The following table summarizes the properties we lease and own at December 31, 2002:
Other includes shared services that are utilized by both the protection products and accumulation products segments.
Our predecessor, AMHC, was originally formed in 1996 as a mutual holding company and therefore, had no shares of common stock outstanding until its demutualization on September 20, 2000. On September 20, 2000, we distributed 17.4 million shares of common stock to our former members and exchanged our common stock for the 12.6 million shares of common stock held by the public in ALHI, our former subsidiary and another of our predecessor entities, on a one-for-one basis. Our operating income for the full fiscal years presented above primarily reflects the operating income of ALHI. Therefore, adjusted net operating income and net income from continuing operations per share was calculated based on the number of shares of stock we owned of ALHI through September 20, 2000. Since then, adjusted net operating income and net income from continuing operations per share has been calculated based on the shares of our common stock actually outstanding.
We did not have common stock until our demutualization on September 20, 2000, therefore, there were no dividends to declare on common stock for the years 1998 and 1999. ALHI, our predecessor to our company did declare dividends on its common stock of $0.40 per share for the years ended December 31, 1999 and 1998.
Basic and diluted adjusted net operating income per common share is calculated using the weighted average number of shares as shown in the table above.
For purposes of computing the ratio of earnings to fixed charges, “earnings” consist of income from operations before income taxes, fixed charges and pre-tax earnings required to cover preferred stock dividend requirements. “Fixed charges” consist of interest expense on debt, amortization of debt expense and preferred stock dividend requirements.
We are a holding company whose subsidiaries are primarily engaged in the business of marketing, underwriting and distributing a broad range of individual life, annuity and insurance deposit products to individuals and businesses in 50 states, the District of Columbia and the U.S. Virgin Islands. We have two reportable operating segments: protection products and accumulation products. The protection products segment was formerly known as the life insurance segment and the accumulation products segment was formerly known as the annuity segment. The primary offerings of the protection products segment are interest-sensitive whole life, term life, universal life and equity-indexed life insurance policies. The primary offerings of the accumulation products segment are individual fixed annuities and funding agreements.
We acquired ILICO which had assets of approximately $6 billion on May 18, 2001. Its operations have been included with ours since that date.
Adjusted operating income does not constitute net income computed in accordance with accounting principles generally accepted in the United States, or GAAP. See Adjusted Net Operating Income section for additional information.
Adjusted pre-tax operating income in both of our operating segments increased in 2002 and 2001 as compared to each of the prior years. Growth in our protection products adjusted pre-tax operating income in 2002 was primarily attributable to the acquisition of ILICO combined with a slight growth in product margins and a decline in operating expenses. The increase in the protection products adjusted pre-tax operating income in 2001 was primarily due to the acquisition of ILICO together with decreased insurance expenses and level gross margins. Our accumulation products pre-tax operating income also increased in 2002 and 2001 due to the acquisition of ILICO. In addition, increased Independent Marketing Organizations (IMOs) operating income and the discontinuation of goodwill amortization in 2002 also contributed to the growth in accumulation products earnings. Adjusted pre-tax operating income from other operations primarily consists of holding company revenues and expenses and operations of our real estate management subsidiary. Adjusted pre-tax operating income from other operations has declined each year as compared to the prior year as we reduce our investments in real estate management. In addition, we had more revenues at our holding company in 2000 from cash equivalents we were holding to fund the demutualization payments to our former members in October of 2000.
Net income increased in 2001 compared to 2000 primarily as a result of the growth in our protection products and accumulation products segments. In addition, 2000 net income was reduced for amounts applicable to minority interest shareholders through September 2000, when we acquired such interest. Partially offsetting these additions to net income were increased realized losses on investments and increased net unrealized losses from SFAS 133 related market value adjustments on trading securities, derivatives and certain annuity contracts. Net income decreased in 2002 compared to 2001 primarily as a result of realized losses on investments, unrealized losses from SFAS 133 and increased restructuring charges. The 2002 reductions in net income were partially offset by the growth in our protection and accumulation products segments. See the Adjusted Net Operating Income section for a further discussion of the items included in net income but excluded from operating income.
Represents total realized gains or losses on investments less core realized gains or losses (defined as gains or losses from the closed block and gains or losses on the convertible preferred stock and bond portfolios). Non-core realized gains or losses may vary widely between periods. Such amounts are determined by management’s timing of individual transactions or current market conditions and do not necessarily correspond to the underlying operating trends.
