PER SHARE DATA(3) Net income from continuing operations(4) - basic.............. $ 3.10 $ 2.54 $ 2.02 $ 2.09 $ 1.98 Net income - basic..................... $ 3.10 $ 2.54 $ 1.48 $ 2.33 $ 2.31 Average shares outstanding - basic..... 70,033,288 69,923,955 69,410,525 65,832,349 65,604,311 Net income from continuing operations(4) - diluted............ $ 3.07 $ 2.52 $ 2.01 $ 2.08 $ 1.96 Net income - diluted.................. $ 3.07 $ 2.52 $ 1.47 $ 2.32 $ 2.29 Average shares outstanding - diluted.............. 70,644,642 70,462,797 69,950,173 66,281,128 66,161,367 Cash dividends......................... $ .63 $ .59 $ .55 $ .51 $ .47 Share-owners' equity................... $ 29.02 $ 25.06 $ 20.42 $ 17.26 $ 13.41 ---------------------------------------------------------------------------------------------------------------------------
(1) Income from discontinued operations in 2001 includes loss on sale of discontinued operations and loss from discontinued operations, net of income tax. (2) Cumulative effect of change in accounting principle relating to SFAS No. 133, net of income tax. (3) Prior periods have been restated to reflect discontinued operations. (4) Net income excluding change in accounting principle and income (loss) from discontinued operations.
(5) Includes stable value contract account balances and annuity account balances which do not pose significant mortality risk.
Protective Life Corporation (the Company) is a holding company whose subsidiaries provide financial services through the production, distribution, and administration of insurance and investment products. The Company operates five business segments. An operating segment is generally distinguished by products and/or channels of distribution. The Company’s operating segments are Life Marketing, Acquisitions, Annuities, Stable Value Products, and Asset Protection. In addition, the Company has another segment referred to as the Corporate and Other segment.
The Asset Protection segment incurred a pretax operating loss of $12.8 million in 2003, compared to a loss of $23.4 million in 2002. Due to negative trends in used vehicle prices affecting the segment’s residual value product, the segment recorded charges totaling $28.4 million in 2003. This charge more than offset the improvements realized in the segment’s other lines of business.
Corporate and Other pretax operating income was $1.0 million in 2003 compared to $5.6 million in 2002. A $3.0 million increase in interest expense contributed to this decline.
The Company incurs significant costs in connection with acquiring new insurance business. These costs, which vary with and are primarily related to the production of new business and coinsurance of blocks of policies, are deferred. The recovery of such costs is dependent on the future profitability of the related policies. The amount of future profit is dependent principally on investment returns, mortality, morbidity, persistency, and expenses to administer the business and certain economic variables, such as inflation. These factors enter into management’s estimates of future profits which generally are used to amortize certain of such costs. Accounting for other intangible assets such as goodwill also requires an estimate of the future profitability of the associated lines of business. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future profits are less than the unamortized deferred amounts.
The Company has a deferred policy acquisition costs asset of approximately $99.7 million related to its variable annuity product line with an account balance of $2.2 billion at December 31, 2003. The Company monitors the rate of amortization of the deferred policy acquisition costs associated with its variable annuity product line. The methodologies employ varying assumptions about how much and how quickly the stock markets will appreciate. The primary assumptions used to project future profits as part of the analysis include: a long-term equity market growth rate of 9%, reversion to the mean methodology with a reversion to the mean cap rate of 14%, reversion to the mean period of 5 years, and an amortization period of 20 years. A recovery in equity markets, or methodologies and assumptions that anticipate a recovery, results in lower amounts of amortization, and a worsening of equity markets results in higher amounts of amortization.
The Company utilizes derivative transactions primarily in order to reduce its exposure to interest rate risk as well as currency exchange risk. Assessing the effectiveness of these hedging programs and evaluating the carrying values of the related derivatives often involve a variety of assumptions and estimates. The Company employs a variety of methods for determining the fair value of its derivative instruments. The fair values of interest rate swaps, interest rate swaptions, total return swaps and put or call options are based upon industry standard models which present-value the projected cash flows of the derivatives using current and implied future market conditions.
Premiums and policy fees were $810.3 million in 2002, an increase of $191.7 million, or 31.0% from the $618.7 million reported for 2001. During 2002, the Company discovered that it had overpaid the reinsurance premiums due on certain life insurance policies over a period of 10 years. The Company recorded cash and receivables totaling $69.7 million, and a corresponding increase in premiums and policy fees, which reflected its then current estimate of amounts to be recovered. Excluding this increase, premiums and policy fees in the Life Marketing segment increased $29.5 million due to an increase in sales. Premiums and policy fees in the Acquisitions segment are expected to decline with time (due to the lapsing of policies resulting from deaths of insureds or terminations of coverage) unless new acquisitions are made. In June 2002, the Company coinsured a block of insurance policies from Conseco Variable Insurance Company (Conseco). This transaction resulted in an increase in premiums and policy fees of $18.8 million. The acquisition of Inter-State and First Variable resulted in a $27.0 million increase in premiums and policy fees. Premiums and policy fees from older acquired blocks decreased $3.7 million. Premiums and policy fees from the Annuities segment declined $2.3 million due to a decline in variable annuity management fees caused by the general decline in the equity markets. Premiums and policy fees related to the Asset Protection segment increased $53.7 million due to continued higher sales in its service contracts and residual value lines. Lower sales in other Asset Protection lines during 2002 were more than offset by a decline in the amount of reinsurance ceded. The decline in reinsurance ceded was primarily due to a change in the form of a credit reinsurance agreement in 2002. Premiums and policy fees relating to various health insurance lines in the Corporate and Other segment decreased $0.9 million.
Net investment income in 2002 increased $142.8 million or 16.2% over 2001, and in 2003 increased $7.8 million or 0.8% over 2002, primarily due to increases in the average amount of invested assets. Invested assets have increased primarily due to acquisitions, receiving stable value and annuity deposits, and the asset growth that results from the sale of various insurance products. The Standard coinsurance transaction and the acquisition of Inter-State and First Variable resulted in an increase in investment income of $57.5 million in 2002. The Conseco coinsurance transaction resulted in an increase in investment income of $13.3 million in 2003. This increase was more than offset by $19.3 million decline in investment income from older acquisitions.
The Company generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs.
Year Ended Percentage December 31 Amount Increase (Decrease) ------------------------------------------------------------------------------ (in thousands) 2001 $120,647 (20.5)% 2002 100,196 (17.0) 2003 120,282 20.1 ------------------------------------------------------------------------------
Other income was $120.3 million in 2003, an increase of $20.1 million, or 20.1% from 2002. In 2003, revenues from the Company’s direct response businesses increased by $3.2 million. Other income in the service contract businesses increased $0.8 million. The sale of an inactive charter in 2003 resulted in a $6.9 million gain. Other income from the Consumer Direct line of business increased $2.2 million in 2003. Other income increased by $3.7 million due to the impact of exiting some non-core lines of business in the Asset Protection segment. Other income from all other sources increased $6.0 million.
Periodic settlements of interest rate swaps associated with corporate debt and certain investments included in realized investment gains and considered a part of operating income
The Life Marketing segment’s 2003 pretax operating income was $159.2 million, an increase of $33.6 million over 2002. During 2003, the Company received payment from substantially all of the affected reinsurance companies. As a result the Company increased premiums and policy fees by $18.4 million and amortization of deferred policy acquisition costs by $6.1 million, resulting in an increase in the Life Marketing segment’s pretax operating income of $12.3 million. The remaining increase is attributable to growth of business-in-force due to strong sales in 2002 and 2003 and favorable expense variances as compared to pricing allowances.
In 2002, the segment’s pretax operating income was $95.1 million, $27.1 million above 2001. The Conseco and Standard coinsurance transactions and the acquisition of Inter-State and First Variable resulted in a $24.7 million increase in earnings in 2002. Earnings on older acquired blocks of policies increased $2.4 million. In 2003, the segment’s pretax operating income was $95.2 million, $0.1 million above 2002. The Conseco transaction contributed a $9.1 million increase in earnings over 2002, and earnings from older acquired blocks of business decreased by $9.0 million.
The Annuities segment’s pretax operating income for 2002 was $15.7 million as compared to $16.9 million in 2001. Fixed annuity earnings increased $1.2 million due to higher account balances. This increase was more than offset by a decline in variable annuity earnings of $2.4 million due to the general decline in the equity markets. The segment’s 2003 pretax operating income was $13.4 million, a decrease of $2.3 million from 2002. The decrease is primarily attributable to spread compression and the inability to capitalize excess expenses due to lower sales of fixed annuities caused by lower interest rates in 2003. The segment had a $0.3 million realized investment gain (net of related amortization of deferred policy acquisition costs) in 2002 and a $3.8 million gain in 2003. As a result, total pretax income was $16.0 million in 2002 and $17.2 million in 2003.
The Stable Value Products segment’s 2002 pretax operating income was $42.3 million, $9.1 million above 2001. This increase is due primarily to higher average account balances and operating spreads. Average account balances were $3.9 billion in 2002 as compared to $3.5 billion in 2001. Operating spreads averaged 107 basis points in 2002 compared to an average of 90 basis points in 2001. The segment’s 2003 pretax operating income was $38.9 million, a decrease of $3.4 million from 2002. Average operating spreads were down to 96 basis points in 2003, causing the decrease in pretax operating income. The primary reason for the spread compression was a reduction in yield caused by the high level of prepayments in the mortgage-backed securities portfolio in 2003. The segments average quarterly account balances increased by $189.6 million in 2003 to $4.1 billion. The segment had realized investment losses in 2002 of $7.1 million compared to gains of $9.8 million in 2003. As a result, total income before income tax was $35.2 million in 2002 and $48.7 million in 2003.
