The statements, analyses, and other information contained in this management's narrative and elsewhere in this Form 10-K, relating to trends in John Hancock Financial Services, Inc.'s, (the Company's) operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "will," "should," "may," and other similar expressions, are "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning future events and their potential effects on the Company. Future events and their effects on the Company may not be those anticipated by management. The Company's actual results may differ materially from the results anticipated in these forward-looking statements.
For additional information, refer to John Hancock and other related public filings with the U.S. SEC relating to the merger.
The Company has finalized its FIN 46R analysis for all of the entities described below. The Company is not the primary beneficiary of any of them. For many of these, the application of FIN 46R required estimation by the Company of the future periodic cash flows and changes in fair values for each candidate, starting as of the Company's original commitment to invest in and/or manage each candidate, and extending out to the end of the full expected life of each. These cash flows and fair values were then analyzed for variability, and this expected variability was quantified and compared to total historical amounts invested in each candidate's equity to help determine if each candidate is a VIE. The Company also evaluated quantitative and non-quantitative aspects of control relationships among the owners and decision makers of each candidate to help determine if they are VIEs.
Since 1995, the Company generates income tax benefits by investing in apartment properties (the Properties) that qualify for low income housing and/or historic tax credits. The Company invests in the Properties directly, but primarily invests indirectly via limited partnership real estate investment funds (the Funds). The Funds are consolidated into the Company's financial statements. The Properties are organized as limited partnerships or limited liability companies each having a managing general partner or a managing member. The Company is usually the sole limited partner or investor member in each Property; it is not the general partner or managing member in any Property. The Properties typically raise additional capital by qualifying for long-term debt, which in some cases is guaranteed or otherwise subsidized by Federal or state agencies or Fannie Mae. In certain cases, the Company invests in the mortgages of the Properties.
The Company recognizes several intangible assets, all of which resulted from business combinations. Valuation, and where applicable, amortization of these assets require significant management estimates and judgment.
Amortizable assets include value of business acquired (VOBA), distribution networks and other investment management contracts. VOBA is the present value of estimated future profits of insurance policies in force related to the Company's businesses acquired by Manulife in the recent merger. VOBA had weighted average lives ranging from 6 to 17 years for various insurance businesses at the merger. Distribution networks are fair values assigned to the Company's networks of sales agents and producers responsible for procuring business. Distribution networks had weighted average lives of 21 years at the merger. Collectively, these amortizable intangible assets had a weighted average life of 14.7 years at the merger.
Costs that vary with, and are related primarily to, the production of new business are deferred to the extent that they are deemed recoverable. Such costs include commissions, certain costs of policy issue and underwriting, and certain agency expenses. Similarly, any amounts assessed as initiation fees or front-end loads are recorded as unearned revenue. The Company has also recorded intangible assets representing the present value of estimated future profits of insurance policies inforce related to business acquired. The Company tests the recoverability of its DAC and VOBA assets quarterly with a model that uses data such as market performance, lapse rates and expense levels. We amortize DAC and VOBA on term life and long-term care insurance ratably with premiums. We amortize DAC and VOBA on our annuity products and retail life insurance, other than term life insurance policies, based on a percentage of the estimated gross profits over the lives of the policies. These policy lives are, generally, up to thirty years for products supporting DAC and VOBA. Our estimated gross profits are computed based on assumptions related to the underlying policies including mortality, lapse, expenses, and asset growth rates. We amortize DAC, VOBA and unearned revenue on these policies such that the percentage of gross profits realized compared to the amount of DAC, VOBA and unearned revenue amortized is constant over the life of the policies.
The liability for future policy benefits is the largest liability included in our consolidated balance sheets, equal to $42,962.8 million, or 47.6%, of total liabilities as of December 31, 2004. Changes in this liability are generally reflected in the benefits to policyholders in our consolidated statements of income. This liability is primarily comprised of the present value of estimated future payments to holders of life insurance and annuity products based on certain management judgments. Reserves for future policy benefits of certain insurance products are calculated using management's judgments of mortality, morbidity, lapse, investment performance and expense levels that are based primarily on the Company's past experience and are therefore reflective of the Company's proven underwriting and investing abilities. Once these assumptions are made for a given policy or group of policies, they will not be changed over the life of the policy unless the Company recognizes a loss on the entire line of business, or the Company is acquired. The Company periodically reviews its policies for loss recognition and, based on management's judgment, the Company from time to time may recognize a loss on certain lines of business. Short-term variances of actual results from the judgments made by management are reflected in current period earnings and can impact quarter to quarter earnings.
Impairments on our investment portfolio are recorded as a charge to other comprehensive income, and if judged by management to be other than temporary in nature, are recorded as a charge to income. See the General Account Investments section of this document for a more detailed discussion of the investment officers' professional judgments involved in determining impairments and fair values.
Certain of our fixed income securities classified as available-for-sale are not publicly traded, and quoted market prices are not available from brokers or investment bankers on these securities. Changes in the fair values of the available-for-sale securities are recorded in other comprehensive income as unrealized gains and /or losses. We calculate the fair values of these securities ourselves through the use of pricing models and discounted cash flows which therefore calls for a substantial level of professional investment management judgment. Our approach is based on currently available information, including information obtained by reviewing similarly traded securities in the market, and we believe it to be appropriate and fundamentally sound. However, different pricing models or assumptions or changes in relevant current information could produce different valuation results. The Company's pricing model takes into account a number of factors based on current market conditions and trading levels of similar securities. These include current market based factors related to credit quality, country of issue, market sector and average investment life. The resulting prices are then reviewed by the pricing analysts and members of the Security Operations Department. Our pricing analysts take appropriate action to reduce the valuation of securities where an event occurs that negatively impacts the securities' value. Certain events that could impact the valuation of securities include issuer credit ratings, business climate, management changes at the investee level, litigation, fraud and government actions, among others.
The compensation rate increase assumption is generally set at a rate consistent with current and expected long-term compensation and salary policy including inflation. A change in the compensation rate increase assumption can be expected to move in the same direction as a change in the discount rate. A 4.0% compensation rate increase assumption is being used. A 0.25% increase in
On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily by adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act) provides for special tax-free subsidies to employers that offer plans with qualifying drug coverages beginning in 2006. There are two broad groups of retirees receiving employer-subsidized prescription drug benefits at the Company. The first group, those who retired prior to January 1, 1992, receives a subsidy of between 90% and 100% of total cost. Since this subsidy level will clearly meet the criteria for qualifying drug coverage, the Company anticipates that the benefits it pays after 2005 for pre-1992 retirees will be lower as a result of the new Medicare provisions. In accordance with Financial Accounting Standards Board Staff Position FAS 106-2 (FSP FAS 106-2), the Company reflected a reduction in the accumulated plan benefit obligation for this group of $40.9 million as of the purchase accounting remeasurement (April 28, 2004) and reduced net periodic postretirement benefit costs by $1.0 million for the period from April 29 through December 31, 2004. With respect to the second group, those who retired on or after January 1, 1992, the employer subsidy on prescription drug benefits is capped and currently provides as low as 25% of total cost. Since final authoritative accounting guidance has not yet been issued on determining whether a benefit meets the actuarial criteria for qualifying drug coverage, the Company has deferred recognition as permitted by FSP FAS 106-2 for this group. The final accounting guidance could require changes to previously reported information.
As part of the Manulife group of companies' subsequent to the merger we reinsure portions of the risks we assume for our protection insurance products. The maximum amount of individual ordinary life insurance retained by us on any life is $20 million under an individual policy and $25 million under a second-to-die policy. As of January 1, 2001, we established additional reinsurance programs, which limit our exposure to fluctuations in life insurance claims for individuals for whom the net amount at risk is $3 million or more.
As of January 1, 2001, the Company also entered into agreements with two reinsurers covering 50% of its closed block business. One of these reinsurers is Manulife. Effective April 28, 2004 the Company operates as a subsidiary of Manulife. During the fourth quarter of 2004, the Company entered into an additional agreement covering closed block policies with a Manulife affiliate in order to facilitate its statutory capital management process. This transaction increased the amount of reinsurance of the closed block with Manulife by 20%. Effective December 31, 2003, the Company entered into an agreement with a third reinsurer covering another 5% of its closed block business. The reinsurance agreements are structured so they will not affect policyholder dividends or any other financial items reported within the closed block, which was established at the time of the Life Company's demutualization to protect the reasonable dividend expectations of certain participating life insurance policyholders In addition, the Company has entered into reinsurance agreements to specifically address insurance exposure to multiple life insurance claims as a result of a catastrophic event. The Company has put into place, effective July 1, 2002, catastrophic reinsurance covering individual life insurance policies written by all of its U.S. life insurance subsidiaries. Effective July 1, 2004, the Company is covered by its parent's catastrophic reinsurance under its global catastrophe reinsurance program which covers the entire Manulife group of companies for losses in excess of $50 million up to $150 million. This global catastrophe reinsurance covers all terrorist acts in Canada; in the United States and elsewhere, nuclear, biological and chemical terrorist acts are not covered. Should catastrophic reinsurance become unavailable to the Company in the future, the absence of, or further limitations on, reinsurance coverage could adversely affect the Company's future net income and financial position.
Discontinued operations. Pursuant to Manulife's rationalization of its worldwide business operations along geographic lines, the Company's non-USA operations were or will be transferred to Manulife's previously existing subsidiaries in each region of the world.
On December 29, 2004, the remaining operations and substantially all of the remaining assets and liabilities of the Maritime Life Assurance Company (Maritime Life), which was formerly reported as the Company's Canada Segment, were transferred to The Manufacturers Life Insurance Company (MLI), Manulife's primary Canadian insurance subsidiary. Maritime Life legal shell continues to be owned by the Company. Maritime's net income is reflected in the Company's Consolidated Statements of Income as income from discontinued operations for all periods presented.
Assets and liabilities transferred December 29, December 31, 2004 2003 ---------------------------- (in millions) Investments................................. $ 8,705.0 $ 7,538.8 Total assets................................ 12,583.3 14,351.3 Total liabilities........................... 10,589.0 13,348.6
As further discussed in Note 1 to the Consolidated Financial Statements the merger was accounted for as a purchase. Accordingly, the operating results for the periods subsequent to April 28, 2004 reflect the results of operations of the Company subsequent to the merger and include the impact of adjustments required under the purchase method of accounting.
As a result of Manulife's merger with 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, its 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 Statements of Income 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 Institutional Investment Management Segment to the Corporate and Other Segment. Other realignments include moving Signator Investors, Inc. our agent sales organization, from the Wealth Management Segment to the Protection Segment, and group life, retail discontinued operations, discontinued health insurance operations and creditor from the Corporate and Other Segment to the Protection Segment. 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 Statements of Income 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.
During the majority of 2004, the Company operated in the following five business segments: two segments primarily served retail customers, one segment served institutional customers, one segment served primarily Canadian retail and group customers and our fifth segment was the Corporate and Other Segment, which includes our institutional advisory business, the remaining international operations, and the corporate account. Our retail segments are the Protection Segment and the Wealth Management Segment, previously called Asset Gathering. Our institutional segment is the Guaranteed and Structured Financial Products Segment (G&SFP). As previously discussed, the Canada Segment was transferred to an affiliated entity on December 29, 2004 and is presented in the discussion below as a disposed operation. Effective January 27, 2005, the G&SFP Segment became a part of the Wealth Management Segment. This organizational change reflects G&SFP's increasing focus on retail-oriented products and will enable the company to better leverage the strong distribution channels of the Wealth Management Segment with G&SFP's strong product development, risk management, and immediate annuity servicing capabilities. G&SFP is presented as its own operating segment for the discussion of 2004 results below.
Consolidated income from continuing operations before income taxes, discontinued operations, and cumulative effect of accounting changes decreased 22.1%, or $254.8 million, from the prior year. The decrease was driven by decreased earnings in the non-traditional life insurance business, institutional investment management business, spread-based business and integration expenses. Consolidated income from continuing operations before income taxes, discontinued operations, and cumulative effect of accounting changes by operating segment were as follows: a decrease of $364.0 million in the Corporate and Other Segment, an increase of $39.8 million in the Wealth Management Segment, an increase of $37.1 million in the Guaranteed and Structured Financial Products, and partially offset by growth of $32.3 million in the Protection Segment. After consolidated income from continuing operations before income taxes, discontinued operations, and cumulative effect of accounting changes the Company recorded income from discontinued operations of $159.7 million and a decrease to net income of $4.3 million (net of tax of $1.8 million) resulting from the adoption of a new accounting pronouncement, Statement of Position 03-1 - Accounting and Reporting by Insurance Enterprises for Certain Untraditional Long Duration Contracts for Separate Accounts (SOP 03-1), see Note 2 - Summary of Significant Accounting Policy for additional discussion.
Universal life and investment-type product fees increased 2.6%, or $17.2 million, from the prior year. These product fees consist primarily of cost of insurance fees on our variable life insurance and universal life insurance products and mortality and expense fees on our variable annuity products. The increase was primarily due to an increase of $34.3 million in the Protection Segment driven by growth in average account values in universal life insurance products driven by growth in the existing business. Partially offsetting the growth in the Protection Segment was a decline of $8.8 million in product fees in the Wealth Management Segment which declined on lower mortality and expense fees in the variable annuity business. In addition, product fees decreased $8.4 million in the G&SFP Segment driven by lowers fees in the single premium annuity business.
o On April 28, 2004, as a result of Manulife's acquisition of John Hancock, assets were marked to market in accordance with purchase accounting rules. The impact of the asset adjustment and related amortization was a reduction in yield of approximately 71 basis points compared to the prior year.
o As of December 31, 2004, the Company's asset portfolio had approximately $12 billion of floating-rate exposure (primarily LIBOR). This compares to a $13 billion level of exposure as of December 31, 2003. This exposure was created mostly through interest rate swaps designed to match our floating-rate liability portfolio. As of December 31, 2004, approximately 86% of this exposure, excluding cash and short-term investments, was directly offset by exposure to floating-rate liabilities. Most of the remaining 14% of exposure is in floating rate assets were acquired for their relative value and are accounted for in the portfolio's interest rate risk management plan. The impact was a reduction of 43 basis points for 2004 compared to 56 basis points in 2003.
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.
Net realized investment and other gains increased 268.5%, or $63.9 million, from prior year. See detail of current year net realized investment and other gains in the table below. The improvement in the net realized investment and other gains was driven by gross gains on disposal of fixed maturity securities generated in the management of the portfolios for tax optimization and ongoing portfolio positioning, as well as $104.8 million of prepayments. In addition, there were $42.5 million of recoveries on sales of previously impaired securities for the year ended December 31, 2004. Partially offsetting these gains were impairments of $329.4 million driven by $179.5 million in other than temporary impairments of fixed maturity securities (which excludes $14.4 million of previously recognized gains where the bond was part of a hedging relationship). Fixed maturity impairments in 2004 relate primarily to: securities in the airline industry ($62.8 million), a manufacturer of parcel delivery vans ($28.0 million), private placement securities related to secured lease obligations of a regional retail food chain ($22.0 million), a holding in a privately held pharmaceutical company ($21.3 million), and one of the world's largest dairy companies ($17.5 million). 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 recorded a net loss of $63.7 million on mortgage loans for the year ended December 31, 2004 (of which $17.6 million was losses on hedging adjustments). Included in this loss is $65.7 million in impairments. These impairments primarily relate to mortgages on a company that operates flour milling facilities ($20.2 million), a refrigeration warehouse company ($21.5 million), and a commercial office property ($10.0 million). There were also gains of $107.4 million on the sale of equity securities as part of our overall investment strategy of using equity gains to offset credit losses in the long
term, gains of $50.3 million from the sale of other invested assets, and gains of $83.1 million resulting from the sale of real estate for the year ended December 31, 2004. For additional analysis regarding net realized investment and other gains (losses), see below and General Account Investments in this management's narrative. The Company recorded total impairments of $210.2 million for the period subsequent to the merger with Manulife, April 29, 2004 through December 31, 2004, and $119.2 million for the period prior to the merger with Manulife, from January 1, 2004 through April 28, 2004, compared to $574.9 million for the prior year.
Investment management revenues, commissions, and other fees increased 7.7%, or $38.6 million, from the prior year. The increase in fee revenue was driven by the mutual funds business where fees increased $18.9 million driven by a 10.0%, or $2,702.6 million, increase in average assets under management. In addition, advisory fees increased 3.3%, or $3.8 million, in the institutional asset management business despite a 5.5%, or $1,542.1 million, decrease in average assets under management. This increase in advisory fees was driven by success with the new vertical integration strategy in the Hancock Natural Resource Group. In addition, advisory fees earned in the Signator Financial Network increased due to sales of the Manulife product since the merger.
Benefits to policyholders decreased 8.0%, or $387.3 million, from the prior year. The decrease in benefits to policyholders was driven by a 22.1%, or $358.2 million, decline in the G&SFP Segment on a 53.2% decline in premiums on single premium annuities. In addition, interest credited in the G&SFP Segment decreased 10.6%, or $107.5 million, from the prior year. The decrease in interest credited was due to a decline in the average interest credited rate on account balances for spread-based products, due to the reset of approximately $10.5 billion of liabilities with floating rates and new business added at current market rates. Interest credited in the G&SFP Segment also decreased due to the repricing of liability products at the date of the merger with Manulife for purchase accounting which resulted in resetting the crediting rates to a lower market rate. The average crediting rate fell to 3.65% from 4.31% in the prior year. Benefits to policyholders declined 23.0%, or $109.3 million, in the fixed annuity business driven by lower sales of single premium immediate annuities, as noted above, and impact of purchase accounting in the merger with Manulife whereby reserves established at merger date are being amortized to benefits to policyholders. In addition, benefits to policyholders declined 10.3%, or $111.2 million, in the traditional life insurance business driven by lower premiums. Partially offsetting these decreases was growth in benefits to policyholders of $134.2 million in the long-term care insurance business, driven by 13.3%, or $128.5 million, increase in premiums. In addition, benefits to policyholders increased $61.3 million in the non-traditional life insurance business driven by 14.4% growth in average account balance.
Dividends to policyholders decreased 11.4%, or $62.7 million from the prior year. The decrease in dividends to policyholders was driven by the traditional life insurance business, which decreased 5.1%, or $23.0 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 2.9% from the prior period. Dividends to policyholders decreased $26.7 million due to a return of a claim stabilization reserve to a single customer in the group life business in the prior year. The result of this transaction in the prior year was a reduction in benefits to policyholders and an increase in dividends resulting in no net income impact. Group life was sold effective May 1, 2003. In addition, dividends to policyholders declined $16.5 million in the institutional fee-based business on lower average reserves from the prior year.
Income taxes were $251.0 million in 2004, compared to $316.7 million for 2003. Our effective tax rate was 27.9% in 2004, compared to 27.4% in 2003. The change in effective tax rate was primarily due to changes in the recognition of tax expense as a result of the purchase accounting for leveraged leases as required by FASB Interpretation No. 21, "Accounting for Leases in a Business Combination" and FASB Statement of Financial Accounting Standards No. 13, "Accounting for Leases".
The following discussion has been updated to remain comparable with the current year management's narrative; it therefore reflects the state of the Company's operations subsequent to the merger with Manulife. In the following management's narrative, references to operating segments which have been merged with other operating segments or renamed since the date of the merger have been updated to reflect such business decisions. In addition, the following discussion has been updated to reflect the transfer of the Canada Segment, referred to as the Maritime Life Segment at the time this discussion was originally published, to an affiliate. The operating results of the Canada Segment appear as discontinued operations on the Company's updated statements of income for the periods covered by this discussion.
Net realized investment and other gains increased 105.3%, or $472.3 million, from prior year. See detail of current year net realized investment and other gains in the table below. The change in net realized investment gains is the results of gross gains on disposal of; fixed maturity securities of $469.0 million including $90.8 million of previously written down securities, real estate of $251.8 million driven by the sale of the Home Office properties, equity securities of $102.8 million and mortgage loans on real estate of $75.9 million primarily from prepayment penalties. These gains are partially offset by impairments on fixed maturity securities of $517.3 million and associated hedging adjustments during the period. The improvement of $472.3 million in net realized investment and other losses in 2003 is net of $3.2 million in net realized investment and other losses allocated to the participating pension contractholders and $58.5 million in net realized investment and other losses allocated to the policyholder dividend obligation.
The impairments in the current period were driven by losses recognized on other than temporary declines in value of fixed maturity securities of $542.0 million, including impairment losses of $517.3 million and $24.7 million of previously recognized gains where the bond was part of a hedging relationship. The largest impairments were; $153.0 million on securities in the dairy industry, $73.5 million in the airline industry and $69.3 million in the securities in the power and energy industry, Additional losses were recorded for other than temporary declines in the equity in collateralized bond obligations of $29.8 million and other equity securities of $27.8 million during 2003. See General Accounts Investments in this management's narrative for a more comprehensive discussion of impairments.
Universal life and investment-type product fees increased 6.2%, or $38.3 million, from the prior year. These product fees consist primarily of cost of insurance fees on our variable life insurance and universal life insurance products and mortality and expense fees on our variable annuity products. The increase was primarily due to an increase of $35.3 million in the Protection Segment driven by growth in average account values in universal life insurance products driven by the acquisition of the Allmerica block of fixed universal life insurance business as of December 31, 2002 and growth in the existing business.
Net investment income increased $221.0 million from the prior year. The increase was primarily the result of asset growth and lower investment expenses. The yield, net of investment expenses, on the general account portfolio decreased to 5.95% from 6.29% in the prior year. The lower portfolio yield was driven primarily by the drop in short-term interest rates during the year, which impacted floating rate investments, and lower yields on investment acquisitions. The change in yields was impacted by the following factors:
o As of December 31, 2003, the Company's asset portfolio had approximately $13 billion of floating-rate exposure (primarily LIBOR). This compares to $12 billion of exposure as of December 31, 2002. This exposure was created mostly through interest rate swaps designed to match our floating-rate liability portfolio. As of December 31, 2003, approximately 87% of this exposure, excluding cash and short-term investments, was directly offset by exposure to floating-rate liabilities. Most of the remaining 13% of exposure is in floating rate assets acquired for their relative value and is accounted for in the portfolio's interest rate risk management plan. As a result of the drop in short term rates over the year, as well as the increase in exposure, this floating-rate exposure reduced the portfolio yield by 11 basis points in 2003 compared to the prior year.
o Certain of our tax-preferenced investments (lease residual management and affordable housing limited partnerships) dilute the Company's net portfolio yield on a pre-tax basis. In 2003, this dilutive effect was 8 basis points, compared to 11 basis points in 2002. However, adjusting for taxes, these investments increased the Company's net income by $7.6 million in 2003 compared to the prior year.
Investment management revenues, commissions, and other fees decreased 1.6%, or $7.9 million, from the prior year. The decrease in fee revenue was driven by the mutual funds business where fees declined $23.8 million where
distribution and advisory fees declined due to a shift in the product mix. The decline in fee rates was primarily due to a decrease in contingent deferred sales charges on a decline in open-end mutual fund class B share redemptions. Rule 12b-1 fee revenue also declined due to lower eligible assets under management. Average mutual fund assets under management were $27,159.7 million, an increase of $356.4 million, or 1.3% from the prior year. Partially offsetting the decline in the mutual funds business management fees was growth in the institutional investment advisory business of $7.0 million driven by success with the new vertical integration strategy in the Hancock Natural Resource Group.
Other operating costs and expenses increased $118.0 million from the prior year, driven by an increase in net periodic pension costs of $32.0 million, deficiency interest of $22.4 million, $12.3 million in compensation costs, $3.3 million in pension curtailment losses and administrative service contracts of $4.6 million. In addition, Signature Fruit operating expenses increased $16.5 million. Signature Fruit other operating costs and expenses were $257.8 million in 2003 and $241.3 million in the prior year. G&SFP Segment other operating costs and expenses increased $21.1 million on higher advertising, compensation and commission costs. Wealth Management Segment other operating costs and expenses increased $23.0 million driven by business growth.
Amortization of deferred policy acquisition costs increased 1.6%, or $5.3 million, from the prior year. The decrease in amortization of deferred policy acquisition costs was primarily due to the $64.0 million Q3 2002 Unlocking of the Company's deferred policy acquisition costs (DAC) asset, which increased amortization of the DAC asset in 2002. The Q3 2002 Unlocking of the DAC asset occurred based on changes in the future investment return assumptions and our lowering of the long-term growth rate assumption from 9% to 8%, gross of fees (which are approximately 1% to 2%). In addition, we lowered the average rates for the next five years from the mid-teens to 13%, gross of fees. The Q3 2002 Unlocking impacted the Wealth Management and Protection Segments. See Note 1--Summary of Significant Accounting Policies in the notes to consolidated financial statements and Critical Accounting Policies in the MD&A to the Company's 2003 Form 10-K for further discussion. The decrease in amortization of DAC due to Q3 2002 Unlocking of the DAC asset was partially offset by a $26.0 million increase in amortization in the Protection Segment for growth in the long-term care insurance business and adjusting gross profit margins for term conversions in the non-traditional life insurance business.
Cumulative effect of accounting change, net of tax, was $166.2 million for the year ended December 31, 2003, no cumulative effect of accounting change was recorded in 2002. In 2003 the cumulative effect of accounting change related to the adoption of DIG B36 as of October 1, 2003; refer to Note 2 - Summary of Significant Accounting Policies in the notes to the Consolidated Financial Statements of this Form 10-K.
o Interest rate risk, meaning changes in the market value of fixed maturity securities as interest rates change over time, and
o Credit risk, meaning uncertainties associated with the continued ability of an obligor to make timely payments of principal and interest.
o material declines in the issuer's revenues or margins; o significant management or organizational changes; o significant uncertainty regarding the issuer's industry; o debt service coverage or cash flow ratios that fall below industry-specific thresholds; o violation of financial covenants; and o other business factors that relate to the issuer.
(1) For securities that are awaiting an SVO rating, the Company has assigned a rating based on an analysis that it believes is equivalent to that used by the SVO.
(3) Includes 61 securities that are awaiting an SVO rating, with a carrying value of $881.0 million as of December 31, 2004 and 175 securities that are awaiting an SVO rating, with a carrying value of $4,066.9 million at December 31, 2003. 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.
(4) Includes the effect of $185.0 million notional invested in the Company's credit-linked note program, $165.0 million notional of written credit default swaps on fixed maturity securities in the AAA/AA/A category and $20.0 million notional of written credit default swaps on fixed maturity securities in the BBB category. As of December 31, 2003 the Company had $130.0 million notional invested in the Company's credit linked note program, $110.0 million notional written credit default swaps on fixed maturity securities in the AAA/AA/A category and $20.0 million notional written credit default swaps on fixed maturity securities in the BBB category.
(5) The Company entered into a credit enhancement agreement in the form of a guaranty from an AAA rated financial guarantor in 1996 which was terminated during 2004. In 2003, to reflect the impact of this guaranty on the overall portfolio, the Company has presented securities covered in aggregate by the guaranty at rating levels provided by the SVO and Moody's that reflect the guaranty. As a result, $421.0 million of SVO Rating 3, $185.2 million of SVO Rating 4, and $7.6 million of SVO Rating 5 underlying securities are included as $397.6 million of SVO Rating 1, $162.1 million of SVO Rating 2 and $54.1 million of SVO Rating 3 as of December 31, 2003. The guaranty also contained a provision that the guarantor can recover from the Company certain amounts paid over the history of the program in the event a payment is required under the guaranty. As of December 31, 2003, the maximum amount that could be recovered under this provision was $112.8 million.
evaluation of a wide range of below investment grade offerings in a variety of industries resulting in a well-diversified high yield portfolio.
Valuation techniques for the bond portfolio vary by security type and the availability of market data. Pricing models and their underlying assumptions impact the amount and timing of unrealized gains and losses recognized, and the use of different pricing models or assumptions could produce different financial results. External pricing services are used where available, broker dealer quotes are used for thinly traded securities, and a spread pricing matrix is used when price quotes are not available, which typically is the case for our private placement securities. The spread pricing matrix is based on credit quality, country of issue, market sector and average investment life and is created for these dimensions through brokers' estimates of public spreads derived from their respective publications. When utilizing the spread pricing matrix, securities are valued through a discounted cash flow method where each bond is assigned a spread, which is added to the current U.S. Treasury rates to discount the cash flows of the security. The spread assigned to each security is changed from month to month based on changes in the market. Certain market events that could impact the valuation of securities include issuer credit ratings, business climate, management changes, litigation, and government actions among others. The resulting prices are then reviewed by the pricing analysts and members of the Security Operations Department. The Company's pricing analysts take appropriate actions to reduce valuations of securities where such an event occurs that negatively impacts the securities' value. Although the Company believes its estimates reasonably reflect the fair value of those securities, the key assumptions about risk premiums, performance of underlying collateral (if any) and other factors involve significant assumptions and may not reflect those of an active market. To the extent that bonds have longer maturity dates, management's estimate of fair value may involve greater subjectivity since they involve judgment about events well into the future. Every quarter, there is a comprehensive review of all impaired securities and problem loans by Manulife's Credit Committee, a group consisting of Manulife's Chief Investment Officer, Chief Financial Officer, Chief Risk Officer and Chief Credit Officer. The valuation of impaired bonds for which there is no quoted price is typically based on the present value of the future cash flows expected to be received. If the company is likely to continue operations, the estimate of future cash flows is typically based on the expected operating cash flows of the company that are available to make payments on the bonds. If the company is likely to liquidate, the estimate of future cash flows is based on an estimate of the liquidation value of its net assets.
In keeping with the investment philosophy of tightly managing interest rate risk, the Company's MBS & ABS holdings are heavily concentrated in commercial MBS where the underlying loans are largely call protected, which means they are not pre-payable without penalty prior to maturity at the option of the issuer. By investing in MBS and ABS securities with relatively predictable repayments, the Company adds high quality, liquid assets to our portfolios without incurring the risk of cash flow variability. The Company believes the portion of its MBS/ABS portfolio subject to prepayment risk as of December 31, 2004 and December 31, 2003 was limited to approximately 27.3% and 23.3% of our total MBS/ABS portfolio and 5.6% and 3.5% of our total fixed maturity securities holdings, respectively.
As of December 31, 2004 and December 31, 2003, there were gross unrealized gains of $945.0 million and $3,493.3 million, and gross unrealized losses of $116.0 million and $478.7 million on the fixed maturities portfolio. As of December 31, 2004 gross unrealized losses of $116.0 million included $90.8 million or 78.3% was concentrated in asset-backed/mortgage-backed securities, manufacturing, bank & finance and utilities securities. The tables above show gross unrealized losses before amounts that are allocated to the closed block policyholders or participating pension contractholders. Of the $116.0 million of gross unrealized losses in the portfolio at December 31, 2004, $12.3 million was in the closed block and $6.7 million has been allocated to participating pension contractholders, leaving $97.0 million of gross unrealized losses after such allocations. The 2003 gross unrealized losses of $478.7 million included $417.6 million, or 87.2%, of gross unrealized losses concentrated in the utilities, manufacturing, oil and gas, transportation and asset-backed and mortgage-backed securities. The tables above show gross unrealized losses before amounts that were allocated to the closed block policyholders or participating pension contractholders. Of the $478.7 million of gross unrealized losses in the portfolio at December 31, 2003, $61.8 million was in the closed block and $20.2 million was allocated to participating pension contractholders, leaving $396.7 million of gross unrealized losses after such allocations.
Unrealized losses can be created by rising interest rates or by rising credit concerns and hence widening credit spreads. Credit concerns are apt to play a larger role in the unrealized loss on below investment grade bonds and hence the gross unrealized loss on the portfolio has been split between investment grade and below investment grade bonds in the above tables. The gross unrealized loss on below investment grade fixed maturity securities declined from $261.1 million at December 31, 2003 to $18.0 million at December 31, 2004 primarily due to the marking to market of the portfolio at April 28, 2004. The gross unrealized loss on December 31, 2004 was largely due to interest rate changes since April 28, 2004 and is fairly evenly distributed across the portfolio.
The following table shows the composition by credit quality of the securities with gross unrealized losses in our fixed maturity securities portfolio. The gross unrealized loss on investment grade bonds (those rated in categories 1 and 2 by the SVO) decreased by $109.8 million in the year ended December 31, 2004 to $97.3 million. The gross unrealized loss on below investment grade bonds (those rated in categories 3, 4, 5 and 6 by the SVO) declined over this period, dropping by $244.4 million to a total of $16.1 million as of December 31, 2004 which was driven by the mark to market and subsequent increase in interest rates.
Mortgage Loans. As of December 31, 2004 and December 31, 2003, the Company held mortgage loans with a carrying value of $11.8 billion and $12.9 billion, including $2.9 billion and $3.0 billion respectively, of agricultural loans and $8.9 billion and $9.9 billion, respectively, of commercial loans. Impaired loans
comprised 1.4% and 1.0% of the mortgage portfolio as of December 31, 2004 and December 31, 2003, respectively. The Company's average historical impaired loan percentage during the period from 1999 through 2004 is 1.0%.
The following table shows the carrying values of our mortgage loan portfolio that are delinquent but not in foreclosure, delinquent and in foreclosure, restructured and foreclosed. The table also shows the respective ratios of these items to the total carrying value of our mortgage loan
(1) Cash and cash equivalents are included in invested assets in the table above for the purposes of calculating yields on income producing assets for the Company. (2) 2003 and 2002 invested assets include $5.6 billion and $8.1 billion respectively of assets for Maritime Life. These assets have been excluded from the yield calculations due to Maritime Life becoming a discontinued operation in December 2004.
o On April 28, 2004, as a result of Manulife's acquisition of John Hancock, assets were marked to market in accordance with purchase accounting rules. The impact of the asset adjustment and related amortization was a reduction in yield of approximately 71 basis points for 2004 compared to 2003.
o Certain of our tax-preferenced investments (lease residual management and affordable housing limited partnerships) dilute the Company's net portfolio yield on a pre-tax basis. In 2003, this dilutive effect was 8 basis points, compared to 11 basis points in 2002. However, adjusting for taxes, these investments increased the Company's net income by $7.6 million in 2003 relative to 2002.
(1) Fixed maturities gain on disposals includes $42.5 million of gains from previously impaired securities. (2) Fixed maturities loss on disposals includes $7.0 million of credit related losses.
At the end of each quarter, our Investment Review Committee reviews all securities where market value is less than ninety percent of amortized cost for three months or more to determine whether impairments need to be taken. This committee includes the head of workouts, the head of each industry team, the head of portfolio management, and the Chief Credit Officer of Manulife. The analysis focuses on each company's or project's ability to service its debts in a timely fashion and the length of time the security has been trading below cost. The results of this analysis are reviewed by the Credit Committee at Manulife. This committee includes Manulife's Chief Financial Officer, Chief Investment Officer, Chief Risk Officer, and Chief Credit Officer. This quarterly process includes a fresh assessment of the credit quality of each investment in the entire fixed maturities portfolio.
The Company recorded $179.5 million of other than temporary impairments of fixed maturity securities for the year ended December 31, 2004. These impairments relate primarily to: securities in the airline industry ($62.8 million), a manufacturer of parcel delivery vans ($28.0 million), private placement securities related to secured lease obligations of a regional retail food chain ($22.0 million), a holding in a privately held pharmaceutical company ($21.3 million), and one of the world's largest dairy companies ($17.5 million).
Realized Gains, Losses and Impairments on Disposals - Year Ended December 31,
Of the $95.6 million of realized losses on sales of fixed maturity securities for the year ended December 31, 2003, there was a total of $28.8 million in credit losses. The significant credit losses for 2003 were $16.7 million of losses related to the sale of public bonds of a major health care service provider and $4.9 million related to the sale of public bonds of a power provider. All other sales were related to general portfolio management, including the sale of a number of below investment grade bonds to maintain the Company's exposure below 10% of invested assets on a statutory basis.
The Company recorded $542.0 million of other than temporary impairments of fixed maturity securities for the year ended December 31, 2003 (including impairment losses of $517.3 million and $24.7 million of previously recognized gains where the bond was part of a hedging relationship). These impairments relate primarily to: securities in the dairy industry ($153.0 million), securities in the airline industry ($73.5 million), and securities in the power and energy industry ($69.3 million).
The Company recorded a net loss of $28.8 million on mortgage loans for the year ended December 31, 2003 (of which $63.7 million were losses on hedging adjustments). Included were losses of $29.7 million associated with agricultural mortgages.
Liquidity describes the ability of a company to generate sufficient cash flows to meet its immediate needs in order to facilitate its business operations. John Hancock Financial Services, Inc. (the Company) is an insurance holding company. The assets of the Company consist primarily of the outstanding capital stock of the Life Company, John Hancock Canadian Holdings Limited and investments in other subsidiaries both domestic and international. The Company's cash flows primarily consist of dividends from its operating subsidiaries and proceeds from the Company's debt offerings (see Note 8--Debt and Line of Credit in the notes to the Company's consolidated financial statements) offset by expenses and shareholder dividends. As a holding company, the Company's ability to meet its cash requirements, including, but not limited to, paying interest on any debt, paying expenses related to its affairs and paying dividends on its common stock, substantially depends upon receiving dividends from its operating subsidiaries.
The Company's relative liquidity is reflected in its credit ratings assigned by the Major credit rating agencies. At December 31, 2004, The Company's insurance subsidiaries' financial strength / claims paying abilities were all rated AA+ by Standard & Poor's Ratings Services, a division of the McGraw-Hill Companies, Inc. (S&P), Aa3 by Moody's Investors Service (Moody's), A++ by A.M. Best Company (AM Best) and AA by Fitch Ratings (Fitch). The Company's senior unsecured debt rating was AA- from S&P, A3 from Moody's, a+ from AM Best and A+ from Fitch.
The liquidity of our insurance operations is also related to the overall quality of our investments. As of December 31, 2004, $42.851.4 million, or 90.0% of the consolidated fixed maturity securities held by us and rated by S&P, Moody's or the National Association of Insurance Commissioners were rated investment grade (BBB- or higher by S&P, Baa3 or higher for Moody's, or 1 or 2 by the National Association of Insurance Commissioners). The remaining $4,737.2 million, or 10.0% of rated fixed maturity investments, were rated non-investment grade. For additional discussion of our investment portfolio see the General Account Investments section of this Management's Discussion and Analysis of Financial Condition and Results of Segment Operations.
We employ an asset/liability management approach tailored to the specific requirements of each of our product lines. Each product line has an investment strategy based on the specific characteristics of the liabilities in the product line. As part of this approach, we develop investment policies and operating
Individual life insurance policies are less susceptible to withdrawal than are individual annuity contracts because policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. Annuity benefits under group annuity contracts are generally not subject to early withdrawal. As indicated in the table above, there are a substantial percentage of annuity reserves and deposit fund liabilities that are not subject to withdrawal. As a matter of policy, we seek to include provisions limiting withdrawal rights from general account institutional structured investment products. These include GICs and funding agreements sold to plan sponsors where the contract prohibits the contractholder from making any withdrawals, whether at book value or at market value, other than on a scheduled maturity date. In addition, none of these obligations can be accelerated based on any change in the Company's credit rating. The Company does not sell contracts with put provisions.
Individual life insurance policies (other than term life insurance) generally increase in cash value over their lives. Policyholders have the right to borrow from us an amount generally up to the cash value of their policy at any time. As of December 31, 2004, we had approximately $22.9 billion in cash values in which policyholders have rights to policy loans. The majority of cash values eligible for policy loans are at variable interest rates, which are reset annually on the policy anniversary. Moreover, a portion of our fixed interest rate policy loans have features that provide for reduced crediting rates on the portion of cash values loaned. The amount of policy loans has remained consistent over the past three years at approximately $2.0 billion; $1.5 billion of which are in the closed block at December 31, 2004.
Net cash provided by operating activities was $3,172.5 million, $3,052.7 million and $2,561.1 million, for the years ended December 31, 2004, 2003 and 2002, respectively. Cash flows from operating activities are affected by the timing of premiums received, fees received and investment income. The $119.8 million increase in 2004 compared to 2003 resulted primarily from a $112.7 million increase in net investment income received and a $142.1 million decrease in expenses offset by a $135.1 million decrease in premiums received. The $491.6 million increase in 2003 compared to 2002 resulted primarily from a $221.6 million increase in premiums received and a $151.5 million increase in net investment income received offset by a $225.7 million increase in expenses.
Net cash (used in) provided by financing activities was $(2,063.0) million, $2,527.9 million and $4,029.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. Changes in cash provided by financing activities primarily relate to the execution of transactions with our customers demonstrated by deposits and withdrawals under investment-type contracts and the payment of the Company's annual dividend to shareholders. In addition, where advantageous or otherwise necessary, the Company may issue equity securities or debt, borrowing or re-pay corporate debt, acquire our stock on the market, or pay dividends to shareholders.
The $(4,590.9) million change in 2004 as compared to 2003 resulted from a $2,978.5 million decrease in deposits, a $775.7 million increase in cash payments made on withdrawals of investment-type contracts, a $480.5 million decrease in funds provided by the Consumer Notes program initiated in the second half of 2002 and a net reduction in the Company's commercial paper outstanding of $223.5 million.
The Company's ability to generate customer deposits in excess of withdrawals is critical to our long-term growth. The $1,502.0 million decrease in the 2003 as compared to 2002 resulted from a $1,453.0 million decrease in deposits and a $1,492.2 million increase in cash payments made on withdrawals of universal life insurance and investment-type contracts offset somewhat by $970.0 million in funds from the Consumer Notes program (initiated in the second half of 2002), and a $373.2 million decline in treasury stock acquired due to the suspension of activity under the stock repurchase program. Withdrawals on and maturities of universal life insurance and investment-type contracts exceeded deposits by $2,723.3 million for the year ended December 31, 2004, and deposits exceeded withdrawals by $969.5 million and $3,914.7 million for the years ended December 31, 2003 and 2002, respectively.
the capitalization ratio and a negative pledge clause (with exceptions) as well as limitations on subsidiary debt, none of which were triggered as of December 31, 2004. The external line of credit also contains cross-acceleration provisions, none of which were triggered as of December 31, 2004. The fee structure of the external line of credit is determined by the rating levels of JHFS or the Life Company. To date, the Company has not borrowed any amounts under the external lines of credit as of December 31, 2004. The Manulife line of credit agreement provides for a 364-day credit facility for $1.0 billion. Manulife will commit, when requested, to loan funds at prevailing interest rates as determined in accordance with the line of credit agreement. Under the terms of the agreement, the Company is required to maintain certain minimum levels of net worth and comply with certain other covenants, which were met at December 31, 2004. To date, the Company has not borrowed any amounts under the external or Manulife lines of credit as of December 31, 2004.
On November 29, 2001, JHFS sold, under its $1.0 billion shelf registration statement, $500.0 million in 7-year senior unsecured notes at a coupon of 5.625% with the proceeds used for general corporate purposes. Covenants contained in this issue include, among others, limitations on the disposition of and liens on the stock of the Life Company. This issue also contains cross-acceleration provisions. The remaining capacity of the shelf registration is currently $500.0 million.
The Company guarantees certain mortgage securitizations transactions JHFS entered into with FNMA and FHLMC. In the course of business the Company enters into guarantees which vary in nature and purpose and which are accounted for and disclosed under accounting principles generally accepted in the U.S. specific to the insurance industry. The Company has no material guarantees outstanding outside the scope of insurance accounting at December 31, 2004.
These unconsolidated special purpose entities also include CDO funds we manage (and may also invest in), which are considered variable interest entities and are discussed in detail in Note 4 - Relationships with Variable Interest Entities to our consolidated financial statements. The Company generates fee income from the CDO funds we manage, and generates net investment income from CDOs we invest in, whether we manage them or not.
The Company's risk of loss from these relationships is limited to its investment in the unconsolidated entities. Consolidation of unconsolidated accounts from these entities would inflate the Company's balance sheet but would not be reflective of additional risk to the Company from these entities. In each, there are no potential liabilities which might arise in the future as a result of these relationships that would not be completely satisfied by the assets of each entity.
Given the historical cash flow of our subsidiaries and current financial results, management believes that the cash flow from the operating activities over the next year will provide sufficient liquidity to provide for our operations, as well as to satisfy debt service obligations and to pay other operating expenses. Although we anticipate that we will be able to meet our cash requirements, we can give no assurances in this regard.
Consolidated Statements of Cash Flows for the periods April 29, 2004 through December 31, 2004 (Company) and January 1, 2004 through April 28, 2004 and the years ended December 31, 2003 and 2002 (Predecessor Company)......... 80
We have audited the accompanying consolidated balance sheet of John Hancock Financial Services, Inc. as of December 31, 2004, and the related consolidated statements of income, changes in shareholder's equity and other comprehensive income, and cash flows for the period April 29, 2004 through December 31, 2004. We have also audited the consolidated balance sheet as of December 31, 2003 and the related consolidated statements of income, changes in shareholder's equity and other comprehensive income, and cash flows of the predecessor company for the period January 1, 2004 through April 28, 2004 and for the years ended December 31, 2003 and 2002. Our audits also include the financial statement schedules listed in the Index at Item 15 (a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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 2 to the financial statements, in 2004 the Company changed its method of accounting for certain nontraditional long duration contracts and for separate accounts. In 2003 the Company changed its method of accounting for stock-based compensation, participating pension contracts and modified coinsurance contracts.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY AND COMPREHENSIVE INCOME - (CONTINUED)
Effective April 28, 2004, Manulife Financial Corporation ("Manulife") acquired all of the outstanding common shares of John Hancock Financial Services, Inc. (JHFS or the Company) that were not already beneficially owned by Manulife as general fund assets and JHFS became a wholly owned subsidiary of Manulife (the "acquisition" or "merger"). The combined entity has a more diversified product line and distribution capabilities and expects to have improved operating efficiencies and a leading position across all its core business lines. For additional information, refer to relevant John Hancock and other related public filings with the U.S. SEC relating to the merger. In order to more efficiently manage its corporate structure, on October 7, 2004 Manulife transferred all of its shares in JHFS to John Hancock Holdings (Delaware) LLC - a wholly-owned subsidiary of Manulife.
The acquisition of the Company's shares by Manulife was effected through the merger of the Company with Jupiter Merger Corporation (Jupiter), a subsidiary of Manulife, which was organized solely for the purpose of effecting the merger with the Company. Prior to the merger, Jupiter had a note payable to MLI Resources Inc., an affiliated Manulife entity in the amount of $260.7 million in consideration for previously purchased shares of the Company, which were cancelled upon merger.
Assets: Fair Value -------------- (in millions) Fixed maturity securities................................. $ 54,016.1 Equity securities......................................... 1,170.4 Mortgage loans............................................ 13,731.0 Policy loans.............................................. 2,122.2 Other invested assets..................................... 3,659.5 Goodwill.................................................. 4,417.2 Value of business acquired................................ 3,886.0 Intangible assets......................................... 1,488.9 Deferred tax asset........................................ 566.7 Cash and cash equivalents................................. 2,009.4 Reinsurance recoverable, net.............................. 2,195.5 Other assets acquired..................................... 3,569.9 Separate account assets................................... 23,121.1 ----------- Total assets acquired...................... 115,953.9
Liabilities: Policy liabilities........................................ 75,818.2 Other liabilities......................................... 6,597.6 Separate accounts......................................... 23,121.1 ----------- Total liabilities assumed................... 105,536.9
Prior to the merger, the Company continued its Competitive Positioning Project, which involved reducing costs and increasing future operating efficiencies by consolidating portions of the Company's operations. The Project consisted primarily of reducing staff in the home office and terminating certain operations outside the home office. Following the acquisition of the Company by Manulife on April 28, 2004, as previously discussed, Manulife developed a plan to integrate the operations of the Company with its consolidated subsidiaries. Manulife expects the restructuring to be substantially completed by the end of 2005. Restructuring costs of $85.1 million were recognized by the Company as part of the purchase transaction and consist primarily of exit and consolidation activities involving operations, certain compensation costs, and facilities. The accruals for the restructuring costs are included in other liabilities on the Company's Consolidated Balance Sheets and in other operating costs and expenses on the consolidated income statements.
The following details the amounts and status of restructuring costs (in millions):
Business. John Hancock Financial Services, Inc. is a diversified financial services organization that provides a broad range of insurance and investment products and investment management and advisory services. Since April 28, 2004, the Company operates as a subsidiary of Manulife, as a result of the merger. The "John Hancock" name is Manulife's primary U.S. brand.
On December 29, 2004, the remaining operations, and substantially all of the remaining assets and liabilities of the Maritime Life Assurance Company (Maritime Life), which was formerly reported as the Company's Canada Segment, were transferred to The Manufacturers Life Insurance Company (MLI), Manulife's primary Canadian insurance subsidiary. Maritime Life's legal shell company continues to be owned by the Company. Maritime Life's revenues, expenses and resulting net income are presented in the Company's Consolidated Statements of Income as income from discontinued operations for all periods presented.
Recent Acquisition/Disposal Activity. The acquisitions described under the table below were recorded under the purchase method of accounting and, accordingly, the operating results have been included in the Company's consolidated results of operations from each date of acquisition. Each purchase price was allocated to the assets acquired and the liabilities assumed based on estimated fair values, with the excess, if any, of the applicable purchase price over the estimated fair values of the acquired assets and liabilities recorded as goodwill. These acquisitions were made by the Company in execution of its plan to acquire businesses and products that have strategic value, meet its earnings requirements and advance the growth of its current business.
The disposals described under the table below were conducted in order to execute the Company's strategy to focus resources on businesses 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.
On July 8, 2003, the Maritime Life Insurance Company (Maritime Life), formerly a majority owned Canadian subsidiary of the Company, completed its purchase of the insurance business of Liberty Health, a Canadian division of U.S.-based Liberty Mutual Insurance Company, through a reinsurance agreement for approximately $97.5 million. Through the agreement, Maritime Life assumed the entire business of Liberty Health, including its group life, group disability and group health divisions, as well as its individual health insurance business. There was no impact on the Company's results of operations from the acquired insurance business during 2002 or the first six months of 2003.
Investments. At December 31, 2004, the Company classifies its debt securities into one category: available-for-sale. The Company determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Fixed maturity investments include bonds, mortgage-backed securities, and mandatorily redeemable preferred stock and are classified as available-for-sale. Fixed maturity investments classified as available-for-sale and are carried at fair value. Unrealized gains and losses related to available-for-sale securities are reflected in shareholder's equity, net of related amortization of deferred policy acquisition costs, amounts credited to participating pension contractholders, amounts credited to the policyholder dividend obligation, and applicable taxes. Interest income is generally recognized on the accrual basis. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. The amortized cost of fixed maturity investments is adjusted for impairments in value deemed to be other than temporary, and such adjustments are reported as a component of net realized investment and other gains (losses). Gains and losses, both realized and unrealized, on fixed maturity securities which were classified as trading are included in discontinued operations as part of investment returns related to equity indexed universal life insurance policies sold at Maritime Life.
Mortgage loans on real estate are carried at unpaid principal balances adjusted for amortization of premium or discount, less allowance for probable losses. When it is probable that the Company will be unable to collect all amounts of principal and interest due according to the contractual terms of the mortgage loan agreement, the loan is deemed to be impaired and a valuation allowance for probable losses is established. The valuation allowance is based on the present value of the expected future cash flows, discounted at the loan's original effective interest rate, or is based on the collateral value of the loan if the loan is collateral dependent. The Company estimates this level to be adequate to absorb estimated probable credit losses that exist at the balance sheet date. Any change to the valuation allowance for mortgage loans on real estate is reported as a component of net realized investment and other gains (losses). Interest received on impaired mortgage loans on real estate is included in interest income in the period received. If foreclosure becomes probable, the measurement method used is based on the collateral value. Foreclosed real estate is recorded at the collateral's fair value at the date of foreclosure, which establishes a new cost basis.
In certain cases, the Company uses hedge accounting as allowed by the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, by designating derivative instruments as either fair value hedges or cash flow hedges. For derivative instruments that are designated and qualify as fair value hedges, any changes in fair value of the derivative instruments as well as the offsetting changes in fair value of the hedged items are recorded in net realized investment and other gains (losses). For fair value hedges, when the derivative has been terminated, a final fair value change is recorded in net realized investment and other gains (losses), as well as the offsetting changes in fair value for the hedged item. At maturity, expiration or sale of the hedged item, a final fair value change for the hedged item is recorded in net realized investment and
other gains (losses), as well as offsetting changes in fair value for the derivative. Basis adjustments are amortized into income through net realized investment and other gains (losses).
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the change in fair value of the derivative instrument is recorded in other comprehensive income, and then reclassified into income when the hedged item affects income. When a cash flow hedge is terminated, the effective portion of the accumulated derivative gain or loss continues to be reported in other comprehensive income and then is reclassified into income when the hedged item affects income. If it is determined that the forecasted transaction is not probable of occurring, the accumulated other comprehensive income is immediately recognized in earnings.
When DAC and unearned revenue are amortized in proportion to estimated gross profits, the effects on the amortization of DAC and unearned revenues of revisions to estimated gross margins and profits are reflected in earnings in the period such revisions are made. Expected gross profits or expected gross margins are discounted at periodically revised interest rates and are applied to the remaining benefit period. At December 31, 2004, the average discount rate was 5.0% for universal life insurance products. The total amortization period was 30 years for both participating traditional life insurance products and universal life products.
Amortization of DAC is allocated to: (1) net realized investment and other gains (losses) for those products in which such gains (losses) have a direct impact on the amortization of DAC; (2) unrealized investment gains and losses, net of tax, to provide for the effect on the DAC asset that would result from the realization of unrealized gains and losses on assets backing participating traditional life insurance and universal life and investment-type contracts; and (3) a separate component of benefits and expenses to reflect amortization related to the gross margins or profits, excluding realized gains and losses, relating to policies and contracts in force.
For non-participating traditional life insurance policies, future policy benefits are estimated using a net level premium method on the basis of actuarial assumptions as to mortality, persistency, interest and expenses established at policy issue. Assumptions established at policy issue as to mortality and persistency are based on the Company's experience, which, together with interest and expense assumptions, include a margin for adverse deviation. Benefit liabilities for annuities during the accumulation period are equal to accumulated contractholders' fund balances and after annuitization are equal to the present value of expected future payments. Interest rates used in establishing such liabilities range from 2.5% to 9.5% for life insurance liabilities, from 4.2% to 6.5% for individual annuity liabilities and from 1.7% to 11.3% for group annuity liabilities.
Future policy benefits for long-term care insurance policies are based on the net level premium method. Assumptions established at policy issue as to mortality, morbidity, persistency, interest and expenses, which include a margin for adverse deviation, are based on estimates developed by management. Interest rates used in establishing such liabilities range from 5.0% to 6.6%.
Major components of policyholders' funds in the Company's Consolidated Balance Sheets are summarized in the table below:
Global Funding Agreements and Canadian Institutional Annuities. The Company's domestic insurance subsidiary, the John Hancock Life Insurance Company (the Life Company) has two distribution programs for global funding agreements that back medium-term notes sold worldwide. The Company also had, before December 29, 2004, another distribution program for Canadian institutional annuities that back medium-term notes sold in Canada. This program was operated through the Company's Canadian insurance subsidiary, The Maritime Life Assurance Company (Maritime Life). This third program was transferred along with all of the assets, liabilities and operations of Maritime Life, to The Manufacturers Life Insurance Company (MLI), a Manulife Canadian subsidiary, on December 29, 2004. See Discontinued Operations above for more discussion of this transfer.
Under these programs, global funding agreements (and, before the transfer of Maritime to MLI, annuities) are purchased from the Company by special purpose entities (SPEs) that fund their purchases with the proceeds from their issuance of medium-term notes to investors. These SPEs pledge the global funding agreements and annuities as security for the repayment of their medium-term notes, but the notes are non-recourse to the Company and its subsidiaries. Under these distribution programs, as of December 31, 2004 and 2003, the Company had $11.3 billion and $12.9 billion, respectively, of global funding agreements and annuities outstanding.
Participating Insurance. Participating business represents approximately 100.0%, 80.9% and 81.6%, of the Company's traditional life insurance in force, 100.0%, 96.2% and 96.3%, of the number of traditional life insurance policies in force, and 100.0%, 94.3% and 92.5%, of traditional life insurance premiums in 2004, 2003 and 2002, respectively.
The portion of earnings allocated to participating pension contractholders and closed block policyholders that cannot be expected to inure to the Company is excluded from net income and shareholder's equity.
Premiums from universal life and investment-type contracts are reported as deposits to policyholders' account balances. Revenues from these contracts consist of amounts assessed during the period against policyholders' account balances for mortality charges, policy administration charges and surrender charges.
In the merger all of the JHFS unvested stock options as of the date of announcement of the merger on September 28, 2003, vested immediately prior to the closing date and were exchanged for options exercisable for approximately 23 million Manulife common shares. In addition, substantially all outstanding grants of restricted stock as of the date of the announcement of the merger on September 28, 2003, vested immediately prior to the closing date. The Company granted approximately 29,000 shares of Manulife restricted stock subsequent to the merger. Subsequent to the merger the Company continues to incur compensation expense related to stock compensation issued by Manulife.
Federal Income Taxes. The provision for Federal income taxes includes amounts currently payable or recoverable and deferred income taxes, computed under the liability method, resulting from temporary differences between the tax basis and book basis of assets and liabilities. A valuation allowance is established for deferred tax assets when it is more likely than not that an amount will not be realized. Foreign subsidiaries and U.S. subsidiaries operating outside of the United States are taxed under applicable foreign statutory rates. Refer to Note 6 - Income Taxes for additional disclosures on this topic.
Foreign Currency Translation. The assets and liabilities of operations in foreign currencies are translated into United States dollars at current exchange rates. Revenues and expenses are translated at average rates during the year. The resulting net translation adjustments for each year are accumulated and included in shareholder's equity. Gains or losses on foreign currency transactions are reflected in earnings.
The Company adopted DIG B36 on October 1, 2003, which resulted in a decrease in shareholder's equity of $66.3 million (net of tax of $35.7 million). The Company recorded a reduction in net income of $166.2 million (net of tax of $89.5 million) partially offset by an increase in other comprehensive income of $99.9 million (net of tax of $53.8 million) which were recorded as the cumulative effects of an accounting change, on October 1, 2003. For additional discussion of DIG B-36, refer to the Recent Accounting Pronouncements section below.
The Company adopted the fair-value-based method of accounting for share-based payments effective January 1, 2003 using the prospective method described in Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. The Company uses the Black-Scholes-Merton option pricing model to estimate the value of stock options granted to employees and expects to continue to use this model upon our anticipated adoption of SFAS No. 123(R), on July 1, 2005.
On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily by adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. The Medicare Prescription Drug Improvement and Modernization Act of 2003 provides for special tax-free subsidies to employers that offer plans with qualifying drug coverages beginning in 2006. There are two broad groups of retirees receiving employer-subsidized prescription drug benefits from John Hancock. The first group, those who retired prior to January 1, 1992, receive a subsidy of between 90% and 100% of total cost. Since this subsidy level will clearly meet Medicare's criteria for a qualifying drug coverage, the Company anticipates that the benefits it pays after 2005 for pre-1992 retirees will be lower as a result of the new Medicare provisions. In accordance with FASB Staff Position FAS 106-2, the Company reflected a reduction in liability for this group of $40.9 million as of the purchase accounting remeasurement (April 28, 2004). With respect to the second group, those who retired on or after January 1, 1992, the employer subsidy on prescription drug benefits is capped and currently provides as low as 25% of total cost. Since final regulations on determining whether a benefit meets the actuarial criteria for qualifying drug coverage have not been issued by Medicare as of December 31, 2004, the Company will address the impact of the Act with respect to post-1991 retirees once these clarifying regulations have been issued.
FASB Interpretation No. 46 (revised December 2003) - Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51
Additional liabilities recognized as a result of consolidating any VIEs with which the Company is involved would not represent additional claims on the general assets of the Company; rather, they would represent claims against additional assets recognized by the Company as a result of consolidating the VIEs. Conversely, additional assets recognized as a result of consolidating VIEs would not represent additional assets which the Company could use to satisfy claims against its general assets, rather they would be used only to settle additional liabilities recognized as a result of consolidating the VIEs.
Statement of Position 03-1 - Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long Duration Contracts and for Separate Accounts
On July 7, 2003, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long Duration Contracts and for Separate Accounts" (SOP 03-1). SOP 03-1 provides guidance on a number of topics unique to insurance enterprises, including separate account presentation, interest in separate accounts, gains and losses on the transfer of assets from the general account to a separate account, liability valuation, returns based on a contractually referenced pool of assets or index, accounting for contracts that contain death or other insurance benefit features, accounting for reinsurance and other similar contracts, accounting for annuitization benefits, and sales inducements to contractholders. Refer to Note 12- Certain Separate Accounts for additional disclosures required by SOP 03-1. Refer to Cumulative Effect of Account Changes above for presentation of impact of adoption.
SFAS No. 150 - Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity
SFAS No. 149 - Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires certain types of guarantees to be recorded by the guarantor as liabilities, at fair value. This differs from previous practice, which generally required recognition of a liability only when a potential loss was deemed to be probable and was reasonably estimable in amount. FIN 45 does not apply to guarantees that are accounted for under existing insurance accounting principles. FIN 45 requires more extensive disclosures of certain other types of guarantees, including certain categories of guarantees which are already accounted for under specialized accounting principles, such as SFAS No. 133, even when the likelihood of making any payments under the guarantee is remote.
In January 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill and other intangible assets deemed to have indefinite lives no longer be amortized against earnings, but instead be reviewed at least annually for impairment. Intangible assets with definite lives will continue to be amortized over their useful lives. The Company has performed the required initial impairment tests of goodwill and management contracts as of September 30, 2003, based on the guidance in SFAS No. 142. The Company evaluated the goodwill and indefinite lived management contracts of each reporting unit for impairment using valuations of reporting units based on earnings and book value multiples and by reference to similar multiples of publicly traded peers. No goodwill or management contract impairments resulted from these required impairment tests.
No impairment test was performed in 2004, because the Company's goodwill was replaced with new goodwill as a result of the merger with Manulife on April 28, 2004. The Company's post-merger goodwill will be initially tested for impairment in the second quarter of 2005.
The Company's investments in held-to-maturity, and available-for-sale securities are summarized below for the dates indicated:
The change in net unrealized gains (losses) on trading securities that has been included in earnings during 2004, 2003 and 2002 amounted to $14.6 million, $5.8 million and $(5.9) million, respectively.
The Company participates in a security lending program for the purpose of enhancing income on securities held. At December 31, 2004 and 2003, $339.3 million and $426.9 million, respectively, of the Company's securities, at market value, were on loan to various brokers/dealers, and were fully collateralized by cash and highly liquid securities. The market value of the loaned securities is monitored on a daily basis, and the collateral is maintained at a level of at least 102% of the loaned securities' market value.
For 2004, 2003 and 2002, net investment income passed through to participating pension contractholders as interest credited to policyholders' account balances amounted to $170.5 million, $161.7 million and $168.3 million, respectively.
The Company has a process in place to identify securities that could potentially have an impairment that is other than temporary. This process involves monitoring market events that could impact issuers' credit ratings, business climate, management changes, litigation and government actions, and other similar factors. This process also involves monitoring late payments, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.
The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other than temporary. Relevant facts and circumstances considered include (1) the length of time the fair value has been below cost; (2) the financial position of the issuer, including the current and future impact of any specific events; and (3) the Company's ability and intent to hold the security to maturity or until it recovers in value. To the extent the Company determines that a security is deemed to be other than temporarily impaired, the difference between amortized cost and fair value is be charged to earnings.
Summarized data for securities with unrealized losses, sorted by duration of unrealized loss status, are presented in the table below.
At December 31, 2004 the fixed maturity securities had a total gross unrealized loss of $116.0 million. Unrealized losses can be created by rising interest rates or by rising credit concerns and hence widening credit spreads. Credit concerns are apt to play a larger role in the unrealized loss on below investment grade securities. Unrealized losses on investment grade securities principally relate to changes in interest rates or changes in credit spreads since the securities were acquired. Credit rating agencies' statistics indicate that investment grade securities have been found to be less likely to develop credit concerns. The gross unrealized loss on below investment grade fixed maturity securities declined from $261.1 million at December 31, 2003 to $18.0 million at December 31, 2004 primarily due to the mark to market on the portfolio as of April 28, 2004. The gross unrealized loss as of December 31, 2004 was largely due to interest rate changes since April 28, 2004.
Mortgage loans on real estate are evaluated periodically as part of the Company's loan review procedures and are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts of principal and interest due according to the contractual terms of the loan agreement. The valuation allowance is based on the present value of the expected future cash flows, discounted at the loan's original effective interest rate, or is based on the collateral value of the loan if the loan is collateral dependent. This level is believed adequate by management to absorb estimated probable credit losses that exist at the balance sheet date. Management's periodic evaluation of the adequacy of the allowance for losses is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires estimating the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Any change to the valuation allowance for mortgage loans on real estate is reported as a component of net realized investment and other gains (losses). Interest received on impaired mortgage loans on real estate is included in interest income in the period received. If foreclosure becomes probable, the measurement method used is based on the collateral value. Foreclosed real estate is recorded at the fair value of the collateral at the date of foreclosure, which establishes a new cost basis.
Restructured mortgage loans aggregated $107.3 million and $87.8 million as of December 31, 2004 and 2003, respectively. The expected gross interest income that would have been recorded had the loans been current in accordance with the original loan agreements and the actual interest income recorded were as follows:
Years Ended December 31, 2004 2003 2002 ---------------------------- (in millions) Expected.......................................... $10.1 $7.6 $4.8 Actual............................................ 8.7 7.2 4.7
The Company originates commercial mortgages and sells them to Commercial Mortgage Backed Securities Trusts (Trusts), and in certain cases, retains servicing rights to the mortgages sold. These Trusts are QSPEs in accordance with SFAS No. 140 and therefore, as transferor of financial assets to these Trusts, the Company is prohibited from using consolidation accounting for its relationships with them. During 2004, 2003, and 2002, the Company sold $124.7 million, $529.8 million, and $343.5 million of commercial mortgage loans in securitization transactions, respectively, for which it received net proceeds of $125.0 million, $541.4 million, and $345.2 million, respectively, from which it recognized pre-tax gains of $0.3 million, $12.0 million, and $1.9 million, respectively, and from which it retained servicing assets of (none for 2004), $0.4 million, and $0.3 million, respectively. The Company's mortgage servicing assets were valued, in the aggregate, at $1.6 million, and $4.7 million at December 31, 2004 and 2003, respectively.
During December, 2003, the Company securitized $277.6 million of below investment grade corporate bonds, all of which were previously owned by the Company, by transferring them to a trust, Signature QSPE, Limited (the Trust), which the Company sponsored. The Trust is a QSPE in accordance with SFAS No. 140, and as transferor of assets to the Trust, the Company is prohibited from consolidating the Trust. The Company retained $140.0 million of notes issued by the Trust which were rated A1, and which are recorded as fixed maturities available for sale on the Company's Consolidated Balance Sheets, and retained $12.7 million of equity issued by the QSPE, which is unrated, and which is recorded in other invested assets on the Company's Consolidated Balance Sheets. The Company received net proceeds of $124.9 million, representing the proceeds from sales of notes issued by the Trust to unrelated parties, and the Company recorded a realized gain of $10.8 million on these proceeds. The Company recognized no servicing assets as a result of this securitization. All of the assets transferred from the Company to the trust were performing assets; none of the transferred assets were delinquent or in default. No similar securitization was performed in 2004.
The Company has relationships with various types of special purpose entities (SPEs) and other entities, some of which are variable interest entities (VIEs), in accordance with FIN 46R, as discussed in Note 2--Summary of Significant Accounting Policies. Presented below are discussions of the Company's significant relationships with them, the Company's conclusions about whether the Company should consolidate them, and certain summarized financial information for them.
Collateralized Debt Obligation Funds (CDOs). Since 1996, the Company has acted as investment manager to certain asset backed investment vehicles, commonly known as collateralized debt obligation funds (CDOs). The Company also invests in the debt and/or equity of these CDOs, and in the debt and/or equity of CDOs managed by others. CDOs raise capital by issuing debt and equity securities, and use their capital to invest in portfolios of interest bearing securities. The returns from a CDO's portfolio of investments are used by the CDO to finance its operations including paying interest on its debt and paying advisory fees and other expenses. Any net income or net loss is shared by the CDO's equity owners and, in certain circumstances where the Company manages the CDO, positive investment experience is shared by the Company through variable performance management fees. Any net losses in excess of the CDO equity are borne by the debt owners in ascending order of subordination. Owners of securities issued by CDOs that are managed by the Company have no recourse to the Company's assets in the event of default by the CDO. The Company's risk of loss from any CDO it manages, or in which it invests, is limited to its investment in the CDO.
In accordance with previous consolidation accounting principles (now superceded by FIN 46R), the Company formerly consolidated a CDO only if the Company owned a majority of the CDO's equity. The Company is now required to consolidate a CDO when, in accordance with FIN 46R, the CDO is deemed to be a VIE, but only if the Company is deemed to be the primary beneficiary of the CDO. For those CDOs which are not deemed to be VIEs, the Company determines its consolidation status by considering the control relationships among the equity owners of the CDOs. The Company has determined whether each CDO should be considered a VIE, and while most are VIEs, some are not. The Company has determined that it is not the primary beneficiary of any CDO which is a VIE, and for those that are not VIEs, the Company also does not have controlling financial interests. Therefore, the Company does not use consolidation accounting for any of the CDOs which it manages.
The Company believes that its relationships with its managed CDOs are collectively significant, and accordingly provides, in the tables below, summary financial data for all these CDOs and data relating to the Company's maximum exposure to loss as a result of its relationships with them. The Company has determined that it is not the primary beneficiary of any CDO in which it invests and does not manage and thus will not be required to consolidate any of them, and considers that its relationships with them are not collectively significant, therefore the Company does not disclose data for them. Credit ratings are provided by nationally recognized credit rating agencies, and relate to the debt issued by the CDOs in which the Company has invested.
Total size of Company-Managed CDOs (1) December 31, 2004 2003 ------------------------- (in millions)
Low-Income Housing Properties. Since 1995, the Company has generated income tax benefits by investing in apartment properties (the Properties) that qualify for low income housing and/or historic tax credits. The Company initially invested in the Properties directly, but now primarily invests indirectly via limited partnership real estate investment funds (the Funds), which are consolidated into the Company's financial statements. The Properties are organized as limited partnerships or limited liability companies each having a managing general partner or a managing member. The Company is usually the sole limited partner or investor member in each Property; it is not the general partner or managing member in any Property.
The Properties typically raise additional capital by qualifying for long-term debt, which at times is guaranteed or otherwise subsidized by Federal or state agencies, or by Fannie Mae. In certain cases, the Company invests in the mortgages of the Properties. The Company's maximum loss in relation to the Properties is limited to its equity investment in the Properties, future equity commitments made, and where the Company is the mortgagor, the outstanding balance of the mortgages originated for the Properties, and outstanding mortgage commitments the Company has made to the Properties. The Company receives Federal income tax credits in recognition of its investment in each of the Properties for a period of ten years. In some cases, the Company receives distributions from the Properties which are based on a portion of the Property cash flows.
Total size of the Properties (1) December 31, 2004 2003 ------------------------ (in millions)
Total assets ....................................... $1,103.9 $ 982.7 ======== ======== Total debt ......................................... $ 669.9 $ 576.3 Total other liabilities ............................ 103.3 116.6 -------- -------- Total liabilities .................................. 773.2 692.9 Total equity ....................................... 330.7 289.8 -------- -------- Total liabilities and equity ....................... $1,103.9 $ 982.7 ======== ========
(1) Property level data reported above is reported with three month delays due to the delayed availability of financial statements of the Funds.
Equity investment in the Properties (1) ................... $323.2 $291.0 Outstanding equity capital commitments to the Properties .. 90.9 108.2 Carrying value of mortgages for the Properties ............ 67.1 62.8 Outstanding mortgage commitments to the Properties ........ 0.9 5.1 ------ ------ Total Company exposure .................................... $482.1 $467.1 ====== ======
Other Entities. The Company has investment relationships with a disparate group of entities (Other Entities), which result from the Company's direct investment in their debt and/or equity. This category includes energy investment partnerships, investment funds organized as limited partnerships, and businesses which have undergone debt restructurings and reorganizations and various other relationships. The Company has determined that for each of these Other Entities which are VIEs, the Company is not the primary beneficiary, and should not use consolidation accounting for them. The Company believes that its relationships with the Other Entities are not significant, and is accordingly not providing summary financial data for them, or data relating to the Company's maximum exposure to loss as a result of its relationships with them. These potential losses are generally limited to amounts invested, which are included on the Company's Consolidated Balance Sheets in the appropriate investment categories.
Since 2001, the Company has been involved with Arclight Energy Partner Fund I, L.P. (Arclight), which is a private equity fund which invests in the electric power, utility and energy industry sectors. The Company is a limited partner investor, owning approximately 55.0% of Arclight's partners' capital at December 31, 2004. The Company's potential losses in relation to Arclight are limited to its investment in Arclight. As of September 30, 2004, the most recent date for which data is available, Arclight had total assets of $825.4 million, $0.8 million of liabilities, and $824.6 million of partners' capital. The Company has determined that it is not the primary beneficiary of this entity and accordingly does not need to consolidate Arclight.
The fair values of derivative instruments classified as assets at December 31, 2004 and 2003 were $1,167.4 million and $1,168.9 million, respectively, and appear on the consolidated balance sheet in other assets. The fair values of derivative instruments classified as liabilities at December 31, 2004 and 2003 were $1,148.7 million and $1,277.3 million, respectively, and appear on the consolidated balance sheet in other liabilities. The fair values of derivative instruments, identified as embedded derivatives in participating pension contracts pursuant to DIG B36, classified as liabilities and appear on the in policyholders' funds at December 31, 2004 and 2003 were $48.6 million and $225.6 million, respectively.
Fair Value Hedges. The Company uses interest rate futures contracts and interest rate swap agreements as part of its overall strategies of managing the duration of assets and liabilities or the average life of certain asset portfolios to specified targets. Interest rate swap agreements are contracts with a counterparty to exchange interest rate payments of a differing character (e.g., fixed-rate payments exchanged for variable-rate payments) based on an underlying principal balance (notional principal). The net differential to be paid or received on interest rate swap agreements is accrued and recognized as a component of net investment income.
The Company enters into purchased interest rate cap agreements, cancelable interest rate swap agreements, and written swaptions to manage the interest rate exposure of options that are embedded in certain assets and liabilities. A written swaption obligates the Company to enter into an interest rate agreement on the expiration date contingent on future interest rates. Purchased interest rate cap and floor agreements are contracts with a counterparty which require the payment of a premium for the right to receive payments for the difference between the cap or floor interest rate and a market interest rate on specified future dates based on an underlying principal balance (notional principal). Amounts earned on interest rate cap and floor agreements and swaptions are recorded as an adjustment to net investment income.
The Company uses equity collar agreements to reduce its equity market exposure with respect to certain common stock investments that the Company holds. A collar consists of a written call option that limits the Company's potential for gain from appreciation in the stock price as well as a purchased put option that limits the Company's potential for loss from a decline in the stock price.
For the period January 1, 2004 through April 28, 2004, the Company recognized net gains of $4.4 million related to the ineffective portion of its fair value hedges, and net losses of $3.8 million related to the portion of the hedging instruments that were excluded from the assessment of hedge effectiveness. For the period April 29, 2004 through December 31, 2004, the Company recognized net losses of $38.5 million related to the ineffective portion of its fair value hedges, and net gains of $1.1 million related to the portion of the hedging instruments that were excluded from the assessment of hedge effectiveness. For the year ended December 31, 2003, the Company recognized net losses of $5.8 million related to the ineffective portion of its fair value hedges, and net losses of $1.5 million related to the portion of the hedging instruments that were excluded from the assessment of hedge effectiveness. These amounts are recorded in net realized investment and other gains and losses.
Cash Flow Hedges. The Company uses forward starting interest rate swap agreements to hedge the variable cash flows associated with future fixed income asset acquisitions, which will support the Company's long-term care and life
insurance businesses. These agreements will reduce the impact of future interest rate changes on the cost of acquiring adequate assets to support the investment income assumptions used in pricing these products. During the periods in the future when the acquired assets are held by the Company, the accumulated gain or loss will be amortized into investment income as a yield adjustment on the assets.
The Company also uses interest rate swap agreements to hedge the variable cash flows associated with payments that it will make on certain funding agreements issued by the company. Amounts are reclassified from other comprehensive income as a yield adjustment when the payments are made.
For the period January 1, 2004 through April 28, 2004, the Company recognized losses of $4.8 million related to the ineffective portion of its cash flow hedges. For the period April 29, 2004 through December 31, 2004 the Company recorded gains of $7.7 million related to the ineffective portion of its cash flow hedges. These amounts are recorded in net realized investment and other gains and losses. For the year ended December 31, 2004, all of the Company's hedged forecast transactions qualified as cash flow hedges.
For the period January 1, 2004 through April 28, 2004, a net gain of $1.2 million was reclassified from other accumulated comprehensive income to earnings. For the period April 29, 2004 through December 31, 2004, the Company reclassified no gains or losses from other accumulated comprehensive income to earnings. It is anticipated that approximately $1.3 million will be reclassified from other accumulated comprehensive income to earnings within the next twelve months. The maximum length for which variable cash flows are hedged is 24 years.
Derivatives Not Designated as Hedging Instruments. The Company enters into interest rate swap agreements, cancelable interest rate swap agreements, total return swaps, interest rate futures contracts, credit default swaps and interest rate cap and floor agreements to manage exposure to interest rates as described above under Fair Value Hedges, without designating the derivatives as hedging instruments.
Income before income taxes, discontinued operations and cumulative effect of accounting changes includes the following:
April 29 January 1 through through December 31, 2004 April 28, 2004 2003 2002 ----------------------------------------------------- (in millions) Current taxes: Federal .................. $ 56.8 $(34.3) $147.7 $ 47.2 Foreign .................. 7.7 1.1 3.9 2.0 State .................... 3.0 1.5 4.6 4.6 --------------------------------------------------- Total current taxes ...... 67.5 (31.7) 156.2 53.8 Deferred taxes: Federal .................. 73.4 149.8 167.1 42.8 Foreign .................. (0.6) (0.8) 0.1 0.7 State .................... (4.4) (2.2) (6.7) (6.7) --------------------------------------------------- Total deferred taxes .. 68.4 146.8 160.5 36.8 --------------------------------------------------- Total income taxes ....... $135.9 $115.1 $316.7 $ 90.6 ===================================================
The Company made income tax payments of $40.6 million, $177.2 million and $65.2 million in 2004, 2003 and 2002, respectively.
If, over time, the aggregate performance of the closed block assets and policies is better than was assumed in funding the closed block, dividends to policyholders will be increased. If, over time, the aggregate performance of the closed block assets and policies is less favorable than was assumed in the funding, dividends to policyholders will be reduced.
If actual cumulative earnings are greater than expected cumulative earnings, only expected earnings will be recognized in income. Actual cumulative earnings in excess of expected cumulative earnings represents undistributed accumulated earnings attributable to policyholders, which are recorded as a policyholder dividend obligation because the excess will be paid to closed block policyholders as an additional policyholder dividend unless otherwise offset by future performance of the closed block that is less favorable than originally expected. If actual cumulative performance is less favorable than expected, only actual earnings will be recognized in income.
The issuance of Surplus Notes by the Life Company was approved by the Massachusetts Commissioner of Insurance, and any payment of interest or principal on the Surplus Notes requires the prior approval of the Massachusetts Commissioner of Insurance. The bonds payable consist of 7-year senior unsecured registered notes at a coupon of 5.625% issued by the parent insurance holding company, JHFS, with the proceeds used for general corporate purposes. Covenants contained in this issue include, among others, limitations on the disposition of and liens on the stock of the Life Company, the Company's primary operations subsidiary. This issue also contains cross acceleration provisions. The issuance of bonds payable was
Aggregate maturities of long-term debt represent the enumerated obligations owed pursuant to respective agreements therefore are not equivalent to the U.S. GAAP carrying amount and are as follows: 2005--$137.7 million; 2006--$16.0 million; 2007--$306.9 million; 2008-- $501.2 million; 2009--$1.2 million and thereafter--$783.1 million.
Interest expense on debt, included in other operating costs and expenses, was $70.5 million and $32.3 million for the period April 29 through December 31, 2004 and January 1 through April 28, 2004, respectively. Interest expense on debt, included in other operating costs and expenses, was $99.4 million and $98.6 million 2003 and 2002, respectively. Interest paid amounted to $90.0 million and $21.1 million for the period April 29 through December 31, 2004 and January 1 through April 28, 2004, respectively. Interest paid amounted to $96.2 million in 2003 and $89.6 million in 2002.
Interest expense on consumer notes, included in benefits to policyholders, was $100.8 million in 2004, $39.0 million in 2003 and $2.5 million in 2002. Interest paid amounted to $90.1 million in 2004, $29.8 million in 2003 and $1.4 million in 2002.
On March 14, 2003, the Company sold three of its Home Office complex properties to Beacon Capital Partners for $910.0 million. As part of the transaction, the Company entered into a long-term lease of the space it now occupies in those buildings and plans on continuing to use them as its corporate headquarters. As a result of the sale-leaseback transaction, the Company recognized a current realized gain of $233.8 million and a deferred profit of $247.7 million. A capital lease obligation of $90.0 million was recorded for one of the properties, which has a 15 year market-based lease term. The other two properties have operating market-based leases which range from 5 to 12 years. The Company also provided Beacon Capital Partners with a long-term sublease on the Company's parking garage. This sublease was terminated in April 2004, when the Company sold the parking garage to Beacon Capital Partners. The Company recognized a gain on the sale of the garage of $74.2 million. The Company has a cancelable market rate lease for parking spaces at the garage.
The Company provides certain administrative and asset management services to its pension plans and employee welfare trust (the Plans). Fees paid to the Company for these services were $6.4 million, $5.7 million and $7.2 million during the years ended December 31, 2004, 2003 and 2002, respectively.
The Company, in the ordinary course of business, invests funds deposited with it by customers and manages the resulting invested assets for growth and income for customers. From time to time, successful investment strategies of the Company may attract deposits from affiliates of the Company. At December 31, 2004, the Company managed approximately $58.5 million of investments for Manulife affiliates which generated market-based revenue for the Company.
The acquisition of the Company's shares by Manulife was effected through the merger of the Company with Jupiter Merger Corporation (Jupiter), a subsidiary of Manulife, which was organized solely for the purpose of effecting the merger with the Company. Prior to the merger, Jupiter had a note payable to MLI Resources, Inc., an affiliated Manulife entity, in the amount of $260.7 million in consideration for previously purchased shares of the Company, which were cancelled upon merger. Subsequent to the merger, the Company included in other liabilities a $260.7 million promissory note payable to a subsidiary of Manulife, which matures February 10, 2007, and bears interest at a rate of 0.25% over the 90-day Canadian Bankers Acceptance Rate, and is payable quarterly. The Company paid $5.2 million to Manulife under the terms of the promissory note for the post merger period April 29, 2004 through ended December 31, 2004.
On December 29, 2004, the remaining operations, assets, and liabilities of the Maritime Life Assurance Company (Maritime Life), which was formerly reported as the Company's Canada Segment, were transferred to The Manufacturers Life Insurance Company (MLI), Manulife's primary Canadian insurance subsidiary. Proceeds to the Company of the transfer were in the form of notes receivable from affiliates, which are included in other assets on the Company's Consolidated Balance Sheets. Maritime's net income is reflected in the Company's Consolidated Statements of Income as income from discontinued operations for all periods presented.
At December 31, 2004, minority interests consist of preferred stock issued by Maritime Life and an outside equity interest in a consolidated investment partnership. The assets, liabilities, revenues, expenses and earnings of the investment partnership are consolidated in the Company's financial statements. As part of aligning business with geographic similarities the Company transferred the operations, assets and liabilities of its Canada Segment consisting primarily of Maritime Life to MLI on December 29, 2004, see further discussion of the transfer in Note 2 - Summary of Significant Accounting Policies and Note 10- Related Party Transactions.
share, on or after December 31, 2010 at Cdn. $25.25 per preferred share and on or after December 31, 2011 at Cdn. $25.00 per preferred share.
For the period January 1 through April 28, and April 29 through December 31, 2004, benefits to policyholders under life, health and annuity ceded reinsurance contracts were $117.4 million and $234.2 million, respectively. For the years ended December 31, 2003 and 2002, benefits to policyholders under life, health and annuity ceded reinsurance contracts were $351.4 million and $549.6 million, respectively.
On February 28, 1997, the Company sold a major portion of its group insurance business to UNICARE Life & Health Insurance Company (UNICARE), a wholly owned subsidiary of WellPoint Health Networks, Inc. The business sold included the Company's group accident and health business and related group life business and Cost Care, Inc., Hancock Association Services Group and Tri-State, Inc., all of which were indirect wholly-owned subsidiaries of the Company. The Company retained its group long-term care operations. The insurance business sold was transferred to UNICARE through a 100% coinsurance agreement. The Company remains liable to its policyholders to the extent that UNICARE does not meet its contractual obligations under the coinsurance agreement.
Note 13 -- Pension Benefit Plans and Other Postretirement Benefit Plans
The Company provides pension benefits to substantially all employees and general agency personnel. These benefits are provided through both funded qualified and unfunded non-qualified defined benefit and qualified defined contribution pension plans. Through the non-qualified defined benefit plans, the Company provides supplemental pension benefits to employees with salaries and/or pension benefits in excess of the qualified plan limits under applicable law. Prior to 2002, pension benefits under the defined benefit plans were also based on years of service and final average compensation (generally during the three years prior to retirement). In 2001, the defined benefit pension plans were amended to a cash balance basis under which benefits are based on career average compensation. Under grandfathering rules, employees within 5 years of early retirement eligibility or employees over age 40 and with at least 10 years of service will receive pension benefits based on the greater of the benefit from the cash balance basis or the prior final average salary basis. This amendment became effective on January 1, 2002.
Benefits related to the defined benefit pension plans paid to employees and retirees were $80.6 million for the period January 1 through April 28, 2004 and $128.9 million for the period April 29 through December 31, 2004. Benefits related to the defined benefit pension plans paid to employees and retirees were $167.7 million and $161.0 million in 2003, and 2002, respectively.
Defined contribution plans include the Investment Incentive Plan and the Savings and Investment Plan. The expense for defined contribution plans was $9.0 million, $9.6 million, and $10.4 million in 2004, 2003 and 2002, respectively.
On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily by adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. The Medicare Prescription Drug Improvement and Modernization Act of 2003 provides for special tax-free subsidies to employers that offer plans with qualifying drug coverages beginning in 2006. There are two broad groups of retirees receiving employer-subsidized prescription drug benefits from John Hancock. The first group, those who retired prior to January 1, 1992, receive a subsidy of between 90% and 100% of total cost. Since this subsidy level will clearly meet Medicare's criteria for a qualifying drug coverage, the Company anticipates that the benefits it pays after 2005 for pre 1992 retirees will be lower as a result of the new Medicare provisions. In accordance with FASB Staff Position FAS 106-2, the Company reflected a reduction in liability for this group of $40.9 million as of the purchase accounting remeasurement (April 28, 2004). With respect to the second group, those who retired on or after January 1, 1992, the employer subsidy on prescription drug benefits is capped and currently provides as low as 25% of total cost. Since final regulations on determining whether a benefit meets the actual criteria for qualifying drug coverage have not been issued by Medicare as of December 31, 2004, the Company will address the impact of the Act with respect to post-1991 retirees once these clarifying regulations have been issued.
The Company's weighted-average asset allocations for its plans at December 31, 2004 and 2003, by asset category are as follows:
The plans did not own any of the common stock of Manulife at December 31, 2004 and did not own any of the common stock of the Company at December 31, 2003.
Other postretirement benefit plan weighted-average asset allocations at December 31, 2004, and 2003, by asset category are as follows:
Plan assets for other post retirement benefits for non-union employees are comprised of an irrevocable health insurance contract and a 401(h) account under the pension plan. The plan assets for other postretirement benefits for other employees are held in a 401(h) account under the pension plan. The plan assets underlying the insurance contract have target allocations of approximately 60% equity securities and 40% fixed maturity securities. The plan assets in the 401(h) account are invested on a combined basis with the assets of the Company's defined benefit pension plans.
The Company's policy is to fund its other post retirement benefits in amounts at or below the annual tax qualified limits.
