10-Q 1 a10-17495_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549


 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2010

 

or

 

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

 

For the transition period from                     to                    

 

Commission File Number 001-11339

 

Protective Life Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-2492236

(State or other jurisdiction of incorporation or organization)

 

(IRS Employer Identification Number)

 

 

 

2801 Highway 280 South

Birmingham, Alabama 35223

(Address of principal executive offices and zip code)

 

(205) 268-1000

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x   No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x   No o

 

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

 

Large accelerated filer x

 

Accelerated Filer o

 

 

 

Non-accelerated filer o

 

Smaller Reporting Company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   Yes o   No x

 

Number of shares of Common Stock, $0.50 Par Value, outstanding as of October 29, 2010: 85,666,562

 

 

 



Table of Contents

 

PROTECTIVE LIFE CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

 

TABLE OF CONTENTS

 

 

 

 

Page

 

PART I: Financial Information

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited):

 

 

 

Consolidated Condensed Statements of Income For The Three and Nine Months Ended September 30, 2010 and 2009

 

3

 

Consolidated Condensed Balance Sheets as of September 30, 2010 and December 31, 2009

 

4

 

Consolidated Condensed Statement of Shareowners’ Equity For The Nine Months Ended September 30, 2010

 

5

 

Consolidated Condensed Statements of Cash Flows For The Nine Months Ended September 30, 2010 and 2009

 

7

 

Notes to Consolidated Condensed Financial Statements

 

8

Item 2.

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

 

41

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

101

Item 4.

Controls and Procedures

 

101

 

 

 

 

 

PART II

 

 

 

 

 

 

Item 1A.

Risk Factors and Cautionary Factors that may Affect Future Results

 

102

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

108

Item 6.

Exhibits

 

108

 

Signature

 

109

 



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(Unaudited)

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(Dollars In Thousands, Except Per Share Amounts)

 

Revenues

 

 

 

 

 

 

 

 

 

Premiums and policy fees

 

$

640,265

 

$

652,497

 

$

1,948,278

 

$

1,991,638

 

Reinsurance ceded

 

(334,040

)

(351,664

)

(1,019,598

)

(1,104,188

)

Net of reinsurance ceded

 

306,225

 

300,833

 

928,680

 

887,450

 

Net investment income

 

429,548

 

409,956

 

1,264,045

 

1,262,785

 

Realized investment gains (losses):

 

 

 

 

 

 

 

 

 

Derivative financial instruments

 

(94,034

)

(195,540

)

(236,994

)

(201,098

)

All other investments

 

110,787

 

165,576

 

226,390

 

291,532

 

Other-than-temporary impairment losses

 

(12,898

)

(14,873

)

(71,437

)

(181,064

)

Portion of loss recognized in other comprehensive income (before taxes)

 

5,283

 

(16,095

)

35,155

 

19,299

 

Net impairment losses recognized in earnings

 

(7,615

)

(30,968

)

(36,282

)

(161,765

)

Other income

 

58,190

 

41,222

 

161,134

 

119,471

 

Total revenues

 

803,101

 

691,079

 

2,306,973

 

2,198,375

 

Benefits and expenses

 

 

 

 

 

 

 

 

 

Benefits and settlement expenses, net of reinsurance ceded: (three months: 2010 - $308,594; 2009 - $308,979; nine months: 2010 - $971,061; 2009 - $1,014,907)

 

549,567

 

521,218

 

1,582,233

 

1,503,725

 

Amortization of deferred policy acquisition costs and value of business acquired

 

42,386

 

47,240

 

146,761

 

250,837

 

Other operating expenses, net of reinsurance ceded: (three months: 2010 - $48,851; 2009 - $54,791; nine months: 2010 - $142,932; 2009 - $161,819)

 

104,151

 

80,985

 

305,246

 

229,803

 

Total benefits and expenses

 

696,104

 

649,443

 

2,034,240

 

1,984,365

 

Income before income tax

 

106,997

 

41,636

 

272,733

 

214,010

 

Income tax expense

 

36,626

 

14,051

 

91,412

 

73,533

 

Net income

 

70,371

 

27,585

 

181,321

 

140,477

 

Less: Net income (loss) attributable to noncontrolling interests

 

(77

)

 

(277

)

 

Net income available to PLC’s common shareowners(1)

 

$

70,448

 

$

27,585

 

$

181,598

 

$

140,477

 

 

 

 

 

 

 

 

 

 

 

Net income available to PLC’s common shareowners - basic

 

$

0.81

 

$

0.32

 

$

2.10

 

$

1.79

 

Net income available to PLC’s common shareowners - diluted

 

$

0.80

 

$

0.32

 

$

2.07

 

$

1.77

 

Cash dividends paid per share

 

$

0.14

 

$

0.12

 

$

0.40

 

$

0.36

 

 

 

 

 

 

 

 

 

 

 

Average shares outstanding - basic

 

86,603,569

 

86,481,240

 

86,555,761

 

78,465,685

 

Average shares outstanding - diluted

 

87,701,592

 

87,372,659

 

87,640,221

 

79,156,305

 

 


(1) Protective Life Corporation (“PLC”)

 

See Notes to Consolidated Condensed Financial Statements

 

3



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

 

 

As of

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(Dollars In Thousands)

 

Assets

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: 2010 - $23,605,857; 2009 - $23,228,317)

 

$

24,838,626

 

$

22,830,427

 

Equity securities, at fair value (cost: 2010 - $327,045; 2009 - $280,615)

 

335,151

 

275,497

 

Mortgage loans (2010 includes: $951,105 related to securitizations)

 

4,884,102

 

3,877,087

 

Investment real estate, net of accumulated depreciation (2010 - $1,073; 2009 - $803)

 

24,669

 

25,188

 

Policy loans

 

767,214

 

794,276

 

Other long-term investments

 

256,093

 

204,754

 

Short-term investments

 

483,698

 

1,049,609

 

Total investments

 

31,589,553

 

29,056,838

 

Cash

 

151,340

 

205,325

 

Accrued investment income

 

320,668

 

285,350

 

Accounts and premiums receivable, net of allowance for uncollectible amounts (2010 - $4,570; 2009 - $5,170)

 

65,948

 

56,216

 

Reinsurance receivables

 

5,563,824

 

5,333,401

 

Deferred policy acquisition costs and value of business acquired

 

3,642,484

 

3,663,350

 

Goodwill

 

115,532

 

117,856

 

Property and equipment, net of accumulated depreciation (2010 - $128,947; 2009 - $123,709)

 

37,722

 

37,037

 

Other assets

 

207,198

 

176,303

 

Income tax receivable

 

2,438

 

115,447

 

Assets related to separate accounts

 

 

 

 

 

Variable annuity

 

3,899,308

 

2,948,457

 

Variable universal life

 

336,299

 

316,007

 

Total Assets

 

$

45,932,314

 

$

42,311,587

 

Liabilities

 

 

 

 

 

Policy liabilities and accruals

 

$

19,129,506

 

$

18,548,267

 

Stable value product account balances

 

3,105,822

 

3,581,150

 

Annuity account balances

 

10,451,322

 

9,911,040

 

Other policyholders’ funds

 

577,275

 

515,078

 

Other liabilities

 

1,115,755

 

715,110

 

Mortgage loan backed certificates

 

74,324

 

 

Deferred income taxes

 

1,113,532

 

553,062

 

Non-recourse funding obligations

 

548,000

 

575,000

 

Long-term debt

 

1,485,852

 

1,644,852

 

Subordinated debt securities

 

