Revenues by Segment*
| 2005 | 2004 | 2003 | ||||||||||
| (In Millions) | ||||||||||||
Individual Products |
$ | 1,821 | $ | 1,780 | $ | 1,774 | ||||||
Annuity and Investment Products |
732 | 718 | 694 | |||||||||
Benefit Partners |
1,279 | 1,202 | 820 | |||||||||
Communications |
247 | 239 | 214 | |||||||||
Corporate and Other |
141 | 163 | 71 | |||||||||
| $ | 4,220 | $ | 4,102 | $ | 3,573 | |||||||
* Revenues include net investment income earned on assets backing insurance liabilities and line surplus for each reportable segment. Corporate and Other revenues include $11, $41 and ($47) of realized gains (losses) for 2005, 2004 and 2003.
The following briefly describes our principal wholly-owned subsidiaries, including their principal products and services, markets and methods of distribution.
INSURANCE COMPANY SUBSIDIARIES
JP Life is domiciled in North Carolina and began business in 1903. It is authorized to write insurance in 49 states, the District of Columbia, Guam, the Virgin Islands and Puerto Rico. It primarily writes universal life insurance policies on an individual basis, and individual non-variable annuities including equity indexed annuities.
JPFIC has been domiciled in Nebraska since its redomestication from New Hampshire in August 2000. It began business in 1903 through predecessor companies, and is authorized to write insurance in 49 states, the District of Columbia, Guam, the Virgin Islands and Puerto Rico. It principally writes universal life, variable universal life and term insurance policies. JPFIC also writes substantially all our group term life, disability income and dental insurance.
JPLA, domiciled in New Jersey, began business in 1897. It is authorized to write insurance in 50 states, the District of Columbia and several U.S. possessions/territories. JPLA is “commercially domiciled” in New York due to the large percentage of its business in that state. It primarily writes universal life, variable universal life and term insurance policies, and non-variable annuities.
The former AH Life block of universal life insurance policies and variable and non-variable annuities is now part of JPFIC.
The former FAHL block of non-variable annuities and universal life insurance policies is now part of JPLA.
Individual Products. Our insurance subsidiaries offer individual life insurance policies, primarily universal life and variable universal life policies, as well as traditional life products and level and decreasing term policies. On most policies, accidental death and disability benefits are available in the form of riders, as are other benefits. We accept certain substandard risks at higher premiums.
Our companies market individual life products through independent general agents, independent national marketing organizations, agency building general agents, our district agency network, broker/dealers, banks and strategic alliances.
Annuity and Investment Products. Our insurance subsidiaries offer annuity and investment products. They market through most of the distribution channels discussed above and through investment professionals and annuity marketing organizations. Our broker/dealers market variable life insurance written by our insurance subsidiaries, and also sell other securities and mutual funds.
Benefit Partners. JPFIC offers group term life, disability income and dental insurance, which are sold through regional group offices throughout the U.S., marketing to employee benefit brokers, third-party administrators and employee benefit firms.
Other Information Regarding Insurance Company Subsidiaries
Regulation. Insurance companies are subject to regulation and supervision in all the states where they do business. Generally the state supervisory agencies have broad administrative powers relating to granting and revoking licenses to transact business, licensing agents, approving policy forms used, regulating trade practices and market conduct, the form and content of required financial statements, reserve requirements, permitted investments, approval of dividends and, in general, the conduct of all insurance activities.
Insurance companies also must file detailed annual reports on a statutory accounting basis with the state supervisory agencies where each company does business. See Note 11 regarding statutory accounting principles, including differences from General Accepted Accounting Principles. These agencies may examine the business and accounts at any time. Under the rules of the National
Association of Insurance Commissioners (NAIC) and state laws, the supervisory agencies of one or more states examine a company periodically, usually at three to five year intervals.
Various states, including Nebraska, New Jersey, New York and North Carolina, have enacted insurance holding company legislation. Our insurance subsidiaries have registered as members of an “insurance holding company system” under applicable laws. Most states require prior approval by state insurance regulators of transactions with affiliates, including dividends by insurance subsidiaries above specified limits, and of acquisitions of insurance companies.
