Back to GetFilings.com
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
________________
COMMISSION FILE NUMBER 33-03094
________________
THE TRAVELERS INSURANCE COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CONNECTICUT 06-0566090
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE CITYPLACE, HARTFORD, CONNECTICUT 06103-3415
(Address of principal executive offices) (Zip Code)
(860) 308-1000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Yes [X] No [ ]
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Exchange Act Rule 12b-2).
Yes [ ] No [X]
As of the date hereof, there were outstanding 40,000,000 shares of common stock,
par value $2.50 per share, of the registrant, all of which were owned by
Citigroup Insurance Holding Corporation, an indirect wholly owned subsidiary of
Citigroup Inc.
REDUCED DISCLOSURE FORMAT
The registrant meets the conditions set forth in General Instruction I(1)(a) and
(b) of Form 10-K and is therefore filing this Form with the reduced disclosure
format.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
TABLE OF CONTENTS
FORM 10-K
ITEM NUMBER PART I PAGE
- ----------- ------ ----
1. Business............................................................................................. 2
A. General........................................................................................... 2
B. Business by Segment
Travelers Life & Annuity..................................................................... 2
Primerica.................................................................................... 4
C. Insurance Regulations............................................................................. 4
2. Properties........................................................................................... 6
3. Legal Proceedings.................................................................................... 6
4. Submission of Matters to a Vote of Security Holders.................................................. 7
PART II
-------
5. Market for Registrant's Common Equity and Related Stockholder Matters................................ 7
6. Selected Financial Data.............................................................................. 7
7. Management's Discussion and Analysis of Financial Condition and Results of Operations................ 7
7A. Quantitative and Qualitative Disclosures About Market Risk........................................... 15
8. Financial Statements and Supplementary Data.......................................................... 18
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................. 64
9A. Controls and Procedures.............................................................................. 64
PART III
10. Directors and Executive Officers of the Registrant................................................... 64
11. Executive Compensation............................................................................... 64
12. Security Ownership of Certain Beneficial Owners and Management....................................... 64
13. Certain Relationships and Related Transactions....................................................... 64
14. Principal Accountant Fees and Services............................................................... 64
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................... 66
Exhibit Index........................................................................................ 67
Signatures........................................................................................... 68
Index to Financial Statements and Financial Statement Schedules...................................... 69
Exhibit 31.01........................................................................................ 74
Exhibit 31.02........................................................................................ 75
Exhibit 32.01........................................................................................ 76
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
PART I
ITEM 1. BUSINESS.
GENERAL
The Travelers Insurance Company (TIC, together with its subsidiaries, the
Company), is a wholly owned subsidiary of Citigroup Insurance Holding
Corporation (CIHC), an indirect wholly owned subsidiary of Citigroup Inc.
(Citigroup). Citigroup is a diversified global financial services holding
company whose businesses provide a broad range of financial services to consumer
and corporate customers around the world. The periodic reports of Citigroup
provide additional business and financial information concerning it and its
consolidated subsidiaries. TIC was incorporated in 1863.
The Company's two reportable business segments are Travelers Life & Annuity and
Primerica. The primary insurance entities of the Company are TIC and its
subsidiaries The Travelers Life and Annuity Company (TLAC), included in the
Travelers Life & Annuity segment, and Primerica Life Insurance Company
(Primerica Life) and its subsidiaries, Primerica Life Insurance Company of
Canada, CitiLife Financial Limited (CitiLife) and National Benefit Life
Insurance Company (NBL), included in the Primerica segment. The consolidated
financial statements include the accounts of the insurance entities of the
Company and Tribeca Citigroup Investments Ltd., among others, on a fully
consolidated basis.
At December 31, 2001, the Company was a wholly owned subsidiary of The Travelers
Insurance Group, Inc. (TIGI). On February 4, 2002, TIGI changed its name to
Travelers Property Casualty Corp. (TPC). TPC completed its initial public
offering (IPO) on March 27, 2002 and on August 20, 2002 Citigroup made a
tax-free distribution of the majority of its remaining interest in TPC to
Citigroup's stockholders. Prior to the IPO, the common stock of TIC was
distributed by TPC to CIHC so that TIC would remain an indirect wholly owned
subsidiary of Citigroup. See Note 14 of Notes to Consolidated Financial
Statements.
Additional information about the Company is available on the Citigroup website
at http://www.citigroup.com by selecting the "Investor Relations" page and
selecting "SEC Filings."
BUSINESS BY SEGMENT
TRAVELERS LIFE & ANNUITY
Travelers Life & Annuity (TLA) core offerings include individual annuity,
individual life, corporate owned life insurance (COLI) and group annuity
insurance products distributed by TIC and TLAC principally under the Travelers
Life & Annuity name. The Company has a license from TPC to use the names
"Travelers Life & Annuity," "The Travelers Insurance Company," "The Travelers
Life and Annuity Company" and related names in connection with the Company's
business. Among the range of individual products offered are deferred fixed and
variable annuities, payout annuities and term, universal and variable life
insurance. The COLI product is a variable universal life product distributed
through independent specialty brokers. The group products include institutional
pensions, including guaranteed investment contracts (GICs), payout annuities,
group annuities sold to employer-sponsored retirement and savings plans,
structured settlements and funding agreements.
2
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
Individual deferred fixed and variable annuities are primarily used for
retirement funding purposes. Variable annuities permit policyholders to direct
retirement funds into a number of separate accounts, which offer differing
investment options. Individual payout annuities offer a guaranteed payment
stream over a specified or life contingent period.
Individual annuity products are distributed through affiliated channels and
non-affiliated channels. The affiliated channels include CitiStreet Retirement
Services, a division of CitiStreet LLC, (CitiStreet), a joint venture between
Citigroup and State Street Bank; Smith Barney (SB), a division of Citigroup
Global Markets Inc.; Primerica Financial Services (PFS); and Citibank. The
non-affiliated channels primarily include a nationwide network of independent
financial professionals and independent broker-dealers. CitiStreet is a sales
organization of personal retirement planning specialists focused primarily on
the qualified periodic deferred compensation marketplace. CitiStreet's share of
total individual annuity premiums and deposits was 30% in 2003. SB distributes
TLA's individual annuities and individual life products, and accounted for 18%
of total individual annuity premiums and deposits in 2003. Sales by PFS and
Citibank accounted for 16% and 8%, respectively, of total individual annuity
premiums and deposits in 2003. The non-affiliated channels accounted for 28% of
individual annuity premiums and deposits.
Individual life insurance is used to meet estate, business planning and
retirement needs and also to provide protection against financial loss due to
death. Individual life products are primarily marketed by the independent
financial professionals, by SB and by Citibank, who accounted for 81% , 11% and
5%, respectively, of total individual life sales for 2003.
Group annuity products, including fixed and variable rate GICs, which provide a
guaranteed return on investment, continue to be a popular investment choice for
employer-sponsored retirement and savings plans. Annuities purchased by
employer-sponsored plans fulfill retirement obligations to individual employees.
Payout annuities are used primarily as a pension close-out investment for
companies. Structured settlements are purchased as a means of settling certain
indemnity claims and making other payments to policyholders over a period of
time. Funding agreement transactions offer fixed term and fixed or variable rate
investment options with policyholder status to domestic and foreign
institutional investors. These group annuity products are sold through direct
sales and various intermediaries.
TIC is licensed to sell and market its individual products in all 50 states, the
District of Columbia, Puerto Rico, Guam, the Bahamas and the U.S. and British
Virgin Islands.
The Company operates Tower Square Securities, Inc., which is an introducing
broker-dealer offering a full line of brokerage services. Tower Square
Securities facilitates the sale of individual variable life and annuity
insurance products by the independent financial professionals. Travelers
Distribution LLC, a limited purpose broker-dealer, is the principal underwriter
and distributor for TLA variable products.
3
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
PRIMERICA
Primerica Life and its subsidiaries, Primerica Life Insurance Company of Canada,
CitiLife and NBL, are the insurance operations of PFS. Their primary product is
individual term life insurance marketed through a sales force composed of
approximately 107,000 representatives. A great majority of the domestic licensed
sales force works on a part-time basis. NBL also provides statutory disability
benefit insurance and other insurance, primarily in New York, as well as direct
response student term life insurance nationwide. CitiLife was established in
September 2000 to underwrite insurance in Europe. Primerica, directly or through
its subsidiaries, is licensed or otherwise authorized to sell and market term
life insurance in all 50 states, the District of Columbia, Puerto Rico, Guam,
the U.S. Virgin Islands, Northern Mariana Islands, Canada, the United Kingdom
and Spain.
INSURANCE REGULATIONS
Insurance Regulatory Information System
The National Association of Insurance Commissioners (NAIC) Insurance Regulatory
Information System (IRIS) was developed to help state regulators identify
companies that may require special attention. The IRIS system consists of a
statistical phase and an analytical phase whereby financial examiners review
annual statements and financial ratios. The statistical phase consists of 12 key
financial ratios based on year-end data that are generated from the NAIC
database annually; each ratio has an established "usual range" of results. These
ratios assist state insurance departments in executing their statutory mandate
to oversee the financial condition of insurance companies.
