Table
of Contents
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
x
|
|
Quarterly Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
|
|
For the quarterly period ended September
30, 2008
|
|
or
|
|
o
|
|
Transition Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
|
For the transition period from to
Commission File Number 001-11339
Protective
Life Corporation
(Exact name of registrant as specified in its
charter)
Delaware
|
|
95-2492236
|
(State or other jurisdiction of
incorporation or organization)
|
|
(IRS Employer Identification
No.)
|
2801 Highway 280 South
Birmingham, Alabama 35223
(Address of principal executive offices and zip code)
(205) 268-1000
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes
x
No
o
Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, or a non-accelerated
filer.See definition of accelerated filer and large accelerated filer in Rule
12b-2 of the Exchange Act.(Check one):
Large accelerated filer
x
|
|
Accelerated Filer
o
|
|
Non-accelerated filer
o
|
|
Smaller Reporting Company
o
|
Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
o
No
x
Number of shares of Common Stock, $0.50 par
value, outstanding as of November 5, 2008: 69,905,807
Table of Contents
PROTECTIVE LIFE CORPORATION
CONSOLIDATED
CONDENSED STATEMENTS OF INCOME (LOSS)
(Unaudited)
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands, Except Per Share Amounts)
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
Premiums and policy fees
|
|
$
|
664,464
|
|
$
|
676,500
|
|
$
|
2,005,741
|
|
$
|
2,024,682
|
|
Reinsurance ceded
|
|
(366,734
|
)
|
(368,878
|
)
|
(1,161,580
|
)
|
(1,162,641
|
)
|
Net of reinsurance ceded
|
|
297,730
|
|
307,622
|
|
844,161
|
|
862,041
|
|
Net investment income
|
|
423,522
|
|
428,792
|
|
1,270,928
|
|
1,254,910
|
|
Realized investment (losses) gains:
|
|
|
|
|
|
|
|
|
|
Derivative financial instruments
|
|
91,991
|
|
(37,467
|
)
|
155,421
|
|
36,523
|
|
All other investments
|
|
(351,102
|
)
|
43,114
|
|
(491,558
|
)
|
(10,201
|
)
|
Other income
|
|
47,943
|
|
51,874
|
|
141,435
|
|
183,118
|
|
Total revenues
|
|
510,084
|
|
793,935
|
|
1,920,387
|
|
2,326,391
|
|
Benefits and expenses
|
|
|
|
|
|
|
|
|
|
Benefits and settlement expenses, net of
reinsurance ceded:
(three months: 2008 - $309,675; 2007 - $360,749
nine months: 2008 - $1,084,504; 2007 - $1,112,579)
|
|
535,839
|
|
504,905
|
|
1,500,859
|
|
1,431,639
|
|
Amortization of deferred policy acquisition
costs and value of business acquired
|
|
39,331
|
|
73,863
|
|
179,151
|
|
228,279
|
|
Other operating expenses, net of
reinsurance ceded:
(three months: 2008 - $51,584; 2007 - $62,470
nine months: 2008 - $160,252; 2007 - $209,762)
|
|
94,856
|
|
107,750
|
|
289,251
|
|
324,287
|
|
Total benefits and expenses
|
|
670,026
|
|
686,518
|
|
1,969,261
|
|
1,984,205
|
|
Income (loss) before income tax
|
|
(159,942
|
)
|
107,417
|
|
(48,874
|
)
|
342,186
|
|
Income tax (benefit) expense
|
|
(59,934
|
)
|
34,425
|
|
(22,932
|
)
|
113,506
|
|
Net income (loss)
|
|
$
|
(100,008
|
)
|
$
|
72,992
|
|
$
|
(25,942
|
)
|
$
|
228,680
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share - basic
|
|
$
|
(1.41
|
)
|
$
|
1.03
|
|
$
|
(0.36
|
)
|
$
|
3.22
|
|
Net income (loss) per share - diluted
|
|
$
|
(1.40
|
)
|
$
|
1.02
|
|
$
|
(0.36
|
)
|
$
|
3.20
|
|
Cash dividends paid per share
|
|
$
|
0.235
|
|
$
|
0.225
|
|
$
|
0.695
|
|
$
|
0.665
|
|
|
|
|
|
|
|
|
|
|
|
Average share outstanding - basic
|
|
71,115,365
|
|
71,074,619
|
|
71,104,383
|
|
71,055,969
|
|
Average share outstanding - diluted
|
|
71,380,898
|
|
71,467,009
|
|
71,425,610
|
|
71,481,471
|
|
See Notes to Consolidated Condensed Financial
Statements
3
Table
of Contents
PROTECTIVE LIFE CORPORATION
CONSOLIDATED
CONDENSED BALANCE SHEETS
(Unaudited)
|
|
September 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
Assets
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
Fixed maturities, at fair market value
(amortized cost: 2008 - $23,815,283; 2007 - $23,448,784)
|
|
$
|
22,084,909
|
|
$
|
23,389,069
|
|
Equity securities, at fair market value
(cost: 2008 - $378,407; 2007 - $112,406)
|
|
312,389
|
|
117,037
|
|
Mortgage loans
|
|
3,653,919
|
|
3,284,326
|
|
Investment real estate, net of accumulated
depreciation (2008 - $411; 2007 - $283)
|
|
7,793
|
|
8,026
|
|
Policy loans
|
|
811,846
|
|
818,280
|
|
Other long-term investments
|
|
329,259
|
|
185,892
|
|
Short-term investments
|
|
987,604
|
|
1,236,443
|
|
Total investments
|
|
28,187,719
|
|
29,039,073
|
|
Cash
|
|
86,587
|
|
146,152
|
|
Accrued investment income
|
|
308,144
|
|
291,734
|
|
Accounts and premiums receivable, net of
allowance for uncollectible amounts
(2008 - $2,950; 2007 - $3,587)
|
|
163,258
|
|
87,883
|
|
Reinsurance receivables
|
|
5,227,020
|
|
5,089,100
|
|
Deferred policy acquisition costs and value
of business acquired
|
|
3,965,955
|
|
3,400,493
|
|
Goodwill
|
|
122,128
|
|
117,366
|
|
Property and equipment, net of accumulated
depreciation (2008 - $116,022; 2007 - $111,213)
|
|
40,274
|
|
42,795
|
|
Other assets
|
|
172,759
|
|
144,296
|
|
Income tax receivable
|
|
154,454
|
|
165,741
|
|
Assets related to separate accounts
|
|
|
|
|
|
Variable annuity
|
|
2,426,806
|
|
2,910,606
|
|
Variable universal life
|
|
297,687
|
|
350,802
|
|
Total Assets
|
|
$
|
41,152,791
|
|
$
|
41,786,041
|
|
Liabilities
|
|
|
|
|
|
Policy liabilities and accruals
|
|
$
|
18,131,666
|
|
$
|
17,429,307
|
|
Stable value product account balances
|
|
6,021,834
|
|
5,046,463
|
|
Annuity account balances
|
|
8,976,496
|
|
8,708,383
|
|
Other policyholders funds
|
|
424,185
|
|
307,950
|
|
Other liabilities
|
|
741,120
|
|
1,204,018
|
|
Deferred income taxes
|
|
58,747
|
|
512,156
|
|
Non-recourse funding obligations
|
|
1,375,000
|
|
1,375,000
|
|
Liabilities related to variable interest
entities
|
|
|
|
400,000
|
|
Long-term debt
|
|
649,852
|
|
559,852
|
|
Subordinated debt securities
|
|
524,743
|
|
524,743
|
|
Liabilities related to separate accounts
|
|
|
|
|
|
Variable annuity
|
|
2,426,806
|
|
2,910,606
|
|
Variable universal life
|
|
297,687
|
|
350,802
|
|
Total liabilities
|
|
39,628,136
|
|
39,329,280
|
|
Commitments and contingent liabilities -
Note 3
|
|
|
|
|
|
Shareowners equity
|
|
|
|
|
|
Preferred Stock; $1 par value, shares
authorized: 4,000,000; Issued: None
|
|
|
|
|
|
Common Stock, $.50 par value, shares
authorized: 2008 and 2007 - 160,000,000 shares issued: 2008 and 2007 -
73,251,960
|
|
36,626
|
|
36,626
|
|
Additional paid-in-capital
|
|
448,887
|
|
444,765
|
|
Treasury stock, at cost (2008 - 3,348,529
shares; 2007 - 3,102,898 shares)
|
|
(26,978
|
)
|
(11,140
|
)
|
Unallocated stock in Employee Stock
Ownership Plan (2008 - 138,857 shares ; 2007 - 251,231 shares)
|
|
(474
|
)
|
(852
|
)
|
Retained earnings (includes FAS157
cumulative effect adjustment - $1,470)
|
|
1,994,799
|
|
2,067,891
|
|
Accumulated other comprehensive income
(loss):
|
|
|
|
|
|
Net unrealized (losses) on investments, net
of income tax: (2008 - $(486,000); 2007 - $(26,675))
|
|
(885,588
|
)
|
(45,339
|
)
|
Accumulated (loss) - hedging, net of income
tax: (2008 - $(11,434); 2007 - $(6,185))
|
|
(20,598
|
)
|
(12,222
|
)
|
Postretirement benefits liability
adjustment, net of income tax: (2008 - $(11,856); 2007 - $(11,622))
|
|
(22,019
|
)
|
(22,968
|
)
|
Total shareowners equity
|
|
1,524,655
|
|
2,456,761
|
|
Total liabilities and shareowners equity
|
|
$
|
41,152,791
|
|
$
|
41,786,041
|
|
See Notes to Consolidated Condensed Financial
Statements
4
Table
of Contents
PROTECTIVE LIFE CORPORATION
CONSOLIDATED
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
Cash flows from operating activities
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(25,942
|
)
|
$
|
228,680
|
|
Adjustments to reconcile net income to net
cash provided by operating activities:
|
|
|
|
|
|
Realized investment losses (gains)
|
|
336,137
|
|
(26,322
|
)
|
Amortization of deferred policy acquisition
costs and value of business acquired
|
|
179,151
|
|
228,279
|
|
Capitalization of deferred policy
acquisition costs
|
|
(294,154
|
)
|
(348,730
|
)
|
Depreciation expense
|
|
7,667
|
|
5,832
|
|
Deferred income tax
|
|
69,252
|
|
130,010
|
|
Accrued income tax
|
|
10,775
|
|
(11,638
|
)
|
Interest credited to universal life and
investment products
|
|
773,877
|
|
753,170
|
|
Policy fees assessed on universal life and
investment products
|
|
(419,384
|
)
|
(423,823
|
)
|
Change in reinsurance receivables
|
|
(137,920
|
)
|
(338,857
|
)
|
Change in accrued investment income and
other receivables
|
|
(91,785
|
)
|
(33,071
|
)
|
Change in policy liabilities and other
policyholders funds of traditional life and health products
|
|
300,800
|
|
200,778
|
|
Trading securities:
|
|
|
|
|
|
Maturities and principal reductions of
investments
|
|
358,437
|
|
316,189
|
|
Sale of investments
|
|
956,257
|
|
1,605,326
|
|
Cost of investments acquired
|
|
(995,657
|
)
|
(2,019,909
|
)
|
Other net change in trading securities
|
|
(83,440
|
)
|
212,076
|
|
Change in other liabilities
|
|
(107,668
|
)
|
173,298
|
|
Other, net
|
|
(176,217
|
)
|
(60,041
|
)
|
Net cash provided by operating activities
|
|
660,186
|
|
591,247
|
|
Cash flows from investing activities
|
|
|
|
|
|
Investments available-for-sale:
|
|
|
|
|
|
Maturities and principal reductions of
investments
|
|
1,588,245
|
|
1,007,775
|
|
Sale of investments
|
|
2,520,126
|
|
1,743,960
|
|
Cost of investments acquired
|
|
(5,573,114
|
)
|
(3,692,079
|
)
|
Mortgage loans:
|
|
|
|
|
|
New borrowings
|
|
(640,186
|
)
|
(684,495
|
)
|
Repayments
|
|
269,864
|
|
367,475
|
|
Change in investment real estate, net
|
|
456
|
|
36,041
|
|
Change in policy loans, net
|
|
6,434
|
|
22,544
|
|
Change in other long-term investments, net
|
|
17,278
|
|
(1,537
|
)
|
Change in short-term investments, net
|
|
63,391
|
|
38,933
|
|
Purchase of property and equipment
|
|
(4,192
|
)
|
(12,555
|
)
|
Sales of property and equipment
|
|
787
|
|
4,094
|
|
Net cash used in investing activities
|
|
(1,750,911
|
)
|
(1,169,844
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
Borrowings under line of credit
arrangements and long-term debt
|
|
90,000
|
|
142,000
|
|
Principal payments on line of credit
arrangement and long-term debt
|
|
|
|
(138,280
|
)
|
Net proceeds from securities sold under
repurchase agreements
|
|
|
|
127,251
|
|
Payments on liabilities related to variable
interest entities
|
|
(400,000
|
)
|
(20,395
|
)
|
Issuance of non-recourse funding
obligations
|
|
|
|
750,000
|
|
Dividends to share owners
|
|
(48,620
|
)
|
(46,598
|
)
|
Investments product deposits and change in
universal life deposits
|
|
4,066,785
|
|
2,739,113
|
|
Investment product withdrawals
|
|
(2,647,740
|
)
|
(2,773,473
|
)
|
Excess tax benefits on stock based compensation
|
|
|
|
1,653
|
|
Other financing activities, net
|
|
(29,265
|
)
|
(96,770
|
)
|
Net cash provided by financing activities
|
|
1,031,160
|
|
684,501
|
|
Change in cash
|
|
(59,565
|
)
|
105,904
|
|
Cash at beginning of period
|
|
146,152
|
|
69,516
|
|
Cash at end of period
|
|
$
|
86,587
|
|
$
|
175,420
|
|
See Notes to Consolidated Condensed Financial
Statements
5
Table
of Contents
PROTECTIVE LIFE CORPORATION
NOTES TO
CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS
OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated condensed financial statements
of Protective Life Corporation and subsidiaries (the Company) have
been prepared in accordance with accounting principles generally accepted in
the United States of America (U.S. GAAP) for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they
do not include all of the disclosures required by U.S. GAAP for complete
financial statements. In the opinion of
management, the accompanying financial statements reflect all adjustments
(consisting only of normal recurring items) necessary for a fair statement of
the results for the interim periods presented.
Operating results for the three and nine month periods ended September 30,
2008 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2008. The
year-end consolidated condensed balance sheet data was derived from audited
financial statements, but does not include all disclosures required by
U.S. GAAP. For further information,
refer to the consolidated financial statements and notes thereto included in
the Companys Annual Report on Form 10-K for the year ended December 31,
2007.
Accounting Pronouncements Recently Adopted
Financial
Accounting Standards Board (FASB) Statement No. 157,
Fair Value Measurement
(SFAS No. 157)
.
In September 2006, the FASB
issued SFAS No. 157. On January 1,
2008, the Company adopted this Statement, which defines fair value, establishes
a framework for measuring fair value, establishes a fair value hierarchy based
on the quality of inputs used to measure fair value and enhances disclosure
requirements for fair value measurements.
The adoption of SFAS No. 157 did not have a material impact on the
Companys consolidated financial statements.
Additionally, on January 1, 2008, the Company elected the partial
adoption of SFAS No. 157 under the provisions of FASB Staff Position
(FSP) FAS 157-2, which amends SFAS No. 157 to allow an entity to delay
the application of this Statement until periods beginning January 1, 2009
for certain non-financial assets and liabilities. Under the provisions of this FSP, the Company
will delay the application of SFAS No. 157 for fair value measurements
used in the impairment testing of goodwill and indefinite-lived intangible
assets and eligible non-financial assets and liabilities included within a
business combination. In January 2008,
FASB also issued proposed FSP FAS 157-c that would amend SFAS No. 157 to
clarify the principles on fair value measurement of liabilities. Management is monitoring the status of this
proposed FSP for any impact on the Companys consolidated financial
statements. On October 10, 2008,
the FASB issued FSP FAS 157-3,
Determining the Fair Value
of a Financial Asset When the Market for That Asset is Not Active
(FSP FAS 157-3), to clarify the application of SFAS No. 157 in a market
that is not active and provides examples to illustrate key considerations in
determining the fair value of a financial asset when the market for that
financial asset is not active. It also reaffirms the notion of fair value as an
exit price as of the measurement date. This statement was effective upon
issuance, including prior periods for which the financial statements have not
been issued. For more information, see Note 10,
Fair Value
of Financial Instruments
.
SFAS No. 157 defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. In determining fair value, the Company uses
various methods including market, income and cost approaches. The Company utilizes valuation techniques
that maximize the use of observable inputs and minimizes the use of
unobservable inputs. For more
information, see Note 10,
Fair Value of Financial
Instruments
.
FASB Statement No. 159,
The Fair Value Option for Financial Assets and Financial Liabilities
(SFAS No. 159)
. In February 2007, the FASB issued SFAS No. 159. This Statement provides entities the option
to measure certain financial assets and financial liabilities at fair value
with changes in fair value recognized in earnings each period. SFAS No. 159 permits the fair value
option election on an instrument-by-instrument basis at initial recognition of
an asset or liability or upon an event that gives rise to a new basis of
accounting for that instrument. The
Company adopted SFAS No. 159 as of January 1, 2008. The Company has elected not to apply the
provisions of SFAS No. 159 to its eligible financial assets and financial
liabilities on the date of adoption.
6
Table of Contents
Accordingly, the initial application of SFAS No. 159 had no effect
on the Companys consolidated results of operations or financial position.
FASB Staff Position (FSP) FIN 39-1,
Amendment of FASB Interpretation No. 39 (FSP FIN39-1)
. As of January 1, 2008, the Company
adopted FSP FIN39-1. This FSP amends FIN
39,
Offsetting of Amounts Related to Certain Contracts
,
to allow fair value amounts recognized for collateral to be offset against fair
value amounts recognized for derivative instruments that are executed with the
same counterparty under certain circumstances.
The FSP also requires an entity to disclose the accounting policy
decision to offset, or not to offset, fair value amounts in accordance with FIN
39, as amended. The Company does not,
and has not previously, offset the fair value amounts recognized for derivatives
with the amounts recognized as collateral.
Accounting
Pronouncements Not Yet Adopted
FASB Statement No. 141(R),
Business Combinations (SFAS No. 141(R))
.
In December of
2007, the FASB issued SFAS No. 141(R).
This Statement is a revision to the original Statement and continues the
movement toward a greater use of fair values in financial reporting. It changes
how business acquisitions are accounted for and will impact financial
statements at the acquisition date and in subsequent periods. Further, certain of the changes will introduce
more volatility into earnings and thus may impact a companys acquisition
strategy. SFAS No. 141(R) will
also impact the annual goodwill impairment test associated with acquisitions
that close both before and after the effective date of this Statement. Thus, any potential goodwill impact from an
acquisition that closed prior to the effective date of the Statement will need
to be assessed under the provisions of SFAS No. 141(R). This Statement applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December 15,
2008.
FASB Statement No. 160,
Noncontrolling Interests in Consolidated Financial Statements (SFAS No. 160)
. In December of 2007, the FASB issued
SFAS No. 160. This Statement
applies to all entities that prepare consolidated financial statements, except
not-for-profit organizations, but will affect only those entities that have an
outstanding non-controlling interest in one or more subsidiaries or that
deconsolidate a subsidiary. This
statement is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008 (that is, January 1,
2009, for entities with calendar year-ends).
The Company does not expect this Statement to have a significant impact
on its consolidated results of operations or financial position.
FASB
Statement No. 161,
Disclosures about
Derivative Instruments and Hedging Activities (SFAS No. 161)
. In March of 2008, the FASB issued SFAS No. 161. This Statement requires enhanced disclosures
about how and why an entity uses derivative instruments, how derivative
instruments and related hedged items are accounted for under FASB Statement No. 133,
Accounting Derivative Instruments and Hedging
Activities
(SFAS No. 133).
This statement is effective for fiscal years and interim periods
beginning after November 15, 2008.
The Statement will be effective for the Company beginning January 1,
2009. The Company is currently evaluating
the impact, if any, that SFAS No. 161 will have on its consolidated
results of operations or financial position.
FSP
No. 140-3,
Accounting for Transfers of Financial Assets
and Repurchase Financing Transactions (FAS No. 140-3)
.
In February of 2008, the FASB
issued FSP No. 140-3 to provide guidance on accounting for a transfer of a
financial asset and a repurchase financing, which is not directly addressed by
FASB Statement No. 140,
Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities
(SFAS
No. 140). This FSP is effective
for fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years. The FSP will
be effective for the Company beginning January 1, 2009. The Company is currently evaluating the
impact, if any, that this FSP will have on its consolidated results of
operations or financial position.
FSP
No. 142-3,
Determination of the Useful Life of
Intangible Assets (FAS No. 142-3)
.
In April of 2008, the FASB
issued FSP No. 142-3 to improve consistency between the useful life of a
recognized intangible asset under SFAS No. 142,
Goodwill and
Other Intangible Assets
, and the period of expected cash flows used
to measure the fair value of the asset under SFAS No. 141 (revised 2007),
Business Combinations, and other guidance under U.S. GAAP. This FSP is effective for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal
years. The FSP will be effective for the
Company beginning January 1, 2009.
The Company does not expect this FSP to have a significant impact on its
consolidated results of operations or financial position.
7
Table of Contents
FASB
Statement No. 162,
The Hierarchy of Generally
Accepted Accounting Principles (SFAS No. 162)
. In May of 2008, the FASB issued SFAS No. 162. This Statement identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP)
in the United States (the GAAP hierarchy).
This Statement is effective sixty days following the United States
Securities and Exchange Commissions approval of the Public Company Accounting
Oversight Board amendments to AU Section 411,
The Meaning
of Present Fairly in Conformity With Generally Accepted Accounting Principles
. The Company does not expect this Statement to
have a significant impact on its consolidated results of operations or
financial position.
FASB
Statement No. 163,
Accounting for Financial
Guarantee Insurance Contracts (SFAS No. 163)
. In May of 2008, the FASB issued SFAS No. 163. This Statement requires that an insurance
enterprise recognize a claim liability prior to an event of default (insured
event) when there is evidence that credit deterioration has occurred in an
insured financial obligation. This
Statement also clarifies how FASB Statement No. 60,
Accounting
and Reporting by Insurance Enterprises
, (SFAS No. 60),
applies to financial guarantee insurance contracts, including the recognition
and measurement to be used to account for premium revenue and claim
liabilities. It also requires expanded
disclosures about financial guarantee insurance contracts. This Statement does not apply to financial
guarantee insurance contracts that would be within the scope of SFAS No. 133. This Statement is effective for fiscal years
and interim periods beginning after December 15, 2008. The standard will be effective for the
Company beginning January 1, 2009. The Company does not expect this Statement to
have a significant impact on its consolidated results of operations or
financial position.
FSP EITF
Issue No. 03-6-1, Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities (FSP EITF Issue No. 03-6-1)
.
In June of
2008, the FASB issued FSP EITF Issue No. 03-6-1. This FSP addresses whether instruments
granted in share-based payment transactions are participating securities prior
to vesting and, therefore, need to be included in the earnings allocation in
computing earnings per share (EPS) under the two-class method described in
paragraphs 60 and 61 of FASB Statement No. 128,
Earnings per
Share
. The FSP will be
effective for financial statements issued for fiscal years and interim periods
beginning after December 15, 2008.
All prior period EPS data presented shall be adjusted retrospectively to
conform to the provisions of this FSP.
The Company is currently evaluating the impact of this FSP, but does not
expect it to have a significant impact on its consolidated results of
operations or financial position.
FSP FAS
133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain
Guarantees: An Amendment of FASB
Statement No. 133 and FASB Interpretation No. 45; and Clarification
of the Effective Date of FASB Statement No. 161 (FSP FAS 133-1 and FIN
45-4)
.
In September of 2008, the
FASB issued FSP FAS 133-1 and FIN 45-4.
This FSP amends SFAS No. 133 to require disclosures by sellers of
credit derivatives, including credit derivatives embedded in a hybrid
instrument, and also amends FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Guarantees of Indebtedness of Others
, to require an
additional disclosure about the current status of the payment/performance risk
of a guarantee. In addition, this FSP
clarifies the FASBs intent about the effective date of SFAS No. 161.
The FSP will be effective for financial statements issued
for fiscal years and interim periods ending after November 15, 2008. In periods after adoption, this FSP requires
comparative disclosures only for periods ending subsequent to initial
adoption. The Company is currently
evaluating the impact of this FSP, but does not expect it to have a significant
impact on its consolidated results of operations or financial position.
Reclassifications
Certain reclassifications have been made in
the previously reported financial statements and accompanying notes to make the
prior period amounts comparable to those of the current period. Such reclassifications had no effect on
previously reported net income or shareowners equity.
Significant Accounting Policies
Valuation of investment securities
The fair value
for fixed maturity, short term, and equity securities, is determined by
management after considering and evaluating one of three primary sources of
information: third party pricing services, independent broker quotations, or
pricing matrices. Security pricing is
applied using a waterfall approach whereby publicly
8
Table of Contents
available prices are first sought
from third party pricing services, the remaining unpriced securities are
submitted to independent brokers for prices, or lastly, securities are priced
using a pricing matrix. Typical inputs
used by these three pricing methods include, but are not limited to: reported
trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash
flows and rates of prepayments. Based on
the typical trading volumes and the lack of quoted market prices for fixed
maturities, third party pricing services will normally derive the security
prices through recent reported trades for identical or similar securities
making adjustments through the reporting date based upon available market
observable information as outlined above.
If there are no recent reported trades, the third party pricing services
and brokers may use matrix or model processes to develop a security price where
future cash flow expectations are developed based upon collateral performance
and discounted at an estimated market rate.
Included in the pricing of asset-backed securities (ABS),
collateralized mortgage obligations (CMOs), and mortgage-backed securities
(MBS) are estimates of the rate of future prepayments of principal over the
remaining life of the securities. Such estimates are derived based on the
characteristics of the underlying structure and rates of prepayments previously
experienced at the interest rate levels projected for the underlying
collateral.
Determining whether a decline in the current
fair value of invested assets is an other-than-temporary decline in value can
involve a variety of assumptions and estimates, particularly for investments
that are not actively traded in established markets. For example, assessing the value of certain
investments requires that we perform an analysis of expected future cash flows
or rates of prepayments. Other
investments, such as collateralized mortgage or bond obligations, represent
selected tranches of a structured transaction, supported in the aggregate by
underlying investments in a wide variety of issuers. Management considers a number of factors when
determining the impairment status of individual securities. These include the economic condition of
various industry segments and geographic locations and other areas of
identified risks. Although it is
possible for the impairment of one investment to affect other investments, we
engage in ongoing risk management to safeguard against and limit any further
risk to our investment portfolio.
Special attention is given to correlative risks within specific
industries, related parties, and business markets. We consider a number of
factors in determining whether the impairment is other-than-temporary. These include, but are not limited to:
1) actions taken by rating agencies, 2) default by the issuer,
3) the significance of the decline in fair value, 4) the intent and
ability to hold the investment until recovery, 5) the time period during
which the decline has occurred, 6) an economic analysis of the issuers
industry, and 7) the financial strength, liquidity, and recoverability of
the issuer. Management performs a
security-by-security review each quarter in evaluating the need for any
other-than-temporary impairments.
Although no set formula is used in this process, the investment
performance, collateral position, and continued viability of the issuer are
significant measures considered.
For the three and nine months ended September 30, 2008, the
Company recorded pre-tax other-than-temporary impairments, excluding $20.0
million of modified coinsurance (Modco) related impairments, of $202.6
million and $282.6 million, respectively, in our investments compared to no
impairments and $0.1 million for the same periods in 2007. The impairments related to debt obligations
and preferred stock holdings in Lehman Brothers and Washington Mutual,
residential mortgage-backed securities collateralized by Alt-A mortgages, and preferred
stock holdings in Fannie Mae and Freddie Mac. The decline in the estimated fair
value of these securities resulted from factors including distressed credit
markets, the failure or near failure of a number of large financial service
companies resulting in intervention by the United States Federal Government,
downgrades in rating, and interest rate changes. These other-than-temporary
impairments resulted from our analysis of circumstances and our belief that
credit events, loss severity, changes in credit enhancement, and/or other
adverse conditions of the respective issuers have caused, or will lead to, a
deficiency in the contractual cash flows related to these investments. For more information on impairments, refer to
Item 2,
Managements Discussion and Analysis of Financial
Condition and Results of Operations
.
Reinsurance
The Company uses reinsurance extensively in
certain of its segments. The following summarizes some of the key aspects of
the Companys accounting policies for reinsurance:
Reinsurance
Accounting Methodology
The Company accounts for reinsurance under the provisions of FASB
Statement No. 113,
Accounting and Reporting
for Reinsurance of Short-Duration and Long-Duration Contracts
(SFAS
No. 113). The methodology for
accounting for the impact of reinsurance on the Companys life insurance and
annuity products is determined by whether the specific products are subject to
SFAS No. 60 or 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
(SFAS No. 97).
9
Table of Contents
The Companys traditional life insurance
products are subject to SFAS No. 60 and the recognition of the impact of
reinsurance costs on the Companys financial statements reflect the
requirements of that pronouncement. Ceded premiums are treated as an offset to
direct premium and policy fee revenue and are recognized when due to the
assuming company. Ceded claims are treated as an offset to direct benefits and
settlement expenses and are recognized when the claim is incurred on a direct
basis. Ceded policy reserve changes are also treated as an offset to benefits
and settlement expenses and are recognized during the applicable financial
reporting period. Expense allowances paid by the assuming companies are treated
as an offset to other operating expenses. Since reinsurance treaties typically
provide for allowance percentages that decrease over the lifetime of a policy,
allowances in excess of the ultimate or final level allowance are
capitalized. Amortization of capitalized reinsurance expense allowances is
treated as an offset to direct amortization of deferred policy acquisition
costs or value of business acquired (VOBA). Amortization of deferred expense
allowances is calculated as a level percentage of expected premiums in all
durations given expected future lapses and mortality and accretion due to
interest.
The Companys short duration insurance
contracts (primarily issued through the Asset Protection segment) are also
subject to SFAS No. 60 and the recognition of the impact of reinsurance
costs on the Companys financial statements also reflect the requirements of
that pronouncement.
Reinsurance
allowances include such acquisition costs as commissions and premium
taxes. A ceding fee is also collected to
cover other administrative costs and profits for the Company. Reinsurance allowances received are
capitalized and charged to expense in proportion to premiums earned. Ceded unamortized acquisition costs are
netted with direct unamortized acquisition costs in the balance sheet.
The Companys universal life (UL), variable
universal life, bank-owned life insurance (BOLI), and annuity products are
subject to SFAS No. 97 and the recognition of the impact of reinsurance
costs on the Companys financial statements reflect the requirements of that
pronouncement. Ceded premiums and policy
fees on SFAS No. 97 products reduce premiums and policy fees recognized by
the Company. Ceded claims are treated as an offset to direct benefits and
settlement expenses and are recognized when the claim is incurred on a direct
basis. Ceded policy reserve changes are also treated as an offset to benefits
and settlement expenses and are recognized during the applicable valuation
period. Commission and expense allowances paid by the assuming companies are
treated as an offset to other operating expenses. Since reinsurance treaties
typically provide for allowance percentages that decrease over the lifetime of
a policy, allowances in excess of the ultimate or final level allowance are
capitalized. Amortization of
capitalized reinsurance expense allowances are amortized based on future
expected gross profits according to SFAS No. 97. Unlike with SFAS No. 60
products, assumptions for SFAS No. 97 regarding mortality, lapses and
interest are continuously reviewed and may be periodically changed. These
changes will result in unlocking that changes the balance in the ceded
deferred amortization cost and can affect the amortization of deferred
acquisition cost and VOBA. Ceded unearned revenue liabilities are also
amortized based on expected gross profits. Assumptions for SFAS No. 97
products are based on the best current estimate of expected mortality, lapses
and interest spread. The Company complies with AICPA Statement of Position
03-1,
Accounting and Reporting by Insurance Enterprises
for Certain Nontraditional Long-Duration Contracts and for Separate Accounts
,
which impacts the timing of direct and ceded earnings on certain blocks of the
Companys SFAS No. 97 business.
Reinsurance Allowances -
The amount and timing of reinsurance
allowances (both first year and renewal allowances) are contractually
determined by the applicable reinsurance contract
and
may or may not bear a relationship to the amount and incidence of expenses
actually paid by the ceding company.
Many of the Companys reinsurance treaties do, in fact, have ultimate
renewal allowances that exceed the direct ultimate expenses. Additionally, allowances are intended to
reimburse the ceding company for some portion of the ceding companys commissions,
expenses, and taxes. As a result, first
year expenses paid by the Company may be higher than first year allowances paid
by the reinsurer, and reinsurance allowances may be higher in later years than
renewal expenses paid by the Company.
The Company recognizes allowances according
to the prescribed schedules in the reinsurance contracts, which may or may not
bear a relationship to actual expenses incurred by the Company. A portion of these allowances is deferred
while the non-deferrable allowances are recognized immediately as a reduction
of other operating expenses. The
Companys practice is to defer reinsurance allowances in excess of the ultimate
allowance. This practice is consistent
with the Companys practice of capitalizing direct expenses. While the recognition of reinsurance allowances
is consistent with U.S. GAAP, in some cases non-deferred reinsurance
allowances may exceed non-deferred direct costs, causing net other operating
expenses to be negative.
10
Table
of Contents
Ultimate reinsurance allowances are defined as the lowest allowance
percentage paid by the reinsurer in any policy duration over the lifetime of a
universal life policy (or through the end of the level term period for a
traditional life policy). The Company determines ultimate allowances as the
final amount to be paid over the life of a contract after higher acquisition
related expenses (whether first year or renewal) are completed. Ultimate
reinsurance allowances are determined by the reinsurer and set by the
individual contract of each treaty during the initial negotiation of each such
contract. Ultimate reinsurance allowances and other treaty provisions are listed
within each treaty and will differ between agreements since each reinsurance
contract is a separately negotiated agreement. The Company uses the ultimate
reinsurance allowances set by the reinsurers and contained within each treaty
agreement to complete its accounting responsibilities.
Amortization of Reinsurance Allowances -
Reinsurance
allowances do not affect the methodology used to amortize DAC and VOBA, or the
period over which such DAC and VOBA are amortized. Reinsurance allowances
offset the direct expenses capitalized, reducing the net amount that is
capitalized. The amortization pattern varies with changes in estimated gross
profits arising from the allowances. DAC and VOBA on SFAS No. 60 policies are
amortized based on the pattern of estimated gross premiums of the policies in
force. Reinsurance allowances do not affect the gross premiums, so therefore
they do not impact SFAS No. 60 amortization patterns. DAC and VOBA on SFAS No.
97 products are amortized based on the pattern of estimated gross profits of
the policies in force. Reinsurance allowances are considered in the
determination of estimated gross profits, and therefore do impact SFAS No. 97
amortization patterns.
Reinsurance Liabilities -
Claim liabilities and policy
benefits are calculated consistently for all policies in accordance with U.S.
GAAP, regardless of whether or not the policy is reinsured. Once the claim
liabilities and policy benefits for the underlying policies are estimated, the
amounts recoverable from the reinsurers are estimated based on a number of
factors including the terms of the reinsurance contracts, historical payment
patterns of reinsurance partners, and the financial strength and credit
worthiness of reinsurance partners. Liabilities for unpaid reinsurance claims
are produced from claims and reinsurance system records, which contain the
relevant terms of the individual reinsurance contracts. The Company monitors
claims due from reinsurers to ensure that balances are settled on a timely
basis. Incurred but not reported claims are reviewed by the Companys actuarial
staff to ensure that appropriate amounts are ceded.
The Company analyzes and monitors the credit worthiness of each of its
reinsurance partners to minimize collection issues. For newly executed
reinsurance contracts with reinsurance companies that do not meet predetermined
standards, the Company requires collateral such as assets held in trusts or
letters of credit.
Components of Reinsurance Cost -
The following
income statement lines are affected by reinsurance cost:
Premiums and policy fees
(reinsurance ceded on the Companys financial statements)
represent
consideration paid to the assuming company for accepting the ceding companys
risks. Ceded premiums and policy fees increase reinsurance cost.
Benefits and settlement expenses
include
incurred claim amounts ceded and changes in policy reserves. Ceded benefits and
settlement expenses decrease reinsurance cost.
Amortization of deferred policy acquisition cost
and VOBA
reflects the amortization of capitalized
reinsurance allowances. Ceded amortization decreases reinsurance cost.
Other expenses
include
reinsurance allowances paid by assuming companies to the Company less amounts
capitalized. Non-deferred reinsurance allowances decrease reinsurance cost.
The Companys reinsurance programs do not materially impact the other
income line of the Companys income statement. In addition, net investment
income generally has no direct impact on the Companys reinsurance cost.
However, it should be noted that by ceding business to the assuming companies,
the Company forgoes investment income on the reserves ceded to the assuming
companies. Conversely, the assuming companies will receive investment income on
the reserves assumed which will increase the assuming companies profitability
on business assumed from the Company.