524,743

 

524,743

 

Liabilities related to separate accounts

 

 

 

 

 

Variable annuity

 

3,899,308

 

2,948,457

 

Variable universal life

 

336,299

 

316,007

 

Total liabilities

 

42,361,738

 

39,832,766

 

Commitments and contingencies - Note 7

 

 

 

 

 

Shareowners’ equity

 

 

 

 

 

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

 

 

 

 

 

Common Stock, $.50 par value, shares authorized: 2010 and 2009 - 160,000,000; shares issued: 2010 and 2009 - 88,776,960

 

44,388

 

44,388

 

Additional paid-in-capital

 

584,865

 

576,887

 

Treasury stock, at cost (2010 - 3,112,442 shares; 2009 - 3,196,157 shares)

 

(26,101

)

(25,929

)

Retained earnings

 

2,366,276

 

2,204,644

 

Accumulated other comprehensive income (loss):

 

 

 

 

 

Net unrealized gains (losses) on investments, net of income tax: (2010 -$364,723; 2009 - $(121,737))

 

677,343

 

(225,648

)

Net unrealized (losses) gains relating to other-than-temporary impaired investments for which a portion has been recognized in earnings, net of income tax: (2010 - $(7,698); 2009 - $(16,704))

 

(14,296

)

(31,021

)

Accumulated loss - derivatives, net of income tax: (2010 - $(9,002); 2009 - $(10,182))

 

(16,718

)

(18,327

)

Postretirement benefits liability adjustment, net of income tax: (2010 -$(23,889); 2009 - $(24,862))

 

(44,365

)

(46,173

)

Total Protective Life Corporation’s shareowners’ equity

 

3,571,392

 

2,478,821

 

Noncontrolling interest

 

(816

)

 

Total equity

 

3,570,576

 

2,478,821

 

Total liabilities and shareowners’ equity

 

$

45,932,314

 

$

42,311,587

 

 

See Notes to Consolidated Condensed Financial Statements

 

4



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF SHAREOWNERS’ EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive Income (Loss)

 

Protective

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minimum

 

Life

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Net Unrealized

 

Accumulated

 

Pension

 

Corporation’s

 

Non

 

 

 

 

 

Common

 

Paid-In-

 

Treasury

 

Retained

 

Gains / (Losses)

 

Gain / (Loss)

 

Liability

 

shareowners’

 

controlling

 

Total

 

 

 

Stock

 

Capital

 

Stock

 

Earnings

 

on Investments

 

Derivatives

 

Adjustments

 

equity

 

Interest

 

Equity

 

 

 

 

 

 

 

 

 

 

 

(Dollars In Thousands)

 

 

 

 

 

 

 

 

 

Balance, December 31, 2009

 

$

44,388

 

$

576,887

 

$

(25,929

)

$

2,204,644

 

$

(256,669

)

$

(18,327

)

$

(46,173

)

$

2,478,821

 

$

 

$

2,478,821

 

Net income for the three months ended March 31, 2010

 

 

 

 

 

 

 

69,779

 

 

 

 

 

 

 

69,779

 

(73

)

69,706

 

Change in net unrealized gains/losses on investments (net of income tax - $142,481)

 

 

 

 

 

 

 

 

 

263,959

 

 

 

 

 

263,959

 

 

263,959

 

Reclassification adjustment for investment amounts included in net income (net of income tax - $1,725)

 

 

 

 

 

 

 

 

 

3,418

 

 

 

 

 

3,418

 

 

3,418

 

Change in net unrealized gains/losses relating to other-than-temporary impaired investments for which a portion has been recognized in earnings (net of income tax $(3,495))

 

 

 

 

 

 

 

 

 

(6,492

)

 

 

 

 

(6,492

)

 

(6,492

)

Change in accumulated gain (loss) derivatives (net of income tax - $3,423)

 

 

 

 

 

 

 

 

 

 

 

5,718

 

 

 

5,718

 

 

5,718

 

Reclassification adjustment for derivative amounts included in net income (net of income tax - $(974))

 

 

 

 

 

 

 

 

 

 

 

(1,752

)

 

 

(1,752

)

 

(1,752

)

Change in minimum pension liability adjustment (net of income tax - $324)

 

 

 

 

 

 

 

 

 

 

 

 

 

602

 

602

 

 

602

 

Comprehensive income for the three months ended March 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

335,232

 

(73

)

335,159

 

Cash dividends ($0.120 per share)

 

 

 

 

 

 

 

(10,270

)

 

 

 

 

 

 

(10,270

)

 

(10,270

)

Cumulative effect adjustments

 

 

 

 

 

 

 

14,290

 

 

 

 

 

 

 

14,290

 

 

14,290

 

Noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(418

)

(418

)

Stock-based compensation

 

 

 

3,028

 

(68

)

 

 

 

 

 

 

 

 

2,960

 

 

2,960

 

Balance, March 31, 2010

 

$

44,388

 

$

579,915

 

$

(25,997

)

$

2,278,443

 

$

4,216

 

$

(14,361

)

$

(45,571

)

$

2,821,033

 

$

(491

)

$

2,820,542

 

Net income for the three months ended June 30, 2010

 

 

 

 

 

 

 

41,371

 

 

 

 

 

 

 

41,371

 

(127

)

41,244

 

Change in net unrealized gains/losses on investments (net of income tax - $130,774)

 

 

 

 

 

 

 

 

 

242,856

 

 

 

 

 

242,856

 

 

242,856

 

Reclassification adjustment for investment amounts included in net income (net of income tax - $3,894)

 

 

 

 

 

 

 

 

 

7,241

 

 

 

 

 

7,241

 

 

7,241

 

Change in net unrealized gains/losses relating to other-than-temporary impaired investments for which a portion has been recognized in earnings (net of income tax $(6,960))

 

 

 

 

 

 

 

 

 

(12,924

)

 

 

 

 

(12,924

)

 

(12,924

)

Change in accumulated gain (loss) derivatives (net of income tax - $(3,229))

 

 

 

 

 

 

 

 

 

 

 

(5,952

)

 

 

(5,952

)

 

(5,952

)

Reclassification adjustment for derivative amounts included in net income (net of income tax - $768)

 

 

 

 

 

 

 

 

 

 

 

1,382

 

 

 

1,382

 

 

1,382

 

Change in minimum pension liability adjustment (net of income tax - $325)

 

 

 

 

 

 

 

 

 

 

 

 

 

603

 

603

 

 

603

 

Comprehensive income for the three months ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

274,577

 

(127

)

274,450

 

Cash dividends ($0.14 per share)

 

 

 

 

 

 

 

(11,994

)

 

 

 

 

 

 

(11,994

)

 

(11,994

)

Cumulative effect adjustments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(121

)

(121

)

Stock-based compensation

 

 

 

1,731

 

252

 

 

 

 

 

 

 

 

 

1,983

 

 

1,983

 

Balance, June 30, 2010

 

$

44,388

 

$

581,646

 

$

(25,745

)

$

2,307,820

 

$

241,389

 

$

(18,931

)

$

(44,968

)

$

3,085,599

 

$

(739

)

$

3,084,860

 

 

See Notes to Consolidated Condensed Financial Statements

 

5



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF SHAREOWNERS’ EQUITY

(Unaudited)

(continued)

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive Income (Loss)

 

Protective

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minimum

 

Life

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Net Unrealized

 

Accumulated

 

Pension

 

Corporation’s

 

Non

 

 

 

 

 

Common

 

Paid-In-

 

Treasury

 

Retained

 

