We also lease continuation of business, print/distribution, and warehouse space in or around Duluth, Georgia, under leases expiring in February 2020, June 2028 and June 2023, respectively.
For additional details on our operating leases, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Contractual Obligations.”
New recruits increased in 2017 to 303,867 from 262,732 in 2016 and 228,115 in 2015 primarily due to sustained growth in the size of our independent sales force, resulting in more agents available to actively recruit. In addition, the increase in recruits during 2017 included approximately 19,000 recruits from hurricane-affected areas whose Independent Business Application (“IBA”) fees were waived in the second half of 2017.
The increase in new life insurance policies issued in 2017 from 2016 and in 2016 from 2015 reflected the positive impact of strong growth in the size of our life-licensed sales force in recent periods. Productivity, measured by the average monthly rate of new policies
In 2016, the face amount of term life insurance policies in force increased compared with 2015 also as a result of higher policy sales and the consistent level of terminations as a percentage of the beginning face amount in force. Our average issued face amount in 2016 was consistent with the average issued face amount in 2015 of $241,700.
Individual retirement accounts (“IRA”) and other qualified accounts are an important component of the investment and savings products we distribute. If the DOL Fiduciary Rule, including the final exemptions, were to become applicable without revisions, we believe that certain changes to our qualified plan business would be necessary in order for us to continue to help investors save for retirement. Because of the uncertain status of the DOL Fiduciary Rule or any SEC Rule, and because of the unsettled nature of the Transition Period, we have not determined the extent to which we would make necessitated compensation, product or other changes to our qualified plan business, nor whether we would make such changes consistent across our non-qualified business. As a result, we are currently unable to quantify the impact on our business, financial position or results of operations. During the year ended December 31, 2017, average client assets held in U.S. qualified retirement plans accounted for an estimated 59% of total average client account assets. During the year ended December 31, 2017, product sales of assets held in U.S. qualified retirement plans accounted for approximately 54% of total investment and savings product sales.
We anticipate that the provisions of the Tax Reform Act may indirectly affect consumer demand for the Company’s product offerings. Reductions to corporate and personal income taxes may result in additional income for our clients, which could lead to higher long-term sales of our term life insurance and investment and savings products. To the extent the Tax Reform Act influences the fair value of equity securities, we are likely to see a similar effect on demand for our investment and savings products and the value of our clients’ assets. We are unable to quantify the impact on our future product sales due to the inherent uncertainty regarding the long-term economic impact of the Tax Reform Act.
Persistency. Persistency is a measure of how long our insurance policies stay in force. As a general matter, persistency that is lower than our pricing assumptions adversely affects our results over the long term because we lose the recurring revenue
In 2010, as part of our corporate reorganization and the initial public offering of our common stock, we entered into significant coinsurance transactions (the “IPO coinsurance transactions”) with entities then affiliated with Citigroup, Inc. (collectively, the “IPO coinsurers”) and ceded between 80% and 90% of the risks and rewards of our term life insurance policies that were in force at year-end 2009. Beginning in 2017, policies reaching the end of their initial level term period are no longer ceded under the IPO coinsurance transactions. We continue to administer all policies subject to these coinsurance agreements.
Asset values in client accounts. We earn marketing and support fees as well as distribution fees (trail commissions or, with respect to U.S. mutual funds, 12b-1 fees) on mutual fund and annuity assets in the United States and Canada. In the United States, we also earn investment advisory fees on assets in managed investments. In Canada, we earn management fees on certain mutual fund assets and on the segregated funds for which we serve as investment manager. Asset values are influenced by new product sales, ongoing contributions to existing accounts, redemptions and the change in market values in existing accounts. While we offer a wide variety of asset classes and investment styles, our clients’ accounts are primarily invested in equity funds.
Positions. We earn recordkeeping fees for administrative functions we perform on behalf of several of our mutual fund providers. An individual client account may include multiple fund positions for which we earn recordkeeping fees. We may also receive fees earned for non-bank custodial services that we provide to clients with retirement plan accounts.
The Corporate and Other Distributed Products segment is also affected by corporate income and expenses not allocated to our other segments, general and administrative expenses (other than expenses that are allocated to our Term Life Insurance or Investment and Savings Products segments), interest expense on notes payable, redundant reserve financing transactions and our revolving credit facility, as well as realized gains and losses on our invested asset portfolio.
Capital Structure. Our financial results are affected by our capital structure, which includes our senior unsecured notes (the “Senior Notes”) redundant reserve financing transactions, our revolving credit facility, and common stock. See Note 10 (Debt), Note 12 (Stockholders’ Equity) and Note 16 (Commitments and Contingent Liabilities) to our consolidated financial statements included elsewhere in this report for more information on changes in our capital structure.
See “Results of Operations” and “Financial Condition” and “Quantitative and Qualitative Disclosures About Market Risk - Canadian Currency Risk” and Note 3 (Segment and Geographical Information) to our consolidated financial statements included elsewhere in this report for more information on our Canadian subsidiaries and the impact of foreign currency on our financial results.
Income Taxes. The profitability of the Company and its subsidiaries is affected by income taxes assessed by federal, state, and U.S. territorial jurisdictions in the U.S. and federal and provincial jurisdictions in Canada. Changes in tax legislation, such as the Tax Reform Act, will impact the measurement of our deferred tax assets and liabilities and the amount of income tax expense we incur in current and future periods.
We prepare our financial statements in accordance with U.S. GAAP. These principles are established primarily by the Financial Accounting Standards Board. The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions based on currently available information when recording transactions resulting from business operations. Our significant accounting policies are described in Note 1 (Description of Business, Basis of Presentation, and Summary of Significant Accounting Policies) to our consolidated financial statements included elsewhere in this report. The most significant items on our consolidated balance sheets are based on fair value determinations, accounting estimates and actuarial determinations, which are susceptible to changes in future periods and could affect our results of operations and financial position.
