Our Communications segment consists of radio and television broadcasting operations located in selected markets in the Southeastern and Western United States, and sports program production. We generate revenues for this segment through advertising, sales of programming rights and other programming compensation.
We assign invested assets backing insurance liabilities to our segments in relation to policyholder funds and reserves. We assign net DAC and VOBA, reinsurance receivables and communications assets to the respective segments where those assets originate. We also assign invested assets to back capital allocated to each segment in relation to our philosophy for managing business risks, reflecting appropriate conservatism. We assign the remainder of invested and other assets, including all defaulted securities, to the Corporate and Other segment. Segment assets as of December 31 were as follows:
The increase in product charge revenue in 2005 was due to higher sales, continued growth and aging of our insurance blocks, and a management action in the first quarter of 2005 to reduce non-guaranteed cost of insurance bonuses (partial refunds) on certain older UL-type life products. Cost of insurance charges (COIs) grew 8.2% in 2005 and 5.3% in 2004. The 2005 increase was favorably impacted by $12.7 in the first quarter associated with the reduction in certain non-guaranteed COI bonus rates. These COI bonuses are paid to certain policyholders at specified policy anniversaries for continuing persistency. This reduction in bonus rates favorably impacts quarterly COI charges by approximately $1.5, through lower refunds of COIs, on a comparative basis. Excluding the impact of lower COI bonuses, COIs grew 7.4% in 2005 from an increase in the average age of our insureds (this contributes to increased death benefits as well), timing of reinsurance premiums which vary with the proportion of new business issued exceeding retention limits, and growth in face amount of UL-type policies. The 2004 increases in product charge revenue were due to growth and aging of our insurance blocks, dynamic adjustments to unearned expense charges, as noted below, and higher surrender rates offsetting the reinsurance recapture that increased COIs by $8.4 in 2003. Products issued in recent years are designed to generate a higher proportion of their revenues from expense charges. We defer expense charges received in excess of ultimate annual expense charges and amortize them into income relative to future estimated gross profits. The effect of reflecting updated longer-term assumptions in estimated gross profits on our insurance blocks increased the amortization of unearned expense charges by $3.3 in 2005 and decreased it by $1.1 in 2004. Additionally, the adoption of new accounting guidance for secondary guarantee insurance products and other benefits in 2004 impacted estimated gross profits and reduced the amortization of unearned expense charges by $4.0. Excluding the impact of these amortization adjustments, expense charges increased over 2004 due to the impact of higher sales and changes in product mix. Surrenders of policies subject to a surrender charge decreased in 2005 resulting in lower surrender charge income. Surrender activity increased in 2004 due to higher lapses in our BOLI block of business.
Policy benefits on traditional business include death benefits, dividends, surrenders and changes in reserves, with the most significant being death benefits. Policy benefits as a percentage of premiums and other considerations were 112.6% in 2005, 113.5% in 2004 and 114.3% in 2003.
incidence and terminations in the Canada Life block, partially offset by unfavorable claims incidence and claim termination rates in our core long-term disability business. Additionally, during the second quarter of 2005, we reduced the discount rate used to calculate long-term disability and life waiver reserves by 0.25% (to 4.75%) on 2005 and future incurrals. The increase in policy benefits in 2004 reflected growth from the acquired Canada Life business as well as strong organic growth in our existing business. The combined loss ratio for 2004 of 73.7% was in line with 2003 as adverse experience in our long-term disability business (from unfavorable experience in incidence rates and unfavorable claims termination experience) offset favorable experience in our life business. Additionally in 2004, we made pricing increases to address an isolated segment of our life business that was under-performing, and we implemented greater management scrutiny of larger cases, especially renewals of groups with adverse experience. These changes contributed to the improved loss ratio in our life business in 2004.
Interest expense on debt increased $12.0 and $14.3 in 2005 and 2004 after remaining flat in 2003. The 2005 increase is primarily due to higher short-term interest rates, partially offset by a decrease in average debt volume. The 2004 increase reflects a change in the mix of outstanding indebtedness between floating and fixed rate instruments and an increase in the overall level of outstanding indebtedness. Specifically, our fixed rate indebtedness increased with the issuance of $300 of ten-year notes on January 27, 2004 at an effective interest rate of 4.77%, a portion of which was used to support the Canada Life acquisition (See Note 14). See Note 8 for details of our debt structure and interest costs. Operating expenses vary from period to period based upon the level of corporate activities and strategies and decreased in 2005 and in the two previous years. The 2005 decline was driven by a $7.1 reduction in litigation-related reserves.
Our capital structure consists of 10-year term notes, floating rate EXtendible Liquidity Securities® (EXLs), short-term commercial paper, securities sold under repurchase agreements, junior subordinated debentures, and stockholders’ equity. We also have a bank credit agreement, under which
Total assets increased $973 in 2005, primarily due to net policyholder contract deposits and growth in DAC, which more than offset dividends, stock repurchases and lower unrealized gains on investments.
