10-K 1 y84465e10vk.txt TRAVELERS INSURANCE COMPANY UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM______ TO ______ -------------------------- COMMISSION FILE NUMBER 33-03094 -------------------------- THE TRAVELERS INSURANCE COMPANY (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CONNECTICUT 06-0566090 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) ONE CITYPLACE, HARTFORD, CONNECTICUT 06103-3415 (Address of principal executive offices) (Zip Code) (860) 308-1000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes [X] No [ ] Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] As of the date hereof, there were outstanding 40,000,000 shares of common stock, par value $2.50 per share, of the registrant, all of which were owned by Citigroup Insurance Holding Corporation, an indirect wholly owned subsidiary of Citigroup Inc. REDUCED DISCLOSURE FORMAT The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form with the reduced disclosure format. DOCUMENTS INCORPORATED BY REFERENCE: NONE THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES TABLE OF CONTENTS
FORM 10-K ITEM NUMBER PAGE ----------- ---- PART I 1. Business................................................................................................... 2 A. General................................................................................................ 2 B. Business by Segment Travelers Life & Annuity........................................................................... 2 Primerica Life Insurance........................................................................... 4 C. Insurance Regulations................................................................................... 4 2. Properties................................................................................................. 6 3. Legal Proceedings.......................................................................................... 6 4. Submission of Matters to a Vote of Security Holders........................................................ 6 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters...................................... 6 6. Selected Financial Data.................................................................................... 6 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 7 7A. Quantitative and Qualitative Disclosures About Market Risk................................................. 15 8. Financial Statements and Supplementary Data................................................................ 18 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................... 61 PART III 10. Directors and Executive Officers of the Registrant......................................................... 61 11. Executive Compensation..................................................................................... 61 12. Security Ownership of Certain Beneficial Owners and Management............................................. 61 13. Certain Relationships and Related Transactions............................................................. 61 14. Controls and Procedures.................................................................................... 61 PART IV 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................................... 62 Exhibit Index.............................................................................................. 63 Signatures and Certifications.............................................................................. 64 Index to Financial Statements and Financial Statement Schedules............................................ 67 Exhibit 10.04.............................................................................................. 72 Exhibit 10.05.............................................................................................. 78 Exhibit 14.01.............................................................................................. 82 Exhibit 99.01.............................................................................................. 84
THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K PART I ITEM 1. BUSINESS. GENERAL The Travelers Insurance Company (TIC, together with its subsidiaries, the Company), is a wholly owned subsidiary of Citigroup Insurance Holding Corporation (CIHC), an indirect wholly owned subsidiary of Citigroup Inc. (Citigroup). Citigroup is a diversified global financial services holding company whose businesses provide a broad range of financial services to consumer and corporate customers around the world. The periodic reports of Citigroup provide additional business and financial information concerning it and its consolidated subsidiaries. TIC was incorporated in 1863. With $83.0 billion of assets and $549.1 billion of life insurance in force at December 31, 2002, the Company believes that it is one of the largest stock life insurance groups in the United States as measured by these criteria. At December 31, 2001, the Company was a wholly owned subsidiary of The Travelers Insurance Group, Inc. (TIGI). On February 4, 2002, TIGI changed its name to Travelers Property Casualty Corp. (TPC). TPC completed its initial public offering (IPO) on March 27, 2002 and on August 20, 2002 Citigroup made a tax-free distribution of the majority of its remaining interest in TPC, to Citigroup's stockholders. Prior to the IPO, the common stock of TIC was distributed by TPC to CIHC so that TIC would remain an indirect wholly owned subsidiary of Citigroup. See Note 15 of Notes to Consolidated Financial Statements. The Company's two reportable business segments are Travelers Life & Annuity and Primerica Life Insurance. The primary insurance entities of the Company are TIC and its subsidiary The Travelers Life and Annuity Company (TLAC), included in the Travelers Life & Annuity segment, and Primerica Life Insurance Company (Primerica Life) and its subsidiaries, Primerica Life Insurance Company of Canada, CitiLife Financial Limited (CitiLife) and National Benefit Life Insurance Company (NBL), included in the Primerica Life Insurance segment. The consolidated financial statements include the accounts of the insurance entities of the Company and Tribeca Citigroup Investments Ltd. on a fully consolidated basis. Additional information about the Company is available on the Citigroup website at http://www.citigroup.com by selecting the "Investor Relations" page and selecting "SEC Filings." BUSINESS BY SEGMENT TRAVELERS LIFE & ANNUITY Travelers Life & Annuity (TLA) core offerings include individual annuity, individual life, corporate owned life insurance (COLI) and group annuity insurance products distributed by TIC and TLAC principally under the Travelers Life & Annuity name. Among the range of individual products offered are fixed and variable deferred annuities, payout annuities and term, universal and variable life insurance. The COLI product is a variable universal life product distributed through independent specialty brokers. The group products include institutional pensions, including guaranteed investment contracts, payout annuities, group annuities sold to employer-sponsored retirement and savings plans and structured finance funding agreements. The majority of the annuity business and a substantial portion of the life business written by TLA are accounted for as investment contracts, with the result that the deposits collected are reported as liabilities and are not included in revenues. 2 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K Individual fixed and variable annuities are primarily used for retirement funding purposes. Variable annuities permit policyholders to direct retirement funds into a number of separate accounts, which offer differing investment options. Individual payout annuities offer a guaranteed payment stream over a specified or life contingent period. Individual life insurance is used to meet estate, business planning and retirement needs and also to provide protection against financial loss due to death. Group annuity products, including fixed and variable rate guaranteed investment contracts, which provide a guaranteed return on investment, continue to be a popular investment choice for employer-sponsored retirement and savings plans. Annuities purchased by employer-sponsored plans fulfill retirement obligations to individual employees. Payout annuities are used for providing structured settlements of certain indemnity claims and making other payments to policyholders over a period of time. Structured finance transactions offer fixed term and rate investment options with policyholder status to domestic and foreign institutional investors. These group annuity products are sold through direct sales and various intermediaries. TIC is licensed to sell and market its individual products in all 50 states, the District of Columbia, Puerto Rico, Guam, the Bahamas and the U.S. and British Virgin Islands. Individual annuity products are distributed through affiliated channels and non-affiliated channels. The affiliated channels include CitiStreet Retirement Services LLC (CitiStreet), a joint venture between Citigroup and State Street Bank; Salomon Smith Barney (SSB); Primerica Financial Services (PFS); and Citibank. The non-affiliated channels primarily include a nationwide network of independent financial professionals and independent broker-dealers. CitiStreet is a sales organization of personal retirement planning specialists focused primarily on the qualified periodic deferred annuity marketplace. CitiStreet's share of total individual annuity premiums and deposits was 29% in 2002. SSB distributes TLA's individual annuities and individual life products, and accounted for 19% of total individual annuity premiums and deposits in 2002. Sales by PFS and Citibank accounted for 15% and 7% respectively, of total individual annuity premiums and deposits in 2002. The non-affiliated channels accounted for 30% of individual annuity premiums and deposits. Individual life products are primarily marketed by the independent financial professionals and by SSB, who accounted for 80% and 16%, respectively, of total individual life sales for 2002. Effective July 1, 2000, the Company sold 90% of its individual long-term care insurance business to General Electric Capital Assurance Company in the form of an indemnity reinsurance arrangement. See Note 2 of Notes to Consolidated Financial Statements. The Company operates Tower Square Securities, Inc. (Tower Square Securities), which is an introducing broker-dealer offering a full line of brokerage services. Tower Square Securities facilitates the sale of individual variable life and annuity insurance products by the independent financial professionals. Travelers Distribution LLC is the principal underwriter and distributor for Travelers Life & Annuity variable products. 3 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K PRIMERICA LIFE INSURANCE Primerica Life and its subsidiaries, Primerica Life Insurance Company of Canada, CitiLife and NBL, are the insurance operations of PFS. Their primary product is individual term life insurance marketed through a sales force composed of approximately 107,000 representatives. A great majority of the domestic licensed sales force works on a part-time basis. NBL also provides statutory disability benefit insurance and other insurance, primarily in New York, as well as direct response student term life insurance nationwide. CitiLife was established in September 2000 to underwrite insurance in Europe. Primerica Life, directly or through its subsidiaries, is licensed or otherwise authorized to sell and market term life insurance in all 50 states, the District of Columbia, Puerto Rico, Guam, the U.S. Virgin Islands, Northern Mariana Islands, Canada and Spain. INSURANCE REGULATIONS Insurance Regulatory Information System The National Association of Insurance Commissioners (NAIC) Insurance Regulatory Information System ("IRIS") was developed to help state regulators identify companies that may require special attention. The IRIS system consists of a statistical phase and an analytical phase whereby financial examiners review annual statements and financial ratios. The statistical phase consists of 12 key financial ratios based on year-end data that are generated from the NAIC database annually; each ratio has an established "usual range" of results. These ratios assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies. A ratio result falling outside the usual range of IRIS ratios is not considered a failing result; rather, unusual values are viewed as part of the regulatory early monitoring system. Furthermore, in some years, it may not be unusual for financially sound companies to have several ratios with results outside the usual ranges. An insurance company may fall out of the usual range for one or more ratios because of specific transactions that are in themselves immaterial. Generally, an insurance company will become subject to regulatory scrutiny if it falls outside the usual ranges for four or more of the ratios. Prior to codification of statutory accounting principles effective in 2001, 15% of the companies included in the IRIS system were expected by the NAIC, in normal years, to be outside the usual range on four or more ratios. In 2001, four IRIS ratios for TLAC had fallen outside of the usual range due to growth in business volume. For 2001, the regulators have been satisfied upon follow-up that there was no solvency problem. In 2002, TLAC had three IRIS ratios fall outside of the usual range. No regulatory action has been taken by any state insurance department or the NAIC with respect to IRIS ratios of the primary domestic insurance entities of the Company or any of its insurance subsidiaries during the two years ended December 31, 2002. Risk-Based Capital (RBC) Requirements In order to enhance the regulation of insurer solvency, the NAIC adopted a formula and model law to implement RBC requirements for most life and annuity insurance companies, which are designed to determine minimum capital requirements and to raise the level of protection that statutory surplus provides for policyholder obligations. For this purpose, an insurer's total adjusted capital is measured in relation to its specific asset and liability profiles. A company's risk-based capital is calculated by applying factors to various asset, premium and reserve items, where the factor is higher for those items with greater underlying risk and lower for less risky items. 4 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K The RBC formula for life insurers measures four major areas of risk: - asset risk (i.e., the risk of asset default), - insurance risk (i.e., the risk of adverse mortality and morbidity experience), - interest rate risk (i.e., the risk of loss due to changes in interest rates) and - business risk (i.e., normal business and management risk). Under laws adopted by the states, insurers having less total adjusted capital than that required by the RBC calculation will be subject to varying degrees of regulatory action, depending upon the level of capital inadequacy. The RBC law provides for four levels of regulatory action as defined by the NAIC. The extent of regulatory intervention and action increases as the level of total adjusted capital to RBC falls. The first level, the company action level, requires an insurer to submit a plan of corrective actions to the regulator if total adjusted capital falls below 200% of the RBC amount. The second level, the regulatory action level, requires an insurer to submit a plan containing corrective actions and requires the relevant insurance commissioner to perform an examination or other analysis and issue a corrective order if total adjusted capital falls below 150% of the RBC amount. The third level, the authorized control level, authorizes the relevant commissioner to take whatever regulatory actions are considered necessary to protect the best interest of the policyholders and creditors of the insurer which may include the actions necessary to cause the insurer to be placed under regulatory control, i.e., rehabilitation or liquidation, if total adjusted capital falls below 100% of the RBC amount. The fourth level, the mandatory control level, requires the relevant insurance commissioner to place the insurer under regulatory control if total adjusted capital falls below 70% of the RBC amount. The formulas have not been designed to differentiate among adequately capitalized companies, which operate with higher levels of capital. Therefore, it is inappropriate and ineffective to use the formula to rate or rank companies. At December 31, 2002, the Company's principal domestic insurance entities all had total adjusted capital in excess of amounts requiring company action or any level of regulatory action at any prescribed RBC level. Insurance Regulation Concerning Dividends TIC is domiciled in the State of Connecticut. The insurance holding company law of Connecticut requires notice to, and approval by, the State of Connecticut Insurance Department for the declaration or payment of any dividend which, together with other distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's surplus or (ii) the insurer's net gain from operations for the twelve-month period ending on the preceding December 31st, in each case determined in accordance with statutory accounting practices. Such declaration or payment is further limited by adjusted unassigned funds (surplus), as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the Company's insurance subsidiaries are domiciled generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends. A maximum of $966 million is available by the end of the year 2003 for such dividends without prior approval of the State of Connecticut Insurance Department, depending upon the amount and timing of the payments. TLAC may not pay a dividend to TIC without such approval. Primerica Life may pay up to $148 million to TIC in 2003 without prior approval of the Massachusetts Insurance Department. 5 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K Code of Ethics The Company has adopted a code of ethics for financial professionals which applies to the Company's principal executive officer and principal financial and accounting officer. The code of ethics for financial professionals has been included as an exhibit to this Form 10-K. ITEM 2. PROPERTIES. The Company's executive offices are located in Hartford, Connecticut. At December 31, 2002 the Company leased approximately 284,000 square feet from TPC at One Tower Square, Hartford, Connecticut under a lease that runs through March 31, 2003. The Company previously owned this building complex, and sold it as well as a building in Norcross, Georgia housing TPC's information systems department, to TPC for $68 million as part of the TPC spin-off from Citigroup on February 28, 2002. See Note 15 of Notes to Consolidated Financial Statements. The Company is moving its executive offices to One Cityplace, Hartford, Connecticut, during the first quarter of 2003. The Company will occupy 373,000 square feet at this location under an operating lease that runs through October 31, 2008. Other leasehold interests of the Company include approximately 620,000 square feet of office space in 14 locations throughout the United States. Management believes that these facilities are suitable and adequate for the Company's current needs. See Note 11 of Notes to Consolidated Financial Statements for additional information regarding these facilities. The foregoing discussion does not include information on investment properties. ITEM 3. LEGAL PROCEEDINGS. In the ordinary course of business, TIC and its subsidiaries are defendants or co-defendants in various other litigation matters incidental to and typical of the businesses in which they are engaged. These include civil actions, arbitration proceedings and other matters arising in the normal course of business out of activities as an insurance company, a broker and dealer in securities or otherwise. In the opinion of the Company's management, the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on the Company's results of operations, financial condition or liquidity. This statement is a forward-looking statement within the meaning of the Private Securities Litigation Reform Act. See "Forward-Looking Statements" on page 15. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Omitted pursuant to General Instruction I(2)(c) of Form 10-K. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. The Company has 40,000,000 authorized shares of common stock, all of which are issued and outstanding as of December 31, 2002. All shares are held by an indirect subsidiary of Citigroup, and there exists no established public trading market for the common equity of the Company. The Company paid dividends to its parent of $586 million and $472 million in 2002 and 2001, respectively. See Note 9 of Notes to Consolidated Financial Statements for certain information regarding dividend restrictions. 6 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K ITEM 6. SELECTED FINANCIAL DATA. Omitted pursuant to General Instruction I(2)(a) of Form 10-K. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Management's narrative analysis of the results of operations is presented in lieu of Management's Discussion and Analysis of Financial Condition and Results of Operations, pursuant to General Instruction I(2)(a) of Form 10-K. The Travelers Insurance Company (TIC, together with its subsidiaries, the Company) is a direct subsidiary of Citigroup Insurance Holdings Corporation (CIHC), an indirect wholly owned subsidiary of Citigroup Inc. (Citigroup). At December 31, 2001, the Company was a wholly owned subsidiary of The Travelers Insurance Group, Inc. (TIGI). On February 4, 2002, TIGI changed its name to Travelers Property Casualty Corp. (TPC). TPC completed its initial public offering (IPO) on March 27, 2002 and on August 20, 2002 Citigroup made a tax-free distribution of the majority of its remaining interest in TPC, to Citigroup's stockholders. Prior to the IPO, the common stock of TIC was distributed by TPC to CIHC so that TIC would remain an indirect wholly owned subsidiary of Citigroup. See Note 15 of Notes to Consolidated Financial Statements. The Company is composed of two business segments, Travelers Life & Annuity and Primerica Life Insurance. Travelers Life & Annuity (TLA) core offerings include individual annuity, individual life, corporate owned life insurance (COLI) and group annuity insurance products distributed by TIC and The Travelers Life and Annuity Company (TLAC) under the Travelers Life & Annuity name. Among the range of individual products offered are fixed and variable deferred annuities, payout annuities and term, universal and variable life insurance. These products are primarily distributed through CitiStreet Retirement Services (CitiStreet), Smith Barney Financial Consultants, Primerica Financial Services (PFS), Citibank, and a nationwide network of independent agents and the growing outside broker dealer channel. The COLI product is a variable universal life product distributed through independent specialty brokers. The group products include institutional pensions, including guaranteed investment contracts, payout annuities, group annuities sold to employer-sponsored retirement and savings plans and structured finance transactions. Primerica Life and its subsidiaries, Primerica Life Insurance Company of Canada, CitiLife and NBL, are the insurance operations of PFS. Their primary product is individual term life insurance marketed through a sales force composed of approximately 107,000 representatives. A great majority of the domestic licensed sales force works on a part-time basis. NBL also provides statutory disability benefit insurance and other insurance, primarily in New York, as well as direct response student term life insurance nationwide. CitiLife was established in September 2000 to underwrite insurance in Europe. Primerica Life, directly or through its subsidiaries is licensed or otherwise authorized to sell and market term life insurance in all 50 states, the District of Columbia, Puerto Rico, Guam, the U.S. Virgin Islands, Northern Mariana Islands, Canada and Spain. CRITICAL ACCOUNTING POLICIES The financial statements contain a summary of the Company's significant accounting policies, including a discussion of recently issued accounting pronouncements. Certain of these policies are considered to be critical to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. 7 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K INVESTMENTS Fixed maturities include bonds, notes and redeemable preferred stocks. Fixed maturities, including instruments subject to securities lending agreements (see Note 4 of Notes to Consolidated Financial Statements), are classified as "available for sale" and are reported at fair value, with unrealized investment gains and losses, net of income taxes, credited or charged directly to shareholder's equity. Fair values of investments in fixed maturities are based on quoted market prices or dealer quotes. If quoted market prices are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment are used to record fair value. Changes in assumptions could affect the fair values of fixed maturities. Impairments are realized when investment losses in value are deemed other-than-temporary. The Company conducts regular reviews to assess whether other-than-temporary impairments exist. Changing economic conditions - global, regional, or related to specific issuers or industries - could adversely affect these values. DEFERRED ACQUISITION COSTS Costs of acquiring traditional life, universal life, COLI, deferred annuities and payout annuities are deferred. These deferred acquisition costs (DAC) include principally commissions and certain expenses related to policy issuance, underwriting and marketing, all of which vary with and are primarily related to the production of new business. The method for determining amortization of deferred acquisition costs varies by product type based upon three different accounting pronouncements: Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by Insurance Enterprises" (FAS 60), Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases" (FAS 91) and Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long Duration Contracts and for Realized Gains and Losses from the Sale of Investments" (FAS 97). DAC for deferred annuities, both fixed and variable, and payout annuities are amortized employing a level effective yield methodology per FAS 91 as permitted by AICPA Practice Bulletin 8. An amortization rate is developed using the outstanding DAC balance and projected account balances and is applied to actual account balances to determine the amount of DAC amortization. The projected account balances are derived using a model that contains assumptions related to investment returns and persistency. The model rate is evaluated periodically, at least annually, and the actual rate is reset in the following quarter and applied prospectively. A new amortization pattern is developed so that the DAC balances will be amortized over the remaining estimated life of the business. DAC for these products is currently being amortized over 10-15 years. DAC for universal life and COLI are amortized in relation to estimated gross profits from surrender charges, investment, mortality, and expense margins per FAS 97. Actual profits can vary from management's estimates, resulting in increases or decreases in the rate of amortization. Re- estimates of gross profits result in retrospective adjustments to earnings by a cumulative charge or credit to income. DAC for these products is currently being amortized over 16-25 years. DAC relating to traditional life, including term insurance, and health insurance are amortized in relation to anticipated premiums per FAS 60. Assumptions as to the anticipated premiums are made at the date of policy issuance or acquisition and are consistently applied over the life of the policy. DAC for these products is currently being amortized over 5-20 years. DAC is reviewed to determine if it is recoverable from future income, including investment income, and, if not recoverable, is charged to expense. All other acquisition expenses are charged to operations as incurred. 8 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K FUTURE POLICY BENEFITS Future policy benefits represent liabilities for future insurance policy benefits. The annuity payout reserves are calculated using the mortality and interest assumptions used in the actual pricing of the benefit. Mortality assumptions are based on the Company's experience and are adjusted to reflect deviations such as substandard mortality in structured settlement benefits. The interest rates range from 2.0% to 9.0%, with a weighted average rate of 7.1% for these annuity products. Traditional life products include whole life and term insurance. Future policy benefits for traditional life products are estimated on the basis of actuarial assumptions as to mortality, persistency and interest, established at policy issue. Interest assumptions applicable to traditional life products range from 2.5% to 7.0%, with a weighted average of 3.6%. Assumptions established at policy issue as to mortality and persistency are based on the Company's experience, which, together with interest assumptions, include a margin for adverse deviation. Appropriate recognition has been given to experience rating and reinsurance. PREMIUMS Premiums are recognized as revenues when due. Premiums for contracts with a limited number of premium payments, due over a significantly shorter period than the period over which benefits are provided, are considered income when due. The portion of premium which is not required to provide for benefits and expenses is deferred and recognized in income in a constant relationship to insurance benefits in force. CONSOLIDATED OVERVIEW
