We prepared the following financial data, other than statutory data, in conformity with GAAP. We derived the statutory data from the Annual Statements of our Life Companies filed with insurance regulatory authorities and prepared it in accordance with statutory accounting practices, which vary in certain 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 included in this Form 10-K.
Basic and Diluted Earnings Per Share: Income (loss) from continuing operations (4). $ (1.18) $ (1.31) $ .91 $ 1.55 $ .88 ============ ============ ============= ============= ============ Net income (loss)(4) ........................ $ (2.51) $ (1.94) $ .80 $ .85 $ 1.31 ============ ============ ============= ============= ============
2002 2001 2000 1999 1998 ------------ ------------ ------------- ------------- ------------ Ratio of Earnings to Fixed Charges: Ratio of earnings to fixed charges(5) ....... -- -- 4.2 6.9 5.3 Supplemental ratio of earnings to fixed charges-including interest credited on policyholder contract balances(6) ...... 0.6 0.3 1.8 2.5 2.0
2002 2001 2000 1999 1998 ------------ ------------ ------------- ------------- ------------ Balance Sheet Data: Cash and investments........................ $ 16,780.3 $ 14,420.4 $ 12,597.4 $ 11,600.7 $ 11,534.5 Total assets................................ $ 25,245.7 $ 22,535.9 $ 20,313.2 $ 20,287.0 $ 18,798.0 ============ ============ ============= ============= ============ Indebtedness................................ $ 644.3 $ 599.3 $ 425.1 $ 499.4 $ 449.3 ============ ============ ============= ============= ============ Total liabilities........................... $ 23,203.2 $ 20,131.4 $ 18,335.4 $ 18,430.9 $ 16,969.4 ============ ============ ============= ============= ============ Minority interest in net assets of consolidated subsidiaries................. $ 10.8 $ 8.8 $ 136.9 $ 100.1 $ 92.0 ============ ============ ============= ============= ============ Total stockholders' equity.................. $ 2,031.7 $ 2,395.7 $ 1,840.9 $ 1,756.0 $ 1,736.6 ============ ============ ============= ============= ============
Assets Under Management:(7) ................. $ 63,813.9 $ 61,212.2 $ 64,543.6 $ 73,185.4 $ 61,206.3 ============ ============ ============= ============= ============
(1) For a summary of our significant accounting policies, refer to the notes to our consolidated financial statements included elsewhere in this Form 10-K.
(2) During 1999, Phoenix Home Life discontinued the operations of three of its businesses which in prior years were reflected as the following reportable business segments: reinsurance operations, group life and health insurance operations and real estate management operations.
Effective January 1, 2001, we adopted a new accounting pronouncement for derivative instruments. This adoption resulted in a cumulative effect adjustment of $3.9 million (after income taxes of $2.1 million). Additional information on this accounting change is included in Notes 1 and 14 to our consolidated financial statements included elsewhere in this Form 10-K.
Effective April 1, 2001, we adopted a new accounting pronouncement for recognition of interest income and impairment on certain investments. This pronouncement requires investors in certain asset-backed securities to record changes in their estimated yield on a prospective basis and to apply specific valuation methods to these securities for an other-than-temporary decline in value. Upon adoption, we recorded a $20.5 million charge to net income as a cumulative effect of accounting change, net of income taxes. Additional information on this accounting change is included in Notes 1 and 5 to our consolidated financial statements included elsewhere in this Form 10-K.
(9) The AVR is a statutory reserve intended to mitigate changes to the balance sheet as a result of fluctuations in asset values.
The following discussion may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends these forward-looking statements to be covered by the safe harbor provisions of the federal securities laws relating to forward-looking statements. These include statements relating to trends in, or representing management's beliefs about, the company's future strategies, operations and financial results, as well as other statements including words such as "anticipate", "believe," "plan," "estimate," "expect," "intend," "may," "should" and other similar expressions. Forward-looking statements are made based upon management's current expectations and beliefs concerning trends and future developments and their potential effects on the company. They are not guarantees of future performance. Actual results may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties which include, among others: (i) changes in general economic conditions, including changes in interest and currency exchange rates and the performance of financial markets; (ii) heightened competition, including with respect to pricing, entry of new competitors and the development of new products and services by new and existing competitors; (iii) the company's primary reliance, as a holding company, on dividends and other payments from its subsidiaries to meet debt payment obligations, particularly since the company's insurance subsidiaries' ability to pay dividends is subject to regulatory restrictions; (iv) regulatory, accounting or tax changes that may affect the cost of, or demand for, the products or services of the company's subsidiaries; (v) downgrades in the claims paying ability or financial strength ratings of the company's subsidiaries or in its credit ratings; (vi) discrepancies between actual claims experience and assumptions used in setting prices for the products of insurance subsidiaries and establishing the liabilities of such subsidiaries for future policy benefits and claims relating to such products; (vii) movements in the equity markets that affect our investment results, including those from venture capital, the fees we earn from assets under management and the demand for our variable products; (viii) the company's success in achieving planned expense reductions; and (ix) other risks and uncertainties described in any of the company's filings with the SEC. The company undertakes no obligation to update or revise publicly any forward-looking statement, whether as a result of new information, future events or otherwise.
There are two main ways in which market declines and volatility have affected, or have the potential to affect, our revenues negatively.
• First, significant market volatility or declines may cause potential purchasers of our products to refrain from new or additional investments, and current investors to withdraw from the markets or reduce their rates of ongoing investment. At this time we cannot estimate the impact to date of the market on our sales.
We experienced significant operating losses in 2002. Continued significant operating losses could impair our ability to access the capital markets or repay our debt obligations.
We experienced losses from continuing operations before cumulative effect of accounting changes of $115.7 million in 2002. Continuing operating losses could impair our ability to raise debt or equity capital or pay amounts due under our debt obligations.
The plan of reorganization relating to our demutualization in June 2001 required Phoenix Life to establish and operate an arrangement, known as a closed block, to ensure that the reasonable dividend expectations of policyholders who own certain individual insurance policies of Phoenix Life are met, and that benefits under such policies are paid. Phoenix Life must retain within the closed block the cash flows produced by closed block assets in order to pay policy benefits and dividends to closed block policyholders, which means that these cash flows are not available to us to meet unexpected cash needs in our other businesses. The assets that are within the closed block include a substantial portion of our most liquid assets.
resulting from such an insufficiency. Moreover, even if these assets, cash flows and revenues are sufficient, we may choose to support closed block policyholder dividend payments with assets and cash flows from outside of the closed block.
In addition, the returns we achieve in Venture Capital depend in large part on the efforts and performance results obtained by the managers of the partnerships in which we invest. We have neither an active role in the day to-day management of the partnerships in which we invest, nor the ability to approve the specific investment management decisions made by the managers of the partnerships. Although we evaluate each potential partnership investment based on criteria such as the performance history of the partnership and its manager, as well as the partnership's investment strategies, the past performance of a partnership and its manager may not be a reliable indicator of future results. Furthermore, the managers, key personnel and investment strategies of a partnership may change at any time without our consent.
