Selected consolidated financial data for the Corporation are presented below for each of the five years in the period ended December 31, 2004. This data incorporates a restatement by the Corporation of its Consolidated Financial Statements for the years ended December 31, 2002 and 2003 related to the consolidation of the issuers of certain principal protected note investments made by the Corporation and the application of the provisions of EITF 99-20 in accounting for the variable income notes now included as separate investments in the Company’s financial statements as a result of the restatement, as well as the remaining other principal protected notes, whose issuers were not required to be consolidated. This data should be read in conjunction with the Corporation’s Consolidated Financial Statements and notes thereto and Item 7, Management’s Discussion and Analysis of Operations and Financial Condition. The effects of such restatement have also been given for fiscal years 2001 and 2000.
<1> This table includes restated financial results for the Corporation for the years ended 2003, 2002, 2001, and 2000. See Note 1 and 12 in Notes to Consolidated Financial Statements for the effects of the restatement on the Corporation’s Balance Sheet as of December 31, 2003. Fiscal Years 2002, 2001 and 2000 have also been corrected for the effects of the restatement. 17.
<1> This table includes restated financial results for the Corporation for the years ended 2003, 2002, 2001, and 2000. See Note 1 and 12 in Notes to Consolidated Financial Statements for the effects of the restatement on the Corporation’s Balance Sheet as of December 31, 2003. Fiscal Years 2002, 2001 and 2000 have also been corrected for the effects of the restatement.
Earnings from core assets have been and are expected to be affected by the decline in interest rates. Net investment return on assets for 2004 increased, however, due to the strong performance of the Insurance Company’s limited partnership investments.
For financial statement purposes, our revenues from the sale of whole life and term life insurance products and
Deferred acquisition costs and related amortization also involved a correction with regard to the application of the Company’s methodology for applying unrealized gains and loss information in connection with its shadow DAC calculation.
Earnings per share were $2.25 for 2004, as compared to $1.31 in 2003 and a loss of $2.16 in 2002. Results in 2004 reflected a continuing of year-to-year increases in investment income and net realized investment gains from the prior years. Our total revenues in 2004 were $396 million, compared to $355 million in 2003 and $215 million in 2002. The Corporation’s performance in 2004 resulted primarily from the improved performance of the investment portfolio, particularly the investments in limited partnerships. The improvement of global capital and equity markets in 2004 also contributed significantly to our financial performance.
Market Conditions: The Corporation, like all companies, is affected by the general state of financial markets and economic conditions in the U.S. and elsewhere. Despite certain recent improvements in business conditions, the business environment in recent years has been difficult and the ability to obtain desired returns on the investment portfolio without exposing the Corporation to excess risk has been challenging. This, in turn, has had an impact on our willingness to expand sale of our single premium annuity products.
The Insurance Company seeks to manage its investment portfolio in part to reduce its exposure to interest rate fluctuations. In general, the market value of our fixed maturity portfolio increases or decreases in an inverse relationship with fluctuations in interest rates, and our net investment income increases or decreases in direct relationship with interest rate changes. For example, if interest rates decline, the Insurance Company's fixed maturity investments generally will increase in market value, while net investment income will decrease as fixed income investments mature or are sold and proceeds are reinvested at the declining rates, and vice versa. Management is aware that prevailing market interest rates frequently shift and, accordingly, has adopted strategies that are designed to address either an increase or decrease in prevailing rates.
The Insurance Company¢s principal investments are in fixed maturities, all of which are exposed to at least one of three primary sources of investment risk: credit, interest rate and market valuation. The financial statement risks are those associated with the recognition of impairments and income, as well as the determination of fair values. Management evaluates whether other than temporary impairments have occurred on a case by case basis. Inherent in management¢s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Insurance Company in the other than temporary impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the market value has been below amortized cost; (ii) the potential for impairments of securities when the issuer is experiencing significant financial difficulties; (iii) the potential for impairments in an entire industry sector or sub-sector; (iv) the potential for impairments in certain economically depressed geographic locations; (v) the potential for impairments of securities where the issuer, series of issuers or industry has a catastrophic type of loss or has exhausted natural resources; (vi) consistency with accounting treatment applicable to other similarly situated investments; and (vii) other subjective factors, including concentrations and information obtained from regulators and rating agencies. In addition, the earnings on certain investments are dependent upon market conditions, which could result in prepayments and changes in amounts to be earned due to changing interest rates or equity markets. The determination of fair values in the absence of quoted market values is based on valuation methodologies, securities the Insurance Company deems to be comparable and assumptions deemed appropriate given the circumstances. There can be no assurance that the assumptions relied upon by the Insurance Company will yield accurate assessments of the fair value of these investments. As such, the Insurance Company reassesses its assumptions regularly.
