Critical Accounting Policies In the conduct of business, the Company makes certain assumptions regarding the mortality, persistency, expenses and interest rates, (or other factors appropriate to the type of business) it expects to experience in future periods. Similar assumptions are also used to estimate the amounts of deferred policy acquisition costs, policy liabilities and accruals, and various other items. The Company’s actual experience, as well as changes in estimates, are components of the Company’s statements of income.
Premiums and policy fees........................... $29,086,430 $30,557,133 (4.8)% Net investment income.............................. 33,876,409 31,686,448 6.9 Realized investment (losses) gains................. (1,113,538) 42,148 - Other income (loss)................................ 5,731 (6,551) - ----------- ----------- $61,855,032 $62,279,178 =========== ===========
Net investment income for 2001 was $2.2 million or 6.9% higher than for the preceding year primarily due to increases in the average amount of invested assets. The percentage earned on average cash and investments was 6.6% in 2001 and 6.5% in 2000.
2001 2000 ---- ---- Operating Income (Loss)(1) Life Insurance Acquisitions.................................. $11,538,404 $11,605,470 Specialty Insurance Products Credit Products............................... 976,656 603,586 Retirement Savings and Investment Products Annuities..................................... (646,706) 870,329 Corporate and Other................................ 1,531,512 305,451 ------------ ---------- Total operating income............................. 13,399,866 13,384,836 ============ ========== Realized Investment Gains (Losses) Unallocated Realized Investment Gains (Losses)..... (1,113,538) 42,148 ------------ ---------- Total.............................................. (1,113,538) 42,148 ------------ ---------- Income (Loss) Before Income Tax Life Insurance Acquisitions.................................. 11,538,404 11,605,470 Specialty Insurance Products Credit Products............................... 976,656 603,586 Retirement Savings and Investment Products Annuities..................................... (646,706) 870,329 Corporate and Other................................ 1,531,512 305,451 Unallocated Realized Investment Gains (Losses)..... (1,113,538) 42,148 ------------ ----------- Total income from continuing operations before income tax....................................... $12,286,328 $13,426,984 ============ ===========
Pretax earnings from the Acquisitions segment decreased $0.1 million in 2001 as compared to 2000. Earnings from the Acquisitions segment are normally expected to decline over time (due to the lapsing of policies resulting from deaths of insureds or terminations of coverage) unless new acquisitions are made. There were no new acquisitions made in 2001.
Statements of Income for the years ended December 31, 2001, 2000, and 1999............................... 10
Financial Statement Schedules: Schedule III-- Supplementary Insurance Information.................................................. 28 Schedule IV-- Reinsurance........................................................................... 29
BENEFITS AND EXPENSES Benefits and settlement expenses (net of reinsurance ceded: 2001-$13,449,131; 2000-$15,454,285; 1999-$17,399,370)............... 33,344,929 32,765,035 30,549,469 Amortization of deferred policy acquisition costs..................... 7,034,480 6,765,446 6,835,492 Other operating expenses (net of reinsurance ceded: 2001-$397,265; 2000-$286,602; 1999-$291,274)....................................... 9,189,295 9,321,713 12,880,099 ------------ ------------ ------------ 49,568,704 48,852,194 50,265,060 ------------ ------------ ------------
Income from continuing operations before income tax....................... 12,286,328 13,426,984 12,568,009 ------------ ------------ ------------
Net income before cumulative effect of change in accounting principle..... 9,905,152 8,743,668 9,401,173 Cumulative effect of change in accounting principle, net of income tax.... (284,968) ------------ ------------ ------------
Net income................................................................ $ 9,620,184 $ 8,743,668 $ 9,401,173 ============ ============ ============
(5,000,000) (5,000,000) --------- ---------- ------------ ----------- ------------- ------------- Balance, December 31, 1999.............. 2,000 2,500,000 101,386,324 22,754,665 (11,344,864) 115,298,125 Net income for 2000................... 8,743,668 8,743,668 Change in net unrealized gains/losses on investments (net of income tax: $4,363,726)..... 8,104,062 8,104,062 Reclassification adjustment for amounts included in net income (net of income tax: ($14,752))...... (27,396) (27,396) ------------ Comprehensive income for 2000......... 16,820,334 ------------ Common dividends ($51 per share)...... (12,750,000) (12,750,000)
CASH FLOWS FROM INVESTING ACTIVITIES Maturities and principal reduction of investments: Investments available for sale.......................................... 134,614,161 401,392,138 256,525,416 Other................................................................... 415,557 845,893 2,701,003 Sale of investments: Investments available for sale.......................................... 103,958,267 11,251,538 17,961,720 Other................................................................... 0 1,197,324 0 Cost of investments acquired: Investments available for sale.......................................... (262,462,048) (453,746,936) (301,844,318) Sale of discontinued operations............................................. 2,500,000 -------------- ----------- ------------ Net cash used in investing activities........................................... (20,974,063) (39,060,043) (24,656,179) ============== =========== ============
CASH FLOWS FROM FINANCING ACTIVITIES Dividends to share owners................................................... (12,900,000) (12,750,000) (5,000,000) Investment product deposits and change in universal life deposits........... 56,941,071 47,248,477 36,600,618 Investment product withdrawals.............................................. (34,810,896) (23,654,329) (10,806,493) -------------- ----------- ------------ Net cash provided by financing activities................................... 9,230,175 10,844,148 20,794,125 ============== =========== ============
BASIS OF PRESENTATION The accompanying financial statements of Protective Life and Annuity Insurance Company (“the Company”) are prepared on the basis of accounting principles generally accepted in the United States of America. Such accounting principles differ from statutory reporting practices used by insurance companies in reporting to state regulatory authorities. (See also Note B.)
