Item 1. Business Protective Life and Annuity Insurance Company (“the Company”), a stock life insurance company, was founded in 1978. Since 1983, all outstanding shares of the Company’s common stock have been owned by Protective Life Insurance Company (“Protective”), which is a wholly-owned subsidiary of Protective Life Corporation (“PLC”), an insurance holding company whose common stock is traded on the New York Stock Exchange under the symbol “PL”. All outstanding shares of the Company’s preferred stock are owned by PLC. The Company is authorized to transact insurance business, as an insurance company or a reinsurance company, in 49 states, including New York.
PLC through its subsidiaries provides financial services through the production, distribution, and administration of insurance and investment products. PLC through its subsidiaries operates business segments each having a strategic focus which can be grouped into three general categories: life insurance, retirement savings and investment products, and specialty insurance products. PLC’s operating segments are Life Marketing, Acquisitions, Stable Value Products, Annuities, and Asset Protection.
The Company, since it is licensed in the State of New York, is the entity through which PLC markets, distributes, and services insurance and annuity products in New York. As of December 31, 2002, the Company was involved in the businesses of four of PLC’s operating segments: Life Marketing, Acquisitions, Asset Protection, and Annuities. The Company has an additional business segment which is described herein as the Corporate and Other segment.
Protective has entered into an intercompany guaranty agreement, enforceable by the Company or its successors, whereby Protective has guaranteed the Company’s payment of claims made by the holders of Company policies according to the terms of such policies. The guarantee will remain in force until the earlier of (a) when the Company achieves a claims-paying rating equal to or better than Protective without the benefit of any inter-company guaranty agreement or (b) 90 days after the guaranty agreement is revoked by written instrument; provided, however, even after any revocation or termination by such notice, the guarantee shall remain effective as to policies issued during the existence of the guaranty agreement.
Item 2.
Item 2. Properties The Company has no properties. The Company has contracts with PLC and Protective under which it receives investment, legal, and data processing services on a fee basis and other managerial and administrative services on a shared cost basis.
Protective’s administrative office building is located at 2801 Highway 280 South, Birmingham, Alabama 35223.
Item 3.
Item 3. Legal Proceedings To the knowledge and in the opinion of management, there are no material pending legal proceedings, other than routine litigation incidental to the business of the Company, to which the Company or any of its affiliates is a party or of which any of its affiliates’ properties is subject. For additional information regarding legal proceedings see Note E to the financial statements included herein.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not required in accordance with General Instruction I(2)(c).
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Share-Owner Matters The Company is a wholly-owned subsidiary of Protective. All of the preferred stock issued by the Company is owned by PLC. Therefore, neither the Company’s common stock nor its preferred stock is publicly traded.
At December 31, 2002, $91.3 million of share-owners’ equity, excluding net unrealized gains and losses, represented net assets of the Company that cannot be transferred to Protective in the form of dividends, loans, or advances.
Insurers are subject to various state statutory and regulatory restrictions on the insurers’ ability to pay dividends. In general, dividends up to specific levels are considered ordinary and may be paid thirty days after written notice to the insurance commissioner of the state of domicile unless such commissioner objects to the dividend prior to the expiration of such period. Dividends in larger amounts are considered extraordinary and are subject to affirmative prior approval by such commissioner. The maximum amount that would qualify as ordinary dividends to Protective by the Company in 2003 is estimated to be $12.1 million.
In 2002, the Company declared and paid a cash dividend on common stock of $14.7 million. In 2001, the Company declared and paid a cash dividend on common stock of approximately $11.9 million. Preferred dividends of $50,000 were paid in 2002. Preferred dividends of $1.0 million were paid in 2001. The Company expects to continue to be able to pay cash dividends, subject to its earnings, financial condition and other relevant factors.
Item 6.
Item 6. Selected Financial Data Not required in accordance with General Instruction I(2)(a).
Item 7.
Item 7. Management's Narrative Analysis of the Results of Operations In accordance with General Instruction I(2)(a), the Company includes the following analysis with the reduced disclosure format.
Forward-Looking Statements - Cautionary Language This report reviews the Company’s financial condition and results of operations. Historical information is presented and discussed. 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,” 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 the Company cannot give assurances that such statements will prove to be correct. Given these risks and uncertainties, undue reliance should not be placed on forward-looking statements as a prediction of actual results.
Critical Accounting Policies The Company’s 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 financial statements. A discussion of the various critical accounting policies is presented below.
The Company incurs significant costs in connection with acquiring new insurance business. These costs, which vary with and are primarily related to the production of new business and coinsurance of blocks of policies, are deferred. The recovery of such costs is dependent on the future profitability of the related policies. The amount of future profit is dependent principally on investment returns, mortality, morbidity, persistency, and expenses to administer the business and certain economic variables, such as inflation. These factors enter into management’s estimates of future profits which generally are used to amortize certain of such costs. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future profits are less than the unamortized deferred amounts.
The Company has a deferred policy acquisition costs asset of approximately $1 million related to its variable annuity product lines with an account balance of $13.2 million at December 31, 2002. The Company monitors the rate of amortization of the deferred policy acquisition costs associated with its variable annuity product line. The methodologies employ varying assumptions about how much and how quickly the stock markets will recover from their current depressed levels. The primary assumptions used to project future profits as part of the recoverability analysis include: a long-term equity market growth rate of 8%, reversion to the mean methodology with a reversion to the mean cap rate of 13%, reversion to the mean period of 5 years, and an amortization period of 20 years. A recovery in equity markets, or methodologies and assumptions that anticipate a recovery, result in lower amounts of amortization, and a worsening of equity markets result in higher amounts of amortization.
Establishing an adequate liability for the Company’s obligations to its policyholders requires the use of assumptions. Liabilities for future policy benefits on traditional life insurance products requires the use of assumptions relative to future investment yields, mortality, persistency and other assumptions based on the Company’s experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation.
The Company also establishes liabilities for guaranteed minimum death benefits (GMDB) on its variable annuity products. The methods used to estimate the liabilities employ assumptions about mortality and the performance of equity markets. The Company assumes mortality of 60% of the National Association of Insurance Commissioners 1994 Variable Annuity GMDB Mortality Table to reflect improvements in mortality since the table was derived and other factors. Future declines in the equity market would increase the Company’s GMDB liability. Differences between the actual experience and the assumptions used result in variances in profit and could result in losses.
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 on established markets. For example, assessing the value of some investments requires the Company to 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 overall by underlying investments in a wide variety of issuers. The Company’s specific accounting policies related to its invested assets are discussed in the notes to the financial statements.
The assessment of potential obligations for tax, regulatory, and litigation matters inherently involve a variety of estimates of potential future outcomes. The Company makes such estimates after consultation with its advisors and a review of available facts.
Revenues
The following table sets forth revenues by source for the periods shown:
Year Ended Percentage December 31 Increase (Decrease) ----------------------------------- ----------
2002 2001 ---- ----
Premiums and policy fees........................... $27,558,996 $29,086,430 (5.3)% Net investment income.............................. 36,245,837 33,876,409 7.0 Realized investment losses......................... (696,209) (1,113,538) 37.5 Other income....................................... 11,087 5,731 93.5 ----------- ----------- $63,119,711 $61,855,032 =========== ===========
Premiums and policy fees, net of reinsurance (“premiums and policy fees”) decreased $1.5 million or 5.3% in 2002 as compared to 2001. Premiums and policy fees in the Acquisitions segment are expected to decline with time unless new acquisitions are made. There were no new acquisitions made in 2002, resulting in a decrease of $1.4 million. Premiums and policy fees from the Asset Protection segment were $0.3 million lower in 2002 as compared to 2001. The Annuities segment's premiums in 2002 were approximately the same as in 2001. The Company became involved with PLC's Life Marketing segment in 2002 which added $0.1 million in premiums for the year.
Net investment income for 2002 was $2.4 million or 7.0% higher than for the preceding year primarily due to increases in the average amount of invested assets. The percentage earned on average cash and investments was 6.3% in 2002 and 6.6% in 2001.
The Company generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs. However, the Company may sell any of its investments to maintain proper matching of assets and liabilities. Accordingly, the Company has classified its fixed maturities and certain other securities as “available for sale.” The sales of investments that have occurred generally result from portfolio management decisions to maintain proper matching of assets and liabilities.
Realized investment gains in 2002 were approximately $2.7 million and realized investment losses were approximately $3.4 million. During 2002, the Company recorded other than temporary impairments in its investments of $4.3 million.
Each quarter the Company reviews investments with material unrealized losses and tests for other-than-temporary impairments. Management analyzes various factors to determine if any specific other than temporary asset impairments exist. Once a determination has been made that a specific other-than-temporary impairment exists, a realized loss is recognized and the cost basis of the impaired asset is adjusted to its fair value. An other-than-temporary impairment loss is recognized based upon all relevant facts and circumstances for each investment. With respect to unrealized losses due to issuer-specific events, the Company considers the creditworthiness and financial performance of the issuer and other available information. With respect to unrealized losses that are not due to issuer-specific events, such as losses due to interest rate fluctuations, general market conditions or industry-related events, the Company considers its intent and ability to hold the investment to allow for a market recovery or to maturity together with an assessment of the likelihood of full recovery.
Income Before Income Tax
Management evaluates the results of the Company’s segments on a before-income-tax basis as adjusted for certain items which management believes are not indicative of the Company’s core operations. Segment operating income (loss) excludes net realized investment gains and losses and the related amortization of deferred policy acquisition costs because fluctuations in these items are due to changes in interest rates and other financial market factors instead of mortality and morbidity. Also, operating segment income (loss) excludes any net gains or losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes, and any other items, that, in each case, are neither normal nor recurring. Although the items excluded from segment operating income (loss) may be significant components in understanding and assessing the Company’s overall financial performance, management believes that operating segment income (loss) enhances an investor’s understanding of the Company’s results of operations by highlighting the income (loss) attributable to the normal, recurring operations of the insurance business (i.e., mortality and morbidity), consistent with industry practice. However, the Company’s segment income (loss) measures may not be comparable to similarly titled measures reported by other companies. Segment income (loss) should not be construed as a substitute for net income (loss) determined in accordance with accounting principles generally accepted in the United States of America (GAAP). “Total income from continuing operations before income tax” is a GAAP measure to which the non-GAAP measure “total operating income” may be compared. Unlike total operating income, total income before income tax includes net realized investment gains and losses and the related amortization of deferred policy acquisition costs.
