PER SHARE DATA(3) Net income from continuing operations(4) - basic $3.34 $3.10 $2.54 $2.02 $2.09 Net income - basic $3.34 $3.10 $2.54 $1.48 $2.33 Average shares outstanding - basic 70,299,470 70,033,288 69,923,955 69,410,525 65,832,349 Net income from continuing operations(4) - diluted $3.30 $3.07 $2.52 $2.01 $2.08 Net income - diluted $3.30 $3.07 $2.52 $1.47 $2.32 Average shares outstanding - diluted 71,064,539 70,644,642 70,462,797 69,950,173 66,281,128 Cash dividends $0.685 $0.63 $0.59 $0.55 $0.51 Share-owners' equity $31.19 $29.02 $25.06 $20.42 $17.26 _________________________________________________________________________________________________________________________
(1)Income from discontinued operations in 2001 includes loss on sale of discontinued operations and loss from discontinued operations, net of income tax. (2)Cumulative effect of change in accounting principle, net of income tax - amount in 2004 relates to SOP 03-1; amount in 2001 relates to SFAS No. 133. (3)Prior periods have been restated to reflect discontinued operations. (4)Net income excluding change in accounting principle and income (loss) from discontinued operations.
December 31 ________________________________________________________________________ 2004 2003 2002 2001 2000 _________________________________________________________________________________________________________________________ (dollar in thousands) BALANCE SHEET DATA Total assets $ 27,211,378 $ 24,517,615 $ 21,893,403 $19,718,824 $15,145,633 Total long-term debt $ 451,433 $ 461,329 $ 406,110 $ 376,211 $ 306,125 Total stable value contract and annuity account balances(5) $ 5,725,172 $ 4,847,518 $ 4,198,070 $ 3,907,892 $ 3,385,092 Liabilities related to variable interest entities $ 482,434 $ 400,000 Subordinated debt securities $ 324,743 $ 221,650 $ 215,000 $ 175,000 $ 190,000 Shares-owners' equity $ 2,166,327 $ 2,002,144 $ 1,720,702 $ 1,400,144 $ 1,114,058 _________________________________________________________________________________________________________________________
(5)Includes stable value contract account balances and annuity account balances which do not pose significant mortality risk.
This report reviews the Company’s financial condition and results of operations including its liquidity and capital resources. Historical information is presented and discussed. Where appropriate, factors that may affect future financial performance are also identified and discussed. Certain statements made in this report include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance or achievements instead of historical facts and may contain words like “believe,” “expect,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “plan,” “will,” “shall,” “may,” and other words, phrases, or expressions with similar meaning. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from the results contained in the forward-looking statements, and the Company cannot give assurances that such statements will prove to be correct. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Please refer to “Known Trends and Uncertainties” herein for more information about factors which could affect future results.
Protective Life Corporation (the Company) is a holding company whose subsidiaries provide financial services through the production, distribution, and administration of insurance and investment products. The Company operates five business segments: Life Marketing, Acquisitions, Annuities, Stable Value Products, and Asset Protection. In addition, the Company has another segment referred to as Corporate and Other which consists of net investment income on unallocated capital, interest expense on all debt, earnings from various investment-related transactions, and the operations of several non-strategic lines of business.
The Company incurs significant costs in connection with acquiring new insurance business. These costs, which vary with and are primarily related to the production of new business and coinsurance of blocks of policies, are deferred. The recovery of such costs is dependent on the future profitability of the related policies. The amount of future profit is dependent principally on investment returns, mortality, morbidity, persistency, and expenses to administer the business and certain economic variables, such as inflation. These factors enter into management’s estimates of future profits which generally are used to amortize certain of such costs. Accounting for other intangible assets such as goodwill also requires an estimate of the future profitability of the associated lines of business. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future profits are less than the unamortized deferred amounts. At December 31, 2004, the Company had a deferred acquisition cost asset and goodwill asset of $1.8 billion and $46.6 million, respectively.
The Company has a deferred policy acquisition costs asset of approximately $107.7 million related to its variable annuity product line with an account balance of $2.3 billion at December 31, 2004. The Company monitors the rate of amortization of the deferred policy acquisition costs associated with its variable annuity product line. The Company’s monitoring methodologies employ varying assumptions about how much and how quickly the stock markets will appreciate. The primary assumptions used to project future profits as part of the analysis include: a long-term equity market growth rate of 9%, reversion to the mean methodology with a reversion to the mean cap rate of 14%, reversion to the mean period of 5 years, and an amortization period of 20 years. A recovery in equity markets, or the use of methodologies and assumptions that anticipate a recovery, result in lower amounts of amortization, and a worsening of equity markets results in higher amounts of amortization.
Establishing an adequate liability for the Company’s obligations to its policyholders requires the use of assumptions. Estimating liabilities for future policy benefits on life and health insurance products requires the use of assumptions relative to future investment yields, mortality, morbidity, persistency and other assumptions based on the Company’s historical experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation. Determining liabilities for the Company’s property and casualty insurance products also requires the use of assumptions, including the projected levels of used vehicle prices, the frequency and severity of claims, and the effectiveness of internal processes designed to reduce the level of claims. At December 31, 2004, the Company had total policy liabilities and accruals of $10.7 billion.
Determining the Company’s obligations to employees under its defined benefit pension plan and stock-based compensation plans requires the use of estimates. The calculation of the liability related to the Company’s defined benefit pension plan requires assumptions regarding the appropriate weighted average discount rate, estimated rate of increase in the compensation of its employees and the expected long-term rate of return on the plan’s assets. Accounting for other stock-based compensation plans may require the use of option pricing models to estimate the Company’s obligations. Assumptions used in such models relate to equity market volatility, the risk-free interest rate at the date of grant, as well as expected exercise dates. See Notes 7 and 11 to the Consolidated Financial Statements for further information on these plans.
The assessment of potential obligations for tax, regulatory, and litigation matters inherently involve a variety of estimates of potential future outcomes. The Company makes such estimates after consultation with its advisors and a review of available facts.
(1)Realized investment gains (losses) - investments $28,305 $58,064 $910 Related amortization of DAC (6,935) (18,947) (1,981) ________________________________ 21,370 39,117 (1,071)
Net income for 2004 reflects strong overall growth in segment operating income, somewhat offset by lower realized investment gains and the cumulative effect charge. Excluding the $12.3 million of reinsurance recoveries during 2003 (see Note 12 to the Consolidated Financial Statements), Life Marketing’s operating income increased 13.0%, reflecting continued growth in life insurance in-force and improved results from the segment’s non-insurance businesses, somewhat offset by lower expense capitalization levels driven by a reduction in traditional life sales in 2004. Strong growth in average balances and a widening of spreads drove significant improvement in Stable Value Products’ earnings, while improvement in the equity markets and higher sales levels contributed to the increase in Annuities’ income. Excluding charter sales in 2004 and 2003, Asset Protection segment operating income increased 34.3% in 2004 primarily due to improved loss ratios in the service contract business and effective expense management. Earnings in the Acquisitions segment declined in 2004 as the result of the normal runoff of the segment’s previously acquired blocks of business. Corporate and Other earnings reflect dramatically lower losses on the runoff insurance lines as well as higher participating mortgage income and investment income on unallocated capital.
Included in net income for 2004 is a cumulative effect charge of $15.8 million arising from the Company’s adoption of SOP 03-1 (see Note 1 to the Consolidated Financial Statements for further discussion of SOP 03-1).
In the following segment discussions, various statistics and other key data the Company uses to evaluate its segments are presented. Sales statistics are used by the Company to measure the relative progress in its marketing efforts, but may or may not have an immediate impact on reported segment operating income. Sales data for traditional life insurance are based on annualized premiums, while universal life sales are based on annualized target premiums. Sales of annuities are measured based on the amount of deposits received. Stable value contract sales are measured at the time that the funding commitment is made, based on the amount of deposit to be received. Sales within the Asset Protection segment are generally based on the amount of single premium and fees received.
The Life Marketing segment markets level premium term and term-like insurance, universal life (UL), and variable universal life products on a national basis primarily through networks of independent insurance agents and brokers, stockbrokers, and in the “bank owned life insurance” (BOLI) market. Segment results were as follows:
REVENUES Gross premiums and policy fees $1,026,889 $856,431 $673,412 19.9% 27.2% Reinsurance ceded (818,207) (657,778) (453,228) 24.4 45.1 ______________________________________ Net premiums and policy fees 208,682 198,653 220,184 5.0 (9.8) Net investment income 238,193 231,238 209,002 3.0 10.6 Other income 94,695 59,961 56,372 57.9 6.4 ______________________________________ Total operating revenues 541,570 489,852 485,558 10.6 0.9
Operating income increased 4.2% in 2004 reflecting the continued growth in life insurance in-force and improved results from non-insurance businesses, offset by the impact of lower sales in the current year and the positive impact of reinsurance recoveries on 2003 results. During 2003, the segment recognized additional net premiums of $18.4 million, amortization of DAC of $6.1 million, and operating income of $12.3 million, as a result of recoveries from previously overpaid reinsurance premiums (see Note 12 to the Consolidated Financial Statements). Excluding the impact from these recoveries, operating income increased 13.0% in 2004. During 2002, the segment recognized additional net premiums of $69.7 million, amortization of DAC of $62.5 million, and operating income of $7.2 million as the estimate of the effect of previously overpaid reinsurance premiums (see Note 12 to the Consolidated Financial Statements). Excluding the impact of recoveries recorded in 2003 and 2002, operating income increased by 24.1% in 2003. This increase reflects continued growth of life insurance in-force as well as favorable expense capitalization levels driven by strong sales in 2003.