Gains / (Losses)

 

Gain / (Loss)

 

Liability

 

shareowners’

 

controlling

 

Total

 

 

 

Stock

 

Capital

 

Stock

 

Earnings

 

on Investments

 

Derivatives

 

Adjustments

 

equity

 

Interest

 

Equity

 

 

 

(Dollars In Thousands)

 

 

 

 

 

 

 

Net income for the three months ended September 30, 2010

 

 

 

 

 

 

 

70,448

 

 

 

 

 

 

 

70,448

 

(77

)

70,371

 

Change in net unrealized gains/losses on investments (net of income tax - $211,169)

 

 

 

 

 

 

 

 

 

392,180

 

 

 

 

 

392,180

 

 

392,180

 

Reclassification adjustment for investment amounts included in net income (net of income tax - $(3,583))

 

 

 

 

 

 

 

 

 

(6,663

)

 

 

 

 

(6,663

)

 

(6,663

)

Change in net unrealized gains/losses relating to other-than-temporary impaired investments for which a portion has been recognized in earnings (net of income tax $19,461)

 

 

 

 

 

 

 

 

 

36,141

 

 

 

 

 

36,141

 

 

36,141

 

Change in accumulated gain (loss) derivatives (net of income tax - $1,951)

 

 

 

 

 

 

 

 

 

 

 

3,581

 

 

 

3,581

 

 

3,581

 

Reclassification adjustment for derivative amounts included in net income (net of income tax - $(760))

 

 

 

 

 

 

 

 

 

 

 

(1,368

)

 

 

(1,368

)

 

(1,368

)

Change in minimum pension liability adjustment (net of income tax - $325)

 

 

 

 

 

 

 

 

 

 

 

 

 

603

 

603

 

 

603

 

Comprehensive income for the three months ended September 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

494,922

 

(77

)

494,845

 

Cash dividends ($0.14 per share)

 

 

 

 

 

 

 

(11,992

)

 

 

 

 

 

 

(11,992

)

 

(11,992

)

Cumulative effect adjustments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

 

3,219

 

(356

)

 

 

 

 

 

 

 

 

2,863

 

 

2,863

 

Balance, September 30, 2010

 

$

44,388

 

$

584,865

 

$

(26,101

)

$

2,366,276

 

$

663,047

 

$

(16,718

)

$

(44,365

)

$

3,571,392

 

$

(816

)

$

3,570,576

 

 

See Notes to Consolidated Condensed Financial Statements

 

6



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

For The

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2010

 

2009

 

 

 

(Dollars In Thousands)

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

181,321

 

$

140,477

 

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

 

 

 

 

 

Realized investment losses (gains)

 

46,886

 

71,331

 

Amortization of deferred policy acquisition costs and value of business acquired

 

146,761

 

250,837

 

Capitalization of deferred policy acquisition costs

 

(365,499

)

(316,914

)

Depreciation expense

 

7,184

 

5,928

 

Deferred income tax

 

(5,813

)

(48,926

)

Accrued income tax

 

112,281

 

25,077

 

Interest credited to universal life and investment products

 

658,488

 

749,552

 

Policy fees assessed on universal life and investment products

 

(471,383

)

(441,410

)

Change in reinsurance receivables

 

(230,423

)

(81,583

)

Change in accrued investment income and other receivables

 

(38,996

)

(24,104

)

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

 

328,042

 

170,502

 

Trading securities:

 

 

 

 

 

Maturities and principal reductions of investments

 

262,153

 

446,993

 

Sale of investments

 

555,904

 

595,676

 

Cost of investments acquired

 

(769,120

)

(587,057

)

Other net change in trading securities

 

20,078

 

(152,691

)

Change in other liabilities

 

23,478

 

(89,588

)

Other, net

 

113,153

 

9,882

 

Net cash provided by operating activities

 

574,495

 

723,982

 

Cash flows from investing activities

 

 

 

 

 

Maturities and principal reductions of investments, available-for-sale

 

1,372,385

 

2,003,690

 

Sale of investments, available-for-sale

 

2,807,438

 

1,250,831

 

Cost of investments acquired, available-for sale

 

(5,274,565

)

(3,304,310

)

Mortgage loans:

 

 

 

 

 

New borrowings

 

(231,931

)

(203,490

)

Repayments

 

249,363

 

199,271

 

Change in investment real estate, net

 

(1,127

)

(3,347

)

Change in policy loans, net

 

27,062

 

22,531

 

Change in other long-term investments, net

 

(138,419

)

(6,896

)

Change in short-term investments, net

 

517,278

 

118,993

 

Net unsettled security transactions

 

80,412

 

48,742

 

Purchase of property and equipment

 

(7,050

)

(5,989

)

Net cash (used in) provided by investing activities

 

(599,154

)

120,026

 

Cash flows from financing activities

 

 

 

 

 

Borrowings under line of credit arrangements and long-term debt

 

116,000

 

212,000

 

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

 

(275,000

)

(122,000

)

Issuance (repayment) of non-recourse funding obligations

 

(27,000

)

 

Dividends to shareowners

 

(34,257

)

(27,069

)

Issuance of common stock

 

 

132,575

 

Investments product deposits and change in universal life deposits

 

2,652,811

 

1,956,715

 

Investment product withdrawals

 

(2,459,566

)

(2,902,277

)

Other financing activities, net

 

(2,314

)

(18,008

)

Net cash used in financing activities

 

(29,326

)

(768,064

)

Change in cash

 

(53,985

)

75,944

 

Cash at beginning of period

 

205,325

 

149,358

 

Cash at end of period

 

$

151,340

 

$

225,302

 

 

See Notes to Consolidated Condensed Financial Statements

 

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PROTECTIVE LIFE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

 

1.             BASIS OF PRESENTATION

 

Basis of Presentation

 

The accompanying unaudited consolidated condensed financial statements of Protective Life Corporation and subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. In the opinion of management, the accompanying financial statements reflect all adjustments (consisting only of normal recurring items) necessary for a fair statement of the results for the interim periods presented. Operating results for the three and nine months period ended September 30, 2010, are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. The year-end consolidated condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 

The operating results of companies in the insurance industry have historically been subject to significant fluctuations due to changing competition, economic conditions, interest rates, investment performance, insurance ratings, claims, persistency, and other factors.

 

Reclassifications

 

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

 

Entities Included

 

The consolidated condensed financial statements include the accounts of Protective Life Corporation and subsidiaries and its affiliate companies in which the Company holds a majority voting or economic interest. Intercompany balances and transactions have been eliminated.

 

2.             SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Accounting Pronouncements Recently Adopted

 

Accounting Standard Update (“ASU” or “Update”) No. 2010-06 — Fair Value Measurements and Disclosures — Improving Disclosures about Fair Value Measurements. In January of 2010, Financial Accounting Standards Board (“FASB”) issued ASU No. 2010-06 — Fair Value Measurements and Disclosures — Improving Disclosures about Fair Value Measurements. This Update provides amendments to Subtopic 820-10 that requires the following new disclosures. 1) A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number).

 

This Update provides amendments to Subtopic 820-10 that clarifies existing disclosures. 1) A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. 2) A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. This Update also includes conforming amendments to the guidance on employers’ disclosures about postretirement benefit plan assets (Subtopic 715-20). The conforming amendments to Subtopic 715-20 change the terminology from major categories of assets to classes of assets and provide a cross reference to the guidance in Subtopic 820-10 on how to determine appropriate classes to present fair value disclosures. This Update is effective for interim and annual reporting periods beginning after December 15, 2009, which became

 

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effective for the Company for the period ending March 31, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. This Update did not have a material impact on the Company’s consolidated results of operations or financial position.