11
Table
of Contents
Insurance liabilities and
reserves
Establishing an adequate
liability for the Companys obligations to policyholders requires the use of
assumptions. Estimating liabilities for future policy benefits on life and
health insurance products requires the use of assumptions relative to future
investment yields, mortality, morbidity, persistency and other assumptions
based on the Companys historical experience, modified as necessary to reflect
anticipated trends and to include provisions for possible adverse deviation. Determining
liabilities for the Companys property and casualty insurance products also
requires the use of assumptions, including the projected levels of used vehicle
prices, the frequency and severity of claims, and the effectiveness of internal
processes designed to reduce the level of claims. The Companys results depend
significantly upon the extent to which its actual claims experience is
consistent with the assumptions the Company used in determining its reserves
and pricing its products. The Companys reserve assumptions and estimates
require significant judgment and, therefore, are inherently uncertain. The
Company cannot determine with precision the ultimate amounts that it will pay
for actual claims or the timing of those payments. In addition, effective January 1, 2007, the
Company adopted FASB Statement No. 155,
Accounting
for Certain Hybrid Financial Instruments an amendment of FASB Statements
No. 133 and 140
(SFAS No. 155)
,
related
to its equity indexed annuity product. SFAS No. 155 requires that the Company
determine a fair value for the liability related to this block of business at
each balance sheet date, with changes in the fair value recorded through
earnings. Changes in this liability may be significantly affected by interest
rate fluctuations.
As
a result of the adoption of SFAS No. 157 at January 1, 2008, the Company made
certain modifications to the method used to determine fair value for its
liability related to equity indexed annuities to take into consideration
factors such as policyholder behavior, the Companys credit rating and other
market considerations. The impact of adopting SFAS No. 157 is discussed further
in Note 10,
Fair Value of Financial Instruments
.
Guaranteed
minimum withdrawal benefits
The Company also
establishes liabilities for guaranteed minimum withdrawal
benefits (GMWB) on its variable annuity products. The GMWB is valued in
accordance with SFAS No. 133 which requires the liability to be
marked-to-market using current implied volatilities for the equity indices. The
methods used to estimate the liabilities employ assumptions, primarily about
mortality and lapses, equity market and interest returns, market volatility and
the Companys credit rating. The Company assumes mortality of 65% of the
National Association of Insurance Commissioners 1994 Variable Annuity GMDB
Mortality Table. Differences between the actual experience and the assumptions
used result in variances in profit and could result in losses.
As a result of the adoption of SFAS No. 157 at January 1, 2008, the Company
made certain modifications to the method used to determine fair value for its
liability related embedded derivatives related to annuities with guaranteed
minimum withdrawal benefits to take into consideration factors such as
policyholder behavior, the Companys credit rating and other market
considerations.
See Note 10,
Fair Value of Financial
Instruments
for more information related to the impact of adopting
SFAS No. 157.
Goodwill
Goodwill is tested for impairment at least annually.
The Company evaluates the carrying value of goodwill during the fourth quarter
of each year and between annual evaluations if events occur or circumstances
change that would more likely than not reduce the fair value of a reporting
unit below its carrying amount. Such circumstances could include, but are not
limited to: (1) a significant adverse change in legal factors or in business
climate, (2) unanticipated competition, or (3) an adverse action or assessment
by a regulator. When evaluating whether goodwill is impaired, the Company compares
the fair value of the reporting unit to which the goodwill is assigned to the
reporting units carrying amount, including goodwill. The Company plans to
evaluate goodwill during the fourth quarter and determine if an adjustment will
be necessary in accordance with FASB Statement No. 142,
Goodwill and
Other Intangible Assets
.
12
Table
of Contents
2.
NON-RECOURSE
FUNDING OBLIGATIONS
Non-recourse funding obligations
outstanding as of September 30, 2008, on a consolidated basis, listed by
issuer, are reflected in the following table:
|
|
|
|
|
|
Year-to-Date
|
|
|
|
|
|
|
|
Weighted-Avg
|
|
Issuer
|
|
Balance
|
|
Maturity Year
|
|
Interest Rate
|
|
(Dollars In Thousands)
|
|
Golden Gate
Captive Insurance Company
|
|
$
|
800,000
|
|
2037
|
|
5.10
|
%
|
Golden Gate II
Captive Insurance Company
|
|
575,000
|
|
2052
|
|
3.95
|
%
|
Total
|
|
$
|
1,375,000
|
|
|
|
|
|
3.
COMMITMENTS
AND CONTINGENT LIABILITIES
The Company is contingently liable to obtain a
$20 million letter of credit under indemnity agreements with directors. Such
agreements provide insurance protection in excess of the directors and
officers liability insurance in force at the time up to $20 million. Should
certain events occur constituting a change in control, the Company must obtain
the letter of credit upon which directors may draw for defense or settlement of
any claim relating to performance of their duties as directors. The Company has
similar agreements with certain of its officers providing up to
$10 million in indemnification that are not secured by the obligation to
obtain a letter of credit. These obligations are in addition to the customary
obligation to indemnify officers and directors contained in our bylaws.
Under insurance guaranty fund laws, in most states
insurance companies doing business therein can be assessed up to prescribed
limits for policyholder losses incurred by insolvent companies. The Company
does not believe such assessments will be materially different from amounts
already provided for in the financial statements. Most of these laws do
provide, however, that an assessment may be excused or deferred if it would
threaten an insurers own financial strength.
A number of civil
jury verdicts have been returned against insurers, broker dealers and other
providers of financial services involving sales, refund or claims practices,
alleged agent misconduct, failure to properly supervise representatives,
relationships with agents or persons with whom the insurer does business, and
other matters. Often these lawsuits have resulted in the award of substantial
judgments that are disproportionate to the actual damages, including material
amounts of punitive and non-economic compensatory damages. In some states, juries,
judges, and arbitrators have substantial discretion in awarding punitive
non-economic compensatory damages which creates the potential for unpredictable
material adverse judgments or awards in any given lawsuit or arbitration. Arbitration
awards are subject to very limited appellate review. In addition, in some class
action and other lawsuits, companies have made material settlement payments. The
Company, like other financial service companies, in the ordinary course of
business, is involved in such litigation and arbitration. Although the Company
cannot predict the outcome of any such litigation or arbitration, the Company
does not believe that any such outcome will have a material impact on the
financial condition or results of the operations of the Company.
13
Table
of Contents
4.
STOCK-BASED COMPENSATION
Performance shares
awarded during the first nine months of 2008 and 2007, and their estimated fair
value at grant date are as follows:
Year
|
|
Performance
|
|
Estimated
|
|
Year
|
|
Performance
|
|
Estimated
|
|
Awarded
|
|
Shares
|
|
Fair Value
|
|
Awarded
|
|
Shares
|
|
Fair Value
|
|
(Dollars In Thousands, Except Share Amounts)
|
|
2008
|
|
75,900
|
|
$
|
2,900
|
|
2007
|
|
64,700
|
|
$
|
2,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The criteria for
payment of performance awards is based primarily upon a comparison of the
Companys average return on average equity (earlier upon the death, disability,
or retirement of the executive, or in certain circumstances, upon a change in
control of the Company) to that of a comparison group of publicly held life and
multi-line insurance companies. For the 2008 awards, if the Companys results
are below the 25th percentile of the comparison group, no portion of the award
is earned. For the 2005-2007 awards, if the Companys results are below the
40th percentile of the comparison group, no portion of the award is earned. If
the Companys results are at or above the 90th percentile, the award
maximum is earned. Awards are paid in shares of the Companys Common Stock.
During the first nine months of 2008, stock
appreciation rights (SARs) were granted to certain officers of the
Company to provide long-term incentive compensation based solely on the
performance of the Companys Common Stock. The SARs are exercisable in four
equal annual installments beginning one year after the date of grant (earlier
upon the death, disability, or retirement of the officer, or in certain
circumstances, upon a change in control of the Company) and expire after ten
years or upon termination of employment. The SARs activity as well as
weighted-average base price for the first nine months of 2008 is as follows:
|
|
Weighted-Average
|
|
Number of
|
|
|
|
Base Price
|
|
SARs
|
|
Balance at December 31, 2007
|
|
$
|
31.98
|
|
1,262,704
|
|
SARs granted
|
|
38.59
|
|
327,500
|
|
SARs exercised
|
|
32.67
|
|
(32,131
|
)
|
Balance at
September 30, 2008
|
|
$
|
33.36
|
|
1,558,073
|
|
The SARs issued in 2008 had estimated fair values at
grant date of $2.2 million. The fair value of the 2008 SARs was estimated
using a Black-Scholes option pricing model. Significant assumptions used in the
model for the 2008 SARs were as follows:expected volatility ranged from 16.4%
to 22.1%, the risk-free interest rate ranged from 2.7% to 3.3%, a dividend rate
of 2.1%, a 4.0% forfeiture rate, and the expected exercise date ranged from
2013 to 2016. The Company will pay an amount in stock equal to the difference
between the specified base price of the Companys Common Stock and the market
value at the exercise date for each SAR.
Additionally during 2008, the Company issued 13,100
restricted stock units at an average fair value of $39.07 per unit. These
awards, with a total fair value of $0.5 million, vest ten years after the
date of grant.
14
Table
of Contents
5.
DEFINED
BENEFIT PENSION PLAN AND UNFUNDED EXCESS BENEFITS PLAN
Components of the
net periodic benefit cost of the Companys defined benefit pension plan and
unfunded excess benefits plan are as follows:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Service cost -
Benefits earned during the period
|
|
$
|
2,155
|
|
$
|
2,016
|
|
$
|
7,193
|
|
$
|
6,657
|
|
Interest cost on
projected benefit obligations
|
|
2,316
|
|
2,169
|
|
7,731
|
|
7,163
|
|
Expected return
on plan assets
|
|
(2,571
|
)
|
(2,405
|
)
|
(8,582
|
)
|
(7,943
|
)
|
Amortization of
prior service cost
|
|
49
|
|
46
|
|
164
|
|
152
|
|
Amortization of
actuarial losses
|
|
748
|
|
699
|
|
2,496
|
|
2,309
|
|
Net periodic
benefit cost
|
|
$
|
2,697
|
|
$
|
2,525
|
|
$
|
9,002
|
|
$
|
8,338
|
|
As of September 30, 2008, no contributions
have been made to the defined benefit pension plan. The Company does not expect
to make a contribution to the defined benefit pension plan during the fourth
quarter of 2008.
In addition to pension benefits, the
Company provides life insurance benefits to eligible retirees and limited
healthcare benefits to eligible retirees who are not yet eligible for Medicare.
The cost of these plans for the nine months ended September
30, 2008 and 2007 was immaterial to the Companys financial position.
15
Table
of Contents
6.
EARNINGS PER SHARE
Basic earnings per share
is computed by dividing net (loss) income by the weighted-average number of
common shares outstanding during the period, including shares issuable under various
deferred compensation plans. Diluted earnings per shareis computed by dividing
net (loss) income by the weighted-average number of common shares and dilutive
potential common shares outstanding during the period, including shares
issuable under various stock-based compensation plans and stock purchase
contracts.
A reconciliation of the
numerators and denominators of the basic and diluted earnings per share is
presented below:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands, Except Per Share Amounts)
|
|
Calculation
of basic earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
Net income
(loss)
|
|
$
|
(100,008
|
)
|
$
|
72,992
|
|
$
|
(25,942
|
)
|
$
|
228,680
|
|
|
|
|
|
|
|
|
|
|
|
Average share
issued and outstanding
|
|
70,130,015
|
|
70,031,170
|
|
70,114,522
|
|
70,019,383
|
|
Issuable under
various deferred compensation plans
|
|
985,350
|
|
1,043,449
|
|
989,861
|
|
1,036,586
|
|
Weighted shares
outstanding - Basic
|
|
71,115,365
|
|
71,074,619
|
|
71,104,383
|
|
71,055,969
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings
(loss) per share
|
|
$
|
(1.41
|
)
|
$
|
1.03
|
|
$
|
(0.36
|
)
|
$
|
3.22
|
|
|
|
|
|
|
|
|
|
|
|
Calculation
of diluted earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
Net income
(loss)
|
|
$
|
(100,008
|
)
|
$
|
72,992
|
|
$
|
(25,942
|
)
|
$
|
228,680
|
|
|
|
|
|
|
|
|
|
|
|
Weighted shares
outstanding - Basic
|
|
71,115,365
|
|
71,074,619
|
|
71,104,383
|
|
71,055,969
|
|
Stock
appreciation rights (SARs)
(1)
|
|
126,779
|
|
215,107
|
|
167,911
|
|
243,930
|
|
Issuable under
various other stock-based compensation plans
|
|
125,355
|
|
165,869
|
|
141,230
|
|
172,337
|
|
Restricted stock
units
|
|
13,399
|
|
11,414
|
|
12,086
|
|
9,235
|
|
Weighted shares
outstanding - Diluted
|
|
71,380,898
|
|
71,467,009
|
|
71,425,610
|
|
71,481,471
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings
(loss) per share
|
|
$
|
(1.40
|
)
|
$
|
1.02
|
|
$
|
(0.36
|
)
|
$
|
3.20
|
|
(1)
Excludes
680,920 and 358,820 SARs as of September 30, 2008 and 2007, respectively, that
are antidilutive. In the event the average
market price exceeds the
issue price of the SARs, such right would be dilutive to the Companys earnings
(loss) per share and will be included in the Companys calculation of the
diluted average shares outstanding.
16
Table
of Contents
7.
COMPREHENSIVE
INCOME (LOSS)
The following
table sets forth the Companys comprehensive income (loss) for the periods
presented below:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
Net income (loss)
|
|
$
|
(100,008
|
)
|
$
|
72,992
|
|
$
|
(25,942
|
)
|
$
|
228,680
|
|
Change in net
unrealized gains on investments, net of income tax:
|
|
|
|
|
|
|
|
|
|
(three months:
2008 - $(310,166); 2007 - $33,525
|
|
|
|
|
|
|
|
|
|
nine months:
2008 - $(556,570); 2007 - $(46,191))
|
|
(567,195
|
)
|
61,916
|
|
(1,017,865
|
)
|
(84,584
|
)
|
Change in
accumulated gain-hedging, net of income tax:
|
|
|
|
|
|
|
|
|
|
(three months:
2008 - $(8,121); 2007 - $(4,303)
|
|
|
|
|
|
|
|
|
|
nine months:
2008 - $(4,703); 2007 - $(5,251))
|
|
(15,226
|
)
|
(7,753
|
)
|
(8,465
|
)
|
(9,461
|
)
|
Minimum pension
liability adjustment, net of income tax:
|
|
|
|
|
|
|
|
|
|
(three months:
2008 - $195; 2007 - $672
|
|
|
|
|
|
|
|
|
|
nine months:
2008 - $511; 2007 - $672)
|
|
316
|
|
1,247
|
|
949
|
|
1,247
|
|
Reclassification
adjustment for investment amounts included in net income, net of income tax:
|
|
|
|
|
|
|
|
|
|
(three months:
2008 - $76,837; 2007 - $(1,347)
|
|
|
|
|
|
|
|
|
|
nine months:
2008 - $97,245; 2007 - $(3,093))
|
|
140,034
|
|
(2,489
|
)
|
177,616
|
|
(5,663
|
)
|
Reclassification
adjustment for hedging amounts included in net income, net of income tax:
|
|
|
|
|
|
|
|
|
|
(three months:
2008 - $(288); 2007 - $278
|
|
|
|
|
|
|
|
|
|
nine months:
2008 - $49; 2007 - $177)
|
|
88
|
|
500
|
|
89
|
|
319
|
|
Comprehensive
income (loss)
|
|
$
|
(541,991
|
)
|
$
|
126,413
|
|
$
|
(873,618
|
)
|
$
|
130,538
|
|
8.
OPERATING
SEGMENTS
The Company operates several business segments each
having a strategic focus. An operating segment is generally distinguished by
products and/or channels of distribution. A brief description of each segment
follows.
·
The Life Marketing segment
markets level premium term insurance (traditional), UL, variable universal
life and BOLI products on a national basis primarily through networks of
independent insurance agents and brokers, stockbrokers, and independent
marketing organizations.
·
The Acquisitions segment
focuses on acquiring, converting, and servicing policies acquired from other
companies. The segments primary focus is on life insurance policies and
annuity products that were sold to individuals.
·
The Annuities segment
manufactures, sells, and supports fixed and variable annuity products. These
products are primarily sold through stockbrokers, but are also sold through
financial institutions and independent agents and brokers.
·
The Stable Value
Products segment sells guaranteed funding agreements to special purpose
entities that in turn issue notes or certificates in smaller, transferable
denominations. The segment also markets fixed and floating rate funding
agreements directly to the trustees of municipal bond proceeds, institutional
investors, bank trust departments, and money market funds. Additionally, the
segment markets guaranteed investment contracts (GICs) to 401(k) and other
qualified retirement savings plans.
·
The Asset Protection
segment primarily markets extended service contracts and credit life and
disability insurance to protect consumers investments in automobiles,
watercraft, and recreational vehicles. In addition, the segment markets a
guaranteed asset protection product and an inventory protection product.
17
Table
of Contents
·
The Corporate and Other
segment primarily consists of net investment income and expenses not
attributable to the segments above (including net investment income on capital
and interest on debt). This segment also includes earnings from several
non-strategic lines of business (primarily cancer insurance, residual value
insurance, surety insurance, and group annuities), various investment-related
transactions, and the operations of several small subsidiaries.
The Company uses the same
accounting policies and procedures to measure segment operating income and
assets as it uses to measure consolidated net income (loss) and assets. Segment
operating income is generally income before income tax excluding net realized
investment gains and losses (net of the related amortization of DAC/VOBA and
participating income from real estate ventures), and the cumulative effect of
change in accounting principle. Periodic settlements of derivatives associated
with corporate debt and certain investments and annuity products are included
in realized gains and losses but are considered part of operating income
because the derivatives are used to mitigate risk in items affecting
consolidated and segment operating income. Segment operating income represents
the basis on which the performance of the Companys business is internally
assessed by management. Premiums and policy fees, other income, benefits and
settlement expenses, and amortization of DAC/VOBA are attributed directly to
each operating segment. Net investment income is allocated based on directly
related assets required for transacting the business of that segment. Realized
investment gains (losses) and other operating expenses are allocated to the
segments in a manner that most appropriately reflects the operations of that
segment. Investments and other assets are allocated based on statutory policy
liabilities, while DAC/VOBA and goodwill are shown in the segments to which
they are attributable.
There were no significant intersegment transactions.
18
Table
of Contents
The following
tables summarize financial information for the Companys segments. Asset
adjustments represent the inclusion of assets related to discontinued
operations:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
Life Marketing
|
|
$
|
279,307
|
|
$
|
264,116
|
|
$
|
775,293
|
|
$
|
769,860
|
|
Acquisitions
|
|
161,372
|
|
221,430
|
|
567,949
|
|
680,582
|
|
Annuities
|
|
76,189
|
|
80,490
|
|
254,405
|
|
231,968
|
|
Stable Value
Products
|
|
96,238
|
|
73,168
|
|
259,602
|
|
224,589
|
|
Asset Protection
|
|
74,554
|
|
87,463
|
|
222,830
|
|
249,704
|
|
Corporate and
Other
|
|
(177,576
|
)
|
67,268
|
|
(159,692
|
)
|
169,688
|
|
Total revenues
|
|
$
|
510,084
|
|
$
|
793,935
|
|
$
|
1,920,387
|
|
$
|
2,326,391
|
|
Segment
Operating Income
|
|
|
|
|
|
|
|
|
|
Life Marketing
|
|
$
|
52,222
|
|
$
|
39,974
|
|
$
|
136,798
|
|
$
|
143,088
|
|
Acquisitions
|
|
33,021
|
|
30,375
|
|
101,111
|
|
93,438
|
|
Annuities
|
|
556
|
|
6,436
|
|
12,532
|
|
18,711
|
|
Stable Value
Products
|
|
28,184
|
|
13,107
|
|
61,945
|
|
37,648
|
|
Asset Protection
|
|
8,186
|
|
9,905
|
|
24,702
|
|
31,511
|
|
Corporate and
Other
|
|
(32,173
|
)
|
2,342
|
|
(64,239
|
)
|
2,819
|
|
Total segment
operating income
|
|
89,996
|
|
102,139
|
|
272,849
|
|
327,215
|
|
|
|
|
|
|
|
|
|
|
|
Realized
investment (losses) gains - investments
(1)
|
|
(350,399
|
)
|
43,070
|
|
(491,434
|
)
|
(19,128
|
)
|
Realized
investment (losses) gains - derivatives
(2)
|
|
100,461
|
|
(37,792
|
)
|
169,711
|
|
34,099
|
|
Income tax
benefit (expense)
|
|
59,934
|
|
(34,425
|
)
|
22,932
|
|
(113,506
|
)
|
Net income
(loss)
|
|
$
|
(100,008
|
)
|
$
|
72,992
|
|
$
|
(25,942
|
)
|
$
|
228,680
|
|
(1)
Realized investment (losses) gains -
investments
|
|
$
|
(351,102
|
)
|
$
|
43,114
|
|
$
|
(491,558
|
)
|
$
|
(10,201
|
)
|
Less:
participating income from real estate ventures
|
|
|
|
|
|
|
|
6,857
|
|
Less: related
amortization of DAC
|
|
(703
|
)
|
44
|
|
(124
|
)
|
2,070
|
|
|
|
$
|
(350,399
|
)
|
$
|
43,070
|
|
$
|
(491,434
|
)
|
$
|
(19,128
|
)
|
|
|
|
|
|
|
|
|
|
|
(2)
Realized investment gains (losses) -
derivatives
|
|
$
|
91,991
|
|
$
|
(37,467
|
)
|
$
|
155,421
|
|
$
|
36,523
|
|
Less:
settlements on certain interest rate swaps
|
|
1,915
|
|
132
|
|
4,185
|
|
626
|
|
Less: derivative
activity related to certain annuities
|
|
(10,385
|
)
|
193
|
|
(18,475
|
)
|
1,798
|
|
|
|
$
|
100,461
|
|
$
|
(37,792
|
)
|
$
|
169,711
|
|
$
|
34,099
|
|
19
Table
of Contents
|
|
Operating Segment Assets
|
|
|
|
September 30, 2008
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Life
|
|
|
|
|
|
Stable Value
|
|
|
|
Marketing
|
|
Acquisitions
|
|
Annuities
|
|
Products
|
|
Investments and
other assets
|
|
$
|
7,830,578
|
|
$
|
10,203,761
|
|
$
|
7,673,160
|
|
$
|
5,995,532
|
|
Deferred policy
acquisition costs and value of business acquired
|
|
2,497,526
|
|
962,600
|
|
363,220
|
|
16,622
|
|
Goodwill
|
|
10,192
|
|
48,783
|
|
|
|
|
|
Total assets
|
|
$
|
10,338,296
|
|
$
|
11,215,144
|
|
$
|
8,036,380
|
|
$
|
6,012,154
|
|
|
|
Asset
|
|
Corporate
|
|
|
|
Total
|
|
|
|
Protection
|
|
and Other
|
|
Adjustments
|
|
Consolidated
|
|
Investments and
other assets
|
|
$
|
945,692
|
|
$
|
4,389,048
|
|
$
|
26,937
|
|
$
|
37,064,708
|
|
Deferred policy
acquisition costs and value of business acquired
|
|
121,205
|
|
4,782
|
|
|
|
3,965,955
|
|
Goodwill
|
|
63,070
|
|
83
|
|
|
|
122,128
|
|
Total assets
|
|
$
|
1,129,967
|
|
$
|
4,393,913
|
|
$
|
26,937
|
|
$
|
41,152,791
|
|
|
|
Operating Segment Assets
|
|
|
|
December 31, 2007
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Life
|
|
|
|
|
|
Stable Value
|
|
|
|
Marketing
|
|
Acquisitions
|
|
Annuities
|
|
Products
|
|
Investments and
other assets
|
|
$
|
9,830,156
|
|
$
|
11,218,519
|
|
$
|
7,732,288
|
|
$
|
5,035,479
|
|
Deferred policy
acquisition costs and value of business acquired
|
|
2,071,508
|
|
950,174
|
|
221,516
|
|
16,359
|
|
Goodwill
|
|
10,192
|
|
44,741
|
|
|
|
|
|
Total assets
|
|
$
|
11,911,856
|
|
$
|
12,213,434
|
|
$
|
7,953,804
|
|
$
|
5,051,838
|
|
|
|
Asset
|
|
Corporate
|
|
|
|
Total
|
|
|
|
Protection
|
|
and Other
|
|
Adjustments
|
|
Consolidated
|
|
Investments and
other assets
|
|
$
|
1,360,218
|
|
$
|
3,063,927
|
|
$
|
27,595
|
|
$
|
38,268,182
|
|
Deferred policy
acquisition costs and value of business acquired
|
|
140,568
|
|
368
|
|
|
|
3,400,493
|
|
Goodwill
|
|
62,350
|
|
83
|
|
|
|
117,366
|
|
Total assets
|
|
$
|
1,563,136
|
|
$
|
3,064,378
|
|
$
|
27,595
|
|
$
|
41,786,041
|
|
20
Table of Contents
9.
GOODWILL
During the nine months
ended September 30, 2008, the Company increased its goodwill balance by
approximately $4.8 million. The increase was due to an increase of $4.1 million
in the Acquisitions segment and a $0.7 million increase in the Asset Protection
segment. The Acquisitions segment increase reflects the net of a purchase
accounting adjustment, which was partially offset by an adjustment related to
tax benefits realized during the first nine months of 2008 on the portion of
tax goodwill in excess of GAAP basis goodwill. The Asset Protection segment
increased by $0.4 million due to the purchase of a small administrative
subsidiary and $0.6 million due to a contingent consideration related to the
Western General acquisition. These increases were partially offset by a
decrease of $0.3 million due to the sale of a small insurance subsidiary during
the first quarter of 2008. As of September 30, 2008, the Company had an
aggregate goodwill balance of $122.1 million.
The Company tests its
goodwill balance annually, during the fourth quarter of each year and between
annual evaluations if events occur or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
amount. Such circumstances could include, but are not limited to: (1) a
significant adverse change in legal factors or in business climate, (2)
unanticipated competition, or (3) adverse action or assessment by a regulator. Additionally,
a decline in the market capitalization or market value of an entitys
securities may or may not be indicative of a triggering event to perform an
interim or event driven impairment analysis. When evaluating whether goodwill
is impaired, the Company compares the fair value of the reporting unit to which
the goodwill is assigned to the reporting unitsoverall carrying value
(including goodwill) to determine if factors are present that would be
indicative of impairment. The Company reviews the market values and carrying
values of its reporting units on an ongoing basis and has determined that no
such factors were noted as of or during the period ended September 30, 2008. The
Company will perform its full assessment of goodwill during the fourth quarter
of 2008.
10.
FAIR
VALUE OF FINANCIAL INSTRUMENTS
Effective
January 1, 2008, the Company determined the fair value of its financial
instruments based on the fair value hierarchy established in SFAS No. 157 which
requires an entity to maximize the use of observable inputs and minimize the
use of unobservable inputs when measuring fair value.
In compliance with SFAS
No. 157, the Company has categorized its financial instruments, based on the
priority of the inputs to the valuation technique, into a three level
hierarchy. The fair value hierarchy gives the highest priority to quoted prices
in active markets for identical assets or liabilities (Level 1) and the lowest
priority to unobservable inputs (Level 3). If the inputs used to measure fair
value fall within different levels of the hierarchy, the category level is
based on the lowest priority level input that is significant to the fair value
measurement of the instrument.
Financial assets and
liabilities recorded at fair value on the Consolidated Balance Sheets are
categorized as follows:
·
Level 1:
Unadjusted quoted prices for identical assets or liabilities in an active
market.
·
Level 2:
Quoted prices in markets that are not active or significant inputs that are
observable either directly or indirectly. Level 2 inputs include the following:
a)
Quoted
prices for similar assets or liabilities in active markets
b)
Quoted
prices for identical or similar assets or liabilities in non-active markets
c)
Inputs
other than quoted market prices that are observable
d)
Inputs
that are derived principally from or corroborated by observable market data
through correlation or other means.
·
Level 3:
Prices or valuation techniques that require inputs that are both unobservable
and significant to the overall fair value measurement. They reflect managements
own assumptions about the assumptions a market participant would use in pricing
the asset or liability.
21
Table of Contents
As a
result of the adoption of SFAS No. 157, the Company recognized the following
adjustment to opening retained earnings for its Equity Indexed Annuities that
were previously accounted for under SFAS No. 155:
|
|
Carrying
|
|
Carrying
|
|
|
|
|
|
Value
|
|
Value
|
|
Transition
|
|
|
|
Prior to
|
|
After
|
|
Adjustment to
|
|
|
|
Adoption
|
|
Adoption
|
|
Retained Earnings
|
|
|
|
January 1, 2008
|
|
January 1, 2008
|
|
Gain (Loss)
|
|
|
|
(Dollars In Thousands)
|
|
|
|
|
|
|
|
|
|
Equity-indexed
annuity reserves, net
|
|
$
|
145,912
|
|
$
|
143,634
|
|
$
|
2,278
|
|
Pre-tax
cumulative effect of adoption of SFAS No. 157
|
|
|
|
|
|
2,278
|
|
Change
in deferred income taxes
|
|
|
|
|
|
(808
|
)
|
Cumulative
effect of adoption of SFAS No. 157
|
|
|
|
|
|
$
|
1,470
|
|
|
|
|
|
|
|
|
|
|
|
|
In addition, the Company
recognized a transition adjustment for the embedded derivative liability
related to annuities with guaranteed minimum withdrawal benefits. The impact of
this adjustment, net of DAC amortization, reduced income before income taxes by
$0.4 million during the first quarter of 2008.
22
Table of Contents
The
following table presents the Companys hierarchy for its assets and liabilities
measured at fair value on a recurring basis as of September 30, 2008:
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
|
(Dollars In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities - available-for-sale
|
|
|
|
|
|
|
|
|
|
Mortgage-backed
and asset-backed securities
|
|
$
|
|
|
$
|
5,405,742
|
|
$
|
1,630,179
|
|
$
|
7,035,921
|
|
US
government and authorities
|
|
55,792
|
|
21,229
|
|
|
|
77,021
|
|
State,
municipalities and political subdivisions
|
|
|
|
30,945
|
|
97
|
|
31,042
|
|
Public
utilities
|
|
|
|
1,721,099
|
|
|
|
1,721,099
|
|
All
other corporate bonds
|
|
|
|
9,739,652
|
|
61,336
|
|
9,800,988
|
|
Redeemable
preferred stocks
|
|
|
|
|
|
36
|
|
36
|
|
Convertible
bonds with warrants
|
|
|
|
37
|
|
|
|
37
|
|
Total
fixed maturity securities - available-for-sale
|
|
55,792
|
|
16,918,704
|
|
1,691,648
|
|
18,666,144
|
|
Fixed
maturity securities - trading
|
|
284,072
|
|
3,111,230
|
|
23,463
|
|
3,418,765
|
|
Total
fixed maturity securities
|
|
339,864
|
|
20,029,934
|
|
1,715,111
|
|
22,084,909
|
|
Equity
securities
|
|
221,103
|
|
14,927
|
|
76,359
|
|
312,389
|
|
Other
long-term investments
(1)
|
|
6,414
|
|
13,584
|
|
148,060
|
|
168,058
|
|
Short-term
investments
|
|
896,604
|
|
89,644
|
|
1,356
|
|
987,604
|
|
Total
investments
|
|
1,463,985
|
|
20,148,089
|
|
1,940,886
|
|
23,552,960
|
|
Cash
|
|
86,587
|
|
|
|
|
|
86,587
|
|
Other
assets
|
|
4,920
|
|
|
|
|
|
4,920
|
|
Assets
related to separate acccounts
|
|
|
|
|
|
|
|
|
|
Variable
annuity
|
|
2,426,806
|
|
|
|
|
|
2,426,806
|
|
Variable
universal life
|
|
297,687
|
|
|
|
|
|
297,687
|
|
Total
assets measured at fair value on a recurring basis
|
|
$
|
4,279,985
|
|
$
|
20,148,089
|
|
$
|
1,940,886
|
|
$
|
26,368,960
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Annuity
account balances
(2)
|
|
$
|
|
|
$
|
|
|
$
|
154,154
|
|
$
|
154,154
|
|
Other
liabilities
(1)
|
|
|
|
49,798
|
|
13,430
|
|
63,228
|
|
Total
liabilities measured at fair value on a recurring basis
|
|
$
|
|
|
$
|
49,798
|
|
$
|
167,584
|
|
$
|
217,382
|
|
(1)
Includes
certain freestanding and embedded derivatives.
(2)
Represents
liabilities related to equity indexed annuities.
23
Table of Contents
The
following table presents a reconciliation of the beginning and ending balances
for fair value measurements for the three months ended September 30, 2008, for
which we have used significant unobservable inputs (Level 3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains (losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
included in
|
|
|
|
|
|
Total Realized and Unrealized
|
|
|
|
|
|
|
|
Earnings
|
|
|
|
|
|
Gains (losses)
|
|
|
|
|
|
|
|
related to
|
|
|
|
|
|
|
|
Included in
|
|
Purchases,
|
|
|
|
|
|
Instruments
|
|
|
|
|
|
|
|
Other
|
|
Issuances, and
|
|
Transfers in
|
|
|
|
still held at
|
|
|
|
Beginning
|
|
Included in
|
|
Comprehensive
|
|
Settlements
|
|
and/or out of
|
|
Ending
|
|
the Reporting
|
|
|
|
Balance
|
|
Earnings
|
|
Income
|
|
(net)
|
|
Level 3
|
|
Balance
|
|
Date
|
|
|
|
(Dollars In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities - available-for-sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed
and asset-backed securities
|
|
$
|
2,117,728
|
|
$
|
|
|
$
|
90,558
|
|
$
|
(333,096
|
)
|
$
|
(245,011
|
)
|
$
|
1,630,179
|
|
$
|
|
|
State,
municipalities and political subdivisions
|
|
9,025
|
|
|
|
6
|
|
|
|
(8,934
|
)
|
97
|
|
|
|
Public
utilities
|
|
190,164
|
|
|
|
(5,174
|
)
|
(30,281
|
)
|
(154,709
|
)
|
|
|
|
|
All
other corporate bonds
|
|
2,427,207
|
|
(41,514
|
)
|
(60,217
|
)
|
(626,039
|
)
|
(1,638,101
|
)
|
61,336
|
|
|
|
Redeemable
preferred stocks
|
|
36
|
|
|
|
|
|
|
|
|
|
36
|
|
|
|
Convertible
bonds with warrants
|
|
39
|
|
|
|
(1
|
)
|
|
|
(38
|
)
|
|
|
|
|
Total
fixed maturity securities - available-for-sale
|
|
4,744,199
|
|
(41,514
|
)
|
25,172
|
|
(989,416
|
)
|
(2,046,793
|
)
|
1,691,648
|
|
|
|
Fixed
maturity securities - trading
|
|
576,424
|
|
(15,275
|
)
|
|
|
(140,675
|
)
|
(397,011
|
)
|
23,463
|
|
25,548
|
|
Total
fixed maturity securities
|
|
5,320,623
|
|
(56,789
|
)
|
25,172
|
|
(1,130,091
|
)
|
(2,443,804
|
)
|
1,715,111
|
|
25,548
|
|
Equity
securities
|
|
69,566
|
|
|
|
69
|
|
7,221
|
|
(497
|
)
|
76,359
|
|
|
|
Other
long-term investments
(1)
|
|
44,422
|
|
105,196
|
|
|
|
(1,558
|
)
|
|
|
148,060
|
|
105,196
|
|
Short-term
investments
|
|
45,718
|
|
|
|
(612
|
)
|
|
|
(43,750
|
)
|
1,356
|
|
|
|
Total
investments
|
|
5,480,329
|
|
48,407
|
|
24,629
|
|
(1,124,428
|
)
|
(2,488,051
|
)
|
1,940,886
|
|
130,744
|
|
Total
assets measured at fair value on a recurring basis
|
|
$
|
5,480,329
|
|
$
|
48,407
|
|
$
|
24,629
|
|
$
|
(1,124,428
|
)
|
$
|
(2,488,051
|
)
|
$
|
1,940,886
|
|
$
|
130,744
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuity
account balances
(2)
|
|
$
|
146,579
|
|
$
|
(4,196
|
)
|
$
|
|
|
$
|
(3,379
|
)
|
$
|
|
|
$
|
154,154
|
|
$
|
(4,196
|
)
|
Other
liabilities
(1)
|
|
6,459
|
|
(8,536
|
)
|
|
|
1,565
|
|
|
|
13,430
|
|
(8,536
|
)
|
Total
liabilities measured at fair value on a recurring basis
|
|
$
|
153,038
|
|
$
|
(12,732
|
)
|
$
|
|
|
$
|
(1,814
|
)
|
$
|
|
|
$
|
167,584
|
|
$
|
(12,732
|
)
|
(1)
Represents
certain freestanding and embedded derivatives
(2)
Represents
liabilities related to equity indexed annuities
24
Table of Contents
The
following table presents a reconciliation of the beginning and ending balances
for fair value measurements for the nine months ended September 30, 2008, for
which we have used significant unobservable inputs (Level 3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains (losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
included in
|
|
|
|
|
|
Total Realized and Unrealized
|
|
|
|
|
|
|
|
Earnings
|
|
|
|
|
|
Gains (losses)
|
|
|
|
|
|
|
|
related to
|
|
|
|
|
|
|
|
Included in
|
|
Purchases,
|
|
|
|
|
|
Instruments
|
|
|
|
|
|
|
|
Other
|
|
Issuances, and
|
|
Transfers in
|
|
|
|
still held at
|
|
|
|
Beginning
|
|
Included in
|
|
Comprehensive
|
|
Settlements
|
|
and/or out of
|
|
Ending
|
|
the Reporting
|
|
|
|
Balance
|
|
Earnings
|
|
Income
|
|
(net)
|
|
Level 3
|
|
Balance
|
|
Date
|
|
|
|
(Dollars In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities - available-for-sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed
and asset-backed securities
|
|
$
|
1,290,299
|
|
$
|
|
|
$
|
(63,138
|
)
|
$
|
516,643
|
|
$
|
(113,625
|
)
|
$
|
1,630,179
|
|
$
|
|
|
State,
municipalities and political subdivisions
|
|
9,126
|
|
|
|
(92
|
)
|
(3
|
)
|
(8,934
|
)
|
97
|
|
|
|
Public
utilities
|
|
176,473
|
|
|
|
(9,762
|
)
|
(12,002
|
)
|
(154,709
|
)
|
|
|
|
|
All
other corporate bonds
|
|
2,248,703
|
|
(41,514
|
)
|
(161,520
|
)
|
(348,222
|
)
|
(1,636,111
|
)
|
61,336
|
|
|
|
Redeemable
preferred stocks
|
|
36
|
|
|
|
|
|
|
|
|
|
36
|
|
|
|
Convertible
bonds with warrants
|
|
227
|
|
|
|
(47
|
)
|
(142
|
)
|
(38
|
)
|
|
|
|
|
Total
fixed maturity securities - available-for-sale
|
|
3,724,864
|
|
(41,514
|
)
|
(234,559
|
)
|
156,274
|
|
(1,913,417
|
)
|
1,691,648
|
|
|
|
Fixed
maturity securities - trading
|
|
874,380
|
|
(40,765
|
)
|
|
|
(304,273
|
)
|
(505,879
|
)
|
23,463
|
|
1,646
|
|
Total
fixed maturity securities
|
|
4,599,244
|
|
(82,279
|
)
|
(234,559
|
)
|
(147,999
|
)
|
(2,419,296
|
)
|
1,715,111
|
|
1,646
|
|
Equity
securities
|
|
18,135
|
|
|
|
(19
|
)
|
58,761
|
|
(518
|
)
|
76,359
|
|
|
|
Other
long-term investments
(1)
|
|
2,951
|
|
147,001
|
|
|
|
(1,892
|
)
|
|
|
148,060
|
|
147,001
|
|
Short-term
investments
|
|
66,327
|
|
|
|
(612
|
)
|
|
|
(64,359
|
)
|
1,356
|
|
|
|
Total
investments
|
|
4,686,657
|
|
64,722
|
|
(235,190
|
)
|
(91,130
|
)
|
(2,484,173
|
)
|
1,940,886
|
|
148,647
|
|
Total
assets measured at fair value on a recurring basis
|
|
$
|
4,686,657
|
|
$
|
64,722
|
|
$
|
(235,190
|
)
|
$
|
(91,130
|
)
|
$
|
(2,484,173
|
)
|
$
|
1,940,886
|
|
$
|
148,647
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuity
account balances
(2)
|
|
$
|
143,634
|
|
$
|
(4,365
|
)
|
$
|
|
|
$
|
(6,155
|
)
|
$
|
|
|
$
|
154,154
|
|
$
|
(4,365
|
)
|
Other
liabilities
(1)
|
|
39,168
|
|
23,840
|
|
|
|
1,898
|
|
|
|
13,430
|
|
23,840
|
|
Total
liabilities measured at fair value on a recurring basis
|
|
$
|
182,802
|
|
$
|
19,475
|
|
$
|
|
|
$
|
(4,257
|
)
|
$
|
|
|
$
|
167,584
|
|
$
|
19,475
|
|
(1)
Represents
certain freestanding and embedded derivatives
(2)
Represents
liabilities related to equity indexed annuities
Certain
changes have been made to the January 1, 2008 balances in the table above from
the amounts reported in the first quarter to make the amounts comparable to
those of the current quarter. These changes had no effect on the Companys
consolidated condensed balance sheets or consolidated condensed statements of
income and cash flows. The changes resulted in an increase to the amount of
assets categorized as Level 3 by $324.1 million at January 1, 2008, and a
corresponding decrease that was predominately to the amount of assets in Level
2. There were immaterial changes to the amount of liabilities categorized as
Level 3 at January 1, 2008.