Marketing Companies: Commissions 62,483 45,646 46,684 36.9 (2.2) Other 29,833 15,567 8,765 91.6 77.6 ______________________________________ Other operating expenses 92,316 61,213 55,449 50.8 10.4 ______________________________________ Other operating expenses $ 42,119 $ 10,832 $ 13,948 288.8 (22.3) ______________________________________
Currently, the segment is reinsuring significant amounts of new life insurance sold. Pursuant to the underlying reinsurance contracts, reinsurers pay allowances to the segment as a percentage of both first year and renewal premiums. A portion of these allowances is deferred as part of DAC while the remainder is recognized immediately as a reduction of other operating expenses. While the recognition of reinsurance allowances is consistent with GAAP, non-deferred allowances often exceed the segment’s non-deferred direct costs, causing net other operating expenses to be negative. Consideration of all components of the segment’s income statement, including amortization of DAC, is required to assess the impact of reinsurance on segment operating income.
All categories of insurance related operating expenses increased in 2003, reflecting the segment’s strong growth during the year. Overall insurance expenses declined, however, as the 29.2% increase in sales caused the segment’s expense capitalization levels to compare favorably with 2002. Amounts capitalized as DAC generally include first year commissions and allowances, and other deferrable acquisition expenses. The change in these amounts generally reflects the trend in sales for the year. Other operating expenses for the marketing companies increased in 2003 primarily as a result of higher expenses in the segment’s direct response business. This increase was driven by a shift during the year to a multi-carrier strategy in this business which resulted in higher revenues and expenses.
Sales for the segment decreased in 2004 primarily due to lower production of traditional life at Empire General, which is included within the brokerage general agent channel. As expected, traditional life business sold through Empire General declined $27.9 million versus the unusually strong levels achieved in 2003. Offsetting this decline was a $7.2 million increase in sales of UL business through the stockbroker channel, primarily resulting from a new product introduction in the fourth quarter of 2004. Sales of BOLI business declined significantly from the strong sales achieved in 2003. BOLI sales will vary widely between periods as the segment responds to opportunities for these products only when the market accommodates required returns. The segment has changed its direct response business sold through Matrix Direct to focus on a multi-carrier distribution strategy, resulting in the significant decrease in the Company’s direct response sales versus 2003.
BENEFITS AND EXPENSES Benefits and settlement expenses 287,356 291,768 301,401 (1.5) (3.2) Amortization of deferred policy acquisition costs 28,652 32,690 35,245 (12.4) (7.2) Other operating expenses 35,795 43,087 46,525 (16.9) (7.4) ________________________________________ Total benefits and expenses 351,803 367,545 383,171 (4.3) (4.1)
Interest Spread - UL and Fixed Annuities Net investment income yield 7.17% 7.51% 8.15% Interest credited to policyholders 5.22 5.57 6.25 ________________________________________ Interest spread 1.95% 1.94% 1.90% ________________________________________
REVENUES Gross premiums and policy fees $ 30,341 $ 26,265 $ 25,826 15.5% 1.7% Reinsurance ceded 0 0 0 0.0 0.0 _________________________________________ Net premiums and policy fees 30,341 26,265 25,826 15.5 1.7 Net investment income 210,888 224,332 220,447 (6.0) 1.8 Other income 7,004 8,745 8,876 (19.9) (1.5) _________________________________________ Total operating revenues 248,233 259,342 255,149 (4.3) 1.6
As of December 31 CHANGE _________________________________________ _____________________ 2004 2003 2002 2004 2003 _________________________________________ _____________________
The improvement in the equity markets in 2004 caused a significant increase in variable annuity account values, which drove the increase in net premiums and policy fees for the year. The lower interest rate environment and decrease in fixed annuity balances in 2004 caused net investment income to decline from 2003 levels. Interest spreads on fixed annuities declined 6 basis points in 2004 as lower rates on new investments more than offset the effects of crediting rate reductions. Other income declined significantly in 2004 due to the elimination of fee income from segment-managed mutual funds that are no longer offered as investment options within variable annuity products.
Interest credited decreased $9.8 million in 2004 due to the decline in fixed annuity account values and reductions in credited rates. Benefits expense also benefited from lower guaranteed minimum death benefit (GMDB) expenses of $3.1 million, as the segment’s net amount at risk, reserves, and paid claims declined from 2003. The additional profits on variable annuities were partially offset by higher amortization of DAC, accounting for an increase of $5.3 million in 2004. Other operating expenses decreased $5.6 million, reflecting lower administrative expenses and the elimination of sub-advisor fees paid for the segment-managed mutual funds, as well as higher expense capitalization caused by the increase in sales.
Sales of fixed annuities increased significantly in 2004, reflecting higher interest rates and more competitive pricing. Sales trends showed steady improvement throughout 2004, with approximately 40% of total fixed annuity sales coming in the fourth quarter. Included in fixed annuity sales in the fourth quarter of 2004, were $122 million of single premium immediate annuities sold on an institutional basis in a structured transaction. Sales made through structured transactions are opportunistic in nature and may vary widely between periods. Variable annuity sales were 19.3% lower than the historically high levels achieved in 2003 as the Company maintained its pricing discipline. The segment continues to develop new products, including an equity-indexed fixed annuity, that are designed to be a catalyst for sales growth in 2005.
Operating Spread Net investment income yield 5.39% 5.73% 6.22% Interest credited 4.12 4.59 4.97 Operating expenses 0.20 0.19 0.18 _________________________________________ Operating spread 1.07% 0.95% 1.07% _________________________________________
CHANGE ___________________ 2004 2003 2002 2004 2003 __________________________________________ ___________________ Sales Credit insurance $217,585 $198,252 $177,722 9.8% 11.6% Service contracts 202,983 204,810 195,803 (0.9) 4.6 Other products 39,755 69,351 94,323 (42.7) (26.5) __________________________________________ $460,323 $472,413 $467,848 (2.6) 1.0 __________________________________________
Excluding gains from charter sales, operating income increased significantly in both 2004 and 2003. Excluding gains from the sale of separate inactive charters of $1.2 million and $6.9 million in 2004 and 2003, respectively, income increased 34.3% in 2004. This increase is primarily due to growth of 92.8% in service contract earnings, which were partially offset by lower earnings from credit insurance and other products. The service contract lines benefited from more favorable claims experience as well as proactive expense management. Excluding the impact of the 2003 charter sale and a $2.7 million gain from a charter sale reported in 2002, operating income increased $30.9 million in 2003. The increase in 2003 earnings reflects the $25.6 million charge taken in 2002 for certain under-performing lines of business, as well as improved results from the segment's service contract business. The vehicle service contract business improved to contribute income of $3.7 million in 2003, as compared to a loss of $2.8 million in 2002, due to improving loss ratios caused by the effect of increasing prices in 2000 through 2003.
Net premiums for 2003 declined due to relatively flat sales and the termination of various under-performing lines of business during the year. The decrease in net investment income for 2003 was attributable to the overall decline in business and lower levels of invested assets as well as a lower net yield on investments. Excluding the impact of charter sale gains, other income increased $7.3 million or 26.1% during 2003. This increase was attributable to service contract fee income driven by higher volumes during the year.
Benefits and settlement expenses declined in 2003, reflecting the decrease in the segment's net premiums and the significant improvement in loss ratios. Amortization of DAC increased in 2003 primarily as a result of the higher overall sales of credit insurance during the year. Operating expenses declined primarily due to a reduction in commissions expense caused by the drop in net premiums for the year.
Loss ratios for the service contract business improved over 2003 levels as a result of segment initiatives to increase pricing and tighten the underwriting and claims processes during 2004. Price increases implemented during 2000 through 2003 on the service contract business allowed for the significant reduction in loss ratios during 2003. Loss ratios for other products have declined in 2004 and 2003 primarily due to the segment exiting certain under-performing lines during 2002.
Realized gains and losses - investments 6,366 26,550 5,694 (20,184) 20,856 Realized gains and losses - derivatives (790) (9,512) 5,236 8,722 (14,748) _________________________________________ _________________________ Income (loss) before income tax $27,136 $(14,914) $ 8,042 $ 42,050 $(22,956) _________________________________________ _________________________
(1) Includes settlements on interest rate swaps of $19,222, $21,087 and $23,072 for 2004, 2003 and 2002, respectively.
