NBLIC subleases general office space in Long Island City, New York, from a subsidiary of Citigroup under a sublease expiring in March 2020.
In Canada, we lease general office space in Mississauga, Ontario, under a lease expiring in April 2018 and warehouse and printing operation space in Mississauga, Ontario, under a lease also expiring in April 2018.
In January 2014, we sold the assets and liabilities of our short-term statutory disability benefit insurance business (“DBL”) and the results of operations for DBL have been reported in discontinued operations for all periods presented in the statements of income data. For more information see Note 2 (Discontinued Operations) to our consolidated financial statements included elsewhere in this report.
Economic conditions, including unemployment levels and consumer confidence, influence investment and spending decisions by middle income consumers, who are generally our primary clients. Consumer spending and borrowing levels affect how consumers evaluate their savings and debt management plans. In addition, interest rates and equity market returns impact consumer demand for the savings and investment products we distribute. These conditions and factors also impact prospective recruits’ perceptions of the business opportunity that becoming a Primerica sales representative offers, which can drive or dampen recruiting. The effects of these trends and conditions are discussed in the Results of Operations section below.
Recruiting and Sales Representatives. Our ability to increase the size of our sales force is largely based on the success of our recruiting efforts, our ability to train and motivate recruits to get licensed to sell life insurance, and retention of licensed sales representatives. We believe that recruitment and licensing levels are important to sales force trends and growth in recruiting and licensing is usually indicative of future growth in the overall size of the sales force. Recruiting results do not always result in commensurate changes in the size of our licensed sales force because new recruits may obtain the requisite licenses at rates above or below historical levels.
Regulatory changes can also impact the size of our independent sales force. The insurance regulators in the Canadian provinces and territories entered into a Memorandum of Understanding and related agreements to implement a new life insurance licensing examination program across Canada in early 2016. If this new licensing program is implemented under the terms set forth in the agreements, we believe it would significantly decrease the ability of applicants to obtain their life insurance licenses in Canada. At this time, we cannot quantify the impact of the new licensing program might have on our Canadian sales force. However, we believe the program could result in a significant decline in the number of our new life-licensed representatives in Canada and ultimately the size of our life-licensed sales force. This could lower new life insurance sales and, over time, lower the size of our life insurance in force and materially adversely affect our Canadian Term Life insurance business. For more information, see “Part I - Item 3. Legal Proceedings.” included elsewhere within this report.
Term Life Insurance Product Sales and Face Amount In Force. We issued 220,984 new life insurance policies in 2014 compared with 214,617 new policies in 2013. Issued term life insurance policies grew during 2014 consistent with the size of our life-licensed sales force.
The average number of life-licensed sales representatives and the number of term life insurance policies issued, as well as the average monthly rate of new policies issued per life-licensed sales representative (historically between 0.18x and 0.22x), were as follows:
During 2014, the average monthly rate of new policies issued per life-licensed sales representative remained relatively consistent with the prior year and historical experience.
Our average issued face amount of approximately $244,600 in 2014 was relatively consistent compared with approximately $246,800 in 2013.
Interest Rates. We assume interest rates based on forecasted interest rates at the time a policy is issued. For policies issued in 2010 and after, we have been using an increasing interest rate assumption to reflect the historically low interest rate
In 2010, as part of our corporate reorganization, we entered into significant coinsurance transactions (the “coinsurance transactions”) with three affiliates (collectively, the “Citigroup reinsurers”) of Citigroup Inc. (“Citigroup”) and ceded between 80% and 90% of the risks and rewards of our term life insurance policies that were in force at year-end 2009. We continue to administer all policies subject to these coinsurance agreements. With each successive period, we expect revenue and earnings growth to continue to decelerate as the size of our in-force book grows and incremental sales have a reduced marginal effect on the size of the then-existing in force book.
Insurance expenses. Insurance expenses are reduced by the allowances received from coinsurance, including the business reinsured with Citigroup. There is no impact on insurance expenses associated with our YRT contracts.
sales of a higher proportion of mutual fund products and the composition of the fund families sold will impact the timing and amount of revenue we earn given the marketing, support, recordkeeping and custodial services we perform for the various mutual fund products we distribute.
Capital Structure. Our financial results have also been affected by changes in our capital structure, including the issuance of our senior unsecured notes, as well as repurchases of shares and warrants of our common stock.
See Note 10 (Debt), Note 12 (Stockholders’ Equity) and Note 16 (Commitments and Contingent Liabilities) to our consolidated financial statements included elsewhere in this report for more information on changes in our capital structure.
Foreign Currency. The Canadian dollar is the functional currency for our Canadian subsidiaries and our financial results, reported in U.S. dollars, are affected by changes in the currency exchange rate. As such, the translated amount of revenues, expenses, assets and liabilities attributable to our Canadian subsidiaries will be higher or lower in periods where the Canadian dollar appreciates or weakens relative to the U.S. dollar. See “Results of Operations” and “Financial Condition” and “Quantitative and Qualitative Disclosures About Market Risk - Canadian Currency Risk” and Note 3 (Segment and Geographical Information) to our consolidated financial statements included elsewhere in this report for more information on our Canadian subsidiaries and the impact of foreign currency on our financial results.
We prepare our financial statements in accordance with U.S generally accepted accounting principles (“U.S. GAAP”). These principles are established primarily by the Financial Accounting Standards Board (“FASB”). The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions based on currently available information when recording transactions resulting from business operations. Our significant accounting policies are described in Note 1 (Description of Business, Basis of Presentation, and Summary of Significant Accounting Policies) to our consolidated financial statements included elsewhere in this report. The most significant items on our consolidated balance sheets are based on fair value determinations, accounting estimates and actuarial determinations, which are susceptible to changes in future periods and could affect our results of operations and financial position.
