1 ======================================================================================================================================== 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, 2002 -------------- 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__. - On March 31, 2002, the registrant had 100,054,114 shares of common stock outstanding. ======================================================================================================================================== TABLE OF CONTENTS PART I. FINANCIAL INFORMATION Item 1. Unaudited Consolidated Financial Statements: Consolidated Balance Sheet as of March 31, 2002 and December 31, 2001 Consolidated Statement of Income and Comprehensive Income for the three months ended March 31, 2002 and 2001 Consolidated Statement of Cash Flows for the three months ended March 31, 2002 and 2001 Consolidated Statement of Changes in Stockholders' Equity for the three months ended March 31, 2002 and 2001 Notes to Unaudited Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 2. Changes in Securities and Use of Proceeds Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K Signature PART I. FINANCIAL INFORMATION ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS THE PHOENIX COMPANIES, INC. Consolidated Balance Sheet (Amounts in millions, except per share data) March 31, 2002 and December 31, 2001 2002 2001 ASSETS: Available-for-sale debt securities, at fair value................. $ 10,014.0 $ 9,607.7 Equity securities, at fair value.................................. 303.7 290.9 Mortgage loans, at unpaid principal balances...................... 522.7 535.8 Real estate, at lower of cost or fair value....................... 75.3 83.1 Venture capital partnerships, at equity in net assets............. 290.3 291.7 Affiliate equity and debt securities.............................. 295.1 330.6 Policy loans, at unpaid principal balances........................ 2,162.8 2,172.2 Other investments................................................. 278.0 282.4 ----------- ----------- Total investments............................................. 13,941.9 13,594.4 Cash and cash equivalents......................................... 564.4 815.5 Accrued investment income......................................... 217.0 203.1 Premiums, accounts and notes receivable........................... 187.8 147.8 Reinsurance recoverable balances.................................. 55.9 21.3 Deferred policy acquisition costs................................. 1,191.8 1,123.7 Premises and equipment............................................ 117.3 117.7 Deferred income taxes............................................. -- 1.8 Goodwill and other intangible assets.............................. 832.8 858.6 Net assets of discontinued operations............................. 20.7 20.8 Other general account assets...................................... 25.7 50.7 Separate account and investment trust assets...................... 5,711.2 5,570.0 ----------- ----------- Total assets.................................................. $22,866.5 $22,525.4 ============ =========== LIABILITIES: Policy liabilities and accruals................................... $13,395.6 $13,005.0 Policyholder deposit funds........................................ 340.5 356.6 Deferred income taxes............................................. 2.7 -- Indebtedness...................................................... 599.9 599.3 Other general account liabilities................................. 596.8 595.1 Separate account and investment trust liabilities................. 5,708.0 5,564.9 ------------ ----------- Total liabilities............................................. 20,643.5 20,120.9 MINORITY INTEREST: ------------ ----------- Minority interest in net assets of subsidiaries................... 4.1 8.8 ------------ ----------- STOCKHOLDERS' EQUITY: Common stock, $0.01 par value: 1.0 billion shares authorized; 106.4 million shares issued................................... 1.0 1.0 Additional paid-in capital........................................ 2,410.4 2,410.4 Accumulated deficit............................................... (132.3) (30.8) Accumulated other comprehensive income............................ 38.8 81.1 Treasury stock, at cost: 6.3 million and 4.5 million shares (99.0) (66.0) ------------ ----------- Total stockholders' equity.................................... 2,218.9 2,395.7 ------------ ----------- Total liabilities, minority interest and stockholders'equity.. $22,866.5 $22,525.4 ============== =============== The accompanying notes are an integral part of these consolidated financial statements. THE PHOENIX COMPANIES, INC. Consolidated Statement of Income and Comprehensive Income (Amounts in millions, except per share data) Three Months Ended March 31, 2002 and 2001 2002 2001 ----------- ----------- REVENUES: Premiums................................................................ $ 257.4 $ 266.0 Insurance and investment product fees................................... 140.3 145.5 Net investment income................................................... 231.2 168.2 Net realized investment losses.......................................... (35.0) (15.6) ----------- ----------- Total revenues...................................................... 593.9 564.1 ----------- ----------- BENEFITS AND EXPENSES: Policy benefits and increases in policy liabilities..................... 333.9 334.1 Policyholder dividends.................................................. 74.2 106.3 Policy acquisition cost amortization.................................... (10.9) 35.1 Intangible asset amortization........................................... 8.1 13.2 Interest expense........................................................ 7.7 7.1 Demutualization expenses................................................ .9 10.7 Other operating expenses................................................ 136.0 237.4 ----------- ----------- Total benefits and expenses 549.9 743.9 ----------- ----------- Income (loss) before income taxes and minority interest................. 44.0 (179.8) Applicable income tax expense (benefit)................................. 12.3 (69.0) ----------- ----------- Income (loss) before minority interest.................................. 31.7 (110.8) Minority interest in net income of subsidiaries......................... (2.8) (1.8) ----------- ----------- Income (loss) before cumulative effect of accounting changes ........... 28.9 (112.6) Cumulative effect of accounting changes: Goodwill impairment (note 4)........................................ (130.3) -- Venture capital partnerships and derivative financial instruments... -- (44.9) ----------- ----------- Net loss................................................................ $(101.4) $ (157.5) =========== =========== EARNINGS PER SHARE (note 3) : Income (loss) before cumulative effect of accounting changes ........... $ 0.29 $ (1.08) Cumulative effect of accounting changes................................. (1.29) (.43) ----------- ----------- Net loss................................................................ $ (1.00) $ (1.51) =========== =========== Weighted-average common shares outstanding.............................. 101.2 104.6 =========== =========== Pro forma amounts assuming the goodwill change is applied retroactively: Net income (loss)....................................................... $ 28.9 $ (153.7) =========== =========== Earnings per share...................................................... $ 0.29 $ (1.47) =========== =========== COMPREHENSIVE INCOME: Net loss................................................................ $(101.4) $ (157.5) Other comprehensive loss: Net unrealized investment losses.................................... (28.6) (12.7) Net unrealized foreign currency translation adjustment and other.... (13.7) (3.3) ----------- ----------- Total other comprehensive loss.................................. (42.3) (16.0) ----------- ----------- Comprehensive loss...................................................... $(143.7) $ (173.5) =========== =========== The accompanying notes are an integral part of these consolidated financial statements. THE PHOENIX COMPANIES, INC. Consolidated Condensed Statement of Cash Flows (Amounts in millions) Three Months Ended March 31, 2002 and 2001 2002 2001 ------------ ----------- OPERATING ACTIVITIES: Net loss................................................................. $ (101.4) $ (157.5) ------------ ----------- Cash from (for) operations............................................... 7.7 (23.5) ------------ ----------- INVESTING ACTIVITIES: Available-for-sale debt security sales................................... 210.2 240.8 Debt security maturities: Available-for-sale.................................................... 268.1 29.9 Held-to-maturity...................................................... -- 4.2 Debt security repayments: Available-for-sale.................................................... 8.6 94.3 Held-to-maturity -- 41.9 Equity security sales.................................................... 13.1 39.7 Subsidiary sales......................................................... -- 2.0 Mortgage loan maturities................................................. 4.1 16.2 Mortgage loan principal repayments....................................... 9.2 8.1 Venture capital partnership distributions................................ 9.2 9.2 Real estate and other invested assets sales.............................. 22.2 .7 Available-for-sale debt security purchases............................... (944.2) (520.5) Held-to-maturity debt security purchases................................. -- (68.9) Equity security purchases................................................ (14.1) (23.5) Subsidiary purchases..................................................... (110.8) (367.2) Mortgage loan principal disbursements.................................... -- (.2) Unconsolidated affiliate and other invested asset purchases.............. (20.0) (12.4) Venture capital partnership investments.................................. (13.0) (12.9) Other continuing operation investing activities, net..................... (6.5) (6.1) Policy loan advances, net................................................ 9.4 (16.5) Premises and equipment additions......................................... (4.3) (3.9) ------------ ----------- Cash for continuing operations........................................... (558.8) (545.1) Cash from discontinued operations........................................ 25.4 16.0 ------------ ----------- Cash for investing activities............................................ (533.4) (529.1) ------------ ----------- FINANCING ACTIVITES: Policyholder deposit fund receipts, net.................................. 315.9 100.9 Indebtedness proceeds.................................................... .7 180.0 Indebtedness repayments.................................................. -- (115.0) Debenture repayments..................................................... -- (19.2) Common stock repurchases................................................. (32.9) -- Minority interest distributions.......................................... (9.1) (5.8) ------------ ----------- Cash from financing activities........................................... 274.6 140.9 ------------ ----------- Cash and cash equivalents changes........................................ (251.1) (411.7) Cash and cash equivalents, beginning of period........................... 815.5 720.0 ------------ ----------- Cash and cash equivalents, end of period................................. $ 564.4 $ 308.3 ============ =========== The accompanying notes are an integral part of these consolidated financial statements. THE PHOENIX COMPANIES, INC. Consolidated Statement of Changes in Stockholders' Equity (Amounts in millions) Three Months Ended March 31, 2002 and 2001 2002 2001 ----------- ----------- Stockholders' equity, beginning of period............................... $ 2,395.7 $ 1,840.9 Accumulated deficit: Net loss................................................................ (101.4) (157.5) Other equity adjustments................................................ -- 3.2 Accumulated other comprehensive income: Other comprehensive loss................................................ (42.3) (16.0) Treasury stock: Common shares acquired.................................................. (33.1) -- ----------- ----------- Stockholders' equity, end of period..................................... $ 2,218.9 $ 1,670.6 =========== =========== The accompanying notes are an integral part of these consolidated financial statements. THE PHOENIX COMPANIES, INC. Notes to the Unaudited Consolidated Financial Statements 1. Description of Business The Phoenix Companies, Inc. and its subsidiaries ("Phoenix") provide 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. Phoenix offers a broad range of life insurance, annuity and investment management solutions through a variety of distributors. These products and services are managed within four reportable segments: Life and Annuity, Investment Management, Venture Capital and Corporate and Other. See note 6, "Segment Information." 2. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair statement have been included. Operating results for the three months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements of Phoenix for the year ended December 31, 2001 on Form 10-K. 3. Reorganization and Initial Public Offering On December 18, 2000, the board of directors of Phoenix Home Life Mutual Insurance Company ("Phoenix Mutual") unanimously adopted a plan of reorganization which was amended and restated on January 26, 2001. On June 25, 2001, the effective date of the demutualization, Phoenix Mutual converted from a mutual life insurance company to a stock life insurance company, became a wholly owned subsidiary of Phoenix and changed its name to Phoenix Life Insurance Company ("Phoenix Life"). At the same time, Phoenix Investment Partners, Ltd. ("PXP") became an indirect wholly owned subsidiary of Phoenix. All policyholder membership interests in the mutual company were extinguished on the effective date and eligible policyholders of the mutual company received 56.2 million shares of common stock, $28.8 million of cash and $12.7 million of policy credits as compensation. The demutualization was accounted for as a reorganization. Accordingly, Phoenix's retained earnings immediately following the demutualization and the closing of the Initial Public Offering ("IPO") on June 25, 2001 (net of the cash payments and policy credits that were charged directly to retained earnings) were reclassified to common stock and additional paid-in capital. In addition, Phoenix Life established a closed block for the benefit of holders of certain of its individual life insurance policies. The purpose of the closed block is to protect, after demutualization, the reasonable policy dividend expectations of the holders of the policies included in the closed block. The closed block will continue in effect until such date as none of such policies are in force. See note 7, "Closed Block." On June 25, 2001, Phoenix closed its IPO, in which 48.8 million shares of common stock were issued at a price of $17.50 per share. Net proceeds from the IPO equaling $807.9 million were contributed to Phoenix Life. On July 24, 2001, Morgan Stanley Dean Witter exercised its right to purchase 1,395,900 shares of the common stock of Phoenix at the IPO price of $17.50 per share less underwriters discount. Net proceeds of $23.2 million were contributed to Phoenix Life. The 2001 weighted-average shares outstanding calculation for earnings per share is pro forma and excludes the period of time before the IPO during which no common stock shares were issued. 4. Summary of New Significant Accounting Policies Business Combinations/Goodwill and Other Intangible Assets Effective January 1, 2002, Phoenix adopted a new accounting standard for goodwill and other intangible assets. The standard primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. Under the standard, amortization of goodwill and other intangible assets with indefinite lives recorded in past business combinations is discontinued after 2001 and reporting units must be identified for the purpose of assessing potential future impairments of goodwill. In accordance with the standard, goodwill amortization will not be recognized after 2001. The provisions of the standard also apply to equity-method investments. The standard prohibits amortization of the excess of cost over the underlying equity in the net assets of an equity-method investee that is recognized as goodwill. The standard also requires that goodwill and indefinite-lived intangible assets be tested at least annually for impairment. Upon adoption of the standard, goodwill and indefinite-lived intangibles were tested for impairment by comparing the fair value to the carrying amount of the asset as of the beginning of 2002. The effect of adopting the standard in 2002 decreased after-tax income by $130.3 million ($1.29 per share) for the three months ended March 31, 2002, primarily due to declines in the market value of the business units previously acquired. Phoenix recognized $4.0 million in goodwill amortization in the first quarter of 2001. Impairment of Long-Lived Assets Effective January 1, 2002, Phoenix adopted a new accounting standard, Accounting for the Impairment or Disposal of Long-Lived Assets. Under the standard, long-lived assets to be sold within one year must be separately identified and carried at the lower of carrying value or fair value less cost to sell. Long-lived assets expected to be held longer than one year are subject to depreciation and must be written down to fair value upon impairment. Long-lived assets no longer expected to be sold within one year, such as some foreclosed real estate, must be written down to the lower of current fair value or fair value at the date of foreclosure adjusted to reflect depreciation since acquisition. Upon adoption of the standard, Phoenix determined there was no material effect on its results of operations or financial condition. 5. Significant Transactions PXP's Purchase of Kayne Anderson Rudnick Investment Management, LLC On January 29, 2002, PXP acquired a majority interest in Kayne Anderson Rudnick. In accordance with the terms of the acquisition agreement, PXP purchased an initial 60% interest, with future purchases of an additional 15% to occur by 2007. Its management retained the remaining ownership interests in Kayne Anderson Rudnick. In addition to the cash payment of approximately $100 million made at closing, a subsequent payment may be made in 2004 based upon management fee revenue growth of the purchased business through 2003. Kayne Anderson Rudnick, based in Los Angeles, California, had approximately $9.0 billion in assets under management at March 31, 2002. Kayne Anderson Rudnick's results of operations for the period beginning January 30, 2002 through March 31, 2002 are included in our consolidated results of operations for the three months ended March 31, 2002. Our 2001 results do not include the financial results of Kayne Anderson Rudnick. Stock Repurchase Program On September 17, 2001, Phoenix announced a plan to repurchase up to an aggregate of six million shares of the company's outstanding common stock. On January 7, 2002, Phoenix announced its authorization to repurchase up to an aggregate of five million additional shares, bringing the combined share repurchase authorization up to an aggregate of 11 million shares of common stock. Purchases can be made on the open market, as well as through negotiated transactions, subject to market prices and other conditions. No time limit was placed on the duration of the repurchase program, which may be modified, extended or terminated by the board of directors at any time. For the three months ended March 31, 2002, 1,858,700 shares of the company's common stock had been repurchased at a cumulative weighted-average price of $17.73 per share. Deferred Policy Acquisition Costs In the first quarter of 2002, Phoenix refined 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 $22.1 million increase in the DAC balances. 6. Segment Information The following tables provide certain information with respect to Phoenix's operating segments as of March 31, 2002, December 31, 2001 and for each of the three months ended March 31, 2002 and 2001 (amounts in millions). 2002 2001 ------------- ------------- Total consolidated revenues: Life and Annuity.................................... $ 558.2 $ 562.5 Investment Management............................... 69.9 73.2 Venture Capital..................................... (5.0) (57.3) Corporate and Other................................. 10.2 6.6 ------------- ------------- Total segment revenues........................... 633.3 585.0 Net realized investment losses...................... (35.0) (15.6) Inter-segment revenues.............................. (4.4) (5.3) ------------- ------------- Total consolidated revenues...................... $ 593.9 $ 564.1 ============= ============= Investment Life and Annuity Management ------------------------ ---------------------- 2002 2001 2002 2001 ---------- ---------- --------- --------- Premiums....................................... $ 257.4 $ 266.0 $ -- $ -- Insurance and investment product fees.......... 77.6 78.3 66.7 70.7 Net investment income.......................... 223.2 218.2 3.2 2.5 ---------- ---------- --------- --------- Total revenues.............................. $ 558.2 $ 562.5 $69.9 $73.2 ========== ========== ========= ========= 2002 2001 ------------- ------------- Operating income before income taxes: Life and Annuity................................... $ 28.2 $ 9.0 Investment Management.............................. 1.9 1.7 Venture Capital.................................... (5.0) (57.3) Corporate and Other................................ (8.7) (18.9) ------------- ------------- Operating income before income taxes............... 16.4 (65.5) Applicable income taxes............................ 3.6 (25.6) ------------- ------------- Operating income................................... 12.8 (39.9) Net realized investment gains (losses), net of income taxes........................................... 1.6 (10.1) Non-recurring items, net of income taxes........... 14.5 (62.6) ------------- ------------- Income (loss) before cumulative effect of accounting changes......................................... $ 28.9 $ (112.6) ============= ============= Total consolidated assets: Life and Annuity................................... $ 19,806.1 $ 18,925.0 Investment Management.............................. 1,101.3 1,165.0 Venture Capital.................................... 290.3 291.7 Corporate and Other................................ 1,648.1 2,122.9 ------------- ------------- Total segment assets............................ 22,845.8 22,504.6 Net assets of discontinued operations.............. 20.7 20.8 ------------- ------------- Total consolidated assets....................... $ 22,866.5 $ 22,525.4 ============= ============= 7. Closed Block On the date of demutualization, Phoenix Life established a closed block for the benefit of holders of certain individual participating life insurance policies and annuities of Phoenix Life for which Phoenix Life had a dividend scale payable in 2000. See note 15 of Phoenix's consolidated financial statements for the year ended December 31, 2001 in Phoenix's Form 10-K for more information on the closed block. As specified in the plan of reorganization, the allocation of assets for the closed block was made as of December 31, 1999. Consequently, cumulative earnings on the closed block assets and liabilities for the period January 1, 2001 to March 31, 2002 in excess of expected cumulative earnings did not inure to stockholders and have been used to establish a policyholder dividend obligation as of March 31, 2002. The decrease in the policyholder dividend obligation of $64.4 million pre-tax, consists of $26.2 million of pre-tax losses for the period January 1, 2002 to March 31, 2002 and the unrealized losses on assets in the closed block for the period January 1, 2002 to March 31, 2002 of $38.2 million, pre-tax. The following sets forth certain summarized financial information relating to the closed block as of March 31, 2002 and December 31, 2001 (in millions): 2002 2001 -------------- ------------ LIABILITIES: Policy liabilities and accruals and policyholder deposit funds..... $ 9,202.2 $ 9,150.2 Policyholder dividends payable..................................... 366.4 357.3 Policyholder dividend obligation................................... 102.8 167.2 Other closed block liabilities..................................... 62.5 57.0 -------------- ------------ Total closed block liabilities..................................... 9,733.9 9,731.7 -------------- ------------ ASSETS: Available-for-sale debt securities at fair value................... 5,812.0 5,734.2 Mortgage loans..................................................... 380.5 386.5 Policy loans....................................................... 1,399.8 1,407.1 Deferred income taxes.............................................. 391.9 392.6 Investment income due and accrued.................................. 127.4 125.3 Net due and deferred premiums...................................... 39.5 41.1 Cash and cash equivalents.......................................... 162.7 239.7 Other closed block assets.......................................... 43.4 14.8 -------------- ------------ Total closed block assets.......................................... 8,357.2 8,341.3 -------------- ------------ Excess of reported closed block liabilities over closed block assets representing maximum future earnings to be recognized from closed block assets and liabilities............................. $ 1,376.7 $ 1,390.4 ============== ============ CHANGE IN POLICYHOLDER DIVIDEND OBLIGATION: Balance at beginning of period..................................... $ 167.2 $ 115.5 Change during the period........................................... (64.4) 51.7 -------------- ------------ Balance at end of period........................................... $ 102.8 $ 167.2 ============== ============ The following sets forth certain summarized financial information relating to the closed block for the quarter ended March 31, 2002 (in millions): REVENUES: Premiums........................................................... $ 248.7 Net investment income.............................................. 138.8 Realized investment losses, net.................................... (36.1) -------------- Total revenues..................................................... 351.4 -------------- EXPENSES: Benefits to policyholders.......................................... 253.5 Other operating costs and expenses................................. 2.8 Change in policyholder dividend obligation......................... (26.2) Dividends to policyholders......................................... 100.2 -------------- Total benefits and expenses........................................ 330.3 -------------- Contribution from the closed block, before income taxes ........... 21.1 Income tax expense................................................. 7.4 -------------- Contributions from closed block, after income taxes ................ $ 13.7 ============== 8. Discontinued Reinsurance Operations In 1999, Phoenix exited its reinsurance operations through a combination of sale, reinsurance and placement of certain components into run-off. The reinsurance segment consisted primarily of individual life reinsurance operations as well as group accident and health reinsurance business. Phoenix placed the retained group accident and health reinsurance business into run-off. Phoenix 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, Phoenix remained liable for claims under those contracts. Phoenix has reviewed its estimates of future losses related to the group accident and health reinsurance business as well as future expenses associated with managing the run-off. Based on the most recent information available, Phoenix did not recognize any additional reserve provisions during the first three months of 2002. Phoenix's reserves and aggregate excess of loss reinsurance coverage are expected 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, Phoenix expects to pay claims out of existing estimated reserves for up to ten years as the level of business diminishes. A significant portion of the claims arising from the 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 certain other facilities, which reinsured the life and health insurance components of workers' compensation insurance policies issued by various property and casualty insurance companies. Phoenix was a member of the Unicover pool. Phoenix terminated its participation in the Unicover pool effective March 1, 1999. Phoenix is 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, Phoenix is involved in several disputes 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, Phoenix was, 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, Phoenix joined an arbitration proceeding that Sun Life had begun against the members of the Unicover pool and the Unicover facilities. In this arbitration, Phoenix and Sun Life sought to cancel their retrocession agreement on the grounds that material misstatements and nondisclosures were made to them about, among other things, the amount of risks they would be reinsuring. The arbitration proceedings are ongoing only with respect to the Unicover pool, because Phoenix, Sun Life and Cologne Life reached settlement with the two Unicover facilities in the first quarter of 2000. In its capacity as a retrocessionaire of the Unicover business, Phoenix had an extensive program of its own reinsurance in place to protect it from financial exposure to the risks it had assumed. Currently, Phoenix is involved in separate arbitration proceedings with certain of its own retrocessionaires which are seeking on various grounds to avoid paying any amounts to Phoenix. Most of these proceedings remain in their preliminary phases. Because the same retrocession program that covers Phoenix's Unicover business covers a significant portion of its other remaining group accident and health reinsurance business, Phoenix could have additional material losses if one or more of its retrocesssionaires successfully avoids its obligations. A second set of disputes involves personal accident business that was reinsured in the London reinsurance market in the mid-1990s in which Phoenix participated. The 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 arbitrations in which those top layer companies are attempting 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 Phoenix believes that similar discussions will follow for the remaining years. Although Phoenix is vigorously defending its contractual rights, Phoenix is actively involved in the attempt to reach negotiated business solutions. Given the uncertainty associated with litigation and other dispute resolution proceedings, and the expected long-term development of net claims payments, the estimated amount of the loss on disposal of reinsurance discontinued operations may differ from actual results. However, it is management's opinion, after consideration of the provisions made in these financial statements, that future developments will not have a material effect on Phoenix's consolidated financial position. The assets and liabilities of the discontinued operations have been excluded from the assets and liabilities of continuing operations and separately identified on the Consolidated Balance Sheet. Net assets of the discontinued operations totaled $20.7 million and $20.8 million as of March 31, 2002 and December 31, 2001, respectively. There were no discontinued reinsurance operating results for the three months ended March 31, 2002 and 2001 because the operations were discontinued prior to January 1, 2001. 9. Commitments and Contingencies Certain group accident and health reinsurance business has become the subject of disputes concerning the placement of the business with reinsurers and the recovery of the reinsurance. See note 8, "Discontinued Operations." Under the terms of the Capital West Asset Management, LLC ("CapWest") purchase agreement, PXP may be obligated to pay more for its initial 65% ownership interest in 2005 depending upon CapWest's revenue growth through 2004. In addition, under the terms of the purchase agreement, PXP will purchase an additional 10% ownership interest in CapWest by 2007. Under the terms of the Kayne Anderson Rudnick purchase agreement, PXP will purchase an additional 15% ownership interest by 2007. PXP may be obligated to pay additional sums in 2004 for its initial 60% interest based upon Kayne Anderson Rudnick's management fee revenue growth through 2003. Under the terms of the Seneca purchase agreement, PXP is obligated to make additional payments for its ownership interest in 2002 and future years to the extent there is growth in Seneca's revenues. This amount totaled $3.5 million in the first quarter of 2002. Phoenix makes off-balance sheet commitments related to venture capital partnerships. As of March 31, 2002, total unfunded capital commitments were $162.0 million. Phoenix also unconditionally guarantees loans to Phoenix Life and PXP under the master credit facility. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's discussion and analysis reviews our consolidated financial condition as of March 31, 2002 as compared to December 31, 2001; our consolidated results of operations for the three months ended March 31, 2002 and 2001; and, where appropriate, factors that may affect our future financial performance. This discussion and analysis should be read in conjunction with the unaudited interim financial statements and notes thereto of The Phoenix Companies, Inc. ("Phoenix") contained in this filing as well as in conjunction with the audited financial statements and related notes included in the Annual Report on Form 10-K of Phoenix for the year ended December 31, 2001. This quarterly report contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include statements relating to trends in, or representing management's beliefs about, Phoenix'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 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) Phoenix's primary reliance, as a holding company, on dividends from its subsidiaries to meet debt payment obligations and the applicable regulatory restrictions on the ability of the subsidiaries to pay such dividends; (iv) regulatory, accounting or tax changes that may affect the cost of, or demand for, the products or services of Phoenix's subsidiaries; (v) downgrades in the claims paying ability or financial strength ratings of Phoenix's subsidiaries; (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) Phoenix's success in achieving its planned expense reductions; (ix) and other risks and uncertainties described from time to time in Phoenix's filings with the Securities and Exchange Commission. Phoenix specifically disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. 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. Our Demutualization On June 25, 2001, Phoenix Home Life Mutual Insurance Company ("Phoenix Mutual") converted from a mutual life insurance company to a stock life insurance company, became a wholly owned subsidiary of Phoenix and changed its name to Phoenix Life Insurance Company ("Phoenix Life"). At the same time, Phoenix Investment Partners, Ltd. ("PXP") became an indirect wholly owned subsidiary of Phoenix. Phoenix Life established a closed block for the benefit of holders of certain individual life insurance policies (closed block policies). The purpose of the closed block is to ensure that the reasonable dividend expectations of policyholders who own policies included in the closed block are met. The closed block will continue in effect until the date none of such policies is in force. On June 25, 2001, Phoenix Life allocated assets to the closed block in an amount that produces cash flows which, together with anticipated revenue from the closed block policies, are reasonably expected to be sufficient in the aggregate: (i) to support the obligations and liabilities relating to these policies, and (ii) to provide for a continuation of dividend scales in effect at that time, if the experience underlying such scales continues. Appropriate adjustments will be made to the dividend scales when actual experience differs from the aggregate experience underlying such scales. In addition to the closed block assets, we hold assets outside the closed block in support of closed block liabilities. Investment earnings on these assets less allocated expenses and the amortization of deferred acquisition costs provide an additional source of earnings to our stockholders. In addition, the amortization of deferred acquisition costs requires the use of various assumptions. To the extent that actual experience is more or less favorable than assumed, stockholder earnings will be impacted. In addition, Phoenix Life remains responsible for paying the benefits guaranteed under the policies included in the closed block, even if cash flows and revenues from the closed block prove insufficient. We funded the closed block to provide for these payments and for continuation of dividends paid under 2000 policy dividend scales, assuming the experience underlying such dividend scales continues. Therefore, we do not believe that Phoenix Life will have to pay these benefits from assets outside the closed block unless the closed block business experiences very substantial adverse deviations in investment, mortality, persistency or other experience factors. We intend to accrue any additional contributions necessary to fund guaranteed benefits under the closed block if and when it becomes probable that we will be required to fund any shortage. The allocation of assets for the closed block was made as of December 31, 1999. Consequently, cumulative earnings on the closed block assets and liabilities for the period January 1, 2001 to March 31, 2002 in excess of expected cumulative earnings do not inure to stockholders and have been used to establish a policyholder dividend obligation as of March 31, 2002. The decrease in the policyholder dividend obligation of $64.4 million pre-tax, consists of $26.2 million of pre-tax losses for the period January 1, 2002 to March 31, 2002 and the unrealized losses on assets in the closed block for the period January 1, 2002 to March 31, 2002 of $38.2 million, pre-tax. We incurred costs relating to the demutualization, excluding costs relating to the initial public offering, of $38.6 million, net of income taxes of $10.0 million, of which $14.1 million was recognized in the year ended December 31, 2000, $23.9 million was recognized in the year ended December 31, 2001 and $0.6 million was recognized in the three months ended March 31, 2002. We estimate we will have additional after-tax expenses relating to the demutualization of $0.2 million in 2002. Recently Issued Accounting Standards Business Combinations/Goodwill and Other Intangible Assets. Effective January 1, 2002, we adopted a new accounting standard for goodwill and other intangible assets. The standard primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. Under the standard, amortization of goodwill and other intangible assets with indefinite lives recorded in past business combinations is discontinued after 2001 and reporting units must be identified for the purpose of assessing potential future impairments of goodwill. In accordance with the standard, goodwill amortization will not be recognized after 2001. The provisions of the standard also apply to equity-method investments. The standard prohibits amortization of the excess of cost over the underlying equity in the net assets of an equity-method investee that is recognized as goodwill. The standard also requires that goodwill and indefinite-lived intangible assets be tested at least annually for impairment. Upon adoption of the standard, intangible assets deemed to have an indefinite life was tested for impairment by comparing the fair value to the carrying amount of the asset as of the beginning of the fiscal year in the year of adoption. The effect of adopting the standard in 2002 decreased after-tax income by $130.3 million ($1.29 per share) for the three months ended March 31, 2002, primarily due to declines in the market value of the business units previously acquired. Goodwill amortization recognized in the first quarter of 2001 was $4.0 million. Impairment of Long-Lived Assets. Effective January 1, 2002, we adopted a new accounting standard, Accounting for the Impairment or Disposal of Long-Lived Assets. Under the standard, long-lived assets to be sold within one year must be separately identified and carried at the lower of carrying value or fair value less cost to sell. Long-lived assets expected to be held longer than one year are subject to depreciation and must be written down to fair value upon impairment. Long-lived assets no longer expected to be sold within one year, such as some foreclosed real estate, must be written down to the lower of current fair value or fair value at the date of foreclosure adjusted to reflect depreciation since acquisition. Upon adoption of the standard, we determined there was no material effect on our results of operations or financial condition. Consolidated Results of Operations The following table presents summary consolidated financial data for the three months ended March 31, 2002 and 2001 (in millions). 2002 2001 Change ---------- ---------- ---------- REVENUES: Premiums............................................................ $257.4 $266.0 $ (8.6) Insurance and investment product fees............................... 140.3 145.5 (5.2) Net investment income............................................... 231.2 168.2 63.0 Net realized investment losses...................................... (35.0) (15.6) (19.4) ---------- ---------- ---------- Total revenues................................................. 593.9 564.1 29.8 ---------- ---------- ---------- BENEFITS AND EXPENSES: Policy benefits and increase in policy liabilities.................. 333.9 334.1 (.2) Policyholder dividends.............................................. 74.2 106.3 (32.1) Policy acquisition cost amortization................................ (10.9) 35.1 (46.0) Intangible asset amortization....................................... 8.1 13.2 (5.1) Interest expense.................................................... 7.7 7.1 .6 Demutualization expenses............................................ .9 10.7 (9.8) Other operating expenses............................................ 136.0 237.4 (101.4) ---------- ---------- ---------- Total benefits and expenses.................................... 549.9 743.9 (194.0) ---------- ---------- ---------- Income (loss) before income taxes and minority interest............. 44.0 (179.8) 223.8 Applicable income tax expense (benefit)............................. 12.3 (69.0) 81.3 ---------- ---------- ---------- Income (loss) before minority interest.............................. 31.7 (110.8) 142.5 Minority interest in net income of subsidiaries..................... (2.8) (1.8) (1.0) ---------- ---------- ---------- Income (loss) before cumulative effects of accounting changes ...... 28.9 (112.6) 141.5 Cumulative effect of accounting changes: Goodwill impairment............................................. (130.3) -- (130.3) Venture capital partnerships and derivative financial instruments -- (44.9) 44.9 ---------- ---------- ---------- Net loss ........................................................... $ (101.4) $ (157.5) $ 56.1 ========== ========== ========== The increase in net investment income of 38% for the three months ended March 31, 2002 was primarily due to smaller losses in our venture capital portfolio, compared to significant declines in the first quarter of 2001. The increase in net realized investment losses of 124% for the three months ended March 31, 2002 was primarily due to increased credit related losses in telecom and collateralized debt obligation holdings. The majority of these losses were in the closed block and were offset by a decrease to the policyholder dividend obligation. The decrease in policyholder dividends of 30% for the three months ended March 31, 2002 was primarily due to the decrease in the policyholder dividend obligation as a result of net realized investment losses. This decrease was slightly offset by the increase in dividends paid to policyholders. The decrease in policy acquisition cost amortization of 131% for the three months ended March 31, 2002 is primarily due to revised mortality assumptions. In the first quarter of 2002, we refined the mortality assumptions used in the development of estimated gross margins to reflect favorable experience. As a result, the amortization of deferred acquisition costs in the closed block was revised to reflect higher future estimated gross margins. Accordingly, the amortization cost decreased. This revision also resulted in a $22.1 million increase in the DAC balances for individual participating life insurance policies. The decrease in intangible asset amortization of 39% for the three months ended March 31, 2002 resulted primarily from our adoption of a new accounting standard, which eliminates the amortization of goodwill and indefinite-lived intangible assets beginning January 1, 2002, partially offset by the amortization of intangible assets resulting from our acquisition of a 60% interest in Kayne Anderson Rudnick in January 2002. The decrease in other operating expenses of 43% for the three months ended March 31, 2002 is primarily due to the decrease of $89.9 million in non-recurring items including expenses of $71.6 million related to the acquisition of the PXP minority interest and of $18.3 million related to an early retirement program. Other operating expenses decreased in the Life and Annuity segment by 6% as a result of lower commissions for certain Life and Annuity distributors and a higher level of reinsurance allowances in 2001 compared to 2002. In addition, other operating expenses decreased in the Corporate and Other segment by 51% as a result of exiting our physician practice management business in the second quarter of 2001. Corporate and Other also experienced lower compensation, advertising, and charitable contributions during the three months ended March 31, 2002 compared to the same period in 2001. As a result, we believe we are on track to reduce expenses by more than $25 million by the end of 2002. The income tax expense was $12.3 million for the three months ended March 31, 2002 compared to an income tax benefit of $69.0 million for the three months ended March 31, 2001. This change reflects a tax expense from operating income for the three months ended March 31, 2002, compared to a tax benefit on operating losses for the three months ended March 31, 2001. The effective tax rate decreased to 28.0% for the three months ended March 31, 2002 compared to a nominal tax rate of 35%, primarily due to an IRS tax settlement and low-income housing credits. The increase in minority interest in net income of subsidiaries of 56% for the three months ended March 31, 2002 was due to increased earnings in Seneca and the acquisition of Kayne Anderson Rudnick. Results of Operations by Segment We evaluate segment performance on the basis of segment after-tax operating income. Realized investment gains and some non-recurring items are excluded because we do not consider them when evaluating the financial performance of the segments. The size and timing of realized investment gains are often subject to our discretion. Non-recurring items are removed from segment after-tax operating income if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income reported in accordance with generally accepted accounting principles ("GAAP"), we believe that segment after-tax operating income is an appropriate measure that represents the net income attributable to the ongoing operations of our business. The criteria used to identify non-recurring items and to determine whether to exclude a non-recurring item from segment after-tax operating income include whether the item is infrequent and: - is material to the segment's after-tax operating income; or - results from a business restructuring; or - results from a change in the regulatory environment; or - relates to other unusual circumstances (e.g., litigation). Non-recurring items excluded from segment after-tax operating income may vary from period to period. Because such items are excluded based on our discretion, inconsistencies in the application of our selection criteria may exist. Segment after-tax operating income is not a substitute for net income determined in accordance with GAAP and may be different from similarly titled measures of other companies. Segment Allocations We allocate capital to Investment Management on an historical cost basis and to insurance products based on 250% of company action level risk-based capital. We allocate net investment income based on the assets allocated to each segment. We allocate other costs and operating expenses to each segment based on a review of the nature of such costs, cost allocations using time studies, and other allocation methodologies. The following table presents a reconciliation of segment after-tax operating income to GAAP reported income for the three months ended March 31, 2002 and 2001 (in millions). 2002 2001 ------------ ----------- SEGMENT OPERATING INCOME: Life and Annuity............................................. $ 18.3 $ 5.9 Investment Management........................................ 2.4 .2 Venture Capital.............................................. (3.3) (37.3) Corporate and Other.......................................... (4.6) (8.7) ------------ ----------- Total segment after-tax operating income (loss)......... 12.8 (39.9) ------------ ----------- ADJUSTMENTS: Net realized investment gains (losses)....................... 1.6 (10.1) Deferred policy acquisition costs............................ 15.1 -- Pension adjustment........................................... -- (6.9) Demutualization expenses..................................... (.6) (11.9) Expense of purchase of PXP minority interest................. -- (43.8) ------------ ----------- Total after-tax adjustments............................. 16.1 (72.7) ------------ ----------- GAAP REPORTED INCOME: Income (loss) before cumulative effect of accounting changes......................................... $ 28.9 $(112.6) ============ =========== Life and Annuity Segment The following table presents summary financial data relating to Life and Annuity for the three months ended March 31, 2002 and 2001 (in millions). 2002 2001 Change ------------ ------------ ----------- REVENUES: Premiums.............................................. $ 257.4 $ 266.0 $ (8.6) Insurance and investment product fees................. 77.6 78.3 (.7) Net investment income 223.2 218.2 5.0 ------------ ------------ ----------- Total revenues................................. 558.2 562.5 (4.3) ------------ ------------ ----------- BENEFITS AND EXPENSES: Policy benefits and dividends......................... 439.7 437.6 2.1 Policy acquisition cost amortization.................. 14.7 35.1 (20.4) Other operating expenses.............................. 75.6 80.8 (5.2) ------------ ------------ ----------- Total expenses................................ 530.0 553.5 (23.5) ------------ ------------ ----------- Operating income before income taxes.................. 28.2 9.0 19.2 Applicable income tax expense......................... 9.9 3.1 6.8 ------------ ------------ ----------- Segment operating income.............................. $ 18.3 $ 5.9 $ 12.4 ============ ============ =========== The decrease in policy acquisition cost amortization of 58% for the three months ended March 31, 2002 is primarily due to revised mortality assumptions. Deferred policy acquisition costs ("DAC") for individual participating life insurance policies are amortized in proportion to estimated gross margins. The amortization process requires the use of various assumptions, estimates and judgments about the future. The primary assumptions involve expenses, investment performance, mortality and contract 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. In the first quarter of 2002, we refined the mortality assumptions used in the development of estimated gross margins to reflect favorable experience. The decrease in other operating expenses of 6% for the three months ended March 31, 2002 is primarily due to lower commissions for certain Life and Annuity distributors and a higher level of reinsurance allowances in 2001 compared to 2002. Investment Management Segment The following table presents summary financial data relating to Investment Management for the three months ended March 31, 2002 and 2001 (in millions). 2002 2001 Change ------------ ------------ ------------ REVENUES: Investment product fees................................ $ 66.7 $ 70.7 $ (4.0) Net investment income.................................. 3.2 2.5 .7 ------------ ------------ ------------ Total revenues.................................. 69.9 73.2 (3.3) ------------ ------------ ------------ EXPENSES: Intangible asset amortization.......................... 8.1 12.5 (4.4) Other operating expenses............................... 57.1 57.2 (.1) ------------ ------------ ------------ Total expenses................................. 65.2 69.7 (4.5) ------------ ------------ ------------ Income (loss) from continuing operations before income taxes and minority interest.................. 4.7 3.5 1.2 Applicable income tax (benefit) expense................ (.5) 1.5 (2.0) Minority interest in net income of subsidiaries (2.8) (1.8) (1.0) ------------ ------------ ------------ Segment operating loss................................. $ 2.4 $ .2 $ 2.2 ============ ============ ============ The decrease in investment product fees of 6% for the three months ended March 31, 2002 was primarily the result of a decrease in the fee structure for the Phoenix general account, partially offset by increases of $5.5 billion and $4.0 billion in average assets under management for the private client and institutional lines of business, respectively. The increase in average assets under management is the result of our acquisition of Kayne Anderson Rudnick in January 2002. The increase in net investment income was due primarily to equity in the increased earnings of Aberdeen. The decrease in intangible asset amortization of 35% for the three months ended March 31, 2002 resulted primarily from our adoption of a new accounting standard, which eliminates the amortization of goodwill and indefinite-lived intangible assets beginning January 1, 2002, partially offset by the amortization of intangible assets resulting from our acquisition of a 60% interest in Kayne Anderson Rudnick in January 2002. The increase in minority interest in net income of subsidiaries of 56% for the three months ended March 31, 2002 was due to increased earnings in Seneca and the acquisition of Kayne Anderson Rudnick. Venture Capital Segment Our investments in Venture Capital are primarily in the form of limited partnership interests in venture capital funds, leveraged buyout funds and other private equity partnerships sponsored and managed by third parties. We refer to all of these types of investments as venture capital. We record our investments in venture capital partnerships in accordance with the equity method of accounting. Our pro rata share of the earnings or losses of the partnerships, which represent realized and unrealized investment gains and losses, as well as operations of the partnership, is included in our investment income. We record our share of the net equity in earnings of the venture capital partnerships in accordance with GAAP, using the most recent financial information received from the partnerships. Historically, this information had been provided to us on a one-quarter lag. Due to the volatility in the equity markets, we believed the one-quarter lag in reporting was no longer appropriate. Therefore, beginning in the first quarter of 2001 we changed our method of applying the equity method of accounting to eliminate the quarterly lag in reporting. We removed the lag in reporting by estimating the change in our share of the net equity in earnings of the venture capital partnerships for the period from December 31, 2000, the date of the most recent financial information provided by the partnerships, to our then current reporting date of March 31, 2001. To estimate the net equity in earnings of the venture capital partnerships for each quarter, we developed a methodology to estimate the change in value of the underlying investee companies in the venture capital partnerships. For public investee companies, we used quoted market prices at the end of each quarter, applying liquidity discounts to these prices in instances where such discounts were applied in the underlying partnerships' financial statements. For private investee companies, we applied a public industry sector index to roll the value forward each quarter. We applied this methodology consistently each quarter with subsequent adjustments to reflect market events reported by the partnerships (e.g., new rounds of financing, initial public offerings and writedowns by the general partners). In addition, on an annual basis we revised the valuations we have assigned to the investee companies to reflect the valuations contained in the audited financial statements received from the venture capital partnerships. Our venture capital earnings remain subject to variability. In the first quarter of 2001, we recorded a charge of $48.8 million (net of income taxes of $26.3 million) representing the cumulative effect of this accounting change on the fourth quarter of 2000. The cumulative effect was based on the actual fourth quarter 2000 financial results as reported by the partnerships. The following table presents summary financial data relating to Venture Capital for the quarters ended March 31, 2002 and 2001 (in millions). 2002 2001 Change ---------- ---------- ---------- REVENUES: Net investment loss............................... $ (5.0) $ (57.3) $52.3 ---------- ---------- ---------- Operating loss before income taxes................ (5.0) (57.3) 52.3 EXPENSES: Applicable income tax benefit..................... (1.7) (20.0) 18.3 ---------- ---------- ---------- Segment operating loss (1)................... $ (3.3) $ (37.3) $34.0 ========== ========== ========== (1) Excludes the charge of $48.8 million representing the cumulative effect of an accounting change in the first quarter of 2001, as described above. The increase in net investment income of 91% for the three months ended March 31, 2002 was due to declines in the sector indexes in 2001, which were more severe than they were in 2002, applied against a higher investment balance in 2001. The 2002 balance represents an adjustment to the 2001 audited partnership financial statements of a $12.9 million gain offset by operating losses of $2.0 million and a first quarter loss estimate of $15.9 million based on declines in the industry sector indexes. Corporate and Other Segment The following table presents summary financial data relating to Corporate and Other for the quarters ended March 31, 2002 and 2001 (in millions). 2002 2001 Change ----------- ----------- ----------- REVENUES: Insurance and investment product fees................. $ 2.8 $ 3.7 $ (.9) Net investment income................................. 7.4 2.9 4.5 ----------- ----------- ----------- Total revenues................................. 10.2 6.6 3.6 ----------- ----------- ----------- EXPENSES: Policy benefits, excluding policyholder dividends .... 3.6 2.8 .8 Interest expense...................................... 7.7 7.1 .6 Other operating expenses.............................. 7.6 15.6 (8.0) ----------- ----------- ----------- Total expenses................................. 18.9 25.5 (6.6) ----------- ----------- ----------- Operating loss before income taxes.................... (8.7) (18.9) 10.2 Applicable income tax benefit......................... (4.1) (10.2) 6.1 ----------- ----------- ----------- Segment operating loss......................... $ (4.6) $ (8.7) $ 4.1 =========== =========== =========== The increase in net investment income of 155% for the three months ended March 31, 2002 was primarily due to our equity in the increased earnings of EMCO and Hilb, Rogal and Hamilton Company. Also, interest on inter-company lending increased, offset by a decline due to asset re-allocation to Life and Annuity, effective January 1, 2002. The decrease in other operating expenses of 51% for the three months ended March 31, 2002 was primarily the result of exiting our physician practice management business in the second quarter of 2001. We also experienced lower compensation, advertising, charitable contributions and income tax expenses during the three months ended March 31, 2002 compared to the same period in 2001. General Account The invested assets in our general account are generally of high quality and broadly diversified across asset classes, sectors and individual credits and issuers. Our Investment Management professionals manage our general account assets. We manage our general account assets in investment segments that support specific product liabilities. These investment segments have distinct investment policies that are structured to support the financial characteristics of the specific liability or liabilities within them. Segmentation of assets allows us to manage the risks and measure returns on capital for our various businesses and products. Separate Account and Investment Trust Assets Separate account assets are managed in accordance with the specific investment contracts and guidelines relating to our variable products. We generally do not bear any investment risk on assets held in separate accounts. Rather, we receive investment management fees based on assets under management. Generally, assets held in separate accounts are not available to satisfy general account obligations. Investment trusts are assets held for the benefit of those institutional clients which have investments in structured finance products offered and managed by our investment management subsidiary. Investment trusts for which PXP is the sponsor and actively manages the assets, and for which there is not a substantive amount of outside third party equity investment in the trust, are consolidated in the financial statements. In 2001, we determined that two out of the eight investment trusts that PXP sponsored did not have a substantive amount of outside equity and, as a result, we concluded that consolidation was required. Our financial exposure is limited to our share of equity and bond investments in these vehicles and there are no financial guarantees from, or recourse to, us for these investment trusts. Asset valuation changes are directly offset by changes in the corresponding liabilities. We receive investment management fees for services provided to the trusts. Asset/Liability and Risk Management Our primary investment objective is to maximize after-tax investment return within defined risk parameters. Our primary sources of investment risk are: o credit risk, which relates to the uncertainty associated with the ongoing ability of an obligor to make timely payments of principal and interest; o interest rate risk, which relates to the market price and cash flow variability associated with changes in market interest rates; and o equity risk, which relates to the volatility of prices for equity and equity-like investments. We manage credit risk through fundamental analysis of the underlying obligors, issuers and transaction structures. We employ a staff of specialized and experienced credit analysts who review obligors' management, competitive position, financial statements, cash flow, coverage ratios, liquidity and other key financial and non-financial information. These specialists recommend the investments needed to fund our liability guarantees within diversification and credit rating guidelines. In addition, when investing in private debt securities, we rely upon broad access to management information, negotiated protective covenants, call protection features and collateral protection. We review our debt security portfolio regularly to monitor the performance of obligors and assess the integrity of their current credit ratings. We manage interest rate risk as part of our asset/liability management process and product design procedures. Asset/liability management strategies include the segmentation of investments by product line, and the construction of investment portfolios designed to satisfy the projected cash needs of the underlying liabilities. We identify potential interest rate risk in portfolio segments by modeling asset and liability durations and cash flows under current and projected interest rate scenarios. We use these projections to assess and control interest rate risk. We also manage interest rate risk by emphasizing the purchase of securities that feature prepayment restrictions and call protection. Our product design and pricing strategies include the use of surrender charges or restrictions on withdrawals in some products. In addition, we selectively apply derivative instruments, such as interest rate swaps, swaptions, and floors to reduce the interest rate risk inherent in our portfolios. These derivatives are transacted with highly rated counterparties and monitored for effectiveness on an ongoing basis. We use derivatives exclusively for hedging purposes. We manage equity risk, as well as credit risk, through industry and issuer diversification and asset allocation. Maximum exposure to an issuer is defined by quality ratings, with higher quality issuers having larger exposure limits. We have an overall limit on below investment-grade rated issuer exposure. For further information about our management of interest rate risk and equity risk, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Quantitative and Qualitative Information About Market Risk." Debt Securities Our debt security portfolio consists primarily of investment-grade publicly traded and privately placed corporate bonds; residential mortgage-backed securities; commercial mortgage-backed securities; and asset-backed securities. As of March 31, 2002, debt securities represented 69% of general account invested assets, with a carrying value of $10,014.0 million. Public debt securities represented 77% of this total amount, with the remaining 23% consisted of private debt securities. Our debt securities are classified as available-for-sale and are reported at fair value with unrealized gains or losses included in equity. Each year, the majority of our net cash flows are invested in investment grade debt securities. However, we maintain a portfolio allocation between 6% and 10% of debt securities in below investment grade rated bonds. Allocations are based on our assessment of relative value and the likelihood of enhancing risk-adjusted portfolio returns. The size of our allocation to below investment grade bonds is constrained by the size of our net worth. We are subject to the risk that the issuers of the debt securities we own may default on principal and interest payments, particularly if a major economic downturn occurs. As of March 31, 2002, total debt securities having an increased risk of default (those securities with a Securities Valuation Office ("SVO") securities rating of four or greater) totaled $191.5 million, or 2%, of our total debt security portfolio, and our below investment grade debt securities represented 8% of our total debt security portfolio. The following table displays the SVO ratings for our debt security portfolio as of March 31, 2002 and December 31, 2001 (in millions), along with an equivalent S&P rating agency designation. The majority of our bonds are investment grade, with 92% invested in Categories 1 and 2 securities as of March 31, 2002. Total Debt Securities by Credit Quality SVO Rating S&P Equivalent Designation 2002 2001 ---------- -------------------------------------- ------------ ------------ 1 AAA/AA/A $6,558.2 $6,139.3 2 BBB 2,700.1 2,686.7 3 BB 574.4 581.6 4 B 150.5 173.0 5 CCC and lower 24.2 38.6 6 In or near default 16.8 23.3 ------------ ------------ Total 10,024.2 9,634.0 Less debt securities of discontinued operations................ 10.2 34.8 ------------ ------------ Total debt securities, continuing operations................... $ 10,014.0 $9,607.7 ============ ============ The following table displays the credit quality of our public debt security portfolio as of March 31, 2002 and December 31, 2001 (in millions). Public Debt Securities by Credit Quality.... SVO Rating S&P Equivalent Designation 2002 2001 ---------- -------------------------------------- ------------ ------------ 1 AAA/AA/A $5,411.4 $5,019.3 2 BBB 1,704.8 1,667.9 3 BB 452.3 452.9 4 B 129.8 150.4 5 CCC and lower 12.5 18.0 6 In or near default 16.8 19.8 ------------ ------------ Total $ 7,727.6 $7,328.3 ============ ============ The following table displays the credit quality of our private debt security portfolio as of March 31, 2002 and December 31, 2001 (in millions). Private Debt Securities by Credit Quality SVO Rating S&P Equivalent Designation 2002 2001 ---------- -------------------------------------- ------------ ------------ 1 AAA/AA/A $1,146.8 $1,111.5 2 BBB 995.3 1,018.8 3 BB 122.1 128.7 4 B 20.7 22.6 5 CCC and lower 11.7 20.6 6 In or near default -- 3.5 ------------ ------------ Total $2,296.6 $2,305.7 ============ ============ Liquidity and Capital Resources In the normal course of business, we enter into transactions involving various types of financial instruments such as debt securities and equity securities. These instruments have credit risk and also may be subject to risk of loss due to interest rate and market fluctuations. We also make off-balance sheet commitments related to venture capital partnerships; as of March 31, 2002, such total unfunded capital commitments were $162.0 million. Liquidity refers to the ability of a company to generate sufficient cash flow to meet its cash requirements. The following discussion combines liquidity and capital resources as these subjects are interrelated. Consistent with the discussion of our results of operations, we discuss liquidity and capital resources on both consolidated and segment bases. The Phoenix Companies, Inc. (unconsolidated) Our primary uses of liquidity include the payment of dividends on our common stock, loans or contributions to our subsidiaries, debt service and the funding of our general corporate expenses. Our primary source of liquidity is dividends from Phoenix Life. Based on the historic cash flows and the current financial results of Phoenix Life, and subject to any dividend limitations which may be imposed upon Phoenix Life or any of its subsidiaries by regulatory authorities, we believe that cash flows from Phoenix Life's operating activities will be sufficient to enable us to make dividend payments on our common stock, pay our operating expenses, service our outstanding debt, make contributions to our subsidiaries and meet our other obligations. In addition, we have a master credit facility (the "Master Credit Facility") under which we have direct borrowing rights, as do Phoenix Life and PXP with our unconditional guarantee. Under the New York Insurance Law, the ability of Phoenix Life to pay stockholder dividends to us in any calendar year in excess of the lesser of: (1) 10% of Phoenix Life's surplus to policyholders as of the immediately preceding calendar year; or (2) Phoenix Life's statutory net gain from operations for the immediately preceding calendar year, not including realized capital gains, is subject to the discretion of the New York Superintendent of Insurance. The dividend limitation imposed by the New York Insurance Law is based on the statutory financial results of Phoenix Life. Statutory accounting practices differ in certain respects from accounting principles used in financial statements prepared in conformity with GAAP. The significant differences relate to deferred acquisition costs, deferred income taxes, required investment reserves, reserve calculation assumptions and surplus notes. We do not expect to receive significant dividend income from PXP for several years, because we expect that during this time PXP will use a substantial portion of its cash flows from operations to pay down its outstanding debt. Phoenix Life Phoenix Life's liquidity requirements principally relate to: the liabilities associated with its various life insurance and annuity products; the payment of dividends to us; operating expenses; contributions to subsidiaries; and payment of principal and interest on outstanding debt obligations. Phoenix Life's liabilities arising from its life insurance and annuity products include the payment of benefits, as well as cash payments in connection with policy surrenders, withdrawals and loans. Phoenix Life also has liabilities arising from the runoff of the remaining group accident and health reinsurance discontinued operations. Historically, Phoenix Life has used cash flow from operations and investment activities to fund its liquidity requirements. Phoenix Life's principal cash inflows from its life insurance and annuities activities come from premiums, annuity deposits and charges on insurance policies and annuity contracts, as well as dividends and distributions from subsidiaries. Phoenix Life's principal cash inflows from its investment activities result from repayments of principal, proceeds from maturities, sales of invested assets and investment income. Additional sources of liquidity to meet unexpected cash outflows are available from Phoenix Life's portfolio of liquid assets. These liquid assets include substantial holdings of U.S. government and agency bonds, short-term investments and marketable debt and equity securities. The cash Phoenix Life received as consideration for the transfer of shares of common stock of PXP and other subsidiaries following the demutualization was a non-recurring source of liquidity. Pursuant to the plan of reorganization, this cash payment was $659.8 million. Phoenix Life's current sources of liquidity also include a master credit facility under which Phoenix Life has direct borrowing rights, subject to our unconditional guarantee (see "Debt Financing"). Following the demutualization, Phoenix Life no longer has access to the cash flows generated by the closed block assets for any purpose other than funding the closed block. A primary liquidity concern with respect to life insurance and annuity products is the risk of early policyholder and contractholder withdrawal. Phoenix Life closely monitors its liquidity requirements in order to match cash inflows with expected cash outflows, and employs an asset/liability management approach tailored to the specific requirements of each product line, based upon the return objectives, risk tolerance, liquidity, tax and regulatory requirements of the underlying products. In particular, Phoenix Life maintains investment programs generally intended to provide adequate funds to pay benefits without forced sales of investments. Products having liabilities with relatively long lives, such as life insurance, are matched with assets having similar estimated lives, such as long-term bonds, private placement bonds and mortgage loans. Shorter-term liabilities are matched with investments such as short-term and medium-term fixed maturities. The following table summarizes Phoenix Life's annuity contract reserves and deposit fund liabilities in terms of contractholders' ability to withdraw funds as of March 31, 2002 and December 31, 2001 (dollars in millions): Withdrawal Characteristics of Annuity Contract Reserves and Deposit Fund Liabilities (1) 2002 2001 ----------------------- ---------------------- Amount % Amount % ----------- --------- ----------- -------- Not subject to discretionary withdrawal provisions ...... $ 172.3 3% $ 173.9 3% Subject to discretionary withdrawal without adjustment... 1,282.4 24% 1,054.8 21% Subject to discretionary withdrawal with market value adjustment............................................ 299.1 6% 239.1 5% Subject to discretionary withdrawal at contract value less surrender charge................................. 489.9 9% 453.3 9% Subject to discretionary withdrawal at market value ..... 3,079.5 58% 3,087.5 62% ----------- --------- ----------- -------- Total annuity contract reserves and deposit fund liabiltiy............................................. $ 5,323.2 100% $ 5,008.6 100% =========== =========== - ---------- (1) Data are reported on a statutory basis, which more accurately reflects the potential cash outflows. Data include variable product liabilities. Annuity contract reserves and deposit fund liabilities are monetary amounts that an insurer must have available to provide for future obligations with respect to its annuities and deposit funds. These are liabilities on the balance sheet of financial statements prepared in conformity with statutory accounting practices. These amounts are at least equal to the values available to be withdrawn by policyholders. Individual life insurance policies are less susceptible to withdrawals than are annuity contracts because policyholders may incur surrender charges and be required to undergo a new underwriting process in order to obtain a new insurance policy. As indicated in the table above, most of Phoenix Life's annuity contract reserves and deposit fund liabilities are subject to withdrawals. Individual life insurance policies, other than term life insurance policies, increase in cash values over their lives. Policyholders have the right to borrow from Phoenix Life an amount generally up to the cash value of their policies at any time. As of March 31, 2002, Phoenix Life had approximately $10.6 billion in cash values with respect to which policyholders had rights to take policy loans. The majority of cash values eligible for policy loans are at variable interest rates that are reset annually on the policy anniversary. Phoenix Life's amount of policy loans has not changed significantly since 1999. Policy loans at March 31, 2002 were $2.2 billion. The primary liquidity concerns with respect to Phoenix Life's cash inflows from its investment activities are the risks of default by debtors, interest rate and other market volatility and potential illiquidity of investments. Phoenix Life closely monitors and manages these risks. We believe that Phoenix Life's current and anticipated sources of liquidity are adequate to meet its present and anticipated needs. PXP PXP's cash requirements are primarily to fund operating expenses and repay outstanding debt. PXP also will require liquidity to fund the costs of any future acquisitions. Historically, PXP's principal source of liquidity has been cash flows from operations. We expect that cash flow from operations will continue to be PXP's principal source of working capital for the foreseeable future. PXP, together with Phoenix and Phoenix Life, has entered into a master credit facility. Under this facility, PXP has direct borrowing rights, subject to Phoenix's unconditional guarantee. See "Debt Financing-- Master Credit Facility." We believe that PXP's current and anticipated sources of liquidity are adequate to meet its present and anticipated needs. Debt Financing As of March 31, 2002, we had outstanding debt of $300 million (excluding the indebtedness of Phoenix Life and PXP described below under "Phoenix Life" and "PXP," respectively). Debt offering. On December 19, 2001, we completed a debt offering of $300 million, thirty-year senior unsecured bonds at a coupon of 7.45%. The bonds are traded on the New York Stock Exchange under the symbol PFX. The carrying value at March 31, 2002 was $300 million. Master Credit Facility. In June 2001, we, Phoenix Life and PXP entered into a $375 million revolving credit facility which matures on June 10, 2005 (the "Master Credit Facility") and terminated Phoenix Life's and PXP's prior credit facilities. Bank of Montreal is the administrative agent for this credit facility. Each company has direct borrowing rights under this credit facility. We unconditionally guarantee loans to Phoenix Life and PXP. Base rate loans bear interest at the greater of the Bank of Montreal's prime commercial rate or the effective federal funds rate plus 0.5%. Eurodollar rate loans bear interest at LIBOR plus an applicable margin. At March 31, 2002, the outstanding balance under this facility was $125 million, subject to the Eurdollar rate structure. The credit agreement contains customary financial and operating covenants that include, among other provisions, requirements that we maintain a minimum stockholders' equity and a maximum debt to capitalization ratio; that Phoenix Life maintain a minimum risk based capital ratio and a minimum financial strength rating; and that PXP maintain a maximum debt to capitalization ratio and a minimum stockholder's equity. Phoenix Life As of March 31, 2002, Phoenix Life had $175 million of debt outstanding, but none under the Master Credit Facility. Surplus Notes. In November 1996, Phoenix Life issued $175 million principal amount of 6.95% surplus notes due December 1, 2006. Each payment of interest or principal of the notes requires the prior approval of the New York Superintendent of Insurance and may be made only out of surplus funds which the Superintendent determines to be available for such payment under the New York Insurance Law. The notes contain neither financial covenants nor early redemption provisions and are to rank equally with any subsequently issued surplus, capital or contribution notes or similar obligations of Phoenix Life. Section 1307 of the New York Insurance Law provides that the notes are not part of the legal liabilities of Phoenix Life and are not a basis of any set-off against Phoenix Life. PXP As of March 31, 2002, PXP had $464 million of debt outstanding, including: Phoenix Life Subordinated Note. In exchange for the debentures held by it, Phoenix Life agreed to accept from PXP, in lieu of cash, a $69.0 million subordinated note due 2006, bearing interest annually at the rate of LIBOR plus two hundred basis points. Phoenix Subordinated Note. In December 2001, PXP paid down $150 million in debt from the Master Credit Facility and borrowed from Phoenix in the form of a $150 million subordinated note due 2007, bearing interest annually at the rate of LIBOR plus seventy-two basis points. During the first quarter of 2002, PXP borrowed an additional $100 million from Phoenix to fund the purchase of Kayne Anderson Rudnick. Senior Note. During the first quarter of 2002, PXP borrowed $20 million from Phoenix to fund significant non-operating cash outflows. The senior note matures in 2006 and bears interest annually at 7.6%. Master Credit Facility. As of March 31, 2002, PXP had $125 million of debt outstanding under the Master Credit Facility. Reinsurance We maintain life reinsurance programs designed to protect against large or unusual losses in our life insurance business. Over the last several years in response to the reduced cost of reinsurance coverage, we increased the amount of individual mortality risk coverage purchased from third party reinsurers. Based on our review of their financial statements and reputations in the reinsurance marketplace, we believe that these third party reinsurers are financially sound and, therefore, that we have no material exposure to uncollectable life reinsurance. Risk Based Capital Section 1322 of the New York Insurance Law requires that New York life insurers report their risk based capital ("RBC"). RBC is based on a formula calculated by applying factors to various asset, premium and statutory reserve items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk and business risk. Section 1322 gives the New York Superintendent of Insurance explicit regulatory authority to require various actions by, or take various actions against, insurers whose total adjusted capital does not exceed certain RBC levels. As of December 31, 2001, Phoenix Life's total adjusted capital was in excess of each of these RBC levels. Each of the U.S. insurance subsidiaries of Phoenix Life is also subject to these same RBC requirements. As of December 31, 2001, the total adjusted capital of each of these insurance subsidiaries was in excess of each of their respective RBC levels. Net Capital Requirements Phoenix Equity Planning Corporation ("PEPCO"), PXP Securities Corp. ("PSC") and Rutherford, Brown and Catherwood, LLC ("Rutherford"), each a direct or indirect owned subsidiary of PXP, PHOENIXLINK Investments, Inc. ("PHOENIXLINK") and PFG Distribution Company, both of which are subsidiaries of Phoenix Life, and Main Street Management and WS Griffith, both of which are subsidiaries of Phoenix Distribution Management Company, are each subject to the net capital requirements imposed on registered broker-dealers by the Securities Exchange Act of 1934 (the "Exchange Act"). Each company is also required to maintain a ratio of aggregate indebtedness to net capital that does not exceed 15 to 1. PEPCO had net capital of approximately $6.5 million. This amount exceeded PEPCO's regulatory minimum of $0.8 million. The ratio of aggregate indebtedness to net capital for PEPCO was 1.9 to 1. The ratios of aggregate indebtedness to net capital for each of the other listed broker-dealers were also below the margin limit at March 31, 2002. Consolidated Cash Flows The following table presents summary consolidated cash flow data for the three months ended March 31, 2002 and 2001 for the purpose of illustrating significant changes in the components of our cash flows (in millions). 2002 2001 -------------- ----------------- Cash from (for) operations............................................ $ 7.7 $ (23.5) Cash from financing activities........................................ 274.6 140.9 The increase in cash from operations in the first quarter of 2002 is primarily due to lower operating expenses partially offset by lower investment income and higher claim payments by our reinsurance discontinued operations. The increase in cash from financing activities is largely due to an increase in net annuity deposits in the guaranteed interest account and increased sales of fixed annuities, partially offset by a buyback of treasury stock, distributions to minority stockholders and a lower level of borrowing. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Exposures and Risk Management We must effectively manage, measure and monitor the market risk generally associated with our insurance and annuity business and, in particular, our commitment to fund insurance liabilities. We have developed an integrated process for managing risk, which we conduct through our Corporate Portfolio Management Department, Actuarial Department, Corporate Finance Department and additional specialists at the business segment level. These groups confer with each other regularly. We have implemented comprehensive policies and procedures at both the corporate and business segment level to minimize the effects of potential market volatility. Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to market risk through both our insurance operations and our investment activities. Our primary market risk exposure is to changes in interest rates, although we also have exposures to changes in equity prices and foreign currency exchange rates. We also have credit risks in connection with our derivative contracts. Interest Rate Risk Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our commitment to fund interest-sensitive insurance liabilities, as well as from our significant holdings of fixed rate investments. Our insurance liabilities are largely comprised of dividend-paying individual whole life and universal life policies. Our fixed maturity investments include U.S. and foreign government bonds, securities issued by government agencies, corporate bonds, asset-backed securities, mortgage-backed securities and mortgage loans, most of which are mainly exposed to changes in medium-term and long-term U.S. Treasury rates. We manage interest rate risk as part of our asset/liability management process and product design procedures. Asset/liability strategies include the segmentation of investments by product line and the construction of investment portfolios designed to specifically satisfy the projected cash needs of the underlying product liability. We manage the interest rate risk inherent in our assets relative to the interest rate risk inherent in our insurance products. We identify potential interest rate risk in portfolio segments by modeling asset and product liability durations and cash flows under current and projected interest rate scenarios. One of the key measures we use to quantify this interest rate exposure is duration. Duration is one of the most significant measurement tools in measuring the sensitivity of the fair value of assets and liabilities to changes in interest rates. For example, if interest rates increase by 100 basis points, or 1%, the fair value of an asset with a duration of five years is expected to decrease by 5%. We believe that as of March 31, 2002 and December 31, 2001, our asset and liability portfolio durations were well matched, especially for the largest segments of our balance sheet (i.e., whole life and universal life). Since our insurance products have variable interest rates (which expose us to the risk of interest rate fluctuations), we regularly undertake a sensitivity analysis that calculates liability durations under various cash flow scenarios. The selection of a 100 basis point immediate, parallel increase or decrease in interest rates is a hypothetical rate scenario used to demonstrate potential risk. While a 100 basis point immediate, parallel increase or decrease does not represent our view of future market changes, it is a reasonably possible hypothetical near-term change that illustrates the potential impact of such events. Although these fair value measurements provide a representation of interest rate sensitivity, they are based on our portfolio exposures at a point in time and may not be representative of future market results. These exposures will change as a result of ongoing portfolio transactions in response to new business, management's assessment of changing market conditions and available investment opportunities. To calculate duration, we project asset and liability cash flows and discount them to a net present value using a risk-free market rate adjusted for credit quality, sector attributes, liquidity and any other relevant specific risks. Duration is calculated by revaluing these cash flows at an alternative level of interest rates and by determining the percentage change in fair value from the base case. We also employ product design and pricing strategies to manage interest rate risk. Product design and pricing strategies include the use of surrender charges or restrictions on withdrawals in some products. The tables below show the interest rate sensitivity of our fixed income financial instruments measured in terms of fair value as of March 31, 2002 and December 31, 2001 (in millions). Given that our asset and liability portfolio durations were well matched for the periods indicated, it is expected that market value gains or losses in assets would be largely offset by corresponding changes in liabilities. 2002: Fair Value ------------------------------------------------------- Book -100 Basis As of +100 Basis Value Point Change 3/31/02 Point Change -------------- ----------------- ------------- ---------------- Cash and short term investments $ 451.8 $ 452.1 $ 451.8 $ 451.4 Floating rate notes............ 135.8 137.3 138.5 139.6 Long term bonds................ 10,019.7 10,677.5 10,174.9 9,698.6 Commercial mortgages........... 522.7 577.2 555.3 534.6 ------------ ------------ ------------ ------------ Total $ 11,130.0 $ 11,844.1 $ 11,320.5 $ 10,824.2 ============ ============ ============ ============ 2001: Fair Value ------------------------------------------------------- Book -100 Basis As of +100 Basis Value Point Change 12/31/01 Point Change -------------- ----------------- ------------- ---------------- Cash and short term investments $ 514.8 $ 515.2 $ 514.8 $ 514.4 Floating rate notes............ 150.0 152.4 150.0 147.6 Long term bonds................ 9,490.7 10,145.8 9,657.2 9,193.2 Commercial mortgages........... 535.8 594.5 571.6 549.8 ------------ ------------ ------------ ------------ Total $ 10,691.3 $ 11,407.9 $ 10,893.6 $ 10,405.0 ============ ============ ============ ============ With respect to our residual exposure to fluctuations in interest rates, we use various derivative financial instruments to manage such exposure to fluctuations in interest rates, including interest rate swap agreements, interest rate caps, interest rate floors, interest rate swaptions and foreign currency swap agreements. To reduce counterparty credit risks and diversify counterparty exposure, we enter into derivative contracts only with highly rated financial institutions. We enter into interest rate swap agreements to reduce market risks from changes in interest rates. We do not enter into interest rate swap agreements for trading purposes. Under interest rate swap agreements, we exchange cash flows with another party at specified intervals for a set length of time based on a specified notional principal amount. Typically, one of the cash flow streams is based on a fixed interest rate set at the inception of the contract and the other is based on a variable rate that periodically resets. Generally, no premium is paid to enter into the contract and neither party makes payment of principal. The amounts to be received or paid on these swap agreements are accrued and recognized in net investment income. We enter into interest rate floor, cap and swaption contracts for our assets and our insurance liabilities as a hedge against substantial changes in interest rates. We do not enter into such contracts for trading purposes. Interest rate floor and interest rate cap agreements are contracts with a counterparty which require the payment of a premium and give us the right to receive over the term of the contract the difference between the floor or cap interest rate and a market interest rate on specified future dates based on an underlying notional principal. Swaption contracts are options to enter into an interest rate swap transaction on a specified future date and at a specified interest rate. Upon the exercise of a swaption, we receive either a swap agreement at the pre-specified terms or cash for the market value of the swap. We pay the premium for these instruments on a quarterly basis over the term of the contract and recognize these payments in computing net investment income. The tables below show the interest rate sensitivity of our interest rate derivatives measured in terms of fair value as of March 31, 2002 and December 31, 2001 (dollars in millions). These exposures will change as our insurance liabilities are created and discharged and as a result of ongoing portfolio and risk management activities. 2002: Fair Value Weighted ----------------------------------------------------- Average Notional Term -100 Basis As of +100 Basis Amount (Years) Point Change 3/31/02 Point Change --------------- -------------- ---------------- ----------- ------------------ Interest rate floors $ 85.0 1.3 $ 1.0 $ .2 $ -- Interest rate swaps 605.0 11.6 23.9 7.0 (10.0) Interest rate caps 50.0 6.2 (.2) .3 1.3 ------------ ---------- -------- --------- Total $ 740.0 $ 24.7 $ 7.5 $ (8.7) ============ ========== ======== ========= 2001: Fair Value Weighted ----------------------------------------------------- Average Notional Term -100 Basis As of +100 Basis Amount (Years) Point Change 12/31/01 Point Change --------------- -------------- ---------------- ----------- ------------------ Interest rate floors $ 110.0 1.4 $ 1.7 $ .4 $ (.4) Interest rate swaps 590.0 12.2 25.0 6.4 (12.1) Interest rate caps 50.0 6.5 -- .4 1.3 ------------ ---------- --------- ---------- Total $ 750.0 $ 26.7 $ 7.2 $ (11.2) ============ ========== ========= ========== Equity Risk Equity risk is the risk that we will incur economic losses due to adverse changes in equity prices. Our exposure to changes in equity prices primarily results from our commitment to fund our variable annuity and variable life products, as well as from our holdings of common stocks, mutual funds and other equities. We manage our insurance liability risks on an integrated basis with other risks through our liability and risk management and capital and other asset allocation strategies. We also manage equity price risk through industry and issuer diversification and asset allocation techniques. We held $303.7 million and $290.9 million in equities on our balance sheet as of March 31, 2002 and December 31, 2001, respectively. A 10% decline in the relevant equity price would decrease the value of these assets by approximately $30 million and $29 million as of March 31, 2002 and December 31, 2001, respectively. Conversely, a 10% increase in the relevant equity price would increase the value of these assets by approximately $30 million and $29 million as of March 31, 2002 and December 31, 2001, respectively. Foreign Exchange Risks Foreign exchange risk is the risk that we will incur economic losses due to adverse changes in foreign currency exchange rates. Our functional currency is the U.S. dollar. Our exposure to fluctuations in foreign exchange rates against the U.S. dollar results from our holdings in non-U.S. dollar-denominated fixed maturity securities and equity securities and through our investments in foreign subsidiaries and affiliates. The principal currencies that create foreign exchange rate risk for us are the British pound sterling, due to our investment in Aberdeen and Lombard and the Argentine Peso, due to our investment in EMCO. In the first quarter of 2002, a charge of $11.1 million was taken through other comprehensive income to reflect the devaluation of the Argentine peso. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS General We are regularly 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 adviser, investor or taxpayer. In addition, state regulatory bodies, the SEC, the NASD and other 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. These types of lawsuits and regulatory actions may be difficult to assess or quantify, may seek recovery of very large and/or indeterminate amounts, including punitive and treble damages, and their existence and magnitude may remain unknown for substantial periods of time. A substantial legal liability or significant regulatory action against us could have a material adverse effect on our business, results of operations and financial condition. While it is not feasible to predict or determine the ultimate outcomes of all pending investigations and legal proceedings or to provide reasonable ranges of potential losses, it is the opinion of our management that such outcomes, after consideration of available insurance and reinsurance and the provisions made in our consolidated financial statements, are not likely to have a material adverse effect on our consolidated financial condition. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on our operating results or cash flows. Discontinued Reinsurance Business The life companies' reinsurance business included, among other things, reinsurance by the life companies of other insurance companies' group accident and health business. During 1999, the life companies placed their remaining group accident and health reinsurance business into runoff, adopting a formal plan to terminate the related contracts as early as contractually permitted and not entering into any new contracts. As part of the decision to discontinue remaining reinsurance operations, Phoenix Life reviewed the runoff block and estimated the amount and timing of future net premiums, claims and expenses. We established reserves for claims and related expenses that we expect to pay on our discontinued group accident and health reinsurance business. These reserves are a net present value amount that is based on currently known facts and estimates about, among other things, the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid, the amount of reinsurance we believe we will collect under our finite reinsurance and our other reinsurance to cover our losses and the likely legal and administrative costs of winding down the business. Total net reserves were $10 million at March 31, 2002. In addition, in 1999 we purchased finite aggregate excess-of-loss reinsurance to further protect us from unfavorable results from this discontinued business. The initial premium for this coverage was $130 million. The maximum coverage available is currently $180 million and increases to $230 million by 2004. The life companies are involved in two sets of disputes relating to reinsurance arrangements under which it reinsured group accident and health risks. The first of these involves contracts for reinsurance of the life and health carveout components of workers compensation insurance arising out of a reinsurance pool created and formerly managed by Unicover Managers, Inc. ("Unicover"). In addition, the life companies are involved in arbitrations and negotiations pending in the United Kingdom between multiple layers of reinsurers and reinsureds relating to transactions in which the life companies participated involving certain personal accident excess-of-loss business reinsured in the London market. In light of our provisions for our discontinued reinsurance operations through the establishment of reserves and the finite reinsurance, based on currently available information, we do not expect these operations, including the proceedings described above, to have a material adverse effect on our consolidated financial position. However, given the large and/or indeterminate amounts involved and the inherent unpredictability of litigation, it is not possible to predict with certainty the ultimate impact on us of all pending matters or of our discontinued reinsurance operations. Policyholder Lawsuits Challenging the Plan of Reorganization Three pending lawsuits seek to challenge Phoenix Life's reorganization and the adequacy of the information provided to policyholders regarding the plan of reorganization. We believe that each of these lawsuits lacks merit. The first of these lawsuits, Andrew Kertesz v. Phoenix Home Life Mut. Ins. Co., et al., was filed on April 16, 2001, in the Supreme Court of the State of New York for New York County. The plaintiff seeks to maintain a class action on behalf of a putative class consisting of the eligible policyholders of Phoenix Life as of December 18, 2000, the date the plan of reorganization was adopted. Plaintiff seeks compensatory damages for losses allegedly sustained by the class as a result of the demutualization, punitive damages and other relief. The defendants named in the lawsuit include Phoenix Life and Phoenix and their directors, as well as Morgan Stanley &Co. Incorporated, financial advisor to Phoenix Life in connection with the plan of reorganization. The second lawsuit, Paulette M. Fantozzi v. Phoenix Home Life Mut. Ins. Co., et al., was filed on August 23, 2001, in the Supreme Court of the State of New York for New York County. The allegations and relief requested in this class-action complaint are virtually identical to the allegations and relief sought in the Kertesz lawsuit. The defendants named in the Fantozzi action are the same as those named in Kertesz. On October 19, 2001, motions to dismiss the claims asserted in the Kertesz and Fantozzi lawsuits were filed. These motions are pending. We intend to vigorously defend against all claims asserted in these two pending lawsuits. On October 22, 2001, Andrew Kertesz filed a proceeding pursuant to Article 78 of the New York Civil Practice Law and Rules, Andrew Kertesz v. Gregory V. Serio, et al., in the Supreme Court of New York for New York County. The Article 78 petition seeks to vacate and annul the decision and order of the New York Superintendent, dated June 1, 2001, approving the plan of reorganization. The petition names as respondents Phoenix Life and Phoenix and their directors and the New York Superintendent. We believe that the allegations of the petition are meritless and intend to vigorously defend against all the claims asserted. Another lawsuit that sought to challenge the plan of reorganization, Billie J. Burns v. Phoenix Home Life Mut. Ins. Co., et al., was filed on April 4, 2001, in the Circuit Court of Cook County, Illinois County Department, Chancery Division. A motion to dismiss that action was filed on May 4, 2001. On October 2, 2001, the court entered an order dismissing the action for want of prosecution. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In connection with the June 25, 2001 demutualization of Phoenix Mutual, during the three months ended March 31, 2002, Phoenix issued 1,005 shares of common stock to eligible policyholders, effective as of June 25. In reliance on the exemption under Section 3(a)(10) of the Securities Act of 1933, Phoenix issued such shares to policyholders in exchange for their membership interests without registration under such Act. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable ITEM 5. OTHER INFORMATION Not applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K During the three months ended March 31, 2002, Phoenix filed the following reports on Form 8-K: o dated January 7, 2002, Items 5 and 7, regarding announcement of authorization of additional shares for stock repurchase program; o dated February 11, 2002, Items 5 and 7, regarding announcement of a commission-free purchase and sale program; o dated March 19, 2002, Items 5 and 7, regarding announcement of a new member of the company's Board of Directors; and o dated March 26, 2002, Items 5 and 7, regarding announcement of the appointment of Coleman D. Ross as executive vice president and chief financial officer, effective April 1, 2002. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE PHOENIX COMPANIES, INC. By /s/ Coleman D. Ross Coleman D. Ross, Executive Vice President and Chief Financial Officer May 15, 2002
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10-Q Filing
Phoenix Companies (PNX) Inactive 10-Q2002 Q2 Quarterly report
Filed: 15 May 02, 12:00am