Our executive headquarters consist of our main office building at One American Row and two other buildings in Hartford, Connecticut. We own these buildings and occupy most of the space contained in them. In addition to these properties, we own offices in East Greenbush, New York for use in the operation of our business. In February 2005, we entered into an agreement for the sale and short-term leaseback of the East Greenbush property with an anticipated relocation in 2006 of business functions currently located at that property to a site to be leased in the Albany area. In May 2004, we sold our offices in Enfield, Connecticut. Business functions from Enfield are being relocated to our existing Hartford offices. We also lease office space within and out of the United States as needed for our operations.
You should read the following in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements in this Form 10-K.
Basic Earnings Per Share(1) Income (loss) from continuing operations........................... $ 0.91 $ (0.04) $ (1.44) $ (1.41) $ 0.92 ============= ============= ============= ============== ============= Net income (loss)...................... $ 0.91 $ (0.07) $ (2.78) $ (2.06) $ 0.80 ============= ============= ============= ============== =============
Balance Sheet Data Cash and general account investments... $ 17,334.6 $ 17,242.8 $ 16,812.8 $ 14,400.4 $ 12,767.5 ============= ============= ============= ============== ============= Total assets........................... $ 28,362.6 $ 27,559.2 $ 25,235.9 $ 22,535.9 $ 20,313.5 ============= ============= ============= ============== ============= Indebtedness........................... $ 690.8 $ 639.0 $ 644.3 $ 599.3 $ 425.1 ============= ============= ============= ============== ============= Total liabilities...................... $ 26,299.2 $ 25,588.8 $ 23,389.9 $ 20,266.6 $ 18,341.6 ============= ============= ============= ============== ============= Minority interest in net assets of consolidated subsidiaries............ $ 41.0 $ 22.6 $ 19.2 $ 1.2 $ 130.7 ============= ============= ============= ============== ============= Total stockholders' equity............. $ 2,022.4 $ 1,947.8 $ 1,826.8 $ 2,307.8 $ 1,840.9 ============= ============= ============= ============== =============
Asset Management Segment Third-party assets under management......................... $ 42,908.5 $ 46,260.5 $ 41,835.3 $ 41,723.5 $ 47,391.9 ============= ============= ============= ============== =============
Consolidated Statutory Data Premiums, deposits and fees............ $ 2,151.1 $ 3,364.9 $ 3,919.7 $ 3,144.8 $ 2,344.8 ============= ============= ============= ============== ============= Net income (loss)...................... $ 46.3 $ (26.0) $ (130.7) $ (66.0) $ 266.1 ============= ============= ============= ============== ============= Capital and surplus(4)................. $ 814.6 $ 762.4 $ 861.4 $ 1,149.8 $ 1,322.8 Asset valuation reserve, or AVR(5)..... 221.2 200.0 147.8 223.4 560.4 ------------- ------------- ------------- -------------- ------------- Capital, surplus and AVR............... $ 1,035.8 $ 962.4 $ 1,009.2 $ 1,373.2 $ 1,883.2 ============= ============= ============= ============== =============
(1) We calculated earnings per share for each of the two years from 2000 through 2001 on a pro forma basis, based on 104.6 million weighted-average shares outstanding. The pro forma weighted-average shares outstanding calculation for 2001 is based on the weighted-average shares outstanding for the period from the demutualization and IPO to the end of the year. (2) Due to our losses during 2003, 2002 and 2001, the ratio of earnings to fixed charges for those years was less than 1:1. We would need $11.4 million, $113.6 million and $131.6 million in additional earnings for the years 2003, 2002 and 2001, respectively, to achieve a 1:1 coverage ratio. (3) Due to our losses during 2003, 2002 and 2001, the ratio coverages, excluding interest credited on policyholder contract balances, were less than 1:1. We would need $11.4 million, $113.6 million and $131.6 million in additional earnings for the years 2003, 2002 and 2001, respectively, to achieve a 1:1 coverage ratio. (4) In accordance with accounting practices prescribed by the New York State Insurance Department, Phoenix Life's capital and surplus includes $205.2 million and $175.0 million principal amount of surplus notes outstanding at December 31, 2004 and 2003, respectively. (5) The AVR is a statutory reserve intended to mitigate changes to the balance sheet as a result of fluctuations in asset values.
The following discussion may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Phoenix Companies, Inc., or the Company, intends these forward-looking statements to be covered by the safe harbor provisions of the federal securities laws relating to forward-looking statements. These include statements relating to trends in, or representing management's beliefs about, the Company's future strategies, operations and financial results, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "may," "should" and other similar expressions. Forward-looking statements are made based upon management's current expectations and beliefs concerning trends and future developments and their potential effects on the Company. They are not guarantees of future performance. Actual results may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties which include, among others: (i) changes in general economic conditions, including changes in interest and currency exchange rates and the performance of financial markets; (ii) heightened competition, including with respect to pricing, entry of new competitors and the development of new products and services by new and existing competitors; (iii) the Company's primary reliance, as a holding Company, on dividends and other payments from its subsidiaries to meet debt payment obligations, particularly since the Company's insurance subsidiaries' ability to pay dividends is subject to regulatory restrictions; (iv) regulatory, accounting or tax developments that may affect the Company or the cost of, or demand for, its products or services; (v) downgrades in the financial strength ratings of the Company's subsidiaries or in the Company's credit ratings; (vi) discrepancies between actual claims experience and assumptions used in setting prices for the products of insurance subsidiaries and establishing the liabilities of such subsidiaries for future policy benefits and claims relating to such products; (vii) movements in the equity markets that affect our investment results, including those from venture capital, the fees we earn from assets under management and the demand for our variable products; (viii) the Company's continued success in achieving planned expense reductions; (ix) the effects of closing the Company's retail brokerage operations; and (x) other risks and uncertainties described in any of the Company's filings with the SEC. The Company undertakes no obligation to update or revise publicly any forward-looking statement, whether as a result of new information, future events or otherwise.
The United States equity markets can be volatile and experience both periods of strong growth and of substantial declines.
Changes in interest rates could harm cash flow and profitability in our life and annuity businesses.
Conversely, during periods of declining interest rates, we could experience increased premium payments on products with flexible premium features, repayment of policy loans and increased percentages of policies remaining in force. We would obtain lower returns on investments made with these cash flows. In addition, borrowers may prepay or redeem mortgages and bonds in our investment portfolio so that we might have to reinvest those proceeds in lower interest-bearing investments. As a consequence of these factors, we could experience a decrease in the spread between the returns on our investment portfolio and amounts credited to policyholders and contractholders, which could adversely affect our profitability.
We depend on non-affiliated distribution for our product sales and if our relationships with these distributors were harmed, we could suffer a loss in revenues.
Downgrades to PNX's debt ratings and Phoenix Life's financial strength ratings could increase policy surrenders and withdrawals, adversely affect relationships with distributors, reduce new sales and earnings from certain of our life insurance products and increase our future borrowing costs.
Financial strength ratings reflect a rating agency's view of an insurance company's ability to meet its obligations to its insureds. These ratings are therefore key factors underlying the competitive position of life insurers. The current financial strength and debt ratings are set forth in the chart below.
Financial Strength Rating Senior Debt Rating Rating Agency of Phoenix Life of PNX --------------------------- --------------------------- --------------------------
Moody's and Standard & Poor's each have a stable outlook for our ratings, while A.M. Best and Fitch have a negative outlook.
Any rating downgrades may result in increased interest costs in connection with future borrowings. Such an increase would decrease our earnings and could reduce our ability to finance our future growth on a profitable basis.
The independent trustees of our mutual funds and closed-end funds, intermediary program sponsors, managed account clients and institutional asset management clients could terminate their contracts with us. This would reduce our investment management fee revenues.
The termination of any of the above agreements relating to material portion of assets under management would adversely affect our investment management fee revenues and could require us to impair the goodwill or intangible assets associated with our asset management partners.
We might be unable to attract or retain personnel who are key to our business.
As of December 31, 2004, our Asset Management business had $725.3 million in goodwill and intangible assets associated with our various partners. The amount of goodwill and intangible assets on our balance sheet is
supported by the assets under management and the related revenues of each of the partners. It might be necessary to impair those assets if:
We could have material losses in the future from our discontinued reinsurance business.
In 1999, we discontinued our reinsurance operations through a combination of sale, reinsurance and placement of certain retained group accident and health reinsurance business into run-off. We adopted a formal plan to stop writing new contracts covering these risks and to end the existing contracts as soon as those contracts would permit. However, we remain liable for claims under those contracts. We also purchased aggregate excess-of-loss reinsurance to further protect us from unfavorable results from this discontinued business. On February 7, 2005 we notified the aggregate excess-of-loss reinsurer that we were exercising our option to commute this contract. The commutation will be effective during the second quarter of 2005. The effect of the commutation will not be material to our consolidated financial statements.
We have established reserves for claims and related expenses that we expect to pay on our discontinued group accident and health reinsurance business. These reserves are based on currently known facts and estimates about, among other things, the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid, the amount of reinsurance we believe we will collect under our aggregate excess-of-loss reinsurance, the amounts we believe we will collect from our retrocessionaires and the likely legal and administrative costs of winding down the business. Our total reserves, including coverage available from our reinsurance and reserves for amounts recoverable from retrocessionaires, were $110.0 million as of December 31, 2004. Our total amounts recoverable from retrocessionaires related to paid losses were $60.0 million as of December 31, 2004.
In establishing our reserves described above for the payment of insured losses and expenses on this discontinued business, we have made assumptions about the likely outcome of the disputes referred to above, including an assumption that substantial recoveries would be available from our reinsurers on all of our discontinued reinsurance business. However, the inherent uncertainty of arbitrations and lawsuits, including the uncertainty of estimating whether any settlements we may enter into in the future would be on favorable terms, makes it hard to predict outcomes with certainty. Given the need to use estimates in establishing loss reserves, and the difficulty in predicting the outcome of arbitrations and lawsuits, our actual net ultimate exposure likely will differ from our current estimate. If future facts and circumstances differ significantly from our estimates and assumptions about future events with respect to the disputes referred to above or other portions of our discontinued reinsurance business, our current reserves may need to be increased materially, with a resulting material adverse effect on our results of operations and financial condition.
The United States federal government does not directly regulate the insurance business. However, federal legislation and administrative policies in areas which include employee benefit plan regulation, financial services regulation and federal taxation and securities laws could significantly affect each of our businesses, most notably our costs.
Management's discussion and analysis reviews our consolidated financial condition at December 31, 2004 and 2003; our consolidated results of operations for the years 2004, 2003 and 2002; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with "Selected Financial Data" and our consolidated financial statements in this Form 10-K.