If actual lapses or withdrawals are different from pricing assumptions for a particular period, DAC amortization for that period will be affected. If the rate of policies that lapse are 1% higher than the rate of policies that we expected to lapse in our original pricing assumptions, approximately 1% more of the existing DAC balance will be amortized, which would have been equal to approximately $12.6 million as of December 31, 2014 (assuming such lapses were distributed proportionately among policies of all durations). We believe that a lapse rate in the number of policies that is 1% higher than the rate assumed in our pricing assumptions is a reasonably possible variation. Higher lapses in the early durations would have a greater effect on DAC amortization since the DAC balances are higher at the earlier durations. Due to the inherent uncertainties in making assumptions about future events, materially different experience from expected results in persistency could result in a material increase or decrease of DAC amortization in a particular period.
Deferrable acquisition costs for Canadian segregated funds are amortized over the life of the policies in relation to historical and future estimated gross profits before amortization. The gross profits and resulting DAC amortization will vary with actual and anticipated fund returns, redemptions, commissions and expenses. DAC from our Canadian segregated funds reflects approximately 4% of our total DAC, and DAC amortization on these segregated funds reflects approximately 6% of our total DAC amortization for the year ended December 31, 2014.
If the rate of policies that lapse are 1% higher than the rate of policies that we expected to lapse in our pricing assumptions, approximately 1% more of the future policy benefit reserves will be released, which would have been equal to approximately $50.5 million (assuming such lapses were distributed proportionately among policies of all durations), partially offset by the release of the corresponding due from reinsurers asset of approximately $38.4 million as of December 31, 2014, which decreases over time with the run-off of policies subject to the Citigroup coinsurance transactions. Higher lapses in later durations would have a greater effect on the release of future policy benefit reserves since the future policy benefit reserves are higher at the later durations.
Other, net. Reflects revenues generated primarily from the fees charged for access to our sales force support applications, as well as revenues from the sale of marketing materials and other miscellaneous items.
Total revenues. Total revenues for 2014 increased from 2013 primarily due to incremental premiums on term life insurance policies not subject to the Citigroup coinsurance transactions, higher investment and savings products sales, and positive client asset performance. Partially offsetting the increase in revenues were lower net investment income and realized investment gains (losses) in 2014 versus 2013. In comparing the realized investment losses in 2014 to realized investment gains in 2013, the difference was mostly attributable to large gains on tendered securities and gains on certain sales of fixed maturity securities in 2013, as well as OTTI losses recognized on certain investments in 2014. The decrease in net investment income was primarily driven by lower average yield on invested assets, partially offset by a higher average base of invested assets and the positive change in market value of the deposit asset underlying our 10% Coinsurance Agreement.
During 2013, total revenues increased from 2012 largely due to similar factors including incremental premiums on term life insurance policies not subject to the Citigroup coinsurance transactions, higher sales of investment and savings products, and growth in client asset values. In addition, declines in net investment income and realized investment gains partially offset the increase in total revenues in 2013 from 2012 primarily due to a lower average yield on invested assets, a lower average base of invested assets, and lower realized gains from the sale of invested assets.
The increase in total benefits and expenses in 2013 from 2012 was also driven by growth in revenue-related costs including benefits and claims, DAC amortization, and certain insurance expenses from the continued growth in our Term Life business. Additionally, sales commissions on investment products were higher and consistent with the increase in commissions and fees revenue. In 2013, we experienced higher other operating expenses than in 2012 primarily attributable to higher legal fees and settlement costs in our Investment and Savings Product segment as further described below. These increased costs were partially offset by lower non-
Income taxes. Our effective income tax rate was relatively consistent each period at 34.8%, 35.2%, and 34.9% in 2014, 2013, and 2012, respectively.
Net premiums. Direct premiums grew in 2014 compared to 2013 largely due to incremental premiums on term life insurance policies not subject to the Citigroup coinsurance transactions. Ceded premiums declined primarily due to the run-off of business subject to the Citigroup coinsurance transactions. The continued impact of growth in direct premiums not subject to the Citigroup coinsurance transactions and the run-off of business subject to the Citigroup coinsurance transactions resulted in net premiums growing faster than direct premiums.
Benefits and claims. Benefits and claims in 2014 compared to 2013 increased slightly more than the growth in net premiums mostly due to higher policy reserves from improved persistency.
Amortization of DAC. The increase in amortization of DAC in 2014 versus 2013 was impacted by a higher portion of commissions deferred in recent periods, resulting in a rate of DAC amortization in excess of the growth in net premiums, partially offset by improved persistency in 2014.
The increase in amortization of DAC in 2013 compared to 2012 was consistent with the increase in net premiums as higher amortization from increases in deferrable agent incentive program costs were partially offset by better persistency.
The increase in interest expense in 2013 from 2012 was attributable to financing charges on an issued letter of credit associated with our redundant reserve financing transaction that was executed in March 2012.
Product Sales and Face Amount In Force. The changes in the face amount of our in-force book of term life insurance policies were as follows:
The total face amount of policies in force increased in 2013 from 2012 mostly reflecting lower terminations on existing policies as a result of slightly better persistency. Issued face amount during 2013 remained largely consistent from 2012 due to the offsetting impacts of the year-over-year decline in the number of policies issued and the larger average size of policies underwritten. In addition, the strengthening of the U.S. dollar in relation to the Canadian dollar also reduced the translated face amount of Canadian in-force policies from 2012 to 2013.
