net realized investment gains on fixed maturity securities in both 2002 and
2001 were primarily due to the sale of securities in a decreasing interest rate
environment that resulted in higher market values in fixed maturity
investments. Significantly offsetting these realized gains were
other-than-temporary declines in value of certain securities due to
credit-related concerns about a number of issuers and collateralized bond
obligation impairment losses related to Emerging Issues Task Force 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets. (See INVESTMENTS
section.) These pre-tax write-downs totaled $18.5 million and $15.5 million in
2002 and 2001, respectively. In 2000, pre-tax fixed maturity write-downs
totaled $11.4 million and were primarily related to other-than-temporary
declines in value of certain securities due to credit-related concerns about a
small number of issuers.
The other losses, net, for 2002 consist primarily of a write-down on a
leveraged lease that covers two aircraft. The aircraft are leased by United
Airlines ("UAL") and were written down to zero subsequent to UAL filing Chapter
11 bankruptcy in the fourth quarter of 2002. The pre-tax write-down totaled
$17.5 million.
The real estate-related gains in 2001 were primarily due to the release of
reserve allowances originally recorded against certain mortgage loans. (See
INVESTMENTS section.).
The decrease in amortization of goodwill and other intangibles was due to
the implementation of Statement of Financial Accounting Standards No. 142
("SFAS 142"), Goodwill and Other Intangible Assets, issued in July 2001. SFAS
142 primarily addresses the accounting that must be applied to goodwill and
intangible assets subsequent to their acquisition. Effective January 1, 2002,
SFAS 142 requires that goodwill and indefinite-lived intangible assets no
longer be amortized, but be tested annually for impairment at the reporting
unit level.
We tested our goodwill for impairment, based on the guidance under SFAS 142,
at the life insurance and annuities operating segment level as a result of a
shift in our financial focus to a line of business performance view. As a
result of the testing performed, an impairment of $21.9 million was recorded in
the annuities segment as of June 30, 2002 as a cumulative effect of accounting
change, net of tax. The fair value of that segment was estimated using expected
present value of future cash flows for both current business in-force and
future production estimates.
In September 2002, the board of directors of our indirect, 100% shareholder,
Zurich Financial Services Group ("the Group"), approved a plan designed to
improve the profitability of the Group and its subsidiaries. Under this plan,
the Group considered a number of strategic options, the completion of which
could have a significant impact on the recoverability of the carrying value of
certain assets. Among the assets affected by the approval of the plan is the
goodwill associated with the acquisition of the Zurich Life companies. The
Company filed its Form 10-Q for the period ended June 30, 2002 prior to the
board's action. As a result, the Company recorded the complete write-down of
the remaining goodwill of $156.5 million in the third quarter of 2002, the
period during which we became aware of this action by the Group's board of
directors.
12
Operating earnings before the amortization of goodwill and other intangibles
decreased to $10.7 million in 2002, compared with $51.9 million in 2001,
primarily due to:
. a decrease in spread revenue (net investment income less interest credited
to policyholders),
. an increase in claims incurred and other policyholder benefits,
. an increase in taxes, licenses and fees,
. an increase in commissions and operating expenses, net of the deferral of
insurance acquisition costs, and
. an increase in the amortization of insurance acquisition costs and value
of business acquired,
offset by
. an increase in separate account fees,
. an increase in other income, and
. a decrease in income tax expense.
Operating earnings before the amortization of goodwill and other intangibles
decreased to $51.9 million in 2001, compared with $66.8 million in 2000,
primarily due to:
. a decrease in premium income,
. an increase in claims incurred and other policyholder benefits,
. an increase in commissions and operating expenses, net of the deferral of
insurance acquisition costs, and
. an increase in income tax expense,
offset by
. an increase in separate account fees,
. an increase in other income,
. an increase in spread revenue (net investment income less interest
credited to policyholders),
. a decrease in taxes, licenses and fees, and
. a decrease in the amortization of insurance acquisition costs and value
of business acquired.
The following table reflects our sales and reinsurance assumed:
Sales and reinsurance assumed
(in millions)
Year Ended December 31,
--------------------------
2002 2001 2000
-------- -------- --------
Annuities:
Variable........................................... $ 979.3 $2,547.4 $1,160.5
Fixed.............................................. 370.3 142.0 168.6
Funding Agreements assumed......................... -- -- 100.0
-------- -------- --------
Total annuities................................ 1,349.6 2,689.4 1,429.1
-------- -------- --------
Life Insurance:
Separate account business-owned variable universal
life ("BOLI").................................... 863.7 515.3 819.6
Separate account variable universal life........... 17.7 29.6 36.5
Term life.......................................... 3.7 1.6 (8.2)
Interest-sensitive life............................ 1.1 1.3 1.4
-------- -------- --------
Total life..................................... 886.2 547.8 849.3
-------- -------- --------
Total sales................................. $2,235.8 $3,237.2 $2,278.4
======== ======== ========
13
Sales of annuity products consist of total deposits received, which are not
recorded as revenue within the consolidated statements of operations. Variable
annuity deposits, including deposits under the fixed account option, decreased
$1.6 billion in 2002, compared with 2001. The decrease in the variable annuity
deposits is primarily due to lower sales of our DESTINATIONS/SM/ product. In
the fourth quarter of 2001, we discontinued offering the guaranteed retirement
income benefit ("GRIB") option with the DESTINATIONS/SM/ product due to the
continued decline in the stock market over the past two years and in the first
quarter of 2003, we discontinued all sales of DESTINATIONS/SM/. While we
continued to receive renewal premiums and Section 1035 premium (tax-free
exchange of certain insurance policies) during 2002, sales of the
DESTINATIONS/SM /product will continue to be substantially lower in future
years because of these decisions.
The GRIB is an optional benefit to the DESTINATIONS/SM/ variable annuity,
for an additional asset-based fee. It allows for a proxy account value, called
the GRIB Base, to be applied to the guaranteed annuity factors (settlement
option purchase rates) in the contract. The GRIB Base prior to attained age 80
is the greatest of:
. the contract value (account value),
. the greatest anniversary value before the exercise (annuitization) date, or
. purchase payments minus previous withdrawals, accumulated at 5 percent
interest per year to the annuitization date.
Fixed annuity deposits increased $228.3 million in 2002 when compared with
2001, primarily due to the successful promotion of our Zurich Classic II fixed
annuity product in the second half of 2002.
The $100.0 million Funding Agreement assumed in 2000 resulted from a new
reinsurance agreement with FKLA. (See the note captioned "Reinsurance" in the
Notes to Consolidated Financial Statements.)
Sales of variable annuities increase separate account fees earned. In
addition, they pose less investment risk to us, to the extent that
policyholders allocate net premium to one or more subaccounts that invest in
underlying investment funds that invest in stocks or bonds. The customer bears
the investment risk on these stocks or bonds, however, the risk is subject to
the underlying guarantees provided in the contract. Additional fees are charged
to cover specific benefit options elected by the policyholders, such as the
GRIB option.
Sales of BOLI increased $348.4 million to $863.7 million in 2002, compared
with $515.3 million in 2001, the majority of which was attributable to renewal
premiums. Due to the nature of the product--high dollar volume per sale, low
frequency of sales, the level of BOLI sales can fluctuate, sometimes
significantly, between periods. Continued maturation of the BOLI market and our
ratings as a company can also affect the level of BOLI sales. Sales of
individual variable universal life insurance decreased $11.9 million to $17.7
million in 2002, compared with $29.6 million in 2001 as we exited this product
line in 2002 due to lack of scale and profitability. Sales of these separate
account variable products pose minimal investment risk as policyholders also
direct their premium to one or more subaccounts that invest in underlying
investment funds which invest in stocks and bonds. We receive premium tax and
DAC tax expense loads from certain policyholders, as well as administrative
fees and cost of insurance charges. These fees and charges are compensation for
providing life insurance coverage to the policyholders potentially in excess of
their cash surrender values.
Face amount of new variable universal life insurance business issued
amounted to $0.1 billion in 2002, compared with $2.2 billion in 2001 and $3.8
billion in 2000. The decrease in face amount issued in 2002, compared with
2001, is primarily due to the decrease in first year sales of BOLI.
14
The following table reflects our assets under management:
Assets under management
(in millions)
2002 2001 2000
--------- --------- ---------
General account........... $ 3,930.9 $ 3,815.8 $ 3,689.5
Separate account--BOLI.... 8,769.6 7,598.9 6,905.9
Separate account--non-BOLI 4,777.8 5,509.8 4,273.7
--------- --------- ---------
Total.............. $17,478.3 $16,924.5 $14,869.1
========= ========= =========
Total assets under management have increased over the last few years
primarily reflecting the volume of sales. The level of policyholder surrenders,
withdrawals and death benefits also directly impacts the level of assets under
management from year to year. Total assets under management were also affected
by equity market and interest rate fluctuations.
Spread revenue decreased in 2002, compared with 2001, due to a larger
decrease in investment income than the decrease in interest credited. The
decrease in investment income was primarily due to the reinvestment of 2001 and
2002 sales proceeds, maturities and prepayments in lower yielding securities
due to the lower interest rate environment, the non-recurrence of the positive
impact during 2001 of placing certain mortgage loans on accrual status in the
fourth quarter of 2001 (see INVESTMENTS--Real estate-related investments for
further discussion) and the loss of investment income earned on the BOLI FWA
during 2002. During the first quarter of 2002, we amended our BOLI reinsurance
agreement with a ZFS affiliated company, Zurich Insurance Company, Bermuda
Branch ("ZICBB"). Under the amended agreement, the balance in the FWA was
transferred to a trust account that acts as security for the reinsurance
agreement. On January, 25, 2002, approximately $222.5 million in cash was
transferred to the trust account. The trust account is not reflected in our
consolidated financial statements but is included in ZICBB's financial
statements.
The decrease in interest credited in 2002, compared to 2001, was due to
lower average interest crediting rates reflecting the declining interest rate
environment, somewhat offset by higher average policyholder account balances.
Spread revenue increased in 2001, compared with 2000, due to a larger
increase in investment income than in interest credited to policyholders. The
increase in investment income in 2001, compared with 2000, was primarily due to
placing certain mortgage loans on accrual status in the fourth quarter of 2001.
(See INVESTMENTS--Real estate-related investments for further discussion.) This
increase was somewhat offset by the reinvestment of 2000 and 2001 sales
proceeds, maturities and prepayments in lower yielding securities due to the
lower interest rate environment.
The increase in interest credited in 2001, compared with 2000, was due to
higher average policyholder account balances and a slight increase in average
interest crediting rates, primarily due to new business issued.
Investment income was also reduced over the last three years reflecting
purchase accounting adjustments related to the amortization of premiums on
fixed maturity investments. Under purchase accounting, the fair value of the
fixed maturity investments as of January 4, 1996, the date Kemper was acquired
by ZFS, became the new cost basis in the investments. The difference between
the new cost basis and original par is then amortized against investment income
over the remaining effective lives of the fixed maturity investments. As a
result of the interest rate environment as of January 4, 1996, the market value
of the fixed maturity investments was approximately $133.9 million greater than
original par. Premium amortization decreased investment income by approximately
$1.9 million in 2002, compared with $2.8 million in 2001 and $3.5 million in
2000.
15
Separate account fees and charges
(in millions)
2002 2001 2000
------- ------- -------
Separate account fees on non-BOLI variable life and
annuities........................................ $ 85.9 $ 67.6 $ 62.1
BOLI cost of insurance charges and fees--direct.... 164.8 163.5 164.4
BOLI cost of insurance charges and fees--ceded..... (156.9) (168.4) (173.8)
BOLI premium tax expense loads..................... 16.2 8.3 15.6
------- ------- -------
Total....................................... $ 110.0 $ 71.0 $ 68.3
======= ======= =======
Included in separate account fees and charges are administrative and other
fees received from the separate account products of $79.0 million in 2002,
compared with $66.7 million and $61.4 million in 2001 and 2000, respectively.
Administrative and other fee revenue increased in each of the last three years
due to growth in average separate account assets, somewhat offset by the
decline in the stock market, as the fees are primarily asset-based. Also
included in separate account fees and charges are cost of insurance ("COI")
charges related to variable universal life insurance, primarily BOLI, of $163.1
million, $162.1 million and $164.4 million in 2002, 2001 and 2000,
respectively. Of these COI charges, $156.5 million, $168.1 million and $173.8
million, respectively, were ceded to ZICBB.
Net BOLI cost of insurance charges and fees increased $12.8 million in 2002,
compared with 2001, primarily related to the transfer of the assets supporting
the FWA to a trust, as previously discussed. Prior to the transfer, we ceded
additional cost of insurance charges due to appreciation of the FWA, resulting
in ceded COI charges in excess of 100 percent of direct COI charges received.
Other income increased $5.5 million in 2002, compared with 2001. The
increase was primarily due to an increase in surrender charge revenue as well
as an increase in commission revenue from broker-dealer operations. Surrender
charge revenue totaled $10.1 million in 2002, compared with $6.5 million and
$6.0 million in 2001 and 2000, respectively. The increase in surrender charge
revenue over the past three years reflects the increased policyholder surrender
and withdrawal activity, excluding BOLI, during the same period. Broker-dealer
commission revenue increased $2.5 million in 2002, compared with 2001. This
increase was substantially offset by an increase in broker-dealer commission
expense in 2002.
Other income increased $1.7 million in 2001, compared with 2000. The
increase was primarily due to an increase in commission revenue from
broker-dealer operations. The increase was substantially offset by an increase
in broker-dealer commission expense in 2001.
Policyholder surrenders, withdrawals and death benefits
(in millions)
2002 2001 2000
------ ------ ------
General account.. $358.6 $450.9 $579.1
Separate account. 552.1 523.8 393.3
------ ------ ------
Total..... $910.7 $974.7 $972.4
====== ====== ======
Reflecting the current interest rate environment and other competitive
market factors, we adjust crediting rates on interest-sensitive products over
time in order to manage spread revenue and policyholder surrender and
withdrawal activity. Spread revenue can also be improved over time by
increasing investment income.
General account surrenders, withdrawals and death benefits decreased $92.3
million in 2002, compared with 2001, due to a decrease in overall surrenders
and withdrawals as equity markets remained volatile.
Surrenders, withdrawals and death benefits on separate account products
increased $28.3 million in 2002, compared with 2001. Excluding surrenders of
$92.4 million on BOLI contracts in 2001, the majority of which
16
was a contact with an affiliate, surrenders, withdrawals and death benefits on
separate account products increased $120.7 million in 2002, compared with 2001.
The increase is primarily due to investors' seeking more stable returns during
a period of equity market uncertainty.
Claims incurred and other policyholder benefits increased $40.7 million in
2002, compared with 2001, primarily due to an increase in policyholder reserves
for guaranteed minimum death benefits ("GMDB") and GRIB on certain of our
variable annuity contracts due to increasing variable annuity business in-force
and a lower stock market. We reserve for death benefit guarantees in our
variable annuities. For policies that were deemed to have elected
annuitization, GRIB reserves have been established to cover the present value
of future benefits. A further decline in the stock market would have the impact
of increasing these GMDB and GRIB reserves.
Pursuant to accounting principles generally accepted in the United States of
America, no additional liabilities for future policy benefits related to
guaranteed living benefits have been established. However, a number of
accounting exposure drafts on this subject have been circulated for comment.
While these exposure drafts vary significantly in terms of recognizing future
policy liabilities for guaranteed living benefits, it appears some form of
recognition will be forthcoming. As a result, recognition of future policy
benefits for GRIB in future periods could vary significantly from amounts
recorded as of December 31, 2002.
The increase in claims incurred and other policyholder benefits is also due
to higher mortality experience in 2002, compared with 2001, and higher
guaranteed minimum death benefit payments on certain of our variable annuity
contracts due to increasing variable annuity business in-force and a lower
stock market.
The termination of the assumed term life reinsurance agreement with FKLA
decreased claims incurred and other policyholder benefits in 2001, compared to
2000.
Taxes, licenses and fees primarily reflect premium taxes on BOLI. Excluding
the taxes due on BOLI, for which we received a corresponding expense load in
separate account fees and other charges; taxes, licenses and fees amounted to
$3.1 million in 2002, compared with $2.4 million in 2001 and $2.3 million in
2000.
Commission and operating expenses, net of the deferral of insurance
acquisition costs increased in 2002, compared with 2001 and 2000. The increase
is primarily due to an increase in broker-dealer commission expense, as
previously mentioned.
Amortization of insurance acquisition costs increased $16.9 million in 2002,
compared with 2001. This net increase was attributable to lower future
estimated gross profits (EGPs) due to the continued decline in the stock
market, realized capital gains on investments purchased subsequent to the ZFS
acquisition and a lower yielding investment portfolio. The percentage changes
in the S&P 500 for the years ended December 31, 2002, 2001 and 2000 were -23.4
percent, -13.0 percent, and -10.1 percent, respectively. Depreciation in the
stock market resulted in depreciation in the separate account assets, which
reduces asset-based separate account fees and future EGPs. This accelerated
amortization in the current period. Realized capital gains on post-purchase
(i.e., after January 4, 1996) investments increased current gross profits,
decreasing future EGPs, and accelerated amortization in the current period. The
lower yielding investment portfolio compresses future interest margins (spread
income) which reduces future EGPs and also accelerates current year
amortization.
Amortization of insurance acquisition costs decreased $5.2 million in 2001,
compared with 2000. This net decrease was attributable to several factors.
During 2000, the amortization of insurance acquisition costs was increased by
$10.5 million due to loss recognition resulting from our periodic review of the
estimated future gross profits on annuity contracts. Estimated future gross
profits on annuity contracts were lowered at that time based on the reduction
in the asset-based separate account fees. During 2001, realized capital losses
on investments purchased subsequent to the ZFS acquisition decreased the
amortization of insurance acquisition costs by $6.4 million. These amounts were
partially offset by an increase in amortization, due to the higher volume of
annuity business in force.
17
Deferred insurance acquisition costs, and their related amortization, for
policies sold prior to January 4, 1996 have been replaced under purchase
accounting by the value of business acquired ("VBA"). The VBA reflects the
present value of the right to receive future cash flows from insurance
contracts existing at the date of acquisition. The amortization of the VBA is
calculated assuming an interest rate equal to the liability or contract rate on
the business acquired. Deferred insurance acquisition costs are established on
all new policies sold after January 4, 1996.