The net impact of differences between actual and expected persistency on future policy benefit reserves and reinsurance recoverables will partially offset the earnings impact recognized from DAC amortization noted above. In our Term Life Insurance segment, if actual annual lapses at each policy duration are 10% higher, the additional future policy benefit reserves that would be released is approximately $24 million, partially offset by the release of the corresponding recoverable from reinsurers asset of approximately $12 million using balances as of December 31, 2017. Higher lapses in later policy durations would have a greater effect on the release of future policy benefit reserves since the future policy benefit reserves are higher at the later durations.
For available-for-sale securities in an unrealized loss position that we intend to sell or would more-likely-than-not be required to sell before the expected recovery of the amortized cost basis, we recognize an impairment charge for the difference between amortized cost and fair value as a realized investment loss in our statements of income. For available-for-sale fixed maturity securities in an unrealized loss position for which we have no intent to sell and believe that it is not more-likely-than-not that we will be required to sell before the expected recovery of the amortized cost basis, only the amount related to the principal cash flows not expected to be received over the remaining term of the security, or the credit loss component, of the difference between cost and fair value is recognized as a realized investment loss in our statements of income, while the remainder is recognized in other comprehensive income in our statements of comprehensive income.
Sales commissions. Represents commissions to our sales representatives in connection with the sale of investment and savings products and products other than insurance products.
Insurance expenses and other operating expenses directly attributable to the Term Life Insurance and the Investment and Savings Products segments are recorded directly to the applicable segment. We allocate certain other revenue and operating expenses that are not directly attributable to a specific operating segment based on the relative sizes of our life-licensed and securities-licensed independent sales forces. These allocated items include fees charged for access to POL and costs incurred for field technology, supervision, training and certain other costs. We also allocate certain technology and occupancy costs to our operating segments based on estimated usage. Costs that are not directly charged or allocated to our two primary operating segments are included in our Corporate and Other Distributed Products segment.
Net investment income in 2017 remained consistent with 2016, as the positive impact from a larger invested asset portfolio of approximately $5.6 million was mostly offset by the portfolio’s lower yield of approximately $2.9 million as well as the impact of approximately $2.2 million attributable to lower total return on the deposit asset backing the 10% coinsurance agreement that is subject to deposit method accounting. The continued multi-year trend of low interest rates has negatively affected our portfolio’s yield as debt securities issued in prior years at higher coupon rates mature and are replaced with newly-issued debt securities with lower yields. Interest expense on surplus note line item will fluctuate from period to period along with the principal amount of our surplus note (the “Surplus Note”) based on the balance of reserves being contractually supported under a redundant reserve financing transaction used by Vidalia Re, Inc. (“Vidalia Re”). Investment income earned on our held-to-maturity invested asset completely offsets the interest expense on Surplus Note line item, thereby eliminating any impact on net investment income. For more information on the Surplus Note, see Note 10 (Debt) and for additional information on the redundant reserve financing transaction used by Vidalia Re, see Note 4 (Investments) to our consolidated financial statements included elsewhere in this report.
During 2016, total revenues increased from 2015 primarily due to the same trend noted in 2017 that involved incremental premiums on term life insurance policies that are not subject to the IPO coinsurance transactions, as well as direct premiums growth from the increased number of new policies issued in recent periods. Commissions and fees generated from our Investment and Savings Products segment increased modestly in 2016 from 2015 as higher asset-based and account-based revenues were largely offset by lower sales-based revenues. Net investment income increased in 2016 from 2015 as increasing prices on fixed-income investments led to an approximately $4.7 million higher year-over-year total return on the deposit asset backing the 10% coinsurance agreement that is
The increase in total benefits and expenses in 2016 from 2015 was also largely driven by growth in premium-related expenses. Insurance expenses and other operating expenses increased due to increased spending of approximately $10.4 million in technology-related costs associated primarily with POL, higher employee-related expenses of approximately $4.3 million, and costs related to preparing for the implementation of the DOL Fiduciary Rule of approximately $3.3 million. These increases were partially offset by the decline in interest expense incurred on our 10% coinsurance agreement, which is discussed further in Note 6 (Reinsurance) to our consolidated financial statements included elsewhere in this report.
Income taxes. Our effective income tax rate declined to 7.7% in 2017 from 35.0% in 2016. The largest factor driving the decline in the effective income tax rate was the recognition of the transition impact of the Tax Reform Act. In 2017, we recognized the impact from the reduction in the U.S. federal tax rate from 35% to 21% that is expected to be in effect when our net U.S. deferred tax liabilities reverse, which resulted in an income tax benefit of approximately $98.5 million or 26.0% of our 2017 income before income taxes. Partially offsetting the income tax benefit recognized for the transition impact of the Tax Reform Act is approximately $3.0 million of one-time income tax expense, or 0.8% of our 2017 income before income taxes, due to the inclusion of mandatory deemed repatriation of earnings attributable to our Canadian subsidiaries.
Term Life Insurance Segment. Our results for the Term Life Insurance segment for the years ended December 31, 2017, 2016, and 2015 were as follows:
Benefits and claims. Benefits and claims increased in 2017 from 2016 primarily due to the growth in net premiums. Actual life claims experience in the first half of 2017 negatively impacted benefits and claims by approximately $6 million. However, this impact from claims experience was mostly offset by YRT rate reductions negotiated for 2014 and later issue years, which continues to dampen the growth in benefits and claims relative to the growth in net premiums.
In comparing 2016 to 2015, the increase in benefits and claims was primarily driven by the growth in net premiums. However, benefits and claims increased at a slower rate than net premiums primarily due to disabled life premium waiver claims experience during 2016 being approximately $5 million lower than historical levels, YRT rate reductions negotiated for 2014 and later issue years. Death claims were relatively consistent with historical experience.
The increase in amortization of DAC in 2016 compared to 2015 was primarily driven by growth in net premiums. DAC amortization grew at a higher rate than net premiums reflecting weaker early-duration persistency than the prior year.
Insurance expenses. The increase in insurance expenses in 2017 from 2016 was primarily due to higher spending of approximately $5.9 million in technology-related costs primarily associated with POL, higher employee-related expenses of approximately $3.7 million, and net higher growth-related expenses of approximately $2.8 million. These higher growth-related expenses from increased premiums is net of approximately $3.3 million of benefits reflecting lower retaliatory premium taxes and representative licensing fees we incurred due to changing the state of domicile of Primerica Life to Tennessee in December 2017.
