developed. Office space is leased in Lexington, Kentucky for operation of the Kentucky Central Life business assumed.
AH Life owns an office building in Farmington Hills, Michigan which had been used as its home office.
Insurance sales office space is leased in various jurisdictions, as is Chubb Life's small computer center in Chattanooga, Tennessee.
Chubb Life's home office complex, located in Concord, New Hampshire on approximately 196 acres owned by Chubb Life, consists of two buildings. One building is occupied pursuant to an Operating Lease with a third party, which also leases the ground under a Ground Lease running through 2040. Chubb Life acquires ownership of the building at the end of the Ground Lease, and can acquire earlier. Chubb Life also owns a separate non-adjoining seven acre parcel with a building used for printing and off-site storage.
Management's discussion and analysis of financial condition and results of operations for the three years ended December 31, 1997 analyzes the results of operations, consolidated financial condition, liquidity and capital resources of Jefferson-Pilot Corporation and consolidated subsidiaries (collectively referred to as JP or Company). The discussion should be read in conjunction with the Consolidated Financial Statements and Notes. All dollar amounts are in millions except per share amounts. All references to Notes are to Notes to the Consolidated Financial Statements.
JP's acquisition strategy is designed to deploy capital to enhance its core business growth. The focus of such acquisitions is to increase distribution, add product offerings, and provide economies of scale. In May 1997, the Company acquired Chubb Life Insurance Company of America and subsidiaries (collectively, Chubb Life). In October 1995, JP acquired Alexander Hamilton Life Insurance Company of America and FAHL (collectively, AH Life). The discussion of these acquisitions and other significant transactions contained in Note 1 is incorporated herein by reference.
In the following discussion "operating income" means income from operations before realized investment gains, but after dividends on Capital Securities and mandatorily redeemable preferred stock, except where otherwise indicated. Also, results discussed as "excluding acquisitions" exclude the effects of Chubb Life in comparisons between 1997 and 1996, and exclude AH Life and the business assumed from Kentucky Central Life (KCL) for comparisons between 1996 and 1995.
These results were achieved in spite of declines in earnings in the Group Products class. Excluding the earnings impact of acquisitions and related financing costs as well as the Group Products earnings, operating income increased 11.4% in 1997 and 16.1% in 1996.
Operating income of the Insurance and Communications business segments includes investment income but excludes net realized investment gains.
The following table illustrates JP's results by segment and product class.
Net investment income increased $161.0 or 34.7% in 1997 and $165.2 or 55.3% in 1996, consistent with the increase in policyholder fund balances from internal growth and acquisitions. Average policyholder fund balances of interest sensitive products of $4,280, excluding Chubb Life, represent a 6.8% increase over the $4,008 of average fund balances for 1996. In 1996, average policyholder fund balances increased 91.6% (17.7% excluding acquisitions) over 1995.
Excluding acquisitions, 1997 expenses were down $22.7 or 12.3% compared to 1996, which had increased $4.7 or 7.4% compared to 1995. General and administrative expenses declined in 1997 due to efficiencies realized from the integration of purchased businesses. Amortization of deferred acquisition costs on the KCL block declined $15.0 or 31.3% compared to 1996 due to improved persistency in the block. 1996 had shown an increase of $16.1 or 50.3% compared to annualized 1995 amortization, due to higher surrender rates.
Annuity and Investment Products (AIP) offers its products through financial institutions, independent agents, career agents, investment professionals and broker-dealers. Operating results were:
Operating income increased $6.1 or 9.3% in 1997 and $23.6 or 56.5% in 1996. The results for 1997 were negatively impacted by administrative office restructuring charges and a redeployment of allocated corporate capital. Other than the redeployment of capital, the Chubb Life acquisition did not significantly impact AIP operating earnings. Excluding the impact of acquisitions, 1996 operating income increased 2% from 1995 levels. Average assets under management (net of reinsurance) increased 19.2% to $5,820 in 1997 from $4,882 in 1996 as a result of internal growth, the third quarter 1996 recapture of a block of periodic payment annuities from affiliates of Household International, Inc. (Household) and the acquisition of Chubb Life AIP assets under management of $353.9.
Premiums and other considerations decreased 47.5% in 1997 after increasing 34.6% in 1996. The decline occurred on record sales of single premium immediate annuities during 1996 and increased competition in that market in 1997. The increase in other income during 1997 relates to the broker-dealer subsidiary acquired with Chubb Life. Net investment income increased $34.4 or 8.9% in 1997 and $9.1 or 7.5% in 1996, excluding the
Policy benefits excluding acquisitions decreased $6.3 or 2.0% in 1997 versus a 1996 increase of $17.4 or 15.7% as the level of single premium immediate annuities in force continued to decline. Interest credited on policyholder account balances increased 10.5% in 1997 and 9.0% in 1996, excluding acquisitions. The 1997 increase in expenses consists primarily of broker/dealer commissions related to sales of variable rate products.