Depreciation in the stock market has continued to decrease the pre-purchase
(i.e., prior to January 4, 1996) separate account assets and the related
asset-based separate account fees over the past few years. The continued
reduction in the asset-based separate account fees has decreased the current
and future EGPs in 2002, 2001 and 2000. The amortization of the VBA over the
past several years reflects the net impact that the continued decline in the
stock market has had on the current and future EGPs of the pre-purchase annuity
contracts. A lower yielding pre-purchase investment portfolio during 2002 has
also impacted VBA amortization in 2002. The lower yielding investment portfolio
compresses future interest margins (spread income) which reduces future EGPs
and accelerates current year amortization.
As previously discussed, we wrote off the remaining goodwill asset that was
on the books at January 1, 2002. In accordance with SFAS 142, no amortization
was recorded in 2002 related to the goodwill asset. Other intangible assets
related to the purchase of PMG continue to be amortized on a straight-line
basis over a ten-year period.
Tax expense for 2002 decreased by $30.5 million, compared with 2001,
primarily due to lower operating earnings in 2002, compared to 2001 and
realized capital losses in 2002, compared to realized capital gains in 2001.
Prior year's provision to return adjustments created a tax benefit of $2.2
million during 2002. There were no such adjustments during 2001. Tax expense
also decreased by $3.6 million in 2002 related to a tax settlement with the
Internal Revenue Service.
Tax expense increased in 2001, compared with 2000, primarily due to the
release of a $15.2 million valuation allowance in 2000. The valuation allowance
was related to the ultimate realization of losses on real estate assets
disposed of before December 31, 1995. In 2000, an additional $4.6 million
benefit was realized on the termination of the reinsurance agreement with FKLA.
Operations by Business Segment
We, along with FKLA, ZLICA and FLA, operate under the trade name Zurich
Life, formerly Zurich Kemper Life. Prior to 2002, Zurich Life was organized by
Strategic Business Unit ("SBU"). Each SBU concentrated on specific distribution
channels. However, the SBUs were not managed at the legal entity level, but
rather at the Zurich Life level. Zurich Life's SBUs crossed legal entity lines,
as certain similar products were sold by more than one legal entity and/or
through more than one distribution channel.
In 2002, our management team shifted its financial focus from SBU
performance to a line of business performance, within each legal entity. The
SBUs are now primarily responsible for market management, including
distribution management, product design, sales and marketing.
We have two primary operating segments, life insurance and annuities, that
offer different types of products and services. These two operating segments
reflect the way we manage our operations and make business decisions.
Premiums received from the sale of annuity products and the majority of our
life insurance products are treated as deposit-type funds and are not recorded
as revenue within the consolidated statements of operations. However, revenues
for both the life insurance and annuity segments are generated from investing
these deposit-type funds. For universal life insurance products and fixed
annuity products, deposits are primarily invested in
18
fixed maturity securities from which we earn investment income. Variable life
insurance deposits and variable annuity deposits are transferred to the
separate account and invested in underlying investment funds that invest in
stocks and bonds. We receive cost of insurance charges and other separate
account fees as revenues from this business. In addition, we receive premium
tax and DAC tax expense loads from certain policyholders.
In the following table, we use the caption "net operating income" as an
operating measure of segment performance. Net operating income is calculated by
deducting net realized investment gains or losses, net of related income taxes,
and the cumulative effect of a change in accounting principle, net of tax, from
net income. Net realized investment gains or losses are excluded from net
operating income because they can, in part, be discretionary and are not
indicative of operational trends.
Prior period information has been restated to conform to the new composition of
our segments.
Twelve Months Ended Twelve Months Ended
December 31, 2002 December 31, 2001
----------------------------------- ---------------------------------
(in thousands) Life Annuity Total Life Annuity Total
-------------- ---------- ---------- ----------- ---------- ---------- -----------
Total operating revenue............................... $ 80,573 $ 300,968 $ 381,541 $ 78,196 $ 299,441 $ 377,637
========== ========== =========== ========== ========== ===========
Operating income (loss) before tax expense, goodwill
impairment and cumulative effect of accounting
change............................................... $ 13,663 $ (5,800) $ 7,863 $ 15,721 $ 43,370 $ 59,091
Income tax expense (benefit) on operations............ 5,238 (7,342) (2,104) 7,128 13,795 20,923
Goodwill impairment................................... (32,832) (123,679) (156,511) -- -- --
---------- ---------- ----------- ---------- ---------- -----------
Net operating income (loss) before cumulative effect
of accounting change................................. (24,407) (122,137) (146,544) 8,593 29,575 38,168
Cumulative effect of accounting change, net of tax.... -- (21,907) (21,907) -- -- --
---------- ---------- ----------- ---------- ---------- -----------
Net operating income (loss)........................... $ (24,407) $ (144,044) $ (168,451) $ 8,593 $ 29,575 $ 38,168
========== ========== =========== ========== ========== ===========
Goodwill.............................................. $ -- $ -- $ -- $ 6,601 $ 171,817 $ 178,418
========== ========== =========== ========== ========== ===========
Total assets.......................................... $9,840,840 $8,825,442 $18,666,282 $8,841,469 $9,248,359 $18,089,828
========== ========== =========== ========== ========== ===========
Total reserve for policyholder benefits in the general
account.............................................. $ 808,389 $3,303,100 $ 4,111,489 $ 628,899 $3,005,262 $ 3,634,161
Total Separate Account liabilities.................... 8,848,140 4,699,236 13,547,376 7,696,013 5,412,740 13,108,753
---------- ---------- ----------- ---------- ---------- -----------
Total reserve for policyholder benefits............... $9,656,529 $8,002,336 $17,658,865 $8,324,912 $8,418,002 $16,742,914
========== ========== =========== ========== ========== ===========
Twelve Months Ended
December 31, 2000
----------------------------------
(in thousands) Life Annuity Total
-------------- ---------- ---------- -----------
Total operating revenue............................... $ 90,913 $ 278,274 $ 369,187
========== ========== ===========
Operating income (loss) before tax expense, goodwill
impairment and cumulative effect of accounting
change............................................... $ 23,820 $ 34,005 $ 57,825
Income tax expense (benefit) on operations............ 4,171 (27) 4,144
---------- ---------- -----------
Net operating income (loss) before cumulative effect
of accounting change................................. 19,649 34,032 53,681
Cumulative effect of accounting change, net of tax.... -- -- --
---------- ---------- -----------
Net operating income (loss)........................... $ 19,649 $ 34,032 $ 53,681
========== ========== ===========
Goodwill.............................................. $ 5,764 $ 185,399 $ 191,163
========== ========== ===========
Total assets.......................................... $8,077,697 $7,928,946 $16,006,643
========== ========== ===========
Total reserve for policyholder benefits in the general
account.............................................. $ 691,290 $2,896,850 $ 3,588,140
Total Separate Account liabilities.................... 7,009,309 4,170,330 11,179,639
---------- ---------- -----------
Total reserve for policyholder benefits............... $7,700,599 $7,067,180 $14,767,779
========== ========== ===========
19
Total operating revenues for the life insurance segment increased slightly
in 2002, compared with 2001. The increase is primarily due to higher separate
account fees offset by lower net investment income. The higher separate account
fees were mainly due to the increase in BOLI premium in 2002, compared with
2001. The decrease in net investment income was mainly due to a lower invested
asset base in recent years, as previously discussed.
Total operating revenues for the annuity segment also increased slightly in
2002, compared with 2001. The increase is primarily due to higher separate
account fees due to a larger separate account asset base and an increase in
surrender charges. These increases were offset by lower net investment income
in 2002, compared with 2001.
Net operating income, before taxes, goodwill impairment and the cumulative
effect of an accounting change, for the life insurance segment decreased in
2002, compared with 2001. The decrease is primarily due to an increase in
claims incurred.
Net operating income, before taxes, goodwill impairment and the cumulative
effect of an accounting change, for the annuity segment decreased in 2002,
compared with 2001, primarily due to an increase in policyholder reserves and
an increase in the amortization of deferred acquisition costs. Policyholder
reserves increased due to GMDB and GRIB reserve increases, as previously
discussed. Amortization of deferred acquisition costs increased due to lower
future EGPs, as previously discussed.
INVESTMENTS
Our principal investment strategy is to maintain a balanced,
well-diversified portfolio supporting the insurance contracts written. We make
shifts in our investment portfolio depending on, among other factors:
. our evaluation of risk and return in various markets,
. consistency with our business strategy and investment guidelines approved
by the board of directors,
. the interest rate environment,
. liability durations, and
. changes in market and business conditions.
Invested assets and cash
(in millions)
December 31, December 31,
2002 2001
------------ ------------
Cash and short-term investments....................... $ 47 1.2% $ 216 5.7%
Fixed maturity securities:
Investment-grade:
NAIC(1) Class 1................................ 2,442 62.1 1,846 48.4
NAIC(1) Class 2................................ 881 22.4 1,121 29.4
Below investment-grade (NAIC classes 3 through 6):
Performing..................................... 95 2.4 123 3.2
Non-performing................................. 3 0.0 5 0.1
Equity securities..................................... 59 1.5 68 1.8
Joint venture mortgage loans.......................... 114 2.9 104 2.7
Third-party mortgage loans............................ 58 1.5 64 1.7
Other real estate-related investments................. 6 0.2 8 0.2
Policy loans.......................................... 224 5.7 240 6.3
Other................................................. 2 0.1 21 0.5
------ ----- ------ -----
Total(2).................................... $3,931 100.0% $3,816 100.0%
====== ===== ====== =====
- --------
(1) National Association of Insurance Commissioners ("NAIC").
--Class 1 = A- and above
--Class 2 = BBB- through BBB+
(2) See the note captioned "Financial Instruments--Off-Balance-Sheet Risk" in
the Notes to Consolidated Financial Statements.
20
Fixed maturity securities
We carry our fixed maturity investment portfolio, which is considered
available-for-sale, at estimated fair value. The aggregate unrealized
appreciation or depreciation is recorded as a component of accumulated other
comprehensive income, net of any applicable income tax expense on unrealized
appreciation. The after-tax aggregate unrealized appreciation on fixed maturity
securities at December 31, 2002 was $69.5 million. The after-tax aggregate
unrealized appreciation on fixed maturity securities at December 31, 2001 was
$24.3 million. We record tax benefits related to aggregate unrealized
depreciation on investments. However, where appropriate, the tax benefit is
offset by a valuation allowance. Fair values are sensitive to movements in
interest rates and other economic developments and can be expected to
fluctuate, at times significantly, from period to period.
At December 31, 2002, investment-grade fixed maturity securities, cash and
short-term investments accounted for 85.7 percent of invested assets and cash,
compared with 83.5 percent at December 31, 2001. Approximately 48.0 percent of
our NAIC Class 1 bonds were rated AAA or equivalent at year-end 2002, compared
with 53.3 percent at December 31, 2001.
Approximately 16.2 percent of the investment-grade fixed maturity securities
at December 31, 2002 were residential mortgage-backed securities, down from
22.0 percent at December 31, 2001. Approximately 6.3 percent of the
investment-grade fixed maturity securities at December 31, 2002 were commercial
mortgage-backed securities, compared with 5.7 percent at December 31, 2001. The
residential mortgage-backed securities consist primarily of marketable mortgage
pass-through securities issued by the Government National Mortgage Association,
the Federal National Mortgage Association or the Federal Home Loan Mortgage
Corporation and other investment-grade securities collateralized by mortgage
pass-through securities issued by these entities. We have not made any
investments in interest-only or other similarly volatile tranches of
mortgage-backed securities. Our mortgage-backed investments are generally of
AAA credit quality, and the markets for these investments have been and are
expected to remain liquid.
Approximately 7.3 percent and 9.6 percent of the investment-grade fixed
maturity securities at December 31, 2002 and 2001, respectively, consisted of
asset-backed securities. The majority of investments in asset-backed securities
were backed by home equity loans (34.7%), manufactured housing loans (17.7%),
collateralized loan and bond obligations (15.4%) and automobile loans (13.1%).
Future investment income from mortgage-backed securities and other
asset-backed securities may be affected by the timing of principal payments and
the yields on reinvestment alternatives available at the time of such payments.
Prepayment activity resulting from a decline in interest rates on such
securities purchased at a premium would accelerate the amortization of the
premiums. Accelerated amortization would result in reductions of investment
income related to such securities.
At December 31, 2002 and 2001, unamortized premiums and discounts related to
mortgage-backed and asset-backed securities were as follows (in millions):
December 31,
-----------
2002 2001
----- -----
Unamortized premiums. $19.0 $12.2
===== =====
Unamortized discounts $ 3.5 $ 9.0
===== =====
Amortization of the discount or premium from mortgage-backed and
asset-backed securities is recognized using a level, effective yield method.
This method considers the estimated timing and amount of prepayments of the
underlying loans and is adjusted to reflect differences between the prepayments
originally anticipated and the
21
actual prepayments received and currently anticipated. To the extent that the
estimated lives of these securities change as a result of changes in prepayment
rates, the adjustment is also included in net investment income.
The table below provides information about the mortgage-backed and
asset-backed securities that are sensitive to changes in interest rates. The
expected maturity dates have been calculated on a security by security basis
for asset-backed securities and collateralized mortgage obligations. Mortgage
pass-though expected maturities are calculated from grouped securities by
collateral type, weighted average coupon and maturity date. Prepayment
assumptions were obtained from a survey conducted by a securities information
service and are consistent with the current interest rate and economic
environment.
Carrying
Value at Expected Maturity Date Fair Value at
December 31, ---------------------------------------------------- December 31,
(in millions) 2002 2003 2004 2005 2006 2007 Thereafter 2002
------------- ------------ ------- ------- ------- ------ ------ ---------- -------------
Mortgage-backed
Residential
--Principal payments..... $ 536.8 $ 216.3 $ 111.1 $ 120.0 $ 53.1 $ 14.7 $ 21.6 $ 536.8
--Average yield.......... 4.80% 5.26% 5.78% 6.08% 6.06% 5.88% 5.71% 4.80%
Commercial
--Principal payments..... $ 210.9 $ 19.3 $ -- $ 8.1 $ -- $ 46.7 $ 136.9 $ 210.9
--Average yield.......... 6.18% 6.18% 6.18% 6.18% 6.11% 6.09% 6.58% 6.18%
Asset-backed
--Principal payments..... $ 245.3 $ 39.2 $ 54.3 $ 45.2 $ 38.2 $ 31.2 $ 37.2 $ 245.3
--Average yield.......... 6.55% 6.55% 6.38% 6.27% 6.84% 7.39% 7.44% 6.55%
------- -------
$ 993.0 $ 993.0
======= =======
Carrying
Value at Expected Maturity Date Fair Value at
December 31, ------------------------------------------------- December 31,
(in millions) 2001 2002 2003 2004 2005 2006 Thereafter 2001
------------- ------------ ------ ------ ------ ------ ------ ---------- -------------
Mortgage-backed
Residential
--Principal payments..... $ 726.5 $ 62.9 $ 87.8 $ 72.8 $ 85.6 $ 86.4 $ 331.0 $ 726.5
--Average yield.......... 6.39% 6.39% 6.36% 6.36% 6.47% 6.29% 6.27% 6.39%
Commercial
--Principal payments..... $ 92.4 $ 8.8 $ 7.4 $ 3.9 $ 17.4 $ 11.9 $ 43.0 $ 92.4
--Average yield.......... 6.52% 6.52% 6.52% 6.52% 6.45% 6.45% 6.67% 6.52%
Asset-backed
--Principal payments..... $ 291.3 $ 31.4 $ 44.7 $ 45.8 $ 37.5 $ 18.5 $ 113.4 $ 291.3
--Average yield.......... 7.12% 7.12% 7.10% 7.34% 7.47% 7.57% 7.54% 7.12%
-------- --------
$1,110.2 $1,110.2
======== ========
The current weighted average maturity of the mortgage-backed and
asset-backed securities at December 31, 2002, is 2.96 years. A 50 basis point
increase in interest rates would extend the weighted average maturity to
22
approximately 3.14 years, while a 50 basis point decrease in interest rates
would decrease the weighted average maturity to approximately 2.87 years.
The weighted average maturity of the mortgage-backed and asset-backed
securities at December 31, 2001, was 4.55 years. A 200 basis point increase in
interest rates would have extended the weighted average maturity by
approximately .55 of a year, while a 200 basis point decrease in interest rates
would have decreased the weighted average maturity by approximately 2.27 of a
year.
Below investment-grade securities holdings (NAIC classes 3 through 6),
representing securities of 40 issuers at December 31, 2002, totaled 2.4 percent
of cash and invested assets at December 31, 2002 and 3.3 percent at December
31, 2001. Below investment-grade securities are generally unsecured and often
subordinated to other creditors of the issuers. These issuers may have
relatively higher levels of indebtedness and be more sensitive to adverse
economic conditions than investment-grade issuers. Our strategy of limiting
exposure to below investment-grade securities takes into account the more
conservative nature of today's consumer and the resulting demand for
higher-quality investments in the life insurance and annuity marketplace.
Real estate-related investments
The $177.7 million real estate-related portfolio consists of joint venture
and third party mortgage loans and other real estate-related investments. The
real estate-related portfolio constituted 4.6 percent of cash and invested
assets at December 31, 2002, compared with $176.4 million, or 4.6 percent, at
December 31, 2001.
During 2001, a change in circumstances surrounding a water development
project located in California's Sacramento River Valley led to a decision to
reclassify the related mortgage loans to accrual status and release the general
reserve allowance originally set up for these loans. These changes included the
State of California's State Water Resources Control Board ("SWRCB") approval of
the project's water right permit as well as the completion of a third-party
appraisal of the project, subsequent to the SWRCB's approval of the permit and
the project's inclusion by the CALFED Bay-Delta Program ("CALFED") as a
potential first phase implementation project. CALFED is a collaborative effort
of state and federal agencies working to find solutions for California's water
management issues.
Taken together, these facts supported, in our best judgment, not only the
level of existing debt on the project but also the accrual of interest as
specified in the terms of the loans. As a result, interest income was recorded
in the fourth quarter of 2001 in the amount of $24.9 million, representing
interest earned in 2001 as well as recaptured interest from 2000 and 1999, the
years in which these loans were on non-accrual status. The release of the
general reserve allowance generated a realized gain of $16.4 million in 2001.