The following table sets forth operating income or loss and income or loss before income tax by business segment for the periods shown:
Operating Income (Loss) and Income (Loss) Before Income Tax Year Ended December 31 ---------------------------------------------------- 2002 2001 ---- ---- Operating Income (Loss)(1) Life Insurance Life Marketing................................ $ 142,070 Acquisitions.................................. 11,732,882 $11,538,404 Specialty Insurance Products Asset Protection.............................. 1,593,905 976,656 Retirement Savings and Investment Products Annuities..................................... (536,584) (646,706) Corporate and Other................................ 1,010,857 1,531,512 ------------ ----------- Total operating income............................. 13,943,130 13,399,866 ============ =========== Realized Investment Gains (Losses) Annuities..................................... 79,719 Unallocated Realized Investment Gains (Losses)..... (775,928) (1,113,538) ------------ ----------- Total.............................................. (696,209) (1,113,538) ------------ ----------- Income (Loss) Before Income Tax Life Insurance Life Marketing................................ 142,070 Acquisitions.................................. 11,732,882 11,538,404 Specialty Insurance Products Asset Protection.............................. 1,593,905 976,656 Retirement Savings and Investment Products Annuities..................................... (456,865) (646,706) Corporate and Other................................ 1,010,857 1,531,512 Unallocated Realized Investment Gains (Losses)..... (775,928) (1,113,538) ------------ ------------- Total income from continuing operations before income tax....................................... $13,246,921 $12,286,328 ============ =============
(1) Income (loss) from continuing operations before income tax excluding realized investment gains and losses and related amortization of deferred policy acquisition costs.
The Company became involved with PLC's Life Marketing segment during 2002, resulting in additional pretax earnings of $0.1 million.
Pretax earnings from the Acquisitions segment increased $0.2 million in 2002 as compared to 2001. Earnings from the Acquisitions segment are normally expected to decline over time (due to the lapsing of policies resulting from deaths of insureds or terminations of coverage) unless new acquisitions are made. However, the decline in premium income was more than offset by increased net investment income and increases in other income.
The Asset Protection segment’s 2002 pretax earnings increased $0.6 million as compared to 2001 primarily due to ceding commissions related to reinsurance arrangements with affiliates. The reinsurance arrangements are more fully discussed in Note J to the Company's financial statements included herein.
The Annuities segment’s 2002 pretax loss decreased $0.1 million primarily due to an increase in net investment income on capital. The Annuities segment’s future results may be negatively affected by a slow economy. Volatile equity markets could negatively affect sales of variable annuities and the fees the segment assesses on variable annuity contracts. Lower interest rates could negatively affect sales of fixed annuities. In this segment, equity market volatility may create uncertainty regarding the level of future profitability in the variable annuity business and the related rate of amortization of deferred policy acquisition cost. Also, beginning in January 2003, the Company is no longer marketing variable annuity products.
The Company offers a guaranteed minimum death benefit feature (GMDB) on its variable annuity products. The Company’s accounting policy has been to calculate its total exposure to GMDB, and then apply a mortality factor to determine the amount of claims that could be expected to occur in the coming twelve months. The Company then accrues to that amount over four quarters. At December 31, 2002, the total GMDB reserve was $0.2 million, an increase of $0.1 million from December 31, 2001. At December 31, 2002, the total guaranteed amount payable under the GMDB feature based on variable annuity account balances at December 31, 2002, was $3.4 million, compared to $1.7 million at December 31, 2001. Based on variable annuity account balances as of January 31, 2003, the total guaranteed dollar amount payable under the GMDB feature was approximately $3.5 million.
In accordance with statutory accounting practices prescribed or permitted by regulatory authorities (which require the assumption that equity markets will significantly worsen), the Company reported GMDB related policy liabilities and accruals of $0.2 million at December 31, 2002.
The Corporate and Other segment consists of net investment income and expenses not identified with the preceding business segments. Pretax earnings in 2002 decreased $0.5 million over 2001, primarily due to decreased net investment income on capital.
Income Tax Expense
The following table sets forth the effective income tax rates for the periods shown:
Year Ended Effective Income December 31 Tax Rates ----------- ----------------
2002................................... 34.9% 2001................................... 33.9
Management’s current estimate of the effective income tax rate for 2003 is 34.9%.
Discontinued Operations On December 31, 2001, PLC completed the sale to Fortis, Inc. of substantially all of its Dental Benefits Division (Dental Division), and discontinued certain other remaining Dental Division related operations, primarily other health insurance lines. In 2000, the loss from discontinued operations, net of income tax, was $51,006. In 2001, income from discontinued operations was $158,889 and the gain from the sale of discontinued operations was $1,625,000, both net of income tax.
Change in Accounting Principle On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." The adoption of SFAS No. 133 resulted in a cumulative after-tax charge to net income of approximately $0.3 million.
Net Income The following table sets forth net income from continuing operations before cumulative effect of change in accounting principle for the periods shown:
Net Income ---------------------------------------- Percentage Year Ended Increase December 31 Amount (Decrease) ------------ ------ -----------
2002...................................... $8,624,649 6.2% 2001...................................... $8,121,263 (7.7)
Net income from continuing operations before cumulative effect of change in accounting principle in 2002 increased 6.2%, compared to 2001, reflecting improved operating earnings in the Life Marketing, Acquisitions, Asset Protection and the Annuities segments offset by lower operating earnings in the Corporate and Other segment.
Recently Issued Accounting Standards For information regarding recently issued accounting standards see Note A to the financial statements included herein.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Investments
The Company generally purchases its investments with the intent to hold to maturity by purchasing investments that match future cash flow needs. However, the Company may sell any of its investments to maintain proper matching of assets and liabilities. Accordingly, the Company has classified its fixed maturities and certain other securities as “available for sale.”
The Company’s investments in debt securities are reported at market value, and investments in mortgage loans are reported at amortized cost. At December 31, 2002, the Company’s fixed maturity investments (bonds) had a market value of $488.7 million, which is 4.7% above amortized cost of $466.9 million. The Company had $1.8 million in mortgage loans at December 31, 2002. While the Company’s mortgage loans do not have quoted market values, at December 31, 2002, the Company estimates the market value of its mortgage loans to be $1.9 million (using discounted cash flows from the next call date), which is 3.9% above amortized cost.
At December 31, 2001, the Company’s fixed maturity investments had a market value of $445.7 million, which was 0.7% below amortized cost of $442.6 million. The Company estimated the market value of its mortgage loans to be $2.9 million at December 31, 2001, which was 5.7% above amortized cost of $2.7 million.
The approximate percentage distribution of the Company's fixed maturity investments by quality rating at December 31 is as follows:
Rating 2002 2001 ------ ---- ----
AAA........................................... 8.3% 6.0% AA............................................ 7.2 5.4 A............................................. 38.2 44.0 BBB........................................... 40.7 42.2 BB or Less.................................... 5.6 2.4 ----- ----- 100.0% 100.0% ===== =====
The following table sets forth the estimated market values of the Company’s fixed maturity investments and mortgage loans resulting from a hypothetical immediate 1 percentage point increase in interest rates from levels prevailing at December 31, and the percent change in market value the following estimated market values would represent.
Estimated Market Values Resulting From An Immediate 1 Percentage Point Increase In Interest Rates
Percent At December 31, 2002 Amount Change -------------------- ------ -------
Fixed maturities....................................... $458,352,064 (6.2)% Mortgage loans......................................... 1,847,861 (0.8)
At December 31, 2001 ---------------------
Fixed maturities....................................... $425,089,252 (4.6)% Mortgage loans......................................... 2,817,280 (1.9)
Estimated market values were derived from the durations of the Company’s fixed maturities and mortgage loans. Duration measures the relationship between changes in market value to changes in interest rates. While these estimated market values generally provide an indication of how sensitive the market values of the Company’s fixed maturities and mortgage loans are to changes in interest rates, they do not represent management’s view of future market changes, and actual market results may differ from these estimates.
During 2002, the Company recorded pretax other than temporary impairments in its investments of $4.3 million.
The Company’s 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, the Company engages in ongoing risk management to safeguard against and limit any further risk to its investment portfolio. Special attention is given to correlative risks within specific industries, related parties and business markets.
Once management has determined that a particular investment has suffered an other-than-temporary impairment, the asset is written down to its estimated fair value. The Company generally considers 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 of the Company to hold the investment until recovery, 5) the time period during which the decline has occurred, 6) an economic analysis of the issuer’s 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 and continued viability of the issuer are significant measures.
The Company generally considers a number of factors relating to the issuer in determining the financial strength, liquidity, and recoverability of an issuer. These include but are not limited to: available collateral, tangible and intangible assets that might be available to repay debt, operating cash flows, financial ratios, access to capital markets, quality of management, market position, exposure to litigation or product warranties, and the effect of general economic conditions on the issuer.
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. The Company continuously monitors these factors as they relate to the investment portfolio in determining the status of each investment. The majority of unrealized losses can be attributed to interest rate fluctuations and are, therefore, deemed temporary. As indicated above, when the Company’s investment management deems an investment’s market value decline as other than temporary, it is written down to estimated market value. In all cases, management will continue to carefully review and monitor each security.
Liabilities
Many of the Company’s products contain surrender charges and other features that reward persistency and penalize the early withdrawal of funds. Certain annuity contracts have market-value adjustments that protect the Company against investment losses if interest rates are higher at the time of surrender than at the time of issue.
At December 31, 2002, the Company had $60.1 million of annuity account balances with an estimated fair value of $63.0 million (using surrender value).
At December 31, 2001, the Company had $47.3 million of annuity account balances with an estimated fair value of $46.4 million.
The following table sets forth the estimated fair values of the Company’s annuity account balances resulting from a hypothetical immediate 1 percentage point decrease in interest rates from levels prevailing at December 31, and the percent change in fair value the following estimated fair values would represent.
