10-Q 1 y91191e10vq.txt METLIFE, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 OR [ ] 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: 001-15787 METLIFE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Delaware 13-4075851 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) ONE MADISON AVENUE NEW YORK, NEW YORK 10010-3690 (212) 578-2211 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE, AND 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 [X] NO [ ] At November 5, 2003, 760,163,283 shares of the Registrant's Common Stock, $.01 par value per share, were outstanding. TABLE OF CONTENTS
PAGE PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS................................................................... 4 Unaudited Interim Condensed Consolidated Balance Sheets at September 30, 2003 and December 31, 2002........................................................................................ 4 Unaudited Interim Condensed Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2003 and 2002.................................................... 5 Unaudited Interim Condensed Consolidated Statement of Stockholders' Equity for the Nine Months Ended September 30, 2003.................................................................... 6 Unaudited Interim Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002................................................................. 7 Notes to Unaudited Interim Condensed Consolidated Financial Statements........................... 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................................................. 33 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................. 92 ITEM 4. CONTROLS AND PROCEDURES................................................................ 92 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS...................................................................... 93 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................... 96 SIGNATURES......................................................................................... 97 EXHIBIT INDEX...................................................................................... 98
- 2 - NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q, including the Management's Discussion and Analysis of Financial Condition and Results of Operations, contains statements which constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements relating to trends in the operations and financial results and the business and the products of the Registrant and its subsidiaries, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend" and other similar expressions. "MetLife" or the "Company" refers to MetLife, Inc., a Delaware corporation (the "Holding Company"), and its subsidiaries, including Metropolitan Life Insurance Company ("Metropolitan Life"). Forward-looking statements are made based upon management's current expectations and beliefs concerning future developments and their potential effects on the Company. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those included in the forward-looking statements as a result of risks and uncertainties including, but not limited to, the following: (i) changes in general economic conditions, including the performance of financial markets and interest rates; (ii) heightened competition, including with respect to pricing, entry of new competitors and the development of new products by new and existing competitors; (iii) unanticipated changes in industry trends; (iv) MetLife, Inc.'s primary reliance, as a holding company, on dividends from its subsidiaries to meet debt payment obligations and the applicable regulatory restrictions on the ability of the subsidiaries to pay such dividends; (v) deterioration in the experience of the "closed block" established in connection with the reorganization of Metropolitan Life; (vi) catastrophe losses; (vii) adverse results from litigation, arbitration or regulatory investigations; (viii) regulatory, accounting or tax changes that may affect the cost of, or demand for, the Company's products or services; (ix) downgrades in the Company's and its affiliates' claims paying ability, financial strength or debt ratings; (x) changes in rating agency policies or practices; (xi) discrepancies between actual claims experience and assumptions used in setting prices for the Company's products and establishing the liabilities for the Company's obligations for future policy benefits and claims; (xii) discrepancies between actual experience and assumptions used in establishing liabilities related to other contingencies or obligations; (xiii) the effects of business disruption or economic contraction due to terrorism or other hostilities; and (xiv) other risks and uncertainties described from time to time in MetLife, Inc.'s filings with the U.S. Securities and Exchange Commission, including its S-1 and S-3 registration statements. The Company specifically disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. - 3 - PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2003 AND DECEMBER 31, 2002 (DOLLARS IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------------- ------------ ASSETS Investments: Fixed maturities available-for-sale, at fair value (amortized cost: $149,985 and $132,899, respectively) $ 159,940 $ 140,288 Equity securities, at fair value (cost: $1,390 and $1,556, respectively) 1,659 1,613 Mortgage loans on real estate 25,535 25,086 Policy loans 8,668 8,580 Real estate and real estate joint ventures held-for-investment 4,724 3,926 Real estate held-for-sale 640 799 Other limited partnership interests 2,450 2,395 Short-term investments 2,718 1,921 Other invested assets 4,617 3,727 --------- --------- Total investments 210,951 188,335 Cash and cash equivalents 5,372 2,323 Accrued investment income 2,265 2,088 Premiums and other receivables 7,133 6,472 Deferred policy acquisition costs 12,367 11,727 Other assets 6,897 6,788 Separate account assets 69,998 59,693 --------- --------- Total assets $ 314,983 $ 277,426 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Future policy benefits $ 92,817 $ 89,815 Policyholder account balances 74,857 66,830 Other policyholder funds 6,293 5,685 Policyholder dividends payable 1,159 1,030 Policyholder dividend obligation 2,278 1,882 Short-term debt 2,935 1,161 Long-term debt 5,703 4,425 Shares subject to mandatory redemption 277 - Current income taxes payable 728 769 Deferred income taxes payable 2,400 1,625 Payables under securities loaned transactions 24,666 17,862 Other liabilities 9,967 7,999 Separate account liabilities 69,998 59,693 --------- --------- Total liabilities 294,078 258,776 --------- --------- Commitments, contingencies and guarantees (Note 8) Company-obligated mandatorily redeemable securities of subsidiary trusts - 1,265 --------- --------- Stockholders' Equity: Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; none issued - - Series A junior participating preferred stock - - Common stock, par value $0.01 per share; 3,000,000,000 shares authorized; 786,766,664 shares issued at September 30, 2003 and December 31, 2002; 760,162,476 shares outstanding at September 30, 2003 and 700,278,412 shares outstanding at December 31, 2002 8 8 Additional paid-in capital 14,960 14,968 Retained earnings 3,667 2,807 Treasury stock, at cost; 26,604,188 shares at September 30, 2003 and 86,488,252 shares at December 31, 2002 (739) (2,405) Accumulated other comprehensive income 3,009 2,007 --------- --------- Total stockholders' equity 20,905 17,385 --------- --------- Total liabilities and stockholders' equity $ 314,983 $ 277,426 ========= =========
SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 4 - METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- --------------------- 2003 2002 2003 2002 --------- --------- --------- --------- REVENUES Premiums $ 5,079 $ 4,672 $ 14,994 $ 13,855 Universal life and investment-type product policy fees 623 591 1,798 1,561 Net investment income 2,864 2,778 8,605 8,341 Other revenues 335 320 988 1,030 Net investment losses (net of amounts allocated from other accounts of ($39), ($16), ($77) and ($102), respectively) (85) (250) (342) (524) -------- -------- -------- -------- Total revenues 8,816 8,111 26,043 24,263 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims (excludes amounts directly related to net investment losses of ($29), ($5), ($52) and ($76), respectively) 5,178 4,739 15,096 14,239 Interest credited to policyholder account balances 767 736 2,275 2,177 Policyholder dividends 473 504 1,483 1,489 Other expenses (excludes amounts directly related to net investment losses of ($10), ($11), ($25) and ($26), respectively) 1,691 1,707 5,286 4,932 -------- -------- -------- -------- Total expenses 8,109 7,686 24,140 22,837 -------- -------- -------- -------- Income from continuing operations before provision for income taxes 707 425 1,903 1,426 Provision for income taxes 147 118 476 456 -------- -------- -------- -------- Income from continuing operations 560 307 1,427 970 Income from discontinued operations, net of income taxes 14 26 89 74 -------- -------- -------- -------- Income before cumulative effect of change in accounting 574 333 1,516 1,044 Cumulative effect of change in accounting - (5) - - -------- -------- -------- -------- Net income $ 574 $ 328 $ 1,516 $ 1,044 ======== ======== ======== ======== Income from continuing operations available to common shareholders per share Basic $ 0.74 $ 0.44 $ 1.92 $ 1.37 ======== ======== ======== ======== Diluted $ 0.74 $ 0.42 $ 1.92 $ 1.33 ======== ======== ======== ======== Net income available to common shareholders per share Basic $ 0.75 $ 0.47 $ 2.05 $ 1.48 ======== ======== ======== ======== Diluted $ 0.75 $ 0.45 $ 2.04 $ 1.42 ======== ======== ======== ========
SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 5 - METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 (DOLLARS IN MILLIONS)
Accumulated Other Comprehensive Income --------------------------------------- Net Foreign Minimum Additional Treasury Unrealized Currency Pension Common Paid-in Retained Stock Investment Translation Liability Stock Capital Earnings at Cost Gains (Losses) Adjustment Adjustment Total ------ ---------- -------- -------- -------------- ----------- ---------- -------- Balance at December 31, 2002 $ 8 $ 14,968 $2,807 $(2,405) $2,282 $(229) $(46) $17,385 Stock grants and issuance of stock options 13 4 17 Settlement of common stock purchase contracts (656) 1,662 1,006 Premium on conversion of company-obligated mandatorily redeemable securities of a subsidiary trust (21) (21) Comprehensive income: Net income 1,516 1,516 Other comprehensive income: Unrealized losses on derivative instruments, net of income taxes (165) (165) Unrealized investment gains, net of related offsets, reclassification adjustments and income taxes 1,051 1,051 Foreign currency translation adjustments 125 125 Minimum pension liability adjustment (9) (9) ------- Other comprehensive income 1,002 ------- Comprehensive income 2,518 ------ -------- ------ ------- ------ ----- ---- ------- Balance at September 30, 2003 $ 8 $ 14,960 $3,667 $ (739) $3,168 $(104) $(55) $20,905 ====== ======== ====== ======= ====== ===== ==== =======
SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 6 - METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (DOLLARS IN MILLIONS)
NINE MONTHS ENDED SEPTEMBER 30, --------------------- 2003 2002 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ 5,043 $ 2,427 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Sales, maturities and repayments of: Fixed maturities 55,201 46,342 Equity securities 215 1,558 Mortgage loans on real estate 2,271 1,888 Real estate and real estate joint ventures 276 227 Other limited partnership interests 186 115 Purchases of: Fixed maturities (71,904) (58,076) Equity securities (10) (853) Mortgage loans on real estate (3,215) (1,991) Real estate and real estate joint ventures (285) (330) Other limited partnership interests (394) (218) Net change in short-term investments (800) (1,213) Purchase of businesses, net of cash received 18 (879) Proceeds from sales of businesses 5 - Net change in payable under securities loaned transactions 6,804 3,590 Other, net (645) (69) -------- -------- Net cash used in investing activities (12,277) (9,909) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Policyholder account balances: Deposits 27,981 21,557 Withdrawals (20,650) (17,753) Net change in short-term debt 1,774 523 Long-term debt issued 225 10 Long-term debt repaid (53) (210) Treasury stock acquired - (471) Settlement of common stock purchase contracts 1,006 - -------- -------- Net cash provided by financing activities 10,283 3,656 -------- -------- Change in cash and cash equivalents 3,049 (3,826) Cash and cash equivalents, beginning of period 2,323 7,473 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,372 $ 3,647 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 293 $ 264 ======== ======== Income taxes $ 329 $ 177 ======== ======== Non-cash transactions during the period: Business acquisitions - assets $ 126 $ 2,630 ======== ======== Business acquisitions - liabilities $ 144 $ 1,751 ======== ======== Business dispositions - assets $ 9 $ - ======== ======== Business dispositions - liabilities $ 4 $ - ======== ======== Purchase money mortgage on real estate sale $ 50 $ 222 ======== ======== MetLife Capital Trust I transactions $ 1,037 $ - ======== ======== Real estate acquired in satisfaction of debt $ - $ 20 ======== ========
SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 7 - METLIFE, INC. NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF ACCOUNTING POLICIES BUSINESS MetLife, Inc. (the "Holding Company") and its subsidiaries (together with the Holding Company, "MetLife" or the "Company") is a leading provider of insurance and other financial services to a broad spectrum of individual and institutional customers. The Company offers life insurance, annuities, automobile and property insurance and mutual funds to individuals, as well as group insurance, reinsurance and retirement and savings products and services to corporations and other institutions. BASIS OF PRESENTATION The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the unaudited interim condensed consolidated financial statements. The most significant estimates include those used in determining: (i) investment impairments; (ii) the fair value of investments in the absence of quoted market values; (iii) the fair value of derivatives; (iv) the amortization of deferred policy acquisition costs, including value of business acquired ("DAC"); (v) the liability for future policyholder benefits; (vi) the liability for litigation, arbitration, or regulatory matters; and (vii) accounting for reinsurance transactions, derivatives and employee benefit plans. In applying these policies, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company's businesses and operations. Actual results could differ from those estimates. The accompanying unaudited interim condensed consolidated financial statements include the accounts of (i) the Holding Company and its subsidiaries; (ii) partnerships and joint ventures in which the Company has a majority voting interest; and (iii) variable interest entities ("VIEs") created or acquired on or after February 1, 2003 of which the Company is deemed to be the primary beneficiary. Closed block assets, liabilities, revenues and expenses are combined on a line by line basis with the assets, liabilities, revenues and expenses outside the closed block based on the nature of the particular item. See Note 7. Intercompany accounts and transactions have been eliminated. The Company uses the equity method of accounting for investments in real estate joint ventures and other limited partnerships in which it has more than a minor equity interest or more than minor influence over the partnership's operations, but does not have a controlling interest. The Company uses the cost method of accounting for interests in which it has a minor equity investment and virtually no influence over the partnership's operations. Minority interest related to consolidated entities included in other liabilities was $605 million and $491 million at September 30, 2003 and December 31, 2002, respectively. Certain amounts in the prior period's consolidated financial statements have been reclassified to conform with the 2003 presentation. The accompanying unaudited interim condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly the consolidated financial position of the Company at September 30, 2003, its consolidated results of operations for the three months and nine months ended September 30, 2003 and 2002, its consolidated cash flows for the nine months ended September 30, 2003 and 2002 and its consolidated statement of stockholders' equity for the nine months ended September 30, 2003 in accordance with GAAP. Interim results are not necessarily indicative of full year performance. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company for the year ended December 31, 2002 included in MetLife, Inc.'s 2002 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission ("SEC"). - 8 - FEDERAL INCOME TAXES Federal income taxes for interim periods have been computed using an estimated annual effective income tax rate. This rate is revised, if necessary, at the end of each successive interim period to reflect the current estimate of the annual effective income tax rate. APPLICATION OF ACCOUNTING PRONOUNCEMENTS In July 2003, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"). SOP 03-1 provides guidance on separate account presentation and valuation, the accounting for sales inducements and the classification and valuation of long-duration contract liabilities. SOP 03-1 is effective for fiscal years beginning after December 15, 2003. The Company is in the process of quantifying the impact of SOP 03-1 on its unaudited interim condensed consolidated financial statements. In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity ("SFAS 150"). SFAS 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as a liability or, in certain circumstances, an asset. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150, as of July 1, 2003, required the Company to reclassify $277 million of company-obligated mandatorily redeemable securities of subsidiary trusts from mezzanine equity to liabilities, as reflected in its unaudited interim condensed consolidated financial statements. In April 2003, the FASB cleared Statement 133 Implementation Issue No. B36, Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments ("Issue B36"). Issue B36 concluded that (i) a company's funds withheld payable and/or receivable under certain reinsurance arrangements, and (ii) a debt instrument that incorporates credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor include an embedded derivative feature that is not clearly and closely related to the host contract. Therefore, the embedded derivative feature must be measured at fair value on the balance sheet and changes in fair value reported in income. Issue B36 was effective October 1, 2003. The Company believes that the impact of the adoption of Issue B36 will be insignificant. However, management continues to validate its models and refine its assumptions. Additionally, industry standards and practices continue to evolve related to valuing these types of embedded derivative features. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Except for certain implementation guidance that is incorporated in SFAS 149 and already effective, SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company's adoption of SFAS 149 on July 1, 2003 did not have a significant impact on its unaudited interim condensed consolidated financial statements. Effective February 1, 2003, the Company adopted FASB Interpretation ("FIN") No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 ("FIN 46"), as amended. Effective October 9, 2003, FASB Staff Position No. 46-6, "Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities" deferred the effective date of FIN 46 for variable interests held by a public entity in a VIE that was created before February 1, 2003 to the end of the first interim or annual period ending after December 15, 2003. Certain of the Company's asset-backed securitizations, collateralized debt obligations, structured investment transactions, and investments in real estate joint ventures and other limited partnership interests meet the definition of a VIE under FIN 46. FIN 46 defines a VIE as (i) any entity in which the equity investors at risk in such entity do not have the characteristics of a controlling financial interest, or (ii) any entity that does not have sufficient equity at risk to finance its activities without additional subordinated financial support from other parties. It requires the consolidation of the VIE by the primary beneficiary. The adoption of FIN 46 requires the Company to include disclosures for VIEs created or acquired on or after February 1, 2003 in its unaudited interim condensed consolidated financial statements related to the total assets and the maximum exposure to loss resulting from the Company's interests in VIEs (see Note 6). The Company is in the process of assessing the impact of the provisions of FIN 46 on its consolidated financial statements for the year ending December 31, 2003 for VIEs created or acquired prior to February 1, 2003. Effective January 1, 2003, the Company adopted FIN No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"). FIN 45 requires entities to establish liabilities for certain types of guarantees and expands financial statement disclosures for others. The initial recognition and initial measurement - 9 - provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a significant impact on the Company's unaudited interim condensed consolidated financial statements. See Note 8. Effective January 1, 2003, the Company adopted SFAS No. 148, Accounting for Stock-Based Compensation -- Transition and Disclosure ("SFAS 148"), which provides guidance on how to apply the fair value method of accounting and use the prospective transition method for stock options granted by the Company subsequent to December 31, 2002. As permitted under SFAS 148, options granted prior to January 1, 2003 will continue to be accounted for under Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and the pro forma impact of accounting for these options at fair value will continue to be disclosed in the unaudited interim condensed consolidated financial statements until the last of those options vest in 2005. See Note 10. Effective January 1, 2003, the Company adopted SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS 146"). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recorded and measured initially at fair value only when the liability is incurred rather than at the date of an entity's commitment to an exit plan as required by Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) ("EITF 94-3"). The Company's activities subject to this guidance in 2003 were not significant. Effective January 1, 2003, the Company adopted SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). In addition to amending or rescinding other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions, SFAS 145 generally precludes companies from recording gains and losses from the extinguishment of debt as an extraordinary item. SFAS 145 also requires sale-leaseback treatment for certain modifications of a capital lease that result in the lease being classified as an operating lease. SFAS 145 did not have a significant impact on the Company's unaudited interim condensed consolidated financial statements. 2. SEPTEMBER 11, 2001 TRAGEDIES On September 11, 2001 terrorist attacks occurred in New York, Washington, D.C. and Pennsylvania (the "tragedies") triggering a significant loss of life and property, which had an adverse impact on certain of the Company's businesses. The Company's original estimate of the total insurance losses related to the tragedies, which was recorded in the third quarter of 2001, was $208 million, net of income taxes of $117 million. As of September 30, 2003, the Company's remaining liability for unpaid and future claims associated with the tragedies was $15 million, principally related to disability coverages. This estimate has been and will continue to be subject to revision in subsequent periods, as claims are received from insureds and processed. Any revision to the estimate of losses in subsequent periods will affect net income in such periods. - 10 - 3. NET INVESTMENT LOSSES Net investment gains (losses), including changes in valuation allowances, and related policyholder amounts were as follows:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- 2003 2002 2003 2002 ------ ------ ------ ------ (DOLLARS IN MILLIONS) Fixed maturities $ (23) $(323) $(215) $(698) Equity securities 5 (38) (3) 222 Mortgage loans on real estate (36) - (58) (22) Real estate and real estate joint ventures (1) 2 (9) (3) (17) Other limited partnership interests (11) 42 (73) 24 Derivatives (2) (74) 40 (91) (107) Other 13 22 24 (28) ----- ----- ----- ----- Total (124) (266) (419) (626) Amounts allocated from: Deferred policy acquisition costs 10 11 25 26 Participating contracts - (2) - (2) Policyholder dividend obligation 29 7 52 78 ----- ----- ----- ----- Total net investment losses $ (85) $(250) $(342) $(524) ===== ===== ===== =====
--------------------- (1) The amounts presented exclude amounts related to sales of real estate held-for-sale presented as discontinued operations in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). (2) The amounts presented include settlement payments on derivative instruments that do not qualify for hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, ("SFAS 133"). Investment gains and losses are net of related policyholder amounts. The amounts netted against investment gains and losses are (i) amortization of DAC to the extent that such amortization results from investment gains and losses; (ii) adjustments to participating contractholder accounts when amounts equal to such investment gains and losses are applied to the contractholder's accounts; and (iii) adjustments to the policyholder dividend obligation resulting from investment gains and losses. This presentation may not be comparable to presentations made by other insurers. 4. DERIVATIVE INSTRUMENTS The Company uses derivative instruments to manage risk through one of four principal risk management strategies, the hedging of: (i) liabilities; (ii) invested assets; (iii) portfolios of assets or liabilities; and (iv) firm commitments and forecasted transactions. Additionally, the Company enters into income generation and replication derivative transactions as permitted by its insurance subsidiaries' derivatives use plans approved by the applicable state insurance departments. The Company's derivative hedging strategy employs a variety of instruments, including financial futures, financial forwards, interest rate, credit default and foreign currency swaps, foreign currency forwards and options, including caps and floors. On the date the Company enters into a derivative contract, management designates the derivative as a hedge of the identified exposure (fair value, cash flow or foreign currency). If a derivative does not qualify for hedge accounting, according to SFAS 133, the changes in its fair value and all periodic settlement receipts and payments are generally reported in net investment gains or losses. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategy for undertaking various hedge transactions. In this documentation, the Company specifically identifies the asset, liability, firm commitment or forecasted transaction that has been designated as a hedged item; states how the hedging instrument is expected to hedge the risks related to the hedged item; sets forth the method that will be used to assess the hedging instrument's effectiveness both at inception and on an ongoing basis; and establishes the method that will be used to measure hedge ineffectiveness. The Company generally determines hedge effectiveness based on total changes in the fair value of a derivative instrument. The Company discontinues hedge accounting prospectively when: (i) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated, or - 11 - exercised; (iii) the derivative is de-designated as a hedge instrument; (iv) it is probable that the forecasted transaction will not occur; (v) a hedged firm commitment no longer meets the definition of a firm commitment; or (vi) management determines that designation of the derivative as a hedge instrument is no longer appropriate. The table below provides a summary of the notional amount and fair value of derivatives by type of hedge designation at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------- --------------------------------- FAIR VALUE FAIR VALUE NOTIONAL -------------------- NOTIONAL ---------------------- AMOUNT ASSETS LIABILITIES AMOUNT ASSETS LIABILITIES -------- ------ ----------- -------- -------- ----------- (DOLLARS IN MILLIONS) BY TYPE OF HEDGE Fair value $ 2,620 $ 14 $ 210 $ 420 $ - $ 64 Cash flow 7,982 40 284 3,520 69 73 Non qualifying 19,545 211 132 19,513 239 183 -------- ---- ------- -------- -------- ------ Total $ 30,147 $265 $ 626 $ 23,453 $ 308 $ 320 ======== ==== ======= ======== ======== ======
During the three months and nine months ended September 30, 2003, the Company recognized net investment expense from the periodic settlement of qualifying interest rate, foreign currency and credit default swaps of $21 million and $36 million, respectively. During the three months and nine months ended September 30, 2002, the Company recognized net investment expense from the periodic settlement of qualifying interest rate, foreign currency and credit default swaps of $14 million and net investment income of $2 million, respectively. During the three months and nine months ended September 30, 2003, the Company recognized $10 million and $102 million, respectively, in net investment losses related to qualifying fair value hedges. In addition, $14 million of unrealized losses and $72 million of unrealized gains on fair value hedged investments were recognized in net investment losses during the three months and nine months ended September 30, 2003, respectively. There were no derivatives designated as fair value hedges during the three months and nine months ended September 30, 2002. There were no discontinued fair value hedges during the three months and nine months ended September 30, 2003 or 2002. At September 30, 2003 and December 31, 2002, the net amounts accumulated in other comprehensive income relating to cash flow hedges were net losses of $279 million and $24 million, respectively. For the three months and nine months ended September 30, 2003, the market value of cash flow hedges decreased by $153 million and $275 million, respectively. During the three months and nine months ended September 30, 2003, the Company recognized other comprehensive net losses of $146 million and $262 million, respectively, relating to the effective portion of cash flow hedges. During the three months ended September 30, 2003, other comprehensive losses reclassified to net investment income and to net investment losses were insignificant. During the nine months ended September 30, 2003, $1 million of other comprehensive losses was reclassified to net investment income, and $12 million of other comprehensive losses were reclassified to net investment losses, relating to the discontinuation of cash flow hedges. For the three months and nine months ended September 30, 2003, $2 million and $6 million of other comprehensive income were reclassified to net investment income, respectively, related to the SFAS 133 transition adjustment. During the three months and nine months ended September 30, 2002, the Company recognized other comprehensive net losses of $24 million and $75 million, respectively, relating to the effective portion of cash flow hedges. For the three months and nine months ended September 30, 2002, amounts related to ineffectiveness of qualifying cash flow hedges were insignificant. During both the three months and nine months ended September 30, 2002, $46 million of other comprehensive losses were reclassified to net investment losses relating to the discontinuation of cash flow hedges. For the three months and nine months ended September 30, 2002, $3 million and $9 million of other comprehensive income were reclassified to net investment income, respectively, related to the SFAS 133 transition adjustment. Approximately $3 million and $49 million of net losses reported in accumulated other comprehensive income at September 30, 2003 are expected to be reclassified during the year ending December 31, 2003 into net investment income and net investment gains and losses, respectively, as the underlying investments mature or expire according to their original terms. For the three months and nine months ended September 30, 2003, the Company recognized as net investment gains, settlement payments on derivative instruments of $35 million and $55 million, respectively, and net investment losses from changes in fair value of $109 million and $146 million, respectively, related to derivatives not qualifying as accounting hedges. For the three months and nine months ended September 30, 2002 the Company recognized as net investment gains, settlement payments on derivative instruments of $19 million and $22 million, respectively, and net investment gains of $21 million and net investment losses of $129 - 12 - million from changes in fair value, respectively, related to derivatives not qualifying as accounting hedges. The use of these non-speculative derivatives is permitted by the applicable insurance departments. 5. STRUCTURED INVESTMENT TRANSACTIONS The Company participates in structured investment transactions, primarily asset securitizations and structured notes. These transactions enhance the Company's total return on its investment portfolio principally by generating management fee income on asset securitizations and by providing equity-based returns on debt securities through structured notes consisting of equity-linked notes and similar instruments. The Company sponsors financial asset securitizations of high yield debt securities, investment grade bonds and structured finance securities and also is the collateral manager and a beneficial interest holder in such transactions (commonly referred to as collateralized debt obligations). As the collateral manager, the Company earns management fees on the outstanding securitized asset balance, which are recorded in income as earned. When the Company transfers assets to a bankruptcy-remote special purpose entity ("SPE") and surrenders control over the transferred assets, the transaction is accounted for as a sale. Gains or losses on securitizations are determined with reference to the carrying amount of the financial assets transferred. Such gains or losses are allocated to the assets sold and the beneficial interests retained based on relative fair values at the date of transfer. Beneficial interests in securitizations are carried at fair value in fixed maturities. Income on the beneficial interests is recognized using the prospective method in accordance with EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. Prior to the effective date of FIN 46, the SPEs used to securitize assets were not consolidated by the Company because unrelated third parties hold controlling interests through ownership of equity in the SPEs, representing at least three percent of the value of the total assets of the SPE throughout the life of the SPE, and such equity class has the substantive risks and rewards of the residual interest of the SPE. The Company purchases or receives beneficial interests in SPEs, which generally acquire financial assets, including corporate equities, debt securities and purchased options. The Company has not guaranteed the performance, liquidity or obligations of the SPEs and the Company's exposure to loss is limited to its carrying value of the beneficial interests in the SPEs. The Company uses the beneficial interests as part of its risk management strategy, including asset-liability management. Prior to the effective date of FIN 46, these SPEs were not consolidated by the Company because unrelated third parties hold controlling interests through ownership of equity in the SPEs, representing at least three percent of the value of the total assets of the SPE throughout the life of the SPE, and such equity class has the substantive risks and rewards of the residual interest of the SPE. The beneficial interests in SPEs where the Company exercises significant influence over the operating and financial policies of the SPE are accounted for in accordance with the equity method of accounting. Impairments of these beneficial interests are included in net investment gains and losses. The beneficial interests in SPEs where the Company does not exercise significant influence are accounted for based on the substance of the beneficial interest's rights and obligations. Beneficial interests are included in fixed maturities. 6. VARIABLE INTEREST ENTITIES Effective February 1, 2003, FIN 46 established new accounting guidance relating to the consolidation of VIEs. Certain of the Company's asset-backed securitizations, collateralized debt obligations, structured investment transactions, and investments in real estate joint ventures and other limited partnership interests meet the definition of a VIE under FIN 46. The Company currently consolidates VIEs created or acquired on or after February 1, 2003 for which it is the primary beneficiary. At December 31, 2003, the Company will consolidate those entities created before February 1, 2003 for which it is the primary beneficiary. - 13 - The following table presents the total assets of and maximum exposure to loss relating to VIEs of which the Company has concluded that it is the primary beneficiary and which will be consolidated in the Company's financial statements beginning December 31, 2003:
SEPTEMBER 30, 2003 ---------------------------- TOTAL MAXIMUM EXPOSURE ASSETS (1) TO LOSS (2) ---------- ---------------- (DOLLARS IN MILLIONS) Real estate joint ventures (3) $ 571 $ 237 Other limited partnerships (4) 27 27 ----- ----- Total $ 598 $ 264 ===== =====
--------------- (1) The assets of the real estate joint ventures and other limited partnerships are reflected at the carrying amounts at which such assets would have been reflected on the Company's balance sheet had the Company consolidated the VIE from the date of its initial investment in the entity. (2) The maximum exposure to loss relating to real estate joint ventures and other limited partnerships is equal to the carrying amounts plus any unfunded commitments, reduced by amounts guaranteed by other partners. (3) Real estate joint ventures include partnerships and other ventures, which engage in the acquisition, development, management and disposal of real estate investments. (4) Other limited partnerships include partnerships established for the purpose of investing in public and private debt and equity securities, as well as limited partnerships established for the purpose of investing in low-income housing that qualifies for Federal tax credits. Had the Company consolidated these VIEs at September 30, 2003, the transition adjustments would have been $4 million, net of income tax. The following table presents the total assets of and the maximum exposure to loss relating to VIEs in which the Company holds a significant variable interest but is not the primary beneficiary:
SEPTEMBER 30, 2003 -------------------------- TOTAL MAXIMUM EXPOSURE ASSETS TO LOSS (1) ------ ---------------- (DOLLARS IN MILLIONS) Asset-backed securitizations and collateralized debt obligations (2) $ 101 $ 14 Other limited partnerships (3) 420 10 Real estate joint ventures (3) 57 50 ------ ------ Total $ 578 $ 74 ====== ======
------------- (1) The maximum exposure to loss of the asset-backed securitizations and collateralized debt obligations is equal to the carrying amounts of retained interests. The maximum exposure to loss relating to the other limited partnerships and real estate joint ventures is equal to the carrying amounts plus any unfunded commitments reduced by amounts guaranteed by other partners. (2) The assets of the asset-backed securitizations and collateralized debt obligations are reflected at fair value as of September 30, 2003. (3) The assets of the real estate joint ventures and other limited partnerships are reflected at the carrying amounts at which such assets would have been reflected on the Company's balance sheet had the Company consolidated the VIE from the date of its initial investment in the entity. Due to the complexity of the judgments and interpretations required in the application of FIN 46 to the Company's collateralized debt obligations, the Company is continuing to evaluate certain entities for consolidation and/or disclosure under FIN 46. At September 30, 2003, the fair value of the assets of the entities still under evaluation is approximately $1.3 billion. The Company's maximum exposure to loss related to these entities at September 30, 2003 is approximately $5 million. - 14 - 7. CLOSED BLOCK On April 7, 2000, (the "date of demutualization"), Metropolitan Life Insurance Company ("Metropolitan Life") converted from a mutual life insurance company to a stock life insurance company and became a wholly-owned subsidiary of MetLife, Inc. The conversion was pursuant to an order by the New York Superintendent of Insurance (the "Superintendent") approving Metropolitan Life's plan of reorganization, as amended (the "plan"). On the date of demutualization, Metropolitan Life established a closed block for the benefit of holders of certain individual life insurance policies of Metropolitan Life. Closed block liabilities and assets designated to the closed block are as follows:
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------------- ------------ (DOLLARS IN MILLIONS) CLOSED BLOCK LIABILITIES Future policy benefits $ 41,670 $ 41,207 Other policyholder funds 261 279 Policyholder dividends payable 804 719 Policyholder dividend obligation 2,278 1,882 Payables under securities loaned transactions 5,665 4,851 Other liabilities 251 433 -------- ---------- Total closed block liabilities 50,929 49,371 -------- ---------- ASSETS DESIGNATED TO THE CLOSED BLOCK Investments: Fixed maturities available-for-sale, at fair value (amortized cost: $29,170 and $28,339, respectively) 31,328 29,981 Equity securities, at fair value (cost: $215 and $236, respectively) 223 218 Mortgage loans on real estate 7,433 7,032 Policy loans 4,041 3,988 Short-term investments 91 24 Other invested assets 394 604 -------- ---------- Total investments 43,510 41,847 Cash and cash equivalents 574 435 Accrued investment income 544 540 Deferred income taxes 1,129 1,151 Premiums and other receivables 89 130 -------- ---------- Total assets designated to the closed block 45,846 44,103 -------- ---------- Excess of closed block liabilities over assets designated to the closed block 5,083 5,268 -------- ---------- Amounts included in accumulated other comprehensive loss: Net unrealized investment gains, net of deferred income tax of $741 and $577, respectively 1,425 1,047 Unrealized derivative (losses) gains, net of deferred income tax of ($17) and $7, respectively (28) 13 Allocated from policyholder dividend obligation, net of deferred income tax of ($778) and ($668), respectively (1,500) (1,214) -------- ---------- (103) (154) -------- ---------- Maximum future earnings to be recognized from closed block assets and liabilities $ 4,980 $ 5,114 ======== ==========
- 15 - Information regarding the policyholder dividend obligation is as follows:
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, DECEMBER 31, 2003 2002 ------- ------- (DOLLARS IN MILLIONS) Balance at beginning of period $ 1,882 $ 708 Impact on net income before amounts allocated from policyholder dividend obligation 52 157 Net investment losses (52) (157) Change in unrealized investment and derivative gains 396 1,174 ------- ------- Balance at end of period $ 2,278 $ 1,882 ======= =======
Closed block revenues and expenses are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ------------------ 2003 2002 2003 2002 ------- ------- ------- ------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 809 $ 851 $ 2,433 $ 2,563 Net investment income and other revenues 639 645 1,904 1,925 Net investment gains (losses) (net of amounts allocated from the policyholder dividend obligation of ($29), ($7), ($52) and ($78), respectively) - 4 (29) 47 ------- ------- ------- ------- Total revenues 1,448 1,500 4,308 4,535 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 879 913 2,643 2,720 Policyholder dividends 392 426 1,178 1,224 Change in policyholder dividend obligation (excludes amounts directly related to net investment losses of ($29), ($7), ($52) and ($78), respectively) 29 6 52 77 Other expenses 73 76 225 234 ------- ------- ------- ------- Total expenses 1,373 1,421 4,098 4,255 ------- ------- ------- ------- Revenues net of expenses before income taxes 75 79 210 280 Income taxes 27 25 76 98 ------- ------- ------- ------- Revenues net of expenses and income taxes $ 48 $ 54 $ 134 $ 182 ======= ======= ======= =======
The change in maximum future earnings of the closed block is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ------------------ 2003 2002 2003 2002 ------- ------- ------- ------- (DOLLARS IN MILLIONS) Balance at end of period $ 4,980 $ 5,236 $ 4,980 $ 5,236 Less: Reallocation of assets - 85 - 85 Balance at beginning of period 5,028 5,205 5,114 5,333 ------- ------- ------- ------- Change during period $ (48) $ (54) $ (134) $ (182) ======= ======= ======= =======
During the period ended September 30, 2002, the allocation of assets to the closed block was revised to appropriately classify assets in accordance with the plan of demutualization. This reallocation of assets had no impact on consolidated assets or liabilities. Metropolitan Life charges the closed block with federal income taxes, state and local premium taxes, other additive state or local taxes, investment management expenses and maintenance expenses relating to the closed block as provided in the plan of demutualization. - 16 - Many of the derivative instrument strategies used by the Company are also used for the closed block. The table below provides a summary of the notional amount and fair value of derivatives by type of hedge designation at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------ -------------------------------- FAIR VALUE FAIR VALUE NOTIONAL -------------------- NOTIONAL --------------------- AMOUNT ASSETS LIABILITIES AMOUNT ASSETS LIABILITIES -------- -------- ----------- -------- -------- ----------- (DOLLARS IN MILLIONS) BY TYPE OF HEDGE Fair value $ 7 $ - $ 1 $ - $ - $ - Cash flow 429 - 56 128 2 11 Non qualifying 49 - 1 258 32 2 -------- -------- -------- -------- -------- -------- Total $ 485 $ - $ 58 $ 386 $ 34 $ 13 ======== ======== ======== ======== ======== ========
