PRIMERICA, INC. – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to inform the reader about matters affecting the financial condition and results of operations ofPrimerica, Inc. (the "Parent Company") and its subsidiaries (collectively, "we" or the "Company") for the period fromDecember 31, 2011 toMarch 31, 2012 . As a result, the following discussion should be read in conjunction with MD&A and the consolidated and combined financial statements and notes thereto that are included in our Annual Report on Form 10-K for the year endedDecember 31, 2011 (the "2011 Annual Report"). This discussion contains forward-looking statements that constitute our plans, estimates and beliefs. These forward-looking statements involve numerous risks and uncertainties, including, but not limited to those discussed under the heading "Risk Factors" in the 2011 Annual Report. Actual results may differ materially from those contained in any forward-looking statements. This MD&A is divided into the following sections: • Business Overview
• Critical Accounting Estimates
• Factors Affecting Our Results
• Results of Operations • Financial Condition
• Liquidity and Capital Resources
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Business Overview We are a leading distributor of financial products to middle income households inthe United States and Canada. We assist our clients in meeting their needs for term life insurance, which we underwrite, and mutual funds, annuities and other financial products, which we distribute primarily on behalf of third parties. We have two primary operating segments,Term Life Insurance and Investment and Savings Products, and a third segment, Corporate and Other Distributed Products.Term Life Insurance . We distribute the term life insurance products that we originate through our three life insurance company subsidiaries:Primerica Life Insurance Company ("Primerica Life");National Benefit Life Insurance Company ("NBLIC"); and Primerica Life Insurance Company of Canada ("Primerica Life Canada"). Our in-force term insurance policies have level premiums for the stated term period. As such, the policyholder pays the same amount each year. Initial policy term periods are between 10 and 35 years. While premiums are guaranteed to remain level during the initial term period (up to a maximum of 20 years inthe United States ), our claim obligations generally increase as our policyholders age. In addition, we incur significant upfront costs in acquiring new insurance business. Our deferral and amortization of policy acquisition costs and reserving methodology are designed to match the recognition of premium revenues with the timing of acquisition costs and the payment of claims obligations, such that profits are realized ratably with the level premiums of the underlying policies. OurTerm Life Insurance segment results are primarily driven by sales and policies in force, accuracy of our pricing assumptions, terms and use of reinsurance, investment income, and expenses. In connection with our corporate reorganization in 2010, we entered into certain reinsurance transactions with affiliates of Citigroup Inc. (the "Citi reinsurers") and ceded between 80% and 90% of the risks and rewards of our term life insurance policies that were in force at year-end 2009 (the "Citi reinsurance transactions"). We continue to administer all policies subject to these coinsurance agreements. Subsequent to the Citi reinsurance transactions, the revenues and earnings of ourTerm Life Insurance segment initially declined in proportion to the amount of revenues and earnings historically associated with the book of term life insurance policies that we ceded to the Citi reinsurers. As we have added new in-force business, our revenues and earnings have grown from these initial levels. With each successive period, we expect revenue and earnings growth to decelerate as the size of our in-force book grows and incremental sales have a reduced marginal effect on the size of the then-existing in-force book. Investment and Savings Products. We distribute mutual funds, managed accounts, annuities and segregated funds. Inthe United States , we distribute mutual fund and managed accounts products and variable and fixed annuity products of several third-party companies. In Canada, we offer our own Primerica-branded mutual funds, as well as mutual funds of other companies, and segregated funds, which are underwritten byPrimerica Life Canada . Revenues associated with these products consist of commissions and fees earned at the time of sale, fees based on the asset values of client accounts and recordkeeping and custodial fees charged on a per-account basis. Results in our Investment and Savings Products segment are driven by sales of mutual funds and annuities, the value of assets in client accounts for which we earn ongoing service, distribution and advisory fees and the number of fee generating accounts for which we provide administration functions or retirement plan custodial services. While our investment and savings products all have similar long-term earnings characteristics, our results in a given fiscal period are affected by changes in the overall mix of products within these broad categories. Corporate and Other Distributed Products. Our Corporate and Other Distributed Products segment consists primarily of revenues and expenses related to other distributed products, including various insurance products, prepaid legal services and a credit information product. These products are distributed pursuant to distribution arrangements with third parties, except for certain life and disability insurance products underwritten by NBLIC, ourNew York life insurance subsidiary, that are not distributed through our sales force. In addition, our Corporate and Other Distributed Products segment includes corporate income (including net investment income) and expenses not allocated to other segments, interest expense on the Citi note and realized gains and losses on our invested asset portfolio. Accounting Policy Change. EffectiveJanuary 1, 2012 , we adopted ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts ("ASU 2010-26"), and will no longer defer certain indirect acquisition costs or costs attributable to unsuccessful efforts of acquiring life insurance policies. We adopted this accounting policy change retrospectively and, accordingly, our historical results have been adjusted to reflect the adoption on a consistent basis across all periods presented. As a result of this accounting change, we reduced stockholders' equity as ofDecember 31, 2011 by$96.0 million to $1.33 billion . This accounting change 23
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also reduced net income for the three months endedMarch 31, 2011 by$5.2 million to $47.3 million . For additional information regarding this accounting policy change, see Note 1 to our condensed consolidated financial statements and the Critical Accounting Estimates section below. Critical Accounting Estimates We prepare our financial statements in accordance with U.S. generally accepted accounting principles ("GAAP"). These principles are established primarily by theFinancial Accounting Standards Board ("FASB"). The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions based on currently available information when recording transactions resulting from business operations. Our significant accounting policies are described in Note 1 to our consolidated and combined financial statements included in our 2011 Annual Report. The most significant items on the balance sheet are based on fair value determinations, accounting estimates and actuarial determinations which are susceptible to changes in future periods and which affect our results of operations and financial position. The estimates that we deem to be most critical to an understanding of our results of operations and financial position are those related to the valuation of investments, reinsurance, deferred policy acquisition costs, future policy benefit reserves, and income taxes. The preparation and evaluation of these critical accounting estimates involve the use of various assumptions developed from management's analyses and judgments. Subsequent experience or use of other assumptions could produce significantly different results. During the three months endedMarch 31, 2012 , there have been no changes in the items that we have identified as critical accounting estimates. However, onJanuary 1, 2012 , we retrospectively adopted the guidance in ASU 2010-26. For additional information regarding critical accounting estimates, see the Critical Accounting Estimates section of MD&A included in our 2011 Annual Report. Accounting for Deferred Policy Acquisition Costs. In accordance with ASU 2010-26, we defer incremental direct costs of successful contract acquisitions that result directly from and are essential to the contract transaction(s) and that would not have been incurred had the contract transaction(s) not occurred. These costs mainly include commissions and policy issue expenses. The recovery of such costs is dependent on the