10-Q: Quarterly report [Sections 13 or 15(d)]
Published on
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-----------
FORM 10-Q
-----------
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- - EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 33-37587
-----------------------
PRUCO LIFE INSURANCE
COMPANY
(Exact name of Registrant as specified in its charter)
ARIZONA 22-1944557
(State or other jurisdiction, (IRS Employer Identification No.)
incorporation or organization)
213 WASHINGTON STREET, NEWARK, NEW JERSEY 07102
(Address of principal executive offices ) (Zip Code)
(973) 802-6000
-----------------------------------------------------------------
(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
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
--- ---
As of August 12, 2005, 250,000 shares of the registrant's Common Stock (par
value $10), were outstanding. As of such date, Prudential Insurance Company of
America, a New Jersey Corporation, owned all of the registrant's Common Stock.
PRUCO LIFE INSURANCE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION (H)(1)(A) AND (B) ON FORM 10-Q AND IS THEREFORE FILING THIS FORM
WITH THE REDUCED DISCLOSURE FORMAT.
================================================================================
1
TABLE OF CONTENTS
FORWARD-LOOKING STATEMENTS
Some of the statements included in this Annual Report on Form 10-Q, including
but not limited to those in Management's Discussion and Analysis of Financial
Condition and Results of Operations, may constitute forward-looking statements
within the meaning of the U.S. Private Securities Litigation Reform Act of 1995.
Words such as "expects," "believes," "anticipates," "includes," "plans,"
"assumes," "estimates," "projects," "intends," "should," "will," "shall" or
variations of such words are generally part of forward-looking statements.
Forward-looking statements are made based on management's current expectations
and beliefs concerning future developments and their potential effects upon
Pruco Life Insurance Company and its subsidiaries. There can be no assurance
that future developments affecting Pruco Life Insurance Company and its
subsidiaries will be those anticipated by management. These forward-looking
statements are not a guarantee of future performance and involve risks and
uncertainties, and there are certain important factors that could cause actual
results to differ, possibly materially, from expectations or estimates reflected
in such forward-looking statements, including, among others: (1) general
economic, market and political conditions, including the performance of
financial markets and interest rate fluctuations; (2) domestic or international
military or terrorist activities or conflicts; (3) volatility in the securities
markets; (4) fluctuations in foreign currency exchange rates and foreign
securities markets; (5) regulatory or legislative changes, including changes in
tax law; (6) changes in statutory or U.S. GAAP accounting principles, practices
or policies; (7) differences between actual experience regarding mortality,
morbidity, persistency, surrender experience, interest rates, or market returns
and the assumptions we use in pricing our products, establishing liabilities and
reserves or for other purposes; (8) re-estimates of our reserves for future
policy benefits and claims; (9) changes in our assumptions related to deferred
policy acquisition costs; (10) events resulting in catastrophic loss of life;
(11) investment losses and defaults; (12) changes in our claims-paying ratings;
(13) competition in our product lines and for personnel; (14) economic,
political, currency and other risks relating to our international operations;
(15) adverse determinations in litigation or regulatory matters and our exposure
to contingent liabilities; and (16) the effects of acquisitions, divestitures
and restructurings, including possible difficulties in integrating and realizing
the projected results of acquisitions. Pruco Life Insurance Company does not
intend, and is under no obligation, to update any particular forward-looking
statement included in this document.
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
AS OF JUNE 30, 2005 AND DECEMBER 31, 2004 (IN THOUSANDS)
- --------------------------------------------------------------------------------
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (IN THOUSANDS)
- --------------------------------------------------------------------------------
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (UNAUDITED)
SIX MONTHS ENDED June 30, 2005 (IN THOUSANDS)
- ---------------------------------------------
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (IN THOUSANDS)
- --------------------------------------------------------------------------------
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
6
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
Pruco Life Insurance Company, or the "Company," is a wholly owned subsidiary of
The Prudential Insurance Company of America, or "Prudential Insurance," which in
turn is a wholly owned subsidiary of Prudential Financial, Inc., or "Prudential
Financial."
The unaudited interim consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States,
or "GAAP," on a basis consistent with reporting interim financial information in
accordance with instructions to Form 10-Q and Article 10 of Regulation S-X of
the Securities and Exchange Commission. These interim financial statements are
unaudited but reflect all adjustments that, in the opinion of management, are
necessary to provide a fair presentation of the consolidated results of
operations and financial condition of the Company for the interim periods
presented. All such adjustments are of a normal recurring nature. The results of
operations for any interim period are not necessarily indicative of results for
a full year. Certain amounts in the Company's prior year consolidated financial
statements have been reclassified to conform to the current year presentation.
The Company has extensive transactions and relationships with Prudential
Insurance and other affiliates. It is possible that the terms of these
transactions are not the same as those that would result from transactions among
wholly unrelated parties. These unaudited financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004.