The following table shows the diversification of unrealized gains and losses for our debt securities portfolio across industry sectors as of December 31, 2005:
industry factors or conditions related to a geographic area that are negatively affecting the security;
In 2004, there were two securities with write-down amounts of greater than $10. The first was the write down of a commercial cable equipment company for $10.1. This was due to the likely bankruptcy filing following an adverse judicial ruling on a summary judgment motion. The value of assets may not exceed the cost of a bankruptcy filing or the costs of winding down the operations. This had no impact on other holdings in our portfolio. The second was the write-down of a national passenger airline for $17.5. This was due to high labor costs, increasing fuel prices, intense competition from low cost carriers, an inability to access capital, and the lack of demand for older aircraft. We have been actively managing all of our exposures to the passenger airline industry, although this write-down had no impact on other holdings in our portfolio.
Jefferson-Pilot Corporation (with its subsidiaries, referred to as the Company) operates in the insurance, securities and broadcasting industries. Life insurance, annuities, disability and dental insurance are currently marketed to individuals and businesses in the United States through the Company’s principal life insurance subsidiaries: Jefferson-Pilot Life Insurance Company (JP Life), Jefferson Pilot Financial Insurance Company (JPFIC) and its subsidiary, Jefferson Pilot LifeAmerica Insurance Company (JPLA). Jefferson Pilot Securities Corporation (with related entities, JPSC) is a registered non-clearing broker/dealer that sells affiliated and non-affiliated variable life and annuity products and other investment products, including mutual funds, stocks, bonds and other investments. Collectively, these insurance and securities subsidiaries are referred to as JP Financial. Broadcasting operations are conducted by Jefferson-Pilot Communications Company (JPCC) and consist of radio and television broadcasting, through facilities located in strategically selected markets in the Southeastern and Western United States, and sports program production.
historical experience adjusted for trends and circumstances. Management believes that the recorded liability is sufficient to provide for claims and the associated adjustment expenses incurred through the balance sheet date.
Aggregate cost or amortized cost, aggregate fair value and gross unrealized gains and losses were as follows:
Investment expenses include salaries, expenses of maintaining and operating investment real estate, real estate depreciation and other allocated costs of investment management and administration.
The Company monitors its portfolio closely to ensure that all other-than-temporary impairments are identified and recognized in earnings as they occur. At December 31, 2005, 1,052 of the Company’s securities were in an unrealized loss position. The table below summarizes unrealized losses on all securities held by both asset class and length of time that a security has been in an unrealized loss position:
The table below summarizes the securities with unrealized losses in our debt portfolio as of December 31, 2005.
For the years ended December 31, 2005, 2004 and 2003 the Company recognized $0, $0 and $4 in previously deferred losses as a result of sales of securities purchased through the use of cash flow hedges.
Activity in the liabilities for accident and health and disability benefits, including reserves for future policy benefits and unpaid claims and claim adjustment expenses, was as follows:
In conjunction with the establishment of an intercompany reinsurance subsidiary, we obtained a $500 letter of credit facility. The credit agreement will provide credit enhancement for the subsidiary’s reinsurance obligations. JP is a guarantor under the letter of credit facility. At December 31, 2005, we had not reinsured any reserves to this subsidiary.
Risk-Based Capital (“RBC”) requirements promulgated by the NAIC require life insurers to maintain minimum capitalization levels that are determined based on formulas incorporating credit risk, insurance risk, interest rate risk and general business risk. The NAIC and the Life and Health Actuarial Task Force recently approved statutory reserving practices under Actuarial Guideline 38 (referred to as “AXXX” or the “Guideline”) that will require us, and other companies, to record higher AXXX reserves on new sales during a 21-month period beginning July 1, 2005, followed by a long-term change to reserving methods for these products. Under these reserving practices we established approximately $77 of additional statutory reserves ($45 after-tax reduction in surplus) over the second half of 2005. As of December 31, 2005, the life insurance subsidiaries’ adjusted capital and surplus exceeded their authorized control level RBC.
Under prior federal income tax law, one-half of the excess of a life insurance company’s income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as “Policyholders’ Surplus.” The Company set aside approximately $107 of untaxed “Policyholders’ Surplus.” The prior federal income tax law states that no payment of federal income taxes will be required unless it is distributed as a dividend, or under other specified conditions. No related deferred tax liability has been recognized for the potential tax, which would have approximated $37. The American Jobs Creation Act of 2004 allows for the Policyholders’ Surplus to be distributed during a specific time period without being subjected to tax. The distributions must be made no later than December 31, 2006. As of December 31, 2005, the Company’s subsidiaries had distributed $105 as a dividend and intend to payout the remaining $2 in 2006.
Information for Pension Plans with Accumulated Benefit Obligation in Excess of Plan Assets
The fair value of the funding agreements approximates the carrying value since interest is based on a variable rate. The above carrying and fair value amounts at December 31, 2005 include $1 in accrued interest.