The significant improvement in 2004 operating income reflects a $28.4 million reserve charge taken in 2003 as well as significantly higher net investment income partially offset by higher overall expenses. Results for the runoff insurance lines improved by $16.0 million in 2004, primarily as a result of reduced reserve strengthening taken in the residual value line of $19.0 million partially offset by higher losses in the cancer line of $3.6 million for 2004. Net investment income increased $44.2 million over 2003, reflecting mark-to-market gains on trading securities, increased participating mortgage income, and higher amounts of unallocated capital. Mark-to-market gains on the Company’s trading portfolio were $4.9 million in 2004 with no similar activity in 2003. Participating mortgage income increased $9.5 million, reflecting increased transaction activity within the Company’s mortgage portfolio. Higher overall expenses and lower amounts of income from interest rate swaps accounted for the remainder of the change in the current year’s results.
The decline in 2003 earnings was primarily due to a $28.4 million reserve strengthening taken in the residual value line of business as a result of negative trends in used vehicle prices. Including this charge, results from the residual value line decreased $23.2 million from 2002. Other decreases in operating income included a $3.0 million increase in interest expense, a $2.0 million decrease in net settlements on derivatives, an increase of $3.9 million in expenses related to employee incentive plans and other corporate expenses, a $1.2 million decline in results from the surety line of business, and a $1.6 million charge related to the early extinguishment of debt. These decreases were partially offset by a $5.8 million increase in investment income on unallocated capital.
Realized investment gains and losses related to derivatives represent changes in the fair value of derivative financial instruments and gains (losses) on derivative contracts closed during the period. The Company has entered into foreign currency swaps to mitigate the risk of changes in the value of principal and interest payments to be made on certain of its foreign currency denominated stable value contracts. The net change in the realized gains (losses) resulting from these securities during 2004 was $(0.5) million. These changes were the result of differences in the related foreign currency spot and forward rates used to value the stable value contracts and foreign currency swaps. The Company also uses interest rate swaps to mitigate interest rate risk related to its Senior Notes, Medium-Term Notes, and subordinated debt securities. Long-term interest rates moved lower during 2004 and caused the 2004 results from these swaps to compare favorably with the 2003 results. The Company has taken short positions in U.S. Treasury futures to mitigate interest rate risk related to the Company’s mortgage loan commitments. The changes in net gains (losses) from these securities were the result of fluctuations in interest rates and adjustments to the Company’s short positions during the respective periods.
The Company also uses various swaps and options to mitigate risk related to other interest rate exposures of the Company. For a portion of the change, a $2.7 million increase in realized gains (losses), resulted from lower interest rates, which impacted the fair value of certain interest rate swaps and options. Further, 2003 results reflected a $2.9 million gain from a total return swap that was not reflected in 2004 due to the implementation of FIN 46. An additional increase of $3.9 million during 2004 was related to gains from embedded derivatives within certain bonds that either matured or were called during 2004, with no similar activity in 2003.
As of December 31, 2003, the Company consolidated a special-purpose entity, in accordance with FIN 46, whose investments are managed by the Company. These investments with a market value of $417.3 million at December 31, 2004 have been classified as “trading” securities by the Company. No realized or unrealized gains (losses) were recognized in 2003 on the trading portion of the Company’s investments.
Included in the table above are $410.1 million and $420.1 million of fixed maturities and $7.2 million and $4.8 million of short-term investments classified by the Company as trading securities in 2004 and 2003, respectively.
Market values for private, non-traded securities are determined as follows: 1) the Company obtains estimates from independent pricing services or 2) the Company estimates market value based upon a comparison to quoted issues of the same issuer or issues of other issuers with similar terms and risk characteristics. The market value of private, non-traded securities was $1.9 billion at December 31, 2004, representing 9.7% of the Company’s total invested assets.
AAA $ 4,983,896 35.6% AA 872,185 6.2 A 3,109,075 22.2 BBB 4,067,784 29.1 _________________________________________________________________________________________ Investment grade 13,032,940 93.1 _________________________________________________________________________________________ BB 698,321 5.0 B 248,627 1.8 CCC or lower 18,920 0.1 In or near default 101 0.0 _________________________________________________________________________________________ Below investment grade 965,969 6.9 _________________________________________________________________________________________ Redeemable preferred stock 3,593 0.0 _________________________________________________________________________________________ Total $14,002,502 100.0% _________________________________________________________________________________________
Limiting bond exposure to any creditor group is another way the Company manages credit risk. The following table summarizes the Company’s ten largest fixed maturity exposures to an individual creditor group as of December 31, 2004.
Wachovia $80.9 Citigroup 80.1 FPL Group 77.3 Dominion 76.8 Duke Energy 75.6 BellSouth 74.4 Cox Communications 74.2 Union Pacific 73.8 Merrill Lynch 73.4 Berkshire Hathaway 72.1 _______________________________________________________
There are certain risks and uncertainties associated with determining whether declines in market values are other than temporary. These include significant changes in general economic conditions and business markets, trends in certain industry segments, interest rate fluctuations, rating agency actions, changes in significant accounting estimates and assumptions, commission of fraud and legislative actions. The Company continuously monitors these factors as they relate to the investment portfolio in determining the status of each investment. Provided below are additional facts concerning the potential effect upon the Company’s earnings should circumstances lead management to conclude that some of the current declines in market value are other than temporary.
Estimated % Market Amortized % Amortized Unrealized % Unrealized Market Value Value Cost Cost Loss Loss ________________________________________________________________________________________________________________________ (in thousands) =90 days $1,283,554 59.4% $1,293,509 58.5% $ (9,955) 19.2% 90 days but =180 days 57,082 2.6 62,029 2.8 (4,946) 9.6 180 days but= 270 days 346,083 16.0 353,030 16.0 (6,947) 13.4 270 days but = 1 year 116,581 5.4 118,812 5.4 (2,231) 4.3 1 year but = 2 years 299,794 13.9 310,320 14.0 (10,526) 20.3 2 years but = 3 years 339 0.0 568 0.0 (229) 0.4 3 years but = 4 years 22,386 1.1 25,387 1.1 (3,001) 5.8 4 years but = 5 years 259 0.0 411 0.0 (152) 0.3 5 years 34,333 1.6 48,176 2.2 (13,844) 26.7 ________________________________________________________________________________________________________________________ Total $2,160,411 100.0% $2,212,242 100.0% $(51,831) 100.0% ________________________________________________________________________________________________________________________
S&P or Equivalent Estimated % Market Amortized % Amortized Unrealized % Unrealized Designation Market Value Value Cost Cost Loss Loss ________________________________________________________________________________________________________________________ (in thousands) AAA/AA/A $1,524,183 70.6% $1,544,480 69.8% $(20,297) 39.1% BBB 519,326 24.0 531,230 24.0 (11,904) 23.0 ________________________________________________________________________________________________________________________ Investment grade 2,043,509 94.6 2,075,710 93.8 (32,201) 62.1 ________________________________________________________________________________________________________________________ BB 31,739 1.5 32,918 1.5 (1,179) 2.3 B 70,804 3.3 78,906 3.6 (8,102) 15.6 CCC or lower 14,359 0.6 24,708 1.1 (10,349) 20.0 ________________________________________________________________________________________________________________________ Below investment grade 116,902 5.4 136,532 6.2 (19,630) 37.9 ________________________________________________________________________________________________________________________ Total $2,160,411 100.0% $2,212,242 100.0% $(51,831) 100.0% ________________________________________________________________________________________________________________________
Estimated % Market Amortized % Amortized Unrealized % Unrealized Market Value Value Cost Cost Loss Loss ________________________________________________________________________________________________________________________ (in thousands) = 90 days $11,071 9.5% $ 11,261 8.2% $ (190) 1.0% 90 days but = 180 days 1,442 1.2 1,781 1.3 (339) 1.7 180 days but = 270 days 39,883 34.1 42,625 31.2 (2,742) 14.0 270 days but = 1 year 11,936 10.2 12,399 9.1 (463) 2.3 1 year but = 2 years 597 0.5 661 0.5 (64) 0.3 2 years but = 3 years 186 0.2 251 0.2 (65) 0.3 3 years but = 4 years 22,109 18.9 25,051 18.4 (2,942) 15.0 4 years but = 5 years 14 0.0 45 0.0 (31) 0.2 5 years 29,664 25.4 42,458 31.1 (12,794) 65.2 ________________________________________________________________________________________________________________________ Total $116,902 100.0% $136,532 100.0% $(19,630) 100.0% ________________________________________________________________________________________________________________________
Realized losses are comprised of both write-downs on other-than-temporary impairments and actual sales of investments. During the year ended December 31, 2004, the Company recorded pretax other-than-temporary impairments in its investments of $18.3 million as compared to $22.3 million in the year ended December 31, 2003. The most significant impairments taken during 2004 were $11.6 million in write-downs taken on airline equipment trust certificates that were secured by passenger aircraft. Given the continued difficulties in this industry as well as developments with the specific assets backing these securities, management deemed these securities to be other than temporarily impaired. The remaining impairments were not concentrated from an industry perspective and no individual impairment was greater than $2.5 million.