Commissions and fees. The largest contributing factor to the increase in commissions and fees in 2014 from 2013 was the growth in sales-based revenues from strong sales of mutual funds. The growth in sales-based revenues exceeded the increase in sales-based revenue generating product sales mainly due to the change in sales mix to product offerings with higher sales commission rates. Commissions and fees also increased due to higher asset-based revenues attributable to the rise in average client asset values, which was indicative of favorable market performance. Additionally, the higher number of client managed investments and retail mutual funds added during 2014 contributed to the growth in account-based revenues compared to 2013.
The increase in commissions and fees in 2013 compared to 2012 was also largely due to higher product sales and growth in average client asset values. The increase in product sales was also led by higher mutual fund sales in 2013 as compared with 2012. The rise in
average client asset values, which was indicative of favorable market performance from 2012 to 2013, also contributed to the increase in commissions and fees in the form of higher asset-based revenues.
Amortization of DAC. Amortization of DAC in 2014 compared to 2013 slowed due to favorable market performance experienced by assets held within segregated funds as well as the positive impact of revised assumptions for future redemptions used in the estimate of DAC amortization.
Other operating expenses. Other operating expenses in 2014 decreased from 2013 due to lower legal fees and expenses attributable to defending claims alleged by certain participants in the Florida Retirement System’s benefit plan (“FRS”) and costs from the settlement of these FRS claims, which accounted for approximately $27.1 million of other operating costs in 2013. Higher employee compensation costs and other growth-related costs in 2014 partially offset the favorable impact of the lower FRS-related costs.
The increase in client asset values in 2014 from 2013 was led by favorable market performance that continued in 2014 combined with the positive impact of sales volumes in excess of redemptions. This increase was partially offset by a reduction in the translated value of client assets in Canada due to the strengthening of the U.S. dollar relative to the Canadian dollar.
Total revenues decreased in 2013 from 2012 also in large part due to declines in net investment income and realized investment gains. The decrease in net investment income was due to the higher allocation of assets and net investment income to the Term Life Insurance segment, a lower average base of our total portfolio of invested assets subsequent to repurchases of common stock and warrants, a lower return on the deposit asset underlying our 10% Coinsurance Agreement driven by the overall rise in interest rates, and lower yield on our total portfolio of invested assets as a result of replacing maturing investments with lower yielding securities. Realized investment gains decreased year-over-year largely due to higher income received from proceeds of invested assets sold to fund share repurchases during 2012 compared with 2013. Net premiums and commissions and fees were relatively similar in 2013 as compared to 2012.
In 2013, total benefits and expenses decreased from 2012 primarily due to lower other operating expenses which included a reduction in stock compensation costs related to the completion of the vesting of restricted stock granted in connection with our April 2010 initial public offering, partially offset by higher employee compensation costs from merit increases and one-time expenses related to the relocation of our corporate headquarters.
We have an investment committee composed of members of our senior management team that is responsible for establishing and maintaining our investment guidelines and supervising our investment activity. Our investment committee regularly monitors our overall investment results and our compliance with our investment objectives and guidelines. We use a third-party investment advisor to manage our investing activities. Our investment advisor reports to our investment committee.
Ratings for our investments in fixed-maturity securities are determined using Nationally Recognized Statistical Rating Organizations designations and/or equivalent ratings. The distribution of our investments in fixed-maturity securities (excluding our held-to-maturity security) by rating, including those classified as trading securities, were as follows:
Deferred policy acquisition costs, net. The increase in DAC was primarily a result of incremental commissions and expenses deferred as a result of new business, which was not subject to the Citigroup reinsurance agreements.
declared and paid ordinary dividends of $248.4 million to the Parent Company primarily for repurchases of our common stock. See Note 15 (Statutory Accounting and Dividend Restrictions) to our consolidated financial statements included elsewhere in this report for more information on insurance subsidiary dividends and statutory restrictions. In addition, our non-life insurance subsidiaries declared and paid dividends of approximately $71.3 million to the Parent Company in 2014. At December 31, 2014, the Parent Company had cash and invested assets of approximately $194.5 million.
Operating activities. Cash provided by operations increased in 2014 from 2013 primarily due to cash received from the collection of premium revenues in excess of benefits and claims paid in our Term Life Insurance segment. The additional layering of net premiums from term life insurance policies not subject to the coinsurance transactions with Citigroup has continued to generate positive incremental cash flows after payments are made for policy acquisition costs during the first year that policies are issued. Partially offsetting the increase in cash provided by operating activities is higher policy acquisition costs due to a higher volume of policies issued in 2014.
The increase in net cash provided by operating activities in 2013 from 2012 was also driven by the impact of an additional year of term life insurance policies issued subsequent to the coinsurance transactions with Citigroup. In addition, timing differences in payments to fund obligations under the 10% Coinsurance Agreement with Citigroup contributed to the increase in operating cash flows in 2013 from 2012. This increase was partially offset by proceeds from maturities of trading investments during 2012.
The decline in cash provided by investing activities in 2013 compared to 2012 was primarily attributable to lower net proceeds from sales and purchases of invested assets used to fund share repurchases. Additionally, capital expenditures related to the relocation of our corporate headquarters in 2013 resulted in higher investing cash outflows than in 2012.
Financing activities. Net cash used in financing activities during 2014 decreased compared to 2013 primarily due to a lower amount of employee equity awards that were withheld by the Company to satisfy income tax withholding obligations upon vesting. This decrease is attributable to a decline in the amount of employee equity awards that vested in 2014 compared with 2013 as the last tranche of large equity awards issued in connection with the IPO vested in 2013.
Cash used in financing activities during 2013 was lower compared to 2012 due to fewer repurchases of shares and warrants. This was partially offset by the net increase in borrowings from the refinancing of our notes payable in 2012 and higher dividends paid to stockholders in 2013.
