Our selected historical consolidated financial data as of and for each of the five years ended December 31, 2003 follows ($ amounts in millions, except earnings per share). We derived the data for the years 2003, 2002 and 2001 from our consolidated financial statements in this Form 10-K. We derived the data for the years 2000 and 1999 from audited consolidated financial statements not in this Form 10-K. Also, we have restated or reclassified certain amounts for prior years to conform with 2003 presentation as further described in Note 1 of our consolidated financial statements in this Form 10-K. Prior to June 25, 2001, Phoenix Life was the parent company of our consolidated group. In connection with its demutualization, Phoenix Life became a subsidiary and PNX became the parent company of our consolidated group.
Income (loss) from continuing operations... $ (4.1) $ (140.7) $ (147.3) $ 96.0 $ 166.2 Loss from discontinued operations, net of income taxes(2)................... (2.1) (1.3) (2.5) (12.7) (77.0) ------------ ------------ ------------ ------------ ------------ Income (loss) before cumulative effect of accounting changes....................... (6.2) (142.0) (149.8) 83.3 89.2 Cumulative effect of accounting changes(3). -- (130.3) (65.4) -- -- ------------ ------------ ------------ ------------ ------------ Net income (loss).......................... $ (6.2) $ (272.3) $ (215.2) $ 83.3 $ 89.2 ============ ============ ============ ============ ============
Basic and Diluted Earnings Per Share Income (loss) from continuing operations(4) $ (0.04) $ (1.44) $ (1.41) $ 0.92 $ 1.59 ============ ============ ============ ============ ============ Net income (loss)(4)....................... $ (0.07) $ (2.78) $ (2.06) $ 0.80 $ 0.85 ============ ============ ============ ============ ============
Dividends per share....................... $ 0.16 $ 0.16 $ -- $ -- $ -- ============ ============ ============ ============ ============
Ratio of Earnings to Fixed Charges Ratio of earnings to fixed charges(5)...... 0.7 -- -- 4.3 7.0 Supplemental ratio of earnings to fixed charges - including interest credited on policyholder contract balances(6)..... 0.9 0.5 0.2 1.8 2.6
Third-Party Assets Under Management $42,841.6 $38,568.2 $38,604.3 $44,056.8 $52,082.1 ============ ============ ============ ============ ============
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 9 to our consolidated financial statements in this Form 10-K.
(7) In accordance with accounting practices prescribed by the New York State Insurance Department, Phoenix Life's capital and surplus includes $175.0 million principal amount of surplus notes outstanding.
Poor performance of the equity markets could adversely affect sales and assets under management of our asset management, variable universal life and variable annuity products, as well as the performance of our venture capital segment and potential future pension plan funding requirements.
• Second, because the revenues of our asset management and variable products businesses are, to a large extent, based on fees related to the value of assets under our management, the poor performance of the equity markets in 2000, 2001 and 2002 limited our fee revenues by reducing the value of the assets we manage. Our assets under management at December 31, 2002 were 8.4% less than at December 31, 2000. We could experience increasing surrenders and redemptions if equity markets perform poorly again. The
possibility of declines in assets under management is heightened by the fact that, as of December 31, 2003, approximately 28% of our variable universal life insurance assets under management excluding our private placement business, and approximately 56% of our variable annuity assets under management excluding our private placement business, were not subject to any surrender penalties. The surrender charges applicable to our variable universal life insurance policies and variable annuities typically decline over a period of years and generally expire after 10 years. Moreover, surrenders of life insurance policies and annuities require faster amortization of deferred policy acquisition costs, which would reduce our profitability.
• Third, returns on venture capital investments are correlated with the performance of the equity markets. During the severe market declines of 2002 and 2001, our venture capital investments decreased our income from continuing operations by $38.5 million and $54.9 million, respectively. Conversely, in 2003 venture capital decreased the loss from continuing operations by $23.5 million. It is possible we will again experience declines related to our venture capital investments comparable to those experienced in 2002 and 2001.
• Fourth, the funding requirements of our pension plan are dependent on the performance of the equity markets. The portfolio funding for the company's pension plan currently consists of 63% equities. In a severe market decline, the value of the assets supporting the pension plan will decrease, increasing the requirement for future funding. This funding requirement will increase expenses and decrease the earnings of the company.
We have allocated assets to our closed block to produce cash flows that, together with additional revenues from the closed block policies, are reasonably expected to support our obligations relating to these policies. Our allocation of assets to the closed block was based on actuarial assumptions about our payment obligations to closed block policyholders, the continuation of the non-guaranteed policyholder dividend scales in effect for 2000, as well as assumptions about the investment earnings the closed block assets will generate over time. Since such assumptions are to some degree uncertain, it is possible that the cash flows generated by the closed block assets and the anticipated revenues from the policies included in the closed block will prove insufficient to provide for the benefits guaranteed under these policies. We would have to fund the shortfall resulting from such an insufficiency.
Rating agencies assign Phoenix Life financial strength ratings, and assign us debt ratings, based in each case on their opinions of the relevant company's ability to meet its financial obligations.
A.M. Best, Moody's and Standard & Poor's each have a stable outlook for our ratings, while Fitch has a negative outlook.
Lower ratings increase borrowing costs. Additional downgrades may increase interest costs in connection with future borrowings. Such increased costs would decrease our earnings and could reduce our ability to finance our future growth on a profitable basis.
The recent downgrades did not trigger any defaults or repurchase obligations.
We have established reserves for claims and related expenses that we expect to pay on our discontinued group accident and health reinsurance business. These reserves are a net present value amount that is based on currently known facts and estimates about, among other things, the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid, the amount of reinsurance we believe we will collect under our finite reinsurance, the amounts we believe we will collect from our retrocessionaires and the likely legal and administrative costs of winding down the business. Our total reserves, including coverage available from our finite reinsurance and reserves for amounts recoverable from retrocessionaires, were $185.0 million as of December 31, 2003. Our total amounts recoverable from retrocessionaires related to paid losses were $165.0 million as of December 31, 2003.
Legislation enacted in the spring of 2001 increased the size of estates exempt from the federal estate tax, phased in reductions in the estate tax rate between 2002 and 2009 and repealed the estate tax entirely in 2010. This legislation, despite its reinstatement of the estate tax in 2011, could have a negative effect on our revenues from the sale of estate planning products including in particular sales of second-to-die life insurance policies. Second-to-die policies are often purchased by two people whose assets are largely illiquid, and whose heirs otherwise might have to attempt to liquidate part of the estate in order to pay the tax. Second-to-die policies represented 21% and 35% of our new life insurance premiums and deposits in 2003 and 2002, respectively. President Bush and members of Congress have expressed a desire to modify the existing legislation, which could result in faster or more complete reduction or repeal of the estate tax.
Conversely, during periods of declining interest rates, we could experience increased premium payments on products with flexible premium features, repayment of policy loans and increased percentages of policies remaining inforce. We would obtain lower returns on investments made with these cash flows. In addition, borrowers may prepay or redeem mortgages and bonds in our investment portfolio so that we might have to reinvest those proceeds in lower interest-bearing investments. As a consequence of these factors, we could
experience a decrease in the spread between the returns on our investment portfolio and amounts credited to policyholders and contractholders, which could adversely affect our profitability.
We sell our products through our affiliated retail producers and non-affiliated advisors, broker-dealers and other financial intermediaries. There is substantial competition in most of our non-affiliated distributors. Non-affiliated distribution sources have contributed significantly to our sales in recent years. For example, Merrill Lynch, with over 13,000 registered representatives, accounted for 29% of our asset management combined inflows for sponsored managed accounts and mutual funds in 2003. The loss or diminution of our relationships with non-affiliated distributors could materially reduce our sales and revenues.
The independent trustees of our mutual funds and closed-end funds, as well as intermediary program sponsors, managed account clients and institutional asset management clients, could terminate their contracts with us. This would reduce our investment management fee revenues and could also impair our intangible assets.
The termination of any of the above agreements relating to material portion of assets under management would adversely affect our investment management fee revenues and could impair our intangible assets.
We compete for distribution sources in our life, annuity and asset management businesses. We believe that our success in competing for distributors depends on factors such as our financial strength and on the services we provide to, and the relationships we develop with, these distributors. Our distributors are generally free to sell products from a variety of providers, which makes it important for us to continually offer distributors products and services they find attractive. If our products or services fall short of distributors' needs, we may not be able to establish and maintain satisfactory relationships with distributors of our life insurance, annuity and asset management products. Accordingly, our revenues and profitability would suffer.
National banks, with their pre-existing customer bases for financial services products, may increasingly compete with insurers as a result of the Gramm-Leach-Bliley Act of 1999, which permits mergers among commercial banks, insurers and securities firms under one holding company. Until passage of this act, prior legislation had limited the ability of banks to engage in securities-related businesses and had restricted banks from being affiliated with insurance companies. The ability of banks to increase their securities-related business or to affiliate with insurance companies may materially and adversely affect sales of all of our products by substantially increasing the number and financial strength of our potential competitors.
The U.S. federal government does not directly regulate the insurance business. However, federal legislation and administrative policies in areas which include employee benefit plan regulation, financial services regulation and federal taxation and securities laws could significantly affect the insurance industry and our costs.
Management's discussion and analysis reviews our consolidated financial condition at December 31, 2003 and 2002 restated; our consolidated results of operations for the years 2003, 2002 restated and 2001 restated; and, where appropriate, factors that may affect our future financial performance. You should read this discussion in conjunction with "Selected Financial Data" and our consolidated financial statements in this Form 10-K.
We are a manufacturer of insurance, annuity and asset management products for the accumulation, preservation and transfer of wealth. We provide products and services to affluent and high-net-worth individuals through their advisors and to institutions directly and through consultants. We offer a broad range of life insurance, annuity and asset management products and services through a variety of distributors. These distributors include affiliated and non-affiliated advisors and financial services firms who make our products and services available to their clients.
We manufacture our products through two operating segments - Life and Annuity and Asset Management - which include three product lines - life insurance, annuities and asset management. Through Life and Annuity we offer a variety of life insurance and annuity products, including universal, variable universal, whole and term life insurance, and a range of variable annuity offerings. Asset Management comprises two lines of business - private client and institutional.
Through our private client line of business, we provide investment management services principally on a discretionary basis, with products consisting of open-end mutual funds and managed accounts. Managed accounts include intermediary programs sponsored and distributed by non-affiliated broker-dealers and direct managed accounts sold and administered by us. Managed accounts sponsored and distributed by non-affiliated broker-dealers generally require minimum investments of $100,000, and direct managed accounts sold and administered by us generally require minimum investments of $1 million. Our private client business also provides transfer agency, accounting and administrative services to most of our open-end mutual funds.
Our sales and financial results over the last several years have been affected by demographic, industry and market trends. The baby boom generation has begun to enter its prime savings years. Americans generally have begun to rely less on defined benefit retirement plans, social security and other government programs to meet their post-retirement financial needs. Product preferences have shifted between fixed and variable options depending on market and economic conditions. These factors have had a positive effect on sales of our balanced product portfolio including universal life, variable life and variable annuity products, as well as a broad array of mutual funds and managed accounts.
In 2003, we revised our method of consolidation for the years 2003, 2002 and 2001 for three collateralized obligation trusts where we serve as investment advisor. Under the new method, the applicable assets, liabilities, revenues, expenses and minority interest are presented on a disaggregated basis and investments pledged as collateral are recorded at fair value with unrealized gains or losses recorded as a component of accumulated other
The effect of our change in method of consolidation for the three consolidated collateralized obligation trusts was to increase our net loss and to reduce stockholders' equity for the years 2003, 2002 and 2001 as follows ($ amounts in millions):
Increase in net loss.................................... $ (2.4) $ (26.3) $ (12.5) =============== =============== =============== Reduction in stockholders' equity....................... $ (77.3) $ (204.9) $ (87.9) =============== =============== ===============
GAAP requires us to consolidate all the assets and liabilities of these collateralized obligation trusts which results in the recognition of realized and unrealized investment losses even though we have no legal obligation to fund such losses in the settlement of the collateralized obligations.
The Financial Accounting Standards Board, or FASB, continues to evaluate, through the issuance of FASB staff positions, the various technical implementation issues related to consolidation accounting. We will continue to assess the impact of any new implementation guidance issued by the FASB as well as evolving interpretations among accounting professionals. Additional guidance and interpretations may affect our application of consolidation accounting in future periods.
See Notes 1 and 8 to our consolidated financial statements in this Form 10-K for additional information on these revisions to our 2002 and 2001 financial statements and our consolidated collateralized obligation trusts and other variable interest entities.
Goodwill and Other Intangible Assets. At the beginning of 2002, we adopted a new accounting standard for goodwill and other intangible assets, including amounts reflected in our carrying value of equity method investments. Under this new standard, we discontinued recording amortization expense on goodwill and other intangible assets with indefinite lives, but we continue recording amortization expense for those assets with definite estimated lives. See Note 4 to our consolidated financial statements in this Form 10-K for a comprehensive discussion of the adoption of the new standard and its effects on our consolidated financial statements.
The amortization of DAC and PVFP requires the use of various assumptions, estimates and judgments about the future. Significant assumptions include those concerning expenses, investment performance, mortality and policy cancellations (i.e., lapses, withdrawals and surrenders). These assumptions are reviewed on a regular basis and are generally based on our past experience, industry studies, regulatory requirements and judgments about the future. Changes in estimated gross margins and gross profits based on actual experiences are reflected as an adjustment to total amortization to date resulting in a charge or credit to earnings. Finally, analyses are performed periodically to assess whether there are sufficient gross margins or gross profits to amortize the remaining DAC balances.
• Goodwill and Other Intangible Assets At the beginning of 2002, we adopted the new accounting standard for goodwill and other intangible assets, including amounts reflected in our carrying value of equity-method investments. Under this new standard, we discontinued recording amortization expense on goodwill and other intangible assets with indefinite lives, but we continue recording amortization expense for those intangible assets with definite estimated lives. For goodwill and intangible assets, we perform impairment tests at the reporting-unit level at least annually. For purposes of the goodwill and indefinite-lived intangible assets impairment test, the fair value of the reporting units is based on the sum of: a multiple of revenue, plus the fair value of the units' tangible fixed assets. Prior to 2002, we amortized goodwill principally over 40 years and investment management contracts and employment contracts over five to 16 years and three to seven years, respectively. All amortization expense has been and continues, for intangible assets with definite lives, to be calculated on a straight-line basis.
See Note 4 to our consolidated financial statements in this Form 10-K for more information.
To estimate the net equity in earnings of the venture capital partnerships for each quarter, we developed a methodology to estimate the change in value of the underlying investee companies in the venture capital partnerships. For public investee companies, we used quoted market prices at the end of each quarter, applying liquidity discounts to these prices in instances where such discounts were applied in the underlying partnerships' financial statements. For private investee companies, we applied a public industry sector index to roll the value forward each quarter. We apply this methodology consistently each quarter with subsequent adjustments to reflect market events reported by the partnerships (e.g., new rounds of financing, initial public offerings and writedowns by the general partners). Our methodology recognizes downward adjustments based on the indices, but limits upward adjustments to the amounts previously reported by the partnerships. In addition, we annually revise the valuations we have assigned to the investee companies to reflect the valuations in the audited financial statements received from the venture capital partnerships.
• 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 of Financial Condition and Results of Operations in this Form 10-K for more information.
We have determined, based on our earnings and future income, that it is more likely than not that the deferred income tax assets after valuation allowance already recorded as of December 31, 2003 and 2002 will be realized. In determining the adequacy of future income, we have considered projected future income, reversal of existing temporary differences and available tax planning strategies that could be implemented, if necessary.
Our federal income tax returns are routinely audited by the Internal Revenue Service, or the IRS, and estimated provisions are routinely provided in the financial statements in anticipation of the results of these audits. The IRS has examined our consolidated group's federal income tax returns through 1997. The IRS is currently examining our federal income tax returns for 1998 through 2001. While it is often difficult to predict the outcome of these audits, including the timing of any resolution of any particular tax matter, we believe that our reserves, as recorded in other liabilities on the balance sheet, have been adequately provided for all open tax years. Unfavorable resolution of any particular issue could result in additional use of cash to pay liabilities that would be deemed owed to the IRS. Additionally, any unfavorable or favorable resolution of any particular issue could result in an increase or decrease, respectively, to our effective income tax rate to the extent that our estimates differ from the ultimate resolution.
See Note 10 to our consolidated financial statements in this Form 10-K for more information related to income taxes.
REVENUES Premiums................................... $ 1,042.2 $ 1,082.0 $ 1,112.7 $ (39.8) $ (30.7) Insurance and investment product fees...... 565.3 560.5 543.2 4.8 17.3 Investment income, net of expenses......... 1,107.4 947.7 892.8 159.7 54.9 Net realized investment losses............. (100.5) (133.9) (84.9) 33.4 (49.0) ----------- ----------- ----------- ----------- ----------- Total revenues............................. 2,614.4 2,456.3 2,463.8 158.1 (7.5) ----------- ----------- ----------- ----------- -----------
Insurance and investment product fees increased by $4.8 million, or 1%, in 2003 compared to 2002, primarily due to higher sales of universal life and variable life products, a growing inforce in universal life and variable universal life products and slightly higher surrender fees for variable universal life products. These increases were partially offset by lower fees for our Asset Management segment resulting from decreases in both private client and institutional average assets under management.
Net investment income increased by $159.7 million, or 17%, in 2003 compared to 2002, primarily due to improved equity market conditions and the related effect on our earnings from our venture capital segment and to increased general account spread-type funds under management in our life and annuity segment partially offset by the impact of reinvesting maturities at lower interest rates. In addition, investment income from our debt securities pledged as collateral related to our consolidated CDOs increased $21.2 million from 2002, primarily due to investment income from the Mistic CDO which closed in the third quarter of 2002.
Net investment income increased $54.9 million, or 6%, 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, or RPE, variable annuity. Increases in net investment income for variable universal life were offset by a modest decrease in universal life net investment income from 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 Management's Discussion and Analysis of Financial Condition and Results of Operations. The yield on average invested assets, excluding venture capital partnerships, was 6.6% for the year 2002, compared to 7.3% for the year 2001. The increase in net investment income was also offset by lower earnings from debt securities pledged as collateral related to our consolidated CDOs in 2002 compared to 2001.
The decrease in policy acquisition cost amortization of $73.8 million, or 55%, in 2002 compared to 2001 was primarily due to favorable mortality and persistency experience on life products, offset by a $13.5 million acceleration of DAC amortization expense related to our annuity business in 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 DAC asset related to our variable annuities business. The Valley Forge block we acquired in 2002, which experienced significant declines in assets due to equity market declines, accounts for $4.5 million of this acceleration. DAC for individual participating life insurance policies is amortized in
As a result of adopting the new standard on goodwill and intangible assets with indefinite lives, an impairment charge of $66.3 million was recorded during the third quarter as discussed further in Note 4 to our consolidated financial statements in this Form 10-K.
Interest expense on indebtedness increased $4.1 million, or 15%, in 2002 compared to 2001, due to higher levels of average indebtedness in 2002 than in 2001. Average borrowings were higher during 2002, due to the issuance of $300.0 million senior bonds in December 2001.
Our 2002 effective income tax benefit rate of 30.5% 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 and non-taxable dividend and interest income) and the recovery of amounts related to an IRS settlement, offset by the tax on non-deductible goodwill impairment charges and realized losses from investments pledged as collateral for which there is no tax benefit. In 2001, the effective income tax benefit rate of 45.2% differed from the statutory income tax benefit rate of 35% as a result of the non-deductible demutualization expenses and realized losses from our securities pledged as collateral related to our consolidated CDOs, for which there is no tax benefit, offset by the tax benefits associated with tax advantaged investment income and the elimination of the surplus tax liability.
The increase in minority interest expense was the result of our 2002 acquisition of a majority interest in Kayne Anderson Rudnick.
For the years 2003, 2002 and 2001, we do not believe inflation had a material effect on our consolidated results of operations, except to the extent inflation may have affected interest rates.
We evaluate segment performance on the basis of segment income. Realized investment gains and losses and certain other items are excluded because we do not consider them when evaluating the financial performance of the segments. The size and timing of realized investment gains and losses are often subject to our discretion. Certain items are removed from segment after-tax income if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income reported in accordance with GAAP, we believe that segment income is an appropriate measure that represents the earnings attributable to the ongoing operations of the business. Investment income on debt and equity securities pledged as collateral as well as interest expense on non-recourse collateralized obligations, both related to three consolidated collateralized obligation trusts we sponsor, are included in the Corporate and Other segment. Excess investment income on debt and equity securities pledged as collateral represents investment advisory fees earned by our asset management subsidiary and are allocated to the Asset Management segment as investment product fees for segment reporting purposes only. Also, all interest expense is included in the Corporate and Other segment, as are several smaller subsidiaries and investment activities which do not meet the thresholds of reportable segments. These include our remaining international operations and the run-off of our group pension and guaranteed investment contract businesses.
The criteria used to identify an item that will be excluded from segment income include: whether the item is infrequent and is material to the segment's income; or whether it results from a business restructuring or a change in the regulatory requirements, or relates to other unusual circumstances (e.g., non-routine litigation). We include information on other items allocated to our segments in their respective notes for information only. Items excluded from segment income may vary from period to period. Because these items are excluded based on our discretion, inconsistencies in the application of our selection criteria may exist. Segment income is not a substitute for net income determined in accordance with GAAP and may be different from similarly titled measures of other companies.
The following amounts, net of applicable income taxes and other offsets, are included in income (loss) from continuing operations for the years 2003, 2002 and 2001 but are excluded from our operating segment results ($ amounts in millions): Changes ------------------------ 2002 2001 2003 Restated Restated 2003/02 2002/01 ----------- ----------- ----------- ----------- -----------
Net realized investment losses............. $ (54.2) $ (65.6) $ (55.5) $ 11.4 $ (10.1) Management restructuring charges and early retirement costs................... (8.5) (28.5) (15.5) 20.0 (13.0) Deferred policy acquisition cost adjustment.......................... -- 15.1 -- (15.1) 15.1 Mutual life surplus tax.................... -- -- 21.0 -- (21.0) Expenses of purchase of Phoenix Investment Partners' minority interest... -- -- (52.8) -- 52.8 Other income............................... 1.3 -- 5.3 1.3 (5.3) Demutualization expense.................... -- (1.3) (23.9) 1.3 22.6 ----------- ----------- ----------- ----------- ----------- Total...................................... $ (61.4) $ (80.3) $ (121.4) $ 18.9 $ 41.1 =========== =========== =========== =========== ===========
The following table and discussion presents summary financial data relating to Life and Annuity for 2003, 2002 and 2001 ($ amounts in millions).
Changes ------------------------ 2003 2002 2001 2003 / 02 2002 / 01 ----------- ----------- ----------- ----------- ----------- Results of Operations Premiums................................... $ 1,042.2 $ 1,082.0 $ 1,112.7 $ (39.8) $ (30.7) Insurance and investment product fees...... 333.0 315.1 303.1 17.9 12.0 Net investment income...................... 993.2 947.4 890.8 45.8 56.6 ----------- ----------- ----------- ----------- ----------- Total segment revenues..................... 2,368.4 2,344.5 2,306.6 23.9 37.9 ----------- ----------- ----------- ----------- ----------- Policy benefits, including policyholder dividends................... 1,869.9 1,867.6 1,812.6 2.3 55.0 Policy acquisition cost amortization....... 98.2 88.6 122.5 9.6 (33.9) Other operating expenses................... 300.5 307.4 288.3 (6.9) 19.1 ----------- ----------- ----------- ----------- ----------- Total segment benefits and expenses........ 2,268.6 2,263.6 2,223.4 5.0 40.2 ----------- ----------- ----------- ----------- ----------- Segment income before income taxes and minority interest....... 99.8 80.9 83.2 18.9 (2.3) Allocated income taxes..................... 31.1 28.0 28.8 3.1 (0.8) ----------- ----------- ----------- ----------- ----------- Segment income before minority interest.... 68.7 52.9 54.4 15.8 (1.5) Minority interest in net income of consolidated subsidiaries............. 0.4 0.6 0.3 (0.2) 0.3 ----------- ----------- ----------- ----------- ----------- Segment income............................. 68.3 52.3 54.1 16.0 (1.8) Net realized investment losses, net of income taxes and other offsets.... (4.7) (15.0) (16.6) 10.3 1.6 Deferred acquisition cost adjustment, net of income taxes...................... (1.3) 14.4 -- (15.7) 14.4 Other adjustments, net of income taxes..... -- 0.7 -- (0.7) 0.7 ----------- ----------- ----------- ----------- ----------- Segment net income......................... $ 62.3 $ 52.4 $ 37.5 $ 9.9 $ 14.9 =========== =========== =========== =========== ===========
Premium revenue for 2003 decreased by $39.8 million, or 4%, 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 the prior year, the 2003 premium revenue for participating life insurance policies decreased by $40.5 million. Since our 2001 demutualization, we no longer sell participating life policies, resulting in a decline in renewal participating life premiums and related inforce.
Net investment income for 2003, increased by $45.8 million, or 5%, compared to 2002, due to increased general account spread-type funds, primarily annuities, partially offset by lower rates earned on invested assets.
Policy benefits, including policyholder dividends for 2003, were relatively flat compared to 2002. This was primarily due to a decrease in reserves for the participating life insurance driven by lower inforce and an $0.8
Minority interest expense relates to our subsidiary, PFG. We acquired the 33% of the minority interest in PFG we did not already own in May 2003.
Allocated income taxes for 2003 increased $3.1 million over 2002 as a result of higher segment income before income taxes as well as a current year allocation of the tax effects of tax advantaged investments to the Life and Annuity segment.
Premium revenue declined $30.7 million, or 3%, in 2002 compared to 2001, primarily as the result of a shift in sales from traditional life products to variable universal life, universal life and annuity products. Insurance and investment product fees increased $12.0 million, or 4%, in 2002 as compared to 2001. 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 products, particularly in 2001 and 2002. Annuity fees declined $4.8 million as the result of lower funds under management in variable sub-accounts.
Net investment income increased $56.6 million, or 6%, in 2002 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 RPE variable annuity. Small increases in net investment income for variable universal life were offset by a modest decrease in universal life net investment income resulting from lower new money rates, reinvestment rates and asset defaults. The 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 compared to 2001. The 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 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 Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K.
The increase in policy benefits and dividends of $55.0 million, or 3%, 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, mostly 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 this Form 10-K). Our policyholder dividend obligation decreased by $4.6 million as a result of realized losses partially offset by continuing favorable mortality and persistency experience. 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, $176.6 million was the result of the acquisition of a block of annuity business from Valley Forge Life Insurance Company in the third quarter of 2002, with the remaining increase in exposure resulting from the impact of the overall decline in equity markets on fund balances.
The increase in other operating expenses was primarily due to higher benefit costs, mainly pension-related costs. The segment also experienced slightly higher compensation expense and corporate overhead absorption costs.
Life and Annuity segment revenues by product for the years 2003, 2002 and 2001 are as follows ($ amounts in millions):
Universal life product revenues increased $1.1 million, or less than 1%, in 2003 compared to 2002, primarily due to higher cost of insurance and other fees from higher sales and a growing inforce, offset by lower interest earned.
Other life insurance revenues increased $1.9 million, or 1%, in 2003 compared to 2002, primarily due to higher revenue in an old block of corporate-owned life insurance business and from higher investment income, partially offset by lower revenues in non-life insurance subsidiaries.
Variable universal life product revenues increased $11.9 million, or 12%, in 2002 compared to 2001, primarily due to higher cost of insurance fees from a growing inforce, higher fees from higher sales, and higher interest earned on the increase in funds under management.
Life and Annuity segment income before income taxes by product for the years 2003, 2002 and 2001 is as follows ($ amounts in millions):
Changes ------------------------ 2003 2002 2001 2003/02 2002/01 ----------- ----------- ----------- ----------- -----------
Term product pre-tax income decreased $0.9 million, or 19%, in 2003 compared to 2002, primarily due to slightly higher expense levels partially offset by higher insurance margins.
Universal life product pre-tax income increased $8.9, or 51%, in 2002 compared to 2001, due primarily to higher insurance and investment margins, partially offset by higher incurred expenses.
Term product pre-tax income increased $3.4 million in 2002 compared to 2001, due primarily to higher sales.
Other life insurance pre-tax income decreased $0.9 million, or 53%, in 2002 compared to 2001, primarily due to an old block of corporate-owned life insurance business which had higher benefit costs, partially offset by higher investment income in 2002.
Participating life product pre-tax income increased $11.9 million, or 56%, in 2002 compared to 2001, primarily due to lower benefit costs and lower incurred expenses from lower amortization of DAC, partially offset by lower revenues.
The following table and discussion presents summary financial data relating to Asset Management for the years 2003, 2002 and 2001 ($ amounts in millions).
Investment product fees decreased $14.9 million, or 6%, in 2003 compared to 2002. This decrease was primarily due to the decrease in average assets under management compared to the prior year. Private client and institutional investment product fees decreased $8.9 million and $6.5 million, respectively, as a result of the decrease in average assets under management. Approximately 56% of our management fee revenues are based on assets as of the beginning of a quarter, which causes fee revenues to lag behind changes in average assets under management.
Assets under management were $59.2 billion and $54.0 billion, of which $15.5 billion and $14.5 billion as of December 31, 2003 and 2002, respectively, were our Life Companies' assets, including the general and variable separate accounts. The increase in assets under management during 2003 is due primarily to positive investment performance of $5.8 billion for the year. Sales of private client products in 2003 were $4.1 billion, which is a decrease of 29% from 2002. The majority of this decline is due to reduced sales of sponsored managed accounts at Seneca and Kayne Anderson Rudnick. Redemptions of private client products in 2003 were $4.9 billion, which is a decrease of 11% from 2002. This improvement was primarily a result of lower redemptions for mutual funds. Sales of institutional accounts in 2003 were $3.0 billion, which is a 32% decrease from 2002. The decrease in sales is due to the fact that 2002 included the issuance of a $1.0 billion CDO, which we consolidate in our financial statements, that did not recur in 2003. Redemptions of institutional accounts in 2003 were $3.5 billion, which is a decrease of 22% from 2002. The majority of the improvement in redemptions was attributable to Seneca.
Other operating expenses decreased $10.9 million, or 5%, in 2003 compared to 2002, of which $5.3 million related to compensation expense and $5.5 million related to lower non-compensation related operating expenses. The decrease in non-compensation related operating expenses was primarily the result of lower professional, rent, depreciation, and travel related charges offset, in part, by increased computer services charges.
Allocated income tax benefits decreased $2.7 million, or 45%, from the comparable period in 2002 as a result of lower segment losses offset by the impact of non-deductible asset impairments in the prior year.
Investment product fees remained relatively constant compared to 2001. The acquisition of a 60% interest in Kayne Anderson Rudnick in 2002 increased investment product fees by $41.2 million. A corresponding decrease resulted from reductions in other assets under management and changes to fee structures. Excluding Kayne Anderson Rudnick, total average assets under management decreased by $4.6 billion. Average assets under management for the private client line of business, excluding Kayne Anderson Rudnick, decreased $5.1 billion, decreasing investment product fees by $34.1 million. Although assets under management for the institutional line of business increased by $0.5 billion, a change in our Life Companies general account fee structure in July 2001 was the principal cause of a $6.9 million decrease in institutional investment product fees. At December 31, 2002, Asset Management had $54.0 billion in assets under management, an increase of $1.9 billion, or 4%, from December 31, 2001. This increase consisted of $7.7 billion from the acquisition of Kayne Anderson Rudnick, net asset inflows of $0.2 billion, including the issuance of a $1.0 billion collateralized obligation in 2002 and $1.8 billion of increased annuity deposits in our Life Companies general accounts offset, in part, by a decrease of $7.9 billion resulting from investment performance.
The decrease in intangible asset amortization of $16.5 million, or 34%, in 2002 compared to 2001 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.
The increase in other operating expenses of $5.8 million, or 3%, in 2002 compared to 2001 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.
During the first quarter of 2003, we sold a 50% interest in certain of our venture capital partnerships to an outside party and transferred the remaining 50% interest in those partnerships to our closed block. The carrying value of the partnerships sold and transferred totaled $52.2 million after realizing a loss of $19.4 million ($5.1 million recorded in 2002 and $14.3 million recorded in 2003). The unfunded commitments of the partnerships sold and transferred totaled $27.2 million; the outside party and the closed block will each fund half of these commitments. At the time of transfer, the partnerships transferred constituted less than 0.5% of the assets of the closed block.
The following table and discussion present summary financial data relating to our Venture Capital segment for the years 2003, 2002 and 2001 ($ amounts in millions).
Changes ------------------------ 2003 2002 2001 2003/02 2002/01 ----------- ----------- ----------- ----------- ----------- Results of Operations Net realized gains (losses) on partnership cash and stock distributions. $ 4.9 $ (4.7) $ 17.8 $ 9.6 $ (22.5) Net unrealized gains (losses) on partnership investments.................. 37.1 (47.2) (95.9) 84.3 48.7 Partnership operating expenses............. (5.8) (7.4) (6.4) 1.6 (1.0) ----------- ----------- ----------- ----------- ----------- Segment net investment income (loss)....... 36.2 (59.3) (84.5) 95.5 25.2 Applicable income taxes (benefit).......... 12.7 (20.7) (29.6) 33.4 8.9 ----------- ----------- ----------- ----------- ----------- Segment net income (loss).................. $ 23.5 $ (38.6) $ (54.9) $ 62.1 $ 16.3 =========== =========== =========== =========== ===========
Net investment income increased $95.5 million in 2003 compared to 2002 due to overall improved equity market conditions and the true-up to the partnerships' audited fourth quarter of 2002 financial statements from estimated amounts as of December 31, 2002.
The reduction in net investment loss of $25.2 million in 2002 compared to 2001 was primarily due to a reduced effect of industry sector indices when applied to lower partnership holdings balances during 2002 compared to 2001. The loss in 2002 was primarily driven by stock market performance, most notably in technology and related sectors ($ amounts in millions).
See Note 5 to our consolidated financial statements in this Form 10-K for more information regarding our Venture Capital segment.
Interest expense on indebtedness increased $8.2 million, or 26%, in 2003 compared to 2002, primarily due to a restructuring of debt in late 2002 through the issuance of equity units to paydown shorter term, lower cost borrowings under our bank credit facility.
Corporate expenses were relatively level for 2003 compared to 2002. Expenses increased $7.2 million for costs related to the stock purchase contracts issued in 2002, but this was offset by lower unallocated corporate expenses.
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 asset 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 related liabilities within them. Segmentation of assets allows us to manage the risks and measure returns on capital for our various businesses and products.
Our primary investment objective is to maximize after-tax investment return within defined risk parameters. Our primary sources of investment risk are:
• 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, such as venture capital partnerships.
We also manage interest rate risk by emphasizing the purchase of securities that feature prepayment restrictions and call protection. Our product design and pricing strategies include the use of surrender charges or restrictions on withdrawals in some products. In addition, we selectively apply derivative instruments, primarily interest rate swaps, to reduce the interest rate risk inherent in our portfolios. These derivatives are transacted with highly rated counterparties and monitored for effectiveness on an ongoing basis. We use derivatives exclusively for hedging purposes.
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.
Our general account debt securities portfolio consists primarily of investment-grade publicly traded and privately placed corporate bonds, residential mortgage-backed securities, commercial mortgage-backed securities and asset-backed securities. As of December 31, 2003, our general account debt securities with a carrying value of $13,273.0 million represented 79% of total general account investments. Public debt securities represented 78.9% of total debt securities, with the remaining 21.1% represented by private debt securities.
The following table presents our general account debt security portfolio at fair value as of December 31, 2003 and 2002 ($ amounts in millions), by SVO ratings, along with an equivalent Standard & Poor's, or S&P, rating agency designation, and by public and private securities. The majority of our debt securities are investment grade, with 91.7% invested in Categories 1 and 2 securities as of December 31, 2003.
Total Debt Securities Public Debt Securities Private Debt Securities (Fair Value) (Fair Value) (Fair Value) SVO S&P Equivalent ------------------------ ----------------------- ------------------------ Rating Designation 2003 2002 2003 2002 2003 2002 --------- -------------------- ----------- ---------- ---------- ---------- ---------- ----------
The following tables present our general account debt security portfolio by investment type as of December 31, 2003 ($ amounts in millions), along with a breakout of credit quality based on equivalent S&P rating agency designation.
Investment Grade Below Investment Grade ------------------------- ------------------------ Fair Value Cost Fair Value Cost ------------ ---------- ----------- ----------- Debt Securities by Type and Credit Quality U.S. government and agency.......................... $ 757.0 $ 714.5 $ -- $ -- State and political subdivision..................... 510.3 468.4 -- -- Foreign government.................................. 126.8 117.7 133.6 121.3 Corporate........................................... 6,013.3 5,682.2 752.5 730.2 Mortgage-backed..................................... 3,035.2 2,907.8 62.3 55.6 Other asset-backed.................................. 1,729.4 1,704.7 152.6 158.9 ------------ ---------- ----------- ----------- Total debt securities............................... $12,172.0 $11,595.3 $ 1,101.0 $1,066.0 ============ ========== =========== ===========
Total AAA/AA/A BBB ---------- ----------- ----------- Investment Grade Debt Securities (Fair Value) U.S. government and agency........................................ $ 757.0 $ 757.0 $ -- State and political subdivision................................... 510.3 497.2 13.1 Foreign government................................................ 126.8 24.5 102.3 Corporate......................................................... 6,013.3 3,237.2 2,776.1 Mortgage-backed................................................... 3,035.2 2,857.3 177.9 Other asset-backed................................................ 1,729.4 1,448.0 281.4 ----------- ----------- ----------- Total debt securities............................................. $12,172.0 $8,821.2 $3,350.8 ========== =========== ===========
We manage credit risk through industry and issuer diversification. Maximum exposure to an issuer is defined by quality ratings, with higher quality issuers having larger exposure limits. Our investment approach has been to create a high level of industry diversification. The top five industry holdings as of December 31, 2003 in our debt securities portfolio are banking (4.0%), insurance (2.6%), diversified financial services (2.5%), electrical utilities (2.3%) and broker-dealers (2.2%).
The following table presents certain information with respect to realized investment gains and losses including those on debt securities pledged as collateral, with losses from other-than-temporary impairment charges reported separately in the table. These impairment charges were determined based on our assessment of factors enumerated below, as they pertain to the individual securities determined to be other-than-temporarily impaired. Sources and types of net realized investment gains (losses) in our general account for 2003, 2002 and 2001 follow ($ amounts in millions):
Debt and equity security impairments.................................... $ (80.4) $ (124.1) $ (46.1) Affiliate equity security impairments................................... (96.9) -- -- Debt securities pledged as collateral impairments....................... (8.3) (34.9) (39.0) Other investment impairments............................................ (25.2) (27.7) (9.8) ----------- ----------- ---------- Impairment losses....................................................... (210.8) (186.7) (94.9) ----------- ----------- ---------- Debt and equity security transaction gains.............................. 152.5 118.8 65.4 Debt and equity security transaction losses............................. (40.6) (68.3) (52.5) Other investments transaction gains (losses)............................ (1.6) 2.3 (2.9) ----------- ----------- ---------- Net transaction gains................................................... 110.3 52.8 10.0 ----------- ----------- ---------- Net realized investment losses.......................................... (100.5) (133.9) (84.9) ----------- ----------- ---------- Applicable closed block policyholder dividend obligation (reduction).... (5.9) (40.3) (15.4) Applicable deferred acquisition costs (benefit)......................... (4.1) (7.2) 10.5 Applicable deferred income tax benefit.................................. (36.3) (20.8) (24.5) ----------- ----------- ---------- Offsets to realized investment losses................................... (46.3) (68.3) (29.4) ----------- ----------- ---------- Net realized investment losses included in net income................... $ (54.2) $ (65.6) $ (55.5) =========== =========== ==========
Total Outside Closed Block Closed Block --------------------- --------------------- ---------------------- Gains Losses Gains Losses Gains Losses ---------- ---------- ---------- ---------- ---------- ----------- Debt Securities Number of positions........................ 1,938 447 785 264 1,153 183 ---------- ---------- ---------- ---------- ---------- ----------- Unrealized gains (losses).................. $ 710.1 $ (98.4) $ 222.3 $ (49.9) $ 487.8 $ (48.5) ---------- ---------- ---------- ---------- ---------- ----------- Applicable policyholder dividend obligation (reduction)................... 487.8 (48.5) -- -- 487.8 (48.5) Applicable deferred policy acquisition costs (benefit).......................... 120.4 (22.8) 120.4 (22.8) -- -- Applicable deferred income taxes (benefit). 35.7 (10.8) 35.7 (10.8) -- -- --------------------- ---------- ---------- ---------- ----------- Offsets to net unrealized gains (losses)... 643.9 (82.1) 156.1 (33.6) 487.8 (48.5) --------------------- ---------- ---------- ---------- ----------- Unrealized gains (losses) after offsets.... $ 66.2 $ (16.3) $ 66.2 $ (16.3) $ -- $ -- ========== ========= ========== ========== ========== =========== Net unrealized gains after offsets......... $ 49.9 $ 49.9 $ -- ========== ========== ==========
Total net unrealized gains on debt and equity securities were $701.3 million (unrealized gains of $801.5 less unrealized losses of $100.2). Of that net amount, $254.3 million was outside the closed block ($103.1 million after applicable deferred policy acquisition costs and deferred income taxes) and $447.0 million was in the closed block ($0.0 million after applicable policyholder dividend obligation).
The following tables present certain information with respect to our gross unrealized losses with respect to our investments in general account debt securities, both outside and inside the closed block, as of December 31, 2003. In the tables, we separately present information that is applicable to unrealized losses both outside and inside the closed block. We believe it is unlikely that there would be any effect on our net income related to the realization of investment losses inside the closed block due to the current sufficiency of the policyholder dividend obligation liability in the closed block. See Note 3 to our consolidated financial statements in this Form 10-K for more information regarding the closed block. Applicable deferred policy acquisition costs and income taxes further reduce the effect on our comprehensive income.
Investment grade: Number of positions....................... 230 193 11 13 13 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (38.7) $ (16.4) $ (5.8) $ (3.7) $ (12.8) ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ (12.4) $ (6.4) $ (0.5) $ (0.4) $ (5.1) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (11.1) $ -- $ (3.7) $ (2.5) $ (4.9) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ (3.3) $ -- $ (0.6) $ (0.7) $ (2.0) ============ ============ =========== ============ ============
Equity Securities Outside Closed Block Number of positions....................... 24 16 3 2 3 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (1.4) $ (0.6) $ (0.2) $ (0.5) $ (0.1) ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ (0.9) $ (0.4) $ (0.1) $ (0.3) $ (0.1) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (0.4) $ (0.1) $ (0.2) $ -- $ (0.1) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============
Of the 230 investment grade debt securities held outside the closed block with unrealized losses, 204 have been in an unrealized loss position for 12 months or less at December 31, 2003 (including 203 that have unrealized losses less than 20% of cost). Of the remaining 26 security positions, 13 have been in an unrealized loss position for 12 to 24 months (including 12 that have unrealized losses less than 20% of cost) and 13 have been in an unrealized loss position for over 24 months (including 11 that have unrealized losses less than 20% of cost).
unrealized losses less than 20% of cost). Of the remaining 19 security positions, eight have been in an unrealized loss position for 12 to 24 months (all that have unrealized losses less than 20% of cost) and 11 have been in an unrealized loss position for over 24 months (including seven that have unrealized losses less than 20% of cost).
0 - 6 6 - 12 12 - 24 Over 24 Total Months Months Months Months ------------ ------------ ----------- ------------ ------------ Debt Securities Inside Closed Block Number of positions....................... 183 139 15 13 16 ------------ ------------ ----------- ------------ ------------ Total fair value......................... $ 1,098.7 $ 916.0 $ 32.6 $ 56.3 $ 93.8 Total amortized cost...................... 1,147.2 944.7 34.7 63.5 104.3 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (48.5) $ (28.7) $ (2.1) $ (7.2) $ (10.5) ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (11.3) $ (2.5) $ (0.7) $ (3.1) $ (5.0) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============
Investment grade: Number of positions....................... 155 129 12 5 9 ------------ ------------ ----------- ------------ ------------ Unrealized losses......................... $ (30.4) $ (24.2) $ (0.8) $ (1.7) $ (3.7) ============ ============ =========== ============ ============ Unrealized losses after offsets........... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============ Unrealized losses over 20% of cost........ $ (1.1) $ -- $ -- $ -- $ (1.1) ============ ============ =========== ============ ============ Unrealized losses over 20% of cost after offsets........................... $ -- $ -- $ -- $ -- $ -- ============ ============ =========== ============ ============
For debt securities in the closed block with gross unrealized losses, 63% of the unrealized losses pertain to investment grade securities and 37% of the unrealized losses pertain to below investment grade securities.
Of the five below investment grade debt security positions held in the closed block with gross unrealized losses greater than 20% of cost at December 31, 2003, two have been in an unrealized loss position of greater than 20% of cost for 12 months or less at December 31, 2003. Of the remaining three positions, two have been in an unrealized position greater than 20% of cost for 12 to 24 months. None of these securities were considered to be other-than-temporarily impaired at December 31, 2003. Each security has performed, and is expected to continue to perform, in accordance with their original contractual terms. Two issues are collateralized airplane lease related holdings that have declined in fair value due to airline bankruptcies, reduced travel and higher risk premiums required for aircraft related investments. The unrealized loss on these securities at December 31, 2003 was $(5.9) million. The other issue is an energy/power generation related holding that has declined in fair value due to downgrades, bankruptcies and weakness in the energy market. The unrealized loss on this security at December 31, 2003 was $(1.1) million, or 22%, of its amortized cost.
In determining that the securities giving rise to the previously mentioned unrealized losses were not other-than-temporarily impaired, we evaluated the factors cited above, which we consider when assessing whether a security is other-than-temporarily impaired. In making these evaluations, we must exercise considerable judgment. Accordingly, there can be no assurance that actual results will not differ from our judgments and that such differences may require the future recognition of other-than-temporary impairment charges that could have a material affect on our financial position and results of operations. In addition, the value of, and the realization of any loss on, a debt security or equity security is subject to numerous risks, including; interest rate risk, market risk, credit risk and liquidity risk. The magnitude of any loss incurred by us may be affected by the relative concentration of our investments in any one issuer or industry. We have established specific policies limiting the concentration of our investments in any single issuer and industry and believe our investment portfolio is prudently diversified.
As of December 31, 2003, we owned $27.5 million of Aberdeen 7.5% convertible subordinated notes. The 7.5% convertible subordinated notes were originally issued in 1996 at 7%, with a maturity of March 29, 2003, subject to four six-month extensions at Aberdeen's option with increasing interest rates. In March 2003, these notes were partially paid down by $5.0 million, with the remainder extended, subject to a rate increase to 7.5% and a maturity of September 29, 2003. The maturity on these notes was extended again to March 29, 2004 with a partial pay down of $5.0 million received in November 2003 at an interest rate of 7.5%. Prior to the fourth quarter of 2003, we owned $19.0 million of 5.875% convertible bonds which were issued in 2002 and mature in 2007. During the fourth quarter of 2003, we sold the Aberdeen 5.875% bonds and realized a gain of $0.7 million.
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
Since the third quarter of 2002, we have evaluated the carrying value of our equity method investment in Aberdeen for other-than-temporary impairment. This evaluation considered quantitative and qualitative factors including quoted market price for the underlying securities, the length of time that the carrying value has been in excess of fair value, historical and projected earnings and cash flow capacity.
The other-than-temporary impairment of our equity investment in Aberdeen resulted in an $89.1 million pre-tax ($55.0 million after income taxes), non-cash charge to earnings during the three-month period ended June 30, 2003.
On October 24, 2003, Aberdeen completed the acquisition of 100% of the outstanding common stock of Edinburgh Fund Managers Group plc, an Edinburgh Scotland based asset manager, for £36 million through the issuance of 58.9 million shares of Aberdeen common stock. Subsequent to this acquisition, and as of December 31, 2003 our percentage ownership in Aberdeen's common stock was diluted from approximately 22% to 16.2%, although our representation on Aberdeen's Board of Directors remained at two seats out of 12 seats. Based on our continued substantial ownership position and related board representation, we have the ability to significantly influence the operations of Aberdeen and, therefore, we continue to account for our investment using the equity method of accounting subsequent to October 24, 2003.
Our investment in HRH, a Virginia-based property and casualty insurance and employee benefit products distributor, includes primarily common stock. See Notes 5 and 6 to our consolidated financial statements in this Form 10-K for detailed information regarding our investment in HRH.
The following table presents summary consolidated cash flow data for 2003, 2002 and 2001 ($ amounts in millions):
Changes 2002 2001 -------------------------- 2003 Restated Restated 2003/02 2002/01 ------------ ------------ ------------ ------------- ------------
Cash from continuing operations......... $ 393.1 $ 316.1 $ 251.2 $ 77.0 $ 64.9 Cash for discontinued operations........ (36.5) (59.1) (76.8) 22.6 17.7 Cash for continuing operations investing activities.................. (1,134.7) (2,498.7) (1,891.0) 1,364.0 (607.7) Cash from discontinued operations investing activities.................. (4.4) 37.3 79.4 (41.7) (42.1) Cash from financing activities.......... 119.9 2,491.6 1,742.9 (2,371.7) 748.7
For 2003, cash for continuing operations investing activities decreased $1,364.0 million compared to 2002, due primarily to lower cash from financing activities from lower policyholder deposit fund receipts and lower net proceeds from collateralized obligations. Proceeds from collateralized obligations were higher in 2002 due to proceeds from Mistic CDO which closed in 2002.
The following table presents cash flow data for 2003, 2002 and 2001 ($ amounts in millions):
Cash from operating activities......... $ 33.2 $ 61.3 $ 90.3 $ (28.1) $ (29.0) Cash for investing activities.......... (25.7) (372.0) (900.4) 346.3 528.4 Cash (for) from financing activities... (15.1) 136.1 1,015.1 (151.2) (879.0)
Cash from operating activities decreased $28.1 million in 2003 compared to 2002, primarily due to a decrease of $22.5 million in the dividend from Phoenix Life and slightly higher expense payments.
Cash for investing activities decreased $346.3 million in 2003 compared to 2002, due to reduced contributions and advances to subsidiaries and lower equity security purchases. This resulted from reduced cash from financing as discussed below.
