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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
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 001-16517
THE PHOENIX COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1599088
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One American Row, Hartford, Connecticut 06102-5056
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code
(860) 403-5000
Securities registered pursuant to section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common stock, $.01 par value New York Stock Exchange
7.45% Quarterly Interest Bonds, due 2032 New York Stock Exchange
7.25% Equity Units New York Stock Exchange
Securities registered pursuant to Section 12(G) of the Act:
Stock Purchase Contracts
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 twelve 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 ninety days. YES X NO ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form
10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
YES X NO ___
As of June 30, 2004, the aggregate market value of voting common equity held by non-affiliates of the
registrant was approximately $1.2 billion based on the last reported sale price of $12.25 per share of the
common stock on the New York Stock Exchange on that date. On February 28, 2005, the registrant had 94,942,332
shares of common stock outstanding; it had no non-voting common equity.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days
after the end of the registrant's fiscal year are incorporated by reference in Part III.
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TABLE OF CONTENTS
Item No. Description Page
Part I 1 Business........................................................................ 3
2 Properties...................................................................... 17
3 Legal Proceedings............................................................... 17
4 Submission of Matters to a Vote of Security Holders............................. 18
Part II 5 Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities......................................... 19
6 Selected Financial Data......................................................... 20
7 Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................................... 23
7A Quantitative and Qualitative Disclosures About Market Risk...................... 86
8 Financial Statements and Supplementary Data..................................... 86
Report of Independent Registered Public Accounting Firm......................... F-1
Consolidated Balance Sheet as of December 31, 2004 and 2003..................... F-3
Consolidated Statement of Income and Comprehensive Income For the Years
Ended December 31, 2004, 2003 and 2002........................................ F-4
Consolidated Statement of Cash Flows For the Years Ended
December 31, 2004, 2003 and 2002.............................................. F-5
Consolidated Statement of Changes in Stockholders' Equity and Comprehensive
Income For the Years Ended December 31, 2004, 2003 and 2002................... F-6
Notes to Consolidated Financial Statements...................................... F-7
9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.......................................................... 86
9A Controls and Procedures......................................................... 86
9B Other Information............................................................... 87
Part III 10 Directors and Executive Officers of the Registrant.............................. 87
11 Executive Compensation.......................................................... 88
12 Security Ownership of Certain Beneficial Owners and Management.................. 89
13 Certain Relationships and Related Transactions.................................. 91
14 Principal Accountant Fees and Services.......................................... 91
Part IV 15 Exhibits and Financial Statement Schedules...................................... 92
Signatures................................................................................................ 93
Exhibit Index............................................................................................. E-1
2
Unless otherwise stated, at all times on and after June 25, 2001, the effective date of Phoenix Home Life
Mutual Insurance Company's demutualization, "Phoenix," "we," "our" or "us" means The Phoenix Companies, Inc.
(the "Company" or "PNX") and its direct and indirect subsidiaries. At all times prior to June 25, 2001, "we,"
"our" or "us" means Phoenix Home Life Mutual Insurance Company (which has been known as Phoenix Life Insurance
Company since June 25, 2001) and its direct and indirect subsidiaries. Furthermore, "Phoenix Life" refers to
Phoenix Life Insurance Company, "Life Companies" refers to Phoenix Life and its direct and indirect
subsidiaries and "Phoenix Investment Partners" refers to Phoenix Investment Partners, Ltd. and its direct and
indirect subsidiaries.
PART I
Item 1. Business
Description of Business
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 offer a broad range of life insurance,
annuity and asset management products and services through a variety of distributors.
The affluent and high-net-worth market is a growing market with significant demand for customized products and
services. We define affluent as those households with a net worth of $500,000 or greater, excluding their
primary residence. We define high-net-worth, a subset of the affluent category, as those households that have
net worth, excluding primary residence, of over $1,000,000. Our wealth management products and services are
designed to assist advisors and their clients in this target market to achieve three main goals:
• the accumulation of wealth, primarily during an individual's working years;
• the preservation of income and wealth during retirement and following death; and
• the efficient transfer of wealth in a variety of situations, including through estate planning,
business continuation planning and charitable giving.
We distribute our wealth management products and services through various financial intermediaries such as
national and regional broker-dealers, banks, financial planning firms, advisor groups and other insurance
companies.
Segments
We have two operating segments, Life and Annuity and Asset Management, which include three product lines: life
insurance, annuities and asset management. Both segments serve the affluent and high-net-worth market, which
presents opportunities to leverage our capabilities and relationships.
We report our remaining results in two non-operating segments — Venture Capital and Corporate and Other.
Venture Capital includes: limited partnership interests in venture capital funds; leveraged buyout funds; and
other private equity partnerships sponsored and managed by third parties. The segment does not include similar
investments that are part of the closed block. Corporate and Other includes: indebtedness; unallocated assets,
liabilities and expenses; and certain businesses not of sufficient scale to report independently. These
segments are significant for financial reporting purposes, but do not contain products or services relevant to
our core manufacturing operations.
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Operating Segments
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SUMMARY OF OPERATING SEGMENTS
December 31, 2004
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Market Presence Distribution Channels Products
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Life and Annuity
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• $48.1 billion of net life • National and regional broker-dealers • Variable universal life insurance
insurance in force • Financial planning firms • Universal life insurance
• $7.6 billion of annuity assets • Advisor groups • Term life insurance
under management • Insurance companies • Variable annuities
• Banks • Immediate annuities
• Private placement life
Principal operating subsidiaries: insurance and annuities
• Phoenix Life
• PHL Variable Insurance Company
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Asset Management
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Private client products:
• $42.9 billion of third-party • National and regional broker-dealers • Managed accounts
assets under management • Institutional asset management • Mutual funds
consultants • Closed-end funds
Principal operating subsidiary: • Financial planning firms Institutional products:
• Phoenix Investment Partners • Affiliated asset managers • Institutional accounts
• Structured products
• Phoenix Life general and
separate accounts
Life and Annuity Segment
Our Life and Annuity segment offers a variety of life insurance and annuity products through non-affiliated
distributors. We believe our competitive advantage in this segment consists of six main components:
• our innovative products;
• our broad asset management capability;
• our distribution relationships with institutions that have access to our target market;
• the value-added our distributors provide those institutions;
• our ability to combine products and services that distributors and their clients find attractive; and
• our underwriting expertise.
Life and Annuity Products
Life Products
Our life insurance products include variable universal life, universal life, term life and other insurance
products. We offer single life, first-to-die and second-to-die products. Under first-to-die policies, up to
five lives may be insured with the policy proceeds paid after the death of the first of the five insured lives.
Second-to-die products are typically used for estate planning purposes and insure two lives rather than one,
with the policy proceeds paid after the death of both insured individuals.
Variable Universal Life. Variable universal life products provide insurance coverage and give the policyholder
various investment choices, flexible premium payments and coverage amounts and limited guarantees. The
policyholder may direct premiums and cash value into a variety of separate investment accounts, accounts that
are maintained separately from the other assets of the Life Companies and are not part of the general accounts
of the Life Companies, or into the general account. In separate investment accounts, the policyholder bears the
entire
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risk of the investment results. We collect fees for the management of these various investment accounts and the
net return is credited directly to the policyholder's accounts. With some variable universal products, by
maintaining a certain premium level the policyholder receives guarantees that protect the policy's death
benefit if, due to adverse investment experience, the policyholder's account balance is zero. We retain the
right within limits to adjust the fees we assess for providing administrative services. We also collect fees to
cover mortality costs; these fees may be adjusted by us but may not exceed contractual limits.
Universal Life. Universal life products provide insurance coverage on the same basis as variable universal life
products, except that premiums, and the resulting accumulated balances, are allocated only to our general
account for investment. Universal life products may allow the policyholder to increase or decrease the amount
of death benefit coverage over the term of the policy, and also may allow the policyholder to adjust the
frequency and amount of premium payments. Some universal life products provide guarantees that protect the
policy's death benefit if specified minimum premiums are paid. We credit premiums, net of expenses, to an
account maintained for the policyholder. We credit interest to the account at rates that we determine, subject
to certain minimums. Specific charges are made against the account for expenses. We also collect fees to cover
mortality costs; these fees may be adjusted by us but may not exceed contractual limits.
Term Life. Term life insurance provides a guaranteed benefit upon the death of the insured within a specified
time period, in return for the periodic payment of premiums. Specified coverage periods range from one to 30
years, but not longer than the period over which premiums are paid. Premiums may be level for the coverage
period or may vary. Term insurance products are sometimes referred to as pure protection products, in that
there are normally no savings or investment elements. Term contracts expire without value at the end of the
coverage period. Our term insurance policies allow policyholders to convert to permanent coverage, generally
without evidence of insurability.
Annuity Products
We offer a variety of variable annuities to meet the accumulation and preservation needs of the affluent and
high-net-worth market. Deferred annuities, in which funds accumulate for a number of years before periodic
payments begin, enable the contractholder to save for retirement and also provide options that protect against
outliving assets during retirement. Immediate annuities are purchased by means of a single lump sum payment and
begin paying periodic income immediately. We believe this product is especially attractive to those affluent
and high-net-worth retirees who are rolling over pension or retirement plan assets and seek an income stream
based entirely or partly on equity market performance.
Variable annuities are separate account products, which means that the contractholder bears the investment risk
as deposits are directed into a variety of separate investment accounts. The contractholder typically can also
direct funds to a general account option in which case we credit interest at rates we determine, subject to
certain minimums. Contractholders also may elect certain enhanced living benefit guarantees, for which they are
assessed a specific charge. For example, in the fourth quarter of 2004 we introduced a Guaranteed Minimum
Accumulation Benefit option to our products which guarantees an account value of at least 105% of premium after
10 years assuming other contractual obligations are met. Our major sources of revenues from annuities are
mortality and expense fees charged to the contractholder, generally determined as a percentage of the market
value of any underlying separate account balances, and the excess of investment income over credited interest
for funds invested in our general account.
Other Products and Services
Life and Annuity is focused on the development of other products and distribution relationships that respond to
the affluent and high-net-worth market's demand for wealth management solutions.
For example, many of our products are designed to be used by corporations to fund special deferred compensation
plans and benefit programs for key employees, commonly referred to as executive benefits. We view these
products as a source of growing fee-based business. In addition, our products can be applied to a number of
situations to meet the sophisticated needs of business owners and individuals, including for charitable giving.
5
Private Placement Life and Annuity Products. Private placement products are individually customized life and
annuity offerings that include single premium life, second-to-die life and variable annuity products. These
products have minimum deposits of over $500,000, targeting the wealthiest segment of the high-net-worth market.
The average face amount of life insurance policies sold by Philadelphia Financial Group, our private placement
distributor, in 2004 was $15.6 million and the average annuity deposit was $0.8 million.
Underwriting
Insurance underwriting is the process of examining, accepting or rejecting insurance risks, and classifying
those accepted in order to charge appropriate premiums or mortality charges. Underwriting also involves
determining the amount and type of reinsurance appropriate for a particular type of risk.
We believe we have particular expertise in evaluating the underwriting risks relevant to our target market. We
believe this expertise enables us to make appropriate underwriting decisions, including, in some instances, the
issuance of policies on more competitive terms than other insurers would offer. Phoenix Life has a long
tradition of underwriting innovation. Beginning in 1955, we were among the first insurance companies to offer
reduced rates to women. We believe we were the first company to offer reduced rates to non-smokers across all
policy lines, beginning in 1967. Our underwriting team includes doctors and other medical staff to ensure,
among other things, that we are focused on current developments in medical technology.
Our underwriting standards for life insurance are intended to result in the issuance of policies that produce
mortality experience consistent with the assumptions used in product pricing. The overall profitability of our
life insurance business depends, to a large extent, on the degree to which our mortality experience compares to
our pricing assumptions. Our underwriting is based on our historical mortality experience, as well as on the
experience of the insurance industry and of the general population. We continually compare our underwriting
standards to those of the industry to assist in managing our mortality risk and to stay abreast of industry
trends.
Our life insurance underwriters evaluate policy applications on the basis of the information provided by the
applicant and others. We use a variety of methods to evaluate certain policy applications, such as those where
the size of the policy sought is particularly large, or where the applicant is an older individual, has a known
medical impairment or is engaged in a hazardous occupation or hobby. Consistent with industry practice, we
require medical examinations and other tests depending upon the age of the applicant and the size of the
proposed policy.
In the executive benefits market, we issue life policies covering multiple lives on a guaranteed issue basis,
within specified limits per life insured, whereby the amount of insurance issued per life on a guaranteed basis
is related to the total number of lives being covered and the particular need for which the product is being
purchased. Guaranteed issue underwriting applies to employees actively at work, and product pricing reflects
the additional guaranteed issue underwriting risk.
Reserves
We establish and report liabilities for future policy benefits on our consolidated balance sheet to reflect the
obligations under our insurance policies and contracts. Our liability for variable universal life insurance and
universal life insurance policies and contracts is equal to the cumulative account balances, plus additional
reserves we establish for policy riders. Cumulative account balances include deposits plus credited interest,
less expense and mortality charges and withdrawals. Reserves for future policy benefits for whole life policies
are calculated based on actuarial assumptions that include investment yields and mortality.
6
Reinsurance
While we have underwriting expertise and have experienced favorable mortality trends, we believe it is prudent
to spread the risks associated with our life insurance products through reinsurance. As is customary in the
life insurance industry, our reinsurance program is designed to protect us against adverse mortality experience
generally and to reduce the potential loss we might face from a death claim on any one life.
We cede risk to other insurers under various agreements that cover individual life insurance policies. The
amount of risk ceded depends on our evaluation of the specific risk and applicable retention limits. Under the
terms of our reinsurance agreements, the reinsurer agrees to reimburse us for the ceded amount in the event a
claim is incurred. However, we remain liable to our policyholders for ceded insurance if any reinsurer fails to
meet its obligations. Since we bear the risk of nonpayment by one or more of our reinsurers, we cede business
to well-capitalized, highly rated insurers. While our current retention limit on any one life is $10 million
($12 million on second-to-die cases), we may cede amounts below those limits on a case-by-case basis depending
on the characteristics of a particular risk. Typically our reinsurance contracts allow us to reassume ceded
risks after a specified period. This right is valuable where our mortality experience is sufficiently favorable
to make it financially advantageous for us to reassume the risk rather than continue paying reinsurance
premiums.
We reinsure 80% of the mortality risk on a block of policies acquired from Confederation Life Insurance
Company, or Confederation Life, in 1997. We entered into two separate reinsurance agreements in 1998 and 1999
to reinsure a substantial portion of our otherwise retained individual life insurance business. In addition, we
reinsure up to 90% of the mortality risk on some new issues. As of December 31, 2004, we had ceded $80.0
billion in face amount of reinsurance, representing 62.5% of our total face amount of $128.1 billion of life
insurance in force.
On January 1, 1996, we entered into a reinsurance arrangement that covers 100% of the excess death benefits and
related reserves for most variable annuity policies issued through December 31, 1999, including subsequent
deposits. We retain the guaranteed minimum death benefit risks on the remaining variable deferred annuities in
force that are not covered by this reinsurance arrangement.
The following table lists our five principal life reinsurers, together with the reinsurance recoverables on a
statutory basis as of December 31, 2004, the face amount of life insurance ceded as of December 31, 2004, and
the reinsurers' A.M. Best ratings.
Reinsurance Face Amount of
Recoverable Life Insurance A.M. Best
Reinsurer Balances Ceded Rating(1)
------------------- ------------------ ------------------
RGA Reinsurance Company......................... $ 19.8 million $ 21.4 billion A+
AEGON USA....................................... $ 15.2 million $ 12.8 billion A+
Swiss Re Life & Health America, Inc............. $ 13.6 million $ 11.6 billion A+
Employers Reassurance Corporation............... $ 6.2 million $ 8.0 billion A-
XL Capital...................................... $ 6.9 million $ 6.2 billion A+
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(1)A.M. Best ratings are as of December 31, 2004.
Life and Annuity Financial Information
See Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K for
Life and Annuity segment financial information.
7
Asset Management Segment
We conduct activities in Asset Management with a focus on two customer groups — private client and
institutional. Through our private client group, we provide asset management services principally on a
discretionary basis, with products consisting of open-end mutual funds, closed-end funds and managed accounts.
Managed accounts include intermediary programs sponsored and distributed by non-affiliated broker-dealers, and
direct managed accounts which are sold and administered by us. These two types of managed accounts generally
require minimum investments of $100,000 and $1 million, respectively. Our private client business also provides
transfer agency, accounting and administrative services to most of our open-end mutual funds.
Through our institutional group, we provide discretionary and non-discretionary investment management services
primarily to corporations, multi-employer retirement funds and foundations, as well as to endowments and
special purpose funds. In addition, we manage alternative financial products such as structured finance
products. Structured finance products include collateralized obligations such as collateralized debt
obligations, or CDOs, backed by portfolios of public high yield bonds or commercial mortgage-backed or
asset-backed securities.
Affiliated Asset Managers
We offer investment management services through our affiliated asset managers. We provide our affiliated asset
managers with a consolidated platform of distribution support, thereby allowing each manager to devote a high
degree of focus to investment management activities. On an ongoing basis, we monitor the quality of the
affiliates' products by assessing their performance, style consistency and the discipline with which they apply
their investment process.
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Our affiliated managers, and their respective styles, products and assets under management, are as follows:
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Assets Under
Management at
Affiliated Advisor/ December 31, 2004
Ownership/Location Investment Styles Products (in billions)
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GoodwinSM Capital Advisors(1), Fixed Income – Mutual Funds
or Goodwin / 100% / Multi-Sector Institutional Accounts
Hartford, CT Structured Finance Products $6.1
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Seneca Capital Management Equities – Mutual Funds
LLC, or Seneca / 68.4% / Growth with Controlled Risk Sponsored Managed Accounts
San Francisco, CA Earnings-Driven Growth Direct Managed Accounts
Tax Sensitive Growth Institutional Accounts
Fixed Income – Structured Finance Products
Value Driven $12.1
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Kayne Anderson Rudnick Equities – Sponsored Managed Accounts
Investment Management, LLC, Quality at Reasonable Price Direct Managed Accounts
or Kayne Anderson Rudnick / Institutional Accounts
65.2% / Los Angeles, CA Mutual Funds $10.4
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Duff & Phelps Investment Equities – Mutual Funds
Management Co., or DPIM / REITs Sponsored Managed Accounts
100% / Chicago, IL Large Cap Value Direct Managed Accounts
Small Cap Core Institutional Accounts
Fixed Income – Closed-end Funds
Core $5.9
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Engemann Asset Management, Equities – Mutual Funds
INC.(1), or Engemann / 100% / Classic Growth Sponsored Managed Accounts
Pasadena, CA Direct Managed Accounts
Institutional Accounts $3.8
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OakhurstSM Asset Managers(1), Equities – Mutual Funds
or Oakhurst / 100% / Large Cap Value
Scotts Valley, CA Large Cap Core $2.0
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Walnut Asset Management LLC, Equities – Direct Managed Accounts
or Walnut / 100% / Relative Value Institutional Accounts
Philadelphia, PA Fixed Income –
Quality Fixed Income $0.8
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Zweig Fund Group, or Zweig / Equities/Fixed Income – Mutual Funds
100% / New York, NY Tactical Asset Allocation Closed-end Funds
Market Neutral
Small Cap Value $1.3
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Sub-advised Assets Equities – Mutual Funds
Mid-cap Value
International $0.5
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Total Third-Party Assets Under Management $42.9
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(1) As of December 31, 2004, Goodwin and Oakhurst were divisions of Phoenix Investment Counsel, Inc., an
indirect wholly-owned subsidiary of Phoenix Investment Partners. Effective January 1, 2005, Oakhurst became
a division of Engemann.
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Asset Management Products
Private Client Products
Managed Accounts. We provide investment management services through participation in 52 intermediary managed
account programs sponsored by various broker-dealers such as Merrill Lynch, Morgan Stanley and Salomon Smith
Barney. These programs enable the sponsor's client to select one or more of Phoenix Investment Partners'
affiliated asset managers as the provider of discretionary portfolio management services, in return for an
asset-based fee paid by the client to the broker-dealer, which then pays a management fee to us. Seven of these
programs include more than one of our affiliated asset managers. As of December 31, 2004, we managed 43,667
accounts relating to such intermediary managed account programs, representing approximately $9.0 billion of
assets under management. In addition, we offer direct managed accounts, which are individual client accounts
sold and administered by us. As of December 31, 2004, we managed 3,127 direct managed accounts representing
$4.5 billion of assets under management.
Mutual Funds. Our affiliated asset managers are investment advisors or sub-advisors to 39 open-end mutual
funds, which had aggregate assets under management of $10.2 billion as of December 31, 2004. These mutual funds
are available primarily to retail investors. Of these funds, 14 are included as investment choices to
purchasers of our variable life and variable annuity products.
Closed-End Mutual Funds. We manage the assets of five closed-end funds, each of which is traded on the New York
Stock Exchange: DTF Tax-Free Income Inc.; Duff & Phelps Utility and Corporate Bond Trust Inc.; DNP Select
Income Inc.; The Zweig Fund, Inc. and The Zweig Total Return Fund, Inc. Our closed-end fund assets under
management totaled $4.3 billion as of December 31, 2004.
Institutional Products
Institutional Accounts. We have over 1,000 institutional clients, consisting primarily of medium-sized pension
and profit sharing plans of corporations, government entities and unions, as well as endowments and
foundations, public and multi-employer retirement funds and other special purpose funds. Our institutional
assets under management totaled $12.0 billion as of December 31, 2004.
Structured Finance Products. We manage eight structured finance products. These products are collateralized
obligations backed by portfolios of high yield bonds, emerging markets bonds and/or asset-backed securities.
Our structured bond products assets under management totaled $2.9 billion as of December 31, 2004.
Life Companies' General Accounts. Goodwin, in conjunction with Phoenix Life's portfolio management group,
manages most of the assets of the Life Companies' general accounts. As of December 31, 2004, Phoenix Investment
Partners managed $13.2 billion of the Life Companies' assets. The assets under management, revenues and
expenses associated with the general accounts are not included in the Asset Management segment.
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Asset Management Assets under Management
The following table presents information regarding the third-party assets under management by Phoenix
Investment Partners for the years indicated:
As of December 31,
Assets Under Management ------------------------------------------------
($ amounts in millions) 2004 2003 2002
--------------- --------------- ---------------
TOTAL
Deposits................................................ $ 6,669.8 $ 6,987.8 $ 10,246.8
Redemptions and withdrawals............................. (13,255.8) (8,148.6) (9,575.6)
Acquisitions(1) and dispositions........................ -- -- 7,422.0
Performance............................................. 2,923.0 5,788.1 (7,863.1)
Other................................................... 311.0 (202.1) (118.3)
--------------- --------------- ---------------
Change in assets under management....................... (3,352.0) 4,425.2 111.8
Beginning balance....................................... 46,260.5 41,835.3 41,723.5
--------------- --------------- ---------------
Ending balance.......................................... $ 42,908.5 $ 46,260.5 $ 41,835.3
=============== =============== ===============
INSTITUTIONAL PRODUCTS
Deposits................................................ $ 2,743.9 $ 2,974.7 $ 4,312.6
Redemptions and withdrawals............................. (5,750.9) (3,452.2) (4,480.0)
Acquisitions and dispositions........................... -- -- 1,507.7
Performance............................................. 997.2 2,304.3 (2,178.9)
Other(2) ................................................ 37.5 (19.9) (1,294.6)
--------------- --------------- ---------------
Change in assets under management....................... (1,972.3) 1,806.9 (2,133.2)
Beginning balance....................................... 16,866.5 15,059.6 17,192.8
--------------- --------------- ---------------
Ending balance.......................................... $ 14,894.2 $ 16,866.5 $ 15,059.6
=============== =============== ===============
PRIVATE CLIENT PRODUCTS
Mutual Funds
Deposits................................................ $ 1,816.0 $ 1,744.8 $ 1,513.1
Redemptions and withdrawals............................. (2,301.9) (2,039.8) (2,379.2)
Performance............................................. 975.5 1,946.3 (2,406.0)
Other................................................... 273.5 (182.2) (153.7)
--------------- --------------- ---------------
Change in assets under management....................... 763.1 1,469.1 (3,425.8)
Beginning balance....................................... 13,735.6 12,266.5 15,692.3
--------------- --------------- ---------------
Ending balance.......................................... $ 14,498.7 $ 13,735.6 $ 12,266.5
=============== =============== ===============
INTERMEDIARY MANAGED ACCOUNT PROGRAMS
Deposits................................................ $ 1,637.1 $ 2,064.3 $ 4,116.9
Redemptions and withdrawals............................. (4,177.4) (2,362.1) (2,317.9)
Acquisitions(1) ......................................... -- -- 4,723.4
Performance............................................. 844.7 1,590.2 (2,902.9)
--------------- --------------- ---------------
Change in assets under management....................... (1,695.6) 1,292.4 3,619.5
Beginning balance....................................... 10,731.5 9,439.1 5,819.6
--------------- --------------- ---------------
Ending balance.......................................... $ 9,035.9 $ 10,731.5 $ 9,439.1
=============== =============== ===============
DIRECT MANAGED ACCOUNTS
Deposits................................................ $ 472.8 $ 204.0 $ 304.2
Redemptions and withdrawals............................. (1,025.6) (294.5) (398.5)
Acquisitions(1) ......................................... -- -- 1,190.9
Performance............................................. 105.6 (52.7) (375.3)
Other(2) ................................................ -- -- 1,330.0
--------------- --------------- ---------------
Change in assets under management....................... (447.2) (143.2) 2,051.3
Beginning balance....................................... 4,926.9 5,070.1 3,018.8
--------------- --------------- ---------------
Ending balance.......................................... $ 4,479.7 $ 4,926.9 $ 5,070.1
=============== =============== ===============
________
(1)Includes assets of $7.8 billion from Kayne Anderson Rudnick in 2002.
(2)Includes reclassification of certain Seneca funds from institutional products to direct managed
of $1.3 billion.
11
Asset Management Financial Information
See Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K for
Asset Management segment financial information.
Competition
We face significant competition from a wide variety of financial institutions, including insurance companies
and other asset management companies, as well as from proprietary products offered by our distribution sources
such as banks, broker-dealers and financial planning firms. Our competitors include larger and, in some cases,
more highly-rated insurance companies and other financial services companies. Many competitors offer similar
products, use similar distribution sources, offer less expensive products, have greater access to key
distribution channels and have greater resources than us.
Competition in our businesses is based on several factors including ratings, investment performance, access to
distribution channels, service to advisors and their clients, product features, fees charged and commissions
paid.
As we continue to focus on the development of our distribution channels, we increasingly must compete with
other providers of life insurance, annuity and private client products to attract and maintain relationships
with productive distributors that have the ability to sell our products. In particular, our ability to attract
distributors for our products could be adversely affected if for any reason our products became less
competitive or concerns arose about our asset quality, financial strength or ratings.
Distribution
We maintain a broad range of distribution relationships. We seek to build relationships with distributors who
are, or who have access to, advisors to the affluent and high-net-worth market. In May 2004, we disposed of our
affiliated retail distribution channel to focus our distribution efforts on our non-affiliated distribution
channels, in which we have a long history. We began to use non-affiliated distribution in 1954, primarily by
selling life insurance products through agents of other companies.
Our distribution strategy is to increase sales of profitable products by increasing the number of producers
selling Phoenix products within existing relationships, by offering a greater array of products through
existing distribution sources and by developing new relationships.
Since 2002, we have focused on increasing the number of producers selling Phoenix products within existing
relationships. In 2004, over 600 new producers wrote life insurance business with us, over 700 new producers
wrote annuity business with us and over 10,900 new producers placed asset management business with us.
Since late 1999, we have significantly strengthened our wholesaling teams, in order to enhance our
relationships with distributors in each of our product areas. As of December 31, 2004, we employed 63 life
insurance wholesalers, 19 annuity wholesalers and 13 asset management wholesalers, compared to 42, one and 25,
respectively, as of December 31, 1999.
We also engage in collaborative account development among our life insurance, annuity and asset management
wholesalers through joint marketing presentations and specialized services to advisors. We believe having many
of the same investment choices available in each of our product lines contributes to the success of our
strategy.
State Farm. In 2001, we entered into an agreement with a subsidiary of State Farm Mutual Automobile Insurance
Company, or State Farm, to provide our life and annuity products and related services to State Farm's affluent
and high-net-worth customers, through qualified State Farm agents. We are the only third-party provider of life
and annuity products and services at State Farm. By the end of 2004, we had trained and certified approximately
10,474, or 92%, of State Farm's approximately 11,437 securities licensed agents to sell Phoenix products. Our
12
relationship with State Farm gives us potential access to approximately 30% of the high-net-worth households in
the United States. For 2004, State Farm ranked first among our distributors in the sale of life insurance and
second in the sale of annuity products.
National and Regional Broker-Dealers. National and regional broker-dealers are brokerage firms that engage
financial advisors as employees rather than as independent contractors. To meet the evolving wealth management
needs of their customers, national and regional broker-dealers offer products from third-party providers such
as Phoenix. Simultaneously, many of these firms are seeking to reduce the number of relationships they have
with product providers in favor of those that offer a range of products together with services designed to
support advisors' sales efforts. We believe our ability to offer a variety of life insurance, annuity and asset
management products and services positions us to benefit from this trend. We have relationships across all
product lines in many important distribution outlets that target the high-net-worth market including UBS, A.G.
Edwards and Merrill Lynch.
Advisor Groups. The recent industry trend toward affiliations among small independent financial advisory firms
has led to advisor groups becoming a distinct class of distributors. We believe we have a particularly strong
position as a provider of life insurance products through Partners Marketing Group, Inc., or PartnersFinancial,
which, since 1999, has been an important component of the National Financial Partners, or NFP, organization.
Insurance Companies. Insurance companies have been moving their agents into an advisor/planner role, resulting
in a need to provide their agents, particularly their top producers, with a wider selection of life insurance
products to sell. Insurance companies responded to this need, in part, by negotiating arrangements with
third-party providers, including other insurance companies. We have distribution relationships with financial
services providers such as AXA Financial Inc., or AXA, and its brokerage outlet for internal producers, AXA
Network. In addition, we continue to maintain relationships with individual agents of other companies and
independent agents.
Financial Planning Firms. Financial planning firms are brokerage firms that engage financial advisors as
independent contractors rather than as employees. Financial planning firms have begun to expand their offerings
to include wealth preservation and transfer products. To capitalize on this trend, we establish relationships
with the financial planning firm, and then build relationships with the individual advisors within the firm.
This approach permits us to maximize the number of individual registered representatives who potentially may
sell our products.
Emerging Distribution Sources. Philadelphia Financial Group offers private placement life and annuity products
through a variety of distribution sources with access to the high-net-worth market including family offices,
financial institutions, accountants and attorneys. We also offer our life and annuity products through
non-traditional sources such as private banks, private banking groups within commercial banks and regional and
commercial banks that are focused on their high-net-worth client base.
Affiliated Distribution
Effective as of May 31, 2004, Linsco/Private Ledger Financial Services, or LPL, purchased our affiliated retail
distribution operations and as a result, we no longer have affiliated distribution channels. As part of the
transaction, advisors affiliated with WS Griffith Securities, Inc., or Griffith, and Main Street Management
Company, or Main Street, had the opportunity to move to LPL as independent registered representatives. As of
December 31, 2004, LPL had successfully recruited about 45% of Griffith's representatives, representing
approximately 50% of Griffith's total 2003 gross dealer concessions. Since the sale, the Company has pursued an
expansion in its distribution relationship with LPL, adding life and annuity products to existing asset
management offerings and recently commenced a plan to market these products through LPL and its more than 5,500
producers.
13
During 2004, 2003 and 2002, 6%, 15% and 11%, respectively, of total life insurance sales, as measured by new
annualized and single premiums, were conducted through affiliated distribution sources. Annuity sales through
affiliated distribution accounted for 18%, 18% and 35% of gross annuity deposits, excluding discontinued
products, during 2004, 2003 and 2002, respectively. In all three years, asset management sales through
affiliate distribution accounted for 1% of sales.
Institutional Products Distribution
We have an Institutional Marketing Group, or IMG, which markets our institutional product offerings to
consultants and other institutional clients. There are experienced institutional salespeople at several of our
affiliated asset managers, as well as specialists in products such as sub-advisory and defined contribution
investment only retirement services who operate across the enterprise. IMG also provides coordinated marketing
support and services.
We direct our institutional marketing efforts primarily toward consultants who are retained by institutional
investors to assist in competitive reviews of potential investment managers. These consultants recommend
investment managers to their institutional clients based on their review of investment managers' performance
histories and investment styles. We maintain relationships with these consultants and provide information and
materials to them in order to facilitate their review of our funds.
Support and Services
We believe we have a competitive advantage through the service and support we provide our distributors,
including:
• customized advice on estate planning, charitable giving planning, executive benefits and retirement
planning, provided by a staff of professionals with specialized expertise in the advanced application
of life insurance and variable annuity products. This staff includes three attorneys with an average of
approximately 15 years' experience, who combine their advice with tailored presentations, educational
materials and specimen legal documents;
• market research and education programs designed to help advisors better understand which financial
products the affluent and high-net-worth market demands. We assist advisors in marketing to specific
customer segments such as senior corporate executives, business owners and high-net-worth households;
• nationwide teams of life, annuity and asset management product specialists who provide education and
sales support to distributors and who can act as part of the advisory team for case design and
technical support;
• asset management and investment allocation strategies, including our Complementary Investment Analysis
tool, which identifies investment options offered both by us and by third parties that are suitable for
an individual's allocation needs;
• an underwriting team with significant experience in evaluating the financial and medical underwriting
risks associated with high face-value policies and affluent and high-net-worth individuals; and
• internet-accessible information that makes it easier for our distributors to do business with us,
including interactive product illustrations, educational and sales tools, and online access to forms,
marketing materials and policyholder account information.
Non-operating Segments
Venture Capital Segment
We have invested in the venture capital markets for over 25 years through Phoenix Life's investment portfolio.
The Venture Capital segment represented 1% of total investments and cash and cash equivalents as of both
December 31, 2004 and 2003. The carrying value of partnership investments in the Venture Capital segment was
14
$202.9 million as of December 31, 2004. The segment does not include venture capital investments held within
Phoenix Life's closed block.
Phoenix Life's venture capital investments are limited partnership interests in venture capital funds,
leveraged buyout funds and other private equity partnerships sponsored and managed by third parties. We refer
to all of these types of investments as venture capital. We currently have 110 partnership investments through
49 sponsors in our Venture Capital segment. We believe our long-standing relationships and history of
consistent participation with many well-established venture capital sponsors gives us preferred access to
attractive venture capital opportunities.
Historically, we viewed our venture capital investments as an opportunity to enhance returns on our
participating life products. In the past, we allocated between 1% and 2% of Phoenix Life's annual investable
cash flow to venture capital investments. Since 2002, we have made new venture capital commitments only in our
closed block. In addition, in February 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 $19.4 million ($5.1 million recorded in 2002 and $14.3 million recorded in 2003).
See Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K for
Venture Capital segment financial information.
Corporate and Other Segment
The Corporate and Other segment includes: indebtedness; unallocated assets; liabilities and expenses; and
certain businesses not of sufficient scale to report independently. Corporate and Other also includes certain
international operations. As of December 31, 2004, we had a total of $156.1 million in these international
holdings. Among our international holdings was Aberdeen Asset Management PLC, or Aberdeen, a Scottish
investment management company with institutional and retail clients in the United Kingdom, as well as in
continental Europe, Asia, Australia and the United States. At December 31, 2004, our ownership in Aberdeen
stock was 16.5%. On January 14, 2005 we closed the sale of our equity holdings in Aberdeen for net proceeds of
$70.4 million. See Management's Discussion and Analysis of Financial Condition and Results of Operations and
Note 5 to our consolidated financial statements in this Form 10-K for more information.
See Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K for
Corporate and Other segment financial information.
15
General Development of Business
PNX was incorporated in Delaware in 2000. Our principal executive offices are located at One American Row,
Hartford, Connecticut 06102-5056. Our telephone number is (860) 403-5000. Our website is located at
www.PhoenixWealthManagement.com. (This and all other URLs are intended to be inactive textual references only.
They are not intended to be an active hyperlink to our website. The information on our website is not, and is
not intended to be, part of this Form 10-K and is not incorporated into this report by reference.)
Phoenix Mutual Life Insurance Company was organized in Connecticut in 1851. In 1992, in connection with its
merger with Home Life Insurance Company, or Home Life, the company redomiciled to New York and changed its name
to Phoenix Home Life Mutual Insurance Company, or Phoenix Home Life.
On June 25, 2001, the effective date of its demutualization, Phoenix Home Life converted from a mutual life
insurance company to a stock life insurance company, became a wholly-owned subsidiary of PNX and changed its
name to Phoenix Life Insurance Company. All policyholder membership interests in the mutual company were
extinguished on the effective date. At the same time, Phoenix Investment Partners became an indirect
wholly-owned subsidiary of PNX.
In addition, on June 25, 2001, PNX completed its initial public offering, or IPO, in which 48.8 million shares
of common stock were issued at a price of $17.50 per share. Net proceeds from the IPO were $807.9 million,
which was contributed to Phoenix Life, as required under the plan of reorganization. On July 24, 2001, Morgan
Stanley & Co. Incorporated exercised its right to purchase 1,395,900 additional shares of the common stock of
PNX at the IPO price of $17.50 per share less underwriter's discount. Net proceeds of $23.2 million were
contributed to Phoenix Life. Our shares outstanding were subsequently reduced through share repurchases through
October 2002.
The following chart illustrates our corporate structure as of December 31, 2004.
--------------------------------
THE PHOENIX COMPANIES, INC.
--------------------------------
|
|-----------------------------------------------------|
100% 100%
------------------- ------------------------
PHOENIX LIFE PHOENIX INVESTMENT
INSURANCE MANAGEMENT COMPANY,
COMPANY INC.
------------------- ------------------------
| |
100% 100%
------------------- ----------------------------------------
PM HOLDINGS, INC. PHOENIX INVESTMENT PARTNERS, LTD.
------------------- ----------------------------------------
| |
Various %s Various %s
| |
-------------------------------------------- -------------------------------------------
OTHER DOMESTIC AND FOREIGN SUBSIDIARIES OTHER DOMESTIC AND FOREIGN SUBSIDIARIES
-------------------------------------------- -------------------------------------------
At December 31, 2004, we employed approximately 1,500 people. We believe our relations with our employees are
good.
16
Item 2. Properties
Our executive headquarters consist of our main office building at One American Row and two other buildings in
Hartford, Connecticut. We own these buildings and occupy most of the space contained in them. In addition to
these properties, we own offices in East Greenbush, New York for use in the operation of our business. In
February 2005, we entered into an agreement for the sale and short-term leaseback of the East Greenbush
property with an anticipated relocation in 2006 of business functions currently located at that property to a
site to be leased in the Albany area. In May 2004, we sold our offices in Enfield, Connecticut. Business
functions from Enfield are being relocated to our existing Hartford offices. We also lease office space within
and out of the United States as needed for our operations.
Item 3. 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, investor or taxpayer. Several current
proceedings are discussed below. In additional, state regulatory bodies, the Securities and Exchange
Commission, or SEC, the National Association of Securities Dealers, Inc., or 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. For example, during 2003 and 2004, the New York State Insurance Department conducted its
routine quinquennial financial and market conduct examination of Phoenix Life and its New York domiciled life
insurance subsidiary and the SEC conducted examinations of certain Phoenix Life variable products and certain
Phoenix Life affiliated investment advisors and mutual funds. The New York State Insurance Department's report,
for the five-year period ending December 31, 2002, was recently received. It cited no material violations. In
2004, the NASD also commenced examination of Phoenix broker-dealers, which is ongoing. The NASD recently
notified the Company of apparent violations by one of our broker-dealer subsidiaries of certain trade reporting
requirement. The Company is developing its response. We continue to actively cooperate with these regulators.
Federal and state regulatory authorities from time to time make inquiries and conduct examinations regarding
compliance by Phoenix Life and its subsidiaries with securities and other laws and regulations affecting their
registered products. The Company endeavors to respond to such inquiries in an appropriate way and to take
corrective action if warranted. Recently, there has been a significant increase in federal and state regulatory
activity relating to financial services companies, with a number of recent regulatory inquiries focusing on
late-trading, market timing and valuation issues. Our products entitle us to impose restrictions on transfers
between separate account sub-accounts associated with our variable products.
The Boston District Office of the SEC recently completed a compliance examination of certain of the Company's
affiliates that are registered under the Investment Company Act of 1940 or the Investment Advisers Act of 1940.
Following the examination, the staff of the Boston District Office issued a deficient letter primarily focused
on perceived weaknesses in procedures for monitoring trading to prevent market timing activity. The staff
requested the Company to conduct an analysis as to whether shareholders, policyholders and contract holders who
invested in the funds that may have been affected by undetected market timing activity had suffered harm and to
advise the staff whether the Company believes reimbursement is necessary or appropriate under the
circumstances. A third party has been retained to assist the Company in preparing the analysis. Until this
analysis is completed, whether any of these affiliates of The Phoenix Companies, Inc. would be required to make
any reimbursement payments and if so the amount thereof cannot be determined.
17
A number of companies have recently announced settlements of enforcement actions with various regulatory
agencies, primarily the SEC and the New York Attorney General's Office. While no such action has been initiated
against us, it is possible that one or more regulatory agencies may pursue this type of action against us in
the future.
We recently received a subpoena from the Connecticut Attorney General's office requesting information regarding
certain distribution practices since 1998. Over 40 companies received such a subpoena. We are cooperating
fully.
These types of regulatory actions may be difficult to assess or quantify, may seek recovery of indeterminate
amounts, including punitive and treble damages, and the nature and magnitude of their outcomes may remain
unknown for substantial periods of time. While it is not feasible to predict or determine the ultimate outcome
of all pending investigations and legal proceedings or to provide reasonable ranges of potential losses, we
believe that their outcomes are not likely, either individually or in the aggregate, to have a material adverse
effect on our consolidated financial condition, or consideration of available insurance and reinsurance and the
provision made in our consolidated financial statements. However, given the large or indeterminate amounts
sought in certain of these matters and litigation's inherent unpredictability, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse effect on our results of operation
or cash flows.
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
also purchased aggregate excess-of-loss reinsurance to further protect us from unfavorable results from this
discontinued business. On February 7, 2005 we notified the aggregate excess-of-loss reinsurer that we were
exercising our option to commute this contract. The commutation will be effective during the second quarter of
2005. The effect of the commutation will not be material to our consolidated financial statements.
We have established reserves for claims and related expenses that we expect to pay on our discontinued group
accident and health reinsurance business. These reserves are 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 aggregate
excess-of-loss reinsurance, the amounts we believe we will collect from our retrocessionaires and the likely
legal and administrative costs of winding down the business.
Our total reserves, including coverage available from our aggregate excess-of-loss reinsurance and reserves for
amounts recoverable from retrocessionaires, were $110.0 million and $185.0 million as of December 31, 2004 and
2003, respectively. Our total amounts recoverable from retrocessionaires related to paid losses were $60.0
million and $165.0 million as of December 31, 2004 and 2003, respectively. We did not recognize any gains or
losses during the years 2004, 2003 and 2002.
See the Risks Related to Our Business section of Management's Discussion and Analysis as well as Note 17 to our
consolidated financial statements in this Form 10-K for additional information.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of our security holders during the fourth quarter of the fiscal year covered
by this report.
18
PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
Market
Shares of our common stock trade on the New York Stock Exchange under the ticker symbol "PNX". As of February
14, 2005, there were approximately 270,000 registered holders of our common stock.
Unregistered Shares
We issued the following shares of common stock to eligible policyholders of Phoenix Life, effective as of June
25, 2001, in connection with Phoenix Life's demutualization on that date: 56,174,373 shares in 2001; 4,237
shares in 2002; 1,853 shares in 2003; and 54 shares in 2004. We issued these shares to policyholders in
exchange for their membership interests without registration under the Securities Act of 1933 in reliance on
the exemption under Section 3(a)(10) of the Securities Act of 1933.
In 2004, we also issued 43,334 restricted stock units, or RSUs, to 11 of our independent directors, without
registration under that act in reliance on the exemption under Regulation D for accredited investors. Each RSU
is potentially convertible into one share of our common stock.
Stock Price
The following table presents the intraday high and low prices for our common stock on the New York Stock
Exchange for the years 2004 and 2003. The closing price of our common stock at December 31, 2004 was $12.50.
2004 2003
----------------------------- -----------------------------
High Low High Low
-------------- -------------- -------------- --------------
First Quarter................................ $ 14.53 $ 12.06 $ 9.25 $ 6.03
Second Quarter............................... $ 14.21 $ 11.08 $ 9.80 $ 6.95
Third Quarter................................ $ 12.34 $ 9.51 $ 12.10 $ 8.60
Fourth Quarter............................... $ 12.60 $ 9.47 $ 12.65 $ 10.26
Dividends
In 2004 and 2003, we paid a dividend of $0.16 per share to shareholders of record on June 14, 2004 and June 13,
2003, respectively. For a discussion of restrictions on our ability to pay dividends, see the Liquidity and
Capital Resources section of Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Repurchases
We did not repurchase any shares of our common stock during the two years ended December 31, 2004.
19
Item 6. Selected Financial Data
Our selected historical consolidated financial data as of and for each of the five years ended December 31,
2004 follows ($ amounts in millions, except earnings per share). We derived the balance sheet data for 2004 and
2003 and the income statement data for the years 2004, 2003 and 2002 from our consolidated financial statements
in this Form 10-K. We derived the balance sheet data for 2002, 2001 and 2000 and the income statement data for
the years 2001 and 2000 from audited consolidated financial statements not in this Form 10-K. We have
reclassified certain amounts for prior years to conform with our 2004 presentation. Prior to June 25, 2001,
Phoenix Life was the parent company of our consolidated group. In connection with its demutualization, Phoenix
Life became a subsidiary and PNX became the parent company of our consolidated group.
We prepared the following financial data, other than statutory data, in conformity with accounting principles
generally accepted in the United States, or GAAP. We derived the statutory data from the Annual Statements of
our Life Companies filed with state insurance regulatory authorities and prepared it in accordance with
statutory accounting practices prescribed or permitted by state insurance regulators, which vary in certain
material respects from GAAP.
You should read the following in conjunction with Management's Discussion and Analysis of Financial Condition
and Results of Operations and our consolidated financial statements in this Form 10-K.
20
Selected Financial Data:
($ amounts in millions) 2004 2003 2002 2001 2000
------------- ------------- ------------- -------------- -------------
Income Statement Data
Premiums............................... $ 990.6 $ 1,042.2 $ 1,082.0 $ 1,112.7 $ 1,147.4
Insurance and investment product fees.. 534.9 500.9 493.8 469.7 559.1
Broker-dealer commission and
distribution fee revenues............ 56.9 81.5 85.0 96.3 97.3
Net investment income.................. 1,075.7 1,107.4 940.5 882.9 1,131.9
Unrealized gain on trading equity
securities........................... 85.9 -- -- -- --
Net realized investment gains
(losses)............................. (0.8) (98.5) (133.9) (84.9) 89.2
------------- ------------- ------------- -------------- -------------
Total revenues......................... $ 2,743.2 $ 2,633.5 $ 2,467.4 $ 2,476.7 $ 3,024.9
============= ============= ============= ============== =============
Total benefits and expenses............ $ 2,606.0 $ 2,653.7 $ 2,671.0 $ 2,738.8 $ 2,867.1
============= ============= ============= ============== =============
Income (loss) from continuing
operations........................... $ 86.3 $ (4.1) $ (140.7) $ (147.3) $ 96.0
Income (loss) from discontinued
operations, net of income taxes...... 0.1 (2.1) (1.3) (2.5) (12.7)
------------- ------------- ------------- -------------- -------------
Income (loss) before cumulative effect
of accounting changes................ 86.4 (6.2) (142.0) (149.8) 83.3
Cumulative effect of accounting
changes.............................. -- -- (130.3) (65.4) --
------------- ------------- ------------- -------------- -------------
Net income (loss)...................... $ 86.4 $ (6.2) $ (272.3) $ (215.2) $ 83.3
============= ============= ============= ============== =============
Basic Earnings Per Share(1)
Income (loss) from continuing
operations........................... $ 0.91 $ (0.04) $ (1.44) $ (1.41) $ 0.92
============= ============= ============= ============== =============
Net income (loss)...................... $ 0.91 $ (0.07) $ (2.78) $ (2.06) $ 0.80
============= ============= ============= ============== =============
Diluted Earnings Per Share(1)
Income (loss) from continuing
operations........................... $ 0.86 $ (0.04) $ (1.44) $ (1.41) $ 0.92
============= ============= ============= ============== =============
Net income (loss)...................... $ 0.86 $ (0.07) $ (2.78) $ (2.06) $ 0.80
============= ============= ============= ============== =============
Dividends per share.................... $ 0.16 $ 0.16 $ 0.16 $ -- $ --
============= ============= ============= ============== =============
Ratio of Earnings to Fixed Charges
Ratio of earnings to fixed charges(2) .. 1.7 -- -- -- 1.8
Supplemental ratio of earnings to
fixed charges - excluding interest
credited on policyholder contract
balances(3) .......................... 4.5 -- -- -- 4.1
Balance Sheet Data
Cash and general account investments... $ 17,334.6 $ 17,242.8 $ 16,812.8 $ 14,400.4 $ 12,767.5
============= ============= ============= ============== =============
Total assets........................... $ 28,362.6 $ 27,559.2 $ 25,235.9 $ 22,535.9 $ 20,313.5
============= ============= ============= ============== =============
Indebtedness........................... $ 690.8 $ 639.0 $ 644.3 $ 599.3 $ 425.1
============= ============= ============= ============== =============
Total liabilities...................... $ 26,299.2 $ 25,588.8 $ 23,389.9 $ 20,266.6 $ 18,341.6
============= ============= ============= ============== =============
Minority interest in net assets of
consolidated subsidiaries............ $ 41.0 $ 22.6 $ 19.2 $ 1.2 $ 130.7
============= ============= ============= ============== =============
Total stockholders' equity............. $ 2,022.4 $ 1,947.8 $ 1,826.8 $ 2,307.8 $ 1,840.9
============= ============= ============= ============== =============
Asset Management Segment
Third-party assets under
management......................... $ 42,908.5 $ 46,260.5 $ 41,835.3 $ 41,723.5 $ 47,391.9
============= ============= ============= ============== =============
Consolidated Statutory Data
Premiums, deposits and fees............ $ 2,151.1 $ 3,364.9 $ 3,919.7 $ 3,144.8 $ 2,344.8
============= ============= ============= ============== =============
Net income (loss)...................... $ 46.3 $ (26.0) $ (130.7) $ (66.0) $ 266.1
============= ============= ============= ============== =============
Capital and surplus(4)................. $ 814.6 $ 762.4 $ 861.4 $ 1,149.8 $ 1,322.8
Asset valuation reserve, or AVR(5)..... 221.2 200.0 147.8 223.4 560.4
------------- ------------- ------------- -------------- -------------
Capital, surplus and AVR............... $ 1,035.8 $ 962.4 $ 1,009.2 $ 1,373.2 $ 1,883.2
============= ============= ============= ============== =============
21
_________
(1) We calculated earnings per share for each of the two years from 2000 through 2001 on a pro forma basis,
based on 104.6 million weighted-average shares outstanding. The pro forma weighted-average shares
outstanding calculation for 2001 is based on the weighted-average shares outstanding for the period from the
demutualization and IPO to the end of the year.
(2) Due to our losses during 2003, 2002 and 2001, the ratio of earnings to fixed charges for those years was
less than 1:1. We would need $11.4 million, $113.6 million and $131.6 million in additional earnings for the
years 2003, 2002 and 2001, respectively, to achieve a 1:1 coverage ratio.
(3) Due to our losses during 2003, 2002 and 2001, the ratio coverages, excluding interest credited on
policyholder contract balances, were less than 1:1. We would need $11.4 million, $113.6 million and $131.6
million in additional earnings for the years 2003, 2002 and 2001, respectively, to achieve a 1:1 coverage
ratio.
(4) In accordance with accounting practices prescribed by the New York State Insurance Department, Phoenix
Life's capital and surplus includes $205.2 million and $175.0 million principal amount of surplus notes
outstanding at December 31, 2004 and 2003, respectively.
(5) The AVR is a statutory reserve intended to mitigate changes to the balance sheet as a result of
fluctuations in asset values.
22
Item 7. 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 Phoenix Companies, Inc., or 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 developments that may affect the Company or the cost of, or demand for, its
products or services; (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; (ix) the effects of closing the Company's retail brokerage operations; and (x) 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.
