Registrant utilizes space and personnel of JP Life. JP Life owns its home office consisting of a 20-story building and an adjacent 17-story building. These structures house insurance operations and provide space for commercial leasing. JP Life also owns a supply and printing facility, a parking deck and a computer center, all located on nearby properties. It also owns 233 acres in Guilford County, North Carolina, formerly home office of Pilot Life Insurance Company, and over 400 acres of land in northwestern Guilford County which will be
Note: All share information has been restated to reflect a December 1995 3-for-2 (50%) stock split effected in the form of a dividend. Cash dividends per share may not add due to rounding related to this split.
* Premiums are shown on FAS 60 basis. First year life premiums include universal life single premiums.
Management's Discussion and Analysis of Financial Condition and Results of Operation
The Company has two business segments: Insurance and Communications. Within the Insurance segment, JP offers Individual Life Products, Annuity and Investment Products, and Group Products through the following subsidiaries: Jefferson-Pilot Life Insurance Company (JP Life), Alexander Hamilton Life Insurance Company of America and its subsidiary, First Alexander Hamilton Life Insurance Company (FAHL), and recently acquired Chubb Life Insurance Company of America and its subsidiaries, Chubb Colonial Life Insurance Company (Colonial) and Chubb Sovereign Life Insurance Company (Sovereign). Within the Communications business segment, JP operates 3 television and 17 radio broadcasting stations and provides sports and entertainment programming. These operations are conducted through Jefferson-Pilot Communications Company (JPCC) and its subsidiaries.
JP's revenues are derived approximately 88.5% from Insurance (which consists of 50.1% from Individual Life Products, 19.8% from Annuity and Investment Products and 18.6% from Group Products), 7.4% from Communications (2.9% from television, 3.2% from radio, and 1.3% from sports and entertainment) and 4.1% from Other. This composition has shifted more towards Insurance since 1995 as a result of acquisitions.
Income from continuing operations increased 27.5% in 1997 and 14.2% in 1996 due to increased profitablility in the Insurance segment. The following tables illustrate JP's results before and after the inclusion of realized investment gains.
Net realized gains in 1997 increased over historical levels due to sales of investments to finance the acquisition of Chubb Life. Approximately 90% of 1997's realized gains were due to sales of investments in common stocks.
A more detailed discussion of operating results by segment and product class follows.
The Insurance segment includes three product classes: Individual Life Products, Annuity and Investment Products and Group Products.
The Individual Life Products distribution systems offer a wide array of life and health insurance through a career agency force, independent agents recruited through independent marketing organizations and a regional marketing network, home service agents, financial institutions and a targeted marketing division. Operating results were:
Individual Life operating income increased $60.2 or 38.9% and $36.2 or 30.5% in 1997 and 1996. This growth was largely due to acquisitions.
Policy benefits, excluding Chubb Life, increased $8.8 or 1.7% over 1996. Excluding acquisitions, policy benefits in 1996 increased $3.5 or 1.6% over 1995. Increases in fund balances resulted in interest credited to policyholder funds increasing $20.8 or 8.8% in 1997 and $7.2 or 14.3% in 1996, excluding acquisitions. Death benefits declined 4.0% from 1996, which was 3.8% higher than in 1995, excluding acquisitions. In addition, surrender benefits on traditional coverages declined by 11.1% in 1997 and increased 10.4% in 1996. The 1997 decline was due to better persistency in the career distribution channel and in the block of business assumed from KCL in 1995.
Fixed annuity receipts were $596.3 for 1997 compared to $556.8 for 1996 and $379.7 for 1995. Fixed annuity benefits and surrenders as a percentage of beginning fund balances were 15.0% and 13.4% in 1997 and 1996. Annuity surrenders may increase as the percentage of the business that can be withdrawn by policyholders without incurring a surrender charge increases.