A ratio result falling outside the usual range of IRIS ratios is not considered
a failing result; rather, unusual values are viewed as part of the regulatory
early monitoring system. Furthermore, in some years, it may not be unusual for
financially sound companies to have several ratios with results outside the
usual ranges. An insurance company may fall out of the usual range for one or
more ratios because of specific transactions that are in themselves immaterial.
Generally, an insurance company will become subject to regulatory scrutiny if it
falls outside the usual ranges for four or more of the ratios. No regulatory
action has been taken by any state insurance department or the NAIC with respect
to IRIS ratios during the two years ended December 31, 2003.
Risk-Based Capital (RBC) Requirements
In order to enhance the regulation of insurer solvency, the NAIC adopted a
formula and model law to implement RBC requirements for most life and annuity
insurance companies, which are designed to determine minimum capital
requirements and to raise the level of protection that statutory surplus
provides for policyholder obligations. For this purpose, an insurer's total
adjusted capital is measured in relation to its specific asset and liability
profiles. A company's risk-based capital is calculated by applying factors to
various asset, premium and reserve items, where the factor is higher for those
items with greater underlying risk and lower for less risky items.
4
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
The RBC formula for life insurers measures four major areas of risk:
- asset risk (i.e., the risk of asset default),
- insurance risk (i.e., the risk of adverse mortality and
morbidity experience),
- interest rate risk (i.e., the risk of loss due to changes in
interest rates) and
- business risk (i.e., normal business and management risk).
Under laws adopted by the states, insurers having less total adjusted capital
than that required by the RBC calculation will be subject to varying degrees of
regulatory action, depending upon the level of capital inadequacy.
The RBC law provides for four levels of regulatory action as defined by the
NAIC. The extent of regulatory intervention and action increases as the level of
total adjusted capital to RBC falls. The first level, the company action level,
requires an insurer to submit a plan of corrective actions to the regulator if
total adjusted capital falls below 200% of the RBC amount. The second level, the
regulatory action level, requires an insurer to submit a plan containing
corrective actions and requires the relevant insurance commissioner to perform
an examination or other analysis and issue a corrective order if total adjusted
capital falls below 150% of the RBC amount. The third level, the authorized
control level, authorizes the relevant commissioner to take whatever regulatory
actions are considered necessary to protect the best interest of the
policyholders and creditors of the insurer which may include the actions
necessary to cause the insurer to be placed under regulatory control, i.e.,
rehabilitation or liquidation, if total adjusted capital falls below 100% of the
RBC amount. The fourth level, the mandatory control level, requires the relevant
insurance commissioner to place the insurer under regulatory control if total
adjusted capital falls below 70% of the RBC amount.
The formulas have not been designed to differentiate among adequately
capitalized companies, which operate with higher levels of capital. Therefore,
it is inappropriate and ineffective to use the formula to rate or rank
companies. At December 31, 2003, the Company's principal domestic insurance
entities all had total adjusted capital in excess of amounts requiring company
action or any level of regulatory action at any prescribed RBC level.
Insurance Regulation Concerning Dividends
TIC is domiciled in the State of Connecticut. The insurance holding company law
of Connecticut requires notice to, and approval by, the State of Connecticut
Insurance Department for the declaration or payment of any dividend which,
together with other distributions made within the preceding twelve months,
exceeds the greater of (i) 10% of the insurer's surplus or (ii) the insurer's
net gain from operations for the twelve-month period ending on the preceding
December 31st, in each case determined in accordance with statutory accounting
practices. Such declaration or payment is further limited by adjusted unassigned
funds (surplus), reduced by 25% of the change in net unrealized capital gains,
as determined in accordance with statutory accounting practices. The insurance
holding company laws of other states in which the Company's insurance
subsidiaries are domiciled generally contain similar (although in certain
instances somewhat more restrictive) limitations on the payment of dividends. A
maximum of $845 million is available by the end of the year 2004 for such
dividends without prior approval of the State of Connecticut Insurance
Department, depending upon the amount and timing of the payments. In accordance
with the Connecticut statute, TLAC, after reducing its unassigned funds
(surplus) by 25% of the change in unrealized capital gains, may not pay a
dividend to TIC without prior approval of the State of Connecticut Insurance
Department. Primerica may pay up to $242 million to TIC in 2004 without prior
approval of the Commonwealth of Massachusetts Insurance Department.
5
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
In February 2004, the Company requested prior approval of the State of
Connecticut Insurance Department to pay a proposed extraordinary dividend in
March 2004. Under Connecticut law, the ordinary dividend limitation amount is
based upon the cumulative total of all dividend payments made within the
preceding twelve months. The Company's proposed dividend payment of $467.5
million payable on March 30 would exceed the ordinary dividend limitation by
approximately $103 million. The State of Connecticut Insurance Department
approved the request on March 12, 2004. The Company may seek approval from the
Connecticut Insurance Department for additional extraordinary dividend payments
during 2004. This statement is a forward-looking statement within the meaning
of the Private Securities Litigation Reform Act. See "Forward-Looking
Statements" on page 15.
Code of Ethics
The Company has adopted a code of ethics for financial professionals which
applies to the Company's principal executive officer and principal financial and
accounting officer. The code of ethics for financial professionals has been
included as an exhibit to this Form 10-K and can be found on the Citigroup
website by selecting the "Corporate Governance" page.
ITEM 2. PROPERTIES.
The Company's executive offices are located in Hartford, Connecticut. The
Company moved its executive offices to One Cityplace, Hartford, Connecticut,
during the first quarter of 2003. The Company occupies 373,000 square feet at
this location under an operating lease that runs through October 31, 2008. At
December 31, 2002 the Company leased approximately 284,000 square feet from TPC
at One Tower Square, Hartford, Connecticut under a lease that ran through March
31, 2003. The Company previously owned the complex of buildings at One Tower
Square, and sold it as well as a building in Norcross, Georgia housing TPC's
information systems department, to TPC for $68 million in 2002 in connection
with the TPC spin-off from Citigroup. See Note 14 of Notes to Consolidated
Financial Statements.
Other leasehold interests of the Company include approximately 760,000 square
feet of office space in 25 locations throughout the United States.
Management believes that these facilities are suitable and adequate for the
Company's current needs. See Note 10 of Notes to Consolidated Financial
Statements for additional information regarding these facilities.
The preceding discussion does not include information on investment properties.
ITEM 3. LEGAL PROCEEDINGS.
In 2003, several issues in the mutual fund and variable insurance product
industries have come under the scrutiny of federal and state regulators. Like
many other companies in our industry, the Company has received a request for
information from the Securities and Exchange Commission (SEC) and a subpoena
from the New York Attorney General regarding market timing and late trading. In
March 2004 the SEC requested additional information about the Company's variable
product operations on market timing, late trading and revenue sharing. The
Company is cooperating fully with all of these reviews and is not able to
predict their outcomes.
In the ordinary course of business, TIC and its subsidiaries are defendants or
co-defendants in various litigation matters incidental to and typical of the
businesses in which they are engaged. These include civil actions, arbitration
proceedings and other matters arising in the normal course of business out of
activities as an insurance company, a broker and dealer in securities or
otherwise. In the opinion of the Company's management, the ultimate resolution
of these legal proceedings would not be likely to have a material adverse effect
on the Company's results of operations, financial condition or liquidity.
Certain of these statements are forward-looking statements within the meaning of
the Private Securities Litigation Reform Act. See "Forward-Looking Statements"
on page 15.
6
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company has 40,000,000 authorized shares of common stock, all of which are
issued and outstanding as of December 31, 2003. All shares are held by an
indirect subsidiary of Citigroup, and there exists no established public trading
market for the common equity of the Company. The Company paid dividends to its
parent of $545 million and $586 million in 2003 and 2002, respectively. See Note
8 of Notes to Consolidated Financial Statements for certain information
regarding dividend restrictions.
ITEM 6. SELECTED FINANCIAL DATA.
Omitted pursuant to General Instruction I(2)(a) of Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Management's narrative analysis of the results of operations is presented in
lieu of Management's Discussion and Analysis of Financial Condition and Results
of Operations, pursuant to General Instruction I(2)(a) of Form 10-K.
SEGMENTS
The Travelers Insurance Company (TIC, together with its subsidiaries, the
Company) is composed of two business segments, Travelers Life & Annuity (TLA)
and Primerica.
CRITICAL ACCOUNTING POLICIES
The Notes to Consolidated Financial Statements contain a summary of the
Company's significant accounting policies, including a discussion of recently
issued accounting pronouncements. Certain of these policies are considered to be
critical to the portrayal of the Company's financial condition, since they
require management to make difficult, complex or subjective judgments, some of
which may relate to matters that are inherently uncertain.
