UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-Q

 

x   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2008

 

or

 

o    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from           to           

 

Commission File Number 001-11339

 

Protective Life Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-2492236

(State or other jurisdiction of incorporation or organization)

 

(IRS Employer Identification No.)

 

2801 Highway 280 South

Birmingham, Alabama 35223

(Address of principal executive offices and zip code)

 

(205) 268-1000

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

 

Number of shares of Common Stock, $0.50 par value, outstanding as of May 5, 2008:  69,817,937

 

 



 

PROTECTIVE LIFE CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR QUARTER ENDED MARCH 31, 2008

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

PART I:  Financial Information

 

 

 

Item 1.

Financial Statements (unaudited):

 

 

 

 

 

Consolidated Condensed Statements of Income for the Three Months Ended March 31, 2008 and 2007

3

 

 

 

 

Consolidated Condensed Balance Sheets as of March 31, 2008 and December 31, 2007

4

 

 

 

 

Consolidated Condensed Statements of Cash Flows for the Three Months Ended March 31, 2008 and 2007

5

 

 

 

 

Notes to Consolidated Condensed Financial Statements.

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

22

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

64

 

 

 

Item 4.

Controls and Procedures

64

 

 

 

PART II:  Other Information

 

 

 

 

Item 1A.

Risk Factors

65

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

65

 

 

 

Item 6.

Exhibits

65

 

 

 

Signature

 

66

 

2



 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

 (Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars In Thousands, Except Per Share Amounts)

 

Revenues

 

 

 

 

 

Premiums and policy fees

 

$

662,404

 

$

657,017

 

Reinsurance ceded

 

(371,072

)

(370,997

)

Net of reinsurance ceded

 

291,332

 

286,020

 

Net investment income

 

408,465

 

415,682

 

Realized investment (losses) gains:

 

 

 

 

 

Derivative financial instruments

 

(1,657

)

(2,291

)

All other investments

 

(28,045

)

13,294

 

Other income

 

45,509

 

73,792

 

Total revenues

 

715,604

 

786,497

 

Benefits and expenses

 

 

 

 

 

Benefits and settlement expenses, net of reinsurance ceded:
(three months: 2008 - $371,733; 2007 - $292,899)

 

494,676

 

467,785

 

Amortization of deferred policy acquisition costs and value of business acquired

 

68,370

 

76,380

 

Other operating expenses, net of reinsurance ceded:
(three months: 2008 - $52,378; 2007 - $65,303)

 

98,969

 

109,004

 

Total benefits and expenses

 

662,015

 

653,169

 

Income before income tax

 

53,589

 

133,328

 

Income tax expense

 

17,707

 

42,745

 

Net income

 

$

35,882

 

$

90,583

 

 

 

 

 

 

 

Net income per share - basic

 

$

0.50

 

$

1.28

 

Net income per share - diluted

 

$

0.50

 

$

1.27

 

Cash dividends paid per share

 

$

0.225

 

$

0.215

 

 

 

 

 

 

 

Average share outstanding - basic

 

71,080,703

 

70,017,662

 

Average share outstanding - diluted

 

71,453,824

 

71,487,063

 

 

See Notes to Consolidated Condensed Financial Statements

 

3



 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

 (Unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Dollars In Thousands)

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities, at fair market value (amortized cost: 2008 - $23,755,428; 2007 - $23,448,784)

 

$

23,167,901

 

$

23,389,069

 

Equity securities, at fair market value (cost: 2008 - $292,248; 2007 - $112,406)

 

289,307

 

117,037

 

Mortgage loans

 

3,377,397

 

3,284,326

 

Investment real estate, net of accumulated depreciation (2008 - $328; 2007 - $283)

 

7,975

 

8,026

 

Policy loans

 

813,107

 

818,280

 

Other long-term investments

 

193,364

 

185,892

 

Short-term investments

 

1,121,138

 

1,236,443

 

Total investments

 

28,970,189

 

29,039,073

 

Cash

 

117,933

 

146,152

 

Accrued investment income

 

281,396

 

291,734

 

Accounts and premiums receivable, net of allowance for uncollectible amounts (2008 - $3,194; 2007 - $3,587)

 

118,533

 

87,883

 

Reinsurance receivables

 

5,287,241

 

5,089,100

 

Deferred policy acquisition costs and value of business acquired

 

3,499,271

 

3,400,493

 

Goodwill

 

116,481

 

117,366

 

Property and equipment, net of accumulated depreciation (2008 - $112,079; 2007 - $111,213)

 

42,027

 

42,795

 

Other assets

 

156,486

 

144,296

 

Income tax receivable

 

148,342

 

165,741

 

Assets related to separate accounts

 

 

 

 

 

Variable annuity

 

2,686,752

 

2,910,606

 

Variable universal life

 

324,355

 

350,802

 

Total Assets

 

$

41,749,006

 

$

41,786,041

 

Liabilities

 

 

 

 

 

Policy liabilities and accruals

 

$

17,917,162

 

$

17,429,307

 

Stable value product account balances

 

5,207,936

 

5,046,463

 

Annuity account balances

 

8,726,137

 

8,708,383

 

Other policyholders’ funds

 

360,065

 

307,950

 

Other liabilities

 

1,122,106

 

1,204,018

 

Deferred income taxes

 

361,038

 

512,156

 

Non-recourse funding obligations

 

1,375,000

 

1,375,000

 

Liabilities related to variable interest entities

 

400,000

 

400,000

 

Long-term debt

 

579,852

 

559,852

 

Subordinated debt securities

 

524,743

 

524,743

 

Liabilities related to separate accounts

 

 

 

 

 

Variable annuity

 

2,686,752

 

2,910,606

 

Variable universal life

 

324,355

 

350,802

 

Total liabilities

 

39,585,146

 

39,329,280

 

Commitments and contingent liabilities - Note 3

 

 

 

 

 

Shareowners’ equity

 

 

 

 

 

Preferred Stock; $1 par value, shares authorized: 4,000,000; Issued: None

 

 

 

 

 

Common Stock, $.50 par value, shares authorized: 2008 and 2007 - 160,000,000 shares issued: 2008 and 2007 - 73,251,960

 

36,626

 

36,626

 

Additional paid-in-capital

 

446,191

 

444,765

 

Treasury stock, at cost (2008 - 3,422,923 shares; 2007 - 3,102,898 shares)

 

(27,998

)

(11,140

)

Unallocated stock in Employee Stock Ownership Plan (2008 - 147,726 shares ; 2007 - 251,231 shares)

 

(474

)

(852

)

Retained earnings (includes FAS157 cumulative effect adjustment - $1,470)

 

2,089,463

 

2,067,891

 

Accumulated other comprehensive income (loss):

 

 

 

 

 

Net unrealized (losses) gains on investments, net of income tax: (2008 - $(184,362); 2007 - ($26,675))

 

(333,630

)

(45,339

)

Accumulated gain (loss) - hedging, net of income tax: (2008 - $(12,730); 2007 - $(6,185))

 

(23,666

)

(12,222

)

Postretirement benefits liability adjustment, net of income tax: (2008 - $(11,177); 2007 - $(11,622))

 

(22,652

)

(22,968

)

Total shareowners’ equity

 

2,163,860

 

2,456,761

 

Total liabilities and shareowners’ equity

 

$

41,749,006

 

$

41,786,041

 

 

See Notes to Consolidated Condensed Financial Statements

 

4



 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

 (Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars In Thousands)

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

35,882

 

$

90,583

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Realized investment (gains) losses

 

29,702

 

(11,003

)

Amortization of deferred policy acquisition costs and value of business acquired

 

68,370

 

75,202

 

Capitalization of deferred policy acquisition costs

 

(85,095

)

(120,762

)

Depreciation expense

 

2,725

 

3,023

 

Deferred income tax

 

20,718

 

43,166

 

Accrued income tax

 

16,840

 

(179

)

Interest credited to universal life and investment products

 

253,950

 

254,930

 

Policy fees assessed on universal life and investment products

 

(135,022

)

(139,408

)

Change in reinsurance receivables

 

(198,141

)

(162,834

)

Change in accrued investment income and other receivables

 

(20,312

)

92,153

 

Change in policy liabilities and other policyholders’ funds of traditional life and health products

 

212,649

 

73,525

 

Trading securities:

 

 

 

 

 

Maturities and principal reductions of investments

 

168,838

 

104,301

 

Sale of investments

 

441,775

 

406,347

 

Cost of investments acquired

 

(440,279

)

(647,243

)

Other net change in trading securities

 

(69,855

)

85,820

 

Change in other liabilities

 

(13,271

)

78,413

 

Other, net

 

(90,009

)

5,451

 

Net cash provided by operating activities

 

199,465

 

231,485

 

Cash flows from investing activities

 

 

 

 

 

Investments available for sale:

 

 

 

 

 

Maturities and principal reductions of investments

 

558,165

 

395,595

 

Sale of investments

 

1,372,938

 

1,050,320

 

Cost of investments acquired

 

(2,578,904

)

(1,380,416

)

Mortgage loans:

 

 

 

 

 

New borrowings

 

(178,922

)

(239,785

)

Repayments

 

85,723

 

94,635

 

