JPCC owns its three television studios and office buildings, owns most of its radio studios and offices, and owns or leases the towers supporting its radio and television antennas.
JEFFERSON-PILOT CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company has four business segments: Life Insurance Products, Annuity and Investment Products (AIP), Communications, and Corporate and Other. Within the Life Insurance Products segment, JP offers individual life and group insurance products. Life insurance, accident and health insurance, and annuities are currently marketed to individuals and businesses in the United States through the Company's principal life insurance subsidiaries: Jefferson - -Pilot Life Insurance Company (JP Life), Alexander Hamilton Life Insurance Company of America and its subsidiary First Alexander Hamilton Life Insurance Company (collectively, AH Life), and Jefferson Pilot Financial Insurance Company (formerly named Chubb Life Insurance Company of America) and its subsidiary, Jefferson Pilot LifeAmerica Insurance Company (JPLA, formerly named Chubb Colonial Life Insurance Company). Chubb Sovereign Life Insurance Company, formerly a subsidiary of JP Financial, was merged into JP Financial in 1998.
Communications operations are conducted by Jefferson-Pilot Communications Company (JPCC) and consist of radio and television broadcasting properties located in strategically selected markets in the Southeastern and Western United States, and sports program production.
Corporate and Other contains the activities of the parent company and passive investment affiliates, surplus of the life insurance subsidiaries not allocated to other reportable segments including earnings thereon, financing expenses on Corporate debt and debt securities including Capital Securities and mandatorily redeemable preferred stock, and federal and state income taxes not otherwise allocated to business segments.
JP's acquisition strategy is designed to deploy capital to enhance its core business growth. The focus of such acquisitions is to increase distribution, add product offerings, and provide economies of scale. In May 1997, the Company acquired Jefferson Pilot Financial Insurance Company and its subsidiary, JPLA (collectively, JP Financial). The discussion of this acquisition and other significant transactions in Note 1 is incorporated herein by reference.
In the following discussion "operating income" means income from operations before realized investment gains, but after dividends on Capital Securities and mandatorily redeemable preferred stock, except where otherwise indicated.
Operating income increased 21.3% in 1998 and 14.4% in 1997 due primarily to increased profitability in the Life Insurance Products and Annuities and Investment Products segments. 1998's results reflected the acquisition of JP Financial for twelve months, whereas 1997's results only included eight months' operations. Also, due to efforts to improve the economics of group health products, 1998's results benefited from a return to profitability of these coverages. Excluding the earnings impact of JP Financial (less related financing costs) and group medical results, operating income increased approximately 10% in 1998 and 1997.
Reportable segments are determined in a manner consistent with the way management organizes for purposes of making operating decisions and assessing performance. Invested assets backing insurance liabilities are assigned to segments in relation to policyholder funds and reserves. Net deferred acquisition costs incurred or purchased, reinsurance receivables and communications assets are assigned to segments based on specific identification. Assets are also assigned to back capital allocated to each segment in relation to JP's philosophy for managing business risks, reflecting appropriate conservatism.
The Life Insurance Products (Life Insurance) segment offers a wide array of individual and group insurance policies through a career agency force, independent agents recruited through independent marketing organizations and a regional marketing network, home service agents, financial institutions, workplace marketing representatives, and a targeted marketing division.
Life Insurance recorded increases in operating income of 26.6% in 1998 and 29.5% in 1997. In 1998, individual products contributed a 20.1% increase while group products improved 151.6% due to aggressive rate increases and expense management. In 1997, individual products operating income increased 44.2%, due to acquisitions and internal growth, while group products declined 56.6% in a very competitive marketplace for continuing writers of medical coverages. The following table summarizes operating income for each category:
Life Insurance revenues increased only 2.3% in 1998 because of declines in group premiums, and increased 24.0% in 1997 as a result of the JP Financial acquisition. Revenues include traditional insurance premiums, policy charges and investment income. Individual revenues increased 16.3% in 1998 and 41.8% in 1997 due to growth in core businesses from acquisitions and internal growth. To a large degree, increases in individual revenues are driven by growth in average policyholder fund balances, which increased 23.5% in 1998 and 44.4% in 1997. Group revenues declined 33.9% in 1998 and 6.4% in 1997, because the medical rate increases implemented resulted in non-renewals by certain customers.
Investment income on assets assigned to the Life Insurance segment improved 16.5% and 34.3% in 1998 and 1997, following the growth in segment assets. Total portfolio yields have declined as a result of lower investment rates and credit spreads on new investment opportunities. The portfolio yield on traditional assets declined 12 basis points in 1998 versus 26 basis points in 1997. Due to effective management of asset/liability risks, the average investment spread (calculated as the difference between portfolio yields earned on invested assets less interest credited to policyholder funds,
assuming the same level of invested assets) on UL products decreased 9 basis points in 1998 to 1.63% and remained unchanged in 1997 at 1.72%. In addition to being impacted by portfolio yields and crediting rates, interest spreads may vary over time due to competitive strategies and changes in product design.