The recent downgrades to PNX's debt ratings and Phoenix Life's financial strength ratings, as well as the possibility of future downgrades, could increase policy surrenders and withdrawals, adversely affect relationships with distributors, reduce new sales and earnings from our life insurance products and increase our future borrowing costs.
Rating agencies assign Phoenix Life claims paying ability ratings, sometimes referred to as financial strength ratings, and assign us debt ratings, based in each case on their opinions of the relevant company's ability to meet its financial obligations.
Financial strength ratings indicate a rating agency's view of an insurance company's ability to meet its obligations to its insureds. These ratings are therefore key factors underlying the competitive position of life insurers. The current financial strength and debt ratings, including information concerning recent rating agency actions, are set forth in the chart below.
A.M. Best and Moody's each have a stable outlook for our ratings, while Fitch IBCA and Standard & Poor's have a negative outlook.
In addition, the downgrades could adversely affect Phoenix Life's relationships with its existing distributors and its ability to establish additional distributor relationships. If this were to occur, we might experience a decline in sales of certain products and the persistency of existing customers. At this time, we cannot estimate the impact on sales or persistency. If there were a significant decline in Phoenix Life's sales or persistency, our results of operations would be materially adversely affected.
In establishing our provisions described above for the payment of insured losses and expenses on this discontinued business, we have made assumptions about the likely outcome of the disputes referred to above, including an assumption that substantial recoveries would be available from our reinsurers on all of our discontinued reinsurance business. However, the inherent uncertainty of arbitrations and lawsuits, including the uncertainty of estimating whether any settlements we may enter into in the future would be on favorable terms, makes it hard to predict the outcomes with certainty. Given the need to use estimates in establishing loss reserves, and the difficulty in predicting the outcome of arbitrations and lawsuits, our actual net ultimate exposure likely will differ from our current estimate. If future facts and circumstances differ significantly from our estimates and assumptions about future events with respect to the disputes referred to above or other portions of our discontinued reinsurance business, our current reserves may need to be increased materially, with a resulting material adverse effect on our results of operations and financial condition.
Legislation eliminating or modifying either the federal estate tax or the federal taxation of investment income could adversely affect revenues from our life insurance products because some of them are specifically designed and marketed as policies that help a decedent's heirs to pay this tax. In addition, some of the Bush Administration's legislative proposals would reduce or eliminate the benefit of deferral of taxation for our insurance and annuity products.
The attractiveness to our customers of many of our products is due, in part, to favorable tax treatment. Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid by the holders of annuities and life insurance products. Taxes, if any, are payable on income attributable to a distribution under the contract for the year in which the distribution is made. Death benefits under life insurance contracts may be received free of federal income tax. Legislative changes that would have the effect of reducing the taxes imposed on investment income could reduce or eliminate the relative benefit of such deferral of taxation for our insurance, annuity and investment products. President Bush's Fiscal Year 2004 Budget includes changes that would permit corporations to pay tax-free dividends to shareholders and that would create new and expanded vehicles for tax-exempt savings, including "Lifetime Savings Accounts" which would permit large annual contributions and tax-free build-up and distributions. There can be no assurance whether or when any such proposal would be enacted. However, enactment of one or both of these proposals, either in the form proposed by President Bush or in a modified form, could have a negative impact on our revenues.
Conversely, during periods of declining interest rates, a decrease in the spread between interest and dividend rates to policyholders and returns on our investment portfolio could adversely affect our profitability. During such periods, life insurance and annuity products may be relatively more attractive investments, resulting in increased premium payments on products with flexible premium features, repayment of policy loans and increased percentages of policies remaining in force during a period when we are earning lower returns on our own new investments. For this reason, a sustained period of declining interest rates could cause cash flow problems for us. In addition, lower returns on our investments could prove inadequate for us to meet contractually guaranteed minimum payments to holders of our life and annuity products. We also face the risk in a declining interest rate environment that borrowers may prepay or redeem mortgages and bonds in our investment portfolio as they seek to borrow at lower market rates, so that we might have to reinvest proceeds we receive from these prepayments or redemptions in lower interest-bearing investments.
We sell our products through our affiliated retail producers and non-affiliated advisors, broker-dealers and other financial intermediaries. Non-affiliated distribution sources have contributed significantly to our sales in recent years. For example, Merrill Lynch, with over 15,000 registered representatives, accounted for 42% of our Investment Management private client asset inflows in 2002. The loss or diminution of our relationships with non-affiliated distributors could materially reduce our revenues from sales of our products. The risk of such loss or diminution is significant and ongoing, since we face substantial competition in seeking to convince non-affiliated distributors to sell our products, rather than those offered by our competitors.
Each of the mutual funds and closed-end funds for which PXP acts as investment adviser or sub-adviser is registered under the Investment Company Act of 1940 and is governed by a board of trustees or board of directors. The Investment Company Act requires that at least 40% of these board members be unaffiliated with PXP. Each fund's board has the duty of deciding annually whether to renew the contract appointing PXP to manage the fund. Board members have a fiduciary duty to act in the best interests of the shareholders of their funds. Either the board members or the shareholders may terminate an advisory contract with PXP and move the assets to another investment adviser. The board members also may deem it to be in the best interests of a fund's shareholders to make decisions adverse to us, including reducing the compensation paid to PXP or imposing restrictions on PXP's management of the fund.
Our investment management agreements with institutional clients, intermediary program sponsors (who "wrap," or make available, our investment products within the management agreements they have with their own clients), direct managed account clients and institutional clients are generally terminable by these sponsors and clients upon short notice without penalty. As a result, there would be little impediment to these sponsors or clients terminating our agreements if they became dissatisfied with our performance.
We face strong competition in our wealth management businesses from mutual fund companies, banks, investment management firms and other insurance companies. This competition may impair our ability to retain existing customers, attract new customers and maintain our profitability.
We face strong competition in our wealth management businesses, comprising of life insurance, annuities and investment management. We believe that our ability to compete is based on a number of factors, including product features, investment performance, service, price, distribution, capabilities, scale, commission structure, name recognition and financial strength ratings. While there is no single company that we identify as a dominant competitor in our wealth management business, the nature of these businesses means that our actual and potential competitors include a large number of mutual fund companies, banks, investment management firms and other insurance companies, many of which have advantages over us in one or more of the above competitive factors. Recent industry consolidation, including acquisitions of insurance and other financial services companies in the United States by international companies, has resulted in larger competitors with financial resources, marketing and distribution capabilities and brand identities that are stronger than ours. Larger firms also may be able to offer, due to economies of scale, more competitive pricing than we can. In addition, some of our competitors are regulated differently than we are, which may give them a competitive advantage; for example, many non-insurance company providers of financial services are not subject to the costs and complexities of insurance regulation by multiple states.
We compete for distribution sources in our life, annuity and investment management businesses. We believe that our success in competing for distributors depends on factors such as our financial strength and on the services we
We might be unable to attract or retain personnel who are key to our business, especially in Investment Management.