Overall, Group operating income declined $13.2 or 52.8% in 1997 and $12.7 or 33.7% in 1996, as a result of difficult industry conditions in the accident and health insurance lines. As a percentage of total revenues, operating income was 2.5% and 4.9% for 1997 and 1996. Premiums continue to decline due to the competitive environment and as a result of policy lapses, caused in part by rate increases. For 1997, policy benefits as a percentage of premiums and other considerations increased to 86.2% from 83.2% in 1996 and 80.3% in 1995.
JPCC operates television and radio broadcast properties and produces syndicated sports and entertainment programming. Operating results were:
Net sale of time for the Radio division increased 20.0% and 22.5% for 1997 and 1996. These increases were the result of acquisitions and a favorable advertising environment. On a same station basis, adjusting for the effect of the late 1996 acquisitions in San Diego and the early 1997 acquisition in Denver, annual Radio revenues were up 10.4% and broadcast cash flows increased 9.1% in 1997. In total, Radio broadcast cash flows increased 18.1% and 28.7% in 1997 and 1996.
Total expenses increased 1.2% and 15.0% in 1997 and 1996. Expense growth in 1996 was primarily due to the acquisition of radio properties and the increase in the number of Sports events. Expenses as a percent of communication sales and other income for 1996 and 1995 of 76.3% and 76.4% decreased to 74.5% for 1997. The 1997 decrease was attributable to a change in the mix of business away from lower margin sports products toward higher margin broadcast business.
JP's resources are primarily represented by investments related to its Insurance segment, properties and other assets used in the Insurance and Communications segments and investments backing corporate capital. The Investments section reviews the Company's investment portfolio and key strategies.
Value of business acquired (VOBA) represents the actuarially-determined present value of future gross profits of each business acquired, discounted at a risk-adjusted rate of return. This asset is amortized at a constant rate based on the present value of the estimated gross profit amounts expected to be realized over the life of the business. VOBA of $482 was recorded during 1997 related to the Chubb Life acquisition. VOBA of $325 was recorded in 1995 related to the AH Life acquisition. Note 6 contains rollforwards of DAC and VOBA for 1997, 1996 and 1995, and is incorporated herein by reference.
Goodwill (representing the cost of acquired businesses in excess of fair value of net assets) of $225 and $86 at December 31, 1997 and 1996 relates to the acquisitions of Chubb Life, AH Life and communication properties and is being amortized over periods ranging from 5 to 40 years, with a dollar- weighted average amortization period of approximately 32 years. Goodwill as a percentage of shareholders' equity was 8.2% and 3.7% at year end 1997 and 1996.
Carrying amounts of goodwill, VOBA and DAC are regularly reviewed for indications of value impairment, with consideration given to the financial performance of acquired properties, future gross profits of insurance in force and other factors. In 1996, goodwill was decreased $7.9 due to purchase accounting adjustments.
In April 1997, the Company privately placed $75 of 6.95% Mandatorily Exchangeable Debt Securities (MEDS) and in June 1997, the Company privately placed $75 of 6.65% MEDS. The discussion of these issuances and the previously issued Adjustable Common Exchange Securities (ACES) contained in Note 8 is incorporated herein by reference.
JP has sold U. S. Treasury obligations under repurchase agreements involving various counterparties, accounted for as financing arrangements. Proceeds are used to purchase securities with longer durations as an asset/liability management strategy. The maximum amounts outstanding were $242 and $281 during 1997 and 1996. The securities involved had a fair value and amortized cost of $232 and $231 and $241 and $235, as of year end 1997 and 1996.
Of the $53 of mandatorily redeemable preferred stock outstanding, $50 is redeemable at the holder's option beginning April 1998 and $3 beginning April 1999. The Company has been notified by the holder that $50 will be redeemed in April 1998.
While the Company has made no commitments for additional financing, additional securities may be issued to finance acquisitions or for other corporate purposes.