2. CONTINGENCIES AND LITIGATION
CONTINGENCIES
On an ongoing basis, our internal supervisory and control functions review the
quality of our sales, marketing and other customer interface procedures and
practices and may recommend modifications or enhancements. In certain cases, if
appropriate, we may offer customers remediation and may incur charges, including
the cost of remediation, administrative costs and regulatory fines.
It is possible that the results of operations or the cash flow of the Company in
a particular quarterly or annual period could be materially affected as a result
of payments in connection with the matters discussed above, depending, in part,
upon the results of operations or cash flow for that period. Management
believes, however, that the ultimate payments in connection with currently
pending matters should not have a material adverse effect on the Company's
financial position.
LITIGATION AND REGULATORY MATTERS
The Company is subject to legal and regulatory actions in the ordinary course of
its operations, including class actions. Pending legal and regulatory actions
include proceedings relating to aspects of the businesses and operations that
are specific to the Company and that are typical of the businesses in which the
Company operates. Class action and individual lawsuits involve a variety of
issues and/or allegations, which include sales practices, underwriting
practices, claims payments and procedures, premium charges, policy servicing and
breach of fiduciary duties to customers. The Company is also subject to
litigation arising out of its general business activities, such as its
investments and third party contracts. In certain of these matters, the
plaintiffs are seeking large and/or indeterminate amounts, including punitive or
exemplary damages.
The Company has received formal requests for information relating to its
variable annuity business and unregistered separate accounts from regulators,
including, among others, the Securities and Exchange Commission and the State of
New York Attorney General's Office. The Company is cooperating with all such
inquiries.
Prudential Financial and its subsidiaries currently use reinsurance primarily to
transfer mortality risk, to acquire or dispose of blocks of business and to
manage capital more effectively. Given the recent publicity surrounding certain
reinsurance transactions involving other companies in the insurance industry,
Prudential Financial voluntarily commenced a review of the accounting for the
reinsurance arrangements of Prudential Financial and its subsidiaries to confirm
that it complied with applicable accounting rules. This review includes an
inventory and examination of current and past arrangements. This review is
ongoing and not yet complete. Subsequent to commencing this voluntary review,
Prudential Financial and certain subsidiaries received formal requests for
information from the Connecticut Attorney General, the Connecticut Insurance
Department and the Securities and Exchange Commission requesting
7
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. CONTINGENCIES AND LITIGATION (CONTINUED)
information regarding their participation in certain reinsurance transactions.
Prudential Financial believes that a number of other insurance industry
participants have also received similar requests. It is possible that Prudential
Financial and its subsidiaries may receive additional requests from regulators
relating to reinsurance arrangements. Prudential Financial and its subsidiaries
intend to cooperate fully with all such requests.
The Company's litigation and regulatory matters are subject to many
uncertainties, and given their complexity and scope, the outcomes cannot be
predicted. It is possible that the results of operations or the cash flow of the
Company in a particular quarterly or annual period could be materially affected
by an ultimate unfavorable resolution of pending litigation and regulatory
matters. Management believes, however, that the ultimate outcome of all pending
litigation and regulatory matters should not have a material adverse effect on
the Company's financial position.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ADOPTION OF STATEMENT OF POSITION 03-1
In July 2003, the Accounting Standards Executive Committee, or "AcSEC," of the
American Institute of Certified Public Accountants, or "AICPA," issued Statement
of Position, or "SOP," 03-1, "Accounting and Reporting by Insurance Enterprises
for Certain Nontraditional Long-Duration Contracts and for Separate Accounts".
AcSEC issued the SOP to address the need for interpretive guidance to be
developed in three areas: separate account presentation and valuation; the
accounting recognition given sales inducements (bonus interest, bonus credits,
persistency bonuses); and the classification and valuation of certain
long-duration contract liabilities.
The Company adopted the SOP effective January 1, 2004. The effect of initially
adopting SOP 03-1 was a net of tax charge of $9.2 million, reported as a
cumulative effect of accounting change in the results of operations for the six
months ended June 30, 2004. This charge primarily reflected the net impact of
converting certain individual market value adjusted annuity contracts from
separate account accounting treatment to general account accounting treatment
and the effect of establishing reserves for guaranteed minimum death benefit, or
"GMDB," provisions of the Company's variable annuity contracts. In addition, the
Company recorded an increase in other comprehensive income of $4.0 million,
after tax, related to recording the cumulative unrealized investment gains, net
of shadow deferred acquisition costs, or "DAC," on fixed maturities reclassified
from the separate account to the general account as of January 1, 2004. Upon
adoption of this SOP, reclassifications within the statement of financial
position included increases in fixed maturities of $403 million and
policyholders' account balances of $387 million related to the reclassifications
of annuity contracts from the separate account to the general account. This
activity also included the establishment of the GMDB reserves of approximately
$45 million and the increase in DAC of $23 million. Other balance sheet accounts
that were affected include other long-term investments and deferred taxes
payable.