We and some of the policies, contracts and other products that we offer are subject to various levels of regulation under the federal securities laws administered by the SEC as well as regulation by those states and foreign countries in which we provide investment advisory services, offer products or conduct other securities-related activities. We could be restricted in the conduct of our business for failure to comply with such laws and regulations. Future laws and regulations, or the interpretation thereof, could materially adversely affect our results of operations and financial condition by increasing our expenses in having to comply with these regulations.
We provide our wealth management solutions through two operating segments - Life and Annuity and Investment Management - which include three businesses, life insurance, annuities and investment management. Through Life and Annuity we offer a variety of life insurance and annuity products, including universal, variable universal, whole and term life insurance, and a range of annuity offerings. We conduct activities in Investment Management largely through PXP comprising two lines of business - private client and institutional.
We report our remaining activities in two non-operating segments - Venture Capital and Corporate and Other. Venture Capital includes investments primarily in the form of limited partnership interests in venture capital funds, leveraged buyout funds and other private equity partnerships sponsored and managed by third parties. These assets are investments of the general accounts of our Life Companies. See "Business-Venture Capital Segment." Corporate and Other includes indebtedness, unallocated capital and expenses, as well as 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 wealth management operations.
• 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.
Under generally accepted accounting principles (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.
• the adequacy of our product pricing, which is primarily a function of our: • ability to select 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.
Our sales and financial results over the last several years have been affected by economic and industry trends. Americans generally have begun to rely less on whole life insurance, defined benefit retirement plans and social security and other government programs to meet their post-retirement financial needs. Reflecting this trend, sales of our whole life insurance products have declined in recent years. Concurrently, the baby boom generation has begun to enter its prime savings years. These factors have had a positive effect on sales of our variable life and annuity products, mutual funds and managed account products. See "Business-Market Opportunity."
In July 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 for detailed information regarding the acquisition of Valley Forge Life Insurance Company.
Variable Interest Entities: A new accounting standard was issued in January 2003 that interprets the existing standard on consolidation. It clarifies the application of standards of consolidation to certain entities in which 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"). See Note 8 to our consolidated financial statements for more discussion on this new standard as it relates to our business.
Critical accounting policies are reflective of significant judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The following are areas that we believe require significant judgments, together with references to the footnote(s) where each accounting policy is discussed as it relates to our business:
The amortization of DAC and PVFP requires the use of various assumptions, estimates and judgments about the future. Significant assumptions include 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 DAC balances.
• Valuation of Debt and Equity Securities We classify our debt and equity securities as available-for-sale and report them in our balance sheet at fair value. Fair value is based on quoted market price, where available. When quoted market prices are not available, we estimate fair value by discounting debt security cash flows to reflect interest rates currently being offered on similar terms to borrowers of similar credit quality, by quoted market prices of comparable instruments and by independent pricing sources or internally developed pricing models. Investments whose value, in our judgment, is considered to be other-than-temporarily impaired are written down to fair value as a charge to realized losses included in our earnings. The cost basis of these written down investments is adjusted to fair value at the date the determination of impairment is made. The new cost basis is not changed for subsequent recoveries in value. For mortgage-backed and other asset-backed debt securities, we recognize income using a constant effective yield based on anticipated prepayments and the estimated economic lives of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and any resulting adjustment is included in net investment income. For certain asset-backed securities, changes in estimated yield are recorded on a prospective basis and specific valuation methods are applied to these securities to determine if there has been an other-than-temporary decline in value. We report mortgage loans at unpaid principal balances, net of valuation reserves on impaired mortgages. We consider a mortgage loan to be impaired if we believe it is probable that we will be unable to collect all amounts of contractual interest and principal as scheduled in the loan agreement. We do not accrue interest income on impaired mortgage loans when the likelihood of collection is doubtful.
See Note 5 to our consolidated financial statements for more information.
• Valuation of Investments in Affiliates We evaluate our equity method investments for an other than temporary impairment at each balance sheet date considering quantitative and qualitative factors including quoted market price of underlying equity securities, the duration the carrying value is in excess of fair value and historical and projected earnings and cash flow capacity.
See Note 5 to our consolidated financial statements and the Aberdeen Asset Management section of Management's Discussion and Analysis for more information.
• Pension and other Post-employment Benefits See Note 10 to our consolidated financial statements for more information on our pension and other post-employment benefits.
Changes ------------------------- 2002 2001 2000 2002 / 01 2001 / 00 ----------- ----------- ----------- ----------- -----------
The increase in realized investment losses was primarily due to higher credit related losses in the telecommunications industry and collateralized debt obligation holdings. The majority of these losses were in the closed block.
The increase in policyholder dividends was primarily due to the growth of our policyholder dividend obligation resulting from favorable mortality and persistency experience.
The decrease in policy acquisition cost amortization was primarily due to favorable mortality and persistency experience on life products, offset by a $13.5 million acceleration of deferred acquisition cost expense related to our annuity business in the third quarter of 2002. This offset resulted from a revision of our long-term market return assumption for annuities from 8% to 7% and an impairment charge related to the recoverability of our deferred acquisition cost asset related to our variable annuities business. The Valley Forge block we acquired at the beginning of the quarter, which experienced significant declines in assets due to equity market declines, accounts for $4.5 million of this acceleration. Deferred policy acquisition costs for individual participating life insurance policies are amortized in proportion to estimated gross margins. The amortization process requires the use of various assumptions, estimates and judgments about the future. The primary assumptions involve expenses, investment performance, mortality and contract 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. In the first quarter of 2002, we revised the assumptions on traditional life products used in the development of estimated gross margins to reflect favorable experience and, as a result, the amortization cost expense decreased.
Interest expense increased during the current year due to higher levels of indebtedness in 2002 than in 2001.
The decrease in other operating expenses was due mostly to lower non-recurring charges and Corporate and Other segment expenses. This decrease was partially offset by increases in Life and Annuity and Investment Management segment expenses. Life and Annuity expenses were higher due primarily to pension costs, slightly higher compensation and increased corporate overhead absorption. Investment Management expenses were higher due to the expenses of an acquired company, Kayne Anderson Rudnick. We acquired a majority interest in Kayne Anderson Rudnick on January 29, 2002, as further described in Note 4 to our consolidated financial statements.
Our 2002 effective income tax benefit rate of 35.5% differed from the statutory U.S. federal income tax benefit rate of 35% as a result of the tax benefits associated with tax advantaged investment income (low income housing tax credits, non-taxable dividend and interest income) and the recovery of amounts related to an IRS settlement, offset by the tax on nondeductible goodwill impairment charges. In 2001, the effective income tax benefit rate of 44.9% differed from the statutory income tax benefit rate of 35% as a result of the non-deductible demutualization expenses offset by the tax benefits associated with tax advantaged investment income and the elimination of the surplus tax liability.
In 2002, we adopted the new accounting standard related to the accounting for goodwill and other intangible assets resulting in a $130.3 million cumulative effect of accounting change, as further described in Notes 1 and 4 to our consolidated financial statements.
The decrease in premiums in 2001 was primarily due to whole life premiums, which decreased $24.8 million, reflecting the shift to variable products, for which revenues are recognized through insurance and investment product fees. There was also a $4.0 million decrease from the runoff of the Confederation Life whole life business.