Amortization of DAC. Amortization of DAC on our Canadian segregated funds product in 2017 remained consistent with 2016 while each year experienced favorable market performance of the underlying funds and redemptions experience that was better than the original assumptions. The redemption assumption was reduced in both years based on emerging product experience.
Insurance commissions. The increase in insurance commissions in 2017 from 2016 was largely driven by growth in our Canadian segregated funds client assets.
The decline in sales-based commissions in 2016 from 2015 was in line with the decline in sales-based revenue. The increase in asset-based commissions slightly outpaced the increase in asset-based revenue primarily due to fluctuations in the product mix.
sales tool to support our agents’ distribution of products. These increases in other operating expenses were partially offset by approximately $1.4 million of lower costs related to the implementation of DOL Fiduciary Rule.
Corporate and Other Distributed Products Segment. Our results of operations for the Corporate and Other Distributed Products segment for the years ended December 31, 2017, 2016, and 2015 were as follows:
Total Benefits and Expenses. Total benefits and expenses increased in 2017 from 2016 primarily due to higher employee-related equity award expense and agent-related support costs from hurricane-affected areas in Puerto Rico and Texas.
Total benefits and expenses increased in 2016 from 2015 primarily due to higher employee-related costs in other operating expenses of approximately $4.4 million, which includes the full-year effect of reallocated employee-related expenses of approximately $3.3 million between segments in the second quarter of 2015 as described earlier in the Term Life Insurance segment discussion. The increase was partially offset by the reduction in the interest expense incurred on our 10% coinsurance agreement. For more information on the interest expense incurred on our 10% coinsurance agreement, see Note 6 (Reinsurance) to our consolidated financial statements included elsewhere in this report.
Our invested asset portfolio is subject to a variety of risks, including risks related to general economic conditions, market volatility, interest rate fluctuations, liquidity risk and credit and default risk. Investment guideline restrictions have been established to minimize the effect of these risks but may not always be effective due to factors beyond our control. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A significant increase in interest rates could result in significant losses, realized or unrealized, in the value of our invested asset portfolio. Additionally, with respect to some of our investments, we are subject to prepayment and, therefore, reinvestment risk.
Reinsurance recoverables. Reinsurance recoverables reflects future policy benefit and claim reserves due from third-party reinsurers, including the IPO coinsurers. Such amounts are reported as reinsurance recoverables rather than offsetting future policy benefits. Reinsurance recoverables as of December 31, 2017 remained relatively consistent compared with December 31, 2016.
Dividends and other payments to the Parent Company from its subsidiaries are our principal sources of cash. The amount of dividends paid by the subsidiaries is dependent on their capital needs to fund future growth and applicable regulatory restrictions. The primary
The Parent Company’s subsidiaries generate operating cash flows primarily from term life insurance premiums (net of premiums ceded to reinsurers), income from invested assets, commissions and fees collected from the distribution of investment and savings products as well as other financial products. The subsidiaries’ principal operating cash outflows include the payment of insurance claims and benefits (net of ceded claims recovered from reinsurers), commissions to our independent sales force, insurance and other operating expenses, interest expense for future policy benefit reserves financing transactions, and income taxes.
The increase in operating cash flows in 2016 from 2015 was also driven by the impact of growth in net premiums in excess of benefits and claims paid in our Term Life Insurance segment as noted in 2017 versus 2016. In addition, the timing of remittances for monthly reinsurance premiums to reinsurers as well as the timing impact of when outstanding checks were paid from our bank disbursement accounts at year-end contributed to the increase in operating cash flows in 2016 as compared with 2015. Also contributing to the increase in operating cash flows in 2016 versus 2015 was lower cash income taxes in Canada relative to income tax expense incurred due to the timing of remittances to Canadian tax authorities. The year-over-year growth in new life insurance policies issued resulted in higher cash payments for DAC (net of income tax deductions) in 2016 as compared with 2015, which partially offset the year-over-year increase in operating cash flows.
Investing activities. The largest item affecting the year-over-year increase in cash used in investing activities was the higher use of cash in 2017 to purchase investments in fixed-maturity securities compared with 2016 as the size of our investment portfolio
continued to grow along with the growth of our in-force term life business. Additionally, in 2017 the Company had a lower level of fixed-maturity securities that matured and it sold fewer fixed-maturity securities versus the comparable period in 2016.
Financing activities. Cash used in financing activities during 2017 increased modestly compared to the same period in 2016 primarily due to higher tax withholdings on the vesting of employee equity awards as a result of the increased market share price of our common stock. In addition, the per share increase in stockholder dividends declared by the Company in 2017 versus 2016 also contributed to the increase in cash used in financing activities.
Net cash used in financing activities during 2016 decreased compared to 2015 as we repurchased an incremental $50 million of our common stock under our share repurchase programs in 2015 compared with 2016.
Although the recently enacted Tax Reform Act in the United States did not impact our calculated RBC ratio under current regulations, the NAIC could modify its regulations in the future to factor in the lower U.S. federal tax rate in the calculation. Such changes to the regulations would likely reduce our calculated RBC ratio; however, we do not believe it will detract from how we view our capital strength to support our policyholder liabilities.
As of December 31, 2017, our U.S. life insurance subsidiaries had statutory capital and RBC substantially in excess of the applicable statutory requirements and remained well positioned to support existing operations and fund future growth.
Notes Payable. The Company has $375.0 million of publicly-traded, Senior Notes outstanding issued at a price of 99.843% with an annual interest rate of 4.75%, payable semi-annually in arrears on January 15 and July 15. The Senior Notes mature July 15, 2022.
We were in compliance with the covenants of the Senior Notes at December 31, 2017. No events of default occurred on the Senior Notes during the year ended December 31, 2017.
Financial Ratings. As of December 31, 2017, the investment grade credit ratings for our Senior Notes were as follows:
Off-Balance Sheet Arrangements. We have no transactions, agreements or other contractual arrangements to which an entity unconsolidated with the Company is a party, under which the Company maintains any off-balance sheet obligations or guarantees as of December 31, 2017.
