Other includes shared services that are utilized by both protection products and accumulation products segments.
For purposes of computing the ratio of earnings to fixed charges, “earnings” consist of income from operations before income taxes, fixed charges and pre-tax earnings required to cover preferred stock dividend requirements. “Fixed charges” consist of interest credited on annuity and universal life contracts and interest expense on debt, amortization of debt expense and preferred stock dividend requirements.
Non-segment expense, net consists primarily of open block gains and losses, derivative related market value adjustments, non-insurance operations, reinsurance adjustments, restructuring costs, interest expense, income taxes, discontinued operations and cumulative effect of changes in accounting.
Operating segment income decreased for the protection products segment in 2003 compared to 2002 primarily as a result of lower net investment income and the continued decrease in closed block operating income. The acquisition of ILICO, combined with a slight growth in margins, increased protection products segment operating income in 2002 compared to 2001. The increased volume of equity-indexed products and additional income from funding agreements increased accumulation products segment earnings in 2003 compared to 2002. Increased IMO operating income and the discontinuation of goodwill amortization in 2002 contributed to the growth in accumulation products segment operating income in 2002 compared to 2001.
Net income increased in 2003 compared to 2002 primarily due to increased realized gains on open block investments and increased net unrealized gains from market value adjustments on trading securities, derivatives and equity-indexed contracts. Net income decreased in 2002 compared to 2001 primarily as a result of realized losses on investments, unrealized losses from market value adjustments on derivatives and increased restructuring charges. The 2002 reductions in net income were partially offset by the higher income of our protection and accumulation products segments.
We use the same accounting policies and procedures to measure operating segment income as we use to measure consolidated income from operations with the exception of the elimination of certain items which management believes are not necessarily indicative of overall operating trends. These items are shown between segment pre-tax operating income and net income and are as follows:
Our protection products segment primarily consists of interest-sensitive whole life, term life, universal life and equity-indexed life insurance policies. These products are marketed on a national basis primarily through a Preferred Producer agency system, PPGA distribution system and IMOs. Included in protection products segment is the closed block of ALIC and the closed block of ILIC. Each closed block was established when the companies reorganized from mutual companies to stock companies. When protection products are sold, we invest the premiums we receive in our investment portfolio and establish a liability to the policyholder. We manage investment spread by seeking to maximize the return on these invested assets, consistent with our asset/liability and credit quality needs. We enter into reinsurance arrangements in order to reduce the effects of mortality risk and the statutory capital strain from writing new business. All income statement line items are presented net of reinsurance amounts. Protection products in force totaled $84.9 billion at December 31, 2003, $80.6 billion at December 31, 2002 and $70.5 billion at December 31, 2001. Protection products in force is a non-GAAP financial measure utilized by investors, analysts and the Company to assess the Company’s
We recognize premiums on traditional life insurance policies as revenues when the premiums are due. Amounts received as payments for universal life and equity-indexed life insurance policies are not recorded as premium revenue, but are instead recorded as a policyholder liability. Revenues from the universal life and equity-indexed life policies consist of product charges for the cost of insurance, policy administration and
Persistency. Persistency is a key driver of our business as it refers to the policies which remain in our block of business and is measured by the lapse rate. A low lapse rate reflects higher persistency indicating more business is remaining in force to generate future revenues. Annualized lapse rates were 6.5% in 2003 compared to 7.3% in 2002 and 7.7% in 2001. Our persistency experience remained within our pricing assumptions. The lapse rate in 2001 was higher due to the completion of ILICO’s demutualization payout in July 2001. Lapses tend to decline in anticipation of a demutualization transaction as policyholders want to remain policyholders so they will be eligible for the demutualization payout. Following a demutualization, lapses tend to increase for a period before they return to a more normal level.
Net Investment Income. Net investment income is a key driver of our business as it reflects earnings on our invested assets. Net investment income decreased in 2003 and increased in 2002 compared to the respective prior years. The decrease in net investment income in 2003 was due to low interest rates and increased prepayments of mortgage-backed securities. The 2002 increase in net investment income was primarily attributable to the acquisition of ILICO. The earned rate of the investment portfolio was 6.63% in 2003 compared to 7.22% in 2002 and 7.32% in 2001. The decrease in rates in 2003 and 2002 was primarily a result of the lower interest rate environment.