Total
realized and unrealized gains (losses) on Level 3 assets and liabilities are
primarily reported in either realized investment gains (losses) within the
consolidated statements of income or other comprehensive income (loss) within
shareowners equity based on the appropriate accounting treatment for the item.
Purchases,
sales, issuances and settlements, net, represent the activity that occurred
during the period that results in a change of the asset or liability but does
not represent changes in fair value for the instruments held at the beginning
of the period. Such activity primarily relates to purchases and sales of fixed
maturity securities, and issuances and settlements of equity indexed annuities
accounted for under SFAS No. 155.
25
Table of Contents
The
Company reviews the fair value hierarchy classifications each reporting period.
Changes in the observability of the valuation attributes may result in a
reclassification of certain financial assets or liabilities. Such
reclassifications are reported as transfers in and out of Level 3 at the
beginning fair value for the reporting period in which the changes occur. The
asset transfers in the table(s) above primarily related to positions moved from
Level 3 to Level 2 as the Company determined that certain inputs were
observable.
The
amount of total gains (losses) for assets and liabilities still held as of the
reporting date primarily represents changes in fair value of trading securities
and certain derivatives that exist as of the reporting date, and the change in
fair value of equity indexed annuities accounted for under SFAS No. 155.
As
of September 30, 2008, the Company changed certain assumptions used in its
methodology for determining the fair value for retained beneficial interests in
commercial mortgage-backed security (CMBS) holdings related to the Companys
sponsored commercial mortgage loan securitizations. Prior to September 30,
2008, the Company used external broker valuations to determine the fair value
of these positions. These valuations were based on the cash flows of the
commercial mortgages underlying the notes, as well as observable market spread
assumptions for investments with similar coupons and/or characteristics based
on the fair value hierarchy criteria, and non-observable assumptions and
factors utilizing general market information available as of the valuation
date. During the three months ended September 30, 2008, the Company determined
that little or no secondary market existed for CMBS holdings similar to those
in the Companys portfolio, and additionally, certain of the tranches within the
Companys holdings fell below the collapse provision levels in the underlying
security agreements. Therefore, the relevant observable inputs from CMBS sales
activity could not be obtained for what the Company considered a supportable or
appropriate calculation of fair value based on the Companys previous
methodology.
As
a result of the factors noted and in accordance with the clarifying guidance
issued in SFAS No. 157-3, the Company determined the fair value of these CMBS
holdings as of September 30, 2008 using a combination of external broker
valuations and an internally developed model. This model includes inputs
derived by the Company based on assumed discount rates relative to the Companys
current mortgage loan lending rate and an expected cash flow analysis based on
a review of the commercial mortgage loans underlying the notes. The model also
contains the Companys determined representative risk adjustment assumptions
related to nonperformance and liquidity risks. Changes in these assumptions resulted
in an increase of approximately $173.0 million to the fair value of the Companys
retained beneficial interests in CMBS holdings related to the Companys
sponsored commercial mortgage loan securitizations. The Company believes that
this valuation approach provides a more accurate calculation of the fair value
of these securities under the fair value hierarchy guidance and given the
current inactive market conditions.
11.
INCOME
TAXES
There have been no material changes to the
balance of unrecognized income tax benefits which impacted earnings for the
first nine months ended September 30, 2008. The IRS has completed its
examination of the Companys 2004 and 2005 federal income tax returns. The
Company does not expect to have any material adjustments, within the next
twelve months, to its balance of unrecognized income tax benefits in any of the
tax jurisdictions in which it conducts its business operations.
In
general, Accounting Principles Board Opinion No. 28,
Interim
Financial Reporting
, requires that a company compute its interim
period effective income tax rate based upon its expectation of what such rate
will be at year-end. An exception is made when such a rate cannot be reasonably
estimated as of the current interim period. Accordingly, it is then appropriate
to compute an effective income tax rate based upon year-to-date reported net
income or loss. Due to the large investment losses reported by the Company in
the third quarter of 2008, and the unpredictability of additional losses and
certain elements of operating income in the fourth quarter of 2008, the Company
is unable to reasonably estimate its annual income. Based on this fact and the
related accounting guidance, the Company has therefore computed its effective
income tax rate for the three months and nine months ended September 30, 2008
based upon its reported net loss for each of the respective periods.
Based
on the Companys current assessment of future taxable income, including
available tax planning opportunities, the Company anticipates that it is more
likely than not that it will generate sufficient taxable income to realize its
deferred tax assets, and therefore, the Company did not record a valuation
allowance against its deferred tax assets as of September 30, 2008.
12.
SUBSEQUENT
EVENT
On November 5, 2008, Moodys announced a one-step
downgrade of the insurance financial strength (IFS) rating of the Companys
life insurance subsidiaries, including Protective Life Insurance Company, to A1
(Good, 5
th
highest of 21 ratings) from Aa3, as well as a one-step
downgrade of the Companys senior debt rating to Baa1 from A3. Moodys stated that the outlook on all the
ratings is stable and this rating action concludes its review of Protective
that was begun on October 14, 2008.
Additionally, on November 5, 2008, Fitch Ratings
announced a one-step downgrade of its IFS ratings of the Companys life insurance
subsidiaries to A+ (Strong, 5
th
highest of 22 ratings) from AA-, and
a one-step downgrade of the Companys issuer default rating to A- from A, with
negative outlook.
For additional information on the Companys ratings,
see the Item 2,
Managements Discussion and Analysis of
Financial Condition and Results of Operations
Capital Resources.
26
Table of Contents
Item 2. Managements Discussion and
Analysis of Financial Condition and Results of Operations
The following Managements
Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) should be read in conjunction with our
consolidated condensed financial statements included under Part I,
Item 1,
Financial Statements (Unaudited)
,
of this Quarterly Report on Form 10-Q and our audited consolidated
financial statements for the year ended December 31, 2007, included in our
Annual Report on Form 10-K.
For a more complete
understanding of our business and current period results, please read the
following MD&A in conjunction with our latest Annual Report on
Form 10-K and other filings with the United States Securities and Exchange
Commission (the SEC).
Certain reclassifications
have been made in the previously reported financial statements and accompanying
notes to make the prior period amounts comparable to those of the current
period. Such reclassifications had no effect on previously reported net income
or shareowners equity.
FORWARD-LOOKING
STATEMENTS
This report reviews our
financial condition and results of operations including our liquidity and
capital resources. Historical information is presented and discussed and where
appropriate, factors that may affect future financial performance are also
identified and discussed. Certain statements made in this report include
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements include any statement
that may predict, forecast, indicate or imply future results, performance or
achievements instead of historical facts and may contain words like believe,
expect, estimate, project, budget, forecast, anticipate, plan,
will, shall, may, and other words, phrases, or expressions with similar
meaning. Forward-looking statements involve risks and uncertainties, which may
cause actual results to differ materially from the results contained in the
forward-looking statements, and we cannot give assurances that such statements
will prove to be correct. Given these risks and uncertainties, investors should
not place undue reliance on forward-looking statements as a prediction of
actual results. For more information about the risks, uncertainties and other
factors that could affect our future results, please see Exhibit 99 that is
filed with this Quarterly Report on Form 10-Q.
OVERVIEW
Our
business
We are a holding company
headquartered in Birmingham, Alabama, whose subsidiaries provide financial
services through the production, distribution, and administration of insurance
and investment products. Founded in 1907, Protective Life Insurance Company is
our largest operating subsidiary. Unless the context otherwise requires, we,
us, or our refers to the consolidated group of Protective Life Corporation
and our subsidiaries.
We operate several
business segments, each having a strategic focus. An operating segment is
generally distinguished by products and/or channels of distribution. We
periodically evaluate our operating segments in light of the segment reporting
requirements prescribed by the Financial Accounting Standards Board (FASB)
Statement No. 131,
Disclosures about Segments
of an Enterprise and Related Information
(SFAS No. 131), and make
adjustments to our segment reporting as needed.
Our operating segments
are Life Marketing, Acquisitions, Annuities, Stable Value Products, Asset
Protection, and Corporate and Other.
·
Life Marketing
-
We
market level premium term insurance (traditional), universal
life (UL), variable universal life, and bank-owned life
insurance (BOLI) products on a national basis primarily through networks
of independent insurance agents and brokers, stockbrokers, and independent
marketing organizations.
27
Table of Contents
·
Acquisitions
- We focus on acquiring, converting, and
servicing policies acquired from other companies. The segments primary focus
is on life insurance policies and annuity products sold to individuals. In the
ordinary course of business, the Acquisitions segment regularly considers
acquisitions of blocks of policies or smaller insurance companies. The level of
the segments acquisition activity is predicated upon many factors, including
available capital, operating capacity, and market dynamics. Policies acquired
through the Acquisition segment are typically closed blocks of business (no
new policies are being marketed). Therefore, earnings and account values are
expected to decline as the result of lapses, deaths, and other terminations of
coverage unless new acquisitions are made.
·
Annuities
- We manufacture, sell, and support fixed and
variable annuity products. These products are primarily sold through
broker-dealers, but are also sold through financial institutions and independent
agents and brokers.
·
Stable Value Products
- We sell guaranteed funding
agreement (GFAs) to special purpose entities that in turn issue notes or
certificates in smaller, transferable denominations. The segment also markets
fixed and floating rate funding agreements directly to the trustees of
municipal bond proceeds, institutional investors, bank trust departments, and
money market funds. Additionally, the segment markets guaranteed investment
contracts (GICs) to 401(k) and other qualified retirement savings plans.
·
Asset Protection
- We primarily market extended service
contracts and credit life and disability insurance to protect consumers
investments in automobiles, watercraft, and recreational vehicles. In addition,
the segment markets a guaranteed asset protection (GAP) product and an
inventory protection product (IPP).
·
Corporate and Other
- This segment primarily consists of
net investment income and expenses not attributable to the segments above
(including net investment income on capital and interest on debt). This segment
also includes earnings from several non-strategic lines of business (primarily
cancer insurance, residual value insurance, surety insurance, and group
annuities), various investment-related transactions, and the operations of
several small subsidiaries.
Reinsurance Ceded
For approximately 10
years prior to mid-2005, we entered into reinsurance contracts in which we
ceded a significant percentage, generally 90%, of our newly written business on
a first dollar quota share basis. Our traditional life insurance was ceded
under coinsurance contracts and universal life insurance was ceded under yearly
renewable term (YRT) contracts. During this time, we obtained coinsurance on
our traditional life business at favorable rates, while reducing the amount of
capital deployed and increasing overall returns. We continue to reinsure 90% of
the mortality risk, but not the account values, on our newly written universal
life insurance.
During recent years, the
life reinsurance market continued the process of consolidation and tightening,
resulting in a higher net cost of reinsurance for much of our life insurance
business. We have also been challenged by changes in the reinsurance market
which have impacted management of capital, particularly in our traditional life
business which is required to hold reserves pursuant to Regulation XXX. In
response to these challenges, in 2005 we reduced our overall reliance on
reinsurance by changing from coinsurance to YRT reinsurance arrangements for
newly issued traditional life products. Additionally in 2005, for newly issued
traditional life products, we increased, from $500,000 to $1,000,000, the
amount of insurance we will retain on any one life. During 2008, we have
increased our retention limit to $2,000,000 on certain of our traditional life
products. These YRT arrangements are utilized to limit our exposure to large
claims, and are not a significant factor in capital management or the overall
profitability of the business.
28
Table of Contents
In order to fund the
additional statutory reserves required as a result of these changes in our
reinsurance arrangements, we established a surplus notes facility under which
we issued an aggregate of $800 million, on a consolidated basis, of
non-recourse funding obligations through December 2007. In addition, during
2007, we established a surplus notes facility relative to our universal life
products. Under this facility, we issued $575 million of non-recourse funding
obligations that will be used to fund statutory reserves required by the
Valuation of Life Insurance Policies Model Regulation (Regulation XXX),
as clarified by Actuarial Guideline 38 (commonly known as AXXX). We
have received regulatory approval to issue additional series of our floating
rate surplus notes up to an aggregate of $675 million principal amount.
Our maximum retention for newly issued universal life products is $1,000,000.
During 2006, immediately
after the closing of our acquisition of the Chase Insurance Group, we entered
into agreements with Commonwealth Annuity and Life Insurance Company (formerly
known as Allmerica Financial Life Insurance and Annuity Company) (CALIC) and
Wilton Reassurance Company and Wilton Reinsurance Bermuda Limited
(collectively, the Wilton Re Group), whereby CALIC reinsured 100% of the
variable annuity business of the Chase Insurance Group and the Wilton Re Group
reinsured approximately 42% of the other insurance business of the Chase
Insurance Group.
EXECUTIVE SUMMARY
During the
third quarter of 2008, domestic and global economies continued to decline. Gross
domestic product (GDP) fell a seasonally adjusted 0.3% annual rate for July
through September of 2008. This decline represented the weakest GDP result
since a 1.4% decline during the third quarter of 2001. Global equity markets
experienced significant declines. Financial markets continued to experience
increased volatility due to ongoing concerns about the economic outlook,
inflation, and asset impairments. As a result of the extraordinary events
taking place in the markets, a number of large financial institutions came
close to failure or failed during the third quarter of 2008. In response to the
financial institutions distress, on October 3, 2008, President Bush signed
into law the Emergency Economic Stabilization Act of 2008 (EESA), which
provides for the United States Treasury to purchase up to $700 billion of
securities from financial institutions for the purpose of stabilizing the
financial markets. Under EESA and the Troubled Asset Relief Program (TARP)
Capital Purchase Plan, Treasury has begun making equity investments in U.S.
banks.Under EESA, Treasury has the power to expand its investments to include
insurers. There are reports that the Treasury is considering such action, but
the action may be limited to insurers that own or are owned by a
federally-regulated bank or thrift institution. We cannot predict what actions
Treasury or other governmental or regulatory bodies may take nor can there be
any assurance as to what impact any governmental or regulatory actions will
have on the financial markets, the economy, or our consolidated results of operations
and financial position.
In light
of recent events and uncertain capital and credit market conditions, we have
strategically positioned ourselves to have ample liquidity to meet our
projected outflows from currently available sources. We have increased our
short-term investments; we have $410 million available capacity on our existing
credit facility; we have access to the Federal Home Loan Bank (FHLB) for
short-term borrowing; we have temporarily suspended offering new mortgage loan
commitments; we have reduced our holdings of high-risk assets; and we have
discontinued the active pursuit of repurchasing shares of our common stock
under our share repurchase program. As of September 30, 2008 cash and
short-term investments were $1.1 billion. Additionally, on November 3,
2008, we reduced our quarterly dividend to shareholders from $0.235 to $0.12.
For the
three and nine months ended September 30, 2008, our consolidated condensed
financial statementsinclude the results of our annual comprehensive review of
actuarial assumptions and models underlying insurance-related assets and
liabilities commonly known as unlocking. The net impact in the Life Marketing
segment was $8.8 million favorable unlocking and $2.8 million unfavorable in
the Annuities segment.
During the first nine
months of 2008, our operating earnings decreased $54.4 million compared to the
first nine months of 2007, primarily as a result of $39.5 million of
mark-to-market losses recorded on our trading portfolio, a reduction in
investment income during 2008 related to our participating mortgage program of
$21.0 million, and a non-recurring $15.7 million gain recognized during the
first quarter of 2007 resulting from the sale of a direct marketing subsidiary.
Excluding realized losses
pursuant to a modified coinsurance (Modco) arrangement of $33.5 million and
$23.2 million for the nine months ended September 30, 2008 and 2007,
respectively, under which the economic risks and benefits of the investments
are passed to a third-party reinsurer, we experienced net realized losses of
$302.6 million and $3.1 million for the nine months ended September 30, 2008
and 2007, respectively. The 2008 losses
29
Table of Contents
were primarily the result
of $282.6 million of other-than-temporary impairment charges related to debt
obligations and preferred stock holdings in Lehman Brothers and Washington
Mutual, residential mortgage-backed securities collateralized by Alt-A
mortgages, and preferred stock holdings in Fannie Mae and Freddie Mac. The
decline in the estimated fair value of these securities resulted from factors
including distressed credit markets, the recent failure or near failure of a
number of large financial service companies, downgrades in ratings, and
interest rate changes. These other-than-temporary impairments resulted from our
analysis of circumstances and our belief that credit events, loss severity,
changes in credit enhancement, and/or other adverse conditions of the
respective issuers have caused, or will lead to, a deficiency in the
contractual cash flows related to these investments.
The effective tax rate for the three months ended
September 30, 2008 was approximately 37% compared to a rate of 32% for the same
period in the prior year. The effective tax rate for the nine months ended
September 30, 2008 was 47% compared to a rate of 33% for the same period in the
prior year. The effective tax rates in 2008 are higher than historical rates
due to the relative percentage of tax permanent differences to total income in
2007 and total loss in 2008 (which was caused by realized losses on investment
securities).
The interest rate and credit environment continues to
present a significant challenge. Historically low interest rates and market
illiquidity continued to create challenges for our fixed income investment
portfolio and for our products that generate investment spread profits, such as
fixed annuities and stable value contracts. However, active management of
crediting rates on these products allowed us to mitigate spread compression
effects and sales allowed us to take advantage of wider credit spreads on
investments.
Current costs of
reinsurance continue to present challenges from both a new product pricing and
capital management perspective. In response to these challenges, during 2005 we
reduced our reliance on reinsurance by changing from coinsurance to yearly
renewable term reinsurance and increased the maximum amount retained on any one
life from $500,000 to $1,000,000 on certain of our newly written traditional
life products. During the first nine months of 2008, we increased our retention
limit to $2,000,000 on certain newly written traditional life products.
Significant
financial information related to each of our segments is included in
Results of Operations
.
RISKS
AND UNCERTAINTIES
The factors which could
affect our future results include, but are not limited to, general economic
conditions and the following risks and uncertainties:
General
·
exposure to
the risks of natural disasters, pandemics, malicious and terrorist acts could
adversely affect our operations;
·
computer
viruses or network security breaches could affect our data processing systems
or those of our business partners and could damage our business and adversely
affect our financial condition and results of operations;
·
actual
experience may differ from managements assumptions and estimates and
negatively affect our results;
·
we may not
realize our anticipated financial results from our acquisitions strategy;
·
we
may not be able to achieve the expected results from our recent
acquisitions;
·
we are
dependent on the performance of others;
·
our risk
management policies and procedures could leave us exposed to unidentified or
unanticipated risk, which could negatively affect our business or result in
losses;
Financial
environment
·
interest
rate fluctuations could negatively affect our spread income or otherwise impact
our business;
·
our
investments are subject to market and credit risks, which could be heightened
during periods of extreme volatility or disruption in the financial and credit
markets;
·
equity
market volatility could negatively impact our business;
·
credit
market volatility or disruption could adversely impact our financial condition
or results from operations;
30
Table of Contents
·
our ability
to grow depends in large part upon the continued availability of capital;
·
we could be
adversely affected by a ratings downgrade or other negative action by a ratings
organization;
·
a loss of
policyholder confidence in our insurance subsidiaries could lead to higher than
expected levels of policyholder surrenders and withdrawal of funds;
·
we could be
forced to sell investments at a loss to cover policyholder withdrawals;
·
disruption
of the capital and credit markets could negatively affect our ability to meet
our liquidity and financing needs;
·
difficult
conditions in the economy generally could adversely affect our business and
results from operations;
·
there can be
no assurance that the actions of the United States Government or other
governmental and regulatory bodies for the purpose of stabilizing the financial
markets will achieve their intended effect;
Industry
·
insurance
companies are highly regulated and subject to numerous legal restrictions and
regulations;
·
changes to
tax law or interpretations of existing tax law could adversely affect our
ability to compete with non-insurance products or reduce the demand for certain
insurance products;
·
financial
services companies are frequently the targets of litigation, including class
action litigation, which could result in substantial judgments;
·
publicly
held companies in general and the financial services industry in particular are
sometimes the target of law enforcement investigations and the focus of
increased regulatory scrutiny;
·
new accounting
rules or changes to existing accounting rules could negatively impact us;
·
reinsurance
introduces variability in our statements of income;
·
our
reinsurers could fail to meet assumed obligations, increase rates or be subject
to adverse developments that could affect us;
·
policy
claims fluctuate from period to period resulting in earnings volatility;
Competition
·
operating in
a mature, highly competitive industry could limit our ability to gain or
maintain our position in the industry and negatively affect profitability;
·
our ability
to maintain competitive unit costs is dependent upon the level of new sales and
persistency of existing business; and
·
a ratings
downgrade could adversely affect our ability to compete.
For more
information about the risks, uncertainties, and other factors that could affect
our future results, please see Exhibit 99 that is filed with this Quarterly
Report on Form 10-Q.
CRITICAL ACCOUNTING
POLICIES
Our accounting policies
inherently require the use of judgments relating to a variety of assumptions
and estimates, in particular expectations of current and future mortality,
morbidity, persistency, expenses, and interest rates. Because of the inherent
uncertainty when using the assumptions and estimates, the effect of certain
accounting policies under different conditions or assumptions could be
materially different from those reported in the consolidated financial
statements. A discussion of various critical accounting policies is presented
below. For a more complete listing of our critical accounting policies, refer
to our Annual Report on Form 10-K for the year ended December 31,
2007.
Evaluation
of Other-Than-Temporary Impairments
-
One of the significant estimates related to
available-for-sale securities is the evaluation of investments for
other-than-temporary impairments. If a decline in the fair value of an
available-for-sale security is judged to be other-than-temporary, a charge is
recorded in net realized investment losses equal to the difference between the
fair value and cost or amortized cost basis of the security. The fair value of
the other-than-temporarily impaired investment becomes its new cost basis. For
fixed maturities, we accrete the new cost basis to par or to the estimated
future value over the expected remaining life of the security by adjusting the
securitys yields.
31
Table of Contents
Determining whether a
decline in the current fair value of invested assets is an other-than-temporary
decline in value can involve a variety of assumptions and estimates,
particularly for investments that are not actively traded in established
markets. For example, assessing the value of certain investments requires that
we perform an analysis of expected future cash flows or rates of prepayments. Other
investments, such as collateralized mortgage or bond obligations, represent
selected tranches of a structured transaction, supported in the aggregate by
underlying investments in a wide variety of issuers. Management considers a
number of factors when determining the impairment status of individual
securities. These include the economic condition of various industry segments
and geographic locations and other areas of identified risks. Although it is
possible for the impairment of one investment to affect other investments, we
engage in ongoing risk management to safeguard against and limit any further
risk to our investment portfolio. Special attention is given to correlative
risks within specific industries, related parties, and business markets.
For
certain securitized financial assets with contractual cash flows including
asset-backed securities (ABS), Emerging Issues Task Force (EITF) Issue No.
99-20, Recognition of Interest Income and Impairment on Purchased Beneficial
Interests and Beneficial Interests That Continued to Be Held by a Transferor in
Securitized Financial Assets (EITF Issue No. 99-20), requires us to
periodically update our best estimate of cash flows over the life of the
security. If the fair value of a securitized financial asset is less than its
cost or amortized cost and there has been a decrease in the present value of
the estimated cash flows since the last revised estimate, considering both
timing and amount, an other-than-temporary impairment charge is recognized. Estimating
future cash flows is a quantitative and qualitative process that incorporates
information received from third party sources along with certain internal
assumptions and judgments regarding the future performance of the underlying
collateral. Projections of expected future cash flows may change based upon new
information regarding the performance of the underlying collateral. In
addition, we consider our intent and ability to retain a temporarily depressed
security until recovery.
Securities
not subject to EITF Issue No. 99-20 that are in an unrealized loss
position, are reviewed at least quarterly to determine if an
other-than-temporary impairment is present based on certain quantitative and
qualitative factors.
We consider a number of factors in
determining whether the impairment is other-than-temporary. These include, but
are not limited to: 1) actions taken by rating agencies, 2) default
by the issuer, 3) the significance of the decline, 4) the intent and
ability to hold the investment until recovery, 5) the time period during
which the decline has occurred, 6) an economic analysis of the issuers
industry, and 7) the financial strength, liquidity, and recoverability of
the issuer. Management performs a security-by-security review each quarter in
evaluating the need for any other-than-temporary impairments. Although no set
formula is used in this process, the investment performance, collateral position,
and continued viability of the issuer are significant measures that we
consider. Based on our analysis, during the three and nine months ended
September 30, 2008, we concluded that approximately $202.6 million, excluding
$20.0 million of Modco related impairments, and $282.6 million, excluding $20.0
million of Modco related impairments, respectively, of pretax unrealized losses
were other-than-temporarily impaired. The impairments related to debt
obligations and preferred stock holdings in Lehman Brothers and Washington
Mutual, residential mortgage-backed securities collateralized by Alt-A
mortgages, and preferred stock holdings in Fannie Mae and Freddie Mac,
resulting in a
charge to net
realized investment losses
.
Reinsurance
-
For
each of our reinsurance contracts, we must determine if the contract provides
indemnification against loss or liability relating to insurance risk, in
accordance with applicable accounting standards. We must review all contractual
features, particularly those that may limit the amount of insurance risk to
which we are subject or features that delay the timely reimbursement of claims.
If we determine that the possibility of a significant loss from insurance risk
will occur only under remote circumstances, we record the contract under a
deposit method of accounting with the net amount payable/receivable reflected
in other reinsurance assets or liabilities on our consolidated balance sheets.
Fees earned on the contracts are reflected as other revenues, as opposed to
premiums, on our consolidated statements of income.
The balance of the reinsurance is due from
a diverse group of reinsurers. The collectability of reinsurance is largely a
function of the solvency of the individual reinsurers. We perform periodic
credit reviews on our reinsurers, focusing on, among other things, financial
capacity, stability, trends and commitment to the reinsurance business. We also
require assets in trust, letters of credit or other acceptable collateral to
support balances due from reinsurers not authorized to transact business in the
applicable jurisdictions. Despite these measures, a reinsurers insolvency,
inability or unwillingness to make payments under the terms of a reinsurance
contract, could have a material adverse effect on our results of operations and
financial conditio
n. As of September 30, 2008 our third-party
reinsurance receivables amounted to $5.2 billion. These amounts include ceded
reserve balances and ceded benefit payments.
32
Table of
Contents
We
account for reinsurance as required by FASB Statement No. 113,
Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts
(SFAS No. 113). In addition to SFAS No. 113, we rely on
FASB Statement No. 60,
Accounting and Reporting
by Insurance Enterprises
(SFAS No. 60) and 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
(SFAS No. 97) as applicable. In
accordance with those pronouncements, costs for reinsurance are amortized as a
level percentage of premiums for SFAS No. 60 products and a level
percentage of estimated gross profits for SFAS No. 97 products.
Accordingly, ceded reserve and deferred acquisition cost balances are
established using methodologies consistent with those used in establishing
direct policyholder reserves and deferred acquisition costs. Establishing these balances requires the use
of various assumptions including investment returns, mortality, persistency,
and expenses. The assumptions made for
establishing ceded reserves and ceded deferred acquisition costs are consistent
with those used for establishing direct policyholder reserves and deferred
acquisition costs.
Assumptions
are also made regarding future reinsurance premium rates and allowance rates.
Assumptions made for mortality, persistency, and expenses are consistent with
those used for establishing direct policyholder reserves and deferred
acquisition costs. Assumptions made for
future reinsurance premium and allowance rates are consistent with rates
provided for in our various reinsurance agreements. For certain of our reinsurance agreements,
premium and allowance rates may be changed by reinsurers on a prospective
basis, assuming certain contractual conditions are met (primarily that rates
are changed for all companies with which the reinsurer has similar agreements). We do not anticipate any changes to these
rates and, therefore, have assumed continuation of these non-guaranteed
rates. To the extent that future rates
are modified, these assumptions would be revised and both current and future
results would be affected. For products subject to SFAS No. 60,
assumptions are not changed unless projected future revenues are expected to be
less than future expenses. For products subject to SFAS No. 97,
assumptions are periodically updated whenever actual experience and/or
expectations for the future differ from that assumed. When assumptions are updated, changes are
reflected in the income statement as part of an unlocking process. For the
nine months ended September 30, 2008, there were no changes to reinsurance
premium and allowance rates that would require an update of assumptions and
subsequent unlocking of balances under SFAS No. 97.
RESULTS OF OPERATIONS
In
the following discussion, segment operating income is defined as income before
income tax excluding net realized investment gains and losses (net of the
related amortization of deferred policy acquisition costs (DAC) and
value of business acquired (VOBA) and participating income from real
estate ventures), and the cumulative effect of change in accounting
principle. Periodic settlements of
derivatives associated with corporate debt and certain investments and annuity
products are included in realized gains and losses but are considered part of
segment operating income because the derivatives are used to mitigate risk in
items affecting segment operating income.
Management believes that segment operating income provides relevant and
useful information to investors, as it represents the basis on which the
performance of our business is internally assessed. Although the items excluded from segment
operating income may be significant components in understanding and assessing
our overall financial performance, management believes that segment operating
income enhances an investors understanding of our results of operations by
highlighting the income (loss) attributable to the normal, recurring operations
of our business. However, segment
operating income should not be viewed as a substitute for accounting principles
generally accepted in the United States of America (U.S. GAAP) net
income. In addition, our segment
operating income measures may not be comparable to similarly titled measures
reported by other companies.
33
Table of
Contents
The
following table presents a summary of results and reconciles segment operating
income to consolidated net income (loss):
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Segment Operating Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life Marketing
|
|
$
|
52,222
|
|
$
|
39,974
|
|
30.6
|
%
|
$
|
136,798
|
|
$
|
143,088
|
|
(4.4
|
)%
|
Acquisitions
|
|
33,021
|
|
30,375
|
|
8.7
|
|
101,111
|
|
93,438
|
|
8.2
|
|
Annuities
|
|
556
|
|
6,436
|
|
(91.4
|
)
|
12,532
|
|
18,711
|
|
(33.0
|
)
|
Stable Value Products
|
|
28,184
|
|
13,107
|
|
n/m
|
|
61,945
|
|
37,648
|
|
64.5
|
|
Asset Protection
|
|
8,186
|
|
9,905
|
|
(17.4
|
)
|
24,702
|
|
31,511
|
|
(21.6
|
)
|
Corporate and Other
|
|
(32,173
|
)
|
2,342
|
|
n/m
|
|
(64,239
|
)
|
2,819
|
|
n/m
|
|
Total segment operating income
|
|
89,996
|
|
102,139
|
|
(11.9
|
)
|
272,849
|
|
327,215
|
|
(16.6
|
)
|
Realized investment gains (losses) - investments
(1)(3)
|
|
(350,399
|
)
|
43,070
|
|
|
|
(491,434
|
)
|
(19,128
|
)
|
|
|
Realized investment gains (losses) - derivatives
(2)
|
|
100,461
|
|
(37,792
|
)
|
|
|
169,711
|
|
34,099
|
|
|
|
Income tax benefit (expense)
|
|
59,934
|
|
(34,425
|
)
|
|
|
22,932
|
|
(113,506
|
)
|
|
|
Net income (loss)
|
|
$
|
(100,008
|
)
|
$
|
72,992
|
|
n/m
|
|
$
|
(25,942
|
)
|
$
|
228,680
|
|
n/m
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Realized
investment gains (losses) - investments
(3)
|
|
$
|
(351,102
|
)
|
$
|
43,114
|
|
|
|
$
|
(491,558
|
)
|
$
|
(10,201
|
)
|
|
|
Less: participating income from real estate ventures
|
|
|
|
|
|
|
|
|
|
6,857
|
|
|
|
Less: related amortization of DAC
|
|
(703
|
)
|
44
|
|
|
|
(124
|
)
|
2,070
|
|
|
|
|
|
$
|
(350,399
|
)
|
$
|
43,070
|
|
|
|
$
|
(491,434
|
)
|
$
|
(19,128
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2)
Realized investment
gains (losses) - derivatives
|
|
$
|
91,991
|
|
$
|
(37,467
|
)
|
|
|
$
|
155,421
|
|
$
|
36,523
|
|
|
|
Less: settlements on certain interest rate swaps
|
|
1,915
|
|
132
|
|
|
|
4,185
|
|
626
|
|
|
|
Less: derivative activity related to certain annuities
|
|
(10,385
|
)
|
193
|
|
|
|
(18,475
|
)
|
1,798
|
|
|
|
|
|
$
|
100,461
|
|
$
|
(37,792
|
)
|
|
|
$
|
169,711
|
|
$
|
34,099
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3)
|
Includes other-than-termporary impairments of
$(202,644) and $(282,630) for the three and nine months ended September 30,
2008, respectively.
|
34
Table of
Contents
Three Months Ended September 30, 2008 compared to Three Months
Ended September 30, 2007
The
net loss for the three months ended September 30, 2008 included a
$12.1 million, or 11.9%, decrease in segment operating income. The
decrease was primarily related to a $34.5 million decrease in operating
earnings in the Corporate and Other segment, a $5.9 million decrease in the
Annuities segment, and a $1.7 million decrease in the Asset Protection
segment. These decreases were partially
offset by a $15.1 million increase in operating earnings in the Stable Value
segment, a $12.2 million increase in the Life Marketing segment, and a $2.6
million increase in the Acquisitions segment.
Changes in fair value related to the Corporate and Other trading
portfolio and the Annuities segment reduced operating earnings by $28.3 million
in the three months ended September 30, 2008.