Policy benefits declined 6.1% in 1998, primarily due to group medical products, and increased 19.7% in 1997, primarily due to the JP Financial acquisition. Traditional policy benefits improved to 85.0% of premiums in 1998 versus 89.3% and 90.1% in 1997 and 1996. The improvement is attributable to aggressive rate actions taken to restore the profitability of group medical policies, which also resulted in the decline in premiums and premium equivalents. As a result of these actions, the group medical incurred loss ratio improved to 72% in 1998 versus 87% and 84% in 1997 and 1996. Policy benefits on UL-type products improved to 8.2% of average policyholder funds in 1998 versus 8.7% in 1997 and 1996. The improvement is due, in approximately equal measure, to favorable mortality and lower credited rates on policyholder accounts.
Revenues increased 1.2% in 1998 and 13.0% in 1997. Annuity revenues are derived from policy charges, investment income on segment assets and from concession income earned on investment product sales by Jefferson Pilot Securities Corporation (JPSC), a registered broker-dealer, and related entities. The increases in revenues are primarily related to increases in average policyholder fund balances including separate accounts which grew 2.4% in 1998 and 7.1% in 1997. The increases in policyholder fund balances results from interest credited and new receipts less benefits paid and withdrawals. The decline in fixed annuity receipts during 1998's low interest rate environment occurred as fixed rate products were perceived less favorably than other fixed interest investments, and as potential customers chose variable annuities on the strength of United States equity markets. Fixed annuity benefits and surrenders as a percentage of beginning fund balances were 15.8%, 15.0% and 13.4% in 1998, 1997 and 1996. Annuity surrenders may increase in relation to the portion of the business that can be withdrawn by policyholders without incurring a surrender charge. Other income includes concession income earned by JPSC and increased substantially in 1998 and 1997, subsequent to JPSC's acquisition as a part of the JP Financial acquisition.
Policy benefits as a percentage of average policyholder fund balances were 5.2%, 5.7% and 5.8% in 1998, 1997 and 1996. These declines as well as the declines in premiums are primarily attributable to a reclassification for 1998 of certain single premium annuity products as interest-sensitive rather than as traditional products. This reclassification had no effect on operating income. During 1997 and 1996, $16 and $54 of premiums associated with such products were reported as revenues, with similar amounts included in policy benefits. Interest credited represented 5.1%, 5.1% and 4.7% of average policyholder fund balances in 1998, 1997 and 1996. Effective spreads, which represent the yield on the investment portfolio less interest credited to policyholders, adjusted for net deferral of bonus interest and assuming the same level of assets, remained relatively constant at 2.11%, 2.13% and 2.09% for 1998, 1997 and 1996. This occurred in spite of a decline in portfolio yields to 7.38% in 1998 versus 7.44% in 1997 and 7.43% in 1996, due to effective asset/liability management.
Insurance expenses as a percentage of average policyholder fund balances including separate accounts were 0.64%, 0.68% and 0.67% for 1998, 1997 and 1996. In 1997, expenses were negatively impacted by a one-time expense for the relocation of annuity administrative functions to the Greensboro home office. The growth in AIP expenses in 1998 and 1997 was primarily due to broker/dealer operations, similar to the increases in other income. Broker/ dealer expenses, which include commission expense, as a percentage of concession income were 91.1%, 95.1% and 83.3% for 1998, 1997 and 1996. The percentage for 1996 is not comparable because it precedes the JP Financial acquisition.
Average AIP assets increased 4.2% in 1998. In 1997, average assets increased 13.2%, due largely to the JP Financial acquisition. AIP posted returns on average assets of 1.09% in 1998, 1.02% in 1997 and 1.00% in 1996. The 1998 increase is primarily due to earnings of JPSC which were $3 and $1 in 1998 and 1997, as well as effective expense management.
Broadcast cashflow grew by 16.5% and 12.1% in 1998 and 1997, respectively, as the strong growth of the broadcast properties, particularly Radio in 1998 and TV in 1997, was partially offset by the results of Sports.
Total expenses (comprised of operating costs and expenses, depreciation and amortization, and corporate general and administrative expenses) decreased 3.4% in 1998 and increased 1.2% in 1997. Expenses as a percent of communication revenues for 1997 and 1996 of 74.5% and 76.2% decreased to 70.4% for 1998. The 1998 and 1997 decreases were attributable to a change in the mix of business away from lower margin sports products toward higher margin broadcast business, and improved expense control.
Operating income declined 5.6% in 1998, compared to a decline of 53.9% in 1997 which resulted from the redeployment of capital into the Company's core businesses and the acquisition of JP Financial. The results of this segment may vary from year to year due to expenses associated with strategic activities, income recorded on equity-method investments, transfers of assets to and from business segments as well as refinements in asset assignments and investment income allocation methodologies to other reportable segments.