Mortality and Benefit Expense. Mortality is a key driver of our business as this item reflects benefit expense. For 2003 and 2002, we experienced favorable mortality. Total benefit expense was higher in 2002 compared to 2001 due to the acquisition of ILICO. Total policyowner benefits for ILICO increased $59.5 million in 2002 compared to 2001. In addition, we had increased reinsurance recoveries in 2003 and 2002, which reduce benefit expense, as a result of additional reinsurance arrangements.
Our accumulation products segment primary offerings consist of individual fixed annuities and funding agreements. The fixed annuities are marketed on a national basis primarily through IMOs and independent brokers. Similar to our protection products segment, we invest the premiums we receive from accumulation product deposits in our investment portfolio and establish a liability representing our commitment to our policyholder. We manage product spread by seeking to maximize the return on our invested assets consistent with our asset/liability management and credit quality needs. When appropriate, we periodically reset the interest rates credited to our policyholder liability. Accumulation products reserves totaled $11.7 billion at December 31, 2003, $11.3 billion at December 31, 2002 and $10.7 billion at December 31, 2001. A summary of our accumulation products segment operations follows:
The product spread decreased three basis points to 212 basis points in 2003 compared to 2002. The product spread decreased 16 basis points to 215 basis points in 2002 compared to 2001. Liability crediting rates on traditional annuities were lowered in the fourth quarter of 2001 and throughout 2002 to correspond with the decline in investment yields caused by lower rates on new and reinvested funds. As described in the Traditional Annuity Products and Equity-Indexed Annuities sections presented in “Item 1 Business - Accumulation Products Segment,” the annuity products have various differentials between the credited rate and minimum guarantee rate, including some which have no differential, and as such cannot be lowered. Additionally, some traditional annuities have multi-year interest rate guarantees for which the credited rate cannot be decreased until the end of the multi-year period. Also, equity-indexed annuities provide guaranteed rates based on a cumulative floor over the term of the product. Due to these limitations on the ability to lower
interest crediting rates and the potential for credit defaults and lower reinvestment rates on investments, we could experience additional spread compression in future periods.
IMO Operations. IMO operations are a key driver of our business as the earnings from the IMOs are a significant component of the accumulation products segment operating income. IMOs have contractual arrangements to promote our insurance products in their networks of agents and brokers. Additionally, they also contract with third party insurance companies. We own five such IMOs. The income from IMO operations primarily represents annuity commissions received by our IMOs from those third party insurance companies. Net IMO operating income decreased $3.7 million in 2003 compared to 2002 due to increased expenses and increased $5.9 million in 2002 compared to 2001 due to our acquisition of an IMO in 2002.
The other segment is our non-core lines of business outside of protection and accumulation products. These lines of business include holding company revenues and expenses, operations of our real estate management subsidiary, and accident and health insurance. The other segment pre-tax operating loss increased in 2003 and 2002 as compared to the respective prior years primarily due to real estate investment and management fee income which continues to decline as we reduce these investment holdings. In addition, the operating gain in 2001 included investment fee income for asset management services provided to ILICO prior to the acquisition amounting to $2.8 million. After the acquisition of ILICO, such fees are eliminated in consolidation.
Realized and Unrealized Gains (Losses) on Assets and Liabilities. Realized gains (losses) on open block investments will fluctuate from period to period depending on the prevailing interest rate, the economic environment, the timing of investment sales and credit events. Realized gains on open block investments in 2003 included $12.1 million of gains on sales of investments previously impaired and written-down in 2002 or 2003, primarily American Airlines, Dynegy Holdings, Intermedia Communications and NRG Northeast Generating. Realized gains (losses) on open block investments in 2002 consisted primarily of realized losses and writedowns on investments related to Dynegy Holdings, Green Tree Financial, National Century, NRG Northeast Generating, Trenwick Group, United Airlines, US Air and WorldCom Inc. The realized losses in 2001 consisted primarily of writedowns on investments mainly related to telecommunications and emerging markets investments.
