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FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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 333-55268
THE PHOENIX COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0493340
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One American Row, Hartford, Connecticut 06102-5056
(860) 403-5000
(Address, including zip code, and telephone number,
including area code, of principal executive offices)
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 X. No .
On April 30, 2003, the registrant had 94,134,103 shares of common stock outstanding.
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1
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION Page
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheet at March 31, 2003 (unaudited) and December 31, 2002.............. 3
Consolidated Statement of Income and Comprehensive Income for the three months ended
March 31, 2003 and 2002 (unaudited)....................................................... 4
Consolidated Statement of Cash Flows for the three months ended March 31, 2003
and 2002 (unaudited)...................................................................... 5
Consolidated Statement of Changes in Stockholders' Equity for the three months ended
March 31, 2003 and 2002 (unaudited)....................................................... 6
Notes to Consolidated Financial Statements for the three months ended March 31, 2003
and 2002 (unaudited)...................................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 51
Item 4. Controls and Procedures....................................................................... 54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 55
Item 2. Changes in Securities and Use of Proceeds..................................................... 55
Item 3. Defaults Upon Senior Securities............................................................... 55
Item 4. Submission of Matters to a Vote of Security Holders........................................... 55
Item 5. Other Information............................................................................. 56
Item 6. Exhibits and Reports on Form 8-K.............................................................. 56
Signature................................................................................................ 57
Certifications........................................................................................... 57
2
PART I.
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
THE PHOENIX COMPANIES, INC.
Consolidated Balance Sheet
($ amounts in millions, except per share data)
March 31, 2003 (unaudited) and December 31, 2002
2003 2002
--------------- ---------------
ASSETS:
Available-for-sale debt securities, at fair value.......................... $ 12,818.4 $ 11,894.1
Equity securities, at fair value........................................... 361.1 391.2
Mortgage loans, at unpaid principal balances............................... 407.3 468.8
Venture capital partnerships, at equity in net assets...................... 227.4 228.6
Affiliate equity securities, at cost plus equity in undistributed earnings. 131.3 134.7
Policy loans, at unpaid principal balances................................. 2,202.9 2,195.9
Other investments.......................................................... 393.5 398.9
--------------- ---------------
Total investments.......................................................... 16,541.9 15,712.2
Cash and cash equivalents.................................................. 613.0 1,058.5
Accrued investment income.................................................. 212.1 192.3
Receivables................................................................ 276.3 217.3
Deferred policy acquisition costs.......................................... 1,270.0 1,234.1
Deferred income taxes...................................................... 66.0 41.4
Goodwill and other intangible assets....................................... 748.3 762.0
Other general account assets............................................... 214.2 225.2
Separate account and investment trust assets............................... 5,990.7 5,793.1
--------------- ---------------
Total assets............................................................... $ 25,932.5 $ 25,236.1
=============== ===============
LIABILITIES:
Policy liabilities and accruals............................................ $ 12,798.4 $ 12,680.0
Policyholder deposit funds................................................. 3,679.0 3,395.7
Stock purchase contracts................................................... 118.5 137.6
Indebtedness............................................................... 644.0 644.3
Other general account liabilities.......................................... 680.0 542.9
Separate account and investment trust liabilities.......................... 5,990.7 5,793.1
--------------- ---------------
Total liabilities.......................................................... 23,910.6 23,193.6
--------------- ---------------
MINORITY INTEREST:
Minority interest in net assets of consolidated subsidiaries............... 6.4 10.8
--------------- ---------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 106,375,583 and 106,374,510 shares issued.... 1.0 1.0
Additional paid-in capital................................................. 2,427.1 2,424.4
Deferred compensation on restricted stock units............................ (2.8) --
Accumulated deficit........................................................ (289.4) (292.6)
Accumulated other comprehensive income..................................... 74.6 94.6
Treasury stock, at cost: 12,287,667 and 12,330,000 shares.................. (195.0) (195.7)
--------------- ---------------
Total stockholders' equity................................................. 2,015.5 2,031.7
--------------- ---------------
Total liabilities, minority interest and stockholders' equity.............. $ 25,932.5 $ 25,236.1
=============== ===============
The accompanying notes are an integral part of these financial statements.
3
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Income and Comprehensive Income
($ amounts in millions, except per share data)
Three Months Ended March 31, 2003 and 2002 (unaudited)
2003 2002
-------------- --------------
REVENUES:
Premiums........................................................................ $ 246.1 $ 257.4
Insurance and investment product fees........................................... 132.9 140.3
Investment income, net of expenses.............................................. 276.7 231.2
Net realized investment losses.................................................. (12.3) (35.0)
-------------- --------------
Total revenues.................................................................. 643.4 593.9
-------------- --------------
BENEFITS AND EXPENSES:
Policy benefits, excluding policyholder dividends............................... 350.8 333.9
Policyholder dividends.......................................................... 116.5 74.2
Policy acquisition cost amortization............................................ 28.0 (10.9)
Intangible asset amortization................................................... 8.4 8.1
Interest expense................................................................ 9.8 7.7
Other operating expenses........................................................ 126.5 136.9
-------------- --------------
Total benefits and expenses..................................................... 640.0 549.9
-------------- --------------
Income before income taxes and minority interest................................ 3.4 44.0
Applicable income taxes (benefit)............................................... (2.6) 12.3
-------------- --------------
Income before minority interest................................................. 6.0 31.7
Minority interest in net income of consolidated subsidiaries.................... 2.8 2.8
-------------- --------------
Income before cumulative effect of accounting change............................ 3.2 28.9
Cumulative effect of accounting change for goodwill and other intangible assets. -- (130.3)
-------------- --------------
Net income (loss) .............................................................. $ 3.2 $ (101.4)
============== ==============
BASIC AND DILUTED EARNINGS PER SHARE:
Basic weighted average common shares outstanding (in thousands)................. 94,046 101,195
Diluted weighted average common shares outstanding (in thousands)............... 95,014 101,195
============== ==============
Basic and diluted income before cumulative effect of accounting change per share $ 0.03 $ 0.29
Basic and diluted net income (loss) per share................................... $ 0.03 $ (1.00)
============== ==============
COMPREHENSIVE INCOME:
Net income (loss)............................................................... $ 3.2 $ (101.4)
-------------- --------------
Net unrealized investment losses................................................ (30.1) (28.6)
Net unrealized foreign currency translation adjustment.......................... (1.0) (13.6)
Net unrealized derivative instruments gains (losses)............................ 11.1 (0.1)
-------------- --------------
Other comprehensive loss........................................................ (20.0) (42.3)
-------------- --------------
Comprehensive loss.............................................................. $ (16.8) $ (143.7)
============== ==============
The accompanying notes are an integral part of these financial statements
4
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Cash Flows
($ amounts in millions)
Three Months Ended March 31, 2003 and 2002 (unaudited)
2003 2002
-------------- --------------
OPERATING ACTIVITIES:
Income before cumulative effect of accounting change............................ $ 3.2 $ 28.9
Net realized investment (gains) losses.......................................... 12.3 35.0
Amortization and depreciation................................................... 13.5 12.9
Investment loss (income)........................................................ (52.1) (12.9)
Deferred income taxes (benefit)................................................. (12.7) 38.5
Increase in receivables......................................................... (59.0) (74.5)
Deferred policy acquisition costs (increase) decrease........................... (28.6) (61.5)
(Increase) decrease in policy liabilities and accruals.......................... 114.9 58.6
Other assets and other liabilities net change................................... 47.6 8.7
-------------- --------------
Cash from continuing operations................................................. 39.1 33.7
Discontinued operations, net.................................................... -- (25.4)
-------------- --------------
Cash from operating activities.................................................. 39.1 8.3
-------------- --------------
INVESTING ACTIVITIES:
Investment purchases............................................................ (1,839.1) (997.6)
Investment sales, repayments and maturities..................................... 1,080.1 554.0
Subsidiary purchases............................................................ -- (110.8)
Premises and equipment additions................................................ (1.9) (4.3)
Premises and equipment dispositions............................................. -- --
Discontinued operations, net.................................................... -- 25.4
-------------- --------------
Cash (for) from investing activities............................................ (760.9) (533.3)
-------------- --------------
FINANCING ACTIVITIES:
Policyholder deposit fund receipts, net ........................................ 283.3 315.9
Common stock purchases ......................................................... -- (32.9)
Minority interest distributions................................................. (7.0) (9.1)
-------------- --------------
Cash from financing activities.................................................. 276.3 273.9
-------------- --------------
Change in cash and cash equivalents............................................. (445.5) (251.1)
Cash and cash equivalents, beginning of period.................................. 1,058.5 815.5
-------------- --------------
Cash and cash equivalents, end of period........................................ $ 613.0 $ 564.4
============== ==============
The accompanying notes are an integral part of these financial statements.
5
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Changes in Stockholders' Equity
($ amounts in millions)
Three Months Ended March 31, 2003 and 2002 (unaudited)
2003 2002
------------- -------------
COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL:
Additional common shares issued in demutualization (1,073 and 1,041 shares)...... $ -- $ --
Restricted stock units awarded (394,737 units)................................... 3.0 --
Excess of cost over fair value of common shares contributed to employee
savings plan.................................................................. (0.3) --
DEFERRED COMPENSATION ON RESTRICTED STOCK UNITS:
Restricted stock units awarded................................................... (3.0) --
Compensation expense recognized.................................................. 0.2 --
RETAINED EARNINGS (ACCUMULATED DEFICIT):
Net income (loss)................................................................ 3.2 (101.4)
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Other comprehensive income (loss)................................................ (20.0) (42.3)
TREASURY STOCK:
Common shares purchased (1,858,700 shares)....................................... -- (33.1)
Common shares contributed to employee savings plan (42,333 shares)............... 0.7 --
------------- -------------
Change in stockholders' equity................................................... (16.2) (176.8)
Stockholders' equity, beginning of period........................................ 2,031.7 2,395.7
------------- -------------
Stockholders' equity, end of period.............................................. $ 2,015.5 $ 2,218.9
============= =============
The accompanying notes are an integral part of these financial statements
6
THE PHOENIX COMPANIES, INC.
Notes to Consolidated Financial Statements
($ amounts in millions, except per share and per unit data)
Three Months Ended March 31, 2003 and 2002 (unaudited)
1. Organization and Operations
Our consolidated financial statements include the accounts of The Phoenix Companies, Inc. and its subsidiaries.
The Phoenix Companies, Inc. is a holding company and our operations are conducted through subsidiaries, the
principal ones of which are Phoenix Life Insurance Company (Phoenix Life) and Phoenix Investment Partners, Ltd.
(PXP). We have eliminated significant intercompany accounts and transactions in consolidating these financial
statements. Also, we have reclassified certain amounts for 2002 to conform with 2003 presentations.
We have prepared these financial statements in accordance with generally accepted accounting principles (GAAP).
In preparing these financial statements in conformity with GAAP, we are required to make estimates and
assumptions that affect the reported amounts of assets and liabilities at reporting dates and the reported
amounts of revenues and expenses during the reporting periods. Actual results will differ from these estimates
and assumptions. We employ significant estimates and assumptions in the determination of deferred policy
acquisition costs; policyholder liabilities and accruals; the valuation of goodwill and other intangible
assets, investments in debt and equity securities, venture capital partnerships and affiliates; pension and
other post-employment benefits liabilities; and accruals for contingent liabilities. Our significant accounting
policies are presented in the notes to our consolidated financial statements in our 2002 Annual Report on Form
10-K.
Our interim financial statements do not include all of the information required by GAAP for annual financial
statements. In our opinion, we have included all adjustments, consisting of normal, recurring adjustments,
considered necessary for a fair statement of the results for the interim periods. Operating results for the
interim period in 2003 are not necessarily indicative of the results that may be expected for the year 2003.
These unaudited consolidated financial statements should be read in conjunction with our consolidated financial
statements in our 2002 Annual Report on Form 10-K.
In December 1999, we began the process of reorganizing and demutualizing our then principal operating company,
Phoenix Home Life Mutual Insurance Company. We completed the process in June 2001, when all policyholder
membership interests in the mutual company were extinguished and eligible policyholders of the mutual company
received shares of common stock, cash and policy credits as compensation. To protect the future dividends of
these policyholders, we also established a closed block for their existing policies, which we describe in Note
3. Concurrent with the demutualization, we sold common stock of The Phoenix Companies, Inc. to the public.
Accounting changes
Goodwill and Other Intangible Assets. In the first quarter of 2002, we adopted the new accounting standard for
goodwill and other intangible assets, including amounts reflected in our carrying value of equity-method
investments. Under this new standard, we discontinued recording amortization expense on goodwill and other
intangible assets with indefinite lives, but we continue recording amortization expense for those assets with
definite estimated lives. For more information, see Note 4 to our consolidated financial statements in our 2002
Annual Report on Form 10-K.
Variable Interest Entities: A new accounting standard was issued in January 2003 that interprets the existing
standard on consolidation. It clarifies the application of standards of consolidation to certain entities in
which
7
equity investors do not have the characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional subordinated financial support from
other parties ("variable interest entities"). For more information, see Note 8 to our consolidated financial
statements in our 2002 Annual Report on Form 10-K.
Stock-based Compensation: A new standard was issued in December 2002 which amends an existing standard on
accounting for stock-based compensation. The new standard provides methods of transition for a voluntary change
to fair value accounting for stock-based compensation. It also requires annual and quarterly disclosures about
the method of accounting for stock-based compensation and tabular information about the effect of the method of
accounting for stock-based compensation. We adopted fair value accounting for stock-based compensation in
2003 using the prospective method of transition provided by the new standard, which will result in expense
recognition for the award of stock options after December 31, 2002. For more information, see Note 7 of this
Form 10-Q.
Costs Associated with Exit or Disposal Activities. A new standard was issued in June 2002 which requires
recognition of certain costs associated with exit or disposal activities when they are incurred rather than at
the date of a commitment to an exit or disposal plan. The standard is effective for exit or disposal activities
that are initiated after December 31, 2002.
Business combinations
We acquired a 60% interest in Kayne Anderson Rudnick Investment Management, LLC (Kayne Anderson and Rudnick)
for $102.4 on January 29, 2002; management of the company retained the remaining ownership interest. In
addition to the initial cost of the purchase, we may make a subsequent payment in 2004 based upon growth in
management fee revenue for the purchased business through the end of 2003. We are obligated to purchase an
additional 15% interest in the company by 2007. We allocated $0.3 of the purchase price to tangible net assets
acquired and $102.1 to intangible assets ($58.3 to investment management contracts and $43.8 to goodwill).
Kayne Anderson and Rudnick's results of operations for the period from January 30, 2002 through quarter-end
2002 are included in our results of operations for the first quarter of 2002. We have not presented pro forma
information as if Kayne Anderson and Rudnick had been acquired at the beginning of January 2002, as it is not
material to our financial statements.
2. Business Segments
Segment information on assets at quarter-end 2003 and year-end 2002 and revenues and income for the 2003 and
2002 quarters follows:
2003 2002
-------------- --------------
Segment Assets
Life and Annuity.............................................................. $ 22,321.5 $ 21,533.7
Asset Management ............................................................. 949.4 1,027.9
-------------- --------------
Operating segment assets...................................................... 23,270.9 22,561.6
Venture Capital............................................................... 194.3 227.8
Corporate and Other........................................................... 2,446.5 2,425.9
-------------- --------------
Total segment assets.......................................................... 25,911.7 25,215.3
Net assets of discontinued operations......................................... 20.8 20.8
-------------- --------------
Total assets.................................................................. $ 25,932.5 $ 25,236.1
============== ==============
8
2003 2002
-------------- --------------
Segment Revenues
Life and Annuity ............................................................. $ 572.8 $ 558.2
Asset Management.............................................................. 56.8 69.9
Elimination of inter-segment revenues......................................... (3.1) (4.4)
-------------- --------------
Operating segment revenues.................................................... 626.5 623.7
Venture Capital............................................................... 23.9 (5.0)
Corporate and Other........................................................... 5.8 10.2
-------------- --------------
Total segment revenues........................................................ 656.2 628.9
Net realized investment gains (losses)........................................ (12.3) (35.0)
Other......................................................................... (0.5) --
-------------- --------------
Total revenues................................................................ $ 643.4 $ 593.9
============== ==============
Segment Income
Life and Annuity.............................................................. $ 17.4 $ 28.2
Asset Management.............................................................. (4.6) 1.9
-------------- --------------
Operating segment pre-tax income.............................................. 12.8 30.1
Venture Capital............................................................... 23.9 (5.0)
Corporate and Other........................................................... (12.6) (8.7)
-------------- --------------
Total segment income, before income taxes..................................... 24.1 16.4
Applicable income taxes....................................................... 7.3 3.6
-------------- --------------
Total segment income.......................................................... 16.8 12.8
Net realized investment gains (losses), net of income taxes and other offsets. (12.4) 1.6
Other income (expense), net of income taxes................................... (1.2) 14.5
-------------- --------------
Income before cumulative effect of accounting changes......................... $ 3.2 $ 28.9
============== ==============
3. Life and Annuity Segment
The Life and Annuity segment includes individual life insurance and annuity products and results of Phoenix
Life and certain of its subsidiaries and affiliates (together, our Life Companies), including universal life,
variable universal life, term life and fixed and variable annuities. It also includes the results of our closed
block, which consists primarily of participating whole life products. Segment information on assets as of
quarter-end 2003 and year-end 2002 and operating income for the 2003 and 2002 quarters follow:
2003 2002
-------------- --------------
Life and Annuity Segment Assets
Investments................................................................... $ 15,106.8 $ 14,480.0
Cash and cash equivalents..................................................... 827.6 924.0
Receivables................................................................... 258.4 236.4
Deferred policy acquisition costs............................................. 1,270.0 1,234.1
Deferred income taxes......................................................... 326.4 328.2
Goodwill and other intangible assets.......................................... 7.4 6.8
Other general account assets.................................................. 184.3 192.5
Separate accounts............................................................. 4,340.6 4,131.7
-------------- --------------
Total segment assets.......................................................... 22,321.5 21,533.7
-------------- --------------
Policy liabilities and accruals............................................... 12,670.0 12,695.6
Policyholder deposit funds.................................................... 3,667.4 3,237.9
Other general account liabilities............................................. 304.9 171.0
Separate accounts............................................................. 4,340.6 4,131.7
Minority interest............................................................. 1.6 1.6
-------------- --------------
Total segment liabilities and minority interest............................... 20,984.5 20,237.8
-------------- --------------
Segment net assets............................................................ $ 1,337.0 $ 1,295.9
============== ==============
9
2003 2002
--------------- ---------------
Life and Annuity Segment Income
Premiums..................................................................... $ 246.1 $ 257.4
Insurance and investment product fees........................................ 78.3 77.6
Net investment income........................................................ 248.4 223.2
--------------- ---------------
Total segment revenues....................................................... 572.8 558.2
--------------- ---------------
Policy benefits, including policyholder dividends............................ 455.3 439.7
Policy acquisition cost amortization......................................... 27.5 14.7
Other operating expenses..................................................... 72.6 75.6
--------------- ---------------
Total segment benefits and expenses.......................................... 555.4 530.0
--------------- ---------------
Segment income before income taxes........................................... 17.4 28.2
Allocated income taxes....................................................... 3.8 9.9
--------------- ---------------
Segment income............................................................... $ 13.6 $ 18.3
=============== ===============
Deferred policy acquisition costs
In the first quarter 2002, we revised the mortality assumptions used in the development of estimated gross
margins for the traditional participating block of business to reflect favorable experience. This revision
resulted in a decrease in deferred policy acquisition cost amortization of $22.1 ($14.4 after income taxes).
The activity in deferred policy acquisition costs for the 2003 and 2002 quarters follows:
2003 2002
--------------- ---------------
Direct acquisition costs deferred............................................ $ 56.6 $ 50.5
Costs amortized to expenses:
(Cost) credit related to realized investment gains or losses............... (0.5) 3.8
Recurring costs related to segment income.................................. (27.5) (14.7)
Change in actuarial assumption............................................. -- 22.1
Offsets to net unrealized investment gains or losses included
in accumulated other comprehensive income.................................. 7.3 6.4
--------------- ---------------
Change in deferred policy acquisition costs.................................. 35.9 68.1
Deferred policy acquisition costs, beginning of period....................... 1,234.1 1,123.7
--------------- ---------------
Deferred policy acquisition costs, end of period............................. $ 1,270.0 $ 1,191.8
=============== ===============
Policy liabilities and accruals
Policyholder liabilities are primarily for participating life insurance policies and universal life insurance
policies. For universal life, it includes deposits received from customers and investment earnings on their
fund balances, which range from 4.0% to 7.0% at quarter-end 2003 and year-end 2002, less administrative and
mortality charges.