FOR THE YEARS ENDED DECEMBER 31, 2002 2001 -------------------------------- ---- ---- ($ in millions) Revenues $5,234 $5,702 ====== ====== Net income $1,082 $1,272 Net realized (gains) losses 209 (81) Change in accounting principles - 9 ------ ------ Operating income $1,291 $1,200 ====== ======
Net income declined 15% to $1.1 billion in 2002 from $1.3 billion in 2001. This decrease is attributable to net realized investment losses in 2002 of $209 million after-tax, including after-tax impairments to the fixed maturities portfolio related to WorldCom Inc. of $126 million, as well other fixed maturities and equity investment impairments, versus net realized gains of $81 million after-tax in 2001. Offsetting these declines from realized investment losses was an 8% increase in operating income. Operating income was $1.29 billion in 2002 up from $1.20 billion in 2001. The operating earnings increase was driven by increases in both business segments. See detailed description of each business segment. Revenues were down 8%, driven by the $322 million pre-tax realized investment losses in 2002 versus $125 million pre-tax realized investment gains in the prior year. Revenues in 2002 also include $125 million of dividends from Citigroup Series YYY Preferred Stock, contributed from TPC. See Note 15 of Notes to Consolidated Financial Statements. 9 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K TRAVELERS LIFE & ANNUITY
FOR THE YEARS ENDED DECEMBER 31, 2002 2001 -------------------------------- ---- ---- ($ in millions) Revenues $3,653 $4,089 ====== ====== Net income $ 673 $ 826 Net realized (gains) losses 211 (33) Change in accounting principles - 8 ------ ------ Operating income $ 884 $ 801 ====== ======
Net income of $673 million in 2002 declined 19% from $826 million in 2001 primarily due to after-tax realized investment losses of $211 million in 2002, including after-tax impairments to the fixed maturities portfolio related to WorldCom Inc. of $122 million, as well as other fixed maturities and equity investment impairments, versus $33 million after-tax realized investment gains in 2001. The 2002 decline was partially offset by an $83 million increase in operating income. Operating income included a pre-tax increase in net investment income of $116 million, driven by $125 million of dividends from Citigroup Series YYY Preferred Stock not received in the prior year. This operating income increase from the Series YYY dividends was offset by decreased retained investment margins as a result of lower fixed income returns and a declining equity market, partially offset by continued strong volumes in the group annuity and individual life businesses. TLA investment income of $2,646 million, including Citigroup Preferred Stock, in 2002 was approximately level with 2001. The decreased investment margins from the overall rate deterioration in 2002 was offset by a larger invested asset base from higher business volumes. Fixed maturities suffered from the lower rate environment and credit issues. Equity investment returns were below the prior year, but were offset by growth in real estate income. Real estate is primarily comprised of mortgage loan investments and real estate joint ventures. 10 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K The following table shows net written premiums and deposits by product line for each of the years ended December 31, 2002 and 2001. The majority of the annuity business and a substantial portion of the life business written by TLA are accounted for as investment contracts, such that the premiums are considered deposits and are not included in revenues.
2002 2001 -------------------------------- -------------------------------- IN MILLIONS OF DOLLARS Premiums Deposits Total Premiums Deposits Total -------- -------- ------- -------- -------- ------- Individual annuities Fixed $ - $ 2,182 $ 2,182 $ - $ 2,096 $ 2,096 Variable - 3,111 3,111 - 3,982 3,982 Individual payout 28 30 58 22 37 59 -------- -------- ------- -------- -------- ------- Total individual annuities 28 5,323 5,351 22 6,115 6,137 GICS and other annuities 545 5,747 6,292 768 6,300 7,068 Individual life insurance: Direct periodic premiums & deposits 135 636 771 137 515 652 Single premium deposits - 285 285 - 208 208 Reinsurance (28) (85) (113) (25) (71) (96) -------- -------- ------- -------- -------- ------- Total individual life insurance 107 836 943 112 652 764 Other 50 - 50 55 - 55 -------- -------- ------- -------- -------- ------- Total $ 730 $ 11,906 $12,636 $ 957 $ 13,067 $14,024 ======== ======== ======= ======== ======== =======
Individual annuity net written premiums and deposits decreased 13% in 2002 to $5.351 billion from $6.137 billion in 2001. The decrease was driven by a decline in variable annuity sales due to current market conditions, but were partially offset by strong fixed annuity sales increases over the prior-year period. In 2002, non-affiliated sales channel business grew to 30% of total individual annuity sales in 2002 from 26% in 2001 as TLA continued to increase its presence in the broker-dealer marketplace. Individual annuity account balances and benefits reserves were $27.5 billion at December 31, 2002, down from $28.9 billion at December 31, 2001. These decreases reflect declines in market values of variable annuity investments of $3.6 billion in 2002 and $2.4 billion in 2001, partially offset by good in-force retention. Group Annuity net written premiums and deposits (excluding the Company's employee pension plan deposits) in 2002 were $6.292 billion, versus $7.068 billion in 2001. The decline of $776 million in 2002 from 2001 reflects lower fixed guaranteed investment contracts (GIC) and large case employer pension sales. The decline in fixed GIC net written premiums and deposits reflects lower European Medium-Term Note sales due to market conditions. Group annuity account balances and benefit reserves reached $22.3 billion at December 31, 2002, an increase of $1.3 billion or 6% from $21.0 billion at December 31, 2001, primarily reflecting continued strong retention in all products and continued sales momentum in structured settlement products. Net written premiums and deposits for the life insurance business were $943 million in 2002, up 23% from $764 million in 2001. This increase was related to direct periodic premiums and deposits for individual life insurance in 2002, which were up 18% to $771 million from $652 million in 2001, driven by independent agent high-end estate planning and COLI sales. Life insurance in force was $82.3 billion at December 31, 2002, up from $75.7 billion at December 31, 2001. During 2002, TLA expenses increased primarily due to volume related insurance expenses, including premium taxes and renewal commissions and expenses related to the transfer of employee benefit liabilities from the spin-off of Travelers Property Casualty, which were offset in revenue related to the assets transferred. During the first quarter of 2002, TLA had a one-time decrease in DAC amortization of $22 million related to changes in the underlying lapse and interest rate assumptions in the individual annuity business. This decrease was mostly offset in the fourth quarter of 2002, by an increase in amortization expense due to a higher amortization rate resulting from the decrease in market value of individual annuity account balances. 11 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K The amortization of capitalized DAC is a significant component of TLA expenses. TLA's recording of DAC varies based upon product type. DAC for deferred annuities, both fixed and variable, and payout annuities employs a level yield methodology as per FAS 91. DAC for universal life (UL) and COLI are amortized in relation to estimated gross profits as per FAS 97, with traditional life, including term insurance and other products amortized in relation to anticipated premiums as per FAS 60. The following is a summary of capitalized DAC by type:
Deferred & Payout Traditional In millions of dollars Annuities UL & COLI Life & Other Total ---------------------------------------------------------------------------------------------------------------------- Balance December 31, 2000 $ 896 $ 299 $ 96 $ 1,291 ----------------------------------------------------------------------- Commissions and expenses deferred 385 142 26 553 Amortization expense (144) (11) (16) (171) ----------------------------------------------------------------------- Balance December 31, 2001 1,137 430 106 1,673 Commissions and expenses deferred and other 347 172 26 545 Amortization expense (131) (24) (19) (174) ----------------------------------------------------------------------- Balance December 31, 2002 $ 1,353 $ 578 $ 113 $ 2,044 ----------------------------------------------------------------------------------------------------------------------
OUTLOOK TLA should benefit from growth in the aging population which is becoming more focused on the need to accumulate adequate savings for retirement, to protect these savings and to plan for the transfer of wealth to the next generation. TLA is well positioned to take advantage of the favorable long-term demographic trends through its strong financial position, widespread brand name recognition and broad array of competitive life, annuity and retirement, and estate planning products sold through established distribution channels. However, competition in both product pricing and customer service is intensifying. While there has been some consolidation within the industry, other financial services organizations are increasingly involved in the sale and/or distribution of insurance products. Also, the annuities business is interest rate and market sensitive. TLA's business is significantly affected by movements in the U.S. equity and fixed income credit markets. U.S. equity and credit market events can have both positive and negative effects on the deposit, revenue and policy retention performance of the business. A sustained weakness in the equity markets will decrease revenues and earnings in variable products. Declines in credit quality of issuers will have a negative effect on earnings. In order to strengthen its competitive position, TLA expects to maintain a current product portfolio, further diversify its distribution channels, and retain its financial position through strong sales growth and maintenance of an efficient cost structure. President Bush's recent budget proposal (the Budget Proposal) contains a number of provisions that could impact the Company, including provisions to eliminate the double taxation of corporate dividends and to create new types of savings accounts with tax-free earnings. The Budget Proposal is in its early stages of consideration. 12 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K It is not possible to predict whether the Budget Proposal will be enacted, what form such legislation might take when enacted, or the potential effects of such legislation on the Company and its competitors. The Company does not expect the Budget Proposal to have a material impact on its financial condition or liquidity. In July 2002, the Accounting Standards Executive Committee (AcSEC) issued a Proposed Statement of Position (PSOP) on Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. This PSOP includes accounting and disclosure for separate account assets, liabilities, gains and losses transferred from the separate account, as well as accounting and reserving for nontraditional contracts that contain death and other insurance features. The contracts containing death and other insurance features are generally referred to as Guaranteed Minimum Death Benefits (GMDB). The Company reports GMDB reserves in future policy benefits. These reserves are currently sufficient to cover the reserves required by this PSOP. The effective date of this PSOP is for fiscal years beginning after December 15, 2003, with earlier adoption encouraged. The adoption of this PSOP will not have a significant effect on the Company's results of operations, financial condition or liquidity. The statements above are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. See "Forward-Looking Statements" on page 15. PRIMERICA LIFE INSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2002 2001 ------------------------------------ ------ ------ ($ in millions) Revenues $1,581 $1,613 ====== ====== Net income $ 409 $ 446 Net realized (gains) (2) (48) Change in accounting principle - 1 ------ ------ Operating income $ 407 $ 399 ====== ======
Net income decreased 8% to $409 million due to net realized investment gains of $2 million, including the impairment of the fixed maturities portfolio investment in WorldCom Inc. totaling $4 million, net of tax, compared to $48 million of net realized investments gains in 2001. Operating income was $407 million in 2002 compared to $399 million in 2001. The 2% improvement in 2002 reflects growth in life insurance in force and the discontinuance of goodwill amortization in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," offset by lower portfolio return due to a declining interest rate environment. The increase in expense for DAC is the result of an increase in life insurance production. Other general expense increased slightly consistent with the increase in in-force. Mortality experience was unchanged in 2002, however, there was an increase in incurred claims. This increase is provided for by growth in the in-force, associated premium revenues and policyholders reserve balances. 13 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K The amortization of capitalized DAC is a significant component of Primerica Life's expenses. All of Primerica Life's DAC is associated with FAS 60 products. DAC is amortized in relation to anticipated premiums as per FAS 60. Amortized DAC has remained level as a percentage of direct premiums. The increase in the amount of amortization over 2001 is associated with growth in sales and in-force. The following is a summary of capitalized DAC:
In millions of dollars --------------------------------------------------------------- Balance December 31, 2000 $1,698 --------------------------------------------------------------- Deferred expenses and other 298 Amortization expense (208) --------------------------------------------------------------- Balance December 31, 2001 1,788 --------------------------------------------------------------- Deferred expenses and other 323 Amortization expense (219) --------------------------------------------------------------- Balance December 31, 2002 $1,892 ---------------------------------------------------------------
EARNED PREMIUMS, NET OF REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2002 2001 ------------------------------------ ------ ------ ($ in millions) Individual term life $1,127 $1,078 Other 67 67 ------ ------ $1,194 $1,145 ====== ======
The total face amount of term life insurance issued was $79.3 billion in 2002 compared to $71.5 billion in 2001. This increase in term life production resulted from the increase in licensed life representatives. Life insurance in force at year-end 2002 reached $466.8 billion, up from $434.8 billion at year-end 2001, reflecting consistent good in-force policy retention and higher volume of sales. OUTLOOK Over the last few years, programs including sales and product training have been designed to maintain high compliance standards, increase the number of producing agents and customer contacts and, ultimately, increase production levels. Insurance in force has grown and the number of producing agents has also grown. A continuation of these trends could positively influence future operations. This statement is a forward-looking statement within the meaning of the Private Securities Litigation Reform Act. See "Forward-Looking Statements" on page 15. 14 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K FUTURE APPLICATION OF ACCOUNTING STANDARDS See Note 1 of Notes to Consolidated Financial Statements for Future Applications of Accounting Standards. FORWARD-LOOKING STATEMENTS Certain of the statements contained herein that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The Company's actual results may differ materially from those included in the forward-looking statements. Forward-looking statements are typically identified by the words "believe," "expect," "anticipate," "intend," "estimate," "may increase," "may fluctuate," and similar expressions, or future or conditional verbs such as "will," "should," "would," and "could." These forward-looking statements involve risks and uncertainties including, but not limited to, regulatory matters, the resolution of legal proceedings and the Company's market risk, as well as the discussions of the Company's prospects under "Outlook" for each of the businesses. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates, and other relevant market rate or price changes. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded. The following is a discussion of the Company's primary market risk exposures and how those exposures are currently managed as of December 31, 2002. MARKET RISK SENSITIVE INSTRUMENTS ENTERED INTO FOR PURPOSES OTHER THAN TRADING The primary market risk to the Company's investment portfolio is interest rate risk associated with investments. The Company's exposure to equity price risk and foreign exchange risk is not significant. The Company has no direct commodity risk. The interest rate risk taken in the investment portfolio is managed relative to the duration of the liabilities. The portfolio is differentiated by product line, with each product line's portfolio structured to meet its particular needs. Potential liquidity needs of the business are also key factors in managing the investment portfolio. The portfolio duration relative to the liabilities' duration is primarily managed through cash market transactions. For additional information regarding the Company's investment portfolio see Note 4 of Notes to Consolidated Financial Statements. There were no significant changes in the Company's primary market risk exposures or in how those exposures are managed compared to the year ended December 31, 2001. The Company does not anticipate significant changes in the Company's primary market risk exposures or in how those exposures are managed in future reporting periods based upon what is known or expected to be in effect in future reporting periods. The statements above are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. See "Forward-Looking Statements" on page 15. 15 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K SENSITIVITY ANALYSIS Sensitivity analysis is defined as the measurement of potential loss in future earnings, fair values or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates and other market rates or prices over a selected time. In the Company's sensitivity analysis model, a hypothetical change in market rates is selected that is expected to reflect reasonably possible near-term changes in those rates. The term "near-term" means a period of time going forward up to one year from the date of the financial statements. Actual results may differ from the hypothetical change in market rates assumed in this report, especially since this sensitivity analysis does not reflect the results of any actions that would be taken by the Company to mitigate such hypothetical losses in fair value. In this sensitivity analysis model, the Company uses fair values to measure its potential loss. The sensitivity analysis model includes the following financial instruments: fixed maturities, interest-bearing non-redeemable preferred stock, mortgage loans, short-term securities, cash, investment income accrued, policy loans, contractholder funds, guaranteed separate account assets and liabilities and derivative financial instruments. In addition, certain non-financial instrument liabilities have been included in the sensitivity analysis model. These non-financial instruments include future policy benefits and policy and contract claims. The primary market risk to the Company's market sensitive instruments is interest rate risk. The sensitivity analysis model uses a 100 basis point change in interest rates to measure the hypothetical change in fair value of financial instruments and the non-financial instruments included in the model. For invested assets, duration modeling is used to calculate changes in fair values. Durations on invested assets are adjusted for call, put and reset features. Portfolio durations are calculated on a market value weighted basis, including accrued investment income, using trade date holdings as of December 31, 2002 and 2001. The sensitivity analysis model used by the Company produces a loss in fair value of interest rate sensitive invested assets of approximately $1.9 billion and $1.7 billion based on a 100 basis point increase in interest rates as of December 31, 2002 and 2001, respectively. Liability durations are determined consistently with the determination of liability fair values. Where fair values are determined by discounting expected cash flows, the duration is the percentage change in the fair value for a 100 basis point change in the discount rate. Where liability fair values are set equal to surrender values, option-adjusted duration techniques are used to calculate changes in fair values. The sensitivity analysis model used by the Company produces a decrease in fair value of interest rate sensitive insurance policy and claims reserves of approximately $1.5 billion and $1.3 billion based on a 100 basis point increase in interest rates as of December 31, 2002 and 2001, respectively. Based on the sensitivity analysis model used by the Company, the net loss in fair value of market sensitive instruments, including non-financial instrument liabilities, as a result of a 100 basis point increase in interest rates as of December 31, 2002 and 2001 is not material. MARKET RISK SENSITIVE INSTRUMENTS ENTERED INTO FOR TRADING PURPOSES The Company maintains a trading portfolio through Tribeca Citigroup Investments Ltd. consisting of carrying values of $1,531 million and $1,880 million of convertible bonds and common stocks as of December 31, 2002 and 2001, respectively, and $598 million and $891 million of liabilities resulting from common stocks sold not yet purchased (referred to as short sales) as of December 31, 2002 and 2001, respectively. The primary market risk to the trading portfolio is equity risk. Assets are reported as trading securities and liabilities are reported as trading securities sold not yet purchased. 16 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K The common stocks are paired with short sales, reflecting the Company's arbitrage strategy where both positions are invested in each of the companies involved in a merger. The convertible bonds are also paired with short sales of the common stocks of companies issuing the convertible bonds. These positions are established and maintained so that general changes in equity markets and interest rates should not materially impact the value of the portfolio. TABULAR PRESENTATION The table below provides information about the trading portfolio's financial instruments that are primarily exposed to equity price risk. This table presents the fair values of these instruments by trading portfolio type, as designated internally by the Company, as of December 31, 2002 and 2001. Fair values are based upon quoted market prices.