future profitability of the related policies, which, in turn, is dependent principally upon mortality, persistency, the expense of administering the business, and investment returns, as well as upon certain economic variables, such as inflation. Our deferred policy acquisition cost asset (DAC) is subject to recoverability testing annually and when circumstances indicate that recoverability is uncertain. We make certain assumptions regarding persistency, expenses, interest rates and claims. These assumptions may not be modified, or unlocked, unless recoverability testing deems them to be inadequate. We update assumptions for new business to reflect the most recent experience. Deferrable term life insurance policy acquisition costs are amortized over the premium-paying period of the related policies in proportion to premium income. If actual lapses or withdrawals are different from pricing assumptions for a particular period, DAC amortization will be affected. If the number of policies that lapse are 1% higher than the number of policies that we expected to lapse in our pricing assumptions, approximately 1% more of the existing DAC balance will be amortized, which would have been equal to approximately$8.1 million as ofDecember 31, 2011 (assuming such lapses were distributed proportionately among policies of all durations). We believe that a lapse rate in the number of policies that is 1% higher than the rate assumed in our pricing assumptions is a reasonably possible variation. Higher lapses in the early durations would have a greater effect on DAC amortization since the DAC balances are higher at the earlier durations. Differences in actual mortality rates compared to our pricing assumptions will not have a material effect on DAC amortization. Due to the inherent uncertainties in making assumptions about future events, materially different experience from expected results in persistency or mortality could result in a material increase or decrease of DAC amortization in a particular period. Deferrable acquisition costs for Canadian segregated funds are amortized over the life of the policies in relation to historical and future estimated gross profits before amortization. The gross profits and resulting DAC amortization will vary with actual fund returns, redemptions and expenses. As a result of the retrospective adoption of ASU 2010-26, DAC amortization and expense deferrals were lower than had been previously reported. 24
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Factors Affecting Our Results Economic Environment. The relative strength and stability of financial markets and economies inthe United States and Canada affect our growth and profitability. Our business is, and we expect will continue to be, influenced by a number of industry-wide and product-specific trends and conditions. Economic conditions, including unemployment levels and consumer confidence, influence investment and spending decisions by middle income consumers, who are generally our primary clients. These conditions and factors also impact prospective recruits' perceptions of the business opportunity that becoming a Primerica sales representative offers, which can drive or dampen recruiting. Consumer spending and borrowing levels remain under pressure, as consumers take a more conservative financial posture including reevaluating their savings and debt management plans. As overall market and economic conditions have improved in recent periods, sales and the value of consumer investment products across a wide spectrum of asset classes have improved. The effects of these trends and conditions are discussed in the Results of Operations section below. Recruiting and Sales Representatives. Our ability to increase the size of our sales force is largely based on the success of our recruiting efforts and our ability to train and motivate recruits to obtain licenses to sell life insurance. We believe that recruitment levels are an important advance indicator of sales force trends, and growth in recruiting is usually indicative of future growth in the overall size of the sales force. However, because new recruits may obtain the requisite licenses at rates above or below historical levels, recruiting results do not always result in commensurate changes in the size of our licensed sales force. Recruiting of new representatives increased by 11% to 58,551 in the first quarter of 2012, compared with the same period a year ago. Recruiting strength in the first quarter led to a sequential increase over the fourth quarter, which is typically a slower recruiting quarter. New life licenses grew by 7% to 7,650, compared with the first quarter of 2011 but decreased by 6% from the fourth quarter of 2011 when licensing results benefited from the third quarter post-convention recruiting surge. The size of our life-licensed insurance sales force was 89,651 atMarch 31, 2012 down from 91,176 atDecember 31, 2011 , primarily due to recruiting levels in the fourth quarter of 2011. Term Life Insurance Segment. OurTerm Life Insurance segment results are primarily driven by sales, accuracy of our pricing assumptions, terms and use of reinsurance, investment income and expenses. Sales and policies in force. Sales of new term policies and the size and characteristics of our in-force book of policies are vital to our results over the long term. Premium revenue is recognized as it is earned over the term of the policy and acquisition expenses are generally deferred and amortized ratably with the level premiums of the underlying policies. However, because we incur significant cash outflows at or about the time policies are issued, including the payment of sales commissions and underwriting costs, changes in life insurance sales volume will have a more immediate effect on our cash flows. Historically, we have found that while sales volume of term life insurance products between fiscal periods may vary based on a variety of factors, the productivity of our individual sales representatives remains within a relatively narrow range and, consequently, our sales volume over the longer term generally correlates to the size of our sales force. The average number of life-licensed sales representatives and the number of term life insurance policies issued, as well as the average monthly rate of new policies issued per life-licensed sales representative, were as follows: Three months ended
March 31,
2012
2011
Average number of life-licensed sales representatives 90,027
93,001
Number of new policies issued 56,145
51,281
Average monthly rate of new policies issued per life-licensed sales representative .21x
.18x
During the three months endedMarch 31, 2012 , the increased productivity of our sales representatives was largely driven by strong sales of our new TermNow product. Pricing assumptions. Our pricing methodology is intended to provide us with appropriate profit margins for the risks we assume. We determine pricing classifications based on the coverage sought, such as the size and term of the policy, and certain policyholder attributes, such as age and health. In addition, we utilize unisex rates for our term 25
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life insurance policies. The pricing assumptions that underlie our rates are based upon our best estimates of mortality, persistency and investment yields at the time of issuance, sales force commission rates, issue and underwriting expenses, operating expenses and the characteristics of the insureds, including sex, age, underwriting class, product and amount of coverage. Our results will be affected to the extent there is a variance between our pricing assumptions and actual experience. • Persistency. We use historical experience to estimate pricing assumptions
for persistency rates. Persistency is a measure of how long our insurance
policies stay in force. As a general matter, persistency that is lower than our pricing assumptions adversely affects our results over the long term because we lose the recurring revenue stream associated with the policies that lapse. Determining the near-term effects of changes in persistency is more complicated. When persistency is lower than our pricing assumptions, we must accelerate the amortization of DAC. The
resultant increase in amortization expense is offset by a corresponding
release of reserves associated with lapsed policies, which causes a
reduction in benefits and claims expense. The reserves associated with any
given policy will change over the term of such policy. As a general matter, reserves are lowest at the inception of a policy term and rise steadily to a peak before declining to zero at the expiration of the
policy term. Accordingly, depending on when the lapse occurs in relation
to the overall policy term, the reduction in benefits and claims expense
may be greater or less than the increase in amortization expense and,
consequently, the effects on earnings for a given period could be positive
or negative. Persistency levels are meaningful to our results to the
extent actual experience deviates from the persistency assumptions used to
price our products.