The following table presents the amortized cost and gross unrealized losses for fixed maturities and common stock where the estimated fair value had declined and remained below amortized cost at December 31, 2004:
The following table presents the total gross unrealized losses for fixed maturities where the estimated fair value had declined and remained below amortized cost by December 31, 2004.
In February 2005, the Insurance Company determined that due to its percentage ownership of the notes of certain of the issuers of the principal protected note investments it purchased, the issuers were actually deemed to be affiliated parties. This required the issuers to be consolidated with the Corporation. The impact of the consolidation is that the Corporation is required to account separately for the variable rate income note and the U.S. Treasury Strips. Commencing in or about 2000 through 2001, many of the variable income rate notes underlying the Insurance Company’s principal protected note investment, ceased paying periodic income. As part of the restatement, the Corporation recorded the impairment of the notes as unrealized losses.
(2) In addition, in connection with the restatement the Corporation has applied the provisions of EITF 99-20 to certain principal protected note investments, whose issuers are not required to be consolidated. Although the Corporation has a demonstrated ability and intention to hold these instruments to maturity until recovery of fair value at or above cost and does not have the ability to cause the liquidation of the issuers of those instruments, the Corporation has deemed it appropriate to apply the provisions of EITF 99-20 in accounting for these instruments to present consistent accounting treatment for all principal protected note investments, regardless of whether consolidation is required
(3) The U.S. Treasury Strips are recorded as investments at their purchase price when purchased. In each subsequent year, the Corporation has recognized substantial additional income due to the accretion of the value of the Treasury Strips as they move towards maturity, recorded as amortization of the original issue discount for the bonds. Through December 31, 2004, this additional pre-tax income amounted to $60.7 million. In subsequent periods, running through maturity of the bonds, the Corporation is expecting to recognize additional income of approximately $84.8 million.
The downgrades did not have a material impact on the financial statements of the Corporation for 2004. The reduction in sales was primarily attributable to management’s intention to preserve and build the Insurance Company’s capital and surplus ratios. Surrenders of the Insurance Company’s annuity products continue to remain below 5% of the surrenderable annuities and have not had a material impact on the Corporation’s consolidated financial statements.
Total annuity considerations and life insurance premiums decreased to approximately $40.4 million in fiscal 2004 from approximately $43.6 million in fiscal 2003, a decrease of approximately 7.3% and decreased from approximately $81.0 million in fiscal 2002 to $43.6 million in fiscal 2003, a decrease of approximately 46.2% . These decreases are attributable to a decrease in sales of the Insurance Company¢s Single Premium immediate annuities with life contingencies. Annuity considerations decreased to approximately $28.4 million in fiscal 2004 from approximately $32.6 million in fiscal 2003, a decrease of approximately $4.2 million and from approximately $69.4 million in 2002 to $32.6 million in fiscal 2003, a decrease of $36.8 million. In accordance with GAAP, sales of single premium deferred annuities are not reported as annuity considerations, but rather as additions to policyholder account balances. Based on statutory accounting, revenue from sales of single premium annuities were approximately $248.8 million, $243.1 million and $815.8 million in fiscal 2004, 2003 and 2002, respectively. The decrease from 2002 is attributable to many factors, primarily management’s intent to reduce sales to preserve and build the Insurance Company’s capital and surplus ratios.
Net investment income totaled $339.4 million in fiscal 2004, as compared to $299.0 million in fiscal 2003 and $277.6 million in fiscal 2002. This represents a 13.5% increase comparing fiscal 2004 to fiscal 2003 and a 7.7% increase comparing fiscal 2003 to fiscal 2002. The increases from 2002 to 2003 and from 2003 to 2004 were largely attributable to an increase in investment income from the Insurance Company’s limited partnership investments. Income from these investments amounted to $57.5 million in fiscal 2004 as compared to $30.2 million and $21.9 million in fiscal 2003 and 2002, respectively. The full impact of the increase in sales in 2002 was reflected in the increase in fixed maturity income for 2003 and 2004. Income from fixed maturities totaled $284.8 million in 2004 compared to $270.2 million in 2003 and $244.3 in 2002. The Insurance Company's ratio of net investment income to average cash and invested assets less net investment income for the years ended December 31, 2004, 2003 and 2002 was approximately 7.78%, 7.38% and 7.85%, respectively. Without taking into account the Corporation’s returns on its limited partnership investments in those years, the respective ratios would have been 6.92%, 7.12% and 7.06% for the years ended December 31, 2004, 2003 and 2002. For additional information, please refer to “Note 2 of the Notes to Consolidated Financial Statements.”
