Management's Discussion and Analysis of Financial Position and Results of Operations Pruco Life Insurance Company meets the conditions set forth in General Instruction I(1)(a) and (b) on Form 10-K and is filing this form with reduced disclosure.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the consolidated financial condition of Pruco Life Insurance Company as of December 31, 2003, compared with December 31, 2002, and its consolidated results of operations for the years ended December 31, 2003 and 2002.
Besides policy charges and fee income, the Company also earns revenues from insurance premiums from term life insurance and asset management fees on the Separate Account fund balances. The Company's operating expenses principally consist of insurance benefits provided, general business expenses, commissions and other costs of selling and servicing the various products we sell and interest credited on general account liabilities.
o the ability to price our insurance products at a level that enables us to earn a margin over the cost of providing benefits and the expense of acquiring customers and administering those products;
o the amount of our assets under management and changes in their fair value, which affect the amount of asset management fees we receive; and
For example, expected profitability is a significant estimate in evaluating deferred acquisition costs related to annuity products. Expected profitability considers, among other assumptions, our best estimate of future asset returns to estimate the future fees we expect to earn, the costs associated with minimum death benefit guarantees we expect to incur and other profitability factors. For the average remaining life of our variable annuity contracts in force as of December 31, 2003, our evaluation of deferred policy acquisition costs is based on a 7.7% annual blended rate of return that reflects an assumed rate of return of 8.9% for equity type assets. Continuation of current market conditions or further deterioration in market conditions may result in increases in the amortization of deferred policy acquisition costs, while a significant improvement in market conditions may result in a decrease in the amortization of deferred policy acquisition costs. These changes in DAC balances are included as a component of "General, administrative and other expenses" in our statements of operations.
See "Results of Operations" for a discussion of the impact of DAC amortization on our results of our life and annuities products, including decreased amortization in 2003 and increased amortization recorded in 2002 reflecting higher estimates of future gross profits in 2003 and lower estimates of future gross profits in 2002.
From December 31, 2002 to December 31, 2003 there was an increase of $4,004 million in total assets from $21,211 million to $25,215 million. The largest increase was in Separate account assets, which increased by $3,076 million primarily from market value appreciation of $2,842 million as a result of recoveries in the equity markets. Positive net sales (sales less withdrawals) also contributed to the increase in Separate account assets. Fixed maturities increased by $796 million mainly as a result of investing general account policyholder deposits and positive cash flows from insurance operations into fixed maturities. Also contributing to the increase in the fixed maturity balance was unrealized appreciation and a reallocation of cash and shorter-term investments into fixed maturities. Deferred acquisition costs ("DAC") increased by $228 million, as capitalization of distribution expenses from new sales exceeded the amortization of DAC. Reinsurance recoverable is higher by $117 million due to increases in the Taiwan branch reinsurance recoverable and the Pruco Re reinsurance recoverable for term insurance. Other assets are higher by $47 million due to an increase in deferred expenses related to sales inducements for annuity products as the Company has sold more annuity contracts that contain these features. Cash and cash equivalents and short-term investments are lower by $236 million resulting from lower security lending activities and a higher investment into long-term fixed maturities as compared to shorter-term investments, as mentioned above.
During the year, liabilities increased by $3,911 million from $19,489 million to $23,400 million. Corresponding with the asset change, Separate account liabilities increased by $3,076 million, as described above. Policyholder account balances increased by $727 million due primarily to positive net sales of annuity products with fixed rate options and life general account products. Future policy benefits increased by $134 million due to increased reserves for the transferred Taiwan business and increases to life reserves as a result of sales and renewals of term insurance. Income taxes payable, which is a net number comprised of payables and receivables, increased by $90 million as a result of income tax expense and a tax refund received from Prudential Financial. In accordance with the tax sharing agreement with Prudential Financial, the Company was reimbursed for operating losses utilized in the consolidated federal tax return. There was a decrease in total securities lending activity of $97 million and a change in the mix between cash collateral for loaned securities and securities sold under agreements to repurchase, as there are less treasury securities in the portfolio. Treasury securities are commonly used for lending activities, especially in the securities sold under agreements to repurchase category.
Net Income Consolidated net income of $84.9 million for 2003 was an improvement of $71.4 million from the $13.5 million earned for 2002. DAC amortization in 2003 is $138.5 million lower than in 2002 due primarily to an additional charge of $117 million in the prior year and a benefit to net income of $15 million in the current year for our annuity products. Realized investment losses are lower by $65.3 million due to an improving credit environment in 2003. The current year continued to show increases to policyholder benefits, interest credited and general and administrative expenses (other than DAC amortization) offset partially by higher policy charges and fee income and premiums as a result of growth of the business. The increase in taxes for the year of $86.6 million is primarily related to the increase in income from operations before taxes, and a decrease in the dividends received deduction. Further details regarding the components of revenues and expenses are described in the following paragraphs.
Revenues Consolidated revenues increased by $131.8 million, from $950.8 million to $1,082.6 million. Realized investment losses decreased by $65.3 million as a result of an improving credit environment in 2003. Fixed maturity losses were lower by $57.6 million, derivative losses were lower by $5.1 million, and there
In addition to establishing a liability associated with the guaranteed minimum death benefit feature, SOP 03-01 requires a change in valuation and presentation of our liability associated with the market value adjustment ("MVA") feature contained in certain annuity contracts. The MVA feature requires the Company to pay to the contract holder upon surrender the accreted value of the fund as well as a market value adjustment based on the crediting rates on the contract surrendered compared to crediting rates on newly issued contracts. Currently, this liability is reflected at market value, which considers the effects of unrealized gains and losses in contract value resulting from changes in