JPFIC conducts operations in Omaha, NE in three buildings on its 11 acre campus. Portions of two buildings are leased to others. It also conducts some group operations in leased space in Atlanta, GA.
3-for-2 stock split, effected in the form of a stock dividend.
Our Individual Products segment sells life insurance on individuals, through which we underwrite the economic risks of mortality and provide vehicles for the accumulation of individual savings. We select and classify mortality risks within a competitive marketplace and a highly regulated industry. Because we earn revenues for accepting mortality risks, the growth in face amount of insurance in force is a key measure for a portion of our revenue growth. We further analyze this segment by its two unique product types: UL-type products and traditional products. UL-type products offered by this segment include universal life (UL) and variable universal life (VUL) products. UL-type product premiums may vary over the life of the policy at the discretion of the policyholder, so we do not recognize them as revenues when received, although UL-type
Product development activities are important to providing appropriate products to a highly competitive marketplace. We have introduced new products with fixed-interest and equity-index components over the last two years that have contributed to improving sales trends. With careful hedging of the economic risk of equity-index components, these products impact our earnings similarly to fixed-interest products. Sales of traditional fixed-interest, multi-year guarantee products declined in the two most recent years because of competition from other financial services products within a declining interest rate environment. New fixed annuity premium sales and surrenders of existing policies are both key indicators of trends in policyholder fund balances.
Effective March 1, 2004, we acquired substantially all of the U.S.-based group life, disability and dental business of The Canada Life Assurance Company, an indirect subsidiary of Great-West Lifeco Inc, via a reinsurance transaction. As a result of this acquisition, we are positioned with approximately $1 billion of annual group life, disability and dental premiums. See Note 1 for further discussion of the details of this transaction.
Management evaluates the performance of our broadcast stations using a number of metrics including audience levels (ratings), growth in audiences, revenue growth, relative share of market revenues, and operating efficiencies, with the ultimate goal of achieving growth in broadcast cash flow. We focus our efforts at the local level, combining sound business practices with service to the community. We monitor each station’s product through market research and tailor the product to our target audience’s tastes and listening/viewing habits. We attempt to maximize revenues and increase revenue share by focusing on management of commercial inventory and pricing. We achieve operating efficiencies by exercising tight expense control at both the local and corporate levels. FCC licenses, which are required for operations, are subject to periodic renewal. Intangible assets related to FCC licenses that are recognized in our financial statements are included within other assets in our consolidated balance sheets.
Our Corporate and Other segment contains the activities of the parent company and passive investment affiliates, surplus of the life insurance subsidiaries not allocated to other segments, financing expenses on corporate debt, strategic initiatives intended to benefit the entire company, and federal and state income taxes not otherwise allocated to business segments. We include all realized gains and losses on investments in the Corporate and Other segment, and hold all defaulted securities in this segment. Realized investment gains are gains and losses on sales and write downs of investments, and although these are included in revenues and income, we exclude them in assessing the performance of our business segments.
We have identified the accounting policies below as critical to the understanding of our results of operations and our financial position. In applying these critical accounting policies in preparing our financial statements, management must use significant judgments and estimates concerning future results or other developments including the likelihood, timing or amount of one or more future events. Actual results may differ from these estimates under different assumptions or conditions. On an on-going basis, we evaluate our estimates, assumptions and judgments based upon historical experience and various other information that we believe to be reasonable under the circumstances. For a detailed discussion of other significant accounting policies, see Note 2.
DAC and VOBA on UL-type products were $2,043.7 or 75.2% of the gross balances (before adjustments for unrealized gains and losses) at December 31, 2004, including $516.5 related to VUL products. We amortize DAC and VOBA on UL-type products and annuity products relative to the future estimated gross profits (EGP) over the life of these products. In calculating the future EGP for these products, management must make long-term assumptions regarding the following components: 1) estimates of fees charged to policyholders to cover mortality, surrenders and maintenance costs; 2) estimated mortality in excess of fund balances accumulated; 3) expected interest rate spreads between income earned, including default charges paid to the Corporate and Other segment, and amounts credited to policyholder accounts; and 4) estimated costs of policy administration (maintenance).
We consider the following assumptions to be most significant to UL-type products: 1) estimated mortality; 2) estimated interest spreads; and 3) estimated future policy lapses. In addition to these three assumptions, VUL and VA products require an additional critical assumption that affects DAC and VOBA amortization, the rate of growth of the separate account mutual funds that generate additional policy fees we use in the EGP on VUL and VA products. We assume a long-term total net return on separate account assets, including dividends and market value increases, of 8.25% and a five-year reversion period. The reversion period is a period over which a short-term return assumption is used to maintain the model’s overall long-term rate of return. We cap the reversion rate of return at 8.25% for one year and 10% for years two through five. This limitation reduces the cumulative effective long-term rate.
The following table reflects the possible pretax income statement impacts that could occur in a given year if we change our assumptions as illustrated related to UL-type products in the Individual Products segment:
As the discussion above indicates, many judgments are involved in timely identifying and valuing investments, including other-than-temporary impairments on securities. Inherently, there are risks and uncertainties involved in making these judgments. See the discussion of Investments and Note 4 for further details. Critical assumptions and changes in circumstances such as a weak economy, an economic downturn or unforeseen events which affect one or more companies, industry sectors or countries could result in additional write downs in future periods for impairments, including those that are deemed to be other-than-temporary.
The liability for “Future policy benefits” pertains to our traditional individual and group insurance products and represents 9.9% of total liabilities at December 31, 2004. Changes in this liability are reflected in the “Insurance and annuity benefits” caption in our consolidated statements of income. Assumptions we use in determining future policy benefits include: future investment yields, mortality, morbidity and persistency. We base estimates about future circumstances principally on historical experience and provide for possible adverse deviation. Though not anticipated, significant changes in experience or assumptions may require us to provide for expected future losses on a product by establishing premium deficiency reserves. See Note 7 for further discussion of the assumptions we use in estimating these liabilities.
The increase in net income for 2004 reflected higher realized gains and earnings growth in the Benefit Partners and Communications segments. The Individual Products and AIP segments declined over the same period. Earnings from business added via the Canada Life transaction favorably impacted the results of Benefit Partners in 2004. Communications achieved market share advances and benefited from increased political advertising revenues in 2004 resulting in earnings growth. Individual Products and AIP segments were adversely impacted by spread compression due to lower portfolio yields, partially resulting from lower prepayments of investments. In 2003, we experienced growth in all segments, including interest spread improvement in our Individual and our AIP lines (favorably impacted by prepayments), and effective expense management across the organization. These advances were partially offset by higher net investment losses. Realized investment gains, net of taxes, were $26.5 in 2004 versus realized investment losses, net of taxes, of ($30.9) in 2003 and ($14.9) in 2002. The net investment losses in 2003 and 2002 were primarily the result of other-than-temporary bond impairments, partially offset in 2002 by realized gains from sales of equity securities. Other-than-temporary impairments were $60 in 2004. An increase in the accrual for pending litigation in our Corporate and Other segment in 2002 affected the comparison to 2003.
