The relative strength and stability of financial markets and economies in the United States and Canada affect our growth and profitability. Our business is, and we expect will continue to be, influenced by a number of industry-wide and product-specific trends and conditions. Economic conditions, including unemployment levels and consumer confidence, influence investment and spending decisions by middle income consumers, who are generally our primary clients. These conditions and factors also impact prospective recruits’ perceptions of the business opportunity that becoming a Primerica sales representative offers, which can drive or dampen recruiting. Consumer spending and borrowing levels affect how consumers evaluate their savings and debt management plans. In addition, interest rates and equity market returns impact consumer demand for the savings and investment products we distribute. Our customers’ perception of the strength of the capital markets will influence their decisions to invest in the Investment and savings products we distribute.
Our ability to increase the size of our independent sales force is largely based on the success of our recruiting efforts as well as our ability to train and motivate recruits to get licensed to sell life insurance. We believe that recruitment and licensing levels are important to sales force trends and growth in recruiting and licensing is usually indicative of future growth in the overall size of the sales force. Recruiting results do not always result in commensurate changes in the size of our licensed sales force because new recruits may obtain the requisite licenses at rates above or below historical levels.
The increase in new life insurance policies issued in 2015 from 2014 was largely driven by the growth of our life-licensed sales force as well as productivity at the high end of our historical range. Productivity, measured by the average rate of new policies issued per life-licensed sales representative per month, was at the higher-end of our historical range due to the positive sales momentum generated within our independent sales force in 2015 and was complemented by successful initiatives implemented during the year.
Face amount of term life insurance policies in force increased in 2015 from 2014 primarily due to the higher number of new policies issued and policy terminations being consistent with the prior year. Our average issued face amount of approximately $241,700 in 2015 decreased as compared with approximately $244,600 in 2014 due primarily to the translation impact of a weaker Canadian dollar. In terms of the total face amount of policies in force as of December 31, 2015, the impact of the stronger U.S. dollar in relation to the Canadian dollar also reduced the translated face amount of existing Canadian policies in force and partially offset the overall increase in issued face amount when compared with year-end 2014.
The increase in total face amount of policies in force in 2014 from 2013 was also primarily attributable to a rise in issued face amount from the higher number of new policies issued in 2014. Average issued face amount of approximately $244,600 in 2014 declined from approximately $246,800 in 2013, which was also largely due to the impact of a year-over-year weaker Canadian dollar. Total face amount of policies in force as of December 31, 2014 compared to December 31, 2013 increased as the higher issued face amount and better persistency more than offset the translation impact of the weaker Canadian dollar.
Product sales. In 2015, investment and savings products sales increased from 2014 as favorable market conditions, most notably in the first half of the year, drove customer demand for our product sales. The year-over-year increase in investment and savings products was partially offset by the translation impact of the weaker Canadian dollar in relation to the U.S. dollar.
The increase in client asset values during 2014 was led by favorable market performance in 2014 combined with positive net investment flows. This increase was partially offset by a reduction in the translated value of client assets in Canada due to the strengthening of the U.S. dollar relative to the Canadian dollar.
Average number of fee-generating accounts. The average number of fee-generating accounts increased in 2015 from 2014 primarily due to the addition of a mutual fund provider on our recordkeeping and custodial services platform during 2015.
The increase in the average number of fee-generating accounts in 2014 as compared with 2013 is mostly attributable to the higher number of client managed investments and retail mutual funds sold during 2014.
Regulatory changes on business trends. Regulatory changes can also impact our product sales. On April 14, 2015, the Department of Labor (“DOL”) published a proposed regulation (“the DOL Proposed Rule”), which would more broadly define the circumstances under which a person or entity may be considered a fiduciary for purposes of the prohibited transaction rules of the Employee Retirement Income Security Act and Internal Revenue Code (“IRC”) Section 4975. IRC Section 4975 prohibits certain types of compensation paid by third parties with respect to transactions involving assets in qualified accounts, including individual retirement accounts (“IRAs”). In connection with the DOL Proposed Rule, the DOL also proposed new exemptions and amended the existing exemptions. In so doing, the DOL stated its intent to avoid disruption of common compensation arrangements provided the conditions of the exemptions are met. IRAs and other qualified accounts are an important component of the investment and savings products we distribute. While we expect changes in our business will help mitigate any impact of the final rule, we remain concerned that the DOL Proposed Rule and its exemptions are so vague, complex and burdensome that, if finalized as proposed, they would necessitate fundamental changes to our qualified plan business and that these changes could, in particular, impact small-balance investors saving for retirement. The DOL has completed the process of reviewing the extensive comments from stakeholders and making its final revisions to the DOL Proposed Rule. On January 28, 2016, the DOL sent the final version of its proposed rule to the Office of Management and Budget (the “OMB”), which is responsible for reviewing the final proposed rule. Upon completion of its review, the OMB will publicly release the final proposed rule, which will allow the Company and other stakeholders the opportunity to see the rule in its final form for the first time. The form, substance and implementation timeline of a final rule are unknown at this time and therefore we are unable to quantify the impact on our business, financial position or results of operations. During the year ended December 31, 2015, average client assets held in U.S. qualified retirement plans accounted for an estimated 59% of total average client account assets. During the year ended December 31, 2015, product sales of assets held in U.S. qualified retirement plans accounted for approximately 55% of total investment and savings product sales.
Pricing assumptions. Our pricing methodology is intended to provide us with appropriate profit margins for the risks we assume. We determine pricing classifications based on the coverage sought, such as the size and term of the policy, and certain policyholder attributes, such as age and health. In addition, we generally utilize unisex rates for our term life insurance policies. The pricing assumptions that underlie our rates are based upon our best estimates of mortality, persistency and interest rates at the time of issuance, sales force commission rates, issue and underwriting expenses, operating expenses and the characteristics of the insureds, including sex, age, underwriting class, product and amount of coverage. Our results will be affected to the extent there is a variance between our pricing assumptions and actual experience.