We
experienced net realized losses of $259.1 million during the three months ended
September 30, 2008, versus net realized gains of $5.6 million for the same
period of 2007. The losses realized during the three months ended September 30,
2008 were primarily caused by $202.6 million of other-than-temporary impairment
charges related to debt obligations and preferred stock holdings in Lehman
Brothers and Washington Mutual, residential mortgage-backed securities
collateralized by Alt-A mortgages, and preferred stock holdings in Fannie Mae
and Freddie Mac. These losses were
partially offset by mark-to-market gains of $105.6 million on embedded
derivatives related to reinsurance arrangements.
·
Life Marketing segment
operating income was $52.2 million for the three months ended September 30,
2008, representing an increase of $12.2 million, or 30.6%, from the three
months ended September 30, 2007.
The increase was primarily due to net favorable prospective unlocking of
$8.8 million in the segments universal life and BOLI lines. In addition,
higher investment income and lower expenses partially offset the lower earnings
in the segments marketing subsidiaries. Investment income was higher due to
new sales.
·
Acquisitions segment
operating income was $33.0 million and increased $2.6 million, or 8.7%,
for the three months ended September 30, 2008 compared to the three months
ended September 30, 2007, primarily due to lower operating expenses on the
Chase Insurance Group block and improved mortality results, partially offset by
expected runoff of the block of business.
·
Annuities segment operating
income was $0.6 million for the three months ended September 30, 2008,
representing a decrease of $5.9 million, or 91.4%, compared to the three months
ended September 30, 2007, which included $4.8 million of negative fair
value changes including $0.2 million on the equity indexed annuity product line
and $4.6 million on embedded derivatives associated with the variable annuity
guaranteed minimum withdrawal benefits (GMWB) rider related to current market
conditions. In addition, unfavorable
mortality in the segments single premium immediate annuity (SPIA) block
reduced earnings by $3.9 million. These decreases were partially offset by the
continued growth of the single premium deferred annuity (SPDA) line which
accounted for a $3.2 million increase in earnings.
·
Stable Value Products
segment operating income was $28.2 million and increased $15.1 million for
the three months ended September 30, 2008 compared to the three months
ended September 30, 2007. The
increase in operating earnings resulted from the combination of higher average
balances, slightly higher asset yields, and lower liability costs. In addition,
$3.0 million in other income was generated from the early retirement of a
funding agreement backing a medium term note.
Lower liability costs resulted from the increased sales of attractively
priced institutional funding agreements.
As a result, the operating spread increased 61 basis points to 170
basis points during the three months ended September 30, 2008, compared to
an operating spread of 109 basis points during the three months ended September 30,
2007.
·
Asset Protection segment
operating income was $8.2 million, representing a decrease of $1.7 million, or
17.4%, for the three months ended September 30, 2008 compared to the three
months ended September 30, 2007.
The decrease was primarily the result of a $2.1 million decrease in
service contract income due to lower auto and marine volume and higher loss
ratios in certain product lines. Offsetting this loss was $1.1 million of
higher earnings in the GAP line and an increase in credit insurance earnings of
$0.3 million for the three months ended September 30, 2008 compared to the
three months ended September 30, 2007.
35
Table of
Contents
·
Corporate and Other segment
operating income decreased $34.5 million for the three months ended September 30,
2008, compared to the three months ended September 30, 2007, primarily due
to negative mark-to-market adjustments of $23.5 million on a $387.5 million
portfolio of securities designated for trading.
This trading portfolio negatively impacted the three months ended September 30,
2008 by approximately $20.0 million, an $18.2 million less favorable impact
than in the three months ended September 30, 2007. In addition, the segment experienced $10.7
million of lower participating mortgage income due to the current economic
environment.
Nine Months Ended September 30, 2008 compared to Nine Months Ended
September 30, 2007
The
net loss for the nine months ended September 30, 2008 included a
$54.4 million, or 16.6%, decrease in segment operating income. The
decrease was primarily related to a $67.1 million decrease in operating
earnings in the Corporate and Other segment, a $6.3 million decrease in the
Life Marketing segment, and a $6.2 million decrease in the Annuities
segment. These decreases were partially
offset by a $24.3 million increase in operating earnings in the Stable Value
segment and a $7.7 million increase in the Acquisitions segment. Changes in fair value related to the Corporate
and Other trading portfolio and the Annuities segment reduced operating
earnings by $48.3 million in the first nine months of 2008.
We
experienced net realized losses of $336.1 million during the first nine months
of 2008, versus net realized gains of $26.3 million in the first nine months of
2007. The losses realized during the nine months ended September 30, 2008
were primarily caused by $282.6 million of other-than-temporary impairment
charges related to debt obligations and preferred stock holdings in Lehman
Brothers and Washington Mutual, residential mortgage-backed securities
collateralized by Alt-A mortgages, and preferred stock holdings in Fannie Mae
and Freddie Mac. These losses were
partially offset by mark-to-market gains of $183.1 million on embedded
derivatives related to reinsurance arrangements.
·
Life Marketing segment
operating income was $136.8 million for the nine months ended September 30,
2008, representing a decrease of $6.3 million, or 4.4%, from the nine months
ended September 30, 2007. The
decrease was primarily due to a $15.7 million gain recognized during the first
quarter of 2007 on the sale of the segments direct marketing subsidiary offset
by favorable prospective unlocking of $8.8 million in the third quarter of
2008, higher investment income and lower expenses for the nine months ended September 30,
2008. Investment income increased despite the AXXX securitization transaction
that occurred early in the third quarter of 2007 that transferred approximately
$4 million per quarter of investment income to the Corporate and Other segment.
·
Acquisitions segment
operating income was $101.1 million and increased $7.7 million, or 8.2%,
for the nine months ended September 30, 2008 compared to the nine months
ended September 30, 2007, primarily due to lower operating expenses on the
Chase Insurance Group block and improved mortality results, partially offset by
expected runoff of the block of business.
·
Annuities segment operating
income was $12.5 million and declined $6.2 million, or 33.0%, for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007, which included $8.8 million of negative fair value changes of $2.4
million on the equity indexed annuity product and $6.4 million on embedded derivatives
associated with the variable annuity GMWB rider related to current market
conditions. Included in the
mark-to-market adjustment is a SFAS No. 157 transition adjustment loss for
the embedded derivative related to the variable annuity GMWB rider of $0.4
million before income taxes. In addition, unfavorable mortality in the segments
SPIA block reduced earnings by $10.1 million. These items were partially offset
by the continued growth of the SPDA line which accounted for a $6.1 million
increase in operating income.
·
Stable Value Products
segment operating income was $61.9 million and increased $24.3 million, or
64.5%, for the nine months ended September 30, 2008 compared to the nine
months ended September 30, 2007.
The increase in operating earnings resulted from the combination of
higher average balances, slightly higher asset yields, and lower liability
costs. In addition, $3.0 million in other income was generated from the early
retirement of a funding agreement backing a medium term note. Lower liability costs resulted from the
increased sales of attractively priced institutional funding agreements. As a result, the operating spread increased
44 basis points to 145 basis points during the nine months ended September 30,
2008, compared to an operating spread of 101 basis points during the nine
months ended September 30, 2007.
36
Table of
Contents
·
Asset Protection segment
operating income was $24.7 million, representing a decrease of
$6.8 million, or 21.6%, for the nine months ended September 30, 2008
compared to the nine months ended September 30, 2007. The decrease was primarily the result of a
$5.0 million, or 17.3%, decrease in service contract income due to lower auto
and marine volume and higher loss ratios in certain product lines. Earnings
from other products declined $2.3 million, or 70.5%, due primarily to lower
volume in the IPP line, somewhat offset by higher GAP earnings due to improved
underwriting results in 2008. Credit insurance earnings increased $0.9 million,
or 95.0%, for the nine months ended September 30, 2008 compared to the
nine months ended September 30, 2007.
The increase in credit insurance earnings resulted primarily from a $1.1
million decrease in legal expense for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007.
·
Corporate and Other segment
operating income declined $67.1 million for the nine months ended September 30,
2008, compared to the nine months ended September 30, 2007, primarily due
to negative mark-to-market adjustments of $34.0 million on a $387.5 million
portfolio of securities designated for trading.
This represents a $32.2 million less favorable impact than in the first
nine months of 2007. In addition, the
segment experienced lower participating mortgage income of $21.0 million and
lower prepayment fee income of $6.5 million due to the current economic
environment.
37
Table of
Contents
Life Marketing
Segment results of operations
Segment
results were as follows:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
372,674
|
|
$
|
360,450
|
|
3.4
|
%
|
$
|
1,109,264
|
|
$
|
1,067,759
|
|
3.9
|
%
|
Reinsurance ceded
|
|
(205,699
|
)
|
(203,285
|
)
|
1.2
|
|
(669,303
|
)
|
(650,601
|
)
|
2.9
|
|
Net premiums and policy fees
|
|
166,975
|
|
157,165
|
|
6.2
|
|
439,961
|
|
417,158
|
|
5.5
|
|
Net investment income
|
|
88,825
|
|
79,437
|
|
11.8
|
|
260,770
|
|
242,831
|
|
7.4
|
|
Other income
|
|
23,507
|
|
27,514
|
|
(14.6
|
)
|
74,562
|
|
109,871
|
|
(32.1
|
)
|
Total operating revenues
|
|
279,307
|
|
264,116
|
|
5.8
|
|
775,293
|
|
769,860
|
|
0.7
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
212,201
|
|
182,010
|
|
16.6
|
|
551,840
|
|
483,486
|
|
14.1
|
|
Amortization of deferred policy acquisition costs
|
|
5,009
|
|
27,807
|
|
(82.0
|
)
|
59,166
|
|
82,069
|
|
(27.9
|
)
|
Other operating expenses
|
|
9,875
|
|
14,325
|
|
(31.1
|
)
|
27,489
|
|
61,217
|
|
(55.1
|
)
|
Total benefits and expenses
|
|
227,085
|
|
224,142
|
|
1.3
|
|
638,495
|
|
626,772
|
|
1.9
|
|
OPERATING INCOME
|
|
52,222
|
|
39,974
|
|
30.6
|
|
136,798
|
|
143,088
|
|
(4.4
|
)
|
INCOME BEFORE INCOME TAX
|
|
$
|
52,222
|
|
$
|
39,974
|
|
30.6
|
|
$
|
136,798
|
|
$
|
143,088
|
|
(4.4
|
)
|
38
Table of
Contents
The
following table summarizes key data for the Life Marketing segment:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Sales By Product
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Traditional
|
|
$
|
23,039
|
|
$
|
36,326
|
|
(36.6
|
)%
|
$
|
76,928
|
|
$
|
113,773
|
|
(32.4
|
)%
|
Universal life
|
|
11,092
|
|
24,761
|
|
(55.2
|
)
|
38,336
|
|
57,473
|
|
(33.3
|
)
|
Variable universal life
|
|
1,222
|
|
1,826
|
|
(33.1
|
)
|
4,505
|
|
5,835
|
|
(22.8
|
)
|
|
|
$
|
35,353
|
|
$
|
62,913
|
|
(43.8
|
)
|
$
|
119,769
|
|
$
|
177,081
|
|
(32.4
|
)
|
Sales By Distribution Channel
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage general agents
|
|
$
|
20,805
|
|
$
|
35,919
|
|
(42.1
|
)
|
$
|
68,746
|
|
$
|
107,008
|
|
(35.8
|
)
|
Independent agents
|
|
7,403
|
|
11,461
|
|
(35.4
|
)
|
25,586
|
|
30,418
|
|
(15.9
|
)
|
Stockbrokers / banks
|
|
6,587
|
|
9,651
|
|
(31.7
|
)
|
22,341
|
|
27,596
|
|
(19.0
|
)
|
BOLI / other
|
|
558
|
|
5,882
|
|
(90.5
|
)
|
3,096
|
|
12,059
|
|
(74.3
|
)
|
|
|
$
|
35,353
|
|
$
|
62,913
|
|
(43.8
|
)
|
$
|
119,769
|
|
$
|
177,081
|
|
(32.4
|
)
|
Average Life Insurance In-force
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Traditional
|
|
$
|
477,021,367
|
|
$
|
441,839,831
|
|
8.0
|
|
$
|
470,876,402
|
|
$
|
425,693,626
|
|
10.6
|
|
Universal life
|
|
52,655,080
|
|
53,841,008
|
|
(2.2
|
)
|
52,731,566
|
|
52,466,246
|
|
0.5
|
|
|
|
$
|
529,676,447
|
|
$
|
495,680,839
|
|
6.9
|
|
$
|
523,607,968
|
|
$
|
478,159,872
|
|
9.5
|
|
Average Account Values
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Universal life
|
|
$
|
5,297,640
|
|
$
|
5,053,316
|
|
4.8
|
|
$
|
5,250,215
|
|
$
|
4,957,023
|
|
5.9
|
|
Variable universal life
|
|
311,716
|
|
349,300
|
|
(10.8
|
)
|
324,647
|
|
331,608
|
|
(2.1
|
)
|
|
|
$
|
5,609,356
|
|
$
|
5,402,616
|
|
3.8
|
|
$
|
5,574,862
|
|
$
|
5,288,631
|
|
5.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Traditional Life Mortality Experience
(2)
|
|
$
|
(53
|
)
|
$
|
1,511
|
|
|
|
$
|
866
|
|
$
|
3,716
|
|
|
|
Universal Life Mortality Experience
(2)
|
|
$
|
2,005
|
|
$
|
234
|
|
|
|
$
|
3,651
|
|
$
|
1,139
|
|
|
|
(1)
|
Amounts are not adjusted for reinsurance ceded.
|
(2)
|
Represents the estimated pretax earnings impact
resulting from mortality variances. We
periodically review and update as appropriate our key assumptions in
calculating mortality. Changes to these assumptions result in adjustments
which may increase or decrease previously reported mortality amounts.
Excludes results related to the Chase Insurance Group which was acquired in
the third quarter of 2006 and excludes results related to the BOLI product
line.
|
39
Table
of Contents
Operating expenses detail
Other
operating expenses for the segment were as follows:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Insurance Companies:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First year commissions
|
|
$
|
44,007
|
|
$
|
69,863
|
|
(37.0
|
)%
|
$
|
147,258
|
|
$
|
198,715
|
|
(25.9
|
)%
|
Renewal commissions
|
|
9,660
|
|
8,988
|
|
7.5
|
|
28,225
|
|
27,092
|
|
4.2
|
|
First year ceding allowances
|
|
(4,234
|
)
|
(4,731
|
)
|
(10.5
|
)
|
(14,810
|
)
|
(13,575
|
)
|
9.1
|
|
Renewal ceding allowances
|
|
(52,713
|
)
|
(54,497
|
)
|
(3.3
|
)
|
(166,149
|
)
|
(167,092
|
)
|
(0.6
|
)
|
General & administrative
|
|
37,217
|
|
43,670
|
|
(14.8
|
)
|
118,647
|
|
136,527
|
|
(13.1
|
)
|
Taxes, licenses, and fees
|
|
7,659
|
|
8,493
|
|
(9.8
|
)
|
22,391
|
|
24,666
|
|
(9.2
|
)
|
Other operating expenses incurred
|
|
41,596
|
|
71,786
|
|
(42.1
|
)
|
135,562
|
|
206,333
|
|
(34.3
|
)
|
Less: commissions, allowances & expenses capitalized
|
|
(54,792
|
)
|
(83,007
|
)
|
(34.0
|
)
|
(179,022
|
)
|
(235,161
|
)
|
(23.9
|
)
|
Other insurance company operating expenses
|
|
(13,196
|
)
|
(11,221
|
)
|
17.6
|
|
(43,460
|
)
|
(28,828
|
)
|
50.8
|
|
Marketing Companies:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions
|
|
18,423
|
|
19,066
|
|
(3.4
|
)
|
58,185
|
|
65,176
|
|
(10.7
|
)
|
Other operating expenses
|
|
4,648
|
|
6,480
|
|
(28.3
|
)
|
12,764
|
|
24,869
|
|
(48.7
|
)
|
Other marketing company operating expenses
|
|
23,071
|
|
25,546
|
|
(9.7
|
)
|
70,949
|
|
90,045
|
|
(21.2
|
)
|
Other operating expenses
|
|
$
|
9,875
|
|
$
|
14,325
|
|
(31.1
|
)
|
$
|
27,489
|
|
$
|
61,217
|
|
(55.1
|
)
|
Three Months Ended September 30, 2008 compared to Three Months
Ended September 30, 2007
Segment operating income
Operating
income was $52.2 million for the three months ended September 30, 2008,
representing an increase of $12.2 million, or 30.6%, from the three months
ended September 30, 2007. The
increase was primarily due to net favorable prospective unlocking of $8.8
million in the segments universal life and BOLI lines. In addition, higher
investment income and lower expenses partially offset the lower earnings in the
segments marketing subsidiaries.
Investment income was higher due to new sales.
Operating revenues
Total
revenues for the three months ended September 30, 2008 increased $15.2,
million or 5.8%, compared to the three months ended September 30, 2007.
This increase was the result of higher premiums and policy fees in the segments
traditional line and higher investment income due to increases in in-force
volume and higher overall yields, which was partially offset by lower other
income due to the sale of a non-insurance subsidiary in late 2007 and lower
sales in the segments marketing companies.
Net premiums and policy fees
Net
premiums and policy fees increased by $9.8 million, or 6.2%, for the three
months ended September 30, 2008 compared to the three months ended September 30,
2007, primarily due to an increase in retention levels on certain traditional life
products. Beginning in the third quarter of 2005, we reduced our reliance on
reinsurance by changing from coinsurance to yearly renewable term reinsurance
agreements and increased the maximum amount retained on any one life from
$500,000 to $1,000,000 on certain of our newly written traditional life
products (products written during the third quarter of 2005 and later.) In addition to increasing net premiums, this
change results in higher benefits and settlement expenses, and causes greater
variability in financial results due to fluctuations in mortality results. Our maximum retention level for newly issued
universal life products is generally $1,000,000. During 2008, we increased our retention limit
to $2,000,000 on certain of our traditional life products.
40
Table of
Contents
Net investment income
Net
investment income in the segment increased $9.4 million, or 11.8%, for the
three months ended September 30, 2008 compared to the three months ended September 30,
2007. The increase reflects the growth
related to traditional and universal life liabilities.
Other income
Other
income decreased $4.0 million, or 14.6%, for the three months ended September 30,
2008 compared to the three months ended September 30, 2007. The decrease relates primarily to the sale of
a non-insurance subsidiary in the fourth quarter of 2007 and lower
broker-dealer revenues compared to 2007 levels due to current negative market
conditions.
Benefits and settlement expenses
Benefits
and settlement expenses were $30.2 million, or 16.6%, higher for the three
months ended September 30, 2008 than for the three months ended September 30,
2007, due to growth in life insurance in-force, increased retention levels on
certain newly written traditional life products and higher credited interest on
UL products resulting from increases in account values. Changes to assumptions,
from our annual DAC unlocking process, resulted in an adjustment which
increased the benefits and settlements expense by $14.4 million this quarter,
which was offset by the decrease of $23.2 million in the DAC amortization line.
The estimated mortality impact to earnings, related to traditional and
universal life products, for the three months ended September 30, 2008 was
favorable by $2.0 million, and was approximately $0.2 million more
favorable than the estimated mortality impact on earnings for the three months
ended September 30, 2007.
Amortization of DAC
DAC
amortization decreased $22.8 million, or 82.0%, for the three months ended September 30,
2008 compared to the three months ending September 30, 2007. We
periodically review and update as appropriate our key assumptions including
future mortality, expenses, lapses, premium persistency, investment yields and
interest spreads. Changes to these assumptions result in adjustments which
increase or decrease DAC amortization. The periodic review and updating of
assumptions is referred to as unlocking. DAC amortization for the Life
Marketing segment was reduced by $23.2 million during the third quarter of 2008
primarily due to favorable DAC unlocking in the universal life, partially
offset by unfavorable unlocking in BOLI.
Other operating expenses
Other
operating expenses decreased $4.5 million, or 31.1%, for the three months ended
September 30, 2008 compared to the three months ended September 30,
2007. This decrease related to the sale
of a non-insurance subsidiary in the fourth quarter of 2007, lower commissions
in remaining marketing subsidiaries and reduced administrative expenses in our
insurance operations.
Sales
Sales
for the segment decreased $27.6 million, or 43.8%, for the three months ended September 30,
2008 compared to the three months ended September 30, 2007, due to a
decline in sales across product lines. Lower sales levels of traditional
products were primarily the result of pricing changes implemented on certain of
our products at the beginning of 2008 and less favorable market conditions.
Universal life sales declined $13.7 million, or 55.2%, for the three months
ended September 30, 2008 compared to the three months ended September 30,
2007, primarily due to competitive pressures in the brokerage general agent,
independent general agent, stockbroker channels, and less favorable market
conditions. In addition, BOLI sales are subject to significant fluctuation and
were $5.3 million lower in the quarter ending September 30, 2008 compared
to the quarter ending September 30, 2007.
41
Table of
Contents
Nine Months Ended September 30, 2008 compared to Nine Months Ended
September 30, 2007
Segment operating income
Operating
income was $136.8 million for the nine months ended September 30,
2008, representing a decrease of $6.3 million, or 4.4%, compared to the nine
months ended September 30, 2007.
The decrease was primarily due to a $15.7 million gain recognized during
the first quarter of 2007 on the sale of the segments direct marketing
subsidiary offset by favorable prospective unlocking of $8.8 million in the
third quarter of 2008, higher investment income and lower expenses for the nine
months ended September 30, 2008. Investment income increased despite the
AXXX securitization transaction that occurred early in the third quarter of
2007 that transferred approximately $4 million per quarter of investment income
to the Corporate and Other segment.
Operating revenues
Excluding
the prior year $15.7 million gain on the sale of a subsidiary which is
included in other income, total revenues for the nine months ended September 30,
2008 increased $21.2 million, or 2.8%, compared to the nine months ended September 30,
2007. This increase was the result of
higher premiums and policy fees in the segments traditional line and higher
investment income due to increases in in-force volume and higher overall
yields, offset by lower other income due to the sales of two non-insurance
subsidiaries in late 2007 and lower sales in the segments marketing
companies. Investment income increased
despite the approximately $4 million per quarter reduction of investment income
related to the AXXX securitization transaction, beginning with the third
quarter of 2007.
Net premiums and policy fees
Net
premiums and policy fees increased $22.8 million, or 5.5%, for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007. The increase was primarily due to the previously mentioned increase in
retention limits on certain traditional life products.
Net investment income
Net
investment income in the segment increased $17.9 million, or 7.4%, for the
nine months ended September 30, 2008 compared to the nine months ended September 30,
2007. The increase reflects the growth
of the segment assets caused by growth related to traditional and universal
life liabilities, partly offset by a decrease due to the funding of
statutory reserves required by Regulation XXX, as clarified by AXXX. Our AXXX securitization transaction on
universal life products was effective early in the third quarter of 2007. See the Recent Developments section for
additional information concerning AXXX requirements.
Other income
Other
income decreased $35.3 million, or 32.1%, for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007. A major component of the decrease relates to
a $15.7 million gain recognized on the sale of the segments direct
marketing subsidiary in the first quarter of 2007. In addition, broker-dealer
revenues decreased compared to the prior year due to current negative market
conditions and marketing revenue was reduced after the sale of another
subsidiary in the fourth quarter of 2007.
Benefits and settlement expenses
Benefits
and settlement expenses increased $68.4 million, or 14.1%, for the nine months
ended September 30, 2008 compared to the nine months ended September 30,
2007, due to growth in life insurance in-force, increased retention levels on
certain newly written traditional life products and higher credited interest on
UL products resulting from increases in account values. Changes to assumptions,
from our annual DAC unlocking process, resulted in an adjustment which
increased the benefits and settlements expense by $14.4 million this quarter,
which was offset by the decrease of $23.2 million in the DAC amortization line.
The estimated mortality impact to earnings, related to traditional and
universal life products, for the nine months ended September 30, 2008 was
favorable by $4.5 million, and was approximately $0.3 million less
favorable than the estimated mortality impact on earnings for the nine months
ended September 30, 2007.
42
Table
of Contents
Amortization
of DAC
DAC
amortization decreased $22.9 million or 27.9% for the nine months ended September 30,
2008 compared to the nine months ending September 30, 2007. DAC
amortization for the Life Marketing segment was reduced by $23.2 million during
the third quarter of 2008 primarily due to favorable DAC unlocking in UL,
partially offset by unfavorable unlocking in BOLI.
Other operating expenses
Other operating expenses decreased $33.7,
million or 55.1%, for the nine months ended September 30, 2008 compared to
the nine months ended September 30, 2007.
This decrease primarily relates to the impact of the sale of two
marketing subsidiaries during 2007 and lower broker dealer sales compared to
the nine months ended September 30, 2007. The marketing companies
contributed approximately $19.1 million to the decrease in the nine months
ended September 30, 2008 compared to the nine months ended September 30,
2007. In addition, reduced operating expenses in the insurance companies
contributed to the overall decrease.
Sales
Sales for the
segment decreased $57.3 million, or 32.4%, for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007, due to a
decline in sales across all product lines. Lower sales levels of traditional
products were primarily the result of pricing changes implemented on certain of
our products at the beginning of 2008. Universal
life sales declined $19.1 million, or 33.3%, for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007, primarily due
to competitive pressures in the brokerage general agent, independent general
agent and stockbroker channels. In addition, BOLI sales are subject to
significant fluctuation and were $9.0 million lower in the nine months ending September 30,
2008 compared to the nine months ending September 30, 2007.
Reinsurance
Currently, the Life Marketing segment reinsures significant amounts of
its life insurance in-force. Pursuant to
the underlying reinsurance contracts, reinsurers pay allowances to the segment
as a percentage of both first year and renewal premiums. Reinsurance allowances represent the amount
the reinsurer is willing to pay for reimbursement of acquisition costs incurred
by the direct writer of the business. A
portion of reinsurance allowances received is deferred as part of DAC and a
portion is recognized immediately as a reduction of other operating expenses.
As the non-deferred portion of allowances reduces operating expenses in the
period received, these amounts represent a net increase to operating income
during that period.
Reinsurance allowances do not affect the methodology used to amortize
DAC or the period over which such DAC is amortized. However, they do affect the
amounts recognized as DAC amortization. DAC on 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
(SFAS No. 97) is amortized based on the estimated
gross profits of the policies in-force. Reinsurance allowances are considered
in the determination of estimated gross profits, and therefore impact SFAS No. 97
DAC amortization. Deferred reinsurance
allowances on FASB Statement No. 60,
Accounting
and Reporting by Insurance Enterprises
(SFAS No. 60) policies
are recorded as ceded DAC, which is amortized over estimated ceded premiums of
the policies in force. Thus, deferred
reinsurance allowances on SFAS No. 60 policies impact SFAS No. 60
DAC amortization. A more detailed
discussion of the accounting for reinsurance allowances can be found in the
Reinsurance section of Note 1,
Basis of Presentation and
Summary of Significant Accounting Policies.
43
Table of Contents
Impact of reinsurance
Reinsurance impacted the Life Marketing segment line items as shown in
the following table:
Life Marketing Segment
Line Item Impact of Reinsurance
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
Reinsurance ceded
|
|
$
|
(205,699
|
)
|
$
|
(203,285
|
)
|
$
|
(669,303
|
)
|
$
|
(650,601
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
Benefit and settlement expenses
|
|
(184,567
|
)
|
(244,465
|
)
|
(709,321
|
)
|
(703,608
|
)
|
Amortization of deferred policy acquisition
costs
|
|
(12,430
|
)
|
(13,610
|
)
|
(32,528
|
)
|
(49,302
|
)
|
Other operating expenses
(1)
|
|
(33,661
|
)
|
(33,611
|
)
|
(104,531
|
)
|
(100,239
|
)
|
Total benefits and expenses
|
|
(230,658
|
)
|
(291,686
|
)
|
(846,380
|
)
|
(853,149
|
)
|
|
|
|
|
|
|
|
|
|
|
NET IMPACT OF REINSURANCE
(2)
|
|
$
|
24,959
|
|
$
|
88,401
|
|
$
|
177,077
|
|
$
|
202,548
|
|
|
|
|
|
|
|
|
|
|
|
Allowances received
|
|
$
|
(56,947
|
)
|
$
|
(59,228
|
)
|
$
|
(180,958
|
)
|
$
|
(180,667
|
)
|
Less: Amount deferred
|
|
23,286
|
|
25,617
|
|
76,427
|
|
80,428
|
|
Allowances recognized
|
|
|
|
|
|
|
|
|
|
(ceded other operating expenses)
(1)
|
|
$
|
(33,661
|
)
|
$
|
(33,611
|
)
|
$
|
(104,531
|
)
|
$
|
(100,239
|
)
|
(1)
|
Other operating expenses ceded per the
income statement are equal to reinsurance allowances recognized after
capitalization.
|
(2)
|
Assumes no investment income on
reinsurance.Foregone investment income would substantially reduce the
favorable impact of reinsurance. The Company estimates that the impact of
foregone investment income would reduce the net impact of reinsurance by 80%
to 120%.
|
The table above does not reflect the impact
of reinsurance on our net investment income.
By ceding business to the assuming companies, we forgo investment income
on the reserves ceded. Conversely, the
assuming companies will receive investment income on the reserves assumed which
will increase the assuming companies profitability on the business we
cede. The net investment income impact
to us and the assuming companies has not been quantified. The impact of including foregone investment
income would be to substantially reduce the favorable net impact of reinsurance
reflected above. We estimate that the impact of foregone investment income
would be to reduce the net impact of reinsurance presented in the table above
by 80% to 120%. The Life Marketing
segments reinsurance programs do not materially impact the other income line
of our income statement.
As shown above, reinsurance had a favorable impact on the Life
Marketing segments operating income for the periods presented above. The
impact of reinsurance is largely due to our quota share coinsurance program in
place prior to mid-2005. Under that program, 90% of the segments traditional
new business was ceded to reinsurers. Since mid-2005, a much smaller percentage
of overall term business was ceded due to our change in reinsurance strategy on
traditional business discussed previously. As a result of that change, the
relative impact of reinsurance on the Life Marketing segments overall results
is expected to decrease over time. While the significance of reinsurance is
expected to decline over time, the overall impact of reinsurance for a given
year may fluctuate due to variations in mortality and unlocking of balances
under SFAS No. 97.
44
Table of Contents
Premiums and policy fees ceded had been rising over a number of years
with increases in our in-force blocks of traditional and universal life
business. Beginning in mid-2005, we changed our reinsurance approach in our
traditional life product lines. Instead of generally ceding 90% of new business
issued before that date, we began purchasing yearly renewable term on risks in
excess of $1 million (now increased to $2 million). This had the effect of
reducing reinsurance on new policies issued. The increase in ceded premiums
above for the three and nine months ending September 30, 2008 compared to
the same periods in 2007, was caused primarily by growth in ceded universal
life premiums and policy fees of $9.1 million and $29.5 million, respectively.
Ceded benefits were lower for the three months ending September 30,
2008 compared to the three months ending September 30, 2007, primarily due
to lower ceded claims. Ceded benefits and settlement expenses increased for the
first nine months of 2008 compared to the first nine months of 2007 primarily due
to higher death benefits ceded. Traditional ceded benefits decreased $108.9
million for the three months ending September 30, 2008 compared to the
three months ending September 30, 2007 and $79.7 million for the nine
months ending September 30, 2008 compared to the nine months ending September 30,
2007 primarily due to lower death benefits. Universal life ceded benefits
increased $48.5 million for the three months ending September 30, 2008
compared to the three months ending September 30, 2007 and $85.1 million
for the nine months ending September 30, 2008 compared to the nine months
ending September 30, 2007 due to higher ceded claims, higher change in
ceded reserves associated with growth in the business throughout the year and
unlocking in the third quarter of 2008. Ceded universal life claims were $16.7
million higher for the nine months ending September 30, 2008 compared to
the nine months ending September 30, 2007. Ceded benefits and settlement
expenses will fluctuate over time, largely as a function of the segments
overall variations in death benefits incurred.
Ceded amortization of deferred policy acquisitions costs decreased for
the three months and nine months ending September 30, 2008 compared to
2007. In the first nine months of the year, ceded amortization decreased
primarily due to the impact of higher ceded universal life claims on
amortization in the first six months of 2008. For the three months ending September 30,
2008, traditional ceded amortization decreased as a result of system refinements
which were largely offset by direct amortization. This was partially offset by
increased ceded amortization in universal life as a result of unlocking.
Ceded other operating expenses are based on allowances received from
reinsurers. Total allowances received in the first nine months of 2008
increased slightly from 2007 as increases associated with growth in the
universal life line more than offset decreases associated with the change in
our term life reinsurance strategy. Term allowances have decreased since
mid-2005 as new YRT reinsurance replaces the 90% coinsured business. For the
three months ending September 30, 2008 allowances received decreased
relative to the same period in 2007.
45
Table of Contents
Acquisitions
Segment results of operations
Segment results were as follows:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
188,377
|
|
$
|
198,381
|
|
(5.0
|
)%
|
$
|
573,385
|
|
$
|
607,327
|
|
(5.6
|
)%
|
Reinsurance ceded
|
|
(120,785
|
)
|
(122,347
|
)
|
(1.3
|
)
|
(361,627
|
)
|
(377,959
|
)
|
(4.3
|
)
|
Net premiums and policy fees
|
|
67,592
|
|
76,034
|
|
(11.1
|
)
|
211,758
|
|
229,368
|
|
(7.7
|
)
|
Net investment income
|
|
132,177
|
|
143,342
|
|
(7.8
|
)
|
402,872
|
|
437,591
|
|
(7.9
|
)
|
Other income
|
|
1,605
|
|
2,405
|
|
(33.3
|
)
|
4,873
|
|
7,178
|
|
(32.1
|
)
|
Total operating revenues
|
|
201,374
|
|
221,781
|
|
(9.2
|
)
|
619,503
|
|
674,137
|
|
(8.1
|
)
|
Realized gains (losses) - investments
|
|
(146,976
|
)
|
38,431
|
|
|
|
(233,617
|
)
|
(22,852
|
)
|
|
|
Realized gains (losses) - derivatives
|
|
106,974
|
|
(38,782
|
)
|
|
|
182,063
|
|
29,297
|
|
|
|
Total revenues
|
|
161,372
|
|
221,430
|
|
|
|
567,949
|
|
680,582
|
|
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
145,153
|
|
162,460
|
|
(10.7
|
)
|
442,374
|
|
482,648
|
|
(8.3
|
)
|
Amortization of deferred policy acquisition
costs and value of business acquired
|
|
17,181
|
|
18,174
|
|
(5.5
|
)
|
56,195
|
|
57,322
|
|
(2.0
|
)
|
Other operating expenses
|
|
6,019
|
|
10,772
|
|
(44.1
|
)
|
19,823
|
|
40,729
|
|
(51.3
|
)
|
Operating benefits and expenses
|
|
168,353
|
|
191,406
|
|
(12.0
|
)
|
518,392
|
|
580,699
|
|
(10.7
|
)
|
Amortization of DAC / VOBA related to realized
gains (losses) - investments
|
|
(1,776
|
)
|
261
|
|
|
|
(1,217
|
)
|
1,644
|
|
|
|
Total benefits and expenses
|
|
166,577
|
|
191,667
|
|
(13.1
|
)
|
517,175
|
|
582,343
|
|
(11.2
|
)
|
INCOME (LOSS) BEFORE INCOME TAX
|
|
(5,205
|
)
|
29,763
|
|
n/m
|
|
50,774
|
|
98,239
|
|
(48.3
|
)
|
Less: realized gains (losses)
|
|
(40,002
|
)
|
(351
|
)
|
|
|
(51,554
|
)
|
6,445
|
|
|
|
Less: related amortization of DAC
|
|
1,776
|
|
(261
|
)
|
|
|
1,217
|
|
(1,644
|
)
|
|
|
OPERATING INCOME
|
|
$
|
33,021
|
|
$
|
30,375
|
|
8.7
|
|
$
|
101,111
|
|
$
|
93,438
|
|
8.2
|
|
46
Table of Contents
The following table summarizes key data for the Acquisitions segment:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Average
Life Insurance In-Force
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Traditional
|
|
$
|
209,689,391
|
|
$
|
222,737,352
|
|
(5.9
|
)%
|
$
|
212,738,876
|
|
$
|
226,590,005
|
|
(6.1
|
)%
|
Universal life
|
|
29,917,476
|
|
31,727,526
|
|
(5.7
|
)
|
30,370,782
|
|
32,026,221
|
|
(5.2
|
)
|
|
|
$
|
239,606,867
|
|
$
|
254,464,878
|
|
(5.8
|
)
|
$
|
243,109,658
|
|
$
|
258,616,226
|
|
(6.0
|
)
|
Average
Account Values
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Universal life
|
|
$
|
2,933,971
|
|
$
|
3,019,429
|
|
(2.8
|
)
|
$
|
2,956,324
|
|
$
|
3,042,683
|
|
(2.8
|
)
|
Fixed annuity
(2)
|
|
4,350,521
|
|
4,853,211
|
|
(10.4
|
)
|
4,518,949
|
|
5,016,594
|
|
(9.9
|
)
|
Variable annuity
|
|
169,418
|
|
205,556
|
|
(17.6
|
)
|
181,767
|
|
173,704
|
|
4.6
|
|
|
|
$
|
7,453,910
|
|
$
|
8,078,196
|
|
(7.7
|
)
|
$
|
7,657,040
|
|
$
|
8,232,981
|
|
(7.0
|
)
|
Interest
Spread - UL & Fixed Annuities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment
income yield
(4)
|
|
6.05
|
%
|
6.23
|
%
|
|
|
6.04
|
%
|
6.25
|
%
|
|
|
Interest credited
to policyholders
|
|
4.10
|
|
4.11
|
|
|
|
4.11
|
|
4.10
|
|
|
|
Interest spread
|
|
1.95
|
%
|
2.12
|
%
|
|
|
1.93
|
%
|
2.15
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortality
Experience
(3)
|
|
$
|
1,938
|
|
$
|
1,608
|
|
|
|
$
|
3,184
|
|
$
|
1,654
|
|
|
|
(1)
|
Amounts are not adjusted for reinsurance ceded.
|
(2)
|
Includes general account balances held within variable annuity
products and is net of coinsurance ceded.
|
(3)
|
Represents the estimated pretax earnings impact resulting from
mortality variance to pricing.Excludes results related to the Chase Insurance
Group which was acquired in the third quarter of 2006.
|
(4)
|
Includes available-for-sale and trading portfolios.