Sales from our Individual Markets excluding Community Banks and bank-owned life insurance (BOLI) decreased slightly in 2004 from 2003. In 2003, sales increased over 2002 due to continued success of new product introductions during 2002. In recent years, increased competition among providers of UL-type insurance contracts has resulted in a shortening of the product life cycle. A focus on product development efforts has resulted in a greater distribution of product offerings for our customers. Sales to Community Banks and BOLI business were unchanged in 2004 after declining in 2003. Community Bank and BOLI business will vary widely between periods as we respond to sales opportunities for these single premium products only when the market accommodates our required returns.
Interest margin on UL-type products increased 2.4% in 2004. Lower investment yields were mitigated by growth in policyholder fund balances and our management of interest spreads. As discussed further below, the lower investment yield in 2004 was primarily due to the general interest rate environment and lower prepayments from mortgage-backed securities and commercial mortgage loans. We actively manage interest spreads on our fixed UL-type products in response to changes in investment yields by adjusting the rates credited to policyholder fund balances while considering our competitive strategies as well. The average investment spread on fixed UL products declined 10 basis points to 1.93% in 2004 after having increased 14 basis points in 2003 to 2.03%. During 2003 and 2002, prepayments of mortgage-backed securities significantly increased as a result of continued declines in long-term mortgage rates, but then declined rapidly in 2004 as mortgage rates stabilized. This decline was partially offset by an increase in commercial mortgage loan prepayments in 2004. Our mortgage-backed securities portfolio is primarily a discount portfolio. We estimate that prepayments on mortgage-backed securities in excess of expected levels and prepayments of commercial mortgage loans increased effective investment yields by 12, 20 and 15 basis points in 2004, 2003 and 2002. The decrease in excess accretion of discount on mortgage-backed securities contributed to the decline in effective investment spreads on fixed UL products in 2004. Our ability to manage interest-crediting rates on fixed UL-type products is limited by minimum guaranteed rates provided in policyholder contracts. Therefore, continued low general
market interest rates likely will impact future profitability, as the investment of cash flows at current interest rates reduces our average portfolio yield. At the end of 2004 and 2003, our crediting rates were approximately 31 and 49 basis points on average in excess of our minimum guaranteed rates, including 55% and 43% of our UL policyholder fund balances that were already at their minimum guaranteed rates.
The increase in product charge revenue was due to growth and aging of our insurance blocks, dynamic adjustments to unearned expense charges, as noted below, and higher surrender rates. A reinsurance recapture in 2003 increased cost of insurance charges (COIs) by $8.4. Excluding this impact, COIs grew 7.1% over 2003, with an increase in the average age of our insureds contributing to growth (this contributes to increased death benefits as well). Products issued in recent years are designed to generate a higher proportion of their revenues from expense charges. We defer expense charges received in excess of ultimate annual expense charges and amortize them into income relative to future estimated gross profits. The effect of reflecting updated longer-term assumptions in estimated gross profits on our insurance blocks decreased the amortization of unearned expense charges by $1.1 in 2004 and increased amortization by $2.3 in 2003. The adoption of a new accounting standard, related to secondary guarantees and other benefits, in 2004 impacted estimated gross profits and reduced the amortization of unearned expense charges by $4.0. Excluding the impacts from the new accounting standard and the dynamic adjustment to amortization, expense charges increased 10.5% over 2003 due to changes in product mix, as certain of our newer products with level expense loads represented a higher proportion of 2004 sales. Surrender activity also increased during 2004 from higher lapses in our BOLI block of business, resulting in higher surrender charge income.
UL-type death benefits and other insurance benefits included $15.8 for 2004 related to the impact of a new accounting standard (see Note 2) related to secondary guarantees and other benefit features. The accounting for these benefit features incorporates estimated future gross profits used to calculate amortization of DAC, VOBA and unearned expense charges. A change in estimated future gross profits will impact other insurance benefits and the amortization of DAC, VOBA and unearned expense charges. The effect of updating longer-term assumptions in estimated gross profits for our insurance blocks decreased other insurance benefits by $4.7 in 2004. See the Critical Accounting Policies and Estimates section and Note 6 for further discussion. UL-type death benefits in 2003 included $7.6 for the reinsurance recapture mentioned above. Absent the impact of the new accounting standard discussed above and reinsurance recapture items, UL-type death benefits and other insurance benefits increased 12.2% over 2003. UL-type death benefits, net of reinsurance, per thousand dollars of average net face amount at risk (average face amount of insurance in force net of reinsurance and reduced by average policyholder fund balances) were $3.52 in 2004 compared to $3.31 in 2003 and $3.20 in 2002. Aging of our blocks will continue to contribute to increasing levels of UL-type death benefits. While over the long term death benefits should emerge within actuarial expectations, the level of death benefits will fluctuate from year to year.
Traditional premiums and other considerations declined in 2004, 2003 and 2002 reflecting customer preferences for UL-type products. Net investment income from our traditional blocks declined in 2004, due to a decline in investment yields, partly due to lower prepayments of mortgage-backed securities, and the decreasing size of the block.
Policy benefits on traditional business include death benefits, dividends, surrenders and changes in reserves, with the most significant being death benefits. Policy benefits as a percentage of premiums and other considerations were 113.5% in 2004, 114.3% in 2003 and 115.4% in 2002.
Total Individual expenses (including the net deferral and amortization of DAC and VOBA) are as follows:
Net investment income increased at a lower rate than the growth in average policyholder fund balances, due to a decline in investment yields offset somewhat by the options market value adjustment described above. Lower investment yields resulted from a decline in our base earned rate, due to the general interest rate environment, as well as a reduction in excess prepayments of mortgage-backed securities and prepayments of commercial mortgage loans. The effect of these prepayments in the AIP segment increased effective yields by 13, 24 and 4 basis points in 2004, 2003 and 2002.
We actively manage spreads on fixed annuity products in response to changes in our investment portfolio yields by adjusting the interest rates we credit on annuity policyholder fund balances while considering our competitive strategies. Our newer product designs in AIP require lower spreads to achieve targeted returns and require lower levels of capital to support new sales. These factors, combined with the current interest rate environment, will likely result in earnings that lag behind growth in average fund balances for a period of time. Effective investment spreads on fixed annuities decreased in 2004 after having increased in 2003, primarily due to the lower impact of excess prepayments discussed above.
Our ability to manage interest crediting rates on fixed annuity products is limited by continued low general market interest rates, as the investment of cash flows at current interest rates reduces our average portfolio yield, and crediting rate actions are limited by minimum guaranteed rates provided in policyholder contracts. We have approximately $4.4 billion of fixed annuity policyholder fund balances with crediting rates that are reset on an annual basis, for which our crediting rates on average were approximately 10 basis points in excess of minimum guaranteed rates at December 31, 2004. Approximately $3.1 billion of fixed annuity policyholder fund balances have multi-year guaranteed rates (MYG), approximately $800 of which will reset in 2005 with an additional $2.3 billion resetting in 2006 and thereafter. As multi-year guarantees expire, policyholders will have the opportunity to renew their annuities at rates in effect at that time. Our ability to retain these annuities will be subject to then-current competitive conditions. The current average spread to the minimum underlying guarantee on these products is approximately 253 basis points. In 2004, $352 of fixed annuity policyholder fund balances reset, of which approximately $225 lapsed where the holder did not select another product that we offer. These lapses reduced policyholder fund balances and increased DAC amortization, but also increased investment spreads for the business retained. Surrenders are affected by factors such as varying crediting rates on multi-year guarantees compared to current crediting rates at reset dates and the absence of surrender charges at reset dates.
