-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WjZbmkms/sn7eR+KsMLAyfZXIP6Pyjq5cE++ODsFhvSefhMW46o3Xh1Ge6rDzbcd ej9Hugu2sl3W1zhHYT0txA== 0001017062-02-000893.txt : 20020509 0001017062-02-000893.hdr.sgml : 20020509 ACCESSION NUMBER: 0001017062-02-000893 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 20020509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SEPARATE ACCOUNT A OF PACIFIC LIFE INSURANCE CO CENTRAL INDEX KEY: 0000935823 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 333-93059 FILM NUMBER: 02640020 BUSINESS ADDRESS: STREET 1: P O BOX 7500 CITY: NEWPORT BEACH STATE: CA ZIP: 92658-7500 BUSINESS PHONE: 7146403743 MAIL ADDRESS: STREET 1: P O BOX 7500 CITY: NEWPORT BEACH STATE: CA ZIP: 92658-7500 FORMER COMPANY: FORMER CONFORMED NAME: SEPARATE ACCOUNT A OF PACIFIC MUTUAL LIFE INS CO DATE OF NAME CHANGE: 19950119 497 1 d497.txt PACIFIC LIFE - INNOVATIONS & INNOVATIONS SELECT SAI STATEMENT OF ADDITIONAL INFORMATION May 1, 2002 PACIFIC INNOVATIONS SEPARATE ACCOUNT A --------------- Pacific Innovations (the "Contract") is a variable annuity contract underwritten by Pacific Life Insurance Company ("Pacific Life"). This Statement of Additional Information (SAI) is not a Prospectus and should be read in conjunction with the Contract's Prospectus, dated May 1, 2002 which is available without charge upon written or telephone request to Pacific Life. Terms used in this SAI have the same meanings as in the Prospectus, and some additional terms are defined particularly for this SAI. --------------- Pacific Life Insurance Company Mailing Address: P.O. Box 7187 Pasadena, California 91109-7187 1-800-722-2333 TABLE OF CONTENTS
Page No. -------- PERFORMANCE............................................................ 1 Total Returns........................................................ 1 Yields............................................................... 2 Performance Comparisons and Benchmarks............................... 3 Separate Account Performance......................................... 4 DISTRIBUTION OF THE CONTRACTS.......................................... 8 Pacific Select Distributors, Inc. (PSD).............................. 8 THE CONTRACTS AND THE SEPARATE ACCOUNT................................. 9 Calculating Subaccount Unit Values................................... 9 Variable Annuity Payment Amounts..................................... 9 Corresponding Dates.................................................. 11 Age and Sex of Annuitant............................................. 11 Systematic Transfer Programs......................................... 12 Pre-Authorized Withdrawals........................................... 14 Death Benefit........................................................ 14 1035 Exchanges....................................................... 14 Safekeeping of Assets................................................ 14 FINANCIAL STATEMENTS .................................................. 15 INDEPENDENT AUDITORS .................................................. 15
PERFORMANCE From time to time, our reports or other communications to current or prospective Contract Owners or our advertising or other promotional material may quote the performance (yield and total return) of a Subaccount. Quoted results are based on past performance and reflect the performance of all assets held in that Subaccount for the stated time period. Quoted results are neither an estimate nor a guarantee of future investment performance, and do not represent the actual experience of amounts invested by any particular Contract Owner. Total Returns A Subaccount may advertise its "average annual total return" over various periods of time. "Total return" represents the average percentage change in value of an investment in the Subaccount from the beginning of a measuring period to the end of that measuring period. "Annualized" total return assumes that the total return achieved for the measuring period is achieved for each such period for a full year. "Average annual" total return is computed in accordance with a standard method prescribed by the SEC. Average Annual Total Return To calculate a Subaccount's average annual total return for a specific measuring period, we first take a hypothetical $1,000 investment in that Subaccount, at its then-applicable Subaccount Unit Value (the "initial payment") and we compute the ending redeemable value of that initial payment at the end of the measuring period based on the investment experience of that Subaccount ("full withdrawal value"). The full withdrawal value reflects the effect of all recurring fees and charges applicable to a Contract Owner under the Contract, including the Risk Charge, and the Administrative Fee and the deduction of the applicable withdrawal charge, but does not reflect any charges for applicable premium taxes, any non-recurring fees or charges or any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders. The Annual Fee is also taken into account, assuming an average Contract Value of $65,000. The redeemable value is then divided by the initial payment and this quotient is raised to the 365/N power (N represents the number of days in the measuring period), and 1 is subtracted from this result. Average annual total return is expressed as a percentage. T = (ERV/P)(to the power of 365/N) - 1 where T = average annual total return ERV = ending redeemable value P = hypothetical initial payment of $1,000 N = number of days Average annual total return figures will be given for recent one-, three-, five-and ten-year periods (if applicable), and may be given for other periods as well (such as from commencement of the Subaccount's operations, or on a year-by-year basis). When considering "average" total return figures for periods longer than one year, it is important to note that the relevant Subaccount's annual total return for any one year in the period might have been greater or less than the average for the entire period. Aggregate Total Return A Subaccount may use "aggregate" total return figures along with its "average annual" total return figures for various periods; these figures represent the cumulative change in value of an investment in the Subaccount for a specific period. Aggregate total returns may be shown by means of schedules, charts or graphs and may indicate subtotals of the various components of total return. The SEC has not prescribed standard formulas for calculating aggregate total return. Total returns may also be shown for the same periods that do not take into account the withdrawal charge. 1 Non-Standardized Total Returns We may also calculate non-standardized total returns which may or may not reflect any Annual Fee, withdrawal charges and/or increases in Risk Charges, charges for premium taxes, and any non-recurring fees or charges. Standardized return figures will always accompany any non-standardized returns shown. Yields Money Market Subaccount The "yield" (also called "current yield") of the Money Market Subaccount is computed in accordance with a standard method prescribed by the SEC. The net change in the Subaccount's Unit Value during a seven-day period is divided by the Unit Value at the beginning of the period to obtain a base rate of return. The current yield is generated when the base rate is "annualized" by multiplying it by the fraction 365/7; that is, the base rate of return is assumed to be generated each week over a 365-day period and is shown as a percentage of the investment. The "effective yield" of the Money Market Subaccount is calculated similarly but, when annualized, the base rate of return is assumed to be reinvested. The effective yield will be slightly higher than the current yield because of the compounding effect of this assumed reinvestment. The formula for effective yield is: [(Base Period Return +1) (To the power of 365/7)] - 1. Realized capital gains or losses and unrealized appreciation or depreciation of the assets of the underlying Money Market Portfolio are not included in the yield calculation. Current yield and effective yield do not reflect any deduction of charges for any applicable premium taxes, or any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders, but do reflect a deduction for the Annual Fee, the Risk Charge and the Administrative Fee and assumes an average Contract Value of $65,000. At December 31, 2001, the Money Market Subaccount's current yield was 0.25% and the effective yield was 0.25%. Other Subaccounts "Yield" of the other Subaccounts is computed in accordance with a different standard method prescribed by the SEC. The net investment income (investment income less expenses) per Subaccount Unit earned during a specified one-month or 30-day period is divided by the Subaccount Unit Value on the last day of the specified period. This result is then annualized (that is, the yield is assumed to be generated each month or each 30-day period for a year), according to the following formula, which assumes semiannual compounding: YIELD = 2[(a-b + 1)(To the power of 6) - 1] --- cd where: a = net investment income earned during the period by the Portfolio attributable to the Subaccount. b = expenses accrued for the period (net of reimbursements). c = the average daily number of Subaccount Units outstanding during the period that were entitled to receive dividends. d = the Unit Value of the Subaccount Units on the last day of the period. The yield of each Subaccount reflects the deduction of all recurring fees and charges applicable to the Subaccount, such as the Risk Charge, and Administrative Fee, the Annual Fee (assuming an average Contract Value of $65,000), but does not reflect any withdrawal charge, any charge for applicable premium taxes, any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders, or any non-recurring fees or charges. The Subaccounts' yields will vary from time to time depending upon market conditions, the composition of each Portfolio and operating expenses of the Fund allocated to each Portfolio. Consequently, any given performance quotation should not be considered representative of the Subaccount's performance in the future. Yield should also 2 be considered relative to changes in Subaccount Unit Values and to the relative risks associated with the investment policies and objectives of the various Portfolios. In addition, because performance will fluctuate, it may not provide a basis for comparing the yield of a Subaccount with certain bank deposits or other investments that pay a fixed yield or return for a stated period of time. Performance Comparisons and Benchmarks In advertisements and sales literature, we may compare the performance of some or all of the Subaccounts to the performance of other variable annuity issuers in general and to the performance of particular types of variable annuities investing in mutual funds, or series of mutual funds, with investment objectives similar to each of the Subaccounts. This performance may be presented as averages or rankings compiled by Lipper Analytical Services, Inc. ("Lipper"), the Variable Annuity Research and Data Service ("VARDS(R)") or Morningstar, Inc. ("Morningstar"), which are independent services that monitor and rank the performance of variable annuity issuers and mutual funds in each of the major categories of investment objectives on an industry-wide basis. Lipper's rankings include variable life issuers as well as variable annuity issuers. VARDS(R) rankings compare only variable annuity issuers. The performance analyses prepared by Lipper and VARDS(R) rank such issuers on the basis of total return, assuming reinvestment of dividends and distributions, but do not take sales charges, redemption fees or certain expense deductions at the separate account level into consideration. In addition, VARDS(R) prepares risk adjusted rankings, which consider the effects of market risk on total return performance. We may also compare the performance of the Subaccounts with performance information included in other publications and services that monitor the performance of insurance company separate accounts or other investment vehicles. These other services or publications may be general interest business publications such as The Wall Street Journal, Barron's, Business Week, Forbes, Fortune, and Money. In addition, our reports and communications to Contract Owners, advertisements, or sales literature may compare a Subaccount's performance to various benchmarks that measure the performance of a pertinent group of securities widely regarded by investors as being representative of the securities markets in general or as being representative of a particular type of security. We may also compare the performance of the Subaccounts with that of other appropriate indices of investment securities and averages for peer universes of funds or data developed by us derived from such indices or averages. Unmanaged indices generally assume the reinvestment of dividends or interest but do not generally reflect deductions for investment management or administrative costs and expenses. 3 Separate Account Performance The Contract was not available prior to 2001. However, in order to help you understand how investment performance can affect your Variable Account Value, we are including performance information based on the historical performance of the Subaccounts. The following table presents the annualized total return for each Variable Account for the period from each such Variable Account's commencement of operations through December 31, 2001. The accumulated value (AV) reflects the deductions for all contractual fees and charges, but does not reflect the withdrawal charge, any nonrecurring fees and charges, any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders, or any charges for premium. The full withdrawal value (FWV) reflects the deductions for all contractual fees and charges, but does not reflect any increase in the Risk Charge for an optional Death Benefit Rider, any charge for the optional EEG or GPA Riders, any nonrecurring fees or charges, and any charges for premium taxes. The results shown in this section are not an estimate or guarantee of future investment performance. Historical Separate Account Performance Annualized Rates of Return for Periods Ended December 31, 2001 All numbers are expressed as a percentage
Since 1 Year 3 Years 5 Years Inception -------------- ------------- ------------ -------------- Variable Accounts AV FWV AV FWV AV FWV AV FWV - ----------------- ------ ------ ----- ------ ----- ----- ------ ------ Blue Chip 1/2/01*....... (19.71) (27.81) (19.71) (27.81) Aggressive Growth 1/2/01*................ (20.90) (29.00) (20.90) (29.00) Emerging Markets 4/17/96*............... (9.96) (18.06) (4.73) (6.83) (9.60) (9.60) (9.30) (9.31) Diversified Research 1/3/00*................ (4.10) (12.20) 2.10 (1.10) Small-Cap Equity 10/1/99*............... (3.91) (12.01) (2.69) (5.31) International Large-Cap 1/3/00*................ (19.44) (27.54) (21.11) (25.31) I-Net Tollkeeper 5/1/00*................ (34.86) (42.96) (39.06) (44.61) Financial Services 1/2/01*................ (8.58) (16.68) (8.58) (16.68) Health Sciences 1/2/01*................ (8.98) (17.08) (8.98) (17.08) Technology 1/2/01*...... (41.77) (49.91) (41.77) (49.91) Telecommunications 1/2/01*................ (47.47) (55.61) (47.47) (55.61) Multi-Strategy 1/2/96*.. (2.54) (10.64) 0.74 (1.14) 7.04 7.04 7.58 7.58 Large-Cap Core 1/2/96 (formerly called Equity Income)*............... (10.15) (18.25) (2.63) (4.64) 7.47 7.47 8.94 8.94 Strategic Value 10/2/00*............... (11.13) (19.23) (10.88) (16.20) Growth LT 1/2/96*....... (30.59) (38.69) 1.56 (0.28) 12.34 12.34 12.96 12.96 Focused 30 10/2/00*..... (14.57) (22.67) (24.65) (30.25) Mid-Cap Value 1/4/99*... 11.72 3.62 12.65 11.15 International Value 1/2/96*................ (22.97) (31.07) (6.59) (8.78) (1.77) (1.77) 1.34 1.34 Capital Opportunities 1/2/01*................ (16.72) (24.82) (16.72) (24.82) Mid-Cap Growth 1/2/01*.. (19.95) (28.05) (19.95) (28.05) Global Growth 1/2/01*... (16.16) (24.26) (16.16) (24.26) Equity Index 1/2/96*.... (13.38) (21.48) (2.69) (4.70) 8.88 8.88 10.61 10.61 Small-Cap Index 1/4/99*................ 0.31 (7.79) 3.93 2.17 Real Estate 1/4/99 (formerly called REIT)*................. 7.03 (1.07) 11.42 9.89 Inflation Managed 1/2/96*................ 2.81 (5.29) 3.12 1.33 4.98 4.98 4.38 4.38 Managed Bond 1/2/96*.... 5.83 (2.27) 4.03 2.28 5.62 5.62 5.13 5.13 Money Market 1/2/96*.... 2.41 (5.69) 3.53 1.76 3.65 3.65 3.63 3.63 High Yield Bond 1/2/96*................ (0.07) (8.17) (1.26) (3.21) 0.98 0.98 2.37 2.37 Equity 1/2/96*.......... (22.86) (30.96) (8.04) (10.30) 3.09 3.09 6.59 6.59 Aggressive Equity 4/17/96*............... (18.40) (26.50) (7.25) (9.48) (1.84) (1.84) (0.32) (0.32) Large-Cap Value 1/4/99*................ (4.99) (13.09) 5.90 4.20
- -------- * Date Variable Account commenced operations. Effective January 1, 2000, Alliance Capital became the Portfolio Manager of the Emerging Markets Portfolio and Mercury Advisors became the Portfolio Manager of the Equity Index and Small-Cap Index Portfolios. Effective January 2, 2001, Lazard Asset Management became the Portfolio Manager of the International Value Portfolio. Prior to May 1, 2001, the Inflation Managed Portfolio was called the Government Securities Portfolio and some of the investment policies differed. Effective December 1, 2001, Putnam Investment Management, LLC became the Portfolio Manager of the Equity and Aggressive Equity Portfolios; prior to May 1, 1998 some of the investment policies of the Equity and Aggressive Equity Portfolios differed. 4 The Equity Income and Research Subaccounts started operations after December 31, 2001 and there is no historical value available for these Subaccounts. In order to help you understand how investment performance can affect your Variable Account Value, we are including performance information based on the historical performance of the Portfolios. The Separate Account commenced operations as of January 2, 1996. Therefore, no historical performance data exists for the Subaccounts prior to that date. The following table represents what the performance of the Subaccounts would have been if the Subaccounts had been both in existence and invested in the corresponding Portfolio since the date of the Portfolio's (or predecessor series') inception or for the indicated time period. Eight of the Portfolios of the Fund available under the Contract have been in operation since January 4, 1988. The Equity Index Portfolio has been in operation since January 30, 1991; the Growth LT Portfolio since January 4, 1994; the Aggressive Equity and Emerging Markets Portfolios since April 1, 1996; the Mid-Cap Value, Small-Cap Index, REIT and Large-Cap Portfolios since January 4, 1999; the Diversified Research and International Large-Cap Portfolios since January 3, 2000; the I- Net Tollkeeper Portfolio since May 1, 2000; the Strategic Value and Focused 30 Portfolios since October 2, 2000; the Blue Chip, Aggressive Growth, Financial Services, Health Services, Technology Telecommunications, Capital Opportunities, Mid-Cap Growth, and Global Growth Portfolios since January 2, 2001, and the Equity Income and Research Portfolios since January 2, 2002. Historical performance information for the Equity Portfolio is based in part on the performance of that Portfolio's predecessor series which was a series of the Pacific Corinthian Variable Fund that began its first full year of operations in 1984, the assets of which were acquired by the Fund on December 31, 1994. Because the Subaccounts had not commenced operations until January 2, 1996 or later, as indicated in the chart above, and because the Contracts were not available until 2000, these are not actual performance numbers for the Subaccounts or for the Contract. These are hypothetical total return numbers based on accumulated value (AV) and full withdrawal value (FWV) that represent the actual performance of the Portfolios, adjusted to reflect the deductions for the fees and charges applicable to the Contract; the FWV also includes applicable withdrawal charges. Any charge for non-recurring fees and charges, premium taxes, an optional Death Benefit Rider or any optional EEG or GPA Riders are not reflected in these data, and reflection of the Annual Fee assumes an average Contract size of $65,000. The information presented also includes data representing unmanaged market indices. 5 The results shown in this section are not an estimate or guarantee of future investment performance. Historical and Hypothetical Separate Account Performance Annualized Rates of Return for Periods Ended December 31, 2001 All numbers are expressed as a percentage
Since 1 Year* 3 Years* 5 Years* 10 Years* Inception* -------------- ------------- ------------ ----------- -------------- Variable Accounts AV FWV AV FWV AV FWV AV FWV AV FWV - ----------------- ------ ------ ----- ------ ----- ----- ----- ----- ------ ------ Blue Chip............... (19.71) (27.81) (19.71) (27.81) Aggressive Growth....... (20.90) (29.00) (20.90) (29.00) Emerging Markets........ (9.96) (18.06) (4.73) (6.83) (9.60) (9.60) (10.89) (10.91) Diversified Research.... (4.10) (12.20) 2.10 (1.10) Small-Cap Equity........ (3.91) (12.01) 2.27 .45 6.83 6.83 10.32 10.32 11.40 11.40 International Large-Cap. (19.44) (27.54) (21.11) (25.31) I-Net Tollkeeper........ (34.86) (42.96) (39.06) (44.61) Financial Services...... (8.58) (16.68) (8.58) (16.68) Health Sciences......... (8.98) (17.08) (8.98) (17.08) Technology.............. (41.77) (49.91) (41.77) (49.91) Telecommunications...... (47.47) (55.61) (47.47) (55.61) Multi-Strategy.......... (2.54) (10.64) 0.74 (1.14) 7.04 7.04 7.69 7.69 8.62 8.62 Large-Cap Core (formerly called Equity Income).. (10.15) (18.25) (2.63) (4.64) 7.47 7.47 9.11 9.11 10.06 10.06 Strategic Value......... (11.13) (19.23) (10.88) (16.20) Growth LT............... (30.59) (38.69) 1.56 (0.28) 12.34 12.34 5.41 5.41 Focused 30.............. (14.57) (22.67) (24.65) (30.25) Mid-Cap Value........... 11.72 3.62 12.65 11.15 International Value..... (22.97) (31.07) (6.59) (8.78) (1.77) (1.77) 3.34 3.34 4.21 4.21 Capital Opportunities... (16.72) (24.82) (16.72) (24.82) Mid-Cap Growth.......... (19.95) (28.05) (19.95) (28.05) Global Growth........... (16.16) (24.26) (16.16) (24.26) Equity Index............ (13.38) (21.48) (2.69) (4.70) 8.88 8.88 11.20 11.20 Small-Cap Index......... 0.31 (7.79) 3.93 2.17 Real Estate (formerly called REIT)........... 7.03 (1.07) 11.42 9.89 Inflation Managed....... 2.81 (5.29) 3.12 1.33 4.98 4.98 5.10 5.10 6.38 6.38 Managed Bond............ 5.83 (2.27) 4.03 2.28 5.62 5.62 5.84 5.84 7.04 7.04 Money Market............ 2.41 (5.69) 3.53 1.76 3.65 3.65 3.11 3.11 3.76 3.76 High Yield Bond......... (0.07) (8.17) (1.26) (3.21) 0.98 0.98 6.18 6.18 6.51 6.51 Equity.................. (22.86) (30.96) (8.04) (10.30) 3.09 3.09 7.51 7.51 10.26 10.26 Aggressive Equity....... (18.40) (26.50) (7.25) (9.48) (1.84) (1.84) (0.58) (0.58) Large-Cap Value......... (4.99) (13.09) 5.90 4.20
Major Indices 1 Year 3 Years 5 Years 10 Years - ------------- ------ ------- ------- -------- Credit Suisse First Boston High Yield........ 5.80 1.18 3.25 7.85 Lehman Brothers Aggregate Bond............... 8.42 6.27 7.43 7.23 Lehman Brothers Government Bond.............. 7.24 5.88 7.40 7.14 Lehman Brothers Inflation Linked Treasury.... 7.90 7.72 N/A N/A Lehman Brothers Government/Credit............ 8.51 5.89 7.36 7.27 Merrill Lynch 3-Month U.S. T-Bill............ 4.42 5.14 5.20 4.86 Morgan Stanley Capital International All Country World Free.......................... (16.82) (3.37) 5.37 8.05 Morgan Stanley Capital International Emerging Markets Free................................ (2.37) 4.08 (5.74) 3.05 Morgan Stanley Capital International Europe, Australasia & Far East...................... (21.21) (4.79) 1.17 4.76 North American Real Estate Investment Trust Equity...................................... 13.93 11.15 6.38 11.63 Russell 1000 Growth.......................... (20.42) (6.32) 8.27 10.80 Russell 2000................................. 2.49 6.42 7.52 11.51 Russell 2500................................. 1.22 9.43 10.34 13.13 Russell 2500 Growth.......................... (10.83) 5.17 6.60 9.49 Russell Midcap............................... (5.62) 6.50 11.40 13.58 Russell Midcap Growth........................ (20.15) 2.16 9.02 11.10 Standard & Poor's 500 Composite Stock Price.. (11.88) (1.03) 10.70 12.93
- -------- * The performance of the Aggressive Equity, Large-Cap Core, Multi-Strategy, Equity, International Value, and Emerging Markets Variable Accounts for all or a portion of this period occurred at a time when other Portfolio Managers managed the corresponding Portfolio in which each Variable Account invests. Effective January 1, 1994, J. P. Morgan Investment Management Inc. became the Portfolio Manager of the Large-Cap Core and Multi-Strategy Portfolios; prior to January 1, 1994, some of the investment policies of the Large-Cap Core Portfolio and the investment objective of the Multi-Strategy Portfolio differed. Effective January 1, 2000, Alliance Capital became the Portfolio Manager of the Emerging Markets Portfolio and Mercury Advisors became the Portfolio Manager of the Equity Index and Small-Cap Index Portfolios. Effective January 2, 2001, Lazard Asset Management became the Portfolio Manager of the International Value Portfolio. Prior to May 1, 2001, the Inflation Managed Portfolio was called the Government Securities Portfolio and some of the investment policies differed. Effective December 1, 2001, Putnam Investment Management, LLC became the Portfolio Manager of the Equity and Aggressive Equity Portfolios. Prior to May 1, 1998, some of the investment policies of the Equity and 6 Aggressive Equity Portfolios differed. Performance of the Equity Portfolio is based in part on the performance of the predecessor portfolio of Pacific Corinthian Variable Fund, which began its first full year of operations in 1984, the assets of which were acquired by the Fund on December 31, 1994. The Equity Income and Research Portfolios started operations after December 31, 2001 and there is no historical value available for these Subaccounts. Tax Deferred Accumulation In reports or other communications to you or in advertising or sales materials, we may also describe the effects of tax-deferred compounding on the Separate Account's investment returns or upon returns in general. These effects may be illustrated in charts or graphs and may include comparisons at various points in time of returns under the Contract or in general on a tax- deferred basis with the returns on a taxable basis. Different tax rates may be assumed. In general, individuals who own annuity contracts are not taxed on increases in the value under the annuity contract until some form of distribution is made from the contract. Thus, the annuity contract will benefit from tax deferral during the accumulation period, which generally will have the effect of permitting an investment in an annuity contract to grow more rapidly than a comparable investment under which increases in value are taxed on a current basis. The following chart illustrates this benefit by comparing accumulation under a variable annuity contract with accumulations from an investment on which gains are taxed on a current ordinary income basis. The chart shows accumulations on a single Purchase Payment of $10,000, assuming hypothetical annual returns of 0%, 4% and 8%, compounded annually, and a tax rate of 36%. The values shown for the taxable investment do not include any deduction for management fees or other expenses but assume that taxes are deducted annually from investment returns. The values shown for the variable annuity do not reflect the deduction of contractual expenses such as the Risk Charge (equal to an annual rate of 1.25% of average daily Account Value), the Administrative Fee (equal to an annual rate of 0.15% of average daily Account Value), the Annual Fee (equal to $30 per year if your Net Contract Value is less than $50,000), any increase in the Risk Charge for an optional Death Benefit Rider (equal to a maximum annual rate of 0.35% of average daily Account Value) or for the optional EEG or GPA Riders (equal to an annual rate of 0.25% and 0.10% average daily Account Value, respectively), any charge for premium taxes, or the expenses of an underlying investment vehicle, such as the Fund. The values shown also do not reflect the withdrawal charge. Generally, the withdrawal charge is equal to 9% of the amount withdrawn attributable to Purchase Payments that are less than one year old, 8% of the amount withdrawn attributable to Purchase Payments that are less than two years old, and 8% of the amount withdrawn attributable to Purchase Payments that are three years old. The age of the Purchase Payments is considered 1 year old in the Contract Year we receive it and increases by one year beginning on the day preceding each Contract Anniversary. During a Contract Year, you may withdraw free of withdrawal charge amounts up to your "Eligible Purchase Payments". Eligible Purchase Payments include 10% annually of total Purchase Payments that have an "age" of less than four years, plus any remaining portion not withdrawn from the previous Contract Year's Eligible Purchase Payments that are derived from Purchase Payments which have an "age" of less than four years, plus 100% of all Purchase Payments that have an "age" of four years or more. Once all Purchase Payments have been deemed withdrawn, any withdrawal will be deemed a withdrawal of your Earnings and will be free of the withdrawal charge. If these expenses and fees were taken into account, they would reduce the investment return shown for both the taxable investment and the hypothetical variable annuity contract. In addition, these values assume that you do not surrender the Contract or make any withdrawals until the end of the period shown. The chart assumes a full withdrawal, at the end of the period shown, of all Contract Value and the payment of taxes at the 36% rate on the amount in excess of the Purchase Payments. The rates of return illustrated are hypothetical and are not an estimate or guarantee of performance. Actual tax rates may vary for different assets and taxpayers from that illustrated and withdrawals by and distributions to Contract Owners who have not reached age 59 1/2 may be subject to a tax penalty of 10%. 7 Power of Tax Deferral $10,000 investment at annual rates of 0%, 4% and 8%, taxed @ 36% [TAX DEFERRAL GRAPH APPEARS HERE]
0% GROWTH TAX TAXABLE DEFERRED INVESTMENT INVESTMENT YEARS BEFORE TAX BEFORE TAX ----- ---------- ---------- 10 $10,000.00 $10,000.00 20 $10,000.00 $10,000.00 30 $10,000.00 $10,000.00 4% GROWTH TAX TAXABLE DEFERRED INVESTMENT INVESTMENT YEARS BEFORE TAX BEFORE TAX ----- ---------- ---------- 10 $12,875.97 $13,073.56 20 $16,579.07 $17,623.19 30 $21,347.17 $24,357.74 8% GROWTH TAX TAXABLE DEFERRED INVESTMENT INVESTMENT YEARS BEFORE TAX BEFORE TAX ----- ---------- ---------- 10 $16,476.07 $17,417.12 20 $27,146.07 $33,430.13 30 $44,726.05 $68,001.00