The Company continues to monitor the progress of this project and CALFED
continues to study the project's feasibility. A county in which the project
would be located passed a new local permit ordinance in 2002. The Company is
challenging this ordinance at the appeal court level after being unsuccessful
in its initial legal challenge.
As reflected in the "Real estate portfolio" table below, we have continued
to fund both existing projects and legal commitments. The future legal
commitments were $29.9 million at both December 31, 2002 and 2001. As of
December 31, 2002, we expect to fund approximately $0.2 million of these legal
commitments, along with providing capital to existing projects. The disparity
between total legal commitments and the amount expected to be funded relates
principally to standby financing arrangements that provide credit enhancements
to certain tax-exempt bonds. We do not currently expect to fund these
commitments. The total legal commitments, along with estimated working capital
requirements, are considered in management's evaluation of reserves and
write-downs.
23
Excluding the $0.7 million of net equity investments in joint ventures, real
estate loans totaled $177.0 million at December 31, 2002, after reserves and
write-downs. Of this amount, $174.0 million are on accrual status with a
weighted average interest rate of approximately 8.9 percent. Of these accrual
loans:
. 6.8 percent have terms requiring current periodic payments of their full
contractual interest,
. 34.5 percent require only partial payments or payments to the extent of
borrowers' cash flow, and
. 58.7 percent require that payments are deferred until maturity.
The equity investments in real estate at December 31, 2002 consisted of
other equity investments in joint ventures. These equity investments include
our share of periodic operating results. As an equity owner or affiliate of an
equity owner, we have the ability to fund, and historically have elected to
fund, operating requirements of certain joint ventures.
Real estate portfolio
(in millions)
Other Real Estate-
Mortgage Loans Related Investments
------------- -------------------
Joint Third- Other Equity
Venture Party Loans(2) Investments Total
------- ------ -------- ----------- ------
Balance at December 31, 2001.......... $104.3 $63.9 $ 7.3 $ 0.9 $176.4(1)
Additions (deductions):
Fundings.............................. 0.2 -- -- -- 0.2
Interest added to principal........... 9.6 2.0 -- -- 11.6
Sales/paydowns/distributions.......... -- (7.5) (3.8) (0.2) (11.5)
Net realized investment gains (losses) -- (0.4) 1.4 -- 1.0
------ ----- ----- ----- ------
Balance at December 31, 2002.......... $114.1 $58.0 $ 4.9 $ 0.7 $177.7(3)
====== ===== ===== ===== ======
- --------
(1) Net of $6.6 million reserve and write-downs. Excludes $5.4 million of real
estate-related accrued interest.
(2) The other real estate loans are notes receivable evidencing financing,
primarily to joint ventures. These loans were issued generally to provide
financing for Kemper's or our joint ventures for various purposes.
(3) Net of $8.6 million reserve and write-downs. Excludes $5.8 million of real
estate-related accrued interest.
Real estate concentrations and outlook
The real estate portfolio is distributed by geographic location and property
type. However, concentration exposures in certain states and in certain types
of properties do exist. In addition to these exposures, exposures also exist as
to certain real estate developers and partnerships.
As a result of our ongoing strategy to reduce exposure to real
estate-related investments, we had investments in four projects that accounted
for substantially all of the $177.7 million real estate-related portfolio as of
December 31, 2002.
The largest of these investments were loans to a master limited partnership
(the "MLP") between subsidiaries of Kemper and subsidiaries of Lumbermens
Mutual Casualty Company, which amounted to $102.3 million at December 31, 2002.
The MLP's underlying investment primarily consists of the water development
project, as discussed earlier. The SWRCB has approved the water right permit
and the Army Corps of Engineers issued required permits in June of 2002.
Various local permits are/may be required in addition to the state and federal
permits. The final resolution of this permit process will impact the long-term
economic viability of the project. This venture contains uncertainty due to the
difficulty of completing water projects in California and current fiscal
difficulties being experienced by the state. Loans to the MLP were placed on
non-accrual status at
24
the beginning of 1999 to ensure that book value of the MLP did not increase
over net realizable value. In 2001, these loans were placed on accrual status,
as previously discussed.
The second largest of these investments at December 31, 2002, amounted to
$60.0 million and consisted of second mortgages on nine hotel properties and
one retail property. Patrick M. Nesbitt or his affiliates, a third-party real
estate developer, have ownership interests in these properties. These
properties are geographically dispersed and the current market values of the
underlying properties substantially exceed the balances due on all but one of
the mortgages. These loans are on accrual status. As of December 31, 2002, we
carry a valuation reserve of $0.6 million for one of these properties as its
estimated fair value decreased below the debt supported by the property.
At December 31, 2002, a loan to a joint venture amounted to $11.8 million.
This affiliated mortgage loan is on an office property located in Illinois and
owned by an affiliate, Zurich North America.
The remaining real estate-related investment amounted to $4.9 million at
December 31, 2002 and consisted of mortgage loans on various unzoned lots
located in Hawaii. These properties are not currently producing income and the
loans are on non-accrual. All zoned properties were sold by March of 2001. We
are currently pursuing an out of court settlement with the City of Honolulu for
the down zoning of certain unzoned properties. If a settlement is not reached,
the trial will begin in 2003. We are holding the other unzoned properties for
future zoning and sales. It is anticipated that it could be a number of years
until we obtain zoning to allow development or completely dispose of all
investments in Hawaii.
We evaluate our real estate-related investments (including accrued interest)
using an estimate of the investments' observable market price, net of estimated
selling costs. Where no observable market price exists (i.e. the water
development project), periodic appraisals are obtained. Because the real estate
review process includes estimates involving changing economic conditions and
other factors, there can be no assurance that current estimates will prove
accurate over time. Real estate-related investments are expected to continue to
decline further through future sales and paydowns. Net income could be reduced
in future periods if:
. the water development project does not prove viable,
. real estate market conditions worsen in areas where our portfolio is
located,
. Kemper's and our plans with respect to certain projects change, or
. necessary construction or zoning permits are not obtained.
Troubled real estate-related investments consisted of loans on nonaccrual
status, before reserves and write-downs, totaling $10.6 million and $13.0
million at December 31, 2002 and 2001, respectively. Interest does not accrue
on real estate-related investments when it is judged that the likelihood of
interest collection is doubtful. Loans on nonaccrual status after reserves and
write-downs amounted to $5.0 million and $7.4 million at December 31, 2002 and
2001, respectively.
Net investment income
Pre-tax net investment income totaled $228.3 million in 2002, compared with
$269.4 million in 2001 and $257.5 million in 2000. This includes our share of
the operating results from equity investments in real estate consisting of
other income less other expenses. Investment income was adversely impacted in
2002 and 2001 by the declining interest rate environment. Investment income was
positively impacted in 2001 by the inclusion of three years of interest on
loans previously carried on non-accrual status and negatively impacted in 2002,
2001 and 2000 by purchase accounting adjustments, as previously discussed.
25
Total foregone investment income before tax on both nonperforming fixed
maturity investments and nonaccrual real estate-related investments was as
follows:
Foregone investment income
(in millions)
Year Ended
December 31,
--------------
2002 2001 2000
---- ---- ----
Real estate-related investments $1.0 $1.1 $9.1
Fixed maturity securities...... 1.7 1.3 --
---- ---- ----
Total................... $2.7 $2.4 $9.1
==== ==== ====
Foregone investment income is the result of bonds that are in default and
certain real estate-related investments that have been placed on nonaccrual
status. Any increase in nonperforming securities, and either worsening or
stagnant real estate conditions, would increase the expected adverse effect on
future investment income and realized investment results. During 2001, $15.7
million of foregone investment income was recaptured from prior years due to
the previously mentioned reclassification of certain mortgage loans to accrual
status.
Realized investment results
Net income reflects after-tax realized investment losses of $0.5 million in
2002 and after-tax realized gains of $13.4 million in 2001 and after-tax
realized investment losses of $5.4 million in 2000.
Unrealized gains and losses on fixed maturity investments that are
available-for-sale are not reflected in net income. These changes in unrealized
value are recorded as a component of accumulated other comprehensive income,
net of any applicable income taxes. If, and to the extent, a fixed maturity
investment suffers an other-than-temporary decline in value, however, the
security is written down to net realizable value, and the write-down adversely
impacts net income. Pre-tax write-downs amounted to $18.5 million, $15.5
million and $11.4 million for the years ended December 31, 2002, 2001 and 2000,
respectively.
We regularly monitor our investment portfolio and as part of this process
review the assets for possible impairments of carrying value. Because the
review process includes estimates involving changing economic conditions and
other factors, there can be no assurance that current estimates will prove
accurate over time.
See Note 1, "Summary of Significant Accounting Policies", in the Notes to
Consolidated Financial Statements for information regarding derivative
investments.
Interest rates
The Federal Open Market Committee ("FOMC") met eight times in 2002. At the
November meeting, interest rates were lowered by one-half of one percent in
order to help the economy work through the current soft spot. While inflation
and inflation risks remained well contained in 2002, greater uncertainty, in
part attributable to geopolitical risks, has inhibited spending, production and
employment during 2002.
During 2000, the FOMC raised interest rates three times in total, resulting
in a flatter yield curve due to higher short-term interest rates. With signs of
economic weakness becoming more prevalent, the FOMC began lowering interest
rates in January 2001 after raising them 100 basis points in 2000. The FOMC
lowered rates 11 times in 2001, totaling 475 basis points, in an attempt to
stimulate the economy. The yield curve steepening that had begun at the end of
2000 accelerated during 2001, leaving the treasury yield curve at its steepest
levels since
26
1993. The events of September 11, 2001 led to further interest rate declines by
the FOMC to help mitigate economic weakness and liquidity concerns. The
steepening curve and lower rates resulted in a decrease in unrealized fixed
maturity investment losses during 2000 and unrealized fixed maturity investment
gains during 2001 and 2002.
When the proceeds from maturing or sold investments are reinvested at lower
yields in a low interest rate environment, we can adjust crediting rates on
fixed annuities and other interest-bearing liabilities. However, competitive
conditions and contractual commitments do not always permit the reduction in
crediting rates to fully or immediately reflect reductions in investment yield.
This can result in narrower spreads.
A rising interest rate environment can increase net investment income as
well as contribute to both realized and unrealized fixed maturity investment
losses. A declining interest rate environment can decrease net investment
income as well as contribute to both realized and unrealized fixed maturity
investment gains. Also, lower renewal crediting rates on annuities, compared
with competitors' higher new money crediting rates, have influenced certain
annuity holders to seek alternative products. We mitigate this risk somewhat by
charging surrender fees, which decrease over time, when annuity holders
withdraw funds prior to maturity on certain annuity products. Approximately 24
percent of the fixed and variable annuity liabilities as of December 31, 2002,
however, were no longer subject to significant (less than 5%) surrender fees.
LIQUIDITY AND CAPITAL RESOURCES
We carefully monitor cash and short-term investments to maintain adequate
balances for timely payment of policyholder benefits, expenses, taxes and
policyholder's account balances. In addition, regulatory authorities establish
minimum liquidity and capital standards. The major ongoing sources of liquidity
are deposits for fixed annuities, premium income, investment income, separate
account fees, other operating revenue and cash provided from maturing or
investments sold from a large, publicly traded investment portfolio.
We also continuously monitor capital resources. Our adjusted capital and
surplus (statutory accounting basis) is compared with required capital under
the NAIC's risk-based capital ("RBC") approach. During 2002, our RBC ratio
declined due to losses on a statutory accounting basis, but does not require
any regulatory action. One source of the decline in the capital ratio has been
the requirement to establish additional reserves for guarantees on the
DESTINATIONS/SM/ product. These reserves are driven by the decline in the stock
market and additional deposits into existing contracts. Further market declines
will require establishment of additional reserves. We monitor capital resources
very closely and mitigation strategies have been and will be put in place
should further market declines continue.
Ratings
Ratings are an important factor in establishing the competitive position of
life insurance companies. Rating organizations continue to review the financial
performance and condition of life insurers and their investment portfolios. Any
reductions in our claims-paying ability or financial strength ratings could
result in our products being less attractive to consumers. Any reductions in
our parent's ratings could also adversely impact our financial flexibility.
Each rating is subject to revision or withdrawal at any time by the
assigning organization and should be evaluated independently of any other
rating.
Our Standard & Poor's ("S&P") rating was coupled with ZFS through December
31, 2001 due to the perceived financial strength of ZFS and Zurich Life and the
designation of Zurich Life as one of ZFS's core businesses. In September 2001,
S&P announced that it was downgrading several insurance groups based on the
potential catastrophic losses from the September 11, 2001 terrorist attacks on
the United States of America, and
27
the subsequent fall in the equity markets. At that time, ZFS was placed on
CreditWatch with negative implications and its rating, and therefore ours, was
downgraded from "AA+" to "AA". In February 2002, ZFS received another downgrade
to "AA-" and remained on CreditWatch with negative implications. During 2001,
ZFS considered the divestiture of Zurich Life. Although ZFS made the decision
to retain Zurich Life in December 2001, S&P decided to uncouple Zurich Life's
ratings from ZFS in March 2002, primarily due to ZFS's consideration of the
Zurich Life divestiture. At that time we received a rating of "A+", S&P's fifth
highest rating, reflecting the non-supported strength of Zurich Life and we
were taken off CreditWatch. In August 2002, the outlook for ZFS, our parent,
was revised from stable to negative and concurrently our A+ rating was placed
on a negative outlook.
We share our A.M. Best rating with ZFS. In the fall of 2001, A.M. Best
placed ZFS under review with developing implications but did not change its
ratings. In March 2002, ZFS's A.M. Best A+ (Superior) financial strength rating
was affirmed, removed from under review and assigned a negative outlook. In
September 2002, A.M. Best announced that it was downgrading ZFS to "A"
(Excellent) from "A+" (Superior). In December 2002, A.M. Best affirmed the "A"
rating of ZFS and its core operating subsidiaries and placed ZFS on a
positive outlook.
Our Moody's Investors Service ("Moody's") Aa3 rating was reviewed in March
2002 and placed under review for possible downgrade. In June, 2002, Moody's
lowered our rating to A2, its sixth highest rating out of nineteen.
Stockholder's equity
Stockholder's equity totaled $723.8 million at December 31, 2002, compared
with $818.0 million at December 31, 2001 and $730.1 million at December 31,
2000. The decrease in stockholder's equity in 2002 was primarily due to a net
loss of $169.0 million, offset by an increase in other comprehensive income of
$37.5 million and an increase in additional paid-in capital of $37.3 million.
The increase in accumulated other comprehensive income was primarily related to
unrealized appreciation of the fixed maturity investment portfolio due to
declining interest rates during 2002. The increase in additional paid-in
capital was due to a $30 million capital contribution from Kemper Corporation
("Kemper"), our parent company, and a $7.3 million forgiveness of a tax
receivable due to Kemper from us.
The increase in stockholder's equity in 2001 was primarily due to an
increase in accumulated other comprehensive income of $49.3 million and net
income of $51.6 million, offset by dividends of $13.0 million paid to Kemper.
The increase in accumulated other comprehensive income was primarily related to
unrealized appreciation of the fixed maturity investment portfolio due to
declining interest rates during 2001.
Item 8. Financial Statements and Supplementary Data
Page(s)
-------
Report of Independent Accountants.......................................................... 29
Consolidated Balance Sheets, December 31, 2002 and 2001.................................... 30
Consolidated Statements of Operations, three years ended December 31, 2002................. 31
Consolidated Statements of Comprehensive Income (Loss), three years ended December 31, 2002 32
Consolidated Statements of Stockholder's Equity, three years ended December 31, 2002....... 33
Consolidated Statements of Cash Flows, three years ended December 31, 2002................. 34
Notes to Consolidated Financial Statements................................................. 35-56
Financial Statement Schedules:
Supplementary Insurance Information..................................................... 66
Reinsurance............................................................................. 67
Valuation and Qualifying Accounts....................................................... 68
28
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
Kemper Investors Life Insurance Company:
In our opinion, the accompanying consolidated financial statements listed in
the accompanying index present fairly, in all material respects, the financial
position of Kemper Investors Life Insurance Company and its subsidiaries (the
"Company") at December 31, 2002 and 2001, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2002, in conformity with accounting principles generally accepted in the
United States of America. In addition, the financial statement schedules listed
in the accompanying index present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedules are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedules based on our audits. We conducted our audits of
these statements and schedules in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted the provisions of Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets, as of December 31, 2002.
PRICEWATERHOUSECOOPERS LLP
Chicago, Illinois
March 21, 2003
29
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, December 31,
2002 2001
------------ ------------
Assets
Fixed maturity securities, available-for-sale, at fair value (amortized cost:
December 31, 2002, $3,313,920; December 31, 2001, $3,057,139)............... $ 3,420,773 $ 3,094,560
Equity securities (cost: December 31, 2002, $52,627; December 31, 2001,
$65,473).................................................................... 58,615 67,731
Short-term investments........................................................ -- 159,105
Joint venture mortgage loans.................................................. 114,061 104,303
Third-party mortgage loans.................................................... 57,985 63,897
Other real estate-related investments......................................... 5,645 8,240
Policy loans.................................................................. 223,888 239,787
Other invested assets......................................................... 2,491 20,799
----------- -----------
Total investments......................................................... 3,883,458 3,758,422
Cash.......................................................................... 47,436 57,374
Accrued investment income..................................................... 148,549 140,762
Reinsurance recoverable....................................................... 433,566 240,536
Deferred insurance acquisition costs.......................................... 431,915 381,506
Value of business acquired.................................................... 53,600 75,806
Goodwill...................................................................... -- 178,418
Other intangible assets....................................................... 5,502 6,261
Deferred income taxes......................................................... 73,228 95,688
Federal income tax receivable................................................. 11,232 13,866
Receivable on sales of securities............................................. -- 2,100
Fixed assets.................................................................. 3,179 5,619
Other assets and receivables.................................................. 27,241 24,717
Assets held in separate accounts.............................................. 13,547,376 13,108,753
----------- -----------
Total assets.............................................................. $18,666,282 $18,089,828
=========== ===========
Liabilities
Future policy benefits........................................................ $ 4,111,063 $ 3,634,161
Other policyholder benefits and funds payable................................. 203,159 436,449
Other accounts payable and liabilities........................................ 80,905 92,472
Liabilities related to separate accounts...................................... 13,547,376 13,108,753
----------- -----------
Total liabilities......................................................... 17,942,503 17,271,835
----------- -----------
Commitments and contingent liabilities........................................... -- --
Stockholder's equity
Capital stock--$10 par value, authorized 300,000 shares; outstanding
250,000 shares.............................................................. 2,500 2,500
Additional paid-in capital.................................................... 841,633 804,347
Accumulated other comprehensive income........................................ 54,009 16,551
Retained deficit.............................................................. (174,363) (5,405)
----------- -----------
Total stockholder's equity................................................ 723,779 817,993
----------- -----------
Total liabilities and stockholder's equity................................ $18,666,282 $18,089,828
=========== ===========
See accompanying notes to consolidated financial statements.