 

ASU No. 2009-16 — Transfers and Servicing — Accounting for Transfers of Financial Assets. In December of 2009, FASB issued ASU No. 2009-16 — Transfers and Services — Accounting for Transfers of Financial Assets. The amendments in this Update incorporate FASB Statement No. 166, Accounting for Transfers of Financial Assets an amendment of SFAS No. 140 into the Accounting Standards Codification (“ASC”). That Statement was issued by the Board on June 12, 2009. This Update enhances the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a continuing interest in transferred financial assets. This Update also eliminates the concept of a qualifying special-purpose entity (“QSPE”), changes the requirements for de-recognition of financial assets, and calls upon sellers of the assets to make additional disclosures. This Update is effective for interim or annual reporting periods beginning after November 15, 2009. This guidance was effective for the Company on January 1, 2010. As of January 1, 2010, the Company held interests in two previous transfers of financial assets to QSPEs, the 2007 Commercial Mortgage Securitization and the 1996 — 1999 Commercial Mortgage Securitization. As part of adoption of this guidance the Company reviewed these entities as part of our consolidation analysis of variable interest entities (“VIEs”). The conclusion of the review was that the former QSPEs should be consolidated by the Company. Please refer to Note 4, Variable Interest Entities for more information. The Company has not transferred any financial assets since the adoption of this standard. The Company will apply this guidance to all future transfers of financial assets.

 

ASU No. 2009-17 — Consolidations — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. In December of 2009, FASB issued ASU No. 2009-17 — Consolidations — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. The amendments to this Update incorporate FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS No. 167”) into the ASC. SFAS No. 167 was issued by the Board on June 12, 2009. This Statement applies to all investments in VIEs beginning for the Company on January 1, 2010. This analysis will include QSPEs used for securitizations as SFAS No. 166 eliminated the concept of a QSPE which subjects former QSPEs to the provisions of FIN 46(R) as amended by this statement. Based on our review of our December 31, 2009 information, the impact of adoption of ASU No. 2009-17 (SFAS No. 167) resulted in the consolidation of two securitization trusts, the 2007 Commercial Mortgage Securitization and the 1996 — 1999 Commercial Mortgage Securitization. Please refer to Note 4, Variable Interest Entities for more information regarding the consolidation of these two trusts.

 

Accounting Pronouncements Not Yet Adopted

 

ASU No. 2010-15 — Financial Services—Insurance — How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments. The amendments in this Update clarify that an insurance entity should not consider any separate account interests held for the benefit of policy holders in an investment to be the insurer’s interests. The entity should not combine general account and separate account interests in the same investment when assessing the investment for consolidation. Additionally, the amendments do not require an insurer to consolidate an investment in which a separate account holds a controlling financial interest if the investment is not or would not be consolidated in the standalone financial statements of the separate account. The amendments in this Update also provide guidance on how an insurer should consolidate an investment fund in situations in which the insurer concludes that consolidation is required. This Update is effective for fiscal years beginning after December 15, 2010. For the Company this Update will be effective January 1, 2011. The Company is currently evaluating the impact of this Update.

 

ASU No. 2010-20 — Receivables — Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The objective of this Update is to require disclosures that facilitate financial statement users in evaluating the nature of credit risk inherent in the portfolio of financing receivables (loans); how that risk is analyzed and assessed in arriving at the allowance for credit losses; and any changes and the reasons for those changes to the allowance for credit losses. The Update requires several new disclosures regarding the reserve for credit losses and other disclosures related to the credit quality of the Company’s mortgage loan portfolio. These new disclosure requirements will be effective for reporting periods ending on or after December 15, 2010. For the Company this will be December 31, 2010. This standard does not change current accounting for Financing Receivables and Loans, but only requires additional disclosures. The Company is evaluating the impact this Update will have on the footnotes to the financial statements.

 

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ASU No. 2010-26 — Financial Services — Insurance - Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The objective of this Update is to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. This Update prescribes that certain incremental direct costs of successful initial or renewal contract acquisitions may be deferred. It defines incremental direct costs as those costs that result directly from and are essential to the contract transaction and would not have been incurred by the insurance entity had the contract transaction not occurred. This Update also clarifies the definition of the types of incurred costs that may be capitalized and the accounting and recognition treatment of advertising, research, and other administrative costs related to the acquisition of insurance contracts. This Update is effective for periods beginning after December 15, 2011 and is to be applied prospectively. Early adoption and retrospective application are optional. The Company is currently evaluating the impact this Update will have on our financial position and results of operations.

 

Significant Accounting Policies

 

For a full description of significant accounting policies, see Note 2 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. There were no significant changes to the Company’s accounting policies during the nine months ended September 30, 2010, except as noted above.

 

3.             INVESTMENT OPERATIONS

 

Net realized investment gains (losses) for all other investments are summarized as follows:

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2010

 

September 30, 2010

 

 

 

(Dollars In Thousands)

 

Fixed maturities

 

$

17,861

 

$

30,237

 

Equity securities

 

 

13

 

Impairments on fixed maturity securities

 

(7,615

)

(36,282

)

Modco trading portfolio

 

96,689

 

204,749

 

Mortgage loans and other investments

 

(3,763

)

(8,609

)

 

 

$

103,172

 

$

190,108

 

 

For the three and nine months ended September 30, 2010, gross realized gains on investments available-for-sale (fixed maturities, equity securities, and short-term investments) were $18.5 million and $61.8 million and gross realized losses were $8.1 million and $67.6 million, including $7.5 million and $36.0 million of impairment losses, respectively. The $7.5 million and $36.0 million exclude $0.1 million and $0.3 million of impairment losses in the trading portfolio for the three and nine months ended September 30, 2010, respectively.

 

For the three and nine months ended September 30, 2010, the Company sold securities in an unrealized gain position with a fair value (proceeds) of $652.4 million and $2.4 billion, respectively. The gains realized on the sale of these securities were $18.5 million and $61.8 million, respectively.

 

For the three and nine months ended September 30, 2010, the Company sold securities in an unrealized loss position with a fair value (proceeds) of $207.8 million and $442.0 million, respectively. The loss realized on the sale of these securities was $0.6 million and $31.6 million, respectively. The $31.6 million loss recognized on available-for-sale securities for the nine months ended September 30, 2010, includes $12.2 million of loss on the sale of certain oil industry holdings. The Company made the decision to sell these securities due to circumstances regarding the oil spill in the Gulf of Mexico. In addition, a $3.8 million loss was recognized on the sale of securities of which the issuer was a European financial institution. Also included in the $31.6 million loss is a $10.4 million loss due to the exchange of certain holdings as the issuer exited bankruptcy proceedings.

 

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The amortized cost and estimated fair value of the Company’s investments classified as available-for-sale as of September 30, 2010, are as follows:

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Estimated

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

 

 

(Dollars In Thousands)

 

2010

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

Bonds

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

$

3,019,820

 

$

63,901

 

$

(193,082

)

$

2,890,639

 

Commercial mortgage-backed securities

 

165,073

 

9,447

 

 

174,520

 

Other asset-backed securities

 

867,648

 

1,625

 

(70,929

)

798,344

 

U.S. government-related securities

 

1,187,000

 

75,160

 

(91

)

1,262,069

 

Other government-related securities

 

195,446

 

8,074

 

(68

)

203,452

 

States, municipals, and political subdivisions

 

751,248

 

54,082

 

(577

)

804,753

 

Corporate bonds

 

14,280,879

 

1,426,469

 

(141,241

)

15,566,107

 

 

 

20,467,114

 

1,638,758

 

(405,988

)

21,699,884

 

Equity securities

 

317,194

 

14,366

 

(8,739

)

322,821

 

Short-term investments

 

412,166

 

 

 

412,166

 

 

 

$

21,196,474

 

$

1,653,124

 

$

(414,727

)

$

22,434,871

 

 

As of September 30, 2010, the Company had an additional $3.1 billion of fixed maturities, $12.3 million of equity securities, and $71.5 million of short-term investments classified as trading securities.