Reported spreads (the difference between yield on the investment portfolio less interest credited to policyholders as reflected in the income statement) were 1.99% and 2.06% for 1997 and 1996. During 1997, first year "bonus" interest credited, net of related amortization, of $4.7 was deferred. The nominal spread, which reflects interest credited before deferral of bonus interest, was 1.87% for 1997. Prior to 1997, deferred bonus interest amounts were insignificant.
impact of acquisitions, as assets under management increased. The average investment yield was 7.44% and 7.41% for 1997 and 1996.
Group Products provides a wide range of group insurance products for employers and their employees primarily in the Southeast and Southwest. It offers conventionally-insured and alternatively-funded medical benefits as well as a variety of life, disability income, dental and retirement plans. Operating results were:
Group life and annuity operating income was $12.4, $10.3 and $11.8 in 1997, 1996 and 1995. Life and annuity premium receipts increased $30.7 or 27.0% during 1997, primarily due to growth in existing life cases and new annuity sales. Favorable mortality experience had a positive impact on life results for the year.
Operating income from the Communications segment declined $0.7 or 2.5% in 1997 compared to an increase of 19.5% in 1996. Results for 1997 and 1996 were positively impacted by tax refunds and related interest income of $0.3 and $2.6. Excluding the impact of these refunds, operating income for 1997 increased 6.3% over 1996. Net investment income in 1997 reflects increased interest expense on debt to finance acquisitions made since June 30, 1996, versus interest income from the tax refund in 1996.
Due to continued strong audience levels and the favorable advertising environment, Television properties generated increases in revenues of 8.1% and 4.4% during 1997 and 1996. Cost of sales were up 6.6% for 1997, consistent with the increase in net sales, while operating expenses increased 1.9%, resulting in a 17.0% increase in broadcast cash flow for the year. Broadcast cash flow increased 10.6% in 1996.
Revenue from Sports operations decreased 24.7% during 1997 as a result of non-recurring Olympic revenues realized in 1996 and declines in advertising revenue for collegiate properties. The non-recurring Olympic revenues resulted in 1996 revenues exceeding 1995 levels by 33.4%. Cost of sales decreased 25.9% in 1997 and increased 36.1% in 1996, consistent with the changes in revenue in each year. As a result, broadcast cash flows declined 26.1% in 1997, after increasing 44.6% in 1996.
Discontinued Operations Discontinued operations include the operations of Jefferson-Pilot Fire & Casualty (JP F&C). In early 1995, JP sold JP F&C for cash of $55 and recorded a gain on sale of $16.4.
Earnings on investments increased during 1997 as proceeds from issuance of debt securities were invested in interest bearing instruments for a short period prior to the closing of the Chubb Life acquisition. The increase in interest expense and dividends on Capital Securities and mandatorily redeemable preferred stock were both related to acquisition financing. Operating expenses represent costs incurred to fund corporate activities and will fluctuate based on the level of those activities. Federal and state income tax benefits include the tax benefits of preferred dividends on Capital Securities; such dividends are recorded gross of related tax effects.
Total assets increased $5,569 or 31.7% in 1997. Excluding incremental total assets of Chubb Life as of the acquisition date, the increase was $1,689 or 9.6%, which resulted from positive cash flow from operations, increases in Separate Account assets, increases in the market values of "available for sale" investments, increases in net policyholder contract deposits, and net incremental borrowings, partially offset by dividend payments.
The Insurance segment defers the costs of acquiring new business, including commissions, first year bonus interest, certain costs of underwriting and issuing policies plus agency office expenses (referred to as DAC). Such amounts deferred were $742 and $669 at December 31, 1997 and 1996, an increase of 10.9%.
At December 31, 1997 and 1996, JP had recorded reinsurance receivables of $1,250 and $1,213 and policy loans of $834 and $879 which are related to the businesses of AH Life that were coinsured with HI affiliates as described earlier. HI has provided payment, performance and capital maintenance guarantees with respect to the balances receivable. JP also had a recoverable of $97 as of December 31, 1997 from a single reinsurer related to a block of business of Chubb Life that is 50% reinsured. JP and the reinsurer are joint and equal owners of $195 of securities and short-term investments which support the block.
The Company's ratio of capital to assets has declined over time as a result of acquisitions. Stockholders' equity includes net unrealized gains on securities of $675 and $501 at December 31, 1997 and 1996.