Liquidity requirements are met primarily by positive cash flows from the operations of insurance subsidiaries and other consolidated subsidiaries. Overall sources of liquidity are sufficient to satisfy operating requirements. Primary sources of cash from the Insurance segment are premiums, other insurance considerations, receipts for policyholder accounts, investment sales and maturities and investment income. Primary uses of cash include purchase of investments, payment of benefits, operating expenses, withdrawals from policyholder accounts, costs related to acquiring new business and income taxes. Primary sources of cash from the Communications segment are revenues from advertising and sports and entertainment production. Primary uses of cash include payment of agency commissions, cost of sales, operating expenses and income taxes.
Proceeds from the issuance of securities were $450 for 1997 (MEDS of $150 during second quarter and Capital Securities of $300 during first quarter). Net borrowings/(repayments) from short-term debt and securities sold under repurchase agreements were $(138), $40 and $130 for 1997, 1996 and 1995. The 1997 amount primarily reflects maturities of securities sold under reverse repurchase agreements. Cash inflows/(outflows) from changes in policyholder contract deposits were $242, $114 and $359 for 1997, 1996 and 1995. Chubb Life contributed $217 toward the 1997 net inflow of policyholder deposits. Cash was used to pay dividends of $129, $103 and $89 during 1997, 1996 and 1995.
The investment policy permits the use of derivative financial instruments such as futures contracts and interest rate swaps in conjunction with specific direct investments. The Company uses interest rate swaps to protect against interest rate fluctuations, to modify the interest characteristics of certain blocks of annuity contracts, and, on occasion, to protect against yield curve changes between identifying and closing mortgage loan and private placement investments. The Company is exposed to credit risks when entering into swap agreements and limits this risk by entering into agreements with multiple counterparties having high credit ratings. The Company's actual use of derivative financial instruments has been limited, using them to manage well-defined interest rate risks. Interest rate swaps with a notional value of $200, $254 and $125 were open as of December 31, 1997, 1996 and 1995. Termination of these arrangements under then current interest rates would have resulted in a gain of $6. The periodic cash settlements under these arrangements are reflected as an adjustment to investment income.
The Company's investment strategy with respect to CMO's focuses on actively- traded, less volatile issues that produce relatively stable cash flows. The majority of CMO holdings are sequential tranches of federal agency issuers. Chubb Life had CMO's of $751 at December 31, 1997, resulting in the overall increase since year end 1996. The CMO portfolio has been constructed with underlying mortgage collateral characteristics and structure in order to lower cash flow volatility over a range of interest rate levels. Due to the high quality and liquid nature of these investments, the Company believes that the impairment risks associated with these securities are no greater than those applicable to direct agency or corporate issues.
Net investment income grew 23.5% in 1997 to $1,103 versus 64.5% in 1996 to $893. In 1997 and 1996, net investment income without acquisitions grew 5.8% and 14.8% despite lower investment yields on new investments during the three year period.
The Company employs various methodologies to manage its exposure to interest rate risks. The asset/liability management process focuses primarily on the management of interest rate risk of the Company's insurance operations. JP monitors the duration of insurance liabilities compared to the duration of assets backing the insurance lines, giving measurement to the optionality of cash flows. The Company's goal in such analysis is to prudently balance profitability and risk for each insurance product class, and for the Company in whole. At December 31, 1997 and 1996, 84.8% and 81.0% of life insurance invested assets at amortized cost were held for interest-sensitive portfolios and 15.2% and 19.0% were held for traditional portfolios and corporate capital and surplus.
model is based on the Company's existing business in force as of December 31, 1997 and does not consider new sales of life and annuity products or the potential impact (as discussed above) of interest rate fluctuations on sales.
The Company is exposed to equity price risk on its equity securities (other than trading). JP holds common stock with a fair value of $893. Approximately $500 of such value is represented by investments in a single issuer, NationsBank. Additionally, the Company has outstanding debt securities exchangeable into shares of NationsBank stock, referred to as Exchangeable Securities. Had the Exchangeable Securities been redeemable as of year end, the redemption value would have been $327 (see Notes 8 and 17). If the market value of the S&P 500 Index, and of NationsBank stock specifically, decreased 10% from their December 31, 1997 values, the fair value of the Company's common stock and Exchangeable Securities would change as follows:
Certain fixed interest rate market risk sensitive instruments may not give rise to incremental income or loss during the period illustrated but may be subject to changes in fair values. Note 17 presents additional disclosures concerning fair values of Financial Assets and Financial Liabilities, and is incorporated by reference herein.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward looking statements. Certain information contained herein or in any other written or oral statements made by, or on behalf of JP are or may be viewed as forward looking. Although the Company has used appropriate care in developing any such forward looking information, forward looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, the matters discussed in "Market Risk Exposures", "External Trends and Forward Looking Information" and other risks detailed from time to time in the Company's SEC filings; to the risks that the business and/or operations of Chubb Life may deteriorate due to the acquisition, and that JP might fail to successfully complete synergistic strategies for cost reductions and for growth in sales of products of Chubb Life and other insurance subsidiaries through all existing and acquired distribution channels; and more generally to: general economic conditions; competitive factors, including pricing pressures, technological developments, new product offerings and the emergence of new competitors; interest rate trends and fluctuations; and changes in federal and state laws and regulations, including, without limitation, changes in financial services industry or tax laws and regulations. The Company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future developments or otherwise.
