Back to GetFilings.com
==================================================================================================================================
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission file number 333-55268
THE PHOENIX COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0493340
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One American Row, Hartford, Connecticut 06102-5056
(860) 403-5000
(Address, including zip code, and telephone number,
including area code, of principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes X. No__.
Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
Yes X. No__.
On July 31, 2003, the registrant had 94,254,872 shares of common stock outstanding.
==============================================================================================================
1
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheet at June 30, 2003 (unaudited) and December 31, 2002................ 3
Consolidated Statement of Income and Comprehensive Income for the three and six months
ended June 30, 2003 and 2002 (unaudited)................................................... 4
Consolidated Statement of Cash Flows for the three and six months ended June 30, 2003
and 2002 (unaudited)....................................................................... 5
Consolidated Statement of Changes in Stockholders' Equity for the three and six months
ended June 30, 2003 and 2002 (unaudited)................................................... 6
Notes to Consolidated Financial Statements for the three and six months ended June 30,
2003 and 2002 (unaudited).................................................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 60
Item 4. Controls and Procedures........................................................................ 63
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 64
Item 2. Changes in Securities and Use of Proceeds...................................................... 65
Item 3. Defaults Upon Senior Securities................................................................ 65
Item 4. Submission of Matters to a Vote of Security Holders............................................ 65
Item 5. Other Information.............................................................................. 66
Item 6. Exhibits and Reports on Form 8-K............................................................... 66
Signature................................................................................................. 68
2
PART I.
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
THE PHOENIX COMPANIES, INC.
Consolidated Balance Sheet
($ amounts in millions, except per share data)
June 30, 2003 (unaudited) and December 31, 2002
2003 2002
-------------- --------------
ASSETS:
Available-for-sale debt securities, at fair value........................... $ 13,200.4 $ 11,894.1
Equity securities, at fair value............................................ 341.5 391.2
Mortgage loans, at unpaid principal balances................................ 353.5 468.8
Venture capital partnerships, at equity in net assets....................... 237.1 228.6
Affiliate equity securities, at cost plus equity in undistributed earnings.. 42.5 134.7
Policy loans, at unpaid principal balances.................................. 2,212.2 2,195.9
Other investments........................................................... 418.2 398.9
-------------- --------------
Total investments........................................................... 16,805.4 15,712.2
Cash and cash equivalents................................................... 654.3 1,058.5
Accrued investment income................................................... 217.5 192.3
Receivables................................................................. 195.3 217.3
Deferred policy acquisition costs........................................... 1,248.0 1,234.1
Deferred income taxes....................................................... 45.8 41.4
Intangible assets with definite lives....................................... 285.6 291.7
Goodwill and other indefinite-lived intangible assets....................... 464.2 456.0
Other general account assets................................................ 217.2 239.5
Separate account and investment trust assets................................ 6,643.2 5,793.1
-------------- --------------
Total assets................................................................ $ 26,776.5 $ 25,236.1
============== ==============
LIABILITIES:
Policy liabilities and accruals............................................. $ 13,043.6 $ 12,680.0
Policyholder deposit funds.................................................. 3,744.5 3,395.7
Stock purchase contracts.................................................... 123.9 137.6
Indebtedness................................................................ 646.4 644.3
Other general account liabilities........................................... 544.1 542.9
Separate account and investment trust liabilities........................... 6,643.2 5,793.1
-------------- --------------
Total liabilities........................................................... 24,745.7 23,193.6
-------------- --------------
MINORITY INTEREST:
Minority interest in net assets of consolidated subsidiaries................ 4.6 10.8
-------------- --------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 106,376,237 and 106,374,510 shares issued..... 1.0 1.0
Additional paid-in capital.................................................. 2,429.6 2,424.4
Deferred compensation on restricted stock units............................. (4.5) --
Accumulated deficit......................................................... (354.0) (292.6)
Accumulated other comprehensive income...................................... 147.3 94.6
Treasury stock, at cost: 12,172,563 and 12,330,000 shares................... (193.2) (195.7)
-------------- --------------
Total stockholders' equity.................................................. 2,026.2 2,031.7
-------------- --------------
Total liabilities, minority interest and stockholders' equity............... $ 26,776.5 $ 25,236.1
============== ==============
The accompanying notes are an integral part of these financial statements.
3
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Income and Comprehensive Income
($ amounts in millions, except per share data)
Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
Three Months Six Months
------------------------- ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
REVENUES:
Premiums............................................... $ 248.5 $ 259.4 $ 494.6 $ 516.8
Insurance and investment product fees.................. 133.8 145.9 266.7 286.2
Investment income, net of expenses..................... 263.8 215.7 540.5 446.9
Net realized investment losses......................... (104.6) (28.6) (116.9) (63.6)
----------- ----------- ----------- -----------
Total revenues......................................... 541.5 592.4 1,184.9 1,186.3
----------- ----------- ----------- -----------
BENEFITS AND EXPENSES:
Policy benefits, excluding policyholder dividends...... 348.4 338.9 699.2 672.8
Policyholder dividends................................. 94.2 107.5 210.7 181.7
Policy acquisition cost amortization................... 25.9 11.4 53.9 0.5
Intangible asset amortization.......................... 8.2 7.8 16.6 15.9
Interest expense....................................... 9.9 7.7 19.7 15.4
Other operating expenses............................... 136.5 179.7 263.0 316.6
----------- ----------- ----------- -----------
Total benefits and expenses............................ 623.1 653.0 1,263.1 1,202.9
----------- ----------- ----------- -----------
Loss before income taxes and minority interest......... (81.6) (60.6) (78.2) (16.6)
Applicable income tax benefit.......................... (34.4) (26.7) (37.0) (14.4)
----------- ----------- ----------- -----------
Loss before minority interest.......................... (47.2) (33.9) (41.2) (2.2)
Minority interest in net income of
consolidated subsidiaries............................ 2.3 3.3 5.1 6.1
----------- ----------- ----------- -----------
Loss before cumulative effect of
accounting change.................................... (49.5) (37.2) (46.3) (8.3)
Cumulative effect of accounting change for
goodwill and other intangible assets................. -- -- -- (130.3)
----------- ----------- ----------- -----------
Net loss .............................................. $ (49.5) $ (37.2) $ (46.3) $ (138.6)
=========== =========== =========== ===========
BASIC AND DILUTED EARNINGS PER SHARE:
Basic and diluted weighted average common shares
outstanding (in thousands)........................... 94,150 99,497 94,099 100,346
=========== =========== =========== ===========
Basic and diluted loss before cumulative
effect of accounting change per share................ $ (.53) $ (.37) $ (.49) $ (.08)
Basic and diluted net loss per share................... $ (.53) $ (.37) $ (.49) $ (1.38)
=========== =========== =========== ===========
COMPREHENSIVE INCOME:
Net loss............................................... $ (49.5) $ (37.2) $ (46.3) $ (138.6)
----------- ----------- ----------- -----------
Net unrealized investment gains........................ 70.1 72.6 40.0 44.0
Net unrealized foreign currency translation adjustment. 5.8 8.5 4.8 (5.1)
Net unrealized derivative instruments gains (losses)... (3.2) 1.4 7.9 1.3
----------- ----------- ----------- -----------
Other comprehensive income............................. 72.7 82.5 52.7 40.2
----------- ----------- ----------- -----------
Comprehensive income (loss)............................ $ 23.2 $ 45.3 $ 6.4 $ (98.4)
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
4
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Cash Flows
($ amounts in millions)
Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
Three Months Six Months
------------------------- ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
OPERATING ACTIVITIES:
Premiums collected...................................... $ 236.5 $ 246.0 $ 485.5 $ 509.0
Insurance and investment product fees collected......... 135.7 153.8 274.4 295.6
Investment income collected............................. 260.2 242.7 489.0 446.8
Policy benefits paid, excluding policyholder
dividends............................................. (257.8) (260.7) (525.5) (514.3)
Policyholder dividends paid............................. (93.1) (91.0) (187.0) (182.1)
Policy acquisition costs paid........................... (44.0) (62.1) (100.6) (112.6)
Interest expense paid................................... (12.4) (11.3) (17.9) (12.1)
Other operating expenses paid........................... (123.2) (120.2) (282.0) (308.5)
Income taxes refunded (paid)............................ (6.2) (14.6) 9.6 (0.3)
----------- ----------- ----------- -----------
Cash from continuing operations......................... 95.7 82.6 145.5 121.5
Discontinued operations, net............................ (27.9) (48.9) (45.0) (74.2)
----------- ----------- ----------- -----------
Cash from operating activities.......................... 67.8 33.7 100.5 47.3
----------- ----------- ----------- -----------
INVESTING ACTIVITIES:
Investment purchases.................................... (1,284.3) (1,276.5) (3,110.1) (2,293.7)
Investment sales, repayments and maturities............. 1,217.5 865.7 2,297.6 1,419.7
Subsidiary purchases.................................... (19.2) (23.6) (19.2) (134.4)
Premises and equipment additions........................ (3.7) (3.5) (5.8) (7.8)
Discontinued operations, net............................ -- 10.1 (6.7) 35.5
----------- ----------- ----------- -----------
Cash for investing activities........................... (89.7) (427.8) (844.2) (980.7)
----------- ----------- ----------- -----------
FINANCING ACTIVITIES:
Policyholder deposit fund receipts, net ................ 65.5 526.6 348.8 856.8
Common stock purchases ................................. -- (35.6) -- (68.5)
Minority interest distributions......................... (2.3) 1.4 (9.3) (7.7)
----------- ----------- ----------- -----------
Cash from financing activities.......................... 63.2 492.4 339.5 780.6
----------- ----------- ----------- -----------
Change in cash and cash equivalents..................... 41.3 98.3 (404.2) (152.8)
Cash and cash equivalents, beginning of period.......... 613.0 564.4 1,058.5 815.5
----------- ----------- ----------- -----------
Cash and cash equivalents, end of period................ $ 654.3 $ 662.7 $ 654.3 $ 662.7
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
5
THE PHOENIX COMPANIES, INC.
Consolidated Statement of Changes in Stockholders' Equity
($ amounts in millions, except share and per share data)
Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
Three Months Six Months
------------------------- ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
COMMON STOCK AND
ADDITIONAL PAID-IN CAPITAL:
Additional common shares issued in demutualization
(654, 4,503, 1,727 and 5,544 shares)................. $ -- $ -- $ -- $ --
Restricted stock units awarded as compensation
(255,102 and 649,839 units).......................... 2.0 -- 5.0 --
Restricted stock units awarded as payment of
liabilities (161,768 units).......................... 1.5 -- 1.5 --
Excess of cost over fair value of common shares
contributed to employee savings plan................. (1.0) -- (1.3) --
DEFERRED COMPENSATION ON
RESTRICTED STOCK UNITS:
Compensation deferred on restricted stock units awarded (2.0) -- (5.0) --
Compensation expense recognized........................ 0.3 -- 0.5 --
RETAINED EARNINGS
(ACCUMULATED DEFICIT):
Net loss............................................... (49.5) (37.2) (46.3) (138.6)
Common stock dividend declared ($0.16 per share)....... (15.1) (15.8) (15.1) (15.8)
ACCUMULATED OTHER
COMPREHENSIVE INCOME:
Other comprehensive income............................. 72.7 82.5 52.7 40.2
TREASURY STOCK:
Common shares purchased (2,056,400
and 3,915,100 shares)................................ -- (36.8) -- (69.9)
Common shares contributed to employee savings
plan (115,104 and 157,437 shares).................... 1.8 -- 2.5 --
----------- ----------- ----------- -----------
Change in stockholders' equity......................... 10.7 (7.3) (5.5) (184.1)
Stockholders' equity, beginning of period.............. 2,015.5 2,218.9 2,031.7 2,395.7
----------- ----------- ----------- -----------
Stockholders' equity, end of period.................... $ 2,026.2 $ 2,211.6 $ 2,026.2 $ 2,211.6
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
6
THE PHOENIX COMPANIES, INC.
Notes to Consolidated Financial Statements
Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
1. Organization and Operations
Our consolidated financial statements include the accounts of The Phoenix Companies, Inc. and its
subsidiaries. The Phoenix Companies, Inc. is a holding company and our operations are conducted through
subsidiaries, the principal ones of which are Phoenix Life Insurance Company (Phoenix Life) and Phoenix
Investment Partners, Ltd. (PXP). We have eliminated significant intercompany accounts and transactions in
consolidating these financial statements. Also, we have reclassified certain amounts for 2002 to conform with
2003 presentations.
We have prepared these financial statements in accordance with generally accepted accounting principles
(GAAP). In preparing these financial statements in conformity with GAAP, we are required to make estimates and
assumptions that affect the reported amounts of assets and liabilities at reporting dates and the reported
amounts of revenues and expenses during the reporting periods. Actual results will differ from these estimates
and assumptions. We employ significant estimates and assumptions in the determination of deferred policy
acquisition costs; policyholder liabilities and accruals; the valuation of intangible assets; the valuation of
investments in debt and equity securities and venture capital partnerships; pension and other post-employment
benefits liabilities; and accruals for contingent liabilities. Our significant accounting policies are
presented in the notes to our consolidated financial statements in our 2002 Annual Report on Form 10-K.
Our interim financial statements do not include all of the disclosures required by GAAP for annual financial
statements. In our opinion, we have included all adjustments, consisting of normal, recurring adjustments,
considered necessary for a fair statement of the results for the interim periods. Operating results for the
three and six month periods in 2003 are not necessarily indicative of the results that may be expected for the
year 2003. These unaudited consolidated financial statements should be read in conjunction with our
consolidated financial statements in our 2002 Annual Report on Form 10-K.
In December 1999, we began the process of reorganizing and demutualizing our then principal operating company,
Phoenix Home Life Mutual Insurance Company. We completed the process in June 2001, when all policyholder
membership interests in this mutual company were extinguished and eligible policyholders of the mutual company
received shares of common stock of The Phoenix Companies, Inc., together with cash and policy credits, as
compensation. To protect the future dividends of these policyholders, we also established a closed block for
their existing policies, which we describe in Note 3. Concurrent with the demutualization, we sold additional
shares of common stock of The Phoenix Companies, Inc. to the public.
Accounting Changes
Goodwill and Other Intangible Assets: In the first quarter 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. For more information, see Note 4 to our consolidated financial statements in our
2002 Annual Report on Form 10-K.
Variable Interest Entities: In the third quarter of 2003, we will be adopting a new standard interpretation
for the consolidation of variable interest entities. Variable interest entities are required to be
consolidated by their primary beneficiaries if they do not effectively disperse risks among all parties
involved. The primary beneficiary of a variable interest entity is the party that absorbs a majority of the
entity's expected losses, receives a majority of its expected residual returns, or both, as a result of
holding variable interests.
7
We are involved with various entities in the normal course of business that may be deemed to be variable
interest entities and, as a result, we may hold interests in those entities. We serve as the investment
advisor to eight collateralized bond obligations (CBOs) that were motivated by bond market arbitrage
opportunities. We currently consolidate three of these CBOs. The eight CBOs have aggregate assets of
$3 billion that are invested in a variety of fixed income securities and purchased from third parties. The
CBOs reside in bankruptcy remote special purpose entities in which we neither provide recourse or guarantees.
Our exposure under the new standard stems from our debt and equity investments in these CBOs in which
affiliates earn advisory fees to manage the CBO portfolios. Our maximum exposure to loss with respect to the
CBOs was $86.1 million at year-end 2002 and $75.7 million at June 30, 2003.
We are still evaluating the effect of the adoption on our consolidation practices, however, we currently
believe that adoption of this standard interpretation will not be material to our consolidated financial
statements. For more information, see Note 8 to our consolidated financial statements in our 2002 Annual
Report on Form 10-K.
Stock-based Compensation: A new standard was issued in December 2002 which amends an existing standard on
accounting for stock-based compensation. The new standard provides methods of transition for a voluntary
change to fair value accounting for stock-based compensation. We adopted fair value accounting for stock-based
compensation in 2003 using the prospective method of transition provided by the new standard, which results in
expense recognition for stock options awarded after December 31, 2002. For more information, see Note 8 to
this Form 10-Q.
Business combinations
On May 1, 2003, we acquired the remaining interest in PFG Holdings, Inc. not already owned by us for initial
consideration of $16.7 million. Under the terms of the purchase agreement, we may be obligated to pay
additional consideration of up to $89.0 million to the selling shareholders, including $13.0 million during
the years 2004 through 2007 based on certain financial performance targets being met, and the balance in 2008
based on the appraised value of PFG Holdings as of December 31, 2007.
We have accounted for our acquisition of the remaining interest in PFG Holdings as a step-purchase.
Accordingly, we recorded a definite-lived intangible asset of $9.8 million related to the present value of
future profits (PVFP) acquired and a related deferred tax liability of $3.4 million. The PVFP intangible asset
will be amortized over the remaining estimated life of the underlying insurance inforce acquired, estimated to
be 40 years. The remaining acquisition price of $7.6 million has been assigned to goodwill. We have not
presented pro forma information as if PFG Holdings had been acquired at the beginning of January 2003, as it
is not material to our financial statements.
On June 30, 2003, we purchased the remaining interest in Capital West Asset Management, LLC not already owned
by us for $1.1 million. We have accounted for our acquisition of the remaining interest as a step-purchase and
we recorded $0.7 million for definite-lived investment management contracts and the remaining acquisition
price of $0.4 million has been assigned to goodwill. We have not presented pro forma information as if Capital
West Asset Management, LLC had been acquired at the beginning of January 2003, as it is not material to our
financial statements.
8
We acquired a 60% interest in Kayne Anderson Rudnick Investment Management, LLC (Kayne Anderson Rudnick) for
$102.4 million on January 29, 2002; management of the company retained the remaining ownership interest. In
addition to the initial cost of the purchase, we may make a subsequent payment of as much as $65.0 million in
2004 based upon management fee revenue for the purchased business through the end of 2003. At June 30, 2003,
we estimate this payment to be in the range of $25.0 million to $35.0 million. We are also obligated to
purchase an additional 15% interest in the company by 2007. We allocated $0.3 million of the purchase price to
tangible net assets acquired and $102.1 million to intangible assets ($58.3 million to investment management
contracts and $43.8 million to goodwill). Kayne Anderson Rudnick's results of operations for the period from
January 30, 2002 through March 31, 2002 are included in our results of operations for the first quarter of
2002. We have not presented pro forma information as if Kayne Anderson Rudnick had been acquired at the
beginning of January 2002, as it is not material to our financial statements.
2. Business Segments
Segment information on assets at June 30, 2003 and year-end 2002 and revenues and income for the three and six
month periods ended June 30, 2003 and 2002 follow ($ amounts in millions):
2003 2002
------------- -------------
Segment Assets
Life and annuity segment........................................................ $ 23,116.4 $ 21,533.7
Asset management segment........................................................ 819.9 844.3
------------- -------------
Operating segment assets........................................................ 23,936.3 22,378.0
Venture capital segment......................................................... 203.8 227.8
Corporate and other segment..................................................... 2,615.6 2,609.5
------------- -------------
Total segment assets............................................................ 26,755.7 25,215.3
Net assets of discontinued operations........................................... 20.8 20.8
------------- -------------
Total assets.................................................................... $ 26,776.5 $ 25,236.1
============= =============
Three Months Six Months
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Segment Revenues
Life and annuity segment.......................... $ 579.1 $ 575.4 $ 1,152.0 $ 1,133.6
Asset management segment.......................... 56.7 70.4 112.3 137.3
Elimination of inter-segment revenues............. (3.2) (4.5) (6.9) (8.9)
------------- ------------- ------------- -------------
Operating segment revenues........................ 632.6 641.3 1,257.4 1,262.0
Venture capital segment........................... 5.8 (29.9) 29.7 (34.9)
Corporate and other segment....................... 7.7 9.6 14.7 22.8
------------- ------------- ------------- -------------
Total segment revenues............................ 646.1 621.0 1,301.8 1,249.9
Net realized investment gains (losses)............ (104.6) (28.6) (116.9) (63.6)
------------- ------------- ------------- -------------
Total revenues.................................... $ 541.5 $ 592.4 $ 1,184.9 $ 1,186.3
============= ============= ============= =============
9
Three Months Six Months
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Segment Income
Life and annuity segment.......................... $ 27.2 $ 27.9 $ 44.6 $ 56.1
Asset management segment.......................... (5.7) (2.6) (11.5) (3.6)
------------- ------------- ------------- -------------
Operating segment pre-tax income.................. 21.5 25.3 33.1 52.5
Venture capital segment........................... 5.8 (29.9) 29.7 (34.9)
Corporate and other segment....................... (12.5) (8.4) (23.9) (14.3)
------------- ------------- ------------- -------------
Total segment income before income taxes.......... 14.8 (13.0) 38.9 3.3
Applicable income taxes........................... 3.3 (8.9) 10.6 (5.4)
------------- ------------- ------------- -------------
Total segment income.............................. 11.5 (4.1) 28.3 8.7
Net realized investment gains (losses),
net of income taxes and other offsets........... (59.2) (10.8) (71.6) (9.1)
Restructuring and early retirement costs,
net of income taxes............................. (1.8) (21.8) (4.3) (21.8)
Deferred acquisition cost adjustment,
net of income taxes............................. -- -- -- 14.4
Other adjustments, net of income taxes............ 0.7
Demutualization related items, net of income taxes -- (0.5) -- (1.2)
Other income, net of income taxes................. -- -- 1.3 --
------------- ------------- ------------- -------------
Loss before cumulative effect of
accounting change............................... $ (49.5) $ (37.2) $ (46.3) $ (8.3)
============= ============= ============= =============
During the three month period ended June 30, 2003, we transferred our equity investment in Aberdeen Asset
Management PLC from our Asset Management segment to the Corporate and Other segment. As a result, we have
re-segmented prior year information accordingly.
3. Life and Annuity Segment
The Life and Annuity segment includes individual life insurance and annuity products and results of Phoenix
Life and certain of its subsidiaries and affiliates (together, our Life Companies), including universal life,
variable universal life, term life and fixed and variable annuities. It also includes the results of our
closed block, which consists primarily of participating whole life products. Segment information on assets as
of June 30, 2003 and year-end 2002 and operating income for the three and six month periods ended June 30,
2003 and 2002 follow ($ amounts in millions):
10
2003 2002
------------- -------------
Life and Annuity Segment Assets
Investments.................................................................. $ 15,624.1 $ 14,480.0
Cash and cash equivalents.................................................... 575.8 924.0
Receivables.................................................................. 246.1 236.4
Deferred policy acquisition costs............................................ 1,248.0 1,234.1
Deferred income taxes........................................................ 286.1 328.2
Intangible assets with definite lives........................................ 9.8 --
Goodwill and other indefinite-lived intangible assets........................ 14.9 6.8
Other general account assets................................................. 166.8 192.5
Separate accounts............................................................ 4,944.8 4,131.7
------------- -------------
Total segment assets......................................................... 23,116.4 21,533.7
------------- -------------
Policy liabilities and accruals.............................................. 12,918.3 12,695.6
Policyholder deposit funds................................................... 3,733.8 3,237.9
Other general account liabilities............................................ 195.2 171.0
Separate accounts............................................................ 4,944.8 4,131.7
Minority interest............................................................ 5.2 1.6
------------- -------------
Total segment liabilities and minority interest.............................. 21,797.3 20,237.8
------------- -------------
Segment net assets........................................................... $ 1,319.1 $ 1,295.9
============= =============
Three Months Six Months
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Life and Annuity Segment Income
Premiums.......................................... $ 248.5 $ 259.4 $ 494.6 $ 516.8
Insurance and investment product fees............. 79.6 78.9 157.9 156.5
Net investment income............................. 251.0 237.1 499.5 460.3
------------- ------------- ------------- -------------
Total segment revenues............................ 579.1 575.4 1,152.0 1,133.6
------------- ------------- ------------- -------------
Policy benefits, including policyholder dividends. 449.9 455.0 905.2 894.7
Policy acquisition cost amortization.............. 24.7 12.3 52.2 27.0
Other operating expenses.......................... 76.9 80.2 149.6 155.8
------------- ------------- ------------- -------------
Total segment benefits and expenses............... 551.5 547.5 1,107.0 1,077.5
------------- ------------- ------------- -------------
Segment income before income taxes and
minority interest............................... 27.6 27.9 45.0 56.1
Allocated income taxes............................ 8.2 9.8 12.0 19.7
------------- ------------- ------------- -------------
Segment income before minority interest........... 19.4 18.1 33.0 36.4
Minority interest in net income of consolidated
subsidiaries.................................... 0.4 -- 0.4 --
------------- ------------- ------------- -------------
Segment income.................................... 19.0 18.1 32.6 36.4
Net realized investment gains (losses), net of
income taxes and other offsets.................. 3.9 (9.6) 2.6 (6.6)
Deferred acquisition cost adjustment,
net of income taxes............................. -- -- -- 14.4
Other adjustments, net of income taxes............ -- -- -- 0.7
------------- ------------- ------------- -------------
Segment net income................................ $ 22.9 $ 8.5 $ 35.2 $ 44.9
============= ============= ============= =============
Deferred policy acquisition costs
In the first quarter 2002, we revised the mortality assumptions used in the development of estimated gross
margins for the traditional participating block of business to reflect favorable experience. This revision
resulted in a decrease in deferred policy acquisition cost amortization of $22.1 million ($14.4 million after
income taxes).
11
The activity in deferred policy acquisition costs for the three and six month periods ended June 30, 2003 and
2002 follows ($ amounts in millions):
Three Months Six Months
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Acquisition costs deferred......................... $ 44.0 $ 62.1 $ 100.6 $ 112.6
Costs amortized to expenses:
Recurring costs related to segment income........ (24.7) (12.3) (52.2) (27.0)
(Cost) credit related to realized
investment gains or losses..................... (1.2) 0.9 (1.7) 4.4
Change in actuarial assumption................... -- -- -- 22.1
Offsets to net unrealized investment gains or
losses included in other comprehensive income.... (40.1) (30.4) (32.8) (23.7)
------------- ------------- ------------- -------------
Change in deferred policy acquisition costs........ (22.0) 20.3 13.9 88.4
Deferred policy acquisition costs, beginning
of period........................................ 1,270.0 1,191.8 1,234.1 1,123.7
------------- ------------- ------------- -------------
Deferred policy acquisition costs, end of period... $ 1,248.0 $ 1,212.1 $ 1,248.0 $ 1,212.1
============= ============= ============= =============
Policy liabilities and accruals
Policyholder liabilities are primarily for participating life insurance policies and universal life insurance
policies. For universal life, this includes deposits received from customers and investment earnings on their
fund balances, which range from 4.0% to 6.25% at June 30, 2003 and 4.0% to 7.0% at year-end 2002, less
administrative and mortality charges.
Policyholder deposit funds
Policyholder deposit funds primarily consist of annuity deposits received from customers, dividend
accumulations and investment earnings on their fund balances, which range from 1.1% to 12.3% at June 30, 2003
and 1.6% to 12.3% at year-end 2002, less administrative charges.
Participating life insurance
Participating life insurance in-force was 42.4% and 45.5% of the face value of total individual life insurance
in-force at June 30, 2003 and year-end 2002, respectively. The premiums on participating life insurance
policies were 70.0% and 70.5% of total individual life insurance premiums for the three months ended June 30,
2003 and 2002, respectively, and 69.4% and 69.5% of total individual life insurance premiums for the six
months ended June 30, 2003 and 2002, respectively.
12
Funds under management
Activity in annuity funds under management for the three and six month periods ended June 30, 2003 and 2002
follows ($ amounts in millions):
Three Months Six Months
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Deposits......................................... $ 371.0 $ 661.0 $ 803.1 $ 1,236.4
Performance...................................... 351.4 (219.0) 371.6 (220.4)
Fees............................................. (15.4) (15.7) (26.9) (31.6)
Benefits and surrenders.......................... (208.1) (198.4) (462.3) (332.6)
------------- ------------- ------------- -------------
Change in funds under management................. 498.9 227.9 685.5 651.8
Funds under management, beginning of period...... 6,020.0 5,173.0 5,833.4 4,749.1
------------- ------------- ------------- -------------
Funds under management, end of period............ $ 6,518.9 $ 5,400.9 $ 6,518.9 $ 5,400.9
============= ============= ============= =============
Closed Block
Summarized information on closed block assets and liabilities at June 30, 2003, year-end 2002 and inception
(December 31, 1999) and closed block revenues and expenses and changes in the policyholder dividend
obligation, all for the cumulative period from inception to June 30, 2003 and the three and six month periods
ended June 30, 2003 and 2002, follow ($ amounts in millions):
2003 2002 Inception
------------- ------------- -------------
Debt securities............................................... $ 6,913.1 $ 6,431.1 $ 4,773.1
Policy loans.................................................. 1,399.2 1,399.0 1,380.0
Mortgage loans................................................ 285.7 373.2 399.0
Venture capital partnerships.................................. 33.3 0.8 --
Other invested assets......................................... 44.3 -- --
------------- ------------- -------------
Total closed block investments................................ 8,675.6 8,204.1 6,552.1
Cash and cash equivalents..................................... 94.6 187.1 --
Accrued investment income..................................... 119.3 110.9 106.8
Receivables................................................... 40.9 42.1 35.2
Deferred income taxes......................................... 403.1 402.7 389.4
Other closed block assets..................................... 32.6 45.2 6.2
------------- ------------- -------------
Total closed block assets..................................... 9,366.1 8,992.1 7,089.7
------------- ------------- -------------
Policy liabilities and accruals............................... 9,573.5 9,449.0 8,301.7
Policyholder dividends payable................................ 382.3 363.4 325.1
Policyholder dividend obligation.............................. 715.7 547.3 --
Other closed block liabilities................................ 68.0 24.2 12.3
------------- ------------- -------------
Total closed block liabilities................................ 10,739.5 10,383.9 8,639.1
------------- ------------- -------------
Excess of closed block liabilities over closed block assets... $ 1,373.4 $ 1,391.8 $ 1,549.4
============= ============= =============
13
Six Months
----------------------------
Cumulative 2003 2002
------------- ------------- -------------
Premiums......................................................... $ 3,716.2 $ 478.2 $ 499.4
Net investment income ........................................... 1,924.7 286.6 279.8
Net realized investment losses................................... (82.6) (2.9) (49.3)
------------- ------------- -------------
Total revenues................................................... 5,558.3 761.9 729.9
------------- ------------- -------------
Policy benefits, excluding dividends............................. 3,811.4 508.9 514.4
Other operating expenses......................................... 44.1 5.1 5.3
------------- ------------- -------------
Total benefits and expenses, excluding policyholder dividends.... 3,855.5 514.0 519.7
------------- ------------- -------------
Closed block contribution to income before dividends and
income taxes.................................................. 1,702.8 247.9 210.2
Policyholder dividends........................................... 1,387.4 210.5 181.3
------------- ------------- -------------
Closed block contribution to income before income taxes.......... 315.4 37.4 28.9
Applicable income taxes.......................................... 110.8 13.1 10.1
------------- ------------- -------------
Closed block contribution to income.............................. $ 204.6 $ 24.3 $ 18.8
============= ============= =============
Policyholder dividends provided through earnings................. $ 1,387.4 $ 210.5 $ 181.3
Policyholder dividends provided through other comprehensive
income........................................................ 533.2 163.8 128.6
------------- ------------- -------------
Additions to policyholder dividend liabilities................... 1,920.6 374.3 309.9
Policyholder dividends paid...................................... (1,147.7) (187.0) (182.1)
------------- ------------- -------------
Increase in policyholder dividend liabilities.................... 772.9 187.3 127.8
Policyholder dividend liabilities, beginning of period........... 325.1 910.7 524.5
------------- ------------- -------------
Policyholder dividend liabilities, end of period................. 1,098.0 1,098.0 652.3
Policyholder dividends payable, end of period.................... 382.3 382.3 372.2
------------- ------------- -------------
Policyholder dividend obligation, end of period.................. $ 715.7 $ 715.7 $ 280.1
============= ============= =============
4. Asset Management Segment
We conduct activities in our Asset Management segment through our subsidiary, PXP. Two lines of business,
private client and institutional, comprise these activities. We provide investment management services through
our affiliated asset managers. We provide our affiliated asset managers with a consolidated platform of
distribution and administrative support. Each manager has autonomy with its investment process while we
monitor performance and ensure that each manager adheres to its stated investment style.
Segment information on assets as of June 30, 2003 and year-end 2002 and operating income for the three and six
month periods ended June 30, 2003 and 2002 follows ($ amounts in millions):
2003 2002
--------------- ---------------
Asset Management Segment Assets
Investments................................................................ $ 12.7 $ 6.2
Cash and cash equivalents.................................................. 37.2 44.2
Receivables................................................................ 27.5 31.6
Intangible assets with definite lives...................................... 275.8 291.6
Goodwill and other indefinite-lived intangible assets...................... 449.5 448.9
Other assets............................................................... 17.2 21.8
--------------- ---------------
Total segment assets....................................................... 819.9 844.3
--------------- ---------------
Liabilities................................................................ 135.3 141.7
Minority interest.......................................................... 4.9 9.0
--------------- ---------------
Total segment liabilities and minority interest............................ 140.2 150.7
--------------- ---------------
Segment net assets......................................................... $ 679.7 $ 693.6
=============== ===============
14
Three Months Six Months
------------------------- ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Asset Management Segment Income
Investment product fees........................... $ 56.5 $ 70.1 $ 112.0 $ 136.8
Net investment income............................. 0.2 0.3 0.3 0.5
----------- ----------- ----------- -----------
Total segment revenues............................ 56.7 70.4 112.3 137.3
----------- ----------- ----------- -----------
Intangible asset amortization..................... 8.2 7.8 16.6 15.9
Other operating expenses.......................... 52.3 61.9 102.5 118.9
----------- ----------- ----------- -----------
Total segment expenses............................ 60.5 69.7 119.1 134.8
----------- ----------- ----------- -----------
Segment income (loss) before income taxes
and minority interest........................... (3.8) 0.7 (6.8) 2.5
Allocated income tax benefit...................... (2.3) (1.4) (4.4) (1.9)
----------- ----------- ----------- -----------
Segment income (loss), before minority interest... (1.5) 2.1 (2.4) 4.4
Minority interest in segment income .............. 1.9 3.3 4.7 6.1
----------- ----------- ----------- -----------
Segment income (loss)............................. (3.4) (1.2) (7.1) (1.7)
Restructuring charges, net of income taxes........ (1.4) (9.3) (3.1) (9.3)
----------- ----------- ----------- -----------
Segment net loss.................................. $ (4.8) $ (10.5) $ (10.2) $ (11.0)
=========== =========== =========== ===========
Goodwill and other intangible assets
Additions to our Asset Management segment goodwill totaled $0.6 million in both the three and six month
periods ended June 30, 2003 and $39.2 million and $71.4 million in the three and six month periods ended June
30, 2002, respectively. We recorded Asset Management segment goodwill impairment charges of $124.2 million in
the six months ended June 30, 2002, all of which pertained to the adoption of the new accounting standard.
Details of goodwill and other indefinite-lived intangible assets at June 30, 2003 and year-end 2002 follows ($
amounts in millions):
2003 2002
--------------- ---------------
Goodwill............................................................... $ 376.2 $ 375.6
Investment management contracts........................................ 73.3 73.3
--------------- ---------------
Goodwill and other indefinite-lived intangible assets.................. $ 449.5 $ 448.9
=============== ===============
Our Asset Management segment is comprised of several reporting units. For purposes of the goodwill impairment
testing, the fair value of each reporting unit is calculated as the sum of a multiple of revenue plus the fair
value of the reporting unit's tangible net assets and liabilities. Additionally, a pre-tax charge of $124.2
million was recognized on January 1, 2002 upon adoption of a new accounting standard on goodwill as a change
in accounting principle.
At June 30, 2003, the gross carrying amount and accumulated amortization for definite lived asset management
contracts was $403.5 million and $117.9 million, respectively. At December 31, 2002, the gross carrying amount
and accumulated amortization for definite lived asset management contracts was $391.4 million and $99.7
million, respectively. The estimated aggregate amortization expense for the succeeding five fiscal years is
$33.0 million, $32.2 million, $27.2 million, $26.1 million and $25.7 million. At June 30, 2003, the
weighted-average amortization period for definite-lived intangible assets is 9.9 years.
15
5. Investing Activities
Debt and equity securities
Fair value and cost of our debt securities at June 30, 2003 and year-end 2002 follow ($ amounts in millions):
2003 2002
------------------------------- ------------------------------
Fair Value Cost Fair Value Cost
-------------- -------------- -------------- --------------
U.S. government and agency.................. $ 629.2 $ 591.9 $ 461.6 $ 431.3
State and political subdivision............. 602.8 536.1 534.7 481.9
Foreign government.......................... 214.8 193.5 183.9 168.4
Corporate................................... 6,378.5 5,838.7 5,485.2 5,138.7
Mortgage-backed............................. 3,308.7 3,089.1 3,099.9 2,901.9
Other asset-backed.......................... 2,066.4 2,042.0 2,128.8 2,122.1
-------------- -------------- -------------- --------------
Debt securities............................. $ 13,200.4 $ 12,291.3 $ 11,894.1 $ 11,244.3
============== ============== ============== ==============
Amounts applicable to the closed block...... $ 6,913.1 $ 6,271.5 $ 6,431.1 $ 5,952.9
============== ============== ============== ==============
Fair value and cost of our equity securities at June 30, 2003 and year-end 2002 follow ($ amounts in
millions):
2003 2002
------------------------------- ------------------------------
Fair Value Cost Fair Value Cost
-------------- -------------- -------------- --------------
Hilb, Rogal and Hamilton (HRH) common stock.... $ 123.3 $ 42.1 $ 159.3 $ 44.7
GE Life and Annuity Assurance and
GE Group Life Assurance common stock......... 81.0 50.4 60.5 50.4
PXRE Group common stock........................ 22.4 9.4 27.7 9.4
Other equity securities........................ 114.8 106.3 143.7 157.7
------------- --------------- -------------- --------------
Equity securities.............................. $ 341.5 $ 208.2 $ 391.2 $ 262.2
============= =============== ============== ==============
Amounts applicable to the closed block......... $ -- $ -- $ -- $ --
============= =============== ============== ==============
Our holdings in HRH common stock as of June 30, 2003 will be used in November 2005 to settle stock purchase
contracts issued by us. See Note 6 for additional information.
Gross and net unrealized gains and losses from debt and equity securities at June 30, 2003 and year-end 2002
follow ($ amounts in millions):
2003 2002
------------------------------- ------------------------------
Gains Losses Gains Losses
-------------- -------------- -------------- --------------
U.S. government and agency................. $ 37.6 $ (0.3) $ 30.5 $ (0.2)
State and political subdivision............ 66.7 -- 53.1 (0.3)
Foreign government......................... 22.8 (1.5) 20.2 (4.7)
Corporate.................................. 593.8 (54.0) 442.8 (91.3)
Mortgage-backed............................ 221.0 (1.4) 198.5 (0.5)
Other asset-backed......................... 86.5 (62.1) 85.0 (78.3)
------------- -------------- -------------- --------------
Debt securities gains and losses........... $ 1,028.4 $ (119.3) $ 830.1 $ (175.3)
============= ============== ============== ==============
Debt securities net gains.................. $ 909.1 $ 654.8
============= ==============
Equity securities gains and losses......... $ 136.9 $ (3.6) $ 144.4 $ (15.4)
============= ============== ============== ==============
Equity securities net gains................ $ 133.3 $ 129.0
============= ==============
16
Mortgage loans
The carrying values of our investments in mortgage loans by property type at June 30, 2003 and year-end 2002
follow ($ amounts in millions):
2003 2002
--------------- ---------------
Property type:
Apartment buildings..................................................... $ 131.9 $ 159.0
Office buildings........................................................ 80.6 131.5
Retail stores........................................................... 119.6 151.5
Industrial buildings.................................................... 40.0 42.2
Other................................................................... 0.1 0.1
--------------- ---------------
Subtotal................................................................ 372.2 484.3
Less: valuation allowances.............................................. 18.7 15.5
--------------- ---------------
Mortgage loans.......................................................... $ 353.5 $ 468.8
=============== ===============
Amounts applicable to the closed block, at carrying value............... $ 285.7 $ 373.2
=============== ===============
Venture capital partnerships
The components of net investment income related to venture capital partnerships for the three and six month
periods ended June 30, 2003 and 2002 follow ($ amounts in millions):
Three Months Six Months
--------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net realized gains (losses) on partnership
cash and stock distributions....................... $ 2.6 $ 7.4 $ 1.5 $ (5.1)
Net unrealized gains (losses) on partnership
investments........................................ 6.8 (35.7) 37.7 (26.2)
Partnership operating expenses....................... (2.9) (1.6) (3.8) (3.6)
------------ ------------ ------------ ------------
Net Investment Income (loss)......................... $ 6.5 $ (29.9) $ 35.4 $ (34.9)
============ ============ ============ ============
Amounts applicable to the closed block............... $ 0.7 $ -- $ 5.7 $ --
============ ============ ============ ============
Amounts applicable to the venture capital segment.... $ 5.8 $ (29.9) $ 29.7 $ (34.9)
============ ============ ============ ============
The effect of our adjusting estimated partnership results to actual results reflected in partnership financial
statements was to increase net investment income by $3.3 million and $33.8 million for the three and six
months ended June 30, 2003, respectively, and by $2.1 million and $14.9 million for the three and six months
ended June 30, 2002, respectively.
17
Our investments in venture capital partnerships at June 30, 2003 and year-end 2002 by type of investment
follow ($ amounts in millions):
2003 2002
-------------- --------------
Technology........................................................... $ 41.8 $ 25.0
Telecommunications................................................... 16.0 10.2
Biotechnology........................................................ 17.6 11.1
Health care.......................................................... 8.6 9.2
Consumer and business products and services.......................... 33.7 45.9
Financial services................................................... 28.3 28.1
Other................................................................ 35.9 50.6
-------------- --------------
Private holdings..................................................... 181.9 180.1
Public holdings...................................................... 25.5 23.0
Cash and cash equivalents............................................ 10.8 22.4
Other................................................................ 18.9 3.1
-------------- --------------
Venture capital partnerships......................................... $ 237.1 $ 228.6
============== ==============
Unfunded commitments................................................. $ 132.7 $ 154.7
============== ==============
Amounts applicable to the closed block:
Venture capital partnerships......................................... $ 33.3 $ 0.8
============== ==============
Unfunded commitments................................................. $ 46.8 $ 3.4
============== ==============
Amounts applicable to venture capital segment:
Venture capital partnerships......................................... $ 203.8 $ 227.8
============== ==============
Unfunded commitments................................................. $ 85.9 $ 151.3
============== ==============
Investment activity in venture capital partnerships for the three and six month periods ended June 30, 2003
follows ($ amounts in millions):
Three Months Six Months
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Contributions..................................... $ 11.9 $ 7.5 $ 24.8 $ 20.5
Equity in earnings of partnerships................ 6.5 (29.9) 35.4 (34.9)
Distributions..................................... (8.2) (6.1) (11.3) (15.5)
Proceeds from sale of partnership interests....... -- -- (26.1) --
Realized loss on sale of partnership interests.... (0.5) -- (14.3) --
------------ ------------ ------------ ------------
Change in venture capital partnerships............ 9.7 (28.5) 8.5 (29.9)
Venture capital partnership investments,
beginning of period............................. 227.4 290.3 228.6 291.7
------------ ------------ ------------ ------------
Venture capital partnership investments,
end of period................................... $ 237.1 $ 261.8 $ 237.1 $ 261.8
============ ============ ============ ============
Affiliate equity securities
As of June 30, 2003, we recorded an $89.1 million pre-tax, non-cash charge related to the other-than-temporary
impairment of our equity investment in Aberdeen.
The fair value of our investment in Aberdeen common stock, based on the London Stock Exchange closing price at
June 30, 2003 and year-end 2002, was $34.4 million and $43.6 million, respectively. The carrying value of our
investment in Aberdeen on the equity method of accounting totaled $34.4 million and $119.3 million at June 30,
2003 and year-end 2002, respectively.
18
Net investment income
Sources of net investment income for the three and six month periods ended June 30, 2003 and 2002 follow ($
amounts in millions):
Three Months Six Months
------------------------------- ------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
Debt securities.......................... $ 199.1 $ 185.5 $ 386.2 $ 360.0
Equity securities........................ 0.9 1.1 2.2 2.2
Mortgage loans........................... 7.3 10.6 19.4 21.3
Venture capital partnerships............. 6.5 (29.9) 35.4 (34.9)
Affiliate equity securities.............. 0.5 2.7 0.7 7.0
Policy loans............................. 42.6 42.3 85.2 84.8
Other investments........................ 8.1 3.7 12.4 7.3
Cash and cash equivalents................ 1.4 2.9 4.5 4.8
-------------- -------------- -------------- --------------
Total investment income.................. 266.4 218.9 546.0 452.5
Less: investment expenses................ 2.6 3.2 5.5 5.6
-------------- -------------- -------------- --------------
Net investment income.................... $ 263.8 $ 215.7 $ 540.5 $ 446.9
============== ============== ============== ==============
Amounts applicable to the closed block... $ 140.6 $ 141.0 $ 286.6 $ 279.8
============== ============== ============== ==============
Net realized investment gains (losses)
Sources and types of net realized investment gains (losses) for the three and six month periods ended June 30,
2003 and 2002 follow ($ amounts in millions):
Three Months Six Months
----------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------- ------------- ------------
Debt securities................................... $ (19.8) $ (18.2) $ (45.4) $ (71.8)
Equity securities................................. (1.1) -- (1.1) --
Mortgage loans.................................... (2.8) -- (3.2) --
Venture capital partnerships...................... (0.3) -- (4.6) --
Affiliate equity securities....................... (96.9) -- (96.9) --
Other invested assets............................. (1.2) -- (9.9) --
------------- ------------- ------------- ------------
Impairment losses................................. (122.1) (18.2) (161.1) (71.8)
------------- ------------- ------------- ------------
Debt securities gains............................. 16.7 23.1 70.3 38.8
Debt securities losses............................ (11.5) (17.5) (23.8) (24.5)
Equity securities gains........................... 15.2 1.8 15.6 2.8
Equity securities losses.......................... (7.8) (9.8) (10.4) (11.5)
Mortgage loans.................................... (0.4) -- (0.8) --
Venture capital partnerships...................... (0.2) -- (9.7) --
Other invested assets............................. 5.5 (8.0) 3.0 2.6
------------- ------------- ------------- ------------
Net transaction gains (losses).................... 17.5 (10.4) 44.2 8.2
------------- ------------- ------------- ------------
Net realized investment losses.................... $ (104.6) $ (28.6) $ (116.9) $ (63.6)
============= ============= ============= ============
Net realized investment losses.................... $ (104.6) $ (28.6) $ (116.9) $ (63.6)
------------- ------------- ------------- ------------
Applicable closed block policyholder dividend
obligation (reduction).......................... (9.5) (11.2) (1.0) (45.2)
Applicable deferred acquisition costs (benefit)... 1.2 (0.9) 1.7 (4.4)
Applicable deferred income tax benefit............ (37.1) (5.7) (46.0) (4.9)
------------- ------------- ------------- ------------
Offsets to realized investment losses............. (45.4) (17.8) (45.3) (54.5)
------------- ------------- ------------- ------------
Net realized investment losses included in
net income...................................... $ (59.2) $ (10.8) $ (71.6) $ (9.1)
============= ============= ============= ============
19
Unrealized investment gains (losses)
Sources of net unrealized investment gains (losses) for the three and six month periods ended June 30, 2003
and 2002 follow ($ amounts in millions):
Three Months Six Months
---------------------------- --------------------------
2003 2002 2003 2002
------------- ------------ ------------- -----------
Debt securities.................................... $ 279.8 $ 281.2 $ 254.3 $ 182.6
Equity securities.................................. 31.1 16.3 3.0 29.5
Other investments ................................. (0.7) 3.3 0.6 4.7
------------ ------------ ----------- ------------
Net unrealized investment gains.................... $ 310.2 $ 300.8 $ 257.9 $ 216.8
============ ============ ============ ============
Net unrealized investment gains.................... $ 310.2 $ 300.8 $ 257.9 $ 216.8
------------ ------------ ------------ ------------
Applicable closed block policyholder dividend
obligation....................................... 160.2 166.8 163.8 128.6
Applicable deferred policy acquisition costs....... 40.1 30.4 32.8 23.7
Applicable deferred income taxes (benefit)......... 39.8 31.0 21.3 20.5
------------ ------------ ------------ ------------
Offsets to net unrealized investment gains......... 240.1 228.2 217.9 172.8
------------ ------------ ------------ ------------
Net unrealized investment gains
included in other comprehensive income........... $ 70.1 $ 72.6 $ 40.0 $ 44.0
============ ============ ============ ============
6. Financing Activities
Stock Purchase Contracts
In November 2002, we issued stock purchase contracts in a public offering. The stock purchase contracts are
prepaid forward contracts issued by us that will be settled in shares of Hilb, Rogal & Hamilton Company (HRH)
common stock. Upon issuance of the stock purchase contracts, we designated the embedded derivative instrument
as a hedge of the forecasted sale of our investment in HRH, whose shares underlie the stock purchase
contracts. All changes in the fair value of the embedded derivative are recorded in other comprehensive
income. For the three months ended June 30, 2003, we recognized a decrease in the fair value of the embedded
derivative of $6.2 million before income taxes ($4.0 million after income taxes) in other comprehensive
income, primarily due to an increase in the quoted market price of HRH's common stock. For the six months
ended June 30, 2003, we recognized an increase in the fair value of the embedded derivative of $12.2 million
before income taxes ($7.9 million after income taxes) in other comprehensive income, primarily due to a
decrease in the quoted market price of HRH's common stock during the period. The quoted market price at June
30, 2003 ($34.04 per share) was below the price that we received at issuance of the stock purchase contracts.
For more information, see Notes 5 and 6 to our consolidated financial statements in our 2002 Annual Report on
Form 10-K.
Indebtedness
Carrying value and fair value of our indebtedness at June 30, 2003 and year-end 2002 follow ($ amounts in
millions):
2003 2002
--------------------------------- --------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------------- --------------- --------------- ---------------
Surplus notes...................... $ 175.0 $ 190.4 $ 175.0 $ 182.5
Equity units....................... 153.7 161.9 153.7 156.5
Senior unsecured bonds............. 300.0 308.6 300.0 259.8
Interest rate swap................. 17.7 17.7 15.6 15.6
--------------- --------------- --------------- ---------------
Total indebtedness................. $ 646.4 $ 678.6 $ 644.3 $ 614.4
=============== =============== =============== ===============
20
Interest expense on our indebtedness, including amortization of debt issuance costs, for the three and six
month periods ended June 30, 2003 and 2002 follows ($ amounts in millions):
Three Months Six Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Surplus notes...................... $ 3.0 $ 3.0 $ 6.1 $ 6.1
Equity units....................... 3.1 -- 6.1 --
Senior unsecured bonds............. 3.8 3.9 7.5 7.7
Bank credit facility and other..... -- 0.8 -- 1.6
--------------- --------------- --------------- ---------------
Total interest expense............. $ 9.9 $ 7.7 $ 19.7 $ 15.4
=============== =============== =============== ===============
Dividends
On April 28, 2003, we declared a dividend of $0.16 per share to our shareholders of record on June 13, 2003;
we paid the dividend on July 11, 2003.
7. Income Taxes
The allocation of income taxes to elements of comprehensive income (loss) and between current and deferred for
the three and six month periods ended June 30, 2003 and 2002 follows ($ amounts in millions):
Three Months Six Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Loss before cumulative effect of
accounting change...................... $ (34.4) $ (26.7) $ (37.0) $ (14.4)
Cumulative effect of accounting change... -- -- -- (11.4)
--------------- --------------- --------------- ---------------
Net loss................................. $ (34.4) $ (26.7) $ (37.0) $ (25.8)
Other comprehensive income (loss)........ 39.4 (1.2) 27.3 21.6
--------------- --------------- --------------- ---------------
Comprehensive (income) loss.............. $ 5.0 $ (27.9) $ (9.7) $ (4.2)
=============== =============== =============== ===============
Current.................................. $ (12.7) $ (47.2) $ (2.8) $ (28.0)
Deferred................................. 17.7 19.3 (6.9) 23.8
--------------- --------------- --------------- ---------------
Income taxes (benefit) applicable to
comprehensive (income) loss............ $ 5.0 $ (27.9) $ (9.7) $ (4.2)
=============== =============== =============== ===============
For the three and six months ended June 30, 2003 and 2002, the effective income tax rates applicable to income
from continuing operations differ from the 35.0% U.S. federal statutory tax rate. Items giving rise to the
differences and the effects are as follow ($ amounts in millions):
Three Months Six Months
--------------------------------- --------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Income taxes at statutory rate........... $ (28.6) $ (21.2) $ (27.4) $ (5.8)
Tax advantaged investment income......... (1.6) (1.6) (3.1) (3.1)
Non-taxable minority interest income..... (0.6) (1.1) (1.6) (2.1)
Other, net............................... (3.6) (2.8) (4.9) (3.4)
--------------- --------------- --------------- ---------------
Income taxes (benefit) applicable to
continuing operations.................. $ (34.4) $ (26.7) $ (37.0) $ (14.4)
=============== =============== =============== ===============
Effective income tax (benefit) rates..... (42.2%) (44.1%) (47.3%) (86.7%)
=============== =============== =============== ===============
21
8. Employee Benefits
During the three and six month periods ended June 30, 2003, we contributed 115,104 and 157,437 treasury
shares, respectively, to fund the employer match for our saving and investment benefit plans. These shares had
a cost basis of $1.8 million and $2.5 million (weighted average cost of $15.87 per share) and an aggregate
market value of $0.8 million and $1.2 million for the three and six month periods, respectively.
Stock-based Compensation
Pro forma earnings and earnings per share as if we had applied the fair value method of accounting for all
stock-based compensation for the three and six month periods ended June 30, 2003 and 2002 follow ($ amounts in
millions, except per share amounts):
Three Months Six Months
----------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------- ------------- ------------
Net loss, as reported.............................. $ (49.5) $ (37.2) $ (46.3) $ (138.6)
Add: Stock-based employee compensation
expense included in net income (loss),
net of applicable income taxes................... -- -- -- --
Deduct: Stock-based employee compensation
expense determined under fair value accounting
for all awards, net of applicable income taxes... (1.1) (0.1) (2.2) (0.1)
------------- ------------- ------------- ------------
Pro forma net loss................................. $ (50.6) $ (37.3) $ (48.5) $ (138.7)
============= ============= ============= ============
Basic and diluted loss per share, as reported...... $ (.53) $ (.37) $ (.49) $ (1.38)
============= ============= ============= ============
Pro forma basic and diluted loss per share......... $ (.54) $ (.37) $ (.52) $ (1.38)
============= ============= ============= ============
During the three month period ended June 30, 2003, we granted 100,000 stock options which vest over three
years. The options had a weighted-average fair value of $3.65 per option ($0.4 million aggregate) which will
be expensed over the three year vesting period.
Restricted Stock Units
On April 14, 2003, we awarded 255,004 restricted stock units valued at $7.843 per share ($2.0 million
aggregate); on January 1, 2003, we awarded 394,737 restricted stock units valued at $7.60 per share ($3.0
million aggregate). We will recognize the expense associated with these awards over the three-year vesting
periods. We will issue the shares underlying the awards on the later of June 26, 2006 or each employee's
termination of employment. We recognized $0.5 million and $0.7 million in compensation expense for these
awards during the three and six month periods ended June 30, 2003.
On June 26, 2003, we issued 161,769 restricted stock units valued at $9.07 per share ($1.5 million aggregate)
to satisfy deferred compensation liabilities with certain employees. There is no expense associated with this
issuance as the expense was recognized previously when the liabilities were accrued. We will issued the shares
underlying these restricted stock units on the later of June 26, 2006 or each employee's termination of
employment.
9. Earnings Per Share
We have not included common stock equivalents in the weighted average shares outstanding calculation for
diluted earnings per share because their effect would have been anti-dilutive due to our reported net loss for
the three and six month periods ended June 30, 2003. If we had reported net income, there would have been
22
1,385,085 shares of common stock from restricted stock units and 7,707 shares of common stock from employee
stock options. The weighted average effect from the restricted stock units for the three and six month periods
ended June 30, 2003 would have been 1,193,984 shares and 1,081,722 shares, respectively. The weighted average
effect from the employee stock options for the three and six month periods ended June 30, 2003 would have been
4,676 shares and 2,351 shares, respectively.
Other common stock equivalents have exercise prices that were above the average closing price of our common
stock during the periods presented. These include stock options (related to 4,169,538 of our common shares)
and equity units (related to 17,423,859 to 21,256,826 of our common shares depending on our February 2006
quoted market price). The stock option exercise prices of $15.90 and $16.20 and equity units threshold
appreciation price of $8.8206 were greater than the average market price of our common stock of $8.15 and
$7.91 for the three and six month periods ended June 30, 2003, respectively.
10. Contingent Liabilities
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 end the existing contracts as soon as those contracts
would permit. However, we remain liable for claims under those contracts.
We have established reserves and reinsurance recoverables for claims and related expenses that we expect to
pay on our discontinued group accident and health reinsurance business. These reserves and reinsurance
recoverables are a net present value amount that is based on currently known facts and estimates about, among
other things, the amount of insured losses and expenses that we believe we will pay, the period over which
they will be paid, the amount of reinsurance we believe we will collect under our finite aggregate
excess-of-loss reinsurance (finite reinsurance) and other reinsurance to cover our losses and the likely legal
and administrative costs of winding down the business.
Total reserves were $40.0 million and total reinsurance recoverable balances were $125.0 million as of June
30, 2003. In addition, in 1999 we purchased finite reinsurance to further protect us from unfavorable results
from this discontinued business. The maximum coverage available from our finite reinsurance is currently
$120.0 million. The amount of our total financial provisions as of June 30, 2003 was therefore $35.0 million,
consisting of reserves, less reinsurance recoverable balances, plus the amount currently available from our
finite reinsurance. We did not establish any additional reserves during the quarter ended June 30, 2003.
We expect our reserves and reinsurance to cover the run-off of the business; however, the nature of the
underlying risks is such that the claims may take years to reach the reinsurers involved. Therefore, we expect
to pay claims out of existing estimated reserves for up to ten years as the level of business diminishes.
Given the uncertainty associated with litigation and other dispute resolution proceedings, as described
below, our estimated amount of the loss on disposal of reinsurance discontinued operations may differ
from actual results. However, it is our opinion, after consideration of the provisions made in these financial
statements, as described above, that future developments will not have a material effect on our financial
position.
Unicover Managers, Inc.
A significant portion of the claims arising from our discontinued group accident and health reinsurance
business arises from the activities of Unicover Managers, Inc. (Unicover). Unicover organized and managed a
group, or pool, of insurance companies (Unicover pool) and two other facilities (Unicover facilities), which
reinsured the life and health insurance components of workers' compensation insurance policies issued by
various property and casualty insurance companies. We were a member of the Unicover pool but terminated our
participation in the pool effective March 1, 1999.
23
We are involved in disputes relating to the activities of Unicover. Under Unicover's underwriting authority,
the Unicover pool and Unicover facilities wrote a dollar amount of reinsurance coverage that was many times
greater than originally estimated. As a member of the Unicover pool, we are involved in several proceedings in
which the pool members assert that they can deny coverage to certain insurers that claim that they purchased
reinsurance coverage from the pool.
Further, we were, along with Sun Life Assurance of Canada (Sun Life) and Cologne Life Reinsurance Company
(Cologne Life), a retrocessionaire (meaning a reinsurer of other reinsurers) of the Unicover pool and two
other Unicover facilities, providing the pool and facility members with reinsurance of the risks that the pool
and facility members had assumed. In September 1999, we joined an arbitration proceeding that Sun Life had
begun against the members of the Unicover pool and the Unicover facilities. In this arbitration, we and Sun
Life sought to cancel our retrocession agreements on the grounds that material misstatements and
nondisclosures were made to us about, among other things, the amount of risks we would be reinsuring. The
arbitration proceeded only with respect to the Unicover pool because we, Sun Life and Cologne Life reached
settlement with the two Unicover facilities in the first quarter of 2000. In October 2002, the arbitration
panel issued its decision that the agreement by which we provided retrocessional reinsurance to the pool was
valid only to the extent of business bound or renewed to that agreement on or before August 31, 1998. This
decision had the effect of granting us a substantial discount on our potential liabilities, because most of
the business was bound or renewed to the agreement after August 31, 1998. In a clarification dated January 4,
2003, the arbitration panel confirmed its decision. A significant portion of our remaining potential
liabilities as a retrocessionaire of the pool may be recovered from our retrocessionaires.
In one of the Unicover facilities' settlements, the Reliance facility settlement of January 2000, we paid a
settlement amount of $97.9 million and were released from all of our obligations as a retrocessionaire of the
facility. Subsequently, we were reimbursed by one of our retrocessionaires for $38.8 million of the amount we
paid under the settlement. A significant portion of the remainder of the settlement payment may be recovered
from certain of our other retrocessionaires.
In the other Unicover facilities' settlement, the Lincoln facility settlement of March 2000, we paid a
settlement amount of $11.6 million and were released from all of our obligations as a retrocessionaire of the
facility. A significant portion of the settlement payment may be recovered from certain of our
retrocessionaires.
The likelihood of obtaining the additional recoveries from our retrocessionaires cannot be estimated with a
reliable degree of certainty at this stage of our recovery efforts. This is due in part to the lack of
sufficient claims information (which has resulted from disputes among ceding reinsurers that have led to
delayed processing, reporting blockages and standstill agreements among reinsurers) and in part to the matters
discussed below under "Related Proceedings."
The amounts paid and results achieved in the above settlements and arbitration decision are reflected in our
consolidated financial statements. As the amounts previously reserved for these matters were sufficient, we
established no additional reserves with respect to these settlements and arbitration decision.
Related Proceedings
In our capacity as a retrocessionaire of the Unicover business, we had an extensive program of our own
reinsurance in place to protect us from financial exposure to the risks we had assumed. Currently, we are
involved in separate arbitration proceedings with two of our own retrocessionaires which are seeking on
various grounds to avoid paying any amounts to us. Because the same retrocession program that covers our
Unicover business covers a significant portion of our other remaining group accident and health reinsurance
business, we could have additional material losses if one or more of our retrocessionaires successfully avoids
its obligations.
With one of those retrocessionaires, we have three disputes. One concerns an agreement under which the
retrocessionaire reinsures us for up to forty-five thousand dollars per loss in excess of a five thousand
dollar retention. In June 2003, the arbitration panel issued its decision, which upheld in all material
respects the
24
retrocessional obligations to us. The decision is the subject of a pending appeal only with respect to the
Unicover business. The other two disputes will not have a material effect on our reinsurance recoverable
balances. As of June 30, 2003, the reinsurance recoverable balance from this retrocessionaire related to paid
losses was $44.0 million, subject to further development.
The dispute with the other retrocessionaire, which seeks to avoid an excess-of-loss retrocession agreement, a
surplus share retrocession agreement and a quota share retrocession agreement, is the subject of a pending
arbitration that is scheduled for November, 2003. As of June 30, 2003, the reinsurance recoverable balance from
this retrocessionaire related to paid losses was $11.0 million, subject to further development.
We have entered into a standstill agreement with another retrocessionaire under which both parties have agreed
not to commence any proceedings against the other without providing written notice within a specified period.
The purpose of the agreement is to allow the parties to investigate the existence and extent of their
contractual obligations to each other. As of June 30, 2003, the reinsurance recoverable balance from this
retrocessionaire related to paid losses was $28.0 million, subject to further development.
At this stage, we cannot predict the outcome of the above matters, nor can we estimate the amount at risk with
a reliable degree of certainty. This is due in part to our lack of sufficient claims information (which has
resulted from disputes among ceding reinsurers that have led to delayed processing, reporting blockages, and
standstill agreements among reinsurers). This applies with regard both to business related to Unicover and not
related to Unicover.
Other Proceedings
Another set of disputes involves personal accident business that was reinsured in the mid-1990s in the London
reinsurance market, in which we participated. These disputes involve multiple layers of reinsurance and
allegations that the reinsurance program created by the brokers involved in placing those layers was
interrelated and devised to disproportionately pass losses to a top layer of reinsurers. Many companies who
participated in this business are involved in litigation or arbitration in attempts to avoid their obligations
on the basis of misrepresentation. Because of the complexity of the disputes and the reinsurance arrangements,
many of these companies are currently participating in negotiations of the disputes for certain contract years,
and we believe that similar discussions will follow for the remaining years. Although we are vigorously
defending our contractual rights, we are actively involved in the attempt to reach negotiated business
solutions. At this stage, we cannot predict the outcome, nor can we estimate the amount at risk with a reliable
degree of certainty. This is due in part to our lack of sufficient claims information (which has resulted from
disputes among ceding reinsurers that have led to delayed processing, reporting blockages, and standstill
agreements among reinsurers).
25
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENT
The following discussion may contain forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. The company intends these forward-looking statements to be covered by the safe
harbor provisions of the federal securities laws relating to forward-looking statements. These include
statements relating to trends in, or representing management's beliefs about, the company's future strategies,
operations and financial results, as well as other statements including words such as "anticipate," "believe,"
"plan," "estimate," "expect," "intend," "may," "should" and other similar expressions. Forward-looking
statements are made based upon management's current expectations and beliefs concerning trends and future
developments and their potential effects on the company. They are not guarantees of future performance. Actual
results may differ materially from those suggested by forward-looking statements as a result of risks and
uncertainties which include, among others: (i) changes in general economic conditions, including changes in
interest and currency exchange rates and the performance of financial markets; (ii) heightened competition,
including with respect to pricing, entry of new competitors and the development of new products and services
by new and existing competitors; (iii) the company's primary reliance, as a holding company, on dividends and
other payments from its subsidiaries to meet debt payment obligations, particularly since the company's
insurance subsidiaries' ability to pay dividends is subject to regulatory restrictions; (iv) regulatory,
accounting or tax changes that may affect the cost of, or demand for, the products or services of the
company's subsidiaries; (v) downgrades in the 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; and (ix) other risks and uncertainties described in any of the company's filings
with the SEC. The company undertakes no obligation to update or revise publicly any forward-looking statement,
whether as a result of new information, future events or otherwise.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations reviews our consolidated
financial condition as of June 30, 2003 as compared to year-end 2002; our consolidated results of operations
for the three and six month periods ended June 30, 2003 and 2002; and, where appropriate, factors that may
affect our future financial performance. This discussion should be read in conjunction with the unaudited
interim financial statements and notes contained in this filing as well as in conjunction with our
consolidated financial statements for the year 2002 on Form 10-K.
26
Overview
We are a leading provider of wealth management products and services offered through a variety of select
advisors and financial services firms to serve the accumulation, preservation and transfer needs of the
affluent and high-net-worth market, businesses and institutions. We refer to our products and services
together as our wealth management solutions. We offer a broad range of life insurance, annuity and investment
management solutions through a variety of distributors. These distributors include affiliated and
non-affiliated advisors and financial services firms who make our solutions available to their clients.
We provide our wealth management solutions through two operating segments - Life and Annuity and Asset
Management - which include three businesses, life insurance, annuities and investment management. Through Life
and Annuity we offer a variety of life insurance and annuity products, including universal, variable
universal, whole and term life insurance, and a range of annuity offerings. We conduct activities in Asset
Management largely through Phoenix Investment Partners, Ltd. (PXP) comprising two lines of business - private
client and institutional.
Business combinations
In the second quarter of 2003, we acquired the remaining interests in PFG Holdings, Inc. and Capital West
Asset Management, LLC not already owned by us for $17.8 million. We acquired a 60% interest in Kayne Anderson
Rudnick Investment Management, LLC (Kayne Anderson Rudnick) for $102.4 on January 29, 2002; management of the
company retained the remaining ownership interest.
For additional information, see Note 1 to this Form 10-Q.
The Demutualization
Phoenix Home Life Mutual Insurance Company demutualized on June 25, 2001 by converting from a mutual life
insurance company to a stock life insurance company, became a wholly-owned subsidiary of The Phoenix
Companies, Inc. and changed its name to Phoenix Life Insurance Company (Phoenix Life). See Note 1 to our
consolidated financial statements for more information regarding the demutualization and Note 3 for more
information regarding the closed block.
Recently Issued Accounting Standards
See Note 1 of our Consolidated Financial Statements for the three and six months ended June 30, 2003 and 2002
contained herein.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our
consolidated financial statements, which have been prepared in accordance with GAAP. GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Critical accounting policies are reflective of significant judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain. The following are areas that we believe
require significant judgments, together with references to the footnote(s) where each accounting policy is
discussed as it relates to our business:
o Deferred Policy Acquisition Costs, or DAC, and Present Value of Future Profits, or PVFP
The costs of acquiring new business, principally commissions, underwriting, distribution and policy issue
27
expenses, all of which vary with and are primarily related to production of new business, are deferred. In
connection with the 1997 acquisition of the Confederation Life business, we recognized an asset for the
present value of future profits (PVFP) representing the present value of estimated net cash flows embedded
in the existing contracts acquired. This asset is included in deferred acquisition costs (DAC).
We amortize DAC and PVFP based on the related policy's classification. For individual participating life
insurance policies, DAC and PVFP are amortized in proportion to estimated gross margins. For universal
life, variable universal life and accumulation annuities, DAC and PVFP 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 DAC balance associated with the replaced or surrendered policies is
amortized to reflect these surrenders.
The amortization of DAC and PVFP requires the use of various assumptions, estimates and judgments about the
future. Significant assumptions include expenses, investment performance, mortality and policy
cancellations (i.e., lapses, withdrawals and surrenders). These assumptions are reviewed on a regular basis
and are generally based on our past experience, industry studies, regulatory requirements and judgments
about the future. Changes in estimated gross margins and gross profits based on actual experiences are
reflected as an adjustment to total amortization to date resulting in a charge or credit to earnings.
Finally, analyses are performed periodically to assess whether there are sufficient gross margins or gross
profits to amortize the remaining DAC balances.
We regularly evaluate our estimated gross profits, or EGPs, to determine if actual experience or other
evidence suggests that earlier estimates should be revised. Several assumptions considered to be
significant in the development of EGPs include separate account fund performance, surrender and lapse
rates, estimated interest spread and estimated mortality. The separate account fund performance assumption
is critical to the development of the EGPs related to our variable annuity and variable and
interest-sensitive life insurance businesses. The average long-term rate of assumed separate account fund
performance used in estimating gross profits was 7% for the variable annuity business and 8% for the
variable life business at December 31, 2002.
See Note 3 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended
December 31, 2002 and contained herein and Item 3, Quantitative and Qualitative Disclosures About Market
Risk for more information.
o Policy Liabilities and Accruals
See Note 3 to our consolidated financial statements in our Annual Report on Form 10-K for the