The disposals described under the table below were conducted in order to execute the Company's strategy to focus resources on businesses and geographic regions in which it can have a leadership position. The table below presents actual and proforma data for comparative purposes for the periods indicated to demonstrate the proforma effect of the acquisitions and disposals as if they occurred on January 1, 2002.
Income from discontinued operations of $159.7 million and $133.5 million for the years ended December 31, 2004 and 2003, respectively, consist of the net income of the Canada Segment, which was transferred to an affiliated entity on December 29, 2004. See Note 2 - Summary of Significant Accounting Policy for further discussion. Canada Segment's net income consists primarily of the results of Maritime Life, formerly the Company's principal operating subsidiary in Canada.
o The inflow of new cash for the twelve-month period ending December 31, 2003 was invested at rates that were below the portfolio rate. In addition, maturing assets were rolling over into new investments at rates less favorable than those available in 2002.
Dividends to policyholders decreased 3.6%, or $30.9 million from the prior year. The decrease in dividends to policyholders was driven by the Protection Segment, which decreased 2.4%, or $12.4 million. This decrease was due to the full year impact of lowering of the dividend scale on traditional life insurance products in the prior year. Partially offsetting the decrease in the dividend scale was growth in the traditional life insurance products average reserves, which increased approximately 3.3% from the prior period. The decrease in dividends in the traditional life insurance business was partially offset by a return of a claim stabilization reserve to a single customer in the group life insurance business during the year. Due to the return of the claim stabilization reserve dividends to policyholders increased $29.2 million in the group life insurance business in 2003.
(1) With respect to securities that are awaiting rating, the Company has assigned a rating based on an analysis that it believes is equivalent to that used by the SVO. Recent experience has shown that our ratings are generally comparable to those of the SVO. (2) Comparisons between SVO and S&P ratings are published by the National Association of Insurance Commissioners. (3) Includes 59 securities with gross unrealized losses are awaiting an SVO rating with a carrying value of $1,798.1 million and unrealized losses of $27.4 million. Due to lags between the funding of an investment, the processing of final legal documents, the filing with the SVO, and the rating by the SVO, there will always be a number of unrated securities at each statement date. Unrated securities comprised 18.5% and 5.7% of the total carrying value and total gross unrealized losses of securities in a loss position, including redeemable preferred stock, respectively.
o The inflow of new cash for the twelve month period ending December 30, 2004 was invested at rates that were below the portfolio rate. In addition, maturing assets were rolling over into new investments at rates below the portfolio rate. In 2004, weighted-average invested assets grew $3,139.5 million (adjusted for Maritime), or 4.8%, from the prior year. These two factors account for the majority of the remaining decline in portfolio rate.
The Company recorded losses due to other than temporary impairments of other invested assets of $78.1 million for year ended December 31, 2004. These impairments primarily relate to lease investments in the U.S. airline industry ($29.2 million) and an investment in a royalty stream ($25.5 million). There were also $12.7 million in impairments on CBO and CDO equity for the period. Equity in these CBOs and CDOs take the first loss risk in a pool of high yield debt. We have a total remaining carrying value of $34.9 million and $60.0 million of CBO and CDO equity as of December 31, 2004 and December 31, 2003, which is currently supported by expected cash flows.
The Company's primary use of QSPEs arises in its commercial mortgage banking subsidiary. The Company's commercial mortgage banking subsidiary originates commercial mortgages and sells them to QSPEs which then issue mortgage backed securities (MBS). The Company engages in this activity to earn fees during the origination process, and to generate realized gains during the securitization process. The Company may purchase MBS from the QSPEs created in its commercial mortgage banking subsidiary to generate net investment income. The majority of the Company's MBS portfolio was purchased from unrelated QSPEs.
Consolidated Balance Sheets as of December 31, 2004 (Company) and 2003 (Predecessor Company)............................................... 75
Equity securities include common stock and non-mandatorily redeemable preferred stock. Equity securities that have readily determinable fair values are carried at fair value. For equity securities that the Company classifies as available-for-sale, unrealized gains and losses are reflected in shareholder's equity, as described above for fixed maturity securities. Impairments in value deemed to be other than temporary are reported as a component of net realized investment and other gains (losses). Gains and losses, both realized and unrealized, on equity securities which were classified as trading, are part of investment returns related to equity indexed universal life insurance policies sold at Maritime Life and are included in discontinued operations.
In cases where the Company receives or pays a premium as consideration for entering into a derivative instrument (i.e., interest rate caps and floors, swaptions, and equity collars), the premium is amortized into investment income over the term of the derivative instrument. The change in fair value of such premiums (i.e., the inherent ineffectiveness of the derivative) is excluded from the assessment of hedge effectiveness and is included in net realized investment and other gains (losses). Changes in fair value of derivatives that are not hedges are included in net realized investment and other gains (losses).
Separate Accounts. Separate account assets and liabilities reported in the Company's Consolidated Balance Sheets represent funds that are administered and invested by the Company to meet specific investment objectives of the contractholders. Net investment income and net realized investment and other gains (losses) generally accrue directly to such contractholders who bear the investment risk, subject, in some cases, to principal guarantees and minimum guaranteed rates of income. The assets of each separate account are legally segregated and are not subject to claims that arise out of any other business of the Company. Separate account assets are reported at fair value. Deposits, net investment income and net realized investment and other gains (losses) of separate accounts are not included in the revenues of the Company. Fees charged to contractholders, principally mortality, policy administration and surrender charges, are included in universal life and investment-type product charges.