Foreign Currency. The Canadian dollar is the functional currency for our Canadian subsidiaries and our financial results, reported in U.S. dollars, are affected by changes in the currency exchange rate. As such, the translated amount of revenues, expenses, assets and liabilities attributable to our Canadian subsidiaries will be higher or lower in periods where the Canadian dollar appreciates or weakens relative to the U.S. dollar, respectively. In 2015, the value of the Canadian dollar relative to the U.S. Dollar decreased significantly from 2014 and also decreased in 2014 from 2013, albeit to a lesser extent.
The year-over-year decrease in the year-end exchange rates used by the Company to translate our Canadian dollar functional currency assets and liabilities into U.S. dollars was 17% in 2015 from 2014 and 8% from 2014 to 2013. The year-over-year decrease in the
average exchange rates used by the Company to translate our Canadian dollar functional currency revenues and expenses into U.S. dollars was 14% in 2015 from 2014 and 7% in 2014 from 2013.
Deferrable acquisition costs for Canadian segregated funds are amortized over the life of the policies in relation to the present value of estimated gross profits expected to be realized over the life of the underlying policies. The gross profits and resulting DAC amortization will vary with actual and anticipated fund returns, redemptions, commissions and expenses. DAC from our Canadian segregated funds reflects approximately 3% of our total DAC, and DAC amortization on these segregated funds reflects approximately 5% of our total DAC amortization for the year ended December 31, 2015.
corresponding due from reinsurers asset of approximately $38.3 million as of December 31, 2015, which decreases over time with the run-off of policies subject to the IPO coinsurance transactions. Higher lapses in later durations would have a greater effect on the release of future policy benefit reserves since the future policy benefit reserves are higher at the later durations.
Amortization of DAC. Represents the amortization of capitalized costs associated with the sale of an insurance policy or segregated fund, including sales commissions, medical examination and other underwriting costs, and other eligible policy issuance costs.
Interest expense. Reflects interest on our notes payable, the financing charges related to an issued letter of credit, fees paid for the credit enhancement feature on our held-to-maturity invested asset, and a finance charge incurred pursuant to one of our coinsurance agreements with IPO coinsurers.
Other operating expenses. Consists primarily of expenses that are unrelated to the distribution of insurance products, including staff compensation, technology and communications, various sales force-related costs, printing, postage and distribution of sales materials, outsourcing and professional fees, amortization of our definite-lived intangible asset and other corporate and administrative fees and expenses.
Primerica, Inc. and Subsidiaries Results. Our results of operations for the years ended December 31, 2015, 2014, and 2013 were as follows:
Total revenues. Total revenues for 2015 increased from 2014 largely due to incremental premiums on term life insurance policies issued after the IPO that are not subject to the IPO coinsurance transactions. The run-off of business subject to these same transactions is reflected in the decline in ceded premiums. Higher sales of investment and savings products and higher average client asset values also contributed to the increase in total revenues in the form of higher commissions and fees. The increase in net premiums and commissions and fees was partially offset by a decline in net investment income, which was mostly attributed to a lower yield on invested assets and lower income from called fixed income securities as compared with 2014.
The increase in revenues in 2015 was partially offset by the foreign exchange impact of translating the results of our Canadian subsidiaries into our consolidated U.S. dollar reporting currency. Measured in constant currency by translating 2015 Canadian local currency revenues using the average 2014 exchange rate, the year-over-year impact from the decrease in exchange rates negatively impacted revenues in 2015 by approximately $36.2 million.
During 2014, total revenues increased from 2013 primarily due to similar factors including incremental premiums on term life insurance policies not subject to the IPO coinsurance transactions, higher investment and savings products sales, and positive client asset performance. Partially offsetting the increase in revenues were lower realized investment gains (losses) in 2014 versus 2013. In comparing the realized investment losses in 2014 to realized investment gains in 2013, the difference was mostly attributable to large gains on tendered securities and gains on certain sales of fixed maturity securities in 2013, as well as OTTI losses recognized on certain investments in 2014. The decrease in net investment income was primarily driven by lower average yield on invested assets, partially offset by a higher average base of invested assets and the positive change in market value of the deposit asset underlying a 10% coinsurance agreement.
The increase in total benefits and expenses in 2014 from 2013 was also driven by growth in total revenues as well as accelerated expense recognition from amendments to retirement provisions in our 2014 management equity award agreements and transition expenses that were recognized in 2014 due to the modification of our former Co-CEO’s employment terms. Partially offsetting these increases were lower legal fees and expenses within other operating expenses attributable to our Investment and Savings Product segment. For more information on the decrease in other operating expenses in 2014, see the Investment and Savings Product segment discussion below.
Income taxes. Our effective income tax rate was relatively consistent each period at 34.7%, 34.8%, and 35.2% in 2015, 2014, and 2013, respectively.
Term Life Insurance Segment. Our results for the Term Life Insurance segment for the years ended December 31, 2015, 2014, and 2013 were as follows:
Net premiums. Net premiums grew in 2015 compared to 2014 mostly due to incremental premiums on term life insurance policies not subject to the IPO coinsurance transactions. Ceded premiums declined primarily due to the run-off of business subject to the IPO coinsurance transactions. The sustained impact of growth in direct premiums not subject to the IPO coinsurance transactions and the run-off of business subject to the IPO coinsurance transactions resulted in net premiums growing faster than direct premiums.
The increase in net premiums in 2014 from 2013 was largely due to the factors discussed above in the comparison of 2015 to 2014.
Insurance expenses. The increase in insurance expenses in 2015 from 2014 was largely due to growth in the business and the run-off of expense allowances related to the IPO coinsurance transactions, which accounted for a year-over-year increase of approximately
Investment and Savings Product Segment. Our results of operations for the Investment and Savings Product segment for the years ended December 31, 2015, 2014, and 2013 were as follows:
The financial results of our Investment and Savings Product segment are significantly affected by product sales activity and client assets included in the “Business Trends and Conditions” section of MD&A.
