Properties Protective’s Home Office is located at 2801 Highway 280 South, Birmingham, Alabama. This campus includes the original 142,000 square-foot building which was completed in 1976, a second contiguous 220,000 square-foot building which was completed in 1985, and a third contiguous 315,000 square foot building that was completed in 2002. In February 2000, Protective entered into an arrangement related to the construction of the third building. In connection with the arrangement Protective established a special purpose vehicle (SPV) that owns the building and leases it to Protective. The lease is accounted for as an operating lease under SFAS No. 13 “Accounting For Leases”. The SPV is funded and its equity is held by outside investors, and as a result, neither the debt nor the building owned by the SPV are included in Protective’s consolidated financial statements. Lease payments commence upon completion, which occurred January 31, 2003, and is based on then current LIBOR interest rates and the cost of the building. At the end of the lease term, February 1, 2007, Protective may purchase the building for the original building cost of approximately $75 million. Based upon current interest rates, annual lease payments are estimated to be $1.6 million. Were Protective not to purchase the building, a payment of approximately $66.8 million would be due at the end of the lease term. In addition, parking is provided for approximately 2,760 vehicles.
YEAR ENDED DECEMBER 31 ------------------------------------------------------------------------------- 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) INCOME STATEMENT DATA Premiums and policy fees................ $ 1,529,834 $ 1,389,819 $ 1,175,943 $ 861,021 $ 790,586 Reinsurance ceded....................... (746,980) (771,151) (686,108) (462,297) (378,398) ------------ ------------- ------------ ----------- ----------- Net of reinsurance ceded................ 782,854 618,668 489,835 398,724 412,188 Net investment income................... 980,059 839,103 692,081 617,829 597,192 Realized investment gains (losses): Derivative financial instruments..... (12,959) (1,718) 2,157 3,425 All other investments................ 12,314 (6,123) (16,756) 1,335 2,136 Other income............................ 41,483 38,578 35,194 22,599 15,906 ------------ -------------- ------------ ----------- ----------- Total revenues.......................... 1,803,751 1,488,508 1,202,511 1,043,912 1,027,422 Benefits and expenses................... 1,562,128 1,274,550 1,027,889 857,299 855,961 Income tax expense...................... 84,229 70,457 61,478 67,991 60,053 Income from continuing operations before cumulative effect of change in accounting principle................. 157,394 143,501 113,144 118,622 111,408
Cumulative effect of change in accounting principle(2)......................... 0 (8,341) 0 0 0 ------------ -------------- ------------ ------------ ------------ Net Income.............................. $ 157,394 $ 107,550 $ 129,443 $ 140,649 $ 126,464 ============ ============== ============ ============ ============
(1) Income from discontinued operations in 2001 includes loss on sale of discontinued operations and loss from discontinued operations, net of income tax. (2) Cumulative effect of change in accounting principle relating to SFAS No. 133, net of income tax. (3) Includes indebtedness to related parties. Such indebtedness totaled $2.0 million, $6.0 million, $10.0 million, $14.0 million and $20.9 million at December 31, 2002, 2001, 2000, 1999 and 1998, respectively. See also Note E to the Consolidated Financial Statements. (4) Includes stable value contracts account balances and annuity account balances which do not pose significant mortality risk. (5) "Share-owner's equity excluding accumulated other comprehensive income" is a non-GAAP measure. "Share-owner's equity" is a GAAP measure to which "Share-owner's equity excluding accumulated other comprehensive income" may be compared.
CRITICAL ACCOUNTING POLICIES Protective’s accounting policies inherently require the use of judgments relating to a variety of assumptions and estimates, in particular expectations of current and future mortality, morbidity, persistency, expenses, and interest rates. Because of the inherent uncertainty when using the assumptions and estimates, the effect of certain accounting policies under different conditions or assumptions could be materially different from those reported in the consolidated financial statements. A discussion of the various critical accounting policies is presented below.
Protective incurs significant costs in connection with acquiring new insurance business. These costs, which vary with and are primarily related to the production of new business and coinsurance of blocks of policies, are deferred. The recovery of such costs is dependent on the future profitability of the related policies. The amount of future profit is dependent principally on investment returns, mortality, morbidity, persistency, and expenses to administer the business and certain economic variables, such as inflation. These factors enter into management’s estimates of future profits which generally are used to amortize certain of such costs. Accounting for other intangible assets such as goodwill also requires an estimate of the future profitability of the associated lines of business. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future profits are less than the unamortized deferred amounts.
Determining whether a decline in the current fair value of invested assets is an other than temporary decline in value can involve a variety of assumptions and estimates, particularly for investments that are not actively traded on established markets. For example, assessing the value of some investments requires Protective to perform an analysis of expected future cash flows or rates of prepayments. Other investments, such as collateralized mortgage or bond obligations, represent selected tranches of a structured transaction, supported overall by underlying investments in a wide variety of issuers. Protective’s specific accounting policies related to its invested assets are discussed in the notes to the consolidated financial statements.
Protective utilizes derivative transactions primarily in order to reduce its exposure to interest rate risk as well as currency exchange risk. Assessing the effectiveness of these hedging programs and evaluating the carrying values of the related derivatives often involves a variety of assumptions and estimates. Protective employs a variety of methods for determining the fair value of its derivative instruments. The fair values of interest rate swaptions, interest rate swaps, total return swaps and put or call options are based upon industry standard models which present-value the projected cash flows of the derivatives using current and implied future market conditions.
Determining Protective’s obligations to employees under PLC’s defined benefit pension plan and stock based compensation plans requires the use of estimates. The calculation of the liability related to PLC’s defined benefit pension plan requires assumptions regarding the appropriate weighted average discount rate, estimated rate of increase in the compensation of its employees and the expected long-term rate of return on the plan’s assets. Accounting for other stock based compensation plans may require the use of option pricing models to estimate PLC’s obligations. Assumptions used in such models relate to equity market volatility, the risk-free interest rate at the date of grant, as well as the expected exercise date.
Results of Operations Premiums and Policy Fees The following table sets forth for the periods shown the amount of premiums and policy fees, net of reinsurance (premiums and policy fees), and the percentage change from prior period:
Net Investment Income The following table sets forth for the periods shown the amount of net investment income, the percentage change from the prior period, and the percentage earned on average cash and investments:
PERCENTAGE EARNED ON PERCENTAGE AVERAGE CASH AND YEAR ENDED DECEMBER 31 AMOUNT INCREASE INVESTMENTS -------------------------------------------------------------------------------------------- (IN THOUSANDS) 2000 $692,081 12.0% 7.1% 2001 839,103 21.2 7.0 2002 980,059 16.8 6.8
Net investment income in 2001 increased $147.0 million or 21.2% over 2000, and in 2002 increased $141.0 million or 16.8% over 2001, primarily due to increases in the average amount of invested assets. Invested assets have increased primarily due to acquisitions, receiving stable value and annuity deposits, and the asset growth that results from the sale of various insurance products. The Standard coinsurance transaction and the acquisition of Inter-State and First Variable resulted in an increase in investment income of $66.4 million in 2001. The acquisition of Inter-State and First Variable and the Conseco coinsurance transaction resulted in an increase in investment income of $57.5 million in 2002 .
