On March 14, 2003, the Company sold three of its Home Office complex properties to Beacon Capital Partners for $910.0 million. As part of the transaction, the Company also provided Beacon Capital Partners with a long-term sub-lease of the Company's parking garage. JHFS entered into 5 - 15 year market-based leases of the space it now occupies in those buildings, the Company plans on continuing to use them as its corporate headquarters. In addition, we lease office space throughout the United States as needed for our operations, including for our sales force. We believe that our current facilities are adequate for our current and expected needs. Refer to Note 8 - Sale/Leaseback Transaction and Other Lease Obligations to our audited consolidated financial statements for additional information.
The following table sets forth certain selected historical consolidated financial data. The selected income statement data for each of the years in the three year period ended December 31, 2003 and balance sheet data as of December 31, 2003 and 2002 have been derived from our consolidated financial statements and related notes included elsewhere in this Form 10-K and should be read in conjunction with those financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations, also included elsewhere in this Form 10-K. The following selected income statement data for the years ended December 31, 2000 and 1999 and balance sheet data as of December 31, 2001, 2000, and 1999 have been derived from our consolidated financial statements not included herein. The following selected consolidated financial data has been prepared in accordance with U.S.GAAP, except the statutory data presented below which was prepared in accordance with applicable statutory accounting practices and was taken from our annual statements filed with insurance regulatory authorities. Certain reclassifications to prior periods have been made to conform to the current period presentations.
Certain prior year amounts have been reclassified to conform to the current year presentation. We evaluate segment performance and base management's incentives on segment after-tax operating income. For a discussion of segment after-tax operating income see Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K.
recorded as the cumulative effect of an accounting change, on October 1, 2003. For additional discussion of DIG B-36, refer to Note 1--Summary of Significant Accounting Policies in the notes to the financial statements. 6) This is unaudited pro forma information which gives effect to the Reorganization and Initial Public Offering (IPO) of the Company referred to in Note 1 to our consolidated financial statements. Because the Company did not have outstanding common stock prior to its IPO on February 1, 2000, the 1999 per share balances represent earnings per common share on a pro forma basis for the period January 1, 1999 through December 31, 1999 using 314.8 million outstanding common shares for the basic and diluted calculations. The 2000 earnings per common share balances represent earnings per common share on a pro forma basis for the period from January 1, 2000 through December 31, 2000 using 314.5 million and 316.2 million outstanding shares for the basic and diluted earnings per share calculations, respectively. Actual net income per common share for the period from February 1, 2000 through December 31, 2000 was $2.46 and $2.45 for the basic and diluted calculations, respectively, after restatement for implementation of SOP 00-3 (see note 1 above). No cumulative effect of accounting change occurred in 2000. Pro forma earnings per share for the periods prior to 1999 are not presented, as it would not be meaningful. 7) Balances prior to 2000 were formerly referred to as policyholders' equity.
Management's discussion and analysis reviews our consolidated and segment financial condition as of December 31, 2003 and 2002, the consolidated results of operations for the years ended December 31, 2003, 2002 and 2001 and, where appropriate, factors that may affect future financial performance. This discussion should be read in conjunction with the consolidated financial statements and related notes, included elsewhere in this Form 10-K. All of the Company's United States Securities and Exchange Commission filings are available on the internet at www.sec.gov, under the name Hancock John Financial.
The statements, analyses, and other information contained in this Management's Discussion and Analysis (MD&A) and elsewhere in this Form 10-K, in connection with the proposed merger with John Hancock and Manulife Financial Corporation, relating to trends in John Hancock Financial Services, Inc.'s, (the Company's) operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "will," "should," "may," and other similar expressions, are "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning future events and their potential effects on the Company. Future events and their effects on the Company may not be those anticipated by management. The Company's actual results may differ materially from the results anticipated in these forward-looking statements.
adversely affect the Company's future net income and financial position, and (22) in connection with the proposed merger between the Company and Manulife Financial Corporation: we may not achieve the revenue synergies, cost savings and other synergies contemplated by the proposed merger; we may experience litigation related to the merger; John Hancock's (including Maritime Life) and Manulife's distributors, customers and policyholders may react negatively to the transaction; we may encounter difficulties in promptly and effectively integrating the businesses of John Hancock and Manulife; we may not be able to retain the professional and management talent necessary to operate the business; the transaction may result in diversion of management time on merger-related issues; and after the merger, we may experience increased exposure to exchange rate fluctuations and other unknown risks associated with the merger.
A non-GAAP financial measure is a numerical measure of a company's performance, financial position, or cash flows that excludes (includes) amounts that are not normally excluded (included) in the most directly comparable measure calculated and presented in accordance with generally accepted accounting principles (GAAP) in the United States.
In this MD&A and elsewhere in this report we use a non-GAAP financial measure called "total segment after tax operating income". Please see "Adjustments to GAAP Reported Net Income" in this report or Note 14--Segment Information in the notes to the consolidated financial statements, for a description of total segment after-tax operating income and a reconciliation of that measure to net income.
o fees from variable and universal life insurance products, annuities, and insurance ASO business in our group business at Maritime Life;
Our profitability depends in large part upon: (1) the adequacy of our product pricing, which is primarily a function of competitive conditions, our ability to assess and manage trends in mortality and morbidity experience, our ability to generate investment earnings and our ability to maintain expenses in accordance with pricing assumptions; (2) the amount of assets under management; and (3) the maintenance of our target spreads between the rate of earnings on our investments and credited rates on policy or contract holders' general account balances.
Certain financial measures recur throughout our MD&A because they are metrics used by management to run our various businesses. The primary key performance measure is after-tax operating income; refer to the Results of Operations by Segment. Secondary key performance measures include return on equity, where income for the period is divided by average equity excluding unrealized gains (losses); return on assets, where after-tax operating income for the period is divided by average assets, which are both measures of the efficiency with which we invest Company resources; and book value per share, excluding unrealized gains (losses), which is a measure of growth for the Company. A key performance measure used by agencies who rate the Company's liquidity and its ability to repay its debts and execute on customer contracts is the credit quality rating of our fixed maturity portfolio; refer to the Investments section of this MD&A for presentation of the credit quality of the Company's fixed maturity portfolio. Rating agency analysis is especially important to an insurance company because its ratings drive its ability to price and subsequently sell certain products. Performance measures based on National Association of Insurance Commissioners (NAIC) statutory-based accounting measures which are viewed as critical to the Company are: statutory premiums and deposits, a measure of actual inflows from customers indicating growth in any particular product line, and statutory reserves and capital, measures used by rating general agencies and regulators of our ability to pay claims of our customers. Please refer to the tabular presentation of Protection, Asset Gathering, G&SFP and Maritime Life Segments results for a summary of key product statutory premiums and deposits. Return on equity and return on assets are shown below:
Return on equity........................... 11.17% 8.27% 10.65% Return on assets........................... 0.77% 0.53% 0.69%
On September 28, 2003, the Company entered into a definitive merger agreement with Manulife Financial Corporation (Manulife) which is expected to close early in the second quarter of 2004. In accordance with the agreement, each share of JHFS common stock will, at the time of the merger, be converted into the right to receive 1.1853 shares of Manulife stock. It is estimated that the shares of Manulife common stock to be issued to JHFS shareholders in the merger will represent approximately 42.6% of the outstanding Manulife common stock after the merger. The merger has been approved by the Company's shareholders but the closing of the merger remains subject to certain conditions, including the approval by certain U.S. and Canadian regulatory authorities. Until the merger occurs, the Company will continue to operate independently of Manulife. Thereafter, the Company will operate as a subsidiary of Manulife. The John Hancock name will be Manulife's primary U.S. brand. This Annual Report on Form 10-K does not reflect or assume any changes to JHFS'
General. We have identified the accounting policies below as critical to our business operations and understanding of our results of operations. For a detailed discussion of the application of these and other accounting policies, see Note 1--Summary of Significant Accounting Policies in the notes to consolidated financial statements. Note that the application of these accounting policies in the preparation of this report requires management to use judgments involving assumptions and estimates concerning future results or other developments including the likelihood, timing or amount of one or more future transactions or events. There can be no assurance that actual results will not differ from those estimates. These judgments are reviewed frequently by senior management, and an understanding of them may enhance the reader's understanding of the Company's financial statements. We have discussed the identification, selection and disclosure of critical accounting estimates and policies with the Audit Committee of the Board of Directors.
Consolidation Accounting. In December 2003, the Financial Accounting Standards Board re-issued Interpretation 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51," (FIN 46R) which clarifies the consolidation accounting guidance of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," (ARB No. 51) to certain entities for which controlling interests are not measurable by reference to ownership in the equity of the entity. Such entities are known as variable interest entities (VIEs).
The Company has finalized its FIN 46R analysis for some of the entities described below. For each of these, the application of FIN 46R required estimation by the Company of the future periodic cash flows and changes in fair values for each candidate, starting as of the Company's original commitment to invest in and/or manage each candidate, and extending out to the end of the full expected life of each. These cash flows and fair values were then analyzed for variability, and this expected variability was quantified and compared to total historical amounts invested in each candidate's equity to help determine if each candidate is a VIE. The Company also evaluated quantitative and non-quantitative aspects of control relationships among the owners and decision makers of each candidate to help determine if they are VIEs.
For each candidate determined to be a VIE, the expected variable losses and returns were then theoretically allocated out to the various investors and other participants in each candidate, in order to determine if any party had exposure to the majority of the expected variable losses or returns, in which case that party is the primary beneficiary of the VIE. If the Company were determined to be primary beneficiary of any VIE the Company would use consolidation accounting for its relationship with it.
The Company's maximum exposure to loss in relation to these entities is limited to its investments in them, future debt and equity commitments made to them, and where the Company is the mortgagor to the Properties, the outstanding balance of the mortgages originated for them, and outstanding mortgage commitments made to them. Therefore, the Company believes that the application of FIN 46R will have no impact on the Company's liquidity and capital resources beyond what is already presented in the consolidated financial statements and notes thereto.
The Company discloses summary financial data and its maximum exposure to losses for all these candidates in Note 3 - Relationships with Variable Interest Entities in the notes to consolidated financial statements.
Amortization of Deferred Policy Acquisition Costs. Costs that vary with, and are related primarily to, the production of new business have been deferred to the extent that they are deemed recoverable. Such costs include commissions, certain costs of policy issue and underwriting, and certain agency expenses. Similarly, any amounts assessed as initiation fees or front-end loads are recorded as unearned revenue. The Company tests the recoverability of its deferred policy acquisition costs, or DAC, quarterly with a model that uses data such as market performance, lapse rates and expense levels. We amortize DAC on term life and long-term care insurance ratably with premiums. We amortize DAC on our annuity products and retail life insurance, other than term life insurance policies, based on a percentage of the estimated gross profits over the life of the policies, which are generally twenty years for annuities and thirty years for life policies. Our estimated gross profits are computed based on assumptions related to the underlying policies including mortality, lapse, expenses, and asset growth rates. We amortize DAC and unearned revenue on these policies such that the percentage of gross profits to the amount of DAC and unearned revenue amortized is constant over the life of the policies.
Estimated gross profits, including net realized investment and other gains (losses), are adjusted periodically to take into consideration the actual experience to date and assumed changes in the remaining gross profits. When estimated gross profits are adjusted, we also adjust the amortization of DAC to maintain a constant amortization percentage over the life of the policies. Our current estimated gross profits include certain judgments by our actuaries concerning mortality, lapse and asset growth that are based on a combination of actual Company experience and historical market experience of equity and fixed income returns. Short-term variances of actual results from the judgments made by management can impact quarter to quarter earnings. Our history has shown us that the actual results over time for mortality, lapse and the combination of investment returns and crediting rates (referred in the industry as interest spread) for the life insurance and annuity products have reasonably followed the long-term historical trends. In recent years, actual results for market experience, or asset growth, have fluctuated considerably from historical trends and the long-term assumptions made in calculating expected gross profits. As a result, we changed some of these long-term assumptions in the third quarter of 2002 (the Q3 2002 Unlocking), as further described below.
Q3 2002 Unlocking: As of September 30, 2002, the Company changed several future assumptions with respect to the expected gross profits in its variable life insurance business in the Protection Segment and its variable annuity business in the Asset Gathering Segment. First, we lowered the long-term growth rate assumption from 9% to 8% gross of fees (which are approximately 1% to 2%). Second, we lowered the average rates for the next five years from the mid-teens to 13% gross of fees. Finally, we increased certain fee rates on these policies (the variable series trust (VST) fee increase). These three changes are referred to collectively here and elsewhere in this document as the Q3 2002 Unlocking. The performance of the major market indices for the past five quarters has demonstrated the propriety of our changes in assumptions. The result of these changes in assumptions was a net acceleration of amortization of DAC of $36.1 million in the variable annuity business in the Asset Gathering Segment and $13.1 million (net of $12.3 million of unearned revenue and $2.5 million in policy
benefit reserves) in the variable life insurance business in the Protection Segment. The impact on net income of the Q3 2002 Unlocking to Q3 2002 income was a reduction of approximately $27.5 million, or $0.09 diluted earnings per share. The accelerated amortization will reduce the total amortization of DAC in future periods, but will accelerate the amortization in the short term.
Sensitivity of Deferred Policy Acquisition Costs Amortization. The level of DAC amortization in 2004 will vary if separate account growth rates vary from our current assumptions. The table below shows the estimated increased (decreased) quarterly DAC amortization that will result if actual separate account growth rates are different than the rates assumed in our DAC models. Asset Protection Gathering Total ---------- --------- ----- (in millions) 18%..................................... $ (1.2) $ (1.5) $ (2.7) 13%..................................... -- -- -- 8%..................................... 1.3 1.8 3.1
Investment in Debt and Equity Securities. Impairments on our investment portfolio are recorded as a charge to income in the period when the impairment is judged by management to occur. See the General Account Investments section of this document and "Quantitative and Qualitative Information About Market Risk--Credit Risk" section of this document for a more detailed discussion of the investment officers' professional judgments involved in determining impairments and fair values.
As part of the valuation process we attempt to identify securities which may have experienced an other than temporary decline in value, and thus require the recognition of an impairment. To assist in identifying impairments, at the end of each quarter our Investment Review Committee reviews all securities where market value is less than ninety percent of amortized cost for three months or more to determine whether impairments need to be taken. This committee includes the head of workouts, the head of each industry team, the corporate Chief Risk Officer who reports to the Chief Financial Officer, and the head of portfolio management. The analysis focuses on each company's or project's ability to service its debts in a timely fashion and the length of time the security has been trading below cost. The results of this analysis are reviewed by the Life Company's Committee of Finance, a subcommittee of the Life Company's Board of Directors, quarterly. To supplement this process, a quarterly review is made of the entire fixed maturity portfolio to assess credit quality, including a review of all impairments with the Life Company's Committee of Finance. See "Management's Discussion and Analysis of Financial Condition and Analysis of Financial Condition and Results of Operations--General Account Investments" section of this document for a more detailed discussion of this process and the judgments used therein.
Benefit Plans. The Company annually reviews its pension and other post-employment benefit plan assumptions for the discount rate, the long-term rate of return on plan assets, and the compensation increase rate. All assumptions are reviewed and approved by the Chief Financial Officer and reviewed with the Audit Committee of the Board of Directors.