The Company adopted SOP 03-1 on January 1, 2004, which resulted in an increase in shareholder's equity of $40.4 million (net of tax of $21.2 million). The Company recorded a decrease in net income of $4.3 million (net of tax benefit of $1.8 million) which is presented as the cumulative effect of an accounting change, and an increase in other comprehensive income of $3.5 million (net of tax of $1.9 million) on January 1, 2004. An additional increase of $41.3 million of net income, net of tax of $(21.1) million is recorded in discontinued operations. Finally, in conjunction with the adoption of SOP 03-1 the Company reclassified $933.8 million in separate account assets and liabilities to the corresponding general account balance sheet accounts. See Recent Accounting Pronouncements below for further discussion.
The amortized cost and fair value of fixed maturities at December 31, 2004, by contractual maturity, are shown below:
Depreciation expense on investment real estate was $3.9 million, $3.1 million, and $4.4 million in 2004, 2003 and 2002, respectively. Accumulated depreciation was $13.9 million and $45.3 million at December 31, 2004 and 2003, respectively.
The Company values retained security interests in securitizations, at time of issue and subsequently, using the same pricing methods as it uses for its existing investment portfolio. Fair value prices are obtained from an independent pricing service when available, and if not available are estimated by the Company by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments. Refer to Note 17 - Fair Value of Financial Instruments below for further discussion of the Company's fair value methodologies. The Company values servicing rights by estimating future cash flows from the servicing assets using discount rates that approximate market rates.
The Company has unremitted foreign earnings from its foreign subsidiaries, predominantly Canadian, which are permanently reinvested under FASB Statement No. 109. If the unremitted earnings at December 31, 2004 were distributed, there would be an incremental U.S. tax of approximately $410.0 million after foreign tax credits.
As of February 1, 2000, the Company established a closed block for the benefit of certain classes of individual or joint traditional participating whole life insurance policies for which the Company had a dividend scale payable in 1999 and individual term life insurance policies that were in force on February 1, 2000. Assets were allocated to the closed block in an amount that, together with anticipated revenues from policies included in the closed block, was reasonably sufficient to support such business, including provision for payment of benefits, direct asset acquisition and disposition costs, and taxes, and for continuation of dividend scales payable in 1999, assuming experience underlying such dividend scales continues. Assets allocated to the closed block inure solely to the benefit of the holders of the policies included in the closed block and will not revert to the benefit of the shareholders of the Company. No reallocation, transfer, borrowing, or lending of assets can be made between the closed block and other portions of the Company's general account, any of its separate accounts, or any affiliate of the Company without prior approval of the Massachusetts Division of Insurance.
As a result of Manulife's merger of the Company, see Note 1- Change of Control, the Company renamed and reorganized certain businesses within its operating segments to better align the Company with its new parent, Manulife. The Company renamed the Asset Gathering Segment as the Wealth Management Segment and the Maritime Life Segment was renamed the Canada Segment. On December 29, 2004, the Canada Segment, whose primary business was the operations of Maritime Life, was transferred to The Manufacturers Life Insurance Company (MLI), Manulife's primary Canadian insurance subsidiary; see Note 2 - Summary of Significant Accounting Policy. Canada Segment's net income is reflected in the Company's Consolidated Statements of Income as income from discontinued operations for all periods presented. No gain or loss was recorded in the Company's Consolidated Income Statements on this transfer of a business between entities under common control. The remaining Canada Segment notes receivable, equity and interest earned on the notes receivable are reported in the Corporate and Other Segment. Further efforts at reorganization of JHFS included the movement of the Institutional Investment Management Segment to the Corporate and Other Segment. Other realignments include moving Signator Investors, Inc. our agent sales organization, from Wealth Management to Protection, and group life, retail discontinued operations, discontinued health insurance operations and creditor from Corporate and Other to Protection. Direct Foreign Operations (DFO) and International Group Plans (IGP) remain in international operations and John Hancock Accident remains in our non-core business in our Corporate and Other Segment while in Manulife's segment results DFO will be reported in Asia, and IGP and John Hancock Accident will be reported in Reinsurance. On September 30, 2004, the Company's Singapore subsidiary, the John Hancock Life Assurance Limited in Singapore (JHLAC), a DFO subsidiary, was transferred from the Company to Manulife (Singapore) Private Limited, a wholly owned subsidiary of Manulife; see Note 2 - Summary of Significant Accounting Policy. No gain or loss was recorded in the Company's Consolidated Income Statements on this transfer of a business between entities under common control. The financial results for all periods have been reclassified to conform to the current period presentation.
Brand name, distribution networks, and other investment management contracts were initially recognized at the time of the acquisition of the Company by Manulife in the recent merger. Goodwill, investment management contracts and VOBA were expanded in scope and size as a result of the merger.
The Company will test unamortizable intangible assets for impairment on an annual basis, and also in response to any events which suggest that these assets may be impaired (triggering events). Amortizable intangible assets will be tested only in response to triggering events. The Company will test goodwill using the two-step impairment testing program set forth in SFAS No. 142 "Goodwill and Other Intangible Assets." The Company's other intangible assets will be evaluated by comparing their fair values to their current carrying values whenever they are tested. Impairments will be recorded whenever an intangible asset's fair value is deemed to be less than its carrying value.
o Life products used purchase GAAP mortality, lapse, mean investment performance, and discount rate assumptions included in the related deferred acquisition cost (DAC) and value of business acquired (VOBA) models which varied by product.