Total AIP expenses (including the net deferral and amortization of DAC and VOBA) were as follows:
Total revenues for Benefit Partners increased over 2003 due to the acquisition of substantially all of the U.S.-based group life, disability and dental business of Canada Life and due to organic growth from sales during 2004 and 2003. Excluding the Canada Life block, premiums and other considerations increased 14.9% over 2003 due to strong growth in the disability business. Annualized sales increased 1.5% over 2003 due to continued growth in our sales force in a continued strong competitive environment industry-wide. Also, our sales results reflect the actions we implemented in 2003, and continued in 2004, in the life business to tighten certain underwriting rules and strengthen our sales focus on higher margin, smaller case business.
The expense growth in 2004 reflects expenses from Canada Life integration activities and overall growth in the business. The 2004 increase in the total unit expense ratios for the year relative to the 2003 period is driven by the impact of these integration expenses as well as the decline in DAC capitalization and growth in DAC amortization expense on a unit expense basis as this block continues to grow. In the first quarter 2004, we also changed our presentation of commissions, which are paid and expensed on a monthly basis. In the past, we reflected such commissions as capitalized and fully amortized each month. We no longer flow these commissions through DAC. This change has no impact on total expenses or reportable segment results. Expense growth in 2003 was in line with the overall growth in the business.
In October 2004, the Office of the Attorney General of the State of New York announced a lawsuit following a probe into two practices it had observed in the property and casualty insurance brokerage industry: “bid rigging” and “contingent commissions”. The Company has not been named in any litigation or investigation and has not received any subpoenas with regard to such matters, though all insurance companies and brokers licensed in the states of New Jersey, North Carolina and Nebraska were asked by the respective Insurance Commissioners within those states to provide certain information in the context of an industry fact-finding investigation. Benefit Partners has found no evidence of “bid rigging”. We use broker bonus programs in our business development practices. Such bonuses are considered normal practice within the industry. It is unclear at this time what, if any, changes in regulation may come about as a result of this matter, but the Company has positioned its business practices to respond appropriately to any increase in required disclosure or other such change in business practices.
Reportable segment results is a Non-GAAP measure. See Note 15 for further discussion.
Cost of sales represents direct and variable costs, consisting primarily of sales commissions, rights fees and sports production costs. Operating expenses represent other costs to operate the broadcast properties, including salaries, marketing, research, purchased programming and station overhead costs. Total expenses, excluding interest expense, increased 6.6% in 2004 and decreased 1.1% in 2003. As a percent of communication revenues, these expenses were 61.9%, 64.6% and 67.2% for 2004, 2003 and 2002. The 2004 and 2003 improvements reflect growing revenues and continued expense discipline, partially offset in 2004 by increased sales commissions and bonuses.
On April 1, 2004, JPCC acquired the assets and an FCC license to broadcast a FM radio station in San Diego, CA for $18.
Because our broadcasting businesses rely on advertising revenues, they are sensitive to cyclical changes in both the general economy and in the economic strength of local markets. Furthermore, our stations derived 21.4% and 23.5% of their advertising revenues from the automotive industry in 2004 and 2003. If automobile advertising is significantly curtailed, it could have a negative impact on broadcasting revenues. In 2004, 6.7% of television revenues came from a network agreement with our CBS-affiliated stations that expires in 2011. The trend in the industry is away from the networks compensating affiliates for carrying their programming, and there is a possibility those revenues will be eliminated when the contract is renewed. Many different businesses compete for available advertising sales in our markets, including newspapers, magazines, billboards and other radio and television broadcasters. Technological changes (such as satellite radio) and consolidation in the broadcast industry may increase competition for audiences and advertisers.
The following table summarizes results for this segment. Prior year amounts have been restated to conform to the current year presentation for the adoption of FIN 46, under which, as discussed later and in Note 2, we no longer consolidate two affiliated Capital Trusts.
Earnings on investments and other income increased $1.0 in 2004, driven primarily by an increase in default charges received from the operating segments, a $3.6 settlement from a Bank of America merger class action suit, and dividends related to equity securities, offset partially by the allocation of bond calls to our segments and lower portfolio yields. Default charges are received from the operating segments for this segment’s assumption of all credit related losses on the invested assets of those segments. These charges are calculated in part as a percentage of invested assets. Default charge income for 2004, 2003 and 2002 was $38.5, $31.3 and $21.9. The increase in 2004 resulted from an increase in investment assets including those related to the Canada Life business and a change in fixed income securities’ asset mix. Default charges increased in 2003 in response to the credit environment experienced in the securities markets during recent years. Earnings on investments in this segment can fluctuate based upon opportunistic repurchases of common stock, the amount of excess capital generated by the operating segments and lost investment income on bonds defaulted or sold at a loss.
The realized investment gains in 2004 sharply contrasted with the realized investment losses in the two previous years. The 2004 improvement was due to stock gains as well as the decline in bond impairments as a result of significant improvement in the corporate credit environment and proactive portfolio management. The 2004 write downs primarily reflected further deterioration among airline issuers.
Risks for this segment include investment impairments due to weakening in the economy, the risk of rising interest rates on our floating rate debt, our ability to replace existing debt agreements with comparable terms, declines in the dividends on or the values of our equity securities which would limit our potential for realized gains, general uncertainty regarding litigation, and the potential for future impairment of goodwill. Also, as discussed in the Liquidity section, to service our debt and to pay shareholder dividends, we rely on excess cash flows through dividends from our subsidiaries. Dividends from our insurance subsidiaries depend upon regulatory approval when above certain limits.
Outstanding commercial paper has various maturities that can be up to 270 days. If we cannot remarket commercial paper at maturity, we have sufficient liquidity, consisting of the bank credit agreements, liquid assets, such as equity securities, and other resources to retire these obligations. The weighted-average interest rates for commercial paper borrowings outstanding of $188 and $654 at December 31, 2004 and 2003 were 2.30% and 1.13%. The maximum amount outstanding in 2004, after the January issuance of the term debt and EXLs, was $298 compared to $656 in 2003.
In January 2004, we issued $300 of 4.75% 10-year term notes and $300 of floating rate EXtendible Liquidity Securities® (EXLs) that currently have a maturity of November 2005, as of December 31, 2004, subject to periodic extension through 2011. Each quarter, the holders must make an election to extend the maturity of the EXLs for 13 months, otherwise they become due and payable on the next maturity date to which they had previously been extended. The EXLs bear interest at LIBOR plus a spread, which increases annually to a maximum of 10 basis points. The proceeds from the debt issuances were used to support the Canada Life acquisition and to pay down commercial paper while rebalancing the mix of fixed and floating rate debt and short and long term maturities in our capital structure. We received confirmation from both Fitch and S&P that the debt
Our insurance subsidiaries have statutory surplus and risk based capital levels well above current regulatory required levels. As mentioned earlier, a significant portion of our life sales consists of products containing no-lapse guarantees (secondary guarantees), for which statutory reserving practices (referred to as “AXXX”) are currently under review by the National Association of Insurance Commissioners. Numerous proposals have been circulated by regulators and the industry and debate is ongoing. Certain approaches could require companies to hold additional statutory policy reserves. Our estimate of the potential impact on our year end 2004 statutory surplus under various approaches ranges from $0 to $200. This potential impact would grow annually, particularly with continued sales of products subject to these reserve requirements. The proposals under consideration, if adopted in a manner that results in significantly increased statutory reserves, could cause the Company and other insurers to increase pricing or otherwise limit availability of certain product offerings. In December 2004, we formed an insurance subsidiary, chartered in Bermuda for the purpose of providing intracompany reinsurance. In conjunction with the establishment of this subsidiary, we obtained a $500 letter of credit facility, which will provide credit enhancement for our subsidiary’s reinsurance obligations. JP is a guarantor under the letter of credit facility. At December 31, 2004, we had not reinsured any reserves subject to AXXX. We continue to review other strategic alternatives in the event that regulatory requirements ultimately result in provision of higher statutory reserves for our secondary guarantee products. We cannot estimate the cost of potential alternative solutions.
