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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 SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission file number 333-55268
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 ___.
Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
Yes X. No ___.
On October 31, 2003, the registrant had 94,378,543 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 September 30, 2003 (unaudited) and December 31, 2002............ 3
Consolidated Statement of Income and Comprehensive Income for the three and nine months
ended September 30, 2003 and 2002 (unaudited)............................................... 4
Consolidated Statement of Cash Flows for the three and nine months ended September 30, 2003
and 2002 (unaudited)........................................................................ 5
Consolidated Statement of Changes in Stockholders' Equity for the three and nine months ended
September 30, 2003 and 2002 (unaudited)..................................................... 6
Notes to Consolidated Financial Statements for the three and nine months ended
September 30, 2003 and 2002 (unaudited)..................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 27
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 64
Item 4. Controls and Procedures......................................................................... 67
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 69
Item 2. Changes in Securities and Use of Proceeds....................................................... 70
Item 3. Defaults Upon Senior Securities................................................................. 70
Item 4. Submission of Matters to a Vote of Security Holders............................................. 70
Item 5. Other Information............................................................................... 70
Item 6. Exhibits and Reports on Form 8-K................................................................ 70
Signature................................................................................................. 72
2
PART I.
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
THE PHOENIX COMPANIES, INC.
Consolidated Balance Sheet
($ amounts in millions, except per share data)
September 30, 2003 (unaudited) and December 31, 2002
2003 2002
--------------- ---------------
ASSETS:
Available-for-sale debt securities, at fair value........................... $ 13,007.5 $ 11,894.1
Equity securities, at fair value............................................ 357.4 391.2
Mortgage loans, at unpaid principal balances................................ 328.1 468.8
Venture capital partnerships, at equity in net assets....................... 240.3 228.6
Affiliate equity securities, at cost plus equity in undistributed earnings.. 41.9 134.7
Policy loans, at unpaid principal balances.................................. 2,212.1 2,195.9
Other investments........................................................... 413.5 398.9
--------------- ---------------
Total investments........................................................... 16,600.8 15,712.2
Cash and cash equivalents................................................... 628.3 1,058.5
Accrued investment income................................................... 237.5 192.3
Receivables................................................................. 184.5 217.3
Deferred policy acquisition costs........................................... 1,335.6 1,234.1
Deferred income taxes....................................................... 60.9 41.4
Intangible assets with definite lives....................................... 273.6 291.7
Goodwill and other indefinite-lived intangible assets....................... 463.7 456.0
Other general account assets................................................ 238.8 239.5
Separate account and investment trust assets................................ 7,082.5 5,793.1
--------------- ---------------
Total assets................................................................ $ 27,106.2 $ 25,236.1
=============== ===============
LIABILITIES:
Policy liabilities and accruals............................................. $ 12,964.7 $ 12,680.0
Policyholder deposit funds.................................................. 3,737.8 3,395.7
Stock purchase contracts.................................................... 124.1 137.6
Indebtedness................................................................ 642.5 644.3
Other general account liabilities........................................... 542.5 542.9
Separate account and investment trust liabilities........................... 7,082.5 5,793.1
--------------- ---------------
Total liabilities........................................................... 25,094.1 23,193.6
--------------- ---------------
MINORITY INTEREST:
Minority interest in net assets of consolidated subsidiaries................ 6.5 10.8
--------------- ---------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 106,376,291 and 106,374,510 shares issued..... 1.0 1.0
Additional paid-in capital.................................................. 2,429.0 2,424.4
Deferred compensation on restricted stock units............................. (3.9) --
Accumulated deficit......................................................... (340.0) (292.6)
Accumulated other comprehensive income...................................... 110.5 94.6
Treasury stock, at cost: 12,036,586 and 12,330,000 shares................... (191.0) (195.7)
--------------- ---------------
Total stockholders' equity.................................................. 2,005.6 2,031.7
--------------- ---------------
Total liabilities, minority interest and stockholders' equity............... $ 27,106.2 $ 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 and Nine Months Ended September 30, 2003 and 2002 (unaudited)
Three Months Nine Months
--------------------------- -------------------------
2003 2002 2003 2002
------------ ------------ ----------- ------------
REVENUES:
Premiums............................................... $ 286.9 $ 297.1 $ 781.5 $ 813.9
Insurance and investment product fees.................. 143.6 139.4 410.3 425.6
Investment income, net of expenses..................... 254.2 228.8 794.7 675.7
Net realized investment losses......................... (2.6) (10.5) (119.5) (74.1)
------------ ------------ ----------- ------------
Total revenues......................................... 682.1 654.8 1,867.0 1,841.1
------------ ------------ ----------- ------------
BENEFITS AND EXPENSES:
Policy benefits, excluding policyholder dividends...... 389.0 397.9 1,088.2 1,070.7
Policyholder dividends................................. 99.5 112.7 310.2 294.4
Policy acquisition cost amortization................... 22.7 41.1 76.6 41.6
Intangible asset amortization.......................... 8.3 8.9 24.9 24.8
Intangible asset impairments........................... -- 66.3 -- 66.3
Interest expense....................................... 9.8 7.7 29.5 23.1
Other operating expenses............................... 130.3 136.1 393.3 452.7
------------ ------------ ----------- ------------
Total benefits and expenses............................ 659.6 770.7 1,922.7 1,973.6
------------ ------------ ----------- ------------
Income (loss) before income taxes and minority interest 22.5 (115.9) (55.7) (132.5)
Applicable income taxes (benefit)...................... 5.6 (26.0) (31.4) (40.4)
------------ ------------ ----------- ------------
Income (loss) before minority interest................. 16.9 (89.9) (24.3) (92.1)
Minority interest in net income of
consolidated subsidiaries............................ 2.9 3.1 8.0 9.2
------------ ------------ ----------- ------------
Income (loss) before cumulative effect of
accounting change.................................... 14.0 (93.0) (32.3) (101.3)
Cumulative effect of accounting change for
goodwill and other intangible assets................. -- -- -- (130.3)
------------ ------------ ----------- ------------
Net income (loss) ..................................... $ 14.0 $ (93.0) $ (32.3) $ (231.6)
============ ============ =========== ============
EARNINGS PER SHARE:
Weighted average common shares
outstanding (in thousands):
Basic.............................................. 94,276 96,570 94,158 99,087
Diluted............................................ 98,272 96,570 94,158 99,087
============ ============ =========== ============
Income (loss) before cumulative effect of
accounting change:
Basic.............................................. $ 0.15 $ (.96) $ (.34) $ (1.02)
Diluted............................................ $ 0.14 $ (.96) $ (.34) $ (1.02)
============ ============ =========== ============
Net income (loss):
Basic.............................................. $ 0.15 $ (.96) $ (.34) $ (2.34)
Diluted............................................ $ 0.14 $ (.96) $ (.34) $ (2.34)
============ ============ =========== ============
COMPREHENSIVE INCOME:
Net income (loss)...................................... $ 14.0 $ (93.0) $ (32.3) $ (231.6)
------------ ------------ ----------- ------------
Net unrealized investment gains (losses)............... (34.7) (33.0) 5.3 11.0
Net unrealized foreign currency translation adjustment. (1.0) 3.0 3.8 (2.1)
Net unrealized derivative instruments gains (losses)... (1.1) 0.7 6.8 2.0
------------ ------------ ----------- ------------
Other comprehensive income (loss)...................... (36.8) (29.3) 15.9 10.9
------------ ------------ ----------- ------------
Comprehensive loss..................................... $ (22.8) $ (122.3) $ (16.4) $ (220.7)
============ ============ =========== ============
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 and Nine Months Ended September 30, 2003 and 2002 (unaudited)
Three Months Nine Months
------------------------- ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
OPERATING ACTIVITIES:
Premiums collected...................................... $ 286.6 $ 298.0 $ 772.1 $ 807.0
Insurance and investment product fees collected......... 138.8 127.2 413.2 422.8
Investment income collected............................. 221.3 228.9 710.3 675.7
Policy benefits paid, excluding policyholder dividends.. (268.6) (331.1) (794.1) (845.4)
Policyholder dividends paid............................. (105.0) (100.7) (292.0) (282.8)
Policy acquisition costs paid........................... (49.4) (56.6) (150.0) (169.2)
Interest expense paid................................... (6.3) (4.5) (24.2) (16.6)
Other operating expenses paid........................... (122.2) (120.4) (404.2) (428.9)
Income taxes refunded (paid)............................ (3.0) 3.2 6.6 2.9
----------- ----------- ----------- -----------
Cash from continuing operations......................... 92.2 44.0 237.7 165.5
Discontinued operations, net............................ (15.0) 12.2 (60.0) (62.0)
----------- ----------- ----------- -----------
Cash from operating activities.......................... 77.2 56.2 177.7 103.5
----------- ----------- ----------- -----------
INVESTING ACTIVITIES:
Investment purchases.................................... (1,086.6) (1,572.2) (4,196.7) (3,865.9)
Investment sales, repayments and maturities............. 1,016.8 909.7 3,314.4 2,329.4
Subsidiary purchases.................................... (4.4) (1.7) (23.5) (136.1)
Premises and equipment additions........................ (5.8) (3.9) (11.7) (11.7)
Discontinued operations, net............................ -- (12.1) (6.7) 23.4
----------- ----------- ----------- -----------
Cash for investing activities........................... (80.0) (680.2) (924.2) (1,660.9)
----------- ----------- ----------- -----------
FINANCING ACTIVITIES:
Policyholder deposit fund receipts (repayments), net ... (6.7) 745.2 342.1 1,602.0
Common stock purchases ................................. -- (56.0) -- (124.5)
Common stock dividends paid ............................ (15.1) (15.8) (15.1) (15.8)
Minority interest distributions......................... (1.4) (0.1) (10.7) (7.8)
----------- ----------- ----------- -----------
Cash from (for) financing activities.................... (23.2) 673.3 316.3 1,453.9
----------- ----------- ----------- -----------
Change in cash and cash equivalents..................... (26.0) 49.3 (430.2) (103.5)
Cash and cash equivalents, beginning of period.......... 654.3 662.7 1,058.5 815.5
----------- ----------- ----------- -----------
Cash and cash equivalents, end of period................ $ 628.3 $ 712.0 $ 628.3 $ 712.0
=========== =========== =========== ===========
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, except share and per share data)
Three and Nine Months Ended September 30, 2003 and 2002 (unaudited)
Three Months Nine Months
-------------------------- -------------------------
2003 2002 2003 2002
------------ ------------ ------------ -----------
COMMON STOCK AND
ADDITIONAL PAID-IN CAPITAL:
Additional common shares issued in demutualization
(54; 54; 1,781 and 2,624 shares)..................... $ -- $ -- $ -- $ --
Restricted stock units awarded as compensation
(5,537; 573,477; 655,278 and 573,477 units).......... 0.1 8.0 5.1 8.0
Restricted stock units awarded as payment of
deferred compensation liabilities (161,768 units).... -- -- 1.5 --
Excess of cost over fair value of common shares
contributed to employee savings plan................. (0.7) -- (2.0) --
Income tax benefit..................................... -- 6.0 -- 6.0
DEFERRED COMPENSATION ON
RESTRICTED STOCK UNITS:
Compensation deferred on restricted stock units awarded -- -- (5.0) --
Compensation expense recognized - restricted stock units 0.6 -- 1.1 --
RETAINED EARNINGS
(ACCUMULATED DEFICIT):
Net income (loss)...................................... 14.0 (93.0) (32.3) (231.6)
Common stock dividend declared ($0.16 per share)....... -- -- (15.1) (15.8)
ACCUMULATED OTHER
COMPREHENSIVE INCOME:
Other comprehensive income (loss)...................... (36.8) (29.3) 15.9 10.9
TREASURY STOCK:
Common shares purchased (3,631,400
and 7,546,500 shares)................................ -- (55.7) -- (125.6)
Common shares contributed to employee savings
plan (135,977 and 293,414 shares).................... 2.2 -- 4.7 --
------------ ------------ ------------ ------------
Change in stockholders' equity......................... (20.6) (164.0) (26.1) (348.1)
Stockholders' equity, beginning of period.............. 2,026.2 2,211.6 2,031.7 2,395.7
------------ ------------ ------------ ------------
Stockholders' equity, end of period.................... $ 2,005.6 $ 2,047.6 $ 2,005.6 $ 2,047.6
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
6
THE PHOENIX COMPANIES, INC.
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 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 intangible assets; the valuation of
investments in debt and equity securities and venture capital partnerships; 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 disclosures 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
three and nine month periods 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 this mutual company were extinguished and eligible policyholders of the mutual company
received shares of common stock of The Phoenix Companies, Inc., together with 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 additional
shares of 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
intangible 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: In the fourth quarter of 2003, we will be adopting the new standard
interpretation for the consolidation of variable interest entities. Variable interest entities are required to
be consolidated by their primary beneficiaries if they do not effectively disperse risks among all parties
involved. The primary beneficiary of a variable interest entity is the party that absorbs a majority of the
entity's expected losses, receives a majority of its expected residual returns, or both, as a result of holding
variable interests.
7
We are involved with various entities in the normal course of business that may be deemed to be variable
interest entities and, as a result, we may hold interests in those entities. We serve as the investment advisor
to nine collateralized bond obligations (CBOs) that were motivated by bond market arbitrage opportunities. We
currently consolidate three of these CBOs. The remaining six CBOs have aggregate assets with a fair value of
$1.5 billion that are invested in a variety of fixed income securities that were purchased from third parties.
The CBOs reside in bankruptcy remote special purpose entities for which we neither provide recourse or
guarantees. Our exposure under the new standard stems from our debt and equity investments in certain of these
CBOs. Our maximum exposure to loss with respect to the CBOs that we currently do not consolidate was $60.1
million at September 30, 2003 and $67.3 million at year-end 2002, which represents the fair value of our debt
and equity investments in the CBOs.
We are still evaluating the effect of the adoption on our consolidation practices as certain aspects of the
standard are still evolving. 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. We adopted fair value accounting for stock-based
compensation in 2003 using the prospective method of transition provided by the new standard, which results in
expense recognition for stock options awarded after December 31, 2002. For more information, see Note 8.
Business combinations
On May 1, 2003, we acquired the remaining interest in PFG Holdings, Inc. not already owned by us for initial
consideration of $16.7 million. Under the terms of the purchase agreement, we may be obligated to pay
additional consideration of up to $89.0 million to the selling shareholders, including $13.0 million during the
years 2004 through 2007 based on certain financial performance targets being met, and the balance in 2008 based
on the appraised value of PFG Holdings as of December 31, 2007. We have accounted for our acquisition of the
remaining interest in PFG Holdings as a step-purchase. Accordingly, we recorded a definite-lived intangible
asset of $9.8 million related to the present value of future profits (PVFP) acquired and a related deferred
income tax liability of $3.4 million. The PVFP intangible asset will be amortized over the remaining estimated
life of the underlying insurance inforce acquired, estimated to be 40 years. The remaining acquisition price of
$7.6 million has been assigned to goodwill.
On June 30, 2003, we acquired the remaining interest in Capital West Asset Management, LLC not already owned by
us for $1.1 million. We have accounted for our acquisition of the remaining interest as a step-purchase. We
recorded $0.7 million for definite-lived investment management contracts and assigned the remaining acquisition
price of $1.0 million to goodwill.
We acquired a 60% interest in Kayne Anderson Rudnick Investment Management, LLC (Kayne Anderson Rudnick) for
$102.4 million on January 29, 2002; management of the company retained the remaining ownership interest. In
addition to the initial cost of the purchase, we may be obligated to make a subsequent payment, which could be
as much as $65.0 million in 2004 based upon management fee revenue for the purchased business through the end
of 2003. We currently estimate this payment to be between $27.5 million and $32.5 million. We are also
obligated to purchase an additional 15% interest in the company by 2007. We allocated $0.3 million of the
purchase price to tangible net assets acquired and $102.1 million to intangible assets ($58.3 million to
investment management contracts and $43.8 million to goodwill).
In August 2003, certain members of KAR accelerated their put/call arrangement. The purchase price for these
units totaled $4.4 million, which was recorded as additional purchase price by PXP and allocated to goodwill
and definite-lived intangible assets.
8
We have not presented pro forma information as if the minority interests in PFG Holdings and Capital West Asset
Management had been acquired at the beginning of 2003 or as if the majority interest in Kayne Anderson Rudnick
had been acquired at the beginning of 2002, since such pro forma information does not differ materially from
our financial statements.
2. Business Segments
Segment information on assets at September 30, 2003 and year-end 2002 and
revenues and income for the three and nine month periods ended September 30,
2003 and 2002 follow ($ amounts in millions):
2003 2002
-------------- --------------
Segment Assets
Life and annuity segment....................................................... $ 23,728.3 $ 21,534.0
Asset management segment....................................................... 824.0 844.3
-------------- --------------
Operating segment assets....................................................... 24,552.3 22,378.3
Venture capital segment........................................................ 202.5 227.8
Corporate and other segment.................................................... 2,330.6 2,609.2
-------------- --------------
Total segment assets........................................................... 27,085.4 25,215.3
Net assets of discontinued operations.......................................... 20.8 20.8
-------------- --------------
Total assets................................................................... $ 27,106.2 $ 25,236.1
============== ==============
Three Months Nine Months
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Segment Revenues
Life and annuity segment........................... $ 614.8 $ 620.9 $ 1,766.8 $ 1,754.5
Asset management segment........................... 61.2 63.0 173.5 200.2
Elimination of inter-segment revenues.............. (3.5) (3.8) (10.5) (12.7)
------------- ------------- ------------- -------------
Operating segment revenues......................... 672.5 680.1 1,929.8 1,942.0
Venture capital segment............................ 5.1 (22.0) 34.8 (56.9)
Corporate and other segment........................ 7.1 7.2 21.9 30.1
------------- ------------- ------------- -------------
Total segment revenues............................. 684.7 665.3 1,986.5 1,915.2
Net realized investment losses..................... (2.6) (10.5) (119.5) (74.1)
------------- ------------- ------------- -------------
Total revenues..................................... $ 682.1 $ 654.8 $ 1,867.0 $ 1,841.1
============= ============= ============= =============
Segment Income
Life and annuity segment........................... $ 24.4 $ (1.9) $ 69.0 $ 54.2
Asset management segment........................... (3.1) (67.8) (14.6) (71.5)
------------- ------------- ------------- -------------
Operating segment pre-tax income (loss)............ 21.3 (69.7) 54.4 (17.3)
Venture capital segment............................ 5.1 (22.0) 34.8 (56.9)
Corporate and other segment........................ (10.5) (10.1) (34.4) (24.4)
------------- ------------- ------------- -------------
Total segment income before income taxes........... 15.9 (101.8) 54.8 (98.6)
Applicable income taxes (benefit).................. 4.4 (20.0) 15.0 (25.5)
------------- ------------- ------------- -------------
Total segment income (loss)........................ 11.5 (81.8) 39.8 (73.1)
Net realized investment gains (losses),
net of income taxes and other offsets............ 2.5 (7.6) (69.1) (16.7)
Restructuring and early retirement costs,
net of income taxes.............................. -- (3.6) (4.3) (25.4)
Other income, net of income taxes.................. -- -- 1.3 --
Deferred acquisition cost adjustment,
net of income taxes.............................. -- -- -- 15.1
Demutualization related items, net of income taxes. -- -- -- (1.2)
Cumulative effect of accounting change............. -- -- -- (130.3)
------------- ------------- ------------- -------------
Net income (loss).................................. $ 14.0 $ (93.0) $ (32.3) $ (231.6)
============= ============= ============= =============
9
During the three month period ended June 30, 2003, we transferred our equity investment in Aberdeen Asset
Management PLC from our Asset Management segment to the Corporate and Other segment. As a result, we have
reclassified prior year information for consistency.
