Our executive headquarters consist of our main office building at One American Row and two other buildings in Hartford, Connecticut. We own these buildings and occupy most of the space contained in them. In addition to these properties, we own offices in Enfield, Connecticut and East Greenbush, New York for use in the operation of our business. In February 2004, we announced the execution of an agreement to sell our offices in Enfield, which sale is expected to close during the second quarter of 2004. Business functions from Enfield will be relocated to our existing Hartford offices and, if necessary, another facility in the Hartford, Connecticut area. We also lease office space within and out of the United States of America as needed for our operations, including use by our sales force.
We prepared the following financial data, other than statutory data, in conformity with generally accepted accounting principles, or 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.
2002 2001 2003 Restated Restated 2000 1999 ------------ ------------ ------------ ------------ ------------ Income Statement Data(1) Premiums................................... $ 1,042.2 $ 1,082.0 $ 1,112.7 $ 1,147.4 $ 1,175.7 Insurance and investment product fees...... 565.3 560.5 543.2 624.5 569.1 Net investment income...................... 1,107.4 947.7 892.8 1,141.0 961.3 Net realized investment gains (losses)..... (100.5) (133.9) (84.9) 89.2 75.8 ------------ ------------ ------------ ------------ ------------ Total revenues............................. $ 2,614.4 $ 2,456.3 $ 2,463.8 $ 3,002.1 $ 2,781.9 ------------ ------------ ------------ ------------ ------------ Total benefits and expenses................ $ 2,624.6 $ 2,640.8 $ 2,709.1 $ 2,829.6 $ 2,502.0 ------------ ------------ ------------ ------------ ------------
Balance Sheet Data Cash and general account investments....... $17,229.2 $16,812.8 $14,400.4 $12,767.5 $11,768.8 ============ ============ ============ ============ ============ Total assets............................... $27,559.2 $25,235.9 $22,535.9 $20,313.5 $20,283.9 ============ ============ ============ ============ ============ Indebtedness............................... $ 639.0 $ 644.3 $ 599.3 $ 425.1 $ 499.4 ============ ============ ============ ============ ============ Total liabilities.......................... $25,580.0 $23,381.0 $20,219.0 $18,335.4 $18,430.9 ============ ============ ============ ============ ============ Minority interest in net assets of consolidated subsidiaries................ $ 31.4 $ 28.1 $ 8.8 $ 136.9 $ 100.1 ============ ============ ============ ============ ============ Total stockholders' equity................. $ 1,947.8 $ 1,826.8 $ 2,307.8 $ 1,840.9 $ 1,756.0 ============ ============ ============ ============ ============
Consolidated Statutory Data Premiums and deposits...................... $ 3,364.9 $ 3,919.7 $ 3,144.8 $ 2,344.8 $ 2,330.2 ============ ============ ============ ============ ============ Net income (loss).......................... $ (26.0) $ (130.7) $ (66.0) $ 266.1 $ 131.3 ============ ============ ============ ============ ============ Capital and surplus(7)..................... $ 762.4 $ 861.4 $ 1,149.8 $ 1,322.8 $ 1,054.1 Asset valuation reserve (AVR)(8)........... 200.0 147.8 223.4 560.4 373.2 ------------ ------------ ------------ ------------ ------------ Capital, surplus and AVR................... $ 962.4 $ 1,009.2 $ 1,373.2 $ 1,883.2 $ 1,427.3 ============ ============ ============ ============ ============ -------- (1) For a summary of our significant accounting policies, refer to the notes to our consolidated financial statements in this Form 10-K. Certain 2002 and 2001 amounts have been revised from amounts previously reported. See Note 1 to our consolidated financial statements in this Form 10-K for additional information.
(2) During 2003, we signed a definitive purchase and sale agreement to sell Phoenix National Trust Company to a third party. This sale is expected to close in the first quarter of 2004. The financial statement effect of this transaction is immaterial to our consolidated financial statements.
The discontinuation of these businesses resulted from the sales of several operations and the implementation of plans to withdraw from the remaining businesses. These transactions do not affect the comparability of the financial data. The assets and liabilities of the discontinued operations have been excluded from the assets and liabilities of continuing operations and separately identified in the balance sheet data. Additional information on discontinued operations is included in Note 14 to our consolidated financial statements included in this Form 10-K.
(3) During 2002, we recognized a cumulative effect adjustment of an accounting change for goodwill and other intangible assets. Effective January 1, 2002, we adopted the new accounting standard for goodwill and other intangible assets, including amounts reflected in equity method investments. This adoption resulted in a cumulative effect adjustment of $130.3 million (after income taxes of $11.4 million). Additional information on this accounting change is included in Notes 1 and 4 to our consolidated financial statements in this Form 10-K.
In 2001, we changed our method of applying the equity method of accounting for our venture capital partnerships. We recorded a charge of $48.8 million (after income taxes of $26.3 million) representing the cumulative effect of this accounting change on the fourth quarter of 2000. The cumulative effect was based on the actual fourth quarter 2000 financial results as reported by the partnerships. Additional information on this accounting change is included in Notes 1 and 5 to our consolidated financial statements in this Form 10-K.
(4) We calculated earnings per share for each of the three years from 1999 through 2001 on a pro forma basis, based on 104.6 million weighted-average shares outstanding. The pro forma weighted-average shares outstanding calculation for 2001 is based on the weighted-average shares outstanding for the period from the demutualization and IPO to the end of the year.
(5) Due to our losses during 2003, 2002 and 2001, the ratio of earnings to fixed charges for those years was less than 1:1. We would need $13.3 million, $112.3 million and $131.6 million in additional earnings for the years 2003, 2002 and 2001, respectively, to achieve a 1:1 coverage ratio.
(6) Due to our losses during 2003, 2002 and 2001, the ratio coverages, including interest credited on policyholder contract balances, were less than 1:1. We would need $13.3 million, $112.3 million and $131.6 million in additional earnings for the years 2003, 2002 and 2001, respectively, to achieve a 1:1 coverage ratio.
(8) 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 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.
While in 2003 the U.S. equity markets experienced strong growth, this growth was preceded by more than two years of substantial declines. From April 1, 2000 through December 31, 2002, the Nasdaq Composite Index and the Standard & Poor's 500 Index fell 70.79% and 41.29%, respectively. These market declines were accompanied by increased volatility.
• First, significant market volatility or declines may 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.
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.
Financial strength ratings indicate a rating agency's view of an insurance company's ability to meet its obligations to its insureds. These ratings are therefore key factors underlying the competitive position of life insurers. The current financial strength and debt ratings are set forth in the chart below.
Financial Strength Rating Senior Debt Rating Rating Agency of Phoenix Life of PNX --------------------------------- ---------------------------------------- --------------------------------
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, either past or future, 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 1999, we discontinued our reinsurance operations through a combination of sale, reinsurance and placement of certain retained group accident and health reinsurance business into run-off. We adopted a formal plan to stop writing new contracts covering these risks and to end the existing contracts as soon as those contracts would permit. However, we remain liable for claims under those contracts. We also purchased finite reinsurance to further protect us from unfavorable results from this discontinued business.
We expect our reserves and reinsurance to cover the run-off of the business; however, the nature of the underlying risks is such that the claims may take years to reach the reinsurers involved. Therefore, we expect to pay claims out of existing estimated reserves for up to ten years as the level of business diminishes. In addition, unfavorable claims experience is possible and could result in additional future losses. For these reasons, we cannot know today what our actual claims experience will be.
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. 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. In 2003, the tax rate on long-term capital gains and certain dividend income was reduced until 2008. President Bush and members of Congress have expressed a desire to make these rate reductions permanent. If this happens, it could have a negative impact on our sales and revenues. In addition, President Bush's Fiscal Year 2005 Budget proposed changes that would have created new and expanded vehicles for tax-exempt savings. If enacted, the impact of these proposals cannot reasonably be estimated.