Estimated Fair Values Resulting From An Immediate 1 Percentage Point Decrease In Interest Rates
Percent At December 31, 2002 Amount Change -------------------- ------ --------
Annuity account balances............................... $65,819,278 4.5%
At December 31, 2001 --------------------
Annuity account balances............................... $48,484,093 4.5%
Estimated fair values were derived from the durations of the Company's annuity account balances. While these estimated fair values generally provide an indication of how sensitive the fair values of the Company's annuity account balances are to changes in interest rates, they do not represent management's view of future market changes, and actual market results may differ from these estimates.
Approximately one-fourth of the Company's liabilities relate to products (primary whole life insurance), the profitability of which could be affected by changes in interest rates. The effect of such changes in any one year is not expected to be material.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Accountants........................................................................ Statements of Income for the years ended December 31, 2002, 2001, and 2000............................... Balance Sheets as of December 31, 2002 and 2001.......................................................... Statements of Share-Owners' Equity for the years ended December 31, 2002, 2001, and 2000..................................................................... Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000........................... Notes to Financial Statements............................................................................ Financial Statement Schedules: Schedule III-- Supplementary Insurance Information...................................................... Schedule IV-- Reinsurance...............................................................................
All other schedules to the financial statements required by Article 7 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Directors and Share Owners
Protective Life and Annuity Insurance Company
Birmingham, Alabama
In our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Protective Life and Annuity Insurance Company at December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note A of the Notes to the Financial Statements, effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”.
PricewaterhouseCoopers LLP
Birmingham, Alabama
March 3, 2003
PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
STATEMENTS OF INCOME
Year Ended December 31 ------------------------------------------------- 2002 2001 2000 ---- ---- ----
REVENUES Premiums and policy fees.............................................. $51,293,397 $47,707,465 $47,876,379 Reinsurance ceded..................................................... (23,734,401) (18,621,035) (17,319,246) ------------ ------------ ------------ Net of reinsurance ceded............................................ 27,558,996 29,086,430 30,557,133 Net investment income................................................. 36,245,837 33,876,409 31,686,448 Realized investment gains (losses).................................... (696,209) (1,113,538) 42,148 Other income (loss)................................................... 11,087 5,731 (6,551) ------------ ------------ ------------ 63,119,711 61,855,032 62,279,178
BENEFITS AND EXPENSES Benefits and settlement expenses (net of reinsurance ceded: 2002-$18,296,707; 2001-$13,449,131; 2000-$15,454,285)................. 33,299,046 33,344,929 32,765,035 Amortization of deferred policy acquisition costs..................... 8,639,183 7,034,480 6,765,446 Other operating expenses (net of reinsurance ceded: 2002-$31,857,142; 2001-397,265; 2000-$286,602)........................................ 7,934,561 9,189,295 9,321,713 ------------ ------------ ------------ 49,872,790 49,568,704 48,852,194 ------------ ------------ ------------
Income from continuing operations before income tax....................... 13,246,921 12,286,328 13,426,984 ------------ ------------ ------------
INCOME TAX EXPENSE........................................................ 4,622,272 4,165,065 4,632,310 ------------ ------------ ------------
Net income from continuing operations before cumulative effect of change in accounting principle...................................................... 8,624,649 8,121,263 8,794,674 Income (loss) from discontinued operations, net of income tax............. 158,889 (51,006) Gain from sale of discontinued operations, net of income tax.............. 1,625,000 ------------ ------------ ------------
Net income before cumulative effect of change in accounting principle..... 8,624,649 9,905,152 8,743,668 Cumulative effect of change in accounting principle, net of income tax.... (284,968) ------------ ------------ ------------
Net income................................................................ $8,624,649 $ 9,620,184 $ 8,743,668 ============ ============ ============
See notes to financial statements.
PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
BALANCE SHEETS
December 31 ---------------------------------- 2002 2001 ---- ----
ASSETS Investments: Fixed maturities, at market (amortized cost: 2002 - $466,924,086; 2001 - $442,583,178) $488,701,807 $445,730,493 Mortgage loans on real estate....................................................... 1,793,590 2,717,495 Other long term investments......................................................... 572,818 470,030 Policy loans........................................................................ 54,807,151 54,565,016 Short-term investments.............................................................. 178,805,245 12,000,000 ------------ ------------ Total investments............................................................... 724,680,611 515,483,034 Cash 1,669,532 4,284,257 Accrued investment income................................................................ 8,382,989 8,432,689 Accounts and premiums receivable, net of allowance for uncollectible amounts (2002-$7,000; 2001 - $7,000)................................................ 325,479 7,888,382 Reinsurance receivables.................................................................. 92,256,257 20,642,570 Deferred policy acquisition costs........................................................ 104,779,582 118,997,438 Other assets............................................................................. 21,955 19,689 Assets related to separate accounts Variable annuity.................................................................... 8,382,367 9,001,016 ------------ ------------ $940,498,772 $684,749,075 ============ ============
LIABILITIES Policy liabilities and accruals: Future policy benefits and claims................................................... $517,624,864 $458,568,381 Unearned premiums................................................................... 26,349,028 7,767,028 ------------ ------------ 543,973,892 466,335,409 Annuity deposits......................................................................... 60,080,082 47,324,337 Other policyholders' funds............................................................... 6,025,066 5,874,932 Funds held-coinsurance................................................................... 89,552,015 2,944,827 Other liabilities........................................................................ 14,214,260 14,445,632 Deferred income taxes.................................................................... 25,533,038 17,077,829 Liabilities related to separate accounts Variable annuity.................................................................... 8,382,367 9,001,016 ------------ ------------ Total liabilities................................................................ 747,760,720 563,003,982 ============ ============
COMMITMENTS AND CONTINGENT LIABILITIES-- NOTE E
SHARE-OWNERS' EQUITY Preferred Stock, $1.00 par value, shares authorized, issued and outstanding: 2,000........................................... 2,000 2,000 Common Stock, $10.00 par value Shares authorized: 2002 and 2001 - 500,000 Shares issued and outstanding: 2002 and 2001 - 250,000............................... 2,500,000 2,500,000 Additional paid-in capital............................................................... 171,386,324 101,386,324 Retained earnings........................................................................ 9,343,166 15,468,517 Accumulated other comprehensive income: Net unrealized gains (losses) on investments (net of income tax: 2002-$5,118,918; 2001 - $1,285,982)............................. 9,506,562 2,388,252 ------------ ------------ Total share-owners' equity.......................................................... 192,738,052 121,745,093 ------------ ------------ $940,498,772 $684,749,075 ============ ============
See notes to financial statements.
PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
STATEMENTS OF SHARE-OWNERS' EQUITY
Net Unrealized Additional Gains Total Preferred Common Paid-In Retained (Losses) On Share-Owners' Stock Stock Capital Earnings Investments Equity --------- --------- ----------- ---------- ------------- ------------ Balance, December 31, 1999.............. $2,000 $2,500,000 $101,386,324 $22,754,665 $(11,344,864) $115,298,125 Net income for 2000................... 8,743,668 8,743,668 Change in net unrealized gains/losses on investments (net of income tax: $4,363,726)..... 8,104,062 8,104,062 Reclassification adjustment for amounts included in net income (net of income tax: ($14,752))...... (27,396) (27,396) ------------- Comprehensive income for 2000......... 16,820,334 ------------- Common dividends ($51 per share)...... (12,750,000) (12,750,000) --------- --------- ----------- ---------- ------------- ------------ Balance, December 31, 2000.............. 2,000 2,500,000 101,386,324 18,748,333 (3,268,198) 119,368,459 ------------ Net income for 2001................... 9,620,184 9,620,184 Change in net unrealized gains/losses on investments (net of income tax: $2,502,598)..... 4,647,682 4,647,682 Reclassification adjustment for amounts included in net income (net of income tax: $389,738)........ 723,800 723,800 Transition adjustment on derivative financial instruments (net of income tax: $153,444)....................... 284,968 284,968 ----------- Comprehensive income for 2001......... 15,276,634 ----------- Common dividends ($47.60 per share)... (11,900,000) (11,900,000) Preferred dividends ($500.00 per share) (1,000,000) (1,000,000) --------- --------- ----------- ---------- ------------- ------------ Balance, December 31, 2001 2,000 2,500,000 101,386,324 15,468,517 2,388,252 121,745,093 ------------ Net income for 2002................... 8,624,649 $8,624,649 Change in net unrealized gains/losses on investments (net of income tax: $3,589,263)...... 6,665,774 6,665,774 Reclassification adjustment for amounts included in net income (net of income tax: $243,673)........ 452,536 452,536 ------------ Comprehensive income for 2002......... 15,742,959 ------------ Preferred dividends ($25 per share)... (50,000) (50,000) Common dividends ($58.80 per share)... (14,700,000) (14,700,000) Capital contribution.................. 70,000,000 70,000,000 --------- --------- ----------- ---------- ------------- ------------ Balance, December 31, 2002.............. $2,000 $2,500,000 $171,386,324 $ 9,343,166 $9,506,562 $192,738,052 ========= ========= =========== ========== ============= ============
See notes to financial statements.
PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
STATEMENTS OF CASH FLOWS
December 31 ----------------------------------------------------- 2002 2001 2000 ---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES Net income.................................................................. $ 8,624,649 $ 9,620,184 $ 8,743,668 Adjustments to reconcile net income to net cash provided by operating activities: 696,209 1,113,538 (42,148) Realized investment losses (gains)...................................... 8,639,183 7,034,480 6,765,446 Amortization of deferred policy acquisition costs....................... (2,161,267) (1,792,738) (2,593,858) Capitalization of deferred policy acquisition costs..................... 0 (1,625,000) 0 Gain on sale of discontinued operations................................. 4,622,272 5,121,553 4,605,444 Deferred income taxes................................................... 29,693,764 37,752,197 33,753,870 Interest credited to universal life and investment products............. (34,641,740) (36,063,990) (37,777,093) Policy fees assessed on universal life and investment products.......... (64,001,084) (2,959,990) 4,751,257 Change in accrued investment income and other receivables............... Change in policy liabilities and other policyholder funds of traditional life and health products.............................................. 70,326,971 1,495,557 3,848,851
Change in funds held-coinsurance........................................ 86,607,188 (239,299) (381,634) Change in other liabilities............................................. (231,372) (3,579,771) 3,253,106 Other (net)............................................................. (2,266) (1,013,986) 432,557 ------------ ------------- ------------ Net cash provided by operating activities....................................... 108,172,507 14,862,735 25,359,466 ------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES Maturities and principal reduction of investments: Investments available for sale.......................................... 76,794,609 134,614,161 401,392,138 Other................................................................... 1,174,629 415,557 845,893 Sale of investments: Investments available for sale.......................................... 265,621,383 103,958,267 11,251,538 Other................................................................... 0 0 1,197,324 Cost of investments acquired: Investments available for sale.......................................... (529,845,244) (262,462,048) (453,746,936) Sale of discontinued operations............................................. 0 2,500,000 0 ------------ ------------- ------------ Net cash used in investing activities........................................... (186,254,623) (20,974,063) (39,060,043) ------------ ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES Dividends to share owners................................................... (14,750,000) (12,900,000) (12,750,000) Capital contribution........................................................ 70,000,000 0 0 Investment product deposits and change in universal life deposits........... 69,229,610 56,941,071 47,248,477 Investment product withdrawals.............................................. (49,012,219) (34,810,896) (23,654,329) ------------ ------------- ------------ Net cash provided by financing activities................................... 75,467,391 9,230,175 10,844,148 ------------ ------------- ------------
INCREASE (DECREASE) IN CASH..................................................... (2,614,725) 3,118,847 (2,856,429) CASH AT BEGINNING OF YEAR....................................................... 4,284,257 1,165,410 4,021,839 ------------ ------------- ------------ CASH AT END OF YEAR............................................................. $ 1,669,532 $ 4,284,257 $ 1,165,410 ============ ============= ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION There was no cash paid during any of the periods presented related to interest on indebtedness or income taxes.
See notes to financial statements.
PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
Note A-- SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION The accompanying financial statements of Protective Life and Annuity Insurance Company (“the Company”) are prepared on the basis of accounting principles generally accepted in the United States of America. Such accounting principles differ from statutory reporting practices used by insurance companies in reporting to state regulatory authorities. (See also Note B.)
The Company was founded in 1978 as American Foundation Life Insurance Company. Effective March 1, 1999, the Company’s name was changed to Protective Life and Annuity Insurance Company. Since 1983, all outstanding shares of the Company’s common stock have been owned by Protective Life Insurance Company (“Protective”), which is a wholly-owned subsidiary of Protective Life Corporation (“PLC”), an insurance holding company domiciled in the state of Delaware. All outstanding shares of the Company’s preferred stock are owned by PLC.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make various estimates that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, as well as the reported amounts of revenues and expenses. Actual results could differ from these estimates.
NATURE OF OPERATIONS The Company, since it is licensed in the State of New York, is the entity through which PLC markets, distributes, and services insurance and annuity products in New York. The operating results of companies in the insurance industry have historically been subject to significant fluctuations due to changing competition, economic conditions, interest rates, investment performance, insurance ratings, and other factors.
RECENTLY ISSUED ACCOUNTING STANDARDS On January 1, 2001, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133, as amended by SFAS Nos. 137 and 138, requires the Company to record all derivative financial instruments, at fair value on the balance sheet. Changes in fair value of a derivative instrument are reported in net income or other comprehensive income, depending on the designated use of the derivative instrument. The adoption of SFAS No. 133 resulted in a cumulative after-tax charge to net income of $0.3 million and a cumulative after-tax increase to other comprehensive income of $0.3 million on January 1, 2001. Prospectively, the adoption of SFAS No. 133 may introduce volatility into the Company’s reported net income and other comprehensive income depending on future market conditions and the Company’s hedging activities.
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. The standard replaces the requirements to amortize goodwill to one that calls for an annual impairment test, among other provisions. The Company adopted SFAS No. 142 in the first quarter of 2002. The adoption of SFAS No. 142 did not have a material effect on the Company’s financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to have a material effect on the Company’s financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 requires that the same accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, expands the use of discontinued operations accounting to include more types of transactions and changes the timing of when discontinued operations accounting is applied. The Company adopted SFAS No. 144 on January 1, 2002, and the adoption did not have a material effect on the Company’s financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002.” SFAS No. 145 rescinds SFAS No. 4, which required companies to treat the extinguishment of debt as an extraordinary item. SFAS No. 145 requires companies to apply APB Opinion 30 when determining the accounting for the extinguishment of debt. The statement also rescinds and amends other statements to make various technical corrections and clarifications. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. The Company does not expect the adoption of SFAS 145 to have a material effect on the Company’s financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires companies to record a liability for a cost associated with an exit or disposal activity when the liability is incurred. The statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not expect the adoption of SFAS No. 146 to have a material effect on the Company’s financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of SFAS No. 123.” SFAS No. 148 amends SFAS No. 123 to offer alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. PLC adopted the fair value based method prescribed by SFAS No. 123 in 1995, therefore SFAS No. 148 will have no effect on the Company’s financial position or results of operations.
In November, 2002, the FASB issued FASB Interpretation No. (FIN) 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Others.” FIN 45 clarifies the requirements of SFAS No. 5 “Accounting for Contingencies” relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. The initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company does not expect FIN 45 to have a material effect on The Company’s financial position or results of operations.
In January, 2003, the FASB issued FIN 46 “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from the other parties. The Company does not expect the adoption of FIN 46 to have a material effect on the Company’s financial position or results of operations.
In May 2002, the Derivatives Implementation group of the FASB exposed for comment issue No. B36, “Bifurcation of Embedded Credit Derivatives” (DIG B36). DIG B36 would require the bifurcation of potential embedded derivatives within modified coinsurance and funds withheld coinsurance arrangements in which the terms require the future payment of a principal amount plus a return based on a specified proportion of the ceding company’s return on either its general account assets or a specified block of those assets. The proposed effective date of the implementation guidance in DIG B36 is for the first fiscal quarter beginning after June 15, 2003 and would be applied on a prospective basis. The Company is currently evaluating the impact of this pronouncement on its financial statements but does not anticipate a material impact on its financial condition or results of operations.
INVESTMENTS The Company has classified all of its investments in fixed maturities and short-term investments as “available for sale.”
Investments are reported on the following bases less allowances for uncollectible amounts on investments, if applicable:
* Fixed maturities (bonds and redeemable preferred stocks)-- at current market value. Where market values are unavailable, the Company obtains estimates from independent pricing services or estimates market value based upon a comparison to quoted issues of the same issuer or issues of other issuers with similar terms and risk characteristics.
* Mortgage loans--at unpaid balances, adjusted for loan origination costs, net of fees, and amortization of premiums or discount.
* Policy loans-- at unpaid balances.
* Other long-term investments-- at a variety of methods similar to those listed above, as deemed appropriate for the specific investment.
* Short-term investments-- at cost, which approximates current market value.
Estimated market values were derived from the durations of the Company’s fixed maturities and mortgage loans. Duration measures the relationship between changes in market value to changes in interest rates. While these estimated market values generally provide an indication of how sensitive the market values of the Company’s fixed maturities and mortgage loans are to changes in interest rates, they do not represent management’s view of future market changes, and actual market results may differ from these estimates.
Substantially all short-term investments have maturities of three months or less at the time of acquisition.
As prescribed by generally accepted accounting principles certain investments are recorded at their market values with the resulting unrealized gains and losses reduced by a related adjustment to deferred policy acquisition costs, net of income tax, reported as a component of share-owners’ equity. The market values of fixed maturities increase or decrease as interest rates fall or rise.
The Company believes that an insurance company’s balance sheet may be difficult to analyze without disclosing the effects of recording accumulated other comprehensive income (including unrealized gains and losses on investments). The carrying value of the Company’s investments, deferred policy acquisition costs, deferred income taxes and share-owners’ equity are all affected by recording unrealized gains and losses on investments, therefore these items are separately identified in the table below. The captions “all other assets” and “all other liabilities” represent the assets and liabilities unaffected by recording unrealized gains and losses on investments. The Company’s balance sheets at December 31, adjusted for the effects of recording accumulated other comprehensive income (including unrealized gains and losses on investments), are as follows:
2002 2001 ---- ----
Total investments................................... $702,933,934 $512,427,543 Deferred policy acquisition costs................... 111,900,779 118,378,695 All other assets.................................... 111,038,579 50,268,603 ------------ ------------ $925,873,292 $681,074,841 ============ ============
Deferred income taxes............................... $ 20,414,120 $ 15,791,847 All other liabilities............................... 722,227,682 545,926,153 ------------ ------------ 742,641,802 561,718,000 Share-owners' equity................................ 183,231,490 119,356,841 ------------ ------------ $925,873,292 $681,074,841 ============ ============
Realized gains and losses on sales of investments are recognized in net income using the specific identification basis.
CASH Cash includes all demand deposits reduced by the amount of outstanding checks and drafts. The Company has deposits with certain financial institutions which exceed federally insured limits. The Company has reviewed the creditworthiness of these financial institutions and believes there is minimal risk of a material loss.
DEFERRED POLICY ACQUISITION COSTS Commissions and other costs of acquiring traditional life and health insurance, credit insurance, universal life insurance, and investment products that vary with and are primarily related to the production of new business, have been deferred. Traditional life and health insurance acquisition costs are amortized over the premium-payment period of the related policies in proportion to the ratio of annual premium income to the present value of the total anticipated premium income. Credit insurance acquisition costs are being amortized in proportion to earned premium. Acquisition costs for universal life and investment products are amortized over the lives of the policies in relation to the present value of estimated gross profits before amortization. Under SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments,” the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates (equal to the rate used to compute liabilities for future policy benefits; currently 3.0% to 9.4%) it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from that assumed. Additionally, relating to SFAS No. 115, these costs have been adjusted by an amount equal to the amortization that would have been recorded if unrealized gains or losses on investments associated with the Company’s universal life and investment products had been realized.
The cost to acquire blocks of insurance representing the present value of future profits from such blocks of insurance is also included in deferred policy acquisition costs. The Company amortizes the present value of future profits over the premium payment period, including accrued interest of up to approximately 8.0%. The unamortized present value of future profits was approximately $106.5 million and $113.7 million at December 31, 2002 and 2001, respectively. During 2002, $7.2 million of present value of future profits was amortized. During 2001, $6.1 million of present value of future profits was amortized. No amounts were capitalized during 2002 or 2001.