DEFERRED ACQUISITION COSTS
Costs of acquiring traditional life, universal life, COLI, deferred annuities
and payout annuities are deferred. These deferred acquisition costs (DAC)
include principally commissions and certain expenses related to policy issuance,
underwriting and marketing, all of which vary with and are primarily related to
the production of new business. The method for determining amortization of
deferred acquisition costs varies by product type based upon three different
accounting pronouncements: Statement of Financial Accounting Standards (SFAS)
No. 60, "Accounting and Reporting by Insurance Enterprises" (SFAS 60), SFAS No.
91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases" (SFAS 91) and SFAS No. 97,
"Accounting and Reporting by Insurance Enterprises for Certain Long Duration
Contracts and for Realized Gains and Losses from the Sale of Investments" (SFAS
97).
7
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
DAC for deferred annuities, both fixed and variable, and payout annuities is
amortized employing a level effective yield methodology per SFAS 91 as indicated
by AICPA Practice Bulletin 8. An amortization rate is developed using the
outstanding DAC balance and projected account balances. This rate is applied to
actual account balances to determine the amount of DAC amortization. The
projected account balances are derived using a model that contains assumptions
related to investment returns and persistency. The model rate is evaluated at
least annually, and changes in underlying lapse and interest rate assumptions
are to be treated retrospectively. Variances in expected equity market returns
versus actual returns are treated prospectively and a new amortization pattern
is developed so that the DAC balances will be amortized over the remaining
estimated life of the business. DAC for these products is currently being
amortized over 10-15 years.
DAC for universal life and COLI is amortized in relation to estimated gross
profits from surrender charges, investment, mortality, and expense margins per
SFAS 97. Actual profits can vary from management's estimates, resulting in
increases or decreases in the rate of amortization. Re-estimates of gross
profits, performed at least annually, result in retrospective adjustments to
earnings by a cumulative charge or credit to income. DAC for these products is
currently being amortized over 16-25 years.
DAC relating to traditional life, including term insurance, and health insurance
is amortized in relation to anticipated premiums per SFAS 60. Assumptions as to
the anticipated premiums are made at the date of policy issuance or acquisition
and are consistently applied over the life of the policy. DAC for these products
is currently being amortized over 5-20 years.
All DAC is reviewed at least annually to determine if it is recoverable from
future income, including investment income, and, if not recoverable, is charged
to expense. All other acquisition expenses are charged to operations as
incurred.
FUTURE POLICY BENEFITS
Future policy benefits represent liabilities for future insurance policy
benefits for payout annuities and traditional life products. The annuity payout
reserves are calculated using the mortality and interest assumptions used in the
actual pricing of the benefit. Mortality assumptions are based on the Company's
experience and are adjusted to reflect deviations such as substandard mortality
in structured settlement benefits. The interest rates range from 2.0% to 9.0%,
with a weighted average rate of 7.02% for these annuity products. Traditional
life products include whole life and term insurance. Future policy benefits for
traditional life products are estimated on the basis of actuarial assumptions as
to mortality, persistency and interest, established at policy issue. Actuarial
and interest assumptions include a margin for adverse deviation and are based on
the Company's experience. Interest assumptions applicable to traditional life
products range from 2.5% to 7.0%, with a weighted average of 5.23%.
INVESTMENTS IN FIXED MATURITIES
Fixed maturities, which comprise 75% and 72% of total investments at December
31, 2003 and 2002, respectively, include bonds, notes and redeemable preferred
stocks. Fixed maturities, including instruments subject to securities lending
agreements (see Note 3 of Notes to Consolidated Financial Statements), are
classified as "available for sale" and are reported at fair value, with
unrealized investment gains and losses, net of income taxes, credited or charged
directly to shareholder's equity. Fair values of investments in fixed maturities
are based on quoted market prices or dealer quotes. If quoted market prices are
not available, discounted expected cash flows using market rates commensurate
with the credit quality and maturity of the investment are used to determine
fair value. Changes in assumptions could affect the fair values of fixed
maturities. Impairments are realized when investment losses in value are deemed
other-than-temporary. The Company conducts a rigorous review each quarter to
identify and evaluate investments that have possible indications of
8
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
impairment. An investment in a debt or equity security is impaired if its fair
value falls below its cost and the decline is considered other-than-temporary.
Factors considered in determining whether a loss is temporary include the length
of time and extent to which fair value has been below cost; the financial
condition and near-term prospects of the issuer; and the Company's ability and
intent to hold the investment for a period of time sufficient to allow for any
anticipated recovery. Changing economic conditions - global, regional, or
related to specific issuers or industries - could result in other-than-temporary
losses.
PREMIUMS
Premiums are recognized as revenues when due. Premiums for contracts with a
limited number of premium payments, due over a significantly shorter period than
the period over which benefits are provided, are considered revenue when due.
The portion of premium which is not required to provide for benefits and
expenses is deferred and recognized in revenues in a constant relationship to
insurance benefits in force.
CONSOLIDATED OVERVIEW
FOR THE YEARS ENDED DECEMBER 31, 2003 2002
- -------------------------------- ---- ----
($ in millions)
Revenues $ 6,139 $ 5,234
Insurance benefits and interest credited 3,350 2,931
Operating expenses 960 800
-------- -------
Income before taxes 1,829 1,503
Income taxes 471 421
-------- -------
Net income $ 1,358 $ 1,082
======== =======
Net income in 2003 increased 26% from 2002, primarily attributable to increased
revenues due to better net pre-tax realized investment portfolio gain (loss)
activity, better fee income and higher net investment income (NII) from
increased business volumes and an increased invested asset base. These increases
were partially offset by higher insurance benefits and claims from the increased
business volumes, higher DAC amortization and lower investment yields. Included
in net income are current year realized investment gains of $24 million compared
to prior year investment losses of $209 million. The 2002 loss reflects
impairments to the fixed maturities portfolio related to WorldCom Inc. of $126
million, as well as other fixed maturities and equity investment impairments.
See the detailed description of each business segment for additional
information.
9
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
TRAVELERS LIFE & ANNUITY
FOR THE YEARS ENDED DECEMBER 31, 2003 2002
- -------------------------------- ---- ----
($ in millions)
Revenues $4,479 $3,653
Insurance benefits and interest credited 2,816 2,404
Operating expenses 505 364
------ ------
Income before taxes 1,158 885
Income taxes 240 212
------ ------
Net income $ 918 $ 673
====== ======
Net income of $918 million in 2003, which increased 36% from $673 million in
2002, includes net realized investment gains of $20 million compared to net
realized investment losses of $211 million in 2002, largely resulting from the
absence of prior year impairments to the fixed maturities portfolio investments
in WorldCom Inc. of $122 million, as well as other fixed maturities and equity
investment impairments. The increase in 2003 net income was also due to higher
fee revenues and NII from business volumes, and $50 million in tax benefits
related to an adjustment to the Dividends Received Deduction. These increases
were partially offset by higher insurance benefits and claims from the increased
business volumes, higher DAC amortization and lower investment yields.
TLA NII increased 4% to $2,743 million in 2003 from $2,646 million in 2002
despite overall rate deterioration. Fixed maturities suffered from the lower
interest rate environment and credit issues. The increase was driven by a larger
invested asset base from higher business volumes and significant returns from
risk arbitrage activity through the trading portfolio.
10
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
The following table shows net written premiums and deposits by product line for
each of the years ended December 31, 2003 and 2002. The majority of the annuity
business and a substantial portion of the life business written by TLA are
accounted for as investment contracts, with the result that the deposits
collected are reported as liabilities and are not included in revenues. Deposits
represent a statistic used for measuring business volumes, which management of
the Company uses to manage the life insurance and annuities operations, and may
not be comparable to similarly captioned measurements used by other life
insurance companies.
2003 2002
IN MILLIONS OF DOLLARS Premiums Deposits Premiums Deposits
-------- -------- -------- --------
Individual annuities
Fixed $ - $ 535 $ - $ 1,237
Variable - 3,983 - 4,004
Individual payout 26 28 28 29
------ ------- -------- -------
Total individual annuities 26 4,546 28 5,270
Group annuities 908 6,494 545 5,747
Individual life insurance:
Direct periodic premiums & deposits 140 686 135 636
Single premium deposits - 405 - 285
Reinsurance (40) (99) (28) (85)
------ ------- -------- -------
Total individual life insurance 100 992 107 836
Other 48 - 50 -
------ ------- -------- -------
Total $1,082 $12,032 $ 730 $11,853
====== ======= ======== =======
Individual annuity deposits decreased 14% in 2003 to $4.546 billion from $5.270
billion in 2002. The decrease was primarily driven by a decline in fixed annuity
sales due to competitive pressures and current market perception of fixed rate
products. Variable annuity production declined slightly in 2003, primarily in
the first half of the year, which was the continuation of the weak equity market
conditions from the prior year. Production rebounded in the second half of the
year as equity market conditions improved. Individual annuity account balances
and benefits reserves were $32.9 billion at December 31, 2003, up from $27.5
billion at December 31, 2002. This increase reflects equity market growth in
variable annuity investments of $4.0 billion in 2003 and $1.2 billion of net
sales from good in-force retention.