• Mortality. We use historical experience to estimate pricing assumptions
for mortality. Our profitability is affected to the extent actual mortality rates differ from those used in our pricing assumptions. We mitigate a significant portion of our mortality exposure through reinsurance. Variances between actual mortality experience and the assumptions and estimates used by our reinsurers affect the cost and potentially the availability of reinsurance.
• Investment Yields. We generally use a level investment yield rate which
reflects yields currently available. For 2012 and 2011 new issues, we are
using an increasing interest rate assumption to reflect the historically
low interest rate environment. Both DAC and the reserve liability increase
with the assumed investment yield rate. Since DAC is higher than the reserve liability in the early years of a policy, a lower assumed investment yield generally will result in lower profits. In the later
years, when the reserve liability is higher than DAC, a lower assumed
investment yield generally will result in higher profits. Actual investment yields will impact the net investment income allocated to theTerm Life Insurance segment, but will not impact DAC or the reserve liability. Reinsurance. We use reinsurance extensively, which has a significant effect on our results of operations. Since the mid-1990s, we have reinsured between 60% and 90% of the mortality risk on our U.S. term life insurance policies on a quota share YRT basis. Since 2003, we have reinsured Canadian policy face amounts above$500,000 per life on an excess loss YRT basis. However, in the first quarter of 2012, we entered into a YRT reinsurance arrangement inCanada similar to our U.S. program that reinsures 80% of the face amount for every policy sold. YRT reinsurance permits us to fix future mortality exposure at contractual rates by policy class. To the extent actual mortality experience is more or less favorable than the contractual rate, the reinsurer will earn incremental profits or bear the incremental cost, as applicable. In contrast to coinsurance, which is intended to eliminate all risks (other than counterparty risk of the reinsurer) and rewards associated with a specified percentage of the block of policies subject to the reinsurance arrangement, the YRT reinsurance arrangements we enter into are intended only to reduce volatility associated with variances between estimated and actual mortality rates. The effect of our reinsurance arrangements on ceded premiums and benefits and expenses on our statement of income follows: • Ceded premiums. Ceded premiums are the premiums we pay to reinsurers.
These amounts are deducted from the direct premiums we earn to calculate
our net premium revenues. Similar to direct premium revenues, ceded
coinsurance premiums remain level over the initial term of the insurance
policy. Ceded YRT premiums increase over the period that the policy has been in force. Accordingly, ceded YRT premiums generally constitute an increasing percentage of direct premiums over the policy term.
• Benefits and claims. Benefits and claims include incurred claim amounts
and changes in future policy benefit reserves. Reinsurance reduces incurred claims in direct proportion to the percentage ceded. 26
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• Amortization of DAC. Amortization of DAC is reduced on a pro-rata basis for the coinsured business, including the business reinsured with Citi. There is no impact on amortization of DAC associated with our YRT contracts.
• Insurance expenses. Insurance expenses are reduced by the allowances
received from coinsurance, including the business reinsured with Citi.
We may alter our reinsurance practices at any time due to the unavailability of YRT reinsurance at attractive rates or the availability of alternatives to reduce our risk exposure. We presently intend to continue ceding approximately 90% of our U.S. mortality risk on new business and approximately 80% of our Canadian mortality risk on new business. Net investment income.Term Life Insurance segment net investment income is composed of two elements: allocated net investment income and the market return associated with the deposit asset underlying the 10% reinsurance agreement we executed in connection with our corporate reorganization. Invested assets are allocated to the Term Life segment based on the book value of the invested assets necessary to meet statutory reserve requirements and our targeted capital objectives. Net investment income is also impacted by the performance of our invested asset portfolio and the market return on the deposit asset which can be affected by interest rates, credit spreads and the mix of invested assets. Expenses. Results are also affected by variances in client acquisition, maintenance and administration expense levels. Investment and Savings Products Segment. Our Investment and Savings Products segment results are primarily driven by sales, the value of assets in client accounts for which we earn ongoing management, service and distribution fees and the number of fee generating accounts we administer. Sales. We earn commissions and fees, such as dealer re-allowances, and marketing and support fees, based on sales of mutual fund and managed account products and annuities. Sales of investment and savings products are influenced by the overall demand for investment products inthe United States and Canada, as well as by the size and productivity of our sales force. We generally experience seasonality in our Investment and Savings Products segment results due to our high concentration of sales of retirement account products. These accounts are typically funded in February through April, coincident with our clients' tax return preparation season. While we believe the size of our sales force is a factor in driving sales volume in this segment, there are a number of other variables, such as economic and market conditions, that may have a significantly greater effect on sales volume in any given fiscal period. Asset values in client accounts. We earn marketing and distribution fees (trail commissions or, with respect to U.S. mutual funds, 12b-1 fees) on mutual fund and annuity assets inthe United States and Canada. Inthe United States , we also earn investment advisory fees on assets in the managed accounts program. In Canada we earn management fees on certain mutual fund assets and on the segregated funds for which we serve as investment manager. Asset values are influenced by new product sales, ongoing contributions to existing accounts, redemptions and the change in market values in existing accounts. While we offer a wide variety of asset classes and investment styles, our clients' accounts are primarily invested in equity funds. Accounts. We earn recordkeeping fees for administrative functions we perform on behalf of several of our mutual fund providers and custodial fees for services as a non-bank custodian for certain of our mutual fund clients' retirement plan accounts. Sales Mix. While our investment and savings products all have similar long-term earnings characteristics, our results in a given fiscal period will be affected by changes in the overall mix of products within these broad categories. Examples of changes in the sales mix that influence our results include the following: • sales of a higher proportion of mutual fund products of the several mutual
fund families for which we act as recordkeeper will generally increase our
earnings because we are entitled to recordkeeping fees on these accounts;
• sales of variable annuity products in
higher revenues in the period such sales occur than sales of other
investment products that either generate lower upfront revenues or, in the
case of segregated funds, no upfront revenues; 27
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• sales and administration of a higher proportion of mutual funds that
enable us to earn marketing and support fees will increase our revenues
and profitability;
• sales of a higher proportion of retirement products of several mutual fund
families will tend to result in higher revenue generation due to our ability to earn custodial fees on these accounts; and
• sales of a higher proportion of managed accounts products will generally
extend the time over which revenues can be earned because we are entitled
to revenues based on assets under management for these accounts.