Change in investment real estate, net

 

40

 

3,298

 

Change in policy loans, net

 

5,173

 

16,572

 

Change in other long-term investments, net

 

(7,324

)

(1,144

)

Change in short-term investments, net

 

140,151

 

164,799

 

Purchase of property and equipment

 

(2,403

)

(2,145

)

Sales of property and equipment

 

379

 

640

 

Other investing activities, net

 

 

161

 

Net cash (used in) provided by investing activities

 

(604,984

)

102,530

 

Cash flows from financing activities

 

 

 

 

 

Borrowings under line of credit arrangements and long-term debt

 

20,000

 

31,000

 

Principal payments on line of credit arrangement and long-term debt

 

 

(43,600

)

Net proceeds from securities sold under repurchase agreements

 

 

(14,105

)

Payments on liabilities related to variable interest entities

 

 

1,289

 

Issuance of non-recourse funding obligations

 

 

100,000

 

Dividends to share owners

 

(15,780

)

(15,044

)

Investments product deposits and change in universal life deposits

 

1,398,113

 

543,512

 

Investment product withdrawals

 

(1,011,830

)

(837,199

)

Excess tax benefits on stock based compensation

 

 

762

 

Other financing activities, net

 

(13,203

)

(49,956

)

Net cash provided by (used in) financing activities

 

377,300

 

(283,341

)

Change in cash

 

(28,219

)

50,674

 

Cash at beginning of period

 

146,152

 

69,516

 

Cash at end of period

 

$

117,933

 

$

120,190

 

 

See Notes to Consolidated Condensed Financial Statements

 

5



 

PROTECTIVE LIFE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

 

1.             BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited consolidated condensed financial statements of Protective Life Corporation and subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the disclosures required by U.S. GAAP for complete financial statements.  In the opinion of management, the accompanying financial statements reflect all adjustments (consisting only of normal recurring items) necessary for a fair statement of the results for the interim periods presented.  Operating results for the three-month period ended March 31, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.  The year-end consolidated condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP.  For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

 

Accounting Pronouncements Recently Adopted

 

Financial Accounting Standards Board (“FASB”) Statement No. 157, Fair Value Measurement (“SFAS No. 157”)In September 2006, the FASB issued SFAS No. 157. On January 1, 2008, the Company adopted this standard, which defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements.  The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements.  Additionally, on January 1, 2008, the Company elected the partial adoption of SFAS No. 157 under the provisions of FASB Staff Position (“FSP”) FAS 157-2, which amends SFAS No. 157 to allow an entity to delay the application of this statement until periods beginning January 1, 2009 for certain non-financial assets and liabilities.  Under the provisions of this FSP, the Company will delay the application of SFAS No. 157 for fair value measurements used in the impairment testing of goodwill and indefinite-lived intangible assets and eligible non-financial assets and liabilities included within a business combination.  In January 2008, FASB also issued proposed FSP FAS 157-c that would amend SFAS No. 157 to clarify the principles on fair value measurement of liabilities.  Management is monitoring the status of this proposed FSP for any impact on the Company’s consolidated financial statements.

 

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  In determining fair value, the Company uses various methods including market, income and cost approaches.  The Company utilizes valuation techniques that maximize the use of observable inputs and minimizes the use of unobservable inputs.  For more information, see Note 10, Fair Value of Financial Instruments.

 

FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”).  In February 2007, the FASB issued SFAS No. 159.  This standard provides entities the option to measure certain financial assets and financial liabilities at fair value with changes in fair value recognized in earnings each period.  SFAS No. 159 permits the fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.  The Company adopted SFAS No. 159 as of January 1, 2008.  The Company has elected not to apply the provisions of SFAS No. 159 to its eligible financial assets and financial liabilities on the date of adoption. Accordingly, the initial application of SFAS No. 159 had no effect on the Company’s consolidated results of operations or financial position.

 

6



 

FASB Staff Position (“FSP”) FIN 39-1, Amendment of FASB Interpretation No. 39 (“FSP FIN39-1”).  As of January 1, 2008, the Company adopted FSP FIN39-1.  This FSP amends FIN No. 39, Offsetting of Amounts Related to Certain Contracts, to allow fair value amounts recognized for collateral to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under certain circumstances. The FSP also requires an entity to disclose the accounting policy decision to offset, or not to offset, fair value amounts in accordance with FIN No. 39, as amended. The Company does not, and has not previously, offset the fair value amounts recognized for derivatives with the amounts recognized as collateral.

 

Accounting Pronouncements Not Yet Adopted

 

FASB Statement No. 141(R), Business Combinations (“SFAS No. 141(R)”)In December of 2007, the FASB issued SFAS No. 141(R).  This standard is a revision to the original standard and continues the movement toward a greater use of fair values in financial reporting. It changes how business acquisitions are accounted for and will impact financial statements at the acquisition date and in subsequent periods. Further, certain of the changes will introduce more volatility into earnings and thus may impact a company’s acquisition strategy.   SFAS No. 141(R) will also impact the annual goodwill impairment test associated with acquisitions that close both before and after the effective date of this standard. Thus, companies that have goodwill from an acquisition that closed prior to the effective date of the Standard will need to understand the provisions of SFAS No. 141(R) regardless of whether they intend to have future acquisitions. This standard applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.

 

FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, (“SFAS No. 160”).  In December of 2007, the FASB issued SFAS No. 160.  This standard applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary.  This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, January 1, 2009, for entities with calendar year-ends). The Company does not expect this standard to have a significant impact on its consolidated results of operations or financial position.

 

FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities, (“SFAS No. 161”).  In March of 2008, the FASB issued SFAS No. 161. This standard requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133, Accounting Derivative Instruments and Hedging Activities (“SFAS No. 133”).  SFAS No. 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. This statement is effective for fiscal years and interim periods beginning after November 15, 2008. The standard will be effective for the Company beginning January 1, 2009. The Company is currently evaluating the impact, if any, that SFAS No. 161 will have on its consolidated results of operations or financial position.

 

FSP No. 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions (“FAS No. 140-3”)In February of 2008, the FASB issued FAS No. 140-3 to provide guidance on accounting for a transfer of a financial asset and a repurchase financing, which is not directly addressed by SFAS No. 140.  This FSP is effective for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.  The FSP will be effective for the Company beginning January 1, 2009.  The Company is currently evaluating the impact, if any, that this FSP will have on its consolidated results of operations or financial position.

 

Reclassifications

 

Certain reclassifications have been made in the previously reported financial statements and accompanying notes to make the prior period amounts comparable to those of the current period.  Such reclassifications had no effect on previously reported net income or shareowners’ equity.

 

7



 

Significant Accounting Policies

 

Valuation of investment securities

 

 Determining whether a decline in the current fair value of invested assets is an other than temporary decline in value can involve a variety of assumptions and estimates, particularly for investments that are not actively traded in established markets.  For example, assessing the value of certain investments requires that we perform an analysis of expected future cash flows or rates of prepayments.  Other investments, such as collateralized mortgage or bond obligations, represent selected tranches of a structured transaction, supported in the aggregate by underlying investments in a wide variety of issuers.  Management considers a number of factors when determining the impairment status of individual securities.  These include the economic condition of various industry segments and geographic locations and other areas of identified risks.  Although it is possible for the impairment of one investment to affect other investments, we engage in ongoing risk management to safeguard against and limit any further risk to its investment portfolio.  Special attention is given to correlative risks within specific industries, related parties, and business markets. We generally consider a number of factors in determining whether the impairment is other than temporary.  These include, but are not limited to: 1) actions taken by rating agencies, 2) default by the issuer, 3) the significance of the decline, 4) the intent and ability to hold the investment until recovery, 5) the time period during which the decline has occurred, 6) an economic analysis of the 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, collateral position, and continued viability of the issuer are significant measures considered.

 

The fair value for fixed maturity, short term, and equity securities, is determined by management after considering one of three primary sources of information: third party pricing services, independent broker quotations, or pricing matrices.  Security pricing is applied using a “waterfall” approach whereby publicly available prices are first sought from third party pricing services, the remaining unpriced securities are submitted to independent brokers for prices, or lastly, securities are priced using a pricing matrix.  Typical inputs used by these three pricing methods include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows and prepayments speeds.  Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above.  If there are no recent reported trades, the third party pricing services and brokers may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate.  Included in the pricing of asset backed securities (“ABS”), collateralized mortgage obligations (“CMOs”), and mortgage-backed securities (“MBS”) are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral.

 

Reinsurance

 

The Company uses reinsurance extensively in certain of its segments. The following summarizes some of the key aspects of the Company’s accounting policies for reinsurance:

 

Reinsurance Accounting Methodology – The Company accounts for reinsurance under the provisions of FASB Statement No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts (“SFAS No. 113”).  The methodology for accounting for the impact of reinsurance on the Company’s life insurance and annuity products is determined by whether the specific products are subject to FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises (“SFAS No. 60”) or FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments (“SFAS No. 97”).

