JP Life owns its home office consisting of a 20-story building and an adjacent 17-story building in downtown Greensboro, NC. These buildings house insurance operations and provide space for commercial leasing. JP Life also owns a supply and printing facility, a parking deck and a computer center, all located on nearby properties.
Subsidiaries lease insurance sales and broker/dealer office space in various jurisdictions.
JPCC owns its three television studios and office buildings, owns most of its radio studios and offices, and leases the towers (or portions of a tower) supporting its radio and television antennas.
Effective January 1, 2001, the Company adopted SFAS Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended.
Reportable segment results is a non-GAAP measure. See discussion in the MD&A under the section heading, “Results by Business Segment.” Effective January 1, 2002, the Company ceased amortization of goodwill as a result of the adoption of a new accounting standard (See Note 2).
See Item 1 “Business” for discussion of our proposed merger with an affiliate of Lincoln National Corporation (LNC or Lincoln).
In October 2005, a proposed shareholder class action suit was filed in state court in North Carolina naming the Company, most of the individual members of its Board of Directors and LNC as defendants, relating to the merger. The suit alleged a breach of fiduciary duty in entering into the proposed merger and has subsequently been dismissed without prejudice subject to the restriction that the plaintiffs receive the court’s permission before filing any other action asserting the same claims in North Carolina or any other jurisdiction. This voluntary dismissal of the action did not involve a settlement or any compensation being paid or promised to the plaintiffs.
JP is a holding company whose financial services and broadcasting subsidiaries provide products and services in four major businesses: 1) life insurance; 2) annuities and investment products; 3) group life, disability and dental insurance; and 4) broadcasting and sports programming production.
In our three financial services segments, effective investment management and asset/liability management are important to our financial position and results of operations. Interest spread, which represents the difference between interest earned on our investments and interest credited to policyholder funds, is a key component of our results for individual life insurance and annuities products. The earned rate on our investment portfolio has declined steadily in recent years as a result of the decline in the general interest rate environment. We believe that the historically low interest rate levels that we have experienced will continue to challenge our earnings progression. Our operating results also depend on the level of mortality (death) and morbidity (disability and health) costs we incur. We attempt to address these factors through underwriting risk selection and classification, by adjusting policyholder crediting rates to achieve desired spread performance for our individual life insurance and annuity products, by monitoring claim and industry health care trend reports for our group insurance products, and through a focus on conservative product designs. Also, we record substantial intangible asset balances because we defer commissions and expenses incurred in selling new policies (deferred
Traditional products require the policyholder to pay scheduled premiums over the life of the coverage. We recognize traditional premium receipts as revenues and profits are expected to emerge in relation thereto. Because of market preferences, we do not currently offer new traditional products except for term life insurance.
Product development is important to growth in sales. We operate within a competitive marketplace by offering products that respond to demographic changes, the evolving financial needs of our customers, and regulatory requirements. We currently sell individual life insurance products designed to provide our customers vehicles for wealth accumulation, mortality protection, and a balance between those two objectives. Because this segment issues long-duration contracts, sales results may not materially impact current period profitability, but longer-term sales trends are an important indicator of future growth in earnings.
Our Annuity and Investment Product (AIP) segment primarily offers our proprietary fixed annuity products. We also sell mutual funds and other investment products through our broker/dealer. We earn interest spreads and policy charges on our annuity products, and recognize revenues from concession income earned on investment product sales by our broker/dealer. The principal source of segment results is investment spreads on policyholder fund balances. Investment selection and matching of interest rate risk profiles of investments to those of policyholder fund balances are critical to achieving successful results within this segment. In recent years, historically low interest rates have reduced the margin between rates we credit to policyholder accounts and those that are guaranteed under contractual provisions, which limits our ability to reduce crediting rates. We have responded to that exposure through innovative product designs that reduce spreads required to achieve desired returns. Because we derive a majority of our earnings from spread management activities, trends in policyholder fund balances and effective investment spreads earned are both important drivers of segment results.
Product development activities are important to providing appropriate products to a highly competitive marketplace. We have introduced new products with fixed-interest and equity-index components over the last three years. With careful hedging of the economic risk of equity-index components, the emergence of profits on these products is similar to other fixed-interest products. Sales of traditional fixed-interest and multi-year guarantee products declined in recent years because of competition from other financial services products within a declining interest rate environment. New fixed annuity premium sales and surrenders of existing policies are both key indicators of trends in policyholder fund balances.
Our Benefit Partners segment insures individuals for mortality, morbidity and dental costs under master group insurance contracts with employers. This segment offers various forms of contributory and noncontributory plans, as well as supplemental contracts. Most of our group contracts are sold to employers with fewer than 500 employees. We select and classify risks within a competitive marketplace based on group characteristics, applying actuarial science and group underwriting practices. We may adjust premiums charged for insuring group risks, usually on an annual basis, in relation to evolving group characteristics and subject to policyholder acceptance.
Effective March 1, 2004, we acquired substantially all of the U.S.-based group life, disability and dental business of The Canada Life Assurance Company, an indirect subsidiary of Great-West Lifeco Inc., via a reinsurance transaction. As a result of this acquisition, we are positioned with approximately $1 billion of annual group life, disability and dental premiums. See Note 14 for further discussion of the details of this transaction.
The Individual Products, AIP and Benefit Partners segments defer the costs of acquiring new business. These costs include first-year commissions and incentive compensation and certain costs of underwriting and issuing policies plus agency office expenses. These deferred expenses are referred to as deferred policy acquisition costs (DAC). When we acquire new blocks of business through an acquisition, we allocate a portion of the purchase price based on relative fair values to a separately identifiable intangible asset, referred to as value of business acquired (VOBA). We initially establish VOBA as the actuarially determined present value of future gross profits of each business acquired. Both DAC and VOBA are amortized through expenses, as discussed further below.
DAC and VOBA on UL-type products were $2,246.7 or 76.8% of the gross balances (before adjustments for unrealized gains and losses) at December 31, 2005, including $523.9 related to VUL products. We amortize DAC and VOBA on UL-type products and annuity products relative to the future estimated gross profits (EGP) over the life of these products. In calculating the future EGP for these products, management must make long-term assumptions regarding the following components: 1) estimates of fees charged to policyholders to cover mortality, surrenders and maintenance costs; 2) estimated mortality in excess of fund balances accumulated; 3) expected interest rate spreads between income earned, including default charges paid to the Corporate and Other segment, and amounts credited to policyholder accounts; and 4) estimated costs of policy administration (maintenance).
We regularly review the models, and the assumptions we used in them, so that the modeled EGPs reflect management’s current view of future events. At least annually, we compare these assumptions to emerging experience on each of our insurance blocks. Short-term deviations in experience, which are reflected as assumption true-up adjustments, do not necessarily indicate that a change to our long-term assumptions of future experience is warranted. If we determine that it is appropriate to change our long-term assumptions of future experience, we recognize unlocking adjustments for the block of business being evaluated. Certain assumptions, such as interest spreads and lapse rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The balances of DAC, VOBA, unearned revenue reserves and secondary guarantee benefit reserves (discussed in Note 6) are immediately impacted by any assumption changes with the change reflected through the income statement. These adjustments can be positive or negative.