Group Annuity written premiums increased 67%, primarily related to group payout
sales, which increased 129% due to the sale of a group pension close-out
contract of $290 million. Deposits (excluding the Company's employee pension
plan deposits) in 2003 increased 13% from 2002, reflecting higher fixed and
variable rate guaranteed investment contracts (GIC) sales, including a $1.0
billion fixed rate GIC sale to The Federal Home Loan Bank of Boston. Group
annuity account balances and benefit reserves reached $25.2 billion at December
31, 2003, an increase of $2.9 billion, or 13%, from $22.3 billion at December
31, 2002, reflecting continued strong retention in all products, a $105 million,
or 21%, increase in total structured settlement premiums and deposits, as well
as continued strong GIC and group payout sales.
Deposits for the life insurance business increased 19% from 2002. This increase
was related to a 42% increase in single premium sales and higher direct periodic
deposits for individual life insurance in 2003, driven by independent agent
high-end estate planning, partially offset by a 42% decrease in COLI sales. Life
insurance in force was $89.5 billion at December 31, 2003 up from $82.3 billion
at December 31, 2002.
During 2003, TLA expenses increased primarily due to higher DAC amortization and
volume-related insurance expenses.
11
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
The amortization of capitalized DAC is a significant component of TLA expenses.
TLA's recording of DAC amortization varies based upon product type. DAC for
deferred annuities, both fixed and variable, and payout annuities employs a
level yield methodology as described in SFAS 91. DAC for universal life (UL) and
COLI is amortized in relation to estimated gross profits as described in SFAS
97, with traditional life, including term insurance and other products amortized
in relation to anticipated premiums as per SFAS 60. The following is a summary
of capitalized DAC by type:
Deferred & Payout Traditional Life
In millions of dollars Annuities UL & COLI & Other Total
- ----------------------------------------------------------------------------------------------------------------
Balance January 1, 2002 $ 1,137 $ 430 $ 106 $ 1,673
Commissions and expenses deferred & other 347 172 26 545
Amortization expense (142) (24) (19) (185)
Underlying lapse and interest rate adjustment 22 -- -- 22
Amortization related to SFAS 91 reassessment (11) -- -- (11)
----------------------------------------------------------
Balance December 31, 2002 1,353 578 113 2,044
Commissions and expenses deferred 340 221 22 583
Amortization expense (212) (33) (21) (266)
----------------------------------------------------------
Balance December 31, 2003 $ 1,481 $ 766 $ 114 $ 2,361
- ---------------------------------------------------------------------------------------------------------------
DAC capitalization increased 5% during 2003, driven by the increase in UL and
COLI, which is consistent with the increase in premiums and deposits for those
lines of business. The increase in amortization expense in 2003 was primarily
attributable to deferred annuities. During the first quarter of 2002, there was
a one-time decrease in deferred annuity DAC amortization of $22 million due to
changes in underlying lapse and interest rate assumptions. In contrast to equity
market performance differences, these adjustments are to be treated
retrospectively as described in SFAS 91 by adjusting the DAC asset through
amortization expense and employing the new assumptions prospectively. In the
fourth quarter of 2002, TLA increased its deferred annuities DAC amortization by
$11 million due to a significant decline in its individual annuity account
balances and benefit reserves, largely resulting from decreases in the stock
market which caused account balances to decline. Under SFAS 91, variances in
expected versus actual market returns are treated prospectively, resulting in a
new amortization pattern over the remaining estimated life of the business. The
2003 UL and COLI amortization also increased 38% over 2002, primarily due to
volume growth.
TLA OUTLOOK
TLA should benefit from growth in the aging population which is becoming more
focused on the need to accumulate adequate savings for retirement, to protect
these savings and to plan for the transfer of wealth to the next generation. TLA
is well positioned to take advantage of the favorable long-term demographic
trends through its strong financial position, widespread brand name recognition
and broad array of competitive life, annuity, retirement and estate planning
products sold through established distribution channels.
However, competition in both product pricing and customer service is
intensifying. There has been consolidation within the industry, and among other
financial services organizations that are increasingly involved in the sale
and/or distribution of insurance products. Also, the annuities business is
interest rate and market sensitive. TLA's business is significantly affected by
movements in the U.S. equity and fixed income credit markets.
12
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
U.S. equity and credit market events can have both positive and negative effects
on the deposit, revenue and policy retention performance of the business. A
sustained weakness in the equity markets will decrease revenues and earnings in
variable annuity products. Declines in credit quality of issuers will have a
negative effect on earnings.
In order to strengthen its competitive position, TLA expects to maintain a
current product portfolio, further diversify its distribution channels, and
retain its financial position through strong sales growth and maintenance of an
efficient cost structure. Federal and state regulators have focused on, and
continue to devote substantial attention to, the mutual fund and variable
insurance product industries. As a result of publicity relating to widespread
perceptions of industry abuses, there have been numerous proposals for
legislative and regulatory reforms, including mutual fund governance, new
disclosure requirements concerning mutual fund share classes, commission
breakpoints, revenue sharing, advisory fees, market timing, late trading,
portfolio pricing, annuity products, hedge funds, and other issues. It is
difficult to predict at this time whether changes resulting from new laws and
regulations will affect the industries or the Company's businesses, and, if so,
to what degree.
The statements above are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act. See "Forward-Looking Statements" on
page 15.
PRIMERICA
FOR THE YEARS ENDED DECEMBER 31, 2003 2002
-------------------------------- ---- ----
($ in millions)
Revenues $1,660 $1,581
Insurance benefits and interest credited 534 527
Operating expenses 455 436
------ ------
Income before taxes 671 618
Income taxes 231 209
------ ------
Net income $ 440 $ 409
====== ======
Net income increased 8% to $440 million from $409 million in 2002. The increase
in net income reflects growth in life insurance in force from $466.8 billion at
December 31, 2002 to $503.6 billion at December 31, 2003 and higher NII from a
larger invested capital base. The increase in expense for DAC is the result of
an increase in life insurance production. Other general expense increased
slightly consistent with the increase in in-force. Mortality experience was
favorable in 2003, compared to 2002, however, there was an increase in incurred
claims. This increase is provided for by growth in the in-force, associated
premium revenues and policyholders reserve balances.
Net income also includes net realized investment gains of $4 million in 2003
compared to net realized investment gains of $2 million in 2002, including the
impairment of the fixed maturities portfolio investment in WorldCom Inc.
totaling $4 million.
The amortization of capitalized DAC is a significant component of Primerica's
expenses. All of Primerica's DAC is associated with traditional life products.
DAC is amortized in relation to anticipated premiums as per SFAS 60. Amortized
DAC has remained level as a percentage of direct premiums. The increase in the
amount of amortization over 2002 is associated with growth in sales and
in-force.
13
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
The following is a summary of capitalized DAC:
In millions of dollars
- ------------------------------------------------------------------
Balance January 1, 2002 $ 1,788
Deferred expenses and other 323
Amortization expense (219)
- ------------------------------------------------------------------
Balance December 31, 2002 1,892
- ------------------------------------------------------------------
Deferred expenses and other 377
Amortization expense (235)
- ------------------------------------------------------------------
Balance December 31, 2003 $ 2,034
- ------------------------------------------------------------------
EARNED PREMIUMS, NET OF REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2003 2002
- ----------------------------------- ---- ----
($ in millions)
Individual term life $1,179 $1,127
Other 66 67
------ ------
$1,245 $1,194
====== ======
The total face amount of term life insurance issued was $82.2 billion in 2003
compared to $79.3 billion in 2002. This increase in term life production
resulted from the increase in licensed life representatives. Life insurance in
force at year-end 2003 reached $503.6 billion, up from $466.8 billion at
year-end 2002, reflecting consistent in-force policy retention and higher volume
of sales.
PRIMERICA OUTLOOK
Over the last few years, programs including sales and product training have been
designed to maintain high compliance standards, increase the number of producing
agents and customer contacts and, ultimately, increase production levels. A
continuation of these trends could positively influence future operations. This
statement is a forward-looking statement within the meaning of the Private
Securities Litigation Reform Act. See "Forward-Looking Statements" on page 15.
14
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
FUTURE APPLICATION OF ACCOUNTING STANDARDS
See Note 1 of Notes to Consolidated Financial Statements for Future Application
of Accounting Standards.
FORWARD-LOOKING STATEMENTS
Certain of the statements contained herein that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act. The Company's actual results may differ materially from
those included in the forward-looking statements. Forward-looking statements are
typically identified by the words "believe," "expect," "anticipate," "intend,"
"estimate," "may increase," "may fluctuate," and similar expressions or future
or conditional verbs such as "will," "should," "would," and "could." These
forward-looking statements involve risks and uncertainties including, but not
limited to, regulatory matters, the resolution of legal proceedings, the impact
that the adoption of recent legislation may have on the demand for life and
annuity products, the potential impact of a decline in credit quality of
investments on earnings; the Company's market risk and the discussions of the
Company's prospects under "Outlook" on the previous pages.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in market rates and
prices, such as interest rates, foreign currency exchange rates, and other
relevant market rate or price changes. Market risk is directly influenced by the
volatility and liquidity in the markets in which the related underlying assets
are traded. The following is a discussion of the Company's primary market risk
exposures and how those exposures are currently managed as of December 31, 2003.