Projections for benefit payments for the next ten years are as follows:
Net of Medicare Year Gross Payments Part D Subsidy Net Payments --------------------------------------------------------------------- (in millions) 2005 $ 53.5 -- $ 53.5 2006 55.6 $ (4.0) 51.6 2007 56.5 (4.1) 52.4 2008 57.2 (4.2) 53.0 2009 57.5 (4.2) 53.3 2010-2014 285.1 (20.6) 264.5
Commitments. The Company has extended commitments to purchase fixed maturity investments, preferred and common stock and other invested assets and to issue mortgage loans on real estate totaling $323.5 million, $42.0 million, $443.7 million and $558.8 million, respectively, at December 31, 2004. If funded, loans related to real estate mortgages would be fully collateralized by the mortgaged properties. The Company monitors the creditworthiness of borrowers under long-term bond commitments and requires collateral as deemed necessary. The estimated fair values of the commitments described above aggregate $1.4 billion at December 31, 2004. The majority of these commitments expire in 2005.
Contingencies. Through the Company's group health insurance operations, the Company entered into a number of reinsurance arrangements in respect of personal accident insurance and the occupational accident component of workers compensation insurance, a portion of which was originated through a pool managed by Unicover Managers, Inc. Under these arrangements, the Company both assumed risks as a reinsurer, and also passed 95% of these risks on to other companies. This business had originally been reinsured by a number of different companies, and has become the subject of widespread disputes. The disputes concern the placement of the business with reinsurers and recovery of the reinsurance. The Company is engaged in disputes, including a number of legal proceedings, in respect of this business. The risk to the Company is that other companies that reinsured the business from the Company may seek to avoid their reinsurance obligations. However, the Company believes that it has a reasonable legal position in this matter. During the fourth quarter of 1999 and early 2000, the Company received additional information about its exposure to losses under the various reinsurance programs. As a result of this additional information and in connection with global settlement discussions initiated in late 1999 with other parties involved in the reinsurance programs, during the fourth quarter of 1999 the Company recognized a charge for uncollectible reinsurance of $133.7 million, after tax. During 2004, the Company received additional information about its exposure and recognized an additional charge of $92.4 million, after tax, as its current best estimate of its exposure as of December 31, 2004.
(a) Preferred and Common Stock. Effective April 28, 2004, Manulife acquired all the outstanding common shares of the Company that were not already beneficially owned by Manulife as general fund assets and the Company became a wholly owned subsidiary of Manulife. See Note 1 - Change of Control for additional discussion of the merger. In the merger, the Company was recapitalized with two classes of stock outstanding: one class of preferred stock with $.01 par value and 1 (one) share authorized and issued; one class of common stock with $.01 par value and 1,000 shares authorized and issued.
Prior to the merger with Manulife, on June 8, 2001, the Company, using a "shelf registration," registered $1.0 billion in debt securities, preferred stock, common stock, warrants, stock purchase contracts and stock purchase units. On November 29, 2001 the Company sold, under the $1.0 billion shelf, $500.0 million in 7-year senior unsecured notes at a coupon of 5.625% with the proceeds used for general corporate purposes. This shelf registration remained effective at December 31, 2004.
Massachusetts has enacted laws governing the payment of dividends by insurers. Under Massachusetts insurance law, no insurer may pay any shareholder dividends from any source other than statutory unassigned funds without the prior approval of the Massachusetts Division of Insurance. Massachusetts law also limits the dividends an insurer may pay in any twelve month period, without the prior permission of the Massachusetts Division of Insurance, to the greater of (i) 10% of its statutory policyholders' surplus as of the preceding December 31 or (ii) the individual company's statutory net gain from operations for the preceding calendar year, if such insurer is a life company.
During the majority of 2004, the Company operated in the following five business segments: two segments primarily served retail customers, one segment served institutional customers, one segment served primarily Canadian retail and group customers and our fifth segment was the Corporate and Other Segment, which includes our institutional advisory business, the remaining international operations, and the corporate account. Our retail segments are the Protection Segment and the Wealth Management Segment, previously called Asset Gathering. Our institutional segment is the Guaranteed and Structured Financial Products Segment (G&SFP). As previously discussed, the Canada Segment was transferred to an affiliated entity on December 29, 2004 and is presented in the discussion below as a disposed operation. In addition, in January 2005, the Company announced the transfer of the G&SFP Segment to the Wealth Management Segment with an intended focus on retail customers in the future. G&SFP is presented as its own operating segment for the discussion of 2004 results below. See below for a more detail description of the Company's reportable segments.
The Company's reportable segments are strategic business units offering different products and services. The reportable segments are managed separately, as they focus on different products, markets or distribution channels.
Protection Segment. Offers a variety of individual life insurance and individual and group long-term care insurance products, including participating whole life, term life, universal life, variable life, and individual and group long-term care insurance. Products are distributed through multiple distribution channels, including insurance agents and brokers and alternative distribution channels that include banks, financial planners, direct marketing.
Wealth Management Segment. Offers individual annuities and mutual fund products and services. Individual annuities consist of fixed deferred annuities, fixed immediate annuities, single premium immediate annuities, and variable annuities. Mutual fund products and services primarily consist of open-end mutual funds closed-end funds, institutional advisory accounts and privately managed accounts. This segment distributes its products through distribution channels including insurance agents and brokers affiliated with the Company, securities brokerage firms, financial planners, pension plan sponsors, pension plan consultants and banks.
Guaranteed and Structured Financial Products (G&SFP) Segment. Offers a variety of retirement products to qualified defined benefit plans, defined contribution plans and non-qualified buyers. The Company's products include guaranteed investment contracts, funding agreements, single premium annuities, and general account participating annuities and fund type products. These contracts provide non-guaranteed, partially guaranteed, and fully guaranteed investment options through general and separate account products. The segment distributes its products through a combination of dedicated regional representatives, pension consultants and investment professionals. The segment's consumer notes program distributes primarily through brokers affiliated with the Company and securities brokerage firms. The segment's new banking products distribute primarily through the broker-dealer network to the retail investors. In addition, in January 2005, the Company announced the transfer of the G&SFP Segment to the Wealth Management Segment.
Subsequent to the merger, the Company changed its methodology for determining how much capital is needed to support its operating segments and redeployed capital according to the new methodology. As part of this process, the Company moved certain tax preferenced investments from the operating segments to the Corporate and Other Segment. These steps were taken as part of the alignment of the Company's investment and capital allocation processes with those of its parent, and they could have a material impact on each operating segment's investment income and net income in future periods.
The fair value for equity securities is based on quoted market prices.
The following table presents the carrying value and fair values of the Company's financial instruments:
The Company recognized several intangible assets during Manulife's merger with the Company, and subsequently derecognized intangible assets belonging to its Canadian and Asian subsidiaries which were transferred to Manulife's respective Canadian and Asian operations. See Note 1 - Change of Control for additional discussion of the Merger and see Note 2- Summary of Significant Accounting Policies for additional discussion of the transfers.
Unamortizable assets include goodwill, brand name and investment management contracts. Goodwill is the excess of the cost to Manulife over the fair value of the Company's identifiable net assets acquired by Manulife in the recent merger. Brand name is the fair value of the Company's trademark and trade name acquired by Manulife in the recent merger. Investment management contracts are the fair values of the investment management relationships between the Company and each of the mutual funds managed by the Company acquired by Manulife in the recent merger.
Amortizable assets include value of business acquired (VOBA), distribution networks and other investment management contracts. VOBA is the present value of estimated future profits of insurance policies in force related to businesses acquired by Manulife in the recent merger. VOBA had weighted average lives ranging from 6 to 17 years for various insurance businesses at the merger. Distribution networks are values assigned to the Company's networks of sales agents and producers responsible for procuring business acquired by Manulife in the recent merger. Distribution networks had weighted average lives of 21 years at the merger. Other investment management contracts are the values assigned to the Company's individual and group benefit contracts managed by its Canadian subsidiary, as well as contracts managed by its wealth management segment and several investment groups in its corporate segment acquired by Manulife in the recent merger. At December 31, 2004, other investment management contracts remaining after the Company's transfers of its Canadian and Asian businesses are those in the Wealth Management and Corporate and Other Segments. Other investment management contracts had weighted average lives of 9 years at the merger. Collectively, these amortizable intangible assets had a weighted average life of 15 years at the merger.
(1) JHFS's Canada segment was transferred to MLI in 2004. Other adjustments include foreign currency translation adjustment of $(13.0) million.
(1) Distribution networks recognized in the purchase transaction with Manulife. (2) JHFS's Canada segment was transferred to MLI in 2004. For these discontinued operations, the amortization expense for the period was $(2.0) million and the foreign currency translation adjustment was $ 8.5 million.
(1) VOBA existing prior to the merger with Manulife related to the acquisition of the fixed universal life insurance business of Allmerica was adjusted to reflect adjustments to the purchase equation. (2) Other adjustments to the Canadian segment included $ (2.6) million amortization expense for the period, $ 4.8 million adjustment to unrealized gains on securities available for sale, foreign currency translation adjustment of $ (15.6) million, and $ (60.7) million adjustment to VOBA as a result of the adoption of AICPA SOP 03-1.
The Company issues variable annuity contracts through its separate accounts for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contract holder (traditional variable annuities). The Company also issues variable life insurance and variable annuity contracts which contain certain guarantees (variable contracts with guarantees) which are discussed more fully below.
December 31, December 31, 2004 2003 --------------------------- (in millions, except for age) Life contracts with guaranteed benefits In the event of death Account value................................... $ 6,899.0 $ 6,249.4 Net amount at risk related to deposits ......... 117.5 106.2 Average attained age of contractholders ........ 44 46
The variable annuity contracts are issued through separate accounts and the Company contractually guarantees to the contract holder either (a) return of no less than total deposits made to the contract less any partial withdrawals, (b) total deposits made to the contract less any partial withdrawals plus a minimum return, (c) the highest contract value on a specified anniversary date minus any withdrawals following the contract anniversary or (d) a combination benefit of (b) and (c) above. Most business issued after May 2003 has a proportional partial withdrawal benefit instead of a dollar-for-dollar relationship. These variable annuity contract guarantees include benefits that are payable in the event of death or annuitization, or at specified dates during the accumulation period.
At December 31, 2004 and December 31, 2003, the Company had the following variable contracts with guarantees. The Company's variable annuity contracts with guarantees may offer more than one type of guarantee in each contract; therefore, the amounts listed are not mutually exclusive. For guarantees of amounts in the event of death, the net amount at risk is defined as the current guaranteed minimum death benefit in excess of the current account balance at the balance sheet date. For guarantees of amounts at annuitization, the net amount at risk is defined as the present value of the minimum guaranteed annuity payments available to the contract holder determined in accordance with the terms of the contract in excess of the current account balance. For guarantees of accumulation balances, the net amount at risk is defined as the guaranteed minimum accumulation balance minus the current account balance.
Account balances of variable contracts with guarantees were invested in variable separate accounts in various mutual funds which included foreign and domestic equities and bonds as shown below:
Domestic Equity - Growth Funds ................. $ 3,031.6 $ 3,409.0 Domestic Bond Funds ............................ 2,211.2 2,737.9 Domestic Equity - Growth & Income Funds ........ 2,348.1 2,341.2 Balanced Investment Funds ...................... 2,103.5 2,840.5 Domestic Equity - Value Funds .................. 1,097.8 865.0 Canadian Equity Funds .......................... -- 1,555.3 International Equity Funds ..................... 902.9 853.2 International Bond Funds ....................... 119.4 107.3 Hedge Funds .................................... 31.8 22.7 --------- --------- Total ......................................... $11,846.3 $14,732.1 ========= =========
The following table summarizes the liabilities for guarantees on variable contracts reflected in the general account:
The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. The following assumptions and methodology were used to determine the GMDB liability at December 31, 2004.
o Annuity mortality was assumed to be 100% of the Annuity 2000 Table for the Life Company annuities and 100% of the a-83 Basic Table for Maritime annuities.
Note 20 -- Information Provided in Connection with Market Value Annuity of John Hancock Variable Life Insurance Company
JHFS is an insurance holding company. The assets of JHFS consist primarily of the outstanding capital stock of the Life Company and certain international subsidiaries. JHFS' cash flow primarily consists of dividends from its operating subsidiaries and proceeds from debt offerings (see Note 8--Debt and Line of Credit) offset by expenses, shareholder dividends and stock repurchases. As a holding company, the Company's ability to meet its cash requirements, including, but not limited to, paying interest on any debt, paying expenses related to its affairs, paying dividends on its common stock and any board of directors approved repurchase of its common stock pursuant to the board of director's approved plan, substantially depends upon dividends from its operating subsidiaries.
1) Shareholder's equity includes preferred stock of JHFS at $0.01 par value, 1 share authorized, issued and outstanding and common stock of JHFS at $0.01 par value, 1,000 shares authorized, issued and outstanding at December 31, 2004; 2.0 billion shares authorized, 319.8 million shares issued at December 31, 2003, and JHFS treasury stock at a cost of $1,069.0 or 30.0 millions shares at December 31, 2003.
As a result of integration of operations between the Company and its parent, Manulife, the Company is in negotiations to sell its China operations. The Company is divesting itself of its operations in China to accommodate Chinese law, which allows only one license per Company. Manulife had an operation in China prior to the merger with John Hancock.