Unrealized gains (losses) on open block options and trading investments also will fluctuate from period to period depending on prevailing interest rates, the economic environment, the timing of investment sales and credit events. We use options to hedge our equity-indexed products. In accounting for derivatives, we adjusted our options to market value, which, due to the economic environment and stock market conditions, resulted in
Demutualization Costs. The 2001 demutualization costs are associated with the demutualization of ILIC, which was completed when we acquired ILICO in May 2001. As a requirement of ILIC’s demutualization, we undertook a commission-free program under which shareholders with less than one hundred shares could redeem those shares for cash or purchase additional shares, commission-free, to reach a holding of at least one hundred shares. The 2002 costs are primarily for commissions, postage and printing under this program. Since these costs are not ongoing, they have been excluded from our segment results.
The restructuring charges expensed in 2003 included pre-tax severance and termination benefits of $3.0 million related to the termination of approximately ten positions and for severance accrual adjustments and other pre-tax costs of $20.3 million primarily related to the impairment loss on the Indianapolis office
Discontinued Operations. In November 2003, we entered into an agreement to sell our residential financing operations. The results of the residential financing operations have been classified as discontinued operations. The sale was completed in January 2004, resulting in an after-tax gain of approximately $3.9 million to be recognized in 2004.
Change in Accounting. The Financial Accounting Standards Board’s Derivatives Implementation Group issued SFAS 133 Implementation Issue No. B36, “Embedded Derivatives: Bifurcation of a Debt Instrument that Incorporates both Interest Rate Risk and Credit Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the Issuer of that Instrument,” or DIG Issue B36. DIG Issue B36 applies to modified coinsurance and coinsurance with funds withheld arrangements where interest is determined by reference to a pool of fixed maturity assets or a total return debt index. DIG Issue B36 considers the reinsurer’s receivable from the ceding company to contain an embedded derivative that must be bifurcated and accounted for separately under SFAS 133. We adopted DIG Issue B36 on October 1, 2003, which included the reclassification of certain securities supporting the products being reinsured from available-for-sale to held for trading. The net cumulative effect of the change in accounting for DIG Issue B36 after income taxes was an expense of $1.3 million in 2003.
We intend to rely primarily on dividends and interest income from our insurance subsidiaries in order to make dividend payments to our shareholders. The payment of dividends by our insurance subsidiaries is regulated under various state laws. Generally, under the various state statutes, our insurance subsidiaries’ dividends may be paid only from the earned surplus arising from their respective businesses and must receive the prior approval of the respective state regulator to pay any dividend that would exceed certain statutory limitations. The current statutes generally limit any dividend, together with dividends paid out within the preceding 12 months, to the greater of (i) 10% of the respective company’s policyowners’ statutory surplus as of the preceding year end or (ii) the statutory net gain from operations for the previous calendar year.
We generated cash flows from operating activities of $394.9 million, $920.1 million and $97.1 million for the years ended December 31, 2003, 2002, and 2001, respectively. Operating cash flows were primarily used to increase our investment portfolio.
We have a $200 million revolving credit facility with a syndicate of lenders (which we refer to as the Revolving Credit Agreement). As of December 31, 2003, there was a $27.0 million outstanding loan balance under the facility. The Revolving Credit Agreement provides for typical events of default and covenants with respect to the conduct of business and requires the maintenance of various financial levels and ratios. Among other covenants, we (a) cannot have a leverage ratio greater than 0.35:1.0, (b) cannot have an interest coverage ratio less than 2.50:1.0, (c) are prohibited from paying cash dividends on common stock in excess of an amount equal to 3% of consolidated net worth as of the last day of the preceding fiscal year, (d) must cause our insurance subsidiaries to maintain certain levels of risk-based capital, and (e) are prohibited from incurring additional indebtedness for borrowed money in excess of certain limits typical for such lines of credit. We closely monitor all of these covenants to ensure continued compliance.
