-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QzaavCqsS+VO9C785rdjRa62AgWGoNaWS/1aUbvtqYAASSyfPzNLVixwJh3Dzusg S8akTN4P1jhLdJR87C0kyQ== 0001005477-01-003356.txt : 20010516 0001005477-01-003356.hdr.sgml : 20010516 ACCESSION NUMBER: 0001005477-01-003356 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HANCOCK JOHN FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0000736260 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 043483032 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-15607 FILM NUMBER: 1640591 BUSINESS ADDRESS: STREET 1: LAW DIVISION STREET 2: PO BOX 111 CITY: BOSTON STATE: MA ZIP: 02117 MAIL ADDRESS: STREET 1: LAW DIVISION STREET 2: PO BOX 111 CITY: BOSTON STATE: MA ZIP: 02117 10-Q 1 0001.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 Commission File Number: 1-15607 JOHN HANCOCK FINANCIAL SERVICES, INC. Exact name of registrant as specified in charter DELAWARE 04-3483032 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) John Hancock Place Boston, Massachusetts 02117 (Address of principal executive offices) (617) 572-6000 (Registrant's telephone number, including area code) 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 |_| Number of shares outstanding of our only class of common stock as of May 4, 2001: 308,067,506 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS JOHN HANCOCK FINANCIAL SERVICES, INC. CONSOLIDATED BALANCE SHEETS
March 31, 2001 December 31, (Unaudited) 2000 ----------------------------- (in millions) Assets Investments Fixed maturities: Held-to-maturity--at amortized cost (fair value: 2001--$1,940.7; 2000--$11,651.2) ...... $ 1,965.5 $ 11,888.6 Available-for-sale--at fair value (cost: 2001--$27,688.9; 2000--$15,829.7) ........... 28,289.8 16,061.9 Equity securities: Available-for-sale--at fair value (cost: 2001--$909.2; 2000--$870.6) ................. 1,078.9 1,134.4 Trading securities--at fair value (cost: 2001--$288.6; 2000--$193.4) ................. 267.9 231.6 Mortgage loans on real estate ......................... 9,004.0 8,969.4 Real estate ........................................... 528.6 519.0 Policy loans .......................................... 437.3 428.6 Short-term investments ................................ 220.5 151.9 Other invested assets ................................. 1,296.8 1,353.0 ----------------------------- Total Investments .................................. 43,089.3 40,738.4 Cash and cash equivalents ............................. 1,926.5 2,974.4 Accrued investment income ............................. 670.1 586.9 Premiums and accounts receivable ...................... 266.1 210.8 Deferred policy acquisition costs ..................... 2,536.6 2,528.1 Reinsurance recoverable ............................... 1,905.8 1,958.6 Other assets .......................................... 2,257.4 2,191.3 Closed block assets - Note 5 .......................... 9,984.9 9,710.0 Separate accounts assets .............................. 23,411.6 26,454.8 ----------------------------- Total Assets ....................................... $ 86,048.3 $ 87,353.3 =============================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 2 JOHN HANCOCK FINANCIAL SERVICES, INC. CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
March 31, 2001 December 31, (Unaudited) 2000 --------------------------- (in millions) Liabilities and Shareholders' Equity Liabilities Future policy benefits ................................................ $ 23,513.2 $ 22,996.4 Policyholders' funds .................................................. 15,912.3 15,741.1 Unearned revenue ...................................................... 689.2 671.3 Unpaid claims and claim expense reserves .............................. 251.5 253.7 Dividends payable to policyholders .................................... 120.5 130.8 Short-term debt ....................................................... 265.6 245.3 Long-term debt ........................................................ 534.1 534.0 Income taxes .......................................................... 602.3 431.3 Other liabilities ..................................................... 2,398.5 1,986.0 Closed block liabilities - Note 5 ..................................... 12,180.7 12,035.9 Separate accounts liabilities ......................................... 23,411.6 26,454.8 --------------------------- Total Liabilities .................................................. 79,879.5 81,480.6 Minority interest ..................................................... 93.5 93.5 Commitments and contingencies - Note 4 Shareholders' Equity - Note 7 Common stock, $.01 par value; 2.0 billion shares authorized; 315.3 million shares issued, 308.7 million and 312.0 million shares outstanding, respectively .......................................... 3.2 3.2 Additional paid in capital ............................................ 5,090.4 5,086.4 Retained earnings ..................................................... 868.5 700.6 Accumulated other comprehensive income ................................ 330.7 80.8 Treasury stock at cost (6.6 million and 3.0 million shares, respectively) ...................................................... (217.5) (91.8) --------------------------- Total Shareholders' Equity ......................................... 6,075.3 5,779.2 --------------------------- Total Liabilities and Shareholders' Equity ......................... $ 86,048.3 $ 87,353.3 ===========================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 3 JOHN HANCOCK FINANCIAL SERVICES, INC. UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 2001 2000 ------------------------ (in millions) Revenues Premiums ..................................................................... $ 862.1 $ 531.6 Universal life and investment-type product charges ........................... 179.7 205.0 Net investment income ........................................................ 781.4 848.6 Net realized investment and other gains (losses), net of related amortization of deferred policy acquisition costs and amounts credited to participating pension contract holders ($4.3) and $(0.8), respectively) .............................................................. (26.4) 18.3 Investment management revenues, commissions and other fees ................................................................. 151.2 229.3 Other revenue ................................................................ 3.7 2.8 Contribution from the closed block - Note 5 .................................. 20.3 28.7 ------------------------ Total revenues ............................................................ 1,972.0 1,864.3 Benefits and expenses Benefits to policyholders, excluding amounts related to net realized investment and other gains (losses) credited to participating Pension contract holders ($2.3) and $(2.1), respectively) .................. 1,278.2 1,018.1 Other operating costs and expenses ........................................... 355.4 425.8 Amortization of deferred policy acquisition costs, excluding amounts related to net realized investment and other gains (losses) ($2.0 and $1.3, respectively) .................................................... 79.7 44.1 Dividends to policyholders ................................................... 27.4 65.9 Demutualization expenses ..................................................... -- 16.0 ------------------------ Total benefits and expenses ............................................... 1,740.7 1,569.9 ------------------------ Income before income taxes and cumulative effect of accounting changes ................................................. 231.3 294.4 Income taxes ................................................................... 70.6 102.9 ------------------------ Income before cumulative effect of accounting changes .......................... 160.7 191.5 Cumulative effect of accounting changes, net of tax - Note 1 ................................................................. 7.2 -- ------------------------ Net income ..................................................................... $ 167.9 $ 191.5 ========================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 4 JOHN HANCOCK FINANCIAL SERVICES, INC. UNAUDITED CONSOLIDATED STATEMENTS OF INCOME -- (CONTINUED)
Three Months Three Months For the Period Ended March 31, Ended February 1 through 2000 March 31, 2001 March 31, 2000 Pro Forma ---------------------------------------------------------- (in millions, except per share data) Basic earnings per common share: Income before cumulative effect of accounting changes .... $ 0.52 $ 0.47 $ 0.61 Cumulative effect of accounting changes .................. 0.02 -- -- ---------------------------------------------------------- Net income ............................................... $ 0.54 $ 0.47 $ 0.61 ========================================================== Diluted earnings per common share: Income before cumulative effect of accounting changes .... $ 0.52 $ 0.47 $ 0.61 Cumulative effect of accounting changes .................. 0.02 -- -- ---------------------------------------------------------- Net income ............................................... $ 0.54 $ 0.47 $ 0.61 ========================================================== Share data: Weighted-average shares used in basic earnings per common share calculations ......................... 311.2 314.8 314.8 Dilutive securities: Stock options ............................................ 2.5 0.2 0.2 Non-vested stock ......................................... 0.1 0.1 0.1 ---------------------------------------------------------- Weighted-average shares used in diluted earnings per common share calculations ......................... 313.8 315.1 315.1 ==========================================================
The unaudited pro forma information above gives effect to the Reorganization and Initial Public Offering referred to in Note 1. The accompanying notes are an integral part of these unaudited consolidated financial statements. 5 JOHN HANCOCK FINANCIAL SERVICES, INC. UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Additional Accumulated Other Total Outstanding Common Paid In Retained Comprehensive Treasury Shareholders' Shares Stock Capital Earnings Income (Loss) Stock Equity (in thousands) --------------------------------------------------------------------------------------- (in millions) Balance at January 1, 2000 ............ $ -- $ -- $ 4,825.0 $ (33.9) $ -- $ 4,791.1 -- Demutualization transaction ........... 2.2 3,373.3 (4,869.0) (1,493.5) 212,786.5 Initial public offering ............... 1.0 1,656.7 1,657.7 102,000.0 Comprehensive income: Net income before demutualization .. 44.0 44.0 Net income after demutualization ... 147.5 147.5 ------------------------------------------------------------------------------------- Net income for the period .......... 191.5 191.5 Other comprehensive income, net of tax: Net unrealized gains ............... 50.6 50.6 Foreign currency translation adjustment ....................... 8.2 8.2 Minimum pension liability .......... (5.5) (5.5) --------- Comprehensive income .................. 244.8 ------------------------------------------------------------------------------------- Balance at March 31, 2000 ............. $ 3.2 $5,030.0 $ 147.5 $ 19.4 $ -- $ 5,200.1 314,786.5 =====================================================================================
Additional Accumulated Other Total Outstanding Common Paid In Retained Comprehensive Treasury Shareholders' Shares Stock Capital Earnings Income (Loss) Stock Equity (in thousands) --------------------------------------------------------------------------------------- (in millions) Balance at January 1, 2001 .............. $3.2 $5,086.4 $ 700.6 $ 80.8 $ (91.8) $ 5,779.2 311,988.9 Options exercised ....................... -- 4.0 4.0 317.7 Restricted stock issued ................. -- -- -- -- -- 56.0 Treasury stock acquired ................. (125.7) (125.7) (3,577.5) Comprehensive income: Net income ........................... 167.9 167.9 Other comprehensive income, net of tax: Net unrealized gains (losses) ........ 48.6 48.6 Net accumulated gains (losses) on cash flow hedges ................ (2.7) (2.7) Foreign currency translation adjustment ......................... (23.6) (23.6) Minimum pension liability ............... -- -- ---------- Comprehensive income .................... 190.2 Change in accounting principles ......... 227.6 227.6 -------------------------------------------------------------------------------------- Balance at March 31, 2001 ............... $3.2 $5,090.4 $ 868.5 $ 330.7 $(217.5) $6,075.3 308,785.1 ======================================================================================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 6 JOHN HANCOCK FINANCIAL SERVICES, INC. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2001 2000 ------------------------- (in millions) Cash flows from operating activities: Net income ...................................................................... $ 167.9 $ 191.5 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of discount - fixed maturities ................................... (36.0) (26.7) Realized investment and other (gains) losses, net ............................. 26.4 (18.3) Change in deferred policy acquisition costs ................................... (60.1) (93.6) Depreciation and amortization ................................................. 21.8 24.6 Net cash flows from trading securities ........................................ (36.3) (145.7) Increase in accrued investment income ......................................... (83.2) (43.2) Increase in premiums and accounts receivable .................................. (55.3) (62.5) (Increase) decrease in other assets and other liabilities, net ................ (207.6) 272.2 Increase in policy liabilities and accruals, net .............................. 480.3 247.6 Increase in income taxes ...................................................... 232.3 102.9 Initial cash transferred to the closed block .................................. -- (158.6) Contribution from the closed block ............................................ (20.3) (28.7) ------------------------- Net cash provided by operating activities ............................... 429.9 261.5 Cash flows from investing activities: Sales of: Fixed maturities available-for-sale ........................................... 4,960.6 1,178.9 Equity securities available-for-sale .......................................... 59.1 42.2 Real estate ................................................................... 0.6 8.9 Short-term investments and other invested assets .............................. 21.7 11.0 Maturities, prepayments and scheduled redemptions of: Fixed maturities held-to-maturity ............................................. 60.2 472.3 Fixed maturities available-for-sale ........................................... 636.9 289.1 Short-term investments and other invested assets .............................. 26.5 50.2 Mortgage loans on real estate ................................................. 237.2 333.8 Purchases of: Fixed maturities held-to-maturity ............................................. (6.7) (361.1) Fixed maturities available-for-sale ........................................... (6,988.8) (1,957.8) Equity securities available-for-sale .......................................... (111.0) (47.3) Real estate ................................................................... (1.1) (9.2) Short-term investments and other invested assets .............................. (118.9) (258.5) Mortgage loans on real estate issued .......................................... (335.5) (173.2) Cash received related to acquisition of business .............................. -- 126.3 Other, net .................................................................... 11.3 (5.4) ------------------------- Net cash used in investing activities ................................... (1,547.9) (299.8)
The accompanying notes are an integral part of these unaudited consolidated financial statements. 7 JOHN HANCOCK FINANCIAL SERVICES, INC. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
Three Months Ended March 31, 2001 2000 ------------------------- (in millions) Cash flows from financing activities: Issuance of common stock ........................................................ -- 1,657.7 Payments to eligible policyholders under Plan of Reorganization ................. -- (791.7) Acquisition of treasury stock ................................................... (125.7) -- Universal life and investment-type contract deposits ............................ 1,780.9 1,522.9 Universal life and investment-type contract maturities and withdrawals ................................................................... (1,605.4) (2,290.2) Issuance of long-term debt ...................................................... -- 10.0 Repayment of long-term debt ..................................................... -- (18.0) Net increase (decrease) in commercial paper ..................................... 20.3 (13.9) ------------------------- Net cash provided by financing activities ............................... 70.1 76.8 ------------------------- Net increase (decrease) in cash and cash equivalents .................... (1,047.9) 38.5 Cash and cash equivalents at beginning of period ................................... 2,974.4 1,817.9 ------------------------- Cash and cash equivalents at end of period .............................. $ 1,926.5 $ 1,856.4 =========================
The accompanying notes are an integral part of these unaudited consolidated financial statements. 8 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 1 -- Summary of Significant Accounting Policies Basis of Presentation The accompanying unaudited consolidated financial statements of John Hancock Financial Services, Inc. (the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, these unaudited consolidated financial statements contain all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and results of operations. Operating results for the three-month period ended March 31, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. These unaudited consolidated financial statements should be read in conjunction with the Company's annual audited financial statements as of December 31, 2000 included in the Company's Form 10-K for the year ended December 31, 2000 filed with the United States Securities and Exchange Commission (hereafter referred to as the Company's 2000 Form 10-K). The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Reorganization and Initial Public Offering In connection with John Hancock Mutual Life Insurance Company's (the Mutual Company) Plan of Reorganization (the Plan), effective February 1, 2000, the Mutual Company converted from a mutual life insurance company to a stock life insurance company (i.e. demutualized) and became a wholly owned subsidiary of John Hancock Financial Services, Inc., which is a holding company. All policyholder membership interests in the Mutual Company were extinguished on that date and eligible policyholders of the Mutual Company received, in the aggregate, 212.8 million shares of common stock, $1,438.7 million of cash and $43.7 million policy credits as compensation. In addition, the Company established a closed block, to fund the guaranteed benefits and dividends of certain participating insurance policies. In connection with the Plan, the Mutual Company changed its name to John Hancock Life Insurance Company. In addition, on February 1, 2000, the Company completed its initial public offering (IPO) in which 102.0 million shares of common stock were issued at a price of $17.00 per share. Net proceeds from the IPO were $1,657.7 million, of which $105.7 million was retained by the Company and $1,552.0 million was contributed to John Hancock Life Insurance Company. Cumulative Effect of Accounting Change During the first quarter of 2001, the Company changed the method of accounting for the recognition of deferred gains and losses considered in the calculation of the annual expense for its employee pension plan under SFAS No. 87, "Employers' Accounting for Pensions," and for its postretirment health and welfare plans under SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The Company changed the method of recognizing gains and losses from deferral within a 10% corridor and amortization of gains outside this corridor over the future working careers of the participants to a deferral within a 5% corridor and amortization of gains and losses outside this corridor over the future working careers of the participants. The new method is preferable because in the Company's situation, it produces results that more closely match current economic realities of the Company's retirement and welfare plans through the use of the current fair values of assets while still mitigating the impact of extreme gains and losses. As a result, the Company recorded a credit of $18.6 million (net of tax of $9.9 million), related to its employee benefit pension plans, and a credit of $4.7 million (net of tax of $2.6 million), related to its postretirement health and welfare plans. The total credit recorded as a cumulative effect of an accounting change was $23.3 million (net of tax of $12.5 million), or $0.07 diluted earnings per share. This change in accounting increased net income for the quarter ended March 31, 2001 by $1.1 million. The pro forma 9 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 1 -- Summary of Significant Accounting Policies - (Continued) Cumulative Effect of Accounting Change - (Continued) results, assuming this change in accounting had taken place as of the beginning of 2000, would not be materially different from the reported results. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement 133." This Statement amends SFAS No. 133 to defer its effective date for one year, to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of SFAS No. 133". This Statement makes certain changes in the hedging provisions of SFAS No. 133, and is effective concurrent with SFAS No. 133. As amended, SFAS No. 133 requires all derivatives to be recognized on the balance sheet at fair value, and establishes special accounting for the following three types of hedges: fair value hedges, cash flow hedges, and hedges of foreign currency exposures of net investments in foreign operations. Special accounting for qualifying hedges provides for matching the timing of gain or loss recognition on the hedging instrument with the recognition of the corresponding changes in value of the hedged item. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in the fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be recognized immediately in earnings and will be included in net realized and other investment gains. As a result, such amounts will not be included in the determination of the Company's segment after tax operating income. The Company believes that its current risk management philosophy will remain largely unchanged after adoption of the Statement. In addition, SFAS No. 133, as amended, precludes the designation of held-to-maturity fixed maturity investment securities as hedged items in hedging relationships where the hedged risk is interest rate risk. On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended. The adoption of SFAS No. 133, as amended, resulted in a charge to operations accounted for as a cumulative effect of accounting change of $16.1 million (net of tax of $8.3 million) as of January 1, 2001. In addition, as of January 1, 2000, a $227.6 million (net of tax of $122.6 million) cumulative effect of accounting change was recorded in other comprehensive income for the transition adjustment in the adoption of SFAS 133, as amended, and the reclassification of certain securities from the held-to-maturity category to the available-for-sale category. The transition adjustment for the adoption of SFAS 133 resulted in an increase in other comprehensive income of $40.5 million (net of tax of $21.8 million) that was accounted for as the cumulative effect of accounting change. The adjustment for the reclassification of $12.1 billion of the held-to-maturity fixed maturity investment portfolio to the available-for-sale category resulted in an increase in other comprehensive income of $187.1 million (net of tax of $100.8 million) as of January 1, 2001. New Accounting Pronouncements In December 2000, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 00-3, "Accounting by Insurance Enterprises for Demutualizations and Formations of Mutual Insurance Holding Companies and Certain Long-Duration Participating Contracts." The SOP, which was adopted with respect to accounting for demutualization expenses by the Company on December 15, 2000, requires that demutualization related expenses be classified as a single line item within income from continuing operations and should not be classified as an extraordinary item. The adoption of SOP 00-3 resulted in the reclassification of demutualization expenses previously recorded as an extraordinary item in the three months ended March 31, 2000 of $13.7 million (net of tax of $2.3 million). The remaining provisions of this SOP, which will require the (1) inclusion of all closed block activity together with all other assets, liabilities, revenues and expenses and (2) recognition of a policyholder dividend obligation that represents cumulative actual closed block earnings in excess of expected periodic amounts calculated 10 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS at the date of the demutualization, are effective no later than December 31, 2001. See Note 5 for a summary description of the closed block assets, liabilities, revenues and expenses, which do not include the policyholder dividend obligation that will be required in 2001. The Company currently is evaluating the effect that establishing the policyholder dividend obligation will have on its results of operations and financial position. That impact is not known at this time. 11 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 1 -- Summary of Significant Accounting Policies - (Continued) Codification In March 1998, the National Association of Insurance Commissioners (NAIC) adopted codified statutory accounting principles (Codification) effective January 1, 2001. Codification changes prescribe statutory accounting practices and results in changes to the accounting practices that the Company's domestic life insurance subsidiaries use to prepare their statutory-basis financial statements. The states of domicile of the Company's domestic life insurance subsidiaries adopted Codification as the prescribed basis of accounting on which domestic insurers must report their statutory-basis results effective January 1, 2001. The cumulative effect of changes in accounting principles adopted to conform to the requirements of Codification is reported as an adjustment to surplus in the statutory-basis financial statements as of January 1, 2001. Although the implementation of Codification had a negative impact on the Company's domestic life insurance subsidiaries' statutory-basis capital and surplus, the Companies remains in compliance with all regulatory and contractual obligations. Recent Acquisitions On March 1, 2000, the Company acquired the individual long term care insurance business of Fortis, Inc. (Fortis). The pro forma results for the period ended March 31, 2000, assuming the acquisition of Fortis had taken place as of the beginning of 2000, would not be materially different from the reported results. 12 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 2 -- Segment Information The Company operates in the following five business segments: two segments primarily serve retail customers, two segments serve institutional customers and our fifth segment is the Corporate and Other Segment, which includes our international operations. Our retail segments are the Protection Segment and the Asset Gathering Segment. Our institutional segments are the Guaranteed and Structured Financial Products Segment (G&SFP) and the Investment Management Segment. For additional information about the Company's business segments, please refer to the Company's 2000 Form 10-K. The following table summarizes selected financial information by segment for the three months ended or as of March 31 and reconciles segment revenues and segment after-tax operating income to amounts reported in the unaudited consolidated statements of income (in millions). Included in the Protection Segment for 2001 and 2000 are the closed block assets and liabilities, as well as the contribution from the closed block, which is reflected in "Revenues" in the table below (see Note 5).
Retail Institutional Retail Asset Institutional Investment Corporate Protection Gathering G&SFP Management and Other Consolidated ---------- --------- ----- ---------- --------- ------------ As of or for the three months ended March 31, 2001 Revenues: Segment revenues .............................. $ 449.5 $ 288.9 $ 859.3 $ 35.6 $ 365.1 $ 1,998.4 Realized investment and other gains (losses), net ............................. (9.1) 6.9 (14.4) -- (9.8) (26.4) ----------------------------------------------------------------------------- Revenues ...................................... 440.4 295.8 844.9 35.6 355.3 1,972.0 ============================================================================= Net investment income ......................... 145.5 119.8 467.1 5.5 43.5 781.4 Net Income: Segment after-tax operating income ............ 72.6 31.5 59.0 5.4 22.0 190.5 Realized investment gains (losses), net ....... (5.5) 4.6 (8.2) (0.1) (5.6) (14.8) Restructuring charges ......................... (1.2) (13.2) (0.1) (0.4) (0.1) (15.0) Cumulative effect of accounting change ..................................... 11.7 (0.5) (1.2) (0.2) (2.6) 7.2 ----------------------------------------------------------------------------- Net income .................................... $ 77.6 $ 22.4 $ 49.5 $ 4.7 $ 13.7 $ 167.9 ============================================================================= Supplemental Information: Inter-segment revenues ........................ -- -- -- $ 8.1 $ (8.1) -- Equity in net income of investees accounted for by the equity method ........... $ 2.3 $ 1.1 $ 3.4 -- 12.6 $ 19.4 Amortization of deferred policy acquisition costs, excluding amounts related to realized investment gains ......... 28.8 23.4 0.6 -- 26.9 79.7 Segment assets ................................ 26,576.4 13,634.4 30,986.9 2,700.9 12,149.7 86,048.3
13 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 2 -- Segment Information - (Continued)
Retail Institutional Retail Asset Institutional Investment Corporate Protection Gathering G&SFP Management and Other Consolidated ---------- --------- ----- ---------- --------- ------------ As of or for the three months ended March 31, 2000 Revenues: Segment revenues ...................... $ 516.3 $ 297.4 $ 486.2 $ 79.2 $ 465.6 $ 1,844.7 Realized investment and other gains (losses), net ....................... 7.8 1.9 (7.4) -- 17.3 19.6 ----------------------------------------------------------------------------- Revenues .............................. $ 524.1 $ 299.3 $ 478.8 $ 79.2 $ 482.9 $ 1,864.3 ============================================================================= Net investment income ................. $ 175.0 $ 102.6 $ 424.6 $ 5.6 $ 140.8 $ 848.6 Net Income: Segment after-tax operating income .... $ 72.6 $ 36.3 $ 55.2 $ 21.4 $ 19.9 $ 205.4 Realized investment gains (losses), net 4.8 1.2 (4.7) -- 9.9 11.2 Restructuring charges ................. (3.0) (0.9) (2.1) -- (0.9) (6.9) Demutualization expenses .............. (2.6) (0.6) (0.6) -- (9.9) (13.7) Other demutualization related costs ... (6.7) (1.4) (1.6) -- (0.5) (10.2) Group pension dividend transfer ....... -- -- 5.7 -- -- 5.7 ----------------------------------------------------------------------------- Net income ............................ $ 65.1 $ 34.6 $ 51.9 $ 21.4 $ 18.5 $ 191.5 ============================================================================= Supplemental Information: Inter-segment revenues ................ $ -- $ -- $ -- $ 11.1 $ (11.1) $ -- Equity in net income of investees accounted for by the equity method .. -- (0.4) 0.1 12.8 12.5 Amortization of deferred policy acquisition costs, excluding amounts related to realized investment gains 13.5 15.1 0.7 -- 14.8 44.1 Segment assets ........................ $26,407.4 $14,337.6 $29,932.4 $ 2,253.9 $12,077.5 $85,008.8
Note 3 -- Severance The Company has initiated a restructuring plan to reduce costs and increase future operating efficiency by consolidating portions of its operations. The plan consists primarily of reducing staff in the home office and terminating certain operations outside the home office. In connection with the restructuring plan, approximately 642 employees have been or will be terminated. These employees are or have been associated with operations in our Boston office and outside the home office. As of March 31, 2001, the liability for employee termination costs, included in other liabilities was $33.3 million. Employee termination costs, included in other operating costs and expenses, were $23.6 million and $10.8 million for the three months ended March 31, 2001 and 2000, respectively. Of the total number of employees affected, approximately 472 employees were terminated as of March 31, 2001, having received benefit payments of approximately $36.8 million. Note 4 -- Contingencies In the normal course of its business operations, the Company is involved with litigation from time to time with claimants, beneficiaries and others, and a number of litigation matters were pending as of March 31, 2001. It is the opinion of management, after consultation with counsel, that the ultimate liability with respect to these claims, if any, will not materially affect the financial position or results of operations of the Company. 14 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 4 -- Contingencies - (Continued) During 1997, the Company entered into a court-approved settlement relating to a class action lawsuit involving certain individual life insurance policies sold from 1979 through 1996. In entering into the settlement, the Company specifically denied any wrongdoing. The reserve held in connection with the settlement to provide for relief to class members and for legal and administrative costs associated with the settlement amounted to $120.1 million and $172.8 million at March 31, 2001 and December 31, 2000, respectively. There were no additional reserves recorded related to the settlement for the three months ended March 31, 2001 and 2000. The estimated reserve is based on a number of factors, including the estimated cost per claim and the estimated costs to administer the claims. During 1996, management determined that it was probable that a settlement would occur and that a minimum loss amount could be reasonably estimated. Accordingly, the Company recorded its best estimate based on the information available at the time. The terms of the settlement agreement were negotiated throughout 1997 and approved by the court on December 31, 1997. In accordance with the terms of the settlement agreement, the Company contacted class members during 1998 to determine the actual type of relief to be sought by class members. The majority of the responses from class members were received by the fourth quarter of 1998. The type of relief sought by class members differed from the Company's previous estimates, primarily due to additional outreach activities by regulatory authorities during 1998 encouraging class members to consider alternative dispute resolution relief. In 1999, the Company updated its estimate of the cost of claims subject to alternative dispute resolution relief and revised its reserve estimate accordingly. Given the uncertainties associated with estimating the reserve, it is reasonably possible that the final cost of the settlement could differ materially from the amounts presently provided for by the Company. The Company will continue to update its estimate of the final cost of the settlement as the claims are processed and more specific information is developed, particularly as the actual cost of the claims subject to alternative dispute resolution becomes available. However, based on information available at the time, and the uncertainties associated with the final claim processing and alternative dispute resolution, the range of any additional cost related to the settlement cannot be estimated with precision. On February 28, 1997, the Company sold a major portion of its group insurance business to UNICARE Life & Health Insurance Company (UNICARE), a wholly owned subsidiary of WellPoint Health Networks, Inc. The business sold included the Company's group accident and health business and related group life business and Cost Care, Inc., Hancock Association Services Group and Tri-State, Inc., all of which were indirect wholly owned subsidiaries of the Company. The Company retained its group long-term care operations. The insurance business sold was transferred to UNICARE through a 100% coinsurance agreement. The Company has secured a $397.0 million letter of credit facility with a group of banks. The banks have agreed to issue a letter of credit to the Company pursuant to which the Company may draw up to $397.0 million for any claims not satisfied by UNICARE under the coinsurance agreement after the Company has incurred the first $113.0 million of losses from such claims. The amount available pursuant to the letter of credit agreement and any letter of credit issued thereunder automatically will be reduced on a scheduled basis consistent with the anticipated run-off of liabilities related to the business reinsured under the coinsurance agreement. The letter of credit facility was reduced to $272.0 million effective March 1, 2000 and is scheduled to be reduced again to $127.0 million on March 1, 2001. The letter of credit and any letter of credit issued thereunder are scheduled to expire on March 1, 2002. The Company remains liable to its policyholders to the extent that UNICARE does not meet its contractual obligations under the coinsurance agreement. 15 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 4 -- Contingencies - (Continued) Through the Company's group health insurance operations, the Company entered into a number of reinsurance arrangements in respect of personal accident insurance and the occupational accident component of workers compensation insurance, a portion of which was originated through a pool managed by Unicover Managers, Inc. Under these arrangements, the Company both assumed risks as a reinsurer, and also passed 95% of these risks on to other companies. This business had originally been reinsured by a number of different companies, and has become the subject of widespread disputes. The disputes concern the placement of the business with reinsurers and recovery of the reinsurance. The Company is engaged in disputes, including a number of legal proceedings, in respect of this business. The risk to the Company is that other companies that reinsured the business from the Company may seek to avoid their reinsurance obligations. However, the Company believes that it has a reasonable legal position in this matter. During the fourth quarter of 1999 and early 2000, the Company received additional information about its exposure to losses under the various reinsurance programs. As a result of this additional information and in connection with global settlement discussions initiated in late 1999 with other parties involved in the reinsurance programs, during the fourth quarter of 1999 the Company recognized a charge for uncollectible reinsurance of $133.7 million, after tax, as its best estimate of its remaining loss exposure. The Company believes that any exposure to loss from this issue, in addition to amounts already provided for as of March 31, 2001, would not be material. Reinsurance ceded contracts do not relieve the Company from its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet its obligations for reinsurance ceded to it under the reinsurance agreements. Failure of the reinsurers to honor their obligations could result in losses to the Company; consequently, estimates are established for amounts deemed or estimated to be uncollectible. To minimize its exposure to significant losses from reinsurance insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from similar characteristics of the reinsurers. 16 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 5 -- Closed Block Under the Plan, the Company created a closed block for the benefit of policies included therein. The following table sets forth certain summarized financial information relating to the closed block as of the dates indicated:
March 31, December 31, 2001 2000 --------- ----------- (in millions) Assets Investments Fixed maturities: Held-to-maturity--at amortized cost (fair value: March 31--$117.7; December 31--$2,327.4) $ 120.4 $ 2,269.9 Available-for-sale--at fair value (cost: March 31--$4,710.2; December 31--$2,378.7) ... 4,824.6 2,353.0 Equity securities: Available-for-sale--at fair value (cost: March 31--$9.1; December 31--$5.3) ........... 9.5 6.3 Mortgage loans on real estate ............................. 1,956.7 1,930.6 Policy loans .............................................. 1,540.0 1,540.6 Short-term investments .................................... 19.3 62.1 Other invested assets ..................................... 39.8 40.7 --------- --------- Total Investments ...................................... 8,510.3 8,203.2 Cash and cash equivalents ................................. 297.4 305.6 Accrued investment income ................................. 165.8 149.3 Premiums and accounts receivable .......................... 19.5 27.1 Deferred policy acquisition costs ......................... 907.3 947.3 Other assets .............................................. 84.6 77.5 --------- --------- Total Closed Block Assets .............................. $ 9,984.9 $ 9,710.0 ========= ========= Liabilities Future policy benefits .................................... $ 9,983.5 $ 9,910.5 Policyholders' funds ...................................... 1,467.9 1,459.5 Other liabilities ......................................... 729.3 665.9 --------- --------- Total Closed Block Liabilities ......................... $12,180.7 $12,035.9 ========= =========
17 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 5 -- Closed Block - (Continued) The following table sets forth certain summarized financial information relating to the closed block for the period indicated:
For the Period Three Months Ended February 1 March 31, Through March 31, 2001 2000 --------------------------------------------- (in millions) Revenues Premiums ........................................ $233.6 $171.9 Net investment income ........................... 169.0 108.9 Net realized investment and other gains, net .... 2.7 3.1 Other closed block revenue (expense) ............ 0.3 (0.3) ------------------------------------- Total closed block revenues .................. 405.6 283.6 Benefits and Expenses Benefits to policyholders ....................... 253.6 173.0 Other operating costs and expenses .............. (2.3) (3.1) Amortization of deferred policy acquisition costs 24.2 8.5 Dividends to policyholders ...................... 109.8 76.5 ------------------------------------- Total closed block benefits and expenses ..... 385.3 254.9 ------------------------------------- Contribution from the closed block ........... $ 20.3 $ 28.7 =====================================
18 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 6 - Derivatives and Hedging Instruments The Company uses various derivative instruments to hedge and manage its exposure to changes in interest rate levels, foreign exchange rates, and equity market prices, and to manage the duration mismatch of assets and liabilities. The fair value of derivative instruments classified as assets at March 31, 2001 was $30.4 million, and appears on the consolidated balance sheet in other assets. The fair value of derivative instruments classified as liabilities at March 31, 2001 was $268.0 million, and appears on the consolidated balance sheet in other liabilities. In certain of these cases, the Company uses hedge accounting as allowed by SFAS 133, as amended, by designating derivative instruments as either fair value or cash flow hedges. For derivative instruments that are designated and qualify as fair value hedges, the change in fair value of the derivative instrument as well as the offsetting change in fair value of the hedged item are recorded in net realized investment and other gains/losses. The change in value of the hedged item is used to adjust its cost basis and is amortized into investment income over its remaining life, beginning either immediately or when the hedge designation is removed. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the change in fair value of the derivative instrument is recorded in other comprehensive income, and then reclassified into income when the hedged item affects income. Hedge effectiveness is assessed quarterly by a variety of techniques including regression analysis and cumulative dollar offset. In certain cases zero hedge ineffectiveness is assumed because the derivative instrument was constructed such that all the terms of the derivative exactly match the hedged risk in hedged item. The ineffective portion is recorded in net realized investment and other gains and losses. For derivative instruments not designated as hedges, the change in fair value of the derivative is recorded in net realized investment and other gains and losses. In cases where the Company receives or pays a premium as consideration for entering into a derivative instrument (i.e., interest rate caps and floors, swaptions, and equity collars), the premium is amortized into investment income over the useful life of the derivative instrument. The fair value of such premiums (i.e., the inherent ineffectiveness of the derivative) is excluded from the assessment of hedge effectiveness and is included in net realized investment and other gains and losses. 19 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 6 - Derivatives and Hedging Instruments - (Continued) Fair Value Hedges The Company uses interest rate futures contracts and interest rate swap agreements as part of its overall strategies of managing the duration mismatch of assets and liabilities or the average life of certain asset portfolios to specified targets. Interest rate swap agreements are contracts with a counterparty to exchange interest rate payments of a differing character (e.g., fixed-rate payments exchanged for variable-rate payments) based on an underlying principal balance (notional principal). The net differential to be paid or received on interest rate swap agreements and currency rate swap agreements is accrued and recognized as a component of net investment income. The Company also manages interest rate exposure by using interest rate swap agreements to modify certain liabilities, such as fixed rate debt and Constant Maturity Treasuries (CMT) indexed liabilities, by converting them to a floating rate. The Company enters into interest rate cap agreements, cancelable interest rates swap agreements, and written swaptions to manage the interest rate exposure of options that are embedded in certain assets and liabilities. A written swaption obligates the Company to enter into an interest rate agreement on the expiration date, contingent on future interest rates. Interest rate cap and floor agreements are contracts with a counterparty which require the payment of a premium for the right to receive payments for the difference between the cap or floor interest rate and a market interest rate on specified future dates based on an underlying principal balance (notional principal). Amounts earned on interest rate cap and floor agreements and swaptions are recorded as an adjustment to net investment income. The Company uses equity collar agreements to reduce its equity market exposure with respect to certain common stock investments that the Company holds. A collar consists of a written call option that limits the Company's potential for gain from appreciation in the stock price as well as a purchased put option that limits the Company's potential for loss from a decline in the stock price. Currency rate swap agreements are used to manage the Company's exposure to foreign exchange rate fluctuations. Currency rate swap agreements are contracts to exchange the currencies of two different countries at the same rate of exchange at specified future dates. For the three months ended March 31, 2001, the Company recognized a net loss of $7.5 million related to the ineffective portion of its fair value hedges, and a net gain of $2.1 million related to the portion of the hedging instruments that were excluded from the assessment of hedge effectiveness. For the three months ended March 31, 2001, none of the Company's hedged firm commitments no longer qualified as fair value hedges. Cash Flow Hedges The Company uses forward starting interest rate swap agreements to hedge the variable cash flows associated with future asset acquisitions, which will support the Company's long term care businesses. These agreements will reduce the impact of future interest rate changes on the cost of acquiring adequate assets to support the investment income assumptions used in pricing these products. The Company uses interest rate futures contracts to hedge the variable cash flows associated with variable benefit payments that it will make on certain annuity contracts. The Company used interest rate floor agreements to hedge the interest rate risk associated with minimum interest rate guarantees in certain of its life insurance and annuity businesses. For the three months ended March 31, 2001, the Company recognized a net loss of $0.1 million related to the ineffective portion of its cash flow hedges, and a net gain of $8.0 million related to the portion of the hedging instruments that was excluded from the assessment of hedge effectiveness. For the three months ended March 31, 2001, none of the Company's hedged forecast transactions no longer qualified as cash flow hedges. 20 JOHN HANCOCK FINANCIAL SERVICES, INC. NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 6 - Derivatives and Hedging Instruments - (Continued) For the three months ended March 31, 2001, no amounts were reclassified from other accumulated comprehensive income to earnings and it is anticipated that approximately $1.4 million will be reclassified from other accumulated comprehensive income to earnings within the next twelve months. The maximum length for which variable cash flows are hedged is 24 years. For the three months ended March 31, 2001, none of the Company's cash flow hedges have been discontinued because it was probable that the original forecasted transaction would not occur by the end of the originally specified time period documented at inception of the hedging relationship. The transition adjustment for the adoption of the statement resulted in an increase in other comprehensive income of $23.0 million (net of tax of $12.3 million) representing the accumulation in other comprehensive income of the effective portion of the Company's cash flow hedges as of January 1, 2001. As of March 31, 2001, $2.7 million of losses representing the effective portion of the change in fair value of derivative instruments designated as cash flow hedges was added to accumulated other comprehensive income, resulting in a balance of $20.3 million (net of tax of $12.3 million) as of March 31, 2001. Derivatives Not Designated as Hedging Instruments The Company enters into interest rate swap agreements, cancelable interest rate swap agreements, interest rate futures contracts, and interest rate cap and floor agreements to manage exposure to interest rates as described above under Fair Value Hedging without designating the derivatives as hedging instruments. The Company enters into equity indexed futures contracts and equity indexed option contracts and equity swaps to generate investment return to be credited to equity indexed universal life insurance policies. The gains and losses on these derivatives are included in net investment income, and are offset by crediting similar amounts to policyholders accounts. Note 7 - Related Party Transactions Certain directors of the Company are members or directors of other entities that periodically perform services for or have other transactions with the Company. Such transactions are either subject to bidding procedures or are otherwise entered into on terms comparable to those that would be available to unrelated third parties and are not material to the Company's results of operations or financial condition. 21 JOHN HANCOCK FINANCIAL SERVICES, INC. ITEM 2. MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) addresses the financial condition of John Hancock Financial Services, Inc. (John Hancock or the Company) as of March 31, 2001, compared with December 31, 2000, and its consolidated results of operations for the three-month periods ended March 31, 2001 and March 31, 2000, and, where appropriate, factors that may affect future financial performance. The discussion of the Company's consolidated financial results of operations includes the results of the closed block for the three months ended March 31, 2001 and the period February 1, 2000 (the date the closed block became effective) through March 31, 2000 combined on a line by line basis with the results of operations outside the closed block for such period, as further discussed below. This discussion should be read in conjunction with the Company's MD&A and annual audited financial statements as of December 31, 2000 included in the Company's Form 10-K for the year ended December 31, 2000 filed with the Securities and Exchange Commission (hereafter referred to as the Company's 2000 Form 10-K) and unaudited consolidated financial statements and related notes included elsewhere in this Form 10-Q. Statements, analyses, and other information contained in this report relating to trends in the Company's operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "intend," "will," "should," "may," and other similar expressions, are "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning future events and their effects on the Company, which may not be those anticipated by management. The Company's actual results may differ materially from the results anticipated in these forward-looking statements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Important Factors that May Affect Future Results" included herein for a discussion of factors that could cause or contribute to such material differences. The Reorganization and Initial Public Offering The Board of Directors of John Hancock Mutual Life Insurance Company (the Mutual Company) unanimously adopted the Plan of Reorganization (the Plan) on August 31, 1999. Under the terms of the Plan, effective February 1, 2000, the Mutual Company converted from a mutual life insurance company to a stock life insurance company (i.e. demutualized) and became a wholly-owned subsidiary of John Hancock Financial Services, Inc., which is a holding company. All policyholder membership interests in the Mutual Company were extinguished on that date and eligible policyholders of the Mutual Company received, in aggregate, 212.8 million shares of common stock, $1,438.7 million of cash and $43.7 million of policy credits as compensation. In connection with the reorganization, the Mutual Company changed its name to John Hancock Life Insurance Company (the Life Company). In addition, on February 1, 2000, the Company completed its initial public offering (IPO) in which 102.0 million shares of common stock were issued at a price of $17.00 per share. Net proceeds from the IPO were $1,657.7 million, of which $105.7 million was retained by the Company and $1,552.0 million was contributed to the Life Company. Under the Plan, as of February 1, 2000, the Life Company created a closed block for the benefit of policies included therein. The purpose of the closed block is to protect the policy dividend expectations of the policies included in the closed block after demutualization. Unless the Commissioner of Insurance of the Commonwealth of Massachusetts and, in certain circumstances the New York Superintendent of Insurance, consent to an earlier termination, the closed block will continue in effect until the date none of such policies is in-force. As of February 1, 2000, the Company segregated closed block assets of $9,343.0 million, an amount that is expected to produce cash flows which, together with anticipated revenues from policies included in the closed block, is expected to be sufficient to provide for payment of policy benefits, taxes and direct asset acquisition and disposal costs, and for continuation of policy dividend scales payable in 1999, so long as the experience underlying such dividend scales continues. The assets allocated to the 22 JOHN HANCOCK FINANCIAL SERVICES, INC. closed block and any cash flows provided by these assets will solely benefit the holders of policies included in the closed block. As of February 1, 2000, when the closed block was established, total closed block liabilities were $12,118.3 million. If the assets allocated to the closed block, the cash flows therefrom and the revenues from the closed block business prove to be insufficient to pay the benefits guaranteed under the policies included in the closed block, the Life Company will be required to make payments from its general funds in an amount equal to the shortfall. We funded the closed block to provide for payment of guaranteed benefits on such policies and for continuation of dividends paid under 1999 policy dividends scales, assuming the experience underlying such dividend scales continues. Therefore, we do not believe it will be necessary to use general funds to pay guaranteed benefits on closed block business unless the closed block business experiences substantial adverse deviations in investment, mortality, persistency or other experience factors. For additional information on the closed block see Note 5 to the unaudited consolidated financial statements and the Company's 2000 Form 10-K. The costs relating to the demutualization, excluding costs relating to the offering, were approximately $129.1 million, net of income taxes, of which $17.0 million was recognized in the three months ending March 31, 2000. No demutualization costs were incurred in 2001. Demutualization expenses include printing and mailing costs and our aggregate cost of engaging independent accounting, actuarial, financial, investment banking, legal and other consultants to advise us. In addition, our costs include the costs of the staff and advisors of the Massachusetts Division of Insurance and the New York Insurance Department as to the demutualization process and related matters. Results of Operations The table below presents the consolidated results of operations for the three months ended March 31, 2001 and 2000, respectively. For comparability with prior periods, the table below includes the results of operations of the closed block for the period February 1, 2001 through March 31, 2001 combined on a line by line basis with the results of operations outside the closed block. Three months ended March 31, ------------------------- 2001 2000 ---- ---- (in millions) Revenues (1) $2,357.3 $2,119.2 Benefits and expenses (1) 2,126.0 1,824.8 ------------------------- Income before income taxes and cumulative effect of accounting changes 231.3 294.4 Income taxes 70.6 102.9 Cumulative effect of accounting changes 7.2 -- ------------------------- Net income $167.9 $191.5 ========================= (1) Revenues and benefits and expenses above differ from the unaudited statements of net income due to closed block expenses for the three months ended March 31, 2001 and the period February 1, 2000 through March 31, 2000 of $420.0 million and $254.9 million, respectively. These expenses are included in revenues through the contribution from the closed block on the unaudited consolidated statement of income for the three months ended March 31, 2001 and the period February 1, 2000 through March 31, 2000. 23 JOHN HANCOCK FINANCIAL SERVICES, INC. Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 Consolidated income before income taxes and cumulative effect of accounting changes of $231.3 million for the three months ended March 31, 2001 decreased by $63.1 million, or 21.4%, from that reported in the comparable prior year period. The decrease is primarily attributable to a decrease of $27.9 million in income before income taxes and cumulative effect of accounting changes in the Investment Management Segment due to one-time fees in the timber investment management unit and a performance fee earned by the mezzanine fund manager in the first quarter of 2000, and a decrease of $19.1 million in the Asset Gathering Segment due to additions to reserves of $13.1 million from increased sales of single premium immediate annuities, increased amortization of deferred policy acquisition costs in 2001 due to the implementation of new modeling systems and lower product fees in the variable annuity business in 2001 due to depreciation of the equity markets during the period. In addition, income before income taxes and cumulative effect of accounting changes in the Corporate and Other Segment decreased $16.5 million. The Company's indirect majority-owned Canadian life insurance subsidiary (Maritime) increased $17.7 million, primarily due to favorable experience in Maritime's individual life insurance business and group insurance business, was offset by a decrease in investment income in the Corporate and Other Segment due to nonrecurring interest income on IPO proceeds of $13.4 million and $19.6 million of lower realized gains from venture capital partnerships. Income before income taxes and cumulative effect of accounting changes in the Guaranteed and Structured Financial Products Segment (G&SFP) decreased $4.9 million, primarily due to an increase in realized losses of $7.0 million, or 93.6%. These decreases in consolidated income before income taxes and cumulative effect of accounting changes were partially offset by an increase of $5.3 million in the Protection Segment driven by improved performance in the nontraditional life insurance business and retail long term care insurance business. The Company generated $23.7 million in net realized investment and other losses in the three months ended March 31, 2001, compared to $21.4 million in net realized investment and other gains for the three months ended March 31, 2000. Net realized investment and other gains generated in 2000 were the result of the initiative to divest the Company of real estate investments, while losses generated in 2001 were primarily the result of deteriorating market conditions. Revenues of $2,357.3 million for the three months ended March 31, 2001 increased $238.1 million, or 11.2%, compared to the three months ended March 31, 2000, primarily due to revenue growth of $366.1 million in the G&SFP Segment, an increase of 76.5%. The increase in G&SFP revenues is primarily due to the premium growth in the single premium annuity business, which improved $343.0 million on two large sales in the period. Revenues increased $46.8 million, or 6.0%, in the Protection Segment, primarily due to an increase in premiums in the retail long term care insurance business. These increases in revenues were partially offset by a decrease in the Corporate and Other Segment, which decreased $127.6 million, or 26.4%. Net investment income decreased $97.3 million driven by the mark-to-market adjustments on equity securities backing universal life products issued by Maritime Life, and the nonrecurring $13.4 million of investment income on IPO proceeds. Maritime's mark-to-market adjustments are largely offset by changes to policyholder benefits and deferred acquisition costs. In addition, realized gains from venture capital partnerships decreased by $19.6 million. The Investment Management Segment decreased $43.7 million, or 55.1%, primarily due to nonrecurring advisory fee income. The first quarter of 2000 included the receipt of a $35.5 million of one-time fees in the timber investment management unit and $4.8 million in the mezzanine fund. Asset Gathering Segment revenues decreased $3.5 million, or 1.2%, primarily due to a decrease in management advisory fees and commission income from the mutual funds and variable annuity business of $30.3 million and $2.8 million, respectively, driven by depreciation in the equity markets during the period. These decreases were partially offset by an increase in net investment income of $17.2 million driven by the fixed annuity business and $13.5 million in increased premiums primarily due to the single premium immediate annuity business. Benefits and expenses of $2,126.0 million for the three months ended March 31, 2001 increased $301.2 million, or 16.5%, compared to the three months ended March 31, 2000. The increase is driven by G&SFP increasing $371.0 million, or 92.8%. G&SFP's increase is primarily due to an increase in reserves reflecting strong sales of annuities in the first quarter of 2001. Benefits and expenses in the Protection Segment 24 JOHN HANCOCK FINANCIAL SERVICES, INC. increased $41.5 million, or 6.1%, primarily due to increases in benefits to policyholders driven by the growth in the retail long term care insurance business and amortization of deferred policy acquisition costs due to the implementation of new modeling systems. The Asset Gathering Segment's increase in benefits and expenses of $15.7 million, or 6.3%, is primarily due to increased benefits to policyholders and amortization of deferred acquisition expenses due to the implementation of new modeling systems, partially offset by lower commission expense in the mutual fund business driven by lower front end load charge mutual fund sales and lower redemptions of deferred sales charge mutual fund shares and operating expenses. Partially offsetting the $301.2 million increase to benefits and expenses was a $111.1 million decrease in Corporate and Other's benefits and expenses. Corporate and Other's decrease in benefits and expenses was driven by a $103.1 million decrease in benefits to policyholders, primarily the result of reduced policyholder credits due to the negative mark-to-market adjustments on equity securities supporting Maritime's universal life policies and favorable experience on the individual life insurance and group insurance lines of business. The $15.7 million decrease in Investment Management's benefits and expenses was driven by lower operating expenses due to the 2000 restructuring of a portfolio in the timber investment management business. Results of Operations by Segment We operate our business in five segments. Two segments primarily serve retail customers, two segments serve institutional customers and our fifth segment is the Corporate and Other Segment, which includes our international operations. Our retail segments are the Protection Segment and the Asset Gathering Segment. Our institutional segments are the Guaranteed and Structured Financial Products Segment and the Investment Management Segment. We evaluate segment performance and base management's incentives on segment after-tax operating income, which excludes the effect of net realized investment gains and losses and other unusual or non-recurring events and transactions. Segment after-tax operating income is determined by adjusting GAAP net income for net realized investment and other gains and losses, cumulative effect of accounting changes, and certain other items which we believe are not indicative of overall operating trends. While these items may be significant components in understanding and assessing our consolidated financial performance, we believe that the presentation of segment after-tax operating income enhances the understanding of our results of operations by highlighting net income attributable to the normal, recurring operations of the business. However, segment after-tax operating income is not a substitute for net income determined in accordance with GAAP. A discussion of the adjustments to GAAP reported income, many of which affect each operating segment, follows the table below. A reconciliation of segment after-tax operating income, as adjusted, to GAAP reported net income precedes each segment discussion. 25 JOHN HANCOCK FINANCIAL SERVICES, INC. Three months ended March 31, 2001 2000 ------ ------ Segment Data: (1) (in millions) Segment after-tax operating income: Protection Segment .............................. $ 72.6 $ 72.6 Asset Gathering Segment ......................... 31.5 36.3 ------ ------ Total Retail ................................ 104.1 108.9 Guaranteed and Structured Financial Products Segment ..................................... 59.0 55.2 Investment Management Segment ................... 5.4 21.4 ------ ------ Total Institutional ......................... 64.4 76.6 Corporate and Other Segment ..................... 22.0 19.9 ------ ------ Total segment after-tax operating income ........ 190.5 205.4 After-tax adjustments: (1) Realized investment and other gains (losses), net (14.8) 11.2 Restructuring charges ........................... (15.0) (6.9) Corporate account asset transfer ................ -- 5.7 Demutualization expenses ........................ -- (13.7) Other demutualization related costs ............. -- (10.2) ------ ------ Total after-tax adjustments ....................... (29.8) (13.9) ------ ------ GAAP Reported: Income before cumulative effect of accounting changes ......................... 160.7 191.5 Cumulative effect of accounting changes ......... 7.2 -- ------ ------ Net income ...................................... $167.9 $191.5 ====== ====== (1) See "Adjustments to GAAP Reported Net Income" set forth below. Adjustments to GAAP Reported Net Income Our GAAP reported net income was significantly affected by net realized investment and other gains and losses and unusual or non-recurring events and transactions presented in the reconciliation of GAAP reported net income to segment after-tax operating income in Note 2 - Segment Information in the notes to the unaudited consolidated financial statements. A description of these adjustments follows. In both periods, net realized investment and other gains and losses, except for gains and losses from mortgage securitizations and mezzanine funds have been excluded from segment after-tax operating income due to their volatility between periods and because such data are often excluded by analysts and investors when evaluating the overall financial performance of insurers. The volatility between periods can be impacted by fluctuations in the market, as well as by changes in the volume of activity, which can be influenced by us and our investment decisions. Realized investment gains and losses from mortgage securitizations and mezzanine funds were not excluded from segment after-tax operating income because we view the related gains and losses as in integral part of the core business of those operations. Net realized investment and other gains have been reduced by: (1) amortization of deferred policy acquisition costs to the extent that such amortization results from realized gains and losses and (2) the portion of realized gains and losses credited to participating pension contract holder accounts. We believe presenting realized investment and other gains and losses in this format provides information useful in evaluating our operating performance. This presentation may not be comparable to presentations made by other insurers. Summarized below is a reconciliation of (a) net realized investment and other gains per the unaudited consolidated financial statements and (b) the adjustment made for net realized investment and other gains to calculate segment after-tax operating income for the three months ended March 31, 2001 and 2000. 26 JOHN HANCOCK FINANCIAL SERVICES, INC. Three months ended March 31, 2001 2000 ------ ----- (in millions) Net realized investment and other gains (losses) ....... $(20.6) $20.6 Less amortization of deferred policy acquisition costs related to net realized investment gains ........... (0.8) (1.3) Add amounts credited (charged) to participating pension contract holder accounts ........................... (2.3) 2.1 ------ ----- Net realized investment and other gains (losses), net of related amortization of deferred policy acquisition costs and amounts credited to participating pension contract holders per unaudited consolidated financial statements (1) ........................... (23.7) 21.4 Less realized investment gains attributable to mortgage securitizations and mezzanine funds .............................................. (2.5) (1.8) ------ ----- Realized investment and other gains (losses), net - pre-tax adjustment to calculate segment operating income ................................... (26.2) 19.6 Less income tax effect ................................. 11.4 (8.4) ------ ----- Realized investment and other gains (losses), net - after-tax adjustment to calculate segment operating income ................................... $(14.8) $11.2 ====== ===== (1) Net realized investment and other gains, net of related amortization of deferred policy acquisition costs and amounts credited to participating pension contract holders for the three months ended March 31, 2001 and 2000, respectively, includes $2.7 million and $3.1 million in net realized gains generated in the closed block. This balance is included in contribution from the closed block in the unaudited consolidated financial statements. The Company incurred after-tax restructuring charges to reduce costs and increase future operating efficiency by consolidating portions of our operations. Additional information regarding restructuring costs is included in Note 3 - Severance in the notes to the unaudited consolidated financial statements. After-tax restructuring costs were $15.0 million, including $9.0 million from the sale of our retirement plan record-keeping business, for the three months ended March 31, 2001 and $6.9 million for the three months ended March 31, 2000. During 1999, we recorded an amount related to the transfer of certain assets from the Guaranteed and Structured Financial Products Segment to the corporate account within the Corporate and Other Segment. The $5.7 million after-tax credit occurring in the first quarter of 2000 is a change in estimate of this transaction based on information that became available in 2000. In December 2000, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 00-3, "Accounting by Insurance Enterprises for Demutualizations and Formations of Mutual Insurance Holding Companies and Certain Long-Duration Participating Contracts." The SOP, which was adopted with respect to accounting for demutualization expenses by the Company on December 15, 2000, requires that demutualization related expenses be classified as a single line item within income from continuing operations and should not be classified as an extraordinary item. The adoption of SOP 00-3 resulted in the reclassification of demutualization expenses previously recorded as an extraordinary item for the three months ended March 31, 2000 of $13.7 million (net of tax of $2.3 million). No demutualization costs were recognized in 2001. The Company considers demutualization expenses to be an adjustment to GAAP recorded net income. The Company incurred after-tax charges for demutualization related expenses to improve our financial analysis and financial reporting abilities. These charges primarily included consulting fees and planning and expense management costs. After-tax charges for demutualization related expenses were $10.2 million for the three months ended March 31, 2000. No such costs were incurred in 2001. 27 JOHN HANCOCK FINANCIAL SERVICES, INC. Retail-Protection Segment The following table presents certain summary financial data relating to the Protection Segment for the periods indicated. Three months ended March 31, 2001 2000 ------------------- (in millions) Revenues (1) ........................................ $834.9 $771.2 Benefits and expenses ............................... 721.9 663.4 Income taxes ........................................ 40.4 35.2 ------------------- Segment after-tax operating income (1) .............. 72.6 72.6 ------------------- After-tax adjustments: (1) Realized investment and other gains (losses), net ................................... (5.5) 4.8 Demutualization expenses .......................... -- (2.6) Other demutualization related costs ............... -- (6.7) Restructuring charges ............................. (1.2) (3.0) ------------------- Total after-tax adjustments ......................... (6.7) (7.5) ------------------- GAAP Reported: Income before cumulative effect of accounting changes ............................. 65.9 65.1 Cumulative effect of accounting changes, net of tax ............................... 11.7 -- ------------------- Net income .......................................... $ 77.6 $ 65.1 =================== Other Data: Segment after-tax operating income: Non-traditional life (variable and universal life). $ 31.1 $ 26.2 Traditional life .................................. 25.5 34.5 Individual long term care ......................... 12.3 8.8 Group long term care .............................. 5.7 3.2 Other ............................................. (2.0) (0.1) ------------------- Segment after-tax operating income (1) .............. $ 72.6 $ 72.6 =================== (1) See "Adjustments to GAAP Reported Net Income" included in this MD&A. Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 Segment after-tax operating income was $72.6 million for the three months ended March 31, 2001, which was no change from $72.6 million for the three months ended March 31, 2000. Non-traditional life insurance business after-tax operating income increased $4.9 million, or 18.7%, primarily due to increased mortality and interest margin gains. Traditional life insurance business after-tax operating income decreased $9.0 million, or 26.1%, primarily resulting from higher amortization of deferred policy acquisitions costs related to revised estimates resulting from the implementation of new modeling systems. Individual long term care insurance business after-tax operating income increased $3.5 million, or 39.8%, resulting from lower expenses, higher investment income, and positive morbidity gains driven by the growth in business. Group long-term care insurance business after-tax operating income increased $2.5 million, or 78.1%, due to improved morbidity, reduced surrender losses and growth in interest margins. 28 JOHN HANCOCK FINANCIAL SERVICES, INC. Revenues were $834.9 million for the three months ended March 31, 2001, an increase of $63.7 million, or 8.3%, from $771.2 million for the three months ended March 31, 2000. Premiums increased $40.1 million, or 10.7%, primarily due to retail long term care insurance premiums, which increased $42.8 million, or 47.2%, driven by continued growth overall in the business and the business related to the Fortis acquisition completed March 1, 2000. Partially offsetting this increase was a decline in traditional life insurance premiums of $4.9 million, or 1.9%, driven by a decrease in direct term life insurance premiums due to Regulation XXX price increases and the continued trend away from whole life insurance products. Universal life and investment-type product charges consist primarily of cost of insurance fees and separate account fees and were $102.0 million for the three months ended March 31, 2001, a decrease of $9.3 million, or 8.4%, from $111.3 million for the three months ended March 31, 2000. This decrease was due primarily to the variable life insurance products, which decreased by $11.7 million, or 12.3%, from the comparable prior year period, driven by market depreciation on assets under management. Segment net investment income increased $30.7 million, or 10.8%, primarily due to increased asset balances and improved portfolio yields. Benefits and expenses were $721.9 million for the three months ended March 31, 2001, an increase of $58.5 million, or 8.8%, from $663.4 million for the three months ended March 31, 2000. Benefits to policyholders increased $38.6 million, or 9.1%, due to growth in the retail long term care business driven by the Fortis acquisition. Retail long term care benefits and expenses increased primarily due to additions to reserves for premium growth and higher claim volume on expansion of the business and lower lapse rates during the period. Other operating costs and expenses decreased $5.0 million, or 5.2%, primarily due to a decrease of $4.5 million in operating expenses on non-traditional life insurance products mainly attributable to a increase in the deferral of deferred policy acquisition costs. Dividends to policyholders decreased $6.0 million, or 4.9%, primarily due to decreased dividends on traditional life insurance products. Amortization of deferred policy acquisition costs increased $31.0 million, or 140.9%, due to increased amortization resulting from revised estimates related to the implementation of new deferred policy acquisition cost modeling systems in both the traditional and non-traditional products. The Segment's effective tax rate on operating income was 35.8% and 32.7% for the three months ended March 31, 2001 and 2000, respectively. 29 JOHN HANCOCK FINANCIAL SERVICES, INC. Retail-Asset Gathering Segment The following table presents certain summary financial data relating to the Asset Gathering Segment for the periods indicated. Three months ended March 31, 2001 2000 -------------------- (in millions) Revenues (1) ....................................... $288.9 $297.4 Benefits and expenses .............................. 242.0 242.8 Income taxes ....................................... 15.4 18.3 -------------------- Segment after-tax operating income (1) ............. 31.5 36.3 -------------------- After-tax adjustments: (1) Realized investment and other gains, net ..................................... 4.6 1.2 Demutualization expenses ......................... -- (0.6) Other demutualization related costs .............. -- (1.4) Restructuring charges ............................ (13.2) (0.9) -------------------- Total after-tax adjustments ........................ (8.6) (1.7) -------------------- GAAP Reported: Income before cumulative effect of accounting changes ............................ 