During each of the three months ended September 30, 2003 and 2002, the closed block recognized insignificant net investment income from the periodic settlement of interest rate, foreign currency and credit default swaps. During each of the nine months ended September 30, 2003 and 2002, the closed block recognized net investment income from the periodic settlement of interest rate, foreign currency and credit default swaps of $1 million. During the three months and nine months ended September 30, 2003, the closed block recognized $4 million and $3 million in net investment gains related to qualifying fair value hedges, respectively. There were no significant unrealized gains on fair value hedged investments recognized in net investment gains and losses during the three months ended September 30, 2003. There was $1 million of unrealized gains on fair value hedged investments recognized in net investment gains and losses during the nine months ended September 30, 2003. There were no derivatives designated as fair value hedges during the three months and nine months ended September 30, 2002. There were no discontinued fair value hedges during the three months and nine months ended September 30, 2003 or 2002. At September 30, 2003 and December 31, 2002, the net amounts accumulated in other comprehensive income relating to cash flow hedges were net losses of $45 million and net gains of $20 million, respectively. For the three months and nine months ended September 30, 2003, the market value of cash flow hedges decreased by $23 million and $71 million, respectively. During the three months and nine months ended September 30, 2003, the closed block recognized other comprehensive net losses of $14 million and $62 million, respectively, relating to the effective portion of cash flow hedges. During the three months ended September 30, 2003, insignificant amounts of other comprehensive gains were reclassified to net investment income. During the nine months ended September 30, 2003, $2 million of other comprehensive gains was reclassified to net investment income. During the three months and nine months ended September 30, 2003, there were no discontinued cash flow hedges. For both the three months and nine months ended September 30, 2003, $1 million of other comprehensive income was reclassified to net investment income related to the SFAS 133 transition adjustment. During the three months and nine months ended September 30, 2002, the closed block recognized other comprehensive net gains of $13 million and $15 million, respectively, relating to the effective portion of cash flow hedges. For the three months and nine months ended September 30, 2002, amounts related to ineffectiveness of qualifying cash flow hedges were insignificant. During the three months and nine months ended September 30, 2002, there were no discontinued cash flow hedges. For the three months and nine months ended September 30, 2002, $1 million and $3 million of other comprehensive income were reclassified to net investment income, respectively, related to the SFAS 133 transition adjustment. For the three months and nine months ended September 30, 2003, the closed block did not recognize any derivative settlements as net investment gains or losses, and recognized net investment losses from changes in fair value of $2 million and $19 million, respectively, from derivatives not qualifying as accounting hedges. For both the three months and nine months ended September 30, 2002, the closed block recognized derivative settlements as net investment gains of $1 million from derivatives not qualifying as accounting hedges. For the three months and nine months ended September 30, 2002, the closed block recognized changes in fair value in net investment gains of $5 million and net investment losses of $2 million, respectively, from derivatives not qualifying as accounting hedges. The use of these non-speculative derivatives is permitted by the New York Insurance Department. - 17 - 8. COMMITMENTS, CONTINGENCIES AND GUARANTEES SALES PRACTICES CLAIMS Over the past several years, Metropolitan Life, New England Mutual Life Insurance Company ("New England Mutual") and General American Life Insurance Company ("General American") have faced numerous claims, including class action lawsuits, alleging improper marketing and sales of individual life insurance policies or annuities. These lawsuits are generally referred to as "sales practices claims." In December 1999, a federal court approved a settlement resolving sales practices claims on behalf of a class of owners of permanent life insurance policies and annuity contracts or certificates issued pursuant to individual sales in the United States by Metropolitan Life, Metropolitan Insurance and Annuity Company or Metropolitan Tower Life Insurance Company between January 1, 1982 and December 31, 1997. The class includes owners of approximately six million in-force or terminated insurance policies and approximately one million in-force or terminated annuity contracts or certificates. Similar sales practices class actions against New England Mutual, with which Metropolitan Life merged in 1996, and General American, which was acquired in 2000, have been settled. In October 2000, a federal court approved a settlement resolving sales practices claims on behalf of a class of owners of permanent life insurance policies issued by New England Mutual between January 1, 1983 through August 31, 1996. The class includes owners of approximately 600,000 in-force or terminated policies. A federal court has approved a settlement resolving sales practices claims on behalf of a class of owners of permanent life insurance policies issued by General American between January 1, 1982 through December 31, 1996. An appellate court has affirmed the order approving the settlement. The class includes owners of approximately 250,000 in-force or terminated policies. Implementation of the General American class action settlement is proceeding. Certain class members have opted out of the class action settlements noted above and have brought or continued non-class action sales practices lawsuits. In addition, other sales practices lawsuits have been brought. As of September 30, 2003, there are approximately 383 sales practices lawsuits pending against Metropolitan Life, approximately 60 sales practices lawsuits pending against New England Mutual and approximately 25 sales practices lawsuits pending against General American. Metropolitan Life, New England Mutual and General American continue to defend themselves vigorously against these lawsuits. Some individual sales practices claims have been resolved through settlement, won by dispositive motions, or, in a few instances, have gone to trial. Most of the current cases seek substantial damages, including in some cases punitive and treble damages and attorneys' fees. Additional litigation relating to the Company's marketing and sales of individual life insurance may be commenced in the future. The Metropolitan Life class action settlement did not resolve two putative class actions involving sales practices claims filed against Metropolitan Life in Canada, and these actions remain pending. In 2002, a purported class action complaint was filed in a federal court in Kansas by S-G Metals Industries, Inc. against New England Mutual. The complaint seeks certification of a class on behalf of corporations and banks that purchased participating life insurance policies, as well as persons who purchased participating policies for use in pension plans or through work site marketing. These policyholders were not part of the New England Mutual class action settlement noted above. The action was transferred to a federal court in Massachusetts. New England Mutual moved to dismiss the case and in November 2002, the federal district court dismissed the case. In October 2003, the First Circuit Court of Appeals affirmed the district court ruling in favor of New England Mutual. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for sales practices claims against Metropolitan Life, New England Mutual and General American. Regulatory authorities in a small number of states have had investigations or inquiries relating to Metropolitan Life's, New England Mutual's or General American's sales of individual life insurance policies or annuities. Over the past several years, these and a number of investigations by other regulatory authorities were resolved for monetary payments and certain other relief. The Company may continue to resolve investigations in a similar manner. ASBESTOS-RELATED CLAIMS Metropolitan Life is also a defendant in thousands of lawsuits seeking compensatory and punitive damages for personal injuries allegedly caused by exposure to asbestos or asbestos-containing products. Metropolitan Life has never engaged in the business of manufacturing, producing, distributing or selling asbestos or asbestos-containing products nor has Metropolitan Life issued liability or workers' compensation insurance to companies in the business of manufacturing, producing, distributing or selling asbestos or - 18 - asbestos-containing products. Rather, these lawsuits have principally been based upon allegations relating to certain research, publication and other activities of one or more of Metropolitan Life's employees during the period from the 1920's through approximately the 1950's and have alleged that Metropolitan Life learned or should have learned of certain health risks posed by asbestos and, among other things, improperly publicized or failed to disclose those health risks. Metropolitan Life believes that it should not have legal liability in such cases. Legal theories asserted against Metropolitan Life have included negligence, intentional tort claims and conspiracy claims concerning the health risks associated with asbestos. Although Metropolitan Life believes it has meritorious defenses to these claims, and has not suffered any adverse monetary judgments in respect of these claims, due to the risks and expenses of litigation, almost all past cases have been resolved by settlements. Metropolitan Life's defenses (beyond denial of certain factual allegations) to plaintiffs' claims include that: (i) Metropolitan Life owed no duty to the plaintiffs -- it had no special relationship with the plaintiffs and did not manufacture, produce, distribute or sell the asbestos products that allegedly injured plaintiffs; (ii) plaintiffs cannot demonstrate justifiable detrimental reliance; and (iii) plaintiffs cannot demonstrate proximate causation. In defending asbestos cases, Metropolitan Life selects various strategies depending upon the jurisdictions in which such cases are brought and other factors which, in Metropolitan Life's judgment, best protect Metropolitan Life's interests. Strategies include seeking to settle or compromise claims, motions challenging the legal or factual basis for such claims or defending on the merits at trial. In 2002 and 2003, trial courts in California, Utah and Georgia granted motions dismissing claims against Metropolitan Life on some or all of the above grounds. Other courts have denied motions brought by Metropolitan Life to dismiss cases without the necessity of trial. There can be no assurance that Metropolitan Life will receive favorable decisions on motions in the future. Metropolitan Life intends to continue to exercise its best judgment regarding settlement or defense of such cases, including when trials of these cases are appropriate. See Note 11 of Notes to Consolidated Financial Statements for the year ended December 31, 2002 included in the MetLife, Inc. Annual Report on Form 10-K filed with the SEC for information regarding historical asbestos claims information and the increase of its recorded liability at December 31, 2002. During 1998, Metropolitan Life paid $878 million in premiums for excess insurance policies for asbestos-related claims. The excess insurance policies for asbestos-related claims provide for recovery of losses up to $1,500 million, which is in excess of a $400 million self-insured retention. The asbestos-related policies are also subject to annual and per-claim sublimits. Amounts are recoverable under the policies annually with respect to claims paid during the prior calendar year. Although amounts paid by Metropolitan Life in any given year that may be recoverable in the next calendar year under the policies will be reflected as a reduction in the Company's operating cash flows for the year in which they are paid, management believes that the payments will not have a material adverse effect on the Company's liquidity. Each asbestos-related policy contains an experience fund and a reference fund that provides for payments to Metropolitan Life at the commutation date if the reference fund is greater than zero at commutation or pro rata reductions from time to time in the loss reimbursements to Metropolitan Life if the cumulative return on the reference fund is less than the return specified in the experience fund. The return in the reference fund is tied to performance of the Standard & Poor's 500 Index and the Lehman Brothers Aggregate Bond Index. A claim has been made under the excess insurance policies in 2003 for the amounts paid in 2002 with respect to asbestos litigation in excess of the retention. As the performance of the indices impact the return in the reference fund, it is possible that loss reimbursements to the Company and the recoverable with respect to later periods may be less than the amount of the recorded losses. Such forgone loss reimbursements may be recovered upon commutation depending upon future performance of the reference fund. If at some point in the future, the Company believes the liability for probable and reasonably estimable losses for asbestos-related claims should be increased, an expense would be recorded and the insurance recoverable would be adjusted subject to the terms, conditions and limits of the excess insurance policies. A portion of the change in the insurance recoverable would be recorded as a deferred gain and amortized into income over the estimated remaining settlement period of the insurance policies. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for asbestos-related claims. The ability of Metropolitan Life to estimate its ultimate asbestos exposure is subject to considerable uncertainty due to numerous factors. The availability of data is limited and it is difficult to predict with any certainty numerous variables that can affect liability estimates, including the number of future claims, the cost to resolve claims, the disease mix and severity of disease, the jurisdiction of claims filed, tort reform efforts and the impact of any possible future adverse verdicts and their amounts. Recent bankruptcies of other companies involved in asbestos litigation, as well as advertising by plaintiffs' asbestos lawyers, may be resulting in an increase in the number of claims and the cost of resolving claims, as well as the number of trials and possible adverse verdicts Metropolitan Life may experience. Plaintiffs are seeking additional funds from defendants, including Metropolitan Life, in light of such recent bankruptcies by certain other defendants. In addition, publicity regarding legislative reform efforts may be - 19 - resulting in an increase in the number of claims. As reported in MetLife, Inc.'s Annual Report on Form 10-K, Metropolitan Life received approximately 66,000 asbestos-related claims in 2002. During the first nine months of 2003 and 2002, Metropolitan Life received approximately 53,200 and 45,200 asbestos-related claims, respectively. Of the approximately 53,200 claims received in the first nine months of 2003, approximately 23,000 were received in April 2003. A bill reforming asbestos litigation may be voted on by the Senate in 2003. While the Company strongly supports reform efforts, there can be no assurance that legislative reform will be enacted. Metropolitan Life will continue to study its claims experience, review external literature regarding asbestos claims experience in the United States and consider numerous variables that can affect its asbestos liability exposure, including bankruptcies of other companies involved in asbestos litigation and legislative and judicial developments, to identify trends and to assess their impact on the recorded asbestos liability. The number of asbestos cases that may be brought or the aggregate amount of any liability that Metropolitan Life may ultimately incur is uncertain. Accordingly, it is reasonably possible that the Company's total exposure to asbestos claims may be greater than the liability recorded by the Company in its unaudited interim condensed consolidated financial statements and that future charges to income may be necessary. While the potential future charges could be material in particular quarterly or annual periods in which they are recorded, based on information currently known by management, it does not believe any such charges are likely to have a material adverse effect on the Company's consolidated financial position. In 2003, Metropolitan Life also has been named as a defendant in a small number of silicosis, welding and mixed dust cases. The cases are pending in Mississippi, Texas, Ohio, Pennsylvania, West Virginia, Louisiana, Kentucky, Georgia and Arkansas. The Company intends to defend itself vigorously against these cases. PROPERTY AND CASUALTY ACTIONS Purported class action suits involving claims by policyholders for the alleged diminished value of automobiles after accident-related repairs have been filed in Rhode Island, Texas, Georgia and Tennessee against Metropolitan Property and Casualty Insurance Company. Rhode Island and Texas trial courts denied plaintiffs' motions for class certification. In a lawsuit involving another insurer, the Tennessee Supreme Court held that diminished value is not covered under a Tennessee automobile policy. Based on that decision, plaintiffs in Tennessee have dismissed their alleged diminished value lawsuit against Metropolitan Property and Casualty Insurance Company. A settlement was reached in the Georgia class action and has been implemented; the Company determined to settle the case in light of a Georgia Supreme Court decision involving another insurer. A purported class action has been filed against Metropolitan Property and Casualty Insurance Company's subsidiary, Metropolitan Casualty Insurance Company, in Florida. The complaint alleges breach of contract and unfair trade practices with respect to allowing the use of parts not made by the original manufacturer to repair damaged automobiles. Discovery is ongoing and a motion for class certification is pending. Total loss valuation methods are the subject of national class actions involving other insurance companies. A Pennsylvania state court purported class action lawsuit filed in 2001 alleges that Metropolitan Property and Casualty Insurance Company improperly took depreciation on partial homeowner losses where the insured replaced the covered item. The court has dismissed the action. An appeal has been filed. Metropolitan Property and Casualty Insurance Company and Metropolitan Casualty Insurance Company are vigorously defending themselves against these lawsuits. DEMUTUALIZATION ACTIONS Several lawsuits were brought in 2000 challenging the fairness of Metropolitan Life's plan of reorganization and the adequacy and accuracy of Metropolitan Life's disclosure to policyholders regarding the plan. These actions name as defendants some or all of Metropolitan Life, the Holding Company, the individual directors, the Superintendent and the underwriters for MetLife, Inc.'s initial public offering, Goldman Sachs & Company and Credit Suisse First Boston. Five purported class actions pending in the New York state court in New York County were consolidated within the commercial part. In addition, there remained a separate purported class action in New York state court in New York County. On February 21, 2003, the defendants' motions to dismiss both the consolidated action and separate action were granted; leave to replead as a proceeding under Article 78 of New York's Civil Practice Law and Rules has been granted in the separate action. Plaintiffs in the consolidated action and separate action have filed notices of appeal. Another purported class action in New York state court in Kings County has been voluntarily held in abeyance by plaintiffs. The plaintiffs in the state court class actions seek injunctive, declaratory and compensatory relief, as well as an accounting and, in some instances, punitive damages. Some of the plaintiffs in the above described actions also have brought a proceeding under Article 78 of New York's Civil Practice Law and Rules challenging the Opinion and Decision of the Superintendent who approved the plan. In this proceeding, petitioners seek to vacate the Superintendent's Opinion and Decision and enjoin him from granting final approval of the plan. This case also is being held in abeyance by plaintiffs. Three purported class actions were filed in the United States District Court for the Eastern District of New York claiming violation of the Securities Act of 1933. The plaintiffs in these actions, which have been - 20 - consolidated, claim that the Policyholder Information Booklets relating to the plan failed to disclose certain material facts and seek rescission and compensatory damages. Metropolitan Life's motion to dismiss these three cases was denied in 2001. On February 4, 2003, plaintiffs filed a consolidated amended complaint adding a fraud claim under the Securities Exchange Act of 1934. Metropolitan Life has served a motion to dismiss the consolidated amended complaint and a motion for summary judgment in this action. A purported class action also was filed in the United States District Court for the Southern District of New York seeking damages from Metropolitan Life and the Holding Company for alleged violations of various provisions of the Constitution of the United States in connection with the plan of reorganization. In 2001, pursuant to a motion to dismiss filed by Metropolitan Life, this case was dismissed by the District Court. In January 2003, the United States Court of Appeals for the Second Circuit affirmed the dismissal. In June 2003, the United States Supreme Court denied plaintiffs' petition for certiorari in this action. Metropolitan Life, the Holding Company and the individual defendants believe they have meritorious defenses to the plaintiffs' claims and are contesting vigorously all of the plaintiffs' claims in these actions. In 2001, a lawsuit was filed in the Superior Court of Justice, Ontario, Canada on behalf of a proposed class of certain former Canadian policyholders against the Holding Company, Metropolitan Life, and Metropolitan Life Insurance Company of Canada. Plaintiffs' allegations concern the way that their policies were treated in connection with the demutualization of Metropolitan Life; they seek damages, declarations, and other non-pecuniary relief. The defendants believe they have meritorious defenses to the plaintiffs' claims and will contest vigorously all of plaintiffs' claims in this matter. In July 2002, a lawsuit was filed in the United States District Court for the Eastern District of Texas on behalf of a proposed class comprised of the settlement class in the Metropolitan Life sales practices class action settlement approved in December 1999 by the United States District Court for the Western District of Pennsylvania. After the defendants' motion to transfer the lawsuit to the Western District of Pennsylvania was granted, plaintiffs filed an amended complaint alleging that the treatment of the cost of the sales practices settlement in connection with the demutualization of Metropolitan Life breached the terms of the settlement. Plaintiffs sought compensatory and punitive damages, as well as attorneys' fees and costs. In October 2003, the court granted defendants' motion to dismiss the action. RACE-CONSCIOUS UNDERWRITING CLAIMS Insurance departments in a number of states initiated inquiries in 2000 about possible race-conscious underwriting of life insurance. These inquiries generally have been directed to all life insurers licensed in their respective states, including Metropolitan Life and certain of its affiliates. The New York Insurance Department has concluded its examination of Metropolitan Life concerning possible past race-conscious underwriting practices. Four purported class action lawsuits filed against Metropolitan Life in 2000 and 2001 alleging racial discrimination in the marketing, sale, and administration of life insurance policies have been consolidated in the United States District Court for the Southern District of New York. On April 28, 2003, the United States District Court approved a class-action settlement of the consolidated actions. Several persons have filed notices of appeal from the order approving the settlement, but subsequently the appeals were dismissed. Metropolitan Life also has entered into settlement agreements to resolve the regulatory examination. Metropolitan Life recorded a charge in the fourth quarter of 2001 in connection with the anticipated resolution of these matters. During the three months and nine months ended September 30, 2003, the Company reduced its reserve by $28 million, net of income tax, and $92 million, net of income tax, respectively. The Company believes the remaining portion of the previously recorded charge is adequate to cover the costs associated with the resolution of these matters. Eighteen lawsuits involving approximately 130 plaintiffs have been filed in federal and state court in Alabama, Mississippi and Tennessee alleging federal and/or state law claims of racial discrimination in connection with the sale, formation, administration or servicing of life insurance policies. Metropolitan Life is contesting vigorously plaintiffs' claims in these actions. OTHER In 2001, a putative class action was filed against Metropolitan Life in the United States District Court for the Southern District of New York alleging gender discrimination and retaliation in the MetLife Financial Services unit of the Individual segment. The plaintiffs seek unspecified compensatory damages, punitive damages, a declaration that the alleged practices are discriminatory and illegal, injunctive relief requiring Metropolitan Life to discontinue the alleged discriminatory practices, an order restoring class members to their rightful positions (or appropriate compensation in lieu thereof), and other relief. Plaintiffs have filed a motion for class certification. Opposition papers were filed by Metropolitan Life. In August 2003, the court granted preliminary approval to a settlement of the lawsuit. At the fairness hearing held on November 6, 2003, the court approved the settlement of the lawsuit. Implementation of the settlement will commence in 2004. A lawsuit has been filed against Metropolitan Life in Ontario, Canada by Clarica Life Insurance Company regarding the sale of the majority of Metropolitan Life's Canadian operation to Clarica in 1998. Clarica alleges that Metropolitan Life breached certain - 21 - representations and warranties contained in the sale agreement, that Metropolitan Life made misrepresentations upon which Clarica relied during the negotiations and that Metropolitan Life was negligent in the performance of certain of its obligations and duties under the sale agreement. The parties are engaged in settlement discussions. A putative class action lawsuit is pending in the United States District Court for the District of Columbia, in which plaintiffs allege that they were denied certain ad hoc pension increases awarded to retirees under the Metropolitan Life retirement plan. The ad hoc pension increases were awarded only to retirees (i.e., individuals who were entitled to an immediate retirement benefit upon their termination of employment) and not available to individuals like these plaintiffs whose employment, or whose spouses' employment, had terminated before they became eligible for an immediate retirement benefit. The plaintiffs seek to represent a class consisting of former Metropolitan Life employees, or their surviving spouses, who are receiving deferred vested annuity payments under the retirement plan and who were allegedly eligible to receive the ad hoc pension increases awarded in 1977, 1980, 1989, 1992, 1996 and 2001, as well as increases awarded in earlier years. Metropolitan Life is vigorously defending itself against these allegations. A reinsurer of universal life policy liabilities of Metropolitan Life and certain of its affiliates is seeking rescission and has commenced an arbitration proceeding claiming that, during underwriting, material misrepresentations or omissions were made. The reinsurer also has sent a notice purporting to increase reinsurance premium rates. Metropolitan Life and its affiliates intend to defend themselves vigorously against the claims of the reinsurer, including the purported rate increase. As previously reported, the SEC is conducting a formal investigation of New England Securities Corporation ("NES"), an indirect subsidiary of New England Life Insurance Company ("NELICO"), in response to NES informing the SEC that certain systems and controls relating to one NES advisory program were not operating effectively. NES is cooperating fully with the SEC and is continuing to research the effect, if any, of this issue upon approximately 6,500 active and closed accounts. Prior to filing the Company's June 30, 2003 Form 10-Q, MetLife announced a $31 million after-tax charge related to an affiliate, New England Financial. MetLife notified the SEC about the nature of this charge prior to its announcement. The SEC is pursuing a formal investigation of the matter and MetLife is fully cooperating with the investigation. The American Dental Association and two individual providers have sued MetLife, Mutual of Omaha and Cigna in a purported class action lawsuit brought in a Florida federal district court. The plaintiffs purport to represent a nationwide class of in-network providers who allege that their claims are being wrongfully reduced by downcoding, bundling, and the improper use and programming of software. The complaint alleges federal racketeering and various state law theories of liability. MetLife is vigorously defending the case. A purported class action in which a policyholder seeks to represent a class of owners of participating life insurance policies is pending in state court in New York. Plaintiff asserts that Metropolitan Life breached her policy in the manner in which it allocated investment income across lines of business during a period ending with the 2000 demutualization. In August 2003, an appellate court affirmed the dismissal of fraud claims in this action. Various litigation, claims and assessments against the Company, in addition to those discussed above and those otherwise provided for in the Company's unaudited interim condensed consolidated financial statements, have arisen in the course of the Company's business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor and taxpayer. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning the Company's compliance with applicable insurance and other laws and regulations. Regulatory bodies have contacted the Company and have requested information relating to market timing and late trading of mutual funds and variable insurance products. The Company is in the process of responding and is fully cooperating with regard to these information requests. At the present time, the Company is not aware of any systemic problems with respect to such matters that may have a material adverse effect on the Company's consolidated financial position. SUMMARY It is not feasible to predict or determine the ultimate outcome of all pending investigations and legal proceedings or provide reasonable ranges of potential losses, except as noted above in connection with specific matters. In some of the matters referred to above, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations it is possible that an adverse outcome in certain cases could have a material adverse effect upon the Company's consolidated financial position, based on information currently known by the Company's management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods. - 22 - COMMITMENTS TO FUND PARTNERSHIP INVESTMENTS The Company makes commitments to fund partnership investments in the normal course of business. The amounts of these unfunded commitments were $1,511 million and $1,667 million at September 30, 2003 and December 31, 2002, respectively. The Company anticipates that these amounts could be invested in these partnerships any time over the next five years. GUARANTEES In the course of its business, the Company has provided certain indemnities, guarantees and commitments to third parties pursuant to which it may be required to make payments now or in the future. In the context of acquisition, disposition, investment and other transactions, the Company has provided indemnities and guarantees, including those related to tax, environmental and other specific liabilities, and other indemnities and guarantees that are triggered by, among other things, breaches of representations, warranties or covenants provided by the Company. In addition, in the normal course of business, the Company provides indemnifications to counterparties in contracts with triggers similar to the foregoing, as well as for certain other liabilities, such as third party lawsuits. These obligations are often subject to time limitations that vary in duration, including contractual limitations and those that arise by operation of law, such as applicable statutes of limitation. In some cases, the maximum potential obligation under the indemnities and guarantees is subject to a contractual limitation ranging from $1 million to $800 million, while in other cases such limitations are not specified or applicable. Since certain of these obligations are not subject to limitations, the Company does not believe that it is possible to determine the maximum potential amount due under these guarantees in the future. In addition, the Company indemnifies its directors and officers as provided in its charters and by-laws. Also, the Company indemnifies other of its agents for liabilities incurred as a result of their representation of the Company's interests. Since these indemnities are generally not subject to limitation with respect to duration or amount, the Company does not believe that it is possible to determine the maximum potential amount due under these indemnities in the future. The fair value of such indemnities, guarantees and commitments entered into subsequent to December 31, 2002 was insignificant. The Company's recorded liability at September 30, 2003 and December 31, 2002 for indemnities, guarantees and commitments provided to third parties prior to January 1, 2003 was insignificant. - 23 - 9. BUSINESS REALIGNMENT INITIATIVES During the fourth quarter of 2001, the Company implemented several business realignment initiatives, which resulted from a strategic review of operations and an ongoing commitment to reduce expenses. The following tables represent the original expenses recorded in the fourth quarter of 2001 and the remaining liability as of September 30, 2003:
PRE-TAX CHARGES RECORDED IN THE FOURTH QUARTER OF 2001 ------------------------------------------------------ INSTITUTIONAL INDIVIDUAL AUTO & HOME TOTAL ------------- ---------- ----------- ------ (DOLLARS IN MILLIONS) Severance and severance-related costs $ 9 $ 32 $ 3 $ 44 Facilities consolidation costs 3 65 - 68 Business exit costs 387 - - 387 ------ ------ ------ ------ Total $ 399 $ 97 $ 3 $ 499 ====== ====== ====== ======
REMAINING LIABILITY AS OF SEPTEMBER 30, 2003 -------------------------------------------- INSTITUTIONAL INDIVIDUAL TOTAL ------------- ---------- ------ (DOLLARS IN MILLIONS) Facilities consolidation costs $ - $ 10 $ 10 Business exit costs 32 - 32 ------ ------ ------ Total $ 32 $ 10 $ 42 ====== ====== ======
Institutional. The charges to this segment in the fourth quarter of 2001 include costs associated with exiting a business, including the write-off of goodwill and severance and severance-related costs, all of which are included in business exit costs, and facilities consolidation costs. These expenses are the result of the discontinuance of certain 401(k) recordkeeping services and externally-managed guaranteed index separate accounts. These actions resulted in charges to policyholder benefits and claims and other expenses of $215 million and $184 million, respectively. The business realignment initiatives will ultimately result in the elimination of approximately 930 positions. As of September 30, 2003, there were approximately 134 terminations to be completed in connection with the Company's business exit activities. Management expects these terminations to be completed by December 31, 2003. The Company continues to carry a liability as of September 30, 2003 since the exit plan could not be completed within one year due to circumstances outside the Company's control and since certain contractual obligations extended beyond one year. Individual. The charges to this segment in the fourth quarter of 2001 include facilities consolidation costs, severance and severance-related costs, which predominantly stem from the elimination of approximately 560 non-sales positions and 190 operations and technology positions supporting this segment. All terminations were completed prior to June 30, 2003. These costs were recorded in other expenses. The remaining liability as of September 30, 2003 is due to certain contractual obligations that extended beyond one year. Auto & Home. The charges to this segment in the fourth quarter of 2001 include severance and severance-related costs associated with the elimination of approximately 200 positions. All terminations were completed prior to December 31, 2002. The costs were recorded in other expenses. - 24 - 10. STOCK COMPENSATION PLANS Effective January 1, 2003, the Company elected to apply the fair value method of accounting and use the prospective transition method for stock options granted by the Company subsequent to December 31, 2002. As permitted under SFAS 148, options granted prior to January 1, 2003 will continue to be accounted for under APB 25. Had compensation expense for grants awarded prior to January 1, 2003 been determined based on fair value at the date of grant in accordance with SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS 123"), the Company's earnings and earnings per share amounts would have been reduced to the following pro forma amounts:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- -------------------- 2003 2002 2003 2002 -------- ------ --------- --------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) Net Income $ 574 $ 328 $ 1,516 $ 1,044 Charge for conversion of company-obligated mandatorily redeemable securities of a subsidiary trust (1) - - (21) - -------- ------ --------- --------- Actual net income available to common shareholders $ 574 $ 328 $ 1,495 $ 1,044 ======== ====== ========= ========= Pro forma net income available to common shareholders (2)(3) $ 566 $ 317 $ 1,470 $ 1,019 ======== ====== ========= ========= BASIC EARNINGS PER SHARE As reported $ 0.75 $ 0.47 $ 2.05 $ 1.48 ======== ====== ========= ========= Pro forma (2)(3) $ 0.74 $ 0.45 $ 2.01 $ 1.44 ======== ====== ========= ========= DILUTED EARNINGS PER SHARE As reported $ 0.75 $ 0.45 $ 2.04 $ 1.42 ======== ====== ========= ========= Pro forma (2)(3) $ 0.74 $ 0.44 $ 2.01 $ 1.39 ======== ====== ========= =========
--------------- (1) See Note 12 for a discussion of this charge included in the calculation of net income available to common shareholders. (2) The pro forma earnings disclosures are not necessarily representative of the effects on net income and earnings per share in future years. (3) Includes the Company's ownership share of stock compensation costs related to the Reinsurance Group of America, Incorporated incentive stock plan and the stock compensation costs related to the incentive stock plans at SSRM Holdings, Inc. determined in accordance with SFAS 123. Stock-based compensation expense related to the Company's Stock Incentive Plan and Directors Stock Plan for the three months and nine months ended September 30, 2003 was $4 million and $14 million, respectively, including stock-based compensation for non-employees of $202 thousand and $1 million, respectively. Stock-based compensation expense for non-employees for the three months and nine months ended September 30, 2002 was $462 thousand and $1.4 million, respectively. - 25 - 11. COMPREHENSIVE INCOME The components of comprehensive income are as follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- ------------------- 2003 2002 2003 2002 ------- ------- ------- ------- (DOLLARS IN MILLIONS) Net income $ 574 $ 328 $ 1,516 $ 1,044 ------- ------- ------- ------- Other comprehensive (loss) income: Unrealized (losses) gains on derivative instruments, net of income taxes (96) 13 (165) (24) Unrealized investment (losses) gains, net of related offsets, reclassification adjustments and income taxes (183) 736 1,051 545 Foreign currency translation adjustments (18) (104) 125 (80) Minimum pension liability adjustment - - (9) - ------- ------- ------- ------- Other comprehensive (loss) income (297) 645 1,002 441 ------- ------- ------- ------- Comprehensive income $ 277 $ 973 $ 2,518 $ 1,485 ======= ======= ======= =======
12. METLIFE CAPITAL TRUST I In connection with MetLife, Inc.'s initial public offering in April 2000, the Holding Company and MetLife Capital Trust I (the "Trust") issued equity security units (the "units"). Each unit originally consisted of (i) a contract to purchase, for $50, shares of the Holding Company's common stock (the "purchase contracts") on May 15, 2003; and (ii) a capital security of the Trust, with a stated liquidation amount of $50. In accordance with the terms of the units, the Trust was dissolved on February 5, 2003, and $1,006 million aggregate principal amount of 8.00% debentures of the Holding Company (the "MetLife debentures"), the sole assets of the Trust, were distributed to the owners of the Trust's capital securities in exchange for their capital securities. The MetLife debentures were remarketed on behalf of the debenture owners on February 12, 2003 and the interest rate on the MetLife debentures was reset as of February 15, 2003 to 3.911% per annum for a yield to maturity of 2.876%. As a result of the remarketing, the debenture owners received $21 million ($0.03 per diluted common share) in excess of the carrying value of the capital securities. This excess was recorded by the Company as a charge to additional paid-in capital and, for the purpose of calculating earnings per share, is subtracted from net income to arrive at net income available to common shareholders. On May 15, 2003, the purchase contracts associated with the units were settled. In exchange for $1,006 million, the Company issued 2.97 shares of MetLife, Inc. common stock per purchase contract, or approximately 59.8 million shares of treasury stock. Approximately $656 million, which represents the excess of the Company's cost of the treasury stock ($1,662 million) over the contract price of the stock issued to the purchase contract holders ($1,006 million), was recorded as a direct reduction to retained earnings. - 26 - 13. EARNINGS PER SHARE The following table presents a reconciliation of the weighted average shares used in calculating basic earnings per share to those used in calculating diluted earnings per share:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------------- ----------------------------- 2003 2002 2003 2002 ------------ ------------ ------------- -------------- (DOLLARS IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA) Weighted average common stock outstanding for basic earnings per share 760,146,381 701,541,455 730,788,635 706,055,177 Incremental shares from assumed: Conversion of equity security units - 21,213,435 - 25,758,555 Exercise of stock options 65,029 - - 5,127 Deferred stock compensation 716,283 - 533,422 - ------------ ------------ ------------- -------------- Weighted average common stock outstanding for diluted earnings per share 760,927,693 722,754,890 731,322,057 731,818,859 ============ ============ ============= ============== INCOME FROM CONTINUING OPERATIONS $ 560 $ 307 $ 1,427 $ 970 CHARGE FOR CONVERSION OF COMPANY-OBLIGATED MANDATORILY REDEEMABLE SECURITIES OF A SUBSIDIARY TRUST (1) - - (21) - ------------ ------------ ------------- -------------- INCOME FROM CONTINUING OPERATIONS AVAILABLE TO COMMON SHAREHOLDERS $ 560 $ 307 $ 1,406 $ 970 ============ ============ ============= ============== Basic earnings per share $ 0.74 $ 0.44 $ 1.92 $ 1.37 ============ ============ ============= ============== Diluted earnings per share $ 0.74 $ 0.42 $ 1.92 $ 1.33 ============ ============ ============= ============== INCOME FROM DISCONTINUED OPERATIONS $ 14 $ 26 $ 89 $ 74 ============ ============ ============= ============== Basic earnings per share $ 0.02 $ 0.04 $ 0.12 $ 0.10 ============ ============ ============= ============== Diluted earnings per share $ 0.02 $ 0.04 $ 0.12 $ 0.10 ============ ============ ============= ============== CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING $ - $ (5) $ - $ - ============ ============ ============= ============== Basic earnings per share $ - $ (0.01) $ - $ - ============ ============ ============= ============== Diluted earnings per share $ - $ (0.01) $ - $ - ============ ============ ============= ============== NET INCOME $ 574 $ 328 $ 1,516 $ 1,044 CHARGE FOR CONVERSION OF COMPANY-OBLIGATED MANDATORILY REDEEMABLE SECURITIES OF A SUBSIDIARY TRUST (1) - - (21) - ------------ ------------ ------------- -------------- NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 574 $ 328 $ 1,495 $ 1,044 ============ ============ ============= ============== Basic earnings per share $ 0.75 $ 0.47 $ 2.05 $ 1.48 ============ ============ ============= ============== Diluted earnings per share $ 0.75 $ 0.45 $ 2.04 $ 1.42 ============ ============ ============= ==============
---------------- (1) See Note 12. - 27 - On February 19, 2002, the Holding Company's Board of Directors authorized a $1 billion common stock repurchase program. This program began after the completion of the March 28, 2001 and June 27, 2000 repurchase programs, each of which authorized the repurchase of $1 billion of common stock. Under these authorizations, the Holding Company may purchase common stock from the MetLife Policyholder Trust, in the open market and in privately negotiated transactions. The Holding Company did not acquire any shares of common stock during the nine months ended September 30, 2003. The Holding Company acquired 15,244,492 shares of common stock for $471 million during the nine months ended September 30, 2002. During the nine months ended September 30, 2003, 59,884,064 shares of common stock were issued from treasury stock, 59,771,221 of which were issued in connection with the settlement of the purchase contracts (see Note 12) for approximately $1,006 million. During the nine months ended September 30, 2002, 16,379 shares of common stock were issued from treasury stock. On October 21, 2003, the Company announced the declaration by its Board of Directors of a dividend of $0.23 per common share payable on December 15, 2003 to shareholders of record on November 7, 2003. 14. BUSINESS SEGMENT INFORMATION The Company provides insurance and financial services to customers in the United States, Canada, Central America, South America, Europe, South Africa, Asia and Australia. The Company's business is divided into six major segments: Institutional, Individual, Auto & Home, International, Reinsurance and Asset Management. These segments are managed separately because they either provide different products and services, require different strategies or have different technology requirements. Institutional offers a broad range of group insurance and retirement and savings products and services, including group life insurance, non-medical health insurance, such as short and long-term disability, long-term care, and dental insurance, and other insurance products and services. Individual offers a wide variety of individual insurance and investment products, including life insurance, annuities and mutual funds. Auto & Home provides insurance coverages, including private passenger automobile, homeowners and personal excess liability insurance. International provides life insurance, accident and health insurance, annuities and retirement and savings products to both individuals and groups, and auto and homeowners coverage to individuals. Reinsurance provides primarily reinsurance of life and annuity policies in North America and various international markets. Additionally, reinsurance of critical illness policies is provided in select international markets. Asset Management provides a broad variety of asset management products and services to individuals and institutions. Set forth in the tables below is certain financial information with respect to the Company's operating segments for the three months and nine months ended September 30, 2003 and 2002 and at September 30, 2003 and December 31, 2002. The accounting policies of the segments are the same as those of the Company, except for the method of capital allocation and the accounting for gains and losses from intercompany sales, which are eliminated in consolidation. The Company allocates capital to each segment based upon an internal capital allocation system that allows the Company to more effectively manage its capital. The Company evaluates the performance of each operating segment based upon net income excluding certain net investment gains and losses, net of income taxes, and the impact from the cumulative effect of changes in accounting, net of income taxes. Settlement payments on derivative instruments not qualifying for hedge accounting are included in net investment gains/(losses). The Company allocates certain non-recurring items (e.g., expenses associated with the resolution of proceedings alleging race-conscious underwriting practices, sales practices claims and claims for personal injuries caused by exposure to asbestos or asbestos-containing products) to Corporate & Other.