Corporate and Other Distributed Products Segment. We earn revenues and pay commissions and referral fees for various other insurance products, prepaid legal services and other financial products, all of which are originated by third parties. NBLIC also underwrites a mail-order student life policy and a short-term disability benefit policy, neither of which is distributed by our sales force, and has in-force policies from several discontinued lines of insurance. The Corporate and Other Distributed Products segment is affected by corporate income and expenses not allocated to our other segments, net investment income (other than net investment income allocated to ourTerm Life Insurance segment), general and administrative expenses (other than expenses that are allocated to ourTerm Life Insurance Primerica, Inc. and Subsidiaries Results. Our results of operations were as follows: Three months ended March 31, Change 2012 2011 $ % (Dollars in thousands) Revenues: Direct premiums $ 561,037 $ 552,069 $ 8,968 2 % Ceded premiums (418,163 ) (422,238 ) 4,075 * Net premiums 142,874 129,831 13,043 10 % Commissions and fees 103,905 106,116 (2,211 ) (2 )% Net investment income 26,097 28,626 (2,529 ) (9 )% Realized investment gains, including OTTI losses 2,131 327 1,804 * Other, net 11,594 11,452 142 1 % Total revenues 286,601 276,352 10,249 4 % Benefits and expenses: Benefits and claims 67,933 57,635 10,298 18 % Amortization of DAC 26,531 23,229 3,302 14 % Sales commissions 49,717 50,438 (721 ) (1 )% Insurance expenses 22,444 15,798 6,646 42 % Insurance commissions 8,496 8,998 (502 ) (6 )% Interest expense 6,910 6,997 (87 ) (1 )% Other operating expenses 41,105 40,001 1,104 3 % Total benefits and expenses 223,136 203,096 20,040 10 % Income before income taxes 63,465 73,256 (9,791 ) (13 )% Income taxes 21,709 25,985 (4,276 ) (16 )% Net income $ 41,756 $ 47,271 $ (5,515 ) (12 )% ____________________ * Less than 1% or not meaningful Total revenues. Total revenues were primarily driven by growth in net premiums, partially offset by declines in net investment income and commissions and fees. The growth in net premiums largely reflects incremental premiums on New Term policies issued subsequent to the Citi reinsurance transactions ("New Term"). Net investment income 28
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was lower in the first quarter of 2012 primarily reflecting a lower level of invested assets following our$200.0 million stock repurchase in the fourth quarter of 2011. The decrease in commissions and fees was largely driven by lower average client asset values as well as a recordkeeping fee structure change that had no net effect on income before income taxes, partially offset by higher sales of variable annuities in our Investment and Savings Product segment. The decline in commissions and fees also reflects the ongoing decline in and discontinuation of our lending business. Total benefits and expenses. Total benefits and expenses were higher primarily as a result of the growth in our Term Life business and higher overall operating expenses. Benefits and claims and amortization of DAC increased as a result of the continued growth in New Term. The decline in sales commissions was in line with the decline in revenues. Insurance expenses increased primarily as a result of higher, premium-related expenses and prior-year favorable expense items including the release of management incentive compensation accruals for 2010 and lower expense allowances due to the continued run-off in the block of business ceded to the Citi reinsurers. Income taxes. Our effective income tax rate was 34.2% for the three months endedMarch 31, 2012 , compared with 35.5% for the same period a year ago reflecting a lower statutory income tax rate inCanada and lower tax reserves on Canadian earnings. For additional information, see the Segment Results discussions below. Segment Results Term Life Insurance Segment Results. Our results for theTerm Life Insurance segment were as follows: Three months ended March 31, Change 2012 2011 $ % (Dollars in thousands) Revenues: Direct premiums $ 542,157 $ 532,167 $ 9,990 2 % Ceded premiums (414,559 ) (418,653 ) 4,094 * Net premiums 127,598 113,514 14,084 12 % Allocated net investment income 16,660 15,794 866 5 % Other, net 7,546 7,654 (108 ) (1 )% Total revenues 151,804 136,962 14,842 11 % Benefits and expenses: Benefits and claims 57,509 47,351 10,158 21 % Amortization of DAC 23,933 20,127 3,806 19 % Insurance commissions 3,577 4,063 (486 ) (12 )% Insurance expenses 19,717 12,833 6,884 54 % Interest expense 2,785 2,872 (87 ) (3 )% Total benefits and expenses 107,521 87,246 20,275 23 % Income before income taxes $ 44,283 $ 49,716 $ (5,433 ) (11 )% ____________________ * Less than 1% Net premiums. Direct premiums grew largely as a result of growth in New Term business and premium increases for policies reaching the end of their initial level premium period. In the first quarter of 2011, ceded premiums included$8.7 million of ceded premium recoveries for post-issue underwriting class upgrades. Excluding the$8.7 million of ceded premium recoveries, net premiums grew by 22%, primarily as a result of incremental New Term business. Persistency was consistent with the prior-year period. Benefits and claims. The increase in benefits and claims was consistent with net premium growth excluding the ceded premium recoveries noted above. Mortality, which was consistent with prior year, was slightly unfavorable in both periods. Amortization of DAC. The increase in amortization of DAC was also consistent with net premium growth excluding the ceded premium recoveries noted above. In the first quarter of 2012, amortization of DAC included a reduction of approximately$2 million for commission payments previously incurred but not billed on in-force business ceded to the Citi reinsurers. In the first quarter of 2011, amortization of DAC included a one-time DAC adjustment of approximately$2.2 million largely related to in-force business ceded to the Citi reinsurers. 29