The compensation rate increase assumption is generally set at a rate consistent with current and expected long-term compensation and salary policy; including inflation. A change in the compensation rate increase assumption can be expected to move in the same direction as a change in the discount rate. A 0.25% decrease in the salary scale would decrease pension benefits PBO and NPPC by approximately $5.6 million and $1.1 million, respectively. Post employment benefits are independent of compensation.
Income Taxes. We establish reserves for possible penalty and interest payments to various taxing authorities with respect to the admissability and timing of tax deductions. Management makes judgments concerning the eventual outcome of these items and reviews those judgments on an ongoing basis.
business. The rebound in the equity markets in 2003 was the primary driver of the increase in mutual fund assets under management of $3,479.6 million, or 13.5% to $29,289.9 million at December 31, 2003. The increase was due to $4,009.4 million of market appreciation in 2003. Our mutual fund operations are impacted by general market trends, and any upturn or downturn in the market may affect our future operating results. Changes in laws or regulations related to the mutual fund industry may negatively impact our future operating results.
The Canadian life insurance industry faces many of the same macro-economic trends as the U.S. and is also operating within a mature, highly competitive market. Product innovation, operational efficiencies, consolidations and global expansion are the key business strategies used by Canadian insurers for business growth. In responding to this mature market environment, one of Maritime Life's key business strategies has been opportunistic acquisitions. This strategy included the acquisition of the individual life and segregated fund business of Confederation Life in 1995, Aetna Life Insurance of Canada in 1999, Royal & Sun Alliance Financial (Canadian operations) in 2001 and most recently, the Canadian individual health and group life and health businesses of Liberty Mutual Group. These acquisitions have contributed to market share growth, higher profitability through efficiencies of scale, and enhanced access to capital.
New sales in Maritime Life's group life and health segment increased $3.2 million from the prior year. The incremental contribution from the acquisition of the Liberty group life and health Canadian business helped to offset a slowing of sales in the fourth quarter following the merger announcement. This product line is highly competitive with only three large providers and is susceptible to broad economic factors, such as the level of merger and acquisition activity within the Canadian employer environment.
The acquisitions described under the table below were recorded under the purchase method of accounting and, accordingly, the operating results have been included in the Company's consolidated results of operations from each date of acquisition. Each purchase price was allocated to the assets acquired and the liabilities assumed based on estimated fair values, with the excess, if any, of the applicable purchase price over the estimated fair values of the acquired assets and liabilities recorded as goodwill. These acquisitions were made by the Company in execution of its plan to acquire businesses and products that have strategic value, meet its earnings requirements and advance the growth of its current businesses.
On July 8, 2003, Maritime Life completed its purchase of the insurance business of Liberty Health, a Canadian division of U.S.-based Liberty Mutual Insurance Company, through a reinsurance agreement for approximately $97.5 million. Through the agreement, Maritime Life assumed the entire business of Liberty Health, including its group life, group disability and group health divisions, as well as its individual health insurance business. There was no impact on the Company's results of operations from the acquired insurance business during 2002 or the first six months of 2003.
On April 2, 2001, a subsidiary of the Company, Signature Fruit Company, LLC (Signature Fruit), purchased certain assets and assumed certain liabilities out of bankruptcy proceedings of Tri Valley Growers, Inc., a cooperative association, for approximately $53.0 million. The net losses related to the acquired operations included in the Company's results from the date of acquisition through December 31, 2001 were $3.4 million.
In addition to impairment losses, the Company incurred losses on disposal of fixed maturity securities of $99.6 million, losses on the disposal of mortgage loans on real estate investments of $41.0 million, losses on the disposal of other invested assets of $30.7 million, losses on the disposal of real estate of $19.2 million and losses on disposal of equity securities of $7.0 million
The increase in income before income taxes and the cumulative effect of an accounting change in the Corporate and Other Segment was driven by growth in net realized investment and other gains of $335.7 million due to a gain of $233.8 million (and a deferred profit of $247.7 million) on the sale of the Company's Home Office properties during the first quarter
of 2003. See Note 8 - Sale/Leaseback Transaction and other Lease Obligations in the notes to the consolidated financial statements. The increase in the G&SFP Segment was primarily due to a $98.2 million improvement in net realized investment and other losses. The increase in the Protection Segment was driven by a $107.8 million increase in net investment income, a $35.8 million increase in net realized investment and other losses, and a $35.3 million increase in universal life product fees. The increase in the Asset Gathering Segment was driven by growth in net investment income, partially offset by a decrease of $34.4 million in management advisory fees due to lower assets under management, partially offset by a decrease in operating expenses. The Maritime Life Segment experienced a $66.6 million increase in income before income taxes and cumulative effect of accounting changes primarily driven by an increase of $26.1 million in net investment income, an increase of $13.6 million in realized investment and other gains, and an increase of $8.9 million in management advisory fees. In addition, Maritime Life experienced a decrease in amortization of deferred policy acquisition costs of $31.7 million. The Investment Management Segment's income before income taxes and cumulative effect of accounting changes increased due to an increase of $9.0 million in net realized investment and other gains and a $7.0 million increase in management advisory fees.
Universal life and investment-type product fees increased 2.9%, or $23.7 million, from the prior year. These product fees consist primarily of cost of insurance fees on our variable life insurance and universal life insurance products and mortality and expense fees on our variable annuity products. The increase was primarily due to an increase of $35.3 million in the Protection Segment driven by growth in average account values in universal life insurance products driven by the acquisition of the Allmerica block of fixed universal life insurance business as of December 31, 2002 and growth in the existing business. Partially offsetting the growth in the Protection Segment was a decline of $34.3 million in product fees in the Maritime Life Segment which declined on lower assets under management due to increased segregated fund lapses.
reductions in corporate complex expenses and in depreciation expenses associated with the sale of the Company's Home Office properties of $44.9 million.
Income taxes were $376.7 million in 2003, compared to $136.7 million for 2002. Our effective tax rate was 27.9% in 2003, compared to 21.5% in 2002. The higher effective tax rate was primarily due to increased pre-tax income driven by improved net realized investment and other gains/losses, partially offset by increased affordable housing tax credits.
Consolidated income before income taxes and cumulative effect of accounting changes decreased 23.0%, or $189.9 million, from the prior year. The decrease in consolidated income before income taxes was driven by $454.7 million in net realized investment and other losses for the year ended December 31, 2002, compared to $249.1 million in net realized investment and other losses in the prior year. The $454.7 million in net realized investment and other losses in 2002 are net of $23.3 million in net realized investment and other losses allocated to the participating pension contractholders and $11.9 million in net realized investment and other losses allocated to the policyholder dividend obligation in 2002. Net realized investment and other losses in the current period were driven by losses recognized on other than temporary declines in value of fixed maturity securities of $620.7 million (including impairment losses of $582.5 million and $38.2 million of previously recognized gains where the bond was part of a hedging relationship). The largest impairments were write-downs on United Airlines of approximately $99 million, US Airways of approximately $42 million, NRG Energy of approximately $46 million, PG&E National Energy Group of approximately $32 million, Wilton Trust of approximately $32 million, Petroleum Geo-Services of approximately $28 million, Power Facilities of approximately $19 million, Corporate Durango of approximately $17 million, WorldCom of approximately $12 million, Autopistas Del Sol of approximately $12 million and Aguas Argentina of approximately $10 million. Additional losses were recorded for other than temporary declines in the equity in collateralized bond obligations of $61.9 million and other equity securities of $30.8 million during 2002 (See General Account Investments in this MD&A).
o Certain of our tax-preferenced investments (lease residual management and affordable housing limited partnerships) dilute the Company's net portfolio yield on a pre-tax basis. In 2002, this dilutive effect was 10 basis points, compared to 8 basis points in 2001. However, adjusting for taxes, these investments increased the Company's after-tax earnings by $7.9 million in 2002 relative to 2001.
Net realized investment and other losses increased 82.5%, or $205.6 million, from the prior year. The increase was driven by other than temporary declines in value of fixed maturity securities of $620.7 million (including impairment losses of $582.5 million and $38.2 million of previously recognized gains where the bond was part of a hedging relationship), the largest of which were on securities issued by United Airlines, US Airways, Enron and affiliates, NRG Energy Group, among others; additional detail is provided previously and in General Account Investments in this MD&A. The Company also incurred losses on the other than temporary declines in value of the equity in collateralized bond obligations of $61.9 million and other equity securities of $30.8 million. For additional analysis regarding net realized investment and other losses, see General Account Investments in this MD&A.
Other revenue increased 37.1%, or $69.2 million, from the prior year. The increase in other revenue is due to the Signature Fruit transaction in 2001, and is offset by Signature Fruit's expenses in other operating costs and expenses. The increase in revenues is due to the inclusion of the results of Signature Fruit for the nine months subsequent to the transaction in 2001. Signature Fruit is included in other revenue for all of 2002. Signature Fruit, a subsidiary of the Company as of April 2, 2001, acquired certain assets and assumed certain liabilities out of bankruptcy proceedings of Tri Valley Growers, Inc., a cooperative association. The revenues and expenses of Signature Fruit are included in the Company's income statement in other revenue and other operating costs and expenses, respectively. Signature Fruit generated $235.9 million and $177.8 million in revenue in the years ended December 31, 2002 and 2001, respectively.
Other operating costs and expenses decreased $3.0 million from the prior year, despite an increase of $58.2 million in other operating costs and expenses related to Signature Fruit and an increase of $28.3 million in interest expense on debt, both of which were included in only part of the prior year's results. The decrease in expenses was primarily due to cost containment measures. The Asset Gathering Segment other operating costs and expenses decreased $75.6 million driven by lower salary and commission expense in the mutual fund business. In addition, other operating costs and expenses decreased $5.9 million in the Investment Management Segment driven by lower interest expense from lower average levels of warehoused commercial mortgages held for sale and lower average interest rates during 2002. Included in other operating costs and expenses was $241.3 million in operating costs of Signature Fruit in 2002. The increase in Signature Fruit other operating costs and expenses is due to their inclusion in the 2002 results for the full year while included only for nine months in 2001 after its formation.
Amortization of deferred policy acquisition costs increased 14.1%, or $43.4 million, from the prior year. The increase in amortization of deferred policy acquisition costs was primarily due to the $64.0 million Q3 2002 Unlocking of the Company's deferred policy acquisition costs (DAC) asset, which increased amortization of the DAC asset. Amortization of deferred policy acquisition costs increased due to the Q3 2002 Unlocking of the DAC asset based on changes in the future investment return assumptions and lowering the long-term growth rate assumption from 9% to 8%, gross of fees (which are approximately 1% to 2%). In addition, we lowered the average rates for the next five years from the mid-teens to 13%, gross of fees. We also increased certain fee rates on these policies (the VST fee increase). These changes in assumptions resulted in the Q3 2002 Unlocking of the DAC asset, which impacted the Asset Gathering and Protection Segments (See Note 1--Summary of Significant Accounting Policies in the notes to consolidated financial statements and Critical Accounting Policies in this MD&A).
Dividends to policyholders increased 2.5%, or $14.1 million from the prior year. The increase in dividends to policyholders was driven by the Protection Segment, which increased 2.3%, or $11.6 million. This increase was due to the lowering of the dividend scale during the year partially offset by growth in reserves and aging of the in-force business on traditional life insurance products. Traditional life insurance products average reserves increased approximately 4.2% from the prior period.
During 1997, the Company entered into a court-approved settlement relating to a class action lawsuit involving certain individual life insurance policies sold from 1979 through 1996. In entering into the settlement, the Company specifically denied any wrongdoing. The total reserve held in connection with the settlement to provide for relief to class members and for legal and administrative costs associated with the settlement amounted to $3.2 million and $11.9 million at December 31, 2003 and 2002, respectively. Costs incurred related to the settlement were $19.5 million, after-tax, in 2001. No such costs were incurred in 2003, or 2002. The estimated reserve is based on a number of factors, including the estimated cost per claim and the estimated costs to administer the claims.
We allocate surplus to the segments in amounts sufficient to support the associated liabilities of each segment and to maintain capital levels consistent with the overall business segment and corporate strategies. Allocations of net investment income are based on the assets owned by each segment. Other costs and operating expenses are allocated to each segment based on a review of the nature of such costs, cost allocation utilizing time studies, and other allocation methodologies.
- ----------- (1) See "Adjustments to GAAP Reported Net Income" included in this Management's Discussion and Analysis. (2) In 2002, during its start-up phase, the Federal long-term care insurance business was reported in the Corporate and Other Segment. Effective January 1, 2003, the business and its prior year results were reclassified from the Corporate and Other Segment to the Protection Segment. (3) Statutory data has been derived from the annual statements of John Hancock Life Insurance Company (formerly John Hancock Mutual Life Insurance Company), John Hancock Variable Life Insurance Company, Investors Partner Life Insurance Company (formerly John Hancock Life Insurance Company of America), and John Hancock Reassurance Company Ltd. as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices. Universal life statutory premiums include a $639.7 million deposit related to the acquisition of Allmerica's
fixed universal life insurance business in 2002. Long-term care premiums include $15.1 million in Federal long-term care premiums previously reported in the Company's Corporate and Other Segment in 2002.
Segment after-tax operating income increased 13.9%, or $43.0 million, from the prior year. Non-traditional life insurance business after-tax operating income increased 26.9%, or $32.4 million, primarily due to increased universal life and product-type fee income and increased net investment income partially offset by increased benefits to policyholders. Long-term care insurance business after-tax operating income increased 4.0%, or $3.2 million, resulting from increased premiums, and higher net investment income, partially offset by higher benefits and expenses and higher amortization of deferred policy acquisition costs. Traditional life insurance business after-tax operating income decreased 5.4%, or $6.0 million, primarily due to run-off of the closed block. Federal long-term care insurance business after-tax operating income increased $5.1 million from the prior year, which was its start up year.
Benefits and expenses increased 7.7%, or $239.1 million. Benefits to policyholders increased 10.7%, or $223.1 million, primarily due to growth in both the long-term care insurance business and non-traditional life insurance business in force. Long-term care insurance benefits to policyholders increased 26.6%, or $189.1 million, primarily due to additions to reserves for premium growth and higher claim volume on growth of the business during the period. The long-term care insurance business claims are being incurred at an aggregate rate lower than assumed in calculating the reserves of the business. Long-term care insurance business policies have increased to 706.2 thousand from 604.2 thousand in the prior year. The non-traditional life insurance business had an increase in benefits to policyholders of 9.4%, or $27.4 million, primarily due to a $53.0 million increase in interest credited on higher current year account balances. This increase was partially offset by a $17.9 million decrease in reserves due primarily to lower reserves on term conversions and a $7.7 million decrease in death claims, net of reserves released. Other operating costs and expenses increased 9.2%, or $31.5 million, primarily due to increases in general insurance expenses, primarily compensation-related, and higher amortization of the intangibles related to the acquisition of the Allmerica business as of December 31, 2002. Amortization of deferred policy acquisition costs increased 14.0%, or $26.0 million, primarily due to a $23.8 million increase from growth in the long-term care insurance business, and an $8.8 million increase in the non-traditional life business. The non-traditional increase of $8.8 million is $19.2 million higher due to adjusting gross profit margins for term conversions and $17.5 million higher due to normal amortization and true-ups primarily for lower lapse and higher separate account performance in the current year, and is offset by $27.9 million lower DAC amortization because of the prior period's unlocking of the DAC asset (See Critical Accounting Policies in this MD&A). These increases were partially offset by a $6.7 million decrease in the traditional life insurance business amortization of deferred policy acquisition costs due to lower contributions from the closed block. Dividends to policyholders decreased 8.1%, or $41.5 million, primarily due to a dividend scale cut on traditional life insurance products. The Segment's effective tax rate on operating income was 33.2% compared to 35.5% for the prior year. The decrease was primarily due to an increase in affordable housing tax credits, a decrease in the deficiency charge, and a net change in permanent differences.