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
September 30, 2003 and year-end 2002 and operating income for the three and nine month periods ended September
30, 2003 and 2002 follows ($ amounts in millions):
2003 2002
--------------- ---------------
Life and Annuity Segment Assets
Investments.................................................................. $ 15,739.6 $ 14,480.0
Cash and cash equivalents.................................................... 496.3 924.0
Receivables.................................................................. 238.0 236.4
Deferred policy acquisition costs............................................ 1,335.6 1,234.1
Deferred income taxes........................................................ 285.0 328.2
Goodwill and other intangible assets......................................... 15.2 7.1
Other general account assets................................................. 204.7 192.5
Separate accounts............................................................ 5,413.9 4,131.7
--------------- ---------------
Total segment assets......................................................... 23,728.3 21,534.0
--------------- ---------------
Policy liabilities and accruals.............................................. 12,843.4 12,695.6
Policyholder deposit funds................................................... 3,727.4 3,237.9
Other general account liabilities............................................ 251.3 171.0
Separate accounts............................................................ 5,413.9 4,131.7
Minority interest............................................................ 0.1 1.6
--------------- ---------------
Total segment liabilities and minority interest.............................. 22,236.1 20,237.8
--------------- ---------------
Segment net assets........................................................... $ 1,492.2 $ 1,296.2
=============== ===============
10
Three Months Nine Months
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Life and Annuity Segment Income
Premiums.......................................... $ 286.9 $ 297.1 $ 781.5 $ 813.9
Insurance and investment product fees............. 84.7 78.7 242.5 235.2
Net investment income............................. 243.2 245.1 742.8 705.4
------------- ------------- ------------- -------------
Total segment revenues............................ 614.8 620.9 1,766.8 1,754.5
------------- ------------- ------------- -------------
Policy benefits, including policyholder dividends. 491.8 506.0 1,397.0 1,400.7
Policy acquisition cost amortization.............. 25.5 41.2 77.7 68.2
Other operating expenses.......................... 73.1 75.6 222.7 231.4
------------- ------------- ------------- -------------
Total segment benefits and expenses............... 590.4 622.8 1,697.4 1,700.3
------------- ------------- ------------- -------------
Segment income (loss) before income taxes and
minority interest............................... 24.4 (1.9) 69.4 54.2
Allocated income taxes (benefit).................. 10.5 (0.7) 22.5 19.0
------------- ------------- ------------- -------------
Segment income (loss) before minority interest.... 13.9 (1.2) 46.9 35.2
Minority interest in segment income of
consolidated subsidiaries....................... -- -- 0.4 --
------------- ------------- ------------- -------------
Segment income (loss)............................. 13.9 (1.2) 46.5 35.2
Net realized investment gains (losses),
net of income taxes and other offsets........... (1.7) 0.9 0.9 (5.7)
Deferred acquisition cost adjustment,
net of income taxes............................. -- -- -- 14.4
Other adjustments, net of income taxes............ -- -- -- 0.7
------------- ------------- ------------- -------------
Segment net income (loss)......................... $ 12.2 $ (0.3) $ 47.4 $ 44.6
============= ============= ============= =============
Deferred policy acquisition costs
The activity in deferred policy acquisition costs for the three and nine month periods ended September 30, 2003
and 2002 follows ($ amounts in millions):
Three Months Nine Months
-------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Acquisition costs deferred............................. $ 49.4 $ 56.6 $ 150.0 $ 169.2
Acquisition costs recognized in:
PFG Holdings minority interest acquisition......... 9.8 -- 9.8 --
Valley Forge Life acquisition...................... -- 48.5 -- 48.5
Costs amortized to expenses:
Recurring costs related to segment income.......... (25.5) (41.2) (77.7) (68.2)
Credit related to realized investment
gains or losses.................................. 2.8 0.1 1.1 4.5
Change in actuarial assumption..................... -- -- -- 22.1
Offsets to net unrealized investment gains or losses
included in other comprehensive income............... 51.1 (40.6) 18.3 (64.3)
------------ ------------ ------------ ------------
Change in deferred policy acquisition costs............ 87.6 23.4 101.5 111.8
Deferred policy acquisition costs, beginning of period. 1,248.0 1,212.1 1,234.1 1,123.7
------------ ------------ ------------ ------------
Deferred policy acquisition costs, end of period....... $ 1,335.6 $ 1,235.5 $ 1,335.6 $ 1,235.5
============ ============ ============ ============
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 million ($14.4 million after
income taxes).
11
We have included in deferred policy acquisition costs the present value of future profits from two major
reinsurance assumed transactions and the purchase of the minority interest in a subsidiary. The amounts
included at September 30, 2003 and year end 2002 follow: Confederation Life ($38.2 million and $45.7 million,
respectively), Valley Forge Life ($39.8 million and $43.5 million, respectively) and PFG Holdings ($9.8 million
and $0, respectively).
Policy liabilities and accruals
Policyholder liabilities are primarily for participating life insurance policies and universal life insurance
policies. For universal life, this includes deposits received from customers and investment earnings on their
fund balances, which range from 4.0% to 6.25% at September 30, 2003 and 4.0% to 7.0% at year-end 2002, less
administrative and mortality charges.
Policyholder deposit funds
Policyholder deposit funds primarily consist of annuity deposits received from customers, dividend
accumulations and investment earnings on their fund balances, which range from 1.0% to 12.3% at September 30,
2003 and 1.6% to 12.3% at year-end 2002, less administrative charges.
Participating life insurance
Participating life insurance in-force was 40.6% and 45.5% of the face value of total individual life insurance
in-force at September 30, 2003 and year-end 2002, respectively. The premiums on participating life insurance
policies were 70.9% and 76.4% of total individual life insurance premiums for the three months ended September
30, 2003 and 2002, respectively, and 70.0% and 72.0% of total individual life insurance premiums for the nine
months ended September 30, 2003 and 2002, respectively.
Funds under management
Activity in annuity funds under management for the three and nine month periods ended September 30, 2003 and 2002
follows ($ amounts in millions):
Three Months Nine Months
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- --------------- --------------
Deposits..................................... $ 452.0 $ 804.2 $ 1,255.2 $ 2,040.6
Performance.................................. 140.1 (294.7) 511.6 (515.1)
Fees......................................... (14.4) (13.8) (41.3) (45.4)
Benefits and surrenders...................... (231.3) (191.9) (693.7) (524.5)
-------------- -------------- --------------- --------------
Change in funds under management............. 346.4 303.8 1,031.8 955.6
Funds under management, beginning of period.. 6,518.9 5,400.9 5,833.5 4,749.1
-------------- -------------- --------------- --------------
Funds under management, end of period........ $ 6,865.3 $ 5,704.7 $ 6,865.3 $ 5,704.7
============== ============== =============== ==============
12
Closed Block
Summarized information on closed block assets and liabilities at September 30, 2003, year-end 2002 and
inception (December 31, 1999) and on closed block revenues and expenses and changes in the policyholder
dividend obligation, all for the cumulative period from inception to September 30, 2003 and the nine month
periods ended September 30, 2003 and 2002, follows ($ amounts in millions):
2003 2002 Inception
------------- ------------ -----------
Debt securities....................................................... $ 6,763.9 $ 6,431.1 $ 4,773.1
Equity securities..................................................... 49.9 -- --
Mortgage loans........................................................ 268.5 373.2 399.0
Venture capital partnerships.......................................... 37.8 0.8 --
Policy loans.......................................................... 1,391.5 1,399.0 1,380.0
Other invested assets................................................. 45.8 -- --
------------- ------------ -----------
Total closed block investments........................................ 8,557.4 8,204.1 6,552.1
Cash and cash equivalents............................................. 104.7 187.1 --
Accrued investment income............................................. 125.5 110.9 106.8
Receivables........................................................... 42.1 42.1 35.2
Deferred income taxes................................................. 392.8 402.7 389.4
Other closed block assets............................................. 39.0 45.2 6.2
------------- ------------ -----------
Total closed block assets............................................. 9,261.5 8,992.1 7,089.7
------------- ------------ -----------
Policy liabilities and accruals....................................... 9,664.6 9,449.0 8,301.7
Policyholder dividends payable........................................ 375.9 363.4 325.1
Policyholder dividend obligation...................................... 506.7 547.3 --
Other closed block liabilities........................................ 73.9 24.2 12.3
------------- ------------ -----------
Total closed block liabilities........................................ 10,621.1 10,383.9 8,639.1
------------- ------------ -----------
Excess of closed block liabilities over closed block assets........... $ 1,359.6 $ 1,391.8 $ 1,549.4
============= ============ ===========
Nine Months
-------------------------
Cumulative 2003 2002
------------- ------------ -----------
Premiums.............................................................. $ 3,992.4 $ 754.4 $ 788.9
Net investment income ................................................ 2,063.5 425.4 422.8
Net realized investment losses........................................ (85.2) (5.5) (50.3)
------------- ------------ -----------
Total revenues........................................................ 5,970.7 1,174.3 1,161.4
------------- ------------ -----------
Policy benefits, excluding dividends.................................. 4,100.7 798.2 811.4
Other operating expenses.............................................. 47.2 8.2 8.6
------------- ------------ -----------
Total benefits and expenses, excluding policyholder dividends......... 4,147.9 806.4 820.0
------------- ------------ -----------
Closed block contribution to income before dividends and income taxes. 1,822.8 367.9 341.4
Policyholder dividends................................................ 1,486.7 309.8 293.6
------------- ------------ -----------
Closed block contribution to income before income taxes............... 336.1 58.1 47.8
Applicable income taxes............................................... 118.2 20.5 16.6
------------- ------------ -----------
Closed block contribution to income................................... $ 217.9 $ 37.6 $ 31.2
============= ============ ===========
Policyholder dividends provided through earnings...................... $ 1,531.9 $ 309.8 $ 293.6
Policyholder dividends provided through other comprehensive income.... 432.2 (46.0) 364.4
------------- ------------ -----------
Additions to policyholder dividend liabilities........................ 1,964.1 263.8 658.0
Policyholder dividends paid........................................... (1,406.6) (291.9) (282.4)
------------- ------------ -----------
Increase in policyholder dividend liabilities......................... 557.5 (28.1) 375.6
Policyholder dividend liabilities, beginning of period................ 325.1 910.7 524.5
------------- ------------ -----------
Policyholder dividend liabilities, end of period...................... 882.6 882.6 900.1
Less: policyholder dividends payable, end of period................... 375.9 375.9 369.5
------------- ------------ -----------
Policyholder dividend obligation, end of period....................... $ 506.7 $ 506.7 $ 530.6
============= ============ ===========
13
4. Asset Management Segment
We conduct activities in our Asset Management segment through our subsidiary, PXP. Two lines of business,
private client and institutional, comprise these activities. 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.
Segment information on assets as of September 30, 2003 and year-end 2002 and on operating income for the three
and nine month periods ended September 30, 2003 and 2002 follows ($ amounts in millions):
2003 2002
------------ -----------
Asset Management Segment Assets
Investments......................................................................... $ 10.6 $ 5.6
Cash and cash equivalents........................................................... 39.9 44.2
Receivables......................................................................... 29.6 31.6
Intangible assets with definite lives............................................... 270.2 291.7
Goodwill and other indefinite-lived intangible assets............................... 451.9 448.9
Other assets........................................................................ 21.8 22.3
------------ -----------
Total segment assets................................................................ 824.0 844.3
------------ -----------
Liabilities......................................................................... 140.2 141.7
Minority interest................................................................... 6.4 9.0
------------ -----------
Total segment liabilities and minority interest..................................... 146.6 150.7
------------ -----------
Segment net assets.................................................................. $ 677.4 $ 693.6
============ ===========
Three Months Nine Months
--------------------------- -------------------------
2003 2002 2003 2002
------------ ------------ ------------ -----------
Asset Management Segment Income
Investment product fees................................ $ 61.1 $ 62.6 $ 173.2 $ 199.4
Net investment income.................................. 0.1 0.4 0.3 0.8
------------ ------------ ------------ -----------
Total segment revenues................................. 61.2 63.0 173.5 200.2
------------ ------------ ------------ -----------
Intangible asset amortization.......................... 8.3 8.7 24.9 24.6
Intangible asset impairments........................... -- 66.3 -- 66.3
Other operating expenses............................... 53.1 52.7 155.6 171.6
------------ ------------ ------------ -----------
Total segment expenses................................. 61.4 127.7 180.5 262.5
------------ ------------ ------------ -----------
Segment loss before income taxes
and minority interest................................ (0.2) (64.7) (7.0) (62.3)
Allocated income tax benefit........................... (1.2) (5.2) (5.6) (7.1)
------------ ------------ ------------ -----------
Segment income (loss) before minority interest......... 1.0 (59.5) (1.4) (55.2)
Minority interest in segment income of
consolidated subsidiaries............................ 2.9 3.1 7.6 9.2
------------ ------------ ------------ -----------
Segment loss........................................... (1.9) (62.6) (9.0) (64.4)
Restructuring charges, net of income taxes............. -- 1.5 (3.1) (7.8)
Cumulative effect of accounting change................. -- -- -- (119.9)
------------ ------------ ------------ -----------
Segment net loss....................................... $ (1.9) $ (61.1) $ (12.1) $ (192.1)
============ ============ ============ ===========
14
Goodwill and other intangible assets
Details of gross and net carrying amounts for definite-lived intangible assets and goodwill and other
indefinite-lived intangible assets at September 30, 2003 and year-end 2002 follow ($ amounts in millions):
2003 2002
------------ ------------
Asset management contracts.......................................................... $ 396.2 $ 392.8
Less: accumulated amortization...................................................... 126.0 101.1
------------ ------------
Intangible assets with definite lives............................................... $ 270.2 $ 291.7
============ ============
Goodwill............................................................................ $ 378.6 $ 375.6
Investment management contracts..................................................... 73.3 73.3
------------ ------------
Goodwill and other indefinite-live intangible assets................................ $ 451.9 $ 448.9
============ ============
The activity in intangible assets with definite lives and goodwill and other indefinite-lived intangible assets
for the three and nine month periods ended September 30, 2003 and 2002 follows ($ amounts in millions):
Three Months Nine Months
----------------------------- --------------------------
2003 2002 2003 2002
------------- ------------- ------------ ------------
Intangible assets with definite lives:
Asset purchases..................................... $ 2.6 $ 0.9 $ 3.4 $ 78.2
Asset reclassification.............................. -- 20.8 -- 9.7
Asset amortization.................................. (8.3) (8.7) (24.9) (24.6)
------------- ------------- ------------ ------------
Change in intangible assets......................... (5.7) 13.0 (21.5) 63.3
Balance, beginning of period........................ 275.9 293.8 291.7 243.5
------------- ------------- ------------ ------------
Balance, end of period.............................. $ 270.2 $ 306.8 $ 270.2 $ 306.8
============= ============= ============ ============
Goodwill and other indefinite-lived intangible assets:
Asset purchases..................................... $ 1.8 $ 0.8 $ 3.0 $ 60.0
Asset reclassification.............................. -- (20.8) -- (9.7)
Asset impairments................................... -- (66.3) -- (197.7)
------------- ------------- ------------ ------------
Change in goodwill and other intangible assets...... 1.8 (86.3) 3.0 (147.4)
Balance, beginning of period........................ 450.1 527.8 448.9 588.9
------------- ------------- ------------ ------------
Balance, end of period.............................. $ 451.9 $ 441.5 $ 451.9 $ 441.5
============= ============= ============ ============
For purposes of our testing for goodwill and indefinite-lived intangible asset impairments, we calculate the
fair value of each reporting unit based on the sum of a multiple of revenue and the fair value of the unit's
tangible net assets. We calculate the fair value of definite-lived intangible assets based on their discounted
cash flows. We compare the calculated fair value to the recorded values and record an impairment, if warranted.
The estimated aggregate intangible asset amortization expense in future periods is: 2003 - $8.2 million, 2004 -
$33.0 million, 2005 - $32.2 million, 2006 - $27.2 million, 2007 - $26.1 million, 2008 - $25.7 million and
thereafter - $117.8 million. At September 30, 2003, the weighted-average amortization period for definite-lived
intangible assets is 9.6 years.
15
5. Investing Activities
Debt and equity securities
Fair value and cost of our debt and equity securities at September 30, 2003 and year-end 2002 follow ($ amounts
in millions):
2003 2002
------------------------------ ----------------------------
Fair Value Cost Fair Value Cost
------------- -------------- ------------- -------------
U.S. government and agency................... $ 549.1 $ 520.2 $ 461.6 $ 431.3
State and political subdivision.............. 558.9 508.8 534.7 481.9
Foreign government........................... 196.6 176.4 183.9 168.4
Corporate.................................... 6,537.5 6,187.0 5,485.2 5,138.7
Mortgage-backed.............................. 3,238.2 3,078.5 3,099.9 2,901.9
Other asset-backed........................... 1,927.2 1,920.4 2,128.8 2,122.1
------------- -------------- ------------- -------------
Debt securities.............................. $ 13,007.5 $ 12,391.3 $ 11,894.1 $ 11,244.3
============= ============== ============= =============
Amounts applicable to the closed block....... $ 6,763.9 $ 6,329.2 $ 6,431.1 $ 5,952.9
============= ============== ============= =============
2003 2002
------------------------------ ----------------------------
Fair Value Cost Fair Value Cost
------------- -------------- ------------- -------------
Hilb, Rogal and Hamilton (HRH) common stock.. $ 112.6 $ 42.1 $ 159.3 $ 44.7
GE Life and Annuity Assurance and
GE Group Life Assurance common stock....... 69.3 50.4 60.5 50.4
PXRE Group common stock...................... 20.3 9.4 27.7 9.4
Other equity securities...................... 155.2 149.8 143.7 157.7
------------- -------------- ------------- -------------
Equity securities............................ $ 357.4 $ 251.7 $ 391.2 $ 262.2
============= ============== ============= =============
Amounts applicable to the closed block....... $ 49.9 $ 49.7 $ -- $ --
============= ============== ============= =============
Our holdings in HRH common stock as of September 30, 2003 are available to be used in November 2005 to settle
stock purchase contracts issued by us. Upon settlement of such stock purchase contracts, we will recognize a
gross investment gain of $91.8 million ($32.4 net of offsets for applicable deferred acquisition costs and
deferred income taxes). See Note 6 for additional information.
Gross and net unrealized gains and losses from debt and equity securities at September 30, 2003 and year-end
2002 follow ($ amounts in millions):
2003 2002
------------------------------- ------------------------------
Gains Losses Gains Losses
-------------- -------------- -------------- --------------
U.S. government and agency................... $ 29.7 $ (0.8) $ 30.5 $ (0.2)
State and political subdivision.............. 51.4 (1.3) 53.1 (0.3)
Foreign government........................... 21.3 (1.1) 20.2 (4.7)
Corporate.................................... 400.9 (50.4) 442.8 (96.3)
Mortgage-backed.............................. 168.1 (8.4) 198.5 (0.5)
Other asset-backed........................... 62.5 (55.7) 85.0 (78.3)
-------------- -------------- -------------- --------------
Debt securities gains and losses............. $ 733.9 $ (117.7) $ 830.1 $ (180.3)
============== ============== ============== ==============
Debt securities net gains.................... $ 616.2 $ 649.8
============== ==============
Equity securities gains and losses........... $ 108.5 $ (2.8) $ 144.4 $ (15.4)
============== ============== ============== ==============
Equity securities net gains.................. $ 105.7 $ 129.0
============== ==============
16
Mortgage loans
The carrying values of our investments in mortgage loans by property type at September 30, 2003 and year-end
2002 follow ($ amounts in millions):
2003 2002
--------------- ---------------
Apartment buildings.......................................................... $ 130.9 $ 159.0
Office buildings............................................................. 56.4 131.5
Retail stores................................................................ 116.0 151.5
Industrial buildings......................................................... 37.5 42.2
Other........................................................................ 0.1 0.1
--------------- ---------------
Subtotal..................................................................... 340.9 484.3
Less: valuation allowances................................................... (12.8) (15.5)
--------------- ---------------
Mortgage loans............................................................... $ 328.1 $ 468.8
=============== ===============
Amounts applicable to the closed block....................................... $ 268.5 $ 373.2
=============== ===============
Venture capital partnerships
The components of net investment income related to venture capital partnerships for the three and nine month
periods ended September 30, 2003 and 2002 follow ($ amounts in millions):
Three Months Nine Months
--------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net realized gains (losses) on partnership
cash and stock distributions..................... $ 10.0 $ (2.1) $ 11.5 $ (7.2)
Net unrealized gains (losses) on partnership
investments...................................... 2.4 (17.8) 40.1 (44.0)
Partnership operating expenses..................... (2.2) (2.1) (6.0) (5.7)
------------ ------------ ------------ ------------
Net investment income (loss)....................... $ 10.2 $ (22.0) $ 45.6 $ (56.9)
============ ============ ============ ============
Amounts applicable to the closed block............. $ 5.1 $ -- $ 10.8 $ --
============ ============ ============ ============
Amounts applicable to the venture capital segment.. $ 5.1 $ (22.0) $ 34.8 $ (56.9)
============ ============ ============ ============
The effect of our adjusting estimated partnership results to actual results reflected in partnership financial
statements was to increase (decrease) net investment income as follows ($ amounts in millions):
Three Months Nine Months
--------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Closed block....................................... $ 4.7 $ -- $ -- $ --
Venture capital segment............................ (0.4) (0.8) 33.4 12.8
------------ ------------ ------------ ------------
Total.............................................. $ 4.3 $ (0.8) $ 33.4 $ 12.8
============ ============ ============ ============
17
Our investments in venture capital partnerships and unfunded commitments thereon at September 30, 2003 and
year-end 2002 by type of investment follow ($ amounts in millions):
2003 2002
------------ -----------
Technology.......................................................................... $ 42.2 $ 25.0
Telecommunications.................................................................. 15.3 10.2
Biotechnology....................................................................... 18.6 11.1
Health care......................................................................... 8.3 9.2
Consumer and business products and services......................................... 30.6 45.9
Financial services.................................................................. 29.2 28.1
Other............................................................................... 45.0 50.6
------------ -----------
Private holdings.................................................................... 189.2 180.1
Public holdings..................................................................... 27.0 23.0
Cash and cash equivalents........................................................... 12.8 22.4
Other............................................................................... 11.3 3.1
------------ -----------
Venture capital partnerships........................................................ $ 240.3 $ 228.6
============ ===========
Unfunded commitments................................................................ $ 135.6 $ 157.7
============ ===========
Amounts applicable to the closed block:
Venture capital partnerships........................................................ $ 37.8 $ 0.8
============ ===========
Unfunded commitments................................................................ $ 53.2 $ 24.4
============ ===========
Amounts applicable to venture capital segment:
Venture capital partnerships........................................................ $ 202.5 $ 227.8
============ ===========
Unfunded commitments................................................................ $ 82.4 $ 133.3
============ ===========
Investment activity in venture capital partnerships for the three and nine month periods ended September 30,
2003 and 2002 follow ($ amounts in millions):
Three Months Nine Months
----------------------- ------------------------
2003 2002 2003 2002
---------- ---------- ---------- -----------
Contributions............................................... $ 9.4 $ 10.2 $ 34.2 $ 30.7
Equity in earnings of partnerships.......................... 10.2 (22.0) 45.6 (56.9)
Distributions............................................... (16.4) (19.4) (27.7) (34.9)
Proceeds from sale of partnership interests................. -- -- (26.1) --
Realized loss on sale of partnership interests.............. -- -- (14.3) --
---------- ---------- ---------- -----------
Change in venture capital partnerships...................... 3.2 (31.2) 11.7 (61.1)
Venture capital partnership investments, beginning of period 237.1 261.8 228.6 291.7
---------- ---------- ---------- -----------
Venture capital partnership investments, end of period...... $ 240.3 $ 230.6 $ 240.3 $ 230.6
========== ========== ========== ===========
Affiliate equity securities
The fair value of our investment in Aberdeen common stock, based on the London Stock Exchange closing price at
September 30, 2003 and year-end 2002, was $44.6 million and $43.6 million, respectively. The carrying value of
our investment in Aberdeen on the equity method of accounting totaled $34.1 million and $119.3 million at
September 30, 2003 and year-end 2002, respectively. During the second quarter of 2003, we recorded an $89.1
million pre-tax, non-cash charge related to the other-than-temporary impairment of our equity investment in
Aberdeen.
