We lease all of our office, warehouse, printing, and distribution properties. Our executive and home office operations for substantially all of our domestic U.S. operations (except New York) are located in Duluth, Georgia, in a build-to-suit facility completed in 2013. The initial lease term for the facility is 15 years.
Each of these leased properties is used by each of our operating segments, with the exception of our NBLIC office space, which is not used by our Investment and Savings Products segment.
The selected financial data should be read in conjunction with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and accompanying notes included elsewhere in this report.
Prior to April 1, 2010, we were wholly owned by Citigroup Inc. (“Citigroup”). In April 2010, we completed a series of transactions (the “corporate reorganization”) that included an initial public offering of our common stock by Citigroup pursuant to the Securities Act of 1933, as amended (the “Securities Act”). The selected historical income statement data for the year ended December 31, 2010 may not be indicative of the revenues and expenses that would have existed or resulted if we had operated independently of Citigroup during that year. The selected historical financial data are not necessarily indicative of the financial position or results of operations as of any future date or for any future period.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to inform the reader about matters affecting the financial condition and results of operations of Primerica, Inc. (the “Parent Company”) and its subsidiaries (collectively, “we”, “us” or the “Company”) for the three-year period ended December 31, 2014. As a result, the following discussion should be read in conjunction with the consolidated financial statements and accompanying notes that are included herein. This discussion contains forward-looking statements that constitute our plans, estimates and beliefs. These forward-looking statements involve numerous risks and uncertainties, including, but not limited to, those discussed in “Risk Factors”. Actual results may differ materially from those contained in any forward-looking statements.
New recruits increased in 2014 to 190,439 from 186,251 in 2013. The size of our life-licensed sales force increased to 98,358 sales representatives at December 31, 2014 from 95,566 sales representatives at December 31, 2013, primarily due to a lower rate of non-renewals and terminations in relation to the size of our sales force in 2014.
Investment and Savings Product Sales and Asset Values. Investment and savings products sales were higher in 2014, totaling approximately $5.7 billion compared with approximately $5.2 billion in 2013. New product introductions and the impact of favorable market performance were the main contributors to the strong product sales in 2014.
The assets in our clients’ accounts are invested in diversified funds comprised mainly of U.S. and Canadian equity and fixed-income securities. The average value of assets in client accounts increased to approximately $46.9 billion in 2014 from approximately $41.0 billion in 2013, while the period-end asset value increased to approximately $48.7 billion at December 31, 2014 compared with approximately $45.0 billion a year ago. The increases both in period-end asset values and average client asset values during 2014 were attributable to higher product sales and positive returns on client assets.
Term Life Insurance Segment. Our Term Life Insurance segment results are primarily driven by sales volumes and retention of those issued policies, the accuracy of our pricing assumptions, terms and use of reinsurance, investment income and expenses.
Sales and policies in force. Sales of term policies and the size and characteristics of our in-force book of policies are vital to our results over the long term. Premium revenue is recognized as it is earned over the term of the policy and eligible acquisition expenses are deferred and amortized ratably with the level premiums of the underlying policies. However, because we incur significant cash outflows at or about the time policies are issued, including the payment of sales commissions and underwriting costs, changes in life insurance sales volume will have a more immediate effect on our cash flows.
Historically, we have found that while sales volume of term life insurance products between fiscal periods may vary based on a variety of factors, the productivity of our individual sales representatives remains within a relatively narrow range (i.e., an average monthly rate of new policies issued per life-licensed sales representative between 0.18x and 0.22x), and, consequently, our sales volume over the longer term generally correlates to the size of our sales force.
Investment and Savings Products Segment. Our Investment and Savings Products segment results are primarily driven by sales, the value of assets in client accounts for which we earn ongoing management, investor service and distribution fees and the number of fee generating accounts we administer.
Asset values in client accounts. We earn marketing and distribution fees (trail commissions or, with respect to U.S. mutual funds, 12b-1 fees) on mutual fund and annuity assets in the United States and Canada. In the United States, we also earn investment advisory fees on assets in the managed investments program. In Canada, we earn management fees on certain mutual fund assets and on the segregated funds for which we serve as investment manager. Asset values are influenced by new product sales, ongoing contributions to existing accounts, redemptions and the change in market values in existing accounts. While we offer a wide variety of asset classes and investment styles, our clients’ accounts are primarily invested in equity funds.
Corporate and Other Distributed Products Segment. We earn revenues and pay commissions and referral fees for various other insurance products, prepaid legal services and other financial products, all of which are originated by third parties. NBLIC also has in-force policies from several discontinued lines of insurance. During the first quarter of 2014, NBLIC sold its short-term statutory disability benefit insurance business (“DBL”) to AmTrust North America, Inc., and the operating results have been reported as discontinued operations for all periods presented. During the second quarter of 2014, NBLIC ceased the marketing and underwriting of new student life insurance policies but will continue to administer the existing block of student life business. Corporate and Other Distributed Products segment net investment income is composed of two elements: the remainder of net investment income not allocated to our Term Life Insurance segment and the market return associated with the deposit asset underlying a 10% coinsurance agreement with the Citigroup reinsurers (“10% Coinsurance Agreement”).