We consider estimated interest spreads and estimated future policy lapses to be the most significant assumptions related to our annuity products. DAC and VOBA on these products were $373.4 or 12.8% of the gross balances (before adjustments for unrealized gains and losses) at December 31, 2005, including $11.2 related to VA products.
See Results of Operations for discussion of unlocking adjustments we recorded for the three years ended 2005.
Mortgage loans on commercial real estate represented 14.2% of investments at December 31, 2005 and are stated at unpaid balances, net of estimated unrecoverable amounts. In addition to a general estimated allowance, we provide an allowance for unrecoverable amounts when a mortgage loan becomes impaired. We consider a mortgage loan to be impaired when it becomes probable, based upon management’s judgment, that the Company will be unable to collect the total amounts due, including principal and interest, according to contractual terms. We measure the impairment based upon the present value of expected cash flows discounted at the effective interest rate on both a loan-by-loan basis and by measuring aggregated loans with similar risk characteristics. We base the general estimated allowance on historical experience, industry experience and other qualitative factors.
The accounting for secondary guarantee benefit reserves (related to no-lapse guarantees) impacts, and is impacted by, certain elements of estimated future gross profits used to calculate
amortization of DAC, VOBA and unearned revenue reserves. If experience or an assumption changes, we unlock secondary guarantee benefit reserves to reflect the changes in a manner similar to DAC, VOBA and unearned revenue reserves. Secondary guarantee benefit reserves are reported within “Other policy liabilities” in our consolidated balance sheets.
At December 31, 2005 and 2004, the fair values of the assets related to the defined benefit pension plans were $396 and $397. The stability in the value of assets reflects the fact that the sum of investment returns and employer contributions nearly equaled benefits paid. The projected benefit obligations at December 31, 2005 and 2004 were $442 and $405 with the majority of the growth due to the impact of using a lower discount rate in the liability calculations for 2005 due to the lower interest rate environment. Net periodic benefit cost, which includes service cost, interest cost, return on plan assets and net amortization and deferrals of actuarial and investment gains and losses, was $11, $7 and $1 for 2005, 2004 and 2003. The increase in net periodic benefit cost in 2005 was due to increased interest cost on the projected benefit obligation and amortization of plan asset investment losses.
Establishing accruals for specific litigation inherently involves a variety of estimates of future potential outcomes. Accordingly, management, based on the advice of internal counsel, reviews significant litigation matters and makes judgments about whether it is probable we have incurred a loss. Once we determine that a loss is probable, we use professional judgment in determining whether we can reasonably estimate the loss. In general, we accrue the estimated costs of defense until we can reasonably estimate the loss or any potential range of possible loss. At that time, we accrue these additional costs. Based on consultation with our legal advisors, we believe that resolution of pending legal proceedings will not have a material adverse effect on our financial position or liquidity but could have a material adverse effect on the results of operations for a specific period. See further discussion in Note 18.
The increase in income before cumulative effect of change in accounting principle for 2005 reflected earnings growth in all segments except Corporate and Other, partially offset by lower realized investment gains. Individual Products benefited from an increase in interest margin and higher product charge revenue. Results for 2005 also included the effect of management actions taken during the first quarter to reduce non-guaranteed bonuses on certain older universal life products. AIP’s results increased for 2005 due to higher investment spreads, including a favorable change in the fair value of option liabilities related to equity-indexed annuities, partially offset by higher DAC amortization and lower incremental investment income above base (which includes mortgage loan prepayment fees, accelerated accretion of discount on mortgage-backed securities, and income on purchased beneficial interests). Benefit Partners results continued to be driven by organic growth in our core business, partially offset by adverse claim experience in the core long-term disability and life business, and favorable claim experience and reserve development in the acquired Canada Life block. Communications achieved earnings growth on higher sports production revenue and expense controls.
Corporate and Other results were lower in 2005 primarily due to the impact of higher short-term interest rates and lower realized investment gains as discussed below.
Earnings per share amounts were more favorable than the growth in absolute earnings due to repurchases of 3,175,500 shares in 2005, 5,368,200 shares in 2004, and 3,578,600 shares in 2003.
The following table illustrates our results before and after realized investment gains and losses, and reconciles reportable segment results to net income, the most directly comparable GAAP financial measure:
response to changes in investment yields by adjusting the rates credited to policyholder fund balances (up or down), while considering product pricing targets, policyholder value, and competitive conditions. The investment spread statistics that follow include the tax impact of benefits from certain securities discussed above that is reflected in income tax expense. The average investment spread on fixed UL products decreased 2 basis points to 1.91% in 2005 after having decreased 10 basis points in 2004 to 1.93%. Reductions in our crediting rates partially offset the reduction in investment yields compared to 2004. During 2003, prepayments of mortgage-backed securities significantly increased as a result of continued declines in long-term mortgage rates, but then declined rapidly in both 2004 and 2005 as mortgage rates stabilized. This decline was partially offset by an increase in commercial mortgage loan prepayments in 2004 and to a lesser extent in 2005. Our mortgage-backed securities portfolio is primarily a discount portfolio. We estimate that prepayments on mortgage-backed securities in excess of expected levels and prepayments of commercial mortgage loans increased effective investment yields by 5, 12 and 20 basis points in 2005, 2004 and 2003. The decrease in excess accretion of discount on mortgage-backed securities contributed to the decline in effective investment spreads on fixed UL products in both 2005 and 2004. Our ability to manage interest-crediting rates on fixed UL-type products is limited by minimum guaranteed rates provided in policyholder contracts. Therefore, continued low general market interest rates likely will impact future profitability, as the investment of cash flows at current interest rates reduces our average portfolio yield. At the end of 2005 and 2004, our average crediting rates were approximately 31 and 37 basis points in excess of our average minimum guaranteed rates (spread-to-guarantee), including 58% and 55% of our UL policyholder fund balances that were already at their minimum guaranteed rates. Additionally, the spread-to-guarantee presented above was revised, effective January 1, 2005, to include the effect of non-guaranteed interest bonuses that management has the discretion to reduce. A large portion of the remaining spread-to-guarantee relates to products that are currently being marketed, sales of which could be negatively impacted if we reduced crediting rates further.
Individual expenses (including the net deferral and amortization of DAC and VOBA) are as follows:
Expenses excluding amortization of DAC and VOBA decreased in 2005 due to higher capitalization of commissions and general and administrative expenses. Expenses excluding amortization of DAC and VOBA were approximately flat versus 2003, consistent with sales. The expense amounts we capitalize as DAC include first-year commissions and deferrable acquisition expenses. Higher sales in 2005 contributed to the increases in gross commissions and acquisition-related expenses and also resulted in a higher proportion of these expenses being capitalized. Taxes, licenses and fees increased in 2005 due to higher premium volumes in 2005. Taxes, licenses and fees were favorably impacted in both 2005 and 2004 from reductions in our effective tax rate and state income tax accrual releases following the filing of the tax returns. Growth in our insurance blocks for UL-type products was the primary contributor to the increases in the amortization of DAC and VOBA in the three years presented. Unlocking of assumptions for interest spreads, mortality and lapsation on our blocks of business resulted in reductions in DAC and VOBA amortization on UL-type products of $26.7, $26.4 and $17.8 in 2005, 2004 and 2003. The unlocking adjustments in 2005 include the effect of the COI bonus accrual release in the first quarter, which reduced amortization of DAC and VOBA for UL-type products by $16.5. These adjustments to DAC amortization are partially offset by corresponding adjustments to unearned expense charges discussed above. Excluding unlocking adjustments, amortization of DAC and VOBA increased in 2005 compared to 2004 due to growth in our UL-type insurance blocks, partially offset by the effect of favorable persistency and accounting for secondary guarantee benefit features, which extends the term of estimated gross profits and thereby reduces the rate of amortization. See further discussion of DAC and VOBA under the Critical Accounting Policies and Estimates section.