Realized % Realized Proceeds % Proceeds Loss Loss ______________________________________________________________________________________________ (in thousands) = 90 days $291,069 57.8% $(2,706) 36.4% 90 days but = 180 days 18,350 3.6 (186) 2.5 180 days but = 270 days 106,121 21.1 (2,561) 34.4 270 days but = 1 year 76,337 15.2 (1,615) 21.7 1 year 11,650 2.3 (374) 5.0 ______________________________________________________________________________________________ Total $503,527 100.0% $(7,442) 100.0% ______________________________________________________________________________________________
See Note 2 to the Consolidated Financial Statements for additional details on the Company's analysis of its investments.
For several years the Company has offered a type of commercial mortgage loan under which the Company will permit a slightly higher loan-to-value ratio in exchange for a participating interest in the cash flows from the underlying real estate. As of December 31, 2004, approximately $439.8 million of the Company’s mortgage loans have this participation feature.
At December 31, 2004, delinquent mortgage loans and foreclosed properties were 0.1% of invested assets. The Company does not expect these investments to adversely affect its liquidity or ability to maintain proper matching of assets and liabilities.
The Company’s positive cash flows from operations are used to fund an investment portfolio that provides for future benefit payments. The Company employs a formal asset/liability program to manage the cash flows of its investment portfolio relative to its long-term benefit obligations. The Company believes its asset/liability management programs and procedures provide sufficient liquidity to enable it to fulfill its obligation to pay benefits under its various insurance and deposit contracts. However, the Company’s asset/liability management programs and procedures incorporate assumptions about the relationship between short-term and long-term interest rates (i.e., the slope of the yield curve), relationships between risk-adjusted and risk-free interest rates, market liquidity and other factors, and the effectiveness of the Company’s asset/liability management programs and procedures may be negatively affected whenever actual results differ from those assumptions.
The life insurance subsidiaries were committed at December 31, 2004, to fund mortgage loans in the amount of $739.9 million. The Company’s subsidiaries held $1,190.1 million in cash and short-term investments at December 31, 2004. Protective Life Corporation had an additional $0.1 million in cash and short-term investments available for general corporate purposes.
Protective Life Corporation’s primary sources of cash are dividends and payments on surplus notes from its operating subsidiaries; revenues from investment, data processing, legal, and management services rendered to subsidiaries; investment income; and external financing. These sources of cash support the general corporate needs of the holding company including its common stock dividends and debt service. The states in which the Company’s insurance subsidiaries are domiciled impose certain restrictions on the insurance subsidiaries’ ability to pay dividends to Protective Life Corporation. These restrictions are generally based in part on the prior year’s statutory income and surplus. Generally, these restrictions pose no short-term liquidity concerns for Protective Life Corporation. The Company plans to retain substantial portions of the earnings of its insurance subsidiaries in those companies primarily to support their future growth.
The Company’s Subordinated Debentures are held by wholly-owned subsidiary trusts that have issued Trust Originated Preferred Securities (TOPrS) to finance the purchase of such debentures. The principal obligations of the trusts are irrevocably guaranteed by the Company. As described in Note 1 to the Consolidated Financial Statements, the subsidiary trusts are not consolidated and, therefore, the Company’s obligations with respect to the TOPrS are reported in the financial statements as “subordinated debt securities”.
Description (scheduled maturity) Amount Interest Rate ______________________________________________________________________________________ Subordinated Debentures (30-year) $103,093 6.125% Senior Notes (10-year) 150,000 4.875 ______________________________________________________________________________________ Senior Notes (10-year) 250,000 4.30 ______________________________________________________________________________________
The Company plans to redeem all of its $34.7 million in 8.25% Senior Notes in April 2005. The Company plans to fund the redemption with proceeds from its revolving line of credit.
At December 31, 2004, derivative contracts with a notional amount of $4.1 billion were in a $190.1 million net gain position. At December 31, 2003, derivative contracts with a notional amount of $3.6 billion were in a $152.4 million net gain position. The Company recognized $19.6 million, $12.6 million, and $28.3 million of realized investment gains related to derivative financial instruments in 2004, 2003 and 2002, respectively.
The Company is also subject to foreign exchange risk arising from stable value contracts denominated in foreign currencies and related foreign currency swaps. At December 31, 2004, stable value contracts of $389.5 million had a foreign exchange loss of approximately $180.2 million and the related foreign currency swaps had a net unrealized gain of approximately $196.0 million. At December 31, 2003, stable value contracts of $416.1 million had a foreign exchange loss of approximately $151.8 million and the related foreign currency swaps had a net unrealized gain of approximately $154.4 million.
At December 31, 2004, the Company had $5.6 billion of stable value product account balances with an estimated fair value of $5.6 billion (using discounted cash flows), and $3.5 billion of annuity account balances with an estimated fair value of $3.5 billion (using surrender values). At December 31, 2003, the Company had $4.7 billion of stable value product account balances with an estimated fair value of $4.7 billion, and $3.5 billion of annuity account balances with an estimated fair value of $3.5 billion.
Percent At December 31 Amount Change _________________________________________________________________________________ (in millions) Stable value product account balances $4,817.2 1.7% Annuity account balances 3,642.0 4.8 Stable value product account balances $5,723.8 2.4% Annuity account balances 3,621.4 4.8 _________________________________________________________________________________
Change in Used Vehicle Prices _______________________________________________________________________________________ -1.0% -2.0% -3.0% -4.5% ________________________________________________________
2005 2006-2007 2008-2009 After 2009 ___________________________________________________________________________________________________________________ (in thousands) Long-term debt(a) $ 2,202 $ 449,231 Subordinated debt securities(b) 324,743 Stable value products(c) $1,162,578 2,394,535 $ 946,728 1,059,156 Operating leases(d) 5,979 8,113 5,818 6,862 Home office lease(e) 1,665 76,943 Mortgage loan commitments 793,930 Liabilities related to variable interest entities(f) 406,752 3,025 36,089 36,568 Policyholder Obligations(g) 860,459 1,788,764 1,598,549 8,803,941 ___________________________________________________________________________________________________________________ (a) Long-term debt includes all principal amounts owed on note agreements, and does not include interest payments due over the term of the notes. (b) Subordinated debt securities includes all principal amounts owed to non-consolidated special purpose finance subsidiaries of the Company, and does not include interest payments due over the term of the obligations. (c) Anticipated stable value products cash flows, excluding interest not yet accrued. (d) Includes all lease payments required under operating lease agreements. (e) The lease payments shown assume the Company exercises its option to purchase the building at the end of the lease term. (f) Liabilities related to variable interest entities are not the legal obligations of the Company, but will be repaid with cash flows generated by the variable interest entities. The amounts represent scheduled principal payments. (g) Estimated contractual policyholder obligations are based on mortality, morbidity, and lapse assumptions comparable to the Company's historical experience, modified for recent observed trends. These obligations are based on current balance sheet values and do not incorporate an expectation of future market growth, interest crediting, or future deposits. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results. As separate account obligations are legally insulated from general account obligations, the separate account obligations will be fully funded by cash flows from separate account assets. The Company expects to fully fund the general account obligations from cash flows from general account investments. -------------------------------------------------------------------------------------------------------------------
The insurance industry is consolidating, with larger, potentially more efficient organizations emerging from consolidation. Participants in certain of the Company’s independent distribution channels are also consolidating into larger organizations. Some mutual insurance companies are converting to stock ownership, which will give them greater access to capital markets. Additionally, commercial banks, insurance companies, and investment banks may now combine, provided certain requirements are satisfied. The ability of banks to increase their securities-related business or to affiliate with insurance companies may materially and adversely affect sales of all of the Company’s products by substantially increasing the number and financial strength of potential competitors.
The Company’s ability to compete is dependent upon, among other things, its ability to attract and retain distribution channels to market its insurance and investment products, its ability to develop competitive and profitable products, its ability to maintain low unit costs, and its maintenance of strong ratings from rating agencies.
Changes in interest rates may also impact its business in other ways. Lower interest rates may result in lower sales of certain of the Company’s insurance and investment products. In addition, certain of the Company’s insurance and investment products guarantee a minimum credited interest rate, and the Company could become unable to earn its spread income should interest rates decrease significantly.
Additionally, the Company’s asset/liability management programs and procedures incorporate assumptions about the relationship between short-term and long-term interest rates (i.e., the slope of the yield curve) and relationships between risk-adjusted and risk-free interest rates, market liquidity, and other factors. The effectiveness of the Company’s asset/liability management programs and procedures may be negatively affected whenever actual results differ from these assumptions.
In general terms, the Company’s results are improved when the yield curve is positively sloped (i.e., when long-term interest rates are higher than short-term interest rates), and will be adversely affected by a flat or negatively sloped curve.