Our liability for future policy benefits represents the present value of estimated future policy benefits to be paid, less the present value of estimated future net benefit premiums to be collected. Net benefit premiums represent the portion of gross premiums required to provide for all benefits and associated expenses. These benefit payments are contingent on policyholders continuing to renew their policies and make their premium payments. Our contractual obligations table discloses the impact of benefit payments that will be due assuming the underlying policy renewals and premium payments continue as expected in our actuarial models. The future policy benefit payments represented in the table are presented on an undiscounted basis, gross of any amounts recoverable through reinsurance agreements and gross of any premiums to be collected. We expect to fully fund the obligations for future policy benefits from cash flows from general account invested assets, claims reimbursed by reinsurers, and from future premiums. These estimations
are based on mortality and lapse assumptions comparable with our historical experience. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results.
Commissions represent commissions that have been earned by our independent sales force but have not been paid as of December 31, 2017. We are only obligated to pay commissions as earned from sales of our products. The total liability amount is reported within other liabilities in our consolidated balance sheets.
Our operating lease obligations primarily relate to office, warehouse, printing, and distribution properties. For additional information on leased properties, see “Item 2. Properties” included elsewhere in this report.
Description of Business. Primerica, Inc. (the "Parent Company"), together with its subsidiaries (collectively, "we", "us" or the "Company"), is a leading distributor of financial products to middle-income households in the United States and Canada. We assist our clients in meeting their needs for term life insurance, which we underwrite, and mutual funds, annuities, managed investments and other financial products, which we distribute primarily on behalf of third parties. Our primary subsidiaries include the following entities: Primerica Financial Services, Inc. ("PFS"), a general agency and marketing company; Primerica Life Insurance Company ("Primerica Life"), our principal life insurance company; Primerica Financial Services (Canada) Ltd., a holding company for our Canadian operations, which includes Primerica Life Insurance Company of Canada ("Primerica Life Canada") and PFSL Investments Canada Ltd. ("PFSL Investments Canada"); and PFS Investments Inc. ("PFS Investments"), an investment products company and broker-dealer. Primerica Life, domiciled in Tennessee, owns National Benefit Life Insurance Company ("NBLIC"), a New York insurance company. Prior to Primerica Life’s re-domestication to Tennessee in December 2017, Primerica Life was a Massachusetts-domiciled life insurance underwriting company. We established Peach Re, Inc. ("Peach Re") and Vidalia Re, Inc. (“Vidalia Re”) as special purpose financial captive insurance companies and wholly owned subsidiaries of Primerica Life. Peach Re and Vidalia Re have each entered into separate coinsurance agreements with Primerica Life whereby Primerica Life has ceded certain level-premium term life insurance policies to Peach Re and Vidalia Re (respectively, the “Peach Re Coinsurance Agreement” and the “Vidalia Re Coinsurance Agreement”).
Use of Estimates. The most significant items that involve a greater degree of accounting estimates and actuarial determinations subject to change in the future are the valuation of investments, deferred policy acquisition costs (“DAC”), future policy benefit reserves and corresponding amounts recoverable from reinsurers, and income taxes. Estimates for these and other items are subject to change and are reassessed by management in accordance with U.S. GAAP. Actual results could differ from those estimates.
Investments are reviewed on a quarterly basis for OTTI. Credit risk, interest rate risk, the amount of time the security has been in an unrealized loss position, actions taken by ratings agencies, and other factors are considered in determining whether an unrealized loss is other-than-temporary. OTTI in our accompanying consolidated statements of income reflect the impairment on AFS securities that we intend to sell or would more-likely-than-not be required to sell before the expected recovery of the amortized cost basis. For AFS fixed maturity securities that we have no intent to sell and believe that it is not more-likely-than-not we will be required to sell prior to recovery, only the credit loss component of OTTI is recognized in our accompanying consolidated statements of income, while the remainder is recognized in other comprehensive income in the accompanying consolidated statements of comprehensive income (loss). The credit loss component of OTTI recognized in net income is identified as the amount of principal cash flows not expected to be received over the remaining term of the security. Any subsequent changes (if not an other-than-temporary impairment) in the fair value of AFS securities are recognized in other comprehensive income in the accompanying statements of comprehensive income.
All reinsurance contracts in effect for the three-year period ended December 31, 2017 transfer a reasonable possibility of substantial loss to the reinsurer or are accounted for under the deposit method of accounting.
Reinsurance premiums, commissions, expense reimbursements and benefits and reserves related to reinsured long-duration contracts are accounted for over the life of the underlying contracts using assumptions consistent with those used to account for the underlying policies. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liabilities and future policy benefits associated with reinsured policies. Ceded policy reserves and claims liabilities relating to insurance ceded are shown as reinsurance recoverables on the accompanying consolidated balance sheets.
We also have an amortizing intangible asset related to a 1995 sales agreement termination payment to Management Financial Services, Inc. This asset is supported by a non-compete agreement with the founder of our business model. We calculate the amortization of this contract buyout on a straight-line basis over 24 years, which represents the life of the non-compete agreement. Intangible asset amortization expense was approximately $3.4 million in 2017, 2016 and 2015. The remaining amortization expense is expected to be approximately $3.4 million in 2018 and $2.8 million in 2019. No events have occurred during 2017, and no factors exist as of December 31, 2017 that would indicate that the net carrying value of our amortizing intangible asset may not be recoverable or will not be used throughout its estimated useful life.
Depreciation expense is included in other operating expenses in the accompanying consolidated statements of income. Depreciation expense was $10.1 million, $11.2 million, and $7.6 million for the years ended December 31, 2017, 2016, and 2015, respectively.
The separate accounts are represented by individual variable annuity contracts. Purchasers of variable annuity contracts issued by Primerica Life Canada have a direct claim to the benefits of the contract that entitles the holder to units in one or more investment funds (the “Funds”) maintained by Primerica Life Canada. The Funds invest in assets that are held for the benefit of the owners of the contracts. The benefits provided vary in amount depending on the fair value of the Funds’ assets. The Funds’ assets are administered by Primerica Life Canada and are held separate and apart from the general assets of the Company. The liabilities reflect the variable insurance annuity contract holders’ interests in variable annuity assets based upon actual investment performance of the respective
Other Policyholders’ Funds. Other policyholders’ funds primarily represent claim payments left on deposit with us.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Reform Act”) was enacted in the United States. The Tax Reform Act includes a broad range of changes to federal tax legislation including changes to corporate and personal income tax rates, income tax deductions, and international tax provisions. We recognized the effect of tax law changes included in the Tax Reform Act during the year-ended December 31, 2017, as it is the period that includes the date of enactment. See Note 11 (Income Taxes) for details related to the tax effects recognized in connection with the Tax Reform Act.