The Corporate and Other Distributed Products segment is affected by corporate income and expenses not allocated to our other segments, net investment income (other than net investment income allocated to our Term Life Insurance segment), general and administrative expenses (other than expenses that are allocated to our Term Life Insurance or Investment and Savings Products segments), equity awards granted to management and our sales force leaders at the time of our April 2010 initial public offering (“IPO”), interest expense on notes payable and realized gains and losses on our invested asset portfolio.
The estimates that we deem to be most critical to an understanding of our results of operations and financial position are those related to DAC, future policy benefit reserves and corresponding amounts due from reinsurers, income taxes, the valuation of investments, and litigation. The preparation and evaluation of these critical accounting estimates involve the use of various assumptions developed from management’s analyses and judgments. Subsequent experience or use of other assumptions could produce significantly different results.
Income Taxes. We account for income taxes using the asset and liability method. We recognize deferred tax assets and liabilities for the future tax consequences attributable to (i) temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and (ii) operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period that includes the enactment date. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not applicable to the periods in which we expect the temporary difference will reverse.
In light of the multiple tax jurisdictions in which we operate, our tax returns are subject to routine audit by the Internal Revenue Service (“IRS”) and other taxation authorities. These audits at times may produce alternative views regarding particular tax positions taken in the year(s) of review. As a result, the Company records uncertain tax positions, which requires recognition at the time when it is more likely than not that the position in question will be upheld. Although management believes that the judgment and estimates involved are reasonable and that the necessary provisions have been recorded, changes in circumstances or unexpected events could adversely affect our financial position, results of operations, and cash flows.
Invested Assets. We hold primarily fixed-maturity securities, including bonds and redeemable preferred stocks, and equity securities, including common and non-redeemable preferred stock. We have classified these invested assets as available-for-sale or held-to-maturity, except for the securities of our U.S. broker-dealer subsidiary, which we have classified as trading securities. All of these securities are carried at fair value, except for the held-to-maturity security, which is carried at cost. Unrealized gains and losses on available-for-sale securities are included as a separate component of accumulated other comprehensive income except for the credit loss components of other-than-temporary declines in fair value, which are recorded as realized losses in the accompanying consolidated statements of income. Changes in fair value of trading securities are included in net investment income in the period in which the change occurred.
Other-than-temporary impairment analyses that we perform involve the use of estimates, assumptions, and subjectivity. If these factors or future events change, we could experience material other-than-temporary impairments in future periods, which could adversely affect our financial condition, results of operations and the size and quality of our invested assets portfolio.
Litigation. 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 indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation. We recognize losses for legal contingencies when payments associated with the contingency become probable and can be reasonably estimated. Due to the difficulty of estimating litigation outcomes, actual costs may be substantially higher or lower than any amounts reserved. Legal costs, such as attorney’s fees and other litigation-related expenses that are incurred in connection with litigation, are expensed as incurred.
For additional information on legal issues and contingencies, see Note 16 (Commitments and Contingent Liabilities) to our consolidated financial statements included elsewhere in this report.
Commissions and fees. Consists primarily of dealer re-allowances earned on the sales of investment and savings products, trail commissions and management fees based on the asset values of client accounts, marketing and support fees from product originators, custodial fees for services rendered in our capacity as nominee on client retirement accounts funded by mutual funds on our servicing platform, recordkeeping fees for mutual funds on our servicing platform and fees associated with the sale of other distributed products.
Net investment income. Represents income, net of investment-related expenses, generated by our invested asset portfolio, which consists primarily of interest income earned on fixed-maturity investments. Investment income earned on assets supporting our statutory reserves and targeted capital is allocated to our Term Life Insurance segment, with the balance included in our Corporate and Other Distributed Products segment. Investment income recorded on our held-to-maturity invested asset and the offsetting interest expense recorded for our surplus note are included in net investment income.
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 Citigroup.
Insurance expenses and other operating expenses directly attributable to the Term Life Insurance and the Investment and Savings Products segments are recorded directly to the applicable segment. We allocate certain other operating expenses that are not directly attributable to a specific operating segment based on the relative sizes of our life-licensed and securities-licensed independent sales forces. These allocated costs include field technology, supervision, training and certain other costs. We also allocate certain technology and occupancy costs to our operating segments based on usage. Costs that are not directly charged or allocated to our two primary operating segments are included in our Corporate and Other Distributed Products segment.
Primerica, Inc. and Subsidiaries Results. Our results of operations for the years ended December 31, 2014, 2013, and 2012 were as follows:
Total benefits and expenses. Total benefits and expenses increased in 2014 from 2013 primarily as a result of the growth in revenue-related costs, which include sales commissions, benefits and claims, DAC amortization, and certain insurance expenses. Total benefits and expenses also increased due to accelerated expense recognition from amendments to retirement provisions in our 2014 management equity award agreements and Co-CEO transition expenses that were recognized in 2014 due to the modification of their 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 refer to our segment results as further described below.
deferrable insurance commissions for 2013 reflecting changes in agent incentive programs that led to higher commission deferrals as compared to 2012.