Commissions and fees. The increase in commissions and fees in 2015 from 2014 was largely attributable to growth in average client asset values. Account-based revenue increased largely due to the increase in the average number of fee generating accounts from the addition of a mutual fund provider on our recordkeeping and custodial services platform during 2015. Sales-based revenues were flat on a year-over-year basis as modest growth in sales-based revenue generating product sales was offset by a shift in product sales mix to product offerings with lower sales-based commission rates.
DAC amortization in 2014 compared to 2013 slowed primarily due to the adjustment to reduce amortization by approximately $2.4 million based on revised future redemption assumptions. In addition, favorable market performance experienced by the assets held within the segregated funds also reduced the year-over-year amount of amortization by approximately $1.0 million. The impact of these items was partially offset by the increased amortization of approximately $1.9 million as a result of product changes that were recorded in 2014 that affected the expected gross profits of the underlying contracts as mentioned above in the 2015 to 2014 year-over-year comparison.
Corporate and Other Distributed Products Segment. Our results of operations for the Corporate and Other Distributed Products segment for the years ended December 31, 2015, 2014, and 2013 were as follows:
Total revenues. The decrease in total revenues in 2015 from 2014 was primarily attributable to the decline in allocated net investment income. The largest item contributing to the decline in net investment income was the impact of a lower yield on invested assets, which resulted in approximately $3.4 million of lower net investment income. Also contributing to the decline in net investment income was approximately $2.6 million of lower return on the deposit asset underlying a 10% coinsurance agreement and approximately $2.8 million in lower income from called fixed income securities as compared with 2014. Realized investment losses increased in 2015 compared to 2014 as we recognized a higher amount of impairments on certain investments in our invested asset portfolio which we deemed to be other-than-temporarily impaired as a result of factors specific to the issuer or our intent to sell the investment in the near term. Total revenue also decreased due to lower premiums attributable to the continued run-off of NBLIC’s non-term life insurance closed block, which included the student life insurance business that ceased writing new policies in 2014.
Total revenues decreased in 2014 from 2013 mainly due to the impact of net realized investment losses in 2014 versus net realized investment gains in 2013. Realized investment gains decreased in 2014 primarily due to the impact of approximately $6.7 million of income received in 2013 from the tender or sale of certain fixed income securities. In addition, we recognized approximately $4.0 million of impairment losses in 2014 on certain invested assets held at the Parent Company that we intended to sell to fund share repurchases, as well as credit impairments on certain other investments. Also contributing to the decline in total revenues was lower allocated net investment income in 2014 versus 2013 primarily driven by the year-over-year impact of approximately $7.9 million from a lower average yield on invested assets, partially offset by approximately $2.9 million in higher income given a higher average base of invested assets and the year-over-year increase of approximately $2.2 million in the positive mark-to-market adjustment to the deposit asset underlying a 10% coinsurance agreement. Net premiums and commissions and fees in 2014 remained consistent with 2013.
Interest expense on surplus note will fluctuate from period to period along with the principal amount of the surplus note based on the balance of reserves being contractually supported under a redundant reserve financing transaction used by our Vidalia Re, Inc. (“Vidalia Re”) captive insurance company. Investment income earned by our held-to-maturity invested asset, and included in allocated investment income net of investment expenses, completely offsets the interest expense on surplus note, thereby eliminating any impact on allocated net investment income. For more information on the redundant reserve financing transaction used by Vidalia Re, see Note 4 (Investments) to our consolidated financial statements included elsewhere in this report.
Total Benefits and Expenses. The decrease in total benefits and expenses in 2015 from 2014 was primarily due to reduced other operating expenses from the recognition of transition expenses for our former co-CEO’s incurred in 2014 as discussed below, partially offset by higher employee compensation costs from merit increases. In addition, other operating expenses were reduced by
We have an investment committee composed of members of our senior management team that is responsible for establishing and maintaining our investment guidelines and supervising our investment activity. Our investment committee regularly monitors our overall investment results and our compliance with our investment objectives and guidelines. We use a third-party investment advisor to assist us in the management of our investing activities. Our investment advisor reports to our investment committee.
The composition and duration of our portfolio will vary depending on several factors, including the yield curve and our opinion of the relative value among various asset classes. The year-end average rating, duration and book yield of our fixed-maturity portfolio (excluding our held-to-maturity security) were as follows:
2015 was partially offset by the impact of the weaker Canadian dollar on the DAC balance held by our Canadian insurance subsidiary as reported in U.S. dollars.
Dividends and other payments to the Parent Company from its subsidiaries are our principal sources of cash. The amount of dividends paid by the subsidiaries is dependent on their capital needs to fund future growth and applicable regulatory restrictions. The primary uses of funds by the Parent Company include the payments of stockholder dividends, interest on notes payable, general operating expenses, and income taxes, as well as repurchases of shares outstanding. During 2015, our life insurance underwriting companies declared and paid ordinary dividends of $62.6 million to the Parent Company. See Note 15 (Statutory Accounting and Dividend Restrictions) to our consolidated financial statements included elsewhere in this report for more information on insurance subsidiary dividends and statutory restrictions. In addition, our non-life insurance subsidiaries declared and paid dividends of approximately $86.5 million to the Parent Company in 2015. At December 31, 2015, the Parent Company had cash and invested assets of approximately $86.5 million.
The distribution and underwriting of term life insurance requires upfront cash outlays at the time the policy is issued as we pay a substantial majority of the sales commission during the first year following the sale of a policy and incur costs for underwriting activities at the inception of a policy’s term. During the early years of a policy’s term, we generally receive level term premiums in excess of claims paid. We invest the excess cash generated during earlier policy years in fixed-maturity and equity securities held in support of future policy benefit reserves. In later policy years, cash received from the maturity or sale of invested assets is used to pay claims in excess of level term premiums received.