Cash from financing activities decreased $151.2 million in 2003 compared to 2002, due to the proceeds from the issuance of stock purchase contracts and equity units in 2002 for an aggregate of $ 283.0 million, partially offset by common stock repurchases of $131.1 million. Those financing activities did not recur in 2003.
Cash for investing activities decreased 528.4 millions in 2002 compared to 2001, due to purchases of subsidiaries from Phoenix Life in 2001 for $659.8 million that did not recur in 2002. These purchases were part of the demutualization and reorganization discussed previously and in Note 1 to our consolidated financial statements in this Form 10-K.
Cash from financing activities decreased $879.0 million in 2002 compared to 2001, primarily proceeds from our public offering in 2001 of $831.0, which did not recur in 2002. See Note 1 to our consolidated financial statements in this Form 10-K for additional information.
The holding company sponsors post-employment benefit plans through pension and savings plans and post-retirement health care and life insurance for employees of Phoenix Life and Phoenix Investment Partners. Funding of these obligations is provided by Phoenix Life and Phoenix Investment Partners on a 100% cost reimbursement basis through administrative services agreements with the holding company. See Note 11 to our consolidated financial statements in this Form 10-K for additional information.
Historically, our Life Companies have used cash flow from operations and investment activities to fund liquidity requirements. Their principal cash inflows from life insurance and annuities activities come from premiums, annuity deposits and charges on insurance policies and annuity contracts. In the case of Phoenix Life, cash inflows also include dividends, distributions and other payments from subsidiaries. Principal cash inflows from investment activities result from repayments of principal, proceeds from maturities, sales of invested assets and investment income. The principal cash inflows from our discontinued group accident and health reinsurance operations come from our finite reinsurance, recoveries from other retrocessionaires and investment activities. See Note 17 to our consolidated financial statements in this Form 10-K for additional information.
Additional liquidity to meet cash outflows is available from our Life Companies' portfolios of liquid assets. These liquid assets include substantial holdings of U.S. government and agency bonds, short-term investments and marketable debt and equity securities.
A primary liquidity concern with respect to life insurance and annuity products is the risk of early policyholder and contractholder withdrawal. Our Life Companies closely monitor their liquidity requirements in order to match cash inflows with expected cash outflows, and employ an asset/liability management approach tailored to the specific requirements of each product line, based upon the return objectives, risk tolerance, liquidity, tax and regulatory requirements of the underlying products. In particular, our Life Companies maintain investment programs generally intended to provide adequate funds to pay benefits without forced sales of investments. Products having liabilities with relatively long lives, such as life insurance, are matched with assets having similar estimated lives, such as long-term bonds, private placement bonds and mortgage loans. Shorter-term liabilities are matched with investments with short-term and medium-term fixed maturities.
Individual life insurance policies, other than term life insurance policies, increase in cash values over their lives. Policyholders have the right to borrow an amount generally up to the cash value of their policies at any time. As of December 31, 2003, our Life Companies had approximately $11.5 billion in cash values with respect to which policyholders had rights to take policy loans. The majority of cash values eligible for policy loans are at variable interest rates that are reset annually on the policy anniversary. Policy loans at December 31, 2003 were $2.2 billion.
and Note 4 to our consolidated financial statements in this Form 10-K for additional information.
2003 Restated Change ------------- ------------- -------------- ASSETS Available-for-sale debt securities, at fair value................ $ 13,273.0 $ 11,889.5 $ 1,383.5 Available-for-sale equity securities, at fair value.............. 312.0 385.9 (73.9) Mortgage loans, at unpaid principal balances..................... 284.1 468.8 (184.7) Venture capital partnerships, at equity in net assets............ 234.9 228.6 6.3 Affiliate equity securities, at equity in net assets............. 47.5 134.7 (87.2) Policy loans, at unpaid principal balances....................... 2,227.8 2,195.9 31.9 Other investments................................................ 402.0 398.9 3.1 ------------- ------------- -------------- 16,781.3 15,702.3 1,079.0 Available-for-sale debt and equity securities pledged as collateral, at fair value................ 1,350.0 1,358.7 (8.7) ------------- ------------- -------------- Total investments................................................ 18,131.3 17,061.0 1,070.3 Cash and cash equivalents........................................ 447.9 1,110.5 (662.6) Accrued investment income and receivables........................ 447.2 409.7 37.5 Deferred policy acquisition costs................................ 1,367.7 1,234.1 133.6 Deferred income taxes............................................ 58.7 41.4 17.3 Goodwill and other intangible assets............................. 755.0 747.7 7.3 Other general account assets..................................... 268.2 260.3 7.9 Separate account assets.......................................... 6,083.2 4,371.2 1,712.0 ------------- ------------- -------------- Total assets..................................................... $ 27,559.2 $ 25,235.9 $ 2,323.3 ============= ============= ==============
MINORITY INTEREST Minority interest in net assets of consolidated subsidiaries...... 31.4 28.1 3.3 ------------- ------------- --------------
STOCKHOLDERS' EQUITY Common stock and additional paid in capital...................... 2,429.8 2,425.4 4.4 Deferred compensation on restricted stock units.................. (3.6) -- (3.6) Accumulated deficit.............................................. (352.7) (331.4) (21.3) Accumulated other comprehensive income........................... 63.7 (71.5) 135.2 Treasury stock................................................... (189.4) (195.7) 6.3 ------------- ------------- -------------- Total stockholders' equity....................................... 1,947.8 1,826.8 121.0 ------------- ------------- -------------- Total liabilities, minority interest and stockholders' equity.... $ 27,559.2 $ 25,235.9 $ 2,323.3 ============= ============= ==============
our senior unsecured bonds. See Note 6 to our consolidated financial statements in this Form 10-K for additional information.
of 2004 equal to the excess (if any) of (a) the lesser of (i) $165 million or (ii) 2003 net investment advisory fees times 4.5 times 60%, over (b) $100 million. The maximum payment is $65 million. As of December 31, 2003, we have accrued approximately $30 million related to this payment.
In May 2003, we acquired the remaining interest in PFG 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.
Phoenix Life's consolidated statutory basis capital and surplus (including AVR) decreased from $1,009.2 million at December 31, 2002 to $962.4 million at December 31, 2003. The principal factors resulting in this decrease are a decrease in admitted deferred income tax assets of $44.8 million and a dividend of $44.5 million to the parent, partially offset by increases in other admitted assets and unrealized investment gains.
Our broker-dealer subsidiaries are each subject to the net capital requirements imposed on registered broker-dealers by the Securities Exchange Act of 1934. Each is also required to maintain a ratio of aggregate indebtedness to net capital that does not exceed 15:1. The largest of these subsidiaries had net capital of approximately $6.6 million, which is $5.8 in excess of its required minimum net capital of $0.8 million. The ratio of aggregate indebtedness to net capital for that subsidiary was 2:1. The ratios of aggregate indebtedness to net capital for each of the other broker-dealer subsidiaries were also below the regulatory ratio at December 31, 2003 and their respective net capital each exceeded the applicable regulatory minimum.
We have two defined benefit pension plans covering our employees. The employee pension plan, covering substantially all of our employees, provides benefits up to the amount allowed under the Internal Revenue Code. The supplemental plan provides benefits in excess of the primary plan. Retirement benefits under both plans are a function of years of service and compensation. The employee pension plan is funded with assets held in a trust, while the supplemental plan is unfunded.
We expect to contribute $107.8 million to the employee pension plan through 2008, including $7.2 million during 2004.