Available-for-sale portfolio yields were 6.37% and 6.33%, respectively, for
the three and ninemonths ended September 30, 2008 compared to 6.27% and
6.24%, respectively, for the same periods ended September 30, 2007.
|
Three Months Ended September 30, 2008
compared to Three Months Ended September 30, 2007
Segment operating income
Operating income increased $2.6 million, or 8.7%, for the three months
ended September 30, 2008 compared to the three months ended September 30,
2007, primarily due to lower operating expenses on the Chase Insurance Group
block and improved mortality results, partially offset by expected runoff of
the block of business.
Revenues
Net premiums and policy fees decreased $8.4 million, or 11.1%, for
the three months ended September 30, 2008 compared to the three months ended
September 30, 2007, primarily due to the runoff of the acquired
blocks. Investment income decreased
$11.2 million, or 7.8%, for the three months ended September 30, 2008
compared to the three months ended September 30, 2007, primarily due to a
decline in annuity account values in the Chase Insurance Group block, resulting
in a reduction of invested assets and lower investment income.
Benefits and expenses
Total benefits and expenses decreased $25.1 million, or 13.1%, for the
three months ended September 30, 2008 compared to the three months ended September 30,
2007. The decrease related primarily to
the runoff of the acquired blocks, fluctuations in mortality, and lower
operating expenses.
47
Table of Contents
Nine Months Ended September 30, 2008 compared to Nine Months Ended
September 30, 2007
Segment
operating income
Operating
income increased $7.7 million, or 8.2%, for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007, primarily due
to lower operating expenses on the Chase Insurance Group block and improved
mortality results, partially offset by expected runoff of the block of business.
Revenues
Net premiums and policy fees decreased $17.6 million, or 7.7%, for
the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007, primarily due to expected runoff. Investment income decreased $34.7 million,
or 7.9%, for the nine months ended September 30, 2008 compared to the nine
months ended September 30, 2007, primarily due to the runoff of the
remaining acquired blocks, particularly a decline in annuity account values in
the Chase Insurance block.
Benefits and expenses
Total benefits and expenses decreased $65.2 million, or 11.2%, for the
nine months ended September 30, 2008 compared to the nine months ended September 30,
2007. The decrease related primarily to
the runoff of the business, fluctuations in mortality, and lower operating
expenses.
Reinsurance
The Acquisitions segment currently reinsures
portions of both its life and annuity in-force.
The impact of reinsurance on the segments income statement is reflected
in the chart shown below. A more
detailed discussion of the components of reinsurance can be found in the
Reinsurance section of Note 1,
Basis of Presentation and
Summary of Significant Accounting Policies.
Impact of reinsurance
Reinsurance
impacted the Acquisitions segment line items as shown in the following table:
Acquisitions Segment
Line Item Impact of Reinsurance
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
Reinsurance ceded
|
|
$
|
(120,785
|
)
|
$
|
(122,347
|
)
|
$
|
(361,627
|
)
|
$
|
(377,959
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
Benefit and settlement expenses
|
|
(101,965
|
)
|
(76,788
|
)
|
(306,478
|
)
|
(316,915
|
)
|
Amortization of deferred policy acquisition
costs
|
|
(2,081
|
)
|
(10,010
|
)
|
(17,995
|
)
|
(13,448
|
)
|
Other operating expenses
|
|
(18,199
|
)
|
(32,496
|
)
|
(53,064
|
)
|
(84,061
|
)
|
Total benefits and expenses
|
|
(122,245
|
)
|
(119,294
|
)
|
(377,537
|
)
|
(414,424
|
)
|
|
|
|
|
|
|
|
|
|
|
NET IMPACT OF REINSURANCE
|
|
$
|
1,460
|
|
$
|
(3,053
|
)
|
$
|
15,910
|
|
$
|
36,465
|
|
The segments reinsurance programs do not materially impact the other
income line of the income statement. In addition, net investment income
generally has no direct impact on reinsurance cost. However, it should be noted
that by ceding business to the assuming companies, we forgo investment income
on the reserves ceded to the assuming companies. Conversely, the assuming
companies will receive investment income on the reserves assumed which will
increase the assuming companies profitability on business assumed from the
Company. For business ceded under modified coinsurance arrangements, the amount
of investment income attributable to the assuming company is included as part
of the overall change in policy reserves and, as such, is reflected in benefit
48
Table of Contents
and settlement expenses. The net investment income impact to the
Company and the assuming companies has not been quantified as it is not fully
reflected in our consolidated financial statements.
The net impact of reinsurance increased $4.5 million, or 147.8%, and
decreased $20.6 million, or 56.4%, for the three and nine months ended September 30,
2008, respectively, compared to the same periods in 2007, as a result of
fluctuations in ceded claim volume, amortization of deferred acquisition costs
related to the claim fluctuations, and expenses ceded to reinsurers involved
with the Chase Insurance Group acquisition.
49
Table of Contents
Annuities
Segment results of operations
Segment results were as follows:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
7,885
|
|
$
|
8,481
|
|
(7.0
|
)%
|
$
|
24,525
|
|
$
|
25,376
|
|
(3.4
|
)%
|
Reinsurance ceded
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums and policy fees
|
|
7,885
|
|
8,481
|
|
(7.0
|
)
|
24,525
|
|
25,376
|
|
(3.4
|
)
|
Net investment income
|
|
89,742
|
|
69,313
|
|
29.5
|
|
252,035
|
|
195,064
|
|
29.2
|
|
Realized gains (losses) - derivatives
|
|
(10,385
|
)
|
193
|
|
|
|
(18,475
|
)
|
1,798
|
|
|
|
Other income
|
|
3,366
|
|
2,769
|
|
21.6
|
|
9,624
|
|
8,279
|
|
16.2
|
|
Total operating revenues
|
|
90,608
|
|
80,756
|
|
12.2
|
|
267,709
|
|
230,517
|
|
16.1
|
|
Realized gains (losses) - investments
|
|
(14,419
|
)
|
(266
|
)
|
|
|
(13,304
|
)
|
1,451
|
|
|
|
Total revenues
|
|
76,189
|
|
80,490
|
|
(5.3
|
)
|
254,405
|
|
231,968
|
|
9.7
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
81,441
|
|
62,731
|
|
29.8
|
|
220,699
|
|
174,781
|
|
26.3
|
|
Amortization of deferred policy acquisition
costs and value of business acquired
|
|
1,961
|
|
5,239
|
|
(62.6
|
)
|
15,081
|
|
19,633
|
|
(23.2
|
)
|
Other operating expenses
|
|
6,650
|
|
6,350
|
|
4.7
|
|
19,397
|
|
17,392
|
|
11.5
|
|
Operating benefits and expenses
|
|
90,052
|
|
74,320
|
|
21.2
|
|
255,177
|
|
211,806
|
|
20.5
|
|
Amortization of DAC / VOBA related to realized
gains (losses) - investments
|
|
1,073
|
|
(217
|
)
|
|
|
1,093
|
|
426
|
|
|
|
Total benefits and expenses
|
|
91,125
|
|
74,103
|
|
|
|
256,270
|
|
212,232
|
|
|
|
INCOME (LOSS) BEFORE INCOME TAX
|
|
(14,936
|
)
|
6,387
|
|
n/m
|
|
(1,865
|
)
|
19,736
|
|
n/m
|
|
Less: realized gains (losses)
|
|
(14,419
|
)
|
(266
|
)
|
|
|
(13,304
|
)
|
1,451
|
|
|
|
Less: related amortization of DAC
|
|
(1,073
|
)
|
217
|
|
|
|
(1,093
|
)
|
(426
|
)
|
|
|
OPERATING INCOME
|
|
$
|
556
|
|
$
|
6,436
|
|
(91.4
|
)
|
$
|
12,532
|
|
$
|
18,711
|
|
(33.0
|
)
|
50
Table of Contents
The following table summarizes key data for the Annuities segment:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed annuity
|
|
$
|
339,785
|
|
$
|
363,694
|
|
(6.6
|
)%
|
$
|
1,295,821
|
|
$
|
905,439
|
|
43.1
|
%
|
Variable annuity
|
|
132,374
|
|
147,275
|
|
(10.1
|
)
|
340,614
|
|
349,520
|
|
(2.5
|
)
|
|
|
$
|
472,159
|
|
$
|
510,969
|
|
(7.6
|
)
|
$
|
1,636,435
|
|
$
|
1,254,959
|
|
30.4
|
|
Average Account Values
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed annuity
(1)
|
|
$
|
5,796,717
|
|
$
|
4,566,357
|
|
26.9
|
|
$
|
5,448,717
|
|
$
|
4,283,865
|
|
27.2
|
|
Variable annuity
|
|
2,419,949
|
|
2,674,634
|
|
(9.5
|
)
|
2,523,281
|
|
2,653,235
|
|
(4.9
|
)
|
|
|
$
|
8,216,666
|
|
$
|
7,240,991
|
|
13.5
|
|
$
|
7,971,998
|
|
$
|
6,937,100
|
|
14.9
|
|
Interest Spread - Fixed Annuities
(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income yield
|
|
6.12
|
%
|
6.01
|
%
|
|
|
6.11
|
%
|
5.99
|
%
|
|
|
Interest credited to policyholders
|
|
4.89
|
|
5.39
|
|
|
|
4.96
|
|
5.38
|
|
|
|
Interest spread
|
|
1.23
|
%
|
0.62
|
%
|
|
|
1.15
|
%
|
0.61
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
GMDB - Net amount at risk
(3)
|
|
$
|
438,694
|
|
$
|
82,865
|
|
n/m
|
%
|
GMDB - Reserves
|
|
|
|
2,176
|
|
n/m
|
|
Account value subject to GMWB rider
|
|
286,589
|
|
77,882
|
|
n/m
|
|
S&P 500® Index
|
|
1,165
|
|
1,527
|
|
(23.7
|
)
|
|
|
|
|
|
|
|
|
|
|
(1)
Includes general account balances held within
variable annuity products.
(2)
Interest spread on average general account
values.
(3)
Guaranteed death benefits in excess of contract
holder account balance.
Three Months Ended September 30, 2008
compared to Three Months Ended September 30, 2007
Segment operating income
Operating income decreased $5.9 million, or 91.4%, for the three months
ended September 30, 2008 compared to the three months ended September 30,
2007, which included $4.8 million of negative fair value changes including $0.2
million on the equity indexed annuity product and $4.6 million on embedded
derivatives associated with the variable annuity GMWB rider related to current
market conditions. In addition,
unfavorable mortality in the segments SPIA block reduced earnings by $3.9
million. These decreases were partially offset by the continued growth of the
SPDA line which accounted for a $3.2 million increase in earnings.
Operating revenues
Segment operating revenues increased $9.9 million, or 12.2%, for
the three months ended September 30, 2008 compared to the three months
ended September 30, 2007, primarily due to an increase in net investment
income. Average account balances grew
13.5% in the three months ended September 30, 2008, resulting in higher
investment income. The additional income
resulting from the larger account balances was partially reduced in the three
months ended September 30, 2008 by losses on derivatives. The segment continually monitors and adjusts
credited rates as appropriate in an effort to maintain and/or improve its
interest spread.
Benefits and expenses
Operating benefits and expenses increased $15.7 million, or 21.2%, for
the three months ended September 30, 2008 compared to the three months
ended September 30, 2007. This
increase was primarily the result of higher credited interest and unfavorable
SPIA mortality fluctuations. Mortality
was unfavorable by $6.5 million in the three months ended September 30,
2008 compared to unfavorable mortality of $2.6 million in the three months
ended September 30, 2007, an unfavorable change of $3.9 million. The unfavorable mortality variances primarily
relate to sales of large SPIA cases.
These amounts were partially offset by a favorable change of $2.7
million in
51
Table of Contents
unlocking of the unearned premium reserve for the three months ended September 30,
2008. Unfavorable unearned premium
reserve unlocking of $0.2 million was recorded by the segment during the three
months ended September 30, 2007.
Amortization of DAC
The decrease
in DAC amortization (not related to realized capital gains and losses) for the
three months ended September 30, 2008 compared to the three months ended September 30,
2007 was primarily due to fair value losses on the variable annuity line. This
was offset by higher DAC amortization in other annuity lines of business. We
periodically review and update as appropriate our key assumptions including
future mortality, expenses, lapses, premium persistency, investment yields and
interest spreads. Changes to these assumptions
result in adjustments which increase or decrease DAC amortization. The periodic review and updating of
assumptions is referred to as unlocking.
DAC amortization for the Annuities segment increased by
$1.1 million primarily due to favorable DAC unlocking of $6.9 million in
the market value adjusted (MVA) annuity line and $0.8 million of favorable
unlocking in the SPDA line, which were partially offset by unfavorable
unlocking of $8.8 million in the variable annuity line. Favorable DAC unlocking
of $0.9 million was recorded by the segment during the three months ended September 30,
2007.
Sales
Total sales decreased $38.8 million, or 7.6%, for the three months
ended September 30, 2008 compared to the three months ended September 30,
2007. Sales of fixed annuities decreased
$23.9 million, or 6.6%, for the three months ended September 30, 2008
compared to the three months ended September 30, 2007. The decrease in fixed annuity sales was
driven by reduced sales in the SPDA and immediate annuity lines and was
partially offset by increased sales in the MVA annuity products. The decrease
in SPIA and SPDA sales reflects our interest rate positioning in the third
quarter of 2008 versus strong competitor pricing in the bank and agent channel.
MVA sales continued to be strong in the first part of the three months ended September 30,
2008 due to the higher interest rate environment. The continuation of new
annuity sales through the Chase distribution system contributed
$58.3 million in fixed annuity sales in the three months ended September 30,
2008 compared to $130.3 million for the three months ended September 30,
2007. Sales of variable annuities
decreased $14.9 million, or 10.1% for the three months ended September 30,
2008 compared to the three months ended September 30, 2007 primarily due
to weaker demand caused by current unfavorable equity markets.
Nine Months Ended September 30, 2008
compared to Nine Months Ended September 30, 2007
Segment operating income
Operating income declined $6.2 million, or 33.0%, for the nine months
ended September 30, 2008 compared to the nine months ended September 30,
2007, which included $8.8 million of negative fair value changes of $2.4
million on the equity indexed annuity product and $6.4 million on embedded
derivatives associated with the variable annuity GMWB rider related to current
market conditions. Included in the
mark-to-market adjustment is a SFAS No. 157 transition adjustment loss for
the embedded derivative related to the variable annuity GMWB rider of $0.4
million before income taxes. In addition, unfavorable mortality in the segments
SPIA block reduced earnings by $10.1 million. These items were partially offset
by the continued growth of the SPDA line which accounted for a $6.1 million
increase in operating income.
Operating revenues
Segment operating revenues increased $37.2 million, or 16.1%, for
the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007, primarily due to an increase in net investment
income. Average account balances grew
14.9% for the nine months ended September 30, 2008, resulting in higher
investment income. The additional income
resulting from the larger account balances was partially reduced in the first
nine months of 2008 by losses on derivatives related to the GMWB rider caused
by current unfavorable market conditions.
52
Table of Contents
Benefits
and expenses
Operating
benefits and expenses increased $43.4 million, or 20.5%, for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007. This increase was primarily the
result of higher credited interest and unfavorable mortality fluctuations. Mortality was unfavorable by
$17.7 million for the nine months ended September 30, 2008 compared
to unfavorable mortality of $7.6 million for the nine months ended September 30,
2007, an unfavorable change of $10.1 million. The unfavorable mortality variances primarily
relate to the sales of large SPIA cases previously mentioned. These amounts are partially offset by a favorable
change of $2.7 million in unlocking of the unearned premium reserve for the
nine months ended September 30, 2008.
Unfavorable unearned premium reserve unlocking of $0.2 million was
recorded by the segment during the nine months ended September 30, 2007.
Amortization
of DAC
The decrease
in DAC amortization (not related to realized capital gains and losses) for the
nine months ended September 30, 2008 compared to the nine months ended September 30,
2007 was primarily due to fair value losses on the variable annuity line. This
was offset by higher DAC amortization in other annuity lines of business. For
the nine months ended September 30, 2008, DAC amortization for the
Annuities segment was reduced by $0.2 million primarily due to unfavorable DAC
unlocking of $8.8 million in the variable annuity line, which was partially
offset by favorable DAC unlocking of $7.7 million in the MVA annuity line
and $0.9 million of favorable unlocking in the SPDA line. Favorable DAC unlocking of $2.5 million was
recorded by the segment during the nine months ended September 30, 2007.
Sales
Total sales increased $381.5 million, or 30.4%, for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007. Sales of fixed annuities increased
$390.4 million, or 43.1%, for the nine months ended September 30, 2008
compared to the nine months ended September 30, 2007. The increase in fixed annuity sales was
primarily due to strong sales in the SPIA, SPDA, and MVA annuity products, as
well as our continued efforts to increase wholesale distribution. The increase
in sales for MVA and SPDA was due to an environment of higher interest rates
versus 2007 and a more volatile equity market for most of 2008. The increase in
SPIA was due to institutional sales in early 2008 which did not occur in 2007.
The continuation of new annuity sales through the Chase distribution system
contributed $325.7 million in fixed annuity sales for the nine months
ended September 30, 2008 compared to $314.5 million for nine months ended September 30,
2007. Sales of variable annuities
decreased $8.9 million, or 2.5% for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007 primarily due to
weaker demand caused by current unfavorable equity markets.
53
Table of Contents
Stable Value Products
Segment results of operations
Segment results were as follows:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
88,254
|
|
$
|
73,501
|
|
20.1
|
%
|
$
|
244,362
|
|
$
|
224,080
|
|
9.1
|
%
|
Other income
|
|
3,000
|
|
|
|
|
|
3,000
|
|
|
|
|
|
Realized gains (losses)
|
|
4,984
|
|
(333
|
)
|
|
|
12,240
|
|
509
|
|
|
|
Total revenues
|
|
96,238
|
|
73,168
|
|
31.5
|
|
259,602
|
|
224,589
|
|
15.6
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
60,128
|
|
58,340
|
|
3.1
|
|
177,542
|
|
180,156
|
|
(1.5
|
)
|
Amortization of deferred policy acquisition
costs
|
|
1,211
|
|
985
|
|
22.9
|
|
3,373
|
|
3,140
|
|
7.4
|
|
Other operating expenses
|
|
1,731
|
|
1,069
|
|
61.9
|
|
4,502
|
|
3,136
|
|
43.6
|
|
Total benefits and expenses
|
|
63,070
|
|
60,394
|
|
4.4
|
|
185,417
|
|
186,432
|
|
(0.5
|
)
|
INCOME BEFORE INCOME TAX
|
|
33,168
|
|
12,774
|
|
n/m
|
|
74,185
|
|
38,157
|
|
94.4
|
|
Less: realized gains (losses)
|
|
4,984
|
|
(333
|
)
|
|
|
12,240
|
|
509
|
|
|
|
OPERATING INCOME
|
|
$
|
28,184
|
|
$
|
13,107
|
|
n/m
|
|
$
|
61,945
|
|
$
|
37,648
|
|
64.5
|
|
The following table summarizes key data for the Stable Value Products
segment:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GIC
|
|
$
|
22,600
|
|
$
|
54,500
|
|
(58.5
|
)%
|
$
|
107,945
|
|
$
|
132,000
|
|
(18.2
|
)%
|
GFA - Direct Institutional
|
|
636,651
|
|
|
|
n/m
|
|
1,061,651
|
|
|
|
n/m
|
|
GFA - Registered Notes - Institutional
|
|
|
|
475,000
|
|
n/m
|
|
450,000
|
|
525,000
|
|
(14.3
|
)
|
GFA - Registered Notes - Retail
|
|
25,719
|
|
42,735
|
|
(39.8
|
)
|
290,848
|
|
65,870
|
|
n/m
|
|
|
|
$
|
684,970
|
|
$
|
572,235
|
|
19.7
|
|
$
|
1,910,444
|
|
$
|
722,870
|
|
n/m
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Account Values
|
|
$
|
5,824,533
|
|
$
|
4,826,108
|
|
|
|
$
|
5,369,926
|
|
$
|
5,021,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Spread
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income yield
|
|
5.96
|
%
|
6.10
|
%
|
|
|
6.00
|
%
|
6.01
|
%
|
|
|
Interest credited
|
|
4.06
|
|
4.84
|
|
|
|
4.36
|
|
4.83
|
|
|
|
Operating expenses
|
|
0.20
|
|
0.17
|
|
|
|
0.19
|
|
0.17
|
|
|
|
Operating spread
|
|
1.70
|
%
|
1.09
|
%
|
|
|
1.45
|
%
|
1.01
|
%
|
|
|
54
Table of Contents
Three Months Ended September 30, 2008
compared to Three Months Ended September 30, 2007
Segment operating income
Operating income increased $15.1 million for the three months
ended September 30, 2008 compared to the three months ended September 30,
2007. The increase in operating earnings
resulted from the combination of higher average balances, slightly higher asset
yields, and lower liability costs. In addition, $3.0 million in other income
was generated from the early retirement of a funding agreement backing a medium
term note. Lower liability costs
resulted from the increased sales of attractively priced institutional funding
agreements. As a result, the operating
spread increased 61 basis points to 170 basis points during the three
months ended September 30, 2008, compared to an operating spread of 109
basis points during the three months ended September 30, 2007.
Sales
Total sales increased $112.7 million for the three months
ended September 30, 2008 compared to the three months ended September 30,
2007. The increase was primarily due to
increased sales in the institutional market.
Nine Months Ended September 30, 2008
compared to Nine Months Ended September 30, 2007
Segment operating income
Operating income increased
$24.3 million, or 64.5%, for the nine months ended September 30, 2008
compared to the nine months ended September 30, 2007. The increase in operating earnings resulted
from the combination of higher average balances, slightly higher asset yields,
and lower liability costs. In addition,
$3.0 million in other income was generated from the voluntary early retirement
of a funding agreement backing a medium term note. Lower liability costs
resulted from the increased sales of attractively priced institutional funding
agreements. As a result, the operating
spread increased 44 basis points to 145 basis points during the nine
months ended September 30, 2008, compared to an operating spread of 101
basis points during the nine months ended September 30, 2007.
Sales
Total sales increased $1.2 billion, for
the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007. The increase
was primarily due to increased sales in the institutional market.
55
Table of Contents
Asset Protection
Segment results of operations
Segment results were as follows:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
88,763
|
|
$
|
101,189
|
|
(12.3
|
)%
|
$
|
275,208
|
|
$
|
298,594
|
|
(7.8
|
)%
|
Reinsurance ceded
|
|
(40,249
|
)
|
(43,244
|
)
|
(6.9
|
)
|
(130,646
|
)
|
(134,071
|
)
|
(2.6
|
)
|
Net premiums and policy fees
|
|
48,514
|
|
57,945
|
|
(16.3
|
)
|
144,562
|
|
164,523
|
|
(12.1
|
)
|
Net investment income
|
|
9,595
|
|
10,188
|
|
(5.8
|
)
|
29,308
|
|
28,867
|
|
1.5
|
|
Other income
|
|
16,445
|
|
19,330
|
|
(14.9
|
)
|
48,960
|
|
56,314
|
|
(13.1
|
)
|
Total operating revenues
|
|
74,554
|
|
87,463
|
|
(14.8
|
)
|
222,830
|
|
249,704
|
|
(10.8
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
28,021
|
|
30,779
|
|
(9.0
|
)
|
80,449
|
|
82,707
|
|
(2.7
|
)
|
Amortization of deferred policy acquisition
costs
|
|
14,154
|
|
21,291
|
|
(33.5
|
)
|
43,827
|
|
63,458
|
|
(30.9
|
)
|
Other operating expenses
|
|
24,193
|
|
25,488
|
|
(5.1
|
)
|
73,852
|
|
72,028
|
|
2.5
|
|
Total benefits and expenses
|
|
66,368
|
|
77,558
|
|
(14.4
|
)
|
198,128
|
|
218,193
|
|
(9.2
|
)
|
INCOME BEFORE INCOME TAX
|
|
8,186
|
|
9,905
|
|
(17.4
|
)
|
24,702
|
|
31,511
|
|
(21.6
|
)
|
OPERATING INCOME
|
|
$
|
8,186
|
|
$
|
9,905
|
|
(17.4
|
)
|
$
|
24,702
|
|
$
|
31,511
|
|
(21.6
|
)
|
The following table summarizes key data for
the Asset Protection segment:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit insurance
|
|
$
|
15,628
|
|
$
|
27,686
|
|
(43.6
|
)%
|
$
|
56,799
|
|
$
|
87,347
|
|
(35.0
|
)%
|
Service contracts
|
|
72,483
|
|
96,189
|
|
(24.6
|
)
|
226,345
|
|
261,584
|
|
(13.5
|
)
|
Other products
|
|
16,126
|
|
20,763
|
|
(22.3
|
)
|
51,443
|
|
78,995
|
|
(34.9
|
)
|
|
|
$
|
104,237
|
|
$
|
144,638
|
|
(27.9
|
)
|
$
|
334,587
|
|
$
|
427,926
|
|
(21.8
|
)
|
Loss Ratios
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit insurance
|
|
32.6
|
%
|
24.5
|
%
|
|
|
35.1
|
%
|
29.9
|
%
|
|
|
Service contracts
|
|
75.6
|
|
71.6
|
|
|
|
70.5
|
|
67.9
|
|
|
|
Other products
|
|
35.4
|
|
37.1
|
|
|
|
35.9
|
|
33.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Incurred
claims as a percentage of earned premiums
56
Table of Contents
Three Months Ended September 30, 2008
compared to Three Months Ended September 30, 2007
Segment operating income
Operating income was $8.2 million, representing a decrease of $1.7
million, or 17.4%, for the three months ended September 30, 2008 compared
to the three months ended September 30, 2007. The decrease was primarily the result of a
$2.1 million decrease in service contract income due to lower auto and marine
volume and higher loss ratios in certain product lines. Offsetting this loss was $1.1 million of
higher earnings in the GAP line and an increase in credit insurance earnings of
$0.3 million for the three months ended September 30, 2008 compared to the
three months ended September 30, 2007.
Net premiums and policy fees
Net premiums and policy fees decreased $9.4 million, or 16.3%, for the
three months ended September 30, 2008 compared to the three months ended September 30,
2007. Credit insurance premiums decreased $6.7 million, or 46.0%, due to the
sale of a small insurance subsidiary and its related operations during the
first quarter of 2008 and lower auto sales. Net premiums in the service
contract line decreased $4.6 million, or 14.4%, for the three months ended September 30,
2008 compared to the three months ended September 30, 2007. Within the
other product lines, net premiums increased $1.8 million, or 15.7%, for the
three months ended September 30, 2008 compared to the prior year, due to
an increase in the GAP product line related to growth in in-force during the
past few years, partially offset by declines in the IPP line.
Other income
Other income decreased $2.9 million, or 14.9%, for the three months
ended September 30, 2008 compared to the three months ended September 30,
2007, primarily due to a decline in service contract volume.
Benefits
and settlement expenses
Benefits and settlement expenses decreased $2.8 million, or 9.0%, for
the three months ended September 30, 2008 compared to the three months
ended September 30, 2007. Credit insurance claims for the three months
ended September 30, 2008 compared to the prior year decreased $1.0
million, or 28.1% and service contract claims decreased $2.2 million, or 9.5%,
with both decreases resulting from weaker sales volume. Other products claims
increased $0.4 million, or 10.5%, primarily due to higher claims in the GAP and
IPP lines.
Amortization of DAC and Other Operating
Expenses
Amortization of DAC was $7.1 million, or 33.5%, lower for the three
months ended September 30, 2008 compared to the three months ended September 30,
2007, mainly due to lower premium in the credit insurance lines. Also contributing
to the decrease was a $2.7 million decrease resulting from the sale of a small
insurance subsidiary and its related operations during the first quarter of
2008. Other operating expenses decreased $1.3 million, or 5.1%, for the three
months ended September 30, 2008, due to the sale of a small insurance
subsidiary during the first quarter of 2008.
Sales
Total segment sales decreased $40.4 million, or 27.9%, for the three
months ended September 30, 2008 compared to the three months ended September 30,
2007. The decreases in credit insurance
and service contract sales were primarily due to declines in auto and marine
sales. The decline in the other products line is primarily the result of lower
GAP sales, which was primarily due to price increases, tighter underwriting
controls, and lower auto sales.
57
Table of Contents
Nine Months Ended September 30, 2008
compared to Nine Months Ended September 30, 2007
Segment operating income
Operating income was $24.7 million, representing a decrease of
$6.8 million, or 21.6%, for the nine months ended September 30, 2008
compared to the nine months ended September 30, 2007. The decrease was primarily the result of a
$5.0 million, or 17.3%, decrease in service contract income due to lower auto
and marine volume and higher loss ratios in certain product lines. Earnings
from other products declined $2.3 million, or 70.5%, due primarily to lower
volume in the IPP line, somewhat offset by higher GAP earnings due to improved
underwriting results in 2008. Credit
insurance earnings increased $0.9 million, or 95.0%, for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007. The increase in credit insurance earnings
resulted primarily from a $1.1 million decrease in legal expense for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007.
Net premiums and policy fees
Net premiums and policy fees decreased $20.0 million, or 12.1%, for the
nine months ended September 30, 2008 compared to the nine months ended September 30,
2007. Credit insurance earned premiums decreased $22.3 million, or 49.5%,
mainly due to the sale of a small insurance subsidiary during the first quarter
of 2008 and lower auto sales. Net premiums in the service contract line
decreased $2.3 million, or 2.7% resulting from weaker auto and marine sales,
for the nine months ended September 30, 2008 compared to the nine months
ended September 30, 2007. Within the other product lines, net premiums
increased $4.7 million, or 13.7%, for the nine months ended September 30,
2008 compared to the prior year, due to an increase in the GAP product line
related to growth in in-force during the past few years, partially offset by
declines in the IPP line.
Other income
Other income
decreased $7.4 million, or 13.1%, for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007, primarily due
to a decline in service contract volume.
Benefits
and settlement expenses
Benefits and settlement expenses decreased $2.3 million, or 2.7%, for
the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007. The credit insurance and related claims for the nine
months ended September 30, 2008 compared to the prior year decreased $5.5
million, or 40.6%, as a result of lower volume and a $2.3 million decrease
related to the sale of a small insurance subsidiary and its related operations.
Service contract claims increased $0.6 million, or 1.1%, due to higher loss
ratios in some product lines. Other products claims increased $2.6 million, or
22.7%, primarily attributable to higher GAP claims.
Amortization of DAC and Other Operating
Expenses
Amortization of DAC decreased $19.6 million, or 30.9%, for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007, primarily due to lower premiums in the credit insurance products and an
$8.2 million decrease resulting from the sale of a small insurance subsidiary
and its related operations during the first quarter of 2008. Other operating
expenses increased $1.8 million, or 2.5%, for the nine months ended September 30,
2008, primarily due to higher legal expenses related to the runoff lines and
GAP lines compared to the nine months ended September 30, 2007.
Sales
Total segment sales decreased $93.3 million, or 21.8%, for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007. The decreases in credit insurance
and service contract sales are primarily due to declines in auto and marine
sales. The decline in the other products line was primarily the result of lower
GAP sales, which was primarily due to price increases, tighter underwriting
controls, and lower auto sales.
58
Table of Contents
Reinsurance
The majority of the Asset Protection segments reinsurance activity
relates to the cession of single premium credit life and credit accident and
health insurance, credit property, vehicle service contracts and guaranteed
asset protection insurance to producer affiliated reinsurance companies (PARCs).
These arrangements are coinsurance contracts ceding the business on a first
dollar quota share basis at levels ranging from 50% to 100% to limit our
exposure and allow the PARCs to share in the underwriting income of the
product. Reinsurance contracts do not relieve us from our obligations to our
policyholders. Failure of reinsurers to honor their obligations could result in
losses to the Company or our affiliates. A more detailed discussion of the
components of reinsurance can be found in the Reinsurance section of Note 1,
Basis of Presentation and Summary of Significant Accounting Policies.
Reinsurance impacted the Asset Protection segment line items as shown
in the following table:
Asset Protection Segment
Line Item Impact of Reinsurance
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
Reinsurance ceded
|
|
$
|
(40,249
|
)
|
$
|
(43,244
|
)
|
$
|
(130,646
|
)
|
$
|
(134,071
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
Benefit and settlement expenses
|
|
(22,257
|
)
|
(18,913
|
)
|
(65,582
|
)
|
(64,640
|
)
|
Amortization of deferred policy acquisition
costs
|
|
(5,967
|
)
|
(1,655
|
)
|
(22,212
|
)
|
(5,255
|
)
|
Other operating expenses
|
|
(345
|
)
|
(5,881
|
)
|
(3,673
|
)
|
(21,650
|
)
|
Total benefits and expenses
|
|
(28,569
|
)
|
(26,449
|
)
|
(91,467
|
)
|
(91,545
|
)
|
|
|
|
|
|
|
|
|
|
|
NET IMPACT OF REINSURANCE
|
|
$
|
(11,680
|
)
|
$
|
(16,795
|
)
|
$
|
(39,179
|
)
|
$
|
(42,526
|
)
|
Reinsurance premiums ceded decreased $3.0 million, or 6.9%, and $3.4
million, or 2.6%, for the three and nine months ended September 30, 2008,
respectively, compared to the three and nine months ended September 30,
2007. The current quarter and year-to-date decreases were primarily due to the
discontinuation of the marketing of credit insurance products through financial
institutions in 2005 in which a majority of this business was ceded to PARCs
and a decrease in dealer credit ceded premiums due to a decline in auto
sales. This was partially offset by an
increase in ceded premiums in the service contract line. Ceded unearned premium reserves and claim
reserves with PARCs are generally secured by trust accounts, letters of credit
or on a funds withheld basis.
Benefits and settlement expenses ceded increased $3.3 million, or
17.6%, and $0.9 million, or 1.5%, for the three and nine months ended September 30,
2008, respectively, compared to the same periods in 2007. The current quarter increases were mainly due
to increases in losses ceded related to the Lenders Indemnity program in
runoff and in the service contract line, partially offset by decreases in the
credit line. The year-to-date increases were mainly due to increases in the
service contract line mostly offset by decreases in the credit line.
Amortization of DAC ceded increased $4.3 million and $17.0 million, for
the three and nine months ended September 30, 2008, respectively, compared
to the three and nine months ended September 30, 2007, mainly as the
result of increases in the credit insurance line. Other operating expenses ceded decreased $5.5
million, or 94.1%, and $18.0 million, or 83.0%, for the three and nine months
ended September 30, 2008, respectively compared to the three and nine
months ended September 30, 2007. The fluctuation is partly attributable to
the decline in credit insurance products sold through financial institutions
and an overall decline in credit insurance sales.
Net investment income has no direct impact on reinsurance cost.
However, it should be noted that by ceding business to the assuming companies,
we forgo investment income on the reserves ceded to the assuming companies.
Conversely, the assuming companies will receive investment income on the
reserves assumed which will increase the assuming companies profitability on
business assumed from the Company. The net investment income impact to the
Company and the assuming companies has not been quantified as it is not
reflected in our consolidated financial statements.