Operating activities. The largest item contributing to the increase in operating cash flows in 2015 from 2014 was cash received from the collection of premium revenues in excess of benefits and claims paid in our Term Life Insurance segment. The additional layering of net premiums from term life insurance policies not subject to the IPO coinsurance transactions has continued to generate positive incremental cash flows after payments are made for policy acquisition costs during the first year that policies are issued. Operating cash flows also increased in 2015 compared to 2014 due to lower tax payments relative to income tax expense recorded in net income as a result of temporary tax basis differences in our term life insurance operations, as well as prepayments for Canadian tax remittance in prior years. The year-over-year growth in new life insurance policies issued resulted in higher cash payments for DAC in 2015 as compared with 2014, which partially offset the year-over-year increase in operating cash flows.
Cash flows from investing activities changed to a use of cash in 2014 from a source of cash in 2013, primarily due to activity in our available-for-sale invested asset portfolio. In 2014, cash proceeds from sales and maturities of available-for-sale investments were largely offset by purchases of available-for-sale investments. In 2013, net cash proceeds from available-for-sale investments were received and used to fund share and warrant repurchases. The decrease in net cash from available-for-sale investments in 2014 was partially offset by lower purchases of property and equipment in 2014 mostly from assets purchased in connection with the move of our corporate headquarters in 2013.
Financing activities. Net cash used in financing activities during 2015 increased compared to 2014 primarily due to a larger amount of shares that were repurchased, which the Company increased in 2015 given our assessment of the market prices for which we had been able to execute our share repurchases. In addition, an increase in the dividends per share from 2014 to 2015 contributed to a higher amount of cash used in financing activities.
Risk-Based Capital (“RBC”). The National Association of Insurance Commissioners (“NAIC”) has established RBC standards for U.S. life insurers, as well as a risk-based capital model act (the “RBC Model Act”) that has been adopted by the insurance regulatory authorities. The RBC Model Act requires that life insurers annually submit a report to state regulators regarding their RBC based upon four categories of risk: asset risk; insurance risk; interest rate risk and business risk. The capital requirement for each is determined by applying factors that vary based upon the degree of risk to various asset, premiums and policy benefit reserve items. The formula is an early warning tool to identify possible weakly capitalized companies for purposes of initiating further regulatory action.
In Canada, an insurer’s minimum capital requirement is overseen by the Office of the Superintendent of Financial Institutions (“OSFI”) and determined as the sum of the capital requirements for five categories of risk: asset default risk; mortality/morbidity/lapse risks; changes in interest rate environment risk; segregated funds risk; and foreign exchange risk. As of December 31, 2015, Primerica Life Canada was in compliance with Canada’s minimum capital requirements as determined by OSFI.
For more information regarding statutory capital requirements and dividend capacities of our insurance subsidiaries see Note 15 (Statutory Accounting and Dividend Restrictions) to our consolidated financial statements included elsewhere in this report for more information.
As of December 31, 2015, Primerica Life’s financial strength ratings were as follows:
Surplus Note. Vidalia Re issued a Surplus Note in exchange for a credit enhanced note (the “LLC Note”) as a part of the Vidalia Re Redundant Reserve Financing Transaction. The Surplus Note has a principal amount equal to the LLC Note and is scheduled to mature on December 31, 2029. For more information on the Surplus Note, see Note 10 (Debt) to our consolidated financial statements included elsewhere in this report.
Off-Balance Sheet Arrangements. Our off-balance sheet arrangements as of December 31, 2015 consisted of the letter of credit issued under the credit facility agreement with Deutsche Bank (the “Credit Facility Agreement”) and associated with the Peach Re Redundant Reserve Financing Transaction as described in Note 16 (Commitments and Contingent Liabilities) to our consolidated financial statements included elsewhere in this report.
Other policyholders’ funds primarily represent claim payments left on deposit with us.
Interest obligations (reported within other liabilities in our consolidated balance sheets) reflect expected interest on our notes payable, the financing charges related to an issued letter of credit, fees paid for the credit enhancement feature on our held-to-maturity invested asset, and a finance charge incurred pursuant to one of our coinsurance agreements as of December 31, 2015. We did not include the principal or interest on the Surplus Note in the table above as the payments due for these items are contractually offset by the principal
Commissions represent commissions that have been earned by our sales force but have not been paid as of December 31, 2015. We are only obligated to pay commissions as earned from sales of our products. The total liability amount is reported within other liabilities in our consolidated balance sheets.
We have audited the accompanying consolidated balance sheets of Primerica, Inc. and subsidiaries (the Company) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2015. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Primerica, Inc.’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 25, 2016 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Description of Business. Primerica, Inc. (the "Parent Company"), together with its subsidiaries (collectively, "we", "us" or the "Company"), is a leading distributor of financial products to middle income households in the United States and Canada. We assist our clients in meeting their needs for term life insurance, which we underwrite, and mutual funds, annuities and other financial products, which we distribute primarily on behalf of third parties. Our primary subsidiaries include the following entities: Primerica Financial Services, Inc. ("PFS"), a general agency and marketing company; Primerica Life Insurance Company ("Primerica Life"), our principal life insurance company; Primerica Financial Services (Canada) Ltd., a holding company for our Canadian operations, which includes Primerica Life Insurance Company of Canada ("Primerica Life Canada") and PFSL Investments Canada Ltd. ("PFSL Investments Canada"); and PFS Investments, Inc. ("PFS Investments") an investment products company and broker-dealer. Primerica Life, domiciled in Massachusetts, owns National Benefit Life Insurance Company ("NBLIC"), a New York insurance company. We established Peach Re, Inc. ("Peach Re") and Vidalia Re, Inc. (“Vidalia Re”) as special purpose financial captive insurance companies and wholly owned subsidiaries of Primerica Life. Peach Re and Vidalia Re have each entered into separate coinsurance agreements with Primerica Life whereby Primerica Life has ceded certain level premium term life insurance policies to Peach Re and Vidalia Re (respectively, the “Peach Re Coinsurance Agreement” and the “Vidalia Re Coinsurance Agreement”).