Risk-based capital requirements and state guaranty fund laws are discussed in MD&A.
Competition. Our insurance subsidiaries operate in a highly competitive field that consists of a large number of stock, mutual and other types of insurers. Consolidation among producers and increasingly larger marketing organizations has heightened competition among insurance manufacturers who compete to distribute their products through these channels.
Certain insurance and annuity products also compete with other investment vehicles. Marketing of annuities and other competing products by banks and other financial institutions has increased. Our broker/dealers also operate in a highly competitive environment. Existing tax laws affect the taxation of life insurance and many competing products. Various changes and proposals for changes have been made in income and estate tax laws, some of which could adversely affect the taxation of certain products or their use as retirement or estate planning vehicles, or create new tax favored competing products, and thus impact our marketing and the volume of our policies surrendered.
Employees. As of December 31, 2005, our insurance operations including our broker/dealer employed approximately 3,100 persons and contracted with another approximately 682 agency building general agents (career agents) and home service agents who are statutory employees for FICA purposes. Substantially all of these employees are payrolled with JP Life and costs are allocated to affiliates under various service agreements that have been approved by state insurance regulators.
COMMUNICATIONS
JPCC owns and operates three television stations and operates 18 radio stations as well as Jefferson-Pilot Sports, a sports production and syndication business.
Television Operations
WBTV, Channel 3, Charlotte, NC, is affiliated with CBS under a Network Affiliation Agreement expiring on May 31, 2011. WWBT, Channel 12, Richmond, VA, is affiliated with NBC under a Network Affiliation Agreement expiring December 31, 2011. WCSC, Channel 5, Charleston, SC, is affiliated with CBS under a Network Affiliation Agreement expiring on May 31, 2011. Absent cancellation by either party, each of these Agreements will be renewed for successive five-year periods.
Radio Operations
JPCC owns and operates one AM and one FM station in Atlanta, GA, one AM and two FM stations in Charlotte, NC, two AM and three FM stations in Denver, CO and one AM and two FM stations in Miami, FL. In San Diego, CA, JPCC owns and operates four FM stations and owns one AM station now operated by a third party under a local marketing agreement (LMA). The third party operator of the San Diego AM station has declared its intention to exercise a purchase option on that station during 2006.
JP Sports
JP Sports’ principal business is to produce and syndicate broadcasts of Atlantic Coast Conference and Southeastern Conference football and basketball events. The contracts with the leagues were renewed in 2001 and extend through the 2010 seasons for the Atlantic Coast Conference and the 2009 seasons for the Southeastern Conference. Raycom Sports is an equal partner in the contract for Atlantic Coast Conference football and basketball.
Other Information Regarding Communications Companies
Competition. Our radio and television stations compete for programming, talent and revenues with other radio and television stations as well as with other advertising and entertainment media, including direct distribution cable and satellite television and direct transmission radio. JP Sports competes with other vendors of similar products and services.
Employees. As of December 31, 2005, JPCC employed approximately 750 persons full time.
Federal Regulation. Television and radio broadcasting operations are subject to the jurisdiction of the Federal Communications Commission (“FCC”) under the Communications Act of 1934, as amended (the “Act”). The Act empowers the FCC to issue, renew, revoke or modify broadcasting licenses, assign frequencies, determine the locations of stations, regulate the equipment used by stations, establish areas to be served, adopt necessary regulations, and impose certain penalties for violation of the regulations. The Act and present regulations prohibit the transfer of a license or of control of a licensee without prior approval of the FCC; restrict in various ways the common and multiple ownership of broadcast facilities; restrict alien ownership of licenses; and impose various other strictures on ownership and operation.
Broadcasting licenses are granted for a period of eight years for both television and radio and, in the absence of adverse claims as to the licensee’s qualifications or performance, will normally be renewed by the FCC for an additional term.
(d) Financial Information About Geographic Areas
All our operations are conducted within the United States. We occasionally make fixed income investments outside the U.S. for our investment portfolio.