30
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Year Ended December 31,
-------------------------------
2002 2001 2000
--------- --------- ---------
Revenue
Net investment income................................................ $ 228,330 $ 269,419 $ 257,470
Realized investment gains (losses)................................... (779) 20,660 (8,277)
Premium income....................................................... 1,002 486 8,394
Separate account fees and charges.................................... 110,013 70,993 68,293
Other income......................................................... 42,196 36,739 35,030
--------- --------- ---------
Total revenue.................................................... 380,762 398,297 360,910
--------- --------- ---------
Benefits and Expenses
Interest credited to policyholders................................... 152,945 159,127 152,289
Claims incurred and other policyholder benefits...................... 62,613 21,933 13,718
Taxes, licenses and fees............................................. 19,244 10,714 17,861
Commissions.......................................................... 111,461 179,585 114,162
Operating expenses................................................... 67,474 66,026 61,671
Deferral of insurance acquisition costs.............................. (96,509) (166,202) (104,608)
Amortization of insurance acquisition costs.......................... 34,941 18,052 23,231
Amortization of value of business acquired........................... 20,751 15,606 19,926
Goodwill impairment.................................................. 156,511 -- --
Amortization of goodwill............................................. -- 12,744 12,744
Amortization of other intangible assets.............................. 759 961 368
--------- --------- ---------
Total benefits and expenses...................................... 530,190 318,546 311,362
--------- --------- ---------
Income (loss) before income tax expense (benefit) and cumulative
effect of accounting change, net of tax............................ (149,428) 79,751 49,548
Income tax expense (benefit)......................................... (2,377) 28,154 1,247
--------- --------- ---------
Net income (loss) before cumulative effect of accounting change, net
of tax............................................................. (147,051) 51,597 48,301
Cumulative effect of accounting change, net of tax................... (21,907) -- --
--------- --------- ---------
Net income (loss)................................................ $(168,958) $ 51,597 $ 48,301
========= ========= =========
See accompanying notes to consolidated financial statements.
31
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Year Ended December 31,
-----------------------------
2002 2001 2000
--------- -------- --------
Net income (loss)............................................................. $(168,958) $ 51,597 $ 48,301
--------- -------- --------
Other comprehensive income (loss), before tax:
Unrealized holding gains (losses) on investments arising during period:
Unrealized holding gains on investments.................................... 80,067 54,155 61,487
Adjustment to value of business acquired................................... (1,786) (5,914) (3,400)
Adjustment to deferred insurance acquisition costs......................... (15,344) (1,050) (230)
--------- -------- --------
Total unrealized holding gains on investments arising during
period............................................................... 62,937 47,191 57,857
--------- -------- --------
Less reclassification adjustments for items included in net income (loss):
Adjustment for (gains) losses included in realized investment gains
(losses)................................................................. 19,394 (9,203) (24,583)
Adjustment for amortization of premium on fixed maturities included in
net investment income.................................................... (9,400) (5,732) (4,538)
Adjustment for (gains) losses included in amortization of value of
business acquired........................................................ (331) (1,705) 214
Adjustment for (gains) losses included in amortization of insurance
acquisition costs........................................................ (4,185) 6,395 13
--------- -------- --------
Total reclassification adjustments for items included in net
income (loss)..................................................... 5,478 (10,245) (28,894)
--------- -------- --------
Other comprehensive income, before related income tax expense
(benefit)................................................................... 57,459 57,436 86,751
Related income tax expense (benefit).......................................... 20,001 8,167 (1,350)
--------- -------- --------
Other comprehensive income, net of tax.............................. 37,458 49,269 88,101
--------- -------- --------
Comprehensive income (loss)......................................... $(131,500) $100,866 $136,402
========= ======== ========
See accompanying notes to consolidated financial statements.
32
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(in thousands)
Year Ended December 31,
------------------------------
2002 2001 2000
--------- -------- ---------
Capital stock, beginning and end of period........................ $ 2,500 $ 2,500 $ 2,500
--------- -------- ---------
Additional paid-in capital, beginning of period................... 804,347 804,347 804,347
Capital contributions from parent................................. 37,286 -- --
--------- -------- ---------
Additional paid-in-capital, end of period......................... 841,633 804,347 804,347
--------- -------- ---------
Accumulated other comprehensive income (loss), beginning of period 16,551 (32,718) (120,819)
Other comprehensive income, net of tax............................ 37,458 49,269 88,101
--------- -------- ---------
End of period.................................................. 54,009 16,551 (32,718)
--------- -------- ---------
Retained deficit, beginning of period............................. (5,405) (44,002) (56,023)
Net income (loss)................................................. (168,958) 51,597 48,301
Dividends to parent............................................... -- (13,000) (36,280)
--------- -------- ---------
End of period.................................................. (174,363) (5,405) (44,002)
--------- -------- ---------
Total stockholder's equity................................. $ 723,779 $817,993 $ 730,127
========= ======== =========
See accompanying notes to consolidated financial statements.
33
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
-----------------------------------
2002 2001 2000
----------- ----------- ---------
Cash flows from operating activities
Net income (loss).................................................. $ (168,958) $ 51,597 $ 48,301
Reconciliation of net income (loss) to net cash from operating
activities:
Realized investment (gains) losses............................. 779 (20,660) 8,277
Interest credited and other charges............................ 188,926 169,084 142,344
Deferred insurance acquisition costs, net...................... (61,569) (148,150) (81,377)
Amortization of value of business acquired..................... 20,751 15,606 19,926
Amortization of goodwill....................................... -- 12,744 12,744
Goodwill impairment............................................ 156,511 -- --
Amortization of discount and premium on investments............ 9,400 5,731 4,538
Amortization of other intangible assets........................ 759 961 368
Deferred income taxes.......................................... 2,458 16,927 (25,930)
Net change in current federal income taxes..................... 2,634 (5,063) (18,593)
Benefits and premium taxes due related to separate account
business-owned life insurance................................ 11,521 (6,392) (61,476)
Funds withheld account transfer................................ (222,500) -- --
Cumulative effect of accounting change, net of tax............. 21,907 -- --
Change in premium suspense..................................... (43,625) 41,938 657
Other, net..................................................... (13,116) (36,818) 41,720
----------- ----------- ---------
Net cash flow from operating activities..................... (94,122) 97,505 91,499
----------- ----------- ---------
Cash flows from investing activities
Cash from investments sold or matured:
Fixed maturity securities held to maturity..................... 198,824 281,664 170,465
Fixed maturity securities sold prior to maturity............... 2,307,588 1,331,168 589,933
Equity securities.............................................. 17,435 -- 1,271
Mortgage loans, policy loans and other invested assets......... 76,382 60,495 73,177
Cost of investments purchased or loans originated:
Fixed maturity securities...................................... (2,757,149) (1,481,699) (569,652)
Equity securities.............................................. (4,244) -- (1,264)
Mortgage loans, policy loans and other invested assets......... (48,722) (41,395) (47,109)
Investment in subsidiaries..................................... -- (2,690) (4,899)
Short-term investments, net........................................ 159,105 (143,205) 26,491
Net change in receivable and payable for securities transactions... 12,928 6,186 (4,786)
Net change in other assets......................................... 2,440 2,248 (5,141)
----------- ----------- ---------
Net cash from investing activities.......................... (35,413) 12,772 228,486
----------- ----------- ---------
Cash flows from financing activities
Policyholder account balances:
Deposits....................................................... 601,045 680,106 608,363
Withdrawals.................................................... (505,674) (733,521) (881,888)
Capital contributions.............................................. 37,286 -- --
Dividends to parent................................................ -- (13,000) (36,280)
Cash overdrafts.................................................... (13,060) (20,589) 11,906
----------- ----------- ---------
Net cash from financing activities.......................... 119,597 (87,004) (297,899)
----------- ----------- ---------
Net increase (decrease) in cash............................. (9,938) 23,273 22,086
Cash, beginning of period............................................. 57,374 34,101 12,015
----------- ----------- ---------
Cash, end of period................................................... $ 47,436 $ 57,374 $ 34,101
=========== =========== =========
See accompanying notes to consolidated financial statements.
34
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Basis of presentation
Kemper Investors Life Insurance Company and its subsidiaries ("the Company")
issue fixed and variable annuity products, variable life, term life and
interest-sensitive life insurance products marketed primarily through a network
of financial institutions, securities brokerage firms, insurance agents and
financial planners. The Company is licensed in the District of Columbia and all
states except New York. Zurich Life Insurance Company of New York ("ZLICONY"),
formerly Zurich Kemper Life Insurance Company of New York, a wholly-owned
subsidiary, received its license from the State of New York early in 2001 and
began writing business in May of 2001. The Company also owns the PMG group of
companies ("PMG"), acquired in 2000, and Investors Brokerage Services, Inc. The
Company is a wholly-owned subsidiary of Kemper Corporation ("Kemper"), a
non-operating holding company. Kemper is a wholly-owned subsidiary of Zurich
Holding Company of America ("ZHCA"), a holding company. ZHCA is a wholly-owned
subsidiary of Zurich Group Holding ("ZGH" or "Zurich"), a Swiss holding
company. ZGH is wholly-owned by Zurich Financial Services ("ZFS"), a Swiss
holding company.
The financial statements include the accounts of the Company on a
consolidated basis. All significant intercompany balances and transactions have
been eliminated. Certain reclassifications have been made to the 2001 and 2000
consolidated financial statements in order for them to conform to the 2002
presentation. The accompanying consolidated financial statements of the Company
as of and for the years ended December 31, 2002, 2001 and for the three years
in the period ended December 31, 2002, have been prepared in conformity with
Accounting Principles Generally Accepted in the United States of America
("GAAP").
Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that could affect the reported
amounts of assets and liabilities as well as the disclosure of contingent
assets or liabilities at the date of the financial statements. As a result,
actual results reported as revenue and expenses could differ from the estimates
reported in the accompanying financial statements. As further discussed in the
accompanying notes to the consolidated financial statements, significant
estimates and assumptions affect goodwill, deferred insurance acquisition
costs, the value of business acquired, provisions for real estate-related
losses and reserves, other-than-temporary declines in values for fixed maturity
and equity securities, the valuation allowance for deferred income taxes, the
calculation of fair value disclosures for certain financial instruments and
future policy benefit reserves.
Goodwill and other intangibles
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), Goodwill and Other
Intangible Assets. SFAS 142 primarily addresses the accounting that must be
applied to goodwill and intangible assets subsequent to their acquisition.
Effective January 1, 2002, SFAS 142 requires that goodwill and indefinite-lived
intangible assets no longer be amortized, but be tested, at least annually, for
impairment at the reporting unit level.
In conjunction with management's focus on line of business operations, the
Company's goodwill was tested for impairment at the life insurance and
annuities operating segment level based on the guidance under SFAS 142. As a
result of the testing performed, an impairment of $21.9 million was recorded in
the annuities segment as of June 30, 2002 due to more conservative growth
assumptions based on the market's volatility over the last few years. The fair
value of that segment was estimated using expected present value of future cash
flows for both current business in-force and future production estimates.
35
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In September 2002, the board of directors of the Company's indirect, 100%
shareholder, Zurich Financial Services Group ("the Group"), approved a plan
designed to improve the profitability of the Group and its subsidiaries. Under
this plan, the Group considered a number of strategic options, the completion
of which could have a significant impact on the recoverability of the carrying
value of certain assets. Among the assets affected by the approval of the plan
is the goodwill associated with the 1996 acquisition of the Zurich Life
companies by ZFS. The Company filed its Form 10-Q for the period ended June 30,
2002 prior to the Group board's action. As a result, the Company recorded the
complete write-down of the remaining goodwill of $156.5 million in the third
quarter of 2002, the period during which the Company became aware of this
action by the Group's board of directors.
Other definite-lived, intangible assets of $7.6 million, recorded in 2001
and 2000 in connection with the purchase of PMG, continue to be amortized on a
straight-line basis over a ten-year period.
Value of business acquired
The value of business acquired reflects the estimated fair value of the
Company's life insurance business in force and represents the portion of the
cost to acquire the Company that is allocated to the value of the right to
receive future cash flows from insurance contracts existing at the date of
acquisition, January 4, 1996. Such value is the present value of the
actuarially determined projected cash flows for the acquired policies.
The value of the business acquired is amortized over the estimated contract
life of the business acquired in relation to the present value of estimated
gross profits using current assumptions based on an interest rate equal to the
liability or contract rate on the business acquired. The estimated amortization
and accretion of interest for the value of business acquired for each of the
years through December 31, 2007 are as follows:
Projected
Beginning Accretion Of Ending
Year Ended December 31, Balance Amortization Interest Balance
----------------------- --------- ------------ ------------ -------
(in thousands)
2000 (actual)..... $113,111 $(26,805) $6,879 $93,185
2001 (actual)..... 93,185 (21,394) 5,788 77,579
2002 (actual)..... 77,579 (24,464) 3,713 56,828
2003.............. 56,828 (12,977) 3,073 46,924
2004.............. 46,924 (11,795) 2,479 37,608
2005.............. 37,608 (9,585) 2,000 30,023
2006.............. 30,023 (8,321) 1,584 23,286
2007.............. 23,286 (7,624) 1,201 16,863
The projected ending balance of the value of business acquired will be
further adjusted to reflect the impact of unrealized gains or losses on fixed
maturity securities held as available-for-sale in the investment portfolio.
Such adjustments are not recorded in the Company's net income but rather are
recorded as a credit or charge to accumulated other comprehensive income, net
of income tax. This adjustment decreased the value of business acquired by $3.2
million as of December 31, 2002 and by $1.8 million as of December 31, 2001.
This adjustment increased the value of business acquired by $2.4 million as of
December 31, 2000. Accumulated other comprehensive income decreased by
approximately $2.1 million as of December 31, 2002 and $1.2 million as of
December 31, 2001, due to this adjustment and increased accumulated other
comprehensive income by approximately $1.6 million as of December 31, 2000.
Life insurance revenue and expenses
Revenue for annuities, variable life insurance and interest-sensitive life
insurance products consists of investment income and realized capital gains,
policy charges such as mortality, expense and surrender charges,
36
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and expense loads for premium taxes on certain contracts. Expenses consist of
benefits in excess of account balances and interest credited to contracts,
policy maintenance costs and amortization of deferred insurance acquisition
costs and value of business acquired.
Premiums for term life policies are reported as earned when due. Profits for
such policies are recognized over the duration of the insurance policies by
matching benefits and expenses to premium income.
Reinsurance
In the ordinary course of business, the Company enters into reinsurance
agreements to diversify risk and limit its overall financial exposure to
certain blocks of annuities and to individual death claims. Although these
reinsurance agreements contractually obligate the reinsurers to reimburse the
Company, they do not discharge the Company from its primary liabilities and
obligations to policyholders. As such, these amounts paid or deemed to have
been paid are recorded on the Company's consolidated balance sheet as
reinsurance recoverables and ceded future policy benefits.
Deferred insurance acquisition costs
The costs of acquiring new business, principally commission expense and
certain policy issuance and underwriting expenses, have been deferred to the
extent they are recoverable from estimated future gross profits on the related
contracts and policies. The deferred insurance acquisition costs for annuities,
separate account business and interest-sensitive life insurance products are
being amortized over the estimated contract life in relation to the present
value of estimated gross profits. Deferred insurance acquisition costs related
to such interest-sensitive products also reflect the estimated impact of
unrealized gains or losses on fixed maturity securities held as
available-for-sale in the investment portfolio, through a charge or credit to
accumulated other comprehensive income, net of income tax. The deferred
insurance acquisition costs for term life insurance products are being
amortized over the premium paying period of the policies.
Future policy benefits
Liabilities for future policy benefits related to annuities and
interest-sensitive life contracts reflect net premiums received plus interest
credited during the contract accumulation period and the present value of
future payments for contracts that have annuitized. A liability has been
established for guaranteed death benefits in excess of account values. The
guaranteed retirement income benefit ("GRIB") is an optional benefit to the
DESTINATIONS/SM/ variable annuity, for an additional asset-based fee. It allows
for a proxy account value, called the GRIB Base, to be applied to the
guaranteed annuity factors (settlement option purchase rates) in the contract.
The GRIB Base prior to attained age 80 is the greatest of:
. the contract value (account value),
. the greatest anniversary value before the exercise (annuitization) date, or
. purchase payments minus previous withdrawals, accumulated at 5 percent
interest per year to the annuitization date.
GRIB reserves have been established to cover the present value of future
benefits for policies that were deemed to have elected annuitization. In
accordance with current GAAP guidance, no additional liabilities for future
policy benefits related to guaranteed living benefits have been established.
37
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Current interest rates credited during the contract accumulation period
range from 0.5 percent to 12.0 percent. Future minimum guaranteed interest
rates vary from 3.0 percent to 4.5 percent. For contracts that have annuitized,
interest rates used in determining the present value of future payments range
principally from 2.5 percent to 4.5 percent.
Liabilities for future term life policy benefits have been computed
principally by a net level premium method. Anticipated rates of mortality are
based on the 1975-1980 Select and Ultimate Table modified by Company
experience, including withdrawals. Assumed investment yields are by policy
duration and range from 6.0 percent to 7.3 percent over 20 years.
Guaranty fund assessments
The Company is liable for guaranty fund assessments related to certain
unaffiliated insurance companies that have become insolvent during the years
2002 and prior. The Company's financial statements include provisions for all
known assessments that are expected to be levied against the Company as well as
an estimate of amounts (net of estimated future premium tax recoveries) that
the Company believes it will be assessed in the future for which the life
insurance industry has estimated the cost to cover losses to policyholders.