For a discussion of some of the risks that we consider to be most significant to the Company and in certain cases this segment please see Item 1A “Risk Factors.”
Annuity and Investment Products (AIP) are marketed through most of the distribution channels discussed in Individual Products above as well as through financial institutions, investment professionals and annuity marketing organizations. JPSC markets primarily variable life insurance written by our insurance subsidiaries and other carriers, and also sells other securities and mutual funds.
Fixed annuity premium sales declined in 2005 versus 2004 as a result of the effects of a flattening interest rate yield curve, competition from other products, the expectation for a rising interest rate environment, and distraction, particularly in the agency channel, from a notice issued by the NASD suggesting broker/dealer supervisory responsibility for sales of equity-indexed annuity products. The 2004 increase in fixed annuity premium sales resulted from the increased acceptance in the marketplace of equity-indexed annuities (EIAs) introduced in the latter part of 2003. Equity-indexed annuities (EIAs) comprised over three-fourths of our AIP sales during 2005 and 2004. We continue to develop differentiated annuity products designed to create new distribution opportunities and strengthen existing marketing relationships.
We actively manage spreads on fixed annuity products in response to changes in our investment portfolio yields by adjusting the interest rates we credit on annuity policyholder fund balances while considering our competitive strategies. Our newer product designs in AIP require lower
The Benefit Partners segment markets products primarily through a national distribution system of regional group offices. These offices develop business through employee benefit brokers, third-party administrators and other employee benefit firms.
The following table summarizes key information for Benefit Partners that we believe to be important drivers and indicators of our future profitability:
Policy benefits increased 2.5% in 2005 as a result of core business growth and adverse experience in the core non-Canada Life block, substantially offset by favorable claim experience and reserve development in the Canada Life block. The improved combined loss ratio for 2005 of 71.1% was primarily due to favorable experience in our life business. In particular, our life business experienced favorable waiver claims terminations in the Canada Life block in the first half of the year stemming from effective claims management. In long-term disability, we experienced favorable claims
One of our non-core products, Exec-U-Care®, which provides an insured medical expense reimbursement vehicle to executives for non-covered health plan costs, produced revenues for this segment of approximately $140 and reportable segment results of approximately $2 in 2005. A discontinuation of Exec-U-Care® would have a significant impact on segment revenues, but only a limited effect on reportable segment results.
JPCC operates radio and television broadcast properties and produces syndicated sports programming. Reportable segment results(1)for Communications were as follows:
Communications revenues and earnings increased in 2005 due to strong growth in sports and modest growth in radio. Revenues from sports operations increased $5.0 in 2005 and $4.5 in 2004 due to increased demand for both our football and basketball products. In 2005, combined revenues for radio and television increased 0.2% due to improved revenue shares in several radio markets and modest growth in two of our radio and one of our television markets. Typically, political advertising favorably impacts revenues in even-numbered years and consequently, television revenues declined in 2005. Excluding the impact of political revenues, revenues from television increased 5.3% in 2005 and 4.3% in 2004.
Broadcast cash flow, a non-GAAP measure that is commonly used in the broadcast industry, is calculated as communications revenues less operating costs and expenses before depreciation and amortization. Broadcast cash flow increased in 2005 and 2004 due to increases in revenues discussed above combined with effective operating expense control in all of the businesses.
Earnings on investments and other income increased $8.1 in 2005, including an increase in real estate and mortgage loan income, income recovery on defaulted bonds, and default charges. This increase would have been larger but for $4.0 received from a Bank of America merger class action suit that settled in the first quarter of 2004. Default charges are received from the operating segments for this segment’s assumption of all credit-related losses on the invested assets of those segments. These charges are calculated in part as a percentage of invested assets. Default charge income for 2005, 2004 and 2003 was $39.5, $38.5 and $31.3. The 2005 and 2004 increases resulted from an increase in investment assets, including Canada Life in 2004, and a change in fixed income securities’ asset mix. Earnings on investments in this segment can fluctuate based upon opportunistic repurchases of our own common stock, the amount of excess capital generated by the operating segments and lost investment income on bonds defaulted or sold at a loss.
The realized investment gains in 2005 and 2004 sharply contrasted with the realized investment losses experienced in 2003. The decline in realized investment gains in 2005 versus 2004 was primarily due to significantly lower stock gains, and the improvements in both years over 2003 reflected lower bond impairments, largely attributable to continued improvement in the corporate credit environment.
We reflect provisions for credit-related losses in our estimated gross profits when calculating DAC and VOBA amortization for UL-type products. As reflected in the preceding table, we record DAC amortization on realized gains and losses on investments that back UL-type products. We further discuss modeling of expected gross profits related to DAC and VOBA in the Critical Accounting Policies and Estimates section.
we have the option to borrow at various interest rates. The agreement, as amended on May 7, 2004, aggregates $348, which is available until May 2007. The credit agreement principally supports our issuance of commercial paper.
Outstanding commercial paper has various maturities that can be up to 270 days. If we cannot remarket commercial paper at maturity, we have sufficient liquidity, consisting of the bank credit agreements, liquid assets, such as equity securities, and other resources to retire these obligations. The weighted-average interest rates for commercial paper borrowings outstanding of $261 and $188 at December 31, 2005 and 2004 were 4.31% and 2.30%. The maximum amount outstanding in 2005 was $306 compared to $298 after the January issuance of the term debt and EXLs during 2004.
LIBOR plus a spread, which increases annually to a maximum of 10 basis points. The proceeds from the debt issuances were used to support the Canada Life acquisition and to pay down commercial paper while rebalancing the mix of fixed and floating rate debt and short and long term maturities in our capital structure.
Stockholders’ equity decreased $17 in 2005 compared to an increase of $128 in 2004. Unrealized gains on available-for-sale securities, which are included as a component of stockholders’ equity, decreased $237 and increased $12 in those years. The remaining change in stockholders’ equity reflects net income, dividends to stockholders, changes in the fair values of derivatives, changes in the minimum pension liability, and common share activity due to issuance of shares under our stock option plans and share repurchases. Our ratio of stockholders’ equity to assets excluding separate accounts was 11.7%, 12.0% and 12.5% at December 31, 2005, 2004 and 2003.