We have audited the consolidated statements of income, stockholders' equity and cash flows of Jefferson-Pilot Corporation and subsidiaries for the year ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the consolidated financial statements of Alexander Hamilton Life Insurance Company of America and subsidiaries for the three months ended December 31, 1995, which are included in the financial statements of Jefferson-Pilot Corporation and subsidiaries referred to above. The consolidated statement of income of Alexander Hamilton Life Insurance Company of America and subsidiaries for the three months ended December 31, 1995 reflects total revenues constituting 9% of Jefferson-Pilot Corporation and subsidiaries' consolidated revenues for 1995. The consolidated financial statements of Alexander Hamilton Life Insurance Company of America and subsidiaries for the three months ended December 31, 1995 were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Alexander Hamilton Life Insurance Company of America and subsidiaries, is based solely on the report of the other auditors.
Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Our audit also included the information contained in financial statement schedules II-Financial Statements of Jefferson-Pilot Corporation, III-Supplementary Insurance Information and IV-Reinsurance insofar as it relates to 1995. These schedules are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a part of the basic consolidated financial statements. The 1995 information included in these schedules has been subjected to the auditing procedures applied in the audit of the basic financial statements for 1995 and, in our opinion, when considered in relation to the basic 1995 financial statements taken as a whole, presents fairly in all material respects the information required to be set forth therein.
Business Acquisitions: In May 1997, the Company acquired all the outstanding shares of Chubb Life from The Chubb Corporation (Seller). Chubb Life's operations, principally universal life, variable universal life and term insurance, are conducted nationwide through Chubb Life and its life insurance subsidiaries, Colonial and Sovereign. Hereinafter, Chubb Life and its subsidiaries are collectively referred to as "Chubb Life." Jefferson Pilot Securities Corporation (formerly Chubb Securities Corporation) is a full service NASD registered broker-dealer. The cost of the acquisition consisted of $775 cash paid by JP to Seller at closing, plus other acquisition costs. In addition, Chubb Life paid a $100 special dividend to Seller which was funded through liquidation of short-term investments. The $775 was financed through the liquidation of invested assets, various securities offerings (see Notes 8 and 9) and the issuance of commercial paper. The acquisition, which was effective as of April 30, 1997, is being accounted for using the purchase method. As a result, Chubb Life's results of operations from May 1, 1997 forward are included in the accompanying financial statements. The purchase price has been allocated to Chubb Life's tangible and identifiable intangible assets and liabilities based on management's estimate of their respective fair values. The transaction included the assumption of $3,851 of liabilities and the receipt of assets with a fair value of $4,005 (including $28 in cash). The acquisition resulted in the recording of value of business acquired of $482 and cost in excess of net assets acquired (i.e., goodwill) of $150. Goodwill arising from the acquisition is being amortized over a period of 35 years.
Effective October 1, 1995, the Company acquired AH Life and FAHL from Household International, Inc. (Household). The businesses acquired included substantially all of the life insurance and single premium deferred annuity contracts of AH Life and FAHL that were in force on the acquisition date. AH Life Periodic Payment Annuity (PPA) contracts, consisting primarily of structured settlements and lottery business, and Corporate-Owned Life Insurance (COLI) written prior to the acquisition, as well as certain pre-acquisition credit life, accident and health and other (Affiliated) business written in conjunction with the lending activities of Household, were 100% reinsured with affiliates of Household on a coinsurance basis. The aggregate purchase price of $575 was paid $475 in cash and $50 in mandatorily redeemable preferred stock of AH Life, plus the purchase from Household of a $50 surplus note of AH Life. The transaction included the assumption of $7,872 of liabilities and the receipt of assets with a fair value of $8,072 (including $20 in cash). The acquisition resulted in value of business acquired of $325, and cost in excess of net assets acquired of $50. This acquisition was accounted for as a purchase, and the results of operations of the acquired companies have been included in the consolidated operations of the Company since the date of acquisition.