Share-Based Transactions. For employee and director share-based compensation awards, we determine a grant date fair value based on the price of our publicly-traded common stock and recognize the related compensation expense, adjusted for actual forfeitures, in the statement of income on a straight-line basis over the requisite service period for the entire award. For non-employee share-based compensation, we recognize the impact during the period of performance, and the fair value of the award is measured as of the date performance is complete, which is the vesting date. To the extent that a share-based award contains sale restrictions extending beyond the vesting date, we reduce the recognized fair value of the award to reflect the corresponding illiquidity discount. Most non-employee share-based compensation is an incremental direct cost of successful acquisitions or renewals of life insurance policies that result directly from and are essential to the policy acquisition(s) and would not have been incurred had the policy acquisition(s) not occurred. We defer these expenses and amortize the impact in the same manner as all other DAC.
Future Application of Accounting Standards. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 clarifies the principles for recognizing revenue by establishing the core principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue that is recognized. Insurance contracts are specifically excluded from the scope of ASU 2014-09 and therefore revenue from our insurance product lines will not be affected by the new standard. The amendments in ASU 2014-09, as updated by ASU No. 2015-14, are effective for the Company beginning in fiscal year 2018 and can be adopted either retrospectively or by using the modified retrospective method. We will adopt the amendments in ASU 2014-09 effective January 1, 2018 by using the modified retrospective method. The cumulative effect of adopting ASU 2014-09 will result in an immaterial increase to retained earnings on January 1, 2018. The adjustment to be recognized upon adoption of ASU 2014-09 primarily consists of recognizing the lifetime expected value of renewal commissions we anticipate collecting in future periods for the sale of prepaid legal service subscriptions and the referral of auto and homeowners’ insurance policies in our Corporate and Other Distributed Products segment made prior to December 31, 2017. After the initial product sale or referral, we earn commissions from product providers as clients pay monthly subscription fees for prepaid legal service subscriptions or premiums on auto and homeowners’ insurance policies purchased through our referral channel. We currently recognize commission revenue upon receipt of the commission revenue from the product providers, which is the point in time when revenue becomes fixed and determinable, as the commissions earned are dependent on our clients’ future renewal activity. Subsequent to the adoption of ASU 2014-09, we will recognize commission revenue equal to the expected value of the commissions we will earn over the life of the subscription or the referred policy when that initial subscription sale or policy referral occurs, which coincides with when we satisfy our performance obligation to the product provider. We do not anticipate the adoption of ASU 2014-09 will have a notable impact on our results of operations given the immaterial amount of revenue associated with these product distributions and no significant accounting changes for revenue will be made in any of our other product lines.
(1) Effect of U.S. statutory rate reduction enacted by the Tax Reform Act in 2017 is not recognized in OCI, rather it is recognized in the statements of income in accordance with U.S. GAAP. Refer to Note 11 (Income Taxes) for more information.
Segments. We have two primary operating segments - Term Life Insurance and Investment and Savings Products. The Term Life Insurance segment includes underwriting profits on our in-force book of term life insurance policies, net of reinsurance, which are underwritten by our life insurance company subsidiaries. The Investment and Savings Products segment includes retail and managed mutual funds and annuities distributed through licensed broker-dealer subsidiaries and includes segregated funds, an individual annuity savings product that we underwrite in Canada through Primerica Life Canada. In the United States, we distribute mutual fund and annuity products of several third-party companies. We also earn fees for account servicing on a subset of the mutual funds we distribute. In Canada, we offer a Primerica-branded fund-of-funds mutual fund product, as well as mutual funds of well-known mutual fund companies. These two operating segments are managed separately because their products serve different needs - term life insurance income protection versus wealth-building savings products.
(1) The Investment and Savings Products segment includes assets held in separate accounts. Excluding separate accounts, the Investment and Savings Products segment assets were approximately $112.0 million, $103.7 million, and $93.8 million as of December 31, 2017, 2016, and 2015, respectively.
Geographical Information. Results of continuing operations by country and long-lived assets - primarily tangible assets reported in other assets in our consolidated balance sheets -were as follows:
Includes approximately $0.2 million of OTTI losses related to corporates and mortgage- and asset-backed securities recognized in accumulated other comprehensive income.
The scheduled maturity distribution of the AFS fixed-maturity portfolio at December 31, 2017 was as follows:
The LLC Note is classified as a held-to-maturity debt security in the Company’s invested asset portfolio as we have the positive intent and ability to hold the security until maturity. As of December 31, 2017, the LLC Note, which was rated A+ by Fitch Ratings, had an estimated unrealized holding gain of approximately $42.3 million based on its amortized cost and estimated fair value, which is derived using the valuation techniques described in Note 5 (Fair Value of Financial Instruments).
Securities Lending Transactions. We participate in securities lending transactions with broker-dealers and other financial institutions to increase investment income with minimal risk. We require minimum collateral on securities loaned equal to 102% of the fair value of the loaned securities. We accept collateral in the form of securities, which we are not able to sell or encumber, and to the extent the collateral declines in value below 100%, we require additional collateral from the borrower. Any securities collateral received is not reflected on our consolidated balance sheets. We also accept collateral in the form of cash, all of which we reinvest. For loans involving unrestricted cash collateral, the collateral is reported as an asset with a corresponding liability representing our obligation to return the collateral. We continue to carry the loaned securities as invested assets on our consolidated balance sheets during the terms of the loans, and we do not report them as sales. Cash collateral received and reinvested was approximately $89.8 million and $73.6 million as of December 31, 2017 and 2016, respectively.