 

8



 

The Company’s traditional life insurance products are subject to SFAS No. 60 and the recognition of the impact of reinsurance costs on the Company’s financial statements reflect the requirements of that pronouncement. Ceded premiums are treated as an offset to direct premium and policy fee revenue and are recognized when due to the assuming company. Ceded claims are treated as an offset to direct benefits and settlement expenses and are recognized when the claim is incurred on a direct basis. Ceded policy reserve changes are also treated as an offset to benefits and settlement expenses and are recognized during the applicable financial reporting period. Expense allowances paid by the assuming companies are treated as an offset to other operating expenses. Since reinsurance treaties typically provide for allowance percentages that decrease over the lifetime of a policy, allowances in excess of the “ultimate” or final level allowance are capitalized. Amortization of capitalized reinsurance expense allowances is treated as an offset to direct amortization of deferred policy acquisition costs or value of business acquired (“VOBA”). Amortization of deferred expense allowances is calculated as a level percentage of expected premiums in all durations given expected future lapses and mortality and accretion due to interest.

 

The Company’s short duration insurance contracts (primarily issued through the Asset Protection segment) are also subject to SFAS No. 60 and the recognition of the impact of reinsurance costs on the Company’s financial statements also reflect the requirements of that pronouncement.  Reinsurance allowances include such acquisition costs as commissions and premium taxes.  A ceding fee is also collected to cover other administrative costs and profits for the Company.  Reinsurance allowances received are capitalized and charged to expense in proportion to premiums earned.  Ceded unamortized acquisition costs are netted with direct unamortized acquisition costs in the balance sheet.

 

The Company’s universal life, variable universal life, bank-owned life insurance (“BOLI”), and annuity products are subject to SFAS No. 97 and the recognition of the impact of reinsurance costs on the Company’s financial statements reflect the requirements of that pronouncement.  Ceded premiums and policy fees on SFAS No. 97 products reduce premiums and policy fees recognized by the Company. Ceded claims are treated as an offset to direct benefits and settlement expenses and are recognized when the claim is incurred on a direct basis. Ceded policy reserve changes are also treated as an offset to benefits and settlement expenses and are recognized during the applicable valuation period. Commission and expense allowances paid by the assuming companies are treated as an offset to other operating expenses. Since reinsurance treaties typically provide for allowance percentages that decrease over the lifetime of a policy, allowances in excess of the “ultimate” or final level allowance are capitalized.   Amortization of capitalized reinsurance expense allowances are amortized based on future expected gross profits according to SFAS No. 97. Unlike with SFAS No. 60 products, assumptions for SFAS No. 97 regarding mortality, lapses and interest are continuously reviewed and may be periodically changed. These changes will result in “unlocking” which change the balance in the ceded deferred amortization cost and can affect the amortization of deferred acquisition cost and VOBA. Ceded unearned revenue liabilities are also amortized based on expected gross profits. Assumptions for SFAS No. 97 products are based on the best current estimate of expected mortality, lapses and interest spread. The Company complies with AICPA Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts, which impacts the timing of direct and ceded earnings on certain blocks of the Company’s SFAS No. 97 business.

 

Reinsurance Allowances - The amount and timing of reinsurance allowances (both first year and renewal allowances) are contractually determined by the applicable reinsurance contract and may or may not bear a relationship to the amount and incidence of expenses actually paid by the ceding company.  Many of the Company’s reinsurance treaties do, in fact, have ultimate renewal allowances that exceed the direct ultimate expenses.  Additionally, allowances are intended to reimburse the ceding company for some portion of the ceding company’s commissions, expenses, and taxes.  As a result, first year expenses paid by the Company may be higher than first year allowances paid by the reinsurer, and reinsurance allowances may be higher in later years than renewal expenses paid by the Company.

 

The Company recognizes allowances according to the prescribed schedules in the reinsurance contracts, which may or may not bear a relationship to actual expenses incurred by the Company.  A portion of these allowances is deferred while the non-deferrable allowances are recognized immediately as a reduction of other operating expenses.  The Company’s practice is to defer reinsurance allowances in excess of the ultimate allowance.  This practice is consistent with the Company’s practice of capitalizing direct expenses.  While the recognition of reinsurance allowances is consistent with U.S. GAAP, in some cases non-deferred reinsurance allowances may exceed non-deferred direct costs, which may cause net other operating expenses to be negative.

 

9



 

Ultimate reinsurance allowances are defined as the lowest allowance percentage paid by the reinsurer in any policy duration over the lifetime of a universal life policy (or through the end of the level term period for a traditional life policy).  The Company determines ultimate allowances as the final amount to be paid over the life of a contract after higher acquisition related expenses (whether first year or renewal) are completed.  Ultimate reinsurance allowances are determined by the reinsurer and set by the individual contract of each treaty during the initial negotiation of each such contract.  Ultimate reinsurance allowances and other treaty provisions are listed within each treaty and will differ between agreements since each reinsurance contract is a separately negotiated agreement.  The Company uses the ultimate reinsurance allowances set by the reinsurers and contained within each treaty agreement to complete its accounting responsibilities.

 

Amortization of Reinsurance Allowances - Reinsurance allowances do not affect the methodology used to amortize DAC and VOBA, or the period over which such DAC and VOBA are amortized.  Reinsurance allowances offset the direct expenses capitalized, reducing the net amount that is capitalized.  The amortization pattern varies with changes in estimated gross profits arising from the allowances.  DAC and VOBA on SFAS No. 60 policies are amortized based on the pattern of estimated gross premiums of the policies in force.  Reinsurance allowances do not affect the gross premiums, so therefore they do not impact SFAS No. 60 amortization patterns.  DAC and VOBA on SFAS No. 97 products are amortized based on the pattern of estimated gross profits of the policies in force.  Reinsurance allowances are considered in the determination of estimated gross profits, and therefore do impact SFAS No. 97 amortization patterns.

 

Reinsurance Liabilities - Claim liabilities and policy benefits are calculated consistently for all policies in accordance with U.S. GAAP, regardless of whether or not the policy is reinsured.  Once the claim liabilities and policy benefits for the underlying policies are estimated, the amounts recoverable from the reinsurers are estimated based on a number of factors including the terms of the reinsurance contracts, historical payment patterns of reinsurance partners, and the financial strength and credit worthiness of reinsurance partners.  Liabilities for unpaid reinsurance claims are produced from claims and reinsurance system records, which contain the relevant terms of the individual reinsurance contracts. The Company monitors claims due from reinsurers to ensure that balances are settled on a timely basis. Incurred but not reported claims are reviewed by the Company’s actuarial staff to ensure that appropriate amounts are ceded.

 

The Company analyzes and monitors the credit worthiness of each of its reinsurance partners to minimize collection issues. For newly executed reinsurance contracts with reinsurance companies that do not meet predetermined standards, the Company requires collateral such as assets held in trusts or letters of credit.

 

Components of Reinsurance Cost - The following income statement lines are affected by reinsurance cost:

 

Premiums and policy fees (“reinsurance ceded” on the Company’s financial statements) represent consideration paid to the assuming company for accepting the ceding company’s risks. Ceded premiums and policy fees increase reinsurance cost.

 

Benefits and settlement expenses include incurred claim amounts ceded and changes in policy reserves. Ceded benefits and settlement expenses decrease reinsurance cost.

 

Amortization of deferred policy acquisition cost and VOBA reflects the amortization of capitalized reinsurance allowances.  Ceded amortization decreases reinsurance cost.

 

Other expenses include reinsurance allowances paid by assuming companies to the Company less amounts capitalized.  Non-deferred reinsurance allowances decrease reinsurance cost.

 

The Company’s reinsurance programs do not materially impact the other income line of the Company’s income statement. In addition, net investment income generally has no direct impact on the Company’s reinsurance cost. However, it should be noted that by ceding business to the assuming companies, the Company forgoes investment income on the reserves ceded to the assuming companies. Conversely, the assuming companies will receive investment income on the reserves assumed which will increase the assuming companies’ profitability on business assumed from the Company.

 

10



 

Insurance liabilities and reserves

 

Establishing an adequate liability for the Company’s obligations to policyholders requires the use of assumptions.  Estimating liabilities for future policy benefits on life and health insurance products requires the use of assumptions relative to future investment yields, mortality, morbidity, persistency and other assumptions based on the Company’s historical experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation.  Determining liabilities for the Company’s property and casualty insurance products also requires the use of assumptions, including the projected levels of used vehicle prices, the frequency and severity of claims, and the effectiveness of internal processes designed to reduce the level of claims.  The Company’s results depend significantly upon the extent to which its actual claims experience is consistent with the assumptions the Company used in determining its reserves and pricing its products.  The Company’s reserve assumptions and estimates require significant judgment and, therefore, are inherently uncertain.  The Company cannot determine with precision the ultimate amounts that it will pay for actual claims or the timing of those payments.  In addition, effective January 1, 2007, the Company adopted FASB Statement No. 155, Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140 (“SFAS No. 155”), related to its equity indexed annuity product. SFAS No. 155 requires that the Company determine a fair value for the liability related to this block of business at each balance sheet date, with changes in the fair value recorded through earnings.  Changes in this liability may be significantly affected by interest rate fluctuations.   As a result of the adoption of SFAS No. 157 at January 1, 2008, the Company made certain modifications to the method used to determine fair value for its liability related to equity indexed annuities to take into consideration factors such as policyholder behavior, the Company’s credit rating and other market considerations.  The impact of adopting SFAS No. 157 is discussed further in Note 10, Fair Value of Financial Instruments.