In Canada, an insurer’s minimum capital requirement is overseen by the Office of the Superintendent of Financial Institutions Canada (“OSFI”) and determined as the sum of the capital requirements for five categories of risk: asset default risk; mortality/morbidity/lapse risks; changes in interest rate environment risk; segregated funds risk; and foreign exchange risk. As of December 31, 2014, Primerica Life Canada was in compliance with Canada’s minimum capital requirements as determined by OSFI.
In March 2012, Peach Re, Inc. (“Peach Re”), a special purpose financial captive insurance company and wholly owned subsidiary of Primerica Life, and Primerica Life entered into a Regulation XXX redundant reserve financing transaction (the “Peach Re Redundant Reserve Financing Transaction”) to more efficiently manage and deploy our capital. See Note 16 (Commitments and Contingent Liabilities) to our consolidated financial statements included elsewhere in this report for more information on this redundant reserve financing transaction.
In July 2014, Vidalia Re and Primerica Life entered into a Regulation XXX redundant reserve financing transaction (the “Vidalia Re Redundant Reserve Financing Transaction”) to more efficiently manage and deploy our capital. During 2014, Primerica Life ceded certain term life policies issued in 2011, 2012, 2013 and 2014 to Vidalia Re as part of the Vidalia Re Redundant Reserve Financing Transaction. For more information on the Vidalia Re Redundant Reserve Financing Transaction, see Note 4 (Investments) and Note 10 (Debt) to our consolidated financial statements included elsewhere in this report.
We were in compliance with the covenants of the Senior Notes at December 31, 2014. No events of default(s) occurred on the Senior Notes during the year ended December 31, 2014.
Financial Ratings. As of December 31, 2014, the investment grade credit ratings for our Senior Notes were as follows:
Short-Term Borrowings. We had no short-term borrowings as of or during the year ended December 31, 2014.
Surplus Note. Vidalia Re issued the Surplus Note in exchange for the LLC Note as a part of the Vidalia Re Redundant Reserve Financing Transaction. The Surplus Note has a principal amount equal to the LLC Note and is scheduled to mature on December 31, 2029. For more information on the Surplus Note, see Note 10 (Debt) to our consolidated financial statements included elsewhere in this report.
Off-Balance Sheet Arrangements. Our off-balance sheet arrangements as of December 31, 2014 consisted of the letter of credit issued under the credit facility agreement with Deutsche Bank (the “Credit Facility Agreement”) and associated with the Peach Re Redundant Reserve Financing Transaction as described in Note 16 (Commitments and Contingent Liabilities) to our consolidated financial statements included elsewhere in this report.
Long-term debt principal relates to our Senior Notes and the Surplus Note. Interest obligations (reported within other liabilities in our consolidated balance sheets) reflect expected interest on our notes payable, the financing charges related to an issued letter of credit, fees paid for the credit enhancement feature on our held-to-maturity invested asset, and a finance charge incurred pursuant to one of our coinsurance agreements with Citigroup as of December 31, 2014.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Primerica, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
Description of Business. Primerica, Inc. (the “Parent Company”), together with its subsidiaries (collectively, “we”, “us” or the “Company”), is a leading distributor of financial products to middle income households in the United States and Canada. We assist our clients in meeting their needs for term life insurance, which we underwrite, and mutual funds, annuities and other financial products, which we distribute primarily on behalf of third parties. Our primary subsidiaries include the following entities: Primerica Financial Services, Inc. (“PFS”), a general agency and marketing company; Primerica Life Insurance Company (“Primerica Life”), our principal life insurance company; Primerica Financial Services (Canada) Ltd., a holding company for our Canadian operations, which includes Primerica Life Insurance Company of Canada (“Primerica Life Canada”) and PFSL Investments Canada Ltd. (“PFSL Investments Canada”); and PFS Investments Inc. (“PFS Investments”), an investment products company and broker-dealer. Primerica Life, domiciled in Massachusetts, owns National Benefit Life Insurance Company (“NBLIC”), a New York life insurance company.
Basis of Presentation. We prepare our financial statements in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). These principles are established primarily by the Financial Accounting Standards Board (“FASB”). The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect financial statement balances, revenues and expenses and cash flows, as well as the disclosure of contingent assets and liabilities. Management considers available facts and knowledge of existing circumstances when establishing the estimates included in our financial statements.
Use of Estimates. The most significant items that involve a greater degree of accounting estimates and actuarial determinations subject to change in the future are the valuation of investments, deferred policy acquisition costs (“DAC”), and liabilities for future policy benefits and unpaid policy claims. Estimates for these and other items are subject to change and are reassessed by management in accordance with U.S. GAAP. Actual results could differ from those estimates.
Reclassifications. Certain reclassifications have been made to prior-period amounts to conform to current-period reporting classifications. These reclassifications had no impact on net income or total stockholders’ equity and were primarily related to discontinued operations. See Note 2 (Discontinued Operations) for more information.
Reinsurance. We use reinsurance extensively, utilizing yearly renewable term (“YRT”) and coinsurance agreements. Under YRT agreements, we reinsure only the mortality risk, while under coinsurance, we reinsure a proportionate part of all risks arising under the reinsured policy. Under coinsurance, the reinsurer receives a proportionate part of the premiums, less commission allowances, and is liable for a corresponding part of all benefit payments.
Ceded premiums are treated as a reduction to direct premiums and are recognized when due to the assuming company. Ceded claims are treated as a reduction to direct benefits and are recognized when the claim is incurred on a direct basis. Ceded policy reserve changes are also treated as a reduction to benefits expense and are recognized during the applicable financial reporting period.