The following pro forma financial information has been prepared assuming that the acquisition of Chubb Life had taken place at the beginning of each year presented, and assuming that the acquisitions of AH Life and FAHL had taken place at the beginning of 1995:
In January 1997, JPCC purchased substantially all of the broadcast assets of radio station KQKS-FM in Denver, Colorado for $15 in cash. This acquisition resulted in cost in excess of net assets acquired of $14. The call letters were reassigned to an existing station, and the newly acquired station now operates under the call letters KCKK-FM. In July 1996, JPCC purchased substantially all of the broadcast assets of radio station KIFM-FM in San Diego, California for $29 in cash. In October 1996, JPCC purchased substantially all of the outstanding capital stock of San Diego Broadcasting Corporation, a California corporation that owns and operates radio station KBZT-FM in San Diego, California, for $30 in cash. The 1996 acquisitions resulted in cost in excess of net assets acquired of $26. These acquisitions were accounted for as purchases, and the results of operations of the acquisitions have been included in the consolidated operations of the Company since the respective dates of acquisition. Pro forma financial information for these acquisitions has not been presented, as the pro forma impact on consolidated operations for 1997, 1996 and 1995 is not significant.
Discontinued Operations: On April 3, 1995, the Company sold Jefferson-Pilot Fire & Casualty Company (JPF&C) for $55. Revenue and net income of the discontinued operation prior to the disposition for the year ended December 31, 1995 were $16 and $2 (net of an insignificant amount of income taxes). The Company realized a gain of $16 from the disposition of JPF&C, net of income taxes of $4.
Supplemental Cash Flow Information of Dispositions: A summary of supplemental cash flow information resulting from disposals in 1995 follows:
Basis of Presentation: The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP). The insurance subsidiaries also submit financial statements to insurance industry regulatory authorities. Those financial statements are prepared on the basis of statutory accounting practices (SAP) and are significantly different from financial statements prepared in accordance with GAAP. See Note 12.
Debt and Equity Securities: Debt and equity securities are classified as either 1) securities held to maturity, stated at amortized cost; 2) trading securities, stated at fair value with unrealized gains and losses reflected in income; or 3) securities available for sale, stated at fair value with net unrealized gains and losses included in a separate component of stockholders' equity, net of deferred income taxes and adjustments to deferred policy acquisition costs and value of business acquired.
Real Estate and Other Investments: Real estate not acquired by foreclosure is stated at cost less accumulated depreciation. Real estate acquired by foreclosure is stated at the lower of depreciated cost or fair value minus estimated costs to sell. Real estate, primarily buildings, is depreciated principally by the straight-line method over estimated useful lives generally ranging from 30 to 40 years. Accumulated depreciation was $38 and $37 at December 31, 1997 and 1996. Other investments are stated at equity, or the lower of cost or market, as appropriate.
Property and Equipment: Property and equipment, which is included in other assets, is stated at cost and depreciated principally by the straight-line method over their estimated useful lives, generally 30 to 50 years for buildings and approximately 10 years for other property and equipment. Accumulated depreciation was $133 and $129 at December 31, 1997 and 1996.
Separate Accounts: Separate account assets and liabilities represent funds segregated by the Company for the benefit of certain policyholders who bear the investment risk. The separate account assets and liabilities, which are equal, are recorded at fair value. Policyholder account deposits and withdrawals, investment income and realized investment gains and losses are excluded from the amounts reported in the Consolidated Statements of Income. Fees charged on policyholders' deposits are included in other revenue.
Premiums on accident and health, and disability insurance are reported as earned, over the contract period. A reserve is provided for the portion of premiums written which relate to unexpired coverage terms.
Revenue from universal life-type and annuity products includes charges for the cost of insurance, for initiation and administration of the policy, and for surrender of the policy. Revenue from these products is recognized in the year assessed to the policyholder, except that any portion of an assessment which relates to services to be provided in future years is deferred and recognized over the period during which services are provided.
Communications sales are presented net of agency and representative commissions. Concession income of the broker/dealer subsidiaries is recorded as earned and is presented in other revenue.
Recognition of Benefits and Expenses: Benefits and expenses, other than deferred policy acquisition costs, related to traditional life, accident and health, and disability insurance products are recognized when incurred in a manner designed to match them with related premiums and spread income recognition over expected policy lives. For universal life-type and annuity products, benefits include interest credited to policyholders' accounts, which is recognized as it accrues.