MARKET RISK SENSITIVE INSTRUMENTS ENTERED INTO FOR PURPOSES OTHER THAN TRADING
The primary market risk to the Company's investment portfolio is interest rate
risk associated with investments. The Company's exposure to equity price risk
and foreign exchange risk is not significant. The Company has no direct
commodity risk.
The interest rate risk taken in the investment portfolio is managed relative to
the duration of the liabilities. The portfolio is differentiated by product
line, with each product line's portfolio structured to meet its particular
needs. Potential liquidity needs of the business are also key factors in
managing the investment portfolio. The portfolio duration relative to the
liabilities' duration is primarily managed through cash market transactions. For
additional information regarding the Company's investment portfolio see Note 3
of Notes to Consolidated Financial Statements.
There were no significant changes in the Company's primary market risk exposures
or in how those exposures are managed compared to the year ended December 31,
2002. The Company does not anticipate significant changes in the Company's
primary market risk exposures or in how those exposures are managed in future
reporting periods based upon what is known or expected to be in effect in future
reporting periods. The statements above are forward-looking statements within
the meaning of the Private Securities Litigation Reform Act. See
"Forward-Looking Statements" above.
15
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
SENSITIVITY ANALYSIS
Sensitivity analysis is defined as the measurement of potential loss in future
earnings, fair values or cash flows of market-sensitive instruments resulting
from one or more selected hypothetical changes in interest rates and other
market rates or prices over a selected time. In the Company's sensitivity
analysis model, a hypothetical change in market rates is selected that is
expected to reflect reasonably possible near-term changes in those rates. The
term "near-term" means a period of time going forward up to one year from the
date of the financial statements. Actual results may differ from the
hypothetical change in market rates assumed in this report, especially since
this sensitivity analysis does not reflect the results of any actions that would
be taken by the Company to mitigate such hypothetical losses in fair value.
In this sensitivity analysis model, the Company uses fair values to measure its
potential loss. The sensitivity analysis model includes the following financial
instruments: fixed maturities, interest-bearing non-redeemable preferred stock,
mortgage loans, short-term securities, cash, investment income accrued, policy
loans, contractholder funds, guaranteed separate account assets and liabilities
and derivative financial instruments. In addition, certain non-financial
instrument liabilities have been included in the sensitivity analysis model.
These non-financial instruments include future policy benefits and policy and
contract claims. The primary market risk to the Company's market-sensitive
instruments is interest rate risk. The sensitivity analysis model uses a 100
basis point change in interest rates to measure the hypothetical change in fair
value of financial instruments and the non-financial instruments included in the
model.
For invested assets, duration modeling is used to calculate changes in fair
values. Durations on invested assets are adjusted for call, put and reset
features. Portfolio durations are calculated on a market value weighted basis,
including accrued investment income, using trade date holdings as of December
31, 2003 and 2002. The sensitivity analysis model used by the Company produces a
loss in fair value of interest rate sensitive invested assets of approximately
$2.2 billion and $1.9 billion based on a 100 basis point increase in interest
rates as of December 31, 2003 and 2002, respectively.
Liability durations are determined consistently with the determination of
liability fair values. Where fair values are determined by discounting expected
cash flows, the duration is the percentage change in the fair value for a 100
basis point change in the discount rate. Where liability fair values are set
equal to surrender values, option-adjusted duration techniques are used to
calculate changes in fair values. The sensitivity analysis model used by the
Company produces a decrease in fair value of interest rate sensitive insurance
policy and claims reserves of approximately $1.7 billion and $1.5 billion based
on a 100 basis point increase in interest rates as of December 31, 2003 and
2002, respectively. Based on the sensitivity analysis model used by the Company,
the net loss in fair value of market sensitive instruments, including
non-financial instrument liabilities, as a result of a 100 basis point increase
in interest rates as of December 31, 2003 and 2002 is not material.
MARKET RISK SENSITIVE INSTRUMENTS ENTERED INTO FOR TRADING PURPOSES
The Company maintains a trading portfolio consisting of convertible bonds and
common stocks with carrying values of $1,707 million and $1,531 million as of
December 31, 2003 and 2002, respectively, and $637 million and $598 million of
liabilities resulting from common stocks sold not yet purchased (referred to as
short sales) as of December 31, 2003 and 2002, respectively. The primary market
risk to the trading portfolio is equity risk. Assets are reported as trading
securities and liabilities are reported as trading securities sold not yet
purchased.
16
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
The Company's primary investment strategy is convertible bond arbitrage where
convertible bonds are paired with short sales of the common stocks of companies
issuing the convertible bonds. These positions are established and maintained so
that general changes in equity markets and interest rates should not materially
impact the value of the portfolio.
TABULAR PRESENTATION
The table below provides information about the trading portfolio's financial
instruments that are primarily exposed to equity price risk. This table presents
the fair values of these instruments as of December 31, 2003 and 2002. Fair
values are based upon quoted market prices.
Fair value as of Fair value as of
($ in millions) December 31, 2003 December 31, 2002
- --------------- ----------------- -----------------
ASSETS
Trading securities
Convertible bond arbitrage $ 1,447 $ 1,442
Other 260 89
-------- ---------
$ 1,707 $ 1,531
======== =========
LIABILITIES
Trading securities sold not yet purchased
Convertible bond arbitrage $ 629 $ 520
Other 8 78
-------- --------
$ 637 $ 598
======== ========
The Company's trading portfolio investments and related liabilities are normally
held for periods less than six months. Therefore, expected future cash flows for
these assets and liabilities are expected to be realized in less than one year.
17
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report................................................................................ 19
Consolidated Financial Statements:
Consolidated Statements of Income for
the years ended December 31, 2003, 2002 and 2001........................................................ 20
Consolidated Balance Sheets - December 31, 2003 and 2002................................................ 21
Consolidated Statements of Changes in Shareholder's Equity
for the years ended December 31, 2003, 2002 and 2001.................................................... 22
Consolidated Statements of Cash Flows for
the years ended December 31, 2003, 2002 and 2001........................................................ 23
Notes to Consolidated Financial Statements.............................................................. 24-63
18
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholder
The Travelers Insurance Company:
We have audited the accompanying consolidated balance sheets of The Travelers
Insurance Company and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of income, changes in shareholder's equity, and
cash flows for each of the years in the three-year period ended December 31,
2003. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The Travelers
Insurance Company and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its methods of accounting for variable interest entities in 2003, for
goodwill and intangible assets in 2002, and for derivative instruments and
hedging activities and for securitized financial assets in 2001.
/s/KPMG LLP
Hartford, Connecticut
February 26, 2004
19
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
($ in millions)
FOR THE YEAR ENDED DECEMBER 31, 2003 2002 2001
---- ---- ----
REVENUES
Premiums $ 2,327 $ 1,924 $ 2,102
Net investment income 3,058 2,936 2,831
Realized investment gains (losses) 37 (322) 125
Fee income 606 560 537
Other revenues 111 136 107
- -------------------------------------------------------------------------------------------------------------------
Total Revenues 6,139 5,234 5,702
- -------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES
Current and future insurance benefits 2,102 1,711 1,862
Interest credited to contractholders 1,248 1,220 1,179
Amortization of deferred acquisition costs 501 393 379
General and administrative expenses 459 407 371
- -------------------------------------------------------------------------------------------------------------------
Total Benefits and Expenses 4,310 3,731 3,791
- -------------------------------------------------------------------------------------------------------------------
Income from operations before federal income taxes and cumulative effects of
changes in accounting principles 1,829 1,503 1,911
- -------------------------------------------------------------------------------------------------------------------
Federal income taxes
Current 360 236 471
Deferred 111 185 159
- -------------------------------------------------------------------------------------------------------------------
Total Federal Income Taxes 471 421 630
- -------------------------------------------------------------------------------------------------------------------
Income before cumulative effects of changes in accounting principles 1,358 1,082 1,281
Cumulative effect of change in accounting for derivative instruments and
hedging activities, net of tax -- -- (6)
Cumulative effect of change in accounting for securitized financial assets,
net of tax -- -- (3)
- -------------------------------------------------------------------------------------------------------------------
Net Income $ 1,358 $ 1,082 $ 1,272
===================================================================================================================
See Notes to Consolidated Financial Statements.