On May 28, 2003, we issued $125 million of PRIDES securities. On June 5, 2003, the underwriters exercised their over-allotment option in full and the Company issued an additional $18.8 million of PRIDES. On March 6, 2002, we issued and sold in a private placement $185 million aggregate original principal amount of OCEANs. The issuance of PRIDES and OCEANs were previously discussed in “Item 5 - Market for Registrant’s Common Equity and Related Stockholder Matters,” which portions are incorporated herein by reference.
The Company has several options for deploying excess capital, including supporting higher sales growth, reducing debt levels, pursuing acquisitions and buying back common stock. We may resume purchasing shares of our common stock pursuant to the repurchase program previously approved by the Company’s Board of Directors. Our Board of Directors approved a stock purchase program effective August 9, 2002, under which we may purchase up to three million shares of our common stock at such times and under such conditions, as we deem advisable. The purchases may be made in the open market or by such other means as we determine to be appropriate, including privately negotiated purchases. The purchase program supercedes all prior purchase programs. We plan to fund the purchase program from a combination of our internal sources, dividends from insurance subsidiaries and the Revolving Credit Agreement. Approximately 2.3 million shares remain available for repurchase under this program. There were no significant shares purchased in 2003.
benefit obligations to policyowners and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business.
Management believes that the current level of cash and available-for-sale, held for trading and short-term securities, combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on mortgage-backed securities and sales of its insurance products, will be adequate to meet the anticipated short-term cash obligations of the insurance subsidiaries.
We also have variable separate account assets and liabilities representing funds that are separately administered, principally for variable annuity contracts, and for which the contractholder bears the investment risk. Separate account assets and liabilities are reported at fair value and amounted to $261.7 million at December 31, 2003. Separate account contractholders have no claim against the assets of the general account. The operations of the separate accounts are not included in the accompanying consolidated financial statements.
Through their respective memberships in the Federal Home Loan Banks (FHLB) of Des Moines and Topeka, ALIC and American are eligible to borrow under variable-rate short term fed funds arrangements to provide additional liquidity. These borrowings are secured and interest is payable at the current rate at the time of each advance. There were borrowings totaling $23.6 million outstanding under these arrangements at December 31, 2003. In addition, ALIC has long-term fixed rate advances from the FHLB outstanding of $13.3 million at December 31, 2003.
The insurance subsidiaries may also obtain liquidity through sales of investments. The investment portfolio as of December 31, 2003, had a carrying value of $17.9 billion, including closed block investments.
The level of capital in the insurance companies is regulated by risk-based capital formulas and is monitored by rating agencies. In order to maintain appropriate capital levels, it may be necessary from time to time for AmerUs Group Co. to provide additional capital to the insurance companies.
At December 31, 2003, the statutory capital and surplus of the insurance subsidiaries was approximately $828 million. Management believes that each insurance company has statutory capital which provides adequate risk based capital that exceeds required levels.
We have an agreement with Bank One, N.A. whereby we guarantee the payment of loans made to certain managers and executives for the purpose of purchasing common stock and ACES pursuant to the stock purchase program. Our liability in respect of the principal amount of loans is limited to $3.3 million which was repaid in March 2004 by the participants. We have also guaranteed interest and all other fees and obligations owing on the loans. Each participant in the program has agreed to repay any amounts paid by us under the guarantee in accordance with a reimbursement agreement with the participant. This agreement was entered into in 1999, prior to the restrictions imposed by the Sarbanes-Oxley Act regarding loans with executive officers.
Certain partnership investments provide for commitments of future capital, loans or guarantees. We have obligations to make future capital contributions to various partnerships of up to $1.3 million at December 31, 2003. In addition, at December 31, 2003, we had loan guarantees which totaled $1.3 million. ALIC and its joint venture partner are contingently liable in the event AVLIC cannot meet its obligations. At December 31, 2003, AVLIC had statutory assets of $2,379 million, liabilities of $2,282 million and surplus of $97 million.