(1) See "Adjustments to GAAP Reported Net Income" included in this Management's Discussion and Analysis. (2) Statutory data have been derived from the annual statements of John Hancock Life Insurance Company and John Hancock Variable Life Insurance Company, as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices. (3) Variable annuity deposits exclude internal exchanges as part of the safe harbor internal exchange program of $92.0 million and $1,910.5 million, respectively, for the years ending December 31, 2002 and 2001. No such exchanges took place in 2003.
Revenues increased 9.3%, or $106.6 million, from the prior year. The increase in revenue was due to a $134.4 million increase in net investment income, driven by the annuity business, offset by a $34.4 million decrease in investment management revenues and other fees. The increase in net investment income was primarily due to increases in invested assets backing fixed annuity products, partially offset by lower earned yields in the portfolio. Average invested assets backing fixed annuity products increased 31.6% to $10,157.5 million while the average investment yield decreased 61 basis points. Investment-type product fees decreased 1.6%, or $1.9 million, including a $6.9 million decrease in the variable annuity business, mostly due to a decline in the average fund values of 5.2%, or $300.3 million, to $5,512.5 million from the prior year. Fixed annuity investment-type product fees increased $5.0 million generally due to higher average account values. For variable annuities the mortality and expense fees as a percentage of average account balances was 1.29% for the current and prior year periods.
- ----------- (1) See "Adjustments to GAAP Reported Net Income" included in this Management's Discussion and Analysis.
Revenues increased 7.4%, or $153.5 million from the prior year, largely due to an increase in premiums of 57.6%, or $170.4 million, driven by a 60.0%, or $175.7 million, increase in single premium annuities from the prior year. Net investment income decreased 1.1%, or $19.7 million from the prior year, despite growth of 9.2%, or $2.1 billion in the spread-based average invested assets. Net investment income declined due to a lower average investment yield, which fell to 5.85% from the prior year, reflecting the lower interest rate environment in the current period. Net investment income varies with market interest rates because the return on approximately $11 billion, or 43.9% of the asset portfolio, floats with market rates. In addition, new sales generate cash flows, which are invested at the current market interest rates, which have decreased from the prior year. Matching the interest rate exposure on our asset portfolio to the exposure on our liabilities is a central feature of our asset/liability management process. Investment-type product fees increased 4.1%, or $2.3 million from the prior year due to increased sale of structured settlement contracts partially offset by lower asset-based fees on separate accounts.
Benefits and expenses decreased 32.4%, or $785.9 from the prior year. The decrease was primarily due to lower benefits to policyholders as a result of lower sales of single premium annuities. Benefits to policyholders for spread-based products decreased 36.5%, or $773.3 million from the prior year, due to lower sales of single premium annuity contracts, combined with lower interest credited on account balances. Interest credited decreased 12.8%, or $158.7 million, from the prior year. The decrease in interest credited was due to a decline in the average interest credited rate on account balances for spread-based products, due to the reset of approximately $10 billion of liabilities with floating rates and new business added at current market rates. The average crediting rate fell to 4.93% from 6.35% in the prior year. Other operating costs and expenses increased 8.2%, or $4.9 million from the prior year. This increase was driven by higher product development costs, commissions on structured settlement sales, state taxes, licenses, and fees, and corporate communications costs. Dividends to policyholders increased 28.8%, or $10.4 million from the prior year. The segment's effective tax rate on operating income was 33.1% compared to 33.3% in the prior year.
Total revenues increased $20.4 million, or 16.4%, from the prior year. Net investment income increased $2.0 million, or 13.2%, to $17.1 million, primarily from increases in equity method income of $3.8 on limited partnership energy investments at John Hancock Energy Resources Management due to the required adoption of fair value accounting at the limited partnerships offset by a decrease of $1.3 million at John Hancock Real Estate Finance due to a lower average level of warehoused commercial mortgages. Investment management revenues, commissions, and other fees increased $7.0 million, or 6.5%, from the prior year. Advisory fees at the Hancock Natural Resource Group increased $8.2 million, or 35.0%, primarily from property management revenue at the new northwest property management division, which was established in December of 2002. One of the Hancock Natural Resource Group's strategies is to vertically integrate its operations in the timber business and the establishment of the northwest property management division is one of the steps taken to implement that strategy. Mortgage origination and servicing fees at John Hancock Real Estate Finance increased $1.4 million, or 21.2 %, from 2002 mostly from a higher volume of loans generated for the Company's General Account and from higher securitized assets under management. Advisory fees at the Company's Bond and Corporate Finance Group increased by $1.1 million, or 7.7%, from increases of $2.6 million from its general partnership investment in private equity funds and a $1.0 million increase in fees on third party pension assets offset by $2.5 million in lower fees from CDO funds. Offsetting these increases, advisory fees at the Company's institutional investment advisor, the Independence group of companies (Independence), were down $3.3 million, or 6.0%. This decrease reflects lower fees on lower average assets under management of $0.6 billion and a shift from equity to fixed income assets which have lower fee rates and from the closure of the managed accounts business. John Hancock Realty Advisors' fees decreased $0.5 million, or 5.4%, reflecting lower acquisition fees based on lower acquisition activity offset by higher management fees on higher assets under management. Investment management revenues, commissions and other fees were 0.41% and 0.39% of average advisory assets under management in 2003 and 2002, respectively, for the segment. Net realized investment and other gains increased $10.3 million mainly from an improvement in net realized gains of $9.6 million at John Hancock Real Estate Finance, primarily due to higher profitability on a higher volume of commercial mortgage securitizations.
Total revenues decreased $18.6 million, or 13.0%, from the prior year. Net investment income declined $13.6 million, or 47.4%, to $15.1 million. Net investment income was down $6.6 million, or 95.7%, at John Hancock Energy Resources Management due to prior year income recognized from investment partnerships on the liquidation of underlying investments and down $5.4 million, or 37.8%, at John Hancock Real Estate Finance due to a lower average level of warehoused commercial mortgages. Investment management revenues, commissions, and other fees decreased $3.1 million, or 2.8% from the prior year. Advisory fees at Independence Investment LLC were down $8.6 million, or 13.6% based on declines in average assets under management which resulted from market depreciation of $3.0 billion offset by $1.1 billion of net sales. John Hancock Realty Advisors saw an increase of $3.5 million, or 61.4%, in higher portfolio acquisition fees based on higher acquisition activity compared to the prior year. Hancock Natural Resource Group saw an increase of $2.4 million, or 11.4% over the prior year, primarily based on higher management fees earned from higher assets under management. Mortgage origination and servicing fees at John Hancock Real Estate Finance were $6.6 million for both 2002 and 2001. Investment management revenues, commissions and other fees were 0.39% and 0.38% of average advisory assets under management in 2002 and 2001, respectively, for the segment. Net realized gains were down $2.0 million, or 62.5% at John Hancock Real Estate Finance, primarily due to a lower level of commercial mortgage securitizations.
In the first quarter of 2003, the Company implemented organizational changes within the Corporate and Other Segment that resulted in reporting the Maritime Life business as its own operating segment for the first time. The Maritime Life Segment consists of our consolidated Canadian operations, principally those of our Canadian life insurance business, The Maritime Life Assurance Company (Maritime Life). The reclassifications associated with the realignment of our operating segments had no impact on segment after-tax operating income, or net income of the Maritime Life, or Corporate and Other Segments, other than to display these segments separately. The following table presents certain summary financial data relating to the Maritime Life Segment for the periods indicated.
amortization in 2003. In addition, improving equity market returns further lowered amortization $4.2 million through reduced VOBA and DAC amortization, net of lower segregated fund fees. Other experience factors in the asset gathering business contributed $6.9 million, including a $2.2 million improvement in net investment income on capital allocated to this business. The retail protection business after-tax operating income increased 31.1%, or $11.0 million, from the prior year, including a $4.6 million increase in earnings from the acquired Liberty Health individual health business, $0.8 million in natural growth and $5.0 million positive experience in both the existing individual health and life businesses. The group life & health operations increased 15.5%, or $3.3 million, including $3.0 million from the acquired business, $4.3 million from prior year pricing increases and in-force growth and $2.8 million of positive experience factors, partially offset by $7.6 million of prior year favorable changes in expected future claims levels for long-term disability reserves not repeated in the current year. The corporate & other business had an after-tax loss of $0.9 million, a $4.1 million improvement from last year due primarily to income in a subsidiary from a commission contract renegotiation of $3.4 million that is offset by a higher commission expense in the retail protection business.
Total revenue increased 27.4%, or $335.3 million. Premiums increased $330.5 million, driven by an increase of $223.0 million in the group life & health business following a recapture of significant portions of its group life, accidental death and dismemberment and long-term disability reinsurance and including $100.8 million from the acquired group business. Premiums in the retail protection business increased $72.7 million, including $32.7 million of acquired individual health business. Asset gathering premiums increased $34.8 million, or 158.2%, due to sales of structured settlements and other immediate annuities. Net investment income increased $26.1 million driven by higher assets under management. Investment management revenues, commissions and other fees increased 41.2%, or $8.9 million, from increased administrative services only (ASO) business, including $6.1 million contributed by the acquired business.
Total benefits and expenses increased 25.4%, or $282.9 million, from the prior year. Benefits to policyholders increased $238.4 million. The group life & health business accounted for $193.1 million of this increase, primarily due to the reinsurance recapture discussed above and the impact of the acquired business of $85.6 million. Retail protection products increased $37.3 million, driven by increased provisions for future policy benefits on traditional life products and the impact of reinsurance recapture on claims, and $16.9 million of acquired individual health business. The asset gathering business had an $8.0 million increase in benefits paid and accrued, due to business growth in the structured settlement and immediate annuities products. Operating costs and expenses increased 29.4%, or $59.4 million. Operating costs of the acquired business account for $25.3 million of the year over year change. Increased group life and health operating costs, excluding the acquired business, were $24.2 million higher than the previous year primarily reflecting lower reinsurance allowances, and increased general expenses. The retail protection business had $13.8 million of higher expenses, primarily higher employment-related expenses. Commission costs of $121.7 million were $2.8 million higher than the prior year. The increase reflects $4.4 million from the acquired operations, while commission fell by $0.9 million in the group business and $2.1 million in asset gathering due to lower sales in 2003. Deferred acquisition costs were $67.9 million in the current year, $14.0 million less than in 2002 due to lower sales and deferrable costs. DAC amortization decreased by $31.7 million driven by unlocking of $36.5 million to reflect continued refinement of US GAAP models, stronger market returns and improved experience in expenses, investment margins and lapses, offset by higher amortization of $4.8 million. The effective tax rate fell to 35.1% in 2003 from 37.0% in 2002, as income taxes on higher taxable income levels do not impact the level of fixed, capital taxes incurred. The impact of foreign currency translation for the Maritime Life Segment is reported in the Corporate and Other Segment.
Segment after-tax operating income increased $21.1 million, or 44.1%, from the prior year. The acquisition of Royal & Sun Alliance Life Insurance Company of Canada (RSAF), concluded late in 2001, contributed $3.1 million to the increase. The retail protection business decreased by $1.2 million from the prior year, after a contribution of $1.6 million from RSAF. An accounting provision for $3.2 million due to a decision to delay repricing of a critical illnesses product following a change in reinsurance terms and refined allocation of corporate overhead of $4.9 million were partially offset by refinements to estimated gross profits for investment and expense experience for universal life products that resulted in a DAC unlocking and revisions to reserves of $3.2 million and positive mortality, surrenders and expense experience of $2.0 million. The asset gathering business after-tax income increased $11.3 million over the prior year, including $1.8 million from RSAF, favorable margin increases of $2.6 million and refined allocation of corporate overhead of $3.3 million. In addition, a review of the valuation of DAC on segregated funds products (separate accounts) was completed, resulting in a $5.9 million reduction of DAC amortization. In the group business, changes in the expected future claim levels for long-term disability products contributed $8.9 million, partially offset by recognition of $1.3 million for uncollectible receivables and higher interdivisional charges of $4.3 million. In corporate and other, the impact of no longer amortizing goodwill due to adoption of SFAS No. 142 in 2001 improved current year's earnings by $5.0 million, lower integration costs contributed $1.9 million, and a special research and development tax recovery of $0.9 million, and refined allocation of corporate overhead of $11.6 million were offset by increased interest expense of $5.9 million on debt used in part to finance the RSAF acquisition.
After-tax operating loss from corporate operations was $66.5 million compared to income of $1.6 million in the prior year. Investment income on corporate surplus was $46.1 million lower due to increased surplus requirements from growth in several of our capital intense businesses. Group Life after-tax operating income was $7.8 million lower reflecting a sale of the Group Life business to MetLife effective May 1, 2003. Other expense increases in our corporate account were driven by a $32.0 million increase for net periodic pension costs, $6.7 million reduction in rent reimbursements due to the sale of the Home Office, and merger related expenses in our holding company and corporate account of $4.1 million and $2.5 million respectively. This was partially offset by our corporate owned life insurance program that increased $15.8 million due to an increase in the asset base and to improved performance of the separate account assets supporting some of the program. The impact of currency fluctuations for Maritime Life are included in corporate operations, after-tax gains of $13.1 million resulted in 2003. Other subsidiaries with after-tax improvement include JH Leasing with $1.1 million increase in profit and Signature Fruit Company with a $0.9 million reduction in loss.
After-tax operating income from corporate operations decreased $22.1 million, or 93.2% from the prior year. The decrease was due to a decrease in net periodic pension credits of $21.1 million, a decrease in other post-employment benefit credits of $1.7 million, and increased interest expense of $16.1 million as a result of senior notes issued by our holding company in the fourth quarter of 2001. Partially offsetting these decreases was the impact of our corporate-owned life insurance program. The corporate-owned life insurance program's results were $20.8 million favorable due to an increase in the asset base and improved performance of the underlying assets.
Overall Composition of the General Account. Invested assets, excluding separate accounts, totaled $76.2 billion and $67.1 billion as of December 31, 2003 and December 31, 2002, respectively. Invested assets have grown 13.5% over the year. Included in this growth are $5.8 billion of fixed income securities and $1.9 billion of cash and cash equivalents. The following table shows the composition of investments in the general account portfolio.
(1) In addition to bonds, the fixed maturity security portfolio contains redeemable preferred stock with a carrying value of $606.3 million and $593.3 million as of December 31, 2003 and December 31, 2002, respectively. The total fair value of the fixed maturity security portfolio was $53,452.2 million and $47,648.0 million, at December 31, 2003 and December 31, 2002, respectively. (2) The fair value for the mortgage loan portfolio was $13,979.5 million and $12,726.1 million as of December 31, 2003 and December 31, 2002, respectively. (3) Policy loans are secured by the cash value of the underlying life insurance policies and do not mature in a conventional sense, but expire in conjunction with the related policy liabilities. (4) Other invested assets as of December 31, 2002 contains a receivable of $471.1 million from Allmerica Financial Corporation pursuant to the Company's agreement to reinsure Allmerica's fixed universal life insurance business. At December 31, 2003, the acquisition accounting was finalized and these assets are reflected in the applicable line items in the portfolio detail above. (5) Cash and cash equivalents are included in total invested assets in the table above for the purposes of calculating yields on the income producing assets for the Company.