Term Life Insurance Segment. Our results for the Term Life Insurance segment for the years ended December 31, 2014, 2013, and 2012 were as follows:
The increase in direct and net premiums in 2013 from 2012 was also primarily attributable to the continued addition to in-force business of term life insurance policies not subject to the Citigroup coinsurance transactions combined with the run-off of business subject to the Citigroup coinsurance transactions. The increase in net premiums was partially offset by ceded premium recoveries of $6.4 million in 2012, which resulted in a similar reduction in benefits and claims that did not reoccur in 2013.
Allocated net investment income. Allocated net investment income in 2014 remained consistent with 2013, as the higher allocation related to the growth in invested assets that support our statutory capital and reserves (“required assets”) of $7.0 million was mostly offset by the impact of the lower yield on invested assets of $6.5 million.
The increase in allocated net investment income from 2012 to 2013 was largely attributable to the growth in required assets, partially offset by lower yield on invested assets.
In comparing 2013 to 2012, benefits and claims increased primarily due to the growth in net premiums. Partially offsetting this increase was the impact of approximately $6.0 million of ceded premium recoveries during 2012 that did not reoccur during 2013.
Insurance expenses. The increase in insurance expenses in 2014 from 2013 was partially due to higher growth-related expenses and the run-off of expense allowances related to the Citigroup coinsurance transactions. Additionally, higher employee incentive compensation, including accelerated expense recognition of approximately $2.3 million for the segment from amendments to retirement provisions in our 2014 management equity award agreements, contributed to the increase in insurance expenses in 2014.
Insurance expenses in 2013 increased compared to 2012 mainly due to higher employee compensation costs, the run-off of expense allowances received under the Citigroup coinsurance transactions, higher costs in support of our independent sales force, and higher premium-related taxes, licenses and fees.
Insurance commissions. Insurance commissions in 2014 were relatively consistent compared to 2013.
The decrease in year-over-year insurance commissions from 2012 to 2013 was largely driven by a higher rate of commission deferrals consistent with agent incentive program changes.
Interest expense. Interest expense in 2014 was consistent with the amount incurred in 2013.
Face amount of term life insurance policies in force increased in 2014 from 2013 primarily due to a rise in issued face amount from the higher number of new policies issued in 2014. However, the strengthening of the U.S. dollar in relation to the Canadian dollar reduced the translated face amount of Canadian in-force policies in 2014 and partially offset the overall increase in issued face amount. As a percentage of beginning face amount in force, issued face amount remained flat in 2014, while terminations improved as a result of better persistency compared to 2013.
The increase in 2013 sales-based commissions compared to 2012 was also primarily the result of the increase in product sales noted above. The increase in asset-based commissions in 2013 from 2012 was consistent with the increase in asset-based revenues when excluding segregated funds.
In 2013, other operating expenses increased from 2012 mainly due to higher legal fees and expenses associated with the FRS-related claims. Legal fees and expenses incurred in 2013 included approximately $11.4 million of expenses attributable to defending FRS claims, which was up from $2.9 million in 2012. Additionally, a charge of approximately $15.7 million associated with the settlement reached with the FRS claimants contributed to higher legal fees and expenses in 2013 compared to 2012. An increase in growth-related expenses, higher employee compensation costs, and higher costs in support of our independent sales force further contributed to the increase in other operating expenses in 2013 from 2012.
Product sales. Investment and savings products sales increased progressively from 2012 to 2014 as a result of the impact of new product introductions and favorable market performance during this period.
Client asset values also increased in 2013 from 2012 primarily due to strong market performance in 2013 along with product sales in excess of redemptions.
Corporate and Other Distributed Products Segment. Our results of operations for the Corporate and Other Distributed Products segment for the years ended December 31, 2014, 2013, and 2012 were as follows:
Total revenues. 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 due to the impact of income received in 2013 from the tender of certain fixed income securities. In addition, we recognized impairment losses in the fourth quarter of 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, which was attributable to lower assets allocated to the Corporate and Other Distributed Products segment and lower average yield on our total portfolio of invested assets, partially offset by the change in market value of the deposit asset underlying our 10% Coinsurance Agreement. Net premiums and commissions and fees in 2014 remained consistent with 2013.
Investments. Our insurance business is primarily focused on selling term life insurance, which does not include an investment component for the policyholder. The invested asset portfolio supporting our term life insurance business does not involve the substantial asset accumulations and spread requirements that exist with other non-term life insurance products. As a result, the
We also hold within our invested asset portfolio a credit enhanced note (“LLC Note”) issued by a limited liability company owned by a third party service provider which is classified as a held-to-maturity security. The LLC Note, which is scheduled to mature on December 31, 2029, was obtained in exchange for a surplus note of equal principal amount issued (“Surplus Note”) by Vidalia Re, Inc. (“Vidalia Re”), a newly formed special purpose financial captive insurance company and wholly owned subsidiary of Primerica Life. For more information on the LLC Note held-to-maturity security, see Note 4 (Investments) to our consolidated financial statements included elsewhere in this report.