The expected amortization of the present value of future profits for the next five years is as follows:
Year Expected Amortization ------ ----------------------
2003 $5,774,552 2004 5,553,514 2005 5,576,901 2006 5,698,837 2007 5,910,611
SEPARATE ACCOUNTS The assets and liabilities related to separate accounts in which the Company does not bear the investment risk are valued at market and reported separately as assets and liabilities related to separate accounts in the accompanying financial statements.
REVENUES AND BENEFITS EXPENSE • Traditional Life, Health, and Credit Insurance Products - Traditional life insurance products consist principally of those products with fixed and guaranteed premiums and benefits and include whole life insurance policies, term and term-like life insurance policies, limited-payment life insurance policies, and certain annuities with life contingencies. Life insurance and immediate annuity premiums are recognized as revenue when due. Health and credit insurance premiums are recognized as revenue over the terms of the policies. Benefits and expenses are associated with earned premiums so that profits are recognized over the life of the contracts. This is accomplished by means of the provision for liabilities for future policy benefits and the amortization of deferred policy acquisition costs. Gross premiums in excess of net premiums related to immediate annuities are deferred and recognized over the life of the policy.
Liabilities for future policy benefits on traditional life insurance products have been computed using a net level method including assumptions as to investment yields, mortality, persistency, and other assumptions based on the Company’s experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation. Reserve investment yield assumptions are graded and range from 2.5% to 7.0%. The liability for future policy benefits and claims on traditional life, health, and credit insurance products includes estimated unpaid claims that have been reported to the Company and claims incurred but not yet reported. Policy claims are charged to expense in the period in which the claims are incurred.
Activity in the liability for unpaid claims is summarized as follows:
2002 2001 2000 ---- ---- ----
Balance beginning of year.............................. $7,074,480 $ 7,372,438 $ 9,557,627 Less reinsurance.................................... 1,459,829 1,954,392 4,924,705 ---------- ----------- -----------
Net balance beginning of year.......................... 5,614,651 5,418,046 4,632,922 ---------- ----------- -----------
Incurred related to: Current year........................................... 11,448,215 11,883,729 11,780,396 Prior year............................................. 181,838 584,972 (213,798) ---------- ----------- ----------- Total incurred...................................... 11,630,053 12,468,701 11,566,598 ---------- ----------- -----------
Acquisitions and reserve transfers..................... (662,216)
Paid related to: Current year........................................... 10,612,857 9,454,229 9,504,618 Prior year............................................. 1,137,071 2,155,651 1,276,856 ---------- ----------- ----------- Total paid.......................................... 11,749,928 11,609,880 10,781,474 ---------- ----------- -----------
Net balance end of year................................ 5,494,776 5,614,651 5,418,046 Plus reinsurance.................................... 2,339,338 1,459,829 1,954,392 ---------- ----------- ----------- Balance end of year.................................... $7,834,114 $ 7,074,480 $ 7,372,438 ========== =========== ===========
• Universal Life and Investment Products - Universal life and investment products include universal life insurance, deferred annuities, and annuities without life contingencies. Premiums and policy fees for universal life and investment products consist of policy fees that have been assessed against policy account balances for the costs of insurance, policy administration, and surrenders. Such fees are recognized when assessed and earned. Benefit reserves for universal life and investment products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized in income over the term of the policies. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances and interest credited to policy account balances. Interest credit rates for universal life and investment products ranged from 3.6% to 9.4% in 2002.
The Company’s accounting policies with respect to variable universal life and variable annuities are identical except that policy account balances (excluding account balances that earn a fixed rate) are valued at market and reported as components of assets and liabilities related to separate accounts.
INCOME TAXES The Company uses the asset and liability method of accounting for income taxes. Income tax provisions are generally based on income reported for financial statement purposes. Deferred federal income taxes arise from the recognition of temporary differences between the basis of assets and liabilities determined for financial reporting purposes and the basis determined for income tax purposes. Such temporary differences are principally related to the deferral of policy acquisition costs and the provision for future policy benefits and expenses.
DISCONTINUED OPERATIONS On December 31, 2001, PLC completed the sale to Fortis, Inc. of substantially all of its Dental Benefits Division (Dental Division), and discontinued certain other remaining Dental Division related operations, primarily other health insurance lines. These discontinued operations have been included in various operating subsidiaries of PLC, including the Company. The results of the operations of the Dental Division as related to the Company have been included herein as discontinued operations. PLC recorded an overall loss on the sale and discontinuance. The intercompany allocation of such loss resulted in the recognition of a net gain of $1,625,000 to the Company, reported herein as a gain on the sale of discontinued operations.
The operating results and charges related to the sale of the Dental division at December 31 are as follows:
2002 2001 2000 -----------------------------------------------------------------------------------------------
Total revenues $ 0 $ 970,192 $ 653,995 -----------------------------------------------------------------------------------------------
Income (loss) before income taxes from discontinued operations $ 0 $ 240,377 $ (77,872) Income tax (expense) benefit (81,488) 26,866 ----------------------------------------------------------------------------------------------- Income (loss) from discontinued operations $ 0 $ 158,889 $ (51,006) ----------------------------------------------------------------------------------------------- Gain from sale of discontinued operations $ 2,500,000 before income tax Income tax expense related to sale $ 875,000 ----------------------------------------------------------------------------------------------- Gain from sale of discontinued operations $ 1,625,000 -----------------------------------------------------------------------------------------------
RECLASSIFICATIONS Certain reclassifications have been made in the previously reported financial statements and accompanying notes to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on previously reported net income, total assets, or share-owners’ equity.
Note B-- RECONCILIATION WITH STATUTORY REPORTING PRACTICES
Financial statements prepared in conformity with accounting principles generally accepted in the United States of America differ in some respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. The most significant differences are as follows: (a) acquisition costs of obtaining new business are deferred and amortized over the approximate life of the policies rather than charged to operations as incurred; (b) benefit liabilities are computed using a net level method and are based on realistic estimates of expected mortality, interest, and withdrawals as adjusted to provide for possible unfavorable deviation from such assumptions; (c) deferred income taxes are not subject to statutory limitations as to amounts recognized and are recognized through earnings as opposed to being charged to share-owners’ equity; (d) the Asset Valuation Reserve and Interest Maintenance Reserve are restored to share-owners’ equity; (e) agents’ debit balances and prepaid expenses are reported as assets rather than being charged directly to surplus (referred to as nonadmitted items); (f) certain items of interest income, such as mortgage and bond discounts, are amortized differently; and (g) bonds are recorded at their market values instead of amortized cost. The National Association of Insurance Commissioners (NAIC) has adopted the Codification of Statutory Accounting Principles (Codification). Codification changed statutory accounting rules in several areas and was effective January 1, 2001. The adoption of Codification did not have a material effect on the Company’s statutory capital.
The reconciliations of net income and share-owners’ equity prepared in conformity with statutory reporting practices to that reported in the accompanying financial statements are as follows:
Net Income Share-Owners' Equity ---------------------------------------- ------------------------------------------- 2002 2001 2000 2002 2001 2000 ---- ---- ---- ---- ---- ----
In conformity with statutory reporting practices: $10,879,132 $13,895,381 $ 13,006,859 $102,550,549 $ 34,354,020 $ 31,878,162 Additions (deductions) by adjustment: Deferred policy acquisition costs, net of amortization................. (6,477,916) (5,241,742) (4,700,240) 104,779,582 118,997,438 128,228,360 Deferred income tax................... (4,622,272) (5,121,553) (4,605,444) (25,533,038) (17,077,829) (9,063,941) Asset Valuation Reserve............... 1,678,921 217,592 2,797,912 Interest Maintenance Reserve.......... (811,107) (446,638) 118,604 1,505,616 694,509 247,870 Nonadmitted items..................... 374,966 281,394 25,902 Other timing and valuation adjustments 9,656,812 6,534,736 4,923,889 7,381,456 (15,722,031) (34,745,806) ----------- ------------ ------------ ------------ ------------- ------------ In conformity with generally accepted accounting principles $8,624,649 $ 9,620,184 $ 8,743,668 $192,738,052 $121,745,093 $119,368,459 =========== ============ ============ ============ ============= ============
As of December 31, 2002, the Company had on deposit with regulatory authorities, fixed maturity and short-term investments with a market value of approximately $7.6 million.
Note C-- INVESTMENT OPERATIONS
Major categories of net investment income for the years ended December 31 are summarized as follows:
2002 2001 2000 ---- ---- ----
Fixed maturities................................... $33,778,487 $31,496,317 $28,808,155 Mortgage loans..................................... 170,428 282,544 314,376 Investment real estate............................. 0 0 211,521 Policy loans....................................... 3,748,912 3,691,041 3,625,750 Other, principally short-term investments.......... 312,989 236,511 556,879 ----------- ----------- ----------- 38,010,816 35,706,413 33,516,681 Investment expenses................................ (1,764,979) (1,830,004) (1,830,233) ----------- ----------- ----------- $36,245,837 $33,876,409 $31,686,448 =========== =========== ===========
Realized investment gains (losses) for the years ended December 31 are summarized as follows:
2002 2001 2000 ---- ---- ----
Fixed maturities.................................. $(480,629) $(1,113,538) $ (70,176) Mortgage loans and other investments.............. (215,580) 112,324 ---------- ------------ ---------- $(696,209) $(1,113,538) $ 42,148 ========== ============ ==========
In 2002, gross gains on the sale of investments available for sale (fixed maturities and short-term investments) were approximately $2.1 million and gross losses were approximately $2.6 million. In 2001, gross gains were approximately $1.1 million and gross losses were approximately $2.2 million. In 2000, gross gains were approximately $27,500 and gross losses were approximately $97,700.
Each quarter the Company reviews investments with material unrealized losses and tests for other-than-temporary impairments. The Company analyzes various factors to determine if any specific other-than-temporary asset impairments exist. Once a determination has been made that a specific other-than-temporary impairment exists, a realized loss is incurred and the cost basis of the impaired asset is adjusted to its fair value. During 2002 and 2001, the Company recorded other than temporary impairments in its investments of $4.3 million and $1.9 million, respectively. There were no other-than-temporary impairments recorded in 2000.