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Insurance expenses. The growth in insurance expenses primarily reflects the impact of premium-related increases in taxes, licenses and fees and the run-off of expense allowances received under the terms of the Citi reinsurance agreements as well as prior-year favorable expense items including the release of management incentive compensation accruals for 2010. Product Sales and Face Amount In Force. We issued 56,145 new policies during the three months endedMarch 31, 2012 , compared with 51,281 new policies for the same period in 2011. The increased sales of our term life insurance products primarily reflect an increase in the number of applications received and a higher rate of converting applications to issued policies largely as a result of TermNow, our new rapid-issue term life insurance product. The average face amount of policies issued during the first quarter of 2012 was approximately$244,100 , compared with approximately$260,000 in the first quarter of 2011. The changes in the face amount of our in-force book of term life insurance policies were as follows: Three months ended March 31, Change 2012 2011 $ % (Dollars in millions) Face amount in force, beginning of period $ 664,955 $ 656,791 $ 8,164 1 % Issued face amount 16,983 16,735 248 1 % Terminations (16,307 ) (17,247 ) 940 (5 )% Foreign currency (1,208 ) 2,244 (3,452 ) * Face amount in force, end of period (1) $ 664,423 $ 658,523 $ 5,900 * ____________________ * Less than 1% or not meaningful (1) Totals may not add due to rounding. Issued face amount was relatively flat during the first quarter of 2012 reflecting the offsetting effects of higher policy sales as discussed above and lower average size of policies issued primarily due to a higher proportion of TermNow policy sales, which are issued at lower face amounts. The decrease in terminations resulted from aggregate persistency that, while remaining below historical norms, has continued to improve modestly. Investment and Savings Product Segment Results. Investment and Savings Products segment results were as follows: Three months ended March 31, Change 2012 2011 $ % (Dollars in thousands) Revenues: Commissions and fees: Sales-based revenues $ 44,467 $ 43,128 $ 1,339 3 % Asset-based revenues 43,722 44,825 (1,103 ) (2 )% Account-based revenues 9,373 10,432 (1,059 ) (10 )% Other, net 2,572 2,461 111 5 % Total revenues 100,134 100,846 (712 ) * Expenses: Amortization of DAC 3,223 2,785 438 16 % Insurance commissions 2,149 2,140 9 * Sales commissions: Sales-based 31,600 30,553 1,047 3 % Asset-based 14,745 15,451 (706 ) (5 )% Other operating expenses 19,547 18,878 669 4 % Total expenses 71,264 69,807 1,457 2 % Income before income taxes $ 28,870 $ 31,039 $ (2,169 ) (7 )% ____________________ * Less than 1% 30
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Supplemental information on the underlying metrics that drove results follows. Three months ended March 31, Change 2012 2011 $ % (Dollars in millions and accounts in thousands) Product sales: Retail mutual funds $ 612 $ 646 $ (34 ) (5 )% Annuities and other 429 345 84 24 % Total sales-based revenue generating product sales (1) 1,041 991 50 5 % Segregated funds and other 124 123 1 * Managed accounts 23 - 23 * Total product sales (1) $ 1,188 $ 1,114 $ 74 7 % Average client asset values: Retail mutual funds $ 23,694 $ 24,882 $ (1,188 ) (5 )% Annuities and other 8,717 8,242 475 6 % Segregated funds 2,499 2,477 22 1 % Managed accounts 212 - 212 * Total average asset values in client accounts (1) $ 35,122 $ 35,602 $ (480 ) (1 )% Average number of fee-generating accounts: Recordkeeping accounts 2,584 2,662 (78 ) (3 )% Custodial accounts 1,945 1,966 (21 ) (1 )% _____________________ * Not meaningful or less than 1% (1) Totals may not add due to rounding. Commissions and fees. Commissions and fees declined primarily as a result of lower average client asset values in the first quarter of 2012 and a recordkeeping fee structure change beginning in the third quarter of 2011, which had no net effect on income before income taxes. Growth in sales-based revenues partially offset these declines and primarily reflect the impact of internal exchanges for the variable annuity products we offer as well as sales of a newly introduced fixed indexed annuity product. Amortization of DAC. The increase in DAC amortization was primarily driven by the impact on amortization rates of higher than assumed redemption rates on our Canadian Segregated Funds products. Sales commissions. The increase in sales-based commissions was primarily driven by the increases in sales noted above. Other operating expenses. Other operating expenses grew largely as a result of higher new product offering expenses as well as the 2011 release of management incentive compensation accruals, partially offset by lower 2012 expenses due to the impact of the recordkeeping fee structure change noted above. Product sales. Investment and savings products sales were higher in the three months endedMarch 31, 2012 largely reflecting the impact of internal exchanges of variable annuities and our managed accounts and fixed indexed annuities product introductions. Asset Values in Client Accounts. Changes in asset values in client accounts were as follows: Three months ended March 31, Change 2012 2011 $ % (Dollars in millions) Asset values, beginning of period $ 33,664 $ 34,869 $ (1,205 ) (3 )% Inflows 1,188 1,114 74 7 % Redemptions (1,233 ) (1,083 ) (150 ) 14 % Change in market value, net and other 2,660 1,288 1,372 107 % Asset values, end of period $ 36,279 $ 36,188 $ 91 * ____________________ * Less than 1% 31
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The growth in inflows, which reflect the internal exchanges for variable annuities, was in line with the increase in sales volume. However, internal exchanges for variable annuities are also included in redemptions. As a result, redemptions as a percent of average assets were slightly higher in the first quarter of 2012. Corporate and Other Distributed Products Segment Results. Corporate and Other Distributed Products segment results were as follows: Three months ended March 31, Change 2012 2011 $ % (Dollars in thousands) Revenues: Direct premiums $ 18,880 $ 19,902 $ (1,022 ) (5 )% Ceded premiums (3,604 ) (3,585 ) (19 ) * Net premiums 15,276 16,317 (1,041 ) (6 )% Commissions and fees 6,343 7,731 (1,388 ) (18 )% Allocated net investment income 9,437 12,831 (3,394 ) (26 )% Realized investment gains, including OTTI losses 2,131 327 1,804 * Other, net 1,476 1,338 138 10 % Total revenues 34,663 38,544 (3,881 ) (10 )% Benefits and expenses: Benefits and claims 10,424 10,284 140 1 % Amortization of DAC (625 ) 317 (942 ) * Insurance commissions 2,770 2,794 (24 ) * Insurance expenses 2,727 2,965 (238 ) (8 )% Sales commissions 3,372 4,434 (1,062 ) (24 )% Interest expense 4,125 4,125 - - % Other operating expenses 21,558 21,124 434 2 % Total benefits and expenses 44,351 46,043 (1,692 ) (4 )% Loss before income taxes $ (9,688 ) $ (7,499 ) $ (2,189 ) 29 % ____________________ * Less than 1% or not meaningful Total revenues. Total revenues were lower during the first quarter of 2012 due in large part to a decline in net investment income as a result of a lower invested asset base and a higher allocation to theTerm Life Insurance segment, a decline in commissions and fees in connection with the termination of our loan business as well as lower production across other product lines, and a decline in net premiums