The components of net realized investment gains (losses), as well as details on gross realized investment gains and (losses) and proceeds from sales or other redemptions were as follows:
OTTI. We conduct a review each quarter to identify and evaluate impaired investments that have indications of possible OTTI. An investment in a debt or equity security is impaired if its fair value falls below its cost. Factors considered in determining whether an impairment is temporary include the length of time and extent to which fair value has been below cost, the financial condition and near-term prospects for the issue, and our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery, which may be maturity for fixed-maturity securities or within a reasonable period of time for equity securities.
As of December 31, 2017, the unrealized losses on our AFS invested asset portfolio were largely caused by interest rate sensitivity and changes in credit spreads. We believe that fluctuations caused by movement in interest rates and credit spreads have little bearing on the recoverability of our investments. We do not consider these investments to be other-than-temporarily impaired because we have the ability to hold these investments until maturity or a market price recovery, and we have no present intention to dispose of them.
Derivatives. Embedded conversion options associated with fixed-maturity securities are bifurcated from the fixed-maturity security host contracts and separately recognized as equity securities. The change in fair value of these bifurcated conversion options is reflected in realized investment gains (losses), including OTTI losses. As of December 31, 2017 and 2016, the fair value of these bifurcated options was approximately $0.9 million and $4.3 million, respectively.
Level 2. Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets. Level 2 includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. Various inputs are considered in deriving the fair value of the underlying financial instrument, including interest rate and yield curves, credit spread, and foreign exchange rates. All significant inputs are observable, or derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include: certain public and private corporate fixed-maturity and equity securities; government or agency securities; certain mortgage- and asset-backed securities and bifurcated conversion options; and
Because many fixed-maturity securities do not trade on a daily basis, third-party pricing services generally determine fair value using industry-standard methodologies, which vary by asset class. For corporates, governments, and agency securities, these methodologies include developing prices by incorporating available market information such as U.S. Treasury curves, benchmarking of similar securities including new issues, sector groupings, quotes from market participants and matrix pricing. Observable information is compiled and integrates relevant credit information, perceived market movements and sector news. Additionally, security prices are periodically back-tested to validate and/or refine models as conditions warrant. Market indicators and industry and economic events are also monitored as triggers to obtain additional data. For certain structured securities (such as mortgage-and asset-backed securities) with limited trading activity, third-party pricing services generally use industry-standard pricing methodologies that incorporate market information, such as index prices or discounting expected future cash flows based on underlying collateral, and quotes from market participants, to estimate fair value. If these measures are not deemed observable for a particular security, the security will be classified as Level 3 in the fair value hierarchy.
The fair values of financial instruments presented above are estimates of the fair values at a specific point in time using various sources and methods, including market quotations and a complex matrix system that takes into account issuer sector, quality, and spreads in the current marketplace.
Nonrecurring fair value measurements. The estimated fair value of the held-to-maturity fixed-maturity security, which is classified as a Level 3 fair value measurement, is derived using the credit spread on similarly rated debt securities and the hypothetical spread of the security’s credit enhancement feature. Policy loans, which are categorized as Level 3 fair value measurements, are carried at the unpaid principal balances. The fair value of policy loans approximate the unpaid principal balances as the timing of repayment is uncertain and the loans are collateralized by the amount of the policy. The deposit asset underlying 10% coinsurance agreement represents the value of the assets necessary to back the economic reserves held in support of the reinsurance agreement. The carrying value of this deposit asset approximates fair value, which is categorized as Level 3 in the fair value hierarchy. Notes payable represent our publicly-traded senior notes and are valued as a Level 2 fair value measurement using the quoted market price for our notes. The estimated fair value of the Surplus Note is derived by using an assumed credit spread we would expect if Vidalia Re was a credit-rated entity and the hypothetical spread of the Surplus Note’s subordinated structure. The Surplus Note is classified as a Level 3 fair value measurement.
Reinsurance recoverables represents ceded policy reserve balances and ceded claim liabilities. The amounts of ceded claim liabilities included in reinsurance recoverables that we paid and which are recoverable from those reinsurers were $28.6 million and $30.0 million as of December 31, 2017 and 2016, respectively. Benefits and claims ceded to reinsurers for 2017, 2016, and 2015 were $1,337.3 million, $1,205.6 million, and $1,178.6 million, respectively.
The largest of the IPO coinsurance agreements is a coinsurance agreement originally between Primerica Life and Prime Reinsurance Company (“Prime Re”), an affiliate of Citigroup, where we ceded to Prime Re 80% of our U.S. (except New York) term life insurance business in force at year-end 2009 (the “80% U.S. Coinsurance Agreement”). Beginning on January 1, 2016, Pecan Re Inc. (“Pecan Re”), an insurance company owned by Swiss Re Life & Health America Inc. (“Swiss Re”), assumed Prime Re’s obligations under the 80% U.S. Coinsurance Agreement through a novation agreement (the “Swiss Re Novation Agreement”). In addition, the counterparties to the related trust and capital maintenance agreements that provide Primerica Life with statutory reinsurance credit for the 80% U.S. Coinsurance Agreement were replaced by Pecan Re and Swiss Re, respectively. No material terms and conditions of the 80% U.S. Coinsurance Agreement and the related trust and capital maintenance agreements were modified.
In a fourth IPO coinsurance agreement, (the “10% Coinsurance Agreement”), we have ceded to Prime Re 10% of our U.S. (except New York) term life insurance business in force at year-end 2009 subject to an experience refund provision. As the 10% Coinsurance Agreement includes an experience refund provision, it does not satisfy U.S. GAAP risk transfer rules. As a result, we have accounted for this contract using deposit method accounting and have recognized a deposit asset in other assets on our consolidated balance sheets for assets backing the economic reserves. The deposit asset held in support of this agreement was $217.3 million and $202.4 million at December 31, 2017 and 2016, respectively. We make contributions to the deposit asset during the life of the agreement to fulfill our responsibility of funding the economic reserve. The market return on the deposit asset is reflected in net investment income during the life of the agreement. Prime Re is responsible for ensuring that there are sufficient assets to meet all statutory requirements. In exchange for our consent to the Swiss Re Novation Agreement discussed above, the finance charge on the statutory reserves in excess of economic reserves funded by Prime Re in support of the 10% Coinsurance Agreement was reduced from 3.0% to 2.0% beginning on July 1, 2015 and then from 2.0% to 0.5% beginning on January 1, 2016. This finance charge is reflected in interest expense in our consolidated statements of income.