JP considers existing capital resources to be more than adequate to support the current level of its business activities. The business plan places priority on redirecting certain capital resources invested in bonds and stocks into its core businesses, such as the Chubb Life acquisition, which would be expected to produce higher returns over time. Such available invested resources declined substantially with the Chubb Life acquisition.
The Insurance segment is subject to regulatory constraints. The Company's insurance subsidiaries have statutory surplus and risk based capital levels well above required levels. This has enabled JP Life, AH Life and Chubb Life to attain the following ratings:
Short-term borrowings outstanding as of December 31, 1997 and 1996 consisted of commercial paper. The weighted average interest rates were 6.02% and 5.53%. During 1995, JP utilized uncommitted bank lines of credit to manage parent company cash flows. In October 1995, JP replaced these lines with an unsecured revolving credit agreement. In 1996, the Company began issuing commercial paper. The maximum commercial paper outstanding during 1997 and 1996 was $317 and $250.
In January and March 1997, the Company privately placed $200 of 8.14% Capital Securities Series A and $100 of 8.285% Capital Securities Series B. Net proceeds were temporarily invested prior to closing of the Chubb Life acquisition, in major part by reducing short-term borrowings under JP's ongoing commercial paper program.
The Company used cash of $758 during the second quarter of 1997 to purchase Chubb Life. Such amount represents the purchase price less cash held by Chubb Life at the acquisition date. Exclusive of the $758, net cash used in investing activities was $415, $1,124 and $720 for 1997, 1996 and 1995. The reduction in 1997 reflects the liquidation of investments in the months preceding the Chubb Life acquisition, with the proceeds used to partially fund the acquisition.
In order to meet the parent company's dividend payments, debt servicing obligations and other expenses, internal dividends are received from the subsidiary companies. Total internal cash dividends paid to the parent company from its subsidiaries during 1997, 1996 and 1995 were $391, $156 and $134. JP Life has been the primary source of dividends. Of the 1997 dividends to JP by its subsidiaries, $219 from JP Life was specifically to assist in funding the Chubb Life acquisition. The Company's life insurance subsidiaries are subject to laws in the states of domicile that limit the amount of dividends that can be paid without the prior approval of the respective State's Insurance Commissioner. Because of the extraordinary dividends paid by JP Life and Chubb Life (to its former parent) during the second quarter of 1997, any future dividends by these companies through April 1998 will require regulatory approval. The Company obtained regulatory approval for a JP Life dividend of $30 which was paid on March 5, 1998. An additional $90 of dividends from JP Life are planned for 1998, a portion of which will require regulatory approval. The Company has no reason to believe that such approval will be withheld. No dividends from Chubb Life are planned for 1998.
Cash and short-term investments were $9, $105 and $122 at December 31, 1997, 1996 and 1995. Additionally, fixed income and equity securities held by the parent company and non-regulated subsidiaries were
$564, $483 and $392 at December 31, 1997, 1996 and 1995. These securities, less the $327 (at December 31, 1997) of NationsBank stock which supports the Exchangeable Securities, are considered to be sources of liquidity to support the Company's strategies. Total trading securities and debt and equity securities available for sale at December 31, 1997 were $11,048.
JP's strategy for managing the insurance investment portfolio is to dependably meet pricing assumptions while achieving the highest possible after-tax returns over the long term. Cash flows are invested primarily in fixed income securities. The nature and quality of the various types of investments held by insurance subsidiaries must comply with state regulatory requirements. The Company has a formal investment policy that governs overall quality and diversification.
The strategy of identifying market sectors and niches that provide investment opportunities to meet the portfolios' growth, quality and yield requirements is expected to continue to result in increasing percentages of private placements and commercial mortgage loans, which as a percentage of total investments declined in 1997 due to the Chubb Life acquisition.