The amortized cost and estimated market values of the Company’s investments classified as available for sale at December 31 are as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Values -------------- -------------- ------------- ---------------- ---- Fixed maturities: Bonds: Mortgage-backed securities.............. $ 17,963,051 $ 995,934 $ 0 $ 18,958,985 United States Government and authorities............................. 8,822,336 268,990 0 9,091,326 Public utilities........................ 76,359,211 2,799,099 3,751,446 75,406,864 All other corporate bonds............... 363,779,488 28,095,926 6,630,782 385,244,632 ------------- ----------- ------------ ----------- 466,924,086 32,159,949 10,382,228 488,701,807 Short-term investments........................... 178,805,245 0 0 178,805,245 ------------- ----------- ------------ ----------- $645,729,331 $32,159,949 $ 10,382,228 $667,507,052 ============= =========== ============ ===========
Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Values 2001 -------------- -------------- ------------- ---------------- ---- Fixed maturities: Bonds: Mortgage-backed securities.............. $ 6,655,797 $ 214,820 $ 0 $ 6,870,617 United States Government and authorities............................. 7,736,901 406,974 2,454 8,141,421 States, municipalities, and political subdivisions.................. 3,012,672 70,074 0 3,082,746 Public utilities........................ 64,825,621 1,228,963 1,229,425 64,825,159 All other corporate bonds............... 360,352,187 10,242,579 7,784,216 362,810,550 ------------- ----------- ------------ ----------- 442,583,178 12,163,410 9,016,095 445,730,493 Short-term investments........................... 12,000,000 0 0 12,000,000 ------------- ----------- ------------ ----------- $ 454,583,178 $12,163,410 $ 9,016,095 $457,730,493 ============= =========== ============ ============
The amortized cost and estimated market value of fixed maturities at December 31, by expected maturity, are shown below. Expected maturities are derived from rates of prepayment that may differ from actual rates of prepayment.
Estimated Amortized Market Cost Values --------------- ----------------
---- Due in one year or less.......................... $ 54,352,524 $ 55,079,080 Due after one year through five years............ 93,935,056 98,446,189 Due after five years through ten years........... 132,434,167 142,450,128 Due after ten years.............................. 186,202,339 192,726,410 ------------ ------------ $466,924,086 $488,701,807 ============ ============
At December 31, 2002 and 2001, the Company had bonds which were rated less than investment grade of $27.7 million and $10.8 million, respectively, having an amortized cost of $32.9 million and $15.0 million, respectively. Approximately $7.6 million of bonds are not publicly traded.
The change in unrealized gains (losses), net of income tax on fixed maturities for the years ended December 31 is summarized as follows:
2002 2001 2000 ---- ---- ----
Fixed maturities $12,109,764 $8,309,103 $5,081,516
At December 31, 2002, 99% of the Company’s mortgage loans were commercial loans of which 74% were retail, and 25% were office buildings. The Company specializes in making mortgage loans on either credit-oriented or credit-anchored commercial properties, most of which are strip shopping centers in smaller towns and cities. All of the mortgage loans are on properties located in the following states listed in decreasing order of significance: Tennessee, Florida, Alabama, Arkansas and Texas.
At December 31, 2002, the average mortgage loan was $0.3 million, and the weighted average interest rate was 8.2%. The largest single mortgage loan was $1.1 million.
At December 31, 2002 and 2001, the Company had no problem mortgage loans (over ninety days past due) and foreclosed properties. Since the Company’s mortgage loans are collateralized by real estate, any assessment of impairment is based upon the estimated fair value of the real estate. Based on the Company’s evaluation of its mortgage loan portfolio, the Company does not expect any material losses on its mortgage loans.
Policy loan interest rates generally range from 4.5% to 8.0%.
Note D-- FEDERAL INCOME TAXES
The Company's effective income tax rate varied from the maximum federal income tax rate as follows:
2002 2001 2000 ---- ---- ----
Statutory federal income tax rate applied to pretax income....... 35.0% 35.0% 35.0% Tax-exempt interest.............................................. (0.1) Other adjustments................................................ (1.1) (0.5) ----- ------ ----- Effective income tax rate........................................ 34.9% 33.9% 34.5% ===== ====== =====
The provision for federal income tax differs from amounts currently payable due to certain items reported for financial statement purposes in periods which differ from those in which they are reported for income tax purposes.
Details of the deferred income tax provision for the years ended December 31 are as follows:
2002 2001 2000 ---- ---- ----
Deferred policy acquisition costs................................ $(8,924,591) $10,448,277 $ 6,202,088 Benefit and other policy liability changes....................... 15,201,433 (6,335,100) (3,129,276) Temporary differences of investment income....................... (1,654,570) 51,888 1,532,632 ------------ ------------ ------------- $4,622,272 $ 4,165,065 $ 4,605,444 ============ ============ =============
The components of the Company's net deferred income tax liability as of December 31 were as follows:
2002 2001 ---- ----
Deferred income tax assets: Policy and policyholder liability reserves................... $6,260,637 $ 21,462,070 Unrealized (gain) loss on investments........................ (3,644,299) (1,295,737) ----------- ------------- 2,616,338 20,166,333 ----------- ------------- Deferred income tax liabilities: Deferred policy acquisition costs............................ 27,509,713 36,434,304 Other........................................................ 639,663 809,858 ----------- ----------- 28,149,376 37,244,162 ------------ ------------ Net deferred income tax liability............................ $25,533,038 $ 17,077,829 ============ =============
The Company’s income tax returns are included in the consolidated income tax returns of PLC. The allocation of income tax liabilities among affiliates is based upon separate income tax return calculations. At December 31, 2001 and 2000 no amounts were payable to PLC for income tax liabilities.
Note E-- COMMITMENTS AND CONTINGENT LIABILITIES
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 insurer’s own financial strength.
A number of civil jury verdicts have been returned against insurers and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives' relationships with agents or persons with whom the insurer does business, and other matters. Increasingly 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 and 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 little 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 or, alternatively, in arbitration. Although the outcome of any such litigation or arbitration cannot be predicted, the Company believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position, results of operations, or liquidity of the Company.
Note F-- SHARE-OWNERS' EQUITY AND RESTRICTIONS
Dividends on common stock are noncumulative and are paid as determined by the Board of Directors. At December 31, 2002, approximately $91.3 million of share-owners’ equity excluding net unrealized gains and losses represented net assets of the Company that cannot be transferred to Protective. In general, dividends up to specified levels are considered ordinary and may be paid thirty days after written notice to the insurance commissioner of the state of domicile unless such commissioner objects to the dividend prior to the expiration of such period. Dividends in larger amounts are considered extraordinary and are subject to affirmative prior approval by such commissioner. The maximum amount that would qualify as ordinary dividends to Protective by the Company in 2003 is estimated to be $12.1 million.
Note G-- PREFERRED STOCK
The Company’s preferred stock pays, when and if declared, noncumulative participating dividends to the extent the Company’s statutory earnings for the immediately preceding year exceeded $1.0 million. In 2002, the Company paid $50,000 of preferred dividends. In 2001, the Company paid $1.0 million of preferred dividends. No preferred dividends were paid in 2000.
Note H-- RELATED PARTY MATTERS
The Company has no employees; therefore, the Company purchases data processing, legal, investment, and other management services from PLC and other affiliates. The cost of such services was $8.4 million in 2002, $8.6 million in 2001, and $7.8 million in 2000.
Receivables from and payables to related parties consisted of receivables from and payables to affiliates under control of PLC in the amount of a $6.5 million payable at December 31, 2002 and a $4.9 million payable at December 31, 2001. The Company routinely receives from or pays to affiliates under the control of PLC reimbursements for expenses incurred on one another’s behalf. Receivables and payables among affiliates are generally settled monthly.
Protective and the Company entered into a guaranty agreement on October 27, 1993, whereby Protective guaranteed the payment of all insurance policy claims made by the holders or beneficiaries of any of the Company’s policies which were issued after the date of the guaranty agreement in accordance with the terms of said policies. Total liabilities for policies covered by this agreement were $50.6 million and $43.8 million at December 31, 2002 and 2001, respectively.
Protective and the Company also entered into a guaranty agreement on December 31, 1995, whereby Protective guaranteed that the Company will perform all of the obligations of Protective pursuant to the terms and conditions of an indemnity coinsurance agreement between Protective and an unaffiliated life insurance company. Total liabilities related to this coinsurance agreement were $9.7 million and $10.1 million at December 31, 2002 and 2001, respectively.
Note I-- OPERATING SEGMENTS
PLC, through its subsidiaries, operates business segments each having a strategic focus which can be grouped into three general categories: life insurance, retirement savings and investment products, and specialty insurance products. An operating segment is generally distinguished by products and/or channels of distribution. A brief description of each division the Company operates in follows.
Life Insurance
The Company became involved with PLC's Life Marketing segment beginning in 2002. The Life Marketing segment markets level premium term and term-like insurance, universal life, and variable universal life products on a national basis primarily through networks of independent insurance agents and brokers, and in the “bank owned life insurance” market.
The Acquisitions segment focuses on acquiring, converting, and servicing policies acquired from other companies. The segment’s primary focus is on life insurance policies sold to individuals.
Retirement Savings and Investment Products
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 the Life Marketing segment’s sales force. As of January 2003, the Company is no longer actively marketing variable annuity products.
Specialty Insurance Products
The Asset Protection segment markets credit life and disability insurance products through banks, consumer finance companies and automobile dealers, and markets vehicle and recreational marine extended service contracts.
Corporate and Other
The Company has an additional business segment herein referred to as Corporate and Other. The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on unallocated capital).
The Company uses the same accounting policies and procedures to measure operating segment income and assets as it uses to measure its net income and assets. Operating segment income is generally income before income tax. Premiums and policy fees, other income, benefits and settlement expenses, and amortization of deferred policy acquisition costs 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 which most appropriately reflects the operations of that segment. Unallocated realized investment gains (losses) are deemed not to be associated with any specific segment.