Interest credited and benefits to policyholders amounted to approximately $254.0 million in fiscal 2004 as compared to approximately $258.1 million in fiscal 2003 and approximately $276.8 million in fiscal 2002. This represents a decrease of approximately 1.6% comparing fiscal 2004 to fiscal 2003 and approximately a 6.7% decrease comparing fiscal 2003 to fiscal 2002. The decreases in 2004 from 2003 and 2003 from 2002 were primarily attributable to varying levels of policyholder account balances as a result of variations in annuity considerations received and surrenders paid during the respective years, as well as a reduction of the interest rates credited on renewals.
The Insurance Company’s average credited rates for reserves and account balances for the 12 months ended December 31, 2004, 2003 and 2002 were less than the Insurance Company’s ratio of net investment income to mean assets for the same periods as noted above under “Net Investment Income.” There can be no assurance that the spread between the Insurance Company’s average credited rate for reserves and account balances and the Insurance Company’s ratio of net investment income to mean assets (the “Spread”), will not decline in future periods or that such decline will not have a material adverse effect on the Corporation’s financial condition and results of operations.
The change in the net DAC for the twelve months ended December 31, 2004 resulted in a charge of approximately $4.5 million, as compared to credits of approximately $2.7 million and $29.7 million for the twelve months ended December 31, 2003 and 2002, respectively. Such changes are due in part to the costs associated with product sales that have been deferred (accounting for credits of approximately $11.4 million for fiscal 2004, $10.5 million for fiscal 2003 and $30.9 million for fiscal 2002). Another portion of such changes is due to amortization of the DAC on deferred annuity business, which reflects the impact that changes in estimated gross profits have on these unamortized deferred acquisition costs. Such changes accounted for charges of approximately $11.0 million in fiscal 2004 and approximately $3.0 million in fiscal 2003 and a credit of approximately $3.0 million in fiscal 2002. The balance of the changes is due to the amortization of the DAC for the remainder of the business (accounting for charges of approximately $4.9 million for fiscal 2004, approximately $4.8 million for fiscal 2003 and approximately $4.2 million in fiscal 2002).
For the reasons discussed above, income (loss) before income taxes amounted to approximately $100.0 million in fiscal 2004, as compared to approximately $60.2 million in fiscal 2003 and approximately $(90.1) million in fiscal 2002.
Income tax expense was approximately $34.1 million for fiscal 2004, as compared to an expense of approximately $22.0 million for fiscal 2003 and a benefit of approximately $(26.8) million in fiscal 2002. The increase in income taxes in fiscal 2004 was primarily attributable to an increase in investment income as compared to 2003. The increase in 2003 from 2002 is primarily attributable to the net investment losses the Company realized in fiscal 2002 of approximately $146.7 as compared to a net investment gain of approximately $10.3 million in fiscal 2003.
For the reasons discussed above, the Corporation had net income of approximately $66.0 million in fiscal 2004, as compared to net income of approximately $38.3 million in fiscal 2003 and a net loss of approximately $(63.4) million in fiscal 2002.
The Corporation is an insurance holding company and its primary uses of cash are debt service obligations, operating expenses and dividend payments. The Corporation’s principal sources of cash are sales of and interest on the Corporation’s investments and rent from its real estate. During 2004, the Corporation’s Board of Directors maintained the quarterly dividend rate of $.10 per share. During 2004 and 2003, the Corporation did not repurchase any of its common stock, although at December 31, 2004, the Corporation was authorized to purchase approximately 385,000 shares of common stock.