Our contractual obligations primarily consist of amounts owed for notes payable and operating lease commitments. See note 8 to the consolidated financial statements for further discussion about the notes payable and note 12 for additional information regarding leases. Maturities of notes payable and lease obligations are as follows for each of the five years ending December 31, 2003:
We maintain a diversified portfolio of investments which is supervised by an experienced in-house staff of investment professionals. Sophisticated asset/liability management techniques are employed in order to achieve competitive yields, while maintaining risk at acceptable levels. The asset portfolio is segmented by liability type, with tailored investment strategies for specific product lines. Investment policies and significant individual investments are subject to approval by the Board of Directors and are overseen by the Investment and Risk Management Committee of our Board of Directors. Management regularly monitors individual assets and asset groups, in addition to monitoring the overall asset mix. In addition, the Investment and Risk Management Committee review investment guidelines and monitor internal controls.
Investment strategies have been established based on the specific characteristics of each product line. The portfolio investment strategies establish asset duration, quality and other guidelines. Analytical systems are utilized to establish an optimal asset mix for each line of business. We seek to manage the asset/liability mismatch and the associated interest rate risk through active management of the investment portfolio. Financial, actuarial, investment, product development and product marketing professionals work together
Our diversified portfolio of investments includes public and private fixed maturity securities and commercial mortgage loans. Our objective is to maintain a high-quality, diversified fixed maturity securities portfolio that produces a yield and total return that supports the various product line liabilities and our earnings goals.
The fixed maturity securities portfolio consists primarily of investment grade corporate fixed maturity securities, high-quality mortgage-backed securities (or MBS) and United States government and agency obligations. As of December 31, 2003, fixed maturity securities were $16,034.5 million, or 89.4% of the carrying value of invested assets with public and private fixed maturity securities constituting $14,094.2 million, or 87.9%, and $1,940.3 million, or 12.1%, respectively, of total fixed maturity securities, respectively.
The following table summarizes fixed maturity securities by remaining maturity as of December 31, 2003:
As of December 31, 2003, 82.4% of total invested assets were investment grade fixed maturity securities. The following table sets forth the credit quality, by NAIC designation and Standard & Poor’s rating equivalents, of fixed maturity securities as of December 31, 2003:
We have utilized a limited number of structured finance arrangements. The structures primarily consisted of interests in collateralized bond obligations and special-purpose entities with principal protected limited partnership interests. Neither AmerUs nor any management members had operating control or management
oversight of the entities and accordingly the entities were not consolidated but rather accounted for as available for sale debt securities or equity method investments. In addition, we did not have any continued obligation or commitment to provide additional financing to the entities. At December 31, 2002, approximately $560 million of such structured finance investments were included in invested assets. These structured securities were liquidated during 2003.
We hold investments in indexed debt instruments (IDIs) in which the principal is initially partially defeased by an obligation of a third party financial institution (institution) collateralized by U.S. Treasuries which will accrete to 50% of the original principal amount of the IDIs at maturity. The balance of the principal amount due at maturity is subject to a dynamic defeasance mechanism, which should provide a return of the initial investment. The instruments issued by the institutions are linked to the performance of a hedge fund or fund of funds. The annual income on these investments will be equal to the quarterly distribution of the hedge fund or fund of funds plus the change in the present value of anticipated distributions to be received at maturity and will be included in net investment income. Over the life of the IDIs, the income will be a function of the cumulative performance of the linked hedge fund or fund of funds and the return on any defeased portion of the investment. The quarterly distribution paid, if any, reduces the amount of future participation in the performance of the linked hedge fund or fund of funds. At maturity, the Company will take delivery of the referenced hedge fund interests and cash or U.S. Treasuries equal to the portion of the instruments that have been defeased, the total of which should equal or exceed the instruments’ principal amount. The investment purpose of these instruments is to enable the Company to obtain the return as if they had invested in hedge funds or fund of funds with dynamic principal protection. The instruments as of December 31, 2003 carried an A rating or better by Fitch. The carrying value of IDIs was $396.1 million at December 31, 2003.