 

The amortized cost and fair value of available-for-sale fixed maturities as of September 30, 2010, by expected maturity, are shown below. Expected maturities of securities without a single maturity date are allocated based on estimated rates of prepayment that may differ from actual rates of prepayment.

 

 

 

Amortized

 

Fair

 

 

 

Cost

 

Value

 

 

 

(Dollars In Thousands)

 

Due in one year or less

 

$

482,217

 

$

491,959

 

Due after one year through five years

 

3,776,610

 

3,883,575

 

Due after five years through ten years

 

5,858,895

 

6,365,726

 

Due after ten years

 

10,349,392

 

10,958,624

 

 

 

$

20,467,114

 

$

21,699,884

 

 

Each quarter the Company reviews investments with unrealized losses and tests for other-than-temporary impairments. The Company analyzes various factors to determine if any specific other-than-temporary asset impairments exist. These include, but are not limited to: 1) actions taken by rating agencies, 2) default by the issuer, 3) the significance of the decline, 4) an assessment of the Company’s intent to sell the security (including a more likely than not assessment of whether the Company will be required to sell the security) before recovering the security’s amortized cost, 5) the time period during which the decline has occurred, 6) an economic analysis of the issuer’s industry, and 7) the financial strength, liquidity, and recoverability of the issuer. Management performs a security by security review each quarter in evaluating the need for any other-than-temporary impairments. Although no set formula is used in this process, the investment performance, collateral position, and continued viability of the issuer are significant measures considered, and in some cases, an analysis regarding the Company’s expectations for recovery of the security’s entire amortized cost basis through the receipt of future cash flows is performed. Once a determination has been made that a specific other-than-temporary impairment exists, the security’s basis is adjusted and an other-than-temporary impairment is recognized. Equity securities that are other-than-temporarily impaired are written down to fair value with a realized loss recognized in earnings. Other-than-temporary impairments to debt securities that the Company does not intend to sell and does not expect to be required to sell before recovering the security’s amortized cost are written down to discounted expected future cash flows (“post impairment cost”) and credit losses are recorded in earnings. The difference between the securities’ discounted expected future cash flows and the fair value of the securities is recognized in other comprehensive income (loss) as a non-credit portion of the recognized other-than-temporary impairment. When calculating the post impairment cost for residential mortgage-backed securities, commercial mortgage-backed securities, and other asset-backed securities, the Company considers all known market data related to cash flows to estimate future cash flows. When calculating the post

 

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impairment cost for corporate debt securities, the Company considers all contractual cash flows to estimate expected future cash flows. To calculate the post impairment cost, the expected future cash flows are discounted at the original purchase yield. Debt securities that the Company intends to sell or expects to be required to sell before recovery are written down to fair value with the change recognized in earnings.

 

During the three and nine months ended September 30, 2010, the Company recorded other-than-temporary impairments of investments of $12.9 million and $71.4 million, respectively. Of the $12.9 million of impairments for the three months ended September 30, 2010, $7.6 million was recorded in earnings and $5.3 million was recorded in other comprehensive income (loss). Of the $71.4 million of impairments for the nine months ended September 30, 2010, $36.3 million was recorded in earnings and $35.1 million was recorded in other comprehensive income (loss). For the three and nine months ended September 30, 2010, there were no other-than-temporary impairments related to equity securities. For the three and nine months ended September 30, 2010, there were $12.9 million and $71.4 million of other-than-temporary impairments related to debt securities, respectively. During these periods, there were no other-than-temporary impairments related to debt securities or equity securities that the Company intends to sell or expects to be required to sell.

 

The following chart is a rollforward of credit losses on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income (loss):

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(Dollars In Thousands)

 

Beginning balance

 

$

31,576

 

$

46,728

 

$

25,076

 

$

 

Additions for newly impaired securities

 

6,211

 

11,601

 

25,661

 

67,019

 

Additions for previously impaired securities

 

1,179

 

 

2,930

 

7,136

 

Reductions for previously impaired securities due to a change in expected cash flows

 

 

(16,625

)

 

(32,451

)

Reductions for previously impaired securities that were sold in the current period

 

(2,947

)

(17,949

)

(17,648

)

(17,949

)

Ending balance

 

$

36,019

 

$

23,755

 

$

36,019

 

$

23,755

 

 

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The following table includes investments’ gross unrealized losses and fair value of the Company’s investments that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2010:

 

 

 

Less Than 12 Months

 

12 Months or More

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Loss

 

Value

 

Loss

 

Value

 

Loss

 

 

 

(Dollars In Thousands)

 

Residential mortgage-backed securities

 

$

102,086

 

$

(18,161

)

$

1,418,476

 

$

(174,921

)

$

1,520,562

 

$

(193,082

)

Commercial mortgage-backed securities

 

 

 

 

 

 

 

Other asset-backed securities

 

55,705

 

(1,791

)

624,329

 

(69,138

)

680,034

 

(70,929

)

U.S. government-related securities

 

44,270

 

(91

)

 

 

44,270

 

(91

)

Other government-related securities

 

48,902

 

(58

)

19,990

 

(10

)

68,892

 

(68

)

States, municipals, and political subdivisions

 

24,423

 

(577

)

 

 

24,423

 

(577

)

Corporate bonds

 

372,139

 

(25,063

)

1,211,768

 

(116,178

)

1,583,907

 

(141,241

)

Equities

 

11,916

 

(3,833

)

12,430

 

(4,906

)

24,346

 

(8,739

)

 

 

$

659,441

 

$

(49,574

)

$

3,286,993

 

$

(365,153

)

$

3,946,434

 

$

(414,727

)

 

The residential mortgage-backed securities (“RMBS”) have a gross unrealized loss greater than twelve months of $174.9 million as of September 30, 2010. These losses relate to a widening in spreads and defaults as a result of continued weakness in the residential housing market which have reduced the fair value of the RMBS holdings. Factors such as the credit enhancement within the deal structure, the average life of the securities, and the performance of the underlying collateral support the recoverability of the investments.

 

The corporate bonds category has gross unrealized losses greater than twelve months of $116.2 million as of September 30, 2010. These losses relate primarily to fluctuations in credit spreads. The aggregate decline in market value of these securities was deemed temporary due to positive factors supporting the recoverability of the respective investments. Positive factors considered include credit ratings, the financial health of the issuer, the continued access of the issuer to capital markets, and other pertinent information including the Company’s ability and intent to hold these securities to recovery.

 

The other asset-backed securities have a gross unrealized loss greater than twelve months of $69.1 million as of September 30, 2010. This category predominately includes student-loan backed auction rate securities whose underlying collateral is at least 97% guaranteed by the Federal Family Education Loan Program (“FFELP”). These losses relate to the auction rate securities (“ARS”) market collapse during 2008. At this time, the Company has no reason to believe that the U.S. Department of Education would not honor the FFELP guarantee, if it were necessary. In addition, the Company has the ability and intent to hold these securities until their values recover or maturity.