JP's Investment Policy Statement (Policy) requires an average quality fixed income portfolio (excluding mortgage loans) of "A" or higher. Currently, the average quality is "A+", excluding mortgage loans. The Policy also imposes limits on the amount of lower quality investments and requires diversification by issuer and asset type. The Company monitors "higher risk" investments for compliance with the Policy and for proper valuation. Securities that experience other than temporary declines in value are adjusted to net realizable values through a charge to earnings. Commercial mortgage loans in foreclosure are carried at the net present value of expected future cash flows. The Company has established a reserve to account for impaired mortgage loans which was $27 as of December 31, 1997 and 1996.
The level of below investment grade bonds, which increased slightly during 1997, is within the guidelines authorized by the Policy. Generally, non- investment grade bonds, whether purchased via private placements or in public markets, are in the highest tier of ratings just below investment grade.
The Company has been analyzing the Year 2000 computer systems problem since 1995. During the course of this analysis, the Company has ascertained that failure to alleviate Year 2000 systems problems could result in a material disruption to the Company's operations in the year 2000. A centralized oversight and project management process has been put into place to facilitate compliance of all Company information systems prior to the end of 1999. This oversight process includes communications with significant suppliers to the extent the Company's systems are vulnerable to those third parties' failure to remedy Year 2000 issues. The assessment phase of the Year 2000 effort (including mainframe and alternative systems) is complete for the majority of systems and several have been brought into Year 2000 compliance. To date, the Company has incurred external costs of $3. The remainder of this effort is expected to be completed by the third quarter of 1999 utilizing internal and external resources, with remaining external costs estimated at approximately $9. However, there can be no guarantee that these results will be achieved and actual results could differ materially. All costs associated with this effort are being expensed as incurred.
Since JP's assets and liabilities are largely monetary in nature, the Company's financial position and earnings are subject to risks resulting from changes in interest rates at varying maturities, changes in spreads over U.S. Treasuries on new investment opportunities, changes in the yield curve and equity pricing risks. Continued favorable economic conditions in the United States, contributed to a decline in 10 year U.S. Treasury rates of 68 basis points in 1997 versus an 84 basis point increase in 1996. These forces contributed to an increase in unrealized gains on securities available for sale of $173 in 1997 and a decrease of $24 in 1996. Further,
throughout 1997, various forces in the fixed income markets have resulted in a compression of risk premiums over Treasury securities that can be earned on new investments.
As is typical in the industry, the Company's life and annuity products contain minimum rate guarantees regarding interest credited. For interest sensitive life products the minimum rates range from approximately 4.0% to 5.5%, with an approximate weighted average of 4.5%. For annuity products, the minimum rates range from 3.0% to 5.5%, with the greatest concentration in the 3.5% to 4.0% range.
The Company also considers the timing of cash flows arising from market risk sensitive instruments (other than trading) and insurance portfolios under varying interest rate scenarios as well as the related impact on reported earnings under those varying scenarios. Market risk sensitive instruments (other than trading) include debt and equity securities available for sale and held to maturity, mortgage loans, policy loans, investment commitments, annuities in the accumulation phase and periodic payment annuities, commercial paper borrowings, repurchase agreements, interest rate swaps, debt and Exchangeable Securities, and mandatorily redeemable preferred stock. The following table shows the estimated impact that various hypothetical interest rate scenarios would be expected to have on the Company's earnings for a calendar year, based on the assumptions contained in the Company's model:
These estimates were derived by modeling estimated cash flows of the Company's market risk sensitive instruments and insurance portfolios. Changes in interest rates illustrated above assume parallel shifts in the yield curve graded pro-rata over four quarters. Incremental income or loss is net of taxes at 35%. Estimated cash flows produced in the model assume reinvestments representative of JP's current investment strategy and calls/prepayments include scheduled maturities as well as those expected to occur when issuers can benefit financially based on the difference between prepayment penalties and new money rates under each scenario. Assumed lapse rates among insurance portfolios give consideration to relationships expected between credited rates and market interest rates, as well as the level of surrender charges inherent in individual contracts. The illustrated incremental income or loss also includes the expected impact on amortization of DAC and VOBA. The
JP operates largely in the U.S. Financial Services market, which is subject to general economic conditions in the U.S. During 1996 and 1997, the U.S. economy showed signs of improvement and growth evidenced by strong bond and stock markets and a stronger U.S. dollar. However, soft market conditions have continued to have a negative impact on the insurance industry.