The ratings by A.M. Best and Standard & Poor’s are currently the highest available by those rating agencies and have been reaffirmed in 2005, while the ratings by Fitch Ratings is that agency’s second highest rating. A significant drop in our ratings, while not anticipated, could potentially impact future sales and/or accelerate surrenders on our business in force.
Net cash provided by operations in 2004, 2003 and 2002 was $991, $537 and $403. The primary driver for the increase over 2003 related to the proceeds received in the Canada Life transaction, an increase in traditional premium receipts from organic growth in Benefit Partners, and lower federal income tax payments. The increase in 2003 over 2002 was from an increase in traditional product premium receipts in our Benefit Partners segment due to growth in that segment, combined with the timing of the processing of Community Banks and BOLI single premiums received in late 2001, pending policy issuance which then occurred in 2002. Those premiums were reported as cash received from operations in 2001 and as a decrease in cash from operations in 2002.
Net cash used in investing activities was $1,786, $1,420 and $1,599 in 2004, 2003 and 2002. In 2004, investment purchases increased substantially due to cash received in the Canada Life transaction and from higher sales of EIAs. Cash used in other investing activities increased due to purchases of affordable housing tax credit securities, higher originations of mortgages loans, and an acquisition of assets and an FCC license for a radio station. The decrease in AIP sales in 2003 provided less funds for investment purposes. Record sales levels in our Individual Products segment in 2002 increased funds available for investment.
Net cash provided by financing activities was $810, $888 and $1,124 in 2004, 2003 and 2002, including cash inflows from policyholder contract deposits net of withdrawals of $1,022, $1,081 and $1,404. The fluctuations in net policyholder contract deposits reflect higher sales of EIAs offset by higher surrenders in 2004 and lower Community Bank life sales in 2003 compared to 2002. Net borrowings increased in 2004 over 2003 largely due to the funding of the Canada Life acquisition.
In order to meet the parent company’s dividend payments, debt servicing obligations and other expenses, we rely on dividends from our insurance subsidiaries. Cash dividends received from subsidiaries by the parent company were $289, $273 and $402 in 2004, 2003 and 2002. Our life insurance subsidiaries are subject to laws in their states of domicile that limit the amount of dividends that can be paid without the prior approval of the respective state’s insurance regulator. The limits are based in part on the prior year’s statutory income and capital, which are negatively impacted by bond losses and write downs. Approval of these dividends will depend upon the circumstances at the time, but we have not experienced problems with state approvals in the past.
Cash and cash equivalents were $87, $72 and $67 at December 31, 2004, 2003 and 2002. The parent company and non-regulated subsidiaries held equity and fixed income securities of $678, $753 and $424 at these dates. We consider the majority of these securities to be a source of liquidity to support our strategies.
Total assets increased $2,409 in 2004 and $2,077 in 2003 due primarily to the Canada Life acquisition, net policyholder contract deposits, growth in DAC, and growth in separate account assets, which more than offset dividends, stock repurchases and impairment losses.
At December 31, 2004 and 2003, we had reinsurance receivables of $828 and $845 and policy loans of $61 and $103 which are related to the businesses of JP Financial that are coinsured with Household International (HI) affiliates. HI has provided payment, performance and capital maintenance guarantees with respect to the balances receivable. We regularly evaluate the financial condition of our reinsurers and monitor concentrations of credit risk related to reinsurance activities. We have not suffered any significant credit losses from reinsurance activities in the last three years.
The following table details our contractual obligations, including principal and interest where applicable, at December 31, 2004. The amounts in the table are different than those reported in our consolidated balance sheet at December 31, 2004 due to the consideration of interest in debt obligations and discounted estimates of future payments for policy liabilities excluding the impact of future premium revenues. Some of the figures we include
Purchase obligations consist of JPCC commitments for purchases of syndicated television programming and commitments on other contracts and future sports programming rights. In 2004, JPCC announced an agreement in principle that will give JP Sports and its broadcasting partner television syndication rights to Atlantic Coast Conference football and basketball games through the 2010 season. While the agreement is not yet final, we have estimated the amount of the future obligations that will be required under the present terms of the arrangement. Purchase obligations represent $337 as of December 31, 2004, payable through the year 2011. We have commitments to sell a portion of those sports programming rights to other entities for $231 over the same period. These commitments are not reflected as an asset or liability in our balance sheets because the programs are not currently available for use. We expect advertising revenues that are sold on an annual basis to fund the purchase commitments.
We have no material off balance sheet arrangements of a financing nature. We routinely enter into commitments to extend credit in the form of mortgage loans and to purchase certain debt instruments in private placement transactions for our investment portfolio. The fair value of such outstanding commitments as of
The majority of our unrealized gains and losses can be attributed to changes in interest rates and market changes in credit spreads. These unrealized gains and losses do not necessarily represent future gains or losses that will be realized. Changing conditions related to specific bonds, overall market interest rates, credit spreads or equity securities markets as well as general portfolio management decisions are likely to impact values we ultimately realize. Gross unrealized gains and losses at December 31, 2003 were $1,633 and $(128).
Our internal guidelines require an average quality of an S&P or equivalent rating of “A” or higher for the entire bond portfolio. At December 31, 2004, the average quality rating of our bond portfolio was “A”, which equates to a rating of 1 from the National Association of Insurance Commissioners’ Securities Valuation Office (SVO). We monitor the overall credit quality of our portfolio within internal investment guidelines. This table describes our debt security portfolio by credit rating.
In identifying “potentially distressed securities”, we first screen for all securities that have a fair value to amortized cost ratio of less than 80%. However, as part of this identification process, management must make assumptions and judgments using the following information:
industry factors or conditions related to a geographic area that are negatively affecting the security
The following table shows the maturity date distribution of our debt securities in an unrealized loss position at December 31, 2004. The fair values of these securities could fluctuate over the respective periods to maturity or any sale.
The following table shows the credit quality of our debt securities with unrealized losses at December 31, 2004:
Realized losses are comprised of both write downs on other-than-temporary impairments and actual sales of securities.
$16.6 write down on debt of Dairy Holdings (a subsidiary of Parmalat). This issuer defaulted on this security and subsequently filed for bankruptcy protection. This is the only exposure we had to Parmalat. This security was sold for its written down value in 2003. This had no impact on other holdings in our portfolio.
$15.0 write down of US Generating. This was an investment in a project finance security in the power generating industry. The lessee of this facility filed bankruptcy and rejected this lease. As a result, the investment became other than temporarily impaired. This had no impact on other holdings in our portfolio.