(e) Available Information
JP makes available free of charge on or through our Internet website (http://www.jpfinancial.com) JP’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after JP electronically files this material with, or furnishes it to, the SEC. The public may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE. Washington, DC 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site (http:// www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
Item 1A. Risk Factors
JP’s management has established policies and procedures designed to identify and address the material risks that are inherent to our business. These fall into two broad categories: internal risks that can be directly controlled by management and external risks that are subject to factors outside the Company. Those controllable by management include, but are not limited to, selection and
monitoring of third parties we deal with in investment, credit and reinsurance related transactions; product and marketing initiatives; investment policies; financial policies affecting liquidity, agency issued ratings and concentration of sales; and utilization of human and technological capital in the financial reporting process as well as the organization as a whole. External risks may arise from macro-economic events in the U.S. and world markets, taxation, legislative matters and factors inherent to the insurance and communications industries.
Our management and board of directors have implemented corporate governance policies and practices to help mitigate risk. Our Corporate Governance Principles, Committee Charters, Code of Ethics for Directors, Code of Ethics for Financial Officers, and Business Conduct Guidebook are accessible on our web site, www.jpfinancial.com, through the Investors, Corporate Governance link.
Although we have devoted significant resources to develop our risk management policies and procedures, we may be exposed to unidentified or unanticipated risks, which could negatively affect our financial position and earnings. Many of our methods for managing risk and exposures are based upon our use of observed historical market behavior or statistics based on historical models. As a result, these methods may not predict future exposures that could be significantly greater than the historical measures indicate. Other risk management methods depend upon the evaluation of information regarding markets, clients, catastrophe occurrence or other matters that are publicly available or otherwise accessible to us, which may not always be accurate, complete, up-to-date or properly evaluated. Management of operational, legal and regulatory risks requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective.
We are subject to operational risks that could lead to adverse effects on our operations and operating results
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people or systems. We have an operational risk management system with policies and procedures designed to help limit our operational risks. These policies and control processes comply with the Sarbanes-Oxley Act, the Gramm-Leach-Bliley Act, the Health Insurance Portability and Accountability Act (HIPAA) and other regulatory guidance. In addition, we compete to attract and retain quality employees, as well as distributors of our products. We compete with other financial institutions primarily on the basis of our products, compensation, support services and financial position. Product sales and our financial position and earnings could be materially adversely affected if we are unsuccessful in attracting quality employees and distributors.
Managing merger integration risk is a key component of our operational risk. Lincoln and JP entered into the merger agreement expecting that the merger would result in various benefits. Achieving the anticipated benefits of the merger is subject to a number of uncertainties, including whether Lincoln and JP are integrated in an efficient and effective manner, and general competitive factors in the marketplace. Failure to achieve these anticipated benefits could result in increased costs, decreases in the amount of expected revenues and diversion of management’s time and energy, and could materially impact the resulting company’s business, financial condition and operating results.
The resulting company may experience material unanticipated difficulties or expenses in connection with integrating JP and Lincoln, especially given the relatively large size of the merger. Integration will be a complex, time-consuming and expensive process. Before the merger, Lincoln and JP operated independently, each with its own business, products, customers, employees, culture and systems. The resulting company may face substantial difficulties, costs and delays in integration. These factors may include:
• perceived adverse changes in product offerings available to clients or client service standards, whether or not these changes do, in fact, occur;
• conditions imposed by regulators in connection with decisions whether to approve the merger;
• potential charges to earnings resulting from the application of purchase accounting to the transactions;
• the retention of existing clients, key portfolio managers, sales representatives and wholesalers of each company; and
• retaining and integrating management and other key employees of the resulting company.
After the merger, we may seek to combine certain operations and functions using common information and communication systems, operating procedures, financial controls and human resource practices, including training, professional development and benefit programs. We may be unsuccessful or delayed in implementing the integration of these systems and processes.
Any one or all of these factors may cause increased operating costs, worse than anticipated financial performance or the loss of clients, employees and agents. Many of these factors are outside the control of either company.
The merger is also subject to provisions and approvals that could delay, deter or prevent a change in control. These provisions and approvals include: anti-takeover provisions of Indiana law, the approval of shareholders of both companies, governmental and regulatory approvals, and satisfaction of customary closing conditions.