Future Policy Benefits: Liabilities for future policy benefits on traditional life and disability insurance are computed by the net level premium valuation method based on assumptions about future investment yield, mortality, morbidity and persistency. Estimates about future circumstances are based principally on historical experience and provide for possible adverse deviations.
Income Taxes: The Company and most of its subsidiaries file a consolidated life/nonlife federal income tax return. Currently, AH Life and Chubb Life each file a separate consolidated return with their respective subsidiaries. Deferred income taxes are recorded on the differences between the tax bases of assets and liabilities and the amounts at which they are reported in the consolidated financial statements. Recorded amounts are adjusted to reflect changes in income tax rates and other tax law provisions as they become enacted.
Also in June 1997, the FASB issued SFAS 131, "Disclosures about Segments of an Enterprise and Related Information." This pronouncement is effective for annual periods beginning after December 15, 1997, and for interim periods beginning in the following year. SFAS 131 requires disaggregated disclosures based on internal segments used by a company in managing its business. Adoption will not impact the Company's financial position or results of operation, but will require additional footnote disclosures and may affect the presentation of operating earnings by business segment.
In February 1998, the FASB issued SFAS 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This pronouncement is effective for annual periods beginning after December 15, 1997. SFAS 132 standardizes the disclosure requirements about pensions and other postretirement benefits in order to make the required information easier to prepare and understand. Adoption will not impact the Company's financial position or results of operation, but will require additional footnote disclosures.
requirements. The following table sets forth the computation of earnings per share and earnings per share assuming dilution:
At December 31, 1997 and 1996, the recorded investment in mortgage loans that are considered to be impaired was $75 and $81. Delinquent loans outstanding as of December 31, 1997 and 1996 totaled $7 and $9. The related allowance for credit losses was $27 at December 31, 1997 and 1996. The average recorded investment in impaired loans was $78, $79 and $79 during the years ended December 31, 1997, 1996 and 1995, on which interest income of $8 was recognized each year.
On November 30, 1995, the Company transferred certain debt securities between the held to maturity and available for sale classifications concurrent with the adoption of additional SFAS 115 implementation guidance, which permitted a one time reassessment of the appropriateness of classification of securities held. This reassessment resulted in available for sale debt securities with fair value of $393 and amortized cost of $380 being transferred to the held to maturity classification. The excess of transfer date fair value of individual securities over their amortized cost, and the related unrealized net holding gain, is amortized over the period to
Use of Derivatives: The Company's investment policy permits the use of derivative financial instruments such as interest rate swaps in certain circumstances. The following summarizes open interest rate swaps:
Hedging Direct Investments: Interest rate swaps are used to reduce the impact of interest rate fluctuations on specific floating-rate direct investments. Interest is exchanged periodically on the notional value, with the Company receiving the fixed rate and paying various short-term LIBOR rates on a net exchange basis. The net amount received or paid under these swaps is reflected as an adjustment to investment income. For hedges of investments classified as available for sale, net unrealized losses, net of the effects of income taxes and the impact on deferred policy acquisition costs and the value of business acquired, are not significant and are included in net unrealized gains on securities available for sale in stockholders' equity as of December 31, 1997 and 1996.
Credit and Market Risk: The Company is exposed to credit risk in the event of non-performance by counterparties to swap agreements. The Company limits this exposure by entering into swap agreements with counterparties having high credit ratings and by regularly monitoring the ratings.
Note 6. Deferred Policy Acquisition Costs and Value of Business Acquired
Value of Business Acquired: Information about value of business acquired follows:
In September 1996, the Company finalized its purchase accounting for the acquisition of AH Life, and an adjustment to reduce the value of business acquired was made for $25 to reflect more appropriate lapse assumptions.
The Mandatorily Exchangeable Debt Securities (MEDS) and Automatic Common Exchange Securities (ACES) are collectively referred to as "Exchangeable Securities."
In April and June 1997, the Company issued MEDS of $75 at 6.95% and $75 at 6.65%, respectively. The MEDS are based on NationsBank Corporation (NationsBank) common stock. Annual interest is payable quarterly. The MEDS mature January 10, 2002 and represent senior indebtedness of the Corporation.
In December 1995, the Company publicly sold 1,815,000 unsecured 7.25% ACES Due January 21, 2000, having a principal amount of $72.50 per security. In the 30 days prior to, or at, maturity, the principal amount of the ACES will be mandatorily exchanged into either (1) a number of shares of NationsBank stock determined based on an exchange rate reflecting the then trading price for the stock or (2) cash in an amount of equal value. In February 1997, NationsBank completed a 2-for-1 stock split. The following fractional share and stock price information has been restated for the split. Subject to adjustments to reflect future dilution, the exchange rate is equal to (1) 1.6666 shares if the stock price is at least $43.50, (2) fractional shares of the stock having a value equal to $36.25 if the price is more than $36.25 but less than $43.50 or (3) two shares if the price is not more than $36.25.