Earnings on investments increased 9.2% in 1998 compared to 3.7% in 1997 primarily due to growth in investment income on surplus not assigned to the other reportable segments and increased income from equity method investments. Acquisition financing accounts for the increase in interest expense and dividends on Capital Securities and mandatorily redeemable preferred stock for both 1998 and 1997. Operating expenses in 1998 increased by non-recurring expenses of $2.5 related to the recording of surplus furniture and equipment at its net realizable value and $3.0 associated with promoting the new brand name, Jefferson Pilot Financial. Federal and state income tax expense includes the tax benefits of preferred dividends on Capital Securities; such dividends are recorded gross of related tax effects.
JP's primary resources are investments related to its Life Insurance Products and AIP segments, properties and other assets utilized in all segments and investments backing corporate capital. The Investments section reviews the Company's investment portfolio and key strategies.
The Life Insurance Products and Annuities and Investment Products segments defer the costs of acquiring new business, including commissions, first year bonus interest, certain costs of underwriting and issuing policies plus agency office expenses (referred to as DAC). Such amounts deferred were $844 and $742 at December 31, 1998 and 1997, an increase of 13.7%.
Value of business acquired (VOBA) represents the actuarially-determined present value of future gross profits of each business acquired. VOBA of $482 was recorded during 1997 related to the JP Financial acquisition. Note 6 contains rollforwards of DAC and VOBA for 1998, 1997 and 1996, and is incorporated herein by reference.
Goodwill (representing the cost of acquired businesses in excess of the fair value of net assets) was $229 and $225 at December 31, 1998 and 1997, with the net increase due to final allocation of purchase price related to the JP Financial acquisition. Goodwill as a percentage of shareholders' equity was 7.5% and 8.2% at year end 1998 and 1997.
JP considers existing capital resources to be more than adequate to support the current level of its business activities. The business plan places priority on redirecting certain capital resources invested in bonds and stocks into its core businesses, such as the JP Financial acquisition, which would be expected to produce higher returns over time.
Short-term borrowings outstanding of $289 and $285 as of December 31, 1998 and 1997 consisted of commercial paper. The weighted average interest rates were 5.61% and 6.02% as of December 31, 1998 and 1997. The maximum commercial paper outstanding during 1998 and 1997 was $302 and $317.
JP has sold U. S. Treasury obligations and collateralized mortgages under repurchase agreements involving various counterparties, accounted for as financing arrangements. Proceeds are used to purchase securities with longer durations as an asset/liability management strategy. The maximum amounts outstanding were $290 and $242 during 1998 and 1997. The securities involved had a fair value and amortized cost of $303 and $232, and $287 and $241, as of year end 1998 and 1997.
In April 1997, the Company privately placed $75 of 6.95% Mandatorily Exchangeable Debt Securities (MEDS) and in June 1997, the Company privately placed $75 of 6.65% MEDS. The discussion of these issuances and the previously issued Automatic Common Exchange Securities (ACES) in Note 8 is incorporated herein by reference.
Of the $53 of mandatorily redeemable preferred stock outstanding at December 31, 1997, $50 was redeemed upon the request of the holder in April 1998 at par plus accrued dividends. The remaining $3 was repurchased and canceled as of January 1, 1999.
Cash provided by operations for 1998, 1997 and 1996 was $435, $516 and $998. In 1996, cash flow from operations was impacted by the receipt of $462 in conjunction with the retrocession assumption of periodic payment annuities from HI. Cash flows from operations may decline as the Company's policy receipts continue to shift from traditional products (which are reflected in operating cash flows) to interest sensitive products (which are reflected in financing cash flows).
Net cash used in investing activities was $716, $1,173 and $1,124 for 1998, 1997 and 1996. The Company used cash of $758 in 1997 to acquire JP Financial. The 1996 amount included the investing of the $462 received from HI mentioned in the preceding paragraph. Sales of securities available for sale were $465, $1,614 and $500 in 1998, 1997 and 1996. Sales of securities in 1997 were used to partially fund the JP Financial acquisition. Total maturities, calls, and redemptions were $1,379, $839 and $1,276 in 1998, 1997 and 1996.
In order to meet the parent company's dividend payments, debt servicing obligations and other expenses, internal dividends are received from the subsidiary companies. Total internal cash dividends paid to the parent company from its subsidiaries during 1998, 1997 and 1996 were $235, $391 and $156. JP Life and AH Life were the primary source of dividends in 1998. The Company's life insurance subsidiaries are subject to laws in the states of domicile that limit the amount of dividends that can be paid without the prior approval of the respective State's Insurance Commissioner. Approximately 20% of the amount of dividends planned from life subsidiaries for 1999 will require regulatory approval. The Company has no reason to believe that such approval will be withheld.