Through our private client line of business, we provide investment management services principally on a discretionary basis, with products consisting of open-end mutual funds, closed-end funds and managed accounts. Managed accounts include intermediary programs sponsored and distributed by non-affiliated broker-dealers and direct managed accounts sold and administered by us. These two types of managed accounts generally require minimum investments of $100,000 and $1 million, respectively. Our private client business also provides transfer agency, accounting and administrative services to our open-end mutual funds.
Our sales and financial results over the last several years have been affected by demographic, industry and market trends. The baby boom generation has begun to enter its prime savings years. Americans generally have begun to rely less on defined benefit retirement plans, social security and other government programs to meet their postretirement financial needs. Product preferences have shifted between fixed and variable options depending on market and economic conditions. Our balanced product portfolio including universal life, variable life and variable annuity products, as well as a broad array of mutual funds and managed accounts, is well positioned to meet this shifting demand.
On October 25, 2004, we entered into an agreement with Friends Provident plc, or Friends Provident, to sell our 12% interest in Lombard International Assurance S.A., or Lombard, and to relinquish our notes receivable from Lombard's affiliate, Insurance Development Holdings A.G., or IDH. This transaction closed on January 11, 2005 for consideration of $59.0 million and, under the terms of the sale, we may be entitled to additional consideration, in the form of cash, based on Lombard's financial performance through 2006. We currently expect to recognize an after-tax realized gain of between $7.0 million and $10.0 million in the first quarter of 2005 related to our sale of Lombard.
Revenues net of eliminations and direct expenses net of deferrals and certain transaction related costs included in our consolidated financial statements related to our retail affiliated broker-dealer operations sold during 2004 are as follows:
Year Ended December 31, Revenues and Direct Expenses Of ---------------------------------- Retail Affiliated Broker-dealer Operations: 2004 2003 2002 ($ amounts in millions) ---------- ----------- ---------- Insurance and investment product fees revenues, net of eliminations..... $ 32.0 $ 60.8 $ 61.8 Direct other operating expenses, net of deferrals....................... 38.7 72.8 74.4
In 2002, we acquired the variable life and variable annuity business of Valley Forge Life Insurance Company (a subsidiary of CNA Financial Corporation). See Note 3 to our consolidated financial statements in this Form 10-K for further information regarding the acquisition of Valley Forge Life Insurance Company.
In March 2004, we acquired the remaining minority interests in Walnut Asset Management LLC and Rutherford Brown & Catherwood, LLC for $2.1 million. This additional purchase price was accounted for as a step-acquisition by Phoenix Investment Partners and was allocated to goodwill and definite-lived intangible assets, accordingly.
In addition to the initial cost of the purchase of Kayne Anderson Rudnick, in the first quarter of 2004 we made a payment of $30.1 million in contingent consideration, which was based upon management fee revenues for the purchased business through the end of 2003. Phoenix Investment Partners had accrued for this payment as of December 31, 2003 and allocated it entirely to goodwill.
In January 2004, one member of Kayne Anderson Rudnick accelerated his portion of the 15% noncontrolling interest redemption, at which time we acquired an additional 0.3% of the company. Phoenix Investment Partners has accrued $11.4 million related to the remaining 4.9% redemption required as of December 31, 2004, has accounted for this payment as a step-acquisition and has allocated the purchase price to goodwill and definite-lived intangible assets, accordingly. The two remaining 4.9% noncontrolling interest redemptions will be accounted for as step-acquisitions as the purchase price contingency resolves.
During 2004, we sold the stock of Phoenix Global Solutions (India) Pvt. Ltd., our India-based information technology subsidiary, and essentially all of the assets of its United States affiliate, Phoenix Global Solutions, Inc., to Tata Consultancy Services Limited, a division of Tata Sons Ltd. This transaction is not material to our consolidated financial statements.
Effective July 1, 2003, we adopted SFAS 150. The effect of our adoption was to reclassify the mandatorily redeemable noncontrolling interests related to our asset management subsidiaries from "minority interest" to "other liabilities" in our consolidated balance sheet. In addition, within our consolidated statement of operations, we reclassified earnings attributed to those interests from the caption "minority interest in net income of subsidiaries" to "other operating expenses." These changes in presentation were not material to our consolidated financial statements.
Nontraditional Long-Duration Contracts and Separate Accounts: Effective January 1, 2004, we adopted the AICPA's Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts, or SOP 03-1. SOP 03-1 provides guidance related to the accounting, reporting and disclosure of certain insurance contracts and separate accounts, including guidance for computing reserves for products with guaranteed benefits such as guaranteed minimum death benefits and for products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1 addresses the presentation and reporting of separate accounts, as well as rules concerning the capitalization and amortization of sales inducements. Since this new accounting standard largely codifies certain accounting and reserving practices related to applicable nontraditional long-duration contracts and separate
accounts that we already followed, our adoption did not have a material effect on our consolidated financial statements.
In accordance with previous guidance, we continue to consolidate certain collateralized obligation trusts, or CDOs, which we sponsor.
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.
We amortize deferred acquisition costs and present value of future profits based on the related policy's classification. For individual participating life insurance policies, deferred acquisition costs and present value of future profits are amortized in proportion to estimated gross margins. For universal life, variable universal life and accumulation annuities, deferred acquisition costs and present value of future profits are amortized in proportion to estimated gross profits. Policies may be surrendered for value or exchanged for a different one of our products (internal replacement). The deferred acquisition costs balance associated with the replaced or surrendered policies is amortized to reflect these surrenders.
The amortization of deferred acquisition costs and present value of future profits requires the use of various assumptions, estimates and judgments about the future. Significant assumptions include those concerning expenses, investment performance, mortality and policy cancellations (i.e., lapses, withdrawals and surrenders). These assumptions are reviewed on a regular basis and are generally based on our past experience, industry studies, regulatory requirements and judgments about the future. Changes in estimated gross margins and gross profits based on actual experiences are reflected as an adjustment to total amortization to date resulting in a charge or credit to earnings. Finally, analyses are performed periodically to assess whether there are sufficient gross margins or gross profits to amortize the remaining deferred acquisition cost balances.
See Note 3 to our consolidated financial statements and Item 7A, Quantitative and Qualitative Disclosures About Market Risk in this Form 10-K for more information.
• Goodwill and Other Intangible Assets At the beginning of 2002, we adopted a new accounting standard for goodwill and other intangible assets, including amounts reflected in our carrying value of equity-method investments. Under this new standard, we discontinued recording amortization expense on goodwill and other intangible assets with indefinite lives, but we continue recording amortization expense for those intangible assets with definite estimated lives. For goodwill and intangible assets, we perform impairment tests at the reporting-unit level at least annually. For purposes of the goodwill and indefinite-lived intangible assets impairment test, the fair value of the reporting units is based on the sum of: a multiple of revenue, plus the fair value of the units' tangible fixed assets. Prior to 2002, we amortized goodwill principally over 40 years and investment management contracts and employment contracts over five to 16 years and three to seven years, respectively. All amortization expense has been and continues, for intangible assets with definite lives, to be calculated on a straight-line basis.
Investments whose value, in our judgment, is considered to be other-than-temporarily impaired are written down to fair value as a charge to realized losses included in our earnings. The cost basis of these written-down investments is adjusted to fair value at the date the determination of impairment is made. The new cost basis is not changed for subsequent recoveries in value. For mortgage-backed and other asset-backed debt securities, we recognize income using a constant effective yield based on anticipated prepayments and the estimated economic lives of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and any resulting adjustment is included in net investment income. For certain asset-backed securities, changes in estimated yield are recorded on a prospective basis and specific valuation methods are applied to these securities to determine if there has been an other-than-temporary decline in value. We report mortgage loans at unpaid principal balances, net of valuation reserves on impaired mortgages. We consider a mortgage loan to be impaired if we believe it is probable that we will be unable to collect
all amounts of contractual interest and principal as scheduled in the loan agreement. We do not accrue interest income on impaired mortgage loans when the likelihood of collection is doubtful.
• Valuation of Investments in Venture Capital Partnerships We record our equity in the earnings of venture capital partnerships in net investment income using the most recent financial information received from the partnerships and estimating the earnings for any lag in reporting. To estimate the net equity in earnings of the venture capital partnerships for each quarter, we developed a methodology to estimate the change in value of the underlying investee companies in the venture capital partnerships. For public investee companies, we use quoted market prices at the end of each quarter, applying liquidity discounts to these prices in instances where such discounts were applied in the underlying partnerships' financial statements. For private investee companies, we apply a public industry sector index to estimate changes in valuations each quarter. We apply this methodology consistently each quarter with subsequent adjustments to reflect market events reported by the partnerships (e.g., new rounds of financing, initial public offerings and write-downs by the general partners). Our methodology recognizes both downward and upward adjustments in estimated values based on the indices, but when the general partner reduces the value of a private investee company, we do not adjust the fair value upward (by applying the public sector index) in excess of the most recent value reported by the general partner. Finally, we revise the valuations we have assigned to the investee companies annually to reflect the valuations in the audited financial statements received from the venture capital partnerships. Adjustments to the valuation of these companies to reflect reported valuations in the audited financial statements received from the venture capital partnerships will be reflected in our financial statements when received in the first and second quarters of 2005.
We have elected to file a consolidated federal income tax return for 2004 and prior years. Within the consolidated tax return, we are required by regulations of the Internal Revenue Service, or the IRS, to segregate our companies into two groups: life insurance companies and non-life insurance companies.
We are limited as to the amount of any operating losses from one group that can be offset against taxable income of the other group. These limitations affect the amount of any operating loss carryforwards that we have recorded in our deferred tax assets now or in the future.
As of December 31, 2004, we had deferred tax assets of $51.6 million related to net operating losses for federal income tax purposes and $7.9 million for state income tax purposes. The related federal net operating losses are scheduled to expire as follows: $61.2 million in 2017, $12.5 million in 2018, $1.1 million in 2019, $1.8 million in 2022, $33.5 million in 2023 and $44.8 million in 2024. The state net operating losses relate to the non-life subgroup and are scheduled to expire as follows: $29.8 million in 2012 and 2013 and $72.0 million in 2019 through 2023. Due to the inability to combine the life insurance and non-life insurance subgroups for state income tax purposes, we established a $7.9 million and a $4.6 million valuation allowance at the end of 2004 and 2003, respectively, relative to the state net operating loss carryforwards.