Changes in economic conditions could adversely affect our results or financial position
The Company’s performance is impacted by U.S. economic conditions, which include the level of interest rates, price compression, competition, bankruptcy filings and unemployment rates, as well as political policies, regulatory guidelines and general developments. For example, our investment returns, and thus our profitability, may be adversely affected from time to time by conditions affecting our investments in equity and debt instruments and real estate, and by low interest rates. General economic, market, and political conditions in the U.S. and abroad may also affect our profitability. Our general account investment portfolios include investments, primarily comprised of fixed maturity securities, purchased from issuers in stressed or economically sensitive industries. The financial strength of these issuers may depend on the strength of the economic cycle.
Changes in interest rates or market prices of assets and liabilities could adversely affect our results
Market risk is the risk of loss from adverse changes in market prices of assets and liabilities (including derivative financial instruments) as a result of changes in interest rates, equity markets or other factors. The Company’s market risk arises principally from interest rate risk inherent in our interest sensitive life insurance and annuity products and in our investment portfolio. Interest rate risk is the risk of decline in earnings or equity represented by the impact of changes in market interest rates. See the Market Risk Exposures section in Item 7 Management’s Discussion and Analysis.
Changes in interest rates may reduce both our profitability from spread businesses and our return on invested capital. Our interest sensitive products expose us to the risk that changes in interest rates will reduce our “spread,” or the difference between the amounts that we are required to pay under the contracts and the amounts we are able to earn on our general account investments
intended to support our obligations under the contracts. Declines in our spread from these products could have a material adverse effect on our businesses or results of operations.
In periods of increasing interest rates, we may not be able to replace the assets in our general account with higher yielding assets needed to fund the higher crediting rates necessary to keep our interest sensitive products competitive. We therefore may have to accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts and related assets. In periods of declining interest rates, we have to reinvest the cash we receive as interest or return of principal on our investments in lower yielding instruments then available. Moreover, borrowers may prepay fixed-income securities, commercial mortgages and mortgage-backed securities in our general account in order to borrow at lower market rates, which exacerbates this risk. Because we are entitled to reset the interest rates on our fixed rate annuities only at limited, pre-established intervals, and since many of our policies have guaranteed minimum interest or crediting rates, our spreads could decrease and potentially become negative.
Increases in interest rates may cause increased surrenders and withdrawals of insurance products. In periods of increasing interest rates, policy loans and surrenders and withdrawals of life insurance policies and annuity contracts may increase as policyholders seek to buy products with perceived higher returns. This process may lead to a flow of cash out of our businesses. These outflows may require investment assets to be sold at a time when the prices of those assets are lower because of the increase in market interest rates, which may result in realized investment losses. A sudden demand among consumers to change product types or withdraw funds could lead us to sell assets at a loss to meet the demand for funds. In addition, unanticipated withdrawals and terminations also may require us to accelerate the amortization of DAC. This would increase our current expenses.
In our Benefit Partners segment, lower investment yields on investments backing longer-tail liabilities could require us to lower our claims reserves discount rates, which would increase our policy liabilities and adversely affect our earnings.
Defaults or downgrades of others could reduce our profitability or negatively affect the value of our investments
Credit risk is the potential for financial loss resulting from the failure of a borrower or counterparty to honor its financial or contractual obligation. Credit risk arises most prominently in our derivative activities, ownership of debt and equity securities, mortgage loans we make, reinsurance agreements and when we act as an intermediary on behalf of our customers and other third parties. Third parties may default on their obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure, corporate governance issues or other reasons. A downturn in the U.S. economy could result in increased impairments. Our investment portfolio’s overall exposure to credit markets makes it sensitive to any general re-pricing of the credit risk associated with particular industries or issuers in financial markets.
Ratings downgrades could adversely affect our life insurance subsidiaries or our borrowing costs
Our claims-paying ratings, which are intended to measure our ability to meet policyholder obligations, are an important factor affecting public confidence in most of our products and, as a result, our competitiveness. The interest rates we pay on our borrowings are largely dependent on our credit ratings. Rating agencies periodically review the financial performance and condition of insurers, including our insurance subsidiaries. A significant downgrade or potential downgrade in any or all of our insurance subsidiaries’ ratings could harm our financial position and earnings by adversely affecting:
• our ability to compete and sell our products;
• the return on the products we issue;
• the number of policies surrendered and cash value withdrawn; and
• relationships with creditors, agents, banks, wholesalers and other distributors of our insurance subsidiaries’ products and services.