Use of Estimates. The most significant items that involve a greater degree of accounting estimates and actuarial determinations subject to change in the future are the valuation of investments, deferred policy acquisition costs (“DAC”), and liabilities for future policy benefits and unpaid policy claims, and income taxes. Estimates for these and other items are subject to change and are reassessed by management in accordance with U.S. GAAP. Actual results could differ from those estimates.
Foreign Currency Translation. Assets and liabilities of our Canadian subsidiaries are translated into U.S. dollars using year-end exchange rates. Revenues and expenses of our Canadian subsidiaries are translated monthly at amounts that approximate weighted-average exchange rates. Translation adjustments resulting from translating the financial statements of our Canadian subsidiaries into U.S. dollars are reported in other comprehensive income (loss).
Policy loans are carried at unpaid principal balances, which approximate fair value.
Investments are reviewed on a quarterly basis for OTTI. Credit risk, interest rate risk, the amount of time the security has been in an unrealized loss position, actions taken by ratings agencies, and other factors are considered in determining whether an unrealized loss is other-than-temporary. OTTI in our accompanying consolidated statements of income reflect the impairment on AFS securities that we intend to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For AFS fixed maturity securities that we have no intent to sell and believe that it is not more likely than not we will be required to sell prior to recovery, only the credit loss component of OTTI is recognized in our accompanying consolidated statements of income, while the remainder is recognized in other comprehensive income (“OCI”) in the accompanying consolidated statements of comprehensive income (loss). The credit loss component of OTTI recognized in net income is identified as the amount of principal cash flows not expected to be received over the remaining term of the security. Any subsequent changes (if not an other-than-temporary impairment) in the fair value of AFS securities are recognized in other comprehensive income in the accompanying statements of comprehensive income.
DAC. We only defer the costs of acquiring new business to the extent that they result directly from and are essential to the contract transaction(s) and would not have been incurred had the contract transaction(s) not occurred. These deferred policy acquisition costs mainly include commissions and policy issue expenses. All other acquisition-related costs, including unsuccessful acquisition and renewal efforts, are charged to expense as incurred. Also, administrative costs, rent, depreciation, occupancy, equipment, and all other general overhead costs are considered indirect costs and are charged to expense as incurred.
DAC for term life insurance policies is amortized over the initial premium-paying period of the related policies in proportion to premium income. DAC for Canadian segregated funds is amortized over the life of the underlying policies at a constant rate based on the present value of the estimated gross profits expected to be realized over the life of the underlying policies. DAC is subject to recoverability testing annually and when impairment indicators exist.
Depreciation expense is included in other operating expenses in the accompanying consolidated statements of income. Depreciation expense was $7.6 million, $7.0 million, and $7.3 million for the years ended December 31, 2015, 2014, and 2013, respectively.
The separate accounts are represented by individual variable annuity contracts. Purchasers of variable annuity contracts issued by Primerica Life Canada have a direct claim to the benefits of the contract that entitles the holder to units in one or more investment funds (the “Funds”) maintained by Primerica Life Canada. The Funds invest in assets that are held for the benefit of the owners of the contracts. The benefits provided vary in amount depending on the market value of the Funds’ assets. The Funds’ assets are administered by Primerica Life Canada and are held separate and apart from the general assets of the Company. The liabilities reflect the variable insurance annuity contract holders’ interests in variable annuity assets based upon actual investment performance of the respective Funds. Separate account operating results relating to contract holders’ interests are excluded from our consolidated statements of income.
Primerica Life Canada’s contract offerings guarantee the maturity value at the date of maturity (or upon death, whichever occurs first) to be equal to 75% of the sum of all contributions made, net of withdrawals, on a first-in first-out basis. Otherwise, the maturity value or death benefit will be the accumulated value of units allocated to the contract at the specified valuation date. The amount of this value is not guaranteed, but will fluctuate with the fair value of the Funds.
Commissions and Fees. We receive commission revenues from the sale of various non-life insurance products. Commissions are generally received on sales of mutual funds and annuities. We also receive trail commission revenues from mutual fund and annuity products based on the net asset value of shares sold by us. We, in turn, pay certain commissions to our sales force. Additionally, we receive marketing and support fees from product originators. We also receive management fees based on the average daily net asset value of managed investments and contracts related to separate account assets issued by Primerica Life Canada. We earn recordkeeping fees for administrative functions that we perform on behalf of several of our mutual fund providers and custodial fees for services performed as a non-bank custodian of our clients’ retirement plan accounts. We, in turn, pay a third-party provider for its servicing of certain of these accounts. Commissions and fees are recognized as income during the period in which they are earned.
Earnings Per Share (“EPS”). The Company has outstanding common stock and equity awards that consist of restricted stock, restricted stock units (“RSUs”), and stock options. The restricted stock and RSUs maintain non-forfeitable dividend rights that result in dividend payment obligations on a one-to-one ratio with common shares for any future dividend declarations. Unvested restricted stock and unvested RSUs are deemed participating securities for purposes of calculating EPS as they maintain dividend rights.
New Accounting Principles. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 clarifies the principles for recognizing revenue by establishing the core principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue that is recognized. Insurance contracts are specifically excluded from the scope of ASU 2014-09 and therefore revenue from our insurance product lines will not be affected by the new standard. The amendments in ASU 2014-09, as updated by ASU No. 2015-14, are effective retrospectively for the Company beginning in fiscal year 2018. Early adoption is not permitted. While we are still in the process of evaluating the guidance in ASU 2014-09, we do not expect it will have a material impact on our consolidated financial statements.
After the sale, we no longer had significant continuing involvement in the operations of DBL, and its direct cash flows have been eliminated from our ongoing operations. As a result, beginning in 2014, the results of operations for DBL have been reported in discontinued operations for all periods presented in the consolidated statements of income. We had no assets or liabilities related to DBL as of December 31, 2015 and 2014. The results of DBL included in discontinued operations were as follows:
We also have a Corporate and Other Distributed Products segment, which consists primarily of revenues and expenses related to the distribution of non-core products, allocated net investment income, prepaid legal services and various financial products other than our core term life insurance products generally underwritten or offered by third-party providers. All of the Company’s net investment income, except for the portion allocated to the Term Life Insurance segment that represents the assumed interest accreted to its U.S. GAAP-measured future policy benefit reserve liability less DAC, is attributed to the Corporate and Other Distributed Products segment. The results of operations for DBL were previously reported in our Corporate and Other Distributed Products segment and have been reclassified into discontinued operations as discussed in Note 2 (Discontinued Operations).
Prior to this change, invested assets were allocated to the Term Life Insurance segment based on the book value of the invested assets necessary to meet statutory reserve requirements. Net investment income was allocated based on the ratio of invested assets allocated to the Term Life Insurance segment and the remaining balances of invested assets and net investment income were attributed to the
The use of captive insurance companies has provided the Company with an efficient method of supporting the portion of statutorily-prescribed term life insurance benefit reserves that are redundant. Accordingly, the net investment income earned by the Company’s invested assets is no longer aligned directly with the level of statutory reserves in the Term Life Insurance segment. As such, the updated measurement of segment results is also consistent with the Company’s strategies for managing capital, which have evolved over time with the use of captive insurance company financing transactions.
Includes approximately $0.7 million of OTTI losses related to corporates and mortgage- and asset-backed securities recognized in accumulated other comprehensive income.
The LLC Note is classified as a held-to-maturity debt security in the Company’s invested asset portfolio as we have the positive intent and ability to hold the security until maturity. As of December 31, 2015, the LLC Note, which was rated A+ by Fitch Ratings, had an estimated unrealized holding gain of $6.5 million based on its amortized cost and estimated fair value, which is derived using the valuation techniques described in Note 5 (Fair Value of Financial Instruments).
Securities Lending Transactions. We participate in securities lending transactions with broker-dealers and other financial institutions to increase investment income with minimal risk. We require minimum collateral on securities loaned equal to 102% of the fair value of the loaned securities. We accept collateral in the form of securities, which we are not able to sell or encumber, and to the extent the collateral declines in value below 100%, we require additional collateral from the borrower. Any securities collateral received is not reflected on our consolidated balance sheets. We also accept collateral in the form of cash, all of which we reinvest. For loans involving unrestricted cash collateral, the collateral is reported as an asset with a corresponding liability representing our obligation to return the collateral. We continue to carry the loaned securities as invested assets on our consolidated balance sheets during the terms of the loans, and we do not report them as sales. Cash collateral received and reinvested was approximately $71.5 million and $50.2 million as of December 31, 2015 and 2014, respectively.
Analysis of residential mortgage-backed securities based on loss projections provided by models compared to current credit enhancement levels;
Analysis of our other fixed-maturity and equity security investments, as required based on the type of investment; and
The securities noted above were considered to be other-than-temporarily impaired due to our intent to sell them; adverse credit events, such as news of an impending filing for bankruptcy; analyses of the issuer’s most recent financial statements or other information in which liquidity deficiencies, significant losses and large declines in capitalization were evident; or analyses of rating agency information for issuances with severe ratings downgrades that indicated a significant increase in the possibility of default. We also recognized impairment losses related to invested assets held at the Parent Company that we intended to sell to fund share repurchases, as well as credit impairments on certain other investments.
As of December 31, 2015, the unrealized losses on our AFS invested asset portfolio were largely caused by increases in credit spreads. We believe that fluctuations caused by movement in interest rate and credit spreads have little bearing on the recoverability of our investments. We do not consider these investments to be other-than-temporarily impaired because we have the ability to hold these investments until maturity or a market price recovery, and we have no present intention to dispose of them.
We have a deferred loss related to closed forward contracts, which were settled several years ago, that were used to mitigate our exposure to foreign currency exchange rates that resulted from the net investment in our Canadian operations. The amount of deferred loss included in accumulated other comprehensive income was approximately $26.4 million as of December 31, 2015 and 2014. While we have no current intention to do so, these deferred losses will not be recognized until such time as we sell or substantially liquidate our Canadian operations.
In assessing fair value of our investments, we use a third-party pricing service for approximately 95% of our securities that are measured at fair value on a recurring basis. The remaining securities are primarily thinly traded securities such as private placements and are valued using models based on observable inputs on public corporate spreads having similar characteristics (e.g., sector,
average life and quality rating) and liquidity and yield based on quality rating, average life and treasury yields. All observable data inputs are corroborated by independent third-party data. In the absence of sufficient observable inputs, we utilize non-binding broker quotes, which are reflected in our Level 3 classification as we are unable to evaluate the valuation technique(s) or significant inputs used to develop the quotes. Therefore, we do not internally develop the quantitative unobservable inputs used in measuring the fair value of Level 3 investments. However, we do corroborate pricing information provided by our third-party pricing servicing by performing a review of selected securities. Our review activities include obtaining detailed information about the assumptions, inputs and methodologies used in pricing the security; documenting this information; and corroborating it by comparison to independently obtained prices and or independently developed pricing methodologies.
The roll-forward of the Level 3 assets measured at fair value on a recurring basis was as follows:
We obtain independent pricing quotes based on observable inputs as of the end of the reporting period for all securities in Level 2. Those inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers, quoted prices for similar instruments in markets that are not active, and other relevant data. We monitor these inputs for market indicators as well as industry and economic events. We recognize transfers into new levels and out of previous levels as of the end of the reporting period, including interim reporting periods, as applicable. There were no material transfers between Level 1 and Level 3 during the year ended December 31, 2015. We transferred a $1.0 million security from Level 1 to Level 2 during the year ended December 31, 2015 as it was not consistently trading in an active market. There were no material transfers between Level 1 and Level 2 or Level 1 and Level 3 during the year ended December 31, 2014.
Nonrecurring fair value measurements. The estimated fair value of the held-to-maturity fixed-maturity security, which is classified as a Level 3 fair value measurement, is derived using the credit spread on similarly rated debt securities and the hypothetical spread of the security’s credit enhancement feature. Policy loans, which are categorized as Level 3 fair value measurements, are carried at the unpaid principal balances. The fair value of policy loans approximate the unpaid principal balances as the timing of repayment is uncertain and the loans are collateralized by the amount of the policy. The deposit asset underlying the 10% Coinsurance Agreement represents the value of the assets necessary to back the economic reserves held in support of the reinsurance agreement. The carrying value of this deposit asset approximates fair value, which is categorized as Level 3 in the fair value hierarchy. Notes payable represent our publicly-traded senior notes and are valued as a Level 2 fair value measurement using the quoted market price for our notes. The estimated fair value of the Surplus Note is derived by using an assumed credit spread we would expect if Vidalia Re was a credit-rated entity and the hypothetical spread of the Surplus Note’s subordinated structure. The Surplus Note is classified as a Level 3 fair value measurement.
The carrying amounts for cash and cash equivalents, receivables, accrued investment income, accounts payable, cash collateral and payables for security transactions approximate their fair values due to the short-term nature of these instruments. Consequently, such instruments are not included in the above table.
In connection with our corporate reorganization that included an initial public offering (“IPO”) of our common stock by Citigroup, Inc. (“Citigroup”), Primerica Life, Primerica Life Canada and NBLIC entered into significant coinsurance transactions (the “IPO coinsurance agreements”) on March 30, 2010 with three insurance companies then affiliated with Citigroup (collectively, the “IPO coinsurance”). Under the IPO coinsurance agreements, we ceded between 80% and 90% of the risks and rewards of our term life insurance policies in force at year-end 2009. Because these agreements were part of a business reorganization among entities under common control, they did not generate any deferred gain or loss upon their execution. Concurrent with signing these agreements, we transferred the corresponding account balances in respect of the coinsured policies along with the assets to support the statutory liabilities assumed by the IPO coinsurers. Each of the account balances transferred were at book value with no gain or loss recorded in net income.
Reinsurers are affiliates of Citigroup. Amounts shown are net of their share of the reinsurance receivable from other reinsurers.
Certain reinsurers with which we do business receive group ratings. Individually, those reinsurers are SCOR Global Life Americas Reinsurance Company, SCOR Global Life U.S.A. Reinsurance Company, SCOR Global Life Re Insurance Company of Delaware, and SCOR Global Life of Canada.
The Funds primarily consist of a series of banded investment funds known as the Asset Builder Funds and a money market fund known as the Cash Management Fund. In 2014, the Funds introduced a registered retirement income fund known as the Strategic Retirement Income Fund (“SRIF”). The principal investment objective of the Asset Builder Funds is to achieve long-term growth while preserving capital. The principal objective of the SRIF is to provide a stream of investment income during retirement plus the opportunity for modest capital appreciation. The Asset Builder Funds and the SRIF use diversified portfolios of publicly-traded Canadian stocks, investment-grade corporate bonds, Government of Canada bonds, and foreign equity investments to achieve their objectives. The Cash Management Fund invests in government guaranteed short-term bonds and short-term commercial and bank papers, with the principal investment objective being the provision of interest income while maintaining liquidity and preserving capital.
We periodically assess the exposure related to these contracts to determine whether any additional liability should be recorded. As of December 31, 2015 and 2014, an additional liability for these contracts was deemed to be unnecessary.
At December 31, 2015, we had $375.0 million in principal amount of publicly-traded, senior unsecured notes (the “Senior Notes”). The Senior Notes were issued in 2012 at a price of 99.843% of the principal amount with an annual interest rate of 4.75%, payable semi-annually in arrears on January 15 and July 15, and are scheduled to mature on July 15, 2022. We were in compliance with the covenants of the Senior Notes at December 31, 2015. No events of default occurred on the Senior Notes during the year ended December 31, 2015.
Surplus Note. As of December 31, 2015, the principal amount outstanding on the Surplus Note issued by Vidalia Re was approximately $365.2 million, equal to the principal amount of the LLC Note invested asset. The Surplus Note was issued in exchange for the LLC Note, which supports certain obligations of Vidalia Re for a portion of the statutory accounting-based reserves (commonly referred to as Regulation XXX reserves) related to the Vidalia Re Coinsurance Agreement. The principal amount of the Surplus Note and the LLC Note will fluctuate over time to coincide with the amount of reserves contractually supported. Both the LLC Note and the Surplus Note mature on December 31, 2029 and bear interest at an annual interest rate of 4.50%. Based on the estimated reserves for ceded policies issued in 2011, 2012, 2013, and 2014, the maximum principal amounts of the Surplus Note and the LLC Note are expected to be approximately $915.0 million each. This financing arrangement is non-recourse to the Parent Company and Primerica Life, meaning that neither of these companies has guaranteed the Surplus Note or is otherwise liable for reimbursement for any payments triggered by the credit enhancement feature underlying the LLC Note. The Parent Company has agreed to support Vidalia Re’s obligation to pay the credit enhancement fee incurred on the LLC Note.
The Company has state net operating losses resulting in a deferred tax asset of approximately $8.9 million, which are available for use through 2035. The Company has no other material net operating loss or credit carryforwards.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, carryback and carryforward periods, and tax planning strategies in making this assessment. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. Therefore, there was no deferred tax asset valuation allowance at December 31, 2015 or 2014.
The total amount of unrecognized benefits on uncertain tax positions that, if recognized, would affect our effective tax rate was approximately $9.3 million and $8.9 million as of December 31, 2015 and 2014, respectively. We recognize interest expense related to unrecognized tax benefits in tax expense net of federal income tax. As of December 31, 2015 and 2014, the total amount of accrued interest and penalties in the consolidated balance sheets were approximately $2.0 million and $2.6 million, respectively. Additionally, we recognized interest related to unrecognized tax benefits in the consolidated statements of income of less than $0.1 million of expense in 2015, 2014, and 2013.