A deficiency in the Company’s systems could result in over or underpayments of amounts owed to or by the Company and/or errors in the Company’s critical assumptions or reported financial results.
The business of insurance necessarily involves the collection and dissemination of large amounts of data using systems operated by the Company. Examples of data collected and analyzed include policy information, policy rates, expenses, mortality and morbidity experience. To the extent that data input errors, systems errors, or systems failures are not identified and corrected by the Company’s internal controls, the information generated by the systems and used by the Company and/or supplied to business partners, policyholders, and others may be incorrect and may result in an overpayment or underpayment of amounts owed to or by the Company and/or the Company using incorrect assumptions in its business decisions or financial reporting.
Insurance companies are highly regulated and subject to numerous legal restrictions and regulations.
Under Section 404 of the Sarbanes Oxley Act of 2002, effective at year-end 2004, management is required to assess the effectiveness of the Company’s internal control over financial reporting. The Company’s auditors are required to attest to and report on management’s assessment. Implementation guidance has been issued by the Public Company Accounting Oversight Board (PCAOB) and the SEC. The Company, like other publicly traded companies, has no prior experience with this process. The Company believes that its control environment is effective; however, it is possible that adverse attestations with respect to other companies in the industry or in business in general could result in a loss of investor confidence and/or impact the Company or the environment in which it operates.
Group health coverage issued through associations has received some negative coverage in the media as well as increased regulatory consideration and review. The Company has a small closed block of group health insurance coverage that was issued to members of an association; a lawsuit is currently pending against the Company in connection with this business.
The Company may not realize its anticipated financial results from its acquisitions strategy.
Recently, access to reinsurance has become more costly for the Company as well as the insurance industry in general. This could have a negative effect on the Company’s ability to compete. In recent years, the number of life reinsurers has decreased as the reinsurance industry has consolidated. The decreased number of participants in the life reinsurance market results in increased concentration risk for insurers, including the Company. In addition, going forward reinsurers are unwilling to continue to reinsure new sales of long-term guarantee products. If the reinsurance market further contracts, the Company’s ability to continue to offer its products on terms as favorable to the Company would be adversely impacted.
>The Company’s ability to grow depends in large part upon the continued availability of capital.
The higher interest rates that have traditionally accompanied inflation could also affect the Company’s operations. Policy loans increase as policy loan interest rates become relatively more attractive. As interest rates increase, disintermediation of stable value and annuity account balances and individual life policy cash values may increase. The market value of the Company’s fixed-rate, long-term investments may decrease, the Company may be unable to implement fully the interest rate reset and call provisions of its mortgage loans, and the Company’s ability to make attractive mortgage loans, including participating mortgage loans, may decrease. In addition, participating mortgage loan income may decrease. The difference between the interest rate earned on investments and the interest rate credited to life insurance and investment products may also be adversely affected by rising interest rates.
The following financial statements are located in this report on the pages indicated. Page Consolidated Statements of Income for the years ended December 31, 2004, 2003, and 2002...................................................................... Consolidated Balance Sheets as of December 31, 2004 and 2003.......................................................................................... Consolidated Statements of Share-Owners' Equity for the years ended December 31, 2004, 2003, and 2002.................................................. Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and 2002.................................................. Notes to Consolidated Financial Statements................................................................ Report of Independent Registered Public Accounting Firm...................................................
December 31 _________________________________ 2004 2003 ___________________________________________________________________________________________________________________________________ (dollars in thousands) Assets Investments: Fixed maturities, at market (amortized cost: 2004 - $13,711,526; 2003 - $12,743,213) $14,412,605 $13,355,911 Equity securities, at market (cost: 2004 - $56,049; 2003 - $45,379) 58,941 46,731 Mortgage loans 3,005,418 2,733,722 Investment real estate, net of accumulated depreciation (2004 - $1,417; 2003 - $1,377) 107,246 18,126 Policy loans 482,780 502,748 Other long-term investments 259,025 249,494 Short-term investments 1,059,557 519,419 ___________________________________________________________________________________________________________________________________ Total investments 19,385,572 17,426,151 Cash 130,596 136,698 Accrued investment income 196,076 189,232 Accounts and premiums receivable, net of allowance for uncollectible amounts (2004 - $2,452; 2003 - $2,617) 44,364 57,944 Reinsurance receivables 2,750,260 2,350,606 Deferred policy acquisition costs 1,821,972 1,817,990 Goodwill 46,619 47,312 Property and equipment 45,454 45,640 Other assets 264,512 225,235 Assets related to separate accounts Variable annuity 2,308,858 2,045,038 Variable universal life 217,095 171,408 Other 0 4,361 ___________________________________________________________________________________________________________________________________ $27,211,378 $24,517,615 ___________________________________________________________________________________________________________________________________
The accompanying consolidated financial statements of Protective Life Corporation and subsidiaries (the Company) are prepared on the basis of accounting principles generally accepted in the United States of America (GAAP). Such accounting principles differ from statutory reporting practices used by insurance companies in reporting to state regulatory authorities (see also Note 9).
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 46, “Consolidation of Variable Interest Entities,” which was revised in December 2003. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. The Company consolidated, as of December 31, 2003, a special-purpose entity whose investments are managed by the Company. The special-purpose entity was consolidated based on the determination that the Company was its primary beneficiary. The consolidation resulted in the Company’s reported assets and liabilities increasing by $430.6 million with an immaterial impact on the results of operations. The increase in assets was the result of the entity’s $430.6 million investment portfolio, while the increase in liabilities was due to $400.0 million of notes payable (reported in “liabilities related to variable interest entities”), $15.0 million of derivative liabilities (reported in “other liabilities”), and $15.6 million of minority interest (reported in “other liabilities”). Additionally, the Company deconsolidated, as of December 31, 2003, the special-purpose entities PLC Capital Trust III and PLC Capital Trust IV after determining the Company was not the primary beneficiary of these special-purpose entities. The deconsolidation resulted in a $6.6 million increase to “investments” and “subordinated debt securities”. The Company consolidated, as of March 31, 2004, two real estate investment companies that the Company had previously reported as investments. The entities were consolidated based on the determination that the Company was the primary beneficiary. The consolidation resulted in the Company’s reported assets and liabilities increasing by $76.2 million with an immaterial impact on results of operations.
In July 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) 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 related to the establishment of reserves for benefit guarantees provided under certain long-duration contracts, as well as the accounting for mortality benefits provided in certain universal life products. In addition, it addresses the capitalization and amortization of sales inducements to contract holders. The SOP was effective January 1, 2004 and was adopted through an adjustment for the cumulative effect of change in accounting principle originally amounting to $10.1 million (net of $5.5 income tax). During the third quarter of 2004, AcSEC issued a Technical Practice Aid (TPA) which provided additional interpretive guidance on applying certain provisions of the SOP. As a result of this additional guidance, the Company restated its cumulative effect charge as of January 1, 2004 to record an additional expense of $5.7 million (net of $3.1 income tax). The following table presents the results for the first quarter of 2004 as originally reported and as adjusted for the addition to the cumulative effect adjustment.
Three Months Ended Three Months Ended March 31, 2004 Adoption March 31, 2004 As Reported of TPA Restated ________________________________________________________________________________________________________________________
Per share information (basic): Cumulative effect of change in accounting principle, net of tax (0.14) (0.08) (0.22) Net income 0.79 (0.08) 0.71 ________________________________________________________________________________________________________________________
Equity mutual funds $2,089,744 $1,845,952 Fixed income mutual funds 219,114 199,086 _______________________________________________________________________________ Total $2,308,858 $2,045,038 _______________________________________________________________________________
Activity in the Company's deferred sales inducement asset for the years ended December 31 was as follows:
Derivative instruments expose the Company to credit and market risk. The Company minimizes its credit risk by entering into transactions with highly rated counterparties. The Company also maintains netting and collateral support arrangements with its counterparties to further minimize the credit risk associated with its derivative instruments. The Company manages the market risk associated with interest rate and foreign exchange contracts by establishing and monitoring limits as to the types and degrees of risk that may be undertaken.
Cash-Flow Hedges. The Company has entered into a foreign currency swap to hedge the risk of changes in the value of interest and principal payments to be made on certain foreign-currency-based stable value contracts. Under the terms of the swap, the Company pays a fixed U.S.-dollar-denominated rate and receives a fixed foreign-currency-denominated rate. Effective July 1, 2002, the Company designated this swap as a cash flow hedge and therefore recorded the change in the fair value of the swap during the period in accumulated other comprehensive income. Gains and losses on this swap are reclassified from other comprehensive income to current earnings as payments are made on the hedged stable value contract. In connection with the issuance of inflation adjusted funding agreements, the Company has entered into swaps to convert the floating CPI-linked interest rate on the contracts to a fixed rate. The Company pays a fixed rate on the swap and receives a floating rate equal to the CPI change paid on the funding agreements. Gains and losses on these swaps are reclassified from other comprehensive income to current earnings as interest payments are made on the funding agreements. For the years ended December 31, 2004, 2003 and 2002, the amount of hedge ineffectiveness reported in income was a $1.0 million gain, a $0.3 million gain, and an immaterial loss, respectively. Additionally, as of December 31, 2004 and 2003, the Company reported an after-tax increase to accumulated other comprehensive income of $5.9 million and $2.7 million, respectively, related to its cash flow hedges. During 2005, the Company expects to reclassify $4.9 million out of accumulated other comprehensive income and into earnings.
The Company uses interest rate swaps to convert the fixed interest rate payments on certain of its debt obligations to a floating rate. Interest is exchanged periodically on the notional value, with the Company receiving the fixed rate and paying various LIBOR-based rates. In 2004, 2003, and 2002, the Company recognized pre-tax gains of $17.6 million, $1.4 million, and $41.5 million, respectively, representing the change in value of these derivatives.
The Company uses certain foreign currency swaps, which are not designated as cash flow hedges, to mitigate its exposure to changes in currency rates. For 2004, 2003, and 2002, the Company recorded a pre-tax gain of $0.6 million, a pre-tax gain of $2.6 million, and a pre-tax gain of $70.8 million on these swaps, respectively. In connection with these swaps, the Company also recognized a $0.4 million pre-tax loss, a $1.9 million pre-tax loss, and a $74.9 million pre-tax loss, respectively, during 2004, 2003, and 2002 as the change in value of the related foreign currency denominated stable value contracts. These net gains or losses primarily result from differences in the forward and spot exchange rates used to revalue the swaps and the stable value contracts.
The Company has also entered into a total return swap in connection with a portfolio of investment securities managed by the Company for an unrelated party. The Company recognized a $0.7 million pre-tax loss, a $2.9 million pre-tax gain, and an $8.5 million pre-tax loss in 2004, 2003, and 2002, respectively, for the change in the total return swap’s fair value.
The cost to acquire blocks of insurance, representing the present value of future profits from such blocks of insurance, is also included in deferred policy acquisition costs. The Company amortizes the present value of future profits over the premium payment period, including accrued interest of up to approximately 8%. The unamortized present value of future profits for all acquisitions was approximately $468.0 million and $502.2 million at December 31, 2004 and 2003, respectively. During 2004, no present value of profits was capitalized and $34.2 million was amortized. During 2003, no present value of profits was capitalized and $40.3 million was amortized.
2005 $31,100 2006 29,800 2007 28,300 2008 26,800 2009 25,000 _____________________________________________
2004 2003 ____________________________________________________________________________________ Home Office building $ 50,156 $ 48,678 Data processing equipment 39,527 35,708 Other, principally furniture and equipment 48,786 46,270 ____________________________________________________________________________________ 138,469 130,656 Accumulated depreciation 93,015 85,016 ____________________________________________________________________________________ $ 45,454 $ 45,640 ____________________________________________________________________________________
The Company markets guaranteed investment contracts (GICs) to 401(k) and other qualified retirement savings plans, and fixed and floating rate funding agreements to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds. Through its registered funding agreement-backed note program, the Company is able to offer secured notes to both institutional and retail investors. GICs are generally contracts that specify a return on deposits for a specified period and often provide flexibility for withdrawals at book value in keeping with the benefits provided by the plan. Stable value product account balances include GICs and funding agreements issued by the Company as well as the obligations of consolidated special purpose trusts or entities formed to purchase funding agreements issued by the Company. At December 31, 2004 and 2003 the Company had $3.9 billion and $2.8 billion, respectively of stable value product account balances marketed through structured programs. Most GICs and funding agreements written by the Company have maturities of three to seven years. At December 31, 2004, future maturities of stable value products were $1.2 billion in 2005, $2.4 billion in 2006-2007, $0.9 billion in 2008-2009, and $1.1 billion after 2009.
Traditional life insurance products consist principally of those products with fixed and guaranteed premiums and benefits, and they include whole life insurance policies, term and term-like life insurance policies, limited payment life insurance policies, and certain annuities with life contingencies. Life insurance premiums are recognized as revenue when due. Health and credit insurance premiums are recognized as revenue over the terms of the policies. Benefits and expenses are associated with earned premiums so that profits are recognized over the life of the contracts. This is accomplished by means of the provision for liabilities for future policy benefits and the amortization of deferred policy acquisition costs. Gross premiums in excess of net premiums related to immediate annuities are deferred and recognized over the life of the policy.
Property and casualty insurance products include service contract business, surety bonds, residual value insurance, guaranteed asset protection (GAP), credit-related coverages, and inventory protection products. Premiums for service contracts and GAP products are recognized based on expected claim patterns. For all other products, premiums are generally recognized over the terms of the contract on a pro-rata basis. Fee income from providing administrative services is recognized as earned when the related services are performed. Unearned premium reserves are maintained for the portion of the premiums that is related to the unexpired period of the policy. Benefit reserves are recorded when insured events occur. Benefit reserves include case basis reserves for known but unpaid claims as of the balance sheet date as well as incurred but not reported (IBNR) reserves for claims where the insured event has occurred but has not been reported to the Company as of the balance sheet date. The case base reserves and IBNR are calculated based on historical experience and on assumptions relating to claim severity and frequency, the level of used vehicle prices, and other factors. These assumptions are modified as necessary to reflect anticipated trends.
The Company uses the asset and liability method of accounting for income taxes. Income tax provisions are generally based on income reported for financial statement purposes. Deferred federal income taxes arise from the recognition of temporary differences between the basis of assets and liabilities determined for financial reporting purposes and the basis determined for income tax purposes. Such temporary differences are principally related to the deferral of policy acquisition costs and the provision for future policy benefits and expenses.
Fixed maturities $ 822,081 $ 743,934 $ 680,825 Equity securities 2,684 2,321 3,500 Mortgage loans 232,577 208,983 218,165 Investment real estate 1,622 3,478 2,437 Short-term investments and other 55,573 91,795 134,900 ________________________________________________________________________________________________ 1,114,537 1,050,511 1,039,827 Investment expenses 30,320 19,759 16,874 ________________________________________________________________________________________________ $1,084,217 $1,030,752 $1,022,953 ________________________________________________________________________________________________
In 2004, gross gains on investments available for sale (fixed maturities, equity securities, and short-term investments) were $54.8 million, and gross losses were $25.7 million. In 2003, gross gains were $84.9 million, and gross losses were $28.9 million. In 2002, gross gains were $48.0 million, and gross losses were $44.3 million.
________________________________________________________________________________________________________________________ Fixed maturities: Bonds: Mortgage-backed securities $ 4,491,392 $132,984 $(36,112) $ 4,588,264 United States Government and authorities 83,834 6,538 (119) 90,253 States, municipalities, and political subdivisions 25,349 1,738 (1) 27,086 Public utilities 1,389,389 96,926 (10,776) 1,475,539 Convertibles and bonds with warrants 43,384 743 (277) 43,850 All other corporate bonds 6,286,776 455,323 (34,476) 6,707,623 Redeemable preferred stocks 2,957 207 0 3,164 ________________________________________________________________________________________________________________________ 12,323,081 694,459 (81,761) 12,935,779 Equity securities 45,379 1,881 (529) 46,731 Short-term investments 514,619 0 0 514,619 ________________________________________________________________________________________________________________________ $12,883,079 $696,340 $(82,290) $13,497,129 ________________________________________________________________________________________________________________________
Estimated Estimated Amortized Market Cost Value ___________________________________________________________________________ Due in one year or less $ 401,392 $ 412,418 Due after one year through five years 1,681,414 1,747,893 Due after five years through ten years 3,701,871 3,901,563 Due after ten years 7,520,618 7,940,628 ___________________________________________________________________________ $13,305,295 $14,002,502 ___________________________________________________________________________
Less Than 12 Months 12 Months or More Total _________________________ ________________________ ____________________________ Market Unrealized Market Unrealized Market Unrealized Value Loss Value Loss Value Loss ________________________________________________________________________________________________________________
Mortgage-backed $1,005,036 $(18,075) $ 21,120 $ (4,922) $1,026,156 $(22,997) securities US government 22,545 (187) 2,162 (80) 24,707 (267) State, municipalities, 72 0 0 0 72 0 etc. Public utilities 99,112 (787) 97,405 (3,972) 196,517 (4,759) Convertible bonds 0 0 184 (89) 184 (89) Other corporate bonds 681,747 (12,799) 226,548 (10,321) 908,295 (23,120) Equities 2,687 (281) 1,793 (318) 4,480 (599) ________________________________________________________________________________________________________________ $1,811,199 $(32,129) $349,212 $(19,702) $2,160,411 $(51,831) ________________________________________________________________________________________________________________
At December 31, 2004 and 2003, the Company had bonds which were rated less than investment grade of $966.0 million and $995.5 million, respectively, having an amortized cost of $933.4 million and $990.7 million, respectively. Not included in these less than investment grade bonds at December 31, 2004 and 2003, are $11.2 million and $10.9 million of trading securities. At December 31, 2004, approximately $63.4 million of the bonds rated less than investment grade were securities issued in Company-sponsored commercial mortgage loan securitizations. Approximately $1,889.9 million of bonds are not publicly traded.
Fixed maturities $54,931 $110,499 $227,283 Equity securities 1,001 2,372 (480) ________________________________________________________________________
At December 31, 2004, all of the Company’s mortgage loans were commercial loans of which 71% were retail, 10% were apartments, 9% were office buildings, 8% were warehouses, and 2% were other. The Company specializes in making mortgage loans on either credit-oriented or credit-anchored commercial properties. No single tenant’s leased space represents more than 2.7% of mortgage loans. Approximately 73% of the mortgage loans are on properties located in the following states listed in decreasing order of significance: Texas, Tennessee, Georgia, South Carolina, North Carolina, Alabama, Pennsylvania, Florida, Utah, Mississippi, Virginia, California and Ohio.
At December 31, 2004, the average mortgage loan was $2.4 million, and the weighted average interest rate was 7.1%. The largest single mortgage loan was $22.6 million.
At December 31, 2004 and 2003, the Company had investments related to retained beneficial interests of mortgage loan securitizations of $265.1 million and $283.6 million, respectively.
Certain investments with a carrying value of $2.4 million were non-income producing for the twelve months ended December 31, 2004.
2004 2003 2002 ______________________________________________________________________________________ Statutory federal income tax 35.0% 35.0% 35.0% rate applied to pretax income State income taxes 0.7 0.2 0.8 Dividends received deduction and tax-exempt income (1.5) (1.5) (2.1) Low-income housing credit 0.0 (0.3) (0.4) Other 0.8 (0.1) (0.2) ______________________________________________________________________________________ 35.0% 33.3% 33.1% ______________________________________________________________________________________
The components of the Company’s income tax expense for the years ended December 31 are as follows:
The components of the Company's net deferred income tax liability as of December 31 were as follows:
Deferred income tax liabilities: 537,933 485,361 Deferred policy acquisition costs Unrealized gains (losses) on investments 128,615 139,132 _____________________________________________________________________________________ 666,548 624,493 _____________________________________________________________________________________ Net deferred income tax liability $312,544 $337,609 _____________________________________________________________________________________
2004 2003 _______________________________________________________________________________________________________ Long-term debt (year of issue): Notes payable to banks $ 0 $ 25,000 7.95% Senior Notes (1994), due 2004 0 75,000 7.45% Medium-Term Notes (1996), due 2011 9,852 9,852 8.25% Senior Notes (2000), due 2030, callable 2005 34,699 34,699 7.50% Senior Notes (2000), due 2016, callable 2004 0 59,864 4.30% Senior Notes (2003), due 2013 250,000 250,000 4.875% Senior Notes (2004), due 2014 150,000 0 Mortgage notes on investment real estate 6,882 6,914 _______________________________________________________________________________________________________ Total long-term debt $451,433 $461,329 _______________________________________________________________________________________________________ Subordinated debt securities (year of issue): 7.50% Subordinated Debentures (2001), due 2031, callable 2006 $103,093 $103,093 7.25% Subordinated Debentures (2002), due 2032, callable 2007 118,557 118,557 6.125% Subordinated Debentures (2004), due 2034, callable 2009 103,093 0 _______________________________________________________________________________________________________ Total subordinated debt securities $324,743 $221,650 _______________________________________________________________________________________________________
2005 $ 0 2006 2,202 2007 0 2008 0 2009 0 Thereafter 773,974
Under revolving line of credit arrangements with several banks, the Company can borrow up to $200 million on an unsecured basis. No compensating balances are required to maintain the line of credit. These arrangements contain, among other provisions, requirements for maintaining certain financial ratios and restrictions on indebtedness incurred by the Company and its subsidiaries. Additionally, the Company, on a consolidated basis, cannot incur debt in excess of 40% of its total capital. At December 31, 2004, the Company had no outstanding borrowings under these arrangements. At December 31, 2004, the Company was in compliance with all debt covenants.
The Company has also accessed capital from subordinated debt securities issued to wholly-owned subsidiary trusts. Securities currently outstanding were offered through a series of trusts (PLC Capital Trust III, PLC Capital Trust IV, and PLC Capital Trust V). These trusts were formed solely to issue preferred securities (TOPrS) and use the proceeds thereof to purchase subordinated debentures of the Company. The sole assets of the trusts are the subordinated debt securities issued by the Company. The principal obligations of the trusts are irrevocably guaranteed by the Company. Under the terms of the subordinated debentures, the Company has the right to extend interest payment periods up to five consecutive years. Consequently, dividends on the preferred securities may be deferred (but will continue to accumulate, together with additional dividends on any accumulated but unpaid dividends at the dividend rate) by the trusts during any such extended interest payment period.
Limited amounts of the 8.25% Senior Notes and 7.45% Medium-Term Notes may be redeemed upon the death of the beneficial owner of the notes.
In June 2002, the Company coinsured a block of traditional life and interest-sensitive life insurance policies from Conseco Variable Insurance Company (Conseco). This transaction has been accounted for as a purchase, and the results of the transaction have been included in the accompanying financial statements since its effective date.
Summarized below are the consolidated results of operations for 2002, on an unaudited pro forma basis, as if the Conseco transaction had occurred as of January 1, 2002. The pro forma information is based on the Company’s consolidated results of operations for 2002, and on data provided by the acquired block, after giving effect to certain pro forma adjustments. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transaction occurred on the basis assumed above nor are they indicative of results of the future operations of the combined enterprises.
The Company leases administrative and marketing office space in approximately 25 cities including Birmingham, with most leases being for periods of three to ten years. The aggregate annualized rent is approximately $6.0 million. Additionally, the Company leases a building contiguous to its home office, which expires in February 2007. Lease payments in 2005 and 2006 approximate $1.7 million per year. At the end of the lease term the Company may purchase the building for approximately $75 million.
2004 125,670 $4,600 2003 148,730 3,900 2002 192,360 5,700 2001 153,490 40,000 4,900 2000 3,330 513,618 3,700 _________________________________________________________________
Performance shares are equivalent in value to one share of Company Common Stock times the award earned percentage payout. P-SARs convert to the equivalent of one stock appreciation right (SAR) if earned times the award percentage payout. Of the 2000 P-SARs awarded, 87,778 were canceled and 425,840 converted to 547,728 SARs. The 40,000 P-SARs awarded in 2001 were not earned and have been canceled. The P-SARs, once converted to SARs, expire 10 years after the grant date. At December 31, 2004, the total outstanding performance shares related to these performance-based plans measured at maximum payouts were 846,313.
Between 1996 and 2003 SARs were granted (in addition to the P-SARs discussed above) to certain officers of the Company to provide long-term incentive compensation based solely on the performance of the Company’s Common Stock. The SARs are exercisable after five years (earlier upon the death, disability, or retirement of the officer, or in certain circumstances, of a change in control of the Company) and expire after ten years or upon termination of employment. The SARs activity as well as weighted average base price for 2002, 2003, and 2004 is as follows:
Balance at December 31, 2001 $19.92 1,113,823 SARs granted 32.00 480,000 SARs exercised 32.60 (80,000) SARs canceled 22.31 (15,000) ____________________________________________________________________________ Balance at December 31, 2002 23.90 1,498,823 SARs granted 26.49 95,000 P-SARs converted 22.31 45,838 P-SARs canceled 30.77 (22,500) ____________________________________________________________________________ Balance at December 31, 2003 23.91 1,617,161 P-SARs converted 22.31 401,818 SARs exercised 18.68 (451,036) ____________________________________________________________________________ Balance at December 31, 2004 $25.01 1,567,943 ____________________________________________________________________________
The outstanding SARs at December 31, 2004, were at the following base prices:
The SARs issued in 2002 and 2003 had estimated fair values at grant date of $3.7 million and $0.6 million, respectively. The fair value of the 2003 SARs was estimated using a Black-Scholes option pricing model. Assumptions used in the model were as follows: expected volatility of 25.0% (approximately equal to that of the S&P Life and Health Insurance Index), a risk-free interest rate of 3.1%, a dividend rate of 2.1%, and an expected exercise date of 2009.
The Company will pay an amount in stock equal to the difference between the specified base price of the Company’s Common Stock and the market value at the exercise date for each SAR.
At December 31, 2004, approximately $574.2 million of consolidated share-owners’ equity, excluding net unrealized gains on investments, represented net assets of the Company’s insurance subsidiaries that cannot be transferred to Protective Life Corporation. In addition, the Company’s insurance subsidiaries are subject to various state statutory and regulatory restrictions on the insurance subsidiaries’ ability to pay dividends to Protective Life Corporation. 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 the Company by its insurance subsidiaries in 2005 is estimated to be $231.6 million.
As of December 31, 2004, the Company’s insurance subsidiaries had on deposit with regulatory authorities, fixed maturity and short-term investments with a market value of approximately $61.1 million.