20
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in millions)
AT DECEMBER 31, 2003 2002
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed maturities, available for sale at fair value (including $2,170 and $2,687
subject to securities lending agreements) (cost $40,119; $35,428) $42,323 $36,434
Equity securities, at fair value (cost $323; $328) 362 332
Mortgage loans 1,886 1,985
Real estate 96 36
Policy loans 1,135 1,168
Short-term securities 3,603 4,414
Trading securities, at fair value 1,707 1,531
Other invested assets 5,092 4,909
- --------------------------------------------------------------------------------------------------------------------
Total Investments 56,204 50,809
- --------------------------------------------------------------------------------------------------------------------
Cash 149 186
Investment income accrued 567 525
Premium balances receivable 165 151
Reinsurance recoverables 4,470 4,301
Deferred acquisition costs 4,395 3,936
Separate and variable accounts 26,972 21,620
Other assets 2,426 1,467
- --------------------------------------------------------------------------------------------------------------------
Total Assets $95,348 $82,995
- --------------------------------------------------------------------------------------------------------------------
LIABILITIES
Contractholder funds $30,252 $26,634
Future policy benefits and claims 15,964 15,009
Separate and variable accounts 26,972 21,620
Deferred federal income taxes 2,030 1,448
Trading securities sold not yet purchased, at fair value 637 598
Other liabilities 6,136 6,051
- --------------------------------------------------------------------------------------------------------------------
Total Liabilities 81,991 71,360
- --------------------------------------------------------------------------------------------------------------------
SHAREHOLDER'S EQUITY
Common stock, par value $2.50; 40 million shares authorized, issued and outstanding 100 100
Additional paid-in capital 5,446 5,443
Retained earnings 6,451 5,638
Accumulated other changes in equity from nonowner sources 1,360 454
- --------------------------------------------------------------------------------------------------------------------
Total Shareholder's Equity 13,357 11,635
- --------------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholder's Equity $95,348 $82,995
====================================================================================================================
See Notes to Consolidated Financial Statements.
21
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
($ in millions)
FOR THE YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------
2003 2002 2001
- ---------------------------------------------------------------------------------------------------
COMMON STOCK
Balance, beginning of year $ 100 $ 100 $ 100
Changes in common stock -- -- --
- ---------------------------------------------------------------------------------------------------
Balance, end of year $ 100 $ 100 $ 100
- ---------------------------------------------------------------------------------------------------
ADDITIONAL PAID-IN CAPITAL
- ---------------------------------------------------------------------------------------------------
Balance, beginning of year $ 5,443 $ 3,864 $ 3,843
Stock option tax benefit (expense) 3 (17) 21
Capital contributed by parent -- 1,596 --
- ---------------------------------------------------------------------------------------------------
Balance, end of year $ 5,446 $ 5,443 $ 3,864
- ---------------------------------------------------------------------------------------------------
RETAINED EARNINGS
- ---------------------------------------------------------------------------------------------------
Balance, beginning of year $ 5,638 $ 5,142 $ 4,342
Net income 1,358 1,082 1,272
Dividends to parent (545) (586) (472)
- ---------------------------------------------------------------------------------------------------
Balance, end of year $ 6,451 $ 5,638 $ 5,142
- ---------------------------------------------------------------------------------------------------
ACCUMULATED OTHER CHANGES
IN EQUITY FROM NONOWNER SOURCES
- ---------------------------------------------------------------------------------------------------
Balance, beginning of year $ 454 $ 74 $ 104
Cumulative effect of accounting for
derivative instruments and hedging activities, net
of tax -- -- (29)
Unrealized gains, net of tax 818 455 68
Foreign currency translation, net of tax 4 3 (3)
Derivative instrument hedging activity losses, net
of tax 84 (78) (66)
- ---------------------------------------------------------------------------------------------------
Balance, end of year $ 1,360 $ 454 $ 74
- ---------------------------------------------------------------------------------------------------
SUMMARY OF CHANGES IN EQUITY
FROM NONOWNER SOURCES
- ---------------------------------------------------------------------------------------------------
Net income $ 1,358 $ 1,082 $ 1,272
Other changes in equity from nonowner sources 906 380 (30)
- ---------------------------------------------------------------------------------------------------
Total changes in equity from nonowner sources $ 2,264 $ 1,462 $ 1,242
- ---------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDER'S EQUITY
- ---------------------------------------------------------------------------------------------------
Changes in total shareholder's equity $ 1,722 $ 2,455 $ 791
Balance, beginning of year 11,635 9,180 8,389
- ---------------------------------------------------------------------------------------------------
Balance, end of year $ 13,357 $ 11,635 $ 9,180
- ---------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
22
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH
($ in millions)
FOR THE YEAR ENDED DECEMBER 31, 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Premiums collected $ 2,335 $ 1,917 $ 2,109
Net investment income received 2,787 2,741 2,430
Other revenues received 335 384 867
Benefits and claims paid (1,270) (1,218) (1,176)
Interest paid to contractholders (1,226) (1,220) (1,159)
Operating expenses paid (1,375) (1,310) (1,000)
Income taxes paid (456) (197) (472)
Trading account investments (purchases), sales, net (232) 76 (92)
Other (84) (105) (227)
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 814 1,068 1,280
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of investments
Fixed maturities 7,446 4,459 3,706
Mortgage loans 358 374 455
Proceeds from sales of investments
Fixed maturities 15,078 15,472 14,110
Equity securities 124 212 112
Real estate held for sale 5 26 6
Purchases of investments
Fixed maturities (26,766) (23,623) (22,556)
Equity securities (144) (134) (50)
Mortgage loans (317) (355) (287)
Policy loans, net 34 39 41
Short-term securities purchases, net 814 (1,320) (914)
Other investments (purchases), sales, net 108 (69) 103
Securities transactions in course of settlement, net (618) 529 1,086
- ---------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (3,878) (4,390) (4,188)
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Contractholder fund deposits 8,326 8,505 8,308
Contractholder fund withdrawals (4,754) (4,729) (4,932)
Capital contribution by parent -- 172 --
Dividends to parent company (545) (586) (472)
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 3,027 3,362 2,904
- ---------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (37) 40 (4)
Cash at December 31, previous year 186 146 150
- ---------------------------------------------------------------------------------------------------------
Cash at December 31, current year $ 149 $ 186 $ 146
=========================================================================================================
See Notes to Consolidated Financial Statements.
23
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies used in the preparation of the accompanying
financial statements follow.
BASIS OF PRESENTATION
The Travelers Insurance Company (TIC, together with its subsidiaries, the
Company), is a wholly owned subsidiary of Citigroup Insurance Holding
Corporation (CIHC), an indirect wholly owned subsidiary of Citigroup Inc.
(Citigroup), a diversified global financial services holding company whose
businesses provide a broad range of financial services to consumer and corporate
customers around the world. The consolidated financial statements include the
accounts of the Company and its insurance and non-insurance subsidiaries on a
fully consolidated basis. The primary insurance entities of the Company are TIC
and its subsidiaries, The Travelers Life and Annuity Company (TLAC), Primerica
Life Insurance Company (Primerica Life), and its subsidiaries, Primerica Life
Insurance Company of Canada, CitiLife Financial Limited (CitiLife) and National
Benefit Life Insurance Company (NBL). Significant intercompany transactions and
balances have been eliminated. The Company consolidates entities deemed to be
variable interest entities when the Company is determined to be the primary
beneficiary under Financial Accounting Standards Board (FASB) Interpretation No.
46, "Consolidation of Variable Interest Entities" (FIN 46).
At December 31, 2001, the Company was a wholly owned subsidiary of The Travelers
Insurance Group, Inc. (TIGI). On February 4, 2002, TIGI changed its name to
Travelers Property Casualty Corp. (TPC). TPC completed its initial public
offering (IPO) on March 27, 2002 and on August 20, 2002 Citigroup made a
tax-free distribution of the majority of its remaining interest in TPC, to
Citigroup's stockholders. Prior to the IPO, the common stock of TIC was
distributed by TPC to CIHC so that TIC would remain an indirect wholly owned
subsidiary of Citigroup. See Note 14.
The financial statements and accompanying footnotes of the Company are prepared
in conformity with accounting principles generally accepted in the United States
of America (GAAP). The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and benefits and expenses during the reporting period. Actual
results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to the 2003
presentation.
ACCOUNTING CHANGES
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the FASB released FIN 46, which changes the method of
determining whether certain entities, including securitization entities, should
be included in the Company's consolidated financial statements. An entity is
subject to FIN 46 and is called a variable interest entity (VIE) if it has (1)
equity that is insufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, or (2)
equity investors that cannot make significant decisions about the entity's
operations, or that do not absorb the expected losses or receive the expected
returns of the entity. All other entities are evaluated for consolidation under
Statement of Financial Accounting Standards (SFAS) No. 94, "Consolidation of All
Majority-Owned Subsidiaries" (SFAS 94). A VIE is consolidated by its primary
beneficiary, which is the party involved with the VIE that has a majority of the
expected losses or a majority of the expected residual returns or both.
24
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
For any VIEs that must be consolidated under FIN 46 that were created before
February 1, 2003, the assets, liabilities and noncontrolling interest of the VIE
are initially measured at their carrying amounts with any difference between the
net amount added to the balance sheet and any previously recognized interest
being recognized as the cumulative effect of an accounting change. If
determining the carrying amounts is not practicable, fair value at the date FIN
46 first applies may be used to measure the assets, liabilities and
noncontrolling interest of the VIE. In October 2003, the FASB announced that the
effective date of FIN 46 was deferred from July 1, 2003 to periods ending after
December 15, 2003 for VIEs created prior to February 1, 2003. TIC elected to
implement the provisions of FIN 46 in the 2003 third quarter, resulting in the
consolidation of VIEs, increasing both assets and liabilities by approximately
$407 million.