Our federal income tax returns are routinely audited by the IRS and estimated provisions are routinely provided in the financial statements in anticipation of the results of these audits. The IRS has examined our consolidated group's federal income tax returns through 2001. The IRS is currently examining our federal income tax returns for 2002 and 2003. While it is often difficult to predict the outcome of these audits, including the timing of any resolution of any particular tax matter, we believe that our reserves, as recorded in other liabilities on the balance sheet, are adequate for all open tax years. Unfavorable resolution of any particular issue could result in additional use of cash to pay liabilities that would be deemed owed to the IRS. Additionally, any unfavorable or favorable resolution of any particular issue could result in an increase or decrease, respectively, to our effective income tax rate to the extent that our estimates differ from the ultimate resolution. During 2004 we recognized a $5.7 million favorable tax benefit as a result of the favorable resolution of certain tax matters with the IRS.
Weighted-average common shares outstanding................................ 94.7 94.2 97.9 0.5 (3.7) ============ ============ ============ =========== ===========
Total segment income for 2004 of $80.6 million, or $0.80 per diluted share, is substantially improved from 2003 full year total segment income of $57.3 million, or $0.59 per diluted share, and 2002 total segment loss of $60.4 million, or $0.62 per share, as a result of higher earnings in both the Life and Annuity and Asset Management segments, somewhat offset by lower Venture Capital earnings in 2004 as compared to 2003 and a higher Corporate and Other segment loss. Both the Life and Annuity and Asset Management businesses benefited in 2004 as compared to 2003 and 2002 from lower distribution, general and administrative expenses, and favorable equity market conditions. Life and Annuity also benefited from continued strong fundamentals in its in-force block characterized by favorable mortality, strong persistency and improved investment margins. Asset Management experienced a sharp increase in net outflows in assets under management during 2004, principally the result of continued poor product performance in certain of our equity strategies. Asset Management expense levels also continue to reflect structural challenges related to our operations that are not wholly-owned, primarily Seneca Capital Management LLC, or Seneca, and Kayne Anderson Rudnick.
We ended 2004 with in a strong financial position. Shareholders' equity grew to $2,022.4 million at December 31, 2004 compared to $1,947.8 million at December 31, 2003, Phoenix Life's statutory capital, surplus and AVR of $1,028.2 million at December 31, 2004 is improved from the December 31, 2003 amount of $961.5 million, Phoenix Life's risk-based capital, or RBC, is well above 300%, and Holding Company cash is $61.0 million at December 31, 2004 compared to $22.8 million at the end of 2003. We also took steps to enhance our financial flexibility. We closed on a tender offer for our 6.95% surplus notes scheduled to mature on December 1, 2006, receiving valid tenders of $144.8 million of notes, and issued $175.0 million of 7.15% surplus notes maturing December 15, 2034. We also entered into a new $150.0 million three-year, unsecured senior revolving credit facility replacing the prior facility, which was to expire during the quarter. The five-year funding requirements for our qualified pension plan improved from $107.8 million as of December 31, 2003 to $43.3 million as of December 31, 2004. Finally, we laid the groundwork to dispose of our two largest non-strategic assets, Aberdeen and Lombard, which resulted in the receipt of net proceeds of nearly $130.0 million in January 2005 and brought closure to the issue of dispositions of non-strategic assets.
The benefits of many initiatives that we have implemented in recent years became increasingly apparent in 2004. We have stabilized and strengthened the Company, significantly improved profitability, established a track record of disciplined execution and built a solid foundation for growth. While earnings in Life and Annuity have improved much more quickly than in Asset Management, we expect a stronger, better positioned Asset Management business to emerge in 2005 as we continue to address structural, performance and profitability challenges and begin to benefit from the expense initiatives we announced in the fourth quarter of 2004. A
number of significant accomplishments in 2004 contributed to our earnings improvement and position us well for the future. Our exit from affiliated retail distribution operations is already generating significant savings, and we are building back sales from formerly affiliated producers. The outsourcing of our information technology infrastructure will produce meaningful savings beginning in 2005 and will also improve service. We enhanced our financial flexibility through our two surplus notes transactions and our new three-year credit facility. Operationally, we continued to implement "lean" manufacturing principles to improve product and service quality, create capacity for higher business volumes, and enhance speed to market. We are moving forward, focused intensely on growth in 2005.
The Life and Annuity segment had pre-tax income of $142.8 million in 2004, compared to $99.4 million in for 2003 and $80.3 million for 2002. The life insurance business had full-year 2004 pre-tax income of $134.5 million, compared to $103.5 million reported for 2003 and $101.0 million in 2002. The annuity business also demonstrated improvement with pre-tax income of $8.3 million, up from a $4.1 million pre-tax loss in 2003 and a $20.7 million pre-tax loss in 2002. Full-year 2004 earnings improvements in Life and Annuity reflect the benefits of expense savings, particularly from the sale of our retail affiliated distribution operations, and continued strong fundamentals including mortality, higher investment margins and persistency. Life insurance and annuity sales and deposits fell short of our expectations and were well below 2003 and 2002 levels. Life insurance sales were lower due to our decision to maintain pricing and risk management discipline, particularly relating to the universal life contracts with low-priced no-lapse guarantees that prevailed in the market throughout the year. In addition, sales decreased as anticipated after the sale of our affiliated retail distribution operations to LPL during the second quarter and were slower to rebound than originally projected. These factors were compounded by the longer-than-anticipated time to achieve ratings improvement, which the company continues to pursue in 2005. The decrease in annuity deposits reflects our strategic decisions in the fall of 2003 to discontinue sales of deferred fixed annuities, and to focus annuity wholesaling on select distribution relationships, as well as the sale of our affiliated retail distribution operations in the second quarter of 2004.
• First, we are rebuilding our product development capabilities. We added talented product development staff last year and used "lean" manufacturing principles to streamline the process. Senior management drives the product development process: vetting ideas, setting priorities and eliminating roadblocks. As a result, in 2005 we will improve our time to market, shorten the product development cycle and focus on a distinctive value proposition for our market. In life insurance, we have updates to our variable universal life portfolio and a new investment-oriented life product coming out in the spring. • The second driver of sales growth in 2005 will be a 50% expansion of our distribution force to reach out more broadly in our existing relationships, particularly State Farm and LPL. The hiring process is under way, and a number of new wholesalers are on board already. • And third, we have significant resources focused on establishing new strategic distribution relationships.
• The Goodwin Multi-Sector Short-Term Bond Fund was recognized as a five star fund by Morningstar. The Goodwin Fund also received an award from Lipper in 2004 for superior long-term performance and the Phoenix Mid-Cap Fund was similarly recognized early in 2005. • Goodwin's institutional strategies also delivered another year of outstanding performance, beating their benchmarks over one, three, five and ten years. • On the specialty side, the Duff & Phelps REIT fund has been a standout and we are successfully selling REIT strategies in the institutional market. • The fixed income team at Seneca has a very strong track record across several fixed income strategies and has attracted institutional flows. • In January 2005, we launched an open-end utility fund, which builds on our successful track record in utilities at Duff & Phelps. • Effective April 1, 2005, two of our funds, the Phoenix Mid-Cap Value Fund and Phoenix-Kayne Small-Mid-Cap Fund will be on the platform of one of the largest 401K providers. This is a win both for our new institutional sales team and the investment teams of the funds.
In addition to the above, we have implemented an institutional strategy focused on leveraging existing core strengths while building out the distribution infrastructure. On the retail side, we expect to implement a sub-advisory strategy in mid-2005 to complement existing strengths with a focus towards the high-net-worth market. These steps will not only help turn around flows but also lead to sustainable growth and a more flexible, profitable business model.
The Venture Capital segment had 2004 pre-tax income of $19.3 million, compared with income of $36.2 million in 2003 and a loss of $59.3 million in 2002. The 2004 and 2003 results reflect generally favorable private equity market conditions as compared to unfavorable market conditions experienced in 2002.
The Corporate and Other segment loss for 2004 of $59.1 million is higher than the 2003 and 2002 losses of $47.8 and $40.0 million, respectively. The full-year 2004 results reflect higher earnings from the company's international operations offset by higher regulatory, compliance and corporate information technology costs and lower corporate investment income. During 2003 and into 2004, we undertook a comprehensive review of our internal control over financial reporting as required under Section 404 of The Sarbanes-Oxley Act of 2002, which resulted in the dedication of more than 30,000 hours of internal management and staff time and nearly $4 million in incremental corporate expense for 2004. As noted in Item 9A this Annual Report on Form 10-K, management has concluded that our internal control over financial reporting is effective as of December 31, 2004.
considerable improvement in credit market conditions since mid-2003. Impairment losses for 2004 include an $11.6 million impairment ($6.7 million after-taxes) related to our investment in an Argentina affiliate, while 2003 impairments include an $89.1 million impairment ($55.0 million after-taxes) of our equity investment in Aberdeen. Transaction gains, before offsets, of $48.7 million for 2004 compares with gains of $112.3 million in 2003 and $52.8 million in 2002. Transaction gains in 2003 include $35.3 million in pre-tax gains from the sale of interests in two General Electric life insurance subsidiaries and in PXRE Group, Ltd.
Policyholder benefits, including dividends, decreased $45.9 million, or 2%, primarily due to lower benefits and changes in policy reserves and policyholder dividends for participating life from a decline in renewal premiums, as discussed above; lower interest credited from reduced crediting rates, principally from universal life; and lower general account funds on deposit for annuities. These decreases were partially offset by a larger increase in the policyholder dividend obligation, higher reserves for annuities and higher benefits for universal life and variable universal life insurance. The increase in universal life and variable universal life benefits was due to a large death claim, for universal life, in the first quarter of 2004 combined with very favorable mortality for both lines of business in 2003.
Interest expense on non-recourse collateralized obligations decreased $15.3 million, or 31%, in 2004 from 2003 due primarily to decreased liabilities from paydowns.
Net investment income increased by $166.9 million, or 18%, in 2003 over 2002, primarily due to improved equity market conditions and the related effect on our earnings from our Venture Capital segment and to increased general account spread-type funds on deposit in our Life and Annuity segment partially offset by the impact of reinvesting maturities at lower interest rates. In addition, investment income from our debt securities pledged as collateral related to our consolidated CDOs increased $21.2 million from 2002, primarily due to investment income from the Mistic CDO which closed in the third quarter of 2002.
Policy benefits, including policyholder dividends, increased $34.9 million, or 2%, in 2003 over 2002, primarily due to higher interest credited on guaranteed interest accounts, or GIAs, and fixed annuities from higher fund account balances and higher mortality expense for universal life insurance. Policyholder dividend expense for 2003 was also higher compared to 2002, primarily due to growth in cash values of existing participating life policies and the growth of our policyholder dividend obligation from favorable results, in part from the portion of the venture capital funds transferred to the closed block in the first quarter of 2003.