Interest: Interest expense totaled $76, $39 and $22 for 1997, 1996 and 1995.
Mandatorily redeemable non-voting floating rate preferred stock (with a par value of $100 per share) of subsidiaries authorized, issued and outstanding at December 31, 1997 and 1996 totaled 530,000 shares. Dividends on $50 of such stock issued by AH Life in 1995 are cumulative at LIBOR plus 1.25% per annum. Beginning April 6, 1998, any holder may require AH Life to redeem its shares at par plus accrued dividends. Beginning October 6, 2000, AH Life may redeem the stock at par plus accrued dividends. An additional $3 of mandatorily redeemable preferred stock was issued in September 1996 related to the PPA recapture (Note 15), with similar terms and the respective redemption dates being April 1, 1999 and October 1, 2001.
Common Stock: On May 6, 1996, the shareholders approved an amendment to the articles of incorporation that increased the number of authorized shares of common stock from 150 million to 350 million.
On November 6, 1995, the Board authorized a three-for-two common stock split which was effected as a 50% stock dividend distributed on December 22, 1995 to shareholders of record as of December 8, 1995. The split-adjusted value of fractional shares was paid in cash. The par value of additional shares issued, which totaled $30, was reclassified from retained earnings to common stock during 1995. All share and per share information gives retroactive effect to the stock split.
A total of 4,206,505 shares are available for issuance pursuant to outstanding or future awards under the Employees' Plan as of December 31, 1997. The option price may not be less than the market value of the Company's common stock on the date awarded. Options are exercisable for periods determined by the
Summary Stock Option Activity: Summarized information about the Company's stock option activity for the three years in the period ended December 31 follows:
following weighted-average assumptions for 1997, 1996 and 1995: risk-free interest rates of 6.2%, 5.9% and 7.6%; volatility factors of the expected market price of the Company's common stock of 0.17; and a weighted-average expected life of the options of 7.7 years for 1997 and 10 years for 1996 and 1995. For purposes of this calculation, dividends are assumed to increase at a rate of 10% annually.
A comparison of net income and statutory capital and surplus of the life insurance subsidiaries determined on the basis of SAP to net income and stockholder's equity of these life insurance subsidiaries on the basis of GAAP is as follows:
Risk-Based Capital ("RBC") requirements promulgated by the NAIC require life insurers to maintain minimum capitalization levels that are determined based on formulas incorporating credit risk pertaining to its investments, insurance risk, interest rate risk and general business risk. As of December 31, 1997, the life insurance subsidiaries' adjusted capital and surplus exceeded their authorized control level RBC.
A reconciliation of the federal income tax rate to the Company's effective income tax rate, computed based on income from continuing operations follows:
Federal income tax returns for all years through 1993 are closed. In the opinion of management, recorded income tax liabilities adequately provide for all remaining open years.
The following table sets forth the funded status of the plans and amounts as of December 31 recognized in the consolidated balance sheets:
Other Postretirement Benefit Plans: The Company sponsors contributory health care and life insurance benefit plans for eligible retired employees, qualifying retired agents and certain surviving spouses. Substantially all of the Company's employees and qualifying agents may become eligible for these benefits if they reach retirement age or become disabled while employed by the Company and meet certain years-of-service requirements. Most of the postretirement health care and life insurance benefits are provided through JP Life. The Company contributes to a welfare benefit trust from which future benefits will be paid. The Company accrues the cost of providing postretirement benefits other than pensions during the employees' active service periods.
Certain assumptions used in determining the funded status of the plans were as follows:
Benefits do not take into consideration compensation increases. The Company's postretirement health care plan limits annual benefit increases to a maximum rate of 4%. Because future health care cost trend rates of 4% have been assumed in determining the accumulated postretirement benefit obligation as of December 31, 1997, future health care cost increases exceeding 4% per year will have no effect on the Company's obligation.
Defined Contribution Plan: Effective January 1, 1995, the Company adopted defined contribution retirement plans covering most employees and full time agents. The Company matches a portion of participant contributions and makes profit sharing contributions to a fund that acquires and holds shares of the Company's common stock. Plan assets are invested under a group variable annuity contract issued by JP Life. Expenses were $4 , $3 and $2 during 1997, 1996 and 1995.