In 2004 we incurred losses of $40.0 on sales of securities. There were no individually material losses on sales of securities in 2004. After consideration of all available evidence, none of these disposals previously met the criteria for other-than-temporary impairment. The Company will continue to manage its AFS portfolio in a manner that is consistent with the available-for-sale classification.
Mortgage-backed securities (including Commercial Mortgage-backed Securities) at December 31, 2004 and 2003 all of which are included in debt securities available-for-sale, were as follows:
Our investment strategy with respect to mortgage-backed securities (MBS) portfolio focuses on actively traded issues with less volatile cash flows. The majority of the MBS holdings are sequential and planned amortization class tranches of federal agency issuers. The MBS portfolio has been constructed with underlying mortgage collateral characteristics and structure in order to mitigate cash flow volatility over a range of interest rates.
Because of the decline in interest rates during the early months of 2003, the mortgage market experienced record levels of refinancings and the structural protection of our MBS portfolio eroded. We experienced MBS prepayments totaling $1,034 or 39.3% and $2,656 or 64.1% of the average carrying value of the MBS portfolio in 2004 and 2003. Our MBS portfolio is primarily a discount portfolio; therefore, prepayments accelerate the accretion of discount into income. The excess accretion of discount increased investment income $5.6, $49.8 and $28.0 in 2004, 2003 and 2002. These prepayments are reinvested at yields that are lower than our current portfolio yields, producing less investment income going forward. Our MBS portfolio declined significantly in 2004 and 2003, and we reinvested most of the proceeds in investment grade corporate bonds.
We record mortgage loans on real property net of an allowance for credit losses. This allowance includes both reserve amounts for specific loans, and a general reserve that is calculated by review of historical industry loan loss statistics. We consider future cash flows and the probability of payment when we calculate our specific loan loss reserve. Prepayments on mortgage loans result from sales of the related properties or loan refinancings.
Prepayments on mortgage loans were $17.1, $4.4 and $3.5 in 2004, 2003 and 2002, and proceeds were reinvested at lower yields. See Note 4 for more detail regarding the composition and concentration of our mortgage loan portfolio.
Our investment guidelines permit use of derivative financial instruments such as futures contracts and interest rate swaps in conjunction with specific direct investments. Our actual use of derivatives through December 31, 2004 has been limited to managing well-defined interest rate risks. Interest rate swaps utilized in our asset/ liability management strategy with a current notional value of $339 and $348 were open as of December 31, 2004 and 2003. During 2002, we began using interest rate swaps to hedge prospective bond purchases to back deposits on certain annuity contracts. This hedging strategy protects the spread between the annuity crediting rate offered at the time the annuities are sold and the yield on bonds to be purchased to back those annuity contracts. These interest rate swap contracts are generally terminated within a month. We also purchase S&P 500 Index® options in conjunction with our sales of equity indexed annuities.
In a falling interest rate environment, the risk of prepayment on some fixed income securities increases and funds prepaid are then reinvested at lower yields. We limit this risk by concentrating the fixed income portfolio mainly on non-callable securities, by purchasing securities that provide for “make-whole” type prepayment fees. Falling interest rates can also impact demand for our products, as interest-bearing investments with no surrender charges and higher average returns from equity markets may become more attractive to new and existing customers. Conversely, in a rising interest rate environment, competitive pressures may make it difficult for us to sustain spreads between rates we credit on interest-sensitive products and our portfolio earnings rates, thereby prompting withdrawals by policyholders. We manage these risks by adjusting our interest crediting rates with due regard to the yield of our investment portfolio, minimum rate guarantees and pricing assumptions and by prudently managing interest rate risk of assets and liabilities.
While a modest interest rate increase would initially be unfavorable to our earnings, due to the near-term impact on our cost of borrowing, such an increase would be favorable to our earnings over a longer timeframe as higher investment yields would be incorporated into our investment portfolio and our interest spreads. Conversely, a sustained period of flat to declining new money rates would reduce reported earnings due to the effect of minimum rate guarantees and the possible impact of increased lapsation in our insurance products.
We also consider the timing of cash flows arising from market risk sensitive instruments and insurance portfolios under varying interest rate scenarios as well as the related impact on reported earnings under those varying scenarios. Market risk sensitive instruments include debt and equity securities available-for-sale and held-to-maturity (including MBS securities), mortgage loans, policy loans, investment commitments, annuities in the
These estimated impacts are incremental to potential earnings impacts from trends and/ or environmental factors already in existence, such as a reduction in the level of prepayments on mortgage-backed securities or the increased lapsation in our annuity business. The model assumes that changes in our crediting rates will occur correspondingly with increases or declines in investment yields, subject to the impact of minimum rate guarantees. As discussed previously, as of year end our crediting rates on blocks of business that are on an annual reset basis were approximately 31 basis points and 10 basis points on average in excess of minimum guaranteed rates for Individual Products and AIP.
Certain fixed interest rate market risk sensitive instruments may not give rise to incremental income or loss during the period illustrated, but may be subject to changes in fair values which are reflected in equity. Note 17 presents additional disclosures concerning fair values of financial assets and financial liabilities.
Demographic changes include the aging of the baby boomers, reaching their high earning years at a time when investment yields from fixed rate products are at historically low points. This challenge has been met by the insurance industry by offering various types of fixed and variable products aimed at this population. The industry’s overall individual life insurance sales in the U.S. were flat in 2004 and, until late in the year, reflected a trend towards those financial products with a fixed rate given the volatility in the equity markets.
The U.S. insurance industry has experienced mergers, acquisitions, consolidations, sales of business lines and marketing arrangements with other financial services providers. These activities have been driven by a need to reduce costs of distribution and to increase economies of scale in the face of growing competition from larger insurers, banks, securities brokers, mutual funds and other non-traditional competitors. We expect further strategic alignments in the financial services industry given changing demographics, technological advances, and customer expectations for one-stop shopping. We continue to analyze our options within this environment for increasing distribution, adding products and technology and improving economies of scale.
State guaranty associations make assessments to cover losses to policyholders of insolvent or rehabilitated insurance companies. Assessments may be partially recovered through a reduction in future premium taxes in most states. We have accrued for expected assessments net of estimated future premium tax deductions.
As a matter of policy, we do not normally make projections or forecasts of future events or our performance. When we do, we rely on a safe harbor provided by the Private Securities Litigation Reform Act of 1995 for statements that are not historical facts, called forward looking statements. These may include statements relating to our future actions, sales and product development efforts, expenses, the outcome of contingencies such as legal proceedings, or financial performance.
Certain information in our SEC filings and in any other written or oral statements made by us or on our behalf, involves forward looking statements. We have used appropriate care in developing this information, but any forward looking statements may turn out to be wrong. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties that could significantly affect our actual results or financial condition. These risks and uncertainties include among others, general economic conditions (including the uncertainty as to the duration and rate of the current economic recovery), the impact on the economy from further terrorist activities or US military engagements, and interest rate levels, changes and fluctuations, all of which can impact our sales, investment portfolios, and earnings; competitive factors, including pricing pressures, technological developments, new product offerings and the emergence of new competitors; changes in federal and state taxes (including the recent or future changes to general tax rates, dividends, capital gains, retirement savings, and estate taxes); changes in the regulation of the insurance industry or financial services industry; changes in generally accepted or statutory accounting principles (such as the AXXX actuarial guideline discussed in Capital Resources) or changes in other laws and regulations and their impact; and the various risks discussed earlier in this management’s discussion and analysis.
sections it may reference, in our most recent 10-K report as it may be updated in our subsequent 10-Q and 8-K reports. This discussion covers certain risks, uncertainties and possibly inaccurate assumptions that could cause our actual results to differ materially from expected and historical results. Other factors besides those listed there could also adversely affect our performance.