DISTRIBUTION OF THE CONTRACTS Pacific Select Distributors, Inc. (PSD) Pacific Select Distributors, Inc., a subsidiary of ours, acts as the principal underwriter ("distributor") of the Contracts and offers the Contracts on a continuous basis. PSD is registered as a broker-dealer with the SEC and is a member of the National Association of Securities Dealers (NASD). We pay PSD for acting as principal underwriter under a Distribution Agreement. We and PSD enter into selling agreements with broker-dealers whose registered representatives are authorized by state insurance departments to sell the Contracts. The aggregate amount of underwriting commissions paid to PSD for 2001 and 2000, respectively, with regard to this Contract was $4,339,558 and $8,943,198, of which $0 was retained. 8 THE CONTRACTS AND THE SEPARATE ACCOUNT Calculating Subaccount Unit Values The Unit Value of the Subaccount Units in each Variable Investment Option is computed at or about 4:00 p.m. Eastern time on each Business Day. The initial Unit Value of each Subaccount was $10 on the Business Day the Subaccount began operations. At the end of each Business Day, the Unit Value for a Subaccount is equal to: Y X Z where (Y) = the Unit Value for that Subaccount as of the end of the preceding Business Day; and (Z) = the Net Investment Factor for that Subaccount for the period (a "valuation period") between that Business Day and the immediately preceding Business Day. The "Net Investment Factor" for a Subaccount for any valuation period is equal to: (A / B) - C where (A) = the "per share value of the assets" of that Subaccount as of the end of that valuation period, which is equal to: a + b + c where (a) = the net asset value per share of the corresponding Portfolio shares held by that Subaccount as of the end of that valuation period; (b) = the per share amount of any dividend or capital gain distributions made by the Fund for that Portfolio during that valuation period; and (c) = any per share charge (a negative number) or credit (a positive number) for any income taxes and/or any other taxes or other amounts set aside during that valuation period as a reserve for any income and/or any other taxes which we determine to have resulted from the operations of the Subaccount or Contract, and/or any taxes attributable, directly or indirectly, to Investments; (B) = the net asset value per share of the corresponding Portfolio shares held by the Subaccount as of the end of the preceding valuation period; and (C) = a factor that assesses against the Subaccount net assets for each calendar day in the valuation period the basic Risk Charge plus any applicable increase in the Risk Charge and the Administrative Fee (see CHARGES, FEES AND DEDUCTIONS section in the Prospectus). As explained in the Prospectus, the Annual Fee, if applicable, is assessed against your Variable Account Value through the automatic debit of Subaccount Units; the Annual Fee decreases the number of Subaccount Units attributed to your Contract but does not alter the Unit Value for any Subaccount. Variable Annuity Payment Amounts The following steps show how we determine the amount of each variable annuity payment under your Contract. First: Pay Applicable Premium Taxes When you convert your Net Contract Value into annuity payments, you must pay any applicable charge for premium taxes on your Contract Value (unless applicable law requires those taxes to be paid at a later time). We assess this charge by reducing each Account Value proportionately, relative to your Account Value in each Subaccount and in the Fixed Option, in an amount equal to the aggregate amount of the charges. The remaining amount of your available Net Contract Value may be used to provide variable annuity payments. Alternatively, your remaining available Net Contract Value may be used to provide fixed annuity payments, or it may be divided to provide both fixed and variable annuity payments. You may also choose to withdraw some or all of your remaining Net Contract Value, less any applicable Annual Fee, withdrawal charge, and less any charges for premium taxes without converting this amount into annuity payments. 9 Second: The First Variable Payment We begin by referring to your Contract's Option Table for your Annuity Option (the "Annuity Option Table"). The Annuity Option Table allows us to calculate the dollar amount of the first variable annuity payment under your Contract, based on the amount applied toward the variable annuity. The number that the Annuity Option Table yields will be based on the Annuitant's age (and, in certain cases, sex) and assumes a 5% rate of return, as described in more detail below. Example: Assume a man is 65 years of age at his Annuity Date and has selected a lifetime annuity with monthly payments guaranteed for 10 years. According to the Annuity Option Table, this man should receive an initial monthly payment of $5.79 for every $1,000 of his Contract Value (reduced by applicable charges) that he will be using to provide variable payments. Therefore, if his Contract Value after deducting applicable fees and charges is $100,000 on his Annuity Date and he applies this entire amount toward his variable annuity, his first monthly payment will be $579.00. You may choose any other Annuity Option Table that assumes a different rate of return which we offer at the time your Annuity Option is effective. Third: Subaccount Annuity Units For each Subaccount, we use the amount of the first variable annuity payment under your Contract attributable to each Subaccount to determine the number of Subaccount Annuity Units that will form the basis of subsequent payment amounts. First, we use the Annuity Option Table to determine the amount of that first variable payment for each Subaccount. Then, for each Subaccount, we divide that amount of the first variable annuity payment by the value of one Subaccount Annuity Unit (the "Subaccount Annuity Unit Value") as of the end of the Annuity Date to obtain the number of Subaccount Annuity Units for that particular Subaccount. The number of Subaccount Annuity Units used to calculate subsequent payments under your Contract will not change unless exchanges of Annuity Units are made (or if the Joint and Survivor Annuity Option is elected and the Primary Annuitant dies first), but the value of those Annuity Units will change daily, as described below. Fourth: The Subsequent Variable Payments The amount of each subsequent variable annuity payment will be the sum of the amounts payable based on each Subaccount. The amount payable based on each Subaccount is equal to the number of Subaccount Annuity Units for that Subaccount multiplied by their Subaccount Annuity Unit Value at the end of the Business Day in each payment period you elected that corresponds to the Annuity Date. Each Subaccount's Subaccount Annuity Unit Value, like its Subaccount Unit Value, changes each day to reflect the net investment results of the underlying investment vehicle, as well as the assessment of the Risk Charge at an annual rate of 1.25% and the Administrative Fee at an annual rate of 0.15%. In addition, the calculation of Subaccount Annuity Unit Value incorporates an additional factor; as discussed in more detail below, this additional factor adjusts Subaccount Annuity Values to correct for the Option Table's implicit assumed annual investment return on amounts applied but not yet used to furnish annuity benefits. Any increase in your Risk Charge for an Optional Death Benefit Rider is not charged on and after the Annuity Date. Different Subaccounts may be selected for your Contract before and after your Annuity Date, subject to any restrictions we may establish. Currently, you may exchange Subaccount Annuity Units in any Subaccount for Subaccount Annuity Units in any other Subaccount(s) up to four times in any twelve month period after your Annuity Date. The number of Subaccount Annuity Units in any Subaccount may change due to such exchanges. Exchanges following your Annuity Date will be made by exchanging Subaccount Annuity Units of equivalent aggregate value, based on their relative Subaccount Annuity Unit Values. Understanding the "Assumed Investment Return" Factor The Annuity Option Table incorporates a number of implicit assumptions in determining the amount of your first variable annuity payment. As noted above, the numbers in the Annuity Option Table reflect certain actuarial assumptions based on the Annuitant's age, and, in some cases, the Annuitant's sex. In addition, these numbers 10 assume that the amount of your Contract Value that you convert to a variable annuity will have a positive net investment return of 5% (or such other rate of return you may elect) each year during the payout of your annuity; thus 5% is referred to as an "assumed investment return." The Subaccount Annuity Unit Value for a Subaccount will increase only to the extent that the investment performance of that Subaccount exceeds the Risk Charge, the Administrative Fee, and the assumed investment return. The Subaccount Annuity Unit Value for any Subaccount will generally be less than the Subaccount Unit Value for that same Subaccount, and the difference will be the amount of the assumed investment return factor. Example: Assume the net investment performance of a Subaccount is at a rate of 5.00% per year (after deduction of the 1.25% Risk Charge and the 0.15% Administrative Fee). The Subaccount Unit Value for that Subaccount would increase at a rate of 5.00% per year, but the Subaccount Annuity Unit Value would not increase (or decrease) at all. The net investment factor for that 5% return [1.05] is then divided by the factor for the 5% assumed investment return [1.05] and 1 is subtracted from the result to determine the adjusted rate of change in Subaccount Annuity Unit Value: 1.05 = 1; 1 - 1 = 0; 0 X 100% = 0%. ---- 1.05 If the net investment performance of a Subaccount's assets is at a rate less than 5.00% per year, the Subaccount Annuity Unit Value will decrease, even if the Subaccount Unit Value is increasing. Example: Assume the net investment performance of a Subaccount is at a rate of 2.60% per year (after deduction of the 1.25% Risk Charge and the 0.15% Administrative Fee). The Subaccount Unit Value for that Subaccount would increase at a rate of 2.60% per year, but the Subaccount Annuity Unit Value would decrease at a rate of 2.29% per year. The net investment factor for that 2.6% return [1.026] is then divided by the factor for the 5% assumed investment return [1.05] and 1 is subtracted from the result to determine the adjusted rate of change in Subaccount Annuity Unit Value: 1.026 = 0.9771; 0.9771 - 1 = -0.0229; -0.0229 X 100% = -2.29%. ----- 1.05 The assumed investment return will always cause increases in Subaccount Annuity Unit Values to be somewhat less than if the assumption had not been made, will cause decreases in Subaccount Annuity Unit Values to be somewhat greater than if the assumption had not been made, and will (as shown in the example above) sometimes cause a decrease in Subaccount Annuity Unit Values to take place when an increase would have occurred if the assumption had not been made. If we had assumed a higher investment return in our Annuity Option tables, it would produce annuities with larger first payments, but the increases in subaccount annuity payments would be smaller and the decreases in subsequent annuity payments would be greater; a lower assumed investment return would produce annuities with smaller first payments, and the increases in subsequent annuity payments would be greater and the decreases in subsequent annuity payments would be smaller. Corresponding Dates If any transaction or event under your Contract is scheduled to occur on a "corresponding date" that does not exist in a given calendar period, the transaction or event will be deemed to occur on the following Business Day. In addition, as stated in the Prospectus, any event scheduled to occur on a day that is not a Business Day will occur on the next succeeding Business Day. Example: If your Contract is issued on February 29 in year 1 (a leap year), your Contract Anniversary in years 2, 3 and 4 will be on March 1. Example: If your Annuity Date is July 31 and you select monthly annuity payments, the payments received will be based on valuations made on July 31, August 31, October 1 (for September), October 31, December 1 (for November), December 31, January 31, March 1 (for February), March 31, May 1 (for April), May 31 and July 1 (for June). Age and Sex of Annuitant As mentioned in the Prospectus, the Contracts generally provide for sex- distinct annuity income factors in the case of life annuities. Statistically, females tend to have longer life expectancies than males; consequently, if the amount of annuity payments is based on life expectancy, they will ordinarily be higher if an annuitant is male than if an annuitant is female. Certain states' regulations prohibit sex-distinct annuity income factors, and Contracts issued in those states will use unisex factors. In addition, Contracts issued in connection with Qualified Plans are required to use unisex factors. 11 We may require proof of your Annuitant's age and sex before or after starting annuity payments. If the age or sex (or both) of your Annuitant are incorrectly stated in your Contract, we will correct the amount payable based on your Annuitant's correct age or sex, if applicable. If we make the correction after annuity payments have started, and we have made overpayments, we will deduct the amount of the overpayment, with interest at 3% a year, from any payments due then or later; if we have made underpayments, we will add the amount, with interest at 3% a year, of the underpayments to the next payment we make after we receive proof of the correct age and/or sex. Additionally, we may require proof of the Annuitant's or Owner's age before any payments associated with the Death Benefit provisions of your Contract are made. If the age or sex of the Annuitant is incorrectly stated in your Contract, we will base any payment associated with the Death Benefit provisions on your Contract on the Annuitant's or Owner's correct age or sex. Systematic Transfer Programs The Fixed Account is not available in connection with portfolio rebalancing. If you are using the earnings sweep, you may also use portfolio rebalancing only if you selected the Fixed Option as your sweep option. You may not use dollar cost averaging and the earnings sweep at the same time. Dollar Cost Averaging When you request dollar cost averaging, you are authorizing us to make periodic reallocations of your Contract Value without waiting for any further instruction from you. You may request to begin or stop dollar cost averaging at any time prior to your Annuity Date; the effective date of your request will be the day we receive written notice from you in proper form. Your request may specify the date on which you want your first transfer to be made. If you do not specify a date for your first transfer, we will treat your request as if you had specified the effective date of your request. Your first transfer may not be made until 30 days after your Contract Date, and if you specify an earlier date, your first transfer will be delayed until one calendar month after the date you specify. If you request dollar cost averaging on your application for your Contract and you fail to specify a date for your first transfer, your first transfer will be made one period after your Contract Date (that is, if you specify monthly transfers, the first transfer will occur 30 days after your Contract Date; quarterly transfers, 90 days after your Contract Date; semiannual transfers, 180 days after your Contract Date; and if you specify annual transfers, the first transfer will occur on your Contract Anniversary). If you stop dollar cost averaging, you must wait 30 days before you may begin this option again. Your request to begin dollar cost averaging must specify the Investment Option you wish to transfer money from (your "source account"). You may choose any one Investment Option as your source account. The Account Value of your source account must be at least $5,000 for you to begin dollar cost averaging. Your request to begin dollar cost averaging must also specify the amount and frequency of your transfers. You may choose monthly, quarterly, semiannual or annual transfers. The amount of your transfers may be specified as a dollar amount or a percentage of your source Account Value; however, each transfer must be at least $250. Dollar cost averaging transfers are not subject to the same requirements and limitations as other transfers. Finally, your request must specify the Variable Investment Option(s) you wish to transfer amounts to (your "target account(s)"). If you select more than one target account, your dollar cost averaging request must specify how transferred amounts should be allocated among the target accounts. Your source account may not also be a target account. Your dollar cost averaging transfers will continue until the earlier of (i) your request to stop dollar cost averaging is effective, or (ii) your source Account Value is zero, or (iii) your Annuity Date. If, as a result of a dollar cost averaging transfer, your source Account Value falls below any minimum Account Value we may establish, we have the right, at our option, to transfer that remaining Account Value to your target account(s) on a proportionate basis relative to your most recent allocation instructions. We may change, terminate or suspend the dollar cost averaging option at any time. 12 Portfolio Rebalancing Portfolio rebalancing allows you to maintain the percentage of your Contract Value allocated to each Variable Investment Option at a pre-set level prior to annuitization. For example, you could specify that 30% of your Contract Value should be in the Equity Index Subaccount, 40% in the Managed Bond Subaccount, and 30% in the Growth LT Subaccount. Over time, the variations in each Subaccount's investment results will shift this balance of these Subaccount Value allocations. If you elect the portfolio rebalancing feature, we will automatically transfer your Subaccount Value back to the percentages you specify. You may choose to have rebalances made quarterly, semiannually or annually until your Annuity Date; portfolio rebalancing is not available after you annuitize. Procedures for selecting portfolio rebalancing are generally the same as those discussed in detail above for selecting dollar cost averaging: You may make your request at any time prior to your Annuity Date and it will be effective when we receive it in proper form. If you stop portfolio rebalancing, you must wait 30 days to begin again. You may specify a date for your first rebalance, or we will treat your request as if you selected the request's effective date. If you specify a date fewer than 30 days after your Contract Date, your first rebalance will be delayed one month, and if you request rebalancing on your application but do not specify a date for the first rebalance, it will occur one period after your Contract Date, as described above under Dollar Cost Averaging. We may change, terminate or suspend the portfolio rebalancing feature at any time. Earnings Sweep An earnings sweep automatically transfers the earnings attributable to a specified Investment Option (the "sweep option") to one or more other Investment Options (your "target option(s)"). If you elect to use the earnings sweep, you may select either the Fixed Option or the Money Market Subaccount as your sweep option. The Account Value of your sweep option will be required to be at least $5,000 when you elect the earnings sweep. You may select one or more Variable Investment Options (but not the Money Market Subaccount) as your target option(s). You may choose to have earnings sweeps occur monthly, quarterly, semiannually or annually until you annuitize. At each earnings sweep, we will automatically transfer your accumulated earnings attributable to your sweep option for the previous period proportionately to your target option(s). That is, if you select a monthly earnings sweep, we will transfer the sweep option earnings from the preceding month; if you select a semiannual earnings sweep, we will transfer the sweep option earnings accumulated over the preceding six months. Earnings sweep transfers are not subject to the same requirements and limitations as other transfers. To determine the earnings, we take the change in the sweep option's Account Value during the sweep period, add any withdrawals or transfers out of the sweep option Account that occurred during the sweep period, and subtract any allocations to the sweep option Account during the sweep period. The result of this calculation represents the "total earnings" for the sweep period. If, during the sweep period, you withdraw or transfer amounts from the sweep option Account, we assume that earnings are withdrawn or transferred before any other Account Value. Therefore, your "total earnings" for the sweep period will be reduced by any amounts withdrawn or transferred during the sweep option period. The remaining earnings are eligible for the sweep transfer. Procedures for selecting the earnings sweep are generally the same as those discussed in detail above for selecting dollar cost averaging and portfolio rebalancing: You may make your request at any time and it will be effective when we receive it in a form satisfactory to us. If you stop the earnings sweep, you must wait 30 days to begin again. You may specify a date for your first sweep, or we will treat your request as if you selected the request's effective date. If you specify a date fewer than 30 days after your Contract Date, your first earnings sweep will be delayed one month, and if you request the earnings sweep on your application but do not specify a date for the first sweep, it will occur one period after your Contract Date, as described above under Dollar Cost Averaging. 13 If, as a result of an earnings sweep transfer, your source Account Value falls below $500, we have the right, at our option, to transfer that remaining Account Value to your target account(s) on a proportionate basis relative to your most recent allocation instructions. We may change, terminate or suspend the earnings sweep option at any time. Pre-Authorized Withdrawals You may specify a dollar amount for your pre-authorized withdrawals, or you may specify a percentage of your Contract Value or an Account Value. You may direct us to make your pre-authorized withdrawals from one or more specific Investment Options; if you do not give us these specific instructions, amounts will be deducted proportionately from your Account Value in each Fixed or Variable Investment Option. Procedures for selecting pre-authorized withdrawals are generally the same as those discussed in detail above for selecting dollar cost averaging, portfolio rebalancing, and earnings sweeps: You may make your request at any time and it will be effective when we receive it in proper form. If you stop the pre- authorized withdrawals, you must wait 30 days to begin again. You may specify a date for the first withdrawal, or we will treat your request as if you selected the request's effective date. If you specify a date fewer than 30 days after your Contract Date, your first pre-authorized withdrawal will be delayed one month, and if you request the pre-authorized withdrawals on your application but do not specify a date for the first withdrawal, it will occur one period after your Contract Date. If your pre-authorized withdrawals cause your Account Value in any Investment Option to fall below $500, we have the right, at our option, to transfer that remaining Account Value to your other Investment Options on a proportionate basis relative to your most recent allocation instructions. If your pre- authorized withdrawals cause your Contract Value to fall below $1,000, we may, at our option, terminate your Contract and send you the remaining withdrawal proceeds. Pre-authorized withdrawals are subject to the same withdrawal charges as are other withdrawals, and each withdrawal is subject to any applicable charge for premium taxes and/or other taxes, to federal income tax on its taxable portion, and, if you have not reached age 59 1/2, a federal tax penalty of at least 10%. Death Benefit Any death benefit payable will be calculated as of the date we receive proof (in proper form) of the Annuitant's death (or, if applicable, the Contract Owner's death) and instructions regarding payment; any claim of a death benefit must be made in proper form. A recipient of death benefit proceeds may elect to have this benefit paid in one lump sum, in periodic payments, in the form of a lifetime annuity or in some combination of these. Annuity payments will begin within 30 days once we receive all information necessary to process the claim. If your Contract names Joint or Contingent Annuitants, no death benefit proceeds will be payable unless and until the last Annuitant dies prior to the Annuity Date or a Contract Owner dies prior to the Annuity Date. 1035 Exchanges You may make your initial Investment through an exchange of an existing annuity contract. To exchange, you must complete a 1035 Exchange form, which is available by calling your representative, or by calling us at 1-800-722- 2333, and mail the form along with the annuity contract you are exchanging (plus your completed application if you are making an initial Purchase Payment) to us. In general terms, Section 1035 of the Code provides that you recognize no gain or loss when you exchange one annuity contract solely for another annuity contract. However, transactions under Section 1035 may be subject to special rules and may require special procedures and record-keeping, particularly if the exchanged annuity contract was issued prior to August 14, 1982. You should consult your tax adviser prior to effecting a 1035 Exchange. Safekeeping of Assets We are responsible for the safekeeping of the assets of the Separate Account. These assets are held separate and apart from the assets of our General Account and our other separate accounts. 14 FINANCIAL STATEMENTS The statement of assets and liabilities of Separate Account A as of December 31, 2001 and the related statement of operations and financial highlights for the year then ended and statements of changes in net assets for each of the two years in the period then ended are incorporated by reference in this Statement of Additional Information from the Annual Report of Separate Account A dated December 31, 2001. Pacific Life's consolidated financial statements as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 are set forth beginning on the next page. These financial statements should be considered only as bearing on the ability of Pacific Life to meet its obligations under the Contracts and not as bearing on the investment performance of the assets held in the Separate Account. INDEPENDENT AUDITORS The consolidated financial statements of Pacific Life as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein. 15 INDEPENDENT AUDITORS' REPORT - ---------------------------- Pacific Life Insurance Company and Subsidiaries: We have audited the accompanying consolidated statements of financial condition of Pacific Life Insurance Company and Subsidiaries (the Company) as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholder's equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pacific Life Insurance Company and Subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP Costa Mesa, CA February 27, 2002 PL-1 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2001 2000 - ------------------------------------------------------------------------------ (In Millions) ASSETS Investments: Fixed maturity securities available for sale, at estimated fair value $17,047 $15,136 Equity securities available for sale, at estimated fair value 266 179 Trading securities, at fair value 458 71 Mortgage loans 2,933 3,026 Real estate 183 221 Policy loans 4,899 4,680 Other investments 2,796 2,654 - ----------------------------------------------------------------------------- TOTAL INVESTMENTS 28,582 25,967 Cash and cash equivalents 510 211 Deferred policy acquisition costs 2,113 1,796 Accrued investment income 377 335 Other assets 642 557 Separate account assets 23,458 25,918 - ----------------------------------------------------------------------------- TOTAL ASSETS $55,682 $54,784 ============================================================================= LIABILITIES AND STOCKHOLDER'S EQUITY Liabilities: Universal life and investment-type products $21,796 $19,410 Future policy benefits 4,580 4,542 Short-term and long-term debt 439 359 Other liabilities 1,690 1,323 Separate account liabilities 23,458 25,918 - ----------------------------------------------------------------------------- TOTAL LIABILITIES 51,963 51,552 - ----------------------------------------------------------------------------- Commitments and contingencies (Note 18) Stockholder's Equity: Common stock - $50 par value; 600,000 shares authorized, issued and outstanding 30 30 Paid-in capital 151 147 Unearned ESOP shares (3) (6) Retained earnings 3,271 3,030 Accumulated other comprehensive income 270 31 - ----------------------------------------------------------------------------- TOTAL STOCKHOLDER'S EQUITY 3,719 3,232 - ----------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $55,682 $54,784 =============================================================================
See Notes to Consolidated Financial Statements PL-2 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001 2000 1999 - ------------------------------------------------------------------------------ (In Millions) REVENUES Universal life and investment-type product policy fees $ 821 $ 769 $ 654 Insurance premiums 812 552 484 Net investment income 1,628 1,683 1,510 Net realized investment gain (loss) (14) 997 99 Commission revenue 181 270 234 Other income 225 209 145 - ------------------------------------------------------------------------------ TOTAL REVENUES 3,653 4,480 3,126 - ------------------------------------------------------------------------------ BENEFITS AND EXPENSES Policy benefits paid or provided 1,163 879 735 Interest credited to universal life and invest- ment-type products 1,029 997 938 Commission expenses 524 576 485 Operating expenses 634 575 453 - ------------------------------------------------------------------------------ TOTAL BENEFITS AND EXPENSES 3,350 3,027 2,611 - ------------------------------------------------------------------------------ INCOME BEFORE PROVISION FOR INCOME TAXES 303 1,453 515 Provision for income taxes 55 458 144 - ------------------------------------------------------------------------------ INCOME BEFORE CUMULATIVE ADJUSTMENTS DUE TO CHANGES IN ACCOUNTING PRINCIPLES 248 995 371 Cumulative adjustments due to changes in account- ing principles, net of taxes (7) - ------------------------------------------------------------------------------ NET INCOME $ 241 $ 995 $ 371 ==============================================================================
See Notes to Consolidated Financial Statements PL-3 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
Accumulated Other Comprehensive Income (Loss) ---------------------------------------- Unrealized Gain (Loss) on Unrealized Derivatives Foreign Gain on Unearned and Securities Currency Interest in Common Paid-in ESOP Retained Available for Translation PIMCO Stock Capital Shares Earnings Sale, Net Adjustment Advisors L.P. Total - -------------------------------------------------------------------------------------------------------------------- (In Millions) BALANCES, JANUARY 1, 1999 $30 $126 $1,664 $ 507 $ 1 $2,328 Comprehensive loss: Net income 371 371 Other comprehensive loss (785) (1) (786) ------ Total comprehensive loss (415) Other equity adjustments 11 11 Capital contribution 3 3 Purchase of ESOP note $(13) (13) Allocation of unearned ESOP shares 1 1 - -------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 1999 30 140 (12) 2,035 (278) - 1,915 Comprehensive income: Net income 995 995 Other comprehensive income (loss) 236 (4) $77 309 ------ Total comprehensive income 1,304 Other equity adjustments 5 5 Allocation of unearned ESOP shares 2 6 8 - -------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 2000 30 147 (6) 3,030 (42) (4) 77 3,232 Comprehensive income: Net income 241 241 Other comprehensive income (loss) 129 (1) 111 239 ------ Total comprehensive income 480 Other equity adjustments 1 1 Allocation of unearned ESOP shares 3 3 6 - -------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 2001 $30 $151 $ (3) $3,271 $ 87 $(5) $188 $3,719 ====================================================================================================================
See Notes to Consolidated Financial Statements PL-4 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001 2000 1999 - ------------------------------------------------------------------------------- (In Millions) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 241 $ 995 $ 371 Adjustments to reconcile net income to net cash provided by operating activities: Amortization on fixed maturity securities (73) (72) (78) Depreciation and other amortization 26 36 21 Earnings of equity method investees (6) (23) (93) Deferred income taxes 56 424 (8) Net realized investment (gain) loss 14 (997) (99) Net change in deferred policy acquisition costs (317) (350) (545) Interest credited to universal life and investment-type products 1,029 997 938 Change in trading securities (387) 29 (3) Change in accrued investment income (42) (48) (28) Change in future policy benefits 38 156 58 Change in other assets and liabilities 154 24 172 - ------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 733 1,171 706 - ------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Fixed maturity and equity securities available for sale: Purchases (4,864) (2,903) (4,173) Sales 941 1,595 2,334 Maturities and repayments 1,652 1,601 1,400 Repayments of mortgage loans 682 700 681 Proceeds from sales of mortgage loans and real estate 44 1 24 Purchases of mortgage loans and real estate (593) (806) (886) Change in policy loans (219) (422) (255) Cash received from acquisition of insurance block of business 165 Other investing activity, net 467 (664) 390 - ------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (1,890) (898) (320) - -------------------------------------------------------------------------------
(Continued) See Notes to Consolidated Financial Statements PL-5 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, (Continued) 2001 2000 1999 - -------------------------------------------------------------------------- (In Millions) CASH FLOWS FROM FINANCING ACTIVITIES Policyholder account balances: Deposits $ 4,690 $ 4,090 $ 4,453 Withdrawals (3,320) (4,734) (4,322) Net change in short-term and long-term debt 80 135 (220) Purchase of ESOP note (13) Allocation of unearned ESOP shares 6 8 1 - -------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,456 (501) (101) - -------------------------------------------------------------------------- Net change in cash and cash equivalents 299 (228) 285 Cash and cash equivalents, beginning of year 211 439 154 - -------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 510 $ 211 $ 439 ========================================================================== SUPPLEMENTAL SCHEDULE OF INVESTING AND FINANCING ACTIVITIES In connection with the acquisition of an annuity block of business in 1999, as discussed in Note 4, the following assets and liabilities were assumed: Fixed maturity securities $ 1,593 Cash and cash equivalents 165 Other assets 100 -------- Total assets assumed $ 1,858 ======== Annuity reserves $ 1,847 Other liabilities 11 -------- Total liabilities assumed $ 1,858 ======== ========================================================================== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Income taxes paid (received) $ (48) $ 74 $ 83 Interest paid $ 23 $ 28 $ 23 ==========================================================================
See Notes to Consolidated Financial Statements PL-6 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND DESCRIPTION OF BUSINESS Pacific Life Insurance Company (Pacific Life) was established in 1868 and is organized under the laws of the State of California as a stock life insurance company. Pacific Life is an indirect subsidiary of Pacific Mutual Holding Company (PMHC), a mutual holding company, and a wholly owned subsidiary of Pacific LifeCorp, an intermediate stock holding company. PMHC and Pacific LifeCorp were organized pursuant to consent received from the Insurance Department of the State of California (CA DOI) and the implementation of a plan of conversion to form a mutual holding company structure in 1997 (the Conversion). Pacific Life and its subsidiaries and affiliates have primary business operations consisting of life insurance, annuities, pension and institutional products, group employee benefits, broker-dealer operations, and investment management and advisory services. Pacific Life's primary business operations provide a broad range of life insurance, asset accumulation and investment products for individuals and businesses and offer a range of investment products to institutions and pension plans. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements of Pacific Life Insurance Company and Subsidiaries (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and include the accounts of Pacific Life and its majority owned and controlled subsidiaries. All significant intercompany transactions and balances have been eliminated. Pacific Life prepares its regulatory financial statements based on accounting practices prescribed or permitted by the CA DOI. These consolidated financial statements differ from those filed with regulatory authorities (Note 2). NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 2001, the Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of SFAS No. 133. SFAS No. 133 and SFAS No. 138 establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item are recognized in net realized investment gain (loss). If the derivative is designated as a cash flow hedge, changes in the fair value of the derivative are recorded in other comprehensive income (loss) (OCI) and are recognized in earnings when the hedged item affects earnings. For derivative instruments not designated as hedges, the change in fair value of the derivative is recorded in net realized investment gain (loss). Upon adoption of SFAS No. 133 and SFAS No. 138, the Company recorded an increase to net income of $1 million, net of taxes, as a cumulative adjustment due to change in accounting principle. This increase was primarily attributable to recording derivatives not designated as hedges at fair value, offset by the recording of initial ineffectiveness on fair value hedges. In addition, upon adoption the Company recorded an increase to accumulated OCI of $38 million, net of taxes. This increase was primarily attributable to the designation of derivatives as fair value hedges. Gains and losses on derivatives that were previously deferred as adjustments to the carrying amount of the hedged items were not affected by the implementation of SFAS No. 133 and SFAS No. 138. PL-7 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Upon adoption of SFAS No. 133 and SFAS No. 138, the Company transferred $306 million of fixed maturity securities available for sale into the trading category. The transfer resulted in a reclassification of unrealized losses of $4 million, net of taxes, from accumulated OCI into net realized investment gain (loss). Effective April 1, 2001, the Company adopted Emerging Issues Task Force Issue (EITF) 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. Under EITF 99-20, investors in certain asset-backed securities are required to record changes in their estimated yield on a prospective basis and to evaluate these securities for a decline in value, which is other than temporary. If the fair value of the asset-backed security has declined below its carrying amount and the decline is determined to be other than temporary, the security is written down to fair value. Upon adoption of EITF 99-20, the Company recorded a decrease to net income of $8 million, net of taxes, as a cumulative adjustment due to change in accounting principle. Effective April 1, 2001, the Company adopted the requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125, which revises the standards of accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of FASB Statement No. 125's provisions without reconsideration. Adoption of SFAS No. 140 did not have a material impact on the Company's consolidated financial statements. In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141, which was effective July 1, 2001, for any business combination entered into subsequent to June 30, 2001, requires the purchase method of accounting and separate recognition of intangible assets apart from goodwill if such intangible assets meet certain criteria. Adoption of SFAS No. 141 did not have a material impact on the Company's consolidated financial statements. SFAS No. 142, effective for fiscal years beginning after December 15, 2001, requires that ratable amortization of goodwill be replaced with periodic impairment tests of the goodwill asset and that intangible assets, other than goodwill, should be amortized over their useful lives. Amortization of goodwill was $5 million, $3 million and $12 million for the years ended December 31, 2001, 2000 and 1999, respectively. The Company has not yet finalized the quantification of the impact, if any, on its consolidated financial statements of applying the new requirements of SFAS No. 142. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company has not yet finalized the quantification of the impact, if any, on its consolidated financial statements of applying the new requirements of SFAS No. 144. INVESTMENTS Fixed maturity and equity securities available for sale are reported at estimated fair value, with unrealized gains and losses, net of deferred income taxes and adjustments related to deferred policy acquisition costs, recorded as a component of OCI. The cost of fixed maturity and equity securities is adjusted for impairments in value deemed to be other than temporary and changes in fair value of fixed maturity securities attributable to the risk designated in a fair value hedge. Trading securities are reported at fair value with changes in fair value included in net realized investment gain (loss). For mortgage-backed securities included in fixed maturity securities available for sale, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. This adjustment is reflected in net investment income. PL-8 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Realized gains and losses on investment transactions are determined on a specific identification basis and are included in net realized investment gain (loss). Mortgage loans, net of valuation allowances and writedowns, and policy loans are stated at unpaid principal balances. Real estate is carried at depreciated cost, net of writedowns, or, for real estate acquired in satisfaction of debt, estimated fair value less estimated selling costs at the date of acquisition, if lower than the related unpaid balance. Partnership and joint venture interests in which the Company does not have a controlling interest or a majority ownership are generally recorded using the equity method of accounting and are included in other investments. Investments in low income housing tax credits (LIHTC) are included in other investments. These investments are recorded under either the effective interest method or the equity method. For investments in LIHTC recorded under the effective interest method, the amortization of the original investment and the tax credits are recorded in the provision for income taxes. For investments in LIHTC recorded under the equity method, the amortization of the initial investment is included in net investment income and the related tax credits are recorded in the provision for income taxes. The amortization recorded in net investment income was $27 million, $33 million and $22 million for the years ended December 31, 2001, 2000 and 1999, respectively. The Company, through its wholly owned subsidiary Pacific Asset Management LLC and subsidiaries (PAM), had an approximate 33% beneficial ownership interest in PIMCO Advisors L.P. (PIMCO Advisors) as of December 31, 1999 and May 4, 2000, through the direct and indirect ownership of PIMCO Advisors' Class A limited partnership units (Class A units). This interest was accounted for using the equity method through May 4, 2000. On May 5, 2000, a transaction was closed whereby Allianz of America, Inc. (Allianz), a subsidiary of Allianz AG, acquired substantially all interests in PIMCO Advisors other than those beneficially owned by PAM. PAM exchanged its Class A units for a new security, PIMCO Advisors Class E limited partnership units (Class E units). This exchange resulted in a realized, pretax nonmonetary exchange gain of $1,082 million, based on the fair value of the Class A units exchanged, or $38.75 per unit, the per unit value that Allianz paid to acquire its interest in PIMCO Advisors. This gain is included in net realized investment gain (loss) for the year ended December 31, 2000. A net deferred tax liability of $365 million was also established. As a result of this transaction, the Company has virtually no influence over PIMCO Advisors' operating and financial policies. Effective May 5, 2000, the interest in PIMCO Advisors is being accounted for using the cost method. The interest in PIMCO Advisors, which is included in other investments, is being reported at estimated fair value, as determined by the put and call option price described below. Unrealized gains of $177 million and $124 million, net of deferred income taxes of $66 million and $47 million, for the years ended December 31, 2001 and 2000, respectively, are reported as a component of OCI. In connection with this transaction, PAM entered into a Continuing Investment Agreement with Allianz with respect to its interest in PIMCO Advisors. The interest in PIMCO Advisors held by PAM is subject to put and call options held by PAM and Allianz, respectively. The put option gives PAM the right to require Allianz, on the last business day of each calendar quarter, to purchase all of the interest in PIMCO Advisors held by PAM. The put option price is based on the per unit amount, as defined in the Continuing Investment Agreement, for the most recently completed four calendar quarters multiplied by a factor of 14. The call option gives Allianz the right to require PAM, on any January 31, April 30, July 31, or October 31, beginning on January 31, 2003, to sell its interest in PIMCO Advisors to Allianz. The call option price is based on the per unit amount, as defined in the Continuing Investment Agreement, for the most recently completed four calendar quarters multiplied by a factor of 14 and can be exercised only if the call per unit value reaches a minimum value. Effective January 1, 2002, PIMCO Advisors changed its name to Allianz Dresdner Asset Management of America L.P. PL-9 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) CASH AND CASH EQUIVALENTS Cash and cash equivalents include all investments with a remaining maturity of three months or less. DEFERRED POLICY ACQUISITION COSTS The costs of acquiring new insurance business, principally commissions, medical examinations, underwriting, policy issue and other expenses, all of which vary with and are primarily related to the production of new business, have been deferred. For universal life and investment-type products, such costs are generally amortized over the expected life of the contract in proportion to the present value of expected gross profits using investment, mortality, expense margins and surrender charge assumptions and estimates. Adjustments are reflected in income or equity in the period the Company experiences deviations in gross profit assumptions and estimates. Adjustments directly affecting equity result from experience deviations due to changes in unrealized gains and losses in securities available for sale. For traditional life insurance products, such costs are being amortized over the premium-paying period of the related policies in proportion to premium revenues recognized, using assumptions and estimates consistent with those used in computing policy reserves. Value of business acquired (VOBA), included as part of deferred policy acquisition costs, represents the present value of future profits generated from existing insurance contracts in force at the date of acquisition and is amortized over the expected policy or contract duration in relation to the present value of estimated gross profits from such policies and contracts. The VOBA balance was $91 million and $94 million as of December 31, 2001 and 2000, respectively. Components of deferred policy acquisition costs are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Balance, January 1 $1,796 $1,446 $ 901 ---------------------------- Additions: Capitalized during the year 566 646 538 Acquisition of insurance block of business 75 ---------------------------- Total additions 566 646 613 ---------------------------- Amortization: Allocated to commission expenses (181) (188) (112) Allocated to operating expenses (65) (54) (49) Allocated to OCI, unrealized gains (losses) (3) (54) 93 ---------------------------- Total amortization (249) (296) (68) ---------------------------- Balance, December 31 $2,113 $1,796 $1,446 ============================
UNIVERSAL LIFE AND INVESTMENT-TYPE PRODUCTS Universal life and investment-type products, including guaranteed interest contracts (GICs) and funding agreements, are valued using the retrospective deposit method and consist principally of deposits received plus interest credited, less accumulated assessments. Interest credited to these policies primarily ranged from 2.0% to 8.0% during 2001, 2000 and 1999. PL-10 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) FUTURE POLICY BENEFITS Life insurance reserves are valued using the net level premium method. Interest rate assumptions ranged from 4.5% to 9.3% for 2001, 2000 and 1999. Mortality, morbidity and withdrawal assumptions are generally based on the Company's experience, modified to provide for possible unfavorable deviations. Future dividends for participating business are provided for in the liability for future policy benefits. Dividends to policyholders are included in policy benefits paid or provided. Dividends are accrued based on dividend formulas approved by the Board of Directors and reviewed for reasonableness and equitable treatment of policyholders by an independent consulting actuary. As of December 31, 2001 and 2000, participating experience rated policies paying dividends represent less than 1% of direct written life insurance in force. REVENUES, BENEFITS AND EXPENSES Insurance premiums are recognized as revenues when due. Benefits and expenses, other than deferred policy acquisition costs, are recognized when incurred. Generally, receipts for universal life and investment-type products are classified as deposits. Policy fees from these contracts include mortality charges, surrender charges and earned policy service fees. Expenses related to these products include interest credited to account balances and benefit amounts in excess of account balances. Commission revenue from Pacific Life's broker-dealer subsidiaries is recorded on the trade date. DEPRECIATION AND AMORTIZATION Depreciation of investment real estate is computed on the straight-line method over the estimated useful lives, which range from 5 to 30 years. Certain other assets are depreciated or amortized on the straight-line method over periods ranging from 3 to 40 years. Depreciation of investment real estate is included in net investment income. Depreciation and amortization of certain other assets is included in operating expenses. INCOME TAXES Pacific Life and its wholly owned life insurance subsidiary domiciled in Arizona, Pacific Life & Annuity Company (PL&A), are taxed as life insurance companies for income tax purposes. Pacific Life and its includable subsidiaries are included in the consolidated Federal income tax return of PMHC and are allocated an expense or benefit based principally on the effect of including their operations in the consolidated return. Pacific Life's non insurance subsidiaries are either included in PMHC's combined California franchise tax return or file separate state tax returns. Deferred income taxes are provided for timing differences in the recognition of revenues and expenses for financial reporting and income tax purposes. SEPARATE ACCOUNTS Separate account assets are recorded at fair value and the related liabilities represent segregated contract owner funds maintained in accounts with individual investment objectives. The investment results of separate account assets generally pass through to separate account contract owners. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of financial instruments, disclosed in Notes 5, 6 and 7, has been determined using available market information and appropriate valuation methodologies. However, considerable judgment is often required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented may not be indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts. PL-11 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) RISKS AND UNCERTAINTIES The Company operates in a business environment which is subject to various risks and uncertainties. Such risks and uncertainties include, but are not limited to, interest rate risk, investment market risk, credit risk and legal and regulatory changes. Interest rate risk is the potential for interest rates to change, which can cause fluctuations in the value of investments, the liabilities for future policy benefits and the carrying amount of deferred policy acquisition costs. To the extent that fluctuations in interest rates cause the duration of assets and liabilities to differ, the Company may have to sell assets prior to their maturity and realize losses. The Company controls its exposure to this risk by, among other things, asset/liability matching techniques that attempt to match the duration of assets and liabilities and utilization of derivative instruments. Additionally, the Company includes contractual provisions limiting withdrawal rights for certain of its products. A substantial portion of the Company's liabilities are not subject to surrender or can be surrendered only after deduction of a surrender charge or a market value adjustment. Credit risk is the risk that issuers of investments owned by the Company may default or that other parties may not be able to pay amounts due to the Company. The Company manages its investments to limit credit risk by diversifying its portfolio among various security types and industry sectors. The credit risk of financial instruments is controlled through credit approval procedures, limits and ongoing monitoring. Real estate and mortgage loan investment risks are limited by diversification of geographic location and property type. Management does not believe that significant concentrations of credit risk exist. The Company is also exposed to credit loss in the event of nonperformance by the counterparties to interest rate swap contracts and other derivative securities. The Company manages this risk through credit approvals and limits on exposure to any specific counterparty. However, the Company does not anticipate nonperformance by the counterparties. The Company is subject to various state and Federal regulatory authorities. The potential exists for changes in regulatory initiatives which can result in additional, unanticipated expense to the Company. Existing Federal laws and regulations affect the taxation of life insurance or annuity products and insurance companies. There can be no assurance as to what, if any, cases might be decided or future legislation might be enacted, or if decided or enacted, whether such cases or legislation would contain provisions with possible negative effects on the Company's life insurance or annuity products. USE OF ESTIMATES The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates include those used in determining deferred policy acquisition costs, investment valuation and allowances, derivative valuation, and liabilities for future policy benefits. Actual results could differ from those estimates. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the 2001 financial statement presentation. PL-12 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. STATUTORY RESULTS Pacific Life prepares its statutory financial statements in conformity with accounting practices prescribed or permitted by the CA DOI, which is a comprehensive basis of accounting other than U.S. GAAP. Effective January 1, 2001, the CA DOI required that insurance companies domiciled in the State of California prepare their statutory basis financial statements in accordance with the National Association of Insurance Commissioners' (NAIC) Accounting Practices and Procedures Manual, version effective January 1, 2001 (NAIC SAP), subject to any deviations prescribed or permitted by the CA DOI. As a result of adopting NAIC SAP, Pacific Life reported a statutory cumulative effect of change in accounting principle that increased statutory surplus by $229 million as of January 1, 2001. NAIC SAP does not allow for restatement of prior year amounts. Therefore, prior year statutory amounts presented in this footnote are not comparable to current year statutory amounts. The following are reconciliations of statutory capital and surplus, and statutory net income for Pacific Life as compared to the amounts reported as stockholder's equity and net income included on the accompanying consolidated financial statements:
December 31, 2001 2000 -------------- (In Millions) Statutory capital and surplus $1,869 $1,678 Deferred policy acquisition costs 2,124 1,764 Asset valuation reserve 524 524 Non admitted assets 378 115 Accumulated other comprehensive income 270 31 Surplus notes (150) (150) Deferred income taxes (356) 181 Insurance and annuity reserves (795) (767) Other (145) (144) -------------- Stockholder's equity as reported herein $3,719 $3,232 ==============
Years Ended December 31, 2001 2000 1999 --------------------------- (In Millions) Statutory net income $ 24 $ 141 $ 168 Deferred policy acquisition costs 329 393 379 Insurance and annuity reserves 25 (106) (184) Deferred income taxes (29) (87) (3) Earnings of subsidiaries (60) 674 (27) Other (48) (20) 38 --------------------------- Net income as reported herein $ 241 $ 995 $ 371 ===========================
PL-13 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. STATUTORY RESULTS (Continued) RISK-BASED CAPITAL Risk-based capital is a method developed by the NAIC to measure the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formulas for determining the amount of risk-based capital specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. The adequacy of a company's actual capital is measured by the risk-based capital results, as determined by the formulas. Companies below minimum risk-based capital requirements are classified within certain levels, each of which requires specified corrective action. As of December 31, 2001 and 2000, Pacific Life and PL&A exceeded the minimum risk-based capital requirements. PERMITTED PRACTICE For the year ended December 31, 2000, the CA DOI approved a permitted practice effective May 5, 2000, allowing Pacific Life to apply the accounting guidance promulgated for limited liability companies in Statement of Statutory Accounting Principle (SSAP) No. 48, Joint Ventures, Partnerships and Limited Liability Companies, and SSAP No. 46, Investments in Subsidiary, Controlled and Affiliated Entities, prior to the effective date of NAIC SAP, for its investment in PAM. Under this permitted practice, PAM was accounted for using the equity method of accounting. The permitted practice also required that the equity of PAM be adjusted for certain tax effects not recorded at PAM due to its limited liability company structure. As of January 1, 2001, this permitted practice became prescribed practice. Prior to May 5, 2000, net cash distributions received on PAM's interest in PIMCO Advisors were recorded as income, as permitted by the CA DOI. DIVIDEND RESTRICTIONS Dividend payments by Pacific Life to Pacific LifeCorp in any 12-month period cannot exceed the greater of 10% of adjusted statutory capital and surplus as of the preceding year end or the statutory net gain from operations for the previous calendar year, without prior approval from the CA DOI. Based on this limitation and 2001 statutory results, Pacific Life could pay $165 million in dividends in 2002 without prior approval. No dividends were paid during 2001, 2000 and 1999. The maximum amount of ordinary dividends that can be paid by PL&A to Pacific Life without restriction cannot exceed the lesser of 10% of statutory surplus as regards to policyholders, or the statutory net gain from operations. No dividends were paid during 2001, 2000 and 1999. Based on this limitation and 2001 statutory results, PL&A could pay $21 million in dividends in 2002 without prior approval. 3. CLOSED BLOCK In connection with the Conversion, an arrangement known as a closed block (the Closed Block) was established, for dividend purposes only, for the exclusive benefit of certain individual life insurance policies that had an experience based dividend scale for 1997. The Closed Block was designed to give reasonable assurance to holders of Closed Block policies that policy dividends will not change solely as a result of the Conversion. Assets that support the Closed Block, which are primarily included in fixed maturity securities, policy loans and accrued investment income, amounted to $292 million and $290 million as of December 31, 2001 and 2000, respectively. Liabilities allocated to the Closed Block, which are primarily included in future policy benefits, amounted to $326 million and $330 million as of December 31, 2001 and 2000, respectively. The contribution to income from the Closed Block amounted to $5 million, $6 million and $4 million and is primarily included in insurance premiums, net investment income and policy benefits paid or provided for the years ended December 31, 2001, 2000 and 1999, respectively. PL-14 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. ACQUISITIONS All of the Company's acquisitions are accounted for using the purchase method of accounting. On December 31, 2001, a transaction was closed whereby Pacific Life exchanged its 100% common stock ownership in World-Wide Holdings Limited (World-Wide) for a 22.5% common stock ownership in Scottish Annuity & Life Holdings, Ltd. (Scottish). World-Wide's assets and liabilities were approximately $164 million and $103 million, respectively. Scottish, a publicly traded specialty reinsurer, issued new ordinary shares in exchange for World-Wide at a value of $78 million. Pacific Life recorded a nonmonetary exchange gain of $13 million, net of taxes, in connection with this exchange. Pacific Life will account for its investment in Scottish using the equity method of accounting. The Company has not yet completed the allocation of the purchase price to assets and liabilities acquired. In 1999, Pacific Life acquired a payout annuity block of business from Confederation Life Insurance Company (U.S.) in Rehabilitation, which is currently under rehabilitation. On the effective date, this block of business consisted of approximately 16,000 annuitants having reserves of $1.8 billion. The assets received as part of this acquisition amounted to $1.6 billion in fixed maturity securities and $0.2 billion in cash. During 1999, Pacific Life acquired a 95% interest in Grayhawk Golf Holdings, LLC (Grayhawk) for $65 million, which owns 100% of a real estate investment property in Arizona. Goodwill resulting from this transaction was $22 million. PL-15 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INVESTMENTS The net carrying amount, gross unrealized gains and losses, and estimated fair value of fixed maturity and equity securities available for sale are shown below. The net carrying amount represents amortized cost adjusted for other than temporary declines in value and change in fair value of fixed maturity securities attributable to the risk designated in a fair value hedge. The fair value of publicly traded securities is based on quoted market prices. For securities not actively traded, fair values were estimated based on amounts provided by independent pricing services specializing in matrix pricing and modeling techniques. The Company also estimates certain fair values based on interest rates, credit quality and average maturity or from securities with comparable trading characteristics.
Net Gross Unrealized Carrying ------------------ Estimated Amount Gains Losses Fair Value ---------------------------------------- (In Millions) As of December 31, 2001: ------------------------ U.S. Treasury securities and obligations of U.S. government authorities and agencies $ 32 $ 2 $ 34 Obligations of states and political subdivisions 669 92 761 Foreign governments 292 27 $ 11 308 Corporate securities 10,985 377 194 11,168 Mortgage-backed and asset- backed securities 4,822 137 190 4,769 Redeemable preferred stock 8 1 7 ---------------------------------------- Total fixed maturity securities $16,808 $ 635 $ 396 $17,047 ======================================== Total equity securities $ 255 $ 20 $ 9 $ 266 ======================================== As of December 31, 2000: ------------------------ U.S. Treasury securities and obligations of U.S. government authorities and agencies $ 32 $ 2 $ 34 Obligations of states and political subdivisions 641 55 $ 1 695 Foreign governments 302 20 5 317 Corporate securities 8,780 258 232 8,806 Mortgage-backed and asset- backed securities 5,230 101 100 5,231 Redeemable preferred stock 52 9 8 53 ---------------------------------------- Total fixed maturity securities $15,037 $ 445 $ 346 $15,136 ======================================== Total equity securities $ 173 $ 18 $ 12 $ 179 ========================================
PL-16 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INVESTMENTS (Continued) The net carrying amount and estimated fair value of fixed maturity securities available for sale as of December 31, 2001, by contractual repayment date of principal, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Net Carrying Estimated Amount Fair Value ------------------- (In Millions) Due in one year or less $ 794 $ 811 Due after one year through five years 4,785 4,924 Due after five years through ten years 3,699 3,775 Due after ten years 2,708 2,768 ------------------ 11,986 12,278 Mortgage-backed and asset-backed securities 4,822 4,769 ------------------ Total $16,808 $17,047 ==================
Major categories of investment income are summarized as follows:
Years Ended December 31, 2001 2000 1999 ------------------------ (In Millions) Fixed maturity securities $1,118 $1,109 $1,030 Equity securities 5 13 15 Mortgage loans 206 230 208 Real estate 64 61 46 Policy loans 202 182 159 Other 172 218 166 ------------------------ Gross investment income 1,767 1,813 1,624 Investment expense 139 130 114 ------------------------ Net investment income $1,628 $1,683 $1,510 ========================
PL-17 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INVESTMENTS (Continued) Net realized investment gain (loss), including changes in valuation allowances, is as follows:
Years Ended December 31, 2001 2000 1999 ------------------ (In Millions) Fixed maturity securities $(45) $ 2 $16 Equity securities 31 (13) 58 Mortgage loans 6 7 Real estate 9 (3) 18 Interest in PIMCO Advisors (Note 1) 1,082 Other investments (9) (77) ----------------- Total $(14) $ 997 $99 =================
The change in fair value on investments in available for sale and trading securities is as follows:
December 31, 2001 2000 1999 ------------------- (In Millions) Available for sale securities: Fixed maturity $140 $477 $ (925) Equity 5 (20) (157) ------------------- Total $145 $457 $(1,082) =================== Trading securities $(17) $ 6 $ 0 ===================
Gross gains of $67 million, $125 million and $188 million and gross losses of $48 million, $44 million and $62 million, which have been included in earnings as a result of sales of available for sale securities, were realized for the years ended December 31, 2001, 2000 and 1999, respectively. Trading securities as of December 31, 2001 and 2000, included net unrealized losses of $15 million and net unrealized gains of $2 million, respectively. As of December 31, 2001 and 2000, investments in fixed maturity securities of $13 million were on deposit with state insurance departments to satisfy regulatory requirements. The Company's interest in PIMCO Advisors (Note 1) exceeds 10% of total stockholder's equity as of December 31, 2001. PL-18 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount and estimated fair value of the Company's financial instruments are as follows:
December 31, 2001 December 31, 2000 ------------------- ------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value --------------------------------------- (In Millions) Assets: Fixed maturity and equity securities (Note 5) $17,313 $17,313 $15,315 $15,315 Trading securities 458 458 71 71 Mortgage loans 2,933 3,088 3,026 3,246 Policy loans 4,899 4,899 4,680 4,680 Cash and cash equivalents 510 510 211 211 Interest in PIMCO Advisors (Note 1) 1,703 1,703 1,548 1,548 Derivative instruments (Note 7) 26 26 15 15 Notes receivable from affiliates 88 88 Liabilities: Guaranteed interest contracts 7,498 7,625 6,676 6,803 Deposit liabilities 482 495 470 483 Annuity liabilities 1,955 1,955 1,114 1,114 Short-term debt 275 275 195 195 Long-term debt 164 160 164 166 Derivative instruments (Note 7) 530 530 445 445
The following methods and assumptions were used to estimate the fair value of these financial instruments as of December 31, 2001 and 2000: TRADING SECURITIES The fair value of trading securities is based on quoted market prices. MORTGAGE LOANS The estimated fair value of the mortgage loan portfolio is determined by discounting the estimated future cash flows, using a year-end market rate which is applicable to the yield, credit quality and average maturity of the composite portfolio. POLICY LOANS The carrying amounts of policy loans are a reasonable estimate of their fair values because interest rates are generally variable and based on current market rates. CASH AND CASH EQUIVALENTS The carrying values approximate fair values due to the short-term maturities of these instruments. PL-19 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) NOTES RECEIVABLE FROM AFFILIATES The carrying amount of notes receivable from affiliates (Note 16) is a reasonable estimate of its fair value because the interest rates are variable and based on current market rates. GUARANTEED INTEREST CONTRACTS AND DEPOSIT LIABILITIES The estimated fair value of GICs is estimated using the rates currently offered for deposits of similar remaining maturities. The estimated fair value of deposit liabilities with no defined maturities is the amount payable on demand. ANNUITY LIABILITIES The estimated fair value of annuity liabilities approximates carrying value and primarily includes policyholder deposits and accumulated credited interest. SHORT-TERM DEBT The carrying amount of short-term debt is a reasonable estimate of its fair value because the interest rates are variable and based on current market rates. LONG-TERM DEBT The estimated fair value of surplus notes (Note 10) is based on market quotes. The carrying amount of other long-term debt is a reasonable estimate of its fair value because the interest rate on the debt is approximately the same as current market rates. 7. DERIVATIVES AND HEDGING ACTIVITIES The Company primarily utilizes various derivative instruments to hedge and manage its exposure to changes in interest rate levels, foreign exchange rates, and equity market prices, and to manage the duration mismatch of assets and liabilities. The Company uses hedge accounting as allowed by SFAS No. 133 and SFAS No. 138, by designating derivative instruments as either fair value or cash flow hedges on the date the Company enters into a derivative contract. 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 and states how the hedging instrument is expected to hedge the risks related to the hedged item. The Company formally measures effectiveness of its hedging relationships both at the hedge inception and on an ongoing basis in accordance with its risk management policy. Hedge effectiveness is assessed quarterly by a variety of techniques including Value-at-Risk, regression analysis and cumulative dollar offset. In certain cases, hedge effectiveness is assumed because the derivative instrument was constructed such that all critical terms of the derivative exactly match the hedged risk in the hedged item. PL-20 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. DERIVATIVES AND HEDGING ACTIVITIES (Continued) Fair Value Hedges ----------------- The Company primarily uses interest rate and foreign currency swaps and options to manage its exposure to changes in the fair values of its assets and liabilities due to fluctuations in foreign currencies and the benchmark interest rate. For derivative instruments that are designated as fair value hedges, the change in value of the derivative instrument as well as the change in fair value of the hedged item associated with the risk being hedged is recorded in net realized investment gain (loss). Periodic net settlements on derivatives designated as fair value hedges are reflected on an accrual basis as an adjustment to net investment income or interest credited on universal life and investment-type products, based on the item being hedged. The change in value of the hedged item associated with the risk being hedged is reflected as an adjustment to the carrying amount of the hedged item. Upon termination of the fair value hedging relationship, the accumulated cost basis adjustment is amortized into net investment income or interest credited to universal life or investment-type products over its remaining life or recognized immediately in connection with the disposal of the hedged item. For the year ended December 31, 2001, the ineffectiveness related to fair value hedges was approximately $0.2 million, net of tax, which is recorded in net realized investment gain (loss). No component of the hedging instrument's fair value is excluded from the determination of effectiveness. Cash Flow Hedges ---------------- The Company primarily uses interest rate and foreign currency swaps and interest rate futures contracts to manage its exposure to variability in cash flows due to changes in foreign currencies and the benchmark interest rate. These cash flows include those associated with existing assets and liabilities as well as the forecasted interest cash flows related to anticipated investment purchases and liability issuances. Such anticipated investment purchases and liability issuances are considered to be probable to occur and are generally completed within 180 days of the inception of the hedge. The Company has not discontinued any cash flow hedges of anticipated transactions. For derivative instruments that are designated as cash flow hedges, the effective portion of the change in fair value of the derivative instrument is recorded in OCI and is recognized as an adjustment to net investment income or interest credited on universal life and investment-type products when the hedged item affects earnings. The Company did not record any ineffectiveness for cash flow hedges during the year ended December 31, 2001. Over the next twelve months, the Company anticipates that $0.8 million of deferred gains on derivative instruments in accumulated OCI will be reclassified to earnings. For the year ended December 31, 2001, none of the Company's hedged forecasted transactions were determined to be probable of not occurring. No component of the hedging instrument's fair value is excluded from the determination of effectiveness. Derivatives Not Designated as Hedging Instruments ------------------------------------------------- The Company enters into swap agreements, interest rate futures contracts, interest rate cap and floor agreements, and equity indexed futures contracts without designating the derivatives as hedging instruments. Derivatives that are not designated as hedging instruments are entered into primarily to manage the Company's interest rate risk from rising or falling interest rates, equity risk and yield enhancement. The Company uses credit default and total return swaps to manage the credit exposure of the portfolio, equity risk embedded in certain liabilities and to take advantage of market opportunities. Net realized investment gain (loss) for the year ended December 31, 2001 includes $2 million related to realized gains and losses and changes in fair value of derivative instruments not designated as hedges. Periodic net settlements on such derivatives are recorded as adjustments to net investment income or interest credited on universal life and investment-type products on an accrual basis, based upon the purpose of the derivative. PL-21 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. DERIVATIVES AND HEDGING ACTIVITIES (Continued) Embedded Derivatives -------------------- The Company may enter into contracts that are not derivative instruments, but contain embedded derivatives. When it is determined that the embedded derivative possesses economic and risk characteristics that are not clearly and closely related to those of the host contract and that a separate instrument with the same terms would qualify as a derivative instrument, it is separated from the host contract and accounted for as a stand-alone derivative. Such derivatives are recorded on the consolidated statement of financial condition at fair value, with changes in their fair value recorded in net realized investment gain (loss). Derivative Instruments ---------------------- The Company uses a variety of derivative financial instruments, including swaps, caps, floors, and exchange traded futures contracts. Interest rate swap agreements involve the exchange, at specified intervals, of interest payments resulting from the difference between fixed rate and floating rate interest amounts calculated by reference to an underlying notional amount. Credit default swaps involve the receipt of fixed rate payments in exchange for assuming potential credit exposure of an underlying security. Total return swaps involve the exchange of floating rate payments for the total return performance of a specified index, market or security. Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party. Foreign currency swaps involve the exchange of an initial principal amount in two currencies, and the agreement to re-exchange the currencies at a future date, at an agreed exchange rate. There is also periodic exchange of interest payments in the two currencies at specified intervals, calculated using agreed upon rates and the exchanged principal amounts. The Company issues synthetic GICs to Employee Retirement Income Security Act of 1974 (ERISA) qualified defined contribution employee benefit plans (ERISA Plan). The ERISA Plan uses the contracts in its stable value or guaranteed fixed income option. Synthetic GICs provide certain of the ERISA Plan's assets a guarantee of principal and interest, as it relates to certain benefit payments. The Company has an off balance sheet risk that the value of the underlying assets is insufficient to meet these guarantees. To control this risk, the Company pre-approves all investment guidelines. Default risk is absorbed by the ERISA Plan. The interest rate guarantee is reset periodically to reflect actual performance results. As of December 31, 2001 the Company had outstanding commitments to maintain liquidity for benefit payments on notional amounts of $2.6 billion compared to $1.7 billion as of December 31, 2000. The notional amounts represent the value of the ERISA Plan's assets only and are not a measure of the exposure to the Company. Interest rate floor agreements entitle the Company to receive the difference when the current rate of the underlying index is below the strike rate. Interest rate cap agreements entitle the Company to receive the difference when the current rate of the underlying index is above the strike rate. Options purchased involve the right, but not the obligation, to purchase the underlying securities at a specified price during a given time period. Cash requirements for these instruments are generally limited to the premium paid by the Company at acquisition. Financial futures contracts obligate the holder to buy or sell the underlying financial instrument at a specified future date for a set price and may be settled in cash or by delivery of the financial instrument. Price changes on futures are settled daily through the required margin cash flows. The notional amounts of the contracts do not represent future cash requirements, as the Company intends to close out open positions prior to expiration. PL-22 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. DERIVATIVES AND HEDGING ACTIVITIES (Continued) Outstanding derivatives with off-balance sheet risks, shown in notional or contract amounts along with their carrying value and estimated fair value as of December 31, 2001 and 2000 are as follows:
Assets (Liabilities) ----------------------------------------- Notional or Carrying Estimated Carrying Estimated Contract Amounts Value Fair Value Value Fair Value ----------------- -------- ---------- -------- ---------- 2001 2000 2001 2001 2000 2000 ----------------------------------------------------------- (In Millions) Interest rate swap contracts $ 3,512 $ 2,648 $(144) $(144) $ (89) $ (89) Credit default and total return swaps 2,375 3,896 (105) (105) (132) (132) Foreign currency swaps 3,310 2,488 (281) (281) (224) (224) Synthetic GICs 2,599 1,695 Interest rate floors, caps, options and swaptions 829 745 26 26 15 15 Financial futures contracts 97 58 ---------------------------------------------------------- Total $12,722 $11,530 $(504) $(504) $(430) $(430) ==========================================================
A reconciliation of the notional or contract amounts is as follows:
Balance Acquisitions Terminations Balance Beginning and Other and End of of Year Additions Maturities Year ------------------------------------------- (In Millions) December 31, 2001: ------------------ Interest rate swap contracts $ 2,648 $1,100 $ 236 $ 3,512 Credit default and total return swaps 3,896 254 1,775 2,375 Foreign currency swaps 2,488 1,439 617 3,310 Synthetic GICs 1,695 1,046 142 2,599 Interest rate floors, caps, options and swaptions 745 103 19 829 Financial futures contracts 58 3,398 3,359 97 ------------------------------------------- Total $11,530 $7,340 $6,148 $12,722 =========================================== December 31, 2000: ------------------ Interest rate swap contracts $ 2,867 $2,419 $2,638 $ 2,648 Credit default and total return swaps 2,120 2,898 1,122 3,896 Foreign currency swaps 1,685 1,079 276 2,488 Synthetic GICs 1,632 470 407 1,695 Interest rate floors, caps, options and swaptions 1,033 160 448 745 Financial futures contracts 677 2,762 3,381 58 ------------------------------------------- Total $10,014 $9,788 $8,272 $11,530 ===========================================
PL-23 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. UNIVERSAL LIFE AND INVESTMENT-TYPE PRODUCTS The detail of universal life and investment-type product liabilities is as follows:
December 31, 2001 2000 --------------- (In Millions) Universal life $12,278 $11,405 Investment-type products 9,518 8,005 --------------- $21,796 $19,410 ===============
The detail of universal life and investment-type products policy fees and interest credited, net of reinsurance ceded, is as follows:
Years Ended December 31, 2001 2000 1999 ------------------------- (In Millions) Policy fees: Universal life $ 582 $ 541 $ 509 Investment-type products 239 228 145 ------------------------- Total policy fees $ 821 $ 769 $ 654 ========================= Interest credited: Universal life $ 500 $ 467 $ 444 Investment-type products 529 530 494 ------------------------- Total interest credited $ 1,029 $ 997 $ 938 =========================
9. LIABILITY FOR GROUP HEALTH UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSE Activity in the liability for group health unpaid claims and claim adjustment expenses, which is included in future policy benefits, is summarized as follows:
Years Ended December 31, 2001 2000 -------------------------- (In Millions) Balance at January 1 $130 $116 Incurred related to: Current year 569 395 Prior years (12) (19) -------------------------- Total incurred 557 376 -------------------------- Paid related to: Current year 448 297 Prior years 80 65 -------------------------- Total paid 528 362 -------------------------- Balance at December 31 $159 $130 ==========================
As a result of favorable settlement of prior years' estimated claims, the provision for claims and claim adjustment expenses decreased by $12 million and $19 million for the years ended December 31, 2001 and 2000, respectively. PL-24 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. SHORT-TERM AND LONG-TERM DEBT Pacific Life borrows for short-term needs by issuing commercial paper. There was no commercial paper debt outstanding as of December 31, 2001 and 2000. As of December 31, 2001 and 2000, Pacific Life had a revolving credit facility of $350 million. There was no debt outstanding under the revolving credit facility as of December 31, 2001 and 2000. PAM had bank borrowings outstanding of $275 million and $195 million as of December 31, 2001 and 2000, respectively. The interest rate was 2.3% and 6.9% as of December 31, 2001 and 2000, respectively. The amount of the borrowings and the interest rates are reset monthly. The borrowing limit for PAM as of December 31, 2001 and 2000, was $275 million and $215 million, respectively. Grayhawk has a note payable with a maturity date of May 22, 2008. The note bears a fixed rate of interest of 7.6%. The outstanding balance as of December 31, 2001 and 2000 was $14 million. Pacific Life has $150 million of long-term debt, which consists of surplus notes outstanding at an interest rate of 7.9% maturing on December 30, 2023. Interest is payable semiannually on June 30 and December 30. The surplus notes may not be redeemed at the option of Pacific Life or any holder of the surplus notes. The surplus notes are unsecured and subordinated to all present and future senior indebtedness and policy claims of Pacific Life. Each payment of interest and principal on the surplus notes may be made only with the prior approval of the Insurance Commissioner of the State of California. Interest expense amounted to $12 million for each of the years ended December 31, 2001, 2000 and 1999 and is included in net investment income. 11. INCOME TAXES The provision for income taxes is as follows:
Years Ended December 31, 2001 2000 1999 --------------------------- (In Millions) Current $(5) $ 34 $152 Deferred 60 424 (8) --------------------------- Provision for income taxes on income before cumulative adjustments due to changes in accounting principles 55 458 144 Deferred income tax provision on cumulative adjustments due to changes in accounting principles (4) --------------------------- Total $51 $458 $144 ===========================
PL-25 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. INCOME TAXES (Continued) The sources of the Company's provision for deferred taxes are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Nonmonetary exchange of PIMCO Advisors units (Note 1) $447 Deferred policy acquisition costs $ 99 57 $ 20 Policyholder reserves 7 19 51 Duration hedging 3 (30) Investment valuation (7) (19) (28) Partnership income (26) 3 (25) Low income housing credit carryover (31) Other 14 (4) 4 ---------------------------- Deferred taxes from operations 56 506 (8) Release of deferred taxes in connection with nonmonetary exchange of PIMCO Advisors units (Note 1) (82) ---------------------------- Provision for deferred taxes $ 56 $424 $ (8) ============================
In connection with the nonmonetary exchange of partnership units at PIMCO Advisors (Note 1), certain nonoperating deferred taxes previously established were released during the year ended December 31, 2000. A reconciliation of the provision for income taxes based on the prevailing corporate statutory tax rate to the provision reflected in the consolidated financial statements is as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Provision for income taxes at the statutory rate $106 $509 $180 State income taxes 4 25 Nontaxable investment income (6) (6) (7) Low income housing and foreign tax credits (28) (22) (19) Book to tax basis difference on nonmonetary exchange of PIMCO Advisors units (Note 1) (35) Other (21) (13) (10) ---------------------------- Provision for income taxes on income before cumulative adjustments due to changes in accounting principles 55 458 144 Deferred income tax provision on cumulative adjustments due to changes in accounting principles (4) ---------------------------- Total $ 51 $458 $144 ============================
PL-26 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. INCOME TAXES (Continued) The net deferred tax liability, included in other liabilities as of December 31, 2001 and 2000, is comprised of the following tax effected temporary differences:
December 31, 2001 2000 -------------- (In Millions) Deferred tax assets Policyholder reserves $ 177 $ 184 Investment valuation 99 92 Deferred compensation 40 35 Low income housing credit carryover 31 Duration hedging 18 18 Partnership income 10 Dividends 7 7 Postretirement benefits 6 8 Other 5 22 -------------- Total deferred tax assets 393 366 -------------- Deferred tax liabilities Nonmonetary exchange of PIMCO Advisors units (Note 1) (429) (429) Deferred policy acquisition costs (200) (101) Partnership income (16) Depreciation (2) (2) -------------- Total deferred tax liabilities (631) (548) -------------- Net deferred tax liability from operations (238) (182) Deferred taxes on World-Wide (Note 4) (11) Deferred taxes on OCI (159) (23) -------------- Net deferred tax liability $ (397) $(216) ==============
PL-27 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. COMPREHENSIVE INCOME (LOSS) The Company displays comprehensive income (loss) and its components on the accompanying consolidated statements of stockholder's equity and as follows. OCI is shown net of reclassification adjustments and net of deferred income taxes. The disclosure of the gross components of OCI is as follows:
Years Ended December 31, 2001 2000 1999 --------------------------- (In Millions) Gross Holding Gain (Loss): Holding gain (loss) on securities available for sale $151 $ 457 $(948) Holding loss on derivatives (20) (70) (226) Income tax (expense) benefit (45) (135) 411 Reclassification adjustment: Realized (gain) loss on sale of securities available for sale (5) 3 (78) Realized loss on derivatives 71 Provision for income taxes (benefit) (24) (1) 27 Allocation of holding (gain) loss to deferred policy acquisition costs 2 (27) 44 Provision for income (taxes) benefit (1) 9 (15) --------------------------- Net unrealized gain (loss) on securities available for sale 129 236 (785) Foreign currency translation adjustment (1) (4) (1) Unrealized gain on interest in PIMCO Advisors (Note 1) 111 77 --------------------------- Total $239 $309 $(786) ===========================
13. REINSURANCE The Company has reinsurance agreements with other insurance companies for the purpose of diversifying risk and limiting exposure on larger mortality risks or, in the case of a producer-owned reinsurance company, to diversify risk and retain top producing agents. Amounts receivable from reinsurers for reinsurance of future policy benefits, universal life deposits, and unpaid losses is included in other assets. All assets associated with business reinsured on a yearly renewable term and modified coinsurance basis remain with, and under the control of the Company. Amounts recoverable (payable) from (to) reinsurers include the following amounts:
December 31, 2001 2000 -------------- (In Millions) Universal life deposits $(79) $(66) Future policy benefits 155 156 Unpaid claims 34 26 Paid claims 16 13 Other 17 33 -------------- Net reinsurance recoverable $143 $162 ==============
PL-28 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. REINSURANCE (Continued) As of December 31, 2001, 75% of the reinsurance recoverables were from two reinsurers, of which 100% is secured by payables to the reinsurer. To the extent that the assuming companies become unable to meet their obligations under these agreements, the Company remains contingently liable. The Company does not anticipate nonperformance by the assuming companies. The components of insurance premiums are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Direct premiums $ 923 $ 646 $563 Ceded reinsurance (129) (108) (93) Assumed reinsurance 18 14 14 --------------------------- Insurance premiums $ 812 $ 552 $484 ===========================
Revenues and benefits are shown net of the following reinsurance transactions:
Years Ended December 31, 2001 2000 1999 ------------------------- (In Millions) Ceded reinsurance netted against policy fees $ 85 $ 74 $ 52 Ceded reinsurance netted against net investment income 266 244 212 Ceded reinsurance netted against interest credited 210 161 111 Ceded reinsurance netted against policy benefits 115 110 88 Assumed reinsurance included in policy benefits 11 12 8
14. SEGMENT INFORMATION The Company has five operating segments: Life Insurance, Institutional Products, Annuities, Group Insurance and Broker-Dealers. These segments are managed separately and have been identified based on differences in products and services offered. All other activity is included in Corporate and Other. Prior to May 4, 2000, the Company had another operating segment, Investment Management. In connection with the PIMCO Advisors transaction (Note 1), Investment Management was no longer considered an operating segment by management and, effective May 5, 2000, it's activities are included in Corporate and Other. PIMCO Advisors offers a diversified range of investment products through separately managed accounts, and institutional, retail and offshore funds. The Life Insurance segment offers universal life, variable universal life and other life insurance products to individuals, small businesses and corporations through a network of distribution channels that include branch offices, sales centers, marketing organizations, National Association of Securities Dealers (NASD) firms and a national producer group that has produced over 10% of the segment's in force business. The Institutional Products segment offers investment and annuity products to pension fund sponsors and other institutional investors primarily through its home office marketing team and other intermediaries. The Annuities segment offers variable and fixed annuities to individuals and small businesses through NASD firms, regional and national wirehouses, and financial institutions. PL-29 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The Group Insurance segment primarily offers group life, health and dental insurance, and stop loss insurance products to corporate, government and labor-management-negotiated plans. The group life, health and dental insurance is primarily distributed through a network of sales offices and the stop loss insurance is distributed through a network of third party administrators. The Broker-Dealers segment includes five NASD registered firms that provide securities and insurance brokerage services and investment advisory services through approximately 3,100 registered representatives. Pacific Life's direct wholly owned broker-dealer subsidiary, Pacific Select Distributors, Inc. (PSD), primarily serves as the underwriter/distributor of registered investment-related products and services, principally variable life and annuity contracts issued by Pacific Life. During 2001, PSD became the distributor of the Pacific Funds, a multi-class, open end investment management company. Pacific Life is the investment adviser to the Pacific Funds. Corporate and Other primarily includes investment income, expenses and assets not attributable to the operating segments, and the operations of World-Wide (Note 4). Corporate and Other also includes the elimination of intersegment revenues, expenses and assets, including commission revenue and expense from the sale of Pacific Life's variable life and annuity products. The Company uses the same accounting policies and procedures to measure segment income and assets as it uses to measure its consolidated net income and assets. Net investment income and net realized investment gain (loss) are allocated based on invested assets purchased and held as is required for transacting the business of that segment. Overhead expenses are allocated based on services provided. Interest expense is allocated based on the short-term borrowing needs of the segment and is included in net investment income. The provision for income taxes is allocated based on each segment's actual tax provision. The Company generates substantially all of its revenues and income from customers located in the United States. Additionally, substantially all of the Company's assets are located in the United States. Depreciation expense and capital expenditures are not material and have not been reported herein. The Company's significant noncash item disclosed herein is interest credited to universal life and investment-type products. PL-30 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The following is segment information as of and for the year ended December 31, 2001:
Life Institutional Group Broker- Corporate Insurance Products Annuities Insurance Dealers and Other Total ----------------------------------------------------------------------------------------------- (In Millions) REVENUES Policy fees $ 582 $ 2 $ 237 $ 821 Insurance premiums (59) 113 $723 $ 35 812 Net investment income 645 831 67 19 $ 1 65 1,628 Net realized investment gain (loss) 5 2 (21) (14) Commission revenue 580 (399) 181 Other income 28 10 99 2 40 46 225 --------------------------------------------------------------------- Total revenues 1,196 961 403 746 621 (274) 3,653 --------------------------------------------------------------------- BENEFITS AND EXPENSES Policy benefits 205 351 27 557 23 1,163 Interest credited 506 456 67 1,029 Commission expenses 149 3 146 50 570 (394) 524 Operating expenses 172 20 144 113 53 132 634 --------------------------------------------------------------------- Total benefits and expenses 1,032 830 384 720 623 (239) 3,350 --------------------------------------------------------------------- Income (loss) before provision for income taxes (benefit) 164 131 19 26 (2) (35) 303 Provision for income taxes (benefit) 38 34 1 7 (1) (24) 55 --------------------------------------------------------------------- Income (loss) before cumulative adjustments due to changes in accounting principles 126 97 18 19 (1) (11) 248 Cumulative adjustments due to changes in accounting principles, net of taxes (3) (8) (1) 1 4 (7) --------------------------------------------------------------------- Net income (loss) $ 123 $ 89 $ 17 $ 20 $ (1) $ (7) $ 241 ===================================================================== Total assets $18,216 $16,121 $17,928 $431 $ 74 $2,912 $55,682 Deferred policy acquisition costs $ 923 $ 75 $ 1,115 $ 2,113 Separate account assets $ 3,615 $ 4,461 $15,382 $23,458 Policyholder and contract liabilities $13,325 $10,965 $ 1,874 $212 $26,376 Separate account liabilities $ 3,615 $ 4,461 $15,382 $23,458
PL-31 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The following is segment information as of and for the year ended December 31, 2000, except for the Investment Management Segment, which is for the period ended, May 4, 2000:
Life Institutional Group Investment Broker- Corporate Insurance Products Annuities Insurance Management Dealers and Other Total --------------------------------------------------------------------------------------------------------- (In Millions) REVENUES Policy fees $ 541 $ 3 $ 225 $ 769 Insurance premiums (49) 64 2 $511 $ 24 552 Net investment income 609 838 58 29 $49 $ 1 99 1,683 Net realized investment gain (loss) (22) (40) (4) (7) 10 1,060 997 Commission revenue 687 (417) 270 Other income 32 8 97 4 6 23 39 209 -------------------------------------------------------------------------------- Total revenues 1,111 873 378 537 65 711 805 4,480 -------------------------------------------------------------------------------- BENEFITS AND EXPENSES Policy benefits 190 298 6 385 879 Interest credited 474 458 53 12 997 Commission expenses 161 2 135 36 650 (408) 576 Operating expenses 159 20 126 93 27 47 103 575 -------------------------------------------------------------------------------- Total benefits and expenses 984 778 320 514 27 697 (293) 3,027 -------------------------------------------------------------------------------- Income before provision for income taxes 127 95 58 23 38 14 1,098 1,453 Provision for income taxes 29 18 21 6 8 6 370 458 -------------------------------------------------------------------------------- Net income $ 98 $ 77 $ 37 $ 17 $30 $ 8 $ 728 $ 995 ================================================================================ Total assets $17,232 $17,908 $16,661 $374 $ 72 $2,537 $54,784 Deferred policy acquisition costs $ 825 $ 75 $ 886 $ 10 $ 1,796 Separate account assets $ 3,543 $ 7,104 $15,271 $25,918 Policyholder and contract liabilities $12,439 $10,218 $ 1,019 $189 $ 87 $23,952 Separate account liabilities $ 3,543 $ 7,104 $15,271 $25,918
PL-32 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The following is segment information for the year ended December 31, 1999:
Life Institutional Group Investment Broker- Corporate Insurance Products Annuities Insurance Management Dealers and Other Total -------------------------------------------------------------------------------------------------------- (In Millions) REVENUES Policy fees $ 509 $ 3 $142 $ 654 Insurance premiums (32) 25 6 $476 $ 9 484 Net investment income 582 679 78 23 $116 $ 1 31 1,510 Net realized investment gain (loss) 11 26 (1) 10 53 99 Commission revenue 583 (349) 234 Other income 25 11 57 3 15 19 15 145 ------------------------------------------------------------------------------- Total revenues 1,095 744 283 501 141 603 (241) 3,126 ------------------------------------------------------------------------------- BENEFITS AND EXPENSES Policy benefits 174 197 10 354 735 Interest credited 451 418 65 4 938 Commission expenses 163 87 33 549 (347) 485 Operating expenses 128 17 48 84 78 42 56 453 ------------------------------------------------------------------------------- Total benefits and expenses 916 632 210 471 78 591 (287) 2,611 ------------------------------------------------------------------------------- Income before provision for income taxes 179 112 73 30 63 12 46 515 Provision for income taxes 54 31 24 10 12 5 8 144 ------------------------------------------------------------------------------- Net income $ 125 $ 81 $ 49 $ 20 $ 51 $ 7 $ 38 $ 371 ===============================================================================
15. EMPLOYEE BENEFIT PLANS PENSION PLANS Pacific Life provides a defined benefit pension plan covering all eligible employees of the Company. On July 1, 2000, Pacific Life converted this final average pay formula defined benefit plan to a cash balance approach. Active employees' existing benefits in this plan were converted to opening balances and will increase over time from credits, based on years of service and compensation levels, and quarterly interest accruals. The full-benefit vesting period for all participants is five years. Pacific Life's funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as may be determined appropriate. Contributions are intended to provide not only for benefits attributed to employment to date but also for those expected to be earned in the future. All such contributions are made to a tax-exempt trust. Plan assets consist primarily of group annuity contracts issued by Pacific Life, as well as mutual funds managed by an affiliate of Pacific Life. PL-33 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. EMPLOYEE BENEFIT PLANS (Continued) Components of the net periodic pension expense (benefit) are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Service cost - benefits earned during the year $ 12 $ 6 $ 5 Interest cost on projected benefit obligation 12 12 11 Expected return on plan assets (16) (17) (16) Amortization of net obligations and prior service cost (1) (4) (2) ---------------------------- Net periodic pension expense (benefit) $ 7 $ (3) $ (2) ============================
The following tables set forth the changes in projected benefit obligation and plan assets and funded status reconciliation:
December 31, 2001 2000 -------------- (In Millions) Change in Projected Benefit Obligation: --------------------------------------- Projected benefit obligation, beginning of year $170 $156 Service cost 12 6 Interest cost 12 12 Plan expense (1) (1) Actuarial loss 4 5 Benefits paid (19) (8) -------------- Projected benefit obligation, end of year $178 $170 ============== Change in Plan Assets: ---------------------- Fair value of plan assets, beginning of year $197 $212 Actual return on plan assets (13) (6) Employer contributions 17 Plan expense (1) (1) Benefits paid (19) (8) -------------- Fair value of plan assets, end of year $181 $197 ============== Funded Status Reconciliation: ----------------------------- Funded status $ 3 $ 27 Unrecognized transition asset (1) Unrecognized actuarial (gain) loss 15 (18) -------------- Prepaid pension cost $ 18 $ 8 ==============
In determining the actuarial present value of the projected benefit obligation as of December 31, 2001 and 2000, the weighted average discount rate used was 7.0% and 7.5%, respectively, and the rate of increase in future compensation levels was 4.5% and 5.0%, respectively. The expected long-term rate of return on plan assets was 8.5% in 2001 and 2000. PL-34 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. EMPLOYEE BENEFIT PLANS (Continued) POSTRETIREMENT BENEFITS Pacific Life provides a defined benefit health care plan and a defined benefit life insurance plan (the Plans) that provide postretirement benefits for all eligible retirees and their dependents. Generally, qualified employees may become eligible for these benefits if they reach normal retirement age, have been covered under Pacific Life's policy as an active employee for a minimum continuous period prior to the date retired, and have an employment date before January 1, 1990. The Plans contain cost-sharing features such as deductibles and coinsurance, and require retirees to make contributions which can be adjusted annually. Pacific Life's commitment to qualified employees who retire after April 1, 1994 is limited to specific dollar amounts. Pacific Life reserves the right to modify or terminate the Plans at any time. As in the past, the general policy is to fund these benefits on a pay-as-you-go basis. The net periodic postretirement benefit cost for the years ended December 31, 2001, 2000 and 1999 is $1 million. As of December 31, 2001 and 2000, the accumulated benefit obligation is $19 million and $20 million, respectively. The fair value of the plan assets as of December 31, 2001 and 2000 is zero. The amount of accrued benefit cost included in other liabilities is $24 million as of December 31, 2001 and 2000. The Plans include both indemnity and HMO coverage. The assumed health care cost trend rate used in measuring the accumulated benefit obligation for indemnity coverage was 9.0% and 10.0% for 2001 and 2000, respectively, and is assumed to decrease gradually to 5.0% in 2005 and remain at that level thereafter. The assumed health care cost trend rate used in measuring the accumulated benefit obligation for HMO coverage was 8.0% and 9.0% for 2001 and 2000, respectively, and is assumed to decrease gradually to 4.5% in 2005 and remain at that level thereafter. The amount reported is materially affected by the health care cost trend rate assumptions. If the health care cost trend rate assumptions were increased by 1%, the accumulated postretirement benefit obligation as of December 31, 2001 would be increased by 7.0%, and the aggregate of the service and interest cost components of the net periodic benefit cost would increase by 6.6%. If the health care cost trend rate assumptions were decreased by 1%, the accumulated postretirement benefit obligation as of December 31, 2001 would be decreased by 6.6%, and the aggregate of the service and interest cost components of the net periodic benefit cost would decrease by 6.4%. The discount rate used in determining the accumulated postretirement benefit obligation is 7.0% and 7.5% for 2001 and 2000, respectively. OTHER PLANS Pacific Life provides a voluntary Retirement Incentive Savings Plan (RISP) pursuant to Section 401(k) of the Internal Revenue Code covering all eligible employees of the Company. Pacific Life's RISP matches 75% of each employee contributions, up to a maximum of 6.0% of eligible employee compensation, to an Employee Stock Ownership Plan (ESOP). ESOP contributions made by the Company amounted to $9 million, $8 million and $7 million for the years ended December 31, 2001, 2000 and 1999, respectively, and are included in operating expenses. The ESOP was formed at the time of the Conversion and is only available to the participants of the RISP in the form of matching contributions. Pacific LifeCorp issued 1.7 million shares of common stock to the ESOP in 1997, in exchange for a promissory note of $21 million (ESOP Note) bearing an interest rate of 6.5%. Interest and principal payments are due semiannually in equal installments through September 2, 2012. Interest and principal payments made by the ESOP to Pacific LifeCorp were funded by contributions from Pacific Life. In 1999, Pacific Life loaned cash to the ESOP to pay off the ESOP Note due Pacific LifeCorp. Interest and principal payments made by the ESOP to Pacific Life continue to be funded by contributions from Pacific Life. The interest rate was reduced to 6.0% effective September 2, 1999. PL-35 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. EMPLOYEE BENEFIT PLANS (Continued) The ESOP Note is included in unearned ESOP shares. The unearned ESOP shares account is reduced as ESOP shares are released for allocation to participants through ESOP contributions by Pacific Life. In addition, when the fair value of ESOP shares being released for allocation to participants exceeds the original issue price of those shares, paid-in capital is increased by this difference. On January 9, 2002, Pacific Life loaned cash of $46 million to the ESOP in exchange for a 5.5% promissory note due January 9, 2017. The ESOP then purchased 2 million shares of newly issued common stock of Pacific LifeCorp at a price of $23.00 per share in exchange for cash. These newly issued shares were purchased in order for the ESOP to maintain its matching contributions to participants in the plan. The Company has deferred compensation plans that permit eligible employees to defer portions of their compensation and earn interest on the deferred amounts. The interest rate is determined annually. The compensation that has been deferred has been accrued and the primary expense related to this plan, other than compensation, is interest on the deferred amounts. The Company also has performance-based incentive compensation plans for its employees. 16. TRANSACTIONS WITH AFFILIATES Pacific Life serves as the investment adviser for the Pacific Select Fund, the investment vehicle provided to the Company's variable life and variable annuity contractholders. Pacific Life charges fees based upon the net asset value of the portfolios of the Pacific Select Fund, which amounted to $117 million, $115 million and $70 million for the years ended December 31, 2001, 2000 and 1999, respectively. In addition, Pacific Life provides certain support services to the Pacific Select Fund and other affiliates based on an allocation of actual costs. Fees amounted to $948,000, $698,000 and $1,288,000 for the years ended December 31, 2001, 2000 and 1999, respectively. PAM has an agreement to loan Pacific LifeCorp up to $350 million at variable rates. The outstanding balance as of December 31, 2001 was $70 million. There was no balance outstanding as of December 31, 2000. The interest rate as of December 31, 2001 was 2.2%. During 2001, PAM entered into an agreement to loan Aviation Capital Group Holding Corp., a subsidiary of Pacific LifeCorp, up to $100 million at variable rates. The outstanding balance as of December 31, 2001 was $18 million. The interest rate as of December 31, 2001 was 4.1%. 17. TERMINATION AND NONCOMPETITION AGREEMENTS The Company had termination and noncompetition agreements with certain former key employees of PAM's subsidiaries. In connection with the closing of the PIMCO Advisors transaction (Note 1), these agreements were assumed by Allianz. These agreements provided terms and conditions for the allocation of future proceeds received from distributions and sales of certain PIMCO Advisors units and other noncompete payments. For the years ended December 31, 2000 and 1999, $14 million and $54 million, respectively, is included in operating expenses related to these agreements. PL-36 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. COMMITMENTS AND CONTINGENCIES The Company has outstanding commitments to make investments primarily in fixed maturity securities, mortgage loans, limited partnerships and other investments as follows (In Millions):
Years Ending December 31: ------------------------- 2002 $290 2003 through 2006 234 2007 and thereafter 82 ---- Total $606 ====
The Company leases office facilities under various noncancelable operating leases. Rent expense, which is included in operating expenses, in connection with these leases was $15 million, $14 million and $9 million for the years ended December 31, 2001, 2000 and 1999, respectively. Aggregate minimum future commitments are as follows (In Millions):
Years Ending December 31: ------------------------- 2002 $ 16 2003 through 2006 53 2007 and thereafter 31 ---- Total $100 ====
The Company has investments in entities that are not consolidated because of control and substantive ownership by independent third parties. There are no material unrecorded liabilities and all material guarantees and commitments have been disclosed herein. The Company is a respondent in a number of legal proceedings, some of which involve allegations for extra-contractual damages. In the opinion of management, the outcome of the foregoing proceedings is not likely to have a material adverse effect on the consolidated financial position or results of operations of the Company. --------------------------------------------------------------------------- PL-37 STATEMENT OF ADDITIONAL INFORMATION May 1, 2002 PACIFIC INNOVATIONS SELECT SEPARATE ACCOUNT A ---------------- Pacific Innovations Select (the "Contract") is a variable annuity contract underwritten by Pacific Life Insurance Company ("Pacific Life"). This Statement of Additional Information (SAI) is not a Prospectus and should be read in conjunction with the Contract's Prospectus, dated May 1, 2002 which is available without charge upon written or telephone request to Pacific Life. Terms used in this SAI have the same meanings as in the Prospectus, and some additional terms are defined particularly for this SAI. ---------------- Pacific Life Insurance Company Mailing Address: P.O. Box 7187 Pasadena, California 91109-7187 1-800-722-2333 TABLE OF CONTENTS
Page No. -------- PERFORMANCE............................................................ 1 Total Returns........................................................ 1 Yields............................................................... 2 Performance Comparisons and Benchmarks............................... 3 Separate Account Performance......................................... 3 DISTRIBUTION OF THE CONTRACTS.......................................... 7 Pacific Select Distributors, Inc. (PSD).............................. 7 THE CONTRACTS AND THE SEPARATE ACCOUNT................................. 8 Calculating Subaccount Unit Values................................... 8 Variable Annuity Payment Amounts..................................... 8 Corresponding Dates.................................................. 10 Age and Sex of Annuitant............................................. 11 Systematic Transfer Programs......................................... 11 Pre-Authorized Withdrawals........................................... 13 Death Benefit........................................................ 13 1035 Exchanges....................................................... 14 Safekeeping of Assets................................................ 14 FINANCIAL STATEMENTS .................................................. 14 INDEPENDENT AUDITORS .................................................. 14
PERFORMANCE From time to time, our reports or other communications to current or prospective Contract Owners or our advertising or other promotional material may quote the performance (yield and total return) of a Subaccount. Quoted results are based on past performance and reflect the performance of all assets held in that Subaccount for the stated time period. Quoted results are neither an estimate nor a guarantee of future investment performance, and do not represent the actual experience of amounts invested by any particular Contract Owner. Total Returns A Subaccount may advertise its "average annual total return" over various periods of time. "Total return" represents the average percentage change in value of an investment in the Subaccount from the beginning of a measuring period to the end of that measuring period. "Annualized" total return assumes that the total return achieved for the measuring period is achieved for each such period for a full year. "Average annual" total return is computed in accordance with a standard method prescribed by the SEC. Average Annual Total Return To calculate a Subaccount's average annual total return for a specific measuring period, we first take a hypothetical $1,000 investment in that Subaccount, at its then-applicable Subaccount Unit Value (the "initial payment") and we compute the ending redeemable value of that initial payment at the end of the measuring period based on the investment experience of that Subaccount ("full withdrawal value"). The full withdrawal value reflects the effect of all recurring fees and charges applicable to a Contract Owner under the Contract, including the Risk Charge, the Administrative Fee and the deduction of the applicable withdrawal charge, but does not reflect any charges for applicable premium taxes, any non-recurring fees or charges or any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders. The Annual Fee is also taken into account, assuming an average Contract Value of $65,000. The redeemable value is then divided by the initial payment and this quotient is raised to the 365/N power (N represents the number of days in the measuring period), and 1 is subtracted from this result. Average annual total return is expressed as a percentage. T = (ERV/P)(to the power of 365/N) - 1 where T = average annual total return ERV = ending redeemable value P = hypothetical initial payment of $1,000 N = number of days Average annual total return figures will be given for recent one-, three-, five-and ten-year periods (if applicable), and may be given for other periods as well (such as from commencement of the Subaccount's operations, or on a year-by-year basis). When considering "average" total return figures for periods longer than one year, it is important to note that the relevant Subaccount's annual total return for any one year in the period might have been greater or less than the average for the entire period. Aggregate Total Return A Subaccount may use "aggregate" total return figures along with its "average annual" total return figures for various periods; these figures represent the cumulative change in value of an investment in the Subaccount for a specific period. Aggregate total returns may be shown by means of schedules, charts or graphs and may indicate subtotals of the various components of total return. The SEC has not prescribed standard formulas for calculating aggregate total return. Total returns may also be shown for the same periods that do not take into account the withdrawal charge. 1 Non-Standardized Total Returns We may also calculate non-standardized total returns which may or may not reflect any Annual Fee, withdrawal charges and/or increases in Risk Charges, charges for premium taxes or optional riders, and any non-recurring fees or charges. Standardized return figures will always accompany any non-standardized returns shown. Yields Money Market Subaccount The "yield" (also called "current yield") of the Money Market Subaccount is computed in accordance with a standard method prescribed by the SEC. The net change in the Subaccount's Unit Value during a seven-day period is divided by the Unit Value at the beginning of the period to obtain a base rate of return. The current yield is generated when the base rate is "annualized" by multiplying it by the fraction 365/7; that is, the base rate of return is assumed to be generated each week over a 365-day period and is shown as a percentage of the investment. The "effective yield" of the Money Market Subaccount is calculated similarly but, when annualized, the base rate of return is assumed to be reinvested. The effective yield will be slightly higher than the current yield because of the compounding effect of this assumed reinvestment. The formula for effective yield is: [(Base Period Return +1) (To the power of 365/7)] - 1. Realized capital gains or losses and unrealized appreciation or depreciation of the assets of the underlying Money Market Portfolio are not included in the yield calculation. Current yield and effective yield do not reflect any deduction of charges for any applicable premium taxes, or any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders, but do reflect a deduction for the Annual Fee, the Risk Charge and the Administrative Fee and assumes an average Contract Value of $65,000. At December 31, 2001, the Money Market Subaccount's current yield was 0.00% and the effective yield was 0.00%. Other Subaccounts "Yield" of the other Subaccounts is computed in accordance with a different standard method prescribed by the SEC. The net investment income (investment income less expenses) per Subaccount Unit earned during a specified one-month or 30-day period is divided by the Subaccount Unit Value on the last day of the specified period. This result is then annualized (that is, the yield is assumed to be generated each month or each 30-day period for a year), according to the following formula, which assumes semiannual compounding: YIELD = 2[(a-b + 1)(to the power of 6) - 1] --- cd where: a = net investment income earned during the period by the Portfolio attributable to the Subaccount. b = expenses accrued for the period (net of reimbursements). c = the average daily number of Subaccount Units outstanding during the period that were entitled to receive dividends. d = the Unit Value of the Subaccount Units on the last day of the period. The yield of each Subaccount reflects the deduction of all recurring fees and charges applicable to the Subaccount, such as the Risk Charge, the Administrative Fee, the Annual Fee (assuming an average Contract Value of $65,000), but does not reflect any withdrawal charge, any charge for applicable premium taxes, any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders, or any non-recurring fees or charges. The Subaccounts' yields will vary from time to time depending upon market conditions, the composition of each Portfolio and operating expenses of the Fund allocated to each Portfolio. Consequently, any given performance quotation should not be considered representative of the Subaccount's performance in the future. Yield should 2 also be considered relative to changes in Subaccount Unit Values and to the relative risks associated with the investment policies and objectives of the various Portfolios. In addition, because performance will fluctuate, it may not provide a basis for comparing the yield of a Subaccount with certain bank deposits or other investments that pay a fixed yield or return for a stated period of time. Performance Comparisons and Benchmarks In advertisements and sales literature, we may compare the performance of some or all of the Subaccounts to the performance of other variable annuity issuers in general and to the performance of particular types of variable annuities investing in mutual funds, or series of mutual funds, with investment objectives similar to each of the Subaccounts. This performance may be presented as averages or rankings compiled by Lipper Analytical Services, Inc. ("Lipper"), the Variable Annuity Research and Data Service ("VARDS(R)") or Morningstar, Inc. ("Morningstar"), which are independent services that monitor and rank the performance of variable annuity issuers and mutual funds in each of the major categories of investment objectives on an industry-wide basis. Lipper's rankings include variable life issuers as well as variable annuity issuers. VARDS(R) rankings compare only variable annuity issuers. The performance analyses prepared by Lipper and VARDS(R) rank such issuers on the basis of total return, assuming reinvestment of dividends and distributions, but do not take sales charges, redemption fees or certain expense deductions at the separate account level into consideration. In addition, VARDS(R) prepares risk adjusted rankings, which consider the effects of market risk on total return performance. We may also compare the performance of the Subaccounts with performance information included in other publications and services that monitor the performance of insurance company separate accounts or other investment vehicles. These other services or publications may be general interest business publications such as The Wall Street Journal, Barron's, Business Week, Forbes, Fortune, and Money. In addition, our reports and communications to Contract Owners, advertisements, or sales literature may compare a Subaccount's performance to various benchmarks that measure the performance of a pertinent group of securities widely regarded by investors as being representative of the securities markets in general or as being representative of a particular type of security. We may also compare the performance of the Subaccounts with that of other appropriate indices of investment securities and averages for peer universes of funds or data developed by us derived from such indices or averages. Unmanaged indices generally assume the reinvestment of dividends or interest but do not generally reflect deductions for investment management or administrative costs and expenses. Separate Account Performance The Contract was not available prior to 2001. However, in order to help you understand how investment performance can affect your Variable Account Value, we are including performance information based on the historical performance of the Subaccounts. The following table presents the annualized total return for each Variable Account for the period from each such Variable Account's commencement of operations through December 31, 2001. The accumulated value (AV) reflects the deductions for all contractual fees and charges, but does not reflect the withdrawal charge, any nonrecurring fees and charges, any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders, or any charges for premium taxes. The full withdrawal value (FWV) reflects the deductions for all contractual fees and charges, but does not reflect any increase in the Risk Charge for an optional Death Benefit Rider, or any charge for the optional EEG or GPA Riders, any nonrecurring fees and charges, and any charges for premium taxes. 3 The results shown in this section are not an estimate or guarantee of future investment performance. Historical Separate Account Performance Annualized Rates of Return for Periods Ended December 31, 2001 All numbers are expressed as a percentage
Since 1 Year 3 Years 5 Years* Inception -------------- ------------ ------------ -------------- Variable Accounts AV FWV AV FWV AV FWV AV FWV - ----------------- ------ ------ ----- ----- ----- ----- ------ ------ Blue Chip 1/2/01*....... (19.91) (26.21) (19.91) (26.21) Aggressive Growth 1/2/01*................ (21.10) (27.40) (21.10) (27.40) Emerging Markets 4/17/96*............... (10.18) (16.48) (4.97) (6.31) (9.83) (9.83) (9.52) (9.54) Diversified Research 1/3/00*................ (4.34) (10.64) 1.84 (0.85) Small-Cap Equity 10/1/99*............... (4.15) (10.45) (2.94) (4.62) International Large-Cap 1/3/00*................ (19.64) (25.94) (21.31) (24.85) I-Net Tollkeeper 5/1/00*................ (35.03) (41.33) (39.22) (43.86) Financial Services 1/2/01*................ (8.81) (15.11) (8.81) (15.11) Health Sciences 1/2/01*................ (9.21) (15.51) (9.21) (15.51) Technology 1/2/01*...... (41.91) (48.26) (41.91) (48.26) Telecommunications 1/2/01*................ (47.60) (53.94) (47.60) (53.94) Multi-Strategy 1/2/96*.. (2.78) (9.08) 0.48 (0.72) 6.77 6.77 7.31 7.31 Large-Cap Core 1/2/96* (formerly called Equity Income)................ (10.37) (16.67) (2.87) (4.16) 7.20 7.20 8.67 8.67 Strategic Value 10/2/00*............... (11.35) (17.65) (11.10) (15.59) Growth LT 1/2/96*....... (30.76) (37.06) 1.31 0.12 12.06 12.06 12.68 12.68 Focused 30 10/2/00*..... (14.78) (21.08) (24.84) (29.57) Mid-Cap Value 1/4/99*... 11.44 5.14 12.37 11.40 International Value 1/2/96*................ (23.21) (29.51) (6.82) (8.22) (2.01) (2.01) 1.09 1.09 Capital Opportunities 1/2/01*................ (16.93) (23.23) (16.93) (23.23) Mid-Cap Growth 1/2/01*.. (20.15) (26.45) (20.15) (26.45) Global Growth 1/2/01*... (16.37) (22.67) (16.37) (22.67) Equity Index 1/2/96*.... (13.60) (19.90) (2.93) (4.23) 8.61 8.61 10.34 10.34 Small-Cap Index 1/4/99*................ 0.06 (6.24) 3.67 2.54 Real Estate 1/4/99* (formerly called REIT).................. 6.76 0.46 11.14 10.16 Inflation Managed 1/2/96*................ 2.55 (3.75) 2.86 1.71 4.72 4.72 4.12 4.12 Managed Bond 1/2/96*.... 5.56 (0.74) 3.77 2.64 5.35 5.35 4.87 4.87 Money Market 1/2/96*.... 2.16 (4.14) 3.27 2.13 3.39 3.39 3.37 3.37 High Yield Bond 1/2/96*................ (0.32) (6.62) (1.50) (2.75) 0.73 0.73 2.11 2.11 Equity 1/2/96*.......... (23.05) (29.35) (8.27) (9.72) 2.83 2.83 6.32 6.32 Aggressive Equity 4/17/96*............... (18.60) (24.90) (7.49) (8.91) (2.08) (2.08) (0.57) (0.57) Large-Cap Value 1/4/99*................ (5.23) (11.53) 5.63 4.54
- -------- * Date Variable Account commenced operations. Effective January 1, 2000, Alliance Capital became the Portfolio Manager of the Emerging Markets Portfolio and Mercury Advisors became the Portfolio Manager of the Equity Index and Small-Cap Index Portfolios. Effective January 2, 2001, Lazard Asset Management became the Portfolio Manager of the International Value Portfolio. Prior to May 1, 2001, the Inflation Managed Portfolio was called the Government Securities Portfolio and some of the investment policies differed. Effective December 1, 2001, Putnam Investment Management, LLC became the Portfolio Manager of the Equity and Aggressive Equity Portfolios; prior to May 1, 1998 some of the investment policies of the Equity and Aggressive Equity Portfolios differed. The Equity Income and Research Subaccounts started operations after December 31, 2001 and there is no historical value available for these Subaccounts. In order to help you understand how investment performance can affect your Variable Account Value, we are including performance information based on the historical performance of the Portfolios. The Separate Account commenced operations as of January 2, 1996. Therefore, no historical performance data exists for the Subaccounts prior to that date. The following table represents what the performance of the Subaccounts would have been if the Subaccounts had been both in existence and invested in the corresponding Portfolio since the date of the Portfolio's (or predecessor series') inception or for the indicated time period. Eight of the Portfolios of the Fund available under the Contract have been in operation since January 4, 1988. The Equity Index Portfolio has been in operation since January 30, 1991, the Growth LT Portfolio since January 4, 1994; the Aggressive Equity and Emerging Markets Portfolios since April 1, 1996; the Mid-Cap Value, Small-Cap Index, Real Estate (formerly called REIT) and Large-Cap Portfolios since January 4, 1999; the Diversified Research and International Large-Cap Portfolios since January 3, 2000; the I-Net Tollkeeper Portfolio since 4 May 1, 2000; the Strategic Value and Focused 30 Portfolios since October 2, 2000; the Blue Chip, Aggressive Growth, Financial Services, Health Sciences, Technology, Telecommunications, Capital Opportunities, Mid-Cap Growth, and Global Growth Portfolios since January 2, 2001, and the Equity Income and Research Portfolios since January 2, 2002. Historical performance information for the Equity Portfolio is based in part on the performance of that Portfolio's predecessor series which was a series of the Pacific Corinthian Variable Fund that began its first full year of operations in 1984, the assets of which were acquired by the Fund on December 31, 1994. Because the Subaccounts had not commenced operations until January 2, 1996 or later, as indicated in the chart above, and because the Contracts were not available until 2001, these are not actual performance numbers for the Subaccounts or for the Contract. These are hypothetical total return numbers based on accumulated value (AV) and full withdrawal value (FWV) that represent the actual performance of the Portfolios, adjusted to reflect the deductions for the fees and charges applicable to the Contract; the FWV also includes applicable withdrawal charges. Any charge for non-recurring fees and charges, premium taxes, an optional Death Benefit Rider, or the optional EEG or GPA Riders are not reflected in these data, and reflection of the Annual Fee assumes an average Contract size of $65,000. The information presented also includes data representing unmanaged market indices. The results shown in this section are not an estimate or guarantee of future investment performance. Historical and Hypothetical Separate Account Performance Annualized Rates of Return for Periods Ended December 31, 2001 All numbers are expressed as a percentage
Since 1 Year* 3 Years* 5 Years* 10 Years* Inception* -------------- ------------ ------------ ----------- -------------- Variable Accounts AV FWV AV FWV AV FWV AV FWV AV FWV - ----------------- ------ ------ ----- ----- ----- ----- ----- ----- ------ ------ Blue Chip............... (19.91) (26.21) (19.91) (26.21) Aggressive Growth....... (21.10) (27.40) (21.10) (27.40) Emerging Markets........ (10.18) (16.48) (4.97) (6.31) (9.83) (9.83) (9.30) (9.30) Diversified Research.... (4.34) (10.64) 1.84 (0.85) Small-Cap Equity........ (4.15) (10.45) 1.86 0.69 6.47 6.47 9.91 9.91 11.01 11.01 International Large- Cap.................... (19.64) (25.94) (21.31) (24.83) I-Net Tollkeeper........ (35.03) (41.33) (39.22) (43.86) Financial Services...... (8.81) (15.11) (8.81) (15.11) Health Sciences......... (9.21) (15.51) (9.21) (15.51) Technology.............. (41.91) (48.26) (41.91) (48.26) Telecommunications...... (47.60) (53.94) (47.60) (53.94) Multi-Strategy.......... (2.78) (9.08) 0.48 (0.72) 6.77 6.77 7.42 7.42 8.39 8.39 Large-Cap Core (formerly called Equity Income).. (10.37) (16.67) (2.87) (4.16) 7.20 7.20 8.87 8.87 9.76 9.76 Strategic Value......... (11.35) (17.65) (11.10) (15.59) Growth LT............... (30.76) (37.06) 1.31 0.12 12.06 12.06 15.06 15.06 Focused 30.............. (14.78) (21.08) (24.83) (29.52) Mid-Cap Value........... 11.44 5.14 12.37 11.40 International Value..... (23.21) (29.51) (6.82) (8.22) (2.01) (2.01) 3.08 3.08 3.99 3.99 Capital Opportunities... (16.93) (23.23) (16.93) (23.23) Mid-Cap Growth.......... (20.15) (26.45) (20.15) (26.45) Global Growth........... (16.37) (22.67) (16.37) (22.67) Equity Index............ (13.60) (19.90) (2.93) (4.23) 8.61 8.61 10.67 10.67 11.82 11.82 Small-Cap Index......... 0.06 (6.24) 3.67 2.54 Real Estate (formerly called REIT)........... 6.76 0.46 11.14 10.16 Inflation Managed....... 2.55 (3.75) 2.86 1.71 4.72 4.72 4.83 4.83 6.16 6.16 Managed Bond............ 5.56 (0.74) 3.77 2.64 5.35 5.35 5.58 5.58 6.81 6.81 Money Market............ 2.16 (4.14) 3.27 2.13 3.39 3.39 2.86 2.86 3.55 3.55 High Yield Bond......... (0.32) (6.62) (1.50) (2.75) 0.73 0.73 5.92 5.92 6.28 6.28 Equity.................. (23.05) (29.35) (8.27) (9.72) 2.83 2.83 7.89 7.89 7.15 7.15 Aggressive Equity....... (18.60) (24.90) (7.49) (8.91) (2.08) (2.08) (0.73) (0.73) Large-Cap Value......... (5.23) (11.53) 5.63 4.54
Major Indices 1 Year 3 Years 5 Years 10 Years - ------------- ------ ------- ------- -------- Credit Suisse First Boston High Yield........ 5.80 1.18 3.25 7.85 Lehman Brothers Aggregate Bond............... 8.42 6.27 7.43 7.23 Lehman Brothers Government Bond.............. 7.24 5.88 7.40 7.14 Lehman Brothers Inflation Linked Treasury.... 7.90 7.72 N/A N/A Lehman Brothers Government/Credit............ 8.51 5.89 7.36 7.27 Merrill Lynch 3-Month U.S. T-Bill............ 4.42 5.14 5.20 4.86 Morgan Stanley Capital International All Country World Free.......................... (16.82) (3.37) 5.37 8.05 Morgan Stanley Capital International Emerging Markets Free................................ (2.37) 4.08 (5.74) 3.05 Morgan Stanley Capital International Europe, Australasia & Far East...................... (21.21) (4.79) 1.17 4.76
5
Major Indices (continued) 1 Year 3 Years 5 Years 10 Years - ------------------------- ------ ------- ------- -------- North American Real Estate Investment Trust Equity...................................... 13.93 11.15 6.38 11.63 Russell 1000 Growth.......................... (20.42) (6.32) 8.27 10.80 Russell 2000................................. 2.49 6.42 7.52 11.51 Russell 2500................................. 1.22 9.43 10.34 13.13 Russell 2500 Growth.......................... (10.83) 5.17 6.60 9.49 Russell Midcap............................... (5.62) 6.50 11.40 13.58 Russell Midcap Growth........................ (20.15) 2.16 9.02 11.10 Standard & Poor's 500 Composite Stock Price.. (11.88) (1.03) 10.70 12.93
- -------- * The performance of the Aggressive Equity, Large-Cap Core, Multi-Strategy, Equity, International Value, and Emerging Markets Variable Accounts for all or a portion of this period occurred at a time when other Portfolio Managers managed the corresponding Portfolio in which each Variable Account invests. Effective January 1, 1994, J. P. Morgan Investment Management Inc. became the Portfolio Manager of the Large-Cap Core and Multi-Strategy Portfolios; prior to January 1, 1994, some of the investment policies of the Large-Cap Core Portfolio and the investment objective of the Multi- Strategy Portfolio differed. Performance of the Equity Portfolio is based in part on the performance of the predecessor portfolio of Pacific Corinthian Variable Fund, which began its first full year of operations in 1984, the assets of which were acquired by the Fund on December 31, 1994. Effective January 1, 2000, Alliance Capital became the Portfolio Manager of the Emerging Markets Portfolio and Mercury Advisors became the Portfolio Manager of the Equity Index and Small-Cap Index Portfolios. The Equity Income and Research Portfolios started operations after December 31, 2001 and there is no historical value available for these Subaccounts. Effective December 1, 2001, Putnam Investment Management, LLC became the Portfolio Manager of the Equity and Aggressive Equity Portfolios; prior to May 1, 1998 some of the investment policies of the Equity and Aggressive Equity Portfolios differed. Tax Deferred Accumulation In reports or other communications to you or in advertising or sales materials, we may also describe the effects of tax-deferred compounding on the Separate Account's investment returns or upon returns in general. These effects may be illustrated in charts or graphs and may include comparisons at various points in time of returns under the Contract or in general on a tax- deferred basis with the returns on a taxable basis. Different tax rates may be assumed. In general, individuals who own annuity contracts are not taxed on increases in the value under the annuity contract until some form of distribution is made from the contract. Thus, the annuity contract will benefit from tax deferral during the accumulation period, which generally will have the effect of permitting an investment in an annuity contract to grow more rapidly than a comparable investment under which increases in value are taxed on a current basis. The following chart illustrates this benefit by comparing accumulation under a variable annuity contract with accumulations from an investment on which gains are taxed on a current ordinary income basis. The chart shows accumulations on a single Purchase Payment of $10,000, assuming hypothetical annual returns of 0%, 4% and 8%, compounded annually, and a tax rate of 36%. The values shown for the taxable investment do not include any deduction for management fees or other expenses but assume that taxes are deducted annually from investment returns. The values shown for the variable annuity do not reflect the deduction of contractual expenses such as the Risk Charge (equal to an annual rate of 1.40% of average daily Account Value), the Administrative Fee (equal to an annual rate of 0.25% of average daily Account Value), the Annual Fee (equal to $30 per year if your Net Contract Value is less than $50,000), any increase in the Risk Charge for an optional Death Benefit Rider (equal to a maximum annual rate of 0.35% of average daily Account Value) or for the optional EEG or GPA Riders (equal to an annual rate of 0.25% and 0.10% average daily Account Value, respectively), any charge for premium taxes, or the expenses of an underlying investment vehicle, such as the Fund. The values shown also do not reflect the withdrawal charge. Generally, the withdrawal charge is equal to 7% of the amount withdrawn attributable to Purchase Payments that are less than one year old, 6% of the amount withdrawn attributable to Purchase Payments that are less than two years old, and 4% of the amount withdrawn attributable to Purchase Payments that are three years old. The age of a Purchase Payment is considered 1 year old in the Contract Year we receive it and increases by one year beginning on the day preceding each Contract Anniversary. There is no withdrawal charge on withdrawals of your Earnings, on amounts attributed to Purchase Payments at least four years old, or to the extent that total withdrawals that are free of charge during the Contract Year do not exceed 10% of the sum of your remaining Purchase Payments at the beginning of the Contract Year that have been held under your Contract for less than four years plus 6 additional Purchase Payments applied to your Contract during that Contract Year. If these expenses and fees were taken into account, they would reduce the investment return shown for both the taxable investment and the hypothetical variable annuity contract. In addition, these values assume that you do not surrender the Contract or make any withdrawals until the end of the period shown. The chart assumes a full withdrawal, at the end of the period shown, of all Contract Value and the payment of taxes at the 36% rate on the amount in excess of the Purchase Payments. The rates of return illustrated are hypothetical and are not an estimate or guarantee of performance. Actual tax rates may vary for different assets and taxpayers from that illustrated and withdrawals by and distributions to Contract Owners who have not reached age 59 1/2 may be subject to a tax penalty of 10%. Power of Tax Deferral $10,000 investment at annual rates of return of 0%, 4% and 8%, taxed @ 36% [GRAPH APPEARS HERE]
0% GROWTH TAX TAXABLE DEFERRED INVESTMENT INVESTMENT YEARS BEFORE TAX BEFORE TAX ----- ---------- ---------- 10 $10,000.00 $10,000.00 20 $10,000.00 $10,000.00 30 $10,000.00 $10,000.00 4% GROWTH TAX TAXABLE DEFERRED INVESTMENT INVESTMENT YEARS BEFORE TAX BEFORE TAX ----- ---------- ---------- 10 $12,875.97 $13,073.56 20 $16,579.07 $17,623.19 30 $21,347.17 $24,357.74 8% GROWTH TAX TAXABLE DEFERRED INVESTMENT INVESTMENT YEARS BEFORE TAX BEFORE TAX ----- ---------- ---------- 10 $16,476.07 $17,417.12 20 $27,146.07 $33,430.13 30 $44,726.05 $68,001.00
DISTRIBUTION OF THE CONTRACTS Pacific Select Distributors, Inc. (PSD) Pacific Select Distributors, Inc. a subsidiary of ours, acts as the principal underwriter ("distributor") of the Contracts and offers the Contracts on a continuous basis. PSD is registered as a broker-dealer with the SEC and is a member of the National Association of Securities Dealers (NASD). We pay PSD for acting as principal underwriter under a Distribution Agreement. We and PSD enter into selling agreements with broker-dealers whose registered representatives are authorized by state insurance departments to sell the Contracts. The aggregate amount of underwriting commissions paid to PSD with regard to this Contract in 2001 was $68,740,084, of which $0 was retained. 7 THE CONTRACTS AND THE SEPARATE ACCOUNT Calculating Subaccount Unit Values The Unit Value of the Subaccount Units in each Variable Investment Option is computed at or about 4:00 p.m. Eastern time on each Business Day. The initial Unit Value of each Subaccount was $10 on the Business Day the Subaccount began operations. At the end of each Business Day, the Unit Value for a Subaccount is equal to: Y X Z where (Y) = the Unit Value for that Subaccount as of the end of the preceding Business Day; and (Z) = the Net Investment Factor for that Subaccount for the period (a "valuation period") between that Business Day and the immediately preceding Business Day. The "Net Investment Factor" for a Subaccount for any valuation period is equal to: (A / B) - C where (A) = the "per share value of the assets" of that Subaccount as of the end of that valuation period, which is equal to: a + b + c where (a) = the net asset value per share of the corresponding Portfolio shares held by that Subaccount as of the end of that valuation period; (b) = the per share amount of any dividend or capital gain distributions made by the Fund for that Portfolio during that valuation period; and (c) = any per share charge (a negative number) or credit (a positive number) for any income taxes and/or any other taxes or other amounts set aside during that valuation period as a reserve for any income and/or any other taxes which we determine to have resulted from the operations of the Subaccount or Contract, and/or any taxes attributable, directly or indirectly, to Investments; (B) = the net asset value per share of the corresponding Portfolio shares held by the Subaccount as of the end of the preceding valuation period; and (C) = a factor that assesses against the Subaccount net assets for each calendar day in the valuation period the basic Risk Charge plus any applicable increase in the Risk Charge and the Administrative Fee (see CHARGES, FEES AND DEDUCTIONS section in the Prospectus). As explained in the Prospectus, the Annual Fee, if applicable, is assessed against your Variable Account Value through the automatic debit of Subaccount Units; the Annual Fee decreases the number of Subaccount Units attributed to your Contract but does not alter the Unit Value for any Subaccount. Variable Annuity Payment Amounts The following steps show how we determine the amount of each variable annuity payment under your Contract. First: Pay Applicable Premium Taxes When you convert your Net Contract Value into annuity payments, you must pay any applicable charge for premium taxes on your Contract Value (unless applicable law requires those taxes to be paid at a later time). We assess this charge by reducing each Account Value proportionately, relative to your Account Value in each Subaccount and in the Fixed Option, in an amount equal to the aggregate amount of the charges. The remaining amount of your available Net Contract Value may be used to provide variable annuity payments. Alternatively, your remaining available Net Contract Value may be used to provide fixed annuity payments, or it may be divided to provide both fixed and variable annuity payments. You may also choose to withdraw some or all of your remaining Net Contract Value, less any applicable Annual Fee, withdrawal charge, and less any charges for premium taxes without converting this amount into annuity payments. 