Our life insurance and annuity businesses are sensitive to interest rate changes. In periods of increasing interest rates, life insurance policy loans and surrenders and withdrawals may increase as policyholders seek investments with higher perceived returns. This could require us to sell invested assets at a time when their prices are depressed by the increase in interest rates, which could cause us to realize investment losses.
We face strong competition in our businesses from mutual fund companies, banks, asset management firms and other insurance companies. This competition may impair our ability to retain existing customers, attract new customers and maintain our profitability.
which may give them a competitive advantage; for example, many non-insurance company providers of financial services are not subject to the costs and complexities of insurance regulation by multiple states.
Our life insurance and annuity businesses are subject to comprehensive state regulation and supervision throughout the United States. State insurance regulators and the National Association of Insurance Commissioners continually reexamine existing laws and regulations, and may impose changes in the future that put further regulatory burdens on us, thereby increasing our costs of business. This could materially adversely affect our results of operations and financial condition.
Under GAAP, premium and deposit collections for variable life, universal life and annuity products are not recorded as revenues. These collections are reflected on our balance sheet as an increase in separate account liabilities for certain investment options of variable products. Collections for fixed annuities and certain investment options of variable annuities are reflected on our balance sheet as an increase in policyholder deposit funds. Collections for other products are reflected on our balance sheet as an increase in policy liabilities and accruals.
• 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 inforce from year to year as measured by premiums); • the amount and composition of assets under management; • the maintenance of our target spreads between the rate of earnings on our investments and dividend and interest rates credited to customers; and • our ability to manage expenses.
Prior to Phoenix Life's demutualization, we focused on participating life insurance products, which pay policyholder dividends. As of December 31, 2003, 74% of our life insurance reserves were for participating policies. As a result, a significant portion of our expenses consists, and will continue to consist, of such policyholder dividends. Our net income is reduced by the amounts of these dividends. Policyholder dividends expense was $418.8 million during 2003, $401.8 million during 2002 and $400.1 million during 2001.
During 1999, we discontinued the operations of several businesses that did not align with our business strategy including reinsurance, group life and health and real estate management operations. See Note 14 to our consolidated financial statements in this Form 10-K for detailed information regarding our discontinued operations.
In 2001, we acquired the minority interest in Phoenix Investment Partners for $339.3 million. Prior to this acquisition, Phoenix Investment Partners had been a publicly-held company listed on the New York Stock Exchange in which we held approximately a 55.1% interest. See Note 4 to our consolidated financial statements in this Form 10-K for detailed information regarding our acquisition of the Phoenix Investment Partners minority interest.
In May 2003, we acquired the remaining interest in PFG Holdings, Inc., or PFG, the holding company for our private placement operation, not already owned by us for initial consideration of $16.7 million. Under the terms of the purchase agreement, we may be obligated to pay additional consideration of up to $89.0 million to the selling shareholders, including $13.0 million during the years 2004 through 2007 based on certain financial performance targets being met, and the balance in 2008 based on the appraised value of PFG as of December 31, 2007. See Note 3 to our consolidated financial statements in this Form 10-K for further information regarding PFG.
In 2002, we acquired a 60% interest in Kayne Anderson Rudnick for $102.4 million. In 2001, we acquired a 75% interest in Walnut for $7.5 million in cash. We also paid $5.5 million in cash for a 65% interest in Capital West, which is reported as part of DPIM. See Note 4 to our consolidated financial statements in this Form 10-K for further information regarding Kayne Anderson Rudnick, Walnut and Capital West.
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 where we may hold a variable interest. Our adoption of FIN 46-R resulted in no additional variable interest entities being consolidated by us.
comprehensive income, other-than-temporary impairment of investments are recorded as a charge to earnings, and non-recourse collateralized obligations are recorded at unpaid principal balance. Prior to our revision of previously reported 2003, 2002 and 2001 amounts, investments pledged as collateral were recorded at fair value with asset valuation changes directly offset by changes in the corresponding liabilities in a manner similar to separate accounts. See Note 1 and Note 8 to our consolidated financial statements in this Form 10-K for additional information.
The above non-cash charges to earnings and stockholders' equity primarily relate to realized and unrealized investment losses within the collateralized obligation trusts, that will ultimately be borne by third-party investors in the non-recourse collateralized obligations. Accordingly, these losses and any future gains or losses under this method of consolidation will ultimately reverse upon the maturity or other liquidation of the non-recourse collateralized obligations.
Stock-based Compensation. A new standard was issued in December 2002 which amends an existing standard on accounting for stock-based compensation. The new standard provides methods of transition for a voluntary change to fair value accounting for stock-based compensation. It also requires annual and quarterly disclosures about the method of accounting for stock-based compensation and tabular information about the effect of the method of accounting for stock-based compensation. Effective January 1, 2003 we prospectively changed our accounting for stock options using the fair value method. See Note 11 to our consolidated financial statements in this Form 10-K for more discussion on the requirements of the new standard as it relates to our business.
• Deferred Policy Acquisition Costs, or DAC, and Present Value of Future Profits, or PVFP 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, or PVFP, representing the present value of estimated net cash flows embedded in the existing contracts acquired. This asset is included in deferred acquisition costs, or DAC.
We regularly evaluate our estimated gross profits, or EGP, 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 EGP 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 EGP 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 7% for the variable annuity business and 8% for the variable life business at December 31, 2003.
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.
• 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.
Priced via independent market quotations.......................... $ 10,024.5 76% Priced via matrices............................................... 2,062.8 16% Priced via broker quotations...................................... 725.3 5% Priced via other methods.......................................... 326.5 2% Short-term investments*........................................... 133.9 1% ----------------- ----------------- Total............................................................. $ 13,273.0 100% ================= =================
*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.
• Valuation of Investments in Venture Capital Partnerships We record our equity in the earnings of venture capital partnerships in net investment income using the most recent financial information received from the partnerships and estimating the earnings for any lag in reporting. In the first quarter of 2001, we changed our accounting for venture capital partnership earnings to eliminate the quarterly lag in information provided to us. We did this by estimating the change in our share of partnership earnings for the quarter. This resulted in a $75.1 million charge ($48.8 million after income taxes), representing the cumulative effect of this accounting change on the fourth quarter of 2000.
See Note 5 to our consolidated financial statements in this Form 10-K for more information.
We have elected to file a consolidated federal income tax return for 2003 and prior years. Within the consolidated tax return, we are required by Internal Revenue Service regulations to segregate the entities into two groups: life insurance companies and non-life insurance companies. We are limited as to the amount of any operating losses from one group that can be offset against taxable income of the other group. These limitations affect the amount of any operating loss carryforwards that we have recorded in our deferred tax assets now or in the future.
As of December 31, 2003, we had deferred tax assets related to net operating losses of $49.7 million for federal income tax purposes and $24.3 million for state income tax purposes. The deferred tax assets related to the federal net operating losses are scheduled to expire as follows: $7.7 million in 2015, $5.4 million in 2016, $19.8 million in 2017, $1.1 million in 2018 and $15.7 in 2023. The deferred tax assets related to the state net operating losses relate to the non-life subgroup and are scheduled to expire as follows: $12.7 million in 2020 and $11.6 million in 2021. Due to the inability to combine the life insurance and non-life insurance subgroups for state income tax purposes, a $24.3 million and a $29.0 million valuation allowance has been established at the end of 2003 and 2002, respectively, relative to the state net operating loss carryforwards.
• Pension and other Post-employment Benefits See Note 11 to our consolidated financial statements in this Form 10-K for more information on our pension and other post-employment benefits.