The Company’s principal operating subsidiary, Protective Life Insurance Company (Protective Life) has registered a program with the Securities and Exchange Commission in which up to $3 billion of secured medium-term notes may be issued to the institutional market and InterNotes® may be issued to the retail market on a delayed (or shelf) basis. Each series of notes will be issued by a separate trust and will be secured by one or more funding agreements issued by Protective Life. Notes issued under the program will be accounted for in a manner consistent with the Company’s other stable value products (i.e., included in “stable value product account balances” in the Company’s balance sheet). The Company issued $450 million of notes under this program in the fourth quarter of 2003 to institutional investors.
In 2002, as a result of the negative trends the Asset Protection segment was experiencing, the Company performed claims experience studies and other analyses and determined that it should increase its estimates of policy liabilities and accruals and write off certain deferred policy acquisition costs and receivables which resulted in a pretax charge of $30.9 million. In 2003, the negative trends in used vehicle prices continued to negatively affect the segment, and the Company took a pretax charge of $28.4 million. Examples of the negative trends affecting the segment are lower used vehicle prices resulting from new vehicle sales incentives and an increase in residual value claims on automobiles. Claims experience studies are necessarily complex and involve analyzing and interpreting large quantities of data to deduce whether the trends appear to be temporary and likely to reverse, or not. Any adverse development in the trends of used vehicle prices or in service contract claims could have a material adverse effect on the Company.
The Asset Protection segment had a pretax operating loss of $23.4 million in 2002, $57.4 million lower than the pretax operating income of $34.0 in 2001. The decrease included the $30.9 million charge discussed above. The segment also experienced lower service contract administration fees of $2.8 million and lower earned credit premiums that reduced income $5.8 million. Higher loss ratios in the vehicle service contract line lowered earnings $2.8 million. Also, higher loss ratios in the segment’s ancillary lines led to higher losses of $6.1 million in 2002. Included in the segment’s pretax loss for 2002 was $2.7 million of income related to the sale of the inactive charter of a small subsidiary compared to $2.0 million for a charter sale in 2001. In addition, 2001 operating income included a change in estimate of $6.7 million related to reserves in certain credit lines. All other items decreased 2002 operating income by $3.0 million.
The Corporate and Other segment consists primarily of net investment income on unallocated capital, interest expense on substantially all debt, several lines of business that the Company is not actively marketing (mostly health insurance), earnings from various investment-related transactions, and the operations of several small subsidiaries (including a subsidiary that markets discount plans). In 2002, the segment had pretax operating income of $5.6 million, $16.5 million higher than 2001. The increase primarily relates to a $12.8 million increase in net settlements on derivatives relating to corporate debt and investments in 2002 as compared to 2001, a $10.9 million increase in investment income allocated to the segment, and $0.6 million lower corporate expenses, which was partially offset by a $1.3 million increase in interest expense, a $2.2 million charge for the early extinguishment of debt, and $4.3 million less income from the cancer line of business.
Year Ended Effective Income December31 Tax Rates -------------------------------------------- 2001 32.7% 2002 33.1 2003 33.3 --------------------------------------------
Management’s current estimate of the effective income tax rate for 2004 is approximately 34.0%. The expected increase is primarily due to the expiration of certain tax credits.
On December 31, 2001, the Company completed the sale to Fortis, Inc. of substantially all of its Dental Benefits Division (Dental Division) and discontinued certain other remaining Dental Division related operations, primarily other health insurance lines. In 2001, the loss from discontinued operations was $10.0 million (primarily due to the non-performance of reinsurers) and the loss from sale of discontinued operations was $20.5 million, both net of income tax.
Life and health insurance is a mature industry. In recent years, the industry has experienced little growth in life insurance sales, though the aging population has increased the demand for retirement savings products. Life and health insurance is a highly competitive industry. The Company encounters significant competition in all lines of business from other insurance companies, many of which have greater financial resources than the Company, as well as competition from other providers of financial services. Competition could result in, among other things, lower sales or higher lapses of existing products.
Rating organizations assign ratings based upon several factors. While most of the factors relate to the rated company, some of the factors relate to the views of the rating organization, general economic conditions and circumstances outside the rated company’s control. In addition, rating organizations use various models and formulas to assess the strength of a rated company, and from time to time rating organizations have, in their discretion, altered the models. Changes to the models could impact the rating organizations’ judgment of the rating to be assigned to the rated company. The Company cannot predict what actions the rating organizations may take, or what actions the Company may be required to take in response to the actions of the rating organizations, which could adversely affect the Company.
The use of reinsurance introduces variability in the Company’s statements of income.
From time to time, the Company has participated in securities repurchase transactions that have contributed to the Company’s investment income. Such transactions involve some degree of risk that the counterparty may fail to perform its obligations to pay amounts owed and the collateral has insufficient value to satisfy the obligation. No assurance can be given that such transactions will continue to be entered into and contribute to the Company’s investment income in the future.
The Company and its subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with many aspects of the Company’s business, which may include premium rates, marketing practices, advertising, privacy, policy forms, and capital adequacy, and is concerned primarily with the protection of policyholders and other customers rather than share owners. At any given time, a number of financial and/or market conduct examinations of the Company’s subsidiaries is ongoing. The Company is required to obtain state regulatory approval for rate increases for certain health insurance products, and the Company’s profits may be adversely affected if the requested rate increases are not approved in full by regulators in a timely fashion. From time to time, regulators raise issues during examinations or audits of the Company’s subsidiaries that could, if determined adversely, have a material impact on the Company. The Company cannot predict whether or when regulatory actions may be taken that could adversely affect the Company or its operations. In addition, the interpretations of regulations by regulators may change and statutes may be enacted with retroactive impact, particularly in areas such as health insurance.
Other types of regulation that could affect the Company and its subsidiaries include insurance company investment laws and regulations, state statutory accounting practices, state anti-trust laws, minimum solvency requirements, state securities laws, federal privacy laws, federal money laundering and anti-terrorism laws, and because the Company owns and operates real property state, federal, and local environmental laws. The Company cannot predict what form any future changes in these or other areas of regulation affecting the insurance industry might take or what effect, if any, such proposals might have on the Company if enacted into law.
The Company’s acquisitions have increased its earnings in part by allowing the Company to enter new markets and to position itself to realize certain operating efficiencies. There can be no assurance, however, that suitable acquisitions, presenting opportunities for continued growth and operating efficiencies, or capital to fund acquisitions will continue to be available to the Company, or that the Company will realize the anticipated financial results from its acquisitions.
The Company’s results may be affected by the performance of others because the Company has entered into various arrangements involving other parties. For example, most of the Company’s products are sold through independent distribution channels, and variable annuity deposits are invested in funds managed by third parties. Additionally, the Company’s operations are dependent on various technologies, some of which are provided and/or maintained by other parties.
Recently, certain commentators on the insurance industry have speculated that reinsurance might become more costly or less available in the future, which could have a negative effect on the Company’s ability to compete. In recent years, the number of life reinsurers has decreased as the reinsurance industry has consolidated. The decreased number of participants in the life reinsurance market results in increased concentration risk for insurers, including the Company. In addition, some reinsurers have indicated an unwillingness to continue to reinsure new sales of long-term guarantee products. If the reinsurance markets for these products further contracts, the Company’s ability to continue to offer such products would be adversely impacted.
Computer viruses or network security breaches could affect the data processing systems of the Company or its business partners.
The Company’s ability to grow depends in large part upon the continued availability of capital.
The Company has recently deployed significant amounts of capital to support its sales and acquisitions efforts. Capital has also been consumed as the Company increased its reserves on the residual value product. Although positive performance in the equity markets has recently allowed the Company to decrease its GMDB related policy liabilities and accruals, deterioration in these markets could lead to further capital consumption. Although the Company believes it has sufficient capital to fund its immediate growth and capital needs, the amount of capital available can vary significantly from period to period due to a variety of circumstances, some of which are neither predictable nor foreseeable, nor within the Company’s control. A lack of sufficient capital could impair the Company’s ability to grow.
Like all publicly traded companies, the Company is required to comply with accounting principles generally accepted in the United States of America (GAAP). A number of organizations are instrumental in the development of GAAP such as the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), and the American Institute of Certified Public Accountants (AICPA). GAAP is subject to constant review by these organizations and others in an effort to address emerging issues and otherwise improve financial reporting. In this regard, these organizations adopt new accounting rules and issue interpretive accounting guidance on a continual basis. The Company can give no assurance that future changes to GAAP will not have a negative impact on the Company’s reported financial results.
On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133, as amended by SFAS Nos. 137, 138, and 149, requires the Company to record all derivative financial instruments, at fair value on the balance sheet. Changes in fair value of a derivative instrument are reported in net income or other comprehensive income, depending on the designated use of the derivative instrument. The adoption of SFAS No. 133 resulted in a cumulative charge to net income, net of income tax, of $7.6 million ($0.11 per share on both a basic and diluted basis) and a cumulative after-tax increase to other comprehensive income of $4.0 million on January 1, 2001. The charge to net income and increase to other comprehensive income primarily resulted from the recognition of derivative instruments embedded in the Company’s corporate bond portfolio. In addition, the charge to net income includes the recognition of the ineffectiveness on existing hedging relationships including the difference in spot and forward exchange rates related to foreign currency swaps used as an economic hedge of foreign-currency-denominated stable value contracts. The adoption of SFAS No. 133 has introduced volatility into the Company’s reported net income and other comprehensive income depending on market conditions and the Company’s hedging activities.