In the face of flat premium growth, the U.S. insurance industry has experienced an increasing number of mergers, acquisitions, consolidations and sales of business lines. These activities have been driven by a need to reduce costs of distribution and by the need to increase economies of scale in the face of growing competition from larger consolidating traditional insurers, from non-traditional players such as banks, securities brokers and mutual funds and from HMO's and managed care providers. Consolidation is expected to continue, and there is an increasing possibility of federal legislation in 1998 that would allow banks, insurance companies and investment banks to affiliate.
JP has grown at a rate faster than the overall industry because of acquisitions, its strong financial position, superior claims paying ratings, and efforts to increase distribution sources.
Medical inflation and utilization of medical services affect the profitability of health products offered through the Individual and Group distribution systems. In the event that premium rates are not adequately adjusted in anticipation of medical trends, profitability of health insurance products is adversely affected.
JP is exposed to environmental regulation and litigation as a result of ownership of investment real estate and property and casualty and Communications subsidiaries. Actual loss experience has been minimal and exposure to environmental losses is considered by the Company to be insignificant.
Prescribed or permitted Statutory Accounting Principles (SAP) may vary between states and between companies. The (NAIC) is in the process of codifying SAP to promote standardization of methods, which might result in changes in statutory accounting practices for the Company. Such changes are not expected to impact the Company's statutory capital requirements significantly.
In recent years, the life insurance industry has experienced increased litigation in which large jury awards including punitive damages have occurred. See Note 18, which is incorporated herein by reference, for discussion of the Company's contingent liabilities.
We have audited the accompanying consolidated balance sheets of Jefferson- Pilot Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Jefferson-Pilot Corporation and subsidiaries for the year ended December 31, 1995 were audited by predecessor auditors, whose report dated February 6, 1996 expressed an unqualified opinion on those statements. The consolidated financial statements for the year ended December 31, 1995 of Alexander Hamilton Life Insurance Company of America and subsidiaries were audited by other auditors whose report was furnished to the predecessor auditors, and the predecessor auditors' opinion, insofar as it relates to the amounts included for Alexander Hamilton Life Insurance Company of America and subsidiaries, is based solely on the report of the other auditors. The consolidated financial statements of Alexander Hamilton Life Insurance Company of America and subsidiaries reflect total revenue constituting 9% of the related consolidated totals for 1995.
In our opinion, the 1997 and 1996 financial statements referred to above present fairly, in all material respects, the financial position of Jefferson- Pilot Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.
We conducted our audit in accordance with generally accepted auditing standards. 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 examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit and the report of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Jefferson- Pilot Corporation and subsidiaries for the year ended December 31, 1995, in conformity with generally accepted accounting principles.
Under the Stock Purchase Agreement, the purchase price was subject to certain post-closing adjustments, none of which is material. The allocation of the purchase price has been made based on preliminary estimates of the tax bases of assets and liabilities and the assignment of goodwill among affiliates and may be subject to change.
On a pro-forma basis, net income available to common stockholders before realized investment gains, net of income taxes, increased from $297 to $309 for 1997. However, the pro-forma adjustments eliminate the effect of realized gains on invested assets sold in 1997 to finance the Chubb Life acquisition. Thus, 1997 pro-forma realized gains and pro-forma income from continuing operations are lower than actual 1997 results.
Reinsurance Transactions: On May 31, 1995, the Company assumed certain life insurance and annuity business of Kentucky Central Life Insurance Company (KCL) in a transaction which was accomplished through an assumption reinsurance agreement. Adjusted for the 1996 resolution of certain policies, the Company received assets with an aggregate fair value of $872, including $164 of cash, and the Company assumed liabilities with aggregate fair value of $1,136. The difference between the fair values of assets received and liabilities assumed was recorded as deferred policy acquisition costs.
In September 1996, the Company recaptured $489 of PPA reserves that had previously been reinsured with affiliates of Household on a coinsurance basis. See Note 15 for discussion of this transaction.
Other Dispositions: On February 14, 1995, substantially all of the assets and the media industry data processing operations of Jefferson-Pilot Data Services, Inc. (JPDS) were sold for $33, resulting in a pre-tax gain of $16. Prior to the sale, JPDS was a part of the Company's communications business segment. JPDS net income prior to the disposition for 1995 was $1.
Mortgage and Policy Loans: Mortgage loans on real estate are stated at unpaid balances net of allowances for unrecoverable amounts. Policy loans are stated at their unpaid balances.
Value of business acquired represents the actuarially determined present value of anticipated profits to be realized from life insurance and annuity business purchased, using the same assumptions used to value the related liabilities. Amortization of the value of business acquired occurs over the related contract periods, using current crediting rates to accrete interest and a constant amortization rate based on the present value of expected future profits.
Recognition of Revenue: Premiums on traditional life insurance products are reported as revenue when received unless received in advance of the due date.
Policyholder Contract Deposits: Policyholder contract deposits consist of policy values that accrue to holders of universal life-type contracts and annuities. The liability is determined using the retrospective deposit method and consists of policy values that accrue to the benefit of the policyholder, before deduction of surrender charges.
Policy and Contract Claims: The liability for policy and contract claims consists of the estimated amount payable for claims reported but not yet settled and an estimate of claims incurred but not reported, which is based on historical experience, adjusted for trends and circumstances. Management believes that the recorded liability is sufficient to provide for the associated claims adjustment expenses.
Reinsurance Balances and Transactions: Reinsurance receivables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policy benefits and policyholder contract deposits. The cost of reinsurance is accounted for over the terms of the underlying reinsured policies using assumptions consistent with those used to account for the policies.
Stock Based Compensation: The Company accounts for stock incentive awards in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees", and accordingly, recognizes no compensation expense for stock option awards when the option price is equal to the market value of the stock at the date of award.
New Accounting Pronouncements: In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS 130, "Reporting Comprehensive Income", which is effective for fiscal years beginning after December 15, 1997. SFAS 130 sets standards for the reporting and display of comprehensive income and its components in financial statements. Application of the new rules will not impact the Company's financial position or net income. The Company expects to adopt this pronouncement in the first quarter of 1998, which will include the presentation of comprehensive income for prior periods presented for comparative purposes, as required by SFAS 130. The primary element of comprehensive income applicable to the Company is changes in unrealized gains and losses on securities classified as available for sale.
In 1997, the FASB issued SFAS 128, "Earnings Per Share." This pronouncement replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. In addition, SFAS 128 requires that diluted earnings per share be disclosed even if the difference from basic earnings per share is negligible. Hereinafter, basic earnings per share is referred to as earnings per share. All earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to the SFAS 128
Summary Cost and Fair Value Information: Aggregate amortized cost, aggregate fair value and gross unrealized gains and losses are as follows:
Contractual Maturities: Aggregate amortized cost and aggregate fair value of debt securities as of December 31, 1997, according to contractual maturity date, are as indicated below. Actual future maturities will differ from the contractual maturities shown because the issuers of certain debt securities have the right to call or prepay the amounts due the Company, with or without penalty.
Investment Concentration, Risk, and Impairment: Investments in debt and equity securities include 1,500 issuers, with only one corporate issuer representing more than one percent of the aggregate reported amounts of these investments. Included with equity securities available for sale is an investment in common stock of NationsBank Corporation of $500 (3.4%) and $402 (3.5%) as of December 31, 1997 and 1996. Debt securities considered less than investment grade approximated 5.5% and 4.3% of the total debt securities portfolio as of December 31, 1997 and 1996.
The Company's mortgage loan portfolio is comprised primarily of conventional real estate mortgages collateralized by retail (44%), apartment (17%), industrial (11%), office (11%) and hotel (10%) properties.
Changes in Net Unrealized Gains on Securities: Changes during the three year period ended December 31, 1997 in amounts affecting net unrealized gains included in the separate component of stockholders' equity, reduced by deferred income taxes, are as follows:
Net Investment Income: The details of investment income, net of investment expenses follow:
Investment expenses include salaries, taxes, interest, expenses of maintaining and operating investment real estate, real estate depreciation and other allocated costs of investment management and administration.
Other Information: During 1997, the Company sold certain securities that had been classified as held to maturity, due to significant declines in credit worthiness Total proceeds were $10. A held to maturity security with amortized cost of $5 was transferred to the available for sale category during 1995 due to a significant decline in the credit worthiness of the issuer.
During 1996 and 1995, JP Life transferred securities classified as available for sale to the Company's defined benefit pension plans. Equity securities with cost of $5 and fair value of $27 were transferred during 1996, and gains of $22 were recognized. Equity securities with cost of $7 and fair value of $33 were transferred during 1995, and gains of $26 were recognized.
The Company's credit exposure on swaps is limited to the fair value of swap agreements that are favorable to the Company. The Company does not expect any counterparty to fail to meet its obligation; however, non-performance would not have a material adverse effect on the Company's financial position or results of operations.
The Company's exposure to market risk is mitigated by the offsetting effects of changes in the value of swap agreements and the related direct investments, anticipated investments and credited interest on annuities. The Company routinely monitors correlation between hedged items and hedging instruments. In the event a hedge relationship was terminated, any related hedging instrument that remained would be marked to market.
Deferred Policy Acquisition Costs: Information about deferred policy acquisition costs follows:
The Company uses conservative estimates for determining its liability for accident and health, and disability benefits, which are based on historical claim payment patterns and attempt to provide for potential adverse changes in claim patterns and severity. Lower than anticipated claims resulted in adjustments to the liability for accident and health, and disability benefits in each of the years presented.
Commercial Paper and Revolving Credit Borrowings: The Company has entered into a bank credit agreement for $375 of unsecured revolving credit extending through May 2002, under which the Company has the option to borrow at various interest rates. Subsequent to the establishment of a commercial paper arrangement in 1996, the credit agreement has principally supported the issuance of commercial paper. As of December 31, 1997, outstanding commercial paper had various maturities, with none in excess of 90 days. The Company can issue commercial paper with maturities of up to 270 days. If the Company is not able to remarket its commercial paper on the respective maturity dates, the Company intends to borrow a like amount under the credit agreement. The weighted-average interest rate for commercial paper borrowings outstanding of $285 at December 31, 1997 was 6.02%. The weighted-average interest rate for $222 of commercial paper borrowings outstanding at December 31, 1996 was 5.53%.
The Exchangeable Securities are carried at fair value. Changes in the carrying value, net of deferred income taxes, are charged against net unrealized gains in stockholders' equity. At December 31, 1997 and 1996, the combined carrying value of the Exchangeable Securities was $327 and $148, based on the market value of NationsBank stock, which had a market value of $60.81 per share as of year end.
On February 9, 1998, the Board authorized a three-for-two common stock split which will be effected as a 50% stock dividend distributed on April 13, 1998 to shareholders of record as of March 20, 1998.
Shareholders' Rights Plan: Under a shareholders' rights plan, one common share purchase right is attached to each share of the Company's common stock. The plan becomes operative in certain events involving an offer for or the acquisition of 15% or more of the Company's common stock by any person or group. Following such an event, each right, unless redeemed by the Board, entitles the holder (other than the acquiring person or group) to purchase for an exercise price of $123.33 an amount of common stock of the Company, or in certain circumstances stock of the acquiring company, having a market value of twice the exercise price. Approximately 70 million shares of common stock are reserved for the amended rights plan. The rights expire on November 7, 2004 unless extended by the Board, and are redeemable by the Board at a price of $.01 per right at any time before they become exercisable.
Long Term Stock Incentive Plan: Under the Long Term Stock Incentive Plan (Employees' Plan), a Committee of disinterested directors may award nonqualified or incentive stock options and stock appreciation rights, and make grants of the Company's stock, to employees of the Company and certain full-time life insurance agents. Stock grants may be either restricted stock or unrestricted stock distributed upon the achievement of performance goals established by the Committee.
Non-Employee Directors' Plan: Under the Non-Employee Directors' Stock Option Plan (Directors' Plan), 285,000 shares of the Company's common stock are reserved for issuance pursuant to outstanding or future awards as of December 31, 1997. Nonqualified stock options are automatically awarded, at market prices on specified award dates. The options vest over a period of one to three years, and terminate ten years from the date of award, but are subject to earlier vesting or termination under certain circumstances. The Directors' Plan will terminate as to further awards on March 31, 1999.
Pro Forma Information: FASB Statement 123, "Accounting for Stock-Based Compensation", requires the presentation of pro forma information regarding net income and earnings per share as if the Company had accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
The NAIC is in the process of codifying SAP, in order to create uniformity across states. Any resulting changes in SAP would take effect no earlier than 1999, and are expected to result in a net reduction of statutory surplus and RBC industry wide.
The insurance statutes of the states of domicile limit the amount of dividends that the life insurance subsidiaries may pay annually without first obtaining regulatory approval. Generally, the limitations are based on a combination of statutory net gain from operations for the preceding year, 10% of statutory surplus at the end of the preceding year, and dividends and distributions made within the preceding twelve months. At December 31, 1997, any future dividends paid by JP Life and Chubb Life through April 1998 will require regulatory approval.
Under prior federal income tax law, one-half of the excess of a life insurance company's income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as "Policyholders' Surplus". The Company has approximately $91 of untaxed "Policyholders' Surplus" on which no payment of federal income taxes will be required unless it is distributed as a dividend, or under other specified conditions. The Company does not believe that any significant portion of the account will be taxed in the foreseeable future and no related deferred tax liability has been recognized. If the entire balance of the account became taxable under the current federal rate, the tax would approximate $32.
Pension Plans: The Company and its subsidiaries have defined benefit pension plans covering substantially all employees and some full-time life insurance agents. The plans provide benefits based on annual compensation and years of service. The plans are noncontributory and are funded through group annuity contracts with JP Life. The assets of the plans are those of the related contracts, and are primarily held in separate accounts of JP Life. The funding policy is to contribute annually no more than the maximum amount deductible for federal income tax purposes.
Benefits provided to retirees by annuity contracts issued by JP Life approximated $14 in 1997, $15 in 1996 and $11 in 1995.
AH Life and FAHL reinsured 100% of the PPA, COLI and Affiliated business written prior to their acquisition with affiliates of Household on a coinsurance basis. Balances are settled monthly, and AH Life is compensated by the reinsurers for administrative services related to the reinsured business. On September 30, 1996, the Company recaptured a portion of the PPA reinsurance from affiliates of Household. This recapture was completed by Household's transferring approximately $463 of assets and $489 of reserves to the Company. The Company also established a $29 deferred tax asset on this recapture, and issued $3 of mandatorily redeemable preferred stock of one of the Company's life insurance subsidiaries to Household (see Note 9). The amount due
Reinsurance contracts do not relieve an insurer from its primary obligation to policyholders. Therefore, the failure of a reinsurer that is party to a contract with a subsidiary to discharge its reinsurance obligations could result in a loss to the affected subsidiary. The Company regularly evaluates the financial condition of its reinsurers and monitors concentrations of credit risk related to reinsurance activities. No significant credit losses have resulted from the reinsurance activities of the subsidiaries during the three years ended December 31, 1997.
The Company's operations are conducted principally through the following business segments:
Life insurance - Life insurance operations include the writing of individual and group life insurance, accident and health insurance, disability insurance and annuity products.
Interest rate swaps that hedge direct investments classified as available for sale are recorded at fair value (1997 - gain of $5; 1996 - loss of $1) and are included in the carrying value of debt securities available for sale. The fair value of interest rate swaps that hedge direct investments classified as held to maturity, that hedge anticipated transactions and that hedge annuity contract deposits (1997 - gain of $1; 1996 - $0) have not been recorded on the balance sheet.