The following table and discussion present summary consolidated financial data for the years 2003, 2002 and 2001 ($ amounts in millions).
Changes ------------------------ 2002 2001 2003 Restated Restated 2003 / 02 2002 / 01 ----------- ----------- ----------- ----------- -----------
BENEFITS AND EXPENSES Policy benefits, excluding policyholder dividends................... 1,454.0 1,436.1 1,406.7 17.9 29.4 Policyholder dividends..................... 418.8 401.8 400.1 17.0 1.7 Policy acquisition cost amortization....... 94.1 59.2 133.0 34.9 (73.8) Intangible asset amortization.............. 33.2 32.5 49.4 0.7 (16.9) Intangible asset impairments............... -- 66.3 -- (66.3) 66.3 Interest expense on indebtedness........... 39.6 31.4 27.3 8.2 4.1 Interest expense on non-recourse collateralized obligations............... 48.9 30.5 42.3 18.4 (11.8) Demutualization expenses................... -- 1.8 25.9 (1.8) (24.1) Other operating expenses................... 536.0 581.2 624.4 (45.2) (43.2) ----------- ----------- ----------- ----------- ----------- Total benefits and expenses................ 2,624.6 2,640.8 2,709.1 (16.2) (68.3) ----------- ----------- ----------- ----------- ----------- Loss before income taxes and minority interest.................... (10.2) (184.5) (245.3) 174.3 60.8 Applicable income taxes (benefit).......... (18.5) (56.2) (105.2) 37.7 49.0 ----------- ----------- ----------- ----------- ----------- Income (loss) before minority interest..... 8.3 (128.3) (140.1) 136.6 11.8 Minority interest in net income of consolidated subsidiaries............. 12.4 12.4 7.2 -- 5.2 ----------- ----------- ----------- ----------- ----------- Loss from continuing operations............ (4.1) (140.7) (147.3) 136.6 6.6 Loss from discontinued operations.......... (2.1) (1.3) (2.5) (0.8) 1.2 ----------- ----------- ----------- ----------- ----------- Loss before cumulative effect of accounting changes....................... (6.2) (142.0) (149.8) 135.8 7.8 Cumulative effect of accounting changes.... -- (130.3) (65.4) 130.3 (64.9) ----------- ----------- ----------- ----------- ----------- Net loss................................... $ (6.2) $ (272.3) $ (215.2) $ 266.1 $ (57.1) =========== =========== =========== =========== ===========
Premium revenue decreased $39.8 million, or 4%, in 2003 compared to 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 inforce 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 inforce.
Policy benefits, including policyholder dividends, increased $34.9 million, or 2%, in 2003 compared to 2002, primarily due to higher interest credited on guaranteed interest accounts and fixed annuities from higher fund account balances and higher mortality expense for universal life insurance. Policyholder dividend expense for 2003 was also higher compared to 2002, primarily due to growth in cash values of existing participating life policies and the growth of our policyholder dividend obligation from favorable results, in part from the portion of the venture capital funds transferred to the closed block in the first quarter of 2003.
Policy acquisition cost amortization increased $34.9 million, or 59%, in 2003 compared to 2002, primarily due to higher amortization for participating life insurance and increased amortization for variable universal life and annuities from a growing inforce 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 compared to 2002, due to a restructuring of debt in late 2002 through the issuance of equity units to paydown borrowings from a lower cost bank credit facility.
Interest expense on non-recourse collateralized obligations increased $18.4 million, or 60%, in 2003 compared to 2002, primarily due to interest expense from the Mistic CDO which closed in the third quarter of 2002.
Other operating expenses decreased $45.2 million, or 8%, in 2003 compared to 2002, primarily due to lower management restructuring costs and lower overall operating expenses.
Our income tax benefit of $18.5 million applicable to income before income taxes and minority interest for 2003 differed from the statutory U.S. federal income tax benefit of $3.6 million, primarily as a result of the tax benefits associated with low income housing tax credits, non-taxable dividend and interest income and income related to the minority interest in various non-taxable entities. The income tax benefit of $56.2 million for 2002 also differed from the statutory U.S. federal income tax benefit of $64.6 million, primarily as a result of tax benefits associated with low income housing tax credits, non-taxable dividend and interest income, the recovery of non-taxable amounts related to an IRS settlement offset by non-deductible charges for the impairment of intangible assets and realized investment losses of $26.3 million related to debt securities pledged as collateral from our consolidated CDOs for which there is no tax benefit.
Premium revenue declined $30.7 million, or 3%, in 2002, primarily as the result of a shift in sales from traditional life products to variable universal life, universal life and annuity products. Since our 2001 demutualization, we no
longer sell participating life policies resulting in a decline in renewal participating life premiums and the related inforce. Insurance and investment product fees increased $17.3 million, 3%, in 2002. Variable universal life and universal life fees increased $9.4 million and $8.6 million, respectively, due to higher funds under management driven by strong sales of universal life and variable universal life product, particularly in 2001 and 2002. Annuity fees declined $4.8 million as the result of lower funds under management in variable sub-accounts.
The fluctuation in both premiums and insurance and investment product fees reflect our continued emphasis on variable universal life, universal life and annuity product sales, rather than on traditional life product sales. Investment product fees remained constant compared to 2001. The acquisition of a 60% interest in Kayne Anderson Rudnick in January 2002 increased investment product fees, but was offset by a corresponding decrease resulting from reductions in other assets under management and changes to fee structures.
The increase in realized investment losses was primarily due to higher credit related losses in the telecommunications industry, primarily in the closed block, and debt securities pledged as collateral related to our consolidated CDOs. See Debt and Equity Securities section of Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K for additional information.
The increase in policy benefits of $29.4 million, or 2%, in 2002 compared to 2001 is primarily due to a $48.2 million increase in interest credited on the guaranteed interest accounts portion of our annuity business, primarily from late 2001 and 2002 sales of RPE (see the General Account section of Management's Discussion and Analysis of Financial Condition and Results of Operations). In addition, expense related to minimum death benefit guarantees on certain of our variable annuity products increased $8.7 million during 2002 as the result of an increase in net minimum death benefit exposure from $5.8 million at December 31, 2001 to $234.9 million at December 31, 2002. Of this increase in exposure, $176.6 million was the result of the acquisition of a block of annuity business from Valley Forge Life Insurance Company, with the remaining increase in exposure resulting from the impact of the overall decline in equity markets on fund balances.
The decrease in intangible asset amortization of $16.9 million, or 34%, in 2002 compared to 2001 was due to our adoption of a new standard on goodwill and intangible assets with indefinite lives which requires that, upon adoption, amortization cease for goodwill and intangible assets with indefinite lives. See Note 4 to our consolidated financial statements in this Form 10-K for more information.
Interest expense on non-recourse collateralized obligations decreased $11.8 million, or 28%, in 2002 compared to 2001, primarily due to reduced interest income received (discussed above) resulting in lower distributions to investment holders.
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 in this Form 10-K.
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.
Investment product fees for 2003 increased by $17.9 million, or 6%, compared to 2002, primarily due to higher sales in universal life products, a growing inforce in universal life and variable universal life products and slightly higher surrender fees for variable universal life products. Specifically, higher net amounts at risk in these two lines of business, as well as higher sales of universal life products, resulted in higher fees.
Policy acquisition cost amortization for 2003 increased $9.6 million, or 11%, compared to 2002, primarily due to a growing inforce, higher margins and slightly higher surrenders, partially offset by lower amortization expense for annuities due to the charges incurred in the third quarter of 2002, which did not recur in 2003.
Other operating expenses decreased $6.9 million, or 2%, in 2003 compared to 2002 as a result of generally lower non-deferrable operating expenses, partially offset by higher employee benefit costs.