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” effective January 1, 2002. SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. The Company performed an impairment test and determined that its goodwill was not impaired at October 31, 2003 and 2002. The following table illustrates adjusted income from continuing operations before cumulative effect of change in accounting principle as if this pronouncement was adopted as of January 1, 2001:
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 46, “Consolidation of Variable Interest Entities,” which was revised in December 2003. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. The effective date of FIN 46 is March 31, 2004, for the Company. However, FIN 46 shall be applied to entities that are considered special-purpose entities no later than as of the end of the first reporting period that ends after December 15, 2003 (December 31, 2003, for the Company). As such, the Company consolidated, as of December 31, 2003, a special-purpose entity whose investments are managed by the Company. The special-purpose entity was consolidated based on the determination that the Company was its primary beneficiary. The consolidation resulted in the Company’s reported assets and liabilities increasing by $430.6 million with an immaterial impact on the results of operations. The increase in assets was the result of the entity’s $430.6 million investment portfolio, while the increase in liabilities was due to $400.0 million of notes payable (reported in “liabilities related to variable interest entities”), $15.0 million of derivative liabilities (reported in “other liabilities”), and $15.6 million of minority interest (reported in “other liabilities”). Additionally, the Company deconsolidated, as of December 31, 2003, the special-purpose entities PLC Capital Trust III and PLC Capital Trust IV after determining the Company was not the primary beneficiary of these special-purpose entities. The deconsolidation resulted in a $6.6 million increase to “investments” and “subordinate debt securities”. The Company is currently evaluating the impact of FIN 46 on entities not considered to be special-purpose entities, which would be required to be consolidated as of March 31, 2004. Although the Company does not expect the implementation of the provisions of FIN 46, on March 31, 2004, to have a material impact on its results of operations, had the provisions been effective at December 31, 2003, the Company’s reported assets and liabilities would have increased by approximately $109 million.
On October 1, 2003, the Company adopted the 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” (DIG B36). DIG B36 requires the bifurcation of embedded derivatives within certain modified coinsurance and funds withheld coinsurance arrangements that expose the creditor to credit risk of a company other than the debtor, even if the debtor owns as investment assets the third-party securities to which the creditor is exposed. The adoption did not have a material impact on the Company’s financial condition or results of operations.
The Company’s investments in debt and equity securities are reported at market value, and investments in mortgage loans are reported at amortized cost. At December 31, 2003, the Company’s fixed maturity investments (bonds and redeemable preferred stocks) had a market value of $13.4 billion, which is 4.8% above amortized cost of $12.7 billion. The Company had $2.7 billion in mortgage loans at December 31, 2003. While the Company’s mortgage loans do not have quoted market values, at December 31, 2003, the Company estimates the market value of its mortgage loans to be $3.0 billion (using discounted cash flows from the next call date), which is 8.2% above amortized cost. Most of the Company’s mortgage loans have significant prepayment fees. These assets are invested for terms approximately corresponding to anticipated future benefit payments. Thus, market fluctuations are not expected to adversely affect liquidity.
The following table shows the carrying values of the Company’s invested assets.
Percent of S&P or Equivalent Designation Market Value Market Value -------------------------------------------------------------------------------------- (in thousands) AAA $ 4,717,638 36.5% AA 775,458 6.0 A 2,980,376 23.0 BBB 3,474,563 26.9 -------------------------------------------------------------------------------------- Investment grade 11,948,035 92.4 -------------------------------------------------------------------------------------- BB 665,565 5.2 B 300,974 2.3 CCC or lower 13,344 0.1 In or near default 4,697 0.0 -------------------------------------------------------------------------------------- Below investment grade 984,580 7.6 -------------------------------------------------------------------------------------- Redeemable preferred stock 3,164 0.0 -------------------------------------------------------------------------------------- Total $12,935,779 100.0% --------------------------------------------------------------------------------------
Market values for private, non-traded securities are determined as follows: 1) the Company obtains estimates from independent pricing services or 2) the Company estimates market value based upon a comparison to quoted issues of the same issuer or issues of other issuers with similar terms and risk characteristics. The market value of private, non-traded securities was $1,975.3 million at December 31, 2003, representing 11.3% of the Company’s total invested assets.
The Company has no material concentrations of issuers or guarantors of fixed maturity securities. The industry segment composition of all securities in an unrealized loss position held by the Company at December 31, 2003, is presented in the following table.
Estimated % Market Amortized % Amortized Unrealized % Unrealized Market Value Value Cost Cost Loss Loss ------------------------------------------------------------------------------------------------------------------------ (in thousands) Agency mortgages $ 125,623 5.9% $ 130,607 5.9% $ (4,984) 6.1% Banks 176,174 8.3 178,656 8.1 (2,482) 3.0 Basic industrial 33,760 1.6 35,542 1.6 (1,782) 2.2 Brokerage 52,968 2.5 53,951 2.4 (983) 1.2 Capital goods 511 0.0 517 0.0 (6) 0.0 Communications 105,841 5.0 109,866 5.0 (4,025) 4.9 Consumer-cyclical 45,533 2.1 46,259 2.1 (726) 0.9 Consumer-noncyclical 67,854 3.2 70,120 3.2 (2,266) 2.8 Electric 397,666 18.7 412,023 18.7 (14,357) 17.4 Energy 114,662 5.4 117,935 5.3 (3,273) 4.0 Insurance 68,143 3.2 71,085 3.2 (2,942) 3.6 Municipal agencies 488 0.0 489 0.0 (1) 0.0 Natural gas 151,207 7.1 156,227 7.1 (5,020) 6.1 Non-agency mortgages 563,655 26.6 586,001 26.7 (22,346) 27.1 Other finance 74,585 3.5 82,252 3.7 (7,667) 9.3 Other industrial 7,343 0.3 7,395 0.3 (52) 0.1 Other utility 21 0.0 44 0.0 (23) 0.0 Technology 24,849 1.2 25,063 1.1 (214) 0.3 Transportation 97,393 4.7 106,415 4.9 (9,022) 10.9 U.S. Government 15,765 0.7 15,884 0.7 (119) 0.1 ------------------------------------------------------------------------------------------------------------------------ Total $2,124,041 100.0% $2,206,331 100.0% $(82,290) 100.0% ------------------------------------------------------------------------------------------------------------------------
At December 31, 2003, 88.3% of total securities in an unrealized loss position were rated as investment grade. Bonds rated less than investment grade were 5.7% of invested assets. The Company generally purchases its investments with the intent to hold to maturity. The Company does not consider these unrealized losses as other-than-temporary impairments.
At December 31, 2003, securities in an unrealized loss position that were rated as below investment grade represented 11.7% of the total market value and 39.2% of the total unrealized loss. Unrealized losses related to below investment grade securities that had been in an unrealized loss position for more than twelve months were $28.9 million. Bonds in an unrealized loss position rated less than investment grade were 1.4% of invested assets. The Company does not expect these investments to adversely affect its liquidity or ability to maintain proper matching of assets and liabilities.
The following table shows the estimated market value, amortized cost, unrealized loss and total time period that the security has been in an unrealized loss position for all below investment grade securities.
Estimated % Market Amortized % Amortized Unrealized % Unrealized Market Value Value Cost Cost Loss Loss -------------------------------------------------------------------------------------------------------------------- (in thousands) = 90 days $ 25,138 10.1% $ 25,959 9.3% $ (821) 2.5% 90 days but = 180 days 34,423 13.9 35,497 12.7 (1,074) 3.3 180 days but = 270 days 40,369 16.3 41,363 14.8 (994) 3.1 270 days but = 1 year 14,111 5.7 14,567 5.2 (456) 1.4 1 year but = 2 years 34,399 13.9 38,085 13.6 (3,686) 11.4 2 years but = 3 years 29,901 12.1 32,746 11.7 (2,845) 8.8 3 years but = 4 years 1,919 0.8 2,044 0.7 (125) 0.4 4 years but = 5 years 26,182 10.6 30,335 10.8 (4,153) 12.9 5 years 41,319 16.6 59,458 21.2 (18,139) 56.2 -------------------------------------------------------------------------------------------------------------------- Total $247,761 100.0% $280,054 100.0% $(32,293) 100.0% --------------------------------------------------------------------------------------------------------------------
At December 31, 2003, delinquent mortgage loans and foreclosed properties were 0.1% of invested assets. The Company does not expect these investments to adversely affect its liquidity or ability to maintain proper matching of assets and liabilities.
In the ordinary course of its commercial mortgage lending operations, the Company will commit to provide a mortgage loan before the property to be mortgaged has been built or acquired. The mortgage loan commitment is a contractual obligation to fund a mortgage loan when called upon by the borrower. The commitment is not recognized in the Company’s financial statements until the commitment is actually funded. The mortgage loan commitment contains terms, including the rate of interest, which may be less than prevailing interest rates.
At December 31, 2003, the Company had outstanding mortgage loan commitments of $578.5 million with an estimated fair value of $595.7 million (using discounted cash flows from the first call date). At December 31, 2002, the Company had outstanding commitments of $455.7 million with an estimated fair value of $494.1 million. The following table sets forth the estimated fair value of the Company’s mortgage loan commitments resulting from a hypothetical immediate 1 percentage point increase in interest rate levels prevailing at December 31, and the percent change in fair value the following estimated fair values would represent.
At December 31 Amount Percent Change --------------------------------------------------------------------------------- (in millions) Stable value product account balances $4,198.4 1.8% Annuity account balances 3,920.0 4.5 Stable value product account balances $4,817.2 1.7% Annuity account balances 3,642.0 4.8 ---------------------------------------------------------------------------------
The Company uses a risk management strategy that incorporates the use of derivative financial instruments, primarily to reduce its exposure to interest rate risk as well as currency exchange risk.
At December 31, 2003, contracts with a notional amount of $3.6 billion were in a $152.4 million net gain position. At December 31, 2002, contracts with a notional amount of $7.1 billion were in a $89.9 million net gain position. The Company recognized $12.6 million and $28.3 million of realized investment gains related to derivative financial instruments in 2003 and 2002, respectively, while it recognized $1.1 million of realized investment losses related to derivative financial instruments in 2001.