23
RISKS RELATED TO OUR BUSINESS
Poor relative investment performance of some of our equity asset management strategies has led to material
redemptions which have reduced assets under management and revenues. We could have continued underperformance
and outflows.
In 2004, 61% of third-party assets under management underperformed against their respective one-year
benchmarks. Partly as a result, our asset management business experienced net outflows of $6.6 billion during
the year. This poor relative performance could continue, which could result in lower assets under management
and lower revenues.
Poor performance of the equity markets could adversely affect sales and assets under management of our asset
management, variable universal life and variable annuity products, as well as the performance of our Venture
Capital segment and potential future pension plan funding requirements.
The United States equity markets can be volatile and experience both periods of strong growth and of
substantial declines.
There are four ways in which equity market declines and volatility have affected, or have the potential to
affect, us negatively.
• First, because the fee revenues of our asset management and, to a lesser degree, variable products
businesses are based on the value of assets under our management, poor performance of the equity
markets limits our fee revenues by reducing the value of the assets we manage.
• Second, returns on venture capital investments are correlated with the performance of the equity
markets. During the severe market declines of 2002 and 2001, our venture capital investments decreased
our income from continuing operations by $38.5 million and $54.9 million, respectively. If equity
markets decline, we could again experience losses in our venture capital investments.
• Third, the funding requirements of our pension plan are dependent on the performance of the equity
markets. As of December 31, 2004, the portfolio funding the Company's pension plan consisted of 67%
equities. In a severe market decline, the value of the assets supporting the pension plan would
decrease, increasing the requirement for future funding. This funding requirement would increase
expenses and decrease the earnings of the Company.
• Fourth, significant market volatility or declines could cause potential purchasers of our products to
refrain from investing, and current investors to withdraw from the markets or reduce their level of
investment. We cannot estimate the impact of prior market declines on our sales.
Changes in interest rates could harm cash flow and profitability in our life and annuity businesses.
Our life insurance and annuity businesses are sensitive to interest rate changes. In periods of increasing
interest rates, life insurance policy loans and surrenders and withdrawals could increase as policyholders seek
investments with higher perceived returns. This could require us to sell invested assets at a time when their
prices are depressed by the increase in interest rates, which could cause us to realize investment losses.
Conversely, during periods of declining interest rates, we could experience increased premium payments on
products with flexible premium features, repayment of policy loans and increased percentages of policies
remaining in force. We would obtain lower returns on investments made with these cash flows. In addition,
borrowers may prepay or redeem mortgages and bonds in our investment portfolio so that we might have to
reinvest those proceeds in lower interest-bearing investments. As a consequence of these factors, we could
experience a decrease in the spread between the returns on our investment portfolio and amounts credited to
policyholders and contractholders, which could adversely affect our profitability.
24
We depend on non-affiliated distribution for our product sales and if our relationships with these distributors
were harmed, we could suffer a loss in revenues.
We distribute our products through non-affiliated advisors, broker-dealers and other financial intermediaries.
There is substantial competition for business within most of these distributors. We believe that our sales
through these distributors depend on factors such as our financial strength, the quality of our products and on
the services we provide to, and the relationships we develop with, these distributors. Our distributors are
generally free to sell products from a variety of providers, which makes it important for us to continually
offer distributors products and services they find attractive. We may not be able to establish or maintain
satisfactory relationships with distributors if our products or services do not meet their needs. Accordingly,
our revenues and profitability would suffer.
Downgrades to PNX's debt ratings and Phoenix Life's financial strength ratings could increase policy surrenders
and withdrawals, adversely affect relationships with distributors, reduce new sales and earnings from certain
of our life insurance products and increase our future borrowing costs.
Rating agencies assign Phoenix Life financial strength ratings, and assign us debt ratings, based in each case
on their opinions of the relevant company's ability to meet its financial obligations.
Financial strength ratings reflect a rating agency's view of an insurance company's ability to meet its
obligations to its insureds. These ratings are therefore key factors underlying the competitive position of
life insurers. The current financial strength and debt ratings are set forth in the chart below.
Financial Strength Rating Senior Debt Rating
Rating Agency of Phoenix Life of PNX
--------------------------- --------------------------- --------------------------
A.M. Best Company, Inc. A ("Excellent") Bbb+ ("Adequate")
Fitch AA- ("Very Strong") A- ("Strong")
Standard & Poor's A ("Strong") BBB ("Good")
Moody's A3 ("Good") Baa3 ("Adequate")
Moody's and Standard & Poor's each have a stable outlook for our ratings, while A.M. Best and Fitch have a
negative outlook.
Any rating downgrades may result in increased interest costs in connection with future borrowings. Such an
increase would decrease our earnings and could reduce our ability to finance our future growth on a profitable
basis.
Downgrades may also trigger defaults or repurchase obligations.
Downgrades could adversely affect our reputation and, hence, our relationships with existing distributors and
our ability to establish additional distributor relationships. If this were to occur, we might experience a
decline in sales of certain products and the persistency of existing customers. At this time, we cannot
estimate the impact on sales or persistency. A significant decline in our sales or persistency could have a
material adverse effect on our financial results.
25
We might need to fund deficiencies in our closed block, which would result in a reduction in net income and
could result in a reduction in investments in our on-going business.
We have allocated assets to our closed block to produce cash flows that, together with additional revenues from
the closed block policies, are reasonably expected to support our obligations relating to these policies. Our
allocation of assets to the closed block was based on actuarial assumptions about our payment obligations to
closed block policyholders and the continuation of the non-guaranteed policyholder dividend scales in effect
for 2000, as well as assumptions about the investment earnings the closed block assets will generate over time.
Since such assumptions are to some degree uncertain, it is possible that the cash flows generated by the closed
block assets and the anticipated revenues from the policies included in the closed block will prove
insufficient to provide for the benefits guaranteed under these policies even if the non-guaranteed
policyholder dividend scale were to be cut. If this were to occur, we would have to fund the resulting
shortfall from assets outside of the closed block, which could adversely affect our profitability.
The independent trustees of our mutual funds and closed-end funds, intermediary program sponsors, managed
account clients and institutional asset management clients could terminate their contracts with us. This would
reduce our investment management fee revenues.
Each of the mutual funds and closed-end funds for which Phoenix Investment Partners acts as investment advisor
or sub-advisor is registered under the Investment Company Act of 1940 and is governed by a board of trustees or
board of directors. SEC rules require a majority of each board's members to be independent, and proposed
amendments would increase that requirement to 75%. Each fund's board has the duty of deciding annually whether
to renew the contract under which Phoenix Investment Partners manages the fund. Board members have a fiduciary
duty to act in the best interests of the shareholders of their funds. Either the board members or, in limited
circumstances, the shareholders may terminate an advisory contract with Phoenix Investment Partners and move
the assets to another investment advisor. The board members also may deem it to be in the best interests of a
fund's shareholders to make other decisions adverse to us, such as reducing the compensation paid to Phoenix
Investment Partners or imposing restrictions on Phoenix Investment Partners' management of the fund.
Our asset management agreements with institutional clients, intermediary program sponsors (who "wrap," or make
available, our investment products within the management agreements they have with their own clients), direct
managed account clients and institutional clients are generally terminable by these sponsors and clients upon
short notice without penalty. As a result, there would be little impediment to these sponsors or clients
terminating our agreements if they became dissatisfied with our performance.
The termination of any of the above agreements relating to material portion of assets under management would
adversely affect our investment management fee revenues and could require us to impair the goodwill or
intangible assets associated with our asset management partners.
We might be unable to attract or retain personnel who are key to our business.
The success of our business is dependent to a large extent on our ability to attract and retain key employees.
Competition in the job market for professionals such as securities analysts, portfolio managers, sales
personnel and actuaries is generally intense. In general, our employees are not subject to employment contracts
or non-compete agreements.
Goodwill or intangible assets associated with our Asset Management business could become impaired requiring a
non-cash charge to earnings in the event of significant market declines, net outflows of assets, changes in
investment management contracts or the departure of key employees.
As of December 31, 2004, our Asset Management business had $725.3 million in goodwill and intangible assets
associated with our various partners. The amount of goodwill and intangible assets on our balance sheet is
26
supported by the assets under management and the related revenues of each of the partners. It might be
necessary to impair those assets if:
• we experienced a drop in assets under management due to a significant market decline or continued
outflows such as in 2004 when we had net outflows of $6.6 billion;
• a material investment management contract, such as one with one of our mutual funds, were terminated, in
this case by the independent trustees; or
• certain key employees at our Asset Management partners left the Company, which could cause outflows as
clients opt to withdraw their funds following such departures.
We face strong competition in our businesses from mutual fund companies, banks, Asset Mmanagement firms and
other insurance companies. This competition could impair our ability to retain existing customers, attract new
customers and maintain our profitability.
We face strong competition in each of our businesses, comprising life insurance, annuities and asset
management. We believe that our ability to compete is based on a number of factors, including product features,
investment performance, service, price, distribution capabilities, scale, commission structure, name
recognition and financial strength ratings. While there is no single company that we identify as a dominant
competitor in our business overall, our actual and potential competitors include a large number of mutual fund
companies, banks, asset management firms and other insurance companies, many of which have advantages over us
in one or more of the above competitive factors. Recent industry consolidation, including acquisitions of
insurance and other financial services companies in the United States by international companies, has resulted
in larger competitors with financial resources, marketing and distribution capabilities and brand identities
that are stronger than ours. Larger firms also may be able to offer, due to economies of scale, more
competitive pricing than we can. In addition, some of our competitors are regulated differently than we are,
which may give them a competitive advantage; for example, many non-insurance company providers of financial
services are not subject to the costs and complexities of insurance regulation by multiple states. Further,
national banks, with their pre-existing customer bases for financial services products, may compete with
insurers as a result of the Gramm-Leach-Bliley Act of 1999, which permits mergers among commercial banks,
insurers and securities firms under one holding company.
We could have material losses in the future from our discontinued reinsurance business.
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 also purchased aggregate excess-of-loss
reinsurance to further protect us from unfavorable results from this discontinued business. On February 7, 2005
we notified the aggregate excess-of-loss reinsurer that we were exercising our option to commute this contract.
The commutation will be effective during the second quarter of 2005. The effect of the commutation will not be
material to our consolidated financial statements.
We have established reserves for claims and related expenses that we expect to pay on our discontinued group
accident and health reinsurance business. These reserves are 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 aggregate
excess-of-loss reinsurance, the amounts we believe we will collect from our retrocessionaires and the likely
legal and administrative costs of winding down the business. Our total reserves, including coverage available
from our reinsurance and reserves for amounts recoverable from retrocessionaires, were $110.0 million as of
December 31, 2004. Our total amounts recoverable from retrocessionaires related to paid losses were $60.0
million as of December 31, 2004.
27
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. In
addition, unfavorable claims experience is possible and could result in additional future losses. For these
reasons, we cannot know today what our actual claims experience will be.
In addition, we are involved in disputes relating to certain portions of our discontinued group accident and
health reinsurance business. See Note 17 to our consolidated financial statements in this Form 10-K for more
information.
In establishing our reserves described above for the payment of insured losses and expenses on this
discontinued business, we have made assumptions about the likely outcome of the disputes referred to above,
including an assumption that substantial recoveries would be available from our reinsurers on all of our
discontinued reinsurance business. However, the inherent uncertainty of arbitrations and lawsuits, including
the uncertainty of estimating whether any settlements we may enter into in the future would be on favorable
terms, makes it hard to predict outcomes with certainty. Given the need to use estimates in establishing loss
reserves, and the difficulty in predicting the outcome of arbitrations and lawsuits, our actual net ultimate
exposure likely will differ from our current estimate. If future facts and circumstances differ significantly
from our estimates and assumptions about future events with respect to the disputes referred to above or other
portions of our discontinued reinsurance business, our current reserves may need to be increased materially,
with a resulting material adverse effect on our results of operations and financial condition.
Some of the Bush administration's legislative proposals would reduce or eliminate the benefit of deferral of
taxation for our insurance and annuity products. In addition, legislation eliminating or modifying either the
federal estate tax or the federal taxation of investment income could adversely affect sales of and revenues
from our life and annuity products.
The attractiveness to our customers of many of our products is due, in part, to favorable tax treatment.
Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid
by the holders of annuities and life insurance products. In 2003, the tax rate on long-term capital gains and
certain dividend income was reduced until 2008. President Bush's 2006 budget proposal would make these rate
reductions permanent. If this happens, it could have a negative impact on our sales and revenues. In addition,
President Bush has indicated that fundamental changes to the Internal Revenue Code of 1986, as amended, or the
Code, are among his legislative priorities for his second term. These changes might include the adoption of a
flat tax, value-added tax or similar alternative structure, modifications to Social Security, the creation of
new and expanded vehicles for tax-exempt savings and lower taxes on investment income. The impact of these
proposals, if enacted, cannot reasonably be estimated.
Some of our life insurance products are specifically designed and marketed as policies that help a decedent's
heirs to pay estate tax. Legislation enacted in the spring of 2001 increased the size of estates exempt from
the federal estate tax, phased in reductions in the estate tax rate between 2002 and 2009 and repealed the
estate tax entirely in 2010. This legislation, despite its reinstatement of the estate tax in 2011, could have
a negative effect on our revenues from the sale of estate planning products. President Bush and members of
Congress have expressed a desire to modify the existing legislation, which could result in faster or more
complete reduction or repeal of the estate tax.
Changes in insurance and securities regulation could affect our profitability by imposing further restrictions
on the conduct of our business.
Our life insurance and annuity businesses are subject to comprehensive state regulation and supervision
throughout the United States. State insurance regulators and the National Association of Insurance
Commissioners, or the NAIC, continually reexamine existing laws and regulations, and may impose changes in the
future that put further regulatory burdens on us, thereby increasing our costs of doing business or otherwise
28
harm our business. This could have a material adverse affect on our results of operations and financial
condition.
The United States federal government does not directly regulate the insurance business. However, federal
legislation and administrative policies in areas which include employee benefit plan regulation, financial
services regulation and federal taxation and securities laws could significantly affect each of our businesses,
most notably our costs.
We and some of the policies, contracts and other products that we offer are subject to various levels of
regulation under the federal securities laws administered by the SEC as well as regulation by those states and
foreign countries in which we provide investment advisory services, offer products or conduct other
securities-related activities. We could be restricted in the conduct of our business for failure to comply with
such laws and regulations. Future laws and regulations, or the interpretation thereof, could have a material
adverse effect on our results of operations and financial condition by increasing our expenses in order to
comply with these regulations.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS
Management's discussion and analysis reviews our consolidated financial condition at December 31, 2004 and
2003; our consolidated results of operations for the years 2004, 2003 and 2002; and, where appropriate, factors
that may affect our future financial performance. This discussion should be read in conjunction with "Selected
Financial Data" and our consolidated financial statements in this Form 10-K.
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 offer a broad range of life insurance,
annuity and asset management products and services through a variety of distributors. These distributors
include independent advisors and financial services firms who make our products and services available to their
clients.
We manufacture our products through two operating segments — Life and Annuity and Asset Management — which
include three product lines — life insurance, annuities and asset management. Through Life and Annuity we
offer a variety of life insurance and annuity products, including universal, variable universal, term life
insurance, and a range of variable annuity offerings. Asset Management comprises two lines of business —
private client and institutional.
Through our private client line of business, we provide investment management services principally on a
discretionary basis, with products consisting of open-end mutual funds, closed-end funds and managed accounts.
Managed accounts include intermediary programs sponsored and distributed by non-affiliated broker-dealers and
direct managed accounts sold and administered by us. These two types of managed accounts generally require
minimum investments of $100,000 and $1 million, respectively. Our private client business also provides
transfer agency, accounting and administrative services to our open-end mutual funds.
Through our institutional group, we provide discretionary and non-discretionary investment management services
primarily to corporations, multi-employer retirement funds and foundations, as well as to endowments and
special purpose funds. In addition, we manage alternative financial products such as structured finance
products. Structured finance products include collateralized obligations such as collateralized debt
obligations, or CDOs, backed by portfolios of public high yield bonds, commercial mortgage-backed or
asset-backed securities.
We report our remaining activities in two non-operating segments — Venture Capital and Corporate and Other.
Venture Capital includes limited partnership interests in venture capital funds, leveraged buyout funds and
other private equity partnerships sponsored and managed by third parties. These assets are investments of the
general accounts of our Life Companies. See Business—Venture Capital Segment. Corporate and Other includes
indebtedness; unallocated assets, liabilities and expenses; and certain businesses not of sufficient scale to
report independently. See Business—Corporate and Other Segment. These non-operating segments are significant
for financial reporting purposes, but do not contain products or services relevant to our core manufacturing
operations.
We derive our revenues principally from:
• premiums on whole life insurance;
• insurance and investment product fees on variable life and annuity products and universal life
products;
• investment management and related fees; and
• net investment income and net realized investment gains.
30
Under GAAP, premium and deposit collections for variable life, universal life and annuity products are not
recorded as revenues. These collections are reflected on our balance sheet as an increase in separate account
liabilities for certain investment options of variable products. Collections for fixed annuities and certain
investment options of variable annuities are reflected on our balance sheet as an increase in policyholder
deposit funds. Collections for other products are reflected on our balance sheet as an increase in policy
liabilities and accruals.
Our expenses consist principally of:
• insurance policy benefits provided to policyholders, including interest credited on policies;
• policyholder dividends;
• deferred policy acquisition costs amortization;
• intangible assets amortization;
• interest expense;
• other operating expenses; and
• income taxes.
Our profitability depends principally upon:
• the adequacy of our product pricing, which is primarily a function of our:
• ability to select appropriate underwriting risks;
• mortality experience;
• ability to generate investment earnings;
• ability to maintain expenses in accordance with our pricing assumptions; and
• policies' persistency (the percentage of policies remaining in force from year to year as measured
by premiums);
• the amount and composition of assets under management;
• the maintenance of our target spreads between the rate of earnings on our investments and dividend and
interest rates credited to customers; and
• our ability to manage expenses.
Prior to Phoenix Life's demutualization, we focused on participating life insurance products, which pay
policyholder dividends. As of December 31, 2004, 74.0% of our life insurance reserves were for participating
policies. As a result, a significant portion of our expenses consists, and will continue to consist, of such
policyholder dividends. Our net income is reduced by the amounts of these dividends. Policyholder dividends
expense was $404.7 million during 2004, $418.8 million during 2003 and $401.8 million during 2002.
Our sales and financial results over the last several years have been affected by demographic, industry and
market trends. The baby boom generation has begun to enter its prime savings years. Americans generally have
begun to rely less on defined benefit retirement plans, social security and other government programs to meet
their postretirement financial needs. Product preferences have shifted between fixed and variable options
depending on market and economic conditions. Our balanced product portfolio including universal life, variable
life and variable annuity products, as well as a broad array of mutual funds and managed accounts, is well
positioned to meet this shifting demand.
Discontinued Operations
During 2004, we completed the sale of 100% of the common stock held by us in Phoenix National Trust Company.
The effect of this transaction is not material to our consolidated financial statements. Phoenix National Trust
Company is presented as a discontinued operation in our consolidated financial statements for all periods
presented.
31
In 1999, we discontinued our reinsurance operations. See Note 14 to our consolidated financial statements in
this Form 10-K for detailed information regarding our discontinued operations.
Recent Acquisitions and Dispositions
Life and Annuity
On October 25, 2004, we entered into an agreement with Friends Provident plc, or Friends Provident, to sell our
12% interest in Lombard International Assurance S.A., or Lombard, and to relinquish our notes receivable from
Lombard's affiliate, Insurance Development Holdings A.G., or IDH. This transaction closed on January 11, 2005
for consideration of $59.0 million and, under the terms of the sale, we may be entitled to additional
consideration, in the form of cash, based on Lombard's financial performance through 2006. We currently expect
to recognize an after-tax realized gain of between $7.0 million and $10.0 million in the first quarter of 2005
related to our sale of Lombard.
During the second quarter of 2004, we sold our retail affiliated broker-dealer operations to LPL. As part of
the transaction, advisors affiliated with Griffith and Main Street had the opportunity to move to LPL as
independent registered representatives. As of December 31, 2004, LPL had successfully recruited about 45% of
Griffith's total representatives, representing about 50% of Griffith's total gross dealer concessions. As of
December 31, 2004, we have not determined the ultimate persistency of the business written by these advisors,
but our experience through that date shows no material deterioration, reflecting the quality of our in-force
products and the professionalism of these advisors. As part of this transaction, we are expanding our
distribution relationship with LPL, adding life and annuity products to our existing asset management
offerings, and we have recently commenced a marketing plan to position these products within LPL and its more
than 5,500 producers.
Revenues net of eliminations and direct expenses net of deferrals and certain transaction related costs
included in our consolidated financial statements related to our retail affiliated broker-dealer operations
sold during 2004 are as follows:
Year Ended December 31,
Revenues and Direct Expenses Of ----------------------------------
Retail Affiliated Broker-dealer Operations: 2004 2003 2002
($ amounts in millions) ---------- ----------- ----------
Insurance and investment product fees revenues, net of eliminations..... $ 32.0 $ 60.8 $ 61.8
Direct other operating expenses, net of deferrals....................... 38.7 72.8 74.4
During 2004, we incurred a $3.6 million after-tax charge for an impairment of goodwill related to Main Street,
offset by a $2.7 million after-tax gain on the sale of the broker-dealer operations. Both the charge and the
gain were recorded to realized investment gains and losses. In addition, we incurred a $10.2 million after-tax
charge related to lease termination costs, offset by a $4.4 million after-tax gain related to curtailment
accounting in connection with employee benefit plans.
In 2003, we acquired the remaining interest in PFG Holdings, Inc., or PFG, the holding company for our private
placement operation, 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 $86.5 million to the selling shareholders, including
$10.0 million during 2005 through 2007 based on certain financial performance targets being met, and the
balance in 2008 based on the appraised value of PFG as of December 31, 2007. During the year ended December 31,
2004, we paid $3.0 million under this obligation.
In 2002, we acquired the variable life and variable annuity business of Valley Forge Life Insurance Company (a
subsidiary of CNA Financial Corporation). See Note 3 to our consolidated financial statements in this Form 10-K
for further information regarding the acquisition of Valley Forge Life Insurance Company.
32
Asset Management
In March 2004, we acquired the remaining minority interests in Walnut Asset Management LLC and Rutherford Brown
& Catherwood, LLC for $2.1 million. This additional purchase price was accounted for as a step-acquisition by
Phoenix Investment Partners and was allocated to goodwill and definite-lived intangible assets, accordingly.
In 2002 we acquired a 60% equity interest in Kayne Anderson Rudnick, LLC, or Kayne Anderson Rudnick, for $102.4
million. This acquisition was accounted for using the purchase method under FASB Statement No. 141, Business
Combinations, or SFAS 141. In connection with this acquisition, the Acquisition Agreement and the related
Amended and Restated Operating Agreement resulted in the creation of mandatorily redeemable noncontrolling
interests, or noncontrolling interests, representing 40% of Kayne Anderson Rudnick's members' interests held by
certain of its members. Certain of these noncontrolling interests in Kayne Anderson Rudnick have scheduled
redemption dates (5% at each date) as of December 31, 2004, 2005, and 2006, at a price based upon operating
results of Kayne Anderson Rudnick for the year then ended. These 15% noncontrolling interests, as well as the
remaining 25% of Kayne Anderson Rudnick's noncontrolling interests, are mandatorily redeemable upon death of a
member and, as such, are reported as a liability on our consolidated balance sheet in accordance with FASB
Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and
Equity, or SFAS 150. Separate agreements in connection with the 25% noncontrolling interests held by certain
Kayne Anderson Rudnick's members give the noncontrolling interest-holders the right to require Phoenix
Investment Partners to redeem all or a part of their noncontrolling interest at specified future dates and at a
price determined based upon operating results of Kayne Anderson Rudnick. Conversely, the terms of these
agreements also give Phoenix Investment Partners the right to redeem the outstanding minority interests at the
same price as the noncontrolling interest-holder may exercise its right to sell. These agreements may expire
unexercised should Kayne Anderson Rudnick's operating results decline from the initial measurement date.
In addition to the initial cost of the purchase of Kayne Anderson Rudnick, in the first quarter of 2004 we made
a payment of $30.1 million in contingent consideration, which was based upon management fee revenues for the
purchased business through the end of 2003. Phoenix Investment Partners had accrued for this payment as of
December 31, 2003 and allocated it entirely to goodwill.
In January 2004, one member of Kayne Anderson Rudnick accelerated his portion of the 15% noncontrolling
interest redemption, at which time we acquired an additional 0.3% of the company. Phoenix Investment Partners
has accrued $11.4 million related to the remaining 4.9% redemption required as of December 31, 2004, has
accounted for this payment as a step-acquisition and has allocated the purchase price to goodwill and
definite-lived intangible assets, accordingly. The two remaining 4.9% noncontrolling interest redemptions will
be accounted for as step-acquisitions as the purchase price contingency resolves.
During 2004, we purchased a contract to manage the assets of the FMI Sasco Contrarian Value Fund, an open-end
mutual fund. This transaction is not material to our consolidated financial statements.
Corporate and Other
During 2004, we sold the stock of Phoenix Global Solutions (India) Pvt. Ltd., our India-based information
technology subsidiary, and essentially all of the assets of its United States affiliate, Phoenix Global
Solutions, Inc., to Tata Consultancy Services Limited, a division of Tata Sons Ltd. This transaction is not
material to our consolidated financial statements.
In January 2005, we sold our equity interest in Aberdeen for net proceeds of $70.4 million as further described
in Notes 1 and 5 to our consolidated financial statements in this Form 10-K.
33
The Demutualization
Phoenix Home Life 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 PNX and changed its name to Phoenix Life Insurance
Company, or Phoenix Life. See Note 3 to our consolidated financial statements in this Form 10-K for detailed
information regarding the demutualization and closed block.
Recently Issued Accounting Standards
Share-Based Payment: On December 16, 2004, the Financial Accounting Standards Board, or the FASB, issued FASB
Statement No. 123 (revised 2004), Share-Based Payment, or SFAS 123(R), which requires that compensation cost
related to share-based payment transactions be recognized in financial statements at the fair value of the
instruments issued. While prior to the issuance of SFAS 123(R), recognition of such costs at fair value was
optional, we elected to do so for all share-based compensation that we awarded after December 31, 2002.
Accordingly, we do not expect our adoption of SFAS 123(R) to have a material effect on our consolidated
financial statements.
Other-Than-Temporary Impairments: Portions of Emerging Issues Task Force Abstract EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, or EITF 03-1, are effective for
fiscal periods beginning after June 15, 2004. EITF 03-1 provides guidance as to the determination of
other-than-temporarily impaired securities and requires additional financial disclosures with respect to
unrealized losses. These accounting and disclosure requirements largely codify our existing practices as to
other-than-temporarily impaired securities and thus, are not anticipated to have a material effect on our
consolidated financial statements. The effective date of certain portions of EITF 03-1 has been delayed pending
further interpretive guidance. Because significant uncertainty remains surrounding what form the guidance will
ultimately take, we cannot predict what effect, if any, adoption of the pending portions will have on our
consolidated financial statements.
Postretirement Benefits: On May 19, 2004, the FASB issued FASB Staff Position No. FAS 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,
or the FSP. For employers that sponsor postretirement benefit plans, or plan sponsors that provide prescription
drug benefits to retirees, the FSP requires any effects of the anticipated federal tax subsidy related to those
drug benefits be treated as an actuarial gain. The effect of our adoption of the FSP is not material to our
consolidated financial statements.
Effective July 1, 2003, we adopted SFAS 150. The effect of our adoption was to reclassify the mandatorily
redeemable noncontrolling interests related to our asset management subsidiaries from "minority interest" to
"other liabilities" in our consolidated balance sheet. In addition, within our consolidated statement of
operations, we reclassified earnings attributed to those interests from the caption "minority interest in net
income of subsidiaries" to "other operating expenses." These changes in presentation were not material to our
consolidated financial statements.
Accounting Changes
Nontraditional Long-Duration Contracts and Separate Accounts: Effective January 1, 2004, we adopted the AICPA's
Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts, or SOP 03-1. SOP 03-1 provides guidance related to the
accounting, reporting and disclosure of certain insurance contracts and separate accounts, including guidance
for computing reserves for products with guaranteed benefits such as guaranteed minimum death benefits and for
products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1
addresses the presentation and reporting of separate accounts, as well as rules concerning the capitalization
and amortization of sales inducements. Since this new accounting standard largely codifies certain accounting
and reserving practices related to applicable nontraditional long-duration contracts and separate
34
accounts that we already followed, our adoption did not have a material effect on our consolidated financial
statements.
Variable Interest Entities. A new accounting standard was issued in January 2003 that interprets the existing
standard on consolidation. This new accounting standard was revised and reissued in December 2003 as FIN 46(R),
Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, or FIN 46(R). It clarifies the
application of standards of consolidation to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from other parties ("variable interest
entities"). As of December 31, 2003, we adopted FIN 46(R) for special purpose entities, or SPEs, where we may
hold a variable interest. Our adoption of FIN 46(R) resulted in no additional variable interest entities being
consolidated by us.
In accordance with previous guidance, we continue to consolidate certain collateralized obligation trusts, or
CDOs, which we sponsor.
Effect of Consolidation of Certain CDOs on
Consolidated Financial Statements: 2004 2003 2002
($ amounts in millions) -------------- -------------- --------------
Decrease in net income or increase in net loss.............. $ (12.9) $ (2.4) $ (26.3)
============== ============== ==============
Reduction in stockholder's equity........................... $ (67.5) $ (77.3) $ (204.9)
============== ============== ==============
The above non-cash charges to earnings and stockholders' equity primarily relate to realized and unrealized
investment losses within the CDOs. Upon maturity or other liquidation of the trusts, the fair value of the
investments pledged as collateral will be used to settle the non-recourse collateralized obligations with any
shortfall in such investments inuring to the third-party note and equity holders. To the extent there remains a
recorded liability for non-recourse obligations after all the assets pledged as collateral are exhausted, such
amount will be reduced to zero with a corresponding benefit to earnings. Accordingly, these investment losses
and any future investment losses under this method of consolidation will ultimately reverse upon the maturity
or other liquidation of the non-recourse collateralized obligations. These non-recourse obligations mature
between 2011 through 2014 but contain call provisions. The call provisions may be triggered at the discretion
of the equity investors based on market conditions and are subject to certain contractual limitations.
GAAP requires us to consolidate all the assets and liabilities of these collateralized obligation trusts which
results in the recognition of realized and unrealized losses even though we have no legal obligation to fund
such losses in the settlement of the collateralized obligations. The FASB continues to evaluate, through the
issuance of FASB staff positions, the various technical implementation issues related to consolidation
accounting. We will continue to assess the impact of any new implementation guidance issued by the FASB as well
as evolving interpretations among accounting professionals. Additional guidance and interpretations may affect
our application of consolidation accounting in future periods.
Stock-based Compensation: A new standard was issued by the FASB 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. See Note 11 to our
consolidated financial statements in this Form 10-K for additional disclosure on the requirements of the new
standard as it relates to our business.
Goodwill and Other Intangible Assets. At the beginning of 2002, we adopted a new accounting standard for
goodwill and other intangible assets, including amounts reflected in our carrying value of equity method
investments. Under this new standard, we discontinued recording amortization expense on goodwill and other
intangible assets with indefinite lives, but we continue recording amortization expense for those assets with
definite estimated lives. See Note 4 to our consolidated financial statements in this Form 10-K for a
35
comprehensive discussion of the adoption of the new standard and its effects on our consolidated financial
statements.
Critical Accounting Estimates
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 could differ from those estimates.
Critical accounting estimates 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 footnote(s) in which each accounting policy is
discussed in relation to our business:
• Deferred Policy Acquisition Costs and Present Value of Future Profits
The costs of acquiring new business, principally commissions, underwriting, distribution and policy
issue expenses, all of which vary with and are primarily related to production of new business, are
deferred. In connection with our 1997 acquisition of the Confederation Life business, we recognized an
asset for the present value of future profits representing the present value of estimated net cash
flows embedded in the existing contracts acquired. This asset is included in deferred acquisition
costs.
We amortize deferred acquisition costs and present value of future profits based on the related
policy's classification. For individual participating life insurance policies, deferred acquisition
costs and present value of future profits are amortized in proportion to estimated gross margins. For
universal life, variable universal life and accumulation annuities, deferred acquisition costs and
present value of future profits 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
deferred acquisition costs balance associated with the replaced or surrendered policies is amortized
to reflect these surrenders.
The amortization of deferred acquisition costs and present value of future profits requires the use of
various assumptions, estimates and judgments about the future. Significant assumptions include those
concerning expenses, investment performance, mortality and policy cancellations (i.e., lapses,
withdrawals and surrenders). These 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 actual experiences 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 deferred acquisition cost balances.
We regularly evaluate our estimated gross profits to determine if actual experience or other evidence
suggests that earlier estimates should be revised. Several assumptions considered to be significant in
the development of estimated gross profits include separate account fund performance, surrender and
lapse rates, estimated interest spread and estimated mortality. The separate account fund performance
assumption is critical to the development of the estimated gross profits related to our variable
annuity and variable and interest-sensitive life insurance businesses. The average long-term rate of
assumed separate account fund performance used in estimating gross profits was 6.0% for the variable
annuity business and 6.9% for the variable life business at December 31, 2004.
See Note 3 to our consolidated financial statements and Item 7A, Quantitative and Qualitative
Disclosures About Market Risk in this Form 10-K for more information.
36
• Policy Liabilities and Accruals
See Note 3 to our consolidated financial statements and Item 7A, Quantitative and Qualitative
Disclosures About Market Risk in this Form 10-K for more information.
• Goodwill and Other Intangible Assets
At the beginning of 2002, we adopted a 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 intangible assets, we perform impairment tests at the
reporting-unit level at least annually. For purposes of the goodwill and indefinite-lived intangible
assets 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 fixed assets. Prior to 2002, we amortized goodwill
principally 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, for
intangible assets with definite lives, to be calculated on a straight-line basis.
See Note 4 to our consolidated financial statements in this Form 10-K for more information.
• Valuation of Debt and Equity Securities
We classify our debt and equity securities held in our general account, as well as those pledged as
collateral, 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.
Fair Value of General Account Fixed Maturity Securities As of December 31, 2004
by Pricing Source: -----------------------------------
($ amounts in millions) Fixed
Maturities % of Total
At Fair Value Fair Value
----------------- -----------------
Priced via independent market quotations..................... $ 10,904.4 80.9%
Priced via matrices.......................................... 2,149.5 16.0%
Priced via broker quotations................................. 298.6 2.2%
Priced via other methods..................................... 119.3 0.9%
Short-term investments*...................................... 4.5 --%
----------------- -----------------
Total........................................................ $ 13,476.3 100.0%
================= =================
*Short-term investments are valued at amortized cost, which approximates fair value.
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. 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
37
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, the Debt and Equity Securities section of
Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 7A,
Quantitative and Qualitative Disclosures About Market Risk in this Form 10-K for more information.
• 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. 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 estimate changes in valuations 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 write-downs
by the general partners). Our methodology recognizes both downward and upward adjustments in estimated
values based on the indices, but when the general partner reduces the value of a private investee
company, we do not adjust the fair value upward (by applying the public sector index) in excess of the
most recent value reported by the general partner. Finally, we revise the valuations we have assigned
to the investee companies annually to reflect the valuations in the audited financial statements
received from the venture capital partnerships. Adjustments to the valuation of these companies to
reflect reported valuations in the audited financial statements received from the venture capital
partnerships will be reflected in our financial statements when received in the first and second
quarters of 2005.
The estimation process for valuing the private investee companies is inherently less precise than the
estimation process for valuing public company investees. For private investee companies, we employ a
sector index based on biotechnology, telecom, computer and healthcare indices as a proxy for
estimating changes in fair value of individual private investee companies that will not necessarily
match the underlying changes in fair value of an individual private investee company. Based on our
experience, we have found that such indices represent a reasonable basis for estimating the fair value
of an investee company during a period of deteriorating public equity markets such as that experienced
in 2002. However, we believe this method is less reliable in rising markets such as that experienced
in 2003 and 2004 relative to general partner valuations. Specifically, our experience indicates that
upward revisions of valuations by the general partners for private company investees tend to lag
increases in public equity markets as general partner valuations typically will be revised upward
based on company specific liquidity events including new rounds of financing, mergers and acquisitions
and initial public offerings.
See Note 5 to our consolidated financial statements in this Form 10-K for more information.
• Deferred Income Taxes
We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. The deferred
tax assets and/or liabilities are determined by multiplying the differences between the financial
reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be
in effect when such differences are recovered or settled. The effect on deferred taxes of a change in
tax rates is recognized in income in the period that includes the enactment date. Valuation allowances
on deferred tax assets are estimated based on the Company's assessment of the realizability of such
amounts.
We have elected to file a consolidated federal income tax return for 2004 and prior years. Within the
consolidated tax return, we are required by regulations of the Internal Revenue Service, or the IRS,
to segregate our companies into two groups: life insurance companies and non-life insurance companies.
38
We are limited as to the amount of any operating losses from one group that can be offset against
taxable income of the other group. These limitations affect the amount of any operating loss
carryforwards that we have recorded in our deferred tax assets now or in the future.
As of December 31, 2004, we had deferred tax assets of $51.6 million related to net operating losses
for federal income tax purposes and $7.9 million for state income tax purposes. The related federal
net operating losses are scheduled to expire as follows: $61.2 million in 2017, $12.5 million in 2018,
$1.1 million in 2019, $1.8 million in 2022, $33.5 million in 2023 and $44.8 million in 2024. The state
net operating losses relate to the non-life subgroup and are scheduled to expire as follows: $29.8
million in 2012 and 2013 and $72.0 million in 2019 through 2023. Due to the inability to combine the
life insurance and non-life insurance subgroups for state income tax purposes, we established a $7.9
million and a $4.6 million valuation allowance at the end of 2004 and 2003, respectively, relative to
the state net operating loss carryforwards.
We have determined, based on our earnings and future income, that it is more likely than not that the
deferred income tax assets after valuation allowance already recorded as of December 31, 2004 and 2003
will be realized. In determining the adequacy of future income, we have considered projected future
income, reversal of existing temporary differences and available tax planning strategies that could be
implemented, if necessary.
Our federal income tax returns are routinely audited by the IRS and estimated provisions are routinely
provided in the financial statements in anticipation of the results of these audits. The IRS has
examined our consolidated group's federal income tax returns through 2001. The IRS is currently
examining our federal income tax returns for 2002 and 2003. While it is often difficult to predict the
outcome of these audits, including the timing of any resolution of any particular tax matter, we
believe that our reserves, as recorded in other liabilities on the balance sheet, are adequate for all
open tax years. Unfavorable resolution of any particular issue could result in additional use of cash
to pay liabilities that would be deemed owed to the IRS. Additionally, any unfavorable or favorable
resolution of any particular issue could result in an increase or decrease, respectively, to our
effective income tax rate to the extent that our estimates differ from the ultimate resolution. During
2004 we recognized a $5.7 million favorable tax benefit as a result of the favorable resolution of
certain tax matters with the IRS.
See Note 10 to our consolidated financial statements in this Form 10-K for more information related to
income taxes.
• Pension and other Postemployment Benefits
See Note 11 to our consolidated financial statements in this Form 10-K for more information on our
pension and other postemployment benefits.
39
Consolidated Results of Operations
Summary Consolidated Financial Data: Year Ended December 31, Changes
($ amounts in millions, except per share data) -------------------------------------- -----------------------
2004 2003 2002 2004/03 2003/02
------------ ------------ ----------- ----------- -----------
REVENUES
Premiums..................................... $ 990.6 $ 1,042.2 $ 1,082.0 $ (51.6) $ (39.8)
Insurance and investment product fees........ 534.9 500.9 493.8 34.0 7.1
Broker-dealer commission and
distribution fee revenues.................. 56.9 81.5 85.0 (24.6) (3.5)
Investment income, net of expenses........... 1,075.7 1,107.4 940.5 (31.7) 166.9
Unrealized gain on trading equity securities. 85.9 -- -- 85.9 --
Net realized investment gains (losses)....... (0.8) (98.5) (133.9) 97.7 35.4
------------ ------------ ------------ ----------- ----------
Total revenues............................... 2,743.2 2,633.5 2,467.4 109.7 166.1
------------ ------------ ------------ ----------- ----------
BENEFITS AND EXPENSES
Policy benefits, excluding
policyholder dividends..................... 1,422.2 1,454.0 1,436.1 (31.8) 17.9
Policyholder dividends....................... 404.7 418.8 401.8 (14.1) 17.0
Policy acquisition cost amortization......... 110.2 94.1 59.2 16.1 34.9
Intangible asset amortization................ 33.8 33.2 32.5 0.6 0.7
Intangible asset impairments................. -- -- 66.3 -- (66.3)
Interest expense on indebtedness............. 40.8 39.6 31.4 1.2 8.2
Interest expense on non-recourse
collateralized obligations................. 33.6 48.9 30.5 (15.3) 18.4
Other operating expenses..................... 560.7 565.1 613.2 (4.4) (48.1)
------------ ------------ ------------ ----------- ----------
Total benefits and expenses.................. 2,606.0 2,653.7 2,671.0 (47.7) (17.3)
------------ ------------ ------------ ----------- ----------
Income (loss) before income taxes, minority
interest, equity in earnings of affiliates and
cumulative effect of accounting changes.... 137.2 (20.2) (203.6) 157.4 183.4
Applicable income taxes (benefit)............ 40.5 (18.3) (58.8) 58.8 40.5
------------ ------------ ------------ ----------- ----------
Income (loss) from continuing operations
before minority interest, equity in earnings
of affiliates and cumulative effect of
accounting changes......................... 96.7 (1.9) (144.8) 98.6 142.9
Minority interest in net income
of consolidated subsidiaries............... -- (0.4) (0.5) 0.4 0.1
Equity in undistributed earnings (loss)
of affiliates............................. (10.4) (1.8) 4.6 (8.6) (6.4)
------------ ------------ ------------ ----------- ----------
Income (loss) from continuing operations..... 86.3 (4.1) (140.7) 90.4 136.6
Income (loss) from discontinued operations... 0.1 (2.1) (1.3) 2.2 (0.8)
------------ ------------ ------------ ----------- ----------
Income (loss) before cumulative effect of
accounting changes......................... 86.4 (6.2) (142.0) 92.6 135.8
Cumulative effect of accounting changes...... -- -- (130.3) -- 130.3
Net income (loss)............................ $ 86.4 $ (6.2) $ (272.3) $ 92.6 $ 266.1
============ ============ ============ =========== ==========
Earnings (loss) per share:
Basic....................................... $ 0.91 $ (0.07) $ (2.78) $ 0.98 $ 2.71
============ ============ ============ =========== ===========
Diluted..................................... $ 0.86 $ (0.07) $ (2.78) $ 0.93 $ 2.71
============ ============ ============ =========== ===========
Weighted-average common shares
outstanding................................ 94.7 94.2 97.9 0.5 (3.7)
============ ============ ============ =========== ===========
Weighted-average common shares outstanding
and dilutive potential common shares....... 100.8 94.2 97.9 4.2 (1.3)
============ ============ ============ =========== ===========
40
Executive Overview and Outlook
Full year 2004 net income of $86.4 million, or $0.86 per diluted share, is substantially improved from 2003 net
loss of $6.2 million, or $0.07 per diluted share and 2002 net loss of $272.3 million, or $2.78 per share as a
result of higher operating earnings from our Life and Annuity and Asset Management businesses, higher net
investment gains and a lower effective tax rate, somewhat offset by lower earnings from venture capital in 2004
as compared to 2003, and a higher loss from Corporate and Other segment. Full year 2004 net income includes a
net $41.2 million after-tax gain on our equity investment in Aberdeen, a $6.4 million after-tax charge related
to the fourth quarter tender of $144.8 million in surplus notes, and net after-tax restructuring charges of
$21.9 million, principally related to severance and other transition costs related to the sale of our Life and
Annuity retail affiliated distribution operations and the outsourcing of our information technology
infrastructure to with Electronic Data Systems, or EDS. Full year 2003 net income includes a $55.0 million
after-tax charge for the impairment of our equity investment in Aberdeen and after-tax restructuring charges of
$8.5 million principally related to employee severance costs, while full year 2002 net income includes
after-tax restructuring charges of $28.5 million and a $192.6 million after-tax writedown of goodwill related
to the adoption of new accounting for goodwill and an impairment charge. Finally, full year 2004 results
include $12.9 million of realized investment losses related to CDOs consolidated by us under FIN 46(R), which
will reverse upon the maturity or other liquidation of the non-recourse collateralized obligations. Full year
2003 and 2002 results include a $2.4 million and $26.3 million, respectively, in realized losses related to
these CDOs consolidated under FIN 46(R).
Total segment income for 2004 of $80.6 million, or $0.80 per diluted share, is substantially improved from 2003
full year total segment income of $57.3 million, or $0.59 per diluted share, and 2002 total segment loss of
$60.4 million, or $0.62 per share, as a result of higher earnings in both the Life and Annuity and Asset
Management segments, somewhat offset by lower Venture Capital earnings in 2004 as compared to 2003 and a higher
Corporate and Other segment loss. Both the Life and Annuity and Asset Management businesses benefited in 2004
as compared to 2003 and 2002 from lower distribution, general and administrative expenses, and favorable equity
market conditions. Life and Annuity also benefited from continued strong fundamentals in its in-force block
characterized by favorable mortality, strong persistency and improved investment margins. Asset Management
experienced a sharp increase in net outflows in assets under management during 2004, principally the result of
continued poor product performance in certain of our equity strategies. Asset Management expense levels also
continue to reflect structural challenges related to our operations that are not wholly-owned, primarily Seneca
Capital Management LLC, or Seneca, and Kayne Anderson Rudnick.
We ended 2004 with in a strong financial position. Shareholders' equity grew to $2,022.4 million at December
31, 2004 compared to $1,947.8 million at December 31, 2003, Phoenix Life's statutory capital, surplus and AVR
of $1,028.2 million at December 31, 2004 is improved from the December 31, 2003 amount of $961.5 million,
Phoenix Life's risk-based capital, or RBC, is well above 300%, and Holding Company cash is $61.0 million at
December 31, 2004 compared to $22.8 million at the end of 2003. We also took steps to enhance our financial
flexibility. We closed on a tender offer for our 6.95% surplus notes scheduled to mature on December 1, 2006,
receiving valid tenders of $144.8 million of notes, and issued $175.0 million of 7.15% surplus notes maturing
December 15, 2034. We also entered into a new $150.0 million three-year, unsecured senior revolving credit
facility replacing the prior facility, which was to expire during the quarter. The five-year funding
requirements for our qualified pension plan improved from $107.8 million as of December 31, 2003 to $43.3
million as of December 31, 2004. Finally, we laid the groundwork to dispose of our two largest non-strategic
assets, Aberdeen and Lombard, which resulted in the receipt of net proceeds of nearly $130.0 million in January
2005 and brought closure to the issue of dispositions of non-strategic assets.
The benefits of many initiatives that we have implemented in recent years became increasingly apparent in 2004.
We have stabilized and strengthened the Company, significantly improved profitability, established a track
record of disciplined execution and built a solid foundation for growth. While earnings in Life and Annuity
have improved much more quickly than in Asset Management, we expect a stronger, better positioned Asset
Management business to emerge in 2005 as we continue to address structural, performance and profitability
challenges and begin to benefit from the expense initiatives we announced in the fourth quarter of 2004. A
41
number of significant accomplishments in 2004 contributed to our earnings improvement and position us well for
the future. Our exit from affiliated retail distribution operations is already generating significant savings,
and we are building back sales from formerly affiliated producers. The outsourcing of our information
technology infrastructure will produce meaningful savings beginning in 2005 and will also improve service. We
enhanced our financial flexibility through our two surplus notes transactions and our new three-year credit
facility. Operationally, we continued to implement "lean" manufacturing principles to improve product and
service quality, create capacity for higher business volumes, and enhance speed to market. We are moving
forward, focused intensely on growth in 2005.
The Life and Annuity segment had pre-tax income of $142.8 million in 2004, compared to $99.4 million in for
2003 and $80.3 million for 2002. The life insurance business had full-year 2004 pre-tax income of $134.5
million, compared to $103.5 million reported for 2003 and $101.0 million in 2002. The annuity business also
demonstrated improvement with pre-tax income of $8.3 million, up from a $4.1 million pre-tax loss in 2003 and a
$20.7 million pre-tax loss in 2002. Full-year 2004 earnings improvements in Life and Annuity reflect the
benefits of expense savings, particularly from the sale of our retail affiliated distribution operations, and
continued strong fundamentals including mortality, higher investment margins and persistency. Life insurance
and annuity sales and deposits fell short of our expectations and were well below 2003 and 2002 levels. Life
insurance sales were lower due to our decision to maintain pricing and risk management discipline, particularly
relating to the universal life contracts with low-priced no-lapse guarantees that prevailed in the market
throughout the year. In addition, sales decreased as anticipated after the sale of our affiliated retail
distribution operations to LPL during the second quarter and were slower to rebound than originally projected.
These factors were compounded by the longer-than-anticipated time to achieve ratings improvement, which the
company continues to pursue in 2005. The decrease in annuity deposits reflects our strategic decisions in the
fall of 2003 to discontinue sales of deferred fixed annuities, and to focus annuity wholesaling on select
distribution relationships, as well as the sale of our affiliated retail distribution operations in the second
quarter of 2004.
Looking forward, we are optimistic about our prospects for life and annuity sales in 2005 as we are building
the foundation for sustainable growth. We are focusing on three areas:
• First, we are rebuilding our product development capabilities. We added talented product development
staff last year and used "lean" manufacturing principles to streamline the process. Senior management
drives the product development process: vetting ideas, setting priorities and eliminating roadblocks.
As a result, in 2005 we will improve our time to market, shorten the product development cycle and
focus on a distinctive value proposition for our market. In life insurance, we have updates to our
variable universal life portfolio and a new investment-oriented life product coming out in the spring.
• The second driver of sales growth in 2005 will be a 50% expansion of our distribution force to reach
out more broadly in our existing relationships, particularly State Farm and LPL. The hiring process is
under way, and a number of new wholesalers are on board already.
• And third, we have significant resources focused on establishing new strategic distribution
relationships.
The Asset Management segment had pre-tax segment income of $0.1 million for 2004, compared with a $8.7 million
pre-tax loss in 2003 and a $69.9 million pre-tax loss in 2002. The improvement in 2004 results was driven by
higher revenues from higher average assets under management and lower general and administrative expenses,
partially offset by higher formulaic compensation expense, which is driven by higher investment product fee
revenues. December 31, 2004 assets under management for the segment were $42.9 billion, compared with $46.3
billion on December 31, 2003, although 2004 average assets under management were $44.9 billion as compared to
2003 and 2002 average assets under management of $42.9 billion and $45.5 billion, respectively. Full-year 2004
net flows were negative $6.6 billion (inflows of $6.7 billion; outflows of $13.3 billion), compared with
negative $1.2 billion in 2003 (inflows of $7.0 billion; outflows of $8.2 billion) and positive $0.6 billion
(inflows of $10.2 billion and outflows of $9.6 billion) in 2002. The 2004 full year negative net flows were
driven primarily by poor equity product performance, particularly at Kayne Anderson Rudnick and Seneca, and by
$1.7 billion of fixed income institutional redemptions in the year that were unrelated to performance. In
Seneca's case, the firm was put on hold or removed from several managed account programs
42
during the fourth quarter of 2004. These developments are likely to result in some additional outflows in 2005.
Fixed income products performed strongly, with positive net flows for the year, excluding the institutional
outflows noted above. Retail mutual fund sales rose by 12% for the full year, reflecting the strong fixed
income and specialty fund performance.
Asset Management achieved a higher operating margin in 2004 as compared to 2003 and 2002, but the business only
broke even and continued to have significant net outflows, although expense actions over the course of 2004
offset the consequent decline in revenues to some extent. We are focused on restructuring the asset management
business as this represents our largest opportunity for earnings growth in the near term. We are actively
working with our partners to address performance and structural issues in the context of our overall strategy.
As such, we have identified $17.0 million in additional annualized expense savings, which will begin to benefit
Asset Management earnings in 2005. A number of recent developments underscore the opportunity we have to
leverage some of our strong track records, especially in our fixed income and specialty strategies.
• The Goodwin Multi-Sector Short-Term Bond Fund was recognized as a five star fund by Morningstar. The
Goodwin Fund also received an award from Lipper in 2004 for superior long-term performance and the
Phoenix Mid-Cap Fund was similarly recognized early in 2005.
• Goodwin's institutional strategies also delivered another year of outstanding performance, beating their
benchmarks over one, three, five and ten years.