18
Net investment income
Sources of net investment income for the three and nine month periods ended September 30, 2003 and 2002 follow
($ amounts in millions):
Three Months Nine Months
--------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Debt securities........................................ $ 184.0 $ 192.7 $ 570.2 $ 552.7
Equity securities...................................... 0.9 0.9 3.1 3.1
Mortgage loans......................................... 7.0 9.8 26.4 31.1
Venture capital partnerships........................... 10.2 (22.0) 45.6 (56.9)
Affiliate equity securities............................ -- 0.2 0.7 7.2
Policy loans........................................... 42.2 42.7 127.4 127.5
Other investments...................................... 11.0 4.3 23.4 11.6
Cash and cash equivalents.............................. 1.4 3.0 5.9 7.8
------------ ------------ ------------ ------------
Total investment income................................ 256.7 231.6 802.7 684.1
Less: investment expenses.............................. 2.5 2.8 8.0 8.4
------------ ------------ ------------ ------------
Net investment income.................................. $ 254.2 $ 228.8 $ 794.7 $ 675.7
============ ============ ============ ============
Amounts applicable to the closed block................. $ 138.8 $ 143.0 $ 425.4 $ 422.8
============ ============ ============ ============
Net realized investment gains (losses)
Sources and types of net realized investment gains (losses) for the three and nine month periods ended
September 30, 2003 and 2002 follow ($ amounts in millions):
Three Months Nine Months
--------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Debt securities........................................ $ (15.0) $ (8.9) $ (60.4) $ (80.7)
Equity securities...................................... (3.2) -- (4.3) --
Mortgage loans......................................... (0.9) -- (4.1) --
Venture capital partnerships........................... -- -- (4.6) --
Affiliate equity securities............................ -- -- (96.9) --
Other invested assets.................................. (0.4) -- (10.3) --
------------ ------------ ------------ ------------
Impairment losses...................................... (19.5) (8.9) (180.6) (80.7)
------------ ------------ ------------ ------------
Debt securities gains.................................. 12.4 15.7 82.7 54.5
Debt securities losses................................. (1.3) (9.1) (25.1) (33.6)
Equity securities gains................................ 5.5 3.4 21.1 6.2
Equity securities losses............................... (0.6) (9.0) (11.0) (20.5)
Mortgage loans......................................... (0.6) 0.2 (1.4) 0.2
Venture capital partnerships........................... -- -- (9.7) --
Other invested assets.................................. 1.5 (2.8) 4.5 (0.2)
------------ ------------ ------------ ------------
Net transaction gains (losses)......................... 16.9 (1.6) 61.1 6.6
------------ ------------ ------------ ------------
Net realized investment losses......................... $ (2.6) $ (10.5) $ (119.5) $ (74.1)
============ ============ ============ ============
Net realized investment losses......................... $ (2.6) $ (10.5) $ (119.5) $ (74.1)
------------ ------------ ------------ ------------
Applicable closed block policyholder
dividend obligation (reduction)...................... (3.5) 1.2 (4.5) (44.0)
Applicable deferred policy acquisition costs (benefit). (2.8) (0.1) (1.1) (4.5)
Applicable deferred income taxes (benefit)............. 1.2 (4.0) (44.8) (8.9)
------------ ------------ ------------ ------------
Offsets to realized investment losses.................. (5.1) (2.9) (50.4) (57.4)
------------ ------------ ------------ ------------
Net realized investment gains (losses)
included in net income............................... $ 2.5 $ (7.6) $ (69.1) $ (16.7)
============ ============ ============ ============
19
Unrealized investment gains (losses)
Sources of net unrealized investment gains (losses) for the three and nine month periods ended September 30,
2003 and 2002 follow ($ amounts in millions):
Three Months Nine Months
--------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Debt securities........................................ $ (292.9) $ 279.5 $ (33.6) $ 462.1
Equity securities...................................... (27.6) (54.7) (23.3) (25.2)
Other investments ..................................... 5.9 4.5 0.2 9.2
------------ ------------ ------------ ------------
Net unrealized investment gains (losses)............... $ (314.6) $ 229.3 $ (56.7) $ 446.1
============ ============ ============ ============
Net unrealized investment gains (losses)............... $ (314.6) $ 229.3 $ (56.7) $ 446.1
------------ ------------ ------------ ------------
Applicable closed block policyholder
dividend obligation (reduction)...................... (209.8) 235.8 (46.0) 364.4
Applicable deferred policy acquisition costs (benefit). (51.1) 40.6 (18.3) 64.3
Applicable deferred income taxes (benefit)............. (19.0) (14.1) 2.3 6.4
------------ ------------ ------------ ------------
Offsets to net unrealized investment gains (losses).... (279.9) 262.3 (62.0) 435.1
------------ ------------ ------------ ------------
Net unrealized investment gains (losses)
included in other comprehensive income............... $ (34.7) $ (33.0) $ 5.3 $ 11.0
============ ============ ============ ============
6. Financing Activities
Stock Purchase Contracts
In November 2002, we issued stock purchase contracts in a public offering. The stock purchase contracts are
prepaid forward contracts issued by us that will be settled in shares of Hilb, Rogal and Hamilton Company (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 underlie the stock purchase contracts.
All changes in the fair value of the embedded derivative instrument are recorded in other comprehensive income.
For the three months ended September 30, 2003, we recognized a decrease in the fair value of the embedded
derivative instrument of $0.9 million before income taxes ($0.6 million after income taxes) in other
comprehensive income, primarily due to a decrease in the time value of the option offset by an increase in the
intrinsic value of the option due to a decrease in the quoted market price of HRH common stock. For the nine
months ended September 30, 2003, we recognized an increase in the fair value of the embedded derivative
instrument of $11.3 million before income taxes ($7.3 million after income taxes) in other comprehensive
income, primarily due to a decrease in the quoted market price of HRH common stock during the period. The
quoted market price of HRH common stock ($31.04) at September 30, 2003 was below the price that we received at
issuance of the stock purchase contracts. For more information, see Notes 5 and 6 to our consolidated financial
statements in our 2002 Annual Report on Form 10-K.
20
Indebtedness
Carrying value and fair value of our indebtedness at September 30, 2003 and year-end 2002 follow ($ amounts in
millions):
2003 2002
--------------------------------- --------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------------- --------------- --------------- ---------------
Surplus notes......................... $ 175.0 $ 187.4 $ 175.0 $ 182.5
Equity units.......................... 153.7 159.3 153.7 156.5
Senior unsecured bonds................ 300.0 304.6 300.0 259.8
Interest rate swap.................... 13.8 13.8 15.6 15.6
--------------- --------------- --------------- ---------------
Total indebtedness.................... $ 642.5 $ 665.1 $ 644.3 $ 614.4
=============== =============== =============== ===============
Interest expense on our indebtedness, including amortization of debt issuance costs, for the three and nine
month periods ended September 30, 2003 and 2002 follows ($ amounts in millions):
Three Months Nine Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Surplus notes......................... $ 3.0 $ 3.0 $ 9.1 $ 9.1
Equity units.......................... 3.0 -- 9.1 --
Senior unsecured bonds................ 3.7 3.9 11.1 11.5
Bank credit facility and other........ 0.1 0.8 0.2 2.5
--------------- --------------- --------------- ---------------
Total interest expense................ $ 9.8 $ 7.7 $ 29.5 $ 23.1
=============== =============== =============== ===============
Common Stock Dividends
On April 28, 2003, we declared a dividend of $0.16 per share to our shareholders of record on June 13, 2003;
we paid the dividend on July 11, 2003. In the prior year, we declared a dividend of $0.16 per share on May 15,
2002 to our shareholders of record on June 14, 2002; we paid that dividend on July 10, 2002.
7. Income Taxes
The allocation of income taxes to elements of comprehensive income (loss) and between current and deferred for
the three and nine month periods ended September 30, 2003 and 2002 follows ($ amounts in millions):
Three Months Nine Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Income taxes (benefit) applicable to:
Income (loss) before cumulative
effect of accounting change........... $ 5.6 $ (26.0) $ (31.4) $ (40.4)
Cumulative effect of accounting
change................................ -- -- -- (11.4)
--------------- --------------- --------------- ---------------
Net income (loss)....................... $ 5.6 $ (26.0) $ (31.4) $ (51.8)
Other comprehensive income (loss)....... (20.8) (10.4) 6.5 11.2
--------------- --------------- --------------- ---------------
Comprehensive loss...................... $ (15.2) $ (36.4) $ (24.9) $ (40.6)
=============== =============== =============== ===============
Current................................. $ (2.6) $ 24.3 $ (5.4) $ (3.7)
Deferred................................ (12.6) (60.7) (19.5) (36.9)
--------------- --------------- --------------- ---------------
Income tax benefit applicable to
comprehensive (income) loss........... $ (15.2) $ (36.4) $ (24.9) $ (40.6)
=============== =============== =============== ===============
21
For the three and nine months ended September 30, 2003 and 2002, the effective income tax rates applicable to
income from continuing operations differ from the 35.0% U.S. federal statutory tax rate. Items giving rise to
the differences and the effects are as follows ($ amounts in millions):
Three Months Nine Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Income taxes at statutory rate.......... $ 7.9 $ (40.6) $ (19.5) $ (46.4)
Tax advantaged investment income........ (2.0) (2.6) (5.0) (5.7)
Non-taxable minority interest income.... (1.0) (1.1) (2.7) (3.2)
Intangible assets impairments........... -- 19.5 -- 19.5
Other, net.............................. 0.7 (1.2) (4.2) (4.6)
--------------- --------------- --------------- ---------------
Income taxes (benefit) applicable to
continuing operations................. $ 5.6 $ (26.0) $ (31.4) $ (40.4)
=============== =============== =============== ===============
Effective income tax (benefit) rates.... 25% (22)% (56)% (30)%
=============== =============== =============== ===============
8. Employee Benefits
During the three and nine month periods ended September 30, 2003, we contributed 135,977 and 293,414 treasury
shares, respectively, to fund the employer match for our saving and investment benefit plans. These shares had
a cost basis of $2.2 million and $4.7 million (weighted average cost of $15.83 per share) and an aggregate
market value of $1.4 million and $2.6 million for the three and nine month periods, respectively.
Stock-based Compensation
Pro forma earnings and earnings per share as if we had applied the fair value method of accounting for all
stock-based compensation for the three and nine month periods ended September 30, 2003 and 2002 follow ($
amounts in millions, except per share amounts):
Three Months Nine Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net income (loss), as reported.......... $ 14.0 $ (93.0) $ (32.3) $ (231.6)
Add: Employee stock option compensation
expense included in net income (loss),
net of applicable income taxes........ 0.1 -- 0.1 --
Deduct: Employee stock option
compensation expense determined under
fair value accounting for all awards,
net of applicable income taxes........ 1.2 2.4 3.4 5.3
--------------- --------------- --------------- ---------------
Pro forma net income (loss)............. $ 12.9 $ (95.4) $ (35.6) $ (236.9)
=============== =============== =============== ===============
Basic earnings (loss) per share:
As reported......................... $ .15 $ (.96) $ (.34) $ (2.34)
Pro forma........................... $ .14 $ (.99) $ (.38) $ (2.39)
Diluted earnings (loss) per share:
As reported......................... $ .14 $ (.96) $ (.34) $ (2.34)
Pro forma........................... $ .13 $ (.99) $ (.38) $ (2.39)
During the third quarter of 2003, we granted 431,089 stock options which vest over three years. The options
had a weighted-average fair value of $4.15 per option ($1.8 million aggregate) which we are expensing over
their three-year vesting period.
22
During the second quarter of 2003, we granted 100,000 stock options which vest over three years. The options
have a weighted-average fair value of $3.65 per option ($0.4 million aggregate) which we are expensing over
their three-year vesting period.
Restricted Stock Units
On July 1, 2003, we awarded 5,537 restricted stock units valued at $9.03 per share ($0.1 million aggregate) to
certain directors as payment of their retainer for the current quarter. We recognized the expense associated
with this grant during the current quarter.
On June 26, 2003, we awarded 161,769 restricted stock units valued at $9.07 per share ($1.5 million aggregate)
to certain employees to satisfy our deferred compensation liabilities with them. We recognized no expense
associated with this issuance as the expense was recognized previously when the liabilities were accrued.
On April 14, 2003, we awarded 255,004 restricted stock units valued at $7.843 per share ($2.0 million
aggregate) to an employee; on January 1, 2003, we awarded 394,737 restricted stock units valued at $7.60 per
share ($3.0 million aggregate) to an employee. We recognized $0.4 million and $1.1 million in compensation
expense for these awards during the three and nine month periods ended September 30, 2003, respectively.
During the third quarter of 2002, we awarded 573,477 restricted stock units valued at $13.95 per share ($8.0
million aggregate) to an employee. We recognized the expense associated with the award during that quarter.
At September 30, 2003, we had 1,390,524 restricted stock units issued (573,477 units at year-end 2002). We
will issue the shares underlying these awards on the later of June 26, 2006 or each employee's and each
director's termination or retirement.
9. Earnings Per Share
The following table presents the shares used in the calculation of basic and diluted earnings per share for
the three and nine month periods ended September 30, 2003 and 2002 (amounts in thousands):
Three Months Nine Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Weighted average common shares
outstanding........................... 94,276 96,570 94,158 99,087
--------------- --------------- --------------- ---------------
Effect of potential common shares:
Equity units.......................... 2,531 -- -- --
Restricted stock units................ 1,390 19 1,181 6
Employee stock options................ 75 -- 5 --
--------------- --------------- --------------- ---------------
Potentially dilutive common shares...... 3,996 19 1,186 6
Less: anti-dilutive potential common
shares................................ -- 19 1,186 6
--------------- --------------- --------------- ---------------
Dilutive potential common shares........ 3,996 -- -- --
--------------- --------------- --------------- ---------------
Weighted average common shares
outstanding and dilutive potential
common shares......................... 98,272 96,570 94,158 99,087
=============== =============== =============== ===============
Other common stock equivalents have exercise prices that were above the average closing price of our common
stock during the periods presented. During the three month period ended September 30, 2003, these primarily
include stock options related to 4,087,146 of our common shares. The stock option exercise prices of $10.49 to
$16.20 per share were greater than the average per share market price of our common stock of $10.32 for the
three month period ended September 30, 2003. During the nine month period ended September 30, 2003, these
include stock options (as discussed above) and equity units (related to 17,423,859 to 21,256,826 of our common
shares depending on our February 2006 quoted market price). The stock options' exercise price and equity
units'
23
threshold appreciation price of $8.8206 were greater than the average market price of our common stock of
$8.74 for the nine month period ended September 30, 2003.
Treasury Stock
During the three and nine month periods ended September 30, 2002, we purchased 3.6 million and 7.5 million
shares, respectively, of our common stock in the market at weighted average per share prices of $15.41 and
$16.61, respectively.
10. 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 to 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 aggregate
excess-of-loss reinsurance (finite reinsurance) and other reinsurance to cover our losses and the likely legal
and administrative costs of winding down the business.
Our total reserves were $80.0 million and our total reinsurance recoverable balances related to paid losses
were $175.0 million at September 30, 2003. In addition, in 1999 we purchased finite reinsurance to further
protect us from unfavorable results from this discontinued business. The maximum coverage available from our
finite reinsurance is currently $120.0 million. The amount of our total financial provisions at September 30,
2003 was, therefore, $25.0 million, consisting of reserves, less reinsurance recoverable balances, plus the
amount currently available from our finite reinsurance. We did not establish any additional financial
provisions during the three and nine month periods ended September 30, 2003 and 2002.
We expect our reserves and reinsurance 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.
Given the uncertainty associated with litigation and other dispute resolution proceedings, as described below,
our 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.
Unicover Managers, Inc.
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 two other facilities (Unicover 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 but 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
24
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. In October 2002, the arbitration
panel issued its decision that the agreement by which we provided retrocessional reinsurance to the pool was
valid only to the extent of business bound or renewed to that agreement on or before August 31, 1998. This
decision had the effect of granting us a substantial discount on our potential liabilities, because most of
the business was bound or renewed to the agreement after August 31, 1998. In a clarification dated January 4,
2003, the arbitration panel confirmed its decision. A significant portion of our remaining potential
liabilities as a retrocessionaire of the pool may be recovered from our retrocessionaires.
In one of the Unicover facilities' settlements, the Reliance facility settlement of January 2000, we paid a
settlement amount of $97.9 million and were released from all of our obligations as a retrocessionaire of the
facility. Subsequently, we were reimbursed by one of our retrocessionaires for $38.8 million of the amount we
paid under the settlement. A significant portion of the remainder of the settlement payment may be recovered
from certain of our other retrocessionaires.
In the other Unicover facilities' settlement, the Lincoln facility settlement of March 2000, we paid a
settlement amount of $11.6 million and were released from all of our obligations as a retrocessionaire of the
facility. A significant portion of the settlement payment may be recovered from certain of our
retrocessionaires. The likelihood of obtaining the additional recoveries from our retrocessionaires cannot be
estimated with a reliable degree of certainty at this stage of our recovery efforts. This is due in part to
the lack of sufficient claims information (which has resulted from disputes among ceding reinsurers leading to
delayed processing, reporting blockages and standstill agreements among reinsurers) and in part to the matters
discussed below under "Related Proceedings."
The amounts paid and results achieved in the above settlements and arbitration decision are reflected in our
consolidated financial statements. As the amounts previously reserved for these matters were sufficient, we
established no additional reserves with respect to these settlements and arbitration decision.
Related Proceedings
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 two 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.
With one of those retrocessionaires, we have three disputes. One concerns an agreement under which the
retrocessionaire reinsures us for up to $45 thousand per loss in excess of a $5 thousand retention. In June
2003, the arbitration panel issued its decision which upheld in all material respects the retrocessional
obligations to us. The decision is the subject of a pending appeal only with respect to the Unicover business.
The other two disputes will not have a material effect on our reinsurance recoverable balances. As of
September 30, 2003, the
25
reinsurance recoverable balance from this retrocessionaire related to paid losses was $57.0 million, subject
to further development.
The dispute with the other retrocessionaire, which seeks to avoid an excess-of-loss retrocession agreement, a
surplus share retrocession agreement and a quota share retrocession agreement, is the subject of a pending
arbitration that is scheduled for November, 2003. As of September 30, 2003, the reinsurance recoverable
balance from this retrocessionaire related to paid losses was $9.0 million, subject to further development.
We have entered into a standstill agreement with another retrocessionaire under which both parties have agreed
not to commence any proceedings against the other without providing written notice within a specified period.
The purpose of the agreement is to allow the parties to investigate the existence and extent of their
contractual obligations to each other. As of September 30, 2003, the reinsurance recoverable balance from this
retrocessionaire related to paid losses was $71.0 million, subject to further development.
At this stage, we cannot predict the outcome of the above matters, nor can we estimate the amount at risk with
a reliable degree of certainty. This is due in part to our lack of sufficient claims information (which has
resulted from disputes among ceding reinsurers that have led to delayed processing, reporting blockages, and
standstill agreements among reinsurers). This applies with regard both to business related to Unicover and not
related to Unicover.