59
Table of Contents
Corporate and Other
Segment results of operations
Segment results were as follows:
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
6,765
|
|
$
|
7,999
|
|
(15.4
|
)%
|
$
|
23,359
|
|
$
|
25,626
|
|
(8.8
|
)%
|
Reinsurance ceded
|
|
(1
|
)
|
(2
|
)
|
(50.0
|
)
|
(4
|
)
|
(10
|
)
|
(60.0
|
)
|
Net premiums and policy fees
|
|
6,764
|
|
7,997
|
|
(15.4
|
)
|
23,355
|
|
25,616
|
|
(8.8
|
)
|
Net investment income
|
|
14,929
|
|
53,011
|
|
(71.8
|
)
|
81,581
|
|
126,477
|
|
(35.5
|
)
|
Realized gains (losses) - investments
|
|
|
|
|
|
|
|
|
|
6,857
|
|
|
|
Realized gains (losses) - derivatives
|
|
1,915
|
|
132
|
|
|
|
4,185
|
|
626
|
|
|
|
Other income
|
|
20
|
|
(144
|
)
|
n/m
|
|
416
|
|
1,476
|
|
(71.8
|
)
|
Total operating revenues
|
|
23,628
|
|
60,996
|
|
(61.3
|
)
|
109,537
|
|
161,052
|
|
(32.0
|
)
|
Realized gains (losses) - investments
|
|
(197,887
|
)
|
5,134
|
|
|
|
(259,499
|
)
|
7,852
|
|
|
|
Realized gains (losses) - derivatives
|
|
(3,317
|
)
|
1,138
|
|
|
|
(9,730
|
)
|
784
|
|
|
|
Total revenues
|
|
(177,576
|
)
|
67,268
|
|
n/m
|
|
(159,692
|
)
|
169,688
|
|
n/m
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
8,895
|
|
8,585
|
|
3.6
|
|
27,955
|
|
27,861
|
|
0.3
|
|
Amortization of deferred policy acquisition
costs
|
|
518
|
|
323
|
|
60.4
|
|
1,633
|
|
587
|
|
n/m
|
|
Other operating expenses
|
|
46,388
|
|
49,746
|
|
(6.8
|
)
|
144,188
|
|
129,785
|
|
11.1
|
|
Total benefits and expenses
|
|
55,801
|
|
58,654
|
|
(4.9
|
)
|
173,776
|
|
158,233
|
|
9.8
|
|
INCOME (LOSS) BEFORE INCOME TAX
|
|
(233,377
|
)
|
8,614
|
|
n/m
|
|
(333,468
|
)
|
11,455
|
|
n/m
|
|
Less: realized gains (losses) - investments
|
|
(197,887
|
)
|
5,134
|
|
|
|
(259,499
|
)
|
7,852
|
|
|
|
Less: realized gains (losses) - derivatives
|
|
(3,317
|
)
|
1,138
|
|
|
|
(9,730
|
)
|
784
|
|
|
|
OPERATING INCOME (LOSS)
|
|
$
|
(32,173
|
)
|
$
|
2,342
|
|
n/m
|
|
$
|
(64,239
|
)
|
$
|
2,819
|
|
n/m
|
|
Three Months Ended September 30, 2008
compared to Three Months Ended September 30, 2007
Segment operating income (loss)
The Corporate and Other segment operating income decreased
$34.5 million for the three months ended September 30, 2008, compared
to the three months ended September 30, 2007, primarily due to negative
mark-to-market adjustments of $23.5 million on a $387.5 million portfolio of
securities designated for trading. This trading portfolio negatively impacted
the three months ended September 30, 2008 by approximately $20.0 million,
an $18.2 million less favorable impact than for the three months ended September 30,
2007. In addition, the segment
experienced $10.7 million of lower participating mortgage income due to the current
economic environment.
Operating revenues
Operating revenues for the Corporate and Other segment are primarily
comprised of net investment income on capital and net premiums and policy fees
related to several non-strategic lines of business. Net investment income for this segment
decreased $38.1 million for the three months ended September 30, 2008
compared to the three months ended September 30, 2007, and net premiums
and policy fees declined $1.2 million, or 15.4%. The decrease in net investment income was
primarily the result of mark-to-market changes on the trading portfolio and a
decline in participating mortgage income in the securities and mortgage
investment portfolios caused by unfavorable market conditions.
60
Table of Contents
Benefits
and expenses
Benefits and expenses decreased $2.9 million, or 4.9%, for the
three months ended September 30, 2008 compared to the three months ended September 30,
2007. The decrease was primarily due to
a decrease in interest expense of $2.9 million, or 7.9%, for the three
months ended September 30, 2008 compared to the three months ended September 30,
2007. Of this decrease in interest
expense, approximately $2.6 million relates to non-recourse funding obligations
and was primarily due to a decline in 1-month LIBOR rates.
Nine Months Ended September 30, 2008
compared to Nine Months Ended September 30, 2007
Segment operating income (loss)
The Corporate and Other segment operating income declined
$67.1 million for the nine months ended September 30, 2008, compared
to the nine months ended September 30, 2007, primarily due to negative
mark-to-market adjustments of $34.0 million on a $387.5 million portfolio of
securities designated for trading, representing a $32.2 million less favorable
impact than for the first nine months of 2007.
In addition, the segment experienced lower participating mortgage income
of $21.0 million and lower prepayment fee income of $6.5 million in the
securities and mortgage investment portfolios.
Operating revenues
Net investment income for this segment decreased $44.9 million for
the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007, and net premiums and policy fees declined
$2.3 million, or 8.8%. The decrease
in net investment income was primarily the result of mark-to-market changes on
the trading portfolio, a decline in participating mortgage income and prepayment
fee income in the securities and mortgage investment portfolios, partially
offset by an increase in yields on unallocated capital and additional
investments related to issuances of non-recourse funding obligations.
Benefits
and expenses
Benefits and expenses increased $15.5 million, or 9.8%, for the
nine months ended September 30, 2008 compared to the nine months ended September 30,
2007. The increase was primarily due to
an increase in interest expense of $14.8 million, or 16.8%, for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007. Of this increase in interest
expense, approximately $13.9 million relates to additional issuances of
non-recourse funding obligations.
61
Table of Contents
CONSOLIDATED INVESTMENTS
Portfolio Description
As of September 30, 2008, our investment portfolio equaled
approximately $28.2 billion. The types
of assets in which we may invest are influenced by various state laws which
prescribe qualified investment assets.
Within the parameters of these laws, we invest in assets giving
consideration to such factors as liquidity needs, investment quality,
investment return, matching of assets and liabilities, and the overall
composition of the investment portfolio by asset type and credit exposure.
The following table shows the reported values of our invested assets:
|
|
September 30, 2008
|
|
December 31, 2007
|
|
|
|
(Dollars In Thousands)
|
|
Publicly-issued bonds (amortized cost: 2008
- $19,382,391; 2007 - $19,608,446)
|
|
$
|
17,977,425
|
|
63.7
|
%
|
$
|
19,588,486
|
|
67.5
|
%
|
Privately issued bonds (amortized cost:
2008 - $4,432,806; 2007 - $3,840,252)
|
|
4,107,445
|
|
14.6
|
|
3,800,505
|
|
13.1
|
|
Redeemable preferred stock (amortized cost:
2008 - $86; 2007 - $86)
|
|
39
|
|
0.0
|
|
78
|
|
0.0
|
|
Fixed maturities
|
|
22,084,909
|
|
78.3
|
|
23,389,069
|
|
80.6
|
|
Equity securities (cost: 2008 - $378,407;
2007 - $112,406)
|
|
312,389
|
|
1.1
|
|
117,037
|
|
0.4
|
|
Mortgage loans
|
|
3,653,919
|
|
13.0
|
|
3,284,326
|
|
11.3
|
|
Investment real estate
|
|
7,793
|
|
0.0
|
|
8,026
|
|
0.0
|
|
Policy loans
|
|
811,846
|
|
2.9
|
|
818,280
|
|
2.8
|
|
Other long-term investments
|
|
329,259
|
|
1.2
|
|
185,892
|
|
0.6
|
|
Short-term investments
|
|
987,604
|
|
3.5
|
|
1,236,443
|
|
4.3
|
|
Total investments
|
|
$
|
28,187,719
|
|
100.0
|
%
|
$
|
29,039,073
|
|
100.0
|
%
|
Included in the preceding table are $3.4 billion and $4.0 billion
of fixed maturities and $149.1 million and $67.0 million of short-term
investments classified as trading securities as of September 30, 2008 and December 31,
2007, respectively. The trading portfolio includes invested assets of $3.0
billion and $3.6 billion as of September 30, 2008 and December 31,
2007, respectively, held pursuant to Modco arrangements under which the
economic risks and benefits of the investments are passed to third-party
reinsurers.
Fixed Maturity Investments
As of September 30, 2008, our fixed
maturity investment holdings were approximately $22.1 billion. The approximate
percentage distribution of our fixed maturity investments by quality rating as
of September 30, 2008, is as follows:
|
|
Percentage of
|
|
|
|
Fixed Maturity
|
|
Rating
|
|
Investments
|
|
AAA
|
|
38.6
|
%
|
AA
|
|
7.1
|
|
A
|
|
18.8
|
|
BBB
|
|
30.3
|
|
Below investment grade
|
|
5.2
|
|
|
|
100.0
|
%
|
Our portfolio consists primarily of fixed maturity securities (bonds
and redeemable preferred stocks) and commercial mortgage loans. Within our fixed maturity securities, we
maintain portfolios classified as available-for-sale and trading. We generally purchase our investments with
the intent to hold to maturity by purchasing investments that match future cash
flow needs. However, we may sell any of
our investments to maintain proper matching of assets and liabilities. Accordingly, we classified $18.7 billion or
84.5% of our fixed maturities as available-for-sale as of September 30,
2008. These securities are carried at
fair value on our Consolidated Balance Sheets.
Changes in fair value, net of related DAC and VOBA, are charged or
credited directly to shareowners equity.
Changes in fair value that are other-than-temporary are recorded as
realized losses in the Consolidated Statements of Income. For more information regarding our evaluation
of other-than-temporary losses, refer to Critical Accounting Policies
.
62
Table of Contents
Our trading portfolio accounts for $3.4 billion or 15.5% of our
fixed maturities as of September 30, 2008. Of this balance, fixed
maturities with a market value of $3.0 billion and short-term investments with
a market value of $149.1 million were added as part of the Chase Insurance
Group acquisition. Investment results
for the Chase Insurance Group portfolios, including gains and losses from
sales, are passed to the reinsurers through the contractual terms of the
reinsurance arrangements. Trading
securities are carried at fair value and changes in fair value are recorded in
net income (loss) as they occur.
Offsetting these amounts are corresponding changes in the fair value of
the embedded derivative liability associated with the underlying reinsurance
arrangement.
$3.0 billion of our trading portfolio is held pursuant to Modco
arrangements under which the economic risks and benefits of the investments are
passed to third-party reinsurers. The total Modco trading portfolio fixed
maturities by rating is as follows:
|
|
September 30, 2008
|
|
December 31, 2007
|
|
|
|
(Dollars In Thousands)
|
|
AAA
|
|
$
|
1,330,512
|
|
$
|
1,631,208
|
|
AA
|
|
200,152
|
|
344,930
|
|
A
|
|
654,928
|
|
800,531
|
|
BBB
|
|
792,468
|
|
789,000
|
|
Below investment grade
|
|
53,183
|
|
38,966
|
|
Total Modco trading fixed maturities
|
|
$
|
3,031,243
|
|
$
|
3,604,635
|
|
A portion of our bond portfolio is invested in residential
mortgage-backed securities, commercial mortgage-backed securities, and
asset-backed securities. These holdings
as of September 30, 2008 were approximately $8.1 billion. Mortgage-backed securities are constructed
from pools of mortgages and may have cash flow volatility as a result of
changes in the rate at which prepayments of principal occur with respect to the
underlying loans. Prepayments of
principal on the underlying loans can be expected to accelerate with decreases
in market interest rates and diminish with increases in interest rates. In addition, we have entered into derivative
contracts at times to partially offset the volatility in the market value of
these securities.
63
Table of Contents
Residential mortgage-backed securities -
The
tables below show a breakdown of our residential mortgage-backed securities
portfolio by type and rating as of September 30, 2008. As of September 30, 2008, these holdings
were approximately $5.7 billion. Planned amortization class securities (PACs)
pay down according to a schedule.
Sequentials receive payments in order until each class is paid off. Pass through securities receive principal as
principal of the underlying mortgages is received.
|
|
Percentage of
|
|
|
|
Residential
|
|
|
|
Mortgage-Backed
|
|
Type
|
|
Securities
|
|
Sequential
|
|
68.4
|
%
|
PAC
|
|
15.6
|
|
Pass Through
|
|
4.9
|
|
Other
|
|
11.1
|
|
|
|
100.0
|
%
|
|
|
Percentage of
|
|
|
|
Residential
|
|
|
|
Mortgage-Backed
|
|
Rating
|
|
Securities
|
|
AAA
|
|
97.7
|
%
|
AA
|
|
0.5
|
|
A
|
|
0.0
|
|
BBB
|
|
0.7
|
|
Below investment grade
|
|
1.1
|
|
|
|
100.0
|
%
|
As of September 30, 2008, we held $655.8 million, or 2.3% of
invested assets, of securities supported by collateral classified as
Alt-A. As of June 30, 2008, March 31,
2008, and December 31, 2007, we held securities with a market value of
$754.7 million, $663.9 million, and $274.5 million, respectively, of securities
supported by collateral classified as Alt-A.
The following table shows the percentage of our collateral classified
as Alt-A grouped by rating category as of September 30, 2008:
|
|
Percentage of
|
|
|
|
Alt-A
|
|
Rating
|
|
Securities
|
|
AAA
|
|
79.7
|
%
|
AA
|
|
3.5
|
|
A
|
|
6.5
|
|
BBB
|
|
6.2
|
|
Below investment grade
|
|
4.1
|
|
|
|
100.0
|
%
|
64
Table of Contents
The following tables categorize the estimated fair value and unrealized
gain/ (loss) of our mortgage-backed securities collateralized by Alt-A mortgage
loans by rating as of September 30, 2008:
Alt-A Collateralized Holdings
Estimated Fair Value of Security by Year of Origination
|
|
2004 and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2005
|
|
2006
|
|
2007
|
|
2008
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
7.9
|
|
$
|
88.3
|
|
$
|
227.3
|
|
$
|
199.2
|
|
$
|
|
|
$
|
522.7
|
|
AA
|
|
|
|
|
|
|
|
23.1
|
|
|
|
23.1
|
|
Subtotal
|
|
$
|
7.9
|
|
$
|
88.3
|
|
$
|
227.3
|
|
$
|
222.3
|
|
$
|
|
|
$
|
545.8
|
|
A
|
|
|
|
|
|
42.8
|
|
|
|
|
|
42.8
|
|
BBB
|
|
|
|
2.9
|
|
37.8
|
|
|
|
|
|
40.7
|
|
Below investment grade
|
|
|
|
|
|
19.5
|
|
7.0
|
|
|
|
26.5
|
|
Total mortgage-backed securities collateralized
by Alt-A mortgage loans
|
|
$
|
7.9
|
|
$
|
91.2
|
|
$
|
327.4
|
|
$
|
229.3
|
|
$
|
|
|
$
|
655.8
|
|
Estimated Unrealized Gain (Loss) on Security by Year of
Origination
|
|
2004 and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2005
|
|
2006
|
|
2007
|
|
2008
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
(1.2
|
)
|
$
|
(5.3
|
)
|
$
|
(10.7
|
)
|
$
|
(15.5
|
)
|
$
|
|
|
$
|
(32.7
|
)
|
AA
|
|
|
|
|
|
|
|
(1.1
|
)
|
|
|
(1.1
|
)
|
Subtotal
|
|
$
|
(1.2
|
)
|
$
|
(5.3
|
)
|
$
|
(10.7
|
)
|
$
|
(16.6
|
)
|
$
|
|
|
$
|
(33.8
|
)
|
A
|
|
|
|
|
|
(4.6
|
)
|
|
|
|
|
(4.6
|
)
|
BBB
|
|
|
|
(4.9
|
)
|
(18.4
|
)
|
|
|
|
|
(23.3
|
)
|
Below investment grade
|
|
|
|
|
|
(4.8
|
)
|
(59.3
|
)
|
|
|
(64.1
|
)
|
Total mortgage-backed securities collateralized
by Alt-A mortgage loans
|
|
$
|
(1.2
|
)
|
$
|
(10.2
|
)
|
$
|
(38.5
|
)
|
$
|
(75.9
|
)
|
$
|
|
|
$
|
(125.8
|
)
|
65
Table of Contents
As of September 30, 2008,
we had residential mortgage-backed securities with a total market value of
$57.4 million, or 0.2% of total invested assets, that were supported by
collateral classified as sub-prime. $29.0 million, or 50.5%, of these
securities were rated AAA. As of June 30,
2008, March 31, 2008, and December 31, 2007, we held securities with
a market value of $72.8 million, $78.8 million, and $89.9 million,
respectively, of securities supported by collateral classified as sub-prime.
The following tables categorize
the estimated fair value and unrealized gain/ (loss) of our mortgage-backed
securities collateralized by sub-prime mortgage loans by rating as of September 30,
2008:
Sub-prime Collateralized Holdings
Estimated Fair Value of Security by Year of Origination
|
|
2004 and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2005
|
|
2006
|
|
2007
|
|
2008
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
1.9
|
|
$
|
3.7
|
|
$
|
17.2
|
|
$
|
6.1
|
|
|
|
$
|
28.9
|
|
AA
|
|
0.8
|
|
|
|
11.4
|
|
5.9
|
|
|
|
18.1
|
|
Subtotal
|
|
$
|
2.7
|
|
$
|
3.7
|
|
$
|
28.6
|
|
$
|
12.0
|
|
$
|
|
|
$
|
47.0
|
|
A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BBB
|
|
1.0
|
|
|
|
|
|
8.1
|
|
|
|
9.1
|
|
Below investment grade
|
|
0.7
|
|
|
|
|
|
0.6
|
|
|
|
1.3
|
|
Total mortgage-backed securities
collateralized by sub-prime mortgage
loans
|
|
$
|
4.4
|
|
$
|
3.7
|
|
$
|
28.6
|
|
$
|
20.7
|
|
$
|
|
|
$
|
57.4
|
|
Estimated Unrealized Gain (Loss) by Year of Security
Origination
|
|
2004 and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2005
|
|
2006
|
|
2007
|
|
2008
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
(0.5
|
)
|
$
|
(0.3
|
)
|
$
|
(2.7
|
)
|
$
|
(4.0
|
)
|
|
|
$
|
(7.5
|
)
|
AA
|
|
(0.1
|
)
|
|
|
(2.6
|
)
|
(5.1
|
)
|
|
|
(7.8
|
)
|
Subtotal
|
|
$
|
(0.6
|
)
|
$
|
(0.3
|
)
|
$
|
(5.3
|
)
|
$
|
(9.1
|
)
|
$
|
|
|
$
|
(15.3
|
)
|
A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BBB
|
|
(0.9
|
)
|
|
|
|
|
(5.1
|
)
|
|
|
(6.0
|
)
|
Below investment grade
|
|
(0.3
|
)
|
|
|
|
|
(4.5
|
)
|
|
|
(4.8
|
)
|
Total mortgage-backed securities
collateralized by sub-prime mortgage
loans
|
|
$
|
(1.8
|
)
|
$
|
(0.3
|
)
|
$
|
(5.3
|
)
|
$
|
(18.7
|
)
|
$
|
|
|
$
|
(26.1
|
)
|
The tables
above referencing our holdings collateralized by Alt-A and sub-prime mortgage
loans exclude approximately $2.5 million of securities collateralized by Alt-A
mortgage loans which are part of a modified coinsurance trading portfolio. The
reinsurer bears the ultimate investment risk related to these securities.
Commercial mortgage-backed securities
-
Our commercial mortgage-backed security (CMBS) portfolio consists of
commercial mortgage-backed securities issued in securitization
transactions. Portions of the CMBS are
sponsored by the Company, in which we securitized portions of our mortgage loan
portfolio. As of September 30, 2008, the CMBS holdings were approximately
$1.2 billion. Of this amount, $910.6
million related to retained beneficial interests of commercial mortgage loan
securitizations the Company completed. The following table shows the
percentages of our CMBS holdings grouped by rating category as of September 30,
2008:
|
|
Percentage of
|
|
|
|
Commercial
|
|
|
|
Mortgage-Backed
|
|
Rating
|
|
Securities
|
|
AAA
|
|
79.4
|
%
|
AA
|
|
7.4
|
|
A
|
|
5.1
|
|
BBB
|
|
2.0
|
|
Below investment grade
|
|
6.1
|
|
|
|
100.0
|
%
|
66
Table of Contents
Asset-backed securities -
Asset-backed
securities (ABS) pay down based on cash flow received from the underlying
pool of assets, such as receivables on auto loans, student loans, credit cards,
etc. As of September 30, 2008, these holdings were approximately $1.2
billion. The following table shows the
percentages of our ABS holdings grouped by rating category as of September 30,
2008:
|
|
Percentage of
|
|
|
|
Asset-Backed
|
|
Rating
|
|
Securities
|
|
AAA
|
|
89.2
|
%
|
AA
|
|
7.2
|
|
A
|
|
2.4
|
|
BBB
|
|
1.2
|
|
|
|
100.0
|
%
|
We obtained ratings of our fixed maturities from Moodys Investors
Service, Inc. (Moodys), Standard & Poors
Corporation (S&P) and Fitch Ratings (Fitch). If a bond is not rated by Moodys, S&P,
or Fitch, we use ratings from the Securities Valuation Office of the National
Association of Insurance Commissioners (NAIC), or we rate the bond based
upon a comparison of the unrated issue to rated issues of the same issuer or
rated issues of other issuers with similar risk characteristics. As of September 30, 2008, over 99.0% of
our bonds were rated by Moodys, S&P, Fitch, and/or the NAIC.
The industry segment composition of our fixed maturity securities is
presented in the following table:
|
|
As of
|
|
% Market
|
|
As of
|
|
% Market
|
|
|
|
September 30, 2008
|
|
Value
|
|
December 31, 2007
|
|
Value
|
|
|
|
(Dollars In Thousands)
|
|
Non-Agency Mortgages
|
|
$
|
5,041,908
|
|
22.8
|
%
|
$
|
5,543,339
|
|
23.7
|
%
|
Banking
|
|
2,332,859
|
|
10.6
|
|
2,123,100
|
|
9.1
|
|
Other Finance
|
|
2,448,696
|
|
11.1
|
|
2,114,596
|
|
9.0
|
|
Electric
|
|
2,171,743
|
|
9.8
|
|
1,971,961
|
|
8.4
|
|
Agency Mortgages
|
|
1,107,448
|
|
5.0
|
|
2,441,993
|
|
10.4
|
|
Natural Gas
|
|
1,440,457
|
|
6.5
|
|
1,185,115
|
|
5.1
|
|
Insurance
|
|
1,040,707
|
|
4.7
|
|
992,470
|
|
4.2
|
|
Energy
|
|
1,094,641
|
|
5.0
|
|
907,093
|
|
3.9
|
|
Communications
|
|
923,334
|
|
4.2
|
|
973,607
|
|
4.2
|
|
Basic Industrial
|
|
770,983
|
|
3.5
|
|
692,937
|
|
3.0
|
|
Consumer Noncyclical
|
|
723,540
|
|
3.3
|
|
668,293
|
|
2.9
|
|
Consumer Cyclical
|
|
573,083
|
|
2.6
|
|
625,923
|
|
2.7
|
|
Finance Companies
|
|
479,496
|
|
2.2
|
|
616,278
|
|
2.6
|
|
Capital Goods
|
|
448,447
|
|
2.0
|
|
437,013
|
|
1.9
|
|
Transportation
|
|
441,477
|
|
2.0
|
|
446,264
|
|
1.9
|
|
U.S. Govt Agencies
|
|
235,940
|
|
1.1
|
|
190,430
|
|
0.7
|
|
Other Industrial
|
|
202,701
|
|
0.9
|
|
157,582
|
|
0.7
|
|
U.S. Government
|
|
182,141
|
|
0.8
|
|
165,527
|
|
0.7
|
|
Brokerage
|
|
140,861
|
|
0.6
|
|
768,656
|
|
3.3
|
|
Technology
|
|
128,038
|
|
0.6
|
|
152,491
|
|
0.7
|
|
Real Estate
|
|
42,854
|
|
0.2
|
|
55,371
|
|
0.2
|
|
Canadian Governments
|
|
47,707
|
|
0.2
|
|
108,006
|
|
0.5
|
|
Other Utility
|
|
21,413
|
|
0.1
|
|
19,796
|
|
0.1
|
|
Other Government Agencies
|
|
20,009
|
|
0.1
|
|
|
|
0.0
|
|
Municipal Agencies
|
|
18,512
|
|
0.1
|
|
25,427
|
|
0.1
|
|
Foreign Governments
|
|
5,914
|
|
0.0
|
|
5,801
|
|
0.0
|
|
Total
|
|
$
|
22,084,909
|
|
100.0
|
%
|
$
|
23,389,069
|
|
100.0
|
%
|
67
Table of Contents
Our investments in debt and equity securities are reported at market
value, and investments in mortgage loans are reported at amortized cost. As of September 30, 2008, our fixed
maturity investments (bonds and redeemable preferred stocks) had a market value
of $22.1 billion, which was 7.1% below amortized cost of $23.8 billion. We had $3.7 billion in mortgage loans as
of September 30, 2008. While
our mortgage loans do not have quoted market values, as of September 30, 2008,
we estimated the market value of our mortgage loans to be $3.9 billion
(using discounted cash flows from the next call date), which was 5.4% greater
than the amortized cost. Most of our
mortgage loans have significant prepayment fees. These assets are invested for terms approximately
corresponding to anticipated future benefit payments. Thus, market fluctuations are not expected to
adversely affect liquidity.
Market values for private, non-traded securities are determined as
follows: 1) we obtain estimates from independent pricing services and
2) we estimate market value based upon a comparison to quoted issues of
the same issuer or issues of other issuers with similar terms and risk
characteristics. We analyze the
independent pricing services valuation methodologies and related inputs,
including an assessment of the observability of market inputs. For retained
beneficial interests in Company sponsored commercial mortgage loan
securitizations as of September 30, 2008, we used an internally developed
model that includes discount rates based on our current mortgage loan lending
rate and expected cash flows based on a review of the commercial mortgage loans
underlying the securities. Upon
obtaining this information related to market value, management makes a
determination as to the appropriate valuation amount.
Mortgage
Loans
We invest a portion of our investment portfolio in commercial mortgage
loans. As of September 30, 2008,
our mortgage loan holdings were approximately $3.7 billion. We generally do not
lend on speculative properties and have specialized in making loans on either
credit-oriented commercial properties or credit-anchored strip shopping centers
and apartments. Our underwriting
procedures relative to our commercial loan portfolio are based on a
conservative, disciplined approach. We
concentrate our underwriting expertise on a small number of commercial real
estate asset types associated with the necessities of life (retail,
multi-family, professional office buildings, and warehouses). We believe these
asset types tend to weather economic downturns better than other commercial
asset classes in which we have chosen not to participate. We believe this
disciplined approach has helped to maintain a relatively low delinquency and
foreclosure rate throughout our history.
We record mortgage loans net of an allowance for credit losses. This allowance is calculated through analysis
of specific loans that have indicators of potential impairment based on current
information and events. As of September 30,
2008 and December 31, 2007, our allowance for mortgage loan credit losses
was $1.4 million and $0.5 million, respectively.
Our mortgage lending criteria generally require that the loan-to-value
ratio on each mortgage be at or less than 75% at the time of origination. Projected rental payments from credit anchors
(i.e., excluding rental payments from smaller local tenants) generally
exceed 70% of the propertys projected operating expenses and debt
service. We also offer a commercial loan
product under which we will permit a loan-to-value ratio of up to 85% in
exchange for a participating interest in the cash flows from the underlying
real estate. Approximately
$693.8 million of our mortgage loans have this participation feature.
Many of our mortgage loans have call or interest rate reset provisions
between 3 and 10 years.
However, if interest rates were to significantly increase, we may be
unable to call the loans or increase the interest rates on our existing
mortgage loans commensurate with the significantly increased market rates.
As of September 30, 2008, delinquent mortgage loans and foreclosed
properties were less than 0.1% of invested assets. We do not expect these investments to
adversely affect our liquidity or ability to maintain proper matching of assets
and liabilities. As of September 30,
2008, $15.2 million, or 0.4%, of the mortgage loan portfolio was
nonperforming. It is our policy to cease
to carry accrued interest on loans that are over 90 days delinquent. For loans less than 90 days delinquent,
interest is accrued unless it is determined that the accrued interest is not
collectible. If a loan becomes over
90 days delinquent, it is our general policy to initiate foreclosure
proceedings unless a workout arrangement to bring the loan current is in place.
Between 1996 and 1999, we securitized $1.4 billion of our mortgage
loans. We sold the senior tranches while retaining the subordinate
tranches. We continue to service the
securitized mortgage loans. During 2007,
we
68
Table of Contents
securitized an
additional $1.0 billion of our mortgage loans.
We sold the highest rated tranche for approximately $218.3 million,
while retaining the remaining tranches.
We continue to service the securitized mortgage loans. As of September 30, 2008, we had
investments related to retained beneficial interests of mortgage loan
securitizations of $910.6 million.
Securities
Lending
We participate in securities lending, primarily as an investment yield
enhancement, whereby securities that are held as investments are loaned to
third parties for short periods of time.
We require initial collateral of 102% of the market value of the loaned
securities to be separately maintained.
The loaned securities market value is monitored on a daily basis. As of September 30, 2008, securities
with a market value of $115.4 million were loaned under these agreements. As collateral for the loaned securities, we
receive short-term investments, which are recorded in short-term investments
with a corresponding liability recorded in other liabilities to account for
our obligation to return the collateral.
As of September 30, 2008, the fair market value of the collateral
related to this program was $107.0 million and we have an obligation to return
$121.4 million of collateral to the securities borrower.
Risk Management and Impairment Review
We monitor the overall credit quality of our
portfolio within established guidelines.
The following table shows our available-for-sale fixed maturities by
credit rating as of September 30, 2008:
|
|
|
|
Percent of
|
|
S&P or Equivalent Designation
|
|
Market Value
|
|
Market Value
|
|
|
|
(Dollars In Thousands)
|
|
|
|
AAA
|
|
$
|
6,990,857
|
|
37.5
|
%
|
AA
|
|
1,351,547
|
|
7.3
|
|
A
|
|
3,430,589
|
|
18.4
|
|
BBB
|
|
5,766,276
|
|
30.8
|
|
Investment grade
|
|
17,539,269
|
|
94.0
|
|
BB
|
|
739,709
|
|
4.0
|
|
B
|
|
225,312
|
|
1.2
|
|
CCC or lower
|
|
161,100
|
|
0.8
|
|
In or near default
|
|
715
|
|
0.0
|
|
Below investment grade
|
|
1,126,836
|
|
6.0
|
|
Redeemable preferred stock
|
|
39
|
|
0.0
|
|
Total
|
|
$
|
18,666,144
|
|
100.0
|
%
|
Not included in the table above are $3.4 billion of investment grade
and $49.4 million of below investment grade fixed maturities classified as
trading securities.
Limiting bond exposure to any creditor group
is another way we manage credit risk.
The following table includes securities held in our Modco portfolio and
summarizes our ten largest fixed maturity exposures to an individual creditor
group as of September 30, 2008:
Creditor
|
|
Market Value
|
|
|
|
(Dollars In Millions)
|
|
Toyota Motor Credit
|
|
$
|
135.2
|
|
AT&T
|
|
129.8
|
|
Citigroup
|
|
128.8
|
|
Wells Fargo & Company
|
|
127.7
|
|
Metlife Inc.
|
|
123.8
|
|
Prudential Financial
|
|
121.4
|
|
JP Morgan Chase & Co.
|
|
118.9
|
|
Dominion Resources
|
|
116.5
|
|
Bank of America Corp
|
|
114.3
|
|
General Electric
|
|
112.6
|
|
|
|
|
|
|
69
Table of Contents
Determining whether a decline in the current fair value of invested
assets is an other-than-temporary decline in value can involve a variety of
assumptions and estimates, particularly for investments that are not actively
traded in established markets. We review
our positions on a monthly basis for possible credit concerns and review our current
exposure, credit enhancement, and delinquency experience. Management considers a number of factors when
determining the impairment status of individual securities. These include the economic condition of
various industry segments and geographic locations and other areas of
identified risks. Although it is
possible for the impairment of one investment to affect other investments, we
engage in ongoing risk management to safeguard against and limit any further
risk to our investment portfolio.
Special attention is given to correlative risks within specific
industries, related parties, and business markets.
For certain securitized financial assets with
contractual cash flows including ABS, EITF Issue No. 99-20 requires us to
periodically update our best estimate of cash flows over the life of the
security. If the fair value of a
securitized financial asset is less than its cost or amortized cost and there
has been a decrease in the present value of the estimated cash flows since the
last revised estimate, considering both timing and amount, an
other-than-temporary impairment charge is recognized. Estimating future cash flows is a
quantitative and qualitative process that incorporates information received
from third party sources along with certain internal assumptions and judgments
regarding the future performance of the underlying collateral. Projections of expected future cash flows may
change based upon new information regarding the performance of the underlying
collateral. In addition, we consider our
intent and ability to retain a temporarily depressed security until recovery.
On October 10, 2008, the FASB issued FSP FAS 157-3,
Determining the Fair Value of a Financial Asset When the Market for
That Asset is Not Active
, (FSP 157-3), to clarify the application
of SFAS No. 157 in a market that is not active and provides an example to
illustrate key considerations in determining the fair value of a financial
asset when the market for that financial asset is not active. It also reaffirms
the notion of fair value as an exit price as of the measurement date. FSP 157-3
was effective upon issuance, including prior periods for which the financial
statements have not been issued. Based on the guidance in FSP 157-3, we
utilized internal models to determine the fair value of retained beneficial interests
of Company sponsored commercial mortgage loan securitizations for which there
was no active market as of September 30, 2008.
Securities not subject to EITF Issue No. 99-20 that are in an
unrealized loss position, are reviewed at least quarterly to determine if an
other-than-temporary impairment is present based on certain quantitative and
qualitative factors. We consider a
number of factors in determining whether the impairment is
other-than-temporary. These include, but
are not limited to: 1) actions taken by rating agencies, 2) default
by the issuer, 3) the significance of the decline, 4) the intent and
ability to hold the investment until recovery, 5) the time period during
which the decline has occurred, 6) an economic analysis of the issuers
industry, and 7) the financial strength, liquidity, and recoverability of
the issuer. Management performs a
security-by-security review each quarter in evaluating the need for any
other-than-temporary impairments.
Although no set formula is used in this process, the investment
performance, collateral position, and continued viability of the issuer are
significant measures considered. Based
on our analysis, during the three months ended September 30, 2008, we
concluded that approximately $202.6 million of pretax unrealized losses were
other-than-temporarily impaired resulting in a charge to net realized
investment losses.
There are certain risks and uncertainties associated with determining
whether declines in market values are other-than-temporary. These include significant changes in general
economic conditions and business markets, trends in certain industry segments,
interest rate fluctuations, rating agency actions, changes in significant
accounting estimates and assumptions, commission of fraud, and legislative
actions. We continuously monitor these
factors as they relate to the investment portfolio in determining the status of
each investment.
70
Table of Contents
Realized Gains and Losses
The following table sets forth realized
investment gains and losses for the periods shown.
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
|
|
September 30,
|
|
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
Fixed maturity gains - sales
|
|
$
|
21,613
|
|
$
|
4,398
|
|
$
|
17,215
|
|
$
|
43,627
|
|
$
|
8,261
|
|
$
|
35,366
|
|
Fixed maturity losses - sales
|
|
(35,219
|
)
|
(549
|
)
|
(34,670
|
)
|
(35,921
|
)
|
(5,355
|
)
|
(30,566
|
)
|
Equity gains - sales
|
|
3
|
|
|
|
3
|
|
63
|
|
5,911
|
|
(5,848
|
)
|
Equity losses - sales
|
|
|
|
(12
|
)
|
12
|
|
|
|
(12
|
)
|
12
|
|
Impairments on fixed maturity securities
|
|
(202,644
|
)
|
|
|
(202,644
|
)
|
(282,630
|
)
|
(48
|
)
|
(282,582
|
)
|
Impairments on equity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Modco trading portfolio trading activity
|
|
(133,625
|
)
|
42,080
|
|
(175,705
|
)
|
(220,148
|
)
|
(23,189
|
)
|
(196,959
|
)
|
Other
|
|
(1,230
|
)
|
(2,803
|
)
|
1,573
|
|
3,451
|
|
4,231
|
|
(780
|
)
|
Total realized gains (losses) - investments
|
|
$
|
(351,102
|
)
|
$
|
43,114
|
|
$
|
(394,216
|
)
|
$
|
(491,558
|
)
|
$
|
(10,201
|
)
|
$
|
(481,357
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency swaps
|
|
$
|
(3,977
|
)
|
$
|
1,723
|
|
$
|
(5,700
|
)
|
$
|
(1,115
|
)
|
$
|
6,695
|
|
$
|
(7,810
|
)
|
Foreign currency adjustments on stable
value contracts
|
|
4,169
|
|
(1,750
|
)
|
5,919
|
|
1,304
|
|
(2,559
|
)
|
3,863
|
|
Derivatives related to mortgage loan
commitments
|
|
(509
|
)
|
|
|
(509
|
)
|
(5,401
|
)
|
|
|
(5,401
|
)
|
Embedded derivatives related to reinsurance
|
|
105,568
|
|
(38,144
|
)
|
143,712
|
|
183,134
|
|
32,265
|
|
150,869
|
|
Derivatives related to corporate debt
|
|
2,702
|
|
6,392
|
|
(3,690
|
)
|
6,432
|
|
(1,098
|
)
|
7,530
|
|
Credit default swaps
|
|
(2,154
|
)
|
7,404
|
|
(9,558
|
)
|
(4,156
|
)
|
6,665
|
|
(10,821
|
)
|
Other derivatives
|
|
(13,808
|
)
|
(13,092
|
)
|
(716
|
)
|
(24,777
|
)
|
(5,445
|
)
|
(19,332
|
)
|
Total realized gains (losses) - derivatives
|
|
$
|
91,991
|
|
$
|
(37,467
|
)
|
$
|
129,458
|
|
$
|
155,421
|
|
$
|
36,523
|
|
$
|
118,898
|
|
Realized gains and losses
on investments reflect portfolio management activities designed to maintain
proper matching of assets and liabilities and to enhance long-term investment
portfolio performance. The change in net
realized investment gains (losses), excluding impairments, during the nine
months ended September 30, 2008 primarily reflects the normal operation of
our asset/liability program within the context of the changing interest rate
and spread environment.