The percentage earned on average cash and investments was 7.0% in 2001 and 6.8% in 2002.
Realized Investment Gains (Losses) Protective generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs. The following table sets forth realized investment gains (losses) relating to derivative financial instruments and all other investments for the periods shown:
The sales of investments that have occurred generally result from portfolio management decisions to maintain proper matching of assets and liabilities. Realized investment losses in 2001 of $27.7 million were partially offset by realized investment gains of $29.7 million. Realized investment gains in 2002 of $73.0 million were largely offset by realized investment losses of $60.3 million. During 2001 and 2002, Protective recorded other than temporary impairments in its investments of $12.6 million and $17.8 million, respectively.
Other Income The following table sets forth other income for the periods shown:
YEAR ENDED DECEMBER 31 AMOUNT ------------------------------------------------------------------ (IN THOUSANDS) 2000 $35,194 2001 38,578 2002 41,483
OPERATING INCOME (LOSS) AND INCOME (LOSS) BEFORE INCOME TAX (IN THOUSANDS)
================================================================================================================ YEAR ENDED DECEMBER 31 ------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------- Operating Income (Loss) (1) Life Insurance Life Marketing $125,419 $ 92,016 $ 75,806 Acquisitions 96,418 69,251 53,624 Retirement Savings and Investment Products Stable Value Contracts 42,272 33,150 31,208 Annuities 14,656 15,093 13,584 Specialty Insurance Products Asset Protection (15,192) 35,731 34,826 Corporate and Other (19,324) (22,446) (19,417) ------------------------------------------------------- Total operating income 244,249 222,795 189,631 ------------------------------------------------------- Realized Investment Gains (Losses) Stable Value Contracts (7,061) 7,218 (6,556) Annuities 2,277 1,139 410 Unallocated Realized Investment Gains (Losses) 4,139 (16,198) (8,453) Related Amortization of Deferred Policy Acquisition Costs Annuities (1,981) (996) (410) ------------------------------------------------------- Total net (2,626) (8,837) (15,009) ------------------------------------------------------- Income (Loss) Before Income Tax Life Insurance Life Marketing 125,419 92,016 75,806 Acquisitions 96,418 69,251 53,624 Retirement Savings and Investment Products Stable Value Contracts 35,211 40,368 24,652 Annuities 14,952 15,236 13,584 Specialty Insurance Products Asset Protection (15,192) 35,731 34,826 Corporate and Other (19,324) (22,446) (19,417) Unallocated Realized Investment Gains (Losses) 4,139 (16,198) (8,453) ------------------------------------------------------- Total income before income tax $241,623 $213,958 $174,622 =======================================================
The Life Marketing segment’s 2001 pretax operating income was $92.0 million, $16.2 million above 2000. This increase is primarily due to growth in sales. The segment’s 2002 pretax operating income was $125.4 million, $33.4 million above 2001. An increase of $7.2 million is attributable to favorable mortality experience. An increase of $19.0 million can be attributed to growth through sales.
Because the overpayments were made over a period of 10 years beginning in 1992, and had the effect of reducing the amortization of deferred policy acquisition costs during that period, Protective believes that no prior period results were materially understated and that no operating trends were materially affected as a result.
The Annuities segment’s 2001 pretax operating income was $15.1 million, $1.5 million above 2000. The 2001 results include a tax benefit of approximately $3.0 million related to the segment’s variable annuities which was partially offset by an increase in reserves related to minimum death benefit guarantees of $0.7 million. The segment’s pretax operating income for 2002 was $14.7 million as compared to $15.1 million in 2001. Fixed annuity earnings increased $1.2 million due to higher account balances. This increase was more than offset by a decline in variable annuity earnings of $2.4 million due to the general decline in the equity markets. The segment had $0.1 million realized investment gains (net of related amortization of deferred policy acquisition costs) in 2001 and a $0.3 million gain in 2002. As a result, total pretax income was $15.2 million in 2001 and $15.0 million in 2002. The Annuities segment’s future results may be negatively affected by a slow economy. Volatile equity markets could negatively affect sales of variable annuities and the fees the segment assesses on variable annuity contracts. Lower interest rates could negatively affect sales of fixed annuities. In this segment, equity market volatility may create uncertainty regarding the level of future profitability in the variable annuity business and the related rate of amortization of deferred policy acquisition cost.
Protective offers a guaranteed minimum death benefit feature (GMDB) on its variable annuity products. Protective’s accounting policy has been to calculate its total exposure to GMDB, and then apply a mortality factor to determine the amount of claims that could be expected to occur in the coming twelve months. Protective then accrues to that amount over four quarters. At December 31, 2002, the total GMDB reserve was $5.6 million, an increase of $1.6 million from December 31, 2001. At December 31, 2002, the total guaranteed amount payable under the GMDB feature based on variable annuity account balances at December 31, 2002, was $539.0 million, compared to $295.0 million at December 31, 2001. Based on variable annuity account balances as of January 31, 2003, the total guaranteed dollar amount payable under the GMDB feature was approximately $561.0 million.
In view of the negative trends recently experienced in this segment, Protective performed claims experience studies in 2002 and other analyses and determined that it should increase its estimates of policy liabilities and accruals and write off certain deferred policy acquisition costs and receivables which resulted in pretax charge of $30.9 million in 2002. Examples of the negative trends affecting the segment are lower used vehicle prices resulting from new vehicle sales incentives and an increase in service contract claims. Claims experience studies are necessarily complex and involve analyzing and interpreting large quantities of data to deduce whether the trends appear to be temporary and likely to reverse, or not. Any adverse development in the trends of used vehicle prices or in service contract claims could have a material adverse effect on Protective.
EFFECTIVE INCOME YEAR ENDED DECEMBER 31 TAX RATE ------------------------------------- ---------------------------- 2000 35.2% 2001 32.9 2002 34.9
Discontinued Operations On December 31, 2001, Protective completed the sale to Fortis, Inc. of substantially all of its Dental Benefits Division (Dental Division) and discontinued certain other remaining Dental Division related operations, primarily other health insurance lines. In 2001, the loss from discontinued operations was $9.9 million (primarily due to the non-performance of reinsurers) and the loss from sale of discontinued operations was $17.8 million, both net of income tax.
PERCENT YEAR ENDED DECEMBER 31 AMOUNT INCREASE/(DECREASE) ---------------------------------------------------------------------------------------- (IN THOUSANDS) 2000 $113,144 (4.6)% 2001 143,501 26.8 2002 157,394 9.7
Compared to 2000, net income from continuing operations before cumulative effect of change in accounting principle in 2001 increased 26.8%, reflecting improved operating earnings in the Life Marketing, Acquisitions, Stable Value Contracts, Annuities, and Asset Protection segments and lower realized investment losses, which were offset by lower operating earnings in the Corporate and Other segment. Compared to 2001, net income from continuing operations before cumulative effect of change in accounting principle in 2002 increased $13.9 million, reflecting improved operating earnings in the Life Marketing, Acquisitions, Stable Value Contracts, and Corporate and Other segments offset by lower operating results in the Annuities and Asset Protection segment.