There were no impairments of goodwill or intangible assets in 2003. In 2002, the $66.3 million impairment related to goodwill for certain of our asset management partners.
Interest expense on non-recourse collateralized obligations increased $18.4 million, or 60%, in 2003 over 2002, primarily due to interest expense from the Mistic CDO which closed in the third quarter of 2002.
Other operating expenses decreased $48.1 million, or 8%, in 2003 compared to 2002, primarily due to lower management restructuring costs and lower overall operating expenses.
For the years 2004, 2003 and 2002, inflation did not have a material effect on our consolidated results of operations.
Results of Operations by Segment Year Ended December 31, as Reconciled to Consolidated Net Income: --------------------------------------- ($ amounts in millions) 2004 2003 2002 ----------- ----------- ----------- Segment Income (Loss) Life and annuity segment............................................ $ 142.8 $ 99.4 $ 80.3 Asset management segment............................................ 0.1 (8.7) (69.9) ----------- ----------- ----------- Operating segment pre-tax income.................................... 142.9 90.7 10.4 Venture capital segment............................................. 19.3 36.2 (59.3) Corporate and other segment: Interest expense on indebtedness.................................. (40.8) (39.6) (31.4) Other............................................................. (18.3) (8.2) (8.6) ----------- ----------- ----------- Total segment income (loss) before income taxes..................... 103.1 79.1 (88.9) Applicable income taxes (benefit) .................................. 22.5 21.8 (28.5) ----------- ----------- ----------- Total segment income (loss)......................................... 80.6 57.3 (60.4) Income (loss) from discontinued operations.......................... 0.1 (2.1) (1.3) Net realized investment gains (losses), net of income taxes and other offsets..................................................... (7.2) 0.8 (65.6) Unrealized gains (losses) on equity investment in Aberdeen.......... 55.9 (55.0) -- Share of Aberdeen extraordinary charge for FSA settlement........... (14.7) -- -- Restructuring and early retirement costs, net of income taxes....... (21.9) (8.5) (28.5) Surplus notes tender costs.......................................... (6.4) -- -- Other income, net of income taxes................................... -- 1.3 -- Deferred acquisition cost adjustment, net of income taxes........... -- -- 15.1 Demutualization related items, net of income taxes.................. -- -- (1.3) Cumulative effect of accounting changes, net of income taxes........ -- -- (130.3) ----------- ----------- ----------- Net income (loss)................................................... $ 86.4 $ (6.2) $ (272.3) =========== =========== ===========
Total Segment Return on Equity: 2004 2003 2002 2001 ($ amounts in millions) ----------- ----------- ------------ ----------- Stockholders' equity, end of year............................ $ 2,022.4 $ 1,947.8 $ 1,826.8 $ 2,307.8 Adjustments for:
Accumulated other comprehensive (income) loss.............. (58.0) (63.7) 71.5 (2.8) Accumulated realized losses in retained earnings related to consolidated collateralized obligation trusts. 54.1 41.2 38.8 12.5 Stockholders' equity attributed to discontinued operations. (23.0) (28.2) (30.4) (23.6) ----------- ----------- ------------ ----------- Adjusted stockholders' equity, end of year................... $ 1,995.5 $ 1,897.1 $ 1,906.7 $ 2,293.9 =========== =========== ============ =========== Adjusted stockholders' equity, average....................... 1,946.3 1,901.9 2,100.3 =========== =========== ============ Total segment income......................................... $ 80.6 $ 57.3 $ (60.4) =========== =========== ============ Total segment return on equity............................... 4.1% 3.0% (2.9)% =========== =========== ============
Premium revenue decreased $51.6 million, or 5%, in 2004 from 2003, primarily due to a $51.1 million decrease in participating life insurance premiums. Since our demutualization in 2001, we no longer sell participating life policies, resulting in a decline in renewal participating life premiums. This decline in policies in force results in a reduction of reserves, thereby lower policyholder benefit costs.
Broker-dealer commission and distribution fee revenues decreased $25.8 million, or 47%, in 2004 from 2003, due to the sale of our retail affiliated broker-dealer operations in May 2004.
Policy benefits and dividends decreased $55.1 million, or 3%, in 2004 from 2003, primarily due to lower benefits and changes in policy reserves and policyholder dividends for participating life from a decline in renewal premiums, as discussed above; lower interest credited from reduced crediting rates principally from universal life; and lower general account funds on deposit for annuities. These decreases were partially offset by higher reserves for annuities and higher benefits for universal life and variable universal life insurance, as well as a larger increase in the policyholder dividend obligation. The increase in universal life and variable universal life benefits was due to a large death claim, for universal life, in the first quarter of 2004 combined with very favorable mortality for both lines of business in 2003.
Policy acquisition cost amortization increased $12.4 million, or 13%, in 2004 compared to 2003, due primarily to higher amortization for annuities from higher gross margins, growth in funds on deposit and lower relative performance in 2004. Amortization for variable universal life, universal life and term life increased modestly as a result of growth in funds under deposit, or in-force policies, for term life. These increases were partially offset by modestly lower amortization for participating life.
Allocated income taxes increased by $5.3 million, or 17%, in 2004 compared to 2003 due to higher pre-tax income, partially offset by tax benefits related to the favorable resolution of certain tax matters with the IRS.
Premium revenue decreased by $39.8 million, or 4%, in 2003 from 2002, primarily due to a continued shift in sales from participating life to universal life and variable universal life products as well as to a continued decline of the participating life in-force business. Compared to the prior year, the 2003 premium revenue for participating life insurance policies decreased by $40.5 million. Since our 2001 demutualization, we no longer sell participating life policies, resulting in a decline in renewal participating life premiums and related in-force policies.
Investment product fees increased by $18.9 million, or 7%, in 2003 over 2002, primarily due to higher sales in universal life products, the growth of in-force business for universal life and variable universal life products and slightly higher surrender fees for variable universal life products. Specifically, higher net amounts at risk in these two lines of business, as well as higher sales of universal life products, resulted in higher fees.
Allocated income taxes increased $3.1 million, or 11%, in 2003 over 2002 as a result of higher segment income before income taxes as well as a current year allocation of the tax effects of tax advantaged investments to the Life and Annuity segment.
Year Ended December 31, Variable Universal Life Funds on Deposit: --------------------------------------- ($ amounts in millions) 2004 2003 2002 ----------- ----------- -----------
Annuity, variable universal life and universal life funds on deposit experienced growth in 2004 as a result of positive net flows for variable universal life and universal life blocks and the effects of favorable equity markets on variable annuity and variable universal life funds on deposit.
Annuity products 2003 deposits declined to $1.4 billion in 2003 from $2.3 billion in 2002 as the result of the forth quarter 2002 decision to terminate sales of Retirement Planners Edge, or RPE, coupled with the forth quarter 2003 decision to exit certain unprofitable distribution relationships and a decision to terminate sales of fixed annuities.
Variable universal life insurance revenue increased $2.3 million, or 2%, in 2004 over 2003, due primarily to higher COI fees from the growth of in-force business, partially offset by lower fees due to lower premium deposits.
Other life insurance revenue decreased $24.8 million, or 17%, in 2004 from 2003, due primarily to lower broker-dealer commission and distribution fee revenues resulting from the sale of our retail affiliated broker-dealer operations in May 2004, offset by a modest increase in investment earnings, primarily related to an old block of corporate-owned life insurance.
Variable universal life product revenues increased $5.6 million, or 5%, in 2003 over 2002, primarily due to higher COI fees from the growth of in-force business, and higher surrender charges, partially offset by slightly lower sales and lower interest earned.
Term life revenues increased $2.4 million, or 20%, in 2003 over 2002, due to premium growth from higher sales.
Annuity product revenues increased $41.7 million, or 26%, in 2003 compared to 2002, primarily due to higher fees from improved equity market performance and to an increase in interest earned on higher spread based asset products. Earlier in 2004, we extended the duration of interests underlying our RPE annuity block to better align the investment portfolio with actual lapse experience. This extension strategy contributed to higher investment earnings for this block as compared to 2003.
Variable universal life insurance............ $ 35.7 $ 35.0 $ 35.9 $ 0.7 $ (0.9) Universal life insurance..................... 34.4 21.7 26.3 12.7 (4.6) Term life insurance.......................... 3.4 3.8 4.7 (0.4) (0.9) Other life insurance......................... 16.0 6.9 0.8 9.1 6.1 ----------- ----------- ----------- ----------- ----------- Total, non-participating life insurance...... 89.5 67.4 67.7 22.1 (0.3) Participating life insurance................. 45.0 36.1 33.3 8.9 2.8 ----------- ----------- ----------- ----------- ----------- Total, life insurance........................ 134.5 103.5 101.0 31.0 2.5 Annuities.................................... 8.3 (4.1) (20.7) 12.4 16.6 ----------- ----------- ----------- ----------- ----------- Segment income before income taxes........... $ 142.8 $ 99.4 $ 80.3 $ 43.4 $ 19.1 =========== =========== =========== =========== ===========
Variable universal life pre-tax income increased $0.7 million, or 2%, in 2004 over 2003, primarily due to reduced expenses from lower sales and expense reduction initiatives combined with higher revenues, as discussed above. These increases were partially offset by higher benefit costs and slightly higher deferred acquisition cost amortization in 2004.
Universal life pre-tax income increased $12.7 million, or 59%, in 2004 over 2003, primarily due to higher revenues, as discussed above, lower interest credited from reduced crediting rates and lower general and administrative expenses. These increases were partially offset by higher benefit costs resulting from a large death claim in the first quarter of 2004, combined with very favorable mortality in 2003, which did not recur in 2004.
Participating life pre-tax income increased $8.9 million, or 25%, in 2004 over 2003, primarily due to lower general and administrative expenses. Because operating expenses are excluded for the closed block, such operating expense savings inure to the benefit of shareholders. The decrease in revenues, as discussed above, are largely offset by lower benefits, changes in reserves and dividends to policyholders.
Other life insurance pre-tax income increased $6.1 million in 2003 from 2002, due to favorable mortality in an old block of corporate-owned life insurance business, the release of a reserve on a life contingent annuity due to the death of the annuitant and higher income from certain non-life insurance subsidiaries.
Participating life product pre-tax income increased $2.8 million, or 8%, in 2003 over 2002, primarily due to a one-time investment gain during the second quarter of 2003 and lower non-deferrable expenses, partially offset by higher deferred acquisition cost amortization and the release of a policyholder tax contingency in 2002 that did not recur in 2003.