In September 2004, the Company adopted new accounting guidance that resulted in the restatement of the previously reported cumulative effect from ($13) to ($17) (See Note 2).
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Jefferson-Pilot Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004 of Jefferson-Pilot Corporation and subsidiaries and our report dated March 11, 2005 expressed an unqualified opinion thereon.
We have audited the accompanying consolidated balance sheets of Jefferson-Pilot Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index at item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Jefferson-Pilot Corporation and subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Jefferson-Pilot Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2005 expressed an unqualified opinion thereon.
Jefferson-Pilot Corporation (with its subsidiaries, referred to as the Company) operates in the insurance, securities and broadcasting industries. Life insurance, annuities, disability and dental insurance are currently marketed to individuals and businesses in the United States through the Company’s principal life insurance subsidiaries: Jefferson-Pilot Life Insurance Company (JP Life), and Jefferson Pilot Financial Insurance Company (JPFIC) and its subsidiary, Jefferson Pilot LifeAmerica Insurance Company (JPLA). Jefferson Pilot Securities Corporation (with related entities, JPSC) is a registered non-clearing broker/dealer that sells affiliated and non-affiliated variable life and annuity products and other investment products, including mutual funds, stocks, bonds and other investments. Collectively, these insurance and securities subsidiaries are referred to as JP Financial. Broadcasting operations are conducted by Jefferson-Pilot Communications Company (JPCC) and consist of radio and television broadcasting, through facilities located in strategically selected markets in the Southeastern and Western United States, and sports program production.
Effective March 1, 2004, the Company acquired via a reinsurance transaction substantially all of the in-force U.S. group life, disability and dental business of The Canada Life Assurance Company (Canada Life), an indirect subsidiary of Great-West Lifeco Inc.
The consolidated financial statements include the accounts of Jefferson-Pilot Corporation and all of its subsidiaries. All material intercompany accounts and transactions have been eliminated. The Company has two equity investments in which it owns less than 50%, but greater than 20%. The Company does not exercise control over any of these entities and therefore, does not consolidate these entities. The Company accounts for these investments on the equity method. Neither the carrying value on the balance sheet nor the equity in earnings on
the income statement related to these investments is material. In accordance with the provisions of Financial Accounting Standards Board issued Interpretation No. 46(R), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (the Interpretation), as of December 31, 2003, the Company deconsolidated two variable interest entities, as defined in the Interpretation, that had previously been consolidated. All periods presented have been restated accordingly.
Basic earnings per share is computed by dividing income attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised.
Amortization of premiums and accrual of discounts on investments in debt securities are reflected in earnings over the contractual terms of the investments in a manner that produces a constant effective yield. Investment securities are regularly reviewed for impairment based on criteria that include the extent to which cost exceeds market value, the duration of the market decline, and the financial health of and specific prospects for the issuer. Unrealized losses that are considered to be other-than-temporary are recognized in realized gains and losses. See Note 4 for further discussion of the Company’s policies regarding identification of other-than-temporary impairments. Realized gains and losses on dispositions of securities are determined by the specific-identification method.
Real estate acquired by foreclosure is stated at the lower of depreciated cost or fair value less estimated costs to sell. Real estate not acquired by foreclosure is stated at cost less accumulated depreciation. Real estate, primarily buildings, is depreciated principally by the straight-line method over estimated useful lives ranging from 30 to 40 years. Accumulated depreciation was $59 and $55 at December 31, 2004 and 2003. Other investments are stated at equity, fair value or the lower of cost or market, as appropriate.
Value of business acquired represents the actuarially determined present value of anticipated profits to be realized from life insurance and annuity business acquired in business combinations, using the same assumptions used to value the related liabilities. Amortization of the value of business acquired occurs over the related contract periods, using current crediting rates to accrete interest and a constant amortization rate based on the present value of expected future profits for fixed universal life and annuity products.
The carrying amounts of deferred policy acquisition costs and value of business acquired are adjusted for the effect of non-credit-related realized gains and losses, credit-related gains, and the effects of unrealized gains and losses on debt securities classified as available-for-sale. Deferred policy acquisition costs and value of business acquired are not adjusted for the effect of credit-related losses, rather as a part of the investment income allocation process a charge, referred to as a default charge, is made against the investment income allocated to the Individual Products, Annuity and Investment Products, and Benefit Partners segments. The default charge is based upon the credit quality of the assets supporting each segment and is meant to replicate the expected credit losses that will emerge over an economic cycle. Through this mechanism, the Individual Products, Annuity and Investment Products, and Benefit Partners segments pay a relatively level charge to the corporate segment and in return are reimbursed when credit-related losses actually occur. See Note 6 for further discussion.
Deferred policy acquisition costs and value of business acquired are reviewed periodically to determine that the unamortized portion does not exceed the expected recoverable amounts. No significant impairment adjustments have been reflected in the results of operations for the years presented.
Separate account assets and liabilities represent funds segregated for the benefit of certain policyholders who bear the investment risk. The separate account assets and liabilities, which are equal, are recorded at fair value. Policyholder account deposits and withdrawals, investment income and realized investment gains and losses in the separate accounts are excluded from the amounts reported in the consolidated statements of income. Fees charged on separate account policyholders’ deposits are included in universal life and investment product charges in the consolidated statements of income.
Film and program rights result from license agreements under which the Company has acquired rights to broadcast certain television program material and are stated at cost less amortization. The cost of rights acquired is recorded as an asset within other assets, and an offsetting liability is also recorded in other liabilities when the cost is known or reasonably determinable, and the program material has been accepted and made available for broadcast. Amortization is determined using both straight-line and accelerated methods based on the terms of the license agreements. Carrying amounts are regularly reviewed by management for indications of impairment and are adjusted when appropriate to estimated amounts recoverable from future broadcast of the applicable program material.
Policyholder contract deposits consist of policy values that accrue to holders of universal life-type contracts and annuities. The liability is determined using the retrospective deposit method and is presented before deduction of potential surrender charges.
The liability for policy and contract claims consists of the estimated amount payable for claims reported but not yet settled and an estimate of claims incurred but not reported, which is based on historical experience, adjusted for trends and circumstances. Management believes that the recorded liability is sufficient to provide for claims and the associated claims adjustment expenses incurred through the balance sheet date.
Premiums on traditional life insurance products are reported as revenue when received unless received in advance of the due date. Premiums on traditional accident and health, disability income and dental insurance are reported as earned over the contract period. A reserve is provided for the portion of premiums written that relates to unexpired coverage terms.
reflected in universal life and investment product charges in the consolidated statements of income. The effects of changes in estimates of future gross profits, referred to as unlockings, on unearned revenue are reflected in the consolidated statements of income within universal life and investment product charges in the period such revisions occur.