Protective operates in a mature, highly competitive industry, which could limit its ability to gain or maintain its position in the industry. Life and health insurance is a mature industry. In recent years, the industry has experienced little growth in life insurance sales, though the aging population has increased the demand for retirement savings products. Life and health insurance is a highly competitive industry. Protective encounters significant competition in all lines of business from other insurance companies, many of which have greater financial resources than Protective, as well as competition from other providers of financial services. Competition could result in, among other things, lower sales or higher lapses of existing products.
Mortality, morbidity, and casualty expectations incorporate assumptions about many factors, including for example, how a product is distributed, persistency and lapses, and future progress in the fields of health and medicine. Actual mortality, morbidity, and casualty claims could differ from expectations if actual results differ from those assumptions.
Protective could be forced to sell investments at a loss to cover policyholder withdrawals. Many of the products offered by Protective and its insurance subsidiaries allow policy-holders and contract holders to withdraw their funds under defined circumstances. Protective and its insurance subsidiaries manage their liabilities and configure their investment portfolios so as to provide and maintain sufficient liquidity to support anticipated withdrawal demands and contract benefits and maturities. While Protective and its life insurance subsidiaries own a significant amount of liquid assets, a certain portion of their assets are relatively illiquid. If Protective or its subsidiaries experience unanticipated withdrawal or surrender activity, Protective or its subsidiaries could exhaust their liquid assets and be forced to liquidate other assets, perhaps on unfavorable terms. If Protective or its subsidiaries are forced to dispose of assets on unfavorable terms, it could have an adverse effect on Protective’s financial condition.
Interest-rate fluctuations could negatively affect Protective’s spread income or otherwise impact its business. Significant changes in interest rates expose insurance companies to the risk of not earning anticipated spreads between the interest rate earned on investments and the credited interest rates paid on outstanding policies and contracts. Both rising and declining interest rates can negatively affect Protective’s spread income. While Protective develops and maintains asset/liability management programs and procedures designed to preserve spread income in rising or falling interest rate environments, no assurance can be given that changes in interest rates will not affect such spreads.
In general terms, Protective’s results are improved when the yield curve is positively sloped (i.e., when long-term interest rates are higher than short-term interest rates), and will be adversely affected by a flat or negatively sloped curve.
Equity market volatility could negatively impact Protective’s business. The amount of policy fees received from variable products is affected by the performance of the equity markets, increasing or decreasing as markets rise or fall. Equity market volatility can also affect the profitability of variable products in other ways.
The amortization of deferred policy acquisitions costs relating to variable products and the estimated cost of providing guaranteed minimum death benefits incorporate various assumptions about the overall performance of equity markets over certain time periods. The rate of amortization of deferred policy acquisition costs and the estimated cost of providing guaranteed minimum death benefits could increase if equity market performance is worse than assumed.
A deficiency in Protective’s systems could result in over- or underpayments of amounts owed to or by Protective and/or errors in Protective’s critical assumptions or reported financial results. The business of insurance necessarily involves the collection and dissemination of large amounts of data using systems operated by Protective. Examples of data collected and analyzed include policy information, policy rates, expenses, mortality and morbidity experience. To the extent that data input errors, systems errors, or systems failures are not identified and corrected by Protective’s internal controls, the information generated by the systems and used by Protective and/or supplied to business partners, policyholders, and others may be incorrect and may result in an overpayment or underpayment of amounts owed to or by Protective and/or Protective using incorrect assumptions in its business decisions or financial reporting.
Protective and its insurance subsidiaries may be subject to regulation by the United States Department of Labor when providing a variety of products and services to employee benefit plans governed by the Employee Retirement Income Security Act (ERISA). Severe penalties are imposed for breach of duties under ERISA.
Certain policies, contracts, and annuities offered by Protective and its insurance subsidiaries are subject to regulation under the federal securities laws administered by the Securities and Exchange Commission. The federal securities laws contain regulatory restrictions and criminal, administrative, and private remedial provisions.
Changes to tax law or interpretations of existing tax law could adversely affect Protective and its ability to compete with non-insurance products or reduce the demand for certain insurance products. Under the Internal Revenue Code of 1986, as amended (the “Code”), income tax payable by policyholders on investment earnings is deferred during the accumulation period of certain life insurance and annuity products. This favorable tax treatment may give certain of Protective’s products a competitive advantage over other non-insurance products. To the extent that the Code is revised to reduce the tax-deferred status of life insurance and annuity products or to increase the tax-deferred status of competing products, all life insurance companies, including Protective and its subsidiaries, would be adversely affected with respect to their ability to sell such products, and, depending upon grandfathering provisions, would be affected by the surrenders of existing annuity contracts and life insurance policies. For example, changes in laws or regulations could restrict the ability of some companies to purchase certain corporate or bank-owned life insurance products. Additionally, changes in tax law based on recent proposals to reduce or eliminate federal income tax on corporate dividends and to establish new tax advantaged retirement and life savings plans could, if enacted, reduce the tax advantage of investing in certain life insurance or annuity products. In addition, life insurance products are often used to fund estate tax obligations. Legislation has recently been enacted that would, over time, reduce and eventually eliminate the estate tax. If the estate tax is significantly reduced or eliminated, the demand for certain life insurance products could be adversely affected. Additionally, Protective is subject to the federal corporation income tax. Protective cannot predict what changes to tax law or interpretations of existing tax law could adversely affect Protective.
Financial services companies are frequently the targets of litigation, including class action litigation, which could result in substantial judgments. A number of civil jury verdicts have been returned against insurers, broker-dealers, and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives, relationships with agents or other persons with whom the insurer does business, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive non-economic compensatory damages. In some states, juries, judges, and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages, which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very limited appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. Protective, like other financial services companies, in the ordinary course of business is involved in such litigation or, alternatively, arbitration. Protective cannot predict the outcome of any such litigation or arbitration.
Protective’s ability to maintain low unit costs is dependent upon the level of new sales and persistency of existing business. Protective’s ability to maintain low unit costs is dependent upon the level of new sales and persistency (continuation or renewal) of existing business. A decrease in sales or persistency without a corresponding reduction in expenses may result in higher unit costs.
Our reinsurers could fail to meet assumed obligations, increase rates or be subject to adverse developments that could affect Protective. Protective and its insurance subsidiaries cede material amounts of insurance and transfer related assets to other insurance companies through reinsurance. Protective may enter into third-party reinsurance arrangements under which Protective will rely on the third party to collect premiums, pay claims, and/or perform customer service functions. However, Protective remains liable with respect to ceded insurance should any reinsurer fail to meet the obligations assumed by it.
Recently Issued Accounting Standards In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001.