In June 2004, the FASB issued FASB Staff Position, or "FSP," 97-1, "Situations
in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and
Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments, Permit or Require an
Accrual of an Unearned Revenue Liability." FSP 97-1 clarifies the accounting for
unearned revenue liabilities of certain universal-life contracts under SOP 03-1.
The Company's adoption of FSP 97-1 on July 1, 2004 did not change the accounting
for unearned revenue liabilities and therefore had no impact on the Company's
results of operations.
Stock Options
In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123(R), "Share-Based Payment," that replaces
FASB Statement No. 123, "Accounting for Stock-Based Compensation." SFAS No.
123(R) requires all entities to apply the fair value based measurement method in
accounting for share-based payment transactions with employees, except for
equity instruments held by employee share ownership plans. Under this method,
compensation costs of awards to employees, such as stock options, are measured
at fair value and expensed over the period during which an employee is required
to provide service in exchange for the award (the vesting period). The Company
had previously adopted the fair value recognition provision of the original SFAS
No. 123, prospectively for all new stock options issued to employees on or after
January 1, 2003. As issued, SFAS No. 123(R), is effective for interim and annual
periods beginning after June 15, 2005. However, the SEC recently deferred the
effective date and as a result the Company will adopt SFAS No. 123(R) on January
1, 2006. By that date, there will be no unvested stock options issued prior to
January 1, 2003.
8
PRUCO LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4. RELATED PARTY TRANSACTIONS
CORPORATE OWNED LIFE INSURANCE
Prudential Insurance owns Corporate Owned Life Insurance Policies issued by the
Company. The cash surrender value, which approximates the contract value of
these policies, included in separate account liabilities was $1.1 billion as of
June 30, 2005 and December 31, 2004. Fees related to the COLI policies in the
three months ended June 30, 2005 and June 30, 2004 were $4 million and $3
million, respectively. Fees related to the COLI policies in the six months ended
June 30, 2005 and June 30, 2004 were $8 million and $7 million, respectively.
Purchase of fixed maturities from an affiliate
In 2004, the Company purchased certain fixed maturities from Prudential
Insurance for $110 million, the fair market value plus accrued interest at the
acquisition date, but reflected the investments at the historical amortized cost
of $99 million. The Company also sold $31 million of fixed maturities
securities, recorded at an amortized cost of $29 million, to Prudential Arizona
Reinsurance Captive Company, or "PARCC." The difference between the historical
amortized cost and the fair value, net of taxes, was reflected as a reduction to
additional paid-in capital. The fixed maturity investments are categorized in
the Company's consolidated statements of financial position as available for
sale fixed maturities, and are therefore carried at fair value, with the
difference between amortized cost and fair value reflected in accumulated other
comprehensive income. Gains and losses will be realized upon disposition of the
investment to an entity not under common control.
Reinsurance with Affiliates
During the third quarter of 2004, the Company entered into an agreement to
reinsure its term life insurance policies, known as Term Elite and Term
Essential, or "Term," with PARCC, an affiliated company. The Company reinsured
with PARCC 90 percent of the risks under such policies through a coinsurance
agreement. The Company is not relieved of its primary obligation to the
policyholder as a result of these reinsurance transactions.
Concurrently with implementing the new Agreement, the Company recaptured the
term reinsurance previously reinsured under a coinsurance treaty with an
affiliated offshore captive company, Pruco Reinsurance, Ltd. The agreement had
covered all term policies written on or after October 1, 2002. As a result of
this recapture, the Company recognized a net gain of $1.2 million.
The coinsurance agreement with PARCC replaced yearly renewable term agreements
with external reinsurers that were previously in effect with respect to this
block of business. Similar yearly renewable term agreements on this block of
business have been placed with external reinsurers, through affiliated
companies. There was no net cost associated with the initial transaction and
initial transactions were accounted for in accordance with SFAS No. 113,
"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts." Reinsurance recoverable related to this agreement was $298 million
as of June 30, 2005.
In December 2004, the Company recaptured the excess of loss reinsurance
agreement with Prudential Insurance and replaced it with a revised agreement to
reinsure all risks not otherwise reinsured. Reinsurance recoverable related to
this agreement was $45 million as of June 30, 2005. The Company is not relieved
of its primary obligation to the policyholder as a result of these transactions.