In connection with our corporate reorganization, we entered into a tax separation agreement with Citigroup, whereby Citigroup agreed to indemnify the Company against any consolidated, combined, affiliated, unitary or similar federal, state or local income tax liability related to any taxable period ending on or before April 2010. As of December 31, 2015, the Company had a Citigroup tax indemnification asset of $1.7 million.
The Company has outstanding common stock and equity awards that consist of restricted stock, RSUs and stock options. The restricted stock and RSUs maintain non-forfeitable dividend rights that result in dividend payment obligations on a one-to-one ratio with common shares for any future dividend declarations.
In calculating basic EPS, we deduct any dividends and undistributed earnings allocated to unvested restricted stock and unvested RSUs from net income and then divide the result by the weighted-average number of common shares and vested RSUs outstanding for the period.
We determine the potential dilutive effect of warrants and stock options outstanding on EPS using the treasury-stock method. Under this method, we determine the proceeds that would be received from the exercise of the warrants and stock options outstanding, which includes cash received for the exercise price, the remaining unrecognized stock option compensation expense and the resulting effect on the income tax deduction from the exercise of stock options. We then use the average market price of our common shares during the period the warrants and stock options were outstanding to determine how many shares we could repurchase with the proceeds raised from the exercise of the warrants and stock options outstanding. The net incremental share count issued represents the potential dilutive securities. We then reallocate earnings to common shares and vested RSUs by incorporating the increased fully diluted share count to determine diluted EPS.
Prior to 2014, management of the Company’s U.S. based subsidiaries received restricted stock and management of the Company’s Canadian subsidiaries received RSUs. These awards have time-based vesting requirements with equal and annual graded vesting over approximately three years subsequent to the grant date.
In 2013, non-employee directors received RSUs that have time-based vesting requirements that lapsed approximately one year after the grant date. These awards also contain post-vesting sale restrictions until the non-employee director no longer serves on our Board.
The following table summarizes activity related to stock options outstanding and exercisable during the years ended December 31, 2015 and 2014.
As of December 31, 2015, there was approximately $0.3 million of total unrecognized compensation cost related to unvested options, and the weighted-average period over which cost will be recognized was approximately 0.7 years.
The following table summarizes non-employee RSU activity during the years ended December 31, 2015, 2014, and 2013.
U.S. Insurance Subsidiaries. Our two underwriting U.S. insurance subsidiaries are Primerica Life and NBLIC. Primerica Life wholly owns Peach Re and Vidalia Re, and ceded to each in separate coinsurance arrangements certain level premium term life insurance policies.
Massachusetts Division of Insurance (“Massachusetts DOI”) and includes the statutory financial statements of its wholly owned insurance subsidiaries, NBLIC, Peach Re, and Vidalia Re. NBLIC’s statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the NAIC and the New York State Department of Financial Services, while the statutory financial statements of Peach Re and Vidalia Re are prepared on the basis of accounting practices prescribed or permitted by the NAIC and the Vermont Department of Financial Regulation (“Vermont DOI”). Our U.S. insurance subsidiaries’ ability to pay dividends to their parent is subject to and limited by the various laws and regulations of their respective states. There are no regulatory restrictions on the ability of the Parent Company to pay dividends.
Primerica Life’s statutory net gain from operations was approximately $436.3 million, $267.4 million and $306.7 in 2015, 2014 and 2013, respectively. Primerica Life made no pro rata distributions of any class of its own securities during 2015. During 2015, Primerica Life paid ordinary dividends of $45.6 million to the Parent Company and had estimated ordinary dividend capacity of approximately $48.7 million as of January 1, 2016.
of our prior executive and home office operations. The initial lease term is 15 years with estimated minimum annual rental payments ranging from approximately $4.5 million at inception to approximately $5.6 million in year 15.
As of December 31, 2015 and 2014, we had no material capital leases.
Under the Credit Facility Agreement, Deutsche Bank issued a letter of credit in the initial amount of $450.0 million with a term of approximately 14 years (the “LOC”) for the benefit of Primerica Life, the direct parent of Peach Re. Subject to certain conditions, the amount of the LOC periodically increased up to a maximum amount of approximately $507.0 million, which was reached in 2014. Pursuant to the terms of the Credit Facility Agreement, in the event amounts are drawn under the LOC by Primerica Life, Peach Re will be obligated, subject to certain limited conditions, to reimburse Deutsche Bank for the amount of any draws and interest thereon. Peach Re has collateralized its obligations to Deutsche Bank by granting it a security interest in all of its assets with the exception of amounts held in a special account established to meet minimum asset thresholds required by state regulatory authorities. As of December 31, 2015, the Company was in compliance with all financial covenants under the Credit Facility Agreement.
Contingent Liabilities. The Company is involved from time to time in legal disputes, regulatory inquiries and arbitration proceedings in the normal course of business. These disputes are subject to uncertainties, including the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation. As such, the Company is unable to estimate the possible loss or range of loss that may result from these matters unless otherwise indicated.
The Company is currently undergoing multi-state treasurer unclaimed property audits by 30 jurisdictions focusing on the life insurance claims paying practices of its subsidiaries, Primerica Life and NBLIC. Primerica Life is subject to a multi-state market conduct exam also regarding its life insurance claims paying practices. The West Virginia State Treasurer brought a suit against Primerica Life and other insurance companies alleging violations of the West Virginia unclaimed property act. Other jurisdictions may pursue similar audits, examinations and litigation. The potential outcome of such actions is difficult to predict but could subject the Company to adverse consequences, including, but not limited to, settlement payments, additional payments to beneficiaries and additional escheatment of funds deemed abandoned under state laws. At this time, the Company cannot reasonably estimate the likelihood or the impact of additional costs or liabilities that could result from the resolution of these matters.
We sponsor a defined contribution plan for the benefit of our employees. The expense associated with this plan was approximately $6.7 million, $6.5 million, and $6.5 million in 2015, 2014, and 2013, respectively.