The following tables present unrealized losses for fixed maturity securities at December 31, 2003 and 2002 by investment category and industry sector:
The following table provides a summary of unrealized losses for fixed maturity securities which identifies the length of time the securities have continually been in an unrealized loss position as of December 31, 2003 and 2002:
The following table identifies the type, carrying value and unrealized loss of individual material securities with unrealized losses at December 31, 2003 and 2002, exceeding $3 million:
In addition to the above listing, at December 31, 2003 and 2002, securities with a market value of $500.7 million and $149.4 million and unrealized loss position of $45.4 million and $57.4 million, respectively, were principal protected. These securities included underlying holdings that provided for a return of principal through maturity of zero coupon bonds from a highly rated issuer or a principal guarantee from a highly rated company. These securities along with the securities in the above listing of unrealized losses did not meet the criteria as described in our other-than-temporary process for impairment determination. As a result, there was no realized loss for these securities. Unrealized gains or losses may not represent future gains or losses that will be realized. These unrealized gains or losses are subject to fluctuation, reflective of such things as volatile financial markets, interest rate movements, credit spread changes and sale decisions.
Interest rate changes may have temporary effects on the sale and profitability of the protection products and accumulation products offered. For example, if interest rates rise, competing investments (such as
We have developed an asset/liability management approach with separate investment portfolios for major product lines such as traditional life, universal life, equity-indexed life, traditional annuities, equity-indexed annuities, variable annuities and funding agreements. Investment strategies have been established based on the specific characteristics of each product line. The portfolio investment strategies establish asset duration, quality and other guidelines. Analytical systems are utilized to establish an optimal asset mix for each line of business. We seek to manage the asset/liability mismatch and the associated interest rate risk through active management of the investment portfolio. Financial, actuarial, investment, product development and product marketing professionals work together throughout the product development, introduction and management phases to jointly develop and implement product features, initial and renewal crediting strategies, and investment strategies based on extensive modeling of a variety of factors under a number of interest rate scenarios.
In April 2003, the Financial Accounting Standards Board issued SFAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS 149 is intended to provide more consistent reporting of contracts as either freestanding derivative instruments subject to SFAS 133 in its entirety, or as hybrid instruments with debt host contracts and embedded derivative features. SFAS 149 incorporates decisions previously made by the Derivatives Implementation Group, changes in financial instruments resulting from other projects, and deliberations in connection with issues raised in the application of the definition of a derivative and it does not amend the definition of a derivative. The provisions of SFAS 149 are effective for contracts entered into or modified after June 30, 2003, except for the codification of previous derivative decisions which were already effective and continue to be applied in accordance with their respective effective dates. SFAS 149 had no impact on net income or stockholders’ equity as of or for the year ended December 31, 2003.
In May 2003, the Financial Accounting Standards Board issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 establishes standards for how an issuer classifies and measures freestanding financial instruments as liabilities or equity and was generally effective at the beginning of the first interim period after June 30, 2003. A Financial Accounting Standards Board Staff Position has deferred the application of various provisions of SFAS 150 for specified mandatorily redeemable non-controlling interests in consolidated limited life entities. The AmerUs Capital I 8.85% Capital Securities were issued through a wholly-owned subsidiary trust and are mandatorily redeemable securities which are carried as notes payable on the consolidated balance sheet with interest expense recorded in the consolidated statement of income. The adoption of SFAS 150 did not have any effect on the consolidated financial statements.
In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” or FIN 45. FIN 45 clarifies disclosure and recognition and measurement requirements related to certain guarantees. The disclosure requirements are effective for financial statements issued after December 15, 2002 and the recognition and measurement requirements are effective on a prospective basis for guarantees issued or modified after December 31, 2002. Adoption of FIN 45 in 2003 did not have an effect on net income or stockholders’ equity. See note 12 to the consolidated financial statements for disclosures related to our guarantees.
beneficiaries to consolidate VIEs in their financial statements and also requires additional disclosures for enterprises which are not primary beneficiaries but which have a significant variable interest in a VIE. The provisions of FIN 46 are effective immediately for VIEs created after January 31, 2003 and is to be applied in the first interim period beginning after June 15, 2003 for interests in VIEs acquired before February 1, 2003. The additional disclosure is required for financial statements issued after January 31, 2003.
The consolidated financial statements begin on page. Reference is made to the Index to Financial Statements on page herein.