Represents the net effect of Statement of Financial Accounting Standard (SFAS) 133, “Accounting for Derivative Instruments and Hedging Activities,” related accounting entries. The accounting entries consist of cash flow hedge amortization, market value adjustments on trading securities, derivatives, certain annuity contracts, and the associated change in amortization of DAC and VOBA resulting from such adjustments.
Represents costs of restructuring our operations to eliminate duplicative functions. The costs consist primarily of relocation of employees, severance and termination benefits, and system conversions.
Our predecessor, AMHC, was originally formed in 1996 as a mutual holding company and, therefore, had no shares of common stock outstanding until the demutualization of our group on September 20, 2000. On September 20, 2000, we distributed 17.4 million shares of our common stock to our former members and exchanged our common stock for the 12.6 million shares of common stock held by the public in ALHI, our former subsidiary and another of our predecessor entities, on a one-for-one basis. Our operating income primarily reflects the operating income of ALHI. Therefore, adjusted net operating income per share was calculated based on the number of shares of stock we owned of ALHI through September 30, 2000. Since then, adjusted net operating income per share has been calculated based on the shares of our common shares actually outstanding.
3) Amortization of DAC and VOBA related to the realized gains and losses on the non-core investments and the SFAS 133 adjustments.
These items will fluctuate from period to period depending on the prevailing interest rate and economic environment, are not continuing in nature, or are not part of the core insurance operations. As a result, management believes they do not reflect the ongoing earnings capacity of our operating segments.
Adjusted pre-tax operating income from our protection products increased 35% in 2002 and 62% in 2001 compared to the respective prior years. The increase in 2002 was due to a slight growth in product margins, a decline in operating expenses and the acquisition of ILICO. The increase in 2001 was primarily due to the acquisition of ILICO together with decreased insurance expenses and level gross margins. The key drivers of our protection products business include sales, persistency, net investment income, mortality and expenses.
Sales, Premiums and Product Charges. Annualized premium for new products issued represents sales for protection products. As illustrated in the Sales Activity Product table presented in “Item 1 Business - Protection Products Segment,” direct first year annualized premiums increased 74% in 2002 compared to 2001 and 89% in 2001 compared to 2000. The increases were primarily due to the acquisition of ILICO during the second quarter of 2001. Excluding the sales from ILICO, life insurance sales increased 31% in 2002 and 11% in 2001. We experienced growth in almost all our protection product lines with significant increases coming from our interest-sensitive whole life and equity-indexed life products. Interest-sensitive whole life insurance has flexible premium and benefit patterns and its cash value accumulation changes with current interest and mortality rates. The equity-indexed life product allows the policyowner to elect an earnings strategy for a portion of the account value whereby earnings are credited based primarily on increases in the S&P 500 Index, excluding dividends. The earnings credit is subject to a participation rate and an annual cap. Sales of interest-
Our persistency experience remained within our pricing assumptions. Our lapse rate, including ILICO, for 2002 as compared to 2001 and 2000 increased as expected due to the completion of ILICO’s demutualization payout in July 2001. Lapses tend to decline in anticipation of a demutualization transaction as policyholders want to remain policyholders so they will be eligible for the demutualization payout. Following a demutualization, lapses tend to increase for a period before they return to a more normal level. Our lapse rate, excluding ILICO, decreased in 2002 compared to 2001 and increased in 2001 compared to 2000. ALIC experienced higher lapse rates in 2001 following the completion of a demutualization in the third quarter of 2000.
Net Investment Income. Net investment income increased in 2002 and 2001 compared to the respective prior years. The increases were primarily attributable to the acquisition of ILICO partially offset by lower effective yields. The effective yield of the investment portfolio was 7.22% in 2002 compared to 7.32% in 2001 and 7.94% in 2000. The decrease in yields in 2002 and 2001 was primarily a result of the lower interest rate market.