Invested assets and related income
Investments in fixed maturity securities and equity securities are carried
at fair value. Short-term investments are carried at cost, which approximates
fair value.
The amortized cost of fixed maturity securities is adjusted for amortization
of premiums and accretion of discounts to maturity, or in the case of
mortgage-backed and asset-backed securities, over the estimated life of the
security. Such amortization is included in net investment income. Amortization
of the discount or premium from mortgage-backed and asset-backed securities is
recognized using a level effective yield method which considers the estimated
timing and amount of prepayments of the underlying loans and is adjusted to
reflect differences which arise between the prepayments originally anticipated
and the actual prepayments received and currently anticipated. To the extent
that the estimated lives of such securities change as a result of changes in
prepayment rates, the adjustment is also included in net investment income. The
Company does not accrue interest income on fixed maturity securities deemed to
be impaired on an other-than-temporary basis, or on mortgage loans and other
real estate loans where the likelihood of collection of interest is doubtful.
Mortgage loans are carried at their unpaid balance, net of unamortized
discount and any applicable reserves or write-downs. Other real estate-related
investments, net of any applicable reserves and write-downs, include notes
receivable from real estate ventures and investments in real estate ventures,
adjusted for the equity in the operating income or loss of such ventures. Real
estate reserves are established when declines in collateral values, estimated
in light of current economic conditions, indicate a likelihood of loss.
Investments in policy loans and other invested assets, consisting primarily
of venture capital investments and a leveraged lease are carried primarily at
cost, net of any applicable reserves or write-downs.
Realized gains or losses on sales of investments, determined on the basis of
identifiable cost on the disposition of the respective investment, recognition
of other-than-temporary declines in value and changes in real estate-related
reserves and write-downs are included in revenue. Net unrealized gains or
losses on revaluation of investments are credited or charged to accumulated
other comprehensive income (loss). Such unrealized gains are recorded net of
deferred income tax expense and unrealized losses are tax benefited. However,
the tax benefits from unrealized losses are offset by a valuation allowance,
where appropriate.
38
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Derivative instruments
The Company is party to an interest rate swap agreement with Zurich Capital
Markets, Inc. ("ZCM"), an affiliated counterparty. The Company invests
primarily in fixed rate investments. A floating rate funding agreement was
reinsured in 2000 and the Company subsequently entered into an interest rate
swap agreement. Under interest rate swaps, the Company agrees with other
parties to exchange, at specified intervals, the difference between fixed-rate
and floating-rate interest amounts calculated by reference to an agreed
notional principal amount. No cash is exchanged at the outset of the contract
and no principal payments are made by either party. A single net payment is
made by one counterparty at each due date. In 2002, the Company paid
$3.8 million as settlement for the difference between the fixed-rate and
floating-rate interest.
The Company is exposed to credit-related losses in the event of
nonperformance by counterparties to financial instruments, but it does not
expect its counterparty to fail to meet its obligations given its high credit
ratings. The credit exposure of interest rate swaps is represented by the fair
value (market value) of contracts. At December 31, 2002, and 2001 an open swap
agreement with a notional value of $100.0 million and an expiration date of
November 2004, had a negative market value of $8.1 million and $5.0 million,
respectively. The negative market value was included as a component of other
accounts payable and liabilities in the accompanying consolidated balance
sheets.
Separate account business
The assets and liabilities of the separate accounts represent segregated
funds administered and invested by the Company for purposes of funding variable
annuity and variable life insurance contracts for the exclusive benefit of
variable annuity and variable life insurance contractholders. The Company
receives administrative fees from the separate account and retains varying
amounts of withdrawal charges to cover expenses in the event of early
withdrawals by contractholders. The assets and liabilities of the separate
accounts are carried at fair value.
Income tax
The Company will file a consolidated federal income tax return with Zurich
Holding Company of America, beginning with the 2002 tax year. Deferred taxes
are provided on the temporary differences between the tax and financial
statement basis of assets and liabilities.
(2) Cash Flow Information
The Company defines cash as cash in banks and money market accounts. The
Company received a federal income tax refund of $2.7 million in 2002 and paid
taxes of $19.8 million and $43.9 million directly to the United States Treasury
Department during 2001 and 2000, respectively.
39
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(3) Invested Assets and Related Income
The Company is carrying its fixed maturity investment portfolio at estimated
fair value as fixed maturity securities are considered available-for-sale. The
carrying value of fixed maturity securities compared with amortized cost,
adjusted for other-than-temporary declines in value, and estimated unrealized
gains and losses, were as follows:
Estimated Unrealized
Carrying Amortized --------------------
Value Cost Gains Losses
----- ---- ----- ------
(in thousands)
December 31, 2002
U.S. treasury securities and obligations of U.S.
government agencies and authorities..................... $ 265,400 $ 260,287 $ 5,140 $ (26)
Obligations of states and political subdivisions,
special revenue and nonguaranteed....................... 19,873 19,073 800 --
Debt securities issued by foreign Governments............. 4,793 4,506 287 --
Corporate securities...................................... 2,137,716 2,062,712 90,030 (15,026)
Mortgage and asset-backed securities...................... 992,990 967,342 35,972 (10,324)
---------- ---------- -------- --------
Total fixed maturity securities....................... $3,420,773 $3,313,920 $132,229 $(25,376)
========== ========== ======== ========
Equity securities......................................... $ 58,615 $ 52,627 $ 5,988 $ --
========== ========== ======== ========
December 31, 2001
U.S. treasury securities and obligations of U.S.
government agencies and authorities..................... $ 21,354 $ 21,286 $ 254 $ (186)
Obligations of states and political subdivisions, special
revenue and nonguaranteed............................... 13,488 13,292 196 --
Debt securities issued by foreign governments............. 4,537 4,508 29 --
Corporate securities...................................... 1,945,006 1,926,160 45,602 (26,756)
Mortgage and asset-backed securities...................... 1,110,175 1,091,893 24,795 (6,513)
---------- ---------- -------- --------
Total fixed maturity securities....................... $3,094,560 $3,057,139 $ 70,876 $(33,455)
========== ========== ======== ========
Equity securities......................................... $ 67,731 $ 65,473 $ 2,261 $ --
========== ========== ======== ========
The carrying value and amortized cost of fixed maturity investments, by
contractual maturity at December 31, 2002, are shown below. Actual maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties and
because mortgage-backed and asset-backed securities provide for periodic
payments throughout their life.
Carrying Amortized
Value Cost
---------- ----------
(in thousands)
One year or less..................................................... $ 63,112 $ 62,223
Over one year through five years..................................... 806,702 774,553
Over five years through ten years.................................... 1,312,277 1,265,409
Over ten years....................................................... 245,692 244,393
Securities not due at a single maturity date, primarily mortgage- and
asset-backed securities(1)......................................... 992,990 967,342
---------- ----------
Total fixed maturity securities............................... $3,420,773 $3,313,920
========== ==========
- --------
(1) Weighted average maturity of 3.4 years.
40
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Proceeds from sales of investments in fixed maturity securities prior to
maturity were $2,307.6 million, $1,331.2 million and $589.9 million during
2002, 2001 and 2000, respectively. Gross gains of $81.2 million, $32.9 million
and $8.6 million and gross losses, including write-downs of fixed maturity
securities, of $65.8 million, $28.6 million and $20.8 million were realized on
sales and maturities in 2002, 2001 and 2000, respectively. Pre-tax write-downs
amounted to $18.5 million, $15.5 million and $11.4 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
At December 31, 2002, the Company held $102.3 million in mortgage loan
investments in Delta Wetlands, which exceeded 10 percent of the Company's
stockholder's equity at December 31, 2002. Excluding agencies of the U.S.
government, no other individual investment exceeded 10 percent of the Company's
stockholder's equity at December 31, 2002.
At December 31, 2002, securities carried at approximately $5.3 million were
on deposit with governmental agencies as required by law.
For its securitized financial assets, the Company recognizes an impairment
loss if the fair value of the security is below book value and the net present
value of expected future cash flows is less than the net present value of
expected future cash flows at the most recent (prior) estimation date. The
Company recorded write-downs totaling $9.5 million and $8.6 million in 2002 and
2001, respectively, related to their securitized financial assets. The Company
did not have any write-downs in 2000 related to their securitized financial
assets.
Upon default or indication of potential default by an issuer of fixed
maturity securities other than securitized financial assets, the issue(s) of
such issuer would be placed on nonaccrual status and, since declines in fair
value would no longer be considered by the Company to be temporary, would be
analyzed for possible write-down. Any such issue would be written down to its
net realizable value during the fiscal quarter in which the impairment was
determined to have become other-than-temporary. Thereafter, each issue on
nonaccrual status is regularly reviewed, and additional write-downs may be
taken in light of later developments. The Company recorded fixed maturity
write-downs on other than securitized financial assets of $9.0 million, $6.9
million and $11.4 million in 2002, 2001 and 2000, respectively.
The Company's computation of net realizable value involves judgments and
estimates, so such value should be used with care. Such value determination
considers such factors as the existence and value of any collateral; the
capital structure of the issuer; the level of actual and expected market
interest rates; where the issue ranks in comparison with other debt of the
issuer; the economic and competitive environment of the issuer and its
business; the Company's view on the likelihood of success of any proposed
issuer restructuring plan; and the timing, type and amount of any restructured
securities that the Company anticipates it will receive.
The Company's $177.7 million real estate portfolio at December 31, 2002
consists of joint venture and third-party mortgage loans and other real
estate-related investments. At December 31, 2002 and 2001, total impaired real
estate-related loans were as follows:
December 31, December 31,
2002 2001
------------ ------------
(in millions)
Impaired loans without reserves--gross $ 4.8 $ 7.3
Impaired loans with reserves--gross... 10.8 11.3
----- -----
Total gross impaired loans..... 15.6 18.6
Reserves related to impaired loans.... (2.7) (2.7)
Write-downs related to impaired loans. (3.5) (3.5)
----- -----
Net impaired loans............. $ 9.4 $12.4
===== =====
41
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company had an average balance of $13.6 million and $65.3 million in
impaired loans for 2002 and 2001, respectively. Cash payments received on
impaired loans are generally applied to reduce the outstanding loan balance.
At December 31, 2002 and 2001, loans on nonaccrual status, before reserves
and write-downs, amounted to $10.6 million and $13.0 million, respectively. The
Company's nonaccrual loans are generally included in impaired loans.
Net Investment Income
The sources of net investment income were as follows:
2002 2001 2000
-------- -------- --------
(in thousands)
Interest on fixed maturity securities............ $186,034 $214,505 $223,964
Dividends on equity securities................... 4,508 4,598 4,573
Income from short-term investments............... 1,479 2,332 3,433
Income from mortgage loans....................... 15,598 30,771 6,091
Income from policy loans......................... 23,189 19,394 20,088
Income from other real estate-related investments 13 27 99
Income from other loans and investments.......... 951 646 2,455
-------- -------- --------
Total investment income................... 231,772 272,273 260,703
Investment expense............................... 3,442 2,854 3,233
-------- -------- --------
Net investment income..................... $228,330 $269,419 $257,470
======== ======== ========
During 2001, a change in circumstances surrounding a water development
project located in California's Sacramento River Valley led to a decision to
reclassify the related mortgage loans to accrual status and release the general
reserve allowance originally set up for these loans. These changes included the
State of California's State Water Resources Control Board ("SWRCB") approval of
the project's water right permit as well as the completion of a third-party
appraisal of the project, subsequent to the SWRCB's approval of the permit and
the project's inclusion by the CALFED Bay-Delta Program ("CALFED") as a
potential early implementation project. CALFED is a collaborative effort of
state and federal agencies working to find solutions for California's water
management issues.
Taken together, these facts supported, in management's best judgment, not
only the level of existing debt on the project but also the accrual of interest
as specified in the terms of the loans. As a result, interest income was
recorded in the fourth quarter of 2001 in the amount of $24.9 million,
representing interest earned in 2001 as well as recaptured interest from 2000
and 1999, the years in which the loans were on non-accrual status. The release
of the general reserve allowance generated a realized gain of $16.4 million in
2001.
42
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) for the years ended December 31,
2002, 2001 and 2000, were as follows:
2002 2001 2000
-------- ------- --------
(in thousands)
Real estate-related..................................... $ 961 $16,081 $ 1,711
Fixed maturity securities............................... 15,444 4,284 (12,185)
Equity securities....................................... 346 262 245
Other................................................... (17,530) 33 1,952
-------- ------- --------
Realized investment gains (losses) before income tax
expense (benefit).................................. (779) 20,660 (8,277)
Income tax expense (benefit)............................ (273) 7,231 (2,897)
-------- ------- --------
Net realized investment gains (losses)........... $ (506) $13,429 $ (5,380)
======== ======= ========
The other losses, net, for 2002 consist primarily of a write-down on a
leveraged lease that covers two aircraft. The aircraft are leased by United
Airlines ("UAL") and were written down to zero subsequent to UAL filing Chapter
11 bankruptcy in the fourth quarter of 2002. The pre-tax write-down totaled
$17.5 million.
Unrealized gains (losses) are computed below as follows: fixed maturity
securities--the difference between fair value and amortized cost, adjusted for
other-than-temporary declines in value; equity and other securities--the
difference between fair value and cost. The change in net unrealized investment
gains (losses) by class of investment for the years ended December 31, 2002,
2001 and 2000 were as follows:
December 31, December 31, December 31,
2002 2001 2000
------------ ------------ ------------
(in thousands)
Fixed maturity securities................... $ 69,432 $69,970 $89,421
Equity and other securities................. 641 (879) 1,187
Adjustment to deferred insurance acquisition
costs..................................... (11,159) (7,446) (243)
Adjustment to value of business acquired.... (1,455) (4,209) (3,614)
-------- ------- -------
Unrealized gain (loss) before income tax
expense (benefit)...................... 57,459 57,436 86,751
Income tax expense (benefit)................ 20,001 8,167 (1,350)
-------- ------- -------
Net unrealized gain (loss) on
investments........................ $ 37,458 $49,269 $88,101
======== ======= =======
Income tax expense related to the change in unrealized gains for the years
ended December 31, 2002, 2001 and 2000 was $24.4 million, $12.2 million and $0,
respectively. The income tax benefit related to the adjustment to deferred
insurance acquisition costs for the years ended December 31, 2002, 2001 and
2000 was $3.9 million, $2.6 million and $0.1 million, respectively. The income
tax benefit related to the adjustment to value of business acquired for the
years ended December 31, 2002, 2001 and 2000 was $0.5 million, $1.5 million and
$1.3 million, respectively.
(4) Concentration of Credit Risk
The Company generally strives to maintain a diversified invested asset
portfolio; however, certain concentrations of credit risk exist in mortgage-
and asset-backed securities and real estate.
43
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Approximately 16.2 percent of the investment-grade fixed maturity securities
at December 31, 2002 were residential mortgage-backed securities, down from
22.0 percent at December 31, 2001. Approximately 6.3 percent of the
investment-grade fixed maturity securities at December 31, 2002 were commercial
mortgage-backed securities, compared with 5.7 percent at December 31, 2001. The
residential mortgage-backed securities consist primarily of marketable mortgage
pass-through securities issued by the Government National Mortgage Association,
the Federal National Mortgage Association or the Federal Home Loan Mortgage
Corporation and other investment-grade securities collateralized by mortgage
pass-through securities issued by these entities. The Company has not made any
investments in interest-only or other similarly volatile tranches of
mortgage-backed securities. The Company's mortgage-backed investments are
generally of AAA credit quality, and the markets for these investments have
been and are expected to remain liquid.
Approximately 7.3 percent and 9.6 percent of the investment-grade fixed
maturity securities at December 31, 2002 and 2001, respectively, consisted of
asset-backed securities. The majority of investments in asset-backed securities
were backed by home equity loans (34.7%), manufactured housing loans (17.7%),
collateralized loan and bond obligations (15.4%) and automobile loans (13.1%).
The Company's real estate portfolio is distributed by geographic location
and property type. The geographic distribution of a majority of the real estate
portfolio as of December 31, 2002 was as follows: California (58.0%),
Washington (9.4%), Colorado (7.6%) and Illinois (6.6%). The property type
distribution of a majority of the real estate portfolio as of December 31, 2002
was as follows: land (57.0%), hotels (31.4%) and office (6.6%).
To maximize the value of certain land and other projects, additional
development has been proceeding or has been planned. Such development of
existing projects would continue to require funding, either from the Company or
third parties. In the present real estate markets, third-party financing can
require credit enhancing arrangements (e.g., standby financing arrangements and
loan commitments) from the Company. The values of development projects are
dependent on a number of factors, including Kemper's and the Company's plans
with respect thereto, obtaining necessary construction and zoning permits and
market demand for the permitted use of the property. There can be no assurance
that such permits will be obtained as planned or at all, nor that such
expenditures will occur as scheduled, nor that Kemper's or the Company's plans
with respect to such projects may not change substantially.
More than half of the Company's real estate mortgage loans are on properties
or projects where the Company, Kemper, or their affiliates have taken ownership
positions in joint ventures with a small number of partners.
At December 31, 2002, loans to a master limited partnership (the "MLP")
between subsidiaries of Kemper and subsidiaries of Lumbermens Mutual Casualty
Company, a former affiliate, constituted approximately $102.3 million of the
Company's real estate portfolio. Kemper's interest in the MLP is 75.0 percent
at December 31, 2002. Loans to the MLP were placed on non-accrual status at the
beginning of 1999 due to management's desire not to increase book value of the
MLP over net realizable value, as interest on these loans has historically been
added to principal. During 2001, a change in circumstances surrounding the
water development project related to these loans led to the reclassification of
these loans to accrual status. As a result, interest income was recorded in the
fourth quarter of 2001 and subsequent periods and the general reserve allowance
related to these loans was released. At December 31, 2002, MLP-related
commitments accounted for approximately $0.2 million of the Company's
off-balance-sheet legal commitments.
At December 31, 2002, loans to and investments in joint ventures in which
Patrick M. Nesbitt or his affiliates ("Nesbitt"), a third-party real estate
developer, have ownership interests constituted approximately
44
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$60.0 million of the Company's real estate portfolio. The Nesbitt ventures
consist of nine hotel properties and one retail property. At December 31, 2002,
the Company did not have any Nesbitt-related off-balance-sheet legal funding
commitments outstanding. At December 31, 2002, the Company carried a valuation
reserve of $0.6 million for one of these properties as its estimated fair value
decreased below the debt supported by the property.
