Properties Protective's administrative office building is located at 2801 Highway 280 South, Birmingham, Alabama 35223. This building includes the original 142,000 square-foot building which was completed in 1976 and a second contiguous 220,000 square-foot building which was completed in 1985. In addition, parking is provided for approximately 1,000 vehicles.
Marketing offices are leased in 14 cities, substantially all under leases for periods of three to five years with five leases running longer than five years. The aggregate monthly rent is approximately $43 thousand.
Management's Narrative Analysis of the Results of Operations In accordance with General Instruction I(2)(a), Protective includes the following analysis with the reduced disclosure format.
Year Ended Percentage December 31 Increase ---------------------- ---------- 1996 1995 -------- ------ (in thousands)
increase in premiums and policy fees. Decreases in older acquired blocks resulted in an $11.1 million decrease in premiums and policy fees. Premiums and policy fees from the Financial Institutions Division increased $7.8 million. This resulted from the coinsurance of a block of policies in the second quarter of 1996 representing a $32.6 million increase in premiums and policy fees. This increase was largely offset by decreases resulting from a reinsurance arrangement begun in 1995. Premiums and policy fees from the Group Division increased $14.1 million. Premiums and policy fees related to the Group Division's dental business increased $22.5 million. This increase was partially offset by a reduction to premiums related to a refund of premiums to certain cancer insurance policyholders and to decreases in traditional group health premiums. Increases in premiums and policy fees from the Individual Life and Investment Product Divisions were $17.7 million and $3.6 million, respectively.
The Financial Institutions Division's 1996 pretax earnings increased $1.3 million compared to 1995. Included in the Division's 1996 results are earnings from the coinsurance of a block of policies in the second quarter of 1996. A reinsurance arrangement begun in the first quarter of 1995 reduced the Division's reported earnings by approximately $3.3 million, which was contemplated when the arrangement was entered into.
Group 1996 pretax earnings of $0.8 million were $8.3 million lower than 1995. The previously discussed estimate for the refund of cancer premiums and related expenses resulted in a $6.8 million decrease in the Division's pretax earnings. Improved dental earnings were offset by lower traditional group health earnings.
The Guaranteed Investment Contracts ("GIC") Division had pretax operating earnings of $40.1 million in 1996 and $33.0 million in 1995. The 1996 increase was due to improved operating spreads and to the growth in GIC deposits. Realized investment losses associated with this Division in 1996 were $8.0 million as compared to $4.0 million in 1995. As a result, total pretax earnings were $32.1 million in 1996 and $29.0 million in 1995. The rate of growth in GIC deposits has decreased as the amount of maturing contracts has increased.
Year Ended Effective Income December 31 Tax Rates ----------- --------------- 1996........................................... 34.1% 1995........................................... 34.0
Management's current estimate of the effective income tax rate for 1997 is 34.0%.
Net Income Year Ended Percentage December 31 Amount Increase (in thousands) 1996.................................. $82,543 6.2% 1995.................................. 77,696 6.8
We have audited the consolidated financial statements and the financial statement schedules of Protective Life Insurance Company and Subsidiaries listed in the index on page 7 of this Form 10-K. 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.
BASIS OF PRESENTATION The accompanying consolidated financial statements of Protective Life Insurance Company and subsidiaries ("Protective") are prepared on the basis of generally accepted accounting principles. Such accounting principles differ from statutory reporting practices used by insurance companies in reporting to state regulatory authorities. (See also Note B.)
NATURE OF OPERATIONS Protective markets individual life insurance; group life, health, dental, and cancer insurance; annuities and investment products; credit life and disability insurance; and guaranteed investment contracts. Its products are distributed nationally through independent agents and brokers; through stockbrokers and financial institutions to their customers; through company sales representatives; and through other insurance companies. Protective also seeks to acquire blocks of insurance policies from other insurers.
In 1995 PLC adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which changes the way stock-based compensation expense is measured and requires additional disclosures relating to PLC's stock-based compensation plans. The adoption of this accounting standard did not have a material effect on PLC's or Protective's financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (All dollar amounts in tables are in thousands)
Total investments................................ $6,495,259 $5,915,357 Deferred policy acquisition costs................ 495,965 426,432 All other assets................................. 1,161,830 747,884 ------------- --------- $8,153,054 $7,089,673
Deferred income taxes........................... $ 34,121 $ 36,263 All other liabilities........................... 7,349,430 6,458,036 ----------- ------------ 7,383,551 6,494,299 Redeemable preferred stock...................... 2,000 Stockholder's equity............................ 769,503 593,374 ------------ ------------ $8,153,054 $7,089,673
Protective uses interest rate swap contracts to convert certain investments from a variable to a fixed rate of interest. At December 31, 1996, related open interest rate swap contracts with a notional amount of $150.3 million were in a $0.7 million net unrealized loss position. At December 31, 1995, related open interest rate swap contracts with a notional amount of $170.3 million were in a $1.3 million net unrealized gain position.