Fixed Maturity Securities. The fixed maturity securities portfolio is predominantly comprised of low risk, investment grade, publicly and privately traded corporate bonds and senior tranches of asset-backed securities (ABS) and mortgage-backed securities (MBS). The fixed maturity securities portfolio also includes redeemable preferred stock. As of
The Securities Valuation Office (SVO) of the National Association of Insurance Commissioners evaluates all public and private bonds purchased as investments by insurance companies. The SVO assigns one of six investment categories to each security it reviews. Category 1 is the highest quality rating, and Category 6 is the lowest. Categories 1 and 2 are the equivalent of investment grade debt as defined by rating agencies such as S&P and Moody's (i.e., BBB-/Baa3 or higher), while Categories 3-6 are the equivalent of below-investment grade securities. SVO ratings are reviewed and may be revised at least once a year.
The following table shows the composition by credit quality of the fixed maturity securities portfolio,
Valuation techniques for the bond portfolio vary by security type and the availability of market data. Pricing models and their underlying assumptions impact the amount and timing of unrealized gains and losses recognized, and the use of different pricing models or assumptions could produce different financial results. External pricing services are used where available, and broker dealer quotes are used for thinly traded securities. A spread pricing matrix is used when price quotes are not available, which typically is the case for our private placement securities. The spread pricing matrix is based on credit quality, country of issue, market sector and average investment life and is created for these dimensions through brokers' estimates of public spreads derived from their respective publications. When utilizing the spread pricing matrix, securities are valued through a discounted cash flow method where each bond is assigned a spread, which is added to the current U.S. Treasury rates to discount the cash flows of the security. The spread assigned to each security is changed from month to month based on changes in the market. Certain market events that could impact the valuation of securities include issuer credit ratings, business climate, management changes, litigation, and government actions among others. The resulting prices are then reviewed by the pricing analysts and members of the Controller's Department. The Company's pricing analysts take appropriate actions to reduce valuations of securities where such an event occurs which negatively impacts the securities' value. Although the Company believes its estimates reasonably reflect the fair value of those securities, the key assumptions about risk premiums, performance of underlying collateral (if any) and other factors involve significant assumptions and may not reflect those of an active market. To the extent that bonds have longer maturity dates, management's estimate of fair value may involve greater subjectivity since they involve judgment about events well into the future. Then, every quarter, there is a comprehensive review of all impaired securities and problem loans by a group consisting of the Chief Investment Officer, Chief Risk Officer who reports to the Chief Financial Officer and the Bond Investment Committee. The valuation of impaired bonds for which there is no quoted price is typically based on the present value of the future cash flows expected to be received. If the issuer is likely to continue operations, the estimate of future cash flows is typically based on the expected operating cash flows of the issuer that are available to make payments on the bonds. If the issuer is likely to liquidate, the estimate of future cash flows is based on an estimate of the liquidation value of its net assets.
In keeping with the investment philosophy of tightly managing interest rate risk, the Company's MBS & ABS holdings are heavily concentrated in commercial MBS where the underlying loans are largely call protected, which means they are not pre-payable without penalty prior to maturity at the option of the issuer. By investing in MBS and ABS securities with relatively predictable repayments, the Company adds high quality, liquid assets to its portfolios without incurring the risk of cash flow variability. The Company believes the portion of its MBS/ABS portfolio subject to prepayment risk as of December 31, 2003 and December 31, 2002 was limited to 23.3% and 12.9% of our total MBS/ABS portfolio and 3.5% and 2.1% of our total fixed maturity securities holdings, respectively.
- ----------- (1) Includes $1,905.2 million in debt securities held in Maritime Life, our Canadian insurance subsidiary, and issued and fully supported by various Canadian Federal, provincial or municipal governments.
Unrealized losses can be created by rising interest rates or by rising credit concerns and hence widening credit spreads. Credit concerns are apt to play a larger role in the unrealized loss on below investment grade bonds and hence the gross unrealized loss on the portfolio has been split between investment grade and below investment grade bonds in the above tables. The gross unrealized loss on below investment grade fixed maturity securities declined from $914.1 million at December 31, 2002 to $261.1 million at December 31, 2003 primarily due to the easing of credit concerns and the resulting spread tightening.
We remain most concerned about the airline sector. We lend to this industry almost exclusively on a secured basis (approximately 99% of our loans are secured). These secured airline financings are of two types: Equipment Trust Certificates (ETC's) and Enhanced Equipment Trust Certificates (EETC's). The ETC's initially have an 80% loan-to-value ratio and the EETC senior tranches initially have a 40-50% loan-to-value and include a provision for a third party to pay interest for eighteen months from a default. For us to lose money on an ETC, three things must happen: the airline must default, the airline must decide it does not want to fly our aircraft, and the aircraft must be worth less than our loan. When lending to this industry, we underwrite both the airline and the aircraft. We've been lending to this industry in this fashion for 25 years through several economic cycles and have seen values on our secured airline bonds fall and recover thorough these cycles. EETC's are classified as asset-backed securities and they account for $58.6 million and $181.1 million of the $144.9 million and $278.5 million of gross unrealized loss in the asset-backed and mortgage-backed securities category as of December 31, 2003 and December 31, 2002, respectively. While the airline industry is making positive strides in reducing its cost structure, a significant recovery in this sector requires a growing economy and a pick up in business travel. In the most recent quarter ending December 31, 2003, most of the major carriers have reported improved financial results. This trend is encouraging and we expect it to continue barring any new terrorist events or a reversal of the course of the U.S. economy. We do still expect that the senior secured nature of our loans to this industry will protect our holdings through this difficult time.
As of December 31, 2003 and December 31, 2002, $170.0 million and $604.8 million, respectively, of the $331.0 million and $1,211.9 million of gross unrealized losses resides in below investment grade securities with various amounts of unrealized loss for over nine months. At December 31, 2003, all of these securities are current as to the payments of principal and interest with the exception of 2 securities with a carrying value of $16.8 million and an unrealized loss of $18.3 million. Of the total $170.0 million, $87.6 million traded above 80% of amortized cost at December 31, 2003 and an additional $11.3 million traded above 80% of amortized cost within the last nine months, for a total of $98.9 million. Of the total $98.9 million in this category, $58.1 million comes from airline related bonds, an industry that continues to experience stress and hence has lagged the general recovery. While, as described earlier, we expect the secured nature of our positions to protect our value, the increased stress in this industry is of concern.
The remaining portion of the unrealized loss, $71.1 million, arises from below investment grade securities that have traded below 80 percent of amortized cost for over nine months. All of these bonds, with the exception of the 2 securities mentioned above, are current on payments of principal and interest and we believe, based on currently available information that it is probable that these securities will continue to pay based on their original terms. On the 2 securities on which interest is overdue, this interest was actually paid to the trustee, but the investors chose to use these payments for expenses related to protecting the collateral underlying the bonds rather than distribute them. We carefully track these investments to ensure our continued belief that their prices will recover. More detail on the most significant securities is contained below:
o $9.4 million on a fertilizer plant that sources its natural gas from PDVSA, the Venezuelan oil company. While the cost of the natural gas in very inexpensive, there are concerns about the reliability of the supply. Also, the plant experienced some start up operational difficulties that now appear to have been fixed. Additionally, its equity sponsors have supported the project with additional contributions of equity and based on our review of this credit we expect their continued support. Hence, we expect the price to continue to recover.
o $5.2 million on the bond of a major telecommunications company. A major portion of the value of this company is derived from its local exchange business. The company has taken steps to de-leverage and is expected to be in a positive cash flow position this year. As the company continues to reduce leverage through cost cutting and asset dispositions, we expect these securities to continue to recover in value.
o $1.2 million markdown of an asset backed security resulting from a bond being downgraded. The bankruptcy filing of the issuer/servicer of the bond has caused significant performance deterioration on the underlying collateral during December 2002 to June 2003. However, performance has improved gradually since the service reorganization which took place in June 2003.
The Company believes that after its comprehensive review of each borrower's ability to meet the obligations of the notes, and based on information available at this time, these securities will continue to pay as scheduled, and the Company has the ability and the intent to hold these securities until they recover in value or mature. The scheduled maturity dates for securities in an unrealized loss position at December 31, 2003 and 2002 are shown below.
As of December 31, 2003 we had 59 securities representing 9 credit exposures that had unrealized losses of near $10 million or more. They include:
Unrealized losses improved during the year ending December 31, 2003. As of December 31, 2002, there were 86 securities, representing 40 credit exposures, with an unrealized loss of $10 million or more with an amortized cost of $2,660.0 million and unrealized loss of $825.7 million. The area of most concern continues to be the airline sector and it represents 5 names on this list. All of the above securities have undergone thorough analysis by our investment professionals, and at this time we believe that the borrowers have the financial capacity to make all required contractual payments on the notes when due, and we intend to hold these securities until they either mature or recover in value.
Mortgage Loans. As of December 31, 2003 and 2002, the Company held mortgage loans with carrying values of $12.9 billion and $11.8 billion, including $3.0 billion and $2.6 billion respectively, of agricultural loans at each period end and $9.9 billion and $9.2 billion, respectively, of commercial loans. Impaired loans comprised 1.0% of the mortgage portfolio at December 31, 2003. The Company's average historical impaired loan percentage during the period from 1998 through 2003 is 1.1%. This historical percentage is higher than the current 1.0% because the historical percentage includes some remaining problem assets of the 1990's real estate downturn, some of which are still held. Maritime Life managed $2.0 billion and $1.5 billion of mortgage loans, respectively, of which $1.1 billion and $0.7 billion, respectively, were government-insured by the Canada Mortgage and Housing Corporation.
The following table shows the distribution of our mortgage loan portfolio by property type as of the dates indicated. Our commercial mortgage loan portfolio consists primarily of non-recourse fixed-rate mortgages on existing, well-leased commercial properties.
(1) As of December 31, 2003 and December 31, 2002 the Company held mortgage loans with carrying values of $12.9 billion and $11.8 billion, respectively. (2) Increase as of December 31, 2003 is from a U.S. based forest products company that filed for bankruptcy during 2003.
The valuation allowance is maintained at a level that is sufficient to absorb estimated probable credit losses. Management's periodic evaluation of the adequacy of the allowance for losses is based on past experience, known and inherent risks, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of the underlying security, the general composition of the portfolio, current economic conditions and other factors. This evaluation is inherently subjective and is susceptible to significant changes and no assurance can be given that the allowances taken will in fact be adequate to cover all losses or that additional valuation allowances or asset write-downs will not be required in the future. The valuation allowance for the mortgage loan portfolio was $66.2 million, or 0.5 % of the carrying value of the portfolio as of December 31, 2003.
Net investment income increased $292.9 million from the prior year. The increase was primarily the result of asset growth and lower investment expenses. Overall, the 2003 yield, net of investment expenses, on the general account portfolio decreased to 5.90% from 6.24% in the prior year. The lower portfolio yield was driven primarily by the drop in short-term interest rates during the year, which impacts floating rate investments, and lower yields on investment acquisitions. In summary, the change in yields was driven by the following factors:
o The inflow of new cash for the twelve-month period ending December 31, 2003 was invested at rates that were below the portfolio rate. In addition, maturing assets rolling over into new investments at rates less favorable than those available in 2002. These two factors account for the majority of the remaining decline in portfolio rates.
Partially offsetting the effects of these decreases to yields on investments was an increase in invested assets and a reduction in investment expenses. In 2003, weighted-average invested assets grew $8,589.9 million, or 13.6%, from the prior year. In addition, investment expenses were reduced $34.9 million in 2003 compared to the prior year. Included are reductions in corporate complex expenses and in depreciation expenses associated with the sale of the Company's Home Office real estate of $44.9 million.
Net investment income decreased $10.8 million from 2001 to 2002. The decrease was primarily the result of lower yields, partially offset by asset growth and lower investment expenses. Overall, the 2002 yield, net of investment expenses, on the general account portfolio decreased to 6.24 % from 7.09% in the prior year. The lower portfolio yield was driven primarily by the sharp drop in short-term interest rates during the year, which impacts floating rate investments, and lower yields on investment acquisitions. The change in yields was impacted by the following drivers:
o The inflow of new cash for the twelve-month period ending December 31, 2002 was invested at rates that were below the portfolio rate. In addition, maturing assets rolling over into new investments at rates less favorable than those available in 2001 also contributed to the decline in yields.
In 2003, we realized $490.9 million of gains on disposal of fixed maturities excluding hedging adjustments. These gains resulted from managing our portfolios for tax optimization and ongoing portfolio management regarding our targeted below investment grade assets, and included $62.0 million of prepayments and approximately $90.8 million from recoveries on sales of previously impaired securities.
In 2003, we realized $99.6 million of losses upon disposal of bonds excluding hedging adjustments. We generally intend to hold securities in unrealized loss positions until they mature or recover. However, we do sell bonds under certain
circumstances such as when new information causes us to change our assessment of whether a bond will recover or perform according to its contractual terms, in response to external events (such as a merger or a downgrade) that result in investment guideline violations (such as single issuer or overall portfolio credit quality limits), in response to extreme catastrophic events (such as September 11, 2001) that result in industry or market wide disruption, or to take advantage of tender offers. Sales generate both gains and losses.
As disclosed in our discussion of the Results of Operations in this MD&A, the Company recorded losses due to other than temporary impairments of fixed maturity securities for the year 2003 of $546.1 million (including impairment losses of $521.4 million, and $24.7 million of previously recognized gains where the bond was part of a hedging relationship). The following list shows the largest losses recognized year to date, the related circumstances giving rise to the loss and a discussion of how those circumstances impacted other material investments held. Unless noted otherwise, all of the items shown are impairments of securities held at December 31, 2003, including hedging adjustments.
o $29.8 million on private fixed maturity securities relating to an Australian mining company. The company filed the equivalent of Chapter 11 due to weaker commodity prices, operational difficulties, and losses on currency transactions. Attempts to sell assets at prices sufficient to pay our debt have not been successful. As a result, the investment has been written off entirely. While lower commodity prices affect a broad range of credits, the unique circumstances of this company are not present in our other investments.
o $27.3 million on public fixed maturity securities relating to a large North American transportation provider to a variety of industries that has struggled to emerge from bankruptcy due to litigation with a subsidiary, tax claims by the U.S. Internal Revenue Service, and most recently, a claim by a regulatory agency. We had further impaired the security and the reorganization out of bankruptcy has occurred. These circumstances are unique to this issuer. We have recovered $26.4 million on subsequent sales of this security.
o $26.3 million (including an impairment loss of $23.2 million and $3.1 million in previously recognized gains where the bonds were part of a hedging relationship) on public fixed maturity securities relating to a special purpose company created to sublease aircraft to two major U.S. airlines. This investment is the subordinated tranche in a multi-tier structure of an Enhanced Equipment Trust Certificate (EETC). One of the airlines has recently indicated that it will not honor the original lease rates on the aircraft in this investment. Hence, with the loan exceeding the current value of the securities, we have impaired the security to the market level. While we do have an investment in the senior tranche of this EETC, the senior tranche exposure is still less than the current market value of the underlying planes and the senior tranche enjoys an 18 month liquidity facility. Accordingly, we do not anticipate a loss on the senior tranche.
o $14.2 million on public fixed maturity securities relating to a subordinated holding company structure comprised of ownership interests in three power generation facilities in the western U.S. Due to the severe overcapacity in the power markets and the lack of an off take provider for the potential power generated from the plants, this subordinated interest in the facilities was not refinanced and we wrote off the investment completely. The overcapacity in the power markets has put stress on all power producers as we discuss in our sector commentary.
o $11.1 million on private fixed maturity securities on a Chilean based conglomerate. Attempts to renegotiate the agreement have not materialized and the likelihood of receiving any recovery is remote. We have completely written off the investment. The circumstances surrounding this investment are unique as the borrower has demonstrated a lack of willingness to repay the debt on this investment.
o $3.1 million on the sale of public bonds of an oil and gas company's bonds. This position was sold to reduce its below investment grade exposure.
o $2.9 million credit loss on the sale of public bonds of a merchant energy producer. When this company announced it had broken off talks with its banks on a line coming due in the next month, we sold these bonds.
o $2.1 million on the sale of public bonds of an unregulated power generating company. This bond was sold after a downgrade created a credit limit violation.
o $1.8 million on the sale of public bonds of an oil and gas exploration and production company. The loss is due to a rise in interest rates since the time of purchase.
o $1.1 million on the sale of public bonds of a gas pipeline company. The loss is due to a rise in interest rates since the time of purchase.