Other Proceedings
Another set of disputes involves personal accident business that was reinsured in the mid-1990s in the London
reinsurance market in which we participated. These 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 litigation or arbitration in attempts 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. At this stage, we cannot predict the outcome, nor can we estimate the amount at risk with a
reliable degree of certainty. This is due in part to our lack of sufficient claims information (which has
resulted from disputes among ceding reinsurers that have led to delayed processing, reporting blockages, and
standstill agreements among reinsurers).
26
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 financial strength ratings of the company's subsidiaries or in
the company's 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 continued 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.
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 September 30, 2003 as compared to year-end 2002; our consolidated results of
operations for the three and nine month periods ended September 30, 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.
27
Overview
We are a manufacturer of insurance, annuity and asset management products for the accumulation, preservation
and transfer of wealth. We provide products and services to affluent and high net worth individuals through
their advisors and to institutions directly and through consultants.
We have two operating segments - Life and Annuity and Asset Management - which include three businesses: life
insurance, annuities and asset 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 combinations
In the second quarter of 2003, we acquired the remaining interests in PFG Holdings, Inc. and Capital West
Asset Management, LLC not already owned by us for $17.8 million. On January 29, 2002, we acquired a 60%
interest in Kayne Anderson Rudnick Investment Management, LLC (Kayne Anderson Rudnick) for $102.4 million;
management of the company retained the remaining ownership interest. For additional information, see Note 1 to
our consolidated financial statements in this Form 10-Q.
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). For additional
information, see notes to our consolidated financial statements in this Form 10-Q, specifically Note 1
regarding the demutualization and Note 3 for more information regarding the closed block.
Recently Issued Accounting Standards
For information on recently issued accounting standards, see Note 1 to our consolidated financial statements
in this Form 10-Q.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our
consolidated financial statements, which have been prepared in accordance with GAAP. GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results will differ from those estimates.
Critical accounting policies are reflective of significant judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain. The following are areas that we believe
require significant judgments, together with references to the note(s) to our consolidated financial
statements where each accounting policy is discussed as it relates to our business:
o Deferred Policy Acquisition Costs, or DAC, and Present Value of Future Profits, or PVFP
The costs of acquiring new business, principally commissions and underwriting, distribution and policy
issue expenses, all of which vary with and are primarily related to production of new business, are
deferred. We recognized assets for the present value of future profits (PVFP) representing the present
value of estimated net cash flows embedded in the existing contracts acquired in connection with our
acquisitions of Confederation Life (1997), Valley Forge Life (2002) and PFG Holdings (2003). PVFP is
included in deferred acquisition costs (DAC).
28
We amortize DAC and PVFP based on the related policy's classification. For individual participating life
insurance policies, DAC and PVFP are amortized in proportion to estimated gross margins. For universal
life, variable universal life and accumulation annuities, DAC and PVFP are amortized in proportion to
estimated gross profits. Policies may be surrendered for value or exchanged for a different one of our
products (internal replacement). The DAC balance associated with the replaced or surrendered policies is
amortized to reflect these surrenders.
The estimation of gross profits, or EGPs, requires the use of various assumptions about the future.
Significant assumptions include expenses, investment performance, mortality and policy cancellations
(i.e., lapses, withdrawals and surrenders). The separate account fund performance assumption is critical
to the development of the EGPs related to our variable annuity and variable life insurance businesses.
The average long-term rate of assumed separate account fund performance used in estimating gross profits
was 7% for the variable annuity business and 8% for the variable life business. All assumptions are
reviewed on a regular basis and are generally based on our past experience, industry studies, regulatory
requirements and judgments about the future.
Changes in estimated gross margins and gross profits based on a review of the assumptions and actual
experience are reflected as an adjustment to total amortization to date resulting in a charge or credit
to earnings. Finally, analyses are performed periodically to assess whether there are sufficient gross
margins or gross profits to amortize the remaining DAC balances.
See Note 3 to our consolidated financial statements in both our 2002 Annual Report on Form 10-K and in
this Form 10-Q and Item 3, Quantitative and Qualitative Disclosures About Market Risk herein for more
information.
o Policy Liabilities and Accruals
See Note 3 to our consolidated financial statements in both our 2002 Annual Report on Form 10-K and in
this Form 10-Q and Item 3, Quantitative and Qualitative Disclosures About Market Risk herein for more
information.
o Goodwill and Other Intangible Assets
At the beginning 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 intangible assets with
definite estimated lives. For goodwill and indefinite-lived intangible assets, we perform impairment
tests at the reporting-unit level at least annually. For purposes of the impairment test, the fair value
of the reporting units is based on the sum of: a multiple of revenue, plus the fair value of the units'
tangible net assets. Prior to 2002, we generally amortized goodwill over 40 years and investment
management contracts and employment contracts over five to 16 years and three to seven years,
respectively. All amortization expense has been and continues to be calculated on a straight-line basis.
See Note 4 to our consolidated financial statements in both our 2002 Annual Report on Form 10-K and in
this Form 10-Q for more information.
o Valuation of Debt and Equity Securities
We classify our debt and equity securities as available-for-sale and report them in our balance sheet at
fair value. Fair value is based on quoted market price, where available. When quoted market prices are
not available, we estimate fair value by discounting debt security cash flows to reflect 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
29
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. For mortgage-backed and other asset-backed debt securities,
we recognize income using a constant effective yield based on anticipated prepayments and the estimated
economic lives of the securities. When actual prepayments differ significantly from anticipated
prepayments, the effective yield is recalculated to reflect actual payments to date and any resulting
adjustment is included in net investment income. For certain asset-backed securities, changes in
estimated yield are recorded on a prospective basis and specific valuation methods are applied to these
securities to determine if there has been an other-than-temporary decline in value. We report mortgage
loans at unpaid principal balances, net of valuation reserves on impaired mortgages. We consider a
mortgage loan to be impaired if we believe it is probable that we will be unable to collect all amounts
of contractual interest and principal as scheduled in the loan agreement. We do not accrue interest
income on impaired mortgage loans when the likelihood of collection is doubtful.
See Note 5 to our consolidated financial statements in both our 2002 Annual Report on Form 10-K and in
this Form 10-Q, the Debt and Equity Securities section of Management's Discussion and Analysis and Item
3, Quantitative and Qualitative Disclosures About Market Risk for more information.
o Valuation of Investments in Affiliates
We evaluate our equity method investments for an other-than-temporary impairment at each balance sheet
date considering quantitative and qualitative factors including quoted market price of underlying equity
securities, the duration the carrying value is in excess of fair value, historical and projected earnings
and cash flow capacity.
See Note 5 to our consolidated financial statements in both our 2002 Annual Report on Form 10-K and in
this Form 10-Q and the Aberdeen Asset Management section of Management's Discussion and Analysis for more
information.
o Valuation of Investments in Venture Capital Partnerships
We record our equity in the earnings of venture capital partnerships in net investment income using the
most recent financial information received from the partnerships and estimating the earnings for any lag
in reporting. In the first quarter of 2001, we changed our accounting for venture capital partnership
earnings to eliminate the quarterly lag in information provided to us. We did this by estimating the
change in our share of partnership earnings for the quarter. This resulted in a $75.1 million charge
($48.8 million after income taxes), representing the cumulative effect of this accounting change on the
fourth quarter of 2000.
To estimate the net equity in earnings of the venture capital partnerships for each quarter, we developed
a methodology to estimate the change in value of the underlying investee companies in the venture capital
partnerships. For public investee companies, we use quoted market prices at the end of each quarter,
applying liquidity discounts to these prices in instances where such discounts were applied in the
underlying partnerships' financial statements. For private investee companies, we apply a public industry
sector index to roll the value forward each quarter. We apply this methodology consistently each quarter
with subsequent adjustments to reflect market events reported by the partnerships (e.g., new rounds of
financing, initial public offerings and writedowns by the general partners). Our methodology recognizes
both downward and upward change in value of the underlying investee companies, but we do not exceed the
value last reported by the partnerships. We adjust estimated partnership results to actual results
reported by the venture capital partnerships in the period in which venture capital partnerships
financial statements are received. The effect of adjusting estimated partnership results to actual
results was to increase (decrease) investment income by $4.3 million and $33.4 million for the three and
nine months ended September 30, 2003, respectively, and by $(0.8) million and $12.8 million for the three
and nine months ended September 30, 2002.
See Note 5 to our consolidated financial statements in both our 2002 Annual Report on Form 10-K and in
this Form 10-Q for more information.
30
o Pension and Other Post-employment Benefits
See Note 10 to our consolidated financial statements in our 2002 Annual Report on Form 10-K for more
information on our pension and other post- employment benefits.
Consolidated Results of Operations
The following table and discussion presents summary consolidated financial data for the three and nine month
periods ended September 30, 2003 and 2002 ($ amounts in millions).
Three Months Nine Months
----------------------------------- -----------------------------------
2003 2002 Change 2003 2002 Change
----------- ----------- ----------- ----------- ----------- -----------
REVENUES:
Premiums............................. $ 286.9 $ 297.1 $ (10.2) $ 781.5 $ 813.9 $ (32.4)
Insurance and investment product
fees............................... 143.6 139.4 4.2 410.3 425.6 (15.3)
Investment income, net of expenses... 254.2 228.8 25.4 794.7 675.7 119.0
Net realized investment losses....... (2.6) (10.5) 7.9 (119.5) (74.1) (45.4)
----------- ----------- ----------- ----------- ----------- -----------
Total revenues....................... 682.1 654.8 27.3 1,867.0 1,841.1 25.9
----------- ----------- ----------- ----------- ----------- -----------
BENEFITS AND EXPENSES:
Policy benefits, excluding
policyholder dividends............. 389.0 397.9 (8.9) 1,088.2 1,070.7 17.5
Policyholder dividends............... 99.5 112.7 (13.2) 310.2 294.4 15.8
Policy acquisition cost amortization. 22.7 41.1 (18.4) 76.6 41.6 35.0
Intangible asset amortization........ 8.3 8.9 (0.6) 24.9 24.8 0.1
Intangible asset impairments......... -- 66.3 (66.3) -- 66.3 (66.3)
Interest expense..................... 9.8 7.7 2.1 29.5 23.1 6.4
Other operating expenses............. 130.3 136.1 (5.8) 393.3 452.7 (59.4)
----------- ----------- ----------- ----------- ----------- -----------
Total benefits and expenses.......... 659.6 770.7 (111.1) 1,922.7 1,973.6 (50.9)
----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes
and minority interest.............. 22.5 (115.9) 138.4 (55.7) (132.5) 76.8
Applicable income taxes (benefit).... 5.6 (26.0) 31.6 (31.4) (40.4) 9.0
----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before minority
interest........................... 16.9 (89.9) 106.8 (24.3) (92.1) 67.8
Minority interest in net income
of subsidiaries.................... 2.9 3.1 (0.2) 8.0 9.2 (1.2)
----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before cumulative
effect of accounting change........ 14.0 (93.0) 107.0 (32.3) (101.3) 69.0
Cumulative effect of accounting
change............................. -- -- -- -- (130.3) 130.3
----------- ----------- ----------- ----------- ----------- -----------
Net income (loss).................... $ 14.0 $ (93.0) $ 107.0 $ (32.3) $(231.6) $ 199.3
=========== =========== =========== =========== =========== ===========
For the three and nine month periods, premium revenue decreased by $10.2 million and $32.4 million, or 3% and
4%, respectively, primarily due to a continued shift in sales from participating life to universal life
products as well as to a continued decline of the participating life in-force business. Compared to the prior
year three and nine month periods, premium revenue for participating life policies decreased by $12.4 million
to $279.2 million from $291.6 million, and by $32.7 million to $764.2 million from $796.9 million,
respectively.
31
For the three month period ending September 30, 2003, insurance and investment product fees increased $4.2
million, or 3%, over the comparable period in 2002, due primarily to higher sales in universal life products
and a growing in-force in universal life and variable universal life products partially offset by lower fees
from private client and institutional assets under management. For the nine months ending September 30, 2003
insurance and investment product fees decreased by $15.3 million, or 4%, from the comparable period in 2002,
primarily due to decreases in both private client and institutional assets under management. This decrease was
partially offset by higher sales and a growing in-force in universal life and variable universal life
products.
For the three and nine month periods ended September 30, 2003, net investment income increased by $25.4
million and $119.0 million, respectively, over the comparable periods in the prior year. The three month
increase was primarily due to the effects of overall improved market conditions on our venture capital segment
partially offset by lower yields on general account assets in our life and annuity segment. The nine month
increase is attributable to improved market conditions and the reconciliation to the partnerships' financial
statements in our venture capital segment and to increased general account spread-type funds in our life and
annuity segment.
For the three month period ended September 30, 2003, net realized investment losses decreased $7.9 million
from the comparable period in the prior year due to improved credit market conditions during the current year
quarter. For the nine month period ended September 30, 2003, net realized investment losses increased by $45.4
million over the comparable period in the prior year primarily due to an other-than-temporary impairment
($58.0 million after income taxes) on our ownership of Aberdeen common stock during the second quarter of
2003. See Debt and Equity Securities section of Management's Discussion and Analysis for more information.
For the three month period ending September 30, 2003, policy benefits, including policyholder dividends,
decreased $22.1 million to $488.5 million from $510.6 million, or 4%, from the comparable period in 2002
primarily due to decreased policyholder dividends from lower growth in the policyholder dividend obligation
and decreased change in reserves as a result of lower revenues. For the nine month period ending September 30,
2003, policy benefits, including policyholder dividends, increased $33.3 million, or 2%, from $1,365.1 million
to $1,398.4 million primarily due to the impact of realized investment losses on dividend expense. In the 2003
dividend expense was higher due to the impact of $4.5 million in realized investment gains, a change of $39.5
million from the 2002 realized investment gain of $44.0 million.
For the three month period ending September 30, 2003, policy acquisition cost amortization, decreased $18.4
million to $22.7 million from $41.1 million, or 45%, from the comparable period in 2002 primarily due to write
downs of deferred acquisition costs during the prior year quarter related to revisions of our long-term market
return assumption for annuities and a charge related to equity market declines that affected the value of
assets of the Valley Forge Life block that we purchased during the 2002 quarter. For the nine month periods
ending September 30, 2003 and 2002, policy acquisition cost amortization increased $35.0 million, or 84%, from
$41.6 million to $76.6 million primarily due to higher amortization for participating life insurance and
increased amortization for variable universal life and annuities partially offset by higher write downs during
the third quarter of the prior year.
Our income tax expense (benefit) of $5.6 million and $(31.4) million applicable to income before income taxes
and minority interest for the three and nine month periods ended September 30, 2003, respectively, differed
from the statutory U.S. federal income tax expense (benefit) of $7.4 million and $(19.5) million,
respectively, as a result of the tax benefits associated with low income housing tax credits and non-taxable
dividend and interest income. The nine month period ended September 30, 2003 was also affected by the recovery
of interest amounts previously paid to the Internal Revenue Service. The effective income tax benefit of
$(26.0) million and $(40.4) million for the three and nine month periods ended September 30, 2002 also
differed from the statutory U.S. federal income tax benefit of $(40.6) million and $(46.4) million,
respectively, as a result of tax benefits associated with low income housing tax credits, non-taxable dividend
and interest income, the recovery of non-taxable amounts related to an I.R.S. settlement offset by the tax
expense related to the impairment of intangible assets.
32
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 benefit rate for the three and nine month periods ended September 30,
2002 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 are several smaller subsidiaries and investment activities which do not meet the thresholds of
reportable segments. These include our remaining 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.
The following amounts, net of applicable income taxes and other offsets, are included in income (loss) before
cumulative effect of accounting change for the three and nine month periods ended September 30, 2003 and 2002
but are excluded from our operating segment results:
Three Months Nine Months
--------------------------------- ---------------------------------
2003 2002 Change 2003 2002 Change
---------- ----------- ---------- ---------- ---------- ----------
Net realized investment gains
(losses)........................... $ 2.5 $ (7.6) $ 10.1 $ (69.1) $ (16.7) $ (52.4)
Management restructuring charges
and early retirement costs......... -- (3.6) 3.6 (4.3) (25.4) 21.1
Deferred policy acquisition
cost adjustment.................... -- -- -- -- 15.1 (15.1)
Other income......................... -- -- -- 1.3 -- 1.3
Demutualization expense.............. -- -- -- -- (1.2) 1.2
---------- ----------- ---------- ---------- ---------- ----------
Total................................ $ 2.5 $ (11.2) $ 13.7 $ (72.1) $ (28.2) $ (43.9)
========== =========== ========== ========== ========== ==========
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 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.
33
Life and Annuity Segment
The following table and discussion present summary financial data relating to the Life and Annuity segment for
the three and nine month periods ended September 30, 2003 and 2002 ($ amounts in millions).
Three Months Nine Months
------------------------------------ -----------------------------------
2003 2002 Change 2003 2002 Change
----------- ------------ ----------- ----------- ----------- -----------
Results of Operations
Premiums............................ $ 286.9 $ 297.1 $ (10.2) $ 781.5 $ 813.9 $ (32.4)
Insurance and investment product
fees.............................. 84.7 78.7 6.0 242.5 235.2 7.3
Net investment income............... 243.2 245.1 (1.9) 742.8 705.4 37.4
----------- ------------ ----------- ----------- ----------- -----------
Total segment revenues.............. 614.8 620.9 (6.1) 1,766.8 1,754.5 12.3
----------- ------------ ----------- ----------- ----------- -----------
Policy benefits, including
policyholder dividends............ 491.8 506.0 (14.2) 1,397.0 1,400.7 (3.7)
Policy acquisition cost
amortization...................... 25.5 41.2 (15.7) 77.7 68.2 9.5
Other operating expenses............ 73.1 75.6 (2.5) 222.7 231.4 (8.7)
----------- ------------ ----------- ----------- ----------- -----------
Total segment benefits and
expenses.......................... 590.4 622.8 (32.4) 1,697.4 1,700.3 (2.9)
----------- ------------ ----------- ----------- ----------- -----------
Segment income (loss) before
income taxes and minority
interest.......................... 24.4 (1.9) 26.3 69.4 54.2 15.2
Allocated income taxes (benefit).... 10.5 (0.7) 11.2 22.5 19.0 3.5
----------- ------------ ----------- ----------- ----------- -----------
Segment income (loss) before
minority interest................. 13.9 (1.2) 15.1 46.9 35.2 11.7
Minority interest in net income
of consolidated subsidiaries..... -- -- -- 0.4 -- 0.4
----------- ------------ ----------- ----------- ----------- ----------
Segment income (loss)............... 13.9 (1.2) 15.1 46.5 35.2 11.3
Net realized investment gains
(losses), net of income taxes
and other offsets................. (1.7) 0.9 (2.6) 0.9 (5.7) 6.6
Deferred acquisition cost
adjustment, net of income taxes... -- -- -- -- 14.4 (14.4)
Other adjustments, net of income
taxes............................. -- -- -- -- 0.7 (0.7)
----------- ------------ ----------- ----------- ----------- -----------
Segment net income (loss)........... $ 12.2 $ (0.3) $ 12.5 $ 47.4 $ 44.6 $ 2.8
=========== ============ =========== =========== =========== ===========
For the three and nine month periods, premium revenue decreased by $10.2 million and $32.4 million, or 3% and
4%, respectively, primarily due to a continued shift in sales from participating life to universal life
products as well as to a continued decline of the participating life in-force business. Compared to the prior
year three and nine month periods, premium revenue for participating life insurance policies decreased by $12.4
million to $279.2 million from $291.6 million, and by $32.7 million to $764.2 million from $796.9 million,
respectively.
For the three and nine month periods, insurance and investment product fees increased by $6.0 million and $7.3
million, or 8% and 3%, respectively, primarily due to higher sales in universal life products and a growing
in-force in universal life and variable universal life products. Life insurance in-force for universal life
and variable universal life was 19% and 9% higher at September 30, 2003 than at September 30, 2002.
Specifically, higher net amounts at risk in these two lines of business, as well as, higher sales of universal
life products resulted in recognition of higher fees.
Net investment income for the three and nine month periods ending September 30, 2003, decreased by $1.9
million and increased by $37.4 million, or 1% and 5%, respectively, over the same periods in the prior year.
The decrease for the three month periods was due to lower yields on general account assets. The nine month
increase was due to increased general account spread-type funds partially offset by lower rates earned on
invested assets. At September 30, 2003, annuity funds under management for general account funds under
management were approximately $1.1 billion higher than at September 30, 2002.
34
For the three month periods ending September 30, 2003, policy benefits, including policyholder dividends,
decreased $14.2 million to $491.8 million from $506.0 million, or 3%, from the comparable period in 2002
primarily due to decreased policyholder dividends from lower growth in the policyholder dividend obligation and
decreased change in reserves as a result of lower premium revenues. For the nine month periods ending,
September 30, 2003 and 2002, policy benefits, including policyholder dividends, decreased $3.7 million, or
0.3%, from $1,400.7 million to $1,397.0 million primarily due to decreased policyholder dividends and change in
reserves partially offset by higher interest credited on guaranteed interest accounts and fixed annuities.