As mentioned earlier, our insurance subsidiaries have statutory surplus and risk based capital levels well above regulatory required levels. These capital levels together with the rating agencies’ assessments of our business strategies have enabled our major life insurance affiliates to attain the following financial strength ratings:
The ratings by A.M. Best and Standard & Poor’s are currently the highest available by those rating agencies, while the ratings by Fitch Ratings is that agency’s second highest rating. All of these ratings were reaffirmed in 2005. A significant drop in our ratings, could potentially impact future sales
and/or accelerate surrenders on our business in force. Concurrent with the proposed merger announcement discussed earlier in the Overview section, our ratings were placed under review with negative implications, reflecting the rating agencies’ assessments of the merged entity that will exist following the closing of the transaction.
Liquidity management is designed to ensure that adequate funds are available to meet all current and future financial obligations. The Company meets its liquidity requirements primarily by positive cash flows from the operations of subsidiaries, and to a lesser extent, cash flows provided by debt securities and borrowings. Primary sources of cash from the Communications operations are revenues from broadcast advertising, and primary uses include payments for commissions, compensation and related costs, sports rights, interest, income taxes and purchases of fixed assets.
Net cash provided by operations in 2005, 2004 and 2003 was $476, $991 and $537. The changes reflect higher federal income tax payments in 2005 and lower payments in 2004, and the proceeds received in the Canada Life reinsurance transaction.
Net cash used in investing activities was $979, $1,786 and $1,420 in 2005, 2004 and 2003. The decline from 2004 is primarily due to higher investment purchases last year from cash received in the Canada Life transaction and to lower sales of EIAs in 2005. In 2004, investment purchases increased substantially due to cash received in the Canada Life transaction and from higher sales of EIAs.
The following table details our contractual obligations, including principal and interest where applicable, at December 31, 2005. The amounts in the table are different than those reported in our consolidated balance sheet at December 31, 2005 due to the consideration of interest in debt obligations and discounted estimates of future payments for policy liabilities excluding the impact of future premium revenues. Some of the figures we include in this table are based on management’s estimates and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties, and other factors. Because these estimates and assumptions are necessarily subjective, the enforceable and legally binding obligations we will actually pay in future periods are likely to vary from those reflected in the table.
External commercial paper and reverse repurchase agreements represent short-term debts that are due in less than one year.
As discussed earlier, a life insurance subsidiary of the Company established a program in 2005 for an unconsolidated special purpose entity, Jefferson-Pilot Life Funding Trust I (the Trust), to sell medium-term notes through investment banks to commercial investors, and $300 were sold in June 2005. The funding agreements issued to the Trust are classified as a component of policy liabilities within the consolidated balance sheets.
As discussed earlier, the floating-rate EXLs currently were renewed in November 2005, subject to periodic extension through 2011. For purposes of this table, we have assumed these securities will be extended until 2011 and have calculated interest payments by applying the spreads defined in the agreement to 1-year LIBOR forward rates.
The payments for the 10-year term notes are based on the amortization schedule included in the debt agreement.
As discussed under “Capital Resources”, the junior subordinated debentures mature in 2046, or earlier at our option beginning in 2007. For purposes of this table, we have assumed the debentures will be paid off in 2007. We expect the funds needed to pay off these debentures would come from new, lower cost borrowings.
The following table shows the carrying values of our invested assets.
The following table summarizes by category the unrealized gains and losses in our entire securities portfolios, including common stock and redeemable preferred stock, as of December 31, 2005:
Our internal guidelines require an average quality of an S&P or equivalent rating of “A” or higher for the entire bond portfolio. At December 31, 2005, the average quality rating of our bond portfolio was “A”, which equates to a rating of 1 from the National Association of Insurance Commissioners’ Securities Valuation Office (SVO). We monitor the overall credit quality of our portfolio within internal investment guidelines. This table describes our debt security portfolio by credit rating.
At December 31, 2005 and 2004, below investment grade bonds were $1,334 or 6.0% and $1,299 or 5.9% of the carrying value of the bond portfolio, reflecting sales, purchases, upgrades and downgrades of below investment grade bonds that occurred in 2005.
As noted above, credit risk is inherent in our bond portfolio. We manage this risk through a structured approach in which we assess the effects of the changing economic landscape. We devote a significant amount of effort of both highly specialized, well-trained internal resources and external experts in our approach to managing credit risk.
In identifying “potentially distressed securities”, we review all securities held, with a particular emphasis on securities that have a fair value to amortized cost ratio of less than 80%. However, as part of this identification process, management must make assumptions and judgments using the following information:
past due interest or principal payments or other violation of covenants; and
fundamental analysis of the liquidity and financial condition of the specific issuer;
time period in which the fair value has been significantly below amortized cost;
The following table shows the maturity date distribution of our debt securities in an unrealized loss position at December 31, 2005. The fair values of these securities could fluctuate over the respective periods to maturity or any sale.
Of the $245 gross unrealized losses on debt securities at December 31, 2005, $10.9 was included in our potentially distressed securities list of which $5.8 has been on the list for less than six months.
Realized losses are comprised of both write-downs on other-than-temporary impairments and actual sales of securities.
In 2005 we incurred losses of $19.8 on sales of securities. There were no individually material losses on sales of securities in 2005. After consideration of all available evidence, none of these disposals previously met the criteria for other-than-temporary impairment. The Company will continue to manage its AFS portfolio in a manner that is consistent with the available-for-sale classification.
than our current portfolio yields, producing less investment income going forward. During 2005, our MBS exposure increased slightly due to portfolio sales of corporate bonds being reinvested in MBS.
We record mortgage loans on real property net of an allowance for credit losses. This allowance includes reserve amounts for specific loans, and a general reserve that is calculated by review of historical industry loan loss statistics. We consider future cash flows and the probability of payment when we calculate our specific loan loss reserve. At December 31, 2005 and 2004, our allowance for mortgage loan credit losses was $15.0 and $21.2. Prepayments on mortgage loans may result from sales of the related properties or loan refinancings. Prepayments on mortgage loans were $14.1, $17.1 and $4.4 in 2005, 2004 and 2003, and proceeds were reinvested at lower yields. See Note 4 for more detail regarding the composition and concentration of our mortgage loan portfolio.
We purchase S&P 500 Index® options in conjunction with our sales of equity-indexed annuities. Included in our consolidated balance sheets at December 31, 2005 and 2004 are $107 and $72 related to these options. We discuss the impact of these index options on our consolidated statements of income within the Annuity and Investment Products segment results section. Also, our investment guidelines permit use of derivative financial instruments such as futures contracts and interest rate swaps in conjunction with specific direct investments.
Except as described above, our actual use of derivatives through December 31, 2005 has been limited to managing well-defined interest rate risks. Interest rate swaps utilized in our asset/liability management strategy with a current notional value of $661 and $339 were open as of December 31, 2005 and 2004. We use interest rate swaps to hedge prospective bond purchases to back deposits on certain annuity contracts. This hedging strategy protects the spread between the annuity crediting rate offered at the time the annuities are sold and the yield on bonds to be purchased to back those annuity contracts. These interest rate swap contracts are generally terminated within a month. The notional amount of interest rate swaps increased by $300 in the second quarter of 2005 related to the issuance of $300 of funding agreements in June 2005. The duration of this swap matches the duration of the related funding agreements (three years, at issuance).