Reinsurance premiums, commissions, expense reimbursements and benefits and reserves related to reinsured long-duration contracts are accounted for over the life of the underlying contracts using assumptions consistent with those used to account for the underlying policies. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liabilities and policy benefits associated with reinsured policies. Ceded policy reserves and claims liabilities relating to insurance ceded are shown as due from reinsurers on the accompanying consolidated balance sheets.
Deferred Policy Acquisition Costs. We only defer the costs of acquiring new business to the extent that they result directly from and are essential to the contract transaction(s) and would not have been incurred had the contract transaction(s) not occurred. These deferred policy acquisition costs mainly include commissions and policy issue expenses. All other acquisition-related costs, including
unsuccessful acquisition and renewal efforts, are charged to expense as incurred. Also, administrative costs, rent, depreciation, occupancy, equipment, and all other general overhead costs are considered indirect costs and are charged to expense as incurred.
The future policy benefit reserves we establish are necessarily based on estimates, assumptions and our analysis of historical experience. Our results depend significantly upon the extent to which our actual claims experience is consistent with the assumptions we used in determining our future policy benefit reserves and pricing our products. Our future policy benefit reserve assumptions and estimates require significant judgment and, therefore, are inherently uncertain. We cannot determine with precision the ultimate amounts that we will pay for actual claims or the timing of those payments.
Litigation. The Company is involved from time to time in legal disputes, regulatory inquiries and arbitration proceedings in the normal course of business. Legal contingencies are recognized when probable and can be reasonably estimated. Legal costs, such as attorney’s fees and other litigation-related expenses, that are incurred in connection with resolving litigation are expensed as incurred. These disputes are subject to uncertainties, including indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation. Due to the difficulty of estimating costs of litigation, actual costs may be substantially higher or lower than any amounts reserved.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to (i) differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and (ii) operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not applicable to the periods in which we expect the temporary difference will reverse.
Benefits and Expenses. Benefit and expense items are charged to income in the period in which they are incurred. Both the change in policyholder liabilities, which is included in benefits and claims, and the amortization of deferred policy acquisition costs will vary with policyholder persistency.
Share-Based Transactions. For employee and director share-based compensation awards, we determine a grant date fair value, based on the price of our publicly-traded common stock, and recognize the related compensation expense, adjusted for expected forfeitures, in the statement of income on a straight-line basis over the requisite service period for the entire award. For non-employee share-based compensation, we recognize the impact during the period of performance, and the fair value of the award is measured as of the date performance is complete, which is the vesting date. To the extent that a share-based award contains sale restrictions extending beyond the vesting date, we reduce the recognized fair value of the award to reflect the corresponding illiquidity discount. Most non-employee share-based compensation is an incremental direct cost of successful acquisitions or renewals of life insurance policies that result directly from and are essential to the policy acquisition(s) and would not have been incurred had the policy acquisition(s) not occurred. We defer these expenses and amortize the impact over the life of the underlying life insurance policies acquired.
New Accounting Principles. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 clarifies the principles for recognizing revenue by establishing the core principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue that is recognized. Insurance contracts are specifically excluded from the scope of ASU 2014-09 and therefore revenue from our insurance product lines will not be affected by the new standard. The amendments in ASU 2014-09 are effective retrospectively for the Company beginning in fiscal year 2017. Early adoption is not permitted. While we are still in the process of evaluating the guidance in ASU 2014-09, we do not expect it will have a material impact on our consolidated financial statements.
We no longer have significant continuing involvement in the operations of DBL, and its direct cash flows have been eliminated from our ongoing operations. As a result, beginning in 2014, the results of operations for DBL have been reported in discontinued operations for all periods presented in the consolidated statements of income. The results of operations and the carrying values of the assets and liabilities related to DBL were as follows:
Segments. We have two primary operating segments - Term Life Insurance and Investment and Savings Products. The Term Life Insurance segment includes underwriting profits on our in-force book of term life insurance policies, net of reinsurance, which are underwritten by our life insurance company subsidiaries. The Investment and Savings Products segment includes retail and managed mutual funds and annuities distributed through licensed broker-dealer subsidiaries and includes segregated funds, an individual annuity savings product that we underwrite in Canada through Primerica Life Canada. In the United States, we distribute mutual fund and annuity products of several third-party companies. We also earn fees for account servicing on a subset of the mutual funds we distribute. In Canada, we offer a Primerica-branded fund-of-funds mutual fund product, as well as mutual funds of well-known mutual fund companies. These two operating segments are managed separately because their products serve different needs - term life insurance protection versus wealth-building savings products.
Insurance expenses and other operating expenses directly attributable to the Term Life Insurance and the Investment and Savings Products segments are recorded directly to the applicable segment. We allocate certain other operating expenses that are not directly attributable to a specific operating segment based on the relative sizes of our life-licensed and securities-licensed independent sales forces. These allocated costs include field technology, supervision, training and certain miscellaneous costs. We also allocate certain technology and occupancy costs to our operating segments based on usage. Any remaining unallocated revenue and expense items, as well as realized investment gains and losses, are reported in the Corporate and Other Distributed Products segment. We measure income and loss for the segments on an income before income taxes basis.
Excluding separate accounts, the Investment and Savings Product segment assets were approximately $202.9 million, $195.8 million, and $192.8 million as of December 31, 2014, 2013, and 2012, respectively.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report for more information regarding our operating segments.
Includes approximately $0.7 million of other-than-temporary impairment losses related to corporates and mortgage- and asset-backed securities recognized in accumulated other comprehensive income.
Includes approximately $2.1 million of other-than-temporary impairment losses related to corporates and mortgage- and asset-backed securities recognized in accumulated other comprehensive income.
Investments on Deposit with Governmental Authorities. As required by law, we have investments on deposit with governmental authorities and banks for the protection of policyholders. The fair values of investments on deposit were $19.9 million and $18.4 million as of December 31, 2014 and 2013, respectively.