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment” (SFAS 123-R), which prescribes fair value expense recognition for stock options and is effective for interim and annual periods ending after June 15, 2005. As discussed above, the Company currently accounts for employee stock options using the intrinsic value method of APB 25, and related interpretations, and discloses the impact of the fair value method prescribed by SFAS 123 through footnote disclosure only. Under APB 25, the Company does not recognize any stock-based compensation expense for employee stock options because all options granted have an exercise price equal to the market value of the underlying stock on the date of grant. The Company is required to adopt the provisions of SFAS 123-R by July 1, 2005 under the modified prospective method. Under this method, the fair value of all employee stock options vesting on or after the adoption date will be included in the determination of net income. The Company also plans to restate prior periods using the modified retrospective application described in SFAS 123-R. The fair value of stock options will be estimated using an appropriate fair value option-pricing model considering assumptions for dividend yield, expected volatility, risk-free interest rate, and expected life of the option. The fair value of the option grants will be amortized on a straight-line basis over the three-year vesting period of the awards. The adoption of SFAS 123-R will reduce our earnings per share as described in our proforma disclosures discussed earlier within the stock-based compensation section of Note 2. However, the implementation of more sophisticated modeling techniques may reduce this impact.
On May 19, 2004, the FASB issued FASB Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003” (FSP 106-2). FSP 106-2 was issued to interpret Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Act) signed into law on December 8, 2003. This Act introduces a prescription drug benefit under Medicare beginning in 2006. Under the Act, employers who sponsor postretirement plans that provide prescription drug benefits that are actuarially equivalent to Medicare qualify to receive subsidy payments. The Company adopted FSP 106-2 effective July 1, 2004 under the prospective application approach. Accordingly, the Company remeasured its plan assets and Accumulated Postretirement Benefit Obligation (“APBO”) as of that date to account for the subsidy and other effects of the Act. See Note 13 for further discussion.
In December 2003, the FASB issued Statement of Financial Accounting Standards No. 132 (Revised), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (SFAS 132-R) which revises employers’ disclosures about pension plans and other postretirement benefit plans. It does not require change in the measurement or recognition of those plans. This statement was effective for financial statements with fiscal years ending after December 15, 2003. See Note 13 for the related disclosures.
In July 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) issued Statement of Position 03-1 “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (SOP 03-1). SOP 03-1 addresses: (i) separate account presentation; (ii) accounting for an insurance company’s proportionate interest in separate accounts; (iii) transfers of assets from the general account to a separate account; (iv) valuation of certain
insurance liabilities and policy features such as guaranteed minimum death benefits and annuitization benefits; and (v) accounting for sales inducements. SOP 03-1 was effective January 1, 2004 and was adopted through an adjustment for the cumulative effect of a change in accounting principle originally amounting to $13.
In June 2004, the FASB issued FSP 97-1 “Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, Permit or Require Accrual for an Unearned Revenue Liability”. FSP 97-1 clarifies the accounting for unearned revenue liabilities of certain universal-life type contracts under SOP 03-1. The Company’s adoption of FSP 97-1 on July 1, 2004 had no impact on the Company’s consolidated financial position or results of operations.
The following table rolls forward our deferred sales inducement asset for the twelve months ended December 31, 2004.
Separate account assets and liabilities represent funds segregated for the benefit of certain policyholders who bear the investment risk. SOP 03-1 did not impact our accounting policies with respect to separate accounts, as they meet the criteria for summary presentation contained in SOP 03-1. Separate account assets and liabilities are
equal and are recorded at fair value. Policyholder deposits and withdrawals, investment income and related realized investment gains and losses in the separate account are excluded from the amounts reported in our income statement. Fees charged on separate account policyholder deposits are included in universal life and investment product charges. The policies reported in our separate accounts are VA and VUL policies. As indicated above, the amounts of minimum guarantees or other similar benefits related to these policies are negligible.
The FASB has issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (FIN 46). Under FIN 46, an enterprise consolidates a variable interest entity (VIE), as defined, if the enterprise absorbs a majority of the VIE’s expected losses, receives a majority of its expected residual returns, or both, as a result of ownership, contractual or other financial interests in the VIE. Prior to FIN 46, entities were generally consolidated by an enterprise only when it had a controlling financial interest through ownership of a majority voting interest in the entity. In accordance with FIN 46, effective December 31, 2003, the Company deconsolidated Jefferson Pilot Capital Trust A and Jefferson Pilot Capital Trust B (the Trusts), VIEs that issued $300 of redeemable preferred securities in private placement transactions in 1997. The redeemable preferred securities were previously presented in the Company’s financial statements as Capital Securities in the consolidated balance sheets. Dividends on the Capital Securities were presented in the consolidated statements of income as a deduction to arrive at net income available to common stockholders, and as a financing outflow on the consolidated statements of cash flows. As a result of the deconsolidation of the Trusts, the consolidated balance sheets now reflect junior subordinated debentures purchased from the Company by the Trusts in 1997, which had previously been eliminated in consolidation. Interest expense on the junior subordinated debentures is presented as interest expense in the consolidated statements of income and is presented as an operating cash outflow on the consolidated statements of cash flow.
The following table sets forth the computation of earnings per share before cumulative effect of change in accounting principle and earnings per share assuming dilution before cumulative effect of change in accounting principle.
Aggregate amortized cost and aggregate fair value of debt securities as of December 31, 2004, according to maturity date, are as indicated below. Contractual maturity dates were utilized for all securities except for mortgage-backed securities, which are based upon estimated maturity dates. Actual future maturities may differ from the contractual maturities shown because the issuers of certain debt securities have the right to call or prepay the amounts due the Company, with or without penalty.
See Note 6 for discussion of amortization of deferred policy acquisition costs and value of business acquired.
The Company’s commercial mortgage loan portfolio is comprised of conventional real estate mortgages collateralized primarily by retail (33%), industrial (23%), office (18%), apartment (14%), and hotel (8%) properties. Mortgage loan underwriting standards emphasize the credit status of a prospective borrower, quality of the underlying collateral and loan-to-value relationships. Approximately 30% of stated mortgage loan balances as of December 31, 2004 are for properties located in South Atlantic states, approximately 17% are for properties located in Pacific states, approximately 15% are for properties located in West South Central states and approximately 11% are for properties located in Mountain states. No other geographic region represents as much as 10% of December 31, 2004 mortgage loans.
The Company sold certain securities that had been classified as held-to-maturity, due to significant declines in credit worthiness. The net amortized costs of sold securities were $24, $29, and $86 for 2004, 2003 and 2002. The realized gains on the sales of these securities, some of which were previously impaired, were $1, $9 and $0 for 2004, 2003 and 2002.
One statistic to which we pay particular attention with respect to debt securities is the Fair Value to Amortized Cost ratio. Securities with a fair value to amortized cost ratio in the 90%-99% range are typically securities that have been impacted by increases in market interest rates or sector spreads. Securities in the 80%-89% range are typically securities that have been impacted by increased market yields, specific credit concerns or both. These securities are monitored to ensure that the impairment is not other-than-temporary. Securities with a fair value to amortized cost ratio less then 80% are considered to be “potentially distressed securities,” and are subjected to rigorous review. The following factors are considered: the length of time a security’s fair value has been below amortized cost, industry factors or conditions related to a geographic area that are negatively affecting the security, downgrades by rating agencies, the valuation of assets specifically pledged to support the credit, the overall financial condition of the issuer, past due interest or principal payments, and our intent and ability to hold the security for a sufficient time to allow for a recovery in value.