Assets are allocated based on policy liabilities and deferred policy acquisition costs directly attributable to each segment.
There are no significant intersegment transactions.
The following table sets forth total operating segment income and assets for the periods shown. Adjustments represent the inclusion of unallocated realized investment gains (losses), the recognition of income tax expense and income from discontinued operations and cumulative effect of change in accounting. Asset adjustments represent the inclusion of assets related to discontinued operations.
In December 2001, the Company sold substantially all of its Dental Division, and discontinued other Dental related operations. Prior period segment results have been restated to reflect these changes.
Corporate Life Asset and Operating Segment Income Marketing Acquisitions Protection Annuities Other Adjustments Total ------------------------ --------- ------------ ---------- --------- ---------- ----------- -----
Premiums and policy fees, net.... $142,454 $23,808,052 $3,454,960 $153,530 $27,558,996 Net investment income............ 8,123 30,989,460 571,275 3,729,514 $947,465 36,245,837 Realized investment gains(losses) 79,719 $(775,928) (696,209) Other income (loss).............. 5,072 6,015 11,087 ---------- ----------- ---------- --------- --------- ---------- ------------ Total revenues............. 150,577 54,802,584 4,026,235 3,968,778 947,465 (775,928) 63,119,711 ---------- ----------- ---------- --------- --------- ---------- ------------ Benefits and settlement expenses. 186,800 27,513,318 2,087,070 3,511,858 33,299,046 Amortization of deferred policy acquisition costs.......... 76,132 7,225,750 669,620 667,681 8,639,183 Other operating expenses......... (254,425) 8,330,634 (324,360) 246,104 (63,392) 7,934,561 ---------- ----------- ---------- --------- --------- ---------- ------------ Total benefits and expenses 8,507 43,069,702 2,432,330 4,425,643 (63,392) 49,872,790 ---------- ----------- ---------- --------- --------- ---------- ------------ Income (loss) from continuing operations before income tax. 142,070 11,732,882 1,593,905 (456,865) 1,010,857 (775,928) 13,246,921 Income tax expense............... 4,622,272 4,622,272 ------------ Net Income....................... $8,624,649 ============
Premiums and policy fees, net.... $25,209,340 $3,721,792 $ 155,298 $29,086,430 Net investment income............ 29,892,723 606,345 1,909,607 $1,467,734 33,876,409 Realized investment gains (losses) $(1,113,538) (1,113,538) Other income (loss).............. 244 5,487 5,731 ----------- ---------- --------- --------- ---------- ------------ Total revenues............. 55,102,307 4,328,137 2,070,392 1,467,734 (1,113,538) 61,855,032 ----------- ---------- --------- --------- ---------- ------------ Benefits and settlement expenses. 28,533,646 2,567,742 2,243,541 33,344,929 Amortization of deferred policy acquisition costs.......... 6,092,729 694,491 247,260 7,034,480 Other operating expenses......... 8,937,528 89,248 226,297 (63,778) 9,189,295 ----------- ---------- --------- --------- ---------- ------------ Total benefits and expenses 43,563,903 3,351,481 2,717,098 (63,778) 49,568,704 ----------- ---------- --------- --------- ---------- ------------ Income (loss) from continuing operations before income tax. 11,538,404 976,656 (646,706) 1,531,512 (1,113,538) 12,286,328 Income tax expense............... 4,165,065 4,165,065 Discontinued operations, net of income taz ................. 1,783,889 1,783,889 Change in accounting principle, net of income tax........... (284,968) (284,968) ------------ Net income....................... $ 9,620,184 ============
Premiums and policy fees, net.... $27,443,897 $2,997,130 $ 116,106 $30,557,133 Net investment income............ 29,275,899 628,572 1,416,117 $ 365,860 31,686,448 Realized investment gains........ $ 42,148 42,148 Other income (loss)............. (4,486) (2,065) (6,551) ----------- ---------- --------- --------- ---------- ------------ Total revenues............. 56,715,310 3,625,702 1,530,158 365,860 42,148 62,279,178 ----------- ---------- --------- --------- ---------- ------------ Benefits and settlement expenses. 29,247,353 2,250,237 1,267,445 32,765,035 Amortization of deferred policy acquisition costs.......... 5,871,420 714,278 179,748 6,765,446 Other operating expenses......... 9,991,067 57,601 (787,364) 60,409 9,321,713 ----------- ---------- --------- --------- ---------- ------------ Total benefits and expenses 45,109,840 3,022,116 659,829 60,409 48,852,194 ----------- ---------- --------- --------- ---------- ------------ Income from continuing operations before income tax..... 11,605,470 603,586 870,329 305,451 42,148 13,426,984 Income tax expense............... 4,632,310 4,632,310 Discontinued operations, net of income tax.................. (51,006) (51,006) ----------- Net income...................... $ 8,743,668 ============
Note I-- OPERATING SEGMENTS (continued)
Life Asset Corporate Operating Segment Assets Marketing Acquisitions Protection Annuities and Other Adjustments Total ------------------------ ---------- ------------ ------------ ---------- ----------- ----------- ------------ Investments and other assets.....(476,600) $600,231,727 $78,120,621 $54,071,804 $100,048,550 $3,723,088 $835,719,190 Deferred policy acquisition costs 583,131 100,007,935 1,607,207 2,581,309 104,779,582 ---------- ------------ ------------ ------------ ------------ ----------- ------------ Total assets.................... $106,531 $700,239,662 $79,727,828 $56,653,113 $100,048,550 $3,723,088 $940,498,772 ========== ============ ============ ============ ============ =========== ============
Investments and other assets...... $471,065,653 $10,390,438 $46,091,122 $34,248,362 $3,956,062 $565,751,637 Deferred policy acquisition costs. 114,902,459 1,611,339 2,483,640 118,997,438 ------------ ------------ ------------ ----------- ----------- ------------ Total assets...................... $585,968,112 $12,001,777 $48,574,762 $34,248,362 $3,956,062 $684,749,075 ============ ============ ============ =========== =========== ============
Note J-- REINSURANCE
The Company reinsures certain of its risks with, and assumes risks from, other insurers under yearly renewable term, coinsurance, and modified coinsurance agreements. Under yearly renewable term agreements, the Company generally pays specific premiums to the reinsurer and receives specific amounts from the reinsurer as reimbursement for certain expenses. Coinsurance agreements are accounted for by passing a portion of the risk to the reinsurer. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of all benefit payments. Modified coinsurance is accounted for similarly to coinsurance except that the liability for future policy benefits is held by the original company, and settlements are made on a net basis between the companies. A substantial portion of the Company’s new life insurance and credit insurance sales is being reinsured. The Company reviews the financial condition of its reinsurers and monitors the amount of reinsurance it has with its reinsurers.
During 2002, Protective sold one of its subsidiaries, Lyndon Life Insurance Company (Lyndon Life) to an unaffiliated insurance company. As part of the transaction, the Company assumed and subsequently ceded a portion of Lyndon Life’s business to Protective. The Company paid a ceding allowance of $31.2 million to Lyndon Life and received from Protective an allowance of $31.6 million. The total amount of reserves transferred in the transaction from Lyndon Life to the Company was $91.8 million. The same amount of reserves were ceded from the Company to Protective by structure of the treaty as funds withheld.
The Company has reinsured approximately $6.6 billion, $4.9 billion, and $5.3 billion in face amount of life insurance risks with other insurers representing $18.1 million, $17.6 million, and $17.4 million of premium income for 2002, 2001, and 2000, respectively. The Company has also reinsured accident and health risks representing $0.8 million, $0.1 million, and $0.7 million of premium income for 2002, 2001, and 2000, respectively. In 2002 and 2001, policy and claim reserves relating to insurance ceded of $89.9 million and $19.2 million respectively are included in reinsurance receivables. Should any of the reinsurers be unable to meet its obligation at the time of the claim, obligation to pay such claim would remain with the Company. At December 31, 2002 and 2001, the Company had paid $2.3 million and $1.5 million, respectively, of ceded benefits which are recoverable from reinsurers.
Approximately 16% and 65% of the reinsurance receivable balances at December 31, 2002 and 2001, respectively, relate to one unaffiliated insurance company rated “A+” (Superior) by the A. M. Best Company, an independent rating organization. Another $73.1 or 79% of the reinsurance receivable balance at December 31, 2002 relates to Protective.
Note K-- ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of the Company's financial instruments at December 31 are as follows:
2002 2001 --------------------------------- --------------------------------
Estimated Estimated Carrying Fair Carrying Fair Amount Values Amount Values -------- ----------- ----------- --------------
Assets (see Notes A and C): Investments: Fixed maturities...................... $488,701,807 $488,701,807 $445,730,493 $445,730,493 Mortgage loans on real estate......... 1,793,590 1,863,134 2,717,495 2,873,017 Short-term investments................ 178,805,245 178,805,245 12,000,000 12,000,000 Cash 1,669,532 1,669,532 4,284,257 4,284,257 Liabilities (see Note A): Annuity deposits...................... 60,080,082 62,984,955 47,324,337 46,396,261
Except as noted below, fair values were estimated using quoted market prices.
The Company estimates the fair value of its mortgage loans using discounted cash flows from the next call date.
The Company believes the fair value of short-term investments approximates their book value due to their short-term nature.
The Company estimates the fair value of its annuities using surrender values.
The Company believes it is not practicable to determine the fair value of its policy loans since there is no stated maturity, and policy loans are often repaid by reductions to policy benefits.