The Company attempts to reduce its exposure to significant individual claims by reinsuring portions of certain individual life insurance policies and annuity contracts written. The Company reinsures the portion of an individual life insurance risk in excess of the Company's retention, which ranges from $0.3 to $1.4 for various individual life and annuity products. The Company also attempts to reduce exposure to losses that may result from unfavorable events or circumstances by reinsuring certain levels and types of accident and health insurance risks underwritten. The Company assumes portions of the life and accident and health risks underwritten by certain other insurers on a limited basis, but amounts related to assumed reinsurance are not significant to the consolidated financial statements.
from reinsurers as reported in the consolidated balance sheet includes $1,250 and $1,213 due from the Household affiliates under these reinsurance agreements at December 31, 1997 and 1996.
As of December 31, 1997, Chubb Life had a reinsurance recoverable of $97 from a single reinsurer, pursuant to a 50% coinsurance agreement. Chubb Life and the reinsurer are joint and equal owners in $195 of securities and short-term investments, 50% of which is included in investments as of December 31, 1997.
Amounts related to all operations which do not constitute reportable business segments have been combined with realized investment gains and consolidating adjustments in the lines described as "Corporate and other." Corporate operations consist of certain management and treasury activities and include income, gains and expenses that have not been allocated to reportable business segments. Amounts related to the discontinued other insurance segment are not included in segment information pertaining to results of operations. Depreciation and amortization includes amortization of cost in excess of net assets acquired and amortization of other intangible assets related to communications operations, but does not include depreciation of real estate investments, amortization of deferred policy acquisition costs or amortization of value of business acquired.
Additions to property and equipment were $41 in 1997, $20 in 1996 and $30 in 1995 (including amounts resulting from acquisitions). Included in the preceding amounts are additions related to the communications industry segment totaling $11, $12 and $7 in 1997, 1996 and 1995. Other additions to property and equipment related primarily to the life insurance segment. During 1995, equity securities carried at $327 were transferred from the life insurance segment to the corporate segment.
The fair values of cash, cash equivalents, balances due on account from agents, reinsurers and others, and accounts payable approximate their carrying amounts as reflected in the consolidated balance sheets due to their short- term maturity or availability. Assets and liabilities related to the Company's separate accounts are reported at fair value in the accompanying consolidated balance sheets.
The fair values of debt and equity securities have been determined from nationally quoted market prices and by using values supplied by independent pricing services and discounted cash flow techniques. These fair values are disclosed together with carrying amounts in Note 4.
The fair values of commercial paper and revolving credit borrowings approximate their carrying amounts due to their short-term nature. Similarly, the fair value of the liability for securities sold under repurchase agreements approximates its carrying amount, which includes accrued interest. With respect to the Exchangeable Securities, the fair value of the ACES is based on its nationally quoted market price. The fair value of the MEDS, which are not publicly traded, is estimated based on the value holders would have received had the MEDS been redeemable as of year end (which was derived based on the market price of NationsBank stock as of year end).
The Company routinely enters into commitments to extend credit in the form of mortgage loans and to purchase certain debt instruments for its investment portfolio in private placement transactions. The fair value of outstanding commitments to fund mortgage loans and to acquire debt securities in private placement transactions, which are not reflected in the consolidated balance sheet, approximates $176 as of December 31, 1997.
JPCC has commitments for purchases of syndicated television programming, future sports programming rights and guaranteed revenues of approximately $83 as of December 31, 1997. These commitments are not reflected as an asset or liability in the accompanying 1997 consolidated balance sheet because these programs are not currently available for use.
JP Life is a defendant in a proposed class action suit alleging deceptive practices, fraudulent and negligent misrepresentation and breach of contract in the sale of certain life insurance policies using policy performance illustrations which used then current interest or dividend rates and insurance charges and illustrated that some or all of the future premiums might be paid from policy values rather than directly by the insured. The claimant's actual policy values exceeded those illustrated on a guaranteed basis, but were less than those illustrated on a then current basis due primarily to the interest crediting rates having declined along with the overall decline in interest rates in recent years. Unspecified compensatory and punitive damages, costs and equitable relief are sought. While management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome, management believes that it has made appropriate disclosures to policyholders as a matter of practice, and intends to vigorously defend its position.
In the normal course of business, the Company and its subsidiaries are parties to various lawsuits. Because of the considerable uncertainties that exist, the Company cannot predict the outcome of pending or future litigation. However, management believes that the resolution of pending legal proceedings will not have a material adverse effect on the Company's financial position or liquidity, but could have a material adverse effect on the results of operations for a specific period.