Statement of Financial Accounting Standard No. 133 “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) requires companies to recognize all derivative instruments as either assets or liabilities in the balance sheet at fair value. The fair values of the Company’s derivative instruments of $82 and $33 at December 31, 2004 and 2003 are included in other investments in the consolidated balance sheets. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must
For the years ended December 31, 2004, 2003 and 2002 the Company recognized other comprehensive income related to cash flow hedges, net of taxes, of $(3), $(5) and $9. The Company does not expect to reclassify a significant amount of net gains (losses) on derivative instruments from accumulated other comprehensive income to earnings during the next twelve months.
For the years ended December 31, 2004, 2003 and 2002 the Company recognized $0, $4 and $0 in previously deferred losses as a result of sales of securities purchased through the use of cash flow hedges.
Certain swaps serve as economic hedges but do not qualify for hedge accounting under SFAS 133. These swaps are marked to market through realized gains. The Company’s realized investment gains from these swaps were $1 in 2004 and insignificant in years 2003 and 2002.
Credited interest rates for universal life-type products ranged from 3.0% to 9.0% in 2004 and 2003 and from 4.0% to 7.5% in 2002. The average credited interest rates for universal life-type products were 4.6% for 2004, 5.0% for 2003 and 5.6% for 2002. For annuity products, credited interest rates generally ranged from 3.0% to 8.0% in 2004, 3.0% to 7.6% in 2003 and 3.0% to 7.8% in 2002. The average credited interest rates for annuity products were 4.4% for 2004, 4.9% for 2003 and 5.5% for 2002.
The Company uses estimates for determining its liability for accident and health and disability benefits, which are based on historical claim payment patterns and attempt to provide for the inherent variability in claim patterns and severity. In 2004, the amount incurred for accident and health and disability benefits related to prior years was favorably impacted by claims termination experience in our long-term disability business. Actual claims experience emerged favorably in 2003 and 2002.
The Company has entered into a bank credit agreement for unsecured revolving credit, under which the Company has the option to borrow at various interest rates. The current agreement, as amended on May 7, 2004, aggregates $348, which is available until May 2007. This credit agreement principally supports the issuance of commercial paper. As of December 31, 2004, outstanding commercial paper had various maturities, with none in excess of 120 days. The Company can issue commercial paper with maturities of up to 270 days. In the event the Company is not able to remarket commercial paper at maturity, the Company has sufficient liquidity, consisting
In January 2004, the Company issued $300 of 4.75% 10-year term notes and $300 of floating rate EXtendible Liquidity Securities® (EXLs). The EXLs bear interest at LIBOR plus a spread, which increases annually to a maximum of 10 basis points. As of December 31, 2004, the EXLs had a maturity of November 2005 subject to periodic extension through 2011. The proceeds from the debt issuance were used to finance the Canada Life transaction and to pay down commercial paper while rebalancing the mix of fixed and floating rate debt and short and long term maturities in the Company’s capital structure.
In conjunction with the establishment of an intercompany reinsurance subsidiary, we obtained a $500 letter of credit facility. The credit agreement will provide credit enhancement for the subsidiary’s reinsurance obligations. JP is a guarantor under the letter of credit facility. At December 31, 2004, we had not reinsured any reserves to this subsidiary.
The following table summarizes certain stock option information at December 31, 2004:
The insurance statutes of the states of domicile limit the amount of dividends that the life insurance subsidiaries may pay annually without first obtaining regulatory approval. The limitations are based on a
Federal income tax returns for 2000 through 2002 are currently under examination. In the opinion of management, recorded income tax liabilities adequately provide for additional assessments on all remaining open years.
The amount included within other comprehensive income for 2004 related to the increase in the minimum pension liability is $9, net of taxes.
The assumption for discount rate is based upon an evaluation of specific plan attributes using cash flow analysis. The weighted average duration of the projected cash flows for the plans was used to select an appropriate AA-rated bond interest rate. The discount rate assumption declined in 2004 and 2003 as a result of the low interest rate environment experienced in the past few years.
The Company’s pension plans weighted-average asset allocations by asset category are as follows based on fair value:
The expected benefit payments for the Company’s pension plans for the years indicated are as follows:
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act (the Act) was signed into law. The Act includes a federal subsidy to sponsors of retiree health plans that provide a prescription drug benefit that is at least actuarially equivalent to the benefit to be provided under Medicare Part D. We have
On May 19, 2004, the FASB issued FSP 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003”. In accordance with FSP 106-2, the Company remeasured its plan assets and Accumulated Postretirement Benefit Obligation (“APBO”) as of July 1, 2004 to account for the subsidy and other effects of the Act, which resulted in an immaterial reduction in postretirement benefit cost. The reduction in the APBO for the subsidy related to past service was insignificant.
Defined contribution retirement plans cover most employees and full time agents. The Company matches a portion of participant contributions and makes profit sharing contributions to a fund that acquires and holds shares of the Company’s common stock. The Company also contributes to accounts in two plans in which full time agents participate. Most plan assets are invested under a group variable annuity contract issued by JP Life. Expenses were $4, $2 and $4 during 2004, 2003 and 2002.
JPFIC reinsures certain insurance business written prior to 1995 with affiliates of Household International, Inc. on a coinsurance basis. Balances are settled monthly, and the reinsurers compensate JPFIC for administrative services related to the reinsured business. The amount due from reinsurers in the consolidated balance sheets includes $828 and $845 due from the Household affiliates at December 31, 2004 and 2003.
Reinsurance contracts do not relieve an insurer from its primary obligation to policyholders. Therefore, the failure of a reinsurer to discharge its reinsurance obligations could result in a loss to the subsidiaries. The subsidiaries regularly evaluate the financial condition of their reinsurers and monitor concentrations of credit risk related to reinsurance activities. No credit losses have resulted from the reinsurance activities of the subsidiaries during the three years ended December 31, 2004.
The life insurance subsidiaries generally assume portions of the life and accident and health risks underwritten by certain other insurers on a limited basis. In 2004, assumed premium was significantly higher due to the Canada Life reinsurance transaction discussed in Note 1. Most of the business assumed has subsequently been rewritten to our own policy forms such that the Company is now the direct writer of this business.
Default charges paid to the Corporate and Other segment by Individual, AIP and Benefit Partners were $23, $14, $2 for 2004; $20, $10, $1 for 2003 and $13, $8, $1 for 2002.
The fair values of commercial paper and revolving credit borrowings approximate their carrying amounts due to their short-term nature. Similarly, the fair value of the liability for securities sold under repurchase agreements approximates its carrying amount, which includes accrued interest.
The Company routinely enters into commitments to extend credit in the form of mortgage loans and to purchase certain debt instruments for its investment portfolio in private placement transactions. The fair value of outstanding commitments to fund mortgage loans and to acquire debt securities in private placement transactions, which are not reflected in the consolidated balance sheets, approximates $121 at December 31, 2004.
JPCC has commitments for purchases of syndicated television programming and commitments on other contracts, and future sports programming rights as of December 31, 2004. The Company also has commitments to sell a portion of the sports programming rights to other entities, over the same period. The table below summarizes these commitments and revenues, including estimates for those that are not yet finalized: