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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 MARCH 31, 2005
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 001-16517
THE PHOENIX COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1599088
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One American Row, Hartford, Connecticut 06102-5056
(860) 403-5000
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(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 April 30 2005, the registrant had 95,008,800 shares of common stock outstanding.
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1
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page
Item 1. Unaudited Interim Condensed Consolidated Financial Statements:
Unaudited Interim Condensed Consolidated Balance Sheet at March 31, 2005 and
December 31, 2004......................................................................... 3
Unaudited Interim Condensed Consolidated Statement of Income and Comprehensive
Income for the three months ended March 31, 2005 and 2004................................. 4
Unaudited Interim Condensed Consolidated Statement of Cash Flows for the three months
ended March 31, 2005 and 2004............................................................. 5
Unaudited Interim Condensed Consolidated Statement of Changes in Stockholders' Equity
for the three months ended March 31, 2005 and 2004........................................ 6
Notes to Unaudited Interim Condensed Consolidated Financial Statements for the
three months ended March 31, 2005 and 2004................................................ 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 27
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 53
Item 4. Controls and Procedures....................................................................... 53
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 54
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds................................... 55
Item 3. Defaults Upon Senior Securities............................................................... 55
Item 4. Submission of Matters to a Vote of Security Holders........................................... 55
Item 5. Other Information............................................................................. 56
Item 6. Exhibits...................................................................................... 56
Signature................................................................................................ 60
2
PART I. FINANCIAL INFORMATION
ITEM 1. UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THE PHOENIX COMPANIES, INC.
Unaudited Interim Condensed Consolidated Balance Sheet
($ amounts in millions, except share data)
March 31, 2005 (unaudited) and December 31, 2004
2005 2004
-------------- --------------
ASSETS:
Available-for-sale debt securities, at fair value.............................. $ 13,454.4 $ 13,476.3
Available-for-sale equity securities, at fair value............................ 277.6 304.3
Trading equity securities, at fair value....................................... 65.9 87.3
Mortgage loans, at unpaid principal balances................................... 181.1 207.9
Venture capital partnerships, at equity in net assets.......................... 250.5 255.3
Policy loans, at unpaid principal balances..................................... 2,207.6 2,196.7
Other investments.............................................................. 334.5 371.8
-------------- --------------
16,771.6 16,899.6
Available-for-sale debt and equity securities pledged as collateral, at
fair value................................................................... 1,235.1 1,278.8
-------------- --------------
Total investments.............................................................. 18,006.7 18,178.4
Cash and cash equivalents...................................................... 372.1 435.0
Accrued investment income...................................................... 226.5 222.3
Receivables.................................................................... 169.9 135.8
Deferred policy acquisition costs.............................................. 1,494.3 1,429.9
Deferred income taxes.......................................................... 34.9 30.7
Intangible assets.............................................................. 300.1 308.4
Goodwill....................................................................... 427.2 427.2
Other assets................................................................... 261.0 244.6
Separate account assets........................................................ 7,284.4 6,950.3
-------------- --------------
Total assets................................................................... $ 28,577.1 $ 28,362.6
============== ==============
LIABILITIES:
Policy liabilities and accruals................................................ $ 13,082.2 $ 13,132.3
Policyholder deposit funds..................................................... 3,425.8 3,492.4
Stock purchase contracts....................................................... 129.8 131.9
Indebtedness................................................................... 688.2 690.8
Other liabilities.............................................................. 623.4 546.3
Non-recourse collateralized obligations........................................ 1,301.4 1,355.2
Separate account liabilities................................................... 7,284.4 6,950.3
-------------- --------------
Total liabilities.............................................................. 26,535.2 26,299.2
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CONTINGENT LIABILITIES (NOTE 11)
MINORITY INTEREST:
Minority interest in net assets of consolidated subsidiaries................... 38.0 41.0
-------------- --------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value: 106,401,157 and 106,394,959 shares issued........ 1.0 1.0
Additional paid-in capital..................................................... 2,436.6 2,435.2
Deferred compensation on restricted stock units................................ (4.0) (3.6)
Accumulated deficit............................................................ (276.5) (285.6)
Accumulated other comprehensive income......................................... 27.7 58.0
Treasury stock, at cost: 11,425,972 and 11,517,387 shares...................... (180.9) (182.6)
-------------- --------------
Total stockholders' equity..................................................... 2,003.9 2,022.4
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Total liabilities, minority interest and stockholders' equity.................. $ 28,577.1 $ 28,362.6
============== ==============
The accompanying notes are an integral part of these financial statements.
3
THE PHOENIX COMPANIES, INC.
Unaudited Interim Condensed Consolidated Statement of Income and Comprehensive Income
($ amounts in millions, except share data)
Three Months Ended March 31, 2005 and 2004
2005 2004
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REVENUES:
Premiums....................................................................... $ 226.8 $ 232.7
Insurance and investment product fees.......................................... 129.0 136.1
Broker-dealer commission and distribution fees................................. 6.8 24.3
Investment income, net of expenses............................................. 268.7 277.7
Net realized investment gains (losses)......................................... (17.9) 2.5
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Total revenues................................................................. 613.4 673.3
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BENEFITS AND EXPENSES:
Policy benefits, excluding policyholder dividends.............................. 343.3 345.6
Policyholder dividends......................................................... 83.8 105.9
Policy acquisition cost amortization........................................... 28.2 22.6
Intangible asset amortization.................................................. 8.4 8.3
Interest expense on indebtedness............................................... 11.1 9.8
Interest expense on non-recourse collateralized obligations.................... 8.9 8.9
Other operating expenses....................................................... 117.2 149.1
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Total benefits and expenses.................................................... 600.9 650.2
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Income from continuing operations before income taxes, minority interest
and equity in earnings of affiliates......................................... 12.5 23.1
Applicable income tax (benefit) expense........................................ 2.8 7.1
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Income from continuing operations before minority interest and equity in
earnings of affiliates....................................................... 9.7 16.0
Minority interest in net income of consolidated subsidiaries................... (0.3) --
Equity in undistributed earnings of affiliates................................. -- 0.3
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Income from continuing operations.............................................. 9.4 16.3
Income from discontinued operations............................................ -- 0.3
-------------- --------------
Net income..................................................................... $ 9.4 $ 16.6
============== ==============
EARNINGS PER SHARE:
Earnings from continuing operations - basic.................................... $ 0.10 $ 0.17
Earnings from continuing operations - diluted.................................. $ 0.09 $ 0.16
============== ==============
Net earnings - basic........................................................... $ 0.10 $ 0.18
Net earnings - diluted......................................................... $ 0.09 $ 0.16
============== ==============
Basic weighted-average common shares outstanding (in thousands)................ 94,930 94,512
Diluted weighted-average common shares outstanding (in thousands).............. 102,301 102,008
============== ==============
COMPREHENSIVE INCOME:
Net income..................................................................... $ 9.4 $ 16.6
-------------- --------------
Net unrealized investment gains (losses)....................................... (56.0) 38.4
Net unrealized foreign currency translation gains (losses)..................... (6.8) 2.6
Net unrealized derivative instruments gains (losses)........................... 32.5 (10.9)
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Other comprehensive income (loss).............................................. (30.3) 30.1
-------------- --------------
Comprehensive income (loss).................................................... $ (20.9) $ 46.7
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The accompanying notes are an integral part of these financial statements.
4
THE PHOENIX COMPANIES, INC.
Unaudited Interim Condensed Consolidated Statement of Cash Flows
($ amounts in millions)
Three Months Ended March 31, 2005 and 2004
2005 2004
-------------- --------------
OPERATING ACTIVITIES:
Premiums collected............................................................. $ 244.0 $ 236.0
Insurance and investment product fees collected................................ 142.9 166.8
Investment income collected.................................................... 250.8 241.7
Proceeds from sale of trading equity securities................................ 70.4 --
Policy benefits paid, excluding policyholder dividends......................... (280.3) (261.0)
Policyholder dividends paid.................................................... (92.7) (91.7)
Policy acquisition costs paid.................................................. (32.8) (47.0)
Interest expense on indebtedness paid.......................................... (6.6) (6.3)
Interest expense on collateralized obligations paid............................ (8.9) (8.9)
Other operating expenses paid.................................................. (128.7) (175.3)
Income taxes refunded.......................................................... 0.4 6.7
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Cash from continuing operations................................................ 158.5 61.0
Discontinued operations, net................................................... 3.8 (14.4)
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Cash from operating activities................................................. 162.3 46.6
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INVESTING ACTIVITIES:
Investment purchases........................................................... (889.2) (940.7)
Investment sales, repayments and maturities.................................... 706.7 934.8
Debt and equity securities pledged as collateral purchases..................... -- (30.7)
Debt and equity securities pledged as collateral sales......................... 9.0 --
Subsidiary purchases........................................................... (0.1) (29.2)
Premises and equipment additions............................................... (3.7) (2.7)
Discontinued operations, net................................................... 1.2 1.4
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Cash for investing activities.................................................. (176.1) (67.1)
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FINANCING ACTIVITIES:
Policyholder deposit fund deposits............................................. 164.5 209.3
Policyholder deposit fund withdrawals.......................................... (231.1) (295.6)
Other indebtedness proceeds.................................................... -- 25.0
Loaned securities proceeds..................................................... 59.0 --
Collateralized obligations repayments.......................................... (33.2) (38.2)
Minority interest distributions................................................ (8.3) (6.2)
-------------- --------------
Cash for financing activities.................................................. (49.1) (105.7)
-------------- --------------
Change in cash and cash equivalents............................................ (62.9) (126.2)
Cash and cash equivalents, beginning of period................................. 435.0 447.9
-------------- --------------
Cash and cash equivalents, end of period....................................... $ 372.1 $ 321.7
============== ==============
Included in cash and cash equivalents above is cash pledged as collateral of $36.8 million and $2.1 million at
March 31, 2005 and 2004, respectively.
The accompanying notes are an integral part of these financial statements.
5
THE PHOENIX COMPANIES, INC.
Unaudited Interim Condensed Consolidated Statement of Changes in Stockholders' Equity
($ amounts in millions, except share data)
Three Months Ended March 31, 2005 and 2004
2005 2004
-------------- --------------
COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL:
Restricted stock units awarded as compensation (91,995 and 46,073 units)........ $ 1.1 $ 0.7
Stock options awarded as compensation........................................... 0.3 0.2
DEFERRED COMPENSATION ON RESTRICTED STOCK UNITS:
Compensation expense deferred on restricted stock units awarded................. (1.0) (0.5)
Compensation expense recognized on restricted stock units....................... 0.6 0.4
RETAINED EARNINGS (ACCUMULATED DEFICIT):
Net income...................................................................... 9.4 16.6
Excess of cost over fair value of common shares contributed to employee
savings plan.................................................................. (0.3) (0.3)
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Other comprehensive income (loss)............................................... (30.3) 30.1
TREASURY STOCK:
Common shares contributed to employee savings plan (111,688 and 134,281 shares). 1.7 2.2
-------------- --------------
Change in stockholders' equity.................................................. (18.5) 49.4
Stockholders' equity, beginning of period....................................... 2,022.4 1,947.8
-------------- --------------
Stockholders' equity, end of period............................................. $ 2,003.9 $ 1,997.2
============== ==============
The accompanying notes are an integral part of these financial statements.
6
THE PHOENIX COMPANIES, INC.
Notes to Unaudited Interim Condensed Consolidated Financial Statements
Three Months Ended March 31, 2005 and 2004
1. ORGANIZATION AND OPERATIONS
Our unaudited interim condensed consolidated financial statements include the accounts of The Phoenix
Companies, Inc., its subsidiaries and certain sponsored collateralized obligation trusts as described in Note
7. 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, or Phoenix Life, and Phoenix Investment Partners,
Ltd., or PXP. We have eliminated significant intercompany accounts and transactions in consolidating these
financial statements. We have reclassified certain amounts for 2004 to conform with 2005 presentation.
We have prepared these financial statements in accordance with accounting principles generally accepted in the
United States, or 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; the valuation of
deferred tax assets; pension and other postemployment benefits liabilities; and accruals for contingent
liabilities. Our significant accounting policies are presented in the notes to our consolidated financial
statements in our 2004 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. Financial results for the
three-month period in 2005 are not necessarily indicative of the results that may be expected for the year
2005. These unaudited interim condensed consolidated financial statements should be read in conjunction with
our consolidated financial statements in our 2004 Annual Report on Form 10-K.
RECENTLY ISSUED ACCOUNTING STANDARDS
Share-Based Payment: On December 16, 2004, the Financial Accounting Standards Board, or the FASB, issued
Statement of Financial Accounting Standards Statement No. 123 (revised 2004), Share-Based Payment, or
SFAS 123(R), which requires that compensation cost related to share-based payment transactions be recognized in
financial statements at the fair value of the instruments issued. While prior to the issuance of SFAS 123(R),
recognition of such costs at fair value was optional, we elected to do so for all share-based compensation that
we awarded after December 31, 2002. Accordingly, our adoption of SFAS 123(R) will not have a material effect on
our consolidated financial statements.
Upon our adoption of fair value accounting for stock-based compensation in 2003, we used the prospective method
of transition provided by the new standard, which results in expense recognition for stock options awarded
after December 31, 2002.
7
Pro forma earnings and earnings per share, as if we had applied the fair value method of accounting for all
stock-based compensation, follow:
Pro Forma Net Income and Earnings Per Share: Three Months Ended
($ amounts in millions, except per share data) March 31,
------------------------------
2005 2004
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Net income, as reported........................................................ $ 9.4 $ 16.6
Add: Employee stock option compensation expense included in net income,
net of applicable income taxes............................................... 0.2 0.2
Deduct: Employee stock option compensation expense determined under
fair value accounting for all awards, net of applicable income taxes......... (1.3) (1.3)
-------------- --------------
Pro forma net income........................................................... $ 8.3 $ 15.5
============== ==============
Basic earnings per share:
As reported................................................................ $ 0.10 $ 0.18
Pro forma.................................................................. $ 0.09 $ 0.16
Diluted earnings per share:
As reported................................................................ $ 0.09 $ 0.16
Pro forma.................................................................. $ 0.08 $ 0.15
See Note 9 to our unaudited interim condensed consolidated financial statements in this Form 10-Q for
additional information related to stock-based compensation.
Nontraditional Long-Duration Contracts and Separate Accounts: Effective January 1, 2004, we adopted the AICPA's
Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts, or SOP 03-1. SOP 03-1 provides guidance related to the
accounting, reporting and disclosure of certain insurance contracts and separate accounts, including guidance
for computing reserves for products with guaranteed benefits such as guaranteed minimum death benefits and for
products with annuitization benefits such as guaranteed minimum income benefits. In addition, SOP 03-1
addresses the presentation and reporting of separate accounts, as well as rules concerning the capitalization
and amortization of sales inducements. Our adoption of SOP 03-1 did not have a material effect on our
consolidated financial statements.
Business combinations and divestitures
On May 2, 2005, we completed the acquisition of the noncontrolling interest in Seneca Capital Management, or
Seneca, that we did not already own. The effect of this acquisition is not material to our consolidated
financial statements.
On January 14, 2005, we disposed of our equity interest in Aberdeen Asset Management PLC for proceeds of $70.4
million, which resulted in a $7.0 million after-tax realized investment loss.
On January 11, 2005, we disposed of our interests in Lombard International Assurance S.A., or Lombard, for
proceeds of $59.0 million. We realized an after-tax gain of $9.3 million in the first quarter of 2005 related
to this sale, including earn-out consideration received. We may be entitled to additional earn-out
consideration based on Lombard's financial performance through 2006.
8
Effective May 31, 2004, we sold our retail affiliated broker-dealer operations to Linsco/Private Ledger
Financial Services, or LPL. As part of the transaction, advisors affiliated with WS Griffith Securities, Inc.,
or Griffith, and Main Street Management Company, or Main Street, had the opportunity to move to LPL as
independent registered representatives. During 2004, we incurred a $3.6 million net after-tax charge for an
impairment of goodwill related to Main Street, offset by a $2.7 million after-tax gain on the sale of the
retail affiliated broker-dealer operations. Both the charge and the gain were recorded to realized investment
gains and losses. In addition, we incurred a $10.2 million net after-tax charge related to severance and lease
termination costs, offset by a $4.4 million after-tax gain related to curtailment accounting in connection with
employee benefit plans.
Our consolidated financial statements include the following expenses and certain transaction-related costs
related to our retail affiliated broker-dealer operations sold during 2004:
Revenues and Direct Expenses of Three Months Ended
Retail Affiliated Broker-dealer Operations: March 31,
($ amounts in millions) ------------------------------
2005 2004
-------------- --------------
Insurance and investment product fee revenues, net of eliminations............ $ -- $ 12.8
Direct other operating expenses, net of deferrals............................. $ -- $ 25.5
2. Business Segments
We are a manufacturer of insurance, annuity and asset management products for the accumulation, preservation
and transfer of wealth. We provide products and services to affluent and high-net-worth individuals through
their advisors and to institutions directly and through consultants. We offer a broad range of life insurance,
annuity and asset management products through a variety of independent distributors. These products are managed
within two operating segments — Life and Annuity and Asset Management. We report our remaining activities in
two non-operating segments — Venture Capital and Corporate and Other.
The Life and Annuity segment includes individual life insurance and annuity products including participating
whole life, universal life, variable universal life, term life and variable annuities. The Asset Management
segment includes private client and institutional investment management and distribution, including managed
accounts, open-end mutual funds and closed-end funds. We provide more information on the Life and Annuity and
Asset Management operating segments in Notes 3 and 4, respectively, to our unaudited interim condensed
consolidated financial statements in this Form 10-Q.
The Venture Capital segment includes our equity share in the operating income and the realized and unrealized
investment gains of our venture capital partnership investments held in the general account of Phoenix Life,
but outside the closed block. We provide more information on this segment in Note 5 to our unaudited interim
condensed consolidated financial statements in this Form 10-Q. The Corporate and Other segment includes all
interest expense, as well as several smaller subsidiaries and investment activities which do not meet the
thresholds of reportable segments. These include our remaining international operations and the run-off of our
group pension and guaranteed investment contract businesses.
9
Segment assets, revenues and income information follows:
Segment Information On Assets: Mar 31, Dec 31,
($ amounts in millions) 2005 2004
-------------- --------------
Segment Assets
Life and annuity segment....................................................... $ 25,468.1 $ 25,117.0
Asset management segment....................................................... 816.6 833.9
-------------- --------------
Operating segment assets....................................................... 26,284.7 25,950.9
Venture capital segment........................................................ 197.2 202.9
Corporate and other segment.................................................... 2,074.4 2,185.8
-------------- --------------
Total segment assets........................................................... 28,556.3 28,339.6
Net assets of discontinued operations.......................................... 20.8 23.0
-------------- --------------
Total assets................................................................... $ 28,577.1 $ 28,362.6
============== ==============
Segment Information On Revenues and Income: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Segment revenues
Life and annuity segment....................................................... $ 556.1 $ 572.1
Asset management segment....................................................... 61.0 70.2
Elimination of inter-segment revenues.......................................... 2.1 0.8
-------------- --------------
Operating segment revenues..................................................... 619.2 643.1
Venture capital segment........................................................ (2.2) 11.6
Corporate and other segment.................................................... 14.3 16.1
-------------- --------------
Total segment revenues......................................................... 631.3 670.8
Net realized investment gains (losses)......................................... (17.9) 2.5
-------------- --------------
Total revenues................................................................. $ 613.4 $ 673.3
============== ==============
Segment income (loss)
Life and annuity segment....................................................... $ 44.0 $ 25.8
Asset management segment....................................................... (1.7) 0.1
-------------- --------------
Operating segment pre-tax income............................................... 42.3 25.9
Venture capital segment........................................................ (2.2) 11.6
Corporate and other segment.................................................... (16.3) (12.7)
-------------- --------------
Total segment income before income taxes....................................... 23.8 24.8
Applicable income taxes........................................................ 7.0 7.3
-------------- --------------
Total segment income........................................................... 16.8 17.5
Gain from discontinued operations, net of income taxes......................... -- 0.3
Net realized investment gains (losses), net of income taxes and other offsets.. (5.5) 0.8
Restructuring costs, net of income taxes....................................... (1.9) (2.0)
-------------- --------------
Net income..................................................................... $ 9.4 $ 16.6
============== ==============
10
3. Life and Annuity Segment
The Life and Annuity segment includes individual life insurance and annuity products 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, segment income
and deferred policy acquisition costs follows:
Life and Annuity Segment Assets: Mar 31, Dec 31,
($ amounts in millions) 2005 2004
-------------- --------------
Segment assets
Investments..................................................................... $ 16,228.5 $ 16,273.4
Cash and cash equivalents....................................................... 200.0 255.2
Receivables..................................................................... 225.4 222.2
Deferred policy acquisition costs............................................... 1,494.3 1,429.9
Deferred income taxes........................................................... 17.6 --
Goodwill and other intangible assets............................................ 10.2 10.2
Other general account assets.................................................... 156.0 118.9
Separate accounts............................................................... 7,136.1 6,807.2
-------------- --------------
Total segment assets............................................................ $ 25,468.1 $ 25,117.0
============== ==============
Life and Annuity Segment Income: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Segment income
Premiums........................................................................ $ 226.8 $ 232.7
Insurance and investment product fees........................................... 75.6 73.0
Broker-dealer commission and distribution fee revenues.......................... -- 16.5
Net investment income........................................................... 253.7 249.9
-------------- --------------
Total segment revenues.......................................................... 556.1 572.1
-------------- --------------
Policy benefits, including policyholder dividends............................... 429.0 449.0
Policy acquisition cost amortization............................................ 33.0 22.2
Other operating expenses........................................................ 50.1 75.1
-------------- --------------
Total segment benefits and expenses............................................. 512.1 546.3
-------------- --------------
Segment income before income taxes.............................................. 44.0 25.8
Allocated income taxes.......................................................... 14.0 7.2
-------------- --------------
Segment income.................................................................. 30.0 18.6
Net realized investment gains (losses), net of income taxes and other offsets... (0.6) (3.5)
Restructuring charges, after income taxes....................................... -- (0.8)
-------------- --------------
Segment net income.............................................................. $ 29.4 $ 14.3
============== ==============
11
Life and Annuity Segment Revenues by Product: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Premiums
Term life insurance............................................................. $ 3.0 $ 2.7
Other life insurance............................................................ 3.1 2.6
-------------- --------------
Total, non-participating life insurance......................................... 6.1 5.3
Participating life insurance.................................................... 220.7 227.4
-------------- --------------
Total premiums.................................................................. 226.8 232.7
-------------- --------------
Insurance and investment product fees
Variable universal life insurance............................................... 28.3 27.9
Universal life insurance........................................................ 29.2 26.8
Other life insurance............................................................ -- 1.7
-------------- --------------
Total, life insurance........................................................... 57.5 56.4
Annuities....................................................................... 18.1 16.6
-------------- --------------
Total insurance and investment product fees..................................... 75.6 73.0
Broker-dealer commission and distribution fee revenues.......................... -- 16.5
Net investment income........................................................... 253.7 249.9
-------------- --------------
Segment revenues................................................................ $ 556.1 $ 572.1
============== ==============
Deferred Policy Acquisition Costs: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Policy acquisition costs deferred............................................... $ 32.8 $ 47.0
Costs amortized to expenses:
Recurring costs related to segment income..................................... (33.0) (22.2)
Decrease (increase) related to realized investment gains or losses............ 4.8 (0.4)
Offsets to net unrealized investment gains or losses
included in other comprehensive income........................................ 59.8 (33.6)
-------------- --------------
Change in deferred policy acquisition costs..................................... 64.4 (9.2)
Deferred policy acquisition costs, beginning of period.......................... 1,429.9 1,367.7
-------------- --------------
Deferred policy acquisition costs, end of period................................ $ 1,494.3 $ 1,358.5
============== ==============
12
Closed Block
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. Summary financial data for the closed block follows:
Inception
Closed Block Assets and Liabilities: Mar 31, Dec 31, (Dec 31,
($ amounts in millions) 2005 2004 1999)
-------------- -------------- --------------
Debt securities................................................. $ 6,925.8 $ 6,949.6 $ 4,773.1
Equity securities............................................... 91.3 90.8 --
Mortgage loans.................................................. 158.2 181.9 399.0
Venture capital partnerships.................................... 53.3 52.4 --
Policy loans.................................................... 1,358.6 1,363.4 1,380.0
Other invested assets........................................... 60.3 60.0 --
-------------- -------------- --------------
Total closed block investments.................................. 8,647.5 8,698.1 6,552.1
Cash and cash equivalents....................................... 51.2 100.5 --
Accrued investment income....................................... 118.2 118.8 106.8
Receivables..................................................... 50.6 32.7 35.2
Deferred income taxes........................................... 353.4 359.7 389.4
Other closed block assets....................................... 33.4 24.0 6.2
-------------- -------------- --------------
Total closed block assets....................................... 9,254.3 9,333.8 7,089.7
-------------- -------------- --------------
Policy liabilities and accruals................................. 9,715.3 9,686.9 8,301.7
Policyholder dividends payable.................................. 373.3 365.5 325.1
Policyholder dividend obligation................................ 393.8 535.9 --
Other closed block liabilities.................................. 60.0 41.5 12.3
-------------- -------------- --------------
Total closed block liabilities.................................. 10,542.4 10,629.8 8,639.1
-------------- -------------- --------------
Excess of closed block liabilities over closed block assets..... $ 1,288.1 $ 1,296.0 $ 1,549.4
============== ============== ==============
13
Three Months Ended
Closed Block Revenues and Expenses and Changes in Cumulative March 31,
Policyholder Dividend Obligations: from ------------------------------
($ amounts in millions) Inception 2005 2004
-------------- -------------- --------------
Closed block revenues
Premiums........................................................ $ 5,384.8 $ 214.0 $ 224.6
Net investment income........................................... 2,905.0 133.8 147.6
Net realized investment losses.................................. (101.7) (10.6) (1.9)
-------------- -------------- --------------
Total revenues.................................................. 8,188.1 337.2 370.3
-------------- -------------- --------------
Policy benefits, excluding dividends............................ 5,606.7 239.1 245.0
Other operating expenses........................................ 60.3 2.4 2.6
-------------- -------------- --------------
Total benefits and expenses, excluding policyholder dividends... 5,667.0 241.5 247.6
-------------- -------------- --------------
Closed block contribution to income before dividends and
income taxes.................................................. 2,521.1 95.7 122.7
Policyholder dividends.......................................... 2,083.8 83.6 105.5
-------------- -------------- --------------
Closed block contribution to income before income taxes......... 437.3 12.1 17.2
Applicable income taxes......................................... 153.4 4.2 6.1
-------------- -------------- --------------
Closed block contribution to income............................. $ 283.9 $ 7.9 $ 11.1
============== ============== ==============
Policyholder dividend obligation
Policyholder dividends provided through earnings................ $ 2,128.9 $ 83.5 $ 105.5
Policyholder dividends provided through other
comprehensive income ......................................... 311.1 (125.4) 160.0
-------------- -------------- --------------
Additions to (reductions in) policyholder dividend liabilities.. 2,440.0 (41.9) 265.5
Policyholder dividends paid..................................... (1,998.0) (92.4) (91.3)
-------------- -------------- --------------
Increase (decrease) in policyholder dividend liabilities........ 442.0 (134.3) 174.2
Policyholder dividend liabilities, beginning of period.......... 325.1 901.4 889.0
-------------- -------------- --------------
Policyholder dividend liabilities, end of period................ 767.1 767.1 1,063.2
Less: policyholder dividends payable, end of period........... 373.3 373.3 377.1
-------------- -------------- --------------
Policyholder dividend obligation, end of period................. $ 393.8 $ 393.8 $ 686.1
============== ============== ==============
4. Asset Management Segment
We conduct activities in Asset Management with a focus on two customer groups —— private client and
institutional. Through our private client group, we provide asset management services principally on a
discretionary basis, with products consisting of open-end mutual funds, closed-end funds and managed accounts.
Managed accounts include intermediary programs sponsored and distributed by non-affiliated broker-dealers and
direct managed accounts which are sold and administered by us. Our private client business also provides
transfer agency, accounting and administrative services to most of our open-end mutual funds.
Through our institutional group, we provide discretionary asset management services primarily to corporations,
multi-employer retirement funds and foundations, as well as to endowment and special purpose funds. In
addition, we manage alternative financial products, including structured finance products. Structured finance
products include collateralized obligations backed by portfolios of public high yield bonds, emerging markets
bonds, commercial mortgage-backed and asset-backed securities or bank loans. See Note 7 to our unaudited
interim condensed consolidated financial statements in this Form 10-Q for additional information.
We offer asset management services through our affiliated asset managers. We provide these affiliated asset
managers with a consolidated platform of distribution and administrative support, thereby allowing each manager
to devote a high degree of focus to investment management activities. On an ongoing basis, we monitor the
quality of the affiliates' products by assessing their performance, style consistency and the discipline with
which they apply their investment process. Segment information on assets, segment income and intangible assets
and goodwill follows:
14
Asset Management Segment Assets: Mar 31, Dec 31,
($ amounts in millions) 2005 2004
-------------- --------------
Segment assets
Investments.................................................................... $ 12.4 $ 12.8
Cash and cash equivalents...................................................... 45.7 50.0
Receivables.................................................................... 29.5 34.2
Intangible assets.............................................................. 300.1 308.4
Goodwill....................................................................... 417.0 416.9
Other assets................................................................... 11.9 11.6
-------------- --------------
Total segment assets........................................................... $ 816.6 $ 833.9
============== ==============
Asset Management Segment Income: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Segment income
Investment product fees........................................................ $ 53.9 $ 62.3
Broker-dealer commission and distribution fees................................. 6.8 7.8
Net investment income.......................................................... 0.3 0.1
-------------- --------------
Total segment revenues......................................................... 61.0 70.2
-------------- --------------
Intangible asset amortization.................................................. 8.4 8.3
Other operating expenses....................................................... 54.3 61.8
-------------- --------------
Total segment expenses......................................................... 62.7 70.1
-------------- --------------
Segment income (loss) before income taxes...................................... (1.7) 0.1
Allocated income taxes (benefit)............................................... (0.5) 0.4
-------------- --------------
Segment loss................................................................... (1.2) (0.3)
Restructuring charges, net of income taxes..................................... (0.2) --
Realized investment gains (losses), net of income taxes(benefit)............... (0.1) 1.4
Other.......................................................................... -- (0.1)
-------------- --------------
Segment net income (loss)...................................................... $ (1.5) $ 1.0
============== ==============
Goodwill and intangible assets included in the Asset Management segment
Carrying Amounts of Intangible Assets and Goodwill: Mar 31, Dec 31,
($ amounts in millions) 2005 2004
-------------- --------------
Asset management contracts with definite lives................................. $ 401.3 $ 401.2
Less: accumulated amortization............................................... 174.5 166.1
-------------- --------------
Intangible assets with definite lives.......................................... $ 226.8 $ 235.1
Asset management contracts with indefinite lives............................... 73.3 73.3
-------------- --------------
Intangible assets.............................................................. $ 300.1 $ 308.4
============== ==============
Goodwill....................................................................... $ 417.0 $ 416.9
============== ==============
15
Activity in Intangible Assets and Goodwill: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Intangible assets
Asset purchases................................................................ $ 0.1 $ 1.8
Asset amortization............................................................. (8.4) (8.3)
-------------- --------------
Change in intangible assets.................................................... (8.3) (6.5)
Balance, beginning of period................................................... 308.4 335.1
-------------- --------------
Balance, end of period......................................................... $ 300.1 $ 328.6
============== ==============
Goodwill
Asset purchases................................................................ $ 0.1 $ 2.5
-------------- --------------
Change in goodwill............................................................. 0.1 2.5
Balance, beginning of period................................................... 416.9 408.1
-------------- --------------
Balance, end of period......................................................... $ 417.0 $ 410.6
============== ==============
Upon acquisition, we calculate and record the fair value of definite-lived intangible assets based on their
discounted cash flows. To conduct subsequent tests for impairments, we calculate the current fair value of the
asset, compare it to the recorded value, and record an impairment if warranted. For purposes of our testing for
goodwill and indefinite-lived intangible asset impairments, we calculate the fair value of each reporting unit
based on the sum of a multiple of revenue and the fair value of the unit's tangible net assets. Tests for
impairments are performed at least annually, or more frequently if warranted by changes in business conditions.
5. Investing Activities
Debt and equity securities
Fair Value and Cost of Debt and
Equity Securities: March 31, 2005 December 31, 2004
($ amounts in millions) ------------------------------ ------------------------------
Fair Value Cost Fair Value Cost
-------------- -------------- -------------- --------------
U.S. government and agency..................... $ 671.3 $ 633.9 $ 679.1 $ 625.4
State and political subdivision................ 481.4 451.5 446.5 413.7
Foreign government............................. 342.7 320.9 314.8 284.0
Corporate...................................... 7,305.7 7,109.8 7,365.4 7,040.7
Mortgage-backed................................ 3,306.6 3,230.8 3,253.4 3,122.9
Other asset-backed............................. 1,346.7 1,343.0 1,417.1 1,405.0
-------------- -------------- -------------- --------------
Available-for-sale debt securities............. $ 13,454.4 $ 13,089.9 $ 13,476.3 $ 12,891.7
============== ============== ============== ==============
Amounts applicable to the closed block......... $ 6,925.8 $ 6,616.7 $ 6,949.6 $ 6,515.2
============== ============== ============== ==============
Hilb Rogal and Hobbs Company, or HRH,
common stock................................. $ 133.9 $ 42.1 $ 131.3 $ 42.1
Lombard International Assurance, S.A........... -- -- 43.3 43.3
Other equity securities........................ 143.7 127.1 129.7 113.9
-------------- -------------- -------------- --------------
Available-for-sale equity securities........... $ 277.6 $ 169.2 $ 304.3 $ 199.3
============== ============== ============== ==============
Amounts applicable to the closed block......... $ 91.3 $ 80.0 $ 90.8 $ 78.3
============== ============== ============== ==============
Our holdings in HRH common stock as of March 31, 2005 are available to be used in November 2005 to settle stock
purchase contracts issued by us. Upon settlement of such stock purchase contracts, we will recognize a gross
investment gain of $91.8 million ($32.4 million gain net of offsets for applicable deferred acquisition costs
and income taxes). See Note 6 to our unaudited interim condensed consolidated financial statements in this
Form 10-Q for additional information.
16
On January 11, 2005, we closed the sale of our interest in Lombard to Friends Provident plc, or Friends
Provident, for common shares in Friends Provident valued at $59.0 million as further described in Note 1 to our
unaudited interim condensed consolidated financial statements in this Form 10-Q. As part of our disposition of
Lombard, we entered into a total return swap agreement with a third party, which was settled with cash proceeds
of $59.0 million on April 1, 2005. Accordingly, we designated our holdings in Friends Provident as trading
equity securities whose fair value was $65.9 million at March 31, 2005. The increase in fair value of Friends
Provident shares of $6.9 million through March 31, 2005 is offset by the decrease in fair value of the total
return swap contract of $6.9 million through March 31, 2005, where both of these changes in fair value are
reflected in our unaudited interim condensed consolidated statement of income for the quarter ended March 31,
2005. Under the total return swap agreement, we entered into a pledge delivery obligation where the shares of
Friends Provident were loaned to the third party, and we received cash of $59.0 million as security for such
shares loaned. Both the pledge delivery obligation and the total return swap were settled on April 1, 2005.
Unrealized Gains and Losses from March 31, 2005 December 31, 2004
General Account Securities: ------------------------------ ------------------------------
($ amounts in millions) Gains Losses Gains Losses
-------------- -------------- -------------- --------------
U.S. government and agency..................... $ 40.9 $ (3.5) $ 55.4 $ (1.7)
State and political subdivision................ 32.6 (2.7) 34.4 (1.6)
Foreign government............................. 23.2 (1.4) 31.1 (0.3)
Corporate...................................... 278.0 (82.1) 364.2 (39.5)
Mortgage-backed................................ 95.6 (19.8) 137.0 (6.5)
Other asset-backed............................. 25.0 (21.3) 32.4 (20.3)
-------------- -------------- -------------- --------------
Debt securities gains (losses)................. $ 495.3 $ (130.8) $ 654.5 $ (69.9)
============== ==============
============== ==============
Debt securities net gains...................... $ 364.5 $ 584.6
============== ==============
Hilb Rogal and Hobbs Company, or HRH,
common stock................................. $ 91.8 $ -- $ 89.2 $ --
Other equity securities........................ 19.7 (3.1) 19.1 (3.3)
-------------- -------------- -------------- --------------
Equity securities gains (losses)............... $ 111.5 $ (3.1) $ 108.3 $ (3.3)
============== ============== ============== ==============
Equity securities net gains.................... $ 108.4 $ 105.0
============== ==============
Aging of Temporarily Impaired March 31, 2005
Debt and Equity Securities: ---------------------------------------------------------------------
($ amounts in millions) Less Than 12 Months Greater Than 12 Months Total
----------------------- ---------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ----------- ---------- ----------- ---------- -----------
Debt securities
U.S. government and agency............... $ 173.8 $ (3.1) $ 6.1 $ (0.4) $ 179.9 $ (3.5)
State and political subdivision.......... 91.3 (1.5) 14.5 (1.2) 105.8 (2.7)
Foreign government....................... 48.3 (1.0) 10.6 (0.4) 58.9 (1.4)
Corporate................................ 2,466.2 (55.3) 394.7 (26.8) 2,860.9 (82.1)
Mortgage-backed.......................... 1,342.9 (16.5) 112.2 (3.3) 1,455.1 (19.8)
Other asset-backed....................... 496.4 (7.3) 91.9 (14.0) 588.3 (21.3)
----------- ----------- ---------- ----------- ---------- -----------
Debt securities.......................... $ 4,618.9 $ (84.7) $ 630.0 $ (46.1) $5,248.9 $ (130.8)
Common stock............................. 23.6 (2.3) 6.1 (0.8) 29.7 (3.1)
----------- ----------- ---------- ----------- ---------- -----------
Total temporarily impaired securities.... $ 4,642.5 $ (87.0) $ 636.1 $ (46.9) $5,278.6 $ (133.9)
=========== =========== ========== =========== ========== ===========
Amounts inside the closed block.......... $ 1,489.1 $ (31.3) $ 341.7 $ (21.4) $1,830.8 $ (52.7)
=========== =========== ========== =========== ========== ===========
Amounts outside the closed block......... $ 3,153.4 $ (55.7) $ 294.4 $ (25.5) $3,447.8 $ (81.2)
=========== =========== ========== =========== ========== ===========
Amounts outside the closed block
that are below investment grade........ $ 198.6 $ (6.5) $ 80.0 $ (13.9) $ 278.6 $ (20.4)
=========== =========== ========== =========== ========== ===========
After offsets for deferred acquisition
cost adjustment and taxes.............. $ (2.6) $ (5.1) $ (7.7)
=========== =========== ===========
17
These securities are considered to be temporarily impaired at March 31, 2005 as each of these securities has
performed, and is expected to continue to perform, in accordance with their original contractual terms, and we
have the ability and intent to hold these securities until they recover their value.
Venture Capital Partnerships
We record our equity in the earnings of venture capital partnerships in net investment income using the most
recent financial information received from the partnerships and estimating the change in our share of
partnership earnings for significant changes in equity market conditions during the quarter to eliminate any
lag in reporting.
Components of Net Investment Income Related to Venture Capital Partnerships: Three Months Ended
($ amounts in millions) March 31,
-----------------------------
2005 2004
-------------- --------------
Net realized losses on partnership cash and stock distributions............... $ (0.3) $ (3.7)
Net unrealized gains (losses) on partnership investments...................... (4.0) 22.2
Partnership operating earnings (losses)....................................... 1.5 (0.9)
-------------- --------------
Net investment income (loss).................................................. $ (2.8) $ 17.6
============== ==============
Amounts applicable to the closed block........................................ $ (0.6) $ 6.0
============== ==============
Amounts applicable to the venture capital segment............................. $ (2.2) $ 11.6
============== ==============
The effect of our adjusting estimated partnership results to actual results reflected in partnership financial
statements was to increase (decrease) net investment income as follows:
Effect of Adjustment From Estimated Partnership Results to Three Months Ended
Actual Partnership Financial Statements: March 31,
($ amounts in millions) -------------------------------
2005 2004
-------------- --------------
Closed block.................................................................. $ (4.9) $ 4.7
Venture capital segment....................................................... (1.5) 9.2
-------------- --------------
Total......................................................................... $ (6.4) $ 13.9
============== ==============
Investment Activity in Venture Capital Partnerships: Three Months Ended
($ amounts in millions) March 31,
-------------------------------
2005 2004
-------------- --------------
Contributions................................................................. $ 16.9 $ 11.8
Equity in earnings (losses) of partnerships................................... (2.8) 17.6
Distributions................................................................. (18.9) (14.8)
-------------- --------------
Change in venture capital partnerships........................................ (4.8) 14.6
Venture capital partnership investments, beginning of period.................. 255.3 234.9
-------------- --------------
Venture capital partnership investments, end of period........................ $ 250.5 $ 249.5
============== ==============
Affiliate equity securities
As of December 31, 2004, we owned 38.1 million shares of Aberdeen Asset Management PLC, or Aberdeen, common
stock, which represented 16.5% of the Company's outstanding common shares. We acquired these shares between
1996 and 2001 at a total cost of $109.1 million, which, through November 18, 2004, we accounted for under the
equity method of accounting based on our ability to significantly influence Aberdeen's operations. On January
14, 2005, we sold our equity holdings in Aberdeen to third parties for proceeds of $70.4 million, resulting in
an after-tax realized loss of $7.0 million in the first quarter of 2005.
18
Previously, we recorded an unrealized gain on trading equity securities of $55.1 million, after tax, in the
fourth quarter of 2004 and a non-cash realized investment loss related to an other-than-temporary impairment of
$55.0 million, after tax, in the second quarter of 2003.
Net investment income
Sources of Net Investment Income: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Debt securities............................................................... $ 197.3 $ 192.1
Equity securities............................................................. 2.1 0.4
Mortgage loans................................................................ 6.4 5.9
Venture capital partnerships.................................................. (2.8) 17.6
Policy loans.................................................................. 40.7 42.2
Other investments............................................................. 15.5 11.9
Cash and cash equivalents..................................................... 1.7 0.7
-------------- --------------
Total investment income....................................................... 260.9 270.8
Less: investment expenses................................................... 3.1 3.2
-------------- --------------
Net investment income, general account investments............................ 257.8 267.6
Debt and equity securities pledged as collateral (Note 7)..................... 10.9 10.1
-------------- --------------
Net investment income......................................................... $ 268.7 $ 277.7
============== ==============
Amounts applicable to the closed block........................................ $ 133.8 $ 147.6
============== ==============
Net realized investment gains (losses)
Sources and Types of Net Realized Investment Gains (Losses): Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Debt security impairments..................................................... $ (12.2) $ (2.8)
Other invested asset impairments.............................................. -- (3.3)
Debt and equity securities pledged as collateral impairments.................. (0.3) (4.7)
-------------- --------------
Impairment losses............................................................. (12.5) (10.8)
-------------- --------------
Debt security transaction gains............................................... 3.1 10.2
Debt security transaction losses.............................................. (10.3) (3.2)
Equity security transaction gains............................................. 0.5 2.6
Equity security transaction losses............................................ (1.5) (0.4)
Debt and equity securities pledged as collateral.............................. 0.7 --
Affiliate transactions........................................................ 3.7 0.2
Other invested asset transaction gains (losses)............................... (1.6) 3.9
-------------- --------------
Net transaction gains (losses)................................................ (5.4) 13.3
-------------- --------------
Net realized investment gains (losses)........................................ $ (17.9) $ 2.5
-------------- --------------
Net realized investment gains (losses)........................................ $ (17.9) $ 2.5
-------------- --------------
Applicable closed block policyholder dividend obligation...................... (4.4) 0.1
Applicable deferred policy acquisition costs.................................. (4.8) 0.4
Applicable deferred income taxes (benefit).................................... (3.2) 1.2
-------------- --------------
Offsets to realized investment gains.......................................... (12.4) 1.7
-------------- --------------
Net realized investment gains (losses) included in net income................. $ (5.5) $ 0.8
============== ==============
19
Unrealized Investment Gains (Losses)
Sources of Changes in Net Unrealized Investment Gains (Losses): Three Months Ended
($ amounts in millions) March 31,
-----------------------------
2005 2004
-------------- --------------
Debt securities............................................................... $ (220.2) $ 235.1
Equity securities............................................................. 3.4 24.1
Debt and equity securities pledged as collateral.............................. (34.9) (4.7)
Other investments............................................................. -- 1.9
-------------- --------------
Net unrealized investment gains (losses)...................................... $ (251.7) $ 256.4
============== ==============
Net unrealized investment gains (losses)...................................... $ (251.7) $ 256.4
-------------- --------------
Applicable closed block policyholder dividend obligation...................... (125.4) 160.0
Applicable deferred policy acquisition costs (benefit)........................ (59.8) 33.6
Applicable deferred income taxes (benefit).................................... (10.5) 24.4
-------------- --------------
Offsets to net unrealized investment gains (losses)........................... (195.7) 218.0
-------------- --------------
Net unrealized investment gains (losses) included in other
comprehensive income........................................................ $ (56.0) $ 38.4
============== ==============
6. Financing Activities
Stock purchase contracts and indebtedness
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 and Hobbs Company, or HRH,
common stock in the fourth quarter of 2005.
Stock Purchase Contracts: March 31, 2005 December 31, 2004
($ amounts in millions) ------------------------------ ------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------------- -------------- -------------- --------------
Stock purchase contracts stated amount.......... $ 140.3 $ 129.8 $ 141.1 $ 131.9
Settlement amount adjustment.................... (10.5) -- (9.2) --
-------------- -------------- -------------- --------------
Stock purchase contracts........................ $ 129.8 $ 129.8 $ 131.9 $ 131.9
============== ============== ============== ==============
Indebtedness: March 31, 2005 December 31, 2004
($ amounts in millions) ----------------------------- ------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------------- -------------- -------------- --------------
6.95% surplus notes............................. $ 30.2 $ 34.4 $ 30.2 $ 34.4
7.15% surplus notes............................. 173.9 179.2 173.9 174.8
Equity units.................................... 153.7 229.8 153.7 227.8
Senior unsecured bonds.......................... 300.0 305.4 300.0 306.7
Revolving credit facility....................... 25.0 25.0 25.0 25.0
Interest rate swap.............................. 5.4 5.4 8.0 8.0
-------------- -------------- -------------- --------------
Total indebtedness.............................. $ 688.2 $ 779.2 $ 690.8 $ 776.7
============== ============== ============== ==============
In December 2002, we issued 6,147,500 of 7.25% equity units in a public offering at $25 per unit for gross
proceeds of $153.7 million (net proceeds of $149.1 million). Each equity unit is composed of an unsecured,
subordinated note and a purchase contract (equity forward on our common stock collateralized by the note). The
notes bear interest at an annual rate of 6.6% and $25 principal amount per note is initially due in February
2008. On or after November 2005 the notes will be remarketed as senior unsecured obligations and the interest
rate will be reset at that time. The holders of the purchase contracts will be paid a contract adjustment
payment at a rate of
20
0.65% per year and have agreed to purchase a minimum 2.8343 shares (17,423,859 shares aggregate) and a maximum
of 3.4578 shares (21,256,826 shares aggregate) of our common stock, depending on its quoted market price, in
February 2006. The present value of the future contract adjustment payments of $2.8 million was recorded as a
charge to paid-in capital at inception.
Common Stock Dividends
On April 28, 2005, we declared a cash dividend of $0.16 per share, payable July 11, 2005 to shareholders of
record on June 13, 2005. In the prior year, we declared a dividend of $0.16 per share on April 29, 2004 to our
shareholders of record on June 14, 2004; we paid that dividend on July 12, 2004.
7. Investments Pledged as Collateral and Non-recourse Collateralized Obligations
We are involved with various entities in the normal course of business that are deemed to be variable interest
entities and, as a result, we are deemed to hold interests in those entities. We serve as the investment
advisor to eight collateralized obligation trusts that were organized to take advantage of bond market
arbitrage opportunities, including the three in the table below. These eight collateralized obligation trusts
are investment trusts with aggregate assets of $2.9 billion that are primarily invested in a variety of fixed
income securities acquired from third parties. These collateralized obligation trusts, in turn, issued tranched
collateralized obligations and residual equity securities to third parties, as well as to our principal life
insurance subsidiary's general account. The collateralized obligation trusts reside in bankruptcy remote
special purpose entities for which we provide neither recourse nor guarantees. Accordingly, our sole financial
exposure to these collateralized obligation trusts stems from our life insurance subsidiary's general account
direct investment in certain debt or equity securities issued by these collateralized obligation trusts and our
asset management affiliates' advisory. Our maximum exposure to loss with respect to our life insurance
subsidiary's direct investment in the eight collateralized obligation trusts is $79.3 million at March 31, 2005
($29.9 million of which relates to trusts that are consolidated). Of that exposure, $54.7 million ($20.0
million of which relates to trusts that are consolidated) relates to investment grade debt securities.
We consolidated three collateralized obligation trusts as of March 31, 2005 and 2004. As of March 31, 2005, our
direct investment in these three consolidated collateralized obligation trusts is $29.9 million, $20.0 million
of which is an investment grade debt security as of March 31, 2005. We recognized investment income on debt and
equity securities pledged as collateral, net of interest expense on collateralized obligations and applicable
minority interest of $0.8 million and $0.9 million for the quarters ended March 31, 2005 and 2004,
respectively, related to these three consolidated collateralized obligation trusts.
Consolidated Variable Interest Entities: Mar 31, Dec 31,
($ amounts in millions) 2005 2004
-------------- --------------
Assets Pledged as Collateral, At Fair Value
Phoenix CDO I................................................................. $ 75.4 $ 94.4
Phoenix CDO II................................................................ 285.8 294.5
Phoenix-Mistic 2002-1 CDO, Ltd................................................ 933.1 967.0
-------------- --------------
Total......................................................................... $ 1,294.3 $ 1,355.9
============== ==============
Non-recourse Collateralized Obligations
Phoenix CDO I (March 2011 maturity)........................................... $ 111.3 $ 127.3
Phoenix CDO II (December 2012 mandatorily redeemable)......................... 321.4 329.4
Phoenix-Mistic 2002-1 CDO, Ltd. (September 2014 maturity)..................... 868.7 898.5
-------------- --------------
Total......................................................................... $ 1,301.4 $ 1,355.2
============== ==============
21
Assets pledged as collateral are comprised of available-for-sale debt and equity securities at fair value of
$1,235.1 million and $1,278.8 million at March 31, 2005 and December 31, 2004, respectively. In addition, cash
and accrued investment income of $59.2 million and $77.1 million are included in these amounts at March 31,
2005 and December 31, 2004, respectively.
Non-recourse collateralized obligations are comprised of callable collateralized obligations of $1,234.2
million and $1,253.4 million at March 31, 2005 and December 31, 2004, respectively, and non-recourse derivative
cash flow hedge liabilities of $67.2 million (notional amount of $1,082.7 million with maturities of 2005-2013)
and $101.8 million (notional amount of $1,118.2 million with maturities of 2005-2013) at March 31, 2005 and
December 31, 2004, respectively. Minority interest liabilities related to third-party equity investments in the
consolidated variable interest entities is $34.4 million and $37.7 million at March 31, 2005 and December 31,
2004, respectively.
Fair Value and Cost of Debt and Equity Securities March 31, 2005 December 31, 2004
Pledged as Collateral: ------------------------------ ------------------------------
($ amounts in millions) Fair Value Cost Fair Value Cost
-------------- -------------- -------------- --------------
Debt securities pledged as collateral.............. $ 1,233.7 $ 1,151.1 $ 1,276.9 $ 1,159.9
Equity securities pledged as collateral............ 1.4 0.4 1.9 0.4
-------------- -------------- -------------- --------------
Total debt and equity securities pledged
as collateral.................................... $ 1,235.1 $ 1,151.5 $ 1,278.8 $ 1,160.3
============== ============== ============== ==============
Gross and Net Unrealized Gains and Losses From March 31, 2005 December 31, 2004
Debt and Equity Securities Pledged as Collateral: ------------------------------ ------------------------------
($ amounts in millions) Gains Losses Gains Losses
-------------- -------------- -------------- --------------
Debt securities pledged as collateral.............. $ 101.3 $ (18.7) $ 131.3 $ (14.3)
Equity securities pledged as collateral............ 1.1 (0.1) 1.6 (0.1)
-------------- -------------- -------------- --------------
Total.............................................. $ 102.4 $ (18.8) $ 132.9 $ (14.4)
============== ============== ============== ==============
Net unrealized gains............................... $ 83.6 $ 118.5
============== ==============
Gross unrealized losses related to debt securities pledged as collateral whose fair value is less than the
security's amortized cost total $18.7 million at March 31, 2005. Debt securities with a fair value less than
80% of the security's amortized cost total $10.9 million at March 31, 2005. The majority of these debt
securities are investment grade issues that continue to perform to their original contractual terms at March
31, 2005.
We recognized a $0.3 million and a $4.7 million charge to earnings in the quarters ended March 31, 2005 and
2004, respectively, related to the other-than-temporary impairment of debt securities pledged as collateral.
$0.0 million and $3.7 million of the 2005 and 2004 charge, respectively, relate to our direct investment in
these consolidated trusts.
The effect of the method of consolidation of these three collateralized debt obligation trusts was to increase
our net income by $0.4 million and decrease it $1.0 million for the three months ended March 31, 2005 and 2004,
respectively, and to decrease our stockholders' equity by $71.2 million and $67.5 million as of March 31, 2005
and December 31, 2004, respectively.
The above non-cash charges to earnings and stockholders' equity primarily relate to realized investment and
unrealized investment and derivative cash flow gains (losses) within the collateralized obligation trusts,
which will ultimately be borne by third-party investors in the non-recourse collateralized obligations.
Accordingly, these losses and any future gains or losses under this method of consolidation will ultimately
reverse upon the deconsolidation, maturity or other liquidation of the non-recourse collateralized obligations.
22
GAAP requires us to consolidate all the assets and liabilities of these collateralized obligation trusts, which
results in the recognition of realized and unrealized losses even though we have no legal obligation to fund
such losses in the settlement of the collateralized obligations. The FASB continues to evaluate, through the
issuance of FASB staff positions, the various technical implementation issues related to consolidation
accounting. We will continue to assess the impact of any new implementation guidance issued by the FASB as well
as evolving interpretations among accounting professionals. Additional guidance and interpretations may affect
our application of consolidation accounting in future periods.
The amount of derivative cash flow hedge ineffectiveness recognized for the three months ended March 31, 2005
and 2004 is not material to our consolidated financial statements.
8. Income taxes
For the three months ended March 31, 2005 and 2004, the effective income tax rates applicable to income from
continuing operations differ from the 35.0% U.S. federal statutory tax rate. Items giving rise to the
differences and the effects are as follows:
Analysis of Effective Income Tax Rates: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Income taxes at statutory rate................................................ $ 4.4 $ 8.1
Tax advantaged investment income.............................................. (1.5) (1.3)
Other, net.................................................................... (0.1) 0.3
-------------- --------------
Income taxes applicable to continuing operations.............................. $ 2.8 $ 7.1
============== ==============
Effective income tax rates.................................................... 22.4% 30.7%
============== ==============
9. Employee Benefits
Pension and other postretirement benefits
We provide our employees with postemployment benefits that include retirement benefits, through pension and
savings plans, and other benefits, including health care and life insurance. The components of pension and
postretirement benefit costs follow:
Components of Pension Benefit Costs: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Service cost.................................................................. $ 2.7 $ 3.3
Interest cost................................................................. 8.4 8.0
Expected return on plan assets................................................ (8.2) (8.1)
Net loss amortization......................................................... 1.5 1.2
Prior service cost amortization............................................... 0.2 0.3
Net transition asset amortization............................................. -- (0.6)
-------------- --------------
Pension benefit cost.......................................................... $ 4.6 $ 4.1
============== ==============
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Components of Other Postretirement Benefit Costs: Three Months Ended
($ amounts in millions) March 31,
------------------------------
2005 2004
-------------- --------------
Service cost.................................................................. $ 0.4 $ 0.5
Interest cost................................................................. 1.0 1.1
Net gain amortization......................................................... (0.1) --
Prior service cost amortization............................................... (0.4) (0.7)
-------------- --------------
Other postretirement benefit cost............................................. $ 0.9 $ 0.9
============== ==============
Savings Plans
During the three months ended March 31, 2005 and 2004, we incurred costs of $1.4 million and $1.8 million,
respectively, for contributions to our employer-sponsored savings plans.
Our contributions to sponsored savings plans may be in the form of common stock or cash. During the three
months ended March 31, 2005 and 2004, we contributed 111,688 and 134,281 treasury shares, respectively, to fund
the employer match for our saving and investment benefit plans. These shares had a cost basis of $1.7 million
and $2.2 million and an aggregate market value of $1.4 million and $1.8 million for the three months ended
March 31, 2005 and 2004, respectively.
Stock-based compensation
Stock Option Activity: Three Months Ended March 31,
--------------------------------------------------------------
2005 2004
------------------------------ ------------------------------
Number Weighted- Number Weighted-
of Average of Average
Common Exercise Common Exercise
Shares Price Shares Price
-------------- -------------- -------------- --------------
Outstanding, beginning of period............. 4,329,983 $ 15.05 4,627,856 $ 15.45
Granted...................................... 50,000 12.91 130,000 13.00
Exercised.................................... (6,180) 9.07 -- --
Canceled..................................... (100,425) 15.47 (208,167) 15.74
-------------- --------------
Outstanding, end of period................... 4,273,378 $ 15.03 4,549,689 $ 15.37
============== ============== ============== ==============
During the first quarter of 2005, we granted 50,000 stock options which vest over three years. The options had
a fair value of $4.64 per option ($0.6 million aggregate) which we are expensing over their three-year vesting
period.
At March 31, 2005, 2,754,306 of outstanding stock options were exercisable, with a weighted-average exercise
price of $15.86. At March 31, 2005, the weighted-average remaining contractual life for all options outstanding
was 7.6 years.
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Restricted Stock Units (RSUs)
RSU Activity At Weighted-Average Grant Price: Three Months Ended March 31,
--------------------------------------------------------------
2005 2004
------------------------------ ------------------------------
RSUs Price RSUs Price
-------------- -------------- -------------- --------------
Outstanding, beginning of period................ 1,649,888 $ 10.61 1,436,843 $ 10.47
Awarded to officers and directors............... 91,995 12.84 46,073 14.03
-------------- --------------
Outstanding, end of period...................... 1,741,883 $ 10.73 1,482,916 $ 10.58
============== ============== ============== ==============
Generally, the shares underlying these awards which are or become vested will be issued on the later of June
26, 2006 or each employee's and each director's respective termination or retirement.
10. Earnings Per Share
Shares Used in Calculation of Basic and Diluted Earnings Per Share: Three Months Ended
(in thousands) March 31,
------------------------------
2005 2004
-------------- --------------
Weighted-average common shares outstanding..................................... 94,930 94,512
-------------- --------------
Effect of potential common shares:
Equity units................................................................. 5,489 5,884
Restricted stock units....................................................... 1,713 1,456
Director and employee stock options.......................................... 169 156
-------------- --------------
Dilutive potential common shares............................................... 7,371 7,496
-------------- --------------
Weighted-average common shares outstanding and dilutive potential
common shares................................................................ 102,301 102,008
============== ==============
Employee stock options and equity units excluded from calculation due to anti-dilutive
exercise prices (i.e., in excess of average common share market prices)
Stock options.............................................................. 3,499 3,996
Equity units............................................................... -- --
11. Contingent Liabilities
In addition to the matters discussed below, we are, in the normal course of business, involved in litigation
both as a defendant and as a plaintiff. The litigation naming us as a defendant ordinarily involves our
activities as an insurer, employer, investment advisor, investor or taxpayer. In addition, various regulatory
bodies regularly make inquiries of us and, from time to time, conduct examinations or investigations concerning
our compliance with, among other things, insurance laws, securities laws and laws governing the activities of
broker-dealers. While it is not feasible to predict or determine the ultimate outcome of all pending
investigations and legal proceedings or to provide reasonable ranges of potential losses, we believe that their
outcomes are not likely, either individually or in the aggregate, to have a material adverse effect on our
consolidated financial condition. However, given the large or indeterminate amounts sought in certain of these
matters and litigation's inherent unpredictability, it is possible that an adverse outcome in certain matters
could, from time to time, have a material adverse effect on our results of operations or cash flows.
Discontinued Reinsurance Operations
In 1999, we discontinued our reinsurance operations through a combination of sale, reinsurance and placement of
certain retained group accident and health reinsurance business into run-off. We adopted a formal plan to stop
writing new contracts covering these risks and to end the existing contracts as soon as those contracts would
permit. However, we remain liable for claims under those contracts.
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We have established reserves for claims and related expenses that we expect to pay on our discontinued group
accident and health reinsurance business. These reserves are based on currently known facts and estimates
about, among other things, the amount of insured losses and expenses that we believe we will pay, the period
over which they will be paid, the amount of reinsurance we believe we will collect from our retrocessionaires
and the likely legal and administrative costs of winding down the business.
Our total reserves, including reserves for amounts recoverable from retrocessionaires, were $100.0 million as
of March 31, 2005 and $110.0 million and December 31, 2004. Our total amounts recoverable from
retrocessionaires related to paid losses were $62.0 million as of March 31, 2005 and $60.0 million as of
December 31, 2004. We did not recognize any gains or losses related to our discontinued group accident and
health reinsurance business during the quarter ended March 31, 2005 and 2004, respectively.
As of March 31, 2005 and December 31, 2004, we have a reinsurance recoverable balance related to paid losses of
$45.0 million from a retrocessionaire that has been the subject of an appeal of a London arbitration decision.
In June 2003, the arbitration panel issued a decision, which upheld in all material respects the retrocessional
obligations to us. The retrocessionaire appealed the arbitration decision only with respect to the Unicover
business. We received a favorable decision from the Court of Appeals in December 2004. In January 2005, the
retrocessionaire submitted a request to the House of Lords to review the decision. In April 2005, the House of
Lords refused to review the decision