Ratings organizations assign ratings based upon several factors. While most of the factors are related to the rated company, some of the factors relate to general economic conditions and circumstances outside of the rated company’s control, or may reflect a change in the rating organization’s rating criteria. A rating is not a recommendation to purchase, sell or hold any particular security. Such ratings do not comment as to market price or suitability for a particular investor. In addition, there can be no assurance that a rating will be maintained for any given period of time or that a rating will not be lowered or withdrawn in its entirety.
A downgrade of our debt ratings could increase our costs on floating rate debt and affect our ability to raise additional debt comparable to our current debt, and accordingly, likely increase our cost of capital.
Our parent company and insurance subsidiaries face liquidity risk
JP’s business is also subject to liquidity risk. Liquidity risk arises from the difficulty of selling an asset to meet a financial commitment to a customer, creditor or investor when due. Because we are a holding company with no direct operations, we rely on dividends from our insurance and communication subsidiaries to meet our financial commitments. Our life insurance subsidiaries are subject to laws in their states of domicile that limit the amount of dividends that can be paid without the prior approval of the respective state’s insurance regulator. The limits are based in part on the prior year’s statutory income and capital, which are negatively impacted by bond losses and write-downs and by increases in reserves. Approval of these dividends will depend upon the circumstances at the time.
Our investments in preferred stocks, collateralized debt obligations, commercial mortgage loans, real estate, and certain private placement bonds are relatively illiquid. If we require significant amounts of cash on short notice in excess of our normal cash requirements, we may have difficulty selling these investments at attractive prices, in a timely manner, or both. For further discussion and analysis regarding liquidity, see the Liquidity section in Management’s Discussion and Analysis.
Our sales may be concentrated in certain products or distribution, increasing our risk from changes that may occur
Approximately 55-60% of sales in our Individual Products segment over the last three years were attributable to products with secondary guarantee benefits. See Capital Resources in Management’s Discussion and Analysis for further discussion, including increased statutory reserving requirements.
Approximately three-fourths of sales within our Annuities and Investment Products segment over the last two years were attributable to equity-indexed annuities. The potential for a regulation requiring broker/dealer supervision over sales of equity-indexed annuities, as suggested by the NASD, has begun to impact the marketplace for these products. The SEC may also be examining EIA sales practices.
UL-type products sold to community banks are generally not subject to surrender charges and are owned by several thousand policyholders. They were primarily originated through, and
continue to be serviced by, two marketing organizations. At December 31, 2005, these policies accounted for $2.0 billion in UL policyholder fund balances and have averaged 5% to 8% of earnings for the Individual Products segment in recent years. At December 31, 2005, DAC and VOBA balances, net of unearned revenue reserves, related to these blocks amounted to approximately $90. An increase in the surrender rate for this product may result if returns available to policyholders on competitors’ products become more attractive than returns on our policies in force. The following factors may influence policyholders to continue these coverages:
• our ability to adjust crediting rates;
• relatively high minimum rate guarantees;
• the difficulty of re-underwriting existing and additional covered lives; and
• unfavorable tax attributes of certain surrenders.
Our assumptions for amortizing DAC, VOBA and unearned revenue for these policies reflect a higher long-term expected lapse rate than other UL blocks of business due to the factors noted above. Lapse experience for this block in a particular period could vary significantly from our long-term lapse assumptions.
In our Benefit Partners segment, continued medical cost inflation may put pressure on non-medical premium rates, because employers may focus more on managing the cost of their non-medical group benefit programs.
Intense competition could negatively affect our ability to maintain or increase our profitability
Competition in our insurance subsidiaries’ business lines is based on a number of factors, including quality of customer service, product features, price, underwriting guidelines, commission structures, name recognition and claims-paying and credit ratings. JP’s insurance subsidiaries compete with a large number of other insurers, as well as non-insurance financial service companies such as banks, broker-dealers, and asset managers. We compete for customers (e.g., individuals and employers), and distributors of insurance and investment products (e.g., agents, banks, broker-dealers and financial advisors). To attract and retain productive sales organizations and producers to sell our products, we compete with other insurers primarily on the basis of our financial strength and ratings, support services, compensation, product features and pricing.