Policyholder deposit funds
Policyholder deposit funds primarily consist of annuity deposits received from customers, dividend
accumulations and investment earnings on their fund balances, which range from 1.3% to 12.3% at quarter-end
2003 and 1.6% to 12.3% at year-end 2002, less administrative charges.
Participating life insurance
Participating life insurance in-force was 44.2% and 45.5% of the face value of total individual life insurance
in-force at quarter-end 2003 and year-end 2002, respectively. The premiums on participating life insurance
policies were 68.8% and 68.9% of total individual life insurance premiums in the 2003 and 2002 quarters,
respectively.
10
Funds under management
Activity in annuity funds under management for the 2003 and 2002 quarters, respectively, follows:
2003 2002
--------------- ---------------
Deposits.................................................................... $ 432.1 $ 575.4
Performance................................................................. 20.2 (1.4)
Fees........................................................................ (11.5) (15.9)
Benefits and surrenders..................................................... (254.2) (134.2)
--------------- ---------------
Change in funds under management............................................ 186.6 423.9
Funds under management, beginning of period................................. 5,833.4 4,749.1
--------------- ---------------
Funds under management, end of period....................................... $ 6,020.0 $ 5,173.0
=============== ===============
Closed Block
Summarized information on closed block assets and liabilities at quarter-end 2003, year-end 2002 and inception
(December 31, 1999) and closed block revenues and expenses and changes in the policyholder dividend obligation,
all for the cumulative period from inception to quarter-end 2003 and the 2003 and 2002 quarters, follow:
2003 2002 Inception
--------------- --------------- ---------------
Debt securities.............................................. $ 6,635.1 $ 6,418.0 $ 4,773.1
Policy loans................................................. 1,401.1 1,399.0 1,380.0
Mortgage loans............................................... 338.9 373.2 399.0
Venture capital partnerships................................. 33.2 0.8 --
Other invested assets........................................ 44.0 -- --
--------------- --------------- ---------------
Total closed block investments............................... $ 8,452.3 8,191.0 6,552.1
Cash and cash equivalents.................................... 123.0 200.2 --
Accrued investment income.................................... 116.9 110.9 106.8
Receivables.................................................. 40.5 42.1 35.2
Deferred income taxes........................................ 404.9 402.7 389.4
Other closed block assets.................................... 28.3 45.2 6.2
--------------- --------------- ---------------
Total closed block assets.................................... 9,165.9 8,992.1 7,089.7
--------------- --------------- ---------------
Policy liabilities and accruals.............................. 9,515.5 9,449.0 8,301.7
Policyholder dividends payable............................... 374.5 363.4 325.1
Policyholder dividend obligation............................. 562.2 547.3 --
Other closed block liabilities............................... 89.9 24.2 12.3
--------------- --------------- ---------------
Total closed block liabilities............................... 10,542.1 10,383.9 8,639.1
--------------- --------------- ---------------
Excess of closed block liabilities over closed block assets.. $ 1,376.2 $ 1,391.8 $ 1,549.4
=============== =============== ===============
11
Cumulative 2003 2002
--------------- --------------- ---------------
Premiums..................................................... $ 3,476.7 $ 238.7 $ 248.7
Net investment income ....................................... 1,784.1 146.0 138.8
Net realized investment gains (losses)....................... (68.2) 11.5 (36.1)
--------------- --------------- ---------------
Total revenues............................................... 5,192.6 396.2 351.4
--------------- --------------- ---------------
Policy benefits, excluding dividends......................... 3,556.7 254.2 253.5
Policyholder dividends....................................... 1,258.1 105.1 100.2
Additional policyholder dividend obligation provision........ 35.3 11.4 (26.2)
Other operating expenses..................................... 41.7 2.7 2.8
--------------- --------------- ---------------
Total benefits and expenses.................................. 4,891.8 373.4 330.3
--------------- --------------- ---------------
Closed block contribution to income before income taxes...... 300.8 22.8 21.1
Applicable income taxes...................................... 105.7 8.0 7.4
--------------- --------------- ---------------
Closed block contribution to income.......................... $ 195.1 $ 14.8 $ 13.7
=============== =============== ===============
Unrealized investment gains.................................. $ 481.7 $ 3.5 $ (38.3)
Revenue in excess of benefits and expenses................... 80.5 11.4 (26.2)
Policyholder dividend obligation, beginning of period........ -- 547.3 167.2
--------------- --------------- ---------------
Policyholder dividend obligation, end of period.............. $ 562.2 $ 562.2 $ 102.7
=============== =============== ===============
4. Asset Management Segment
We conduct activities in Asset Management largely through our subsidiary, PXP, comprising two lines of business
- - private client and institutional. We provide investment management services through our affiliated asset
managers. We provide our affiliated asset managers with a consolidated platform of distribution and
administrative support. Each manager has autonomy with its investment process while we monitor performance and
ensure that each manager adheres to its stated investment style.
We report within our Asset Management segment our equity investment in Aberdeen Asset Management PLC
(Aberdeen), a Scottish investment management company with institutional and retail clients in the United
Kingdom, as well as in continental Europe, Asia, Australia and the U.S. We acquired 21.8% of the common stock
of Aberdeen in a series of transactions from 1996 through May 2001. Prior to 2003, we also reported our
investments in Aberdeen debt securities within our Asset Management segment. Aberdeen equity and debt
securities are holdings of Phoenix Life's general account.
Segment information on assets as of year-end 2002 and quarter-end 2003 and operating income for the 2003 and
2002 quarters follows:
12
2003 2002
--------------- ---------------
Asset Management Segment Assets
Aberdeen equity securities.................................................. $ 116.1 $ 119.3
Aberdeen debt securities.................................................... -- 52.7
Other investments........................................................... 11.1 6.3
Cash and cash equivalents................................................... 48.5 55.7
Receivables................................................................. 28.1 31.6
Goodwill and other intangible assets........................................ 732.1 740.5
Other assets................................................................ 13.5 21.8
--------------- ---------------
Total segment assets........................................................ 949.4 1,027.9
--------------- ---------------
Liabilities................................................................. 136.7 136.8
Minority interest........................................................... 4.7 9.0
--------------- ---------------
Total segment liabilities and minority interest............................. 141.4 145.8
--------------- ---------------
Segment net assets.......................................................... $ 808.0 $ 882.1
=============== ===============
2003 2002
--------------- ---------------
Asset Management Segment Income
Investment product fees..................................................... $ 55.5 $ 66.7
Net investment income....................................................... 1.3 3.2
--------------- ---------------
Total segment revenues...................................................... 56.8 69.9
--------------- ---------------
Intangible asset amortization............................................... 8.4 8.1
Other operating expenses.................................................... 50.2 57.1
--------------- ---------------
Total segment expenses...................................................... 58.6 65.2
--------------- ---------------
Segment income (loss) before income taxes and minority interest............. (1.8) 4.7
Allocated income tax benefit................................................ (1.7) (0.5)
--------------- ---------------
Segment income before minority interest..................................... (0.1) 5.2
Minority interest in segment income ........................................ 2.8 2.8
--------------- ---------------
Segment income (loss)....................................................... $ (2.9) $ 2.4
=============== ===============
Goodwill and other intangible assets
The gross and net carrying amounts of Asset Management segment goodwill and other intangible assets at
quarter-end 2003 and year-end 2002 follow:
2003 2002
--------------------------------- -------------------------------
Gross Net Gross Net
--------------- --------------- --------------- --------------
Goodwill.................................... $ 429.5 $ 375.5 $ 429.5 $ 375.5
Asset management contracts.................. 491.0 356.5 491.0 364.9
Other....................................... 1.5 0.1 1.5 0.1
--------------- --------------- --------------- --------------
Goodwill and other intangible assets........ 922.0 $ 732.1 922.0 $ 740.5
=============== ==============
Accumulated amortization.................... (189.9) (181.5)
--------------- ---------------
Goodwill and other intangible assets........ $ 732.1 $ 740.5
=============== ===============
Aberdeen Asset Management
The fair value of our investment in Aberdeen common stock, based on the London Stock Exchange closing price at
quarter-end 2003 and year-end 2002, was $37.4 and $43.6, respectively. The carrying value of our investment in
Aberdeen on the equity method of accounting totaled $116.1 and $119.3 at quarter-end 2003 and year-end 2002,
respectively.
13
5. Stock Purchase Contracts
In November 2002, we issued stock purchase contracts in a public offering. The stock purchase contracts are
repaid forward contracts issued by us that will be settled in shares of Hilb, Rogal & Hamilton (HRH) common
stock. Upon issuance of the stock purchase contracts, we designated the embedded derivative instrument as a
hedge of the forecasted sale of our investment in HRH, whose shares underly the stock purchase contracts. All
changes in the fair value of the embedded derivative are recorded in other comprehensive income. During the
2003 quarter, we recorded a favorable change in fair value of the embedded derivative of $18.4 before income
taxes ($12.0 after income taxes) in other comprehensive income, primarily due to a decrease in the quoted
market price of HRH's common stock. The quoted market price at quarter-end 2003 ($31.24 per share) was below
the price that we received at issuance of the stock purchase contracts. For more information, see Notes 5 and 6
to our consolidated financial statements in our 2002 Annual Report on Form 10-K.
6. Income Taxes
The allocation of income taxes to elements of comprehensive income (loss) and between current and deferred for
the quarters-ended 2003 and 2002 follows:
2003 2002
--------------- ---------------
Income before cumulative effect of accounting change......................... $ (2.6) $ 12.3
Cumulative effect of accounting change....................................... -- (11.4)
--------------- ---------------
Net income (loss)............................................................ $ (2.6) $ 0.9
Other comprehensive loss..................................................... (11.9) (22.6)
--------------- ---------------
Comprehensive loss........................................................... $ (14.5) $ (21.7)
=============== ===============
Current...................................................................... $ 10.1 $ (26.2)
Deferred..................................................................... (24.6) 4.5
--------------- ---------------
Income taxes (benefit) applicable to comprehensive income.................... $ (14.5) $ (21.7)
=============== ===============
For the 2003 and 2002 quarters, the effective income tax rates applicable to income from continuing
operations differ from the 35.0% statutory tax rate. Items giving rise to the differences and the effects are
as follow:
2003 2002
--------------- ---------------
Income taxes at statutory rate............................................... $ 1.2 $ 15.4
Tax advantaged investment income............................................. (1.5) (1.5)
Non-taxable minority interest income......................................... (1.0) (1.0)
Other, net................................................................... (1.3) (0.6)
--------------- ---------------
Income taxes (benefit) applicable to continuing operations................... $ (2.6) $ 12.3
=============== ===============
7. Stockholders' Equity
During the 2003 quarter, we contributed 42,333 treasury shares to fund the employer match for our saving and
investment benefit plans. These shares had a cost basis of $0.7 (weighted average of $15.87 per share) and an
aggregate market value of $0.4.
On April 28, 2003, we declared a dividend of $0.16 per share to our shareholders. The record date will be
June 13, 2003 and the payable date will be July 11, 2003.
14
Stock-based Compensation
In the first quarter of 2003, we adopted a new accounting standard that amends an existing standard on
stock-based compensation. The new standard provides methods of transition for a voluntary change to fair value
accounting from intrinsic value accounting for stock-based compensation. It also requires annual and quarterly
disclosures about the method of accounting for stock-based compensation and tabular information about the
effect of the method of accounting for stock-based compensation. We adopted fair value accounting for
stock-based compensation on January 1, 2003 using the prospective method of transition.
Pro forma earnings and earnings per share as if we had applied the fair value method of accounting for
stock-based compensation for the 2003 and 2002 quarters follows:
2003 2002
--------------- ---------------
Net income (loss), as reported................................................ $ 3.2 $ (101.4)
Add: Stock-based employee compensation expense included in
net income (loss), net of applicable income taxes........................... -- --
Deduct: Stock-based employee compensation expense determined
under fair value accounting for all awards, net of applicable income taxes.. (1.1) --
--------------- ---------------
Pro forma net income (loss)................................................... $ 2.1 $ (101.4)
=============== ===============
Basic and diluted earnings per share, as reported............................. $ 0.03 $ (1.00)
=============== ===============
Pro forma basic and diluted earnings per share................................ $ 0.02 $ (1.00)
=============== ===============
Restricted Stock Units
On January 1, 2003, we awarded 394,737 restricted stock units valued at $7.60 per share ($3.0 aggregate). We
will recognize the expense associated with this award over the three-year vesting period. We will issue the
shares underlying this award on the later of June 26, 2006 or the employee's termination of employment. For the
2003 quarter, we recognized $0.2 in compensation expense for this award.
8. Earnings Per Share
A reconciliation of the weighted average number of shares outstanding (in thousands) used to compute basic
earnings per share to diluted earnings per share for 2003 and 2002 quarters follows:
2003 2002
--------------- ---------------
Basic weighted average shares outstanding..................................... 94,046 101,195
Shares issuable for restricted stock units.................................... 968 --
--------------- ---------------
Diluted weighted average shares outstanding................................... 95,014 101,195
=============== ===============
Other common stock equivalents, including stock options (related to 4,409,558 of our common shares) and equity
units (related to 17,423,859 to 21,256,826 of our common shares depending on its February 2006 quoted market
price), have not been included in the diluted earnings per share calculation because the effect would be
anti-dilutive. The related stock options exercise prices of $15.90 and $16.20 and equity units threshold
appreciation price of $8.8206 were greater than the average market price of the common stock.
15
9. Contingent Liabilities
In 1999, we discontinued our reinsurance operations through a combination of sale, reinsurance and placement of
certain retained group accident and health reinsurance business into run-off. We adopted a formal plan to stop
writing new contracts covering these risks and end the existing contracts as soon as those contracts would
permit. However, we remain liable for claims under those contracts.
We have established reserves and reinsurance recoverables for claims and related expenses that we expect to pay
on our discontinued group accident and health reinsurance business. These reserves and reinsurance recoverables
are a net present value amount that is based on currently known facts and estimates about, among other things,
the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid,
the amount of reinsurance we believe we will collect under our finite reinsurance and other reinsurance to
cover our losses and the likely legal and administrative costs of winding down the business.
Total reserves were $25.0 and total reinsurance recoverable balances were $75.0 as of March 31, 2003. In
addition, in 1999 we purchased finite aggregate excess-of-loss reinsurance to further protect us from
unfavorable results from this discontinued business. The maximum coverage available from our finite reinsurance
coverage is currently $125.0. The amount of our total financial provisions as of March 31, 2003 was therefore
$75.0, consisting of reserves, less reinsurance recoverable balances, plus the amount currently available from
our finite aggregate excess-of-loss reinsurance. Based on the most recent information, we did not recognize any
additional reserve provisions during the first quarter of 2003.
We expect the additional reserves and aggregate excess-of-loss reinsurance coverage to cover the run-off of the
business; however, the nature of the underlying risks is such that the claims may take years to reach the
reinsurers involved. Therefore, we expect to pay claims out of existing estimated reserves for up to ten years
as the level of business diminishes.
A significant portion of the claims arising from our discontinued group accident and health reinsurance
business arises from the activities of Unicover Managers, Inc. (Unicover). Unicover organized and managed a
group, or pool, of insurance companies (Unicover pool) and certain other facilities, which reinsured the life
and health insurance components of workers' compensation insurance policies issued by various property and
casualty insurance companies. We were a member of the Unicover pool and we terminated our participation in the
pool effective March 1, 1999.
We are involved in disputes relating to the activities of Unicover. Under Unicover's underwriting authority,
the Unicover pool and Unicover facilities wrote a dollar amount of reinsurance coverage that was many times
greater than originally estimated. As a member of the Unicover pool, we are involved in several proceedings in
which the pool members assert that they can deny coverage to certain insurers that claim that they purchased
reinsurance coverage from the pool.
Further, we were, along with Sun Life Assurance of Canada (Sun Life) and Cologne Life Reinsurance Company
(Cologne Life), a retrocessionaire (meaning a reinsurer of other reinsurers) of the Unicover pool and two other
Unicover facilities, providing the pool and facility members with reinsurance of the risks that the pool and
facility members had assumed. In September 1999, we joined an arbitration proceeding that Sun Life had begun
against the members of the Unicover pool and the Unicover facilities. In this arbitration, we and Sun Life
sought to cancel our retrocession agreements on the grounds that material misstatements and nondisclosures were
made to us about, among other things, the amount of risks we would be reinsuring. The arbitration proceeded
only with respect to the Unicover pool because we, Sun Life and Cologne Life reached settlement with the two
Unicover facilities in the first quarter of 2000. On October 8, 2002, the arbitration panel issued its
decision. The financial implications of the decision are consistent with our current financial provisions.
In our capacity as a retrocessionaire of the Unicover business, we had an extensive program of our own
reinsurance in place to protect us from financial exposure to the risks we had assumed. Currently, we are
involved in separate arbitration proceedings with certain of our own retrocessionaires which are seeking on
various grounds to avoid paying any amounts to us. Because the same retrocession program that covers our
Unicover business covers a significant portion of our other remaining group accident and health reinsurance
business, we could have additional material losses if one or more of our retrocessionaires successfully avoids
its obligations.
A second set of disputes involves personal accident business that was reinsured in the London reinsurance
market in the mid-1990s in which we participated. The disputes involve multiple layers of reinsurance, and
allegations that the reinsurance program created by the brokers involved in placing those layers was
interrelated and devised to disproportionately pass losses to a top layer of reinsurers. Many companies who
participated in this business are involved in arbitrations in which those top layer companies are attempting to
avoid their obligations on the basis of misrepresentation. Because of the complexity of the disputes and the
reinsurance arrangements, many of these companies are currently participating in negotiations of the disputes
for certain contract years, and we believe that similar discussions will follow for the remaining years.
Although we are vigorously defending our contractual rights, we are actively involved in the attempt to reach
negotiated business solutions.
Given the uncertainty associated with litigation and other dispute resolution proceedings, and the expected
long-term development of net claims payments, the estimated amount of the loss on disposal of reinsurance
discontinued operations may differ from actual results. However, it is our opinion, after consideration of the
provisions made in these financial statements, as described above, that future developments will not have a
material effect on our financial position.
16
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENT
The following discussion may contain forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. The company intends these forward-looking statements to be covered by the safe
harbor provisions of the federal securities laws relating to forward-looking statements. These include
statements relating to trends in, or representing management's beliefs about, the company's future strategies,
operations and financial results, as well as other statements including words such as "anticipate," "believe,"
"plan," "estimate," "expect," "intend," "may," "should" and other similar expressions. Forward-looking
statements are made based upon management's current expectations and beliefs concerning trends and future
developments and their potential effects on the company. They are not guarantees of future performance. Actual
results may differ materially from those suggested by forward-looking statements as a result of risks and
uncertainties which include, among others: (i) changes in general economic conditions, including changes in
interest and currency exchange rates and the performance of financial markets; (ii) heightened competition,
including with respect to pricing, entry of new competitors and the development of new products and services by
new and existing competitors; (iii) the company's primary reliance, as a holding company, on dividends and
other payments from its subsidiaries to meet debt payment obligations, particularly since the company's
insurance subsidiaries' ability to pay dividends is subject to regulatory restrictions; (iv) regulatory,
accounting or tax changes that may affect the cost of, or demand for, the products or services of the company's
subsidiaries; (v) downgrades in the claims paying ability or financial strength ratings of the company's
subsidiaries or in its credit ratings; (vi) discrepancies between actual claims experience and assumptions used
in setting prices for the products of insurance subsidiaries and establishing the liabilities of such
subsidiaries for future policy benefits and claims relating to such products; (vii) movements in the equity
markets that affect our investment results, including those from venture capital, the fees we earn from assets
under management and the demand for our variable products; (viii) the company's success in achieving planned
expense reductions; and (ix) other risks and uncertainties described in any of the company's filings with the
SEC. The company undertakes no obligation to update or revise publicly any forward-looking statement, whether
as a result of new information, future events or otherwise.
RISKS RELATED TO OUR BUSINESS
Continued poor performance of the equity markets could adversely affect sales of our investment management,
variable universal life and variable annuity products. Sales of all of our products could also be adversely
affected by a general economic downturn.
The U.S. equity markets experienced strong growth followed by substantial declines. From April 1, 2000 through
quarter-end 2003, the Nasdaq Composite Index and the Standard & Poor's 500 Index fell 70.67% and 43.40%,
respectively. These market declines have been accompanied by increased volatility.
There are two main ways in which market declines and volatility have affected, or have the potential to affect,
our revenues negatively.
o First, significant market volatility or declines may cause potential purchasers of our products to
refrain from new or additional investments, and current investors to withdraw from the markets or reduce
their rates of ongoing investment. At this time we cannot estimate the impact to date of the market on
our sales.
o Second, because the revenues of our investment management and variable products businesses are to a
17
large extent based on fees related to the value of assets under our management, the poor performance of
the equity markets has limited our fee revenues by reducing the value of the investment assets we
manage. The possibility of declines in assets under management is heightened by the fact that as of
quarter-end 2003, approximately 22% of our variable universal life insurance assets under management
excluding our private placement business, and approximately 58% of our variable annuity assets under
management excluding our private placement business, were not subject to any surrender penalties. It is
also possible that we could begin to experience increasing surrenders if equity markets continue to
perform poorly. The surrender charges applicable to our variable universal life insurance policies and
variable annuities typically decline over a period of years and generally expire after 10 years.
Moreover, surrenders of life insurance policies and annuities require faster amortization of deferred
policy acquisition costs, which would reduce our profitability. Our total expense for amortization of
deferred policy acquisition costs was $28.0 million for the quarter ended quarter-end 2003.
In addition to the effects of poorly performing equity markets, a general economic downturn could have a
negative effect on households in our target affluent and high-net-worth market and therefore could hurt sales
of our products.
We experienced significant operating losses in 2002. Continued significant operating losses could impair our
ability to access the capital markets or repay our debt obligations.
We experienced losses from continuing operations before cumulative effect of accounting changes of $115.7
million in 2002. While we experienced net income of $28.9 million and $3.2 million in the first quarter of
2002 and 2003, respectively, any continuing operating losses could impair our ability to raise debt or equity
capital or pay amounts due under our debt obligations.
Some of our investments outside the closed block have limited liquidity, which could hurt our cash flow.
The plan of reorganization relating to our demutualization in June 2001 required Phoenix Life to establish and
operate an arrangement, known as a closed block, to ensure that the reasonable dividend expectations of
policyholders who own certain individual insurance policies of Phoenix Life are met, and that benefits under
such policies are paid. Phoenix Life must retain within the closed block the cash flows produced by closed
block assets in order to pay policy benefits and dividends to closed block policyholders, which means that
these cash flows are not available to us to meet unexpected cash needs in our other businesses. The assets that
are within the closed block include a substantial portion of our most liquid assets.
As of quarter-end 2003, $2.4 billion, or 28% of the invested assets outside the closed block, consisted of
investments in private debt securities, mortgage loans, real estate, policy loans, equity securities and
limited partnership interests, including our venture capital investments, all of which have limited liquidity.
If we need to sell such investments because we require significant amounts of cash on short notice in excess of
our normal cash requirements, as could be the case if we experience unexpectedly sudden and high volumes of
non-participating insurance policy and annuity surrenders, we might have difficulty doing so at attractive
prices or in a timely manner. This could cause a drain on our cash and, therefore, limit the cash we have
available to meet our other obligations.
We might need to fund deficiencies in our closed block, which would result in a reduction in net income and
could result in a reduction in investments in our on-going business.
We have allocated assets to the closed block required by our demutualization in an amount that will produce
cash flows that, together with anticipated revenues from the policies included in the closed block, are
reasonably expected to be sufficient to support obligations and liabilities relating to these policies. These
obligations and liabilities include, but are not limited to, provisions for the payment of claims and certain
expenses and taxes, and
18
provisions for the continuation of the policyholder dividend scales in effect for 2000, if the experience
underlying such scales continues, and for appropriate adjustments in such scales if the experience changes. Our
allocation of assets to the closed block was based on actuarial assumptions about our payment obligations to
closed block policyholders, as well as assumptions about the investment earnings the closed block assets will
generate over time. Since such assumptions are to some degree uncertain, it is possible that the cash flows
generated by the closed block assets and the anticipated revenues from the policies included in the closed
block will prove insufficient to provide for the benefits guaranteed under these policies. We would have to
fund the shortfall resulting from such an insufficiency. Moreover, even if these assets, cash flows and
revenues are sufficient, we may choose to support closed block policyholder dividend payments with assets and
cash flows from outside of the closed block.
Venture Capital earnings are dependent on the performance of the equity markets, which means that this
segment's effect on our income from continuing operations has been volatile.
At times in the last five years Venture Capital has represented a large component of our total income or loss
from continuing operations. Venture Capital is a higher risk, less liquid investment, the value of which is
prone to significant fluctuation. Income from Venture Capital represented 190% and 56% of our total income from
continuing operations in 2000 and 1999, respectively. In 2002 and 2001, however, our venture capital
investments decreased our income from continuing operations by $38.5 million and $54.9 million, respectively,
representing 33% and 40% of our total loss from continuing operations in 2002 and 2001, respectively.
Similarly, venture capital income of $18.8 million through quarter-end 2003 (including $3.3 million in the
closed block) represented 588% of income from operations. The performance of the partnerships depends upon the
economic performance of the underlying assets held by the partnerships, which is difficult to predict.
Our Venture Capital portfolio has a large technology component and includes investments in other sectors such
as telecommunications, the asset values of which tend to move in close relation with the technology sector. The
decrease in this portfolio's income in 2002 and 2001 resulted primarily from equity market declines in the
technology sector and other related sectors. It is possible that we will continue to experience declines
related to our venture capital investments.
In addition, the returns we achieve in Venture Capital depend in large part on the efforts and performance
results obtained by the managers of the partnerships in which we invest. We have neither an active role in the
day to-day management of the partnerships in which we invest, nor the ability to approve the specific
investment management decisions made by the managers of the partnerships. Although we evaluate each potential
partnership investment based on criteria such as the performance history of the partnership and its manager, as
well as the partnership's investment strategies, the past performance of a partnership and its manager may not
be a reliable indicator of future results. Furthermore, the managers, key personnel and investment strategies
of a partnership may change at any time without our consent.
The downgrades to the Company's debt ratings and Phoenix Life's financial strength ratings in 2002, as well as
the possibility of future downgrades, could increase policy surrenders and withdrawals, adversely affect
relationships with distributors, reduce new sales and earnings from our life insurance products and increase
our future borrowing costs.
Rating agencies assign Phoenix Life claims paying ability ratings, sometimes referred to as financial strength
ratings, and assign us debt ratings, based in each case on their opinions of the relevant company's ability to
meet its financial obligations.
19
Financial strength ratings indicate a rating agency's view of an insurance company's ability to meet its
obligations to its insureds. These ratings are therefore key factors underlying the competitive position of
life insurers. The current financial strength and debt ratings are set forth in the chart below.
Financial Strength Rating Senior Debt Rating
Rating Agency of Phoenix Life of the Company
- ------------------------------- --------------------------------- ----------------------------
A.M. Best Company, Inc. A ("Excellent") bbb+ ("Adequate")
Fitch Ratings AA- ("Very Strong") A- ("Strong")
Standard & Poor's A+ ("Strong") BBB+ ("Good")
Moody's A3 ("Good") Baa3 ("Adequate")
A.M. Best and Moody's have a stable outlook for our ratings, while Fitch Ratings and Standard & Poor's have a
negative outlook.
As a consequence of ratings downgrades, we may experience increased interest costs in connection with future
borrowings. Such increased costs would decrease our earnings and could reduce our ability to finance our future
growth on a profitable basis. The downgrades did not trigger any defaults or repurchase obligations.
In addition, the downgrades could adversely affect Phoenix Life's relationships with its existing distributors
and its ability to establish additional distributor relationships. If this were to occur, we might experience a
decline in sales of certain products and the persistency of existing customers. At this time, we cannot
estimate the impact on sales or persistency. If there were a significant decline in Phoenix Life's sales or
persistency, our results of operations would be materially adversely affected.
We could have material losses in the future from our discontinued reinsurance business.
In 1999, we sold our individual life reinsurance business and discontinued the operations of our group accident
and health and group life reinsurance business. We adopted a plan to stop writing new contracts covering these
risks and end our existing contracts as soon as those contracts would permit. However, we remain liable for
claims under those contracts.
We have established reserves and reinsurance recoverables for claims and related expenses that we expect to pay
on our discontinued group accident and health reinsurance business. These reserves and reinsurance recoverables
are a net present value amount that is based on currently known facts and estimates about, among other things,
the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid,
the amount of reinsurance proceeds we believe we will collect under finite reinsurance and other reinsurance
and the likely legal and administrative cost of winding down the business. Total reserves were $25 million and
total reinsurance recoverable balances were $75 million at quarter-end 2003. In addition, in 1999 we purchased
finite aggregate excess-of-loss reinsurance to further protect us from unfavorable results from this
discontinued business. The maximum coverage available is currently $125 million. The amount of our total
financial provisions at quarter-end 2003 was, therefore, $75 million, consisting of reserves, less reinsurance
recoverable balances, plus the amount currently available from our finite aggregate excess-of-loss reinsurance,
and represents our best estimate of the provisions required for the payment of our entire remaining loss
exposure on the discontinued group accident and health reinsurance business.
20
Because we must use estimates in establishing our loss and expense reserves, they are subject to uncertainty.
In the case of our discontinued group accident and health reinsurance business, several factors make estimating
the required provisions more difficult. First, it may take a number of years for the claims on the large
majority of the remaining business to be reported to us. In many cases, the types of losses involved will
develop over a relatively long period. Further, some of our remaining contracts cover losses that will be
incurred in 2003 and subsequent years. For these reasons, we cannot know today what our actual claims
experience will be.
In addition, we are involved in two sets of disputes relating to certain portions of our discontinued group
accident and health reinsurance business. See Note 17 to our consolidated financial statements for the year
2002 on Form 10-K for more information.
In establishing our provisions described above for the payment of insured losses and expenses on this
discontinued business, we have made assumptions about the likely outcome of the disputes referred to above,
including an assumption that substantial recoveries would be available from our reinsurers on all of our
discontinued reinsurance business. However, the inherent uncertainty of arbitrations and lawsuits, including
the uncertainty of estimating whether any settlements we may enter into in the future would be on favorable
terms, makes it hard to predict the outcomes with certainty. Given the need to use estimates in establishing
loss reserves, and the difficulty in predicting the outcome of arbitrations and lawsuits, our actual net
ultimate exposure likely will differ from our current estimate. If future facts and circumstances differ
significantly from our estimates and assumptions about future events with respect to the disputes referred to
above or other portions of our discontinued reinsurance business, our current reserves may need to be increased
materially, with a resulting material adverse effect on our results of operations and financial condition.
A challenge to the plan of reorganization is outstanding.
A pending lawsuit seeks to challenge Phoenix Life's reorganization and the adequacy of the information provided
to policyholders regarding the plan of reorganization. We believe that this lawsuit lacks merit. The lawsuit,
Andrew Kertesz v. Phoenix Home Life Mut. Ins. Co., et al., was filed on April 16, 2001, in the Supreme Court of
the State of New York for New York County. The plaintiff seeks to maintain a class action on behalf of a
putative class consisting of the eligible policyholders of Phoenix Life as of December 18, 2000, the date the
plan of reorganization was adopted. Plaintiff seeks compensatory damages for losses allegedly sustained by the
class as a result of the demutualization, punitive damages and other relief. The defendants named in the
lawsuit include Phoenix Life, The Phoenix Companies, Inc., directors of Phoenix Life, as well as Morgan Stanley
& Co. Incorporated, financial advisor to Phoenix Life in connection with the plan of reorganization. A motion
to dismiss the claims asserted in this lawsuit has recently been granted. The plaintiff has filed a notice of
appeal.
Legislation eliminating or modifying either the federal estate tax or the federal taxation of investment income
could adversely affect revenues from our life insurance products because some of them are specifically designed
and marketed as policies that help a decedent's heirs to pay this tax. In addition, some of the Bush
Administration's legislative proposals would reduce or eliminate the benefit of deferral of taxation for our
insurance and annuity products.
Legislation eliminating or modifying either the federal estate tax or the federal taxation of investment income
could adversely affect revenues from our life insurance and annuity products. Some of our life insurance
products are specifically designed and marketed as policies that help a decedent's heirs to pay estate tax. In
addition, our life insurance and annuity products generally benefit from the deferral of federal income
taxation on the accretion of their value.
Legislation enacted in the spring of 2001 increased the size of estates exempt from the federal estate tax,
phased in reductions in the estate tax rate between 2002 and 2009 and repealed the estate tax entirely in 2010.
This legislation, despite its reinstatement of the estate tax in 2011, could have a negative effect on our
revenues from
21
the sale of estate planning products including in particular sales of second-to-die life insurance policies.
These policies insure the lives of both a husband and wife, with the policy proceeds payable after both spouses
have died. A second-to-die policy effectively enables a couple to pre-fund its heirs' estate tax obligations by
making the policy proceeds available to the heirs at the time estate taxes are due. Second-to-die policies are
often purchased by couples whose assets are largely illiquid, and whose heirs otherwise might have to attempt
to liquidate part of the estate in order to pay the tax. Second-to-die policies represented 35% and 22% of our
new life insurance premiums and deposits in 2002 and 2001, respectively, and the repeal, increase in exemption
or the reduction of the rate, of the federal estate tax may reduce the attractiveness of second-to-die policies
sold for this purpose. President Bush and members of Congress have expressed a desire to modify the existing
legislation, which modification could result in faster or more complete reduction or repeal of the estate tax.
The attractiveness to our customers of many of our products is due, in part, to favorable tax treatment.
Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid
by the holders of annuities and life insurance products. Taxes, if any, are payable on income attributable to a
distribution under the contract for the year in which the distribution is made. Death benefits under life
insurance contracts may be received free of federal income tax. Legislative changes that would have the effect
of reducing the taxes imposed on investment income could reduce or eliminate the relative benefit of such
deferral of taxation for our insurance, annuity and investment products. There can be no assurance whether or
when any such legislation changes would be enacted. However, enactment of any such legislation could have a
negative impact on our revenues.
Changes in interest rates could harm cash flow and profitability in our life and annuity businesses.
Cash flows relating to, and the profitability of, our life insurance and annuity businesses are sensitive to
interest rate changes. In periods of increasing interest rates, life insurance policy loans and surrenders and
withdrawals may increase as policyholders seek investments with higher perceived returns. This process could
result in cash outflows requiring us to sell invested assets at a time when the prices of those assets are
adversely affected by the increase in market interest rates, which could cause us to suffer realized investment
losses.
Conversely, during periods of declining interest rates, a decrease in the spread between interest and dividend
rates to policyholders and returns on our investment portfolio could adversely affect our profitability. During
such periods, life insurance and annuity products may be relatively more attractive investments, resulting in
increased premium payments on products with flexible premium features, repayment of policy loans and increased
percentages of policies remaining in force during a period when we are earning lower returns on our own new
investments. For this reason, a sustained period of declining interest rates could cause cash flow problems for
us. In addition, lower returns on our investments could prove inadequate for us to meet contractually
guaranteed minimum payments to holders of our life and annuity products. We also face the risk in a declining
interest rate environment that borrowers may prepay or redeem mortgages and bonds in our investment portfolio
as they seek to borrow at lower market rates, so that we might have to reinvest proceeds we receive from these
prepayments or redemptions in lower interest-bearing investments.
Our product sales are highly dependent on our relationships with non-affiliated distributors. If these
relationships ended or diminished, our revenues would suffer accordingly.
We sell our products through our affiliated retail producers and non-affiliated advisors, broker-dealers and
other financial intermediaries. Non-affiliated distribution sources have contributed significantly to our sales
in recent years. For example, Merrill Lynch, with over 15,000 registered representatives, accounted for 42% of
our Asset Management private client asset inflows in 2002. The loss or diminution of our relationships with
non-affiliated distributors could materially reduce our revenues from sales of our products. The risk of such
loss or diminution is significant and ongoing, since we face substantial competition in seeking to convince
non-affiliated distributors
22
to sell our products, rather than those offered by our competitors.
The independent trustees of our mutual funds and closed-end funds, as well as intermediary program sponsors,
managed account clients and institutional investment management clients, could terminate their contracts with
us. This would reduce our Asset Management fee revenues and could also impair our intangible assets.
Each of the mutual funds and closed-end funds for which PXP acts as investment adviser or sub-adviser is
registered under the Investment Company Act of 1940 and is governed by a board of trustees or board of
directors. The Investment Company Act requires that at least 40% of these board members be unaffiliated with
PXP. Each fund's board has the duty of deciding annually whether to renew the contract appointing PXP to manage
the fund. Board members have a fiduciary duty to act in the best interests of the shareholders of their funds.
Either the board members or the shareholders may terminate an advisory contract with PXP and move the assets to
another investment adviser. The board members also may deem it to be in the best interests of a fund's
shareholders to make decisions adverse to us, including reducing the compensation paid to PXP or imposing
restrictions on PXP's management of the fund.
Our investment management agreements with institutional clients, intermediary program sponsors (who "wrap," or
make available, our investment products within the management agreements they have with their own clients),
direct managed account clients and institutional clients are generally terminable by these sponsors and clients
upon short notice without penalty. As a result, there would be little impediment to these sponsors or clients
terminating our agreements if they became dissatisfied with our performance.
The termination of any of the above agreements representing a material portion of assets under management would
adversely affect our Asset Management fee revenues.
We face strong competition in our wealth management businesses from mutual fund companies, banks, investment
management firms and other insurance companies. This competition may impair our ability to retain existing
customers, attract new customers and maintain our profitability.
We face strong competition in our wealth management businesses, comprising of life insurance, annuities and
investment management. We believe that our ability to compete is based on a number of factors, including
product features, investment performance, service, price, distribution, capabilities, scale, commission
structure, name recognition and financial strength ratings. While there is no single company that we identify
as a dominant competitor in our wealth management business, the nature of these businesses means that our
actual and potential competitors include a large number of mutual fund companies, banks, investment management
firms and other insurance companies, many of which have advantages over us in one or more of the above
competitive factors. Recent industry consolidation, including acquisitions of insurance and other financial
services companies in the United States by international companies, has resulted in larger competitors with
financial resources, marketing and distribution capabilities and brand identities that are stronger than ours.
Larger firms also may be able to offer, due to economies of scale, more competitive pricing than we can. In
addition, some of our competitors are regulated differently than we are, which may give them a competitive
advantage; for example, many non-insurance company providers of financial services are not subject to the costs
and complexities of insurance regulation by multiple states.
Our ability to compete in the investment management business depends in particular on our investment
performance. We may not be able to accumulate and retain assets under management if our investment results
underperform the market or the competition, since such underperformance likely would result in asset
withdrawals and reduced sales. For example, from 1993 through 1999, we experienced net asset withdrawals in our
private client investment management business. We attribute this in part to underperformance in some of our
mutual funds and managed accounts.
23
We compete for distribution sources in our life, annuity and investment management businesses. We believe that
our success in competing for distributors depends on factors such as our financial strength and on the services
we provide to, and the relationships we develop with, these distributors. Our distributors are generally free
to sell products from whichever providers they wish, which makes it important for us to continually offer
distributors products and services they find attractive. If our products or services fall short of
distributors' needs, we may not be able to establish and maintain satisfactory relationships with distributors
of our life insurance, annuity and investment management products. Accordingly, our revenues and profitability
would suffer.
National banks, with their pre-existing customer bases for financial services products, may increasingly
compete with insurers, as a result of recently enacted legislation removing restrictions on bank affiliations
with insurers. This legislation, the Gramm-Leach-Bliley Act of 1999, permits mergers that combine commercial
banks, insurers and securities firms under one holding company. Until passage of the Gramm-Leach-Bliley Act,
prior legislation had limited the ability of banks to engage in securities-related businesses and had
restricted banks from being affiliated with insurance companies. The ability of banks to increase their
securities-related business or to affiliate with insurance companies may materially and adversely affect sales
of all of our products by substantially increasing the number and financial strength of our potential
competitors.
We might be unable to attract or retain personnel who are key to our business, especially in Asset
Management and distribution.
The success of our business is dependent to a large extent on our ability to attract and retain key employees.
Our investment management business, in particular, depends on the employment of experienced securities analysts
and portfolio managers. In addition, our wealth management businesses are dependent on the employment of highly
productive sales personnel. Competition in the job market for these types of professionals is generally
intense, and is particularly acute with respect to experienced securities analysts and portfolio managers such
as those needed by PXP. In general, our employees are not subject to employment contracts or non-compete
arrangements.
Changes in insurance and securities regulation could affect our profitability by imposing further
restrictions on the conduct of our business.
Our life insurance and annuity businesses are subject to comprehensive state regulation and supervision
throughout the United States. State insurance regulators and the National Association of Insurance
Commissioners continually reexamine existing laws and regulations, and may impose changes in the future that
put further regulatory burdens on us, thereby increasing our costs of business. This could materially adversely
affect our results of operations and financial condition.
The U.S. federal government does not directly regulate the insurance business. However, federal legislation and
administrative policies in areas which include employee benefit plan regulation, financial services regulation
and federal taxation and securities laws could significantly affect the insurance industry and our costs.
We and some of the policies, contracts and other products that we offer are subject to various levels of
regulation under the federal securities laws administered by the SEC as well as regulation by those states and
foreign countries in which we provide investment advisory services, offer products or conduct other
securities-related activities. We could be restricted in the conduct of our business for failure to comply with
such laws and regulations. Future laws and regulations, or the interpretation thereof, could materially
adversely affect our results of operations and financial condition by increasing our expenses in having to
comply with these regulations.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations reviews our consolidated
financial condition as of quarter-end 2003 as compared to year-end 2002; our consolidated results of operations
for the quarters ended 2003 and 2002; and, where appropriate, factors that may affect our future financial
performance. This discussion should be read in conjunction with the unaudited interim financial statements and
notes contained in this filing as well as in conjunction with our consolidated financial statements for the
year 2002 on Form 10-K.
Overview
We are a leading provider of wealth management products and services offered through a variety of select
advisors and financial services firms to serve the accumulation, preservation and transfer needs of the
affluent and high-net-worth market, businesses and institutions. We refer to our products and services together
as our wealth management solutions. We offer a broad range of life insurance, annuity and investment management
solutions through a variety of distributors. These distributors include affiliated and non-affiliated advisors
and financial services firms who make our solutions available to their clients.
We provide our wealth management solutions through two operating segments - Life and Annuity and Asset
Management - which include three businesses, life insurance, annuities and investment management. Through Life
and Annuity we offer a variety of life insurance and annuity products, including universal, variable universal,
whole and term life insurance, and a range of annuity offerings. We conduct activities in Asset Management
largely through Phoenix Investment Partners, Ltd. (PXP) comprising two lines of business - private client and
institutional.
Business Acquisition
On May 1, 2003, we acquired the remaining interest in PFG Holdings, Inc. (PFG) not already owned by us for
initial consideration of $16.7 million. Under the terms of the purchase agreement, additional consideration of
up to $13.0 million may be paid to the selling shareholders during the years 2004 through 2007 in the event
that certain financial performance targets are met. In addition, a final contingent payment may be paid in 2008
based on appraised value of PFG as of December 31, 2007. Maximum total contingent consideration, inclusive of
the additional consideration that may be paid in 2004 through 2007, under the terms of the purchase agreement
is $89.0 million, based on a contractually capped appraised value of PFG of $450.0 million as of December 31,
2007.
The Demutualization
Phoenix Home Life Mutual Insurance Company demutualized on June 25, 2001 by converting from a mutual life
insurance company to a stock life insurance company, became a wholly-owned subsidiary of The Phoenix Companies,
Inc. and changed its name to Phoenix Life Insurance Company (Phoenix Life). See Note 1 to our consolidated
financial statements for more information regarding the demutualization and Note 3 for more information
regarding the closed block.
Consolidated Results of Operations
The following table and discussion presents summary consolidated financial data for the quarters ended 2003 and
2002 ($ amounts in millions).
25
2003 2002 Change
--------------- --------------- ---------------
REVENUES:
Premiums...................................................... $ 246.1 $ 257.4 $ (11.3)
Insurance and investment product fees......................... 132.9 140.3 (7.4)
Investment income, net of expenses............................ 276.7 231.2 45.5
Net realized investment gains (losses)........................ (12.3) (35.0) 22.7
--------------- --------------- ---------------
Total revenues................................................ 643.4 593.9 49.5
--------------- --------------- ---------------
BENEFITS AND EXPENSES:
Policy benefits, excluding policyholder dividends............. 350.8 333.9 16.9
Policyholder dividends........................................ 116.5 74.2 42.3
Policy acquisition cost amortization.......................... 28.0 (10.9) 38.9
Intangible asset amortization................................. 8.4 8.1 0.3
Interest expense.............................................. 9.8 7.7 2.1
Other operating expenses...................................... 126.5 136.9 (10.4)
--------------- --------------- ---------------
Total benefits and expenses................................... 640.0 549.9 90.1
--------------- --------------- ---------------
Income (loss) before income taxes and minority interest....... 3.4 44.0 (40.6)
Applicable income taxes (benefit)............................. (2.6) 12.3 (14.9)
--------------- --------------- ---------------
Income before minority interest............................... 6.0 31.7 (25.7)
Minority interest in net income of subsidiaries............... 2.8 2.8 --
--------------- --------------- ---------------
Income (loss) before cumulative effect of accounting change... 3.2 28.9 (25.7)
Cumulative effect of accounting change........................ -- (130.3) 130.3
--------------- --------------- ---------------
Net income (loss) ............................................ $ 3.2 $ (101.4) $ 104.6
=============== =============== ===============
Premium revenues declined $11.3 million, or 4%, primarily as a result of a shift in sales from traditional life
to universal life products and a decline in the traditional in-force business. Premium revenue for traditional
life policies during the 2003 quarter was $241.5 million versus $252.3 million in the 2002 quarter, a decrease
of $10.8 million.
Insurance and investment product fees decreased by $7.4 million, or 5% from the prior year. Universal life fees
increased due to increased sales while annuity fees declined due to lower separate account assets. Further,
decreased investment product fees resulted from lower private client and institutional assets under management.
Net investment income increased $45.5 million, or 20%, due to an increase in invested assets related to the
guaranteed interest account portion of our annuity business, principally from the sales of the Retirement
Planners Edge (RPE) variable annuity and fixed annuities. Invested assets at the end of the 2003 quarter were
approximately $1.6 billion higher than at the end of the 2002 quarter. Equity in earnings in venture capital
investments increased $28.9 million to $23.9 million in the 2003 quarter from $5.0 million loss in the 2002
quarter.
Net realized investment losses decreased $22.7 million, or 65%, from the prior quarter due to lower impairments
on debt securities during the 2003 quarter than the 2002 quarter. Additionally, net transaction gains increased
substantially from the 2002 quarter, primarily for debt securities sale.
Policy benefits increased $16.9 million, or 5%, primarily due to an increase in interest credited on the
guaranteed interest accounts portion of our variable annuity business and on fixed annuities.
Policyholder dividends increased $42.3 million, or 57%, from the 2002 quarter due to the impact of realized
gains and losses on the policyholder dividend obligation. In the 2002 quarter, dividend expense was lower due
to the impact of $34.0 million in realized losses. In the 2003 quarter, dividend expense was higher due to the
impact of
26
$8.5 million in realized gains, a change of $42.5 million.
Policy acquisition cost amortization increased $38.9 million from the prior year quarter primarily due to lower
margins due to spread compression, higher surrenders and favorable variable universal life mortality.
Amortization in the 2002 quarter includes a $22.1 million adjustment (credit) associated with a revision of the
mortality assumptions.
Interest expense increased $2.1 million, or 27%, due to the equity units issuance during the fourth quarter of
2002. This increased interest expense is reflected in the 2003 quarter.
Our income tax benefit of $2.6 million applicable to operating income for the quarter ended 2003 differed from
the statutory U.S. federal income tax of $1.2 million as a result of the tax benefits associated with low
income housing tax credits, non-taxable dividend and interest income and the recovery of interest amounts
previously paid to the Internal Revenue Service (I.R.S). The effective income tax of $12.3 million for the
quarter ended 2002 also differed from the statutory income tax of $15.4 million as a result of the tax benefits
associated with low income housing tax credits, non-taxable dividend and interest income and the recovery of
non-taxable amounts related to an I.R.S settlement.
Based on the current low level of pre-tax operating income in relation to permanent tax benefits, future
changes in our pre-tax operating income may produce disproportionate changes to our effective income tax rate.
As a result, our effective income tax rate for the quarter ended 2003 should not be considered an estimate of
the effective income tax rate for the year 2003. The effective income tax benefit rate for the year 2002 was
35.5%.
Results of Operations by Segment
We evaluate segment performance on the basis of segment income. Realized investment gains and losses and
certain other items are excluded because we do not consider them when evaluating the financial performance of
the segments. The size and timing of realized investment gains and losses are often subject to our discretion.
Certain items are removed from segment after-tax income if, in our opinion, they are not indicative of overall
operating trends. While some of these items may be significant components of net income reported in accordance
with GAAP, we believe that segment income is an appropriate measure that represents the earnings attributable
to the ongoing operations of the business. Also, all interest expense is included in the Corporate and Other
segment, as well as several smaller subsidiaries and investment activities which do not meet the thresholds of
reportable segments. These include international operations and the run-off of our group pension and guaranteed
investment contract businesses.
The criteria used to identify an item that will be excluded from segment income include: whether the item is
infrequent and is material to the segment's income; or whether it results from a business restructuring or a
change in regulatory requirements, or relates to other unusual circumstances (e.g., non-routine litigation). We
include information on other items allocated to our segments in their respective notes for information only.
Items excluded from segment income may vary from period to period. Because these items are excluded based on
our discretion, inconsistencies in the application of our selection criteria may exist. Segment income is not a
substitute for net income determined in accordance with GAAP and may be different from similarly titled
measures of other companies.
Segment Allocations
We allocate capital to our Life and Annuity segment based on risk-based capital (RBC) for our insurance
products. We used 300% RBC levels for 2003 and 2002. Capital within our Life Companies that is unallocated is
included in our Corporate and Other segment. We allocate capital to our Asset Management segment on the basis
of the historical capital within that segment. We allocate net investment income based on the assets allocated
to the segments. We allocate tax benefits related to tax advantaged investments to the segment that
27
holds the investment. We allocate certain costs and expenses to the segments based on a review of the nature of
the costs, time studies and other methodologies.
The following table presents a reconciliation of segment after-tax income (loss) to consolidated income (loss)
from continuing operations for the 2003 and 2002 quarters ($ amounts in millions).
2003 2002 Change
--------------- --------------- ---------------
Segment Income
Life and Annuity...................................... $ 17.4 $ 28.2 $ (10.8)
Asset Management...................................... (4.6) 1.9 (6.5)
--------------- --------------- ---------------
Operating segment pre-tax income...................... 12.8 30.1 (17.3)
Venture Capital....................................... 23.9 (5.0) 28.9
Corporate and Other................................... (12.6) (8.7) (3.9)
--------------- --------------- ---------------
Total segment income, before income taxes............. 24.1 16.4 7.7
Applicable income taxes............................... 7.3 3.6 3.7
--------------- --------------- ---------------
Total segment income.................................. 16.8 12.8 4.0
--------------- --------------- ---------------
Adjustments after income taxes
Net realized investment gains (losses).............. (12.4) 1.6 (14.0)
Management restructuring charges.................... (2.5) -- (2.5)
Deferred policy acquisition costs adjustment........ -- 15.1 (15.1)
Other income........................................ 1.3 -- 1.3
Demutualization expense............................. -- (0.6) 0.6
Cumulative effect of accounting change.............. -- (130.3) 130.3
--------------- --------------- ---------------
Net income (loss)..................................... $ 3.2 $ (101.4) $ 104.6
=============== =============== ===============
Life and Annuity Segment
The following table and discussion present summary financial data relating to Life and Annuity for the 2003 and
2002 quarters ($ amounts in millions).
2003 2002 Change
--------------- --------------- ---------------
Results of Operations
Premiums.............................................. $ 246.1 $ 257.4 $ (11.3)
Insurance and investment product fees................. 78.3 77.6 0.7
Net investment income................................. 248.4 223.2 25.2
--------------- --------------- ---------------
Total segment revenues................................ 572.8 558.2 14.6
--------------- --------------- ---------------
Policy benefits, including policyholder dividends..... 455.3 439.7 15.6
Policy acquisition cost amortization.................. 27.5 14.7 12.8
Other operating expenses.............................. 72.6 75.6 (3.0)
--------------- --------------- ---------------
Total segment benefits and expenses................... 555.4 530.0 25.4
--------------- --------------- ---------------
Segment income (loss) before income taxes and
minority interest................................... 17.4 28.2 (10.8)
Allocated income taxes................................ 3.8 9.9 (6.1)
--------------- --------------- ---------------
Segment income (loss) before minority interest........ 13.6 18.3 (4.7)
Minority interest in segment income................... -- -- --
--------------- --------------- ---------------
Segment income........................................ $ 13.6 $ 18.3 $ (4.7)
=============== =============== ===============
Premium revenues declined $11.3 million, or 4%, primarily as a result of a shift in sales from traditional life
to universal life products and a decline in the traditional in-force business. Premium revenue for traditional
life policies during the quarter was $241.5 million versus $252.3 in the 2002 quarter, a decrease of $10.8
million.
Insurance and investment product fees decreased by $0.7 million from the prior year. Universal life fees
28
increased due to increased sales while annuity fees declined as a result of lower separate account assets.
Net investment income increased $25.2 million, or 11.3%, due to an increase in invested assets related to the
guaranteed interest account portion of our annuity business, principally from the sales of the Retirement
Planners Edge (RPE) variable annuity and fixed annuities. Invested assets at the end of the 2003 quarter were
approximately $1.6 billion higher than at the end of the 2002 quarter.
Policy benefits and dividends increased $15.6 million, or 4%, due to an increase in interest credited on the
guaranteed interest accounts portion of our annuity business and on fixed annuities. Also, the policyholder
dividend obligation increased by $11.4 million due to a realized gain in venture capital investments and
favorable persistency.
Policy acquisition cost amortization increased $12.8 million, or 87%, from the prior year quarter primarily due
to spread compression and higher surrenders and favorable variable universal life mortality.
Allocated income taxes were $6.1 million lower in the 2003 quarter as a result of lower segment income before
income taxes as well as a current year allocation of the tax benefit of tax advantaged investments to the Life
and Annuity segment.
The table below presents the composition of Life and Annuity's segment income before income taxes by product
for the 2003 and 2002 quarters:
Life and Annuity segment income by product 2003 2002 Change
--------------- --------------- ---------------
Variable universal life insurance......................... $ 6.3 $ 10.0 $ (3.7)
Universal life insurance.................................. 4.7 5.9 (1.2)
Term life insurance....................................... 0.4 (0.5) 0.9
Other life and annuity.................................... 2.5 (1.8) 4.3
--------------- --------------- ---------------
Total non-participating life insurance.................... 13.9 13.6 0.3
Participating Life insurance.............................. 8.8 12.0 (3.2)
--------------- --------------- ---------------
Total life insurance...................................... 22.7 25.6 (2.9)
Annuities................................................. (5.3) 2.6 (7.9)
--------------- --------------- ---------------
Segment income before income taxes........................ $ 17.4 $ 28.2 $ (10.8)
=============== =============== ===============
The decrease in Variable Universal Life pre-tax income for 2003 is primarily due to higher non-deferrable
expenses, and higher amortization of deferred acquisitions costs resulting primarily from favorable mortality
and higher surrenders.
The decrease in Universal Life pre-tax income for 2003 is primarily due to lower insurance margins and to
higher non-deferrable expenses, partially offset by higher investment margins.
The decrease in Participating Life pre-tax income for 2003 is primarily due the release of a policyholder tax
contingency in the first quarter of 2002, plus higher amortization of deferred acquisition costs in 2003.
The increase in Other Life and Annuity pre-tax income for 2003 is primarily due to improved 2003 results for
our Group Executive Ordinary (corporate owned life product) and Single Premium Immediate Annuity lines of
businesses.
The decrease in Annuity pre-tax income of $7.9 million is primarily due to an increase in controllable,
non-deferrable expenses and an increase in DAC amortization due to narrower interest spreads and higher
surrenders.
Asset Management Segment
The following table and discussion present summary financial data relating to Asset Management for the 2003
29
and 2002 quarters ($ amounts in millions).
2003 2002 Change
-------------- -------------- --------------
Results of Operations
Investment product fees................................ $ 55.5 $ 66.7 $ (11.2)
Net investment income.................................. 1.3 3.2 (1.9)
-------------- -------------- --------------
Total segment revenues................................. 56.8 69.9 (13.1)
-------------- -------------- --------------
Intangible asset amortization.......................... 8.4 8.1 0.3
Other operating expenses............................... 50.2 57.1 (6.9)
-------------- -------------- --------------
Total segment expenses................................. 58.6 65.2 (6.6)
-------------- -------------- --------------
Segment income (loss) before income taxes and
minority interest..................................... (1.8) 4.7 (6.5)
Allocated income taxes (benefit)....................... (1.7) (0.5) (1.2)
-------------- -------------- --------------
Segment income (loss) before minority interest......... (0.1) 5.2 (5.3)
Minority interest in segment income ................... 2.8 2.8 --
-------------- -------------- --------------
Segment income (loss).................................. $ (2.9) $ 2.4 $ (5.3)
============== ============== ==============
The decrease in investment product fees compared to 2002 resulted primarily from decreases in both private
client and institutional assets under management. A decrease in billable assets under management for the
private client and institutional lines of business decreased investment product fees by $5.6 million and $4.8
million, respectively. At quarter-end 2003, our Asset Management segment had $52.9 billion in assets under
management, a decrease of $1.1 billion, or 2%, from year-end 2002 and a decrease of $7.8 billion, or 13%, from
quarter-end 2002. The decreases from year-end 2002 and quarter-end 2002 resulted primarily from decreases in
investment performance of $1.4 billion and $9.4 billion, respectively. Net asset outflows from year-end 2002 of
$0.2 billion were offset by increases in our Phoenix general account of $0.5 billion. The issuance of a $1.0
billion CDO in August 2002, as well as a $1.9 billion increase in our Phoenix general account, which was
largely driven by annuity deposits, offset net asset outflows of $1.4 billion since quarter-end 2002.
Sales of private client products in 2003 were $0.9 billion, an decrease of 38% from the same period in 2002,
and redemptions from existing accounts were $1.2 billion, an increase of 4% from the same period in 2002. Sales
of institutional accounts in 2003 were $0.8 billion, a decrease of 5% from the same period in 2002, and lost
accounts and withdrawals from existing accounts were $0.6 billion, a decrease of 11% from the same period in
2002.
The increase in intangible asset amortization resulted from the acquisition of a 60% interest in Kayne Anderson
Rudnick in January 2002 and amortization for an entire quarter in 2003.
The decrease in other operating expenses in 2003 was primarily due to a $7.5 million decrease in compensation
expense. Non-compensation expenses increased $0.6 million, of which a $1.8 million increase was due to charges
related to computer services that were previously included in compensation, partially offset by decreases in
brokerage clearing and execution costs, and travel.
Assets under management were $52,909 and $53,956, of which $14,886 and $14,498 at quarter-end 2003 and
year-end 2002, respectively, were our Life Companies' assets.
Venture Capital Segment
Our venture capital investments are primarily in the form of limited partnership interests in venture capital
funds, leveraged buyout funds and other private equity partnerships sponsored and managed by third parties. We
record our investments in venture capital partnerships in accordance with the equity method of accounting. (See
Venture Capital Partnerships in the Critical Accounting Policies section of the Management's Discussion and
Analysis to our consolidated financial statements in our 2002 Annual Report on Form 10-K.) Venture capital
investments are investments of the general account of Phoenix Life.
For more information, see Notes 4 and 5 to our consolidated financial statements in our 2002 Annual Report on
Form 10-K
30
During the first quarter, we sold a 50% interest in certain of our venture capital partnerships to an outside
party and transferred the remaining 50% interest in those partnerships to our closed block. The carrying value
of the partnerships being sold and transferred totaled $52.2 million after realizing a loss of $18.8 million
($5.1 million recorded in 2002 and $13.8 million recorded in 2003). The unfunded commitments of the
partnerships sold and transferred totaled $27.2 million; the outside party and the closed block will each fund
half of these commitments. The partnerships transferred constitute less than 0.5% of the assets of the closed
block.
The following table and discussion present summary financial data relating to our Venture Capital segment for
the 2003 and 2002 quarters ($ amounts in millions).
2003 2002 Change
--------------- --------------- -------------
Net realized gains (losses) on partnership cash
and stock distributions........................................ $ (6.2) $ (12.5) $ 6.3
Net unrealized gains on partnership investments................. 31.0 9.5 21.5
Partnership operating expenses.................................. (0.9) (2.0) 1.1
--------------- --------------- -------------
Segment net investment income (loss)............................ 23.9 (5.0) 28.9
Applicable income taxes (benefit)............................... 8.4 (1.8) 10.2
--------------- --------------- -------------
Segment income (loss)........................................... $ 15.5 $ (3.2) $ 18.7
=============== =============== =============
Net investment income increased $28.9 million primarily due to the reconciliation to the partnerships' audited
fourth quarter financial statements to previously estimated amounts.
Venture Capital Investments
Contributions (dollars invested)............................................................... $ 11.6
Equity in earnings of partnerships............................................................. 23.9
Distributions.................................................................................. (3.0)
Sale of partnership interests and transfer to closed block..................................... (52.2)
Realized loss on sale of partnership interests and transfer to closed block.................... (13.8)
---------------
Change in Venture Capital investments.......................................................... (33.5)
Venture Capital investments, beginning of quarter.............................................. 227.8
---------------
Venture capital segment investments, end of quarter............................................ $ 194.3
===============
Total investments decreased during the 2003 quarter by $33.5 million, or 14.7%, due to a sale of partnership
interests to third parties and a transfer of partnership interests to the closed block as discussed above.
Further, realized losses on the sale and transfer decreased the investment balance by $13.8 million. These were
offset by contributions during the quarter of $11.6 million and equity in earnings of partnerships of $23.9
million.
Corporate and Other Segment
The following table and discussion present summary financial data relating to Corporate and Other for the
quarters ended 2003 and 2002 ($ amounts in millions).
31
2003 2002 Change
-------------- -------------- --------------
Interest expense............................................... $ 9.8 $ 7.7 $ 2.1
Other expenses, net............................................ 2.8 1.0 1.8
-------------- -------------- --------------
Segment pre-tax operating income (loss)........................ (12.6) (8.7) (3.9)
Allocated income tax benefit................................... (3.2) (4.1) (0.9)
-------------- -------------- --------------
Segment income (loss).......................................... $ (9.4) $ (4.6) $ (4.8)
============== ============== ==============
The increase in interest expense of $2.1 million was due to increased indebtedness during the 2003 quarter over
the same quarter in 2002. This increase was primarily related to interest and issuance cost amortization
associated with the equity units issued in December 2002.
The increase in other expenses is due to higher costs associated with the stock purchase contracts issued in
November 2002 and larger losses from international operations, partially offset by lower controllable expenses.
General Accounts
The invested assets in the general accounts of our Life Companies are generally of high quality and broadly
diversified across asset classes, sectors and individual credits and issuers. Our Asset Management
professionals manage these general account assets in investment segments that support specific product
liabilities. These investment segments have distinct investment policies that are structured to support the
financial characteristics of the specific liability or liabilities within them. Segmentation of assets allows
us to manage the risks and measure returns on capital for our various businesses and products.
Separate Account Investments and Investment Trusts
Assets in our Life Companies' separate accounts are managed in accordance with the specific investment
contracts and guidelines relating to our variable products. We generally do not bear any investment risk on
assets held in separate accounts. Rather, we receive investment management fees based on assets under
management. Generally, assets held in separate accounts are not available to satisfy general account
obligations.
Investment trusts are assets held for the benefit of those institutional clients which have investments in
structured finance products offered and managed by our investment management subsidiary.
Asset/Liability and Risk Management
Our primary investment objective is to maximize after-tax investment return within defined risk parameters. Our
primary sources of investment risk are:
o credit risk, which relates to the uncertainty associated with the ongoing ability of an obligor to make
timely payments of principal and interest;
o interest rate risk, which relates to the market price and cash flow variability associated with changes
in market interest rates; and
o equity risk, which relates to the volatility of prices for equity and equity-like investments.
We manage credit risk through fundamental analysis of the underlying obligors, issuers and transaction
structures. We employ a staff of specialized and experienced credit analysts who review obligors' management,
competitive position, financial statements, cash flow, coverage ratios, liquidity and other key financial and
non-financial information. These specialists recommend the investments needed to fund our liability guarantees
within
32
diversification and credit rating guidelines. In addition, when investing in private debt securities, we rely
upon broad access to management information, negotiated protective covenants, call protection features and
collateral protection. We review our debt security portfolio regularly to monitor the performance of obligors
and assess the integrity of their current credit ratings.
We manage interest rate risk as part of our asset/liability management process and product design procedures.
Asset/liability management strategies include the segmentation of investments by product line, and the
construction of investment portfolios designed to satisfy the projected cash needs of the underlying
liabilities. We identify potential interest rate risk in portfolio segments by modeling asset and liability
durations and cash flows under current and projected interest rate scenarios. We use these projections to
assess and control interest rate risk.
We offer a variety of variable and fixed annuities to meet the accumulation and preservation needs of the
affluent and high-net-worth market. Our major sources of revenues from separate account variable annuities are
mortality and expense fees charged to the contractholder, generally determined as a percentage of the market
value of the underlying assets under management. Our major source of profit from fixed annuities and general
account variable annuities is from the interest rate spread, or the excess of investment income earned over
interest credited.
In 2000, we began selling Retirement Planners Edge (RPE), a no-load variable annuity. Commissions on these
sales were 1% to 1.2% per year depending on the distribution outlet. RPE was designed to attract contributions
into variable sub-accounts on which we earn mortality and expense fees. During the second half of 2002, as
planners and their clients sought refuge from stock market volatility and as interest rates dropped to
historically low levels, policyholders allocated their deposits to general account guaranteed interest accounts
carrying the regulatory required minimum crediting rate of 3%. In September 2002, we stopped accepting
applications for RPE, although existing policyholders have the right to make subsequent deposits up to a
maximum of $1 million per contract.
Amounts held by our policyholders in guaranteed interest accounts, or GIAs, including RPE and fixed annuities,
as of quarter-end 2003 and year-end 2002 follow ($ amounts in millions):
Policyholder Deposit Funds 2003 2002
- -------------------------- -------------- --------------
Retirement Planners Edge GIAs.............................................. $ 1,312.2 $ 1,345.6
Other variable annuity GIAs................................................ 912.6 813.7
-------------- --------------
Variable annuity GIAs...................................................... 2,224.8 2,159.3
Fixed annuities............................................................ 921.4 737.2
-------------- --------------
Total variable annuity GIAs and fixed annuities............................ $ 3,146.2 $ 2,896.5
============== ==============
As interest rates declined during the second half of 2002, we experienced reduced interest spreads on RPE
guaranteed interest account liabilities, as we invested related cash inflows in shorter-term, lower yielding,
primarily publicly-traded, investment-grade debt securities to correspond with what we believe to be short
duration liabilities. To the extent short-term interest rates remain below the regulatory required minimum
crediting rate of 3%, we expect to continue to experience spread compression on our variable guaranteed
interest account deposits, particularly on the RPE GIA balances. In addition, we anticipate that, to the extent
RPE guaranteed interest account balances do not lapse or transfer to variable sub-accounts, spread compression
and additional commission payments on RPE fund balances will result in losses on our RPE variable annuity.
33
Debt and Equity Securities
Our debt securities portfolio consists primarily of investment-grade publicly traded and privately placed
corporate bonds, residential mortgage-backed securities, commercial mortgage-backed securities and asset-backed
securities. As of quarter-end 2003, non-affiliated debt securities with a carrying value of $12,818.4 million
represented 77.5% of total investments. Public debt securities represented 77.8% of total debt securities, with
the remaining 21.2% represented by private debt securities. Affiliated debt securities represent convertible
debt securities issued by Aberdeen Asset Management PLC with a total carrying value of $48.4 at quarter-end
2003. See further discussion under Aberdeen Asset Management PLC. The tables below do not include affiliated
debt securities.
Each year, the majority of our net cash flows are invested in investment grade debt securities. However, we
maintain a portfolio allocation of between 6% and 10% of debt securities in below investment grade rated bonds.
Allocations are based on our assessment of relative value and the likelihood of enhancing risk-adjusted
portfolio returns. The size of our allocation to below investment grade bonds is constrained by the size of our
net worth. We are subject to the risk that the issuers of the debt securities we own may default on principal
and interest payments, particularly in the event of a major economic downturn. Our investment strategy has been
to invest the majority of our below investment grade rated bond exposure in the "BB" rating category, which is
equivalent to a Securities Valuation Office, or SVO, securities rating of 3. The BB rating category is the
highest quality tier within the below investment grade universe, and BB rated securities historically
experienced lower defaults compared to B or CCC rated bonds. As of quarter-end 2003, our total below investment
grade securities totaled $1,074.9 million, or 8.4% of our total debt security portfolio. Of that amount, $767.9
million, or 6.0% of our debt security portfolio was invested in the BB category. Our debt securities having an
increased risk of default (those securities with an SVO rating of four or greater) totaled $307.0 million, or
2.4% of our total debt security portfolio.
Our debt and equity securities are classified as available-for-sale and are reported at fair value with
unrealized gains or losses included in equity. Accordingly, the carrying value of such securities reflects
their fair value at the balance sheet date. Fair value is based on quoted market price, where available. When
quoted market prices are not available, we estimate fair value for debt securities by discounting projected
cash flows based on market interest rates currently being offered on similar terms to borrowers of similar
credit quality, by quoted market prices of comparable instruments and by independent pricing sources or
internally developed pricing models. Investments whose value, in our judgment, is considered to be
other-than-temporarily impaired are written down to fair value as a charge to realized losses included in our
earnings. The cost basis of these written down investments is adjusted to fair value at the date the
determination of impairment is made. The new cost basis is not changed for subsequent recoveries in value.
The following table presents the SVO ratings for our non-affiliated debt security portfolio as of quarter-end
2003 and year-end 2002 ($ amounts in millions), along with an equivalent Standard & Poor's, or S&P,
rating agency designation. The majority of our bonds are investment grade, with 91.6% invested in Categories 1
and 2 securities as of quarter-end 2003.
Total Debt Securities Public Debt Securities Private Debt Securities
(Fair Value) (Fair Value) (Fair Value)
SVO S&P Equivalent --------------------------- ------------------------- -------------------------
Rating Designation 2003 2002 2003 2002 2003 2002
- ------ ---------------- ------------ ------------- ------------ ----------- ----------- ------------
1 AAA/AA/A $ 8,913.3 $ 7,960.9 $ 7,453.2 $ 6,549.8 $ 1,460.1 $ 1,411.1
2 BBB 2,781.8 2,811.5 1,768.4 1,767.1 1,013.4 1,044.4
------------ ------------- ------------ ----------- ----------- ------------
Total investment grade 11,695.1 10,772.4 9,221.6 8,316.9 2,473.5 2,455.5
3 BB 767.9 785.7 544.2 577.4 223.7 208.3
4 B 155.6 105.4 106.1 82.2 49.5 23.2
5 CCC and lower 97.8 118.5 42.0 53.3 55.8 65.2
6 In or near default 53.6 59.4 19.6 25.4 34.0 34.0
------------ ------------- ------------ ----------- ----------- ------------
Total debt securities $ 12,770.0 $ 11,841.4 $ 9,933.5 $ 9,055.2 $ 2,836.5 $ 2,786.2
============ ============= ============ =========== =========== ============
34
The following tables present our non-affiliated debt security portfolio by investment type as of quarter-end
2003 ($ amounts in millions), along with a breakout of credit quality based on equivalent S&P rating agency
designation.
Unrealized Gains (Losses)
---------------------------------------
Fair Gross Gross Net
Value Cost Gains Losses Gains
----------- ----------- ----------- ----------- -----------
Debt Securities by Type
U.S. government and agency............ $ 791.4 $ 753.1 $ 38.5 $ (0.2) $ 38.3
State and political subdivision....... 540.9 487.1 54.3 (0.5) 53.8
Foreign government.................... 235.0 226.2 14.8 (6.0) 8.8
Corporate............................. 5,758.0 5,394.5 450.4 (86.9) 363.5
Mortgage-backed....................... 3,321.2 3,139.7 183.0 (1.5) 181.5
Other asset-backed.................... 2,123.5 2,140.1 69.6 (86.2) (16.6)
---------- ----------- ----------- ----------- -----------
Total debt securities................. $ 12,770.0 $ 12,140.7 $ 810.6 $ (181.3) $ 629.3
========== =========== =========== =========== ===========
Outside closed block:
Unrealized gains................... $ 5,358.3 $ 5,104.5 $ 253.8 $ -- $ 253.8
Unrealized losses.................. 776.6 884.0 -- (107.4) (107.4)
---------- ----------- ----------- ----------- -----------
Total outside the closed block..... 6,134.9 5,988.5 253.8 (107.4) 146.4
---------- ----------- ----------- ----------- -----------
Closed block:
Unrealized gains................... 6,056.5 5,499.7 556.8 -- 556.8
Unrealized losses.................. 578.6 652.5 -- (73.9) (73.9)
---------- ----------- ----------- ----------- -----------
Total closed block................. 6,635.1 6,152.2 556.8 (73.9) 482.9
---------- ----------- ----------- ----------- -----------
Total debt securities................. $ 12,770.0 $ 12,140.7 $ 810.6 $ (181.3) $ 629.3
========== =========== =========== =========== ===========
Investment Grade Below Investment Grade
------------------------- -------------------------
Fair Value Cost Fair Value Cost
------------ ----------- ----------- ------------
Debt Securities by Type and Credit Quality
U.S. government and agency...................... $ 791.4 $ 753.1 $ -- $ --
State and political subdivision................. 540.9 487.1 -- --
Foreign government.............................. 57.2 51.3 177.8 174.9
Corporate....................................... 5,065.0 4,677.3 693.0 717.2
Mortgage-backed................................. 3,249.2 3,073.4 72.0 66.3
Other asset-backed.............................. 1,991.4 1,977.8 132.1 162.3
------------ ----------- ----------- ------------
Total debt securities........................... $ 11,695.1 $11,020.0 1,074.9 $ 1,120.7
============ =========== =========== ============
Percentage of total debt securities............. 91.6% 90.8% 8.4% 9.2%
============ =========== =========== ============
Total AAA/AA/A BBB
----------- ------------ ------------
Investment Grade Debt Securities (Fair Value)
U.S. government and agency........................................ $ 791.4 $ 791.4 $ --
State and political subdivision................................... 540.9 528.8 12.1
Foreign government................................................ 57.2 12.4 44.8
Corporate........................................................ 5,065.0 2,784.1 2,280.9
Mortgage-backed................................................... 3,249.2 3,048.5 200.7
Other asset-backed................................................ 1,991.4 1,748.0 243.4
----------- ----------- ------------
Total debt securities............................................ $11,695.1 $ 8,913.2 $2,781.9
=========== =========== ============
Percentage of total debt securities............................... 91.6% 69.8% 21.8%
=========== =========== ============
35
In or Near
Total BB B CC or Lower Default
------------- ------------ ------------ ------------ -------------
Below Investment Grade Debt
Securities (Fair Value)
Foreign government.................... $ 177.8 $ 173.9 $ 2.5 $ 1.4 $ --
Corporate............................. 693.0 458.8 136.0 52.2 46.0
Mortgage-backed....................... 72.0 69.3 2.4 0.3 --
Other asset-backed.................... 132.1 65.9 14.7 43.9 7.6
------------- ------------ ------------ ------------ -------------
Total debt securities................. $ 1,074.9 $ 767.9 $ 155.6 $ 97.8 $ 53.6
============= ============ ============ ============ =============
Percentage of total debt securities... 8.4% 6.0% 1.2% 0.8% 0.4%
============= ============ ============ ============ ==============
We manage credit risk through industry and issuer diversification. Maximum exposure to an issuer is defined by
quality ratings, with higher quality issuers having larger exposure limits. Our investment philosophy has been
to create a high level of industry diversification. The top five industry holdings as of quarter-end 2003 in
our debt securities portfolio are banking (3%), financial services (2%), insurance (2%), electric utilities
(2%) and oil (2%).
Our corporate bond exposure to recently troubled industries including telecommunication equipment, telephone
utilities, airlines, and media, publishing and broadcasting comprise 4% of the debt securities portfolio at
quarter-end 2003. In addition, within the asset-backed securities sector our exposure to securitized aircraft
receivable securities comprises approximately 1% of the debt securities portfolio, with less than one third of
that exposure rated below investment grade at quarter-end 2003.
The following table presents certain information with respect to realized investment losses ($ amounts in
millions). Losses from "other-than-temporary impairment" charges are reported separately. These impairment
charges were determined based on our assessment of factors to be enumerated below, as they pertain to the
individual securities determined to be other-than-temporarily impaired. Sources and types of net realized
investment gains (losses) for the quarters ended quarters-ended 2003 and 2002 follow:
2003 2002
--------------- ---------------
Debt securities............................................................. $ (25.6) $ (53.6)
Mortgage loans.............................................................. (0.4) --
Venture capital partnerships................................................ (4.3) --
Other invested assets....................................................... (8.7) --
--------------- ---------------
Impairment losses........................................................... (39.0) (53.6)
--------------- ---------------
Debt securities gains....................................................... 53.6 15.7
Debt securities losses...................................................... (12.3) (7.0)
Equity securities gains..................................................... 0.4 1.0
Equity securities losses.................................................... (2.6) (1.7)
Mortgage loans.............................................................. (0.4) --
Venture capital partnerships................................................ (9.5) --
Real estate................................................................. 0.5 9.1
Other invested assets....................................................... (3.0) 1.5
--------------- ---------------
Net transaction gains....................................................... 26.7 18.6
--------------- ---------------
Net realized investment losses.............................................. $ (12.3) $ (35.0)
=============== ===============
Net realized investment losses.............................................. $ (12.3) $ (35.0)
--------------- ---------------
Closed block applicable policyholder dividend obligation (reduction)........ 8.5 (34.0)
Applicable deferred acquisition costs (benefit)............................. 0.5 (3.4)
Applicable deferred income taxes (benefit).................................. (8.9) 0.8
--------------- ---------------
Offsets to realized investment gains (losses)............................... 0.1 (36.6)
--------------- ---------------
Net realized investment gains (losses) included in net income............... $ (12.4) $ 1.6
=============== ===============
36
Gross and net unrealized gains and losses from debt and equity securities at quarter-end 2003 follow ($ amounts
in millions):
Total Outside Closed Block Closed Block
---------------------- --------------------- --------------------
Gains Losses Gains Losses Gains Losses
---------- ----------- --------- ----------- --------- ----------
Debt securities............................ $ 810.6 $ (181.3) $ 253.8 $ (107.4) $ 556.8 $ (73.9)
Equity securities.......................... 118.2 (17.3) 118.2 (17.3) -- --
---------- ----------- --------- ----------- --------- ----------
Unrealized gains (losses).................. 928.8 (198.6) 372.0 (124.7) 556.8 (73.9)
---------- ----------- --------- ----------- --------- ----------
Applicable policyholder
dividend obligation...................... 556.8 (73.9) -- -- 556.8 (73.9)
Applicable deferred policy
acquisition costs (credit)............... 144.7 (45.5) 144.7 (45.5) -- --
Applicable deferred income taxes........... 79.6 (27.7) 79.6 (27.7) -- --
---------- ----------- --------- ----------- --------- ----------
Total offsets to net unrealized gains...... 781.1 (147.1) 224.3 (73.2) 556.8 (73.9)
---------- ----------- --------- ----------- --------- ----------
Unrealized gains (losses) after offsets.... $ 147.7 $ (51.5) $ 147.7 $ (51.5) $ -- $ --
========== =========== ========= =========== ========= ==========
Net unrealized gains after offsets......... $ 96.2 $ 96.2 $ --
========== ========= =========
Total net unrealized gains were $730.2 million (unrealized gains of $928.8, less unrealized losses of $198.6).
Of that net amount, $247.3 million was outside the closed block ($96.2 million after applicable deferred policy
acquisition costs and deferred income taxes) and $482.9 million was in the closed block ($0.0 million after
applicable policyholder dividend obligation).
During the 2003 quarter, both investment grade and below-investment rated corporate bonds appreciated in value
while lower rated asset-backed securities were generally flat. Some sectors of the asset-backed market,
particularly aircraft-related securities and lower rated collateralized debt obligations, suffered price
declines. As a result, our unrealized losses on debt securities increased modestly, as reduced unrealized
losses in corporate securities were offset by increased unrealized losses in asset-backed securities.
At the end of each reporting period we review all securities for potential recognition of an
other-than-temporary impairment. We maintain a watch list for the identification and monitoring of securities
in default, near default or otherwise considered by our investment professionals as being distressed,
potentially distressed or requiring a heightened level of scrutiny. As validation of our watch list process, we
review all securities whose amortized cost basis was in excess of carrying value on a continuous basis for
durations of zero to six months, six to 12 months, 12 to 24 months and greater than 24 months. This analysis is
further broken down as to investment grade and non-investment grade securities and closed block and outside of
closed block securities. Using this analysis, coupled with our watch list, we review all securities whose fair
value is less than 80% of amortized cost ("significant unrealized loss") with emphasis on below investment
grade securities with a continuous significant unrealized loss in excess of six months. In addition, we review
securities that had experienced lesser percentage declines in value on a more selective basis using many of the
previously discussed factors that we consider in making a determination that a security is
other-than-temporarily impaired.
Our assessment of whether an investment by us in a debt or equity security is other-than-temporarily impaired is
primarily based on whether the issuer has:
o defaulted on payment obligations;
o declared that it will default at a future point outside the current reporting period;
o announced a restructure will occur outside the current reporting period;
o severe liquidity problems that cannot be resolved;
o filed for bankruptcy; and/or
o a financial condition such that future payments are highly unlikely.
The following tables present certain information with respect to our gross unrealized losses with respect to
our
37
investments in debt securities, both inside and outside of the closed block, as of quarter-end 2003 ($ amounts
in millions). In the following tables, we separately present information that is applicable to outside the
closed block and information that is applicable to the closed block. We believe it is unlikely that there would
be any effect on our net income related to the realization of closed block unrealized investment losses due to
the current sufficiency of the policyholder dividend obligation liability in the closed block. See Note 3 to
our consolidated financial statements presented elsewhere in this Form 10-Q. Applicable deferred policy
acquisition costs and income taxes further reduce the effect on our net income.
Gross unrealized losses on debt securities outside of the closed block at quarter-end 2003 by duration of
unrealized loss and by credit quality follow ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
----------- ----------- ----------- ----------- -----------
Total debt securities:
Number of positions......................... 197 128 14 29 26
----------- ----------- ----------- ----------- -----------
Total fair value............................ $ 776.6 $ 542.7 $ 38.0 $ 83.4 $ 112.5
Total amortized cost........................ 884.0 589.4 42.6 108.3 143.7
----------- ----------- ----------- ----------- -----------
Unrealized losses........................... $ (107.4) $ (46.7) $ (4.6) $ (24.9) $ (31.2)
=========== =========== =========== =========== ===========
Unrealized losses after offsets............. $ (40.3) $ (17.4) $ (1.8) $ (9.3) $ (11.8)
=========== =========== =========== =========== ===========
Investment grade debt securities:
Number of positions......................... 142 109 9 10 14
----------- ----------- ----------- ----------- -----------
Total fair value............................ $ 655.7 $ 505.8 $ 29.7 $ 33.0 $ 87.2
Total amortized cost........................ 716.5 539.7 32.4 38.4 106.0
----------- ----------- ----------- ----------- -----------
Unrealized losses........................... $ (60.8) $ (33.9) $ (2.7) $ (5.4) $ (18.8)
=========== =========== =========== =========== ===========
Unrealized losses after offsets............. $ (23.7) $ (13.1) $ (1.1) $ (2.2) $ (7.3)
=========== =========== =========== =========== ===========
Below investment grade debt securities:
Number of positions......................... 55 19 5 19 12
----------- ----------- ----------- ----------- -----------
Total fair value............................ $ 120.9 $ 36.9 $ 8.3 $ 50.4 $ 25.3
Total amortized cost........................ 167.5 49.7 10.2 69.9 37.7
----------- ----------- ----------- ----------- -----------
Unrealized losses........................... $ (46.6) $ (12.8) $ (1.9) $ (19.5) $ (12.4)
=========== =========== =========== =========== ===========
Unrealized losses after offsets............. $ (16.6) $ (4.3) $ (0.7) $ (7.1) $ (4.5)
=========== =========== =========== =========== ===========
For the below investment grade debt securities outside the closed block, 22 of the 55 security positions have
had gross unrealized losses greater than 20% of cost continuously for the durations that follow ($ amounts in
millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
----------- ----------- ----------- ----------- -----------
Number of positions......................... 22 16 4 1 1
----------- ----------- ----------- ----------- -----------
Total fair value............................ $38.9 $ 29.3 $ 8.9 $ 0.7 $ --
Total amortized cost........................ 78.9 63.4 14.5 1.0 --
----------- ----------- ----------- ----------- -----------
Unrealized losses........................... $ (40.0) $ (34.1) $ (5.6) $ (0.3) $ --
=========== =========== =========== =========== ===========
Unrealized losses after offsets............. $ (14.4) $ (12.2) $ (2.0) $ (0.2) $ --
=========== =========== =========== =========== ===========
For the investment grade debt security positions held outside the closed block, 24 of the 142 security
positions have been in an unrealized loss position for more than 12 months as of quarter-end 2003 (14 of which
have been in an unrealized loss position for more than 24 months). The aggregate unrealized loss relating to
these positions
38
was $24.2 million as of that date ($18.8 million of which relate to holdings in an unrealized loss position for
more than 24 months). None of the 24 investment grade debt securities held outside the closed block were
considered to be other-than-temporarily impaired as of quarter-end 2003. Five individual public issues
aggregated $19.9 million in unrealized losses, all of which continue to, and in our opinion, are expected to
continue to perform to their original contractual terms as of quarter-end 2003. One security acquired before
2000 is a AAA-rated security structured to receive coupon payments indexed to the performance of the S&P 500.
The security has declined in fair value due to the drop in the S&P 500 index but is defeased with U.S. treasury
strips. One security acquired in 1998 is a AAA-rated interest-only security that has declined in fair value due
to the drop in interest rates. One security is an A-rated bank issue that has declined in fair value due to an
increase in required credit spreads for the security. One security is an A2/AA- rated issue that has declined
in fair value due to the default of the original servicer of the pool of manufactured housing loans that are
collateral for the transaction, and uncertainty about the new servicer. One security is a AA/Aa1-rated
collateralized bond obligation that has declined in value due to a decline in value of the collateral backing
the security and an increase in required credit spreads for this type of security. The remaining 19 investment
grade debt securities held outside the closed block that have been in an unrealized loss position for more than
12 months as of quarter-end 2003 have $4.3 million in unrealized losses. Each of the remaining 19 securities
have unrealized losses of less than $0.8 million. These securities represent holdings in the banking and
transportation sectors, collateralized bond obligations, mortgage-backed securities and asset-backed
securities. We are of the opinion that these unrealized losses are temporary in nature, resulting primarily
from market conditions affecting the overall equity, credit and interest rate markets. In addition, our
analysis of the issuers' financial strength and our analysis of underlying collateral supported the conclusion
that these securities were not other-than-temporarily impaired. Finally, as of quarter-end 2003, we had the
ability and intent to hold these securities until their value has fully recovered.
For the below-investment grade debt security positions held outside the closed block, 31 of the 55 security
positions have been in an unrealized loss position for more than 12 months as of quarter-end 2003 (12 of the
previously mentioned securities have been in an unrealized position for more than 24 months). The aggregate
gross pre-tax unrealized loss relating to these 31 positions was $31.9 million ($11.6 million after offsets for
applicable deferred acquisition costs and income taxes). $12.4 million ($4.5 million after offsets) of these
unrealized losses have been in an unrealized loss position for more than 24 months. Two of the previously
mentioned 31 securities with unrealized losses of $0.3 million ($0.2 million after offsets) had unrealized
losses greater than 20% of cost continuously for greater than 12 months. None of the 31 previously mentioned
securities held outside the closed block were considered to be other-than-temporarily impaired as of
quarter-end 2003. Of the 31 below-investment grade securities, ten individual publicly-traded issues comprised
approximately $24.4 million of the gross unrealized loss ($8.3 million after offsets), all of which continue to
and, in our opinion, are expected to continue to perform as to their original contractual terms. Three of these
holdings are in collateralized airline pass-through certificates, two are in energy sector issues, one holding
is a Latin American sovereign holding, one is a cable television operator, one is a specialty pharmaceutical
company, one is a credit-card asset backed security, and one is a collateralized debt obligation. The remaining
21 below investment grade debt securities held outside the closed block that have been in an unrealized loss
position for more than 12 months as of quarter-end 2003 have $7.5 million in unrealized losses ($3.3 million
after offsets). Each of the remaining 21 holdings has gross unrealized losses less than $0.9 million. These
securities represent holdings in airline pass-through certificates and in the energy, telecommunications and
retail sectors. We believe that these unrealized losses are temporary in nature and are primarily related to
temporary market conditions affecting the overall equity, credit and interest rate markets as well as the
airline, energy and Latin American sectors. In addition, our analysis of the issuers' financial strength and
our analysis of underlying collateral supported the conclusion that these securities were not
other-than-temporarily impaired. Finally, as of quarter-end 2003, we have the ability and intent to hold these
securities until their value has fully recovered.
39
Gross unrealized losses on debt securities in the closed block at quarter-end 2003 by duration of unrealized
loss and by credit quality follow ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
----------- ----------- ----------- ----------- -----------
Total debt securities:
Number of positions......................... 135 90 7 21 17
----------- ----------- ----------- ----------- -----------
Total fair value........................... $ 578.6 $ 362.0 $ 22.1 $ 98.2 $ 96.3
Total amortized cost........................ 652.5 382.5 24.3 132.4 113.3
----------- ----------- ----------- ----------- -----------
Unrealized losses........................... $ (73.9) $ (20.5) $ (2.2) $ (34.2) $ (17.0)
=========== =========== =========== =========== ===========
Unrealized losses after offsets............. $ -- $ -- $ -- $ -- $ --
=========== =========== =========== =========== ===========
Investment grade debt securities:
Number of positions......................... 88 67 2 7 12
----------- ----------- ----------- ----------- -----------
Total fair value............................ $ 365.1 $ 261.4 $ 2.8 $ 28.6 $ 72.3
Total amortized cost........................ 394.4 270.6 2.9 40.6 80.3
----------- ----------- ----------- ----------- -----------
Unrealized losses........................... $ (29.3) $ (9.2) $ (0.1) $ (12.0) $ (8.0)
=========== =========== =========== =========== ===========
Unrealized losses after offsets............. $ -- $ -- $ -- $ -- $ --
=========== =========== =========== =========== ===========
Below investment grade debt securities:
Number of positions......................... 47 23 5 14 5
----------- ----------- ----------- ----------- -----------
Total fair value............................ $ 213.5 $ 100.6 $ 19.3 $ 69.6 $ 24.0
Total amortized cost........................ 258.1 111.9 21.4 91.8 33.0
----------- ----------- ----------- ----------- -----------
Unrealized losses........................... $ (44.6) $ (11.3) $ (2.1) $ (22.2) $ (9.0)
=========== =========== =========== =========== ===========
Unrealized losses after offsets............. $ -- $ -- $ -- $ -- $ --
=========== =========== =========== =========== ===========
For the below investment grade debt securities in the closed block at quarter-end 2003, 13 of the 47 security
positions had gross unrealized losses greater than 20% of cost continuously for the durations that follow ($
amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
----------- ----------- ----------- ----------- ------------
Number of positions......................... 13 8 1 3 1
----------- ----------- ----------- ----------- ------------
Total fair value............................ $ 53.0 $ 41.9 $ 2.5 $ 5.8 $ 2.8
Total amortized cost........................ 81.9 60.4 4.9 12.6 4.0
----------- ----------- ----------- ----------- ------------
Unrealized losses........................... $ (28.9) $ (18.5) $ (2.4) $ (6.8) $ (1.2)
=========== =========== =========== =========== ============
Unrealized losses after offsets............. $ -- $ -- $ -- $ -- $ --
=========== =========== =========== =========== ============
40
For the investment grade debt security positions held in the closed block, 19 of the 88 security positions have
been in an unrealized loss position for more than 12 months as of quarter-end 2003 (12 of which have been in an
unrealized loss positions for more than 24 months). The aggregate unrealized loss relating to these positions
was $20.0 million as of that date ($8.0 million of which relates to securities in an unrealized loss position
for more than 24 months). None of the 19 investment grade securities held in the closed block were considered
to be other-than-temporarily impaired as of quarter-end 2003. Eight individual public issues aggregated $16.1
million in unrealized losses, all of which continue to, and in our opinion, are expected to continue to perform
to their original contractual terms as of quarter-end 2003. One issue is an A-rated timber-collateralized
holding that has declined in fair value due to a decline in the price of lumber. One security is an A-rated
bank issue that has declined in fair value due to an increase in required credit spreads for this type of
security. Five issues are collateralized aircraft financings that have declined in fair value due to airline
bankruptcies, reduced travel and higher risk premiums required for aircraft-related investments. One issue is
an asset-backed security collateralized by franchise loan receivables that has declined in value due to
deterioration in the franchise receivables. The remaining 11 investment grade debt securities held in the
closed block that have been in an unrealized loss position for more than 12 months as of quarter-end 2003 have
$3.9 million in unrealized losses. Each of the remaining 12 securities has unrealized losses less than $0.9
million. These securities represent holdings in mortgage or asset-backed securities and holdings in the
airline, transportation, energy, paper products and banking sectors. We are of the opinion that these
unrealized losses are temporary in nature and are primarily related to temporary market conditions affecting
the overall equity, credit and interest rate markets, as well as the energy sectors. In addition, our analysis
of the issuers' financial strength and our analysis of underlying collateral supported the conclusion that
these securities were not other-than-temporarily impaired. Finally, as of quarter-end 2003, we have the ability
and intent to hold these securities until their value has fully recovered.
For the below investment grade security positions held in the closed block, 19 of the 47 security positions
have been in an unrealized loss position for more than 12 months as of quarter-end 2003 (5 of which have been
in unrealized loss positions for more than 24 months). The aggregate gross pre-tax unrealized loss relating to
these positions was $31.2 million ($9.0 million of which relates to securities in an unrealized loss position
for more than 24 months). None of the 19 previously mentioned securities held in the closed block were
considered to be other-than-temporarily impaired as of quarter-end 2003. Four of these securities with
unrealized losses of $8.0 million had unrealized losses greater than 20% of cost continuously for greater than
12 months. Of the 19 below investment grade positions, ten individual public issues comprise approximately
$24.9 million of the gross unrealized loss, all of which continue to and, in our opinion, are expected to
continue to perform as to their original contractual terms. One issue is a multi-line insurance company holding
that has declined in fair value due to financial losses. One issue is an energy/power generation related
holding that has declined in fair value due to downgrades, bankruptcies and weakness in the energy market.
Three issues are collateralized airplane lease related holdings that have declined in fair value due to airline
bankruptcies, reduced travel and higher risk premiums required for aircraft-related investments. One issue is a
security that has declined in fair value due to the default of the original servicer of the pool of
manufactured housing loans that are collateral for the transaction and potential reductions in future cash
flows. Two securities are collateralized by oil receivables and have declined in value due to a decline in oil
production in Venezuela. One security is a foreign sovereign holding and one security is a specialty
pharmaceutical company. The remaining nine below investment grade debt securities held in the closed block that
have been in an unrealized loss position for more than 12 months as of quarter-end 2003 have $6.3 million in
unrealized losses. Each of the remaining nine holdings has gross unrealized losses less than $1.0 million.
These securities represent holdings in airline pass-through certificates, other asset backed securities, and in
the energy, media, theatre and consumer products sectors. We are of the opinion that these unrealized losses
are temporary in nature and are primarily related to temporary market conditions affecting the overall equity,
credit and interest rate markets as well as the airline and energy sectors. In addition, our analysis of the
issuers' financial strength and our analysis of underlying collateral supported the conclusion that these
securities were not other-than-temporarily impaired. Finally, as of quarter-end 2003, we have the ability and
intent to hold these securities until their value has fully recovered.
41
Gross unrealized losses on equity securities as of quarter-end 2003 by duration of unrealized loss follow ($
amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
----------- ----------- ----------- ----------- -----------
Number of positions........................ 323 251 33 20 19
----------- ----------- ----------- ----------- -----------
Total fair value........................... $ 58.7 $ 38.6 $ 5.2 $ 2.5 $ 12.4
Total cost................................. 76.0 46.8 6.4 3.3 19.5
----------- ----------- ----------- ----------- -----------
Unrealized losses.......................... $ (17.3) $ (8.2) $ (1.2) $ (0.8) $ (7.1)
=========== =========== =========== =========== ===========
Unrealized losses after offsets............ $ (11.2) $ (5.3) $ (0.8) $ (0.5) $ (4.6)
=========== =========== =========== =========== ===========
As indicated in the above table, $7.9 million ($5.1 million after income taxes) of our gross unrealized losses
in equity securities were continuously in an unrealized loss position for more than 12 months as of quarter-end
2003 ($7.1 million relates to securities in an unrealized loss position for more than 24 months). $5.9 million
($3.8 million after taxes) of the $7.1 million in unrealized losses relates to one individual holding
representing seed money invested in mutual fund offerings of our Asset Management segment which, as of
quarter-end 2003, are long-term holdings of our life insurance subsidiary's general account. Accordingly, we do
not consider our investments in this seed money as being other-than-temporarily impaired at quarter-end 2003.
In determining that the securities giving rise to the previously mentioned unrealized losses were not
other-than-temporarily impaired, we evaluated the factors cited above, which we consider when assessing whether
a security is other-than-temporarily impaired. In making these evaluations, we must exercise considerable
judgment. Accordingly, there can be no assurance that actual results will not differ from our judgments and
that such differences may require the future recognition of other-than-temporary impairment charges that could
have a material affect on our financial position and results of operations. In addition, the value of, and the
realization of any loss on, a debt security or equity security is subject to numerous risks, including;
interest rate risk, market risk, credit risk and liquidity risk. The magnitude of any loss incurred by us may
be affected by the relative concentration of our investments in any one issuer or industry. We have established
specific policies limiting the concentration of our investments in any single issuer and industry and believe
our investment portfolio is prudently diversified. At quarter-end 2003, no single non-affiliated issuer
constituted more than $8.6 million of our gross unrealized losses.
Aberdeen Asset Management PLC
Our ownership of Aberdeen convertible debt securities includes two issues: $32.5 million of 7.5% convertible
subordinated notes and $19.0 million in 5.875% convertible bonds. The notes were originally issued in 1996 at
7%, with a maturity of March 29, 2003, subject to four six-month extensions at Aberdeen's option with
increasing rates for each extension. In the 2003 quarter, the notes were partially paid down by $5.0 million,
with the remainder extended, subject to a rate increase to 7.5% and a maturity of September 29, 2003. The
5.875% convertible bonds were issued in 2002 and mature in 2007. The carrying value of these issues, which have
investment grade ratings and are included in available-for-sale debt securities, was $48.4 million and $52.7
million at quarter-end 2003 and year-end 2002, respectively. The cost of these issues was $53.3 million and
$58.7 million at quarter-end 2003 and year-end 2002, respectively.
Our ownership of Aberdeen common stock included 4% of the company's outstanding shares that we purchased in May
2001 for $46.8 million and 18% of its outstanding shares that we purchased between 1996 and 1999 for $62.3
million. The carrying value of our equity investment in Aberdeen was $116.1 million and $119.3 million at
42
quarter-end 2003 and year-end 2002, respectively. The fair value, based on quoted market price of underlying
shares, of our equity investment in Aberdeen was $37.4 million and $43.6 million at quarter-end 2003 and
year-end 2002, respectively. Included in our carrying value of Aberdeen was approximately $42 million and $50
million of goodwill as of quarter-end 2003 and year-end 2002, respectively, related to our acquisition of
Aberdeen common stock. For more information, see Notes 4 and 5 to our consolidated financial statements in our
2002 Annual Report on Form 10-K.
During the second half of 2002, the value of Aberdeen's publicly traded shares experienced a significant
decline due to a general decline in valuations of U.K. asset managers as well as regulatory matters related to
the U.K. split-capital trust sector, including Aberdeen's managed funds. In late 2002, Aberdeen announced the
results of a strategic review, which concluded with an announcement of a decision to divest itself of a
business segment that actively manages property investments and of a conditional agreement to dispose of its
rights to manage certain retail funds. On February 21, 2003, Aberdeen announced the closing of its retail funds
transaction, which resulted in proceeds of £86.8 million (or $138.0 million). A significant portion of the
proceeds were used to repay £60.4 million (or $96.0 million) of existing debt, including $5.0 million of
convertible debt held by us. Subsequent to these transactions, Aberdeen will be an independent asset management
group with approximately £13.5 billion (approximately $21.3 billion) of assets under management, featuring
a diverse range of investment vehicles catering to some 400,000 investors worldwide.
We evaluated the carrying value of our equity method investment in Aberdeen for other-than-temporary
impairment, considering quantitative and qualitative factors including quoted market price for the underlying
securities, the duration carrying value is in excess of fair value and historical and projected earnings and
cash flow capacity.
Considerations in our analysis included the following:
o Aberdeen continued to report net income and positive cash flow from operations as of its six month period
ended March 31, 2003 and continues to declare and pay dividends to common shareholders;
o the proposed property management transaction is anticipated to further increase the book value of
Aberdeen through the monetization of the underlying fair value of the property management business to be
disposed;
o proceeds from the pending property management disposition are anticipated to be used to repay debt,
resulting in a further improvement of Aberdeen's leverage and interest coverage ratios; and
o expense reduction efforts have been implemented to better align Aberdeen's cost structure with revenues
from its remaining businesses.
o the fair value of our equity in Aberdeen was below our carrying value for less than nine months as of
quarter-end 2003;
We will continue to evaluate our carrying value in Aberdeen for other than temporary impairment, taking into
account Aberdeen's underlying business fundamentals. A significant deterioration of Aberdeen's underlying
business fundamentals, or financial performance, a materially adverse regulatory development related to the
split capital trusts, or a prolonged period where our carrying value is in excess of fair value could lead us
to determine that an other-than-temporary impairment exists. Should we make such a determination, we would
write down the carrying value of our equity investment as a charge to realized investment losses for the period
that we make the determination.
Liquidity and Capital Resources
In the normal course of business, we enter into transactions involving various types of financial instruments
such as debt and equity securities. These instruments have credit risk and also may be subject to risk of loss
due to interest rate and market fluctuations.
43
Liquidity refers to the ability of a company to generate sufficient cash flow to meet its cash requirements.
The following discussion combines liquidity and capital resources as these subjects are interrelated.
Consistent with the discussion of our results of operations, we discuss liquidity and capital resources on both
consolidated and segment bases.
The Phoenix Companies, Inc. (holding company)
The holding company's primary uses of liquidity include dividend payments on its common stock, loans or
contributions to its subsidiaries, debt servicing and general corporate expenses.
The holding company's primary sources of liquidity have been dividends from Phoenix Life and interest income
received from PXP. Under New York Insurance Law, Phoenix Life can pay stockholder dividends to the holding
company in any calendar year without prior approval from the New York Superintendent of Insurance in the amount
of the lesser of 10% of Phoenix Life's surplus to policyholders as of the immediately preceding calendar year
or Phoenix Life's statutory net gain from operations for the immediately preceding calendar year, not including
realized capital gains. Phoenix Life paid a dividend of $44.5 million in April 2003 under this provision and
any amount in excess of this would, accordingly, be subject to the discretion of the New York Superintendent of
Insurance.
The holding company does not expect to receive dividends from PXP in the near term because we expect PXP will
use a substantial portion of its cash flows from operations to pay contingent considerations from prior
acquisitions, to repay debt and meet intercompany interest obligations.
The holding company has a 364-day unfunded unsecured senior revolving credit facility, or revolving credit
facility, under which it has direct borrowing rights, as do Phoenix Life and PXP with the holding company's
unconditional guarantee. We expect dividend payments from Phoenix Life, debt servicing from PXP and borrowing
capacity under the holding company's revolving credit facility to be sufficient to enable the holding company
to make dividend payments on its common stock, pay its operating expenses, service its outstanding debt, make
contributions to its subsidiaries and meet its other obligations if required.
44
Consolidated Financial Condition
The following table presents the consolidated balance sheet as of quarter-end 2003 and year-end 2002 ($ amounts
in millions):
2003 2002 Change
-------------- -------------- --------------
ASSETS:
Available-for-sale debt securities............................ $ 12,818.4 $ 11,894.1 $ 924.3
Equity securities............................................. 361.1 391.2 (30.1)
Mortgage loans................................................ 407.3 468.8 (61.5)
Venture capital partnerships.................................. 227.4 228.6 (1.2)
Affiliate equity securities................................... 131.3 134.7 (3.4)
Policy loans.................................................. 2,202.9 2,195.9 7.0
Other investments............................................. 393.5 398.9 (5.4)
-------------- -------------- --------------
Total investments............................................. 16,541.9 15,712.2 829.7
Cash and cash equivalents..................................... 613.0 1,058.5 (445.5)
Accrued investment income..................................... 212.1 192.3 19.8
Receivables................................................... 276.3 217.3 59.0
Deferred policy acquisition costs............................. 1,270.0 1,234.1 35.9
Deferred income taxes......................................... 66.0 41.4 24.6
Goodwill and other intangible assets.......................... 748.3 762.0 (13.7)
Other general account assets.................................. 214.2 225.2 (11.0)
Separate account and investment trust assets.................. 5,990.7 5,793.1 197.6
-------------- -------------- --------------
Total assets.................................................. $ 25,932.5 $ 25,236.1 $ 696.4
============== ============== ==============
LIABILITIES:
Policy liabilities and accruals............................... $ 12,798.4 $ 12,680.0 $ 118.4
Policyholder deposit funds.................................... 3,679.0 3,395.7 283.3
Stock purchase contracts...................................... 118.5 137.6 (19.1)
Indebtedness.................................................. 644.0 644.3 (0.3)
Other general account liabilities............................. 680.0 542.9 137.1
Separate account and investment trust liabilities............. 5,990.7 5,793.1 197.6
-------------- -------------- --------------
Total liabilities............................................. 23,910.6 23,193.6 717.0
-------------- -------------- --------------
MINORITY INTEREST:
Minority interest in net assets of consolidated subsidiaries.. 6.4 10.8 (4.4)
-------------- -------------- --------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 106,374,510 shares issued....... 1.0 1.0 --
Additional paid-in capital.................................... 2,427.1 2,424.4 2.7
Deferred Compensation on Restricted Stock Units............... (2.8) -- (2.8)
Accumulated deficit........................................... (289.4) (292.6) 3.2
Accumulated other comprehensive income........................ 74.6 94.6 (20.0)
Treasury stock, at cost: 12,287,667 and 12,330,000 shares..... (195.0) (195.7) 0.7
-------------- -------------- --------------
Total stockholders' equity.................................... 2,015.5 2,031.7 (16.2)
-------------- -------------- --------------
Total liabilities, minority interest and stockholders' equity. $ 25,932.5 $ 25,236.1 $ 696.4
============== ============== ==============
Available-for-sale debt securities increased $924.3 million, or 7.8%, from year-end 2002 primarily due to
increased annuity deposits, as well as, the investment of year-end cash and cash equivalents in fixed
maturities.
Equity securities decreased $30.1 million, or 8%, from year-end 2002 primarily due to a decrease in the fair
value of HRH common stock, which we hold as collateral for our stock purchase contracts.
Mortgage loans decreased $61.5 million, or 13%, compared to year-end 2002 reflecting continued mortgage loan
paydowns, including several significant prepayments in the 2003 quarter.
Cash and cash equivalents decreased $445.5 million, or 42%, from year-end 2002 primarily due to cash outflows
for investment purchases partially offset by policyholder deposit fund receipts.
Accrued investment income increased $19.8 million, or 10%, during the quarter as a result of higher invested
asset balances.
Receivables increased $59.0 million, or 27%, primarily due to increases in unsettled investments of $33.3
million plus increases in reinsurance recoverables of $19.2 million due to timing of claim payments and
subsequent recovery from reinsurers.
Deferred income taxes increased $24.6 million, or 59%, due primarily to policy and contract reserves,
intangible asset amortization and book to tax differences on investment assets.
Stock purchase contracts decreased $19.1 million, or 14%, from year-end 2002 primarily due to the increase in
the fair value of the embedded derivative. We recorded a favorable change in fair value of the embedded
derivative of $18.4 with an offset to other comprehensive income. The increased fair value of the embedded
derivative was primarily due to a decrease in the quoted market price of HRH common stock.
Other general account liabilities increased $137.1 million, or 25%, during the quarter. This increase was
primarily due to increases in payables on unsettled investment transactions.
45
Life Companies
Our Life Companies' liquidity requirements principally relate to: the liabilities associated with various life
insurance and annuity products; the payment of dividends by Phoenix Life to The Phoenix Companies, Inc.;
operating expenses; contributions to subsidiaries; and payment of principal and interest by Phoenix Life on its
outstanding debt obligation. Liabilities arising from life insurance and annuity products include the payment
of benefits, as well as cash payments in connection with policy surrenders, withdrawals and loans. The Life
Companies also have liabilities arising from the runoff of the remaining group accident and health reinsurance
discontinued operations.
Historically, our Life Companies have used cash flow from operations and investment activities to fund
liquidity requirements. Their principal cash inflows from life insurance and annuities activities come from
premiums, annuity deposits and charges on insurance policies and annuity contracts. In the case of Phoenix
Life, cash inflows also include dividends, distributions and other payments from subsidiaries. Principal cash
inflows from investment activities result from repayments of principal, proceeds from maturities, sales of
invested assets and investment income.
Additional sources of liquidity to meet cash outflows are available from the Life Companies' portfolios of
liquid assets. These liquid assets include substantial holdings of U.S. government and agency bonds, short-term
investments and marketable debt and equity securities. The cash Phoenix Life received as consideration for the
transfer of shares of common stock of PXP and other subsidiaries following the demutualization was a
non-recurring source of liquidity. Pursuant to the plan of reorganization, this cash payment was $659.8
million.
Phoenix Life's current sources of liquidity also include a revolving credit facility under which Phoenix Life
has direct borrowing rights, subject to our unconditional guarantee (see "Debt Financing"). Since the
demutualization, Phoenix Life's access to the cash flows generated by the closed block assets has been
restricted to funding the closed block.
A primary liquidity concern with respect to life insurance and annuity products is the risk of early
policyholder and contractholder withdrawal. The Life Companies closely monitor their liquidity requirements in
order to match cash inflows with expected cash outflows, and employ an asset/liability management approach
tailored to the specific requirements of each product line, based upon the return objectives, risk tolerance,
liquidity, tax and regulatory requirements of the underlying products. In particular, the Life Companies
maintain investment programs generally intended to provide adequate funds to pay benefits without forced sales
of investments. Products having liabilities with relatively long lives, such as life insurance, are matched
with assets having similar estimated lives, such as long-term bonds, private placement bonds and mortgage
loans. Shorter term liabilities are matched with investments such as short-term and medium-term fixed
maturities.
The following table summarizes the withdrawal characteristics of the Life Companies' annuity contract reserves
and deposit fund liabilities as of quarter-end 2003 and year-end 2002 ($ amounts in millions).
2003 2002
---------------------- ------------------------
Amount(1) Percent Amount(1) Percent
----------- --------- ------------ ----------
Not subject to discretionary withdrawal provision........... $ 188.4 3% $ 168.1 3%
Subject to discretionary withdrawal without adjustment...... 2,071.5 35% 2,073.3 35%
Subject to discretionary withdrawal with market value
adjustment................................................ 725.8 12% 649.7 11%
Subject to discretionary withdrawal at contract value less
surrender charge.......................................... 805.1 13% 701.5 11%
Subject to discretionary withdrawal at market value......... 2,198.3 37% 2,386.5 40%
----------- -------- ------------ ----------
Total annuity contract reserves and deposit fund liability.. $ 5,989.1 100% $ 5,979.1 100%
=========== ======== ============ ==========
(1) Contract reserves and deposit fund liability amounts are reported on a statutory basis, which more
accurately
46
reflects the potential cash outflows, and include variable product liabilities. Annuity contract reserves
and deposit fund liabilities are monetary amounts that an insurer must have available to provide for future
obligations with respect to its annuities and deposit funds. These are liabilities on the balance sheet of
financial statements prepared in conformity with statutory accounting practices. These amounts are at least
equal to the values available to be withdrawn by policyholders.
Individual life insurance policies are less susceptible to withdrawals than annuity contracts because
policyholders may incur surrender charges and be required to undergo a new underwriting process in order to
obtain a new insurance policy. As indicated in the table above, most of our annuity contract reserves and
deposit fund liabilities are subject to withdrawals.
Individual life insurance policies, other than term life insurance policies, increase in cash values over their
lives. Policyholders have the right to borrow an amount generally up to the cash value of their policies at any
time. As of quarter-end 2003, our Life Companies had approximately $10.9 billion in cash values with respect to
which policyholders had rights to take policy loans. The majority of cash values eligible for policy loans are
at variable interest rates that are reset annually on the policy anniversary. The amount of our policy loans
has not changed significantly since 1999. Our policy loans at quarter-end 2003 were $2.2 billion.
The primary liquidity risks regarding cash inflows from the investment activities of our Life Companies are the
risks of default by debtors, interest rate and other market volatility and potential illiquidity of
investments. We closely monitor and manage these risks.
We believe that the current and anticipated sources of liquidity for our Life Companies are adequate to meet
their present and anticipated needs.
PXP
PXP's liquidity requirements are primarily to fund operating expenses and pay outstanding debt and interest
obligations. PXP also would require liquidity to fund the costs of any potential acquisitions, as well as, any
contingent payments for previous acquisitions. Historically, PXP's principal source of liquidity has been cash
flows from operations. We expect that cash flow from operations will continue to be PXP's principal source of
working capital. PXP, together with the holding company and Phoenix Life, has entered into a revolving credit
facility. Under this facility, PXP has direct borrowing rights, subject to the holding company's unconditional
guarantee. We believe that PXP's current and anticipated sources of liquidity, including this facility, are
adequate to meet its present and anticipated needs.
47
Contractual Obligations and Commercial Commitments
As of quarter-end 2003, we had $679.7 million outstanding related to contractual obligations, excluding
derivative instruments, and $139.0 million in commercial commitments. The following table presents the years in
which our contractual obligations will come due and our commercial commitments will expire ($ amounts in
millions).
Payments Due by Fiscal Period
----------------------------------------------------------
Total 2003 2004 - 2005 2006 - 2007 Thereafter
------------- ------------- ------------- ------------- -------------
Contractual Obligations
Indebtedness (1)................... $ 628.7 $ -- $ -- $ 175.0 $ 453.7
Future Minimum Lease Payments...... 51.0 11.5 26.3 5.4 7.8
Other(2)........................... -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Total Contractual Obligations...... $ 679.7 $ 11.5 $ 26.3 $ 180.4 $ 461.5
============= ============= ============= ============= =============
Commitment Expiration
----------------------------------------------------------
Total 2003 2004 - 2005 2006 - 2007 Thereafter
------------- ------------- ------------- ------------- -------------
Commercial Commitments
Standby Letters of Credit (3)...... $ 10.7 $ 10.7 $ -- $ -- $ --
Other Commercial Commitments (2)(4) 128.3 1.5 5.6 10.8 110.4
------------- ------------- ------------- ------------- -------------
Total Commercial Commitments....... $ 139.0 $ 12.2 $ 5.6 $ 10.8 $ 110.4
============= ============= ============= ============= =============
(1) Indebtedness amounts include principal only.
(2) There are no minimum contractual obligations in this category, however, see discussion below with respect
to Commitments Related to Recent Business Combinations.
(3) Our standby letters of credit automatically renew on an annual basis.
(4) Other commercial commitments relate to venture capital partnerships. These commitments can be drawn down
by private equity funds as necessary to fund their portfolio investments through the end of the funding
period as stated in each agreement. The amount collectively drawn down by the private equity funds in our
portfolio in the first quarter of 2003 was $12.9 million. Cash and stock distributions received by us for
the first quarter of 2003 were $3.0 million.
Commitments Related to Recent Business Combinations
Under the terms of purchase agreements related to certain recent business combinations, we are subject to
certain contractual obligations and commitments related to additional purchase consideration and put/call
arrangements summarized as follows:
PFG Holdings, Inc.
On May 1, 2003, we acquired the remaining interest in PFG Holdings, Inc. (PFG) not already owned by us for
initial consideration of $16.7 million. Under the terms of the purchase agreement, additional consideration of
up to $13.0 million may be paid to the selling shareholders during the years 2004 through 2007 in the event
that certain financial performance targets are met. In addition, a final contingent payment may be paid in 2008
based on appraised value of PFG as of December 31, 2007. Maximum total contingent consideration, inclusive of
the additional consideration that may be paid in 2004 through 2007, under the terms of the purchase agreement
is $89.0 million, based on a contractually capped appraised value of PFG of $450.0 million as of December 31,
2007.
Seneca
We have a put/call arrangement with respect to the 31.6% membership interests in Seneca not owned by PXP. The
purchase price is equal to investment advisory fees for the relevant year multiplied by 3.5 multiplied by the
amount of membership interest purchased. The pricing on the put/calls will be determined within 60 days after
each calendar year-end and can be exercised within 60 days of the finalization of the price. All of these
membership interests acquired will be reissued to members/employees of Seneca. The reissuance process involves
PXP contributing the units to Seneca and then Seneca selling the units to the members/employees. The
members/employees do not pay cash for these purchases, but enter into a note payable agreement with Seneca. PXP
has preferential distribution rights with respect to payments of principal and interest on these notes. Since
these units have been purchased by PXP already, the amount of cash that PXP will need to pay to repurchase
these units in the future will be the amount related to the growth in revenues since the various reissuance
dates. There is no cap or floor on the put/call price. The put/call agreements will expire after the year ended
12/31/07.
Kayne Anderson Rudnick
We have an earn-out arrangement effective December 31, 2003 for Non-Phoenix members of Kayne Anderson Rudnick
(KAR) that is in the form of a put/call. Non-Phoenix shareholders will be entitled to a payment in the first
quarter of 2004 equal to the excess (if any) of (a) the lesser of (i) $165.0 million or (ii) 2003 net investment
advisory fees times 4.5 times 60%, over (b) $100.0 million. The maximum earnout payment is $65 million. In certain
instances the earn-out date will be accelerated, in which case the net investment advisory fees used in the
calculation will be the trailing twelve months.
48
Phoenix has an additional purchase arrangement in which existing members of KAR will sell 15% of membership
interest to Phoenix as follows:
o Effective December 31, 2004 (but paid in first Quarter 2005), 5% of the ownership interest will be
purchased for the following amount: 2004 Revenue times 4.5 times 5%
o Effective December 31, 2005 (but paid in first Quarter 2006), 5% of the ownership interest will be
purchased for the following amount: 2005 Revenue times 4.5 times 5%
o Effective December 31, 2006 (but paid in first Quarter 2007), 5% of the ownership interest will be
purchased for the following amount: 2006 Revenue times 4.5 times 5%
Revenue is defined as investment advisory fees for the applicable twelve month period. Under certain
circumstances, the purchases may be accelerated.
There is also a put/call arrangement with respect to 25% of the total membership interests. The purchase price
will be equal to investment advisory fees for the relevant contract year multiplied by 4.5 multiplied by the
amount of membership interest purchased. The contract year is defined as the twelve months ending December 31,
2006 and each calendar year thereafter. The pricing on the put/calls will be determined within 60 days after
each such year-end and can be exercised within 60 days of the finalization of the price. All of these
membership interests acquired will be reissued to members/employees of KAR. The reissuance process involves PXP
contributing the units to KAR and then KAR selling the units to the members/employees. The members/employees
will not pay cash for these purchases, but will enter into a note payable agreement with KAR. PXP will have
preferential distribution rights with respect to payments of principal and interest on these notes. None of
these units subject to these agreements have yet been purchased by PXP. Once these units are purchased and then
reissued the amount of cash that PXP will need to pay to repurchase these units in the future will be based on
the growth in revenues since the reissuance dates. There is no expiration date for the put/call agreements.
There is no cap or floor on the put/call price.
Reinsurance
We maintain life reinsurance programs designed to protect against large or unusual losses in our life insurance
business. Over the last several years in response to the reduced cost of reinsurance coverage, we increased the
amount of individual mortality risk coverage purchased from third party reinsurers. Based on our review of
their financial statements and reputations in the reinsurance marketplace, we believe that these third party
reinsurers are financially sound and, therefore, that we have no material exposure to uncollectable life
reinsurance.
Statutory Capital and Surplus and Risk-Based Capital
Phoenix Life's statutory basis capital and surplus (including asset valuation reserve) increased from $1,008.8
million at year-end 2002 to $1,013.0 million at quarter-end 2003. Phoenix Life's statutory gain from operations
was $17.1 million for the 2003 quarter.
Section 1322 of New York Insurance Law requires that New York life insurers report their Risk-Based Capital.
(RBC). RBC is based on a formula calculated by applying factors to various asset, premium and statutory reserve
items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance
risk, interest rate risk and business risk. Section 1322 gives the New York Insurance Department explicit
regulatory authority to require various actions by, or take various action against insurers whose Total
Adjusted Capital does not exceed certain RBC levels. Each of our other life insurance subsidiaries are subject
to these same RBC requirements.
49
The levels of regulatory action, the trigger point and the corrective actions are summarized below:
Company Action Level, results when Total Adjusted Capital falls below 100% of Company Action Level at
which point the Company must file a comprehensive plan to the state insurance regulators;
Regulatory Action Level, results when Total Adjusted Capital falls below 75% of Company Action Level
where in addition to the above, insurance regulators are required to perform an examination or
analysis deemed necessary and issue a corrective order specifying corrective actions;
Authorized Control Level, results when Total Adjusted Capital falls below 50% of Company Action Level
where in addition to the above, the insurance regulators are permitted but not required to place the
company under regulatory control; and
Mandatory Control Level, results when Total Adjusted Capital falls below 35% of Company Action Level
where insurance regulators are required to place the Company under regulatory control.
At quarter-end 2003, Phoenix Life and each of its insurance subsidiaries' RBC levels were in excess of 300% of
Company Action Level.
Net Capital Requirements
Our broker-dealer subsidiaries are each subject to the net capital requirements imposed on registered
broker-dealers by the Securities Exchange Act of 1934. Each is also required to maintain a ratio of aggregate
indebtedness to net capital that does not exceed 15 to 1. The largest of these subsidiaries had net capital of
approximately $6.9 million, which exceeded the regulatory minimum of $0.7 million by $6.2 million. The ratio of
aggregate indebtedness to net capital for that subsidiary was 1.6 to 1. The ratios of aggregate indebtedness to
net capital for each of the other broker-dealer subsidiaries were also below the regulatory ratio at
quarter-end 2003, and their respective net capital each exceeded the applicable regulatory minimum.
Consolidated Cash Flows
The following table presents summary consolidated cash flow data for the quarters ended 2003 and 2002 ($
amounts in millions):
2003 2002
--------------------------------
Cash from continuing operations..................................... $ 39.1 $ 33.7
Cash for discontinued operations.................................... -- (25.4)
Cash for continuing operations investing activities................. (760.9) (558.7)
Cash from discontinued operations investing activities.............. -- 25.4
Cash from financing activities...................................... $ 276.3 $ 273.9
Cash from continuing operations was relatively unchanged for quarter-end 2003 versus quarter-end 2002. Cash
used for investing activities was higher for quarter-end 2003 due primarily to increased investments in
available-for-sale debt securities. Cash from financing activities was slightly higher for quarter-end 2003
compared to quarter-end 2002. This increase was due to treasury share purchases in the 2002 quarter that were
not repeated in the 2003 quarter, partially offset by lower policyholder deposit fund receipts in the 2003
quarter.
Related Party Transactions
State Farm Mutual Automobile Insurance Company (State Farm) currently owns of record more than 5 percent of our
outstanding common stock. During the first quarter of 2003, our subsidiaries recognized a total expense of $4.9
million related to compensation to entities which were either subsidiaries of State Farm or owned by State Farm
employees for the sale our insurance and annuity products.
50
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Exposures and Risk Management
We must effectively manage, measure and monitor the market risk generally associated with our insurance and
annuity business and, in particular, our commitment to fund insurance liabilities. We have developed an
integrated process for managing risk, which we conduct through our Corporate Portfolio Management Department,
Actuarial Department, Corporate Finance Department and additional specialists at the business segment level.
These groups confer with each other regularly. We have implemented comprehensive policies and procedures at
both the corporate and business segment level to minimize the effects of potential market volatility.
Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have
exposure to market risk through both our insurance operations and our investment activities. Our primary market
risk exposure is to changes in interest rates, although we also have exposures to changes in equity prices and
foreign currency exchange rates. We also have credit risk in connection with our derivative contracts.
Interest Rate Risk
Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our
exposure to interest rate changes primarily results from our commitment to fund interest-sensitive insurance
liabilities, as well as from our significant holdings of fixed rate investments. Our insurance liabilities
largely comprise dividend-paying individual whole life and universal life policies and annuity contracts. Our
fixed maturity investments include U.S. and foreign government bonds, securities issued by government agencies,
corporate bonds, asset-backed securities, mortgage-backed securities and mortgage loans, most of which are
mainly exposed to changes in medium-term and long-term U.S. Treasury rates.
We manage interest rate risk as part of our asset/liability management process and product design procedures.
Asset/liability strategies include the segmentation of investments by product line and the construction of
investment portfolios designed to specifically satisfy the projected cash needs of the underlying product
liability. We manage the interest rate risk inherent in our assets relative to the interest rate risk inherent
in our insurance products. We identify potential interest rate risk in portfolio segments by modeling asset and
product liability durations and cash flows under current and projected interest rate scenarios.
One of the key measures we use to quantify this interest rate exposure is duration. Duration is one of the most
significant measurement tools in measuring the sensitivity of the fair value of assets and liabilities to
changes in interest rates. For example, if interest rates increase by 100 basis points, or 1%, the fair value
of an asset with a duration of five years is expected to decrease by 5%. We believe that as of quarter-end
2003, our asset and liability portfolio durations were well matched, especially for the largest segments of our
balance sheet (i.e. whole life and universal life). Since our insurance products have variable interest rates
(which expose us to the risk of interest rate fluctuations), we regularly undertake a sensitivity analysis that
calculates liability durations under various cash flow scenarios.
The selection of a 100 basis point immediate, parallel increase or decrease in interest rates is a hypothetical
rate scenario used to demonstrate potential risk. While a 100 basis point immediate, parallel increase or
decrease does not represent our view of future market changes, it is a reasonably possible hypothetical
near-term change that illustrates the potential impact of such events. Although these fair value measurements
provide a representation of interest rate sensitivity, they are based on our portfolio exposures at a point in
time and may not be representative of future market results. These exposures will change as a result of
on-going portfolio transactions
51
in response to new business, management's assessment of changing market conditions and available investment
opportunities.
To calculate duration, we project asset and liability cash flows and discount them to a net present value using
a risk-free market rate adjusted for credit quality, sector attributes, liquidity and any other relevant
specific risks. Duration is calculated by revaluing these cash flows at an alternative level of interest rates
and by determining the percentage change in fair value from the base case.
We also employ product design and pricing strategies to manage interest rate risk. Product design and pricing
strategies include the use of surrender charges or restrictions on withdrawals in some products.
The tables below show the interest rate sensitivity of our fixed income financial instruments measured in terms
of fair value as of quarter-end 2003 ($ amounts in millions). Given that our asset and liability portfolio
durations were well matched for the periods indicated, we would expect market value gains or losses in assets
to be largely offset by corresponding changes in liabilities.
-100 Basis +100 Basis
Carrying Point Point
Value Change Fair Value Change
--------------- --------------- --------------- ---------------
Cash and cash equivalents................ $ 613.0 $ 613.5 $ 613.0 $ 612.5
Available-for-sale debt securities....... 12,818.4 13,390.2 12,818.4 12,265.7
Mortgage loans........................... 407.3 432.7 417.8 403.4
--------------- --------------- --------------- ---------------
Totals................................... $ 13,838.7 $ 14,436.4 $ 13,849.2 $ 13,281.6
=============== =============== =============== ===============
We use derivative financial instruments, primarily interest rate swaps, to manage our residual exposure to
fluctuations in interest rates. We enter into derivative contracts only with highly rated financial
institutions to reduce counterparty credit risks and diversify counterparty exposure.
We enter into interest rate swap agreements to reduce market risks from changes in interest rates. We do not
enter into interest rate swap agreements for trading purposes. Under interest rate swap agreements, we exchange
cash flows with another party at specified intervals for a set length of time based on a specified notional
principal amount. Typically, one of the cash flow streams is based on a fixed interest rate set at the
inception of the contract and the other is based on a variable rate that periodically resets. Generally, no
premium is paid to enter into the contract and neither party makes payment of principal. The amounts to be
received or paid on these swap agreements are accrued and recognized in net investment income.
The tables below show the interest rate sensitivity of our interest rate derivatives measured in terms of fair
value as of quarter-end 2003 ($ amounts in millions). These exposures will change as our insurance liabilities
are created and discharged and as a result of ongoing portfolio and risk management activities.
Weighted -100 +100
Average Basis Basis
Notional Term Point Point
Amount (Years) Change Fair Value Change
------------ ------------ ------------ ------------ ------------
Interest rate swaps................ $ 540.0 11.2 $ 37.0 $ 24.9 $ 12.9
Other.............................. 90.0 3.3 1.0 0.7 0.5
------------ ------------ ------------ ------------
Totals............................. $ 630.0 $ 38.0 $ 25.6 $ 13.4
============ ============ ============ ============
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Equity Risk
Equity risk is the risk that we will incur economic losses due to adverse changes in equity prices. Our
exposure to changes in equity prices primarily results from our commitment to fund our variable annuity and
variable life products, as well as from our holdings of common stocks, mutual funds and other equities. We
manage our insurance liability risks on an integrated basis with other risks through our liability and risk
management and capital and other asset allocation strategies. We also manage equity price risk through industry
and issuer diversification and asset allocation techniques. We held $361.1 million in equity securities on our
balance sheet as of quarter-end 2003. A 10% decline or increase in the relevant equity price would have
decreased or increased, respectively, the value of these assets by approximately $36.1 million as of
quarter-end 2003.
Certain annuity products sold by our Life Companies contain guaranteed minimum death benefits. The guaranteed
minimum death benefit feature provides annuity contract holders with a guarantee that the benefit received at
death will be no less than a prescribed amount. This minimum amount is based on the net deposits paid into the
contract, the net deposits accumulated at a specified rate, the highest historical account value on a contract
anniversary, or more typically, the greatest of these values. To the extent that the guaranteed minimum death
benefit is higher than the current account value at the time of death, the company incurs a cost. This
typically results in an increase in annuity policy benefits in periods of declining financial markets and in
periods of stable financial markets following a decline. As of quarter-end 2003, the difference between the
guaranteed minimum death benefit and the current account value (the "net amount at risk") for all existing
contracts was $242.3 million.
2003 2002
------------ -------------
Net amount at risk on minimum guaranteed death benefits (before reinsurance).... $ 1,188.4 $ 337.5
Net amount at risk reinsured.................................................... (946.1) (331.8)
------------- ------------
Net amount at risk on minimum guaranteed death benefits (after reinsurance)..... $ 242.3 $ 5.7
============= ============
Statutory reserve (after reinsurance)........................................... 16.1 5.3
GAAP reserve (after reinsurance)................................................ 9.2 0.3
The following analysis represents an estimated sensitivity of our deferred acquisition cost asset and
guaranteed minimum death benefit liability to equity market changes, based on their quarter-end 2003 carrying
values ($ amounts in millions):
+ 10%
-10% Equity Carrying Equity
Market Value Market
-------------- ------------- -------------
Deferred policy acquisition costs (variable annuities)........... $ 262.1 $ 271.2 $ 274.4
Deferred policy acquisition costs (variable universal life)...... 308.0 310.9 310.4
Guaranteed minimum death benefit liability (variable annuities).. 12.2 9.2 7.0
We sponsor defined benefit pension plans for our employees. For GAAP accounting purposes, we assumed an 8.5%
long-term rate of return on plan assets for the quarter ended 2003 and year-ended 2002. To the extent there are
deviations in actual returns, there will be changes in our projected expense and funding requests.
Foreign Exchange Risks
Foreign exchange risk is the risk that we will incur economic losses due to adverse changes in foreign currency
exchange rates. Our functional currency is the U.S. dollar. Our exposure to fluctuations in foreign exchange
rates
53
against the U.S. dollar results from our holdings in non-U.S. dollar-denominated debt and equity securities and
through our investments in foreign subsidiaries and affiliates. The principal currencies that create foreign
exchange rate risk for us are the British pound sterling, due to our investments in Aberdeen and Lombard, and
the Argentine peso, due to our investment in EMCO. During the quarter ended 2003, we recorded a foreign
currency translation adjustment loss of $3.0 million and a gain of $1.2 million in other comprehensive income
related to changes in valuation of the British pound sterling and Argentine peso, respectively.
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. We have developed controls and procedures to ensure that
information required to be disclosed by us in reports we file or submit pursuant to the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and
forms of the Securities and Exchange Commission. Based on our review within 90 days prior to the filing of this
report, our Chief Executive Officer and Chief Financial Officer each concluded that our disclosure controls and
procedures, as in effect on the date hereof, are effective, both in design and operation, for achieving the
foregoing purpose.
Changes in Internal Controls. During the quarter ended 2003, there were no significant changes in our internal
controls or in other factors that could significantly affect these controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to significant deficiencies and material
weaknesses.
54
PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
General
We are regularly involved in litigation, both as a defendant and as a plaintiff. The litigation naming us as a
defendant ordinarily involves our activities as an insurer, employer, investment adviser, investor or taxpayer.
In addition, state regulatory bodies, the SEC, the NASD and other regulatory bodies regularly make inquiries of
us and, from time to time, conduct examinations or investigations concerning our compliance with, among other
things, insurance laws, securities laws, and laws governing the activities of broker-dealers. These types of
lawsuits and regulatory actions may be difficult to assess or quantify, may seek recovery of very large and/or
indeterminate amounts, including punitive and treble damages, and their existence and magnitude may remain
unknown for substantial periods of time. A substantial legal liability or significant regulatory action against
us could have a material adverse effect on our business, results of operations and financial condition.
While it is not feasible to predict or determine the ultimate outcomes of all pending investigations and legal
proceedings or to provide reasonable ranges of potential losses, it is the opinion of our management that such
outcomes, after consideration of available insurance and reinsurance and the provisions made in our
consolidated financial statements, are not likely to have a material adverse effect on our consolidated
financial condition.
However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent
unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to
time, have a material adverse effect on our operating results or cash flows.
For information about proceedings involving our discontinued reinsurance business or challenging Phoenix Life
Insurance Company's Plan of Reorganization, see Part I, Item 3 of our Form 10-K for the year ended 2002 filed
with the Securities and Exchange Commission on March 21, 2003, which Item is hereby incorporated by reference.
There have been no material developments in such proceedings during the 2003 quarter.
Discontinued Reinsurance Business
During 1999, our Life Companies placed their remaining group accident and health reinsurance business into
run-off, adopting a formal plan to terminate the related contracts as early as contractually permitted and not
entering into any new contracts. As part of the decision to discontinue these reinsurance operations, we
reviewed the run-off block and estimated the amount and timing of future net premiums, claims and expenses.
We established reserves and reinsurance recoverables for claims and related expenses that we expect to pay on
our discontinued group accident and health reinsurance business. These reserves and reinsurance recoverables
are a net present value amount that is based on currently known facts and estimates about, among other things,
the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid,
the amount of reinsurance we believe we will collect under finite reinsurance and other reinsurance and the
likely legal and administrative cost of winding down the business. Total reserves were $25.0 million and total
reinsurance recoverables were $75.0 million at March 31, 2003. In addition, in 1999 we purchased finite
aggregate excess-of-loss reinsurance to further protect us from unfavorable results from this discontinued
business. The maximum coverage available is currently $125.0 million. The amount of our total financial
provisions at March 31, 2003 was, therefore, $75.0 million, consisting of reserves, less reinsurance
recoverables, plus the amount currently available from our finite aggregate excess-of-loss reinsurance.
Our Life Companies are involved in disputes relating to reinsurance arrangements under which they reinsured
group accident and health risks. The first of these involves contracts for reinsurance of the life and health
carveout components of workers compensation insurance arising out of a reinsurance pool created and formerly
managed by Unicover Managers, Inc., or Unicover. In one of those, the arbitration panel issued its decision on
October 8, 2002. The financial implications of this decision are consistent with our Life Companies’
current financial provisions. In addition, Phoenix Life is involved in arbitrations and negotiations pending in
the United Kingdom between multiple layers of reinsurers and reinsureds relating to transactions in which it
participated involving certain personal accident excess-of-loss business reinsured in the London market.
In light of our provisions for our discontinued reinsurance operations through the establishment of reserves
and the finite reinsurance, based on currently available information, we do not expect these operations,
including the proceedings described above, to have a material adverse effect on our consolidated financial
position. However, given the large and/or indeterminate amounts involved and the inherent unpredictability of
litigation, it is not possible to predict with certainty the ultimate impact on us of all pending matters or of
our discontinued reinsurance operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable
(b) Not applicable
(c) During the quarter ended 2003, The Phoenix Companies, Inc. issued 1,073 shares of common stock to an
eligible policyholder, effective as of June 25, 2001 and in connection with the demutualization of
Phoenix Home Life Mutual Insurance Company at that date. Phoenix issued these shares, without
registration under such act, in exchange for the policyholder's membership interests in reliance on
the exemption under Section 3(a)(10) of the Securities Act of 1933,
(d) Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
55
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are attached to this Form 10-Q:
Exhibit Number
10.1 Credit Agreement, dated as of December 23, 2002, by and among the Phoenix Companies, Inc.,
Phoenix Life Insurance Company, Phoenix Investment Partners, Ltd., various financial
institutions as lenders, Fleet National Bank, as Syndication Agent, Bank of Montreal, as
Administrative Agent, Fleet Securities, Inc. and Bank of Montreal Nesbitt Burns, as Joint
Lead Arrangers and Key Bank National Association and The Bank of New York as documentation
agents.
12 Ratio of Earnings to Fixed Charges.
99.1 Chief executive officer certification, pursuant to 18 United States Code Section 1350, of the
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 of The Phoenix Companies,
Inc.
99.2 Chief financial officer certification, pursuant to 18 United States Code Section 1350, of the
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 of The Phoenix Companies,
Inc.
(b) During the three months ended March 31, 2003, Phoenix filed the following reports on Form 8-K:
o Filed January 3, 2003, containing (i) Executive Employment Agreement between Dona D. Young and The
Phoenix Companies, Inc. dated January 1, 2003; and (ii) Employment Continuation Agreement between
Dona D. Young and The Phoenix Companies, Inc. dated January 1, 2003.
o Filed February 6, 2003, containing a news release of The Phoenix Companies, Inc., dated February
6, 2003, regarding fourth quarter and full-year 2002 results, additional actions in support of key
priorities and strategic plan, and revised ROE target.
o Filed February 10, 2003, containing a news release of The Phoenix Companies, Inc., dated February
10, 2003, regarding the election of Dona D. Young as Chairman of the Board of Directors, effective
April 1, 2003.
56
Signature
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.
THE PHOENIX COMPANIES, INC.
By: /s/ Coleman D. Ross
Coleman D. Ross, Executive Vice President
and Chief Financial Officer
May 15, 2003
Certifications
Chief Executive Officer certification, pursuant to Section 302 of The Sarbanes-Oxley Act of 2002, of the
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 of The Phoenix Companies, Inc.
I, Dona D. Young, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Phoenix Companies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements and other financial information included in this
quarterly report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have;
a) designed such disclosure controls and procedures to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a
date within 90 days prior to the filing of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent
evaluation, to the registrant's auditors and the audit committee of the registrant's board of
directors:
57
a) all significant deficiencies in the design or operation of internal controls which could
adversely effect the registrant's ability to record, process, summarize and report financial
data and have identified for the registrant's auditors any material weakness in internal
controls; and
b) any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this quarterly report whether
there were significant changes in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/Dona D. Young
Dona D. Young
Chief Executive Officer
Chief Financial Officer certification, pursuant to Section 302 of The Sarbanes-Oxley Act of 2002, of the
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 of The Phoenix Companies, Inc.
I, Coleman D. Ross, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Phoenix Companies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements and other financial information included in this
quarterly report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have;
a) designed such disclosure controls and procedures to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a
date within 90 days prior to the filing of this quarterly report (the "Evaluation Date");
and
c) presented in this quarterly report our conclusions about the effectiveness of the
disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent
evaluation, to
58
the registrant's auditors and the audit committee of the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal controls which could
adversely effect the registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's auditors any material weakness in
internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this quarterly report whether
there were significant changes in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/Coleman D. Ross
Coleman D. Ross
Chief Financial Officer
59