Net cash provided by the Insurance Company's operating activities was approximately $41.8 million, $15.7 million and $26.8 million in fiscal 2004, 2003 and 2002, respectively. The increase from 2003 is largely attributable to the increase in net investment income for fiscal 2004. Net cash (used)/provided by in the Insurance Company's investing activities (principally reflecting investments purchased less investments called, redeemed or sold) was approximately $(183.2) million, $76.9 million and $(684.6) million in fiscal 2004, 2003 and 2002, respectively.
For purposes of the Corporation's consolidated statements of cash flows, financing activities relate primarily to sales and surrenders of the Insurance Company's annuity and universal life insurance products. The payment of dividends by the Corporation to its stockholders is also considered to be a financing activity. Net cash provided by /(used) by the Insurance Company's financing activities amounted to approximately $134.8 million, $(92.8) million and $668.9 million in fiscal 2004, 2003 and 2002, respectively. These fluctuations primarily are attributable to higher policyholder account balances as a result of sales and interest earned by the policyholders.
The market value of our fixed maturity portfolio changes as interest rates change. In general, rate decreases cause asset prices to rise, while rate increases cause asset prices to fall. Based on market values and prevailing interest rates as of December 31, 2004, a hypothetical instantaneous increase in interest rates of 100 basis points would produce a loss in fair value of our fixed maturity assets of approximately $343.7 million.
In March 2004, the EITF reached consensus on Issue No. 03-16, Accounting for Investments in Limited Liability Companies ("EITF 03-16"). EITF 03-16 provides guidance regarding whether a limited liability company should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a noncontrolling investment should be accounted for using the cost method or the equity method of accounting. EITF 03-16 did not have a material impact on the Company's consolidated financial statements. 29.
In December 2003, FASB issued Statement of Financial Accounting Standards (“SOFAS”) No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. This standard requires additional detailed disclosures regarding pension plan assets, benefit obligations, cash flow, benefit costs and related information. With the exception of disclosures related to foreign plans, the new disclosures were required to be provided in annual statements of public entities with fiscal years ending after December 15, 2003. See Note 5.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN46”). Fin 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities entered into prior to February 1, 2003, FIN 46 if effective for the first interim or annual period beginning after June 15, 2003. In October 2003, the FASB issued FASB Staff Position (“FSP”) FIN 46-6, Effective Date of FASB Interpretation, No.46 Consolidation of Variable Interest Entities. This FSP provides a deferral of interests held by public entities in a variable interest entity or potential variable interest entity until the end of the first interim or annual period after December 15, 2003, if (a) the variable interest entity was created before February 1, 2003 and (b) the public entity has not issued financial statements reporting the variable interest entity that was created before February 1, 2003,
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 entities to establish liabilities for certain types of guarantees, and expands financial statement disclosures for others. Disclosure requirements under FIN 45 are effective for financial statements of annual periods ending after December 15, 2002 and are applicable to all guarantees issued by the guarantor subject to the provisions of FIN 45. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have an impact on the Company’s consolidated financial statements.
In August 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”). The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Previous accounting guidance was provided by EITF 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. SFAS 146 replaces EITF 94-3. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 did not have an impact on the Company’s consolidated financial statements.
The Insurance Company¢s principal investments are in fixed maturities, all of which are exposed to at least one of three primary sources of investment risk: credit, interest rate and market valuation. The financial statement risks are those associated with the recognition of other than temporary impairments and income, as well as the determination of fair values. Recognition of income ceases when a bond goes into default and management evaluates whether temporary or other than temporary impairments have occurred on a case-by-case basis. Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause and decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the other than temporary impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the market value has been below amortized cost; (ii) whether the issuer is experiencing significant financial difficulties; (iii) financial difficulties being experienced by an entire industry sector or sub-sector; (iv) economically depressed geographic locations; (v) situations where the issuer, series of issuers or industry has a catastrophic type of loss or has exhausted natural
resources; (vi) in situations where it is determined that an impairment is attributable to changes in market interest rates, the
Corporation’s ability and intent to hold impaired securities until recovery of fair value at or above cost; and (vii) other subjective factors, including concentrations and information obtained from regulators and rating agencies. In addition, the earnings on certain investments are dependent upon market conditions, which could result in prepayments and changes in amounts to be earned due to changing interest rates or equity markets. The determination of fair values in the absence of quoted market values is based on valuation methodologies, securities the Company deems to be comparable and assumptions deemed appropriate given the circumstances. The use of different methodologies and assumptions may have a material effect of the estimated fair value amounts.