Since our assets and liabilities are largely monetary in nature, our financial position and earnings are subject to risks resulting from changes in interest rates at varying maturities, changes in spreads over U.S. Treasuries on new investment opportunities, changes in the yield curve, and equity price risks. In 2005, the average daily 10-year U.S. Treasury rate increased 2 basis points to 4.28% as compared to 4.26% in 2004.
In a falling interest rate environment, the risk of prepayment on some fixed income securities increases and funds prepaid are then reinvested at lower yields. We limit this risk by concentrating the fixed income portfolio mainly on non-callable securities and by purchasing securities that provide for “make-whole” type prepayment fees. Falling interest rates can also impact demand for our products, as interest-bearing investments with no surrender charges and higher average returns from equity markets may become more attractive to new and existing customers. Conversely, in a rising interest rate environment, competitive pressures may make it difficult for us to sustain spreads between rates we credit on interest-sensitive products and our portfolio earnings rates, thereby prompting withdrawals by policyholders. We manage these risks by adjusting our interest crediting rates with due regard to the yield of our investment portfolio, minimum rate guarantees and pricing assumptions and by prudently
As is typical in the industry, our life and annuity products contain minimum rate guarantees regarding interest we credit. For interest sensitive life products, our minimum rates range from 3.0% to 9.0%, with an approximate weighted average of 4.1%. For annuity products, our minimum rates range from 1.5% to 6.0%, with an approximate weighted average of 3.2%.
We also consider the timing of cash flows arising from market risk sensitive instruments and insurance portfolios under varying interest rate scenarios as well as the related impact on reported earnings under those varying scenarios. Market risk sensitive instruments include debt and equity securities available-for-sale and held-to-maturity (including MBS securities), mortgage loans, policy loans, investment commitments, annuities in the accumulation phase and periodic payment annuities, commercial paper borrowings, repurchase agreements, notes payable and interest rate swaps.
The following table shows our estimate of the impact that various hypothetical interest rate scenarios would have on our earnings for a single year, based on the assumptions in our model. We believe that, based upon historically low current interest rates, a symmetrical change in interest rates is not reasonably possible. Our model shows the effect on income with an increase of up to 300 basis points and a decrease of 100 basis points. We believe that the 300 basis point increase or 100 basis point decrease, graded pro-rata over four quarters, reflects reasonably possible near term changes in interest rates as of December 31, 2005. We have also provided the estimated earnings impact for a single year assuming the interest rate changes occur instantaneously. The incremental loss for a year derives primarily from differences in the yield curves and in the sensitivities they introduce to our
Generally, an increase in interest rates will benefit our earnings in the insurance portfolio, yet increase our interest expense on floating rate debt. Conversely, a decrease in interest rates will decrease earnings from the insurance portfolio as minimum rate guarantees have more of an effect and/or competitive conditions would not permit us to reduce crediting rates, while we would benefit from the decline in interest expense on our floating rate debt.
The incremental income or loss for shifts in excess of those shown does not have a linear relationship to the values shown above. The incremental loss resulting from a higher change in interest rates would be proportionally greater due to the optionality of our interest-sensitive assets and liabilities. Similarly, the effect of minimum rate guarantees in our interest-sensitive liabilities would compound the negative impact on the incremental gain (loss), resulting from a greater decrease in interest rates. A significant change in the slope of the yield curve could also affect our results. For example, competing products such as bank CDs could become relatively more attractive than our longer duration annuities under an inverted yield curve, resulting in higher policyholder withdrawals.
We operate within the United States financial services and broadcasting markets, which are both subject to general economic conditions. Interest rates on longer maturity debt instruments stabilized and rebounded slightly in 2005 and 2004 after dropping dramatically in 2003. Additional changes in rates may affect our businesses in many ways as discussed earlier in the Market Risk Exposures section. As noted in the Investments section, the continued improvement in the corporate credit environment experienced in recent years decreased our levels of impairments. A prolonged period of declining or even level interest rates would have an adverse impact on our Individual and AIP segments. Investments purchased for those segments yielding rates lower than our current portfolio yields are lowering our overall portfolio earned rates. In the Individual and AIP segments, there are minimum crediting rates on policyholder accounts inherent in the insurance portfolio due to both product guarantees and various state requirements. Our inability to reduce crediting rates in response to the declines in earned rates would result in a significant negative impact on future earnings. Furthermore, a general economic weakness would cause deterioration in our balance sheet and our overall future profitability.
You should note that this document and our other SEC filings reflect information that we believe was accurate as of the date the respective materials were made publicly available. They do not reflect later developments.
Certain information in our SEC filings and in any other written or oral statements made by us or on our behalf, involves forward looking statements. We have used appropriate care in developing this information, but any forward looking statements may turn out to be wrong. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties that could significantly affect our actual results or financial condition. These risks and uncertainties include among others, the risk that our proposed merger with an affiliate of Lincoln will not be completed or that the resulting larger Lincoln will not be successful; recent tax proposals affecting taxation of life insurance and annuities and competing products, general economic conditions (including the uncertainty as to the duration and rate of the current economic recovery), the impact on the economy from further terrorist activities or US military engagements, and interest rate levels, changes and fluctuations, all of which can impact our sales, investment portfolios, and earnings; re-estimates of policy and contract liabilities; competitive factors, including pricing pressures, technological developments, new product offerings and the emergence of new competitors; changes in federal and state taxes (including past or future changes to general tax rates, dividends, capital gains, retirement savings, and estate taxes); changes in the
We undertake no obligation to publicly correct or update any forward-looking statements, whether as a result of new information, future developments or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our press releases and filings with the SEC. In particular, you should read the discussions in the sections entitled “Risk Factors” and “External Trends and Forward Looking Information,” and other sections they may reference, in our most recent 10-K report as it may be updated in our subsequent 10-Q and 8-K reports. These discussions cover certain risks, uncertainties and possibly inaccurate assumptions that could cause our actual results to differ materially from expected and historical results. Other factors besides those listed there could also adversely affect our performance.
JP’s internal control system was designed to provide reasonable assurance to the company’s management and board of directors regarding the preparation and fair presentation of published financial statements.
In our opinion, management’s assessment that Jefferson-Pilot Corporation and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Jefferson-Pilot Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Jefferson-Pilot Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 of Jefferson-Pilot Corporation and subsidiaries and our report dated March 10, 2006 expressed an unqualified opinion thereon.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Jefferson-Pilot Corporation and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
On October 10, 2005, Lincoln National Corporation (“LNC”) and the Company announced that they had entered into a definitive merger agreement. At closing, the Company’s shareholders will receive 1.0906 shares of LNC common stock or $55.96 in cash for each share of the Company’s common stock, at their election but subject to proration. The aggregate amount of cash to be paid to the Company’s shareholders will equal $1.8 billion. This transaction, which is subject to the approval of shareholders of both companies, regulatory approvals and customary closing conditions, is expected to close at the beginning of the second quarter of 2006.