SCHEDULE III-- SUPPLEMENTARY INSURANCE INFORMATION PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
---------------------------- ------------- ------------ ----------- ------------- ----------- ----------- ------------ ------------ ------------- COL. A COL. B COL. C COL. D COL. E COL. F COL. G COL. H COL. I COL. J ---------------------------- ------------- ------------ ----------- ------------- ----------- ----------- ------------ ------------ -------------
Future Annuity Amortization Deferred Policy Deposits Premiums Benefits of Deferred Policy Benefits and Other and Net and Policy Other Acquisition and Unearned Policyholders' Policy Investment Settlement Acquisition Operating Segment Costs Claims Premiums Funds Fees Income (1) Expenses Costs Expenses (1) ------- ----------- --------- ---------- -------------- -------- ---------- --------- ----------- ------------
Year Ended December 31, 2002 Life Insurance Life Marketing........... $ 583,131 $ 689,662 $ 0 $ 0 $ 142,454 $ 8,123 $ 186,800 $ 76,132 $ (254,425) Acquisitions............. 100,007,935 460,211,404 43,965 4,841,464 23,808,052 30,989,460 27,513,318 7,225,750 8,330,634 Specialty Insurance Products Asset Protection......... 1,607,207 54,415,603 26,305,063 614,369 3,454,960 571,275 2,087,070 669,620 (324,360) Retirement Savings and Investment Products Annuities................ 2,581,309 1,962,360 0 57,272,062 153,530 3,729,514 3,511,858 667,681 246,104 Corporate and Other........ 0 0 0 0 0 947,465 0 0 (63,392) Adjustments (2) ........... 0 345,835 0 3,377,253 0 0 0 0 0 ----------- ------------ ----------- ----------- ----------- ----------- ----------- ---------- ----------- TOTAL................. $104,779,582 $517,624,864 $26,349,028 $66,105,148 $27,558,996 $36,245,837 $33,299,046 $8,639,183 $7,934,561 =========== ============ =========== =========== =========== =========== =========== ========== ===========
Year Ended December 31, 2001 Life Insurance Acquisitions............ $114,902,459 $457,126,255 $ 46,457 $ 1,924,344 $25,209,340 $29,892,723 $28,533,646 $6,092,729 $8,937,528 Specialty Insurance Products Asset Protection........ 1,611,339 2,178,423 7,718,370 493,645 3,721,792 606,345 2,567,742 694,491 89,248 Retirement Savings and Investment Products Annuities............... 2,483,640 (1,233,215) 0 47,324,337 155,298 1,909,607 2,243,541 247,260 226,297 Corporate and Other....... 0 0 0 0 0 1,467,734 0 0 (63,778) Adjustments (2) .......... 0 496,918 2,201 3,456,943 0 0 0 0 0 ----------- ------------ ----------- ----------- ----------- ----------- ----------- ---------- ----------- Adjustments (2) .......... $118,997,438 $458,568,381 $7,767,028 $53,199,269 $29,086,430 $33,876,409 $33,344,929 $7,034,480 $9,189,295 =========== ============ =========== =========== =========== =========== =========== ========== ===========
Year Ended December 31, 2000 Life Insurance Acquisitions............ $124,984,368 $447,949,295 $ 50,335 $ 4,925,125 $27,443,897 $29,275,899 $29,247,353 $5,871,420 $9,991,067 Specialty Insurance Prodcuts Asset Protection 1,596,654 3,037,218 8,101,233 323,800 2,997,130 628,572 2,250,237 714,278 57,601 Retirement Savings and Investment Products Annuities............... 1,647,338 619,322 0 25,179,780 116,106 1,416,117 1,267,445 179,748 (787,364) Corporate and Other....... 0 0 0 0 0 365,860 0 0 60,409 Adjustments (2) .......... 0 607,136 2,665 3,424,830 0 0 0 0 0 ----------- ------------ ----------- ----------- ----------- ----------- ---------- ---------- ----------- TOTAL............... $128,228,360 $452,212,971 $ 8,154,233 $33,853,535 $30,557,133 $31,686,448 $32,765,035 $6,765,446 $9,321,713 =========== ============ =========== =========== =========== =========== =========== ========== ===========
(1) Allocations of Net Investment Income and Other Operating Expenses are based on a number of assumptions and estimates and results would change if different methods were applied. (2) Adjustments represent the inclusion of assets related to discontinued operations.
SCHEDULE IV-- REINSURANCE PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
------------------------------------------------------------ -------------- -------------- -------------- -------------- ------------- COL. A COL. B COL. C COL. D COL. E COL. F ------------------------------------------------------------ -------------- -------------- -------------- -------------- -------------
Percentage Ceded to Assumed of Amount Gross Other from Other Net Assumed Amount Companies Companies Amount to Net ----------- ----------- ----------- ----------- ------------
Year Ended December 31, 2002: Life insurance in force(1) ................... $1,045,749 $ 6,646,105 $7,207,124 $1,606,768 448.5% =========== ========== =========== ========== ==========
Premiums and policy fees: Life insurance................................ $6,379,102 $22,962,666 $42,221,864 $25,638,300 164.7% Accident and health insurance................. 3,131,323 771,735 (438,892) 1,920,696 - ---------- ----------- ------------ ----------- TOTAL...................................... $9,510,425 $23,734,401 $41,782,972 $27,558,996 =========== =========== ============ ===========
Year Ended December 31, 2001: Life insurance in force(1) ..................... $ 337,079 $ 4,865,367 $ 6,087,816 $ 1,559,528 390.4% =========== ========== =========== ========== ==========
Premiums and policy fees: Life insurance.................................. $6,006,689 $18,481,015 $39,585,878 $27,111,552 146.0% Accident and health insurance................... 2,106,881 140,020 8,017 1,974,878 ---------- ----------- ------------ ----------- 0.4% TOTAL........................................ $8,113,570 $18,621,035 $39,593,895 $29,086,430 ========== =========== =========== ===========
Year Ended December 31, 2000: Life insurance in force(1) ..................... $ 324,167 $ 5,287,046 $ 6,600,096 $ 1,637,217 403.1% =========== ========== =========== ========== ==========
Premiums and policy fees: Life insurance.................................. $4,372,841 $17,244,402 $41,747,694 $28,876,133 144.6% Accident and health insurance................... 1,751,478 74,844 4,366 1,681,000 ---------- ----------- ------------ ----------- 0.3% TOTAL........................................ $6,124,319 $17,319,246 $41,752,060 $30,557,133 ========== =========== ============ ===========
(1) Dollars in thousands
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Not required in accordance with General Instruction I(2)(c).
Item 11.
Item 11. Executive Compensation
Not required in accordance with General Instruction I(2)(c).
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Share Owner Matters
Not required in accordance with General Instruction I(2)(c).
Item 13.
Item 13. Certain Relationships and Related Transactions
Not required in accordance with General Instruction I(2)(c).
Item 14.
Item 14. Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have, within the 90-day period preceding the filing of the report evaluated the Company’s disclosure controls and procedures and believe them to be operating effectively to make known to them on a timely basis any material information required to be included in the Company’s periodic filings with the Securities and Exchange Commission. There have been no significant changes in the internal controls, or in other factors that could significantly affect internal controls, subsequent to the date this evaluation was completed.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements (Item 8)
2. Financial Statement Schedules (see index annexed)
3. Exhibits:
The exhibits listed in the Exhibit Index on page 37 of this Form 10-K are filed herewith or are incorporated herein by reference. No management contract or compensatory plan or arrangement is required to be filed as an exhibit to this form. The Registrant will furnish a copy of any of the exhibits listed upon the payment of $5.00 per exhibit to cover the cost of the Registrant in furnishing the exhibit.
(b) Reports on Form 8-K:
None
SIGNATURES
Pursuant to the requirements of Section 13 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, in the City of Birmingham, State of Alabama on March 25, 2003.
PROTECTIVE LIFE AND ANNUITY INSURANCE COMPANY
By: /s/ WAYNE E. STUENKEL President
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated: Exhibit 3(b)
Signature Title Date
(i) Principal Executive Officer /s/ WAYNE E. STUENKEL President and Wayne E. Stuenkel Director March 25, 2003
(ii) Principal Financial Officer /s/ ALLEN W. RITCHIE Chief Financial Officer Allen W. Ritchie and Director March 25, 2003
(iii) Board of Directors: * Director March 25, 2003 ------------------------------------ John D. Johns
* Director March 25, 2003 ------------------------------------ Richard J. Bielen
* Director March 25, 2003 ------------------------------------ R. Stephen Briggs
* Director March 25, 2003 ------------------------------------ J. William Hamer, Jr.
* Director March 25, 2003 ------------------------------------ T. Davis Keyes
* Director March 25, 2003 ------------------------------------ Carolyn King
* Director March 25, 2003 ------------------------------------ Deborah J. Long
* Director March 25, 2003 ------------------------------------ Jim E. Massengale
* Director March 25, 2003 ------------------------------------ Allen W. Ritchie
*By: /s/JERRY W. DEFOOR Jerry W. DeFoor Attorney-in-fact
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Wayne E. Stuenkel, certify that:
1. I have reviewed this annual report on Form 10-Q of Protective Life and Annuity Insurance Company;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
Title: President and Chief Actuary
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Allen W. Ritchie, certify that:
1. I have reviewed this annual report on Form 10-Q of Protective Life and Annuity Insurance Company;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
Title: Executive Vice President and Chief Financial Officer
Exhibit Index Item Number Document --------- ------------ * 3 (a) (1) 1998 Amended and Restated Articles of Incorporation * 3 (a) (2) Articles of Amendment to 1998 Amended and Restated Articles of Incorporation ***** 3(b) Amended and Restated Bylaws Effective August 1, 2000 ** 4(a) Tax-Sheltered Annuity Endorsement ** 4(b) Qualified Retirement Plan Endorsement ** 4(c) Individual Retirement Annuity Endorsement *** 4(d) Group Modified Guaranteed Annuity Contract *** 4(e) Application for Group Modified Guaranteed Annuity Contract *** 4(f) Individual Modified Guaranteed Annuity Certificate **** 10 (a) Guaranty Agreement from Protective Life Insurance Company **** 10 (a) (1) Amendment to Guaranty Agreement from Protective Life Insurance Company ****** 10 (b) Indemnity Reinsurance Agreement By and Between Protective Life & Annuity Insurance Company and First Fortis Life Insurance Company dated December 31, 2001 24 Power of Attorney 99(a) Safe Harbor for Forward-Looking Statements 99(b) Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99(c) Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998. ** Incorporated herein by reference to the Registrant's Form N-4 Registration Statement, Registration No. 333-41577, filed on December 5, 1997. *** Incorporated herein by reference to the Registrant's Pre-Effective Amendment No. 1 to Form S-1 Registration Statement, Registration No. 333-42425, filed on April 16, 1998. **** Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999. ***** Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000. ****** Incorporated herein by reference to the Registrant's Annual Report on form 10-K for the year ended December 31, 2001.