Annuity product pre-tax loss was $16.6 million, or 80%, less in 2003 compared to 2002. This was primarily due to lower amortization of deferred acquisition costs in 2003, a decrease in minimum guaranteed death benefits expense in 2003, and higher investment margins from higher spread type funds on deposit. These were partially offset by higher non-deferrable expenses and commissions as well as further spread compression in 2003. Amortization of deferred acquisition costs was lower in 2003, due to acceleration of amortization from a revision of long-term market return assumptions and an impairment charge in 2002, neither of which recurred in 2003.
Year Ended December 31, Changes Summary Asset Management ------------------------------------ ----------------------- Financial Data: 2004 2003 2002 2004/03 2003/02 ($ amounts in millions) ----------- ----------- ----------- ----------- ----------- Results of Operations Investment product fees...................... $ 237.9 $ 225.3 $ 238.6 $ 12.6 $ (13.3) Broker-dealer commission and distribution fee revenues.................. 28.0 26.8 29.5 1.2 (2.7) Net investment income........................ 0.8 0.7 1.0 0.1 (0.3) ----------- ----------- ----------- ----------- ----------- Total segment revenues....................... 266.7 252.8 269.1 13.9 (16.3) ----------- ----------- ----------- ----------- ----------- Intangible asset amortization................ 33.8 33.2 32.5 0.6 0.7 Intangible asset impairments................. -- -- 66.3 -- (66.3) Other operating expenses..................... 232.8 228.3 240.2 4.5 (11.9) ----------- ----------- ----------- ----------- ----------- Total segment expenses....................... 266.6 261.5 339.0 5.1 (77.5) ----------- ----------- ----------- ----------- ----------- Segment income (loss) before income taxes.... 0.1 (8.7) (69.9) 8.8 61.2 Allocated income taxes (benefit)............. 2.3 (3.3) (6.0) 5.6 2.7 ----------- ----------- ----------- ----------- ----------- Segment loss................................. (2.2) (5.4) (63.9) 3.2 58.5 Net realized investment gains (losses)....... 1.8 (0.3) -- 2.1 (0.3) Restructuring and other costs, net of income taxes............................... (1.2) (4.0) (8.4) 2.8 4.4 Cumulative effect of accounting change....... -- -- (119.9) -- 119.9 ----------- ----------- ----------- ----------- ----------- Segment net loss............................. $ (1.6) $ (9.7) $ (192.2) $ 8.1 $ 182.5 =========== =========== =========== =========== ===========
End of year................................................... $ 42,908.5 $ 46,260.5 $ 41,835.3 ============== ============== ============== Average (based on how fees are calculated).................... $ 44,904.6 $ 42,900.2 $ 45,534.5 ============== ============== ==============
Investment product fees increased $12.6 million, or 6%, in 2004 over 2003. This increase was primarily due to an increase in average assets under management compared to the prior year. Private client and institutional investment product fees increased $9.8 million and $6.2 million, respectively, as a result of the increase in average assets under management. Other investment product fees decreased $1.7 million due to decreased volumes in equity trading by certain of our clients, which resulted in fewer commissions earned. Approximately 57% of our management fee revenues are based on assets as of the beginning of a quarter, which causes the trend in fee revenues to lag behind that of assets under management.
Assets under management were $42.9 billion and $46.3 billion at December 31, 2004 and 2003, respectively. The decrease in assets under management during 2004 is due primarily to customer withdrawals of $13.3 billion for the year. Sales of private client products in 2004 were $3.9 billion, which is a decrease of 2% from 2003. The majority of this decline is due to reduced sales of sponsored managed accounts at Seneca and Kayne Anderson Rudnick. Redemptions of private client products in 2004 were $7.5 billion, which is an increase of 60% from 2003. This increase is primarily related to the loss of sponsored managed accounts at Seneca. Sales of institutional accounts in 2004 were $2.7 billion, which is an 8% decrease from 2003. Redemptions of institutional accounts in 2004 were $5.6 billion, which is an increase of 67% from 2003. Of the institutional redemptions, $1.7 billion were not performance related.
There were no impairments of goodwill or other intangible assets in 2004 and 2003. The $66.3 million charge in 2002 was associated with the impairment of goodwill related to certain of our asset management partners.
Allocated income tax expense increased $5.6 million in 2004 over 2003 as a result of segment income in 2004 compared to segment losses in 2003 and additional state taxes allocated to the Asset Management segment.
Investment product fees decreased $13.3 million, or 6%, in 2003 from 2002. This decrease was primarily due to the decrease in average assets under management compared to the prior year. Private client and institutional investment product fees decreased $8.9 million and $6.5 million, respectively, as a result of the decrease in average assets under management. Approximately 56% of our management fee revenues are based on assets as of the beginning of a quarter, which causes fee revenues to lag behind changes in average assets under management.
Assets under management were $46.3 billion and $41.8 billion at December 31, 2003 and 2002, respectively. The increase in assets under management during 2003 is due primarily to positive investment performance of $5.8 billion for the year. Sales of private client products in 2003 were $4.1 billion, which is a decrease of 29% from 2002. The majority of this decline is due to reduced sales of sponsored managed accounts at Seneca and Kayne Anderson Rudnick. Redemptions of private client products in 2003 were $4.9 billion, which is a decrease of 11% from 2002. This improvement was primarily a result of lower redemptions for mutual funds. Sales of institutional accounts in 2003 were $3.0 billion, which is a 32% decrease from 2002. The decrease in sales is due to the fact that 2002 included the issuance of a $1.0 billion CDO, which we consolidate in our financial statements, that did not recur in 2003. Redemptions of institutional accounts in 2003 were $3.5 billion, which is a decrease of 22% from 2002. The majority of the improvement in redemptions was attributable to Seneca.
Our venture capital investments are limited partnership interests in venture capital funds, leveraged buyout funds and other private equity partnerships sponsored and managed by third parties. We record our investments in venture capital partnerships in accordance with the equity method of accounting. (See Venture Capital Partnerships in the Critical Accounting Estimates section of Management's Discussion and Analysis of Financial Condition and Results of Operations.) Venture capital investments are investments of the general account of Phoenix Life.
Net investment income decreased $16.9 million in 2004 from 2003, due primarily to less favorable equity market conditions in 2004 as compared to 2003.
Our accounting methodology recognizes both downward and upward adjustments based on public market indices, but when the general partner writes down the value of a private investee company, we do not override the most recent value reported by the general partner by applying the public sector index in excess of the most recent value reported by the general partner. Finally, we revise the valuations we have assigned to the investee companies annually to reflect the valuations in the audited financial statements received from the venture capital partnerships. As a result, the effect of our adjusting estimated partnership results to actual results increased investment income by $7.8 million, $33.4 million and $12.8 million in 2004, 2003 and 2002, respectively.
Adjustments to the valuation of these companies to reflect reported valuations in the audited financial statements received from the venture capital partnerships will be reflected in our financial statements when received in the first and second quarters of 2005.
Year Ended December 31, Changes Changes in Venture Capital Investments: ------------------------------------ ----------------------- ($ amounts in millions) 2004 2003 2002 2004/03 2003/02 ----------- ----------- ----------- ----------- -----------
Contributions (dollars invested)............. $ 37.7 $ 31.0 $ 42.2 $ 6.7 $ (11.2) Equity in earnings of partnerships........... 19.3 36.2 (59.3) (16.9) 95.5 Distributions................................ (50.4) (32.2) (41.7) (18.2) 9.5 Proceeds from sale of partnership interests and transfer to closed block............... -- (52.2) -- 52.2 (52.2) Realized loss on sale of partnership interests and transfer to closed block............... -- (14.3) (5.1) 14.3 (9.2) ----------- ----------- ----------- ----------- ----------- Change in venture capital investments........ 6.6 (31.5) (63.9) 38.1 32.4 Venture capital segment investments, beginning of period........................ 196.3 227.8 291.7 (31.5) (63.9) ----------- ----------- ----------- ----------- ----------- Venture capital segment investments, end of period.............................. $ 202.9 $ 196.3 $ 227.8 $ 6.6 $ (31.5) =========== =========== =========== =========== ===========
Year Ended December 31, Changes Summary Corporate and Other ------------------------------------ ----------------------- Financial Data: 2004 2003 2002 2004/03 2003/02 ($ amounts in millions) ----------- ----------- ----------- ----------- ----------- Results of Operations Corporate investment income.................. $ 0.4 $ 4.3 $ 1.5 $ (3.9) $ 2.8 Investment income from collateralized obligations................. 40.1 52.2 31.0 (12.1) 21.2 Interest expense on indebtedness............. (40.8) (39.6) (31.4) (1.2) (8.2) Interest expense on non-recourse collateralized obligations................. (33.6) (48.9) (30.5) 15.3 (18.4) Corporate expenses........................... (18.9) (11.0) (10.4) (7.9) (0.6) International................................ 3.7 (1.4) 4.2 5.1 (5.6) Other........................................ (10.0) (3.4) (4.4) (6.6) 1.0 ----------- ----------- ----------- ----------- ----------- Segment loss, before income taxes............ (59.1) (47.8) (40.0) (11.3) (7.8) Allocated income tax (benefit)............... (22.9) (18.8) (29.8) (4.1) 11.0 ----------- ----------- ----------- ----------- ----------- Segment loss................................. $ (36.2) $ (29.0) $ (10.2) $ (7.2) $ (18.8) =========== =========== =========== =========== ===========
Investment income from debt and equity securities pledged as collateral related to our CDOs decreased $12.1 million in 2004 from 2003, due primarily to decreased asset levels from paydowns and defaults. Consequently, lower distributions were made to investment holders resulting in a $15.3 million decrease in interest expense on non-recourse collateralized obligations during 2004.
Corporate expenses increased $7.9 million in 2004 over 2003, primarily due to increases in liability insurance costs, incremental regulatory compliance and audit costs associated with Section 404 of The Sarbanes-Oxley Act of 2002 and higher information technology costs.
The loss in other improved $1.0 million in 2003 over 2002, due primarily to lower losses from non-core operations offset by slightly higher expenses related to debt and equity securities pledged as collateral related to our consolidated CDOs of $2.8 million.
We measure, manage and monitor market risk associated with our insurance and annuity business, as part of our ongoing commitment to fund insurance liabilities. We have developed an integrated process for managing the interaction between product features and market risk. This process involves our Corporate Finance, Corporate Portfolio Management, Life and Annuity Finance, and Life and Annuity Product Development departments. These areas coordinate with each other and report results and make recommendations to our Asset-Liability Management Committee, or ALCO, chaired by the Chief Financial Officer.
