10-Q 1 c80808e10vq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 333-14761 FIRST FORTIS LIFE INSURANCE COMPANY (Exact name of registrant as specified in its charter) NEW YORK (State or other jurisdiction of incorporation or organization) 13-2699219 (IRS Identification No.) 308 MALTBIE STREET, SUITE 200, SYRACUSE, NY 13204 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: 315-451-0066 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X 1 FIRST FORTIS LIFE INSURANCE COMPANY BALANCE SHEETS (In thousands, except share data) PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS.

SEPTEMBER 30, DECEMBER 31, 2003 2002 ---------------------------------------- ASSETS (UNAUDITED) Investments: Fixed maturities, at fair value (amortized cost 2003 - $152,770; $ 164,832 $ 175,616 2002 - $166,221) Preferred stock (cost 2003- $9,162, 2002- $3,054) 9,270 3,100 Policy loans 34 24 Short-term investments 7,843 3,394 Real estate and other investment 304 348 ---------------------------------------- 182,283 182,482 Cash and cash equivalents -- 2,041 Receivables: Uncollected premiums, less allowance (2003-$0 and 2002-$100) 1,684 1,627 Reinsurance recoverable on unpaid and paid losses 101,976 109,942 Other 138 1,457 ---------------------------------------- 103,798 113,026 Accrued investment income 2,272 2,333 Deferred policy acquisition costs 1,103 1,570 Property and equipment at cost, less accumulated depreciation (2003-$1,753 and 2002-$1,751) -- 4 Due from affiliates -- 1,511 Federal income tax recoverable 640 -- Deferred federal income taxes 2,759 4,170 Goodwill 2,086 1,971 Assets held in separate accounts 39,500 43,430 ---------------------------------------- Total assets $ 334,441 $ 352,538 ========================================

The accompanying notes are an integral part of the financial statements. 2 FIRST FORTIS LIFE INSURANCE COMPANY BALANCE SHEETS (In thousands, except share data)

SEPTEMBER 30, DECEMBER 31, 2003 2002 ---------------------------------------- POLICY RESERVES, LIABILITIES AND SHAREHOLDER'S EQUITY (UNAUDITED) Policy reserves and liabilities: Future policy benefit reserves: Life insurance $ 42,528 $ 55,084 Interest sensitive and investment products 6,796 6,699 Accident and health 96,125 92,598 ---------------------------------------- 145,449 154,381 Unearned revenues 19,873 24,906 Other policy claims and benefits payable 30,646 31,424 Income taxes payable - 2,478 Deferred gain on reinsurance ceded 8,540 9,963 Other liabilities 12,180 14,883 Liabilities related to separate accounts 39,500 43,430 ---------------------------------------- Total policy reserves and liabilities 256,188 281,465 ---------------------------------------- Shareholder's equity: Common stock, $20 par value: authorized, issued 2,000 2,000 and outstanding shares -- 100,000 Additional paid-in capital 43,006 43,006 Retained earnings 25,546 20,139 Accumulated other comprehensive income 7,701 5,928 ---------------------------------------- Total shareholder's equity 78,253 71,073 ---------------------------------------- Total policy reserves, liabilities and shareholder's equity $ 334,441 $ 352,538 ========================================

The accompanying notes are an integral part of the financial statements. 3 FIRST FORTIS LIFE INSURANCE COMPANY STATEMENTS OF INCOME AN COMPREHENSIVE INCOME (In thousands, unaudited)

NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 ----------------------------------------- REVENUES: Insurance operations: Life insurance premiums $ 16,351 $ 18,389 Accident and health insurance premiums 34,128 37,188 ----------------------------------------- 50,479 55,577 Net investment income 7,742 8,363 Net realized gains (losses) on investments 652 (1,922) Other income 1,612 1,902 ----------------------------------------- Total revenues 60,485 63,920 BENEFITS AND EXPENSES: Benefits to policyholders: Life insurance 9,900 14,608 Accident and health claims 22,869 24,725 ----------------------------------------- 32,769 39,333 Amortization of deferred policy acquisition costs (53) 1,986 Insurance commissions 6,847 6,401 General and administrative expenses 12,604 10,130 ----------------------------------------- Total benefits and expenses 52,167 57,850 ----------------------------------------- Income before federal income taxes 8,318 6,070 Income taxes expense (benefit) Current 2,455 2,942 Deferred 456 (400) ----------------------------------------- 2,911 2,542 Net income $ 5,407 $ 3,528 ========================================= Other comprehensive income: Unrealized gain on investments 1,773 2,360 ----------------------------------------- Comprehensive income $ 7,180 $ 5,888 =========================================

The accompanying notes are an integral part of the financial statements. 4 FIRST FORTIS LIFE INSURANCE COMPANY STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (In thousands, unaudited)

THREE MONTHS ENDED SEPTEMBER 30, 2003 2002 ------------------------------------- REVENUES: Insurance operations: Life insurance premiums $ 4,412 $ 5,564 Accident and health insurance premiums 11,212 12,844 ------------------------------------- 15,624 18,408 Net investment income 2,563 2,848 Net realized (losses) on investments (89) (839) Other income 483 583 ------------------------------------- Total revenues 18,581 21,000 BENEFITS AND EXPENSES: Benefits to policyholders: Life insurance 1,979 4,513 Accident and health claims 9,326 8,957 ------------------------------------- 11,305 13,470 Amortization of deferred policy acquisition costs (534) (86) Insurance commissions 1,913 491 General and administrative expenses 5,781 2,952 ------------------------------------- Total benefits and expenses 18,465 16,827 ------------------------------------- Income before federal income taxes 116 4,173 Income taxes expense (benefit) Current 193 2,082 Deferred (153) (204) ------------------------------------- 40 1,878 Net income $ 76 $ 2,295 ===================================== Other comprehensive (loss) income: Unrealized (loss) gain on investments (2,015) 3,747 ------------------------------------- Comprehensive (loss) income $ (1,939) $ 6,042 =====================================

The accompanying notes are an integral part of the financial statements. 5 FIRST FORTIS LIFE INSURANCE COMPANY STATEMENTS OF CASH FLOWS (In thousands, unaudited)

NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 ---------------------------------------- OPERATING ACTIVITIES Net income $ 5,407 $ 3,528 Adjustments to reconcile net income to net cash used in operating activities: (Decrease) increase in future policy benefit reserves and other policy claims and benefits (14,744) 2,526 Provision for deferred federal income taxes 456 (400) Decrease in federal income taxes (3,118) (3,919) (Decrease) increase in other liabilities (2,699) 2,954 Depreciation, amortization and accretion 356 2,090 Amortization of investment premiums, net 23 (175) Amortization of gain on reinsurance transaction (1,423) (1,686) Decrease (increase) in uncollected premiums, accrued investment income and other 2,834 4,862 Decrease in reinsurance recoverable 7,966 160 Net realized (gain) loss on investments (652) 1,922 ---------------------------------------- Net cash (used in) provided by operating activities (5,594) 11,862 INVESTING ACTIVITIES Purchases of fixed maturity investments (39,472) (89,230) Sales of fixed maturity investments 47,485 77,118 Purchases of other investments (69,365) (1,057) Sales of other investments 64,905 - ---------------------------------------- Net cash provided by (used in) investing activities 3,553 (13,169) ---------------------------------------- Decrease in cash (2,041) (1,307) Cash and cash equivalents at beginning of period 2,041 5,598 ---------------------------------------- Cash and cash equivalents at end of period $ - $ 4,291 ========================================

The accompanying notes are an integral part of the financial statements. 6 FIRST FORTIS LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS September 30, 2003 (In thousands) 1. GENERAL The accompanying unaudited financial statements of First Fortis Life Insurance Company contain all adjustments necessary to present fairly the balance sheet as of September 30, 2003 and the related statement of income for the nine and three months ended September 30, 2003 and 2002, and cash flow for the nine months ended September 30, 2003 and 2002. Income tax payments for the nine months ended September 30, 2003 and September 30, 2002 were $5,573 and $6,862 respectively. 2. INVESTMENTS The classification of fixed maturity investments is made at the time of purchase and, prospectively, that classification is reevaluated as of each balance sheet date. At September 30, 2003 all fixed maturity and equity securities are classified as available-for-sale and carried at fair value. The amortized cost and fair values of investments available-for-sale were as follows at September 30, 2003:

GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSS VALUE --------------------------------------------------------------------- Fixed Income Securities: Governments $ 8,106 $ 621 $ 15 $ 8,712 Public utilities 12,379 1,342 28 13,693 Industrial and miscellaneous 132,285 10,268 126 142,427 -------------- ---------------- --------------- -------------- Total 152,770 12,231 169 164,832 Preferred Stock 9,162 152 44 9,270 -------------- ---------------- --------------- -------------- Total $ 161,932 $ 12,383 $ 213 $ 174,102 ============== ================ =============== ==============

7 FIRST FORTIS LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS September 30, 2003 (In thousands) The amortized cost and fair value of available-for-sale investments in fixed maturities at September 30, 2003 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

AMORTIZED FAIR COST VALUE ---------------- ---------------- Due in one year or less $ 3,439 $ 3,539 Due after one year through five years 29,571 31,935 Due after five years through ten years 58,557 62,743 Due after ten years 61,203 66,615 ---------------- ---------------- Total $ 152,770 $ 164,832 ================ ================

Proceeds from sales of investments in fixed maturities in the nine-month period ended September 30, 2003 and 2002 were $ 43,916 and $74,195, respectively. Gross gains of $1,160 and $1,226 and gross losses of $508 and $3,148 were realized on sales during the nine-month period ended September 30, 2003 and 2002, respectively. 3. NET INVESTMENT INCOME AND NET REALIZED LOSSES ON INVESTMENTS Major categories of net investment income and realized gains and losses on investments for the first nine months of each year were as follows:

Investment Income Realized Gain (Loss) --------------------------------------------------------------- 2003 2002 2003 2002 ----------------------------- ----------------------------- Fixed maturities $ 7,449 $ 8,352 $ 672 $ (1,913) Preferred Stock 368 192 24 (9) Short-term investments 38 50 (44) - ----------------------------- ----------------------------- 7,855 8,594 $ 652 $ (1,922) ============================= Expenses (113) (231) ----------------------------- Net investment income $ 7,742 $ 8,363 =============================

7 FIRST FORTIS LIFE INSURANCE COMPANY September 30, 2003 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FOR THE NINE MONTHS SEPTEMBER 30, 2003 COMPARED TO SEPTEMBER 30, 2002 Fortis, Inc., the ultimate parent of First Fortis Life Insurance Company (the "Company") has initiated the process with the Securities and Exchange Commission for an initial public offering of its common stock. REVENUES The Company's accident and health insurance premiums are principally composed of group and credit coverages. Group accident and health and credit accident and health business represented 81% and 19%, respectively of premium for the nine months ended September 30, 2003; and 76% and 24%, respectively of premium for the nine months ended September 30, 2002. This shift in premium is due to the credit accident and health line's non-renewal of business. Premium associated with both the group life and credit life lines also decreased as a result of business non-renewals. The Company continues to match investment portfolio composition to liquidity needs and capital requirements. Net investment income decreased from $8.4 million during the nine months ended September 30, 2002 to $7.7 million during the nine months ended September 30, 2003 due to lower yielding investment markets. Changes in interest rates during the first nine months of 2002 and 2003 resulted in recognition of realized gains and losses upon sales of securities. BENEFITS The total Company ratio of benefits to premium decreased from 71% to 65% for the nine months ended September 30, 2002 and September 30, 2003, respectively. This change is due primarily to a decrease in the group life line's benefit to premium ratio from 95% at September 30, 2002 to 64% at September 30, 2003. Driving this decrease was a change in reserve estimates. During the third quarter, Fortis Employee Benefits completed actuarial reserve adequacy studies for the group long-term disability, and group life products, which reflected that, in the aggregate, these reserves were redundant by $0.2 million (pre-tax). Therefore, reserves were released by $0.2 million in the third quarter to reflect these best estimates. EXPENSES The Company continues to monitor its commission rate structures, and, as indicated by market conditions, periodically adjusts rates paid. Rates paid vary by product type, group size and duration. The Company's general and administrative expense to premium ratio increased to 25% from 18% for the nine months ended September 30, 2003 and 2002, respectively. The timing of overhead costs allocated to the credit life and credit accident and health lines is the primary reason for this increase. Also driving the increase are shifts in the mix of business as different products require varying levels of administrative costs. The Company continues to strive for improvements in the expense to gross revenue ratio while maintaining quality and timely services to the policyholders. 9 FIRST FORTIS LIFE INSURANCE COMPANY September 30, 2003 ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS In April of 2003, the FASB's Derivative Implementation Group ("DIG") released FAS 133 Implementation Issue B36, Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments that Incorporate Credit Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under those Instruments ("DIG B36"). The effective date of the implementation of the guidance is October 1, 2003. The Company is assessing whether adoption of DIG B36 will have a material impact on the Company's financial position or the results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. MARKET RISK AND RISK MANAGEMENT Interest rate risk is the Company's primary market risk exposure. Substantial and sustained increases and decreases in market interest rates can affect the profitability of insurance products and market value of investments. The yield realized on new investments generally increases or decreases in direct relationship with interest rate changes. The market value of the Company's fixed maturity investments generally increases when interest rates decrease, and decreases when interest rates increase. Interest rate risk is monitored and controlled through asset/liability management. As part of the risk management process, different economic scenarios are modeled, including cash flow testing required for insurance regulatory purposes, to determine that existing assets are adequate to meet projected liability cash flows. A major component of the Company's asset/liability management program is structuring the investment portfolio with cash flow characteristics consistent with the cash flow characteristics of the Company's insurance liabilities. The Company uses computer models to perform simulations of the cash flow generated from existing insurance policies under various interest rate scenarios. Information from these models is used in the determination of interest crediting strategies and investment strategies. The asset/liability management discipline includes strategies to minimize exposure to loss as market 10 FIRST FORTIS LIFE INSURANCE COMPANY September 30, 2003 interest rates change. On the basis of these analyses, management believes there is no material solvency risk to the Company with respect to interest rate movements up or down of 100 basis points from year end levels. Equity market risk exposure is not significant. Equity investments in the general account are not material enough to threaten solvency and contract owners bear the investment risk related to the variable products. Therefore, the risks associated with the investments supporting the variable separate accounts are assumed by contract owners, not by the Company. The Company provides certain minimum death benefits that depend on the performance of the variable separate accounts. Currently the majority of these death benefit risks are reinsured which then protects the Company from adverse mortality experience and prolonged capital market decline. LIQUIDITY AND CAPITAL RESOURCES The liquidity requirements of the Company have been met by funds provided from operations, including investment income. Funds are principally used to provide for policy benefits, operating expenses, commissions and investment purchases. The Company expects its operating activities to continue to generate sufficient funds. The National Association of Insurance Commissioners has implemented risk-based capital standards to determine the capital requirements of a life insurance company based upon the risks inherent in its operations. These standards require the computation of a risk-based capital amount which is then compared to a company's actual total adjusted capital. Based upon current calculation using these risk-based capital standards, the Company's percentage of total adjusted capital is in excess of ratios which would require regulatory attention. The Company has no long or short term debt. As of September 30, 2003, 95.1% of the Company's fixed maturity investments consisted of investment grade bonds. The Company does not expect this percentage to change significantly in the future. REGULATION The Company is subject to the laws and regulations established by the New York State Insurance Department governing insurance business conducted in New York State. Periodic audits are conducted by the New York Insurance Department related to the Company's compliance with these laws and regulations. To date, there have been no adverse findings regarding the Company's operations. ITEM 4. CONTROLS AND PROCEDURES. As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act")). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange 11 FIRST FORTIS LIFE INSURANCE COMPANY September 30, 2003 Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in the Company's internal control over financial reporting during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 12 FIRST FORTIS LIFE INSURANCE COMPANY September 30, 2003 PART II. OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K a. 302 Certification of Chief Executive Officer (Exhibit 31.1) 302 Certification of Chief Financial Officer (Exhibit 31.2) 906 Certification of Chief Executive Officer (Exhibit 32.1) 906 Certification of Chief Financial Officer (Exhibit 32.2) b. None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. First Fortis Life Insurance Company (Registrant) /s/ Larry M. Cains ----------------------------------- Larry M. Cains Treasurer Date: November 12, 2003 13