Protective adopted SFAS No. 142 effective January 1, 2002. Protective performed an impairment test and determined that its goodwill was not impaired at January 1, or October 31, 2002. The following table illustrates adjusted income from continuing operations before cumulative effect of change in accounting principle as if this pronouncement was adopted as of January 1, 2000:
In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. Protective does not expect the adoption of SFAS No. 143 to have a material effect on Protective’s financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires that the same accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, expands the use of discontinued operations accounting to include more types of transactions and changes the timing of when discontinued operation accounting is applied. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 did not have a material effect on Protective’s financial position or results of operations when adopted on January 1, 2002.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002.” SFAS No. 145 rescinds SFAS No. 4, which required companies to treat the extinguishment of debt as an extraordinary item. SFAS No. 145 requires companies to apply APB Opinion 30 when determining the accounting for the extinguishment of debt. The statement also rescinds and amends other statements to make various technical corrections and clarifications. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. Protective does not expect the adoption of SFAS No. 145 to have a material effect on its financial position or results of operations.
In November, 2002, the FASB issued FASB Interpretation No. (FIN) 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Others.” FIN 45 clarifies the requirements of SFAS No. 5 “Accounting for Contingencies” relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. The initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Protective does not expect FIN 45 to have a material effect on Protective’s financial position or results of operations.
YEAR ENDED DECEMBER 31 ------------------------------------------- 2002 2001 2000 ---- ---- ---- REVENUES Premiums and policy fees................................................ $1,529,834 $1,389,819 $1,175,943 Reinsurance ceded....................................................... (746,980) (771,151) (686,108) ----------- ----------- ----------- Net of reinsurance ceded.............................................. 782,854 618,668 489,835 Net investment income................................................... 980,059 839,103 692,081 Realized investment gains (losses): Derivative financial instruments..................................... (12,959) (1,718) 2,157 All other investments................................................ 12,314 (6,123) (16,756) Other income............................................................ 41,483 38,578 35,194 ----------- ----------- ----------- 1,803,751 1,488,508 1,202,511 ----------- ----------- ----------- BENEFITS AND EXPENSES Benefits and settlement expenses (net of reinsurance ceded: 2002 - $699,808; 2001 - $609,996; 2000 - $538,291)............................ 1,162,231 972,624 760,778 Amortization of deferred policy acquisition costs .................... 239,490 147,058 143,180 Amortization of goodwill.............................................. 0 2,827 2,514 Other operating expenses (net of reinsurance ceded: 2002 - $177,509; 2001 - $167,243; 2000 - $223,498)..................................... 160,407 152,041 121,417 ----------- ----------- ----------- 1,562,128 1,274,550 1,027,889 ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAX 241,623 213,958 174,622 ----------- ----------- ----------- INCOME TAX EXPENSE Current................................................................. 75,335 118,421 12,180 Deferred................................................................ 8,894 (47,964) 49,298 ----------- ----------- ----------- 84,229 70,457 61,478 ----------- ----------- -----------
Net income from continuing operations before cumulative effect of change in accounting principle....................................................... 157,394 143,501 113,144 Income (loss) from discontinued operations, net of income tax ............. 0 (9,856) 16,299 Loss from sale of discontinued operations, net of income tax .............. 0 (17,754) 0 ----------- ----------- ----------- Net income before cumulative effect of change in accounting principle...... 157,394 115,891 129,443 Cumulative effect of change in accounting principle, net of income tax..... 0 (8,341) 0 ----------- ----------- ----------- NET INCOME................................................................. $ 157,394 $ 107,550 $ 129,443 =========== =========== ===========
In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS Nos. 141, “Business Combinations”, and 142, “Goodwill and Other Intangible Assets”. SFAS No. 141 requires that business combinations initiated after June 30, 2001, be accounted for using the purchase method. SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. Protective adopted SFAS No. 142 in the first quarter of 2002. Protective has performed an impairment test and determined that its goodwill was not impaired at January 1, or October 31, 2002.
YEAR ENDED DECEMBER 31 ---------------------------------------------------- 2002 2001 2000 ---- ---- ---- Adjusted net income: Income from continuing operations before cumulative effect of change in accounting principle $157,394 $143,501 $113,144 Add back amortization of goodwill, net of income tax 0 1,838 1,634 --------- --------- --------- Adjusted income from continuing operations before cumulative effect of change in accounting principle $157,394 $145,339 $114,778 Income (loss) from discontinued operations, net of income tax 0 (9,856) 16,299 Loss from sale of discontinued operations, net of income tax 0 (17,754) 0 --------- -------- -------- Adjusted net income before cumulative effect of change in accounting principle 157,394 117,729 131,077 Cumulative effect of change in accounting principle, net of income tax 0 (8,341) 0 --------- --------- --------- Adjusted net income $157,394 $109,388 $131,077 ========= ========= =========
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. Protective does not expect the adoption of SFAS No. 143 go have a material effect on Protective's financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002." SFAS No. 145 rescinds SFAS No. 4, which required companies to treat the extinguishment of debt as an extraordinary item. SFAS No. 145 requires companies to apply APB Opinion 30 when determining the accounting for the extinguishment of debt. The statement also rescinds and amends other statements to make various technical corrections and clarifications. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. Protective does not accept the adoption of SFAS No. 145 to have a material effect on Protective's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to record a liability for a cost associated with an exit or disposal activity when the liability is incurred. The statement is effective for exit or disposal activities initiated after December 31, 2002. Protective does not expect the adoption of SFAS No. 146 to have a material effect on Protective's financial position or results of operations.
In January, 2003, the FASB issued FIN 46 "Consolidation of Variable Interest Entities." FIN 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from the other parties. Protective is currently assessing the impact that FIN 46 will have on its financial condition and results of operations. FIN 46 potentially will affect the accounting related to a lease arrangement currently accounted for as an operating lease that involves a special purpose vehicle (SPV). Although Protective does not expect the provisions of FIN 46 to have a material impact on its results of operations, had the provision been effective at December 31, 2002, Protective's reported assets and liabilities would have increased by approximately $75 million.
In May 2002, the Derivatives Implementation group of the FASB exposed for comment issue No. B36, "Bifurcation of Embedded Credit Derivatives" (DIG B36). DIG B36 would require the bifurcation of potential embedded derivatives within modified coinsurance and funds withheld coinsurance arrangements in which the terms require the future payment of a principal amount plus a return based on a specified proportion of the ceding company's return on either its general account assets or a specified block of those assets. The proposed effective date of the implementation guidance in DIG B36 is for the first fiscal quarter beginning after June 15, 2003 and would be applied on a prospective basis. Protective is currently evaluating the impact of this pronouncement on its financial statements but does not anticipate a material impact on its financial condition or results of operations.
o Mortgage loans-- at unpaid balances, adjusted for loan origination costs, net of fees, and amortization of premium or discount.
Estimated market values were derived from the durations of Protective's fixed maturities and mortgage loans. Duration measures the relationship between changes in market value to changes in interest rates. While these estimated market values generally provide an indication of how sensitive the market values of Protective's fixed maturities and mortgage loans are to changes in interest rates, they do not represent management's view of future market changes, and actual market results may differ from these estimates.
Protective believes that an insurance company's balance sheet may be difficult to analyze without disclosing the effects of recording accumulated other comprehensive income (including unrealized gains and losses on investments). The carrying value of Protective's investments, deferred policy acquisition costs, deferred income taxes and share-owner's equity are all affected by recording unrealized gains and losses on investments, therefore these items are separately identified in the table below. The captions "all other assets" and "all other liabilities" represent the assets and liabilities unaffected by recording unrealized gains and losses on investments. Protective's balance sheets at December 31, adjusted for the effects of recording accumulated other comprehensive income (including unrealized gains and losses on investments), are as follows:
Protective monitors its use of derivatives in connection with its overall asset/liability management programs and procedures. Protective’s asset/liability committee is responsible for implementing various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into Protective’s overall interest rate and currency exchange risk management strategies.
Fair-Value Hedges. Protective has designated, as a fair value hedge, callable interest rate swaps used to modify the interest characteristics of certain stable value contracts. In assessing hedge effectiveness, Protective excludes the embedded call option’s time value component from each derivative’s total gain or loss. In 2002 and 2001, total measured ineffectiveness for the fair value hedging relationships was insignificant while the excluded time value component resulted in a pre-tax gain of $0 and $1.3 million, respectively. Both the measured ineffectiveness and the excluded time value component are reported in “Realized Investment Gains (Losses) - Derivative Financial Instruments” in Protective’s consolidated statements of income.
Cash-Flow Hedges. Protective has entered into a foreign currency swap to hedge the risk of changes in the value of interest and principal payments to be made on certain of its foreign-currency-based stable value contracts. Under the terms of the swap, Protective pays a fixed U.S.-dollar-denominated rate and receives a fixed foreign-currency-denominated rate. Effective July 1, 2002, Protective designated this swap as a cash flow hedge and therefore recorded the change in the fair value of the swap during the period in accumulated other comprehensive income. During 2002, a pretax loss of $19.8 million representing the change in fair value of the hedged contracts and a gain of like amount representing the application of hedge accounting to this transaction, were recorded in “Realized Investment Gains (Losses) - Derivative Financial Instruments” in Protective’s consolidated statements of income. For the year ended December 31, 2002, the amount of the hedge’s ineffectiveness reported as a loss was insignificant. Additionally, as of December 31, 2002, Protective reported a reduction to accumulated other comprehensive income of $2.1 million (net of income tax of $1.1 million) related to its derivative designated as a cash flow hedge. During 2003, Protective expects to reclassify out of accumulated other comprehensive income and into earnings, as a reduction of interest expenses, approximately $0.9 million.
Other Derivatives. Protective uses certain interest rate swaps, caps, floors, options and futures contracts as economic hedges against the changes in value or cash flows of outstanding mortgage loan commitments and certain owned investments. In 2002 and 2001, Protective recognized total pre-tax losses of $3.0 million and $1.2 million, respectively, representing the change in fair value of these derivative instruments as well as realized gain or loss on contracts closed during the period.
At December 31, 2002 and 2001, contracts with a notional amount of $6.0 billion were in an $83.9 million net gain position. At December 31, 2001, contracts with a notional amount of $4.5 billion were in a $3.5 million net loss position.
CASH Cash includes all demand deposits reduced by the amount of outstanding checks and drafts. Protective has deposits with certain financial institutions which exceed federally insured limits. Protective has reviewed the credit worthiness of these financial institutions and believes there is minimal risk of a material loss.
GOODWILL The goodwill balance at December 31, 2002 and 2001, was $35.1 million and $36.0 million, respectively. The decrease of $0.9 million in 2002 relates to the sale of a small subsidiary in the first quarter. At October 31, 2002, Protective evaluated its goodwill and determined that fair value had not decreased below carrying value and no adjustment to impair goodwill was necessary in accordance with SFAS No. 142.
PROPERTY AND EQUIPMENT Property and equipment are reported at cost. Protective primarily uses the straight-line method of depreciation based upon the estimated useful lives of the assets. Protective’s Home Office building is depreciated over a thirty-nine year useful life, furniture is depreciated over a ten year useful life, office equipment and machines are depreciated over a five year useful life, and software and computers are depreciated over a three year useful life. Major repairs or improvements are capitalized and depreciated over the estimated useful lives of the assets. Other repairs are expensed as incurred. The cost and related accumulated depreciation of property and equipment sold or retired are removed from the accounts, and resulting gains or losses are included in income.
Paid related to: Current year............................................... 243,206 312,748 241,566 Prior year................................................. 22,528 81,220 60,972 --------- --------- --------- Total paid............................................. 265,734 393,968 302,538 --------- --------- ---------
Net balance end of year.................................... 61,449 66,300 84,143 Plus reinsurance....................................... 54,765 33,723 25,830 --------- --------- --------- Balance end of year............................................ $116,214 $100,023 $109,973 ========= ========= =========
INCOME TAXES Protective uses the asset and liability method of accounting for income taxes. Income tax provisions are generally based on income reported for financial statement purposes. Deferred federal income taxes arise from the recognition of temporary differences between the basis of assets and liabilities determined for financial reporting purposes and the basis of assets and liabilities determined for financial reporting purposes and the basis for income tax purposes. Such temporary differences are principally related to the deferral of policy acquisition costs and the provision for future policy benefits and expenses.
DISCONTINUED OPERATIONS On December 31, 2001, Protective completed the sale to Fortis, Inc. of substantially all of its Dental Benefits Division (Dental Division) and discontinued other remaining Dental Division related operations, primarily other health insurance lines.
2002 2001 2000 ---- ---- ---- Total revenues....................................... $15,809 $350,988 $368,319 ------- --------- --------- Income (loss) before income taxes from discontinued operations........................ $ 0 $(12,749) $ 26,988 Income tax (expense) benefit........................................ 0 2,893 (10,689) ------- --------- ---------- Income (loss) from discontinued operations........................ $ 0 $ (9,856) $ 16,299 ------- --------- ---------- Gain from sale of discontinued operations before income tax.............................. $ 27,221 Income tax expense related to sale................................ (44,975) ------- --------- ---------- Loss from sale of discontinued operations........................ $(17,754) ------- --------- ----------
RECLASSIFICATIONS Certain reclassifications have been made in the previously reported financial statements and accompanying notes to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on previously reported net income, total assets, or share-owners’ equity.
The reconciliations of net income and share-owners’ equity prepared in conformity with statutory reporting practices to that reported in the accompanying consolidated financial statements are as follows:
In conformity with statutory reporting practices:(1).............................. $ 67,242 $163,181 $ 66,694 $ 852,645 $ 775,138 $ 628,274 Additions (deductions) by adjustment: Deferred policy acquisition costs, net of amortization......................... 197,835 163,243 157,617 1,683,224 1,532,683 1,189,380 Deferred income tax.................... (8,894) 47,964 (52,580) (206,844) (74,083) (72,065) Asset Valuation Reserve................ 189,828 108,062 103,853 Interest Maintenance Reserve........... (3,344) (10,444) (3,540) 24,015 16,959 9,715 Nonadmitted items...................... 272,137 139,500 97,447 Other timing and valuation adjustments. (63,189) (32,564) (38,349) (357,244) (334,198) (195,445) Discontinued operations................ (193,688) Noninsurance affiliates................ 15,920 19,022 21,276 Consolidation elimination.............. (48,176) (49,164) (21,675) (172,477) (280,728) (221,204) --------- --------- --------- ----------- ---------- ----------- In conformity with generally accepted accounting principles...................... $157,394 $107,550 $129,443 $2,285,284 $1,883,333 $1,539,955 ========= ========= ========= =========== =========== ===========
As of December 31, 2002, Protective had on deposit with regulatory authorities, fixed maturity and short-term investments with a market value of approximately $81.4 million.
2002 2001 2000 ------------------------------------- Fixed maturities.................................... $ 12,606 $ (4,693) $ (14,787) Equity securities................................... 65 2,462 1,685 Mortgage loans and other investments................ (357) (3,892) (3,654) --------- --------- ---------- $ 12,314 $ (6,123) $ (16,756) ========= ========= ==========
Each quarter Protective reviews investments with material unrealized losses and tests for other-than-temporary impairments. Protective analyzes various factors to determine if any specific other than temporary asset impairments exist. Once a determination has been made that a specific other-than-temporary impairment exists, a realized loss is incurred and the cost basis of the impaired asset is adjusted to its fair value. During 2002 and 2001, respectively, Protective recorded other than temporary impairments in its investments of $17.8 million and $12.6 million. Protective did not record any other-than-temporary impairments in its investments in 2000.
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUES ------------------------------------------------------- ---- Fixed maturities: Bonds: Mortgage-backed securities........... $4,168,026 $199,316 $28,311 $4,339,031 United States Government and authorities........................ 90,647 5,752 0 96,399 States, municipalities, and political subdivision.............. 27,005 2,349 0 29,354 Public utilities..................... 1,153,710 61,831 42,139 1,173,402 Convertibles and bonds with warrants........................... 115,728 2,656 5,872 112,512 All other corporate bonds............ 5,655,949 348,809 101,818 5,902,940 Redeemable preferred stocks............... 1,700 127 0 1,827 ----------- -------- -------- ----------- 11,212,765 620,840 178,140 11,655,465 Equity securities............................ 51,095 2,409 4,705 48,799 Short-term investments....................... 447,155 0 0 447,155 ----------- -------- -------- ----------- $11,711,015 $623,249 $182,845 $12,151,419 =========== ======== ======== ===========
2002 2001 2000 ---- ---- ---- Fixed maturities........................................ $227,283 $108,307 $109,625 Equity securities....................................... (480) 715 (820)
At December 31, 2002 and 2001, Protective’s problem mortgage loans (over ninety days past due) and foreclosed properties totaled $20.6 million and $29.6 million, respectively. Since Protective’s mortgage loans are collateralized by real estate, any assessment of impairment is based upon the estimated fair value of the real estate. Based on Protective’s evaluation of its mortgage loan portfolio, Protective does not expect any material losses on its mortgage loans.
At December 31, 2002 and 2001, Protective had investments related to retained beneficial interests of mortgage loan securitizations of $295.7 million and $286.4 million, respectively.
Certain investments with a carrying value of $87.6 million were non-income producing for the twelve months ended December 31, 2002.
On December 31, 2001, Protective Life Insurance Company had $117.0 million of securities sold under repurchase agreements with an interest rate of 2.0%. The agreement-to-repurchase liability is recorded as securities sold under repurchase agreements.
Note D - FEDERAL INCOME TAXES Protective’s effective income tax rate related to continuing operations varied from the maximum federal income tax rate as follows:
Statutory federal income tax rate applied to pretax income.................. 35.0% 35.0% 35.0% Dividends received deduction and tax-exempt interest........................ (2.3) (1.7) (0.6) Low-income housing credit................................................... (0.5) (0.5) (0.4) Other....................................................................... 2.1 (0.1) 0.0 State income taxes.......................................................... 0.6 0.2 1.2 ----- ----- ----- Effective income tax rate................................................... 34.9% 32.9% 35.2% ===== ===== =====
2002 2001 2000 ------------------------------ Deferred policy acquisition costs........................................... $ 51,998 $ 81,015 $41,533 Benefits and other policy liability changes................................. (22,359) (127,189) 10,969 Temporary differences of investment income.................................. (28,637) 7,145 (3,333) Other items................................................................. 7,892 (8,935) 129 --------- --------- -------- $ 8,894 $(47,964) $49,298 ========= ========= ========
2002 2001 ---------------------- Deferred income tax assets: Policy and policyholder liability reserves............................ $320,081 $334,876 Other................................................................. 3,001 10,893 -------- -------- 323,082 345,769 ======== ======== Deferred income tax liabilities: Deferred policy acquisition costs..................................... 431,069 379,072 Unrealized gains (losses) on investments.............................. 98,857 39,100 -------- -------- 529,926 418,172 -------- -------- Net deferred income tax liability $206,844 $ 72,403 ======== ========
Included in indebtedness to related parties is a surplus debenture issued by Protective to PLC. At December 31, 2002, the balance of the surplus debenture was $2 million. The debenture matures in 2003 and has an interest rate of 8.5%.
Note F - RECENT ACQUISITIONS In January 2001, Protective coinsured a block of individual life policies from Standard Insurance Company.
(UNAUDITED) 2002 2001 -------------------------------------------------------------------------- Total revenues $1,844,221 $1,649,798 Net income 160,020 121,577
Note G - COMMITMENTS AND CONTINGENT LIABILITIES Protective leases administrative and marketing office space in approximately 60 cities including Birmingham, with most leases being for periods of three to ten years. The aggregate annualized rent is approximately $10.8 million.
A number of civil jury verdicts have been returned against insurers and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives’ relationships with agents or persons with whom the insurer does business, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very little appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. Protective, like other financial service companies, in the ordinary course of business, is involved in such litigation or, alternatively, in arbitration. Although the outcome of any such litigation or arbitration cannot be predicted Protective believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position, results of operations, or liquidity of Protective.
Note H - SHARE-OWNER'S EQUITY AND RESTRICTIONS At December 31, 2002, approximately $1,384.0 million of consolidated share-owner’s equity, excluding net unrealized gains on investments, represented net assets of Protective and its subsidiaries that cannot be transferred to PLC in the form of dividends, loans, or advances. In addition, Protective and its subsidiaries are subject to various state statutory and regulatory restrictions on their ability to pay dividends to PLC. In general, dividends up to specified levels are considered ordinary and may be paid thirty days after written notice to the insurance commissioner of the state of domicile unless such commissioner objects to the dividend prior to the expiration of such period. Dividends in larger amounts are considered extraordinary and are subject to affirmative prior approval by such commissioner. The maximum amount that would qualify as ordinary dividends to PLC by Protective in 2003 is estimated to be $93.1 million.
Protective leases furnished office space and computers to affiliates. Lease revenues were $3.5 million in 2002, $4.0 million in 2001, and $4.0 million in 2000. Protective purchases data processing, legal, investment and management services from affiliates. The costs of such services were $88.0 million, $82.6 million, and $76.7 million in 2002, 2001, and 2000, respectively. Commissions paid to affiliated marketing organizations of $8.2, $10.0 million, and $12.0 million in 2002, 2001, and 2000, respectively, were included in deferred policy acquisition costs.
Life Insurance The Life Marketing segment markets level premium term and term-like insurance, universal life, and variable universal life products on a national basis primarily through networks of independent insurance agents and brokers, and in the “bank owned life insurance” market.
Corporate and Other Protective has an additional business segment herein referred to as the Corporate and Other segment. The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on unallocated capital and interest on substantially all debt). This segment also includes earning from several lines of business which Protective is not actively marketing (mostly cancer insurance and group annuities), various investment-related transactions, and the operations of several subsidiaries.
The following table sets forth total operating segment income and assets for the periods shown. Adjustments represent the inclusion of unallocated realized investment gains (losses), the recognition of income tax expense, income from discontinued operations, and cumulative effect of change in accounting principle. Asset adjustments represent the inclusion of assets related to discontinued operations.
- $ 25,826 $ 490,452 $ 55,357 - $1,529,834 - - (228,719) (19,260) - (746,980) ---------------------------------------------------------------------------------------------------------- - 25,826 261,733 36,097 - 782,854 $246,098 220,433 43,789 9,141 - 980,059 (7,061) 2,277 - - $4,139 (645) - 3,229 33,670 1,414 - 41,483 ---------------------------------------------------------------------------------------------------------- 239,037 251,765 339,192 46,652 - 1,803,751 ---------------------------------------------------------------------------------------------------------- 196,576 186,107 200,958 34,436 - 1,162,231 2,304 24,669 57,957 1,479 - 239,490 4,946 26,037 95,469 30,061 - 160,407 ---------------------------------------------------------------------------------------------------------- 203,826 236,813 354,384 65,976 - 1,562,128 ---------------------------------------------------------------------------------------------------------- 35,211 14,952 (15,192) (19,324) 4,139 241,623 84,229 84,229 - - - - ---------------------------------------------------------------------------------------------------------- $157,394 ----------------------------------------------------------------------------------------------------------
- $ 28,145 $ 524,281 $ 51,072 - $ 1,389,819 - - (274,220) (14,038) - (771,151) ---------------------------------------------------------------------------------------------------------- - 28,145 250,061 37,034 - 618,668 $261,079 167,809 48,617 (4,803) - 839,103 7,218 1,139 - - $(16,198) (7,841) - 3,441 31,907 1,751 - 38,578 ---------------------------------------------------------------------------------------------------------- 268,297 200,534 330,585 33,982 (16,198) 1,488,508 ---------------------------------------------------------------------------------------------------------- 222,306 137,204 154,893 28,806 - 972,624 1,662 24,021 60,508 1,795 - 149,885 3,961 24,073 79,453 25,827 - 152,041 ---------------------------------------------------------------------------------------------------------- 227,929 185,298 294,854 56,428 - 1,274,550 ---------------------------------------------------------------------------------------------------------- 40,368 15,236 35,731 (22,446) (16,198) 213,958 70,457 70,457 (27,610) (27,610) (8,341) (8,341) ---------------------------------------------------------------------------------------------------------- $ 107,550 ----------------------------------------------------------------------------------------------------------
$3,930,669 $4,821,398 $1,069,341 $1,355,762 $123,829 $ 20,069,201 4,908 93,140 165,751 7,702 - 1,683,224 - - 34,795 348 - 35,143 ---------------------------------------------------------------------------------------------------------- $3,935,577 $4,914,538 $1,269,887 $1,363,812 $123,829 $ 21,787,568 ---------------------------------------------------------------------------------------------------------- $3,872,637 $4,501,667 $1,050,546 $955,984 $109,881 $ 18,013,828 6,374 128,488 142,230 8,302 - 1,532,683 - - 35,644 348 - 35,992 ---------------------------------------------------------------------------------------------------------- $3,879,011 $4,630,155 $1,228,420 $964,634 $109,881 $ 19,582,503 ----------------------------------------------------------------------------------------------------------
Note L - EMPLOYEE BENEFIT PLANS PLC has a defined benefit pension plan covering substantially all of its employees. The plan is not separable by affiliates participating in the plan. The benefits are based on years of service and the employee’s highest thirty-six consecutive months of compensation. PLC’s funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements of ERISA plus such additional amounts as PLC may determine to be appropriate from time to time. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.
2002 2001 2000 ------------------------------ Service cost............................................................ $3,723 $ 3,739 $ 3,338 Interest cost........................................................... 4,111 3,531 3,195 Expected return on plan assets.......................................... (4,265) (3,669) (3,049) Amortization of prior service cost...................................... 263 176 176 Amortization of transition asset........................................ (17) Amortization of losses.................................................. 302 141 Recognized net actuarial loss........................................... Cost of divestiture..................................................... 186 ------- -------- -------- Net pension cost........................................................ $4,134 $ 4,104 $ 3,643 ======= ======== ========
At December 31, 2002 approximately $7.7 million of the assets of the pension plan were in a group annuity contract with Protective and therefore are included in the general assets of Protective. Approximately $41.7 million of the assets of the pension plan are invested in a collective trust managed by Northern Trust Corporation.
PLC also sponsors an unfunded excess benefits plan, which is a nonqualified plan that provides defined pension benefits in excess of limits imposed on qualified plans by federal tax law. At December 31, 2002 and 2001, the projected benefit obligation of this plan totaled $17.1 million and $15.9 million, respectively, of which $14.5 million and $13.8 million, respectively, have been recognized in PLC’s financial statements.
In addition to pension benefits, PLC provides limited healthcare benefits to eligible retired employees until age 65. The postretirement benefit is provided by an unfunded plan. At December 31, 2002 and 2001, the liability for such benefits was approximately $1.2 million. The expense recorded by PLC was $0.1 million in 2002, 2001 and 2000. PLC’s obligation is not materially affected by a 1% change in the healthcare cost trend assumptions used in the calculation of the obligation.
PLC sponsors a defined contribution retirement plan which covers substantially all employees. Employee contributions are made on a before-tax basis as provided by Section 401(k) of the Internal Revenue Code. PLC established an Employee Stock Ownership Plan (ESOP) to match voluntary employee contributions to PLC’s 401(k) Plan. In 1994, a stock bonus was added to the 401(k) Plan for employees who are not otherwise under a bonus or sales incentive plan. Expense related to the ESOP consists of the cost of the shares allocated to participating employees plus the interest expense on the ESOP’s note payable to Protective less dividends on shares held by the ESOP. At December 31, 2002, PLC had committed approximately 134,293 shares to be released to fund employee benefits. The expense recorded by PLC for these employee benefits was less than $0.1 million in 2002, 2001, and 2000.