• On the specialty side, the Duff & Phelps REIT fund has been a standout and we are successfully selling
REIT strategies in the institutional market.
• The fixed income team at Seneca has a very strong track record across several fixed income strategies
and has attracted institutional flows.
• In January 2005, we launched an open-end utility fund, which builds on our successful track record in
utilities at Duff & Phelps.
• Effective April 1, 2005, two of our funds, the Phoenix Mid-Cap Value Fund and Phoenix-Kayne
Small-Mid-Cap Fund will be on the platform of one of the largest 401K providers. This is a win both for
our new institutional sales team and the investment teams of the funds.
In addition to the above, we have implemented an institutional strategy focused on leveraging existing core
strengths while building out the distribution infrastructure. On the retail side, we expect to implement a
sub-advisory strategy in mid-2005 to complement existing strengths with a focus towards the high-net-worth
market. These steps will not only help turn around flows but also lead to sustainable growth and a more
flexible, profitable business model.
The Venture Capital segment had 2004 pre-tax income of $19.3 million, compared with income of $36.2 million in
2003 and a loss of $59.3 million in 2002. The 2004 and 2003 results reflect generally favorable private equity
market conditions as compared to unfavorable market conditions experienced in 2002.
The Corporate and Other segment loss for 2004 of $59.1 million is higher than the 2003 and 2002 losses of $47.8
and $40.0 million, respectively. The full-year 2004 results reflect higher earnings from the company's
international operations offset by higher regulatory, compliance and corporate information technology costs and
lower corporate investment income. During 2003 and into 2004, we undertook a comprehensive review of our
internal control over financial reporting as required under Section 404 of The Sarbanes-Oxley Act of 2002,
which resulted in the dedication of more than 30,000 hours of internal management and staff time and nearly $4
million in incremental corporate expense for 2004. As noted in Item 9A this Annual Report on Form 10-K,
management has concluded that our internal control over financial reporting is effective as of December 31,
2004.
Our 2004 realized investment losses of $0.8 million (before offsets for deferred acquisition costs,
policyholder dividend obligation liability and taxes) compare to 2003 realized investment losses of $98.5
million and 2002 losses of $133.9 million. After offsets, realized investment losses were $7.2 million, $52.9
million and $65.6 million, respectively. Impairment losses, before offsets, of $49.5 million in 2004, are
significantly reduced from 2003 and 2002 impairment losses of $210.8 million and $186.7 million, respectively,
as a result of the
43
considerable improvement in credit market conditions since mid-2003. Impairment losses for 2004 include an
$11.6 million impairment ($6.7 million after-taxes) related to our investment in an Argentina affiliate, while
2003 impairments include an $89.1 million impairment ($55.0 million after-taxes) of our equity investment in
Aberdeen. Transaction gains, before offsets, of $48.7 million for 2004 compares with gains of $112.3 million in
2003 and $52.8 million in 2002. Transaction gains in 2003 include $35.3 million in pre-tax gains from the sale
of interests in two General Electric life insurance subsidiaries and in PXRE Group, Ltd.
2004 vs. 2003
Premium revenue decreased $51.6 million, or 5%, in 2004 from 2003, primarily due to a $51.1 million decrease in
participating life insurance premiums. Since our demutualization in 2001, we no longer sell participating life
policies, resulting in a decline in renewal participating life premiums. This decline in policies in force
results in a reduction of reserves, resulting in lower policyholder benefit costs.
Insurance and investment product fees increased $34.0 million, or 7%, in 2004 from 2003 primarily due to $12.6
million increase in Asset Management fees and a $18.5 million increase for Life and Annuity. Asset Management
private client and institutional investment product fees which are asset-based increased $9.8 million and $6.2
million, respectively as a result of increased assets under management. These increases were partially offset
by lower other investment product fees as a result of decreased volumes in equity trading by certain of our
clients, which resulted in lower commissions earned. Approximately 57% of our management fee revenues are based
on assets as of the beginning of a quarter, which causes the trend in fees to lag behind that of assets under
management. The increase in Life and Annuity revenues in 2004 is primarily due to higher universal life
insurance fees of $14.3 million, principally from cost of insurance, or COI, fees, and higher annuity fees
primarily due to higher fee-based funds on deposit. Corporate and Other fees decreased in 2004 due to the sale
of our India software services subsidiary.
Broker-dealer commission and distribution fee revenues decreased $24.6 million, or 30%, in 2004 from 2003, due
to the sale of our retail affiliated broker-dealer operations in May 2004. This decrease was partially offset
by a modest increase in broker-dealer commissions for Asset Management.
Net investment income decreased $31.7 million, or 3%, in 2004 from 2003, primarily due to lower venture capital
earnings, which reflected the effect of less than favorable equity market conditions in 2004 compared to 2003.
Mortgage loan income also declined in 2004 compared to 2003, reflecting the continued decline in mortgage loan
assets, as the portfolio continues to run-off. Income reflected in the other invested assets category increased
in 2004 compared to 2003, benefiting from higher investment income related to two direct equity investments.
This increase was partially offset by lower investment income from our debt securities pledged as collateral
related to our consolidated CDOs, which decreased $12.1 million from 2003, primarily due to decreased asset
levels from paydowns and defaults.
The $85.9 million unrealized gain on trading equity securities in 2004 relates to our investment in Aberdeen.
See Notes 1 and 5 to our consolidated financial statements in this Form 10-K for additional information.
Net realized investment losses decreased by $97.7 million, or 99%, in 2004 compared to 2003, due primarily to
significantly lower impairments in general account debt and equity securities as a result of the improved in
credit environment in 2004, offset by lower transaction-related gains. Realized losses from impairments on
general account debt securities decreased $60.6 million from 2003. Impairment losses in 2004 included $12.6
million in charges related to two international investments, while 2003 included a $96.9 million pre-tax charge
for the impairment of three international investments, $89.1 million of which related to the impairment of our
equity investment in Aberdeen.
44
Policyholder benefits, including dividends, decreased $45.9 million, or 2%, primarily due to lower benefits and
changes in policy reserves and policyholder dividends for participating life from a decline in renewal
premiums, as discussed above; lower interest credited from reduced crediting rates, principally from universal
life; and lower general account funds on deposit for annuities. These decreases were partially offset by a
larger increase in the policyholder dividend obligation, higher reserves for annuities and higher benefits for
universal life and variable universal life insurance. The increase in universal life and variable universal
life benefits was due to a large death claim, for universal life, in the first quarter of 2004 combined with
very favorable mortality for both lines of business in 2003.
Policy acquisition cost amortization increased $16.1 million, or 17%, in 2004 over 2003, due primarily to
higher amortization for annuities from higher gross margins, growth in funds on deposit and lower relative
performance in 2004. Amortization for variable universal life, universal life and term life increased modestly
as a result of growth in funds on deposit, or in-force policies, for term life. The effect of realized gains
(losses) on the amortization also contributed to the increase in 2004. These increases were partially offset by
modestly lower amortization for participating life.
Interest expense on non-recourse collateralized obligations decreased $15.3 million, or 31%, in 2004 from 2003
due primarily to decreased liabilities from paydowns.
Other operating expenses, which include non-deferrable policy acquisition costs, commissions due to
broker-dealer registered agents, finders fees, formulaic compensation related to asset management revenue
growth and other segment and administrative expenses, decreased $4.4 million, or 1%, in 2004 from 2003. The
decrease is principally due to a decrease of $55.9 million for Life and Annuity ($48.1 million after
elimination of inter-segment expenses), partially offset by increases in management restructuring and early
retirement costs of $23.2 million and surplus notes tender costs of $9.8 million in 2004. The Life and Annuity
expense decrease is primarily due to reductions resulting from the sale of our retail affiliated broker-dealer
operations in May 2004 and lower general and administrative and non-deferred expenses from expense reduction
initiatives. Asset Management expense increased modestly due to an increase in formulaic compensation expense
driven by higher investment management fees partially offset by the impact of expense reduction initiatives. In
addition, Corporate and Other operating expenses increased due primarily to higher regulatory compliance and
corporate information technology costs.
Income tax expense of $40.5 million in 2004 increased by $58.8 million from a tax benefit of $18.3 million in
2003. This increase is primarily due to the tax effect of the increase to income before continuing operations
before minority interest and equity earnings of affiliates.
2003 vs. 2002
Premium revenue decreased $39.8 million, or 4%, in 2003 from 2002, primarily due to a continued shift in sales
from participating life to universal life and variable universal life products as well as to a continued
decline of the participating life in-force business. Compared to 2002, 2003 premium revenue for participating
life policies decreased by $40.5 million. Since our 2001 demutualization, we no longer sell participating life
policies resulting in a decline in renewal participating life premiums and related in-force business.
Insurance and investment product fees increased by $7.1 million, or 1%, in 2003 over 2002, primarily due to
higher sales of universal life and variable life products, a growing in-force business in universal life and
variable universal life products and slightly higher surrender fees for variable universal life products. These
increases were partially offset by lower fees for our Asset Management segment resulting from decreases in both
private client and institutional average assets under management.
Broker-dealer commission and distribution fee revenues decreased $3.5 million, or 4%, in 2003 from 2002, due to
modest decreases for both Asset Management and Life and Annuity.
45
Net investment income increased by $166.9 million, or 18%, in 2003 over 2002, primarily due to improved equity
market conditions and the related effect on our earnings from our Venture Capital segment and to increased
general account spread-type funds on deposit in our Life and Annuity segment partially offset by the impact of
reinvesting maturities at lower interest rates. In addition, investment income from our debt securities pledged
as collateral related to our consolidated CDOs increased $21.2 million from 2002, primarily due to investment
income from the Mistic CDO which closed in the third quarter of 2002.
Net realized investment losses decreased $35.4 million, or 26%, in 2003 from 2002, primarily due to lower
impairments from improved credit market conditions including a $26.6 million reduction in impairment losses
related to debt securities pledged as collateral related to our consolidated and higher net transaction related
gains.
Policy benefits, including policyholder dividends, increased $34.9 million, or 2%, in 2003 over 2002, primarily
due to higher interest credited on guaranteed interest accounts, or GIAs, and fixed annuities from higher fund
account balances and higher mortality expense for universal life insurance. Policyholder dividend expense for
2003 was also higher compared to 2002, primarily due to growth in cash values of existing participating life
policies and the growth of our policyholder dividend obligation from favorable results, in part from the
portion of the venture capital funds transferred to the closed block in the first quarter of 2003.
Policy acquisition cost amortization increased $34.9 million, or 59%, in 2003 over 2002, primarily due to
higher amortization for participating life insurance and increased amortization for variable universal life and
annuities from the growth of in-force business and higher margins, partially offset by a $9.0 million
acceleration of amortization annuities related to a revision of long-term market return assumptions and a $4.5
million impairment charge in the third quarter of 2002.
There were no impairments of goodwill or intangible assets in 2003. In 2002, the $66.3 million impairment
related to goodwill for certain of our asset management partners.
Interest expense on indebtedness increased $8.2 million, or 26%, in 2003 over 2002, due to a restructuring of
debt in late 2002 through the issuance of equity units to paydown borrowings from a lower cost bank credit
facility.
Interest expense on non-recourse collateralized obligations increased $18.4 million, or 60%, in 2003 over 2002,
primarily due to interest expense from the Mistic CDO which closed in the third quarter of 2002.
Other operating expenses decreased $48.1 million, or 8%, in 2003 compared to 2002, primarily due to lower
management restructuring costs and lower overall operating expenses.
The income tax benefit of $18.3 million in 2003 decreased $40.5 million from an income tax benefit of $58.8
million in 2002. This decrease is primarily due to the tax effect of the decrease in loss from continuing
operations before income taxes, minority interest and equity earnings of affiliates offset by the tax effect of
non-deductible goodwill and indefinite-lived intangible assets written off in 2002.
Effects of Inflation
For the years 2004, 2003 and 2002, inflation did not have a material effect on our consolidated results of
operations.
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
46
the ongoing operations of the business. Investment income on debt and equity securities pledged as collateral
as well as interest expense on non-recourse collateralized obligations, both related to three consolidated
collateralized obligation trusts we sponsor, are included in the Corporate and Other segment. Excess investment
income on debt and equity securities pledged as collateral represents investment advisory fees earned by our
asset management subsidiary and are allocated to the Asset Management segment as investment product fees for
segment reporting purposes only. 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 criteria 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 the 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.
Results of Operations by Segment Year Ended December 31,
as Reconciled to Consolidated Net Income: ---------------------------------------
($ amounts in millions) 2004 2003 2002
----------- ----------- -----------
Segment Income (Loss)
Life and annuity segment............................................ $ 142.8 $ 99.4 $ 80.3
Asset management segment............................................ 0.1 (8.7) (69.9)
----------- ----------- -----------
Operating segment pre-tax income.................................... 142.9 90.7 10.4
Venture capital segment............................................. 19.3 36.2 (59.3)
Corporate and other segment:
Interest expense on indebtedness.................................. (40.8) (39.6) (31.4)
Other............................................................. (18.3) (8.2) (8.6)
----------- ----------- -----------
Total segment income (loss) before income taxes..................... 103.1 79.1 (88.9)
Applicable income taxes (benefit) .................................. 22.5 21.8 (28.5)
----------- ----------- -----------
Total segment income (loss)......................................... 80.6 57.3 (60.4)
Income (loss) from discontinued operations.......................... 0.1 (2.1) (1.3)
Net realized investment gains (losses), net of income taxes and
other offsets..................................................... (7.2) 0.8 (65.6)
Unrealized gains (losses) on equity investment in Aberdeen.......... 55.9 (55.0) --
Share of Aberdeen extraordinary charge for FSA settlement........... (14.7) -- --
Restructuring and early retirement costs, net of income taxes....... (21.9) (8.5) (28.5)
Surplus notes tender costs.......................................... (6.4) -- --
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.................. -- -- (1.3)
Cumulative effect of accounting changes, net of income taxes........ -- -- (130.3)
----------- ----------- -----------
Net income (loss)................................................... $ 86.4 $ (6.2) $ (272.3)
=========== =========== ===========
Total segment income return on equity is 4.1%, 3.0% and (2.9)% for 2004, 2003 and 2002, respectively. Total
segment return on equity is calculated as total segment income as a percentage of the average of beginning and
end of year adjusted stockholders' equity as follows:
47
Total Segment Return on Equity: 2004 2003 2002 2001
($ amounts in millions) ----------- ----------- ------------ -----------
Stockholders' equity, end of year............................ $ 2,022.4 $ 1,947.8 $ 1,826.8 $ 2,307.8
Adjustments for:
Accumulated other comprehensive (income) loss.............. (58.0) (63.7) 71.5 (2.8)
Accumulated realized losses in retained earnings
related to consolidated collateralized obligation trusts. 54.1 41.2 38.8 12.5
Stockholders' equity attributed to discontinued operations. (23.0) (28.2) (30.4) (23.6)
----------- ----------- ------------ -----------
Adjusted stockholders' equity, end of year................... $ 1,995.5 $ 1,897.1 $ 1,906.7 $ 2,293.9
=========== =========== ============ ===========
Adjusted stockholders' equity, average....................... 1,946.3 1,901.9 2,100.3
=========== =========== ============
Total segment income......................................... $ 80.6 $ 57.3 $ (60.4)
=========== =========== ============
Total segment return on equity............................... 4.1% 3.0% (2.9)%
=========== =========== ============
Segment Allocations
We allocate capital to our Life and Annuity segment based on RBC for our insurance products. We used 300% RBC
for 2002 through 2004. 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.
Life and Annuity Segment
Summary Life and Annuity Year Ended December 31, Changes
Financial Data: ------------------------------------- ------------------------
($ amounts in millions) 2004 2003 2002 2004/03 2003/02
Results of Operations ----------- ----------- ----------- ----------- -----------
Premiums.................................. $ 990.6 $ 1,042.2 $ 1,082.0 $ (51.6) $ (39.8)
Insurance and investment product fees..... 296.9 278.4 259.5 18.5 18.9
Broker-dealer commission and
distribution fee revenues............... 28.8 54.6 55.6 (25.8) (1.0)
Net investment income..................... 996.5 993.2 947.4 3.3 45.8
----------- ----------- ----------- ----------- -----------
Total segment revenues.................... 2,312.8 2,368.4 2,344.5 (55.6) 23.9
----------- ----------- ----------- ----------- -----------
Policy benefits, including
policyholder dividends.................. 1,814.8 1,869.9 1,867.6 (55.1) 2.3
Policy acquisition cost amortization...... 110.6 98.2 88.5 12.4 9.6
Other operating expenses.................. 244.6 300.5 307.5 (55.9) (6.9)
----------- ----------- ----------- ----------- -----------
Total segment benefits and expenses....... 2,170.0 2,268.6 2,263.6 (98.6) 5.0
----------- ----------- ----------- ----------- -----------
Segment income before income taxes
and minority interest................... 142.8 99.8 80.9 43.0 18.9
Allocated income taxes.................... 36.4 31.1 28.0 5.3 3.1
----------- ----------- ----------- ----------- -----------
Segment income before minority interest... 106.4 68.7 52.9 37.7 15.8
Minority interest in net income of
consolidated subsidiaries............... -- 0.4 0.6 (0.4) (0.2)
----------- ----------- ----------- ----------- -----------
Segment income............................ 106.4 68.3 52.3 38.1 16.0
Net realized investment losses, net of
income taxes and other offsets.......... (2.5) (4.7) (15.0) 2.2 10.3
Deferred acquisition cost adjustment,
net of income taxes..................... -- (1.3) 14.4 1.3 (15.7)
Other adjustments, net of income taxes.... (7.3) -- 0.7 (7.3) (0.7)
----------- ----------- ----------- ----------- -----------
Segment net income........................ $ 96.6 $ 62.3 $ 52.4 $ 34.3 $ 9.9
=========== =========== =========== =========== ===========
48
2004 vs. 2003
Premium revenue decreased $51.6 million, or 5%, in 2004 from 2003, primarily due to a $51.1 million decrease in
participating life insurance premiums. Since our demutualization in 2001, we no longer sell participating life
policies, resulting in a decline in renewal participating life premiums. This decline in policies in force
results in a reduction of reserves, thereby lower policyholder benefit costs.
Insurance and investment product fees increased $18.5 million, or 7%, in 2004 over 2003, primarily due to
higher universal life insurance fees of $14.3 million, principally from COI fees and higher annuity fees
primarily due to higher fee-based funds on deposit.
Broker-dealer commission and distribution fee revenues decreased $25.8 million, or 47%, in 2004 from 2003, due
to the sale of our retail affiliated broker-dealer operations in May 2004.
Policy benefits and dividends decreased $55.1 million, or 3%, in 2004 from 2003, primarily due to lower
benefits and changes in policy reserves and policyholder dividends for participating life from a decline in
renewal premiums, as discussed above; lower interest credited from reduced crediting rates principally from
universal life; and lower general account funds on deposit for annuities. These decreases were partially offset
by higher reserves for annuities and higher benefits for universal life and variable universal life insurance,
as well as a larger increase in the policyholder dividend obligation. The increase in universal life and
variable universal life benefits was due to a large death claim, for universal life, in the first quarter of
2004 combined with very favorable mortality for both lines of business in 2003.
Policy acquisition cost amortization increased $12.4 million, or 13%, in 2004 compared to 2003, due primarily
to higher amortization for annuities from higher gross margins, growth in funds on deposit and lower relative
performance in 2004. Amortization for variable universal life, universal life and term life increased modestly
as a result of growth in funds under deposit, or in-force policies, for term life. These increases were
partially offset by modestly lower amortization for participating life.
Other operating expenses, which include non-deferrable policy acquisition costs, broker-dealer commissions due
to Griffith and Main Street registered agents and general and administrative costs, decreased $55.9 million, or
19% in 2004 from 2003. This decrease is principally due to lower broker-dealer commissions for Griffith and
Main Street registered agents, reduced operating expenses as a result of the sale of our retail affiliated
broker-dealer operations in May of 2004 and lower general and administrative non-deferred expenses as a result
of recent expense reduction initiatives.
Allocated income taxes increased by $5.3 million, or 17%, in 2004 compared to 2003 due to higher pre-tax
income, partially offset by tax benefits related to the favorable resolution of certain tax matters with the
IRS.
2003 vs. 2002
Premium revenue decreased by $39.8 million, or 4%, in 2003 from 2002, primarily due to a continued shift in
sales from participating life to universal life and variable universal life products as well as to a continued
decline of the participating life in-force business. Compared to the prior year, the 2003 premium revenue for
participating life insurance policies decreased by $40.5 million. Since our 2001 demutualization, we no longer
sell participating life policies, resulting in a decline in renewal participating life premiums and related
in-force policies.
Investment product fees increased by $18.9 million, or 7%, in 2003 over 2002, primarily due to higher sales in
universal life products, the growth of in-force business for universal life and variable universal life
products and slightly higher surrender fees for variable universal life products. Specifically, higher net
amounts at risk in these two lines of business, as well as higher sales of universal life products, resulted in
higher fees.
49
Net investment income increased by $45.8 million, or 5%, in 2003 over 2002, due to increased general account
spread-type funds, primarily annuities, partially offset by lower rates earned on invested assets.
Policy benefits, including policyholder dividends, were relatively flat in 2003 compared to 2002. This was
primarily due to a decrease in reserves for the participating life insurance driven by lower in-force block of
business and an $0.8 million decrease in our reserves for minimum death benefit guarantees due to favorable
equity markets, partially offset by higher interest credited on GIAs and fixed annuities driven by higher
average fund balances and higher mortality expense for universal life insurance.
Policy acquisition cost amortization increased $9.6 million, or 11%, in 2003 over 2002, primarily due to the
growth of in-force business, higher margins and slightly higher surrenders, partially offset by lower
amortization expense for annuities due to the charges incurred in the third quarter of 2002, which did not
recur in 2003.
Other operating expenses decreased $6.9 million, or 2%, in 2003 from 2002 as a result of generally lower
non-deferrable operating expenses, partially offset by higher employee benefit costs.
Minority interest expense relates to our subsidiary, PFG. We acquired the 33% of the minority interest in PFG
we did not already own in May 2003.
Allocated income taxes increased $3.1 million, or 11%, in 2003 over 2002 as a result of higher segment income
before income taxes as well as a current year allocation of the tax effects of tax advantaged investments to
the Life and Annuity segment.
Year Ended December 31,
Annuity Funds on Deposit: ---------------------------------------
($ amounts in millions) 2004 2003 2002
----------- ----------- -----------
Deposits.............................................................. $ 670.9 $ 1,428.1 $ 2,258.4
Performance and interest credited..................................... 664.6 865.3 (338.0)
Fees.................................................................. (59.8) (57.7) (58.8)
Benefits and surrenders............................................... (856.0) (925.3) (777.3)
----------- ----------- -----------
Change in funds on deposit............................................ 419.7 1,310.4 1,084.3
Funds on deposit, beginning of period................................. 7,143.8 5,833.4 4,749.1
----------- ----------- -----------
Annuity funds on deposit, end of period............................... $ 7,563.5 $ 7,143.8 $ 5,833.4
=========== =========== ===========
Year Ended December 31,
Variable Universal Life Funds on Deposit: ---------------------------------------
($ amounts in millions) 2004 2003 2002
----------- ----------- -----------
Deposits.............................................................. $ 245.4 $ 353.4 $ 465.7
Performance and interest credited..................................... 179.3 252.1 (149.8)
Fees and cost of insurance............................................ (103.0) (106.2) (102.2)
Benefits and surrenders............................................... (77.5) (70.8) (39.4)
----------- ----------- -----------
Change in funds on deposit............................................ 244.2 428.5 174.3
Funds on deposit, beginning of period................................. 1,698.8 1,270.3 1,096.0
----------- ----------- -----------
Variable universal life funds on deposit, end of period............... $ 1,943.0 $ 1,698.8 $ 1,270.3
=========== =========== ===========
50
Year Ended December 31,
Universal Life Funds on Deposit: ---------------------------------------
($ amounts in millions) 2004 2003 2002
----------- ----------- -----------
Deposits.............................................................. $ 229.4 $ 217.8 $ 149.3
Interest credited..................................................... 74.6 78.0 85.8
Fees and cost of insurance............................................ (114.2) (103.8) (88.3)
Benefits and surrenders............................................... (143.1) (138.0) (132.4)
----------- ----------- -----------
Change in funds on deposit............................................ 46.7 54.0 14.4
Funds on deposit, beginning of period................................. 1,564.0 1,510.0 1,495.6
----------- ----------- -----------
Universal life funds on deposit, end of period....................... $ 1,610.7 $ 1,564.0 $ 1,510.0
=========== =========== ===========
2004 vs 2003
Annuity, variable universal life and universal life funds on deposit experienced growth in 2004 as a result of
positive net flows for variable universal life and universal life blocks and the effects of favorable equity
markets on variable annuity and variable universal life funds on deposit.
Life insurance and annuity sales and deposits fell short of our expectations and were at levels well below 2003
levels due to the following factors.
• Sale of retail affiliated broker-dealer operations. All producers associated with Griffith and Main
Street had to go through the complex process of changing broker-dealers. The effort required strained
our relationships with some of these advisors and distracted others from writing new business. We
underestimated the amount of time needed to recover and rebuild momentum, particularly as it related to
the fourth quarter, which had historically been a time of significant sales.
• Our decision not to compete with aggressive secondary no-lapse guarantees in universal life. We have
seen evidence suggesting that industry sales growth was fueled by products with secondary guarantees
priced at levels we do not view to be profitable.
• The compounding impact of our ratings. Ratings improvement is a key priority for us. Despite significant
improvement in our profitability and risk profile, as well as our strong capital and liquidity, the
rating agencies have not yet responded favorably.
2003 vs. 2002
Annuity products 2003 deposits declined to $1.4 billion in 2003 from $2.3 billion in 2002 as the result of the
forth quarter 2002 decision to terminate sales of Retirement Planners Edge, or RPE, coupled with the forth
quarter 2003 decision to exit certain unprofitable distribution relationships and a decision to terminate sales
of fixed annuities.
Annuity and variable universal life funds under deposit benefited from strong performance of underlying funds
due to favorable equity markets in 2003 as compared to 2002.
Variable universal life deposits in 2003 decreased and universal life deposits increase as compared to 2002
amounts as variable universal life product sales shifted to universal life products due to volatile equity
markets.
51
As of December 31, Changes
Life and Annuity Segment Revenues ------------------------------------- ------------------------
By Product: 2004 2003 2002 2004/03 2003/02
($ amounts in millions) ----------- ----------- ----------- ----------- -----------
Variable universal life insurance............ $ 117.1 $ 114.8 $ 109.2 $ 2.3 $ 5.6
Universal life insurance..................... 213.4 196.9 195.8 16.5 1.1
Term life insurance.......................... 15.9 14.6 12.2 1.3 2.4
Other life insurance......................... 123.4 148.2 146.3 (24.8) 1.9
----------- ----------- ----------- ----------- -----------
Total, non-participating life insurance...... 469.8 474.5 463.5 (4.7) 11.0
Participating life insurance................. 1,627.1 1,690.1 1,718.9 (63.0) (28.8)
----------- ----------- ----------- ----------- -----------
Total, life insurance........................ 2,096.9 2,164.6 2,182.4 (67.7) (17.8)
Annuities.................................... 215.9 203.8 162.1 12.1 41.7
----------- ----------- ----------- ----------- -----------
Segment revenues............................. $ 2,312.8 $ 2,368.4 $ 2,344.5 $ (55.6) $ 23.9
=========== =========== =========== =========== ===========
2004 vs. 2003
Variable universal life insurance revenue increased $2.3 million, or 2%, in 2004 over 2003, due primarily to
higher COI fees from the growth of in-force business, partially offset by lower fees due to lower premium
deposits.
Universal life insurance revenue increased $16.5 million, or 8%, in 2004 over 2003, primarily due to higher COI
fees from the growth of in-force business, higher fees from higher premium deposits and slightly higher
investment earnings from higher funds on deposit.
Term life insurance revenue increased $1.3 million, or 9%, in 2004 over 2003, primarily due to higher premiums
from the growth of in-force policies and modestly higher investment earnings.
Other life insurance revenue decreased $24.8 million, or 17%, in 2004 from 2003, due primarily to lower
broker-dealer commission and distribution fee revenues resulting from the sale of our retail affiliated
broker-dealer operations in May 2004, offset by a modest increase in investment earnings, primarily related to
an old block of corporate-owned life insurance.
Participating life insurance revenue decreased $63.0 million, or 4%, in 2004 from 2003, due to lower renewal
premiums and net investment income. Since our demutualization in 2001, we no longer sell participating life
insurance policies.
Annuity revenue increased $12.1 million, or 6%, in 2004 over 2003, primarily due to higher investment earnings
from improved spreads and fees from increased fee-based funds on deposit.
2003 vs. 2002
Variable universal life product revenues increased $5.6 million, or 5%, in 2003 over 2002, primarily due to
higher COI fees from the growth of in-force business, and higher surrender charges, partially offset by
slightly lower sales and lower interest earned.
Universal life product revenues increased $1.1 million, or less than 1%, in 2003 over 2002, primarily due to
higher COI and other fees from higher sales and the growth of in-force business, offset by lower interest
earned.
Term life revenues increased $2.4 million, or 20%, in 2003 over 2002, due to premium growth from higher sales.
Other life insurance revenues increased $1.9 million, or 1%, in 2003 over 2002, primarily due to higher revenue
in an old block of corporate-owned life insurance business and from higher investment income, partially offset
by lower revenues in non-life insurance subsidiaries.
52
Participating life product revenues decreased $28.8 million, or 2%, in 2003 from 2002, primarily due to lower
renewal premiums, partially offset by higher net investment income. Since our demutualization in 2001, we no
longer sell participating life insurance policies.
Annuity product revenues increased $41.7 million, or 26%, in 2003 compared to 2002, primarily due to higher
fees from improved equity market performance and to an increase in interest earned on higher spread based asset
products. Earlier in 2004, we extended the duration of interests underlying our RPE annuity block to better
align the investment portfolio with actual lapse experience. This extension strategy contributed to higher
investment earnings for this block as compared to 2003.
Year Ended December 31, Changes
Segment Income by Product: ------------------------------------ -----------------------
($ amounts in millions) 2004 2003 2002 2004/03 2003/02
----------- ----------- ----------- ----------- -----------
Variable universal life insurance............ $ 35.7 $ 35.0 $ 35.9 $ 0.7 $ (0.9)
Universal life insurance..................... 34.4 21.7 26.3 12.7 (4.6)
Term life insurance.......................... 3.4 3.8 4.7 (0.4) (0.9)
Other life insurance......................... 16.0 6.9 0.8 9.1 6.1
----------- ----------- ----------- ----------- -----------
Total, non-participating life insurance...... 89.5 67.4 67.7 22.1 (0.3)
Participating life insurance................. 45.0 36.1 33.3 8.9 2.8
----------- ----------- ----------- ----------- -----------
Total, life insurance........................ 134.5 103.5 101.0 31.0 2.5
Annuities.................................... 8.3 (4.1) (20.7) 12.4 16.6
----------- ----------- ----------- ----------- -----------
Segment income before income taxes........... $ 142.8 $ 99.4 $ 80.3 $ 43.4 $ 19.1
=========== =========== =========== =========== ===========
2004 vs. 2003
Variable universal life pre-tax income increased $0.7 million, or 2%, in 2004 over 2003, primarily due to
reduced expenses from lower sales and expense reduction initiatives combined with higher revenues, as discussed
above. These increases were partially offset by higher benefit costs and slightly higher deferred acquisition
cost amortization in 2004.
Universal life pre-tax income increased $12.7 million, or 59%, in 2004 over 2003, primarily due to higher
revenues, as discussed above, lower interest credited from reduced crediting rates and lower general and
administrative expenses. These increases were partially offset by higher benefit costs resulting from a large
death claim in the first quarter of 2004, combined with very favorable mortality in 2003, which did not recur
in 2004.
Other pre-tax income increased $9.1 million, or 132%, in 2004 over 2003, due primarily to higher investment
earnings, principally from an old block of corporate-owned life insurance, plus a premium received on a bond
investment.
Participating life pre-tax income increased $8.9 million, or 25%, in 2004 over 2003, primarily due to lower
general and administrative expenses. Because operating expenses are excluded for the closed block, such
operating expense savings inure to the benefit of shareholders. The decrease in revenues, as discussed above,
are largely offset by lower benefits, changes in reserves and dividends to policyholders.
Annuity pre-tax income increased to $8.3 million in 2004 from a loss of $4.1 million in 2003, due primarily to
higher revenues, as discussed above, lower interest credited from lower general account funds on deposit and
reduced expenses from lower sales and expense reduction initiatives, partially offset by higher deferred
acquisition cost amortization from higher gross margins, growth in funds on deposit, lower relative performance
in 2004 and slightly higher benefit costs.
53
2003 vs. 2002
Variable universal life product pre-tax income decreased $0.9 million, or 3%, in 2003 from 2002. The decrease
can be attributed to lower sales, higher amortization of deferred acquisition costs and higher non-deferrable
expenses, partially offset by favorable insurance margins and higher surrender charges.
Universal life product pre-tax income decreased $4.6 million, or 17%, in 2003 over 2002, due to lower insurance
margins and surrender charges, partially offset by higher investment margins and lower expenses.
Term product pre-tax income decreased $0.9 million, or 19%, in 2003 from 2002, primarily due to slightly higher
expense levels partially offset by higher insurance margins.
Other life insurance pre-tax income increased $6.1 million in 2003 from 2002, due to favorable mortality in an
old block of corporate-owned life insurance business, the release of a reserve on a life contingent annuity due
to the death of the annuitant and higher income from certain non-life insurance subsidiaries.
Participating life product pre-tax income increased $2.8 million, or 8%, in 2003 over 2002, primarily due 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 2002 that
did not recur in 2003.
Annuity product pre-tax loss was $16.6 million, or 80%, less in 2003 compared to 2002. This was primarily due
to lower amortization of deferred acquisition costs in 2003, a decrease in minimum guaranteed death benefits
expense in 2003, and higher investment margins from higher spread type funds on deposit. These were partially
offset by higher non-deferrable expenses and commissions as well as further spread compression in 2003.
Amortization of deferred acquisition costs was lower in 2003, due to acceleration of amortization from a
revision of long-term market return assumptions and an impairment charge in 2002, neither of which recurred in
2003.
See Note 3 to our consolidated financial statements in this Form 10-K for more information.
54
Asset Management Segment
Year Ended December 31, Changes
Summary Asset Management ------------------------------------ -----------------------
Financial Data: 2004 2003 2002 2004/03 2003/02
($ amounts in millions) ----------- ----------- ----------- ----------- -----------
Results of Operations
Investment product fees...................... $ 237.9 $ 225.3 $ 238.6 $ 12.6 $ (13.3)
Broker-dealer commission and
distribution fee revenues.................. 28.0 26.8 29.5 1.2 (2.7)
Net investment income........................ 0.8 0.7 1.0 0.1 (0.3)
----------- ----------- ----------- ----------- -----------
Total segment revenues....................... 266.7 252.8 269.1 13.9 (16.3)
----------- ----------- ----------- ----------- -----------
Intangible asset amortization................ 33.8 33.2 32.5 0.6 0.7
Intangible asset impairments................. -- -- 66.3 -- (66.3)
Other operating expenses..................... 232.8 228.3 240.2 4.5 (11.9)
----------- ----------- ----------- ----------- -----------
Total segment expenses....................... 266.6 261.5 339.0 5.1 (77.5)
----------- ----------- ----------- ----------- -----------
Segment income (loss) before income taxes.... 0.1 (8.7) (69.9) 8.8 61.2
Allocated income taxes (benefit)............. 2.3 (3.3) (6.0) 5.6 2.7
----------- ----------- ----------- ----------- -----------
Segment loss................................. (2.2) (5.4) (63.9) 3.2 58.5
Net realized investment gains (losses)....... 1.8 (0.3) -- 2.1 (0.3)
Restructuring and other costs, net of
income taxes............................... (1.2) (4.0) (8.4) 2.8 4.4
Cumulative effect of accounting change....... -- -- (119.9) -- 119.9
----------- ----------- ----------- ----------- -----------
Segment net loss............................. $ (1.6) $ (9.7) $ (192.2) $ 8.1 $ 182.5
=========== =========== =========== =========== ===========
Our investment product fee revenues are based on assets under management. Approximately 57% of our investment
product fees are based on beginning of quarter assets under management while the remaining 43% are based on end
of day balances. End of year and average assets (based on how fees are calculated) under management follow:
Assets Under Management: As of or for the Year Ended
($ amounts in millions) December 31,
---------------------------------------------
2004 2003 2002
-------------- -------------- --------------
End of year................................................... $ 42,908.5 $ 46,260.5 $ 41,835.3
============== ============== ==============
Average (based on how fees are calculated).................... $ 44,904.6 $ 42,900.2 $ 45,534.5
============== ============== ==============
2004 vs. 2003
Investment product fees increased $12.6 million, or 6%, in 2004 over 2003. This increase was primarily due to
an increase in average assets under management compared to the prior year. Private client and institutional
investment product fees increased $9.8 million and $6.2 million, respectively, as a result of the increase in
average assets under management. Other investment product fees decreased $1.7 million due to decreased volumes
in equity trading by certain of our clients, which resulted in fewer commissions earned. Approximately 57% of
our management fee revenues are based on assets as of the beginning of a quarter, which causes the trend in fee
revenues to lag behind that of assets under management.
Assets under management were $42.9 billion and $46.3 billion at December 31, 2004 and 2003, respectively. The
decrease in assets under management during 2004 is due primarily to customer withdrawals of $13.3 billion for
the year. Sales of private client products in 2004 were $3.9 billion, which is a decrease of 2% from 2003. The
majority of this decline is due to reduced sales of sponsored managed accounts at Seneca and Kayne Anderson
Rudnick. Redemptions of private client products in 2004 were $7.5 billion, which is an increase of 60% from
2003. This increase is primarily related to the loss of sponsored managed accounts at Seneca. Sales of
institutional accounts in 2004 were $2.7 billion, which is an 8% decrease from 2003. Redemptions of
institutional accounts in 2004 were $5.6 billion, which is an increase of 67% from 2003. Of the institutional
redemptions, $1.7 billion were not performance related.
55
There were no impairments of goodwill or other intangible assets in 2004 and 2003. The $66.3 million charge in
2002 was associated with the impairment of goodwill related to certain of our asset management partners.
Other operating expenses increased $2.2 million, or 1%, in 2004 over 2003, primarily due to an increase in
formulaic compensation expense, which is driven by higher investment product fee revenues. Increases in
compensation expense were offset, in part, by lower general and administrative expenses, primarily related to a
decrease in information technology costs.
Allocated income tax expense increased $5.6 million in 2004 over 2003 as a result of segment income in 2004
compared to segment losses in 2003 and additional state taxes allocated to the Asset Management segment.
2003 vs. 2002
Investment product fees decreased $13.3 million, or 6%, in 2003 from 2002. This decrease was primarily due to
the decrease in average assets under management compared to the prior year. Private client and institutional
investment product fees decreased $8.9 million and $6.5 million, respectively, as a result of the decrease in
average assets under management. Approximately 56% of our management fee revenues are based on assets as of the
beginning of a quarter, which causes fee revenues to lag behind changes in average assets under management.
Assets under management were $46.3 billion and $41.8 billion at December 31, 2003 and 2002, respectively. The
increase in assets under management during 2003 is due primarily to positive investment performance of $5.8
billion for the year. Sales of private client products in 2003 were $4.1 billion, which is a decrease of 29%
from 2002. The majority of this decline is due to reduced sales of sponsored managed accounts at Seneca and
Kayne Anderson Rudnick. Redemptions of private client products in 2003 were $4.9 billion, which is a decrease
of 11% from 2002. This improvement was primarily a result of lower redemptions for mutual funds. Sales of
institutional accounts in 2003 were $3.0 billion, which is a 32% decrease from 2002. The decrease in sales is
due to the fact that 2002 included the issuance of a $1.0 billion CDO, which we consolidate in our financial
statements, that did not recur in 2003. Redemptions of institutional accounts in 2003 were $3.5 billion, which
is a decrease of 22% from 2002. The majority of the improvement in redemptions was attributable to Seneca.
There were no impairments of goodwill or other intangible assets in 2003. The $66.3 million charge in 2002 was
associated with the impairment of goodwill related to certain of our asset management partners.
Other operating expenses decreased $12.0 million, or 5%, in 2003 compared to 2002, of which $5.3 million
related to compensation expense and $5.5 million related to lower non-compensation related operating expenses.
The decrease in non-compensation related operating expenses was primarily the result of lower professional,
rent, depreciation, and travel related charges offset, in part, by increased computer services charges.
Allocated income tax benefits decreased $2.7 million, or 45%, from the comparable period in 2002 as a result of
lower segment losses offset by the impact of non-deductible asset impairments in the prior year.
See Note 4 to our consolidated financial statements in this Form 10-K for more information.
56
Venture Capital Segment
Our venture capital investments are 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 Estimates section of Management's Discussion and Analysis of Financial
Condition and Results of Operations.) Venture capital investments are investments of the general account of
Phoenix Life.
During 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 $19.4 million ($5.1 million
recorded in 2002 and $14.3 million recorded in 2003). The unfunded commitments of the partnerships sold and
transferred totaled $27.2 million; the outside party and the closed block will each fund half of these
commitments. At the time of transfer, the partnerships transferred constituted less than 0.5% of the assets of
the closed block.
Year Ended December 31, Changes
Summary Venture Capital Financial Data: ------------------------------------ -----------------------
($ amounts in millions) 2004 2003 2002 2004/03 2003/02
----------- ----------- ----------- ----------- -----------
Results of Operations
Net realized gains (losses) on partnership
cash and stock distributions............... $ 7.4 $ 4.9 $ (4.7) $ 2.5 $ 9.6
Net unrealized gains (losses) on
partnership investments.................... 13.6 37.1 (47.2) (23.5) 84.3
Partnership operating expenses............... (1.7) (5.8) (7.4) 4.1 1.6
----------- ----------- ----------- ----------- -----------
Segment net investment income (loss)......... 19.3 36.2 (59.3) (16.9) 95.5
Applicable income taxes (benefit)............ 6.8 12.7 (20.7) (5.9) 33.4
----------- ----------- ----------- ----------- -----------
Segment net income (loss).................... $ 12.5 $ 23.5 $ (38.6) $ (11.0) $ 62.1
=========== =========== =========== =========== ===========
2004 vs. 2003
Net investment income decreased $16.9 million in 2004 from 2003, due primarily to less favorable equity market
conditions in 2004 as compared to 2003.
Our accounting methodology recognizes both downward and upward adjustments based on public market indices, but
when the general partner writes down the value of a private investee company, we do not override the most
recent value reported by the general partner by applying the public sector index in excess of the most recent
value reported by the general partner. Finally, we revise the valuations we have assigned to the investee
companies annually to reflect the valuations in the audited financial statements received from the venture
capital partnerships. As a result, the effect of our adjusting estimated partnership results to actual results
increased investment income by $7.8 million, $33.4 million and $12.8 million in 2004, 2003 and 2002,
respectively.
Adjustments to the valuation of these companies to reflect reported valuations in the audited financial
statements received from the venture capital partnerships will be reflected in our financial statements when
received in the first and second quarters of 2005.
2003 vs. 2002
Net investment income increased $95.5 million in 2003 over 2002 due to overall improved equity market
conditions and the true-up to the partnerships' audited fourth quarter of 2002 financial statements from
estimated amounts as of December 31, 2002.
57
Year Ended December 31, Changes
Changes in Venture Capital Investments: ------------------------------------ -----------------------
($ amounts in millions) 2004 2003 2002 2004/03 2003/02
----------- ----------- ----------- ----------- -----------
Contributions (dollars invested)............. $ 37.7 $ 31.0 $ 42.2 $ 6.7 $ (11.2)
Equity in earnings of partnerships........... 19.3 36.2 (59.3) (16.9) 95.5
Distributions................................ (50.4) (32.2) (41.7) (18.2) 9.5
Proceeds from sale of partnership interests
and transfer to closed block............... -- (52.2) -- 52.2 (52.2)
Realized loss on sale of partnership interests
and transfer to closed block............... -- (14.3) (5.1) 14.3 (9.2)
----------- ----------- ----------- ----------- -----------
Change in venture capital investments........ 6.6 (31.5) (63.9) 38.1 32.4
Venture capital segment investments,
beginning of period........................ 196.3 227.8 291.7 (31.5) (63.9)
----------- ----------- ----------- ----------- -----------
Venture capital segment investments,
end of period.............................. $ 202.9 $ 196.3 $ 227.8 $ 6.6 $ (31.5)
=========== =========== =========== =========== ===========
2004 vs, 2003
Venture capital investments for 2004 increased $38.1 million over the change for 2003, primarily due to
proceeds from, and realized losses on, the sale of partnership interests and transfer to the closed block in
2003, which reduced the venture capital balance by $66.5 million. This change was partially offset by a
decrease in equity in earnings of $16.9 million and higher distributions, which increased $18.2 million over
2003.
2003 vs. 2002
Venture capital investments for 2003 increased $32.4 million over the change for 2002, primarily due to $36.2
million in equity in earnings in 2003 compared to equity in losses of $59.3 million in 2002. This $95.5 million
improvement in equity in earnings in 2003 was partially offset by proceeds from, and realized losses on, the
sale of partnership interests and transfer to the closed block in 2003, which totaled $66.5 million.
As of December 31,
Segment Investments in Venture Capital Partnerships -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Technology................................................................... $ 26.9 $ 36.8
Telecommunications........................................................... 7.9 13.3
Biotechnology................................................................ 8.6 16.3
Health care.................................................................. 6.7 8.2
Consumer and business products and services.................................. 29.7 29.6
Financial services........................................................... 20.7 28.5
Other........................................................................ 57.3 44.9
-------------- --------------
Private holdings............................................................. 157.8 177.6
Public holdings.............................................................. 20.7 11.3
Cash and cash equivalents.................................................... 8.8 5.5
Other........................................................................ 15.6 1.9
-------------- --------------
Venture capital partnerships................................................. $ 202.9 $ 196.3
============== ==============
Unfunded commitments......................................................... $ 53.5 $ 76.7
============== ==============
See Note 5 to our consolidated financial statements in this Form 10-K for more information regarding our
Venture Capital segment.
58
Corporate and Other Segment
Year Ended December 31, Changes
Summary Corporate and Other ------------------------------------ -----------------------
Financial Data: 2004 2003 2002 2004/03 2003/02
($ amounts in millions) ----------- ----------- ----------- ----------- -----------
Results of Operations
Corporate investment income.................. $ 0.4 $ 4.3 $ 1.5 $ (3.9) $ 2.8
Investment income from
collateralized obligations................. 40.1 52.2 31.0 (12.1) 21.2
Interest expense on indebtedness............. (40.8) (39.6) (31.4) (1.2) (8.2)
Interest expense on non-recourse
collateralized obligations................. (33.6) (48.9) (30.5) 15.3 (18.4)
Corporate expenses........................... (18.9) (11.0) (10.4) (7.9) (0.6)
International................................ 3.7 (1.4) 4.2 5.1 (5.6)
Other........................................ (10.0) (3.4) (4.4) (6.6) 1.0
----------- ----------- ----------- ----------- -----------
Segment loss, before income taxes............ (59.1) (47.8) (40.0) (11.3) (7.8)
Allocated income tax (benefit)............... (22.9) (18.8) (29.8) (4.1) 11.0
----------- ----------- ----------- ----------- -----------
Segment loss................................. $ (36.2) $ (29.0) $ (10.2) $ (7.2) $ (18.8)
=========== =========== =========== =========== ===========
2004 vs. 2003
Investment income from debt and equity securities pledged as collateral related to our CDOs decreased $12.1
million in 2004 from 2003, due primarily to decreased asset levels from paydowns and defaults. Consequently,
lower distributions were made to investment holders resulting in a $15.3 million decrease in interest expense
on non-recourse collateralized obligations during 2004.
Corporate expenses increased $7.9 million in 2004 over 2003, primarily due to increases in liability insurance
costs, incremental regulatory compliance and audit costs associated with Section 404 of The Sarbanes-Oxley Act
of 2002 and higher information technology costs.
International income increased $5.1 million in 2004 over 2003 due primarily to higher earnings from an
Argentine affiliate combined with lower losses from our India software services affiliate, which was sold in
2004.
Other results decreased $6.6 million in 2004 from 2003, due primarily to losses in a small group pension
run-off block, lower investment earnings, slightly higher employee benefit costs and higher administrative
expenses related to the CDOs.
2003 vs. 2002
Investment income from debt and equity securities pledged as collateral related to our consolidated CDOs
increased $21.2 million, or 68%, in 2003 over 2002, primarily from earnings from the Mistic CDO which closed in
the third quarter of 2002.
Interest expense on indebtedness increased $8.2 million, or 26%, in 2003 over 2002, primarily due to a
restructuring of debt in late 2002 through the issuance of equity units to paydown shorter term, lower cost
borrowings under our bank credit facility.
Interest expense on non-recourse collateralized obligations increased $18.4 million, or 60%, in 2003 over 2002,
primarily due to interest expense from the Mistic CDO which closed in the third quarter of 2002.
Corporate expenses were relatively level for 2003 compared to 2002. Expenses increased $7.2 million for costs
related to the stock purchase contracts issued in 2002, but this was offset by lower unallocated corporate
expenses.
59
International results decreased $5.6 million in 2003 from 2002, due primarily to lower equity in earnings from
Aberdeen.
The loss in other improved $1.0 million in 2003 over 2002, due primarily to lower losses from non-core
operations offset by slightly higher expenses related to debt and equity securities pledged as collateral
related to our consolidated CDOs of $2.8 million.
General Account
The invested assets in the Life Companies' general accounts are generally of high quality and broadly
diversified across asset classes, sectors and individual credits and issuers. Our investment 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 related liabilities within them. Segmentation of assets allows us to manage the risks
and measure returns on capital for our various businesses and products.
Separate Accounts
Separate account assets 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. Assets held in
separate accounts are not available to satisfy general account obligations.
Debt and Equity Securities Pledged as Collateral and Non-recourse Collateralized Obligations
Investments pledged as collateral trusts are assets held for the benefit of those institutional clients which
have investments in structured bond products offered and managed by our asset management subsidiary.
See Note 8 to our consolidated financial statements in this Form 10-K for more information.
Enterprise Risk Management
During 2003, we implemented a comprehensive, enterprise-wide risk management program. Early in 2004 we
appointed a Chief Risk Officer, reporting to the Chief Financial Officer, to oversee all of our risk management
activities. We have established an Enterprise Risk Management Committee, chaired by the Chief Executive
Officer, to ensure our risk management principles are followed and our objectives are accomplished. In
addition, we have established several management committees overseeing and addressing issues pertaining to all
our major risks—product, market and operations—and capital management.
Operational Risk
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems
or from external events. We have established an Operational Risk Committee, chaired by the Chief Risk Officer,
to develop an enterprise-wide framework for managing and measuring operational risks. This committee meets
monthly and has a membership that represents all significant operating, financial and staff departments of the
company.
60
Market Risk
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 investment activities and our insurance operations. Our investment
objective is to maximize after-tax investment return within defined risk parameters. Our primary sources of
investment risk are:
• interest rate risk, which relates to the market price and cash flow variability associated with
changes in market interest rates;
• credit risk, which relates to the uncertainty associated with the ongoing ability of an obligor to
make timely payments of principal and interest; and
• equity risk, which relates to the volatility of prices for equity and equity-like investments, such as
venture capital partnerships.
We measure, manage and monitor market risk associated with our insurance and annuity business, as part of our
ongoing commitment to fund insurance liabilities. We have developed an integrated process for managing the
interaction between product features and market risk. This process involves our Corporate Finance, Corporate
Portfolio Management, Life and Annuity Finance, and Life and Annuity Product Development departments. These
areas coordinate with each other and report results and make recommendations to our Asset-Liability Management
Committee, or ALCO, chaired by the Chief Financial Officer.
We also measure, manage and monitor market risk associated with our general account investments, both backing
insurance liabilities and supporting surplus. This process involves Corporate Portfolio Management and Goodwin,
our Hartford-based asset management affiliate. These organizations work together, make recommendations and
report results to our Investment Policy Committee, chaired by the Chief Investment Officer. Please refer to the
sections that follow, including "Debt and Equity Securities Held in General Account", for more information on
our investment risk exposures. We regularly refine our policies and procedures to appropriately balance market
risk exposure and expected return.
Interest Rate Risk Management
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 and product development processes.
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 product
liability. All asset-liability strategies are approved by the ALCO. We manage the interest rate risk in
portfolio segments by modeling and analyzing asset and product liability durations and projected cash flows
under a number of interest rate scenarios.