Our invested asset portfolio is subject to a variety of risks, including risks related to general economic conditions, market volatility, interest rate fluctuations, liquidity risk and credit and default risk. Investment guideline restrictions have been established to mitigate the effect of these risks but may not always be effective due to factors beyond our control. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A significant increase in interest rates could result in significant losses, realized or unrealized, in the value of our invested asset portfolio. Additionally, with respect to some of our investments, we are subject to prepayment and, therefore, reinvestment risk.
Details on asset mix (excluding our held-to-maturity security) were as follows:
For additional information on our invested asset portfolio, see Note 4 (Investments) and Note 5 (Fair Value of Financial Instruments) to our consolidated financial statements included elsewhere in this report.
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 outstanding debt, general operating expenses, and income taxes, as well as repurchases of shares outstanding. During 2014, our life insurance underwriting companies
The Parent Company’s subsidiaries generate operating cash flows primarily from term life insurance premiums (net of premiums ceded to reinsurers), income from invested assets, commissions and fees collected from the distribution of investment and savings products as well as other financial products. The subsidiaries’ principal operating cash outflows include the payment of insurance claims and benefits (net of ceded claims recovered from reinsurers), commissions to our sales force, insurance and other operating expenses, interest expense for future policy benefit reserves financing transactions, and income taxes.
Historically, cash flows generated by our businesses, primarily from our existing block of term life policies and our investment and savings products, have provided us with sufficient liquidity to meet our operating requirements. We anticipate that cash flows from our businesses will continue to provide sufficient operating liquidity over the next 12 months.
Investing activities. 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.
Risk-Based Capital. 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.
As of December 31, 2014, our U.S. life insurance subsidiaries had statutory capital substantially in excess of the applicable statutory requirements to support existing operations and to fund future growth. Primerica Life’s RBC ratio remained well positioned to support existing operations and fund future growth.
Notes Payable. The Company has $375.0 million of publicly-traded, senior unsecured notes outstanding issued at a price of 99.843% with an annual rate of 4.75%, payable semi-annually in arrears on January 15 and July 15. The Senior Notes mature July 15, 2022.
As of December 31, 2014, Primerica Life’s financial strength ratings were as follows:
Securities Lending. We participate in securities lending transactions with brokers to increase investment income with minimal risk. See Note 1 (Description of Business, Basis of Presentation, and Summary of Significant Accounting Policies) and Note 4 (Investments) to our consolidated financial statements included elsewhere in this report for additional information.
Our liability for future policy benefits represents the present value of estimated future policy benefits to be paid, less the present value of estimated future net premiums to be collected. Net benefit premiums represent the portion of gross premiums required to provide for all benefits and associated expenses. These benefit payments are contingent on policyholders continuing to renew their policies and make their premium payments. Our contractual obligations table discloses the impact of benefit payments that will be due assuming the underlying policy renewals and premium payments continue as expected in our actuarial models. The future policy benefit payments represented in the table are presented on an undiscounted basis, gross of any amounts recoverable through reinsurance agreements and gross of any premiums to be collected. We expect to fully fund the obligations for future policy benefits from cash flows from general account invested assets and from future premiums. These estimations are based on mortality and lapse assumptions comparable with our historical experience. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results.
Commissions represent gross, undiscounted commissions that we expect to incur, contingent on the policyholders continuing to renew their policies and make their premium payments as noted above. The total liability amount is reported within other liabilities in our consolidated balance sheets.
Our operating lease obligations primarily relate to office, warehouse, printing, and distribution properties. Our executive and home operations for all of our domestic U.S. operations (except New York) are located in Duluth, Georgia, in a build-to-suit facility that was completed in 2013.
We have audited the accompanying consolidated balance sheets of Primerica, Inc. and subsidiaries (the Company) as of December 31, 2014 and 2013, 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, 2014. 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, 2014, 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 26, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
We capitalized Peach Re, Inc. (“Peach Re”), a special purpose financial captive insurance company and wholly owned subsidiary of Primerica Life, and Primerica Life ceded to Peach Re certain level premium term life insurance policies pursuant to a coinsurance agreement (the “Peach Re Coinsurance Agreement”) effective March 31, 2012.
In June 2014, we established Vidalia Re, Inc. (“Vidalia Re”) as a special purpose financial captive insurance company and wholly owned subsidiary of Primerica Life. Vidalia Re and Primerica Life entered into a coinsurance agreement whereby Primerica Life ceded to Vidalia Re certain level premium term life insurance policies (the “Vidalia Re Coinsurance Agreement”) effective July 31, 2014 and December 31, 2014.