Protective’s share of net costs related to employee benefit plans was approximately $3.4 million, $5.4 million, and $4.1 million, in 2002, 2001, and 2000, respectively.
Since 1973, Protective has had stock-based incentive plans to motivate management to focus on PLC’s long-range performance through the awarding of stock-based compensation. Under plans approved by share owners in 1997 and 1998, up to 5,000,000 shares may be issued in payment of awards.
WTD. AVG. NO. OF BASE PRICE SARS --------------------------------------------------------------------------------------------- Balance at December 31, 1999 $17.44 675,000 SARs Granted 22.31 217,500 SARs Cancelled 18.14 (17,500) --------------------------------------------------------------------------------------------- Balance at December 31, 2000 $18.64 875,000 SARs Granted 26.34 138,751 P-SARs Converted 22.31 100,072 --------------------------------------------------------------------------------------------- Balance at December 31, 2001 $19.92 1,113,823 SARs Granted 32.00 480,000 SARs Exercised 32.60 (80,000) SARs Cancelled 22.31 (15,000) --------------------------------------------------------------------------------------------- Balance at December 31, 2002 $23.90 1,498,823 =============================================================================================
The outstanding SARs at December 31, 2002, were at the following base prices:
The expense recorded by PLC for its stock-based compensation plans was $5.2 million, $5.6 million, and $4.1 million in 2002, 2001, and 2000, respectively. PLC’s obligations of its stock-based compensation plans that are expected to be settled in shares of PLC’s Common Stock are reported as a component of share-owners’ equity.
Note O - ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS The carrying amount and estimated fair values of Protective’s financial instruments at December 31 are as follows:
Liabilities (see Notes A and E): Stable value account balances............ 4,018,552 4,124,192 3,716,530 3,821,955 Annuity account balances................. 3,744,000 3,795,794 3,248,218 3,166,052 Notes payable............................ 2,264 2,264 2,291 2,291 Other (see Note A): Derivative Financial Instruments......... 86,766 86,766 (1,634) (1,634)
Protective believes it is not practicable to determine the fair value of its policy loans since there is no stated maturity, and policy loans are often repaid by reductions to policy benefits.
COL. A COL. B COL. C COL. D COL. E COL. F COL. G COL. H COL. I COL. J ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ GIC, ANNUITY AMORTIZATION DEFERRED DEPOSITS AND OF DEFERRED POLICY FUTURE POLICY OTHER NET PREMIUMS NET BENEFITS AND POLICY OTHER ACQUISITION BENEFITS AND UNEARNED POLICYHOLDERS' AND POLICY INVESTMENT SETTLEMENT ACQUISITIONS OPERATING SEGMENT COSTS CLAIMS PREMIUMS FUNDS FEES INCOME(1) EXPENSES COSTS EXPENSES(1) ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, 2002: Life Marketing $ 973,631 $4,031,021 $ 318 $ 48,558 $220,184 $208,451 $ 228,225 $117,836 $(41,501) Acquisitions 438,092 3,240,407 395 1,054,031 239,014 252,147 315,929 35,245 45,395 Stable Value Contracts 4,908 0 0 3,930,668 0 246,098 196,576 2,304 4,945 Annuities 93,140 571,109 0 2,742,642 25,826 220,433 186,107 24,669 26,038 Asset Protection 165,751 328,849 777,797 8,714 261,733 43,789 200,958 57,957 95,469 Corporate and Other 7,702 55,863 2,212 96,118 36,097 9,141 34,436 1,479 30,061 Adjustments(2) 0 88,922 286 23,157 0 0 0 0 0 ---------- ---------- -------- ---------- -------- -------- ---------- -------- --------- TOTAL $1,683,224 $8,316,171 $781,008 $7,903,888 $782,854 $980,059 $1,162,231 $239,490 $160,407 ========== ========== ======== ========== ======== ======== ========== ======== ========= Year Ended December 31, 2001: Life Marketing $ 829,021 $3,326,841 $ 303 $ 86,937 $120,996 $178,866 $ 190,538 $ 41,399 $(22,957) Acquisitions 418,268 3,046,401 434 876,221 182,432 187,535 238,877 20,500 41,684 Stable Value Contracts 6,374 0 0 3,872,637 0 261,079 222,306 1,662 3,961 Annuities 128,488 281,074 0 2,232,779 28,145 167,809 137,204 24,021 24,073 Asset Protection 142,230 211,713 898,340 3,856 250,061 48,617 154,893 57,681 82,280 Corporate and Other 8,302 16,572 2,242 247 37,034 (4,803) 28,806 1,795 25,827 Adjustments(2) 0 92,084 334 24,195 0 0 0 0 0 ---------- ---------- -------- ---------- -------- -------- ---------- -------- -------- TOTAL $1,532,683 $6,974,685 $901,653 $7,096,872 $618,668 $839,103 $ 972,624 $147,058 $154,868 ========== ========== ======== ========== ======== ======== ========== ======== ======== Year Ended December 31, 2000: Life Marketing $ 99,813 $152,317 $ 149,430 $ 48,771 $(23,255) Acquisitions 102,997 116,940 125,151 17,081 24,077 Stable Value Contracts - 243,133 207,143 900 3,882 Annuities 30,127 132,204 109,607 24,156 18,203 Asset Protection 220,466 46,464 135,494 50,132 74,830 Corporate and Other 36,432 1,024 33,953 2,140 26,196 Adjustments(2) 0 0 0 0 0 -------- -------- ---------- -------- -------- TOTAL $489,835 $692,082 $ 760,778 $143,180 $123,933 ======== ======== ========== ======== ========
Premiums and policy fees: Life insurance.................................... $ 854,813 $ 545,976 $ 235,198 $ 544,035 43.2% Accident and health insurance..................... 103,858 61,512 44,337 86,683 51.1% Property and liability insurance.................. 194,601 152,730 110,543 152,414 72.5% ------------ ------------ ----------- ----------- TOTAL......................................... $ 1,153,272 $ 760,218 $ 390,078 $ 783,132 ============ ============ =========== ===========
Year Ended December 31, 2001: Life insurance in force........................... $191,105,511 $171,449,182 $23,152,614 $42,808,943 54.1% ============ ============ =========== =========== =====
COL. A COL. B COL. C COL. D COL. E ------ ------ ------ ------ ------ ADDITIONS (1) BALANCE AT CHARGED TO (2) BEGINNING OF COSTS AND CHARGES TO BALANCE AT END DESCRIPTION PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS OF PERIOD ----------------------------------------------------------------------------------------------------------------------- Allowance for Uncollected Reinsurance Receivable $ 0 $ 0 $ 24,833 $ 0 $ 24,833