Fair Value Resulting From an Immediate +/-1% Change in Notional Fair Value at Interest Rates Amount December 31 +1% -1% ------------------------------------------------------------------------------------------- (in millions) Options Puts $4,000.0 $ 1.2 $ 2.5 $ 0.0 Futures 570.0 (11.9) 8.3 (30.9) Fixed to floating Swaps 1,550.5 44.2 12.1 77.8 Swaptions 25.0 (0.1) (1.6) 0.3 Floating to fixed Swaps 385.0 (19.0) (13.5) (24.6) ------------------------------------------------------------------------------------------- $6,530.5 $ 14.4 $ 7.8 $ 22.6 ------------------------------------------------------------------------------------------- Options Puts $1,300.0 $ 0.5 $ 1.2 $ 0.0 Fixed to floating Swaps 593.7 30.2 5.9 54.4 Floating to fixed Swaps 460.1 (31.9) (24.7) (38.0) Floating to floating Swaps 800.0 0.0 0.0 0.0 ------------------------------------------------------------------------------------------- $3,153.8 $ (1.2) $ (17.6) $ 16.4 -------------------------------------------------------------------------------------------
The Company is also subject to foreign exchange risk arising from stable value contracts denominated in foreign currencies and related foreign currency swaps. At December 31, 2003, stable value contracts of $416.1 million had a foreign exchange loss of approximately $151.8 million and the related foreign currency swaps had a net unrealized gain of approximately $154.4 million. At December 31, 2002, stable value contracts of $539.2 million had a foreign exchange loss of approximately $86.5 million and the related foreign currency swaps had a net unrealized gain of approximately $78.4 million.
Fair Value Resulting From an Immediate +/-10% Change in Fair Value at Foreign Currency Exchange Rates Notional Amount December 31 +10% -10% --------------------------------------------------------------------------------------------------- (in millions) Stable Value Contracts $ 539.2 $ (86.5) $(149.1) $(24.0) Foreign Currency Swaps 539.2 78.4 124.5 32.3 --------------------------------------------------------------------------------------------------- $1,078.4 $ (8.1) $ (24.6) $ 8.3 --------------------------------------------------------------------------------------------------- Stable Value Contracts $ 416.1 $(151.8) $(208.6) $(95.0) Foreign Currency Swaps 416.1 154.4 180.6 128.2 --------------------------------------------------------------------------------------------------- $ 832.2 $ 2.6 $ (28.0) $ 33.2 ---------------------------------------------------------------------------------------------------
The Company’s asset/liability management programs and procedures involve the monitoring of asset and liability durations for various product lines; cash flow testing under various interest rate scenarios; and the continuous rebalancing of assets and liabilities with respect to yield, risk, and cash flow characteristics. It is the Company’s policy to generally maintain asset and liability durations within one-half year of one another, although, from time to time, a broader interval may be allowed.
The life insurance subsidiaries were committed at December 31, 2003, to fund mortgage loans in the amount of $578.5 million. The Company’s subsidiaries held $655.0 million in cash and short-term investments at December 31, 2003. Protective Life Corporation had an additional $1.1 million in cash and short-term investments available for general corporate purposes.
Protective Life Corporation’s cash flow is dependent on cash dividends and payments on surplus notes from its subsidiaries; revenues from investment, data processing, legal and management services rendered to subsidiaries; and investment income. At December 31, 2003, approximately $529.8 million of consolidated share-owners’ equity, excluding net unrealized investment gains and losses, represented net assets of the Company’s insurance subsidiaries that cannot be transferred to Protective Life Corporation. In addition, the states in which the Company’s insurance subsidiaries are domiciled impose certain restrictions on the insurance subsidiaries’ ability to pay dividends to Protective Life Corporation.
The Company plans to retain substantial portions of the earnings of its insurance subsidiaries in those companies primarily to support their future growth. Protective Life Corporation’s cash disbursements have, from time to time, exceeded its cash receipts, and these shortfalls have been funded through various external financings. Therefore, Protective Life Corporation may, from time to time, require additional external financing.
To give the Company flexibility in connection with future acquisitions and other growth opportunities, the Company has registered debt securities, preferred and common stock, and stock purchase contracts of Protective Life Corporation, and additional preferred securities of special purpose finance subsidiaries under the Securities Act of 1933 on a delayed (or shelf) basis.
In February 2001, the Company issued 3.9 million shares of its Common Stock under stock purchase contracts relating to its 6.5% FELINE PRIDES. In the transaction, substantially all of the preferred securities comprising part of the FELINE PRIDES and the underlying subordinated debt were redeemed.
In February 2001, the Company issued $100 million of Floating Rate Senior Notes. The proceeds were used to invest in the Company’s insurance subsidiaries - which included completing the funding of the Standard transaction - and for general corporate purposes. The Floating Rate Notes, as scheduled, were redeemed in 2003.
PLC Capital Trust III was formed solely to issue securities and use the proceeds thereof to purchase subordinated debentures of the Company. The sole assets of PLC Capital Trust III are $103.1 million of Protective Life Corporation 7.5% Subordinated Debentures due 2031, Series D. The proceeds of the Company’s subordinated debentures were used to repay outstanding bank indebtedness and the balance was used for general corporate purposes. The Company has the right under the subordinated debentures to extend interest payment periods up to five consecutive years, and, as a consequence, dividends on the 7.5% TOPrS may be deferred (but will continue to accumulate, together with additional dividends on any accumulated but unpaid dividends at the dividend rate) by PLC Capital Trust III during any such extended interest payment period. The 7.5% TOPrS are redeemable by PLC Capital Trust III at any time on or after August 22, 2006.
In May 2003, the Company issued $250 million of 4.3% Senior Notes which are due June 1, 2013. The proceeds from the issuance were used to pay off $150 million of bank borrowings on the Company’s revolving line of credit, and to redeem $50 million of 8.0% Senior Notes due in 2010 and $40 million of 8.1% Senior Notes due in 2015. The Company recorded a $1.6 million charge related to the early extinguishment of debt. The charge was comprised primarily of the write-off of deferred debt issue costs.
On January 27, 2004, a special purpose finance subsidiary of the Company, PLC Capital Trust V, issued $100 million of 6.125% TOPrS. The 6.125% TOPrS are guaranteed on a subordinated basis by the Company. This guarantee, considered together with the other obligations of the Company with respect to the 6.125% TOPrS, constitutes a full and unconditional guarantee by the Company of PLC Capital Trust V’s obligations with respect to the 6.125% TOPrS.
The majority of the proceeds of the 6.125% TOPrS was used to pay down outstanding bank debt, $59.9 million of which was issued to redeem the Company’s outstanding 7.50% 15-year Senior Notes on January 1, 2004. In addition, the Company repaid the $25 million outstanding as of December 31, 2003, on its $200 million line of credit. The balance of the proceeds will be used for general corporate purposes, affording the Company additional financial flexibility in the future.
The table below sets forth future maturities of long-term debt, guaranteed preferred beneficial interests in the Company’s subordinated debt securities, stable value products, notes payable, operating lease obligation, mortgage loan commitments, and liabilities related to variable interest entities.
The table above excludes liabilities related to separate accounts of $2,220.8 million. Separate account liabilities represent funds maintained for contract holders who bear the related investment risk. These liabilities are supported by assets that are legally segregated and are not subject to claims that arise from other business activities of the Company. These assets and liabilities are separately identified on the consolidated balance sheets of the Company. The table also excludes future cash flows related to certain insurance liabilities due to the uncertainty with respect to the timing of the cash flows.
Page Consolidated Statements of Income for the years ended December 31, 2003, 2002, and 2001............................................................... Consolidated Balance Sheets as of December 31, 2003 and 2002 ........................................................................................ Consolidated Statements of Share-Owners' Equity for the years ended December 31, 2003, 2002, and 2001................................................. Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001................................................. Notes to Consolidated Financial Statements................................................................ Report of Independent Auditors............................................................................
Year Ended December 31 --------------------------------------------- 2003 2002 2001 ---------------------------------------------------------------------------------------------------------------------------- (dollars in thousands, except per share amounts) Revenues Premiums and policy fees $1,670,312 $1,561,717 $1,389,820 Reinsurance ceded (934,435) (751,396) (771,151) ---------------------------------------------------------------------------------------------------------------------------- Net of reinsurance ceded 735,877 810,321 618,669 Net investment income 1,030,752 1,022,953 880,141 Realized investment gains (losses) Derivative financial instruments 12,550 28,308 (1,114) All other investments 58,064 910 (8,740) Other income 120,282 100,196 120,647 ---------------------------------------------------------------------------------------------------------------------------- Total revenues 1,957,525 1,962,688 1,609,603 ---------------------------------------------------------------------------------------------------------------------------- Benefits and expenses Benefits and settlement expenses (net of reinsurance ceded: 2003 - $932,164; 2002 - $712,866; 2001 - $609,996) 1,151,574 1,167,085 972,624 Amortization of deferred policy acquisition costs 225,107 267,662 147,058 Amortization of goodwill 0 0 3,555 Other operating expenses (net of reinsurance ceded: 2003 - $144,921; 2002 - $176,871; 2001 - $167,243) 255,432 262,898 276,770 ---------------------------------------------------------------------------------------------------------------------------- Total benefits and expenses 1,632,113 1,697,645 1,400,007 ---------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before income tax 325,412 265,043 209,596 ---------------------------------------------------------------------------------------------------------------------------- Income tax expense Current 30,451 51,247 64,667 Deferred 77,911 36,441 3,871 ---------------------------------------------------------------------------------------------------------------------------- Total income tax expense 108,362 87,688 68,538 ---------------------------------------------------------------------------------------------------------------------------- Net income from continuing operations before 217,050 177,355 141,058 cumulative effect of change in accounting principle Loss from discontinued operations, net of income tax 0 0 (9,977) Loss from sale of discontinued operations, net of income tax 0 0 (20,545) ---------------------------------------------------------------------------------------------------------------------------- Net income before cumulative effect of change 217,050 177,355 110,536 in accounting principle Cumulative effect of change in accounting principle, net of income tax 0 0 (7,593) ---------------------------------------------------------------------------------------------------------------------------- Net income $ 217,050 $ 177,355 $ 102,943 ============================================================================================================================ Net income from continuing operations before cumulative effect of $ 3.10 $ 2.54 $ 2.02 change in accounting principle per share - basic Net income per share - basic $ 3.10 $ 2.54 $ 1.48 Net income from continuing operations before cumulative effect of change in accounting principle per share - diluted $ 3.07 $ 2.52 $ 2.01 Net income per share - diluted $ 3.07 $ 2.52 $ 1.47 Cash dividends paid per share $ .63 $ .59 $ .55 ----------------------------------------------------------------------------------------------------------------------------
December 31 ---------------------------------------- 2003 2002 --------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Liabilities Policy liabilities and accruals Future policy benefits and claims $ 8,948,131 $ 8,248,182 Unearned premiums 784,566 875,956 --------------------------------------------------------------------------------------------------------------------- Total policy liabilities and accruals 9,732,697 9,124,138 Stable value product account balances 4,676,531 4,018,552 Annuity account balances 3,480,577 3,697,495 Other policyholders' funds 158,875 174,140 Other liabilities 875,652 698,677 Accrued income taxes (34,261) 3,186 Deferred income taxes 377,990 242,593 Liabilities related to variable interest entities 400,000 0 Long-term debt 461,329 406,110 Subordinated debt securities 221,650 215,000 Liabilities related to separate accounts Variable annuity 2,045,038 1,513,824 Variable universal life 171,408 114,364 Other 4,361 4,330 --------------------------------------------------------------------------------------------------------------------- Total liabilities 22,571,847 20,212,409 --------------------------------------------------------------------------------------------------------------------- Commitments and contingent liabilities - Note 6 --------------------------------------------------------------------------------------------------------------------- Share-owners' equity Preferred Stock, $1 par value Shares authorized: 3,600,000 Issued: none Junior Participating Cumulative Preferred Stock, $1 par value Shares authorized: 400,000 Issued: none Common Stock, $.50 par value Shares authorized: 2003 and 2002 - 160,000,000 Issued: 2003 and 2002 - 73,251,960 36,626 36,626 Additional paid-in capital 418,351 408,397 Treasury stock, at cost (2003 - 4,260,259 shares; 2002 - 4,576,066 shares) (15,275) (16,402) Stock held in trust (2003 - 97,700 shares; 2002 - 79,632 shares) (2,788) (2,417) Unallocated stock in Employee Stock Ownership Plan (2003 - 724,068 shares; 2002 - 838,401 shares) (2,367) (2,777) Retained earnings 1,235,012 1,061,361 Accumulated other comprehensive income Net unrealized gains on investments (net of income tax: 2003 - $177,642; 2002 - $128,145) 329,907 237,983 Accumulated gain (loss) - hedging (net of income tax: 2003 - $1,442; 2002 - $(1,114)) 2,678 (2,069) --------------------------------------------------------------------------------------------------------------------- Total share-owners' equity 2,002,144 1,720,702 --------------------------------------------------------------------------------------------------------------------- $24,573,991 $21,933,111 =====================================================================================================================
Balance, December 31, 2000 $34,667 $289,819 $(12,812) $(1,318) $(3,686) $858,761 $(51,373) $ 0 $1,114,058 ---------- Net income for 2001 102,943 102,943 Change in net unrealized gains/ losses on innvestments (net of income tax - $51,729) 96,069 96,069 Reclassification adjustment for amounts included in net income (net of income tax - $3,059) 5,681 5,681 Transition adjustment on derivative financial instruments (net of income tax - $2,127) 3,951 3,951 ---------- Comprehensive income for 2001 208,644 ---------- Cash dividends ($0.55 per share) (37,187) (37,187) Redemption of FELINE PRIDES 1,959 111,455 113,414 Purchase of common stock (217) (217) Purchase of treasury stock (3,405) (3,405) Stock-based compensation 3,349 240 3,589 Reissuance of treasury stock to ESOP 797 82 (879) 0 Allocation of stock to employee accounts 1,248 1,248 --------------------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001 36,626 405,420 (15,895) (1,535) (3,317) 924,517 54,328 0 1,400,144 ---------- Net income for 2002 177,355 177,355 Change in net unrealized gains/losses on investments (net of income tax -$99,209) 184,246 184,246 Reclassification adjustment for amounts included in net income (net of income tax - $(318)) (591) (591) Change in accumulated gain (loss) hedging (net of income tax - $(1,114)) (2,069) (2,069) ---------- Comprehensive income for 2002 358,941 ---------- Cash dividends ($0.59 per share) (40,511) (40,511) Purchase of common stock (882) (882) Purchase of treasury stock (828) (828) Stock-based compensation 2,928 311 3,239 Reissuance of treasury stock to ESOP 49 10 (59) 0 Allocation of stock to employee accounts 599 599 --------------------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002 36,626 408,397 (16,402) (2,417) (2,777) 1,061,361 237,983 (2,069) 1,720,702 ---------- Net income for 2003 217,050 217,050 Change in net unrealized gains/losses on investments (net of income tax -$69,820) 129,666 129,666 Reclassification adjustment for amounts included in net income (net of income tax - $(20,322)) (37,742) (37,742) Change in accumulated gain (loss) hedging (net of income tax - $(2,556)) 4,747 4,747 ---------- Comprehensive income for 2003 313,721 ---------- Cash dividends ($0.63 per share) (43,399) (43,399) Purchase of common stock (371) (371) Purchase of treasury stock 0 Stock-based compensation 9,195 1,009 10,204 Reissuance of treasury stock to ESOP 759 118 (877) 0 Allocation of stock to employee accounts 1,287 1,287 --------------------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003 - Note 7 $36,626 $418,351 $(15,275) $(2,788) $(2,367) $1,235,012 $329,907 $2,678 $2,002,144 ---------------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31 ---------------------------------------------------- 2003 2002 2001 --------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Cash flows from operating activities Net income $ 217,050 $ 177,355 $ 102,943 Adjustments to reconcile net income to net cash provided by operating activities: Realized investment (gains) losses (58,064) (910) 8,740 Amortization of deferred policy acquisition costs 225,107 239,490 154,384 Capitalization of deferred policy acquisition costs (381,120) (435,324) (317,627) Depreciation expense 12,302 11,015 12,110 Deferred income taxes 77,911 36,441 6,856 Accrued income taxes (37,447) (57,711) 98,476 Amortization of goodwill 0 0 9,056 Loss from sale of discontinued operations 0 0 20,545 Interest credited to universal life and investment products 647,695 900,930 944,098 Policy fees assessed on universal life and investment products (324,773) (268,191) (222,415) Change in accrued investment income and other receivables 18,885 (272,362) (241,517) Change in policy liabilities and other policyholders'funds of traditional life and health products 500,871 528,122 442,193 Change in other liabilities (187,892) 98,504 157,529 Other, net 74,994 (55,214) 5,930 --------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 785,519 902,145 1,181,301 --------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities Investments available for sale, net of short-term investments: Maturities and principal reductions of investments 4,618,380 3,624,740 1,984,515 Sale of investments 7,539,941 15,272,346 7,698,056 Cost of investments acquired (13,173,599) (20,014,231) (10,903,478) Increase in mortgage loans, net (215,570) (5,308) (244,620) Decrease (increase) in investment real estate, net 2,585 5,638 (13,783) Decrease (increase) in policy loans, net 40,413 (21,320) (291,314) Increase in other long-term investments, net (26,760) (117,866) (38,162) Decrease (increase) in short-term investments, net 258,442 (211,244) (47,994) Acquisitions and bulk reinsurance assumptions 0 130,515 (124,027) Sale of discontinued operations, net of cash transferred 0 0 216,031 Purchase of property and equipment (16,618) (10,880) (12,212) --------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (972,786) (1,347,610) (1,776,988) --------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities Borrowings under line of credit arrangements and long-term debt 6,271,766 2,119,772 2,738,763 Principal payments on line of credit arrangements and long-term debt (6,216,546) (2,206,874) (2,551,677) Payment of guaranteed preferred beneficial interests 0 (75,000) 0 Dividends to share owners (43,399) (40,511) (37,187) Issuance of guaranteed preferred beneficial interests 0 115,000 100,000 Purchase of common stock held in trust (371) (882) (217) Purchase of treasury stock 0 (828) (3,405) Investment product deposits and change in universal life deposits 2,721,579 1,687,213 1,735,653 Investment product withdrawals (2,511,017) (1,177,030) (1,315,179) --------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 222,012 420,860 666,751 --------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash 34,745 (24,605) 71,064 --------------------------------------------------------------------------------------------------------------------- Cash at beginning of year 101,953 126,558 55,494 --------------------------------------------------------------------------------------------------------------------- Cash at end of year $ 136,698 $ 101,953 $ 126,558 ---------------------------------------------------------------------------------------------------------------------
The consolidated financial statements include the accounts, after intercompany eliminations, of Protective Life Corporation and its wholly owned subsidiaries.
On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133, as amended by SFAS Nos. 137, 138, and 149, requires the Company to record all derivative financial instruments at fair value on the balance sheet. Changes in fair value of a derivative instrument are reported in net income or other comprehensive income, depending on the designated use of the derivative instrument. The adoption of SFAS No. 133 resulted in a cumulative charge to net income, net of income tax, of $7.6 million ($0.11 per share on both a basic and diluted basis) and a cumulative after-tax increase to other comprehensive income of $4.0 million on January 1, 2001. The charge to net income and increase to other comprehensive income primarily resulted from the recognition of derivative instruments embedded in the Company’s corporate bond portfolio. In addition, the charge to net income includes the recognition of the ineffectiveness on existing hedging relationships including the difference in spot and forward exchange rates related to foreign currency swaps used as an economic hedge of foreign-currency-denominated stable value contracts. The adoption of SFAS No. 133 has introduced volatility into the Company’s reported net income and other comprehensive income depending on market conditions and the Company’s hedging activities.
The Company monitors its use of derivatives in connection with its overall asset/liability management programs and procedures. The Company’s asset/liability committee is responsible for implementing various strategies to mitigate or eliminate certain financial and market risks. These strategies are developed through the committee’s analysis of data from financial simulation models and other internal and industry sources and are then incorporated into the Company’s overall interest rate and currency exchange risk management strategies.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is designated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; (4) because a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, the derivative will continue to be carried on the balance sheet at its fair value, and the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the derivative will continue to be carried on the balance sheet at its fair value, and any asset or liability that was recorded pursuant to recognition of the firm commitment will be removed from the balance sheet and recognized as a gain or loss in current-period earnings. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will remain therein until such time as they are reclassified to earnings as originally forecasted to occur. In all situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current-period earnings.
Cash-Flow Hedges. The Company has entered into a foreign currency swap to hedge the risk of changes in the value of interest and principal payments to be made on certain of its foreign-currency-based stable value contracts. Under the terms of the swap, the Company pays a fixed U.S.-dollar-denominated rate and receives a fixed foreign-currency-denominated rate. Effective July 1, 2002, the Company designated this swap as a cash flow hedge and therefore recorded the change in the fair value of the swap during the period in accumulated other comprehensive income. In 2003 and 2002, a pretax loss of $66.0 million and $19.8 million, respectively, representing the change in fair value of the hedged contracts, and a gain of like amount representing the application of hedge accounting to this transaction, were recorded in “Realized investment gains (losses) - Derivative financial instruments” in the Company’s consolidated condensed statements of income. For the years ended December 31, 2003 and 2002, the amount of the hedge’s ineffectiveness reported in income was a $0.3 million gain and an immaterial loss, respectively. Additionally, as of December 31, 2003 and 2002, the Company reported an increase to accumulated other comprehensive income of $2.7 million (net of income tax of $1.4 million) and a reduction to accumulated other comprehensive income of $2.1 million (net of income tax of $1.1 million), respectively, related to its derivative designated as a cash flow hedge. During 2004, the Company expects to reclassify out of accumulated other comprehensive income and into earnings, as a reduction of interest expense, approximately $3.4 million.
At December 31, 2003, contracts with a notional amount of $3.6 billion were in a $152.4 million net gain position. At December 31, 2002, contracts with a notional amount of $7.1 billion were in a $89.9 million net gain position.
Universal life and investment products include universal life insurance, guaranteed investment contracts, deferred annuities, and annuities without life contingencies. Premiums and policy fees for universal life and investment products consist of fees that have been assessed against policy account balances for the costs of insurance, policy administration, and surrenders. Such fees are recognized when assessed and earned. Benefit reserves for universal life and investment products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized in income over the term of the policies. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances and interest credited to policy account balances. Interest rates credited to universal life products ranged from 4.6% to 6.5% and investment products ranged from 2.6% to 4.8% in 2003.
The operating results and charges related to the sale of the Dental Division and discontinuance of other related operations at December 31 are as follows:
2003 2002 2001 ----------------------------------------------------------------------------------------------------------------------- Total revenues $12,293 $15,809 $350,916 ----------------------------------------------------------------------------------------------------------------------- Loss before income taxes from discontinued operations $ 0 $ 0 $(12,797) Income tax benefit 0 0 2,820 ----------------------------------------------------------------------------------------------------------------------- Loss from discontinued operations $ 0 $ 0 $ (9,977) ----------------------------------------------------------------------------------------------------------------------- Gain from sale of discontinued operations before income tax $ 22,927 Income tax expense related to sale (43,472) ----------------------------------------------------------------------------------------------------------------------- Loss from sale of discontinued operations $(20,545) ----------------------------------------------------------------------------------------------------------------------- Loss from discontinued operations - per share (diluted and basic) $ 0 $ 0 $ (.14) Loss from sale of discontinued operations - per share (diluted and basic) $ (.29) -----------------------------------------------------------------------------------------------------------------------
Assets and liabilities related to the discontinued lines of business of approximately $60.3 million remain at December 31, 2003.
2003 2002 2001 -------------------------------------------------------------------------------------------------------------- Net income $217,050 $177,355 $102,943 -------------------------------------------------------------------------------------------------------------- Average shares issued and outstanding 68,886,442 68,659,881 68,037,410 Stock held in trust (102,412) (67,566) (47,759) Issuable under various deferred compensation plans 1,249,258 1,331,640 1,420,874 -------------------------------------------------------------------------------------------------------------- Average shares outstanding - basic 70,033,288 69,923,955 69,410,525 Stock held in trust 102,412 67,566 47,759 Stock appreciation rights 248,289 220,500 266,132 Issuable under various other stock-based compensation plans 260,653 250,776 225,757 -------------------------------------------------------------------------------------------------------------- Average shares outstanding - diluted 70,644,642 70,462,797 69,950,173 --------------------------------------------------------------------------------------------------------------
The following table sets forth supplemental cash flow information for the years ended December 31:
2003 2002 2001 ------------------------------------------------------------------------------------------------ Fixed maturities $ 743,934 $ 680,825 $615,089 Equity securities 2,321 3,500 3,550 Mortgage loans 208,983 218,165 208,830 Investment real estate 3,478 2,437 4,632 Short-term investments and other 91,795 134,900 65,144 ------------------------------------------------------------------------------------------------ 1,050,511 1,039,827 897,245 Investment expenses 19,759 16,874 17,104 ------------------------------------------------------------------------------------------------ $1,030,752 $1,022,953 $880,141 ------------------------------------------------------------------------------------------------
2003 2002 2001 ------------------------------------------------------------------------------------------------ Fixed maturities $57,401 $2,674 $(7,311) Equity securities (1,372) 65 2,462 Mortgage loans and other investments 2,035 (1,829) (3,891) ------------------------------------------------------------------------------------------------ $58,064 $ 910 $(8,740) ------------------------------------------------------------------------------------------------
2003 2002 2001 ------------------------------------------------------------------------------------------- Derivative financial instruments $12,550 $28,308 $(1,114) -------------------------------------------------------------------------------------------
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Market Value ------------------------------------------------------------------------------------------------------------------------- Fixed maturities: Bonds: Mortgage-backed securities $ 4,491,392 $132,984 $(36,112) $ 4,588,264 United States Government and authorities 83,834 6,538 (119) 90,253 States, municipalities, and political subdivisions 25,349 1,738 (1) 27,086 Public utilities 1,389,389 96,926 (10,776) 1,475,539 Convertibles and bonds with warrants 43,384 743 (277) 43,850 All other corporate bonds 6,286,776 455,323 (34,476) 6,707,623 Redeemable preferred stocks 2,957 207 0 3,164 ------------------------------------------------------------------------------------------------------------------------- 12,323,081 694,459 (81,761) 12,935,779 Equity securities 45,379 1,881 (529) 46,731 Short-term investments 514,619 0 0 514,619 ------------------------------------------------------------------------------------------------------------------------- $12,883,079 $696,340 $(82,290) $13,497,129 ------------------------------------------------------------------------------------------------------------------------- Fixed maturities: Bonds: Mortgage-backed securities $ 4,168,026 $199,316 $ (28,311) $ 4,339,031 United States Government and authorities 90,647 5,752 96,399 States, municipalities, and political subdivisions 27,005 2,349 0 29,354 Public utilities 1,153,710 61,831 (42,139) 1,173,402 Convertibles and bonds with warrants 115,728 2,656 (5,872) 112,512 All other corporate bonds 5,664,549 348,809 (101,818) 5,911,540 Redeemable preferred stocks 1,700 127 0 1,827 ------------------------------------------------------------------------------------------------------------------------- 11,221,365 620,840 (178,140) 11,664,065 Equity securities 66,820 2,408 (4,705) 64,523 Short-term investments 448,399 0 0 448,399 ------------------------------------------------------------------------------------------------------------------------- $11,736,584 $623,248 $(182,845) $12,176,987 -------------------------------------------------------------------------------------------------------------------------
The amortized cost and estimated market value of available for sale fixed maturities at December 31, 2003, by expected maturity, are shown as follows. Expected maturities are derived from rates of prepayment that may differ from actual rates of prepayment.
Less Than 12 Months 12 Months or More Total -------------------------- ------------------------ ---------------------------- Market Unrealized Market Unrealized Market Unrealized Value Loss Value Loss Value Loss --------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities $ 653,360 $(12,329) $100,397 $(23,784) $753,757 $(36,113) US government 15,763 (119) 0 0 15,763 (119) State, municipalities, etc. 488 (1) 0 0 488 (1) Public utilities 286,552 (10,080) 18,165 (696) 304,717 (10,776) Convertible bonds 21,409 (167) 229 (111) 21,638 (278) Other corporate bonds 940,949 (25,414) 83,757 (9,077) 1,024,706 (34,491) Equities 102 (45) 2,870 (467) 2,972 (512) --------------------------------------------------------------------------------------------------------------------- $1,918,623 $(48,155) $205,418 $(34,135) $2,124,041 $(82,290) ---------------------------------------------------------------------------------------------------------------------
The Corporate Bonds category has gross unrealized losses of $9.1 million at December 31, 2003, composed of $2.8 million of electrical industry securities, $5.0 million of transportation industry securities, and $1.3 million of other industry securities. The aggregate decline in market value of these securities was deemed temporary due to positive factors supporting the recoverability of the respective investments. Positive factors considered included credit ratings, the financial health of the investee, the continued access of the investee to capital markets, and other pertinent information.
At December 31, 2003 and 2002, the Company had bonds which were rated less than investment grade of $995.5 million and $869.2 million, respectively, having an amortized cost of $990.7 million and $969.4 million, respectively. Not included in these less than investment grade bonds at December 31, 2003, are $10.9 million of trading securities. At December 31, 2003, approximately $66.9 million of the bonds rated less than investment grade were securities issued in Company-sponsored commercial mortgage loan securitizations. Approximately $1,975.3 million of bonds are not publicly traded.
2003 2002 2001 ------------------------------------------------------------------------ Fixed maturities $110,499 $227,283 $108,307 Equity securities 2,372 (480) 715 ------------------------------------------------------------------------
At December 31, 2003, all of the Company’s mortgage loans were commercial loans of which 75% were retail, 8% were apartments, 8% were office buildings, 8% were warehouses, and 1% were other. The Company specializes in making mortgage loans on either credit-oriented or credit-anchored commercial properties. No single tenant’s leased space represents more than 2.8% of mortgage loans. Approximately 74% of the mortgage loans are on properties located in the following states listed in decreasing order of significance: Texas, Tennessee, Georgia, North Carolina, South Carolina, Alabama, Virginia, Florida, Pennsylvania, Ohio, California, Mississippi and Washington.
Many of the mortgage loans have call provisions between 3 and 10 years. Assuming the loans are called at their next call dates, approximately $125.0 million would become due in 2004, $537.3 million in 2005 through 2008, $461.5 million in 2009 through 2013, and $40.2 million thereafter.
For several years the Company has offered a type of commercial mortgage loan under which the Company will permit a slightly higher loan-to-value ratio in exchange for a participating interest in the cash flows from the underlying real estate. As of December 31, 2003 and 2002, approximately $382.7 million and $475.5 million, respectively, of the Company’s mortgage loans have this participation feature.
At December 31, 2003 and 2002, the Company’s problem mortgage loans (over ninety days past due) and foreclosed properties totaled $11.8 million and $16.2 million, respectively. Since the Company’s mortgage loans are collateralized by real estate, any assessment of impairment is based upon the estimated fair value of the real estate. Based on the Company’s evaluation of its mortgage loan portfolio, the Company does not expect any material losses on its mortgage loans.
2003 2002 --------------------------------------------------------------------------------------------------- Long-term debt (year of issue): Notes payable to banks, due 2005 $ 25,000 $ 30,000 Floating Rate Senior Notes (2001), due 2003 0 100,000 7.95% Senior Notes (1994), due 2004 75,000 75,000 7.45% Medium-Term Notes (1996), due 2011 9,852 9,852 8.00% Senior Notes (2000), due 2010, callable 2003 0 49,858 8.10% Senior Notes (2000), due 2015, callable 2003 0 39,843 8.25% Senior Notes (2000), due 2030, callable 2005 34,699 34,699 7.50% Senior Notes (2000), due 2016, callable 2004 59,864 59,914 4.30% Senior Notes (2003), due 2013 250,000 0 Mortgage notes on investment real estate 6,914 6,944 --------------------------------------------------------------------------------------------------- $461,329 $406,110 ---------------------------------------------------------------------------------------------------
Under revolving line of credit arrangements with several banks, the Company can borrow up to $200 million on an unsecured basis. No compensating balances are required to maintain the line of credit. At December 31, 2003, the Company had $25.0 million outstanding under these credit arrangements at an interest rate of 1.64%. The amounts outstanding under the line of credit are due in 2005. At December 31, 2002, the Company had $30.0 million outstanding under these credit arrangements.
The aforementioned revolving line of credit arrangements contain, among other provisions, requirements for maintaining certain financial ratios and restrictions on indebtedness incurred by the Company and its subsidiaries. Additionally, the Company, on a consolidated basis, cannot incur debt in excess of 40% of its total capital.
At December 31, 2003, future maturities of long-term debt are $75.0 million in 2004, $25.0 million in 2005, and $361.3 million in 2006 or after.
In 1997, a special purpose finance subsidiary, PLC Capital Trust II, issued $115 million of FELINE PRIDESSM which are comprised of stock purchase contracts and a beneficial ownership of 6.5% TOPrS. The sole assets of PLC Capital Trust II were $118.6 million of Protective Life Corporation 6.5% Subordinated Debentures due 2003, Series C. In February 2001, the Company issued 3,918,843 shares of its Common Stock under the stock purchase contracts. In the transaction, substantially all of the 6.5% TOPrS and the underlying subordinated debt was redeemed. The dividend rate on the TOPrS that remained outstanding after February 2001 was reset to 6.77% under a formula specified in the agreement. The remaining outstanding TOPrS and underlying subordinated debt were redeemed in April 2001.
PLC Capital Trust III was formed solely to issue securities and use the proceeds thereof to purchase subordinated debentures of the Company. The sole assets of PLC Capital Trust III are $103.1 million of Protective Life Corporation 7.5% Subordinated Debentures due 2031, Series D. The Company has the right under the subordinated debentures to extend interest payment periods up to five consecutive years, and, as a consequence, dividends on the 7.5% TOPrS may be deferred (but will continue to accumulate, together with additional dividends on any accumulated but unpaid dividends at the dividend rate) by PLC Capital Trust III during any such extended interest payment period. The 7.5% TOPrS are redeemable by PLC Capital Trust III at any time on or after August 22, 2006.
The subordinated debentures related to PLC Capital Trust III, PLC Capital Trust IV, and PLC Capital Trust V are reported in the accompanying balance sheets as “subordinated debt securities.”
As of December 31, 2003, the Company consolidated a special-purpose entity, as a result of the implementation of FIN 46. The consolidated entity included a $430.6 million investment portfolio, $400.0 million of notes payable, $15.0 million of derivative liabilities, and $15.6 million of minority interest. The $400.0 million of notes payable are recognized on the balance sheet in “liabilities related to variable interest entities” and are not the legal obligations of the Company, but will be repaid with cash flows generated by the entity’s investment portfolio.
In January 2001, the Company coinsured a block of individual life policies from Standard Insurance Company.
In October 2001, the Company completed the acquisition of the stock of Inter-State Assurance Company (Inter-State) and First Variable Life Insurance Company (First Variable) from ILona Financial Group, Inc., a subsidiary of Irish Life & Permanent plc of Dublin, Ireland. The purchase price was approximately $250 million. The assets acquired included $166.1 million of present value of future profits.
The Company leases administrative and marketing office space in approximately 25 cities including Birmingham, with most leases being for periods of three to ten years. The aggregate annualized rent is approximately $8.1 million.
The Company may, from time to time, reissue treasury shares or buy in the open market additional shares of Common Stock to complete its 401(k) obligations. Accordingly, in 2002, the Company reissued from treasury 2,960 shares of Common Stock to the 401(k) Plan and reissued from treasury another 38,317 shares during 2003.
Between 1996 and 2003 SARs were granted (in addition to the P-SARs discussed above) to certain officers of the Company to provide long-term incentive compensation based solely on the performance of the Company’s Common Stock. The SARs are exercisable after five years (earlier upon the death, disability, or retirement of the officer, or in certain circumstances, of a change in control of the Company) and expire after ten years or upon termination of employment. The SARs activity as well as weighted average base price for 2001, 2002, and 2003 is as follows:
Wtd. Avg. Base Price No. of SARs ---------------------------------------------------------------------------- Balance at December 31, 2000 $18.64 875,000 SARs granted 26.34 138,751 P-SARs converted 22.31 100,072 ---------------------------------------------------------------------------- Balance at December 31, 2001 $19.92 1,113,823 SARs granted 32.00 480,000 SARs exercised 32.60 (80,000) SARs canceled 22.31 (15,000) ---------------------------------------------------------------------------- Balance at December 31, 2002 $23.90 1,498,823 SARs granted 26.49 95,000 P-SARs converted 22.31 45,838 P-SARs canceled 30.77 (22,500) ---------------------------------------------------------------------------- Balance at December 31, 2003 $23.91 1,617,161 ----------------------------------------------------------------------------
The outstanding SARs at December 31, 2003, were at the following base prices:
SARs Remaining Life in Currently Base Price Outstanding Years Exercisable ----------------------------------------------------------------------------- $17.44 580,000 2 580,000 22.31 419,661 6 239,661 31.26 50,000 7 0 31.29 7,500 7 2,500 32.00 465,000 8 30,000 26.49 95,000 9 15,000 -----------------------------------------------------------------------------
The SARs issued in 2001, 2002, and 2003 had estimated fair values at grant date of $0.6 million, $3.7 million, and $0.6 million, respectively. The fair value of the 2003 SARs was estimated using a Black-Scholes option pricing model. Assumptions used in the model were as follows: expected volatility of 25.0% (approximately equal to that of the S&P Life and Health Insurance Index), a risk-free interest rate of 3.1%, a dividend rate of 2.1%, and an expected exercise date of 2009.
The expense recorded by the Company for its stock-based compensation plans was $5.5 million, $5.2 million, and $5.6 million in 2003, 2002, and 2001, respectively. The Company’s obligations of its stock-based compensation plans that are expected to be settled in shares of the Company’s Common Stock are reported as a component of share-owners’ equity.
The Company has established deferred compensation plans for directors, officers, and others. Compensation deferred is credited to the participants in cash, Common Stock equivalents, or a combination thereof. The Company may, from time to time, reissue treasury shares or buy in the open market shares of Common Stock to fulfill its obligation under the plans. At December 31, 2003, the plans had 1,193,525 shares of Common Stock equivalents credited to participants.
Certain corporations with which the Company’s directors were affiliated paid the Company premiums and policy fees or other amounts for various types of insurance and investment products. Such premiums, policy fees, and other amounts totaled $12.2 million, $16.0 million, and $19.6 million in 2003, 2002, and 2001, respectively. The Company paid commissions, interest on debt and investment products, and fees to these same corporations totaling $2.1 million, $1.6 million, and $5.9 million in 2003, 2002, and 2001, respectively. In addition, the Company has a swap contract with a related party having a notional amount of $303.7 million, which to the Company was in a $31.0 million gain position at December 31, 2003.
As of December 31, 2003, the Company’s insurance subsidiaries had on deposit with regulatory authorities, fixed maturity and short-term investments with a market value of approximately $74.8 million.
o The Life Marketing segment markets level premium term and term-like insurance, universal life, and variable universal life products on a national basis primarily through networks of independent insurance agents and brokers, and in the “bank owned life insurance” market.
o The Acquisitions segment focuses on acquiring, converting, and servicing policies acquired from other companies. The segment’s primary focus is on life insurance policies sold to individuals.
The Company has an additional segment herein referred to as Corporate and Other. The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on unallocated capital and interest on substantially all debt). This segment also includes earnings from several lines of business which the Company is not actively marketing (mostly cancer insurance and group annuities), various investment-related transactions, and the operations of several small subsidiaries (including a subsidiary that markets discount plans).
Operating Segment Income for the Year Ended December 31, 2003 -------------------------------------------------------------------------------------------------------------------------------- Life Stable Value Marketing Acquisitions Annuities Products -------------------------------------------------------------------------------------------------------------------------------- Premiums and policy fees $856,431 $289,906 $ 26,265 Reinsurance ceded (657,778) (75,994) -------------------------------------------------------------------------------------------------------------------------------- Net of reinsurance ceded 198,653 213,912 26,265 Net investment income 231,238 246,143 224,332 $233,104 Realized investment gains (losses) 22,733 9,756 Other income 59,961 2,640 8,745 -------------------------------------------------------------------------------------------------------------------------------- Total revenues 489,852 462,695 282,075 242,860 -------------------------------------------------------------------------------------------------------------------------------- Benefits and settlement expenses 253,785 291,768 197,955 186,565 Amortization of deferred policy acquisition costs 66,078 32,690 38,196 2,279 Other operating expenses 10,832 43,087 28,765 5,349 -------------------------------------------------------------------------------------------------------------------------------- Total benefits and expenses 330,695 367,545 264,916 194,193 -------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before income tax 159,157 95,150 17,159 48,667 Less: realized investment gains (losses) 22,733 9,756 Add back: related amortization of deferred policy acquisition cost 18,947 -------------------------------------------------------------------------------------------------------------------------------- Operating income 159,157 95,150 13,373 38,911
Operating Segment Income for the Year Ended December 31, 2002 -------------------------------------------------------------------------------------------------------------------------------- Life Stable Value Marketing Acquisitions Annuities Products -------------------------------------------------------------------------------------------------------------------------------- Premiums and policy fees $673,412 $300,818 $ 25,826 Reinsurance ceded (453,228) (76,333) -------------------------------------------------------------------------------------------------------------------------------- Net of reinsurance ceded 220,184 224,485 25,826 Net investment income 209,002 252,147 220,447 $246,098 Realized investment gains (losses) 2,277 (7,061) Other income 56,372 1,636 8,876 -------------------------------------------------------------------------------------------------------------------------------- Total revenues 485,558 478,268 257,426 239,037 -------------------------------------------------------------------------------------------------------------------------------- Benefits and settlement expenses 228,224 301,401 186,107 196,576 Amortization of deferred policy acquisition costs 117,836 35,245 24,669 2,304 Other operating expenses 13,948 46,525 30,660 4,946 -------------------------------------------------------------------------------------------------------------------------------- Total benefits and expenses 360,008 383,171 241,436 203,826 -------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before income tax 125,550 95,097 15,990 35,211 Less: realized investment gains (losses) 2,277 (7,061) Add back: related amortization of deferred policy acquisition cost 1,981 -------------------------------------------------------------------------------------------------------------------------------- Operating income 125,550 95,097 15,694 42,272
Operating Segment Assets December 31, 2003 -------------------------------------------------------------------------------------------------------------------------------- Life Stable Value Marketing Acquisitions Annuities Products -------------------------------------------------------------------------------------------------------------------------------- Investments and other assets $4,991,028 $4,373,737 $4,728,396 $4,520,955 Deferred policy acquisition costs 1,185,102 385,042 101,096 7,186 Goodwill 10,354 -------------------------------------------------------------------------------------------------------------------------------- Total assets $6,186,484 $4,758,779 $4,829,492 $4,528,141 --------------------------------------------------------------------------------------------------------------------------------
The Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee’s highest thirty-six consecutive months of compensation. The Company’s funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements of ERISA plus such additional amounts as the Company may determine to be appropriate from time to time. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.
At December 31, 2003, the Company estimated that its 2004 defined benefit pension plan expense will be $6.4 million, which is the Company’s estimate of its expected contributions for 2004. The measurement date used to determine the benefit expense and benefit obligations of the plan is December 31, 2003.
2003 2002 ---------------------------------------------------------------------------------- Weighted average discount rate 6.25% 6.75% Rates of increase in compensation level 4.00 4.50 Expected long-term rate of return on assets 8.50 8.50 ----------------------------------------------------------------------------------
Net pension cost of the defined benefit pension plan includes the following components for the years ended December 31:
2003 2002 2001 ------------------------------------------------------------------------------------------------- Service cost $ 4,513 $ 3,723 $ 3,739 Interest cost 4,666 4,111 3,531 Expected return on plan assets (5,604) (4,265) (3,669) Amortization of prior service cost 214 263 176 Amortization of losses 1,049 302 141 Cost of divestiture 186 ------------------------------------------------------------------------------------------------- Net pension cost $ 4,838 $ 4,134 $ 4,104 -------------------------------------------------------------------------------------------------
2003 2002 ----------------------------------------------------------------------------------- Cash and cash equivalents $ 3,273 $ 2,588 Equity securities 53,413 39,157 Fixed income 17,385 7,705 ----------------------------------------------------------------------------------- Total $74,071 $49,450 -----------------------------------------------------------------------------------
Life insurance benefits for retirees from $10,000 up to a maximum of $75,000, are provided through the payment of premiums under a group life insurance policy. This plan is partially funded at a maximum of $50,000 face amount of insurance.
The Company sponsors a defined contribution retirement plan which covers substantially all employees. Employee contributions are made on a before-tax basis as provided by Section 401(k) of the Internal Revenue Code. The Company has established an Employee Stock Ownership Plan (ESOP) to match voluntary employee contributions to the Company’s 401(k) Plan. In 1994, a stock bonus component was added to the 401(k) Plan for employees who are not otherwise under a bonus or sales incentive plan. Expense related to the ESOP consists of the cost of the shares allocated to participating employees plus the interest expense on the ESOP’s note payable to the Company less dividends on shares held by the ESOP. All shares held by the ESOP are treated as outstanding for purposes of computing earnings per share. At December 31, 2003, the Company had committed approximately 124,682 shares to be released to fund the 401(k) Plan match. The expense recorded by the Company for these employee benefits was $0.6 million, $0.1 million, and less than $0.1 million in 2003, 2002, and 2001, respectively.
The Company continues to monitor the consolidation of reinsurers and the concentration of credit risk the Company has with any reinsurer. At December 31, 2003, the Company had reinsured approximately 89.6% of the face value of its life insurance in force. The Company had reinsured approximately 59.1% of the face value of its life insurance in force with three reinsurers. These reinsurers had a minimum Standard & Poor’s rating of AA- and a minimum A. M. Best rating of A+. The Company has not experienced any credit losses for the years ended December 31, 2003, 2002, or 2001 related to these reinsurers.
The Company has reinsured approximately $292.7 billion, $219.0 billion, and $171.4 billion in face amount of life insurance risks with other insurers representing $781.8 million, $546.0 million, and $565.1 million of premium income for 2003, 2002, and 2001, respectively. The Company has also reinsured accident and health risks representing $61.6 million, $61.5 million, and $122.7 million of premium income for 2003, 2002, and 2001, respectively. In addition, the Company reinsured property and casualty risks representing $91.0 million, $143.9 million, and $83.3 million of premium income for 2003, 2002, and 2001, respectively. In 2003 and 2002, policy and claim reserves relating to insurance ceded of $2,230.7 million and $2,304.9 million, respectively, are included in reinsurance receivables. Should any of the reinsurers be unable to meet its obligation at the time of the claim, obligation to pay such claim would remain with the Company. At December 31, 2003 and 2002, the Company had paid $53.3 million and $45.5 million, respectively, of ceded benefits which are recoverable from reinsurers. In addition, at December 31, 2003, the Company had receivables of $66.6 million related to insurance assumed.
In 2002, the Company discovered that it had overpaid reinsurance premiums to several reinsurance companies of approximately $94.5 million. At December 31, 2002, the Company had recorded cash and receivables totaling $69.7 million, which reflected the amounts received and the Company’s then current estimate of amounts to be recovered in the future, based upon the information available. The corresponding increase in premiums and policy fees resulted in $62.5 million of additional amortization of deferred policy acquisition costs in 2002. The amortization of deferred policy acquisition costs took into account the amortization relating to the increase in premiums and policy fees as well as the additional amortization required should the remainder of the overpayment not be collected. In 2003, the Company substantially completed its recovery of the reinsurance overpayments. As a result, the Company increased premiums and policy fees by $18.4 million in 2003. The increase in premiums and policy fees resulted in $6.1 million of additional amortization of deferred policy acquisitions costs. As a result of the recoveries income before income tax increased $12.3 million and $7.2 million in 2003 and 2002, respectively.
The Company estimates the fair value of its guaranteed investment contracts and annuities using discounted cash flows and surrender values, respectively.
In our opinion, the consolidated financial statements listed in the accompanying index on page 49 of this Annual Report on Form 10-K present fairly, in all material respects, the financial position of Protective Life Corporation and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index on page 87 of this Annual Report on Form 10-K present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.