Cash and short-term investments were $21, $9 and $105 at December 31, 1998, 1997 and 1996. Additionally, fixed income and equity securities held by the parent company and non-regulated subsidiaries were $538, $564 and $483 at December 31, 1998, 1997 and 1996. These securities, less the $325 (at December 31, 1998) of BankAmerica Corporation common stock which supports the Exchangeable Securities, are considered to be sources of liquidity to support the Company's strategies. Total trading securities and debt and equity securities available for sale at December 31, 1998 and 1997 were $11,907 and $11,048.
The strategy of identifying market sectors and niches that provide investment opportunities to meet the portfolios' growth, quality and yield requirements is expected to continue to result in increasing percentages of private placements and commercial mortgage loans.
Collateralized Mortgage Obligations (CMO's), which are included in debt securities available for sale, as of December 31 were:
Like most if not all companies, JP faces certain risks associated with the coming of the year 2000. The year 2000 issue relates to the way computer systems and programs define calendar dates. By using only two digit dates, they could fail or make miscalculations due to the inability to distinguish between dates in the 1900's and in the 2000's. Also, many systems and equipment that are not typically thought of as "computer-related" (referred to as "non-IT") contain embedded hardware or software that must handle dates and may not properly perform with dates after 1999.
The Company began work on the Year 2000 compliance issue in 1995. The scope of the project includes: ensuring the compliance of all applications, operating systems and hardware on mainframe, PC and LAN platforms; addressing issues related to non-IT embedded software and equipment; and addressing the compliance of key vendors and service providers to the Company (business partners).
For the majority of the Company's non-IT related systems and equipment, the Company has been advised by vendors that the systems and equipment are currently Year 2000 compliant. Written documentation regarding compliance is being obtained. Where feasible, certification testing will be conducted for systems and equipment that are material to operations. Some systems and equipment, such as electrical power supply, are not feasible for the Company to certify. Completion for non-IT systems and equipment is scheduled for September 1999.
Since inception of the project, the Company has incurred external costs of $7 and internal costs of $7. The current estimate, based on actual experience to date, of total project expense is $24, with remaining external costs of $5 and internal costs of $5. Costs are included in various budgets and expensed as incurred. Expected total costs are less than earlier estimates due in part to refinements in estimates as more projects near completion. In addition, remediation/certification costs on projects completed to date have been lower than originally estimated. Total 1998 costs were $8. There has not been a material adverse impact on the Company's operations as a result of IT projects being deferred due to resource constraints caused by the Year 2000 project.
Specifically, from Year 2000 problems, the Company could experience an interruption in its ability to collect and process premiums, process claim payments, safeguard and manage its invested assets and operating cash accounts, accurately maintain policyholder information, accurately maintain accounting records, issue new policies and/or perform adequate customer service. JPCC could experience an inability to broadcast commercial spots and invoice them, or to receive TV network programming. While the Company believes the occurrence of such a situation is unlikely, a possible worst case scenario might include one or more of the Company's significant policyholder systems or broadcasting inventory management systems being non-compliant. Such an event could result in a material disruption to the Company's or JPCC's operations. Should the worst case scenario occur (except in JPCC), it could, depending on its duration, have a material impact on the Company's results of operations and liquidity and ultimately on its financial position.
The Company also considers the timing of cash flows arising from market risk sensitive instruments (other than trading) and insurance portfolios under varying interest rate scenarios as well as the related impact on reported earnings under those varying scenarios. Market risk sensitive instruments (other than trading) include debt and equity securities available for sale and held to maturity, mortgage loans, policy loans, investment commitments, annuities in the accumulation phase and periodic payment annuities, commercial paper borrowings, repurchase agreements, interest rate swaps, and debt and Exchangeable Securities. The following table shows the estimated impact that various hypothetical interest rate scenarios would be expected to have on the Company's earnings for a calendar year, based on the assumptions contained in the Company's model. The change in these estimates as of year end 1998 versus year end 1997 was due primarily to differences in the yield curve and in the sensitivities they introduced to the Company's model.
Certain fixed interest rate market risk sensitive instruments may not give rise to incremental income or loss during the period illustrated but may be subject to changes in fair values. Note 18 presents additional disclosures concerning fair values of financial assets and financial liabilities, and is incorporated by reference herein.
JP has grown at a rate faster than the overall industry because of acquisitions, and its strong financial position, superior claims paying ratings, and efforts to increase distribution sources.
The Clinton Administration has recently recommended $34 billion in new corporate taxes as part of its proposal for next year's budget, and has targeted a substantial share of the new tax burden at the life insurance industry. Several of the Administration's proposals which could impact JP include:
1. An increase in the DAC tax on annuities and life insurance (e.g. life insurance companies are required to defer certain expenses, by formula, attributable to premium revenues from the sale of these products).
3. A proposal to place an additional tax on companies that borrow for any purpose if those companies also own life insurance, including key employee insurance.