We also measure, manage and monitor market risk associated with our general account investments, both backing insurance liabilities and supporting surplus. This process involves Corporate Portfolio Management and Goodwin, our Hartford-based asset management affiliate. These organizations work together, make recommendations and report results to our Investment Policy Committee, chaired by the Chief Investment Officer. Please refer to the sections that follow, including "Debt and Equity Securities Held in General Account", for more information on our investment risk exposures. We regularly refine our policies and procedures to appropriately balance market risk exposure and expected return.
One of the key measures we use to quantify this interest rate exposure is duration, as a measure of the sensitivity of the fair value of assets and liabilities to changes in interest rates. For example, if interest rates increase by 100 basis points, or 1%, the fair value of an asset with a duration of five years is expected to decrease by 5%. We believe that as of December 31, 2004, our asset and liability portfolio durations were well matched, especially for our largest and most interest-sensitive segments. Since our insurance products have variable interest rates (which expose us to the risk of interest rate fluctuations), we regularly undertake a sensitivity analysis that calculates liability durations under various cash flow scenarios.
The table below shows the estimated interest rate sensitivity of our fixed income financial instruments measured in terms of fair value. Given that our asset and liability portfolio durations were well matched for the periods indicated, we would expect market value gains or losses in assets to be largely offset by corresponding changes in liabilities.
Cash and cash equivalents............................... $ 435.0 $ 435.3 $ 435.0 $ 434.7 Available-for-sale debt securities...................... 13,476.3 14,138.2 13,476.3 12,814.8 Mortgage loans.......................................... 207.9 225.9 220.4 214.9 ------------ ------------ ------------ ------------ Subtotal................................................ 14,119.2 14,799.4 14,131.7 13,464.4 Debt and equity securities pledged as collateral........ 1,278.8 1,335.4 1,278.8 1,221.9 ------------ ------------ ------------ ------------ Totals.................................................. $ 15,398.0 $ 16,134.8 $ 15,410.5 $ 14,686.3 ============ ============ ============ ============
We enter into interest rate swap agreements to reduce market risks from changes in interest rates. We do not enter into interest rate swap agreements for trading purposes. Under interest rate swap agreements, we exchange cash flows with another party at specified intervals for a set length of time based on a specified notional principal amount. Typically, one of the cash flow streams is based on a fixed interest rate set at the inception of the contract and the other is based on a variable rate that periodically resets. Generally, no premium is paid to enter into the contract and neither party makes payment of principal. The amounts to be received or paid on these swap agreements are accrued and recognized in net investment income.
The table below shows the interest rate sensitivity of our general account interest rate derivatives measured in terms of fair value. These exposures will change as our insurance liabilities are created and discharged and as a result of ongoing portfolio and risk management activities.
In 1999, we began selling RPE, a no-load variable annuity. RPE was designed to attract contributions into variable sub-accounts on which we earn mortality and expense fees. However, the bulk of the funds were allocated to GIAs, which offered a 3% guaranteed interest rate. We anticipated the liabilities would be of a short duration and with the low level of interest rates, we were unable to invest funds at a rate that guaranteed a spread that covered commissions and interest credited. In September 2002, we stopped accepting applications for RPE, although existing policyholders have the right to make subsequent cumulative gross deposits up to $1 million per contract.
Because experience has shown that the duration of the RPE liabilities is longer than we had previously assumed, beginning in the second quarter of 2004 we extended the duration of the assets. This has enhanced operating income to the point where this product essentially breaks even.
We manage credit risk through the fundamental analysis of the underlying obligors, issuers and transaction structures. Through Goodwin, our Hartford-based asset management affiliate, we employ a staff of experienced credit analysts who review obligors' management, competitive position, cash flow, coverage ratios, liquidity and other key financial and non-financial information. These analysts recommend the investments needed to fund our liabilities while adhering to diversification and credit rating guidelines. In addition, when investing in private debt securities, we rely upon broad access to management information, negotiated protective covenants, call protection features and collateral protection. We review our debt security portfolio regularly to monitor the performance of obligors and assess the stability of their current credit ratings.
Certain annuity products sold by our Life Companies contain guaranteed minimum death benefits. The guaranteed minimum death benefit feature provides annuity contract holders with a guarantee that the benefit received at death will be no less than a prescribed amount. This minimum amount is based on the net deposits paid into the contract, the net deposits accumulated at a specified rate, the highest historical account value on a contract anniversary, or more typically, the greatest of these values. To the extent that the guaranteed minimum death benefit is higher than the current account value at the time of death, the company incurs a cost. This typically results in an increase in annuity policy benefits in periods of declining financial markets and in periods of stable financial markets following a decline. As of December 31, 2004 and 2003, the difference between the guaranteed minimum death benefit and the current account value (net amount at risk) for all existing contracts was $123.5 and $183.1 million, respectively. This is our exposure to loss should all of our contractholders have died on either December 31, 2004 or December 31, 2003.
Net amount at risk on minimum guaranteed death benefits (before reinsurance)......... $ 441.1 $ 616.9 Net amount at risk reinsured......................................................... (317.6) (433.8) ----------- ----------- Net amount at risk on minimum guaranteed death benefits (after reinsurance).......... $ 123.5 $ 183.1 =========== ===========
Payments Related to Guaranteed Minimum Death Benefits, Year Ended December 31, Net of Reinsurance Recoveries: ------------------------------------- ($ amounts in millions) 2004 2003 2002 ----------- ----------- -----------
We establish a reserve for guaranteed minimum death benefits using a methodology consistent with the AICPA SOP No. 03-01, Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration Contracts and for Separate Accounts. This reserve is determined using the net amount at risk taking into account estimates for mortality, equity market returns, and voluntary terminations under a wide range of scenarios at December 31, 2004 and 2003.
Reserves Related to Guaranteed Minimum Death Benefits, As of December 31, Net of Reinsurance Recoverables: ------------------------ ($ amounts in millions) 2004 2003 ----------- -----------
We also provide reserves for guaranteed minimum income benefits and guaranteed payout annuity floor benefits. The statutory reserves for these totaled $2.3 million and $2.0 million at December 31, 2004 and 2003, respectively. The GAAP reserves for these totaled $1.6 million and $0.4 million at December 31, 2004 and 2003, respectively.
Deferred policy acquisition costs (variable annuities)................... $ 283.0 $ 286.0 $ 289.3 Deferred policy acquisition costs (variable universal life).............. 325.2 326.4 327.0 Guaranteed minimum death benefit liability (variable annuities).......... 12.1 9.1 7.1
1 AAA/AA/A............. $ 8,668.9 $ 8,821.2 $ 7,123.2 $ 7,442.1 $ 1,545.7 $ 1,379.1 2 BBB.................. 3,733.3 3,350.8 2,493.6 2,160.6 1,239.7 1,190.2 ----------- ----------- ----------- ----------- ----------- ----------- Total investment grade 12,402.2 12,172.0 9,616.8 9,602.7 2,785.4 2,569.3 3 BB................... 814.6 764.9 698.6 635.5 116.0 129.4 4 B.................... 150.9 218.9 97.3 157.8 53.6 61.1 5 CCC and lower........ 68.9 94.6 51.1 53.7 17.8 40.9 6 In or near default... 39.7 22.6 36.1 19.0 3.6 3.6 ----------- ----------- ----------- ----------- ----------- ----------- Total debt securities $13,476.3 $13,273.0 $10,499.9 $10,468.7 $ 2,976.4 $ 2,804.3 =========== =========== =========== =========== =========== ===========
Debt Securities by Type and Credit Quality: As of December 31, 2004 ($ amounts in millions) -------------------------------------------------- Investment Grade Below Investment Grade ------------------------ ------------------------ Fair Value Cost Fair Value Cost ----------- ----------- ----------- -----------
Percentage of total debt securities........................ 92.0% 92.0% 8.0% 8.0% =========== =========== =========== ===========
Percentage of total debt securities...................................... 92.0% 64.3% 27.7% =========== =========== ===========
Below Investment Grade As of December 31, 2004 Debt Securities at Fair Value: --------------------------------------------------------------- ($ amounts in millions) CC or In or Near Total BB B Lower Default ----------- ----------- ----------- ----------- -----------
We manage credit risk through industry and issuer diversification. Maximum exposure to an issuer is defined by quality ratings, with higher quality issuers having larger exposure limits. Our investment approach has been to create a high level of industry diversification. The top five industry holdings as of December 31, 2004 in our debt securities portfolio are banking (4.98%), insurance (3.35%), electrical utilities (3.06%), diversified financial services (2.54%), and publishing, broadcasting, printing and cable (2.25%).
Debt security impairments.............................................. $ (15.5) $ (76.1) $ (114.3) Equity security impairments............................................ (1.5) (4.3) (9.8) Mortgage loan impairments.............................................. -- (4.1) (0.6) Venture capital partnership impairments................................ -- (4.6) (5.1) Affiliate equity security impairments.................................. (12.6) (96.9) -- Other invested asset impairments....................................... (3.3) (16.5) (22.0) Debt and equity securities pledged as collateral impairments........... (16.6) (8.3) (34.9) ----------- ----------- ----------- Impairment losses...................................................... (49.5) (210.8) (186.7) ----------- ----------- ----------- Debt security transaction gains........................................ 39.0 93.7 94.3 Debt security transaction losses....................................... (10.6) (29.0) (45.9) Equity security transaction gains...................................... 17.7 58.8 24.5 Equity security transaction losses..................................... (3.1) (9.6) (22.4) Mortgage loan transaction gains (losses)............................... 0.2 (1.3) 0.2 Venture capital partnership transaction losses......................... -- (9.7) -- Other invested asset transaction gains................................. 5.5 9.4 2.1 ----------- ----------- ----------- Net transaction gains.................................................. 48.7 112.3 52.8 ----------- ----------- ----------- Net realized investment losses......................................... $ (0.8) $ (98.5) $ (133.9) ----------- ----------- -----------
Gross and Net Unrealized As of December 31, 2004 Gains (Losses): ----------------------------------------------------------------------- ($ amounts in millions) Total Outside Closed Block Closed Block ----------------------- ----------------------- ----------------------- Gains Losses Gains Losses Gains Losses ----------- ----------- ----------- ----------- ----------- ----------- Debt Securities Unrealized gains (losses)........... $ 654.5 $ (69.9) $ 195.0 $ (44.8) $ 459.5 $ (25.1) ----------- ----------- ----------- ----------- ----------- ----------- Applicable policyholder dividend obligation (reduction)............ 459.5 (25.1) -- -- 459.5 (25.1) Applicable deferred policy acquisition costs (benefit)....... 100.3 (16.5) 100.3 (16.5) -- -- Applicable deferred income taxes (benefit)................... 33.1 (9.9) 33.1 (9.9) -- -- ----------- ----------- ----------- ----------- ----------- ----------- Offsets to net unrealized gains (losses).................... 592.9 (51.5) 133.4 (26.4) 459.5 (25.1) ----------- ----------- ----------- ----------- ----------- ----------- Unrealized gains (losses) after offsets..................... $ 61.6 $ (18.4) $ 61.6 $ (18.4) $ -- $ -- =========== =========== =========== =========== =========== =========== Net unrealized gains after offsets.. $ 43.2 $ 43.2 $ -- =========== =========== ===========
Investment grade: Unrealized losses................................... $ (30.3) $ (16.1) $ (0.9) $ (13.3) ============= ============= ============= ============= Unrealized losses after offsets..................... $ (13.0) $ (7.1) $ (0.4) $ (5.5) ============= ============= ============= ============= Unrealized losses over 20% of cost.................. $ (6.5) $ -- $ -- $ (6.5) ============= ============= ============= ============= Unrealized losses over 20% of cost after offsets.... $ (2.6) $ -- $ -- $ (2.6) ============= ============= ============= =============
Equity Securities Outside Closed Block Unrealized losses................................... $ (1.5) $ (1.1) $ (0.1) $ (0.3) ============= ============= ============= ============= Unrealized losses after offsets..................... $ (1.0) $ (0.7) $ (0.1) $ (0.2) ============= ============= ============= ============= Unrealized losses over 20% of cost.................. $ (1.4) $ (1.1) $ (0.1) $ (0.2) ============= ============= ============= ============= Unrealized losses over 20% of cost after offsets.... $ (0.8) $ (0.7) $ (0.1) $ (0.1) ============= ============= ============= =============
For debt securities outside of the closed block with gross unrealized losses, 68.0% of the unrealized losses after offsets pertains to investment grade securities and 32.0% of the unrealized losses after offsets pertains to below investment grade securities at December 31, 2004.