There were also gains of $106.2 million on the sale of equity securities as part of our overall investment strategy of using equity gains to minimize credit losses in the long term, gains of $26.0 million from the sale of other invested assets, and gains of $255.0 million resulting from the sale of real estate for the year 2003. Net derivative activity resulted in a gain of $117.7 million on $39.6 billion of derivative notional for the year 2003 as interest rates increase approximately 45 basis points on swap curve. Because of the fundamental strategy of the Company's derivative usage is designed to neutralized interest rate risk, certain components of the derivative's fair value change are not offset in earnings. For the year 2002, net realized investment and other losses were $454.7 million. Gross losses on impairments and on disposal of investments - including bonds, equities, mortgages, real estate, and other invested assets were $876.5 million, excluding hedging adjustments.
o $56.1 million on a large energy company that filed for bankruptcy in late 2001.
o $48.0 million on secured financings backed by an airline, or its subsidiaries, that filed for Chapter 11 bankruptcy protection during the third quarter of 2002.
o $35.3 million on issuers affiliated with the Argentina government and other investments in that country
o $33.5 million on fixed maturity securities for an unregulated power and pipeline energy company.
o $31.6 million of fixed maturity investments of U.K. based projects providing power and other essential services to an industrial complex.
o $28.3 million on fixed maturity securities relating to an oil field service company.
o $24.8 million on a redeemable preferred stock of a large domestic farm cooperative due to the cyclical nature of the business and a heavy debt load.
o $19.2 million on redeemable preferred stock of a technology based manufacturer of engineering products with a tight liquidity position.
o $16.9 million on securities issued by a Mexican producer of corrugated boxes and newsprint.
Write-downs of CBO/CDO fixed maturity investments and other invested assets were $61.9 million for the year ended December 31, 2002.
Canadian insurance laws generally restrict the ability of insurance companies to pay cash dividends in excess of prescribed limitations without prior approval. Maritime Life, our Canadian life insurance subsidiary, is subject to restrictions on dividend payments to its holding company, John Hancock Canadian Holdings, Ltd, by Canadian regulators. Maritime Life may not make dividend payments which would make its minimum continuing capital and surplus ratio fall below 150%, as required by the Office of the Superintendent of Financial Institutions. Maritime Life's minimum continuing capital and surplus ratio is measured annually, and was 185% as of December 31, 2003. The Company did not request any dividend payment from Maritime Life in 2003, nor did Maritime Life make any dividend payments to JHFS or its operating subsidiaries in 2003.
Sources of cash for the Company's insurance subsidiaries are from premiums, deposits and charges on policies and contracts, investment income, maturing investments, and proceeds from sales of investment assets. Our liquidity requirements relate principally to the liabilities associated with various insurance, annuity, and structured investment products, and to the funding of investments in new products, processes, and technology and general operating expenses. Product liabilities include the payment of benefits under insurance, annuity and structured investment products and the payment of policy surrenders, withdrawals and policy loans. The Company periodically adjusts its investment policy to respond to changes in short-term and long-term cash requirements and provide adequate funds to pay benefits without forced sales of investments.
As noted above, on September 28, 2003, JHFS entered into a definitive merger agreement with Manulife. Until the closing of the transaction, the Company will continue to operate independently and does not expect the proposed merger to have a negative impact on financial condition, liquidity or sales. Following the announcement of the proposed merger, Standard and Poor's, Moody's, A.M. Best and Fitch affirmed all ratings. In addition, Standard & Poor's noted that "the `A' long-term counterparty credit and senior debt ratings on John Hancock Financial Services Inc., a holding company for its U.S. and Canadian operating insurance companies, have been placed on CreditWatch with positive implications." Dominion Bond Rating Service placed John Hancock Financial Services' corporate rating of A (high) and Maritime Life's long-term
The liquidity of our insurance operations is also related to the overall quality of our investments. As of December 31, 2003, $46,635.4 million, or 88.3% of the consolidated fixed maturity securities held by us and rated by Standard & Poor's Ratings Services, a division of the McGraw-Hill Companies, Inc. (S&P) or the National Association of Insurance Commissioners were rated investment grade (BBB- or higher by S&P, Baa3 or higher for Moody's, or 1 or 2 by the National Association of Insurance Commissioners). The remaining $6,186.1 million, or 11.7% of fixed maturity investments, were rated non-investment grade. $41,258.2 million, or 87.1% of the Life Company fixed maturity securities held by us and rated by Standard & Poor's Ratings Services (S&P) or the National Association of Insurance Commissioners were rated investment grade (BBB- or higher by S&P, Baa3 or higher for Moody's, or 1 or 2 by the National Association of Insurance Commissioners). The remaining $6,112.3 million, or 12.9% of the Life Company fixed maturity investments, were rated non-investment grade. And $4,472.9 million, or 99.3% of the Maritime Life fixed maturity securities held by us and rated by Standard & Poor's Ratings Services, a division of the McGraw-Hill Companies, Inc. (S&P) or the National Association of Insurance Commissioners were rated investment grade (BBB- or higher by S&P, Baa3 or higher for Moody's, or 1 or 2 by the National Association of Insurance Commissioners). The remaining $30.9 million, or 0.7% of the Maritime Life fixed maturity investments, were rated non-investment grade. For additional discussion of our investment portfolio see the General Account Investments section of this Management's Discussion and Analysis of Financial Condition and Results of Segment Operations.
Individual life insurance policies (other than term life insurance) increase in cash value over their lives. Policyholders have the right to borrow from us an amount generally up to the cash value of their policy at any time. As of December 31, 2003, we had approximately $22.6 billion in cash values in which policyholders have rights to policy loans. The majority of cash values eligible for policy loans are at variable interest rates, which are reset annually on the policy anniversary. Moreover, a portion of our fixed interest rate policy loans have features that provide for reduced
crediting rates on the portion of cash values loaned. The amount of policy loans has remained consistent over the past three years, at approximately $2.1 billion, $1.6 billion of which are in the closed block at December 31, 2003.
The Company's primary operating subsidiary is John Hancock Life Insurance Company. The risk-based capital standards for life insurance companies, as prescribed by the National Association of Insurance Commissioners, establish a risk-based capital ratio comparing adjusted surplus to required surplus for each of our United States domiciled insurance subsidiaries. If the risk-based capital ratio falls outside of acceptable ranges, regulatory action may be taken ranging from increased information requirements to mandatory control by the domiciliary insurance department. The risk-based capital ratios of all our insurance subsidiaries as of December 31, 2003, were above the ranges that would require regulatory action.
Net cash provided by operating activities was $3,052.7 million, $2,561.1 million and $2,633.8 million, for the years ended December 31, 2003, 2002 and 2001, respectively. Cash flows from operating activities are affected by the timing of premiums received, fees received and investment income. The $491.6 million increase in 2003 compared to 2002 resulted primarily a $677.4 million increase in premiums received, and a $239.4 million increase in net investment income received offset by a $281.8 million increase in expenses and a $329.8 million increase in income taxes paid. The $72.7 million decrease in 2002 compared to 2001 resulted primarily from a $422.5 million decrease in premiums received and a $130.5 million increase in expenses, offset by a $153.5 million decrease in benefits paid, a $143.3 million increase in net investment income received.
o The Company made certain payments which related to the rent of its Home Office properties since the sale of these properties effective March 14, 2003. The Company has signed several market-based leases for use of the Home Office properties ranging from 5 to 15 years.
o The Company's defined-benefit retiree pension plan has not required funding since 1991, related post retirement benefits plans received funding of $32.3 million, $21.6 million and $20.6 million for each years ended December 31, 2003, 2002 and 2001 respectively. Prior to 2002, pension benefits under the non-Maritime Life defined benefit plans were also based on years of service and final average compensation (generally during the three years prior to retirement). In 2001, the defined benefit pension plans were amended to a cash balance basis under which benefits are based on career average compensation. Under grandfathering rules, employees within 5 years of early retirement eligibility or employees over age 40 and with at least 10 years of service will receive pension benefits based on the greater of the benefit from the cash balance basis or the prior final average salary basis. This amendment became effective on January 1, 2002.
offset by an $11.4 billion decrease in sales, maturities and redemptions of fixed maturity securities in 2002 compared to the prior year. The decrease was offset by increased net purchases of mortgages and short-term investment over prior year.
Net cash provided by financing activities was $2,527.9 million, $4,029.9 million and $2,182.8 million for the years ended December 31, 2003, 2002 and 2001, respectively. Changes in cash provided by financing activities primarily relate to the execution of transactions with our customers demonstrated by deposits and withdrawals under investment-type contracts and the payment of the Company's annual dividend to shareholders. In addition, where advantageous or otherwise necessary, the Company may issue equity securities or debt, borrowing or re-pay corporate debt, acquire our stock on the market, or pay dividends to shareholders. The $1,502.0 million decrease in the 2003 as compared to 2002 resulted from a $1,453.0 million decrease in deposits and a $1,492.2 million increase in cash payments made on withdrawals of universal life insurance and investment-type contracts offset somewhat by $970.0 million in funds from the Consumer Notes program initiated in the second half of 2002, and a $373.2 million decline in treasury stock acquired due to the suspension of activity under the stock repurchase program. Deposits on universal life insurance and investment-type contracts exceeded withdrawals by $969.5 million and $3,914.7 million for the years ended December 31, 2003 and 2002, respectively. The Company's ability to generate customer deposits in excess of withdrawals is critical to our long-term growth. The increase in 2002 as compared to 2001 resulted from a $1,589.9 million increase in deposits net of cash payments made on withdrawals of universal life insurance and investment-type contracts. Deposits on such universal life insurance and investment-type contracts exceeded withdrawals by $3,914.7 million and $2,324.8 million for the years ended December 31, 2002 and December 31, 2001, respectively. The Company's acquisitions of treasury stock decreased to $385.0 million in 2002 as compared to $580.4 million in 2001.
On October 26, 2000, the Company announced that its Board of Directors authorized a stock repurchase program, with no termination date, under which the Company was authorized to purchase up to $500 million of its outstanding common stock. On August 6, 2001, the Company's board of directors authorized a $500 million increase to the stock repurchase program. On June 21, 2002, the Company's board of directors authorized a second increase of $500 million to the stock repurchase program, bringing the total amount authorized to be used to repurchase Company stock to $1.5 billion. Under the stock repurchase program, purchases have been and will be, made from time to time, depending on market conditions, business opportunities and other factors, in the open market or through privately negotiated transactions. Through December 31, 2003, the Company has repurchased 30.0 million shares with a total cost of $1,057.2 million, of which 0.5 million shares were repurchased in 2003 at a cost of $11.8 million. The 2003 repurchase activity consisted primarily of the acquisition of certain restricted stock from key executives of the Company. The proceeds from some of these purchases were used by the executives to repay loans under a discontinued stock ownership and loan program and taxes. The outstanding loans under that program, which were grandfathered under the Sarbanes-Oxley Act of 2002, have been repaid in full at the request of the Company's Board of Directors. At December 31, 2003, the Company was not actively repurchasing its common stock but will continue to assess when it might resume repurchases of its common stock under the stock repurchase program.
Cash flow requirements are also supported by a committed line of credit of $1.0 billion, through a syndication of banks including Fleet National Bank, JPMorgan Chase, Citicorp USA, Inc., The Bank of New York, The Bank of Nova Scotia, Fleet Securities, Inc. and JPMorgan Securities, Inc., and an effective shelf registration statement which initially provided for the issuance, from time to time, of up to $1 billion of the Company's debt and equity securities. The line of credit agreement provides for two facilities: one for $500 million pursuant to a 364-day commitment (renewed effective July 25, 2003) and a second multi-year facility for $500 million (renewable in 2005). The line of credit is available for general corporate purposes. The line of credit agreement has no material adverse change clause, and includes, among others, the following covenants: minimum requirements for JHFS shareholder's equity, maximum limit on the capitalization ratio and a negative pledge clause (with exceptions) as well as limitations on subsidiary debt. The line of credit also contains cross-acceleration provisions. The fee structure is determined by the rating levels of JHFS or the Life Company such that a downgrade would result in higher fees. To date, we have not borrowed any amounts under the line of credit. On November 29, 2001, JHFS sold, under the $1.0 billion shelf registration statement, $500.0 million in 7-year senior unsecured notes at a coupon of 5.625% with the proceeds used for general corporate purposes. Covenants contained in this issue include, among others, limitations on the disposition of and liens on the stock of the Life Company. This issue also contains cross-acceleration provisions. The remaining capacity of the shelf registration is currently $500.0 million.
paper, of which $381.3 million was outstanding at December 31, 2003. The commercial paper program established at the Company has replaced the commercial paper program at its indirect subsidiary, John Hancock Capital Corporation. In addition, the Company has outstanding $1,550.4 million of consumer notes which are redeemable upon the death of the holder, subject to an annual overall program redemption limitation of 1% of the aggregate securities outstanding, or an individual redemption limitation of $200,000 of aggregate principal, and mature at a various dates in the future. Covenants in this program include, among others, limitations on liens.
$150 million in letters of credit for JH Reassurance Company, guaranteed by the Company, are subject to rating triggers that require the posting of deposits (within three business days) as additional collateral if the ratings of JHFS or the Life Company fall below designated rating levels. Currently, JHFS and the Life Company's ratings are several levels away from a triggering event for the guaranteed letters of credit. Failure to make such deposit under one or more of the guaranteed letters of credit could trigger the cross-acceleration provisions in other financing agreements, including the line of credit referenced above. Certain of these guaranteed letters of credit incorporate the financial covenants from the line of credit as well as contain cross-default and cross-acceleration provisions.