Available-for-sale fixed-maturity securities, including bonds and redeemable preferred stocks not classified as trading securities, are carried at fair value. When quoted market values are unavailable, we obtain estimates from independent pricing services or estimate fair value based upon a comparison to quoted issues of the same issuer or of other issuers with similar characteristics.
Equity securities, including common and nonredeemable preferred stocks, are classified as available-for-sale and are carried at fair value. When quoted market values are unavailable, we obtain estimates from independent pricing services or estimates fair value based upon a comparison to quoted issues of the same issuer or of other issuers with similar characteristics.
All reinsurance contracts in effect for the three-year period ended December 31, 2014 transfer a reasonable possibility of substantial loss to the reinsurer or are accounted for under the deposit method of accounting.
See Note 7 (Deferred Policy Acquisition Costs) for more information related to our accounting for DAC.
We have an indefinite-lived intangible asset related to the 1989 purchase of the right to contract with our sales force. This asset represents the core distribution model of our business, which is our primary competitive advantage to profitably distribute term life insurance and investment and savings products on a significant scale, and as such, is considered to have an indefinite life. This indefinite-lived intangible asset is supported by a significant portion of the discounted cash flows of our future business. We assessed this asset for impairment as of October 1, 2014 and determined that no impairment had occurred. There have been no subsequent events requiring further analysis.
We also have an amortizing intangible asset related to a 1995 sales agreement termination payment to Management Financial Services, Inc. This asset is supported by a non-compete agreement with the founder of our business model. We calculate the amortization of this contract buyout on a straight-line basis over 24 years, which represents the life of the non-compete agreement. Intangible asset amortization expense was approximately $3.4 million in 2014, 2013 and 2012. Amortization expense is expected to be approximately $3.4 million annually during the remainder of the amortization period. No events have occurred during 2014, and no factors exist as of December 31, 2014 that would indicate that the net carrying value of our amortizing intangible asset may not be recoverable or will not be used throughout its estimated useful life.
Depreciation expense is included in other operating expenses in the accompanying consolidated statements of income. Depreciation expense was $7.0 million, $7.3 million, and $6.1 million for the years ended December 31, 2014, 2013, and 2012, respectively.
(1) In 2014, property and equipment with no remaining net book value was disposed of in connection with asset maintenance activities and the move of our corporate headquarters. The gross carrying amount of assets and accumulated depreciation written off were each $28.9 million.
Policyholder Liabilities. Future policy benefits are accrued over the current and expected renewal periods of the contracts. Liabilities for future policy benefits on traditional life insurance products have been computed using a net level method, including assumptions as to interest rates, mortality, persistency, and other assumptions based on our experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation. The underlying mortality tables are the Society of Actuaries (“SOA”) 65-70, SOA 75-80, SOA 85-90, and the 91 Bragg, modified to reflect various underwriting classifications and assumptions. Interest rate reserve assumptions at December 31, 2014 and 2013 ranged from approximately 3.5% to 7.0%. For policies issued in 2010 and after, we have been using an increasing interest rate assumption to reflect the historically low interest rate environment. The liability for policy claims and other benefits payable on traditional life insurance products includes estimated unpaid claims that have been reported to us and claims incurred but not yet reported.
Commissions and Fees. We receive commission revenues from the sale of various non-life insurance products on a monthly basis. Commissions are generally received on sales of mutual funds and annuities. We also receive trail commission revenues from mutual fund and annuity products on a monthly basis based on the daily 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 also receive recordkeeping fees monthly from mutual fund accounts on our servicing platform and, 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.
In January 2014, NBLIC sold the assets and liabilities of its short-term statutory disability benefit insurance business (“DBL”) to AmTrust North America, Inc. and its affiliates (the “buyer”). As part of the sale agreement, the buyer assumed all liabilities for DBL insurance policies. In addition, NBLIC transferred the assets held in support of DBL’s insurance liabilities and all other premium-related assets and liabilities to the buyer as of January 1, 2014. The results of DBL’s operations from January 1, 2014 forward were also transferred to the buyer. NBLIC received cash proceeds from the sale of $3.0 million and recognized a pre-tax gain on the sale of approximately $2.4 million, which comprised income from discontinued operations before income taxes in our results of operations for the year ended December 31, 2014.
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, prepaid legal services and various financial products other than our core term life insurance products generally underwritten or offered by third-party providers. 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).
The scheduled maturity distribution of the available-for-sale fixed-maturity portfolio at December 31, 2014 follows:
Unrealized Gains and Losses on Investments. The net effect on stockholders’ equity of unrealized gains and losses on available-for-sale securities was as follows:
Held-to-maturity Security. Concurrent with the execution of the Vidalia Re Coinsurance Agreement, Vidalia Re entered into a Surplus Note Purchase Agreement (the “Surplus Note Purchase Agreement”) with Hannover Life Reassurance Company of America and certain of its affiliates (collectively, “Hannover Re”) and a newly formed limited liability company (the “LLC”) owned by a third party service provider. Under the Surplus Note Purchase Agreement, Vidalia Re issued a surplus note (the “Surplus Note”) to the LLC in exchange for a credit enhanced note from the LLC with an equal principal amount (the “LLC Note”). The principal amount of both the LLC Note and the Surplus Note will fluctuate over time to coincide with the amount of reserves contractually supported under the Vidalia Re Coinsurance Agreement. Both the LLC Note and the Surplus Note mature on December 31, 2029 and bear interest at an annual interest rate of 4.50%. The LLC Note is guaranteed by Hannover Re through a credit enhancement feature in exchange for a fee.