 

Guaranteed minimum withdrawal benefits

 

The Company also establishes liabilities for guaranteed minimum withdrawal benefits (“GMWB”) on its variable annuity products.  The GMWB is valued in accordance with SFAS No. 133 which requires the liability to be marked-to-market using current implied volatilities for the equity indices.  The methods used to estimate the liabilities employ assumptions, primarily about mortality and lapses, equity market and interest returns, market volatility and the Company’s credit rating.  The Company assumes mortality of 65% of the National Association of Insurance Commissioners 1994 Variable Annuity GMDB Mortality Table.  Differences between the actual experience and the assumptions used result in variances in profit and could result in losses.

 

As a result of the adoption of SFAS No. 157 at January 1, 2008, the Company made certain modifications to the method used to determine fair value for its liability related embedded derivatives related to annuities with guaranteed minimum withdrawal benefits to take into consideration factors such as policyholder behavior, the Company’s credit rating and other market considerations.  See Note 10, Fair Value of Financial Instruments for more information related to the impact of adopting SFAS No. 157.

 

11



 

2.             NON-RECOURSE FUNDING OBLIGATIONS

 

The following table shows the non-recourse funding obligations outstanding as of March 31, 2008, listed by issuer:

 

 

 

 

 

 

 

Year-to-Date

 

 

 

 

 

 

 

Weighted-Avg

 

Issuer

 

Balance

 

Maturity Year

 

Interest Rate

 

 

 

(Dollars In Thousands)

 

 

 

 

 

Golden Gate Captive Insurance Company

 

$

800,000

 

2037

 

5.33

%

Golden Gate II Captive Insurance Company

 

575,000

 

2052

 

4.48

%

Total

 

$

1,375,000

 

 

 

 

 

 

3.             COMMITMENTS AND CONTINGENT LIABILITIES

 

The Company is contingently liable to obtain a $20 million letter of credit under indemnity agreements with directors.  Such agreements provide insurance protection in excess of the directors’ and officers’ liability insurance in force at the time up to $20 million.  Should certain events occur constituting a change in control, the Company must obtain the letter of credit upon which directors may draw for defense or settlement of any claim relating to performance of their duties as directors.  The Company has similar agreements with certain of its officers providing up to $10 million in indemnification that are not secured by the obligation to obtain a letter of credit.  These obligations are in addition to the customary obligation to indemnify officers and directors contained in our bylaws.

 

Under insurance guaranty fund laws, in most states insurance companies doing business therein can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies.  The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements.  Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer’s own financial strength.

 

A number of civil jury verdicts have been returned against insurers, broker dealers and other providers of financial services involving sales, refund or claims practices, alleged agent misconduct, failure to properly supervise representatives, relationships with agents or persons with whom the insurer does business, and other matters.  Often these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages.  In some states, juries, judges, and arbitrators have substantial discretion in awarding punitive non-economic compensatory damages which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration.  Arbitration awards are subject to very limited appellate review.  In addition, in some class action and other lawsuits, companies have made material settlement payments.  The Company, like other financial service companies, in the ordinary course of business, is involved in such litigation and arbitration.  Although the Company cannot predict the outcome of any such litigation or arbitration, the Company does not believe that any such outcome will have a material impact on the financial condition or results of the operations of the Company.

 

4.             STOCK-BASED COMPENSATION

 

Performance shares awarded during the first three months of 2008 and 2007, and their estimated fair value at grant date are as follows:

 

Year

 

Performance

 

Estimated

 

Year

 

Performance

 

Estimated

 

Awarded

 

Shares

 

Fair Value

 

Awarded

 

Shares

 

Fair Value

 

 

 

 

 

(Dollars In Thousands, Except Share Amounts)

 

 

 

 

 

2008

 

75,900

 

$

2,900

 

2007

 

64,700

 

$

2,800

 

 

12



 

The criteria for payment of performance awards is based primarily upon a comparison of the Company’s average return on average equity (earlier upon the death, disability, or retirement of the executive, or in certain circumstances, upon a change in control of the Company) to that of a comparison group of publicly held life and multi-line insurance companies.  If the Company’s results are below the median of the comparison group (25th percentile for 2008 awards), no portion of the award is earned.  If the Company’s results are at or above the 90th percentile, the award maximum is earned.  Awards are paid in shares of the Company’s Common Stock.

 

During the first three months of 2008, stock appreciation rights (“SARs”) were granted to certain officers of the Company to provide long-term incentive compensation based solely on the performance of the Company’s Common Stock.  The SARs are exercisable in four equal annual installments beginning one year after the date of grant (earlier upon the death, disability, or retirement of the officer, or in certain circumstances, upon a change in control of the Company) and expire after ten years or upon termination of employment.  The SARs activity as well as weighted average base price for the first three months of 2008 is as follows:

 

 

 

Weighted-Average

 

Number of

 

 

 

Base Price

 

SARs

 

Balance at December 31, 2007

 

$

31.98

 

1,262,704

 

SARs granted

 

38.59

 

329,800

 

SARs exercised

 

22.31

 

(2,731

)

Balance at March 31, 2008

 

$

33.37

 

1,589,773

 

 

The SARs issued in 2008 had estimated fair values at grant date of $2.2 million.  The fair value of the 2008 SARs was estimated using a Black-Scholes option pricing model.  Assumptions used in the model for the 2008 SARs were as follows:  expected volatility ranged from 16.4% to 22.1%, the risk-free interest rate ranged from 2.7% to 3.3%, a dividend rate of 2.1%, a 4.0% forfeiture rate, and the expected exercise date ranged from 2013 to 2016.  The Company will pay an amount in stock equal to the difference between the specified base price of the Company’s Common Stock and the market value at the exercise date for each SAR.

 

Additionally during 2008, the Company issued 13,100 restricted stock units at an average fair value of $39.07 per unit.  These awards, with a total fair value of $0.5 million, vest ten years after the date of grant.

 

5.             DEFINED BENEFIT PENSION PLAN AND UNFUNDED EXCESS BENEFITS PLAN

 

Components of the net periodic benefit cost of the Company’s defined benefit pension plan and unfunded excess benefits plan are as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars In Thousands)

 

 

 

 

 

 

 

Service cost - Benefits earned during the period

 

$

2,907

 

$

2,625

 

Interest cost on projected benefit obligations

 

3,125

 

2,540

 

Expected return on plan assets

 

(3,469

)

(2,893

)

Amortization of prior service cost

 

66

 

53

 

Amortization of actuarial losses

 

1,009

 

849

 

Net periodic benefit cost

 

$

3,638

 

$

3,174

 

 

The Company has not yet determined the amount, if any, that it will contribute to its defined benefit pension plan during 2008.  As of March 31, 2008, no contributions have been made to the defined benefit pension plan.

 

In addition to pension benefits, the Company provides limited healthcare benefits and life insurance benefits to eligible retirees who are not yet eligible for Medicare.  The cost of these plans for the three months ended March 31, 2008 and 2007 was immaterial to the Company’s financial position.

 

13



 

6.             EARNINGS PER SHARE

 

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period, including shares issuable under various deferred compensation plans.  Diluted earnings per share  is computed by dividing net income by the weighted-average number of common shares and dilutive potential common shares outstanding during the period, including shares issuable under various stock-based compensation plans and stock purchase contracts.

 

A reconciliation of the numerators and denominators of the basic and diluted earnings per share is presented below:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars In Thousands, Except Per Share Amounts)

 

Calculation of basic earnings per share:

 

 

 

 

 

Net income

 

$

35,882

 

$

90,583

 

 

 

 

 

 

 

Average share issued and outstanding

 

70,100,334

 

69,996,445

 

Issuable under various deferred compensation plans

 

980,369

 

1,021,217

 

Weighted shares outstanding - Basic

 

71,080,703

 

71,017,662

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.50

 

$

1.28

 

 

 

 

 

 

 

Calculation of diluted earnings per share:

 

 

 

 

 

Net income

 

$

35,882

 

$

90,583

 

 

 

 

 

 

 

Weighted shares outstanding - Basic

 

71,080,703

 

71,017,662

 

Stock appreciation rights (“SARs”)(a)

 

178,618

 

264,585

 

Issuable under various other stock-based compensation plans

 

194,503

 

204,816

 

Weighted shares outstanding - Diluted

 

71,453,824

 

71,487,063

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.50

 

$

1.27

 

 


(a) Excludes 717,845 and 385,720 SARs as of March 31, 2008 and 2007, respectively, that are antidilutive. In the event the average market price exceeds the issue price of the SARs, such right would be dilutive to the Company’s earnings per share and will be included in the Company’s calculation of the diluted average shares outstanding.