The Company's primary use of QSPEs arises in its commercial mortgage banking subsidiary. The Company's commercial mortgage banking subsidiary originates commercial mortgages and sells them to QSPEs which then issues mortgage backed securities (MBS). The Company engages in this activity to earn fees during the origination process, and to generate realized gains during the securitization process. The Company may purchase MBS from the QSPEs created in its commercial mortgage banking subsidiary to generate net investment income. The majority of the Company's MBS portfolio was purchased from unrelated QSPEs.
These QSPEs and other special purpose entities also include CDO funds we manage and may also invest in, which are considered variable interest entities and are discussed in detail in Note 3 - Relationships with Variable Interest Entities to our consolidated financial statements. The Company generates fee income from the CDO funds we manage, and generates net investment income from CDOs we invest in, whether we manage them or not.
These arrangements also include credit and collateral support agreements with FNMA and FHMLC, through which the Company securitized some of its mortgage investments, which provided a potential source of liquidity to the Company. These agreements are described in detail in Note 12 - Commitments, Guarantees and Contingencies to our consolidated financial statements.
The following table summarizes the Company's information about contractual obligations by due date and expiration date as of December 31, 2003. Contractual obligations of the Company are those obligations fixed by agreement as to dollar amount and date of payment. These obligations are inputs into the Company's asset liability management system described elsewhere in this document.
Consolidated Statements of Income for the Years Ended December 31, 2003, 2002 and 2001..........................................................121
Consolidated Statements of Changes in Shareholder's Equity and Comprehensive Income for the Years Ended December 31, 2003, 2002 and 2001............123
Business. John Hancock Financial Services, Inc. (the Company) is a diversified financial services organization that provides a broad range of insurance and investment products and investment management and advisory services.
Basis of Presentation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. All of the Company's United States Securities and Exchange Commission filings are available on the internet at www.sec.gov, under the name Hancock John Financial. - -----------
Partnerships, joint venture interests and other equity investments in which the Company does not have a controlling financial interest, but has significant influence, are recorded using the equity method of accounting and are included in other invested assets. Other entities in which the Company has a less than controlling financial interest, whether variable interest entities (VIEs) or not, are accounted for under guidance appropriate to each relationship, whether the Company invests in their debt or equity securities, issues funding agreements to them, manages them as investment advisor, or performs other transactions with them or provides services to them. Please refer to the Recent Accounting Pronouncements section below for a discussion of new accounting guidance relative to VIEs.
On July 8, 2003, the Maritime Life Insurance Company (Maritime Life), a majority owned Canadian subsidiary of the Company, completed its purchase of the insurance business of Liberty Health, a Canadian division of U.S.-based Liberty Mutual Insurance Company, through a reinsurance agreement for approximately $97.5 million. Through the agreement, Maritime Life assumed the entire business of Liberty Health, including its group life, group disability and group health divisions, as well as its individual health insurance business. There was no impact on the Company's results of operations from the acquired insurance business during 2002 or the first six months of 2003.
Investments. The Company classifies its debt and equity investment securities into one of three categories: held-to-maturity, available-for-sale or trading. The Company determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Fixed maturity investments include bonds, mortgage-backed securities, and mandatorily redeemable preferred stock and are classified as held-to-maturity, available-for-sale, or trading. Those bonds and mortgage-backed securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and carried at amortized cost. Fixed maturity investments not classified as held-to-maturity are classified as available-for-sale or trading and are carried at fair value. Unrealized gains and losses related to available-for-sale securities are reflected in shareholders' equity, net of related amortization of deferred policy acquisition costs, amounts credited to participating pension contractholders, amounts credited to the policyholder dividend obligation, and applicable taxes. Interest income is generally recognized on the accrual basis. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. The amortized cost of fixed maturity investments is adjusted for impairments in value deemed to be other than temporary, and such adjustments are reported as a component of net realized investment and other gains (losses). Gains and losses, both realized and unrealized, on fixed maturity securities classified as trading are included in benefits to policyholders as part of investment returns related to equity indexed universal life insurance policies sold at Maritime Life.
Hedge effectiveness is assessed quarterly using a variety of techniques including regression analysis and cumulative dollar offset. When it is determined that a derivative is not effective as a hedge, the Company discontinues hedge accounting. In certain cases, there is no hedge ineffectiveness because the derivative instrument was constructed such that all the terms of the derivative exactly match the hedged risk in the hedged item.
In the development of expected gross profits, the Company is required to estimate the growth in the policyholder account balances upon which certain asset based fees are charged. In doing so, the Company assumes that, over the long term, account balances will grow from investment performance. The rate of growth takes into account the current fixed income/equity mix of account balances as well as historical fixed income and equity investment returns. The Company also assumes that historical variances from the long-term rate of investment return will reverse over the next five year period. The resulting rates for the next five years are reviewed for reasonableness, and they are raised or lowered if they produce an annual growth rate that the Company believes to be unreasonable.
The effects on the amortization of DAC and unearned revenues of revisions to estimated gross margins and profits are reflected in earnings in the period such revisions are made. Expected gross profits or expected gross margins are discounted at periodically revised interest rates and are applied to the remaining benefit period. At December 31, 2003, the average discount rate was 8.4% for participating traditional life insurance products and 6.0% for universal life products. The total amortization period was 30 years for both participating traditional life insurance products and universal life products.
The cost of mutual fund investment management contracts acquired is recorded as indefinite-lived intangible assets and are included in other assets in the consolidated balance sheets. These management contract intangible assets are not amortized; instead they are reviewed for impairment using a testing regimen similar to that used for goodwill. Refer to Note 17 - Goodwill and Other Intangible Assets for presentation of summarized financial information regarding all of these intangible assets.
Liabilities for unpaid claims and claim expenses include estimates of payments to be made on reported individual and group life, long-term care, and group accident and health insurance claims and estimates of incurred but not reported claims based on historical claims development patterns.
Estimates of future policy benefit reserves, claim reserves and expenses are reviewed continually and adjusted as necessary; such adjustments are reflected in current earnings. Although considerable variability is inherent in such estimates, management believes that future policy benefit reserves and unpaid claims and claims expense reserves are adequate.
Policyholders' funds for universal life and investment-type products, including guaranteed investment contracts and funding agreements, are equal to the policyholder account values before surrender charges. Policy benefits that are charged to expense include benefit claims incurred in the period in excess of related policy account balances and interest credited to policyholders' account balances. Interest crediting rates range from 3.0% to 8.0% for universal life insurance products and from 1.1% to 13.8% for investment-type products.
Major components of policyholders' funds in the consolidated statements of financial position, are summarized as follows:
Under the first program, established in May 1998 for $2.5 billion, expanded to $7.5 billion in 1999, an SPE issued medium-term notes in Europe, Asia and Australia. As of December 31, 2003 and 2002, there was $3.8 billion and $3.8 billion, respectively, outstanding under this program. This SPE is consolidated in the Company's financial statements. The medium-term notes issued by this SPE are reported with global funding agreements in the Company's consolidated balance sheets.
Under the third program, established in December 2001, for $1.0 billion (Cdn $1.5 billion), an SPE issued medium-term notes to investors in Canada. As of December 31, 2003 and 2002, there were $0.4 billion (Cdn $0.5 billion) and $0.2 billion (Cdn $0.3 billion), respectively, outstanding under this program. This SPE is also a QSPE and is therefore not consolidated in the Company's financial statements. The annuity contracts backing the related medium-term notes are included in policyholders' funds in the Company's consolidated balance sheets.
At December 31, 2003, the annual contractual maturities of global funding agreements and annuities backing medium term notes issued under these programs were as follows: 2004--$2,198.6 million; 2005--$2,547.0 million; 2006--$2,884.5 million; 2007--$787.4 million; 2008--$1,640.0 million and thereafter--$2,860.6 million.
The portion of earnings allocated to participating pension contractholders and closed block policyholders that cannot be expected to inure to the Company is excluded from net income and shareholders' equity.
The amount of policyholders' dividends to be paid is approved annually by the Life Company's Board of Directors and separately for Maritime Life products by the Maritime Life Board of Directors.
Foreign Currency Translation. The assets and liabilities of operations in foreign currencies are translated into United States dollars at current exchange rates. Revenues and expenses are translated at average rates during the year. The resulting net translation adjustments for each year are accumulated and included in shareholders' equity. Gains or losses on foreign currency transactions are reflected in earnings.
Since the inception of the project as well as from similar initiatives such as our information technology outsourcing and the sale of the home office real estate, approximately 1,590 employees have been terminated or identified for termination. Benefits paid since the inception of the project were $110.7
Earnings per Share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period excluding the dilutive effects of options, or non-vested stock. Diluted earnings per share reflects the potential dilution that could occur if dilutive securities, such as options and non-vested stock grants, were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.
On January 1, 2001, the Company adopted SFAS No. 133, as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No. 133." The adoption of SFAS No. 133, as amended, resulted in a charge to operations accounted for as a cumulative effect of accounting change of $16.1 million (net of tax of $8.3 million) as of January 1, 2001. In addition, as of January 1, 2001, a $227.6 million (net of tax of $122.6 million) cumulative effect of accounting change was recorded in other comprehensive income for (1) the transition adjustment in the adoption of SFAS No. 133, as amended, an increase of $40.5 million (net of tax of $21.8 million), and (2) the reclassification of $12.1 billion in securities from the held-to-maturity category to the available-for-sale category, an increase of $187.1 million (net of tax of $100.8 million).
FASB Interpretation No. 46 (revised December 2003)--Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51
Controlling financial interests of a VIE are defined as exposure of a party to the VIE to a majority of either the expected variable losses or expected variable returns of the VIE, or both. Such party is the primary beneficiary of the VIE and FIN 46R requires that the primary beneficiary of a VIE consolidate the VIE. FIN 46R also requires certain disclosures for significant relationships with VIEs, whether or not consolidation accounting is either used or anticipated. The consolidation requirements of FIN 46R apply as of December 31, 2003 for entities considered to be special purpose entities (SPEs), and otherwise will be applicable at March 31, 2004,
The Company has categorized its FIN 46R consolidation candidates into three categories- 1) Collateral Debt Obligation funds we manage (CDO funds or CDOs), which are SPEs, 2) low-income housing properties (the Properties) which are not SPEs, and 3) assorted other entities (Other Entities) which are not SPEs. The Company has determined that it should not consolidate any of the CDO funds, therefore the adoption of FIN46R for the CDO funds had no impact on the Company's consolidated financial position, results of operations or cash flows. The Company is re-evaluating whether it should consolidate any of the Properties based on FIN 46R, and is still evaluating the Other Entities, and is also evaluating the future potential impact of consolidating any of them.
Additional liabilities recognized as a result of consolidating VIEs with which the Company is involved would not represent additional claims on the general assets of the Company; rather, they would represent claims against additional assets recognized by the Company as a result of consolidating the VIEs. Conversely, additional assets recognized as a result of consolidating these VIEs would not represent additional assets which the Company could use to satisfy claims against its general assets, rather they would be used only to settle additional liabilities recognized as a result of consolidating the VIEs. Refer to Note 3--Relationships with Variable Interest Entities for a more complete discussion of the Company's relationships with VIEs, their assets and liabilities, and the Company's maximum exposure to loss as a result of its involvement with them.
FASB Derivatives Implementation Group Issue No. B36--Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments
In April 2003, the FASB's Derivatives Implementation Group (DIG) released SFAS No. 133 Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments" (DIG B36). DIG B36 addresses whether SFAS No. 133 requires bifurcation of a debt instrument into a debt host contract and an embedded derivative if the debt instrument incorporates both interest rate risk and credit risk exposures that are unrelated or only partially related to the creditworthiness of the issuer of that instrument. Under DIG B36, modified coinsurance and coinsurance with funds withheld reinsurance agreements as well as other types of receivables and payables where interest and/or other investment results are determined by reference to a specific pool of assets or a total return debt index are examples of arrangements containing embedded derivatives requiring bifurcation under SFAS No. 133. Under SFAS No. 133, bifurcation requires that the embedded derivative be held at fair value and that changes in fair value be charged or credited to income. The effective date of DIG B36 was October 1, 2003.
FIN 45's disclosure requirements are effective for financial statements of interim or annual periods ending after December 31, 2002. Refer to Note 12--Commitments, Guarantees and Contingencies. Initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 had no impact on the Company's consolidated financial position, results of operations or cash flows.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires that all business combinations be accounted for under a single method, the purchase method. Use of the pooling-of-interests method is no longer permitted. SFAS No. 141 also clarifies the criteria to recognize intangible assets separately from goodwill, and prohibits the amortization of goodwill relating to acquisitions completed after July 1, 2001. SFAS No. 141 is effective for business combinations initiated after June 30, 2001. Adoption of SFAS No. 141 had no impact on the Company's consolidated financial position, results of operations or cash flows.
EITF Issue No. 99-20--Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets
The following information summarizes the components of net investment income and net realized investment and other gains (losses):
Gross gains were realized on the sale of available-for-sale securities of $638.7 million in 2003, $352.3 million in 2002 and $463.6 million in 2001, and gross losses were realized on the sale of available-for-sale securities of $243.6 million in 2003, $185.7 million in 2002, and $182.9 million in 2001.
The amortized cost and fair value of fixed maturities at December 31, 2003, by contractual maturity, are shown below:
Amortized Cost Fair Value ---------------------------- (in millions) Held-to-Maturity: Due in one year or less ........................ $ 3.9 $ 4.3 Due after one year through five years .......... 34.5 42.4 Due after five years through ten years ......... 252.9 259.7 Due after ten years ............................ 860.6 848.6 Mortgage-backed securities ..................... 346.7 368.0 --------- --------- Total .................................... $ 1,498.6 $ 1,523.0 ========= ========= Available-for-Sale: Due in one year or less ........................ $ 2,201.2 $ 2,265.7 Due after one year through five years .......... 11,417.7 12,013.0 Due after five years through ten years ......... 14,852.1 15,981.6 Due after ten years ............................ 12,847.8 13,900.6 Mortgage-backed securities ..................... 7,578.0 7,726.1 --------- --------- Total .................................... $48,896.8 $51,887.0 ========= =========
The change in net unrealized gains (losses) on trading securities that has been included in earnings during 2003, 2002 and 2001 amounted to $5.8 million, $(5.9) million, and $ (23.4) million, respectively.
The Company participates in a security lending program for the purpose of enhancing income on securities held. At December 31, 2003 and 2002, $426.9 million and $625.5 million, respectively, of the Company's securities, at market value, were on loan to various brokers/dealers, and were fully collateralized by cash and highly liquid securities. The market value of the loaned securities is monitored on a daily basis, and the collateral is maintained at a level of at least 102% of the loaned securities' market value.
There are a number of significant risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other than temporary. These risks and uncertainties include (1) the risk that our assessment of an issuer's ability to meet all of its contractual obligations will change based on changes in the credit characteristics of that issuer, (2) the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated, (3) the risk that fraudulent information could be provided to our investment professionals who determine the fair value estimates and other than temporary impairments, and (4) the risk that new information obtained by us or changes in other facts and circumstances lead us to change our intent to hold the security to maturity or until it recovers in value. Any of these situations could result in a charge to earnings in a future period.
Gross unrealized losses from hedging adjustments represent the amount of the unrealized loss that results from the security being designated as a hedged item in a fair value hedge. When a security is so designated, its cost basis is adjusted in response to movements in interest rates. These adjustments, which are non-cash and reverse over time as the asset and derivative mature, impact the amount of unrealized loss on a security. The remaining portion of the gross unrealized loss represents the impact of interest rates on the non-hedged portion of the portfolio and unrealized losses due to creditworthiness on the total fixed maturity portfolio.
At December 31, 2003 the fixed maturity securities had a total gross unrealized loss of $331.0 million excluding basis adjustments related to hedging relationships. Of the total, $219.8 million is due to securities that have had various amounts of unrealized loss for more than nine months. Of this, $49.8 million comes from securities rated investment grade. Unrealized losses on investment grade securities principally relate to changes in interest rates or changes in credit spreads since the securities were acquired. Credit rating agencies' statistics indicate that investment grade securities have been found to be less likely to develop credit concerns.
As of December 31, 2003, $170.0 million of the $331.0 million gross unrealized loss resides in below investment grade securities with various amounts of unrealized loss for over nine months. All of these securities are current as to the payments of principal and interest with the exception of 2 securities with a carrying value of $16.8 million and an unrealized loss of $18.3 million. Of the total $170.0 million, $87.6 million traded above 80% of amortized cost at December 31, 2003 and an additional $11.3 million traded above 80% of amortized cost within the last nine months, for a total of $98.9 million. Of the total $98.9 million in this category, $58.1 million comes from airline related bonds, an industry that continues to experience stress and hence has lagged the general recovery. While we expect the secured nature of our positions to protect our value, the increased stress in this industry is of concern.
The remaining portion of the unrealized loss, $71.1 million, arises from below investment grade securities that have traded below 80 percent of amortized cost for over nine months. All of these bonds are current on payments of principal and interest and we believe, based on currently available information that it is probable that these securities will continue to pay based on their original terms. We carefully track these investments to ensure our continued belief that their prices will recover.
component of net realized investment and other gains (losses). Interest received on impaired mortgage loans on real estate is included in interest income in the period received. If foreclosure becomes probable, the measurement method used is based on the collateral value. Foreclosed real estate is recorded at the fair value of the collateral at the date of foreclosure, which establishes a new cost basis.
Changes in the allowance for probable losses on mortgage loans on real estate and real estate to be disposed of are summarized below.
At December 31, 2003 and 2002, the total recorded investment in mortgage loans that are considered to be impaired under SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," along with the related provision for losses were as follows:
Years Ended December 31, -------------------------------- 2003 2002 2001 -------------------------------- (in millions) Expected................................... $ 7.6 $4.8 $ 24.3 Actual..................................... 7.2 4.7 23.0
Mortgage loans with outstanding principal balances of $61.8 million, bonds with amortized cost of $260.6 million and real estate with a carrying value of $0.5 million were non-income producing for the year ended December 31, 2003.
when available, and if not available are estimated by the Company by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments. Refer to Note 15 - Fair Value of Financial Instruments below for further discussion of the Company's fair value methodologies. The Company values servicing rights by estimating future cash flows from the servicing assets using discount rates that approximate market rates.
status by considering the control aspects of the equity classes of the CDOs. The Company has determined whether each CDO should be considered a VIE, and while most are VIEs, some are not. The Company has determined that it is not the primary beneficiary of any CDO which is a VIE, and for those that are not VIEs, the Company does not have controlling financial interests. Therefore, the Company will not use consolidation accounting for any of the CDOs which it manages.
December 31, -------------------- 2003 2002 -------------------- (in millions) Total size of the Properties(1) Total assets ....................................... $982.7 $682.2 ==================== Total debt ......................................... 576.3 396.4 Total other liabilities ............................ 116.6 101.8 -------------------- Total liabilities .................................. 692.9 498.2 Total equity ....................................... 289.8 184.0 -------------------- Total liabilities and equity ....................... $982.7 $682.2 ====================
- ---------- (1) Certain data is reported with a one-year delay, due to the delayed availability of financial statements of the properties.
The table below presents summary financial data for the Other Entities, and data relating to the Company's maximum exposure to loss as a result of its relationships with them.
Total assets ................................. $284.8 $281.8 ====== ====== Total debt ................................... 301.7 309.3 Total other liabilities ...................... 65.3 62.1 ------ ------ Total liabilities ............................ 367.0 371.4 Total equity(2) .............................. (82.2) (89.6) ------ ------ Total liabilities and equity ................. $284.8 $281.8 ====== ======
The fair values of derivative instruments classified as assets at December 31, 2003 and 2002 were $815.9 million and $343.5 million, respectively, and appear on the consolidated balance sheet in other assets. The fair values of derivative instruments classified as liabilities at December 31, 2003 and 2002 were $1,277.3 million and $1,185.9 million, respectively, and appear on the consolidated balance sheet in other liabilities. In addition, as a result of the Company's adoption of SFAS No. 133 issue B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments" (DIG B36), the Company has recorded as derivatives amounts aggregating $225.6 million as of December 31, 2003 related to participating pension contracts which appears on the consolidated balance sheet in policyholders' funds.
The Company also manages interest rate exposure by using interest rate swap agreements to modify certain liabilities, such as fixed rate debt and Constant Maturity Treasuries (CMT) indexed liabilities, by converting them to a LIBOR-based floating rate.
For the years ended December 31, 2003 and 2002, the Company recognized net losses of $5.8 million and $19.5 million, respectively, related to the ineffective portion of its fair value hedges, and net losses of $1.5 million and $6.4 million, respectively, related to the portion of the hedging instruments that were excluded from the assessment of hedge effectiveness. Both of these amounts are recorded in net realized investment and other gains and losses.
Cash Flow Hedges. The Company uses forward starting interest rate swap agreements to hedge the variable cash flows associated with future fixed income asset acquisitions, which will support the Company's long-term care and life insurance businesses. These agreements will reduce the impact of future interest rate changes on the cost of acquiring adequate assets to support the investment income assumptions used in pricing these products. During the periods in the future when the acquired assets are held by the Company, the accumulated gain or loss will be amortized into investment income as a yield adjustment on the assets.
For the years ended December 31, 2003 and 2002, the Company recognized gains of $1.8 million and $7.2 million, respectively, related to the ineffective portion of its cash flow hedges. These amounts are recorded in net realized investment and other gains and losses. For the year ended December 31, 2003, all of the Company's hedged forecast transactions qualified as cash flow hedges.
The Company files a life/non-life insurance company consolidated Federal income tax return. The life insurance company sub-group includes three domestic life insurance companies (John Hancock Life Insurance Company, (the Life Company), John Hancock Variable Life Insurance Company and Investors Partner Life Insurance Company) and a Bermuda life insurance company (John Hancock Reassurance Company, Ltd.) that is treated as a U.S. company for Federal income tax purposes. The non-life insurance company subgroup consists of John Hancock Financial Services, Inc., John Hancock Subsidiaries, LLC and John Hancock International Holdings, Inc.
In addition to taxes on operations, mutual life insurance companies are charged an equity base tax (the surplus tax). The Life Company was a mutual life insurance company for the entire year 1999, therefore it was subject to the re-computation of its 1999 equity base tax liability in its 2000 tax return. The surplus tax is determined by application of an industry-based earnings rate to the Mutual Company's average equity base, as defined by the Internal Revenue Code. The industry earnings rate is determined by the Internal Revenue Service (IRS) and is not finalized until the subsequent year. As such, the financial statements for the year ended December 31, 2001 include the impact of final tax return adjustments related to the 1999 equity base tax.
Income before income taxes and cumulative effect of accounting changes includes the following:
Domestic ..................................... $1,161.5 $ 521.5 $ 760.2 Foreign ...................................... 187.4 114.7 65.9 -------- -------- -------- Income before income taxes and cumulative effect of accounting changes .............. $1,348.9 $ 636.2 $ 826.1 ======== ======== ========
Years Ended December 31, ------------------------------ 2003 2002 2001 ------------------------------ (in millions) Current taxes: Federal ...................................... $ 154.0 $ 46.4 $ (38.6) Foreign ...................................... 22.5 37.2 8.6 State ........................................ 4.6 4.6 4.6 -------- -------- -------- 181.1 88.2 (25.4) ======== ======== ======== Deferred taxes: Federal ...................................... 167.0 42.8 235.9 Foreign ...................................... 35.3 12.4 10.8 State ........................................ (6.7) (6.7) (6.7) -------- -------- -------- 195.6 48.5 240.0 -------- -------- -------- Total income taxes ........................... $ 376.7 $ 136.7 $ 214.6 ======== ======== ========
The significant components of the Company's deferred tax assets and liabilities were as follows:
If, over time, the aggregate performance of the closed block assets and policies is better than was assumed in funding the closed block, dividends to policyholders will be increased. If, over time, the aggregate performance of the closed block assets and policies is less favorable than was assumed in the funding, dividends to policyholders could be reduced.
The following tables set forth certain summarized financial information relating to the closed block as of the dates indicated:
- ---------- (1) As part of its interest rate management, the Company uses interest rate swaps to convert the interest expense on the Surplus Notes from fixed to variable. Under SFAS No. 133, these swaps are designated as fair value hedges, which results in the carrying value of the notes being adjusted for changes in fair value.
The Company issues commercial paper primarily to meet working capital needs. The Company had commercial paper with a book value of $381.3 million and a face value of $382.0 million outstanding at December 31, 2003. The weighted-average interest rate for outstanding commercial paper at December 31, 2003 was 1.18%. The weighted-average life for outstanding commercial paper at December 31, 2003 was approximately 33 days. Commercial paper borrowing arrangements are supported by a syndicated line of credit. The Company had commercial paper with a book value of $249.4 million and a face value of $250.0 million outstanding at December 31, 2002. The weighted-average interest rate for outstanding commercial paper at December 31, 2002 was 1.52%. The weighted-average life for outstanding commercial paper at December 31, 2002 was approximately 29 days.
Aggregate maturities of long-term debt are as follows: 2004--$104.0 million; 2005--$28.5 million; 2006--$16.8 million; 2007--$9.6 million; 2008-- $500.9 million; and thereafter--$759.7 million.
The future minimum lease payments by year and in the aggregate, under the capital lease and under non-cancelable operating leases and future sublease rental income on the garage are presented below:
For the years ended December 31, 2003, 2002 and 2001, benefits to policyholders under life, health and annuity ceded reinsurance contracts were $541.6 million, $755.5 million and $527.0 million, respectively.
The Company provides pension benefits to substantially all employees and general agency personnel. These benefits are provided through both funded qualified and unfunded non-qualified defined benefit and qualified defined contribution pension plans. Through the non-qualified defined benefit plans, the Company provides supplemental pension benefits to employees with salaries and/or pension benefits in excess of the qualified plan limits under applicable law. The Maritime Life qualified plans provide pension benefits based on years of service and final average salary (generally during the 5 years prior to retirement). The Maritime Life non-qualified plans provide supplemental pension benefits to employees with salaries in excess of the qualified limit under Canadian law and to two former executives. Prior to 2002, pension benefits under the non-Maritime Life defined benefit plans were also based on years of service and final average compensation (generally during the three years prior to retirement). In 2001, the defined benefit pension plans were amended to a cash balance basis under which benefits are based on career average compensation. Under grandfathering rules, employees within 5 years of early retirement eligibility or employees over age 40 and with at least 10 years of service will receive pension benefits based on the greater of the benefit from the cash balance basis or the prior final average salary basis. This amendment became effective on January 1, 2002.
On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily by adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. The company anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions; however, the retiree medical obligations and costs reported do not reflect the impact of this legislation. Deferring the recognition of the new Medicare provisions' impact is permitted by Financial Accounting Standards Board Staff Position 106-1 due to open questions about some of the new Medicare provisions and a lack of authoritative accounting guidance about certain matters. The final accounting guidance could require changes to previously reported information.
Years Ended December 31, ---------------------------------- Other Postretirement Pension Benefits Benefits ---------------------------------- 2003 2002 2003 2002 ---------------------------------- (in millions) Increase in minimum liabilities included in other comprehensive income............. $34.9 $41.2 N/A N/A
Note 11--Pension Benefit Plans and Other Postretirement Benefit Plans - (continued)
Years Ended December 31, ---------------------------------- Other Postretirement Pension Benefits Benefits ---------------------------------- 2003 2002 2003 2002 ---------------------------------- Discount rate............................... 6.25% 6.75% 6.25% 6.75% Rate of compensation increase............... 3.00% 3.50% N/A N/A Health care trend rate for following year... 11.00% 10.00% Ultimate trend rate......................... 5.25% 5.25% Year ultimate rate reached.................. 2010 2008
Asset Category - -------------- Equity securities............................................... 50% - 80% Fixed maturity securities...................................... 25% - 35% Real estate..................................................... 1% - 5% Other........................................................... --% - 18%
The plans do not own any of the Company's common stock at December 31, 2003 and 2002.
Other postretirement benefit plan weighted-average asset allocations at December 31, 2003, and 2002, by asset category are as follows:
The Company's policy is to fund its US other post retirement benefits in amounts at or below the annual tax qualified limits.
The Company expects to contribute approximately $50 million to its US other post retirement benefit plans in 2004.
Guarantees. In the course of business the Company enters into guarantees which vary in nature and purpose and which are accounted for and disclosed under accounting principles generally accepted in the U.S, specific to the insurance industry. The following guarantee falls outside the scope of insurance accounting and is disclosed pursuant to FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others".
o The Life Company guarantees certain mortgage securitizations transactions the Company entered into with FNMA and FHLMC. These guarantees will persist until the pools of mortgages are paid off in full by the mortgagees. The Life Company must perform under these guarantees where the mortgagees fail to repay their mortgages. The maximum amount of future payments the Life Company may be required to make pursuant to these guarantees is up to 12.25% of the total principal and interest for the FNMA securitization, or $13.2 million, and up to 10.50% of total principal and interest for the FHLMC securitization, or $14.6 million, at December 31, 2003.
Harris Trust. Beginning in 1983, the Company became involved in complex litigation known as Harris Trust and Savings Bank, as Trustee of Sperry Master Retirement Trust No. 2 v. John Hancock Mutual Life Insurance Company (S.D.N.Y. Civ. 83-5491). After successive appeals to the Second Circuit and to the U.S. Supreme Court, the case was remanded to the District Court and tried by a Federal District Court judge in 1997. The judge issued an opinion in November 2000.
The action has been dismissed and the settlement consummated as of December 11, 2003. The settlement costs were paid in 2003.
Other. In the normal course of its business operations, the Company is involved with litigation from time to time with claimants, beneficiaries and others, and a number of litigation matters were pending as of December 31, 2003. It is the opinion of management, after consultation with counsel, that the ultimate liability with respect to these claims, if any, will not materially affect the financial position or results of operations of the Company.
(a) Common Stock. The Company has one class of common stock with $.01 par value and 2.0 billion shares are authorized. At December 31, 2003, approximately 14.3 million shares of common stock were reserved for issuance related to the issuance of stock under both the 1999 Long-term Stock Incentive Plan (as amended, the Long-Term Stock Incentive Plan) and the Non-Employee Directors' Long-Term Stock Incentive Plan.
(b) Other Comprehensive Income. The components of accumulated other comprehensive income are as follows:
Net unrealized investment gains (losses), included in the consolidated balance sheets as a component of shareholders' equity, are summarized as follows:
(c) Statutory Results. The Company adopted the new codified statutory accounting principles (Codification) effective January 1, 2001. Codification changes prescribe statutory accounting practices and results in changes to the accounting practices that the Company and its domestic life insurance subsidiaries use to prepare their statutory-basis financial statements.