Duration of Gross Unrealized Losses On As of December 31, 2004 General Account Securities: ---------------------------------------------------- ($ amounts in millions) 0 - 6 6 - 12 Over 12 Total Months Months Months ------------ ------------ ------------ ------------ Debt Securities Inside Closed Block Total fair value....................................... $ 1,035.8 $ 646.5 $ 42.7 $ 346.6 Total amortized cost.................................... 1,060.9 655.2 43.5 362.2 ------------ ------------ ------------ ------------ Unrealized losses....................................... $ (25.1) $ (8.7) $ (0.8) $ (15.6) ============ ============ ============ ============ Unrealized losses after offsets......................... $ -- $ -- $ -- $ -- ============ ============ ============ ============ Unrealized losses over 20% of cost...................... $ (3.8) $ (0.1) $ -- $ (3.7) ============ ============ ============ ============ Unrealized losses over 20% of cost after offsets........ $ -- $ -- $ -- $ -- ============ ============ ============ ============
Below investment grade: Unrealized losses....................................... $ (6.5) $ (1.1) $ -- $ (5.4) ============ ============ ============ ============ Unrealized losses after offsets......................... $ -- $ -- $ -- $ -- ============ ============ ============ ============ Unrealized losses over 20% of cost...................... $ (3.7) $ -- $ -- $ (3.7) ============ ============ ============ ============ Unrealized losses over 20% of cost after offsets........ $ -- $ -- $ -- $ -- ============ ============ ============ ============
Equity Securities Inside Closed Block Unrealized losses....................................... $ (1.8) $ (1.1) $ (0.1) $ (0.6) ============ ============ ============ ============ Unrealized losses after offsets......................... $ -- $ -- $ -- $ -- ============ ============ ============ ============ Unrealized losses over 20% of cost...................... $ (0.5) $ (0.1) $ -- $ (0.4) ============ ============ ============ ============ Unrealized losses over 20% of cost after offsets........ $ -- $ -- $ -- $ -- ============ ============ ============ ============
As of December 31, 2004 and 2003, we owned 16.5% of the outstanding shares of Aberdeen, which we sold to third parties on January 14, 2005 for net proceeds of $70.4 million. We also owned a $27.5 million convertible subordinated note issued by Aberdeen, which was repaid in full on November 19, 2004. These transactions completed our disposition of our direct financial interests in Aberdeen. See Notes 1 and 5 to our consolidated financial statements in this Form 10-K for more information related to our investments in Aberdeen.
Our investment in Hilb Rogal & Hobbs, or HRH, a Virginia-based property and casualty insurance and employee benefit products distributor, includes primarily common stock. See Notes 5 and 6 to our consolidated financial statements in this Form 10-K for detailed information regarding our investment in HRH.
Cash from continuing operations.............. $ 59.1 $ 397.6 $ 323.5 $ (338.5) $ 74.1 Cash from (for) discontinued operations...... 14.9 (36.5) (59.1) 51.4 22.6 Cash from (for) continuing operations investing activities....................... 133.9 (1,139.2) (2,506.1) 1,273.1 1,366.9 Cash from (for) discontinued operations investing activities....................... 6.5 (4.4) 37.3 10.9 (41.7) Cash from (for) financing activities......... (227.3) 119.9 2,491.6 (347.2) (2,371.7)
Cash from continuing operations decreased $338.5 million, or 85%, in 2004 from 2003, primarily due to higher benefits paid, which are funded through investing activities. Benefit payments were higher in 2004 due primarily to scheduled surrenders and withdrawals of $184.2 million related to a portion of a group of large corporate-owned policies and higher surrenders for an old run-off block of corporate-owned life insurance and for participating life insurance.
Cash from financing activities decreased $347.2 million, or 289%, in 2004 from 2003, due to reductions in policyholder deposit fund deposits of $416.9 million in 2004 compared to 2003. This decrease was partially offset by net proceeds from borrowings in 2004 of $41.4 million. See Note 6 of to consolidated financial statements in this Form 10-K for more information on financing activities.
For 2003, cash from continuing operations increased $74.1 million over 2002, due primarily to higher investment income collected and lower operating expenses paid, partially offset by lower premiums collected.
For 2003, cash from financing activities decreased $2,371.7 million from 2002, due primarily to lower policyholder deposit fund receipts and lower net proceeds from collateralized obligations (discussed above), partially offset by treasury stock purchases in 2002 that were not continued in 2003.
Summary Cash Flows: Year Ended December 31, Changes ($ amounts in millions) ------------------------------------ ----------------------- 2004 2003 2002 2004/03 2003/02 ----------- ----------- ----------- ----------- -----------
Cash from operating activities............... $ 61.2 $ 33.2 $ 61.3 $ 28.0 $ (28.1) Cash for investing activities................ (8.0) (25.7) (372.0) 17.7 346.3 Cash (for) from financing activities......... (15.0) (15.1) 136.1 0.1 (151.2)
Cash for investing activities decreased $17.7 million in 2004 from 2003, primarily due to a decrease in subsidiary purchases and advances to subsidiaries in 2004.
Cash from financing activities decreased $151.2 million in 2003 from 2002, due to the proceeds from the issuance of stock purchase contracts and equity units in 2002 for an aggregate of $ 283.0 million, partially offset by common stock repurchases of $131.1 million. Those financing activities did not recur in 2003.
Our primary uses of liquidity include dividend payments on our common stock, loans or contributions to our subsidiaries, debt service and general corporate expenses.
Our primary sources of liquidity have been dividends from Phoenix Life and interest income received from Phoenix Investment Partners. Under New York Insurance Law, Phoenix Life can pay stockholder dividends to the holding company in any calendar year without prior approval from the New York Superintendent of Insurance in the amount of the lesser of 10% of Phoenix Life's surplus to policyholders as of the immediately preceding calendar year or Phoenix Life's statutory net gain from operations for the immediately preceding calendar year, not including realized capital gains. Phoenix Life paid a dividend of $69.7 million in April 2004 and is able to pay a dividend of $35.1 million in 2005 under this provision. See Note 15 to our consolidated financial statements in this Form 10-K for more information on Phoenix Life statutory financial information and regulatory matters.
Phoenix Investment Partners pays interest to the holding company on its debt from the holding company. The holding company does not expect to receive dividends from Phoenix Investment Partners in the near term because this subsidiary will likely use a substantial portion of its cash flows from operations to pay for additional ownership in its existing majority-owned subsidiaries and to repay intercompany debt, including debt to the holding company and interest on debt.
On November 22, 2004, we entered into a new $150.0 million three-year, unsecured senior revolving credit facility to replace the prior $150.0 million credit facility that was to expire on December 20, 2004. The prior facility consisted of two tranches: a $112.5 million, 364-day revolving credit facility and a $37.5 million three-year revolving credit facility. Potential borrowers on the new credit line are The Phoenix Companies, Inc., Phoenix Investment Partners and Phoenix Life. We unconditionally guarantee any loans under this new facility to Phoenix Life and Phoenix Investment Partners. Base rate loans will bear interest at the greater of Wachovia Bank, National Association's prime commercial rate or the federal funds rate plus 0.50%. Eurodollar rate loans will bear interest at LIBOR plus an applicable percentage based on our Standard & Poor's and Moody's ratings. The $25 million drawn by Phoenix Investment Partners on the prior facility was refinanced using this new facility at the Eurodollar rate.
The new credit facility contains covenants that require us at all times to maintain consolidated stockholders' equity, in accordance with GAAP, excluding the accounting effects of FIN 46(R), of $1,648.4 million, plus 50% of positive quarterly net income and 100% of equity issuances and a maximum consolidated debt-to-capital ratio of 30% and that limit consolidated indebtedness, subject to certain exceptions, to $750.0 million. In addition, Phoenix Life must maintain a minimum RBC ratio of 250% and a minimum A.M. Best financial strength rating of "A-". The new facility no longer has a fixed charge coverage covenant. Borrowings under the facility are not conditioned on the absence of a material adverse change.
Phoenix Life's current sources of liquidity also include the revolving credit facility under which Phoenix Life has direct borrowing rights, discussed above, subject to our unconditional guarantee. Since the demutualization, Phoenix Life's access to the cash flows generated by the closed block assets has been restricted to funding the closed block.
Annuity Actuarial Reserves and Deposit Liabilities As of December 31, Withdrawal Characteristics: 2004 2003 ($ amounts in millions) ----------------------- ----------------------- Amount(1) Percent Amount(1) Percent ----------- ----------- ----------- -----------
Individual life insurance policies, other than term life insurance policies, increase in cash values over their lives. Policyholders have the right to borrow an amount generally up to the cash value of their policies at any time. As of December 31, 2004, our Life Companies had approximately $11.7 billion in cash values with respect to which policyholders had rights to take policy loans. The majority of cash values eligible for policy loans are at variable interest rates that are reset annually on the policy anniversary. Policy loans at December 31, 2004 were $2.2 billion.