22.9 34.6 Cumulative effect of accounting changes ............ (0.5) -- -------------------- Net income ......................................... $ 22.4 $ 34.6 ==================== (1) See "Adjustments to GAAP Reported Net Income" included in this MD&A. Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 Segment after-tax operating income was $31.5 million for the three months ended March 31, 2001, a decrease of $4.8 million, or 13.2%, from $36.3 million reported in the comparable prior year period. Annuity business after-tax operating income was $20.2 million for the three months ended March 31, 2001, an decrease of $5.6 million, or 21.7%, primarily due to increased amortization of deferred policy acquisition costs resulting from revised estimates related to the implementation of new deferred policy acquisition cost modeling systems, and reduced fees on variable annuity products due to depreciation of the equity markets in the quarter. Fixed annuities spreads increased 12 basis points to 1.98% for the three months ended March 31, 2001 from 1.86% for the three months ended March 31, 2000. The average interest credited rate increased 40 basis points to 6.14% from 5.74%, while the earned interest rate increased 52 basis points to 8.12% from 7.60%. Mutual funds after-tax operating income increased $3.0 million, or 26.3%, primarily due to lower operating expenses that decreased $9.9 million, or 17.9% from the comparable prior year period. Revenues were $288.9 million for the three months ended March 31, 2001, a decrease of $8.5 million, or 2.9%, from $297.4 million reported for the comparable prior year period. The decreased revenue was due to lower management advisory fees and commission income primarily from the mutual funds business, which decreased $30.3 million, or 23.9%, from the comparable prior year period due to a decrease in weighted assets under management between the two periods. Net investment income was $119.8 million for the three months ended March 31, 2001, an increase of $17.2 million, or 16.8%, from $102.6 million reported in the comparable prior year period. Net investment income increased primarily 30 JOHN HANCOCK FINANCIAL SERVICES, INC. due to increases in invested assets backing fixed annuity products, reflecting higher market interest rates on new fixed income investments. Investment-type product fees were $32.8 million for the three months ended March 31, 2001, a decrease of $2.8 million, or 7.9%, from $35.6 million reported for the comparable prior year period. The decrease in investment-type product fees is primarily due to a decline in the average variable annuity reserves, driven by depreciation of the equity markets, which decreased 12.8% to $6,780.6 million for the three months ended March 31, 2001 from $7,780.0 million reported in the comparable prior year period. For retail annuities, the mortality and expense fees as a percentage of average account balances were 1.29% and 1.39% for the three months ended March 31, 2001 and 2000, respectively. Investment management revenues, commissions, and other fees were $115.3 million for the three months ended March 31, 2001, a decrease of $35.7 million, or 23.6%, from $151.0 million for the comparable prior year period. Average mutual fund assets under management were $30,560.3 million for the three months ended March 31, 2001, a decrease of $2,313.0 million or 7.0%, from $32,873.3 million reported in the comparable prior year period, due to market depreciation. The mutual fund business experienced net deposits for the three months ended March 31, 2001 of $260.6 million compared to net redemptions of $304.0 million in the comparable prior year period, an improvement of $564.6 million, or 186%, primarily due to a decrease in redemptions of $732.6 million, or 37.8%, despite difficult market conditions. Deposits and reinvestments for the first quarter of 2001 include the funding of a $246 million institutional advisory account. Investment advisory fees were $46.1 million for the three months ended March 31, 2001, a decrease of $1.7 million, or 3.5%, from $47.8 million reported in the comparable prior year period and were 0.60% and 0.58% of average mutual fund assets under management for the three months ended March 31, 2001 and 2000, respectively. Underwriting and distribution fees decreased $33.2 million, or 36.0%, to $59.0 million for the three months ended March 31, 2001, primarily due to a decrease in front end load charge mutual fund sales, lower deferred sales charges due to decreased redemptions, and accordingly, commission revenue. Shareholder service and other fees were $10.2 million for the three months ended March 31, 2001 compared to $12.5 million reported in the comparable prior year period. Benefits and expenses decreased $0.8 million, or 0.3%, to $242.0 million for the three months ended March 31, 2001 from $242.8 million reported in the comparable prior year period. Benefits to policyholders increased $25.7 million, or 32.2%, primarily due to an increase in interest credited on fixed annuity account balances due to higher average account balances. Other operating costs and expenses decreased $34.7 million, or 23.5%, to $113.1 million for the three months ended March 31, 2001 from $147.8 million reported in the comparable prior year period. The decrease was primarily due to the decrease in commission fees incurred in the mutual fund business, the result of lower front-end load charge mutual fund sales and lower deferred sales charges due to lower redemptions. In addition, mutual fund operating expenses decreased due to operating efficiencies, lower subadvisory asset based fees due to a decline in assets under management, and the sale of the retirement plan record-keeping business. Amortization of deferred policy acquisition costs increased $8.3 million, or 55.0%, to $23.4 million for the three months ended March 31, 2001 from $15.1 million reported in the comparable prior year period, primarily due to increased amortization resulting from revised estimates relating to the implementation of new deferred policy acquisition cost modeling systems in the annuity business. The Segment's effective tax rate on operating income was 32.8% and 33.5% for the three months ended March 31, 2001 and 2000, respectively. 31 JOHN HANCOCK FINANCIAL SERVICES, INC. Institutional-Guaranteed and Structured Financial Products Segment The following table presents certain summary financial data relating to the Guaranteed and Structured Financial Products Segment for the periods indicated. Three months ended March 31, 2001 2000 ------------------------ (in millions) Revenues (1) ................................... $ 859.3 $ 486.2 Benefits and expenses .......................... 770.7 402.0 Income taxes ................................... 29.6 29.0 ------------------------ Segment after-tax operating income (1) ......... 59.0 55.2 ------------------------ After-tax adjustments: (1) Realized investment and other gains (losses), net .............................. (8.2) (4.7) Restructuring charges ........................ (0.1) (2.1) Demutualization expenses ..................... -- (0.6) Other demutualization related costs .......... -- (1.6) Corporate account asset transfer ............. -- 5.7 ------------------------ Total after-tax adjustments .................... (8.3) (3.3) ------------------------ GAAP Reported: Income before cumulative effect of accounting changes ........................... 50.7 51.9 Cumulative effect of accounting changes, net of tax .......................... (1.2) -- ------------------------ Net income ..................................... $ 49.5 $ 51.9 ======================== Other Data: Segment after-tax operating income: Spread-based products: GICs and funding agreements ................ $ 40.0 $ 35.4 Single premium annuities ................... 12.3 12.0 Fee-based products ........................... 6.7 7.8 ------------------------ Segment after-tax operating income (1) ......... $ 59.0 $ 55.2 ======================== (1) See "Adjustments to GAAP Reported Net Income" included in this MD&A. Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 Segment after-tax operating income was $59.0 million for the three months ended March 31, 2001, an increase of $3.8 million, or 6.9%, from $55.2 million reported in the comparable prior-year period. Spread-based product after-tax operating income was $52.3 million, an increase of $4.9 million, or 10.3%, from $47.4 million reported in the comparable prior year period, primarily due to increased investment spreads largely as a result of growth in the average asset base of $2.8 billion to $19.9 billion. GICs and funding agreements accounted for 67.8% of segment after-tax operating income for the three months ended March 31, 2001 as compared to 64.1% in the comparable prior period. On a total-company basis, GICs and funding agreements accounted for 21.0% of after-tax operating income for the three months ended March 31, 2001 as compared to 17.2% in the comparable prior period. Fee-based product after-tax operating 32 JOHN HANCOCK FINANCIAL SERVICES, INC. income was $6.7 million, a decrease of $1.1 million, or 14.1%, from $7.8 million reported in the comparable prior year period, primarily due to lower asset-based fees on Separate Account GICs. Revenues increased $373.1 million, or 76.7%, to $859.3 million for the three months ended March 31, 2001 from $486.2 million reported in the comparable prior year period, largely due to a $332.9 million increase in premiums. Single Premium Annuity premiums improved $343.0 million to $355.3 million primarily due to two large sales in the period. Terminal Funding premiums decreased by $10.6 million to $4.7 million, and Structured Settlement premiums decreased by $2.7 million to $11.5 million from the comparable prior period. Investment-type product charges were $15.0 million for the three months ended March 31, 2001, a decrease of $2.0 million, or 11.8%, primarily due to lower expense recoveries from participating contracts. Investment-type product charges were 0.52% and 0.55% of average fee-based policy reserves for the three months ended March 31, 2001 and 2000, respectively. Net investment income increased $42.5 million, or 10.0%, for the three months ended March 31, 2001 compared to the prior year period, primarily as a result of a higher level of average invested assets backing spread-based products. Average invested assets backing spread-based products increased $2,806.7 million, or 16.4% to $19,918.2 million for the three months ended March 31, 2001 from $17,111.5 million reported in the comparable prior year period. The average investment yield on these invested assets decreased to 8.49% for the three months ended March 31, 2001 compared to 8.58% reported in the prior year period, reflecting the lower interest rate environment in the current period. Benefits and expenses increased $368.7 million, or 91.7%, to $770.7 million for the three months ended March 31, 2001 from $402.0 million reported in the comparable prior year period. The increase was largely due to a $370.4 million increase in benefits to policyholders as a result of increased sales of single premium annuity contracts which increased annuity reserves by $304.4 million combined with interest credited on account balances for spread-based products, which was $319.8 million for the three months ended March 31, 2001, an increase of $42.1 million, or 15.2%, from $277.7 million reported in the comparable prior year period. The increase in interest credited was due to an increase in average account balances for spread-based products of $2,534.9 million to $18,810.1 million for the three months ended March 31, 2001 from $16,275.2 million reported in the comparable prior year period combined with an increase in the average interest credited rate on account balances for spread-based products, which was 7.08% for the three months ended March 31, 2001 compared to 7.00% reported in the prior year period. The increase in the average interest credited rate on account balances for spread-based products was due to the increased average interest crediting rate on GICs and funding agreements. Other operating costs and expenses were $12.4 million for the three months ended March 31, 2001, a decrease of $2.9 million, or 19.0%, from $15.3 million reported in the comparable prior year period. The decrease was primarily due to lower compensation expenses and lower systems expenses related to projects completed during 2000. Dividends of $8.8 million for the three months ended March 31, 2001, increased $1.3 million, or 17.3%, from $7.5 million reported in the comparable prior year period, reflecting a higher level of distributable surplus to participating contract holder accounts. The Segment's effective tax rate on operating income was 33.4% and 34.4% for the three months ended March 31, 2001 and 2000, respectively. This decrease in the effective tax rate is primarily due to increases in certain tax credits and deductions in the current period. 33 JOHN HANCOCK FINANCIAL SERVICES, INC. Institutional-Investment Management Segment The following table presents certain summary financial data relating to the Investment Management Segment for the periods indicated. Three months ended March 31, 2001 2000 -------------------- (in millions) Revenues (1) .......................................... $35.6 $79.2 Benefits and expenses ................................. 26.5 43.1 Income taxes .......................................... 3.7 14.7 -------------------- Segment after-tax operating income (1) ................ 5.4 21.4 -------------------- After-tax adjustments: (1) Realized investment and other gains, net ............ (0.1) -- Restructuring charges ............................... (0.4) -- -------------------- Total after-tax adjustments ........................... (0.5) -- -------------------- GAAP Reported: Income before cumulative effect of accounting changes .................................. 4.9 21.4 Cumulative effect of accounting changes ............... (0.2) -- -------------------- Net income ............................................ $ 4.7 $21.4 ==================== (1) See "Adjustments to GAAP Reported Net Income" included in this MD&A. Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 Segment after-tax operating income was $5.4 million for the three months ended March 31, 2001, a decrease of $16.0 million, or 74.8%, from $21.4 million reported in the comparable prior year period. The decrease was primarily due to lower investment advisory fees. Revenues decreased $43.6 million, or 55.1%, to $35.6 million for the three months ended March 31, 2001 from $79.2 million reported in the comparable prior year period. Net investment income was $5.5 million for the three months ended March 31, 2001, a decrease of $0.1 million from reported in the comparable prior year period. Investment management revenues, commissions, and other fees decreased $43.9 million, or 61.4%, for the three months ended March 31, 2001, primarily due to a decrease in investment advisory fees, which decreased $43.4 million to $26.5 million for the three months ended March 31, 2001 compared to $69.9 million reported in the prior year period. The decrease in investment advisory fees was primarily due to a $35.5 million incentive fee receipt in connection with the restructuring of a timber management contractand a $4.8 million performance fee received by the mezzanine fund manager during the first quarter 2000, while the balance came from lower assets under management in the segment. Investment advisory fees were 0.34% and 0.71% of average advisory assets under management in 2001 and 2000, respectively. Mortgage origination and servicing fees were $1.1 million for the three months ended March 31, 2001 compared to $1.6 million in 2000. Net realized investment and other gains increased $0.8 million for the three months ended March 31, 2001, primarily due to a larger collateralized mortgage-backed securitization in the first quarter of 2001 as compared to the first quarter of 2000. 34 JOHN HANCOCK FINANCIAL SERVICES, INC. Benefits and expenses were $26.5 million for the three months ended March 31, 2001, a decrease of $16.6 million, or 38.5%, from $43.1 million reported in the comparable prior year period. The decrease was primarily due to a $12.3 million incentive compensation payment related to the receipt of the incentive fee on the timber management contract and a $2.7 million performance fee paid for the management of the mezzanine fund during the first quarter 2000. Other operating costs and expenses were 0.34% and 0.43% of average advisory assets under management in 2001 and 2000, respectively. The Segment's effective tax rate on operating income was 40.0% and 40.7% for the three months ended March 31, 2001 and 2000, respectively. The effective tax rate for the Institutional Investment Management Segment is higher than our other business segments due to the state tax on certain subsidiaries. Corporate and Other Segment The following table presents certain summary financial data relating to the Corporate and Other Segment for the periods indicated. Three months ended March 31, 2001 2000 --------------------- (in millions) Revenues (1) ....................................... $365.0 $465.6 Benefits and expenses .............................. 341.3 440.3 Income taxes ....................................... 1.7 5.4 ---------------------- Segment after-tax operating income (1) ............. 22.0 19.9 ---------------------- After-tax adjustments: (1) Realized investment and other gains (losses), net .................................. (5.6) 9.9 Restructuring charges ............................ (0.1) (0.9) Demutualization expenses ......................... -- (9.9) Other demutualization related costs .............. -- (0.5) ---------------------- Total after-tax adjustments ........................ (5.7) (1.4) ---------------------- GAAP Reported: Income before cumulative effect of accounting changes ............................... 16.3 18.5 Cumulative effect of accounting changes, net of tax .............................. (2.6) -- ---------------------- Net income ......................................... $ 13.7 $ 18.5 ====================== (1) See "Adjustments to GAAP Reported Net Income" included in this MD&A. Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 Segment after-tax operating income from international operations was $18.1 million for the three months ended March 31, 2001, an increase of $15.0 million from $3.1 million reported in the comparable prior year period. The increase in segment after-tax operating income is primarily due to The Maritime Life Assurance Company, an indirect majority owned Canadian subsidiary of the Company. Individual Life experienced favorable expense, mortality and investment margins and Group Insurance benefited from rate strengthening, favorable claims experience and reinsurance programs that were put in place in 2000. 35 JOHN HANCOCK FINANCIAL SERVICES, INC. Segment after-tax operating income from corporate operations was $2.1 million for the three months ended March 31, 2001, a decrease of $15.3 million from $17.4 million reported in the comparable prior year period. The decrease was primarily due to nonrecurring investment income on the proceeds from the IPO in the first quarter of 2000 as well as lower investment income on corporate surplus due to greater surplus requirements in our other business lines. The Segment's effective tax rate on operating income was 7.2% and 21.3% for the three months ended March 31, 2001 and 2000, respectively. This rate decreased primarily due to a reduction in Maritime's deferred tax liability to reflect decreased Canadian tax rates and a decrease in the deferred tax liability associated with contracts entered into to transfer the management of certain lease investment residuals to a foreign jurisdiction. General Account Investments On the effective date of the Plan of Reorganization, the Company's invested assets were allocated between the closed block and operations outside the closed block. In view of the similar asset quality characteristics of the major asset categories in the two portfolios, the invested assets in the closed block have been combined with the Company's invested assets outside the closed block for purposes of the following discussion and analysis. Overall Composition of the General Account Invested assets, excluding separate accounts, totaled $53.8 billion and $52.2 billion as of March 31, 2001 and December 31, 2000, respectively. The portfolio composition has not significantly changed at March 31, 2001 as compared to December 31, 2000. The following table shows the composition of investments in our general account portfolio.
As of March 31, As of December 31, 2001 2000 --------------------------------------------------- Carrying % of Carrying % of Value Total Value Total --------------------------------------------------- (in millions) (in millions) Fixed maturity securities (1) ..... $35,200.3 65.4% $32,573.4 62.4% Mortgage loans (2) ................ 10,960.7 20.4 10,900.0 20.9 Real estate ....................... 528.6 1.0 519.0 1.0 Policy loans(3) ................... 1,977.3 3.7 1,969.2 3.8 Equity securities ................. 1,356.3 2.5 1,372.3 2.6 Other invested assets ............. 1,336.6 2.5 1,393.7 2.6 Short-term investments ............ 239.8 0.4 214.0 0.4 Cash and cash equivalents (4) ..... 2,223.9 4.1 3,280.0 6.3 --------- ----- --------- ----- Total invested assets ......... $53,823.5 100.0% $52,221.6 100.0% ========= ===== ========= =====
(1) In addition to bonds, the fixed maturity security portfolio contains redeemable preferred stock with a carrying value of $757.4 million and $735.3 million as of March 31, 2001 and December 31, 2000, respectively. Carrying value is composed of investments categorized as held-to-maturity, which are carried at amortized cost, and investments categorized as available-for-sale, which are carried at fair value. The total fair value of our fixed maturity security portfolio was $35,172.8 and $32,393.5 million, at March 31, 2001 and December 31, 2000, respectively. (2) The fair value for our mortgage loan portfolio was $11,545.0 and $11,359.6 million as of March 31, 2001 and December 31, 2000, respectively. (3) Policy loans are secured by the cash value of the underlying life insurance policies and do not mature in a conventional sense, but expire in conjunction with the related policy liabilities. (4) Cash and cash equivalents are included in total invested assets for the purposes of calculating yields on the income producing assets for the Company. Cash and cash equivalents are not considered part of Total Investments as shown of the Company of $51,599.6 million and $48,941.6 million at March 31, 2001 and December 31, 2000, respectively. Closed block Total Investments of $8,510.3 million and $8,203.2 million as of March 31, 2001 and December 31, 2000, respectively, are presented in closed block assets on the Consolidated Balance Sheets but remain part of the Company's total invested assets. 36 JOHN HANCOCK FINANCIAL SERVICES, INC. Consistent with the nature of our product liabilities, our assets are heavily oriented toward fixed maturity securities. We determine the allocation of our assets primarily on the basis of cash flow and return requirements of our products and secondarily by the level of investment risk. Fixed Maturity Securities. Our fixed maturity securities portfolio is predominantly comprised of low risk, investment grade, publicly and privately traded corporate bonds and senior tranches of asset-backed securities (ABS) and mortgage-backed securities (MBS), with the balance invested in government bonds. Our fixed maturity securities portfolio also includes redeemable preferred stock. As of March 31, 2001, fixed maturity securities represented 65.4% of general account investment assets with a carrying value of $35.2 billion, roughly comprised of 53% public securities and 47% private securities. Each year we direct the majority of our net cash inflows into investment grade fixed maturity securities. We typically invest between 10% and 15% of funds allocated to fixed maturity securities in below-investment-grade bonds while maintaining our policy to limit the overall level of these bonds to no more than 10% of invested assets and two-thirds of that balance in the BB category. Allocations are based on our assessment of relative value and the likelihood of enhancing risk-adjusted portfolio returns. While the general account has profited from the below-investment-grade asset class in the past, care is taken to manage its growth strategically by limiting its size relative to our net worth. The following table shows the composition by issuer of our fixed maturity securities portfolio. Fixed Maturity Securities -- By Issuer
As of March 31, As of December 31, 2001 2000 ----------------------------------------------- Carrying % of Carrying % of Value Total Value Total ----------------------------------------------- (in millions) (in millions) Corporate securities.................................. $27,737.8 78.8% $25,193.6 77.4% MBS/ABS............................................... 5,747.9 16.3 5,483.5 16.8 U.S. Treasury securities and obligations of U.S. government agencies........................... 139.9 0.4 205.8 0.6 Debt securities issued by foreign Governments........................................ 1,429.5 4.1 1,549.9 4.8 Obligations of states and political Subdivisions....................................... 145.2 0.4 140.6 0.4 --------- ----- --------- ----- Total........................................... $35,200.3 100.0% $32,573.4 100.0% ========= ===== ========= =====
Our MBS and ABS holdings, in keeping with our investment philosophy of tightly managing interest rate risk, are heavily concentrated in commercial MBS where the underlying loans are largely call protected, which means they are not pre-payable without penalty prior to maturity at the option of the issuer, rather than in residential MBS where the underlying loans have no call protection. By investing in MBS and ABS securities with relatively predictable repayments, we add high quality, liquid assets to our portfolios without incurring the risk of excessive cash flow in periods of low interest rates or a cash flow deficit in periods of high interest rates. We believe the portion of our MBS/ABS portfolio subject to prepayment risk as of March 31, 2001 and December 31, 2000 was limited to 11.2% and 3.3% of our total MBS/ABS portfolio and 1.8% and 0.6% of our total fixed maturity securities holdings, respectively. The increase is due to a $500 million portfolio in a new duration neutral strategy used in the corporate investment segment as a liquid alternative to a cash portfolio. The Securities Valuation Office (SVO) of the National Association of Insurance Commissioners evaluates all public and private bonds purchased as investments by insurance companies. The SVO assigns one of six investment categories to each security it reviews. Category 1 is the highest quality rating, 37 JOHN HANCOCK FINANCIAL SERVICES, INC. and Category 6 is the lowest. Categories 1 and 2 are the equivalent of investment grade debt as defined by rating agencies such as S&P and Moody's (i.e., BBB-/Baa3 or higher), while Categories 3-6 are the equivalent of below-investment grade securities. SVO ratings are reviewed and may be revised at least once a year. The following table sets forth the SVO ratings for our bond portfolio along with an equivalent S&P rating agency designation. The majority of our bonds are investment grade, with 87.4% invested in Category 1 and 2 securities as of March 31, 2001. As a percent of total invested assets, our below investment grade bonds, at 8.1% as of March 31, 2001, are higher than the American Council of Life Insurers (ACLI) industry average of 5.9%, last published as of December 31, 1999. This allocation reflects our strategy of avoiding the unpredictability of interest rate risk in favor of relying on our bond analysts' ability to better predict credit or default risk. Our bond analysts operate in an industry-based, team-oriented structure that permits the evaluation of a wide range of below investment grade offerings in a variety of industries resulting in a well-diversified high yield portfolio. A majority (63.5%) of our below investment grade bonds are in category 3, the highest quality below investment grade. Category 6 bonds, those in or near default, represent securities that were originally acquired as long-term investments, but subsequently became distressed. The carrying value of bonds in or near default was $227.7 million and $216.7 million as of March 31, 2001 and December 31, 2000, respectively. For the three months ended March 31, 2001 and 2000, $6.9 million and $4.0 million of net investment income on bonds in or near default was recognized in net investment income, respectively. As of March 31, 2001 and December 31, 2000, $4.7 million and $2.6 million of interest on bonds in or near default was included in accrued investment income, respectively. It is the Company's policy to reverse any accrued investment income and cease accruing interest income on bonds in default and accrue interest income on bonds near default that the Company expects to collect. Fixed Maturity Securities -- By Credit Quality
As of March 31, As of December 31, ------------------------------------------------------------------------ 2001 2000 ------------------------------------------------------------------------ SVO S&P Equivalent Carrying % of Carrying % of Rating (1) Designation (2) Value (3) Total Value (3) Total - ------------------------------------------------------------------------------------------------------------------------ (in millions) (in millions) 1 AAA/AA/A..................... $16,941.4 49.2% $14,614.2 45.9% 2 BBB.......................... 13,152.9 38.2 12,877.8 40.5 3 BB........................... 2,760.6 8.0 2,793.3 8.8 4 B............................ 1,001.4 2.9 1,066.4 3.3 5 CCC and lower................ 358.9 1.0 269.7 0.8 6 In or near default........... 227.7 0.7 216.7 0.7 ------------------------------------------------------------------------ Total........................ $34,442.9 100.0% $31,838.1 100.0% ========================================================================
(1) With respect to securities that are awaiting an SVO rating, we have assigned a rating based on an analysis that we believe is equivalent to that used by the SVO. (2) Comparisons between SVO and S&P ratings are published by the National Association of Insurance Commissioners. (3) Does not include redeemable preferred stock with a carrying value of $757.4 million and $735.3 million as of March 31, 2001 and December 31, 2000, respectively. Mortgage Loans. As of March 31, 2001 and December 31, 2000, we held mortgage loans with a carrying value of $11.0 billion and $10.9 billion, respectively, including $2.6 billion and $2.5 billion of agricultural loans, respectively, and $1.2 billion and $1.2 billion of loans managed by Maritime, respectively, of which $0.6 billion respectivelywere government-insured by the Canada Mortgage and Housing Corporation (CMHC). 38 JOHN HANCOCK FINANCIAL SERVICES, INC. Investment Results The following table summarizes the Company's investment results for the periods indicated. Overall, the yield, net of investment expenses, on our general account portfolio decreased by 64 basis points from the first quarter of the prior year. The lower yield was the result of old assets rolling over into new investments with less favorable interest rates and narrower acquisition spreads than those present in our 2000 fixed maturity portfolio. The inflow of new cash was invested at rates that were less than the overall portfolio earnings rate during the first quarter of 2000. Indicative of this environment, between March 2000 and March 2001, the 10-year U.S. Treasury rate fell 137 basis points to 4.89%, while Moody's seasoned BAA spreads fell by 53 basis points to 7.84%.
As of As of March 31, 2001 March 31, 2000 ------------------------------------------------- Yield Amount Yield Amount ------------------------------------------------- (in millions) (in millions) General account assets-excluding policy loans Gross income 7.72% $ 984.7 8.58% $ 1,010.0 Ending assets-excluding policy Loans 51,846.2 47,385.8 Policy loans Gross income 6.33% 31.2 6.07% 29.6 Ending assets 1,977.3 1,947.0 Total gross income 7.66% 1,015.9 8.48% 1,039.6 Less: investment expenses (65.5) (82.1) --------- --------- Net investment income (1) 7.17% $ 950.4 7.81% $ 957.5 ========= =========
(1) Total Company net investment income of $950.4 million and $957.5 million for the period ended March 31, 2001 and 2000, respectively, is discussed in the Management's Discussion and Analysis, which includes net investment income of $781.4 million and $848.6 million in the unaudited consolidated statements of income and $169.0 million and $108.9 million in Note 5 - Closed Block to the unaudited consolidated financial statements for the three months ended March 31, 2001 and 2000, respectively. 39 JOHN HANCOCK FINANCIAL SERVICES, INC. Liquidity and Capital Resources Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. John Hancock Financial Services, Inc. is an insurance holding company. The assets of JHFS consist of the outstanding capital stock of John Hancock Life Insurance Company (the Life Company) and a portion of the net proceeds of our initial public offering (the offering), and investments in international subsidiaries. The amount of net offering proceeds retained by JHFS was $105.7 million. JHFS cash flow consists of dividends from its subsidiaries and investment returns on the $105.7 million in invested net proceeds of the offering retained by it, offset by expenses. As a holding company, JHFS ability to meet its cash requirements, pay interest on any debt, pay expenses related to its affairs and pay dividends on its common stock substantially depends upon dividends from its subsidiaries. State insurance laws generally restrict the ability of insurance companies to pay cash dividends in excess of prescribed limitations without prior approval. The Life Company's limit is the greater of 10% of the statutory surplus or the prior calendar year's statutory net gain from operations of the Life Company. The ability of the Life Company, JHFS' primary operating subsidiary, to pay shareholder dividends is and will continue to be subject to restrictions set forth in the insurance laws and regulations of Massachusetts, its domiciliary state. The Massachusetts insurance law limits how and when the Life Company can pay shareholder dividends. The Life Company, in the future, could also be viewed as being commercially domiciled in New York. If so, dividend payments may also be subject to New York's holding company act as well as Massachusetts' law. JHFS currently does not expect such regulatory requirements to impair its ability to meet its liquidity and capital needs. However, JHFS can give no assurance it will declare or pay dividends on a regular basis. No such dividends were declared or paid in the three months ended March 31, 2001 or 2000. In March 2001, the Commissioner of Insurance for the Commonwealth of Massachusetts approved, and the Life Company paid, dividends to JHFS in the amount of $250.0 million. None of this dividend was classified as extraordinary by state regulators. The funds from these dividends, together with the net proceeds of the offering, were principally used to repurchase $125.8 million in JHFS common stock. Sources of cash for the Company's insurance subsidiaries are from premiums, deposits and charges on policies and contracts, investment income, maturing investments, and proceeds from sales of investment assets. In addition to the need for cash flow to meet operating expenses, our liquidity requirements relate principally to the liabilities associated with various life insurance, annuity, and structured investment products, and to the funding of investments in new products, processes, and technologies. Product liabilities include the payment of benefits under life insurance, annuity and structured investment products and the payment of policy surrenders, withdrawals and policy loans. The Company periodically adjusts its investment policy to respond to changes in short-term and long-term cash requirements and provide adequate funds to pay benefits without forced sales of investments. The liquidity of our insurance operations is also related to the overall quality of our investments. As of March 31, 2001, $30,094.3 million, or 87.4% of the fixed maturity securities held by us and rated by Standard & Poor's Ratings Services, a division of the McGraw-Hill Companies, Inc. (S&P) or the National Association of Insurance Commissioners were rated investment grade (BBB or higher by S&P or 1 or 2 by the National Association of Insurance Commissioners). The remaining $4,348.6 million, or 12.4%, of fixed maturity investments, and 8.0% of invested assets, were rated non-investment grade. For additional discussion of our investment portfolio see the General Account Investments section above in this Management's Discussion and Analysis of Financial Condition and Results of Segment Operations. We employ an asset/liability management approach tailored to the specific requirements of each of our product lines. Each product line has an investment strategy based on the specific characteristics of the liabilities in the product line. As part of this approach, we develop investment policies and operating guidelines for each portfolio based upon the return objectives, risk tolerance, liquidity, and tax and regulatory requirements of the underlying products and business segments. 40 JOHN HANCOCK FINANCIAL SERVICES, INC. Net cash provided by operating activities was $429.9 million and $261.5 million for the three months ended March 31, 2001 and 2000, respectively. The increase in 2001 compared to 2000 was primarily due to the initial cash transfer to the closed block of $158.6 million during the first quarter of 2000 which did not recur in the current period. Net cash used in investing activities was $1,547.9 million and $299.8 million for the three months ended March 31, 2001 and 2000, respectively. The increase in cash used in 2001 as compared to 2000 resulted from increased acquisitions of fixed maturities during the three months ended March 31, 2001 related to the comparable prior year period, while the issuance of mortgage loans on real estate continued to increase. Net cash provided by financing activities was $70.1 million and $76.8 million, for the three months ended March 31, 2001 and 2000, respectively. The decrease in 2001 as compared to 2000 resulted from a reduction in cash payments made on withdrawals of universal life insurance and investment-type contracts and increased deposits on such contracts. This activity was partially offset by non-recurring cash activity related to the IPO in the first quarter of 2000. In addition, the Company used $125.8 million in cash to acquire treasury stock during the first quarter of 2001; this was partially offset by the increase in issued commercial paper of $20.3 million. On October 26, 2000, the Company announced that its Board of Directors authorized a stock repurchase program, with no termination date, under which the Company will purchase up to $500 million of its outstanding common stock. Under the stock repurchase program, purchases will be made from time to time, depending on market conditions, business opportunities and other factors, in the open market or through privately negotiated transactions, and which may be, if deemed appropriate, through a systematic program. During the three months ended March 31, 2001, the Company repurchased 3.6 million shares with a total cost of $125.7 million. Since the inception of the Program, the Company has repurchased 6.6 million shares with a total cost of $217.5 million. Cash flow requirements also are supported by a committed line of credit of $1.0 billion. The line of credit agreement provides for two facilities: one for $500 million pursuant to a 364-day commitment (subject to renewal) and a second for $500 million pursuant to a five-year facility. The line of credit is available for general corporate purposes. The line of credit agreement contains various covenants, among these being that shareholders' equity meet certain requirements. To date, we have not borrowed any amounts under the line of credit. As of March 31, 2001, we had $799.7 million of debt outstanding consisting of $265.6 million of debt classified as short term and $534.1 million classified as long term, including $447.2 million of surplus notes. A new commercial paper program has been established at JHFS that will ultimately replace the commercial paper program now in place at its indirect subsidiary, John Hancock Capital Corporation. During the three months ended March 31, 2001, $50.0 million in commercial paper was issued by JHFS and none was outstanding at March 31, 2001. The risk-based capital standards for life insurance companies, as prescribed by the National Association of Insurance Commissioners, establish a risk-based capital ratio comparing adjusted surplus to required surplus for each of our United States domiciled insurance subsidiaries. If the risk-based capital ratio falls outside of acceptable ranges, regulatory action may be taken ranging from increased information requirements to mandatory control by the domiciliary insurance department. The risk-based capital ratios of all our insurance subsidiaries as of year end were above the ranges that would require regulatory action. We maintain reinsurance programs designed to protect against large or unusual losses. Based on our review of our reinsurers' financial statements and reputations in the reinsurance marketplace, we believe that our reinsurers are financially sound, and, therefore, that we have no significant exposure to uncollectable reinsurance in excess of uncollectable amounts already recognized in our unaudited consolidated financial statements. 41 JOHN HANCOCK FINANCIAL SERVICES, INC. Given the historical cash flow of our subsidiaries and current financial results, management believes that the cash flow from the operating activities over the next year will provide sufficient liquidity for our operations, as well as to satisfy debt service obligations and to pay other operating expenses. Although we anticipate that we will be able to meet our cash requirements, we can give no assurances in this regard. Important Factors that May Affect Future Results The statements, analyses, and other information contained herein relating to trends in the Company's operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "will," "should," "may," and other similar expressions, are "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning future events and their effects on the Company, which may not be those anticipated by management. John Hancock's actual results may differ materially from the results anticipated in these forward-looking statements. These forward-looking statements are subject to risks and uncertainties including, but not limited to, the risks that (1) a significant downgrade in our ratings for claims-paying ability and financial strength may lead to policy and contract withdrawals and materially harm our ability to market our products; (2) elimination of Federal tax benefits for our products and other changes in laws and regulations (including in particular the possible amendment or repeal of the Federal Estate Tax) which the Company expects would adversely affect sales of our insurance and investment advisory products; (3) as a holding company, we depend on dividends from our subsidiaries and the Massachusetts insurance law may restrict the ability of John Hancock Life Insurance Company to pay dividends to us; (4) we face increasing competition in our retail and institutional businesses from mutual fund companies, banks and investment management firms as well as from other insurance companies; (5) a decline or increased volatility in the securities markets, and other economic factors, may adversely affect our business, particularly our variable life insurance, mutual fund, variable annuity and investment business; (6) our life insurance sales are highly dependent on a third party distribution relationship; (7) customers may not be responsive to new or existing products or distribution channels, (8) interest rate volatility may adversely affect our profitability; (9) our net income and revenues will suffer if customers surrender annuities and variable and universal life insurance policies or redeem shares of our open-end mutual funds; (10) the independent directors of our variable series trusts and of our mutual funds could reduce the compensation paid to us or could terminate our contracts to manage the funds; (11) under our Plan of Reorganization, we were required to establish the closed block, a special arrangement for the benefit of a group of our policyholders, and we may have to fund deficiencies in our closed block, and any overfunding of the closed block will benefit only the holders of policies included in the closed block, not our stockholders; (12) there are a number of provisions in our Plan of Reorganization, our Restated Certificate of Incorporation and by-laws, laws applicable to us, agreements that we have entered into with our senior management, and our stockholder rights plan, that will prevent or discourage takeovers and business combinations that our stockholders might otherwise consider to be in their best interests; (13) we will face losses if the claims on our insurance products, or reductions in rates of mortality on our annuity products, are greater than we projected; (14) we face risks relating to our investment portfolio; (15) the market price of our common stock may decline if persons who received common stock as compensation in the reorganization sell their stock in the public market; (16) we may experience volatility in net income due to changes in standards for accounting for derivatives and other changes; (17) our United States insurance companies are subject to risk-based capital requirements and possible guaranty fund assessments; (18) the National Association of Insurance Commissioners' codification of statutory accounting practices will adversely affect the statutory surplus of John Hancock Life Insurance Company; (19) we may be unable to retain personnel who are key to our business; (20) we face risks from assumed reinsurance business in respect of personal accident insurance and the occupational accident component of workers compensation insurance; (21) litigation and regulatory proceedings may result in financial losses, harm our reputation and divert management resources, and (22) we face unforeseen liabilities arising from our acquisitions and dispositions of businesses. 42 JOHN HANCOCK FINANCIAL SERVICES, INC. Readers are also directed to other risks and uncertainties discussed, as well as to further discussion of the risks described above, in other documents filed by the Company with the United States Securities and Exchange Commission. The Company specifically disclaims any obligation to update or revise any forward-looking information, whether as a result of new information, future developments, or otherwise. 43 JOHN HANCOCK FINANCIAL SERVICES, INC. ITEM 3. QUANTITATIVE and QUALITATIVE DISCLOSURES ABOUT MARKET RISK Capital Markets Risk Management The Company maintains a disciplined, comprehensive approach to managing capital market risks inherent in its business operations. To mitigate these risks, and effectively support Company objectives, investment operations are organized and staffed to focus investment management expertise on specific classes of investments, with particular emphasis placed on private placement markets. In addition, a dedicated unit of asset / liability risk management (ALM) professionals centralizes the implementation of its interest rate risk management program. As an integral component of its ALM program, derivative instruments are used in accordance with risk reduction techniques established through Company policy and with formal approval granted from the New York Insurance Department. The Company's use of derivative instruments is monitored on a regular basis by senior management and reviewed quarterly with the Company's Committee of Finance. The Company's principal capital market exposures are credit and interest rate risk, although we have certain exposures to changes in equity prices and foreign currency exchange rates. Credit risk pertains to the uncertainty associated with the ability of an obligor or counterparty to continue to make timely and complete payments of contractual principal and/or interest. Interest rate risk pertains to the market value fluctuations that occur within fixed maturity securities or liabilities as market interest rates move. Equity and foreign currency risk pertain to price fluctuations, associated with the Company's ownership of equity investments or non-US dollar denominated investments, driven by dynamic market environments. Credit Risk The Company manages the credit risk inherent in its fixed maturity securities by applying strict credit and underwriting standards, with specific limits regarding the proportion of permissible below investment grade holdings. We also diversify our fixed maturity securities with respect to investment quality, issuer, industry, geographical, and property-type concentrations. Where possible, consideration of external measures of creditworthiness, such as ratings assigned by nationally recognized rating agencies, supplement our internal credit analysis. The Company uses simulation models to examine the probability distribution of credit losses to ensure that it can readily withstand feasible adverse scenarios. In addition, the Company periodically examines, on various levels of aggregation, its actual default loss experience on significant asset classes to determine if the losses are consistent with the (1) levels assumed in product pricing, (2) ACLI loss experience and (3) rating agencies' quality-specific cohort default data. These tests have generally found the Company's aggregate experience to be favorable relative to these external benchmarks and consistent with priced for levels. As of March 31, 2001, the Company's fixed maturity portfolio was comprised of 87.4% investment grade securities and 12.6% below-investment-grade securities. These percentages are consistent with recent experience and indicative of the Company's long-standing investment philosophy of pursuing moderate amounts of credit risk in return for higher expected returns. We believe that credit risk can be successfully managed given our proprietary credit evaluation models and experienced personnel. Interest Rate Risk The Company maintains a tightly controlled approach to managing its potential interest rate risk. Interest rate risk arises from many of our primary activities, as we invest substantial funds in interest-sensitive assets to support the issuance of our various interest-sensitive liabilities, primarily within our Protection, Asset Gathering and Guaranteed & Structured Financial Products Segments. We manage interest rate sensitive segments of our business, and their supporting investments, under one of two broadly defined risk management methods designed to provide an appropriate matching of assets and liabilities. For guaranteed rate products, where contractual liability cash flows are highly predictable (e.g., GICs or immediate annuities) we apply sophisticated duration-matching techniques to manage the segment's exposure to both parallel and non-parallel yield curve movements. Typically this 44 JOHN HANCOCK FINANCIAL SERVICES, INC. type of management is expressed as a duration mismatch tolerance of only +/- .05 years, with other measures used for limiting exposure to non-parallel risk. For non-guaranteed rate products, such as whole life insurance or single premium deferred annuities, liability cash flows are less predictable. Therefore, a conventional duration-matching strategy is less effective at managing the inherent risk. For these products, we manage interest rate risk based on scenario-based portfolio modeling that seeks to identify the most appropriate investment strategy given probable policyholder behavior and liability crediting needs under a wide range of interest rate environments. As of March 31, 2001, there have been no material changes to the interest rate exposures as reported in the Company's 2000 Form 10-K. Derivative Instruments The Company uses a variety of derivative financial instruments, including swaps, caps, floors, and exchange traded futures contracts, in accordance with Company policy. Permissible derivative applications include the reduction of economic risk (i.e., hedging) related to changes in yields, price, cash flows, and currency exchange rates. In addition, certain limited applications of "income generation" are allowed. Examples of this type of use include the purchase of call options to offset the sale of embedded options in Company liability issuance or the purchase of swaptions to offset the purchase of embedded put options in certain investments. The Company does not make a market or trade derivatives for the purpose of speculation. The Company's Investment Compliance Unit monitors all derivatives activity for consistency with internal policies and guidelines. All derivatives trading activity is reported monthly to the Company's Committee of Finance for review, with a comprehensive governance report provided jointly each quarter by the Company's Derivatives Supervisory Officer and Chief Investment Compliance Officer. The table below reflects the Company's derivative positions that are managing interest rate risk as of March 31, 2001. The notional amounts in the table represent the basis on which pay or receive amounts are calculated and are not reflective of credit risk. These exposures represent only a point in time and will be subject to change as a result of ongoing portfolio and risk management activities.
As of March 31, 2001 ----------------------------------------------------------------------------------------- Fair Value ------------------------------------------------------- Weighted Notional Average Term -100 Basis Point As of +100 Basis Point Amount (Years) Change 3/31/01 Change ------ ------- ------ ------- ------ (in millions, except for Weighted Average Term) Interest rate swaps......... $10,670.8 8.0 $(569.9) $(334.4) $(102.1) CMT swaps................... 491.3 1.4 0.9 0.9 1.0 Futures contracts (1)....... 1,291.9 9.6 (23.7) 1.5 22.7 Interest rate caps.......... 321.6 3.0 0.8 2.1 4.5 Interest rate floors........ 8,328.0 9.4 152.2 66.6 33.8 Swaptions................... 30.0 24.2 (2.7) (1.1) (0.4) -------------- -------------------------------------------------- Totals................ $21,133.6 8.4 $(442.4) $(264.4) $(40.5) ============== ==================================================
- ---------- (1) Represents the notional value on open contracts as of March 31, 2001. Our non-exchange-traded derivatives are exposed to the possibility of loss from a counterparty failing to perform its obligations under terms of the derivative contract. We believe the risk of incurring losses due to nonperformance by our counterparties is remote. To manage this risk, Company procedures include the (a) on-going evaluation of each counterparty's credit ratings, (b) the application of credit limits and monitoring procedures based on an internally developed, scenario-based, risk assessment system, (c) monthly reporting of each counterparty's "potential exposure", (d) master netting agreements and, where appropriate, (e) collateral agreements. Futures contracts trade on organized exchanges and, therefore, have effectively no credit risk. 45 JOHN HANCOCK FINANCIAL SERVICES, INC. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Reference is made to Item 3. Legal Proceedings in the Company's 2000 Form 10-K under the subsection, Harris Trust Litigation, for additional information concerning such litigation. On April 11, 2001, the court in the Harris Trust litigation entered a judgment against John Hancock for approximately $84.9 million, which includes damages to plaintiff, pre-judgment interest, attorneys' fees and other costs. John Hancock believes that the case was wrongly decided, denies that its actions have violated ERISA in any way, and intends to appeal. Notwithstanding what John Hancock believes to be the merits of its position in this case, John Hancock is unable to predict the outcome of its appeal. Even if unsuccessful on appeal, however, in John Hancock's opinion, its ultimate liability would not be material in relation to its financial position or liquidity. ITEM 6. EXHIBITS and REPORTS on FORM 8-K (a) Exhibits Exhibit Number Description - ------ ----------- 10.1 Letter Agreement Concerning Employment, Termination of Employment and Related Affiliation with Stephen L. Brown 18.1 Letter re change in accounting principle b) Reports on Form 8-K. There were no reports on Form 8-K required to be filed during the period covered by this report. 46 JOHN HANCOCK FINANCIAL SERVICES, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. JOHN HANCOCK FINANCIAL SERVICES, INC. Date: May 15, 2001 By: /s/ Thomas E. Moloney ---------------------------------- Thomas E. Moloney Chief Financial Officer 47 JOHN HANCOCK FINANCIAL SERVICES, INC. EXHIBIT INDEX Exhibit Number Description - ------ ----------- 10.1 Letter Agreement Concerning Employment, Termination of Employment and Related Affiliation with Stephen L. Brown 18.1 Letter re change in accounting principle 48 EX-10.1 2 0002.txt LETTER AGREEMENT Exhibit 10.1 LETTER AGREEMENT CONCERNING EMPLOYMENT, TERMINATION OF EMPLOYMENT AND RELATED AFFILIATION WITH STEPHEN L. BROWN. February 1, 2001 Mr. Stephen L. Brown Dear Mr. Brown: This letter will confirm the agreement that has been reached between you and John Hancock Financial Services, Inc. and all of its subsidiary and affiliated entities (collectively, "John Hancock" or the "Company") concerning your employment at the Company and the termination of such employment and all related affiliations. 1. Your last day of active employment with John Hancock will be May 14, 2001, as of which date you will voluntarily resign and retire from your position as Chairman of the Company and from all related officerships and directorships in connection therewith. 2. During the period from the effective date of this Agreement until May 14, 2001, you shall remain employed by John Hancock as the Company's Chairman. 3. Following the effective date of this Agreement, in addition to the obligations set forth in Paragraph 4 hereof, and in consideration of your commitments as set forth herein, the Company agrees to provide you with the following compensation and benefits: (a) Through May 31, 2001, the Company will continue to compensate you at the rate of your current weekly base salary ($19,230.77 per week), less legally required deductions for FICA, FUTA, taxes and the like, and will likewise continue to provide you with all of the regular employee benefits afforded to similarly situated executives of the Company. (b) On or around February 5, 2001, you will receive a cash bonus under the Incentive Compensation Plan for Employees of John Hancock Financial Services, Inc., as amended and restated from time to time by the Company for participants generally, based on the Company's economic performance in Calendar Year 2000, said bonus (which will be no less than $1,910,000.00, less legally required deductions for FICA, FUTA, taxes and the like) to be paid to you in the ordinary course and in accordance with the regular compensation practices of the Company as the same have been applied to you. (c) You will receive all payouts in each of the years 2001, 2002 and 2003, respectively, under John Hancock's Long-Term Incentive Plan for Senior Executives, in accordance with and subject to the terms of such Plan, as amended and restated from time to time by the Company for participants generally. The Long-Term Incentive Plan for Senior Executives will be amended prior to your retirement to accomplish this result. It Mr. Stephen L. Brown -2- February 1, 2001 is agreed and understood that there shall be no other amendments to this Plan that diminish or impair your economic rights thereunder. (d) On or around February 5, 2001, you will be granted options to purchase 1,000,000 shares of John Hancock Financial Services, Inc. common stock, in accordance with and subject to the terms of the John Hancock Financial Services, Inc. 1999 Long-Term Stock Incentive Plan, and the standard stock option agreements applicable generally to Plan participants in connection therewith, each as amended and restated from time to time by the Company for participants generally. These stock options shall become fully vested and thus immediately exercisable upon your retirement from John Hancock on May 14, 2001. Provided, however, and notwithstanding any contrary provisions of the referenced agreements, the stock options granted to you pursuant to this Paragraph 3(d) shall remain fully exercisable for a term of five years following the effective date of the grant thereof. (e) During the first quarter of 2001, you will be eligible to receive a matching grant of restricted stock from John Hancock in accordance with and subject to the terms of both the Incentive Compensation Plan for Employees of John Hancock Financial Services, Inc., as amended and restated from time to time by the Company for participants generally, and the Company's Long-Term Incentive Plan for Senior Executives, as amended and restated from time to time by the Company for participants generally. 4. Following the effective date of your retirement and resignation from John Hancock on May 14, 2001, during and through the end of Calendar Year 2002, and in consideration of your commitments as set forth herein, the Company agrees to provide you with the following separation compensation and benefits: (a) Although you will not continue to earn any regular base salary during Calendar Year 2002, you will be eligible to receive a cash bonus equal to your "pool" amount for Calendar Year 2001 under the Incentive Compensation Plan for Employees of John Hancock Financial Services, Inc., as amended and restated from time to time by the Company for participants generally, based on the Company's economic performance in Calendar Year 2001, said bonus to be paid to you when similarly situated executives of the Company receive the same in the ordinary course of their employment. (b) You will receive an Incentive Compensation Plan-equivalent cash bonus for Calendar Year 2002 in the gross amount of $1,000,000.00, said amount to be paid to you in a single lump sum, less legally required deductions for FICA, FUTA, taxes and the like, which sum shall be payable to you coincident with the Incentive Compensation Plan bonus paid to you pursuant to Paragraph 4(a) hereof. If you provide written notice to the Company's Vice President of Compensation prior to December 31, 2001 that you wish to do so, you may defer all or part of the cash bonus described in this paragraph for a period of time not to exceed three years from the effective date of this Agreement. Any amount so deferred shall be credited with interest determined on the same basis as for deferred amounts under the Incentive Compensation Plan for Employees of John Hancock Financial Services, Inc., as amended and restated from time to time by the Company for participants generally. Mr. Stephen L. Brown -3- February 1, 2001 (c) You will be eligible to apply up to 50% of the bonus compensation paid to you in Calendar Year 2002 under Paragraphs 3(c), 4(a) and 4(b) hereof to purchase on a commission-free basis shares of John Hancock common stock. The Company will provide you with a matching grant of restricted stock in an amount equal to 50% of any shares so purchased under the John Hancock Financial Services, Inc. 1999 Long-Term Stock Incentive Plan, in accordance with the provisions set forth in the Incentive Compensation Plan for Employees of John Hancock Financial Services, Inc. and the Company's Long-Term Incentive Plan for Senior Executives as such plans are amended and restated from time to time by the Company for participants generally. 5. Health insurance benefits for you, and for your spouse as a dependent, under the John Hancock Financial Services, Inc. Employee Welfare Plan will continue without interruption following the effective date of this Agreement, with the Company providing such primary coverage until you reach age 65. When you reach age 65, Medicare shall substitute as your primary provider of health insurance coverage, and all benefits under the Company's Employee Welfare Plan shall become secondary thereto. Your insurance coverage under the Company's Employee Welfare Plan shall at all times remain subject to the required retiree contribution levels customary for retirees with your years of service, and shall in all respects be in accordance with and subject to the terms of such Plan as amended and restated from time to time by the Company for participants generally. 6. Following your May 14, 2001 retirement and resignation from John Hancock, and effective June 1, 2001, you shall begin receiving due retirement benefits under the terms of both the qualified John Hancock Financial Services, Inc. Pension Plan and the Non-qualified Pension Plan for Home Office and Field Employees, in each case in accordance with and subject to the terms of such Plans as the same may be amended and restated from time to time by the Company for participants generally. 7. Commencing on May 15, 2001, you shall participate in all other benefit plans and arrangements, in addition to retirement and medical benefits, but with the exception of the John Hancock Financial Services, Inc. Senior Officer Severance Pay Plan, as may be generally available to retired members of the John Hancock Policy Committee, in accordance with and subject to the terms of such plans and arrangements as the same may be amended and restated from time to time by the Company for Policy Committee members generally. 8. Commencing on May 15, 2001, John Hancock will engage you to provide consulting services to the Company as an independent contractor, which services shall consist of providing such counsel and assistance to the CEO (to whom you will report) and the Policy Committee as may reasonably be requested from time to time. Under this consulting agreement, which shall continue for a term of two years (or such other period as may be mutually agreed upon), you agree to provide up to 200 hours per year in services (including in that total travel time for services that you are asked to perform outside of Massachusetts, and including any study or preparation time), and will receive annualized compensation in an amount equal to $200,000.00, Mr. Stephen L. Brown -4- February 1, 2001 together with reasonable expense reimbursement for travel, lodging, meals and the like. In this capacity, however, you will be eligible to receive no John Hancock employee benefits other than those expressly provided for hereunder or otherwise due you as a retiree of the Company. 9. Following the effective date of your retirement and resignation from John Hancock on May 14, 2001, and for the duration of your life or until such earlier time as may be mutually agreed upon, you will have access to the following perquisites customarily available to retired Chief Executive Officers of the Company: o An office comparable in size and location to those of previously retired CEOs or, in the alternative, an office located outside of the John Hancock complex for which the Company will reimburse you quarterly in an amount equal to (i) the fair rental value of the office space you would otherwise have received in the John Hancock Tower pursuant to this Agreement; and (ii) the actual cost, including payroll taxes, insurance and benefits, incurred by you (up to $50,000 per year) of a secretary retained by you, provided that John Hancock shall not be the employer of, nor have any relationship with, nor have any obligations to or with respect to, such secretary other than the reimbursement described herein. o A full-time secretary, who will retain her current job grade and compensation and benefits eligibility, who would be available for service to others in your absence (provided, however, such secretary will not be afforded in the event you elect not to maintain an office in the John Hancock complex); o Appropriate office furnishings, supplies, periodical subscriptions and the like; o Appropriate computer and accessory equipment, black and white and color printers, telephone, cellular telephone, photocopier, and fax machine, all maintained to preserve currency and compatibility with those of other John Hancock users; o Access to a first floor/VIP section parking space in the John Hancock garage; o Reasonable access to John Hancock's Security Department for driving assignments; o Reasonable access to John Hancock's Catering/Food Services for breakfasts and luncheons in the office; Mr. Stephen L. Brown -5- February 1, 2001 o Reasonable access to John Hancock's Corporate Travel Services and Meeting Management for help in arranging trips; o Renewal of annual memberships in the Algonquin Club and Commercial Club; and o Reasonable access to sports tickets over which the Company has control, at your cost. In the event that any of the perquisites described above result in the imputation of income and the imposition of a state or federal income tax, John Hancock shall pay to you, upon presentation of reasonable documentation, an amount sufficient to prevent there being an out-of-pocket cost to you associated with such tax. 10. It is agreed and understood that this Agreement will inure to the benefit of and be binding upon the parties' successors and assigns. 11. You agree to continue to maintain the strict confidentiality of all trade secrets, proprietary and confidential business information belonging to John Hancock. For purposes of this Agreement, all information concerning the business of the Company shall be considered confidential unless (a) such information is publicly available prior to the date of this Agreement, or (b) such information becomes publicly available by reason of acts not attributable to your breach of this Agreement. 12. You agree that you will not disparage John Hancock or any of its affiliates, employees, directors or agents in communications with third parties. John Hancock, in turn, agrees that neither its Board of Directors nor members of its senior management team will disparage you in communications with third parties. John Hancock further agrees that it will provide you with a reasonable advance review of any internal or external written communications announcing your planned retirement. 13. You agree to cooperate with John Hancock with respect to matters arising during or related to your employment, including but not limited to cooperation in connection with any litigation, governmental investigation, or regulatory or other proceeding which may have arisen or which may arise following the execution of this Agreement. As part of the cooperation agreed to herein, you shall provide complete and truthful information to the Company and its attorneys with respect to any matter arising during or related to your employment. Specifically, you shall make yourself available to meet with Company personnel and the Company's attorneys, and shall provide to the Company and its attorneys any and all documentary or other physical evidence pertinent to any such matter; and, at the Company's request and upon reasonable notice, you shall travel to such places as the Company may specify (for which the Company will reimburse you for your reasonable travel and lodging expenses) and provide such complete and truthful information and evidence to parties whom the Company may specify. Further, upon the oral request of the Company or its attorneys, you shall testify, truthfully and accurately, to any such matter in any civil case to which the Company is a party or in connection with any investigation or regulatory or other proceeding relating to the Company or its activities. Finally, Mr. Stephen L. Brown -6- February 1, 2001 you shall promptly notify the Company's General Counsel, within three business days, of your receipt from any third party or governmental entity of a request for testimony and/or documents, whether by legal process or otherwise, relating to any matter arising during or relating to your employment or directorship at the Company. 14. In consideration of the benefits to be provided you hereunder, which benefits you acknowledge are not otherwise due, you hereby release, waive and forever discharge John Hancock and all those persons, employees, directors, agents and entities affiliated with it from and against any and all claims, rights and causes of action now existing, both known and unknown, including but not limited to all claims of breach of contract or misrepresentation, wrongful discharge, breach of fiduciary duty or claims of alleged violations of Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, the Fair Labor Standards Act, the Employee Retirement Income Security Act, the Americans With Disabilities Act, Massachusetts G.L. c. 151B, Massachusetts G.L. c. 149, ss.148, or any other local, state, or federal law, regulation or other requirement or any other claim relating to or arising out of your employment and/or directorship with John Hancock and/or your ownership of Company stock. You hereby covenant that you will not institute any charge, complaint, or lawsuit to challenge the validity of this release or to otherwise assert claims against the Company, and that you will execute and not revoke another such release in favor of John Hancock in the form appended hereto and marked "A" coincident with the effective date of your resignation. It is agreed and understood that the foregoing general release does not waive any of the following rights: (1) to the pay or benefits to be provided to you as set forth herein; (2) to enforce the terms of this Agreement; (3) to exercise vested stock options in accordance with the terms of applicable plans; (4) to access any currently vested benefits in any John Hancock retirement plan; (5) to raise counterclaims related to claims that John Hancock has not waived pursuant to this Agreement; and (6) to avail yourself of any rights to insurance or indemnification you may have under John Hancock's by-laws or applicable insurance policies. 15. In exchange for the commitments set forth herein, John Hancock voluntarily and forever discharges you from any and all causes of action, rights or claims now existing, both known and unknown, which the Company may have against you, except for: (a) claims related to the Company's right to enforce the terms of this Agreement; (b) claims arising from any criminal or fraudulent conduct on your part that is reasonably determined by the Company to be contrary to its interests; (c) claims arising from your violation of state or federal securities laws or regulations; (d) claims arising after the effective date of this Agreement; (e) counterclaims related to claims that you have not waived pursuant to this Agreement; and (f) claims which John Hancock may not release pursuant to its by-laws or applicable laws and regulations. 16. Except as otherwise required by law, you and John Hancock shall maintain the terms of this Agreement in confidence, disclosing the same to no third parties (other than your spouse and our respective legal and financial advisers or as otherwise consistent with the legitimate business needs of the Company) without the express written consent of the other. 17. John Hancock agrees to reimburse you for reasonable attorney's fees and expenses incurred in connection with the negotiation of this Agreement. Mr. Stephen L. Brown -7- February 1, 2001 18. The performance by John Hancock of its commitments hereunder shall be expressly conditioned on your performance of all of your obligations, including without limitation those set forth in Paragraphs 11, 12, 13 and 14 (each of which shall be deemed a material term of this Agreement), set forth herein. Similarly, your performance of your commitments hereunder shall be expressly conditioned upon the Company's fulfillment of its obligations set forth herein. Either party may suspend or terminate its performance hereunder in the event the other commits a material breach hereof. 19. You shall be entitled (a) to such rights to indemnification as shall exist in the Company's articles and/or bylaws and related Board votes, as amended from time to time, and (b) to coverage under the Company's directors' and officers' insurance policy and other applicable liability policies, for causes relating to all actions occurring prior to May 14, 2001, to the extent set forth in such documents, but in no event greater than the extent to which such coverage or rights have been or are extended to other officers of the Company or its subsidiaries or their affiliates. In addition, John Hancock will indemnify you and hold you harmless in connection with any liabilities associated with your consulting services under Paragraph 8 hereof. 20. It is expressly understood that this Agreement does not constitute, and shall not be construed as constituting, an admission on the part of John Hancock that it has behaved unlawfully or improperly with respect to you, or as an admission on your part that you have behaved unlawfully or improperly with respect to the Company. This Agreement may only be amended or modified by a writing signed by parties duly authorized to do so. 21. In the event of any dispute arising out of or relating to this Agreement or the breach thereof, the parties shall use their best efforts to settle the dispute by direct negotiations. (a) If the dispute is not settled promptly through negotiation, the parties shall submit the dispute to mediation under the Commercial Mediation Rules of the American Arbitration Association. The parties shall each pay their own attorney's fees associated with the mediation, but shall share equally the mediation fees. (b) Thereafter, any unresolved controversy or claim arising out of or relating to this Agreement, or breach thereof, shall be decided in binding arbitration by a sole arbitrator in accordance with the Commercial Arbitration Rules of the American Arbitration Association, and judgment upon the Award rendered by the arbitrator may be entered in any court having jurisdiction thereof. In the event of a conflict between such Rules and the terms of this Agreement, this Agreement shall govern. (c) The arbitrator shall be a Massachusetts lawyer with experience in executive compensation matters, and shall be a current equity partner or equity owner of a law firm of at least 50 lawyers. The arbitrator shall determine the arbitrability of the dispute if it is in controversy. The arbitrator may consider and rule on any dispositive- motions submitted by the parties. Mr. Stephen L. Brown -8- February 1, 2001 (d) Except for any stenographer and the arbitrator, attendance at the arbitration shall be limited to the parties and their counsel and witnesses. Except as necessary for purposes of an action to enforce, modify, or vacate the arbitration award, and except to the extent that disclosure is required by law, all documents and other information submitted to the arbitrator, including any transcript of the proceedings, shall be confidential and shall not be disclosed to anyone other than the parties and their counsel and financial advisors. (e) The arbitration shall be held in Boston, Massachusetts, shall commence no later than 90 days after service of the demand, and shall proceed from day to day until concluded. The arbitrator shall issue an award in writing no later than 30 days after the conclusion of the arbitration hearing. (f) The parties shall rely solely on the procedures set forth herein to resolve any dispute. If any party to this Agreement files an action in court (other than an action to compel arbitration or to vacate, modify, or enforce the arbitral award) in violation of this Agreement, that party shall indemnify the other party for its reasonable attorney's fees and costs incurred as a result of such violation. The prevailing party shall be entitled to recover reasonable attorney's fees and costs incurred in connection with the enforcement of the award if the award is not paid within sixty days of issuance, or if the non-prevailing party in the arbitration unsuccessfully challenges the award in any court. Each party shall bear its own expenses (except as expressly provided above) in connection with the arbitration, but the AAA arbitration fees and the arbitrator's fee shall be paid by the non-prevailing party. 22. This Agreement constitutes the entire agreement between you and John Hancock, and supersedes any other contracts or commitments with respect to your employment and/or service on the Company's Board of Directors, and/or the termination thereof, except to the extent expressly provided for herein. 23. All notices and other communications hereunder shall be in writing and shall be deemed to have been given three days after having been mailed by first-class, registered or certified mail, or twelve hours after having been delivered or sent by facsimile, to the following addresses or to such other addresses as the parties shall have furnished to each other in writing. Stephen L. Brown P.O. Box 47 Boston, MA 02117 John Hancock Financial Services, Inc. Attn: Wayne Budd, Executive Vice President & General Counsel John Hancock Place P. O. Box 111 Boston, MA 02117 Mr. Stephen L. Brown -9- February 1, 2001 24. In order to be certain that this Agreement will resolve any and all concerns that you might have, John Hancock requests that you carefully consider its terms, including the general release of claims set forth above. For a period of seven days following your execution of this Agreement, you may revoke your acceptance hereof as to the release of claims under the Age Discrimination in Employment Act, and this Agreement shall not become effective or enforceable as to the release of such claims until after that seven-day revocation period has expired. 25. In signing this Agreement, you acknowledge that you understand its provisions; that your agreement is knowing and voluntary; that you have been afforded a full and reasonable opportunity of at least 21 days to consider its terms and consult with or seek advice from an attorney of your choosing; and that you have been advised to seek counsel from an attorney and have in fact done so. 26. The parties' substantive and procedural rights with respect to this Agreement shall be governed by the law of the Commonwealth of Massachusetts, without resort to choice of law or conflict of law principles. 27. This Agreement is subject to and in all respects conditioned upon the approval of the John Hancock Board of Directors, and shall not become effective or enforceable until such Board approval is secured. 28. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, and which together shall be deemed to be one and the same instrument. If the foregoing accurately recites the terms of your agreement with John Hancock, kindly execute this Agreement in the space provided below and return the original to me at your convenience. Very truly yours, David F. D'Alessandro Chief Executive Officer ACCEPTED AND AGREED TO: - -------------------------------- Stephen L. Brown Dated: "A" RELEASE OF CLAIMS FOR AND IN CONSIDERATION OF the special payments to be made to me in connection with my separation from employment and membership on the Board of Directors and related affiliations, as set forth in the Agreement between me and John Hancock Financial Services, Inc. and all of its subsidiaries and affiliates (the "Company"), dated as of February 1, 2001 (the "Agreement") I, on my own behalf and on behalf of my heirs, beneficiaries and representatives and all others connected with me, hereby forever release, waive and discharge any and all causes of action or claims against the Company, its parent, subsidiary and affiliated organizations and the respective past, present and future directors, officers, agents, employees, successors and assigns of such organizations, that I have had, now have or may have in any way related to or arising out of my employment or other affiliations with John Hancock, including claims pursuant to any federal, state or local employment laws, regulations, executive orders or other requirements, including without limitation Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, the Older Workers Benefit Protection Act, the Americans with Disabilities Act of 1990, the Employee Retirement Income Security Act, and Mass. G.L. c. 151B, all as they may have been amended. In signing this Release of Claims, I acknowledge that I have had a full and reasonable opportunity of at least twenty-one (21) days to consider the terms of this Release of Claims, that I was encouraged by John Hancock to consult with an attorney prior to signing this Release of Claims, and that I am signing this Release of Claims voluntarily and with a full understanding of its terms. I understand that I may revoke this Release of Claims as to rights and claims under the Age Discrimination in Employment Act (ADEA) at any time within seven (7) days of the date of my signing by written notice to the Company, and that this Release of Claims as to rights and claims under the ADEA will take effect only upon the expiration of such seven-day revocation period and only if I have not timely revoked it. As to all other claims, this Release of Claims shall be effective upon execution. Intending to be legally bound, I have set my hand and seal on the date written below. Signature: ______________________________ Stephen L. Brown Dated: ______________________________ EX-18.1 3 0003.txt LETTER RE CHANGE IN ACCOUNTING PRINCIPLE Exhibit 18.1 Letter re Change in Accounting Principle Mr. Thomas E. Moloney Chief Financial Officer John Hancock Financial Services, Inc. John Hancock Place Boston, Massachusetts 02117 Dear Sir: Note 1 of Notes to the Unaudited Consolidated Financial Statements of John Hancock Financial Services, Inc. included in its Form 10-Q for the period ended March 31, 2001 describes a change in the method of accounting for the recognition of deferred gains and losses considered in the calculation of the annual expense for its employee pension plans under SFAS No. 87, Employers' Accounting for Pensions, and for its postretirement health and welfare plans under SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The Company changed the method of recognizing gains and losses from deferral within a 10% corridor and amortization of gains outside this corridor over the future working careers of the participants to a deferral within a 5% corridor and amortization of gains and losses outside this corridor over the future working careers of the participants. There are no authoritative criteria for determining a "preferable" method of accounting for the recognition of gains and losses from deferrals for determining the annual expense for employee pension plans and postretirement health and welfare plans based upon the particular circumstances; however, we conclude that such change in the method of accounting is to an acceptable alternative method which, based on your business judgment to make this change and for the stated reason, is preferable in your circumstance. We have not conducted an audit in accordance with auditing standards generally accepted in the United States of any financial statements of the Company as of any date or for any period subsequent to December 31, 2000, and therefore we do not express any opinion on any financial statements of John Hancock Financial Services, Inc. subsequent to that date. Very truly yours, /s/ Ernst & Young LLP Boston, Massachusetts May 11, 2001 -----END PRIVACY-ENHANCED MESSAGE-----