If adopted, item 1 would result in an increase in current tax liabilities but would not impact earnings except for lost investment income on accelerated tax payments. Item 2 would result in approximately $37 million of additional tax expense over ten years. Item 3 would limit the attractiveness of life insurance policies for corporate policyholders. JP believes that life insurers already pay higher effective tax rates than the average for corporate America as a whole. It is not possible to predict the outcome of the Administration's proposals at this time.
Prescribed or permitted Statutory Accounting Principles (SAP) may vary between states and between companies. The NAIC has completed the process of codifying SAP (Codification) to promote standardization of methods, and is encouraging each state to adopt Codification as soon as possible, with a proposed implementation date of January 1, 2001. Related statutory accounting changes are not expected to significantly impact the Company's statutory capital requirements, although they are expected to reduce levels of statutory capital industry wide.
To the Board of Directors and Stockholders Jefferson-Pilot Corporation Greensboro, North Carolina
We have audited the accompanying consolidated balance sheets of Jefferson-Pilot Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Jefferson-Pilot Corporation and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in millions, except share information)
Nature of Operations: Jefferson-Pilot Corporation (the Company) operates in the life insurance and communications industries. Life insurance, accident and health insurance and annuities are currently marketed to individuals and businesses in the United States through the Company's principal life insurance subsidiaries: Jefferson-Pilot Life Insurance Company (JP Life), Alexander Hamilton Life Insurance Company of America (AH Life) and its subsidiary First Alexander Hamilton Life Insurance Company (FAHL) and Jefferson Pilot Financial Insurance Company (JP Financial, formerly named Chubb Life Insurance Company of America) and its subsidiary, Jefferson Pilot LifeAmerica Insurance Company (JPLA, formerly named Chubb Colonial Life Insurance Company). Chubb Sovereign Life Insurance Company, formerly a subsidiary of JP Financial, was merged into JP Financial in 1998. Communications operations are conducted by Jefferson-Pilot Communications Company (JPCC) and consist of radio and television broadcasting, through facilities located in strategically selected markets in the Southeastern and Western United States, and sports program production.
The following pro-forma financial information has been prepared assuming that the acquisition of JP Financial had taken place at the beginning of each year presented:
On a pro-forma basis, net income available to common stockholders before realized investment gains, net of income taxes, increased from $297 to $309 for 1997. The pro-forma adjustments eliminate the effect of realized gains on invested assets sold in 1997 to finance the JP Financial acquisition. Thus, 1997 pro-forma realized gains and pro-forma net income available to common stockholders are lower than actual 1997 results. In January 1997, JPCC purchased substantially all of the broadcast assets of a radio station in Denver, Colorado for $15 in cash. This acquisition resulted in cost in excess of net assets acquired of $14. In 1996, JPCC
Basis of Presentation: The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP). The insurance subsidiaries also submit financial statements to insurance industry regulatory authorities. Those financial statements are prepared on the basis of statutory accounting practices (SAP) and are significantly different from financial statements prepared in accordance with GAAP. See Note 12. All share and per share amounts have been restated to give retroactive effect to the April 1998 three-for-two common stock split. See Note 10.
Principles of Consolidation: The consolidated financial statements include the accounts of Jefferson-Pilot Corporation and all of its subsidiaries. All material intercompany accounts and transactions have been eliminated.
Debt and Equity Securities: Debt and equity securities are classified as either securities held to maturity, stated at amortized cost, or securities available for sale, stated at fair value with net unrealized gains and losses included in accumulated other comprehensive income, net of deferred income taxes and adjustments to deferred policy acquisition costs and value of business acquired.
Real Estate and Other Investments: Real estate not acquired by foreclosure is stated at cost less accumulated depreciation. Real estate acquired by foreclosure is stated at the lower of depreciated cost or fair value minus estimated costs to sell. Real estate, primarily buildings, is depreciated principally by the straight-line method over estimated useful lives generally ranging from 30 to 40 years. Accumulated depreciation was $39 and $38 at December 31, 1998 and 1997. Other investments are stated at equity, or the lower of cost or market, as appropriate.
Property and Equipment: Property and equipment, which is included in other assets, is stated at cost and depreciated principally by the straight-line method over estimated useful lives, generally 30 to 50 years for buildings and approximately 10 years for other property and equipment. Accumulated depreciation was $144 and $133 at December 31, 1998 and 1997.
The carrying amounts of deferred policy acquisition costs and value of business acquired are adjusted for the effect of realized gains and losses and the effects of unrealized gains or losses on debt securities classified as available for sale. Both deferred policy acquisition costs and value of business acquired are reviewed periodically to determine that the unamortized portion does not exceed expected recoverable amounts. No impairment adjustments have been reflected in earnings of any year presented.
Cost in Excess of Net Assets Acquired: Cost in excess of net assets acquired (goodwill) is amortized on a straight-line basis over periods of 25 to 40 years. Accumulated amortization was $21 and $14 at December 31, 1998 and 1997. Carrying amounts are regularly reviewed for indications of value impairment, with consideration given to financial performance and other relevant factors.
Separate Accounts: Separate account assets and liabilities represent funds segregated by the Company for the benefit of certain policyholders who bear the investment risk. The separate account assets and liabilities, which are equal, are recorded at fair value. Policyholder account deposits and withdrawals, investment income and realized investment gains and losses are excluded from the amounts reported in the Consolidated Statements of Income. Fees charged on policyholders' deposits are included in other considerations.
Premiums on accident and health, and disability insurance are reported as earned, over the contract period. A reserve is provided for the portion of premiums written which relates to unexpired coverage terms.
Policy and Contract Claims: The liability for policy and contract claims consists of the estimated amount payable for claims reported but not yet settled and an estimate of claims incurred but not reported, which is based on historical experience, adjusted for trends and circumstances. Management believes that the recorded liability is sufficient to provide for claims incurred through the balance sheet date and the associated claims adjustment expenses.
Stock Based Compensation: The Company accounts for stock incentive awards in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and accordingly, recognizes no compensation expense for stock option awards when the option price is not less than the market value of the stock at the date of award.
Reclassifications: Certain amounts reported in prior years' consolidated financial statements have been reclassified to conform with the presentations adopted in the current year. These reclassifications have no effect on net income or stockholders' equity of the prior years.
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and for Hedging Activities". This pronouncement is effective for annual periods beginning after June 15, 1999. SFAS 133 requires all derivatives to be recorded on the balance sheet and establishes accounting rules for hedging activities. The effect of the hedge accounting rules is to offset changes in value or cash flows of both the hedge and hedged item in earnings in the same period. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported in earnings in the period of the change. Based on the limited nature of the Company's use of derivatives and hedging activities, adoption of this pronouncement is not expected to have a material impact on the Company's financial position or results of operations.
During 1998, the Company adopted SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", which requires capitalization of certain costs incurred in connection with developing or obtaining internal use software. The impact of adoption was not material.
The following table sets forth the computation of earnings per share and earnings per share assuming dilution:
At December 31, 1998 and 1997, the recorded investment in mortgage loans that are considered to be impaired was $65 and $75. Delinquent loans outstanding as of December 31, 1998 and 1997 totaled $3 and $7. The related allowance for credit losses increased from $27 at December 31, 1997 to $31 at December 31, 1998 through a $4 charge to realized gains in 1998. The average recorded investment in impaired loans was $70, $78 and $79 during the years ended December 31, 1998, 1997 and 1996, on which interest income of $7, $8 and $8 was recognized.
Securities Lending: The Company participates in a securities lending program. The Company generally receives cash collateral in an amount that is in excess of the market value of the securities loaned. Market values of securities loaned and collateral are monitored daily, and additional collateral is obtained as necessary. At December 31, 1998, the market value of securities loaned and collateral received amounted to $239 and $250, respectively. There was no outstanding securities lending at December 31, 1997.
Changes in Net Unrealized Gains on Securities: Changes in amounts affecting net unrealized gains included in other comprehensive income, reduced by deferred income taxes, are as follows:
Realized Gains and Losses: The details of realized investment gains (losses) follow:
During 1996, JP Life transferred securities classified as available for sale to the Company's defined benefit pension plans. Equity securities with cost of $5 and fair value of $27 were transferred during 1996, and gains of $22 were recognized.
During 1998, the Company finalized its purchase accounting for the acquisition of JP Financial, resulting in an adjustment to increase the value of business acquired by $12. In September 1996, the Company finalized its purchase accounting for the acquisition of AH Life, and an adjustment of $25 was made to reduce the value of business acquired.
Credited interest rates for universal life-type products ranged from 3.8% to 6.85% in 1998, 4.0% to 7.5% in 1997 and 4.2% to 6.75% in 1996. The average credited interest rates for universal life-type products were 5.84%, 6.02%, and 6.03% for 1998, 1997 and 1996. For annuity products, credited interest rates generally ranged from 4.0% to 8.15% in 1998, 4.0% to 9.25% in 1997 and 4.4% to 8.65% in 1996.
Exchangeable Securities: The Mandatorily Exchangeable Debt Securities (MEDS) and Automatic Common Exchange Securities (ACES) are collectively referred to as "Exchangeable Securities."
In April and June 1997, the Company issued MEDS of $75 at 6.95% and $75 at 6.65%. The MEDS are based on BankAmerica common stock. Interest is payable quarterly. The MEDS mature January 10, 2002 and represent senior indebtedness of the Corporation.
The MEDS had principal amounts of: 6.95% MEDS, $55.55 per security and 6.65% MEDS, $66.625 per security. Two weeks prior to, or at, maturity, the principal amount of the MEDS will be mandatorily exchanged into either a number of shares of the common stock of BankAmerica (stock) determined based on an exchange rate reflecting the then trading price for the stock, or cash in an amount of equal value, at the Company's option. Subject to adjustments to reflect dilution, the exchange rate is equal to (1) 0.8264 shares if the stock price is at least: 6.95% MEDS, $67.22 and 6.65% MEDS, $80.62, (2) a fractional share of the stock having a value equal to the principal amount if the price is more than the principal amount but less than the amount stated in (1), or (3) one share if the price is less than or equal to the principal amount.