 

14



 

7.             COMPREHENSIVE INCOME

 

The following table sets forth the Company’s comprehensive income (loss) for the periods presented below:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars In Thousands)

 

Net income

 

$

35,882

 

$

90,583

 

Change in net unrealized gains on investments, net of income tax:

 

 

 

 

 

(three months: 2008 - ($155,582); 2007 - $16,330)

 

(282,781

)

29,782

 

Change in accumulated gain-hedging, net of income tax:

 

 

 

 

 

(three months: 2008 - ($5,945); 2007 - $1,247)

 

(10,708

)

2,254

 

Reclassification adjustment for amounts included in net income, net of income tax:

 

 

 

 

 

(three months: 2008 - ($3,031); 2007 - $(3,571))

 

(5,510

)

(6,513

)

Reclassification adjustment for hedging amounts included in net income, net of income tax:

 

 

 

 

 

(three months: 2008 - $263; 2007 - $0)

 

(736

 

Comprehensive income (loss)

 

$

(263,853

)

$

116,106

 

 

8.             OPERATING SEGMENTS

 

The Company operates several business segments each having a strategic focus.  An operating segment is generally distinguished by products and/or channels of distribution.  A brief description of each segment follows.

 

·    The Life Marketing segment markets level premium term insurance (“traditional”), universal life (“UL”), variable universal life and BOLI products on a national basis primarily through networks of independent insurance agents and brokers, stockbrokers, and independent marketing organizations.

 

·    The Acquisitions segment focuses on acquiring, converting, and servicing policies acquired from other companies.  The segment’s primary focus is on life insurance policies and annuity products that were sold to individuals.

 

·    The Annuities segment manufactures, sells, and supports fixed and variable annuity products.  These products are primarily sold through stockbrokers, but are also sold through financial institutions and independent agents and brokers.

 

·    The Stable Value Products segment sells guaranteed funding agreements to special purpose entities that in turn issue notes or certificates in smaller, transferable denominations.  The segment also markets fixed and floating rate funding agreements directly to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds.  Additionally, the segment markets guaranteed investment contracts (“GICs”) to 401(k) and other qualified retirement savings plans.

 

·    The Asset Protection segment primarily markets extended service contracts and credit life and disability insurance to protect consumers’ investments in automobiles, watercraft, and recreational vehicles.  In addition, the segment markets a guaranteed asset protection product and an inventory protection product.

 

·    The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on capital and interest on debt).  This segment also includes earnings from several non-strategic lines of business (primarily cancer insurance, residual value insurance, surety insurance, and group annuities), various investment-related transactions, and the operations of several small subsidiaries.

 

15



 

The Company uses the same accounting policies and procedures to measure segment operating income and assets as it uses to measure consolidated net income and assets.  Segment operating income is generally income before income tax excluding net realized investment gains and losses (net of the related amortization of DAC/VOBA and participating income from real estate ventures), and the cumulative effect of change in accounting principle.  Periodic settlements of derivatives associated with corporate debt and certain investments and annuity products are included in realized gains and losses but are considered part of operating income because the derivatives are used to mitigate risk in items affecting consolidated and segment operating income.  Segment operating income represents the basis on which the performance of the Company’s business is internally assessed by management.  Premiums and policy fees, other income, benefits and settlement expenses, and amortization of DAC/VOBA are attributed directly to each operating segment.  Net investment income is allocated based on directly related assets required for transacting the business of that segment.  Realized investment gains (losses) and other operating expenses are allocated to the segments in a manner that most appropriately reflects the operations of that segment.  Investments and other assets are allocated based on statutory policy liabilities, while DAC/VOBA and goodwill are shown in the segments to which they are attributable.

 

There were no significant intersegment transactions.

 

The following tables summarize financial information for the Company’s segments.  Asset adjustments represent the inclusion of assets related to discontinued operations:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars In Thousands)

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

Life Marketing

 

$

260,919

 

$

270,539

 

Acquisitions

 

205,635

 

231,704

 

Annuities

 

82,260

 

73,754

 

Stable Value Products

 

83,794

 

80,526

 

Asset Protection

 

72,933

 

80,023

 

Corporate and Other

 

10,063

 

49,951

 

Total revenues

 

$

715,604

 

$

786,497

 

 

 

 

 

 

 

Segment Operating Income

 

 

 

 

 

Life Marketing

 

$

46,449

 

$

65,280

 

Acquisitions

 

33,576

 

32,249

 

Annuities

 

2,489

 

5,606

 

Stable Value Products

 

16,216

 

12,186

 

Asset Protection

 

9,852

 

10,084

 

Corporate and Other

 

(29,973

)

1,777

 

Total segment operating income

 

78,609

 

127,182

 

 

 

 

 

 

 

Realized investment gains (losses) - investments(1)

 

(29,119

)

8,948

 

Realized investment gains (losses) - derivatives(2)

 

4,099

 

(2,802

)

Income tax expense

 

(17,707

)

(42,745

)

Net income

 

$

35,882

 

$

90,583

 

 


      (1) Realized investment gains (losses) - investments

 

$

(28,045

)

$

13,294

 

          Less: participating income from real estate ventures

 

 

3,150

 

          Less: related amortization of DAC

 

1,074

 

1,196

 

 

 

$

(29,119

)

$

8,948

 

 

 

 

 

 

 

      (2) Realized investment gains (losses) - derivatives

 

$

(1,657

)

$

(2,291

)

          Less: settlements on certain interest rate swaps

 

484

 

257

 

          Less: derivative activity related to certain annuities

 

(6,240

)

254

 

 

 

$

4,099

 

$

(2,802

)

 

16



 

 

 

Operating Segment Assets

 

 

 

March 31, 2008

 

 

 

(Dollars In Thousands)

 

 

 

Life

 

 

 

 

 

Stable Value

 

 

 

Marketing

 

Acquisitions

 

Annuities

 

Products

 

 

 

 

 

 

 

 

 

 

 

Investments and other assets

 

$

10,228,632

 

$

11,046,126

 

$

7,786,736

 

$

5,193,945

 

Deferred policy acquisition costs and value of business acquired

 

2,146,665

 

959,841

 

250,465

 

17,047

 

Goodwill

 

10,192

 

44,147

 

 

 

Total assets

 

$

12,385,489

 

$

12,050,114

 

$

8,037,201

 

$

5,210,992

 

 

 

 

Asset

 

Corporate

 

 

 

Total

 

 

 

Protection

 

and Other

 

Adjustments

 

Consolidated

 

Investments and other assets

 

$

1,325,372

 

$

2,522,877

 

$

29,566

 

$

38,133,254

 

Deferred policy acquisition costs and value of business acquired

 

119,701

 

5,552

 

 

3,499,271

 

Goodwill

 

62,059

 

83

 

 

116,481

 

Total assets

 

$

1,507,132

 

$

2,528,512

 

$

29,566

 

$

41,749,006

 

 

 

 

Operating Segment Assets

 

 

 

December 31, 2007

 

 

 

(Dollars In Thousands)

 

 

 

Life

 

 

 

 

 

Stable Value

 

 

 

Marketing

 

Acquisitions

 

Annuities

 

Products

 

Investments and other assets

 

$

9,830,156

 

$

11,218,519

 

$

7,732,288

 

$

5,035,479

 

Deferred policy acquisition costs and value of business acquired

 

2,071,508

 

950,174

 

221,516

 

16,359

 

Goodwill

 

10,192

 

44,741

 

 

 

Total assets

 

$

11,911,856

 

$

12,213,434

 

$

7,953,804

 

$

5,051,838

 

 

 

 

Asset

 

Corporate

 

 

 

Total

 

 

 

Protection

 

and Other

 

Adjustments

 

Consolidated

 

Investments and other assets

 

$

1,360,218

 

$

3,063,927

 

$

27,595

 

$

38,268,182

 

Deferred policy acquisition costs and value of business acquired

 

140,568

 

368

 

 

3,400,493

 

Goodwill

 

62,350

 

83

 

 

117,366

 

Total assets

 

$

1,563,136

 

$

3,064,378

 

$

27,595

 

$

41,786,041

 

 

9.             GOODWILL

 

During the three months ended March 31, 2008, the Company decreased its goodwill balance by approximately $0.9 million. The decrease was due to a $0.6 million decrease in the Acquisitions segment related to tax benefits realized during the first three months of 2008 on the portion of tax goodwill in excess of GAAP basis goodwill, and a $0.3 million decrease in the Asset Protection segment related to the sale of a small insurance subsidiary.  As of March 31, 2008, the Company had an aggregate goodwill balance of $116.5 million.

 

17



 

10.          FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Effective January 1, 2008, the Company determined the fair value of its financial instruments based on the fair value hierarchy established in SFAS No. 157 which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

In compliance with SFAS No. 157, the Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three level hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.

 

Financial assets and liabilities recorded at fair value on the Consolidated Balance Sheets are categorized as follows:

 

·      Level 1. Unadjusted quoted prices for identical assets or liabilities in an active market.

 

·      Level 2. Quoted prices in markets that are not active or significant inputs that are observable either directly or indirectly. Level 2 inputs include the following:

 

a)              Quoted prices for similar assets or liabilities in active markets

b)             Quoted prices for identical or similar assets or liabilities in non-active markets

c)              Inputs other than quoted market prices that are observable

d)             Inputs that are derived principally from or corroborated by observable market data through correlation or other means.

 

·      Level 3. Prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. They reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.