In the first quarter of 2005, the Company’s net income was impacted by management actions and claims experience, which when taken together increased pretax earnings and net income by $49 and $32 and affects the comparability of earnings results. Management reduced the rates for non-guaranteed cost of insurance bonuses (partial refunds) on certain older UL-type life insurance products. These bonuses are paid to certain policyholders at specified policy anniversaries for continuing coverage. Consequently, we
The consolidated financial statements include the accounts of Jefferson-Pilot Corporation and all other entities in which it has a controlling financial interest. All material intercompany accounts and transactions have been eliminated in consolidation.
The following affiliated trusts are variable interest entities (VIEs): Jefferson-Pilot Capital Trust A, Jefferson-Pilot Capital Trust B and Jefferson-Pilot Life Funding Trust I. VIEs are defined by FASB Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (FIN 46-R). We are not the primary beneficiary of these affiliated trusts and do not have a controlling financial interest. Accordingly, under FIN 46-R, the accounts of these entities are not included in our consolidated financial statements.
Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised, using the treasury stock method.
market data or estimated using an internal pricing matrix for privately placed securities when quoted market prices are not available. This matrix relies on management’s judgment concerning: 1) the discount rate used in calculating expected future cash flows; 2) credit quality; 3) industry sector performance; and 4) expected maturity. Under certain circumstances, we apply professional judgment and make adjustments based upon specific detailed information concerning the issuer.
Real estate acquired by foreclosure is stated at the lower of depreciated cost or fair value less estimated costs to sell. Real estate not acquired by foreclosure is stated at cost less accumulated depreciation. Real estate, primarily buildings, is depreciated principally by the straight-line method over estimated useful lives ranging from 30 to 40 years. Accumulated depreciation was $63 and $59 at December 31, 2005 and 2004. Other investments, which consist primarily of S&P 500 Index® options and affordable housing tax credit investments, are stated at equity, fair value or the lower of cost or market, as appropriate.
The Company uses derivatives to help manage exposure to certain equity and interest rate risks. SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), requires companies to recognize all derivative instruments as either assets or liabilities in their consolidated balance sheets at fair value, which we classify within other investments on our consolidated balance sheets. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, we designate the hedging instrument, based upon the exposure being
The Company includes with cash and cash equivalents its holdings of highly liquid investments that mature within three months of the date of purchase.
Deferred policy acquisition costs and the value of business acquired for variable life and annuity products are amortized incorporating the assumptions listed above for fixed products, except for interest spreads, but also incorporating mean reversion techniques. In calculating the estimated gross profits for these products, the Company utilizes a long-term total net return on assets of 8.0% and a five-year reversion period. The reversion period is a period over which a short-term return assumption is utilized to maintain the model’s overall long-term rate of return. The Company caps the reversion rate of return at 8.25% for one year and 10% for years two through five. Mean reversion techniques result in the application of reasonable yield assumptions to trend the long-term rate of return back to the assumed rate over a period of time following a historical deviation from the assumed long-term rate.
for the effect of non-credit-related realized gains and losses, credit-related gains, and the effects of unrealized gains and losses on debt securities classified as available-for-sale. Deferred policy acquisition costs and value of business acquired are not adjusted for the effect of credit-related losses, rather as a part of the investment income allocation process a charge, referred to as a default charge, is made against the investment income allocated to the Individual Products, Annuity and Investment Products, and Benefit Partners segments. The default charge is based upon the credit quality of the assets supporting each segment and is meant to replicate the expected credit losses that will emerge over an economic cycle. Through this mechanism, the Individual Products, Annuity and Investment Products, and Benefit Partners segments pay a relatively level charge to the Corporate and Other segment and in return are reimbursed when credit-related losses actually occur. See Note 6 for further discussion.
At least annually, the assumptions used to estimate future gross profits in calculating the amortization of deferred policy acquisition costs and value of business acquired are evaluated in relation to emerging experience. When actual experience varies from the assumptions, adjustments are made in the quarter in which the evaluation of the respective blocks of business is completed. The effects of changes in estimated future gross profits on unamortized deferred policy acquisition costs and value of business acquired, referred to as unlockings, are reflected in amortization expense within the consolidated statements of income.
Goodwill (purchase price in excess of net assets acquired in a business combination) carrying amounts are regularly reviewed for indications of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator, or unanticipated competition would cause the Company to review carrying amounts of goodwill for impairment. When considered impaired, the carrying amounts are written down using a combination of fair value and discounted cash flows. No impairments occurred during the three years ending December 31, 2005.
Film and program rights result from license agreements under which the Company has acquired rights to broadcast certain television program material and are stated at cost less amortization. The cost of rights acquired is recorded as an asset within other assets, and an offsetting liability is also recorded in other liabilities when the cost is known or reasonably determinable, and the program material has been accepted and made available for broadcast. Amortization is determined using both straight-line and accelerated methods based on the terms of the license agreements. Carrying amounts are regularly reviewed by
management for indications of impairment and are adjusted when appropriate to estimated amounts recoverable from future broadcast of the applicable program material.
Policyholder contract deposits consist of policy values that accrue to holders of universal life-type contracts and annuities other than portions carried in the separate accounts, discussed above. The liability is determined using the retrospective deposit method and is presented before deduction of potential surrender charges.
The liability for policy and contract claims consists of the estimated amount payable for claims reported but not yet settled and an estimate of claims incurred but not reported, which are based on
Funding agreements consist of investment contracts, which back medium term notes sold by a life insurance subsidiary of the Company through investment banks to commercial investors. Accrued interest on the funding agreements is classified within other policy liabilities on our consolidated balance sheets.
compensation expense for stock option awards to employees or directors when the option price is not less than the market value of the stock at the date of award. The Company recognizes expense utilizing the fair value method in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), for stock options granted to non-employees, specifically agents.
Terms of Loan Products That May Give Rise to a Concentration of Credit Risk
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements” (SFAS 154). SFAS 154 requires retrospective application to prior periods’ financial statements for all voluntary changes in accounting principle, unless impracticable. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS 154 will have no immediate impact on our consolidated financial statements, though it will impact our presentation of future voluntary accounting changes, should such changes occur.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share Based Payment” (SFAS 123-R), which prescribes fair value expense recognition for stock options and is effective for interim and annual periods ending after June 15, 2005. In April 2005, the Securities and Exchange Commission announced the adoption of a new rule that delays our required effective date of SFAS 123-R to January 1, 2006. In August 2005, the FASB issued FASB Staff Position (FSP) No. 123(R)-1, “Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R)” (FSP 123R-1), which indefinitely defers the requirement of SFAS 123-R that a freestanding financial instrument originally subject to SFAS 123-R becomes subject to other applicable GAAP when the rights conveyed by the instrument are no longer dependent on the holder being an employee of the entity. In October 2005, the FASB issued FSP No. 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R)”, which allows the grant date of an award to be the date the award is approved in accordance with an entity’s corporate governance provisions, so long as the approved grant is communicated to employees within a relatively short time period from the date of approval, which is consistent with our current policy.
under SFAS 123-R. The alternative method provides a simplified method to calculate the beginning pool of excess tax benefits and also provides a method of determining the subsequent impact on the pool of awards that are outstanding and fully or partially vested upon the adoption of SFAS 123-R. Finally, FSP 123R-3 also provides guidance on how to present excess tax benefits in the statement of cash flows when the alternative pool calculation is used. The guidance in FSP 123R-3 was effective on November 10, 2005. An entity that adopts Statement 123-R using either the modified retrospective or modified prospective methods described in SFAS 123-R may make a one-time election to adopt the transition method described in FSP 123R-3. An entity may take up to one year from the later of (1) its initial adoption of SFAS 123-R or (2) November 10, 2005, to evaluate its available transition alternatives and make its one-time election.