Realized losses are
comprised of both write-downs on other-than-temporary impairments and actual
sales of investments. For the nine
months ended September 30, 2008, there were pre-tax other-than-temporary
impairments of $282.6 million, excluding $20.0 million of Modco related
impairments, in our investments compared to $0.1 million for the nine months
ended September 30, 2007. The
impairments related to debt obligations and preferred stock holdings in Lehman
Brothers and Washington Mutual, residential mortgage-backed securities
collateralized by Alt-A mortgages, and preferred stock holdings in Fannie Mae
and Freddie Mac. The decline in the estimated fair value of these securities
resulted from factors including distressed credit markets, the failure or near
failure of a number of large financial service companies resulting in
intervention by the United States Federal Government, downgrades in rating, and
interest rate changes. These other-than-temporary impairments resulted from our
analysis of circumstances and our belief that credit events, loss severity,
changes in credit enhancement, and/or other adverse conditions of the
respective issuers have caused, or will lead to, a deficiency in the
contractual cash flows related to these investments. These other-than-temporary
impairments, net of Modco, are presented in the chart below:
Pre-Tax Impairments
(Net of Modco)
|
|
Three Months
|
|
Nine Months
|
|
|
|
Ended
|
|
Ended
|
|
|
|
September 30, 2008
|
|
|
|
(Dollars In Millions)
|
|
Freddie Mac
|
|
$
|
7.1
|
|
$
|
7.1
|
|
Fannie Mae
|
|
21.9
|
|
21.9
|
|
Lehman
|
|
92.4
|
|
92.4
|
|
Washington Mutual
|
|
45.3
|
|
45.3
|
|
Alt-A Bonds
|
|
35.9
|
|
115.9
|
|
Total
|
|
$
|
202.6
|
|
$
|
282.6
|
|
71
Table of Contents
As previously
discussed, management considers several factors when determining
other-than-temporary impairments.
Although we generally intend to hold securities until maturity, we may
change our position as a result of a change in circumstances. Any such decision is consistent with our
classification of all but a specific portion of our investment portfolio as
available-for-sale. For the nine months
ended September 30, 2008, we sold securities in an unrealized loss
position with a market value of $151.9 million resulting in a realized
loss of $35.9 million. Of this total, approximately $33.8 million related
to the sale of Washington Mutual debt obligations. These obligations were sold subsequent to the
takeover of Washington Mutual by the Office of Thrift Supervision. For such securities, the proceeds, realized
loss, and total time period that the security had been in an unrealized loss
position are presented in the table below:
|
|
Proceeds
|
|
% Proceeds
|
|
Realized Loss
|
|
% Realized Loss
|
|
|
|
(Dollars In Thousands)
|
|
<= 90 days
|
|
$
|
83,826
|
|
55.2
|
%
|
$
|
(324
|
)
|
0.9
|
%
|
>90 days but <= 180 days
|
|
32,462
|
|
21.4
|
|
(997
|
)
|
2.8
|
|
>180 days but <= 270 days
|
|
8,002
|
|
5.3
|
|
(309
|
)
|
0.9
|
|
>270 days but <= 1 year
|
|
17,833
|
|
11.7
|
|
(5,992
|
)
|
16.7
|
|
>1 year
|
|
9,746
|
|
6.4
|
|
(28,299
|
)
|
78.7
|
|
Total
|
|
$
|
151,869
|
|
100.0
|
%
|
$
|
(35,921
|
)
|
100.0
|
%
|
The $3.5 million of other realized gains recognized for the nine months
ended September 30, 2008 includes foreign exchange gains of $6.0 million
and other losses totaling $2.5 million.
As of September 30, 2008, net losses of $220.1 million primarily
related to mark-to-market changes on our Modco trading portfolios associated
with the Chase Insurance Group acquisition were also included in realized gains
and losses. Of this amount,
approximately $33.5 million of losses were realized through the sale of certain
securities, which will be reimbursed to us over time through the reinsurance
settlement process for this block of business. Additional details on our
investment performance and evaluation are provided in the sections below.
Realized investment gains and losses related to derivatives represent
changes in the fair value of derivative financial instruments and
gains (losses) on derivative contracts closed during the period. We have entered into foreign currency swaps
to mitigate the risk of changes in the value of principal and interest payments
to be made on certain of our foreign currency denominated stable value
contracts. We recorded net realized gains
of $0.2 million from these securities for both the three months and nine
months ended September 30, 2008.
These losses were the result of differences in the related foreign
currency spot and forward rates used to value the stable value contracts and
foreign currency swaps. We have taken short
positions in U.S. Treasury futures to mitigate interest rate risk related
to our mortgage loan commitments. The
net losses for the three months ended September 30, 2008 were the result
of $7.1 million of losses related to closed positions, partially offset by $6.6
million of mark-to-market gains. The net
losses for the nine months ended September 30, 2008 were the result of
$12.1 million of losses related to closed positions, partially offset by $6.7
million of mark-to-market gains.
We also have in place various modified coinsurance and funds withheld
arrangements that, in accordance with DIG B36 (Embedded Derivatives:
Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit
Risk Exposures That Are Unrelated or Only Partially Related to the
Creditworthiness of the Obligor under Those Instruments), contain embedded
derivatives. The $105.6 million and
$183.1 million of gains on these embedded derivatives in the three and nine
months ended September 30, 2008, respectively, were a result of spread
widening, partially offset by lower interest rates. In the three and nine months ended September 30,
2008, the investment portfolios that support the related modified coinsurance
reserves and funds withheld arrangements had mark-to-market losses that offset
the gains on these embedded derivatives.
We use interest rate swaps to mitigate interest rate risk related to
certain Senior Notes, Medium-Term Notes, and subordinated debt securities. These positions resulted in gains of
$2.7 million and $6.4 million for the three and nine months ended September 30,
2008, respectively.
We reported net losses of $2.2 million and $4.2 million related to
credit default swaps for the three and nine months ended September 30,
2008, respectively. The net losses for
the three months ended September 30, 2008 were primarily the result of
$2.4 million of mark-to-market losses. The net losses for the nine months ended
September 30, 2008 were primarily the result of $10.3 million of
mark-to-market losses, partly offset by $4.2 million of gains related to closed
positions. We entered into these credit
default swaps to enhance the return on our investment portfolio.
72
Table of Contents
We also use various swaps, options, and swaptions to mitigate risk
related to other exposures. We realized
losses of $1.4 million on interest rate swaps for both the three months and
nine months ended September 30, 2008. Included in the 2008 losses was a
$2.4 million loss resulting from the termination of a hedging relationship
related to the early retirement of a funding agreement backed-note. Swaptions
realized losses of $0.9 million and $3.9 million for the three and nine
months ended September 30, 2008, respectively. Equity call options generated losses of
$1.5 million and $6.2 million for the three and nine months ended September 30,
2008, respectively. The GMWB rider
embedded derivatives on certain variable deferred annuities had realized losses
of $8.8 million and $12.2 million for the three and nine months ended September 30,
2008, respectively. Other derivative
contracts generated net losses of $1.2 million and $1.1 million for the three
and nine months ended September 30, 2008, respectively.
Unrealized
Gains and Losses Available-for-Sale Securities
The information presented below relates to investments at a certain
point in time and is not necessarily indicative of the status of the portfolio
at any time after September 30, 2008, the balance sheet date. Information about unrealized gains and losses
is subject to rapidly changing conditions, including volatility of financial
markets and changes in interest rates.
As indicated above, management considers a number of factors in
determining if an unrealized loss is other-than-temporary, including our
ability and intent to hold the security until recovery. Furthermore, since the timing of recognizing
realized gains and losses is largely based on managements decisions as to the
timing and selection of investments to be sold, the tables and information
provided below should be considered within the context of the overall
unrealized gain (loss) position of the portfolio. As of September 30, 2008, we had an
overall pre-tax net unrealized loss of $1.8 billion.
Credit markets have experienced reduced liquidity, higher volatility
and widening credit spreads across numerous asset classes over the past several
quarters, primarily as a result of marketplace uncertainty arising from the
failure or near failure of a number of large financial service companies
resulting in intervention by the United States Federal Government, downgrades
in rating, interest rate changes, higher defaults in sub-prime and Alt-A
residential mortgage loans and a weakening of the overall economy. In connection with this uncertainty, we
believe investors have departed from many investments in asset-backed
securities including those associated with sub-prime and Alt-A residential
mortgage loans, as well as types of debt investments with fewer lender
protections or those with reduced transparency and/or complex features which
may hinder investor understanding. We believe these factors have contributed to
an increase in our net unrealized investment losses through declines in market
values. We expect to experience
continued volatility in connection with the valuation of our fixed maturity
investments.
For fixed maturity and equity securities held that are in an unrealized
loss position as of September 30, 2008, the estimated market value,
amortized cost, unrealized loss, and total time period that the security has
been in an unrealized loss position are presented in the table below:
|
|
Estimated
|
|
% Market
|
|
Amortized
|
|
% Amortized
|
|
Unrealized
|
|
% Unrealized
|
|
|
|
Market Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
<= 90 days
|
|
$
|
3,148,346
|
|
20.2
|
%
|
$
|
3,308,977
|
|
18.8
|
%
|
$
|
(160,631
|
)
|
8.2
|
%
|
>90 days but <= 180 days
|
|
3,092,150
|
|
19.8
|
|
3,451,792
|
|
19.7
|
|
(359,642
|
)
|
18.4
|
|
>180 days but <= 270 days
|
|
5,012,016
|
|
32.1
|
|
5,488,947
|
|
31.3
|
|
(476,931
|
)
|
24.3
|
|
>270 days but <= 1 year
|
|
1,330,138
|
|
8.5
|
|
1,557,849
|
|
8.9
|
|
(227,711
|
)
|
11.6
|
|
>1 year but <= 2 years
|
|
1,813,888
|
|
11.6
|
|
2,272,797
|
|
12.9
|
|
(458,909
|
)
|
23.5
|
|
>2 years but <= 3 years
|
|
528,046
|
|
3.4
|
|
637,794
|
|
3.6
|
|
(109,748
|
)
|
5.6
|
|
>3 years but <= 4 years
|
|
564,247
|
|
3.6
|
|
687,312
|
|
3.9
|
|
(123,065
|
)
|
6.3
|
|
>4 years but <= 5 years
|
|
55,530
|
|
0.4
|
|
85,380
|
|
0.5
|
|
(29,850
|
)
|
1.5
|
|
>5 years
|
|
56,204
|
|
0.4
|
|
68,938
|
|
0.4
|
|
(12,734
|
)
|
0.6
|
|
Total
|
|
$
|
15,600,565
|
|
100.0
|
%
|
$
|
17,559,786
|
|
100.0
|
%
|
$
|
(1,959,221
|
)
|
100.0
|
%
|
73
Table of Contents
The unrealized losses as of September 30, 2008, primarily relate
to the widening of credit spreads and fluctuations in treasury rates during the
quarter. Factors such as credit enhancements within the deal structures and the
underlying collateral performance/characteristics support the recoverability of
the investments. We do not consider these unrealized loss positions to be
other-than-temporary, based on the factors discussed and because we have the
ability and intent to hold these investments until maturity or until the fair
values of the investments have recovered.
As of September 30, 2008, there were estimated gross unrealized
losses of $126.4 million and $26.2 million, related to our mortgage-backed
securities collateralized by Alt-A mortgage loans and sub-prime mortgage loans,
respectively. Gross unrealized losses in
our securities collateralized by sub-prime and Alt-A residential mortgage loans
as of September 30, 2008, were primarily the result of continued widening
spreads during 2008, representing marketplace uncertainty arising from higher
defaults in sub-prime and Alt-A residential mortgage loans and rating agency
downgrades of securities collateralized by sub-prime and Alt-A residential
mortgage loans. For the nine months
ended September 30, 2008, we recorded $115.9 million of pre-tax
other-than-temporary impairments on residential mortgage-backed securities
collateralized by Alt-A mortgages. The
decline in the estimated fair value of these securities resulted from factors
including downgrades in rating, interest rate changes, and the current
distressed credit markets. These other-than-temporary impairments resulted from
our analysis of circumstances and our belief that credit events, loss severity,
changes in credit enhancement, and/or other adverse conditions of the
respective issuers have caused, or will lead to, a deficiency in the
contractual cash flows related to these investments. Excluding the securities on which other-than-temporary
impairments were recorded, we expect these investments to continue to perform
in accordance with their original contractual terms. We have the ability and
intent to hold these investments until maturity or until the fair values of the
investments have recovered, which may be at maturity. Additionally, we do not expect these
investments to adversely affect our liquidity or ability to maintain proper
matching of assets and liabilities.
As of September 30, 2008, securities with a market value of
$642.8 million and unrealized losses of $84.8 million were issued in
commercial mortgage loan securitizations that we sponsored, including
$2.0 million of unrealized losses greater than five years. We do not consider these unrealized positions
to be other-than-temporary because the underlying mortgage loans continue to
perform consistently with our original expectations. Our underwriting procedures relative to our
commercial loan portfolio are based on a conservative, disciplined approach. We concentrate our underwriting expertise on
a small number of commercial real estate asset types associated with the
necessities of life (retail, multi-family, professional office buildings, and
warehouses). We believe these asset types tend to weather economic downturns
better than other commercial asset classes that we have chosen to avoid. We
believe this disciplined approach has helped to maintain a relatively low
delinquency and foreclosure rate throughout our history.
In assessing whether or not these unrealized positions should be
considered other-than-temporary, we review the underlying cash flows, as well
as the associated values of the real estate collateral for the loans included
in our commercial mortgage loan securitizations.
74
Table of Contents
We have no material concentrations of issuers or guarantors of fixed
maturity securities. The industry
segment composition of all securities in an unrealized loss position held as of
September 30, 2008, is presented in the following table:
|
|
Estimated
|
|
% Market
|
|
Amortized
|
|
% Amortized
|
|
Unrealized
|
|
% Unrealized
|
|
|
|
Market Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
Agency Mortgages
|
|
$
|
544,665
|
|
3.5
|
%
|
$
|
573,653
|
|
3.3
|
%
|
$
|
(28,988
|
)
|
1.5
|
%
|
Banking
|
|
1,724,048
|
|
11.1
|
|
2,132,605
|
|
12.1
|
|
(408,557
|
)
|
20.9
|
|
Basic Industrial
|
|
548,253
|
|
3.5
|
|
628,601
|
|
3.6
|
|
(80,348
|
)
|
4.1
|
|
Brokerage
|
|
115,637
|
|
0.7
|
|
142,056
|
|
0.8
|
|
(26,419
|
)
|
1.3
|
|
Capital Goods
|
|
245,164
|
|
1.6
|
|
270,053
|
|
1.5
|
|
(24,889
|
)
|
1.3
|
|
Communications
|
|
581,470
|
|
3.7
|
|
689,876
|
|
3.9
|
|
(108,406
|
)
|
5.5
|
|
Consumer Cyclical
|
|
388,412
|
|
2.5
|
|
459,754
|
|
2.6
|
|
(71,342
|
)
|
3.6
|
|
Consumer Noncyclical
|
|
448,431
|
|
2.9
|
|
489,467
|
|
2.8
|
|
(41,036
|
)
|
2.1
|
|
Electric
|
|
1,599,607
|
|
10.3
|
|
1,756,343
|
|
10.0
|
|
(156,736
|
)
|
8.0
|
|
Energy
|
|
693,763
|
|
4.4
|
|
763,318
|
|
4.3
|
|
(69,555
|
)
|
3.6
|
|
Finance Companies
|
|
342,303
|
|
2.2
|
|
418,547
|
|
2.4
|
|
(76,244
|
)
|
3.9
|
|
Insurance
|
|
790,570
|
|
5.1
|
|
960,173
|
|
5.5
|
|
(169,603
|
)
|
8.7
|
|
Municipal Agencies
|
|
1,281
|
|
0.0
|
|
1,365
|
|
0.0
|
|
(84
|
)
|
0.0
|
|
Natural Gas
|
|
949,143
|
|
6.1
|
|
1,050,609
|
|
6.0
|
|
(101,466
|
)
|
5.2
|
|
Non-Agency Mortgages
|
|
4,260,387
|
|
27.3
|
|
4,623,887
|
|
26.3
|
|
(363,500
|
)
|
18.6
|
|
Other Finance
|
|
1,753,243
|
|
11.2
|
|
1,929,621
|
|
11.0
|
|
(176,378
|
)
|
9.0
|
|
Other Industrial
|
|
147,250
|
|
0.9
|
|
160,215
|
|
0.9
|
|
(12,965
|
)
|
0.7
|
|
Other Utility
|
|
21,434
|
|
0.1
|
|
24,044
|
|
0.1
|
|
(2,610
|
)
|
0.1
|
|
Real Estate
|
|
17,359
|
|
0.1
|
|
19,242
|
|
0.1
|
|
(1,883
|
)
|
0.1
|
|
Technology
|
|
88,865
|
|
0.6
|
|
97,596
|
|
0.6
|
|
(8,731
|
)
|
0.4
|
|
Transportation
|
|
230,215
|
|
1.5
|
|
252,467
|
|
1.4
|
|
(22,252
|
)
|
1.1
|
|
Canadian Government Agencies
|
|
18,198
|
|
0.1
|
|
18,688
|
|
0.1
|
|
(490
|
)
|
0.0
|
|
U.S. Govt Agencies
|
|
90,867
|
|
0.6
|
|
97,606
|
|
0.7
|
|
(6,739
|
)
|
0.3
|
|
Total
|
|
$
|
15,600,565
|
|
100.0
|
%
|
$
|
17,559,786
|
|
100.0
|
%
|
$
|
(1,959,221
|
)
|
100.0
|
%
|
The range of maturity dates for securities in
an unrealized loss position as of September 30, 2008, varies, with 16.8%
maturing in less than 5 years, 20.5% maturing between 5 and 10 years,
and 62.7% maturing after 10 years.
The following table shows the credit rating of securities in an
unrealized loss position as of September 30, 2008:
S&P or Equivalent
|
|
Estimated
|
|
% Market
|
|
Amortized
|
|
% Amortized
|
|
Unrealized
|
|
% Unrealized
|
|
Designation
|
|
Market Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
AAA/AA/A
|
|
$
|
10,190,437
|
|
65.3
|
%
|
$
|
11,268,947
|
|
64.2
|
%
|
$
|
(1,078,510
|
)
|
55.0
|
%
|
BBB
|
|
4,447,025
|
|
28.5
|
|
5,024,189
|
|
28.6
|
|
(577,164
|
)
|
29.5
|
|
Investment grade
|
|
14,637,462
|
|
93.8
|
|
16,293,136
|
|
92.8
|
|
(1,655,674
|
)
|
84.5
|
|
BB
|
|
643,256
|
|
4.1
|
|
775,271
|
|
4.4
|
|
(132,015
|
)
|
6.7
|
|
B
|
|
203,099
|
|
1.3
|
|
295,787
|
|
1.7
|
|
(92,688
|
)
|
4.7
|
|
CCC or lower
|
|
116,748
|
|
0.8
|
|
195,592
|
|
1.1
|
|
(78,844
|
)
|
4.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Below investment grade
|
|
963,103
|
|
6.2
|
|
1,266,650
|
|
7.2
|
|
(303,547
|
)
|
15.5
|
|
Total
|
|
$
|
15,600,565
|
|
100.0
|
%
|
$
|
17,559,786
|
|
100.0
|
%
|
$
|
(1,959,221
|
)
|
100.0
|
%
|
75
Table of Contents
As of September 30, 2008, securities in
an unrealized loss position that were rated as below investment grade
represented 6.2% of the total market value and 15.5% of the total unrealized
loss. Unrealized losses related to below
investment grade securities that had been in an unrealized loss position for
more than twelve months were $147.3 million.
Securities in an unrealized loss position rated below investment grade
were 3.4% of invested assets. We
primarily purchase our investments with the intent to hold to maturity. We do not expect these investments to
adversely affect our liquidity or ability to maintain proper matching of assets
and liabilities.
The following table shows the estimated market value, amortized cost,
unrealized loss, and total time period that the security has been in an
unrealized loss position for all below investment grade securities:
|
|
Estimated
|
|
% Market
|
|
Amortized
|
|
% Amortized
|
|
Unrealized
|
|
% Unrealized
|
|
|
|
Market Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
<= 90 days
|
|
$
|
185,985
|
|
19.3
|
|
$
|
201,612
|
|
15.9
|
%
|
$
|
(15,627
|
)
|
5.1
|
%
|
>90 days but <= 180 days
|
|
194,988
|
|
20.2
|
|
234,772
|
|
18.5
|
|
(39,784
|
)
|
13.1
|
|
>180 days but <= 270 days
|
|
123,544
|
|
12.8
|
|
182,645
|
|
14.4
|
|
(59,101
|
)
|
19.5
|
|
>270 days but <= 1 year
|
|
164,703
|
|
17.1
|
|
206,401
|
|
16.3
|
|
(41,698
|
)
|
13.7
|
|
>1 year but <= 2 years
|
|
141,251
|
|
14.7
|
|
192,159
|
|
15.2
|
|
(50,908
|
)
|
16.8
|
|
>2 years but <= 3 years
|
|
32,132
|
|
3.3
|
|
48,397
|
|
3.8
|
|
(16,265
|
)
|
5.4
|
|
>3 years but <= 4 years
|
|
98,334
|
|
10.2
|
|
152,838
|
|
12.1
|
|
(54,504
|
)
|
18.0
|
|
>4 years but <= 5 years
|
|
21,042
|
|
2.2
|
|
45,335
|
|
3.6
|
|
(24,293
|
)
|
8.0
|
|
>5 years
|
|
1,124
|
|
0.2
|
|
2,491
|
|
0.2
|
|
(1,367
|
)
|
0.4
|
|
Total
|
|
$
|
963,103
|
|
100.0
|
%
|
$
|
1,266,650
|
|
100.0
|
%
|
$
|
(303,547
|
)
|
100.0
|
%
|
Of the total below investment grade
securities, approximately $765.2 million and $105.9 million, respectively,
relate to corporate securities and public utility securities.
76
Table of Contents
LIQUIDITY
AND CAPITAL RESOURCES
Liquidity
We meet our liquidity requirements primarily through positive cash
flows from our operating subsidiaries.
Primary sources of cash from the operating subsidiaries are premiums,
deposits for policyholder accounts, investment sales and maturities, and
investment income. Primary uses of cash
for the operating subsidiaries include benefit payments, withdrawals from
policyholder accounts, investment purchases, policy acquisition costs, and
other operating expenses.
While we anticipate that the cash flow of our operating
subsidiaries will be sufficient to meet our investment commitments and
operating cash needs in a normal credit market environment, we recognize that
investment commitments scheduled to be funded may, from time to time, exceed
the funds then available. Therefore, we
have established repurchase agreement programs for certain of our insurance
subsidiaries to provide liquidity when needed.
We expect that the rate received on our investments will equal or exceed
our borrowing rate. As of September 30,
2008, we had no outstanding balance related to such borrowings. Additionally,
we may, from time to time, sell short-duration stable value products to
complement our cash management practices.
Depending on market conditions, we may also use securitization
transactions involving our commercial mortgage loans to increase liquidity for
the operating subsidiaries.
During the second quarter of 2008, we joined the FHLB of
Cincinnati. FHLB advances provide an
attractive funding source for short-term borrowing and for the sale of funding
agreements. Membership in the FHLB
requires that we purchase FHLB capital stock based on a minimum requirement and
a percentage of the dollar amount of advances outstanding. We held $58.1 million of common stock as of September 30,
2008, which is included in equity securities.
In addition, our obligations under the advances must be
collateralized. We maintain control over
any such pledged assets, including the right of substitution. As of September 30, 2008, we had $976
million of funding agreement-related advances outstanding under the FHLB
program.
Under a revolving line of credit arrangement, we have the ability to
borrow on an unsecured basis up to a maximum principal amount of $500 million
(the Credit Facility). This replaced
our previously existing $200 million revolving line of credit. We have the right in certain circumstances to
request that the commitment under the Credit Facility be increased up to a
maximum principal amount of $600 million. Balances outstanding under the Credit
Facility accrue interest at a rate equal to (i) either the prime rate or
the London Interbank Offered Rate (LIBOR), plus (ii) a spread based on the
ratings of our senior unsecured long-term debt. The Credit Agreement provides
that we are liable for the full amount of any obligations for borrowings or
letters of credit, including those of Protective Life Insurance Company, under
the Credit Facility. The maturity date on the Credit Facility is April 16,
2013. There was an outstanding balance
of $90.0 million at an interest rate of LIBOR plus 0.30% under the Credit
Facility as of September 30, 2008. Of this amount, $75.0 million was used
to purchase non-recourse funding obligations issued by an indirect, wholly
owned special-purpose financial captive insurance company. For additional
information related to special purpose financial captives, see Capital
Resources. The Company was in compliance with all financial debt covenants of
the Credit Facility as of September 30, 2008.
Our positive cash flows from operations are used to fund an investment
portfolio that provides for future benefit payments. We employ a formal asset/liability program to
manage the cash flows of our investment portfolio relative to our long-term
benefit obligations. The life insurance
subsidiaries were committed as of September 30, 2008, to fund mortgage
loans in the amount of $840.0 million.
In response to the volatility and disruption in the credit markets,
during the third quarter of 2008 we increased our cash and short-term
investment balances to provide liquidity for cash outflows projected for the
coming months. Our subsidiaries held
approximately $1.0 billion in cash and short-term investments as of September 30,
2008, and we held an additional $6.1 million in cash and short-term
investments available for general corporate purposes.
As of September 30, 2008, we reported approximately $684.9 million
(fair value) of Auction Rate Securities (ARSs), which were all rated AAA. These holdings are student loan-backed
auction rate securities, for which the underlying collateral is at least 97%
guaranteed by the Federal Family Education Loan Program. While the auction rate
market has experienced liquidity constraints, we believe that based on our
current liquidity position and our operating cash flows, any lack of liquidity
in the ARS market will not have a material impact on our liquidity, financial
condition, or cash flows.
77
Table of Contents
Sources and
Uses of Cash
Our primary sources of funding are dividends from our operating
subsidiaries; revenues from investment, data processing, legal, and management
services rendered to subsidiaries; investment income; and external
financing. These sources of cash support
our general corporate needs including our common stock dividends and debt
service. The states in which our
insurance subsidiaries are domiciled impose certain restrictions on the
insurance subsidiaries ability to pay us dividends. These restrictions are based in part on the
prior years statutory income and surplus.
Generally, these restrictions pose no short-term liquidity
concerns. We plan to retain substantial
portions of the earnings of our insurance subsidiaries in those companies
primarily to support their future growth.
The liquidity requirements of our regulated insurance subsidiaries
primarily relate to the liabilities associated with their various insurance and
investment products, operating expenses, and income taxes. Liabilities arising from insurance and
investment products include the payment of policyholder benefits, as well as
cash payments in connection with policy surrenders and withdrawals, policy loans
and obligations to redeem funding agreements.
Our insurance subsidiaries have used cash flows from operations and
investment activities as a primary source to fund their liquidity requirements.
Our insurance subsidiaries primary cash inflows from operating activities are
derived from premiums, annuity deposits, stable value contract deposits, and
insurance and investment product fees and other income, including cost of
insurance and surrender charges, contract underwriting fees, and intercompany
dividends or distributions. The
principal cash inflows from investment activities result from repayments of
principal, investment income and, as necessary, sales of invested assets.
Our insurance subsidiaries maintain investment strategies intended to
provide adequate funds to pay benefits and expected surrenders, withdrawals,
loans and redemption obligations without forced sales of investments. In addition, our insurance subsidiaries hold
highly liquid, high-quality short-term investment securities and other liquid
investment grade fixed maturity securities to fund our expected operating
expenses, surrenders, and withdrawals. As of September 30, 2008, our total
cash, cash equivalents and invested assets were $28.3 billion.
The following chart shows the cash flows provided by or used in
operating, investing, and financing activities for the nine months ended September 30,
2008 and September 30, 2007:
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
(Dollars In Thousands)
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
660,186
|
|
$
|
591,247
|
|
Net cash used in investing activities
|
|
(1,750,911
|
)
|
(1,169,844
|
)
|
Net cash provided by financing activites
|
|
1,031,160
|
|
684,501
|
|
Total
|
|
$
|
(59,565
|
)
|
$
|
105,904
|
|
Nine Months Ended September 30, 2008
compared to Nine Months Ended September 30, 2007
Net cash provided by operating activities
-
Cash flows from operating activities
are affected by the timing of premiums received, fees received, investment
income, and expenses paid. Principal sources of cash include sales of our
products and services. As an insurance business, we typically generate positive
cash flows from operating activities, as premiums and deposits collected from
our insurance and investment products exceed benefits paid and redemptions, and
we invest the excess. Accordingly, in analyzing our cash flows we focus on the
change in the amount of cash available and used in investing activities.
Net cash used in investing activities
-
The variance
in net cash used in investing activities for the nine months ended September 30,
2008 compared to September 30, 2007 was primarily the result of activity
related to our investment portfolio.
Net cash provided by financing activities
-
Changes in cash from financing activities primarily relate
to the issuance and repayment of borrowings, dividends to our stockholders and
other capital transactions, as well as the issuance of, and redemptions and
benefit payments on, investment contracts. The increase for the nine months
ended
78
Table of Contents
September 30, 2008 compared to September 30, 2007 was
primarily the result of fluctuations in investment product deposits and
withdrawals, offset by the termination of a variable interest entity.
Capital
Resources
To give us flexibility in connection with future acquisitions and other
funding needs, we have registered debt securities, preferred and common stock,
and stock purchase contracts of Protective Life Corporation, and additional
preferred securities of special purpose finance subsidiaries under the
Securities Act of 1933 on a delayed (or shelf) basis.
As of September 30, 2008, our capital structure consisted of
Medium-Term Notes, Senior Notes, Subordinated Debentures, and shareowners
equity. We also have a $500 million
revolving line of credit (the Credit Facility), under which we could borrow
funds with balances due April 16, 2013.
We have the right in certain circumstances to request that the
commitment under the Credit Facility be increased up to a maximum principal
amount of $600 million. No compensating
balances are required to maintain the line of credit. The line of credit arrangement contains,
among other provisions, requirements for maintaining certain financial ratios
and restrictions on the indebtedness that we and our subsidiaries can
incur. Additionally, the line of credit
arrangement precludes us, on a consolidated basis, from incurring debt in
excess of 40% of our total capital.
There was a $90.0 million outstanding balance as of September 30,
2008 under the Credit Facility at an interest rate of LIBOR plus 0.30%. Of this
amount, $75.0 million was utilized to purchase non-recourse funding obligations
issued by Golden Gate Captive Insurance Company (Golden Gate) an indirect
wholly owned special-purpose financial captive insurance company. As the need arises and in light of the
current credit market environment, we may utilize the Credit Facility to
purchase additional non-recourse funding obligations from this indirect wholly
owned special-purpose financial captive insurance company in future
quarters. We were in compliance with our
debt covenants under this facility as of September 30, 2008.
On September 30, 2008, Golden Gate, which is wholly owned by
Protective Life, our largest operating subsidiary, increased by $200 million
the capacity under its surplus notes facility (the Facility) through which
Golden Gate may issue floating rate surplus notes resulting in a total capacity
of $1 billion of aggregate principle amount. On that date, Golden Gate issued
$75.0 million in aggregate principal amount of floating rate surplus notes,
series B, due August 15, 2037 (the Series B Notes and together with
the $800 million in aggregate principle amount of floating rate surplus notes
previously issued under the Facility (the Series A Surplus Notes), the Notes)
to the Company, resulting in an outstanding balance under the Facility in the
aggregate principal amount of $875.0 million. Of this amount, $75.0 million is
eliminated at the Company consolidated level. The Series B Notes accrue
interest at the rate of LIBOR plus 30 basis points. The Notes are direct
financial obligations of Golden Gate and are not guaranteed by the Company or
Protective Life. As the block of business grows and ages, unless additional
funding mechanisms are put into place, reserving increases will reduce our
available statutory capital and surplus.
We have experienced higher borrowing costs associated with the Series A
Surplus Notes. The current rate on the Series A Surplus Notes is LIBOR
plus 275 basis points; the maximum rate we could be required to pay is LIBOR
plus 425 basis points.
Golden Gate II Captive Insurance Company (Golden
Gate II), a special purpose financial captive insurance company wholly
owned by Protective Life, had $575.0 million of non-recourse funding
obligations outstanding as of September 30, 2008. These non-recourse funding obligations mature
in 2052. We do not anticipate having to
pursue additional funding related to this block of business; however, we have
contingent approval to issue an additional $100 million of obligations if
necessary. $275 million of this amount
is currently accruing interest at a rate of LIBOR plus 30 basis points. We have experienced higher proportional
borrowing costs associated with $300 million of our non-recourse funding
obligations supporting the business reinsured to Golden Gate II. These higher costs
are the result of higher interest costs associated with the illiquidity of the
current market for auction rate securities, as well as a rating downgrade of
our guarantor by certain rating agencies.
The current rate associated with these obligations is LIBOR plus 200
basis points, which is the maximum rate we can be required to pay under these
obligations. These costs have partially
been mitigated by a decrease in LIBOR during the nine months ended September 30,
2008.
On May 7, 2007, our Board of Directors extended our previously
authorized $100 million share repurchase program. The current authorization extends through May 6,
2010. During the first three months of 2008, we repurchased approximately
450,800 shares, at a total cost of approximately $17.1 million. We did not
repurchase any additional shares during the months of April through
September, 2008. In light of recent
credit market
79
Table of Contents
disruption, extraordinary events and developments affecting financial
markets generally, and a specific focus on capital preservation and liquidity,
we did not purchase shares of our common stock under the existing share
repurchase program during the third quarter of 2008. For additional
information, see Part II, Item 2,
Unregistered Sales of
Equity Securities and Use of Proceeds
. Future activity will be dependent upon many
factors, including capital levels, liquidity needs, rating agency expectations,
and the relative attractiveness of alternative uses for capital.
A life insurance companys statutory capital is computed according to rules prescribed
by the National Association of Insurance Commissioners (NAIC), as
modified by state law. Generally
speaking, other states in which a company does business defer to the
interpretation of the domiciliary state with respect to NAIC rules, unless
inconsistent with the other states law.
Statutory accounting rules are different from U.S. GAAP and
are intended to reflect a more conservative view, for example, requiring
immediate expensing of policy acquisition costs. The NAICs risk-based capital requirements
require insurance companies to calculate and report information under a
risk-based capital formula. The achievement
of long-term growth will require growth in the statutory capital of our
insurance subsidiaries. The subsidiaries
may secure additional statutory capital through various sources, such as
retained statutory earnings or equity contributions by us.
We cede
material amounts of insurance and transfer related assets to other insurance
companies through reinsurance. However,
notwithstanding the transfer of related assets, we remain liable with respect
to ceded insurance should any reinsurer fail to meet the obligations that such
reinsurer assumed. We evaluate the
financial condition of our reinsurers and monitor the concentration of credit
risk arising from them. During the three
and nine months ended September 30, 2008, we ceded premiums to third-party
reinsurers amounting to $366.7 million and $1.2 billion, respectively. In addition, we had receivables from
reinsurers amounting to $5.2 billion as of September 30, 2008. We review reinsurance receivable amounts for
collectability and establish appropriate bad debt reserves if deemed
appropriate.
As of September 30, 2008, we reported residential mortgage-backed
securities with a total market value of $57.4 million, or 0.2% of total
invested assets, that were supported by collateral classified as sub-prime.
$29.0 million, or 50.5%, of these securities were rated AAA. Additionally, as of September 30, 2008,
we held $655.8 million, or 2.3% of invested assets, of securities supported by
collateral classified as Alt-A. While the estimated fair market values of
certain of these securities have experienced significant declines, we believe
that based on our current liquidity position and our operating cash flows,
continuing to hold these securities until the fair value recovers will not have
a material impact on our liquidity, financial condition, or cash flows.
As of September 30,
2008, we no longer held liabilities related to variable interest entities.
During June 2008, we received notification of the intent to terminate the
notes in existence under the trust facility. The trust was previously
consolidated on our financial statements in accordance with FASB Interpretation
No. 46 (revised December 2003),
Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51
(FIN 46(R)).
As of September 30, 2008, we no longer had a beneficial interest in the
trust. The termination of the notes did not have a material impact on our
liquidity, financial condition, or cash flows.
In an effort
to improve our capital position, during the three months ended September 30,
2008, certain noninsurance subsidiaries loaned securities with a fair value
amount of $105.7 million, including accrued interest, to the holding company (PLC). PLC then transferred these securities to
Protective Life Insurance Company through a capital contribution.
80
Table of Contents
Ratings
Various Nationally Recognized Statistical Rating Organizations (rating
organizations) review the financial performance and condition of insurers,
including our insurance subsidiaries, and publish their financial strength
ratings as indicators of an insurers ability to meet policyholder and contract
holder obligations. These ratings are important to maintaining public
confidence in an insurers products, its ability to market its products and its
competitive position. Rating
organizations also publish credit ratings for the issuers of debt security,
including the Company. Credit ratings
are indicators of a debt issuers ability to meet the terms of debt obligations
in a timely manner. These ratings are
important in the debt issuers overall ability to access certain types of
liquidity. The following table
summarizes our significant member companies financial ratings from the major
independent rating organizations as of November 6, 2008:
|
|
|
|
|
|
Standard &
|
|
|
|
Legal Entity
|
|
A.M. Best
|
|
Fitch
|
|
Poors
|
|
Moodys
|
|
|
|
|
|
|
|
|
|
|
|
Insurance companies financial strength
ratings:
|
|
|
|
|
|
|
|
|
|
Protective Life Insurance Company
|
|
A+
|
|
A+
|
|
AA
|
|
A1
|
|
West Coast Life Insurance Company
|
|
A+
|
|
A+
|
|
AA
|
|
A1
|
|
Protective Life and Annuity Insurance
Company
|
|
A+
|
|
A+
|
|
AA
|
|
|
|
Lyndon Property Insurance Company
|
|
A-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Holding company ratings:
|
|
|
|
|
|
|
|
|
|
Protective Life Corporation
|
|
|
|
A- / BBB+
(1)
|
|
A
|
|
Baa1
|
|
(1)
The default rating is A-. The BBB+
rating is related to our senior notes due at 2013, 2014, and 2018.
Our ratings
are subject to review and change by the rating organizations at any time and
without notice. A downgrade or other
negative action by a ratings organization with respect to the financial
strength ratings of our insurance subsidiaries could adversely affect sales,
relationships with distributors, the level of policy surrenders and
withdrawals, competitive position in the marketplace, and the cost or
availability of reinsurance. A downgrade
or other negative action by a ratings organization with respect to our credit
rating could limit our access to capital markets, increase the cost of issuing
debt, and a downgrade of sufficient magnitude, combined with other negative
factors, could require us to post collateral.
During September of
2008, Fitch Ratings (Fitch) revised its outlook for the U.S. life insurance
sector to negative from stable. Fitch stated that this revision reflected the
significant deterioration in the credit and equity markets, and the expected
impact of realized and unrealized investment losses on life insurers capital
levels and profitability. In addition,
during October of 2008, Standard & Poors (S&P) and Moodys
Investor Service (Moodys) each revised their outlook for the U.S. Life
Insurance sector to negative. S&P
stated that it expects to revise the ratings or outlooks on several life
insurers in the next few months because of the impact of challenging
macroeconomic conditions. Moodys said it expects to take negative rating
actions on life insurers that are weakly positioned at their rating levels
and are most exposed and vulnerable to current negative trends, including
rising investment losses and weakening economic conditions.
On November 5,
2008, Moodys announced a one-step downgrade of the insurance financial
strength (IFS) ratings of Protective Life Insurance Company and West Coast
Life Insurance Company to Al from Aa3, and a one-step downgrade of the
Companys senior debt rating to Baa1 from A3. Moodys stated that the outlook
on the ratings is stable and that this rating action concludes its review of
the Company that was begun on October 14, 2008. Also on November 5
th
, Fitch announced a one-step
downgrade of its IFS ratings of Protective Life Insurance Company, West Coast
Life Insurance Company and Protective Life and Annuity Insurance Company to A+
from AA-, and a one-step downgrade of the Companys issuer default rating to A-
from A and a one-step downgrade of the Companys senior debt ratings from A- to
BBB+. Fitch stated that the rating outlook is negative. The ratings downgrades
announced by Moodys and Fitch did not trigger any requirements for us to post
collateral or otherwise negatively impact current obligations of the Company.
81
Table of Contents
LIABILITIES
Many of our products contain surrender charges and other features that
are designed to reward persistency and penalize the early withdrawal of
funds. Certain stable value and annuity
contracts have market-value adjustments that protect us against investment
losses if interest rates are higher at the time of surrender than at the time
of issue.
As of September 30, 2008, we had policy liabilities and accruals
of approximately $18.1 billion. Our
interest-sensitive life insurance policies have a weighted average minimum
credited interest rate of approximately 3.70%.
Contractual
Obligations
The table below sets forth future maturities of debt, non-recourse
funding obligations, subordinated debt securities, stable value products, notes
payable, operating lease obligations, other property lease obligations,
mortgage loan commitments, policyholder obligations, and defined benefit
pension obligations.
We enter into various obligations to third parties in the ordinary
course of our operations. However, we do not believe that our cash flow requirements
can be assessed based upon an analysis of these obligations. The most
significant factor affecting our future cash flows is our ability to earn and
collect cash from our customers. Future cash outflows, whether they are
contractual obligations or not, also will vary based upon our future needs.
Although some outflows are fixed, others depend on future events. Examples of
fixed obligations include our obligations to pay principal and interest on
fixed-rate borrowings. Examples of obligations that will vary include
obligations to pay interest on variable-rate borrowings and insurance
liabilities that depend on future interest rates, market performance, or
surrender provisions. Many of our
obligations are linked to cash-generating contracts. In addition, our
operations involve significant expenditures that are not based upon
commitments. These include expenditures
for income taxes and payroll.
82
Table of Contents
As of September 30, 2008, in accordance with FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes-an
Interpretation of FASB Statement 109
, we carried a
$34.3 million liability for uncertain tax positions, including interest on
unrecognized tax benefits. These amounts
are not included in the long-term contractual obligations table because of the
difficulty in making reasonably reliable estimates of the occurrence or timing
of cash settlements with the respective taxing authorities.
|
|
|
|
Payments due by period
|
|
|
|
|
|
Less than
|
|
|
|
|
|
More than
|
|
|
|
Total
|
|
1 year
|
|
1-3 years
|
|
3-5 years
|
|
5 years
|
|
|
|
(Dollars In Thousands)
|
|
Long-term debt
(1)
|
|
$
|
839,598
|
|
$
|
122,611
|
|
$
|
66,523
|
|
$
|
301,742
|
|
$
|
348,722
|
|
Non-recourse funding obligations
(2)
|
|
4,053,189
|
|
79,392
|
|
158,783
|
|
158,783
|
|
3,656,231
|
|
Subordinated debt securities
(3)
|
|
1,910,528
|
|
37,147
|
|
74,294
|
|
74,294
|
|
1,724,793
|
|
Stable value products
(4)
|
|
6,893,311
|
|
2,018,350
|
|
2,682,491
|
|
1,270,322
|
|
922,148
|
|
Operating leases
(5)
|
|
28,875
|
|
6,574
|
|
11,127
|
|
6,243
|
|
4,931
|
|
Home office lease
(6)
|
|
93,426
|
|
3,533
|
|
6,981
|
|
7,019
|
|
75,893
|
|
Mortgage loan commitments
|
|
840,013
|
|
840,013
|
|
|
|
|
|
|
|
Policyholder obligations
(7)
|
|
21,209,310
|
|
1,371,528
|
|
2,922,484
|
|
2,719,539
|
|
14,195,759
|
|
Defined benefit pension obligations
(8)
|
|
2,326
|
|
2,326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Long-term
debt includes all principal amounts owed on note agreements and expected
interest payments due over the term of notes.
(2)
Non-recourse funding obligations include all
principal amounts owed on note agreements and expected interest payments due
over the term of the notes.
(3)
Subordinated debt securities includes all
principal amounts owed to our non-consolidated special purpose finance
subsidiaries and interest payments due over the term of the obligations.
(4)
Anticipated stable value products cash flows
including interest.
(5)
Includes all lease payments required under
operating lease agreements.
(6)
The lease payments shown assume we exercise
our option to purchase the building at the end of the lease term. Additionally, the payments due by period
above were computed based on the terms of the renegotiated lease agreement,
which was entered in January 2007.
(7)
Estimated contractual policyholder obligations
are based on mortality, morbidity, and lapse assumptions comparable to our
historical experience, modified for recent observed trends. These obligations are based on current
balance sheet values and include expected interest crediting, but do not incorporate
an expectation of future market growth, or future deposits. Due to the significance of the assumptions
used, the amounts presented could materially differ from actual results. As variable separate account obligations are
legally insulated from general account obligations, the variable separate
account obligations will be fully funded by cash flows from variable separate
account assets. We expect to fully fund
the general account obligations from cash flows from general account
investments.
(8)
Estimated 2008 payments related to our
unfunded excess benefit plan in 2008. Due to the significance of the
assumptions used, this amount could differ from actual results. The Company does not expect to make a
contribution to the defined benefit pension plan during the fourth quarter of 2008.
83
Table of Contents
FAIR VALUE OF FINANCIAL INSTRUMENTS
On January 1, 2008, we adopted SFAS No. 157. This standard defines fair value, establishes
a framework for measuring fair value, establishes a fair value hierarchy based
on the quality of inputs used to measure fair value and enhances disclosure
requirements for fair value measurements.
The term fair value as used in this document is defined in accordance
with SFAS No. 157. The cumulative effect of adopting this standard
resulted in an increase to January 1, 2008 retained earnings of $1.5
million and a decrease in income before income taxes of $0.4 million for the
nine months ended September 30, 2008. The standard describes three levels of inputs that may be used to measure
fair value. For more information, see Note 1
,
Basis of Presentation and Summary of Significant Accounting Policies
and Note 10,
Fair Value
of Financial Instruments.
Available-for-sale securities and trading
account securities are recorded at fair value, which is primarily based on
actively traded markets where prices are based on either direct market quotes
or observed transactions. Liquidity is a significant factor in the
determination of the fair value for these securities. Market price quotes may not be readily
available for some positions, or for some positions within a market sector
where trading activity has slowed significantly or ceased. These situations are generally triggered by
the markets perception of credit uncertainty regarding a single company or a
specific market sector. In these instances, fair value is determined based on
limited available market information and other factors, principally from
reviewing the issuers financial position, changes in credit ratings, and cash
flows on the investments. As of September 30,
2008, $1.7 billion of available-for-sale and trading account assets were
classified as level three fair value assets.
The fair values of derivative assets and
liabilities include adjustments for market liquidity, counterparty credit
quality and other deal specific factors, where appropriate. The fair values of
derivative assets and liabilities traded in the over-the-counter market are
determined using quantitative models that require the use of multiple market
inputs including interest rates, prices and indices to generate continuous
yield or pricing curves and volatility factors, which are used to value the
position. The predominance of market inputs are actively quoted and can be
validated through external sources. Estimation risk is greater for derivative
asset and liability positions that are either option-based or have longer
maturity dates where observable market inputs are less readily available or are
unobservable, in which case quantitative based extrapolations of rate, price or
index scenarios are used in determining fair values. As of September 30,
2008, the level three fair values of derivative assets and liabilities
determined by these quantitative models were $148.1 million and $13.4 million.
These amounts reflect the full fair value of the derivatives as defined in
accordance with SFAS No. 157 and do not isolate the discrete value
associated with the specific subjective valuation variable.
The liabilities of certain of our annuity
account balances are calculated at fair value using actuarial valuation models.
These models use various observable and unobservable inputs including projected
future cash flows, policyholder behavior, the Companys credit rating and other
market conditions. As of September 30,
2008, the level three fair value of these liabilities was $154.2 million. This
amount reflects the full fair value of the liabilities as defined in accordance
with SFAS No. 157 and does not isolate the discrete value associated with
the specific subjective valuation variable.
As of September 30, 2008, we changed certain assumptions used in
our methodology for determining the fair value for retained beneficial
interests in commercial mortgage-backed security (CMBS) holdings related to
our sponsored commercial mortgage loan securitizations. Prior to September 30, 2008, we used
external broker valuations to determine the fair value of these positions.
These valuations were based on the cash flows of the commercial mortgages
underlying the notes, as well as observable market spread assumptions for
investments with similar coupons and/or characteristics based on the fair value
hierarchy criteria, and non-observable assumptions and factors utilizing
general market information available as of the valuation date. During the three months ended September 30,
2008, we determined that little or no secondary market existed for CMBS holdings
similar to those in our portfolio, and additionally, certain of the tranches
within our holdings fell below the collapse provision levels in the underlying
security agreements. Therefore, the
relevant observable inputs from CMBS sales activity could not be obtained for
what we considered a supportable or appropriate calculation of fair value based
on our previous methodology.
84
Table of Contents
As a result of the factors noted and in accordance with the clarifying
guidance issued in SFAS No. 157-3, we determined the fair value of these
CMBS holdings as of September 30, 2008 using a combination of external
broker valuations and an internally developed model. This model includes inputs derived by us
based on assumed discount rates relative to our current mortgage loan lending
rate and an expected cash flow analysis based on a review of the commercial
mortgage loans underlying the notes. The
model also contains our determined representative risk adjustment assumptions
related to nonperformance and liquidity risks.
We believe that this valuation approach provides a more accurate
calculation of the fair value of these securities under the fair value
hierarchy guidance and given the current inactive market conditions.
MARKET
RISK EXPOSURES AND OFF-BALANCE SHEET ARRANGEMENTS
Our financial position and earnings are subject to various market risks
including changes in interest rates, changes in the yield curve, changes in
spreads between risk-adjusted and risk-free interest rates, changes in foreign
currency rates, changes in used vehicle prices, equity price risks and issuer defaults. We analyze and manage the risks arising from
market exposures of financial instruments, as well as other risks, through an
integrated asset/liability management process.
Our asset/liability management programs and procedures involve the
monitoring of asset and liability durations for various product lines; cash
flow testing under various interest rate scenarios; and the continuous
rebalancing of assets and liabilities with respect to yield, risk, and cash
flow characteristics. These programs
also incorporate the use of derivative financial instruments primarily to
reduce our exposure to interest rate risk, inflation risk, currency exchange
risk, and equity market risk.
The primary focus of our asset/liability program is the management of
interest rate risk within the insurance operations. This includes monitoring the duration of both
investments and insurance liabilities to maintain an appropriate balance
between risk and profitability for each product category, and for us as a
whole. It is our policy to generally maintain
asset and liability durations within one-half year of one another, although,
from time to time, a broader interval may be allowed.
We are exposed to credit risk within our
investment portfolio and through derivative counterparties. Credit risk relates to the uncertainty of an
obligors continued ability to make timely payments in accordance with the
contractual terms of the instrument or contract. We manage credit risk through
established investment policies which attempt to address quality of obligors
and counterparties, credit concentration limits, diversification requirements
and acceptable risk levels under expected and stressed scenarios. Derivative counterparty credit risk is
measured as the amount owed to us based upon current market conditions and
potential payment obligations between us and our counterparties. We minimize
the credit risk in derivative instruments by entering into transactions with
high quality counterparties rated AA or higher.
Derivative instruments that are used as part of our interest rate risk
management strategy include interest rate swaps, interest rate futures,
interest rate options and interest rate swaptions. Our inflation risk management strategy
involves the use of swaps that require us to pay a fixed rate and receive a
floating rate that is based on changes in the Consumer Price Index (CPI). We use foreign currency swaps to manage our
exposure to changes in the value of foreign currency denominated stable value
contracts. We also use S&P 500
®
options to mitigate our exposure to the value of equity indexed annuity
contracts.
We have sold credit derivatives to enhance the return on our investment
portfolio. These credit default swaps
create credit exposure similar to an investment in publicly-issued fixed
maturity cash investments. As of September 30,
2008, the notional amount of these credit default swaps was $55.0 million, and
the swaps were in an unrealized loss position of $8.2 million,
respectively. In addition, we held a
credit default swap position with a $10.0 million notional amount that was in a
$1.9 million loss position, under which Lehman Brothers is the
counterparty. As a result of the ongoing
disruption in the credit markets, the fair value of these derivatives is
expected to fluctuate in response to changing market conditions. We believe that the unrealized loss recorded
on the $55.0 million notional of credit default swaps is not indicative of the
economic value of the investment. We expect the unrealized loss to reverse over
the remaining life of the credit default swap portfolio. The Lehman Brothers
credit default swap with a $10.0 million notional in the $1.9 million loss
position is not expected to reverse.
Derivative instruments expose us to credit and market risk and could
result in material changes from quarter-to-quarter. We minimize our credit risk by entering into
transactions with highly rated counterparties.
We manage the market risk associated with interest rate and foreign
exchange contracts by establishing and monitoring
85
Table of Contents
limits as to the types and degrees of risk that may be undertaken. We monitor our use of derivatives in
connection with our overall asset/liability management programs and procedures.
In the ordinary course of our commercial mortgage lending operations,
we will commit to provide a mortgage loan before the property to be mortgaged
has been built or acquired. The mortgage
loan commitment is a contractual obligation to fund a mortgage loan when called
upon by the borrower. The commitment is
not recognized in our financial statements until the commitment is actually
funded. The mortgage loan commitment
contains terms, including the rate of interest, which may be different than
prevailing interest rates. As of September 30,
2008, we had outstanding mortgage loan commitments of $840.0 million at an
average rate of 6.45%.
We believe our asset/liability management programs and procedures and
certain product features provide protection against the effects of changes in
interest rates under various scenarios.
Additionally, we believe our asset/liability management programs and
procedures provide sufficient liquidity to enable us to fulfill our obligation
to pay benefits under our various insurance and deposit contracts. However, our asset/liability management
programs and procedures incorporate assumptions about the relationship between
short-term and long-term interest rates (i.e., the slope of the yield curve),
relationships between risk-adjusted and risk-free interest rates, market
liquidity, spread movements and other factors, and the effectiveness of our
asset/liability management programs and procedures may be negatively affected
whenever actual results differ from those assumptions.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 1,
Basis of Presentation and
Summary of Significant Accounting Policies,
to the Consolidated
Condensed Financial Statements for information regarding recently issued
accounting standards.
RECENT DEVELOPMENTS
On October 3, 2008, President Bush signed the Emergency Economic
Stabilization Act of 2008 (the EESA) into law. Pursuant to the EESA, the U.S. Treasury has
the authority to, among other things, purchase up to $700 billion of securities
from financial institutions for the purpose of stabilizing the financial
markets. Under EESA and the Troubled
Asset Relief Program (TARP) Capital Purchase Plan, the U.S. Treasury has
begun making equity investments in U.S. banks.
Under EESA, Treasury has the power to expand its investments to include
insurers. There are reports that the Treasury is considering such action, but
the action may be limited to insurers that own or are owned by a
federally-regulated bank or thrift institution.
We cannot predict whether Treasury will include insurers in its program
or, if it does, the criteria it will use in selecting participants and whether
participation, or lack thereof, would be viewed positively or negatively.
Further, we cannot predict what other actions Treasury or other governmental
and regulatory bodies may take, nor can there be any assurance as to the impact
any governmental or regulatory actions will have on the financial markets, the
economy or our consolidated results of operations and financial position.
Credit markets have experienced reduced liquidity, higher volatility
and widening credit spreads across numerous asset classes over the past several
quarters, primarily as a result of marketplace uncertainty arising from higher
defaults in sub-prime and Alt-A residential mortgage loans and a weakening of
the overall economy. In connection with
this uncertainty, we believe investors and lenders have retreated from many
investments in asset-backed securities including those associated with
sub-prime and Alt-A residential mortgage loans, as well as types of debt
investments with weak lender protections or those with limited transparency
and/or complex features which hinder investor understanding. We believe such
uncertainty has contributed to an increase in our net unrealized investment
losses through declines in market values.
We expect to experience continued volatility in connection with the
valuation of our fixed maturity investments. However, we believe that the
current credit environment also provides us with opportunities to invest in
select asset classes and sectors that may enhance our investment yields over
time.
86
Table of Contents
Revised Actuarial Guideline 38 was approved by the NAIC, with an
effective date of July 1, 2005.
Actuarial Guideline 38, also known as AXXX, sets forth the reserve
requirements for universal life insurance with secondary guarantees (ULSG). The changes to Actuarial Guideline 38
increased the reserve levels required for many ULSG products, and potentially
make those products more expensive and less competitive as compared to other
products including term and whole life products. To the extent that the additional reserves
are considered to be economically redundant, capital market or other solutions
may emerge to reduce the impact of the amendment. See Note 2,
Summary of
Significant Accounting Policies
to the Consolidated Audited
Financial Statements for information regarding a recent capital market
transaction designed to fund statutory reserves required by AXXX. The NAIC has issued additional changes to
AG38 and Regulation XXX, which had the effect of modestly decreasing the
reserves required for certain traditional and universal life policies that are
issued on January 1, 2007, and later.
In addition, accounting and actuarial groups within the NAIC are
studying whether to change the accounting standards that relate to certain
reinsurance credits, and whether, if changes are made, they are to be applied
retrospectively, prospectively only, or in a phased-in manner; a requirement to
reduce the reserve credit on ceded business, if applied retroactively, would
have a negative impact on our statutory capital. The NAIC is also currently working to reform
state regulation in various areas, including comprehensive reforms relating to
life insurance reserves.
Our ability to implement financing solutions designed to fund a portion
of our statutory reserves on both the traditional and universal life blocks of
business is dependent on factors such as our ratings, the size of the blocks of
business affected, our mortality experience, credit market guarantors, and
other factors. We cannot predict the
continued availability of such solutions or the form that the solution may
take. To the extent that such solutions
are not available, our financial position could be adversely affected through
impacts including, but not limited to, higher borrowing costs, surplus strain,
lower sales capacity and possible reduced earnings expectations. Management continues to monitor options
related to these financing solutions.
During 2006, the NAIC made the determination that certain securities
previously classified as preferred securities had both debt and equity
characteristics and because of this, required unique reporting treatment. Under
a short-term solution, NAIC guidance mandated that certain of these
securities may have to carry a lower rating for asset valuation reserve and
risk-based capital calculations. As
a result, certain securities receive a lower rating classification for asset
valuation reserve and risk-based capital calculations. Our insurance subsidiaries currently invest
in hybrid securities. As of September 30,
2008, we (including both insurance and non-insurance subsidiaries) held
approximately $1.3 billion (statutory carrying value) in securities that
meet the aforementioned notch-down criteria, based on evaluation of the underlying
characteristics of the securities. The
NAIC has since established a long-term solution, which effective January 1,
2009, provides for the classification of these hybrid securities as debt
securities.
During 2006, the NAICs Reinsurance Task Force adopted a proposal
suggesting broad changes to the United States reinsurance market, with the
stated intent to establish a regulatory system that distinguishes financially
strong reinsurers from weak reinsurers, without relying exclusively on their state
or country of domicile, with collateral to be determined as appropriate. The task force recommended that regulation of
reinsurance procedures be amended to focus on broad based risk and credit
criteria and not solely on U.S. licensure status. Evaluation of this proposal will be taken
under consideration by the NAICs Financial Condition (E) Committee, the
Reinsurance Task Forces parent committee, as one of its charges during
2007. We cannot provide any assurance as
to what impact such changes to the United States reinsurance industry will have
on the availability, cost, or collateral restrictions associated with ongoing
or future reinsurance transactions.
The NAIC adopted amendment(s) to the Unfair Trade Practices Act
regarding the use of travel in insurance underwriting. The amendment states that the denial of life
insurance based upon an individuals past lawful travel experiences or future
lawful travel plans, is prohibited unless (i) the risk of loss for
individuals traveling to a specified destination at a specified time is
reasonably anticipated to be greater than if the individuals did not travel to
that destinations at that time, and (ii) the risk of traveling to a
specific destination is based on sound actuarial principles and actual or reasonably
anticipated experience. We cannot
predict at this time what impact, if any, such changes would have on us.
The California Department of Insurance has promulgated proposed
regulations that would characterize some life insurance agents as brokers and
impose certain obligations on those agents that may conflict with the interests
of insurance carriers or require the agent to, among other things, advise the
client with respect to the best
87
Table of Contents
available insurer. We cannot
predict the outcome of this regulatory proposal or whether any other state will
propose or adopt similar actions.
In connection with our discontinued Lenders Indemnity product, we have
discovered facts and circumstances that support allegations against third
parties (including policyholders and the administrator of the associated loan
program), and we have instituted litigation to establish the rights and
liabilities of various parties. A
counterclaim in the litigation and separate related lawsuits have been filed by
various parties (including the Chapter 11 Plan trustee) seeking to assert
liability against us for various matters.
Claims that have been asserted against us in this litigation include
alleged contractual claims, bad faith, claims with respect to policies for
which premiums were not received by us, and recoupment based on a fraudulent
transfer theory; we are vigorously defending these claims. In addition, we are defending an arbitration
claim by the reinsurer of this Lenders Indemnity product. The reinsurer asserts that it is entitled to
a return of most of the Lenders Indemnity claims that were paid on behalf of
us by the administrator, claiming that the claims were not properly payable
under the terms of the policies. The
reinsurer was under common ownership with the program administrator, and we are
vigorously defending this arbitration.
Although we cannot predict the outcome of any litigation or arbitration,
we do not believe that the outcome of these matters will have a material impact
on our financial condition or results of operations.
88
Table of Contents
IMPACT OF INFLATION
Inflation increases the need for life insurance. Many policyholders who once had adequate
insurance programs may increase their life insurance coverage to provide the
same relative financial benefit and protection.
Higher interest rates may result in higher sales of certain of our
investment products.
The higher interest rates that have traditionally accompanied inflation
could also affect our operations. Policy
loans increase as policy loan interest rates become relatively more
attractive. As interest rates increase,
disintermediation of stable value and annuity account balances and individual
life policy cash values may increase.
The market value of our fixed-rate, long-term investments may decrease,
we may be unable to implement fully the interest rate reset and call provisions
of our mortgage loans, and our ability to make attractive mortgage loans,
including participating mortgage loans, may decrease. In addition, participating mortgage loan
income may decrease. The difference
between the interest rate earned on investments and the interest rate credited
to life insurance and investment products may also be adversely affected by rising
interest rates.
Item
3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
See Part I, Item 2,
Managements Discussion
and Analysis of Financial Condition and Results of Operations,
Executive
Summary and Liquidity and Capital Resources, and Part II, Item 1A,
Risk Factors
, and Item 6,
Exhibit 99,
of
this Report for market risk disclosures in light of the current difficult
conditions in the financial and credit markets, and the economy generally.
Item
4. CONTROLS AND PROCEDURES
(a)
Disclosure controls and
procedures
In order to ensure that the information the Company must disclose in
its filings with the Securities and Exchange Commission is recorded, processed,
summarized and reported on a timely basis, the Companys management, under the
direction of its Chief Executive Officer and Chief Financial Officer, evaluated
its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) under
the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the
end of the period covered by this report. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that the Companys
disclosure controls and procedures were effective for the purposes set forth in
the definition thereof in Exchange Act Rule 13a-15(e) as of such date. It should be noted that any system of
controls, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance that the control systems objectives will
be met. Further, the design of any
control system is based in part upon certain judgments, including the costs and
benefits of controls and the likelihood of future events. Because of these and other inherent
limitations of control systems, no evaluation of controls can provide absolute
assurance that all control issues, if any, within the Company have been
detected.
(b)
Changes in internal
control over financial reporting
There have been no changes in the Companys internal control over
financial reporting that occurred during the period ended September 30,
2008 that have materially affected, or are reasonably likely to materially
affect, such internal control over financial reporting. The Companys internal controls exist within
a dynamic environment and the Company continually strives to improve its
internal controls and procedures to enhance the quality of its financial
reporting.
PART II
Item 1A. Risk Factors
The operating results of companies in the insurance industry have
historically been subject to significant fluctuations. The factors which could affect the Companys
future results include, but are not limited to, general economic conditions and
the risks and uncertainties. In addition
to the factors listed in the following paragraphs within this section and other
information set forth in this report, you should carefully consider the factors
discussed in Part I, Item 1A,
Risk Factors and
Cautionary Factors that may Affect Future Results
in the Companys
Annual Report on Form 10-K for the year ended December 31, 2007,
which could materially affect the Companys business, financial condition, or
future results of operations.
89
Table of Contents
A ratings
downgrade
or other negative action by a ratings organization could adversely affect the
Company.
Various Nationally Recognized Statistical Rating Organizations (Rating
organizations) review the financial performance and condition of insurers,
including the Companys insurance subsidiaries, and publish their financial
strength ratings as indicators of an insurers ability to meet policyholder and
contract holder obligations. These
ratings are important to maintaining public confidence in the Companys
products, its ability to market its products and its competitive position. A downgrade or other negative action by a
ratings organization with respect to the financial strength ratings of the
Companys insurance subsidiaries could adversely affect the Company in many
ways, including the following: reducing new sales of insurance and investment
products; adversely affecting relationships with distributors and sales agents;
increasing the number or amount of policy surrenders and withdrawals of funds;
requiring a reduction in prices for the Companys insurance products and
services in order to remain competitive; and adversely affecting the Companys
ability to obtain reinsurance at a reasonable price on reasonable terms or at
all. A downgrade of sufficient magnitude
could result in the Company, its insurance subsidiaries or both being required
to collateralize reserves, balances or obligations under reinsurance, funding,
swap and securitization agreements. A downgrade of sufficient magnitude could
also result in the termination of funding and swap agreements.
Rating organizations also publish credit ratings for the Company. Credit ratings are indicators of a debt
issuers ability to meet the terms of debt obligations in a timely manner. These ratings are important in the Companys
overall ability to access certain types of liquidity. Downgrades in the Companys credit rating
could have a material adverse effect on the Companys financial condition and
results of operations in many ways, including the following: adversely limiting
the Companys access to capital markets, potentially increasing the cost of
debt and requiring the Company to post collateral.
Rating organizations assign ratings based upon several factors. While most of the factors relate to the rated
company, some of the factors relate to the views of the rating organization,
general economic conditions and circumstances outside the rated companys
control. In addition, rating
organizations use various models and formulas to assess the strength of a rated
company, and from time to time rating organizations have, in their discretion,
altered the models. Changes to the
models could impact the rating organizations judgment of the rating to be
assigned to the rated company. The
Company cannot predict what actions the rating organizations may take, or what
actions the Company may take in response to the actions of the rating
organizations, which could adversely affect the Company.
The Company may be required to establish a
valuation allowance against its deferred tax assets, which could materially
adversely affect the Companys results of operations, financial condition and
capital position.
Deferred tax assets refer to assets that are attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. The realization of the deferred
tax assets is dependent upon the generation of sufficient future taxable
income, including capital gains. If it
is determined that the deferred tax assets cannot be realized a deferred tax
valuation allowance must be established.
Based on the Companys current assessment of future taxable income,
including available tax planning opportunities, the Company anticipates that it
is more likely than not that it will generate sufficient taxable income to
realize its deferred tax assets, and, therefore, the Company did not record a
valuation allowance against its deferred tax assets as of September 30,
2008. If future events differ from the Companys current forecasts, a valuation
allowance may need to be established, which could have a material adverse
effect on the Companys results of operations, financial condition and capital
position.
The Companys investments are subject to market and credit risks. These risks could be heightened during
periods of extreme volatility or disruption in financial and credit markets.
The Companys invested assets and derivative
financial instruments are subject to customary risks of credit defaults and
changes in market values. These risks
could be heightened during periods of extreme volatility or disruption in the
financial and credit markets. A widening
of credit spreads will increase the unrealized losses in the Companys
investment portfolio. The factors
affecting the financial and credit markets could lead to other-than-temporary
impairments of assets in the Companys investment portfolio.
90
Table of Contents
The value of the Companys commercial
mortgage loan portfolio depends in part on the financial condition of the
tenants occupying the properties that the Company has financed. Factors that may affect the overall default
rate on, and market value of, the Companys invested assets, derivative
financial instruments, and mortgage loans include interest rate levels,
financial market performance, and general economic conditions as well as
particular circumstances affecting the businesses of individual borrowers and tenants.
Significant continued financial and credit
market volatility, changes in interest rates and credit spreads, credit
defaults, market illiquidity, declines in equity prices, and declines in
general economic conditions, either alone or in combination, could have a
material adverse impact on the Companys results of operations, financial
condition or cash flows through realized losses, impairments and changes in
unrealized loss positions. In addition,
market volatility can make it difficult for the Company to value certain of its
assets, especially if trading becomes less frequent. Valuations may include assumptions or
estimates that may have significant period-to-period changes that could have an
adverse impact on the Companys results of operations or financial condition.
Credit market volatility or disruption could
adversely impact the Companys financial condition or results from operations.
The Companys statutory surplus is also impacted by widening credit
spreads as a result of the accounting for the assets and liabilities on its
fixed market value adjusted (MVA) annuities. Statutory separate account
assets supporting the fixed MVA annuities are recorded at fair value. In
determining the statutory reserve for the fixed MVA annuities, the Company is
required to use current crediting rates in the U.S. In many capital market
scenarios, current crediting rates in the U.S. are highly correlated with
market rates implicit in the fair value of statutory separate account assets.
As a result, the change in the statutory reserve from period to period will
likely substantially offset the change in the fair value of the statutory
separate account assets. However, in periods of volatile credit markets, such
as those the Company is now experiencing, actual credit spreads on investment
assets may increase sharply for certain sub-sectors of the overall credit
market, resulting in statutory separate account asset market value losses. As
actual credit spreads are not fully reflected in current crediting rates in the
U.S., the calculation of statutory reserves will not substantially offset the
change in fair value of the statutory separate account assets resulting in
reductions in statutory surplus. This has resulted and may continue to result
in the need to devote significant additional capital to support the product.
Disruption of the capital and credit markets
could negatively affect the Companys ability to meet its liquidity needs.
The Company needs liquidity to meet its obligations to its
policyholders and its debt holders, and to pay its operating expenses. The Companys sources of liquidity include
insurance premiums, annuity considerations, deposit funds, cash flow from
investments and assets, and other income from its operations. In normal credit and capital market
conditions, the Companys sources of liquidity also include a variety of short
and long-term borrowing arrangements, including issuing debt securities, as
well as raising capital by issuing a variety of equity securities.
When the credit and capital markets are disrupted as they have been
recently, the Company may not be able to borrow or raise equity capital, or the
cost of borrowing or raising equity capital may be prohibitively high. If the Companys internal sources of
liquidity are inadequate during such periods, the Company could suffer negative
effects from not being able to borrow or raise capital, or from having to do so
on unfavorable terms. The negative
effects could include being forced to sell assets at a loss, a lowering of the
Companys credit ratings and the financial strength ratings of its insurance
subsidiaries, and the possibility that customers, lenders, shareholders,
ratings agencies or regulators develop a negative perception of the Companys
financial prospects, which could lead to further adverse effects on the
Company.
Difficult conditions in the economy generally
could adversely affect the Companys business and results from operations.
A general economic slowdown could adversely affect the Company in the
form of consumer behavior and pressure on the Companys investment
portfolios. Consumer behavior could
include decreased demand for the Companys products and elevated levels of
policy lapses, policy loans, withdrawals and surrenders. The Companys investment and mortgage loan
portfolios could be adversely affected as a result of deteriorating financial
and
91
Table of Contents
business conditions affecting the issuers of the securities in the
Companys investment portfolio and the Companys commercial mortgage loan
borrowers and their tenants.
There can be no assurance that the actions of
the U.S. Government or other governmental and regulatory bodies for the purpose
of stabilizing the financial markets will achieve the intended effect.
On October 3, 2008, President Bush signed the Emergency Economic
Stabilization Act of 2008 (the EESA) into law. Pursuant to the EESA, the U.S. Treasury has
the authority to, among other things, purchase up to $700 billion of securities
from financial institutions for the purpose of stabilizing the financial
markets. Under EESA and the Troubled
Asset Relief Program (TARP) Capital Purchase Plan, the U.S. Treasury has
begun making equity investments in U.S. banks.
Under EESA, Treasury has the power to expand its investments to include
insurers, and there are reports that the Treasury is considering such action. There are media reports that Treasury may require
any participating insurance company to be operated by either a federally
regulated financial institution holding company or a savings and loan holding
company, which the Company is not.
Treasury is addressing an unprecedented situation and, as a result, the
situation is fluid and subject to change.
Assuming that Treasury makes capital investments in insurers, an
investment by Treasury could be perceived as a signal of confidence that an
insurance firm will survive the current difficult financial market conditions,
where the failure to receive an investment could be perceived as a negative
signal to customers, investors, regulators and others and could serve to
destabilize the insurer. The Company
cannot predict what actions Treasury or other governmental and regulatory
bodies may take, nor can there be any assurance as to what impact any
governmental or regulatory actions will have on the financial markets, the
economy or the Company.
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds
During the quarter ended September 30, 2008, the Company issued no
securities in transactions which were not registered under the Securities Act
of 1933, as amended (the Act).
Issuer Purchases of Equity Securities
In May 2004, the Company announced the
initiation of its $100 million share repurchase program, which commenced
execution on February 12, 2008. On May 7,
2007, the Board of Directors extended the share repurchase program through May 6,
2010. In the first quarter of 2008, the
Company purchased 450,800 shares as part of the publicly announced program, at
an average price of $38.00. There were
no shares repurchased during the second or third quarter of 2008. The approximate value of shares that may yet
be purchased under the program is $82.9 million.
Item 6. Exhibits
Exhibit 31(a)
|
-
|
Certification
Pursuant to §302 of the Sarbanes Oxley Act of 2002.
|
|
|
|
Exhibit 31(b)
|
-
|
Certification
Pursuant to §302 of the Sarbanes Oxley Act of 2002.
|
|
|
|
Exhibit 32(a)
|
-
|
Certification
Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes
Oxley Act of 2002.
|
|
|
|
Exhibit 32(b)
|
-
|
Certification
Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes
Oxley Act of 2002.
|
|
|
|
Exhibit 99
|
-
|
Safe Harbor
for Forward Looking Statements.
|
92
Table of Contents
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
|
|
PROTECTIVE LIFE CORPORATION
|
|
|
|
Date: November 6,
2008
|
|
/s/ Steven G. Walker
|
|
|
Steven G. Walker
|
|
|
Senior Vice President, Controller
|
|
|
and Chief Accounting Officer
|
93
Planet Labs PBC (NYSE:PL)
Historical Stock Chart
From May 2024 to Jun 2024
Planet Labs PBC (NYSE:PL)
Historical Stock Chart
From Jun 2023 to Jun 2024