NATURE OF OPERATIONS The Company, since it is licensed in the State of New York, is the entity through which PLC markets, distributes, and services insurance and annuity products in New York. The operating results of companies in the insurance industry have historically been subject to significant fluctuations due to changing competition, economic conditions, interest rates, investment performance, insurance ratings, and other factors.
In September 2000, the Financial Accounting Standards Board (FASB) issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125". SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets. This statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The adoption of this accounting standard did not have a material effect on the Company’s financial position or results of operations.
Liabilities for future policy benefits on traditional life insurance products have been computed using a net level method including assumptions as to investment yields, mortality, persistency, and other assumptions based on the Company’s experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation. Reserve investment yield assumptions are graded and range from 2.5% to 7.0%. The liability for future policy benefits and claims on traditional life, health, and credit insurance products includes estimated unpaid claims that have been reported to the Company and claims incurred but not yet reported. Policy claims are charged to expense in the period in which the claims are incurred.
Balance beginning of year.............................. $ 7,372,438 $ 9,557,627 $ 4,089,659 Less reinsurance.................................... 1,954,392 4,924,705 494,064 ----------- ----------- -------------
Incurred related to: Current year........................................... 11,883,729 11,780,396 10,485,712 Prior year............................................. 584,972 (213,798) (501,227) ----------- ----------- ------------- Total incurred...................................... 12,468,701 11,566,598 9,984,485
Net balance end of year................................ 5,614,651 5,418,046 4,632,922 Plus reinsurance.................................... 1,459,829 1,954,392 4,924,705 ----------- ----------- ------------- Balance end of year.................................... $ 7,074,480 $ 7,372,438 $ 9,557,627 =========== =========== =============
Remaining assets and liabilities at December 31, 2001 related to the business sold to Fortis, Inc. consist of reinsurance receivables and policy liabilities and accruals of approximately $3.9 million.
In conformity with statutory reporting practices: $16,643,381 $13,006,859 $12,659,788 $ 34,248,362 $ 31,878,162 $ 32,146,507 Additions (deductions) by adjustment: Deferred policy acquisition costs, net of amortization................. (5,241,742) (4,700,240) (6,133,391) 118,997,438 128,228,360 127,792,025 Deferred income tax................... (5,121,553) (4,605,444) (3,656,012) (17,077,829) (9,063,941) (109,523) Asset Valuation Reserve............... 323,250 2,797,912 2,051,489 Interest Maintenance Reserve.......... (446,638) 118,604 93,585 694,509 247,870 366,474 Nonadmitted items..................... 281,394 25,902 26,068 Other timing and valuation adjustments 3,786,736 4,923,889 6,437,203 (15,722,031) (34,745,806) (46,974,915) ------------ ----------- ---------- ------------- ------------- ------------- In conformity with generally accepted accounting principles $ 9,620,184 $ 8,743,668 $ 9,401,173 $121,745,093 $119,368,459 $115,298,125 ============ =========== =========== ============ ============ =============
As of December 31, 2001, the Company had on deposit with regulatory authorities, fixed maturity and short-term investments with a market value of approximately $7.7 million.
Gross Gross Estimated Amortized Unrealized Unrealized Market 2000 Cost Gains Losses Values ---- -------------- -------------- ------------- ----------------
Fixed maturities: Bonds: Mortgage-backed securities.............. $ 4,979,867 $ 125,349 $ 0 $ 5,105,216 United States Government and authorities............................. 8,108,623 229,091 2,534 8,335,180 States, municipalities, and political subdivisions.................. 3,035,053 26,882 0 3,061,935 Public utilities........................ 68,417,417 811,070 1,404,149 67,824,338 Convertibles and bonds with warrants................................ 689,811 0 152,561 537,250 All other corporate bonds............... 343,161,828 3,187,729 12,456,797 333,892,760 -------------- ------------ ------------ ------------- 428,392,599 4,380,121 14,016,041 418,756,679 Short-term investments........................... 4,000,000 0 0 4,000,000 -------------- ------------ ------------ ------------- $ 432,392,599 $ 4,380,121 $ 14,016,041 $ 422,756,679 ============== ============ ============ =============
At December 31, 2001 and 2000, the Company had bonds which were rated less than investment grade of $10.8 million and $11.6 million, respectively, having an amortized cost of $15.0 million and $13.7 million, respectively. Approximately $77.8 million of bonds are not publicly traded.
2001 2000 1999 ---- ---- ---- Fixed maturities $8,309,103 $5,081,516 $(20,153,473)
At December 31, 2001, 99% of the Company’s mortgage loans were commercial loans of which 68% were retail, and 31% were office buildings. The Company specializes in making mortgage loans on either credit-oriented or credit-anchored commercial properties, most of which are strip shopping centers in smaller towns and cities. All of the mortgage loans are on properties located in the following states listed in decreasing order of significance: Tennessee, Alabama, Florida, Colorado, Arkansas and Texas.
At December 31, 2001, the average mortgage loan was $0.3 million, and the weighted average interest rate was 9.1%. The largest single mortgage loan was $1.2 million.
At December 31, 2001, the Company had no problem mortgage loans (over ninety days past due) and foreclosed properties. At December 31, 2000, the Company’s problem mortgage loans and foreclosed properties totaled less than $0.1 million. Since the Company’s mortgage loans are collateralized by real estate, any assessment of impairment is based upon the estimated fair value of the real estate. Based on the Company’s evaluation of its mortgage loan portfolio, the Company does not expect any material losses on its mortgage loans.
Deferred policy acquisition costs................................ $ 10,448,277 $ 6,202,088 $ 5,095,750 Benefit and other policy liability changes....................... (6,335,100) (3,129,276) 395,046 Temporary differences of investment income....................... 51,888 1,532,632 (1,834,784) ------------- ------------ ------------ $ 4,165,065 $ 4,605,444 $ 3,656,012 ============= ============ ============
The Company's income tax returns are included in the consolidated income tax returns of PLC. The allocation of income tax liabilities among affiliates is based upon separate income tax return calculations. At December 31, 2001 and 2000 no amounts were payable to PLC for income tax liabilities.
Note E-- COMMITMENTS AND CONTINGENT LIABILITIES (Continued) A number of civil jury verdicts have been returned against insurers and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives relationships with agents or persons with whom the insurer does business, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages, which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very little appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. The Company, like other financial service companies, in the ordinary course of business, is involved in such litigation or, alternatively, in arbitration. Although the outcome of any such litigation or arbitration cannot be predicted, the Company believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position, results of operations, or liquidity of the Company.
Note F-- SHARE-OWNERS' EQUITY AND RESTRICTIONS Dividends on common stock are noncumulative and are paid as determined by the Board of Directors. At December 31, 2001, approximately $94.2 million of share-owners’ equity excluding net unrealized gains and losses represented net assets of the Company that cannot be transferred to Protective. In general, dividends up to specified levels are considered ordinary and may be paid thirty days after written notice to the insurance commissioner of the state of domicile unless such commissioner objects to the dividend prior to the expiration of such period. Dividends in larger amounts are considered extraordinary and are subject to affirmative prior approval by such commissioner. The maximum amount that would qualify as ordinary dividends to Protective by the Company in 2002 is estimated to be $16.4 million.
Note H-- RELATED PARTY MATTERS The Company has no employees; therefore, the Company purchases data processing, legal, investment, and other management services from PLC and other affiliates. The cost of such services was $8.6 million in 2001, $7.8 million in 2000, and $6.3 million in 1999.
Protective and the Company entered into a guaranty agreement on October 27, 1993, whereby Protective guaranteed the payment of all insurance policy claims made by the holders or beneficiaries of any of the Company’s policies which were issued after the date of the guaranty agreement in accordance with the terms of said policies. Total liabilities for policies covered by this agreement were $43.8 million and $43.9 million at December 31, 2001 and 2000, respectively.
Protective and the Company also entered into a guaranty agreement on December 31, 1995, whereby Protective guaranteed that the Company will perform all of the obligations of Protective pursuant to the terms and conditions of an indemnity coinsurance agreement between Protective and an unaffiliated life insurance company. Total liabilities related to this coinsurance agreement were $10.1 million and $10.4 million at December 31, 2001 and 2000, respectively.
Retirement Savings and Investment Products The Annuities segment manufactures, sells, and supports fixed and variable annuity products. These products are primarily sold through stockbrokers, but are also sold through financial institutions and the Life Marketing segment’s sales force.
The Company uses the same accounting policies and procedures to measure operating segment income and assets as it uses to measure its consolidated net income and assets. Operating segment income is generally income before income tax. Premiums and policy fees, other income, benefits and settlement expenses, and amortization of deferred policy acquisition costs are attributed directly to each operating segment. Net investment income is allocated based on directly related assets required for transacting the business of that segment. Realized investment gains (losses) and other operating expenses are allocated to the segments in a manner which most appropriately reflects the operations of that segment. Unallocated realized investment gains (losses) are deemed not to be associated with any specific segment.
Note I-- OPERATING SEGMENTS (Continued) The following table sets forth total operating segment income and assets for the periods shown. Adjustments represent the inclusion of unallocated realized investment gains (losses), income from discontinued operations and the recognition of income tax expense. Asset adjustments represent the inclusion of assets related to discontinued operations.
In December 2001, the Company sold substantially all of its Dental segment, and discontinued other dental related operations. Prior period segment results have been restated to reflect these changes.
Corporate Credit and Operating Segment Income Acquisitions Products Annuities Other Adjustments Total ------------------------ ------------- ---------- ---------- ---------- ------------ -----------
---- Premiums and policy fees, net.... $32,290,715 $2,059,410 $ 30,202 $34,380,327 Net investment income............ 27,604,825 269,670 250,000 $ 148,408 28,272,903 Realized investment gains........ $ 89,550 89,550 Other income (loss).............. (8,718) 89,757 9,250 90,289 ----------- ---------- ---------- ---------- ------------ ------------ Total revenues............. 59,886,822 2,418,837 289,452 148,408 89,550 62,833,069 ----------- ---------- ---------- ---------- ------------ ------------ Benefits and settlement expenses. 29,333,102 974,013 242,354 30,549,469 Amortization of deferred policy acquisition costs.......... 6,334,661 500,831 6,835,492 Other operating expenses......... 12,059,458 33,574 761,937 25,130 12,880,099 ----------- ---------- ---------- ---------- ------------ ------------ Total benefits and expenses 47,727,221 1,508,418 1,004,291 25,130 50,265,060 ----------- ---------- ---------- ---------- ------------ ------------ Income from continuing operations before income tax............. 12,159,601 910,419 (714,839) 123,278 89,550 12,568,009 Income tax expense............... 3,519,043 3,519,043 Discontinued operations.......... 352,207 352,207 ------------ Net income....................... $ 9,401,173 ============
Credit Corporate Operating Segment Assets Acquisitions Products Annuities and Other Adjustments Total ------------------------- ------------ ----------- ------------ ----------- ----------- ------------
---- Investments and other assets........ $471,065,653 $10,390,438 $46,091,122 $34,248,362 $3,956,062 $565,751,637 Deferred policy acquisition costs... 114,902,459 1,611,339 2,483,640 118,997,438 ------------ ----------- ----------- ----------- ---------- ------------ Total assets........................ $585,968,112 $12,001,777 $48,574,762 $34,248,362 $3,956,062 $684,749,075 ============ =========== =========== =========== ========== ============
Note J-- REINSURANCE The Company reinsures certain of its risks with, and assumes risks from, other insurers under yearly renewable term, coinsurance, and modified coinsurance agreements. Under yearly renewable term agreements, the Company generally pays specific premiums to the reinsurer as reimbursement for certain expenses. Coinsurance agreements are accounted for by passing a portion of the risk to the reinsurer. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of all benefit payments. Modified coinsurance is accounted for similarly to coinsurance except that the liability for future policy benefits is held by the original company, and settlements are made on a net basis between the companies. A substantial portion of the Company's new life insurance is being reinsured. The Company reviews the financial condition of its reinsurers and monitors the amount of reinsurance it has with its reinsurers.
Note K-- ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS The carrying amount and estimated fair values of the Company's financial instruments at December 31 are as follows:
Estimated Estimated Carrying Fair Carrying Fair Amount Values Amount Values -------- ---------- --------- ----------
The Company estimates the fair value of its mortgage loans using discounted cash flows from the next call date. The Company believes the fair value of its short-term investments approximates book value due to being short-term. The Company estimates the fair value of its annuities using surrender values. The Company believes it is not practicable to determine the fair value of its policy loans since there is no stated maturity, and policy loans are often repaid by reductions to policy benefits.
Future Annuity Amortization Deferred Policy Deposits Premiums Benefits of Deferred Policy Benefits and Other and Net and Policy Other Acquisition and Unearned Policyholders Policy Investment Settlement Acquisition Operating Segment Costs Claims Premiums Funds Fees Income (1) Expenses Costs Expenses (1) ------- ------------- ------------- --------- ------------- -------- ----------- ------------ ------------ ------------
Year Ended December 31, 2000: Life insurance in force(1) ..................... $ 324,167 $ 5,287,046 $ 6,600,096 $ 1,637,217 403.1% =========== ============ ============ ============ ======