For the three month period ending September 30, 2003, policy acquisition cost amortization, decreased $15.7
million to $25.5 million from $41.2 million, or 38%, from the comparable period in 2002 primarily due to write
downs of deferred acquisition costs during the prior year quarter related to revisions of our long-term market
return assumption for annuities and a charge related to equity market declines that affected the value of
assets of the Valley Forge block that we purchased during the 2002 quarter. For the nine month periods ending
September 30, 2003 and 2002, policy acquisition cost amortization increased $9.5 million, or 14%, from $68.2
million to $77.7 million primarily due to higher amortization for participating life insurance and increased
amortization for variable universal life and annuities partially offset by higher write downs during the third
quarter of the prior year (as described above).
For the three and nine month periods ending September 30, 2003, allocated income taxes increased $11.2 million
and $3.5 million, respectively, from the same periods in the prior year as a result of higher segment income
before income taxes as well as a current year allocation of the tax effects of tax advantaged investments to
the Life and Annuity segment.
Life and Annuity segment revenues by product for the three and nine month periods ended September 30, 2003 and
2002 are as follows:
Three Months Nine Months
-------------------------------------- --------------------------------------
2003 2002 Change 2003 2002 Change
----------- ------------ ------------- ------------ ------------ ------------
Variable universal life
insurance.................... $ 28.7 $ 28.3 $ 0.4 $ 85.8 $ 79.5 $ 6.3
Universal life insurance....... 49.5 48.4 1.1 145.1 145.4 (0.3)
Term life insurance............ 2.9 1.9 1.0 8.3 5.7 2.6
Other life insurance........... 38.8 34.6 4.2 107.7 110.9 (3.2)
----------- ------------ ------------- ------------ ------------ ------------
Total non-participating life
insurance.................... 119.9 113.2 6.7 346.9 341.5 5.4
Participating life insurance... 442.1 461.0 (18.9) 1,269.8 1,295.0 (25.2)
----------- ------------ ------------- ------------ ------------ ------------
Total life insurance........... 562.0 574.2 (12.2) 1,616.7 1,636.5 (19.8)
Annuities...................... 52.8 46.7 6.1 150.1 118.0 32.1
----------- ------------ ------------- ------------ ------------ ------------
Segment revenues............... $ 614.8 $ 620.9 $ (6.1) $ 1,766.8 $ 1,754.5 $ 12.3
=========== ============ ============= ============ ============ ============
For nine month period ended September 30, 2003, variable universal life product revenues increased $6.3
million, or 8%, over the comparable period in 2002, primarily due to higher cost of insurance fees, from
higher sales and a growing in-force, and higher surrender charges, partially offset by lower interest earned.
For the three month period ended September 30, 2003, universal life product revenues increased $1.1 million,
or 2%, over the comparable period in 2002, primarily due to higher cost of insurance and other fees, from
higher sales and a growing in-force, offset by lower interest earned.
For the three and nine month periods ended September 30, 2003, Term life revenues increased $1.0 and $2.6
million, or 53% and 46%, respectively, over the comparable periods in 2002, due to premium growth.
For the three month period ended September 30, 2003, other life insurance revenues increased $4.2 million, or
12%, over the comparable period in 2002, due primarily to higher revenue for its corporate owned life
insurance (COLI) business and certain of its non-life insurance subsidiaries. For the nine month period ended
35
September 30, 2003, other life insurance revenues decreased $3.2 million, or 3%, from the comparable periods
in 2002, primarily due to lower revenues in its non-life insurance subsidiaries, partially offset by higher
revenue in its COLI business.
For the three and nine month periods ended September 30, 2003, participating life product revenues decreased
$18.9 and $25.2 million, or 4% and 2%, respectively, from the comparable periods in 2002, primarily due to a
continued shift in sales from participating life to universal and variable universal life products as well as a
continued decline in participating life in-force business.
For the three and nine month periods ended September 30, 2003, annuity product revenues increased $6.1 and
$32.1 million, or 13% and 27%, respectively, over the comparable periods in 2002, primarily due to higher
interest earned on higher spread based asset funds.
Life and Annuity segment income before income taxes by product for the three and nine month periods ended
September 30, 2003 and 2002 is as follows:
Three Months Nine Months
------------------------------------- --------------------------------------
2003 2002 Change 2003 2002 Change
------------ ------------ ----------- ----------- ------------ -------------
Variable universal life
insurance...................... $ 10.5 $ 7.7 $ 2.8 $ 26.0 $ 25.8 $ 0.2
Universal life insurance......... 5.5 5.0 0.5 15.8 19.2 (3.4)
Term life insurance.............. 0.9 (0.8) 1.7 0.5 0.6 (0.1)
Other life insurance............. 0.2 (1.0) 1.2 3.4 (0.5) 3.9
------------ ------------ ----------- ----------- ------------ ------------
Total, non-participating life
insurance...................... 17.1 10.9 6.2 45.7 45.1 0.6
Participating life insurance..... 7.0 6.1 0.9 29.6 24.6 5.0
------------ ------------ ----------- ----------- ------------ ------------
Total, life insurance............ 24.1 17.0 7.1 75.3 69.7 5.6
Annuities........................ 0.3 (18.9) 19.2 (6.3) (15.5) 9.2
------------ ------------ ----------- ----------- ------------ ------------
Segment income (loss)
before income taxes............ $ 24.4 $ (1.9) $ 26.3 $ 69.0 $ 54.2 $ 14.8
============ ============ =========== =========== ============ ============
For the three month period ended September 30, 2003, variable universal life product pre-tax income increased
$2.8 million to $10.5 million, or 36%, over the comparable period in 2002. This was primarily due to favorable
insurance margins from our growing in-force and lower reinsurance costs and slightly higher surrender charges.
These were partially offset by lower interest on general account assets and lower fees due to a decrease in
non-private placement deposits. For the nine month period ended September 30, 2003, variable universal life
product pre-tax income for 2003 increased $0.2 million, or 1%, over the comparable period in 2002. The
increase was attributed to favorable insurance margins and higher surrender charges offset by higher
non-deferrable expenses and deferred amortization costs amortization due to favorable mortality.
For the three month period ended September 30, 2003, universal life product pre-tax income increased $0.5, or
10%, to $5.5 million from $5.0 million over the comparable period in 2002 due to higher investment margins
partially offset by unfavorable mortality. For the nine month period ended September 30, 2003, universal life
product pre-tax income for 2003 decreased $3.4 million, or 18%, from the comparable period in 2002 due to
lower investment margins and higher non-deferrable expenses.
For the three month period ended September 30, 2003, term product pre-tax income increased $1.7 million over
the same period in the prior year due primarily to favorable mortality.
For the three month period ended September 30, 2003, other life insurance pre-tax income increased $1.2
million over the same period in the prior year due to lower investment income for the 2002 quarter. For the
nine month period ended September 30, 2003, other life insurance pre-tax income increased $3.9 million over
the same period in the prior year due to favorable mortality and an old block of corporate-owned life
insurance business and the release of a reserve on a life contingent annuity due to the death of the
annuitant.
36
For the three and nine month periods ended September 30, 2003, participating life product pre-tax income
increased $0.9 million and $5.0 million, respectively, over the same periods in the prior year. The three
month increase was primarily due to lower non-deferrable expenses. The nine month increase was primarily due
primarily to a one-time investment gain during the second quarter of 2003 and lower non-deferrable expenses,
partially offset by higher deferred acquisition cost amortization and the release of a policyholder tax
contingency in the 2002 period that did not occur in 2003.
For the three month period ended September 30, 2003, annuity product pre-tax income increased $19.2 million,
or 102%, over the same period in the prior year due to charges recognized during the prior year period related
to increased deferred acquisition cost amortization due to lowering the assumed long-term assumed return from
8% to 7%, increased reserves for our guaranteed minimum death benefit, and a charge related to our purchase of
the Valley Forge block. For the nine month period ended September 30, 2003, annuity product pre-tax income
increased $9.2 million, or 59%, over the same period in the prior year primarily due to charges recognized
during the prior year which were partially offset this year by higher non-deferrable expenses and commissions
as well as spread compression.
Asset Management Segment
The following table and discussion present summary financial data relating to Asset Management segment for the
three and nine month periods ended September 30, 2003 and 2002 ($ amounts in millions).
Three Months Nine Months
------------------------------------- -----------------------------------
2003 2002 Change 2003 2002 Change
------------ ------------ ----------- ----------- ----------- -----------
Results of Operations
Investment product fees............ $ 61.1 $ 62.6 $ (1.5) $ 173.2 $ 199.4 $ (26.2)
Net investment income.............. 0.1 0.4 (0.3) 0.3 0.8 (0.5)
------------ ------------ ----------- ----------- ----------- -----------
Total segment revenues............. 61.2 63.0 (1.8) 173.5 200.2 (26.7)
------------ ------------ ----------- ----------- ----------- -----------
Intangible asset amortization...... 8.3 8.7 (0.4) 24.9 24.6 0.3
Intangible asset impairments....... -- 66.3 (66.3) -- 66.3 (66.3)
Other operating expenses........... 53.1 52.7 0.4 155.6 171.6 (16.0)
------------ ------------ ----------- ----------- ----------- ----------
Total segment expenses............. 61.4 127.7 (66.3) 180.5 262.5 (82.0)
------------ ------------ ----------- ----------- ----------- -----------
Segment income (loss) before
income taxes and minority
interest......................... (0.2) (64.7) 64.5 (7.0) (62.3) 55.3
Allocated income tax benefit....... (1.2) (5.2) 4.0 (5.6) (7.1) 1.5
------------ ------------ ----------- ----------- ----------- -----------
Segment income (loss) before
minority interest................ 1.0 (59.5) 60.5 (1.4) (55.2) 53.8
Minority interest in net income
of consolidated subsidiaries..... 2.9 3.1 (0.2) 7.6 9.2 (1.6)
------------ ------------ ----------- ----------- ----------- -----------
Segment loss....................... (1.9) (62.6) 60.7 (9.0) (64.4) 55.4
Restructuring and other costs,
net of income taxes.............. -- 1.5 (1.5) (3.1) (7.8) 4.7
Cumulative effect of accounting
change........................... -- -- -- -- (119.9) 119.9
------------ ------------ ----------- ----------- ----------- -----------
Segment net loss................... $ (1.9) $ (61.1) $ 59.2 $ (12.1) $ (192.1) $ 180.0
============ ============ =========== =========== =========== ===========
For the three and nine month periods ending September 30, 2003, investment product fees decreased $1.5 million
and $26.2 million, or 2% and 13%, respectively, from the comparable periods in 2002. These decreases were
primarily due to decreased fees from private client and institutional assets under management compared to the
same periods in the prior year.
Intangible asset impairments decreased $66.3 million, or 100%, during the three and nine month periods from
the comparable periods in the prior year due to an impairment of goodwill associated with certain of our
investment management partners during the three month period ended September 30, 2002. There have been no
impairments of intangible assets during the current year.
37
For the three month period ending September 30, 2003, other operating expenses increased $0.4 million, or 1%,
over the comparable period in the prior year primarily due to higher investment performance-based compensation
expense partially offset by lower non-compensation related operating expenses. For the nine month period
ending September 30, 2003, the decrease in other operating expenses for the comparable period in the prior
year was primarily due to a decrease of $11.5 million in compensation of which $3.2 million related to
incentive compensation.
For the three and nine months ended September 30, 2003, allocated income tax benefits decreased $4.0 million
and $1.5 million, respectively, from the comparable periods in the prior year as a result of lower segment
losses offset by the impact of non-deductible asset impairments in the prior year periods.
Assets under management were $57.3 billion and $54.0 billion, of which $15.4 billion and $14.5 billion at
September 30, 2003 and year-end 2002, respectively, were our Life Companies' assets, including the general
account and variable separate accounts. The increase in assets under management during the nine month period
is due primarily to positive investment performance of $3.3 billion. Net asset outflows from December 31, 2002
of $0.6 billion were offset by increases in our Phoenix general account of $0.7 billion.
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 contained herein.) 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.
During the first quarter of 2003, 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 sold and transferred totaled $52.2 million after realizing a loss of $19.3
million ($5.1 million recorded in 2002 and $14.2 million recorded in 2003). The unfunded commitments of the
partnerships sold and transferred totaled $27.2 million; the outside party and the closed block will each fund
half of these commitments. At the time of transfer, the partnerships transferred constituted less than 0.5% of
the assets of the closed block.
The following table and discussion present summary financial data relating to our Venture Capital segment for
the three and nine month periods ended September 30, 2003 and 2002 ($ amounts in millions).
Three Months Nine Months
------------------------------------- ------------------------------------
2003 2002 Change 2003 2002 Change
------------ ------------ ----------- ----------- ----------- ------------
Results of Operations
Net realized gains (losses)
on partnership cash and
stock distributions............. $ 6.2 $ (2.1) $ 8.3 $ 1.1 $ (7.2) $ 8.3
Net unrealized gains (losses)
on partnership investments...... 0.7 (17.8) 18.5 39.1 (44.0) 83.1
Partnership operating expenses.... (1.8) (2.1) 0.3 (5.4) (5.7) 0.3
------------ ------------ ----------- ----------- ----------- ------------
Segment net investment
income (loss)................... 5.1 (22.0) 27.1 34.8 (56.9) 91.7
Applicable income taxes
(benefit)....................... 1.8 (7.7) 9.5 12.2 (19.9) 32.1
------------ ------------ ----------- ----------- ----------- ------------
Segment net income (loss)......... $ 3.3 $ (14.3) $ 17.6 $ 22.6 $ (37.0) $ 59.6
============ ============ =========== =========== =========== ============
38
For the three and nine month periods ending September, 30, 2003, net investment income increased $27.1 million
and $91.7 million, respectively, over the comparable periods in the prior year due to overall improved market
conditions, primarily in private equity. The nine month increase was also attributable to the reconciliation
to the partnerships' audited fourth quarter financial statements to previously estimated amounts.
Our accounting methodology makes downward adjustments based on public market indices, but limits upward
adjustments to the amounts previously reported by the partnerships. Accordingly, we do not record gains until
they are reported by the partnerships. The effect of our adjusting estimated partnership results to actual
results was to increase (decrease) investment income by $(0.4) million and $33.4 million for the three and nine
months ended September 30, 2003, respectively, and by $(0.8) million and $12.8 million for the three and nine
months ended September 30, 2002.
Three Months Nine Months
------------------------------------- ------------------------------------
2003 2002 Change 2003 2002 Change
------------ ------------ ----------- ----------- ----------- ------------
Venture Capital Investments
Contributions (dollars
invested)...................... $ 6.0 $ 10.2 $ (4.2) $ 27.5 $ 30.7 $ (3.2)
Equity in earnings of
partnerships................... 5.1 (22.0) 27.1 34.8 (56.9) 91.7
Distributions.................... (12.4) (19.4) 7.0 (21.2) (34.9) 13.7
Proceeds from sale of
partnership interests and
transfer to closed block....... -- -- -- (52.2) -- (52.2)
Realized loss on sale of
partnership interests and
transfer to closed block....... -- -- -- (14.2) -- (14.2)
------------ ------------ ----------- ----------- ----------- ------------
Change in venture capital
investments.................... (1.3) (31.2) 29.9 (25.3) (61.1) 35.8
Venture capital segment
investments, beginning of
period......................... 203.8 261.8 (58.0) 227.8 291.7 (63.9)
------------ ------------ ----------- ----------- ----------- ------------
Venture capital segment
investments, end of period..... $ 202.5 $ 230.6 $ (28.1) $ 202.5 $ 230.6 $ (28.1)
============ =========== =========== =========== =========== ============
For the three months ended September 30, 2003, venture capital investments decreased $1.3 million, or 1%,
primarily due to distributions received during the current year quarter partially offset by contributions to
partnerships and net investment income as discussed above.
For the nine months ended September 30, 2003, venture capital investments decreased $25.3 million, or 11%,
primarily due to the sale of partnership interests to third parties and a transfer of partnership interests to
the closed block, all during the first quarter of 2003.
Corporate and Other Segment
The following table and discussion present summary financial data relating to Corporate and Other for the
three and nine month periods ended September 30, 2003 and 2002 ($ amounts in millions).
Three Months Nine Months
------------------------------------- ------------------------------------
2003 2002 Change 2003 2002 Change
------------ ------------ ----------- ----------- ------------ -----------
Results of Operations
Interest expense.................. $ (9.9) $ (7.7) $ (2.2) $ (29.5) $ (23.1) $ (6.4)
Other expenses, net............... (0.6) (2.4) 1.8 (4.9) (1.3) (3.6)
------------ ------------ ----------- ----------- ------------ -----------
Segment loss before income
taxes............................ (10.5) (10.1) (0.4) (34.4) (24.4) (10.0)
Allocated income tax benefit...... (6.7) (6.4) (0.3) (14.1) (17.5) 3.4
------------ ------------ ----------- ----------- ------------ -----------
Segment loss...................... (3.8) (3.7) (0.1) (20.3) (6.9) (13.4)
Net realized investment gains
(losses), net of income taxes... 4.2 (8.5) 12.7 (70.0) (11.0) (59.0)
Restructuring charges and
other, net of income taxes...... -- (5.1) 5.1 0.1 (18.8) 18.9
Cumulative effect of
accounting change............... -- -- -- -- (10.4) 10.4
------------ ------------ ---------- ---------- ------------ ------------
Segment net loss.................. $ 0.4 $ (17.3) $ 17.7 $ (90.2) $ (47.1) $ (43.1)
============ ============ ========== ========== ============ ============
39
For the three and nine-month periods, interest expense increased by $2.2 million and $6.4 million, or 29% and
28%, respectively, over the comparable periods in 2002 primarily due to increased indebtedness during the 2003
compared with 2002. This increase was primarily related to interest and issuance cost amortization associated
with the equity units issued in December 2002.
For the three-month period, other expenses, net decreased by $1.8 million, or 75%, from the comparable period
in 2002. The decrease for the three-month period is primarily due to higher investment income and improved
results from international and other non-core operations, partially offset by higher unallocated corporate
expenses. For the nine-month period, other expenses, net increased by $3.6 million, or 277%, over the
comparable period in 2002. The increase for the nine-month period was primarily due to higher net losses from
our international operations, partially offset by improved results from non-core operations and lower
unallocated corporate 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 Investment 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 sequity-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 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.
40
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 $1 million per contract.
Amounts held by our policyholders in RPE and other guaranteed interest accounts, or GIAs, and fixed annuities,
as of September 30, 2003 and year-end 2002 follow ($ amounts in millions):
2003 2002 Change
--------------- --------------- ---------------
Policyholder Deposit Funds
- --------------------------
Retirement Planners Edge GIAs............................ $ 1,245.2 $ 1,345.6 $ (100.4)
Other variable annuity GIAs.............................. 910.3 813.7 96.6
--------------- --------------- ---------------
Variable annuity GIAs.................................... 2,155.5 2,159.3 (3.8)
Fixed annuities.......................................... 1,055.7 737.2 318.5
--------------- --------------- ---------------
Total variable annuity GIAs and fixed annuities.......... $ 3,211.2 $ 2,896.5 $ 314.7
=============== =============== ===============
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.
Between July 2003 and September 15, 2003, we offered a Reallocation Benefit Rider to encourage RPE contract
holders to reallocate current balances from the GIA option into variable subaccount options. This rider
featured a 0.25% bonus upon reallocation, an additional 0.50% six months after the exchange and an additional
0.50% twelve months after the exchange. In addition, contract holders who chose to reallocate balances from
the GIA option were not able to reallocate such balances back to the GIA under this rider.
41
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 September 30, 2003, debt securities with a carrying value of $13,007.5 million
represented 78.4% of total investments. Public debt securities represented 78.5% of total debt securities,
with the remaining 21.5% represented by private debt securities.
Each year, the majority of our net cash flows are invested in investment grade debt securities. In addition,
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 also 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 September 30, 2003, our total
below investment grade securities totaled $1,119.5 million, or 8.6% of our total debt security portfolio. Of
that amount, $781.4 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 which
is equivalent to B or below) totaled $338.1 million, or 2.6% of our total debt security portfolio.
Our debt and equity securities are classified as available-for-sale and are reported at fair value with
unrealized gains or losses included in equity. Accordingly, the carrying value of such securities reflects
their fair value at the balance sheet date. Fair value is based on quoted market price, where available. When
quoted market prices are not available, we estimate fair value for debt securities by discounting projected
cash flows based on market interest rates currently being offered on similar terms to borrowers of similar
credit quality, by quoted market prices of comparable instruments and by independent pricing sources or
internally developed pricing models. Investments whose value, in our judgment, is considered to be
other-than-temporarily impaired are written-down to fair value as a charge to realized losses included in our
earnings. The cost basis of these written-down investments is adjusted to fair value at the date the
determination of impairment is made. The new cost basis is not changed for subsequent recoveries in value.