The Exchangeable Securities are carried at fair value. Changes in the carrying value, net of deferred income taxes, are recorded in other comprehensive income. At December 31, 1998 and 1997, the combined carrying value of the Exchangeable Securities was $325 and $327, based on the market value of BankAmerica stock, which had a market value of $60.125 per share as of year end 1998.
Interest: Interest expense totaled $46 for 1998, $37 for 1997 and $39 for 1996.
Mandatorily redeemable non-voting floating rate preferred stock (with a par value of $100 per share) of subsidiaries authorized, issued and outstanding at December 31, 1998 and 1997 totaled 30,000 and 530,000 shares. In April 1998, the holder of $50 preferred stock of AH Life redeemed the shares at par plus accrued dividends. The remaining $3 of mandatorily redeemable preferred stock was issued in September 1996 related to the PPA recapture (Note 15), and was repurchased and cancelled as of January 1, 1999.
Preferred Stock: The Company has 20,000,000 shares of preferred stock authorized (none issued) with the par value, dividend rights and other terms to be fixed by the Board of Directors, subject to certain limitations on voting rights.
Shareholders' Rights Plan: Under a shareholders' rights plan, one common share purchase right is attached to each share of the Company's common stock. The plan becomes operative in certain events involving an offer for or the acquisition of 15% or more of the Company's common stock by any person or group. Following such an event, each right, unless redeemed by the Board, entitles the holder (other than the acquiring person or group) to purchase for an exercise price of $235.00 an amount of common stock of the Company, or in certain circumstances stock of the acquiring company, having a market value of twice the exercise price. Approximately 105 million shares of common stock are reserved for the amended rights plan. The rights expire on February 8, 2009 unless extended by the Board, and are redeemable by the Board at a price of 0.44 cents per right at any time before they become exercisable.
The following table summarizes certain stock option information at December 31, 1998:
Pro-Forma Information: SFAS 123, "Accounting for Stock-Based Compensation", requires the presentation of pro-forma information regarding net income and earnings per share as if the Company had accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following
For purposes of pro-forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The pro-forma information follows:
Because the options generally vest over three years and because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, 1998 is the first year in which the full pro-forma effect is reflected.
Risk-Based Capital ("RBC") requirements promulgated by the NAIC require life insurers to maintain minimum capitalization levels that are determined based on formulas incorporating credit risk pertaining to investments, insurance risk, interest rate risk and general business risk. As of December 31, 1998, the life insurance subsidiaries' adjusted capital and surplus exceeded their authorized control level RBC.
The NAIC Codification of Statutory Accounting Principles (Codification) has been completed. The purpose of Codification is to create uniformity in statutory financial reporting across states. Codification must be adopted by individual states before it will have any bearing on the statutory reporting requirements of companies domiciled in a particular state. The NAIC is encouraging the states to adopt Codification as soon as possible, with an implementation date of January 1, 2001. The Company does not expect implementation to have a material impact on statutory surplus of its insurance subsidiaries; however, implementation is expected to result in a net reduction of statutory surplus and RBC throughout the insurance industry.
Federal income tax returns for all years through 1994 are closed. Tax years 1995 and 1996 are currently under examination by the Internal Revenue Service, and no assessments have been proposed to date. In the opinion of management, recorded income tax liabilities adequately provide for all remaining open years.
The Company sponsors contributory health care and life insurance benefit plans for eligible retired employees, qualifying retired agents and certain surviving spouses. The Company contributes to a welfare benefit trust from which future benefits will be paid. The Company accrues the cost of providing postretirement benefits other than pensions during the employees' active service period. The non-pension postretirement expense was $1 in 1998, 1997 and 1996.
The Company attempts to reduce its exposure to significant individual claims by reinsuring portions of certain individual life insurance policies and annuity contracts written. The Company reinsures the portion of an individual life insurance risk in excess of the Company's retention, which ranges from $0.3 to $1.5 for various individual life and annuity products. The Company also attempts to reduce exposure to losses that may result from unfavorable events or circumstances by reinsuring certain levels and types of accident and health insurance risks underwritten. The Company assumes portions of the life and accident and health risks underwritten by certain other insurers on a limited basis, but amounts related to assumed reinsurance are not significant to the consolidated financial statements.