The decrease in insurance and investment product fees in 2001 was due to the following: Investment Management fees decreased $66.3 million primarily as a result of decreases in average assets under management, partially due to negative investment performance and our sale of PXP's Cleveland operations in 2000. Corporate and Other fees decreased $15.5 million primarily due to lower fees resulting from our decision to exit our physician practice management business in the third quarter of 2000. These decreases were slightly offset by the increases in fees in Life and Annuity of $1.1 million primarily as a result of increased sales of variable universal life products.
In 2001, the increase in policyholder dividends was primarily due to higher dividend payments on participating whole life policies and an increase of $10.7 million in the policyholder dividend obligation because of favorable mortality and persistency in the closed block.
The increase in intangible asset amortization in 2001 was primarily due to the increase in Investment Management amortization. This increase in amortization resulted from our purchase of the PXP minority interest in 2001, our acquisition of a 75% interest in Walnut in 2001 and our payment of $50.0 million in 2000 related to the Roger Engemann and Associates, Inc., or Engemann, acquisition.
The increase in other operating expenses in 2001 was primarily due to an increase of $100.7 million in non-recurring items, including expenses of $84.9 million related to the acquisition of the PXP minority interest and of $23.8 million related to an early retirement program. This increase was partially offset by the decrease in Corporate and Other segment expenses of $57.9 million related to decreases of $23.3 million in compensation and related expenses, decreases of $14.1 million in special charitable contributions given in 2000 and our decision to exit our physician practice management business in the third quarter of 2000. Investment Management other operating expenses also decreased $10.4 million primarily as a result of reduced incentive compensation for certain subsidiaries that, in accordance with their respective operating agreements, receive compensation directly related to earnings or revenues, which declined as a result of investment performance.
Income taxes applicable to continuing operations in 2001 decreased 276% from 2000. This change reflects a tax benefit from operating losses for the year end 2001, compared to a tax expense on operating gains for the year end 2000. The effective tax rate increased to 44.9% for the year ended December 31, 2001 compared to a nominal tax rate of 35%, primarily due to the elimination of the surplus tax liability.
In 2001, we adopted new accounting standards related to the accounting for derivative instruments and securitized financial instruments as further described in Notes 1, 5 and 14 to our consolidated financial statements.
For the years 2002, 2001 and 2000, we do not believe inflation had a material effect on our consolidated results of operations, except insofar as inflation may have affected interest rates.
Net realized investment gains (losses)........................... (39.3) (43.0) 62.0 Deferred policy acquisition costs adjustment (1) ................. 15.1 -- (141.8) Early retirement pension adjustment (2) .......................... -- (15.5) -- Pension adjustment (3) ........................................... -- 2.9 -- Demutualization expense (4) ...................................... (1.3) (23.9) (14.1) Mutual life surplus tax (5) ...................................... -- 21.0 (10.4) Portfolio gain (6) ............................................... -- -- 3.1 Loss on sublease transaction (7) ................................. -- -- (.7) Partnership gains (8) ............................................ -- 2.4 -- Expenses of purchase of PXP minority interest (9) ................ -- (52.8) (.7) Litigation settlement (10) ....................................... -- -- (1.8) Management restructuring charge (11) ............................. (28.5) -- -- ------------ ------------ ------------ Total after-tax adjustments...................................... (54.0) (108.9) (104.4) ------------ ------------ ------------ Income (loss) from continuing operations......................... $ (115.7) $ (137.3) $ 94.8 ============ ============ ============
(1) The 2002 adjustment relates primarily to a revision of 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 non-recurring decrease in deferred policy acquisition cost amortization of $22.1 million ($14.4 million after income taxes). In 2000, an increase to deferred policy acquisition costs amortization resulting from a change in estimated future investment earnings due to a reallocation of assets supporting the participating life policies. (2) In 2001, we offered special early retirement programs that enhanced the retirement benefits of employees who accepted the offer. (3) Reduction in pension plan cost due to a change in the corridor used to amortize deferred gains and losses. (4) Represents non-recurring expenses related to the demutualization. (5) As a mutual life insurance company, Phoenix Life was subject, in the periods indicated, to a surplus tax limiting the ability of mutual insurance companies to deduct the full amount of policyholder dividends from taxable income. Phoenix Life was not and will not be subject to such a surplus tax for 2001 and future years, as a result of its demutualization in June 2001. Re-estimation of the surplus tax liability for prior years at September 30, 2001, resulted in the elimination of the liability. (6) Related to insurance recovery for reimbursements made to two mutual fund investment portfolios in 2000. (7) Represents one-time expenses related to sublease transactions on certain office space. (8) Represents gains related to distributions from PXP partnership investments. (9) Represents expenses related to the purchase of the PXP minority interest including: PXP's accrual of non-recurring compensation expenses of $57.0 million to cash out stock options, $5.5 million of related compensation costs, non-recurring retention costs of $19.7 million, and non-recurring transaction costs of $3.9 million. Income taxes of $33.3 million were calculated using an effective tax rate of 38.8%. (10) Represents a charge related to a litigation settlement with former clients of PXP and its former financial consulting subsidiary. (11) Represents costs related primarily to organizational, employment-related and work force reduction costs.
The following table and discussion presents summary financial data relating to Life and Annuity for the years ended December 31, 2002, 2001 and 2000 (in millions).
Changes ------------------------ 2002 2001 2000 2002 / 01 2001 / 00 ----------- ----------- ----------- ----------- ----------- Results of Operations Premiums.................................... $ 1,081.9 $ 1,112.7 $ 1,147.4 $ (30.8) $ (34.7) Insurance and investment product fees....... 316.2 303.8 302.7 12.4 1.1 Net investment income....................... 947.6 890.9 791.4 56.7 99.5 ----------- ----------- ----------- ----------- ----------- Total segment revenues...................... 2,345.7 2,307.4 2,241.5 38.3 65.9 ----------- ----------- ----------- ----------- ----------- Policy benefits, including policyholder dividends................................. 1,867.6 1,812.6 1,775.8 55.0 36.8 Policy acquisition cost amortization........ 88.5 122.5 148.5 (34.0) (26.0) Intangible asset amortization............... -- 0.4 0.9 (0.4) (0.5) Other operating expenses.................... 310.3 292.1 295.9 18.2 (3.8) ----------- ----------- ----------- ----------- ----------- Total segment benefits and expenses......... 2,266.4 2,227.6 2,221.1 38.8 6.5 ----------- ----------- ----------- ----------- ----------- Segment operating income before income taxes and minority interest............... 79.3 79.8 20.4 (0.5) 59.4 Allocated income taxes...................... 27.7 27.9 7.2 (0.2) 20.7 ----------- ----------- ----------- ----------- ----------- Segment operating income before minority interest.................................. 51.6 51.9 13.2 (0.3) 38.7 Minority interest in segment operating income.................................... 0.6 0.3 -- 0.3 0.3 ----------- ----------- ----------- ----------- ----------- Segment operating income.................... $ 51.0 $ 51.6 $ 13.2 $ (0.6) $ 38.4 =========== =========== =========== =========== ===========
Net investment income increased $56.7 million, or 6.4%, in 2002 as compared to 2001, primarily as the result of an increase of invested assets related to the guaranteed interest account portion of our annuity business, principally from the late 2001 and 2002 sales of the Retirement Planners Edge (RPE) variable annuity. Smaller increases in net investment income for variable universal life were offset by a modest decrease in universal life net investment income coupled with lower new money rates, reinvestment rates and asset defaults. Interest spread, or the excess of interest earned on guaranteed interest accounts as compared to interest credited on guaranteed interest accounts, increased by $8.8 million as compared to 2001. Improved interest spread on annuity guaranteed interest accounts is the result of a $1.2 billion increase in guaranteed interest account balances at December 31, 2002 as compared to December 31, 2001, offset by lower new money rates and the investment of related assets in short term, more liquid instruments. We experienced a decline in interest spread in the second half of 2002 as further described in the General Account section of the Management's Discussion and Analysis.