The following table presents our debt security portfolio at fair value as of September 30, 2003 and year-end
2002 ($ amounts in millions), by SVO ratings, along with an equivalent Standard & Poor's (S&P) rating agency
designation, and by public and private securities. The majority of our bonds are investment grade, with 91.4%
invested in Categories 1 and 2 securities as of September 30, 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 $ 8,583.8 $ 7,976.1 $ 7,223.3 $ 6,565.0 $ 1,360.5 $ 1,411.1
2 BBB 3,304.2 2,849.0 2,089.8 1,767.1 1,214.4 1,081.9
---------- ---------- ---------- ---------- ---------- ----------
Total investment grade 11,888.0 10,825.1 9,313.1 8,332.1 2,574.9 2,493.0
3 BB 781.4 785.7 655.3 577.4 126.1 208.3
4 B 178.9 105.4 130.5 82.2 48.4 23.2
5 CCC and lower 119.0 118.5 77.9 53.3 41.1 65.2
6 In or near default 40.2 59.4 30.1 25.4 10.1 34.0
---------- ---------- ---------- ---------- ---------- ----------
Total debt securities $ 13,007.5 $ 11,894.1 $ 10,206.9 $ 9,070.4 $ 2,800.6 $ 2,823.7
========== ========== ========== ========== ========== ==========
42
The following tables present our debt security portfolio by investment type as of September 30, 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
Value Cost Gains Losses Net
-------------- -------------- -------------- -------------- ------------
Debt Securities by Type
U.S. government and agency............ $ 549.1 $ 520.2 $ 29.7 $ (0.8) $ 28.9
State and political subdivision....... 558.9 508.8 51.4 (1.3) 50.1
Foreign government.................... 196.6 176.4 21.3 (1.1) 20.2
Corporate............................. 6,537.5 6,187.0 400.9 (50.4) 350.5
Mortgage-backed....................... 3,238.2 3,078.5 168.1 (8.4) 159.7
Other asset-backed.................... 1,927.2 1,920.4 62.5 (55.7) 6.8
-------------- -------------- -------------- ------------- -------------
Total debt securities................. $ 13,007.5 $ 12,391.3 $ 733.9 $ (117.7) $ 616.2
============== ============== ============== ============= =============
Debt securities outside closed block:
Unrealized gains.................. $ 5,217.0 $ 4,966.1 $ 250.9 $ -- $ 250.9
Unrealized losses................. 1,026.6 1,096.0 -- (69.4) (69.4)
-------------- -------------- -------------- ------------- -------------
Total outside the closed block.... 6,243.6 6,062.1 250.9 (69.4) 181.5
-------------- -------------- -------------- ------------- -------------
Debt securities in closed block:
Unrealized gains.................. 5,955.4 5,472.4 483.0 -- 483.0
Unrealized losses................. 808.5 856.8 -- (48.3) (48.3)
-------------- -------------- -------------- ------------- -------------
Total in the closed block......... 6,763.9 6,329.2 483.0 (48.3) 434.7
-------------- -------------- -------------- ------------- -------------
Total debt securities................. $ 13,007.5 $ 12,391.3 $ 733.9 $ (117.7) $ 616.2
============== ============== ============== ============= =============
Investment Grade Below Investment Grade
--------------------------------- -------------------------------
Fair Value Cost Fair Value Cost
--------------- --------------- --------------- --------------
Debt Securities by Type and Credit Quality
U.S. government and agency.................. $ 549.1 $ 520.2 $ -- $ --
State and political subdivision............. 558.9 508.8 -- --
Foreign government.......................... 56.6 49.2 140.0 127.2
Corporate................................... 5,784.9 5,447.0 752.6 740.0
Mortgage-backed............................. 3,176.0 3,022.4 62.2 56.1
Other asset-backed.......................... 1,762.5 1,733.5 164.7 186.9
--------------- --------------- --------------- --------------
Total debt securities....................... $ 11,888.0 $ 11,281.1 $ 1,119.5 $ 1,110.2
=============== =============== =============== ==============
Percentage of total debt securities......... 91.4% 91.0% 8.6% 9.0%
=============== =============== =============== ==============
TOTAL AAA/AA/A BBB
--------------- --------------- ---------------
Investment Grade Debt Securities (Fair Value)
U.S. government and agency............................... $ 549.1 $ 535.7 $ 13.4
State and political subdivision.......................... 558.9 545.6 13.3
Foreign government....................................... 56.6 18.0 38.6
Corporate................................................ 5,784.9 3,055.8 2,729.1
Mortgage-backed.......................................... 3,176.0 2,956.4 219.6
Other asset-backed....................................... 1,762.5 1,472.1 290.4
--------------- --------------- ---------------
Total debt securities.................................... $ 11,888.0 $ 8,583.6 $ 3,304.4
=============== =============== ===============
Percentage of total debt securities...................... 91.4% 66.0% 25.4%
=============== =============== ===============
43
In or Near
Total BB B CC or Lower Default
-------------- -------------- -------------- -------------- --------------
Below Investment Grade
Debt Securities (Fair Value)
Foreign government.................. $ 140.0 $ 140.0 $ -- $ -- $ --
Corporate........................... 752.6 527.2 142.7 65.0 17.7
Mortgage-backed..................... 62.2 61.8 -- 0.3 0.1
Other asset-backed.................. 164.7 52.4 36.2 53.8 22.3
-------------- -------------- -------------- -------------- --------------
Total debt securities............... $ 1,119.5 $ 781.4 $ 178.9 $ 119.1 $ 40.1
============== ============== ============== ============== ==============
Percentage of total debt securities. 8.6% 6.0% 1.4% 0.9% 0.3%
============== ============== ============== ============== ==============
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 September 30, 2003 in
our debt securities portfolio are banking (3.5%), diversified financial services (2.8%), publishing,
broadcasting, printing and cable (2.3%), insurance (2.2%) and broker-dealers (2.2%).
Our corporate bond exposure to recently troubled industries, including telecommunication equipment, telephone
utilities, airlines, and media, publishing and broadcasting, comprises 4.9% of our debt securities portfolio
at September 30, 2003. In addition, within the asset-backed securities sector, securitized aircraft receivable
securities comprise approximately 1.0% of our debt securities portfolio, with less than one-third of that
exposure rated below investment grade at September 30, 2003.
The following table presents certain information with respect to realized investment losses. Losses from
"other-than-temporary impairment" charges are reported separately. These impairment charges were determined
based on our assessment of factors 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
three and nine month periods ended September 30, 2003 and 2002 follow ($ amounts in millions):
Three Months Nine Months
---------------------------- ----------------------------
2003 2002 2003 2002
------------- -------------- -------------- -------------
Debt and equity securities....................... $ (18.2) $ (8.9) $ (64.7) $ (80.7)
Affiliate equity securities...................... -- -- (96.9) --
Other investments................................ (1.3) -- (19.0) --
------------- -------------- -------------- -------------
Impairment losses................................ (19.5) (8.9) (180.6) (80.7)
------------- -------------- -------------- -------------
Debt and equity securities gains................. 17.9 19.1 103.8 60.7
Debt and equity securities losses................ (1.9) (18.1) (36.1) (54.1)
Other investments................................ 0.9 (2.6) (6.6) --
------------- -------------- -------------- -------------
Net transaction gains............................ 16.9 (1.6) 61.1 6.6
------------- -------------- -------------- -------------
Net realized investment losses................... (2.6) (10.5) (119.5) (74.1)
------------- -------------- -------------- -------------
Applicable closed block policyholder dividend
obligation (reduction)......................... (3.5) 1.2 (4.5) (44.0)
Applicable deferred acquisition costs (benefit).. (2.8) (0.1) (1.1) (4.5)
Applicable deferred income taxes (benefit)....... 1.2 (4.0) (44.8) (8.9)
------------- -------------- -------------- -------------
Offsets to realized investment losses............ (5.1) (2.9) (50.4) (57.4)
------------- -------------- -------------- -------------
Net realized investment gains (losses)
included in net income......................... $ 2.5 $ (7.6) $ (69.1) $ (16.7)
============= ============== ============== =============
44
Gross and net unrealized gains and losses from debt and equity securities at September 30, 2003 follow ($
amounts in millions):
Total Outside Closed Block Closed Block
---------------------- --------------------- ----------------------
Gains Losses Gains Losses Gains Losses
---------- ----------- ---------- ---------- ----------- ----------
Debt Securities
Number of positions....................... 2,007 379 860 228 1,147 151
---------- ----------- ---------- ---------- ----------- ----------
Unrealized gains (losses).................$ 733.9 $ (117.7) $ 250.9 $ (69.4) $ 483.0 $ (48.3)
---------- ----------- ---------- ---------- ----------- ----------
Applicable policyholder dividend
obligation (reduction).................. 483.0 (48.3) -- -- 483.0 (48.3)
Applicable deferred policy acquisition
costs (benefit)......................... 115.5 (27.5) 115.5 (27.5) -- --
Applicable deferred income taxes (benefit) 47.4 (14.7) 47.4 (14.7) -- --
---------- ----------- ---------- ---------- ----------- ----------
Offsets to net unrealized gains (losses).. 645.9 (90.5) 162.9 (42.2) 483.0 (48.3)
---------- ----------- ---------- ---------- ----------- ----------
Unrealized gains (losses) after offsets...$ 88.0 $ (27.2) $ 88.0 $ (27.2) $ -- $ --
========== =========== ========== ========== =========== ==========
Net unrealized gains after offsets........$ 60.8 $ 60.8 $ --
========== ========== ===========
Equity Securities
Number of positions....................... 128 155 44 69 84 86
---------- ----------- ---------- ---------- ------------ ----------
Unrealized gains (losses).................$ 108.5 $ (2.8) $ 107.1 $ (1.6) $ 1.4 $ (1.2)
---------- ----------- ---------- ---------- ------------ ---------
Applicable policyholder dividend
obligation (reduction).................. 1.4 (1.2) -- -- 1.4 (1.2)
Applicable deferred income taxes (benefit) 37.5 (0.6) 37.5 (0.6) -- --
---------- ----------- ---------- ---------- ------------ ----------
Unrealized gains (losses) after offsets...$ 69.6 $ (1.0) $ 69.6 $ (1.0) $ -- $ --
========== =========== ========== ========== =========== ===========
Net unrealized gains after offsets........$ 68.6 $ 68.6 $ --
========== =========== ===========
Total net unrealized gains on debt and equity securities were $721.9 million (unrealized gains of $842.4 less
unrealized losses of $120.5). Of that net amount, $287.0 million was outside the closed block ($129.4 million
after applicable deferred policy acquisition costs and deferred income taxes) and $434.9 million was in the
closed block ($0 million after applicable policyholder dividend obligation).
During the quarter ended September 30, 2003, gross unrealized losses in the debt securities portfolio declined
to $117.7 million at September 30, 2003 from $119.3 million at June 30, 2003. The change was due to
improvements in credit quality, offset by the effect of higher interest rates.
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, greater than six months to 12 months, greater than 12 months 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
includes 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 that a restructuring will occur outside the current
reporting period;
45
o severe liquidity problems that cannot be resolved;
o filed for bankruptcy;
o a financial condition such that future payments are highly unlikely;
o deteriorating financial condition and quality of assets;
o sustained significant losses during the current year;
o announced adverse changes or events such as changes or planned changes in senior management,
restructurings, or a sale of assets; and/or
o been affected by any other factors that indicate that the fair value of the investment may have been
negatively impacted.
The following tables present certain information with respect to our gross unrealized losses with respect to
our investments in debt securities, both outside and inside the closed block, as of September 30, 2003. In the
tables, we separately present information that is applicable to unrealized losses outside the closed block and
information that is applicable to unrealized losses inside the closed block. We believe it is unlikely that
there would be any effect on our net income related to the realization of investment losses inside the closed
block 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 comprehensive income.
Gross unrealized losses on debt and equity securities outside of the closed block at September 30, 2003 by
duration of unrealized loss and by debt securities credit quality follow ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------ ------------ ------------ ------------ ------------
Debt Securities Outside Closed Block
Number of positions....................... 228 173 16 14 25
------------ ------------ ------------ ------------ ------------
Total fair value.......................... $ 1,026.6 $ 830.2 $ 45.7 $ 42.5 $ 108.2
Total amortized cost...................... 1,096.0 864.1 54.9 49.5 127.5
------------ ------------ ------------ ------------ ------------
Unrealized losses......................... $ (69.4) $ (33.9) $ (9.2) $ (7.0) $ (19.3)
============ ============ ============ ============ ============
Unrealized losses after offsets........... $ (27.2) $ (13.4) $ (3.4) $ (2.7) $ (7.7)
============ ============ ============ ============ ============
Investment grade:
Number of positions....................... 182 151 11 7 13
------------ ------------ ------------ ------------ ------------
Unrealized losses......................... $ (43.9) $ (25.2) $ (3.7) $ (3.6) $ (11.4)
============ ============ ============ ============ ============
Unrealized losses after offsets........... $ (16.9) $ (10.0) $ (1.1) $ (1.4) $ (4.4)
============ ============ ============ ============ ============
Below investment grade:
Number of positions....................... 46 22 5 7 12
------------ ------------ ------------ ------------ ------------
Unrealized losses......................... $ (25.5) $ (8.7) $ (5.5) $ (3.4) $ (7.9)
============ ============ ============ ============ ============
Unrealized losses after offsets........... $ (10.3) $ (3.4) $ (2.3) $ (1.3) $ (3.3)
============ ============ ============ ============ ============
Equity Securities Outside Closed Block
Number of positions....................... 69 53 4 8 4
------------ ------------ ------------ ------------ ------------
Unrealized losses......................... $ (1.6) $ (1.2) $ -- $ (0.3) $ (0.1)
============ ============ ============ ============ ============
Unrealized losses after offsets........... $ (1.2) $ (0.9) $ -- $ (0.2) $ (0.1)
============ ============ ============ ============ ============
For debt securities outside of the closed block with gross unrealized losses, 62% of the unrealized losses
after offsets pertain to investment grade securities and 38% of the unrealized losses after offsets pertain to
below investment grade securities.
46
Gross unrealized losses on investment grade debt securities outside of the closed block at September 30, 2003
by duration and extent of unrealized loss follow ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- ------------- ------------- ------------- -------------
Investment Grade Debt Securities
Outside Closed Block
Number of positions................. 182 151 11 7 13
------------- ------------- ------------- ------------- -------------
Total fair value.................... $ 897.6 $ 762.0 $ 28.3 $ 16.2 $ 91.1
Total amortized cost................ 941.5 787.2 32.0 19.8 102.5
------------- ------------- ------------- ------------- -------------
Unrealized losses................... $ (43.9) $ (25.2) $ (3.7) $ (3.6) $ (11.4)
============= ============= ============= ============= =============
Unrealized losses after offsets..... $ (16.9) $ (10.0) $ (1.1) $ (1.4) $ (4.4)
============= ============= ============= ============= =============
Unrealized Loss Under 20% of Cost:
Number of positions................. 176 149 10 6 11
------------- ------------- ------------- ------------- -------------
Total fair value.................... $ 847.4 $ 753.7 $ 23.9 $ 9.5 $ 60.3
Total amortized cost................ 870.0 772.4 25.0 9.7 62.9
------------- ------------- ------------- ------------- -------------
Unrealized losses................... $ (22.6) $ (18.7) $ (1.1) $ (0.2) $ (2.6)
============= ============= ============= ============= =============
Unrealized losses after offsets..... $ (9.0) $ (7.7) $ (0.4) $ -- $ (0.9)
============= ============= ============= ============= =============
Unrealized Loss Over 20% of Cost:
Number of positions................. 6 2 1 1 2
------------- ------------- ------------- ------------- -------------
Total fair value.................... $ 50.2 $ 8.3 $ 4.4 $ 6.7 $ 30.8
Total amortized cost................ 71.5 14.8 7.0 10.1 39.6
------------- ------------- ------------- ------------- -------------
Unrealized losses................... $ (21.3) $ (6.5) $ (2.6) $ (3.4) $ (8.8)
============= ============= ============= ============= =============
Unrealized losses after offsets..... $ (7.9) $ (2.3) $ (0.7) $ (1.4) $ (3.5)
============= ============= ============= ============= =============
Of the 182 investment grade debt securities held outside the closed block with unrealized losses, 162 have
been in an unrealized loss position for 12 months or less at September 30, 2003 (including 159 that have
unrealized losses less than 20% of cost). Of the remaining 20 security positions, seven have been in an
unrealized loss position for 12 to 24 months (including six that have unrealized losses less than 20% of cost)
and 13 have been in an unrealized loss position for over 24 months (including 11 that have unrealized losses
less than 20% of cost).
For the three investment grade debt securities that have been in an unrealized loss position for over 12 months
with unrealized losses greater than 20% of cost, their aggregate unrealized losses were $12.2 million ($8.8
million of which relates to holdings in an unrealized loss position for over 24 months). Their aggregate
unrealized losses after offsets were $4.9 million ($3.5 million of which relates to holdings in an unrealized
loss position for over 24 months). None of these securities were considered to be other-than-temporarily
impaired at September 30, 2003. Each of the three securities has performed, and is expected to continue to
perform, in accordance with their original contractual terms. One security, acquired in 1998, is an AAA-rated
interest only security that has declined in value due to lower short-term interest rates. The gross unrealized
loss on this security at September 30, 2003 was $6.7 million, or 21% of its amortized cost. One security is an
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 gross
unrealized loss on this security at September 30, 2003 was $2.0 million, or 25% of its amortized cost. One
security is an A2/A-rated issue that has declined in 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. The gross unrealized loss on this security at September 30, 2003 was $3.4 million, or 34% of its
amortized cost.
47
Gross unrealized losses on below investment grade debt securities outside of the closed block at September 30,
2003 by duration and extent of unrealized loss follow ($ amount in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- ------------- ------------- -------------- -------------
Below Investment Grade Debt Securities
Outside Closed Block
Number of positions..................... 46 22 5 7 12
------------- ------------- ------------- -------------- -------------
Total fair value........................ $ 129.0 $ 68.2 $ 17.4 $ 26.3 $ 17.1
Total amortized cost.................... 154.5 76.9 22.9 29.7 25.0
------------- ------------- ------------- -------------- -------------
Unrealized losses....................... $ (25.5) $ (8.7) $ (5.5) $ (3.4) $ (7.9)
============= ============= ============= ============== =============
Unrealized losses after offsets......... $ (10.3) $ (3.4) $ (2.3) $ (1.3) $ (3.3)
============= ============= ============= ============== =============
Unrealized Loss Under 20% of Cost:
Number of positions..................... 37 20 3 7 7
------------- ------------- ------------- -------------- -------------
Total fair value........................ $ 117.1 $ 61.8 $ 17.4 $ 26.3 $ 11.6
Total amortized cost.................... 124.9 64.7 17.8 29.7 12.7
------------- ------------- ------------- -------------- -------------
Unrealized losses....................... $ (7.8) $ (2.9) $ (0.4) $ (3.4) $ (1.1)
============= ============= ============= ============== =============
Unrealized losses after offsets......... $ (3.3) $ (1.2) $ (0.3) $ (1.3) $ (0.5)
============= ============= ============= ============== =============
Unrealized Loss Over 20% of Cost:
Number of positions..................... 9 2 2 0 5
------------- ------------- ------------- -------------- -------------
Total fair value........................ $ 11.9 $ 6.4 $ -- $ -- $ 5.5
Total amortized cost.................... 29.6 12.2 5.1 -- 12.3
------------- ------------- ------------- -------------- -------------
Unrealized losses....................... $ (17.7) $ (5.8) $ (5.1) $ -- $ (6.8)
============= ============= ============= ============== =============
Unrealized losses after offsets......... $ (7.0) $ (2.2) $ (2.0) $ -- $ (2.8)
============= ============= ============= ============== =============
Of the 46 below investment grade debt security positions held outside the closed block with unrealized losses,
27 have been in an unrealized loss position for 12 months or less at September 30, 2003 (including 23 that
have unrealized losses less than 20% of cost). Of the remaining 19 security positions, seven have been in an
unrealized loss position for 12 to 24 months (all that have unrealized losses less than 20% of cost) and 12
have been in an unrealized loss position for over 24 months (including seven that have unrealized losses less
than 20% of cost). For the nine below investment grade debt securities outside of the closed block with gross
unrealized losses greater than 20% of cost at September 30, 2003, additional information on the continuous
durations of that extent of loss follows ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------ ------------- ------------- -------------- -------------
Continuous Unrealized Loss
Over 20% of Cost
Number of positions..................... 9 5 3 0 1
------------ ------------- ------------- -------------- -------------
Total fair value........................ $ 11.9 $ 11.2 $ 0.7 $ -- $ --
Total amortized cost.................... 29.6 20.9 8.7 -- --
------------ ------------- ------------- -------------- -------------
Unrealized losses....................... $ (17.7) $ (9.7) $ (8.0) $ -- $ --
============ ============= ============= ============== =============
% unrealized loss to amortized cost..... 64.7% 52.8% 74.9% -- --
============ ============= ============= ============== =============
Unrealized losses after offsets......... $ (7.0) $ (3.8) $ (3.2) $ -- $ --
============ ============= ============= ============== =============
Of the nine below investment grade debt security positions held outside the closed block with gross unrealized
losses greater than 20% of cost at September 30, 2003, five have been in an unrealized position of greater
than 20% of cost for six months or less at September 30, 2003. Of the remaining four positions, none have been
in an
48
unrealized loss position greater than 20% of cost for 12 to 24 months and one has been in an unrealized loss
position greater than 20% of cost for over 24 months with an unrealized loss of less than $0.1 million.