AUTO FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003 INSTITUTIONAL INDIVIDUAL & HOME --------------------------------------------- ------------- ---------- ------ (DOLLARS IN MILLIONS) Premiums $ 2,260 $ 1,064 $ 735 Universal life and investment- type product policy fees 167 386 - Net investment income 976 1,548 39 Other revenues 144 96 10 Net investment (losses) gains (37) (37) 2 Income (loss) from continuing operations before provision (benefit) for income taxes 346 225 56
ASSET CORPORATE FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003 INTERNATIONAL REINSURANCE MANAGEMENT & OTHER TOTAL --------------------------------------------- ------------- ----------- ---------- ------- ----- (DOLLARS IN MILLIONS) Premiums $ 445 $ 579 $ - $ (4) $ 5,079 Universal life and investment- type product policy fees 70 - - - 623 Net investment income 119 122 17 43 2,864 Other revenues 20 11 36 18 335 Net investment (losses) gains 8 5 2 (28) (85) Income (loss) from continuing operations before provision (benefit) for income taxes 62 30 8 (20) 707
- 28 -
AUTO FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 INSTITUTIONAL INDIVIDUAL & HOME --------------------------------------------- ------------- ---------- ------ (DOLLARS IN MILLIONS) Premiums $ 2,046 $ 1,080 $ 711 Universal life and investment- type product policy fees 152 375 - Net investment income 945 1,592 44 Other revenues 154 95 11 Net investment (losses) gains (184) (25) (8) Income (loss) from continuing operations before provision (benefit) for income taxes 154 316 56 ASSET CORPORATE FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 INTERNATIONAL REINSURANCE MANAGEMENT & OTHER TOTAL --------------------------------------------- ------------- ----------- ---------- --------- ----- (DOLLARS IN MILLIONS) Premiums $ 381 $ 461 $ - $ (7) $ 4,672 Universal life and investment- type product policy fees 64 - - - 591 Net investment income 133 95 17 (48) 2,778 Other revenues 2 16 37 5 320 Net investment (losses) gains 6 4 - (43) (250) Income (loss) from continuing operations before provision (benefit) for income taxes 61 39 1 (202) 425
AUTO FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 INSTITUTIONAL INDIVIDUAL & HOME -------------------------------------------- ------------- ---------- ------ (DOLLARS IN MILLIONS) Premiums $ 6,730 $ 3,160 $ 2,168 Universal life and investment- type product policy fees 482 1,124 - Net investment income 2,951 4,636 119 Other revenues 438 291 23 Net investment (losses) gains (145) (122) (4) Income (loss) from continuing operations before provision (benefit) for income taxes 970 617 130 ASSET CORPORATE FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 INTERNATIONAL REINSURANCE MANAGEMENT & OTHER TOTAL -------------------------------------------- ------------- ----------- ---------- -------- ------- (DOLLARS IN MILLIONS) Premiums $ 1,230 $ 1,719 $ - $ (13) $ 14,994 Universal life and investment- type product policy fees 192 - - - 1,798 Net investment income 373 353 49 124 8,605 Other revenues 54 35 102 45 988 Net investment (losses) gains 7 6 10 (94) (342) Income (loss) from continuing operations before provision (benefit) for income taxes 196 93 27 (130) 1,903
AUTO FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 INSTITUTIONAL INDIVIDUAL & HOME -------------------------------------------- ------------- ---------- ------ (DOLLARS IN MILLIONS) Premiums $ 6,069 $ 3,258 $ 2,105 Universal life and investment- type product policy fees 471 1,012 - Net investment income 2,925 4,662 135 Other revenues 482 325 27 Net investment (losses) gains (384) (98) (40) Income (loss) from continuing operations before provision (benefit) for income taxes 699 781 112 ASSET CORPORATE FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 INTERNATIONAL REINSURANCE MANAGEMENT & OTHER TOTAL -------------------------------------------- ------------- ----------- ---------- --------- ----- (DOLLARS IN MILLIONS) Premiums $ 1,030 $ 1,408 $ - $ (15) $ 13,855 Universal life and investment- type product policy fees 78 - - - 1,561 Net investment income 303 296 46 (26) 8,341 Other revenues 8 35 127 26 1,030 Net investment (losses) gains (8) 6 (4) 4 (524) Income (loss) from continuing operations before provision (benefit) for income taxes 71 109 7 (353) 1,426
-29- The following table indicates amounts in the current and prior periods that have been classified as discontinued operations in accordance with SFAS 144:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- ----------------- 2003 2002 2003 2002 --------- -------- ------- ------- (DOLLARS IN MILLIONS) Net investment income Institutional $ - $ 8 $ 1 $ 25 Individual 1 13 4 41 Corporate & Other 14 21 37 60 --------- -------- ------- ------- Total net investment income $ 15 $ 42 $ 42 $ 126 ========= ======== ======= ======= Net investment gains (losses) Institutional $ 6 $ - $ 46 $ - Individual - (1) 47 (2) Corporate & Other 2 - 6 (7) --------- -------- ------- ------- Total net investment gains (losses) $ 8 $ (1) $ 99 $ (9) ========= ======== ======= =======
The following table presents assets for each of the Company's operating segments at:
SEPTEMBER 30, DECEMBER 31, 2003 2002 (1) ------------- ------------- (DOLLARS IN MILLIONS) Assets Institutional $ 112,322 $ 98,234 Individual 159,564 145,152 Auto & Home 4,639 4,540 International 9,313 8,301 Reinsurance 11,408 9,924 Asset Management 294 190 Corporate & Other 17,443 11,085 ------------- ------------- Total $ 314,983 $ 277,426 ============= =============
---------- (1) These balances reflect the allocation of capital using the Risk-Based Capital methodology, which differs from the original presentation of GAAP equity included in MetLife, Inc.'s 2002 Annual Report on Form 10-K. Economic Capital. Beginning in 2003, the Company changed its methodology of allocating capital from Risk-Based Capital to Economic Capital. Prior to 2003, the Company's business segments' allocated equity was primarily based on Risk-Based Capital, an internally developed formula based on applying a multiple to the National Association of Insurance Commissioners Statutory Risk-Based Capital and included certain GAAP accounting adjustments. Economic Capital is an internally developed risk capital model, the purpose of which is to measure the risk in the business and to provide a basis upon which capital is deployed. The Economic Capital model accounts for the unique and specific nature of the risks inherent in MetLife's businesses. This is in contrast to the standardized regulatory Risk-Based Capital formula, which is not as refined in its risk calculations with respect to the nuances of the Company's businesses. The change in methodology is being applied prospectively. This change has and will continue to impact the level of net investment income and net income of each of the Company's business segments. A portion of net investment income is credited to the segments based on the level of allocated equity. This change in methodology of allocating equity does not impact the Company's consolidated net investment income or net income. The following table presents actual and pro forma net investment income with respect to the Company's operating segments for the three months and nine months ended September 30, 2002. The amounts shown as pro forma reflect net investment income that would have been reported in the prior year had the Company allocated capital based on Economic Capital rather than on the basis of Risk-Based Capital.
NET INVESTMENT INCOME ------------------------------------------------------ THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2002 SEPTEMBER 30, 2002 ------------------------ -------------------------- ACTUAL PRO FORMA ACTUAL PRO FORMA ---------- ----------- ---------- ------------- (DOLLARS IN MILLIONS) Institutional $ 945 $ 962 $ 2,925 $ 2,974 Individual 1,592 1,569 4,662 4,595 Auto & Home 44 39 135 122 International 133 124 303 275 Reinsurance 95 86 296 267 Asset Management 17 20 46 55 Corporate & Other (48) (22) (26) 53 ---------- ----------- ---------- ------------- Total $ 2,778 $ 2,778 $ 8,341 $ 8,341 ========== =========== ========== =============
- 30 - The following table presents actual and pro forma assets for each of the Company's operating segments at December 31, 2002. The amounts shown as pro forma reflect assets that would have been reported in the prior year had the Company allocated capital based on Economic Capital rather than on the basis of Risk-Based Capital.
ASSETS ------------------------ ACTUAL (1) PRO FORMA ---------- ----------- (DOLLARS IN MILLIONS) Institutional $ 98,234 $ 98,810 Individual 145,152 144,073 Auto & Home 4,540 4,360 International 8,301 7,990 Reinsurance 9,924 9,672 Asset Management 190 320 Corporate & Other 11,085 12,201 ---------- ----------- Total $ 277,426 $ 277,426 ========== ===========
---------- (1) These balances reflect the allocation of capital using the Risk-Based Capital methodology, which differs from the original presentation of GAAP equity included in MetLife, Inc.'s 2002 Annual Report on Form 10-K. The Individual segment's results of operations for the nine months ended September 30, 2003 include a second quarter 2003 charge resulting from the recognition of previously deferred expenses. The International segment's results of operations include the results of operations of Aseguradora Hidalgo S.A., a Mexican life insurer that was acquired on June 20, 2002. During the second quarter of 2003, as part of its acquisition and integration strategy, International completed the legal merger of Aseguradora Hidalgo, S.A. into its original Mexican subsidiary, Seguros Genesis, S.A., forming MetLife Mexico, S.A. As a result of the merger of these companies, during the second quarter of 2003 the Company recorded a tax benefit of $40 million for the reduction of deferred tax valuation allowances. Additionally, a change in reserve methodology resulted in the recording of a $22 million after-tax reduction in policyholder liabilities in the second quarter of 2003. Corporate & Other includes various start-up and run-off entities, as well as the elimination of all intersegment amounts. The principal component of the intersegment amounts relates to intersegment loans, which bear interest rates commensurate with related borrowings. Net investment income and net investment gains and losses are based upon the actual results of each segment's specifically identifiable asset portfolio adjusted for allocated capital. Other costs and operating costs are allocated to each of the segments based upon: (i) a review of the nature of such costs; (ii) time studies analyzing the amount of employee compensation costs incurred by each segment; and (iii) cost estimates included in the Company's product pricing. Revenues derived from any customer did not exceed 10% of consolidated revenues for the three months and nine months ended September 30, 2003 and 2002. Revenues from U.S. operations were $7,924 million and $7,361 million for the three months ended September 30, 2003 and 2002, respectively, which represented 90% and 91%, respectively, of consolidated revenues. Revenues from U.S. operations were $23,532 million and $22,384 million for the nine months ended September 30, 2003 and 2002, respectively, which represented 90% and 92%, respectively, of consolidated revenues. - 31 - 15. DISCONTINUED OPERATIONS The Company actively manages its real estate portfolio with the objective to maximize earnings through selective acquisitions and dispositions. In accordance with SFAS 144, income related to real estate classified as held-for-sale on or after January 1, 2002 is presented as discontinued operations. These assets are carried at the lower of cost or market. The following table presents the components of income from discontinued operations:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------- 2003 2002 2003 2002 ----------- --------- -------- -------- (DOLLARS IN MILLIONS) Investment income $ 31 $ 118 $ 99 $ 365 Investment expense (16) (76) (57) (239) Net investment gains (losses) 8 (1) 99 (9) ----------- --------- -------- -------- Total revenues 23 41 141 117 Provision for income taxes 9 15 52 43 ----------- --------- -------- -------- Income from discontinued operations $ 14 $ 26 $ 89 $ 74 =========== ========= ======== ========
- 32 - ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For purposes of this discussion, the terms "Company" or "MetLife" refer to MetLife, Inc., a Delaware corporation formed in 1999 (the "Holding Company"), and its subsidiaries, including Metropolitan Life Insurance Company ("Metropolitan Life"). Following this summary is a discussion addressing the consolidated results of operations and financial condition of the Company for the periods indicated. This discussion should be read in conjunction with the Company's unaudited interim condensed consolidated financial statements included elsewhere herein. BUSINESS REALIGNMENT INITIATIVES During the fourth quarter of 2001, the Company implemented several business realignment initiatives, which resulted from a strategic review of operations and an ongoing commitment to reduce expenses. The following tables represent the original expenses recorded in the fourth quarter of 2001 and the remaining liability as of September 30, 2003:
PRE-TAX CHARGES RECORDED IN THE FOURTH QUARTER OF 2001 ---------------------------------------------------------------- INSTITUTIONAL INDIVIDUAL AUTO & HOME TOTAL ------------- ----------- -------------- ------------ (DOLLARS IN MILLIONS) Severance and severance-related costs $ 9 $ 32 $ 3 $ 44 Facilities consolidation costs 3 65 - 68 Business exit costs 387 - - 387 ------------- ----------- -------------- ------------ Total $ 399 $ 97 $ 3 $ 499 ============= =========== ============== ============
REMAINING LIABILITY AS OF SEPTEMBER 30, 2003 ------------------------------------------------ INSTITUTIONAL INDIVIDUAL TOTAL ------------- ----------- -------------- (DOLLARS IN MILLIONS) Facilities consolidation costs $ - $ 10 $ 10 Business exit costs 32 - 32 ------------- ----------- -------------- Total $ 32 $ 10 $ 42 ============= =========== ==============
Institutional. The charges to this segment in the fourth quarter of 2001 include costs associated with exiting a business, including the write-off of goodwill and severance and severance-related costs, all of which are included in business exit costs, and facilities consolidation costs. These expenses are the result of the discontinuance of certain 401(k) recordkeeping services and externally-managed guaranteed index separate accounts. These actions resulted in charges to policyholder benefits and claims and other expenses of $215 million and $184 million, respectively. The business realignment initiatives will ultimately result in the elimination of approximately 930 positions. As of September 30, 2003, there were approximately 134 terminations to be completed in connection with the Company's business exit activities. Management expects these terminations to be completed by December 31, 2003. The Company continues to carry a liability as of September 30, 2003 since the exit plan could not be completed within one year due to circumstances outside the Company's control and since certain contractual obligations extended beyond one year. Individual. The charges to this segment in the fourth quarter of 2001 include facilities consolidation costs, severance and severance-related costs, which predominantly stem from the elimination of approximately 560 non-sales positions and 190 operations and technology positions supporting this segment. All terminations were completed prior to June 30, 2003. These costs were recorded in other expenses. The remaining liability as of September 30, 2003 is due to certain contractual obligations that extended beyond one year. Auto & Home. The charges to this segment in the fourth quarter of 2001 include severance and severance-related costs associated with the elimination of approximately 200 positions. All terminations were completed prior to December 31, 2002. The costs were recorded in other expenses. - 33 - SEPTEMBER 11, 2001 TRAGEDIES On September 11, 2001 terrorist attacks occurred in New York, Washington, D.C. and Pennsylvania (the "tragedies") triggering a significant loss of life and property, which had an adverse impact on certain of the Company's businesses. The Company's original estimate of the total insurance losses related to the tragedies, which was recorded in the third quarter of 2001, was $208 million, net of income taxes of $117 million. As of September 30, 2003, the Company's remaining liability for unpaid and future claims associated with the tragedies was $15 million, principally related to disability coverages. This estimate has been and will continue to be subject to revision in subsequent periods, as claims are received from insureds and processed. Any revision to the estimate of losses in subsequent periods will affect net income in such periods. METLIFE CAPITAL TRUST I In connection with MetLife, Inc.'s, initial public offering in April 2000, the Holding Company and MetLife Capital Trust I (the "Trust") issued equity security units (the "units"). Each unit originally consisted of (i) a contract to purchase, for $50, shares of the Holding Company's common stock (the "purchase contracts") on May 15, 2003; and (ii) a capital security of the Trust, with a stated liquidation amount of $50. In accordance with the terms of the units, the Trust was dissolved on February 5, 2003, and $1,006 million aggregate principal amount of 8.00% debentures of the Holding Company (the "MetLife debentures"), the sole assets of the Trust, were distributed to the owners of the Trust's capital securities in exchange for their capital securities. The MetLife debentures were remarketed on behalf of the debenture owners on February 12, 2003 and the interest rate on the MetLife debentures was reset as of February 15, 2003 to 3.911% per annum for a yield to maturity of 2.876%. As a result of the remarketing, the debenture owners received $21 million ($0.03 per diluted common share) in excess of the carrying value of the capital securities. This excess was recorded by the Company as a charge to additional paid-in capital and, for the purpose of calculating earnings per share, is subtracted from net income to arrive at net income available to common shareholders. On May 15, 2003, the purchase contracts associated with the units were settled. In exchange for $1,006 million, the Company issued 2.97 shares of MetLife, Inc. common stock per purchase contract, or approximately 59.8 million shares of treasury stock. Approximately $656 million, which represents the excess of the Company's cost of the treasury stock ($1,662 million) over the contract price of the stock issued to the purchase contract holders ($1,006 million), was recorded as a direct reduction to retained earnings. ECONOMIC CAPITAL Beginning in 2003, the Company changed its methodology of allocating capital from Risk-Based Capital to Economic Capital. Prior to 2003, the Company's business segments' allocated equity was primarily based on Risk-Based Capital, an internally developed formula based on applying a multiple to the National Association of Insurance Commissioners Statutory Risk-Based Capital and included certain adjustments in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Economic Capital is an internally developed risk capital model, the purpose of which is to measure the risk in the business and to provide a basis upon which capital is deployed. The Economic Capital model accounts for the unique and specific nature of the risks inherent in MetLife's businesses. This is in contrast to the standardized regulatory Risk-Based Capital formula, which is not as refined in its risk calculations with respect to the nuances of the Company's businesses. The change in methodology is being applied prospectively. This change has and will continue to impact the level of net investment income and net income of each of the Company's business segments. A portion of net investment income is credited to the segments based on the level of allocated equity. This change in methodology of allocating equity does not impact the Company's consolidated net investment income or net income. - 34 - The following table presents actual and pro forma net investment income with respect to the Company's operating segments for the three months and nine months ended September 30, 2002. The amounts shown as pro forma reflect net investment income that would have been reported in the prior year had the Company allocated capital based on Economic Capital rather than on the basis of Risk-Based Capital.
NET INVESTMENT INCOME ------------------------------------------------------------ THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2002 SEPTEMBER 30, 2002 ----------------------------- --------------------------- ACTUAL PRO FORMA ACTUAL PRO FORMA ------------ ------------- --------- -------------- (DOLLARS IN MILLIONS) Institutional $ 945 $ 962 $ 2,925 $ 2,974 Individual 1,592 1,569 4,662 4,595 Auto & Home 44 39 135 122 International 133 124 303 275 Reinsurance 95 86 296 267 Asset Management 17 20 46 55 Corporate & Other (48) (22) (26) 53 ------------ ------------- --------- -------------- Total $ 2,778 $ 2,778 $ 8,341 $ 8,341 ============ ============= ========= ==============
ACQUISITIONS AND DISPOSITIONS In June 2002, the Company acquired Aseguradora Hidalgo S.A. ("Hidalgo"), an insurance company based in Mexico with approximately $2.5 billion in assets as of the date of acquisition. The purchase price of this acquisition was subject to adjustment under certain provisions of the purchase agreement. Post-acquisition analysis did not result in any significant adjustments of the purchase price, although certain changes were made that affected goodwill, the value of business acquired and reserve balances. The Company has completed the merger of Hidalgo into Seguros Genesis, S.A., MetLife's wholly-owned Mexican subsidiary headquartered in Mexico City. The combined entity operates under the name MetLife Mexico. In June 2003, the Company sold its 20 percent interest in Santander Central Hispano Seguros y Reaseguros S.A. to Banco Santander Central Hispano S.A. ("Santander") and purchased a 20 percent stake in MetLife Iberia, S.A. from Santander. In July 2003, the Company announced the sale of its Spanish operation, MetLife Iberia, S.A. and its subsidiaries, Seguros Genesis, S.A. and Genesis Seguros Generales, S.A., to Liberty Insurance, a Spanish subsidiary of Liberty Mutual Group. The transaction is subject to certain regulatory approvals. In September 2003, a subsidiary of the Company, Reinsurance Group of America, Incorporated ("RGA") announced the purchase through coinsurance of the traditional U.S. life reinsurance business of Allianz Life Insurance Company of North America. The transaction is subject to certain regulatory approvals and is expected to close in the fourth quarter of 2003 with an effective date retroactive to July 1, 2003. RGA expects the transaction will add approximately $240 billion of life reinsurance in-force. In October 2003, the Company announced that Metropolitan Life and Capital Airports Holding Company have reached agreement on forming a joint venture company to sell life insurance in China. The transaction is subject to certain regulatory approvals. In October 2003, the Company completed the purchase of John Hancock Life Insurance Company's group life insurance business, with an asset size of approximately $200 million. While this transaction provides strategic benefits and extends the Company's customer reach, it will have no material impact on MetLife's 2003 consolidated net income. - 35 - SUMMARY OF CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the consolidated financial statements. The critical accounting policies, estimates and related judgments underlying the Company's consolidated financial statements are summarized below. In applying these policies, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company's businesses and operations. INVESTMENTS The Company's principal investments are in fixed maturities, mortgage loans and real estate, all of which are exposed to three primary sources of investment risk: credit, interest rate and market valuation. The financial statement risks are those associated with the recognition of impairments and income, as well as the determination of fair values. The assessment of whether impairments have occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the market value has been below cost; (ii) the potential for impairments of securities when the issuer is experiencing significant financial difficulties; (iii) the potential for impairments in an entire industry sector or sub-sector; (iv) the potential for impairments in certain economically depressed geographic locations; (v) the potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; and (vi) other subjective factors, including concentrations and information obtained from regulators and rating agencies. In addition, the earnings on certain investments are dependent upon market conditions, which could result in prepayments and changes in amounts to be earned due to changing interest rates or equity markets. The determination of fair values in the absence of quoted market values is based on: (i) valuation methodologies; (ii) securities the Company deems to be comparable; and (iii) assumptions deemed appropriate given the circumstances. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts. DERIVATIVES The Company enters into freestanding derivative transactions primarily to manage the risk associated with variability in cash flows related to the Company's financial assets and liabilities or to changing fair values. The Company also purchases investment securities, issues certain insurance policies and engages in certain reinsurance contracts with embedded derivatives. The associated financial statement risk is the volatility in net income which can result from (i) changes in fair value of derivatives not qualifying as accounting hedges; and (ii) ineffectiveness of designated hedges in an environment of changing interest rates or fair values. In addition, accounting for derivatives is complex, as evidenced by significant authoritative interpretations of the primary accounting standards which continue to evolve, as well as the significant judgments and estimates involved in determining fair value in the absence of quoted market values. These estimates are based on valuation methodologies and assumptions deemed appropriate in the circumstances. Such assumptions include estimated market volatility and interest rates used in the determination of fair value where quoted market values are not available. The use of different assumptions may have a material effect on the estimated fair value amounts. DEFERRED POLICY ACQUISITION COSTS The Company incurs significant costs in connection with acquiring new insurance business. These costs, which vary with and are primarily related to the production of new business, are deferred. The recovery of such costs is dependent upon the future profitability of the related business. The amount of future profit is dependent principally on investment returns, mortality, morbidity, persistency, expenses to administer the business, creditworthiness of reinsurance counterparties and certain economic variables, such as inflation. Of these factors, the Company anticipates that investment returns are most likely to impact the rate of amortization of such costs. The aforementioned factors enter into management's estimates of gross margins and profits, which generally are used to amortize such costs. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future gross margins and profits are less than amounts deferred. In addition, the Company utilizes the reversion to the mean assumption, a standard industry practice, in its determination of the amortization of deferred policy acquisition costs, including value of business acquired ("DAC"). This practice assumes that the expectation for long-term appreciation in equity markets is not changed by minor short-term market fluctuations, but that it does change when large interim deviations have occurred. -36- FUTURE POLICY BENEFITS The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance, annuities and disability insurance. Generally, amounts are payable over an extended period of time and the profitability of the products is dependent on the pricing of the products. Principal assumptions used in pricing policies and in the establishment of liabilities for future policy benefits are mortality, morbidity, expenses, persistency, investment returns and inflation. The Company also establishes liabilities for unpaid claims and claims expenses for property and casualty insurance. Pricing of this insurance takes into account the expected frequency and severity of losses, the costs of providing coverage, competitive factors, characteristics of the insured and the property covered, as well as profit considerations. Liabilities for property and casualty insurance are dependent on estimates of amounts payable for claims reported but not settled and claims incurred but not reported. These estimates are influenced by historical experience and actuarial assumptions of current developments, anticipated trends and risk management strategies. Differences between the actual experience and assumptions used in pricing these policies and in the establishment of liabilities result in variances in profit and could result in losses. REINSURANCE The Company enters into reinsurance transactions as both a provider and a purchaser of reinsurance. Accounting for reinsurance requires extensive use of assumptions and estimates, particularly related to the future performance of the underlying business and the potential impact of counterparty credit risks. The Company periodically reviews actual and anticipated experience compared to the aforementioned assumptions used to establish assets and liabilities relating to ceded and assumed reinsurance and evaluates the financial strength of counterparties to its reinsurance agreements using criteria similar to that evaluated in the security impairment process discussed above. Additionally, for each of its reinsurance contracts, the Company must determine if the contract provides indemnification against loss or liability relating to insurance risk, in accordance with applicable accounting standards. The Company must review all contractual features, particularly those that may limit the amount of insurance risk to which the reinsurer is subject or features that delay the timely reimbursement of claims. If the Company determines that a reinsurance contract does not expose the reinsurer to a reasonable possibility of a significant loss from insurance risk, the Company records the contract using the deposit method of accounting. See "-- Derivatives". LITIGATION The Company is a party to a number of legal actions. Given the inherent unpredictability of litigation, it is difficult to estimate the impact of litigation on the Company's consolidated financial position. Liabilities are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Liabilities related to certain lawsuits, including the Company's asbestos-related liability, are especially difficult to estimate due to the limitation of available data and uncertainty regarding numerous variables used to determine amounts recorded. The data and variables that impact the assumption used to estimate the Company's asbestos-related liability include the number of future claims, the cost to resolve claims, the disease mix and severity of disease, the jurisdiction of claims filed, tort reform efforts and the impact of any possible future adverse verdicts and their amounts. It is possible that an adverse outcome in certain of the Company's litigation, including asbestos-related cases, or the use of different assumptions in the determination of amounts recorded could have a material effect upon the Company's consolidated net income or cash flows in particular quarterly or annual periods. EMPLOYEE BENEFIT PLANS The Company sponsors pension and other retirement plans in various forms covering employees who meet specified eligibility requirements. The reported expense and liability associated with these plans requires an extensive use of assumptions which include the discount rate, expected return on plan assets and rate of future compensation increases as determined by the Company. Management determines these assumptions based upon currently available market and industry data, historical performance of the plan and its assets, and consultation with an independent consulting actuarial firm to aid it in selecting appropriate assumptions and valuing its related liabilities. The actuarial assumptions used by the Company may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of the participants. These differences may have a significant effect on the Company's consolidated financial statements and liquidity. -37- The actuarial assumptions used in the calculation of the Company's aggregate projected benefit obligation may vary and include an expectation of long-term market appreciation in equity markets which is not changed by minor short-term market fluctuations, but does change when large interim deviations occur. For the largest of the plans sponsored by the Company (the Metropolitan Life Retirement Plan for United States Employees, with a projected benefit obligation of $4.3 billion or 98.6% of all qualified plans at December 31, 2002), the discount rate, expected rate of return on plan assets, and the range of rates of future compensation increases used in that plan's valuation at December 31, 2002 were 6.75%, 9% and 4% to 8%, respectively. The expected rate of return on plan assets for use in that plan's valuation in 2003 is 8.5%. -38- RESULTS OF OPERATIONS The following table presents consolidated financial information for the Company for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------------ ------------------------ 2003 2002 2003 2002 ---------- ---------- ---------- ---------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 5,079 $ 4,672 $ 14,994 $ 13,855 Universal life and investment-type product policy fees 623 591 1,798 1,561 Net investment income 2,864 2,778 8,605 8,341 Other revenues 335 320 988 1,030 Net investment losses (net of amounts allocated from other accounts of ($39), ($16), ($77) and ($102), respectively) (85) (250) (342) (524) ---------- ---------- ---------- ---------- Total revenues 8,816 8,111 26,043 24,263 ---------- ---------- ---------- ---------- EXPENSES Policyholder benefits and claims (excludes amounts directly related to net investment losses of ($29), ($5), ($52) and ($76), respectively) 5,178 4,739 15,096 14,239 Interest credited to policyholder account balances 767 736 2,275 2,177 Policyholder dividends 473 504 1,483 1,489 Other expenses (excludes amounts directly related to net investment losses of ($10), ($11), ($25) and ($26), respectively) 1,691 1,707 5,286 4,932 ---------- ---------- ---------- ---------- Total expenses 8,109 7,686 24,140 22,837 ---------- ---------- ---------- ---------- Income from continuing operations before provision for income taxes 707 425 1,903 1,426 Provision for income taxes 147 118 476 456 ---------- ---------- ---------- ---------- Income from continuing operations 560 307 1,427 970 Income from discontinued operations, net of income taxes 14 26 89 74 ---------- ---------- ---------- ---------- Income before cumulative effect of change in accounting 574 333 1,516 1,044 Cumulative effect of change in accounting - (5) - - ---------- ---------- ---------- ---------- Net income $ 574 $ 328 $ 1,516 $ 1,044 ========== ========== ========== ==========
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- THE COMPANY Premiums increased by $407 million, or 9%, to $5,079 million for the three months ended September 30, 2003 from $4,672 million for the comparable 2002 period. This variance is primarily attributable to increases in the Institutional, Reinsurance, International, and Auto & Home segments, partially offset by a decrease in the Individual segment. A $214 million increase in Institutional is primarily the result of growth in this segment's long-term care, disability, dental and life products. In addition, retirement and savings premiums increased due to higher sales in structured settlement products in 2003. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business, particularly in the U.S. and United Kingdom, contributed to a $118 million increase in the Reinsurance segment. A $64 million increase in International is primarily due to growth in Chile, South Korea and Spain. Anticipated actions taken by the Mexican government adversely impacted the insurance and annuities market and resulted in a decline in premiums in Mexico's group and individual life businesses. In addition, the cancellation of a large broker-sponsored case at the end of 2002 and the weakening of the peso, both contributed to the decline in Mexico. A $24 million increase in Auto & Home is primarily the result of rate increases in both the auto and property lines. A $16 million decrease in the Individual segment, is largely attributable to declines in the single premium immediate annuities and supplemental contracts with life contingencies products. Premiums on these policies can fluctuate based on product demand. This decrease was partially offset by a net increase in insurance products which is predominately the result of a drop in reinsurance ceded in the current period, as well as new business growth in insurance products. The increase in insurance products was partially offset by a decrease in renewal premiums associated with an aging block of business, as well as a decrease in insurance purchased by existing customers with their policy dividends. Universal life and investment-type product policy fees increased by $32 million, or 5%, to $623 million for the three months ended September 30, 2003 from $591 million for the comparable 2002 period. This variance is largely attributable to increases in the -39- Institutional, Individual and International segments. A $15 million increase in Institutional is primarily due to sales growth and improved persistency for the group universal life product. An $11 million increase in Individual is predominately due to favorable investment experience and an increase in average separate account balances in annuity and investment-type products, partially offset by higher amortization of deferred fees in the comparable 2002 period. This is a result of lapse, mortality and investment experience. A $6 million increase in International is primarily due to contributions to the policyholders account from a large block of business in Mexico. Net investment income increased by $86 million, or 3%, to $2,864 million for the three months ended September 30, 2003 from $2,778 million for the comparable 2002 period. This variance is attributable to increases of (i) $108 million, or 5%, in income from fixed maturities; (ii) $24 million, or 96%, in income from other invested assets; (iii) $11 million, or 2%, in income from mortgage loans on real estate; and (iv) $2 million, or 1%, in interest income from policy loans. These variances are partially offset by decreases of (i) $33 million, or 174%, in income from equity securities and other limited partnership interests; (ii) $14 million, or 29%, in income from cash, cash equivalents and short-term investments; (iii) $6 million, or 5%, in income from real estate and real estate joint ventures held-for-investment, net of investment expenses and depreciation; and (iv) higher investment expenses of $6 million, or 10%. The increase in income from fixed maturities to $2,140 million in 2003 from $2,032 million in 2002 is mostly due to a higher asset base resulting from the reinvestment of cash flows, higher income from equity-linked notes due to increases in underlying indices, and an increase in income from securities lending. These favorable variances are partially offset by a decline in reinvestment rates. The increase in income on other invested assets to $49 million in 2003 from $25 million in 2002 is primarily due to an increase in reinsurance contracts' funds withheld at interest. The increase in mortgage loans on real estate to $468 million in 2003 from $457 million in 2002 is due to a higher asset base coupled with increased income from fees, somewhat offset by lower reinvestment rates. The decrease in income from equity securities and other limited partnership interests to ($14) million in 2003 from $19 million in 2002 is primarily due to a decline in valuation and lower realizations on corporate joint ventures. Income from cash, cash equivalents and short-term investments decreased to $35 million in 2003 from $49 million in 2002, largely as a result of overall lower market rates. The decrease in income from real estate and real estate joint ventures held-for-investment to $112 million in 2003 from $118 million in 2002 is primarily due to decreased income from lower tenant occupancy at two California properties. The increase in investment expenses to $67 million in 2003 from $61 million in 2002 is due to higher corporate and overhead charges applicable to investment activity. The increase in net investment income is primarily attributable to increases in Corporate & Other and the Institutional and Reinsurance segments, partially offset by decreases in the Individual and International segments. A $91 million increase in Corporate & Other is due to higher sales of underlying assets held in corporate joint ventures, higher income from equity-linked notes and securities lending, as well as an increase in income resulting from a higher asset base, partially offset by lower reinvestment rates. The increase in Institutional of $31 million is mainly due to an increase in equity-linked notes, securities lending income and allocated capital, partially offset by a decline in valuation on corporate joint ventures. The Reinsurance segment increased $27 million largely resulting from an increase in reinsurance contracts' funds withheld at interest, partially offset by reduced income from allocated capital. These increases are partially offset by a decrease in the Individual segment of $44 million primarily resulting from lower reinvestment rates and a decline in valuation on corporate joint ventures, partially offset by a higher income from equity-linked notes and securities lending. The decrease in International of $14 million is mainly due to lower income from allocated capital. Other revenues increased by $15 million, or 5%, to $335 million for the three months ended September 30, 2003 from $320 million for the comparable 2002 period. This variance is primarily attributable to increases in the International segment and Corporate & Other, partially offset by decreases in the Institutional and Reinsurance segments. An $18 million increase in International is primarily due to the recovery of previously uncollectable receivables and the cancellation of a reinsurance contract related to a large block of business in Mexico. A $5 million increase in Corporate & Other is primarily due to the amortization of a deferred gain related to a property sale and leaseback transaction. These increases are partially offset by a $10 million decrease in Institutional due to a decline in administrative fees in the 401(k) business, as a result of the Company's exit from the large market 401(k) business in late 2001. A $5 million decrease in Reinsurance is largely due to less fees earned on financial reinsurance. The remaining variances are due to minor fluctuations in other lines of business. Net investment losses decreased by $165 million, or 66%, to $85 million for the three months ended September 30, 2003 from $250 million for the comparable 2002 period. Total investment losses for 2003, before offsets, is comprised of $124 million (including gross gains of $145 million, gross