 

The Company does not consider these unrealized loss positions to be other-than-temporary, based on the factors discussed and because the Company has the ability and intent to hold these investments until the fair values recover, and does not intend to sell or expect to be required to sell the securities before recovering the Company’s amortized cost of debt securities.

 

As of September 30, 2010, the Company had securities in its available-for-sale portfolio which were rated below investment grade of $3.0 billion and had an amortized cost of $3.3 billion. In addition, included in the Company’s trading portfolio, the Company held $362.0 million of securities which were rated below investment grade. Approximately $563.1 million of the below investment grade securities were not publicly traded.

 

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The change in unrealized gains (losses), net of income tax, on fixed maturity and equity securities, classified as available-for-sale is summarized as follows:

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2010

 

September 30, 2010

 

 

 

(Dollars In Thousands)

 

Fixed maturities

 

$

472,191

 

$

1,059,929

 

Equity securities

 

13,970

 

6,986

 

 

4.                                      VARIABLE INTEREST ENTITIES

 

In June of 2009, the FASB amended the guidance related to VIEs which was later codified in the ASC through ASU No. 2009-17. Among other accounting and disclosure requirements, this guidance replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a VIE with an approach focused on identifying which enterprise has the power to direct the activities of a VIE that most significantly impact its economics and the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. Additionally, the FASB amended the guidance related to accounting for transfers of financial assets which was later codified in the ASC through ASU No. 2009-16. This guidance, among other requirements, removed the concept of a QSPE used for the securitization of financial assets. Previously, QSPEs were excluded from the guidance related to VIEs. Upon adoption of ASU No. 2009-17 and ASU No. 2009-16 on January 1, 2010, the Company will no longer exclude QSPEs from the analysis of VIEs.

 

As part of adopting these updates, the Company updated its process for evaluating VIEs. The Company’s analysis consists of a review of entities in which the Company has an ownership interest that is less than 100% (excluding debt and equity securities held as trading and available-for-sale), as well as entities with which the Company has significant contracts or other relationships that could possibly be considered variable interests. The Company reviews the characteristics of each of these applicable entities and compares those characteristics to the criteria of a VIE set forth in Topic 810 of the FASB ASC. If the entity is determined to be a VIE, the Company then performs a detailed review of all significant contracts and relationships (individually an “interest”, collectively “interests”) with the entity to determine whether the interest would be considered a variable interest under the guidance. The Company then performs a qualitative review of all variable interests with the entity and determines whether the Company: 1) has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and 2) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.

 

Based on this analysis the Company had interests in two former QSPEs that were determined to be VIEs as of January 1, 2010. These two VIEs were trusts used to facilitate commercial mortgage loan securitizations. The determining factor was that the trusts had negligible or no equity at risk. The Company’s variable interests in the trusts are created by the contract to service the mortgage loans held by the trusts as well as the retained beneficial interests in certain of these securities issued by the trusts. The activities that most significantly impact the economics of the trusts are predominantly related to the servicing of the mortgage loans, such as timely collection of principal and interest, direction of foreclosure proceedings, and management and sale of foreclosed real estate owned by the trusts. The Company is the servicer responsible for these activities and has the sole power to appoint such servicer through its beneficial interests in the securities. These criteria give the Company the power to direct the activities of the trusts that most significantly impact the trusts economic performance. Additionally, the Company is obligated, as an owner of the securities issued by the trusts, to absorb its share of losses on the securities. The Company’s share of losses could potentially be significant to the trusts. Based on the fact that the Company has the power to direct the activities that most significantly impact the economics of the trusts and the obligation to absorb losses that could potentially be significant, it was determined that the Company is the primary beneficiary of the trusts, thus resulting in consolidation.

 

The assets of the trusts consist entirely of commercial mortgage loans and accrued interest, which are restricted and can only be used to satisfy the obligations of the trusts. The obligations of the trusts consist of commercial mortgage-backed certificates. The assets and obligations of the trusts are equal and thus, the trusts have no equity interest. The certificates are direct obligations of the trusts and are not guaranteed by the Company. The Company has no other obligations to the trusts other than those that are customary for a servicer of mortgage loans.

 

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Over the life of the trusts, the Company has not provided and will not provide any financial or other support to the trusts other than customary actions taken by a servicer of mortgage loans.

 

The following adjustments to the Company’s consolidated condensed balance sheet were made as of January 1, 2010:

 

Adjustments to the Consolidated Condensed Balance Sheets

 

 

 

As of

 

 

 

January 1, 2010

 

 

 

(Dollars In Thousands)

 

Assets

 

 

 

Fixed maturities:

 

 

 

Commercial mortgage-backed securities at fair value (amortized cost - $873,196)

 

$

(844,535

)(1)

Mortgage loans - securitized (net of loan loss reserve of $1.1 million)

 

1,018,000

(2)

Total investments

 

173,465

 

Accrued investment income

 

361

(2)

Total Assets

 

$

173,826

 

Liabilities

 

 

 

Deferred income taxes

 

$

17,744

(3)

Mortgage loan backed certificates

 

124,580

(2)

Other liabilities

 

(1,400

)(4)

Total liabilities

 

140,924

 

Shareowners’ equity

 

 

 

Retained earnings

 

14,290

(2)

Accumulated other comprehensive income (loss)

 

18,612

(5)

Total shareowners’ equity

 

32,902

 

Total liabilities and shareowners’ equity

 

$

173,826

 

 

(1) The noncash portion for the consolidated condensed statements of cash flows for the three months ended March 31, 2010, was $873.2 million.

(2) The noncash portion for the consolidated condensed statements of cash flows for the three months ended March 31, 2010, is the amount presented.

(3) The noncash portion for the consolidated condensed statements of cash flows for the three months ended March 31, 2010, was $7.7 million.

(4) The other liabilities did not have an effect on the consolidated condensed statements of cash flows for the three months ended March 31, 2010.

(5) The accumulated other comprehensive income (loss) did not have an effect on the consolidated condensed statements of cash flows for the three months ended March 31, 2010.

 

The adjustments had a net zero impact to the consolidated condensed statements of cash flows.

 

The reduction in fixed maturity commercial mortgage-backed securities (“CMBS”) represents the beneficial interests held by the Company that have been removed due to the consolidation of the trusts. This amount is reflected in fixed maturities on the consolidated condensed balance sheet.

 

The increase in mortgage loans represents the mortgage loans held by the trusts that have been consolidated. This balance is net of a loan loss reserve of $1.1 million.

 

The increase in accrued investment income is the result of accruing interest on the entire pool of mortgage loans.

 

The increase in deferred income taxes is a result of a change in temporary tax differences arising from the adjustments to shareowners’ equity.

 

The mortgage loan backed certificates liability represents the commercial mortgage-backed securities issued by the trusts and held by third parties.

 

The decrease in other liabilities is a decrease in amounts payable to the trusts of approximately $1.4 million. Upon consolidation of the trusts as of January 1, 2010, the Company adjusted retained earnings to reflect after tax interest income not recognized in prior periods due to the securitization of the commercial mortgage loans. If the Company had held the mortgage loans as opposed to the retained beneficial interest securities, the Company’s retained earnings would have been $14.3 million higher over the life of the securities.