We hold subordinated debt as well as equity security positions in certain CBOs where we serve as investment
advisor. One such affiliated CBO subordinated debt position is in a CBO that we consolidate and has a cost
basis of $5.0 million at September 30, 2003. This position has had an unrealized loss greater than 20% of cost
for six to 12 months. As a result of a changing interest rate environment, the fair value of the assets of the
CBO trust, including our position and those held in trust for benefit of third parties, are less than the
redemption value of the CBO trust non-recourse liabilities due to third parties. Accordingly, the carrying
value of our position under consolidation accounting is $0 at September 30, 2003, while our position has a
discounted cash flow value of $5.0 million. We have recognized impairments of $3.0 million during 2003 related
to this position. Consequently, our holding in this security is not considered to be other than temporarily
impaired at September 30, 2003. The accounting for positions we hold in affiliated CBO trusts is currently the
subject of evolving accounting guidance that is anticipated to be effective as of December 31, 2003 as further
described in Note 1 to our consolidated financial statements in this Form 10-Q.
Gross unrealized losses on equity securities outside of the closed block, at September 30, 2003 by duration
and extent of unrealized loss follow ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- ------------- ------------- ------------- -------------
Equity Securities
Number of positions.................... 69 53 4 8 4
------------- ------------- ------------- ------------- -------------
Total fair value....................... $ 23.0 $ 17.1 $ 0.5 $ 4.5 $ 0.9
Total cost............................. 24.6 18.3 0.5 4.8 1.0
------------- ------------- ------------- ------------- -------------
Unrealized losses...................... $ (1.6) $ (1.2) $ -- $ (0.3) $ (0.1)
============= ============= ============= ============= =============
Unrealized losses after offsets........ $ (1.0) $ (0.7) $ -- $ (0.2) $ (0.1)
============= ============= ============= ============= =============
Unrealized Loss Under 20% of Cost:
Number of positions.................... 61 48 3 7 3
------------- ------------- ------------- ------------- -------------
Total fair value....................... $ 22.3 $ 16.5 $ 0.5 $ 4.4 $ 0.9
Total cost............................. 23.5 17.3 0.5 4.7 1.0
------------- ------------- ------------- ------------- -------------
Unrealized losses...................... $ (1.2) $ (0.8) $ -- $ (0.3) $ (0.1)
============= ============= ============= ============= =============
Unrealized losses after offsets........ $ (0.8) $ (0.5) $ -- $ (0.2) $ (0.1)
============= ============= ============= ============= =============
Unrealized Loss Over 20% of Cost:
Number of positions.................... 8 5 1 1 1
------------- ------------- ------------- ------------- -------------
Total fair value....................... $ 0.7 $ 0.6 $ -- $ 0.1 $ --
Total cost............................. 1.1 1.0 -- 0.1 --
------------- ------------- ------------- ------------- -------------
Unrealized losses...................... $ (0.4) $ (0.4) $ -- $ -- $ --
============= ============= ============= ============= =============
Unrealized losses after offsets........ $ (0.2) $ (0.2) $ -- $ -- $ --
============= ============= ============= ============= =============
Of the 69 equity securities held outside the closed block with unrealized losses, 57 have been in an
unrealized loss position for 12 months or less at September 30, 2003 (including 51 that have unrealized losses
less than 20% of cost). Of the remaining 12 securities, eight have been in an unrealized loss position for 12
to 24 months (including seven that have unrealized losses less than 20% of cost) and four have been in an
unrealized loss position for over 24 months (including three that have unrealized losses less than 20% of
cost). For the eight equity securities with gross unrealized losses greater than 20% of cost at September 30,
2003, additional information on the continuous durations of that extent of loss follows ($ amounts in
millions):
49
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- ------------- ------------- ------------- -------------
Continuous Unrealized Loss
Over 20% of Cost
Number of positions................ 8 8 0 0 0
------------- ------------- ------------- ------------- -------------
Total fair value................... $ 0.7 $ 0.7 $ -- $ -- $ --
Total cost......................... 1.1 1.1 -- -- --
------------- ------------- ------------- ------------- -------------
Unrealized losses.................. $ (0.4) $ (0.4) $ -- $ -- $ --
============= ============= ============= ============= =============
% unrealized loss to cost.......... 36.4% 36.4% -- -- --
============= ============= ============= ============= =============
Unrealized losses after offsets.... $ (0.2) $ (0.2) $ -- $ -- $ --
============= ============= ============= ============= =============
Of the eight equity securities with gross unrealized losses greater than 20% of cost at September 30, 2003,
all have been in an unrealized loss position of greater than 20% of cost for six months or less at September
30, 2003.
Gross unrealized losses on debt and equity securities in the closed block at September 30, 2003 by duration of
unrealized loss and by debt securities credit quality follow ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- ------------- ------------- ------------- -------------
Debt Securities Inside Closed Block
Number of positions.................. 151 115 12 5 19
------------- ------------- ------------- ------------- -------------
Total fair value.................... $ 808.5 $ 631.6 $ 41.1 $ 27.7 $ 108.1
Total amortized cost................. 856.8 654.5 44.3 34.1 123.9
------------- ------------- ------------- ------------- -------------
Unrealized losses.................... $ (48.3) $ (22.9) $ (3.2) $ (6.4) $ (15.8)
============= ============= ============= ============= =============
Unrealized losses after offsets...... $ -- $ -- $ -- $ -- $ --
============= ============= ============= ============= =============
Investment grade:
Number of positions.................. 115 98 6 0 11
------------- ------------- ------------- ------------- -------------
Unrealized losses.................... $ (25.5) $ (17.7) $ (1.7) $ -- $ (6.1)
============= ============= ============= ============= =============
Unrealized losses after offsets...... $ -- $ -- $ -- $ -- $ --
============= ============= ============= ============= =============
Below investment grade:
Number of positions................. 36 17 6 5 8
------------- ------------- ------------- -------------- ------------
Unrealized losses................... $ (22.8) $ (5.2) $ (1.5) $ (6.4) $ (9.7)
============= ============= ============= ============== ============
Unrealized losses after offsets..... $ -- $ -- $ -- $ -- $ --
============= ============= ============= ============== ============
Equity Securities Inside Closed Block
Number of positions................. 86 86 0 0 0
------------- ------------- ------------- -------------- ------------
Unrealized losses................... $ (1.2) $ (1.2) $ -- $ -- $ --
============= ============= ============= ============== ============
Unrealized losses after offsets..... $ -- $ -- $ -- $ -- $ --
============= ============= ============= ============== ============
For debt securities in the closed block with gross unrealized losses, 53% of the unrealized losses pertain to
investment grade securities and 47% of the unrealized losses pertain to below investment grade securities.
50
Gross unrealized losses on investment grade securities in the closed block at September 30, 2003 by duration
and extent of unrealized loss follow ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- -------------- -------------- ------------- --------------
Investment Grade Debt Securities
Inside Closed Block
Number of positions................ 115 98 6 0 11
------------- -------------- -------------- ------------- --------------
Total fair value................... $ 625.4 $ 544.1 $ 19.0 $ -- $ 62.3
Total amortized cost............... 650.9 561.8 20.7 -- 68.4
------------- -------------- -------------- ------------- --------------
Unrealized losses.................. $ (25.5) $ (17.7) $ (1.7) $ -- $ (6.1)
============= ============== ============== ============= ==============
Unrealized losses after offsets.... $ -- $ -- $ -- $ -- $ --
============= ============== ============== ============= ==============
Unrealized Loss Under 20% of Cost:
Number of positions................ 112 98 6 0 8
------------- -------------- -------------- ------------- --------------
Total fair value................... $ 617.3 $ 544.1 $ 19.0 $ -- $ 54.2
Total amortized cost............... 640.0 561.8 20.7 -- 57.5
------------- -------------- -------------- ------------- --------------
Unrealized losses.................. $ (22.7) $ (17.7) $ (1.7) $ -- $ (3.3)
============= ============== ============== ============= ==============
Unrealized losses after offsets.... $ -- $ -- $ -- $ -- $ --
============= ============== ============== ============= ==============
Unrealized Loss Over 20% of Cost:
Number of positions................ 3 0 0 0 3
------------- -------------- -------------- ------------- --------------
Total fair value................... $ 8.1 $ -- $ -- $ -- $ 8.1
Total amortized cost............... 10.9 -- -- -- 10.9
------------- -------------- -------------- ------------- --------------
Unrealized losses.................. $ (2.8) $ -- $ -- $ -- $ (2.8)
============= ============== ============== ============= ==============
Unrealized losses after offsets.... $ -- $ -- $ -- $ -- $ --
============= ============== ============== ============= ==============
Of the 115 investment grade debt securities held in the closed block with unrealized losses, 104 have been in
an unrealized loss position for 12 months or less at September 30, 2003 (all of which have unrealized losses
less than 20% of cost). Of the remaining 11 security positions, all have been in an unrealized loss position
for over 24 months (including eight that have unrealized losses less than 20% of cost).
Eight investment grade debt securities have been in an unrealized loss position for over 24 months with
unrealized losses less than 20% of cost with an aggregate unrealized loss of $3.3 million. Of these eight
securities, none have an individual unrealized loss of greater than $0.7 million. One of these is an AA-rated
corporate senior debt bank issue with an unrealized loss of $0.5 million, five are A-rated bank issues that
have declined in fair value due to an increase in required credit spreads for the securities with an
unrealized loss of $1.9 million, and two 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 with an unrealized loss of $0.9 million.
For the three investment grade debt securities that have been in an unrealized loss position for over 24
months with unrealized losses greater than 20% of cost, their aggregate unrealized losses was $2.8 million.
None of these securities were considered to be other-than-temporarily impaired at September 30, 2003. Each of
the three securities has performed, and is expected to continue to perform, in accordance with their original
contractual terms. One of the securities is a collateralized aircraft financing that has declined in fair
value due to airline bankruptcies, reduced travel and higher risk premiums required for aircraft related
investments. The unrealized loss on this security at September 30, 2003 totaled $1.4 million, or 31%, of its
amortized cost. One issue is an A-rated timber-collateralized holding that has declined in fair value due to a
decline in the price of lumber. The unrealized loss on this security at September 30, 2003 was $1.1 million,
or 22%, of its amortized cost. One security is an AA/Aa1-rated collateralized bond obligation that has
declined in value due to a decline in value of
51
the collateral backing the security and an increase in credit spreads for this type of security. The
unrealized loss on this security at September 30, 2003 totaled $0.3 million, or 22%, of its amortized cost.
Gross unrealized losses on below investment grade debt securities in the closed block at September 30, 2003 by
duration and extent of unrealized loss follow ($ amount in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- -------------- -------------- -------------- -------------
Below Investment Grade Debt
Securities Inside Closed Block
Number of positions................ 36 17 6 5 8
------------- -------------- -------------- -------------- -------------
Total fair value................... $ 183.1 $ 87.5 $ 22.1 $ 27.7 $ 45.8
Total amortized cost............... 205.9 92.7 23.6 34.1 55.5
------------- -------------- -------------- -------------- -------------
Unrealized losses.................. $ (22.8) $ (5.2) $ (1.5) $ (6.4) $ (9.7)
============= ============== ============== ============== =============
Unrealized losses after offsets.... $ -- $ -- $ -- $ -- $ --
============= ============== ============== ============== =============
Unrealized Loss Under 20% of Cost:
Number of positions................ 31 16 6 3 6
------------- -------------- -------------- -------------- -------------
Total fair value................... $ 169.5 $ 83.6 $ 22.1 $ 24.3 $ 39.5
Total amortized cost............... 182.8 87.7 23.6 27.2 44.3
------------- -------------- -------------- -------------- -------------
Unrealized losses.................. $ (13.3) $ (4.1) $ (1.5) $ (2.9) $ (4.8)
============= ============== ============== ============== =============
Unrealized losses after offsets.... $ -- $ -- $ -- $ -- $ --
============= ============== ============== ============== =============
Unrealized Loss Over 20% of Cost:
Number of positions................ 5 1 0 2 2
------------- -------------- -------------- -------------- -------------
Total fair value................... $ 13.6 $ 3.9 $ -- $ 3.4 $ 6.3
Total amortized cost............... 23.1 5.0 -- 6.9 11.2
------------- -------------- -------------- -------------- -------------
Unrealized losses.................. $ (9.5) $ (1.1) $ -- $ (3.5) $ (4.9)
============= ============== ============== ============== =============
Unrealized losses after offsets.... $ -- $ -- $ -- $ -- $ --
============= ============== ============== ============== =============
Of the 36 below investment grade debt security positions held in the closed block with unrealized losses, 23
have been in an unrealized loss position for 12 months or less at September 30, 2003 (including 22 that have
unrealized losses less than 20% of cost). Of the remaining 13 positions, five have been in an unrealized loss
position for 12 to 24 months (including three that have unrealized losses less than 20% of cost) and eight
have been in an unrealized loss position for over 24 months (including six that have unrealized losses less
than 20% of cost). For the five below investment grade debt securities in the closed block with gross
unrealized losses greater than 20% of cost at September 30, 2003, additional information on the continuous
durations of that extent of loss follows ($ amounts in millions):
0 - 6 6 - 12 12 - 24 Over 24
Total Months Months Months Months
------------- ------------- ------------- ------------- -------------
Continuous Unrealized Loss
Over 20% of Cost
Number of positions................. 5 1 2 2 0
------------- ------------- ------------- ------------- -------------
Total fair value.................... $ 13.6 $ 3.9 $ 3.4 $ 6.3 $ --
Total amortized cost................ 23.1 5.0 6.9 11.2 --
------------- ------------- ------------- ------------- -------------
Unrealized losses................... $ (9.5) $ (1.1) $ (3.5) $ (4.9) $ --
============= ============= ============= ============= =============
% unrealized loss to amortized cost. 48.3% 22.0% 56.5% 48.5% --
============= ============= ============= ============= =============
Unrealized losses after offsets..... $ -- $ -- $ -- $ -- $ --
============= ============= ============= ============= =============
52
Of the five below investment grade debt security positions held in the closed block with gross unrealized
losses greater than 20% of cost at September 30, 2003, three have been in an unrealized loss position of
greater than 20% of cost for 12 months or less at September 30, 2003. Of the remaining two positions, both
have been in an unrealized position greater than 20% of cost for 12 to 24 months. None of these securities
were considered to be other-than-temporarily impaired at September 30, 2003. Each security has performed, and
is expected to continue to perform, in accordance with their original contractual terms. One issue is a
collateralized airplane lease related holding that has declined in fair value due to airline bankruptcies,
reduced travel and higher risk premiums required for aircraft related investments. The unrealized loss on this
security at September 30, 2003 was $3.5 million, or 56.5%, of its amortized cost. The other issue is an
energy/power generation related holding that has declined in fair value due to downgrades, bankruptcies and
weakness in the energy market. The unrealized loss on this security at September 30, 2003 was $1.4 million, or
29.0%, of its amortized cost.
Gross unrealized losses on equity securities in the closed block, at September 30, 2003 by duration and extent
of unrealized loss follow ($ amounts in millions):
Unrealized Loss
------------------------------
0 - 6 Under 20% Over 20%
Total Months of Cost of Cost
-------------- -------------- -------------- --------------
Equity Securities |
Number of positions...................... 86 86 | 85 1
-------------- -------------- | -------------- --------------
Total fair value........................ $ 25.4 $ 25.4 | $ 25.1 $ 0.3
Total cost............................... 26.6 26.6 | 26.2 0.4
-------------- -------------- | -------------- --------------
Unrealized losses........................ $ (1.2) $ (1.2) | $ (1.1) $ (0.1)
============== ============== | ============== ==============
Unrealized losses after offsets.......... $ -- $ -- | $ -- $ --
============== ============== | ============== ==============
Of the 86 equity securities held inside the closed block with unrealized losses, all have been in an
unrealized loss position for 6 months or less at September 30, 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 September 30, 2003, no single
non-affiliated issuer constituted more than $6.7 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 of 5.875% convertible bonds. The 7.5% convertible subordinated 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 interest rates. In March 2003, these 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 maturity on these notes was extended again to March 29, 2004 with a partial pay down of $5.0 million
received in November 2003 at an interest rate of 7.5%. 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
53
available-for-sale debt securities, was $49.4 million and $52.7 million at September 30, 2003 and year-end
2002, respectively. The cost of these issues was $54.2 million and $58.7 million at September 30, 2003 and
year-end 2002, respectively.
Our ownership of Aberdeen common stock includes 4% of the company's outstanding common shares that we
purchased in May 2001 for $46.8 million and 18% of its outstanding common shares that we purchased between
1996 and 1999 for $62.3 million. As of June 30, 2003, we concluded that our equity investment in Aberdeen,
accounted for under the equity method of accounting, was other-than-temporarily impaired resulting in an $89.1
million pre-tax, non-cash charge to earnings during the three month period ended June 30, 2003. The carrying
value of our equity investment in Aberdeen was $34.1 million and $119.3 million at September 30, 2003 and
year-end 2002, respectively. The fair value, based on quoted market price of underlying shares, of our equity
investment in Aberdeen was $44.6 million and $43.6 million at September 30, 2003 and year-end 2002,
respectively.
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.
Since the third quarter of 2002, we have evaluated the carrying value of our equity method investment in
Aberdeen for other-than-temporary impairment. This evaluation considered quantitative and qualitative factors
including quoted market price for the underlying securities, the duration that the carrying value has been in
excess of fair value, historical and projected earnings and cash flow capacity.
As of June 30, 2003, we concluded that our equity investment in Aberdeen, accounted for under the equity
method of accounting, was other-than-temporarily impaired after consideration of the following:
o Restructuring activities announced to date have not materialized as originally contemplated;
o Continuing inquiry by U.K regulatory authorities related to "mis-selling" of certain split capital trusts
funds managed by Aberdeen with no resolution anticipated in the near-term;
o Dispute with clients related to certain closed-end funds managed by Aberdeen; and
o As at June 30, 2003, the carrying value of our equity method investment in Aberdeen continuously exceeded
the underlying fair value as represented by its publicly traded share price for a period of nine to 12
months.
On October 24, 2003, Aberdeen completed the acquisition of 100% of the outstanding common stock of Edinburgh
Fund Managers Group plc, an Edinburgh Scotland based asset manager, for £36 million through the issuance
of 58.9 million shares of Aberdeen common stock. Subsequent to this acquisition, our percentage ownership in
Aberdeen's common stock was diluted from approximately 22% to 17%, although our representation on Aberdeen's
Board of Directors remained at two seats out of 12 seats. Based on our continued substantial ownership
position and related board representation, we have the ability to significantly influence the operations of
Aberdeen and, therefore, we will continue to account for our investment using the equity method of accounting
subsequent to October 24, 2003.
On October 31, 2003, Aberdeen announced the sale of the management rights of the retail unit trusts and
open-ended investment company funds (approximately £965 million in assets under management) in the
acquisition of Edinburgh Fund Managers for £27 million in cash and £3 million in shares of the
acquirer, New Star Asset Management Group Limited. Proceeds from this transaction were used to reduce debt on
Aberdeen's balance sheet, including a partial payment to us of $5 million on the 7.5% note. Subsequent to this
transaction, Aberdeen will continue to manage £23.2 billion as of August 31, 2003 of assets under
management.
54
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.
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. (the 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 consideration for prior
acquisitions, to repay intercompany debt, including debt to the holding company, and to meet intercompany
interest obligations.
The holding company has a $100.0 million 364-day unfunded, unsecured senior revolving credit facility expiring
on December 22, 2003 under which it has direct borrowing rights, as do Phoenix Life and PXP with the holding
company's unconditional guarantee. We are currently renegotiating this revolving credit facility and expect to
have a new facility in place prior to December 22, 2003. Through September 30, 2003, we have not drawn on our
existing revolving credit facility. We expect dividend payments from Phoenix Life, debt servicing from PXP and
borrowing capacity under the holding company's revolving credit facility to be sufficient to enable the
holding company to make dividend payments on its common stock, pay its operating expenses, service its
outstanding debt, make contributions or loans to its subsidiaries and meet its other obligations.
55
Consolidated Financial Condition
The following table presents the consolidated balance sheet as of September 30, 2003 and year-end 2002 ($
amounts in millions):
2003 2002 Change
-------------- --------------- --------------
ASSETS:
Debt securities.............................................. $ 13,007.5 $ 11,894.1 $ 1,113.4
Equity securities............................................ 357.4 391.2 (33.8)
Mortgage loans............................................... 328.1 468.8 (140.7)
Venture capital partnerships................................. 240.3 228.6 11.7
Affiliate equity securities.................................. 41.9 134.7 (92.8)
Policy loans................................................. 2,212.1 2,195.9 16.2
Other investments............................................ 413.5 398.9 14.6
-------------- --------------- --------------
Total investments............................................ 16,600.8 15,712.2 888.6
Cash and cash equivalents.................................... 628.3 1,058.5 (430.2)
Accrued investment income.................................... 237.5 192.3 45.2
Receivables.................................................. 184.5 217.3 (32.8)
Deferred policy acquisition costs............................ 1,335.6 1,234.1 101.5
Deferred income taxes........................................ 60.9 41.4 19.5
Intangible assets with definite lives........................ 273.6 291.7 (18.1)
Goodwill and other indefinite lived intangible assets........ 463.7 456.0 7.7
Other general account assets................................. 238.8 239.5 (0.7)
Separate account and investment trust assets................. 7,082.5 5,793.1 1,289.4
-------------- --------------- --------------
Total assets................................................. $ 27,106.2 $ 25,236.1 $ 1,870.1
============== =============== ==============
LIABILITIES:
Policy liabilities and accruals.............................. $ 12,964.7 $ 12,680.0 $ 284.7
Policyholder deposit funds................................... 3,737.8 3,395.7 342.1
Stock purchase contracts..................................... 124.1 137.6 (13.5)
Indebtedness................................................. 642.5 644.3 (1.8)
Other general account liabilities............................ 542.5 542.9 (0.4)
Separate account and investment trust liabilities............ 7,082.5 5,793.1 1,289.4
-------------- --------------- --------------
Total liabilities............................................ 25,094.1 23,193.6 1,900.5
-------------- --------------- --------------
MINORITY INTEREST:
Minority interest in net assets of consolidated subsidiaries. 6.5 10.8 (4.3)
-------------- --------------- --------------
STOCKHOLDERS' EQUITY:
Common stock and additional paid in capital.................. 2,430.0 2,425.4 4.6
Deferred compensation on restricted stock units.............. (3.9) -- (3.9)
Accumulated deficit.......................................... (340.0) (292.6) (47.4)
Accumulated other comprehensive income....................... 110.5 94.6 15.9
Treasury stock............................................... (191.0) (195.7) 4.7
-------------- --------------- --------------
Total stockholders' equity................................... 2,005.6 2,031.7 (26.1)
-------------- --------------- --------------
Total liabilities, minority interest and stockholders' equity $ 27,106.2 $ 25,236.1 $ 1,870.1
============== =============== ==============
Available-for-sale debt securities increased $1,113.4 million, or 9%, from year-end 2002 reflecting
significant appreciation of bond values due to lower interest rates, as well as, the investment of year-end
cash and cash equivalents and proceeds from disposals of other asset classes in fixed maturities.
Equity securities decreased $33.8 million, or 7%, 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, partially offset by
appreciation in the value of other equity securities.
Affiliate equity securities decreased $92.8 million, or 69%, from year-end 2002 primarily due to an $89.1
million pre-tax, non-cash charge related to the other-than-temporary impairment of our equity investment in
Aberdeen
56
taken in the second quarter of 2003. See Note 5 to our consolidated financial statements included in this Form
10-Q for additional information.
Mortgage loans decreased $140.7 million, or 30%, compared to year-end 2002 reflecting continued mortgage loan
pay downs, including several significant prepayments in the first nine months and the sale of a portfolio of
loans in the second quarter of 2003.
Cash and cash equivalents decreased $430.2 million, or 41%, from year-end 2002 primarily due to cash outflows
for investment purchases partially offset by policyholder deposit fund receipts, and cash from continuing
operations.
Accrued investment income increased $45.2 million, or 24%, from year-end 2002 as a result of higher invested
asset balances.
Deferred policy acquisition costs increased $101.5 million, or 8%, from year-end 2002, due primarily to
business growth and the acquisition of the minority interest PFG Holdings. See Note 3 to our consolidated
financial statements in this Form 10-Q for additional information. The composition of deferred acquisition
costs by product at September 30, 2003 and year-end 2002 follows ($ amounts in millions):
2003 2002 Change
--------------- --------------- ---------------
Variable universal life............................... $ 322.9 $ 309.9 $ 13.0
Universal life........................................ 148.6 105.2 43.4
Variable annuities.................................... 278.2 240.0 38.2
Fixed annuities....................................... 20.8 7.7 13.1
Participating life.................................... 539.7 551.0 (11.3)
Other................................................. 25.4 20.3 5.1
--------------- --------------- ---------------
Total deferred acquisition costs...................... $ 1,335.6 $ 1,234.1 $ 101.5
=============== =============== ===============
Policy liabilities and accruals increased $284.7 million, or 3%, from year-end 2002 primarily due normal
business growth, partially offset by a decrease in the policyholder dividend obligation.
Policyholder deposit funds increased $342.1 million, or 10%, from year-end 2002 primarily due to growth in
fixed and market value adjusted annuity deposits, offset by net withdrawals from retirement planners edge, a
variable annuity product.
Stock purchase contracts decreased $13.5 million, or 10%, from year-end 2002 primarily due to the increase in
the fair value of the embedded derivative investment. We recorded a favorable change in fair value of the
embedded derivative investment of $11.3 with an offset to other comprehensive income. The increased fair value
of the embedded derivative investment was primarily due to a decrease in the quoted market price of HRH common
stock.. See Note 6 to our consolidated financial statements in this Form 10-Q for additional information.
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. Our
Life Companies also have liabilities arising from the runoff of the remaining group accident and health
reinsurance discontinued operations.
57
Historically, our Life Companies have used cash flow from operations and investment activities to fund
liquidity requirements. Their principal cash in-flows 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 in-flows 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 liquidity to meet cash outflows is available from our 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.
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. 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. Our Life Companies closely monitor their liquidity requirements in
order to match cash in-flows with expected cash out-flows, 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, our 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 our Life Companies' annuity contract reserves
and deposit fund liabilities as of September 30, 2003 and year-end 2002 ($ amounts in millions).
2003 2002
----------------------- ---------------------
Amount(1) % Amount(1) %
------------ -------- ------------ --------
Not subject to discretionary withdrawal provision............ $ 180.7 3% $ 168.1 3%
Subject to discretionary withdrawal without adjustment....... 2,032.6 30% 2,073.3 35%
Subject to discretionary withdrawal with market value
adjustment................................................. 804.1 12% 649.7 11%
Subject to discretionary withdrawal at contract value less
surrender charge........................................... 994.5 15% 701.5 11%
Subject to discretionary withdrawal at market value.......... 2,642.8 40% 2,386.5 40%
------------ -------- ------------ --------
Total Annuity Contract Reserves and Deposit Fund Liabilities. $ 6,654.7 100% $ 5,979.1 100%
============ ======== ============ ========
(1) Contract reserves and deposit fund liability amounts are reported on a statutory basis, which more
accurately 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 September 30, 2003, our Life Companies had approximately $11.3 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
58
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 September 30, 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
its present and anticipated needs.
PXP
PXP's liquidity requirements are primarily to fund operating expenses and pay its 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's current sources of liquidity also include a revolving credit facility under which PXP
has direct borrowing rights, subject to our unconditional guarantee. We believe that PXP's current and
anticipated sources of liquidity are adequate to meet its current and anticipated needs.
Contractual Obligations and Commercial Commitments
As of September 30, 2003, we had $672.1 million outstanding related to contractual obligations, excluding
derivative instruments, and $145.9 million in commercial commitments. The following table presents our
contractual obligations and commercial commitments, including the years in which such obligations will come due
and such commercial commitments expire ($ amounts in millions).
Total 2003 2004 - 2005 2006 - 2007 Thereafter
------------ ------------ -------------- ------------- --------------
Contractual Obligations Due
Indebtedness(1) .................... $ 628.7 $ -- $ -- $ 175.0 $ 453.7
Future Minimum Lease Payments...... 43.4 3.9 26.3 5.4 7.8
Other(2) ........................... -- -- -- -- --
------------ ------------ -------------- ------------- --------------
Total Contractual Obligations...... $ 672.1 $ 3.9 $ 26.3 $ 180.4 $ 461.5
============ ============ ============== ============= ==============
Total 2003 2004 - 2005 2006 - 2007 Thereafter
------------ ------------ -------------- ------------- --------------
Commercial Commitments Expire
Standby Letters of Credit(3) ....... $ 10.3 $ 10.3 $ -- $ -- $ --
Other Commercial Commitments(2)(4) .. 135.6 1.4 4.5 19.1 110.6
------------ ------------ -------------- ------------- --------------
Total Commercial Commitments....... $ 145.9 $ 11.7 $ 4.5 $ 19.1 $ 110.6
============ ============ ============== ============= ==============
(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 quarter ended September 30, 2003 was $9.4 million.
59
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:
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 million or (ii) 2003 net investment
advisory fees times 4.5 times 60%, over (b) $100 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. We currently estimate this payment will be between $27.5
million and $32.5 million.
Phoenix has an additional purchase arrangement in which existing minority shareholders of KAR will sell 15% of
KAR to Phoenix at 5% per year at each year-end 2004 through 2006. The purchase price will be net investment
advisory fees for each year times 4.5 times 5% (the proportionate interest purchased). Such amounts are paid
during the following quarter. Under certain circumstances, the purchases may be accelerated.
There is also a put/call arrangement with respect to the remaining 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. Under certain circumstances, these shares can be issued without a note payable or other consideration.
In addition, in certain circumstances, the purchases may be accelerated. 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.
In August 2003, certain members of KAR accelerated their put/call arrangement. The purchase price for these
units totaled $4.4 million, which was recorded as additional purchase price by PXP and allocated to goodwill
and definite-lived intangible assets.
PFG Holdings, Inc.
On May 1, 2003, we acquired the remaining interest in PFG Holdings, Inc. not already owned by us for initial
consideration of $16.7 million. Under the terms of the purchase agreement, we may be obligated to pay
additional consideration of up to $89.0 million to the selling shareholders, including $13.0 million during the
years 2004 through 2007, based on certain financial performance targets being met, and the balance in 2008,
based on the appraised value of PFG Holdings as of December 31, 2007.
We have accounted for our acquisition of the remaining interest in PFG Holdings as a step-purchase acquisition.
Accordingly, we recorded a definite-lived intangible asset of $9.8 million related to the present value of
future profits (PVFP) acquired and a related deferred tax liability of $3.4 million. The PVFP intangible asset
will be amortized over the remaining estimated life of the underlying insurance inforce acquired, estimated to
be 40 years. The remaining acquisition price plus transaction costs of $7.6 million has been assigned to
goodwill. We
60
have not presented pro forma information as if PFG Holdings had been acquired at the beginning of January 2003,
as it is not material to our financial statements. For additional information, see Note 4 to our consolidated
financial statements in this Form 10-Q.
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 already been purchased by PXP and reissued at least once, 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 December 31, 2007.
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, ratings 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) decreased from $1,008.0
million at year-end 2002 to $990.2 million at September 30, 2003. Phoenix Life's statutory gain from operations
was $2.4 million and $42.3 million for the three and nine month periods ended September 30, 2003.
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 actions against, insurers whose Total
Adjusted Capital (capital and surplus plus one-half the policyholder dividend liability) does not exceed
certain RBC levels. Each of our other life insurance subsidiaries is also subject to these same RBC
requirements.
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;
61
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 September 30, 2003, Phoenix Life's 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 $3.4 million, which is $2.8 million in excess of its required minimum net capital of $0.6
million. The ratio of aggregate indebtedness to net capital for that subsidiary was 2.75 to 1. The ratios of
aggregate indebtedness to net capital for each of the other broker-dealer subsidiaries were also below the
regulatory ratio at September 30, 2003, and their respective net capital each exceeded their applicable
required minimum.
Consolidated Cash Flows
The following table presents summary consolidated cash flow data for the three and nine month periods ended
September 30, 2003 and 2002 ($ amounts in millions):
Three Months Nine Months
------------------------------------- ------------------------------------
2003 2002 Change 2003 2002 Change
----------- ------------ ----------- ----------- ------------- -----------
Cash from continuing operations.... $ 92.2 $ 44.0 $ 48.2 $ 237.7 $ 165.5 $ 72.2
Cash for discontinued operations... (15.0) 12.2 (27.2) (60.0) (62.0) 2.0
Cash for continuing operations
investing activities............. (80.0) (668.1) 588.1 (917.5) (1,684.3) 766.8
Cash from discontinued operations
investing activities............. -- (12.1) 12.1 (6.7) 23.4 (30.1)
Cash from financing activities..... $ (23.2) $ 673.3 $(696.5) $ 316.3 $ 1,453.9 $(1,137.6)
For the three and nine month periods ended September 30, 2003, cash from continuing operations increased $48.2
million and $72.2 million, respectively, over the comparable periods in 2002, due primarily to lower benefit
and policy acquisition cost payments made partially offset by lower premiums collected.
For the three and nine month periods ended September 30, 2003, cash for continuing operations investing
activities decreased $588.1 million and $766.8 million, respectively, over the comparable periods in 2002, due
primarily to lower cash from financing activities due to lower policyholder deposit fund receipts.
For the three and nine month periods ended September 30, 2003, cash from (for) financing activities decreased
$696.5 million and $1,137.6 million, respectively, over the comparable periods in 2002, due primarily to lower
policyholder deposit fund receipts, partially offset by treasury stock purchases in the 2002 periods that were
not continued in the 2003 periods.
62
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 three and nine month periods ended September 30, 2003, our
subsidiaries paid total compensation of $6.7 million and $16.8 million, respectively, to entities which were
either subsidiaries of State Farm or owned by State Farm employees, for the sale our insurance and annuity
products.
63
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 Finance Department, Corporate
Portfolio Management Department, Actuarial 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 September 30,
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 in response to new business, management's assessment of changing
market conditions and available investment opportunities.
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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 estimated interest rate sensitivity of our fixed income financial instruments
measured in terms of fair value as of September 30, 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 Value Point Change Fair Value Point Change
--------------- --------------- --------------- ---------------
Cash and cash equivalents................. $ 628.3 $ 628.8 $ 628.3 $ 627.8
Available-for-sale debt securities........ 13,007.5 13,599.6 13,007.5 12,415.9
Mortgage loans............................ 328.1 357.4 348.1 338.8
--------------- --------------- --------------- ---------------
Totals.................................... $ 13,963.9 $ 14,585.8 $ 13,983.9 $ 13,382.5
=============== =============== =============== ===============
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 September 30, 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 Fair Point
Amount (Years) Change Value Change
------------ ------------ ------------ ------------ ------------
Interest rate swaps........... $ 540.0 10.7 $ 35.9 $ 22.6 $ 9.4
Other......................... 90.0 2.8 0.6 0.6 0.8
------------ ------------ ------------ ------------
Totals........................ $ 630.0 $ 36.5 $ 23.2 $ 10.2
============ ============ ============ ============
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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 $357.4 million in equity
securities on our balance sheet as of September 30, 2003. A 10% decline or increase in the relevant equity
price would have decreased or increased, respectively, the value of these assets by approximately $35.7
million as of September 30, 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 September 30, 2003 and year-end 2002, the
difference between the guaranteed minimum death benefit and the current account value (net amount at risk) for
all existing contracts was $161.1 million and $234.9 million, respectively. This is our exposure to loss
should all of our contractholders die on either September 30, 2003 or year-end 2002.
2003 2002 Change
-------------- -------------- --------------
Net amount at risk on minimum guaranteed death
benefits (before reinsurance)................................ $ 797.0 $ 1,148.4 $ (351.4)
Net amount at risk reinsured................................... (635.9) (913.5) 277.6
-------------- -------------- --------------
Net amount at risk on minimum guaranteed death
benefits (after reinsurance)................................. $ 161.1 $ 234.9 $ (73.8)
============== ============== ==============
Weighted average age of contractholder......................... 60 60 --
============== ============== ==============
For the three and nine month periods ended September 30, 2003 and 2002, payments related to guaranteed minimum
death benefits, net of reinsurance recoveries, were as follows ($ amounts in millions):
Three Months Nine Months
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- ---------------
Death claims payments before reinsurance..... $ 1.4 $ 1.5 $ 5.1 $ 5.1
Reinsurance recoveries....................... (1.4) (1.4) (4.4) (4.4)
-------------- -------------- -------------- ---------------
Net death claims payments.................... $ -- $ 0.1 $ 0.7 $ 0.7
============== ============== ============== ===============
We establish a reserve for guaranteed minimum death benefits using a methodology consistent with the AICPA SOP
No. 03-01, "Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration
Contracts and for Separate Accounts". This reserve is determined using the net amount at risk taking into
account estimates for mortality, equity market returns, and voluntary terminations under a full range of
scenarios at September 30, 2003 and year-end 2002.
2003 2002
--------------- ---------------
Statutory reserve (after reinsurance)........................................ $ 19.2 $ 15.8
GAAP reserve (after reinsurance)............................................. 8.1 8.7
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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 September 30, 2003
carrying values ($ amounts in millions):
-10% Equity + 10% Equity
Market Carrying Value Market
------------- --------------- -------------
Deferred policy acquisition costs (variable annuities).......... $ 277.0 $ 282.0 $ 286.8
Deferred policy acquisition costs (variable universal life)..... 315.4 316.2 316.5
Guaranteed minimum death benefit liability (variable annuities). 11.3 8.1 5.9
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 three and nine month periods ended September 30, 2003 and a
9.0% long-term rate of return for the 2002 year. To the extent there are deviations in actual returns, there
will be changes in our projected expense and funding requests.
Foreign Currency Exchange Risks
Foreign currency 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 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 currency exchange rate risk for us are the British pound sterling, due to our
investments in Aberdeen and Lombard International Assurance, S.A., the Argentine peso, due to our investment
in EMCO and the Brazilian real related to a miscellaneous equity investment. During the three months ended
September 30, 2003, we recorded a pre-tax foreign currency translation adjustment losses of $1.1 million and
$0.3 million in other comprehensive income related to changes in valuation of the British pound sterling and
Argentine peso, respectively, and a pre-tax foreign currency translation adjustment gain of $0.1 million
related to changes in valuation of the New Zealand dollar. The components of foreign currency exchange gains
(losses) in accumulated other comprehensive income by currency at September 30, 2003 and year-end 2002 are as
follows ($ amounts in millions):
2003 2002 Change
-------------- -------------- --------------
British pound sterling........................................ $ 13.0 $ 9.1 $ 3.9
New Zealand dollar............................................ 0.9 0.8 0.1
Argentine peso................................................ (8.8) (10.8) 2.0
Japanese yen.................................................. -- (0.7) 0.7
Brazilian real................................................ (1.0) -- (1.0)
-------------- -------------- --------------
$ 4.1 $ (1.6) $ 5.7
============== ============== ==============
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 were effective as of September 30, 2003, both in design and operation, for achieving
the foregoing purpose.
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Changes in Internal Controls. During the three and nine month periods ended September 30, 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.
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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,
and Note 10 herein. There have been no material developments in such proceedings during the three and nine
month periods ended September 30, 2003.
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 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 finite aggregate excess-of-loss
(finite reinsurance) reinsurance and other reinsurance to cover our losses and the likely legal and
administrative cost of winding down the business.
Total reserves were $80.0 million and total reinsurance recoverable balances related to paid losses were
$175.0 million at September 30, 2003. In addition, in 1999 we purchased finite reinsurance to further protect
us from unfavorable results from this discontinued business. The maximum coverage available from our finite
reinsurance is currently $120.0 million. The amount of our total financial provisions at September 30, 2003
was,
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therefore, $25.0 million, consisting of reserves, less reinsurance recoverables, plus the amount currently
available from our finite reinsurance. We did not establish any additional financial provisions during the
three month period ended September 30, 2003.
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. In one of those, the arbitration panel issued its decision in October 2002
and confirmed the award on January 4, 2003. 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 our reserves and 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 three months ended September 30, 2003, The Phoenix Companies, Inc. issued 54 shares of
common stock to eligible policyholders, effective as of June 25, 2001, in connection with the
demutualization of Phoenix Home Life Mutual Insurance Company on that date. Phoenix issued these
shares, without registration under such act, in exchange for the policyholders' 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.
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:
70
Exhibit Number
--------------
12 Ratio of Earnings to Fixed Charges.
31.1 Certification by the Chief Executive Officer of The Phoenix Companies, Inc. pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by the Chief Financial Officer of The Phoenix Companies, Inc. pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification by the Chief Executive Officer and Chief Financial Officer of The Phoenix
Companies, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) During the three months ended September 30, 2003, we filed the following reports on Form 8-K:
o Filed July 16, 2003, containing a news release of The Phoenix Companies, Inc. dated July 16,
2003, regarding its program to provide owners of fewer than 100 shares of its common stock with
the opportunity to either sell all of their shares or purchase enough additional shares to
increase their holdings to 100 shares.
o Filed July 31, 2003, containing a news release of The Phoenix Companies, Inc. dated July 31,
2003, regarding its financial results for the three and six month periods ended June 30, 2003.
o Filed August 1, 2003, announcing that The Phoenix Companies, Inc. had made its Financial
Supplement for the three and six month periods ended June 30, 2003, available on its website and
furnishing a copy of such supplement.
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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
72