The following table represents the Company’s in-force life insurance at December 31, 2017 and 2016:
Includes balances ceded under coinsurance transactions of term life insurance policies that were in force as of December 31, 2009. Amounts shown are net of their share of the reinsurance receivable from other reinsurers.
We defer incremental direct costs of successful contract acquisitions that result directly from and are essential to the contract transaction(s) and that would not have been incurred had the contract transaction(s) not occurred. The amortization of DAC associated with term life insurance policies requires us to make certain assumptions regarding persistency, expenses, interest rates and claims. These assumptions may not be modified, or unlocked, unless recoverability testing deems them to be inadequate. We update assumptions for new business to reflect the most recent experience. For DAC associated with Canadian segregated funds, the assumptions used in determining amortization expense are evaluated regularly and are updated if actual experience or other evidence suggests revisions to earlier estimates are appropriate.
Surplus Note. In May 2017, Primerica Life and Vidalia Re amended the Vidalia Re Coinsurance Agreement (the “Expanded Vidalia Re Coinsurance Agreement”) whereby Primerica Life ceded level-premium term life insurance policies issued in 2015 and 2016 to Vidalia Re effective June 30, 2017. The Expanded Vidalia Re Coinsurance Agreement also provides the option for Primerica Life to cede level-premium term life insurance policies issued in 2017 to Vidalia Re at a future date. Concurrent with the execution of the Expanded Vidalia Re Coinsurance Agreement, Vidalia Re entered into an amendment to the Surplus Note Purchase Agreement (the "Expanded Surplus Note Purchase Agreement") with Hannover Re and the LLC. Under the Expanded Surplus Note Purchase Agreement, the capacity of the principal amount of both the Surplus Note and the credit-enhanced LLC Note will be increased over time in accordance with the expanded amount of policy reserves being contractually supported under the Expanded Vidalia Re Coinsurance Agreement. The maturity date of both notes has been extended from December 31, 2029 to December 31, 2030. Based on the estimated reserves for ceded policies issued in 2011 through 2016, the principal amounts of the Surplus Note and the LLC Note are expected to reach approximately $1.3 billion each. The amended financing arrangement remains non-recourse to the Parent Company and Primerica Life, meaning that neither of these companies has guaranteed the Surplus Note or is otherwise liable for reimbursement for any payments triggered by the credit enhancement feature. The Parent Company has agreed to support Vidalia Re’s obligation to pay the credit enhancement fee incurred on the LLC Note. No other material terms or conditions of the original Surplus Note Purchase Agreement were modified under the Expanded Surplus Note Purchase Agreement. As of December 31, 2017, the principal amount outstanding on the Surplus Note issued by Vidalia Re was approximately $737.2 million, which is equal to the principal amount of the LLC Note. See Note 4 (Investments) for more information on the LLC Note.
We expect to finalize our analysis of the incomplete areas and make any necessary adjustments during the second half of 2018.
Effective tax rate reconciliation. Total income tax expense is different from the amount determined by multiplying income before income taxes by the U.S. statutory federal tax rate of 35% in effect through December 31, 2017.
Deferred tax liabilities associated with net unrealized gains from our AFS investments were originally established through OCI. Under ASC 740, the remeasurement of all deferred taxes, even those associated with net unrealized gains from AFS investments, resulting from the change in the statutory tax rate are recognized through income tax expense. As a result, we recognized an income tax benefit of approximately $7.8 million during the year ended December 31, 2017 to remeasure our U.S. deferred tax liabilities associated with net unrealized gains from AFS investments at the newly enacted 21% U.S. federal statutory tax rate. The stranded component, which is also equal to $7.8 million, remains in accumulated OCI as of December 31, 2017. On February 14, 2018, the FASB issued Accounting Standards Update No. 2018-02 (“ASU 2018-02”), Income Statement - Reporting Comprehensive Income (Topic 220)- Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, a narrow-scoped accounting standards update that allows companies to make an election to eliminate the stranded component within accumulated OCI by reclassifying this amount to retained earnings upon adoption. We expect to adopt ASU 2018-02 in the first quarter of 2018 and reclassify the stranded component from accumulated OCI to retained earnings at that time.
Controlled foreign corporations. The Company has direct ownership of a group of controlled foreign corporations in Canada. During the year ended December 31, 2017, we have recognized a one-time charge of approximately $3.0 million for the inclusion of mandatory deemed repatriation of foreign earnings payable to the U.S. government due to the enactment of the Tax Reform Act. This charge represents the provisional amount of incremental tax expense recognized for the mandatory deemed repatriation of Canadian earnings for which we had asserted a position of permanent reinvestment prior to the enactment of the Tax Reform Act. In response to the provisions of the Tax Reform Act, we have not made a permanent reinvestment assertion for any unremitted earnings in Canada as of December 31, 2017; therefore, we have also established a deferred tax liability to account for Canadian withholding taxes that will occur upon repatriation of such earnings.
Unrecognized tax benefits. The total amount of unrecognized benefits on uncertain tax positions that, if recognized, would affect our effective tax rate was approximately $13.4 million and $11.7 million as of December 31, 2017 and 2016, respectively. We recognize interest expense related to unrecognized tax benefits in tax expense net of federal income tax. As of December 31, 2017 and 2016, the total amount of accrued interest and penalties in the consolidated balance sheets was approximately $1.9 million and $2.1 million, respectively. Additionally, we recognized interest related to unrecognized tax benefits in the consolidated statements of income of less than $0.3 million of expense in 2017, 2016, and 2015.
A reconciliation of the change in the unrecognized income tax benefit for the years ended December 31, 2017 and 2016 is as follows:
We have no penalties included in calculating our provision for income taxes. There is no significant change that is reasonably possible to occur within twelve months of the reporting date.