On May 19, 2004, the FASB issued FSP No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003” (FSP 106-2). FSP 106-2 was issued to address accounting for the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Act) signed into law on December 8, 2003. This Act introduces a prescription drug benefit under Medicare beginning in 2006. Under the Act, employers who sponsor postretirement plans that provide prescription drug benefits that are actuarially equivalent to Medicare qualify to receive subsidy payments. The Company adopted FSP 106-2 effective July 1, 2004 under the prospective application approach. Accordingly, the Company remeasured its plan assets and Accumulated Postretirement Benefit Obligation (“APBO”) as of that date to account for the subsidy and other effects of the Act. See Note 13 for further discussion.
of Paragraphs 10-20 of EITF Issue No. 03-1, ‘The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments’”, which indefinitely deferred the effective date of the other-than-temporary impairment provisions of EITF 03-1 related to interest rates and sector spreads until such time as the FASB issues further implementation guidance.
Aggregate amortized cost and aggregate fair value of debt securities as of December 31, 2005, according to maturity date, were as indicated below. Contractual maturity dates were utilized for all securities except for mortgage-backed securities, which were based upon estimated maturity dates. Actual future maturities may differ from the contractual maturities shown because the issuers of certain debt securities have the right to call or prepay the amounts due the Company, with or without penalty.
The Company uses repurchase agreements to meet various cash requirements. At December 31, 2005 and 2004, the amounts held in debt securities available-for-sale pledged as collateral for these borrowings were $469 and $489.
The fair values of the Company’s derivative instruments were $116 and $82 at December 31, 2005 and 2004 and are included in other investments in the consolidated balance sheets. At December 31, 2005 and 2004, the Company had no fair value hedges or hedges of net investments in foreign operations.
The Company also converts its floating rate funding agreements to a fixed rate using interest rate swaps. Concurrent with the issuance of its floating rate funding agreements in June 2005, the subsidiary executed an interest rate swap for a notional amount equal to the proceeds of the funding agreements. The swap qualifies for cash flow hedge accounting treatment and converts the variable rate of the funding agreements to a fixed rate of 4.28%.
In addition, the Company uses interest rate swaps to hedge anticipated purchases of assets that support the annuity line of business. As assets are purchased, the interest rate swap is unwound resulting in a realized gain (loss) which effectively offsets the change in the cost of the assets purchased to back annuities issued. The gain (loss) is amortized into income over time, resulting in an overall yield that is consistent with the Company’s pricing assumptions.
The Company markets equity-indexed annuities. These contracts permit the holder to elect an interest rate return or an equity market component, where interest credited to the contracts is linked to the performance of the S&P 500® index. Policyholders may elect to rebalance index options at renewal dates, either annually or biannually. At each renewal date, we have the opportunity to re-price the equity-indexed component by establishing participation rates, subject to minimum guarantees. We purchase options that are highly correlated to the portfolio allocation decisions of our policyholders, such that we are economically hedged with respect to equity returns for the current reset period. The mark-to-market of the options held impacts net investment income and interest credited in equal and offsetting amounts. SFAS 133 requires that we calculate fair values of index options we will purchase in the future to hedge policyholder index allocations in future reset periods. These fair values represent an estimate of the cost of the options we will purchase in the future, discounted back to the date of the balance sheet, using current market indicators of volatility and interest rates. Changes in the fair values of these liabilities are reported in interest credited. Interest credited was decreased by $6, $3 and $1 in 2005, 2004 and 2003 for the changes in fair value of these liabilities.
Counterparties to derivative instruments expose the Company to credit risk in the event of non-performance. The Company limits this exposure by diversifying among counterparties with high credit ratings. The Company’s credit risk exposure on swaps is limited to the fair value of swap agreements that it has recorded as an asset. The Company does not expect any counterparty to fail to meet its obligation.
Note 6. Deferred Policy Acquisition Costs, Value Of Business Acquired And Deferred Sales Inducement Asset
The Company uses estimates for determining its liability for accident and health and disability benefits, which are based on historical claim payment patterns and attempt to provide for the inherent variability in claim patterns and severity. In 2005, the amount incurred for accident and health and disability benefits related to prior years was negatively impacted by claims termination experience in our long-term disability business. In 2004, the amount incurred for accident and health and disability benefits related to prior years was favorably impacted by claims termination experience in our long-term disability business. Actual claims experience emerged favorably in 2003.
In June 2005, a life insurance subsidiary of the Company established a program for an unconsolidated special purpose entity, Jefferson-Pilot Life Funding Trust I (the Trust), to sell medium-term notes through investment banks to commercial investors. The notes are backed by funding agreements issued by this subsidiary. The funding agreements are investment contracts that do not subject the subsidiary to mortality or morbidity risk. The medium-term notes issued by the Trust are exposed to all the risks and rewards of owning the funding agreements that collateralize them. The funding agreements issued to the Trust are classified as a component of policy liabilities within the consolidated balance sheets. As spread products, funding agreements generate profit to the extent that the rate of return on the investments earned exceeds the interest credited and other expenses.
In January 2004, the Company issued $300 of 4.75% 10-year term notes and $300 of floating rate EXtendible Liquidity Securities® (EXLs). The EXLs bear interest at LIBOR plus a spread, which increases annually to a maximum of 10 basis points. As of December 31, 2005, the EXLs had a maturity of November 2006 subject to periodic extension through 2011. The proceeds from the debt issuance were used to support the Canada Life transaction and to pay down commercial paper while rebalancing the mix of fixed and floating rate debt and short and long term maturities in the Company’s capital structure.
The maturities of our borrowings outstanding at December 31, 2005, including securities sold under repurchase agreements, are as follows:
Under a shareholders’ rights plan, one common share purchase right is attached to each share of the Company’s common stock. The plan becomes operative in certain events involving an offer for or the acquisition of 15% or more of the Company’s common stock by any person or group. Following such an event, each right, unless redeemed by the Company’s Board, entitles the holder (other than the acquiring person or group) to purchase for an exercise price of $156.67 an amount of common stock of the Company (or in the discretion of the Board, preferred stock, debt securities, or cash), or in certain circumstances stock of the acquiring company, having a market value of twice the exercise price. Approximately 134 million shares of common stock are currently reserved for the amended rights plan. The rights expire on February 8, 2009 unless extended by the Board, and are redeemable by the Board at a price of 0.30 cents per right at any time before they become exercisable.
In October 2005 the rights plan was amended such that the proposed merger transaction discussed in Note 1 will not trigger the plan.