On December 15, 2004, we repurchased $144.8 million of the previously $175.0 million outstanding principal amount of our 6.95% surplus notes scheduled to mature in 2006, and recognized a loss of $10.4 million in connection with the transaction. To finance the tender, we issued $175.0 million principal of 7.15% surplus notes with a scheduled maturity of 30 years for proceeds of $171.6 million, net of discount and issue costs.
On April 30, 2004, Phoenix Life paid a dividend of $69.7 million to The Phoenix Companies, Inc., as Phoenix Life's sole shareholder. Under New York Insurance Law, Phoenix Life can pay dividends to The Phoenix Companies in any calendar year without the approval from the New York Superintendent of Insurance in the amount of the lesser of 10% of Phoenix Life's surplus to policyholders as of the immediately preceding calendar year or Phoenix Life's statutory net gain from operations for the immediately preceding calendar year, not including realized capital gains. Phoenix Life's statutory gain from operations was $35.1 million for the year ended December 31, 2004, net of a $16.0 million tax payment related to the forgiveness of debt on a restructured investment, $10.2 million in after-tax restructuring charges primarily associated with the sale of our retail affiliated broker-dealer operations and the outsourcing of our information technology infrastructure, and $8.3 in after-tax costs related to the surplus notes tender and issuance transactions.
Phoenix Investment Partners' liquidity requirements are primarily to fund operating expenses and pay its debt and interest obligations. Phoenix Investment Partners also would require liquidity to fund the costs of any payments for additional ownership in existing majority-owned subsidiaries, as well as any potential acquisitions. Historically, Phoenix Investment Partners' principal source of liquidity has been cash flow from operations. We expect that cash flow from operations will continue to be its principal source of working capital. Its current sources of liquidity also include a revolving credit facility under which it has direct borrowing rights subject to our unconditional guarantee. We believe that Phoenix Investment Partners' current and anticipated sources of liquidity are adequate to meet its present and anticipated needs. See Notes 4 and 6 to our consolidated financial statements in this Form 10-K for further details on our financing activities.
Mortgage loans decreased $76.2 million, or 27%, in 2004 from December 31, 2003, due to continued paydowns of this portfolio, which is in runoff.
Deferred policy acquisition costs increased $62.2 million, or 5%, in 2004 from December 31, 2003, due primarily to policy acquisition costs deferred of $164.7 million plus $7.7 million for the effect of unrealized investment losses included in other comprehensive income, less amortization of $110.2 million. See Note 3 to our consolidated financial statements in this Form 10-K for additional information.
Composition of Deferred Acquisition Costs by Product: As of December 31, ($ amounts in millions) ---------------------------- 2004 2003 Change ------------- ------------- -------------
Variable universal life........................................... $ 332.5 $ 328.7 $ 3.8 Universal life.................................................... 216.0 169.3 46.7 Variable annuities................................................ 275.4 260.3 15.1 Fixed annuities................................................... 46.0 45.2 0.8 Participating life................................................ 523.0 536.7 (13.7) Other............................................................. 37.0 27.5 9.5 ------------- ------------- ------------- Total deferred acquisition costs.................................. $ 1,429.9 $ 1,367.7 $ 62.2 ============= ============= =============
Indebtedness increased $51.8 million, or 8%, in 2004 from December 31, 2003, primarily due to the issuance of surplus notes of $175.0 million, due in 2034, and borrowings of $25.0 million on our bank credit facility. These increases were offset by the repurchase of $144.8 million of our surplus notes, which were due in 2006. See Note 6 to our consolidated financial statements in this Form 10-K for additional information.
Non-recourse collateralized obligations decreased $116.8 million, or 8%, in 2004 from December 31, 2003, due to distributions to investors in non-recourse collateralized obligations and a decrease in the fair value of non-recourse derivative cash flow hedges as a result of higher interest rates. See Note 7 to our consolidated financial statements in this Form 10-K for additional information.
(3) Other purchase liabilities relate to open purchase orders, required pension funding and other contractual obligations.
(5) Policyholder contractual obligations represent estimated benefit payments, net of reinsurance and offset by expected future deposits and premiums on in-force contracts, from life insurance and annuity contracts issued by our life insurance subsidiaries. Future obligations are based on our estimate of future investment earnings, mortality, surrenders and applicable policyholder dividends. Included in the amounts above are policyholder dividends of $8.5 billion, generated by estimated favorable future investment and mortality, in excess of guaranteed amounts for our closed block. Actual obligations in any single year, or ultimate total obligations, may materially vary from these estimates as actual experience emerges. Because future obligations anticipate future investment earnings, total policyholder contractual obligations exceed policyholder liabilities on our balance sheet (policy liabilities and accruals: $13,132.3 million; and policy deposit funds: $3,492.4 million) at December 31, 2004.
Policyholder contractual obligations also include separate account liabilities, which are contractual obligations of the separate account assets established under applicable state insurance laws and are legally insulated from our general account assets.
(7) Our standby letters of credit automatically renew on an annual basis.
(8) Other commercial commitments relate to venture capital partnerships ($136.5 million) and private placements ($46.1 million). The venture capital commitments can be drawn down by private equity funds as necessary to fund their portfolio investments through the end of the funding period as stated in each agreement. The amount collectively drawn down by the private equity funds in our portfolio during the year ended December 31, 2004 was $59.2 million. The obligations related to private placements are due to be funded by March 15, 2005.
Under the terms of purchase agreements related to certain recent business combinations, we are subject to certain contractual obligations and commitments as follows:
In January 2004 and August 2003, certain members of Kayne Anderson Rudnick accelerated their noncontrolling interest arrangements. The purchase price for their interests totaled $1.7 million and $4.5 million, respectively, which was recorded as additional purchase price by Phoenix Investment Partners and allocated to goodwill and definite-lived intangible assets.
In 2003, we acquired the remaining interest in PFG, the holding company for our private placement operation, not already owned by us for initial consideration of $16.7 million. Under the terms of the purchase agreement, we may be obligated to pay additional consideration of up to $86.5 million to the selling shareholders, including $10.0 million during 2005 through 2007 based on certain financial performance targets being met, and the balance in 2008 based on the appraised value of PFG as of December 31, 2007. During the year ended December 31, 2004, we paid $3.0 million under this obligation.
We have accounted for our acquisition of the remaining interest in PFG as a step-purchase acquisition. Accordingly, we recorded a definite-lived intangible asset of $9.8 million related to the present value of future profits acquired and a related deferred tax liability of $3.4 million. The present value of future profits intangible asset will be amortized over the remaining estimated life of the underlying insurance in force acquired, estimated to be 40 years. The remaining acquisition price plus transaction costs of $7.6 million has been assigned to goodwill. We have not presented pro forma information as if PFG had been acquired at the beginning of January 2003, as it is not material to our financial statements. See Note 3 to our consolidated financial statements in this Form 10-K for more information.
We provide our employees with postemployment benefits that include retirement benefits, through pension and savings plans, and other benefits, including health care and life insurance. Employee benefit expense related to these plans totaled $16.5 million, $33.1 million and $24.9 million for 2004, 2003 and 2002, respectively.
As of May 31, 2004 we revalued our employee benefit assets and liabilities in connection with the sale of our retail affiliated broker-dealer operations. As a result of the revaluation, we recognized a net curtailment gain of $6.8 million ($4.4 million after taxes). In addition, as of September 30, 2004 we revalued our employee benefit assets and liabilities in connection with employee terminations associated with the information technology services agreement with EDS. As a result of this revaluation, we recognized an additional net curtailment gain of $1.6 million ($1.1 million after taxes) for the year ended December 31, 2004.
Plan assets, end of year.................................... $ 396.4 $ 368.9 $ -- $ -- Projected benefit obligation, end of year................... (499.0) (460.6) (134.6) (124.8) ----------- ----------- ----------- ----------- Plan assets less than projected benefit obligations, end of year............................................... $ (102.6) $ (91.7) $ (134.6) $ (124.8) =========== =========== =========== ===========
We have entered into agreements with certain key executives of the Company that will, in certain circumstances, provide separation benefits upon the termination of the executive's employment by the Company for reasons other than death, disability, cause or retirement, or by the executive for "good reason," as defined in the agreements. For most of these executives, the agreements provide this protection only if the termination occurs following (or is effectively connected with) the occurrence of a change of control, as defined in the agreements. As soon as reasonably possible upon a change in control, as so defined, we are required to make an irrevocable contribution to a trust in an amount sufficient to pay benefits due under these agreements.
As of December 31, 2004, we did not have any significant off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K. See Note 8 to our consolidated financial statements in this Form 10-K for more information on variable interest entities.
special non-insurance reserve established in connection with the issuance of $175 million of surplus notes in 2004.
Section 1322 of New York Insurance Law requires that New York life insurers report their RBC. RBC is based on a formula calculated by applying factors to various asset, premium and statutory reserve items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk and business risk. Section 1322 gives the New York State Insurance Department explicit regulatory authority to require various actions by, or take various actions against, insurers whose Total Adjusted Capital (capital and surplus plus AVR plus one-half the policyholder dividend liability) does not exceed certain RBC levels. Each of our other life insurance subsidiaries is also subject to these same RBC requirements.
Authorized Control Level - results when Total Adjusted Capital falls below 50% of Company Action Level where in addition to the above, the insurance regulators are permitted but not required to place the company under regulatory control; and
Mandatory Control Level - results when Total Adjusted Capital falls below 35% of Company Action Level where insurance regulators are required to place the company under regulatory control.
Our broker-dealer subsidiaries are each subject to the net capital requirements imposed on registered broker-dealers by the Securities Exchange Act of 1934. Each is also required to maintain a ratio of aggregate indebtedness to net capital that does not exceed 15:1. At December 31, 2004 the largest of these subsidiaries had net capital of approximately $11.4 million, which is $10.7 million in excess of its required minimum net capital of $0.7 million. The ratio of aggregate indebtedness to net capital for that subsidiary was 1:1. The ratios of aggregate indebtedness to net capital for each of our other broker-dealer subsidiaries were also below the regulatory ratio at December 31, 2004 and their respective net capital each exceeded the applicable regulatory minimum.
State Farm currently owns of record more than five percent of our parent's outstanding common stock. During the years ended December 31, 2004 and 2003, our subsidiaries incurred total compensation of $32.4 million and $25.8 million, respectively, to entities which were either subsidiaries of State Farm or owned by State Farm employees, for the sale of our insurance and annuity products. During the years ended December 31, 2004 and 2003, we made payments of $32.7 million and $24.6 million, respectively, to State Farm entities for this compensation.