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.
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 ============= ============= ============= ============== =============
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 $ -- $ -- ============= ============= ============= ============== =============
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.
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.
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 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.
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.
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.
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.
• 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.
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.
harm our business. This could have a material adverse affect on our results of operations and financial condition.
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.
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 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.
• 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.
• 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.
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.
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 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.
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.
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.
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.
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.
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) ============== ============== ==============
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.
• 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 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.
• 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.
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.
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.
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.
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.
• 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.
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 and dilutive potential common shares....... 100.8 94.2 97.9 4.2 (1.3) ============ ============ ============ =========== ===========
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).
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:
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
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.
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
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.
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.
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.
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.
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.
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.
The income tax benefit of $18.3 million in 2003 decreased $40.5 million from an income tax benefit of $58.8 million in 2002. This decrease is primarily due to the tax effect of the decrease in loss from continuing operations before income taxes, minority interest and equity earnings of affiliates offset by the tax effect of non-deductible goodwill and indefinite-lived intangible assets written off in 2002.
We evaluate segment performance on the basis of segment income. Realized investment gains and losses and certain other items are excluded because we do not consider them when evaluating the financial performance of the segments. The size and timing of realized investment gains and losses are often subject to our discretion. Certain items are removed from segment after-tax income if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income reported in accordance with GAAP, we believe that segment income is an appropriate measure that represents the earnings attributable to
We allocate capital to our Life and Annuity segment based on RBC for our insurance products. We used 300% RBC for 2002 through 2004. Capital within our Life Companies that is unallocated is included in our Corporate and Other segment. We allocate capital to our Asset Management segment on the basis of the historical capital within that segment. We allocate net investment income based on the assets allocated to the segments. We allocate tax benefits related to tax-advantaged investments to the segment that holds the investment. We allocate certain costs and expenses to the segments based on a review of the nature of the costs, time studies and other methodologies.
Summary Life and Annuity Year Ended December 31, Changes Financial Data: ------------------------------------- ------------------------ ($ 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 =========== =========== =========== =========== ===========
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.
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 $9.6 million, or 11%, in 2003 over 2002, primarily due to the growth of in-force business, higher margins and slightly higher surrenders, partially offset by lower amortization expense for annuities due to the charges incurred in the third quarter of 2002, which did not recur in 2003.
Year Ended December 31, Annuity Funds on Deposit: --------------------------------------- ($ 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 =========== =========== ===========
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 =========== =========== ===========
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 =========== =========== ===========
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.
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.
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 =========== =========== =========== =========== ===========
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.
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.
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.
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.
Participating life product revenues decreased $28.8 million, or 2%, in 2003 from 2002, primarily due to lower renewal premiums, partially offset by higher net investment income. Since our demutualization in 2001, we no longer sell participating life insurance policies.
Year Ended December 31, Changes Segment Income by Product: ------------------------------------ ----------------------- ($ amounts in millions) 2004 2003 2002 2004/03 2003/02 ----------- ----------- ----------- ----------- -----------
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.
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.
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 $0.9 million, or 19%, in 2003 from 2002, primarily due to slightly higher expense levels partially offset by higher insurance margins.
Our investment product fee revenues are based on assets under management. Approximately 57% of our investment product fees are based on beginning of quarter assets under management while the remaining 43% are based on end of day balances. End of year and average assets (based on how fees are calculated) under management follow:
Assets Under Management: As of or for the Year Ended ($ amounts in millions) December 31, --------------------------------------------- 2004 2003 2002 -------------- -------------- --------------
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.
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.
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.
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.
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.
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 ============== ==============
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.
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 $8.2 million, or 26%, in 2003 over 2002, primarily due to a restructuring of debt in late 2002 through the issuance of equity units to paydown shorter term, lower cost borrowings under our bank credit facility.
The invested assets in the Life Companies' general accounts are generally of high quality and broadly diversified across asset classes, sectors and individual credits and issuers. Our investment professionals manage these general account assets in investment segments that support specific product liabilities. These investment segments have distinct investment policies that are structured to support the financial characteristics of the related liabilities within them. Segmentation of assets allows us to manage the risks and measure returns on capital for our various businesses and products.
Debt and Equity Securities Pledged as Collateral and Non-recourse Collateralized Obligations
Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our commitment to fund interest-sensitive insurance liabilities, as well as from our significant holdings of fixed rate investments. Our insurance liabilities largely comprise dividend-paying individual whole life and universal life policies and annuity contracts. Our fixed maturity investments include U.S. and foreign government bonds, securities issued by government agencies, corporate bonds, asset-backed securities, mortgage-backed securities and mortgage loans, most of which are mainly exposed to changes in medium-term and long-term U.S. Treasury rates.
Interest Rate Sensitivity of Derivatives: As of December 31, 2004 ($ 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.
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.
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.
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 =========== =========== ===========
Statutory reserve (after reinsurance)............................................... $ 15.0 $ 17.3 GAAP reserve (after reinsurance).................................................... 9.1 7.6
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 ----------- ----------- -----------
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 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.
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 $259.5 million, or 1.9%, of our total debt security portfolio.
General Account Debt Securities As of December 31, 2004 by Investment Type: ------------------------------------------------------------------ ($ 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 =========== =========== =========== =========== ===========
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 =========== =========== ===========
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 =========== =========== =========== =========== ===========
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.
Sources of Realized Investment Gains (Losses): Year Ended December 31, ($ amounts in millions) ------------------------------------- 2004 2003 2002 ----------- ----------- -----------
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.
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 ($0.0 million after applicable policyholder dividend obligation).
Duration of Gross Unrealized Losses on As of December 31, 2004 General Account Securities: ---------------------------------------------------------- ($ 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) ============= ============= ============= =============
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) ============= ============= ============= =============
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........ $ -- $ -- $ -- $ -- ============ ============ ============ ============
Summary Consolidated Cash Flows: Year Ended December 31, Changes ($ amounts in millions) ------------------------------------ ----------------------- 2004 2003 2002 2004/03 2003/02 ----------- ----------- ----------- ----------- -----------
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.
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 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.
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.
See Note 19 to our consolidated financial statements in this Form 10-K for more information on the holding company.
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.
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.
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.
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.
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.
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 $150.3 million, or 4%, in 2004 from December 31, 2003, primarily due to net withdrawals from variable annuity guaranteed interest sub-accounts.
Contractual Obligations and Commercial Commitments: ($ 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.
(4) Commitments related to recent business combinations are not included in amounts presented in this table. See the discussion on the following pages.
(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.
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.
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.
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 $5.9 million.
Funded Status of Qualified and Non-qualified Employee Plan Supplemental Plan Pension Plans: ------------------------ ---------------------- ($ amounts in millions) As of December 31, ------------------------------------------------ 2004 2003 2004 2003 ----------- ----------- ----------- -----------
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.
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
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;
At December 31, 2004, Phoenix Life's and each of its insurance subsidiaries' RBC levels were in excess of 300% of Company Action Level.