Securities Lending Transactions. We participate in securities lending transactions with broker-dealers and other financial institutions to increase investment income with minimal risk. We require minimum collateral on securities loaned equal to 102% of the fair value of the loaned securities. We accept collateral in the form of securities, which we are not able to sell or encumber, and to the extent the collateral declines in value below 100%, we require additional collateral from the borrower. Any securities collateral received is not reflected on our consolidated balance sheets. We also accept collateral in the form of cash, all of which we reinvest. For loans involving unrestricted cash collateral, the collateral is reported as an asset with a corresponding liability representing our obligation to return the collateral. We continue to carry the loaned securities as invested assets on our consolidated balance sheets during the terms of the loans, and we do not report them as sales. Cash collateral received and reinvested was approximately $50.2 million and $89.9 million as of December 31, 2014 and 2013, respectively.
Investment Income. The components of net investment income were as follows:
The following tables summarize, for all available-for-sale securities in an unrealized loss position, the aggregate fair value and the gross unrealized loss by length of time such securities have continuously been in an unrealized loss position:
Derivatives. Embedded conversion options associated with fixed-maturity securities are bifurcated from the fixed-maturity security host contracts and separately recognized as equity securities. The change in fair value of these bifurcated conversion options is reflected in realized investment gains (losses), including OTTI losses. As of December 31, 2014 and 2013, the fair value of these bifurcated options was approximately $5.8 million and $4.6 million, respectively.
Level 2. Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. Various inputs are considered in deriving the fair value of the underlying financial instrument, including interest rate, credit spread, and foreign exchange rates. All significant inputs are observable, or derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include: certain public and private corporate fixed-maturity and equity securities; government or agency securities; certain mortgage- and asset-backed securities and bifurcated conversion options; and
In assessing fair value of our investments, we use a third-party pricing service for approximately 95% of our securities. The remaining securities are primarily thinly traded securities valued using models based on observable inputs on public corporate spreads having similar characteristics (e.g., sector, average life and quality rating) and liquidity and yield based on quality rating, average life and treasury yields. All observable data inputs are corroborated by independent third-party data. In the absence of sufficient observable inputs, we utilize non-binding broker quotes, which are reflected in our Level 3 classification as we are unable to evaluate the valuation technique(s) or significant inputs used to develop the quotes. Therefore, we do not internally develop the quantitative unobservable inputs used in measuring the fair value of Level 3 investments. However, we do corroborate pricing information provided by our third-party pricing servicing by performing a review of selected securities. Our review activities include obtaining detailed information about the assumptions, inputs and methodologies used in pricing the security; documenting this information; and corroborating it by comparison to independently obtained prices and or independently developed pricing methodologies.
We obtain independent pricing quotes based on observable inputs as of the end of the reporting period for all securities in Level 2. Those inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers, quoted prices for similar instruments in markets that are not active, and other relevant data. We monitor these inputs for market indicators as well as industry and economic events. We recognize transfers into new levels and out of previous levels as of the end of the reporting period, including interim reporting periods, as applicable. There were no transfers between Level 1 and Level 2 or Level 1 and Level 3 during the years ended December 31, 2014 and 2013.
are carried at fair value. Equity securities, including common and nonredeemable preferred stocks, are carried at fair value. Segregated funds in separate accounts are carried at the underlying value of the variable insurance contracts, which is fair value.
Our policy is to limit the amount of life insurance retained on the life of any one person to $1 million. To limit our exposure with any one reinsurer, we monitor the concentration of credit risk we have with our reinsurance counterparties, as well as their financial condition. No credit losses related to our reinsurance counterparties have been experienced by the Company during the three-year period ended December 31, 2014.
Three of the Citigroup coinsurance agreements satisfy U.S. GAAP risk transfer rules. Under these agreements, we ceded between 80% and 90% of our term life future policy benefit reserves, and we transferred a corresponding amount of assets to the Citigroup reinsurers. These transactions did not impact our future policy benefit reserves. As such, we have recorded an asset for the same amount of risk transferred in due from reinsurers. We also reduced DAC by a corresponding amount, which reduces future amortization expenses. In addition, we are transferring between 80% and 90% of all future premiums and benefits and claims associated with these policies to the corresponding reinsurance entities. We receive ongoing ceding allowances, which are reflected as a reduction to insurance expenses, to cover policy and claims administration expenses as well as certain corporate overhead charges under each of these reinsurance contracts.
Due from reinsurers includes ceded reserve balances and ceded claim liabilities. Reinsurance receivable and financial strength ratings by reinsurer were as follows:
As Prime Re and Financial Reassurance Company 2010, Ltd. (“FRAC”) do not have financial strength ratings, we required various safeguards prior to executing the coinsurance agreements with these entities. Both coinsurance agreements include provisions to ensure that Primerica Life and Primerica Life Canada receive full regulatory credit for the reinsurance treaties. Under these agreements, Primerica Life and Primerica Life Canada will be able to recapture the ceded business with no fee in the event Prime Re or FRAC do not comply with the various safeguard provisions in their respective coinsurance agreements. Prime Re also has entered into a capital maintenance agreement requiring Citigroup to provide additional funding, if needed, at any point during the term of the agreement up to the maximum as described in the capital maintenance agreement.
In determining DAC amortization expense for term life insurance policies, we use interest rates available at the time a policy is issued. For policies issued in 2010 and after, we have been using an increasing interest rate assumption based on the historically low interest rate environment. Interest rate assumptions at December 31, 2014 and 2013 ranged from 3.5% to 7.0%.