The increase in net investment income during 2001 was primarily the result of higher average invested assets.
The decrease in policy acquisition cost amortization in 2001 was primarily due to a one-time adjustment to deferred acquisition costs in 2000 of $218.2 million in our participating block. Whole life amortization expenses declined $25.5 million in 2000 mostly because of lower deferred acquisition expenses caused by decreased sales volume and $8.0 million related to the runoff of the Confederation Life whole life business.
The following table and discussion presents summary financial data relating to Investment Management for the years 2002, 2001 and 2000 (in millions).
Sales of private client products in 2002 were $5.8 billion, including $3.1 billion from Kayne Anderson Rudnick, an increase of 27% from the same period in 2001, and redemptions from existing accounts were $5.5 billion, including $0.9 billion from Kayne Anderson Rudnick, an increase of 3% from the same period in 2001. Sales of institutional accounts in 2002 were $4.4 billion, including $0.3 billion from Kayne Anderson Rudnick, a decrease of 12% from the same period in 2001, and lost accounts and withdrawals from existing accounts were $4.5 billion, including $0.3 billion from Kayne Anderson Rudnick, an increase of 19% from the same period in 2001.
The decrease in intangible asset amortization was primarily due to the elimination of approximately $20.7 million of amortization on goodwill and indefinite-lived intangible assets in accordance with SFAS No. 142. Additional intangible amortization of $4.2 million in 2002 compared to 2001 resulted from the acquisition of our interest in Kayne Anderson Rudnick.
Intangible asset impairments is the result of a $66.3 million impairment of goodwill taken in the third quarter of 2002.
The increase in other operating expenses in 2002 was primarily due to $24.6 million from Kayne Anderson Rudnick, for the eleven months of 2002. This increase was offset, in part, by an $8.9 million decrease in compensation expense of which $7.6 million related to incentive compensation. Other operating expense decreased $9.9 million primarily related to reductions in consulting, professional, and travel charges.
The decrease in investment product fees in 2001 was primarily the result of decreases in average assets under management. Average assets under management for the private client line of business decreased $8.5 billion. Average assets under management for the institutional line of business decreased $1.4 billion. Our sale of PXP's Cleveland operations in 2000 accounted for approximately $1.7 billion of the decrease in average institutional assets under management. At December 31, 2001, Investment Management had $52.1 billion in assets under management, a decrease of $4.5 billion, or 8%, from December 31, 2000. This decrease consisted of a $7.3 billion decrease due to investment performance, offset, in part, by net asset inflows of $0.5 billion, a $0.8 billion increase as a result of our IPO, a $0.6 billion increase in deposits to the Phoenix general account, and increases of $0.7 billion and $0.1 billion resulting from the acquisition of a 75% interest in Walnut and a 65% interest in Capital West in 2001.
The decrease in minority interest in net income of subsidiaries in 2001 was due primarily to our purchase of the PXP minority interest in 2001.
In February 2003, we reached an agreement to sell a 50% interest in certain of our venture capital partnerships to an outside party and transfer the remaining 50% interest to our closed block. The carrying value of the partnerships being sold and transferred totaled $53.5 million after realizing a loss of $5.1 million in 2002 to reflect the proceeds being received. The unfunded commitments of the partnerships being sold and transferred totaled $28.1 million; the outside party and the closed block will each fund half of these commitments. The partnerships will constitute less than 0.5% of the assets of the closed block after they are transferred.
The following table and discussion presents summary financial data relating to Venture Capital for the years 2002, 2001 and 2000 (in millions).
Net realized gains (losses) on partnership cash and stock distributions.............. $ (4.7) $ 17.8 $ 223.3 $ (22.5) $ (205.5) Partnership operating expenses.............. (7.4) (6.4) (7.7) (1.0) 1.3 Net unrealized gains (losses) on partnership investments............................... (47.2) (95.9) 61.7 48.7 (157.6) ----------- ----------- ----------- ----------- ----------- Segment net investment income (loss)........ (59.3) (84.5) 277.3 25.2 (361.8) Income tax expense (benefit)................ (20.7) (29.6) 97.1 8.9 (126.7) ----------- ----------- ----------- ----------- ----------- Segment operating income (loss)............. $ (38.6) $ (54.9) $ 180.2 $ 16.3 $ (235.1) =========== =========== =========== =========== ===========
See Note 5 to our consolidated financial statements for more information regarding our Venture Capital segment.
Changes ------------------------ 2002 2001 2000 2002 / 01 2001 / 00 ----------- ----------- ----------- ----------- -----------
Interest expense........................... $ (31.4) $ (27.3) $ (32.7) $ (4.1) $ 5.4 Other expenses, net........................ (18.4) (15.9) (37.7) (2.5) 21.8 ----------- ----------- ----------- ----------- ----------- Corporate and Other segment pre-tax operating income (loss).................. (49.8) (43.2) (70.4) (6.6) 27.2 Income tax expense (benefit)............... (29.7) (23.9) (40.6) (5.8) 16.7 ----------- ----------- ----------- ----------- ----------- Segment operating income (loss)............ $ (20.1) $ (19.3) $ (29.8) $ (0.8) $ 10.5 =========== =========== =========== =========== ===========
Interest expense increased due to higher levels of indebtedness in 2002 than in 2001.
The decrease in interest expense in 2001 was due to a decrease in corporate borrowings.
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 Management professionals manage these general account assets in investment segments that support specific product liabilities. These investment segments have distinct investment policies that are structured to support the financial characteristics of the specific liability or liabilities within them. Segmentation of assets allows us to manage the risks and measure returns on capital for our various businesses and products.
Investment trusts are assets held for the benefit of those institutional clients which have investments in structured finance products offered and managed by our investment management subsidiary.
See Note 8 to our consolidated financial statements for more information.
• credit risk, which relates to the uncertainty associated with the ongoing ability of an obligor to make timely payments of principal and interest; • interest rate risk, which relates to the market price and cash flow variability associated with changes in market interest rates; and • equity risk, which relates to the volatility of prices for equity and equity-like investments.