At December 31, 2002, a loan to a joint venture amounted to $11.8 million.
This affiliated mortgage loan was on an office property located in Illinois and
owned by an affiliate, Zurich North America. At December 31, 2002, the Company
did not have any off-balance-sheet legal funding commitments outstanding
related to this investment.
The remaining real estate-related investment amounted to $4.9 million at
December 31, 2002 and consisted of mortgage loans on unzoned lots located in
Hawaii. These properties are not currently producing income and the loans are
on non-accrual. All zoned properties were sold by March of 2001. The Company is
currently pursuing an out of court settlement with the City of Honolulu for the
down zoning of certain unzoned properties. If a settlement is not reached, the
trial will begin in 2003. The Company is holding the other unzoned properties
for future zoning and sales. The Company anticipates that it could be a number
of years until the Company obtains zoning to allow development or completely
disposes of all its investment in Hawaii. At December 31, 2002,
off-balance-sheet legal commitments related to Hawaiian properties totaled $4.0
million.
At December 31, 2002, the Company no longer had any outstanding loans or
investments in projects with the Prime Group, Inc. or its affiliates, as all
such investments have been sold. However, the Company continues to have Prime
Group-related commitments, which accounted for $25.7 million of the Company's
off-balance-sheet legal commitments at December 31, 2002.
(5) Income Taxes
Income tax expense (benefit) was as follows for the years ended December 31,
2002, 2001 and 2000:
2002 2001 2000
------- ------- --------
(in thousands)
Current......... $(4,835) $11,228 $ 28,274
Deferred........ 2,458 16,926 (27,027)
------- ------- --------
Total..... $(2,377) $28,154 $ 1,247
======= ======= ========
Additionally, the deferred income tax expense (benefit) related to items
included in other comprehensive income was as follows for the years ended
December 31, 2002, 2001 and 2000:
2002 2001 2000
------- ------- -------
(in thousands)
Unrealized gains and losses on investments $24,416 $12,246 $ --
Value of business acquired................ (509) (1,473) (1,265)
Deferred insurance acquisition costs...... (3,906) (2,606) (85)
------- ------- -------
Total.............................. $20,001 $ 8,167 $(1,350)
======= ======= =======
45
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The actual income tax expense for 2002, 2001 and 2000 differed from the
"expected" tax expense for those years as displayed below. "Expected" tax
expense was computed by applying the U.S. federal corporate tax rate of 35
percent in 2002, 2001, and 2000 to income before income tax expense.
2002 2001 2000
-------- ------- --------
(in thousands)
Computed expected tax expense........................ $(52,300) $27,913 $ 17,342
Difference between "expected" and actual tax expense:
State taxes....................................... 342 (2,302) 737
Goodwill impairment and amortization of other
intangibles..................................... 55,045 4,797 4,589
Dividend received deduction....................... (2,220) -- (1,191)
Foreign tax credit................................ -- (15) (214)
Change in valuation allowance..................... -- -- (15,201)
Recapture of affiliated reinsurance............... -- -- (4,599)
Prior year tax settlements........................ (3,594) (2,577) --
Other, net........................................ 350 338 (216)
-------- ------- --------
Total actual tax expense...................... $ (2,377) $28,154 $ 1,247
======== ======= ========
Deferred tax assets and liabilities are generally determined based on the
difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
The $4.6 million tax benefit related to the recapture of affiliated
reinsurance in 2000 is due to the deferred tax effect related to the deemed
dividend distribution. (See the note captioned "Summary of Significant
Accounting Policies--Reinsurance.") This deferred tax benefit was recognized in
the tax provision under current accounting guidance relating to the recognition
of deferred taxes.
The Company only records deferred tax assets if future realization of the
tax benefit is more likely than not. The Company had established a valuation
allowance to reduce the deferred federal tax asset related to real estate and
unrealized losses on investments to a realizable amount. This amount was based
on the evidence available and management's judgment. The valuation allowance is
subject to future adjustments based upon, among other items, the Company's
estimates of future operating earnings and capital gains. The decrease in the
valuation allowance in 2001 is related to the change in the amount of
unrealized losses on investments.
46
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The tax effects of temporary differences that give rise to significant
portions of the Company's net deferred federal tax assets or liabilities were
as follows:
December 31, December 31,
2002 2001
------------ ------------
(in thousands)
Deferred federal tax assets:
Deferred insurance acquisition costs ("DAC Tax").......... $141,338 $135,307
Unrealized losses on investments.......................... -- --
Life policy reserves...................................... 82,584 90,870
Unearned revenue.......................................... 56,986 55,574
Real estate-related....................................... -- --
Other investment-related.................................. 13,365 12,646
Other..................................................... 6,131 3,349
-------- --------
Total deferred federal tax assets..................... 300,404 297,746
Valuation allowance....................................... -- --
-------- --------
Total deferred federal tax assets after valuation
allowance........................................... 300,404 297,746
-------- --------
Deferred federal tax liabilities:
Value of business acquired................................ 13,439 24,608
Deferred insurance acquisition costs...................... 156,042 135,317
Depreciation and amortization............................. 13,142 21,165
Other investment-related.................................. 4,848 7,239
Unrealized gains on investments........................... 35,966 12,246
Other..................................................... 3,739 1,483
-------- --------
Total deferred federal tax liabilities................ 227,176 202,058
-------- --------
Net deferred federal tax assets.............................. $ 73,228 $ 95,688
======== ========
The net deferred tax assets relate primarily to unearned revenue and the DAC
Tax associated with a non-registered individual and group variable
business-owned life insurance contract ("BOLI"). Management believes that it is
more likely than not that the results of future operations will generate
sufficient taxable income over the ten year amortization period of the unearned
revenue and DAC Tax to realize such deferred tax assets.
The tax returns through the year 1996 have been examined by the Internal
Revenue Service ("IRS"). Changes proposed are not material to the Company's
financial position. The tax returns for the years 1997 through 1999 are
currently under examination by the IRS.
(6) Related-Party Transactions
The Company received capital contributions from Kemper totaling $37.3
million in 2002 and paid cash dividends of $13.0 million and $20.0 million to
Kemper during 2001 and 2000, respectively. The Company reported a deemed
dividend distribution of $16.3 million during 2000 related to the recapture of
a reinsurance agreement with Federal Kemper Life Assurance Company ("FKLA"), an
affiliated company.
The Company has loans to joint ventures, consisting primarily of mortgage
loans on real estate, in which the Company and/or one of its affiliates has an
ownership interest. At December 31, 2002 and 2001, joint venture mortgage loans
totaled $114.1 million and $104.3 million, respectively, and during 2002, 2001
and 2000, the Company earned interest income on these joint venture loans of
$10.4 million, $25.4 million and $0.8 million, respectively.
47
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In February 2001, the Company sold a $60 million group variable life policy
to FKLA, covering all current FKLA employees as of February 14, 2001. The
transaction, as business-owned life insurance ("BOLI"), permits FKLA to
indirectly fund certain of its employee benefit obligations.
All of the Company's personnel are employees of FKLA. Expenses are allocated
to the Company for the utilization of FKLA employees and facilities. Expenses
allocated to the Company from FKLA during 2002, 2001 and 2000 amounted to $29.9
million, $27.4 million and $23.3 million, respectively. The Company also paid
to Kemper real estate subsidiaries fees of $0.4 million, $0.5 million and $0.6
million in 2002, 2001 and 2000, respectively, related to the management of the
Company's real estate portfolio.
The Company has a service agreement with Deutsche Investment Management
Americas, Inc. ("DIM"), formerly Zurich Scudder Investments, Inc. ("ZSI"), a
subsidiary of Zurich at December 31, 2001. DIM provides investment services,
including purchases or sales of securities, under the supervision of the
Investment Committee of the Company. On September 24, 2001, ZFS announced that
it would sell 100% of its ownership in ZSI to Deutsche Bank in a transaction
valued at $2.5 billion. The sale was completed on April 5, 2002. This
transaction did not include Scudder's United Kingdom operations, Threadneedle
Investments.
At December 31, 2002 and 2001, the Company reported the following amounts due
from or (to) related parties:
December 31, December 31,
2002 2001
------------ ------------
ZLICA................................... $ 17,979 $ 640,705
Zurich Insurance Company--Bermuda Branch -- 1,131,138
Other................................... 1,017 96,037
------------ -----------
Receivable from related parties...... $ 18,996 $ 1,867,880
============ ===========
FKLA.................................... $ (3,536,310) $(2,064,245)
Zurich Direct........................... (52,607) (83,572)
Zurich Insurance Company--Bermuda Branch (16,354,306) --
Other................................... (108,000) (1,859,277)
------------ -----------
Payable to related parties........... $(20,051,223) $(4,007,094)
============ ===========
Net payable to related parties....... $(20,032,227) $(2,139,214)
============ ===========
Related party receivables and payables are settled each month.
In 2000, the Company purchased PMG Securities Corporation, PMG Asset
Management, Inc., PMG Marketing, Inc., and PMG Life Agency, Inc. (collectively
"PMG"). The total cost was $8.2 million, resulting in the recording of
intangible assets in the amount of $7.6 million. The Company owns 100 percent
of the stock of PMG. Also in 2000, the Company transferred $63.3 million in
fixed maturity securities and cash to fund the operations of its newly formed
subsidiary, Zurich Life Insurance Company of New York ("ZLICONY"). ZLICONY
received its insurance license from the State of New York in January 2001 and
began writing business in May of 2001.
At December 31, 2000, the Company held a $100.0 million investment in ZSLM
Trust, issued by an affiliate. On October 30, 2001, the Company sold these
bonds for cash to Farmers Group, Inc., which is an affiliated company.
The Company held an $11.8 million real estate-related investment in an
affiliated mortgage loan at December 31, 2002 and 2001.
48
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As previously discussed, the Company is party to an interest rate swap
agreement with ZCM, an affiliated counterparty. (See the note captioned
"Summary of Significant Accounting Policies--Derivative instruments" above.)
(7) Reinsurance
As of December 31, 2002 and 2001, the reinsurance recoverable related to
fixed-rate annuity liabilities ceded to FLA amounted to $215.3 million and
$230.1 million, respectively.
The Company cedes 90 percent of all new direct individual life insurance
premiums to outside reinsurers. Life reserves ceded to outside reinsurers on
the Company's direct business amounted to approximately $2.4 million and $2.1
million as of December 31, 2002 and 2001, respectively.
The Company is party to a reinsurance agreement with a ZFS affiliated
company, Zurich Insurance Company, Bermuda Branch ("ZICBB"). Under the terms of
this agreement, the Company cedes, on a yearly renewable term basis, 100
percent of the net amount at risk (death benefit payable to the insured less
the insured's separate account cash surrender value) related to BOLI. As
consideration for this reinsurance coverage, the Company cedes separate account
fees (cost of insurance charges) to ZICBB and, under the original agreement,
retained a portion of such funds in a funds withheld account ("FWA") which is
included as a component of benefits and funds payable in the accompanying
consolidated balance sheet as of December 31, 2001.
During the first quarter of 2002, the Company amended the BOLI reinsurance
agreement with ZICBB. Under the amended agreement, the balance in the FWA was
transferred to a trust account that acts as security for the reinsurance
agreement. On January 25, 2002, approximately $222.5 million in cash was
transferred to the trust account. The trust account is not reflected in the
Company's consolidated financial statements but is included in ZICBB's
financial statements as of December 31, 2002. At December 31, 2002, reserve
credits totaling $237.6 million were secured by the trust agreement, which was
supported by cash and invested assets with a fair value of approximately $252.6
million.
The net amount at risk of the guaranteed minimum death benefit and
guaranteed retirement income benefit on certain new variable annuity contracts
issued between March 1, 1997 and April 30, 2000 were ceded to outside
reinsurers. As of December 31, 2002 and 2001, the reinsurance recoverable
related to reinsuring the net amount at risk on these contracts amounted to
$24.7 million and $8.3 million, respectively.
Effective December 31, 2001, the Company entered into a quota-share
reinsurance agreement with ZICBB. Under the terms of this agreement, the
Company cedes 100 percent of the net amount at risk of the guaranteed minimum
death benefit and guaranteed retirement income benefit portions of a small
number of specific variable annuity contracts. As consideration for this
reinsurance coverage, the Company cedes 100 percent of all charges to
policyholders and all revenue sharing income received from fund managers
related to such reinsured policies. In 2001, the Company received $7.9 million
of ceding commissions and expense allowances, and paid $1.2 million of ceded
premiums, related to this reinsurance agreement. The account values related to
these policies are held in the Company's separate account during the
accumulation period of the contracts. The reserve credits under this treaty are
secured by a trust agreement that requires the fair market value of assets
therein to at least equal 102 percent of such reserve credits.
In January 2003, the specific annuities that comprised the block of business
ceded to ZICBB were surrendered. Approximately $5.0 million in surrender
charges collected on these specific annuities was paid to ZICBB at the end of
February 2003, as the final settlement payment related to this reinsurance
agreement.
49
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the fourth quarter of 2000, the yearly renewable term reinsurance
agreement between the Company and FKLA was terminated. Premiums and reserves
were both reduced by $7.7 million. A difference in the basis of the reserves
between GAAP and statutory accounting resulted in a deemed dividend
distribution to Kemper of $16.3 million.
Also in the fourth quarter of 2000, the Company assumed from FKLA $100.0
million in premiums related to a Funding Agreement. Funding Agreements are
insurance contracts similar to structured settlements, immediate annuities and
guaranteed investment contracts ("GICs"). The contracts qualify as insurance
under state laws and are sold as non-surrenderable immediate annuities to a
trust established by a securities firm. The securities firm sold interests in
the trust to institutional investors. This Funding Agreement has a variable
rate of interest based upon LIBOR, is an obligation of the Company's general
account and is recorded as a future policy benefit.
As previously discussed, the Company entered into an interest rate swap in
2000 to exchange the floating-rate interest payments for fixed interest
payments.
The following table contains amounts related to the BOLI funds withheld
reinsurance agreement with ZICBB (in millions):
Business Owned Life Insurance (BOLI)
(in millions)
Year Ended December 31,
----------------------------
2002 2001 2000
-------- -------- --------
Face amount in force........... $ 85,592 $ 85,564 $ 85,358
======== ======== ========
Net amount at risk ceded....... $(75,288) $(76,283) $(78,169)
======== ======== ========
Cost of insurance charges ceded $ 156.5 $ 168.1 $ 173.8
======== ======== ========
Funds withheld account......... $ -- $ 236.1 $ 228.8
======== ======== ========
The Company's FWA supported reserve credits on reinsurance ceded on the BOLI
product at December 31, 2001 and 2000. At December 31, 2002, the trust supports
reserve credits on the reinsurance ceded.
(8) Postretirement Benefits Other Than Pensions
FKLA sponsors a health and welfare benefit plan that provides insurance
benefits covering substantially all eligible, active and retired employees of
FKLA and their covered dependents and beneficiaries. The Company is allocated a
portion of the costs of providing such benefits. The Company is self-insured
with respect to medical benefits, and the plan is not funded except with
respect to certain disability-related medical claims. The medical plan provides
for medical insurance benefits at retirement, with eligibility based upon age
and the participant's number of years of participation attained at retirement.
The plan is contributory for pre-Medicare retirees, and will be contributory
for all retiree coverage for most current employees, with contributions
generally adjusted annually. Postretirement life insurance benefits are
noncontributory and are limited to $5,000 per participant retiring in 2001 and
subsequent years, and $10,000 per participant retiring in years prior to 2001.
The allocated accumulated postretirement benefit obligation accrued by the
Company as of December 31, 2002 and 2001 amounted to $1.4 million and $1.3
million, respectively.
50
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The discount rate used in determining the allocated postretirement benefit
obligation was 6.5 percent and 7.0 percent for 2002 and 2001, respectively. The
assumed health care trend rate used was based on projected experience for 2002,
7.3 percent for 2003, gradually declining to 6.1 percent by the year 2007 and
gradually declining thereafter.
A one percentage point increase in the assumed health care cost trend rate
for each year would increase the accumulated postretirement benefit obligation
as of December 31, 2002 and 2001 by $159 thousand and $142 thousand,
respectively.
(9) Commitments and Contingent Liabilities
The Company is involved in various legal actions for which it establishes
liabilities where appropriate. In the opinion of the Company's management,
based upon the advice of legal counsel, the resolution of such litigation is
not expected to have a material adverse effect on the consolidated financial
statements.
Although neither the Company nor its joint venture projects have been
identified as a "potentially responsible party" under federal environmental
guidelines, inherent in the ownership of, or lending to, real estate projects
is the possibility that environmental pollution conditions may exist on or near
or relate to properties owned or previously owned or on properties securing
loans. Where the Company has presently identified remediation costs, they have
been taken into account in determining the cash flows and resulting valuations
of the related real estate assets. Based on the Company's receipt and review of
environmental reports on most of the projects in which it is involved, the
Company believes its environmental exposure would be immaterial to its
consolidated results of operations.
However, the Company may be required in the future to take actions to remedy
environmental exposures, and there can be no assurance that material
environmental exposures will not develop or be identified in the future. The
amount of future environmental costs is impossible to estimate due to, among
other factors, the unknown magnitude of possible exposures, the unknown timing
and extent of corrective actions that may be required, the determination of the
Company's liability in proportion to others and the extent such costs may be
covered by insurance or various environmental indemnification agreements.
(10) Financial Instruments--Off-Balance-Sheet Risk
At December 31, 2002, the Company had future legal loan commitments and
stand-by financing agreements totaling $29.9 million to support the financing
needs of various real estate investments. To the extent these arrangements are
called upon, amounts loaned would be collateralized by assets of the joint
ventures, including first mortgage liens on the real estate. The Company's
criteria in making these arrangements are the same as for its mortgage loans
and other real estate investments. These commitments are included in the
Company's analysis of real estate-related reserves and write-downs. The fair
values of loan commitments and standby financing agreements are estimated in
conjunction with and using the same methodology as the fair value estimates of
mortgage loans and other real estate-related investments.