The Company has an additional segment herein referred to as Corporate and Other. The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on unallocated capital and interest on all debt). This segment also includes earnings from several non-strategic lines of business (mostly cancer insurance, residual value insurance, surety insurance, and group annuities), various investment-related transactions, and the operations of several small subsidiaries (including a subsidiary that markets discount plans). The surety and residual value insurance lines were moved from the Asset Protection segment to Corporate and Other in 2004, and prior period segment data has been restated to reflect the change.
The Company uses the same accounting policies and procedures to measure segment operating income and assets as it uses to measure its consolidated net income and assets. Segment operating income is generally income before income tax, adjusted to exclude net realized investment gains and losses (and the related amortization of deferred policy acquisition costs) and the cumulative effect of change in accounting principle. Periodic settlements of interest rate swaps associated with corporate debt and certain investments are included in realized gains and losses but are considered part of operating income. Segment operating income represents the basis on which the performance of the Company’s business is assessed by management. Premiums and policy fees, other income, benefits and settlement expenses, and amortization of deferred policy acquisition cost 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 appropriately reflects the operations of that segment.
Assets are allocated based on statutory policy liabilities and deferred policy acquisition costs directly attributable to each segment.
(1) Realized investment gains (losses) - investments $ 28,305 $ 58,064 $ 910 Related amortization of DAC (6,935) (18,947) (1,981) ______________________________________________ $ 21,370 $ 39,117 $ (1,071) ______________________________________________ (2) Realized investment gains (losses) - derivatives $ 19,591 $ 12,550 $ 28,308 Settlements on certain interest rate swaps (19,222) (21,087) (23,072) ______________________________________________ $ 369 $ (8,537) $ 5,236 ______________________________________________ Net investment income Life Marketing $ 238,193 $ 231,238 $ 209,002 Acquisitions 232,499 246,143 252,147 Annuities 210,888 224,332 220,447 Stable Value Products 268,184 233,104 246,098 Asset Protection 30,939 36,652 41,879 Corporate and Other 103,514 59,283 53,380 ______________________________________________ Total net investment income $1,084,217 $1,030,752 $1,022,953 ______________________________________________ Amortization of deferred policy acquisition costs Life Marketing $ 58,970 $ 66,078 $ 117,836 Acquisitions 28,652 32,690 35,245 Annuities 32,271 38,196 24,669 Stable Value Products 3,480 2,279 2,304 Asset Protection 72,273 80,320 75,108 Corporate and Other 4,484 5,544 12,500 ______________________________________________ Total amortization of deferred policy acquisition costs $ 200,130 $ 225,107 $ 267,662 ______________________________________________
Operating Segment Assets December 31, 2004 _______________________________________________________________________________ Life Stable Value Marketing Acquisitions Annuities Products _______________________________________________________________________________
Investments and other assets $5,967,768 $4,063,711 $5,980,259 $5,377,917 Deferred policy acquisition costs 1,262,637 337,372 81,251 18,301 Goodwill 10,354 _______________________________________________________________________________ Total assets $7,240,759 $4,401,083 $6,061,510 $5,396,218 _______________________________________________________________________________
Investments and other assets $ 956,396 $2,333,396 $60,261 $22,652,313 Deferred policy acquisition costs 128,833 10,731 1,817,990 Goodwill 36,875 83 47,312 _______________________________________________________________________________ Total assets $1,122,104 $2,344,210 $60,261 $24,517,615 _______________________________________________________________________________
At December 31, 2004, the Company estimated that its 2005 defined benefit pension plan expense will be $6.6 million, which is the Company’s estimate of its expected contributions for 2005. The measurement date used to determine the benefit expense and benefit obligations of the plan is December 31, 2004.
Projected benefit obligation, beginning of the year $77,454 $62,179 Service cost - benefits earned during the year 5,408 4,513 Interest cost - on projected benefit obligation 5,506 4,666 Actuarial loss 10,756 7,531 Benefits paid (1,725) (1,435) __________________________________________________________________________________________________ Projected benefit obligation, end of the year 97,399 77,454 __________________________________________________________________________________________________ Fair value of plan assets beginning of the year 74,071 49,450 Actual return on plan assets 7,780 12,886 Employer contribution 19,764 13,170 Benefits paid (1,725) (1,435) __________________________________________________________________________________________________ Fair value of plan assets end of the year 99,890 74,071 __________________________________________________________________________________________________ Plan assets less than the projected benefit obligation 2,491 (3,383) Unrecognized net actuarial loss from past experience different from that assumed 36,056 27,453 Unrecognized prior service cost 1,458 1,672 Other adjustments 0 684 __________________________________________________________________________________________________ Net pension asset $40,005 $26,426 __________________________________________________________________________________________________ Accumulated benefit obligation $80,526 $60,984 Fair value of assets $99,890 $74,071 Unfunded accumulated benefit obligation $ 0 $ 0 __________________________________________________________________________________________________
Weighted average discount rate 5.75% 6.25% Rates of increase in compensation level 3.75 4.00 Expected long-term rate of return on assets 8.25 8.50 ___________________________________________________________________________________
The Company also sponsors an unfunded excess benefits plan, which is a nonqualified plan that provides defined pension benefits in excess of limits imposed on qualified plans by federal tax law. At December 31, 2004 and 2003, the projected benefit obligation of this plan totaled $21.6 million and $18.1 million, respectively, of which $16.3 million and $15.3 million, respectively, have been recognized in the Company’s financial statements
Weighted average discount rate 5.75% 6.25% Rates of increase in compensation level 4.75 5.00 Expected long-term rate of return on assets 8.25 8.50 ___________________________________________________________________________________
Service cost $ 542 $ 485 $ 455 Interest cost 1,302 1,182 1,178 Amortization of prior service cost 16 16 16 Recognized net actuarial loss 309 118 71 Cost of divestiture and special termination benefits 0 81 0 __________________________________________________________________________________________________ Net pension cost $2,169 $1,882 $1,720 __________________________________________________________________________________________________
2005 $1,168 2006 1,187 2007 1,206 2008 1,256 2009 1,287 2010-2014 7,210
The Company has reinsured approximately $353.9 billion, $292.7 billion, and $219.0 billion in face amount of life insurance risks with other insurers representing $959.6 million, $781.8 million, and $546.0 million of premium income for 2004, 2003, and 2002, respectively. The Company has also reinsured accident and health risks representing $60.6 million, $61.6 million, and $61.5 million of premium income for 2004, 2003, and 2002, respectively. In addition, the Company reinsured property and casualty risks representing $122.4 million, $91.0 million, and $143.9 million of premium income for 2004, 2003, and 2002, respectively. In 2004 and 2003, policy and claim reserves relating to insurance ceded of $2,750.3 million and $2,230.7 million, respectively, are included in reinsurance receivables. Should any of the reinsurers be unable to meet its obligation at the time of the claim, obligation to pay such claim would remain with the Company. At December 31, 2004 and 2003, the Company had paid $63.1 million and $53.3 million, respectively, of ceded benefits which are recoverable from reinsurers. In addition, at December 31, 2004, the Company had receivables of $66.9 million related to insurance assumed.
The Company’s unaudited consolidated quarterly operating data for the years ended December 31, 2004 and 2003, are presented below. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of quarterly results have been reflected in the data which follow. It is also management’s opinion, however, that quarterly operating data for insurance enterprises are not indicative of results to be achieved in succeeding quarters or years. In order to obtain a more accurate indication of performance, there should be a review of operating results, changes in share-owners’ equity, and cash flows for a period of several quarters. Amounts shown for the first quarter of 2004 have been restated from the amount originally reported due to the Company’s adoption of SOP 03-1 (see Note 1 for further detail).
Premiums and policy fees $ 443,796 $ 456,088 $ 460,784 $ 480,628 Reinsurance ceded (249,339) (285,369) (276,736) (331,200) _______________________________________________________________________________________________________________________ Net of reinsurance ceded 194,457 170,719 184,048 149,428 Net investment income 264,608 265,899 279,271 274,439 Realized investment gains (losses) 21,710 7,817 14,468 3,901 Other income 37,419 37,563 40,921 41,907 _______________________________________________________________________________________________________________________ Total revenues 518,194 481,998 518,708 469,675 Benefits and expenses 418,795 386,628 416,442 381,509 _______________________________________________________________________________________________________________________ Income from before income tax 99,399 95,370 102,266 88,166 Income tax expense 34,094 34,075 35,793 30,858 Cumulative effect of change in accounting principle, net of income tax (15,801) _______________________________________________________________________________________________________________________ Net income $ 49,504 $ 61,295 $ 66,473 $ 57,308 _______________________________________________________________________________________________________________________
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Protective Life Corporation and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements 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 of financial statements 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 1 of the Notes to the Consolidated Financial Statements, effective January 1, 2004, the Company adopted American Institute of Certified Public Accountants Statement of Position (SOP) 03-1 “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” and effective March 31, 2004 and December 31, 2003, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities”.