The implementation of FIN 46 encompassed a review of numerous entities to
determine the impact of adoption and considerable judgment was used in
evaluating whether or not a VIE should be consolidated. The FASB continues to
provide additional guidance on implementing FIN 46 through FASB Staff Positions.
In December 2003, the FASB released a revision of FIN 46 (FIN 46-R or the
interpretation), which includes substantial changes from the original. The
calculation of expected losses and expected residual returns have both been
altered to reduce the impact of decision maker and guarantor fees in the
calculation of expected residual returns and expected losses. In addition, FIN
46-R changes the definition of a variable interest. The interpretation permits
adoption of either the original or the revised versions of FIN 46 until the
first quarter of 2004, at which time FIN 46-R must be adopted. For 2003
year-end, the Company's consolidated financial statements are in accordance with
the original.
The Company is evaluating the impact of applying FIN 46-R to existing VIEs in
which it has variable interests and has not yet completed this analysis. At this
time, it is anticipated that the effect of adopting FIN 46-R on the Company's
consolidated balance sheet would be immaterial. As the Company continues to
evaluate the impact of applying FIN 46-R, additional entities may be identified
that would need to be consolidated. See Note 3.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" (SFAS 149). SFAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." In
particular, this Statement clarifies under what circumstances a contract with an
initial net investment meets the characteristic of a derivative and when a
derivative contains a financing component that warrants special reporting in the
statement of cash flows. This Statement is generally effective for contracts
entered into or modified after June 30, 2003 and did not have a significant
impact on the Company's consolidated financial statements.
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
On January 1, 2003, the Company adopted SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS 146). SFAS 146 requires that
a liability for costs associated with exit or disposal activities, other than in
a business combination, be recognized when the liability is incurred. Previous
generally accepted accounting principles provided for the recognition of such
costs at the date of management's commitment to an exit plan. In addition, SFAS
146 requires that the liability be measured at fair value and be adjusted for
changes in estimated cash flows. The provisions of the new standard are
effective for exit or disposal activities initiated after December 31, 2002. The
adoption of SFAS 146 did not affect the Company's consolidated financial
statements.
25
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
STOCK-BASED COMPENSATION
The Company and its employees participate in stock option plans of Citigroup. On
January 1, 2003, the Company adopted the fair value recognition provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS 123),
prospectively for all awards granted, modified, or settled after January 1,
2003. The prospective method is one of the adoption methods provided for under
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," issued in December 2002. SFAS 123 requires that compensation cost
for all stock awards be calculated and recognized over the service period
(generally equal to the vesting period). This compensation cost is determined
using option pricing models, intended to estimate the fair value of the awards
at the grant date. Prior to January 1, 2003, the Company applied Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25), and related interpretations in accounting for its stock-based compensation
plans. Under APB 25, there is generally no charge to earnings for employee stock
option awards because the options granted under these plans have an exercise
price equal to the market value of the underlying common stock on the grant
date. Similar to APB 25, an offsetting increase to shareholder's equity under
SFAS 123 is recorded equal to the amount of compensation expense charged.
Had the Company applied SFAS 123 prior to 2003 in accounting for Citigroup stock
options, net income would have been the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31,
($ in millions) 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------
Compensation expense related to stock option As reported $ 2 $ - $ -
plans, net of tax Pro forma 7 9 15
- ---------------------------------------------------------------------------------------------------------
Net income As reported $1,358 $1,082 $1,272
Pro forma 1,353 1,073 1,257
- ---------------------------------------------------------------------------------------------------------
BUSINESS COMBINATIONS, GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted the FASB SFAS No. 141, "Business
Combinations" (SFAS 141) and No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142). These standards change the accounting for business combinations by,
among other things, prohibiting the prospective use of pooling-of-interests
accounting and requiring companies to stop amortizing goodwill and certain
intangible assets with an indefinite useful life created by business
combinations accounted for using the purchase method of accounting. Instead,
goodwill and intangible assets deemed to have an indefinite useful life will be
subject to an annual review for impairment. Other intangible assets that are not
deemed to have an indefinite useful life will continue to be amortized over
their useful lives. See Note 5.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or
26
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
liabilities in the consolidated balance sheet and measure those instruments at
fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a recognized asset or liability or of a
forecasted transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated forecasted
transaction. The accounting for changes in the fair value of a derivative (that
is, gains and losses) depends on the intended use of the derivative and the
resulting designation. The cumulative effect of the adoption of SFAS 133 was an
after-tax charge of $6 million included in net income and an after-tax charge of
$29 million to accumulated other changes in equity from nonowner sources.
RECOGNITION OF INTEREST INCOME AND IMPAIRMENT ON PURCHASED AND RETAINED
BENEFICIAL INTERESTS IN SECURITIZED FINANCIAL ASSETS
In April 2001, the Company adopted the FASB Emerging Issues Task Force (EITF)
99-20, "Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets" (EITF 99-20). EITF 99-20
establishes guidance on the recognition and measurement of interest income and
impairment on certain investments, e.g., certain asset-backed securities. The
recognition of impairment resulting from the adoption of EITF 99-20 was recorded
as a cumulative catch-up adjustment. Interest income on a beneficial interest
falling within the scope of EITF 99-20 is to be recognized prospectively. As a
result of adopting EITF 99-20, the Company recorded an after-tax charge of $3
million in the consolidated statement of income. The implementation of this EITF
did not have a significant impact on the Company's consolidated financial
statements.
FUTURE APPLICATION OF ACCOUNTING STANDARDS
ACCOUNTING AND REPORTING BY INSURANCE ENTERPRISES FOR CERTAIN NONTRADITIONAL
LONG-DURATION CONTRACTS AND FOR SEPARATE ACCOUNTS
In July 2003, Statement of Position 03-01 "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts" (SOP 03-01) was released. SOP 03-01 provides guidance on accounting
and reporting by insurance enterprises for separate account presentation,
accounting for an insurer's interest in a separate account, transfers to a
separate account, valuation of certain liabilities, contracts with death or
other benefit features, contracts that provide annuitization benefits, and sales
inducements to contract holders. SOP 03-01 is effective for financial statements
for fiscal years beginning after December 15, 2003. The adoption of SOP 03-01
will not have a material impact on the Company's consolidated financial
statements.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In December 2003, the FASB released a revision of FIN 46 (FIN 46-R). See
"Consolidation of Variable Interest Entities" in the "Accounting Changes"
section of this Note for a discussion of FIN 46-R.
27
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
ACCOUNTING POLICIES
INVESTMENTS
Fixed maturities include bonds, notes and redeemable preferred stocks. Fixed
maturities, including instruments subject to securities lending agreements (see
Note 3), are classified as "available for sale" and are reported at fair value,
with unrealized investment gains and losses, net of income taxes, credited or
charged directly to shareholder's equity. Fair values of investments in fixed
maturities are based on quoted market prices or dealer quotes. If quoted market
prices are not available, discounted expected cash flows using market rates
commensurate with the credit quality and maturity of the investment are used to
determine fair value. Changes in assumptions could affect the fair values of
fixed maturities. Impairments are realized when investment losses in value are
deemed other-than-temporary. The Company conducts a rigorous review each quarter
to identify and evaluate investments that have possible indications of
impairment. An investment in a debt or equity security is impaired if its fair
value falls below its cost and the decline is considered other-than-temporary.
Factors considered in determining whether a loss is temporary include the length
of time and extent to which fair value has been below cost; the financial
condition and near-term prospects of the issuer; and the Company's ability and
intent to hold the investment for a period of time sufficient to allow for any
anticipated recovery. Changing economic conditions - global, regional, or
related to specific issuers or industries - could result in other-than-temporary
losses.
Also included in fixed maturities are loan-backed and structured securities
(including beneficial interests in securitized financial assets). Beneficial
interests in securitized financial assets that are rated "A" and below are
accounted for under the prospective method in accordance with EITF 99-20. Under
the prospective method of accounting, the investments effective yield and
impairment for other-than-temporary losses in value are based upon projected
future cash flows. All other loan-backed and structured securities are amortized
using the retrospective method. The effective yield used to determine
amortization is calculated based upon actual historical and projected future
cash flows.
Equity securities, which include common and non-redeemable preferred stocks, are
classified as "available for sale" and carried at fair value based primarily on
quoted market prices. Changes in fair values of equity securities are charged or
credited directly to shareholder's equity, net of income taxes.
Mortgage loans are carried at amortized cost. A mortgage loan is considered
impaired when it is probable that the Company will be unable to collect
principal and interest amounts due. For mortgage loans that are determined to be
impaired, a reserve is established for the difference between the amortized cost
and fair market value of the underlying collateral. In estimating fair value,
the Company uses interest rates reflecting the higher returns required in the
current real estate financing market.