PROPERTY AND EQUIPMENT Property and equipment are reported at cost. Protective uses both accelerated and straight-line methods of depreciation based upon the estimated useful lives of the assets. Major repairs or improvements are capitalized and depreciated over the estimated useful lives of the assets. Other repairs are expensed as incurred. The cost and related accumulated depreciation of property and equipment sold or retired are removed from the accounts, and resulting gains or losses are included in income.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (All dollar amounts in tables are In thousands)
Balance beginning of year..........$ 73,642 $ 79,462 $ 77,191 Less reinsurance................... 3,330 5,024 3,973 ---------- --------- ---------
Net balance beginning of year...... 70,312 74,438 73,218 ---------- -------- --------
Paid related to: Current year....................... 197,163 164,321 148,548 Prior year.......................... 57,812 48,834 47,002 ---------- --------- --------- Total paid......................... 254,975 213,155 195,550 --------- -------- --------
Net balance end of year............. 101,736 70,312 74,438 Plus reinsurance.................... 6,423 3,330 5,024 --------- --------- ---------
Balance end of year.................$108,159 $ 73,642 $ 79,462 ======= ======== ========
o Policy Acquisition Costs-- Commissions and other costs of acquiring traditional life and health insurance, universal life insurance, and investment products that vary with and are primarily related to the production of new business have been deferred. Traditional life and health insurance acquisition costs are amortized over the premium-payment period of the related policies in proportion to the ratio of annual premium income to total anticipated premium income. Acquisition costs for universal life and investment products are being amortized over the lives of the policies in relation to the present value of estimated gross profits from surrender charges and investment, mortality, and expense margins. Under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," Protective makes certain assumptions regarding the mortality, persistency, expenses, and interest rates it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from initial assumptions. Additionally, relating to SFAS No. 115, these costs have been adjusted by an amount equal to the amortization that would have been recorded if unrealized gains or losses on investments associated with Protective's universal life and investment products had been realized.
Protective has established an allowance for uncollectible amounts on investments. The allowance totaled $30.9 million at December 31, 1996 and $32.7 million at December 31, 1995. Additions and reductions to the allowance are included in realized investment gains (losses). Without such additions/reductions, Protective had net realized investment gains of $3.7 million in 1996, net realized investment losses of $0.5 million in 1995, and net realized investment gains of $6.3 million in 1994.
In 1996, gross gains on the sale of investments available for sale (fixed maturities, equity securities and short-term investments) were $6.9 million and gross losses were $11.8 million. In 1995, gross gains were $18.0 million and gross losses were $11.8 million. In 1994, gross gains on the sale of fixed maturities were $15.2 million and gross losses were $16.4 million.
At December 31, 1996 and 1995, Protective had bonds which were rated less than investment grade of $117.5 million and $75.7 million, respectively, having an amortized cost of $137.0 million and $82.2 million, respectively. Additionally, Protective had bank loan participations which were rated less than investment grade of $43.6 million and $206.0 million, respectively, having an amortized cost of $43.6 million and $206.0 million, respectively.
1996 1995 1994 ----------- ------------- -------- Fixed maturities......................... $(56,898) $199,024 $(175,723) Equity securities........................ $ 207 $ 2,740 $ (5,342)
Certain investments, principally real estate, with a carrying value of $18.8 million were nonincome producing for the twelve months ended December 31, 1996.
1996 1995 Deferred income tax assets Policy and policyholder liability reserves....... $ 80,151 $ 63,830 Other............................................ 2,503 2,303 ----------- ---------- 82,654 66,133 Deferred income tax liabilities: Deferred policy acquisition costs................. 117,696 102,154 Unrealized gain on investments.................... 2,680 31,399 ------------ ---------- 120,376 133,553 ------------ ---------- Net deferred income tax liability $ 37,722 $ 67,420 ========= ========
Protective has arranged sources of credit to temporarily fund scheduled investment commitments. Protective expects that the rate received on its investments will equal or exceed its borrowing rate. Protective had no such temporary borrowings outstanding at December 31, 1996 and 1995.
Interest expense on borrowed money totaled $4.6 million, $6.0 million, and $5.0 million, in 1996, 1995, and 1994, respectively.
In June 1995 Protective acquired through coinsurance a block of term life insurance policies. In January 1996 Protective acquired through coinsurance a block of life insurance policies. In June 1996 Protective acquired through coinsurance a block of credit life insurance policies. In December 1996 Protective acquired a small life insurance company and acquired through coinsurance a block of life insurance policies.
These transactions have been accounted for as purchases, and the results of the transactions have been included in the accompanying financial statements since the effective dates of the agreements.
A number of civil jury verdicts have been returned against life and health insurers in the jurisdictions in which Protective does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments against the insurer that are disproportionate to the actual damages, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages which creates the potential for unpredictable material adverse judgments in any given punitive damage suit. Protective and its subsidiaries, like other life and health insurers, from time to time are involved in such litigation. Pending litigation includes a class action filed in Jefferson County (Birmingham), Alabama with respect to cancer premium refunds. Although the outcome of any litigation cannot be predicted with certainty, Protective believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position of Protective.
On August 6, 1990, PLC announced that its Board of Directors approved the formation of an Employee Stock Ownership Plan ("ESOP"). On December 1, 1990, Protective transferred to the ESOP 520,000 shares of PLC's common stock held by it in exchange for a note. The outstanding balance of the note, $5.6 million at December 31, 1996, is accounted for as a reduction to stockholder's equity. The stock will be used to match employee contributions to PLC's existing 401(k) Plan. The ESOP shares are dividend paying. Dividends on the shares are used to pay the ESOP's note to Protective.
Protective operates predominantly in the life and accident and health insurance industry. The following table sets forth total revenues, income before income tax, and identifiable assets of Protective's business segments. The primary components of revenues are premiums and policy fees, net investment income, and realized investment gains and losses. Premiums and policy fees are attributed directly to each business segment. Net investment income is allocated based on directly related assets required for transacting that segment of business. In the 1996 first quarter, Protective changed the way it allocates certain expenses to its business segments. Accordingly, prior period segment results have been restated to reflect the change.
1996 1995 1994 ----------- ---------- ------- INCOME BEFORE INCOME TAX Acquisitions..................................$53,564 $ 50,376 $ 37,719 Financial Institutions......................... 8,966 7,701 7,544 Group.......................................... 821 9,107 10,122 Guaranteed Investment Contracts................32,130 28,979 31,933 Individual Life................................15,898 16,206 15,957 Investment Products........................... 9,823 10,933 (796) Corporate and Other............................(2,410) (6,490) (2,167) Unallocated Realized Investment Gains (Losses). 6,517 921 5,266 ----------- ----------- --------- $ 125,309 $117,733 $105,578 ========== ======== ========
Acquisitions.............................. 42.7% 42.8% 35.7% Financial Institutions..................... 7.2 6.5 7.1 Group...................................... 0.7 7.7 9.6 Guaranteed Investment Contracts............ 25.6 24.6 30.2 Individual Life............................ 12.7 13.8 15.1 Investment Products........................ 7.8 9.3 (0.7) Corporate and Other........................ (1.9) (5.5) (2.0) Unallocated Realized Investment Gains (Losses) 5.2 0.8 5.0 ----------- --------- --------- 100.0% 100.0% 100.0% ============= ========= =========
IDENTIFIABLE ASSETS Acquisitions.............................. $1,579,253 $1,255,542 $1,204,883 Financial Institutions.................... 344,866 265,132 211,652 Group..................................... 233,640 240,222 215,904 Guaranteed Investment Contracts........... 2,608,037 2,536,939 2,211,079 Individual Life........................... 1,034,960 887,927 752,168 Investment Products....................... 1,871,887 1,578,789 1,284,186 Corporate and Other....................... 490,700 414,142 230,832 ------------ ------------ ------------ $8,163,343 $7,178,693 $6,110,704 ========== ========== ==========
Service cost-- benefits earned during the year......$1,908 $ 1,540 $ 1,433 Interest cost on projected benefit obligation....... 1,793 1,636 1,520 Actual return on plan assets........................(1,674) (1,358) (1,333) Net amortization and deferral....................... 374 114 210 --------- ---------- ------- Net pension cost...................................$ 2,401 $ 1,932 $ 1,830 ======= ======= =======
Protective's share of the net pension cost was $1.5 million, $1.2 million, and $1.2 million, in 1996, 1995, and 1994, respectively.
Certain Protective employees participate in PLC's Performance Share Plan and receive stock appreciation rights (SARs) from PLC.
During 1996, stock appreciation rights (SARs) were granted to certain executives of PLC to provide long-term incentive compensation based on the performance of PLC's Common Stock. Under this arrangement PLC will pay (in shares of PLC Common Stock) an amount equal to the difference between the specified base price of PLC's Common Stock and the market value at the exercise date. The SARs are exercisable after five years (earlier upon the death, disability or retirement of the executive, or in certain circumstances, of a change in control of PLC) and expire in 2006 or upon termination of employment. The number of SARs granted during 1996 and outstanding at December 31, 1996 was 337,500. The SARs have a base price of $34.875 per share of PLC Common Stock (the market price on the grant date was $35.00 per share). The estimated fair value of the SARs on the grant date was $3.0 million. This estimate was derived using the Roll-Geske variation of the Black-Sholes option pricing model. Assumptions used in the pricing model are as follows: expected volatility rate of 15% (approximately equal to that of the S & P Life Insurance Index), a risk free interest rate of 6.35%, a dividend yield rate of 1.97%, and an expected exercise date of August 15, 2002. The expense recorded by PLC for the SARs was $0.2 million in 1996.
Protective assumes risks from and reinsures certain parts of its risks with other insurers under yearly renewable term, coinsurance, and modified coinsurance agreements. Yearly renewable term and coinsurance agreements are accounted for by passing a portion of the risk to the reinsurer. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of all benefit payments. Modified coinsurance is accounted for similarly to coinsurance except that the liability for future policy benefits is held by the original company, and settlements are made on a net basis between the companies. While the amount retained on an individual life will vary based upon age and mortality prospects of the risk Protective, generally, will not carry more than $500,000 individual life insurance on a single risk.
SCHEDULE IV -- REINSURANCE PROTECTIVE LIFE INSURANCE COMPANY AND SUBSIDIARIES (Dollars in thousands)