Outlook. We expect to continue to increase sales through our multiple distribution channels and to continue to shift to higher return products, in particular the equity-indexed life products. We also expect to
Our accumulation products segment primary offerings consist of individual fixed annuities and funding agreements. The fixed annuities are marketed on a national basis primarily through IMOs and independent brokers. Similar to our protection products segment, we invest the deposits we receive from accumulation product sales in our investment portfolio and establish a liability representing our commitment to our policyholder. We manage investment spread by seeking to maximize the return on our invested assets consistent with our asset/ liability management and credit quality needs. When appropriate, we periodically reset the interest rates credited to our policyholder liability. Accumulation products in force totaled $11.3 billion at December 31, 2002, $10.7 billion at December 31, 2001 and $6.7 billion at December 31, 2000. A summary of our accumulation products segment operations follows:
We placed primarily fixed rate funding agreements totaling $875 million in 2002. Funding agreements are arrangements for which we receive deposit funds and for which we agree to repay the deposit and a contractual
Persistency. Withdrawals represent funds taken out of accumulation products by policyowners not including those due to the death of policyowners. Annuity withdrawal rates both with and without internal replacements continued to improve in 2002 as compared to 2001 and 2000. Annuity withdrawals and annualized annuity withdrawal rates were as follows:
Our withdrawal experience remained within our pricing assumptions. Withdrawal rates declined in 2002 and 2001 as compared to the respective prior years as our annuity products provide a favorable investment return in this current low interest rate and declining equity market environment.
Underwriting, Acquisition and Other Expenses. Expenses decreased in 2002 compared to 2001 primarily due to goodwill no longer being amortized effective January 1, 2002 with the adoption of SFAS 142. Goodwill amortization amounted to $7.6 million in 2001 and $8.3 million in 2000. Expenses in 2001 increased as compared to 2000 primarily due to the acquisition of ILICO.
IMO Operations. We own five IMOs which are marketing organizations with contractual arrangements to promote our insurance products to their networks of agents and brokers. Additionally, they also contract with third party insurance companies. The income from IMO operations primarily represents annuity commissions received by our IMOs from those third party insurance companies. Net IMO operating income increased $5.9 million in 2002 compared to 2001 due to our acquisition of an IMO in 2002 and increased $5.4 million in 2001 compared to 2000 due to an IMO acquired in 2001 and in mid-2000.
Realized and Unrealized Losses on Assets and Liabilities. Realized losses on non-core investments in 2002 consisted primarily of realized losses and writedowns on investments related to Dynegy Holdings, Green Tree Financial, National Century, NRG Northeast Generating, Trenwick Group, United Airlines, US Air, and WorldCom Inc. The realized losses in 2001 consisted primarily of writedowns on investments mainly related to telecommunications and emerging markets investments. The level of realized gains and losses will fluctuate from period to period depending on the prevailing interest rate, the economic environment and the timing of investment sales.
Unrealized losses on non-core investments are generated from our options and trading securities. We use options to hedge our equity-indexed products. In accordance with SFAS 133, we adjusted our options to market value, which, due to the economic environment and deteriorating stock market conditions, resulted in an unrealized loss of $40.0 million and $54.2 million in 2002 and 2001, respectively. In addition, we also have trading securities that back our total return strategy fixed annuity products. The market value adjustment on the trading securities resulted in a loss of $5.2 million and $5.9 million in 2002 and 2001, respectively. Most of the unrealized gains and losses on the options and trading securities are offset by similar adjustments to the option portion of the equity-indexed product reserves and to the total return strategy annuity reserves. The reserve adjustments are reflected in policyowner benefits expense in the consolidated statements of income and are included in the fair value change of $28.8 million in 2002 and $52.7 million in 2001 explained in the following paragraph.
third quarter of 2001. The objective of the restructuring plan is to eliminate duplicative functions for all business units and to reduce on-going operating costs. Corporate administrative functions are being transitioned so they are performed primarily in Des Moines, Iowa. Protection products administration processes were previously planned to be performed in Indianapolis, Indiana; Des Moines; or Woodbury, New York; however, it has now been determined that these processes will be transitioned so they are performed in Des Moines, Woodbury, or outsourced. This will result in the elimination of additional positions in Indianapolis. Accumulation products functions are being transitioned to Topeka. Investment activities have been restructured to eliminate certain real estate management services which have been outsourced.
The restructuring charges expensed in 2002 included pre-tax severance and termination benefits of $9.5 million related to the elimination of approximately 240 positions and other pre-tax costs of $11.7 million primarily related to systems conversion and relocation of employees. The restructuring charges expensed in 2001 included pre-tax severance and termination benefits of $6.8 million related to the elimination of approximately 80 positions and other pre-tax costs of $1.8 million. An accrual for severance and termination benefits not yet paid amounted to $6.1 million at December 31, 2002. Additional charges will be incurred for continuing restructuring activities primarily involving severance or relocation benefits for affected employees; various administrative, financial and actuarial system conversion costs; and building disposition costs. System conversion costs will be expensed as incurred and are expected to be substantially completed by the fourth quarter of 2003. A majority of the severance costs due to the transition in 2003 of the protection products processes from Indianapolis to Des Moines, Woodbury or to be outsourced were accrued in the fourth quarter of 2002.
Change in Accounting. We adopted SFAS No. 133 on January 1, 2001. In accordance with the provisions of the statement, we recorded the differences between the previous carrying amounts of our derivative instruments and the fair value of our derivative instruments, as of this initial application date, as the effect of a change in accounting principle. The gross difference between carrying amounts and fair value amounts of our derivative instruments was a reduction of approximately $11.3 million. The DAC and VOBA amortization impact from the derivative adjustments was approximately $1.1 million and the income tax benefit was $4.2 million, resulting in the net cumulative effect of change in accounting for derivatives of $8.2 million.
Proceeds from the OCEANs were used to repay borrowings on the Revolving Credit Agreement and to purchase approximately 1.7 million shares, amounting to $59 million, of AmerUs Group Co.’s common stock. The OCEANs are senior subordinated debt, subordinated in right of payment to all existing and future senior debt and senior to all existing and future junior subordinated debt.
We manage liquidity on a continuing basis. One way is to minimize our need for capital. We accomplish this by attempting to use our capital as efficiently as possible and by developing capital-efficient products in our insurance subsidiaries. We also manage our mix of sales by focusing on the more capital-efficient products.
The cash flows of our insurance subsidiaries consist primarily of premium income; deposits to policyowner account balances; income from investments; sales, maturities and calls of investments and repayments of investment principal. Cash outflows are primarily related to withdrawals of policyowner account balances, investment purchases, payment of policy acquisition costs, payment of policyowner benefits, payment of debt, income taxes and current operating expenses. Insurance companies generally produce a positive cash flow from operations, as measured by the amount by which cash flows are adequate to meet benefit obligations to policyowners and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business.
Management believes that the current level of cash and available-for-sale and short-term securities, combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on mortgage-backed securities and its insurance products, will be adequate to meet the anticipated short-term cash obligations of the insurance subsidiaries.
Matching the investment portfolio maturities to the cash flow demands of the type of insurance being provided is an important consideration for each type of protection product and accumulation product. We continuously monitor benefits and surrenders to provide projections of future cash requirements. As part of this monitoring process, we perform cash flow testing of assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing our investment strategy, we establish a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage-backed securities, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations. There can be no assurance that future experience regarding benefits and surrenders will be similar to historic experience since withdrawal and surrender levels are influenced by such factors as the interest rate environment and general economic conditions and the claims-paying and financial strength ratings of the insurance subsidiaries.
We take into account asset/ liability management considerations in the product development and design process. Contract terms for the interest-sensitive products include surrender and withdrawal provisions which mitigate the risk of losses due to early withdrawals. These provisions generally do one or more of the following: limit the amount of penalty-free withdrawals, limit the circumstances under which withdrawals are permitted, or assess a surrender charge or market value adjustment relating to the underlying assets. The following table summarizes statutory liabilities for interest-sensitive life products and annuities by their contractual withdrawal provisions at December 31, 2002 (including liabilities in the closed blocks and the general account):
The insurance subsidiaries may also obtain liquidity through sales of investments. The investment portfolio as of December 31, 2002, had a carrying value of $16.9 billion, including closed block investments.
At December 31, 2002, the statutory surplus of the insurance subsidiaries was approximately $797 million. Management believes that each insurance company has statutory capital which provides adequate risk based capital that exceeds required levels.
Our contractual obligations primarily consist of amounts owed for notes payable and operating lease commitments. See note 8 to the consolidated financial statements for further discussion about the notes payable and note 12 for additional information regarding leases. Maturities of notes payable and lease obligations are as follows for each of the five years ending December 31, 2002:
We maintain a diversified portfolio of investments which is supervised by an experienced in-house staff of investment professionals. Sophisticated asset/liability management techniques are employed in order to achieve competitive yields, while maintaining risk at acceptable levels. The asset portfolio is segmented by liability type, with tailored investment strategies for specific product lines. Investment policies and significant individual investments are subject to approval by the Board of Directors of each of the insurance companies and are overseen by the Investment and Risk Management Committee of our Board of Directors. Management regularly monitors individual assets and asset groups, in addition to monitoring the overall asset mix. In addition, the insurance companies’ boards and the Investment and Risk Management Committee review investment guidelines and monitor internal controls.
The following table summarizes invested assets by asset category as of December 31, 2002 and 2001:
The following table summarizes fixed maturity securities by remaining maturity as of December 31, 2002:
Interest rate swaps and options are used to reduce exposure to changes in interest rates and to manage duration mismatches. Call options are used to hedge equity-indexed products. Credit default swaps are coupled with a bond to synthetically create an investment cheaper than the equivalent instrument traded in the cash market. Although we are subject to the risk that counterparties will fail to perform, credit standings of counterparties are monitored regularly. We only enter into transactions with highly rated counterparties. We are also subject to the risk associated with changes in the value of contracts. However, such adverse changes in value generally are offset by changes in the value of the items being hedged. The notional principal amounts of the swaps and options, which represent the extent of our involvement in such contracts but not the risk of loss, at December 31, 2002, amounted to $2,155.7 million. The interest rate swaps had a carrying value of a net payable position of $5.6 million at December 31, 2002. The credit default swaps had a carrying value of a net payable position of $0.2 million at December 31, 2002. The carrying value of options amounted to $65.8 million at December 31, 2002. For each of these derivatives, the carrying value is equal to fair value as of December 31, 2002. The derivatives are reflected as other investments on the consolidated financial statements as of December 31, 2002. The net amount payable or receivable from interest rate and credit default swaps are accrued as an adjustment to interest income. Effective January 1, 2001, we adopted SFAS 133. See note 4 to the consolidated financial statements for further discussion of the impact of adopting SFAS 133.
As of December 31, 2002, mortgage loans in the investment portfolio were $883.0 million, or 5.2% of the aggregate carrying value of invested assets. As of December 31, 2002, commercial mortgage loans and residential mortgage loans comprised 99.8% and 0.2%, respectively, of total mortgage loans. Commercial
As of December 31, 2002, one loan in the loan portfolio with a principal balance of $1.7 million was classified as delinquent and no loans were in foreclosure. As of the same date, only two loans aggregating $3.5 million, or 0.1%, of the loan portfolio (as measured by principal balance) were classified as restructured. During 2002, we had no foreclosures.
We have utilized a limited number of structured finance arrangements. The structures primarily consist of interests in collateralized bond obligations and special-purpose entities with principal protected limited partnership interests. Neither AmerUs nor any management members have operating control or management oversight of the entities and accordingly the entities are not consolidated but rather accounted for as available for sale debt securities or equity method investments. In addition, we do not have any continued obligation or commitment to provide additional financing to the entities. At December 31, 2002 and 2001, approximately $560 million and $535 million, respectively, of such structured finance investments were included in invested assets. See additional discussion of structured securities and related accounting developments in “Emerging Accounting Matters.”
We have developed an asset/liability management approach with separate investment portfolios for major product lines such as traditional life, universal life, equity-indexed life, deferred annuities, equity-indexed annuities, variable annuities and funding agreements. Investment policies and strategies have been established based on the specific characteristics of each product line. The portfolio investment policies and strategies establish asset duration, quality and other guidelines. Analytical systems are utilized to establish an optimal asset mix for each line of business. We seek to manage the asset/liability mismatch and the associated interest
Securities in our portfolio with a carrying value of approximately $1,625 million at December 31, 2002 do not have readily determinable market prices. For these securities, we estimate their fair value by comparison to similar securities with quoted prices when possible. Otherwise, we use our most recent purchases and sales of similar unquoted securities, independent broker quotes, or internally prepared valuations (including those based on estimates of future profitability) to estimate the fair value of those securities. All such investments are classified as available for sale. Our ability to liquidate our positions in these securities will be impacted to a significant degree by the lack of an actively traded market, and we may not be able to dispose of these investments in a timely manner. Although we believe our estimates reasonably reflect the fair value of those securities, our key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral (if any), and other factors may not be realized in the event of an actual sale.
Securities are also reviewed to identify potential impairments. In determining if and when a decline in market value below amortized cost is other-than-temporary, we evaluate the market conditions, offering prices, trends of earnings, price multiples, and other key measures for our investments in marketable equity securities and debt instruments. When such a decline in value is deemed to be other-than-temporary, we recognize an impairment loss in the current period operating results to the extent of the decline.