In recent years, there has been substantial consolidation and convergence among companies in the financial services industry resulting in increased competition from large, well-capitalized financial services firms. Many of these firms also have been able to increase their distribution systems through mergers or contractual arrangements. Furthermore, larger competitors may have lower operating costs and an ability to absorb greater risk while maintaining their financial strength ratings, thereby allowing them to price their products more competitively. We expect consolidation to continue and perhaps accelerate in the future, thereby increasing competitive pressure on us.
We face a risk of non-collectibility on reinsurance, which could adversely affect our results of operations
In the course of normal operations, our subsidiaries cede material amounts of insurance, primarily to transfer mortality risk, to third party reinsurers through reinsurance arrangements. We rely on the third party reinsurer to reimburse us for claims incurred on the ceded insurance policies. Although reinsurance does not discharge our subsidiaries from their primary obligation to pay policyholders for losses insured under the policies we issue, reinsurance does make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. We regularly evaluate the financial condition of our reinsurers and monitor concentrations of credit risk related to
reinsurance activities. However, if a reinsurer should fail to meet its obligations to us, we could be adversely affected.
Higher than anticipated mortality or morbidity could adversely affect our results
Our insurance subsidiaries bear mortality and morbidity risk. We reduce our exposure to mortality and morbidity risk by transferring portions of the risk through reinsurance agreements. Within our Individual Products segment, a substantial portion of this risk is reinsured. In this segment, if we were to experience significant adverse mortality experience, much of it would be passed on to our reinsurers. As a result, some or all of the related reinsurers may not renew our reinsurance or may significantly raise reinsurance premiums. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient, we would either have to be willing to accept an increase in our net exposures or revise our pricing to reflect higher reinsurance premiums. If this were to occur, we may be exposed to reduced profitability and cash flow strain or we may not be able to price new business at competitive rates.
Within our Benefit Partners segment, most of our mortality and morbidity risks are retained (i.e. not reinsured). Our morbidity experience may worsen due to continued growth in our disability blocks and due to a weak economy or weakness in particular occupations that may increase disability claim costs (an industry-wide phenomenon). Mortality risk in this segment could be adversely impacted by acts of terrorism not priced for or reinsured.
Changes in federal tax laws could make some products less attractive to consumers
Under U.S. federal tax law, policyholders are not taxed on the investment return of assets underlying certain life insurance policies and annuity contracts unless the policyholder partially or completely surrenders the contract, or in the case of an annuity contract, a periodic payment is made. In addition, death benefits paid to beneficiaries of life insurance policies are generally free from income tax (unless the contract was previously transferred for valuable consideration). This favorable tax treatment gives certain products a competitive advantage over non-insurance products.
Since 2001, Congress has reduced the federal estate tax rates and the federal income tax rates that apply to certain dividends and capital gains. Although we have not suffered any adverse financial impacts from such legislation to date, this legislation may, in the future, lessen the competitive advantage of life insurance and annuity products when compared to other investments that generate dividend and/or capital gain income. As a result, demand for our life insurance and annuity products that offer income tax deferral may be negatively impacted.
Additionally, Congress has from time to time considered possible legislation that would reduce or eliminate the tax deferral benefits on the accretion of policy/account value within insurance products. Current or pending proposals also include repeal of the federal estate tax, a proposed change to limit tax-free death benefits under corporate and bank-owned life insurance contracts, and the further expansion of tax-favored savings and investment accounts. If such proposals were adopted in the future, they could have a material adverse effect on our financial position, liquidity and future earnings by affecting our ability to sell our products or by triggering the surrender of existing policies and contracts.