losses of $106 million, writedowns of $89 million, and a net loss from derivatives of $74 million which includes settlement payments on derivative instruments that do not qualify for hedge accounting of $35 million). Total investment losses for 2002, before offsets, is comprised of $266 million (including gross gains of $408 million, gross losses of $159 million, writedowns of $555 million, and a net gain from derivatives of $40 million which includes settlement payments on derivative instruments that do not qualify for hedge accounting of $19 million). Offsets include the amortization of DAC of $10 million and $11 million for the three months ended September 30, 2003 and 2002, respectively, and changes in the policyholder dividend -40- obligation of $29 million and $7 million for the three months ended September 30, 2003 and 2002, respectively, and adjustments to participating contracts of ($2) million for the three months ended September 30, 2002. The Company's investment gains and losses are net of related policyholder amounts. The amounts netted against investment gains and losses are (i) amortization of DAC, to the extent that such amortization results from investment gains and losses; (ii) adjustments to participating contractholder accounts when amounts equal to such investment gains and losses are applied to the contractholder's accounts; and (iii) adjustments to the policyholder dividend obligation resulting from investment gains and losses. The Company believes its policy of netting related policyholder amounts against investment gains and losses provides important information in evaluating its performance. Investment gains and losses are often excluded by investors when evaluating the overall financial performance of insurers. The Company believes its presentation enables readers to easily exclude investment gains and losses and the related effects on the consolidated statements of income when evaluating its performance. The Company's presentation of investment gains and losses, net of policyholder amounts, may be different from the presentation used by other insurance companies and, therefore, amounts in its unaudited interim condensed consolidated statements of income may not be comparable to amounts reported by other insurers. Policyholder benefits and claims increased by $439 million, or 9%, to $5,178 million for the three months ended September 30, 2003 from $4,739 million for the comparable 2002 period. This variance is primarily attributable to increases in the Institutional, Reinsurance, International, Auto & Home, and Individual segments. The increases of $178 million, $128 million and $46 million, respectively, in Institutional, Reinsurance and International are primarily attributable to the aforementioned growth in premiums. The increase in Auto & Home of $46 million is primarily due to higher auto claims severities and an increase in the adverse development of prior year claim reserves, partially offset by a decrease in property benefits due to reduced non-catastrophe claim frequency and fewer policies in force. A $39 million increase in Individual is primarily due to the impact of the aforementioned reinsurance ceded variance and the reduction of a reserve related to a subsidiary merger in the comparable 2002 period, partially offset by a decrease in the demand for single premium annuities and supplemental contracts with life contingencies, as well as a decrease in the reserves associated with guaranteed minimum death benefits, which fluctuate in response to equity market changes. Interest credited to policyholder account balances increased by $31 million, or 4%, to $767 million for the three months ended September 30, 2003 from $736 million for the comparable 2002 period. This variance is primarily due to increases in the Reinsurance and Individual segments. A $16 million increase in Reinsurance is primarily attributable to the addition of several new annuity transactions during the fourth quarter of 2002 and new deposits on existing annuity treaties. A $15 million increase in Individual is primarily due to growth in the variable universal life and deferred annuity products, partially offset by declines in the interest crediting rates. Policyholder dividends decreased by $31 million, or 6%, to $473 million for the three months ended September 30, 2003 from $504 million for the comparable 2002 period. This variance is primarily attributable to decreases in the Individual and Institutional segments. A $17 million decrease in Individual is primarily due to the reduction of the dividend scale in the fourth quarter of 2002, reflecting the impact of the low interest rate environment on the asset portfolios supporting these policies. A $15 million decrease in Institutional's policyholder dividends can vary from period to period based on participating contract experience, which is generally offset in part in policyholder benefits and claims. Other expenses decreased by $16 million, or 1%, to $1,691 million for the three months ended September 30, 2003 from $1,707 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC, which are discussed below, other expenses increased by $139 million, or 8%, to $1,959 million for the three months ended September 30, 2003 from $1,820 million for the comparable 2002 period. This variance is primarily attributable to increases in the Individual, Reinsurance, Institutional, and International segments, partially offset by a decrease in Corporate & Other and the Auto & Home segment. A $97 million increase in Individual is primarily due to higher commissions resulting from sales growth in new annuity and investment-type products and increased pension and post-retirement benefit expenses. A $64 million increase in Reinsurance is primarily due to an increase in allowances paid on assumed reinsurance, particularly on certain high commission business in the United Kingdom. A $41 million increase in Institutional is predominantly due to a rise in non-deferrable expenses associated with the aforementioned premium growth and additional post-retirement costs. The increase in Institutional is partially offset by expense savings resulting from the Company's exit from the large market 401(k) business. A $20 million increase in International is primarily the result of new business growth and general expansion of operations in South Korea, as well as an increase in sales in Spain, partially offset by a decrease in Mexico due to the weakening of the peso. These increases are partially offset by a $62 million decrease in Corporate & Other due to a $44 million reduction in legal expenses, primarily due to a reduction of a previously established liability related to the Company's race conscious underwriting settlement. A $15 million decrease in Auto & Home is primarily due to a reduction of expenses resulting from the -41- completion of the St. Paul integration and management's focus on expenses, as well as a reduction in the cost of the New York assigned risk plan. DAC is principally amortized in proportion to gross margins and profits, including investment gains and losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization and other expenses to provide amounts related to gross margins and profits originating from transactions other than investment gains and losses. Capitalization of DAC increased by $81 million, or 13%, to $682 million for the three months ended September 30, 2003 from $601 million for the comparable 2002 period. This variance is primarily due to increases in the Reinsurance, Individual, Institutional and International segments. A $37 million increase in Reinsurance is primarily due to an increase in the amount of high-allowance business written in the respective periods, particularly in the United Kingdom. An $18 million increase in Individual is primarily due to higher commissions and other deferrable expenses resulting from higher sales of annuity and investment-type products. An $18 million increase in Institutional is primarily due to an increase in acquisition related costs associated with the aforementioned premium growth, especially in the long-term care product. A $12 million increase in International is primarily due to higher sales in Spain, Mexico and Korea. Total amortization of DAC decreased by $73 million, or 15%, to $404 million for the three months ended September 30, 2003 from $477 million for the comparable 2002 period. Amortization of DAC of $414 million and $488 million are allocated to other expenses in 2003 and 2002, respectively, while the remainder of the amortization in each year is allocated to investment gains and losses. The decreases in amortization allocated to other expenses is largely attributable to the Individual, and Auto & Home segments, partially offset by increases in the Reinsurance, Institutional and International segments. An $85 million decrease in Individual is primarily the result of refinements in the calculation of estimated gross margins in the comparable 2002 period, with the remaining variance attributable to the impact of lapse, mortality and investment experience. A $20 million decrease in Reinsurance is primarily due to a change in product mix. In addition, a $7 million decrease in Auto & Home is primarily due to a change in new business product mix by distribution channels in prior periods. These decreases are partially offset by a $21 million increase in Institutional is primarily due to the reclassification of DAC related to the disability product as well as additional expenses related to increased sales activity. A $17 million increase in International is primarily due to an increase in the amortization of the value of business acquired related a change in reserve methodology in the second quarter of 2003, as well as refinements in the DAC model in Taiwan. Income tax expense for the three months ended September 30, 2003 was $147 million, or 21% of income before provision for income taxes and cumulative effect of change in accounting, compared with $118 million, or 28%, for the comparable 2002 period. The 2003 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, tax credits for investments in low income housing, and tax benefits related to the sale of foreign subsidiaries. In addition, the 2003 effective tax rate reflects an adjustment consisting primarily of a revision in the estimate of income taxes for 2002. The 2002 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, partially offset by the inability to record tax benefits on certain foreign capital losses. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"), income related to the Company's real estate which was identified as held-for-sale on or after January 1, 2002 is presented as discontinued operations for the three months ended September 30, 2003 and 2002. The income from discontinued operations is comprised of net investment income, and net investment gains related to 51 properties that the Company began marketing for sale on or after January 1, 2002. For the three months ended September 30, 2003, the Company recognized $8 million of net investment gains from discontinued operations related to 51 properties sold or held-for-sale. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- THE COMPANY Premiums increased by $1,139 million, or 8%, to $14,994 million for the nine months ended September 30, 2003 from $13,855 million for the comparable 2002 period. This variance is primarily attributable to increases in the Institutional, Reinsurance, International and Auto & Home segments, partially offset by a decrease in the Individual segment. A $661 million increase in Institutional is primarily the result of growth in this segment's long-term care, disability, dental and life products. In addition, retirement and savings premiums increased due to higher sales in structured settlement products in 2003, partially offset by a sale of a significant single premium contract in the second quarter of 2002. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business, particularly in the U.S. and United Kingdom, contributed to a $311 million increase in the Reinsurance segment. A $200 million increase in International is primarily due to the acquisition of Hidalgo in June 2002, which accounted for $255 million of the variance, largely offset by a decrease of $108 million attributable to a non-recurring sale of an annuity contract in the first quarter of 2002 in Canada. Excluding these items, International premiums increased by $53 million primarily due to growth in South Korea, Chile, Taiwan and Spain. Anticipated actions taken by the Mexican government adversely -42- impacted the insurance and annuities market and resulted in a decline in premiums in Mexico's group and individual life businesses. In addition, the cancellation of a large broker-sponsored case at the end of 2002 and the weakening of the peso, both contributed to the decline in Mexico. A $63 million increase in Auto & Home is primarily due to the result of rate increases in both the auto and property lines. These increases are partially offset by a $98 million decrease in Individual primarily due to a decrease in renewal premiums associated with an aging block of business, as well as a decrease in insurance purchased by existing customers with their policy dividends. In addition, there was a decrease in the single premium immediate annuities and supplemental contracts with life contingencies products. Premiums on these policies can fluctuate based on product demand. Universal life and investment-type product policy fees increased by $237 million, or 15%, to $1,798 million for the nine months ended September 30, 2003 from $1,561 million for the comparable 2002 period. This variance is primarily attributable to increases in the International, Individual, and Institutional segments. A $114 million increase in International is primarily due to the acquisition of Hidalgo in June 2002 which contributed $102 million to this variance. Excluding this acquisition, International's premiums increased $12 million due to an increase in contributions to the policyholders account from a large block of business in Mexico. A $112 million increase in Individual is predominately due to higher insurance fees, surrender charges and the amortization of deferred fees. This is a result of lapse, mortality and investment experience. In addition, an increase in average separate account balances and favorable investment experience resulted in an increase in universal life and investment-type product policy fees from annuity and investment-type products. An $11 million increase in Institutional is primarily due to sales growth and improved persistency for the group universal life product, partially offset by a decline in fees resulting from the inclusion in the second quarter of 2002 of significant fees from two bank owned life insurance contracts. Net investment income increased by $264 million, or 3%, to $8,605 million for the nine months ended September 30, 2003 from $8,341 million for the comparable 2002 period. This variance is primarily attributable to increases of (i) $273 million, or 5%, in income from fixed maturities; (ii) $37 million, or 30%, in income from other invested assets; (iii) $19 million, or 1%, in income from mortgage loans on real estate; and (iv) $12 million, or 3%, in interest income from policy loans. These variances are partially offset by decreases of (i) $29 million, or 17%, in income from cash, cash equivalents and short-term investments; (ii) $21 million, or 6%, in income from real estate and real estate joint ventures held-for-investment, net of investment expenses and depreciation; (iii) higher investment expenses of $21 million, or 12%; and (iv) $6 million, or 8%, in income from equity securities and other limited partnership interests. The increase in income from fixed maturities to $6,257 million in 2003 from $5,984 million in 2002 is due to a higher asset base resulting from the reinvestment of cash flows, higher income from equity-linked notes resulting from appreciation in underlying indices, an increase in income from securities lending, and an increase in bond prepayment fees. These increases are partially offset by a decline in reinvestment rates. The increase in income on other invested assets to $161 million in 2003 from $124 million in 2002 is largely due to an increase in reinsurance contracts' funds withheld at interest. The increase in mortgage loans on real estate to $1,410 million in 2003 from $1,391 million in 2002 is due to a higher asset base coupled with an increase in prepayment fees, partially offset by lower reinvestment rates. The increase in interest on policy loans to $419 million in 2003 from $407 in 2002 is due to increased loans outstanding. The decrease in income from cash, cash equivalents and short-term investments to $141 million in 2003 from $170 million in 2002 is mainly due to a decline in short-term interest rates, partially offset by a higher asset base resulting from an increase in short-term financing related liabilities. The decrease in income from real estate and real estate joint ventures held-for-investment to $337 million in 2003 from $358 million in 2002 is largely due to decreased income from lower tenant occupancy at two California properties. The increase in investment expenses to $192 million in 2003 from $171 million in 2002 is due to higher corporate and overhead charges applicable to investment activity. The decrease in income from equity securities and other limited partnership interests to $72 million in 2003 from $78 million in 2002 is primarily due to a decline in valuation and lower realizations on corporate joint ventures, partially offset by an increase in sales of underlying assets held in corporate joint ventures. The increase in net investment income is primarily attributable to increases in Corporate & Other and the International, Reinsurance and Institutional segments, partially offset by decreases in the Individual, and Auto & Home segments. Corporate & Other increased by $150 million which is primarily due to higher income from allocated capital, increased income from corporate joint ventures, equity-linked notes and securities lending. The increase in International of $70 million is mainly due to an increase in income resulting from a higher asset base resulting from the acquisition of Hidalgo in June 2002, partially offset by a decline in income from allocated capital. The Reinsurance segment increased $57 million primarily as a result of an increase in reinsurance contracts' funds withheld at interest somewhat offset by income from allocated capital. The Institutional segment increased $26 million predominantly as a result of higher income from allocated capital and equity-linked notes, partially offset by lower income on other invested assets. These increases are partially offset by a decrease in the Individual segment of $26 million primarily resulting from a decline in valuation on corporate joint ventures and lower income from allocated capital, partially offset by income from higher asset base. These increases are also partially offset by a $16 million decrease in the Auto & Home segment due to lower reinvestment rates and reduced income from allocated capital. Other revenues decreased by $42 million, or 4%, to $988 million for the nine months ended September 30, 2003 from $1,030 million for the comparable 2002 period. This variance is primarily attributable to decreases in the Institutional, Individual, and Asset -43- Management segments, partially offset by increases in the International segment and Corporate & Other. A $44 million decrease in Institutional is primarily attributable to a decline in administrative fees from the 401(k) business, as a result of the Company's exit from the large market 401(k) business in late 2001. A $34 million decrease in Individual is primarily due to lower commission and fee income associated with the volume decline in the broker/dealer and other subsidiaries, principally due to the slow recovery of the equity markets. A $25 million decrease in Asset Management is primarily the result of lower average assets under management on which management and advisory fees are earned. In addition performance fees earned during 2003 on certain investment products were lower than in the comparable period. These decreases are partially offset by a $46 million increase in International primarily due to the acquisition of Hidalgo in June 2002. Excluding this acquisition, International's premiums increased $18 million due to the recovery of previously uncollectable receivables and the cancellation of a reinsurance contract related to a large block of business in Mexico. A $10 million increase in Corporate & Other is largely due to the amortization of a deferred gain related to a property sale and leaseback transaction. The remaining variances are due to minor fluctuations in other lines of business. Net investment losses decreased by $182 million, or 35%, to $342 million for the nine months ended September 30, 2003 from $524 million for the comparable 2002 period. Total investment losses for 2003, before offsets, is comprised of $419 million (including gross gains of $394 million, gross losses of $262 million, writedowns of $460 million, and a net loss from derivatives of $91 million which includes settlement payments on derivative instruments that do not qualify for hedge accounting of $55 million). Total investment losses for 2002, before offsets, is comprised of $626 million (including gross gains of $1,391 million, gross losses of $748 million, writedowns of $1,162 million, and a net loss from derivatives of $107 million which includes settlement payments on derivative instruments that do not qualify for hedge accounting of $22 million). Offsets include the amortization of DAC of $25 million and $26 million for the nine months ended September 30, 2003 and 2002, respectively, and changes in the policyholder dividend obligation of $52 million and $78 million for the nine months ended September 30, 2003 and 2002, respectively, and adjustments to participating contracts of ($2) million for the nine months ended September 30, 2002. The Company's investment gains and losses are net of related policyholder amounts. The amounts netted against investment gains and losses are (i) amortization of DAC, to the extent that such amortization results from investment gains and losses; (ii) adjustments to participating contractholder accounts when amounts equal to such investment gains and losses are applied to the contractholder's accounts; and (iii) adjustments to the policyholder dividend obligation resulting from investment gains and losses. The Company believes its policy of netting related policyholder amounts against investment gains and losses provides important information in evaluating its performance. Investment gains and losses are often excluded by investors when evaluating the overall financial performance of insurers. The Company believes its presentation enables readers to easily exclude investment gains and losses and the related effects on the consolidated statements of income when evaluating its performance. The Company's presentation of investment gains and losses, net of policyholder amounts, may be different from the presentation used by other insurance companies and, therefore, amounts in its unaudited interim condensed consolidated statements of income may not be comparable to amounts reported by other insurers. Policyholder benefits and claims increased by $857 million, or 6%, to $15,096 million for the nine months ended September 30, 2003 from $14,239 million for the comparable 2002 period. This variance is primarily attributable to increases in the Institutional, Reinsurance, International, and Auto & Home segments partially offset by a decrease in the Individual segment. The increases of $434 million and $242 million, respectively, in Institutional and Reinsurance are primarily attributable to the aforementioned growth in premiums. A $101 million increase in International is primarily due to the acquisition of Hidalgo in June 2002, which accounted for $256 million of the variance, largely offset by a decrease of $108 million attributable to a non-recurring sale of an annuity contract in the first quarter of 2002 in Canada. Excluding these items, International's policyholder benefits and claims decreased by $47 million primarily due to a reduction in Mexican policyholder liabilities related to a change in reserve methodology as well as the impact of the overall premium decreases discussed above. This decrease is partially offset by business growth in Chile, South Korea and Spain. A $95 million increase in Auto & Home is primarily due to an increase in auto claims frequencies resulting largely from adverse road conditions in the first quarter of 2003 and higher losses due to adverse claims development related to prior accident years, partially offset by a decrease in property benefits due to reduced non-catastrophe claim frequency, fewer policies in force and underwriting and agency management actions. These increases are partially offset by an $18 million decrease in Individual primarily due to benefits paid on single premium immediate annuities, partially offset by an increase in the reserves associated with guaranteed minimum death benefits, which fluctuate in response to equity market changes. Interest credited to policyholder account balances increased by $98 million, or 5%, to $2,275 million for the nine months ended September 30, 2003 from $2,177 million for the comparable 2002 period. This variance is primarily due to increases in the International, Reinsurance, and Individual segments, partially offset by a decrease in the Institutional segment. A $55 million increase in International is primarily due to the acquisition of Hidalgo in June 2002. A $38 million increase in Reinsurance is primarily due to the addition of several new annuity transactions during the fourth quarter of 2002 and new deposits on existing annuity treaties. A $15 million increase in Individual is primarily due to growth in variable universal life and deferred annuity products, partially offset by -44- declines in the interest crediting rates. These increases are partially offset by a $10 million decrease in Institutional primarily attributable to a decline in average crediting rates in 2003 as a result of the lower interest rate environment, offset in part by an increase in policyholder account balances. Policyholder dividends decreased by $6 million, or less than 1%, to $1,483 million for the nine months ended September 30, 2003 from $1,489 million for the comparable 2002 period. This variance is primarily attributable to a decrease in the Individual segment, partially offset by increases in the Institutional, and International segments. A $58 million decrease in Individual is primarily due to the reduction of the dividend scale in the fourth quarter of 2002, reflecting the impact of the low interest rate environment on the asset portfolios supporting these policies. This decrease is partially offset by a $41 million increase in Institutional largely attributable to favorable mortality experience among several large group clients. Policyholder dividends vary from period to period based on participating contract experience, which is generally offset in policyholder benefits and claims. A $12 million increase in International is primarily attributable to the acquisition of Hidalgo in June 2002. Other expenses increased by $354 million, or 7%, to $5,286 million for the nine months ended September 30, 2003 from $4,932 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC, which are discussed below, other expenses increased by $528 million, or 10%, to $5,919 million for the nine months ended September 30, 2003 from $5,391 million for the comparable 2002 period. This variance is primarily attributable to increases in the Individual, Reinsurance, Institutional, and International segments, partially offset by decreases in Corporate & Other and the Asset Management and Auto & Home segments. A $228 million increase in Individual is primarily due to higher commissions resulting from sales growth in new annuity and investment-type products and increased pensions and post-retirement benefit expenses. A $221 million increase in Reinsurance is primarily due to an increase in allowances paid on assumed reinsurance, particularly on certain high commission business in the United Kingdom. A $156 million increase in Institutional is predominantly due to a rise in non-deferrable expenses associated with the aforementioned premium growth, post-retirement costs and a $15 million charge in the first half of 2003 principally related to office consolidations. These increases in Institutional are partially offset by expense savings resulting from the Company's exit from the large market 401(k) business in late 2001. A $130 million increase in International is primarily due to higher sales in South Korea and Spain, partially offset by a decrease in Mexico due to lower headcount and the weakening of the peso. These increases are partially offset by a $153 million decrease in Corporate & Other which is largely attributable to a $180 million reduction in legal expenses which includes a $144 million reduction, in 2003, of a previously established liability related to the Company's race conscious underwriting settlement. A decrease of $28 million in Asset Management is largely due to staff reductions in the third and fourth quarters of 2002 and reduced expenses as a result of lower average assets under management. A decrease of $26 million in Auto & Home is primarily due to a reduction in expenses resulting from the completion of the St. Paul integration and the reduction in the cost of the New York assigned risk plan. DAC is principally amortized in proportion to gross margins and profits, including investment gains and losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization and other expenses to provide amounts related to gross margins and profits originating from transactions other than investment gains and losses. Capitalization of DAC increased by $324 million, or 20%, to $1,951 million for the nine months ended September 30, 2003 from $1,627 million for the comparable 2002 period. This variance is primarily due to increases in the Reinsurance, International, Individual, Institutional, and Auto & Home segments. A $153 million increase in Reinsurance is primarily due to an increase in the amount of high-allowance business written in the respective periods, particularly in the United Kingdom. A $57 million increase in International is primarily due to the acquisition of Hidalgo and higher sales in Spain and South Korea. A $56 million increase in Individual is primarily due to higher commissions and other deferrable expenses resulting from higher sales of annuity and investment-type products, partially offset by the impact of a revision to previously deferred expenses. A $36 million increase in Institutional is primarily due to an increase in acquisition-related costs associated with the aforementioned premium growth, especially in the long-term care product. A $22 million increase in Auto & Home is primarily due to higher sales and an increase in the average premium per policy due to rate increases. Total amortization of DAC increased by $151 million, or 13%, to $1,293 million for the nine months ended September 30, 2003 from $1,142 million for the comparable 2002 period. Amortization of DAC of $1,318 million and $1,168 million are allocated to other expenses in 2003 and 2002, respectively, while the remainder of the amortization in each year is allocated to investment gains and losses. The increase in amortization allocated to other expenses is attributable to increases in the International, Reinsurance, Institutional, and Auto & Home segments, partially offset by a decrease in the Individual segment. A $79 million increase in International is primarily due to the acquisition of Hidalgo and an increase in Mexico commensurate with the aforementioned change in reserve methodology. A $37 million increase in Reinsurance is primarily due to a change in product mix. A $37 million increase in Institutional is primarily due to the reclassification of DAC related to the disability product, as well as additional expenses related to year over year sales activity. A $14 million increase in Auto & Home is due to higher sales and an increase in the average premium per policy due to rate increases in the comparable period. These increases are partially offset by a $17 -45- million decrease in Individual primarily due to a charge resulting from the amortization of deferred expenses, with the remainder of the variance attributable to the impact of lapse, mortality and investment experience. Income tax expense for the nine months ended September 30, 2003 was $476 million, or 25% of income before provision for income taxes and cumulative effect of change in accounting, compared with $456 million, or 32%, for the comparable 2002 period. The 2003 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, tax credits for investments in low income housing, a tax recovery of prior year tax overpayments on tax-exempt bonds, a reduction of the deferred tax valuation allowance to recognize the effect of certain foreign net operating loss carryforwards, and tax benefits related to the sale of foreign subsidiaries. In addition, the 2003 effective tax rate reflects an adjustment consisting primarily of a revision in the estimate of income taxes for 2002. The 2002 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, partially offset by the inability to record tax benefits on certain foreign capital losses. In accordance with SFAS 144, income related to the Company's real estate which was identified as held-for-sale on or after January 1, 2002 is presented as discontinued operations for the nine months ended September 30, 2003 and 2002. The income from discontinued operations is comprised of net investment income and net investment gains related to 51 properties that the Company began marketing for sale on or after January 1, 2002. For the nine months ended September 30, 2003, the Company recognized $99 million of net investment gains from discontinued operations related to 51 properties sold or held-for-sale. -46- INSTITUTIONAL The following table presents consolidated financial information for the Institutional segment for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------------- ------------------------- 2003 2002 2003 2002 ---------- ---------- ---------- ---------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 2,260 $ 2,046 $ 6,730 $ 6,069 Universal life and investment-type product policy fees 167 152 482 471 Net investment income 976 945 2,951 2,925 Other revenues 144 154 438 482 Net investment losses (37) (184) (145) (384) ---------- ---------- ---------- ---------- Total revenues 3,510 3,113 10,456 9,563 ---------- ---------- ---------- ---------- EXPENSES Policyholder benefits and claims 2,509 2,331 7,394 6,960 Interest credited to policyholder account balances 234 236 686 696 Policyholder dividends 14 29 107 66 Other expenses 407 363 1,299 1,142 ---------- ---------- ---------- ---------- Total expenses 3,164 2,959 9,486 8,864 ---------- ---------- ---------- ---------- Income from continuing operations before provision for income taxes 346 154 970 699 Provision for income taxes 122 54 343 243 ---------- ---------- ---------- ---------- Income from continuing operations 224 100 627 456 Income from discontinued operations, net of income taxes 4 5 30 16 ---------- ---------- ---------- ---------- Net income $ 228 $ 105 $ 657 $ 472 ========== ========== ========== ==========
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- INSTITUTIONAL Premiums increased by $214 million, or 10%, to $2,260 million for the three months ended September 30, 2003 from $2,046 million for the comparable 2002 period. Group insurance premiums increased by $125 million, primarily in the long-term care, disability, dental and life products. The increase in long-term care is largely attributable to a significant contract for which the Company began receiving premiums in the fourth quarter of 2002. Favorable renewals and persistency generated the majority of the increase in disability. The increase in life and dental premiums resulted from improved persistency and strong sales. Retirement and savings premiums increased by $89 million largely due to higher sales in structured settlement products in 2003. Retirement and savings premium levels are significantly influenced by large transactions and, as a result, can fluctuate from period to period. Universal life and investment-type product policy fees increased by $15 million, or 10%, to $167 million for the three months ended September 30, 2003 from $152 million for the comparable 2002 period. This increase is primarily due to sales growth and improved persistency for the group universal life product. Other revenues decreased by $10 million, or 6%, to $144 million for the three months ended September 30, 2003 from $154 million for the comparable 2002 period. This decrease is largely due to a decline in retirement and savings administrative fees from the Company's 401(k) business. This decline resulted from its exit from the large market 401(k) business in late 2001. Consequently, revenue declined as business was transferred to other carriers throughout 2002. Policyholder benefits and claims increased by $178 million, or 8%, to $2,509 million for the three months ended September 30, 2003 from $2,331 million for the comparable 2002 period. Retirement and savings increased by $94 million, commensurate with the aforementioned increase in premiums. Group insurance increased by $84 million, primarily as a result of the premium growth in the long-term care, disability, dental and life products, as well as an $11 million reclassification of DAC related to the disability product in 2002. -47- Interest credited to policyholder account balances decreased by $2 million, or 1%, to $234 million for the three months ended September 30, 2003 from $236 million for the comparable 2002 period. This decrease is primarily attributable to declines in average crediting rates in 2003 as a result of the lower interest rate environment, offset in part by an increase in policyholder account balances. Policyholder dividends decreased by $15 million, or 52%, to $14 million for the three months ended September 30, 2003 from $29 million for the comparable 2002 period. Policyholder dividends vary from period to period based on participating contract experience, which is generally offset in policyholder benefits and claims. Other expenses increased by $44 million, or 12%, to $407 million for the three months ended September 30, 2003 from $363 million for the comparable 2002 period. Excluding the impact of capitalization and amortization of DAC which are discussed below, other expenses increased by $41 million, or 11%, to $430 million in 2003 from $389 million in 2002. Group insurance and retirement and savings expenses increased by $32 million and $9 million, respectively, primarily due to a rise in non-deferrable expenses associated with the aforementioned premium growth and post-retirement costs. Variable expenses include a certain portion of premium taxes, commissions, claim approval and case administration expenses. The increase in retirement and savings is partially offset by expense reductions achieved as the large market 401(k) business was transferred to other carriers throughout 2002. Capitalization of DAC increased by $18 million, or 51%, to $53 million for the three months ended September 30, 2003 from $35 million for the comparable 2002 period. This variance is primarily due to an increase in acquisition-related costs associated with the aforementioned premium growth, especially in the long-term care product. Amortization of DAC increased by $21 million, or 233%, to $30 million in 2003 from $9 million in 2002 due to the aforementioned policyholder benefits reclassification, as well as additional expenses related to quarter over quarter sales activity. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- INSTITUTIONAL Premiums increased by $661 million, or 11%, to $6,730 million for the nine months ended September 30, 2003 from $6,069 million for the comparable 2002 period. Group insurance premiums increased by $533 million primarily in the long-term care, disability, dental and life products. The increase in long-term care is largely attributable to a significant contract entered into for which the Company began receiving premiums in the fourth quarter of 2002. Favorable renewals and persistency generated the increase in disability. The increase in life and dental premiums resulted from improved persistency, strong sales and growth on the existing block of business. Retirement and savings premiums increased by $128 million, primarily as a result of higher sales in structured settlement products, partially offset by a sale of a significant single premium contract in the second quarter of 2002. Retirement and savings premium levels are significantly influenced by large transactions and, as a result, can fluctuate from period to period. Universal life and investment-type product policy fees increased by $11 million, or 2%, to $482 million for the nine months ended September 30, 2003 from $471 million for the comparable 2002 period. This increase is primarily due to sales growth and improved persistency for the group universal life product. This favorable variance is offset in part by a decline in fees resulting from the inclusion in the second quarter of 2002 of significant fees from two bank owned life insurance contracts. Other revenues decreased by $44 million, or 9%, to $438 million for the nine months ended September 30, 2003 from $482 million for the comparable 2002 period. This decrease is largely due to a decline in retirement and savings administrative fees from the Company's 401(k) business. This decline resulted from its exit from the large market 401(k) business in late 2001. Consequently, revenue declined as business was transferred to other carriers throughout 2002. Policyholder benefits and claims increased by $434 million, or 6%, to $7,394 million for the nine months ended September 30, 2003 from $6,960 million for the comparable 2002 period. Group insurance increased by $294 million, primarily as a result of the aforementioned premium growth in this segment's long-term care, disability, dental and life products, as well as an $11 million reclassification of DAC related to the disability product in 2002. The increase in retirement and savings of $140 million is commensurate with the premium growth. Interest credited to policyholder account balances decreased by $10 million, or 1%, to $686 million for the nine months ended September 30, 2003 from $696 million for the comparable 2002 period. This decrease is primarily attributable to a decline in average crediting rates in 2003 as a result of the lower interest rate environment, offset in part by an increase in policyholder account balances. Policyholder dividends increased by $41 million, or 62%, to $107 million for the nine months ended September 30, 2003 from $66 million for the comparable 2002 period. This increase is largely attributable to favorable mortality experience among several large group clients. Policyholder dividends vary from period to period based on participating contract experience, which is generally offset in policyholder benefits and claims. -48- Other expenses increased by $157 million, or 14%, to $1,299 million for the nine months ended September 30, 2003 from $1,142 million for the comparable 2002 period. Excluding the impact of capitalization and amortization of DAC which are discussed below, other expenses increased by $156 million, or 13%, to $1,369 million in 2003 from $1,213 million in 2002. Group insurance and retirement and savings expenses increased by $123 million and $33 million, respectively, primarily due to a rise in non-deferrable expenses associated with the aforementioned premium growth, post-retirement costs and a $15 million charge in the first half of 2003 principally related to office consolidations. Variable expenses include a certain portion of premium taxes, commissions, claim approval and case administration expenses. The increase in retirement and savings is partially offset by expense reductions achieved as the large market 401(k) business was transferred to other carriers throughout 2002. Capitalization of DAC increased by $36 million, or 33%, to $144 million for the nine months ended September 30, 2003 from $108 million for the comparable 2002 period. This variance is primarily due to an increase in acquisition-related costs associated with the aforementioned premium growth, especially in the long-term care product. Amortization of DAC increased by $37 million to $74 million in 2003 from $37 million in 2002 due to the aforementioned policyholder benefits reclassification, as well as additional expenses related to year over year sales activity. -49- INDIVIDUAL The following table presents consolidated financial information for the Individual segment for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- --------------------- 2003 2002 2003 2002 ------- ------- -------- --------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 1,064 $ 1,080 $ 3,160 $ 3,258 Universal life and investment-type product policy fees 386 375 1,124 1,012 Net investment income 1,548 1,592 4,636 4,662 Other revenues 96 95 291 325 Net investment losses (net of amounts allocated from other accounts of ($39), ($16), ($77) and ($102), respectively) (37) (25) (122) (98) ------- ------- -------- -------- Total revenues 3,057 3,117 9,089 9,159 ------- ------- -------- -------- EXPENSES Policyholder benefits and claims (excludes amounts directly related to net investment losses of ($29), ($5), ($52) and ($76), respectively) 1,261 1,222 3,699 3,717 Interest credited to policyholder account balances 452 437 1,347 1,332 Policyholder dividends 442 459 1,321 1,379 Other expenses (excludes amounts directly related to net investment losses of ($10), ($11), ($25) and ($26), respectively) 677 683 2,105 1,950 ------- ------- -------- -------- Total expenses 2,832 2,801 8,472 8,378 ------- ------- -------- -------- Income from continuing operations before provision for income taxes 225 316 617 781 Provision for income taxes 72 113 210 280 ------- ------- -------- -------- Income from continuing operations 153 203 407 501 Income from discontinued operations, net of income taxes 1 7 32 25 ------- ------- -------- -------- Net income $ 154 $ 210 $ 439 $ 526 ======= ======= ======== ========
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- INDIVIDUAL Premiums decreased by $16 million, or 2%, to $1,064 million for the three months ended September 30, 2003 from $1,080 million for the comparable 2002 period. Premiums from annuity and investment-type products decreased by $18 million in the single premium immediate annuities and supplemental contracts with life contingencies products. Premiums on these policies can fluctuate based on product demand. Premiums from insurance products increased by $2 million, primarily as a result of a third quarter 2002 amendment to a reinsurance agreement which increased the amount of insurance ceded in that period, as well as new business growth in insurance products. This variance was partially offset by a decrease in renewal premiums associated with an aging block of business, as well as a decrease in insurance purchased by existing customers with their policy dividends. This decline is a direct result of the dividend scale reduction adopted in the fourth quarter of 2002. Universal life and investment-type product policy fees increased by $11 million, or 3%, to $386 million for the three months ended September 30, 2003 from $375 million for the comparable 2002 period. Policy fees from annuity and investment-type products increased by $24 million resulting from favorable investment experience and an increase in average separate account balances. Policy fees from insurance products decreased by $13 million due to higher amortization of deferred fees in the comparable 2002 period. This is a result of lapse, mortality and investment experience. Other revenues remained essentially unchanged at $96 million for the three months ended September 30, 2003 from $95 million for the comparable 2002 period. The Company's investment gains and losses are net of related policyholder amounts. The amounts netted against investment gains and losses are (i) amortization of DAC, to the extent that such amortization results from investment gains and losses; (ii) adjustments to participating contractholder accounts when amounts equal to such investment gains and losses are applied to the contractholder's accounts; and (iii) adjustments to the policyholder dividend obligation resulting from investment gains and losses. - 50 - The Company believes its policy of netting related policyholder amounts against investment gains and losses provides important information in evaluating its performance. Investment gains and losses are often excluded by investors when evaluating the overall financial performance of insurers. The Company believes its presentation enables readers to easily exclude investment gains and losses and the related effects on the consolidated statements of income when evaluating its performance. The Company's presentation of investment gains and losses, net of policyholder amounts, may be different from the presentation used by other insurance companies and, therefore, amounts in its unaudited interim condensed consolidated statements of income may not be comparable to amounts reported by other insurers. Policyholder benefits and claims increased by $39 million, or 3%, to $1,261 million for the three months ended September 30, 2003 from $1,222 million for the comparable 2002 period. Policyholder benefits and claims for insurance products increased by $60 million primarily due to the impact of the aforementioned amendment to a reinsurance agreement and the reduction of a reserve related to a subsidiary merger, both of which occurred in the comparable 2002 period. In addition, policyholder benefits and claims increased as a result of new business growth. Policyholder benefits and claims for annuity and investment-type products decreased by $21 million largely due to product demand for single premium immediate annuities and supplemental contracts with life contingencies and a decrease in the reserves associated with guaranteed minimum death benefits, which fluctuate in response to equity market changes. Interest credited to policyholder account balances increased by $15 million, or 3%, to $452 million for the three months ended September 30, 2003 from $437 million for the comparable 2002 period. This variance is due to growth in variable universal life and deferred annuity products, partially offset by declines in the interest crediting rates. Policyholder dividends decreased by $17 million, or 4%, to $442 million for the three months ended September 30, 2003 from $459 million for the comparable 2002 period due to the reduction of the dividend scale in the fourth quarter of 2002, reflecting the impact of the low interest rate environment on the asset portfolios supporting these policies. Other expenses decreased by $6 million, or 1%, to $677 million for the three months ended September 30, 2003 from $683 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC that are discussed below, other expenses increased by $97 million, or 14%, to $795 million in 2003 from $698 million in 2002. Other expenses related to insurance products increased by $52 million. Although there are savings from ongoing expense management initiatives, these savings are more than offset by increased pension and post retirement benefits and non-recurring charges. Other expenses related to annuity and investment-type products increased by $45 million. This is primarily due to an increase in commissions stemming from the continued rise in sales of new annuity and investment-type products offered by the MetLife Investors Group distribution channel, as well as increased pension and post-retirement benefit expenses. DAC is principally amortized in proportion to gross margins or gross profits, including investment gains or losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization and other expenses to provide amounts related to gross margins or profits originating from transactions other than investment gains and losses. Capitalization of DAC increased by $18 million, or 7%, to $280 million for the three months ended September 30, 2003 from $262 million for the comparable 2002 period due to higher commissions and other deferrable expenses resulting from higher sales of annuity and investment-type products. Total amortization of DAC decreased by $84 million, or 36%, to $152 million in 2003 from $236 million in 2002. Amortization of DAC of $162 million and $247 million is allocated to other expenses in 2003 and 2002, respectively, while the remainder of the amortization in each period is allocated to investment gains and losses. The $60 million decrease in amortization of DAC allocated to other expenses for insurance products is primarily the result of refinements in the calculation of estimated gross margins in the comparable 2002 period, with the remaining variance attributable to the impact of lapse, mortality and investment experience. The decrease in amortization of DAC allocated to other expenses for annuity and investment-type products of $25 million is due to the impact of investment experience. - 51 - NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- INDIVIDUAL Premiums decreased by $98 million, or 3%, to $3,160 million for the nine months ended September 30, 2003 from $3,258 million for the comparable 2002 period. Premiums from insurance products decreased by $79 million, primarily due to a decrease in renewal premiums associated with an aging block of business, as well as a decrease in insurance purchased by existing customers with their policy dividends. This decline is a direct result of the dividend scale reduction adopted in the fourth quarter of 2002. Premiums from annuity and investment-type products decreased by $19 million in the single premium immediate annuities and supplemental contracts with life contingencies products. Premiums from these policies can fluctuate based on product demand. Universal life and investment-type product policy fees increased by $112 million, or 11%, to $1,124 million for the nine months ended September 30, 2003 from $1,012 million for the comparable 2002 period. Policy fees from insurance products increased by $71 million due to higher insurance fees, surrender charges, and the amortization of deferred fees. The growth in insurance fees stems primarily from an increase in the average general account balance of universal life products. This is a result of lapse, mortality and investment experience. Policy fees from annuity and investment-type products increased by $41 million resulting from favorable investment experience which resulted in an increase in average separate account balances. Other revenues decreased by $34 million, or 10%, to $291 million for the nine months ended September 30, 2003 from $325 million for the comparable 2002 period, largely due to lower commission and fee income associated with the sales volume decline in the broker/dealer and other subsidiaries which is principally due to the slow recovery of the equity markets. Other revenues, which primarily consist of commission and fee income related to the broker/dealer and other subsidiaries, fluctuate from period to period in response to equity market changes. The Company's investment gains and losses are net of related policyholder amounts. The amounts netted against investment gains and losses are (i) amortization of DAC, to the extent that such amortization results from investment gains and losses; (ii) adjustments to participating contractholder accounts when amounts equal to such investment gains and losses are applied to the contractholder's accounts; and (iii) adjustments to the policyholder dividend obligation resulting from investment gains and losses. The Company believes its policy of netting related policyholder amounts against investment gains and losses provides important information in evaluating its performance. Investment gains and losses are often excluded by investors when evaluating the overall financial performance of insurers. The Company believes its presentation enables readers to easily exclude investment gains and losses and the related effects on the consolidated statements of income when evaluating its performance. The Company's presentation of investment gains and losses, net of policyholder amounts, may be different from the presentation used by other insurance companies and, therefore, amounts in its unaudited interim condensed consolidated statements of income may not be comparable to amounts reported by other insurers. Policyholder benefits and claims decreased by $18 million, or 1%, to $3,699 million for the nine months ended September 30, 2003 from $3,717 million for the comparable 2002 period. Policyholder benefits and claims for annuity and investment-type products decreased by $19 million, largely due to benefits paid on single premium immediate annuities, partially offset by an increase in the reserves associated with guaranteed minimum death benefits, which fluctuate in response to equity market changes. Policyholder benefits and claims for life products remained essentially unchanged. Interest credited to policyholder account balances increased by $15 million, or 1%, to $1,347 million for the nine months ended September 30, 2003 from $1,332 million for the comparable 2002 period. This variance is due to growth in variable universal life and deferred annuity products, partially offset by declines in the interest crediting rates. Policyholder dividends decreased by $58 million, or 4%, to $1,321 million for the nine months ended September 30, 2003 from $1,379 million for the comparable 2002 period due to the reduction of the dividend scale in the fourth quarter of 2002, reflecting the impact of the low interest rate environment on the asset portfolios supporting these policies. Other expenses increased by $155 million, or 8%, to $2,105 million for the nine months ended September 30, 2003 from $1,950 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC that are discussed below, other expenses increased by $228 million, or 11%, to $2,381 million in 2003 from $2,153 million in 2002. Other expenses related to annuity and investment-type products increased by $161 million. This is primarily due to an increase in commissions attributable to the continued rise in sales of new annuity and investment-type products offered by the MetLife Investors Group distribution channel, as well as increased pension and post-retirement benefit expenses. Other expenses related to insurance products increased by $67 - 52 - million. Although there are savings from ongoing expense management initiatives, these savings are more than offset by increased pension and post-retirement benefit expenses and non-recurring charges. DAC is principally amortized in proportion to gross margins or gross profits, including investment gains or losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization and other expenses to provide amounts related to gross margins or profits originating from transactions other than investment gains and losses. Capitalization of DAC increased by $56 million, or 7%, to $820 million for the nine months ended September 30, 2003 from $764 million for the comparable 2002 period due to higher commissions and other deferrable expenses as a result of higher sales of annuity and investment-type products, partially offset by the impact of non-deferrable expenses from insurance products that were previously deferred. Total amortization of DAC decreased by $16 million, or 3%, to $519 million in 2003 from $535 million in 2002. Amortization of DAC of $544 million and $561 million is allocated to other expenses in 2003 and 2002, respectively, while the remainder of the amortization in each period is allocated to investment gains and losses. The decrease in amortization of DAC allocated to other expenses for annuity and investment-type products of $34 million is due to the impact of investment experience. The $17 million increase in amortization of DAC allocated to other expenses for insurance products is primarily due to an adjustment resulting from the amortization of deferred expenses, with the remaining variance attributable to the impact of lapse, mortality and investment experience. - 53 - AUTO & HOME The following table presents consolidated financial information for the Auto & Home segment for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- -------------------- 2003 2002 2003 2002 ------- -------- -------- -------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 735 $ 711 $ 2,168 $ 2,105 Net investment income 39 44 119 135 Other revenues 10 11 23 27 Net investment gains (losses) 2 (8) (4) (40) ------- ------- ------- ------- Total revenues 786 758 2,306 2,227 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 543 497 1,604 1,509 Other expenses 187 205 572 606 ------- ------- ------- ------- Total expenses 730 702 2,176 2,115 ------- ------- ------- ------- Income before provision for income taxes 56 56 130 112 Provision for income taxes 13 13 19 24 ------- ------- ------- ------- Net income $ 43 $ 43 $ 111 $ 88 ======= ======= ======= =======
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- AUTO & HOME Premiums increased by $24 million, or 3%, to $735 million for the three months ended September 30, 2003 from $711 million for the comparable 2002 period. Auto and property premiums both increased by $12 million due to increases in average premium resulting from rate increases. Premiums from other personal lines remained unchanged at $13 million. Other revenues decreased by $1 million, or 9%, to $10 million for the three months ended September 30, 2003 from $11 million for the comparable 2002 period. The decrease is due to less income earned on corporate-owned life insurance ("COLI") and fewer installment payment fees. The decrease in payment fees is a result of a decline in policies in force. Policyholder benefits and claims increased by $46 million, or 9%, to $543 million for the three months ended September 30, 2003 from $497 million for the comparable 2002 period. Auto policyholder benefits and claims increased by $51 million due to higher claims severities and an increase in the adverse development of prior year claim reserves. Additionally, the third quarter 2002 results include two reinsurance recoverables totaling $17 million. Automobile non-catastrophe claims frequency was relatively flat versus the comparable 2002 period. Property policyholder benefits and claims decreased by $8 million due to reduced non-catastrophe claim frequency and fewer policies in force. These decreases were partially offset by an increase in catastrophes of $19 million. The property loss ratio decreased by 9.7 percentage points due to this decrease in policyholder benefits and claims and an increase in average earned premium of 17% due to rate increases and insurance-to-value programs. Catastrophes represented 3.4% of the total loss ratio in 2003 compared to .8% in 2002, as a result of adverse weather, including Hurricane Isabel. Ongoing risk management programs, including underwriting activity, agency management, product changes and reinsurance mitigated the impact of the adverse weather. These actions offset catastrophe losses in the third quarter of 2003 by $31 million. Other policyholder benefits and claims increased by $3 million primarily due to more personal umbrella claims. Other expenses decreased $18 million, or 9%, to $187 million for the three months ended September 30, 2003 from $205 million for the comparable 2002 period. The expense ratio decreased to 25.5% in 2003 from 28.9% in 2002. Excluding the capitalization and amortization of DAC that are discussed below, other expenses decreased by $15 million, or 7%, to $193 million in 2003 from $208 million in 2002. This decrease is partially due to a $8 million reduction of expenses resulting from the completion of the St. Paul integration and management's focus on expenses, as well as a $7 million reduction in the cost of the New York assigned risk plan. Capitalization of DAC decreased by $4 million, or 3%, to $112 million for the three months ended September 30, 2003 from $116 million for the comparable 2002 period due to a change in product mix by distribution channel. Amortization of DAC decreased by $7 - 54 - million, or 6%, to $106 million in 2003 from $113 million in 2002 due to a change in new business product mix by distribution channel in prior periods. The effective income tax rates for the three months ended September 30, 2003 and 2002 differ from the corporate tax rate of 35% due to the impact of non-taxable investment income. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- AUTO & HOME Premiums increased by $63 million, or 3%, to $2,168 million for the nine months ended September 30, 2003 from $2,105 million for the comparable 2002 period. Auto and property premiums increased by $33 million and $28 million, respectively, due to increases in average earned premium due to rate increases. These increases were 8% for auto and 17% for property. Premiums from other personal lines increased by $2 million to $41 million. Other revenues decreased by $4 million, or 15%, to $23 million for the nine months ended September 30, 2003 from $27 million for the comparable 2002 period. This decrease is due to fewer installment payment fees and less COLI income. Policyholder benefits and claims increased by $95 million, or 6%, to $1,604 million for the nine months ended September 30, 2003 from $1,509 million for the comparable 2002 period. Auto policyholder benefits and claims increased by $111 million primarily due to an increase in claims frequencies resulting largely from adverse road conditions in the first quarter of 2003 and higher losses due to adverse claims development related to prior accident years, resulting mostly from bodily injury and uninsured motorists claims. The auto loss ratio increased to 79.2% for 2003 from 73.9% in 2002. Property policyholder benefits and claims decreased by $20 million due to improved non-catastrophe claims frequencies, a reduction in the number of homeowners policies in-force, and underwriting and agency management actions. The property loss ratio decreased to 58.8% in 2003 from 66.3% in 2002. Other policyholder benefits and claims increased by $4 million primarily due to more personal umbrella claims. Other expenses decreased by $34 million, or 6%, to $572 million for the nine months ended September 30, 2002 from $606 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC that are discussed below, other expenses decreased by $26 million, or 5%, to $578 million in 2003 from $604 million in 2002. This decrease is partially due to a $18 million reduction in expenses resulting from the completion of the St. Paul integration and a $15 million reduction in the cost of the New York assigned risk plan. The expense ratio decreased to 26.4% in 2003 from 28.8% in 2002. Capitalization of DAC increased by $22 million, or 7%, to $334 million for the nine months ended September 30, 2003 from $312 million for the comparable 2002 period due to an increase in sales and an increase in average premium per policy due to rate increases. Amortization of DAC increased by $14 million, or 4%, to $328 million in 2003 from $314 million in 2002 due to an increase in new business production and an increase in average premium per policy due to rate increases in prior periods. The effective income tax rates for the nine months ended September 30, 2003 and 2002 differ from the corporate tax rate of 35% due to the impact of non-taxable investment income and a $7 million tax recovery recorded in the first quarter of 2003 for prior year tax overpayments on non-taxable investment income. - 55 - INTERNATIONAL The following table presents consolidated financial information for the International segment for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- 2003 2002 2003 2002 ------- -------- ------- -------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 445 $ 381 $ 1,230 $ 1,030 Universal life and investment-type product policy fees 70 64 192 78 Net investment income 119 133 373 303 Other revenues 20 2 54 8 Net investment gains (losses) 8 6 7 (8) ------- ------- ------- ------- Total revenues 662 586 1,856 1,411 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 398 352 1,042 941 Interest credited to policyholder account balances 34 32 107 52 Policyholder dividends 12 10 39 27 Other expenses 156 131 472 320 ------- ------- ------- ------- Total expenses 600 525 1,660 1,340 ------- ------- ------- ------- Income from continuing operations before provision for income taxes 62 61 196 71 Provision for income taxes 11 16 19 28 ------- ------- ------- ------- Income from continuing operations 51 45 177 43 Cumulative effect of change in accounting - (5) - - ------- ------- ------- ------- Net income $ 51 $ 40 $ 177 $ 43 ======= ======= ======= =======
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- INTERNATIONAL Premiums increased by $64 million, or 17%, to $445 million for the three months ended September 30, 2003 from $381 million for the comparable 2002 period. Chile's premiums increased by $29 million due to growth in the individual annuities business. South Korea's premiums increased by $19 million primarily due to a larger professional sales force. Spain's premiums increased by $16 million due to continued business growth and the strengthening of the Euro. These increases were partially offset by a net decrease in Mexico of $3 million attributable to the group and individual life businesses. These declines are primarily the result of anticipated actions taken by the Mexican government, adversely impacting the insurance and annuities market. In addition, the cancellation of a large broker-sponsored case at the end of 2002 and the weakening of the peso contributed to the decline. The decreases in Mexico are partially offset by an increase in premiums due to growth in the institutional major medical and life lines of business. The remainder of the variance is attributable to minor fluctuations in several countries. Universal life and investment-type fees increased by $6 million, or 9%, to $70 million for the three months ended September 30, 2003 from $64 million for the comparable 2002 period. Mexico's universal life and investment-type fees increased by $8 million primarily due to an increase in contributions to the policyholders account from a large block of business. The remainder of the variance is attributable to minor fluctuations in several countries. Other revenues increased by $18 million, or 900% to $20 million for the three months ended September 30, 2003 from $2 million for the comparable 2002 period. Mexico's other revenue increased by $17 million primarily due to the recovery of previously uncollectable receivables and the cancellation of a reinsurance contract related to a large block of business. The remainder of the variance is attributable to minor fluctuations in several countries. Policyholder benefits and claims increased by $46 million, or 13%, to $398 million for the three months ended September 30, 2003 from $352 million for the comparable 2002 period. Chile's, South Korea's and Spain's policyholder benefits and claims increased by $21 million, $18 million and $14 million, respectively, commensurate with the aforementioned premium increases. In addition, the strengthening of the Euro contributed to the increase in Spain. These increases are partially offset by a net decrease in - 56 - Mexico's policyholder benefits and claims of $12 million which is commensurate with the premium variance discussed above and the weakening of the peso. The remainder of the variance is attributable to minor fluctuations in several countries. Interest credited to policyholder account balances increased by $2 million, or 6%, to $34 million for the three months ended September 30, 2003 from $32 million for the comparable 2002 period. This variance is primarily due to an increase of the average policyholder fund balances in Mexico. Policyholder dividends increased by $2 million or 20% to $12 million for the three months ended September 30, 2003 from $10 million for the comparable 2002 period. This variance is primarily attributable to a $1 million increase in Mexico's private institutional line of business and minor fluctuations in several countries. Other expenses increased by $25 million, or 19%, to $156 million for the three months ended September 30, 2003 from $131 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC which are discussed below, other expenses increased by $20 million, or 12%, to $187 million in 2003 from $167 million in 2002. South Korea's expenses increased by $12 million as a result of new business growth and general expansion of operations. Spain's other expenses increased by $5 million primarily due to an increase in commissions from higher sales in investment-type products. These increases are partially offset by a decrease of $3 million in Mexico due to the weakening of the peso. The remainder of the variance is attributable to minor fluctuations in several countries. Capitalization of DAC increased by $12 million, or 20%, to $72 million for the three months ended September 30, 2003 from $60 million for comparable 2002 period. This increase is primarily due to higher sales in Spain's investment-type products, Mexico's individual universal life and group life businesses and South Korea's variable universal life business. The remainder of the variance is attributable to minor fluctuations in several countries. Amortization of DAC increased by $17 million, or 71%, to $41 million for the three months ended September 30, 2003 from $24 million for the comparable 2002 period. Mexico's amortization of DAC increased by $10 million primarily due to an increase in the amortization of the value of business acquired related to a change in reserve methodology in the second quarter of 2003. Taiwan's amortization of DAC increased by $5 million primarily as the result of refinements made to the DAC models during the comparable 2002 period. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- INTERNATIONAL Premiums increased by $200 million, or 19%, to $1,230 million for the nine months ended September 30, 2003 from $1,030 million for the comparable 2002 period. The acquisition of Hidalgo in June 2002 contributed $255 million to this increase. Partially offsetting this is a decline of $108 million attributable to a non-recurring sale of an annuity contract in the first quarter of 2002 in Canada. Excluding these items, premiums increased by $53 million, or 5%, from the comparable 2002 period. Excluding the effects of the acquisition, South Korea's premiums increased by $68 million primarily due to a larger professional sales force and new business growth. Chile's premiums increased by $31 million mainly due to higher sales in the individual annuities business. Spain's premiums increased by $26 million primarily due to business growth and the strengthening of the Euro. Taiwan's premiums increased by $12 million primarily due to increased renewals in the individual life business. These increases are partially offset by a decrease of $92 million in Mexico's premiums primarily attributable to decreases in both the group and individual life businesses. These declines are primarily the result of anticipated actions taken by the Mexican government, adversely impacting the insurance and annuities market. In addition, the cancellation of a large broker-sponsored case at the end of 2002 and the weakening of the peso contributed to this decline. These unfavorable variances in Mexico are partially offset by growth in the institutional, major medical and life lines of business. The remainder of the variance is attributable to minor fluctuations in several countries. Universal life and investment type-product policy fees increased by $114 million, or 146%, to $192 million for the nine months ended September 30, 2003 from $78 million for the comparable 2002 period The acquisition of Hidalgo in June 2002 accounted for $102 million of this increase. Excluding this acquisition, universal life and investment type-product policy fees increased $12 million, or 15%, from the comparable 2002 period. Mexico's universal life and investment type-product policy fees increased by $8 million primarily due to an increase in contributions to the policyholders account from a large block of business. South Korea's universal life and investment type-product policy fees increased by $6 million largely due to a new variable universal life product launched in 2003. The remainder of the variance is attributable to minor fluctuations in several countries. Other revenues increased by $46 million, or 575%, to $54 million for the nine months ended September 30, 2003 from $8 million for the comparable 2002 period. The acquisition of Hidalgo in June 2002 contributed $28 million to this increase. Excluding the impact of this acquisition, other revenues increased by $18 million, or 225%, from the comparable 2002 period. Mexico's other revenue increased by $15 million, primarily due to the recovery of previously uncollectable receivables and the cancellation of a reinsurance contract related to a large block of business. The remainder of the variance is attributable to minor fluctuations in several countries. - 57 - Policyholder benefits and claims increased by $101 million, or 11%, to $1,042 million for the nine months ended September 30, 2003 from $941 million for the comparable 2002 period. The acquisition of Hidalgo in June 2002 contributed $256 million to this increase. Partially offsetting this is a decrease of $108 million for the aforementioned non-recurring sale of an annuity contract during the first quarter of 2002. Excluding these items, policyholder benefits and claims decreased by $47 million, or 5%, from the comparable 2002 period. Mexico's policyholder benefits and claims decreased by $183 million primarily as a result of a reduction in policyholder liabilities related to a change in reserve methodology in the second quarter of 2003, as well as the impact of the overall premium decreases discussed above. South Korea's, Spain's, Chile's and Taiwan's policyholder benefits and claims increased by $54 million, $31 million, $34 million and $5 million, respectively, commensurate with the overall premium increases discussed above, and the strengthening of the Euro in Spain. Brazil's policyholder benefits increased by $5 million primarily due to higher claims in 2003. The remainder of the variance is attributable to minor fluctuations in several countries. Interest credited to policyholder account balances increased by $55 million, or 106%, to $107 million for the nine months ended September 30, 2003 from $52 million for the comparable 2002 period. The acquisition of Hidalgo in June 2002 contributed $50 million to this increase. Excluding this acquisition, interest credited increased by $5 million, or 10%, from the comparable 2002 period. Spain's interest credited increased by $4 million due to the strengthening of the Euro. Mexico's interest credited increased by $3 million due to an increase in the average policyholder fund balances. The remainder of the variance is attributable to minor fluctuations in several countries. Policyholder dividends increased by $12 million, or 44%, to $39 million for the nine months ended September 30, 2003 from $27 million for the comparable 2002 period. This increase is primarily attributable to the acquisition of Hidalgo in June 2002. Other expenses increased by $152 million, or 48%, to $472 million for the nine months ended September 30, 2003 from $320 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC that are discussed below, other expenses increased by $130 million, or 34%, to $517 million in 2003 from $387 million in 2002. The acquisition of Hidalgo in June 2002 contributed $97 million to the current period result. Excluding this acquisition, other expenses increased $33 million, or 9%, from the comparable 2002 period. South Korea's other expenses increased by $32 million primarily a result of new business growth and general expansion of operations. Spain's other expenses increased by $15 million primarily due to higher commissions on sales of investment-type products, as well as the strengthening of the Euro. These increases were partially offset by a decrease in Mexico's other expenses of $17 million primarily due to lower headcount and the weakening of the peso. The remainder of the variance is attributable to minor fluctuations in several countries. Capitalization of DAC increased by $57 million, or 41%, to $197 million for the nine months ended September 30, 2003 from $140 million for comparable 2002 period. The acquisition of Hidalgo in June 2002 contributed $41 million to this variance. Excluding this acquisition, capitalization of DAC increased by $16 million, or 11% from the comparable 2002 period. This variance is due to higher sales of Spain's investment-type products of $22 million and South Korea's variable universal life business of $9 million. Taiwan's capitalization of DAC decreased by $4 million primarily as a result of lower first year premiums. Argentina's capitalization of DAC decreased by $5 million primarily due to the results of refinements in the DAC model in the current period. Hong Kong's capitalization of DAC decreased by $5 million due to lower brokerage sales. The remainder of the variance is attributable to small fluctuations in several countries. Amortization of DAC increased by $79 million, or 108%, to $152 million for the nine months ended September 30, 2003 from $73 million for comparable 2002 period. The acquisition of Hidalgo contributed $21 million to this variance. Excluding this acquisition, amortization of DAC increased by $58 million, or 79% from the comparable 2002 period. Mexico's amortization of DAC increased by $59 million commensurate with the aforementioned change in reserve methodology. Taiwan's amortization of DAC increased by $3 million primarily due to refinements in the DAC model in the prior year. The remainder of the variance is attributable to small fluctuations in several countries. Income tax decreased by $9 million, or 32%, to $19 million for the nine months ended September 30, 2003 from $28 million for the comparable 2002 period. As a result of the merger of the Company's Mexican operation, the Company recorded a tax benefit of $40 million for the reduction of deferred tax valuation allowances. - 58 - REINSURANCE The following table presents consolidated financial information for the Reinsurance segment for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- 2003 2002 2003 2002 ------- -------- ------- -------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 579 $ 461 $ 1,719 $ 1,408 Net investment income 122 95 353 296 Other revenues 11 16 35 35 Net investment gains 5 4 6 6 ------- -------- ------- -------- Total revenues 717 576 2,113 1,745 ------- -------- ------- -------- EXPENSES Policyholder benefits and claims 465 337 1,353 1,111 Interest credited to policyholder account balances 47 31 135 97 Policyholder dividends 5 6 16 17 Other expenses 170 163 516 411 ------- -------- ------- -------- Total expenses 687 537 2,020 1,636 ------- -------- ------- -------- Income before provision for income taxes 30 39 93 109 Provision for income taxes 11 14 32 39 ------- -------- ------- -------- Net income $ 19 $ 25 $ 61 $ 70 ======= ======== ======= ========
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- REINSURANCE Premiums increased by $118 million, or 26%, to $579 million for the three months ended September 30, 2003 from $461 million for the comparable 2002 period. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business, particularly in the U.S. and United Kingdom reinsurance operations, all contributed to the premium growth. Premium levels are significantly influenced by large transactions and reporting practices of ceding companies and, as a result, can fluctuate from period to period. Other revenues decreased by $5 million, or 31%, to $11 million for the three months ended September 30, 2003 from $16 million for the comparable 2002 period. Fees earned on financial reinsurance can vary period to period depending on the level of surplus relief provided to ceding companies. Policyholder benefits and claims increased by $128 million, or 38%, to $465 million for the three months ended September 30, 2003 from $337 million for the comparable 2002 period. As a percentage of premiums, policyholder benefits and claims increased to 80% for the three months ended September 30, 2003 from 73% for the comparable 2002 period. Adverse mortality in the U.S. traditional business was the primary reason for the increase in this ratio. The U.S. traditional business reported favorable mortality experience in the prior-period quarter. Claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to significant fluctuation. Interest credited to policyholder account balances increased by $16 million, or 52%, to $47 million for the three months ended September 30, 2003 from $31 million for the comparable 2002 period. Interest credited to policyholder account balances relates to amounts credited on deposit-type contracts, such as annuities, and certain cash-value contracts. This increase in expense can be attributed to the addition of several new annuity transactions during the fourth quarter of 2002 and new deposits on existing annuity treaties. The crediting rate on certain blocks of annuities is based on the performance of the underlying assets. Policyholder dividends were essentially unchanged at $5 million for the three months ended September 30, 2003 from $6 million for the comparable 2002 period. - 59 - Other expenses increased by $7 million, or 4%, to $170 million for the three months ended September 30, 2003 from $163 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC that are discussed below, other expenses increased by $64 million, or 33%, to $260 million in 2003 from $196 million in 2002 due to a $63 million increase in allowances paid on assumed reinsurance, particularly on certain high commission business in the United Kingdom. Capitalization of DAC increased by $37 million, or 29%, to $165 million for the three months ended September 30, 2003 from $128 million for the comparable 2002 period due to an increase in the amount of high-allowance business written in the respective periods, particularly in the United Kingdom. Amortization of DAC decreased by $20 million, or 21%, to $75 million in 2003 from $95 million in 2002. The capitalization and amortization of DAC can fluctuate significantly due to the mix of business, including the type of product being reinsured, form of the reinsurance treaty and geographic region. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- REINSURANCE Premiums increased by $311 million, or 22%, to $1,719 million for the nine months ended September 30, 2003 from $1,408 million for the comparable 2002 period. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business, particularly in the U.S. and United Kingdom reinsurance operations, all contributed to the premium growth. Premium levels are significantly influenced by large transactions and reporting practices of ceding companies and, as a result, can fluctuate from period to period. Other revenues were unchanged at $35 million for both the nine months ended September 30, 2003 and 2002. Policyholder benefits and claims increased by $242 million, or 22%, to $1,353 million for the nine months ended September 30, 2003 from $1,111 million for the comparable 2002 period. Policyholder benefits and claims were approximately 79% of premiums for the first nine months of 2003 and 2002. Claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to significant fluctuation. Interest credited to policyholder account balances increased by $38 million, or 39%, to $135 million for the nine months ended September 30, 2003 from $97 million for the comparable 2002 period. Interest credited to policyholder account balances relates to amounts credited on deposit-type contracts, such as annuities, and certain cash-value contracts. This increase in expense can be attributed to the addition of several new annuity transactions during the fourth quarter of 2002 and new deposits on existing annuity treaties. The crediting rate on certain blocks of annuities is based on the performance of the underlying assets. Policyholder dividends were essentially unchanged at $16 million for the nine months ended September 30, 2003 from $17 million for the comparable 2002 period. Other expenses increased by $105 million, or 26%, to $516 million for the nine months ended September 30, 2003 from $411 million for the comparable 2002 period. Excluding the capitalization and amortization of DAC that are discussed below, other expenses increased by $221 million, or 42%, to $752 million in 2003 from $531 million in 2002 primarily due to a $192 million increase in allowances paid on assumed reinsurance, particularly on certain high commission businesses in the United Kingdom. Capitalization of DAC increased by $153 million, or 50%, to $456 million for the nine months ended September 30, 2003 from $303 million for the comparable 2002 period due to due to an increase in the amount of high-allowance business written in the respective periods, particularly in the United Kingdom. Amortization of DAC increased by $37 million, or 20%, to $220 million in 2003 from $183 million in 2002. The capitalization and amortization of DAC can fluctuate significantly due to the mix of business, including the type of product being reinsured, form of the reinsurance treaty and geographic region. - 60 - ASSET MANAGEMENT The following table presents consolidated financial information for the Asset Management segment for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- 2003 2002 2003 2002 ------- ------- ------- -------- (DOLLARS IN MILLIONS) REVENUES Net investment income $ 17 $ 17 $ 49 $ 46 Other revenues 36 37 102 127 Net investment gains (losses) 2 - 10 (4) ------- ------- ------- ------- Total revenues 55 54 161 169 ------- ------- ------- ------- OTHER EXPENSES 47 53 134 162 ------- ------- ------- ------- Income before provision for income taxes 8 1 27 7 Provision for income taxes 2 1 10 3 ------- ------- ------- ------- Net income $ 6 $ - $ 17 $ 4 ======= ======= ======= =======
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- ASSET MANAGEMENT Other revenues, which primarily consist of management and advisory fees from third parties, decreased $1 million, or 3%, to $36 million for the three months ended September 30, 2003 from $37 million for the comparable 2002 period. This decrease is primarily the result of lower average assets under management on which these fees are earned. Other expenses decreased by $6 million, or 11%, to $47 million for the three months ended September 30, 2003 from $53 million for the comparable 2002 period. This decrease is largely attributable to staff reductions in the third and fourth quarters of 2002 and reductions in incentive compensation. In addition, there was a reduction in expenses due to lower average assets under management. These decreases were partially offset by an increase in general and administrative expenses. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- ASSET MANAGEMENT Other revenues, which primarily consist of management and advisory fees from third parties, decreased $25 million, or 20% to $102 million for the nine months ended September 30, 2003 from $127 million for the comparable 2002 period. This decrease is primarily the result of lower average assets under management on which these fees are earned. In addition, performance fees earned during 2003 on certain investment products were lower than in the comparable 2002 period. Other expenses decreased by $28 million, or 17%, to $134 million for the nine months ended September 30, 2003 from $162 million for the comparable 2002 period. This decrease is largely due to staff reductions in the third and fourth quarters of 2002, and reductions in incentive compensation. Additionally, expenses declined as a result of lower average assets under management. The remainder of the variance is due to a decrease in general and administrative expenses. - 61 - CORPORATE & OTHER THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2002 -- CORPORATE & OTHER Other revenues increased by $13 million, or 260%, to $18 million for the three months ended September 30, 2003 from $5 million for the comparable 2002 period. This variance is primarily due to the amortization of a deferred gain related to a property sale and leaseback transaction. The Company anticipates that the deferred gain will be amortized into income through 2005. The remainder of the change is due to an increase in the elimination of intersegment activity. Other expenses decreased by $62 million, or 57%, to $47 million for the three months ended September 30, 2003 from $109 million for the comparable 2002 period. This variance is primarily due to a $44 million reduction in legal expenses, primarily due to a reduction of a previously established liability related to the Company's race conscious underwriting settlement. In addition, $5 million of the decrease in other expenses is attributable to the remeasurement of the asbestos insurance recoverable and the amortization of the deferred gain on asbestos insurance, both of which are impacted by equity market performance. The remainder of the change is due to an increase in the elimination of intersegment activity. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2002 -- CORPORATE & OTHER Other revenues increased by $19 million, or 73%, to $45 million for the nine months ended September 30, 2003 from $26 million for the comparable 2002 period. This variance is primarily due to the amortization of a deferred gain related to a property sale and leaseback transaction. The Company anticipates that the deferred gain will be amortized into income through 2005. The remainder of the change is due to an increase in the elimination of intersegment activity. Other expenses decreased by $153 million, or 45%, to $188 million for the nine months ended September 30, 2003 from $341 million for the comparable 2002 period. The 2003 period includes a $144 million reduction of a previously established liability related to the Company's race conscious underwriting settlement. The 2002 period includes a $55 million charge to cover costs associated with the resolution of a federal government investigation of General American's former Medicare business and a $46 million reduction of a previously established liability for settlement death benefits related to the sales practices class action settlement recorded in 1999. In addition, $20 million of the decrease in other expenses is attributable to the remeasurement of the asbestos insurance recoverable and the amortization of the deferred gain on asbestos insurance, both of which are impacted by equity market performance. These decreases were partially offset by a $38 million increase in interest expense related to the Company's long-term debt activities in the fourth quarter of 2002 and the first quarter of 2003. The remainder of the change is due to an increase in the elimination of intersegment activity. - 62 - LIQUIDITY AND CAPITAL RESOURCES THE HOLDING COMPANY CAPITAL Restrictions and Limitations on Bank Holding Companies and Financial Holding Companies -- Capital. MetLife, Inc. and its insured depository institution subsidiary are subject to risk-based and leverage capital guidelines issued by the federal banking regulatory agencies for banks and financial holding companies. The federal banking regulatory agencies are required by law to take specific prompt corrective actions with respect to institutions that do not meet minimum capital standards. At September 30, 2003, MetLife, Inc. and its insured depository institution subsidiary were in compliance with the aforementioned guidelines. LIQUIDITY Liquidity refers to a company's ability to generate adequate amounts of cash to meet its needs. It is managed to preserve stable, reliable and cost-effective sources of cash to meet all current and future financial obligations and is provided by a variety of sources, including a portfolio of liquid assets, a diversified mix of short- and long-term funding sources from the wholesale financial markets and the ability to borrow through committed credit facilities. The Holding Company is an active participant in the global financial markets through which it obtains a significant amount of funding. These markets, which serve as cost-effective sources of funds, are critical components of the Holding Company's liquidity management. Decisions to access these markets are based upon relative costs, prospective views of balance sheet growth, and a targeted liquidity profile. A disruption in the financial markets could limit the Holding Company's access to liquidity. The Holding Company's ability to maintain regular access to competitively priced wholesale funds is fostered by its current debt ratings from the major credit rating agencies. Management views its capital ratios, credit quality, stable and diverse earnings streams, diversity of liquidity sources and its liquidity monitoring procedures as critical to retaining high credit ratings. Liquidity is monitored through the use of internal liquidity risk metrics, including the composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, access to the financial markets for capital and term-debt transactions, and exposure to contingent draws on the Holding Company's liquidity. LIQUIDITY SOURCES Dividends. The primary source of the Holding Company's liquidity is dividends it receives from Metropolitan Life. Under the New York Insurance Law, Metropolitan Life is permitted, without prior insurance regulatory clearance, to pay a stockholder dividend to the Holding Company as long as the aggregate amount of all such dividends in any calendar year does not exceed the lesser of (i) 10% of its statutory surplus as of the immediately preceding calendar year; and (ii) its statutory net gain from operations for the immediately preceding calendar year (excluding realized capital gains). Metropolitan Life will be permitted to pay a stockholder dividend to the Holding Company in excess of the lesser of such two amounts only if it files notice of its intention to declare such a dividend and the amount thereof with the New York Superintendent of Insurance (the "Superintendent") and the Superintendent does not disapprove the distribution. Under the New York Insurance Law, the Superintendent has broad discretion in determining whether the financial condition of a stock life insurance company would support the payment of such dividends to its stockholders. The New York Insurance Department (the "Department") has established informal guidelines for such determinations. The guidelines, among other things, focus on the insurer's overall financial condition and profitability under statutory accounting practices. Management of the Holding Company cannot provide assurance that Metropolitan Life will have statutory earnings to support payment of dividends to the Holding Company in an amount sufficient to fund its cash requirements and pay cash dividends or that the Superintendent will not disapprove any dividends that Metropolitan Life must submit for the Superintendent's consideration. In addition, the Holding Company receives dividends from its other subsidiaries. The Holding Company's other insurance subsidiaries are also subject to restrictions on the payment of dividends to their respective parent companies. The dividend limitation is based on statutory financial results. Statutory accounting practices, as prescribed by insurance regulators of various states in which the Company conducts business, differ in certain respects from accounting principles used in financial statements prepared in conformity with GAAP. The significant differences relate to the treatment of DAC, certain deferred income taxes, required investment reserves, reserve calculation assumptions, goodwill and surplus notes. - 63 - Liquid Assets. An integral part of the Holding Company's liquidity management is the amount of liquid assets that it holds. Liquid assets include cash, cash equivalents, short-term investments and marketable equity and fixed maturity securities. Liquid assets exclude assets relating to securities lending and dollar roll activity. At September 30, 2003 and December 31, 2002, the Holding Company had $1,540 million and $597 million in liquid assets, respectively. Global Funding Sources. Liquidity is also provided by a variety of both short- and long-term instruments, including repurchase agreements, commercial paper, medium- and long-term debt, capital securities and stockholders' equity. The diversification of the Holding Company's funding sources enhances funding flexibility and limits dependence on any one source of funds, and generally lowers the cost of funds. At September 30, 2003, the Holding Company did not have short-term debt outstanding. At December 31, 2002, the Holding Company had $249 million in short-term debt outstanding. At both September 30, 2003 and December 31, 2002, the Holding Company had $3.3 billion in long-term debt outstanding. The Holding Company filed a $4.0 billion shelf registration statement, effective June 1, 2001, with the U.S. Securities and Exchange Commission, which permits the registration and issuance of debt and equity securities as described more fully therein. The Holding Company has issued senior debt in the amount of $2.25 billion under this registration statement. In December 2002, the Holding Company issued $400 million 5.375% senior notes due 2012 and $600 million 6.50% senior notes due 2032 and, in November 2001, the Holding Company issued $500 million 5.25% senior notes due 2006 and $750 million 6.125% senior notes due 2011. In addition, in February 2003, the Holding Company remarketed under the shelf registration statement $1,006 million aggregate principal amount of debentures previously issued in connection with the issuance of equity security units described below. In connection with MetLife, Inc.'s initial public offering in April 2000, the Holding Company and MetLife Capital Trust I (the "Trust") issued equity security units (the "units"). Each unit originally consisted of (i) a contract to purchase, for $50, shares of the Holding Company's common stock (the "purchase contracts") on May 15, 2003; and (ii) a capital security of the Trust, with a stated liquidation amount of $50. On May 15, 2003, the purchase contracts associated with the units were settled. In exchange for $1,006 million, the Company issued 2.97 shares of MetLife, Inc. common stock per purchase contract, or approximately 59.8 million shares of treasury stock. Approximately $656 million, which represents the excess of the Company's cost of the treasury stock ($1,662 million) over the contract price of the stock issued to the purchase contract holders ($1,006 million), was recorded as a direct reduction to retained earnings. Other sources of the Holding Company's liquidity include programs for short- and long-term borrowing, as needed, arranged through Metropolitan Life. Credit Facilities. The Holding Company maintains a committed and unsecured credit facility, which expires in 2005, for approximately $1.25 billion that it shares with Metropolitan Life and MetLife Funding, Inc. ("MetLife Funding"). In April 2003, Metropolitan Life and MetLife Funding replaced an expiring $1 billion five-year credit facility with a $1 billion 364-day credit facility and the Holding Company was added as a borrower. Drawdowns under these facilities bear interest at varying rates stated in the agreements. These facilities are primarily used for general corporate purposes and as back-up lines of credit for the borrowers' commercial paper programs. At September 30, 2003, none of the Holding Company, Metropolitan Life or MetLife Funding had drawn against these credit facilities. LIQUIDITY USES The primary uses of liquidity of the Holding Company include cash dividends on common stock, service on debt, contributions to subsidiaries, payment of general operating expenses and the repurchase of the Holding Company's common stock. Dividends. In October of 2003, the Holding Company declared an annual dividend for 2003 of $0.23 per share. The 2003 dividend will represent an increase of $0.02 per share from the 2002 annual dividend of $0.21 per share. Dividends, if any, in any year will be determined by the Holding Company's Board of Directors after taking into consideration factors such as the Holding Company's current earnings, expected medium- and long-term earnings, financial condition, regulatory capital position, and applicable governmental regulations and policies. Capital Contributions to Subsidiaries. During the nine months ended September 30, 2003, the Holding Company contributed an aggregate of $127 million to various subsidiaries. There were no contributions from the Holding Company to its subsidiaries during the nine months ended September 30, 2002. - 64 - Share Repurchase. On February 19, 2002, the Holding Company's Board of Directors authorized a $1 billion common stock repurchase program. This program began after the completion of the March 28, 2001 and June 27, 2000 repurchase programs, each of which authorized the repurchase of $1 billion of common stock. Under these authorizations, the Holding Company may purchase common stock from the MetLife Policyholder Trust, in the open market and in privately negotiated transactions. The Holding Company did not acquire any shares of common stock during the nine months ended September 30, 2003. The Holding Company acquired 15,244,492 shares of common stock for $471 million during the nine months ended September 30, 2002. At September 30, 2003, the Holding Company had approximately $806 million remaining on its existing share repurchase authorization. Any repurchases during the remainder of 2003 will be dependent upon several factors, including the Company's capital position, its financial strength and credit ratings, general market conditions and the price of the Company's common stock. On November 6, 2003, RGA announced that it would sell 10,500,000 shares of its common stock at $36.65 per share. MetLife, Inc. has indicated that it and certain of its affiliates are interested in purchasing 3,000,000 shares of the common stock being offered by RGA at $36.65 per share, for a total purchase price of approximately $110 million. Assuming the underwriters of the offering do not exercise their over-allotment option to purchase an additional 1,575,000 shares, immediately after the completion of the offering, MetLife will own approximately 53.4% of RGA's outstanding common stock. Support Agreements. In 2002, the Holding Company entered into a net worth maintenance agreement with three of its insurance subsidiaries, MetLife Investors Insurance Company, First MetLife Investors Insurance Company and MetLife Investors Insurance Company of California. Under the agreements, the Holding Company agreed, without limitation as to the amount, to cause each of these subsidiaries to have a minimum capital and surplus of $10 million (or, with respect to MetLife Investors Insurance Company of California, $5 million), total adjusted capital at a level not less than 150% of the company action level Risk-Based Capital ("RBC"), as defined by state insurance statutes, and liquidity necessary to enable it to meet its current obligations on a timely basis. At September 30, 2003, the capital and surplus of each of these subsidiaries was in excess of the minimum capital and surplus amounts referenced above, and their total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2002. The Holding Company has agreed to make capital contributions, in any event not to exceed $120 million, to MIAC in the aggregate amount of the excess of: (i) the debt service payments required to be made, and the capital expenditure payments required to be made or reserved for, in connection with the affiliated borrowings arranged in December 2001 to fund the purchase by MIAC of certain real estate properties from Metropolitan Life during the two year period following the date of the borrowings, over (ii) the cash flows generated by these properties. Based on management's analysis of its expected cash inflows from the dividends it receives from subsidiaries, including Metropolitan Life, that are permitted to be paid without prior insurance regulatory approval and its portfolio of liquid assets and other anticipated cash flows, management believes there will be sufficient liquidity to enable the Holding Company to make payments on debt, make dividend payments on its common stock, pay all operating expenses and meet its other obligations. THE COMPANY CAPITAL RBC. Section 1322 of the New York Insurance Law requires that New York domestic life insurers report their RBC based on a formula calculated by applying factors to various asset, premium and statutory reserve items; similar rules apply to each of the Company's domestic insurance subsidiaries. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk and business risk. Section 1322 gives the Superintendent explicit regulatory authority to require various actions by, or to take various actions against, insurers whose total adjusted capital does not exceed certain RBC levels. At December 31, 2002, Metropolitan Life's and each of the Holding Company's domestic insurance subsidiaries' total adjusted capital was in excess of each of the RBC levels required by each state of domicile. The National Association of Insurance Commissioners ("NAIC") adopted Codification of Statutory Accounting Principles ("Codification"), which is intended to standardize regulatory accounting and reporting to state insurance departments and became effective January 1, 2001. However, statutory accounting principles continue to be established by individual state laws and permitted practices. The Department required adoption of Codification with certain modifications for the preparation of statutory financial statements of insurance companies domiciled in New York effective January 1, 2001. Effective December 31, 2002, the Department adopted a modification to its regulations to be consistent with Codification with respect to the admissibility of deferred income taxes by New York insurers, subject to certain limitations. The adoption of Codification, as modified by the Department, did not adversely affect Metropolitan Life's statutory capital and surplus. Further modifications by state insurance departments may impact the effect of Codification on the statutory capital and surplus of Metropolitan Life and the Holding Company's other insurance subsidiaries. - 65 - LIQUIDITY SOURCES Cash Flow from Operations. The Company's principal cash inflows from its insurance activities come from insurance premiums, annuity considerations and deposit funds. A primary liquidity concern with respect to these cash inflows is the risk of early contractholder and policyholder withdrawal. The Company seeks to include provisions limiting withdrawal rights on many of its products, including general account institutional pension products (generally group annuities, including guaranteed interest contracts and certain deposit fund liabilities) sold to employee benefit plan sponsors. The Company's principal cash inflows from its investment activities result from repayments of principal, proceeds from maturities and sales of invested assets and investment income. The primary liquidity concerns with respect to these cash inflows are the risk of default by debtors and market volatilities. The Company closely monitors and manages these risks through its credit risk management process. Liquid Assets. An integral part of the Company's liquidity management is the amount of liquid assets it holds. Liquid assets include cash, cash equivalents, short-term investments and marketable equity and fixed maturity securities. Liquid assets exclude assets relating to securities lending and dollar roll activity. At September 30, 2003 and December 31, 2002, the Company had $121 billion and $108 billion in liquid assets, respectively. Global Funding Sources. Liquidity is also provided by a variety of both short- and long-term instruments, including repurchase agreements, commercial paper, medium- and long-term debt, capital securities and stockholders' equity. The diversification of the Company's funding sources enhances funding flexibility and limits dependence on any one source of funds, and generally lowers the cost of funds. At September 30, 2003 and December 31, 2002, the Company had $2,935 million and $1,161 million in short-term debt outstanding, respectively, and $5,703 million and $4,425 million in long-term debt outstanding, respectively. See "-- The Holding Company -- Global Funding Sources." On November 1, 2003, the Company redeemed all the outstanding $300 million 7.45% Surplus Notes scheduled to mature on November 1, 2023 at a redemption price of $311 million. MetLife Funding serves as a centralized finance unit for Metropolitan Life. Pursuant to a support agreement, Metropolitan Life has agreed to cause MetLife Funding to have a tangible net worth of at least one dollar. At September 30, 2003 and December 31, 2002, MetLife Funding had a tangible net worth of $10.7 million. MetLife Funding raises funds from various funding sources and uses the proceeds to extend loans, through MetLife Credit Corp., a subsidiary of Metropolitan Life, to the Holding Company, Metropolitan Life and other affiliates. MetLife Funding manages its funding sources to enhance the financial flexibility and liquidity of Metropolitan Life and other affiliated companies. At September 30, 2003 and December 31, 2002, MetLife Funding had total outstanding liabilities, including accrued interest payable, of $940 million and $400 million, respectively, consisting primarily of commercial paper. Credit Facilities. The Company maintains committed and unsecured credit facilities aggregating $2.5 billion ($1 billion expiring in 2004, $1.3 billion expiring in 2005 and $175 million expiring in 2006). In April 2003, the Company replaced an expiring $1 billion five-year credit facility with a $1 billion 364-day credit facility. In May 2003, the Company replaced an expiring $140 million three-year credit facility with a $175 million three-year credit facility, which expires in 2006. If these facilities were drawn upon, they would bear interest at varying rates in accordance with the respective agreements. The facilities can be used for general corporate purposes and also as back-up lines of credit for the Company's commercial paper programs. At September 30, 2003, the Company had drawn approximately $45 million under two of the three facilities expiring in 2005 at interest rates ranging from 4.08% to 5.38% and another approximately $50 million under a facility expiring in 2006 at an interest rate of 1.69%. LIQUIDITY USES Insurance Liabilities. The Company's principal cash outflows primarily relate to the liabilities associated with its various life insurance, property and casualty, annuity and group pension products, operating expenses and income taxes, as well as principal and interest on its outstanding debt obligations. Liabilities arising from its insurance activities primarily relate to benefit payments under the aforementioned products, as well as payments for policy surrenders, withdrawals and loans. Investment and Other. Additional cash outflows include those related to obligations of securities lending activities, investments in real estate, limited partnership and joint ventures, as well as legal liabilities. - 66 - The following table summarizes the Company's major contractual obligations (other than those arising from its ordinary product and investment purchase activities) as of September 30, 2003:
CONTRACTUAL OBLIGATIONS TOTAL 2003 2004 2005 2006 2007 THEREAFTER ----------------------- ------- ------- ------- ------- ------- ------- ---------- (DOLLARS IN MILLIONS) Long-term debt (1) $ 5,717 $ 406 $ 134 $ 1,418 $ 663 $ 39 $ 3,057 Partnership investments (2) 1,511 1,511 - - - - - Operating leases 1,541 53 193 176 156 135 828 Mortgage commitments 1,116 987 129 - - - - Shares subject to mandatory redemption (1) 350 - - - - - 350 ------- ------- ------- ------- ------- ------- ------- Total $10,235 $ 2,957 $ 456 $ 1,594 $ 819 $ 174 $ 4,235 ======= ======= ======= ======= ======= ======= =======
-------------------- (1) Amounts differ from the balances presented on the consolidated balance sheets. The amounts above do not include related premiums and discounts. (2) The Company anticipates that these amounts could be invested in these partnerships any time over next five years, but are presented in the current period, as the timing of the fulfillment of the obligation cannot be predicted. On April 11, 2003, an affiliate of the Company elected not to make future payments required by the terms of a non-recourse loan obligation. The book value of this loan was $15 million at September 30, 2003. The Company's exposure under the terms of the applicable loan agreement is limited solely to its investment in certain securities held by an affiliate. Letters of Credit. At September 30, 2003 and December 31, 2002, the Company had outstanding approximately $751 million and $625 million, respectively, in letters of credit from various banks, all of which expire within one year. Since commitments associated with letters of credit and financing arrangements may expire unused, these amounts do not necessarily reflect the actual future cash funding requirements. Support Agreements. In addition to the support agreements described above, Metropolitan Life entered into a net worth maintenance agreement with New England Life Insurance Company ("NELICO") at the time Metropolitan Life merged with NELICO. Under the agreement, Metropolitan Life agreed without limitation as to the amount to cause NELICO to have a minimum capital and surplus of $10 million, total adjusted capital at a level not less than the company action level RBC, as defined by state insurance statutes, and liquidity necessary to enable it to meet its current obligations on a timely basis. At September 30, 2003, the capital and surplus of NELICO was in excess of the minimum capital and surplus amount referenced above, and its total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2002. In connection with the Company's acquisition of GenAmerica, Metropolitan Life entered into a net worth maintenance agreement with General American Life Insurance Company ("General American"). Under the agreement, Metropolitan Life agreed without limitation as to amount to cause General American to have a minimum capital and surplus of $10 million, total adjusted capital at a level not less than 180% of the company action level RBC, as defined by state insurance statutes, and liquidity necessary to enable it to meet its current obligations on a timely basis. The agreement was subsequently amended to provide that, for the five year period from 2003 through 2007, total adjusted capital must be maintained at a level not less than 200% of the company action level RBC, as defined by state insurance statutes. At September 30, 2003, the capital and surplus of General American was in excess of the minimum capital and surplus amount referenced above, and its total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2002. Metropolitan Life has also entered into arrangements for the benefit of some of its other subsidiaries and affiliates to assist such subsidiaries and affiliates in meeting various jurisdictions' regulatory requirements regarding capital and surplus and security deposits. In addition, Metropolitan Life has entered into a support arrangement with respect to a subsidiary under which Metropolitan Life may become responsible, in the event that the subsidiary becomes the subject of insolvency proceedings, for the payment of certain reinsurance recoverables due from the subsidiary to one or more of its cedents in accordance with the terms and conditions of the applicable reinsurance agreements. General American has agreed to guarantee the obligations of its subsidiary, Paragon Life Insurance Company, and certain obligations of its former subsidiaries, MetLife Investors Insurance Company ("MetLife Investors"), First MetLife Investors Insurance Company and MetLife Investors Insurance Company of California. In addition, General American has entered into a contingent - 67 - reinsurance agreement with MetLife Investors. Under this agreement, in the event that MetLife Investors statutory capital and surplus is less than $10 million or total adjusted capital falls below 150% of the company action level RBC, as defined by state insurance statutes, General American would assume as assumption reinsurance, subject to regulatory approvals and required consents, all of MetLife Investors' life insurance policies and annuity contract liabilities. At September 30, 2003, the capital and surplus of MetLife Investors was in excess of the minimum capital and surplus amount referenced above, and its total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2002. Management does not anticipate that these arrangements will place any significant demands upon the Company's liquidity resources. Litigation. Various litigation claims and assessments against the Company have arisen in the course of the Company's business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor and taxpayer. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning the Company's compliance with applicable insurance and other laws and regulations. It is not feasible to predict or determine the ultimate outcome of all pending investigations and legal proceedings or provide reasonable ranges of potential losses except with respect to certain matters. In some of the matters, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations, it is possible that an adverse outcome in certain cases could have a material adverse effect upon the Company's unaudited interim condensed consolidated financial position, based on information currently known by the Company's management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods. Based on management's analysis of its expected cash inflows from operating activities, the dividends it receives from subsidiaries, including Metropolitan Life, that are permitted to be paid without prior insurance regulatory approval and its portfolio of liquid assets and other anticipated cash flows, management believes there will be sufficient liquidity to enable the Company to make payments on debt, make dividend payments on its common stock, pay all operating expenses and meet its other obligations. The nature of the Company's diverse product portfolio and customer base lessen the likelihood that normal operations will result in any significant strain on liquidity. Consolidated cash flows. Net cash provided by operating activities was $5,043 million and $2,427 million for the nine months ended September 30, 2003 and 2002, respectively. The $2,616 million increase in net cash provided by operating activities in 2003 over the comparable 2002 period is primarily attributable to sales growth in the group life, dental, disability and long-term care businesses, as well as higher sales in retirement and savings' structured settlement products. In addition, growth in MetLife Bank's customer deposits, accelerated prepayments of mortgage-backed securities that have previously been purchased at a premium, an increase in funds withheld related to reinsurance activity and a decrease in the funding of COLI policies contributed to the increase in operating cash flows. Net cash used in investing activities was $12,277 million and $9,909 million for the nine months ended September 30, 2003 and 2002, respectively. The $2,368 million increase in net cash used in investing activities in 2003 over the comparable 2002 period is primarily attributable to an increase in the purchase of fixed maturities and commercial mortgage loan origination as well as an increase in the amount of securities lending cash collateral invested, which resulted from an expansion of the program. In addition, the 2002 period included the proceeds from a significant sale of a block of equity securities. These items were partially offset by the June 2002 acquisition of Hidalgo. Net cash provided by financing activities was $10,283 million and $3,656 million for the nine months ended September 30, 2003 and 2002, respectively. The $6,627 million increase in net cash provided by financing activities in 2003 over the comparable 2002 period is due to a $3,527 million net increase in policyholder account balances primarily from sales of annuity products and the issuance of $1,251 million in short-term debt related to dollar roll activity. In 2003, the Company received $1,006 million on the settlement of common stock purchase contracts, as compared to stock repurchases of $471 million in the comparable 2002 period. - 68 - EFFECTS OF INFLATION The Company does not believe that inflation has had a material effect on its consolidated results of operations, except insofar as inflation may affect interest rates. - 69 - ACCOUNTING STANDARDS In July 2003, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"). SOP 03-1 provides guidance on separate account presentation and valuation, the accounting for sales inducements and the classification and valuation of long-duration contract liabilities. SOP 03-1 is effective for fiscal years beginning after December 15, 2003. The Company is in the process of quantifying the impact of SOP 03-1 on its unaudited interim condensed consolidated financial statements. In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity ("SFAS 150"). SFAS 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as a liability or, in certain circumstances, an asset. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150, as of July 1, 2003, required the Company to reclassify $277 million of company-obligated mandatorily redeemable securities of subsidiary trusts from mezzanine equity to liabilities, as reflected in its unaudited interim condensed consolidated financial statements. In April 2003, the FASB cleared Statement 133 Implementation Issue No. B36, Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments ("Issue B36"). Issue B36 concluded that (i) a company's funds withheld payable and/or receivable under certain reinsurance arrangements, and (ii) a debt instrument that incorporates credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor include an embedded derivative feature that is not clearly and closely related to the host contract. Therefore, the embedded derivative feature must be measured at fair value on the balance sheet and changes in fair value reported in income. Issue B36 was effective October 1, 2003. The Company believes that the impact of the adoption of Issue B36 will be insignificant. However, management continues to validate its models and refine its assumptions. Additionally, industry standards and practices continue to evolve related to valuing these types of embedded derivative features. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Except for certain implementation guidance that is incorporated in SFAS 149 and already effective, SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company's adoption of SFAS 149 on July 1, 2003 did not have a significant impact on its unaudited interim condensed consolidated financial statements. During 2003, the Company adopted or applied the following accounting standards and/or interpretations: (i) FASB Interpretation ("FIN") No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others; (ii) SFAS No. 148, Accounting for Stock-Based Compensation -- Transition and Disclosure; (iii) SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities; and (iv) SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. None of the accounting standards and/or interpretations described in this paragraph had a significant impact on the Company's unaudited interim condensed consolidated financial statements. Effective February 1, 2003, the Company adopted FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 ("FIN 46"), as amended. Effective October 9, 2003, FASB Staff Position No. 46-6, "Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities" deferred the effective date of FIN 46 for variable interests held by a public entity in a variable interest entity ("VIE") that was created before February 1, 2003 to the end of the first interim or annual period ending after December 15, 2003. Certain of the Company's asset-backed securitizations, collateralized debt obligations, structured investment transactions, and investments in real estate joint ventures and other limited partnership interests meet the definition of a VIE under FIN 46. FIN 46 defines a VIE as (i) any entity in which the equity investors at risk in such entity do not have the characteristics of a controlling financial interest, or (ii) any entity that does not have sufficient equity at risk to finance its activities without additional subordinated financial support from other parties. It requires the consolidation of the VIE by the primary beneficiary. The adoption of FIN 46 requires the Company to include disclosures for VIEs created or acquired on or after February 1, 2003 in its unaudited interim condensed consolidated financial statements related to the total assets and the maximum exposure to loss resulting from the Company's interests in VIEs. See "Investments - Variable Interest Entities." The Company is in the process of assessing the impact of the provisions of FIN 46 on its consolidated financial statements for the year ending December 31, 2003 for VIEs created or acquired prior to February 1, 2003. - 70 - INVESTMENTS The Company had total cash and invested assets at September 30, 2003 and December 31, 2002 of $216.3 billion and $190.7 billion, respectively. In addition, the Company had $70.0 billion and $59.7 billion held in its separate accounts, for which the Company generally does not bear investment risk, as of September 30, 2003 and December 31, 2002, respectively. The Company's primary investment objective is to maximize net investment income consistent with acceptable risk parameters. The Company is exposed to three primary sources of investment risk: - credit risk, relating to the uncertainty associated with the continued ability of a given obligor to make timely payments of principal and interest; - interest rate risk, relating to the market price and cash flow variability associated with changes in market interest rates; and - market valuation risk. The Company manages risk through in-house fundamental analysis of the underlying obligors, issuers, transaction structures and real estate properties. The Company also manages credit risk and market valuation risk through industry and issuer diversification and asset allocation. For real estate and agricultural assets, the Company manages credit risk and valuation risk through geographic, property type, and product type diversification and asset allocation. The Company manages interest rate risk as part of its asset and liability management strategies, product design, such as the use of market value adjustment features and surrender charges, and proactive monitoring and management of certain non-guaranteed elements of its products, such as the resetting of credited interest and dividend rates for policies that permit such adjustments. The following table summarizes the Company's cash and invested assets at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ---------------------- ---------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- ------ -------- ------ (DOLLARS IN MILLIONS) Fixed maturities available-for-sale, at fair value $159,940 73.9% $140,288 73.6% Mortgage loans on real estate 25,535 11.8 25,086 13.2 Policy loans 8,668 4.0 8,580 4.5 Cash and cash equivalents 5,372 2.5 2,323 1.2 Real estate and real estate joint ventures held-for-investment 4,724 2.2 3,926 2.1 Other invested assets 4,617 2.1 3,727 1.9 Equity securities and other limited partnership interests 4,109 1.9 4,008 2.1 Short-term investments 2,718 1.3 1,921 1.0 Real estate held-for-sale 640 0.3 799 0.4 -------- ----- -------- ----- Total cash and invested assets $216,323 100.0% $190,658 100.0% ======== ===== ======== =====
- 71 - VARIABLE INTEREST ENTITIES Effective February 1, 2003, FIN 46 established new accounting guidance relating to the consolidation of VIEs. Certain of the Company's asset-backed securitizations, collateralized debt obligations, structured investment transactions, and investments in real estate joint ventures and other limited partnership interests meet the definition of a VIE under FIN 46. The Company currently consolidates VIEs created or acquired on or after February 1, 2003 for which it is the primary beneficiary. At December 31, 2003, the Company will consolidate those entities created before February 1, 2003 for which it is the primary beneficiary. The following table presents the total assets of and maximum exposure to loss relating to VIEs of which the Company has concluded that it is the primary beneficiary and which will be consolidated in the Company's financial statements beginning December 31, 2003:
SEPTEMBER 30, 2003 -------------------------------- TOTAL MAXIMUM EXPOSURE ASSETS (1) TO LOSS (2) ---------- ---------------- (DOLLARS IN MILLIONS) Real estate joint ventures (3) $571 $237 Other limited partnerships (4) 27 27 ---- ---- Total $598 $264 ==== ====
------------ (1) The assets of the real estate joint ventures and other limited partnerships are reflected at the carrying amounts at which such assets would have been reflected on the Company's balance sheet had the Company consolidated the VIE from the date of its initial investment in the entity. (2) The maximum exposure to loss relating to real estate joint ventures and other limited partnerships is equal to the carrying amounts plus any unfunded commitments, reduced by amounts guaranteed by other partners. (3) Real estate joint ventures include partnerships and other ventures, which engage in the acquisition, development, management and disposal of real estate investments. (4) Other limited partnerships include partnerships established for the purpose of investing in public and private debt and equity securities, as well as limited partnerships established for the purpose of investing in low-income housing that qualifies for Federal tax credits. - 72 - Had the Company consolidated these VIEs at September 30, 2003, the transition adjustments would have been $4 million, net of income tax. The following table presents the total assets of and the maximum exposure to loss relating to VIEs in which the Company holds a significant variable interest but is not the primary beneficiary:
SEPTEMBER 30, 2003 ---------------------------------- TOTAL MAXIMUM EXPOSURE ASSETS TO LOSS (1) ----------- ---------------- (DOLLARS IN MILLIONS) Asset-backed securitizations and collateralized debt obligations (2) $ 101 $ 14 Other limited partnerships (3) 420 10 Real estate joint ventures (3) 57 50 ----------- ----------- Total $ 578 $ 74 =========== ===========
------------- (1) The maximum exposure to loss of the asset-backed securitizations and collateralized debt obligations is equal to the carrying amounts of retained interests. The maximum exposure to loss relating to the other limited partnerships and real estate joint ventures is equal to the carrying amounts plus any unfunded commitments reduced by amounts guaranteed by other partners. (2) The assets of the asset-backed securitizations and collateralized debt obligations are reflected at fair value as of September 30, 2003. (3) The assets of the real estate joint ventures and other limited partnerships are reflected at the carrying amounts at which such assets would have been reflected on the Company's balance sheet had the Company consolidated the VIE from the date of its initial investment in the entity. Due to the complexity of the judgments and interpretations required in the application of FIN 46 to the Company's collateralized debt obligations, the Company is continuing to evaluate certain entities for consolidation and/or disclosure under FIN 46. At September 30, 2003, the fair value of the assets of the entities still under evaluation is approximately $1.3 billion. The Company's maximum exposure to loss related to these entities at September 30, 2003 is approximately $5 million. - 73 - INVESTMENT RESULTS Net investment income, including net investment income from discontinued operations, on general account cash and invested assets totaled $2,914 million and $2,839 million for the three months ended September 30, 2003 and 2002, respectively, and $8,702 million and $8,489 million for the nine months ended September 30, 2003 and 2002, respectively. The annualized yields on general account cash and invested assets, including net investment income from discontinued operations and excluding all net investment gains and losses, were 6.47% and 7.13% for the three months ended September 30, 2003 and 2002, respectively, and 6.66% and 7.18% for the nine months ended September 30, 2003 and 2002, respectively. The following table illustrates the net investment income and annualized yields on average assets for each of the components of the Company's investment portfolio for the three months and nine months ended September 30, 2003 and 2002:
AT OR FOR THE THREE MONTHS ENDED SEPTEMBER 30, ---------------------------------------------- 2003 2002 ---------------------- -------------------- YIELD(1) AMOUNT YIELD(1) AMOUNT -------- --------- -------- --------- (DOLLARS IN MILLIONS) FIXED MATURITIES:(2) Investment income 6.83% $ 2,140 7.45% $ 2,032 Net investment gains (losses) (23) (323) -------- -------- Total $ 2,117 $ 1,709 -------- -------- Ending assets $159,940 $132,906 -------- -------- MORTGAGE LOANS ON REAL ESTATE:(3) Investment income 7.37% $ 468 7.68% $ 457 Net investment gains (losses) (36) - -------- -------- Total $ 432 $ 457 -------- -------- Ending assets $ 25,535 $ 23,885 -------- -------- REAL ESTATE AND REAL ESTATE JOINT VENTURES:(4) Investment income, net of expenses 10.17% $ 127 10.99% $ 160 Net investment gains (losses) 10 (10) -------- -------- Total $ 137 $ 150 -------- -------- Ending assets $ 5,364 $ 5,663 -------- -------- POLICY LOANS: Investment income 6.54% $ 141 6.66% $ 139 -------- -------- Ending assets $ 8,668 $ 8,366 -------- -------- EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS:(5) Investment income (1.42%) $ (14) 2.05% $ 19 Net investment gains (losses) (6) 4 -------- -------- Total $ (20) $ 23 -------- -------- Ending assets $ 4,109 $ 3,959 -------- -------- CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: Investment income 1.95% $ 35 3.68% $ 49 Net investment gains (losses) - - -------- -------- Total $ 35 $ 49 -------- -------- Ending assets $ 8,090 $ 6,305 -------- -------- OTHER INVESTED ASSETS:(6) Investment income 7.59% $ 84 5.44% $ 44 Net investment gains (losses) (96) 43 -------- -------- Total $ (12) $ 87 -------- -------- Ending assets $ 4,617 $ 3,214 -------- -------- TOTAL INVESTMENTS: Investment income before expenses and fees 6.62% $ 2,981 7.28% $ 2,900 Investment expenses and fees (0.15%) (67) (0.15%) (61) ----- -------- ----- -------- Net investment income 6.47% $ 2,914 7.13% $ 2,839 Net investment gains (losses) (151) (286) Adjustments to investment gains (losses)(7) 39 16 -------- -------- Total $ 2,802 $ 2,569 ======== ========
- 74 -
AT OR FOR THE NINE MONTHS ENDED SEPTEMBER 30, --------------------------------------------- 2003 2002 -------------------- --------------------- YIELD(1) AMOUNT YIELD(1) AMOUNT -------- -------- -------- --------- (DOLLARS IN MILLIONS) FIXED MATURITIES:(2) Investment income 6.89% $ 6,257 7.51% $ 5,984 Net investment gains (losses) (215) (698) -------- -------- Total $ 6,042 $ 5,286 -------- -------- Ending assets $159,940 $132,906 -------- -------- MORTGAGE LOANS ON REAL ESTATE:(3) Investment income 7.45% $ 1,410 7.82% $ 1,391 Net investment gains (losses) (58) (22) -------- -------- Total $ 1,352 $ 1,369 -------- -------- Ending assets $ 25,535 $ 23,885 -------- -------- REAL ESTATE AND REAL ESTATE JOINT VENTURES:(4) Investment income, net of expenses 10.51% $ 379 11.13% $ 484 Net investment gains (losses) 96 (26) -------- -------- Total $ 475 $ 458 -------- -------- Ending assets $ 5,364 $ 5,663 -------- -------- POLICY LOANS: Investment income 6.49% $ 419 6.52% $ 407 -------- -------- Ending assets $ 8,668 $ 8,366 -------- -------- EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS:(5) Investment income 2.43% $ 72 2.60% $ 78 Net investment gains (losses) (76) 246 -------- -------- Total $ (4) $ 324 -------- -------- Ending assets $ 4,109 $ 3,959 -------- -------- CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: Investment income 2.93% $ 141 3.75% $ 170 Net investment gains (losses) (4) 1 -------- -------- Total $ 137 $ 171 -------- -------- Ending assets $ 8,090 $ 6,305 -------- -------- OTHER INVESTED ASSETS:(6) Investment income 6.95% $ 216 5.87% $ 146 Net investment gains (losses) (118) (158) -------- -------- Total $ 98 $ (12) -------- -------- Ending assets $ 4,617 $ 3,214 -------- -------- TOTAL INVESTMENTS: Investment income before expenses and fees 6.81% $ 8,894 7.33% $ 8,660 Investment expenses and fees (0.15%) (192) (0.15%) (171) ----- -------- ----- -------- Net investment income 6.66% $ 8,702 7.18% $ 8,489 Net investment gains (losses) (375) (657) Adjustments to investment gains (losses)(7) 77 102 -------- -------- Total $ 8,404 $ 7,934 ======== ========
---------- (1) Yields are based on quarterly average asset carrying values, excluding recognized and unrealized gains and losses, and for yield calculation purposes, average assets exclude collateral associated with the Company's securities lending program. (2) Included in fixed maturities are equity-linked notes of $893 million and $793 million at September 30, 2003 and 2002, respectively, which include an equity-like component as part of the notes' return. Investment income for fixed maturities includes prepayment fees and income from the securities lending program. Fixed maturity investment income has been reduced by rebates paid under the securities lending program. (3) Investment income from mortgage loans on real estate includes prepayment fees. (4) Real estate and real estate joint venture income is shown net of depreciation of $48 million and $52 million for the three months ended September 30, 2003 and 2002, respectively, and $136 million and $166 million for the nine months ended September 30, 2003 and 2002, respectively. Real estate and real estate joint venture income includes amounts classified as discontinued operations of $15 million and $42 million for the three months ended September 30, 2003 and 2002, respectively, and $42 million and $126 million for the nine months ended September 30, 2003 and 2002, respectively. These amounts are net of depreciation of $4 million and $15 million for the three months ended September 30, 2003 and 2002, respectively, and $15 million and $58 million for the nine months ended September 30, 2003 and 2002, respectively. Net investment gains (losses) include $8 million and $99 million of gains classified as discontinued operations for the three months and nine months ended September 30, 2003, respectively. Net investment gains (losses) includes ($1) million and ($9) million of losses classified as discontinued operations for the three months and nine months ended September 30, 2002, respectively. (5) Investment loss on equity securities and other limited partnership interests for the three months ended September 30, 2003 is attributable to a decline in the valuation and lower realizations on certain corporate joint ventures. (6) Investment income from other invested assets includes settlement payments on derivative instruments that do not qualify for hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), of $35 million and $19 million for the three months ended September 30, 2003 and 2002, respectively, and $55 million and $22 million for the nine months ended September 30, 2003 and 2002, respectively. These amounts are excluded from net investment gains (losses) from other invested assets. (7) Adjustments to investment gains and losses include amortization of DAC, charges and credits to participating contracts and adjustments to the policyholder dividend obligation resulting from investment gains and losses. FIXED MATURITIES Fixed maturities consist principally of publicly traded and privately placed debt securities, and represented 73.9% and 73.6% of total cash and invested assets at September 30, 2003 and December 31, 2002, respectively. Based on estimated fair value, public fixed maturities represented $139,527 million, or 87.2%, and $121,191 million, or 86.4%, of total fixed maturities at September 30, 2003 and December 31, 2002, respectively. Based on estimated fair value, private fixed maturities represented $20,413 million, or 12.8%, and $19,097 million, or 13.6%, of total fixed maturities at September 30, 2003 and December 31, 2002, respectively. The Company invests in privately placed fixed maturities to (i) obtain higher yields than can ordinarily be obtained with comparable public market securities; (ii) provide the Company with protective covenants, call protection features and, where applicable, a higher level of collateral; and (iii) increase diversification. However, the Company may not freely trade its privately placed fixed maturities because of restrictions imposed by federal and state securities laws and illiquid markets. In cases where quoted market prices are not available, fair values are estimated using present value or valuation techniques. The fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counter-party. Factors considered in estimating fair value include: coupon rate, maturity, estimated duration, call provisions, sinking fund requirements, credit rating, industry sector of the issuer and quoted market prices of comparable securities. The Securities Valuation Office of the NAIC evaluates the fixed maturity investments of insurers for regulatory reporting purposes and assigns securities to one of six investment categories called "NAIC designations." The NAIC ratings are similar to the rating agency designations of the Nationally Recognized Statistical Rating Organizations for marketable bonds. NAIC ratings 1 and 2 include bonds generally considered investment grade (rated "Baa3" or higher by Moody's Investors Services ("Moody's"), or rated "BBB-" or higher by Standard & Poor's ("S&P")) by such rating organizations. NAIC ratings 3 through 6 include bonds generally considered below investment grade (rated "Ba1" or lower by Moody's, or rated "BB+" or lower by S&P). - 75 - The following table presents the Company's total fixed maturities by Nationally Recognized Statistical Rating Organizations designation and the equivalent ratings of the NAIC, as well as the percentage, based on estimated fair value, that each designation comprises at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 -------------------------- --------------------------- ESTIMATED ESTIMATED NAIC RATING AGENCY AMORTIZED FAIR % OF AMORTIZED FAIR % OF RATING DESIGNATION (1) COST VALUE TOTAL COST VALUE TOTAL ------ -------------------------- --------- -------- ----- --------- -------- ----- (DOLLARS IN MILLIONS) 1 Aaa/Aa/A $104,147 $110,708 69.2% $ 91,250 $ 97,495 69.5% 2 Baa 33,060 35,921 22.4 29,345 31,060 22.1 3 Ba 7,509 7,963 5.0 7,413 7,304 5.2 4 B 3,605 3,701 2.3 3,463 3,227 2.3 5 Caa and lower 597 575 0.4 434 339 0.3 6 In or near default 473 567 0.4 430 416 0.3 -------- -------- ----- -------- -------- ----- Subtotal 149,391 159,435 99.7 132,335 139,841 99.7 Redeemable preferred stock 594 505 0.3 564 447 0.3 -------- -------- ----- -------- -------- ----- Total fixed maturities $149,985 $159,940 100.0% $132,899 $140,288 100.0% ======== ======== ===== ======== ======== =====
---------- (1) Amounts presented are based on rating agency designations. Comparisons between NAIC ratings and rating agency designations are published by the NAIC. The rating agency designations are based upon the availability of the applicable ratings beginning with Moody's, followed by S&P. Based on estimated fair values, investment grade fixed maturities comprised 91.6% of total fixed maturities in the general account at both September 30, 2003 and December 31, 2002. The following table shows the amortized cost and estimated fair value of fixed maturities, by contractual maturity dates (excluding scheduled sinking funds) at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 --------------------------- --------------------------- ESTIMATED ESTIMATED AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------- --------- --------- --------- (DOLLARS IN MILLIONS) Due in one year or less $ 4,859 $ 5,013 $ 4,592 $ 4,662 Due after one year through five years 27,897 29,510 26,200 27,354 Due after five years through ten years 27,994 30,588 23,297 24,987 Due after ten years 37,946 42,142 35,507 38,452 -------- -------- -------- -------- Subtotal 98,696 107,253 89,596 95,455 Mortgage-backed and other asset-backed securities 50,695 52,182 42,739 44,386 -------- -------- -------- -------- Subtotal 149,391 159,435 132,335 139,841 Redeemable preferred stock 594 505 564 447 -------- -------- -------- -------- Total fixed maturities $149,985 $159,940 $132,899 $140,288 ======== ======== ======== ========
Actual maturities may differ as a result of prepayments by the issuer. - 76 - The Company diversifies its fixed maturities by security sector. The following tables set forth the amortized cost, gross unrealized gain and loss, and estimated fair value of the Company's fixed maturities by sector, as well as the percentage of the total fixed maturities holdings that each security sector comprises at:
SEPTEMBER 30, 2003 ------------------------------------------------------------------------------ GROSS UNREALIZED AMORTIZED -------------------------- ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL --------- -------- -------- ---------- ----- (DOLLARS IN MILLIONS) U.S. corporate securities $ 53,837 $ 4,247 $ 338 $ 57,746 36.1% Mortgage-backed securities 31,053 909 131 31,831 19.9 Foreign corporate securities 19,919 1,971 103 21,787 13.6 U.S. treasuries/agencies 13,253 1,515 38 14,730 9.2 Asset-backed securities 10,901 216 84 11,033 6.9 Commercial mortgage-backed securities 8,741 604 27 9,318 5.8 Foreign government securities 7,998 1,047 18 9,027 5.7 State and political subdivisions 3,090 205 19 3,276 2.0 Other fixed income assets 599 230 142 687 0.5 -------- -------- -------- -------- ----- Total bonds 149,391 10,944 900 159,435 99.7 Redeemable preferred stocks 594 1 90 505 0.3 -------- -------- -------- -------- ----- Total fixed maturities $149,985 $ 10,945 $ 990 $159,940 100.0% ======== ======== ======== ======== =====
DECEMBER 31, 2002 ------------------------------------------------------------------------------- GROSS UNREALIZED AMORTIZED -------------------------- ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL --------- -------- -------- ---------- ------- (DOLLARS IN MILLIONS) U.S. corporate securities $ 47,021 $ 3,193 $ 957 $ 49,257 35.1% Mortgage-backed securities 26,966 1,076 16 28,026 20.0 Foreign corporate securities 18,001 1,435 207 19,229 13.7 U.S. treasuries/agencies 14,373 1,565 4 15,934 11.4 Asset-backed securities 9,483 228 208 9,503 6.8 Commercial mortgage-backed securities 6,290 573 6 6,857 4.9 Foreign government securities 7,012 636 52 7,596 5.4 State and political subdivisions 2,580 182 20 2,742 1.9 Other fixed income assets 609 191 103 697 0.5 -------- -------- -------- -------- ------- Total bonds 132,335 9,079 1,573 139,841 99.7 Redeemable preferred stocks 564 - 117 447 0.3 -------- -------- -------- -------- ------- Total fixed maturities $132,899 $ 9,079 $ 1,690 $140,288 100.0% ======== ======== ======== ======== =======
Problem, Potential Problem and Restructured Fixed Maturities. The Company monitors fixed maturities to identify investments that management considers to be problems or potential problems. The Company also monitors investments that have been restructured. The Company defines problem securities in the fixed maturities category as securities with principal or interest payments in default, securities to be restructured pursuant to commenced negotiations, or securities issued by a debtor that has entered into bankruptcy. The Company defines potential problem securities in the fixed maturity category as securities of an issuer deemed to be experiencing significant operating problems or difficult industry conditions. The Company uses various criteria, including the following, to identify potential problem securities: - debt service coverage or cash flow falling below certain thresholds which vary according to the issuer's industry and other relevant factors; - 77 - - significant declines in revenues or margins; - violation of financial covenants; - public securities trading at a substantial discount as a result of specific credit concerns; and - other subjective factors. The Company defines restructured securities in the fixed maturities category as securities to which the Company has granted a concession that it would not have otherwise considered but for the financial difficulties of the obligor. The Company enters into a restructuring when it believes it will realize a greater economic value under the new terms rather than through liquidation or disposition. The terms of the restructuring may involve some or all of the following characteristics: a reduction in the interest rate, an extension of the maturity date, an exchange of debt for equity or a partial forgiveness of principal or interest. The following table presents the estimated fair value of the Company's total fixed maturities classified as performing, potential problem, problem and restructured at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------ ------------------------ ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- ----- ---------- ----- (DOLLARS IN MILLIONS) Performing $159,042 99.4% $139,452 99.4% Potential problem 424 0.3 450 0.3 Problem 441 0.3 358 0.3 Restructured 33 0.0 28 0.0 -------- ----- -------- ----- Total $159,940 100.0% $140,288 100.0% ======== ===== ======== =====
Fixed Maturity Impairment. The Company classifies all of its fixed maturities as available-for-sale and marks them to market through other comprehensive income. All securities with gross unrealized losses at the consolidated balance sheet date are subjected to the Company's process for identifying other-than-temporary impairments. The Company writes down to fair value securities that it deems to be other-than-temporarily impaired in the period the securities are deemed to be so impaired. The assessment of whether such impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors, as described below, about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to, the following: - length of time and the extent to which the market value has been below amortized cost; - potential for impairments of securities when the issuer is experiencing significant financial difficulties, including a review of all securities of the issuer, including its known subsidiaries and affiliates, regardless of the form of the Company's ownership; - potential for impairments in an entire industry sector or sub-sector; - potential for impairments in certain economically depressed geographic locations; - potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; and - other subjective factors, including concentrations and information obtained from regulators and rating agencies. The Company records writedowns as investment losses and adjusts the cost basis of the fixed maturities accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. Writedowns of fixed maturities were $38 million - 78 - and $501 million for the three months ended September 30, 2003 and 2002, respectively, and $277 million and $1,026 million for the nine months ended September 30, 2003 and 2002, respectively. The Company's three largest writedowns totaled $23 million and $147 million for the three months ended September 30, 2003 and 2002, respectively, and $110 million and $291 million for the nine months ended September 30, 2003 and 2002, respectively. The circumstances that gave rise to these impairments were either financial restructurings or bankruptcy filings. During the three months ended September 30, 2003 and 2002, the Company sold fixed maturities with a fair value of $7,566 million and $2,096 million at a loss of $93 million and $145 million, respectively. During the nine months ended September 30, 2003 and 2002, the Company sold fixed maturities with a fair value of $19,556 million and $9,341 million at a loss of $233 million and $627 million, respectively. The gross unrealized loss related to the Company's fixed maturities at September 30, 2003 was $990 million. These fixed maturities mature as follows: 1% due in one year or less; 18% due in greater than one year to five years; 15% due in greater than five years to ten years; and 66% due in greater than ten years (calculated as a percentage of amortized cost). Additionally, such securities are concentrated by security type in U.S. corporates (54%), mortgage-backed (16%) and foreign corporates (12%); and are concentrated by industry in mortgage-backed (16%), utilities (14%) and asset-backed (8%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 11% of the $23,696 million fair value and 23% of the $990 million gross unrealized loss on fixed maturities. The following table presents the amortized cost, gross unrealized losses and number of securities for fixed maturities where the estimated fair value had declined and remained below amortized cost by less than 20%, or 20% or more for:
SEPTEMBER 30, 2003 -------------------------------------------------------------------- AMORTIZED COST GROSS UNREALIZED LOSSES NUMBER OF SECURITIES ------------------ ----------------------- ----------------------- LESS THAN 20% OR LESS THAN 20% OR LESS THAN 20% OR 20% MORE 20% MORE 20% MORE -------- ------- ------- ------- ------- ------- (DOLLARS IN MILLIONS) Less than six months $19,528 $ 329 $ 591 $ 82 1,159 43 Six months or greater but less than nine months 408 30 10 7 62 7 Nine months or greater but less than twelve months 790 23 24 7 125 5 Twelve months or greater 3,374 204 201 68 296 36 ------- ------- ------- ------- ----- -- Total $24,100 $ 586 $ 826 $ 164 1,642 91 ======= ======= ======= ======= ===== ==
The Company's review of its fixed maturities for impairments includes an analysis of the total gross unrealized losses by three categories of securities: (i) securities where the estimated fair value had declined and remained below amortized cost by less than 20%; (ii) securities where the estimated fair value had declined and remained below amortized cost by 20% or more for less than six months; and (iii) securities where the estimated value had declined and remained below amortized cost by 20% or more for six months or greater. The first two categories have generally been adversely impacted by the downturn in the financial markets and overall economic conditions. While all of these securities are monitored for potential impairment, the Company's experience indicates that the first two categories do not present as great a risk of impairment, and often, fair values recover over time as the factors that caused the declines improve. The following table presents the total gross unrealized losses for fixed maturities where the estimated fair value had declined and remained below amortized cost by:
SEPTEMBER 30, 2003 ----------------------------- GROSS % OF UNREALIZED LOSSES TOTAL ----------------- ----- (DOLLARS IN MILLIONS) Less than 20% $ 826 83.4% 20% or more for less than six months 82 8.3 20% or more for six months or greater 82 8.3 ---------- ----- Total $ 990 100.0% ========== =====
The category of fixed maturity securities where the estimated fair value has declined and remained below amortized cost by less than 20% is comprised of 1,642 securities with an amortized cost of $24,100 million and a gross unrealized loss of $826 million at September 30, 2003. These fixed maturities mature as follows: 1% due in one year or less; 18% due in greater than one year to five years; 14% due in greater than five years to ten years; and 67% due in greater than ten years (calculated as a percentage of amortized - 79 - cost). Additionally, such securities are concentrated by security type in U.S. corporates (54%) and mortgage-backed (18%); and are concentrated by industry in mortgage-backed (18%), utilities (13%) and services (7%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 10% of the $23,274 million fair value and 17% of the $826 million gross unrealized loss. The category of fixed maturity securities where the estimated fair value has declined and remained below amortized cost by 20% or more for less than six months is comprised of 43 securities with an amortized cost of $329 million and a gross unrealized loss of $82 million at September 30, 2003. These fixed maturities mature as follows: 3% due in greater than one year to five years; 29% due in greater than five years to ten years; and 68% due in greater than ten years (calculated as a percentage of amortized cost). Additionally, such securities are concentrated by security type in U.S. corporates (56%) and asset-backed (29%); and are concentrated by industry in asset-backed (29%), utilities (24%), and manufacturing (20%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 59% of the $247 million fair value and 57% of the $82 million gross unrealized loss. The category of fixed maturity securities where the estimated fair value has declined and remained below amortized cost by 20% or more for six months or greater is comprised of 48 securities with an amortized cost of $257 million and a gross unrealized loss of $82 million at September 30, 2003. These fixed maturities mature as follows: 2% due in one year or less; 35% due in greater than five years to ten years; and 63% due in greater than ten years (calculated as a percentage of amortized cost). Additionally, such securities are concentrated by security type in U.S. corporates (51%) and asset-backed (19%); and are concentrated by industry in transportation (37%), finance (19%) and asset-backed (19%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 57% of the $175 million fair value and 58% of the $82 million gross unrealized loss. The Company held four fixed maturity securities each with a gross unrealized loss at September 30, 2003 greater than $10 million. One of these securities represents 15% of the gross unrealized loss on fixed maturities where the estimated fair value had declined and remained below amortized cost by 20% or more for six months or greater. The estimated fair value and gross unrealized loss at September 30, 2003 for this security was $13 million and $12 million, respectively. This security is concentrated in the U.S. corporate sector. The Company analyzed this fixed maturity security as of September 30, 2003 to determine whether this security was other-than-temporarily impaired. The Company believes that the estimated fair value of this security, which is in the transportation industry, was depressed as a result of generally poor economic and market conditions. The Company believes that the analysis of the security indicated that the financial strength, liquidity, leverage, future outlook and/or recent management actions supports the view that the security was not other-than-temporarily impaired as of September 30, 2003. Corporate Fixed Maturities. The table below shows the major industry types that comprise the corporate bond holdings at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------ ------------------------- ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ------------ ----- ------------ ----- (DOLLARS IN MILLIONS) Industrial $ 32,398 40.8% $ 29,077 42.5% Utility 9,959 12.5 7,219 10.5 Finance 14,194 17.8 12,596 18.4 Yankee/Foreign (1) 21,787 27.4 19,229 28.1 Other 1,195 1.5 365 0.5 ------------ ----- ------------ ----- Total $ 79,533 100.0% $ 68,486 100.0% ============ ===== ============ =====
---------- (1) Includes publicly traded, U.S. dollar-denominated debt obligations of foreign obligors, known as Yankee bonds, and other foreign investments. The Company diversifies its corporate bond holdings by industry and issuer. The portfolio has no exposure to any single issuer in excess of 1% of the total invested assets of the portfolio. At September 30, 2003, the Company's combined holdings in the ten issuers to which it had the greatest exposure totaled $4,842 million, which was less than 3% of the Company's total invested assets at such date. The exposure to the largest single issuer of corporate bonds the Company held at September 30, 2003 was $602 million. At September 30, 2003 and December 31, 2002, investments of $15,962 million and $14,778 million, respectively, or 73.3% and 76.9%, respectively, of the Yankee/Foreign sector, represented exposure to traditional Yankee bonds. The balance of this exposure - 80 - was primarily U.S. dollar-denominated and concentrated by security type in industrial and financial institutions. The Company diversifies the Yankee/Foreign portfolio by country and issuer. The Company has hedged all of its material exposure to foreign currency risk in its invested assets. In the Company's international insurance operations, both its assets and liabilities are generally denominated in local currencies. Foreign currency denominated securities supporting U.S. dollar liabilities are generally swapped back into U.S. dollars. Mortgage-Backed Securities. The following table shows the types of mortgage-backed securities the Company held at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 --------------------- --------------------- ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- ----- ---------- ----- (DOLLARS IN MILLIONS) Pass-through securities $14,913 36.2% $12,515 35.9% Collateralized mortgage obligations 16,918 41.2 15,511 44.5 ------- ----- ------- ----- Total mortgage-backed securities 31,831 77.4 28,026 80.4 Commercial mortgage-backed securities 9,318 22.6 6,857 19.6 ------- ----- ------- ----- Total $41,149 100.0% $34,883 100.0% ======= ===== ======= =====
At September 30, 2003 and December 31, 2002, pass-through and collateralized mortgage obligations totaled $31,831 million and $28,026 million, respectively, or 77.4% and 80.4%, respectively, of total mortgage-backed securities, and a majority of this amount represented agency-issued pass-through and collateralized mortgage obligations guaranteed or otherwise supported by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association. At September 30, 2003 and December 31, 2002, approximately $5,324 million and $3,598 million, respectively, or 57.1% and 52.5%, respectively, of the commercial mortgage-backed securities, and $31,731 million and $27,590 million, respectively, or 99.7% and 98.4%, respectively, of the pass-through securities and collateralized mortgage obligations, were rated Aaa/AAA by Moody's or S&P. The principal risks inherent in holding mortgage-backed securities are prepayment, extension and collateral risks, which will affect the timing of when cash will be received. The Company's active monitoring of its mortgage-backed securities mitigates exposure to losses from cash flow risk associated with interest rate fluctuations. Asset-Backed Securities. Asset-backed securities, which include home equity loans, credit card receivables, collateralized debt obligations and automobile receivables, are purchased both to diversify the overall risks of the Company's fixed maturity assets and to provide attractive returns. The Company's asset-backed securities are diversified both by type of asset and by issuer. Home equity loans constitute the largest exposure in the Company's asset-backed securities investments. Except for asset-backed securities backed by home equity loans, the asset-backed security investments generally have little sensitivity to changes in interest rates. Approximately $6,798 million and $4,912 million, or 61.6% and 51.7%, of total asset-backed securities were rated Aaa/AAA by Moody's or S&P at September 30, 2003 and December 31, 2002, respectively. The principal risks in holding asset-backed securities are structural, credit and capital market risks. Structural risks include the security's priority in the issuer's capital structure, the adequacy of and ability to realize proceeds from the collateral and the potential for prepayments. Credit risks include consumer or corporate credits, such as credit card holders, equipment lessees, and corporate obligors. Capital market risks include the general level of interest rates and the liquidity for these securities in the marketplace. Structured Investment Transactions. The Company participates in structured investment transactions, primarily asset securitizations and structured notes. These transactions enhance the Company's total return on its investment portfolio principally by generating management fee income on asset securitizations and by providing equity-based returns on debt securities through structured notes consisting of equity-linked notes and similar instruments. The Company sponsors financial asset securitizations of high yield debt securities, investment grade bonds and structured finance securities and also is the collateral manager and a beneficial interest holder in such transactions (commonly referred to as collateralized debt obligations). As the collateral manager, the Company earns management fees on the outstanding securitized asset balance, which are recorded in income as earned. When the Company transfers assets to a bankruptcy-remote special purpose entity ("SPE") and surrenders control over the transferred assets, the transaction is accounted for as a sale. Gains or losses on securitizations are determined with reference to the carrying amount of the financial assets transferred. Such gains or losses are allocated to the assets sold and the beneficial interests retained based on relative fair values at the date of transfer. Beneficial interests in securitizations are carried at fair value in fixed maturities. Income on the beneficial interests is recognized using the prospective - 81 - method in accordance with EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. Prior to the effective date of FIN 46, the SPEs used to securitize assets were not consolidated by the Company because unrelated third parties hold controlling interests through ownership of equity in the SPEs, representing at least three percent of the value of the total assets of the SPE throughout the life of the SPE, and such equity class has the substantive risks and rewards of the residual interest of the SPE. See "--Variable Interest Entities." The Company purchases or receives beneficial interests in SPEs, which generally acquire financial assets, including corporate equities, debt securities and purchased options. The Company has not guaranteed the performance, liquidity or obligations of the SPEs and the Company's exposure to loss is limited to its carrying value of the beneficial interests in the SPEs. The Company uses the beneficial interests as part of its risk management strategy, including asset-liability management. Prior to the effective date of FIN 46, these SPEs were not consolidated by the Company because unrelated third parties hold controlling interests through ownership of equity in the SPEs, representing at least three percent of the value of the total assets of the SPE throughout the life of the SPE, and such equity class has the substantive risks and rewards of the residual interest of the SPE. See "--Variable Interest Entities." The beneficial interests in SPEs where the Company exercises significant influence over the operating and financial policies of the SPE are accounted for in accordance with the equity method of accounting. Impairments of these beneficial interests are included in net investment gains and losses. The beneficial interests in SPEs where the Company does not exercise significant influence are accounted for based on the substance of the beneficial interest's rights and obligations. Beneficial interests are included in fixed maturities. These beneficial interests are generally structured notes, as defined by EITF Issue No. 96-12, Recognition of Interest Income and Balance Sheet Classification of Structured Notes, and their income is recognized using the retrospective interest method or the level yield method, as appropriate. MORTGAGE LOANS ON REAL ESTATE The Company's mortgage loans on real estate are collateralized by commercial, agricultural and residential properties. Mortgage loans on real estate comprised 11.8% and 13.2% of the Company's total cash and invested assets at September 30, 2003 and December 31, 2002, respectively. The carrying value of mortgage loans on real estate is stated at original cost net of repayments, amortization of premiums, accretion of discounts and valuation allowances. The following table shows the carrying value of the Company's mortgage loans on real estate by type at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 -------------------- -------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- ----- -------- ----- (DOLLARS IN MILLIONS) Commercial $19,945 78.1% $19,552 78.0% Agricultural 5,131 20.1 5,146 20.5 Residential 459 1.8 388 1.5 ------- ----- ------- ----- Total $25,535 100.0% $25,086 100.0% ======= ===== ======= =====
- 82 - Commercial Mortgage Loans. The Company diversifies its commercial mortgage loans by both geographic region and property type, and manages these investments through a network of regional offices overseen by its investment department. The following table presents the distribution across geographic regions and property types for commercial mortgage loans at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 -------------------- ---------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- ----- -------- ----- (DOLLARS IN MILLIONS) REGION South Atlantic $ 5,027 25.2% $ 5,076 26.0% Pacific 4,587 23.0 4,180 21.4 Middle Atlantic 3,522 17.6 3,441 17.6 East North Central 1,808 9.1 2,147 11.0 West South Central 1,352 6.8 1,097 5.6 New England 1,269 6.4 1,323 6.8 International 811 4.1 632 3.2 Mountain 798 4.0 833 4.2 West North Central 582 2.9 645 3.3 East South Central 189 0.9 178 0.9 ------- ----- ------- ----- Total $19,945 100.0% $19,552 100.0% ======= ===== ======= ===== PROPERTY TYPE Office $ 8,919 44.7% $ 9,340 47.8% Retail 4,825 24.2 4,320 22.1 Apartments 2,932 14.7 2,793 14.3 Industrial 1,940 9.7 1,910 9.7 Hotel 1,038 5.2 942 4.8 Other 291 1.5 247 1.3 ------- ----- ------- ----- Total $19,945 100.0% $19,552 100.0% ======= ===== ======= =====
The following table presents the scheduled maturities for the Company's commercial mortgage loans at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 -------------------- -------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- ----- -------- ----- (DOLLARS IN MILLIONS) Due in one year or less $ 908 4.6% $ 713 3.6% Due after one year through two years 889 4.5 1,204 6.2 Due after two years through three years 2,318 11.6 1,939 9.9 Due after three years through four years 1,724 8.6 2,048 10.5 Due after four years through five years 3,007 15.1 2,443 12.5 Due after five years 11,099 55.6 11,205 57.3 ------- ----- ------- ----- Total $19,945 100.0% $19,552 100.0% ======= ===== ======= =====
- 83 - Problem, Potential Problem and Restructured Mortgage Loans. The Company monitors its mortgage loan investments on an ongoing basis. Through this monitoring process, the Company reviews loans that are restructured, delinquent or under foreclosure and identifies those that management considers to be potentially delinquent. These loan classifications are generally consistent with those used in industry practice. The Company defines restructured mortgage loans, consistent with industry practice, as loans in which the Company, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. This definition provides for loans to exit the restructured category under certain conditions. The Company defines delinquent mortgage loans, consistent with industry practice, as loans in which two or more interest or principal payments are past due. The Company defines mortgage loans under foreclosure, consistent with industry practice, as loans in which foreclosure proceedings have formally commenced. The Company defines potentially delinquent loans as loans that, in management's opinion, have a high probability of becoming delinquent. The Company reviews all mortgage loans on an ongoing basis. These reviews may include an analysis of the property financial statements and rent roll, lease rollover analysis, property inspections, market analysis and tenant creditworthiness. The Company also reviews loan-to-value ratios and debt coverage ratios for restructured loans, delinquent loans, loans under foreclosure, potentially delinquent loans, loans with an existing valuation allowance, loans maturing within two years and loans with a loan-to-value ratio greater than 90% as determined in the prior year. The principal risks in holding commercial mortgage loans are property specific, supply and demand, financial and capital market risks. Property specific risks include the geographic location of the property, the physical condition of the property, the diversification of tenants and the rollover of their leases and the ability of the property manager to attract tenants and manage expenses. Supply and demand risks include changes in the supply and/or demand for rental space, which cause changes in vacancy rates and/or rental rates. Financial risks include the overall level of debt on the property and the amount of principal repaid during the loan term. Capital market risks include the general level of interest rates, the liquidity for these securities in the marketplace and the capital available for loan refinancing. The Company establishes valuation allowances for loans that it deems impaired, as determined through its mortgage review process. The Company's valuation allowance is established both on a loan specific basis for those loans where a property or market specific risk has been identified that could likely result in a future default, as well as for pools of loans with similar high risk characteristics where a property specific or market risk has not been identified. Loans that are individually reviewed are evaluated based on the definition of impaired loans consistent with SFAS No. 114, Accounting by Creditors for Impairments of a Loan ("SFAS 114"), as loans on which it probably will not collect all amounts due according to applicable contractual terms of the agreement. The Company bases valuation allowances upon the present value of expected future cash flows discounted at the loan's original effective interest rate or the value of the loan's collateral. The Company records valuation allowances as investment losses. The Company records subsequent adjustments to allowances as investment gains or losses. The allowance for loan loss for pools of other loans with similar characteristics is established in accordance with SFAS No. 5, Accounting for Contingencies ("SFAS 5"), when a loss contingency exists. A loss contingency exists when the likelihood that a future event will occur is probable based on past events. SFAS 5 works in conjunction with, but does not overlap with, SFAS 114. The Company applies SFAS 5 to groups of loans with similar characteristics based on property types and loan to value risk factors. The Company records loan loss reserves as investment losses. - 84 - The following table presents the amortized cost and valuation allowance for commercial mortgage loans distributed by loan classification at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------------------ -------------------------------------------- % OF % OF AMORTIZED % OF VALUATION AMORTIZED AMORTIZED % OF VALUATION AMORTIZED COST (1) TOTAL ALLOWANCE COST (1) COST TOTAL ALLOWANCE COST --------- ------ --------- --------- --------- ----- --------- --------- (DOLLARS IN MILLIONS) Performing $19,923 99.2% $ 91 0.5% $19,343 98.3% $ 60 0.3% Restructured 80 0.4 25 31.3% 246 1.3 49 19.9% Delinquent or under foreclosure 51 0.3 8 15.7% 14 0.1 - 0.0% Potentially delinquent 21 0.1 6 28.6% 68 0.3 10 14.7% ------- ----- ----- ------- ----- ------ Total $20,075 100.0% $ 130 0.6% $19,671 100.0% $ 119 0.6% ======= ===== ===== ======= ===== ======
---------- (1) Amortized cost is equal to carrying value before valuation allowances. The following table presents the changes in valuation allowances for commercial mortgage loans for the:
NINE MONTHS ENDED SEPTEMBER 30, 2003 --------------------- (DOLLARS IN MILLIONS) Balance, beginning of period $ 119 Net additions 45 Deductions for dispositions, foreclosures and writedowns (34) -------- Balance, end of period $ 130 ========
Agricultural Mortgage Loans. The Company diversifies its agricultural mortgage loans by both geographic region and product type. The Company manages these investments through a network of regional offices and field professionals overseen by its investment department. Approximately 66.2% of the $5,131 million of agricultural mortgage loans outstanding at September 30, 2003 were subject to rate resets prior to maturity. A substantial portion of these loans generally is successfully renegotiated and remains outstanding to maturity. The process and policies for monitoring the agricultural mortgage loans and classifying them by performance status are generally the same as those for the commercial loans. The following table presents the amortized cost and valuation allowances for agricultural mortgage loans distributed by loan classification at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------------------ -------------------------------------------- % OF % OF AMORTIZED % OF VALUATION AMORTIZED AMORTIZED % OF VALUATION AMORTIZED COST (1) TOTAL ALLOWANCE COST (1) COST TOTAL ALLOWANCE COST --------- ------ --------- --------- --------- ----- --------- --------- (DOLLARS IN MILLIONS) Performing $ 4,917 95.4% $ - 0.0% $ 4,980 96.7% $ - 0.0% Restructured 109 2.1 8 7.3% 140 2.7 5 3.6% Delinquent or under foreclosure 112 2.2 11 9.8% 14 0.3 - 0.0% Potentially delinquent 14 0.3 2 14.3% 18 0.3 1 5.6% ------- ----- ----- -------- ----- ----- Total $ 5,152 100.0% $ 21 0.4% $ 5,152 100.0% $ 6 0.1% ======= ===== ===== ======== ===== =====
-------------------- (1) Amortized cost is equal to carrying value before valuation allowances. - 85 - The following table presents the changes in valuation allowances for agricultural mortgage loans for the:
NINE MONTHS ENDED SEPTEMBER 30, 2003 --------------------- (DOLLARS IN MILLIONS) Balance, beginning of period $ 6 Net additions 15 -------- Balance, end of period $ 21 ========
The principal risks in holding agricultural mortgage loans are property specific, supply and demand, financial and capital market risks. Property specific risks include the geographic location of the property, soil types, weather conditions and the other factors that may impact the borrower's guaranty. Supply and demand risks include the supply and demand for the commodities produced on the specific property and the related price for those commodities. Financial risks include the overall level of debt on the property and the amount of principal repaid during the loan term. Capital market risks include the general level of interest rates, the liquidity for these securities in the marketplace and the capital available for loan refinancing. REAL ESTATE AND REAL ESTATE JOINT VENTURES The Company's real estate and real estate joint venture investments consist of commercial, residential and agricultural properties located primarily throughout the U.S. The Company manages these investments through a network of regional offices overseen by its investment department. At September 30, 2003 and December 31, 2002, the carrying value of the Company's real estate, real estate joint ventures and real estate held-for-sale was $5,364 million and $4,725 million, respectively, or 2.5% of total cash and invested assets for both periods. The carrying value of real estate is stated at depreciated cost net of impairments and valuation allowances. The carrying value of real estate joint ventures is stated at the Company's equity in the real estate joint ventures net of impairments and valuation allowances. The following table presents the carrying value of the Company's real estate, real estate joint ventures, real estate held-for-sale and real estate acquired upon foreclosure at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 --------------------- --------------------- CARRYING % OF CARRYING % OF TYPE VALUE TOTAL VALUE TOTAL -------- ----- -------- ----- (DOLLARS IN MILLIONS) Real estate held-for-investment $4,291 80.0% $3,546 75.0% Real estate joint ventures held-for-investment 431 8.0 377 8.0 Foreclosed real estate held-for-investment 2 0.0 3 0.1 ------ ----- ------ ----- 4,724 88.0 3,926 83.1 ------ ----- ------ ----- Real estate held-for-sale 636 11.9 792 16.8 Foreclosed real estate held-for-sale 4 0.1 7 0.1 ------ ----- ------ ----- 640 12.0 799 16.9 ------ ----- ------ ----- Total real estate, real estate joint ventures and real estate held-for-sale $5,364 100.0% $4,725 100.0% ====== ===== ====== =====
Office properties represent 61% and 58% of the Company's equity real estate portfolio at September 30, 2003 and December 31, 2002, respectively. The average occupancy level of office properties was 89% and 92% at September 30, 2003 and December 31, 2002, respectively. Ongoing management of these investments includes quarterly valuations, as well as an annual market update and review of each property's budget, financial returns, lease rollover status and the Company's exit strategy. The Company adjusts the carrying value of real estate and real estate joint ventures held-for-investment for impairments whenever events or changes in circumstances indicate that the carrying value of the property may not be recoverable. The Company writes down impaired real estate to estimated fair value, when the carrying value of the real estate exceeds the sum of the undiscounted cash flow expected to result from the use and eventual disposition of the real estate. The Company records writedowns as investment losses and reduces the cost basis of the properties accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. - 86 - The current real estate equity portfolio is mainly comprised of a core portfolio of multi-tenanted office buildings with high tenant credit quality, net leased properties and apartments. The objective is to maximize earnings by building upon and strengthening the core portfolio through selective acquisitions and dispositions. In light of this objective, the Company took advantage of a significant demand for Class A, institutional grade properties and, as a result, sold certain real estate holdings in its portfolio mostly during the fourth quarter of 2002, although several sales occurred in the first quarter of 2003. This sales program does not represent any fundamental change in the Company's investment strategy. Once the Company identifies a property that is expected to be sold within one year and commences a firm plan for marketing the property, in accordance with SFAS 144, the Company classifies the property as held-for-sale and reports the related net investment income and any resulting investment gains and losses as discontinued operations. Further, the Company establishes and periodically revises, if necessary, a valuation allowance to adjust the carrying value of the property to its expected sales value, less associated selling costs, if it is lower than the property's carrying value. The Company records valuation allowances as investment losses and subsequent adjustments as investment gains or losses. If circumstances arise that were previously considered unlikely and, as a result, the property is expected to be on the market longer than anticipated, a held-for-sale property is reclassified to held-for-investment and measured as such. The Company's carrying value of real estate held-for-sale, including real estate acquired upon foreclosure of commercial and agricultural mortgage loans, in the amounts of $640 million and $799 million at September 30, 2003 and December 31, 2002, respectively, are net of impairments of $0 and $5 million, respectively, and net of valuation allowances of $8 million and $11 million, respectively. The Company records real estate acquired upon foreclosure of commercial and agricultural mortgage loans at the lower of estimated fair value or the carrying value of the mortgage loan at the date of foreclosure. Certain of the Company's investments in real estate joint ventures meet the definition of a VIE under FIN 46. See "--Variable Interest Entities." On August 28 2003, the Company (through one of its subsidiaries) acquired the Sears Tower building through the acquisition of a controlling interest in a partnership holding title to the building. The consideration paid included a cash purchase price of approximately $9 million and the assumption of approximately $691 million of mortgage debt, accrued interest and other liabilities (including approximately $582 million of mortgage debt and accrued interest held by the Company) associated with the property. This acquisition was accounted for in accordance with SFAS No. 141, Business Combinations. EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS The Company's carrying value of equity securities, which primarily consist of investments in common and preferred stocks and mutual fund interests, was $1,659 million and $1,613 million at September 30, 2003 and December 31, 2002, respectively. Substantially all of the common stock is publicly traded on major securities exchanges. The carrying value of the other limited partnership interests (which primarily represent ownership interests in pooled investment funds that make private equity investments in companies in the U.S. and overseas) was $2,450 million and $2,395 million at September 30, 2003 and December 31, 2002, respectively. The Company classifies its investments in common stocks as available-for-sale and marks them to market, except for non-marketable private equities, which are generally carried at cost. The Company uses the equity method of accounting for investments in limited partnership interests in which it has more than a minor interest, has influence over the partnership's operating and financial policies and does not have a controlling interest. The Company uses the cost method for minor interest investments and when it has virtually no influence over the partnership's operating and financial policies. The Company's investments in equity securities excluding partnerships represented 0.8% of cash and invested assets at both September 30, 2003 and December 31, 2002. Equity securities include private equity securities with an estimated fair value of $408 million and $443 million at September 30, 2003 and December 31, 2002, respectively. The Company may not freely trade its private equity securities because of restrictions imposed by federal and state securities laws and illiquid markets. The Company makes commitments to fund partnership investments in the normal course of business. The amounts of these unfunded commitments were $1,511 million and $1,667 million at September 30, 2003 and December 31, 2002, respectively. The Company anticipates that these amounts could be invested in these partnerships any time over the next five years. - 87 - Some of the Company's investments in other limited partnership interests meet the definition of a VIE under FIN 46. See "--Variable Interest Entities." The following tables set forth the cost, gross unrealized gain or loss and estimated fair value of the Company's equity securities, as well as the percentage of the total equity securities at:
SEPTEMBER 30, 2003 -------------------------------------------------------------- GROSS UNREALIZED ------------------- ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL ------ ------ ------ ---------- ------ (DOLLARS IN MILLIONS) Equity Securities: Common stocks $ 827 $ 234 $ 2 $1,059 63.8% Nonredeemable preferred stocks 563 40 3 600 36.2 ------ ------ ------ ------ ----- Total equity securities $1,390 $ 274 $ 5 $1,659 100.0% ====== ====== ====== ====== =====
DECEMBER 31, 2002 -------------------------------------------------------------- GROSS UNREALIZED ------------------- ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL ------ ------ ------ ---------- ------ (DOLLARS IN MILLIONS) Equity Securities: Common stocks $ 877 $ 115 $ 79 $ 913 56.6% Nonredeemable preferred stocks 679 25 4 700 43.4 ------ ------ ------ ------ ----- Total equity securities $1,556 $ 140 $ 83 $1,613 100.0% ====== ====== ====== ====== =====
Problem and Potential Problem Equity Securities and Other Limited Partnership Interests. The Company monitors its equity securities and other limited partnership interests on a continual basis. Through this monitoring process, the Company identifies investments that management considers to be problems or potential problems. Problem equity securities and other limited partnership interests are defined as securities (i) in which significant declines in revenues and/or margins threaten the ability of the issuer to continue operating; or (ii) where the issuer has entered into bankruptcy. Potential problem equity securities and other limited partnership interests are defined as securities issued by a company that is experiencing significant operating problems or difficult industry conditions. Criteria generally indicative of these problems or conditions are (i) cash flows falling below varying thresholds established for the industry and other relevant factors; (ii) significant declines in revenues and/or margins; (iii) public securities trading at a substantial discount compared to original cost as a result of specific credit concerns; and (iv) other information that becomes available. Equity Security Impairment. The Company classifies all of its equity securities as available-for-sale and marks them to market through other comprehensive income. All securities with gross unrealized losses at the consolidated balance sheet date are subjected to the Company's process for identifying other-than-temporary impairments. The Company writes down to fair value securities that it deems to be other-than-temporarily impaired in the period the securities are deemed to be so impaired. The assessment of whether such impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors, as described below, about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to, the following: - length of time and the extent to which the market value has been below cost; - potential for impairments of securities when the issuer is experiencing significant financial difficulties, including a review of all securities of the issuer, including its known subsidiaries and affiliates, regardless of the form of the Company's ownership; - potential for impairments in an entire industry sector or sub-sector; - 88 - - potential for impairments in certain economically depressed geographic locations; - potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; and - other subjective factors, including concentrations and information obtained from regulators and rating agencies. Equity securities or other limited partnership interests which are deemed to be other-than-temporarily impaired are written down to fair value. The Company records writedowns as investment losses and adjusts the cost basis of the equity securities accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. Writedowns of equity securities and other limited partnership interests were $12 million and $51 million for the three months ended September 30, 2003 and 2002, respectively, and $101 million and $111 million for the nine months ended September 30, 2003 and 2002, respectively. During the three months ended September 30, 2003 and 2002, the Company sold equity securities with an estimated fair value of $2 million for both periods, at a loss of $6 million and $2 million, respectively. During the nine months ended September 30, 2003 and 2002, the Company sold equity securities with an estimated fair value of $44 million and $77 million, respectively, at a loss of $12 million and $43 million, respectively. The gross unrealized loss related to the Company's equity securities at September 30, 2003 was $5 million. Such securities are concentrated by security type in common stock (65%) and preferred stock (19%); and are concentrated by industry in financial (53%) and domestic broad market mutual funds (17%) (calculated as a percentage of gross unrealized loss). The following table presents the cost, gross unrealized losses and number of securities for equity securities where the estimated fair value had declined and remained below cost by less than 20%, or 20% or more for:
SEPTEMBER 30, 2003 ------------------------------------------------------------------------ COST GROSS UNREALIZED LOSSES NUMBER OF SECURITIES ----------------- ----------------------- -------------------- LESS THAN 20% OR LESS THAN 20% OR LESS THAN 20% OR 20% MORE 20% MORE 20% MORE --------- ------ --------- ------ --------- ------ (DOLLARS IN MILLIONS) Less than six months $45 $ - $ 4 $ - 30 5 Six months or greater but less than nine months - 1 - - 4 1 Nine months or greater but less than twelve months 7 - - - 12 - Twelve months or greater 44 - 1 - 20 - --- --- --- ------- ---- --- Total $96 $ 1 $ 5 $ - 66 6 === === === ======= ==== ===
The Company's review of its equity security exposure includes the analysis of total gross unrealized losses by three categories of securities: (i) securities where the estimated fair value had declined and remained below cost by less than 20%; (ii) securities where the estimated fair value had declined and remained below cost by 20% or more for less than six months; and (iii) securities where the estimated fair value had declined and remained below cost by 20% or more for six months or greater. While all of these securities are monitored for potential impairment, the Company's experience indicates that the first two categories do not present as great a risk of impairment, and often, fair values recover over time as the factors that caused the declines improve. - 89 - The following table presents the total gross unrealized losses for equity securities at September 30, 2003 where the estimated fair value had declined and remained below cost by:
SEPTEMBER 30, 2003 --------------------------- GROSS % OF UNREALIZED LOSSES TOTAL ----------------- ----- (DOLLARS IN MILLIONS) Less than 20% $ 5 100.0% 20% or more for less than six months - - 20% or more for six months or greater - - ------- ----- Total $ 5 100.0% ======= =====
The category of equity securities where the estimated fair value has declined and remained below cost by less than 20% is comprised of 66 equity securities with a cost of $96 million and a gross unrealized loss of $5 million. These securities are concentrated by security type in common stock (63%) and preferred stock (19%); and concentrated by industry in financial (55%) and domestic broad market mutual funds (18%) (calculated as a percentage of gross unrealized loss). The significant factors considered at September 30, 2003 in the review of equity securities for other-than-temporary impairment were generally poor economic and market conditions. The Company did not hold any equity securities with a gross unrealized loss at September 30, 2003 greater than $5 million. OTHER INVESTED ASSETS The Company's other invested assets consist principally of leveraged leases and funds withheld at interest of $3.5 billion and $3.1 billion at September 30, 2003 and December 31, 2002, respectively. The leveraged leases are recorded net of non-recourse debt. The Company participates in lease transactions, which are diversified by industry, asset type and geographic area. The Company regularly reviews residual values and writes down residuals to expected values as needed. Funds withheld represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. For agreements written on a modified coinsurance basis and certain agreements written on a coinsurance basis, assets supporting the reinsured policies equal to the net statutory reserves are withheld and continue to be legally owned by the ceding company. Interest accrues to these funds withheld at rates defined by the treaty terms and may be contractually specified or directly related to the investment portfolio. The Company's other invested assets represented 2.1% and 1.9% of cash and invested assets at September 30, 2003 and December 31, 2002, respectively. DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative instruments to manage risk through one of four principal risk management strategies: the hedging of (i) liabilities; (ii) invested assets; (iii) portfolios of assets or liabilities; and (iv) firm commitments and forecasted transactions. Additionally, the Company enters into income generation and replication ("RSAT") derivative transactions as permitted by its insurance subsidiaries' Derivatives Use Plans approved by the applicable state insurance departments. The Company's derivative hedging strategy employs a variety of instruments, including financial futures, financial forwards, interest rate, credit default and foreign currency swaps, foreign currency forwards and options, including caps and floors. - 90 - The table below provides a summary of the notional amount and fair value of derivative financial instruments held at:
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------------- ------------------------------------- FAIR VALUE FAIR VALUE NOTIONAL ----------------------- NOTIONAL ------------------------ AMOUNT ASSETS LIABILITIES AMOUNT ASSETS LIABILITIES -------- ------- ----------- -------- -------- ----------- Financial futures $ 547 $ 12 $ 22 $ 4 $ - $ - Interest rate swaps 6,868 220 45 3,866 196 126 Floors 325 7 - 325 9 - Caps 9,040 1 - 8,040 - - Financial forwards 1,440 - 25 1,945 - 12 Foreign currency swaps 3,896 15 490 2,371 92 181 Options 6,200 8 - 6,472 9 - Foreign currency forwards 137 - 11 54 - 1 Written covered calls 1,178 - 32 - - - Credit default swaps 516 2 1 376 2 - ------- ------- ------- ------- ------- ------- Total contractual commitments $30,147 $ 265 $ 626 $23,453 $ 308 $ 320 ======= ======= ======= ======= ======= =======
SECURITIES LENDING The Company participates in a securities lending program whereby blocks of securities, which are included in investments, are loaned to third parties, primarily major brokerage firms. The Company requires a minimum of 102% of the fair value of the loaned securities to be separately maintained as collateral for the loans. Securities with a cost or amortized cost of $23,001 million and $16,196 million and an estimated fair value of $24,532 million and $17,625 million were on loan under the program at September 30, 2003 and December 31, 2002, respectively. The Company was liable for cash collateral under its control of $24,666 million and $17,862 million at September 30, 2003 and December 31, 2002, respectively. Security collateral on deposit from customers may not be sold or repledged and is not reflected in the unaudited interim condensed consolidated financial statements. SEPARATE ACCOUNT ASSETS The Company manages each separate account's assets in accordance with the prescribed investment policy that applies to that specific separate account. The Company establishes separate accounts on a single client and multi-client commingled basis in conformity with insurance laws. Generally, separate accounts are not chargeable with liabilities that arise from any other business of the Company. Separate account assets are subject to the Company's general account claims only to the extent that the value of such assets exceeds the separate account liabilities, as defined by the account's contract. If the Company uses a separate account to support a contract providing guaranteed benefits, the Company must comply with the asset maintenance requirements stipulated under Regulation 128 of the Department. The Company monitors these requirements at least monthly and, in addition, performs cash flow analyses, similar to that conducted for the general account, on an annual basis. The Company reports separately as assets and liabilities investments held in separate accounts and liabilities of the separate accounts. The Company reports substantially all separate account assets at their fair market value. Investment income and gains or losses on the investments of separate accounts accrue directly to contractholders, and, accordingly, the Company does not reflect them in its consolidated statements of income and cash flows. The Company reflects in its revenues fees charged to the separate accounts by the Company, including mortality charges, risk charges, policy administration fees, investment management fees and surrender charges. - 91 - ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has material exposure to interest rate, equity market and foreign currency exchange risk. The Company analyzes interest rate risk using various models including multi-scenario cash flow projection models that forecast cash flows of the liabilities and their supporting investments, including derivative instruments. The Company's market risk exposure at September 30, 2003 is relatively unchanged in amount from that reported on December 31, 2002, a description of which may be found in the 2002 Annual Report on Form 10-K. ITEM 4. CONTROLS AND PROCEDURES Based on their evaluation as of September 30, 2003, the Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective. There were no changes in the Company's internal control over financial reporting that occurred during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. - 92 - PART II - OTHER INFORMATION ITEM I. LEGAL PROCEEDINGS The following should be read in conjunction with Note 8 to unaudited interim condensed consolidated financial statements in Part I of this Report. SALES PRACTICES CLAIMS As previously disclosed, over the past several years, Metropolitan Life, New England Mutual Life Insurance Company ("New England Mutual") and General American Life Insurance Company ("General American") have faced numerous claims, including class action lawsuits, alleging improper marketing and sales of individual life insurance policies or annuities. These lawsuits are generally referred to as "sales practices claims." Settlements have been reached in the sales practice class actions against Metropolitan Life, New England Mutual and General American. Certain class members have opted out of these class action settlements and have brought or continued non-class action sales practices lawsuits. In addition, other sales practices lawsuits have been brought. As of September 30, 2003, there are approximately 383 sales practices lawsuits pending against Metropolitan Life, approximately 60 sales practices lawsuits pending against New England Mutual and approximately 25 sales practices lawsuits pending against General American. In 2002, a purported class action complaint was filed in a federal court in Kansas by S-G Metals Industries, Inc. against New England Mutual. The complaint seeks certification of a class on behalf of corporations and banks that purchased participating life insurance policies, as well as persons who purchased participating policies for use in pension plans or through work site marketing. These policyholders were not part of the New England Mutual class action settlement noted above. The action was transferred to a federal court in Massachusetts. New England Mutual moved to dismiss the case and in November 2002, the federal district court dismissed the case. In October 2003, the First Circuit Court of Appeals affirmed the district court ruling in favor of New England Mutual. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for sales practices claims against Metropolitan Life, New England Mutual and General American. ASBESTOS-RELATED CLAIMS As previously reported, Metropolitan Life received approximately 66,000 asbestos-related claims in 2002. During the first nine months of 2003 and 2002, Metropolitan Life received approximately 53,200 and 45,200 asbestos-related claims, respectively. Of the approximately 53,200 claims received in the first nine months of 2003, approximately 23,000 were received in April 2003. In 2003, Metropolitan Life also has been named as a defendant in a small number of silicosis, welding and mixed dust cases, as previously reported. The cases are pending in Mississippi, Texas, Ohio, Pennsylvania, West Virginia, Louisiana, Kentucky, Georgia and Arkansas. The Company intends to defend itself vigorously against these cases. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for asbestos-related claims. The ability of Metropolitan Life to estimate its ultimate asbestos exposure is subject to considerable uncertainty due to numerous factors. The availability of data is limited and it is difficult to predict with any certainty numerous variables that can affect liability estimates, including the number of future claims, the cost to resolve claims, the disease mix and severity of disease, the jurisdiction of claims filed, tort reform efforts and the impact of any possible future adverse verdicts and their amounts. A bill reforming asbestos litigation may be voted on by the Senate in 2003. While the Company strongly supports reform efforts, there can be no assurance that legislative reforms will be enacted. Publicity regarding legislative reform efforts may be resulting in an increase in the number of claims. Metropolitan Life will continue to study its claims experience, review external literature regarding asbestos claims experience in the United States and consider numerous variables that can affect its asbestos liability exposure, including bankruptcies of other companies involved in asbestos litigation and legislative and judicial developments, to identify trends and to assess their impact on the recorded asbestos liability. The number of asbestos cases that may be brought or the aggregate amount of any liability that Metropolitan Life may ultimately incur is uncertain. Accordingly, it is reasonably possible that the Company's total exposure to asbestos claims may be greater than the - 93 - liability recorded by the Company in its unaudited interim condensed consolidated financial statements and that future charges to income may be necessary. While the potential future charges could be material in particular quarterly or annual periods in which they are recorded, based on information currently known by management, it does not believe any such charges are likely to have a material adverse effect on the Company's consolidated financial position. PROPERTY AND CASUALTY ACTIONS As previously reported, purported class action suits involving claims by policyholders for the alleged diminished value of automobiles after accident-related repairs have been filed in Rhode Island, Texas, Georgia and Tennessee against Metropolitan Property and Casualty Insurance Company. A settlement was reached in the Georgia class action and has been implemented. DEMUTUALIZATION ACTIONS In July 2002, a lawsuit was filed in the United States District Court for the Eastern District of Texas on behalf of a proposed class comprised of the settlement class in the Metropolitan Life sales practices class action settlement approved in December 1999 by the United States District Court for the Western District of Pennsylvania. After the defendants' motion to transfer the lawsuit to the Western District of Pennsylvania was granted, plaintiffs filed an amended complaint alleging that the treatment of the cost of the sales practices settlement in connection with the demutualization of Metropolitan Life breached the terms of the settlement. Plaintiffs sought compensatory and punitive damages, as well as attorneys' fees and costs. In October 2003, the court granted defendants' motion to dismiss the action. RACE-CONSCIOUS UNDERWRITING CLAIMS As previously reported, Insurance Departments in a number of states initiated inquiries in 2000 about possible race-conscious underwriting of life insurance. These inquiries generally have been directed to all life insurers licensed in their respective states, including Metropolitan Life and certain of its affiliates. The New York Insurance Department has concluded its examination of Metropolitan Life concerning possible past race-conscious underwriting practices. Four purported class action lawsuits filed against Metropolitan Life in 2000 and 2001 alleging racial discrimination in the marketing, sale, and administration of life insurance policies have been consolidated in the United States District Court for the Southern District of New York. On April 28, 2003, the United States District Court approved a class action settlement of the consolidated actions. Several persons have filed notices of appeal from the order approving the settlement, but subsequently the appeals were dismissed. Metropolitan Life has entered into settlement agreements to resolve the regulatory examination. Metropolitan Life recorded a charge in the fourth quarter of 2001 in connection with the anticipated resolution of these matters. During the three months and nine months ended September 30, 2003, the Company reduced its reserve by $28 million, net of income tax, and $92 million, net of income tax, respectively. The Company believes the remaining portion of the previously recorded charge is adequate to cover the costs associated with the resolution of these matters. OTHER In 2001, a putative class action was filed against Metropolitan Life in the United States District Court for the Southern District of New York alleging gender discrimination and retaliation in the MetLife Financial Services unit of the Individual segment. The plaintiffs seek unspecified compensatory damages, punitive damages, a declaration that the alleged practices are discriminatory and illegal, injunctive relief requiring Metropolitan Life to discontinue the alleged discriminatory practices, an order restoring class members to their rightful positions (or appropriate compensation in lieu thereof), and other relief. Plaintiffs have filed a motion for class certification. Opposition papers were filed by Metropolitan Life. In August 2003, the court granted preliminary approval to a settlement of the lawsuit. At the fairness hearing held on November 6, 2003, the court approved the settlement of the lawsuit. Implementation of the settlement will commence in 2004. As previously reported, the SEC is conducting a formal investigation of New England Securities Corporation ("NES"), an indirect subsidiary of New England Life Insurance Company ("NELICO"), in response to NES informing the SEC that certain systems and controls relating to one NES advisory program were not operating effectively. NES is cooperating fully with the SEC and is continuing to research the effect, if any, of this issue upon approximately 6,500 active and closed accounts. Prior to filing the Company's June 30, 2003 Form 10-Q, MetLife announced a $31 million after-tax charge related to an affiliate, New England Financial. MetLife notified the SEC about the nature of this charge prior to its announcement. The SEC is pursuing a formal investigation of the matter and MetLife is fully cooperating with the investigation. - 94 - A purported class action in which a policyholder seeks to represent a class of owners of participating life insurance policies is pending in state court in New York. Plaintiff asserts that Metropolitan Life breached her policy in the manner in which it allocated investment income across lines of business during a period ending with the 2000 demutualization. In August 2003, an appellate court affirmed the dismissal of fraud claims in this action. Various litigation, claims and assessments against the Company, in addition to those discussed above and those otherwise provided for in the Company's consolidated financial statements, have arisen in the course of the Company's business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor and taxpayer. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning the Company's compliance with applicable insurance and other laws and regulations. Regulatory bodies have contacted the Company and have requested information relating to market timing and late trading of mutual funds and variable insurance products. The Company is in the process of responding and is fully cooperating with regard to these information requests. At the present time, the Company is not aware of any systemic problems with respect to such matters that may have a material adverse effect on the Company's consolidated financial position. SUMMARY It is not feasible to predict or determine the ultimate outcome of all pending investigations and legal proceedings or provide reasonable ranges of potential losses, except as noted above in connection with specific matters. In some of the matters referred to above, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations it is possible that an adverse outcome in certain cases could have a material adverse effect upon the Company's consolidated financial position, based on information currently known by the Company's management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods. - 95 - ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Form of Employment Continuation Agreement with Messrs. Launer and Lipscomb* 10.2 Amendment to the Metropolitan Life Auxiliary Savings and Investment Plan, effective January 1, 2003* 10.3 Amendment to the Metropolitan Life Supplemental Auxiliary Savings and Investment Plan, effective January 1, 2003* 10.4 MetLife Deferred Compensation Plan for Outside Directors, as amended September 2003* 10.5 MetLife Deferred Compensation Plan for Officers, as amended and restated effective November 1, 2003* 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K During the three months ended September 30, 2003, there were no current reports filed on Form 8-K. ----------- * Indicates management contracts or compensatory plans or arrangements. - 96 - 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. METLIFE, INC. By: /s/ Timothy L. Journy --------------------- Timothy L. Journy Vice-President and Controller (Authorized signatory and principal accounting officer) Date: November 7, 2003 - 97 - EXHIBIT INDEX
Exhibit Page Number Exhibit Name Number 10.1 Form of Employment Continuation Agreement with Messrs. Launer and Lipscomb* 10.2 Amendment to the Metropolitan Life Auxiliary Savings and Investment Plan, effective January 1, 2003* 10.3 Amendment to the Metropolitan Life Supplemental Auxiliary Savings and Investment Plan, effective January 1, 2003* 10.4 MetLife Deferred Compensation Plan for Outside Directors, as amended September 2003* 10.5 MetLife Deferred Compensation Plan for Officers, as amended and restated effective November 1, 2003* 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
---------------- * Indicates management contracts or compensatory plans or arrangements. - 98 -