Under the Long Term Stock Incentive Plan, a Committee of independent directors may award nonqualified or incentive stock options and stock appreciation rights, and make grants of the Company’s stock, to employees of the Company and to life insurance agents. Stock grants may be either restricted stock or unrestricted stock distributed upon the achievement of performance goals established by the Committee.
All director stock options outstanding as of December 31, 2005 will vest upon closing of the proposed merger with LNC.
These tables include 516,382 outstanding and 333,135 exercisable stock options held by life insurance agents. These are five-year options with most vesting based on future production. Forfeitures on agent options have been much higher than on other options. These options are expensed upon vesting in accordance with SFAS 123.
Some states require life insurers to maintain a certain value of securities on deposit with the state in order to conduct business in that state. Our insurance subsidiaries had securities totaling $25 on deposit with various states in 2005 and 2004 which are reported in debt securities within our consolidated balance sheets.
The tax effects of temporary differences that result in significant deferred tax assets and deferred tax liabilities are as follows:
At December 31, 2005 and 2004, the Company had accrued approximately $32 for liabilities primarily related to pending settlements on the definition of life insurance and other life insurance product tax issues. Our currently payable income taxes were reduced by $5, $12 and $10 in 2005, 2004 and 2003 related to the exercise of stock options by employees and agents.
The accumulated benefit obligation for all defined benefit pension plans was $399 and $372 at December 31, 2005 and 2004.
The assumption for discount rate is based upon an evaluation of specific plan attributes using cash flow analysis. The weighted average duration of the projected cash flows for the plans was used to select an
appropriate AA-rated bond interest rate. The discount rate assumption declined in 2005 and 2004 as a result of the low interest rate environment experienced in the past few years.
The Company’s pension plans weighted-average asset allocations by asset category were as follows based on fair value:
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act (the Act) was signed into law. The Act includes a federal subsidy to sponsors of retiree health plans that provide a prescription drug benefit that is at least actuarially equivalent to the benefit to be provided under Medicare Part D. We have evaluated the provisions of the Act and believe that the benefits provided by our plan are actuarially equivalent thereto. In accordance with FSP 106-2, the Company remeasured its plan assets and Accumulated Postretirement Benefit Obligation (“APBO”) as of July 1, 2004 to account for the subsidy and other effects of the Act, which resulted in an immaterial reduction in postretirement benefit cost. The reduction in the APBO for the subsidy related to past service was insignificant.
Defined contribution retirement plans cover most employees and full time agents. The Company matches a portion of participant contributions and makes profit sharing contributions to a fund that acquires and holds shares of the Company’s common stock. The Company also contributes to accounts in two plans in which full time agents participate. Most plan assets are invested under a group variable annuity contract issued by JP Life. Expenses were $3, $4 and $2 during 2005, 2004 and 2003.
JPFIC reinsures certain insurance business written prior to 1995 with affiliates of Household International, Inc. on a coinsurance basis. Balances are settled monthly, and the reinsurers compensate JPFIC for administrative services related to the reinsured business. The amount due from reinsurers in the consolidated balance sheets includes $784 and $828 due from the Household affiliates at December 31, 2005 and 2004.
As of December 31, 2005 and 2004, JPFIC also had a reinsurance recoverable of $70 and $73 from a single reinsurer, pursuant to a 50% coinsurance agreement. JPFIC and the reinsurer are joint and equal owners in $193 of securities and short-term investments as of December 31, 2005 and 2004, 50% of which is included in investments in the consolidated balance sheets.
Reinsurance contracts do not relieve an insurer from its primary obligation to policyholders. Therefore, the failure of a reinsurer to discharge its reinsurance obligations could result in a loss to the subsidiaries. The subsidiaries regularly evaluate the financial condition of their reinsurers and monitor concentrations of credit risk related to reinsurance activities. No credit losses have resulted from the reinsurance activities of the subsidiaries during the three years ended December 31, 2005.
and 58% of Individual Products life insurance sales were attributable to products with secondary guarantee benefits for 2005, 2004 and 2003. AIP offers both fixed and variable annuities, as well as other investment products. Approximately 76%, 81% and 56% of AIP sales were attributable to equity-indexed annuities for 2005, 2004 and 2003. The potential for a regulation requiring broker/dealer supervision over sales of equity-indexed annuities, as suggested by the NASD, has impacted the marketplace for these products. Benefit Partners offers group non-medical products such as term life, disability income and dental insurance to the employer marketplace. Various insurance and investment products are currently marketed to individuals and businesses in the United States. The Communications segment consists principally of radio and television broadcasting operations located in strategically selected markets in the Southeastern and Western United States, and sports program production. The Corporate and Other segment includes activities of the parent company and passive investment affiliates, default charges as discussed in Note 2, surplus of the life insurance subsidiaries not allocated to other reportable segments including earnings thereon, financing expenses on Corporate debt, federal and state income taxes not otherwise allocated to other reportable segments, and all of the Company’s realized gains and losses. Surplus is allocated to the Individual Products, AIP and Benefit Partners reportable segments based on risk-based capital formulae which give consideration to asset/liability and general business risks, as well as the Company’s strategies for managing those risks. Various distribution channels and/or product classes related to the Company’s individual life, annuity and investment products and group insurance have been aggregated in the Individual Products, AIP and Benefit Partners reporting segments.
The fair values of commercial paper and revolving credit borrowings approximate their carrying
Notes payable is comprised of $300 of EXtendible Liquidity Securities® (EXLs) that have variable interest rates; therefore carrying value approximates market value for these securities. The remainder of notes payable represents 10-year notes, the fair market value of which was determined by market quotes for these notes in the secondary market.
The Company routinely enters into commitments to extend credit in the form of mortgage loans and to purchase certain debt instruments for its investment portfolio in private placement transactions. The fair value of outstanding commitments to fund mortgage loans and to acquire debt securities in private placement transactions, which are not reflected in the consolidated balance sheets, approximated $29 at December 31, 2005.
JPCC has commitments for purchases of syndicated television programming and commitments on other contracts and future sports programming rights as of December 31, 2005. The Company also has commitments to sell a portion of the sports programming rights to other entities and advertising contracts with customers for the airing of commercials, over the same period. In the second quarter of 2005, JPCC executed an agreement that gives JP Sports and its broadcasting partner 50/50 television syndication rights to Atlantic Coast Conference football and basketball games through the 2010 seasons. Through 2005, JPCC has held the football rights individually. The table below summarizes these commitments and revenues including its broadcast partner’s portion and estimates for those that are not yet finalized:
These commitments are not reflected as an asset or liability in the consolidated balance sheets because the programs are not currently available for use.
A life insurance subsidiary is a defendant in a proposed class action suit. The suit alleges that a predecessor company, decades ago, unfairly discriminated in the sale of certain small face amount life insurance policies, and unreasonably priced these policies. Management believes that the life company’s practices have complied with state insurance laws and intends to vigorously defend the claims asserted.
Because of the considerable uncertainties that exist, the Company cannot predict the outcome of pending or future litigation. However, management believes that the resolution of pending legal proceedings will not have a material adverse effect on the Company’s financial position or liquidity, although it could have a material adverse effect on the results of operations for a specific period.