 

As a result of the adoption of SFAS No. 157, the Company recognized the following adjustment to opening retained earnings for its Equity Indexed Annuities that were previously accounted for under SFAS No. 155:

 

 

 

Carrying

 

Carrying

 

 

 

 

 

Value

 

Value

 

Transition

 

 

 

Prior to

 

After

 

Adjustment to

 

 

 

Adoption

 

Adoption

 

Retained Earnings

 

 

 

January 1, 2008

 

January 1, 2008

 

gain (loss)

 

 

 

(Dollars In Thousands)

 

 

 

 

 

 

 

 

 

Equity-indexed annuity reserves, net

 

$

145,912

 

$

143,634

 

$

2,278

 

Pre-tax cumulative effect of adoption of SFAS No. 157

 

 

 

 

 

2,278

 

Change in deferred income taxes

 

 

 

 

 

(808

)

Cumulative effect of adoption of SFAS No. 157

 

 

 

 

 

$

1,470

 

 

In addition, the Company recognized a transition adjustment for the embedded derivative liability related to annuities with guaranteed minimum withdrawal benefits.  The impact of this adjustment, net of DAC amortization, reduced income before income taxes by $0.4 million for the three months ended March 31, 2008.

 

18



 

The following table presents the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis as of March 31, 2008:

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(Dollars In Thousands)

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

Fixed maturity securities - available for sale

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

$

 

$

6,462,318

 

$

1,177,436

 

$

7,639,754

 

US government and authorities

 

85,215

 

 

 

85,215

 

State, municipalities and political subdivisions

 

 

53,409

 

9,285

 

62,694

 

Public utilities

 

 

1,476,244

 

176,531

 

1,652,775

 

All other corporate bonds

 

 

7,646,938

 

2,287,735

 

9,934,673

 

Redeemable preferred stocks

 

 

83

 

 

83

 

Convertible bonds with warrants

 

 

 

38

 

38

 

Total fixed maturity securities - available for sale

 

85,215

 

15,638,992

 

3,651,025

 

19,375,232

 

Fixed maturity securities - trading

 

232,525

 

3,000,360

 

559,784

 

3,792,669

 

Total fixed maturity securities

 

317,740

 

18,639,352

 

4,210,809

 

23,167,901

 

Equity securities

 

280,873

 

 

8,434

 

289,307

 

Other long-term investments (1)

 

 

18,445

 

8,460

 

26,905

 

Short-term investments

 

775,725

 

345,413

 

 

1,121,138

 

Total investments

 

1,374,338

 

19,003,210

 

4,227,703

 

24,605,251

 

Cash

 

117,933

 

 

 

117,933

 

Other assets

 

5,580

 

 

 

5,580

 

Assets related to separate acccounts

 

 

 

 

 

 

 

 

 

Variable annuity

 

2,686,752

 

 

 

2,686,752

 

Variable universal life

 

324,355

 

 

 

324,355

 

Total assets measured at fair value on a recurring basis

 

$

4,508,958

 

$

19,003,210

 

$

4,227,703

 

$

27,739,871

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuity account balances (2)

 

$

 

$

 

$

146,017

 

$

146,017

 

Other liabilities (1)(3)

 

14,176

 

414,888

 

18,091

 

447,155

 

Total liabilities measured at fair value on a recurring basis

 

$

14,176

 

$

414,888

 

$

164,108

 

$

593,172

 

 


(1)  Includes certain freestanding and embedded derivatives

(2)  Represents liabilities related to equity indexed annuities

(3)  Includes liabilities under our securities lending program

 

19



 

The following table presents a reconciliation of the beginning and ending balances for fair value measurements for which we have used significant unobservable inputs (Level 3):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains (losses)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

included in

 

 

 

 

 

Total Realized and Unrealized

 

 

 

 

 

 

 

Earnings

 

 

 

 

 

Gains (losses)

 

 

 

 

 

 

 

related to

 

 

 

 

 

 

 

Included in

 

Purchases,

 

 

 

 

 

Instruments

 

 

 

 

 

 

 

Other

 

Issuances, and

 

Transfers in

 

 

 

still held at

 

 

 

Beginning

 

Included in

 

Comprehensive

 

Settlements

 

and/or out of

 

Ending

 

the Reporting

 

 

 

Balance

 

Earnings

 

Income

 

(net)

 

Level 3

 

Balance

 

Date

 

 

 

(Dollars In Thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities - available for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

1,240,268

 

 

(97,018

)

34,186

 

 

1,177,436

 

 

State, municipalities and political subdivisions

 

9,118

 

 

168

 

(1

)

 

9,285

 

 

Public utilities

 

176,473

 

 

210

 

(152

)

 

176,531

 

 

All other corporate bonds

 

2,213,739

 

 

(43,074

)

117,070

 

 

2,287,735

 

 

Convertible bonds with warrants

 

227

 

 

(47

)

(142

)

 

38

 

 

Total fixed maturity securities - available for sale

 

3,639,825

 

 

(139,761

)

150,961

 

 

3,651,025

 

 

Fixed maturity securities - trading

 

711,399

 

(13,505

)

 

(138,110

)

 

559,784

 

(11,450

)

Total fixed maturity securities

 

4,351,224

 

(13,505

)

(139,761

)

12,851

 

 

4,210,809

 

(11,450

)

Equity securities

 

8,506

 

 

(72

)

 

 

8,434

 

 

Other long-term investments (1)

 

2,862

 

5,598

 

 

 

 

8,460

 

5,598

 

Total investments

 

4,362,592

 

(7,907

)

(139,833

)

12,851

 

 

4,227,703

 

(5,852

)

Total assets measured at fair value on a recurring basis

 

$

4,362,592

 

$

(7,907

)

$

(139,833

)

$

12,851

 

$

 

$

4,227,703

 

$

(5,852

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuity account balances (2)

 

$

143,634

 

$

(1,726

)

$

 

$

(657

)

$

 

146,017

 

$

(1,726

)

Other liabilities (1)

 

39,675

 

21,584

 

 

 

 

18,091

 

21,584

 

Total liabilities measured at fair value on a recurring basis

 

$

183,309

 

$

19,858

 

$

 

$

(657

)

$

 

$

164,108

 

$

19,858

 

 


(1)  Represents certain freestanding and embedded derivatives

(2)  Represents liabilities related to equity indexed annuities

 

Total realized and unrealized gains (losses) on Level 3 assets and liabilities are primarily reported in either realized investment gains (losses) within the consolidated statements of income or other comprehensive income (loss) within shareowners’ equity based on the appropriate accounting treatment for the item.

 

Purchases, sales, issuances and settlements, net, represent the activity that occurred during the period that results in a change of the asset or liability but does not represent changes in fair value for the instruments held at the beginning of the period. Such activity primarily relates to purchases and sales of fixed maturity securities, and issuances and settlements of equity indexed annuities accounted for under SFAS No. 155.

 

The Company reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities.  Such reclassifications are reported as transfers in and out of Level 3 at the beginning fair value for the reporting period in which the changes occur.

 

The amount of total gains (losses) for assets and liabilities still held as of the reporting date primarily represents changes in fair value of trading securities and certain derivatives that exist as of the reporting date, and the change in fair value of equity indexed annuities accounted for under SFAS No. 155.

 

20



 

11.          SUBSEQUENT EVENT

 

On April 16, 2008, the Company entered into a Second Amended and Restated Credit Agreement (the “Credit Agreement”) among the Company, Protective Life Insurance Company (“PLICO”), the Several Lenders from time to time party thereto, and Regions Bank, as Administrative Agent, to increase the commitment to a maximum principal amount of $500 million (the “New Credit Facility”). The Company and PLICO have the right in certain circumstances to request that the commitment under the New Credit Facility be increased up to a maximum principal amount of $600 million. Balances outstanding under the New Credit Facility will accrue interest at a rate equal to (i) either the prime rate or the London Interbank Offered Rate (LIBOR), plus (ii) a spread based on the ratings of the Company’s senior unsecured long-term debt. The Credit Agreement provides that the Company is liable for the full amount of any obligations for borrowings or letters of credit, including those of PLICO, under the New Credit Facility. The maturity date on the New Credit Facility is April 16, 2013. On March 31, 2008, the Company had $20 million outstanding under its existing $200 million revolving line of credit due July 30, 2009 (the “Existing Credit Facility”). The Company paid the outstanding balance under the Existing Credit Facility in full on April 16, 2008. There is currently no balance outstanding under the New Credit Facility. In addition, the Company was in compliance with all financial debt covenants as of March 31, 2008.

 

12.          INCOME TAXES

 

There have been no material changes to the balance of unrecognized income tax benefits which impacted earnings for the first three months ended March 31, 2008. The Company expects that the IRS will soon complete its examination of the Company’s 2004 and 2005 federal income tax returns. The Company does not expect to have any material adjustments, within the next twelve months, to its balance of unrecognized income tax benefits in any of the tax jurisdictions in which it conducts its business operations.

 

21



 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our consolidated condensed financial statements included under Part I, Item 1, Financial Statements (Unaudited), of this Quarterly Report on Form 10-Q and our audited consolidated financial statements for the year ended December 31, 2007 included in our Annual Report on Form  10-K.