Fair value as of Fair value as of ($ in millions) December 31, 2002 December 31, 2001 --------------- ----------------- ----------------- ASSETS Trading securities Convertible bond arbitrage $1,442 $1,798 Merger arbitrage 47 80 Other 42 2 ------ ------ $1,531 $1,880 ====== ====== LIABILITIES Trading securities sold not yet purchased Convertible bond arbitrage $ 520 $ 836 Merger arbitrage 13 51 Other 65 4 ------ ------ $ 598 $ 891 ====== ======
The Company's trading portfolio investments and related liabilities are normally held for periods less than six months. Therefore, expected future cash flows for these assets and liabilities are expected to be realized in less than one year. 17 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report...................................................................................... 19 Consolidated Financial Statements: Consolidated Statements of Income for the years ended December 31, 2002, 2001 and 2000............................................................... 20 Consolidated Balance Sheets - December 31, 2002 and 2001....................................................... 21 Consolidated Statements of Changes in Shareholder's Equity for the years ended December 31, 2002, 2001 and 2000........................................................... 22 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000............................................................... 23 Notes to Consolidated Financial Statements..................................................................... 24-60
18 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholder The Travelers Insurance Company: We have audited the accompanying consolidated balance sheets of The Travelers Insurance Company and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholder's equity and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Travelers Insurance Company and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets in 2002, and its methods of accounting for derivative instruments and hedging activities and for securitized financial assets in 2001. /s/ KPMG LLP Hartford, Connecticut January 21, 2003 19 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME ($ in millions)
FOR THE YEAR ENDED DECEMBER 31, 2002 2001 2000 ------ ------ ------ REVENUES Premiums $1,924 $ 2,102 $ 1,966 Net investment income 2,936 2,831 2,730 Realized investment gains (losses) (322) 125 (77) Fee income 560 537 528 Other revenues 136 107 107 -------------------------------------------------------------------------------------------------------------------------- Total Revenues 5,234 5,702 5,254 -------------------------------------------------------------------------------------------------------------------------- BENEFITS AND EXPENSES Current and future insurance benefits 1,711 1,862 1,752 Interest credited to contractholders 1,220 1,179 1,038 Amortization of deferred acquisition costs 393 379 347 General and administrative expenses 407 371 463 -------------------------------------------------------------------------------------------------------------------------- Total Benefits and Expenses 3,731 3,791 3,600 -------------------------------------------------------------------------------------------------------------------------- Income from operations before federal income taxes and cumulative effects of changes in accounting principles 1,503 1,911 1,654 -------------------------------------------------------------------------------------------------------------------------- Federal income taxes Current 236 471 462 Deferred 185 159 89 -------------------------------------------------------------------------------------------------------------------------- Total Federal Income Taxes 421 630 551 -------------------------------------------------------------------------------------------------------------------------- Income before cumulative effects of changes in accounting principles 1,082 1,281 1,103 Cumulative effect of change in accounting for derivative instruments and hedging activities, net of tax - (6) - Cumulative effect of change in accounting for securitized financial assets, net of tax - (3) - -------------------------------------------------------------------------------------------------------------------------- Net Income $1,082 $ 1,272 $ 1,103 ==========================================================================================================================
See Notes to Consolidated Financial Statements. 20 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ($ in millions)
AT DECEMBER 31, 2002 2001 -------------------------------------------------------------------------------------------------------------------------- ASSETS Fixed maturities, available for sale at fair value (including $2,687 and $2,330 subject to securities lending agreements) (cost $35,428; $31,730) $36,434 $32,072 Equity securities, at fair value (cost $328; $471) 332 472 Mortgage loans 1,985 1,995 Real estate 36 55 Policy loans 1,168 1,208 Short-term securities 4,414 3,053 Trading securities, at fair value 1,531 1,880 Other invested assets 4,909 2,485 -------------------------------------------------------------------------------------------------------------------------- Total Investments 50,809 43,220 -------------------------------------------------------------------------------------------------------------------------- Cash 186 146 Investment income accrued 525 487 Premium balances receivable 151 137 Reinsurance recoverables 4,301 4,163 Deferred acquisition costs 3,936 3,461 Separate and variable accounts 21,620 24,837 Other assets 1,467 1,415 -------------------------------------------------------------------------------------------------------------------------- Total Assets $82,995 $77,866 -------------------------------------------------------------------------------------------------------------------------- LIABILITIES Contractholder funds $26,634 $22,810 Future policy benefits and claims 15,009 14,221 Separate and variable accounts 21,620 24,837 Deferred federal income taxes 1,448 409 Trading securities sold not yet purchased, at fair value 598 891 Other liabilities 6,051 5,518 -------------------------------------------------------------------------------------------------------------------------- Total Liabilities 71,360 68,686 -------------------------------------------------------------------------------------------------------------------------- SHAREHOLDER'S EQUITY Common stock, par value $2.50; 40 million shares authorized, issued and outstanding 100 100 Additional paid-in capital 5,443 3,864 Retained earnings 5,638 5,142 Accumulated other changes in equity from nonowner sources 454 74 -------------------------------------------------------------------------------------------------------------------------- Total Shareholder's Equity 11,635 9,180 -------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholder's Equity $82,995 $77,866 ==========================================================================================================================
See Notes to Consolidated Financial Statements. 21 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY ($ in millions)
FOR THE YEAR ENDED DECEMBER 31, -------------------------------------------------------------------------------------------------------------------------- COMMON STOCK 2002 2001 2000 -------------------------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 100 $ 100 $ 100 Changes in common stock - - - -------------------------------------------------------------------------------------------------------------------------- Balance, end of year $ 100 $ 100 $ 100 ========================================================================================================================== -------------------------------------------------------------------------------------------------------------------------- ADDITIONAL PAID-IN CAPITAL -------------------------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 3,864 $ 3,843 $ 3,819 Stock option tax benefit (expense) (17) 21 24 Capital contributed by parent 1,596 - - -------------------------------------------------------------------------------------------------------------------------- Balance, end of year $ 5,443 $ 3,864 $ 3,843 ========================================================================================================================== -------------------------------------------------------------------------------------------------------------------------- RETAINED EARNINGS -------------------------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 5,142 $ 4,342 $ 4,099 Net income 1,082 1,272 1,103 Dividends to parent (586) (472) (860) -------------------------------------------------------------------------------------------------------------------------- Balance, end of year $ 5,638 $ 5,142 $ 4,342 ========================================================================================================================== -------------------------------------------------------------------------------------------------------------------------- ACCUMULATED OTHER CHANGES IN EQUITY FROM NONOWNER SOURCES -------------------------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 74 $ 104 $ (398) Cumulative effect of accounting for derivative instruments and hedging activities, net of tax - (29) - Unrealized gains, net of tax 455 68 501 Foreign currency translation, net of tax 3 (3) 1 Derivative instrument hedging activity losses, net of tax (78) (66) - -------------------------------------------------------------------------------------------------------------------------- Balance, end of year $ 454 $ 74 $ 104 ========================================================================================================================== -------------------------------------------------------------------------------------------------------------------------- SUMMARY OF CHANGES IN EQUITY FROM NONOWNER SOURCES -------------------------------------------------------------------------------------------------------------------------- Net income $ 1,082 $ 1,272 $ 1,103 Other changes in equity from nonowner sources 380 (30) 502 -------------------------------------------------------------------------------------------------------------------------- Total changes in equity from nonowner sources $ 1,462 $ 1,242 $ 1,605 ========================================================================================================================== -------------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDER'S EQUITY -------------------------------------------------------------------------------------------------------------------------- Changes in total shareholders' equity $ 2,455 $ 791 $ 769 Balance, beginning of year 9,180 8,389 7,620 -------------------------------------------------------------------------------------------------------------------------- Balance, end of year $11,635 $ 9,180 $ 8,389 ==========================================================================================================================
See Notes to Consolidated Financial Statements. 22 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH ($ in millions)
FOR THE YEAR ENDED DECEMBER 31, 2002 2001 2000 -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Premiums collected $ 1,917 $ 2,109 $ 1,986 Net investment income received 2,741 2,430 2,489 Other revenues received 384 867 865 Benefits and claims paid (1,218) (1,176) (1,193) Interest credited to contractholders (1,220) (1,159) (1,046) Operating expenses paid (1,022) (1,000) (970) Income taxes paid (197) (472) (490) Trading account investments (purchases), sales, net 76 (92) (143) Other (393) (227) (258) -------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 1,068 1,280 1,240 -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of investments Fixed maturities 4,459 3,706 4,257 Mortgage loans 374 455 380 Proceeds from sales of investments Fixed maturities 15,472 14,110 10,840 Equity securities 945 112 397 Real estate held for sale 26 6 244 Purchases of investments Fixed maturities (23,623) (22,556) (17,836) Equity securities (867) (50) (7) Mortgage loans (355) (287) (264) Policy loans, net 39 41 9 Short-term securities purchases, net (1,320) (914) (810) Other investments (purchases), sales, net (69) 103 (461) Securities transactions in course of settlement, net 529 1,086 944 -------------------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (4,390) (4,188) (2,307) -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Contractholder fund deposits 8,505 8,308 6,022 Contractholder fund withdrawals (4,729) (4,932) (4,030) Capital contribution by parent 172 - - Dividends to parent company (586) (472) (860) -------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Financing Activities 3,362 2,904 1,132 -------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash 40 (4) 65 Cash at December 31, previous year 146 150 85 -------------------------------------------------------------------------------------------------------------------------- Cash at December 31, current year $ 186 $ 146 $ 150 ==========================================================================================================================
See Notes to Consolidated Financial Statements. 23 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Significant accounting policies used in the preparation of the accompanying financial statements follow. BASIS OF PRESENTATION The Travelers Insurance Company (TIC, together with its subsidiaries, the Company), is a wholly owned subsidiary of Citigroup Insurance Holding Corporation (CIHC), an indirect wholly owned subsidiary of Citigroup Inc. (Citigroup), a diversified global financial services holding company whose businesses provide a broad range of financial services to consumer and corporate customers around the world. The consolidated financial statements include the accounts of the Company and its insurance and non-insurance subsidiaries on a fully consolidated basis. The primary insurance entities of the Company are TIC and its subsidiaries, The Travelers Life and Annuity Company (TLAC), Primerica Life Insurance Company (Primerica Life), and its subsidiaries, Primerica Life Insurance Company of Canada, CitiLife Financial Limited (CitiLife) and National Benefit Life Insurance Company (NBL). Significant intercompany transactions and balances have been eliminated. At December 31, 2001, the Company was a wholly owned subsidiary of The Travelers Insurance Group, Inc. (TIGI). On February 4, 2002, TIGI changed its name to Travelers Property Casualty Corp. (TPC). TPC completed its initial public offering (IPO) on March 27, 2002 and on August 20, 2002 Citigroup made a tax-free distribution of the majority of its remaining interest in TPC, to Citigroup's stockholders. Prior to the IPO, the common stock of TIC was distributed by TPC to CIHC so that TIC would remain an indirect wholly owned subsidiary of Citigroup. See Note 15. The financial statements and accompanying footnotes of the Company are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and benefits and expenses during the reporting period. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the 2002 presentation. ACCOUNTING CHANGES BUSINESS COMBINATIONS, GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, the Company adopted the Financial Accounting Standards Board (FASB) Statements of Financial Accounting Standards No. 141, "Business Combinations" (FAS 141) and No. 142, "Goodwill and Other Intangible Assets" (FAS 142). These standards change the accounting for business combinations by, among other things, prohibiting the prospective use of pooling-of-interests accounting and requiring companies to stop amortizing goodwill and certain intangible assets with an indefinite useful life created by business combinations accounted for using the purchase method of accounting. Instead, goodwill and intangible assets deemed to have an indefinite useful life will be subject to an annual review for impairment. Other intangible assets that are not deemed to have an indefinite useful life will continue to be amortized over their useful lives. See Note 6. 24 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company stopped amortizing goodwill on January 1, 2002. During 2001, the Company reversed $8 million of negative goodwill. Net income adjusted to exclude the impact of goodwill amortization for the twelve months ended December 31, 2001 is as follows:
Twelve Months Ended ($ in millions) December 31, 2001 ----------------- Net income: Reported net income $1,272 Negative goodwill reversal (8) Goodwill amortization 7 ------ Adjusted net income $1,271 ======
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS Effective January 1, 2002, the Company adopted the FASB Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144). FAS 144 establishes a single accounting model for long-lived assets to be disposed of by sale. A long-lived asset classified as held for sale is to be measured at the lower of its carrying amount or fair value less cost to sell. Depreciation (amortization) is to cease. Impairment is recognized only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and fair value of the asset. Long-lived assets to be abandoned, exchanged for a similar productive asset, or distributed to owners in a spin-off are considered held and used until disposed of. Accordingly, discontinued operations are no longer to be measured on a net realizable value basis, and future operating losses are no longer recognized before they occur. The provisions of the new standard are to be applied prospectively. There has been no impact as of December 31, 2002 on the Company's results of operations, financial condition or liquidity due to this standard. The Company does not expect the impact of this standard to be significant in future reporting periods. ACCOUNTING STANDARDS NOT YET ADOPTED COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES On January 1, 2003, the Company adopted the FASB Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (FAS 146). FAS 146 requires that a liability for costs associated with exit or disposal activities, other than in a business combination, be recognized when the liability is incurred. Previous generally accepted accounting principles provided for the recognition of such costs at the date of management's commitment to an exit plan. In addition, FAS 146 requires that the liability be measured at fair value and be adjusted for changes in estimated cash flows. The provisions of the new standard are effective for exit or disposal activities initiated after December 31, 2002. It is not expected that FAS 146 will materially affect the Company's consolidated financial statements. 25 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STOCK BASED COMPENSATION On January 1, 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (FAS 123), prospectively for all awards granted, modified, or settled after December 31, 2002. The prospective method is one of the adoption methods provided for under FAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," issued in December 2002. FAS 123 requires that compensation cost for all stock awards be calculated and recognized over the service period (generally equal to the vesting period). This compensation cost is determined using option pricing models, intended to estimate the fair value of the awards at the grant date. Similar to APB 25, the alternative method of accounting, an offsetting increase to stockholders' equity under FAS 123 is recorded equal to the amount of compensation expense charged. Had the Company applied FAS 123 in accounting for Citigroup stock options, net income would have been the pro forma amounts indicated below:
-------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, ($ in millions) 2002 2001 2000 -------------------------------------------------------------------------------------------------- Net income, as reported $ 1,082 $ 1,272 $ 1,103 FAS 123 pro forma adjustments, after tax (9) (15) (19) -------------------------------------------------------------------------------------------------- Net income, pro forma $ 1,073 $ 1,257 $ 1,084 --------------------------------------------------------------------------------------------------
The assumptions used in applying FAS 123 to account for Citigroup stock options were as follows:
-------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2002 2001 2000 -------------------------------------------------------------------------------------------------- Expected volatility of Citigroup Stock 36.98% 38.31% 41.5% Risk-free interest rate 3.65% 4.42% 6.23% -------------------------------------------------------------------------------------------------- Expected annual dividend per Citigroup share $ 0.92 $ 0.92 $ 0.78 -------------------------------------------------------------------------------------------------- Expected annual forfeiture rate 7% 5% 5% --------------------------------------------------------------------------------------------------
The adoption of this change in accounting principle will not have a significant impact on the Company's results of operations, financial condition or liquidity. CONSOLIDATION OF VARIABLE INTEREST ENTITIES In January 2003, the FASB released FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). This Interpretation changes the method of determining whether certain entities should be included in the Company's Consolidated Financial Statements. An entity is subject to FIN 46 and is called a variable interest entity (VIE) if it has (1) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) equity investors that cannot make significant decisions about the entity's operations, or that do not absorb the expected losses or receive the expected returns of the entity. All other entities are evaluated for consolidation under FAS No. 94, "Consolidation of All Majority-Owned Subsidiaries." A VIE is consolidated by its primary beneficiary, which is the party involved with the VIE that has a majority of the expected losses or a majority of the expected residual returns or both. 26 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The provisions of FIN 46 are to be applied immediately to VIEs created after January 31, 2003, and to VIEs in which an enterprise obtains an interest after that date. For VIEs in which an enterprise holds a variable interest that it acquired before February 1, 2003, FIN 46 applies in the first fiscal period beginning after June 15, 2003. For any VIEs that must be consolidated under FIN 46 that were created before February 1, 2003, the assets, liabilities and noncontrolling interest of the VIE would be initially measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46 first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. FIN 46 also mandates new disclosures about VIEs, some of which are required to be presented in financial statements issued after January 31, 2003. The Company has investments in entities that may be considered to be variable interests. The carrying value of investments is approximately $1.3 billion and primarily consists of interests in security and real estate investment funds, and below investment grade asset-backed and mortgage-backed securities, and a collateralized bond obligation. The Company is evaluating the impact of applying FIN 46 to existing VIEs in which it has variable interests and has not yet completed this analysis. However, at this time, it is anticipated that the effect on the Company's Consolidated Balance Sheets could be an increase of less than $1 billion to assets and liabilities. As the Company continues to evaluate the impact of applying FIN 46, additional entities may be identified that would need to be consolidated. ACCOUNTING POLICIES INVESTMENTS Fixed maturities include bonds, notes and redeemable preferred stocks. Fixed maturities, including instruments subject to securities lending agreements (see Note 4), are classified as "available for sale" and are reported at fair value, with unrealized investment gains and losses, net of income taxes, credited or charged directly to shareholder's equity. Fair values of investments in fixed maturities are based on quoted market prices or dealer quotes. If quoted market prices are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment are used to record fair value. Changes in assumptions could affect the fair values of fixed maturities. Impairments are realized when investment losses in value are deemed other-than-temporary. The Company conducts regular reviews to assess whether other-than-temporary impairments exist. Changing economic conditions - global, regional, or related to specific issuers or industries - could adversely affect these values. Also included in fixed maturities are loan-backed and structured securities, which are amortized using the retrospective method. The effective yield used to determine amortization is calculated based upon actual historical and projected future cash flows, which are obtained from a widely accepted securities data provider. Equity securities, which include common and non-redeemable preferred stocks, are classified as "available for sale" and carried at fair value based primarily on quoted market prices. Changes in fair values of equity securities are charged or credited directly to shareholder's equity, net of income taxes. Mortgage loans are carried at amortized cost. A mortgage loan is considered impaired when it is probable that the Company will be unable to collect principal and interest amounts due. For mortgage loans that are determined to be impaired, a reserve is established for the difference between the amortized cost and fair market value of the underlying collateral. In estimating fair value, the Company uses interest rates reflecting the higher returns required in the current real estate financing market. 27 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Real estate held for sale is carried at the lower of cost or fair value less estimated cost to sell. Fair value of foreclosed properties is established at the time of foreclosure by internal analysis or external appraisers, using discounted cash flow analyses and other accepted techniques. Thereafter, an allowance for losses on real estate held for sale is established if the carrying value of the property exceeds its current fair value less estimated costs to sell. There was no such allowance at December 31, 2002 and 2001. Policy loans are carried at the amount of the unpaid balances that are not in excess of the net cash surrender values of the related insurance policies. The carrying value of policy loans, which have no defined maturities, is considered to be fair value. Short-term securities, consisting primarily of money market instruments and other debt issues purchased with a maturity of less than one year, are carried at amortized cost, which approximates fair value. Trading securities and related liabilities are normally held for periods less than six months. These investments are marked to market with the change recognized in net investment income during the current period. Other invested assets include partnership investments and real estate joint ventures accounted for on the equity method of accounting. Undistributed income is reported in net investment income. Also included in other invested assets is an investment in Citigroup Preferred Stock. See Note 14. Accrual of income is suspended on fixed maturities or mortgage loans that are in default, or on which it is likely that future payments will not be made as scheduled. Interest income on investments in default is recognized only as payment is received. DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative financial instruments, including financial futures contracts, swaps, options and forward contracts, as a means of hedging exposure to interest rate changes, equity price change and foreign currency risk. The Company also uses derivative financial instruments to enhance portfolio income and replicate cash market investments. The Company, through Tribeca Citigroup Investments Ltd., holds and issues derivative instruments in conjunction with these funding strategies. (See Note 12 for a more detailed description of the Company's derivative use.) Derivative financial instruments in a gain position are reported in the consolidated balance sheet in other assets, derivative financial instruments in a loss position are reported in the consolidated balance sheet in other liabilities and derivatives purchased to offset embedded derivatives on variable annuity contracts are reported in other invested assets. To qualify for hedge accounting, the hedge relationship is designated and formally documented at inception detailing the particular risk management objective and strategy for the hedge which includes the item and risk that is being hedged, the derivative that is being used, as well as how effectiveness is being assessed. A derivative has to be highly effective in accomplishing the objective of offsetting either changes in fair value or cash flows for the risk being hedged. For fair value hedges, in which derivatives hedge the fair value of assets and liabilities, changes in the fair value of derivatives are reflected in realized investment gains and losses, together with changes in the fair value of the related hedged item. The Company primarily hedges available-for-sale securities. 28 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) For cash flow hedges, the accounting treatment depends on the effectiveness of the hedge. To the extent that derivatives are effective in offsetting the variability of the hedged cash flows, changes in the derivatives' fair value will not be included in current earnings but are reported in the accumulated other changes in equity from nonowner sources in shareholder's equity. These changes in fair value will be included in earnings of future periods when earnings are also affected by the variability of the hedged cash flows. To the extent these derivatives are not effective, changes in their fair values are immediately included in realized investment gains and losses. The Company primarily hedges foreign denominated funding agreements and floating rate available-for-sale securities. For net investment hedges, in which derivatives hedge the foreign currency exposure of a net investment in a foreign operation, the accounting treatment will similarly depend on the effectiveness of the hedge. The effective portion of the change in fair value of the derivative, including any premium or discount, is reflected in the accumulated other changes in equity from nonowner sources as part of the foreign currency translation adjustment in shareholder's equity. The ineffective portion is reflected in realized investment gains and losses. Derivatives that are used to hedge instruments that are carried at fair value, do not qualify or are not designated as hedges, are also carried at fair value with changes in value reflected in realized investment gains and losses. The effectiveness of these hedging relationships is evaluated on a retrospective and prospective basis using quantitative measures of correlation. If a hedge relationship is found to be ineffective, it no longer qualifies as a hedge and any gains or losses attributable to such ineffectiveness as well as subsequent changes in fair value are recognized in realized investment gains and losses. For those hedge relationships that are terminated, hedge designations removed, or forecasted transactions that are no longer expected to occur, the hedge accounting treatment described in the paragraphs above will no longer apply. For fair value hedges, any changes to the hedged item remain as part of the basis of the asset or liability and are ultimately reflected as an element of the yield. For cash flow hedges, any changes in fair value of the end-user derivative remain in the accumulated other changes in equity from nonowner sources in shareholder's equity and are included in earnings of future periods when earnings are also affected by the variability of the hedged cash flow. If the hedged relationship is discontinued because a forecasted transaction will not occur when scheduled, any changes in fair value of the end-user derivative are immediately reflected in realized investment gains and losses. Financial instruments with embedded derivatives: The Company bifurcates an embedded derivative where the economic characteristics and risks of the embedded instrument are not clearly and closely related to the economic characteristics and risks of the host contract, the entire instrument would not otherwise be remeasured at fair value and a separate instrument with the same terms of the embedded instrument would meet the definition of a derivative under FAS 133. The Company purchases investments that have embedded derivatives, primarily convertible debt securities. These embedded derivatives are carried at fair value with changes in value reflected in realized investment gains and losses. Derivatives embedded in convertible debt securities are classified in the consolidated balance sheet as fixed maturity securities, consistent with the host instruments. The Company markets certain insurance contracts that have embedded derivatives, primarily variable annuity contracts with put options. These embedded derivatives are carried at fair value with changes in value 29 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) reflected in realized investment gains and losses. Derivatives embedded in variable annuity contracts are classified in the consolidated balance sheet as future policyholder benefits and claims. Prior to the adoption of FAS 133 on January 1, 2001, end-user derivatives designated as qualifying hedges were accounted for consistently with the associated risk management strategy. Derivatives used for hedging purposes were generally accounted for using hedge accounting. Changes in value of the derivatives which were expected to substantially offset the changes in value of the hedged items qualified for hedge accounting. Hedges were monitored to ensure that there was a high correlation between the derivative instrument and the hedged investment. Derivatives that did not qualify for hedge accounting were marked to market with changes in market value reflected in the consolidated statement of income as realized gains and losses. Payments to be received or made under interest rate swaps were accrued and recognized in net investment income. Swaps hedging available for sale securities were carried at fair value with unrealized gains and losses, net of taxes, charged directly to shareholder's equity. Interest rate and currency swaps hedging liabilities were treated as off-balance sheet instruments. Gains and losses arising from financial future contracts were used to adjust the basis of hedged investments and were recognized in net investment income over the life of the investment. Gains and losses arising from equity index options were marked to market with changes in market value reflected in realized investment gains and losses. Forward contracts hedging investments were marked to market based on changes in the spot rate with changes in market value reflected in realized investment gains and losses and any forward premium or discount was recognized in net investment income over the life of the contract. Gains and losses from forward contracts hedging foreign operations were carried at fair value with unrealized gains and losses, net of taxes, charged directly to shareholder's equity. INVESTMENT GAINS AND LOSSES Realized investment gains and losses are included as a component of pre-tax revenues based upon specific identification of the investments sold on the trade date. Impairments are realized when investment losses in value are deemed other-than-temporary. The Company conducts regular reviews to assess whether other-than-temporary impairments exist. Changing economic conditions - global, regional, or related to specific issuers or industries - could adversely affect these investments. Also included in pre-tax revenues are gains and losses arising from the remeasurement of the local currency value of foreign investments to U.S. dollars, the functional currency of the Company. The foreign exchange effects of Canadian operations are included in unrealized gains and losses. DEFERRED ACQUISITION COSTS Costs of acquiring traditional life and health insurance, universal life, corporate owned life insurance (COLI), deferred annuities and payout annuities are deferred. These deferred acquisition costs (DAC) include principally commissions and certain expenses related to policy issuance, underwriting and marketing, all of which vary with and are primarily related to the production of new business. The method for determining amortization of deferred acquisition costs varies by product type based upon three different accounting pronouncements: Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by Insurance Enterprises" (FAS 60), Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases" (FAS 91) and Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long Duration Contracts and for Realized Gains and Losses from the Sale of Investments" (FAS 97). 30 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DAC for deferred annuities, both fixed and variable, and payout annuities are amortized employing a level effective yield methodology per FAS 91 as permitted by AICPA Practice Bulletin 8. An amortization rate is developed using the outstanding DAC balance and projected account balances and is applied to actual account balances to determine the amount of DAC amortization. The projected account balances are derived using a model that contains assumptions related to investment returns and persistency. The model rate is evaluated periodically, at least annually, and the actual rate is reset in the following quarter and applied prospectively. A new amortization pattern is developed so that the DAC balances will be amortized over the remaining estimated life of the business. DAC for these products is currently being amortized over 10-15 years. DAC for universal life and COLI are amortized in relation to estimated gross profits from surrender charges, investment, mortality, and expense margins per FAS 97. Actual profits can vary from management's estimates, resulting in increases or decreases in the rate of amortization. Re-estimates of gross profits result in retrospective adjustments to earnings by a cumulative charge or credit to income. DAC for these products is currently being amortized over 16-25 years. DAC relating to traditional life, including term insurance, and health insurance are amortized in relation to anticipated premiums per FAS 60. Assumptions as to the anticipated premiums are made at the date of policy issuance or acquisition and are consistently applied over the life of the policy. DAC for these products is currently being amortized over 5-20 years. DAC is reviewed to determine if it is recoverable from future income, including investment income, and if not recoverable, is charged to expenses. All other acquisition expenses are charged to operations as incurred. See Note 6. VALUE OF INSURANCE IN FORCE The value of insurance in force is an asset that was recorded in 1993 at the time of acquisition of the Company by Citigroup's predecessor. It represents the actuarially determined present value of anticipated profits to be realized from life insurance and annuities contracts at the date of acquisition using the same assumptions that were used for computing related liabilities where appropriate. The value of insurance in force was the actuarially determined present value of the projected future profits discounted at interest rates ranging from 14% to 18%. Traditional life insurance is amortized in relation to anticipated premiums; universal life is amortized in relation to estimated gross profits; and annuity contracts are amortized employing a level yield method. The value of insurance in force, which is included in other assets, is reviewed periodically for recoverability to determine if any adjustment is required. Adjustments, if any, are charged to income. See Note 6. SEPARATE AND VARIABLE ACCOUNTS Separate and variable accounts primarily represent funds for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contractholders. Each account has specific investment objectives. The assets of each account are legally segregated and are not subject to claims that arise out of any other business of the Company. The assets of these accounts are carried at fair value. Certain other separate accounts provide guaranteed levels of return or benefits and the assets of these accounts are primarily carried at fair value. 31 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Amounts assessed to the separate account contractholders for management services are included in revenues. Deposits, net investment income and realized investment gains and losses for these accounts are excluded from revenues, and related liability increases are excluded from benefits and expenses. GOODWILL AND INTANGIBLE ASSETS Goodwill and intangible assets are included in other assets. Prior to the adoption of FASB Statements of Financial Accounting Standards No. 141, "Business Combinations" (FAS 141) and No. 142, "Goodwill and Other Intangible Assets" (FAS 142 in the first quarter of 2002, goodwill was being amortized on a straight-line basis principally over a 40-year period. The carrying amount of goodwill and other intangible assets is regularly reviewed for indication of impairment in value that in the view of management would be other-than-temporary. If it is determined that goodwill and other intangible assets are unlikely to be recovered, impairment is recognized on a discounted cash flow basis. See Note 6. Upon adoption of FAS 141 and FAS 142, the Company stopped amortizing goodwill and intangible assets deemed to have an infinite useful life. Instead, these assets are subject to an annual review for impairment. Other intangible assets that are not deemed to have an indefinite useful life will continue to be amortized over their useful lives. See Note 1, Summary of Significant Accounting Policies, Accounting Changes. CONTRACTHOLDER FUNDS Contractholder funds represent receipts from the issuance of universal life, COLI, pension investment, guaranteed investment contracts (GIC), and certain deferred annuity contracts. For universal life and COLI contracts, contractholder fund balances are increased by receipts for mortality coverage, contract administration, surrender charges and interest accrued, where one or more of these elements are not fixed or guaranteed. These balances are decreased by withdrawals, mortality charges and administrative expenses charged to the contractholder. Interest rates credited to contractholder funds related to universal life and COLI range from 4.1% to 6.6%, with a weighted average interest rate of 4.5%. Pension investment, GICs and certain annuity contracts do not contain significant insurance risks and are considered investment type contracts. Contractholder fund balances are increased by receipts and credited interest, and reduced by withdrawals and administrative expenses charged to the contractholder. Interest rates credited to those investment-type contracts range from 1.45% to 10.0% with a weighted average interest rate of 4.9%. FUTURE POLICY BENEFITS Future policy benefits represent liabilities for future insurance policy benefits. The annuity payout reserves are calculated using the mortality and interest assumptions used in the actual pricing of the benefit. Mortality assumptions are based on Company experience and are adjusted to reflect deviations such as substandard mortality in structured settlement benefits. The interest rates range from 2.0% to 9.0% with a weighted average of 7.1% for these products. Traditional life products include whole life and term insurance. Future policy benefits for traditional life products are estimated on the basis of actuarial assumptions as to mortality, persistency and interest, established at policy issue. Interest assumptions applicable to traditional life products range from 2.5% to 7.0%, with a weighted average of 3.6%. Assumptions established at policy issue as to mortality and persistency are based on the Company's experience, which, together with interest assumptions, include a margin for adverse deviation. Appropriate recognition has been given to experience rating and reinsurance. 32 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) GUARANTY FUND AND OTHER INSURANCE RELATED ASSESSMENTS Included in other liabilities is the Company's estimate of its liability for guaranty fund and other insurance-related assessments. State guaranty fund assessments are based upon the Company's share of premium written or received in one or more years prior to an insolvency occurring in the industry. Once an insolvency has occurred, the Company recognizes a liability for such assessments if it is probable that an assessment will be imposed and the amount of the assessment can be reasonably estimated. At December 31, 2002 and 2001, the Company had a liability of $22.6 million and $22.3 million, respectively, for guaranty fund assessments and a related premium tax offset recoverable of $4.2 million and $4.3 million, respectively. The assessments are expected to be paid over a period of three to five years and the premium tax offsets are expected to be realized over a period of 10 to 15 years. PERMITTED STATUTORY ACCOUNTING PRACTICES The Company's insurance subsidiaries, domiciled principally in Connecticut and Massachusetts, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance enterprises domiciled in a particular state. Permitted statutory accounting practices include practices not prescribed by the domiciliary state, but allowed by the domiciliary state regulatory authority. The Company does not have any permitted statutory accounting practices. PREMIUMS Premiums are recognized as revenue when due. Premiums for contracts with a limited number of premium payments, due over a significantly shorter period than the period over which benefits are provided, are considered income when due. The portion of premium which is not required to provide for benefits and expenses is deferred and recognized in income in a constant relationship to insurance benefits in force. FEE INCOME Fee income is recognized on deferred annuity and universal life contracts for mortality, administrative and equity protection charges according to contract due dates. Fee income is recognized on variable annuity and universal life separate accounts either daily, monthly, quarterly or annually as per contract terms. OTHER REVENUES Other revenues include surrender penalties collected at the time of a contract surrender, and other miscellaneous charges related to annuity and universal life contracts recognized when received. Also included are revenues from unconsolidated non-insurance subsidiaries. Amortization of deferred income related to reinsured blocks of business are recognized in relation to anticipated premiums and are reported in other revenues. CURRENT AND FUTURE INSURANCE BENEFITS Current and future insurance benefits represent charges for mortality and morbidity related to fixed annuities, universal life, term life and health insurance benefits. 33 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) INTEREST CREDITED TO CONTRACTHOLDERS Interest credited to contractholders represents amounts earned by universal life, COLI, pension investment, GICs and certain deferred annuity contracts in accordance with contract provisions. FEDERAL INCOME TAXES The provision for federal income taxes is comprised of two components, current income taxes and deferred income taxes. Deferred federal income taxes arise from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities. STOCK-BASED COMPENSATION Prior to January 1, 2003, the Company applied Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related interpretations in accounting for its stock-based compensation plans. Under APB 25, there is generally no charge to earnings for employee stock option awards because the options granted under these plans have an exercise price equal to the market value of the underlying common stock on the grant date. Alternatively, FAS No. 123, "Accounting for Stock-Based Compensation" (FAS 123), allows companies to recognize compensation expense over the related service period based on the grant date fair value of the stock award. 2. BUSINESS DISPOSITION Effective July 1, 2000, the Company sold 90% of its individual long-term care insurance business to General Electric Capital Assurance Company and its subsidiary in the form of indemnity reinsurance arrangements. The proceeds were $410 million, resulting in a deferred gain of approximately $150 million after-tax. The deferred gain is amortized in relation to anticipated premiums. After-tax amortization amounted to $20 million, $21 million and $5 million in 2002, 2001 and 2000, respectively. Earned premiums were $24 million, $25 million and $138 million in 2002, 2001 and 2000, respectively. 3. OPERATING SEGMENTS The Company has two reportable business segments that are separately managed due to differences in products, services, marketing strategy and resource management. The business of each segment is maintained and reported through separate legal entities within the Company. The management groups of each segment report separately to the common ultimate parent, Citigroup Inc. TRAVELERS LIFE & ANNUITY (TLA) core offerings include individual annuity, individual life, COLI and group annuity insurance products distributed by TIC and TLAC principally under the Travelers Life & Annuity name. Among the range of individual products offered are fixed and variable deferred annuities, payout annuities and term, universal and variable life insurance. The COLI product is a variable universal life product distributed through independent specialty brokers. The group products include institutional pensions, including GICs, payout annuities, group annuities sold to employer-sponsored retirement and savings plans and structured finance transactions. The majority of the annuity business and a substantial portion of the life business written by TLA are accounted for as investment contracts, 34 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) with the result that the deposits collected are reported as liabilities and are not included in revenues. The PRIMERICA LIFE INSURANCE business segment consolidates the business of Primerica Life, Primerica Life Insurance Company of Canada, CitiLife and NBL. The Primerica Life Insurance business segment offers individual life products, primarily term insurance, to customers through a sales force of approximately 107,000 representatives. A great majority of the domestic licensed sales force works on a part-time basis. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 1), except that management also includes receipts on long-duration contracts (universal life-type and investment contracts) as deposits along with premiums in measuring business volume. The amount of investments in equity method investees and total expenditures for additions to long- lived assets other than financial instruments, long-term customer relationships of a financial institution, mortgage and other servicing rights, and deferred tax assets, were not material. 35 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
BUSINESS SEGMENT INFORMATION: ------------------------------------------------------------------------------------------------------------------------- AT AND FOR THE YEAR ENDED DECEMBER 31, 2002 TRAVELERS LIFE PRIMERICA LIFE ($ in millions) & ANNUITY INSURANCE TOTAL ------------------------------------------------------------------------------------------------------------------------- Business Volume: Premiums $ 730 $ 1,194 $ 1,924 Deposits 11,906 - 11,906 ------- ------- ------- Total business volume $12,636 $ 1,194 $13,830 Net investment income 2,646 290 2,936 Interest credited to contractholders 1,220 - 1,220 Amortization of deferred acquisition costs 174 219 393 Total expenditures for deferred acquisition costs 556 323 879 Federal income taxes (FIT) on operating income 325 209 534 Operating income (excludes realized gains or losses and the related FIT) $ 884 $ 407 $ 1,291 Segment Assets $74,562 $ 8,433 $82,995 -------------------------------------------------------------------------------------------------------------------------
BUSINESS SEGMENT INFORMATION: ------------------------------------------------------------------------------------------------------------------------- AT AND FOR THE YEAR ENDED DECEMBER 31, 2001 TRAVELERS LIFE PRIMERICA LIFE ($ in millions) & ANNUITY INSURANCE TOTAL ------------------------------------------------------------------------------------------------------------------------- Business Volume: Premiums $ 957 $ 1,145 $ 2,102 Deposits 13,067 - 13,067 ------- ------- ------- Total business volume $14,024 $ 1,145 $15,169 Net investment income 2,530 301 2,831 Interest credited to contractholders 1,179 - 1,179 Amortization of deferred acquisition costs 171 208 379 Total expenditures for deferred acquisition costs 553 298 851 Federal income taxes (FIT) on operating income 377 209 586 Operating income (excludes realized gains or losses and the related FIT) $ 801 $ 399 $ 1,200 Segment Assets $69,836 $ 8,030 $77,866 -------------------------------------------------------------------------------------------------------------------------
36 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------------------------------------------------------------------------- AT AND FOR THE YEAR ENDED DECEMBER 31, 2000 TRAVELERS LIFE PRIMERICA LIFE ($ in millions) & ANNUITY INSURANCE TOTAL ------------------------------------------------------------------------------------------------------------------------- Business Volume: Premiums $ 860 $ 1,106 $ 1,966 Deposits 11,536 - 11,536 ------- ------- ------- Total business volume $12,396 $ 1,106 $13,502 Net investment income 2,450 280 2,730 Interest credited to contractholders 1,038 - 1,038 Amortization of deferred acquisition costs 166 181 347 Total expenditures for deferred acquisition costs 520 272 792 Federal income taxes (FIT) on operating income 381 197 578 Operating income (excludes realized gains or losses and the related FIT) $ 777 $ 376 $ 1,153 Segment Assets $62,771 $ 7,522 $70,293 -------------------------------------------------------------------------------------------------------------------------
37 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------------------------------------------------- BUSINESS SEGMENT RECONCILIATION: ($ in millions) AT AND FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------------------------------------------------------------------------------------- BUSINESS VOLUME AND REVENUES 2002 2001 2000 -------------------------------------------------------------------------------------------------------------------------- Total business volume $ 13,830 $ 15,169 $ 13,502 Other revenues, including fee income 696 644 635 Elimination of deposits (11,906) (13,067) (11,536) ------------------------------------ Revenue from external sources 2,620 2,746 2,601 Net investment income 2,936 2,831 2,730 Realized investment gains (losses) (322) 125 (77) ========================================================================================================================== Total revenues $ 5,234 $ 5,702 $ 5,254 ========================================================================================================================== OPERATING INCOME -------------------------------------------------------------------------------------------------------------------------- Total operating income of business segments $ 1,291 $ 1,200 $ 1,153 Realized investment gains (losses), net of tax (209) 81 (50) Cumulative effect of change in accounting for derivative instruments and hedging activities, net of tax - (6) - Cumulative effect of change in accounting for securitized financial assets, net of tax - (3) - -------------------------------------------------------------------------------------------------------------------------- Income from continuing operations $ 1,082 $ 1,272 $ 1,103 ========================================================================================================================== ASSETS -------------------------------------------------------------------------------------------------------------------------- Total assets of business segments $ 82,995 $ 77,866 $ 70,293 ========================================================================================================================== BUSINESS VOLUME AND REVENUES -------------------------------------------------------------------------------------------------------------------------- Individual Annuities $ 6,307 $ 7,166 $ 7,101 Group Annuities 7,285 8,383 6,563 Individual Life and Health Insurance and COLI 3,116 2,970 2,550 Other (a) 432 250 576 Elimination of deposits (11,906) (13,067) (11,536) -------------------------------------------------------------------------------------------------------------------------- Total revenue $ 5,234 $ 5,702 $ 5,254 ==========================================================================================================================
(a) Other represents revenue attributable to unallocated capital and run-off businesses. The Company's revenue was derived almost entirely from U.S. domestic business. Revenue attributable to foreign countries was insignificant. The Company had no transactions with a single customer representing 10% or more of its revenue. 38 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. INVESTMENTS FIXED MATURITIES The amortized cost and fair value of investments in fixed maturities were as follows:
---------------------------------------------------------------------------------------------------------------------------------- GROSS GROSS DECEMBER 31, 2002 AMORTIZED UNREALIZED UNREALIZED FAIR ($ in millions) COST GAINS LOSSES VALUE ---------------------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE: Mortgage-backed securities - CMOs and pass-through securities $ 6,975 $ 434 $ 2 $ 7,407 U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities 2,402 39 19 2,422 Obligations of states, municipalities and political subdivisions 297 22 0 319 Debt securities issued by foreign governments 365 30 2 393 All other corporate bonds 20,894 982 608 21,268 Other debt securities 4,348 229 66 4,511 Redeemable preferred stock 147 1 34 114 ---------------------------------------------------------------------------------------------------------------------------------- Total Available For Sale $35,428 $ 1,737 $ 731 $36,434 ----------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------- GROSS GROSS DECEMBER 31, 2001 AMORTIZED UNREALIZED UNREALIZED FAIR ($ in millions) COST GAINS LOSSES VALUE ---------------------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE: Mortgage-backed securities - CMOs and pass-through securities $ 6,654 $ 116 $ 57 $ 6,713 U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities 1,677 8 63 1,622 Obligations of states, municipalities and political subdivisions 108 4 1 111 Debt securities issued by foreign governments 810 46 5 851 All other corporate bonds 17,904 482 260 18,126 Other debt securities 4,406 154 86 4,474 Redeemable preferred stock 171 12 8 175 ---------------------------------------------------------------------------------------------------------------------------------- Total Available For Sale $31,730 $ 822 $ 480 $32,072 ----------------------------------------------------------------------------------------------------------------------------------
39 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Proceeds from sales of fixed maturities classified as available for sale were $15.5 billion, $14.1 billion and $10.8 billion in 2002, 2001 and 2000, respectively. Gross gains of $741 million, $633 million and $213 million and gross losses of $309 million, $273 million and $407 million in 2002, 2001 and 2000, respectively, were realized on those sales. Additional losses of $639 million, $153 million and $25 million in 2002, 2001 and 2000, respectively, were realized due to other-than-temporary losses in value. Impairment activity increased significantly beginning in the fourth quarter of 2001 and continued throughout 2002. Impairments were concentrated in telecommunication and energy company investments. Fair values of investments in fixed maturities are based on quoted market prices or dealer quotes or, if these are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. The fair value of investments for which a quoted market price or dealer quote is not available amounted to $5.1 billion and $4.6 billion at December 31, 2002 and 2001, respectively. The amortized cost and fair value of fixed maturities at December 31, 2002, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
-------------------------------------------------------------------------------------- AMORTIZED ($ in millions) COST FAIR VALUE -------------------------------------------------------------------------------------- MATURITY: Due in one year or less $ 2,572 $ 2,605 Due after 1 year through 5 years 10,162 10,430 Due after 5 years through 10 years 8,591 8,768 Due after 10 years 7,128 7,224 -------------------------------------------------------------------------------------- 28,453 29,027 -------------------------------------------------------------------------------------- Mortgage-backed securities 6,975 7,407 -------------------------------------------------------------------------------------- Total Maturity $35,428 $36,434 --------------------------------------------------------------------------------------
The Company makes investments in collateralized mortgage obligations (CMOs). CMOs typically have high credit quality, offer good liquidity, and provide a significant advantage in yield and total return compared to U.S. Treasury securities. The Company's investment strategy is to purchase CMO tranches which are protected against prepayment risk, including planned amortization class and last cash flow tranches. Prepayment protected tranches are preferred because they provide stable cash flows in a variety of interest rate scenarios. The Company does invest in other types of CMO tranches if a careful assessment indicates a favorable risk/return tradeoff. The Company does not purchase residual interests in CMOs. At December 31, 2002 and 2001, the Company held CMOs classified as available for sale with a fair value of $4.7 billion and $4.5 billion, respectively. Approximately 35% and 38%, respectively, of the Company's CMO holdings are fully collateralized by GNMA, FNMA or FHLMC securities at December 31, 2002 and 2001. In addition, the Company held $2.6 billion and $2.1 billion of GNMA, FNMA or FHLMC mortgage-backed pass-through securities at December 31, 2002 and 2001, respectively. All of these securities are rated AAA. 40 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company engages in securities lending whereby certain securities from its portfolio are loaned to other institutions for short periods of time. The Company generally receives cash collateral from the borrower, equal to at least the market value of the loaned securities plus accrued interest, and reinvests it in short-term securities. The loaned securities remain a recorded asset of the Company, however, the Company records a liability for the amount of the cash collateral held, representing its obligation to return the cash collateral related to these loaned securities, and reports that liability as part of other liabilities in the consolidated balance sheet. At December 31, 2002 and 2001, the Company held cash collateral of $2.8 billion and $2.4 billion, respectively. EQUITY SECURITIES The cost and fair values of investments in equity securities were as follows:
----------------------------------------------------------------------------------------------------------------- EQUITY SECURITIES: GROSS UNREALIZED GROSS UNREALIZED FAIR ($ in millions) COST GAINS LOSSES VALUE ----------------------------------------------------------------------------------------------------------------- DECEMBER 31, 2002 Common stocks $ 48 $ 9 $ 7 $ 50 Non-redeemable preferred stocks 280 8 6 282 ----------------------------------------------------------------------------------------------------------------- Total Equity Securities $328 $17 $13 $332 ----------------------------------------------------------------------------------------------------------------- DECEMBER 31, 2001 Common stocks $ 96 $11 $ 6 $101 Non-redeemable preferred stocks 375 8 12 371 ----------------------------------------------------------------------------------------------------------------- Total Equity Securities $471 $19 $18 $472 -----------------------------------------------------------------------------------------------------------------
Proceeds from sales of equity securities were $945 million, $112 million and $397 million in 2002, 2001 and 2000, respectively. Gross gains of $8 million, $10 million and $107 million and gross losses of $4 million, $13 million and $9 million in 2002, 2001 and 2000, respectively, were realized on those sales. Additional losses of $19 million, $96 million and $7 million in 2002, 2001 and 2000, respectively, were realized due to other-than-temporary losses in value. MORTGAGE LOANS AND REAL ESTATE At December 31, 2002 and 2001, the Company's mortgage loan and real estate portfolios consisted of the following:
------------------------------------------------------------------------------------------------ ($ in millions) 2002 2001 ------------------------------------------------------------------------------------------------ Current Mortgage Loans $1,941 $1,976 Underperforming Mortgage Loans 44 19 ------------------------------------------------------------------------------------------------ Total Mortgage Loans 1,985 1,995 ------------------------------------------------------------------------------------------------ Real Estate - Foreclosed 17 42 Real Estate - Investment 19 13 ------------------------------------------------------------------------------------------------ Total Real Estate 36 55 ------------------------------------------------------------------------------------------------ Total Mortgage Loans and Real Estate $2,021 $2,050 ================================================================================================
Underperforming mortgage loans include delinquent mortgage loans over 90 days past due, loans in the process of foreclosure and loans modified at interest rates below market. 41 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Aggregate annual maturities on mortgage loans at December 31, 2002 are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
---------------------------------------------------------------- YEAR ENDING DECEMBER 31, ($ in millions) ---------------------------------------------------------------- Past Maturity $ 13 2003 183 2004 156 2005 123 2006 198 2007 135 Thereafter 1,177 ---------------------------------------------------------------- Total $1,985 ================================================================
TRADING SECURITIES Trading securities of the Company are held in Tribeca Citigroup Investments Ltd. The assets and liabilities are valued at fair value as follows:
Fair value as of Fair value as of ($ in millions) December 31, 2002 December 31, 2001 --------------- ----------------- ----------------- ASSETS Trading securities Convertible bond arbitrage $1,442 $1,798 Merger arbitrage 47 80 Other 42 2 ------ ------ $1,531 $1,880 ====== ====== LIABILITIES Trading securities sold not yet purchased Convertible bond arbitrage $ 520 $ 836 Merger arbitrage 13 51 Other 65 4 ------ ------ $ 598 $ 891 ====== ======
The Company's trading portfolio investments and related liabilities are normally held for periods less than six months. See Note 12. 42 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) OTHER INVESTED ASSETS Other invested assets are composed of the following:
------------------------------------------------------------------------ ($ in millions) 2002 2001 ------------------------------------------------------------------------ Investment in Citigroup preferred stock $3,212 $ 987 Partnership investments 1,269 949 Real estate joint ventures 390 520 Other 38 29 ------------------------------------------------------------------------ Total $4,909 $2,485 ------------------------------------------------------------------------
CONCENTRATIONS At December 31, 2002 and 2001, the Company had an investment in Citigroup Preferred Stock of $3.2 billion and $987 million, respectively. See Note 14. The Company maintains a short-term investment pool for its insurance affiliates in which the Company also participates. See Note 14. The Company had concentrations of investments, excluding those in federal and government agencies, primarily fixed maturities at fair value, in the following industries:
------------------------------------------------------------------------ ($ in millions) 2002 2001 ------------------------------------------------------------------------ Electric Utilities $3,979 $3,883 Finance 3,681 1,633 Banking 1,900 1,944 ------------------------------------------------------------------------
The Company held investments in foreign banks in the amount of $869 million and $954 million at December 31, 2002 and 2001, respectively, which are included in the table above. The Company defines its below investment grade assets as those securities rated Ba1 by Moody's Investor Services (or its equivalent) or below by external rating agencies, or the equivalent by internal analysts when a public rating does not exist. Such assets include publicly traded below investment grade bonds and certain other privately issued bonds and notes that are classified as below investment grade. Below investment grade assets included in the categories of the preceding table include $878 million and $358 million in Electric Utilities at December 31, 2002 and 2001, respectively, and total below investment grade assets were $3.8 billion and $2.3 billion at December 31, 2002 and 2001, respectively. Included in mortgage loans were the following group concentrations:
------------------------------------------------------------------------ ($ in millions) 2002 2001 ------------------------------------------------------------------------ STATE California $ 788 $ 788 PROPERTY TYPE Agricultural $1,212 $1,131
43 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company monitors creditworthiness of counterparties to all financial instruments by using controls that include credit approvals, credit limits and other monitoring procedures. Collateral for fixed maturities often includes pledges of assets, including stock and other assets, guarantees and letters of credit. The Company's underwriting standards with respect to new mortgage loans generally require loan to value ratios of 75% or less at the time of mortgage origination. NON-INCOME PRODUCING INVESTMENTS Investments included in the consolidated balance sheets that were non-income producing amounted to $58.5 million and $27.7 million at December 31, 2002 and 2001, respectively. RESTRUCTURED INVESTMENTS The Company had mortgage loans and debt securities that were restructured at below market terms at December 31, 2002 and 2001. The balances of the restructured investments were insignificant. The new terms typically defer a portion of contract interest payments to varying future periods. Gross interest income on restructured assets that would have been recorded in accordance with the original terms of such loans was insignificant in 2002 and 2001. Interest on these assets, included in net investment income, was also insignificant in 2002 and 2001. NET INVESTMENT INCOME
---------------------------------------------------------------------------------------------------- FOR THE YEAR ENDED DECEMBER 31, ($ in millions) 2002 2001 2000 ---------------------------------------------------------------------------------------------------- GROSS INVESTMENT INCOME Fixed maturities $2,359 $2,328 $2,061 Mortgage loans 167 210 223 Trading 9 131 208 Joint ventures and partnerships 203 71 150 Citigroup preferred stock 178 53 53 Other, including policy loans 104 165 184 ---------------------------------------------------------------------------------------------------- Total gross investment income 3,020 2,958 2,879 ---------------------------------------------------------------------------------------------------- Investment expenses 84 127 149 ---------------------------------------------------------------------------------------------------- Net investment income $2,936 $2,831 $2,730 ----------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED INVESTMENT GAINS (LOSSES) Net realized investment gains (losses) for the periods were as follows:
---------------------------------------------------------------------------------------------------- FOR THE YEAR ENDED DECEMBER 31, ($ in millions) 2002 2001 2000 ---------------------------------------------------------------------------------------------------- REALIZED INVESTMENT GAINS (LOSSES) Fixed maturities $ (207) $ 207 $ (219) Equity securities (15) (99) 91 Mortgage loans - 5 27 Real estate held for sale 8 3 25 Derivatives (77) 14 - Other (31) (5) (1) ---------------------------------------------------------------------------------------------------- Total realized investment gains (losses) $( 322) $ 125 $ (77) ----------------------------------------------------------------------------------------------------
44 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Changes in net unrealized investment gains (losses) that are reported in accumulated other changes in equity from nonowner sources were as follows:
---------------------------------------------------------------------------------------------------- FOR THE YEAR ENDED DECEMBER 31, ($ in millions) 2002 2001 2000 ---------------------------------------------------------------------------------------------------- UNREALIZED INVESTMENT GAINS (LOSSES) Fixed maturities $ 664 $85 $ 891 Equity securities 3 40 (132) Other 31 (20) 13 ---------------------------------------------------------------------------------------------------- Total unrealized investment gains (losses) 698 105 772 ---------------------------------------------------------------------------------------------------- Related taxes 243 37 271 ---------------------------------------------------------------------------------------------------- Change in unrealized investment gains (losses) 455 68 501 Balance beginning of year 171 103 (398) ---------------------------------------------------------------------------------------------------- Balance end of year $ 626 $ 171 $ 103 ----------------------------------------------------------------------------------------------------
5. REINSURANCE Reinsurance is used in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and to effect business-sharing arrangements. Reinsurance is accomplished through various plans of reinsurance, primarily yearly renewable term coinsurance and modified coinsurance. Reinsurance involves credit risk and the Company monitors the financial condition of these reinsurers on an ongoing basis. The Company remains primarily liable as the direct insurer on all risks reinsured. Since 1997 universal life business has been reinsured under an 80%/20% quota share reinsurance program and term life business has been reinsured under a 90%/10% quota share reinsurance program. Maximum retention of $2.5 million is generally reached on policies in excess of $12.5 million for universal life, and in excess of $25.0 million for term insurance. For other plans of insurance, it is the policy of the Company to obtain reinsurance for amounts above certain retention limits on individual life policies, which limits vary with age and underwriting classification. Generally, the maximum retention on an ordinary life risk is $2.5 million. Total in-force business ceded under reinsurance contracts is $321.9 billion and $285.7 billion at December 31, 2002 and 2001. Effective July 1, 2000 the Company sold 90% of its individual long-term care insurance business to General Electric Capital Assurance Company and its subsidiary in the form of indemnity reinsurance arrangements. Written premiums ceded per these arrangements were $231.8 million and $233.3 million in 2002 and 2001, respectively, and earned premiums ceded were $233.8 million and $240.1 million in 2002 and 2001, respectively. The Company also reinsures the guaranteed minimum death benefit (GMDB) on its variable annuity product. Total variable annuity account balances with GMDB is $19.1 billion, of which $12.4 billion or 65% is reinsured at December 31, 2002. GMDB is payable upon the death of a contractholder. When the benefit payable is greater than the account value of the variable annuity, the difference is called the net amount at risk (NAR). NAR totals $4.6 billion at December 31, 2002, of which $3.8 billion or 82% is reinsured. During 2002, substantially all new contracts written were not reinsured. Through TIC, the Company writes workers' compensation business. This business is reinsured through a 100% quota-share agreement with the insurance subsidiaries of TPC. 45 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A summary of reinsurance financial data reflected within the consolidated statements of income and balance sheets is presented below ($ in millions):
FOR THE YEARS ENDING DECEMBER 31, WRITTEN PREMIUMS 2002 2001 2000 ---------------------------------------------------------------------------------------------------- Direct $2,610 $2,848 $2,634 Assumed from: Non-affiliated companies - 1 - Ceded to: Travelers Indemnity Company (83) (146) (195) Non-affiliated companies (614) (591) (465) ---------------------------------------------------------------------------------------------------- Total Net Written Premiums $1,913 $2,112 $1,974 ====================================================================================================
EARNED PREMIUMS 2002 2001 2000 ---------------------------------------------------------------------------------------------------- Direct $2,652 $2,879 $2,644 Assumed from: Non-affiliated companies - 1 - Ceded to: Travelers Indemnity Company (109) (180) (216) Non-affiliated companies (619) (598) (462) ---------------------------------------------------------------------------------------------------- Total Net Earned Premiums $1,924 $2,102 $1,966 ====================================================================================================
Travelers Indemnity Company was an affiliate in 2001, 2000 and for part of 2002. See Note 15. Reinsurance recoverables at December 31, 2002 and 2001 include amounts recoverable on unpaid and paid losses and were as follows ($ in millions):
REINSURANCE RECOVERABLES 2002 2001 ------------------------------------------------------------------------------------- Life and Accident and Health Business: Non-affiliated companies $2,589 $2,282 Property-Casualty Business: Travelers Indemnity Company 1,712 1,881 ------------------------------------------------------------------------------------- Total Reinsurance Recoverables $4,301 $4,163 =====================================================================================
Reinsurance recoverables for the life and accident and health business include $1,351 million and $1,060 million from General Electric Capital Assurance Company, and also include $472 million and $500 million, from The Metropolitan Life Insurance Company at December 31, 2002 and 2001, respectively. 6. DEFERRED ACQUISITION COSTS AND VALUE OF INSURANCE IN FORCE The Company has two intangible, amortizable assets, DAC and the value of insurance in force. The following is a summary of capitalized DAC by type. 46 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Deferred & Payout UL & Traditional Life In millions of dollars Annuities COLI & Other Total ------------------------------------------------------------------------------------------------------------ Balance December 31, 2000 $ 896 $299 $ 1,794 $2,989 -------------------------------------------------------------------- Deferred expenses and other 385 142 324 851 Amortization expense (144) (11) (224) (379) -------------------------------------------------------------------- Balance December 31, 2001 1,137 430 1,894 3,461 Deferred expenses and other 348 172 348 868 Amortization expense (132) (24) (237) (393) -------------------------------------------------------------------- Balance December 31, 2002 $1,353 $578 $ 2,005 $3,936 ------------------------------------------------------------------------------------------------------------
The value of insurance in force totaled $130 million and $144 million at December 31, 2002 and 2001, respectively, and is included in other assets. Amortization expense on the value of insurance in force was $25 million and $26 million for the twelve months ended December 31, 2002 and 2001, respectively. Amortization expense related to the value of insurance in force is estimated to be $20 million in 2003, $18 million in 2004, $16 million in 2005, $13 million in 2006 and $12 million in 2007. In 2002 there was an opening balance sheet reclassification between DAC and the value of insurance in force in the amount of $11 million. This had no impact on results of operations or shareholder's equity. 7. DEPOSIT FUNDS AND RESERVES At December 31, 2002 and 2001, the Company had $38.8 billion and $34.1 billion of life and annuity deposit funds and reserves, respectively. Of that total, $21.8 billion and $19.1 billion is not subject to discretionary withdrawal based on contract terms. The remaining $17.0 billion and $15.0 billion is for life and annuity products that are subject to discretionary withdrawal by the contractholder. Included in the amounts that are subject to discretionary withdrawal is $5.7 billion and $4.2 billion of liabilities that are surrenderable with market value adjustments. Also included are an additional $5.5 billion and $5.0 billion of life insurance and individual annuity liabilities which are subject to discretionary withdrawals, and have an average surrender charge of 4.7% and 4.7%, respectively. In the payout phase, these funds are credited at significantly reduced interest rates. The remaining $5.8 billion and $5.8 billion of liabilities are surrenderable without charge. Approximately 10.0% and 10.2% of these relate to individual life products for 2002 and 2001, respectively. These risks would have to be underwritten again if transferred to another carrier, which is considered a significant deterrent against withdrawal by long-term policyholders. Insurance liabilities that are surrendered or withdrawn are reduced by outstanding policy loans and related accrued interest prior to payout. Included in contractholder funds and in the preceding paragraph are GICs totaling $10.9 billion. The scheduled maturities for these GICs, including interest, are $4.5 billion, $1.5 billion, $1.3 billion, $1.4 billion and $4.0 billion in 2003, 2004, 2005, 2006 and thereafter. These GICs have a weighted average interest rate of 4.81% at December 31, 2002. 47 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. FEDERAL INCOME TAXES EFFECTIVE TAX RATE
($ in millions) ---------------------------------------------------------------------------------------------------- FOR THE YEAR ENDED DECEMBER 31, 2002 2001 2000 ---------------------------------------------------------------------------------------------------- Income before federal income taxes $1,503 $1,911 $1,654 Statutory tax rate 35% 35% 35% ---------------------------------------------------------------------------------------------------- Expected federal income taxes 526 669 579 Tax effect of: Non-taxable investment income (62) (20) (19) Tax reserve release (43) (18) (12) Other, net - (1) 3 ---------------------------------------------------------------------------------------------------- Federal income taxes $ 421 $ 630 $ 551 ==================================================================================================== Effective tax rate 28% 33% 33% ---------------------------------------------------------------------------------------------------- COMPOSITION OF FEDERAL INCOME TAXES Current: United States $ 217 $ 424 $ 429 Foreign 19 47 33 ---------------------------------------------------------------------------------------------------- Total 236 471 462 ---------------------------------------------------------------------------------------------------- Deferred: United States 182 166 96 Foreign 3 (7) (7) ---------------------------------------------------------------------------------------------------- Total 185 159 89 ---------------------------------------------------------------------------------------------------- Federal income taxes $ 421 $ 630 $ 551 ====================================================================================================
Additional tax benefits (expense) attributable to employee stock plans allocated directly to shareholder's equity for the years ended December 31, 2002, 2001 and 2000 were $(17) million, $21 million and $24 million, respectively. 48 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The net deferred tax liabilities at December 31, 2002 and 2001 were comprised of the tax effects of temporary differences related to the following assets and liabilities:
--------------------------------------------------------------------------------------------------------------- ($ in millions) 2002 2001 --------------------------------------------------------------------------------------------------------------- Deferred Tax Assets: Benefit, reinsurance and other reserves $ 422 $ 539 Operating lease reserves 57 62 Employee benefits 199 104 Other 289 158 --------------------------------------------------------------------------------------------------------------- Total 967 863 --------------------------------------------------------------------------------------------------------------- Deferred Tax Liabilities: Deferred acquisition costs and value of insurance in force (1,097) (968) Investments, net (1,180) (215) Other (138) (89) --------------------------------------------------------------------------------------------------------------- Total (2,415) (1,272) --------------------------------------------------------------------------------------------------------------- Net Deferred Tax Liability $ (1,448) $ (409) ---------------------------------------------------------------------------------------------------------------
The Company and its subsidiaries file a consolidated federal income tax return with Citigroup Inc. Federal income taxes are allocated to each member of the consolidated group, according to the Tax Sharing Agreement, on a separate return basis adjusted for credits and other amounts required by the Agreement. At December 31, 2002 and 2001, the Company had no ordinary or capital loss carryforwards. The policyholders' surplus account, which arose under prior tax law, is generally that portion of the gain from operations that has not been subjected to tax, plus certain deductions. The balance of this account is approximately $932 million. Income taxes are not provided for on this amount because under current U.S. tax rules such taxes will become payable only to the extent such amounts are distributed as a dividend or exceed limits prescribed by federal law. Distributions are not currently contemplated from this account. At current rates the maximum amount of such tax would be approximately $326 million. 49 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. SHAREHOLDER'S EQUITY Shareholder's Equity and Dividend Availability The Company's statutory net income, which includes the statutory net income of all insurance subsidiaries, was $256 million, $330 million and $981 million for the years ended December 31, 2002, 2001 and 2000, respectively. The Company's statutory capital and surplus was $6.9 billion and $5.1 billion at December 31, 2002 and 2001, respectively. Effective January 1, 2001, the Company began preparing its statutory basis financial statements in accordance with the National Association of Insurance Commissioners' Accounting Practices and Procedures Manual - version effective January 1, 2001, subject to any deviations prescribed or permitted by its domicilary insurance commissioners (see Note 1, Summary of Significant Accounting Policies, Permitted Statutory Accounting Practices). The impact of this change on statutory capital and surplus was not significant. The impact of this change on the Company's statutory net income was $119 million in 2001, related to recording equity method investment earnings as unrealized gains versus net investment income. The Company is currently subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to its parent without prior approval of insurance regulatory authorities. A maximum of $966 million is available by the end of the year 2003 for such dividends without prior approval of the State of Connecticut Insurance Department, depending upon the amount and timing of the payments. TLAC may not pay a dividend to TIC without such approval. Primerica Life may pay up to $148 million to TIC in 2003 without prior approval of the Massachusetts Insurance Department. The Company paid dividends of $586 million, $472 million and $860 million in 2002, 2001 and 2000, respectively. In connection with the TPC IPO and distribution, the Company's additional paid-in capital increased $1,596 million during 2002 as follows:
($ in millions) --------------- Citigroup Series YYY Preferred Stock $2,225 TLA Holdings LLC 142 Cash and other assets 189 Pension, post-retirement, and post- employment benefits payable (279) Deferred tax assets 98 Deferred tax liabilities (779) ------ $1,596 ======
See Note 15. 50 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. SHAREHOLDER'S EQUITY (CONTINUED) Accumulated Other Changes in Equity from Nonowner Sources, Net of Tax Changes in each component of Accumulated Other Changes in Equity from Nonowner Sources were as follows:
NET UNREALIZED ACCUMULATED OTHER GAIN (LOSS) ON FOREIGN CURRENCY DERIVATIVE CHANGES IN EQUITY INVESTMENT TRANSLATION INSTRUMENTS AND FROM NONOWNER ($ in millions) SECURITIES ADJUSTMENTS HEDGING ACTIVITIES SOURCES -------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1999 $(397) $ (1) $ - $ (398) Unrealized gains on investment securities, net of tax of $297 451 - - 451 Reclassification adjustment for losses included in net income, net of tax of $(27) 50 - - 50 Foreign currency translation adjustment, net of tax of $1 - 1 - 1 -------------------------------------------------------------------------------------------------------------------------------- PERIOD CHANGE 501 1 - 502 -------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2000 104 - - 104 Cumulative effect of change in accounting for derivative instruments and hedging activities, net of tax of $(16) 14 - (43) (29) Unrealized gains on investment securities, net of tax of $80 149 - - 149 Reclassification adjustment for gains included in net income, net of tax of $44 (81) - - (81) Foreign currency translation adjustment, net of tax of $(2) - (3) - (3) Derivative instrument hedging activity losses, net of tax of $(35) - - (66) (66) -------------------------------------------------------------------------------------------------------------------------------- PERIOD CHANGE 82 (3) (109) (30) -------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2001 186 (3) (109) 74 Unrealized gains on investment securities, net of tax of $132 246 - - 246 Reclassification adjustment for losses included in net income, net of tax of $(113) 209 - - 209 Foreign currency translation adjustment, net of tax of $2 - 3 - 3 Derivative instrument hedging activity losses, net of tax of $(42) - - (78) (78) -------------------------------------------------------------------------------------------------------------------------------- PERIOD CHANGE 455 3 (78) 380 -------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2002 $ 641 $ - (187) $ 454 --------------------------------------------------------------------------------------------------------------------------------
51 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. BENEFIT PLANS Pension and Other Postretirement Benefits The Company participates in a qualified, noncontributory defined benefit pension plan sponsored by Citigroup. The Company's share of the expense related to this plan was insignificant in 2002, 2001 and 2000. The Company also participates in a non-qualified, noncontributory defined benefit pension plan sponsored by Citigroup. During 2002, the Company assumed TPC's share of the non-qualified pension plan related to inactive employees of the former Travelers Insurance entities as part of the TPC spin-off. The Company's share of net expense for this plan was $10 million in 2002, and insignificant in 2001 and 2000. In addition, the Company provides certain other postretirement benefits to retired employees through a plan sponsored by Citigroup. The Company assumed TPC's share of the postretirement benefits related to inactive employees of the former Travelers Insurance entities during 2002 as part of the TPC spin-off. The Company's share of net expense for the other postretirement benefit plans was $18 million in 2002 and not significant for 2001 and 2000. 401(k) Savings Plan Substantially all of the Company's employees are eligible to participate in a 401(k) savings plan sponsored by Citigroup. The Company's expenses in connection with the 401(k) savings plan were not significant in 2002, 2001 and 2000. See Note 14. 11. LEASES Most leasing functions for the Company are administered by a Citigroup subsidiary at December 31, 2002. Net rent expense for the Company was $24 million, $26 million, and $26 million in 2002, 2001 and 2000, respectively.
---------------------------------------------------------------------------------------------- YEAR ENDING DECEMBER 31, MINIMUM OPERATING MINIMUM CAPITAL ($ in millions) RENTAL PAYMENTS RENTAL PAYMENTS ---------------------------------------------------------------------------------------------- 2003 $ 43 $ 5 2004 42 5 2005 47 5 2006 54 5 2007 54 6 Thereafter 131 24 ---------------------------------------------------------------------------------------------- Total Rental Payments $371 $50 ==============================================================================================
Future sublease rental income of approximately $66 million will partially offset these commitments. Also, the Company will be reimbursed for 50% of the rental expense for a particular lease, totaling $164 million, by an affiliate. 52 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS Derivative Financial Instruments The Company uses derivative financial instruments, including financial futures contracts, swaps, options and forward contracts, as a means of hedging exposure to interest rate changes, equity price changes and foreign currency risk. The Company also uses derivative financial instruments to enhance portfolio income and replicate cash market investments. The Company, through Tribeca Citigroup Investments Ltd., holds and issues derivative instruments in conjunction with these funding strategies. The Company uses exchange traded financial futures contracts to manage its exposure to changes in interest rates that arise from the sale of certain insurance and investment products, or the need to reinvest proceeds from the sale or maturity of investments. To hedge against adverse changes in interest rates, the Company enters long or short positions in financial futures contracts, which offset asset price changes resulting from changes in market interest rates until an investment is purchased, or a product is sold. Futures contracts are commitments to buy or sell at a future date a financial instrument, at a contracted price, and may be settled in cash or through delivery. The Company uses equity option contracts to manage its exposure to changes in equity market prices that arise from the sale of certain insurance products. To hedge against adverse changes in the equity market prices, the Company enters long positions in equity option contracts with major financial institutions. These contracts allow the Company, for a fee, the right to receive a payment if the Standard and Poor's 500 Index falls below agreed upon strike prices. Currency option contracts are used on an ongoing basis to hedge the Company's exposure to foreign currency exchange rates that result from the Company's direct foreign currency investments. To hedge against adverse changes in exchange rates, the Company enters contracts that give it the right, but not the obligation, to sell the foreign currency within a limited time at a contracted price that may also be settled in cash, based on differentials in the foreign exchange rate. These contracts cannot be settled prior to maturity. The Company enters into interest rate swaps in connection with other financial instruments to provide greater risk diversification and better match assets and liabilities. Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts calculated by reference to an agreed upon notional principal amount. The Company also enters into basis swaps in which both legs of the swap are floating with each based on a different index. Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party. A single net payment is usually made by one counterparty at each due date. The Company enters into currency swaps in connection with other financial instruments to provide greater risk diversification and better match assets purchased in U.S. Dollars with a corresponding liability originated in a foreign currency. Under currency swaps, the Company agrees with other parties to exchange, at specified intervals, foreign currency for U.S. Dollars. Generally, there is an exchange of foreign currency for U.S. Dollars at the outset of the contract based upon prevailing foreign exchange rates. Swap agreements are not exchange traded so they are subject to the risk of default by the counterparty. 53 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Forward contracts are used on an ongoing basis to hedge the Company's exposure to foreign currency exchange rates that result from the net investment in the Company's Canadian Operations as well as direct foreign currency investments. To hedge against adverse changes in exchange rates, the Company enters into contracts to exchange foreign currency for U.S. Dollars with major financial institutions. These contracts cannot be settled prior to maturity. At the maturity date the Company must purchase the foreign currency necessary to settle the contracts. The Company enters into credit default swaps in conjunction with a fixed income investment to reproduce the investment characteristics of a different permissible investment. Under credit default swaps, the Company agrees with other parties to receive, at specified intervals, fixed or floating rate interest amounts calculated by reference to an agreed notional principal amount in exchange for the credit default risk of a specified bond. Swap agreements are not exchange traded so they are subject to the risk of default by the counterparty. The Company monitors the creditworthiness of counterparties to these financial instruments by using criteria of acceptable risk that are consistent with on-balance sheet financial instruments. The controls include credit approvals, credit limits and other monitoring procedures. The following table summarizes certain information related to the Company's hedging activities for the years ended December 31, 2002 and 2001:
Year Ended Year Ended In millions of dollars December 31, 2002 December 31, 2001 -------------------------------------- ----------------- ----------------- Hedge ineffectiveness recognized related to fair value hedges $ (18.3) $ (4.1) Hedge ineffectiveness recognized related to cash flow hedges 14.8 (6.2) Net gain recorded in accumulated other changes in equity from nonowner sources related to net investment hedges (8.4) 0.8
During the year ended December 31, 2002 the Company recorded a gain of $.3 million from discontinued forecasted transactions. During the year ended December 31, 2001 there were no discontinued forecasted transactions. The amount expected to be reclassified from accumulated other changes in equity from nonowner sources into pre-tax earnings within twelve months from December 31, 2002 is $(27.2) million. In 2000, these derivative financial instruments were treated as off-balance sheet instruments. Financial instruments with off-balance sheet risk involve, to varying degrees, elements of credit and market risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of these instruments reflect the extent of involvement the Company has in a particular class of financial instrument. However, the maximum loss of cash flow associated with these instruments can be less than these amounts. For swaps, options and forward contracts, credit risk is limited to the amount that it would cost the Company to replace the contracts. Financial futures contracts and purchased listed option contracts have very little credit risk since organized exchanges are the counterparties. 54 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Financial Instruments with Off-Balance Sheet Risk In the normal course of business, the Company issues fixed and variable rate loan commitments and has unfunded commitments to partnerships. All of these commitments are to unaffiliated entities. The off-balance sheet risk of fixed and variable rate loan commitments was $240.9 million and $212.2 million at December 31, 2002 and 2001, respectively. The Company had unfunded commitments of $630.0 million and $661.5 million to these partnerships at December 31, 2002 and 2001, respectively. Fair Value of Certain Financial Instruments The Company uses various financial instruments in the normal course of its business. Certain insurance contracts are excluded by Statement of Financial Accounting Standards No. 107, "Disclosure about Fair Value of Financial Instruments," and therefore are not included in the amounts discussed. At December 31, 2002 and 2001, investments in fixed maturities had a carrying value and a fair value of $36.4 billion and $32.1 billion, respectively. See Notes 1 and 4. At December 31, 2002, mortgage loans had a carrying value of $2.0 billion and a fair value of $2.2 billion and at year-end 2001 had a carrying value of $2.0 billion and a fair value of $2.1 billion. In estimating fair value, the Company used interest rates reflecting the current real estate financing market. Included in other invested assets are 2,225 shares of Citigroup Cumulative Preferred Stock Series YYY, carried at cost of $2,225 million at December 31, 2002, acquired as a contribution from TPC. This Series YYY preferred stock pays cumulative dividends at 6.767%, has a liquidation value of $1 million per share and has perpetual duration, is not subject to a sinking fund or mandatory redemption but may be optionally redeemed by Citigroup at any time on or after February 27, 2022. Dividends totaling $125 million were received in 2002. There is no established market for this investment and it is not practicable to estimate the fair value of the preferred stock. Included in other invested assets are 987 shares of Citigroup Cumulative Preferred Stock Series YY, carried at cost of $987 million at December 31, 2002 and 2001. This series YY preferred stock pays cumulative dividends at 5.321%, has a liquidation value of $1 million per share, and has perpetual duration, is not subject to a sinking fund or mandatory redemption but may be optionally redeemed by Citigroup at any time on or after December 22, 2018. Dividends totaling $53 million were received during 2002, 2001 and 2000, respectively. There is no established market for this investment and it is not practicable to estimate the fair value of the preferred stock. At December 31, 2002, contractholder funds with defined maturities had a carrying value of $12.5 billion and a fair value of $13.3 billion, compared with a carrying value and a fair value of $9.5 billion and $10.0 billion at December 31, 2001. The fair value of these contracts is determined by discounting expected cash flows at an interest rate commensurate with the Company's credit risk and the expected timing of cash flows. Contractholder funds without defined maturities had a carrying value of $11.1 billion and a fair value of $10.7 billion at December 31, 2002, compared with a carrying value of $10.6 billion and a fair value of $10.3 billion at December 31, 2001. These contracts generally are valued at surrender value. The carrying values of $321 million and $495 million of financial instruments classified as other assets approximated their fair values at December 31, 2002 and 2001, respectively. The carrying value of $1.5 billion of financial instruments classified as other liabilities at both December 31, 2002 and 2001 also approximated their fair values at both December 31, 2002 and 2001. Fair value is determined using various methods, including discounted cash flows, as appropriate for the various financial instruments. 55 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The assets of separate accounts providing a guaranteed return had a carrying value and a fair value of $511 million at December 31, 2002, compared with a carrying value and a fair value of $507 million at December 31, 2001. The liabilities of separate accounts providing a guaranteed return had a carrying value and a fair value of $511 million at December 31, 2002, compared with a carrying value and a fair value of $507 million at December 31, 2001. The carrying values of cash, trading securities and trading securities sold not yet purchased are carried at fair value. The carrying values of short-term securities and investment income accrued approximated their fair values. The carrying value of policy loans, which have no defined maturities, is considered to be fair value. 13. COMMITMENTS AND CONTINGENCIES Litigation TIC and its subsidiaries are defendants or co-defendants in various litigation matters in the normal course of business. These include civil actions, arbitration proceedings and other matters arising in the normal course of business out of activities as an insurance company, a broker and dealer in securities or otherwise. In the opinion of the Company's management, the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on the Company's results of operations, financial condition or liquidity. 14. RELATED PARTY TRANSACTIONS Citigroup and certain of its subsidiaries provide investment management and accounting services, payroll, internal auditing, benefit management and administration, property management and investment technology services to the Company as of December 31, 2002. At December 31, 2001 the majority of these services were provided by either Citigroup and its subsidiaries or TPC. The Company paid Citigroup and its subsidiaries $56.9 million and $43.6 million in 2002 and 2001, respectively, for these services. The Company paid TPC $33.6 million and $30.0 million in 2002 and 2001, respectively, for these services. The amounts due from affiliates related to these services, included in other assets at December 31, 2002, were insignificant and in 2001 were $88.2 million. See Note 15. The Company maintains a short-term investment pool in which its insurance affiliates participate. The position of each company participating in the pool is calculated and adjusted daily. At December 31, 2002 and 2001, the pool totaled approximately $4.2 billion and $5.6 billion, respectively. The Company's share of the pool amounted to $3.8 billion and $2.6 billion at December 31, 2002 and 2001, respectively, and is included in short-term securities in the consolidated balance sheets. 