The Life Company and its domestic insurance subsidiaries prepare their statutory-basis financial statements in accordance with accounting practices prescribed or permitted by the state of domicile. For the Life Company, the Commonwealth of Massachusetts only recognizes statutory accounting practices prescribed or permitted by Massachusetts insurance regulations and laws. The National Association of Insurance Commissioners' "Accounting Practices and Procedures" manual (NAIC SAP) has been adopted as a component of prescribed or permitted practices by Massachusetts. The Commissioner of Insurance has the right to permit other specific practices that deviate from prescribed practices, otherwise known as permitted practices.
During 2002, the Company received permission from the Division to record an admitted asset for the Federal Long-Term Care Program start-up and launch costs due from its experience fund of $19.3 million at December 31, 2002. As a result of this permitted practice, the Company's reported capital and surplus for the 2002 reporting period was increased by $19.3 million. There was no permitted practice for this item in 2003 thus no admitted asset for start-up and launch costs in 2003.
Statutory net income and surplus in the table below include the accounts of the John Hancock Life Company.
2003 2002 2001 ----------------------------- (in millions) Statutory net income........................... $ 441.7 $ 210.4 $ 631.4 Statutory capital and surplus.................. 3,789.9 3,524.1 3,513.6
Protection Segment. Offers a variety of individual life insurance and individual and group long-term care insurance products, including participating whole life, term life, universal life, variable life, and individual and group long-term care insurance. Products are distributed through multiple distribution channels, including insurance agents and brokers and alternative distribution channels that include banks, financial planners, direct marketing and the Internet.
Investment Management Segment. Offers a wide range of investment management products and services to investors covering a variety of private and publicly traded asset classes including fixed income, equity, mortgage loans, and real estate. This segment distributes its products through a combination of dedicated sales and marketing professionals, independent marketing specialists, and investment professionals.
(ii) a 2002 charge to benefits to policyholders and expenses incurred relating to the settlement of a class action lawsuit against the Company involving a dispute regarding disclosure of costs on various modes of life insurance policy premium payment and a 2001 charge to benefits to policyholders and expenses incurred relating to the settlement of a class action lawsuit against the Company involving certain individual life insurance policies sold from 1979 through 1996;
Income Before Income Taxes and Long-lived Cumulative Effect of Location Revenues Assets Assets Accounting Changes - -------- ---------------------------------------------------------
The Company has no reportable major customers and revenues are attributed to countries based on the location of customers.
The following discussion outlines the methodologies and assumptions used to determine the fair value of the Company's financial instruments. The aggregate fair value amounts presented below do not represent the underlying value of the Company and, accordingly, care should be exercised in drawing conclusions about the Company's business or financial condition based on the fair value information presented below.
The following methods and assumptions were used by the Company to determine the fair values of financial instruments:
The carrying value for policy loans, short-term investments and cash and cash equivalents approximates their respective fair values.
Fair values for the Company's guaranteed investment contracts, consumer notes, and funding agreements are estimated using discounted cash flow calculations based on interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued. The fair value for fixed-rate deferred annuities is the account value adjusted for current market interest rates. Fair values for immediate annuities without life contingencies and supplementary contracts without life contingencies are estimated based on discounted cash flow calculations using current market rates.
On January 5, 2000, the Life Company, as sole shareholder of John Hancock Financial Services, Inc., approved and adopted the 1999 Long-Term Stock Incentive Plan (the Incentive Plan), which originally had been approved by the Board of Directors (the Board) of the Company on August 31, 1999. Under the Incentive Plan, which became effective on February 1, 2000, the effective date of the Plan of Reorganization of the Life Company, options granted may be either non-qualified stock options or incentive stock options qualifying under Section 422 of the Internal Revenue Code. The Incentive Plan objectives include attracting and retaining the best personnel, providing for additional performance incentives, and promoting the success of the Company by providing employees the opportunity to acquire the Company's common stock. In 2001, the Board adopted and the stockholders approved the amended and restated 1999 Long-Term Stock Incentive Plan (as amended the Long-Term Stock Incentive Plan) and the Non-Employee Directors' Long-Term Stock Incentive Plan (the Directors' Plan, collectively, the Incentive Plans).
The maximum number of shares available in the Non-Employee Directors' Long-Term Stock Incentive Plan is 1,000,000 shares of common stock. Pursuant to the Non-Employee Directors' Long-Term Stock Incentive Plan, each director receives 50% of the annual retainer paid to eligible directors in the form of stock awards. Where a director elects to have the remaining 50% of their retainer invested in shares of the Company's common stock through open market purchases the Company grants a partial matching stock award, which is forfeitable. Commencing on April 1, 2002, the matching stock award is transferred from the Non-Employee Directors' Long-Term Stock Incentive Plan. In addition, on stockholder approval of the Non-Employee Directors' Long-Term Stock Incentive Plan, each non-employee director received a non-qualified stock option award of 15,000 shares. Through December 31, 2002, as any new non-employee director is appointed that person will receive an initial option award of 15,000 shares and annually thereafter, at the date of the Company's annual meeting, each will receive non-qualified stock option awards for 5,000 shares. As of January 1, 2003, in lieu of stock option grants made in prior year, the Board of Directors receives an annual retainer paid in common stock transferred from the Non Employee Director Long-Term Stock Incentive Plan. The stock compensation granted under the Incentive Plans contain various vesting provisions described in more detail below. All outstanding stock compensation grants made prior to September 28, 2003 vest upon the change of control with Manulife, should that transaction be approved by the shareholders and regulatory authorities. Pursuant to the definitive merger agreement with Manulife, no stock compensation grants made under the Incentive Plans subsequent to September 28, 2003 (except for restricted stock and restricted deferred stock units issued to non-employee directors on or before December 31, 2003) vest on the potential change in control with Manulife.
The status of stock options awards under the Incentive Plans are summarized below as of December 31:
The estimated weighted-average fair value per option using the Black-Scholes option valuation model was $5.79, $7.70 and $9.35, for the years ending December 31, 2003, 2002 and 2001, respectively, using the following assumptions:
2003 2002 2001 ------------------------------- Expected term............................. 3 years 3 years 3-5 years Risk free rate(1)......................... 2.51% 2.51% 4.6%-6.0% Dividend yield............................ 1.05% 1.05% 1.0% Expected volatility....................... 28.8% 28.8% 32.0%
For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
In 2003, the Company anticipates a $7.2 million tax deduction on its tax return for employee stock option compensation. The Company plans to file its 2003 tax return by September 15, 2004. In 2002 and 2001, the Company deducted $12.3 million and $12.4 million, respectively, on its tax return for employee stock option compensation.
During February and March 2001, the Company granted 268,293 total shares of non-vested stock to key personnel. The program was funded with cash and the shares were purchased on the open market at the weighted-average grant price of $37.22 per share. These grants of non-vested stock are forfeitable and, at the time of the grant, vested at three years of service with the Company. The total grant-date exercise price of the non-vested stock granted from January 1, 2001 through December 31, 2001 is $10.0 million. During 2003, 2002 and 2001, 1,939, 4,051 and 16,768 shares of non-vested stock were forfeited with a total grant-date exercise price of $0.1 million $0.2 million and $0.6 million, respectively. During 2003, 163,642 shares were vested. The outstanding share balance in the 2001 plan is 81,893 at December 31, 2003.
During February 2002, the Company granted 154,643 total shares of non-vested stock to key personnel. The program was funded with cash and the shares were purchased on the open market at the weighted-average grant price of $38.22 per share. These grants of non-vested stock are forfeitable and, at the time of the grant, vested at three years of service with the Company. The total grant-date exercise price of the non-vested stock granted from January 1, 2002 through December 31, 2002 is $5.9 million. During 2003 and 2002 1,507 and 66 shares of non-vested stock were forfeited with a total grant-date price of $0.1 million and $0.01 million, respectively. During 2003, 51,307 shares were vested. The outstanding share balance in the 2002 plan is 101,763 at December 31, 2003.
During February 2003, the Company granted 23,076 total shares of non-vested stock to key personnel. The program was funded with cash and the shares were purchased on the open market at the weighted-average grant price of $27.53 per share. The grants of non-vested stock are forfeitable and, at the time of the grant, vested at three years of service with the Company. The total grant-date exercise price of the non-vested stock granted from January 1, 2003 through December 31, 2003 is $0.6 million. During 2003, 1,412 shares of non-vested stock were forfeited with a total-grant date price of $0.03 million. The outstanding share balance in the 2003 plan is 21,664 at December 31, 2003.
During February 2002, the Company granted 87,401 shares of non-vested stock to executive officers at a weighted-average grant price per share of $38.22. These grants of non-vested stock are forfeitable and vest at three years of service with the Company. The total grant-date exercise price of the non-vested stock granted from January 1, 2002 through December 31, 2002, is $3.3 million. There were no forfeitures of this grant during 2003 or 2002. The outstanding share balance of this grant is 87,401 at December 31, 2003.
During February 2003, the Company granted 27,305 total shares of non-vested stock to the Company's policy committee. The program was funded with cash and the shares were purchased from the Company at the weighted-average grant price of $27.53 per share. The grants of non-vested stock are forfeitable and vest at three years of service with the Company. The total grant-date exercise price of the non-vested stock granted from January 1, 2003 through December 31, 2003 is $0.8 million. There were no forfeitures of this grant during 2003. The outstanding share balance in the 2003 plan is 27,305 at December 31, 2003.
During 2003 and 2002, the Company issued 11,158 and 7,504 shares to Non-Employee Directors as payment of 25% and 50% of their quarterly retainer, respectively. These shares are not forfeitable and vest immediately. The total grant-date exercise price of this stock issued to non-employee directors from January 1, 2003 through December 31, 2003 is $0.3 million, from January 1, 2002 through December 31, 2002 is $0.3 million and from January 1, 2001 through December 31, 2001 is $0.1 million. In addition, in July 2001, the Company implemented a plan that would allow directors, at their discretion, to invest the second half of their quarterly retainer in the Company's common stock in lieu of receiving cash. As of July 1, 2003 the Company will match any investment at a rate of 25%. Prior to July 1, 2003 the Company matched investments at a rate of 50%. The restricted stock given as matching shares is forfeitable and vests over three years. For the period from July 1, 2001 through March 31, 2002, the restricted stock given as matching shares was purchased on the open market. As of April 1, 2002, the restricted stock given as matching shares is granted from the Non-Employee Long-Term Stock Incentive Plan. At December 31, 2003 and 2002, 506 and 484 shares were matched under the program at a weighted-average grant price per share of $29.53 and $36.22, respectively. Of 484 shares matched in 2002, 120 were purchased on the open market and 364 were transferred from the Non-Employee Directors' Long-Term Stock Incentive Plan. Total expense recognized for the period ending December 31, 2003 and 2002 was $0.03 million and $0.04 million, respectively.
During May 2003, the Company issued 21,696 shares to the Board of Directors as payment of their annual retainer. These grants of non-vested stock are forfeitable and vest at five years of service with the Company. The Company amortizes compensation expense for the grant over the vesting period. Total amortization for the period ending December 31, 2003 was $0.1 million. There were no forfeitures through December 31, 2003.
During February 2004, the Compensation Committee of the Board of Directors approved stock and stock option grants to the Policy Committee and certain key employees of the Company. The equity grants were made in compliance with the terms of the Long-Term Stock Incentive Plan. A total of 312,500 shares of non-vested stock was granted, with a total grant date
The Company recognizes purchased intangible assets which result from business combinations; goodwill, the value of business acquired (VOBA), and mutual fund investment management contracts acquired (management contracts). The excess of the cost over the fair value of identifiable assets acquired in business combinations is recorded as goodwill. The present value of estimated future profits of insurance policies in force related to businesses acquired is recorded as VOBA.
The following tables set forth certain summarized financial information relating to the Company's purchased intangible assets as of the dates and periods indicated.
Accumulated Gross Amortization Net Carrying And Other Carrying Amount Changes Amount ---------------------------------- (in millions) December 31, 2003 Unamortizable intangible assets: Goodwill............................ $424.5 $ (79.5) $ 345.0 Management contracts................ 13.3 (7.0) 6.3 Amortizable intangible assets: VOBA................................ 585.1 (34.6) 550.5 December 31, 2002 Unamortizable intangible assets: Goodwill............................ $ 334.1 $ (79.5) $ 254.6 Management contracts................ 12.2 (7.0) 5.2 Amortizable intangible assets: VOBA................................ 499.8 (18.1) 481.7
(1) Goodwill related to Maritime Life's acquisition of Liberty Health. (2) Goodwill related to Maritime Life is subject to fluctuations in the value of the Canadian Dollar relative to the US Dollar.
(1) Goodwill related to Maritime Life is subject to fluctuations in the value of the Canadian Dollar relative to the US Dollar. (2) Purchase price negotiations with Fortis, Inc. were concluded during the first quarter of 2002, resulting in an adjustment of $(7.3) million to the goodwill related to the Company's 1999 acquisition of Fortis' long-term care insurance business. Legal fees associated with these negotiations were finalized in the second quarter of 2002, resulting in a further adjustment to goodwill of $(0.1) million. (3) An adjustment of $(19.9) million was made to previously recorded goodwill relating to RSAF, to reflect refinements in methods and assumptions implemented upon finalization of transition to Maritime Life valuation systems.
The changes in the carrying value of management contracts, presented for each business segment, for the periods indicated, are as follows:
(1) This increase results from JH Fund's purchases of the management contracts for the US Global Leaders Fund, Classic Value Fund, and Large Cap Select Fund in 2003.
(1) This increase results from JH Fund's purchases of the management contracts for the U.S. Global Leaders Growth Funds and the Classic Value Fund in 2002.
Note 18--Information Provided in Connection with Market Value Annuity of John Hancock Variable Life Insurance Company
JHFS is an insurance holding company. The assets of JHFS consist primarily of the outstanding capital stock of the Life Company, John Hancock Canadian Holding Company and investments in other international subsidiaries. JHFS' cash flow primarily consists of dividends from its operating subsidiaries and proceeds from debt offerings (see Note 7--Debt and Line of Credit) offset by expenses, shareholder dividends and stock repurchases. As a holding company, the Company's ability to meet its cash requirements, including, but not limited to, paying interest on any debt, paying expenses related to its affairs, paying dividends on its common stock and any board of directors approved repurchase of its common stock pursuant to the board of director's approved plan, substantially depends upon dividends from its operating subsidiaries.
(1) Shareholders' equity includes common stock of JHFS at $0.01 par value per share, 2.0 billion shares authorized, 319.8 million and 317.5 million shares issued as of December 31, 2003 and 2002, respectively, and JHFS treasury stock at a cost of $1,069.0 million or 30.0 million shares, and $1,057.2 million or 29.5 million shares as of December 31, 2003 and 2002, respectively.
Note 18--Information Provided in Connection with Market Value Annuity of John Hancock Variable Life Insurance Company - (continued)
- ---------- (a) Prior year balances have been restated to reflect the reclassification of JHSS expense reimbursement from other operating costs and expenses to investment management revenues, commission and other fees. Reclassification was $6.5 million for the three months ended March 31, 2002, $3.4 million for the three months ended June 30, 2002, $4.5 million for the three months ended September 30, 2002 and $8.6 million for the three months ended December 31, 2002.