(11) Fair Value of Financial Instruments
Fair value estimates are made at specific points in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument. A significant portion of the Company's financial
instruments are carried at fair value. Fair value estimates for
51
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
financial instruments not carried at fair value are generally determined using
discounted cash flow models and assumptions that are based on judgments
regarding current and future economic conditions and the risk characteristics
of the investments. Although fair value estimates are calculated using
assumptions that management believes are appropriate, changes in assumptions
could significantly affect the estimates and such estimates should be used with
care.
Fair value estimates are determined for existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and certain liabilities that are not
considered financial instruments. Accordingly, the aggregate fair value
estimates presented do not represent the underlying value of the Company. For
example, the Company's subsidiaries are not considered financial instruments,
and their value has not been incorporated into the fair value estimates. In
addition, tax ramifications related to the realization of unrealized gains and
losses can have a significant effect on fair value estimates and have not been
considered in any of the estimates.
The Company used the following methods and assumptions in estimating the
fair value of its financial instruments:
Fixed maturity securities and equity securities: Fair values were
determined by using market quotations, or independent pricing services that
use prices provided by market makers or estimates of fair values obtained
from yield data relating to instruments or securities with similar
characteristics, or fair value as determined in good faith by the Company's
portfolio manager, DIM.
Cash and short-term investments: The carrying amounts reported in the
consolidated balance sheets for these instruments approximate fair values.
Policy loans: The carrying value of policy loans approximates the fair
value as the Company adjusts the rates to remain competitive.
Mortgage loans and other real estate-related investments: Fair values
were estimated based upon the investments observable market price, net of
estimated costs to sell and where no observable price is available, by
appraised value. The estimates of fair value should be used with care given
the inherent difficulty in estimating the fair value of real estate due to
the lack of a liquid quotable market. Mortgage loans and other real
estate-related investments are stated at their aggregate unpaid balances,
less a valuation allowance of $4.8 million and $2.8 million in 2002 and
2001, respectively. The real estate portfolio is monitored closely and
reserves are adjusted to reflect market conditions. This results in a
carrying value that approximates fair value at December 31, 2002 and 2001.
Other investments: The carrying amounts reported in the consolidated
balance sheets for these instruments approximate fair values.
Life policy benefits: For deposit liabilities with defined maturities,
the fair value was based on the discounted value of future cash flows. The
discount rate was based on the rate that would be offered for similar
deposits at the reporting date. For all other deposit liabilities, primarily
deferred annuities and universal life contracts, the fair value was based on
the amount payable on demand at the reporting date.
52
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The carrying values and estimated fair values of the Company's financial
instruments at December 31, 2002 and 2001 were as follows:
December 31, 2002 December 31, 2001
--------------------- ---------------------
Carrying Carrying
Value Fair Value Value Fair Value
---------- ---------- ---------- ----------
(in thousands)
Financial instruments recorded as assets:
Fixed maturity securities........................... $3,420,773 $3,420,773 $3,094,560 $3,094,560
Cash and short-term investments..................... 47,436 47,436 216,479 216,479
Mortgage loans and other real estate-related assets. 177,691 177,691 176,440 176,440
Policy loans........................................ 223,888 223,888 239,787 239,787
Equity securities................................... 58,615 58,615 67,731 67,731
Other invested assets............................... 2,491 2,491 20,799 20,799
Financial instruments recorded as liabilities:
Life policy benefits, excluding term life reserves.. 3,625,384 3,565,147 3,376,604 3,324,417
Funds withheld account.............................. -- -- 236,134 236,134
(12) Stockholder's Equity--Retained Earnings
The maximum amount of dividends which can be paid by insurance companies
domiciled in the State of Illinois to stockholders without prior approval of
regulatory authorities is restricted. In 2003, the Company cannot pay any
dividends without Illinois Department of Insurance approval. In 2002, the
Company did not pay dividends. The Company paid cash dividends of $13.0 million
and $20.0 million to Kemper during 2001 and 2000, respectively. The Company
reported a deemed dividend distribution of $16.3 million during 2000 related to
the recapture of the reinsurance agreement with FKLA.
The Company's net income (loss) and capital and surplus as determined in
accordance with statutory accounting principles were as follows:
2002 2001 2000
-------- -------- --------
(in thousands)
Net income (loss)............ $(84,871) $(71,854) $ 19,975
======== ======== ========
Statutory capital and surplus $312,653 $332,598 $397,423
======== ======== ========
The Company's statutory net loss reflects the market downturn and its impact
on reserves for guaranteed death and living benefits consistent with statutory
reserving methodology.
As of January 1, 2001, the Company adopted the Codification of Statutory
Accounting Principles ("Codification") guidance. The National Association of
Insurance Commissioners ("NAIC") Accounting Practices and Procedures Manual is
the NAIC's primary guidance on statutory accounting. Codification provides
guidance for areas where statutory accounting had been silent and changed
current statutory accounting in some areas. The Illinois Insurance Department
adopted Codification, effective January 1, 2001. The Company's statutory
surplus was positively impacted by $16.7 million upon adoption as a result of
the net effect of recording a deferred tax asset, of non-admitting
non-operating system software, of non-admitting net affiliated receivables and
other changes caused by Codification.
53
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(13) Unaudited Interim Financial Information
The following table sets forth the Company's unaudited quarterly financial
information:
Quarter Ended
------------------------------------------------------
March 31 June 30 September 30 December 31 Year
-------- -------- ------------ ----------- ---------
(in thousands)
2002 Operating Summary
Revenue.................................. $ 92,322 $105,170 $ 92,308 $ 90,962 $ 380,762
======== ======== ========= ======== =========
Net operating income, excluding realized
gains, before cumulative effect of
accounting change...................... $ 8,109 $ 394 $(169,309) $ 14,261 $(146,545)
======== ======== ========= ======== =========
Net operating income (loss), excluding
realized gains......................... $(13,798) $ 394 $(169,309) $ 14,261 $(168,452)
Net realized investment gains (losses)... (841) 7,613 1,037 (8,315) (506)
-------- -------- --------- -------- ---------
Net income (loss).................... $(14,639) $ 8,007 $(168,272) $ 5,946 $(168,958)
======== ======== ========= ======== =========
2001 Operating Summary
Revenue.................................. $ 91,072 $ 98,360 $ 85,013 $123,852 $ 398,297
======== ======== ========= ======== =========
Net operating income (loss), excluding
realized gains (losses)................ $ 8,183 $ (1,364) $ (6,443) $ 37,792 $ 38,168
Net realized investment gains (losses)... 1,375 5,257 1,206 5,591 13,429
-------- -------- --------- -------- ---------
Net income (loss).................... $ 9,558 $ 3,893 $ (5,237) $ 43,383 $ 51,597
======== ======== ========= ======== =========
2000 Operating Summary
Revenue.................................. $ 87,648 $103,446 $ 94,249 $ 75,567 $ 360,910
======== ======== ========= ======== =========
Net operating income, excluding realized
gains (losses)......................... $ 12,031 $ 9,953 $ 8,710 $ 22,987 $ 53,681
Net realized investment gains (losses)... (1,378) (105) 948 (4,845) (5,380)
-------- -------- --------- -------- ---------
Net income........................... $ 10,653 $ 9,848 $ 9,658 $ 18,142 $ 48,301
======== ======== ========= ======== =========
(14) Operations by Business Segment
The Company, along with FKLA, ZLICA and FLA, operate under the trade name
Zurich Life, formerly Zurich Kemper Life. Prior to 2002, Zurich Life was
organized by Strategic Business Unit ("SBU"). Each SBU concentrated on specific
distribution channels. However, the SBUs were not managed at the legal entity
level, but rather at the Zurich Life level. Zurich Life's SBUs cross legal
entity lines, as certain similar products are sold by more than one legal
entity and/or through more than one distribution channel.
In 2002, the Company's management team shifted its financial focus from SBU
performance to a line of business performance within each legal entity. The
SBUs are now primarily responsible for market management, including
distribution management, product design, sales and marketing.
The Company has two primary operating segments, life insurance and
annuities, that offer different types of products and services. These two
operating segments reflect the way the Company manages its operations and makes
business decisions.
Premiums received from the sale of annuity products and the majority of our
life insurance products are treated as deposit-type funds and are not recorded
as revenue within the consolidated statements of operations.
54
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
However, revenues for both the life insurance and annuity segments are
generated from investing these deposit-type funds. For universal life insurance
products and fixed annuity products, deposits are primarily invested in fixed
maturity securities and the Company earns investment income. Variable life
insurance deposits and variable annuity deposits are transferred to the
separate account and invested in underlying investment funds that invest in
stocks and bonds. The Company receives cost of insurance charges and other
separate account fees as revenues from this business. In addition, the Company
receives premium tax and DAC Tax expense loads from certain contractholders.
In the following table, the Company uses the caption "net operating income"
as an operating measure of segment performance. Net operating income is
calculated by deducting net realized investment gains or losses, net of related
income taxes, and the cumulative effect of a change in accounting principle,
net of tax, from net income. Net realized investment gains or losses are
excluded from net operating income because they can, in part, be discretionary
and are not indicative of operational trends.
Prior period information has been restated to conform to the new composition
of our segments.
Twelve Months Ended Twelve Months Ended
December 31, 2002 December 31, 2001
----------------------------------- ---------------------------------
Life Annuity Total Life Annuity Total
---------- ---------- ----------- ---------- ---------- -----------
(in thousands)
Total operating revenue............................... $ 80,573 $ 300,968 $ 381,541 $ 78,196 $ 299,441 $ 377,637
---------- ---------- ----------- ---------- ---------- -----------
Operating income (loss) before tax expense, goodwill
impairment and cumulative effect of accounting
change............................................... $ 13,663 $ (5,800) $ 7,863 $ 15,721 $ 43,370 $ 59,091
Income tax expense (benefit) on operations............ 5,238 (7,342) (2,104) 7,128 13,795 20,923
Goodwill impairment................................... (32,832) (123,679) (156,511) -- -- --
---------- ---------- ----------- ---------- ---------- -----------
Net operating income (loss) before cumulative effect
of accounting change................................. (24,407) (122,137) (146,544) 8,593 29,575 38,168
Cumulative effect of accounting change, net of tax.... -- (21,907) (21,907) -- -- --
---------- ---------- ----------- ---------- ---------- -----------
Net operating income (loss)........................... $ (24,407) $ (144,044) $ (168,451) $ 8,593 $ 29,575 $ 38,168
========== ========== =========== ========== ========== ===========
Goodwill.............................................. $ -- $ -- $ -- $ 6,601 $ 171,817 $ 178,418
---------- ---------- ----------- ---------- ---------- -----------
Total assets.......................................... $9,840,840 $8,825,442 $18,666,282 $8,841,469 $9,248,359 $18,089,828
========== ========== =========== ========== ========== ===========
Total reserve for policyholder benefits in the general
account.............................................. $ 808,389 $3,303,100 $ 4,111,489 $ 628,899 $3,005,262 $ 3,634,161
Total Separate Account liabilities.................... 8,848,140 4,699,236 13,547,376 7,696,013 5,412,740 13,108,753
---------- ---------- ----------- ---------- ---------- -----------
Total reserve for policyholder benefits............... $9,656,529 $8,002,336 $17,658,865 $8,324,912 $8,418,002 $16,742,914
========== ========== =========== ========== ========== ===========
55
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Twelve Months Ended
December 31, 2000
----------------------------------
Life Annuity Total
---------- ---------- -----------
(in thousands)
Total operating revenue............................... $ 90,913 $ 278,274 $ 369,187
---------- ---------- -----------
Operating income (loss) before tax expense, goodwill
impairment and cumulative effect of accounting
change............................................... $ 23,820 $ 34,005 $ 57,825
Income tax expense (benefit) on operations............ 4,171 (27) 4,144
---------- ---------- -----------
Net operating income (loss) before cumulative effect
of accounting change................................. 19,649 34,032 53,681
Cumulative effect of accounting change, net of tax.... -- -- --
---------- ---------- -----------
Net operating income (loss)........................... $ 19,649 $ 34,032 $ 53,681
========== ========== ===========
Goodwill.............................................. $ 5,764 $ 185,399 $ 191,163
---------- ---------- -----------
Total assets.......................................... $8,077,697 $7,928,946 $16,006,643
========== ========== ===========
Total reserve for policyholder benefits in the general
account.............................................. $ 691,290 $2,896,850 $ 3,588,140
Total Separate Account liabilities.................... 7,009,309 4,170,330 11,179,639
---------- ---------- -----------
Total reserve for policyholder benefits............... $7,700,599 $7,067,180 $14,767,779
========== ========== ===========
(15) Subsequent Event
In the first quarter of 2003, the specific annuities that comprised the
block of business ceded to ZICBB were surrendered. Approximately $5.0 million
in surrender charges collected on these specific annuities was paid to ZICBB at
the end of February, 2003, as the final settlement payment related to this
reinsurance agreement.
(16) Effects of New Accounting Pronouncements
In January, 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51. The primary objective of FIN 46 is
to provide guidance on the identification of, and financial reporting for,
entities over which control is achieved through means other than voting rights;
such entities are known as variable-interest entities. While there are a number
of criteria that determine the effective date of FIN 46, the Company has
concluded that it does not have any variable-interest entities.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
56
PART III
Item 10. Directors and Executive Officers of the Registrant
Name and Age
Position with Kemper Investors Life
Insurance Company ("KILICO")
Year of Election Other Business Experience During Past 5 Years or More
- ----------------------------------- -----------------------------------------------------
Gale K. Caruso (45) President and Chief Executive Officer of Federal Kemper Life
President and Chief Executive Assurance Company ("FKLA"), Fidelity Life Association ("FLA") and
Officer since June 1999. Director Zurich Life Insurance Company of America ("ZLICA"). President and
since July 1999. Chief Executive Officer of Zurich Direct, Incorporated ("ZD") since
April 2000. Director of FKLA, FLA and ZLICA since July 1999 and of
ZD since March 2000. President and Chief Executive Officer of Zurich
Kemper Life Insurance Company of New York ("ZLICONY") since
April 2000 and Director since October 1999. Chairman and Director of
Investors Brokerage Services, Inc. ("IBS") since May 2000 and of
Investors Brokerage Services Insurance Agency, Inc. ("IBSIA") since
March 2000. Chairman and Director of PMG Asset Management, Inc.
("PMGAM"), PMG Life Agency Inc. ("PMGLA"), PMG Marketing,
Inc. ("PMG Marketing") and PMG Securities Corporation ("PMG
Securities") since March 2000. Executive Vice President and Director
of Kemper Corporation ("Kemper") since February 2000. Chairman,
President and Chief Executive Officer of Scudder Canada Investor
Services, Ltd. from 1995 to June 1999. Managing Director of Scudder
Kemper Investments, Inc. from July 1986 to June 1999.
Frederick L. Blackmon (51) Executive Vice President of FKLA, FLA, ZLICA and ZD since June
Executive Vice President since 2000. Executive Vice President of ZLICONY since May 2001. Chief
June 2000. Chief Financial Officer Financial Officer of FKLA since December 1995. Chief Financial
since December 1995. Director Officer of FLA since January 1996. Chief Financial Officer of ZLICA
since January 2001. and ZD since March 1996. Chief Financial Officer of ZLICONY since
April 2000. Director of FKLA, ZLICA and ZLICONY since January
2001. Senior Vice President of KILICO and FKLA from December
1995 to June 2000. Senior Vice President of FLA from January 1996 to
June 2000. Senior Vice President of ZLICA and ZD from March 1996
to June 2000. Senior Vice President of ZLICONY from April 2000 to
May 2001. Director of FLA since May 1998. Director of ZD from
March 1996 to March 1997 and since January 2001. Chief Financial
Officer of Kemper since January 1996. Treasurer of Kemper from
January 1996 to February 2000.
Russell M. Bostick (46) Executive Vice President of FKLA, FLA, ZLICA and ZD since June
Executive Vice President since 2000. Executive Vice President of ZLICONY since May 2001. Chief
June 2000. Chief Information Information Officer of FKLA, FLA, ZLICA and ZD since April 1998.
Officer since April 1998. Chief Information Officer of ZLICONY since April 2000. Senior Vice
President of FKLA, FLA, ZLICA and ZD from March 1999 to June
2000. Senior Vice President of ZLICONY from April 2000 to May
2001. Vice President of FKLA, FLA, KILICO, ZLICA and ZD from
April 1998 to March 1999. Chief Technology Officer of Corporate
Software & Technology from June 1997 to April 1998. Vice President,
Information Technology Department of CNA Insurance Companies
from January 1995 to June 1997.
57
Name and Age
Position with Kemper Investors Life
Insurance Company ("KILICO")
Year of Election Other Business Experience During Past 5 Years or More
----------------------------------- -----------------------------------------------------
Mark A. Davis (44) Executive Vice President and Chief Actuary of FKLA, FLA, ZD, and
Executive Vice President and Chief ZLICA since August 2002. Executive Vice President and Chief Actuary
Actuary since August 2002. of ZLICONY since July 2002. Principal at Tillinghast-Towers Perrin
from June 1987 to July 2002.
Martin D. Feinstein (54) Chairman of the Board of FKLA, FLA, ZLICA and ZLICONY since
Chairman of the Board since January 2001. Chairman of the Board of Farmers Group, Inc. ("FGI")
January 2001. since November 1997 and President since January 1995. Chief
Executive Officer of FGI since January 1995 and Director since
February 1995. Member of Group Executive Committee of Zurich
Financial Services since March 1998. Director of Zurich Scudder
Investments, Inc. since January 2001. Director of Farmers New World
Life from April 1995 to April 2000 and since May 2002. Chief
Operating Officer of FGI from January 1995 to January 1997. Director
of B.A.T. Industries from January 1997 to September 1998.
Edward K. Loughridge (48) Executive Vice President of FKLA, FLA, ZLICA and ZD since June
Executive Vice President since June 2000. Executive Vice President of ZLICONY since May 2001.
2000. Corporate Development Corporate Development Officer of FKLA and FLA since January 1996.
Officer since January 1996. Corporate Development Officer for ZLICA and ZD since March 1996.
Corporate Development Officer of ZLICONY since April 2000. Senior
Vice President of KILICO, FKLA and FLA from January 1996 to June
2000. Senior Vice President of ZLICA and ZD from March 1996 to
June 2000. Senior Vice President of ZLICONY from April 2000 to
May 2001.
Debra P. Rezabek (47) Executive Vice President of FKLA, FLA, ZLICA and ZD since June
Executive Vice President since June 2000. Executive Vice President of ZLICONY since May 2001. General
2000. General Counsel since May Counsel of FKLA and FLA since 1992. General Counsel ZLICA and
1993. Corporate Secretary since ZD since March 1996. Corporate Secretary of FKLA and FLA since
January 1996. Director since January 1996. Corporate Secretary of ZLICA and ZD since March
January 2001. 1996. General Counsel and Corporate Secretary of ZLICONY since
April 2000. Director of FKLA and ZLICA since January 2001. Senior
Vice President of KILICO, FKLA, FLA, ZLICA and ZD from March
1996 to June 2000. Senior Vice President of ZLICONY from April
2000 to May 2001. Director of FLA since May 1998. Director of
ZLICONY since January 2001. Director of ZD from March 1996 to
March 1997. Secretary of IBS and IBSIA since 1993. Secretary of
PMGAM, PMGLA, PMG Marketing and PMG Securities since March
2000. Director of Government Affairs of FKLA and FLA from 1992 to
April 1997 and of KILICO from 1993 to April 1997. Assistant
Secretary of Kemper since January 1996.
Richard M. Sousa (49) Executive Vice President of FKLA, FLA and ZLICA since June 2002.
Executive Vice President Executive Vice President of ZD since March 2002. Executive Vice
since June 2002. Director since President of ZLICONY since July 2002. Director of FKLA, FLA,
May 2002. ZLICONY and ZLICA since May 2002. Senior Vice President, Call
Center Operations at Kemper from August 1998 to June 2002.
58
Name and Age
Position with Kemper Investors Life
Insurance Company ("KILICO")
Year of Election Other Business Experience During Past 5 Years or More
----------------------------------- -----------------------------------------------------
George Vlaisavljevich (60) Executive Vice President of FKLA, FLA, ZLICA and ZD since June
Executive Vice President since June 2000. Executive Vice President of ZLICONY since May 2001. Director
2000. Director since May 2001. of FKLA and ZLICA since May 2001. Director of FLA since January
2001. Senior Vice President of KILICO, FKLA, FLA and ZLICA since
October 1996. Senior Vice President of ZD from March 1997 to June
2000. Senior Vice President of ZLICONY from April 2000 to May
2001. Director of IBS and IBSIA since October 1996. Director of
PMGAM, PMGLA, PMG Marketing and PMG Securities since March
2000. Executive Vice President of The Copeland Companies from April
1983 to September 1996.
Linda K. Wagner (38) Executive Vice President of FKLA, FLA, ZLICA, ZLICONY and ZD
Executive Vice President since since March 2003. Senior Vice President of KILICO, FKLA, FLA,
March 2003. ZLICA, ZLICONY and ZD from April 2001 to March 2003. Vice
President of GE Financial Assurance from April 1999 to March 2001.
Assistant Vice President of Conseco, Inc. from August 1997 to April
1999.
Item 11. Executive Compensation
SUMMARY COMPENSATION TABLE
Long Term
Compensation
Annual Compensation Awards
--------------------- --------------
Other Annual Long Term All Other
Compensation Incentive Plan Compensation
Name and Principal Position Year Salary($) Bonus($)(2) ($)(3) Payouts ($)(2) ($)(4)
--------------------------- ---- --------- ----------- ------------ -------------- ------------
Gale K. Caruso.................... 2002 $238,500 $ -- $13,143 $ -- $33,072
Chief Executive Officer(1) 2001 211,500 133,480 17,466 -- 27,841
2000 179,500 91,920 10,866 126,720 14,094
Frederick L. Blackmon............. 2002 119,560 -- 7,183 -- 12,373
Executive Vice President and 2001 109,760 51,385 6,306 -- 9,567
Chief Financial Officer(1) 2000 109,760 50,715 7,060 51,695 11,637
George Vlaisavljevich............. 2002 237,000 -- 20,753 -- 26,149
Executive Vice President(1) 2001 275,000 141,000 20,042 -- 28,650
2000 260,000 116,500 17,493 126,000 30,750
Debra Rezabek 2002 152,750 -- 15,044 -- --
Executive Vice President, General 2001 135,450 69,930 8,791 -- 13,135
Counsel and Corporate 2000 100,000 49,250 6,809 48,500 10,700
Secretary(1)
Linda Wagner...................... 2002 138,600 -- -- -- 8,526
Executive Vice President(1) 2001 62,425 42,380 17,100 -- --
2000 -- -- -- -- --
- --------
(1) Also served in same positions for FKLA, ZLICA, ZKLICONY and FLA. An
allocation of the time devoted to duties as executive officer of KILICO has
been made. All compensation items reported in the Summary Compensation
Table reflect this allocation.
59
(2) Annual bonuses are paid pursuant to annual incentive plans. The amounts of
the bonuses and long-term compensation awards earned in 2002 for all
officers were not available as of the date of this filing.
(3) The amounts disclosed in this column include taxable benefit from personal
use of an employer-provided automobile and certain estate planning services
facilitated for executives.
(4) The amounts in this column include:
(a) The amounts of employer contributions allocated to the accounts of the
named persons under profit sharing plans or under supplemental plans
maintained to provide benefits in excess of applicable ERISA limitations.
(b) Distributions from the Kemper and FKLA supplemental retirement plans.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) As of March 1, 2003, 100 percent of the outstanding shares of KILICO
were owned by Kemper Corporation, 1600 McConnor Parkway, Schaumburg,
Illinois 60196.
(b) .
Zurich
Ordinary Shares
Beneficially Owned
------------------
Number (1) Percent
---------- -------
Martin D. Feinstein 1,326(2) *
Gale K. Caruso..... --
-
* Less than 1% of the outstanding Zurich ordinary shares.
(1) Not included in the number above for Mr. Feinstein and Ms. Caruso
are options over Zurich Financial Services Shares. The exercise
price of the 2000 Allied Zurich and Zurich Allied share options are
$706.46 CHF and $901.20 CHF, respectively. The market price as of
December 31, 2002 is $129.00 CHF.
(2) Included are 780 deferred shares that have no voting power.
(c) Not applicable.
Item 13. Certain Relationships and Related Transactions
(a) Transactions with management and others--none.
(b) Certain business relationships--not applicable.
(c) Indebtedness of management--not applicable.
(d) Transactions with promoters--not applicable.
Item 14. Controls and Procedures
In order to ensure the information we must disclose in our filings with the
Securities and Exchange Commission is recorded, processed, summarized and
reported on a timely basis, we have adopted disclosure controls and procedures.
Our Chief Executive Officer, Gale K. Caruso, and our Chief Financial Officer,
Frederick L. Blackmon, have reviewed and evaluated our disclosure controls and
procedures as of March 12, 2003 and have concluded that our disclosure controls
and procedures are appropriate and that no changes are required at this time.
There have been no significant changes in our internal controls, or in other
factors affecting our internal controls, since March 12, 2003.
60
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements.
A listing of all financial statements filed as part of this Annual Report
on Form 10-K is included on page 28 in ITEM 8.
(a)(2) Schedules.
The following schedules are supplemental to the financial statements of
KILICO and its subsidiaries for 2002 and are included in this Form 10-K on the
pages indicated below. All other schedules are omitted because the information
required to be stated therein is included in the financial statements or notes
thereto or because they are not applicable.
Schedule Title Page
- -------- ----- ----
III... Supplementary insurance information at December 31, 2002 and 2001....... 66
IV.... Reinsurance, for the year ended December 31, 2002*...................... 67
V..... Valuation and qualifying accounts, for the year ended December 31, 2002* 68
- --------
* This schedule for the years ended December 31, 2001 and 2000 is incorporated
by reference to KILICO's Form 10-K filed on March 29, 2002 and on March 28,
2001, respectively.
(a)(3) Exhibits.
The exhibits required to be filed by Item 601 of Regulation S-K are
listed under the caption "Exhibits" in Item 15(c).
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the fourth quarter of 2002.
(c) Exhibits.
Exhibit No. Description
- ----------- -----------
2 Not applicable.
3(a) Articles of Incorporation are incorporated herein by reference to Exhibits filed with
Registration Statement on Form S-1 (File No. 333-02491) filed on or about April 12,
1996.
3(b) Bylaws are incorporated herein by reference to Exhibits filed with Registration Statement
on Form S-1 (File No. 333-02491) filed on or about April 12, 1996.
4(a) Variable and Market Value Adjusted Deferred Annuity Contract is incorporated herein by
reference to Exhibits filed with Registration Statement on Form S-1 (File No. 33-43462) filed
October 23, 1991.
4(b) Certificate to Variable and Market Value Adjusted Deferred Annuity Contract and
Enrollment Application is incorporated herein by reference to Exhibits filed with
Registration Statement on Form S-1 (File No. 33-43462) filed October 23, 1991.
4(c) Individual Variable and Market Value Adjusted Annuity Contract and Enrollment
Application is incorporated herein by reference to Exhibits filed with Post-Effective
Amendment No. 4 to the Registration Statement on Form N-4 for KILICO Variable
Annuity Separate Account (File No. 33-43501) filed November 19, 1993.
61
Exhibit No. Description
- ----------- -----------
4(d) Endorsement to Variable and Market Value Adjusted Deferred Annuity Contract
is incorporated herein by reference to Exhibits filed with Post-Effective Amendment No. 4
to the Registration Statement on Form N-4 for KILICO Variable Annuity Separate
Account (File No. 33-43501) filed November 19, 1993.
4(e) Endorsement to Certificate to Variable and Market Value Adjusted Deferred
Annuity Contract is incorporated herein by reference to Exhibits filed with Post-Effective
Amendment No. 4 to the Registration Statement on Form N-4 for KILICO Variable
Annuity Separate Account (File No. 33-43501) filed November 19, 1993.
4(f) Revised Variable and Market Value Adjusted Deferred Annuity Contract is
incorporated herein by reference to Exhibits filed with Post-Effective Amendment No. 4 to
the Registration Statement on Form N-4 for KILICO Variable Annuity Separate Account
(File No. 33-43501) filed November 19, 1993.
4(g) Revised Certificate to Variable and Market Value Adjusted Deferred Annuity
Contract is incorporated herein by reference to Exhibits filed with Post-Effective
Amendment No. 4 to the Registration Statement on Form N-4 for KILICO Variable
Annuity Separate Account (File No. 33-43501) filed November 19, 1993.
9 Not applicable.
10 Distribution Agreement between Kemper Investors Life Insurance Company and Investors
Brokerage Services, Inc. is incorporated herein by reference to Exhibits filed with
Amendment No. 4 to Registration Statement on Form S-1 (File No. 33-43462) filed on
April 14, 1995.
11 Not applicable.
12 Not applicable.
13 Not applicable.
16 Not applicable.
18 Not applicable.
21 Subsidiaries of the registrant are incorporated herein by reference to Post-Effective Amendment
No. 29 to the Registration Statement on Form N-4 (File No. 2-72671) filed on or about April 26,
2000.
22 Not applicable.
23 Consent of PricewaterhouseCoopers LLP.
99.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, As adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
99.2 Certification of CFO Pursuant to 18 U.S.C. Section 1350, As adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
62
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, Kemper Investors Life Insurance Company has duly caused this Annual
Report on Form 10-K for the fiscal year ended December 31, 2002 to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Schaumburg, State of Illinois, on the 27th day of March, 2003.
KEMPER INVESTORS LIFE INSURANCE
COMPANY
/s/ GALE K. CARUSO*
By: __________________________________
Gale K. Caruso
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K for the fiscal year ended December 31, 2002 has been
signed below by the following persons on behalf of Kemper Investors Life
Insurance Company in the capacities indicated on the 27th day of March, 2003.
Signature Title
--------- -----
/S/ MARTIN D. FEINSTEIN Chairman of the Board
- -----------------------------
Martin D. Feinstein
/S/ GALE K. CARUSO President, Chief Executive
- ----------------------------- Officer and Director
Gale K. Caruso
/S/ FREDERICK L. BLACKMON Executive Vice President and
- ----------------------------- Chief Financial Officer
Frederick L. Blackmon
/S/ DEBRA P. REZABEK Executive Vice President,
- ----------------------------- General Counsel and Director
Debra P. Rezabek
/S/ GEORGE VLAISAVLJEVICH Executive Vice President and
- ----------------------------- Director
George Vlaisavljevich
/S/ RICHARD M. SOUSA Executive Vice President and
- ----------------------------- Director
Richard M. Sousa
/S/ DAVID S. JORGENSEN Senior Vice President,
- ----------------------------- Controller and Treasurer
David S. Jorgensen
63
I, Gale K. Caruso, certify that:
1. I have reviewed this annual report on Form 10-K of Kemper Investors Life
Insurance Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 24, 2003
/s/_GALE K. CARUSO
Gale K. Caruso
Chief Executive Officer
64
I, Frederick L. Blackmon, certify that:
1. I have reviewed this annual report on Form 10-K of Kemper Investors Life
Insurance Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: March 24, 2003
/s/ FREDERICK L. BLACKMON
- --------------------------
Frederick L. Blackmon
Chief Financial Officer
65
SCHEDULE III
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
December 31, 2002
(in thousands)
Benefits, Amortization
Deferred Other Claims, Of Deferred
Policy Future Policyholder Net Losses and Policy Other
Acquisition Policy Benefits and Premium Investment Settlement Acquisition Operating
Segment Cost Benefits Funds Payable Revenue Income Expenses Costs Expenses
- ------- ----------- ---------- ------------- ------- ---------- ---------- ------------ ---------
Life... $ 16,377 $ 808,389 $177,279 $1,002 $ 49,360 $ 35,108 $ 2,365 $ 62,269
Annuity 415,538 3,302,674 25,880 -- 178,970 180,450 32,576 217,422
-------- ---------- -------- ------ -------- -------- ------- --------
Total.. $431,915 $4,111,063 $203,159 $1,002 $228,330 $215,558 $34,941 $279,691
======== ========== ======== ====== ======== ======== ======= ========
December 31, 2001
(in thousands)
Benefits, Amortization
Deferred Other Claims, Of Deferred
Policy Future Policyholder Net Losses and Policy Other
Acquisition Policy Benefits and Premium Investment Settlement Acquisition Operating
Segment Cost Benefits Funds Payable Revenue Income Expenses Costs Expenses
- ------- ----------- ---------- ------------- ------- ---------- ---------- ------------ ---------
Life... $ 14,919 $ 628,899 $408,744 $486 $ 68,137 $ 36,023 $ 1,417 $ 25,035
Annuity 366,587 3,005,262 27,705 -- 201,282 145,037 16,635 94,399
-------- ---------- -------- ---- -------- -------- ------- --------
Total.. $381,506 $3,634,161 $436,449 $486 $269,419 $181,060 $18,052 $119,434
======== ========== ======== ==== ======== ======== ======= ========
December 31, 2000
(in thousands)
Benefits, Amortization
Claims, Of Deferred
Net Losses and Policy Other
Premium Investment Settlement Acquisition Operating
Segment Revenue Income Expenses Costs Expenses
------- ------- ---------- ---------- ------------ ---------
Life... $8,394 $ 69,313 $ 36,410 $ 1,406 $ 29,277
Annuity -- 188,157 129,597 21,825 92,847
------ -------- -------- ------- --------
Total.. $8,394 $257,470 $166,007 $23,231 $122,124
====== ======== ======== ======= ========
66
SCHEDULE IV
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
REINSURANCE
Year Ended December 31, 2002
(in thousands)
Assumed Percentage of
Gross Ceded to From Other Net Amount
Description Amount Other(1) Companies Amount Assumed to Net
- ----------- ----------- ------------ ---------- ----------- --------------
Life insurance in force $89,191,416 $(76,949,665) $ -- $12,241,751 0.0%
=========== ============ ===== =========== ===
Life insurance premiums $ 3,336 $ (2,334) $ -- $ 1,002 0.0%
=========== ============ ===== =========== ===
- --------
(1) Life insurance in force ceded to other companies was primarily ceded to an
affiliated company, Zurich Insurance Company, Bermuda Branch.
67
SCHEDULE V
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Year Ended December 31, 2002
(in thousands)
Additions
---------------------
Charged to
Balance at Charged to Other Balance at
Beginning Costs and Accounts Deductions End of
Description of Period Expenses --Describe --Describe Period
- ----------- ---------- ---------- ---------- ---------- ----------
Asset valuation reserves:
Joint venture mortgage loans.......... $ -- $ -- $-- $-- $ --
Third-party mortgage loans............ 600 2,000 -- -- 2,600
Other real estate-related investments. 2,183 -- -- -- 2,183
------ ------ --- --- ------
Total............................. $2,783 $2,000 $-- $-- $4,783
====== ====== === === ======
68
INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
23 Consent of PricewaterhouseCoopers LLP.
99.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, As adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
99.2 Certification of CFO Pursuant to 18 U.S.C. Section 1350, As adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
69
CONSENT OF INDEPENDENT ACCOUNTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-1 (No. 333-22389, 333-32632, 333-54252 and 333-86044) of
Kemper Investors Life Insurance Company and its subsidiaries of our report
dated March 21, 2003 relating to the financial statements and financial
statement schedules, which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLP
March 21, 2003
70
Certification of CEO Pursuant to
18 U.S.C. Section 1350,
As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report of Kemper Investors Life Insurance
Company (the "Company") on Form 10-K for the period ended December 31, 2002, as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Gale K. Caruso, Chief Executive Officer of the Company, hereby
certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906
of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that:
(1) The Report fully complies with the requirements of section 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: March 24, 2003
/S/ GALE K. CARUSO
-----------------------------
Gale K. Caruso
Chief Executive Officer
This certification accompanies this Report pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for
purposes of section 18 of the Securities Exchange Act of 1934, as amended.
71
Certification of CFO Pursuant to
18 U.S.C. Section 1350,
As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report of Kemper Investors Life Insurance
Company (the "Company") on Form 10-K for the period ended December 31, 2002, as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Frederick L. Blackmon, Chief Financial Officer of the Company,
hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge,
that:
(1) The Report fully complies with the requirements of section 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: March 24, 2003
/S/ FREDERICK L. BLACKMON
-----------------------------
Frederick L. Blackmon
Chief Financial Officer
This certification accompanies this Report pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for
purposes of section 18 of the Securities Exchange Act of 1934, as amended.
72