We manage interest rate risk as part of our asset/liability management process and product design procedures. Asset/liability management strategies include the segmentation of investments by product line, and the construction of investment portfolios designed to satisfy the projected cash needs of the underlying liabilities. We identify potential interest rate risk in portfolio segments by modeling asset and liability durations and cash flows under current and projected interest rate scenarios. We use these projections to assess and control interest rate risk.
We offer a variety of variable and fixed annuities to meet the accumulation and preservation needs of the affluent and high-net-worth market. Our major sources of revenues from separate account variable annuities are mortality and expense fees charged to the contractholder, generally determined as a percentage of the market value of the underlying assets under management. Our major source of profit from fixed annuities and general account variable annuities is from the interest rate spread, or the excess of investment income earned over interest credited to guaranteed interest accounts.
In 2000, we began selling Retirement Planners Edge (RPE), a no-load variable annuity. Commissions on these sales were 1% to 1.25% per year depending on the distribution outlet. RPE was designed to attract contributions into variable sub-accounts on which we earn mortality and expense fees. During the second half of 2002, as planners and their clients sought refuge from stock market volatility and as interest rates dropped to historically low levels, policyholders allocated their deposits to general account guaranteed interest accounts carrying the regulatory required minimum crediting rate of 3%. In September 2002, we stopped accepting applications for RPE, although existing policyholders have the right to make subsequent deposits up to a maximum of $1 million per contract.
For further information about our management of interest rate risk and equity risk, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Quantitative and Qualitative Information About Market Risk."
Each year, the majority of our net cash flows are invested in investment grade debt securities. However, we maintain a portfolio allocation between 6% and 10% of debt securities in below investment grade rated bonds. Allocations are based on our assessment of relative value and the likelihood of enhancing risk-adjusted portfolio returns. The size of our allocation to below investment grade bonds is constrained by the size of our net worth. We are subject to the risk that the issuers of the debt securities we own may default on principal and interest payments, particularly if a major economic downturn occurs. 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 experience lower defaults compared to B or
CCC rated bonds. As of December 31, 2002, our total below investment grade securities totaled $1,069.0 million, or 9% of our total debt security portfolio. Of that amount, $785.7 million, or 7% of our debt security portfolio was invested in the BB category. Our debt securities having an increased risk of default (those securities with an SVO rating of four or greater) totaled $283.3 million, or 2% of our total debt security portfolio.
Our debt and equity securities are classified as available-for-sale and are reported at fair value with unrealized gains or losses included in equity. Accordingly, the carrying value of such securities reflects their fair value at the balance sheet date. 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.
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.
The following table presents the SVO ratings for our debt security portfolio as of December 31, 2002 and 2001 (in millions), along with an equivalent Standard & Poor's, or S&P, rating agency designation. The majority of our bonds are investment grade, with 91% invested in Categories 1 and 2 securities as of December 31, 2002.
1 AAA/AA/A $ 7,960.9 $ 6,104.5 $ 6,549.8 $ 4,984.5 $ 1,411.1 $ 1,120.0 2 BBB 2,811.5 2,686.7 1,767.1 1,667.9 1,044.4 1,018.8 ---------- --------- --------- --------- --------- --------- Total investment grade 10,772.4 8,791.2 8,316.9 6,652.4 2,455.5 2,138.8 3 BB 785.7 581.6 577.4 452.9 208.3 128.7 4 B 105.4 173.0 82.2 150.4 23.2 22.6 5 CCC and lower 118.5 38.6 53.3 18.0 65.2 20.6 6 In or near default 59.4 23.3 25.4 19.8 34.0 3.5 ---------- --------- --------- --------- --------- --------- Total debt securities $11,841.4 $ 9,607.7 $ 9,055.2 $ 7,293.5 $ 2,786.2 $ 2,314.2 ========== ========= ========= ========= ========= =========
The following tables present our debt security portfolio by investment type as of December 31, 2002 (in millions), along with a breakout of credit quality based on equivalent S&P rating agency designation.
U.S. government and agency.............. $ 461.6 $ 431.3 $ 30.5 $ (0.2) $ 30.3 State and political subdivision......... 534.7 481.9 53.1 (0.3) 52.8 Foreign government...................... 183.9 168.4 20.2 (4.7) 15.5 Corporate............................... 5,432.5 5,081.0 442.8 (91.3) 351.5 Mortgage-backed......................... 3,099.9 2,901.9 198.5 (0.5) 198.0 Other asset-backed...................... 2,128.8 2,122.1 85.0 (78.3) 6.7 -------------- ------------ ----------- ------------ -------------- Total debt securities................... $ 11,841.4 $ 11,186.6 $ 830.1 $ (175.3) $ 654.8 ============== ============ =========== ============ ============== Outside of the closed block: Unrealized gains..................... $4,831.1 $4,553.1 $ 278.0 $ -- $ 278.0 Unrealized losses.................... 592.3 693.7 -- (101.4) (101.4) -------------- ------------ ----------- ------------ -------------- Total outside the closed block....... 5,423.4 5,246.8 278.0 (101.4) 176.6 -------------- ------------ ----------- ------------ -------------- Closed block: Unrealized gains..................... 5,907.2 5,355.1 552.1 -- 552.1 Unrealized losses.................... 510.8 584.7 -- (73.9) (73.9) -------------- ------------ ----------- ------------ -------------- Total closed block................... 6,418.0 5,939.8 552.1 (73.9) 478.2 -------------- ------------ ----------- ------------ -------------- Total debt securities................... $ 11,841.4 $11,186.6 $ 830.1 $ (175.3) $ 654.8 ============== ============ =========== ============ ==============
Percentage of total debt securities............... 91% 90% 9% 10% ============ =========== ============ ============
Investment Grade Debt Securities (Fair Value) Total AAA/AA/A BBB --------------------------------------------- --------------- --------------- ---------------
U.S. government and agency................................ $ 461.6 $ 461.6 $ - State and political subdivision........................... 534.7 522.6 12.1 Foreign government........................................ 60.8 27.6 33.2 Corporate................................................. 4,729.2 2,437.5 2,291.7 Mortgage-backed........................................... 3,013.6 2,794.7 218.9 Other asset-backed........................................ 1,972.5 1,716.9 255.6 --------------- --------------- --------------- Total debt securities..................................... $ 10,772.4 $ 7,960.9 $ 2,811.5 =============== =============== ===============
Percentage of total debt securities....................... 91% 67% 24% =============== =============== ===============
Below Investment Grade Debt Securities -------------------------------------- CC or In or Near (Fair Value) Total BB B Lower Default ------------ ------------ ----------- ----------- ----------- ------------
Total Outside Closed Block Closed Block ----------------- -------------------- ------------------ Gains Losses Gains Losses Gains Losses ------- -------- ------- --------- -------- -------- Debt securities............................ $ 830.1 $ (175.3) $ 278.0 $ (101.4) $ 552.1 $ (73.9) Equity securities.......................... 144.4 (15.4) 144.4 (15.4) -- -- ------- -------- ------- --------- -------- -------- Total unrealized gains (losses)............ 974.5 $ (190.7) 422.4 $ (116.8) 552.1 $ (73.9) ------- -------- ------- --------- ------- -------- Net unrealized gains....................... 783.8 305.6 478.2 ------- ------- ------- Applicable policyholder dividend obligation 478.2 -- 478.2 Applicable deferred policy acquisition costs (credit)................................... 106.5 106.5 -- Applicable deferred income taxes........... 69.7 69.7 -- ------- ------- ------- Total offsets to net unrealized gains...... 654.4 176.2 478.2 ------- ------ ------- Net unrealized gains....................... $ 129.4 $ 129.4 $ -- ======= ======= =======
At the end of each reporting period we review all securities for potential recognition of an "other-than-temporary" impairment. We maintain a watch list for the identification and monitoring of securities in default, near default or otherwise considered by our investment professionals as being distressed, potentially distressed or requiring a heightened level of scrutiny. As validation of our watch list process, at December 31, 2002, we reviewed all securities whose amortized cost basis is in excess of carrying value on a continuous basis for durations of zero to six months, six to 12 months, 12 to 24 months and greater than 24 months. This analysis is further broken down as to investment grade and non-investment grade securities and closed block and outside of closed block securities. Using this analysis coupled with our watch list, we review all securities whose fair value is less than 80% of amortized cost ("significant unrealized loss") with emphasis on below investment grade securities with a continuous significant unrealized loss in excess of six months. In addition, we review securities that have experienced lesser percentage declines in value on a more selective basis using many of the previously discussed factors that we consider in making a determination that a security is other than temporarily impaired.