In 1995, the Company acquired AH Life and FAHL from Household International, Inc. (Household). AH Life and FAHL reinsured 100% of the PPA, COLI and Affiliated credit insurance business written prior to their acquisition in 1995 with affiliates of Household on a coinsurance basis. Balances are settled monthly, and AH Life is compensated by the reinsurers for administrative services related to the reinsured business. On September 30, 1996, the Company recaptured a portion of the PPA reinsurance from affiliates of Household. This recapture was completed by these affiliates transferring approximately $463 of assets and $489 of reserves to the Company. The Company also established a $29 deferred tax asset on this recapture, and issued $3 of mandatorily redeemable preferred stock of one of the Company's life insurance subsidiaries to Household. The amount due from reinsurers in the consolidated balance sheets includes $1,072 and $1,250 due from the Household affiliates at December 31, 1998 and 1997.
Assets related to the reinsured PPA and COLI business have been placed in irrevocable trusts formed to hold the assets for the benefit of AH Life and FAHL and are subject to investment guidelines which identify (1) the types and quality standards of securities in which new investments are permitted, (2) prohibited new investments, (3) individual credit exposure limits and (4) portfolio characteristics. Household has unconditionally and irrevocably guaranteed, as primary obligor, full payment and performance by its affiliated reinsurers. AH Life has the right to terminate the PPA and COLI reinsurance agreements by recapture of the related assets and liabilities if Household does not take a required action under the guarantee agreements within 90 days of a triggering event. AH Life has the option to terminate the PPA and COLI reinsurance agreements on the seventh anniversary of the acquisition, by recapturing the related assets and liabilities at an agreed-upon price or their then current fair values as independently determined.
As of December 31, 1998 and 1997, JP Financial had a reinsurance recoverable of $95 and $97 from a single reinsurer, pursuant to a 50% coinsurance agreement. JP Financial and the reinsurer are joint and equal owners in $191 and $195 of securities and short-term investments as of December 31, 1998 and 1997, 50% of which is included in investments in the accompanying consolidated balance sheets.
Reinsurance contracts do not relieve an insurer from its primary obligation to policyholders. Therefore, the failure of a reinsurer that is party to a contract with a subsidiary to discharge its reinsurance obligations could result in a loss to the subsidiary. The Company regularly evaluates the financial condition of its reinsurers and monitors concentrations of credit risk related to reinsurance activities. No significant credit losses have resulted from the reinsurance activities of the subsidiaries during the three years ended December 31, 1998.
The Company has four reportable segments which are defined based on the nature of the products and services offered: Life Insurance Products, Annuity and Investment Products (AIP), Communications, and Corporate and Other. The Life Insurance Products segment offers a wide array of life and health insurance through captive agents (career and home service agency forces), independent agents (recruited through independent marketing organizations and a regional marketing network) and financial institutions, as well as offering group insurance products for employers and their employees primarily in the South and Southeast. AIP offers fixed and variable annuities and investment products through proprietary and independent agents, financial institutions, investment professionals and broker-dealers. The Communications segment consists principally of radio and television broadcasting and sports program production. The Corporate and Other segment includes activities of the parent company and passive investment affiliates, surplus of the life insurance subsidiaries not otherwise allocated to reportable segments including earnings thereon, and all of the Company's realized gains and losses. Surplus is allocated to the Life Insurance Products and AIP reportable segments based on risk-based capital formulae which give consideration to asset/liability and general business risks, as well as the Company's strategies for managing those risks. Various distribution channels and/or product classes related to the Company's life insurance, annuity and investment products have been aggregated in the Life Insurance and AIP reporting segments.
The segments are managed separately because of the different products, distribution channels and marketing strategies each employs. The Company evaluates performance based on several factors, of which the primary financial measure is operating income or loss, which excludes realized gains and losses. The accounting policies of the business segments are the same as those described in the summary of significant accounting policies (Note 2). Substantially all the Company's revenue is derived from sales within the United States, and foreign assets are not material. The following table summarizes financial information regarding the Company's reportable segments:
Comprehensive income and its components are displayed in the statements of stockholders' equity. Currently, the only element of other comprehensive income applicable to the Company is changes in unrealized gains and losses on securities classified as available for sale, which are displayed in the following table, along with related tax effects. See Note 4 for further detail of changes in the Company's unrealized gains on securities available for sale.
The fair values of cash, cash equivalents, balances due on account from agents, reinsurers and others, and accounts payable approximate their carrying amounts as reflected in the consolidated balance sheets due to their short-term maturity or availability. Assets and liabilities related to the Company's separate accounts are reported at fair value in the accompanying consolidated balance sheets.
Interest rate swaps that hedge direct investments classified as available for sale are recorded at fair value (1998 - gain of $11; 1997 - gain of $5) and are included in the carrying value of debt securities available for sale. The fair value of interest rate swaps that hedge direct investments classified as held to maturity and that hedge annuity contract deposits (1998 - gain of $2; 1997 - gain of $1) have not been recorded in the consolidated balance sheets.
JPCC has commitments for purchases of syndicated television programming and future sports programming rights of approximately $121 as of December 31, 1998. These commitments are not reflected as an asset or liability in the accompanying 1998 consolidated balance sheet because these programs are not currently available for use.