Our businesses are heavily regulated and subject to legal and regulatory actions, and changes or outcomes could reduce our profitability
JP is a public company and the insurance industry is heavily regulated. Failure to comply with applicable laws and regulations can result in monetary penalties and/or prohibition from
conducting certain types of activities. Furthermore, our conduct of business may result in litigation associated with contractual disputes or other alleged liability to third parties. These matters may be difficult to assess or quantify; third parties may seek recovery of very large and/or indeterminate amounts, including punitive and treble damages; and the magnitude may remain unknown for substantial periods of time. A substantial legal liability or a significant regulatory action against us could have a material adverse effect on our financial position or earnings. Various litigation, claims and assessments have arisen or may arise in the course of our business, including, but not limited to, activities as an insurer (including market conduct and sales practices), employer, investor and taxpayer. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning our compliance with applicable insurance and other laws and regulations. Because of the considerable uncertainties that exist, we cannot predict the ultimate outcome of all pending investigations, regulatory examinations, and legal proceedings.
Our insurance business is subject to comprehensive state regulation and supervision throughout the U.S. The primary purpose of such regulation is to protect policyholders, not our investors. The laws of the various states establish insurance departments with broad powers with respect to matters such as licensing companies to transact business, licensing agents and regulating the type and disclosure of compensation paid to them, admitting statutory assets, mandating certain insurance benefits, regulating premium rates, approving policy forms, regulating unfair trade and claims practices, establishing statutory reserve requirements and solvency standards, fixing maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values, restricting certain transactions between affiliates, regulating the types and utilization of reinsurance, and regulating the types, amounts and statutory valuation of investments.
State insurance regulators and the National Association of Insurance Commissioners continually reexamine existing laws and regulations, and may impose changes in the future that could materially and adversely affect our financial condition and earnings, such as reserving for secondary guarantee benefits.
Although the federal government generally does not directly regulate the insurance business, federal initiatives often have an impact on the business in a variety of ways. From time to time, federal measures are proposed which may significantly affect the insurance business. Several insurance trade associations have proposed federal legislation that would allow a state-chartered and regulated insurer, such as our insurance subsidiaries, to choose instead to be regulated exclusively by a federal insurance regulator.
We may also be subject to similar laws and regulations in the states in which we offer products or conduct other securities-related activities. Our variable annuities and variable universal life products are subject to various levels of regulation under the federal securities laws administered by the SEC. These laws and regulations are primarily intended to protect investors in the securities markets, and generally grant supervisory agencies broad administrative powers, including the power to limit or restrict the conduct of business for failure to comply with such laws and regulations. As discussed earlier, the potential additional regulation over sales of equity-indexed annuities has begun to impact the marketplace for these products.
We cannot predict the impact of future state or federal laws or regulations on our business. Future laws and regulations, or new interpretations of existing laws and regulations, may materially and adversely affect our financial position and earnings.
Our actual results may differ from estimates and judgments we make in financial reporting
The preparation, integrity and fair presentation of our financial statements reflect management’s estimates and judgments concerning future results or other developments including the likelihood, timing or amount of one or more future events, the use of which are inherent in the preparation of financial statements. Actual results may differ from these estimates under different assumptions or conditions. For a detailed discussion of accounting policy and estimates, see the Critical Accounting Policies and Estimates section of Management’s Discussion and Analysis, and Note 2, Significant Accounting Policies in our consolidated financial statements .
Our communications business faces a variety of risks that could adversely affect its results
Our communications business relies on advertising revenues, and therefore is sensitive to cyclical changes in both the general economy and in the economic strength of local markets. Also, our stations derived 21.4%, 21.4%, and 23.5% of their 2005, 2004 and 2003 advertising revenues from the automotive industry. If automobile advertising is severely curtailed, it could have a negative impact on broadcasting revenues.
For 2005, 7.1% of television revenues came from a network agreement with two CBS-affiliated stations that expires in 2011. The trend in the industry is away from the networks compensating affiliates for carrying their programming and there is a possibility those revenues will be eliminated when the contract is renewed.
Technological media changes, such as satellite radio and the Internet, and consolidation in the broadcast and advertising industries, may increase competition for audiences and advertisers.
Our communications business has commitments for purchases of syndicated television programming and commitments for other contracts and future sports programming rights, payable through 2011. These commitments are not reflected as an asset or liability in our balance sheet because the programs are not currently available for use. If sports programming advertising revenue decreases in the future, the commitments may have a material adverse effect on our financial position and earnings.
Item 1B. Unresolved Staff Comments
None.