Real estate held for sale is carried at the lower of cost or fair value less
estimated cost to sell. Fair value of foreclosed properties is established at
the time of foreclosure by internal analysis or external appraisers, using
discounted cash flow analyses and other accepted techniques. Thereafter, an
impairment for losses on real estate held for sale is established if the
carrying value of the property exceeds its current fair value less estimated
costs to sell. These impairments were insignificant at December 31, 2003 and
2002.
Policy loans are carried at the amount of the unpaid balances that are not in
excess of the net cash surrender values of the related insurance policies. The
carrying value of policy loans, which have no defined maturities, is considered
to be fair value.
28
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Short-term securities, consisting primarily of money market instruments and
other debt issues purchased with a maturity of less than one year, are carried
at amortized cost, which approximates fair value.
Trading securities and related liabilities are normally held for periods less
than six months. These investments are marked to market with the change
recognized in net investment income during the current period.
Other invested assets include equity investments, partnership investments and
real estate joint ventures accounted for on the equity method of accounting.
Undistributed income is reported in net investment income. Also included in
other invested assets is an investment in Citigroup Preferred Stock, which is
recorded at cost. See Note 13.
Accrual of investment income is suspended on fixed maturities or mortgage loans
that are in default, or on which it is likely that future payments will not be
made as scheduled. Interest income on investments in default is recognized only
as payment is received.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses derivative financial instruments, including financial futures
contracts, swaps, options and forward contracts, as a means of hedging exposure
to interest rate changes, equity price change, credit and foreign currency risk.
The Company also uses derivative financial instruments to enhance portfolio
income and replicate cash market investments. The Company, through Tribeca
Citigroup Investments Ltd., holds and issues derivative instruments in
conjunction with these investment strategies. (See Note 11 for a more detailed
description of the Company's derivative use.) Derivative financial instruments
in a gain position are reported in the consolidated balance sheet in other
assets, derivative financial instruments in a loss position are reported in the
consolidated balance sheet in other liabilities and derivatives purchased to
offset embedded derivatives on variable annuity contracts are reported in other
invested assets.
To qualify for hedge accounting, the hedge relationship is designated and
formally documented at inception detailing the particular risk management
objective and strategy for the hedge which includes the item and risk that is
being hedged, the derivative that is being used, as well as how effectiveness is
being assessed.
A derivative has to be highly effective in accomplishing the objective of
offsetting either changes in fair value or cash flows for the risk being hedged.
For fair value hedges, in which derivatives hedge the fair value of assets and
liabilities, changes in the fair value of derivatives are reflected in realized
investment gains and losses, together with changes in the fair value of the
related hedged item. The Company primarily hedges available-for-sale securities.
For cash flow hedges, the accounting treatment depends on the effectiveness of
the hedge. To the extent that derivatives are effective in offsetting the
variability of the hedged cash flows, changes in the derivatives' fair value
will not be included in current earnings but are reported in the accumulated
other changes in equity from nonowner sources in shareholder's equity. These
changes in fair value will be included in earnings of future periods when
earnings are also affected by the variability of the hedged cash flows. To the
extent these derivatives are not effective, the ineffective portion of the
change in fair value is immediately included in realized investment gains and
losses. The Company primarily hedges foreign-denominated funding agreements and
floating rate available-for-sale securities.
29
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
For net investment hedges, in which derivatives hedge the foreign currency
exposure of a net investment in a foreign operation, the accounting treatment
will similarly depend on the effectiveness of the hedge. The effective portion
of the change in fair value of the derivative, including any premium or
discount, is reflected in the accumulated other changes in equity from nonowner
sources as part of the foreign currency translation adjustment in shareholder's
equity. The ineffective portion is reflected in realized investment gains and
losses.
The effectiveness of these hedging relationships is evaluated on a retrospective
and prospective basis using quantitative measures of correlation. If a hedge
relationship is found to be ineffective, it no longer qualifies as a hedge and
any gains or losses attributable to such ineffectiveness as well as subsequent
changes in fair value are recognized in realized investment gains and losses.
For those fair value and cash flow hedge relationships that are terminated,
hedge designations removed, or forecasted transactions that are no longer
expected to occur, the hedge accounting treatment described in the paragraphs
above will no longer apply. For fair value hedges, any changes to the hedged
item remain as part of the basis of the asset or liability and are ultimately
reflected as an element of the yield. For cash flow hedges, any changes in fair
value of the end-user derivative remain in the accumulated other changes in
equity from nonowner sources in shareholder's equity and are included in
earnings of future periods when earnings are also affected by the variability of
the hedged cash flow. If the hedged relationship is discontinued because a
forecasted transaction will not occur when scheduled, the accumulated changes in
fair value of the end-user derivative recorded in shareholder's equity are
immediately reflected in realized investment gains and losses.
The Company enters into derivative contracts that are economic hedges but do not
qualify or are not designated as hedges for accounting purposes. These
derivative contracts are carried at fair value, with changes in value reflected
in realized investment gains and losses.
Financial instruments with embedded derivatives
The Company bifurcates an embedded derivative where the economic characteristics
and risks of the embedded instrument are not clearly and closely related to the
economic characteristics and risks of the host contract, the entire instrument
would not otherwise be remeasured at fair value and a separate instrument with
the same terms of the embedded instrument would meet the definition of a
derivative under SFAS 133.
The Company purchases investments that have embedded derivatives, primarily
convertible debt securities. These embedded derivatives are carried at fair
value with changes in value reflected in realized investment gains and losses.
Derivatives embedded in convertible debt securities are classified in the
consolidated balance sheet as fixed maturity securities, consistent with the
host instruments.
The Company markets certain investment contracts that have embedded derivatives,
primarily variable annuity contracts with put options. These embedded
derivatives are carried at fair value, with changes in value reflected in
realized investment gains and losses. Derivatives embedded in variable annuity
contracts are classified in the consolidated balance sheet as future policy
benefits and claims.
INVESTMENT GAINS AND LOSSES
Realized investment gains and losses are included as a component of pre-tax
revenues based upon specific identification of the investments sold on the trade
date. Impairments are realized when investment losses in
30
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
value are deemed other-than-temporary. The Company conducts regular reviews to
assess whether other- than-temporary losses exist. Changing economic conditions
- - global, regional, or related to specific issuers or industries - could result
in other-than-temporary losses. Also included in pre-tax revenues are gains and
losses arising from the remeasurement of the local currency value of foreign
investments to U.S. dollars, the functional currency of the Company. The foreign
exchange effects of Canadian operations are included in unrealized gains and
losses.
DEFERRED ACQUISITION COSTS
Costs of acquiring traditional life and health insurance, universal life,
corporate owned life insurance (COLI), deferred annuities and payout annuities
are deferred. These deferred acquisition costs (DAC) include principally
commissions and certain expenses related to policy issuance, underwriting and
marketing, all of which vary with and are primarily related to the production of
new business. The method for determining amortization of deferred acquisition
costs varies by product type based upon three different accounting
pronouncements: SFAS No. 60, "Accounting and Reporting by Insurance Enterprises"
(SFAS 60), SFAS No. 91, "Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases" (SFAS
91) and SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for
Certain Long Duration Contracts and for Realized Gains and Losses from the Sale
of Investments" (SFAS 97).
DAC for deferred annuities, both fixed and variable, and payout annuities is
amortized employing a level effective yield methodology per SFAS 91 as indicated
by AICPA Practice Bulletin 8. An amortization rate is developed using the
outstanding DAC balance and projected account balances and is applied to actual
account balances to determine the amount of DAC amortization. The projected
account balances are derived using a model that contains assumptions related to
investment returns and persistency. The model rate is evaluated at least
annually, and changes in underlying lapse and interest rate assumptions are to
be treated retrospectively. Variances in expected equity market returns versus
actual returns are treated prospectively and a new amortization pattern is
developed so that the DAC balances will be amortized over the remaining
estimated life of the business. DAC for these products is currently being
amortized over 10-15 years.
DAC for universal life and COLI is amortized in relation to estimated gross
profits from surrender charges, investment, mortality, and expense margins per
SFAS 97. Actual profits can vary from management's estimates, resulting in
increases or decreases in the rate of amortization. Re-estimates of gross
profits, performed at least annually, result in retrospective adjustments to
earnings by a cumulative charge or credit to income. DAC for these products is
currently being amortized over 16-25 years.
DAC relating to traditional life, including term insurance, and health insurance
is amortized in relation to anticipated premiums per SFAS 60. Assumptions as to
the anticipated premiums are made at the date of policy issuance or acquisition
and are consistently applied over the life of the policy. DAC for these products
is currently being amortized over 5-20 years.
All DAC is reviewed at least annually to determine if it is recoverable from
future income, including investment income, and if not recoverable, is charged
to expenses. All other acquisition expenses are charged to operations as
incurred. See Note 5.
31
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
VALUE OF INSURANCE IN FORCE
The value of insu