Our assessment of whether an investment by us in a debt or equity security is other than temporarily impaired is primarily based on whether the issuer has:
• defaulted on payment obligations; • declared that it will default at a future point outside the current reporting period; • announced a restructure will occur outside the current reporting period; • severe liquidity problems that cannot be resolved; • filed for bankruptcy; and/or • financial condition such that future payments are highly unlikely.
The following tables present certain information with respect to our gross unrealized losses with respect to our investment in debt securities outside of the closed block and in the closed block, as of December 31, 2002 (in millions, except number of positions). We separately present the information in the following tables between that applicable to outside the closed block and that applicable to the closed block as we believe it is unlikely that there would be any effect on our net income related to the realization of the closed block unrealized investment losses due to the sufficiency of the policyholder dividend obligation liability in the closed block. See Note 7 to our consolidated financial statements presented elsewhere in this Form 10-K. Applicable deferred policy acquisition costs and income taxes, which are excluded from these tables, would further reduce the effect on our net income.
For below investment grade debt securities outside the closed block at December 31, 2002, 17 securities have had gross unrealized losses greater than 20% of cost continuously for the durations that follow (in millions, except number of positions):
$5.2 million in unrealized losses. Each of the remaining 24 securities have unrealized losses less than $0.8 million. These securities represent holdings in collateralized bond obligations, mortgage-backed securities, asset-backed securities as well as holdings in the energy, banking, and transportation sectors. We are of the opinion that these unrealized losses are temporary in nature and are primarily related to temporary market conditions affecting the overall equity, credit and interest rate markets, as well as the energy sector. In addition, our analysis of the issuers' financial strength and our analysis of underlying collateral supported the conclusion that these securities were not other than temporarily impaired. Finally, as of December 31, 2002, we have the ability and intent to hold these securities until their value has fully recovered.
0 - 6 6 - 12 12 - 24 Over 24 Total Months Months Months Months ----------- ----------- ----------- ----------- ----------- Number of positions....................... 17 11 3 3 0 ----------- ----------- ----------- ----------- ----------- Total fair value.......................... $ 59.9 $ 42.1 $ 6.9 $ 10.9 $ -- Total amortized cost...................... 94.4 65.7 12.9 15.8 -- ---------- ----------- ----------- ----------- ----------- Unrealized loss........................... $ (34.5) $ (23.6) $ (6.0) $ (4.9) $ -- =========== =========== =========== =========== ===========
Gross unrealized losses on equity securities as of December 31, 2002 were as follows (in millions, except number of positions):
As indicated above, $8.7 million ($5.7 million after income taxes) of our gross unrealized losses in equity securities were continuously in an unrealized loss position for more than 12 months as of December 31, 2002 ($0.4 million relates to securities in an unrealized loss position for more than 24 months). $6.8 million ($4.4 million after taxes) of the $8.7 million in unrealized losses relates to two individual holdings representing seed monies invested in mutual fund offerings of our Investment Management operations which, as of December 31, 2002, are long-term holdings of our life insurance subsidiary's general account. Accordingly, we do not consider our investments in these seed monies as being other than temporarily impaired at December 31, 2002.
During the second half of 2002, the value of Aberdeen's publicly traded shares experienced a significant decline due to a general decline in valuations of U.K. asset managers as well as regulatory matters related to the U.K. split-capital trust sector, including Aberdeen's managed funds. In late 2002, Aberdeen announced the results of a strategic review, which concluded with an announcement of a decision to divest itself of a business segment that actively manages property investments and of a conditional agreement to dispose of its rights to manage certain retail funds. Aberdeen anticipates utilizing the related proceeds to paydown existing debt. Subsequent to these transactions, Aberdeen will be an independent asset management group with approximately £15 billion (approximately $24 billion) of assets under management, featuring a diverse range of investment vehicles catering
We evaluated the carrying value of our equity method investment in Aberdeen for other-than-temporary impairment, considering quantitative and qualitative factors including quoted market price for the underlying securities, the duration carrying value is in excess of fair value and historical and projected earnings and cash flow capacity.
• the fair value of our equity in Aberdeen was below our carrying value for less than six months as of December 31, 2002; • Aberdeen continued to report net income and positive cash flow from operations as of its fiscal year ended September 30, 2002 (last publicly available data); • the retail funds and proposed property management transactions are anticipated to substantially increase the book value of Aberdeen through the monetization of the underlying fair values of the businesses to be disposed; • proceeds from the retail funds and proposed property management dispositions are anticipated to be used to paydown debt, resulting in an improvement of Aberdeen's leverage ratios; and • expense reduction efforts have been implemented to better align Aberdeen's cost structure with revenues from its remaining businesses.
See Notes 4 and 5 to our consolidated financial statements regarding our Aberdeen holdings.
Our investment in 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 for detailed information regarding our investment in HRH.
Liquidity refers to the ability of a company to generate sufficient cash flow to meet its cash requirements. The following discussion combines liquidity and capital resources as these subjects are interrelated. Consistent with the discussion of our results of operations, we discuss liquidity and capital resources on both consolidated and segment bases.
PNX has a 364-day unfunded unsecured senior revolving credit facility, or revolving credit facility, under which it has direct borrowing rights, as do Phoenix Life and PXP with PNX's unconditional guarantee. We expect dividend payments from Phoenix Life, debt servicing from PXP and borrowing capacity under PNX's revolving credit facility to be sufficient to enable PNX to make dividend payments on its common stock, pay its operating expenses, service its outstanding debt, make contributions to its subsidiaries and meet its other obligations if required. See Note 6 to our consolidated financial statements for more information on the revolving credit facility.
See Note 18 to our consolidated financial statements for more information on PNX.
