There are four ways in which market declines and volatility have affected, or have the potential to affect, us negatively.
Some of our life insurance products are specifically designed and marketed as policies that help a decedent's heirs to pay estate tax. In addition, our life insurance and annuity products generally benefit from the deferral of federal income taxation on the accretion of their value. Legislation reducing the tax on dividends and capital gains reduces the relative benefits that such deferral provides.
Our ability to compete in the asset management business depends in particular on our investment performance. We may not be able to accumulate and retain assets under management if our investment results underperform the market or the competition, since such underperformance likely would result in asset withdrawals and reduced sales. For example, from 1993 through 1999 and again in 2003, we experienced net asset withdrawals in our private client products. We attribute this in part to underperformance in some of our mutual funds and managed accounts.
• Valuation of Debt and Equity Securities We classify our debt and equity securities held in our general account, as well as those pledged as collateral, as available-for-sale and report them in our balance sheet at fair value. Fair value is based on quoted market price, where available. When quoted market prices are not available, we estimate fair value by discounting debt security cash flows to reflect interest rates currently being offered on similar terms to borrowers of similar credit quality, by quoted market prices of comparable instruments and by independent pricing sources or internally developed pricing models.
The following table identifies the fair value of our general account fixed maturity securities by pricing source as of December 31, 2003 ($ amounts in millions): Fixed Maturities % of Total at Fair Value Fair Value ----------------- -----------------
Net realized investment losses decreased $33.4 million, or 25%, in 2003 compared to 2002, primarily due to lower impairments from improved credit market conditions including a $26.6 million reduction in impairment losses related to debt securities pledged as collateral related to our consolidated CDOs and higher net transaction related gains, partially offset by an other-than-temporary impairment ($55.0 million after income taxes) on our ownership of Aberdeen common stock during the second quarter of 2003. See the Debt and Equity Securities section of Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 5 in this Form 10-K for more information.
The increase in policyholder dividends was primarily due to the increase in cash values for existing participating life policies plus growth of our policyholder dividend obligation resulting from favorable mortality and persistency experience.
proportion to estimated gross margins. The amortization process requires the use of various assumptions, estimates and judgments about the future. The primary assumptions involve expenses, investment performance, mortality and contract cancellations (i.e., lapses, withdrawals and surrenders). These assumptions are reviewed on a regular basis and are generally based on our past experience, industry studies, regulatory requirements and judgments about the future. In 2002, we revised the assumptions on traditional life products used in the development of estimated gross margins to reflect favorable experience and, as a result, the amortization cost expense decreased.
The decrease in other operating expenses of $43.2 million, or 7%, in 2002 compared to 2001 was due mostly to lower non-recurring charges and Corporate and Other segment expenses. This decrease was partially offset by increases in Life and Annuity and Asset Management segment expenses. Life and Annuity expenses were higher due primarily to pension costs, slightly higher compensation and increased corporate overhead absorption. Asset Management expenses were higher due to the expenses of an acquired company, Kayne Anderson Rudnick. We acquired a majority interest in Kayne Anderson Rudnick in 2002, as further described in Note 4 to our consolidated financial statements in this Form 10-K
We allocate capital to our Life and Annuity segment based on risk-based capital, or RBC, for our insurance products. We used 300% RBC levels for 2003 and 2002 and 250% RBC levels prior thereto. Capital within our
Other life insurance revenues increased $6.2 million, or 4%, in 2002 compared to 2001, primarily due to higher revenues in an old block of corporate-owned life insurance business and from higher investment income, offset by lower revenues in non-life insurance subsidiaries.
Annuity product revenues increased $53.3 million, or 49%, in 2002 compared to 2001, primarily due to higher interest earned on higher spread based asset funds, partially offset by slightly lower fees.
Our accounting methodology makes downward adjustments based on public market indices, but limits upward adjustments to the amounts previously reported by the partnerships. Accordingly, we do not record gains until they are reported by the partnerships. As a result, the effect of our adjusting estimated partnership results to actual results increased investment income by $33.4 million and $12.8 million for 2003 and 2002, respectively.
• defaulted on payment obligations; • declared that it will default at a future point outside the current reporting period; • announced that a restructuring will occur outside the current reporting period; • severe liquidity problems that cannot be resolved; • filed for bankruptcy; • a financial condition which suggests that future payments are highly unlikely; • deteriorating financial condition and quality of assets; • sustained significant losses during the current year; • announced adverse changes or events such as changes or planned changes in senior management, restructurings, or a sale of assets; and/or • been affected by any other factors that indicate that the fair value of the investment may have been negatively impacted.
Gross unrealized losses on general account debt and equity securities outside of the closed block as of December 31, 2003 by duration of unrealized loss and by debt securities credit quality follow ($ amounts in millions):
Of the six below investment grade debt security positions held outside the closed block with gross unrealized losses greater than 20% of cost at December 31, 2003, four have been in an unrealized position of greater than 20% of cost for 12 months or less at December 31, 2003. Of the remaining two positions, one has been in an unrealized loss position greater than 20% of cost for 12 to 24 months and one has been in an unrealized loss position greater than 20% of cost for over 24 months with an unrealized loss of less than $(0.0) million.
The following table summarizes the withdrawal characteristics of our Life Companies' annuity contract reserves and deposit fund liabilities as of December 31, 2003 and 2002 ($ amounts in millions):
Available-for-sale debt securities increased $1,383.5 million, or 12%, in 2003 compared to 2002, reflecting significant appreciation of bond values due to lower interest rates, as well as the investment of December 31, 2002 cash in debt securities.
Equity securities decreased $73.9 million, or 19%, in 2003 compared to 2002, primarily due to the sale of equity positions in two General Electric Company life insurance subsidiaries and PXRE Group, Ltd., and a decrease in the fair value of HRH common stock, which we hold as collateral for our stock purchase contracts, partially offset by appreciation in the value of other equity securities.
Policyholder deposit funds increased $247.0 million, or 7%, in 2003 compared to 2002, primarily due to growth in fixed and market value adjusted annuity deposits, offset by net withdrawals from variable annuity guaranteed interest account sub-accounts.
Total 2004 2005 - 2006 2007 - 2008 Thereafter ----------- ----------- ------------ ------------ ------------ Contractual Obligations Due Indebtedness(1) ............................ $ 628.7 $ -- $ 175.0 $ 153.7 $ 300.0 Capital lease obligations.................. -- -- -- -- -- Operating lease obligations................ 41.5 11.4 16.7 10.2 3.2 Other purchase liabilities(2)(6) ............ 59.7 45.5 11.8 2.4 -- ----------- ----------- ------------ ------------ ------------ Subtotal................................... $ 729.9 $ 56.9 $ 203.5 $ 166.3 $ 303.2 Non-recourse collateralized obligations(3) . 1,344.3 -- -- -- 1,344.3 ----------- ----------- ------------ ------------ ------------ Total contractual obligations.............. $ 2,074.2 $ 56.9 $ 203.5 $ 166.3 $ 1,647.5 =========== =========== ============ ============ ============
We have accounted for our acquisition of the remaining interest in PFG as a step-purchase acquisition. Accordingly, we recorded a definite-lived intangible asset of $9.8 million related to the PVFP acquired and a related deferred tax liability of $3.4 million. The PVFP intangible asset will be amortized over the remaining estimated life of the underlying insurance inforce acquired, estimated to be 40 years. The remaining acquisition price plus transaction costs of $7.6 million has been assigned to goodwill. We have not presented pro forma information as if PFG had been acquired at the beginning of January 2003, as it is not material to our financial statements. For additional information, see Note 3 to our consolidated financial statements in this Form 10-K.
The post-retirement plan is unfunded. The projected benefit obligation and, therefore, its funded status was $(78.7) million and $(74.2) million as of December 31, 2003 and 2002, respectively.