The LLC is a variable interest entity as its owner does not have an equity investment at risk that is sufficient to permit the LLC to finance its activities without Vidalia Re or Hannover Re. The Parent Company, Primerica Life, and Vidalia Re share the power to direct the activities of the LLC with Hannover Re, but do not have the obligation to absorb losses or the right to receive any residual returns related to the LLC’s primary risks or sources of variability. Through the credit enhancement feature, Hannover Re is the ultimate risk taker in this transaction and bears the obligation to absorb the LLC’s losses in the event of a Surplus Note default in exchange for the fee. Accordingly, the Company is not the primary beneficiary of the LLC and does not consolidate the LLC within its consolidated financial statements.
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. The LLC Note, which was rated AA- by Fitch Ratings, had an estimated unrealized holding gain of $8.8 million based on its amortized cost and estimated fair value as of December 31, 2014.
See Note 10 (Debt) for more information on the Surplus Note.
Available-for-sale fixed-maturity and equity securities with a cost basis in excess of their fair values were approximately $340.8 million and $454.2 million as of December 31, 2014 and 2013, respectively.
As of December 31, 2014, the unrealized losses on our available-for-sale invested asset portfolio were largely caused by interest rate sensitivity, foreign currency exchange rates on our Canadian dollar-denominated investments, and changes in credit spreads. We believe that fluctuations caused by interest rate movement have little bearing on the recoverability of our investments. Because we have the ability to hold these investments until a market price recovery or maturity and we have no present intention to dispose of them, we do not consider these investments to be other-than-temporarily impaired.
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, 2014 and 2013. 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.
Level 3. Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Level 3 consists of financial instruments whose fair value is estimated based on industry-standard pricing methodologies and models using significant inputs not based on, nor corroborated by, readily available market information. Valuations for this category primarily consist of non-binding broker quotes. Financial instruments in this category primarily include less liquid fixed-maturity corporate securities, mortgage- and asset-backed securities.
Invested assets included in the transfer from Level 3 to Level 2 primarily were fixed-maturity investments for which we were able to obtain independent pricing quotes based on observable inputs.
Recurring fair value measurements. Estimated fair values of investments in available-for-sale fixed-maturity securities are principally a function of current spreads and interest rates that are corroborated by independent third-party data. Therefore, the fair values presented are indicative of amounts we could realize or settle at the respective balance sheet date. We do not necessarily intend to dispose of or liquidate such instruments prior to maturity. Trading securities, which primarily consist of fixed-maturity securities,
Due from reinsurers represents ceded policy reserve balances and ceded claim liabilities. The amounts of ceded claim liabilities included in due from reinsurers that we paid and which are recoverable from those reinsurers were $26.0 million and $32.9 million as of December 31, 2014 and 2013, respectively.
In connection with our corporate reorganization, Primerica Life, Primerica Life Canada and NBLIC entered into significant coinsurance transactions (the “coinsurance agreements”) on March 30, 2010 with Prime Re and two other affiliates of Citigroup (collectively, the “Citigroup reinsurers”). Under the 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 Citigroup reinsurers. Each of the account balances transferred were at book value with no gain or loss recorded in net income.
A fourth agreement, the 10% Coinsurance Agreement, relates to a reinsurance transaction with Prime Re that includes an experience refund provision. This agreement does not satisfy U.S. GAAP risk transfer rules. As a result, we have accounted for this contract using deposit method accounting and have recognized a deposit asset in other assets on our consolidated balance sheets for assets backing the economic reserves. The deposit asset held in support of this agreement was $157.3 million and $124.4 million at December 31, 2014 and 2013, respectively. We make contributions to the deposit asset during the life of the agreement to fulfill our responsibility of funding the economic reserve. The market return on the deposit asset is reflected in net investment income during the life of the agreement. Prime Re is responsible for ensuring that there are sufficient assets to meet all statutory requirements. We pay Prime Re a 3% finance charge for any statutory reserves required above the economic reserves. This finance charge is reflected in interest expense in our statements of income.
The following table represents the Company’s in-force life insurance at December 31, 2014 and 2013:
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. The principal investment objective of the Asset Builder Funds is to achieve long-term growth while preserving capital. The principal objective of the Strategic Retirement Income Fund is to provide a stream of investment income while at the same time defensively preserving capital. The Asset Builder Funds and the Strategic Retirement Income Fund 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.
Changes in policy claims and other benefits payable were as follows:
At December 31, 2014, 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, 2014. No events of default occurred on the Senior Notes during the year ended December 31, 2014.
Total income tax expense from continuing operations is different from the amount determined by multiplying income from continuing operations before income taxes by the statutory federal tax rate of 35%. The reconciliation for such difference follows:
The Company has state net operating losses resulting in a deferred tax asset of approximately $7.3 million, which are available for use through 2034. The Company has no other material net operating loss or credit carryforwards.
As a result of the separation from Citigroup, the Company is required to file two U.S. consolidated income tax returns at least through December 31, 2014. Our life insurance companies comprise one of the U.S. consolidated tax groups, while the Parent Company and the remaining U.S. subsidiaries comprise the second U.S. consolidated tax group. The method of allocation between companies is pursuant to a written agreement. Allocations generally are based upon separate return calculations with credit for net losses as utilized, and are calculated and settled quarterly.
The major tax jurisdictions in which we operate are the United States and Canada. We are currently open to tax audit by the Internal Revenue Service for the years ended December 31, 2009 and thereafter for federal tax purposes. We are currently open to audit in Canada for tax years ended December 31, 2008 and thereafter for federal and provincial tax purposes. For those periods prior to the IPO, we are fully indemnified by Citigroup.
In 2012, we purchased approximately 7.8 million shares of our common stock owned by certain private equity funds managed by Warburg Pincus LLC (“Warburg Pincus”), which obtained shares of our common stock and warrants to purchase 4,103,110 additional shares of our common stock (the “warrants”) at a purchase price of $18.00 per underlying share in a private sale by Citigroup in connection with our IPO. The prices of the shares repurchased were based on the per share market value of our common stock at the time of the purchases. In addition, we repurchased approximately 1.7 million shares of our common stock in open market transactions during 2012.
In November 2014, our Board of Directors authorized a share repurchase program for up to $150.0 million of our outstanding common stock during 2015. Shares of our common stock have not been repurchased under this plan as of December 31, 2014.
The Company has outstanding common stock and equity awards that consist of restricted stock, RSUs and stock options. In addition, the warrants held by Warburg Pincus were outstanding until we repurchased and retired them in 2013. 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.
The Company has outstanding equity awards under its Omnibus Incentive Plan (“OIP”). The OIP provides for the issuance of equity awards, including stock options, stock appreciation rights, restricted stock, deferred stock, RSUs, unrestricted stock, as well as cash-based awards. In addition to time-based vesting requirements, awards granted under the OIP also may be subject to specified performance criteria. Since 2010, the Company has issued equity awards to our management (officers and other key employees), non-employee directors, and sales force leaders under the OIP. As of December 31, 2014, we had approximately 2.1 million shares available for future grants under this plan.
The Company granted shares of restricted stock and RSUs to non-employee members of the Board of Directors (“director restricted stock and RSU awards”) as follows:
Prior to 2013, non-employee directors received restricted stock that have time-based vesting requirements with equal and annual graded vesting over approximately three years subsequent to the grant date.
The following table summarizes management and director restricted stock and RSU activity during the years ended December 31, 2014, 2013, and 2012.
As of December 31, 2014, total compensation cost not yet recognized in our financial statements related to management and director restricted stock and RSU awards with time-based vesting conditions yet to be reached was approximately $7.1 million, and the weighted-average period over which cost will be recognized was 0.8 years. Compensation costs related to management and director restricted stock and RSU awards were impacted by plan modifications, resulting in the accelerated recognition of expense for certain equity awards. Although the expense related to these modifications have been recognized, the respective equity awards are included in
the above table until such time as the retirement eligible employees elect to retire. See the modifications section below for more details.
The fair value of each option was estimated on the date of grant using the Black-Scholes model. We derived expected volatility after considering our own historical volatility, as well as other public peer companies’ historical volatilities. The Company’s per share dividend yield as of the grant date was used as the input for the expected dividend payout on the underlying shares. The risk-free interest rate was based on the U.S. Treasury yield for a term approximating the expected life of the options at the time of grant. The Company used the simplified method to determine the expected life of options, as there was no historical exercise activity for the Company’s stock option awards as of the grant date. All inputs into the Black-Scholes model were estimates made at the time of grant. The actual realized value of each option grant could materially differ from these estimates, which would have no impact to future reported compensation expense.
The aggregate intrinsic value represents the difference between the exercise price of our stock options and the quoted closing price of our common stock as of December 31, 2014. A summary of the intrinsic values of our stock options is as follows:
Non-Employee Share-Based Compensation. Non-employee share-based transactions relate to the granting of RSUs to members of our sales force (“agent equity awards”). Agent equity awards are generally granted as a part of quarterly contests for successful life insurance policy acquisitions or renewals and, in the second half of 2014, for sales of investment and savings products for which the grant and the service period occur within the same calendar quarter.
Agent equity awards vest and are measured using the fair market value at the conclusion of the quarterly contest; which is the time that performance is complete. However, agent equity awards are subject to long-term sales restrictions expiring over three years. Because the sale restrictions extend up to three years beyond the vesting period, the fair market value of the awards incorporates an illiquidity discount reflecting the risk associated with the post-vesting restrictions. To quantify this discount for each award, we use a series of put option models with one-, two- and three-year tenors to estimate a hypothetical cost of eliminating the downside risk associated with the sale restrictions.
As of December 31, 2014, all agent equity awards were fully vested with the exception of approximately 73,000 shares that vested on January 1, 2015. As such, any related compensation cost not recognized as either expense or deferred acquisition costs in our financial statements through December 31, 2014 is immaterial.
U.S. Insurance Subsidiaries. Our U.S. insurance subsidiaries include Primerica Life, NBLIC, Peach Re, and Vidalia Re. Primerica Life, which wholly owns Peach Re and Vidalia Re, ceded to each in separate coinsurance arrangements certain level premium term life insurance policies.
Our U.S. insurance subsidiaries are required to report their results of operations and financial position to state authorities on the basis of statutory accounting practices prescribed or permitted by such authorities and the National Association of Insurance Commissioners (“NAIC”), which is a comprehensive basis of accounting other than U.S. GAAP. Prescribed statutory accounting practices include a variety of publications of the NAIC, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company’s principal life insurance company, Primerica Life, prepares its statutory financial statements on the basis of accounting practices prescribed or permitted by the NAIC and the 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 capital and surplus and statutory unassigned surplus at December 31, 2014 and 2013 was as follows:
Primerica Life’s investment basis in NBLIC, Peach Re, and Vidalia Re reflect their statutory capital and surplus amounts recorded in accordance with statutory accounting practices prescribed or permitted by the NAIC and each subsidiary’s state of domicile; New York and Vermont, respectively. Peach Re was formed as a special purpose financial captive insurance company and, with the explicit permission of the Vermont DOI, has included the value of a letter of credit serving as collateral for its policy reserves as an admitted asset in its statutory capital and surplus. This permitted accounting practice was critical to the organization and operational plans of Peach Re and explicitly included in the licensing order issued by the Vermont DOI. The impact of this permitted practice as of December 31, 2014 was approximately $507.0 million on Peach Re’s statutory capital and surplus. As of December 31, 2014, if Peach Re had not been permitted to include the letter of credit as an admitted asset, Primerica Life would have been below the minimum statutory capital and surplus level of approximately $79.3 million that triggers a regulatory action event. However, if Peach Re was not permitted to include the letter of credit as an admitted asset in its statutory capital and surplus, Primerica Life would not have paid the ordinary dividends to the Parent Company that were paid in 2014.
Canadian Insurance Subsidiary. Primerica Life Canada is incorporated under the provisions of the Canada Business Corporations Act and is a domiciled Canadian Company subject to regulation under the Insurance Companies Act (Canada) by the Office of the Superintendent of Financial Institutions in Canada (“OSFI”) and by Provincial Superintendents of Financial Institutions/Insurance in those provinces in which Primerica Life Canada is licensed. The financial statements of Primerica Life Canada are prepared in accordance with International Financial Reporting Standards (“IFRS”).
Primerica Life Canada’s capacity to pay ordinary dividends to its parent is limited by OSFI regulations to the extent that its capital exceeds projected capital requirements. OSFI requires companies to set internal target levels of capital sufficient to provide for all the risks of the insurer, including risks specified in OSFI’s capital guidelines. As of December 31, 2014 and 2013, Primerica Life Canada’s statutory capital and surplus satisfied regulatory requirements and was approximately $290.1 million and $279.9 million, respectively.
In Canada, dividends can be paid subject to the paying insurance company continuing to have adequate capital and forms of liquidity as defined by OSFI following the dividend payment and upon 15 days minimum notice to OSFI. Primerica Life Canada’s dividend capacity at January 1, 2015 is estimated to be approximately $114.8 million, which is calculated based on its projection of maintaining internal target capital requirements under certain adverse capital scenarios during each year over the next five years. The actual amount of future dividends that Primerica Life Canada will declare and pay is also subject to the Company’s asserted position of permanent reinvestment of certain unremitted earnings discussed in Note 11 (Income Taxes).
Commitments. We lease office equipment and office and warehouse space under various noncancellable operating lease agreements that expire through June 2028. Total minimum rent expense was $7.7 million, $8.3 million, and $6.9 million for the years ended December 31, 2014, 2013, and 2012, respectively. We had no contingent rent expense during 2014, 2013, and 2012. In March 2013, our agreement to lease our new corporate headquarters in Duluth, Georgia, commenced, which replaced and consolidated substantially all 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, 2014, the minimum aggregate rental commitments for operating leases were as follows:
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. At December 31, 2014, the amount of the LOC outstanding was approximately $507.0 million. This amount was also the maximum amount of the LOC, which will decline over the term of the LOC to correspond with declines in the Regulation XXX reserves. 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, 2014, the Company was in compliance with all financial covenants under the Credit Facility Agreement.