Invested assets and cash and cash equivalents increased $2.1 billion and $243.0 million as of December 31, 2002 when compared to December 31, 2001. The increase in invested assets and cash and cash equivalents was the result of net insurance cash inflows, particularly from the annuity product line. Cash inflows related to the Retirement Planners Edge guaranteed interest account have been invested in shorter duration investments to
The decrease in goodwill and other intangible assets was primarily due to the adoption of the new standard on goodwill and other intangible assets, which resulted in a before tax cumulative effect of accounting change charge of $141.7 million and a $66.3 million impairment charge. This was offset by $102.1 million of goodwill and other intangible assets recorded pursuant to the acquisition of Kayne Anderson Rudnick. See Note 4 to the consolidated financial statements for a detailed discussion of goodwill and other intangibles and the acquisition of Kayne Anderson Rudnick.
Indebtedness increased during the year as a result of the issuance of equity units during the fourth quarter, most of the proceeds of which was used to pay down our previous bank credit facility. The increase was also due to an increase in the carrying value of fixed rate debt as a result of a fair value hedge. See Notes 6 and 14 to our consolidated financial statements for further discussion on our financing activities and hedging activities, respectively.
The increase in total investments in 2001 was due to our IPO and debt offering proceeds, growth in our annuity business and the market appreciation recorded on the transfer of Aberdeen and HRH convertible subordinated notes from held-to-maturity to available-for-sale.
The increase in policyholder deposit funds in 2001 was due to an increase in annuity deposits to the guaranteed interest account option during 2001. Annuity deposits increased primarily as a result of successful product launches.
The increase in long-term debt in 2001 was due to our public debt offering during the fourth quarter of 2001.
Historically, the 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. Their principal cash inflows from investment activities result from repayments of principal, proceeds from maturities, sales of invested assets and investment income.
Additional sources of liquidity to meet unexpected cash outflows are available from the Life Companies' portfolio of liquid assets. These liquid assets include substantial holdings of U.S. government and agency bonds, short-term investments and marketable debt and equity securities. The cash Phoenix Life received as consideration for the transfer of shares of common stock of PXP and other subsidiaries following the demutualization was a non-recurring source of liquidity. Pursuant to the plan of reorganization, this cash payment was $659.8 million.
A primary liquidity concern with respect to life insurance and annuity products is the risk of early policyholder and contractholder withdrawal. The Life Companies closely monitor their liquidity requirements in order to match cash inflows with expected cash outflows, and employs an asset/liability management approach tailored to the specific requirements of each product line, based upon the return objectives, risk tolerance, liquidity, tax and regulatory requirements of the underlying products. In particular, the Life Companies maintain investment programs generally intended to provide adequate funds to pay benefits without forced sales of investments. Products having liabilities with relatively long lives, such as life insurance, are matched with assets having similar estimated lives, such as long-term bonds, private placement bonds and mortgage loans. Shorter-term liabilities are matched with investments such as short-term and medium-term fixed maturities.
The following table summarizes the Life Companies' annuity contract reserves and deposit fund liabilities in terms of contractholders' ability to withdraw funds as of December 31, 2002 and 2001 (in millions):
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 the Life Companies' annuity contract reserves and deposit fund liabilities are subject to withdrawals.
We believe that the Life Companies' current and anticipated sources of liquidity are adequate to meet their present and anticipated needs.
As of December 31, 2002, we had $683.5 million outstanding related to contractual obligations, excluding derivative instruments, and $165.3 million in commercial commitments. The following table presents the fiscal periods in which our contractual obligations and commercial commitments will come due.
Contractual Obligations Total 2003 2004 - 2005 2006 - 2007 Thereafter ----------------------- ------------ ------------ ------------ ------------ ------------
Indebtedness(1) ........................... $ 628.7 $ -- $ -- $ 175.0 $ 453.7 Future Minimum Lease Payments(2) .......... 54.8 15.3 26.3 5.4 7.8 ------------ ------------ ------------ ------------ ------------ Total Contractual Obligations............. $ 683.5 $ 15.3 $ 26.3 $ 180.4 $ 461.5 ============ ============ ============ ============ ============
Commercial Commitments Total 2003 2004 - 2005 2006 - 2007 Thereafter ----------------------- ------------ ------------ ------------ ------------ ------------
Standby Letters of Credit(3) .............. $ 10.6 $ 10.6 $ -- $ -- $ -- Other Commercial Commitments(4) ........... 154.7 2.9 6.8 12.9 132.1 ------------ ------------ ------------ ------------ ------------ Total Commercial Commitments.............. $ 165.3 $ 13.5 $ 6.8 $ 12.9 $ 132.1 ============ ============ ============ ============ ============
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.
• a $177.7 million decrease in carrying value of our common stock holdings in Aberdeen reflecting a decrease in Aberdeen's stock price from 399 pence at December 31, 2001 to 71 pence at December 31, 2002; • a $116.1 million increase in an admitted deferred tax asset; • a $94.8 million statutory loss from operations principally driven by the growth in our annuity business and the acquisition of a block of variable annuity business from Valley Forge Life Insurance Company for which acquisition costs are immediately expensed under statutory accounting rules; • $73.1 million in unrealized losses on other equity securities; • $59.4 million in unrealized losses on venture capital partnership investments; and • $49.1 million in net realized investment losses.
Effective December 31, 2002, Phoenix Life adopted Statutory Statement of Accounting Practices No. 10, Income Taxes, or SSAP No. 10, for statutory accounting purposes. Prior to December 31, 2002, New York domiciled insurance companies were precluded from recording deferred tax assets as admitted assets. Recently enacted legislation provides for the admission of deferred tax assets as calculated under SSAP No. 10 effective December 31, 2002, at which point Phoenix Life recorded a deferred tax asset to the extent that federal income taxes paid in prior years were recoverable through loss carrybacks and to the extent that any additional deferred tax assets were expected to be realized by December 31, 2003. Based upon the results through December 31, 2002, $53.1 million of the total admitted deferred tax asset was attributable to federal income taxes paid in prior years available for recovery through net operating loss carrybacks.
The decrease in cash provided from operations for 2002 compared to 2001 was primarily due to higher operating expenses, principally policy acquisition costs, and slightly higher benefit payments, offset by lower cash used by discontinued operations. The increase in net cash provided by operating activities of continuing operations in 2001 over 2000 is primarily due to a reduction in income tax payments in 2001, refunds in 2001 of income taxes paid in prior years, offset by higher non-recurring expenses due to the purchase of the PXP minority interest and lower insurance and investment product fees. The increase in net cash used for operating activities of discontinued operations for 2000 as compared to 2001 resulted primarily from the payment of cash settlements in 2000 associated with the runoff of our group accident and health reinsurance block and from the remaining operating activities of our discontinued operations.
State Farm Mutual Automobile Insurance Company (State Farm) currently owns of record more than 5 percent of our outstanding common stock. In 2002, our subsidiaries paid approximately $10.7 million, as compensation for the sale of our insurance and annuity products, to entities which were either subsidiaries of State Farm or owned by State Farm employees.