DAC is subject to recoverability testing annually and when impairment indicators exist. The recoverability of DAC is dependent on the future profitability of the related policies, which, in turn, is dependent principally upon mortality, persistency, investment returns, and the expense of administering the business, as well as upon certain economic variables, such as inflation.
Under these contract offerings, benefit payments to contract holders or their designated beneficiaries are only due upon death of the annuitant or upon reaching a specific maturity date. Benefit payments are based on the value of the contract holder’s units in the portfolio at the payment date, but are guaranteed to be no less than 75% of the contract holder’s contribution, adjusted for withdrawals. Account values are not guaranteed for withdrawn units if contract holders make withdrawals prior to the maturity dates. Maturity dates for contracts investing in the Asset Builder Funds and Cash Management Fund vary by contract and range from 10 to 56 years from the contract issuance date. Contracts investing in the Strategic Retirement Income Fund mature when the policyholder reaches age 100, which is a minimum of 20 years after issue. The Strategic Retirement Income Fund is designed to provide periodic retirement income payments and as such, regular withdrawals, subject to legislated minimums, are anticipated. The cumulative effects of the periodic withdrawals are expected to substantially reduce both account and minimum guaranteed values prior to maturity.
Both the asset and the liability for the separate accounts reflect the net value of the underlying assets in the portfolio as of the reporting date. Primerica Life Canada’s exposure to losses under the guarantee at the time of account maturity is limited to contract holder accounts that have declined in value more than 25%, adjusted for withdrawals, since the contribution date prior to maturity. Because maturity dates are of a long-term nature, the likelihood guarantee payments are required at any given point is very small. Additionally, the portfolios consist of a very large number of individual contracts, further spreading the risk related to the guarantee being exercised upon death. The length of the contract terms provides significant opportunity for the underlying portfolios to recover any short-term losses prior to maturities or deaths of the contract holders. Furthermore, the funds’ investment allocations are aligned with the maturity risks of the related contracts and include investments in Government Strip Bonds and floating rate notes.
We periodically assess the exposure related to these contracts to determine whether any additional liability should be recorded. As of December 31, 2014 and 2013, an additional liability for these contracts was deemed to be unnecessary.
Surplus Note. As of December 31, 2014, the principal amount outstanding on the Surplus Note issued by Vidalia Re was approximately $220.0 million, equal to the principal amount of the LLC Note invested asset. The Surplus Note was issued in exchange for the LLC Note, which supports certain obligations of Vidalia Re for a portion of the statutory accounting-based reserves (commonly referred to as Regulation XXX reserves) related to the Vidalia Re Coinsurance Agreement. The principal amount of the Surplus Note and the LLC Note will fluctuate over time to coincide with the amount of reserves contractually supported. Both the LLC Note and the Surplus Note mature on December 31, 2029 and bear interest at an annual interest rate of 4.50%. Based on the estimated reserves for ceded policies issued in 2011, 2012, 2013, and 2014, the maximum principal amounts of the Surplus Note and the LLC Note are expected to be approximately $915.0 million each. This financing arrangement is non-recourse to the Parent Company and Primerica Life, meaning that neither of these companies has guaranteed the Surplus Note or is otherwise liable for reimbursement for any payments triggered by the credit enhancement feature underlying the LLC Note. The Parent Company has agreed to support Vidalia Re’s obligation to pay the credit enhancement fee incurred on the LLC Note.
See Note 4 (Investments) for more information on the LLC Note.
Income tax expense (benefit) from continuing operations consists of the following:
The majority of total deferred tax assets are attributable to future policy benefit reserves and unpaid policy claims, which represents the difference between the financial statement carrying value and tax basis for liabilities for future policy benefits. The tax basis for future policy benefit reserves and unpaid policy claims is actuarially determined in accordance with guidelines set forth in the Internal Revenue Code. The majority of total deferred tax liabilities are attributable to DAC, which represents the difference between the policy acquisition costs capitalized for U.S. GAAP purposes and those capitalized for tax purposes, as well as the difference in the resulting amortization methods.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, carryback and carryforward periods, and tax planning strategies in making this assessment. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. There was no deferred tax asset valuation allowance at December 31, 2014 and 2013.
The Company has direct and indirect ownership of a group of controlled foreign corporations in Canada. We have asserted a position of permanent reinvestment for the difference in share basis and certain operational earnings. Such operational earnings if not permanently reinvested would have generated a deferred tax liability of approximately $10.6 million as of December 31, 2014. For those operational earnings for which we have not made a permanent reinvestment assertion, we have established a deferred tax liability to account for the U.S. tax liability that will occur upon repatriation of such earnings. As of December 31, 2014, we had approximately $28.5 million in Canadian operational earnings available to be repatriated to the U.S. for which we have not made a permanent reinvestment assertion.
The total amount of unrecognized benefits on uncertain tax positions that, if recognized, would affect our effective tax rate was approximately $8.9 million and $8.3 million as of December 31, 2014 and 2013, respectively. We recognize interest expense related to unrecognized tax benefits in tax expense net of federal income tax. As of December 31, 2014 and 2013, the total amount of accrued interest and penalties in the consolidated balance sheets were approximately $2.6 million and $2.9 million, respectively. Additionally, we recognized interest related to unrecognized tax benefits in the consolidated statements of income of less than $0.1 million of expense in 2014 and 2013 and approximately $0.1 million of benefit in 2012.
In connection with our corporate reorganization, we entered into a tax separation agreement with Citigroup, whereby Citigroup agreed to indemnify the Company against any consolidated, combined, affiliated, unitary or similar federal, state or local income tax liability related to any taxable period ending on or before April 2010. As of December 31, 2014, the Company had a Citigroup tax indemnification asset of $4.8 million.
The above reconciliation excludes RSUs, which do not have voting rights. As RSUs lapse, we issue common shares with voting rights. As of December 31, 2014, we had a total of approximately 1.2 million RSUs outstanding.
In 2013, we repurchased the remaining equity interest in our Company held by Warburg Pincus, which included approximately 2.5 million shares of our common stock and all outstanding warrants. The per-share purchase price was determined based on the closing price of our common stock on May 28, 2013, which was the execution date of the agreement to repurchase the shares, and the purchase price per warrant was equal to the per-share purchase price less the warrant exercise price per underlying share as noted above.
In November 2013, our Board of Directors authorized a share repurchase program for up to $150.0 million of our outstanding common stock (the “share repurchase program”). Under the share repurchase program, we repurchased 3,016,615 shares of our common stock in open market transactions for an aggregate purchase price of approximately $147.9 million in 2014. As of December 31, 2014, there was approximately $2.1 million remaining for repurchases of our outstanding common stock under the share repurchase program.
Unvested restricted stock and unvested RSUs are deemed participating securities for purposes of calculating EPS as they maintain dividend rights. We calculate EPS using the two-class method. Under the two-class method, we allocate earnings to common shares (excluding unvested restricted stock) and vested RSUs outstanding for the period. Earnings attributable to unvested participating securities, along with the corresponding share counts, are excluded from EPS as reflected in our consolidated statements of income.
Restricted Stock and RSUs. The Company granted shares of restricted stock and RSUs to management (“management restricted stock and RSU awards”) as follows:
In 2013, non-employee directors received RSUs that have time-based vesting requirements that lapse approximately one year after the grant date. These awards also contain post-vesting sale restrictions until the non-employee director no longer serves on our Board.
In 2014, non-employee directors received RSUs that have time-based vesting requirements with equal and annual graded vesting over four quarters subsequent to the grant date. These awards also contain post-vesting sale restrictions until the non-employee director no longer serves on our Board.
In addition, certain directors elected to defer their cash and/or equity retainers into deferred RSUs, which vest immediately or on the dates the RSUs would have vested, respectively.
Stock Options. Beginning in 2013, the Company issued stock options to certain of its executive officers under the OIP as part of their annual equity compensation. The remaining annual equity compensation for these executive officers was granted in the form of management restricted stock awards and RSUs discussed above. Stock options are generally granted with an exercise price equal to the fair market value of our common stock on the grant date, and they expire 10 years from the date of grant. These options have time-based restrictions with equal and annual graded vesting over a three-year period. Stock options issued in 2014 are included in the equity awards that were modified to provide for such awards to vest upon the voluntary termination of employment by any employee who is “retirement eligible” as of his or her termination date. Upon retirement, employees have the lesser of three years or the remaining option term to exercise any vested options.
The following assumptions were used to estimate the fair value of stock options granted:
The following table summarizes activity related to stock options outstanding and exercisable during the years ended December 31, 2014 and 2013.
The intrinsic value of options exercised and the tax benefit realized from the options that were exercised during the year ended December 31, 2014 was approximately $53 thousand and $19 thousand, respectively. The value of issued shares that were withheld to satisfy the exercise price for stock options exercised during the year ended December 31, 2014 was approximately $142 thousand. As of December 31, 2014, there was approximately $0.5 million of total unrecognized compensation cost related to unvested options, and the weighted-average period over which cost will be recognized was approximately 0.9 years. Compensation costs related to stock option awards were impacted by plan modifications, resulting in the accelerated recognition of expense for certain equity awards. Although the expense related to these modifications have been recognized, the respective equity awards are included in the above table until such time as the retirement eligible employees elect to retire. See the modifications section below for more details.
Modification of Equity Awards Issued to Management in 2014. All unrecognized equity compensation expense for the modified awards granted to retirement eligible employees as of the date of the modification was recognized immediately during the third quarter of 2014 as there is no remaining substantive future requisite service period for these awards. The modification affects the timing of expense recognition for the modified awards and not the total amount of expense to be recognized given that the amount of awards expected to vest under the original service condition is not significantly different from the amount of awards now expected to vest after the modification. Almost one-third of our 2014 management equity award recipients were retirement eligible as of the date the modification was made. As a result of this modification, approximately $4.6 million of equity compensation expense for the modified awards was accelerated into 2014 rather than being recognized over the three-year vesting period of the award. This expense acceleration in 2014 will reduce the originally scheduled equity compensation expense for the modified awards in each subsequent period through the final vesting date in 2017. The retirement eligibility provision is expected to be included in equity awards granted to management in future periods.
The following table summarizes non-employee RSU activity during the years ended December 31, 2014, 2013, and 2012.
The following table presents the assumptions used in valuing quarterly RSU grants to agents:
To the extent that these awards are an incremental direct cost of successful acquisitions or renewals of life insurance policies that result directly from and are essential to the policy acquisition(s) and would not have been incurred had the policy acquisition(s) not occurred, we defer and amortize the fair value of the awards in the same manner as other deferred policy acquisition costs. All agent equity awards that are not directly related to the acquisition or renewal of life insurance policies are recognized as expense over the requisite vesting period.
Primerica Life’s statutory net gain from operations was approximately $267.4 million and $306.7 million in 2014 and 2013, respectively. Primerica Life made no pro rata distributions of any class of its own securities during 2014 or 2013. During 2014, Primerica Life paid ordinary dividends of $235.0 million to the Parent Company and had estimated ordinary dividend capacity of approximately $9.8 million as of January 1, 2015.
We established a defined contribution plan for the benefit of our employees in 2010. The expense associated with this plan was approximately $6.5 million, $6.5 million, and $6.4 million in 2014, 2013, and 2012, respectively.