One of the key measures we use to quantify this interest rate exposure is duration, as a measure of 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 December 31, 2004, our asset and liability portfolio durations were
well matched, especially for our largest and most interest-sensitive segments. 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.
61
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.
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 manage interest rate risk by emphasizing the purchase of securities that feature prepayment
restrictions and call protection. Our product design and pricing strategies include the use of surrender
charges or restrictions on withdrawals in some products.
The table below shows the estimated interest rate sensitivity of our fixed income financial instruments
measured in terms of fair value. 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.
As of December 31, 2004
Interest Rate Sensitivity of Fixed Income ----------------------------------------------------
Financial Instruments: -100 Basis +100 Basis
($ amounts in millions) Carrying Point Point
Value Change Fair Value Change
------------ ------------ ------------ ------------
Cash and cash equivalents............................... $ 435.0 $ 435.3 $ 435.0 $ 434.7
Available-for-sale debt securities...................... 13,476.3 14,138.2 13,476.3 12,814.8
Mortgage loans.......................................... 207.9 225.9 220.4 214.9
------------ ------------ ------------ ------------
Subtotal................................................ 14,119.2 14,799.4 14,131.7 13,464.4
Debt and equity securities pledged as collateral........ 1,278.8 1,335.4 1,278.8 1,221.9
------------ ------------ ------------ ------------
Totals.................................................. $ 15,398.0 $ 16,134.8 $ 15,410.5 $ 14,686.3
============ ============ ============ ============
We use derivative financial instruments, primarily interest rate swaps, to manage our residual exposure to
fluctuations in interest rates. We enter into derivative contracts with a number of highly rated financial
institutions, to both diversify and reduce overall counterparty credit risk 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 table below shows the interest rate sensitivity of our general account interest rate derivatives measured
in terms of fair value. These exposures will change as our insurance liabilities are created and discharged and
as a result of ongoing portfolio and risk management activities.
62
Interest Rate Sensitivity of Derivatives: As of December 31, 2004
($ amounts in millions) ---------------------------------------------------------------
Weighted- -100 +100
Average Basis Basis
Notional Term Point Point
Amount (Years) Change Fair Value Change
----------- ----------- ----------- ----------- -----------
Interest rate swaps.......................... $ 540.0 9.4 $ 20.1 $ 13.3 $ 6.6
Other........................................ 50.0 3.5 -- 0.1 0.3
----------- ----------- ----------- -----------
Totals - general account..................... $ 590.0 $ 20.1 $ 13.4 $ 6.9
=========== =========== =========== ===========
Non-recourse interest rate swaps
held in consolidated CDOs.................. $ 1,118.2 4.8 $ 143.5 $ 101.8 $ 61.3
=========== =========== =========== =========== ===========
See Note 9 to our consolidated financial statements in this Form 10-K for more information on derivative
instruments.
In 1999, we began selling RPE, a no-load variable annuity. RPE was designed to attract contributions into
variable sub-accounts on which we earn mortality and expense fees. However, the bulk of the funds were
allocated to GIAs, which offered a 3% guaranteed interest rate. We anticipated the liabilities would be of a
short duration and with the low level of interest rates, we were unable to invest funds at a rate that
guaranteed a spread that covered commissions and interest credited. In September 2002, we stopped accepting
applications for RPE, although existing policyholders have the right to make subsequent cumulative gross
deposits up to $1 million per contract.
Annuity Deposit Fund Balances: As of December 31,
($ amounts in millions) ------------------------
2004 2003
----------- -----------
Policyholder Deposit Funds
Retirement Planners Edge GIAs........................................................ $ 1,121.4 $ 1,209.4
Other variable annuity GIAs.......................................................... 817.7 858.0
----------- -----------
Variable annuity GIAs................................................................ 1,939.1 2,067.4
Fixed annuities...................................................................... 1,038.2 1,056.9
----------- -----------
Total variable annuity GIAs and fixed annuities...................................... $ 2,977.3 $ 3,124.3
=========== ===========
The funds in the RPE GIAs decreased by $88.0 million during 2004. We believe most contract holders currently
view RPE as an attractive alternative to money market investments and, absent a spike in money market rates,
this business is likely to run off slowly.
Because experience has shown that the duration of the RPE liabilities is longer than we had previously assumed,
beginning in the second quarter of 2004 we extended the duration of the assets. This has enhanced operating
income to the point where this product essentially breaks even.
Credit Risk Management
We manage credit risk through the fundamental analysis of the underlying obligors, issuers and transaction
structures. Through Goodwin, our Hartford-based asset management affiliate, we employ a staff of experienced
credit analysts who review obligors' management, competitive position, cash flow, coverage ratios, liquidity
and other key financial and non-financial information. These analysts recommend the investments needed to fund
our liabilities while adhering to 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 stability of their current credit ratings.
63
We also manage credit risk through industry and issuer diversification and asset allocation. Maximum exposure
to an issuer or derivatives counterparty is defined by quality ratings, with higher quality issuers having
larger exposure limits. We have an overall limit on below investment-grade rated issuer exposure.
Equity Risk Management
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 $391.6 million in equity securities,
including $87.3 million in trading equity securities, on our balance sheet as of December 31, 2004. A 10%
decline or increase in the relevant equity price would have decreased or increased, respectively, the value of
these assets by approximately $39.2 million as of December 31, 2004.
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 December 31, 2004 and 2003, the difference
between the guaranteed minimum death benefit and the current account value (net amount at risk) for all
existing contracts was $123.5 and $183.1 million, respectively. This is our exposure to loss should all of our
contractholders have died on either December 31, 2004 or December 31, 2003.
Guaranteed Minimum Death Benefit Exposure: 2004 2003
($ amounts in millions) ----------- -----------
Net amount at risk on minimum guaranteed death benefits (before reinsurance)......... $ 441.1 $ 616.9
Net amount at risk reinsured......................................................... (317.6) (433.8)
----------- -----------
Net amount at risk on minimum guaranteed death benefits (after reinsurance).......... $ 123.5 $ 183.1
=========== ===========
Weighted-average age of contractholder............................................... 61 61
=========== ===========
Payments Related to Guaranteed Minimum Death Benefits, Year Ended December 31,
Net of Reinsurance Recoveries: -------------------------------------
($ amounts in millions) 2004 2003 2002
----------- ----------- -----------
Death claims payments before reinsurance............................... $ 5.4 $ 7.7 $ 8.6
Reinsurance recoveries................................................. (3.0) (5.1) (6.4)
----------- ----------- -----------
Net death claims payments.............................................. $ 2.4 $ 2.6 $ 2.2
=========== =========== ===========
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 wide range of
scenarios at December 31, 2004 and 2003.
64
Reserves Related to Guaranteed Minimum Death Benefits, As of December 31,
Net of Reinsurance Recoverables: ------------------------
($ amounts in millions) 2004 2003
----------- -----------
Statutory reserve (after reinsurance)............................................... $ 15.0 $ 17.3
GAAP reserve (after reinsurance).................................................... 9.1 7.6
We also provide reserves for guaranteed minimum income benefits and guaranteed payout annuity floor benefits.
The statutory reserves for these totaled $2.3 million and $2.0 million at December 31, 2004 and 2003,
respectively. The GAAP reserves for these totaled $1.6 million and $0.4 million at December 31, 2004 and 2003,
respectively.
Interest Rate Sensitivity of Deferred Policy Acquisition Cost Asset and As of December 31, 2004
Guaranteed Minimum Death Benefit Liability: -------------------------------------
($ amounts in millions) -10% + 10%
Equity Carrying Equity
Market Value Market
----------- ----------- -----------
Deferred policy acquisition costs (variable annuities)................... $ 283.0 $ 286.0 $ 289.3
Deferred policy acquisition costs (variable universal life).............. 325.2 326.4 327.0
Guaranteed minimum death benefit liability (variable annuities).......... 12.1 9.1 7.1
See Note 3 to our consolidated financial statements in this Form 10-K for more information regarding deferred
policy acquisition costs.
Certain annuity products sold by our Life Companies contain guaranteed minimum living benefits. These include
guaranteed minimum accumulation and income benefits. We have established a hedging program for managing the
risk associated with our new guaranteed minimum accumulation benefit feature. As of December 31, 2004, sales of
that benefit had not yet created a significant enough exposure to meet our requirement for executing a
derivative transaction under that hedge program. We continue to analyze and refine our strategies for managing
risk exposures associated with all our separate account guarantees.
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 in the most recent valuations, performed as of September 30, 2004, May
31, 2004 and January 1, 2004. To the extent there are deviations in actual returns, there will be changes in
our projected expense and funding requirements. As of December 31, 2004, the projected benefit obligation for
our defined benefit plans was in excess of plan assets by $237.2 million. We expect to contribute $43.3 million
to the employee pension plan through 2009, including $6.5 million during 2005. As of May 31, 2004 we revalued
our employee benefit assets and liabilities in connection with the sale of our retail affiliated broker-dealer
operations. As a result of the revaluation, we recognized a net curtailment gain of $6.8 million ($4.4 million
after taxes). In addition, as of September 30, 2004 we revalued our employee benefit assets and liabilities in
connection with employee terminations associated with the information technology services agreement EDS. As a
result of this revaluation, we recognized an additional net curtailment gain of $1.6 million ($1.1 million
after taxes) for the year ended December 31, 2004. For the estimated 2004 contribution, quarterly payments of
$2.5 million each were made to the pension plan in April, July and October 2004. In September 2004, we made a
payment of $1.6 million, related to the 2003 minimum contribution. See Note 11 to our consolidated financial
statements in this Form 10-K for more information on our employee benefit plans.
Foreign Currency Exchange Risk Management
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 which is not material to our consolidated financial statements at December 31, 2004.
65
Debt and Equity Securities Held in General Account
Our general account 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 December 31, 2004, our general account debt securities, with a carrying
value of $13,476.3 million, represented 79.7% of total general account investments. Public debt securities
represented 77.9% of total debt securities, with the remaining 22.1% represented by private debt securities.
We consolidate debt and equity securities on our consolidated balance sheet that are pledged as collateral for
the settlement of collateralized obligation liabilities related to three collateralized obligation trusts which
we sponsor. See Note 8 of our consolidated financial statements in this Form 10-K for additional information on
these debt and equity securities pledged as collateral.
Each year, the majority of our general account's 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 December 31, 2004, our total
below investment grade securities totaled $1,074.1 million, or 8.0%, of our total debt security portfolio. Of
that amount, $814.6 million, or 6.1%, 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 $259.5 million, or 1.9%, of our total debt security portfolio.
Our general account debt and equity securities are classified as available-for-sale and are reported at fair
value with unrealized gains or losses included in equity. Accordingly, the carrying value of such securities
reflects their fair value at the balance sheet date. Fair value is based on quoted market price, where
available. When quoted market prices are not available, we estimate fair value for debt securities by
discounting projected cash flows based on market interest rates currently being offered on similar terms to
borrowers of similar credit quality, by quoted market prices of comparable instruments and by independent
pricing sources or internally developed pricing models. Investments whose value, in our judgment, is considered
to be other-than-temporarily impaired are written down to fair value as a charge to realized losses included in
our earnings. The cost basis of these written-down investments is adjusted to fair value at the date the
determination of impairment is made. The new cost basis is not changed for subsequent recoveries in value.
66
General Account Debt Securities
at Fair Value: As of December 31,
($ amounts in millions) ----------------------------------------------------------------------------
Total Debt Securities Public Debt Securities Private Debt Securities
(Fair Value) (Fair Value) (Fair Value)
SVO S&P Equivalent ------------------------ ------------------------ ------------------------
Rating Designation 2004 2003 2004 2003 2004 2003
- -------- ----------------------- ----------- ----------- ----------- ----------- ----------- -----------
1 AAA/AA/A............. $ 8,668.9 $ 8,821.2 $ 7,123.2 $ 7,442.1 $ 1,545.7 $ 1,379.1
2 BBB.................. 3,733.3 3,350.8 2,493.6 2,160.6 1,239.7 1,190.2
----------- ----------- ----------- ----------- ----------- -----------
Total investment grade 12,402.2 12,172.0 9,616.8 9,602.7 2,785.4 2,569.3
3 BB................... 814.6 764.9 698.6 635.5 116.0 129.4
4 B.................... 150.9 218.9 97.3 157.8 53.6 61.1
5 CCC and lower........ 68.9 94.6 51.1 53.7 17.8 40.9
6 In or near default... 39.7 22.6 36.1 19.0 3.6 3.6
----------- ----------- ----------- ----------- ----------- -----------
Total debt securities $13,476.3 $13,273.0 $10,499.9 $10,468.7 $ 2,976.4 $ 2,804.3
=========== =========== =========== =========== =========== ===========
General Account Debt Securities As of December 31, 2004
by Investment Type: ------------------------------------------------------------------
($ amounts in millions) Unrealized Gains (Losses)
-------------------------------------
Fair Gross Gross
Value Cost Gains Losses Net
----------- ----------- ----------- ----------- -----------
United States government and agency.......... $ 679.1 $ 625.4 $ 55.4 $ (1.7) $ 53.7
State and political subdivision.............. 446.5 413.7 34.4 (1.6) 32.8
Foreign government........................... 314.8 284.0 31.1 (0.3) 30.8
Corporate.................................... 7,365.4 7,040.7 364.2 (39.5) 324.7
Mortgage-backed.............................. 3,253.4 3,122.9 137.0 (6.5) 130.5
Other asset-backed........................... 1,417.1 1,405.0 32.4 (20.3) 12.1
----------- ----------- ----------- ----------- -----------
Total debt securities........................ $13,476.3 $12,891.7 $ 654.5 $ (69.9) $ 584.6
=========== =========== =========== =========== ===========
Debt securities outside closed block:
Unrealized gains......................... $ 4,534.7 $ 4,339.7 $ 195.0 $ -- $ 195.0
Unrealized losses........................ 1,992.0 2,036.8 -- (44.8) (44.8)
----------- ----------- ----------- ----------- -----------
Total outside the closed block........... 6,526.7 6,376.5 195.0 (44.8) 150.2
----------- ----------- ----------- ----------- -----------
Debt securities in closed block:
Unrealized gains......................... 5,913.8 5,454.3 459.5 -- 459.5
Unrealized losses........................ 1,035.8 1,060.9 -- (25.1) (25.1)
----------- ----------- ----------- ----------- -----------
Total in the closed block................ 6,949.6 6,515.2 459.5 (25.1) 434.4
----------- ----------- ----------- ----------- -----------
Total debt securities........................ $13,476.3 $12,891.7 $ 654.5 $ (69.9) $ 584.6
=========== =========== =========== =========== ===========
Debt Securities by Type and Credit Quality: As of December 31, 2004
($ amounts in millions) --------------------------------------------------
Investment Grade Below Investment Grade
------------------------ ------------------------
Fair Value Cost Fair Value Cost
----------- ----------- ----------- -----------
United States government and agency........................ $ 679.1 $ 625.4 $ -- $ --
State and political subdivision............................ 446.5 413.7 -- --
Foreign government......................................... 194.9 175.9 119.9 108.1
Corporate.................................................. 6,630.3 6,337.9 735.1 702.8
Mortgage-backed............................................ 3,195.4 3,073.6 58.0 49.3
Other asset-backed......................................... 1,256.0 1,230.0 161.1 175.0
----------- ----------- ----------- -----------
Total debt securities...................................... $12,402.2 $11,856.5 $ 1,074.1 $ 1,035.2
=========== =========== =========== ===========
Percentage of total debt securities........................ 92.0% 92.0% 8.0% 8.0%
=========== =========== =========== ===========
67
Investment Grade Debt Securities at Fair Value: As of December 31, 2004
($ amounts in millions) -------------------------------------
Total AAA/AA/A BBB
----------- ----------- -----------
United States government and agency...................................... $ 679.1 $ 679.1 $ --
State and political subdivision.......................................... 446.5 432.9 13.6
Foreign government....................................................... 194.9 91.3 103.6
Corporate................................................................ 6,630.3 3,478.6 3,151.7
Mortgage-backed.......................................................... 3,195.4 3,037.8 157.6
Other asset-backed....................................................... 1,256.0 949.2 306.8
----------- ----------- -----------
Total debt securities.................................................... $12,402.2 $ 8,668.9 $ 3,733.3
=========== =========== ===========
Percentage of total debt securities...................................... 92.0% 64.3% 27.7%
=========== =========== ===========
Below Investment Grade As of December 31, 2004
Debt Securities at Fair Value: ---------------------------------------------------------------
($ amounts in millions) CC or In or Near
Total BB B Lower Default
----------- ----------- ----------- ----------- -----------
Foreign government........................... $ 119.9 $ 114.5 $ 5.4 $ -- $ --
Corporate.................................... 735.1 587.5 117.7 21.7 8.2
Mortgage-backed.............................. 58.0 58.0 -- -- --
Other asset-backed........................... 161.1 54.6 27.8 47.2 31.5
----------- ----------- ----------- ----------- -----------
Total debt securities........................ $ 1,074.1 $ 814.6 $ 150.9 $ 68.9 $ 39.7
=========== =========== =========== =========== ===========
Percentage of total debt securities.......... 8.0% 6.1% 1.1% 0.5% 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 approach has been to
create a high level of industry diversification. The top five industry holdings as of December 31, 2004 in our
debt securities portfolio are banking (4.98%), insurance (3.35%), electrical utilities (3.06%), diversified
financial services (2.54%), and publishing, broadcasting, printing and cable (2.25%).
Our corporate debt security exposure to recently troubled industries, including telecommunications equipment,
telephone utilities, airlines, media, publishing and broadcasting, comprises 5.1% of our debt securities
portfolio at December 31, 2004. 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 December 31, 2004.
The following table presents certain information with respect to realized investment gains and losses including
those on debt securities pledged as collateral, with losses from other-than-temporary impairment charges
reported separately in the table. 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.
68
Sources of Realized Investment Gains (Losses): Year Ended December 31,
($ amounts in millions) -------------------------------------
2004 2003 2002
----------- ----------- -----------
Debt security impairments.............................................. $ (15.5) $ (76.1) $ (114.3)
Equity security impairments............................................ (1.5) (4.3) (9.8)
Mortgage loan impairments.............................................. -- (4.1) (0.6)
Venture capital partnership impairments................................ -- (4.6) (5.1)
Affiliate equity security impairments.................................. (12.6) (96.9) --
Other invested asset impairments....................................... (3.3) (16.5) (22.0)
Debt and equity securities pledged as collateral impairments........... (16.6) (8.3) (34.9)
----------- ----------- -----------
Impairment losses...................................................... (49.5) (210.8) (186.7)
----------- ----------- -----------
Debt security transaction gains........................................ 39.0 93.7 94.3
Debt security transaction losses....................................... (10.6) (29.0) (45.9)
Equity security transaction gains...................................... 17.7 58.8 24.5
Equity security transaction losses..................................... (3.1) (9.6) (22.4)
Mortgage loan transaction gains (losses)............................... 0.2 (1.3) 0.2
Venture capital partnership transaction losses......................... -- (9.7) --
Other invested asset transaction gains................................. 5.5 9.4 2.1
----------- ----------- -----------
Net transaction gains.................................................. 48.7 112.3 52.8
----------- ----------- -----------
Net realized investment losses......................................... $ (0.8) $ (98.5) $ (133.9)
----------- ----------- -----------
Net realized investment losses......................................... $ (0.8) $ (98.5) $ (133.9)
----------- ----------- -----------
Applicable closed block policyholder dividend obligation (reduction)... 3.7 (5.9) (40.3)
Applicable deferred policy acquisition costs (benefit)................. (0.4) (4.1) (7.2)
Applicable deferred income tax expense (benefit)....................... 3.1 (35.6) (20.8)
----------- ----------- -----------
Offsets to realized investment losses.................................. 6.4 (45.6) (68.3)
----------- ----------- -----------
Net realized investment losses included in net income.................. $ (7.2) $ (52.9) $ (65.6)
=========== =========== ===========
Realized impairment losses on debt and equity securities pledged as collateral relating to our direct
investments in the consolidated collateralized obligation trusts are $3.7 million, $5.9 million and $8.6
million for 2004, 2003 and 2002, respectively.
Impairment losses of $49.5 million in 2004 are substantially improved as compared to 2003 and 2002 as a result
of a significant improvement in the credit environment in late 2003 into 2004. Impairment losses in 2004
include $12.6 million in non-cash charges related to two international affiliates, and 2003 includes a
writedown of an equity interest in affiliates of $96.9 million ($89.1 million of which relates to Aberdeen).
Transaction gains of $48.7 million in 2004 are significantly lower than 2003 transaction gains of $112.3
million and modestly lower than 2002 transaction gains of $52.8 million. Transaction gains in 2003 include
realized gains of $35.3 million related to our sale of equity investments in PXRE and certain GE Life &
Annuity subsidiaries. See Notes 1 and 5 to our consolidated financial statements in this Form 10-K for
additional information.
69
Gross and Net Unrealized As of December 31, 2004
Gains (Losses): -----------------------------------------------------------------------
($ amounts in millions) Total Outside Closed Block Closed Block
----------------------- ----------------------- -----------------------
Gains Losses Gains Losses Gains Losses
----------- ----------- ----------- ----------- ----------- -----------
Debt Securities
Unrealized gains (losses)........... $ 654.5 $ (69.9) $ 195.0 $ (44.8) $ 459.5 $ (25.1)
----------- ----------- ----------- ----------- ----------- -----------
Applicable policyholder dividend
obligation (reduction)............ 459.5 (25.1) -- -- 459.5 (25.1)
Applicable deferred policy
acquisition costs (benefit)....... 100.3 (16.5) 100.3 (16.5) -- --
Applicable deferred income
taxes (benefit)................... 33.1 (9.9) 33.1 (9.9) -- --
----------- ----------- ----------- ----------- ----------- -----------
Offsets to net unrealized
gains (losses).................... 592.9 (51.5) 133.4 (26.4) 459.5 (25.1)
----------- ----------- ----------- ----------- ----------- -----------
Unrealized gains (losses)
after offsets..................... $ 61.6 $ (18.4) $ 61.6 $ (18.4) $ -- $ --
=========== =========== =========== =========== =========== ===========
Net unrealized gains after offsets.. $ 43.2 $ 43.2 $ --
=========== =========== ===========
Equity Securities
Unrealized gains (losses)........... $ 108.3 $ (3.3) $ 94.0 $ (1.5) $ 14.3 $ (1.8)
----------- ----------- ----------- ----------- ----------- -----------
Applicable policyholder dividend
obligation (reduction)............ 14.3 (1.8) -- -- 14.3 (1.8)
Applicable deferred income
taxes (benefit)................... 32.9 (0.5) 32.9 (0.5) -- --
----------- ----------- ----------- ----------- ----------- -----------
Offsets to net unrealized
gains (losses).................... 47.2 (2.3) 32.9 (0.5) 14.3 (1.8)
----------- ----------- ----------- ----------- ----------- -----------
Unrealized gains (losses)
after offsets..................... $ 61.1 $ (1.0) $ 61.1 $ (1.0) $ -- $ --
=========== =========== =========== =========== =========== ===========
Net unrealized gains after offsets.. $ 60.1 $ 60.1 $ --
=========== =========== ===========
Total net unrealized gains on debt and equity securities were $689.6 million (unrealized gains of $762.8 less
unrealized losses of $73.2). Of that net amount, $242.7 million was outside the closed block ($103.3 million
after applicable deferred policy acquisition costs and deferred income taxes) and $446.9 million was in the
closed block ($0.0 million after applicable policyholder dividend obligation).
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 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. We also identify securities whose carrying value has been below amortized cost on
a continuous basis for 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 provided for 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 to determine if a security is other-than-temporarily impaired.
70
Our assessment of whether an investment by us in a debt or equity security is other-than-temporarily impaired
includes whether the issuer has:
• defaulted on payment obligations;
• declared that it will default at a future point outside the current reporting period;
• announced that a restructuring will occur outside the current reporting period;
• severe liquidity problems that cannot be resolved;
• filed for bankruptcy;
• a financial condition which suggests that future payments are highly unlikely;
• deteriorating financial condition and quality of assets;
• sustained significant losses during the current year;
• announced adverse changes or events such as changes or planned changes in senior management,
restructurings, or a sale of assets; and/or
• 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 general account debt securities, both outside and inside the closed block, as of December
31, 2003. In the tables, we separately present information that is applicable to unrealized losses both outside
and 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 in this Form 10-K for more information regarding the closed block. Applicable deferred policy
acquisition costs and income taxes further reduce the effect on our comprehensive income.
71
Duration of Gross Unrealized Losses on As of December 31, 2004
General Account Securities: ----------------------------------------------------------
($ amounts in millions) 0 - 6 6 - 12 Over 12
Total Months Months Months
------------- ------------- ------------- -------------
Debt Securities Outside Closed Block
Total fair value.................................... $ 1,992.0 $ 1,612.9 $ 72.0 $ 307.1
Total amortized cost................................ 2,036.8 1,630.9 73.3 332.6
------------- ------------- ------------- -------------
Unrealized losses................................... $ (44.8) $ (18.0) $ (1.3) $ (25.5)
============= ============= ============= =============
Unrealized losses after offsets..................... $ (18.4) $ (7.8) $ (0.5) $ (10.1)
============= ============= ============= =============
Unrealized losses over 20% of cost.................. $ (16.8) $ (0.1) $ -- $ (16.7)
============= ============= ============= =============
Unrealized losses over 20% of cost after offsets.... $ (6.2) $ -- $ -- $ (6.2)
============= ============= ============= =============
Investment grade:
Unrealized losses................................... $ (30.3) $ (16.1) $ (0.9) $ (13.3)
============= ============= ============= =============
Unrealized losses after offsets..................... $ (13.0) $ (7.1) $ (0.4) $ (5.5)
============= ============= ============= =============
Unrealized losses over 20% of cost.................. $ (6.5) $ -- $ -- $ (6.5)
============= ============= ============= =============
Unrealized losses over 20% of cost after offsets.... $ (2.6) $ -- $ -- $ (2.6)
============= ============= ============= =============
Below investment grade:
Unrealized losses................................... $ (14.5) $ (1.9) $ (0.4) $ (12.2)
============= ============= ============= =============
Unrealized losses after offsets..................... $ (5.3) $ (0.7) $ (0.1) $ (4.5)
============= ============= ============= =============
Unrealized losses over 20% of cost.................. $ (10.3) $ (0.1) $ -- $ (10.2)
============= ============= ============= =============
Unrealized losses over 20% of cost after offsets.... $ (3.6) $ -- $ -- $ (3.6)
============= ============= ============= =============
Equity Securities Outside Closed Block
Unrealized losses................................... $ (1.5) $ (1.1) $ (0.1) $ (0.3)
============= ============= ============= =============
Unrealized losses after offsets..................... $ (1.0) $ (0.7) $ (0.1) $ (0.2)
============= ============= ============= =============
Unrealized losses over 20% of cost.................. $ (1.4) $ (1.1) $ (0.1) $ (0.2)
============= ============= ============= =============
Unrealized losses over 20% of cost after offsets.... $ (0.8) $ (0.7) $ (0.1) $ (0.1)
============= ============= ============= =============
72
For debt securities outside of the closed block with gross unrealized losses, 68.0% of the unrealized losses
after offsets pertains to investment grade securities and 32.0% of the unrealized losses after offsets pertains
to below investment grade securities at December 31, 2004.
Duration of Gross Unrealized Losses On As of December 31, 2004
General Account Securities: ----------------------------------------------------
($ amounts in millions) 0 - 6 6 - 12 Over 12
Total Months Months Months
------------ ------------ ------------ ------------
Debt Securities Inside Closed Block
Total fair value....................................... $ 1,035.8 $ 646.5 $ 42.7 $ 346.6
Total amortized cost.................................... 1,060.9 655.2 43.5 362.2
------------ ------------ ------------ ------------
Unrealized losses....................................... $ (25.1) $ (8.7) $ (0.8) $ (15.6)
============ ============ ============ ============
Unrealized losses after offsets......................... $ -- $ -- $ -- $ --
============ ============ ============ ============
Unrealized losses over 20% of cost...................... $ (3.8) $ (0.1) $ -- $ (3.7)
============ ============ ============ ============
Unrealized losses over 20% of cost after offsets........ $ -- $ -- $ -- $ --
============ ============ ============ ============
Investment grade:
Unrealized losses....................................... $ (18.6) $ (7.6) $ (0.8) $ (10.2)
============ ============ ============ ============
Unrealized losses after offsets......................... $ -- $ -- $ -- $ --
============ ============ ============ ============
Unrealized losses over 20% of cost...................... $ (0.1) $ (0.1) $ -- $ --
============ ============ ============ ============
Unrealized losses over 20% of cost after offsets........ $ -- $ -- $ -- $ --
============ ============ ============ ============
Below investment grade:
Unrealized losses....................................... $ (6.5) $ (1.1) $ -- $ (5.4)
============ ============ ============ ============
Unrealized losses after offsets......................... $ -- $ -- $ -- $ --
============ ============ ============ ============
Unrealized losses over 20% of cost...................... $ (3.7) $ -- $ -- $ (3.7)
============ ============ ============ ============
Unrealized losses over 20% of cost after offsets........ $ -- $ -- $ -- $ --
============ ============ ============ ============
Equity Securities Inside Closed Block
Unrealized losses....................................... $ (1.8) $ (1.1) $ (0.1) $ (0.6)
============ ============ ============ ============
Unrealized losses after offsets......................... $ -- $ -- $ -- $ --
============ ============ ============ ============
Unrealized losses over 20% of cost...................... $ (0.5) $ (0.1) $ -- $ (0.4)
============ ============ ============ ============
Unrealized losses over 20% of cost after offsets........ $ -- $ -- $ -- $ --
============ ============ ============ ============
For debt securities in the closed block with gross unrealized losses, 74% of the unrealized losses pertain to
investment grade securities and 26% of the unrealized losses pertain to below investment grade securities.
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.
73
Aberdeen Asset Management PLC
As of December 31, 2004 and 2003, we owned 16.5% of the outstanding shares of Aberdeen, which we sold to third
parties on January 14, 2005 for net proceeds of $70.4 million. We also owned a $27.5 million convertible
subordinated note issued by Aberdeen, which was repaid in full on November 19, 2004. These transactions
completed our disposition of our direct financial interests in Aberdeen. See Notes 1 and 5 to our consolidated
financial statements in this Form 10-K for more information related to our investments in Aberdeen.
Hilb Rogal & Hobbs Company
Our investment in Hilb Rogal & Hobbs, or HRH, a Virginia-based property and casualty insurance and employee
benefit products distributor, includes primarily common stock. See Notes 5 and 6 to our consolidated financial
statements in this Form 10-K for detailed information regarding our investment in HRH.
Liquidity and Capital Resources
In the normal course of business, we enter into transactions involving various types of financial instruments
such as debt and equity securities. These instruments have credit risk and also may be subject to risk of loss
due to interest rate and market fluctuations.
Liquidity refers to the ability of a company to generate sufficient cash flow to meet its cash requirements.
The following discussion combines liquidity and capital resources as these subjects are interrelated.
The Phoenix Companies, Inc. (consolidated)
Summary Consolidated Cash Flows: Year Ended December 31, Changes
($ amounts in millions) ------------------------------------ -----------------------
2004 2003 2002 2004/03 2003/02
----------- ----------- ----------- ----------- -----------
Cash from continuing operations.............. $ 59.1 $ 397.6 $ 323.5 $ (338.5) $ 74.1
Cash from (for) discontinued operations...... 14.9 (36.5) (59.1) 51.4 22.6
Cash from (for) continuing operations
investing activities....................... 133.9 (1,139.2) (2,506.1) 1,273.1 1,366.9
Cash from (for) discontinued operations
investing activities....................... 6.5 (4.4) 37.3 10.9 (41.7)
Cash from (for) financing activities......... (227.3) 119.9 2,491.6 (347.2) (2,371.7)
2004 vs. 2003
Cash from continuing operations decreased $338.5 million, or 85%, in 2004 from 2003, primarily due to higher
benefits paid, which are funded through investing activities. Benefit payments were higher in 2004 due
primarily to scheduled surrenders and withdrawals of $184.2 million related to a portion of a group of large
corporate-owned policies and higher surrenders for an old run-off block of corporate-owned life insurance and
for participating life insurance.
Cash from continuing operations investing activities was $133.9 million for 2004 compared to cash for
continuing operations investing activities of $1,139.2 million for 2003. The $1,273.1 million change is
primarily due to lower investment purchases resulting from lower cash from operating and financing activities
in 2004 and higher cash balances at the beginning of 2003 that were invested during 2003.
Cash from financing activities decreased $347.2 million, or 289%, in 2004 from 2003, due to reductions in
policyholder deposit fund deposits of $416.9 million in 2004 compared to 2003. This decrease was partially
offset by net proceeds from borrowings in 2004 of $41.4 million. See Note 6 of to consolidated financial
statements in this Form 10-K for more information on financing activities.
74
2003 vs. 2002
For 2003, cash from continuing operations increased $74.1 million over 2002, due primarily to higher investment
income collected and lower operating expenses paid, partially offset by lower premiums collected.
For 2003, cash for continuing operations investing activities decreased $1,366.9 million from 2002, due
primarily to lower cash from financing activities from lower policyholder deposit fund receipts and lower net
proceeds from collateralized obligations. Proceeds from collateralized obligations were higher in 2002 due to
proceeds from Mistic CDO, which closed in 2002.
For 2003, cash from financing activities decreased $2,371.7 million from 2002, due primarily to lower
policyholder deposit fund receipts and lower net proceeds from collateralized obligations (discussed above),
partially offset by treasury stock purchases in 2002 that were not continued in 2003.
The Phoenix Companies, Inc. (parent company only)
Summary Cash Flows: Year Ended December 31, Changes
($ amounts in millions) ------------------------------------ -----------------------
2004 2003 2002 2004/03 2003/02
----------- ----------- ----------- ----------- -----------
Cash from operating activities............... $ 61.2 $ 33.2 $ 61.3 $ 28.0 $ (28.1)
Cash for investing activities................ (8.0) (25.7) (372.0) 17.7 346.3
Cash (for) from financing activities......... (15.0) (15.1) 136.1 0.1 (151.2)
2004 vs. 2003
Cash from operating activities increased $28.0 million in 2004 over 2003, primarily due to an increase of $25.2
million in the dividend received from Phoenix Life.
Cash for investing activities decreased $17.7 million in 2004 from 2003, primarily due to a decrease in
subsidiary purchases and advances to subsidiaries in 2004.
2003 vs. 2002
Cash from operating activities decreased $28.1 million in 2003 from 2002, primarily due to a decrease of $22.5
million in the dividend from Phoenix Life and slightly higher expense payments.
Cash for investing activities decreased $346.3 million in 2003 from 2002, due to reduced contributions and
advances to subsidiaries and lower equity security purchases. This resulted from reduced cash from financing as
discussed below.
Cash from financing activities decreased $151.2 million in 2003 from 2002, due to the proceeds from the
issuance of stock purchase contracts and equity units in 2002 for an aggregate of $ 283.0 million, partially
offset by common stock repurchases of $131.1 million. Those financing activities did not recur in 2003.
Our primary uses of liquidity include dividend payments on our common stock, loans or contributions to our
subsidiaries, debt service and general corporate expenses.
75
Our primary sources of liquidity have been dividends from Phoenix Life and interest income received from
Phoenix Investment Partners. 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 $69.7 million in April 2004 and is able
to pay a dividend of $35.1 million in 2005 under this provision. See Note 15 to our consolidated financial
statements in this Form 10-K for more information on Phoenix Life statutory financial information and
regulatory matters.
We sponsor postemployment benefit plans through pension and savings plans and postretirement health care and
life insurance for employees of Phoenix Life and Phoenix Investment Partners. Funding of these obligations is
provided by Phoenix Life and Phoenix Investment Partners on a 100% cost reimbursement basis through
administrative services agreements with the holding company. See Note 11 to our consolidated financial
statements in this Form 10-K for additional information.
Phoenix Investment Partners pays interest to the holding company on its debt from the holding company. The
holding company does not expect to receive dividends from Phoenix Investment Partners in the near term because
this subsidiary will likely use a substantial portion of its cash flows from operations to pay for additional
ownership in its existing majority-owned subsidiaries and to repay intercompany debt, including debt to the
holding company and interest on debt.
On November 22, 2004, we entered into a new $150.0 million three-year, unsecured senior revolving credit
facility to replace the prior $150.0 million credit facility that was to expire on December 20, 2004. The prior
facility consisted of two tranches: a $112.5 million, 364-day revolving credit facility and a $37.5 million
three-year revolving credit facility. Potential borrowers on the new credit line are The Phoenix Companies,
Inc., Phoenix Investment Partners and Phoenix Life. We unconditionally guarantee any loans under this new
facility to Phoenix Life and Phoenix Investment Partners. Base rate loans will bear interest at the greater of
Wachovia Bank, National Association's prime commercial rate or the federal funds rate plus 0.50%. Eurodollar
rate loans will bear interest at LIBOR plus an applicable percentage based on our Standard & Poor's and Moody's
ratings. The $25 million drawn by Phoenix Investment Partners on the prior facility was refinanced using this
new facility at the Eurodollar rate.
The new credit facility contains covenants that require us at all times to maintain consolidated stockholders'
equity, in accordance with GAAP, excluding the accounting effects of FIN 46(R), of $1,648.4 million, plus 50%
of positive quarterly net income and 100% of equity issuances and a maximum consolidated debt-to-capital ratio
of 30% and that limit consolidated indebtedness, subject to certain exceptions, to $750.0 million. In addition,
Phoenix Life must maintain a minimum RBC ratio of 250% and a minimum A.M. Best financial strength rating of
"A-". The new facility no longer has a fixed charge coverage covenant. Borrowings under the facility are not
conditioned on the absence of a material adverse change.
See Note 19 to our consolidated financial statements in this Form 10-K for more information on the holding
company.
Life Companies
The 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 us; operating expenses;
contributions to subsidiaries; and payment of principal and interest by Phoenix Life on its outstanding debt
obligations. Liabilities arising from life insurance and annuity products include the payment of benefits, as
well as cash payments in connection with policy surrenders, withdrawals and loans. The Life Companies also have
liabilities arising from the runoff of the remaining group accident and health reinsurance discontinued
operations.
76
Historically, our Life Companies have used cash flow from operations and investment activities to fund
liquidity requirements. Their principal cash inflows from life insurance and annuities activities come from
premiums, annuity deposits and charges on insurance policies and annuity contracts. In the case of Phoenix
Life, cash inflows also include dividends, distributions and other payments from subsidiaries. Principal cash
inflows from investment activities result from repayments of principal, proceeds from maturities, sales of
invested assets and investment income. The principal cash inflows from our discontinued group accident and
health reinsurance operations come from our reinsurance, recoveries from other retrocessionaires and investment
activities. See Note 17 to our consolidated financial statements in this Form 10-K for additional information.
Additional liquidity to meet cash outflows is available from our Life Companies' portfolios of liquid assets.
These liquid assets include substantial holdings of United States government and agency bonds, short-term
investments and marketable debt and equity securities.
Phoenix Life's current sources of liquidity also include the revolving credit facility under which Phoenix Life
has direct borrowing rights, discussed above, 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 inflows with expected cash outflows, and employ an asset/liability management approach
tailored to the specific requirements of each product line, based upon the return objectives, risk tolerance,
liquidity, tax and regulatory requirements of the underlying products. In particular, 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 with short-term and medium-term fixed maturities.
Annuity Actuarial Reserves and Deposit Liabilities As of December 31,
Withdrawal Characteristics: 2004 2003
($ amounts in millions) ----------------------- -----------------------
Amount(1) Percent Amount(1) Percent
----------- ----------- ----------- -----------
Not subject to discretionary withdrawal provision............ $ 174.9 7% $ 220.8 3%
Subject to discretionary withdrawal without adjustment....... 720.8 29% 1,967.2 28%
Subject to discretionary withdrawal with market value
adjustment................................................. 121.1 5% 811.6 11%
Subject to discretionary withdrawal at contract value
less surrender charge...................................... 43.1 2% 869.8 12%
Subject to discretionary withdrawal at market value.......... 1,397.4 57% 3,294.0 46%
----------- ----------- ----------- -----------
Total annuity contract reserves and deposit fund liability... $ 2,457.3 100% $ 7,163.4 100%
=========== =========== =========== ===========
________
(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.
77
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 December 31, 2004, our Life Companies had approximately $11.7 billion in cash values with respect
to which policyholders had rights to take policy loans. The majority of cash values eligible for policy loans
are at variable interest rates that are reset annually on the policy anniversary. Policy loans at December 31,
2004 were $2.2 billion.
The primary liquidity risks regarding cash inflows from the investment activities of our Life Companies are the
risks of default by debtors, interest rate and other market volatility and potential illiquidity of
investments. We closely monitor and manage these risks.
We believe that the current and anticipated sources of liquidity for our Life Companies are adequate to meet
their present and anticipated needs.
On December 15, 2004, we repurchased $144.8 million of the previously $175.0 million outstanding principal
amount of our 6.95% surplus notes scheduled to mature in 2006, and recognized a loss of $10.4 million in
connection with the transaction. To finance the tender, we issued $175.0 million principal of 7.15% surplus
notes with a scheduled maturity of 30 years for proceeds of $171.6 million, net of discount and issue costs.
On April 30, 2004, Phoenix Life paid a dividend of $69.7 million to The Phoenix Companies, Inc., as Phoenix
Life's sole shareholder. Under New York Insurance Law, Phoenix Life can pay dividends to The Phoenix Companies
in any calendar year without the 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's statutory gain from operations was $35.1 million for the year ended
December 31, 2004, net of a $16.0 million tax payment related to the forgiveness of debt on a restructured
investment, $10.2 million in after-tax restructuring charges primarily associated with the sale of our retail
affiliated broker-dealer operations and the outsourcing of our information technology infrastructure, and $8.3
in after-tax costs related to the surplus notes tender and issuance transactions.
Phoenix Investment Partners
Phoenix Investment Partners' liquidity requirements are primarily to fund operating expenses and pay its debt
and interest obligations. Phoenix Investment Partners also would require liquidity to fund the costs of any
payments for additional ownership in existing majority-owned subsidiaries, as well as any potential
acquisitions. Historically, Phoenix Investment Partners' principal source of liquidity has been cash flow from
operations. We expect that cash flow from operations will continue to be its principal source of working
capital. Its current sources of liquidity also include a revolving credit facility under which it has direct
borrowing rights subject to our unconditional guarantee. We believe that Phoenix Investment Partners' current
and anticipated sources of liquidity are adequate to meet its present and anticipated needs. See Notes 4 and 6
to our consolidated financial statements in this Form 10-K for further details on our financing activities.
78
Consolidated Financial Condition
Consolidated Balance Sheet As of December 31,
($ amounts in millions) -------------------------
2004 2003 Change
------------ ------------ ------------
ASSETS
Available-for-sale debt securities, at fair value...................... $ 13,476.3 $ 13,273.0 $ 203.3
Available-for-sale equity securities, at fair value.................... 304.3 312.0 (7.7)
Trading equity securities.............................................. 87.3 -- 87.3
Mortgage loans, at unpaid principal balances........................... 207.9 284.1 (76.2)
Venture capital partnerships, at equity in net assets.................. 255.3 234.9 20.4
Affiliate equity securities, at equity in net assets................... -- 47.5 (47.5)
Policy loans, at unpaid principal balances............................. 2,196.7 2,241.4 (44.7)
Other investments...................................................... 371.8 402.0 (30.2)
------------ ------------ ------------
16,899.6 16,794.9 104.7
Available-for-sale debt and equity securities pledged as collateral,
at fair value........................................................ 1,278.8 1,350.0 (71.2)
------------ ------------ ------------
Total investments...................................................... 18,178.4 18,144.9 33.5
Cash and cash equivalents.............................................. 435.0 447.9 (12.9)
Accrued investment income.............................................. 222.3 222.3 --
Receivables............................................................ 135.8 224.9 (89.1)
Deferred policy acquisition costs...................................... 1,429.9 1,367.7 62.2
Deferred income taxes.................................................. 30.7 58.7 (28.0)
Other intangible assets................................................ 308.4 335.1 (26.7)
Goodwill............................................................... 427.2 419.9 7.3
Other assets........................................................... 244.6 254.6 (10.0)
Separate account assets................................................ 6,950.3 6,083.2 867.1
------------ ------------ ------------
Total assets........................................................... $ 28,362.6 $ 27,559.2 $ 803.4
============ ============ ============
LIABILITIES
Policy liabilities and accruals........................................ $ 13,132.3 $ 13,088.6 $ 43.7
Policyholder deposit funds............................................. 3,492.4 3,642.7 (150.3)
Stock purchase contracts............................................... 131.9 128.8 3.1
Indebtedness........................................................... 690.8 639.0 51.8
Other liabilities...................................................... 546.3 534.5 11.8
Non-recourse collateralized obligations................................ 1,355.2 1,472.0 (116.8)
Separate account liabilities........................................... 6,950.3 6,083.2 867.1
------------ ------------ ------------
Total liabilities...................................................... 26,299.2 25,588.8 710.4
------------ ------------ ------------
MINORITY INTEREST
Minority interest in net assets of consolidated subsidiaries........... 41.0 22.6 18.4
------------ ------------ ------------
STOCKHOLDERS' EQUITY
Common stock and additional paid in capital............................ 2,436.2 2,432.4 3.8
Deferred compensation on restricted stock units........................ (3.6) (3.6) --
Accumulated deficit.................................................... (285.6) (355.3) 69.7
Accumulated other comprehensive income................................. 58.0 63.7 (5.7)
Treasury stock......................................................... (182.6) (189.4) 6.8
------------ ------------ ------------
Total stockholders' equity............................................. 2,022.4 1,947.8 74.6
------------ ------------ ------------
Total liabilities, minority interest and stockholders' equity.......... $ 28,362.6 $ 27,559.2 $ 803.4
============ ============ ============
2004 vs. 2003
Available-for-sale debt securities increased $203.3 million in 2004 from December 31 2003, reflecting slight
appreciation of bond values as a result of a modest decline in risk-free interest rates and a tightening of
credit spreads since December 31, 2003.
79
Trading equity securities gain of $87.3 in 2004 related to our equity holdings in Aberdeen. See Notes 1 and 5
to our consolidated financial statements in this Form 10-K for more information on Aberdeen.
Mortgage loans decreased $76.2 million, or 27%, in 2004 from December 31, 2003, due to continued paydowns of
this portfolio, which is in runoff.
The decrease in affiliate equity securities primarily relates to the change in accounting for Aberdeen from the
equity method to the fair value method. See Notes 1 and 5 to our consolidated financial statements in this Form
10-K for more information on Aberdeen.
Other investments decreased $30.2 million, or 8%, in 2004 from December 31, 2003, primarily attributable to the
return of seed money held in separate accounts and the liquidation of a hedge fund investment.
Available-for-sale debt and equity securities pledged as collateral decreased $71.2 million, or 5%, in 2004
from December 31, 2003, primarily due to the liquidation of securities to fund the paydown of non-recourse
collateralized obligations.
Deferred policy acquisition costs increased $62.2 million, or 5%, in 2004 from December 31, 2003, due primarily
to policy acquisition costs deferred of $164.7 million plus $7.7 million for the effect of unrealized
investment losses included in other comprehensive income, less amortization of $110.2 million. See Note 3 to
our consolidated financial statements in this Form 10-K for additional information.
Composition of Deferred Acquisition Costs by Product: As of December 31,
($ amounts in millions) ----------------------------
2004 2003 Change
------------- ------------- -------------
Variable universal life........................................... $ 332.5 $ 328.7 $ 3.8
Universal life.................................................... 216.0 169.3 46.7
Variable annuities................................................ 275.4 260.3 15.1
Fixed annuities................................................... 46.0 45.2 0.8
Participating life................................................ 523.0 536.7 (13.7)
Other............................................................. 37.0 27.5 9.5
------------- ------------- -------------
Total deferred acquisition costs.................................. $ 1,429.9 $ 1,367.7 $ 62.2
============= ============= =============
The increase in deferred acquisition costs reflects growing blocks of funds under deposit for variable
universal life and variable annuities, while the decrease for participating life reflects the fact that this
block is in runoff.
Policyholder deposit funds decreased $150.3 million, or 4%, in 2004 from December 31, 2003, primarily due to
net withdrawals from variable annuity guaranteed interest sub-accounts.
Indebtedness increased $51.8 million, or 8%, in 2004 from December 31, 2003, primarily due to the issuance of
surplus notes of $175.0 million, due in 2034, and borrowings of $25.0 million on our bank credit facility.
These increases were offset by the repurchase of $144.8 million of our surplus notes, which were due in 2006.
See Note 6 to our consolidated financial statements in this Form 10-K for additional information.
Non-recourse collateralized obligations decreased $116.8 million, or 8%, in 2004 from December 31, 2003, due to
distributions to investors in non-recourse collateralized obligations and a decrease in the fair value of
non-recourse derivative cash flow hedges as a result of higher interest rates. See Note 7 to our consolidated
financial statements in this Form 10-K for additional information.
80
Contractual Obligations and Commercial Commitments
Contractual Obligations and
Commercial Commitments:
($ Amounts in Millions) Total 2005 2006 - 2007 2008 - 2009 Thereafter
------------ ------------ ------------ ------------ ------------
Contractual Obligations Due
Indebtedness(1)............................. $ 683.9 $ 25.0 $ 30.2 $ 153.7 $ 475.0
Stock purchase contracts(2)................. -- -- -- -- --
Operating lease obligations................ 31.0 8.8 14.3 6.1 1.8
Other purchase liabilities(3)(4) ............ 169.7 38.6 79.7 34.6 16.8
------------ ------------ ------------ ------------ ------------
Total fixed contractual obligations........ 884.6 72.4 124.2 194.4 493.6
Other long-term liabilities(5).............. 43,148.7 1,020.7 2,549.5 2,532.0 37,046.5
------------ ------------ ------------ ------------ ------------
Subtotal................................... $ 44,033.3 $ 1,093.1 $ 2,673.7 $ 2,726.4 $ 37,540.1
Non-recourse collateralized obligations(6).. 1,253.3 -- -- -- 1,253.3
------------ ------------ ------------ ------------ ------------
Total contractual obligations.............. $ 45,286.6 $ 1,093.1 $ 2,673.7 $ 2,726.4 $ 38,793.4
============ ============ ============ ============ ============
Commercial Commitment Expirations
Standby letters of credit(7)................ $ 9.0 $ 9.0 $ -- $ -- $ --
Other commercial commitments(4)(8) .......... 182.6 50.8 13.5 64.0 54.3
------------ ------------ ------------ ------------ ------------
Total commercial commitments............... $ 191.6 $ 59.8 $ 13.5 $ 64.0 $ 54.3
============ ============ ============ ============ ============
________
(1) Indebtedness amounts include principal only. $153.7 million of indebtedness represents mandatorily
convertible debt to be settled with our stock in February 2006.
(2) Stock purchase contracts are prepaid forward contracts issued by us that will be settled in shares of
HRH, as further described in Note 6 of our consolidated financial statements in this Form 10-K.
(3) Other purchase liabilities relate to open purchase orders, required pension funding and other
contractual obligations.
(4) Commitments related to recent business combinations are not included in amounts presented in this
table. See the discussion on the following pages.
(5) Policyholder contractual obligations represent estimated benefit payments, net of reinsurance and offset by
expected future deposits and premiums on in-force contracts, from life insurance and annuity contracts issued
by our life insurance subsidiaries. Future obligations are based on our estimate of future investment
earnings, mortality, surrenders and applicable policyholder dividends. Included in the amounts above are
policyholder dividends of $8.5 billion, generated by estimated favorable future investment and mortality, in
excess of guaranteed amounts for our closed block. Actual obligations in any single year, or ultimate total
obligations, may materially vary from these estimates as actual experience emerges. Because future
obligations anticipate future investment earnings, total policyholder contractual obligations exceed
policyholder liabilities on our balance sheet (policy liabilities and accruals: $13,132.3 million; and
policy deposit funds: $3,492.4 million) at December 31, 2004.
Policyholder contractual obligations also include separate account liabilities, which are contractual
obligations of the separate account assets established under applicable state insurance laws and are legally
insulated from our general account assets.
(6) Non-recourse obligations are not direct liabilities of ours, as they will be repaid from investments
pledged as collateral recorded on our consolidated balance sheet. See Note 8 to our consolidated financial
statements in this Form 10-K for additional information.
(7) Our standby letters of credit automatically renew on an annual basis.
(8) Other commercial commitments relate to venture capital partnerships ($136.5 million) and private
placements ($46.1 million). The venture capital 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 during the year
ended December 31, 2004 was $59.2 million. The obligations related to private placements are due to be funded
by March 15, 2005.