8 Second: The First Variable Payment We begin by referring to your Contract's Option Table for your Annuity Option (the "Annuity Option Table"). The Annuity Option Table allows us to calculate the dollar amount of the first variable annuity payment under your Contract, based on the amount applied toward the variable annuity. The number that the Annuity Option Table yields will be based on the Annuitant's age (and, in certain cases, sex) and assumes a 5% rate of return, as described in more detail below. Example: Assume a man is 65 years of age at his Annuity Date and has selected a lifetime annuity with monthly payments guaranteed for 10 years. According to the Annuity Option Table, this man should receive an initial monthly payment of $5.79 for every $1,000 of his Contract Value (reduced by applicable charges) that he will be using to provide variable payments. Therefore, if his Contract Value after deducting applicable fees and charges is $100,000 on his Annuity Date and he applies this entire amount toward his variable annuity, his first monthly payment will be $579.00. You may choose any other Annuity Option Table that assumes a different rate of return which we offer at the time your Annuity Option is effective. Third: Subaccount Annuity Units For each Subaccount, we use the amount of the first variable annuity payment under your Contract attributable to each Subaccount to determine the number of Subaccount Annuity Units that will form the basis of subsequent payment amounts. First, we use the Annuity Option Table to determine the amount of that first variable payment for each Subaccount. Then, for each Subaccount, we divide that amount of the first variable annuity payment by the value of one Subaccount Annuity Unit (the "Subaccount Annuity Unit Value") as of the end of the Annuity Date to obtain the number of Subaccount Annuity Units for that particular Subaccount. The number of Subaccount Annuity Units used to calculate subsequent payments under your Contract will not change unless exchanges of Annuity Units are made (or if the Joint and Survivor Annuity Option is elected and the Primary Annuitant dies first), but the value of those Annuity Units will change daily, as described below. Fourth: The Subsequent Variable Payments The amount of each subsequent variable annuity payment will be the sum of the amounts payable based on each Subaccount. The amount payable based on each Subaccount is equal to the number of Subaccount Annuity Units for that Subaccount multiplied by their Subaccount Annuity Unit Value at the end of the Business Day in each payment period you elected that corresponds to the Annuity Date. Each Subaccount's Subaccount Annuity Unit Value, like its Subaccount Unit Value, changes each day to reflect the net investment results of the underlying investment vehicle, as well as the assessment of the Risk Charge at an annual rate of 1.40% and the Administrative Fee at an annual rate of 0.25%. In addition, the calculation of Subaccount Annuity Unit Value incorporates an additional factor; as discussed in more detail below, this additional factor adjusts Subaccount Annuity Values to correct for the Option Table's implicit assumed annual investment return on amounts applied but not yet used to furnish annuity benefits. Any increase in your Risk Charge for an Optional Death Benefit Rider is not charged on and after the Annuity Date. Different Subaccounts may be selected for your Contract before and after your Annuity Date, subject to any restrictions we may establish. Currently, you may exchange Subaccount Annuity Units in any Subaccount for Subaccount Annuity Units in any other Subaccount(s) up to four times in any twelve month period after your Annuity Date. The number of Subaccount Annuity Units in any Subaccount may change due to such exchanges. Exchanges following your Annuity Date will be made by exchanging Subaccount Annuity Units of equivalent aggregate value, based on their relative Subaccount Annuity Unit Values. Understanding the "Assumed Investment Return" Factor The Annuity Option Table incorporates a number of implicit assumptions in determining the amount of your first variable annuity payment. As noted above, the numbers in the Annuity Option Table reflect certain actuarial assumptions based on the Annuitant's age, and, in some cases, the Annuitant's sex. In addition, these numbers 9 assume that the amount of your Contract Value that you convert to a variable annuity will have a positive net investment return of 5% (or such other rate of return you may elect) each year during the payout of your annuity; thus 5% is referred to as an "assumed investment return." The Subaccount Annuity Unit Value for a Subaccount will increase only to the extent that the investment performance of that Subaccount exceeds the Risk Charge, the Administrative Fee, and the assumed investment return. The Subaccount Annuity Unit Value for any Subaccount will generally be less than the Subaccount Unit Value for that same Subaccount, and the difference will be the amount of the assumed investment return factor. Example: Assume the net investment performance of a Subaccount is at a rate of 5.00% per year (after deduction of the 1.40% Risk Charge and the 0.25% Administrative Fee). The Subaccount Unit Value for that Subaccount would increase at a rate of 5.00% per year, but the Subaccount Annuity Unit Value would not increase (or decrease) at all. The net investment factor for that 5% return [1.05] is then divided by the factor for the 5% assumed investment return [1.05] and 1 is subtracted from the result to determine the adjusted rate of change in Subaccount Annuity Unit Value: 1.05 = 1; 1 - 1 = 0; 0 X 100% = 0%. ---- 1.05 If the net investment performance of a Subaccount's assets is at a rate less than 5.00% per year, the Subaccount Annuity Unit Value will decrease, even if the Subaccount Unit Value is increasing. Example: Assume the net investment performance of a Subaccount is at a rate of 2.60% per year (after deduction of the 1.40% Risk Charge and the 0.25% Administrative Fee). The Subaccount Unit Value for that Subaccount would increase at a rate of 2.60% per year, but the Subaccount Annuity Unit Value would decrease at a rate of 2.29% per year. The net investment factor for that 2.6% return [1.026] is then divided by the factor for the 5% assumed investment return [1.05] and 1 is subtracted from the result to determine the adjusted rate of change in Subaccount Annuity Unit Value: 1.026 = 0.9771; 0.9771 - 1 = -0.0229; -0.0229 X 100% = -2.29%. ----- 1.05 The assumed investment return will always cause increases in Subaccount Annuity Unit Values to be somewhat less than if the assumption had not been made, will cause decreases in Subaccount Annuity Unit Values to be somewhat greater than if the assumption had not been made, and will (as shown in the example above) sometimes cause a decrease in Subaccount Annuity Unit Values to take place when an increase would have occurred if the assumption had not been made. If we had assumed a higher investment return in our Annuity Option tables, it would produce annuities with larger first payments, but the increases in subaccount annuity payments would be smaller and the decreases in subsequent annuity payments would be greater; a lower assumed investment return would produce annuities with smaller first payments, and the increases in subsequent annuity payments would be greater and the decreases in subsequent annuity payments would be smaller. Corresponding Dates If any transaction or event under your Contract is scheduled to occur on a "corresponding date" that does not exist in a given calendar period, the transaction or event will be deemed to occur on the following Business Day. In addition, as stated in the Prospectus, any event scheduled to occur on a day that is not a Business Day will occur on the next succeeding Business Day. Example: If your Contract is issued on February 29 in year 1 (a leap year), your Contract Anniversary in years 2, 3 and 4 will be on March 1. Example: If your Annuity Date is July 31 and you select monthly annuity payments, the payments received will be based on valuations made on July 31, August 31, October 1 (for September), October 31, December 1 (for November), December 31, January 31, March 1 (for February), March 31, May 1 (for April), May 31 and July 1 (for June). 10 Age and Sex of Annuitant As mentioned in the Prospectus, the Contracts generally provide for sex- distinct annuity income factors in the case of life annuities. Statistically, females tend to have longer life expectancies than males; consequently, if the amount of annuity payments is based on life expectancy, they will ordinarily be higher if an annuitant is male than if an annuitant is female. Certain states' regulations prohibit sex-distinct annuity income factors, and Contracts issued in those states will use unisex factors. In addition, Contracts issued in connection with Qualified Plans are required to use unisex factors. We may require proof of your Annuitant's age and sex before or after starting annuity payments. If the age or sex (or both) of your Annuitant are incorrectly stated in your Contract, we will correct the amount payable based on your Annuitant's correct Age or sex, if applicable. If we make the correction after annuity payments have started, and we have made overpayments, we will deduct the amount of the overpayment, with interest at 3% a year, from any payments due then or later; if we have made underpayments, we will add the amount, with interest at 3% a year, of the underpayments to the next payment we make after we receive proof of the correct age and/or sex. Additionally, we may require proof of the Annuitant's or Owner's age before any payments associated with the Death Benefit provisions of your Contract are made. If the age or sex of the Annuitant is incorrectly stated in your Contract, we will base any payment associated with the Death Benefit provisions on your Contract on the Annuitant's or Owner's correct age or sex. Systematic Transfer Programs The Fixed Account is not available in connection with portfolio rebalancing. If you are using the earnings sweep, you may also use portfolio rebalancing only if you selected the Fixed Option as your sweep option. You may not use dollar cost averaging and the earnings sweep at the same time. Dollar Cost Averaging When you request dollar cost averaging, you are authorizing us to make periodic reallocations of your Contract Value without waiting for any further instruction from you. You may request to begin or stop dollar cost averaging at any time prior to your Annuity Date; the effective date of your request will be the day we receive written notice from you in proper form. Your request may specify the date on which you want your first transfer to be made. If you do not specify a date for your first transfer, we will treat your request as if you had specified the effective date of your request. Your first transfer may not be made until 30 days after your Contract Date, and if you specify an earlier date, your first transfer will be delayed until one calendar month after the date you specify. If you request dollar cost averaging on your application for your Contract and you fail to specify a date for your first transfer, your first transfer will be made one period after your Contract Date (that is, if you specify monthly transfers, the first transfer will occur 30 days after your Contract Date; quarterly transfers, 90 days after your Contract Date; semiannual transfers, 180 days after your Contract Date; and if you specify annual transfers, the first transfer will occur on your Contract Anniversary). If you stop dollar cost averaging, you must wait 30 days before you may begin this option again. Your request to begin dollar cost averaging must specify the Investment Option you wish to transfer money from (your "source account"). You may choose any one Investment Option as your source account. The Account Value of your source account must be at least $5,000 for you to begin dollar cost averaging. Your request to begin dollar cost averaging must also specify the amount and frequency of your transfers. You may choose monthly, quarterly, semiannual or annual transfers. The amount of your transfers may be specified as a dollar amount or a percentage of your source Account Value; however, each transfer must be at least $250. Dollar cost averaging transfers are not subject to the same requirements and limitations as other transfers. Finally, your request must specify the Variable Investment Option(s) you wish to transfer amounts to (your "target account(s)"). If you select more than one target account, your dollar cost averaging request must specify how transferred amounts should be allocated among the target accounts. Your source account may not also be a target account. 11 Your dollar cost averaging transfers will continue until the earlier of (i) your request to stop dollar cost averaging is effective, or (ii) your source Account Value is zero, or (iii) your Annuity Date. If, as a result of a dollar cost averaging transfer, your source Account Value falls below any minimum Account Value we may establish, we have the right, at our option, to transfer that remaining Account Value to your target account(s) on a proportionate basis relative to your most recent allocation instructions. We may change, terminate or suspend the dollar cost averaging option at any time. Portfolio Rebalancing Portfolio rebalancing allows you to maintain the percentage of your Contract Value allocated to each Variable Investment Option at a pre-set level prior to annuitization. For example, you could specify that 30% of your Contract Value should be in the Equity Index Subaccount, 40% in the Managed Bond Subaccount, and 30% in the Growth LT Subaccount. Over time, the variations in each Subaccount's investment results will shift this balance of these Subaccount Value allocations. If you elect the portfolio rebalancing feature, we will automatically transfer your Subaccount Value back to the percentages you specify. You may choose to have rebalances made quarterly, semiannually or annually until your Annuity Date; portfolio rebalancing is not available after you annuitize. Procedures for selecting portfolio rebalancing are generally the same as those discussed in detail above for selecting dollar cost averaging: You may make your request at any time prior to your Annuity Date and it will be effective when we receive it in proper form. If you stop portfolio rebalancing, you must wait 30 days to begin again. You may specify a date for your first rebalance, or we will treat your request as if you selected the request's effective date. If you specify a date fewer than 30 days after your Contract Date, your first rebalance will be delayed one month, and if you request rebalancing on your application but do not specify a date for the first rebalance, it will occur one period after your Contract Date, as described above under Dollar Cost Averaging. We may change, terminate or suspend the portfolio rebalancing feature at any time. Earnings Sweep An earnings sweep automatically transfers the earnings attributable to a specified Investment Option (the "sweep option") to one or more other Investment Options (your "target option(s)"). If you elect to use the earnings sweep, you may select either the Fixed Option or the Money Market Subaccount as your sweep option. The Account Value of your sweep option will be required to be at least $5,000 when you elect the earnings sweep. You may select one or more Variable Investment Options (but not the Money Market Subaccount) as your target option(s). You may choose to have earnings sweeps occur monthly, quarterly, semiannually or annually until you annuitize. At each earnings sweep, we will automatically transfer your accumulated earnings attributable to your sweep option for the previous period proportionately to your target option(s). That is, if you select a monthly earnings sweep, we will transfer the sweep option earnings from the preceding month; if you select a semiannual earnings sweep, we will transfer the sweep option earnings accumulated over the preceding six months. Earnings sweep transfers are not subject to the same requirements and limitations as other transfers. To determine the earnings, we take the change in the sweep option's Account Value during the sweep period, add any withdrawals or transfers out of the sweep option Account that occurred during the sweep period, and subtract any allocations to the sweep option Account during the sweep period. The result of this calculation represents the "total earnings" for the sweep period. If, during the sweep period, you withdraw or transfer amounts from the sweep option Account, we assume that earnings are withdrawn or transferred before any other Account Value. Therefore, your "total earnings" for the sweep period will be reduced by any amounts withdrawn or transferred during the sweep option period. The remaining earnings are eligible for the sweep transfer. 12 Procedures for selecting the earnings sweep are generally the same as those discussed in detail above for selecting dollar cost averaging and portfolio rebalancing: You may make your request at any time and it will be effective when we receive it in a form satisfactory to us. If you stop the earnings sweep, you must wait 30 days to begin again. You may specify a date for your first sweep, or we will treat your request as if you selected the request's effective date. If you specify a date fewer than 30 days after your Contract Date, your first earnings sweep will be delayed one month, and if you request the earnings sweep on your application but do not specify a date for the first sweep, it will occur one period after your Contract Date, as described above under Dollar Cost Averaging. If, as a result of an earnings sweep transfer, your source Account Value falls below $500, we have the right, at our option, to transfer that remaining Account Value to your target account(s) on a proportionate basis relative to your most recent allocation instructions. We may change, terminate or suspend the earnings sweep option at any time. Pre-Authorized Withdrawals You may specify a dollar amount for your pre-authorized withdrawals, or you may specify a percentage of your Contract Value or an Account Value. You may direct us to make your pre-authorized withdrawals from one or more specific Investment Options; if you do not give us these specific instructions, amounts will be deducted proportionately from your Account Value in each Fixed or Variable Investment Option. Procedures for selecting pre-authorized withdrawals are generally the same as those discussed in detail above for selecting dollar cost averaging, portfolio rebalancing, and earnings sweeps: You may make your request at any time and it will be effective when we receive it in proper form. If you stop the pre- authorized withdrawals, you must wait 30 days to begin again. You may specify a date for the first withdrawal, or we will treat your request as if you selected the request's effective date. If you specify a date fewer than 30 days after your Contract Date, your first pre-authorized withdrawal will be delayed one month, and if you request the pre-authorized withdrawals on your application but do not specify a date for the first withdrawal, it will occur one period after your Contract Date. If your pre-authorized withdrawals cause your Account Value in any Investment Option to fall below $500, we have the right, at our option, to transfer that remaining Account Value to your other Investment Options on a proportionate basis relative to your most recent allocation instructions. If your pre- authorized withdrawals cause your Contract Value to fall below $1,000, we may, at our option, terminate your Contract and send you the remaining withdrawal proceeds. Pre-authorized withdrawals are subject to the same withdrawal charges as are other withdrawals, and each withdrawal is subject to any applicable charge for premium taxes and/or other taxes, to federal income tax on its taxable portion, and, if you have not reached age 59 1/2, a federal tax penalty of at least 10%. Death Benefit Any death benefit payable will be calculated as of the date we receive proof (in proper form) of the Annuitant's death (or, if applicable, the Contract Owner's death) and instructions regarding payment; any claim of a death benefit must be made in proper form. A recipient of death benefit proceeds may elect to have this benefit paid in one lump sum, in periodic payments, in the form of a lifetime annuity or in some combination of these. Annuity payments will begin within 30 days once we receive all information necessary to process the claim. If your Contract names Joint or Contingent Annuitants, no death benefit proceeds will be payable unless and until the last Annuitant dies prior to the Annuity Date or a Contract Owner dies prior to the Annuity Date. 13 1035 Exchanges You may make your initial Investment through an exchange of an existing annuity contract. To exchange, you must complete a 1035 Exchange form, which is available by calling your representative, or by calling us at 1-800-722- 2333, and mail the form along with the annuity contract you are exchanging (plus your completed application if you are making an initial Purchase Payment) to us. In general terms, Section 1035 of the Code provides that you recognize no gain or loss when you exchange one annuity contract solely for another annuity contract. However, transactions under Section 1035 may be subject to special rules and may require special procedures and record-keeping, particularly if the exchanged annuity contract was issued prior to August 14, 1982. You should consult your tax adviser prior to effecting a 1035 Exchange. Safekeeping of Assets We are responsible for the safekeeping of the assets of the Separate Account. These assets are held separate and apart from the assets of our General Account and our other separate accounts. FINANCIAL STATEMENTS The statement of assets and liabilities of Separate Account A as of December 31, 2001 and the related statement of operations and financial highlights for the year then ended and statements of changes in net assets for each of the two years in the period then ended are incorporated by reference in this Statement of Additional Information from the Annual Report of Separate Account A dated December 31, 2001. Pacific Life's consolidated financial statements as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 are set forth beginning on the next page. These financial statements should be considered only as bearing on the ability of Pacific Life to meet its obligations under the Contracts and not as bearing on the investment performance of the assets held in the Separate Account. INDEPENDENT AUDITORS The consolidated financial statements of Pacific Life as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein. 14 INDEPENDENT AUDITORS' REPORT - ---------------------------- Pacific Life Insurance Company and Subsidiaries: We have audited the accompanying consolidated statements of financial condition of Pacific Life Insurance Company and Subsidiaries (the Company) as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholder's equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pacific Life Insurance Company and Subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP Costa Mesa, CA February 27, 2002 PL-1 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2001 2000 - ------------------------------------------------------------------------------ (In Millions) ASSETS Investments: Fixed maturity securities available for sale, at estimated fair value $17,047 $15,136 Equity securities available for sale, at estimated fair value 266 179 Trading securities, at fair value 458 71 Mortgage loans 2,933 3,026 Real estate 183 221 Policy loans 4,899 4,680 Other investments 2,796 2,654 - ----------------------------------------------------------------------------- TOTAL INVESTMENTS 28,582 25,967 Cash and cash equivalents 510 211 Deferred policy acquisition costs 2,113 1,796 Accrued investment income 377 335 Other assets 642 557 Separate account assets 23,458 25,918 - ----------------------------------------------------------------------------- TOTAL ASSETS $55,682 $54,784 ============================================================================= LIABILITIES AND STOCKHOLDER'S EQUITY Liabilities: Universal life and investment-type products $21,796 $19,410 Future policy benefits 4,580 4,542 Short-term and long-term debt 439 359 Other liabilities 1,690 1,323 Separate account liabilities 23,458 25,918 - ----------------------------------------------------------------------------- TOTAL LIABILITIES 51,963 51,552 - ----------------------------------------------------------------------------- Commitments and contingencies (Note 18) Stockholder's Equity: Common stock - $50 par value; 600,000 shares authorized, issued and outstanding 30 30 Paid-in capital 151 147 Unearned ESOP shares (3) (6) Retained earnings 3,271 3,030 Accumulated other comprehensive income 270 31 - ----------------------------------------------------------------------------- TOTAL STOCKHOLDER'S EQUITY 3,719 3,232 - ----------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $55,682 $54,784 =============================================================================
See Notes to Consolidated Financial Statements PL-2 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001 2000 1999 - ------------------------------------------------------------------------------ (In Millions) REVENUES Universal life and investment-type product policy fees $ 821 $ 769 $ 654 Insurance premiums 812 552 484 Net investment income 1,628 1,683 1,510 Net realized investment gain (loss) (14) 997 99 Commission revenue 181 270 234 Other income 225 209 145 - ------------------------------------------------------------------------------ TOTAL REVENUES 3,653 4,480 3,126 - ------------------------------------------------------------------------------ BENEFITS AND EXPENSES Policy benefits paid or provided 1,163 879 735 Interest credited to universal life and invest- ment-type products 1,029 997 938 Commission expenses 524 576 485 Operating expenses 634 575 453 - ------------------------------------------------------------------------------ TOTAL BENEFITS AND EXPENSES 3,350 3,027 2,611 - ------------------------------------------------------------------------------ INCOME BEFORE PROVISION FOR INCOME TAXES 303 1,453 515 Provision for income taxes 55 458 144 - ------------------------------------------------------------------------------ INCOME BEFORE CUMULATIVE ADJUSTMENTS DUE TO CHANGES IN ACCOUNTING PRINCIPLES 248 995 371 Cumulative adjustments due to changes in account- ing principles, net of taxes (7) - ------------------------------------------------------------------------------ NET INCOME $ 241 $ 995 $ 371 ==============================================================================
See Notes to Consolidated Financial Statements PL-3 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
Accumulated Other Comprehensive Income (Loss) ---------------------------------------- Unrealized Gain (Loss) on Unrealized Derivatives Foreign Gain on Unearned and Securities Currency Interest in Common Paid-in ESOP Retained Available for Translation PIMCO Stock Capital Shares Earnings Sale, Net Adjustment Advisors L.P. Total - -------------------------------------------------------------------------------------------------------------------- (In Millions) BALANCES, JANUARY 1, 1999 $30 $126 $1,664 $ 507 $ 1 $2,328 Comprehensive loss: Net income 371 371 Other comprehensive loss (785) (1) (786) ------ Total comprehensive loss (415) Other equity adjustments 11 11 Capital contribution 3 3 Purchase of ESOP note $(13) (13) Allocation of unearned ESOP shares 1 1 - -------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 1999 30 140 (12) 2,035 (278) - 1,915 Comprehensive income: Net income 995 995 Other comprehensive income (loss) 236 (4) $77 309 ------ Total comprehensive income 1,304 Other equity adjustments 5 5 Allocation of unearned ESOP shares 2 6 8 - -------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 2000 30 147 (6) 3,030 (42) (4) 77 3,232 Comprehensive income: Net income 241 241 Other comprehensive income (loss) 129 (1) 111 239 ------ Total comprehensive income 480 Other equity adjustments 1 1 Allocation of unearned ESOP shares 3 3 6 - -------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 2001 $30 $151 $ (3) $3,271 $ 87 $(5) $188 $3,719 ====================================================================================================================
See Notes to Consolidated Financial Statements PL-4 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001 2000 1999 - ------------------------------------------------------------------------------- (In Millions) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 241 $ 995 $ 371 Adjustments to reconcile net income to net cash provided by operating activities: Amortization on fixed maturity securities (73) (72) (78) Depreciation and other amortization 26 36 21 Earnings of equity method investees (6) (23) (93) Deferred income taxes 56 424 (8) Net realized investment (gain) loss 14 (997) (99) Net change in deferred policy acquisition costs (317) (350) (545) Interest credited to universal life and investment-type products 1,029 997 938 Change in trading securities (387) 29 (3) Change in accrued investment income (42) (48) (28) Change in future policy benefits 38 156 58 Change in other assets and liabilities 154 24 172 - ------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 733 1,171 706 - ------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Fixed maturity and equity securities available for sale: Purchases (4,864) (2,903) (4,173) Sales 941 1,595 2,334 Maturities and repayments 1,652 1,601 1,400 Repayments of mortgage loans 682 700 681 Proceeds from sales of mortgage loans and real estate 44 1 24 Purchases of mortgage loans and real estate (593) (806) (886) Change in policy loans (219) (422) (255) Cash received from acquisition of insurance block of business 165 Other investing activity, net 467 (664) 390 - ------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (1,890) (898) (320) - -------------------------------------------------------------------------------
(Continued) See Notes to Consolidated Financial Statements PL-5 Pacific Life Insurance Company and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, (Continued) 2001 2000 1999 - -------------------------------------------------------------------------- (In Millions) CASH FLOWS FROM FINANCING ACTIVITIES Policyholder account balances: Deposits $ 4,690 $ 4,090 $ 4,453 Withdrawals (3,320) (4,734) (4,322) Net change in short-term and long-term debt 80 135 (220) Purchase of ESOP note (13) Allocation of unearned ESOP shares 6 8 1 - -------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,456 (501) (101) - -------------------------------------------------------------------------- Net change in cash and cash equivalents 299 (228) 285 Cash and cash equivalents, beginning of year 211 439 154 - -------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 510 $ 211 $ 439 ========================================================================== SUPPLEMENTAL SCHEDULE OF INVESTING AND FINANCING ACTIVITIES In connection with the acquisition of an annuity block of business in 1999, as discussed in Note 4, the following assets and liabilities were assumed: Fixed maturity securities $ 1,593 Cash and cash equivalents 165 Other assets 100 -------- Total assets assumed $ 1,858 ======== Annuity reserves $ 1,847 Other liabilities 11 -------- Total liabilities assumed $ 1,858 ======== ========================================================================== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Income taxes paid (received) $ (48) $ 74 $ 83 Interest paid $ 23 $ 28 $ 23 ==========================================================================
See Notes to Consolidated Financial Statements PL-6 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND DESCRIPTION OF BUSINESS Pacific Life Insurance Company (Pacific Life) was established in 1868 and is organized under the laws of the State of California as a stock life insurance company. Pacific Life is an indirect subsidiary of Pacific Mutual Holding Company (PMHC), a mutual holding company, and a wholly owned subsidiary of Pacific LifeCorp, an intermediate stock holding company. PMHC and Pacific LifeCorp were organized pursuant to consent received from the Insurance Department of the State of California (CA DOI) and the implementation of a plan of conversion to form a mutual holding company structure in 1997 (the Conversion). Pacific Life and its subsidiaries and affiliates have primary business operations consisting of life insurance, annuities, pension and institutional products, group employee benefits, broker-dealer operations, and investment management and advisory services. Pacific Life's primary business operations provide a broad range of life insurance, asset accumulation and investment products for individuals and businesses and offer a range of investment products to institutions and pension plans. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements of Pacific Life Insurance Company and Subsidiaries (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and include the accounts of Pacific Life and its majority owned and controlled subsidiaries. All significant intercompany transactions and balances have been eliminated. Pacific Life prepares its regulatory financial statements based on accounting practices prescribed or permitted by the CA DOI. These consolidated financial statements differ from those filed with regulatory authorities (Note 2). NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 2001, the Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of SFAS No. 133. SFAS No. 133 and SFAS No. 138 establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item are recognized in net realized investment gain (loss). If the derivative is designated as a cash flow hedge, changes in the fair value of the derivative are recorded in other comprehensive income (loss) (OCI) and are recognized in earnings when the hedged item affects earnings. For derivative instruments not designated as hedges, the change in fair value of the derivative is recorded in net realized investment gain (loss). Upon adoption of SFAS No. 133 and SFAS No. 138, the Company recorded an increase to net income of $1 million, net of taxes, as a cumulative adjustment due to change in accounting principle. This increase was primarily attributable to recording derivatives not designated as hedges at fair value, offset by the recording of initial ineffectiveness on fair value hedges. In addition, upon adoption the Company recorded an increase to accumulated OCI of $38 million, net of taxes. This increase was primarily attributable to the designation of derivatives as fair value hedges. Gains and losses on derivatives that were previously deferred as adjustments to the carrying amount of the hedged items were not affected by the implementation of SFAS No. 133 and SFAS No. 138. PL-7 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Upon adoption of SFAS No. 133 and SFAS No. 138, the Company transferred $306 million of fixed maturity securities available for sale into the trading category. The transfer resulted in a reclassification of unrealized losses of $4 million, net of taxes, from accumulated OCI into net realized investment gain (loss). Effective April 1, 2001, the Company adopted Emerging Issues Task Force Issue (EITF) 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. Under EITF 99-20, investors in certain asset-backed securities are required to record changes in their estimated yield on a prospective basis and to evaluate these securities for a decline in value, which is other than temporary. If the fair value of the asset-backed security has declined below its carrying amount and the decline is determined to be other than temporary, the security is written down to fair value. Upon adoption of EITF 99-20, the Company recorded a decrease to net income of $8 million, net of taxes, as a cumulative adjustment due to change in accounting principle. Effective April 1, 2001, the Company adopted the requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125, which revises the standards of accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of FASB Statement No. 125's provisions without reconsideration. Adoption of SFAS No. 140 did not have a material impact on the Company's consolidated financial statements. In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141, which was effective July 1, 2001, for any business combination entered into subsequent to June 30, 2001, requires the purchase method of accounting and separate recognition of intangible assets apart from goodwill if such intangible assets meet certain criteria. Adoption of SFAS No. 141 did not have a material impact on the Company's consolidated financial statements. SFAS No. 142, effective for fiscal years beginning after December 15, 2001, requires that ratable amortization of goodwill be replaced with periodic impairment tests of the goodwill asset and that intangible assets, other than goodwill, should be amortized over their useful lives. Amortization of goodwill was $5 million, $3 million and $12 million for the years ended December 31, 2001, 2000 and 1999, respectively. The Company has not yet finalized the quantification of the impact, if any, on its consolidated financial statements of applying the new requirements of SFAS No. 142. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company has not yet finalized the quantification of the impact, if any, on its consolidated financial statements of applying the new requirements of SFAS No. 144. INVESTMENTS Fixed maturity and equity securities available for sale are reported at estimated fair value, with unrealized gains and losses, net of deferred income taxes and adjustments related to deferred policy acquisition costs, recorded as a component of OCI. The cost of fixed maturity and equity securities is adjusted for impairments in value deemed to be other than temporary and changes in fair value of fixed maturity securities attributable to the risk designated in a fair value hedge. Trading securities are reported at fair value with changes in fair value included in net realized investment gain (loss). For mortgage-backed securities included in fixed maturity securities available for sale, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. This adjustment is reflected in net investment income. PL-8 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Realized gains and losses on investment transactions are determined on a specific identification basis and are included in net realized investment gain (loss). Mortgage loans, net of valuation allowances and writedowns, and policy loans are stated at unpaid principal balances. Real estate is carried at depreciated cost, net of writedowns, or, for real estate acquired in satisfaction of debt, estimated fair value less estimated selling costs at the date of acquisition, if lower than the related unpaid balance. Partnership and joint venture interests in which the Company does not have a controlling interest or a majority ownership are generally recorded using the equity method of accounting and are included in other investments. Investments in low income housing tax credits (LIHTC) are included in other investments. These investments are recorded under either the effective interest method or the equity method. For investments in LIHTC recorded under the effective interest method, the amortization of the original investment and the tax credits are recorded in the provision for income taxes. For investments in LIHTC recorded under the equity method, the amortization of the initial investment is included in net investment income and the related tax credits are recorded in the provision for income taxes. The amortization recorded in net investment income was $27 million, $33 million and $22 million for the years ended December 31, 2001, 2000 and 1999, respectively. The Company, through its wholly owned subsidiary Pacific Asset Management LLC and subsidiaries (PAM), had an approximate 33% beneficial ownership interest in PIMCO Advisors L.P. (PIMCO Advisors) as of December 31, 1999 and May 4, 2000, through the direct and indirect ownership of PIMCO Advisors' Class A limited partnership units (Class A units). This interest was accounted for using the equity method through May 4, 2000. On May 5, 2000, a transaction was closed whereby Allianz of America, Inc. (Allianz), a subsidiary of Allianz AG, acquired substantially all interests in PIMCO Advisors other than those beneficially owned by PAM. PAM exchanged its Class A units for a new security, PIMCO Advisors Class E limited partnership units (Class E units). This exchange resulted in a realized, pretax nonmonetary exchange gain of $1,082 million, based on the fair value of the Class A units exchanged, or $38.75 per unit, the per unit value that Allianz paid to acquire its interest in PIMCO Advisors. This gain is included in net realized investment gain (loss) for the year ended December 31, 2000. A net deferred tax liability of $365 million was also established. As a result of this transaction, the Company has virtually no influence over PIMCO Advisors' operating and financial policies. Effective May 5, 2000, the interest in PIMCO Advisors is being accounted for using the cost method. The interest in PIMCO Advisors, which is included in other investments, is being reported at estimated fair value, as determined by the put and call option price described below. Unrealized gains of $177 million and $124 million, net of deferred income taxes of $66 million and $47 million, for the years ended December 31, 2001 and 2000, respectively, are reported as a component of OCI. In connection with this transaction, PAM entered into a Continuing Investment Agreement with Allianz with respect to its interest in PIMCO Advisors. The interest in PIMCO Advisors held by PAM is subject to put and call options held by PAM and Allianz, respectively. The put option gives PAM the right to require Allianz, on the last business day of each calendar quarter, to purchase all of the interest in PIMCO Advisors held by PAM. The put option price is based on the per unit amount, as defined in the Continuing Investment Agreement, for the most recently completed four calendar quarters multiplied by a factor of 14. The call option gives Allianz the right to require PAM, on any January 31, April 30, July 31, or October 31, beginning on January 31, 2003, to sell its interest in PIMCO Advisors to Allianz. The call option price is based on the per unit amount, as defined in the Continuing Investment Agreement, for the most recently completed four calendar quarters multiplied by a factor of 14 and can be exercised only if the call per unit value reaches a minimum value. Effective January 1, 2002, PIMCO Advisors changed its name to Allianz Dresdner Asset Management of America L.P. PL-9 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) CASH AND CASH EQUIVALENTS Cash and cash equivalents include all investments with a remaining maturity of three months or less. DEFERRED POLICY ACQUISITION COSTS The costs of acquiring new insurance business, principally commissions, medical examinations, underwriting, policy issue and other expenses, all of which vary with and are primarily related to the production of new business, have been deferred. For universal life and investment-type products, such costs are generally amortized over the expected life of the contract in proportion to the present value of expected gross profits using investment, mortality, expense margins and surrender charge assumptions and estimates. Adjustments are reflected in income or equity in the period the Company experiences deviations in gross profit assumptions and estimates. Adjustments directly affecting equity result from experience deviations due to changes in unrealized gains and losses in securities available for sale. For traditional life insurance products, such costs are being amortized over the premium-paying period of the related policies in proportion to premium revenues recognized, using assumptions and estimates consistent with those used in computing policy reserves. Value of business acquired (VOBA), included as part of deferred policy acquisition costs, represents the present value of future profits generated from existing insurance contracts in force at the date of acquisition and is amortized over the expected policy or contract duration in relation to the present value of estimated gross profits from such policies and contracts. The VOBA balance was $91 million and $94 million as of December 31, 2001 and 2000, respectively. Components of deferred policy acquisition costs are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Balance, January 1 $1,796 $1,446 $ 901 ---------------------------- Additions: Capitalized during the year 566 646 538 Acquisition of insurance block of business 75 ---------------------------- Total additions 566 646 613 ---------------------------- Amortization: Allocated to commission expenses (181) (188) (112) Allocated to operating expenses (65) (54) (49) Allocated to OCI, unrealized gains (losses) (3) (54) 93 ---------------------------- Total amortization (249) (296) (68) ---------------------------- Balance, December 31 $2,113 $1,796 $1,446 ============================
UNIVERSAL LIFE AND INVESTMENT-TYPE PRODUCTS Universal life and investment-type products, including guaranteed interest contracts (GICs) and funding agreements, are valued using the retrospective deposit method and consist principally of deposits received plus interest credited, less accumulated assessments. Interest credited to these policies primarily ranged from 2.0% to 8.0% during 2001, 2000 and 1999. PL-10 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) FUTURE POLICY BENEFITS Life insurance reserves are valued using the net level premium method. Interest rate assumptions ranged from 4.5% to 9.3% for 2001, 2000 and 1999. Mortality, morbidity and withdrawal assumptions are generally based on the Company's experience, modified to provide for possible unfavorable deviations. Future dividends for participating business are provided for in the liability for future policy benefits. Dividends to policyholders are included in policy benefits paid or provided. Dividends are accrued based on dividend formulas approved by the Board of Directors and reviewed for reasonableness and equitable treatment of policyholders by an independent consulting actuary. As of December 31, 2001 and 2000, participating experience rated policies paying dividends represent less than 1% of direct written life insurance in force. REVENUES, BENEFITS AND EXPENSES Insurance premiums are recognized as revenues when due. Benefits and expenses, other than deferred policy acquisition costs, are recognized when incurred. Generally, receipts for universal life and investment-type products are classified as deposits. Policy fees from these contracts include mortality charges, surrender charges and earned policy service fees. Expenses related to these products include interest credited to account balances and benefit amounts in excess of account balances. Commission revenue from Pacific Life's broker-dealer subsidiaries is recorded on the trade date. DEPRECIATION AND AMORTIZATION Depreciation of investment real estate is computed on the straight-line method over the estimated useful lives, which range from 5 to 30 years. Certain other assets are depreciated or amortized on the straight-line method over periods ranging from 3 to 40 years. Depreciation of investment real estate is included in net investment income. Depreciation and amortization of certain other assets is included in operating expenses. INCOME TAXES Pacific Life and its wholly owned life insurance subsidiary domiciled in Arizona, Pacific Life & Annuity Company (PL&A), are taxed as life insurance companies for income tax purposes. Pacific Life and its includable subsidiaries are included in the consolidated Federal income tax return of PMHC and are allocated an expense or benefit based principally on the effect of including their operations in the consolidated return. Pacific Life's non insurance subsidiaries are either included in PMHC's combined California franchise tax return or file separate state tax returns. Deferred income taxes are provided for timing differences in the recognition of revenues and expenses for financial reporting and income tax purposes. SEPARATE ACCOUNTS Separate account assets are recorded at fair value and the related liabilities represent segregated contract owner funds maintained in accounts with individual investment objectives. The investment results of separate account assets generally pass through to separate account contract owners. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of financial instruments, disclosed in Notes 5, 6 and 7, has been determined using available market information and appropriate valuation methodologies. However, considerable judgment is often required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented may not be indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts. PL-11 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued) RISKS AND UNCERTAINTIES The Company operates in a business environment which is subject to various risks and uncertainties. Such risks and uncertainties include, but are not limited to, interest rate risk, investment market risk, credit risk and legal and regulatory changes. Interest rate risk is the potential for interest rates to change, which can cause fluctuations in the value of investments, the liabilities for future policy benefits and the carrying amount of deferred policy acquisition costs. To the extent that fluctuations in interest rates cause the duration of assets and liabilities to differ, the Company may have to sell assets prior to their maturity and realize losses. The Company controls its exposure to this risk by, among other things, asset/liability matching techniques that attempt to match the duration of assets and liabilities and utilization of derivative instruments. Additionally, the Company includes contractual provisions limiting withdrawal rights for certain of its products. A substantial portion of the Company's liabilities are not subject to surrender or can be surrendered only after deduction of a surrender charge or a market value adjustment. Credit risk is the risk that issuers of investments owned by the Company may default or that other parties may not be able to pay amounts due to the Company. The Company manages its investments to limit credit risk by diversifying its portfolio among various security types and industry sectors. The credit risk of financial instruments is controlled through credit approval procedures, limits and ongoing monitoring. Real estate and mortgage loan investment risks are limited by diversification of geographic location and property type. Management does not believe that significant concentrations of credit risk exist. The Company is also exposed to credit loss in the event of nonperformance by the counterparties to interest rate swap contracts and other derivative securities. The Company manages this risk through credit approvals and limits on exposure to any specific counterparty. However, the Company does not anticipate nonperformance by the counterparties. The Company is subject to various state and Federal regulatory authorities. The potential exists for changes in regulatory initiatives which can result in additional, unanticipated expense to the Company. Existing Federal laws and regulations affect the taxation of life insurance or annuity products and insurance companies. There can be no assurance as to what, if any, cases might be decided or future legislation might be enacted, or if decided or enacted, whether such cases or legislation would contain provisions with possible negative effects on the Company's life insurance or annuity products. USE OF ESTIMATES The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates include those used in determining deferred policy acquisition costs, investment valuation and allowances, derivative valuation, and liabilities for future policy benefits. Actual results could differ from those estimates. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the 2001 financial statement presentation. PL-12 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. STATUTORY RESULTS Pacific Life prepares its statutory financial statements in conformity with accounting practices prescribed or permitted by the CA DOI, which is a comprehensive basis of accounting other than U.S. GAAP. Effective January 1, 2001, the CA DOI required that insurance companies domiciled in the State of California prepare their statutory basis financial statements in accordance with the National Association of Insurance Commissioners' (NAIC) Accounting Practices and Procedures Manual, version effective January 1, 2001 (NAIC SAP), subject to any deviations prescribed or permitted by the CA DOI. As a result of adopting NAIC SAP, Pacific Life reported a statutory cumulative effect of change in accounting principle that increased statutory surplus by $229 million as of January 1, 2001. NAIC SAP does not allow for restatement of prior year amounts. Therefore, prior year statutory amounts presented in this footnote are not comparable to current year statutory amounts. The following are reconciliations of statutory capital and surplus, and statutory net income for Pacific Life as compared to the amounts reported as stockholder's equity and net income included on the accompanying consolidated financial statements:
December 31, 2001 2000 -------------- (In Millions) Statutory capital and surplus $1,869 $1,678 Deferred policy acquisition costs 2,124 1,764 Asset valuation reserve 524 524 Non admitted assets 378 115 Accumulated other comprehensive income 270 31 Surplus notes (150) (150) Deferred income taxes (356) 181 Insurance and annuity reserves (795) (767) Other (145) (144) -------------- Stockholder's equity as reported herein $3,719 $3,232 ==============
Years Ended December 31, 2001 2000 1999 --------------------------- (In Millions) Statutory net income $ 24 $ 141 $ 168 Deferred policy acquisition costs 329 393 379 Insurance and annuity reserves 25 (106) (184) Deferred income taxes (29) (87) (3) Earnings of subsidiaries (60) 674 (27) Other (48) (20) 38 --------------------------- Net income as reported herein $ 241 $ 995 $ 371 ===========================
PL-13 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. STATUTORY RESULTS (Continued) RISK-BASED CAPITAL Risk-based capital is a method developed by the NAIC to measure the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formulas for determining the amount of risk-based capital specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. The adequacy of a company's actual capital is measured by the risk-based capital results, as determined by the formulas. Companies below minimum risk-based capital requirements are classified within certain levels, each of which requires specified corrective action. As of December 31, 2001 and 2000, Pacific Life and PL&A exceeded the minimum risk-based capital requirements. PERMITTED PRACTICE For the year ended December 31, 2000, the CA DOI approved a permitted practice effective May 5, 2000, allowing Pacific Life to apply the accounting guidance promulgated for limited liability companies in Statement of Statutory Accounting Principle (SSAP) No. 48, Joint Ventures, Partnerships and Limited Liability Companies, and SSAP No. 46, Investments in Subsidiary, Controlled and Affiliated Entities, prior to the effective date of NAIC SAP, for its investment in PAM. Under this permitted practice, PAM was accounted for using the equity method of accounting. The permitted practice also required that the equity of PAM be adjusted for certain tax effects not recorded at PAM due to its limited liability company structure. As of January 1, 2001, this permitted practice became prescribed practice. Prior to May 5, 2000, net cash distributions received on PAM's interest in PIMCO Advisors were recorded as income, as permitted by the CA DOI. DIVIDEND RESTRICTIONS Dividend payments by Pacific Life to Pacific LifeCorp in any 12-month period cannot exceed the greater of 10% of adjusted statutory capital and surplus as of the preceding year end or the statutory net gain from operations for the previous calendar year, without prior approval from the CA DOI. Based on this limitation and 2001 statutory results, Pacific Life could pay $165 million in dividends in 2002 without prior approval. No dividends were paid during 2001, 2000 and 1999. The maximum amount of ordinary dividends that can be paid by PL&A to Pacific Life without restriction cannot exceed the lesser of 10% of statutory surplus as regards to policyholders, or the statutory net gain from operations. No dividends were paid during 2001, 2000 and 1999. Based on this limitation and 2001 statutory results, PL&A could pay $21 million in dividends in 2002 without prior approval. 3. CLOSED BLOCK In connection with the Conversion, an arrangement known as a closed block (the Closed Block) was established, for dividend purposes only, for the exclusive benefit of certain individual life insurance policies that had an experience based dividend scale for 1997. The Closed Block was designed to give reasonable assurance to holders of Closed Block policies that policy dividends will not change solely as a result of the Conversion. Assets that support the Closed Block, which are primarily included in fixed maturity securities, policy loans and accrued investment income, amounted to $292 million and $290 million as of December 31, 2001 and 2000, respectively. Liabilities allocated to the Closed Block, which are primarily included in future policy benefits, amounted to $326 million and $330 million as of December 31, 2001 and 2000, respectively. The contribution to income from the Closed Block amounted to $5 million, $6 million and $4 million and is primarily included in insurance premiums, net investment income and policy benefits paid or provided for the years ended December 31, 2001, 2000 and 1999, respectively. PL-14 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. ACQUISITIONS All of the Company's acquisitions are accounted for using the purchase method of accounting. On December 31, 2001, a transaction was closed whereby Pacific Life exchanged its 100% common stock ownership in World-Wide Holdings Limited (World-Wide) for a 22.5% common stock ownership in Scottish Annuity & Life Holdings, Ltd. (Scottish). World-Wide's assets and liabilities were approximately $164 million and $103 million, respectively. Scottish, a publicly traded specialty reinsurer, issued new ordinary shares in exchange for World-Wide at a value of $78 million. Pacific Life recorded a nonmonetary exchange gain of $13 million, net of taxes, in connection with this exchange. Pacific Life will account for its investment in Scottish using the equity method of accounting. The Company has not yet completed the allocation of the purchase price to assets and liabilities acquired. In 1999, Pacific Life acquired a payout annuity block of business from Confederation Life Insurance Company (U.S.) in Rehabilitation, which is currently under rehabilitation. On the effective date, this block of business consisted of approximately 16,000 annuitants having reserves of $1.8 billion. The assets received as part of this acquisition amounted to $1.6 billion in fixed maturity securities and $0.2 billion in cash. During 1999, Pacific Life acquired a 95% interest in Grayhawk Golf Holdings, LLC (Grayhawk) for $65 million, which owns 100% of a real estate investment property in Arizona. Goodwill resulting from this transaction was $22 million. PL-15 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INVESTMENTS The net carrying amount, gross unrealized gains and losses, and estimated fair value of fixed maturity and equity securities available for sale are shown below. The net carrying amount represents amortized cost adjusted for other than temporary declines in value and change in fair value of fixed maturity securities attributable to the risk designated in a fair value hedge. The fair value of publicly traded securities is based on quoted market prices. For securities not actively traded, fair values were estimated based on amounts provided by independent pricing services specializing in matrix pricing and modeling techniques. The Company also estimates certain fair values based on interest rates, credit quality and average maturity or from securities with comparable trading characteristics.
Net Gross Unrealized Carrying ------------------ Estimated Amount Gains Losses Fair Value ---------------------------------------- (In Millions) As of December 31, 2001: ------------------------ U.S. Treasury securities and obligations of U.S. government authorities and agencies $ 32 $ 2 $ 34 Obligations of states and political subdivisions 669 92 761 Foreign governments 292 27 $ 11 308 Corporate securities 10,985 377 194 11,168 Mortgage-backed and asset- backed securities 4,822 137 190 4,769 Redeemable preferred stock 8 1 7 ---------------------------------------- Total fixed maturity securities $16,808 $ 635 $ 396 $17,047 ======================================== Total equity securities $ 255 $ 20 $ 9 $ 266 ======================================== As of December 31, 2000: ------------------------ U.S. Treasury securities and obligations of U.S. government authorities and agencies $ 32 $ 2 $ 34 Obligations of states and political subdivisions 641 55 $ 1 695 Foreign governments 302 20 5 317 Corporate securities 8,780 258 232 8,806 Mortgage-backed and asset- backed securities 5,230 101 100 5,231 Redeemable preferred stock 52 9 8 53 ---------------------------------------- Total fixed maturity securities $15,037 $ 445 $ 346 $15,136 ======================================== Total equity securities $ 173 $ 18 $ 12 $ 179 ========================================
PL-16 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INVESTMENTS (Continued) The net carrying amount and estimated fair value of fixed maturity securities available for sale as of December 31, 2001, by contractual repayment date of principal, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Net Carrying Estimated Amount Fair Value ------------------- (In Millions) Due in one year or less $ 794 $ 811 Due after one year through five years 4,785 4,924 Due after five years through ten years 3,699 3,775 Due after ten years 2,708 2,768 ------------------ 11,986 12,278 Mortgage-backed and asset-backed securities 4,822 4,769 ------------------ Total $16,808 $17,047 ==================
Major categories of investment income are summarized as follows:
Years Ended December 31, 2001 2000 1999 ------------------------ (In Millions) Fixed maturity securities $1,118 $1,109 $1,030 Equity securities 5 13 15 Mortgage loans 206 230 208 Real estate 64 61 46 Policy loans 202 182 159 Other 172 218 166 ------------------------ Gross investment income 1,767 1,813 1,624 Investment expense 139 130 114 ------------------------ Net investment income $1,628 $1,683 $1,510 ========================
PL-17 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INVESTMENTS (Continued) Net realized investment gain (loss), including changes in valuation allowances, is as follows:
Years Ended December 31, 2001 2000 1999 ------------------ (In Millions) Fixed maturity securities $(45) $ 2 $16 Equity securities 31 (13) 58 Mortgage loans 6 7 Real estate 9 (3) 18 Interest in PIMCO Advisors (Note 1) 1,082 Other investments (9) (77) ----------------- Total $(14) $ 997 $99 =================
The change in fair value on investments in available for sale and trading securities is as follows:
December 31, 2001 2000 1999 ------------------- (In Millions) Available for sale securities: Fixed maturity $140 $477 $ (925) Equity 5 (20) (157) ------------------- Total $145 $457 $(1,082) =================== Trading securities $(17) $ 6 $ 0 ===================
Gross gains of $67 million, $125 million and $188 million and gross losses of $48 million, $44 million and $62 million, which have been included in earnings as a result of sales of available for sale securities, were realized for the years ended December 31, 2001, 2000 and 1999, respectively. Trading securities as of December 31, 2001 and 2000, included net unrealized losses of $15 million and net unrealized gains of $2 million, respectively. As of December 31, 2001 and 2000, investments in fixed maturity securities of $13 million were on deposit with state insurance departments to satisfy regulatory requirements. The Company's interest in PIMCO Advisors (Note 1) exceeds 10% of total stockholder's equity as of December 31, 2001. PL-18 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount and estimated fair value of the Company's financial instruments are as follows:
December 31, 2001 December 31, 2000 ------------------- ------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value --------------------------------------- (In Millions) Assets: Fixed maturity and equity securities (Note 5) $17,313 $17,313 $15,315 $15,315 Trading securities 458 458 71 71 Mortgage loans 2,933 3,088 3,026 3,246 Policy loans 4,899 4,899 4,680 4,680 Cash and cash equivalents 510 510 211 211 Interest in PIMCO Advisors (Note 1) 1,703 1,703 1,548 1,548 Derivative instruments (Note 7) 26 26 15 15 Notes receivable from affiliates 88 88 Liabilities: Guaranteed interest contracts 7,498 7,625 6,676 6,803 Deposit liabilities 482 495 470 483 Annuity liabilities 1,955 1,955 1,114 1,114 Short-term debt 275 275 195 195 Long-term debt 164 160 164 166 Derivative instruments (Note 7) 530 530 445 445
The following methods and assumptions were used to estimate the fair value of these financial instruments as of December 31, 2001 and 2000: TRADING SECURITIES The fair value of trading securities is based on quoted market prices. MORTGAGE LOANS The estimated fair value of the mortgage loan portfolio is determined by discounting the estimated future cash flows, using a year-end market rate which is applicable to the yield, credit quality and average maturity of the composite portfolio. POLICY LOANS The carrying amounts of policy loans are a reasonable estimate of their fair values because interest rates are generally variable and based on current market rates. CASH AND CASH EQUIVALENTS The carrying values approximate fair values due to the short-term maturities of these instruments. PL-19 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) NOTES RECEIVABLE FROM AFFILIATES The carrying amount of notes receivable from affiliates (Note 16) is a reasonable estimate of its fair value because the interest rates are variable and based on current market rates. GUARANTEED INTEREST CONTRACTS AND DEPOSIT LIABILITIES The estimated fair value of GICs is estimated using the rates currently offered for deposits of similar remaining maturities. The estimated fair value of deposit liabilities with no defined maturities is the amount payable on demand. ANNUITY LIABILITIES The estimated fair value of annuity liabilities approximates carrying value and primarily includes policyholder deposits and accumulated credited interest. SHORT-TERM DEBT The carrying amount of short-term debt is a reasonable estimate of its fair value because the interest rates are variable and based on current market rates. LONG-TERM DEBT The estimated fair value of surplus notes (Note 10) is based on market quotes. The carrying amount of other long-term debt is a reasonable estimate of its fair value because the interest rate on the debt is approximately the same as current market rates. 7. DERIVATIVES AND HEDGING ACTIVITIES The Company primarily utilizes various derivative instruments to hedge and manage its exposure to changes in interest rate levels, foreign exchange rates, and equity market prices, and to manage the duration mismatch of assets and liabilities. The Company uses hedge accounting as allowed by SFAS No. 133 and SFAS No. 138, by designating derivative instruments as either fair value or cash flow hedges on the date the Company enters into a derivative contract. 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 and states how the hedging instrument is expected to hedge the risks related to the hedged item. The Company formally measures effectiveness of its hedging relationships both at the hedge inception and on an ongoing basis in accordance with its risk management policy. Hedge effectiveness is assessed quarterly by a variety of techniques including Value-at-Risk, regression analysis and cumulative dollar offset. In certain cases, hedge effectiveness is assumed because the derivative instrument was constructed such that all critical terms of the derivative exactly match the hedged risk in the hedged item. PL-20 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. DERIVATIVES AND HEDGING ACTIVITIES (Continued) Fair Value Hedges ----------------- The Company primarily uses interest rate and foreign currency swaps and options to manage its exposure to changes in the fair values of its assets and liabilities due to fluctuations in foreign currencies and the benchmark interest rate. For derivative instruments that are designated as fair value hedges, the change in value of the derivative instrument as well as the change in fair value of the hedged item associated with the risk being hedged is recorded in net realized investment gain (loss). Periodic net settlements on derivatives designated as fair value hedges are reflected on an accrual basis as an adjustment to net investment income or interest credited on universal life and investment-type products, based on the item being hedged. The change in value of the hedged item associated with the risk being hedged is reflected as an adjustment to the carrying amount of the hedged item. Upon termination of the fair value hedging relationship, the accumulated cost basis adjustment is amortized into net investment income or interest credited to universal life or investment-type products over its remaining life or recognized immediately in connection with the disposal of the hedged item. For the year ended December 31, 2001, the ineffectiveness related to fair value hedges was approximately $0.2 million, net of tax, which is recorded in net realized investment gain (loss). No component of the hedging instrument's fair value is excluded from the determination of effectiveness. Cash Flow Hedges ---------------- The Company primarily uses interest rate and foreign currency swaps and interest rate futures contracts to manage its exposure to variability in cash flows due to changes in foreign currencies and the benchmark interest rate. These cash flows include those associated with existing assets and liabilities as well as the forecasted interest cash flows related to anticipated investment purchases and liability issuances. Such anticipated investment purchases and liability issuances are considered to be probable to occur and are generally completed within 180 days of the inception of the hedge. The Company has not discontinued any cash flow hedges of anticipated transactions. For derivative instruments that are designated as cash flow hedges, the effective portion of the change in fair value of the derivative instrument is recorded in OCI and is recognized as an adjustment to net investment income or interest credited on universal life and investment-type products when the hedged item affects earnings. The Company did not record any ineffectiveness for cash flow hedges during the year ended December 31, 2001. Over the next twelve months, the Company anticipates that $0.8 million of deferred gains on derivative instruments in accumulated OCI will be reclassified to earnings. For the year ended December 31, 2001, none of the Company's hedged forecasted transactions were determined to be probable of not occurring. No component of the hedging instrument's fair value is excluded from the determination of effectiveness. Derivatives Not Designated as Hedging Instruments ------------------------------------------------- The Company enters into swap agreements, interest rate futures contracts, interest rate cap and floor agreements, and equity indexed futures contracts without designating the derivatives as hedging instruments. Derivatives that are not designated as hedging instruments are entered into primarily to manage the Company's interest rate risk from rising or falling interest rates, equity risk and yield enhancement. The Company uses credit default and total return swaps to manage the credit exposure of the portfolio, equity risk embedded in certain liabilities and to take advantage of market opportunities. Net realized investment gain (loss) for the year ended December 31, 2001 includes $2 million related to realized gains and losses and changes in fair value of derivative instruments not designated as hedges. Periodic net settlements on such derivatives are recorded as adjustments to net investment income or interest credited on universal life and investment-type products on an accrual basis, based upon the purpose of the derivative. PL-21 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. DERIVATIVES AND HEDGING ACTIVITIES (Continued) Embedded Derivatives -------------------- The Company may enter into contracts that are not derivative instruments, but contain embedded derivatives. When it is determined that the embedded derivative possesses economic and risk characteristics that are not clearly and closely related to those of the host contract and that a separate instrument with the same terms would qualify as a derivative instrument, it is separated from the host contract and accounted for as a stand-alone derivative. Such derivatives are recorded on the consolidated statement of financial condition at fair value, with changes in their fair value recorded in net realized investment gain (loss). Derivative Instruments ---------------------- The Company uses a variety of derivative financial instruments, including swaps, caps, floors, and exchange traded futures contracts. Interest rate swap agreements involve the exchange, at specified intervals, of interest payments resulting from the difference between fixed rate and floating rate interest amounts calculated by reference to an underlying notional amount. Credit default swaps involve the receipt of fixed rate payments in exchange for assuming potential credit exposure of an underlying security. Total return swaps involve the exchange of floating rate payments for the total return performance of a specified index, market or security. Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party. Foreign currency swaps involve the exchange of an initial principal amount in two currencies, and the agreement to re-exchange the currencies at a future date, at an agreed exchange rate. There is also periodic exchange of interest payments in the two currencies at specified intervals, calculated using agreed upon rates and the exchanged principal amounts. The Company issues synthetic GICs to Employee Retirement Income Security Act of 1974 (ERISA) qualified defined contribution employee benefit plans (ERISA Plan). The ERISA Plan uses the contracts in its stable value or guaranteed fixed income option. Synthetic GICs provide certain of the ERISA Plan's assets a guarantee of principal and interest, as it relates to certain benefit payments. The Company has an off balance sheet risk that the value of the underlying assets is insufficient to meet these guarantees. To control this risk, the Company pre-approves all investment guidelines. Default risk is absorbed by the ERISA Plan. The interest rate guarantee is reset periodically to reflect actual performance results. As of December 31, 2001 the Company had outstanding commitments to maintain liquidity for benefit payments on notional amounts of $2.6 billion compared to $1.7 billion as of December 31, 2000. The notional amounts represent the value of the ERISA Plan's assets only and are not a measure of the exposure to the Company. Interest rate floor agreements entitle the Company to receive the difference when the current rate of the underlying index is below the strike rate. Interest rate cap agreements entitle the Company to receive the difference when the current rate of the underlying index is above the strike rate. Options purchased involve the right, but not the obligation, to purchase the underlying securities at a specified price during a given time period. Cash requirements for these instruments are generally limited to the premium paid by the Company at acquisition. Financial futures contracts obligate the holder to buy or sell the underlying financial instrument at a specified future date for a set price and may be settled in cash or by delivery of the financial instrument. Price changes on futures are settled daily through the required margin cash flows. The notional amounts of the contracts do not represent future cash requirements, as the Company intends to close out open positions prior to expiration. PL-22 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. DERIVATIVES AND HEDGING ACTIVITIES (Continued) Outstanding derivatives with off-balance sheet risks, shown in notional or contract amounts along with their carrying value and estimated fair value as of December 31, 2001 and 2000 are as follows:
Assets (Liabilities) ----------------------------------------- Notional or Carrying Estimated Carrying Estimated Contract Amounts Value Fair Value Value Fair Value ----------------- -------- ---------- -------- ---------- 2001 2000 2001 2001 2000 2000 ----------------------------------------------------------- (In Millions) Interest rate swap contracts $ 3,512 $ 2,648 $(144) $(144) $ (89) $ (89) Credit default and total return swaps 2,375 3,896 (105) (105) (132) (132) Foreign currency swaps 3,310 2,488 (281) (281) (224) (224) Synthetic GICs 2,599 1,695 Interest rate floors, caps, options and swaptions 829 745 26 26 15 15 Financial futures contracts 97 58 ---------------------------------------------------------- Total $12,722 $11,530 $(504) $(504) $(430) $(430) ==========================================================
A reconciliation of the notional or contract amounts is as follows:
Balance Acquisitions Terminations Balance Beginning and Other and End of of Year Additions Maturities Year ------------------------------------------- (In Millions) December 31, 2001: ------------------ Interest rate swap contracts $ 2,648 $1,100 $ 236 $ 3,512 Credit default and total return swaps 3,896 254 1,775 2,375 Foreign currency swaps 2,488 1,439 617 3,310 Synthetic GICs 1,695 1,046 142 2,599 Interest rate floors, caps, options and swaptions 745 103 19 829 Financial futures contracts 58 3,398 3,359 97 ------------------------------------------- Total $11,530 $7,340 $6,148 $12,722 =========================================== December 31, 2000: ------------------ Interest rate swap contracts $ 2,867 $2,419 $2,638 $ 2,648 Credit default and total return swaps 2,120 2,898 1,122 3,896 Foreign currency swaps 1,685 1,079 276 2,488 Synthetic GICs 1,632 470 407 1,695 Interest rate floors, caps, options and swaptions 1,033 160 448 745 Financial futures contracts 677 2,762 3,381 58 ------------------------------------------- Total $10,014 $9,788 $8,272 $11,530 ===========================================
PL-23 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. UNIVERSAL LIFE AND INVESTMENT-TYPE PRODUCTS The detail of universal life and investment-type product liabilities is as follows:
December 31, 2001 2000 --------------- (In Millions) Universal life $12,278 $11,405 Investment-type products 9,518 8,005 --------------- $21,796 $19,410 ===============
The detail of universal life and investment-type products policy fees and interest credited, net of reinsurance ceded, is as follows:
Years Ended December 31, 2001 2000 1999 ------------------------- (In Millions) Policy fees: Universal life $ 582 $ 541 $ 509 Investment-type products 239 228 145 ------------------------- Total policy fees $ 821 $ 769 $ 654 ========================= Interest credited: Universal life $ 500 $ 467 $ 444 Investment-type products 529 530 494 ------------------------- Total interest credited $ 1,029 $ 997 $ 938 =========================
9. LIABILITY FOR GROUP HEALTH UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSE Activity in the liability for group health unpaid claims and claim adjustment expenses, which is included in future policy benefits, is summarized as follows:
Years Ended December 31, 2001 2000 -------------------------- (In Millions) Balance at January 1 $130 $116 Incurred related to: Current year 569 395 Prior years (12) (19) -------------------------- Total incurred 557 376 -------------------------- Paid related to: Current year 448 297 Prior years 80 65 -------------------------- Total paid 528 362 -------------------------- Balance at December 31 $159 $130 ==========================
As a result of favorable settlement of prior years' estimated claims, the provision for claims and claim adjustment expenses decreased by $12 million and $19 million for the years ended December 31, 2001 and 2000, respectively. PL-24 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. SHORT-TERM AND LONG-TERM DEBT Pacific Life borrows for short-term needs by issuing commercial paper. There was no commercial paper debt outstanding as of December 31, 2001 and 2000. As of December 31, 2001 and 2000, Pacific Life had a revolving credit facility of $350 million. There was no debt outstanding under the revolving credit facility as of December 31, 2001 and 2000. PAM had bank borrowings outstanding of $275 million and $195 million as of December 31, 2001 and 2000, respectively. The interest rate was 2.3% and 6.9% as of December 31, 2001 and 2000, respectively. The amount of the borrowings and the interest rates are reset monthly. The borrowing limit for PAM as of December 31, 2001 and 2000, was $275 million and $215 million, respectively. Grayhawk has a note payable with a maturity date of May 22, 2008. The note bears a fixed rate of interest of 7.6%. The outstanding balance as of December 31, 2001 and 2000 was $14 million. Pacific Life has $150 million of long-term debt, which consists of surplus notes outstanding at an interest rate of 7.9% maturing on December 30, 2023. Interest is payable semiannually on June 30 and December 30. The surplus notes may not be redeemed at the option of Pacific Life or any holder of the surplus notes. The surplus notes are unsecured and subordinated to all present and future senior indebtedness and policy claims of Pacific Life. Each payment of interest and principal on the surplus notes may be made only with the prior approval of the Insurance Commissioner of the State of California. Interest expense amounted to $12 million for each of the years ended December 31, 2001, 2000 and 1999 and is included in net investment income. 11. INCOME TAXES The provision for income taxes is as follows:
Years Ended December 31, 2001 2000 1999 --------------------------- (In Millions) Current $(5) $ 34 $152 Deferred 60 424 (8) --------------------------- Provision for income taxes on income before cumulative adjustments due to changes in accounting principles 55 458 144 Deferred income tax provision on cumulative adjustments due to changes in accounting principles (4) --------------------------- Total $51 $458 $144 ===========================
PL-25 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. INCOME TAXES (Continued) The sources of the Company's provision for deferred taxes are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Nonmonetary exchange of PIMCO Advisors units (Note 1) $447 Deferred policy acquisition costs $ 99 57 $ 20 Policyholder reserves 7 19 51 Duration hedging 3 (30) Investment valuation (7) (19) (28) Partnership income (26) 3 (25) Low income housing credit carryover (31) Other 14 (4) 4 ---------------------------- Deferred taxes from operations 56 506 (8) Release of deferred taxes in connection with nonmonetary exchange of PIMCO Advisors units (Note 1) (82) ---------------------------- Provision for deferred taxes $ 56 $424 $ (8) ============================
In connection with the nonmonetary exchange of partnership units at PIMCO Advisors (Note 1), certain nonoperating deferred taxes previously established were released during the year ended December 31, 2000. A reconciliation of the provision for income taxes based on the prevailing corporate statutory tax rate to the provision reflected in the consolidated financial statements is as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Provision for income taxes at the statutory rate $106 $509 $180 State income taxes 4 25 Nontaxable investment income (6) (6) (7) Low income housing and foreign tax credits (28) (22) (19) Book to tax basis difference on nonmonetary exchange of PIMCO Advisors units (Note 1) (35) Other (21) (13) (10) ---------------------------- Provision for income taxes on income before cumulative adjustments due to changes in accounting principles 55 458 144 Deferred income tax provision on cumulative adjustments due to changes in accounting principles (4) ---------------------------- Total $ 51 $458 $144 ============================
PL-26 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. INCOME TAXES (Continued) The net deferred tax liability, included in other liabilities as of December 31, 2001 and 2000, is comprised of the following tax effected temporary differences:
December 31, 2001 2000 -------------- (In Millions) Deferred tax assets Policyholder reserves $ 177 $ 184 Investment valuation 99 92 Deferred compensation 40 35 Low income housing credit carryover 31 Duration hedging 18 18 Partnership income 10 Dividends 7 7 Postretirement benefits 6 8 Other 5 22 -------------- Total deferred tax assets 393 366 -------------- Deferred tax liabilities Nonmonetary exchange of PIMCO Advisors units (Note 1) (429) (429) Deferred policy acquisition costs (200) (101) Partnership income (16) Depreciation (2) (2) -------------- Total deferred tax liabilities (631) (548) -------------- Net deferred tax liability from operations (238) (182) Deferred taxes on World-Wide (Note 4) (11) Deferred taxes on OCI (159) (23) -------------- Net deferred tax liability $ (397) $(216) ==============
PL-27 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. COMPREHENSIVE INCOME (LOSS) The Company displays comprehensive income (loss) and its components on the accompanying consolidated statements of stockholder's equity and as follows. OCI is shown net of reclassification adjustments and net of deferred income taxes. The disclosure of the gross components of OCI is as follows:
Years Ended December 31, 2001 2000 1999 --------------------------- (In Millions) Gross Holding Gain (Loss): Holding gain (loss) on securities available for sale $151 $ 457 $(948) Holding loss on derivatives (20) (70) (226) Income tax (expense) benefit (45) (135) 411 Reclassification adjustment: Realized (gain) loss on sale of securities available for sale (5) 3 (78) Realized loss on derivatives 71 Provision for income taxes (benefit) (24) (1) 27 Allocation of holding (gain) loss to deferred policy acquisition costs 2 (27) 44 Provision for income (taxes) benefit (1) 9 (15) --------------------------- Net unrealized gain (loss) on securities available for sale 129 236 (785) Foreign currency translation adjustment (1) (4) (1) Unrealized gain on interest in PIMCO Advisors (Note 1) 111 77 --------------------------- Total $239 $309 $(786) ===========================
13. REINSURANCE The Company has reinsurance agreements with other insurance companies for the purpose of diversifying risk and limiting exposure on larger mortality risks or, in the case of a producer-owned reinsurance company, to diversify risk and retain top producing agents. Amounts receivable from reinsurers for reinsurance of future policy benefits, universal life deposits, and unpaid losses is included in other assets. All assets associated with business reinsured on a yearly renewable term and modified coinsurance basis remain with, and under the control of the Company. Amounts recoverable (payable) from (to) reinsurers include the following amounts:
December 31, 2001 2000 -------------- (In Millions) Universal life deposits $(79) $(66) Future policy benefits 155 156 Unpaid claims 34 26 Paid claims 16 13 Other 17 33 -------------- Net reinsurance recoverable $143 $162 ==============
PL-28 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. REINSURANCE (Continued) As of December 31, 2001, 75% of the reinsurance recoverables were from two reinsurers, of which 100% is secured by payables to the reinsurer. To the extent that the assuming companies become unable to meet their obligations under these agreements, the Company remains contingently liable. The Company does not anticipate nonperformance by the assuming companies. The components of insurance premiums are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Direct premiums $ 923 $ 646 $563 Ceded reinsurance (129) (108) (93) Assumed reinsurance 18 14 14 --------------------------- Insurance premiums $ 812 $ 552 $484 ===========================
Revenues and benefits are shown net of the following reinsurance transactions:
Years Ended December 31, 2001 2000 1999 ------------------------- (In Millions) Ceded reinsurance netted against policy fees $ 85 $ 74 $ 52 Ceded reinsurance netted against net investment income 266 244 212 Ceded reinsurance netted against interest credited 210 161 111 Ceded reinsurance netted against policy benefits 115 110 88 Assumed reinsurance included in policy benefits 11 12 8
14. SEGMENT INFORMATION The Company has five operating segments: Life Insurance, Institutional Products, Annuities, Group Insurance and Broker-Dealers. These segments are managed separately and have been identified based on differences in products and services offered. All other activity is included in Corporate and Other. Prior to May 4, 2000, the Company had another operating segment, Investment Management. In connection with the PIMCO Advisors transaction (Note 1), Investment Management was no longer considered an operating segment by management and, effective May 5, 2000, it's activities are included in Corporate and Other. PIMCO Advisors offers a diversified range of investment products through separately managed accounts, and institutional, retail and offshore funds. The Life Insurance segment offers universal life, variable universal life and other life insurance products to individuals, small businesses and corporations through a network of distribution channels that include branch offices, sales centers, marketing organizations, National Association of Securities Dealers (NASD) firms and a national producer group that has produced over 10% of the segment's in force business. The Institutional Products segment offers investment and annuity products to pension fund sponsors and other institutional investors primarily through its home office marketing team and other intermediaries. The Annuities segment offers variable and fixed annuities to individuals and small businesses through NASD firms, regional and national wirehouses, and financial institutions. PL-29 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The Group Insurance segment primarily offers group life, health and dental insurance, and stop loss insurance products to corporate, government and labor-management-negotiated plans. The group life, health and dental insurance is primarily distributed through a network of sales offices and the stop loss insurance is distributed through a network of third party administrators. The Broker-Dealers segment includes five NASD registered firms that provide securities and insurance brokerage services and investment advisory services through approximately 3,100 registered representatives. Pacific Life's direct wholly owned broker-dealer subsidiary, Pacific Select Distributors, Inc. (PSD), primarily serves as the underwriter/distributor of registered investment-related products and services, principally variable life and annuity contracts issued by Pacific Life. During 2001, PSD became the distributor of the Pacific Funds, a multi-class, open end investment management company. Pacific Life is the investment adviser to the Pacific Funds. Corporate and Other primarily includes investment income, expenses and assets not attributable to the operating segments, and the operations of World-Wide (Note 4). Corporate and Other also includes the elimination of intersegment revenues, expenses and assets, including commission revenue and expense from the sale of Pacific Life's variable life and annuity products. The Company uses the same accounting policies and procedures to measure segment income and assets as it uses to measure its consolidated net income and assets. Net investment income and net realized investment gain (loss) are allocated based on invested assets purchased and held as is required for transacting the business of that segment. Overhead expenses are allocated based on services provided. Interest expense is allocated based on the short-term borrowing needs of the segment and is included in net investment income. The provision for income taxes is allocated based on each segment's actual tax provision. The Company generates substantially all of its revenues and income from customers located in the United States. Additionally, substantially all of the Company's assets are located in the United States. Depreciation expense and capital expenditures are not material and have not been reported herein. The Company's significant noncash item disclosed herein is interest credited to universal life and investment-type products. PL-30 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The following is segment information as of and for the year ended December 31, 2001:
Life Institutional Group Broker- Corporate Insurance Products Annuities Insurance Dealers and Other Total ----------------------------------------------------------------------------------------------- (In Millions) REVENUES Policy fees $ 582 $ 2 $ 237 $ 821 Insurance premiums (59) 113 $723 $ 35 812 Net investment income 645 831 67 19 $ 1 65 1,628 Net realized investment gain (loss) 5 2 (21) (14) Commission revenue 580 (399) 181 Other income 28 10 99 2 40 46 225 --------------------------------------------------------------------- Total revenues 1,196 961 403 746 621 (274) 3,653 --------------------------------------------------------------------- BENEFITS AND EXPENSES Policy benefits 205 351 27 557 23 1,163 Interest credited 506 456 67 1,029 Commission expenses 149 3 146 50 570 (394) 524 Operating expenses 172 20 144 113 53 132 634 --------------------------------------------------------------------- Total benefits and expenses 1,032 830 384 720 623 (239) 3,350 --------------------------------------------------------------------- Income (loss) before provision for income taxes (benefit) 164 131 19 26 (2) (35) 303 Provision for income taxes (benefit) 38 34 1 7 (1) (24) 55 --------------------------------------------------------------------- Income (loss) before cumulative adjustments due to changes in accounting principles 126 97 18 19 (1) (11) 248 Cumulative adjustments due to changes in accounting principles, net of taxes (3) (8) (1) 1 4 (7) --------------------------------------------------------------------- Net income (loss) $ 123 $ 89 $ 17 $ 20 $ (1) $ (7) $ 241 ===================================================================== Total assets $18,216 $16,121 $17,928 $431 $ 74 $2,912 $55,682 Deferred policy acquisition costs $ 923 $ 75 $ 1,115 $ 2,113 Separate account assets $ 3,615 $ 4,461 $15,382 $23,458 Policyholder and contract liabilities $13,325 $10,965 $ 1,874 $212 $26,376 Separate account liabilities $ 3,615 $ 4,461 $15,382 $23,458
PL-31 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The following is segment information as of and for the year ended December 31, 2000, except for the Investment Management Segment, which is for the period ended, May 4, 2000:
Life Institutional Group Investment Broker- Corporate Insurance Products Annuities Insurance Management Dealers and Other Total --------------------------------------------------------------------------------------------------------- (In Millions) REVENUES Policy fees $ 541 $ 3 $ 225 $ 769 Insurance premiums (49) 64 2 $511 $ 24 552 Net investment income 609 838 58 29 $49 $ 1 99 1,683 Net realized investment gain (loss) (22) (40) (4) (7) 10 1,060 997 Commission revenue 687 (417) 270 Other income 32 8 97 4 6 23 39 209 -------------------------------------------------------------------------------- Total revenues 1,111 873 378 537 65 711 805 4,480 -------------------------------------------------------------------------------- BENEFITS AND EXPENSES Policy benefits 190 298 6 385 879 Interest credited 474 458 53 12 997 Commission expenses 161 2 135 36 650 (408) 576 Operating expenses 159 20 126 93 27 47 103 575 -------------------------------------------------------------------------------- Total benefits and expenses 984 778 320 514 27 697 (293) 3,027 -------------------------------------------------------------------------------- Income before provision for income taxes 127 95 58 23 38 14 1,098 1,453 Provision for income taxes 29 18 21 6 8 6 370 458 -------------------------------------------------------------------------------- Net income $ 98 $ 77 $ 37 $ 17 $30 $ 8 $ 728 $ 995 ================================================================================ Total assets $17,232 $17,908 $16,661 $374 $ 72 $2,537 $54,784 Deferred policy acquisition costs $ 825 $ 75 $ 886 $ 10 $ 1,796 Separate account assets $ 3,543 $ 7,104 $15,271 $25,918 Policyholder and contract liabilities $12,439 $10,218 $ 1,019 $189 $ 87 $23,952 Separate account liabilities $ 3,543 $ 7,104 $15,271 $25,918
PL-32 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT INFORMATION (Continued) The following is segment information for the year ended December 31, 1999:
Life Institutional Group Investment Broker- Corporate Insurance Products Annuities Insurance Management Dealers and Other Total -------------------------------------------------------------------------------------------------------- (In Millions) REVENUES Policy fees $ 509 $ 3 $142 $ 654 Insurance premiums (32) 25 6 $476 $ 9 484 Net investment income 582 679 78 23 $116 $ 1 31 1,510 Net realized investment gain (loss) 11 26 (1) 10 53 99 Commission revenue 583 (349) 234 Other income 25 11 57 3 15 19 15 145 ------------------------------------------------------------------------------- Total revenues 1,095 744 283 501 141 603 (241) 3,126 ------------------------------------------------------------------------------- BENEFITS AND EXPENSES Policy benefits 174 197 10 354 735 Interest credited 451 418 65 4 938 Commission expenses 163 87 33 549 (347) 485 Operating expenses 128 17 48 84 78 42 56 453 ------------------------------------------------------------------------------- Total benefits and expenses 916 632 210 471 78 591 (287) 2,611 ------------------------------------------------------------------------------- Income before provision for income taxes 179 112 73 30 63 12 46 515 Provision for income taxes 54 31 24 10 12 5 8 144 ------------------------------------------------------------------------------- Net income $ 125 $ 81 $ 49 $ 20 $ 51 $ 7 $ 38 $ 371 ===============================================================================
15. EMPLOYEE BENEFIT PLANS PENSION PLANS Pacific Life provides a defined benefit pension plan covering all eligible employees of the Company. On July 1, 2000, Pacific Life converted this final average pay formula defined benefit plan to a cash balance approach. Active employees' existing benefits in this plan were converted to opening balances and will increase over time from credits, based on years of service and compensation levels, and quarterly interest accruals. The full-benefit vesting period for all participants is five years. Pacific Life's funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as may be determined appropriate. Contributions are intended to provide not only for benefits attributed to employment to date but also for those expected to be earned in the future. All such contributions are made to a tax-exempt trust. Plan assets consist primarily of group annuity contracts issued by Pacific Life, as well as mutual funds managed by an affiliate of Pacific Life. PL-33 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. EMPLOYEE BENEFIT PLANS (Continued) Components of the net periodic pension expense (benefit) are as follows:
Years Ended December 31, 2001 2000 1999 ---------------------------- (In Millions) Service cost - benefits earned during the year $ 12 $ 6 $ 5 Interest cost on projected benefit obligation 12 12 11 Expected return on plan assets (16) (17) (16) Amortization of net obligations and prior service cost (1) (4) (2) ---------------------------- Net periodic pension expense (benefit) $ 7 $ (3) $ (2) ============================
The following tables set forth the changes in projected benefit obligation and plan assets and funded status reconciliation:
December 31, 2001 2000 -------------- (In Millions) Change in Projected Benefit Obligation: --------------------------------------- Projected benefit obligation, beginning of year $170 $156 Service cost 12 6 Interest cost 12 12 Plan expense (1) (1) Actuarial loss 4 5 Benefits paid (19) (8) -------------- Projected benefit obligation, end of year $178 $170 ============== Change in Plan Assets: ---------------------- Fair value of plan assets, beginning of year $197 $212 Actual return on plan assets (13) (6) Employer contributions 17 Plan expense (1) (1) Benefits paid (19) (8) -------------- Fair value of plan assets, end of year $181 $197 ============== Funded Status Reconciliation: ----------------------------- Funded status $ 3 $ 27 Unrecognized transition asset (1) Unrecognized actuarial (gain) loss 15 (18) -------------- Prepaid pension cost $ 18 $ 8 ==============
In determining the actuarial present value of the projected benefit obligation as of December 31, 2001 and 2000, the weighted average discount rate used was 7.0% and 7.5%, respectively, and the rate of increase in future compensation levels was 4.5% and 5.0%, respectively. The expected long-term rate of return on plan assets was 8.5% in 2001 and 2000. PL-34 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. EMPLOYEE BENEFIT PLANS (Continued) POSTRETIREMENT BENEFITS Pacific Life provides a defined benefit health care plan and a defined benefit life insurance plan (the Plans) that provide postretirement benefits for all eligible retirees and their dependents. Generally, qualified employees may become eligible for these benefits if they reach normal retirement age, have been covered under Pacific Life's policy as an active employee for a minimum continuous period prior to the date retired, and have an employment date before January 1, 1990. The Plans contain cost-sharing features such as deductibles and coinsurance, and require retirees to make contributions which can be adjusted annually. Pacific Life's commitment to qualified employees who retire after April 1, 1994 is limited to specific dollar amounts. Pacific Life reserves the right to modify or terminate the Plans at any time. As in the past, the general policy is to fund these benefits on a pay-as-you-go basis. The net periodic postretirement benefit cost for the years ended December 31, 2001, 2000 and 1999 is $1 million. As of December 31, 2001 and 2000, the accumulated benefit obligation is $19 million and $20 million, respectively. The fair value of the plan assets as of December 31, 2001 and 2000 is zero. The amount of accrued benefit cost included in other liabilities is $24 million as of December 31, 2001 and 2000. The Plans include both indemnity and HMO coverage. The assumed health care cost trend rate used in measuring the accumulated benefit obligation for indemnity coverage was 9.0% and 10.0% for 2001 and 2000, respectively, and is assumed to decrease gradually to 5.0% in 2005 and remain at that level thereafter. The assumed health care cost trend rate used in measuring the accumulated benefit obligation for HMO coverage was 8.0% and 9.0% for 2001 and 2000, respectively, and is assumed to decrease gradually to 4.5% in 2005 and remain at that level thereafter. The amount reported is materially affected by the health care cost trend rate assumptions. If the health care cost trend rate assumptions were increased by 1%, the accumulated postretirement benefit obligation as of December 31, 2001 would be increased by 7.0%, and the aggregate of the service and interest cost components of the net periodic benefit cost would increase by 6.6%. If the health care cost trend rate assumptions were decreased by 1%, the accumulated postretirement benefit obligation as of December 31, 2001 would be decreased by 6.6%, and the aggregate of the service and interest cost components of the net periodic benefit cost would decrease by 6.4%. The discount rate used in determining the accumulated postretirement benefit obligation is 7.0% and 7.5% for 2001 and 2000, respectively. OTHER PLANS Pacific Life provides a voluntary Retirement Incentive Savings Plan (RISP) pursuant to Section 401(k) of the Internal Revenue Code covering all eligible employees of the Company. Pacific Life's RISP matches 75% of each employee contributions, up to a maximum of 6.0% of eligible employee compensation, to an Employee Stock Ownership Plan (ESOP). ESOP contributions made by the Company amounted to $9 million, $8 million and $7 million for the years ended December 31, 2001, 2000 and 1999, respectively, and are included in operating expenses. The ESOP was formed at the time of the Conversion and is only available to the participants of the RISP in the form of matching contributions. Pacific LifeCorp issued 1.7 million shares of common stock to the ESOP in 1997, in exchange for a promissory note of $21 million (ESOP Note) bearing an interest rate of 6.5%. Interest and principal payments are due semiannually in equal installments through September 2, 2012. Interest and principal payments made by the ESOP to Pacific LifeCorp were funded by contributions from Pacific Life. In 1999, Pacific Life loaned cash to the ESOP to pay off the ESOP Note due Pacific LifeCorp. Interest and principal payments made by the ESOP to Pacific Life continue to be funded by contributions from Pacific Life. The interest rate was reduced to 6.0% effective September 2, 1999. PL-35 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. EMPLOYEE BENEFIT PLANS (Continued) The ESOP Note is included in unearned ESOP shares. The unearned ESOP shares account is reduced as ESOP shares are released for allocation to participants through ESOP contributions by Pacific Life. In addition, when the fair value of ESOP shares being released for allocation to participants exceeds the original issue price of those shares, paid-in capital is increased by this difference. On January 9, 2002, Pacific Life loaned cash of $46 million to the ESOP in exchange for a 5.5% promissory note due January 9, 2017. The ESOP then purchased 2 million shares of newly issued common stock of Pacific LifeCorp at a price of $23.00 per share in exchange for cash. These newly issued shares were purchased in order for the ESOP to maintain its matching contributions to participants in the plan. The Company has deferred compensation plans that permit eligible employees to defer portions of their compensation and earn interest on the deferred amounts. The interest rate is determined annually. The compensation that has been deferred has been accrued and the primary expense related to this plan, other than compensation, is interest on the deferred amounts. The Company also has performance-based incentive compensation plans for its employees. 16. TRANSACTIONS WITH AFFILIATES Pacific Life serves as the investment adviser for the Pacific Select Fund, the investment vehicle provided to the Company's variable life and variable annuity contractholders. Pacific Life charges fees based upon the net asset value of the portfolios of the Pacific Select Fund, which amounted to $117 million, $115 million and $70 million for the years ended December 31, 2001, 2000 and 1999, respectively. In addition, Pacific Life provides certain support services to the Pacific Select Fund and other affiliates based on an allocation of actual costs. Fees amounted to $948,000, $698,000 and $1,288,000 for the years ended December 31, 2001, 2000 and 1999, respectively. PAM has an agreement to loan Pacific LifeCorp up to $350 million at variable rates. The outstanding balance as of December 31, 2001 was $70 million. There was no balance outstanding as of December 31, 2000. The interest rate as of December 31, 2001 was 2.2%. During 2001, PAM entered into an agreement to loan Aviation Capital Group Holding Corp., a subsidiary of Pacific LifeCorp, up to $100 million at variable rates. The outstanding balance as of December 31, 2001 was $18 million. The interest rate as of December 31, 2001 was 4.1%. 17. TERMINATION AND NONCOMPETITION AGREEMENTS The Company had termination and noncompetition agreements with certain former key employees of PAM's subsidiaries. In connection with the closing of the PIMCO Advisors transaction (Note 1), these agreements were assumed by Allianz. These agreements provided terms and conditions for the allocation of future proceeds received from distributions and sales of certain PIMCO Advisors units and other noncompete payments. For the years ended December 31, 2000 and 1999, $14 million and $54 million, respectively, is included in operating expenses related to these agreements. PL-36 Pacific Life Insurance Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. COMMITMENTS AND CONTINGENCIES The Company has outstanding commitments to make investments primarily in fixed maturity securities, mortgage loans, limited partnerships and other investments as follows (In Millions):
Years Ending December 31: ------------------------- 2002 $290 2003 through 2006 234 2007 and thereafter 82 ---- Total $606 ====
The Company leases office facilities under various noncancelable operating leases. Rent expense, which is included in operating expenses, in connection with these leases was $15 million, $14 million and $9 million for the years ended December 31, 2001, 2000 and 1999, respectively. Aggregate minimum future commitments are as follows (In Millions):
Years Ending December 31: ------------------------- 2002 $ 16 2003 through 2006 53 2007 and thereafter 31 ---- Total $100 ====
The Company has investments in entities that are not consolidated because of control and substantive ownership by independent third parties. There are no material unrecorded liabilities and all material guarantees and commitments have been disclosed herein. The Company is a respondent in a number of legal proceedings, some of which involve allegations for extra-contractual damages. In the opinion of management, the outcome of the foregoing proceedings is not likely to have a material adverse effect on the consolidated financial position or results of operations of the Company. --------------------------------------------------------------------------- PL-37 -----END PRIVACY-ENHANCED MESSAGE-----