DEBT AGREEMENTS
The Company had a revolving line of credit facility of up to $800 million with
Prudential Funding, LLC, a wholly owned subsidiary of Prudential Insurance. This
credit facility was revised in July 2005 to increase the total credit line to
$1.2 billion, of which, the amount of borrowings cannot exceed $600 million. As
of June 30, 2005 and December 31, 2004, there was $546 million and $456 million,
respectively, of asset-based financing. There was $213 million of debt
outstanding to Prudential Funding, LLC as of June 30, 2005 and none at December
31, 2004.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PRUCO LIFE INSURANCE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(A) AND (B) ON FORM 10-Q AND IS THEREFORE FILING THIS FORM IN
REDUCED DISCLOSURE FORMAT.
This Management's Discussion and Analysis, or "MD&A," of Financial Condition and
Results of Operations, addresses the consolidated financial condition of Pruco
Life Insurance Company as of June 30 2005, compared with December 31, 2004, and
its consolidated results of operations for the three and six month periods ended
June 30, 2005 and June 30, 2004. You should read the following analysis of our
consolidated financial condition and results of operations in conjunction with
the Company's MD&A and audited Consolidated Financial Statements included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2004, and
Interim Consolidated Financial Statements (unaudited) included elsewhere in this
Quarterly Report on Form 10-Q.
GENERAL
The Company sells interest-sensitive individual life insurance, variable life
insurance, term life insurance and individual variable annuities, primarily
through Prudential Insurance's sales force in the United States. These markets
are subject to regulatory oversight with particular emphasis placed on company
solvency and sales practices. These markets are also subject to increasing
competitive pressure as the legal barriers, which have historically segregated
the markets of the financial services industry, have been changed through both
legislative and judicial processes. Regulatory changes have opened the insurance
industry to competition from other financial institutions, particularly banks
and mutual funds that are positioned to deliver competing investment products
through large, stable distribution channels. The Company also had marketed
individual life insurance through its branch office in Taiwan. All insurance
activity of the Taiwan branch has been ceded to an affiliate and the related
assets and liabilities continue to be reflected in the Company's statements of
financial position. The Company had also marketed a non-participating GIC called
PACE under an agreement with MBIA (the Insurance and Reimbursement Agreement)
that expired June 30, 2004. The Company did not seek an extension of the
agreement. The termination of sales of this product has no impact on the
existing in force contracts of PACE customers.
PRODUCTS
Generally, the Company's products offer the option of investing in separate
accounts, segregated funds for which investment risks are borne by the customer,
or the Company's portfolio, referred to as the "general account." The Company
earns its profits through policy fees charged to separate account annuity and
life policyholders and through the interest spread for the GIC and general
account annuity and life products. Policy charges and fee income consist mainly
of three types: sales charges or loading fees on new sales, mortality and
expense charges ("M&E") assessed on fund balances, and mortality and related
charges based on total life insurance in force business. Policyholder fund
values are affected by net sales (sales less withdrawals), changes in interest
rates, and investment returns. The interest spread represents the difference
between the investment income earned by the Company on its investment portfolio
and the amount of interest credited to policyholders' accounts. Products that
generate interest spread primarily include the GIC product, general account life
insurance products, fixed annuities and the fixed-rate option of variable
annuities.
In addition to policy charges and fee income, the Company earns revenues from
insurance premiums from term life insurance and asset management fees from
separate account fund balances. The Company's operating expenses principally
consist of insurance benefits provided, general business expenses, commissions
and other costs of selling and servicing the various products we sell and
interest credited to policyholders' account balances.
1. CHANGES IN FINANCIAL POSITION
JUNE 30, 2005 VERSUS DECEMBER 31, 2004
From December 31, 2004 to June 30, 2005, total assets increased $489 million,
from $27.887 billion to $28.376 billion. Fixed maturities increased by $455
million mainly as a result of investing positive cash flows and reinvestment of
investment income. Other long-term investments increased $87 million, from $28
million at December 31, 2004, during the current year as additional funds were
invested in commercial loans. Short term investments declined $28 million due to
redeployment in longer-term investments.
Deferred policy acquisition costs increased by $93 million from $1.429 billion
at December 31, 2004, to $1.522 billion at June 30, 2005, driven by an $50
million increase in the shadow DAC adjustment from lower unrealized gains and
$152 million in net capitalization of acquisition expenses, partially offset by
$109 million of amortization. Capitalization in the life business reflects a
reduction in capitalization of $34 million related to ceded costs due to cost
reimbursements under the coinsurance agreement with Prudential Arizona
Reinsurance Captive Company or, "PARCC." (See Note 4 to the Interim Unadited
Financial Statements)
10
Reinsurance recoverable increased by $91 million, from $765 million at December
31, 2004, largely as a result of increased ceded reserves held under the PARCC
agreement (see Note 4 to the Interim Unadited Financial Statements) and
increased recoverables for the Taiwan business.