Minority interest expense relates to our then 67% owned subsidiary, PFG.
Variable universal life insurance.......... $ 114.8 $ 109.2 $ 97.3 $ 5.6 $ 11.9 Universal life insurance................... 196.9 195.8 190.8 1.1 5.0 Term life insurance........................ 14.6 12.2 8.7 2.4 3.5 Other life insurance....................... 148.2 146.3 140.1 1.9 6.2 ----------- ----------- ----------- ----------- ----------- Total, non-participating life insurance.... 474.5 463.5 436.9 11.0 26.6 Participating life insurance............... 1,690.1 1,718.9 1,760.9 (28.8) (42.0) ----------- ----------- ----------- ----------- ----------- Total, life insurance...................... 2,164.6 2,182.4 2,197.8 (17.8) (15.4) Annuities.................................. 203.8 162.1 108.8 41.7 53.3 ----------- ----------- ----------- ----------- ----------- Segment revenues........................... $ 2,368.4 $ 2,344.5 $ 2,306.6 $ 23.9 $ 37.9 =========== =========== =========== =========== ===========
Variable universal life product revenues increased $5.6 million, or 5%, in 2003 compared to 2002, primarily due to higher cost of insurance fees from a growing inforce, and higher surrender charges, partially offset by slightly lower sales and lower interest earned.
Term life revenues increased $2.4 million, or 20%, in 2003 compared to 2002, due to premium growth from higher sales.
Participating life product revenues decreased $28.8 million, or 2%, in 2003 compared to 2002, primarily due to a continued shift in sales from participating life to universal and variable universal life products as well as a continued decline in participating life inforce business.
Annuity product revenues increased $41.7 million, or 26%, in 2003 compared to 2002, primarily due to higher fees from improved equity market performance and to an increase in interest earned on higher spread based asset products.
Term life revenues increased $3.5 million, 40%, in 2002 compared to 2001, due to premium growth from higher sales, partially offset by lower investment income.
Participating life product revenues decreased $42.0 million, or 2%, in 2002 compared to 2001, primarily due to a continued shift in sales from participating life to universal and variable universal life products, a continued decline in participating life inforce business and slightly lower investment income.
Variable universal life insurance.......... $ 35.0 $ 35.9 $ 30.2 $ (0.9) $ 5.7 Universal life insurance................... 21.7 26.3 17.4 (4.6) 8.9 Term life insurance........................ 3.8 4.7 1.3 (0.9) 3.4 Other life insurance....................... 6.9 0.8 1.7 6.1 (0.9) ----------- ----------- ----------- ----------- ----------- Total, non-participating life insurance.... 67.4 67.7 50.6 (0.3) 17.1 Participating life insurance............... 36.1 33.3 21.4 2.8 11.9 ----------- ----------- ----------- ----------- ----------- Total, life insurance...................... 103.5 101.0 72.0 2.5 29.0 Annuities.................................. (4.1) (20.7) 10.9 16.6 (31.6) ----------- ----------- ----------- ----------- ----------- Segment income before income taxes......... $ 99.4 $ 80.3 $ 82.9 $ 19.1 $ (2.6) =========== =========== =========== =========== ===========
Variable universal life product pre-tax income decreased $0.9 million, or 3%, in 2003 compared to 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 compared to 2002, due to lower insurance margins and surrender charges, partially offset by higher investment margins and lower expenses.
Other life insurance pre-tax income increased $6.1 million in 2003 compared to 2002, due to favorable mortality in an old block of corporate-owned life insurance business, the release of a reserve on a life contingent annuity due to the death of the annuitant and higher income from certain non-life insurance subsidiaries.
Participating life product pre-tax income increased $2.8 million, or 8%, in 2003 compared to 2002, primarily due to a one-time investment gain during the second quarter of 2003 and lower non-deferrable expenses, partially offset by higher DAC amortization and the release of a policyholder tax contingency in 2002 that did not recur in 2003.
Annuity product pre-tax loss was $16.6 million, or 80%, less in 2003 compared to 2002. This was primarily due to lower amortization of DAC in 2003, a decrease in minimum guaranteed death benefits expense in 2003, and higher investment margins from higher spread type funds under management. These were partially offset by higher non-deferrable expenses and commissions as well as further spread compression in 2003. Amortization of DAC was lower in 2003, due to acceleration of amortization from a revision of long-term market return assumptions and an impairment charge in 2002, neither of which recurred in 2003.
Variable universal life product pre-tax income increased $5.7 million, or 19%, in 2002 compared to 2001, primarily due to favorable investment margins, slightly higher surrender charges, and lower amortization of DAC.
Annuity product pre-tax loss was $20.7 million in 2002, compared with pre-tax income of $10.9 million in 2001. This $31.6 million decrease was primarily due to higher non-deferrable expenses, amortization of DAC, and benefit costs.
See Note 3 to our consolidated financial statements in this Form 10-K for more information.
Changes ------------------------ 2003 2002 2001 2003/02 2002/01 ----------- ----------- ----------- ----------- ----------- Results of Operations Investment product fees.................... $ 243.2 $ 258.1 $ 258.1 $ (14.9) $ -- Net investment income...................... 0.7 1.0 1.6 (0.3) (0.6) ----------- ----------- ----------- ----------- ----------- Total segment revenues..................... 243.9 259.1 259.7 (15.2) (0.6) ----------- ----------- ----------- ----------- ----------- Intangible asset amortization.............. 33.2 32.5 49.0 0.7 (16.5) Intangible asset impairments............... -- 66.3 -- (66.3) 66.3 Other operating expenses................... 207.4 218.3 212.5 (10.9) 5.8 ----------- ----------- ----------- ----------- ----------- Total segment expenses..................... 240.6 317.1 261.5 (76.5) 55.6 ----------- ----------- ----------- ----------- ----------- Segment income (loss) before income taxes and minority interest....... 3.3 (58.0) (1.8) 61.3 (56.2) Allocated income taxes (benefit)........... (3.3) (6.0) 2.6 2.7 (8.6) ----------- ----------- ----------- ----------- ----------- Segment income (loss) before minority interest........................ 6.6 (52.0) (4.4) 58.6 (47.6) Minority interest in net income of subsidiaries.......................... 12.0 11.9 6.9 0.1 5.0 ----------- ----------- ----------- ----------- ----------- Segment loss............................... (5.4) (63.9) (11.3) 58.5 (52.6) Net realized investment gains (losses)..... (0.3) -- 0.5 (0.3) (0.5) Restructuring and other costs, net of income taxes............................. (4.0) (8.4) (50.4) 4.4 42.0 Cumulative effect of accounting change..... -- (119.9) -- 119.9 (119.9) ----------- ----------- ----------- ----------- ----------- Segment net loss........................... $ (9.7) $ (192.2) $ (61.2) $ 182.5 $ (131.0) =========== =========== =========== =========== ===========
There were no impairments of goodwill or other intangible assets in 2003. The $66.3 million charge in 2002 was associated with the impairment of goodwill related to certain of our asset management partners.
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.
Changes ------------------------ 2003 2002 2001 2003/02 2002/01 ----------- ----------- ----------- ----------- ----------- Venture Capital Investments Contributions (dollars invested)........... $ 31.0 $ 42.2 $ 47.0 $ (11.2) $ (4.8) Equity in earnings of partnerships......... 36.2 (59.3) (159.6) 95.5 100.3 Distributions.............................. (32.2) (41.7) (63.0) 9.5 21.3 Proceeds from sale of partnership interests and transfer to closed block... (52.2) -- -- (52.2) -- Realized loss on sale of partnership interests and transfer to closed block... (14.3) (5.1) -- (9.2) (5.1) ----------- ----------- ----------- ----------- ----------- Change in venture capital investments...... (31.5) (63.9) (175.6) 32.4 111.7 Venture capital segment investments, beginning of period...................... 227.8 291.7 467.3 (63.9) (175.6) ----------- ----------- ----------- ----------- ----------- Venture capital segment investments, end of period............................ $ 196.3 $ 227.8 $ 291.7 $ (31.5) $ (63.9) =========== =========== =========== =========== ===========
Venture capital investments for 2003 increased $32.4 million compared to 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.
Venture capital investments for 2002 increased $111.7 million compared to the change for 2001, primarily due to lower losses from equity interests in partnerships ($59.3 million loss in 2002 compared to $159.6 million loss in 2001) and lower distributions in 2002 compared to 2001. Losses from equity interests in partnerships were higher in 2001 primarily due to the cumulative effect of an accounting change discussed above.
Our investments in venture capital partnerships as of December 31, 2003 and 2002 by type of investment follow ($ amounts in millions):
Technology................................................................. $ 36.8 $ 25.0 Telecommunications......................................................... 13.3 10.2 Biotechnology.............................................................. 16.3 11.1 Health care................................................................ 8.2 9.2 Consumer and business products and services................................ 29.6 45.9 Financial services......................................................... 28.5 28.1 Other...................................................................... 44.9 50.6 -------------- -------------- Private holdings........................................................... 177.6 180.1 Public holdings............................................................ 11.3 23.0 Cash and cash equivalents.................................................. 5.5 21.6 Other...................................................................... 1.9 3.1 -------------- -------------- Venture capital partnerships............................................... $ 196.3 $ 227.8 ============== ==============
The following table and discussion present summary financial data relating to Corporate and Other for the years 2003, 2002 and 2001 ($ amounts in millions):
2002 2001 Changes 2003 Restated Restated 2003/02 2002/01 ----------- ----------- ------------ ----------- ----------- Results of Operations Corporate investment income................ $ 4.3 $ 1.5 $ 7.2 $ 2.8 $ (5.7) Investment income from collateralized obligations............... 52.2 31.0 42.8 21.2 (11.8) Interest expense on indebtedness........... (39.6) (31.4) (27.3) (8.2) (4.1) Interest expense on non-recourse collateralized obligations............... (48.9) (30.5) (42.3) (18.4) 11.8 Corporate expenses......................... (11.0) (10.4) (19.9) (0.6) 9.5 International.............................. (1.4) 4.2 7.7 (5.6) (3.5) Other...................................... (3.4) (4.4) (2.9) 1.0 (1.5) ----------- ----------- ------------ ----------- ----------- Segment loss, before income taxes.......... (47.8) (40.0) (34.7) (7.8) (5.3) Allocated income tax (benefit)............. (18.8) (29.8) (20.9) 11.0 (8.9) ----------- ----------- ------------ ----------- ----------- Segment loss............................... $ (29.0) $ (10.2) $ (13.8) $ (18.8) $ 3.6 =========== =========== ============ =========== ===========
Investment income from debt and equity securities pledged as collateral related to our consolidated CDOs increased $21.2 million, or 68%, in 2003 compared to 2002, primarily from earnings from the Mistic CDO which closed in the third quarter of 2002.
International results decreased $5.6 million in 2003 compared to 2002, due primarily to lower equity in earnings from Aberdeen.
Other increased $1.0 million in 2003 compared to 2002, due primarily to lower losses from non-core operations offset by slightly higher expenses related to debt and equity securities pledged as collateral related to our consolidated CDOs of $2.8 million.
Investment income from debt and equity securities pledged as collateral related to our consolidated CDOs decreased $11.8 million, or 28%, in 2002 compared to 2001, primarily due to a significant drop in interest rates and higher credit defaults resulting in lower interest income received.
Interest expense on indebtedness increased due to higher levels of indebtedness in 2002 than in 2001.
The decrease in net investment income in 2002 from 2001 is primarily due to a decrease in invested assets in 2002, including a reallocation of assets to the Life and Annuity segment, which was effective January 1, 2002. The decrease was partially offset by our equity in increased earnings of unconsolidated affiliates, including HRH, in 2002.
Corporate expenses decreased $9.5 million in 2002 from 2001, due primarily to lower unallocated expenses. Other decreased $1.5 million in 2002 from 2001, due primarily to our exit from our physician practice management business during 2001, offset by higher losses from non-core operations.
We manage credit risk through the fundamental analysis of the underlying obligors, issuers and transaction structures. We employ a staff of experienced credit analysts who review obligors' management, competitive position, cash flow, coverage ratios, liquidity and other key financial and non-financial information. These analysts recommend the investments needed to fund our liabilities while adhering to diversification and credit rating guidelines. In addition, when investing in private debt securities, we rely upon broad access to management information, negotiated protective covenants, call protection features and collateral protection. We review our debt security portfolio regularly to monitor the performance of obligors and assess the stability of their current credit ratings.
In 1999, we began selling 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. In September 2002, we stopped accepting applications for RPE, although existing policyholders have the right to make subsequent cumulative gross deposits up to $1 million per contract.
Amounts held by our policyholders in RPE and other guaranteed interest accounts, or GIAs, and fixed annuities, as of December 31, 2003 and 2002 follow ($ amounts in millions):
We manage credit risk through industry and issuer diversification and asset allocation. Maximum exposure to an issuer is defined by quality ratings, with higher quality issuers having larger exposure limits. We have an overall limit on below investment-grade rated issuer exposure.
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 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.
1 AAA/AA/A............ $ 8,821.2 $ 7,971.5 $ 7,442.1 $ 6,560.4 $ 1,379.1 $ 1,411.1 2 BBB................. 3,350.8 2,849.0 2,160.6 1,767.1 1,190.2 1,081.9 ----------- ---------- ---------- ---------- ---------- ---------- Total investment grade 12,172.0 10,820.5 9,602.7 8,327.5 2,569.3 2,493.0 3 BB.................. 764.9 785.7 635.5 577.4 129.4 208.3 4 B................... 218.9 105.4 157.8 82.2 61.1 23.2 5 CCC and lower....... 94.6 118.5 53.7 53.3 40.9 65.2 6 In or near default.. 22.6 59.4 19.0 25.4 3.6 34.0 ----------- ---------- ---------- ---------- ---------- ---------- Total debt securities $13,273.0 $11,889.5 $10,468.7 $ 9,065.8 $ 2,804.3 $ 2,823.7 =========== ========== ========== ========== ========== ==========
Unrealized Gains (Losses) ------------------------------------ Fair Gross Gross Value Cost Gains Losses Net ------------ ------------ ---------- ----------- ----------- Debt Securities by Type U.S. government and agency........... $ 757.0 $ 714.5 $ 44.0 $ (1.5) $ 42.5 State and political subdivision...... 510.3 468.4 43.5 (1.6) 41.9 Foreign government................... 260.4 239.0 23.2 (1.8) 21.4 Corporate............................ 6,765.8 6,412.4 400.4 (47.0) 353.4 Mortgage-backed...................... 3,097.5 2,963.4 143.4 (9.3) 134.1 Other asset-backed................... 1,882.0 1,863.6 55.6 (37.2) 18.4 ------------ ------------ ---------- ----------- ----------- Total debt securities................ $13,273.0 $12,661.3 $ 710.1 $ (98.4) $ 611.7 ============ ============ ========== =========== =========== Debt securities outside closed block: Unrealized gains................. $ 5,169.1 $ 4,946.8 $ 222.3 $ -- $ 222.3 Unrealized losses................ 1,197.5 1,247.4 -- (49.9) (49.9) ------------ ------------ ---------- ----------- ----------- Total outside the closed block... 6,366.6 6,194.2 222.3 (49.9) 172.4 ------------ ------------ ---------- ----------- ----------- Debt securities in closed block: Unrealized gains................. 5,807.5 5,319.7 487.8 -- 487.8 Unrealized losses................ 1,098.9 1,147.4 -- (48.5) (48.5) ------------ ------------ ---------- ----------- ----------- Total in the closed block........ 6,906.4 6,467.1 487.8 (48.5) 439.3 ------------ ------------ ---------- ----------- ----------- Total debt securities................ $13,273.0 $12,661.3 $ 710.1 $ (98.4) $ 611.7 ============ ============ ========== =========== ===========
Percentage of total debt securities............................... 91.7% 66.5% 25.2% ========== =========== ===========
In or Near Total BB B CC or Lower Default ------------ ----------- ----------- ------------- ------------ Below Investment Grade Debt Securities (Fair Value) Foreign government................... $ 133.6 $ 129.7 $ 3.9 $ -- $ -- Corporate............................ 752.5 526.8 167.1 55.0 3.6 Mortgage-backed...................... 62.3 61.9 -- 0.2 0.2 Other asset-backed................... 152.6 46.5 47.9 39.4 18.8 ------------ ----------- ----------- ------------ ------------ Total debt securities................ $ 1,101.0 $ 764.9 $ 218.9 $ 94.6 $ 22.6 ============ =========== =========== ============ ============
Our corporate debt security exposure to currently troubled industries, including telecommunication equipment, telephone utilities, airlines, media, publishing and broadcasting, comprises 3.1% of our debt securities portfolio at December 31, 2003. In addition, within the asset-backed securities sector, our exposure to securitized aircraft receivable securities comprise approximately 1% of our debt securities portfolio, with less than one-third of that exposure rated below investment grade at December 31, 2003.
Realized impairment losses on debt and equity securities pledged as collateral relating to our direct investments in the consolidated collateralized obligation trusts are $5.9 million, $8.6 million and $26.5 million for 2003, 2002 and 2001, respectively.
Gross and net unrealized gains and losses from our general account debt and equity securities as of December 31, 2003 follow ($ amounts in millions):
Equity Securities Number of positions........................ 320 55 164 24 156 31 ---------- ---------- ---------- ---------- ---------- ----------- Unrealized gains (losses).................. $ 91.4 $ (1.8) $ 83.3 $ (1.4) $ 8.1 $ (0.4) ---------- ---------- ---------- ---------- ---------- ----------- Applicable policyholder dividend obligation (reduction)................... 8.1 (0.4) -- -- 8.1 (0.4) Applicable deferred income taxes (benefit). 29.2 (0.5) 29.2 (0.5) -- -- ---------- ---------- ---------- ---------- ---------- ----------- Offsets to net unrealized gains (losses)... 37.3 (0.9) 29.2 (0.5) 8.1 (0.4) ---------- ---------- ---------- ---------- ---------- ----------- Unrealized gains (losses) after offsets.... $ 54.1 $ (0.9) $ 54.1 $ (0.9) $ -- $ -- ========== ========== ========== ========== ========== =========== Net unrealized gains after offsets......... $ 53.2 $ 53.2 $ -- ========== ========== ==========
Our assessment of whether an investment by us in a debt or equity security is other-than-temporarily impaired includes whether the issuer has:
0 - 6 6 - 12 12 - 24 Over 24 Total Months Months Months Months ------------ ------------ ----------- ------------ ------------ Debt Securities Outside Closed Block Number of positions....................... 264 205 14 21 24 ------------ ------------ ----------- ------------ ------------ Total fair value.......................... $ 1,197.5 $ 943.1 $ 74.0 $ 66.0 $ 114.4 Total amortized cost...................... 1,247.4 961.9 80.4 72.0 133.1 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (49.9) $ (18.8) $ (6.4) $ (6.0) $ (18.7) ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ (16.3) $ (7.6) $ (0.6) $ (0.5) $ (7.6) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (16.4) $ (0.5) $ (3.7) $ (2.5) $ (9.7) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ (7.0) $ (0.2) $ (0.6) $ (2.2) $ (4.0) ============ ============ =========== ============ ============
Below investment grade: Number of positions....................... 34 12 3 8 11 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (11.2) $ (2.4) $ (0.6) $ (2.3) $ (5.9) ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ (3.9) $ (1.2) $ (0.1) $ (0.1) $ (2.5) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (5.3) $ (0.5) $ -- $ -- $ (4.8) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ (3.7) $ (0.2) $ -- $ (1.5) $ (2.0) ============ ============ =========== ============ ============
For debt securities outside of the closed block with gross unrealized losses, 78% of the unrealized losses after offsets pertain to investment grade securities and 22% of the unrealized losses after offsets pertain to below investment grade securities.
Of the 34 below investment grade debt security positions held outside the closed block with unrealized losses, 15 have been in an unrealized loss position for 12 months or less at December 31, 2003 (including 13 that have
Of the 24 equity securities held outside the closed block with unrealized losses, 19 have been in an unrealized loss position for 12 months or less at December 31, 2003 (including 17 that have unrealized losses less than 20% of cost). Of the remaining five securities, two have been in an unrealized loss position for 12 to 24 months (both have unrealized losses less than 20% of cost) and three have been in an unrealized loss position for over 24 months (including one that has unrealized losses less than 20% of cost).
Gross unrealized losses on general account debt and equity securities in the closed block as of December 31, 2003 by duration of unrealized loss and by debt securities credit quality follow ($ amounts in millions):
Below investment grade: Number of positions....................... 28 10 3 8 7 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (18.1) $ (4.5) $ (1.3) $ (5.5) $ (6.8) ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (10.2) $ (2.5) $ (0.7) $ (3.1) $ (3.9) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ -- $ -- $ -- $ -- $ - ============ ============ =========== ============ ============
Equity Securities Inside Closed Block Number of positions....................... 31 31 0 0 0 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (0.4) $ (0.4) $ -- $ -- $ -- ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (0.1) $ (0.1) $ -- $ -- $ -- ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============
Of the 155 investment grade debt securities held in the closed block with unrealized losses, 141 have been in an unrealized loss position for 12 months or less at December 31, 2003 (all of which have unrealized losses less than 20% of cost). Of the remaining 14 security positions, nine have been in an unrealized loss position for over 24 months (including eight that have unrealized losses less than 20% of cost).
Of the 28 below investment grade debt security positions held in the closed block with unrealized losses, 13 have been in an unrealized loss position for 12 months or less at December 31, 2003 (including 11 that have unrealized losses less than 20% of cost). Of the remaining 15 positions, eight have been in an unrealized loss position for 12
to 24 months (including seven that have unrealized losses less than 20% of cost) and seven have been in an unrealized loss position for over 24 months (including five that have unrealized losses less than 20% of cost).
Of the 31 equity securities held inside the closed block with unrealized losses, all have been in an unrealized loss position for 6 months or less as of December 31, 2003.
Prior to October 24, 2003, our ownership of Aberdeen common stock included 22% of the company's outstanding common shares that we purchased in between 1996 and 2001 for $109.1 million. As of June 30, 2003, we concluded that our equity investment in Aberdeen, accounted for under the equity method of accounting, was other-than-temporarily impaired resulting in an $89.1 million pre-tax, non-cash charge to earnings during the three month period ended June 30, 2003. The carrying value of our equity investment in Aberdeen was $38.3 million and $119.3 million at December 31, 2003 and 2002, respectively. The fair value, based on quoted market price of underlying shares, of our equity investment in Aberdeen was $65.2 million, $54.4 million and $43.6 million at March 11, 2004, December 31, 2003 and 2002, respectively.
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.
As of June 30, 2003, we concluded that our equity investment in Aberdeen, accounted for under the equity method of accounting, was other-than-temporarily impaired after consideration of the following:
• restructuring activities announced to date had not materialized as originally contemplated; • continuing inquiry by U.K. regulatory authorities related to "mis-selling" of certain split capital trusts funds managed by Aberdeen with no resolution anticipated in the near-term; • disputes with clients related to certain closed-end funds managed by Aberdeen; and • as at June 30, 2003, the carrying value of our equity method investment in Aberdeen had continuously exceeded the underlying fair value as represented by its publicly traded share price for a period of nine to 12 months.
In the normal course of business, we enter into transactions involving various types of financial instruments such as debt and equity securities. These instruments have credit risk and also may be subject to risk of loss due to interest rate and market fluctuations.
For 2003, cash from continuing operations increased $77.0 million compared to 2002, due primarily to higher investment income collected and lower operating expenses paid, partially offset by lower premiums collected.
For 2003, cash from financing activities decreased $2,371.7 million compared to 2002, due primarily to lower policyholder deposit fund receipts and lower net proceeds from collateralized obligations (discussed above), partially offset by treasury stock purchases in 2002 that were not continued in 2003.
For 2002, cash from continuing operations increased $64.9 million compared to 2001, due primarily to lower benefit payments and expenses paid, partially offset by lower premiums collected.
For 2002, cash for investing activities increased $607.7 million compared to 2001, due primarily to higher cash from financing (discussed below), partially offset by higher acquisition costs of subsidiary purchases in 2001.
For 2002, cash from financing activities increased $748.7 million compared to 2001, due to proceeds from the equity units and stock purchase contract transactions, increases in policyholder deposit fund receipts and proceeds from the Mistic CDO, partially offset by the proceeds from our IPO and debt offering in 2001.
Changes --------------------------- 2003 2002 2001 2003/02 2002/01 ------------ ------------ ------------ ------------ ------------
Cash from operating activities decreased $29.0 million in 2002 compared to 2001, primarily due to a decrease of $65.3 million in the dividend from Phoenix Life, partially offset by lower expenses paid, primarily demutualization related, and higher investment income, primarily related to interest received on borrowing by Phoenix Investment Partners.
The holding company's primary uses of liquidity include dividend payments on its common stock, loans or contributions to its subsidiaries, debt service and general corporate expenses.
The holding company's primary sources of liquidity have been dividends from Phoenix Life and interest income received from Phoenix Investment Partners. Under New York Insurance Law, Phoenix Life can pay stockholder dividends to the holding company in any calendar year without prior approval from the New York Superintendent of Insurance in the amount of the lesser of 10% of Phoenix Life's surplus to policyholders as of the immediately preceding calendar year or Phoenix Life's statutory net gain from operations for the immediately preceding calendar year, not including realized capital gains. Phoenix Life paid a dividend of $44.5 million in April 2003 and is able to pay a dividend of $69.7 million in 2004 under this provision. See Note 15 to our consolidated financial statements in this Form 10-K for more information on Phoenix Life statutory financial information and regulatory matters.
Phoenix Investment Partners pays interest to the holding company on its debt from the holding company. The holding company does not expect to receive dividends from Phoenix Investment Partners in the near term because it will likely use a substantial portion of its cash flows from operations to pay contingent consideration for prior acquisitions, to repay intercompany debt, including debt to the holding company and interest on debt.
On December 22, 2003, we closed on a new $150.0 million unfunded, unsecured senior revolving credit facility to replace our $100 million credit facility, which expired on that date. This new facility consists of two tranches: a $112.5 million, 364-day revolving credit facility and a $37.5 million, 3-year revolving credit facility. Under the 364-day facility, we have the ability to extend the maturity date of any outstanding borrowings for one year from the termination date. Potential borrowers on the new credit line are the holding company, Phoenix Life and Phoenix Investment Partners. Financial covenants require the maintenance at all times of: consolidated stockholders' equity of $1,775.0 million, stepping up by 50% of quarterly positive net income and 100% of equity issuances; a maximum consolidated debt-to-capital ratio of 30%; a minimum consolidated fixed charge coverage ratio (as defined in the credit agreement) of 1.25:1; and, for Phoenix Life, a minimum risk-based capital ratio of 250% and a minimum A.M. Best Financial Strength Rating of A-.
See Note 18 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 The Phoenix Companies, Inc.; 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.
Phoenix Life's current sources of liquidity also include a revolving credit facility under which Phoenix Life has direct borrowing rights, subject to our unconditional guarantee. Since the demutualization, Phoenix Life's access to the cash flows generated by the closed block assets has been restricted to funding the closed block.
2003 2002 --------------------- --------------------- Amount(1) Percent Amount(1) Percent ----------- --------- ----------- ---------
Not subject to discretionary withdrawal provision............. $ 220.8 3% $ 168.1 3% Subject to discretionary withdrawal without adjustment........ 1,967.2 28% 2,073.3 35% Subject to discretionary withdrawal with market value adjustment.................................................. 811.6 11% 649.7 11% Subject to discretionary withdrawal at contract value less surrender charge............................................ 869.8 12% 701.5 11% Subject to discretionary withdrawal at market value........... 3,294.0 46% 2,386.5 40% ----------- --------- ----------- --------- Total annuity contract reserves and deposit fund liability.... $7,163.4 100% $5,979.1 100% =========== ========= =========== ========= ------- (1) Contract reserves and deposit fund liability amounts are reported on a statutory basis, which more accurately reflects the potential cash outflows and include variable product liabilities. Annuity contract reserves and deposit fund liabilities are monetary amounts that an insurer must have available to provide for future obligations with respect to its annuities and deposit funds. These are liabilities on the balance sheet of financial statements prepared in conformity with statutory accounting practices. These amounts are at least equal to the values available to be withdrawn by policyholders.
Phoenix Investment Partners' liquidity requirements are primarily to fund operating expenses and pay its debt and interest obligations. Phoenix Investment Partners also would require liquidity to fund the costs of any contingent payments for previous acquisitions, as well as any potential acquisitions. Historically, Phoenix Investment Partners' principal source of liquidity has been cash flows from operations. We expect that cash flow from operations will continue to be Phoenix Investment Partners' principal source of working capital. Phoenix Investment Partners' current sources of liquidity also include a revolving credit facility under which Phoenix Investment Partners has direct borrowing rights subject to the unconditional guarantee of The Phoenix Companies, Inc. We believe that Phoenix Investment Partners' current and anticipated sources of liquidity are adequate to meet its present and anticipated needs. See Note 6 to our consolidated financial statements in this Form 10-K for further details on our financing activities. It is anticipated that Phoenix Investment Partners will draw $25.0 million against the credit facility during the first quarter of 2004 in order to fulfill an obligation related to the Kayne Anderson Rudnick acquisition. See Commitments Related to Recent Business Combinations
The following table presents the consolidated balance sheet as of December 31, 2003 and 2002 ($ amounts in millions):
LIABILITIES Policy liabilities and accruals.................................. $ 13,088.6 $ 12,680.0 $ 408.6 Policyholder deposit funds....................................... 3,642.7 3,395.7 247.0 Stock purchase contracts and indebtedness........................ 767.8 781.9 (14.1) Other general account liabilities................................ 525.7 542.7 (17.0) Non-recourse collateralized obligations.......................... 1,472.0 1,609.5 (137.5) Separate account liabilities..................................... 6,083.2 4,371.2 1,712.0 ------------- ------------- -------------- Total liabilities................................................ 25,580.0 23,381.0 2,199.0 ------------- ------------- --------------
Affiliate equity securities decreased $87.2 million, or 65%, in 2003 compared to 2002, primarily due to an $89.1 million pre-tax, non-cash charge related to the other-than-temporary impairment of our equity investment in Aberdeen taken in the second quarter of 2003. See Note 5 to our consolidated financial statements in this Form 10-K for additional information.