On November 17, 2016, our Board of Directors authorized a share repurchase program for up to $200.0 million of our outstanding common shares (the “share repurchase program”) for purchases through June 30, 2018. Under the share repurchase program, we repurchased 1,911,380 shares of our common stock in the open market for an aggregate purchase price of approximately $150.0 million through December 31, 2017. Approximately $50.0 million remains for repurchases of our outstanding common stock under the share repurchase program as of December 31, 2017. On February 6, 2018, our Board of Directors authorized a new share repurchase program for up to $275.0 million of our outstanding common stock (including $50.0 million remaining from the prior repurchase program) for purchases through June 30, 2019.
In calculating basic EPS, we deduct from net income any dividends and undistributed earnings allocated to unvested RSUs and then divide the result by the weighted-average number of common shares and vested RSUs outstanding for the period.
The Company has outstanding equity awards under the Primerica, Inc. Second Amended and Restated 2010 Omnibus Incentive Plan (“OIP”). The OIP provides for the issuance of equity awards, including stock options, stock appreciation rights, restricted stock, deferred stock, RSUs, PSUs, unrestricted stock, as well as cash-based awards. In addition to time-based vesting requirements, awards granted under the OIP also may be subject to specified performance criteria. Since 2010, the Company has issued equity awards to our management (officers and other key employees), non-employees who serve on our Board of Directors (“directors”), and sales force leaders under the OIP. As of December 31, 2017, we had approximately 2.0 million shares available for future grants under this plan.
Employee and Director Share-Based Compensation. As of December 31, 2017, the Company had outstanding RSUs, PSUs, and stock options issued to our management (officers and other key employees), as well as RSUs issued to our directors, under the OIP.
RSUs granted to directors have time-based vesting requirements with equal and annual graded vesting over four quarters subsequent to the grant date.
As of December 31, 2017, total compensation cost not yet recognized in our financial statements related to employee and director RSU awards with time-based vesting conditions yet to be reached was approximately $3.4 million, and the weighted-average period over which cost will be recognized was 0.8 years.
In 2016 the Company began issuing PSUs to certain of its executive officers under the OIP as part of their annual equity compensation. PSU awards include a performance target of a specified average annual Return on Adjusted Equity (“ROAE”) for the Company over a three-year performance period, as well as a threshold ROAE and an ROAE at which the maximum number of shares can be earned. Awards cliff vest two months after the performance period ends. Depending on the ROAE achieved within the specified range, recipients may receive shares of common stock equal to between 0% and 150% of the number of PSUs granted. In addition, PSUs accrue forfeitable dividend equivalents, which are also paid out based on the number of shares earned.
The following table summarizes PSU activity during the years ended December 31, 2017 and 2016.
The 2016 PSU shares outstanding are based on target. Depending upon the ROAE achieved within the vesting period, recipients may receive between 0 and 27,577 shares of common stock. .
The 2017 PSU shares outstanding are based on target. Depending upon the ROAE achieved within the vesting period, recipients may receive between 0 and 54,069 shares of common stock.
As of December 31, 2017 total unrecognized compensation related to PSU awards was approximately $0.4 million, and the weighted-average period over which cost will be recognized was 1.0 years.
Stock Options. Beginning in 2013, the Company issued stock options to certain of its executive officers under the OIP as part of their annual equity compensation. Stock options are generally granted with an exercise price equal to the fair market value of our common stock on the grant date, and they expire 10 years from the date of grant. These options have time-based restrictions with equal and annual graded vesting over a three-year period. Stock options issued in 2014 and thereafter provide for such awards to vest upon the voluntary termination of employment by any employee who is “retirement eligible” as of his or her termination date. Upon retirement, employees have the lesser of three years or the remaining option term to exercise any vested options. We did not issue stock options in 2017 and currently do not anticipate issuing any new stock options pursuant to our current employee compensation program.
The following table summarizes activity related to stock options outstanding and exercisable during the years ended December 31, 2017, 2016, and 2015:
The aggregate intrinsic value represents the difference between the exercise price of our stock options and the quoted closing price of our common stock as of December 31, 2017. A summary of the intrinsic values of our stock options is as follows:
Agent equity awards vest and are measured using the fair market value at the conclusion of the quarterly contest, which is the time that performance is complete. However, outstanding agent equity awards are subject to long-term sales restrictions expiring over three years. Because the sale restrictions extend up to three years beyond the vesting period, the fair market value of the awards incorporates an illiquidity discount reflecting the risk associated with the post-vesting restrictions. To quantify this discount for each award, we use a series of put option models with one-, two- and three-year tenors to estimate a hypothetical cost of eliminating the downside risk associated with the sale restrictions.
insurance subsidiaries, NBLIC, Peach Re, and Vidalia Re. Prior to Primerica Life’s re-domestication to Tennessee in December 2017, Primerica Life prepared its statutory financial statements on the basis of accounting practices prescribed or permitted by the NAIC and Massachusetts Division of Insurance. NBLIC’s statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the NAIC and the New York State Department of Financial Services, while the statutory financial statements of Peach Re and Vidalia Re are prepared on the basis of accounting practices prescribed or permitted by the NAIC or the Vermont Department of Financial Regulation (“Vermont DOI”). Our U.S. insurance subsidiaries’ ability to pay dividends to their parent is subject to and limited by the various laws and regulations of their respective states. There are no regulatory restrictions on the ability of the Parent Company to pay dividends (other than limitations under the Delaware General Corporation Code that provide that dividends on common stock shall be declared by the Board of Directors out of surplus or, if there is no surplus, out of net profits for the fiscal year in which the dividend is declared and/or the preceding prior fiscal year).
Primerica Life’s statutory net gain from operations was approximately $398.8 million, $392.4 million and $436.3 in 2017, 2016 and 2015, respectively. Primerica Life made no pro rata distributions of any class of its own securities during 2017. During 2017, Primerica Life paid ordinary dividends of $138.0 million to the Parent Company. As of January 1, 2018, the amount of dividends Primerica Life could pay from statutory unassigned surplus without prior approval of the commissioner of the Tennessee DOCI was approximately $50.3 million, which is prescribed by the amount of statutory unassigned surplus on that date.
As of December 31, 2017, the minimum aggregate rental commitments for operating leases were as follows:
As of December 31, 2017 and 2016, we had no material capital leases.