 

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The adjustment to accumulated other comprehensive income (loss) was a result of different accounting basis for mortgage loans and the CMBS. As of December 31, 2009, the retained beneficial interest securities were carried at fair value in the balance sheet and had an after tax unrealized loss in accumulated other comprehensive income (loss) of $18.6 million. Upon consolidation of the trusts on January 1, 2010, the Company consolidated the mortgage loans held by the trusts which are carried at amortized cost less any related loan loss reserve. The retained beneficial interest securities as well as the associated unrealized loss were eliminated in consolidation.

 

5.             GOODWILL

 

During the nine months ended September 30, 2010, the Company decreased its goodwill balance by approximately $2.3 million. The decrease was due to adjustments in the Acquisitions segment related to tax benefits realized during 2010 on the portion of tax goodwill in excess of GAAP basis goodwill. As of September 30, 2010, the Company had an aggregate goodwill balance of $115.5 million.

 

Accounting for goodwill requires an estimate of the future profitability of the associated lines of business to assess the recoverability of the capitalized acquisition goodwill. The Company evaluates the carrying value of goodwill at the segment (or reporting unit) level at least annually and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to: 1) a significant adverse change in legal factors or in business climate, 2) unanticipated competition, or 3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company compared its estimate of the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The Company utilizes a fair value measurement (which includes a discounted cash flows analysis) to assess the carrying value of the reporting units in consideration of the recoverability of the goodwill balance assigned to each reporting unit as of the measurement date. The Company’s material goodwill balances are attributable to its operating segments (which are considered to be reporting units). The cash flows used to determine the fair value of the Company’s reporting units are dependent on a number of significant assumptions. The Company’s estimates are subject to change given the inherent uncertainty in predicting future results and cash flows, which are impacted by such things as policyholder behavior, competitor pricing, capital limitations, new product introductions, and specific industry and market conditions. Additionally, the discount rate used is based on the Company’s judgment of the appropriate rate for each reporting unit based on the relative risk associated with the projected cash flows. As of December 31, 2009, the Company performed its annual evaluation of goodwill and determined that no adjustment to impair goodwill was necessary.

 

The Company also considers its market capitalization in assessing the reasonableness of the fair values estimated for its reporting units in connection with its goodwill impairment testing. In considering the Company’s September 30, 2010 common equity price, which was lower than its book value per share, the Company noted there are several factors that would result in its market capitalization being lower than the fair value of its reporting units that are tested for goodwill impairment. Such factors that would not be reflected in the valuation of the Company’s reporting units with goodwill include, but are not limited to: a potential concern about future earnings growth; negative market sentiment, different valuation methodologies that resulted in low valuation, and increased risk premium for holding investments in mortgage-backed securities and commercial mortgage loans. Deterioration of or adverse market conditions for certain businesses may have a significant impact on the fair value of the Company’s reporting units. In the Company’s view, the decline in market capitalization does not invalidate the Company’s fair value assessment related to the recoverability of goodwill in its reporting units, and did not result in a triggering or impairment event.

 

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6.             DEBT AND OTHER OBLIGATIONS

 

Non-recourse funding obligations outstanding as of September 30, 2010, on a consolidated basis, are shown in the following table:

 

 

 

 

 

 

 

Year-to-Date

 

 

 

 

 

 

 

Weighted-Avg

 

Issuer

 

Balance

 

Maturity Year

 

Interest Rate

 

 

 

(Dollars In Thousands)

 

Golden Gate II Captive Insurance Company

 

$

548,000

 

2052

 

1.49

%

 

Golden Gate II Captive Insurance Company (“Golden Gate II”), a special purpose financial captive insurance company wholly owned by Protective Life Insurance Company (“PLICO”), had $575 million of outstanding non-recourse funding obligations as of September 30, 2010. Of this amount, $548.0 million were owned by external parties and $27.0 million were owned by affiliates.

 

7.             COMMITMENTS AND CONTINGENCIES

 

The Company has entered into indemnity agreements with each of its current directors that provides, among other things and subject to certain limitations, a contractual right to indemnification to the fullest extent permissible under the law. The Company has agreements with certain of its officers providing up to $10 million in indemnification. These obligations are in addition to the customary obligation to indemnify officers and directors contained in the Company’s governance documents.

 

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

 

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

 

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8.                                      COMPREHENSIVE INCOME (LOSS)

 

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

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(Dollars In Thousands)

 

Net income

 

$

70,371

 

$

27,585

 

$

181,321

 

$

140,477

 

Change in net unrealized gains (losses) on investments, net of income tax: (three months: 2010 - $211,169; 2009 - $342,694; nine months: 2010 - $484,424; 2009 - $655,781)

 

392,180

 

626,065

 

898,995

 

1,192,473

 

Change in net unrealized gains (losses) relating to other-than-temporary impaired investments for which a portion has been recognized in earnings, net of income tax: (three months: 2010 - $19,461; 2009 - $5,633; nine months: 2010 - $9,006; 2009 - $(6,755))

 

36,141

 

10,462

 

16,725

 

(12,544

)

Change in accumulated (loss) gain - derivatives, net of income tax: (three months: 2010 - $1,951; 2009 - $1,833; nine months: 2010 - $2,145; 2009 - $12,154)

 

3,581

 

3,299

 

3,347

 

21,877

 

Minimum pension liability adjustment, net of income tax: (three months: 2010 - $325; 2009 - $178; nine months: 2010 - $974; 2009 - $533)

 

603

 

329

 

1,808

 

989

 

Reclassification adjustment for investment amounts included in net income, net of income tax: (three months: 2010 - $(3,583); 2009 - $9,367; nine months: 2010 - $2,036; 2009 - $48,890)

 

(6,663

)

17,290

 

3,996

 

89,443

 

Reclassification adjustment for derivative amounts included in net income, net of income tax: (three months: 2010 - $(760); 2009 - $(666); nine months: 2010 - $(966); 2009 - $(363))

 

(1,368

)

(1,198

)

(1,738

)

(654

)

Comprehensive income (loss)

 

494,845

 

683,832

 

1,104,454

 

1,432,061

 

Comprehensive income (loss) attributable to noncontrolling interests

 

77

 

 

277

 

 

Comprehensive income (loss) attributable to Protective Life Corporation

 

$

494,922

 

$

683,832

 

$

1,104,731

 

$

1,432,061

 

 

9.             STOCK-BASED COMPENSATION

 

The criteria for payment of performance awards is based primarily upon a comparison of the Company’s average return on average equity over a four-year period (earlier upon the death, disability, or retirement of the executive, or in certain circumstances, upon a change in control of the Company) to that of a comparison group of publicly held life and multi-line insurance companies. For the 2008 awards, if the Company’s results are below the 25th percentile of the comparison group, no portion of the award is earned. For the 2005-2007 awards, if the Company’s results are below the 40th percentile of the comparison group, no portion of the award is earned. If the Company’s results are at or above the 90th percentile, the award maximum is earned. Awards are paid in shares of the Company’s Common Stock. There were no performance share awards issued during the nine months ended September 30, 2010 or 2009.

 

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

 

 

 

Weighted-Average

 

 

 

 

 

Base Price per share

 

No. of SARs

 

Balance as of December 31, 2009

 

$

22.28

 

2,469,202

 

SARs granted

 

18.34

 

344,400

 

SARs exercised / forfeited / expired

 

21.11

 

(457,404

)

Balance as of September 30, 2010

 

$

21.93

 

2,356,198

 

 

The SARs issued for the nine months ended September 30, 2010, had estimated fair values at grant date of $3.3 million. These fair values were estimated using a Black-Scholes option pricing model. The assumptions used in

 

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this pricing model varied depending on the vesting period of awards. Assumptions used in the model for the 2010 SARs granted (the simplified method under the ASC Compensation-Stock Compensation Topic was used for the 2010 awards) were as follows: an expected volatility of 69.4%, a risk-free interest rate of 2.6%, a dividend rate of 2.4%, a zero percent forfeiture rate, and an expected exercise date of 2016. The Company will pay an amount in stock equal to the difference between the specified base price of the Company’s common stock and the market value at the exercise date for each SAR.