56 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) At December 31, 2002 and 2001 the Company had outstanding loaned securities to SSB for $267.1 million and $413.5 million, respectively. Included in other invested assets is a $3.2 billion and $987 million investment in Citigroup preferred stock at December 31, 2002 and 2001, respectively, carried at cost. Dividends received on these investments were $178 million in 2002, and $53 million in each of 2001 and 2000. The Company had investments in an affiliated joint venture, Tishman Speyer, in the amount of $186.1 million and $310.9 million at December 31, 2002 and 2001, respectively. Income of $99.7 million, $65.5 million and $67.0 million was earned on these investments in 2002, 2001 and 2000, respectively. The Company also had an investment in Greenwich Street Capital Partners I, an affiliated private equity investment, in the amount of $21.6 million at both December 31, 2002 and 2001. Income (loss) of $0, $(41.6) million and $8.1 million were earned on this investment in 2002, 2001 and 2000, respectively. In the ordinary course of business, the Company purchases and sells securities through affiliated broker-dealers. These transactions are conducted on an arm's-length basis. The Company markets deferred annuity products and life insurance through its affiliate, Salomon Smith Barney (SSB). Annuity deposits related to these products were $1.0 billion, $1.5 billion, and $1.8 billion in 2002, 2001 and 2000, respectively. Life premiums were $109.7 million, $96.5 million and $77.0 million in 2002, 2001 and 2000, respectively. The Company also markets individual annuity and life insurance through CitiStreet Retirement Services LLC, a division of CitiStreet, a joint venture between Citigroup and State Street Bank. Deposits received from CitiStreet Retirement Services, LLC were $1.6 billion in each of 2002, 2001 and $1.8 billion in 2000. The Company markets individual annuity products through an affiliate Citibank, N.A. (Citibank). Deposits received from Citibank were $303 million, $564 million and $392 million in 2002, 2001 and 2000, respectively. Primerica Financial Services (PFS), an affiliate, is a distributor of products for TLA. PFS sold $787 million, $901 million and $1.03 billion of individual annuities in 2002, 2001 and 2000, respectively. Primerica Life has entered into a General Agency Agreement with PFS, that provides that PFS will be Primerica Life's general agent for marketing all insurance of Primerica Life. In consideration of such services, Primerica Life agreed to pay PFS marketing fees of no less than $10 million per year based upon U.S. gross direct premiums received by Primerica Life. In each of 2002, 2001, and 2000 the fees paid by Primerica Life were $12.5 million. The Company sells structured settlement annuities to the property casualty subsidiaries of TPC. See Note 15. 57 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company participates in a stock option plan sponsored by Citigroup that provides for the granting of stock options in Citigroup common stock to officers and other employees. To further encourage employee stock ownership, Citigroup introduced the WealthBuilder stock option program during 1997 and the Citigroup Ownership Program in 2001. Under these programs, all employees meeting established requirements have been granted Citigroup stock options. During 2000 and 2001, Citigroup introduced the Citigroup 2000 Stock Purchase Plan and Citigroup 2001 Stock Purchase Program for new employees, which allowed eligible employees of Citigroup, including the Company's employees, to enter into fixed subscription agreements to purchase shares at the market value on the date of the agreements. Enrolled employees are permitted to make one purchase prior to the expiration date. The Company's charge to income for these plans was insignificant in 2002, 2001 and 2000. The Company also participates in the Citigroup Capital Accumulation Program. Participating officers and other employees receive a restricted stock award in the form of Citigroup common stock. These restricted stock awards generally vest after a three-year period and, except under limited circumstances, the stock can not be sold or transferred during the restricted period by the participant, who is required to render service to the Company during the restricted period. The Company's charge to income for this program was insignificant in 2002, 2001 and 2000. Unearned compensation expense associated with the Citigroup restricted common stock grants, which represents the market value of Citigroup's common stock at the date of grant, is included with other assets in the Consolidated Balance Sheet and is recognized as a charge to income ratably over the vesting period. The Company's charge to income was insignificant during 2002, 2001 and 2000. The Company applies Accounting Principles Board Opinion No. 25 (APB 25) and related interpretations in accounting for stock options. Since stock options under the Citigroup plans are issued at fair market value on the date of award, no compensation cost has been recognized for these awards. FAS 123 provides an alternative to APB 25 whereby fair values may be ascribed to options using a valuation model and amortized to compensation cost over the vesting period of the options. 58 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. TRAVELERS PROPERTY CASUALTY SPIN-OFF On March 27, 2002, Travelers Property Casualty Corp. (TPC), the Company's parent at December 31, 2001, completed its initial public offering (IPO). On August 20, 2002, Citigroup made a tax-free distribution to its stockholders of a majority portion of its remaining interest in TPC. Prior to the IPO the following transactions occurred: - The common stock of the Company was distributed by TPC to CIHC so the Company would remain an indirect wholly owned subsidiary of Citigroup. - The Company sold its home office buildings in Hartford, Connecticut and a building housing TPC's information systems in Norcross, Georgia to TPC for $68 million. - TLA Holdings LLC, a non-insurance subsidiary valued at $142 million, was contributed to the Company by TPC. - The Company assumed pension, post-retirement and post-employment benefits payable to all inactive employees of the former Travelers Insurance entities and received $189 million of cash and other assets from TPC to offset these benefit liabilities. - The Company received 2,225 shares of Citigroup's 6.767% Cumulative Preferred Stock, Series YYY, with a par value of $1.00 per share and a liquidation value of $1 million per share as a contribution from TPC. At December 31, 2001, TPC and its subsidiaries were affiliates of the Company and provided certain services to the Company. These services included data processing, facilities management, banking and financial functions, benefits administration and others. During 2002, the Company began phasing out these services. At December 31, 2002, the Company still receives certain services from TPC on a contract basis. The Company paid TPC $33.6 million and $30.0 million in 2002 and 2001, respectively, for these services. The Company sells structured settlement annuities to the property casualty insurance subsidiaries of TPC. Such premiums and deposits were $159 million, $194 million and $191 million for 2002, 2001 and 2000, respectively. The Company has a license from TPC to use the names "Travelers Life & Annuity," "The Travelers Insurance Company," "The Travelers Life and Annuity Company" and related names in connection with the Company's business. 59 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 16. RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES The following table reconciles net income to net cash provided by operating activities:
-------------------------------------------------------------------------------------------- FOR THE YEAR ENDED DECEMBER 31, ($ in millions) 2002 2001 2000 -------------------------------------------------------------------------------------------- Net Income $ 1,082 $ 1,281 $ 1,103 Adjustments to reconcile net income to net cash provided by operating activities: Realized (gains) losses 322 (125) 77 Deferred federal income taxes 185 159 89 Amortization of deferred policy acquisition costs 393 379 347 Additions to deferred policy acquisition costs (878) (851) (792) Investment income (119) (493) (384) Premium balances (7) 7 20 Insurance reserves and accrued expenses 493 686 559 Other (403) 237 221 -------------------------------------------------------------------------------------------- Net cash provided by operations $ 1,068 $ 1,280 $ 1,240 --------------------------------------------------------------------------------------------
17. NON-CASH INVESTING AND FINANCING ACTIVITIES Significant non-cash investing and financing activities include the contribution of $2,225 million of Citigroup YYY preferred stock and related deferred tax liability of $779 million; a $17 million COLI asset and $98 million deferred tax asset related to the transfer of $279 million of pension and postretirement benefits, transferred for $172 million cash; and the contribution of a non-insurance company, TLA Holdings, LLC, for $142 million. 60 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Omitted pursuant to General Instruction I(2)(c) of Form 10-K. ITEM 11. EXECUTIVE COMPENSATION. Omitted pursuant to General Instruction I(2)(c) of Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Omitted pursuant to General Instruction I(2)(c) of Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Omitted pursuant to General Instruction I(2)(c) of Form 10-K. ITEM 14. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-14 (c) and 15d-14 (c) under the Exchange Act) as of a date within 90 days prior to the filing date of this annual report (the Evaluation Date). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's reports filed or submitted under the Exchange Act. CHANGES IN INTERNAL CONTROLS Since the Evaluation Date, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect such controls. 61 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed: (1) Financial Statements. See index on page 18 of this report. (2) Financial Statement Schedules. See index on page 67 of this report. (3) Exhibits. See Exhibit Index on page 63. (b) Reports on Form 8-K: None 62 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION 3. Articles of Incorporation and By-Laws a.) Charter of The Travelers Insurance Company (the "Company"), as effective October 19, 1994, incorporated by reference to Exhibit 3.01 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1994 (File No. 33-33691) (the "Company's September 30, 1994 10-Q"). b.) By-laws of the Company, as effective October 20, 1994, incorporated by reference to Exhibit 3.02 to the Company's September 30, 1994 10-Q. 10.01 Lease for office space in Hartford, Connecticut dated as of April 2, 1996, by and between the Company and The Travelers Indemnity Company, incorporated by reference to Exhibit 10.14 to the Annual Report on Form 10-K of Travelers Property Casualty Corp. for the fiscal year ended December 31, 1996 (File No. 1-14328). 10.02 Trademark License Agreement between Travelers Property Casualty Corp. and The Travelers Insurance Company, effective as of August 20, 2002, incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on form 10-Q for the fiscal quarter ended September 30, 2002. 10.03 Lease for office space at CityPlace, Hartford, Connecticut, dated March 28, 1996, by and between Aetna Life and Casualty Company and The Travelers Indemnity Company, (the "Cityplace Lease"), incorporated by reference to Exhibit 10.10 to the Registration Statement on Form S-1 of Travelers Insurance Group Holdings Inc. (then known as Travelers/Aetna Property Casualty Corp.) on April 22, 1996 (File No. 333-2254). 10.04* First Amendment, dated May 15, 2001, by and between Aetna Inc. (formerly Aetna Life and Casualty Company) as Landlord and The Travelers Indemnity Company, as Tenant, with respect to the Cityplace Lease. 10.05* Assignment and Assumption Agreement dated as of August 19, 2002, by and between The Travelers Indemnity Company as Assignor and the Company as Assignee, with respect to the Cityplace Lease. 14.01* Citigroup Code of Ethics for Financial Professionals 21. Subsidiaries of the Registrant: Omitted pursuant to General Instruction I(2)(b) of Form 10-K. 99.01* Certification Pursuant to 18 USC Section 1350. --------------------------------------------------------------------------- *Filed herewith 63 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 21st day of March, 2003. THE TRAVELERS INSURANCE COMPANY (Registrant) By: /s/ Glenn D. Lammey -------------------- Glenn D. Lammey Executive Vice President, Chief Financial Officer and Chief Accounting Officer (Principal Financial Officer and Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on the 21st day of March, 2003.
SIGNATURE CAPACITY --------- -------- /s/ George C. Kokulis Director and Chief Executive Officer ------------------------ (Principal Executive Officer) (George C. Kokulis) /s/ Glenn D. Lammey Director, Chief Financial Officer and Chief Accounting Officer ------------------- (Principal Financial Officer and Principal Accounting Officer) (Glenn D. Lammey) /s/ Kathleen Lynch Preston Director -------------------------- (Kathleen Lynch Preston) /s/ Marla Berman Lewitus Director ------------------------ (Marla Berman Lewitus)
Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Securities pursuant to Section 12 of the Act: NONE No Annual Report to Security Holders covering the registrant's last fiscal year or proxy material with respect to any meeting of security holders has been sent, or will be sent, to security holders. CERTIFICATIONS I, Glenn D. Lammey, Chief Financial Officer, certify that: 1. I have reviewed this annual report on Form 10-K of The Travelers Insurance Company; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 64 CERTIFICATIONS (continued) 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date March 21, 2003 /s/ Glenn D. Lammey ------------------------------------------- Glenn D. Lammey Executive Vice President, Chief Financial Officer and Chief Accounting Officer (Principal Financial Officer and Principal Accounting Officer) I, George C. Kokulis, Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-K of The Travelers Insurance Company; 65 CERTIFICATIONS (continued) 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date March 21, 2003 /s/ George C. Kokulis ------------------------------------------------- George C. Kokulis Chief Executive Officer 66 INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE The Travelers Insurance Company and Subsidiaries Independent Auditors' Report * Consolidated Statements of Income * Consolidated Balance Sheets * Consolidated Statements of Changes In Shareholder's Equity * Consolidated Statements of Cash Flows * Notes to Consolidated Financial Statements * Independent Auditors' Report 68 Schedule I - Summary of Investments - Other than Investments in Related Parties 2002 69 Schedule III - Supplementary Insurance Information 2000-2002 70 Schedule IV - Reinsurance 2000-2002 71 All other schedules are inapplicable for this filing.
* See index on page 18 67 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholder The Travelers Insurance Company: Under date of January 21, 2003, we reported on the consolidated balance sheets of The Travelers Insurance Company and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholder's equity and cash flows for each of the years in the three-year period ended December 31, 2002, which are included in this Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets in 2002, and its methods of accounting for derivative instruments and hedging activities and for securitized financial assets in 2001. /s/KPMG LLP Hartford, Connecticut January 21, 2003 68 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE I SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2002 ($ in millions)
------------------------------------------------------------------------------------------------------ AMOUNT SHOWN IN TYPE OF INVESTMENT COST VALUE BALANCE SHEET(1) ------------------------------------------------------------------------------------------------------ Fixed Maturities: Bonds: U.S. Government and government agencies and Authorities $ 6,416 $ 6,658 $ 6,658 States, municipalities and political subdivisions 297 319 319 Foreign governments 365 393 393 Public utilities 3,261 3,149 3,149 Convertible bonds and bonds with warrants attached 263 269 269 All other corporate bonds 24,679 25,532 25,532 ------------------------------------------------------------------------------------------------------ Total Bonds 35,281 36,320 36,320 Redeemable preferred stocks 147 114 114 ------------------------------------------------------------------------------------------------------ Total Fixed Maturities 35,428 36,434 36,434 ------------------------------------------------------------------------------------------------------ Equity Securities: Common Stocks: Banks, trust and insurance companies 10 10 10 Industrial, miscellaneous and all other 38 40 40 ------------------------------------------------------------------------------------------------------ Total Common Stocks 48 50 50 Nonredeemable preferred stocks 280 282 282 ------------------------------------------------------------------------------------------------------ Total Equity Securities 328 332 332 ------------------------------------------------------------------------------------------------------ Mortgage Loans 1,985 1,985 Real Estate Held For Sale 36 36 Policy Loans 1,168 1,168 Short-Term Securities 4,414 4,414 Trading Securities 1,531 1,531 Other Investments (2)(3)(4) 1,382 1,382 ------------------------------------------------------------------------------------------------------ Total Investments $ 46,272 $ 47,282 ======================================================================================================
(1) Determined in accordance with methods described in Notes 1 and 4 of the Notes to Consolidated Financial Statements. (2) Excludes $3.2 billion of Citigroup Inc. preferred stock. See Note 14 of Notes to Consolidated Financial Statements. (3) Also excludes $315 million fair value of investment in affiliated partnership interests. (4) Includes derivatives marked to market and recorded at fair value in the balance sheet. 69 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION ($ in millions)
--------------------------------------------------------------------------------------------------------------- FUTURE POLICY BENEFITS, DEFERRED LOSSES, OTHER POLICY POLICY AND CLAIMS CLAIMS AND NET BENEFITS, ACQUISITION LOSS BENEFITS PREMIUM INVESTMENT CLAIMS AND COSTS EXPENSES(1) PAYABLE REVENUE INCOME LOSSES (2) --------------------------------------------------------------------------------------------------------------- 2002 ---- Travelers Life & Annuity $ 2,043 $ 37,774 $ 461 $ 730 $ 2,646 $ 2,404 Primerica Life 1,893 3,261 147 1,194 290 527 ------------------------------------------------------------------------------------------------------------- Total $ 3,936 $ 41,035 $ 608 $ 1,924 $ 2,936 $ 2,931 ============================================================================================================= 2001 ---- Travelers Life & Annuity $ 1,672 $ 33,475 $ 368 $ 957 $ 2,530 $ 2,534 Primerica Life 1,789 3,044 144 1,145 301 507 ------------------------------------------------------------------------------------------------------------- Total $ 3,461 $ 36,519 $ 512 $ 2,102 $ 2,831 $ 3,041 ============================================================================================================= 2000 ---- Travelers Life & Annuity $ 1,291 $ 29,377 $ 321 $ 860 $ 2,450 $ 2,294 Primerica Life 1,698 2,856 140 1,106 280 496 ------------------------------------------------------------------------------------------------------------- Total $ 2,989 $ 32,233 $ 461 $ 1,966 $ 2,730 $ 2,790 =============================================================================================================
---------------------------------------------------------------------------- AMORTIZATION OF DEFERRED POLICY OTHER ACQUISITION OPERATING PREMIUMS COSTS EXPENSES WRITTEN ---------------------------------------------------------------------------- 2002 ---- Travelers Life & Annuity $ 174 $ 190 $ 729 Primerica Life 219 217 1,184 ---------------------------------------------------------------------------- Total $ 393 $ 407 $ 1,913 ============================================================================ 2001 ---- Travelers Life & Annuity $ 171 $ 154 $ 955 Primerica Life 208 217 1,157 ---------------------------------------------------------------------------- Total $ 379 $ 371 $ 2,112 ============================================================================ 2000 ---- Travelers Life & Annuity $ 166 $ 233 $ 859 Primerica Life 181 230 1,115 ---------------------------------------------------------------------------- Total $ 347 $ 463 $ 1,974 ============================================================================
(1) Includes contractholder funds. (2) Includes interest credited to contractholders. 70 THE TRAVELERS INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE IV REINSURANCE ($ in millions)
------------------------------------------------------------------------------------------------------------------------ PERCENTAGE OF CEDED TO OTHER ASSUMED FROM AMOUNT ASSUMED GROSS AMOUNT COMPANIES OTHER COMPANIES NET AMOUNT TO NET ------------------------------------------------------------------------------------------------------------------------ 2002 ---- Life Insurance In Force $ 549,066 $ 321,940 $ 3,568 $230,694 1.5% Premiums: Life insurance $ 2,227 377 $ - $ 1,850 - Accident and health insurance 316 242 - 74 - Property casualty 109 109 - - - --------- --------- -------- -------- ----- Total Premiums $ 2,652 $ 728 $ - $ 1,924 - ========= ========= ======== ======== ===== 2001 ---- Life Insurance In Force $ 510,457 $ 285,696 $ 3,636 $228,397 1.6% Premiums: Life insurance $ 2,378 $ 352 $ - $ 2,026 - Accident and health insurance 321 246 1 76 - Property casualty 180 180 - - - --------- --------- -------- -------- ----- Total Premiums $ 2,879 $ 778 $ 1 $ 2,102 - ========= ========= ======== ======== ===== 2000 ---- Life Insurance In Force $ 480,958 $252,498 $ 3,692 $232,152 1.6% Premiums: Life insurance $ 2,106 $ 330 $ - $ 1,776 - Accident and health insurance 322 132 - 190 - Property casualty 216 216 - - - --------- -------- -------- -------- ----- Total Premiums $ 2,644 $ 678 $ - $ 1,966 - ========= ======== ======== ======== =====
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