We hold derivative financial instruments to hedge growth in policyowner liabilities for certain life and annuity products, to hedge the interest variability of a floating-rate funding agreement and to hedge market risk for fixed income investments. These derivatives qualify for hedge accounting or are considered economic hedges as discussed in detail in note 4 to our consolidated financial statements.
We generally amortize DAC based on a percentage of our expected gross margins (EGMs) over the life of the policies. Our estimated EGMs are computed based on assumptions related to the underlying policies written, including the lives of the underlying policies, growth rate of the assets supporting the liabilities, and level of expenses necessary to maintain the policies over their entire life. We amortize DAC by estimating the present value of the EGMs over the lives of the insurance policies and then calculate a percentage of the policy acquisition cost deferred as compared to the present value of the EGMs. That percentage is used to amortize the DAC such that the amount amortized over the life of the policies results in a constant percentage of amortization when related to the actual and future gross margins.
Investments - based on quoted market prices, or in cases where quoted market prices were not available, by using discounted cash flow or other valuation techniques.
Receivables and other assets - reflected at replacement values or realizable values based on the present value of amounts to be received determined at appropriate interest rates less amounts considered uncollectible.
Value of business acquired - actuarially determined future profits from in force business calculated at a 15% risk discount rate using current best estimate assumptions.
Policyowner reserves and funds - established at the present value of all future benefits and expenses associated with the policies using current best estimate assumptions.
Other liabilities and debt - determined as the present value of amounts to be paid using appropriate interest rates.
In July 2001, the Financial Accounting Standards Board issued SFAS 141, “Business Combinations,” and SFAS 142, “Goodwill and Other Intangible Assets.” SFAS 141 requires the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business acquisition must meet to be recognized apart from goodwill. The adoption of SFAS 141 did not have an impact on the consolidated financial statements.
In July 2002, the Financial Accounting Standards Board issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 provides for costs to exit an activity or dispose of long-lived assets to be recorded when they are incurred and are to be measured at fair value. Under previous accounting guidance, a liability for an exit cost was recognized at the date of the commitment to an exit plan. SFAS 146 is effective for exit or disposal activities initiated after December 31, 2002 and its adoption had no impact on net income or stockholders’ equity as of or for the year ended December 31, 2002.
In December 2002, the Financial Accounting Standards Board issued SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation,” and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 requires more
prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. As of December 31, 2002, we continue to account for employee stock-based compensation using the intrinsic value method provided under SFAS 123 and SFAS 148. The disclosure requirements of both standards have been provided in note 1 to the consolidated financial statements.
In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” or FIN 45. FIN 45 clarifies disclosure and recognition and measurement requirements related to certain guarantees. The disclosure requirements are effective for financial statements issued after December 15, 2002 and the recognition and measurement requirements are effective on a prospective basis for guarantees issued or modified after December 31, 2002. See note 12 to the consolidated financial statements for disclosures related to our guarantees.
In February 2003, the Financial Accounting Standards Board’s Derivatives Implementation Group issued SFAS 133 Implementation Issue No. B36, “Embedded Derivatives: Bifurcation of a Debt Instrument that Incorporates both Interest Rate Risk and Credit Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the Issuer of that Instrument,” or DIG Issue B36. DIG Issue B36 applies to modified coinsurance and coinsurance with funds withheld reinsurance agreements where interest is determined by reference to a pool of fixed maturity assets or a total return debt index. Such arrangements in which funds are withheld by the ceding insurer cause the reinsurer to recognize a receivable from the ceding insurer as well as a liability representing reserves for the insurance coverage assumed under the reinsurance arrangements. The terms of the reinsurer’s receivable provide for the future payment of principal plus a rate of return on either its general account assets or a specified block of those assets which is typically composed of fixed-rate debt securities. DIG Issue B36 considers the reinsurer’s receivable from the ceding company to contain an embedded derivative that must be bifurcated and accounted for separately under SFAS 133. DIG Issue B36 is tentatively planned to be effective for quarters beginning after June 15, 2003. Currently, we do not account for such reinsurance receivables and payables as having an embedded derivative which would be bifurcated and accounted for separately. We continue to evaluate the impacts of implementing DIG Issue B36; however, at this time, we are unable to estimate the effects on the financial statements.