Management's Discussion and Analysis of Financial Position and Results of Operations.
The following analysis should be read in conjunction with the Notes to Financial Statements.
Other significant estimates In addition to the items discussed above, the application of GAAP requires management to make other estimates and assumptions. One example is the recognition of deferred tax assets, which depends on management's assumption that future earnings will be sufficient to realize the deferred benefit. This is discussed in Note 7 to the Financial Statements.
Total assets of the Company increased $58 million from $2.525 billion at December 31, 2001 to $2.583 billion at December 31, 2002. Fixed maturities increased $63 million from investing policyholder deposits and unrealized market gains. Deferred acquisition costs grew $18 million primarily as capitalized costs from new sales were higher than the current year DAC amortization. Other increases include receivables from affiliates and other assets due to the increase in reinsurance recoverable resulting from growth in the business. Separate account assets decreased $41 million as a result of market value declines partially offset by increased contributions, as described below.
Total stockholder's equity decreased $176 million from December 31, 2000 to December 31, 2001 mainly due to dividends and policy credits. On December 28, 2001, the Company paid to its Parent an extraordinary dividend, which was approved by the New Jersey Department of Banking and Insurance. The dividend was $186 million and was paid with cash of $26.5 million and fixed maturities of $159.5 million. In connection with Prudential Insurance's demutualization, qualified annuity contract holders were given increases to their policy values in the form of policy credits. The policy credits of $10.3 million are reflected as a reduction of retained earnings. Partially offsetting these decreases are net income of $15.6 million and unrealized investment gains of $4.5 million.
Lower investment results partially offset these increases. Net investment income declined by $11.2 million due to lower yields available on the reinvestment of fixed maturities and short-term investments and a lower average fixed maturity balance than the prior year resulting from the December 2001 dividend of $186 million. Realized investment losses increased $4.6 million primarily from credit related losses on sales in 2002 of $3.7 million compared to losses on sales in the prior year of $.1 million. Losses on impairments increased $1.2 million from $7.8 million in 2001 to $9.0 million in the current year.
Net Income Net income after taxes for the year ended December 31, 2001 was $15.6 million, a decrease of $8.0 million from the year ended December 31, 2000. Realized investment losses increased $8.6 million mainly from recognized impairment writedowns on fixed maturities. In addition, net asset management fee income declined $4.7 million ($7.8 million in revenues less $3.1 million of expenses) as the Company ceased receiving fee income or paying asset management fee expenses related to the Pru Series Fund ("PSF") as of January 1, 2001, as described in the Notes to Financial Statements. Tax expense for the current year is lower than the prior year by $6.2 million due to reduced income from operations before income taxes and a refinement of the estimated benefits from nontaxable investment income.
As of December 31, 2002, our investment portfolio consisted primarily of $553.9 million of fixed maturity securities versus $490.7 million (74% of the total portfolio in 2002 versus 72% in 2001), and $192.2 million of other investments (26% of the total portfolio in 2002 versus 28% in 2001). The remaining $192.2 million of other investments were comprised of other long-term investments, policy loans and short-term investments as compared to $194.4 million in 2001.
The following table sets forth the income yield and investment income, excluding realized investment gains/(losses), for each major asset category of the Company for the periods indicated.
We manage our public portfolio to a risk profile directed by the Asset Liability and Risk Management Group. We seek to employ relative value analysis both in credit selection and in purchasing and selling securities. To the extent that we actively purchase and sell securities as part of portfolio selection and portfolio rebalancing, the total return that we earn on the portfolio will be reflected both as investment income and also as realized gains or losses on investments.
The Company has classified all privately placements and publicly traded securities as available for sale. "Available for sale" securities are carried in the Consolidated Statement of Financial Position at fair value, with unrealized gains and losses (after certain related adjustments) recognized by credits and charges to equity capital. At December 31, 2002 the fixed maturities portfolio totaled $553.9 million, an increase of $63.2 million compared to December 31, 2001. This increase in fixed maturities reflected growth in the overall portfolio due to positive cash flow from insurance operations during 2002, appreciation arising from a lower interest rate environment, as well as reinvestment of net investment income.
The following table sets forth the breakdown of our fixed maturity securities portfolio by contractual maturity as of the dates indicated.
The following table sets forth our private fixed maturity portfolios by NAIC rating as of the dates indicated.
We maintain separate monitoring processes for public and private fixed maturities and create watch lists to highlight securities which require special scrutiny and management. Our public fixed maturity asset managers formally review all public fixed maturity holdings on a monthly basis and more frequently when necessary to identify potential credit deterioration whether due to ratings downgrades, unexpected price variances, and/or industry specific concerns. We classify public fixed maturity securities of issuers that have defaulted as securities not in good standing and all other public watch list assets as closely monitored.
We classify our fixed maturity securities as available for sale. As a result we record unrealized gains and losses to the extent that amortized cost is different from estimated fair value. All available for sale securities with unrealized losses are subject to our review to identify other-than-temporary impairments in value. In evaluating whether a decline in value is other-than-temporary, we consider several factors including, but not limited to, the following:
Estimated fair values for private placement fixed maturities are determined primarily by using a discounted cash flow model which considers the current market spreads between the U.S. Treasury yield curve and corporate bond yield curve, adjusted for type of issue, its current credit quality and its remaining average life. The estimated fair value of certain non-performing private placement fixed maturities is based on amounts estimated by management.
Impairments of fixed maturity securities totaled $9.0 million in 2002 and $7.8 million in 2001.
Gross account withdrawals, amounted to $73.5 million in the year ended December 31, 2002 and $76.3 million in the year ended December 31, 2001. Since these withdrawals as well as the level of surrenders experienced, were consistent with our assumptions in asset liability management, the associated cash outflows did not have an adverse impact on our overall liquidity.
Interest rate fluctuations can affect the timing of cash flows associated with our insurance and annuity liabilities as well as the value of assets supporting these obligations. Changes in interest rates and other market conditions can also expose us to the risk of accelerated surrenders as policyholders and contract holders are attracted to alternative products. We seek to maintain an appropriate match between our assets and liabilities so that we can satisfy the changing cash flow requirements associated with interest rate fluctuations. In response to interest rate changes, we can alter our strategies for investment of new cash flows, adjust interest credited interest rates if and to the extent permitted by contracts, and adjust the pricing of new products.
We use surrender charges and other contract provisions to mitigate the extent, timing and profitability impact of withdrawals of funds by customers from annuity contracts. The following table sets forth withdrawal characteristics of our general account annuity reserves and deposit liabilities (based on statutory liability values) as of the dates indicated.
We sell variable life insurance products that contain both general and separate account components, with the bulk of account balances in separate accounts. The principal product of this type, Variable Appreciable Life, also imposes surrender charges for the first ten years after issuance. In addition to the right to surrender, policyholders may transfer account balances between the general account and the separate account components, subject to limitations on the amount transferred and only within a 30-day period following each anniversary of the policy. As of December 31, 2002 and 2001, general account balances for variable life insurance products were $309.6 million and $286.5 million, respectively, while separate account balances were $1,023.9 million and $930.9 million, respectively.
We believe that cash flows from operating and investing activities of our insurance and annuity operations are adequate to satisfy liquidity requirements of these operations based on our current liability structure and considering a variety of reasonably foreseeable stress scenarios. The continued adequacy of this liquidity will depend upon factors including future securities market conditions, changes in interest rate levels and policyholder perceptions of our financial strength, which could lead to reduced cash inflows or increased cash outflows. As of December 31, 2002 and 2001, we had cash and short-term investments of approximately $91.6 million and $91.2 million, respectively, and fixed maturity investments classified as "available for sale" with fair values of $553.9 million and $490.7 million at those dates, respectively.
Our financing principally consists of an affiliated revolving line of credit with Prudential Funding LLC, a wholly owned subsidiary of Prudential Insurance, and asset-based or secured forms of financing. The total capacity to borrow for the Company and its parent, Pruco Life of Arizona, is $700 million, which includes both the asset-based financing and borrowings from Prudential Funding LLC. There was no outstanding debt relating to the Prudential Funding LLC credit facility as of December 31, 2002 or December 31, 2001. The secured financing arrangements include transactions such as securities lending and repurchase agreements, which we generally use to finance portfolios of liquid securities and earn additional spread income.
Refer to Footnote 2, "Summary of Significant Accounting Policies," of the Notes to Financial Statements.