 

FORWARD-LOOKING STATEMENTS – CAUTIONARY LANGUAGE

 

This report reviews our financial condition and results of operations including our liquidity and capital resources.  Historical information is presented and discussed and where appropriate, factors that may affect future financial performance are also identified and discussed.  Certain statements made in this report include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance or achievements instead of historical facts and may contain words like “believe,” “expect,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “plan,” “will,” “shall,” “may,” and other words, phrases, or expressions with similar meaning.  Forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially from the results contained in the forward-looking statements, and we cannot give assurances that such statements will prove to be correct.  Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

 

For a more complete understanding of our business and current period results, please read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with our latest Annual Report on Form 10-K and other filings with the United States Securities and Exchange Commission (the “SEC”).

 

OVERVIEW

 

Our business

 

We are a holding company headquartered in Birmingham, Alabama, whose subsidiaries provide financial services through the production, distribution, and administration of insurance and investment products.  Founded in 1907, Protective Life Insurance Company is our largest operating subsidiary.  Unless the context otherwise requires, “we,” “us,” or “our” refers to the consolidated group of Protective Life Corporation and our subsidiaries.

 

We operate several business segments, each having a strategic focus.   An operating segment is generally distinguished by products and/or channels of distribution.  We periodically evaluate our operating segments in light of the segment reporting requirements prescribed by the Financial Accounting Standards Board (“FASB”) Statement No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), and makes adjustments to our segment reporting as needed.

 

Our operating segments are Life Marketing, Acquisitions, Annuities, Stable Value Products, Asset Protection, and Corporate and Other.

 

·                  Life Marketing - We market level premium term insurance (“traditional life”), universal life (“UL”), variable universal life, and bank owned life insurance (“BOLI”) products on a national basis primarily through networks of independent insurance agents and brokers, stockbrokers, and independent marketing organizations.

 

·                  Acquisitions - We focus on acquiring, converting, and servicing policies acquired from other companies.  The segment's primary focus is on life insurance policies and annuity products sold to individuals.  In the ordinary course of business, the Acquisitions segment regularly considers acquisitions of blocks of policies or smaller insurance companies.  The level of the segment’s acquisition activity is predicated upon many factors, including available capital, operating capacity, and market dynamics.  Policies acquired through the Acquisition segment are typically “closed” blocks of business (no new policies are being marketed).  Therefore, earnings and account values are expected

 

22



 

                        to decline as the result of lapses, deaths, and other terminations of coverage unless new acquisitions are made.

 

·                  Annuities - We manufacture, sell, and support fixed and variable annuity products.  These products are primarily sold through broker-dealers, but are also sold through financial institutions and independent agents and brokers.

 

·                  Stable Value Products - We sell guaranteed funding agreement (“GFAs”) to special purpose entities that in turn issue notes or certificates in smaller, transferable denominations.  The segment also markets fixed and floating rate funding agreements directly to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds.  Additionally, the segment markets guaranteed investment contracts (“GICs”) to 401(k) and other qualified retirement savings plans.

 

·                  Asset Protection - We primarily market extended service contracts and credit life and disability insurance to protect consumers’ investments in automobiles, watercraft, and recreational vehicles.  In addition, the segment markets a guaranteed asset protection (“GAP”) product and an inventory protection product (“IPP”).

 

·                  Corporate and Other - This segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on capital and interest on debt).  This segment also includes earnings from several non-strategic lines of business (primarily cancer insurance, residual value insurance, surety insurance, and group annuities), various investment-related transactions, and the operations of several small subsidiaries.

 

EXECUTIVE SUMMARY

 

Operating earnings were lower for the first three months of 2008 compared to the first three months of 2007, primarily due to mark-to-market losses on a trading portfolio of approximately $19.4 million resulting primarily from the current volatility and depressed credit and equity markets.  However, due to our assessment and the nature of the investments, we do not expect to experience significant long term losses related to these financial instruments.  Additionally, the Annuities segment’s operating earnings decline was primarily due to $5.7 million of mark-to-market losses, net of DAC amortization, on the equity indexed annuity product line and on embedded derivatives associated with the variable annuity Guaranteed Minimum Withdrawal Benefit (“GMWB”) rider.

 

We experienced realized losses of $29.1 million during the first three months of 2008, versus realized gains of $11.0 million in the first three months of 2007. The losses recognized during the first three months of 2008 were caused primarily by current volatility and depressed credit and equity markets. A significant portion of the losses were due to mark-to-market adjustments related to various derivative instruments.

 

The interest rate and credit environment continues to present a significant challenge. Historically low interest rates and market illiquidity continued to create challenges for our products that generate investment spread profits, such as fixed annuities and stable value contracts.  However, active management of crediting rates on these products allowed us to minimize spread compression effects and strong sales allowed us to take advantage of wider credit spreads on investments.

 

Despite tightened capital market conditions, we were able to enter into an amended and restated credit agreement on April 16, 2008, which increased our access to short term borrowing funds to $500 million from $200 million.  See Note 11, Subsequent Event, to the Consolidated Condensed Financial Statements for additional information.

 

Strong competitive pressures on pricing, particularly in our life insurance business, continued to present a challenge from a new sales perspective.  However, our continued focus on delivering value to consumers and broadening our base of distribution allowed for solid product sales during the quarter.  Additionally, as a result of current market conditions and to optimize profit emergence and returns on capital, we expect to place a greater strategic emphasis on universal life sales.

 

23



 

Current costs of reinsurance continue to present challenges from both a new product pricing and capital management perspective.  In response to these challenges, during 2005 we reduced our reliance on reinsurance by changing from coinsurance to yearly renewable term reinsurance and increased the maximum amount retained on any one life from $500,000 to $1,000,000 on certain of our newly written traditional life products.  During the first three months of 2008, we increased our retention limit to $2,000,000 on certain newly written traditional life products.

 

Significant financial information related to each of our segments is included in Results of Operations.

 

KNOWN TRENDS AND UNCERTAINTIES

 

The factors which could affect our future results include, but are not limited to, general economic conditions and the following known trends and uncertainties:

 

General

 

·                  exposure to the risks of natural disasters, pandemics, malicious and terrorist acts could adversely affect our operations;

·                  computer viruses or network security breaches could affect our data processing systems or those of our business partners and could damage our business and adversely affect our financial condition and results of operations;

·                  actual experience may differ from management's assumptions and estimates and negatively affect our results;

·                  we may not realize our anticipated financial results from our acquisitions strategy;

·                  we may not be able to achieve the expected results from our recent acquisitions;

·                  we are dependent on the performance of others;

·                  our risk management policies and procedures may leave us exposed to unidentified or unanticipated risk, which could negatively affect our business or result in losses;

 

Financial environment

 

·                  interest rate fluctuations could negatively affect our spread income or otherwise impact our business;

·                  our investments are subject to market and credit risks;

·                  equity market volatility could negatively impact our business;

·                  credit market volatility or the inability to access financing solutions could adversely impact our financial condition or results from operations;

·                  our ability to grow depends in large part upon the continued availability of capital;

·                  we could be forced to sell investments at a loss to cover policyholder withdrawals;

 

Industry

 

·                  insurance companies are highly regulated and subject to numerous legal restrictions and regulations;

·                  changes to tax law or interpretations of existing tax law could adversely affect our ability to compete with non-insurance products or reduce the demand for certain insurance products;

·                  financial services companies are frequently the targets of litigation, including class action litigation, which could result in substantial judgments;

·                  publicly held companies in general and the financial services industry in particular are sometimes the target of law enforcement investigations and the focus of increased regulatory scrutiny;

·                  new accounting rules or changes to existing accounting rules could negatively impact us;

·                  reinsurance introduces variability in our statements of income;

·                  our reinsurers could fail to meet assumed obligations, increase rates or be subject to adverse developments that could affect us;

·                  fluctuating policy claims from period to period resulting in earnings volatility;

 

24



 

Competition

 

·                  operating in a mature, highly competitive industry could limit our ability to gain or maintain our position in the industry and negatively affect profitability;

·                  our ability to maintain competitive unit costs is dependent upon the level of new sales and persistency of existing business; and

·                  a ratings downgrade could adversely affect our ability to compete.

 

RESULTS OF OPERATIONS

 

In the following discussion, segment operating income is defined as income before income tax excluding net realized investment gains and losses (net of the related amortization of deferred policy acquisition costs (“DAC”) and value of business acquired (“VOBA”) and participating income from real estate ventures), and the cumulative effect of change in accounting principle.  Periodic settlements of derivatives associated with corporate debt and certain investments and annuity products are included in realized gains and losses but are considered part of segment operating income because the derivatives are used to mitigate risk in items affecting segment operating income.  Management believes that segment operating income provides relevant and useful information to investors, as it represents the basis on which the performance of our business is internally assessed.  Although the items excluded from segment operating income may be significant components in understanding and assessing our overall financial performance, management believes that segment operating income enhances an investor’s understanding of our results of operations by highlighting the income (loss) attributable to the normal, recurring operations of our business.  However, segment operating income should not be viewed as a substitute for accounting principles generally accepted in the United States of America (“U.S. GAAP”) net income.  In addition, our segment operating income measures may not be comparable to similarly titled measures reported by other companies.

 

The following table presents a summary of results and reconciles segment operating income to consolidated net income:

 

 

 

Three Months Ended
March 31,

 

 

 

 

 

2008

 

2007

 

Change

 

 

 

(Dollars In Thousands)

 

 

 

Segment Operating Income

 

 

 

 

 

 

 

Life Marketing

 

$

46,449

 

$

65,280

 

(28.8

)%

Acquisitions

 

33,576

 

32,249

 

4.1

 

Annuities

 

2,489

 

5,606

 

(55.6

)

Stable Value Products

 

16,216

 

12,186

 

33.1

 

Asset Protection

 

9,852

 

10,084

 

(2.3

)

Corporate and Other

 

(29,973

)

1,777

 

 

 

Total segment operating income

 

78,609

 

127,182

 

(38.2

)

Realized investment gains (losses) - investments(1)

 

(29,119

)

8,948

 

 

 

Realized investment gains (losses) - derivatives(2)

 

4,099

 

(2,802

)

 

 

Income tax expense

 

(17,707

)

(42,745

)

 

 

Net income

 

$

35,882

 

$

90,583

 

(60.4

)

 


   (1) Realized investment gains (losses) - investments

 

$

(28,045

)

$

13,294

 

 

 

  Less: participating income from real estate ventures

 

 

3,150

 

 

 

  Less: related amortization of DAC

 

1,074

 

1,196

 

 

 

 

 

$

(29,119

)

$

8,948

 

 

 

 

 

 

 

 

 

 

 

   (2) Realized investment gains (losses) - derivatives

 

$

(1,657

)

$

(2,291

)

 

 

  Less: settlements on certain interest rate swaps

 

484

 

257

 

 

 

  Less: derivative activity related to certain annuities

 

(6,240

)

254

 

 

 

 

 

$

4,099

 

$

(2,802

)

 

 

 

25



 

Three Months Ended March 31, 2008 compared to Three Months Ended March 31, 2007

 

Net income for the three months ended March 31, 2008 reflects a $48.6 million, or 38.2%, decrease in segment operating income. The decrease was primarily related to a $31.8 million decrease in operating earnings in the Corporate and Other segment and an $18.8 million decrease in the Life Marketing segment.  Changes in fair value related to the Corporate and Other trading portfolio and the Annuities segment reduced operating earnings by $26.0 million in the first three months of 2008.  We experienced realized losses of $29.7 million during the first three months of 2008, versus realized gains of $11.0 million in the first three months of 2007. The losses recognized during the first three months of 2008 were caused primarily by current volatility and depressed credit and equity markets. A significant portion of the losses related to mark-to-market adjustments related to various derivative instruments.

 

·                  Life Marketing segment operating income was $46.5 million for the three months ended March 31, 2008, representing a decrease of $18.8 million, or 28.8%, from the three months ended March 31, 2007.  The decrease was primarily due to a $15.7 million gain recognized during the first quarter of 2007 on the sale of the segment’s direct marketing subsidiary combined with less favorable mortality results, partly offset by lower insurance company operating expenses.

 

·                  Acquisitions segment operating income was $33.6 million and increased $1.3 million, or 4.1%, for the three months ended March 31, 2008 compared to the three months ended March 31, 2007.  The increase was due primarily to lower operating expenses, partially offset by the expected runoff of the acquired closed blocks.

 

·                  Annuities segment operating income was $2.5 million for the three months ended March 31, 2008, representing a decrease of $3.1 million, or 55.6%, compared to the three months ended March 31, 2007.  This decline was primarily due to $5.7 million of mark-to-market losses, net of DAC amortization, on the equity indexed annuity product line and on embedded derivatives associated with the variable annuity GMWB rider.

 

·                  Stable Value Products segment operating income was $16.2 million and increased $4.0 million, or 33.1%, for the three months ended March 31, 2008 compared to the three months ended March 31, 2007.  The increase was the result of higher operating spreads, partially offset by a decline in average account values.

 

·                  Asset Protection segment operating income was $9.9 million, representing a decrease of $0.2 million, or 2.3%, for the three months ended March 31, 2008 compared to the three months ended March 31, 2007.  The decrease was primarily the result of $1.5 million of lower IPP earnings in 2008 due to the loss of a significant customer during the second quarter of 2007, and partially offset by a $0.6 million gain from the sale of a small insurance subsidiary.

 

·                  Corporate and Other segment operating income declined $31.8 million for the three months ended March 31, 2008, compared to the three months ended March 31, 2007, due primarily to mark-to-market adjustments on a $419 million portfolio of securities designated for trading. This trading portfolio negatively impacted the first three months of 2008 by approximately $19.4 million, a $20.1 million less favorable impact than in the first three months of 2007.  In addition, the segment experienced lower participating income and higher interest expense.  The overall performance of our investment portfolio continued to operate within our expectations, with no significant credit issues in either the securities or mortgage portfolio.

 

26



 

Life Marketing

 

Segment results of operations

 

Segment results were as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

 

 

2008

 

2007

 

Change

 

 

 

(Dollars In Thousands)

 

 

 

REVENUES

 

 

 

 

 

 

 

Gross premiums and policy fees

 

$

358,783

 

$

345,685

 

3.8

%

Reinsurance ceded

 

(207,865

)

(207,614

)

0.1

 

Net premiums and policy fees

 

150,918

 

138,071

 

9.3

 

Net investment income

 

84,956

 

81,103

 

4.8

 

Other income

 

25,045

 

51,365

 

(51.2

)

Total operating revenues

 

260,919

 

270,539

 

(3.6

)

BENEFITS AND EXPENSES

 

 

 

 

 

 

 

Benefits and settlement expenses

 

177,778

 

149,329

 

19.1

 

Amortization of deferred policy acquisition costs

 

26,923

 

28,698

 

(6.2

)

Other operating expenses

 

9,769

 

27,232

 

(64.1

)

Total benefits and expenses

 

214,470

 

205,259

 

4.5

 

OPERATING INCOME

 

46,449

 

65,280

 

(28.8

)

INCOME BEFORE INCOME TAX

 

$

46,449

 

$

65,280

 

(28.8

)

 

27



 

The following table summarizes key data for the Life Marketing segment:

 

 

 

Three Months Ended March 31,

 

 

 

 

 

2008

 

2007

 

Change

 

 

 

(Dollars In Thousands)

 

 

 

Sales By Product

 

 

 

 

 

 

 

Traditional

 

$

27,008

 

$

33,492

 

(19.4

)%

Universal life

 

14,663

 

14,197

 

3.3

 

Variable universal life

 

1,604

 

1,828

 

(12.3

)

 

 

$

43,275

 

$

49,517

 

(12.6

)

Sales By Distribution Channel

 

 

 

 

 

 

 

Brokerage general agents

 

$

24,396

 

$

29,879

 

(18.4

)

Independent agents

 

8,852

 

8,328

 

6.3

 

Stockbrokers / banks

 

8,447

 

8,493

 

(0.5

)

BOLI / other

 

1,580

 

2,817

 

(43.9

)

 

 

$

43,275

 

$

49,517

 

(12.6

)

Average Life Insurance In-force(1)

 

 

 

 

 

 

 

Traditional

 

$

464,731,437

 

$

409,159,975

 

13.6

 

Universal life

 

52,808,052

 

51,478,248

 

2.6

 

 

 

$

517,539,489

 

$

460,638,223

 

12.4

 

Average Account Values

 

 

 

 

 

 

 

Universal life

 

$

5,202,790

 

$

4,860,730

 

7.0

 

Variable universal life

 

337,578

 

313,917

 

7.5

 

 

 

$

5,540,368

 

$

5,174,647

 

7.1

 

 

 

 

 

 

 

 

 

Traditional Life Mortality Experience(2)

 

$

2,210

 

$

5,154

 

 

 

Universal Life Mortality Experience(2)

 

$

567

 

$

669

 

 

 

 


(1) Amounts are not adjusted for reinsurance ceded.

(2) Represents the estimated pretax earnings impact resulting from mortality variances. Excludes results related to the Chase Insurance Group which was acquired in the third quarter of 2006 and excludes results related to the BOLI product line.

 

28



 

Operating expenses detail

 

Certain reclassifications have been made in the previously reported amounts to make the prior period amounts comparable to those of the current period.  Such reclassifications had no effect on previously reported total operating expenses.  Other operating expenses for the segment were as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

 

 

2008

 

2007

 

Change

 

 

 

(Dollars In Thousands)

 

 

 

Insurance Companies:

 

 

 

 

 

 

 

First year commissions

 

$

53,512

 

$

58,505

 

(8.5

)%

Renewal commissions

 

9,151

 

8,719

 

5.0

 

First year ceding allowances

 

(5,529

)

(4,015

)

37.7

 

Renewal ceding allowances

 

(54,134

)

(53,748

)

0.7

 

General & administrative

 

40,533

 

45,158

 

(10.2

)

Taxes, licenses, and fees

 

7,063

 

7,896

 

(10.5

)

Other operating expenses incurred

 

50,596

 

62,515

 

(19.1

)

Less commissions, allowances & expenses capitalized

 

(64,867

)

(70,131

)

(7.5

)

Other operating expenses

 

(14,271

)

(7,616