In addition during 2004, we signed a seven-year $120.0 million services agreement with EDS under which we will
receive information technology infrastructure services.
81
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 as follows:
Kayne Anderson Rudnick
We have an arrangement in which we are required to redeem the mandatorily redeemable noncontrolling membership
interests, or noncontrolling interests, of Kayne Anderson Rudnick. These interests which represent an
additional 15% interest in Kayne Anderson Rudnick are redeemable at a rate of one-third per year at December
31, 2004, 2005 and 2006. The total redemption price will equal net investment advisory fees for each year times
4.5 times 5.0% (the proportionate interest purchased). Such amounts are paid during the following quarter.
Under certain circumstances, the redemptions may be accelerated.
In January 2004, one member of Kayne Anderson Rudnick accelerated his portion of the 15% noncontrolling
interest redemptions, at which time we redeemed an additional 0.3% of the company. Phoenix Investment Partners
has accrued $11.4 million related to the remaining 4.9% acquisition required as of December 31, 2004. The two
remaining 4.9% noncontrolling interest acquisitions will be accounted for when the purchase price contingency
resolves.
There is also an agreement executed at the time of acquisition, which allows for the redemption and reissuance
with respect to the remaining 25% of the noncontrolling membership interests. The purchase price for these
noncontrolling interests 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 agreements will be
determined within 60 days after each such year-end and can be exercised within 60 days of the finalization of
the price. These agreements may expire unexercised should Kayne Anderson Rudnick's operating results decline
from the acquisition date. Any noncontrolling interests redeemed will be reissued to members/employees of Kayne
Anderson Rudnick. The reissuance process involves Phoenix Investment Partners contributing the interests to
Kayne Anderson Rudnick and then Kayne Anderson Rudnick selling the interests to the members/employees. The
members/employees will not pay cash for these purchases but will enter into a note payable agreement with Kayne
Anderson Rudnick. Phoenix Investment Partners will have preferential distribution rights with respect to
payments of principal and interest on these notes. Under certain circumstances, these interests can be issued
without a note payable or other consideration. In addition, in certain circumstances, the redemptions may be
accelerated. Once these interests are redeemed and then reissued, the amount of cash that Phoenix Investment
Partners will need to pay to redeem them in the future will be based on the growth in Kayne Anderson Rudnick's
revenues since the reissuance dates. There is no expiration date for the agreements. There is no cap or floor
on the redemption price.
In January 2004 and August 2003, certain members of Kayne Anderson Rudnick accelerated their noncontrolling
interest arrangements. The purchase price for their interests totaled $1.7 million and $4.5 million,
respectively, which was recorded as additional purchase price by Phoenix Investment Partners and allocated to
goodwill and definite-lived intangible assets.
PFG
In 2003, we acquired the remaining interest in PFG, the holding company for our private placement operation,
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 $86.5 million to the selling shareholders,
including $10.0 million during 2005 through 2007 based on certain financial performance targets being met, and
the balance in 2008 based on the appraised value of PFG as of December 31, 2007. During the year ended December
31, 2004, we paid $3.0 million under this obligation.
82
We have accounted for our acquisition of the remaining interest in PFG 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 acquired and a related deferred tax liability of $3.4 million. The present value of future
profits intangible asset will be amortized over the remaining estimated life of the underlying insurance in
force acquired, estimated to be 40 years. The remaining acquisition price plus transaction costs of $7.6
million has been assigned to goodwill. We have not presented pro forma information as if PFG had been acquired
at the beginning of January 2003, as it is not material to our financial statements. See Note 3 to our
consolidated financial statements in this Form 10-K for more information.
Seneca
We have arrangements with respect to the noncontrolling membership interests in Seneca not owned by Phoenix
Investment Partners that allow for the redemption and reissuance with respect to the noncontrolling membership
interests. The purchase price for these interests is equal to Seneca's investment advisory fees for the
relevant year multiplied by 3.5 multiplied by the amount of the interest purchased. The pricing on these
arrangements is determined within 60 days after each calendar year-end and can be exercised within 60 days of
the finalization of the price. These arrangements may expire unexercised should Seneca's operating results
decline from the initial measurement date. Any noncontrolling interests redeemed will be reissued to
members/employees of Seneca. The reissuance process involves Phoenix Investment Partners contributing the
interests to Seneca and then Seneca selling them to the members/employees. The members/employees do not pay
cash for these purchases, but enter into a note payable agreement with Seneca. Phoenix Investment Partners has
preferential distribution rights with respect to payments of principal and interest on these notes. Since these
interests have already been redeemed by Phoenix Investment Partners and reissued at least once, the amount of
cash that Phoenix Investment Partners will need to pay to redeem them in the future will be the amount related
to the growth in Seneca's revenues since the various reissuance dates. There is no cap or floor on the
redemption price. These agreements will expire after the year ended December 31, 2007. The estimated amount
that will be payable in 2005 by PNX under these agreements is $5.9 million.
Obligations Related to Pension and Postretirement Employee Benefit Plans
We provide our employees with postemployment benefits that include retirement benefits, through pension and
savings plans, and other benefits, including health care and life insurance. Employee benefit expense related
to these plans totaled $16.5 million, $33.1 million and $24.9 million for 2004, 2003 and 2002, respectively.
We have two defined benefit pension plans covering our employees. The employee pension plan, covering
substantially all of our employees, provides benefits up to the amount allowed under the Internal Revenue Code.
The supplemental plan provides benefits in excess of the primary plan. Retirement benefits under both plans are
a function of years of service and compensation. The employee pension plan is funded with assets held in a
trust, while the supplemental plan is unfunded.
As of May 31, 2004 we revalued our employee benefit assets and liabilities in connection with the sale of our
retail affiliated broker-dealer operations. As a result of the revaluation, we recognized a net curtailment
gain of $6.8 million ($4.4 million after taxes). In addition, as of September 30, 2004 we revalued our employee
benefit assets and liabilities in connection with employee terminations associated with the information
technology services agreement with EDS. As a result of this revaluation, we recognized an additional net
curtailment gain of $1.6 million ($1.1 million after taxes) for the year ended December 31, 2004.
83
Funded Status of Qualified and Non-qualified Employee Plan Supplemental Plan
Pension Plans: ------------------------ ----------------------
($ amounts in millions) As of December 31,
------------------------------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Plan assets, end of year.................................... $ 396.4 $ 368.9 $ -- $ --
Projected benefit obligation, end of year................... (499.0) (460.6) (134.6) (124.8)
----------- ----------- ----------- -----------
Plan assets less than projected benefit obligations,
end of year............................................... $ (102.6) $ (91.7) $ (134.6) $ (124.8)
=========== =========== =========== ===========
We expect to contribute $43.3 million to the employee pension plan through 2008, including $6.5 million during
2005. For the estimated 2004 contribution, quarterly payments of $2.5 million each were made to the pension
plan in April, July and October 2004. In September 2004, we made a payment of $1.6 million, related to the 2003
minimum contribution. As soon as reasonably possible following a change in control, as defined in the plan, we
are required to make an irrevocable contribution to a trust in an amount sufficient to pay the benefits due
under the supplemental plan.
The postretirement plan is unfunded. The projected benefit obligation and, therefore, its funded status was
$(70.3) million and $(78.7) million as of December 31, 2004 and 2003, respectively. The increases in the
projected benefit obligations of the employee plan and the supplemental plan at December 31, 2004 as compared
to December 31, 2003 is principally the result of accrued service cost, interest cost and the effects of the
lowering of the assumed discount rate from 6.0% at December 31, 2003 to 5.75% at December 31, 2004.
We have entered into agreements with certain key executives of the Company that will, in certain circumstances,
provide separation benefits upon the termination of the executive's employment by the Company for reasons other
than death, disability, cause or retirement, or by the executive for "good reason," as defined in the
agreements. For most of these executives, the agreements provide this protection only if the termination occurs
following (or is effectively connected with) the occurrence of a change of control, as defined in the
agreements. As soon as reasonably possible upon a change in control, as so defined, we are required to make an
irrevocable contribution to a trust in an amount sufficient to pay benefits due under these agreements.
See Note 11 to our consolidated financial statements in this Form 10-K for more information.
Off-Balance Sheet Arrangements
As of December 31, 2004, we did not have any significant off-balance sheet arrangements as defined by Item
303(a)(4)(ii) of SEC Regulation S-K. See Note 8 to our consolidated financial statements in this Form 10-K for
more information on variable interest entities.
Reinsurance
We maintain life reinsurance programs designed to protect against large or unusual losses in our life insurance
business. Based on our review of their financial statements and reputations in the reinsurance marketplace, we
believe that these third-party reinsurers are financially sound and, therefore, that we have no material
exposure to uncollectible life reinsurance.
Statutory Capital and Surplus and Risk-based Capital
Phoenix Life's consolidated statutory basis capital and surplus (including AVR) increased from $962.4 million
at December 31, 2003 to $1,035.8 million at December 31, 2004. The principal factors resulting in this increase
were net income, earnings appreciation in Aberdeen and other equity appreciation and the issuance of a net
additional $30.2 million of surplus notes offset by a dividend of $69.7 million to the parent and a $17.5
million
84
special non-insurance reserve established in connection with the issuance of $175 million of surplus notes in
2004.
Section 1322 of New York Insurance Law requires that New York life insurers report their 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 State Insurance Department explicit regulatory authority to
require various actions by, or take various actions against, insurers whose Total Adjusted Capital (capital and
surplus plus AVR 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 required are summarized below:
Company Action Level – results when Total Adjusted Capital falls below 100% of Company Action Level at
which point the company must file a comprehensive plan to the state insurance regulators;
Regulatory Action Level – results when Total Adjusted Capital falls below 75% of Company Action Level
where in addition to the above, insurance regulators are required to perform an examination or analysis
deemed necessary and issue a corrective order specifying corrective actions;
Authorized Control Level – results when Total Adjusted Capital falls below 50% of Company Action Level
where in addition to the above, the insurance regulators are permitted but not required to place the
company under regulatory control; and
Mandatory Control Level – results when Total Adjusted Capital falls below 35% of Company Action Level
where insurance regulators are required to place the company under regulatory control.
At December 31, 2004, Phoenix Life's and each of its insurance subsidiaries' RBC levels were in excess of 300%
of Company Action Level.
See Note 15 to our consolidated financial statements in this Form 10-K regarding the Life Companies' statutory
financial information and regulatory matters.
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 15:1. At December 31, 2004 the largest of these subsidiaries
had net capital of approximately $11.4 million, which is $10.7 million in excess of its required minimum net
capital of $0.7 million. The ratio of aggregate indebtedness to net capital for that subsidiary was 1:1. The
ratios of aggregate indebtedness to net capital for each of our other broker-dealer subsidiaries were also
below the regulatory ratio at December 31, 2004 and their respective net capital each exceeded the applicable
regulatory minimum.
Related Party Transactions
State Farm currently owns of record more than five percent of our parent's outstanding common stock. During the
years ended December 31, 2004 and 2003, our subsidiaries incurred total compensation of $32.4 million and $25.8
million, respectively, to entities which were either subsidiaries of State Farm or owned by State Farm
employees, for the sale of our insurance and annuity products. During the years ended December 31, 2004 and
2003, we made payments of $32.7 million and $24.6 million, respectively, to State Farm entities for this
compensation.
85
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
For information about our management of market risk, see Management's Discussion and Analysis of Financial
Condition and Results of Operations, in the Enterprise Risk Management section.
Item 8. Financial Statements and Supplementary Data
See Table of Contents.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Conclusion regarding disclosure controls and procedures
We have carried out an evaluation under the supervision and with the participation of our management, including
our Principal Executive Officer and our Principal Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures. There are inherent limitations to the effectiveness of any
system of disclosure controls and procedures, including the possibility of human error and the circumvention or
overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can
only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, these
officers have concluded that, as of December 31, 2004, the disclosure controls and procedures were effective to
provide reasonable assurance that information required to be disclosed in the reports Phoenix files and submits
under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported as and when
required.
Changes in internal control over financial reporting
There has been no change in our internal control over financial reporting during the quarter and year ended
December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
Management's report on internal control over financial reporting
Our management, including our Principal Executive Officer and our Principal Financial Officer, is responsible
for establishing and maintaining an adequate system of internal control over financial reporting. Internal
control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external reporting purposes
in accordance with generally accepted accounting principles. Because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements. Management has assessed the
effectiveness of our internal control over financial reporting as of December 31, 2004. In making its
assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission in Internal Control – Integrated Framework. Management concluded that based on its
assessment, our internal control over financial reporting was effective as of December 31, 2004. Management's
assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has
been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in its
report which appears on pages F-1 through F-2 below.
86
Item 9B. Other Information
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by Items 401 and 405 of Regulation S-K, except for Item 401 with respect to the
executive officers as disclosed below, is incorporated herein by reference to the information set forth under
Proposal 1 of our definitive proxy statement (which will be filed pursuant to Regulation 14A under the Exchange
Act within 120 days after the close of its fiscal year) under the following headings: "Corporate Governance,"
"Ownership of Common Stock," "Audit Committee Charter and Report," "Compensation Committee Report,"
"Compensation of Executive Officers," "Performance Graphs" and "Section 16(a) Beneficial Ownership Reporting
Compliance."
Set forth below is a description of the business positions held during at least the past five years by the
current executive officers of Phoenix. All ages are as of March 1, 2005.
DONA D. YOUNG, age 51, has been: Chief Executive Officer of PNX and Phoenix Life since January 2003; President
and a Director of PNX since 2000; a Director of Phoenix Life since 1998; and President of Phoenix Life since
2000. Before then, she was: Chief Operating Officer from 2001 until 2003; Executive Vice President, Individual
Insurance and General Counsel of Phoenix Life from 1994 until 2000; and Senior Vice President and General
Counsel of Phoenix Life from 1989 until 1994. Mrs. Young also serves as a director of Wachovia Corporation and
Foot Locker, Inc.
DANIEL T. GERACI, age 47, has been Executive Vice President, Asset Management, of PNX and President and Chief
Executive Officer of Phoenix Investment Partners since May 2003. From 2001 until May 2003, he was President and
Chief Executive Officer of Pioneer Investment Management USA, Inc. From 1995 to 2001, he held several senior
executive positions with Fidelity Investments, including president of Fidelity's Wealth Management Group. From
1988 through 1995, he was with Midland Walwyn Capital, Inc. (later Merrill Lynch Canada), where he held
successive distribution and management positions, including founder and president of its asset management
subsidiary, Atlas Asset Management, Inc.
MICHAEL E. HAYLON, age 47, has been Executive Vice President and Chief Financial Officer of PNX and Phoenix
Life since January 1, 2004. Before then, he was Executive Vice President and Chief Investment Officer of PNX
and of Phoenix Life from 2002 through 2003. He joined Phoenix Life in 1990, as a Vice President, and became
Senior Vice President in 1993.
PHILIP K. POLKINGHORN, age 47, has been Executive Vice President, Life and Annuity Manufacturing since March
2004. Before then, he had served since 2001 as a Vice President of Sun Life Financial Company with
responsibility for overall management of its annuity business, which it acquired from Keyport Life Insurance
Company in 2001. Mr. Polkinghorn served as President of Keyport Life from 1999 until its acquisition by Sun
Life. From 1996 to 1999, he served as Chief Marketing Officer for American General.
TRACY L. RICH, age 53, has been Executive Vice President, General Counsel and Assistant Secretary of PNX and
Phoenix Life since 2002. Before then, he was Senior Vice President and General Counsel of PNX and Phoenix Life
from 2000 to 2002 and Senior Vice President and Deputy General Counsel of Massachusetts Mutual Life Insurance
Company from 1996 until 2000.
87
JOHN F. SHARRY, age 52, has been Senior Vice President and Chief Marketing Officer since September 2004. From
1995 until September 2004, he held several senior management positions with Phoenix Investment Partners, Ltd.
From 1992 until 1995, he was Managing Director of Putnam Investments. From 1988 until 1992, he was First Vice
President with Dean Witter (now Morgan Stanley).
JAMES D. WEHR, age 47, has been Executive Vice President and Chief Investment Officer since February 2005.
Before then, he had been Senior Vice President and Chief Investment Officer of PNX and Phoenix Life since
January 1, 2004. Before then, he was Senior Managing Director and Portfolio manager of Phoenix Investment
Partners from 1995 through 2003. He joined Phoenix in 1981 and has held a series of increasingly senior
investment positions.
Code of Ethics
We have a code of ethics that is applicable to all of our Company directors and employees, including our
principal executive officer, principal financial officer and principal accounting officer. A copy of this code
(our "Code of Conduct") may be reviewed on our website at www.PhoenixWealthManagement.com, in the Investor
Relations section. The latest amendments to the Code of Conduct will be reflected, together with a description
of the nature of any amendments, other than ones that are technical, administrative or non-substantive, on the
above website. In the event we ever waive compliance with the code by our principal executive officer, our
principal financial officer, or our principal accounting officer, we will disclose the waiver on that website.
Copies of our code may also be obtained without charge by sending a request either by mail to: Corporate
Secretary, The Phoenix Companies, Inc., One American Row, P.O. Box 5056, Hartford, Connecticut 06102-5056, or
by e-mail to: corporate.secretary@phoenixwm.com.
Item 11. Executive Compensation
The information required by Item 402 of Regulation S-K is incorporated herein by reference to the information
set forth under the sections entitled: "Corporate Governance," Compensation of Executive Officers,"
"Compensation Committee Report," and "Performance Graphs" of our definitive proxy statement, which will be
filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, or the Exchange Act, within 120
days after the close of PNX's fiscal year.
In February 2005, the Compensation Committee (and in the case of the Chief Executive Officer, the Board)
approved the performance-based long-term incentive grants for the 2005 through 2007 cycle under the Company's
2003 Restricted Stock, Restricted Stock Unit and Long Term Incentive Plan for the named executive officers. The
target number of RSUs for this incentive cycle are as follows: Mrs. Young - 151,274; Mr. Geraci - 83,599; Mr.
Haylon - 42,118; Mr. Sharry - 37,818; and Mr. Wehr - 22,691. Actual awards, which could range from zero to two
times the above targets, will be determined and paid in 2008 based on actual performance results against
pre-established performance targets.
In connection with Mr. Wehr's promotion to Executive Vice President and Chief Investment Officer on February 4,
2005, the Company plans to amend his change of control agreement. The principal difference from Mr. Wehr's
current agreement, a copy of which is contained as an exhibit to this Form 10-K, is the size of the lump sum he
would be entitled to receive in the event of a change of control, as defined in the agreement. That would
increase from two times to two and a half times his combined annual salary and certain incentive payments.
88
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 403 of Regulation S-K is incorporated herein by reference to the information
set forth under the section entitled "Ownership of Common Stock" of our definitive proxy statement, which will
be filed pursuant to Regulation 14A under the Exchange Act within 120 days after the close of PNX's fiscal
year.
The information required by Item 201(d) of Regulation S-K follows.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information as of the end of the Company's 2004 fiscal year with respect to
compensation plans under which equity securities of the Company are authorized for issuance.
----------------------- -------------------- -----------------------
(A) (B) (C)
- ------------------------------------ ----------------------- -------------------- -----------------------
Number of securities
Number of securities to Weighted-average remaining available for
be issued upon exercise issue price of future issuance under
Plan Category of outstanding options, outstanding options, equity compensation
warrants and rights warrants and rights plans, excluding
securities reflected
in column (A)
- ------------------------------------ ----------------------- -------------------- -----------------------
Equity compensation plans approved
by the Company's shareholders:
• 2003 Restricted Stock,
Restricted Stock Unit and
Long-Term Incentive Plan(1) 2,500,235(2) $9.59 3,499,765
- ------------------------------------ ----------------------- -------------------- -----------------------
Equity compensation plans not
approved by the Company's
shareholders:
• Stock Incentive Plan(3) 4,124,483(4) $15.00 1,130,253
• Directors Stock Plan(5) 205,500(6) $16.20 819,343
• Retirement and Transition
Agreement(7) 573,477(8) $13.95 --
• Executive Employment
Agreement(9) 394,737(8) $7.60 --
- ------------------------------------ ----------------------- -------------------- -----------------------
Total 7,798,432 $12.84 5,449,361
- ------------------------------------ ----------------------- -------------------- -----------------------
(1) A copy of the 2003 Restricted Stock, Restricted Stock Unit and Long-Term Incentive Plan was filed as an
exhibit to the 2003 Proxy Statement filed by the Company with the SEC on March 21, 2003.
(2) This figure consists of the shares underlying 424,716 RSUs that vest over time, 1,818,560 RSUs that are
subject to performance contingencies (including 77,070 RSUs that were determined in 2005 to have met or
exceeded threshold performance contingencies based on 2004 performance results), and 256,959 RSUs that are
subject to no contingencies (but which are not currently convertible).
(3) A copy of the Stock Incentive Plan was filed as an exhibit to the Form S-1 filed by the Company with the
SEC on February 9, 2001. The following summary of the material features of the plan is qualified in its
entirety by reference to the full text of the plan, which is hereby incorporated by reference.
Under the Company's Stock Incentive Plan, the Compensation Committee (or if the committee delegates such
authority to the CEO, the CEO) may grant stock options to officers, employees and insurance agents of the
Company and its subsidiaries. The maximum number of shares issuable under the plan with respect to officers,
employees and insurance agents of the Company other than Phoenix Investment Partners, Ltd, (including those
who are also employees, officers or directors of Phoenix Investment Partners and those individuals who were
officers or employees of the Company on April 17, 2000) is the aggregate of 5% (approximately 5.25 million)
of the shares outstanding on June 26, 2001 (approximately 105 million shares) reduced by the shares issuable
pursuant to options or other awards granted under the Company's
89
Directors Stock Plan and, with respect to officers and employees of Phoenix Investment Partners (other than
those officers, employees or insurance agents described above), 1% (approximately 1.05 million) of the
shares outstanding on June 26, 2001. The maximum number of shares which may be subject to award under the
plan: prior to June 25, 2003, shall not exceed 75% of the shares available under the plan; prior to June 25,
2004, shall not equal 85% of the shares available under the plan; and prior to June 25, 2005, shall not
exceed 100% of the shares available under the plan. During any five-year period, no participant may be
granted options in respect of more than 5% of the shares available for issuance under the plan. The Board
may terminate or amend (subject, in some cases, to the approval of its shareholders and, prior to June 25,
2006, to the approval of the New York Superintendent of Insurance) the plan, but such termination or
amendment may not adversely affect any outstanding stock options without the consent of the affected
participant. The plan will continue in effect until it is terminated by the Board or until no more shares
are available for issuance.
The exercise price per share subject to an option will be not less than the fair market value of such share
on the option's grant date. Each option will generally become exercisable in equal installments on each of
the first three anniversaries of the grant date, except that no option was exercisable prior to June 25,
2003 nor may any option be exercised after the tenth anniversary of its grant date. Options may not be
transferred by the grantee, except in the event of death or, if the committee permits, the transfer of
non-qualified stock options by gift or domestic relations order to the grantee's immediate family members.
Upon a grantee's death, any outstanding options previously granted to such grantee will be exercisable by
the grantee's designated beneficiary until the earlier of the expiration of the option or five years
following the grantee's death. If the grantee terminates employment by reason of disability or retirement,
any outstanding option will continue to vest as if the grantee's service had not terminated and the grantee
may exercise any vested option until the earlier of five years following termination of employment or the
expiration of the option. If the grantee's employment is terminated for cause, the grantee will forfeit any
outstanding options. If the grantee's employment terminates in connection with a divestiture of a business
unit or subsidiary or similar transaction, the committee may provide that all or some outstanding options
will continue to become exercisable and may be exercised at any time prior to the earlier of the expiration
of the term of the options and the third anniversary of the grantee's termination of service. If the grantee
terminates employment for any other reason, any vested options held by the grantee at the date of
termination will remain exercisable for a period of 30 days and any then unvested options will be forfeited.
Generally, upon a change of control (as defined in the plan), each outstanding option will become fully
exercisable. Alternatively, the committee may: (i) require that each option be canceled in exchange for a
payment in an amount equal to the excess, if any, of the price paid in connection with the change of control
over the exercise price of the option; or (ii) if the committee determines in good faith that the option
will be honored or assumed by, or an alternative award will be issued by, the acquirer in the change of
control, require that each option remain outstanding without acceleration of vesting or exchanged for such
alternative award.
(4) This figure consists of the shares which underlie the options issued under the Stock Incentive Plan
(2,588,242 of which are fully vested and 1,536,241 of which are subject to vesting with the
passage of time).
(5) A copy of the Directors Stock Plan was filed as an exhibit to the Form S-1 filed by the Company on February
9, 2001. The following summary of the material features of the plan is qualified in its entirety by
reference to the full text of the plan, which is hereby incorporated by reference.
Under the Directors Stock Plan, the Board of Directors may grant options to outside directors, provided
that: (a) prior to June 25, 2006 such options will be in substitution for a portion of the cash fees that
would otherwise have been payable to such directors; and (b) the aggregate number of shares issuable
pursuant to options will not exceed 0.5% of the total shares outstanding on June 26, 2001, or 524,843
shares. Each option entitles the holder to acquire one share of our Common Stock at the stated exercise
price. The exercise price per share will not be less than the fair market value of a share on the day such
option is granted and the option will be exercisable from the later of June 25, 2003 or the day the option
is granted until the earlier of the tenth anniversary of such grant date or the third anniversary of the day
the outside director ceases to provide services for the Company. Under the Directors Stock Plan, the Board
of Directors may require the outside directors to receive up to one-half of their directors fees in shares
instead of cash and the outside directors may elect to receive any portion of such fees in shares instead of
cash. The aggregate number of shares that may also be issued in lieu of cash fees may not exceed 500,000
shares, bringing the total available under this plan to 1,024,843 shares.
(6) This figure consists of the shares which underlie the options issued under the Directors Stock Plan.
(7) A copy of the Retirement and Transition Agreement with Robert W. Fiondella, retired Chairman, was filed as
an exhibit to the Form 8-K filed by the Company on October 9, 2002. The following summary of the material
features of the RSUs subject to that agreement is qualified in its entirety by reference to the full text of
the agreement, which is hereby incorporated by reference.
90
The Company's Retirement and Transition Agreement with Mr. Fiondella provided for the issuance to him of
$8,000,000 worth of RSUs upon his retirement in March 2003. This equated to 573,477 RSUs, based on the
closing price of $13.95 on September 27, 2002, the date of measurement. Each unit represents the right to
receive one share of Common Stock after June 25, 2006. The agreement expressly prohibits the actual issuance
of stock to Mr. Fiondella prior to the fifth anniversary of the effective date of Phoenix Life's
demutualization (i.e., prior to June 25, 2006). The agreement further provides that while Mr. Fiondella
holds the RSUs, he will not have any right to vote or to direct the vote of the related shares of stock.
Moreover, he is expressly prohibited from disposing of the underlying shares of stock, or of any economic
interest related to the shares of stock, other than upon his death (in which case, the Company will
distribute the shares of stock to his estate after June 25, 2006). The Company will credit each RSU with an
amount equal to cash dividends on the shares of stock underlying the RSUs, or dividend equivalents, and
interest thereon, both to be distributed promptly following June 25, 2006.
(8) This figure consists of the shares which underlie the RSUs issued or issuable pursuant to the related
agreement.
(9) A copy of the Company's Executive Employment Agreement with Mrs. Young was filed as an exhibit to the Form
8-K filed by the Company as of January 1, 2003. The following summary of the material features of the RSUs
subject to that agreement is qualified in its entirety by reference to the full text of the agreement.
The Company's Executive Employment Agreement with Mrs. Young provides for the issuance to her of that number
of RSUs equal to the number resulting from dividing $3,000,000 by the closing price of our Common Stock on
December 31, 2002 ($7.60) (i.e. 394,737 RSUs). The agreement expressly provides, assuming the RSUs
have by then vested, for the issuance of stock to Mrs. Young on the later of: (a) June 26, 2006; or (b) the
15th day after termination of her employment with the Company (the period from the grant date of January 1,
2003 to that date being the "Restricted Period"). The agreement further provides that while Mrs. Young holds
the RSUs, she will not have any right to vote or to direct the vote of the underlying shares of stock.
Moreover, she is expressly prohibited from disposing of the underlying shares of stock, or of any economic
interest related to the shares of stock, other than upon her death (in which case, the Company will
distribute the shares of stock to her estate after June 25, 2006). The Company will credit each RSU with
dividend equivalents and interest thereon, both to be distributed to Mrs. Young at the end of the Restricted
Period.
Item 13. Certain Relationships and Related Transactions
The information required by Item 404 of Regulation S-K is incorporated herein by reference to the information
set forth under the section entitled "Proposal 1: Election of Directors" (under the caption "Certain
Relationships and Related Transactions") of our definitive proxy statement, which will be filed pursuant to
Regulation 14A under the Exchange Act of 1934 within 120 days after the close of our fiscal year.
Item 14. Principal Accountant Fees and Services
The information required by Item 9(C) of Schedule 14A is incorporated herein by reference to the information
set forth in the section entitled "Fees Incurred for Services Performed by PwC", under Proposal 3 of our
definitive proxy statement, which will be filed pursuant to Regulation 14A under the Securities Exchange Act of
1934 within 120 days after the close of our fiscal year.
91
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) Documents filed as part of this Form 10-K include:
1. Financial Statements. The financial statements listed in Part II of the Table of Contents to this
Form 10-K are filed as part of this Form 10-K;
2. Financial Statement Schedules. All financial statement schedules are omitted as they are not
applicable or the information is shown in the consolidated financial statements or notes thereto;
and
3. Exhibits.
i. These management contracts and compensatory plans listed in the Exhibit Index in Section E of
this report which are marked with an (*) are filed with this report.
ii. Financial statement schedules required by instruction to Item 15(c) – Regulation S-X.
* * * * *
We make our periodic and current reports available, free of charge, on our website, at
www.PhoenixWealthManagement.com, in the Investor Relations section, as soon as reasonably practicable after the
material is electronically filed with, or furnished to, the SEC.
92
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE PHOENIX COMPANIES, INC.
(Registrant)
Dated: March 8, 2005 By: /s/Dona D. Young
Dona D. Young
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
Dated: March 8, 2005 By: /s/Michael E. Haylon
Michael E. Haylon
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Dated: March 8, 2005 By: /s/Scott R. Lindquist
Scott R. Lindquist
Senior Vice President and Chief Accounting Officer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below, dated
March 8, 2005, by the following persons on behalf of the Registrant and in the capacities indicated.
/s/Sal H. Alfiero /s/Ann M. Gray
Sal H. Alfiero, Director Ann M. Gray, Director
/s/Jean S. Blackwell /s/John E. Haire
Jean S. Blackwell, Director John E. Haire, Director
/s/Peter C. Browning /s/Jerry J. Jasinowski
Peter C. Browning, Director Jerry J. Jasinowski, Director
/s/Arthur P. Byrne /s/Thomas S. Johnson
Arthur P. Byrne, Director Thomas S. Johnson, Director
/s/Sanford Cloud, Jr. /s/Marilyn E. LaMarche
Sanford Cloud, Jr., Director Marilyn E. LaMarche, Director
/s/Richard N. Cooper /s/Dona D. Young
Richard N. Cooper, Director Dona D. Young, Chairman
/s/Gordon J. Davis
Gordon J. Davis, Director
93
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Phoenix Companies, Inc.:
We have completed an integrated audit of The Phoenix Companies, Inc.'s 2004 consolidated financial statements
and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002
consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income
and comprehensive income, cash flows and changes in stockholders' equity present fairly, in all material
respects, the financial position of The Phoenix Companies, Inc. and its subsidiaries at December 31, 2004 and
2003, and the results of their operations and their cash flows for each of the three years in the period ended
December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting
for goodwill and other intangible assets in 2002.
F-1
To The Board of Directors and Stockholders of
The Phoenix Companies, Inc.
Page 2
Internal control over financial reporting
Also, in our opinion, management's assessment, included in Management's Report on Internal Control Over
Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over
financial reporting as of December 31, 2004 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly
stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31, 2004, based on
criteria established in Internal Control - Integrated Framework issued by the COSO. The Company's management is
responsible for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express opinions on
management's assessment and on the effectiveness of the Company's internal control over financial reporting
based on our audit. We conducted our audit of internal control over financial reporting in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. An audit of internal control over financial
reporting includes obtaining an understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we consider necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that,
in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors
of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
/s/PricewaterhouseCoopers LLP
Hartford, Connecticut
March 8, 2005
F-2
THE PHOENIX COMPANIES, INC.
Consolidated Balance Sheet
($ amounts in millions, except share data)
December 31, 2004 and 2003
2004 2003
------------- -------------
ASSETS:
Available-for-sale debt securities, at fair value.............................. $ 13,476.3 $ 13,273.0
Available-for-sale equity securities, at fair value............................ 304.3 312.0
Trading equity securities, at fair value....................................... 87.3 --
Mortgage loans, at unpaid principal balances................................... 207.9 284.1
Venture capital partnerships, at equity in net assets.......................... 255.3 234.9
Affiliate equity securities, at equity in net assets........................... -- 47.5
Policy loans, at unpaid principal balances..................................... 2,196.7 2,241.4
Other investments.............................................................. 371.8 402.0
------------- -------------
16,899.6 16,794.9
Available-for-sale debt and equity securities pledged as collateral, at
fair value.................................................................... 1,278.8 1,350.0
------------- -------------
Total investments.............................................................. 18,178.4 18,144.9
Cash and cash equivalents...................................................... 435.0 447.9
Accrued investment income...................................................... 222.3 222.3
Receivables.................................................................... 135.8 224.9
Deferred policy acquisition costs.............................................. 1,429.9 1,367.7
Deferred income taxes.......................................................... 30.7 58.7
Intangible assets.............................................................. 308.4 335.1
Goodwill....................................................................... 427.2 419.9
Other assets................................................................... 244.6 254.6
Separate account assets........................................................ 6,950.3 6,083.2
------------- -------------
Total assets................................................................... $ 28,362.6 $ 27,559.2
============= =============
LIABILITIES:
Policy liabilities and accruals................................................ $ 13,132.3 $ 13,088.6
Policyholder deposit funds..................................................... 3,492.4 3,642.7
Stock purchase contracts....................................................... 131.9 128.8
Indebtedness................................................................... 690.8 639.0
Other liabilities.............................................................. 546.3 534.5
Non-recourse collateralized obligations........................................ 1,355.2 1,472.0
Separate account liabilities................................................... 6,950.3 6,083.2
------------- -------------
Total liabilities.............................................................. 26,299.2 25,588.8
------------- -------------
COMMITMENTS AND CONTINGENCIES (NOTES 16, 17 & 18)
MINORITY INTEREST:
Minority interest in net assets of consolidated subsidiaries................... 41.0 22.6
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 106,394,959 and 106,376,363 shares issued........ 1.0 1.0
Additional paid-in capital..................................................... 2,435.2 2,431.4
Deferred compensation on restricted stock units................................ (3.6) (3.6)
Accumulated deficit............................................................ (285.6) (355.3)
Accumulated other comprehensive income......................................... 58.0 63.7
Treasury stock, at cost: 11,517,387 and 11,930,647 shares...................... (182.6) (189.4)
------------- -------------
Total stockholders' equity..................................................... 2,022.4 1,947.8
------------- -------------
Total liabilities, minority interest and stockholders' equity.................. $ 28,362.6 $ 27,559.2
============= =============
The accompanying notes are an integral part of these financial statements.
F-3
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Income and Comprehensive Income
($ amounts in millions, except per share data)
Years Ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------- ------------- -------------
REVENUES:
Premiums......................................................... $ 990.6 $ 1,042.2 $ 1,082.0
Insurance and investment product fees............................ 534.9 500.9 493.8
Broker-dealer commission and distribution fee revenues........... 56.9 81.5 85.0
Investment income, net of expenses............................... 1,075.7 1,107.4 940.5
Unrealized gain on trading equity securities..................... 85.9 -- --
Net realized investment gains (losses)........................... (0.8) (98.5) (133.9)
------------- ------------- -------------
Total revenues................................................... 2,743.2 2,633.5 2,467.4
------------- ------------- -------------
BENEFITS AND EXPENSES:
Policy benefits, excluding policyholder dividends................ 1,422.2 1,454.0 1,436.1
Policyholder dividends........................................... 404.7 418.8 401.8
Policy acquisition cost amortization............................. 110.2 94.1 59.2
Intangible asset amortization.................................... 33.8 33.2 98.8
Interest expense on indebtedness................................. 40.8 39.6 31.4
Interest expense on non-recourse collateralized obligations...... 33.6 48.9 30.5
Other operating expenses......................................... 560.7 565.1 613.2
------------- ------------- -------------
Total benefits and expenses...................................... 2,606.0 2,653.7 2,671.0
------------- ------------- -------------
Income (loss) from continuing operations before income taxes,
minority interest, equity in earnings of affiliates and
cumulative effect of accounting changes...................... 137.2 (20.2) (203.6)
Applicable income tax (benefit) expense.......................... 40.5 (18.3) (58.8)
------------- ------------- -------------
Income (loss) from continuing operations before minority
interest, equity in earnings of affiliates and cumulative
effect of accounting changes................................... 96.7 (1.9) (144.8)
Minority interest in net income of consolidated subsidiaries..... -- (0.4) (0.5)
Equity in undistributed earnings (losses) of affiliates.......... (10.4) (1.8) 4.6
------------- ------------- -------------
Income (loss) from continuing operations and
before cumulative effect of accounting changes................. 86.3 (4.1) (140.7)
Income (loss) from discontinued operations....................... 0.1 (2.1) (1.3)
------------- ------------- -------------
Income (loss) before cumulative effect of accounting changes..... 86.4 (6.2) (142.0)
Cumulative effect of accounting changes.......................... -- -- (130.3)
------------- ------------- -------------
Net income (loss)................................................ $ 86.4 $ (6.2) $ (272.3)
============= ============= =============
EARNINGS PER SHARE:
Earnings (loss) from continuing operations – basic............... $ 0.91 $ (0.04) $ (1.44)
Earnings (loss) from continuing operations – diluted............. $ 0.86 $ (0.04) $ (1.44)
============= ============= =============
Earnings (loss) before cumulative effect of accounting
change – basic................................................. $ 0.91 $ (0.07) $ (1.45)
Earnings (loss) before cumulative effect of accounting
change – diluted............................................... $ 0.86 $ (0.07) $ (1.45)
============= ============= =============
Net earnings (loss) – basic...................................... $ 0.91 $ (0.07) $ (2.78)
Net earnings (loss) – diluted.................................... $ 0.86 $ (0.07) $ (2.78)
============= ============= =============
Basic weighted-average common shares outstanding (in thousands).. 94,676 94,218 97,854
Diluted weighted-average common shares outstanding (in thousands) 100,775 94,218 97,854
============= ============= =============
COMPREHENSIVE INCOME:
Net income (loss)................................................ $ 86.4 $ (6.2) $ (272.3)
Other comprehensive income (loss)................................ (5.7) 135.2 (74.3)
------------- ------------- -------------
Comprehensive income (loss)...................................... $ 80.7 $ 129.0 $ (346.6)
============= ============= =============
The accompanying notes are an integral part of these financial statements.
F-4
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Cash Flows
($ amounts in millions)
Years Ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------- ------------- -------------
OPERATING ACTIVITIES:
Premiums collected............................................... $ 993.9 $ 1,024.9 $ 1,068.2
Insurance and investment product fees collected.................. 601.2 592.2 597.5
Investment income collected...................................... 1,002.1 1,026.2 954.7
Policy benefits paid, excluding policyholder dividends........... (1,373.7) (1,017.9) (1,036.2)
Policyholder dividends paid...................................... (395.9) (396.1) (387.0)
Policy acquisition costs paid.................................... (164.7) (205.5) (217.0)
Interest expense on indebtedness paid............................ (37.3) (36.5) (32.6)
Interest expense on collateralized obligations paid.............. (33.6) (48.9) (30.5)
Other operating expenses paid.................................... (533.4) (547.4) (605.9)
Income taxes refunded............................................ 0.5 6.6 12.3
------------- ------------- -------------
Cash from continuing operations.................................. 59.1 397.6 323.5
Discontinued operations, net..................................... 14.9 (36.5) (59.1)
------------- ------------- -------------
Cash from operating activities................................... 74.0 361.1 264.4
------------- ------------- -------------
INVESTING ACTIVITIES:
Investment purchases (Note 5).................................... (4,163.9) (5,630.0) (4,977.3)
Investment sales, repayments and maturities (Note 5)............. 4,220.7 4,417.2 3,418.6
Debt and equity securities pledged as collateral purchases....... (17.2) (56.9) (891.6)
Debt and equity securities pledged as collateral sales........... 97.0 171.5 96.0
Subsidiary purchases............................................. (36.9) (23.4) (136.1)
Subsidiary sales................................................. 17.1 -- --
Premises and equipment additions................................. (9.3) (17.6) (15.7)
Premises and equipment disposals................................. 26.4 -- --
Discontinued operations, net..................................... 6.5 (4.4) 37.3
------------- ------------- -------------
Cash from (for) investing activities............................. 140.4 (1,143.6) (2,468.8)
------------- ------------- -------------
FINANCING ACTIVITIES:
Policyholder deposit fund deposits .............................. 917.3 1,334.2 2,560.8
Policyholder deposit fund withdrawals............................ (1,067.6) (1,087.2) (911.2)
Stock purchase contracts proceeds................................ -- -- 133.9
Equity units proceeds............................................ -- -- 149.1
Other indebtedness proceeds...................................... 196.6 -- --
Indebtedness repayments.......................................... (155.2) -- (125.1)
Common stock purchases........................................... -- -- (131.1)
Collateralized obligations proceeds.............................. -- -- 841.6
Collateralized obligations repayments............................ (90.8) (99.6) --
Common stock dividends paid...................................... (15.1) (15.1) (15.8)
Minority interest distributions.................................. (12.5) (12.4) (10.6)
------------- ------------- -------------
Cash from (for) financing activities............................. (227.3) 119.9 2,491.6
------------- ------------- -------------
Change in cash and cash equivalents.............................. (12.9) (662.6) 287.2
Cash and cash equivalents, beginning of year..................... 447.9 1,110.5 823.3
------------- ------------- -------------
Cash and cash equivalents, end of year........................... $ 435.0 $ 447.9 $ 1,110.5
============= ============= =============
Included in cash and cash equivalents above is cash pledged as collateral of $61.0 million, $72.0 million, and
$57.0 million at December 31, 2004, 2003 and 2002, respectively.
Included in policy benefits paid for the 2004 period are a group of scheduled surrenders or withdrawals of
$184.2 million from a group of large corporate-owned life insurance policies.
The accompanying notes are an integral part of these financial statements.
F-5
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Changes in Stockholders' Equity
($ amounts in millions, except share data)
Years Ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------- ------------- -------------
COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL:
Restricted stock units awarded as compensation
(213,045; 701,598; and 573,477 units).......................... $ 2.6 $ 5.1 $ 8.0
Restricted stock units (161,768 units)........................... -- 1.5 --
Stock options awarded as compensation (566,070; and 572,504
options)....................................................... 1.0 0.4 --
Exercise of stock options (18,542 shares)........................ 0.2 -- --
Income tax benefit............................................... -- -- 5.9
Present value of future contract adjustment payments on
equity units................................................... -- -- (2.8)
DEFERRED COMPENSATION ON RESTRICTED STOCK UNITS:
Compensation deferred on restricted stock units awarded.......... (1.9) (5.0) --
Compensation expense recognized – restricted stock units......... 1.9 1.4 --
RETAINED EARNINGS (ACCUMULATED DEFICIT):
Net income (loss)................................................ 86.4 (6.2) (272.3)
Common stock dividends declared ($0.16 per share)................ (15.1) (15.1) (15.8)
Excess of cost over fair value of common shares contributed to
employee savings plan.......................................... (1.6) (2.6) --
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS).................... (5.7) 135.2 (74.3)
TREASURY STOCK:
Common shares purchased (7,871,500 shares)....................... -- -- (129.7)
Common shares contributed to employee savings plan
(412,239 and 399,353 shares)................................... 6.8 6.3 --
------------- ------------- -------------
Change in stockholders' equity................................... 74.6 121.0 (481.0)
Stockholders' equity, beginning of year.......................... 1,947.8 1,826.8 2,307.8
------------- ------------- -------------
Stockholders' equity, end of year................................ $ 2,022.4 $ 1,947.8 $ 1,826.8
============= ============= =============
The accompanying notes are an integral part of these financial statements.
F-6
THE PHOENIX COMPANIES, INC.
Notes to Consolidated Financial Statements
($ amounts in millions, except per share and per unit data)
Years Ended December 31, 2004, 2003 and 2002
1. Organization and Operations
Our consolidated financial statements include the accounts of The Phoenix Companies, Inc., its subsidiaries and
certain sponsored collateralized obligation trusts as described in Note 8. The Phoenix Companies, Inc. is a
holding company whose operations are conducted through subsidiaries, the principal ones of which are Phoenix
Life Insurance Company, or Phoenix Life, and Phoenix Investment Partners, Ltd., or Phoenix Investment Partners.
We have eliminated significant intercompany accounts and transactions in consolidating these financial
statements. We have reclassified certain amounts for 2003 and 2002 to conform with 2004 presentation.
We have prepared these financial statements in accordance with generally accepted accounting principles, or
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 postemployment
benefits liabilities; and accruals for contingent liabilities. Significant accounting policies are presented
throughout the notes in italicized type.
Accounting changes
Share-Based Payment: On December 16, 2004 the Financial Accounting Standards Board, or the FASB, issued FASB
Statement No. 123 (revised 2004), Share-Based Payment, or SFAS 123(R), which requires that compensation cost
related to share-based payment transactions be recognized in financial statements at the fair value of the
instruments issued. While prior to the issuance of SFAS 123(R), recognition of such costs at fair value was
optional, we elected to do so for all share-based compensation that we awarded after December 31, 2002. We
anticipate adopting the provisions of SFAS 123(R) on a modified prospective basis effective July 1, 2005, which
will not have a material effect on our consolidated financial statements.
Goodwill and Other Intangible Assets: As of January 1, 2002, we adopted a new accounting standard for goodwill
and other intangible assets and recorded the cumulative effect of the adoption as a charge to earnings. We
describe the adoption of this standard further in Note 4.
Other-Than-Temporary Impairments: Portions of Emerging Issues Task Force Abstract EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, or EITF 03-1, are effective for
fiscal periods beginning after June 15, 2004. EITF 03-1 provides guidance as to the determination of
other-than-temporary impaired securities and requires additional disclosures with respect to unrealized losses.
These accounting and disclosure requirements largely codify our existing practices and thus, are not
anticipated to have a material effect on our consolidated financial statements. The effective date of certain
portions of EITF 03-1 has been delayed pending further interpretive guidance. Because significant uncertainty
remains surrounding what form the guidance will ultimately take, we cannot predict what effect, if any,
adoption of the pending portions will have on our financial results.
F-7
Postretirement Benefits: On May 19, 2004, the FASB, issued FASB Staff Position No. FAS 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,
or the FSP. For employers that sponsor postretirement benefit plans, or plan sponsors that provide prescription
drug benefits to retirees, the FSP requires any effects of the anticipated federal tax subsidy related to those
drug benefits be treated as an actuarial gain. The effect of the FSP is not material to our consolidated
financial statements.
Nontraditional Long-Duration Contracts and Separate Accounts: Effective January 1, 2004, we adopted the AICPA's
Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts, or SOP 03-1. SOP 03-1 provides guidance related to the
accounting, reporting and disclosure of certain insurance contracts and separate accounts, including guidance
for computing reserves for products with guaranteed benefits such as guaranteed minimum death benefits and for
products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1
addresses the presentation and reporting of separate accounts, as well as rules concerning the capitalization
and amortization of sales inducements. Since this new accounting standard largely codifies certain accounting
and reserving practices related to applicable nontraditional long-duration contracts and separate accounts that
we already followed, our adoption did not have a material effect on our consolidated financial statements.
Effective July 1, 2003, we adopted SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, or SFAS 150. The effect of our adoption was to reclassify the
mandatorily redeemable noncontrolling interests related to our asset management subsidiaries from "minority
interest" to "other liabilities" in our consolidated balance sheet. In addition, within our consolidated
statement of operations, we reclassified earnings attributed to those interests from the caption "minority
interest in net income of subsidiaries" to "other operating expenses". These changes in presentation were not
material to our consolidated financial statements.
Variable Interest Entities: In January 2003, a new accounting standard was issued, FASB Interpretation No. 46,
or FIN 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, that interprets the
existing standards on consolidation. FIN 46 was subsequently reissued as FIN 46(R) in December 2003, with FIN
46(R) providing additional interpretation as to existing standards on consolidation. FIN 46(R) clarifies the
application of standards of consolidation to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from other parties (variable interest
entities). 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. As required under the original
standard, on February 1, 2003, we adopted the new standard for variable interest entities created after January
31, 2003 and for variable interest entities in which we obtained an interest after January 31, 2003. In
addition, as required by the revised standard, on December 31, 2003 we adopted FIN 46(R) for Special Purpose
Entities, or SPEs, in which we hold a variable interest that we acquired prior to February 1, 2003. The effect
of our adoption of the foregoing provisions of FIN 46(R) is described further in Note 8. FIN 46(R) requires our
application of its provisions to non-SPE variable interest entities for periods ending after March 15, 2004.
The adoption of FIN 46(R) for our non-SPE variable interest entities did not have a material effect on our
consolidated financial statements.
Stock-based Compensation: A new standard was issued by the FASB in 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.
F-8
Pro forma earnings and earnings per share, as if we had applied the fair value method of accounting for
stock-based compensation awarded prior to December 31, 2002, follow:
Pro Forma Results Related to Stock-based Compensation Year Ended December 31,
Awarded Prior to December 31, 2002: -------------------------------------------
($ amounts in millions) 2004 2003 2002
------------- ------------- -------------
Net income (loss), as reported................................... $ 86.4 $ (6.2) $ (272.3)
Add: Employee stock option compensation expense included in net
income (loss), net of applicable income taxes.................. 0.7 0.4 --
Deduct: Employee stock option compensation expense determined
under fair value accounting for all awards, net of applicable
income taxes................................................... 5.2 5.0 6.5
------------- ------------- -------------
Pro forma net income (loss)...................................... $ 81.9 $ (10.8) $ (278.8)
============= ============= =============
Basic earnings (loss) per share:
As reported................................................. $ 0.91 $ (0.07) $ (2.78)
Pro forma................................................... $ 0.87 $ (0.11) $ (2.85)
Diluted earnings (loss) per share:
As reported................................................. $ 0.86 $ (0.07) $ (2.78)
Pro forma................................................... $ 0.81 $ (0.11) $ (2.85)
The weighted-average fair values of options granted during 2004, 2003 and 2002 were $4.24, $4.07 and $8.18 per
share, respectively, using the Black-Scholes option valuation model.
Valuation and related assumption information used for the options granted include these key variables:
weighted-average expected volatility, weighted-average risk-free interest rate and weighted-average common
share dividend yield.
See Note 11 for additional information related to stock-based compensation.
Business combinations and dispositions
On November 19, 2004, we received payment in full of a $27.5 million convertible subordinated note issued by
Aberdeen Asset Management PLC, or Aberdeen, a United Kingdom-based asset management company. Concurrently we
relinquished our contractual right to one of two Aberdeen board seats we held related to our 16.5% equity
interest in Aberdeen, at which point we concluded that in our judgment, we no longer had the ability to
significantly influence Aberdeen's operations. Accordingly, effective November 19, 2004, we changed our method
of accounting for our equity holdings in Aberdeen from the equity method of accounting to the fair value method
of accounting under SFAS No. 115, Accounting for Investments in Debt and Equity Securities. Based on our intent
to sell our equity holdings in Aberdeen in the near-term, we designated our equity holdings as trading
securities under the fair value method of accounting. Under the fair value method, the changes in fair value,
based on the underlying value of Aberdeen's shares as traded on the London Stock Exchange, as compared to our
carrying value under the equity method are presented as an after-tax realized investment gain of $55.1 million
in our consolidated statement of operations for the year ended December 31, 2004. In addition, our fourth
quarter and full year 2004 consolidated statement of operations includes a $14.7 million after-tax, non-cash
charge related to the accounting for our proportionate share of Aberdeen's December 2004 settlement of alleged
misselling activities with the United Kingdom's Financial Services Authority. This charge has been accounted
for by us under the equity method of accounting as it pre-dates our November 19, 2004 change in accounting for
Aberdeen from the equity method to the fair value method. On January 14, 2005, we closed the sale to third
parties of our equity holdings in Aberdeen for net proceeds of $70.4 million, resulting in an after-tax
realized investment loss of $7.0 million, which will be recognized as a realized investment loss in our first
quarter 2005 consolidated statement of operations. The January 2005 sale of our equity holdings in Aberdeen
completed our disposition of our direct financial interests in Aberdeen. See Note 5 to our consolidated
financial statements in this Form 10-K for more information on our holdings in Aberdeen.
F-9
On October 25, 2004, we entered into an agreement with Friends Provident plc, or Friends Provident, to sell our
12% interest in Lombard International Assurance S.A., or Lombard, and to relinquish $17.5 million in notes
receivable from Lombard's affiliate, Insurance Development Holdings A.G., or IDH. This transaction closed on
January 11, 2005 for consideration of $59.0 million and, under the terms of the sale, we may be entitled to
additional consideration, in the form of cash, based on Lombard's financial performance through 2006.
In July 2004, we sold the stock of Phoenix Global Solutions (India) Pvt. Ltd., our India-based information
technology subsidiary, and essentially all of the assets of its United States affiliate, Phoenix Global
Solutions, Inc., to Tata Consultancy Services Limited, a division of Tata Sons Ltd. This transaction is not
material to our consolidated financial statements.
Effective May 31, 2004, we sold our retail affiliated broker-dealer operations to Linsco/Private Ledger
Financial Services, or LPL. As part of the transaction, advisors affiliated with WS Griffith Securities, Inc.,
or Griffith, and Main Street Management Company, or Main Street, had the opportunity to move to LPL as
independent registered representatives. Revenues net of eliminations and direct expenses net of deferrals and
certain transaction related costs included in our consolidated financial statements related to our retail
affiliated broker-dealer operations sold during 2004 are as follows:
Year Ended December 31,
Revenues and Direct Expenses of --------------------------------
Retail Affiliated Broker-Dealer Operations: 2004 2003 2002
($ amounts in millions) ---------- ---------- ---------
Insurance and investment product fee revenues, net of eliminations........... $ 32.0 $ 60.8 $ 61.8
Direct other operating expenses, net of deferrals............................ $ 38.7 $ 72.8 $ 74.4
During 2004, we incurred a $3.6 million net after-tax charge for an impairment of goodwill related to Main
Street, offset by a $2.7 million after-tax gain on the sale of the retail affiliated broker-dealer operations.
Both the charge and the gain were recorded to realized investment gains and losses. In addition, we incurred a
$10.2 million net after-tax charge related to severance and lease termination costs, offset by a $4.4 million
after-tax gain related to curtailment accounting in connection with employee benefit plans.
In March 2004, we completed the sale of 100% of the common stock held by us in Phoenix National Trust Company.
The effect of this transaction is not material to our consolidated financial statements. Phoenix National Trust
Company is included as a discontinued operation in our consolidated financial statements for all periods
presented.
In March 2004, we acquired the remaining minority interests in Walnut Asset Management LLC and Rutherford Brown
& Catherwood, LLC for $2.1 million. This additional purchase price was accounted for as a step-acquisition by
Phoenix Investment Partners and was allocated to goodwill and definite-lived intangible assets, accordingly.
In 2002 we acquired a 60% equity interest in Kayne Anderson Rudnick, LLC, or Kayne Anderson Rudnick, for $102.4
million. This acquisition was accounted for using the purchase method under FASB Statement No. 141, Business
Combinations, or SFAS 141. In connection with this acquisition, the Acquisition Agreement and the related
Amended and Restated Operating Agreement resulted in the creation of mandatorily redeemable noncontrolling
interests, or noncontrolling interests, representing 40% of Kayne Anderson Rudnick's members' interests held by
certain of its members. Certain of these noncontrolling interests in Kayne Anderson Rudnick have scheduled
redemption dates (5% at each date) as of December 31, 2004, 2005, and 2006, at a price based upon operating
results of Kayne Anderson Rudnick for the year then ended. These 15% noncontrolling interests, as well as the
remaining 25% of Kayne Anderson Rudnick's noncontrolling interests, are mandatorily redeemable upon death of a
member and, as such, are included in other liabilities on our consolidated balance sheet and in our
consolidated statement of income as a part of other operating expenses in accordance with SFAS 150. Separate
agreements in connection with the 25% noncontrolling interests held by certain Kayne Anderson Rudnick's members
give the noncontrolling interest-holders the right to require Phoenix Investment Partners to redeem all or
F-10
a part of their noncontrolling interest at specified future dates and at a price determined based upon
operating results of Kayne Anderson Rudnick. Conversely, the terms of these agreements also give Phoenix
Investment Partners the right to redeem the outstanding minority interests at the same price as the
noncontrolling interest-holder may exercise its right to sell. These agreements may expire unexercised should
Kayne Anderson Rudnick's operating results decline from the initial measurement date.
In addition to the initial cost of the purchase of Kayne Anderson Rudnick in the first quarter of 2004, we made
a payment of $30.1 million in contingent consideration, which was based upon management fee revenues for the
purchased business through the end of 2003. Phoenix Investment Partners had accrued for this payment as of
December 31, 2003 and allocated it entirely to goodwill.
In January 2004, one member of Kayne Anderson Rudnick accelerated his portion of the 15% noncontrolling
interest redemption, at which time we acquired an additional 0.3% of the company. Phoenix Investment Partners
has accrued $11.4 million related to the remaining 4.9% redemption required as of December 31, 2004, has
accounted for this payment as a step-acquisition and has allocated the purchase price to goodwill and
definite-lived intangible assets, accordingly. The two remaining 4.9% noncontrolling interest redemptions will
be accounted for as step-acquisitions as the purchase price contingency resolves.
In 2003, we acquired the outstanding minority interests in PFG Holdings, Inc., or PFG, and Capital West Asset
Management, LLC, or Capital West. Additional information on these acquisitions can be found in Note 3 and Note
4, respectively.
2. Business Segments
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 offer a broad range of life insurance,
annuity and asset management products through a variety of distributors. These products are managed within two
operating segments — Life and Annuity and Asset Management. We report our remaining activities in two
non-operating segments — Venture Capital and Corporate and Other.
The Life and Annuity segment includes individual life insurance and annuity products including participating
whole life, universal life, variable life, term life and fixed and variable annuities. The Asset Management
segment includes private client and institutional investment management and distribution, including managed
accounts, open-end mutual funds and closed-end funds. We provide more information on the Life and Annuity and
Asset Management operating segments in Note 3 and Note 4, respectively.
The Venture Capital segment includes our equity share in the operating income and the realized and unrealized
investment gains of our venture capital partnership investments held in the general account of Phoenix Life,
but outside the closed block. We provide more information on this segment in Note 5. The Corporate and Other
segment includes all interest expense, as well as several smaller subsidiaries and investment activities which
do not meet the thresholds of reportable segments. These include international operations and the run-off of
our group pension and guaranteed investment contract businesses.
We evaluate segment performance on the basis of segment income. Realized investment gains and losses and some
non-recurring 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.
The non-recurring items are removed from segment after-tax operating 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,
we believe that segment income is an appropriate measure that represents the earnings attributable to the
ongoing operations of the business.
F-11
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.
We allocate indebtedness and related interest expense to our Corporate and Other segment. We allocate capital
to our Life and Annuity segment based on risk-based capital, or RBC, for our insurance products. We used 300%
of RBC levels for the three years ended December 31, 2004. Capital within our life insurance 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 certain costs and expenses to the segments based on a review of
the nature of the costs, time studies and other methodologies. Investment income on debt and equity securities
pledged as collateral as well as interest expense on non-recourse collateralized obligations, both related to
three consolidated collateralized obligation trusts we sponsor, are included in the Corporate and Other
segment. Excess investment income on debt and equity securities pledged as collateral represent investment
advisory fees earned by our asset management subsidiary and are allocated to the Asset Management segment as
investment product fees for segment reporting purposes only.
As of December 31,
-----------------------------
Segment Information on Assets: 2004 2003
($ amounts in millions) -------------- --------------
Segment Assets
Life and annuity segment........................................................ $ 25,117.0 $ 24,219.5
Asset management segment........................................................ 833.9 851.2
-------------- --------------
Operating segment assets........................................................ 25,950.9 25,070.7
Venture capital segment......................................................... 202.9 196.3
Corporate and other segment..................................................... 2,185.8 2,264.0
-------------- --------------
Total segment assets............................................................ 28,339.6 27,531.0
Net assets of discontinued operations (Note 14)................................. 23.0 28.2
-------------- --------------
Total assets.................................................................... $ 28,362.6 $ 27,559.2
============== ==============
F-12
Year Ended December 31,
Segment Information on Revenues and Income: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Life and annuity segment........................................ $ 2,312.8 $ 2,368.4 $ 2,344.5
Asset management segment........................................ 266.7 252.8 269.1
Elimination of inter-segment revenues........................... 5.9 (5.8) (7.5)
-------------- -------------- --------------
Operating segment revenues...................................... 2,585.4 2,615.4 2,606.1
Venture capital segment......................................... 19.3 36.2 (59.3)
Corporate and other segment..................................... 53.4 80.4 54.5
-------------- -------------- --------------
Total segment revenues.......................................... 2,658.1 2,732.0 2,601.3
Unrealized gain on trading equity securities.................... 85.9 -- --
Net realized investment gains (losses).......................... (0.8) (98.5) (133.9)
-------------- -------------- --------------
Total revenues.................................................. $ 2,743.2 $ 2,633.5 $ 2,467.4
============== ============== ==============
Segment Income (Loss)
Life and annuity segment........................................ $ 142.8 $ 99.4 $ 80.3
Asset management segment........................................ 0.1 (8.7) (69.9)
-------------- -------------- --------------
Operating segment pre-tax income................................ 142.9 90.7 10.4
Venture capital segment......................................... 19.3 36.2 (59.3)
Corporate and other segment:
Interest expense on indebtedness.............................. (40.8) (39.6) (31.4)
Other......................................................... (18.3) (8.2) (8.6)
-------------- -------------- --------------
Total segment income (loss) before income taxes................. 103.1 79.1 (88.9)
Applicable income taxes (benefit)............................... 22.5 21.8 (28.5)
-------------- -------------- --------------
Total segment income (loss)..................................... 80.6 57.3 (60.4)
Income (loss) from discontinued operations...................... 0.1 (2.1) (1.3)
Net realized investment income (losses),
net of income taxes and other offsets......................... (7.2) 0.8 (65.6)
Unrealized gains (losses) on equity investment in Aberdeen,
net of income taxes........................................... 55.9 (55.0) --
Share of Aberdeen extraordinary charge for FSA settlement
net of income taxes........................................... (14.7) -- --
Restructuring and early retirement costs, net of income taxes... (21.9) (8.5) (28.5)
Surplus notes tender costs, net of income taxes................. (6.4) -- --
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.............. -- -- (1.3)
Cumulative effect of accounting changes, net of income taxes.... -- -- (130.3)
-------------- -------------- --------------
Net income (loss)............................................... $ 86.4 $ (6.2) $ (272.3)
============== ============== ==============
While revenues derived from outside of the United States are not material to our consolidated financial
statements, as of December 31, 2004 we had international investments, the principal ones of which are located
in the United Kingdom (Aberdeen 16.5% owned, Note 5) and Luxembourg (Lombard 12% owned, Note 5) and Argentina.
F-13
3. Life and Annuity Segment
The Life and Annuity segment includes individual life insurance and annuity products 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, segment income
and deferred policy acquisition costs follows:
As of December 31,
Life and Annuity Segment Assets: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Investments.................................................................... $ 16,273.4 $ 16,216.9
Cash and cash equivalents...................................................... 255.2 250.5
Receivables.................................................................... 222.2 228.1
Deferred policy acquisition costs.............................................. 1,429.9 1,367.7
Deferred income taxes.......................................................... -- 40.2
Goodwill and other intangible assets........................................... 10.2 15.3
Other general account assets................................................... 118.9 190.5
Separate accounts.............................................................. 6,807.2 5,910.3
-------------- --------------
Total segment assets........................................................... $ 25,117.0 $ 24,219.5
============== ==============
Year Ended December 31,
Life and Annuity Segment Income: ---------------------------------------
($ amounts in millions) 2004 2003 2002
------------ ------------ -----------
Premiums............................................................... $ 990.6 $ 1,042.2 $1,082.0
Insurance and investment product fees.................................. 296.9 278.4 259.5
Broker-dealer commission and distribution fee revenues................. 28.8 54.6 55.6
Net investment income.................................................. 996.5 993.2 947.4
------------ ------------ -----------
Total segment revenues................................................. 2,312.8 2,368.4 2,344.5
------------ ------------ -----------
Policy benefits, including policyholder dividends...................... 1,814.8 1,869.9 1,867.6
Policy acquisition cost amortization................................... 110.6 98.2 88.5
Other operating expenses............................................... 244.6 300.5 307.5
------------ ------------ -----------
Total segment benefits and expenses.................................... 2,170.0 2,268.6 2,263.6
------------ ------------ -----------
Segment income before income taxes and minority interest............... 142.8 99.8 80.9
Allocated income taxes................................................. 36.4 31.1 28.0
------------ ------------ -----------
Segment income before minority interest................................ 106.4 68.7 52.9
Minority interest in segment income of consolidated subsidiaries....... -- 0.4 0.6
------------ ------------ -----------
Segment income......................................................... 106.4 68.3 52.3
Net realized investment losses, net of income taxes and other offsets.. (2.5) (4.7) (15.0)
Restructuring charges, net of income taxes............................. (7.3) (1.3) --
Deferred acquisition cost adjustment, net of income taxes.............. -- -- 15.1
------------ ------------ -----------
Segment net income..................................................... $ 96.6 $ 62.3 $ 52.4
============ ============ ===========
F-14
Premium and fee revenue and related expenses
Revenues for annuity and universal life products consist of net investment income and mortality, administration
and surrender charges assessed against the fund values during the period. Related benefit expenses include
universal life benefit claims in excess of fund values and net investment income credited to fund values. We
recognize premiums for participating life insurance products and other long-duration life insurance products as
revenue when due from policyholders. We recognize life insurance premiums for short-duration life insurance
products as premium revenue pro rata over the related contract periods. We match benefits, losses and related
expenses with premiums over the related contract periods.
Year Ended December 31,
Life and Annuity Segment Revenues by Product: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Premiums
Term life insurance............................................. $ 13.8 $ 12.8 $ 10.2
Other life insurance............................................ 14.4 15.9 17.6
-------------- -------------- --------------
Total, non-participating life insurance......................... 28.2 28.7 27.8
Participating life insurance.................................... 962.4 1,013.5 1,054.2
-------------- -------------- --------------
Total premiums.................................................. 990.6 1,042.2 1,082.0
-------------- -------------- --------------
Insurance and investment product fees
Variable universal life insurance............................... 111.2 109.1 102.0
Universal life insurance........................................ 113.0 98.7 87.4
Other life insurance............................................ 3.5 6.3 6.3
-------------- -------------- --------------
Total, life insurance........................................... 227.7 214.1 195.7
Annuities....................................................... 69.2 64.3 63.8
-------------- -------------- --------------
Total insurance and investment product fees..................... 296.9 278.4 259.5
Broker-dealer commission and distribution fee revenues.......... 28.8 54.6 55.6
Net investment income........................................... 996.5 993.2 947.4
-------------- -------------- --------------
Segment revenues................................................ $ 2,312.8 $ 2,368.4 $ 2,344.5
============== ============== ==============
Broker-dealer commissions are related to our retail affiliated broker-dealer operations, which we sold May 31,
2004 as further described in Note 1.
Reinsurance
We use reinsurance agreements to provide for greater diversification of business, allow us to control exposure
to potential losses arising from large risks and provide additional capacity for growth.
We recognize assets and liabilities related to reinsurance ceded contracts on a gross basis. The cost of
reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured
policies using assumptions consistent with those used to account for the underlying policies.
We remain liable to the extent that reinsuring companies may not be able to meet their obligations under
reinsurance agreements in effect. Failure of the reinsurers to honor their obligations could result in losses
to us; consequently, estimates are established for amounts deemed or estimated to be uncollectible. To minimize
our exposure to significant losses from reinsurance insolvencies, we evaluate the financial condition of our
reinsurers and monitor concentration of credit risk arising from similar geographic regions, activities, or
economic characteristics of the reinsurers.
F-15
Our reinsurance program varies based on the type of risk, for example:
• On direct policies, the maximum of individual life insurance retained by us on any one life is $10
million for single life and joint first-to-die policies and $12 million for joint last-to-die policies,
with excess amounts ceded to reinsurers.
• We reinsure 80% of the mortality risk on the in-force block of the Confederation Life Insurance
Company, or Confederation Life, business we acquired in December 1997.
• We entered into two separate reinsurance agreements in 1998 and 1999 to reinsure 80% and 60%,
respectively, of the mortality risk on a substantial portion of our otherwise retained individual life
insurance business.
• We reinsure 80% to 90% of the mortality risk on certain new issues of term life insurance.
• We reinsure 100% of guaranteed minimum death benefits on a block of variable deferred annuities issued
between January 1, 1996 through December 31, 1999, including subsequent deposits. We retain the
guaranteed minimum death benefits risks on the remaining variable deferred annuities in force that are
not covered by this reinsurance arrangement.
• We assume and cede business related to the group accident and health block in run-off. While we are not
writing any new contracts, we are contractually obligated to assume and cede premiums related to
existing contracts.
Year Ended December 31,
Direct Business and Reinsurance in Continuing Operations: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Direct premiums................................................. $ 1,054.3 $ 1,092.1 $ 1,104.2
Premiums assumed from reinsureds................................ 2.8 15.5 16.9
Premiums ceded to reinsurers.................................... (66.5) (65.4) (39.1)
-------------- -------------- --------------
Premiums........................................................ $ 990.6 $ 1,042.2 $ 1,082.0
============== ============== ==============
Percentage of amount assumed to net premiums.................... 0.3% 1.5% 1.6%
============== ============== ==============
Direct policy benefits incurred................................. $ 416.3 $ 402.9 $ 357.5
Policy benefits assumed from reinsureds......................... 3.9 13.5 12.6
Policy benefits ceded to reinsurers............................. (52.9) (56.9) (44.8)
-------------- -------------- --------------
Policy benefits................................................. $ 367.3 $ 359.5 $ 325.3
============== ============== ==============
Direct life insurance in force.................................. $ 126,367.9 $ 120,931.3 $ 110,529.8
Life insurance in force assumed from reinsureds................. 1,759.5 1,837.3 1,831.2
Life insurance in force ceded to reinsurers..................... (80,040.1) (77,222.3) (74,575.2)
-------------- -------------- --------------
Life insurance in force......................................... $ 48,087.3 $ 45,546.3 $ 37,785.8
============== ============== ==============
Percentage of amount assumed to net insurance in force.......... 3.7% 4.0% 4.8%
============== ============== ==============
The policy benefit amounts above exclude changes in reserves, interest credited to policyholders, withdrawals
and policyholder dividends, which total $1,447.5 million, $1,510.4 million and $1,542.3 million, net of
reinsurance, for the years ended December 31, 2004, 2003 and 2002, respectively.
Irrevocable letters of credit aggregating $48.1 million at December 31, 2004 have been arranged with commercial
banks in our favor to collateralize the ceded reserves.
F-16
Business combinations and significant reinsurance assumed transaction
In 2003, we acquired the remaining interest in PFG, the holding company for our private placement operation,
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 $86.5 million to the selling shareholders, including $10.0 million during
2005 through 2007 based on certain financial performance targets being met, and the balance in 2008 based on
the appraised value of PFG as of December 31, 2007. During the year ended December 31, 2004, we paid $3.0
million under this obligation.
In July 2002, we acquired the variable life and variable annuity business of Valley Forge Life Insurance
Company (a subsidiary of CNA Financial Corporation), effective July 1, 2002. The business acquired had a total
account value of $557.0 million at June 30, 2002. This transaction was effected through a combination of
coinsurance and modified coinsurance.
Deferred policy acquisition costs
The costs of acquiring new business, principally commissions, underwriting, distribution and policy issue
expenses, all of which vary with and are primarily related to production of new business, are deferred. In
connection with our acquisitions of PFG (2003), we recognized an asset for the present value of future profits
representing the present value of estimated net cash flows embedded in the existing contracts acquired. This
asset is included in deferred acquisition costs.
We amortize deferred acquisition costs and present value of future profits based on the related policy's
classification. For individual participating life insurance policies, we amortize deferred acquisition costs
and present value of future profits in proportion to estimated gross margins. For universal life, variable
universal life and accumulation annuities, deferred acquisition costs and present value of future profits 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 deferred acquisition costs balance associated with
the replaced or surrendered policies is amortized to reflect these surrenders.
The amortization process requires the use of various assumptions, estimates and judgments about the future. Our
primary assumptions relate to anticipated expenses, investment performance, mortality and contract
cancellations (i.e., lapses, withdrawals and surrenders). These assumptions, which we review on a regular
basis, 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 actual experiences are
reflected as an adjustment to total amortization to date resulting in a charge or credit to earnings. Finally,
we periodically assess whether there are sufficient gross margins or gross profits to amortize our remaining
deferred acquisition cost balances.
F-17
Year Ended December 31,
Deferred Policy Acquisition Costs: -------------------------------------
($ amounts in millions) 2004 2003 2002
------------ ----------- ------------
Acquisition costs deferred................................................ $ 164.7 $ 205.5 $ 217.0
Acquisition costs recognized in:
PFG minority interest acquisition....................................... -- 9.8 --
Valley Forge Life reinsurance assumed transaction....................... -- -- 48.5
Costs amortized to expenses:
Recurring costs related to segment income............................... (110.6) (98.2) (88.5)
(Cost) credit related to realized investment gains or losses (Note 5)... 0.4 4.1 7.2
Change in actuarial assumption.......................................... -- -- 22.1
Offsets to net unrealized investment gains or losses
included in other comprehensive income (Note 12)........................ 7.7 12.4 (95.9)
------------ ----------- ------------
Change in deferred policy acquisition costs............................... 62.2 133.6 110.4
Deferred policy acquisition costs, beginning of year...................... 1,367.7 1,234.1 1,123.7
------------ ----------- ------------
Deferred policy acquisition costs, end of year............................ $ 1,429.9 $1,367.7 $ 1,234.1
============ =========== ============
In 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).
Also in 2002, we revised our long-term market return assumption for the variable annuity block of business from
8% to 7%. In addition, we recorded an impairment charge related to the recoverability of our deferred
acquisition cost asset related to the variable annuity business. The revision in long-term market return
assumption and the impairment charge resulted in a $13.5 million pre-tax ($8.8 million after income taxes)
increase in our policy acquisition cost amortization expense in the third quarter of 2002.
Policy liabilities and accruals
Future policy benefits are liabilities for life and annuity products. We establish liabilities in amounts
adequate to meet the estimated future obligations of policies in force. Future policy benefits for traditional
life insurance are computed using the net level premium method on the basis of actuarial assumptions as to
contractual guaranteed rates of interest, mortality rates guaranteed in calculating the cash surrender values
described in such contracts and morbidity. Future policy benefits for variable universal life, universal life
and annuities in the accumulation phase are computed using the deposit-method, which is the sum of the account
balance, unearned revenue liability and liability for minimum policy benefits. Future policy benefits for term
and annuities in the payout phase that have significant mortality risk are computed using the net premium
method on the basis of actuarial assumptions at the issue date of these contracts for rates of interest,
contract administrative expenses, mortality and surrenders. We establish liabilities for outstanding claims,
losses and loss adjustment expenses based on individual case estimates for reported losses and estimates of
unreported losses based on past experience.
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 6.0% as of December 31, 2004, less administrative and mortality
charges.
Certain of our annuity products 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. As of December 31, 2004 and 2003, the difference between the
guaranteed minimum death benefit and the current account value (net amount at risk) for all existing contracts
was $123.5 million and $183.1 million, respectively, for which we had established reserves, net of reinsurance
recoverables, of $9.1 million and $7.6 million, respectively.
F-18
Participating life insurance
Participating life insurance in force was 35.6% and 38.8% of the face value of total individual life insurance
in force at December 31, 2004 and 2003, respectively.
Fair value of investment contracts
For purposes of fair value disclosures (Note 9), we determine the fair value of guaranteed interest contracts
by assuming a discount rate equal to the appropriate United States Treasury rate plus 150 basis points to
determine the present value of projected contractual liability payments through final maturity. We value the
fair value of deferred annuities and supplementary contracts without life contingencies with an interest
guarantee of one year or less at the amount of the policy reserve. In determining the fair value of deferred
annuities and supplementary contracts without life contingencies with interest guarantees greater than one
year, we use a discount rate equal to the appropriate United States Treasury rate plus 150 basis points to
determine the present value of the projected account value of the policy at the end of the current guarantee
period.
Deposit type funds, including pension deposit administration contracts, dividend accumulations, and other funds
left on deposit not involving life contingencies, have interest guarantees of less than one year for which
interest credited is closely tied to rates earned on owned assets. For these liabilities, we assume fair value
to be equal to the stated liability balances.
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 1.8% to 12.3% as of December 31,
2004, less administrative charges.
Demutualization and Closed Block
In 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 company were extinguished and eligible policyholders of the 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 established a closed block for their existing policies.
The closed block assets, including future assets from cash flows generated by the assets and premiums and other
revenues from the policies in the closed block, will benefit only holders of the policies in the closed block.
The principal cash flow items that affect the amount of closed block assets and liabilities are premiums, net
investment income, investment purchases and sales, policyholder benefits, policyholder dividends, premium taxes
and income taxes. The principal income and expense items excluded from the closed block are management and
maintenance expenses, commissions, investment income and realized investment gains and losses on investments
held outside the closed block that support the closed block business. All of these excluded income and expense
items enter into the determination of total gross margins of closed block policies for the purpose of
amortization of deferred policy acquisition costs.
In our financial statements, we present closed block assets, liabilities, revenues and expenses together with
all other assets, liabilities, revenues and expenses. Within closed block liabilities, we have established a
policyholder dividend obligation to record an additional liability to closed block policyholders for cumulative
closed block earnings in excess of expected amounts calculated at the date of demutualization. These closed
block earnings will not inure to stockholders, but will result in additional future dividends to closed block
policyholders unless otherwise offset by future performance of the closed block that is less favorable than
expected.
F-19
Because closed block liabilities exceed closed block assets, we have a net closed block liability at each
period-end. This net liability represents the maximum future earnings contribution to be recognized from the
closed block and the change in this net liability each period is in the earnings contribution recognized from
the closed block for the period. To the extent that actual cash flows differ from amounts anticipated, we may
adjust policyholder dividends. If the closed block has excess funds, those funds will be available only to the
closed block policyholders. However, if the closed block has insufficient funds to make policy benefit payments
that are guaranteed, the payments will be made from assets outside of the closed block.
As of December 31,
Closed Block Assets and Liabilities: ------------------------------
($ amounts in millions) 2004 2003 Inception
-------------- -------------- --------------
Debt securities................................................. $ 6,949.6 $ 6,906.4 $ 4,773.1
Equity securities............................................... 90.8 82.9 --
Mortgage loans.................................................. 181.9 228.5 399.0
Venture capital partnerships.................................... 52.4 38.6 --
Policy loans.................................................... 1,363.4 1,386.8 1,380.0
Other invested assets........................................... 60.0 46.7 --
-------------- -------------- --------------
Total closed block investments.................................. 8,698.1 8,689.9 6,552.1
Cash and cash equivalents....................................... 100.5 40.5 --
Accrued investment income....................................... 118.8 120.2 106.8
Receivables..................................................... 32.7 43.0 35.2
Deferred income taxes........................................... 359.7 377.0 389.4
Other closed block assets....................................... 24.0 62.3 6.2
-------------- -------------- --------------
Total closed block assets....................................... 9,333.8 9,332.9 7,089.7
-------------- -------------- --------------
Policy liabilities and accruals................................. 9,686.9 9,723.1 8,301.7
Policyholder dividends payable.................................. 365.5 369.8 325.1
Policyholder dividend obligation................................ 535.9 519.2 --
Other closed block liabilities.................................. 41.5 63.0 12.3
-------------- -------------- --------------
Total closed block liabilities.................................. 10,629.8 10,675.1 8,639.1
-------------- -------------- --------------
Excess of closed block liabilities over closed block assets..... $ 1,296.0 $ 1,342.2 $ 1,549.4
============== ============== ==============
F-20
Closed Block Revenues and Expenses and Changes in Cumulative Year Ended December 31,
Policyholder Dividend Obligations: From -----------------------------
($ amounts in millions) Inception 2004 2003
-------------- -------------- --------------
Closed block revenues
Premiums................................................................. $ 5,170.8 $ 932.8 $ 1,000.1
Net investment income ................................................... 2,771.2 560.0 573.1
Net realized investment losses........................................... (91.1) (2.0) (9.4)
-------------- -------------- --------------
Total revenues........................................................... 7,850.9 1,490.8 1,563.8
-------------- -------------- --------------
Policy benefits, excluding dividends..................................... 5,367.6 1,007.1 1,058.0
Other operating expenses................................................. 57.9 8.9 10.0
-------------- -------------- --------------
Total benefits and expenses, excluding policyholder dividends............ 5,425.5 1,016.0 1,068.0
-------------- -------------- --------------
Closed block contribution to income before dividends and income taxes.... 2,425.4 474.8 495.8
Policyholder dividends................................................... 2,000.2 403.9 419.4
-------------- -------------- --------------
Closed block contribution to income before income taxes.................. 425.2 70.9 76.4
Applicable income taxes.................................................. 149.3 24.7 26.8
-------------- -------------- --------------
Closed block contribution to income...................................... $ 275.9 $ 46.2 $ 49.6
============== ============== ==============
Policyholder dividend obligation
Policyholder dividends provided through earnings......................... $ 2,045.4 $ 403.9 $ 419.4
Policyholder dividends provided through other comprehensive income....... 436.5 3.8 (45.5)
-------------- -------------- --------------
Additions to policyholder dividend liabilities........................... 2,481.9 407.7 373.9
Policyholder dividends paid.............................................. (1,905.6) (395.3) (395.6)
-------------- -------------- --------------
Change in policyholder dividend liabilities.............................. 576.3 12.4 (21.7)
Policyholder dividend liabilities, beginning of period................... 325.1 889.0 910.7
-------------- -------------- --------------
Policyholder dividend liabilities, end of period......................... 901.4 901.4 889.0
Less: policyholder dividends payable, end of period..................... 365.5 365.5 369.8
-------------- -------------- --------------
Policyholder dividend obligation, end of period.......................... $ 535.9 $ 535.9 $ 519.2
============== ============== ==============
In addition to the closed block assets, we hold assets outside the closed block in support of closed block
liabilities. We recognize investment earnings on these invested assets, less deferred policy acquisition cost
amortization and allocated expenses, as an additional source of earnings to our stockholders.
4. Asset Management Segment
We conduct activities in Asset Management with a focus on two customer groups — private client and
institutional. Through our private client group, we provide asset management services principally on a
discretionary basis, with products consisting of open-end mutual funds, closed-end funds and managed accounts.
Managed accounts include intermediary programs sponsored and distributed by non-affiliated broker-dealers and
direct managed accounts which are sold and administered by us. Our private client business also provides
transfer agency, accounting and administrative services to our open-end mutual funds.
Through our institutional group, we provide discretionary and non-discretionary asset management services
primarily to corporations, multi-employer retirement funds and foundations, as well as to endowment and special
purpose funds. In addition, we manage alternative financial products, including structured finance products.
Structured finance products include collateralized obligations backed by portfolios of public high yield bonds,
commercial mortgage-backed and asset-backed securities or bank loans. See Note 8 for additional information.
We offer asset management services through our affiliated asset managers. We provide these affiliated asset
managers with a consolidated platform of distribution and administrative support, thereby allowing each manager
to devote a high degree of focus to investment management activities. On an ongoing basis, we monitor the
quality of the affiliates' products by assessing their performance, style consistency and the discipline with
which they apply their investment processes.
F-21
As of December 31,
Asset Management Segment Assets: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Investments.................................................................... $ 12.8 $ 11.8
Cash and cash equivalents...................................................... 50.0 39.6
Receivables.................................................................... 34.2 36.0
Intangible assets.............................................................. 308.4 335.1
Goodwill....................................................................... 416.9 408.1
Other assets................................................................... 11.6 20.6
-------------- --------------
Total segment assets........................................................... $ 833.9 $ 851.2
============== ==============
Year Ended December 31,
Asset Management Segment Income: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Investment product fees......................................... $ 237.9 $ 225.3 $ 238.6
Broker-dealer commission and distribution fee revenues.......... 28.0 26.8 29.5
Net investment income........................................... 0.8 0.7 1.0
-------------- -------------- --------------
Total segment revenues.......................................... 266.7 252.8 269.1
-------------- -------------- --------------
Intangible asset amortization................................... 33.8 33.2 32.5
Intangible asset impairments.................................... -- -- 66.3
Other operating expenses........................................ 232.8 228.3 240.2
-------------- -------------- --------------
Total segment expenses.......................................... 266.6 261.5 339.0
-------------- -------------- --------------
Segment income (loss) before income taxes....................... 0.1 (8.7) (69.9)
Allocated income taxes (benefit)................................ 2.3 (3.3) (6.0)
-------------- -------------- --------------
Segment loss.................................................... (2.2) (5.4) (63.9)
Net realized investment gains (losses), net of income taxes..... 1.8 (0.3) --
Restructuring charges, net of income taxes...................... (1.2) (4.0) (8.4)
Cumulative effect of accounting change, net of income taxes..... -- -- (119.9)
-------------- -------------- --------------
Segment net loss................................................ $ (1.6) $ (9.7) $ (192.2)
============== ============== ==============
In 2004, 2003 and 2002, our Asset Management segment incurred restructuring charges primarily in connection
with organizational and employment-related costs of $1.9 million ($1.2 million after-tax), $6.2 million ($4.0
million after-tax) and $12.9 million ($8.4 million after-tax), respectively.
Fee Revenues
Investment management fees and mutual fund ancillary fees included in investment product fees are recorded as
income during the period in which services are performed. Investment management fees are generally computed and
earned based upon a percentage of assets under management and are paid pursuant to the terms of the respective
investment management contracts, which generally require monthly or quarterly payment. Management fees
contingent upon achieving certain levels of performance are recorded when the contingencies are resolved.
Mutual fund ancillary fees consist of distribution fees, administrative fees, shareholder service agent fees,
fund accounting fees, dealer concessions and underwriter fees. Dealer concessions and underwriting fees earned
(net of related expenses) from the distribution and sale of affiliated mutual fund shares and other securities
are recorded on a trade date basis.
Business combinations
In 2001, we acquired a 65% interest in Capital West for $5.5 million. In June 2003, we acquired the remaining
interest in Capital West 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.
F-22
In 2002, we acquired a 60% interest in Kayne Anderson Rudnick for $102.4 million as further described in Note
1. In addition to the initial cost of the purchase, we made a payment of $30.1 million in the first quarter of
2004 based upon growth in management fee revenue for the purchased business through 2003. We had fully accrued
for this estimated payment as of December 31, 2003 and have allocated it entirely to goodwill. In January 2004,
one member of Kayne Anderson Rudnick accelerated his portion of the 15% noncontrolling interest acquisitions,
at which time we acquired an additional 0.3% of the company. Phoenix Investment Partners has accrued $11.4
million related to the remaining 4.9% redemption required as of December 31, 2004, has accounted for this
payment as a step-acquisition and has allocated the purchase price to goodwill and definite-lived intangible
assets, accordingly. The two remaining 4.9% noncontrolling interest redemptions will be accounted for as
step-acquisitions as the purchase price contingency resolves. Related to the initial purchase in 2001, we
allocated $0.3 million of the initial 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). Kayne
Anderson Rudnick's results of operations for the period from January 30, 2002 through December 31, 2002 are
included in our results of operations for the year 2002.
The mandatorily redeemable noncontrolling interests in each of our less than wholly-owned asset management
subsidiaries are subject to certain agreements, which were executed at the time of acquisition, that may
provide for one or all of the following: (a) a contingent purchase price payment; (b) a requirement for Phoenix
Investment Partners to redeem a predetermined percentage of the outstanding noncontrolling membership interests
at predetermined future dates; and/or (c) agreements associated with the purchase of these subsidiaries'
noncontrolling membership interests that are subject to the occurrence of certain events. The redemption price
associated with each of these agreements is contingent upon the operating results of the respective subsidiary.
As additional redemptions of noncontrolling interests occur, the related payments are accounted for in
accordance with SFAS 141 as either contingent purchase price, or as a step-acquisition whereby the purchase
price is allocated to the portion of the assets acquired and the liabilities assumed based upon their
respective fair values, goodwill, and other intangible assets. For each type of agreement, the redemption price
is calculated similarly and is equal to (1) investment advisory fees, or growth in investment advisory fees, as
applicable, for the relevant year multiplied by an agreed upon multiple, multiplied by (2) the amount of
noncontrolling membership interest being purchased. The redemption price is determined within 60 days after
year-end and the payment is made within 60 days of the finalization of the price. There is no cap or floor on
the redemption price for any of the agreements. Notwithstanding (a), (b), and (c) above, these interests are
redeemable upon death of a member and, as such, are included in other liabilities on our consolidated balance
sheet and as earnings attributable to mandatorily redeemable noncontrolling interests as a part of other
operating expenses on our consolidated statement of income in accordance with SFAS 150. Earnings attributable
to mandatorily redeemable noncontrolling interests are not material to our consolidated financial statements.
We recorded $15.2 million and $34.5 million of additional redemption or purchase price in 2004 and 2003,
respectively, related to the redemption of noncontrolling membership interests that existed at the time of
acquisition with certain of our majority-owned subsidiaries.
Goodwill and other intangible assets
Effective January 1, 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. To test for 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. Amortization expense for definite-lived intangible
assets is calculated on a straight-line basis.
F-23
Upon adoption of the new accounting standard, we recorded a before-tax cumulative effect charge of $141.7
million to reduce the carrying value of goodwill and other intangible assets with indefinite lives to fair
value, of which $131.3 million pertained to our Asset Management segment and $10.4 million pertained to an
international equity investment in our Corporate and Other segment (Note 5). After applicable income tax
benefits, the charge reduced earnings by $130.3 million or $1.33 per share. In the third quarter of 2002, we
performed an impairment test at the Asset Management segment reporting-unit level and recorded a before-tax
charge of $66.3 million to further reduce the carrying value of goodwill and other intangible assets.
Asset management segment intangible assets and goodwill
As of December 31,
Carrying Amounts of Intangible Assets and Goodwill: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Asset management contracts with definite lives................................. $ 401.2 $ 396.1
Less: accumulated amortization................................................. 166.1 134.3
-------------- --------------
Intangible assets with definite lives.......................................... 235.1 261.8
Asset management contracts with indefinite lives............................... 73.3 73.3
-------------- --------------
Intangible assets.............................................................. $ 308.4 $ 335.1
============== ==============
Goodwill....................................................................... $ 416.9 $ 408.1
============== ==============
Year Ended December 31,
Activity in Intangible Assets and Goodwill: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Intangible assets
Asset purchases................................................................ $ 7.1 $ 3.3
Asset amortization............................................................. (33.8) (33.2)
-------------- --------------
Change in intangible assets.................................................... (26.7) (29.9)
Balance, beginning of period................................................... 335.1 365.0
-------------- --------------
Balance, end of period......................................................... $ 308.4 $ 335.1
============== ==============
Goodwill
Goodwill acquired.............................................................. $ 8.8 $ 32.5
Balance, beginning of period................................................... 408.1 375.6
-------------- --------------
Balance, end of period......................................................... $ 416.9 $ 408.1
============== ==============
The estimated aggregate intangible asset amortization expense in future periods includes: 2005, $32.9 million;
2006, $28.7 million; 2007, $28.0 million; 2008, $27.7 million; 2009, $26.5 million and thereafter, $91.3
million. At December 31, 2004, the weighted-average amortization period for definite-lived intangible assets is
eight years.
5. Investing Activities
Debt and equity securities
Our debt and equity securities classified as available-for-sale are reported in our balance sheet at fair
value. Trading securities are carried at fair value and changes in fair value are recorded in net income as
they occur. Fair value is based on quoted market price, where available. When quoted market prices are not
available, we estimate fair value by discounting debt security cash flows to reflect interest rates currently
being offered on similar terms to borrowers of similar credit quality (private placement debt securities), by
quoted market prices of comparable instruments (untraded public debt securities) and by independent pricing
sources or internally developed pricing models (equity securities).
F-24
For mortgage-backed and other asset-backed debt securities, we recognize income using a constant effective
yield based on anticipated prepayments and the estimated economic lives of the securities. When actual
prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect
actual payments to date and any resulting adjustment is included in net investment income. For certain
asset-backed securities, changes in estimated yield are recorded on a prospective basis and specific valuation
methods are applied to these securities to determine if there has been an other-than-temporary decline in
value.
See Note 8 for information on available-for-sale debt and equity securities pledged as collateral.
As of December 31,
Fair Value and Cost of Debt and Equity Securities: -----------------------------------------------------------
($ amounts in millions) 2004 2003
----------------------------- -----------------------------
Fair Value Cost Fair Value Cost
-------------- -------------- -------------- --------------
United States government and agency................ $ 679.1 $ 625.4 $ 757.0 $ 714.5
State and political subdivision.................... 446.5 413.7 510.3 468.4
Foreign government................................. 314.8 284.0 260.4 239.0
Corporate.......................................... 7,365.4 7,040.7 6,765.8 6,412.4
Mortgage-backed.................................... 3,253.4 3,122.9 3,097.5 2,963.4
Other asset-backed................................. 1,417.1 1,405.0 1,882.0 1,863.6
-------------- -------------- -------------- --------------
Debt securities.................................... $ 13,476.3 $ 12,891.7 $ 13,273.0 $ 12,661.3
============== ============== ============== ==============
Amounts applicable to the closed block............. $ 6,949.6 $ 6,515.2 $ 6,906.4 $ 6,471.1
============== ============== ============== ==============
Hilb Rogal and Hobbs, or HRH, common stock......... $ 131.3 $ 42.1 $ 116.2 $ 42.2
Lombard International Assurance, S.A............... 43.3 43.3 41.1 41.1
Other equity securities............................ 129.7 113.9 154.7 139.1
-------------- -------------- -------------- --------------
Equity securities.................................. $ 304.3 $ 199.3 $ 312.0 $ 222.4
============== ============== ============== ==============
Amounts applicable to the closed block............. $ 90.8 $ 78.3 $ 82.9 $ 75.0
============== ============== ============== ==============
Our holdings in HRH common stock as of December 31, 2004 are pledged for use in November 2005 to settle certain
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 million net of offsets for applicable deferred acquisition costs
and deferred income taxes). See Note 6 for additional information.
In January 1005, we sold our equity investment in Lombard as further described in Note 1.
In 2003, we sold our 3.0% and 3.1% equity interests in two life insurance subsidiaries of General Electric
Company for $72.0 million and realized a gain of $21.6 million ($14.0 million after income taxes). Also in
2003, we sold our 9.3% equity interest in PXRE Group Ltd., a property catastrophe reinsurer, for $23.1 million
and realized a gain of $13.7 million ($8.9 million after income taxes).
F-25
As of December 31,
Unrealized Gains and Losses from ------------------------------------------------------------
General Account Securities: 2004 2003
($ amounts in millions) ----------------------------- -----------------------------
Gains Losses Gains Losses
-------------- -------------- -------------- --------------
United States government and agency............. $ 55.4 $ (1.7) $ 44.0 $ (1.5)
State and political subdivision................. 34.4 (1.6) 43.5 (1.6)
Foreign government.............................. 31.1 (0.3) 23.2 (1.8)
Corporate....................................... 364.2 (39.5) 400.4 (47.0)
Mortgage-backed................................. 137.0 (6.5) 143.4 (9.3)
Other asset-backed.............................. 32.4 (20.3) 55.6 (37.2)
-------------- -------------- -------------- --------------
Debt securities gains and losses................ $ 654.5 $ (69.9) $ 710.1 $ (98.4)
============== ============== ============== ==============
Debt securities net gains....................... $ 584.6 $ 611.7
============== ==============
Hilb Rogal and Hobbs, or HRH, common stock...... $ 89.2 $ -- $ 74.0 $ --
Other equity securities......................... 19.1 (3.3) 17.4 (1.8)
-------------- -------------- -------------- --------------
Equity securities gains and losses.............. $ 108.3 $ (3.3) $ 91.4 $ (1.8)
============== ============== ============== ==============
Equity securities net gains..................... $ 105.0 $ 89.6
============== ==============
As of December 31, 2004
Aging of Temporarily Impaired ----------------------------------------------------------------------
Debt and Equity Securities: Less than 12 months Greater than 12 months Total
($ amounts in millions) ------------------------ ---------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------ ----------- ---------- ----------- ----------- ----------
Debt Securities
United States government and agency..... $ 85.6 $ (1.4) $ 4.9 $ (0.3) $ 90.5 $ (1.7)
State and political subdivision......... 41.6 (1.2) 9.0 (0.4) 50.6 (1.6)
Foreign government...................... -- -- 10.6 (0.3) 10.6 (0.3)
Corporate............................... 1,212.6 (16.1) 418.8 (23.4) 1,631.4 (39.5)
Mortgage-backed......................... 589.4 (4.8) 113.6 (1.7) 703.0 (6.5)
Other asset-backed...................... 444.6 (5.3) 96.8 (15.0) 541.4 (20.3)
------------ ----------- ---------- ----------- ----------- ----------
Debt securities......................... $ 2,373.8 $ (28.8) $ 653.7 $ (41.1) $ 3,027.5 $ (69.9)
Common stock............................ 15.3 (2.4) 5.4 (0.9) 20.7 (3.3)
------------ ----------- ---------- ----------- ----------- ----------
Total temporarily impaired securities... $ 2,389.1 $ (31.2) $ 659.1 $ (42.0) $ 3,048.2 $ (73.2)
============ =========== ========== =========== =========== ==========
Amounts inside the closed block......... $ 702.0 $ (10.7) $ 347.9 $ (16.2) $ 1,049.9 $ (26.9)
============ =========== ========== =========== =========== ==========
Amounts outside the closed block........ $ 1,687.1 $ (20.5) $ 311.2 $ (25.8) $ 1,998.3 $ (46.3)
============ =========== ========== =========== =========== ==========
Amounts outside the closed block
that are below investment grade....... $ 66.8 $ (2.2) $ 68.3 $ (12.2) $ 135.1 $ (14.4)
============ =========== ========== =========== =========== ==========
After offsets for deferred acquisition $ (0.8) $ (4.5) $ (5.3)
cost adjustment and taxes............. ========== =========== ==========
The securities with gross unrealized losses are considered to be temporarily impaired at December 31, 2004 as
each of these securities has performed, and is expected to continue to perform, in accordance with their
original contractual terms.
Mortgage loans
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.
F-26
For purpose of fair value disclosures (Note 9), we estimate the fair value of mortgage loans by discounting the
present value of scheduled loan payments. We base the discount rate on the comparable United States Treasury
rates for loan durations plus spreads of 130 to 800 basis points, depending on our internal quality ratings of
the loans. For in-process-of-foreclosure or defaulted loans, we estimate fair value as the lower of the
underlying collateral value or the loan balance.
Mortgage loans are collateralized by the related properties and are generally no greater than 75% of the
properties' value at the time the loans are originated.
As of December 31,
Carrying Values of Investments in Mortgage Loans: ------------------------------------------------------------
($ amounts in millions) 2004 2003
----------------------------- -----------------------------
Carrying Carrying
Value Fair Value Value Fair Value
-------------- -------------- -------------- --------------
Property type
Apartment buildings............................... $ 81.8 $ 82.8 $ 105.1 $ 106.7
Office buildings.................................. 18.0 18.2 49.0 49.7
Retail stores..................................... 92.5 93.6 109.0 110.7
Industrial buildings.............................. 25.4 25.7 33.7 34.2
Other............................................. 0.1 0.1 0.1 0.1
-------------- -------------- -------------- --------------
Subtotal.......................................... 217.8 220.4 296.9 301.4
Less: valuation allowances........................ 9.9 -- 12.8 --
-------------- -------------- -------------- --------------
Mortgage loans.................................... $ 207.9 $ 220.4 $ 284.1 $ 301.4
============== ============== ============== ==============
Amounts applicable to the closed block............ $ 181.9 $ 184.1 $ 228.5 $ 242.4
============== ============== ============== ==============
We had no delinquent or in-process-of-foreclosure mortgage loans as of both December 31, 2004 and 2003. The
carrying values of mortgage loans on which the payment terms have been restructured or modified were $12.9
million and $25.8 million as of December 31, 2004 and 2003, respectively. We have provided valuation allowances
for restructured or modified mortgage loans.
Year Ended December 31,
Mortgage Loan Valuation Allowance Activity: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Valuation allowance, beginning of year.......................... $ 12.8 $ 15.5 $ 15.0
Additions charged to income..................................... -- 0.8 0.6
Deductions for write-offs and disposals......................... (2.9) (3.5) (0.1)
-------------- -------------- --------------
Valuation allowance, end of year................................ $ 9.9 $ 12.8 $ 15.5
============== ============== ==============
During the three years ended December 31, 2004, the amount of interest that was foregone due to the
restructuring of mortgage loans and to non-income producing loans is not material to our consolidated financial
statements. Refinancing of mortgage loans was not material in any of the three years ended December 31, 2004.
Venture capital partnerships
We invest as a limited partner in venture capital limited partnerships. Generally, these partnerships focus on
early-stage ventures, primarily in the information technology and life science industries and leveraged buyout
funds. We also have direct equity investments in leveraged buyouts and corporate acquisitions.
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 change in our share of
partnership earnings for the quarter to eliminate any lag in reporting.
F-27
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 used 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 applied a public industry sector index
to estimate changes in valuations 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 adjustments in estimated values based on the indices, but when the general partner reduces the value of
a private investee company, we do not adjust the fair value upward (by applying the public sector index) in
excess of the most recent value reported by the general partner. Finally, we revise the valuations we have
assigned to the investee companies annually to reflect the valuations in the audited financial statements
received from the venture capital partnerships.
Year Ended December 31,
Components of Net Investment Income Related to -----------------------------------
Venture Capital Partnerships: 2004 2003 2002
($ amounts in millions) ---------- ----------- -----------
Net realized gains (losses) on partnership cash and stock distributions.. $ 13.7 $ 17.4 $ (4.7)
Net unrealized gains (losses) on partnership investments................. 14.4 38.2 (47.2)
Partnership operating expenses........................................... (2.6) (6.6) (7.4)
---------- ----------- -----------
Net investment income (loss)............................................. $ 25.5 $ 49.0 $ (59.3)
========== =========== ===========
Amounts applicable to the closed block................................... $ 6.2 $ 12.8 $ --
========== =========== ===========
Amounts applicable to the venture capital segment........................ $ 19.3 $ 36.2 $ (59.3)
========== =========== ===========
As indicated above, we record our equity in earnings of venture capital partnerships based on the most recent
financial information and by estimating the earnings for any lag in partnership reporting. As a result, the
effect of our adjusting our estimates to actual results reflected in partnership financial statements was to
increase net investment income as follows:
Year Ended December 31,
Adjustment of Venture Capital Investment Income Related to ---------------------------------------------
Receipt of Financial Statements 2004 2003 2002
($ amounts in millions) -------------- -------------- --------------
Closed block.................................................... $ 1.0 $ -- $ --
Venture capital segment......................................... 6.8 33.4 12.8
-------------- -------------- --------------
Total........................................................... $ 7.8 $ 33.4 $ 12.8
============== ============== ==============
Year Ended December 31,
Investment Activity in Venture Capital Partnerships: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Contributions................................................... $ 59.2 $ 41.3 $ 43.0
Equity in earnings (losses) of partnerships..................... 25.5 49.0 (59.3)
Distributions................................................... (64.3) (43.6) (41.7)
Proceeds from sale of partnership interests..................... -- (26.1) --
Realized loss on sale of partnership interests.................. -- (14.3) (5.1)
-------------- -------------- --------------
Change in venture capital partnerships.......................... 20.4 6.3 (63.1)
Venture capital partnership investments, beginning of period.... 234.9 228.6 291.7
-------------- -------------- --------------
Venture capital partnership investments, end of period.......... $ 255.3 $ 234.9 $ 228.6
============== ============== ==============
F-28
As of December 31,
Unfunded Commitments and Investments in Venture Capital Partnerships: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Unfunded commitments
Closed block.................................................................. $ 83.0 $ 48.3
Venture capital segment....................................................... 53.5 76.7
-------------- --------------
Total unfunded commitments.................................................... $ 136.5 $ 125.0
============== ==============
Venture capital partnerships
Closed block.................................................................. $ 52.4 $ 38.6
Venture capital segment....................................................... 202.9 196.3
-------------- --------------
Total venture capital partnerships............................................ $ 255.3 $ 234.9
============== ==============
In February 2003, we sold a 50% interest in certain of our venture capital partnerships to an outside party and
transferred the remaining 50% interest to our closed block. The carrying value of the partnerships sold and
transferred totaled $52.2 million after realizing a loss of $5.1 million in 2002 and $14.3 million in 2003 to
reflect the proceeds received.
Affiliate equity securities
Our investments in affiliate equity securities represent investments in operating entities in which we own less
than a majority of the outstanding common stock and where we exercise significant influence over the operating
and financial policies of the companies. We use the equity method of accounting for our investments in common
stock of these affiliates. We evaluate our equity method investments for an other-than-temporary impairment at
each balance sheet date considering quantitative and qualitative factors including quoted market price of
underlying equity securities, the duration the carrying value is in excess of fair value and historical and
projected earnings and cash flow capacity.
As of December 31,
Carrying Value and Cost of Affiliate Securities: -----------------------------
($ amounts in millions) 2003
-----------------------------
Carrying
Value Cost
-------------- --------------
Aberdeen common stock.......................................................... $ 38.3 $ 20.0
Other.......................................................................... 9.2 18.9
-------------- --------------
Affiliate equity securities.................................................... $ 47.5 $ 38.9
============== ==============
The cost basis of Aberdeen common stock is adjusted to reflect an other-than-temporary impairment of $89.1
million, which we recognized as a realized investment loss in 2003.
For the Years Ended December 31,
Sources of Earnings from Affiliate Securities: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Aberdeen common stock dividends................................. $ 3.0 $ 2.7 $ 3.8
Equity in Aberdeen undistributed income (loss).................. (21.9) (2.0) 2.3
HRH common stock dividends...................................... -- -- 0.5
Equity in HRH undistributed income.............................. -- -- 2.5
Other........................................................... 1.7 (2.7) (3.2)
-------------- -------------- --------------
Affiliate equity securities investment income (loss)............ $ (17.2) $ (2.0) $ 5.9
============== ============== ==============
Aberdeen convertible notes and bonds............................ $ 2.0 $ 2.5 $ 3.8
Aberdeen 5.875% convertible notes............................... -- 0.1 1.3
-------------- -------------- --------------
Affiliate debt securities investment income..................... $ 2.0 $ 2.6 $ 5.1
============== ============== ==============
F-29
Aberdeen. As of December 31, 2004 and 2003, we owned 38.1 million shares of Aberdeen common stock, which
represented 16.5% of its outstanding common shares. We acquired these shares between 1996 and 2001 at a total
cost of $109.1 million, which, through November 18, 2004, we accounted for under the equity method of
accounting based on our ability to significantly influence Aberdeen's operations.
During the second quarter of 2003, we recorded a non-cash realized investment loss of $89.1 million ($55.0
million after income taxes) related to an other-than-temporary impairment of our equity investment in Aberdeen.
In addition, as of December 31, 2003 we owned $27.5 million in Aberdeen convertible subordinated notes which
were repaid in full to us on November 19, 2004. Concurrent with this paydown, we relinquished our contractual
right to one of two Aberdeen board seats held related to our 16.5% equity interest in Aberdeen at which point
we concluded that in our judgment, we no longer had the ability to significantly influence Aberdeen's
operations. Accordingly, effective November 19, 2004, we changed our method of accounting for our equity
holdings in Aberdeen from the equity method of accounting to the fair value method of accounting under SFAS No.
115, Accounting for Certain Investments in Debt and Equity Securities. Based on our intent to sell our equity
holdings in Aberdeen in the near-term, we designated our equity holdings as trading securities under the fair
value method of accounting. Under the fair value method, the changes in fair value, based on the underlying
value of Aberdeen's shares as traded on the London Stock Exchange, as compared to our carrying under the equity
method are presented as an after-tax realized investment gain of $55.1 million in our consolidated statement of
operations for the year ended December 31, 2004. In addition, our fourth quarter and full year 2004
consolidated statement of operations includes a $14.7 million after-tax, non-cash charge related to the
accounting for our proportionate share of Aberdeen's December 2004 settlement of alleged misselling activities
with the United Kingdom's Financial Services Authority. This charge has been accounted for by us under the
equity method of accounting as it pre-dates our November 19, 2004 change in accounting for Aberdeen from the
equity method to the fair value method.
Year Ended December 31,
After-tax Effect of Equity Interest in Aberdeen: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Equity in undistributed earnings (losses) of affiliates......... $ (12.3) $ 0.5 $ 3.7
Unrealized gain on trading securities........................... 55.1 -- --
Realized investment gain (loss)................................. -- (55.0) --
-------------- -------------- --------------
Net income (loss)............................................... $ 42.8 $ (54.5) $ 3.7
============== ============== ==============
The carrying value of our equity investment in Aberdeen is $87.3 million at December 31, 2004 and is presented
as a trading equity security on our consolidated balance sheet.
On January 14, 2005, we closed on the sale to third parties of our equity holdings in Aberdeen for net proceeds
of $70.4 million, resulting in an after-tax realized investment loss of $7.0 million, which will be recognized
as a realized investment loss in our first quarter 2005 consolidated statement of operations. The January 2005
sale of our equity holdings in Aberdeen completed our disposition of our direct financial interests in
Aberdeen. We continue to participate in sub-advisory arrangements related to several of our asset management
product offerings with Aberdeen, the financial effects of which are not material to our consolidated financial
statements.
HRH. HRH is a Virginia-based property and casualty insurance and employee benefit products distributor traded
on the New York Stock Exchange. We owned 6.4% of its common shares, as well as convertible debt securities
which, if converted, would have represented 16.8% of HRH's common stock outstanding. Prior to November 2002, we
had a contractual right to designate two nominees for election to its board of directors.
In November 2002, we converted our HRH note into additional shares of HRH common stock, resulting in total HRH
holdings with a fair value of $167.1 million. On the day following the conversion, we sold shares of HRH common
stock in a secondary public offering for $23.5 million and issued stock purchase contracts for $133.9 million,
which contracts require us to deliver shares of HRH common stock on November 13, 2005 (Note 6).
F-30
As a result of these transactions, we recorded a gross realized investment gain of $15.3 million in 2002 and a
gross deferred investment gain of $91.8 million. Net of offsets for applicable deferred policy acquisition
costs and deferred income taxes, our realized gain was $6.4 million and our deferred gain was $32.4 million. We
calculated our gains using the specific identification of the securities sold. The deferred gain will be
realized on settlement of the stock purchase contracts in the fourth quarter of 2005. In addition, in 2003 we
sold shares of HRH common stock in the open market for $9.4 million and recorded a gross realized investment
gain of $6.9 million ($4.5 million after income taxes). As a result of the transactions we completed in
November 2002, it was no longer appropriate to consider HRH as an affiliate for accounting and reporting
purposes.
Policy loans and other invested assets
Policy loans are carried at their unpaid principal balances and are collateralized by the cash values of the
related policies. For purposes of fair value disclosures (Note 9), we estimate the fair value of fixed rate
policy loans by discounting loan interest and loan repayments. We base the discount rate on the 10-year United
States Treasury rate. We assume that loan interest payments are made at the fixed rate less 17.5 basis points
and that loan repayments only occur as a result of anticipated policy lapses. For variable rate policy loans,
we consider the unpaid loan balance as fair value, as interest rates on these loans are reset annually based on
market rates.
Other investments primarily include leveraged lease investments and other partnership and joint venture
interests. Leveraged lease investments represent the net amount of the estimated residual value of the lease
assets, rental receivables and unearned and deferred income to be allocated over the lease term. Investment
income is calculated using the interest method and is recognized only in periods in which the net investment is
positive. Other partnership and joint venture interests in which we do not have control or a majority ownership
interest are recorded using the equity method of accounting. These investments include affordable housing,
mezzanine and other partnership interests.
Our derivative instruments primarily include interest rate swap agreements. We report these contracts at fair
values, which are based on current settlement values. These values are determined by brokerage quotes that
utilize pricing models or formulas based on current assumptions for the respective agreements.
As of December 31,
Other Invested Assets: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Transportation and other equipment leases...................................... $ 67.8 $ 68.7
Separate account equity investments............................................ 40.0 49.2
Mezzanine partnerships......................................................... 61.7 50.9
Affordable housing partnerships................................................ 23.4 24.8
Derivative instruments (Note 9)................................................ 27.4 40.3
Other affiliate investments.................................................... 8.8 15.5
Real estate.................................................................... 70.1 64.0
Other partnership interests.................................................... 72.6 88.6
-------------- --------------
Other invested assets.......................................................... $ 371.8 $ 402.0
============== ==============
Amounts applicable to the closed block......................................... $ 60.0 $ 46.7
============== ==============
Net investment income and net realized investment gains (losses)
We recognize realized investment gains and losses on asset dispositions on a first-in, first-out basis and when
declines in fair value of debt and equity securities are considered to be other-than-temporarily impaired. We
adjust the cost basis of these written down investments to fair value at the date the determination of
impairment is made and do not change the new cost basis for subsequent recoveries in value. The closed block
policyholder dividend obligation, applicable deferred policy acquisition costs and applicable income taxes,
which offset realized investment gains and losses, are each reported separately as components of net income.
F-31
Year Ended December 31,
Sources of Net Investment Income: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Debt securities................................................. $ 772.1 $ 765.3 $ 730.8
Equity securities............................................... 4.5 4.6 4.2
Mortgage loans.................................................. 22.5 32.6 40.4
Venture capital partnerships.................................... 25.5 49.0 (59.3)
Policy loans.................................................... 167.1 171.7 171.8
Other investments............................................... 48.8 35.0 18.9
Cash and cash equivalents....................................... 4.9 7.0 11.9
-------------- -------------- --------------
Total investment income......................................... 1,045.4 1,065.2 918.7
Less: investment expenses...................................... 9.8 10.0 9.2
-------------- -------------- --------------
Net investment income, general account investments.............. 1,035.6 1,055.2 909.5
Debt and equity securities pledged as collateral (Note 8)....... 40.1 52.2 31.0
-------------- -------------- --------------
Net investment income........................................... $ 1,075.7 $ 1,107.4 $ 940.5
============== ============== ==============
Amounts applicable to the closed block.......................... $ 560.0 $ 573.1 $ 562.0
============== ============== ==============
For 2004, 2003 and 2002, net investment income was lower by $9.5 million, $10.4 million and $6.2 million,
respectively, due to non-income producing debt securities. Of these amounts, $5.8 million, $5.5 million and
$5.2 million, respectively, related to the closed block.
Year Ended December 31,
Sources of Realized Investment Gains (Losses): ---------------------------------------
($ amounts in millions) 2004 2003 2002
------------ ------------ ------------
Debt security impairments............................................. $ (15.5) $ (76.1) $ (114.3)
Equity security impairments........................................... (1.5) (4.3) (9.8)
Mortgage loan impairments............................................. -- (4.1) (0.6)
Venture capital partnership impairments............................... -- (4.6) (5.1)
Affiliate equity security impairments................................. (12.6) (96.9) --
Other invested asset impairments...................................... (3.3) (16.5) (22.0)
Debt and equity securities pledged as collateral impairments.......... (16.6) (8.3) (34.9)
------------ ------------ ------------
Impairment losses..................................................... (49.5) (210.8) (186.7)
------------ ------------ ------------
Debt security transaction gains....................................... 39.0 93.7 94.3
Debt security transaction losses...................................... (10.6) (29.0) (45.9)
Equity security transaction gains..................................... 17.7 58.8 24.5
Equity security transaction losses.................................... (3.1) (9.6) (22.4)
Mortgage loan transaction gains (losses).............................. 0.2 (1.3) 0.2
Venture capital partnership transaction losses........................ -- (9.7) --
Other invested asset transaction gains................................ 5.5 9.4 2.1
------------ ------------ ------------
Net transaction gains................................................. 48.7 112.3 52.8
------------ ------------ ------------
Net realized investment losses........................................ $ (0.8) $ (98.5) $ (133.9)
------------ ------------ ------------
Net realized investment gains (losses)................................ $ (0.8) $ (98.5) $ (133.9)
------------ ------------ ------------
Applicable closed block policyholder dividend obligation (reduction).. 3.7 (5.9) (40.3)
Applicable deferred policy acquisition costs (benefit)................ (0.4) (4.1) (7.2)
Applicable deferred income tax expense (benefit)...................... 3.1 (35.6) (20.8)
------------ ------------ ------------
Offsets to realized investment income (losses)........................ 6.4 (45.6) (68.3)
------------ ------------ ------------
Net realized investment losses included in net income................. $ (7.2) $ (52.9) $ (65.6)
============ ============ ============
Included in realized impairment losses on debt and equity securities pledged as collateral above, are
impairments relating to our direct investments in the consolidated collateralized obligation trusts of $3.7
million, $5.9 million and $8.6 million for 2004, 2003 and 2002, respectively.
F-32
On May 25, 2004, we sold our Enfield, Connecticut office facility for a loss of $1.0 million ($0.7 million
after-tax). In anticipation of that sale, we had recorded a $6.2 million ($4.0 million after-tax) realized
impairment loss in 2003.
Unrealized investment gains (losses)
We recognize unrealized investment gains and losses on investments in debt and equity securities that we
classify as available-for-sale. We report these gains and losses as a component of other comprehensive income,
net of the closed block policyholder dividend obligation, applicable deferred policy acquisition costs and
applicable deferred income taxes.
Year Ended December 31,
Sources of Changes in Net Unrealized Investment Gains (Losses): ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Debt securities................................................. $ (27.1) $ (66.1) $ 404.2
Equity securities............................................... 15.4 (39.4) 108.5
Debt and equity securities pledged as collateral................ 7.8 116.4 42.6
Other investments............................................... 0.1 7.0 (2.4)
-------------- -------------- --------------
Net unrealized investment gains (losses)........................ $ (3.8) $ 17.9 $ 552.9
============== ============== ==============
Net unrealized investment gains (losses)........................ $ (3.8) $ 17.9 $ 552.9
-------------- -------------- --------------
Applicable policyholder dividend obligation..................... 3.6 (45.5) 369.4
Applicable deferred policy acquisition costs.................... (7.7) (12.4) 95.9
Applicable deferred income taxes (benefit)...................... (4.0) (9.8) 15.8
-------------- -------------- --------------
Offsets to net unrealized investment gains (losses)............. (8.1) (67.7) 481.1
-------------- -------------- --------------
Net unrealized investment gains included in
other comprehensive income (Note 12).......................... $ 4.3 $ 85.6 $ 71.8
============== ============== ==============
Investing cash flows
Year Ended December 31,
Investment Purchases, Sales, Repayments and Maturities: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Debt security purchases......................................... $ (4,056.8) $ (5,394.9) $ (4,742.4)
Equity security purchases....................................... (66.3) (129.9) (59.8)
Venture capital partnership investments......................... (59.3) (41.6) (43.0)
Affiliate equity and debt security purchases.................... -- -- (28.0)
Other invested asset purchases.................................. (26.2) (27.2) (73.0)
Policy loan advances, net....................................... 44.7 (36.4) (31.1)
-------------- -------------- --------------
Investment purchases............................................ $ (4,163.9) $ (5,630.0) $ (4,977.3)
============== ============== ==============
Debt securities sales........................................... $ 2,405.2 $ 2,124.7 $ 1,807.6
Debt securities maturities and repayments....................... 1,483.0 1,792.0 1,305.6
Equity security sales........................................... 111.2 235.7 139.3
Mortgage loan maturities and principal repayments............... 77.2 180.3 67.7
Venture capital partnership capital distributions............... 59.4 54.2 28.5
Affiliate securities sales...................................... 1.0 -- --
Real estate and other invested assets sales..................... 83.7 30.3 69.9
-------------- -------------- --------------
Investment sales, repayments and maturities..................... $ 4,220.7 $ 4,417.2 $ 3,418.6
============== ============== ==============
F-33
The maturities of general account debt securities and mortgage loans, by contractual sinking fund payment and
maturity, as of December 31, 2004 are summarized in the following table. Actual maturities will differ from
contractual maturities as certain borrowers have the right to call or prepay obligations with or without call
or prepayment penalties, we have the right to put or sell certain obligations back to the issuers and we may
refinance mortgage loans. Refinancing of mortgage loans was not significant during the three years ended
December 31, 2004.
Maturities of General Account Debt Securities Debt Mortgage
and Mortgage Loans at Cost: Securities Loans Total
($ amounts in millions) -------------- -------------- --------------
Due in one year or less....................................... $ 167.4 $ 25.1 $ 192.5
Due after one year through five years......................... 2,356.0 89.3 2,445.3
Due after five years through ten years........................ 3,642.4 59.8 3,702.2
Due after ten years........................................... 6,725.9 33.7 6,759.6
-------------- -------------- --------------
Total......................................................... $ 12,891.7 $ 207.9 $ 13,099.6
============== ============== ==============
6. Financing Activities
Stock purchase contracts and indebtedness
We have recorded our stock purchase contract obligation as a liability on our balance sheet at estimated
settlement amount. This liability includes a premium representing the fair value of a net purchased option
contained in the purchase contract. We amortize the premium over the life of the purchase contract. Contract
adjustment payments and premium amortization on the purchase contracts are recorded in other expenses in our
statement of income.
We have recorded indebtedness at unpaid principal balances of each instrument net of issue discount. In
connection with our senior unsecured bond offering, we entered into an interest rate swap agreement on half of
the offering amount to reduce market risks from changes in interest rates. We have recorded the interest rate
swap at fair value based on the settlement value of the swap. For purposes of fair value disclosures (Note 9),
we have determined the fair value of indebtedness based on contractual cash flows discounted at market rates
for surplus notes and on quoted market prices for bonds and equity units.
As of December 31,
Stock Purchase Contracts: ------------------------------------------------------------
($ amounts in millions) 2004 2003
----------------------------- -----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------------- -------------- -------------- --------------
Stock purchase contracts stated amount.......... $ 141.1 $ 131.9 $ 144.2 $ 128.8
Settlement amount adjustment.................... (9.2) -- (15.4) --
-------------- -------------- -------------- --------------
Stock purchase contracts........................ $ 131.9 $ 131.9 $ 128.8 $ 128.8
============== ============== ============== ==============
In November 2002, we issued 3,622,500 stock purchase contracts in a public offering at $38.10 per contract
($138.0 million aggregate) and raised net proceeds of $133.9 million. The stock purchase contracts are prepaid
forward contracts issued by us that we will settle in shares of HRH common stock. Under each purchase contract,
we will make quarterly contract adjustment payments at the annual rate of 7.00% of the stated contract amount.
F-34
We are obligated to deliver shares of HRH common stock to holders of the stock purchase contracts in November
2005. The number of HRH common shares that we are obligated to deliver is based on the volume weighted-average
daily trading price of HRH common stock over the 20-trading day period ending on the third trading day prior to
November 13, 2005. The maximum number of HRH common shares that we are obligated to deliver, subject to
anti-dilution adjustments, is 3,622,500, or one share of HRH common stock per purchase contract. The minimum
number is 2,969,363 shares, or 0.8197 share of HRH common stock per purchase contract. We have pledged
3,622,500 shares of HRH common stock as collateral for our obligations under the purchase contracts (Note 5).
Upon issuance of the stock purchase contracts, we designated the embedded derivative instrument as a hedge of
the forecasted sale of our investment in HRH, whose shares underlie the stock purchase contracts. All changes
in the fair value of the embedded derivative instrument are recorded in other comprehensive income.
As of December 31,
Indebtedness: ------------------------------------------------------------
($ amounts in millions) 2004 2003
----------------------------- -----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------------- -------------- -------------- --------------
6.95% surplus notes............................. $ 30.2 $ 34.4 $ 175.0 $ 188.8
7.15% surplus notes............................. 173.9 174.8 -- --
Equity units.................................... 153.7 227.8 153.7 232.1
Senior unsecured bonds.......................... 300.0 306.7 300.0 311.2
Revolving credit facility....................... 25.0 25.0 -- --
Interest rate swap.............................. 8.0 8.0 10.3 10.3
-------------- -------------- -------------- --------------
Total indebtedness.............................. $ 690.8 $ 776.7 $ 639.0 $ 742.4
============== ============== ============== ==============
Our 6.95% and 7.15% surplus notes are an obligation of Phoenix Life and are due December 1, 2006 and December
15, 2034, respectively. The carrying value of the 2034 notes is net of $1.1 million of unamortized original
issue discount. Interest payments are at an annual rate of 6.95% and 7.15%, respectively, require the prior
approval of the Superintendent of Insurance of the State of New York and may be made only out of surplus funds
which the Superintendent determines to be available for such payments under New York Insurance Law. The 6.95%
surplus notes have no early redemption provisions. The 7.15% surplus notes may be redeemed at the option of
Phoenix Life at any time at the "make-whole" redemption price set forth in the offering circular. New York
Insurance Law provides that the notes are not part of the legal liabilities of Phoenix Life. On December 15,
2004, Phoenix Life repurchased $144.8 million of the previously issued $175.0 million outstanding principal on
its 6.95% surplus notes and recognized a non-recurring after-tax charge of $6.4 million for costs incurred,
including the tender premium. Concurrent with the closing of the tender, Phoenix Life issued $175.0 million,
7.15% surplus notes.
In December 2002, we issued 6,147,500 of 7.25% equity units in a public offering at $25 per unit for gross
proceeds of $153.7 million (net proceeds of $149.1 million). Each equity unit is composed of an unsecured,
subordinated note and a purchase contract (equity forward on our common stock collateralized by the note). The
notes bear interest at an annual rate of 6.6% and $25 principal amount per note is initially due in February
2008. On or after November 2005 the notes will be remarketed as senior unsecured obligations and the interest
rate will be reset at that time. The holders of the purchase contracts will be paid a contract adjustment
payment at a rate of 0.65% per year and have agreed to purchase a minimum 2.8343 shares (17,423,859 shares
aggregate) and a maximum of 3.4578 shares (21,256,826 shares aggregate) of our common stock, depending on its
quoted market price, in February 2006. The present value of the future contract adjustment payments of $2.8
million was recorded as a charge to paid-in capital at inception.
Our senior unsecured bonds were issued in December 2001 for gross proceeds of $300.0 million (net proceeds of
$290.6 million) and mature in January 2032. We pay interest at an annual rate of 7.45%. We may redeem any or
all of the bonds from January 2007 at a redemption price equal to 100% of principal plus accrued and unpaid
interest to the redemption date. We also have the right to redeem the bonds in whole in certain circumstances
if we are unable to deduct interest paid on the bonds.
F-35
On November 22, 2004, we entered into a new $150.0 million three-year, unsecured senior revolving credit
facility to replace our prior $150.0 million credit facility that was to expire on December 20, 2004. The prior
facility consisted of two tranches: a $112.5 million, 364-day revolving credit facility and a $37.5 million
three-year revolving credit facility. Potential borrowers on the new credit line are The Phoenix Companies,
Inc., Phoenix Investment Partners and Phoenix Life. We unconditionally guarantee any loans under this new
facility to Phoenix Life and Phoenix Investment Partners. Base rate loans will bear interest at the greater of
Wachovia Bank, National Association's prime commercial rate or the federal funds rate plus 0.50%. Eurodollar
rate loans will bear interest at LIBOR plus an applicable percentage based on our Standard & Poor's and Moody's
ratings. The $25 million drawn by Phoenix Investment Partners on the prior facility was refinanced using this
new facility at the Eurodollar rate.
The new credit facility contains covenants that require us at all times to maintain consolidated stockholders'
equity, in accordance with GAAP, excluding the accounting effects of FIN 46(R), of $1,648.4 million, plus 50%
of positive quarterly net income and 100% of equity issuances and a maximum consolidated debt-to-capital ratio
of 30% and limits consolidated indebtedness, subject to certain exceptions, to $750.0 million. In addition,
Phoenix Life must maintain a minimum RBC ratio of 250% and a minimum A.M. Best financial strength rating of
"A-". The new facility no longer has a fixed charge coverage covenant. Borrowings under the facility are not
conditioned on the absence of a material adverse change.
Future minimum annual principal payments on indebtedness as of December 31, 2004 are: 2006, $30.2 million;
2007, $25.0 million; 2008, $153.7 million; 2032, $300.0 million and 2034, $175.0 million.
Year Ended December 31,
Interest Expense on Indebtedness, including ---------------------------------------------
Amortization of Debt Issuance Costs: 2004 2003 2002
($ amounts in millions) -------------- -------------- --------------
Stock purchase contract adjustment expense...................... $ 7.8 $ 8.2 $ 1.0
============== ============== ==============
Surplus notes................................................... $ 12.8 $ 12.2 $ 12.2
Equity units.................................................... 12.1 12.1 0.3
Senior unsecured bonds.......................................... 14.8 14.9 15.5
Bank credit facility and other.................................. 1.1 0.4 3.4
-------------- -------------- --------------
Interest expense on indebtedness................................ $ 40.8 $ 39.6 $ 31.4
============== ============== ==============
Stock purchase contract adjustment payments are included in other operating expenses.
Common stock and stock repurchase program
We have authorization for the issuance of 1,000,000,000 shares of our common stock. In connection with our
demutualization and initial public offering, we issued 106,376,417 common shares (56,180,517 shares to our
policyholders in exchange for their interests in the mutual company and 50,195,900 shares in sales to the
public). As of December 31, 2004, we had 94,877,572 shares outstanding, net of 11,517,387 common shares of
treasury stock. We also had 28,975,127 common shares reserved for issuance at that date under the purchase
contracts included with our equity units (21,256,826 shares), our stock option plans (6,281,458 shares) and our
restricted stock units (1,436,843 shares), or RSUs.
We have authorization from our board of directors to repurchase an additional 670,000 shares of our common
stock. As of December 31, 2004, we had repurchased 12,330,000 shares of our common stock at an average price of
$15.87 per share, including zero, zero and 7,781,500 shares in 2004, 2003 and 2002, respectively. During 2004,
we contributed 412,239 treasury shares to fund the employer match for our saving and investment benefit plans.
These shares had a cost basis of $6.5 million (weighted-average cost of $15.87 per share) and an aggregate
market value of $4.9 million.
F-36
State Farm Mutual Automobile Insurance Company, or State Farm, currently owns of record more than five percent
of our outstanding common stock. In 2004 and 2003, our subsidiaries incurred $32.4 million and $25.8 million,
respectively, as compensation costs for the sale of our insurance and annuity products by entities that were
either subsidiaries of State Farm or owned by State Farm employees.
7. Separate Account Assets and Liabilities
Separate account products are those for which a separate investment and liability account is maintained on
behalf of the policyholder. Investment objectives for these separate accounts vary by fund account type, as
outlined in the applicable fund prospectus or separate account plan of operations. Our separate account
products include variable annuities and variable life insurance contracts.
Separate account assets and liabilities related to policyholder funds are carried at market value. Deposits,
net investment income and realized investment gains and losses for these accounts are excluded from revenues,
and the related liability increases are excluded from benefits and expenses. Fees assessed to the
contractholders for management services are included in revenues when services are rendered.
As of December 31,
Separate Account Assets and Liabilities: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Life and annuity segment separate accounts..................................... $ 6,807.2 $ 5,910.3
Corporate and other segment separate accounts.................................. 143.1 172.9
-------------- --------------
Total separate account assets and liabilities.................................. $ 6,950.3 $ 6,083.2
============== ==============
8. Investments Pledged as Collateral and Non-Recourse Collateralized Obligations
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 be deemed to hold interests in those entities. In particular, we
serve as the investment advisor to eight collateralized obligation trusts that were organized to take advantage
of bond market arbitrage opportunities, including the three in the table below. These eight collateralized
obligation trusts are investment trusts with aggregate assets of $3.0 billion that are primarily invested in a
variety of fixed income securities acquired from third parties. These collateralized obligation trusts, in
turn, issued tranched collateralized obligations and residual equity securities to third parties, as well as to
our principal life insurance subsidiary's general account. Our asset management affiliates earned advisory fees
of $8.0 million, $10.4 million and $7.9 million during the years ended December 31, 2004, 2003 and 2002,
respectively. These advisory fees are either recorded as investment product fees for unconsolidated trusts or
reflected as investment income on debt and equity securities pledged as collateral, net of interest expense on
collateralized obligations and applicable minority interest related to third-party equity investments for
consolidated trusts on our consolidated statement of income. The collateralized obligation trusts reside in
bankruptcy remote SPEs for which we provide neither recourse nor guarantees. Accordingly, our financial
exposure to these collateralized obligation trusts stems from our life insurance subsidiary's general account
direct investment in certain debt or equity securities issued by these collateralized obligation trusts. Our
maximum exposure to loss with respect to our life insurance subsidiary's direct investment in the eight
collateralized obligation trusts is $79.9 million at December 31, 2004 ($30.9 million of which relates to
trusts that are consolidated). Of that exposure, $54.7 million ($20.0 million of which relates to trust that
are consolidated) relates to investment grade debt securities and loss of management fees.
We consolidated three collateralized obligation trusts as of December 31, 2004, 2003 and 2002. As of December
31, 2004, our direct investment in the three consolidated collateralized obligation trusts is $30.9 million
($20.0 million of which is an investment grade debt security). We recognized investment income on debt and
equity securities pledged as collateral, net of interest expense on collateralized obligations and applicable
minority
F-37
interest, of $3.4 million, $3.6 million and $2.6 million for the years ended December 31, 2004, 2003 and 2002,
respectively, related to these three consolidated obligation trusts.
Five variable interest entities not consolidated by us under FIN 46(R) represent collateralized obligation
trusts with approximately $1.6 billion of investment assets pledged as collateral. Our general account's direct
investment in these unconsolidated variable interest entities is $49.0 million ($34.7 million of which are
investment grade debt securities at December 31, 2004). We recognized investment advisory fee revenues related
to the unconsolidated variable interest entities of $4.6 million, $6.8 million and $5.3 million for the years
ended December 31, 2004, 2003 and 2002, respectively.
As of December 31,
Consolidated Variable Interest Entities: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Assets Pledged as Collateral, at Fair Value
Phoenix CDO I.................................................................. $ 94.4 $ 148.8
Phoenix CDO II................................................................. 294.5 332.6
Phoenix-Mistic 2002-1 CDO...................................................... 967.0 963.4
-------------- --------------
Total.......................................................................... $ 1,355.9 $ 1,444.8
============== ==============
Non-recourse Collateralized Obligations
Phoenix CDO I (March 2011 maturity)............................................ $ 127.3 $ 183.2
Phoenix CDO II (December 2012 mandatorily redeemable).......................... 329.4 375.6
Phoenix-Mistic 2002-1 CDO (September 2014 maturity)............................ 898.5 913.2
-------------- --------------
Total.......................................................................... $ 1,355.2 $ 1,472.0
============== ==============
Assets pledged as collateral consist of available-for-sale debt and equity securities at fair value of $1,278.8
million and $1,350.0 million at December 31, 2004 and 2003, respectively. In addition, cash and accrued
investment income of $77.1 million and $94.8 million are included in these amounts at December 31, 2004 and
2003, respectively.
Non-recourse collateralized obligations are comprised of callable collateralized obligations of $1,253.4
million and $1,344.2 million at December 31, 2004 and 2003, respectively, and non-recourse derivative cash flow
hedge liabilities of $101.8 million (notional amount of $1,118.2 million with maturities of 2005-2013) and
$127.7 million (notional amount of $1,211.3 million with maturities of 2005-2013) at December 31, 2004 and
2003, respectively. Minority interest liabilities related to third-party equity investments in the consolidated
variable interest entities is $37.7 million and $22.3 million at December 31, 2004 and 2003, respectively.
Collateralized obligations for which Phoenix Investment Partners is the sponsor and actively manages the
assets, where we are deemed to be a primary beneficiary as a result of our variable interests, and where there
is not a significant amount of outside third-party equity investment in the trust, are consolidated in our
financial statements. Our financial exposure is limited to our share of equity and bond investments in these
vehicles held in our general account as available-for-sale debt and equity securities, as applicable, and there
are no financial guarantees from, or recourse, to us, for these collateralized obligation trusts.
Debt and equity securities pledged as collateral are recorded at fair value with any applicable unrealized
investment gains or losses reflected as a component of accumulated other comprehensive income, net of
applicable minority interest. We recognize realized investment losses on debt and equity securities in these
collateralized obligations when declines in fair values, in our judgment, are considered to be
other-than-temporarily impaired. Non-recourse obligations issued by the consolidated collateralized obligation
trusts at face value and are recorded at unpaid principal balance. Non-recourse derivative cash flow hedges are
carried on our consolidated balance sheet at fair value with an offsetting amount recorded in accumulated other
comprehensive income.
F-38
Effect of Consolidation of Collateralized Obligation Trusts: As of and for the
($ amounts in millions) Year Ended December 31,
---------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Decrease in net income or increase in net loss........................... $ (12.9) $ (2.4) $ (26.3)
============== ============== ==============
Reduction to stockholders' equity........................................ $ (67.5) $ (77.3) $ (204.9)
============== ============== ==============
The above non-cash charges to earnings and stockholders' equity primarily relate to realized and unrealized
investment losses within the collateralized obligation trusts. Upon maturity or other liquidation of the
trusts, the fair value of the investments pledged as collateral will be used to settle the non-recourse
collateralized obligations with any shortfall in such investments inuring to the third-party note and equity
holders. To the extent there remains a recorded liability for non-recourse obligations after all the assets
pledged as collateral are exhausted, such amount will be reduced to zero with a corresponding benefit to
earnings. Accordingly, these investment losses and any future investment losses under this method of
consolidation will ultimately reverse upon the maturity or other liquidation of the non-recourse collateralized
obligations. These non-recourse obligations mature between 2011 through 2014 but contain call provisions. The
call provisions may be triggered at the discretion of the equity investors based on market conditions and are
subject to certain contractual limitations.
GAAP requires us to consolidate all the assets and liabilities of these collateralized obligation trusts which
results in the recognition of realized and unrealized losses even though we have no legal obligation to fund
such losses in the settlement of the collateralized obligations. The FASB continues to evaluate, through the
issuance of FASB staff positions, the various technical implementation issues related to consolidation
accounting. We will continue to assess the impact of any new implementation guidance issued by the FASB as well
as evolving interpretations among accounting professionals. Additional guidance and interpretations may affect
our application of consolidation accounting in future periods.
As of December 31,
Fair Value and Cost of Debt and Equity Securities ------------------------------------------------------
Pledged as Collateral: 2004 2003
($ amounts in millions) ------------------------- ---------------------------
Fair Value Cost Fair Value Cost
------------ ------------ ------------- -------------
Debt securities pledged as collateral................... $ 1,276.9 $ 1,159.9 $ 1,348.8 $ 1,238.6
Equity securities pledged as collateral................. 1.9 0.4 1.2 0.7
------------ ------------ ------------- -------------
Total debt and equity securities pledged as collateral.. $ 1,278.8 $ 1,160.3 $ 1,350.0 $ 1,239.3
============ ============ ============= =============
As of December 31,
Gross and Net Unrealized Gains and Losses from -----------------------------------------------------
Debt and Equity Securities Pledged as Collateral: 2004 2003
($ amounts in millions) ------------------------- ---------------------------
Gains Losses Gains Losses
------------ ------------ ------------- -------------
Debt securities pledged as collateral................... $ 131.3 $ (14.3) $ 138.5 $ (28.3)
Equity securities pledged as collateral................. 1.6 (0.1) 0.7 (0.2)
------------ ------------ ------------- -------------
Total................................................... $ 132.9 $ (14.4) $ 139.2 $ (28.5)
============ ============ ============= =============
Net unrealized gains.................................... $ 118.5 $ 110.7
============ =============
F-39
Aging of Temporarily Impaired As of December 31, 2004
Debt and Equity Securities Pledged -------------------------------------------------------------------
as Collateral: Less than 12 months Greater than 12 months Total
($ amounts in millions) ------------------------- ---------------------- ------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ------------- -------- ------------- ------- -----------
Corporate.................................. $ 16.2 $ (0.2) $ 25.2 $ (4.0) $ 41.4 $ (4.2)
Mortgage-backed............................ -- -- 23.9 (8.3) 23.9 (8.3)
Other asset-backed......................... -- -- 21.0 (1.8) 21.0 (1.8)
----------- ------------- -------- ------------- ------- ----------
Debt securities............................ $ 16.2 $ (0.2) $ 70.1 $ (14.1) $ 86.3 $ (14.3)
Equity securities pledged as collateral.... -- -- -- (0.1) -- (0.1)
----------- ------------- -------- ------------- ------- ----------
Total temporarily impaired securities
pledged as collateral.................... $ 16.2 $ (0.2) $ 70.1 $ (14.2) $ 86.3 $ (14.4)
=========== ============= ======== ============= ======= ==========
Gross unrealized losses related to debt securities pledged as collateral whose fair value is less than the
security’s amortized cost totals $14.3 million at December 31, 2004. Gross unrealized losses on debt securities
with a fair value less than 80% of the security’s amortized cost totaled $7.8 million at December 31, 2004. The
majority of these debt securities are investment grade issues that continue to perform to their original
contractual terms at December 31, 2004.
Maturity of Debt Securities Pledged as Collateral: 2004
($ amounts in millions) Cost
--------------
Due in one year or less............................................................ $ 20.7
Due after one year through five years.............................................. 294.3
Due after five years through ten years............................................. 689.8
Due after ten years................................................................ 155.1
--------------
Total debt securities.............................................................. $ 1,159.9
==============
The amount of CDO-related derivative cash flow hedge ineffectiveness recognized through earnings for the years
ended December 31, 2004 and 2003 is ($0.7) million and $0.0 million, respectively. See Note 5 to our
consolidated financial statements for information on realized investment losses related to these CDOs.
9. Derivative Instruments and Fair Value of Financial Instruments
Derivative instruments
We maintain an overall interest rate risk-management strategy that primarily incorporates the use of interest
rate swaps as hedges of our exposure to changes in interest rates. Our exposure to changes in interest rates
primarily results from our commitments to fund interest-sensitive insurance liabilities, as well as from our
significant holdings of fixed rate financial instruments.
We recognize all derivative instruments on the balance sheet at fair value. Generally, we designate each
derivative according to the associated exposure as either a fair value or cash flow hedge at its inception as
we do not enter into derivative contracts for trading or speculative purposes.
Except for the foreign currency swaps discussed below, all fair value hedges are accounted for with changes in
the fair value of related interest rate swaps recorded on the balance sheet with an offsetting amount recorded
to the hedged item’s balance sheet carrying amount. Changes in the fair value of foreign currency swaps used as
hedges of the fair value of foreign currency denominated assets are reported in current period earnings with
the change in value of the hedged asset attributable to the hedged risk.
F-40
Cash flow hedges are generally accounted for with changes in the fair value of related interest rate swaps
recorded on the balance sheet with an offsetting amount recorded in accumulated other comprehensive income. The
effective portion of changes in fair values of derivatives hedging the variability of cash flows related to
forecasted transactions are reported in accumulated other comprehensive income and reclassified into earnings
in the periods during which earnings are affected by the variability of the cash flows of the hedged item.
Changes in the fair value of derivative instruments not designated as hedging instruments and ineffective
portions of hedges are recognized in net investment income in the period incurred.
Derivative Instruments Held in As of December 31,
General Account: ----------------------------------------------
($ amounts in millions) 2004 2003
----------------------- ----------------------
Notional
Amount Maturity Asset Liability Asset Liability
---------- ----------- ----------- ----------- ----------- ----------
Interest rate swaps
Fair value hedges..................... $ 150 2032 $ 8.0 $ -- $ 10.3 $ --
Cash flow hedges...................... 30 2007 2.8 -- 4.5 --
Non-hedging derivative instruments.... 360 2007 16.5 14.0 25.1 21.7
Other..................................... 50 2004-2008 0.1 -- 0.4 --
----------- ----------- ----------- ----------- ----------
Total general account
derivative instrument positions......... $ 590 $ 27.4 $ 14.0 $ 40.3 $ 21.7
=========== =========== =========== =========== ==========
Fair value hedges. We currently hold interest rate swaps that convert a portion of our fixed rate debt
portfolio to variable rate debt. We account these hedges for under the shortcut method and, therefore, record
no hedge ineffectiveness in current period earnings associated with these interest rate swaps.
Cash flow hedges. We currently hold interest rate swaps that effectively convert variable rate bond cash flows
to fixed cash flows in order to better match the cash flows of associated liabilities. We account for these
hedges under the shortcut method and, therefore, recorded no hedge ineffectiveness in earnings for 2004, 2003
and 2002. We do not expect to reclassify any amounts reported in accumulated other comprehensive income into
earnings over the next twelve months with respect to these hedges.
Total Return Swaps. The Company uses total return swaps to hedge against market risks from declining equity
prices and changes in foreign currency exchange rates. Under total return swaps, the Company agrees with
another party (referred to as the counterparty) to exchange the appreciation or depreciation of an equity
holding in return for a floating rate payment. The appreciation or depreciation of the equity holding includes
both changes from the underlying price of the security in its home currency and changes in the foreign currency
exchange rate between its home currency and United States dollar. Counterparties to such financial instruments
expose the Company to credit-related losses in the event of nonperformance, but we do not expect any
counterparties to fail to meet their obligations given their high credit ratings. The credit exposure of total
return swaps is the fair value (market value) of contracts with a positive fair value (market value) at the
reporting date. The Company had one total return swap with an expiration of April 1, 2005 at the end of the
statement period.
Non-hedging derivative instruments. We also hold interest rate swaps that were initially entered into as hedges
of an anticipated purchase of assets associated with an acquisition of a block of insurance liabilities.
Subsequently, we took offsetting swap positions to lock in a stream of income to supplement the income on the
assets purchased.
We are exposed to credit risk in the event of non-performance by counterparties to these derivative
instruments. We do not expect that counterparties will fail to meet their financial obligation as we only enter
into derivative contracts with a number of highly rated financial institutions. The credit exposure of these
instruments is the positive fair value at the reporting date, or $27.4 million as of December 31, 2004. We
consider the likelihood of any material loss on these instruments to be remote.
F-41
Fair value of financial instruments
Carrying Amounts and Estimated Fair Values As of December 31,
of Financial Instruments: --------------------------------------------------
($ amounts in millions) 2004 2003
------------------------- ------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------ ------------ ------------- ----------
Cash and cash equivalents................................... $ 435.0 $ 435.0 $ 447.9 $ 447.9
Available-for-sale debt securities (Note 5)................. 13,476.3 13,476.3 13,273.0 13,273.0
Available-for-sale equity securities (Note 5)............... 304.3 304.3 312.0 312.0
Trading equity securities................................... 87.3 87.3 -- --
Mortgage loans (Note 5)..................................... 207.9 220.4 284.1 301.4
Debt and equity securities pledged as collateral (Note 8)... 1,278.8 1,278.8 1,350.0 1,350.0
Derivative financial instruments............................ 27.4 27.4 40.3 40.3
Policy loans (Note 5)....................................... 2,196.7 2,318.0 2,241.4 2,370.0
------------ ------------ ------------ ------------
Financial assets............................................ $18,013.7 $ 18,147.5 $ 17,948.7 $ 18,094.6
============ ============ ============ ============
Investment contracts (Note 3)............................... $ 3,492.4 $ 3,510.8 $ 3,642.7 $ 3,680.8
Non-recourse collateralized obligations (Note 8)............ 1,355.2 1,355.9 1,472.0 1,444.8
Stock purchase contracts (Note 6)........................... 131.9 131.9 128.8 128.8
Indebtedness (Note 6)....................................... 690.8 776.7 639.0 742.4
Derivative financial instruments............................ 14.0 14.0 21.7 21.7
------------ ------------ ------------ ------------
Financial liabilities....................................... $ 5,684.3 $ 5,789.3 $ 5,904.2 $ 6,018.5
============ ============ ============ ============
10. Income Taxes
We recognize income tax expense or benefit based upon amounts reported in the financial statements and the
provisions of currently enacted tax laws. We allocate income taxes to income, other comprehensive income and
additional paid-in capital, as applicable.
We recognize current income tax assets and liabilities for estimated income taxes refundable or payable based
on the current year’s income tax returns. We recognize deferred income tax assets and liabilities for the
estimated future income tax effects of temporary differences and carryforwards. Temporary differences are the
differences between the financial statement carrying amounts of assets and liabilities and their tax bases, as
well as the timing of income or expense recognized for financial reporting and tax purposes of items not
related to assets or liabilities. If necessary, we establish valuation allowances to reduce the carrying amount
of deferred income tax assets to amounts that are more likely than not to be realized. We periodically review
the adequacy of these valuation allowances and record any reduction in allowances through earnings.
Allocation of Income Taxes: Year Ended December 31,
($ amounts in millions) ----------------------------------------------
2004 2003 2002
-------------- -------------- ---------------
Income taxes (benefit) applicable to
Current...................................................... $ (15.2) $ (5.4) $ (14.2)
Deferred..................................................... 55.7 (12.9) (44.6)
-------------- -------------- ---------------
Continuing operations........................................ 40.5 (18.3) (58.8)
Equity in earnings of affiliates............................. (6.8) (0.2) 2.6
Discontinued operations...................................... (1.2) (1.2) (0.6)
Cumulative effect of accounting changes...................... -- -- (11.4)
-------------- -------------- ---------------
Net income (loss).............................................. 32.5 (19.7) (68.2)
Other comprehensive income (loss).............................. (20.5) (4.2) 14.2
-------------- -------------- ---------------
Comprehensive income (loss).................................... $ 12.0 $ (23.9) $ (54.0)
============== ============== ===============
F-42
Effective Income Tax Rate: Year Ended December 31,
($ amounts in millions) ---------------------------------------
2004 2003 2002
------------- ------------ ------------
Income tax expense (benefit) at statutory rate of 35%................... $ 48.0 $ (7.1) $ (71.2)
Tax-advantaged investment income........................................ (10.8) (6.8) (12.6)
Intangible asset amortization and impairments........................... -- -- 19.5
Realized losses on available-for-sale securities pledged as collateral.. 4.5 0.9 9.2
State income taxes...................................................... 0.1 (4.3) (1.2)
Tax interest recoveries................................................. -- (1.1) --
Other, net.............................................................. (1.3) 0.1 (2.5)
------------- ------------ ------------
Income tax expense (benefit) applicable to continuing operations........ $ 40.5 $ (18.3) $ (58.8)
============= ============ ============
Effective income tax rates.............................................. 29.5% (90.6)% (28.9)%
============= ============ ============
Deferred Income Tax Balances Attributable to Temporary Differences: As of December 31,
($ amounts in millions) -----------------------------
2004 2003
-------------- --------------
Deferred income tax assets
Future policyholder benefits....................................................... $ 214.1 $ 215.2
Unearned premiums / deferred revenues.............................................. 118.1 125.1
Employee benefits.................................................................. 98.3 91.1
Intangible assets.................................................................. 19.2 18.0
Investments........................................................................ 76.8 114.1
Net operating loss carryover benefits.............................................. 59.5 54.3
Foreign tax credits carryover benefits............................................. 0.1 0.1
Low income housing tax credits..................................................... 12.3 12.3
Other.............................................................................. 11.6 9.1
Valuation allowance................................................................ (7.9) (4.6)
-------------- --------------
Gross deferred income tax assets................................................... 602.1 634.7
-------------- --------------
Deferred tax liabilities
Deferred policy acquisition costs.................................................. (339.0) (316.1)
Investments........................................................................ (137.0) (160.5)
Investment management contracts.................................................... (86.6) (94.2)
Other.............................................................................. (8.8) (5.2)
-------------- --------------
Gross deferred income tax liabilities.............................................. (571.4) (576.0)
-------------- --------------
Deferred income tax asset.......................................................... $ 30.7 $ 58.7
============== ==============
We have elected to file a consolidated federal income tax return for 2004 and prior years. Within the
consolidated tax return, we are required by regulations of the Internal Revenue Service, or IRS, to segregate
the entities into two groups: life insurance companies and non-life insurance companies. We are limited as to
the amount of any operating losses from one group that can be offset against taxable income of the other group.
These limitations affect the amount of any operating loss carryforwards that we have now or in the future.
As of December 31, 2004, we had deferred tax assets of $51.6 million related to net operating losses for
federal income tax purposes and $7.9 million for state income tax purposes. The related federal net operating
losses are scheduled to expire as follows: $61.2 million in 2017, $12.5 million in 2018, $1.1 million in 2019,
$1.8 million in 2022, $33.5 in 2023 and $44.8 in 2024. The state net operating losses relate to the non-life
subgroup and are scheduled to expire as follows: $29.8 million in 2012 and 2013 and $72.0 million in 2019
through 2023. Due to the inability to combine the life insurance and non-life insurance subgroups for state
income tax purposes, we established a $7.9 million and a $4.6 million valuation allowance at the end of 2004
and 2003, respectively, relative to the state net operating loss carryforwards.
As of December 31, 2004, our deferred income tax asset of $0.1 million related to foreign tax credit carryovers
was expected to expire between the 2006 and 2008 tax years.
F-43
As of December 31, 2004, our deferred income tax assets of $12.3 million related to low income housing tax
credits are expected to expire as follows: $4.1 million in 2022, $4.1 million in 2023 and $4.1 million in 2024.
We have determined, based on our earnings and future income, that it is more likely than not that the deferred
income tax assets after valuation allowance already recorded as of December 31, 2004 and 2003 will be realized.
In determining the adequacy of future income, we have considered projected future income, reversal of existing
temporary differences and available tax planning strategies that could be implemented, if necessary.
Our federal income tax returns are routinely audited by the IRS, and estimated provisions are routinely
provided in the financial statements in anticipation of the results of these audits. While it is often
difficult to predict the outcome of these audits, including the timing of any resolution of any particular tax
matter, we believe that our reserves, as reported on our consolidated balance sheet, are adequate for all open
tax years. Unfavorable resolution of any particular issue could result in additional use of cash to pay
liabilities that would be deemed owed to the IRS. Additionally, any unfavorable or favorable resolution of any
particular issue could result in an increase or decrease, respectively, to our effective income tax rate to the
extent that our estimates differ from the ultimate resolution. Tax-advantaged investment income for 2004
includes a $5.7 million benefit related to the favorable resolution of certain tax matters with the IRS.
11. Employee Benefit Plans and Employment Agreements
Pension and other postemployment benefits
We provide our employees with postemployment benefits that include retirement benefits, through pension and
savings plans, and other benefits, including health care and life insurance. The components of pension and
postretirement benefit costs follow:
Components of Pension and Other Postemployment Benefit Cost: Year Ended December 31,
($ amounts in millions) -----------------------------------------
2004 2003 2002
------------ ------------ -------------
Cost components
Recurring pension benefit expense..................................... $ 16.0 $ 22.8 $ 15.2
Recurring other postretirement benefit expense........................ 3.8 3.6 4.2
Savings plans expense................................................. 5.1 5.4 4.9
------------ ------------ -------------
Total continuing operations recurring expense......................... 24.9 31.8 24.3
Total non-recurring and discontinued operations expense (benefit)..... (8.4) 1.3 0.6
------------ ------------ -------------
Total pension and other postemployment benefit cost................... $ 16.5 $ 33.1 $ 24.9
============ ============ =============
Principal Rates and Assumptions: Year Ended December 31,
--------------------------------------
2004 2003 2002
------------ ------------ ------------
Assumptions Used to Determine Benefit Obligations
Projected benefit obligation discount rate............................ 5.75% 6.0% 6.5%
Future compensation increase rate..................................... 4.0% 3.5% 3.5%
Pension plan assets long-term rate of return.......................... 8.5% 8.5% 8.5%
Deferred investment gain/loss amortization corridor................... 5.0% 5.0% 5.0%
Future health care cost increase rate, age 64 and younger............. 8.5% 9.25% 10.0%
Future health care cost increase rate, age 65 and older............... 10.5% 11.25% 12.0%
Assumptions Used to Determine Benefit Expense
Projected benefit obligation discount rate............................ 6.0% 6.5% 7.0%
Future compensation increase rate..................................... 3.5% 3.5% 4.0%
Pension plan assets long-term rate of return.......................... 8.5% 8.5% 9.0%
Deferred investment gain/loss amortization corridor................... 5.0% 5.0% 5.0%
Future health care cost increase rate, age 64 and younger............. 9.25% 10.0% 5.5%
Future health care cost increase rate, age 65 and older............... 11.25% 12.0% 5.5%
F-44
Our investment policy and strategy employs a total return approach combining equities, fixed income, real
estate and other assets to maximize the long-term return of the plan assets for a prudent level of risk. Risk
tolerance is determined based on consideration of plan liabilities and plan-funded status. The investment
portfolio contains a diversified blend of equity, fixed income, real estate and alternative investments. The
equity investments are diversified across domestic and foreign markets, across market capitalizations (large,
mid and small cap), as well as growth, value and blend. Derivative instruments are not typically used for
implementing asset allocation decisions and are never used in conjunction with leverage. Investment performance
is measured and monitored on an on-going basis through quarterly investment portfolio reviews, annual liability
measurement, and periodic presentations by asset managers included in the plan.
We use a building block approach in estimating the long-term rate of return for plan assets. Historical returns
are determined by asset class. The historical relationships between equities, fixed income and other asset
classes are reviewed. We apply long-term asset return estimates to the plan’s target asset allocation to
determine the weighted-average long-term return. Our long-term asset allocation was determined through modeling
long-term returns and asset return volatilities. The allocation reflects proper diversification and was
reviewed against other corporate pension plans for reasonability and appropriateness.
Employee Pension Plan Asset Allocation: As of December 31,
-----------------------------
2004 2003
-------------- --------------
Asset Category
Equity securities........................................................... 67% 63%
Debt securities............................................................. 24% 28%
Real estate................................................................. 6% 6%
Other....................................................................... 3% 3%
-------------- --------------
Total....................................................................... 100% 100%
============== ==============
We recognize pension and other postretirement benefit costs and obligations over the employees’ expected
service periods by discounting an estimate of aggregate benefits. We estimate aggregate benefits by using
assumptions for employee turnover, future compensation increases, rates of return on pension plan assets and
future health care costs. We recognize an expense for differences between actual experience and estimates over
the average future service period of participants. We recognize an expense for our contributions to employee
and agent savings plans at the time employees and agents make contributions to the plans. We also recognize the
costs and obligations of severance, disability and related life insurance and health care benefits to be paid
to inactive or former employees after employment but before retirement.
We use a December 31 measurement date for our pension and postemployment benefits.
In 2004 and 2003, as a result of the sale of our retail affiliated distribution operations and staff reduction
initiatives, there was a curtailment credit for the employee pension plan and postretirement plan in the
aggregate amount of $8.4 million and $0.8 million, respectively.
Pension plans
We have two defined benefit pension plans covering our employees. The employee pension plan, covering
substantially all of our employees, provides benefits up to the amount allowed under the Internal Revenue Code.
The supplemental plan provides benefits in excess of the primary plan. Retirement benefits under both plans are
a function of years of service and compensation.
F-45
Components of Pension Benefit Expense: Year Ended December 31,
($ amounts in millions) ---------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Service cost..................................................... $ 10.4 $ 12.4 $ 14.0
Interest cost.................................................... 32.8 33.0 34.5
Plan assets expected return...................................... (30.6) (27.4) (34.5)
Net gain amortization............................................ 4.9 6.2 1.7
Prior service cost amortization.................................. 0.9 1.1 2.0
Net transition asset amortization................................ (2.4) (2.5) (2.5)
-------------- -------------- --------------
Recurring pension benefit cost................................... 16.0 22.8 15.2
-------------- -------------- --------------
Special retirement programs cost................................. -- 3.3 0.6
Curtailment...................................................... 1.3 -- --
-------------- -------------- --------------
Non-recurring and discontinued operations cost................... 1.3 3.3 0.6
-------------- -------------- --------------
Pension benefit cost............................................. $ 17.3 $ 26.1 $ 15.8
============== ============== ==============
The employee pension plan is funded with assets held in a trust. The assets within the plan include corporate
and government debt securities, equity securities, real estate and venture capital partnerships. The
supplemental plan is unfunded. Upon a change in control (as defined in the plan) of The Phoenix Companies,
Inc., we are required to make an irrevocable contribution to a trust to fund the benefits payable under the
supplemental plan.
Changes in Plan Assets and Benefit Obligations: Employee Plan Supplemental Plan
($ amounts in millions) ----------------------------- -----------------------------
Year Ended December 31,
------------------------------------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Plans’ Assets
Plan assets’ actual gain......................... $ 44.3 $ 66.4 $ -- $ --
Employer contributions........................... 8.9 -- 5.7 5.1
Participant benefit payments..................... (25.7) (25.2) (5.7) (5.1)
-------------- -------------- -------------- --------------
Change in plan assets............................ 27.5 41.2 -- --
Plan assets, beginning of year................... 368.9 327.7 -- --
-------------- -------------- -------------- --------------
Plans’ assets, end of year....................... $ 396.4 $ 368.9 $ -- $ --
============== ============== ============== ==============
Plans’ Projected Benefit Obligation
Service and interest cost accrual................ $ (36.1) $ (37.1) $ (7.0) $ (8.4)
Actuarial gain (loss)............................ (35.5) (39.9) (11.2) 7.6
Curtailment gain (loss).......................... 7.5 1.3 2.7 (2.2)
Participant benefit payments..................... 25.7 25.2 5.7 5.1
-------------- -------------- -------------- --------------
Change in projected benefit obligation........... (38.4) (50.5) (9.8) 2.1
Projected benefit obligation, beginning of year.. (460.6) (410.1) (124.8) (126.9)
-------------- -------------- -------------- --------------
Projected benefit obligation, end of year........ $ (499.0) $ (460.6) $ (134.6) $ (124.8)
============== ============== ============== ==============
Accumulated benefit obligation................... $ 474.5 $ 434.6 $ 126.6 $ 112.9
============== ============== ============== ==============
In addition to the liability for the excess of accrued pension cost of each plan over the amount contributed to
the plan, we recognize a liability for any excess of the accumulated benefit obligation of each plan over the
fair value of plan assets. The offset to this additional liability is first recognized as an intangible asset,
which is limited to unrecognized prior service, including any unrecognized net transition obligation. Any
additional offsets are then recognized as an adjustment to accumulated other comprehensive income.
F-46
Funded Status of Pension Plans: Employee Plan Supplemental Plan
($ amounts in millions) ----------------------- -----------------------
Year Ended December 31,
------------------------------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Excess of accrued pension benefit cost over amount
contributed to plan........................................ $ (37.0) $ (38.3) $ (86.0) $ (82.0)
Excess of accumulated benefit obligation over plan assets... (41.2) (27.4) (40.6) (30.9)
----------- ----------- ----------- -----------
Accrued benefit obligation in other liabilities.............. (78.2) (65.7) (126.6) (112.9)
Intangible asset............................................. 8.0 11.0 -- --
Minimum pension liability adjustment in accumulated
other comprehensive income................................. 33.2 16.4 40.6 30.9
----------- ----------- ----------- -----------
Funding status recognized in balance sheet................... (37.0) (38.3) (86.0) (82.0)
----------- ----------- ----------- -----------
Net unamortized loss......................................... (57.6) (44.8) (52.6) (47.6)
Unamortized prior service (cost) credit...................... (8.0) (11.0) 4.0 4.8
Net unamortized transition asset............................. -- 2.4 -- --
----------- ----------- ----------- -----------
Funding status unrecognized in balance sheet................. (65.6) (53.4) (48.6) (42.8)
----------- ----------- ----------- -----------
Plan assets less than projected benefit obligations,
end of year................................................ $ (102.6) $ (91.7) $ (134.6) $ (124.8)
=========== =========== =========== ===========
We expect to contribute $43.3 million to the employee pension plan through 2009, including $6.5 million during
2005. For the estimated 2004 contribution, quarterly payments of $2.5 million each were made to the pension
plan in April, July and October 2004. In September 2004, we made a payment of $1.6 million, related to the 2003
minimum contribution.
Other postemployment benefits
Components of Postretirement Benefit Cost: Year Ended December 31,
($ amounts in millions) ---------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Service cost.................................................... $ 1.8 $ 1.7 $ 2.0
Interest cost................................................... 4.3 4.8 4.9
Net gain amortization........................................... (0.3) (0.1) (2.5)
Prior service cost amortization................................. (2.0) (2.8) (0.2)
-------------- -------------- --------------
Recurring other postretirement benefit cost..................... 3.8 3.6 4.2
Curtailments.................................................... (9.7) (2.0) --
-------------- -------------- --------------
Other postretirement benefit cost (benefit)..................... $ (5.9) $ 1.6 $ 4.2
============== ============== ==============
Changes in Plan Projected Benefit Obligation: Year Ended December 31,
($ amounts in millions) -----------------------------
2004 2003
-------------- --------------
Service and interest cost accrued.............................................. $ (6.1) $ (6.5)
Actuarial gain (loss).......................................................... 4.4 (5.9)
Curtailments................................................................... 3.6 0.5
Participant benefit payments................................................... 6.5 7.4
-------------- --------------
Change in projected benefit obligation......................................... 8.4 (4.5)
Projected benefit obligations, beginning of year............................... (78.7) (74.2)
-------------- --------------
Projected benefit obligations, end of year..................................... $ (70.3) $ (78.7)
============== ==============
F-47
Funded Status of Other Postretirement Benefit Plans: As of December 31,
($ amounts in millions) -----------------------------
2004 2003
-------------- --------------
Accrued benefit obligation included in other liabilities....................... $ (88.0) $ (100.5)
-------------- --------------
Net unamortized gain........................................................... 10.3 6.3
Unamortized prior service credits.............................................. 7.4 15.5
-------------- --------------
Funding status unrecognized in balance sheet................................... 17.7 21.8
-------------- --------------
Plan assets less than projected benefit obligations, end of year............... $ (70.3) $ (78.7)
============== ==============
The health care cost trend rate has a significant effect on the amounts reported. For example, increasing the
assumed health care cost trend rates by one percentage point in each year would increase the accumulated
postretirement benefit obligation by $1.0 million and the annual service and interest cost by $0.1 million.
Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the
accumulated postretirement benefit obligation by $1.0 million and the annual service and interest cost by $0.1
million.
Savings plans
During 2004, 2003 and 2002, we incurred costs of $5.1 million, $5.4 million and $4.9 million, respectively, for
contributions to our employer-sponsored savings plans.
During 2004 and 2003, we contributed 412,239 and 399,353 treasury shares, respectively, to fund the employer
match for our saving and investment benefit plans. These shares had a cost basis of $6.5 million and $6.3
million (weighted-average cost of $15.87 per share for both periods) and an aggregate market value of $4.9
million and $3.8 million.
In connection with the sale of our retail affiliated broker-dealer operations, we have begun the process of
terminating our employer-sponsored savings plan for affected employees. The effect of this termination is not
expected to be material to our financial statements.
Stock options
We have stock option plans under which we grant options for a fixed number of common shares to employees and
non-employee directors. Our options have an exercise price equal to the market value of the shares at the date
of grant. A new standard was issued which amends an existing standard on accounting for stock-based
compensation. Our adoption of the new standard results in expense recognition for stock options awarded after
December 31, 2002 over the service period of the options equal to their fair value at issuance. We calculate
the fair value of options using the Black-Scholes option valuation model. During 2002, a previous standard
allowed for us to account for stock-based compensation using the intrinsic value method which did not result in
expense recognition because at issuance date, the market price of our common stock was equal to the exercise
price of the options.
During the three years ended December 31, 2004, we granted options to employees and non-employee directors.
Each option, once vested, entitles the holder to purchase one share of our common stock. The employees’ options
vest over a three-year period while the directors’ options vested immediately. No options were exercisable
until June 25, 2003, the second anniversary of our initial public offering. All options terminate ten years
from the date of grant. The Stock Incentive Plan authorizes the issuance to officers and employees of up to
that number of options equal to 5% of the total number of common stock shares outstanding immediately after the
initial public offering in June 2001, or approximately 5,250,000 shares, plus an additional 1%, or
approximately 1,050,000 shares, for Phoenix Investment Partners officers and employees, less the number of
share options issuable under the Directors’ Stock Plan. The Directors’ Stock Plan authorizes the issuance to
non-employee directors of up to that number of options equal to 0.5%, or approximately 525,000 shares, of the
total number of common stock
F-48
shares outstanding immediately after the initial public offering in June 2001,plus 500,000 shares, bringing the
total to approximately 1,025,000 shares.
Stock Option Activity: Year Ended December 31,
($ amounts in millions, except per share data) ------------------------------------------------------------
2004 2003
----------------------------- -----------------------------
Weighted- Weighted-
Number of Average Number of Average
Common Exercise Common Exercise
Shares Price Shares Price
-------------- -------------- -------------- --------------
Outstanding, beginning of year.................... 4,627,856 $ 15.45 4,409,558 $ 16.20
Granted........................................... 566,070 11.24 572,504 9.00
Exercised......................................... (18,542) 9.07 -- 15.63
Canceled.......................................... (845,401) 14.68 (354,206) 14.13
-------------- --------------
Outstanding, end of year.......................... 4,329,983 $ 15.05 4,627,856 $ 15.45
============== ==============
At December 31, 2004, 2,793,742 of outstanding stock options were exercisable, with a weighted-average exercise
price of $15.89. The exercise prices of exercisable stock options ranged from $7.93 to $16.20 per share. At
December 31, 2004 the weighted-average remaining contractual life for all options outstanding was 7.8 years.
Key Assumptions Used in Option Valuation: Year Ended December 31,
-----------------------------
2004 2003
-------------- --------------
Weighted-average expected volatility........................................... 30.8% 43.7%
Weighted-average interest rate................................................. 4.2% 3.5%
Weighted-average common share dividend yield................................... 1.5% 1.8%
Restricted stock units and restricted stock
We record deferred compensation for the fair value of restricted stock unit awards and present deferred
compensation as a separate, offsetting component of stockholders’ equity. We recognized compensation expense
over the vesting period of the RSUs.
Generally, shares underlying those awards which are or become vested will be issued on the later of June 26,
2006 or each employee’s and each director’s respective termination or retirement.
RSU Activity at Weighted-Average Issue Price: Year Ended December 31,
------------------------------------------------------------
2004 2003
----------------------------- -----------------------------
Issue Issue
RSUs Price RSUs Price
-------------- -------------- -------------- --------------
Outstanding, beginning of year.................... 1,436,843 $ 10.47 573,477 $ 13.95
Awarded to officers and directors................. 213,045 11.59 701,598 7.95
Issued to officers in satisfaction of
deferred compensation liabilities............... -- -- 161,768 9.07
-------------- --------------
Outstanding, end of year.......................... 1,649,888 $ 10.61 1,436,843 $ 10.47
============== ==============
In addition to the RSU activity above, 1,818,560 RSUs are subject to future issuance based on the achievement
of performance criteria established under certain of our incentive plans.
Management restructuring expense and employment agreements
We have entered into agreements with certain key executives of the Company that will, in certain circumstances,
provide separation benefits upon the termination of the executive’s employment by the company for reasons other
than death, disability, cause or retirement, or by the executive for “good reason,” as defined in the
agreements.
F-49
For most of these executives, the agreements provide this protection only if the termination occurs following
(or is effectively connected with) the occurrence of a change of control, as defined in the agreements. Upon a
change in control, as defined, we are required to make an irrevocable contribution to a trust as soon as
possible following such change in control in an amount equal to pay such benefits payable under such
agreements.
We recorded a non-recurring expense of $33.7 million ($21.9 million after income taxes), $11.4 million ($7.2
million after income taxes) and $43.4 million ($28.5 million after income taxes) in 2004, 2003 and 2002,
respectively, primarily in connection with organizational and employment-related costs. The 2004 charges relate
mainly to the sale of our retail affiliated broker-dealer operations and the outsourcing of our information
technology infrastructure services. Reserves for management restructuring agreements are not material to our
consolidated financial statements at December 31, 2004 and 2003.
12. Other Comprehensive Income
We record unrealized gains and losses on available-for-sale securities, minimum pension liability adjustments
in excess of unrecognized prior service cost, foreign currency translation gains and losses and effective
portions of the gains or losses on derivative instruments designated as cash flow hedges in accumulated other
comprehensive income. Unrealized gains and losses on available-for-sale securities are recorded in other
comprehensive income until the related securities are sold, reclassified or deemed to be impaired. Minimum
pension liability adjustments in excess of unrecognized prior service cost are adjusted or eliminated in
subsequent periods to the extent that plan assets exceed accumulated benefits. Foreign currency translation
gains and losses are recorded in accumulated other comprehensive income. We also consider unrealized foreign
currency losses when evaluating investments for impairment. The effective portions of the gains or losses on
derivative instruments designated as cash flow hedges are reclassified into earnings in the same period in
which the hedged transaction affects earnings. If it is probable that a hedged forecasted transaction will no
longer occur, the effective portions of the gains or losses on derivative instruments designated as cash flow
hedges are reclassified into earnings immediately.
Year Ended December 31,
Sources of Other Comprehensive Income: ------------------------------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------------- ---------------------- ----------------------
Gross Net Gross Net Gross Net
--------- ---------- ----------- ---------- --------- ------------
Unrealized gains (losses) on investments.. $ 39.2 $ 26.7 $ 131.8 $ 159.6 $ 603.4 $ 104.6
Net realized investment losses on
available-for-sale securities
included in net income................... (43.0) (22.4) (113.9) (74.0) (50.5) (32.8)
--------- ---------- ----------- ---------- --------- ------------
Net unrealized investment gains............ (3.8) 4.3 17.9 85.6 552.9 71.8
Minimum pension liability adjustment....... (26.5) (17.2) 1.7 1.1 (26.8) (17.4)
Net unrealized foreign currency
translation adjustment .................. (4.6) (0.6) 11.9 8.2 7.1 1.2
Net unrealized derivative instruments
and other gains (losses)................. 4.6 7.8 41.6 40.3 (128.0) (129.9)
--------- ---------- ----------- ---------- --------- ------------
Other comprehensive income (loss).......... (30.3) $ (5.7) 73.1 $ 135.2 405.2 $ (74.3)
--------- ========== ----------- ========== --------- ============
Applicable policyholder
dividend obligation...................... 3.6 (45.5) 369.4
Applicable deferred policy acquisition
cost amortization........................ (7.7) (12.4) 95.9
Applicable deferred income taxes (benefit). (20.5) (4.2) 14.2
----------- ----------- -----------
Offsets to other comprehensive income...... (24.6) (62.1) 479.5
----------- ----------- -----------
Other comprehensive income (loss).......... $ (5.7) $ 135.2 $ (74.3)
=========== =========== ===========
F-50
As of December 31,
Components of Accumulated Other Comprehensive Income: ----------------------------------------------------
($ amounts in millions) 2004 2003
-------------------------- -------------------------
Gross Net Gross Net
------------ ------------- ------------ ------------
Unrealized gains on investments......................... $ 808.1 $ 211.6 $ 812.0 $ 207.3
Minimum pension liability adjustment (Note 11).......... (73.8) (47.9) (47.3) (30.7)
Unrealized foreign currency translation adjustment...... 5.7 3.5 10.3 4.1
Unrealized losses on derivative instruments and other... (125.0) (109.2) (129.7) (117.0)
------------ ------------- ------------ ------------
Accumulated other comprehensive income.................. 615.0 $ 58.0 645.3 $ 63.7
------------ ============= ------------ ============
Applicable policyholder dividend obligation............. 436.3 432.7
Applicable deferred policy acquisition costs............ 86.4 94.1
Applicable deferred income taxes........................ 34.3 54.8
------------ ------------
Offsets to accumulated other comprehensive income....... 557.0 581.6
------------ ------------
Accumulated other comprehensive income.................. $ 58.0 $ 63.7
============ ============
13. Earnings Per Share
We calculate earnings per share, EPS, on two bases: basic and diluted. We calculate basic EPS by dividing
earnings available to common stockholders by the weighted-average number of common shares outstanding during
the period. We calculate diluted EPS similarly except that, if applicable, we adjust earnings to reflect
earnings had the dilutive potential common shares been issued during the period, and we increase the
weighted-average number of shares to include the issuance of the dilutive potential common shares.
Year Ended December 31,
Shares Used in Calculation of Earnings Per Share: ---------------------------------------------
(shares in thousands) 2004 2003 2002
-------------- -------------- --------------
Weighted-average common shares outstanding...................... 94,676 94,218 97,854
-------------- -------------- --------------
Weighted-average effect of dilutive potential common shares:
Restricted stock units awarded and outstanding.............. 1,510 1,236 143
Employee stock options assumed issued....................... 101 12 --
Equity units assumed issued................................. 4,488 1,096 --
-------------- -------------- --------------
Potential common shares......................................... 6,099 2,344 143
Less: Potential common shares excluded from calculation
due to operating losses....................................... -- 2,344 143
-------------- -------------- --------------
Dilutive potential common shares................................ 6,099 -- --
-------------- -------------- --------------
Weighted-average common shares outstanding, including
dilutive potential common shares.............................. 100,775 94,218 97,854
============== ============== ==============
Employee stock options and equity units excluded from
calculation due to anti-dilutive exercise prices
(i.e., in excess of average common share market prices)
Stock options............................................... 3,632 4,187 4,410
Equity units................................................ -- -- 17,424
There are no adjustments to net income (loss) for the years 2004, 2003 and 2002 for purposes of calculating
earnings per share.
14. Discontinued Operations
During the first quarter of 2004, we sold 100% of the common stock held by us in Phoenix National Trust
Company. The financial statement effect of this transaction is not material to our consolidated financial
statements. The net after-tax income (loss) included in discontinued operations for the years ended 2004, 2003
and 2002 was $0.1 million, $(2.1) million and $(1.3) million, respectively.
F-51
During 1999, we discontinued our reinsurance operations as further described in Note 17.
We have excluded assets and liabilities of the discontinued operations from the assets and liabilities of
continuing operations and on a net basis included them in other assets on our consolidated balance sheet.
15. Phoenix Life Statutory Financial Information and Regulatory Matters
Our insurance subsidiaries are required to file, with state regulatory authorities, annual statements prepared
on an accounting basis prescribed or permitted by such authorities.
As of January 1, 2001 the New York State Insurance Department adopted the NAIC, Codification of Statutory
Accounting Principles guidance, with the exception for accounting for deferred income taxes. Codification
guidance replaced the accounting practices and procedures manual as the NAIC's primary guidance on statutory
accounting; it also provides guidance for areas where statutory accounting has been silent and changed current
statutory accounting in other areas. The effect of adoption decreased the statutory surplus of our insurance
subsidiaries by $66.4 million, primarily as a result of non-admitting certain assets and recording increased
investment reserves. As of December 31, 2002, the New York State Insurance Department adopted the NAIC
codification guidance for accounting for deferred income taxes.
As of December 31, 2004, statutory surplus differs from equity reported in accordance with GAAP for life
insurance companies primarily as follows:
• policy acquisition costs are expensed when incurred;
• investment reserves are based on different assumptions;
• surplus notes are included in surplus rather than debt;
• postretirement benefit expense allocated to Phoenix Life relate only to vested participants and expense
is based on different assumptions and reflect a different method of adoption;
• life insurance reserves are based on different assumptions; and
• net deferred income tax assets in excess of 10% of previously filed statutory capital and surplus are
not recorded.
As of or for the Year Ended December 31,
Statutory Financial Data for Phoenix Life: ---------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Statutory capital, surplus, and surplus notes................... $ 814.6 $ 762.9 $ 861.0
Asset valuation reserve, or AVR................................. 213.6 198.6 147.0
-------------- -------------- --------------
Statutory capital, surplus, surplus notes and AVR............... $ 1,028.2 $ 961.5 $ 1,008.0
============== ============== ==============
Statutory gain from operations.................................. $ 35.1 $ 69.7 $ 44.5
============== ============== ==============
Statutory net income............................................ $ 47.1 $ 21.5 $ 7.5
============== ============== ==============
New York Insurance Law requires that New York life insurers report their RBC. RBC is based on a formula
calculated by applying factors to various assets, 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. New York Insurance Law gives the New York Superintendent of Insurance explicit regulatory
authority to require various actions by, or take various actions against, insurers whose total adjusted capital
does not exceed certain RBC levels. Each of the United States insurance subsidiaries of Phoenix Life is also
subject to these same RBC requirements. Phoenix Life and each of its insurance subsidiaries' RBC was in excess
of 300% of Company Action Level (the level where a life insurance enterprise must submit a comprehensive plan
to state insurance regulators) as of December 31, 2004 and 2003.
F-52
Under New York Insurance Law, Phoenix Life can pay stockholder dividends to us in any calendar year without
prior approval from the New York State Insurance Department 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 dividends of $69.7 million in 2004 and is able to pay $35.1 million in dividends in 2005 without
prior approval from the New York State Insurance Department. Any additional dividend payments, in excess of
$35.1 million in 2005, would be subject to the discretion of the New York Superintendent of Insurance.
16. Premises and Equipment
Premises and equipment, consisting primarily of office buildings occupied by us, are stated at cost less
accumulated depreciation and amortization. We depreciate buildings on the straight-line method over 10 to 45
years and equipment primarily on a modified accelerated method over 3 to 10 years. We amortize leasehold
improvements over the terms of the related leases.
As of December 31,
Cost and Carrying Value of Premises and Equipment: -----------------------------------------------------------
($ amounts in millions) 2004 2003
----------------------------- -----------------------------
Carrying Carrying
Cost Value Cost Value
-------------- -------------- -------------- --------------
Real estate........................................ $ 116.0 $ 45.7 $ 148.8 $ 63.5
Equipment.......................................... 178.0 26.0 188.3 31.8
Leasehold improvements............................. 8.5 3.3 10.5 6.8
-------------- -------------- -------------- --------------
Premises and equipment cost and carrying value..... 302.5 $ 75.0 347.6 $ 102.1
============== ==============
Accumulated depreciation and amortization.......... (227.5) (245.5)
-------------- --------------
Premises and equipment............................. $ 75.0 $ 102.1
============== ==============
Depreciation and amortization expense for premises and equipment for 2004, 2003 and 2002 totaled $13.5 million,
$19.3 million and $21.4 million, respectively.
On May 25, 2004, we sold our Enfield, Connecticut office facility for a loss of $1.0 million ($0.7 million
after-tax). In anticipation of that sale, we had recorded a $6.2 million ($4.0 million after-tax) realized
impairment loss in 2003.
Rental expenses for operating leases for continuing operations, principally with respect to buildings, amounted
to $10.5 million, $11.4 million and $12.1 million in 2004, 2003 and 2002, respectively. Future minimum rental
payments under non-cancelable operating leases for continuing operations were $31.0 million as of December 31,
2004, payable as follows: 2005, $8.8 million; 2006, $7.8 million; 2007, $6.5 million; 2008, $4.2 million; 2009,
$1.9 million and thereafter, $1.8 million.
17. Contingent Liabilities
In addition to the matters discussed below, we are, in the normal cause of business, 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 advisor, investor or taxpayer. In addition, various 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. While it is not feasible to predict or determine the ultimate outcome of all pending
investigations and legal proceedings or to provide reasonable ranges of potential losses, we believe that their
outcomes are not likely, either individually or in the aggregate, to have a material adverse effect on our
consolidated financial condition. However, given the large or indeterminate amounts sought in certain of these
matters and litigation's inherent unpredictability, it is
F-53
possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on
our results of operations or cash flows.
Recently, there has been a significant increase in federal and state regulatory activity relating to financial
services companies, particularly mutual fund companies. These regulatory inquiries have focused on a number of
mutual fund issues, including late-trading and valuation issues. Our mutual funds, which we offer directly to
retail investors and qualified retirement plans as well as through the separate accounts associated with
certain of our variable life insurance policies and variable annuity products, entitle us to impose
restrictions on frequent exchanges and trades in the mutual funds and on transfers between sub-accounts and
variable products. We, like many others in the financial services industry, have received requests for
information from the SEC and state authorities, in each case requesting documentation and other information
regarding various mutual fund regulatory issues. We continue to cooperate fully with these regulatory agencies
in responding to these requests. In addition, representatives from the SEC's Office of Compliance, Inspections
and Examinations are conducting compliance examinations of our mutual fund, variable annuity and mutual fund
transfer agent operations.
A number of companies have announced settlements of enforcement actions with various regulatory agencies,
primarily the SEC and the New York Attorney General's Office. While no such action has been initiated against
us, it is possible that one or more regulatory agencies may pursue an action against us in the future.
These types of lawsuits and regulatory actions may be difficult to assess or quantify, may seek recovery of
indeterminate amounts, including punitive and treble damages, and the nature and magnitude of their outcomes
may remain unknown for substantial periods of time. While it is not feasible to predict or determine the
ultimate outcome of all pending investigations and legal proceedings or to provide reasonable ranges of
potential losses, we believe that their outcomes are not likely, either individually or in the aggregate, to
have a material adverse effect on our consolidated financial condition.
Discontinued Reinsurance Operations
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 also purchased aggregate excess-of-loss
reinsurance to further protect us from unfavorable results from this discontinued business. On February 7, 2005
we notified the aggregate excess-of-loss reinsurer that we were exercising our option to commute this contract.
The commutation will be effective during the second quarter of 2005. The effect of the commutation will not be
material to our consolidated financial statements.
We have established reserves for claims and related expenses that we expect to pay on our discontinued group
accident and health reinsurance business. These reserves are 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 aggregate
excess-of-loss reinsurance, the amounts we believe we will collect from our retrocessionaires and the likely
legal and administrative costs of winding down the business.
Our total reserves, including coverage available from our aggregate excess-of-loss reinsurance and reserves for
amounts recoverable from retrocessionaires, were $110.0 million as of December 31, 2004. Our total amounts
recoverable from retrocessionaires related to paid losses were $60.0 million as of December 31, 2004. We did
not recognize any gains or losses related to our discontinued group accident and health reinsurance business
during the years ended December 31, 2004, 2003 and 2002, respectively.
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. In
addition, unfavorable
F-54
or favorable claims and/or reinsurance recovery experience is reasonably possible and could result in our
recognition of additional losses or gains, respectively, in future years. Given the uncertainty associated with
litigation and other dispute resolution proceedings, as described below, as well as 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), the range of any reasonably possible
additional future losses or gains is not currently estimable. However, it is our opinion, based on current
information and after consideration of the provisions made in these financial statements, as described above,
that any future adverse or favorable development of recorded reserves and/or reinsurance recoverables will not
have a material effect on our financial position.
Additional information with respect to our group accident and health reinsurance run-off exposures follows:
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., or Unicover. Unicover organized and managed a
group, or pool, of insurance companies, or Unicover pool, and two other facilities, or 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 were involved in several proceedings in
which the pool members asserted that they could deny coverage to certain insurers that claimed that they
purchased reinsurance coverage from the pool. Those matters were settled. Also, the pool members were involved
in proceedings arising from business ceded to the London market. Those proceedings were settled.
Further, we were, along with Sun Life Assurance of Canada, or Sun Life, and Cologne Life Reinsurance Company,
or 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. Subsequently, billing disputes have arisen between certain pool
members and the retrocessionaires, including us, concerning certain losses ceded to the retrocession
agreements. A significant portion of our remaining potential liabilities as a retrocessionaire of the Unicover
pool has been recovered from certain of our retrocessionaires, and additional amounts may be recovered from one
other retrocessionaire, as discussed below under "Related Proceedings."
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 one other retrocessionaire, as discussed below under "Related Proceedings."
F-55
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. Subsequently, we were reimbursed by one of our retrocessionaires for $6.0 million of the amount we
paid under the settlement.
The amounts paid and the results achieved in the above settlements and arbitration decision were consistent
with the amounts previously reflected in our consolidated financial statements.
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. We have been involved
in disputes with certain of our own retrocessionaires who had sought on various grounds to avoid paying any
amounts to us. Most of those disputes, as described below, have been resolved.
Currently, we remain involved in a London arbitration proceeding with one of those retrocessionaires. The
arbitration 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 retrocessionaire appealed the arbitration
decision only with respect to the Unicover business. We received a favorable decision from the Court of Appeal
in December 2004. The retrocessionaire submitted a request to the House of Lords to review the decision. Two
other disputes with this retrocessionaire were settled in March 2004 and did not have a material effect on our
reinsurance recoverable balances. As of December 31, 2004, the reinsurance recoverable balance from this
retrocessionaire related to paid losses was $45.0 million, subject to further development.
A dispute with another retrocessionaire was the subject of arbitration proceedings that we initiated in
December 2003. The purpose of the arbitration proceedings was to confirm the validity and enforce the terms of
the retrocessional contracts. In December 2004, we settled the dispute and discontinued the arbitration
proceedings. The amount received and the results achieved in the settlement were consistent with the amounts
previously reflected in our consolidated financial statements. As of December 31, 2004, the reinsurance
recoverable balance from this retrocessionaire was $0.0 million.
A dispute with a third retrocessionaire, which sought to avoid an excess-of-loss retrocession agreement, a
surplus share retrocession agreement and a quota share retrocession agreement, was the subject of an
arbitration in November 2003. In December 2003, the arbitration panel issued its interim decision, which is
confidential. The financial implications of the interim decision are consistent with our current financial
provisions. Since then, this retrocessionaire has paid $8.0 million to bring the account current. As of
December 31, 2004, the reinsurance recoverable balance from this retrocessionaire related to paid losses was
$0.0 million, subject to further development. In June 2004 the arbitration panel relinquished its jurisdiction.
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 remaining retrocessionaires disputes and successfully avoids its obligations. At this stage, we
cannot estimate the amount at risk related to these potential disputes 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 business not related to
Unicover.
Other Proceedings
Another set of disputes involves personal accident business that was reinsured in the London reinsurance market
in which we participated from 1994 to 1997. These disputes involve multiple layers of reinsurance and
allegations that the reinsurance programs created by the brokers involved in placing those layers were
interrelated
F-56
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, we and many of
these companies have participated in negotiations that have resulted in settlements of disputes relating to the
1994 and 1995 contract years. The amounts paid and the results achieved in the 1994 and 1995 contract year
settlements are consistent with the amounts previously reflected in our consolidated financial statements.
Although we are vigorously defending our contractual rights in respect of the 1996 and 1997 contract year
disputes, we remain actively involved in attempts to reach negotiated business solutions. At this stage, we
cannot predict the outcome, nor can we estimate the remaining 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). However, it is our opinion based on current information that amounts included in our
reserves as of December 31, 2004 are adequate with respect to the 1996 and 1997 contract year disputes.
18. Other Commitments
During the third quarter of 2004, we entered into a seven-year information technology infrastructure services
agreement with Electronic Data Systems, or EDS, under which we expect to make aggregate payments of
approximately $120.0 million.
During the normal course of business, the Company enters into agreements to fund venture capital partnerships
and to purchase private placement investments. As of December 31, 2004, the Company had committed $182.6
million under such investments, of which $50.8 million is expected to be disbursed by December 31, 2005.
19. Condensed Financial Information of The Phoenix Companies, Inc.
A summary of The Phoenix Companies, Inc. (parent company only) financial information follows:
As of December 31,
Parent Company Financial Position: -----------------------------
($ amounts in millions) 2004 2003
-------------- --------------
Assets
Cash and cash equivalents...................................................... $ 61.0 $ 22.8
Investment in Phoenix Life..................................................... 1,700.9 1,637.6
Investment in Phoenix Investment Partners...................................... 226.3 231.0
Investments in other subsidiaries.............................................. 105.7 123.5
Loans to Phoenix Investment Partners........................................... 366.0 377.0
Advances to subsidiaries....................................................... 208.9 234.2
Hilb Rogal and Hobbs, or HRH, common stock, at fair value (Note 5)............. 131.3 116.2
Intangible assets (Note 11).................................................... 8.0 11.0
Deferred income taxes.......................................................... 39.0 21.6
Other assets................................................................... 111.2 103.2
-------------- --------------
Total assets................................................................... $ 2,958.3 $ 2,878.1
============== ==============
Liabilities and Stockholders' Equity
Stock purchase contracts (Note 6).............................................. $ 131.9 $ 128.8
Indebtedness (Note 6).......................................................... 461.7 464.0
Accrued pension and postemployment benefits (Note 11).......................... 275.1 281.1
Other liabilities.............................................................. 67.2 56.4
-------------- --------------
Total liabilities.............................................................. 935.9 930.3
Total stockholders' equity..................................................... 2,022.4 1,947.8
-------------- --------------
Total liabilities and stockholders' equity..................................... $ 2,958.3 $ 2,878.1
============== ==============
F-57
Year Ended December 31,
Parent Company Results of Operations: ----------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
Revenues
Dividends received from subsidiary, Phoenix Life................ $ 69.7 $ 44.5 $ 113.8
Investment income, principally from subsidiary,
Phoenix Investment Partners................................... 22.5 23.0 15.2
Net realized investment gains................................... -- (0.1) 1.7
-------------- -------------- --------------
Total revenues.................................................. 92.2 67.4 130.7
-------------- -------------- --------------
Interest expense................................................ 27.4 26.9 15.8
Demutualization expense......................................... -- -- 1.8
Other operating expenses........................................ 25.9 18.8 7.2
-------------- -------------- --------------
Total expenses.................................................. 53.3 45.7 24.8
-------------- -------------- --------------
Income before income taxes and equity in undistributed losses
of subsidiaries............................................... 38.9 21.7 105.9
Income tax benefit.............................................. (12.3) (8.5) (2.2)
-------------- -------------- --------------
Income before equity in undistributed earnings of subsidiaries.. 51.2 30.2 108.1
Equity in undistributed earnings (losses) of subsidiaries....... 35.2 (36.4) (380.4)
-------------- -------------- --------------
Net income (loss)............................................... $ 86.4 $ (6.2) $ (272.3)
============== ============== ==============
Year Ended December 31,
Parent Company Cash Flows: ----------------------------------------------
($ amounts in millions) 2004 2003 2002
--------------- -------------- --------------
Operating Activities
Cash dividends received from subsidiary......................... $ 69.7 $ 44.5 $ 67.0
Investment income received...................................... 10.6 9.7 11.7
Interest, income taxes and other expenses paid, net............. (19.1) (21.0) (17.4)
--------------- -------------- --------------
Cash from operating activities.................................. 61.2 33.2 61.3
--------------- -------------- --------------
Advances to subsidiaries and capital contributed to subsidiaries (4.0) (7.8) (287.4)
Purchase of subsidiaries........................................ (4.0) (17.9) --
Equity security purchases....................................... -- -- (157.4)
Debt and equity security sales.................................. -- -- 72.8
--------------- -------------- --------------
Cash for investing activities................................... (8.0) (25.7) (372.0)
--------------- -------------- --------------
Stock purchase contract and indebtedness proceeds............... -- -- 133.9
Equity units proceeds........................................... -- -- 149.1
Common stock issuance........................................... 0.1 -- --
Common stock repurchase......................................... -- -- (131.1)
Common stock dividend paid...................................... (15.1) (15.1) (15.8)
Payments to subsidiary to reimburse policyholder
credits and payments in lieu of stock......................... -- -- --
--------------- -------------- --------------
Cash (for) from financing activities............................ (15.0) (15.1) 136.1
--------------- -------------- --------------
Change in cash and cash equivalents............................. 38.2 (7.6) (174.6)
Cash and cash equivalents, beginning of year.................... 22.8 30.4 205.0
--------------- -------------- --------------
Cash and cash equivalents, end of year.......................... $ 61.0 $ 22.8 $ 30.4
=============== ============== ==============
20. Additional Operating Cash Flow Information
Cash and cash equivalents
Cash and cash equivalents consist of cash and short-term investments with original maturities of 90 days or
less.
F-58
Years Ended December 31,
Operating Cash Flows on Indirect Basis: ----------------------------------------------
($ amounts in millions) 2004 2003 2002
-------------- -------------- --------------
OPERATING ACTIVITIES
Income (loss) from continuing operations........................ $ 86.3 $ (4.1) $ (140.7)
Net realized investment losses.................................. 0.8 98.5 133.9
Unrealized gain on trading equity securities.................... (85.9) -- --
Amortization and depreciation................................... 49.1 52.5 122.4
Investment (gains) loss......................................... (73.6) 78.5 74.4
Equity in (earnings) losses of affiliates....................... 17.2 2.0 (7.2)
Deferred income tax (benefit) expense........................... 48.5 (11.9) (42.4)
Decrease (increase) in receivables.............................. 38.3 (7.7) (8.3)
Deferred policy acquisition costs increase...................... (54.5) (111.4) (206.4)
Increase in policy liabilities and accruals..................... 60.1 454.1 473.4
Other assets and other liabilities net change................... (27.2) (152.9) (75.6)
-------------- -------------- --------------
Cash from continuing operations................................. 59.1 397.6 323.5
Discontinued operations, net.................................... 14.9 (36.5) (59.1)
-------------- -------------- --------------
Cash from operating activities.................................. $ 74.0 $ 361.1 $ 264.4
============== ============== ==============
21. Supplemental Unaudited Financial Information
Quarter Ended
Summarized Selected Quarterly Financial Data: ----------------------------------------------------------
($ amounts in millions, except per share amounts) Mar 31, June 30, Sept 30, Dec 31,
-------------- -------------- ------------- -------------
2004
----------------------------------------------------------
Revenues........................................... $ 671.0 $ 666.9 $ 661.9 $ 743.4
Income from continuing operations................. $ 16.3 $ 14.6 $ 7.1 $ 48.3
Net income......................................... $ 16.6 $ 14.4 $ 7.1 $ 48.3
Earnings per share:
Basic............................................ $ 0.18 $ 0.14 $ 0.07 $ 0.51
Diluted.......................................... $ 0.16 $ 0.14 $ 0.07 $ 0.48
Quarter Ended
Summarized Selected Quarterly Financial Data: ----------------------------------------------------------
($ amounts in millions, except per share amounts) Mar 31, June 30, Sept 30, Dec 31,
-------------- -------------- ------------- -------------
2003
----------------------------------------------------------
Revenues........................................... $ 661.3 $ 557.7 $ 698.6 $ 715.9
Income (loss) from continuing operations........... $ 1.7 $ (49.2) $ 13.6 $ 29.8
Net income (loss).................................. $ 1.3 $ (49.6) $ 13.2 $ 28.9
Earnings (loss) per share:
Basic............................................ $ 0.01 $ (0.53) $ 0.14 $ 0.31
Diluted.......................................... $ 0.01 $ (0.53) $ 0.13 $ 0.29
F-59
Revenues as reported above differ from amounts previously reported in our respective Quarterly Reports on Form
10-Q due to our equity in earnings of affiliates, which was reclassified from revenue to "equity in
undistributed earnings of affiliates" on our consolidated statement of income and comprehensive income. The
2004 amounts reclassified were $(2.8) million, $0.0 million and $1.0 million for the first, second and third
quarter, respectively. The 2003 amounts reclassified were $2.1 million, $(0.8) million and $0.0 million for the
first, second and third quarter, respectively.
F-60
EXHIBIT INDEX
Exhibit
- ------------
3.1 Form of Amended and Restated Certificate of Incorporation of The Phoenix Companies, Inc.
(incorporated herein by reference to Exhibit 3.1 to The Phoenix Companies, Inc. Registration
Statement on Form S-l (Registration No. 333-73896), filed on November 21, 2001, as amended)
3.2 Form of By-Laws of The Phoenix Companies, Inc., as amended June 5, 2003*
10.1 Phoenix Home Life Mutual Insurance Company Long-term Incentive Plan (incorporated herein by
reference to Exhibit 10.1 to The Phoenix Companies, Inc. Registration Statement on Form S-l
(Registration No. 333- 55268), filed on February 9, 2001, as amended)
10.2 The Phoenix Companies, Inc. Stock Incentive Plan (incorporated herein by reference to Exhibit
10.2 to The Phoenix Companies, Inc. Registration Statement on Form S-l (Registration No.
333-55268), filed on February 9, 2001, as amended)
10.3 Form of Incentive Stock Option Agreement under The Phoenix Companies, Inc. Stock Incentive Plan*
10.4 Form of Non-Qualified Stock Option Agreement under The Phoenix Companies, Inc. Stock Incentive
Plan*
10.5 The Phoenix Companies, Inc. Performance Incentive Plan (incorporated herein by reference to
Exhibit 10.3 to The Phoenix Companies, Inc. Registration Statement on Form S-1 (Registration No.
333-55268), filed on February 9, 2001, as amended)
10.6 The Phoenix Companies, Inc. Directors Stock Plan (incorporated herein by reference to Exhibit
10.4 to The Phoenix Companies, Inc. Registration Statement on Form S-l (Registration No.
333-55268), filed on February 9, 2001, as amended)
10.7 The Phoenix Companies, Inc. Excess Benefit Plan (as amended and restated effective January 1,
2003)*
10.8 The Phoenix Companies, Inc. Non-Qualified Deferred Compensation and Excess Investment Plan as
amended and restated effective as of January 1, 2004*
10.9 The Phoenix Companies, Inc. Nonqualified Supplemental Executive Retirement Plan, as amended and
restated effective as of January 1, 2004 (incorporated herein by reference to Exhibit 10.10 to
The Phoenix Companies, Inc. Quarterly Report on Form 10-Q filed on November 9, 2004)
10.10 The Phoenix Companies, Inc. Nonqualified Supplemental Executive Retirement Plan B effective as
of August 1, 2004 (incorporated herein by reference to Exhibit 10.11 to The Phoenix Companies,
Inc. Quarterly Report on Form 10-Q filed on November 9, 2004)
10.11 Phoenix Investment Partners 2001 Phantom Option Plan (incorporated herein by reference to
Exhibit 10.15 to The Phoenix Companies, Inc. Annual Report on Form 10-K filed March 21, 2003)
10.12 Phoenix Investment Partners 2002 Phantom Option Plan (incorporated herein by reference to
Exhibit 10.16 to The Phoenix Companies, Inc. Annual Report on Form 10-K filed March 21, 2003)
10.13 The Phoenix Companies, Inc. 2003 Restricted Stock, Restricted Stock Unit and Long-Term Incentive
Plan (incorporated herein by reference to Exhibit B to The Phoenix Companies, Inc. 2003 Proxy
Statement, filed on March 21, 2003)
10.14 Form of Notice to Participates under The Phoenix Companies, Inc. 2003 Restricted Stock,
Restricted Stock Unit and Long-Term Incentive Plan*
10.15 The Phoenix Companies, Inc. Executive Severance Allowance Plan effective as of January 1, 2005*
10.16 Stockholder Rights Agreement dated as of June 19, 2001 (incorporated herein by reference to
Exhibit 10.24
E-1
to The Phoenix Companies, Inc. Registration Statement on Form S-l (Registration No. 333-73896),
filed on November 21, 2001, as amended)
10.17 Binder of Reinsurance dated as of September 30, 1999, between Phoenix Home Life Mutual Insurance
Company, American Phoenix Life & Reassurance Company and European Reinsurance Company of
Zurich (Bermuda Branch) (+) (incorporated herein by reference to Exhibit 10.36 to The Phoenix
Companies, Inc. Registration Statement on Form S-1 (Registration No. 333-55268), filed on
February 9, 2001, as amended)
10.18 Amendment No. 1 dated as of February 1, 2000, to the Binder of Reinsurance, dated as of
September 30, 1999, between Phoenix Home Life Mutual Insurance Company, American Phoenix Life &
Reassurance Company and European Reinsurance Company of Zurich (Bermuda Branch) (+)
(incorporated herein by reference to Exhibit 10.37 to The Phoenix Companies, Inc. Registration
Statement on Form S-l (Registration No. 333-55268), filed on February 9, 2001, as amended)
10.19 Acquisition Agreement dated as November 10, 1999, between Selling Management Shareholders,
Aberdeen Asset Management PLC, The Standard Life Assurance Co., The Non-Selling Management
Shareholders, Lombard International Assurance SA and PM Holdings, Inc. (incorporated herein by
reference to Exhibit 10.43 to The Phoenix Companies, Inc. Registration Statement on Form S-l
(Registration No. 333-55268), filed on February 9, 2001, as amended)
10.20 Subordination Agreement dated as of June 11, 2001 between Phoenix Home Life Mutual Insurance
Company and Phoenix Investment Partners, Ltd. (incorporated herein by reference to Exhibit 10.64
to The Phoenix Companies, Inc. Registration Statement on Form S-l (Registration No. 333-55268),
filed on February 9, 2001, as amended)
10.21 Standstill Agreement dated May 18, 2001, between The Phoenix Companies, Inc. and State Farm
Mutual Insurance Company (incorporated herein by reference to Exhibit 4.2 to The Phoenix
Companies, Inc. Registration Statement on Form S-1 (Registration No. 333-55268), filed on
February 9, 2001, as amended)
10.22 Shareholder's Agreement dated as of June 19, 2001, between The Phoenix Companies, Inc. and State
Farm Mutual Insurance Company (incorporated herein by reference to Exhibit 10.56 to The Phoenix
Companies, Inc. Registration Statement on Form S-1 (Registration No. 333-73896), filed on
November 21, 2001, as amended)
10.23 Acquisition Agreement, dated as of November 12, 2001, by and among Kayne Anderson Rudnick
Investment Management, LLC, the equity holders named therein and Phoenix Investment Partners,
Ltd. (incorporated herein by reference to Exhibit 10.57 to The Phoenix Companies, Inc.
Registration Statement on Form S-1 (Registration No. 333-73896), filed on November 21, 2001, as
amended)
10.24 Subordination Agreement dated as of December 27, 2001 between The Phoenix Companies, Inc. and
Phoenix Investment Partners, Ltd. (incorporated herein by reference to Exhibit 10.64 to The
Phoenix Companies, Inc. Annual Report on Form 10-K filed March 27, 2002)
10.25 Subordination Agreement dated as of January 29, 2002 between The Phoenix Companies, Inc. and
Phoenix Investment Partners, Ltd. (incorporated herein by reference to Exhibit 10.65 to The
Phoenix Companies, Inc. Annual Report on Form 10-K filed March 27, 2002)
10.26 Credit Agreement dated as of November 22, 2004 between The Phoenix Companies, Inc., Phoenix Life
Insurance Company, Phoenix Investment Partners, Ltd. and various financial institutions*
10.27 Executive Employment Agreement dated as of January 1, 2003, between The Phoenix Companies, Inc.
and Dona D. Young (incorporated herein by reference to Exhibit 99.1 to The Phoenix Companies,
Inc. current report on Form 8-K dated January 1, 2003)
10.28 Employment Continuation Agreement dated January 1, 2003, between The Phoenix Companies, Inc. and
Dona D. Young (incorporated herein by reference to Exhibit 99.2 to The Phoenix Companies, Inc.
current report on Form 8-K dated January 1, 2003)
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10.29 Restricted Stock Units Agreement dated as of January 25, 2003, between The Phoenix Companies,
Inc. and Dona D. Young (incorporated herein by reference to Exhibit 10.1 to The Phoenix
Companies, Inc. Quarterly Report on Form 10-Q filed August 14, 2003)
10.30 Change in Control Agreement dated as of January 1, 2003, between The Phoenix Companies, Inc. and
Michael E. Haylon (incorporated herein by reference to Exhibit 10.56 to The Phoenix Companies,
Inc. Annual Report on Form 10-K filed March 21, 2003)
10.31 Individual Long-Term Incentive Plan between The Phoenix Companies, Inc. and Michael E. Haylon*
10.32 Offer Letter dated April 14, 2003 by The Phoenix Companies, Inc. to Daniel T. Geraci
(incorporated herein by reference to Exhibit 10.2 to The Phoenix Companies, Inc. Quarterly
Report on Form 10-Q filed August 14, 2003)
10.33 Change in Control Agreement dated as of May 12, 2003, between The Phoenix Companies, Inc. and
Daniel T. Geraci (incorporated herein by reference to Exhibit 10.3 to The Phoenix Companies,
Inc. Quarterly Report on Form 10-Q filed August 14, 2003)
10.34 Restricted Stock Units Agreement dated as of May 12, 2003 between The Phoenix Companies, Inc.
and Daniel T. Geraci (incorporated herein by reference to Exhibit 10.4 to The Phoenix Companies,
Inc. Quarterly Report on Form 10-Q filed August 14, 2003)
10.35 Change in Control Agreement dated as of January 1, 2003 between The Phoenix Companies, Inc. and
John F. Sharry*
10.36 Change in Control Agreement dated as of January 1, 2003 between The Phoenix Companies, Inc. and
James Wehr*
10.37 Technology Services Agreement effective as of July 29, 2004 by and among Phoenix Life Insurance
Company, Electronic Data Systems Corporation and EDS Information Services, L.L.C. (incorporated
herein by reference to Exhibit 10.49 to The Phoenix Companies, Inc. Quarterly Report on Form
10-Q dated August 9, 2004)
10.38 Fiscal Agency Agreement dated as of December 15, 2004 between Phoenix Life Insurance Company and
The Bank of New York*
12 Ratio of Earnings to Fixed Charges*
23 Consent of PricewaterhouseCoopers LLP*
31.1 Certification of Dona D. Young, Chief Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002*
31.2 Certification of Michael E. Haylon, Chief Financial Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002*
32 Certification by Dona D. Young, Chief Executive Officer and Michael E. Haylon, Chief Financial
Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
- ------------------------
* Filed herewith
(+) Portions subject to confidential treatment request
We will furnish any exhibit upon the payment of a reasonable fee, which fee shall be limited to our reasonable
expenses in furnishing such exhibit.
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