Mortgage loans decreased $184.7 million, or 39%, in 2003 compared to 2002, reflecting continued mortgage loan paydowns, including several significant prepayments and the sale of a portfolio of loans in 2003.
Accrued investment income increased $37.5 million, or 9%, in 2003 compared to 2002, as a result of higher invested asset balances.
Amortization of policy acquisition costs increased $133.6 million, or 11%, in 2003 compared to 2002, due primarily to business growth and the acquisition of the minority interest PFG. See Note 3 to our consolidated financial statements in this Form 10-K for additional information. The composition of deferred acquisition costs by product at December 31, 2003 and 2002 follows ($ amounts in millions):
Policy liabilities and accruals increased $408.6 million, or 3%, in 2003 compared to 2002, primarily due to growth in policyholder inforce, partially offset by a decrease in the policyholder dividend obligation.
Stock purchase contracts and indebtedness decreased $14.1 million, or 2%, in 2003 compared to 2002, primarily due to the increase in the fair value of the embedded derivative investment. We recorded a favorable change in fair value of the embedded derivative investment of $8.8 with an offset to other comprehensive income. The increased fair value of the embedded derivative investment was primarily due to a decrease in the quoted market price of HRH common stock. Additionally, there was a $5.3 million decrease in the interest rate swap related to
Non-recourse collateralized obligations decreased $137.5 million, or 14%, in 2003 compared to 2002, due to distributions to investors and decreases in the non-recourse derivative cash flow hedges.
Commercial Commitments Expire Standby letters of credit(4) ............... $ 9.0 $ 9.0 $ -- $ -- $ -- Other commercial commitments(5)(6) .......... 125.0 3.4 4.6 25.1 91.9 ----------- ----------- ------------ ------------ ------------ Total commercial commitments............... $ 134.0 $ 12.4 $ 4.6 $ 25.1 $ 91.9 =========== =========== ============ ============ ============ ------- (1) Indebtedness amounts include principal only. (2) Other purchase liabilities includes $30.0 million due in the first quarter of 2004 related to a recent business combination. The remainder relates to open purchase orders and other contractual obligations. (3) 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. (4) Our standby letters of credit automatically renew on an annual basis. (5) Other commercial commitments relate to venture capital partnerships. These commitments can be drawn down by private equity funds as necessary to fund their portfolio investments through the end of the funding period as stated in each agreement. The amount collectively drawn down by the private equity funds in our portfolio during 2003 was $41.3 million. (6) Obligations and commitments related to post-employment benefit plans and commitments related to recent business combinations are not included in amounts presented within table. See the discussion on the following pages.
Under the terms of purchase agreements related to certain recent business combinations, we are subject to certain contractual obligations and commitments related to additional purchase consideration and put/call arrangements summarized as follows:
We have an earn-out arrangement effective December 31, 2003 for non-Phoenix members of Kayne Anderson Rudnick that is in the form of a put/call. Non-Phoenix members will be entitled to a payment in the first quarter
Phoenix has an additional arrangement in which existing non-Phoenix members of Kayne Anderson Rudnick will sell a portion of their membership interests in Kayne Anderson Rudnick, representing 15%, to Phoenix at a rate of 33 1/3% per year at December 31, 2004, 2005 and 2006. The total purchase price will equal net investment advisory fees for each year times 4.5 times 4.9% (the proportionate interest purchased). Such amounts are paid during the following quarter. Under certain circumstances, the purchases may be accelerated.
There is also a put/call arrangement with respect to the remaining 25% of the total membership interests. The purchase price will be equal to investment advisory fees for the relevant contract year multiplied by 4.5 multiplied by the amount of membership interest purchased. The contract year is defined as the twelve months ending December 31, 2006 and each calendar year thereafter. The pricing on the put/calls will be determined within 60 days after each such year-end and can be exercised within 60 days of the finalization of the price. All of these membership interests acquired will be reissued to members/employees of Kayne Anderson Rudnick. The reissuance process involves Phoenix Investment Partners contributing the interests to Kayne Anderson Rudnick and then Kayne Anderson Rudnick selling the interests to the members/employees. The members/employees will not pay cash for these purchases but will enter into a note payable agreement with Kayne Anderson Rudnick. Phoenix Investment Partners will have preferential distribution rights with respect to payments of principal and interest on these notes. Under certain circumstances, these interests can be issued without a note payable or other consideration. In addition, in certain circumstances, the purchases may be accelerated. Once these interests are purchased and then reissued, the amount of cash that Phoenix Investment Partners will need to pay to repurchase them in the future will be based on the growth in Kayne Anderson Rudnick's revenues since the reissuance dates. There is no expiration date for the put/call agreements. There is no cap or floor on the put/call price.
In August 2003, certain members of Kayne Anderson Rudnick accelerated their put/call arrangement. The purchase price for their interests totaled $4.5 million, which was recorded as additional purchase price by Phoenix Investment Partners and allocated to goodwill and definite-lived intangible assets.
We have a put/call arrangement with respect to the membership interests in Seneca not owned by Phoenix Investment Partners. The purchase price 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 the put/calls will be determined within 60 days after each calendar year-end and can be exercised within 60 days of the finalization of the price. All of these interests acquired 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 purchased by Phoenix Investment Partners and reissued at least once, the amount of cash that Phoenix Investment Partners will need to pay to repurchase 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 put/call price. The put/call agreements will expire after the year ended December 31, 2007.
As of December 31, 2003 we did not have any significant off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K. See Note 8 to our consolidated financial statements in this Form 10-K for information on variable interest entities.
Section 1322 of New York Insurance Law requires that New York life insurers report their RBC. RBC is based on a formula calculated by applying factors to various asset, premium and statutory reserve items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk and business risk. Section 1322 gives the New York Insurance Department explicit regulatory authority to require various actions by, or take various actions against, insurers whose Total Adjusted Capital (capital and surplus plus AVR plus one-half the policyholder dividend liability) does not exceed certain RBC levels. Each of our other life insurance subsidiaries is also subject to these same RBC requirements.
The levels of regulatory action, the trigger point and the corrective actions are summarized below:
At December 31, 2003, Phoenix Life's and each of its insurance subsidiaries' RBC levels were in excess of 300% of Company Action Level.
We provide our employees with post-employment benefits that include retirement benefits, through pension and savings plans, and other benefits, including health care and life insurance. Employee benefit expense related to these plans totaled $33.1 million, $24.9 million and $25.1 million for 2003, 2002 and 2001, respectively.
The funded status of the qualified and non-qualified pension plans as of December 31, 2003 and 2002 follows ($ amounts in millions):
Employee Plan Supplemental Plan ----------------------------- ----------------------------- 2003 2002 2003 2002 -------------- ------------- -------------- -------------
Plan assets, end of year...................... $ 368.9 $ 327.7 $ -- $ -- Projected benefit obligation, end of year..... (460.6) (410.1) (124.8) (126.9) -------------- ------------- -------------- ------------- Plan assets less than projected benefit obligations, end of year ........... $ (91.7) $ (82.4) $ (124.8) $ (126.9) ============== ============= ============== =============
See note 11 of the consolidated financial statements included in this Form 10-K for additional information.
State Farm currently owns of record more than 5 percent of our outstanding common stock. In 2003 and 2002, our subsidiaries incurred total compensation costs of $25.8 million and $10.7 million, respectively, related to entities which were either subsidiaries of State Farm or owned by State Farm employees, for the sale of our insurance and annuity products.