Cash and cash equivalents declined by $424 million, from $744 million at
December 31, 2004 to $320 million at June 30, 2005, due to the deployment of a
portion of the available cash balance.
Separate account assets increased $193 million, from $17.327 billion at December
31, 2004 to $17.520 billion at June 30, 2005, primarily due to market
performance in 2005.
During the first six months of 2005, total liabilities increased by $384
million, from $25.996 billion at December 31, 2004 to $26.380 billion at June
30, 2005. Corresponding with the asset change, separate account liabilities
increased by $193 million, as described above. The Company had short-term
borrowings from an affiliate of $213 million at June 30, 2005 to provide
short-term working capital. There were no such borrowings outstanding at
December 31, 2004. Future policy benefits increased by $113 million, due to
increased reserves for the Taiwan business, increased guaranteed minimum death
and income benefits in the annuity business from higher revenues and increases
to life reserves as a result of sales and renewals of term and the newer
universal life products. Other liabilities decreased $82 million, primarily due
to decreased investment payables on unsettled trades. Policyholder account
balances decreased by $90 million, due primarily to continued maturities and
surrenders of retirement contracts during the quarter. Income taxes payable,
net, declined by $54 million primarily due to a $76 million tax payment made in
the first three months of 2005 partially offset by current year tax expense.
Total securities lending activity increased by $90 million. The relative amounts
of cash collateral for loaned securities and securities sold under agreements to
repurchase decreased $101 million and increased $191 million, respectively.
2. RESULTS OF OPERATIONS
JUNE 2005 TO JUNE 2004 THREE MONTH COMPARISON
NET INCOME
Consolidated net income increased $23 million, from $19 million in the three
months ended June 30, 2004 to $42 million for the three months ended June 30,
2005. Results for the second quarter of 2005 benefited from lower general and
administrative expenses, increased fees and increased investment income, net of
interest credited and interest expense, on general account balances reflecting
higher asset balances. In addition, results for the current quarter benefited
from more favorable claims experience, net of reinsurance, compared to the prior
year period, as well as the favorable impact of cumulative increases in the
market value of variable life and variable annuity assets.
REVENUES
Consolidated revenues decreased by $21 million, from $280 million in the three
months ended June 30, 2004 to $259 million in the three months ended June 30,
2005. Premiums of $10 million, decreased by $19 million, from $29 million in the
three months ended June 30, 2004, due to increased ceded reinsurance premiums
resulting from the coinsurance agreement with PARCC, an affiliate, to reinsure
90% of the entire term book of business (See Note 4 to the Interim Unadited
Financial Statements) during 2004.
Policy charges and fee income, consisting primarily of mortality and expense,
loading and other insurance charges assessed on general and separate account
policyholders' fund balances for the current year period, decreased by $13
million from the prior year quarter. The decrease was the result of a $20
million decrease for individual life products and a $7 million increase for
annuity products. Policy charges for life products decreased as a result of a
new reinsurance agreement (See Note 4 to the Interim Unadited Financial
Statements) entered into during the fourth quarter of 2004, resulting in higher
ceded variable and universal life premiums, partly offset by growth in the in
force business, the favorable impact of increases in the market value of
variable life insurance assets, and the sale of newer interest-sensitive
products that generally carry higher expense charges in the first few years of
the contract. The gross variable life in force business grew nearly 4% from
$77.1 billion at December 31, 2004 to $80.0 billion at June 30, 2005. Annuity
fees are mainly asset-based fees, which are dependent on fund balances that are
affected by net sales as well as asset depreciation or appreciation on the
underlying investment funds in which customers may invest. Average annuity
separate account fund balances are more than 10% higher than in the prior year
as a result of favorable market performance and positive net sales.
11
Net investment income increased by $5 million for the three months ended June
30, 2005, from $93 million in the same period in 2004, driven by increased
income from fixed maturities due to an increase in the portfolio balance from
the deployment of funds accumulated as of December 31, 2004, proceeds from
short-term borrowings and positive cash flows. This was partially offset by
declining fund balances in the retirement business, due to continued contract
maturities and no new sales.
BENEFITS AND EXPENSES
Total benefits and expenses decreased $56 million, from $259 million for the
three months ended June 30, 2004 to $203 million for the current period, driven
by a $35 million decrease in policyholders' benefits, including changes in
reserves, in 2005. Policyholder benefits, including changes in reserves, in the
life business declined $37 million and increased $2 million in the annuity
business.
Policyholders' benefits, excluding changes in reserves, for life insurance
products decreased by $35 million, from $49 million in the three months ended
June 30, 2004, driven by lower net death benefits of $34 million. While net term
death benefits increased $4 million from the prior year period, net variable and
universal death benefits combined were $38 million lower than the prior year
period, due to lower mortality and an increase in the ceded in force for these
products in December 2004. The Company entered into a new excess of loss
reinsurance agreement in the fourth quarter of 2004 with an affiliate (see Note
4 to the Interim Unadited Financial Statements), resulting in a significant
increase in reinsured variable and universal life business. Annuity
policyholders' benefits of $6 million in 2005 were essentially unchanged from
the prior year period.
The change in reserves for life products decreased $2 million, from $17 million
in the three months ended June 30, 2004 to $15 million in the three months ended
June 30, 2005. The decrease was primarily the result of a $7 million decrease in
net term reserves due to the coinsurance treaty with PARCC, which generated
higher reinsurance reserve credits than last year. This was partly offset by an
increase in variable and universal reserves, which were $5 million higher
primarily due to increased sales of universal life products partly offset by the
new excess of loss reinsurance agreement discussed above. The change in reserves
for annuity products increased $1 million in 2005, due to the establishment of a
GMDB feature as of January 1, 2004. The GMDB feature provides annuity
contractholders with a guarantee that the benefit received at death will be no
less than a prescribed minimum amount. This minimum amount is based on the net
deposits paid into the contract, the net deposits accumulated at a specified
rate, the highest historical account value on a contract anniversary, or more
typically, the greatest of these values, depending on features offered in
various contracts and elected by the contractholders.
Tax expense for the three months ended June 30, 2005 increased $12 million, from
$2 million in the three months ended June 30, 2004 to $14 million in the current
quarter. The increase is primarily due to higher net income before taxes, and a
non-recurring reduction of state income tax liabilities of $4 million in the
prior year quarter.
Interest credited to policyholders' account balances decreased by $5 million,
from $64 million in the three months ended June 30, 2004 to $59 million in the
three months ended June 30, 2005. Interest credited in the retirement business
was more than $4 million lower due to continued maturities and withdrawals in
the current year with no additional sales. Higher interest credited due to
increases in policyholders' account balances in the life business which were
higher due to increased deposits, were offset by lower interest credited in the
annuity business due to lower crediting rates.
General, administrative, and other expenses decreased by $17 million from $122
million in the three months ended June 30, 2004 to $105 million in the prior
year period. General, administrative and other expenses, excluding DAC
amortization, decreased $15 million from the year ago quarter primarily as a
result of lower net distribution costs in the life business, which include
reinsurance expense allowances, net of capitalization. Net reinsurance expense
allowances increased as a result of the PARCC coinsurance agreement discussed
above and are reflected as a deduction within operating expenses. DAC
amortization decreased $2 million, from $51 million in 2004, driven by lower
amortization resulting from the PARCC coinsurance agreement, mostly offset by
higher amortization from improved mortality and growth in the term life business
and higher gross profits from higher spread revenue and fees in the annuity
business.
JUNE 2005 TO JUNE 2004 SIX MONTH COMPARISON
NET INCOME
Consolidated net income increased $50 million, from $41million in the six months
ended June 30, 2004 to $91 million for the six months ended June 30, 2005. The
increase reflects lower general and administrative expenses, increased fees and
more favorable claims experience, net of reinsurance, compared to the prior year
period. In addition, results for the first six months of 2005 included a higher
contribution from investment income, net of interest credited and interest
expense, reflecting the collection of investment income on a previously
defaulted bond, improved investment yields and higher asset balances compared to
the prior year. Contributing to the increase is an after-tax charge to income in
2004 of $9 million for the adoption of SOP 03-1.
12
REVENUES
Consolidated revenues decreased by $43 million, from $568 million for the six
months ended June 30, 2004 to $525 million in the same period in 2005. Premiums
of $19 million, decreased by $38 million, from $57 million in the six months
ended June 30, 2004, due to increased ceded reinsurance premiums resulting from
the coinsurance agreement with PARCC, an affiliate, to reinsure 90% of the
entire term book of business (See Note 4 to the Interim Unaudited Financial
Statements) during the third quarter of 2004.
Policy charges and fee income, consisting primarily of mortality and expense,
loading and other insurance charges assessed on general and separate account
policyholders' fund balances, decreased $24 million from the prior year. The
decrease was the result of a $36 million decrease for individual life products
and a $12 million increase for annuity products. Policy charges for life
products decreased as a result of the new reinsurance agreement (See Note 4 to
the Interim Unaudited Financial Statements) entered into during the fourth
quarter of 2004, resulting in higher ceded variable and universal life premiums,
partly offset by growth in the in force business, the favorable impact of
increases in the market value of variable life insurance assets, and the sale of
newer interest-sensitive products that generally carry higher expense charges in
the first few years of the contract. The gross variable life in force business
grew nearly 4% from $77.1 billion at December 31, 2004 to $80.0 billion at June
30, 2005. Annuity fees are mainly asset-based fees which are dependent on fund
balances that are affected by net sales as well as asset depreciation or
appreciation on the underlying investment funds in which customers may invest.
Average annuity separate account fund balances are more than 10% higher than in
the prior year as a result of favorable market performance and positive net
sales.
Net investment income increased by $14 million for the six months ended June 30,
2005, from $185 million in the same period in 2004, due to more than $6 million
of income resulting from the collection of investment income in 2005, on a
previously defaulted bond and increased income from fixed maturities due to an
increase in the portfolio balance from the deployment of funds accumulated as of
December 31, 2004, proceeds from short-term borrowings and positive cash flows.
This was partially offset by declining fund balances in the retirement business,
which decreased due to greater contract maturities during the current quarter.
BENEFITS AND EXPENSES
Total benefits and expenses decreased $87 million, from $507 million for the six
months ended June 30, 2004 to $420 million in the six months ended June 30,
2005, driven by a $66 million decrease in policyholders' benefits, including
changes in reserves, in 2005. Policyholder benefits, including changes in
reserves, in the life business declined $70 million and increased $4 million in
the annuity business.
Policyholders' benefits, excluding changes in reserves, for life insurance
products decreased by $70 million, from $98 million in the six months ended June
30, 2004, driven by lower net death benefits of $69 million. While net term
death benefits increased by $4 million from the prior year, net variable and
universal death benefits combined were $73 million lower than the prior year,
due to lower mortality and an increase in the ceded in force for these products
as a result of the new excess reinsurance agreement entered into during the
fourth quarter of 2004 (see Note 4 to the Interim Unaudited Financial
Statements). Annuity policyholders' benefits of $14 million in 2005 were
slightly lower than in the prior year, primarily due to lower guaranteed minimum
death benefits, or "GMDB," driven by higher average fund values in the current
year as a result of market appreciation.
The net change in reserves for life products in the six months ended June 30,
2005 was essentially unchanged from the six months ended June 30, 2004.
Increases in reserves resulting from increased variable and universal products,
which were $9 million higher primarily due to increased sales of universal life
products and the new excess of loss reinsurance agreement discussed above, were
offset by decreases in net term reserves due to the coinsurance agreement with
PARCC, which generated higher reinsurance reserve credits than last year. The
change in reserves for annuity products increased $6 million in 2005, due to the
establishment of a reserve for the GMDB feature as of January 1, 2004. The GMDB
feature provides annuity contractholders with a guarantee that the benefit
received at death will be no less than a prescribed minimum amount. This minimum
amount is based on the net deposits paid into the contract, the net deposits
accumulated at a specified rate, the highest historical account value on a
contract anniversary, or more typically, the greatest of these values, depending
on features offered in various contracts and elected by the contractholders.
Tax expense for the six months ended June 30, 2005 increased $2 million, from
$11 million in the six months ended June 30, 2004 to $13 million in the current
year period. The increase is primarily due to higher net income before taxes,
mostly offset by a non-recurring reduction of state income tax liabilities, and
a reduction of reserves of approximately $11 million, reflecting the resolution
of certain items with the IRS during the first quarter of 2005.
13
Interest credited to policyholders' account balances decreased by $6 million,
from $125 million in the six months ended June 30, 2004 to $119 million in the
six months ended June 30, 2005. Interest credited in the retirement business was
nearly $8 million lower due to continued maturities and withdrawals in the
current year and no additional sales, partly offset by growth in policyholders'
account balances in the life business which were higher due to increased
policyholder deposits.
General, administrative, and other expenses decreased by $15 million from $241
million in the six months ended June 30, 2004 to $226 million in the six months
ended June 30, 2005. General, administrative and other expenses, excluding DAC
amortization, decreased $18 million from the prior year due to lower net
distribution costs in the life business, which include reinsurance expense
allowances, net of capitalization. Net reinsurance expense allowances increased
as a result of the PARCC coinsurance agreement discussed above and are reflected
as a deduction within operating expenses. DAC amortization increased $3 million,
from $106 million in 2004, driven by a $10 million of increase in the annuity
business from higher gross profits from higher spread revenue and mostly offset
by lower amortization in the life business resulting from the PARCC coinsurance
agreement.
ITEM 4. CONTROLS AND PROCEDURES
In order to ensure that the information we must disclose in our filings with the
Securities Exchange Commission, or "SEC," is recorded, processed, summarized,
and reported on a timely basis, the Company's management, including our Chief
Executive Officer and Chief Financial Officer, have reviewed and evaluated the
effectiveness of our disclosure controls and procedures, as defined in Exchange
Act Rule 13a-15(e) and 15d-15(e), as of June 30, 2005. Based on such evaluation,
the Chief Executive Officer and Chief Financial Officer have concluded that, as
of June 30, 2005, our disclosure controls and procedures were effective in
timely alerting them to material information relating to us (and our
consolidated subsidiaries) required to be included in our periodic SEC filings.
Other than as discussed in the following paragraph, no change in the Company's
internal control over financial reporting, as defined in Exchange Act Rule 13a -
15(f) and 15d - 15(f), occurred during the quarter ended June 30, 2005 that has
materially affected or is reasonably likely to materially affect our internal
control over financial reporting.
As previously reported, in determining the Company's state tax expense for the
three months ended June 30, 2004, an error was made relating to the treatment of
state net operating loss carryforwards. This error resulted in an understatement
of tax expense, and corresponding overstatement of net income, for the three and
six months ended June 30, 2004 and the nine months ended September 30, 2004. The
error was identified by the Company in the course of a review and inventory by
the Company of its deferred tax balances undertaken during the fourth quarter of
2004. Restated unaudited interim financial statements of the Company reflecting
the correction of this error were included in Amendment No. 1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and amendment
No. 1 to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004.
The Company believes that the error was attributable to a material weakness in
the Company's internal control over financial reporting. The Company has
implemented enhancements to its internal control over financial reporting to
provide reasonable assurance that errors of this type will not recur. These
steps include the completion of the Company's comprehensive review and inventory
of deferred tax assets and liabilities. The Company is in the process of
implementing definitive standards for detailed documentation supporting deferred
tax balances and expects to complete this implementation in 2005. The Company is
also in the process of implementing an automated application to further enhance
control with respect to the collection of detailed deferred tax information, and
it expects to fully implement such application in 2005.
14
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to legal and regulatory actions in the ordinary course of
its operations, including class actions. Pending legal and regulatory actions
include proceedings relating to aspects of the businesses and operations that
are specific to the Company and that are typical of the businesses in which the
Company operates. Class action and individual lawsuits may involve a variety of
issues and/or allegations, which include sales practices, underwriting
practices, claims payment and procedures, premium charges, policy servicing and
breach of fiduciary duties to customers. The Company is also subject to
litigation arising out of its general business activities, such as its
investments and third party contracts. In certain of these matters, the
plaintiffs are seeking large and/or indeterminate amounts, including punitive or
exemplary damages.
The Company has received formal requests for information relating to its
variable annuity business and unregistered separate accounts from regulators,
including, among others, the Securities and Exchange Commission and the State of
New York Attorney General's Office. The Company is cooperating with all such
inquiries.
Prudential Financial and its subsidiaries currently use reinsurance primarily to
transfer mortality risk, to acquire or dispose of blocks of business and to
manage capital more effectively. Given the recent publicity surrounding certain
reinsurance transactions involving other companies in the insurance industry,
Prudential Financial voluntarily commenced a review of the accounting for the
reinsurance arrangements of Prudential Financial and its subsidiaries to confirm
that it complied with applicable accounting rules. This review includes an
inventory and examination of current and past arrangements. This review is
ongoing and not yet complete. Subsequent to commencing this voluntary review,
Prudential Financial and certain subsidiaries received formal requests for
information from the Connecticut Attorney General, the Connecticut Insurance
Department and the Securities and Exchange Commission requesting information
regarding their participation in certain reinsurance transactions. Prudential
Financial believes that a number of other insurance industry participants have
also received similar requests. It is possible that Prudential Financial and its
subsidiaries may receive additional requests from regulators relating to
reinsurance arrangements. Prudential Financial and its subsidiaries intend to
cooperate fully with all such requests.
The Company's litigation and regulatory matters are subject to many
uncertainties, and given their complexity and scope, the outcomes cannot be
predicted. It is possible that the results of operations or the cash flow of the
Company in a particular quarterly or annual period could be materially affected
by an ultimate unfavorable resolution of litigation and regulatory matters.
Management believes, however, that the ultimate outcome of all pending
litigation and regulatory matters should not have a material adverse effect on
the Company's financial position.
ITEM 6. EXHIBITS
- ----------------
31.1 Section 302 Certification of the Chief Executive Officer.
31.2 Section 302 Certification of the Chief Financial Officer.
32.1 Section 906 Certification of the Chief Executive Officer.
32.2 Section 906 Certification of the Chief Financial Officer.
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Pruco Life Insurance Company
By: /s/ John Chieffo
-----------------------------------------------------------
John Chieffo
(Authorized Signatory and Principal Accounting and Financial
Officer)
Date: August 12, 2005
16
EXHIBIT INDEX
EXHIBIT NUMBER AND DESCRIPTION
31.1 Section 302 Certification of the Chief Executive Officer,
31.2 Section 302 Certification of the Chief Financial Officer,
32.1 Section 906 Certification of the Chief Executive Officer,
32.2 Section 906 Certification of the Chief Financial Officer.
17