on our short-term disability line primarily due to an increase in terminations concurrent with a premium rate increase. An increase in realized investment gains partially offset the decline in total revenues. Benefits and expenses. Benefits and claims were relatively flat primarily due to the offsetting effects of improvements in morbidity experienced by the short-term disability line and adverse claims in various run-off blocks of insurance products, all of which were underwritten by NBLIC. In 2011, NBLIC completed an administrative conversion on its block of student life insurance products which, in the fourth quarter of 2011, resulted in insignificant changes to DAC and policy reserves of approximately equal and offsetting amounts. However, in the first quarter of 2012, additional conversion-related adjustments were recognized which resulted in the negative DAC amortization disclosed in the table above. Sales commissions declined primarily as a result of the decline in production noted in total revenues above. 32
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Financial Condition Investments. We have an investment committee composed of members of our senior management team that is responsible for establishing and maintaining our investment guidelines and supervising our investment activity. We follow a conservative investment strategy designed to emphasize the preservation of our invested assets and provide adequate liquidity for the prompt payment of claims. To meet business needs and mitigate risks, our investment guidelines provide restrictions on our portfolio's composition, including limits on asset type, sector limits, credit quality limits, portfolio duration, limits on the amount of investments in approved countries and permissible security types. Additionally, to ensure adequate liquidity for payment of claims, we take into account the maturity and duration of our invested asset portfolio and our general liability profile. Our invested asset portfolio is subject to a variety of risks, including risks related to general economic conditions, market volatility, interest rate fluctuations, liquidity risk and credit and default risk. Investment guideline restrictions have been established to minimize the effect of these risks but may not always be effective due to factors beyond our control. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A significant increase in interest rates could result in significant losses, realized or unrealized, in the value of our invested asset portfolio. The composition and duration of our portfolio will vary depending on several factors, including the yield curve and our opinion of the relative value among various asset classes. The average rating and average approximate duration of our fixed-maturity portfolio were as follows:March 31, 2012
Average rating of our fixed-maturity portfolio A
A
Average duration of our fixed-maturity portfolio 3.7 years 3.5 years Average book yield of our fixed-maturity portfolio 5.46%
5.52%
The distribution of our investments in fixed-maturity securities by rating follows. March 31, 2012 December 31, 2011 Amortized cost % Amortized cost % (Dollars in thousands) AAA $ 413,624 23% $ 428,748 24% AA 151,508 8% 150,894 8% A 416,351 23% 431,175 24% BBB 695,257 39% 683,818 38% Below investment grade 112,727 6% 125,594 7% Not rated 1,236 * 770 * Total (1) $ 1,790,703 100% $ 1,820,999 100% ____________________ * Less than 1% (1) Totals may not add due to rounding. 33
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The ten largest holdings within our invested asset portfolio were as follows: March 31, 2012 Cost or amortized Fair Unrealized Credit Issuer cost value gain rating (Dollars in thousands) Government of Canada $ 35,481 $ 39,134 $ 3,653 AAA Verizon Communications Inc 11,496 13,086 1,590 A- General Electric Co 11,449 12,985 1,536 AA+ ProLogis Inc 11,746 12,627 881 BBB- Bank of America Corp 11,674 12,559 885 A- Time Warner Cable Inc 11,914 12,276 362 BBB ConocoPhillips 9,132 10,854 1,722 A Province of Ontario Canada 8,670 10,759 2,089 AA- National Rural Utilities Cooperative 7,184 10,379 3,195 A+ Iberdrola SA 8,468 9,526 1,058 BBB+ Total - ten largest holdings $ 127,214 $ 144,185 $ 16,971 Total - fixed-maturity and equity securities $ 1,815,393 $ 1,986,011 Percent of total fixed-maturity and equity securities 7 % 7 % OurApril 2012 repurchase of$150.0 million of our common stock did not result in meaningful changes to asset mix, duration or overall credit quality of our invested asset portfolio. However, with the reduction in our consolidated cash and invested assets as a result of the repurchase transaction, we expect net investment income to decline. We also expect our average book yield to increase modestly, as the investments sold to fund the dividend generally had yields that were lower than the average book yield on the pre-dividend invested assets portfolio. For additional information on our invested asset portfolio, see Note 3 to our condensed consolidated financial statements. Liquidity and Capital Resources Dividends and other payments to us from our subsidiaries are our principal sources of cash. Our primary uses of funds by the Parent Company include the payment of general operating expenses, the payment of dividends and the payment of interest to Citi under the Citi note. The liquidity requirements of our subsidiaries principally relate to the liabilities associated with their distribution and underwriting of insurance products (including the payment of claims), distribution of investment and savings products, operating expenses, income taxes and the payment of dividends. Historically, our insurance subsidiaries have used cash flow from operations associated with our in-force book of term life insurance to fund their liquidity requirements. Our insurance subsidiaries' principal cash inflows from operating activities are derived from policyholder premiums and investment income earned on invested assets that support our statutory capital and reserves. We also derive cash inflows from the distribution of investment and savings products and other products. Our principal outflows relate to payments for ceded premiums and benefits and claims. The principal cash inflows from investment activities result from repayments of principal and investment income, while the principal outflows relate to purchases of fixed-maturity securities. We typically hold cash sufficient to fund operating flows, and invest any excess cash. Our distribution and underwriting of term life insurance place significant demands on our liquidity, particularly when we experience growth. We pay a substantial majority of the sales commission during the first year following the sale of a policy. Our underwriting activities also require significant cash outflows at the inception of a policy's term. However, we anticipate that cash flows from our businesses, including our existing block of policies and our investment and savings products, will continue to provide us with sufficient liquidity to meet our operating requirements. We may seek to enhance our liquidity position or capital structure through borrowings from third-party sources, sales of debt or equity securities, reserve financings or some combination of these sources. The Model Regulation entitled Valuation of Life Insurance Policies, commonly known as Regulation XXX, requires insurers to carry 34
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statutory reserves for term life insurance policies with long-term premium guarantees which are often significantly in excess of the reserves that insurers deem necessary to satisfy claim obligations. Accordingly, many insurance companies have sought ways to reduce their capital needs by financing these excess reserves through bank financing, reinsurance arrangements and other financing transactions. EffectiveMarch 31, 2012 , we completed a Regulation XXX reserve financing transaction. As part of this transaction,Peach Re, Inc. ("Peach Re"), a special purpose financial captive insurance company and wholly owned subsidiary of Primerica Life, entered into a credit facility agreement withDeutsche Bank (the "Credit Facility Agreement"). Under the Credit Facility Agreement,Deutsche Bank issued a letter of credit with a term of approximately 14 years in an initial amount of$450 million for the benefit of Primerica Life (the "LOC"). Subject to certain conditions, the amount of the LOC will be periodically increased up to a maximum amount of$510 million in 2014. The LOC will be available to support certain obligations of Peach Re for a portion of reserves (commonly referred to as Regulation XXX reserves) related to level premium term life insurance policies ceded to Peach Re from Primerica Life under a coinsurance agreement. In connection with this transaction, Primerica Life obtained regulatory approval for the payment of an extraordinary dividend of$150.0 million to the Parent Company. InApril 2012 , we completed the repurchase of approximately 5.7 million shares of our common stock beneficially owned by private equity funds managed by Warburg Pincus LLC ("Warburg Pincus") for a total purchase price of approximately$150.0 million . For additional information, see Note 11 to our condensed consolidated financial statements. Cash Flows. Cash flows from operating activities are affected primarily by the timing of premiums received, commissions and fees received, benefits paid, commissions paid to sales representatives, administrative and selling expenses, investment income, and cash taxes. Our principal source of cash historically has been premiums received on term life insurance policies in force. We typically generate positive cash flows from operating activities, as premiums, net investment income, commissions and fees collected from our insurance and investment and savings products exceed benefits, commissions and operating expenses paid, and we invest the excess. The components of the change in cash and cash equivalents were as follows: Three months ended March 31, Change 2012 2011 $ (In thousands) Net cash (used in) provided by operating activities $ (16,124 ) $ 3,208 $ (19,332 ) Net cash provided by (used in) investing activities 31,958 (12,423 ) 44,381 Net cash used in financing activities (2,013 ) (757 ) (1,256 ) Effect of foreign exchange rate changes on cash 5,637
(789 ) 6,426 Change in cash and cash equivalents $ 19,458 $ (10,761 )
Operating Activities. The change in operating cash flows compared with the prior-year period was primarily the result of the timing of payments due to reinsurers in our Term Life business. Investing Activities. The increase in investing cash flows was largely due to fewer investment purchases and higher investment sales, partially offset by fewer investment maturities, during the first quarter of 2012 versus the prior year period as we accumulated cash to fund the capitalization of Peach Re. Financing Activities. The increase in net cash used in financing activities was due to the quarterly cash dividend being$0.03 per share in the first quarter of 2012 versus$0.01 per share in the first quarter of 2011. Citi Note. InApril 2010 , we issued a$300.0 million note to Citi as part of our corporate reorganization. We were in compliance with the covenants of the Citi note atMarch 31, 2012 . No events of default or defaults occurred during the three months endedMarch 31, 2012 . See Note 6 to our condensed consolidated financial statements for additional information. We calculate our debt-to-capital ratio by dividing total long-term debt by the sum of stockholders' equity and total long-term debt. As ofMarch 31, 2012 , our debt-to-capital ratio was 17.8%. 35
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Rating Agencies. There have been no changes toPrimerica, Inc.'s senior debt ratings or Primerica Life's financial strength ratings sinceDecember 31, 2011 .Risk-Based Capital . The NAIC has established risk-based capital ("RBC") standards for U.S. life insurers, as well as a risk-based capital model act (the "RBC Model Act") that has been adopted by the insurance regulatory authorities. The RBC Model Act requires that life insurers annually submit a report to state regulators regarding their RBC based upon four categories of risk: asset risk; insurance risk; interest rate risk and business risk. The capital requirement for each is determined by applying factors that vary based upon the degree of risk to various asset, premiums and reserve items. The formula is an early warning tool to identify possible weakly capitalized companies for purposes of initiating further regulatory action. As ofMarch 31, 2012 , our U.S. life insurance subsidiaries had statutory capital substantially in excess of the applicable statutory requirements to support existing operations and to fund future growth. Following the Regulation XXX reserve financing transaction and the$150.0 million dividend from Primerica Life to the Parent Company, Primerica Life's RBC ratio is well positioned to support existing operations and fund future growth. In Canada, an insurer's minimum capital requirement is overseen by the Office of the Superintendentof Financial Institutions Canada ("OSFI") and determined as the sum of the capital requirements for five categories of risk: asset default risk; mortality/morbidity/lapse risks; changes in interest rate environment risk; segregated funds risk and foreign exchange risk.Primerica Life Canada is in compliance with Canada's minimum capital requirements as ofMarch 31, 2012 , as determined by OSFI. Short-term Borrowings. We had no short-term borrowings as of or during the three months endedMarch 31, 2012 . Off-balance Sheet Arrangements. EffectiveMarch 31, 2012 , Peach Re entered into the Credit Facility Agreement withDeutsche Bank . Under the Credit Facility Agreement, the LOC was issued to support certain obligations of Peach Re for a portion of reserves related to level premium term life insurance policies ceded to Peach Re from Primerica Life under a coinsurance agreement, effective as ofMarch 31, 2012 . The LOC has a term of approximately 14 years and was issued in an initial amount of$450 million . Subject to certain conditions, the amount of the LOC will be periodically increased to a maximum amount of$510 million in 2014. The annual pretax expense of the LOC is expected to range from approximately$5.0 million to $7.0 million in 2012 through 2018,$2.0 million to $4.0 million in 2019 through 2023, and to be less than$1.0 million in 2024 and 2025. Pursuant to the terms of the Credit Facility Agreement, in the event amounts are drawn under the LOC by Primerica Life, Peach Re will be obligated, subject to certain limited conditions, to reimburseDeutsche Bank for the amount of any draw and interest thereon. The Credit Facility Agreement is non-recourse to the Parent Company and Primerica Life, meaning that neither is liable for repayingDeutsche Bank for any draws or interest thereon. Pursuant to the terms of a letter agreement withDeutsche Bank , the Parent Company has agreed to guarantee the payment of fees toDeutsche Bank under the Credit Facility Agreement. Pursuant to the Credit Facility Agreement, Peach Re has collateralized its obligations toDeutsche Bank by granting it a security interest in all of its assets with the exception of amounts held in a special account established to meet minimum asset thresholds required by state regulatory authorities. Contractual Obligations Update. There have been no material changes in contractual obligations from those disclosed in the 2011 Annual Report other than the Credit Facility Agreement discussed above in the Off-balance Sheet Arrangements section. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS Investors are cautioned that certain statements contained in this report as well as some statements in periodic press releases and some oral statements made by our officials during our presentations are "forward-looking" statements. Forward-looking statements include, without limitation, any statement that may project, indicate or imply future results, events, performance or achievements, and may contain the words "expect," "intend," "plan," "anticipate," "estimate," "believe," "will be," "will continue," "will likely result," and similar expressions, or future conditional verbs such as "may," "will," "should," "would," and "could." In addition, any statement concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible actions taken by us or our subsidiaries are also forward-looking statements. These forward-looking statements involve external risks and uncertainties, including, but not limited to, those described under the section entitled "Risk Factors" included herein. 36
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Forward-looking statements are based on current expectations and projections about future events and are inherently subject to a variety of risks and uncertainties, many of which are beyond the control of our management team. All forward-looking statements in this report and subsequent written and oral forward-looking statements attributable to us, or to persons acting on our behalf, are expressly qualified in their entirety by these risks and uncertainties. These risks and uncertainties include, among others: • our failure to continue to attract and license new recruits, retain sales
representatives, or license or maintain the licensing of our sales
representatives;
• changes to the independent contractor status of our sales representatives;
• our or our sales representatives' violation of, or non-compliance with, laws and regulations;
• our or our sales representatives' failure to protect the confidentiality
of client information;
• differences between our actual experience and our expectations regarding
mortality, persistency, expenses and investment yields as reflected in the
pricing for our insurance policies; • the occurrence of a catastrophic event that causes a large number of premature deaths of our insureds;
• changes in federal and state legislation and regulation, including other
legislation or regulation that affects our insurance, investment product
businesses;
• our failure to meet risk-based capital standards or other minimum capital
or surplus requirements; • a downgrade or potential downgrade in our insurance subsidiaries' financial strength ratings or in our investment grade credit ratings for the senior unsecured debt that we may elect to offer pursuant to our existing shelf registration statement at some time in the future;
• the effects of credit deterioration and interest rate fluctuations on our
invested asset portfolio;
• incorrectly valuing our investments;
• inadequate or unaffordable reinsurance or the failure of our reinsurers to
perform their obligations;
• the failure of, or legal challenges to, the support tools we provide to
our sales force;
• heightened standards of conduct or more stringent licensing requirements
for our sales representatives;
• inadequate policies and procedures regarding suitability review of client
transactions;
• the inability of our subsidiaries to pay dividends or make distributions;
• our ability to generate and maintain a sufficient amount of working capital;
• our non-compliance with the covenants of the Citi note;
• legal and regulatory investigations and actions concerning us or our sales
representatives;
• the loss of key personnel;
• the failure of our information technology systems, breach of our information security or failure of our business continuity plan; and
• fluctuations in Canadian currency exchange rates.
Developments in any of these areas could cause actual results to differ materially from those anticipated or projected or cause a significant reduction in the market price of our common stock. The foregoing list of risks and uncertainties may not contain all of the risks and uncertainties that could affect us. In addition, in light of these risks and uncertainties, the matters referred to in the forward-looking statements contained in this document may not in fact occur. Accordingly, undue reliance should not be placed on these statements. We undertake no obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise, except as otherwise required by law.
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