 

Additionally, the Company issued 360,450 restricted stock units for the nine months ended September 30, 2010. These awards had a total fair value at grant date of $6.6 million. Approximately half of these restricted stock units vest in 2013, and the remainder vest in 2014.

 

10.          EMPLOYEE BENEFIT PLANS

 

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

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(Dollars In Thousands)

 

Service cost — benefits earned during the period

 

$

2,068

 

$

1,889

 

$

6,204

 

$

5,667

 

Interest cost on projected benefit obligation

 

2,357

 

2,395

 

7,071

 

7,185

 

Expected return on plan assets

 

(2,312

)

(2,531

)

(6,936

)

(7,593

)

Amortization of prior service cost

 

(98

)

(98

)

(294

)

(294

)

Amortization of actuarial losses

 

1,026

 

568

 

3,078

 

1,704

 

Total benefit cost

 

$

3,041

 

$

2,223

 

$

9,123

 

$

6,669

 

 

During the nine months ended September 30, 2010, the Company made a $6.5 million contribution to its defined benefit pension plan for the 2009 plan year and a $0.2 million contribution to its defined benefit pension plan for the 2010 plan year. In addition, during October of 2010, the Company contributed $1.6 million to the defined benefit pension plan for the 2010 plan year. The Company will continue to make contributions in future periods as necessary to at least satisfy minimum funding requirements. The Company may also make additional contributions in future periods to maintain an adjusted funding target percentage of at least 80%.

 

In addition to pension benefits, the Company provides life insurance benefits to eligible retirees and limited healthcare benefits to eligible retirees who are not yet eligible for Medicare. For a closed group of retirees over age 65, the Company provides a prescription drug benefit. The cost of these plans for the nine months ended September 30, 2010, was immaterial to the Company’s financial statements.

 

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11.                               EARNINGS PER SHARE

 

Basic earnings per share is computed by dividing net income available to PLC’s common shareowners by the weighted-average number of common shares outstanding during the period, including shares issuable under various deferred compensation plans. Diluted earnings per share is computed by dividing net income available to PLC’s common shareowners by the weighted-average number of common shares and dilutive potential common shares outstanding during the period, assuming the shares were not anti-dilutive, including shares issuable under various stock-based compensation plans and stock purchase contracts.

 

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

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(Dollars In Thousands, Except Per Share Amounts)

 

Calculation of basic earnings per share:

 

 

 

 

 

 

 

 

 

Net income available to PLC’s common shareowners

 

$

70,448

 

$

27,585

 

$

181,598

 

$

140,477

 

 

 

 

 

 

 

 

 

 

 

Average shares issued and outstanding

 

85,662,988

 

85,579,525

 

85,628,404

 

77,557,599

 

Issuable under various deferred compensation plans

 

940,581

 

901,715

 

927,357

 

908,086

 

Weighted shares outstanding - Basic

 

86,603,569

 

86,481,240

 

86,555,761

 

78,465,685

 

 

 

 

 

 

 

 

 

 

 

Per share:

 

 

 

 

 

 

 

 

 

Net income available to PLC’s common shareowners - basic

 

$

0.81

 

$

0.32

 

$

2.10

 

$

1.79

 

 

 

 

 

 

 

 

 

 

 

Calculation of diluted earnings per share:

 

 

 

 

 

 

 

 

 

Net income available to PLC’s common shareowners

 

$

70,448

 

$

27,585

 

$

181,598

 

$

140,477

 

 

 

 

 

 

 

 

 

 

 

Weighted shares outstanding - Basic

 

86,603,569

 

86,481,240

 

86,555,761

 

78,465,685

 

Stock appreciation rights (“SARs”)(1)

 

468,886

 

446,269

 

466,511

 

332,604

 

Issuable under various other stock-based compensation plans

 

110,102

 

111,244

 

134,299

 

136,784

 

Restricted stock units

 

519,035

 

333,906

 

483,650

 

221,232

 

Weighted shares outstanding - Diluted

 

87,701,592

 

87,372,659

 

87,640,221

 

79,156,305

 

 

 

 

 

 

 

 

 

 

 

Per share:

 

 

 

 

 

 

 

 

 

Net income available to PLC’s common shareowners - diluted

 

$

0.80

 

$

0.32

 

$

2.07

 

$

1.77

 

 

(1) Excludes 1,475,645 and 1,558,373 as of September 30, 2010 and 2009, respectively, that are antidilutive. In the event the average market price exceeds the issue price of the SARs, such rights would be dilutive to the Company’s earnings per share and will be included in the Company’s calculation of the diluted average shares outstanding for applicable periods.

 

12.                               INCOME TAXES

 

During the three months ended September 30, 2010, earnings were impacted favorably by $0.7 million due to the release of an unrecognized income tax benefit liability that related to a compensation-related tax issue. The measurement of the unrecognized tax benefit was recently reassessed due to recent developments related to the issue, and the Company now believes that the full amount of the tax benefit has a greater than 50% chance of being fully realized. During the nine months ended September 30, 2010, earnings were impacted favorably by $3.3 million due to the aforementioned issue, the release of an unrecognized income tax benefit liability that related to a tax-basis policy liability issue, and the closing of the 2005 tax year’s statute of limitations. The Company reassessed the tax-basis policy liability issue due to recent technical guidance that confirmed the Company’s historical calculations. Within the next twelve months, the Company does not expect to have any material adjustments to its unrecognized income tax benefits liability with regard to any of the tax jurisdictions in which it conducts its business operations.

 

The Company has computed its effective income tax rate for the three and nine months ended September 30, 2010, based upon its estimate of its annual 2010 income. For the three and nine months ended September 30, 2009, due to the unpredictability at that time of future investment losses and certain elements of operating income, the Company was not able to reasonably estimate an expected annual effective tax rate. Instead, the Company computed an effective income tax rate based upon year-to-date reported income. The effective tax rate for the three

 

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and nine months ended September 30, 2010, was 34.2% and 33.5%, respectively, and 33.7% and 34.4% for the three and nine months ended September 30, 2009, respectively.

 

Based on the Company’s current assessment of future taxable income, including available tax planning opportunities, the Company anticipates that it is more likely than not that it will generate sufficient taxable income to realize all of its material deferred tax assets.  The Company did not record a valuation allowance against its material deferred tax assets as of September 30, 2010.

 

13.                               FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Effective January 1, 2008, the Company determined the fair value of its financial instruments based on the fair value hierarchy established in FASB guidance referenced in the Fair Value Measurements and Disclosures Topic which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. In the first quarter of 2009, the Company adopted the provisions from the FASB guidance that is referenced in the Fair Value Measurements and Disclosures Topic for non-financial assets and liabilities (such as property and equipment, goodwill, and other intangible assets) that are required to be measured at fair value on a periodic basis. The effect on the Company’s periodic fair value measurements for non-financial assets and liabilities was not material.

 

The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three level hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.

 

Financial assets and liabilities recorded at fair value on the consolidated condensed balance sheets are categorized as follows:

 

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

 

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

 

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

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

c)         Inputs other than quoted market prices that are observable

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

 

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

 

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The following table presents the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis as of September 30, 2010: