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FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001
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 August 9, 2001, the registrant had 106,365,350 shares of
common stock outstanding.
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
Unaudited Interim Consolidated Balance Sheets
as of June 30, 2001 and December 31, 2000 .............................................................. 3
Unaudited Interim Consolidated Statements of Income, Comprehensive Income and Equity for the
three months ended June 30, 2001 and 2000 and the six months ended June 30, 2001 and 2000 .............. 5
Unaudited Interim Consolidated Statements of Cash Flows for the six months ended
June 30, 2001 and 2000 ................................................................................. 6-7
Notes to Unaudited Interim Consolidated Financial Statements ........................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................. 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................................. 45
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ...................................................................................... 48
Item 2. Changes in Securities and Use of Proceeds .............................................................. 50
Item 3. Defaults Upon Senior Securities ........................................................................ 51
Item 4. Submission of Matters to a Vote of Security Holders .................................................... 51
Item 5. Other Information ...................................................................................... 51
Item 6. Exhibits and Reports on Form 8-K ....................................................................... 51
SIGNATURE 52
Exhibit Index 53
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
The Phoenix Companies, Inc.
Unaudited Interim Consolidated Balance Sheets
As of
December 31, As of June 30,
2000 2001
--------- ---------
(in millions)
Assets:
Investments
Held-to-maturity debt securities, at amortized cost $ 2,109.6 $ 2,153.8
Available-for-sale debt securities, at fair value 5,949.0 6,415.7
Equity securities, at fair value 335.5 310.0
Mortgage loans 593.4 561.3
Real estate 77.9 80.9
Policy loans 2,105.2 2,149.5
Venture capital partnerships 467.3 326.6
Other invested assets 235.7 244.1
Short-term investments 547.2 15.2
--------- ---------
Total investments 12,420.8 12,257.1
Cash and cash equivalents 176.6 1,025.8
Accrued investment income 194.5 202.1
Deferred policy acquisition costs 1,019.0 1,082.2
Premiums, accounts and notes receivable 155.8 141.5
Reinsurance recoverables 16.6 17.9
Property and equipment, net 122.2 121.2
Goodwill and other intangible assets, net 595.9 880.3
Investments in unconsolidated subsidiaries 159.9 205.0
Deferred income taxes 14.7
Net assets of discontinued operations (Note 8) 25.5 20.8
Other assets 49.8 38.7
Separate account assets 5,376.6 5,286.4
--------- ---------
Total assets $20,313.2 $21,293.7
========= =========
The accompanying notes are an integral part of these statements.
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The Phoenix Companies, Inc.
Unaudited Interim Consolidated Balance Sheets (continued)
As of As of
December 31, June 30,
2000 2001
(in millions)
Liabilities:
Policy liabilities and accruals $11,372.6 $11,849.3
Policyholder deposit funds 678.4 667.1
Notes payable 425.4 480.2
Deferred income taxes 9.4
Other liabilities 473.0 615.2
Separate account liabilities 5,376.6 5,286.4
--------- ---------
Total liabilities 18,335.4 18,898.2
--------- ---------
Contingent liabilities (Note 9)
Minority interest in net assets of consolidated subsidiaries 136.9 5.1
--------- ---------
Shareholders' Equity:
Common stock, $.01 par value, 1.0 billion shares authorized;
105.0 million shares issued and outstanding 1.1
Additional paid in capital 2,387.1
Retained earnings 1,820.7 (2.1)
Accumulated other comprehensive income - securities 20.2 6.6
Accumulated other comprehensive income - derivatives (2.3)
--------- ---------
Total equity 1,840.9 2,390.4
--------- ---------
Total liabilities and equity $20,313.2 $21,293.7
========= =========
The accompanying notes are an integral part of these statements.
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The Phoenix Companies, Inc.
Unaudited Interim Consolidated Statements of Income,
Comprehensive Income and Equity
For the Three Months For the Six Months
Ended June 30, Ended June 30,
----------------------- -----------------------
2000 2001 2000 2001
-------- -------- -------- --------
(in millions)
Revenues
Premiums $ 278.7 $ 267.2 $ 544.7 $ 533.2
Insurance and investment product fees 164.4 139.7 327.5 285.2
Net investment income 278.9 224.6 665.3 390.1
Net realized investment gains (losses) 10.4 (4.9) 34.4 (20.5)
-------- -------- -------- --------
Total revenues 732.4 626.6 1,571.9 1,188.0
-------- -------- -------- --------
Benefits and expenses
Policy benefits and increase in policy liabilities 335.4 332.2 665.4 666.3
Policyholder dividends 95.4 89.7 188.9 196.0
Amortization of deferred policy acquisition costs 41.3 26.9 81.5 62.0
Amortization of goodwill and other intangible assets 9.3 11.3 18.0 24.5
Interest expense 8.0 7.7 16.3 14.8
Other operating expenses 123.3 149.0 261.8 397.1
-------- -------- -------- --------
Total benefits and expenses 612.7 616.8 1,231.9 1,360.7
-------- -------- -------- --------
Income (loss) from continuing operations before income taxes (benefit),
minority interest and equity in earnings of and interest earned
from investments in unconsolidated subsidiaries 119.7 9.8 340.0 (172.7)
Income taxes (benefit) 48.6 5.2 126.1 (63.8)
-------- -------- -------- --------
Income (loss) from continuing operations before minority interest
and equity in earnings of and interest earned from investments
in unconsolidated subsidiaries 71.1 4.6 213.9 (108.9)
Minority interest in net income of consolidated subsidiaries 6.1 1.7 11.6 3.5
Equity in earnings of and interest earned from investments
in unconsolidated subsidiaries 2.9 1.1 4.3 3.8
-------- -------- -------- --------
Income (loss) from continuing operations 67.9 4.0 206.6 (108.6)
Discontinued operations (Note 8)
(Loss) income from discontinued operations, net of income taxes (3.7) 3.1
Gain on disposal, net of income taxes 45.5 43.3
-------- -------- -------- --------
Income (loss) before cumulative effect of accounting changes 109.7 4.0 253.0 (108.6)
Cumulative effect of accounting changes for:
Venture capital partnerships, net of income taxes (Note 4) (48.8)
Securitized financial instruments, net of income taxes (Note 4) (20.5) (20.5)
Derivative financial instruments, net of income taxes (Note 4) 3.9
-------- -------- -------- --------
Net income (loss) 109.7 (16.5) 253.0 (174.0)
-------- -------- -------- --------
Earnings per share (Note 11)
Other comprehensive (loss) income, net of income taxes
Unrealized (losses) gains on securities (5.0) 2.5 64.0 (9.1)
Unrealized losses on derivatives (4.0) (3.4)
Reclassification adjustment for net realized (losses) gains
included in net income (7.8) 1.7 (15.9) (4.4)
Cumulative effect of accounting change for derivatives (Note 4) 1.1
-------- -------- -------- --------
Total other comprehensive (loss) income (12.8) 0.2 48.1 (15.8)
-------- -------- -------- --------
Comprehensive income (loss) 96.9 (16.3) 301.1 (189.8)
Initial public offering 766.4 766.4
Equity adjustment for policyholder dividend obligation (Note 4) (30.3) (30.3)
Other equity adjustments 3.2
-------- -------- -------- --------
Equity, beginning of period 1,960.2 1,670.6 1,756.0 1,840.9
-------- -------- -------- --------
Equity, end of period $2,057.1 $2,390.4 $2,057.1 $2,390.4
======== ======== ======== ========
The accompanying notes are an integral part of these statements.
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The Phoenix Companies, Inc.
Unaudited Interim Consolidated Statements of Cash Flows
FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
2000 2001
-------- --------
(IN MILLIONS)
Cash flows from operating activities:
Net income (loss) $ 253.0 $ (174.0)
Adjustments to reconcile net income to net cash provided
by operating activities:
Net gain from discontinued operations (46.4)
Net realized investment (gains) losses (34.4) 20.5
Amortization and depreciation 28.8 34.8
Equity in undistributed earnings of affiliates and partnerships (234.9) 29.7
Securitized financial instruments and derivatives 16.6
Deferred income taxes 85.6 9.6
(Increase) decrease in receivables (50.2) 5.3
Increase in deferred policy acquisition costs (.7) (96.2)
Increase in policy liabilities and accruals 176.1 514.9
Change in other assets/other liabilities, net 52.7 (54.8)
Other operating activities, net 2.8 (17.7)
-------- --------
Net cash provided by continuing operations 232.4 288.7
Net cash used for discontinued operations (249.1) (35.6)
-------- --------
Net cash (used for) provided by operating activities (16.7) 253.1
-------- --------
Cash flows from investing activities:
Proceeds from sales, maturities or repayments
of available-for-sale debt securities 603.0 1,050.3
Proceeds from maturities or repayments of held-to-maturity
debt securities 94.7 80.5
Proceeds from disposals of equity securities 234.5 76.5
Proceeds from mortgage loan maturities or repayments 37.5 33.5
Proceeds from sale of real estate and other invested assets 18.4 .9
Proceeds from distributions of venture capital partnerships 19.2 23.0
Proceeds from sale of subsidiaries and affiliates 19.0
Purchase of available-for-sale debt securities (669.8) (1,357.8)
Purchase of held-to-maturity debt securities (166.0) (147.7)
Purchase of equity securities (62.6) (31.9)
Purchase of subsidiaries (8.6) (36.7)
Purchase of mortgage loans (.5) (.5)
Purchase of investments in unconsolidated subsidiaries and
other invested assets (53.5) (46.0)
Purchase of venture capital partnerships (55.8) (24.1)
Change in short-term investments, net (311.1) 532.0
Increase in policy loans (4.1) (44.3)
Capital expenditures (6.6) (8.1)
Premium paid for redemption of convertible debt (18.8)
-------- --------
Net cash (used for) provided by continuing operations (331.3) 99.8
Net cash provided by discontinued operations 244.8 38.0
-------- --------
Net cash (used for) provided by investing activities $ (86.5) $ 137.8
-------- --------
The accompanying notes are an integral part of these statements.
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The Phoenix Companies, Inc.
Unaudited Interim Consolidated Statements of Cash Flows (continued)
FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
2000 2001
-------- --------
(IN MILLIONS)
Cash flows from financing activities:
Issuance of common stock $ 807.9
Payments to eligible policyholders in lieu of stock (28.7)
Net deposits (withdrawals) of policyholder deposit funds,
net of interest credited $ 33.1 (11.3)
Proceeds from borrowings .9 180.0
Repayment of borrowings (37.8) (125.2)
Distributions to minority shareholders (2.8) (345.0)
Debenture principal payments (19.4)
-------- --------
Net cash (used for) provided by financing activities (6.6) 458.3
-------- --------
Net change in cash and cash equivalents (109.8) 849.2
Cash and cash equivalents, beginning of period 187.6 176.6
-------- --------
Cash and cash equivalents, end of period $ 77.8 $1,025.8
======== ========
Supplemental cash flow information:
Income taxes paid (refunded), net $ 27.4 $ (34.2)
Interest paid on indebtedness $ 16.5 $ 14.8
The accompanying notes are an integral part of these statements
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The Phoenix Companies, Inc.
Notes to the Unaudited Interim Consolidated Financial Statements
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
The Phoenix Companies, Inc. (together with its subsidiaries, Phoenix) is
a 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. Phoenix offers a broad
range of life insurance, variable 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."
In 1999, Phoenix Home Life Mutual Insurance Company, now a Phoenix
subsidiary, renamed Phoenix Life Insurance Company, discontinued the
operations of three of its business units: the Reinsurance Operations,
the Real Estate Management Operations and the Group Life and Health
Operations. See Note 8 - "Discontinued Operations."
2. BASIS OF PRESENTATION
The accompanying unaudited interim 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. The State of New York
Insurance Department (the Insurance Department) recognizes only statutory
accounting practices for determining and reporting the financial
condition and results of operations of an insurance company for
determining solvency under the New York State Insurance Law. No
consideration is given by the Insurance Department to financial
statements prepared in accordance with GAAP in making such determination.
In the opinion of management, adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been
included. Operating results for the six months ended June 30, 2001 are
not necessarily indicative of the results that may be expected for the
year ending December 31, 2001. These unaudited interim consolidated
financial statements should be read in conjunction with the consolidated
financial statements of the company for the year ended December 31, 2000.
3. REORGANIZATION AND INITIAL PUBLIC OFFERING
Under the terms of the plan of reorganization, which the board of
directors of Phoenix Home Life Mutual Insurance Company unanimously
adopted on December 18, 2000 and amended and restated on January 26,
2001, on June 25, 2001, the effective date of the demutualization, such
company converted from a mutual life insurance company to a stock life
insurance company, became a wholly owned subsidiary of The Phoenix
Companies, Inc. and changed its name to Phoenix Life Insurance Company
(Phoenix Life). At the same time, Phoenix Investment Partners, Ltd. (PXP)
became an indirect wholly owned subsidiary of The Phoenix Companies, Inc.
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, and $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
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policy credits, which 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 individual life insurance policies of Phoenix Life. The purpose
of the closed block is to protect the policy dividend expectations of the
holders of the policies included in the closed block after
demutualization. The closed block will continue in effect until the date
none of such policies are in force. See Note 7 - "Closed Block."
In addition, on June 25, 2001, Phoenix completed 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 were $807.9 million, which was
contributed to Phoenix Life. See Note 10 - "Subsequent Events."
4. SUMMARY OF NEW SIGNIFICANT ACCOUNTING POLICIES
Accounting for Demutualizations
Effective June 30, 2001, Phoenix adopted Statement of Position 00-3 (SOP
00-3) "Accounting by Insurance Enterprises for Demutualizations and
Formations of Mutual Insurance Holding Companies and For Certain
Long-Duration Participating Contracts." The provisions of SOP 00-3
provide guidance on accounting by insurance enterprises for
demutualizations and the formation of mutual holding companies, including
the emergence of earnings from and the financial statement presentation
of the closed block formed as a part of the demutualization. SOP 00-3
specifies that closed block assets, liabilities, revenues and expenses
should be displayed with all other assets, liabilities, revenues and
expenses of the insurance enterprise based on the nature of the
particular item, with appropriate disclosures relating to the closed
block. SOP 00-3 also provides guidance regarding accounting for
pre-demutualization participating contracts, for establishment of a
policyholder dividend obligation, for earnings that relate to the closed
block but do not inure to stockholders and for expenses relating to a
demutualization. The financial statements herein reflect the adoption of
SOP 00-3.
Pursuant to SOP 00-3, in the second quarter of 2001, Phoenix recorded a
charge of $30.3 million to equity representing the establishment of the
policyholder dividend obligation along with the corresponding impact on
deferred policy acquisition costs and deferred income taxes.
The following table summarizes the equity adjustment for the policyholder
dividend obligation.
Establishment of policyholder dividend obligation $(115.5)
Impact on deferred policy acquisition costs 68.9
Impact on deferred income taxes 16.3
------
Total equity adjustment for policyholder dividend obligation $ (30.3)
======
See Note 7 - "Closed Block" for additional information.
Venture Capital
Phoenix records its investments in venture capital partnerships in
accordance with the equity method of accounting. Phoenix records its
share of the net equity in earnings of the venture capital partnerships
in accordance with Accounting Practice Bulletin 18, using the most recent
financial information received from the partnerships. Historically, this
information has been provided to Phoenix on a one-quarter lag. Due to the
recent volatility in the equity markets, Phoenix believes the one-quarter
lag in reporting is no longer appropriate. Therefore, Phoenix has changed
its method of applying the equity method of accounting to eliminate the
quarterly lag in reporting.
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In the first quarter of 2001, Phoenix 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.
In the first quarter of 2001, Phoenix removed the lag in reporting by
estimating the change in Phoenix's 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 Phoenix's then current reporting date of March 31, 2001.
To estimate the net equity in earnings of the venture capital
partnerships for the period from January 1, 2001 through March 31, 2001,
Phoenix developed a methodology to estimate the change in value of the
underlying investee companies in the venture capital partnerships. For
public investee companies, Phoenix used quoted market prices at March 31,
2001, applying discounts to public prices, in instances where such
discounts were applied in the underlying partnerships' financial
statements. For private investee companies, Phoenix applied a public
industry sector index to roll the value forward from January 1, 2001
through March 31, 2001. Using this methodology, Phoenix's share of equity
losses from the partnerships decreased income from continuing operations
by $37.3 million (net of income taxes of $20.0 million) for the first
quarter 2001. Phoenix will apply this methodology consistently each
quarter with subsequent adjustments to reflect market events reported by
the partnerships (i.e., new rounds of financing, initial public offerings
and writedowns by the general partners). In the second quarter 2001,
Phoenix recorded investment income before tax of $5.5 million, which
reflects Phoenix's estimate of its venture capital partnership results
for the second quarter, a true-up of the first quarter estimate and
realized gains on cash and stock distributions. Phoenix will also revise
the valuations it has assigned to the investee companies once a year, to
reflect the valuations in the audited financial statements received from
the venture capital partnerships. Phoenix's venture capital earnings
remain subject to volatility.
Securitized Financial Assets
During the third quarter of 2000, the Emerging Issues Task Force (EITF)
of the Financial Accounting Standards Board (FASB) reached a consensus on
a new accounting requirement for the recognition of impairments on
interest-only securities and other retained beneficial interests in
securitized financial assets. The new guidance is summarized in EITF
Issue No. 99-20, "Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial
Assets" (EITF 99-20).
Under prior accounting rules, declines in the value of our interest-only
securities and other retained beneficial interests in securitized
financial assets were recognized in the statement of operations when the
present value of estimated cash flows discounted at a risk-free rate
using current assumptions was less than the carrying value of the
interest-only securities.
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Under the new accounting rule, declines in value are recognized when both
of the following occur: (i) the fair value of the security is less than
its carrying value; and (ii) the timing and/or amount of cash flows
expected to be received from the security has changed adversely from the
previous valuation which determined the carrying value of the security.
The cumulative effect of adoption of EITF 99-20 on April 1, 2001 was to
decrease net income after tax by $20.5 million.
Derivative Financial Instruments
In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Derivatives" - an amendment of
FASB Statement No. 133. This Statement makes certain changes in the
hedging provisions of SFAS No. 133, and is effective concurrent with SFAS
No 133. As amended, SFAS No. 133 requires all derivatives to be
recognized on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through earnings. If the derivative
is a hedge, depending on the nature of the hedge, changes in fair value
of the derivatives will either be offset against the change in fair value
of the hedged assets, liabilities or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change
in fair value will be recognized immediately in earnings.
Phoenix maintains an overall interest rate risk-management strategy that
incorporates the use of derivative financial instruments to manage
exposure to fluctuations in interest rates. Phoenix's exposure to
interest rate changes primarily results from the commitment to fund
interest-sensitive insurance liabilities, as well as from significant
holdings of fixed rate investments. Derivative instruments that are used
as part of Phoenix's interest rate risk-management strategy include
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, Phoenix
enters into derivative contracts only with highly rated financial
institutions.
Phoenix enters into interest rate swap agreements to reduce market risks
from changes in interest rates. Phoenix does not enter into interest rate
swap agreements for trading purposes. Under interest rate swap
agreements, Phoenix exchanges 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 a variable rate that periodically resets. Generally, no premium is
paid to enter into the contract and neither party makes a payment of
principal. The amounts to be received or paid on these swap agreements
are accrued and recognized in net investment income.
Phoenix enters into interest rate floor, interest rate cap and swaption
contracts as a hedge for its assets and insurance liabilities against
substantial changes in interest rates. Phoenix does 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 Phoenix 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 amount. 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, Phoenix would
receive either a swap agreement at the pre-specified terms or cash for
the market value of the swap. Phoenix pays the premium for these
instruments on a quarterly basis over the maturity of the contract, and
recognizes these payments in net investment income.
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Phoenix enters into foreign currency swap agreements to hedge against
fluctuations in foreign currency exposure. Under these agreements,
Phoenix agrees to exchange with another party, principal and periodic
interest payments denominated in foreign currency for payments
denominated in U.S. dollars. The amounts to be received or paid on these
foreign currency swap agreements are recognized in net investment income.
Phoenix adopted SFAS No. 133 and SFAS No. 138 effective January 1, 2001.
Phoenix reviewed its inventory of financial instruments, including
insurance and annuity contracts and "hybrid" investments, for potential
embedded derivatives. Phoenix also reviewed its portfolio of freestanding
derivatives, which includes interest rate swap, cap and floor contracts,
swaptions and foreign currency swap agreements.
On January 1, 2001, in accordance with the transition provisions of SFAS
No. 133, Phoenix recorded a net-of-tax cumulative effect adjustment of
$1.3 million (gain) in earnings to recognize at fair value all
derivatives that are designated as fair-value hedging instruments.
Phoenix also recorded an offsetting net-of-tax cumulative effect
adjustment of $1.3 million (loss) in earnings to recognize the difference
attributable to the hedged risks between the carrying values and fair
values of the related hedged assets and liabilities. Phoenix also
recorded a net-of-tax cumulative effect adjustment of $1.1 million in
accumulated other comprehensive income to recognize, at fair value, all
derivatives that are designated as cash-flow hedging instruments.
For derivative instruments which were not designated as hedges, upon
implementation of SFAS No. 133, Phoenix recorded a net-of-tax cumulative
effect adjustment of $3.9 million in earnings to recognize these
instruments at fair value. Gains and losses on derivatives that were
previously deferred as adjustments to the carrying amount of hedged items
were not included in the cumulative effect adjustment. There were no
gains or losses on derivative instruments that were reported
independently as deferred assets or liabilities that required
de-recognition from the balance sheet.
Phoenix recognized an after-tax loss of $0.5 million for the quarter
ended June 30, 2001 and an after-tax gain of $0.1 million for the six
months ended June 30, 2001 (reported as other comprehensive income in the
Unaudited Consolidated Statement of Income, Comprehensive Income and
Equity), which represented the change in fair value of interest rate
swaps which have been designated as cash flow hedges, using the shortcut
method, assuming no ineffectiveness. These interest rate swaps hedge
floating-rate exposure on asset cash flows that back insurance
liabilities by swapping floating rate bonds to fixed. For changes in the
fair value of derivatives that are designated, qualify, and are highly
effective as cash flow hedges, and for which the critical terms of the
hedging instrument and the assets match, Phoenix recognizes the change in
fair value of the derivative in other comprehensive income. Phoenix
expects that there will be no ineffectiveness to recognize in earnings
during the term of the hedges, and Phoenix does not expect to reclassify
into earnings amounts reported in accumulated other comprehensive income
over the next 12 months.
For the quarter and six months ended June 30, 2001, Phoenix also
recognized an after-tax loss of $3.5 million (reported as other
comprehensive income in the Unaudited Consolidated Statement of Income,
Comprehensive Income and Equity), which represented the change in fair
value of interest rate forward swaps which have been designated as cash
flow hedges of the forecasted purchase of assets. For changes in the fair
value of derivatives that are designated as cash flow hedges of a
forecasted transaction, Phoenix recognizes the change in fair value of
the derivative in other comprehensive
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income. Amounts related to cash flow hedges that are accumulated in other
comprehensive income are reclassified as earnings in the same period or
periods during which the hedged forecasted transaction (the acquired
asset) affects earnings.
Phoenix also recognized an after-tax loss of $1.2 million for the quarter
ended June 30, 2001 and an after-tax loss of $1.3 million for the six
months ended June 30, 2001 (reported as net investment income in the
Unaudited Consolidated Statement of Income, Comprehensive Income and
Equity), which represented the change in fair value of derivative
instruments which were not designated as hedges upon implementation of
SFAS 133. These instruments primarily include: interest rate floors which
hedge spread deficiency risk between assets and deferred annuity product
liabilities; interest rate caps which hedge disintermediation risk
associated with universal life insurance liabilities; and interest rate
swaps which were hedges of an anticipated purchase of assets associated
with an acquisition of a block of insurance liabilities for which
offsetting swap positions were taken to lock in a stream of income to
supplement the income on the assets purchased. For changes in fair value
of derivatives that are not designated, and did not qualify as highly
effective hedges upon implementation of SFAS 133, Phoenix recognizes the
entire change in fair value of the derivatives in current-period
earnings.
Phoenix also holds foreign currency swaps as hedges against
available-for-sale securities that back U.S. dollar denominated
liabilities. For changes in the fair value of derivatives that are
designated, qualify, and are highly effective as fair value hedges,
Phoenix recognizes the change in fair value of the derivative, along with
the change in value of the hedged asset or liability attributable to the
hedged risk, in current-period earnings. For the quarter and six months
ended June 30, 2001, Phoenix recognized an after-tax loss of $0.3
million, representing hedge ineffectiveness which is included in
earnings.
Business Combinations/Goodwill and other Intangible Assets
In June 2001, the FASB approved SFAS No. 141 "Business Combinations" and
SFAS No. 142 "Goodwill and Other Intangible Assets" which are effective
for July 1, 2001 and January 1, 2002, respectively. SFAS 141 requires
that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. Under SFAS 142, amortization
of goodwill, including goodwill and intangible assets with identified
lives recorded in past business combinations, will discontinue upon
adoption of this standard. In addition, goodwill recorded as a result of
business combinations completed during the six-month period ending
December 31, 2001 will not be amortized. Goodwill and intangible assets
will be tested for impairment in accordance with the provisions of the
statement. Phoenix is currently reviewing the provisions of SFAS 141 and
142 and assessing the impact of adoption.
5. SIGNIFICANT TRANSACTIONS
PURCHASE OF PHOENIX INVESTMENT PARTNERS MINORITY INTEREST
On September 10, 2000, Phoenix Life, one of its subsidiaries and PXP
entered into an agreement and plan of merger, pursuant to which such
subsidiary agreed to purchase the outstanding common stock shares of PXP
owned by third parties, for a price of $15.75 per share. In connection
with this merger, Phoenix Life paid, from available cash and short-term
investments, $339.3 million to those stockholders on January 11, 2001. As
a result, PXP became an indirect wholly owned subsidiary of Phoenix Life
and PXP's shares of common stock were de-listed from the New York Stock
Exchange. In addition, PXP has accrued compensation expenses of $57.0
million to cash out options, $5.5 million of related compensation costs,
$5.2 million in retention costs and $3.9 million in transaction costs at
March 31, 2001.
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After the merger, some third party holders of PXP's convertible
subordinated debentures converted their debentures and PXP redeemed all
remaining outstanding debentures held by third parties by the end of
March 2001. PXP made cash payments totaling $38.0 million in connection
with these conversions and redemptions. PXP borrowed $95.0 million from
its then existing credit facility to make these payments.
The excess of purchase price over the minority interest in the net assets
of PXP totaled $224.1 million. Of this excess purchase price, $179.1
million has been allocated to investment management contracts, which are
being amortized over their estimated useful lives using the straight-line
method. The weighted average useful life of the investment management
contracts is 11.3 years. The remaining excess purchase price of $118.4
million has been classified as goodwill and is being amortized over 40
years using the straight-line method. Related amortization of goodwill
and investment management contracts of $1.4 million and $6.9 million,
respectively, has been expensed for the period ended June 30, 2001.
The following table summarizes the calculation and allocation of purchase
price (in millions).
Purchase price:
Purchase price for 21.5 million outstanding shares at $15.75/share $339.3
Premium paid related to third party convertible debt redemption/conversion 18.8
Transaction related costs 3.2
------
Total purchase price $361.3
======
Purchase price allocation:
Fair value of acquired net assets $137.2
Investment management contracts 179.1
Deferred taxes (73.4)
Goodwill 118.4
------
Total purchase price allocation $361.3
======
Prior to this transaction, PXP had a $1.2 million liability related to
options held by certain employees. As a result of this transaction, all
outstanding options were settled and, consistent with previous accounting
treatment, the remaining liability was reversed and recorded as
additional paid-in capital.
Additionally, prior to the transaction, PXP had outstanding restricted
stock, which had been issued to certain employees pursuant to PXP's
Restricted Stock Plan. For book purposes, the fair market value of the
options at the date of the grant was recorded as unearned compensation,
as a separate component of shareholders equity, and amortized over the
restriction period. For tax purposes, PXP can deduct compensation expense
equal to the fair market value of the stock on the date of the
restrictions lapse. The tax benefit of the deduction in excess of the
compensation expense is recorded as an adjustment to additional paid-in
capital. At the time of this transaction, all restrictions lapsed, and
PXP recorded a $2.0 million tax receivable for the deduction and a
corresponding adjustment to additional paid-in capital.
EARLY RETIREMENT PROGRAM
On January 29, 2001, Phoenix offered a special retirement program under
which qualified participants will receive enhanced retirement benefits by
the addition of five years to age and pension plan service under the
Employee Pension Plan. Employees of Phoenix Life and PXP who
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decided to participate will retire between June 1, 2001 and December 31,
2001, with most retirements effective at the beginning of that period. Of
the 309 participants eligible, 159 accepted the special retirement
incentive program. As a result of this program, Phoenix recorded an
additional pension expense of $17.4 million for the period ended June 30,
2001.
ABERDEEN ASSET MANAGEMENT
In May 2001, Phoenix purchased additional shares of common stock of
Aberdeen Asset Management plc, for a cash purchase price of $46.8
million, bringing its ownership to 22.0% (26.95% when the convertible
subordinated note is included) of the common stock of Aberdeen at June
30, 2001.
MASTER CREDIT FACILITY
In June 2001, The Phoenix Companies, Inc., Phoenix Life, and PXP entered
into a $375 million revolving credit facility that matures on June 10,
2005. Phoenix Life's and PXP's existing credit agreements were terminated
at that time. Loans to Phoenix Life and PXP are unconditionally
guaranteed by The Phoenix Companies, Inc. 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. The credit agreement
contains customary financial and operating covenants that include, among
other provisions, requirements that The Phoenix Companies, Inc. maintain
a minimum shareholders' equity and a maximum debt to capitalization
ratio; that Phoenix Life maintain a minimum risk based capital ratio,
minimum financial strength ratings; and that PXP maintain a maximum debt
to capitalization ratio and a minimum shareholders' equity.
6. SEGMENT INFORMATION
The following tables provide certain information with respect to
Phoenix's operating segments as of December 31, 2000, June 30, 2001 and
for each of the three months and six months ended June 30, 2000 and 2001,
as well as the realized investment gains and non-recurring items not
included in segment after-tax operating income.
DECEMBER 31, JUNE 30,
2000 2001
--------- ---------
(IN MILLIONS)
Total assets:
Life and Annuity $17,862.4 $18,013.2
Investment Management 800.2 1,002.3
Venture Capital 467.3 326.6
Corporate and Other 1,157.8 1,930.8
Discontinued operations 25.5 20.8
--------- ---------
Total $20,313.2 $21,293.7
========= =========
Deferred policy acquisition costs:
Life and Annuity $ 1,019.0 $ 1,082.2
========= =========
Policy liabilities and accruals:
Life and Annuity $11,220.0 $11,696.6
Corporate and Other 152.6 152.7
--------- ---------
Total $11,372.6 $11,849.3
========= =========
Policyholder deposit funds:
Life and Annuity $ 665.6 $ 656.6
Corporate and Other 12.8 10.5
--------- ---------
Total $ 678.4 $ 667.1
========= =========
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FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
2000 2001 2000 2001
------- ------- ------- -------
(IN MILLIONS) (IN MILLIONS)
Premiums:
Life and Annuity $ 278.7 $ 267.2 $ 544.7 $ 533.2
------- ------- ------- -------
Total 278.7 267.2 544.7 533.2
------- ------- ------- -------
Insurance and investment product fees:
Life and Annuity 77.6 75.9 157.1 154.2
Investment Management 83.3 66.1 167.5 136.8
Corporate and Other 6.0 2.9 12.3 6.6
Non-recurring items 4.5 3.8 4.5 3.8
Less: inter-segment revenues (7.0) (9.0) (13.9) (16.2)
------- ------- ------- -------
Total 164.4 139.7 327.5 285.2
------- ------- ------- -------
Net investment income:
Life and Annuity 196.0 218.3 391.8 436.5
Investment Management .4 .4 1.0 .8
Venture Capital 67.5 5.6 253.4 (51.7)
Corporate and Other 11.9 (1.7) 13.4 .8
Add: inter-segment investment expenses 3.1 2.0 5.7 3.7
------- ------- ------- -------
Total 278.9 224.6 665.3 390.1
------- ------- ------- -------
Policy benefits and increase in policy liabilities
and policyholder dividends:
Life and Annuity 428.6 419.7 848.0 857.3
Corporate and Other 2.2 2.2 6.3 5.0
------- ------- ------- -------
Total 430.8 421.9 854.3 862.3
------- ------- ------- -------
Amortization of deferred policy acquisition costs:
Life and Annuity 41.3 26.9 81.5 62.0
------- ------- ------- -------
Total 41.3 26.9 81.5 62.0
------- ------- ------- -------
Amortization of goodwill and other intangible assets:
Life and Annuity .4 .1 .4 .2
Investment Management 8.6 11.8 16.5 24.3
Corporate and Other .3 (.6) 1.1
------- ------- ------- -------
Total 9.3 11.3 18.0 24.5
------- ------- ------- -------
Interest expense:
Life and Annuity .2 .3 .5 .5
Investment Management 4.5 4.6 9.1 8.6
Corporate and Other 3.0 3.1 6.7 6.2
Less: inter-segment expenses .3 (.3) (.5)
------- ------- ------- -------
Total 8.0 7.7 16.3 14.8
------- ------- ------- -------
Other operating expenses:
Life and Annuity 63.2 76.1 129.8 156.8
Investment Management 52.1 53.0 105.0 110.2
Corporate and Other 8.6 13.7 31.6 28.7
Non-recurring items 3.6 12.9 3.6 113.4
Less: inter-segment expenses (4.2) (6.7) (8.2) (12.0)
------- ------- ------- -------
Total $ 123.3 $ 149.0 $ 261.8 $ 397.1
------- ------- ------- -------
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FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
2000 2001 2000 2001
------- ------- ------- -------
(IN MILLIONS) (IN MILLIONS)
Operating income (loss) before income taxes (benefit),
minority interest and equity in earnings of and interest
earned from investments in unconsolidated subsidiaries:
Life and Annuity $ 18.6 $ 38.3 $ 33.4 $ 47.1
Investment Management 18.5 (2.9) 37.9 (5.5)
Venture Capital 67.5 5.6 253.4 (51.7)
Corporate and Other 3.8 (17.2) (20.0) (32.5)
Non-recurring items .9 (9.1) .9 (109.6)
------- ------- ------- -------
Total 109.3 14.7 305.6 (152.2)
------- ------- ------- -------
Income taxes (benefit):
Life and Annuity 6.3 13.4 11.6 16.5
Investment Management 7.6 (1.6) 17.1 (.1)
Venture Capital 23.6 1.9 88.7 (18.1)
Corporate and Other 4.4 (9.8) (9.2) (20.0)
Non-recurring items 3.1 2.9 5.9 (35.0)
------- ------- ------- -------
Total 45.0 6.8 114.1 (56.7)
------- ------- ------- -------
Minority interest in net income of consolidated subsidiaries:
Investment Management 5.3 1.7 9.3 3.5
------- ------- ------- -------
Total 5.3 1.7 9.3 3.5
------- ------- ------- -------
Equity in earnings of and interest earned from investments
in unconsolidated subsidiaries:
Investment Management 2.3 .2 2.7 2.3
Corporate and Other .6 .9 1.6 1.5
------- ------- ------- -------
Total 2.9 1.1 4.3 3.8
------- ------- ------- -------
Segment operating income (loss) after taxes:
Life and Annuity 12.3 24.9 21.8 30.6
Investment Management 7.9 (2.8) 14.2 (6.6)
Venture Capital 43.9 3.7 164.7 (33.6)
Corporate and Other (6.5) (9.2) (11.0)
------- ------- ------- -------
Sub-total 64.1 19.3 191.5 (20.6)
Non-recurring items (2.2) (12.0) (5.0) (74.6)
------- ------- ------- -------
Total 61.9 7.3 186.5 (95.2)
------- ------- ------- -------
Net realized investment gains (losses) after taxes:
Life and Annuity (10.1) 2.0 (18.8) (4.4)
Investment Management 1.2 (3.1) 3.5 .5
Corporate and Other 14.9 (2.2) 35.4 (9.5)
------- ------- ------- -------
Total 6.0 (3.3) 20.1 (13.4)
------- ------- ------- -------
Income (loss) from continuing operations:
Life and Annuity 2.2 26.9 3.0 26.2
Investment Management 9.1 (5.9) 17.7 (6.1)
Venture Capital 43.9 3.7 164.7 (33.6)
Corporate and Other 14.9 (8.7) 26.2 (20.5)
Non-recurring items (2.2) (12.0) (5.0) (74.6)
------- ------- ------- -------
Total $ 67.9 $ 4.0 $ 206.6 $(108.6)
======= ======= ======= =======
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The components of after-tax non-recurring items for the three months and
six months ended June 30, were as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
Supplemental Information 2000 2001 2000 2001
------- ------- ------- -------
Non-recurring items:
Investment Management
Portfolio gain (1) $ 3.1 $ $ 3.1
Loss on sublease transaction (2) (.7) (.7)
Partnership gains (3) 2.4 $ 2.4
Expenses of purchase of PXP minority interest (4) (2.9) (46.7)
------- ------- ------- -------
Sub-total 2.4 (.5) 2.4 (44.3)
------- ------- ------- -------
Corporate and Other
Early retirement pension adjustment (5) .6 (11.3)
Demutualization expense (6) (1.7) (12.1) (1.7) (19.0)
Surplus tax (7) (2.9) (5.7)
------- ------- ------- -------
Sub-total (4.6) (11.5) (7.4) (30.3)
------- ------- ------- -------
Total $ (2.2) $ (12.0) $ (5.0) $ (74.6)
======= ======= ======= =======
Non-recurring items include:
(1) the reimbursement, and subsequent reinsurance recovery, related to
two mutual fund investment portfolios which had inadvertently
sustained losses;
(2) one-time expenses related to sublease transactions on certain
office space;
(3) gains related to distributions from PXP partnership investments;
(4) expenses related to the purchase of the PXP minority interest,
including PXP's accrual of non-recurring compensation expenses of
$57.0 million to cash out options, $5.5 million of related
compensation costs, non-recurring retention costs of $5.2 million
and non-recurring transaction costs of $3.9 million. Income taxes
of $27.8 million were calculated using an effective tax rate of
38.8%;
(5) charges incurred in 2001 in connection with early retirement
programs;
(6) expenses related to the demutualization; and
(7) surplus tax because as a mutual life insurance company, Phoenix
Life was subject, in the periods indicated, to a surplus tax
limiting the ability of mutual insurance companies to deduct the
full amount of policyholder dividends from taxable income. Phoenix
Life will not be subject to such surplus tax in 2001 and future
years as a result of the demutualization.
Included in policy benefits and dividend amounts for the Life and Annuity
segment is interest credited on policyholder account balances of $60.6
million and $54.8 million for the six months ended June 30, 2000 and
2001, respectively.
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. Assets have been allocated to the
closed block in an amount that has been determined to produce cash flows
which, together with anticipated revenues from the policies included in
the closed block, are reasonably expected to be sufficient to support
obligations and liabilities relating to these policies, including, but
not limited to, provisions for the
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payment of claims and certain expenses, and taxes, and to provide for the
continuation of policyholder dividend scales in effect for 2000, if the
experience underlying such dividend scales continues, and for appropriate
adjustments in such scales if the experience changes. The closed block
assets, the cash flows generated by the closed block assets and the
anticipated revenues from the policies in the closed block will benefit
only the holders of the policies in the closed block. To the extent that,
over time, cash flows from the assets allocated to the closed block and
claims and other experience related to the closed block are, in the
aggregate, more or less favorable than what was assumed when the closed
block was established, total dividends paid to closed block policyholders
in the future may be greater than or less than the total dividends that
would have been paid to these policyholders if the policyholder dividend
scales in effect for 2000 had been continued. Any cash flows in excess of
amounts assumed will be available for distribution over time to closed
block policyholders and will not be available to stockholders. If the
closed block has insufficient funds to make guaranteed policy benefit
payments, such payments will be made from assets outside of the closed
block. The closed block will continue in effect as long as any policy in
the closed block remains in force.
Other than the provisions of SOP 00-3, Phoenix Life uses the same
accounting principles to account for the participating policies included
in the closed block as it used prior to the date of demutualization. SOP
00-3 requires the establishment of a policyholder dividend obligation for
earnings that will be paid to policyholders as additional dividends as
described below. The excess of closed block liabilities over closed block
assets at the effective date of the demutualization (adjusted to
eliminate the impact of related amounts in accumulated other
comprehensive income) represents the estimated maximum future earnings
from the closed block expected to result from operations attributed to
the closed block after income taxes. Earnings of the closed block are
recognized in income over the period the policies and contracts in the
closed block remain in force. Management believes that over time the
actual cumulative earnings of the closed block will approximately equal
the expected cumulative earnings due to the effect of dividend changes.
If, over the period the closed block remains in existence, the actual
cumulative earnings of the closed block are greater than the expected
cumulative earnings of the closed block, Phoenix Life will pay the excess
of the actual cumulative earnings of the closed block over the expected
cumulative earnings to closed block policyholders as additional
policyholder dividends unless offset by future unfavorable experience of
the closed block and, accordingly, will recognize only the expected
cumulative earnings in income with the excess recorded as a policyholder
dividend obligation. If over such period, the actual cumulative earnings
of the closed block are less than the expected cumulative earnings of the
closed block, Phoenix Life will recognize only the actual earnings in
income. However, Phoenix Life may change policyholder dividend scales in
the future, which would be intended to increase future actual earnings
until the actual cumulative earnings equal the expected cumulative
earnings. An income statement for the closed block is not shown because
the difference between the actual cumulative earnings from the closed
block and the expected cumulative earnings from the closed block from
the date of demutualization, June 25, 2001, to June 30, 2001, are not
considered material.
The principal cash flow items that affect the amount of closed block
assets and liabilities are premiums, net investment income, purchases and
sales of investments, policyholders' benefits, policyholder dividends,
premium taxes and income taxes. The principal income and expense items
excluded from the closed block are management and maintenance expenses,
commissions, and investment income and realized investment gains and
losses of investment assets outside the closed block that support the
closed block business, all of which enter into the determination of total
gross margins of closed block policies for the purpose of the
amortization of deferred acquisition costs. The amounts shown in the
table below for assets and liabilities are those that enter into the
determination of amounts to be paid to policyholders.
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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, 2000 to June 30, 2001 in excess of expected cumulative
earnings do not inure to stockholders and have been used to establish an
initial policyholder dividend obligation as of June 30, 2001. The initial
policyholder dividend obligation of $115.5 million consists of $45.2
million of earnings for the period January 1, 2000 to June 30, 2001 and
unrealized gains on assets in the closed block as of June 30, 2001 of
$70.3 million.
The following sets forth certain summarized financial information
relating to the closed block as of June 30, 2001:
Closed block liabilities:
Policy liabilities and accruals and policyholder deposit funds $8,953.4
Policyholder dividends payable 364.2
Policyholder dividend obligation 115.5
Other closed block liabilities 13.5
--------
Total closed block liabilities 9,446.6
--------
Closed block assets:
Held-to-maturity debt securities at amortized cost 1,608.6
Available-for-sale debt securities at fair value 3,957.3
Mortgage loans 390.2
Policy loans 1,412.5
Deferred income taxes 385.2
Investment income due and accrued 125.0
Net due and deferred premiums 39.4
Cash and cash equivalents 123.4
--------
Total closed block assets 8,041.6
--------
Excess of reported closed block liabilities over closed block assets $1,405.0
========
Maximum future earnings to be recognized from closed block assets
and liabilities $1,405.0
========
Change in policyholder dividend obligation:
Balance at beginning of period $ --
Change during the period 115.5
--------
Balance at end of period $ 115.5
========
8. DISCONTINUED OPERATIONS
During 1999, Phoenix discontinued the operations of three of its business
segments which in prior years had been reflected as reportable business
segments: the reinsurance operations, the real estate management
operations and the group life and health operations. The discontinuation
of these business segments resulted from the sale of several operations,
a signed agreement to sell one of the operations and the implementation
of plans to withdraw from the remaining businesses.
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REINSURANCE OPERATIONS
During 1999, Phoenix completed a comprehensive strategic review of its
reinsurance segment and decided to exit these 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. Accordingly, Phoenix estimated the sales proceeds, net
premiums, net claims payments and expenses of winding-down the business.
As a result, in 1999 Phoenix recognized a $173.0 million pre-tax loss on
the disposal of reinsurance operations.
During 1999, 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.
Based on the most recent information available, Phoenix reviewed the
run-off block and estimated the amount and timing of future net premiums,
claims and expenses. Consequently, Phoenix increased reserve estimates on
the run-off block in 1999 by $180 million (pre-tax). In addition, as part
of the exit strategy, Phoenix purchased aggregate excess of loss
reinsurance to further protect Phoenix from unfavorable results from this
discontinued business. This reinsurance is subject to an aggregate
retention of $100 million on the discontinued business. Phoenix may
commute the agreement at any time after September 30, 2004, subject to
automatic commutation effective September 30, 2019. Phoenix incurred an
initial expense of $130 million on the acquisition of this reinsurance.
During 2000, Phoenix updated 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 increased reserve estimates on the run-off
block by $97 million (pre-tax) in the third quarter of 2000. Phoenix
determined that the increase to reserves was needed based on revised
actuarial assumptions to reflect current and expected deteriorating
trends in claim experience and higher than anticipated expenses.
During the first six months of 2001, Phoenix did not recognize any
additional reserve provisions.
The additional 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
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reinsurance coverage that was many times greater than originally
estimated. As a member of the Unicover pool, Phoenix is involved in
several proceedings in which the pool members assert that they can deny
coverage to certain insurers, which 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 (see discussion below).
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 three of its own
retrocessionaires, which are seeking, on various grounds, to avoid paying
any amounts to Phoenix. All 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 retrocessionaires
successfully avoids its obligations.
During 2000, Phoenix reached settlements with several of the companies
involved in Unicover. On January 13, 2000, Phoenix and the other member
companies of the Unicover pool settled with EBI Indemnity Company and
affiliates of the Orion Group (EBI/Orion), by which all pool members were
released from their obligations as reinsurers of EBI/Orion. On January
21, 2000, Phoenix settled with Reliance Insurance Company (Reliance) and
its parent Reliance Group Holdings, Inc. and was released from its
obligations as a reinsurer of the so-called Reliance facility. On March
27, 2000, Phoenix settled with Reliance, Lincoln National Life Insurance
Company and Lincoln National Health and Casualty Company, releasing
Phoenix from its obligations as a reinsurer of the so-called Lincoln
facility. There was no effect on net income resulting from these
settlements for the quarter ended March 31, 2000.
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.
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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, as described above, that
future developments will not have a material effect on Phoenix's
consolidated financial position.
REAL ESTATE MANAGEMENT OPERATIONS
On May 25, 2000, Phoenix sold its investment in 50% of the outstanding
common stock of Pinnacle Realty Management Company, Inc., a real estate
property management firm, for $6.0 million. This sale represented
Phoenix's entire interest in Pinnacle Realty Management Company, Inc. and
Phoenix now has no other real estate management business. The transaction
resulted in a pre-tax loss of $0.6 million.
GROUP LIFE AND HEALTH OPERATIONS
On April 1, 2000, Phoenix sold its group life and health business to GE
Financial Assurance Holdings, Inc. (GEFA) except for Phoenix Dental
Services, Inc. and California Benefits Dental Plan. Specifically, Phoenix
Group Holdings and PM Holdings sold 97% of the common stock of Phoenix
American Life Insurance Company and 100% of the common stock of Phoenix
Group Services, Inc. and Clinical Disability Management, Inc. for $283.9
million. This amount is comprised of $238.9 million in cash and $45.0
million in common stock of GE Life and Annuity Assurance Company, an
affiliate of GEFA. The common stock represents a 3.1% interest in GE Life
and Annuity Assurance Company. Phoenix retains ownership of 3% of the
common stock of Phoenix American Life Insurance Company. Phoenix Life has
a right to put these shares back to GEFA beginning in 2005 and ending in
2007. These investments are reported as equity securities on the
Consolidated Balance Sheet. The pre-tax gain on the sale was $72.1
million and is reported in discontinued operations gain on disposal, net
of income taxes.
The sale to GEFA of 100% of the common stock of Phoenix Dental Services,
Inc. and California Benefits Dental Plan closed on October 31, 2000. The
sales proceeds for these entities were $2.0 million, which resulted in a
pre-tax loss of $0.4 million.
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 $25.5 million and $20.8 million as of
December 31, 2000 and June 30, 2001, respectively.
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The operating results of discontinued operations and the gain or loss on
disposal are presented below.
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2000 2001 2000 2001
---- ---- ---- ----
(IN MILLIONS) (IN MILLIONS)
Income from discontinued operations
Revenues:
Group Life and Health Operations $ (3.7) $ $ 112.3 $
Real Estate Management Operations .1 .4
------- ------- ------- -------
Total revenues $ (3.6) $ $ 112.7 $
======= ======= ======= =======
Income from discontinued operations:
Group Life and Health Operations $ (4.5) $ $ 5.7 $
Real Estate Management Operations (.4) (.2)
------- ------- ------- -------
Income from discontinued operations before income taxes (4.9) 5.5
Income taxes (1.2) 2.4
------- ------- ------- -------
Income from discontinued operations, net of income taxes $ (3.7) $ $ 3.1 $
======= ======= ======= =======
Gain (Loss) on disposal of discontinued operations:
Gain (Loss) on disposal:
Reinsurance Operations $ 2.3 $ $ (1.3) $
Group Life and Health Operations 69.4 69.4
------- ------- ------- -------
Loss on disposal of discontinued operations before income taxes 71.7 68.1
Income tax benefit 26.2 24.8
------- ------- ------- -------
Loss on disposal of discontinued operations, net of income taxes $ 45.5 $ $ 43.3 $
======= ======= ======= =======
9. COMMITMENTS AND CONTINGENCIES
In the normal course of its business operations, the company is involved
with litigation from time to time with claimants, beneficiaries and
others, and a number of litigation matters were pending as of June 30,
2001. It is the opinion of management, after consultation with counsel,
that the ultimate liability with respect to these claims, if any, will
not materially affect Phoenix's consolidated financial position. See Note
8 - "Discontinued Operations".
10. SUBSEQUENT EVENTS
On July 24, 2001, Morgan Stanley Dean Witter exercised its right to
purchase 1,395,900 shares of the common stock of The Phoenix Companies,
Inc. at the IPO price of $17.50 per share less underwriters discount.
Net proceeds to Phoenix were $23.1 million.
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11. EARNINGS PER SHARE
The unaudited pro forma earnings per common share for the three months
and six months ended June 30, were as follows:
Pro forma (unaudited)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2000 2001 2000 2001
-------- -------- -------- --------
(in millions, except per share data)
Basis earnings per common share:
Income (loss) from continuing operations $ .64 $ .04 $ 1.97 $ (1.04)
Discontinued operations .40 .44
-------- -------- -------- --------
Income (loss) before cumulative effect of accounting changes 1.04 .04 2.41 (1.04)
Cumulative effect of accounting changes (Notes 4) -- (.20) -- (.62)
-------- -------- -------- --------
Net income (loss) $ 1.04 $ (.16) $ 2.41 $ (1.66)
======== ======== ======== ========
Weighted-average shares used in basic earnings per share
calculations 105.0 105.0 105.0 105.0
======== ======== ======== ========
The pro forma earnings per common share reflect the Reorganization and
Initial Public Offering discussed in Note 3 - "Reorganization and Initial
Public Offering".
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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 December 31, 2000 and June 30, 2001; our consolidated results of
operations for the quarter and six months ended June 30, 2001; and, where
appropriate, factors that may affect our future financial performance.
This quarterly report contains statements which 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,
which could affect our investment results, including those from venture capital,
the fees we earn from assets under management and the demand for our variable
products, and (viii) other risks and uncertainties described from time to time
in the 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.
THE REORGANIZATION AND INITIAL PUBLIC OFFERING
Under the terms of the plan of reorganization, which the board of directors of
Phoenix Home Life Mutual Insurance Company unanimously adopted on December 18,
2000 and amended and restated on January 26, 2001, on June 25, 2001, the
effective date of the demutualization, such company converted from a mutual life
insurance company to a stock life insurance company, became a wholly owned
subsidiary of The Phoenix Companies, Inc. and changed its name to Phoenix Life
Insurance Company (Phoenix Life). At the same time, Phoenix Investment Partners,
Ltd. (PXP) became an indirect wholly owned subsidiary of The Phoenix Companies,
Inc. 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.
In addition, on June 25, 2001, Phoenix completed its initial public offering
(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 were $807.9 million, which was
contributed to Phoenix Life, as required under the plan of reorganization. See
Note 10 -- "Subsequent Events" to the unaudited interim consolidated financial
statements.
In addition, Phoenix Life established a closed block for the benefit of holders
of certain individual life insurance policies of Phoenix Life. The purpose of
the closed block is to protect the policy dividend expectations of the holders
of the policies included in the closed block after demutualization. The closed
block will continue in effect until the date none of such policies is in force.
On the effective date of the demutualization, Phoenix Life allocated to the
closed block assets in an amount that is expected to produce cash flows which,
together with anticipated revenues from the closed block policies, are
reasonably expected to be sufficient to support obligations and liabilities
relating to these policies, and for continuation of policy dividend scales
payable in 2000, if the experience underlying such dividend scales continues.
The assets allocated to the closed block and any cash flows provided by those
assets will solely benefit the holders of policies included in the closed block.
The assets and liabilities allocated to the closed block were recorded in our
consolidated financial statements at their historical carrying values. The
carrying values of the assets allocated to the closed block were less than that
of the closed block liabilities at the effective date of the demutualization.
The excess carrying value at the effective date represents the estimated future
post-tax contributions expected from the operation of the closed block, which
will be recognized in Phoenix Life's consolidated income over the period the
policies in the closed block remain in force.
In funding the closed block, Phoenix Life made assumptions regarding the
mortality rates, lapse rates, investment earnings (including a provision for
defaults), premium taxes, federal income taxes and other items applicable to the
policies contained in the closed block. Actual experience may, in the aggregate,
be more favorable than Phoenix Life assumed in establishing the closed block. In
that case, the policy dividend scale will be increased, and neither Phoenix Life
nor our stockholders will benefit from that more favorable experience.
Conversely, to the extent that actual experience is, in the aggregate, less
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27
favorable than Phoenix Life assumed in establishing the closed block, the policy
dividend scale will be decreased, unless Phoenix Life chooses to use assets from
outside the closed block to support the dividends.
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. Therefore, management does 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.
Phoenix Life intends to accrue any additional contributions necessary to fund
guaranteed benefits under the closed block when it becomes probable that Phoenix
Life will be required to fund any shortage.
For additional information on the closed block see Note 4 - "Summary of New
Significant Accounting Policies" and Note 7 - "Closed Block" to the unaudited
interim consolidated financial statements.
The costs relating to the demutualization, excluding costs relating to the IPO,
were approximately $33.1 million, net of income taxes of $8.4 million, of which
$14.1 million was recognized for the year ended December 31, 2000 and $19.0
million was recognized for the six months ended June 30, 2001. Demutualization
expenses consist of our cost of printing and mailing materials to policyholders
and our aggregate cost of engaging independent accounting, actuarial,
compensation, financial, investment banking and legal advisors and other
consultants to advise us in the demutualization process and related matters, as
well as other administrative costs. In addition, our costs include the fees and
expenses of the advisors engaged by the New York State Insurance Department.
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RESULTS OF OPERATIONS
The following table presents summary consolidated financial data for the periods
indicated.
For the Three Months For the Six Months
Ended June 30, Ended June 30,
----------------------- ----------------------
2000 2001 2000 2001
-------- -------- -------- --------
(in millions)
Revenues
Premiums $ 278.7 $ 267.2 $ 544.7 $ 533.2
Insurance and investment product fees 164.4 139.7 327.5 285.2
Net investment income 278.9 224.6 665.3 390.1
Net realized investment gains (losses) 10.4 (4.9) 34.4 (20.5)
-------- -------- -------- --------
Total revenues 732.4 626.6 1,571.9 1,188.0
-------- -------- -------- --------
Benefits and expenses
Policy benefits and increase in policy liabilities 335.4 332.2 665.4 666.3
Policyholder dividends 95.4 89.7 188.9 196.0
Amortization of deferred policy acquisition costs 41.3 26.9 81.5 62.0
Amortization of goodwill and other intangible assets 9.3 11.3 18.0 24.5
Interest expense 8.0 7.7 16.3 14.8
Other operating expenses 123.3 149.0 261.8 397.1
-------- -------- -------- --------
Total benefits and expenses 612.7 616.8 1,231.9 1,360.7
-------- -------- -------- --------
Income (loss) from continuing operations before income taxes (benefit),
minority interest and equity in earnings of and interest earned
from investments in unconsolidated subsidiaries 119.7 9.8 340.0 (172.7)
Income taxes (benefit) 48.6 5.2 126.1 (63.8)
-------- -------- -------- --------
Income (loss) from continuing operations before minority interest
and equity in earnings of and interest earned from investments
in unconsolidated subsidiaries 71.1 4.6 213.9 (108.9)
Minority interest in net income of consolidated subsidiaries 6.1 1.7 11.6 3.5
Equity in earnings of and interest earned from investments
in unconsolidated subsidiaries 2.9 1.1 4.3 3.8
-------- -------- -------- --------
Income (loss) from continuing operations 67.9 4.0 206.6 (108.6)
Discontinued operations
Income from discontinued operations, net of income taxes (3.7) 3.1
Gain on disposal, net of income taxes 45.5 43.3
-------- -------- -------- --------
Income (loss) before cumulative effect of accounting changes 109.7 4.0 253.0 (108.6)
Cumulative effect of accounting changes for:
Venture capital partnerships, net of income taxes (48.8)
Securitized financial instruments, net of income taxes (20.5) (20.5)
Derivative financial instruments, net of income taxes 3.9
-------- -------- -------- --------
Net income (loss) $ 109.7 $ (16.5) $ 253.0 $ (174.0)
======== ======== ======== ========
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THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000
Premiums were $267.2 million for the three months ended June 30, 2001, a
decrease of $11.5 million, or 4%, from $278.7 million for the comparable period
in 2000. Whole life premiums decreased $11.2 million, reflecting the shift to
variable products, for which revenues are recognized through insurance and
investment product fees. There was also a slight decrease due to the runoff of
the Confederation Life whole life business.
Insurance and investment product fees were $139.7 million for the three months
ended June 30, 2001, a decrease of $24.7 million, or 15%, from $164.4 million
for the comparable period in 2000. Investment Management fees decreased $17.2
million, primarily as a result of decreases in average assets under management
due to negative investment performance. Life and Annuity fees decreased $1.7
million primarily as a result of decreases in variable annuity and variable
universal life funds under management due to negative investment performance.
Corporate and Other fees decreased $3.1 million, primarily due to lower fees
resulting from our decision in the third quarter of 2000 to exit our physician
practice management business.
Net investment income was $224.6 million for the three months ended June 30,
2001, a decrease of $54.3 million, or 20%, from $278.9 million for the
comparable period in 2000. Venture Capital net investment income decreased $61.9
million due to market depreciation on portfolio stocks held in partnerships and
a decrease in gains from partnerships' dispositions of stocks. Corporate and
Other net investment income decreased $13.6 million primarily as a result of
lower average invested assets resulting from the privatization of PXP on January
11, 2001. Life and Annuity net investment income increased $22.3 million due to
higher average invested assets. Average invested assets, excluding venture
capital partnerships, were $12,543.2 million in June 2001, an increase of $924.3
million, or 8%, from $11,618.9 million in June 2000. The yield on average
invested assets, excluding venture capital partnerships, was 7.5% in June 2001,
compared to 7.4% in June 2000.
Net realized investment (losses) gains were $(4.9) million for the three months
ended June 30, 2001, a decrease of $15.3 million, or 147%, from $10.4 million
for the comparable period in 2000. In June 2001, a $4.7 million loss was
recorded due to a subsequent price adjustment on the sale of our Cleveland
office which occurred in June 2000. Offsetting this loss were separate account
equity gains of $4.0 million. In 2000, non-recurring gains on the sale of common
stock (primarily National Oilwell ) of $37.6 million, were recorded. Offsetting
these were non-recurring interest related losses on debt securities of $24.1
million.
Policy benefits, increase in policy liabilities and policyholder dividends were
$421.9 million for the three months ended June 30, 2001, a decrease of $8.9
million, or 2%, from $430.8 million for the comparable period in 2000. This
decrease was due to lower reinsurance costs on our participating policies and
lower mortality costs on our variable universal life policies, which was offset
by higher mortality costs on our universal life policies and higher reinsurance
costs on our minimum death benefit guarantees on our variable annuity contracts.
Amortization of deferred policy acquisition costs was $26.9 million for the
three months ended June 30, 2001, a decrease of $14.4 million, or 35%, from
$41.3 million for the comparable period in 2000, primarily due to higher
deferrable policy acquisition costs from increased sales, favorable market
performance and a lower mortality margin on our universal life policies.
Amortization of goodwill and other intangible assets was $11.3 million for the
three months ended June 30, 2001, an increase of $2.0 million, or 22%, from $9.3
million for the comparable period in 2000,
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30
primarily due to the increase in Investment Management amortization of $3.2
million. This increase in amortization resulted from the purchase of the PXP
minority interest, which closed on January 11, 2001, our acquisition of a 75%
interest in Walnut in January 2001 and our final payment of $50.0 million in
September 2000 for the Engemann acquisition.
Interest expense was $7.7 million for the three months ended June 30, 2001, a
decrease of $0.3 million, or 4%, from $8.0 million for the comparable period in
2000. Corporate and Other interest expense decreased as a result of lower
borrowings offset by the increase in Investment Management interest expense due
to additional borrowings under PXP's then existing credit facilities to fund
payments with respect to the purchase of the PXP minority interest.
Other operating expenses were $149.0 million for the three months ended June 30,
2001, an increase of $25.7 million, or 21%, from $123.3 million for the
comparable period in 2000. Life and Annuity other operating expenses increased
$12.9 million due primarily to increased compensation and related expenses
reflecting continued growth in business, including additions to our staff of
Life and Annuity wholesalers as well as increased expenses related to technology
initiatives, increased commissions and general expenses related to the growth of
PFG Holdings, Inc (PFG) and WS Griffith Advisors, Inc. (WS Griffith) and our
acquisition of Main Street Management in July 2000. Investment Management other
operating expenses increased $0.9 million due to increases in various incentive
compensation programs. Non-compensation related costs also increased primarily
in support of technology initiatives begun during the year. Corporate and Other
other operating expenses increased $5.1 million primarily due to increases in
outside services, particularly for our technology initiatives and other general
expenses. There was also an increase of $9 million in non-recurring expenses
which are not included in segment operating income related to: the
demutualization ($7 million), the early retirement program (($1) million) and
the purchase of the PXP minority interest ($3 million).
Income taxes were $5.2 million with respect to continuing operations for the
three months ended June 30, 2001, a decrease of $43.4 million, or 89%, from
$48.6 million for the comparable three month period in 2000. This decrease is
attributable to a decrease in earnings in 2001, elimination of the equity tax
expense, and capitalization of demutualization expenses and goodwill, which were
offset to some extent by investment credits, dividends received deductions, and
tax exempt income.
Minority interest in net income of consolidated subsidiaries was $1.7 million
for the three months ended June 30, 2001, a decrease of $4.4 million, or 72%,
from $6.1 million for the comparable period in 2000, due to the purchase of the
PXP minority interest on January 11, 2001.
Equity in earnings of and interest earned from investments in unconsolidated
subsidiaries was $1.1 million for the three months ended June 30, 2001, a
decrease of $1.8 million, or 62%, from $2.9 million for the comparable period in
2000, due primarily to the true-up of our estimate of our equity in the earnings
of Aberdeen.
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SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
Premiums were $533.2 million for the six months ended June 30, 2001, a decrease
of $11.5 million, or 2%, from $544.7 million in June 2000. Whole life premiums
decreased $9.4 million, reflecting the shift to variable products, for which
revenues are recognized through insurance and investment product fees. There was
also a $2.8 million decrease due to the runoff of the Confederation Life whole
life business.
Insurance and investment product fees were $285.2 million for the six months
ended June 30, 2001, a decrease of $42.3 million, or 13%, from $327.5 million
for the comparable period in 2000. Investment Management fees decreased $30.7
million, primarily as a result of decreases in average assets under management
due to negative investment performance. Life and Annuity fees decreased $2.9
million primarily as a result of decreases in variable annuity funds under
management due to negative investment performance, offset by increases in fees
for variable universal life products as a result of increased sales. Corporate
and Other fees decreased $5.7 million, primarily due to lower fees resulting
from our decision in the third quarter of 2000 to exit our physician practice
management business.
Net investment income was $390.1 million for the six months ended June 30, 2001,
a decrease of $275.2 million, or 41%, from $665.3 million for the comparable
period in 2000. Venture Capital net investment income decreased $305.1 million
due to market depreciation on portfolio stocks held in partnerships and a
decrease in gains from partnerships' dispositions of stocks. Also, due to the
recent volatility in the equity markets, during the first quarter of 2001, we
changed our method of applying the equity method of accounting to our venture
capital partnerships to eliminate the quarterly lag in reporting. See " --
Venture Capital Segment" and Note 4 of our unaudited consolidated financial
statements. Life and Annuity net investment income increased $44.7 million due
to higher average invested assets. Average invested assets, excluding venture
capital partnerships, were $12,543.2 million in June 2001, an increase of $924.3
million, or 8%, from $11,618.9 million in June 2000. The yield on average
invested assets, excluding venture capital partnerships, was 7.5% in June 2001,
compared to 7.4% in June 2000.
Net realized investment (losses) gains were $(20.5) million for the six months
ended June 30, 2001, a decrease of $54.9 million, or 160%, from $34.4 million
for the comparable period in 2000. Credit related realized losses of $19.8
million were recorded, in the first quarter of 2001, in several debt securities.
In 2001, a $4.7 million loss was recorded due to a subsequent price adjustment
on the sale of our Cleveland office which occurred in June 2000. In 2000,
non-recurring gains of $65.6 million on the sale of common stock were recorded.
Offsetting these were non-recurring interest related losses on debt securities
of $36.4 million.
Policy benefits, increase in policy liabilities and policyholder dividends were
$862.3 million for the six months ended June 30, 2001, an increase of $8.0
million, or less than 1%, from $854.3 million for the comparable period in 2000,
primarily due to lower reinsurance costs on our participating policies and lower
mortality costs on our variable universal life policies, offset by higher
mortality costs on our universal life policies and higher reinsurance costs on
our minimum death benefit guarantees on our variable annuity contracts. In
addition, policyholder dividends increased due primarily to growth in cash value
on in force participating policies.
Amortization of deferred policy acquisition costs was $62.0 million for the six
months ended June 30, 2001, a decrease of $19.5 million, or 24%, from $81.5
million for the comparable period in 2000, primarily due to higher deferrable
policy acquisition costs from increased sales, favorable market performance and
a lower mortality margin on our universal life policies.
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32
Amortization of goodwill and other intangible assets was $24.5 million for the
six months ended June 30, 2001, an increase of $6.5 million, or 36%, from $18.0
million for the comparable period in 2000, primarily due to the increase in
Investment Management amortization of $7.8 million. This increase in
amortization resulted from our purchase of the PXP minority interest, which
closed on January 11, 2001, our acquisition of a 75% interest in Walnut in
January 2001 and our final payment of $50.0 million in September 2000 for the
Engemann acquisition.
Interest expense was $14.8 million for the six months ended June 30, 2001, a
decrease of $1.5 million, or 9%, from $16.3 million for the comparable period in
2000, due primarily to the decrease in Corporate and Other's interest expense as
a result of lower borrowings.
Other operating expenses were $397.1 million for the six months ended June 30,
2001, an increase of $135.3 million, or 52%, from $261.8 million for the
comparable period in 2000. Life and Annuity other operating expenses increased
$27.0 million due primarily to increased compensation and related expenses
reflecting continued growth in business, including additions to our staff of
Life and Annuity wholesalers and to investments in technology and increased
commissions and general expenses related to the growth of PFG, WS Griffith, and
the acquisition of Main Street Management in July 2000. Investment Management
other operating expenses increased $5.2 million due to increases in various
incentive compensation programs. Non-compensation related costs also increased
primarily in support of technology initiatives begun during the year. Corporate
and Other other operating expenses decreased $3.8 million primarily due to
decreases in compensation and related expenses. There was also an increase in
non-recurring expenses which are not included in segment operating income of
$109 million related to the demutualization ($17 million), the early retirement
program ($17 million) and the purchase of the PXP minority interest ($75
million).
Income tax benefits were $63.8 million for the six months ended June 30, 2001, a
decrease of $189.9 million, or 151%, from a $126.1 million tax liability for the
comparable period in 2000. This decrease in tax liability is attributable to a
decrease in earnings in 2001, elimination of the equity tax expense, and
capitalization of demutualization expenses and of goodwill, which were offset to
some extent by investment credits, dividends received deductions, and tax exempt
income.
Minority interest in net income of consolidated subsidiaries was $3.5 million
for the six months ended June 30, 2001, a decrease of $8.1 million, or 70%, from
$11.6 million for the comparable period in 2000, due to our purchase of the PXP
minority interest on January 11, 2001.
Equity in earnings of and interest earned from investments in unconsolidated
subsidiaries was $3.8 million for the six months ended June 30, 2001, a decrease
of $0.5 million, or 12%, from $4.3 million for the comparable period in 2000,
due primarily to the true-up of our estimate of our equity in the earnings of
Aberdeen.
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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 they are not considered by management when evaluating the financial
performance of the segments. The size and timing of realized investment gains
are often subject to management's discretion. Non-recurring items are
removed from segment after-tax operating income if, in management's opinion,
they are not indicative of overall operating trends. While some of these items
may be significant components of our GAAP net income, 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
by management 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 by management from segment after-tax operating
income may vary from period to period. Because such items are excluded based on
management's discretion, inconsistencies in the application of management's
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 200% 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.
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34
The following table presents a reconciliation of segment after-tax operating
income to GAAP reported income from continuing operations.
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2000 2001 2000 2001
------- ------- ------- -------
(IN MILLIONS)
SEGMENT AFTER-TAX OPERATING INCOME (LOSS):
Life and Annuity $ 12.3 $ 24.9 $ 21.8 $ 30.6
Investment Management 7.9 (2.8) 14.2 (6.6)
Venture Capital 43.9 3.7 164.7 (33.6)
Corporate and Other (6.5) (9.2) (11.0)
------- ------- ------- -------
Total segment after-tax operating income (loss) 64.1 19.3 191.5 (20.6)
------- ------- ------- -------
AFTER-TAX ADJUSTMENTS:
Net realized investment gains (losses) 6.0 (3.3) 20.1 (13.4)
Early retirement pension adjustment .6 (11.3)
Demutualization expense (1.7) (12.1) (1.7) (19.0)
Surplus tax (2.9) (5.7)
Portfolio loss 3.1 3.1
Loss on sublease transaction (.7) (.7)
Partnership gains 2.4 2.4
Expenses of purchase of PXP minority interest (2.9) (46.7)
------- ------- ------- -------
Total after-tax adjustments 3.8 (15.3) 15.1 (88.0)
------- ------- ------- -------
GAAP REPORTED:
Income (loss) from continuing operations $ 67.9 $ 4.0 $ 206.6 $(108.6)
======= ======= ======= =======
See explanation of after-tax adjustments in Note 6 -- "Segment Information."
34
35
LIFE AND ANNUITY SEGMENT
The following table presents summary financial data relating to Life and Annuity
for the periods indicated.
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ------------------------
2000 2001 2000 2001
-------- -------- -------- --------
(in millions)
OPERATING RESULTS:
Revenues
Premiums $ 278.7 $ 267.2 $ 544.7 $ 533.2
Insurance and investment product fees 77.6 75.9 157.1 154.2
Net investment income 196.0 218.3 391.8 436.5
-------- -------- -------- --------
Total revenues 552.3 561.4 1,093.6 1,123.9
-------- -------- -------- --------
Benefits and Expenses
Policy benefits, increase in policy liabilities
and policyholder dividends 428.6 419.7 848.0 857.3
Amortization of deferred policy acquisition costs 41.3 26.9 81.5 62.0
Other operating expenses 63.8 76.5 130.7 157.5
-------- -------- -------- --------
Total benefits and expenses 533.7 523.1 1,060.2 1,076.8
-------- -------- -------- --------
Operating income before income taxes 18.6 38.3 33.4 47.1
Income taxes 6.3 13.4 11.6 16.5
-------- -------- -------- --------
Segment after-tax operating income 12.3 24.9 21.8 30.6
After-tax adjustments
Net realized investment (losses) gains (10.1) 2.0 (18.8) (4.4)
-------- -------- -------- --------
Total after-tax adjustments (10.1) 2.0 (18.8) (4.4)
-------- -------- -------- --------
GAAP REPORTED:
Income (loss) from continuing operations $ 2.2 $ 26.9 $ 3.0 $ 26.2
======== ======== ======== ========
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000
Premiums were $267.2 million for the three months ended June 30, 2001, a
decrease of $11.5 million, or 4%, from $278.7 million for the comparable period
in 2000. Whole life premiums decreased $11.2 million, reflecting the shift to
variable products, for which revenues are recognized through insurance and
investment product fees. There was also a slight decrease due to the runoff of
the Confederation Life whole life business.
Insurance and investment product fees were $75.9 million for the three months
ended June 30, 2001, a decrease of $1.7 million, or 2%, from $77.6 million for
the comparable period in 2000. Insurance and investment product fees for
variable annuities decreased $3.2 million, primarily as a result of a decrease
in assets under management due to negative investment performance in the fourth
quarter of 2000 and continuing through the first quarter of 2001, offset by
increased sales. At June 30, 2001, funds under management for variable annuities
were $4.4 billion, a decrease of $0.4 billion, or 8%, from June 30, 2000. The
decrease in funds under management due to negative investment performance was
$0.8 billion from June 30, 2000. Variable annuity sales were $377.4 million in
the second quarter of 2001, an increase of 177% from the second quarter of 2000
due in large part to a $200 million deposit from a
35
36
single case in June 2001. These sales were offset by variable annuity benefits
and surrenders of $143.4 million, an increase of 11% from the second quarter of
2000. Universal life insurance and investment product fees also decreased $0.2
million, primarily as a result of a decrease in assets under management of $8.9
million related to the runoff of the Confederation Life universal life business,
partially offset by the increase in universal life premium deposits. Fees
related to our trust operations decreased $1.8 million due to the sale of our
New Hampshire trust and agency operations. Fees related to our variable
universal life products decreased $1.7 million, or 19% due to lower average
funds under management. At June 30, 2001, funds under management for variable
universal life were $1,076.0 million, a decrease of $60.5 million, or 5%, from
June 30, 2000. The decrease in funds under management due to negative investment
performance was $254.7 million from June 30, 2000. Variable universal life
deposits were $72.5 million in the second quarter of 2001, an increase of 19%
from the second quarter of 2000. The increase in sales were offset by variable
universal life benefits and surrenders of $7.0 million, remaining relatively
unchanged from the first quarter of 2000.
Net investment income was $218.3 million for the three months ended June 30,
2001, an increase of $22.3 million, or 11%, from $196.0 million for the
comparable period in 2000, primarily the result of higher average invested
assets.
Policy benefits, increase in policy liabilities and policyholder dividends were
$419.7 million for the three months ended June 30, 2001, a decrease of $8.9
million, or 2%, from $428.6 million for the comparable period in 2000. This
decrease was due to lower reinsurance costs on our participating policies and
lower mortality costs on our variable universal life policies, which was offset
by higher mortality costs on our universal life policies and higher reinsurance
costs on our minimum death benefit guarantees on our variable annuity contracts.
Amortization of deferred policy acquisition costs was $26.9 million for the
three months ended June 30, 2001, a decrease of $14.4 million, or 35%, from
$41.3 million for the comparable period in 2000, primarily due to higher
deferrable acquisition costs from increased sales, favorable market performance
and a lower mortality margin on our universal life policies.
Other operating expenses were $76.5 million for the three months ended June 30,
2001, an increase of $12.7 million, or 20%, from $63.8 million for the
comparable period in 2000. This increase primarily related to the growth of the
Life and Annuity business, due to increases in compensation and related
expenses, including additions to our staff of wholesalers, as well as increased
expenses related to technology initiatives and an increase in expenses due to
the growth in PFG, WS Griffith and the acquisition of Main Street Management in
July 2000.
SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
Premiums were $533.2 million for the six months ended June 30, 2001, a decrease
of $11.5 million, or 2%, from $544.7 million for the comparable period in 2000.
Whole life premiums decreased $9.4 million, reflecting the shift to variable
products, for which revenues are recognized through insurance and investment
product fees. There was also a $2.8 million decrease due to the runoff of the
Confederation Life whole life business.
Insurance and investment product fees were $154.2 million for the six months
ended June 30, 2001, a decrease of $2.9 million, or 2%, from $157.1 million for
the comparable period in 2000. Insurance and investment product fees for
variable annuities decreased $5.8 million, primarily as a result of a decrease
36
37
in assets under management due to negative investment performance offset by
increased sales. At June 30, 2001, funds under management for variable annuities
were $4.4 billion, a decrease of $0.4 billion, or 8%, from June 30, 2000. The
decrease in funds under management due to negative investment performance was
$0.8 billion from June 30, 2000. Variable annuity sales were $664.0 million for
the six months ended June 30, 2001, an increase of 148% from the comparable
period in 2000 primarily as a result of a single case deposit of $200 million in
June 2001. These sales were offset by a decrease in variable annuity benefits
and surrenders of $33.9 million, a decrease of 11% from the six months ended
June 30, 2000. Universal life insurance and investment product fees also
decreased $0.2 million, primarily as a result of a decrease in assets under
management of $9.1 million. Universal life premiums decreased $2.8 million, or
46% from the first six months of 2000. Fees related to our trust operations
decreased $3.6 million due to the sale of our New Hampshire trust and agency
operations. Fee decreases were offset by increases in fees related to our
variable universal life products of $0.8 million, or 6%. Even though the funds
under management for variable universal life decreased, variable universal life
fees increased because a significant portion of the fees are premium-based or
are based upon net amount at risk. At June 30, 2001, funds under management for
variable universal life were $1,076.0 million, a decrease of $60.5 million, or
5%, from June 30, 2000. The decrease in funds under management due to negative
investment performance was $254.7 million from June 30, 2000. Variable universal
life deposits were $179.3 million in the first six months of 2001, an increase
of 51% from the first six months of 2000. These sales were offset by variable
universal life benefits and surrenders of $17.4 million, an increase of 9% from
the first six months of 2000.
Net investment income was $436.5 million for the six months ended June 30, 2001,
an increase of $44.7 million, or 11%, from $391.8 million for the comparable
period in 2000, primarily the result of higher average invested assets.
Policy benefits, increase in policy liabilities and policyholder dividends were
$857.3 million for the six months ended June 30, 2001, an increase of $9.3
million, or 1%, from $848.0 million for the comparable period in 2000. Dividends
increased $7.1 million due to growth in cash value on in force participating
policies. Policy benefits increased due to lower reinsurance costs on our
participating policies and lower mortality costs on our variable universal life
policies, offset by higher mortality costs on our universal life policies and
higher reinsurance costs on our minimum death benefit guarantees on our variable
annuity contracts.
Amortization of deferred policy acquisition costs was $62.0 million for the six
months ended June 30, 2001, a decrease of $19.5 million, or 24%, from $81.5
million for the comparable period in 2000. The decrease was due primarily to
higher deferrable acquisition costs from increased sales, favorable market
performance and a lower mortality margin on our universal life policies.
Other operating expenses were $157.5 million for the six months ended June 30,
2001, an increase of $26.8 million, or 21%, from $130.7 million for the
comparable period in 2000. This increase primarily related to the growth of the
Life and Annuity business, due to increases in compensation and related
expenses, including additions to our staff of wholesalers, as well as increased
expenses related to technology initiatives and an increase in expenses due to
the growth in WS Griffith, PFG, and the acquisition of Main Street Management in
July 2000.
37
38
INVESTMENT MANAGEMENT SEGMENT
The following table presents summary financial data relating to Investment
Management for the periods indicated.
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ---------------------
2000 2001 2000 2001
------- ------- ------- -------
(in millions)
OPERATING RESULTS:
Revenues
Investment product fees $ 83.3 $ 66.1 $ 167.5 $ 136.8
Net investment income .4 .4 1.0 .8
------- ------- ------- -------
Total revenues 83.7 66.5 168.5 137.6
------- ------- ------- -------
Expenses
Amortization of goodwill and other intangible assets 8.6 11.8 16.5 24.3
Interest expense 4.5 4.6 9.1 8.6
Other operating expenses 52.1 53.0 105.0 110.2
------- ------- ------- -------
Total expenses 65.2 69.4 130.6 143.1
------- ------- ------- -------
Income (loss) from continuing operations before income taxes,
minority interest and equity in earnings of and interest
earned from investments in unconsolidated subsidiaries 18.5 (2.9) 37.9 (5.5)
Income tax (benefit) 7.6 (1.6) 17.1 (.1)
Minority interest in net income of consolidated subsidiaries 5.3 1.7 9.3 3.5
Equity in earnings of and interest earned from investments in
unconsolidated subsidiaries 2.3 .2 2.7 2.3
------- ------- ------- -------
Segment after-tax operating income (loss) 7.9 (2.8) 14.2 (6.6)
After-tax adjustments
Net realized investment gains (losses) 1.2 (3.1) 3.5 .5
Portfolio gain 3.1 3.1
Loss on sublease transaction (.7) (.7)
Partnership gains 2.4 2.4
Expenses of purchase of PXP minority interest (2.9) (46.7)
------- ------- ------- -------
Total after-tax adjustments 3.6 (3.6) 5.9 (43.8)
------- ------- ------- -------
GAAP REPORTED:
Income (loss) from continuing operations $ 11.5 $ (6.4) $ 20.1 $ (50.4)
======= ======= ======= =======
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000
Investment product fees were $66.1 million for the three months ended June 30,
2001, a decrease of $17.2 million, or 21%, from $83.3 million for the comparable
period in 2000. This fee decrease was primarily the result of decreases of $6.7
billion and $5.1 billion in average assets under management for the private
client and institutional lines of business, respectively. The sale of PXP's
Cleveland operations in June 2000 accounted for approximately $3.3 billion of
the decrease in average institutional assets under management. At June 30, 2001,
Investment Management had $54.8 billion in assets under management, an increase
of $3.6 billion, or 7%, from March 31, 2001 and a decrease of $6.1 billion, or
10%, from June 30, 2000. The increase from March 31, 2001 consisted of a $1.7
38
39
billion increase due to investment performance, net asset inflows of $1.1
billion, and a $0.8 billion increase as a result of the Phoenix IPO. The
decrease from June 30, 2000 consisted of a $9.3 billion decrease due to
investment performance offset, in part, by $1.7 billion in net asset inflows,
the previously mentioned $0.8 billion increase as a result of the Phoenix IPO,
and our acquisition of a 75% interest in Walnut Asset Management (Walnut) in
January 2001. Sales of private client products in the second quarter of 2001
were $1.3 billion, an increase of 1% from the second quarter of 2000, and
redemptions from existing accounts were $1.4 billion, an increase of 46% from
the second quarter of 2000. Sales of institutional accounts in the second
quarter of 2001 were $1.7 billion, an increase of 11% from the second quarter of
2000, and withdrawals from existing accounts were $0.6 billion, a decrease of
76% from the second quarter of 2000.
Net investment income was $0.4 million for the three months ended June 30, 2001,
remaining unchanged from the comparable period in 2000.
Amortization of goodwill and other intangible assets was $11.8 million for the
three months ended June 30, 2001, an increase of $3.2 million, or 37%, from $8.6
million for the comparable period in 2000. This increase in amortization
resulted primarily from our purchase of the PXP minority interest, the final
payment of $50.0 million in September 2000 for the Engemann acquisition, and our
acquisition of a 75% interest in Walnut in January 2001.
Interest expense was $4.6 million for the three months ended June 30, 2001, an
increase of $0.1 million, or 2%, from $4.5 million for the comparable period in
2000. There was an increase in interest expense as a result of $100.0 million of
additional borrowings under PXP's then existing credit facilities, in January
2001, primarily to fund payments with respect to the outstanding options and
remaining convertible subordinated debentures in connection with our purchase of
the PXP minority interest, as well as the September payment of $50.0 million as
the final portion of the Engemann purchase price. The effect of this increased
borrowing was partially offset by debt repayments beginning in June 2000 and a
2.2% decrease in the average interest rate paid on outstanding debt as compared
to the same period in 2000.
Other operating expenses were $53.0 million for the three months ended June 30,
2001, an increase of $0.9 million, or 2% from $52.1 million for the comparable
period in 2000, of which $0.4 million was related to compensation. The increase
in compensation expense was primarily the result of expanding sales and
marketing personnel in both lines of business, the Walnut acquisition, and
increases in staffing and base compensation as the result of the growth of
certain investment management subsidiaries, as well as cost of living
adjustments. These increases were offset, in part, by reduced incentive
compensation for certain subsidiaries that, in accordance with their respective
operating agreements, receive compensation directly related to earnings, which
have declined as a result of investment performance. In addition, a decrease of
$0.4 million related to the termination of PXP's profit sharing plan effective
January 1, 2001. Non-compensation related costs increased $0.5 million of which
consulting charges increased $1.2 million, as a result of various information
technology initiatives, and brokerage clearance costs increased $1.1 million
(with a corresponding increase in revenue). These increases were offset, in
part, by a decrease of $0.5 million in certain mutual fund expenses resulting
from a change in the method of reimbursing fund expenses, which also reduced
revenue.
Minority interest in net income of consolidated subsidiaries was $1.7 million
for the three months ended June 30, 2001, a decrease of $3.6 million, or 68%,
from $5.3 million for the comparable period in 2000, due primarily to our
purchase of the PXP minority interest on January 11, 2001.
Equity in earnings of and interest earned from investments in unconsolidated
subsidiaries was $0.2
39
40
million for the three months ended June 30, 2001, a decrease of $2.1 million,
or 91%, from $2.3 million for the comparable period in 2000, due primarily to
the true-up of our estimate of our equity in the earnings of Aberdeen.
SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
Investment product fees were $136.8 million for the six months ended June 30,
2001, a decrease of $30.7 million, or 18%, from $167.5 million for the
comparable period in 2000. This decrease was primarily the result of decreases
of $4.8 billion and $5.8 billion in average assets under management for the
private client and institutional lines of business, respectively. Our sale of
PXP's Cleveland operations in June 2000 accounted for approximately $3.3 billion
of the decrease in average institutional assets under management. At June 30,
2001, Investment Management had $54.8 billion in assets under management, a
decrease of $1.8 billion, or 3%, from December 31, 2000 and a decrease of $6.1
billion, or 10%, from June 30, 2000. The decrease from December 31, 2000
consisted of a $4.8 billion decrease due to investment performance, offset by
net asset inflows of $1.4 billion, a $0.8 billion increase as a result of the
Phoenix IPO and an increase of $0.7 billion resulting from the acquisition of a
75% interest in Walnut. The decrease from June 30, 2000 consisted of a $9.3
billion decrease due to investment performance offset, in part, by $2.1 billion
in net asset inflows, the previously mentioned $0.8 billion increase as a result
of the Phoenix IPO and a $0.7 billion increase from the acquisition of a 75%
interest in Walnut in January 2001. Sales of private client products in the
first half of 2001 were $2.7 billion, a decrease of 10% from the first half of
2000, and redemptions from existing accounts were $3.0 billion, an increase of
16% from the first half of 2000. Sales of institutional accounts in the first
half of 2001 were $2.9 billion, an increase of 13% from the first half of 2000,
and withdrawals from existing accounts were $1.2 billion, a decrease of 72% from
the first half of 2000.
Net investment income was $0.8 million for the six months ended June 30, 2001,
remaining relatively unchanged from $1.0 million for the comparable period in
2000.
Amortization of goodwill and other intangible assets was $24.3 million for the
six months ended June 30, 2001, an increase of $7.8 million, or 47%, from $16.5
million for the comparable period in 2000. This increase in amortization
resulted primarily from our purchase of the PXP minority interest, the final
payment of $50.0 million in September 2000 for the Engemann acquisition, and our
acquisition of a 75% interest in Walnut in January 2001.
Interest expense was $8.6 million for the six months ended June 30, 2001, a
decrease of $0.5 million, or 5%, from $9.1 million for the comparable period in
2000. There was an increase in interest expense as a result of $100.0 million of
additional borrowings under PXP's then existing credit facilities, in January
2001, primarily to fund payments with respect to the outstanding options and
remaining convertible subordinated debentures in connection with our purchase of
the PXP minority interest, as well as the September payment of $50.0 million as
the final portion of the Engemann purchase price. The effect of this increased
borrowing was offset by debt repayments in the final three quarters of 2000 and
a 1.6% decrease in the average interest rate paid on outstanding debt as
compared to the same period in 2000.
Other operating expenses were $110.2 million for the six months ended June 30,
2001, an increase of $5.2 million, or 5%, from $105.0 million for the comparable
period in 2000, of which $3.8 million was related to compensation. The increase
in compensation expense was primarily the result of expanding sales and
marketing personnel in both lines of business, the Walnut acquisition, increases
in staffing and base compensation as the result of the growth of certain
investment management subsidiaries, as well as cost of living adjustments. These
increases were offset, in part, by reduced incentive compensation for certain
subsidiaries that, in accordance with their respective operating agreements,
receive compensation directly
40
41
related to earnings, which have declined as a result of investment performance.
In addition, a decrease of $1.5 million related to the termination of PXP's
profit sharing plan effective January 1, 2001. Non-compensation related costs
increased $1.4 million, of which consulting charges increased $2.3 million and
computer services increased $1.1 million as a result of various information
technology initiatives, brokerage clearance costs increased $1.1 million (with a
corresponding increase in revenue), and professional fees increased $1.1 million
as a result of various legal matters. Certain mutual fund expenses decreased
$1.1 million primarily as a result of a change in the method of reimbursing fund
expenses, which also reduced revenue.
Minority interest in net income of consolidated subsidiaries was $3.5 million
for the six months ended June 30, 2001, a decrease of $5.8 million, or 62%, from
$9.3 million for the comparable period in 2000, due primarily to our purchase of
the PXP minority interest on January 11, 2001.
Equity in earnings of and interest earned from investments in unconsolidated
subsidiaries was $2.3 million for the six months ended June 30, 2001, a decrease
of $0.4 million, or 15%, from $2.7 million for the comparable period in 2000,
due primarily to the true-up of our estimate of our equity in the earnings of
Aberdeen.
VENTURE CAPITAL SEGMENT
The following table presents summary financial data relating to Venture Capital
for the periods indicated.
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2000 2001 2000 2001
------- ------- ------- -------
(IN MILLIONS)
OPERATING RESULTS:
Revenues
Net investment income (loss) $ 67.5 $ 5.6 $ 253.4 $ (51.7)
------- ------- ------- -------
Operating income (loss) before income taxes 67.5 5.6 253.4 (51.7)
Expenses
Income taxes (benefit) 23.6 1.9 88.7 (18.1)
------- ------- ------- -------
Segment after-tax operating income (loss) (1) $ 43.9 $ 3.7 $ 164.7 $ (33.6)
======= ======= ======= =======
(1) Excludes the charge of $48.8 million representing the cumulative effect
of an accounting change in the first quarter of 2001, as described
below.
Our investments in Venture Capital are primarily in the form of limited partner
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 has
been provided to us on a one-quarter lag. Due to the recent volatility in
41
42
the equity markets, we believe the one-quarter lag in reporting is no longer
appropriate. Therefore, we have changed our method of applying the equity method
of accounting to eliminate the quarterly lag in reporting.
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.
In the first quarter of 2001, 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 the period from January 1, 2001 through March
31, 2001, 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 March 31, 2001, 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 from January 1, 2001 through March 31, 2001. Using this methodology, our
share of equity losses from the partnerships decreased income from continuing
operations by $37.3 million (net of income taxes of $20.0 million) for the first
quarter 2001. We will apply this methodology consistently each quarter with
subsequent adjustments to reflect market events reported by the partnerships
(e.g., new rounds of financing, initial public offerings and writedowns by the
general partners). In addition, we will annually revise 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 volatility.
Income taxes are provided for at the statutory rate of 35%.
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000
Net investment income from venture capital partnerships was $5.6 million for the
three months ended June 30, 2001, a decrease of $61.9 million, or 92%, from
$67.5 million for the comparable period in 2000. Gains from the partnerships'
dispositions of stocks decreased $18.3 million and appreciation on the portfolio
stocks held in partnerships decreased $43.3 million in 2001. This segment's
results are primarily driven by equity market performance, particularly in the
technology sector. This sector produced less favorable returns in the second
quarter of 2001 compared to the comparable period in 2000.
SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
Net investment income (loss) from venture capital partnerships was $(51.7)
million for the six months ended June 30, 2001, a decrease of $305.1 million, or
120%, from $253.4 million for the comparable period in 2000. Gains from the
partnerships' dispositions of stocks decreased $108.2 million and appreciation
on the portfolio stocks held in partnerships decreased $195.8 million in 2001.
This segment's results are primarily driven by equity market performance,
particularly in the technology sector. This sector produced extremely favorable
returns in the first six months of 2000 but suffered significant declines during
the first six months of 2001.
42
43
CORPORATE AND OTHER SEGMENT
The following table presents summary financial data relating to Corporate and
Other for the periods indicated.
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2000 2001 2000 2001
------- ------- ------- -------
(IN MILLIONS)
OPERATING RESULTS:
Revenues
Insurance and investment product fees $ 6.0 $ 2.9 $ 12.3 $ 6.6
Net investment income (loss) 11.9 (1.7) 13.4 .8
------- ------- ------- -------
Total revenues 17.9 1.2 25.7 7.4
------- ------- ------- -------
Expenses
Policy benefits and increase in policy liabilities 2.2 2.2 6.3 5.0
Interest expense 3.0 3.1 6.7 6.2
Other operating expenses 8.9 13.1 32.7 28.7
------- ------- ------- -------
Total expenses 14.1 18.4 45.7 39.9
------- ------- ------- -------
Operating loss before income taxes, minority interest and
equity in earnings of and interest earned from investments in
unconsolidated subsidiaries 3.8 (17.2) (20.0) (32.5)
Income tax benefit 4.4 (9.8) (9.2) (20.0)
Equity in earnings of and interest earned from investments in
unconsolidated subsidiaries .6 .9 1.6 1.5
------- ------- ------- -------
Segment after-tax operating loss (6.5) (9.2) (11.0)
After-tax adjustments
Net realized investment gains (losses) 14.9 (2.2) 35.4 (9.5)
Early retirement pension adjustment .6 (11.3)
Demutualization expense (1.7) (12.1) (1.7) (19.0)
Surplus tax (2.9) (5.7)
------- ------- ------- -------
Total after-tax adjustments 10.3 (13.7) 28.0 (39.8)
------- ------- ------- -------
GAAP REPORTED:
Income (loss) from continuing operations $ 10.3 $ (20.2) $ 18.8 $ (50.8)
======= ======= ======= =======
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000
Insurance and investment product fees were $2.9 million for the three months
ended June 30, 2001, a decrease of $3.1 million, or 52%, from $6.0 million for
the comparable period in 2000, primarily due to the decision to exit our
physician practice management business in the third quarter of 2000.
Net investment income (loss) consists of income from invested assets not
allocated to other segments. Net investment loss was $1.7 million for the three
months ended June 30, 2001, a decrease of $13.6 million, or 114%, from net
investment income of $11.9 million for the comparable period in 2000, primarily
the result of lower average invested assets resulting from the purchase of
minority interests in PXP on January 11, 2001
43
44
Policy benefits and increase in policy liabilities were $2.2 million for the
three months ended June 30, 2001, remaining unchanged from the comparable period
in 2000.
Interest expense was $3.1 million for the three months ended June 30, 2001, a
decrease of $0.1 million, or 3%, from $3.0 million for the comparable period in
2000, primarily as a result of lower borrowings.
Other operating expenses were $13.1 million for the three months ended June 30,
2001, an increase of $4.2 million, or 47%, from $8.9 million for the comparable
period in 2000, primarily due to increases in outside services, particularly for
our technology initiatives and other general expenses.
Equity in earnings of and interest earned from investments in unconsolidated
subsidiaries was $0.9 million for the three months ended June 30, 2001, an
increase of $0.3 million, or 50%, from $0.6 million for the comparable period in
2000, due to the increased earnings in Hilb, Rogal and Hamilton.
SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
Insurance and investment product fees were $6.6 million for the six months ended
June 30, 2001, a decrease of $5.7 million, or 46%, from $12.3 million for the
comparable period in 2000, primarily due to the decision to exit our physician
practice management business conducted by PractiCare, Inc. in the third quarter
of 2000.
Net investment income consists of income from invested assets not allocated to
other segments. Net investment income was $0.8 million for the six months ended
June 30, 2001, a decrease of $12.6 million, or 94%, from $13.4 million for the
comparable period in 2000, primarily the result of lower average invested assets
resulting from the purchase of minority interests in PXP on January 11, 2001.
Policy benefits and increase in policy liabilities were $5.0 million for the six
months ended June 30, 2001, a decrease of $1.3 million, or 21%, from $6.3
million for the comparable period in 2000, due primarily to a decrease in
reserves related to the group pension business.
Interest expense was $6.2 million for the six months ended June 30, 2001, a
decrease of $0.5 million, or 7%, from $6.7 million for the comparable period in
2000, primarily as a result of lower borrowings.
Other operating expenses were $28.7 million for the six months ended June 30,
2001, a decrease of $4.0 million, or 12%, from $32.7 million for the comparable
period in 2000, primarily due to decreases in compensation and related expenses.
Equity in earnings of and interest earned from investments in unconsolidated
subsidiaries was $1.5 million for the six months ended June 30, 2001, remaining
relatively unchanged from $1.6 million for the comparable period in 2000.
CONSOLIDATED CASH FLOWS
Net cash provided by operating activities of continuing operations was $232.4
million and $288.7 million for the six months ended June 30, 2000 and 2001,
respectively. The increase for the six months ended June 30, 2001 over the
comparable period in 2000 resulted primarily from no estimated income tax
44
45
payments in 2001, refunds in 2001 of estimated income taxes paid in 2000 and
lower benefits paid to policyholders primarily in the closed block.
Net cash used for operating activities of discontinued operation was $249.1
million and $35.6 million for the six months ended June 30, 2000 and 2001,
respectively. The decrease in cash used for the six months ended June 30, 2001
over the comparable period of 2000 resulted primarily from the payment of cash
by our reinsurance discontinued operations in the prior year. The cash used in
2000 resulted primarily from cash settlements to several of the companies
involved in Unicover, which is associated with the runoff of our group accident
and health reinsurance block, plus the remaining operating activities of our
discontinued operations.
Net cash (used for) provided by investing activities of continuing operations
was $(331.3) million and $99.8 million for the six months ended June 30, 2000
and 2001, respectively. The increase in net cash provided by investing
activities for the six months ended June 30, 2001 over the comparable period in
2000 was due to the sale of investments to meet operating cash flow needs.
Net cash provided by investing activities of discontinued operations was $244.8
million and $38.0 million for the six months ended June 30, 2000 and 2001,
respectively. The decrease in net cash for the six months ended June 30, 2001
over the comparable period in 2000 was due to the sale of our group life and
health business in 2000.
Net cash (used for) provided by financing activities of continuing operations
was $(6.6) million and $458.3 million for the six months ended June 30, 2000 and
2001, respectively. The increase for the six months ended June 30, 2001 compared
to the six months ended June 30, 2000 resulted primarily from the proceeds
received from our issuance of common stock in the IPO and a decrease in bank
borrowing, partially offset by distributions to minority shareholders and
payments to eligible policyholders.
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, Corporate Actuarial 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 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 derivatives 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
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46
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- 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 in value by 5%. We believe that as of December 31, 2000 and June 30,
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 which 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 for the periods indicated.
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.
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47
AS OF DECEMBER 31, 2000
-----------------------------------------------------------------
FAIR VALUE
------------------------------------------------
BOOK -100 BASIS AS OF +100 BASIS
VALUE POINT CHANGE 12/31/00 POINT CHANGE
----- ------------ -------- ------------
(IN MILLIONS)
Cash and short term investments $ 660.9 $ 661.5 $ 660.9 $ 660.4
Floating rate notes 193.0 193.3 193.1 192.8
Long term bonds 7,918.4 8,519.8 8,063.5 7,641.7
Commercial mortgages 593.4 612.7 589.1 567.4
--------- --------- --------- ---------
Total $ 9,365.7 $ 9,987.3 $ 9,506.6 $ 9,062.3
========= ========= ========= =========
AS OF JUNE 30, 2001
-----------------------------------------------------------------
FAIR VALUE
------------------------------------------------
BOOK -100 BASIS AS OF +100 BASIS
VALUE POINT CHANGE 6/30/01 POINT CHANGE
----- ------------ -------- ------------
(IN MILLIONS)
Cash and short term investments $ 822.8 $ 823.5 $ 822.8 $ 822.1
Floating rate notes 161.9 139.4 138.6 137.8
Long term bonds 8,477.1 9,001.4 8,555.2 8,131.0
Commercial mortgages 561.3 570.2 548.6 528.1
--------- --------- --------- ---------
Total $10,023.1 $10,534.5 $10,065.2 $ 9,619.0
========= ========= ========= =========
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
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48
would 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 for the periods indicated. These
exposures will change as our insurance liabilities are created and discharged
and as a result of ongoing portfolio and risk management activities.
AS OF DECEMBER 31, 2000
------------------------------------------------------------------------
FAIR VALUE
WEIGHTED -------------------------------------------
NOTIONAL AVERAGE TERM -100 BASIS AS OF +100 BASIS
AMOUNT (YEARS) POINT CHANGE 12/31/00 POINT CHANGE
------ ------- ------------ -------- ------------
(IN MILLIONS EXCEPT FOR WEIGHTED AVERAGE TERM)
Interest rate floors $110.0 7.9 $ 1.1 $ (.1) $ (.4)
Interest rate swaps 453.0 7.5 15.6 7.9 1.1
Interest rate caps 50.0 7.8 (.3) .9
------ ------ ------ ------
Total $613.0 $ 16.4 $ 7.8 $ 1.6
====== ====== ====== ======
AS OF JUNE 30, 2001
------------------------------------------------------------------------
FAIR VALUE
WEIGHTED -------------------------------------------
NOTIONAL AVERAGE TERM -100 BASIS AS OF +100 BASIS
AMOUNT (YEARS) POINT CHANGE 6/30/01 POINT CHANGE
------ ------- ------------ ------- ------------
(IN MILLIONS EXCEPT FOR WEIGHTED AVERAGE TERM)
Interest rate floors $110.0 1.9 $ .9 $ (.1) $ (.4)
Interest rate swaps 714.3 8.0 28.1 4.5 (19.0)
Interest rate caps 50.0 7.0 (.3) .1 1.2
------ ------ ------ ------
Total $874.3 $ 28.7 $ 4.5 $(18.2)
====== ====== ====== ======
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 $335.5
million and $310.0 million in equities on our balance sheet as of December 31,
2000 and June 30, 2001, respectively. A 10% decline in the relevant equity price
would decrease the value of these assets by approximately $34 million and $31
million as of December 31, 2000 and June 30, 2001, respectively. Conversely, a
10% increase in the relevant equity price would increase the value of these
assets by approximately $34 million and $31 million as of December 31, 2000 and
June, 2001, respectively.
FOREIGN EXCHANGE RISKS
Foreign exchange risk is the risk that we will incur economic losses due to
adverse changes in foreign
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49
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 currency that creates foreign
exchange rate risk for us is the British pound sterling, due to our investment
in Aberdeen.
We partially mitigate this risk by using foreign currency swaps, which are
agreements designed to hedge against fluctuations in foreign currency exposure.
Under this type of agreement, we agree to exchange with another party principal
and periodic interest payments denominated in foreign currency for payments
denominated in U.S. dollars. The amounts to be received or paid on a foreign
currency swap agreement are recognized in net investment income. As of December
31, 2000 and June 30, 2001, these swaps represented a notional amount of $24.3
million and $24.3 million, and a fair value of $2.0 million and $4.0 million,
respectively. We believe our outstanding foreign exchange risk is immaterial.
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 outcome of all
pending investigations and legal proceedings or to provide reasonable ranges of
potential losses, it is the opinion of our management that their 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
Phoenix's reinsurance business included, among other things, reinsurance by
Phoenix of other insurance companies' group accident and health business. During
1999, Phoenix placed its 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 its decision to discontinue its remaining reinsurance operations,
Phoenix reviewed the runoff block and
49
50
estimated the amount and timing of future net premiums, claims and expenses.
We have established reserves for claims and related expenses that we expect to
pay on our discontinued group accident and health reinsurance business. These
reserves are a net present value amount that is based on currently known facts
and estimates about, among other things, the amount of insured losses and
expenses that we believe we will pay, the period over which they will be paid,
the amount of reinsurance we believe we will collect under our finite
reinsurance and our other reinsurance to cover our losses and the likely legal
and administrative costs of winding down the business. In 2000, we strengthened
our reserves for our discontinued reinsurance business by $97 million (pre-tax).
Total reserves were $65 million at June 30, 2001. 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 $165
million and increases to $230 million by 2004.
Phoenix is 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. In addition, Phoenix is involved in arbitrations
and negotiations pending in the United Kingdom between multiple layers of
reinsurers and reinsureds relating to transactions in which Phoenix Life
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.
SEC INVESTIGATION OF PXP AFFILIATE
In 1997, PXP received a subpoena from a federal grand jury calling for
production by DPIM, PXP's Chicago-based asset management subsidiary, of account
and trade-related documents having to do with, among other things, whether DPIM
directed client commission dollars to certain brokers in exchange for client
referrals for DPIM during the period 1994 to 1997. Thereafter, PXP conducted an
internal investigation into these activities. Following the internal
investigation, PXP ultimately returned a total of approximately $586,626 of
commission to the appropriate clients, took disciplinary action against certain
employees involved in the matter and implemented a number of compliance
procedures and enhanced controls.
PXP voluntarily disclosed the matter to both the U.S. Department of Labor, or
DOL, which enforces ERISA, and the SEC, and voluntarily provided these agencies
access to documents, records and witnesses. In October 2000, the SEC issued a
formal order of investigation in this matter, and PXP is cooperating fully.
This SEC investigation is a fact-finding inquiry and no enforcement action has
yet been taken by the agency against PXP or any of its affiliates. The federal
grand jury has no outstanding requests for information from PXP, and PXP is
cooperating with the DOL's request for follow-up information. We do not
anticipate that the outcome of this matter will have any material adverse effect
on our business.
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51
POLICYHOLDER LAWSUITS CHALLENGING THE PLAN OF REORGANIZATION
Two lawsuits have been filed challenging the fairness of the plan of
reorganization and the adequacy and accuracy of Phoenix Life's disclosures to
its policyholders regarding the plan. The first of these lawsuits, Burns v.
Phoenix Home Life Mutual Ins. Co., et al., was filed on April 4, 2001 in the
Circuit Court of Cook County for the Illinois County Department in the Chancery
Division. Plaintiff seeks to maintain a class action on behalf of a putative
class consisting of all current policyholders of Phoenix Life who purchased
their policies prior to Phoenix Life's announcement of its intention to
demutualize. The complaint seeks damages for losses allegedly sustained by the
class as a result of the demutualization, as well as other relief. The
defendants named in the complaint are Phoenix Life and some of its directors and
officers. On May 4, 2001, Phoenix filed a motion to dismiss the complaint.
The second lawsuit, Kertesz v. Phoenix Home Life Mutual Ins. Co., et al., was
filed on April 16, 2001 in the Supreme Court of the State of New York for New
York County. 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 to
enjoin the demutualization, damages and other relief. The defendants named in
this complaint include Phoenix, The Phoenix Companies, Inc. and most of their
directors, as well as Morgan Stanley & Co. Incorporated. On May 20, 2001,
Phoenix filed a motion to dismiss the complaint.
We believe we have meritorious defenses and intend to contest vigorously all
plaintiffs' claims.
Item 2. Changes in Securities and Use of Proceeds
The effective date of our registration statement on Form S-1 under the
Securities Act of 1933 (Commission File No. 333-55268) relating to our IPO of
common stock was June 20, 2001. A total of 48,800,000 were sold to an
underwriting syndicate. The lead managing underwriter was Morgan Stanley Dean
Witter. Merrill Lynch & Co., A.G. Edwards and Sons, Inc., Bear, Stearns and Co.
Inc., Deutsche Banc Alex. Brown and UBS Warburg were co-managers in the
offering. The IPO commenced on June 20, 2001 at a price of $17.50 per share. The
IPO closed on June 25, 2001 and resulted in gross proceeds of $854.0 million,
$46.1 million of which was applied to the underwriting discount. The net
proceeds to Phoenix were $807.9 million. In accordance with the plan of
reorganization, $660.0 million of the proceeds was paid to Phoenix Life or its
subsidiaries as consideration for the shares of common stock, including that of
PXP, that were transferred to us and the balance of such net proceeds was
contributed to Phoenix Life, principally to fund demutualization compensation to
policyholders in the form of policy credits and cash and to cover certain
expenses related to the demutualization. None of the net proceeds of the IPO
were paid by Phoenix directly or indirectly, to any director, officer or
employee of the company, other than as demutualization compensation payable to
policyholders pursuant to the plan of reorganization, or to any person owning
ten percent or more of any class of our equity securities, or to any affiliates
of the company.
On July 24, 2001, Morgan Stanley Dean Witter exercised its right to purchase an
additional 1,395,900 shares of common stock at the IPO price of $17.50 per
share. This resulted in gross proceeds of $24.4 million, $1.3 million of which
was applied to the underwriting discount.
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
See page 53 for the Exhibit Index. No reports on Form 8-K have been filed.
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52
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/ Bonnie J. Malley
------------------------
Bonnie J. Malley
Vice President
August 14, 2001
52
53
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------
1.1 Form of Underwriting Agreement*
2.1 Plan of Reorganization*
3.1 Form of Amended and Restated Certificate of Incorporation of
The Phoenix Companies, Inc.*
3.2 Form of By-Laws of The Phoenix Companies, Inc.*
4.1 Form of Certificate for the Common Stock, par value $0.01
per share*
4.2 Standstill Agreement, dated May 18, 2001, between The
Phoenix Companies, Inc. and State Farm Mutual Automobile
Insurance Company*
4.3 Form of Shareholder's Agreement between The Phoenix
Companies, Inc. and State Farm Mutual Automobile Insurance
Company*
10.1 Phoenix Home Life Mutual Insurance Company Long-term
Incentive Plan*
10.2 The Phoenix Companies, Inc. Stock Incentive Plan*
10.3 Phoenix Home Life Mutual Insurance Company Mutual Incentive
Plan*
10.4 The Phoenix Companies, Inc. Directors Stock Plan*
10.5 Phoenix Home Life Mutual Insurance Company Excess Benefit
Plan*
10.6 Amendment to Phoenix Home Life Mutual Insurance Company
Excess Benefit Plan*
10.7 Second Amendment to Phoenix Home Life Mutual Insurance
Company Excess Benefit Plan*
10.8 Phoenix Home Life Mutual Insurance Company Excess Investment
Plan*
10.9 Amendment to Phoenix Home Life Mutual Insurance Company
Excess Investment Plan*
10.10 Second Amendment to Phoenix Home Life Mutual Insurance
Company Excess Investment Plan*
10.11 Third Amendment to Phoenix Home Life Mutual Insurance
Company Excess Investment Plan*
10.12 Nonqualified Supplemental Executive Retirement Plan for
Certain Employees of Phoenix Home Life Mutual Insurance
Company*
10.13 Amendment to Nonqualified Supplemental Executive Retirement
Plan for Certain Employees of Phoenix Home Life Mutual
Insurance Company*
10.14 Second Amendment to Nonqualified Supplemental Executive
Retirement Plan for Certain Employees of Phoenix Home Life
Mutual Insurance Company*
10.15 Third Amendment to Nonqualified Supplemental Executive
Retirement Plan for Certain Employees of Phoenix Home Life
Mutual Insurance Company*
10.16 Fourth Amendment to Nonqualified Supplemental Executive
Retirement Plan for Certain Employees of Phoenix Home Life
Mutual Insurance Company*
10.17 Phoenix Duff & Phelps Nonqualified Profit Sharing Plan*
10.18 Amendment to Phoenix Duff & Phelps Nonqualified Profit
Sharing Plan*
10.19 Form of Change of Control Agreements with Robert W.
Fiondella and Dona D. Young*
10.20 Form of Change of Control Agreements with David W. Searfoss
and Carl T. Chadburn*
10.21 Form of Change of Control Agreement with Philip R.
McLoughlin*
10.22 Form of Stockholder Rights Agreement*
</Table>
53
54
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------
10.23 Global Note, dated as of November 25, 1996, between Phoenix
Home Life Mutual Insurance Company, Bear, Stearns & Co,
Inc., Chase Securities Inc., Merrill Lynch & Co. and The
Bank of New York*
10.24 Form of Indenture between Phoenix Duff & Phelps Corporation
and a Trustee with respect to the 6% Convertible
Subordinated Debentures due 2015 into which the Series A
Convertible Exchangeable Preferred Stock was exchanged*
10.25 Binder of Reinsurance, dated as of September 30, 1999,
between Phoenix Home Life Mutual Insurance Company, American
Phoenix Life & Reassurance Company and European Reinsurance
Company of Zurich (Bermuda Branch)*(+)
</Table>
54
55
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------
10.26 Amendment No. 1, dated as of February 1, 2000, to the Binder
of Reinsurance, dated as of September 30, 1999, between
Phoenix Home Life Mutual Insurance Company, American Phoenix
Life & Reassurance Company and European Reinsurance Company
of Zurich (Bermuda Branch)*(+)
10.27 Acquisition Agreement, dated as of December 15, 1998, by and
among Phoenix Investment Partners, Ltd., and Zweig/Glasser
Advisers, Euclid Advisors LLC, Zweig Advisors Inc., Zweig
Total Return Advisors, Inc., Zweig Securities Corp. and
Named Equityholders*
10.28 Amendment No. 1, dated as of March 1, 1999 to the
Acquisition Agreement by and among Phoenix Investment
Partners, Ltd., and Zweig/Glasser Advisers, Euclid Advisors
LLC, Zweig Advisors Inc., Zweig Total Return Advisors, Inc.,
Zweig Securities Corp. and Named Equityholders*
10.29 Stock Purchase Agreement, dated as of March 29, 1999, by and
among Hilb, Royal and Hamilton, PM Holdings, Inc., Phoenix
Home Life Mutual Insurance Company and Martin L. Vaughn,
III*
10.30 Stock Purchase Agreement, dated as of June 23, 1999, between
Banco Suquia S.A and PM Holdings, Inc.*
10.31 Asset Purchase Agreement, dated as of May 19, 1999, by and
between Phoenix Home Life Mutual Insurance Company and ERC
Life Reinsurance Corporation*
10.32 Acquisition Agreement, dated as November 10, 1999, between
Selling Management Shareholders, Aberdeen Asset Management
PLC, The Standard Life Assurance Co., The Non-Selling
Management Shareholders, Lombard International Assurance SA
and PM Holdings, Inc.*
10.33 Stock Purchase Agreement, dated as of November 12, 1999, by
and between TCW/EMCO Holding LLC and PM Holdings, Inc.*
10.34 Stock Purchase and Exchange Agreement, dated as of December
9, 1999, by and among GE Financial Assurance Holdings, Inc.,
GE Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
10.35 Amendment No. 1, dated as of December 29, 1999, to the Stock
Purchase and Exchange Agreement, dated as of December 9,
1999, by and among GE Financial Assurance Holdings, Inc., GE
Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
10.36 Amendment No. 2, dated as of February 23, 2000, to the Stock
Purchase and Exchange Agreement, dated as of December 9,
1999, by and among GE Financial Assurance Holdings, Inc., GE
Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
10.37 Amendment No. 3, dated as of April 1, 2000, to the Stock
Purchase and Exchange Agreement, dated as of December 9,
1999, by and among GE Financial Assurance Holdings, Inc., GE
Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
10.38 Amendment No. 4, dated as of April 1, 2000, to the Stock
Purchase and Exchange Agreement, dated as of December 9,
1999, by and among GE Financial Assurance Holdings, Inc., GE
Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
10.39 Amendment No. 5, dated as of April 1, 2000, to the Stock
Purchase and Exchange Agreement, dated as of December 9,
1999, by and among GE Financial Assurance Holdings, Inc., GE
Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
10.40 Amendment No. 6, dated as of April 1, 2000, to the Stock
Purchase and Exchange Agreement, dated as of December 9,
1999, by and among GE Financial Assurance Holdings, Inc., GE
Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
55
</Table>
56
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------
10.41 Amendment No. 7, dated as of October 31, 2000, to the Stock
Purchase and Exchange Agreement, dated as of December 9,
1999, by and among GE Financial Assurance Holdings, Inc., GE
Life and Annuity Assurance Company, PM Holdings, Inc. and
Phoenix Group Holdings, Inc.*
10.42 Agreement and Plan of Merger, dated as of September 10,
2000, among PM Holdings, Inc., Phoenix Investment Partners,
Ltd. and Phoenix Home Life Mutual Insurance Company*
10.43 First Supplemental Indenture, dated as of January 10, 2001,
between Phoenix Investment Partners, Ltd. and Harris Trust
and Savings Bank*
10.44 Employment-Related Agreement, dated as of December 20, 2000,
between Phoenix Home Life Mutual Insurance Company and
Robert W. Fiondella*
10.45 Employment-Related Agreement, dated as of December 20, 2000,
between Phoenix Home Life Mutual Insurance Company and Dona
D. Young*
10.46 Employment-Related Agreement, dated as of December 20, 2000,
between Phoenix Home Life Mutual Insurance Company and Carl
T. Chadburn*
10.47 Employment-Related Agreement, dated as of December 20, 2000,
between Phoenix Home Life Mutual Insurance Company and David
W. Searfoss*
10.48 Employment-Related Agreement, dated as of February 1, 2001,
between Phoenix Home Life Mutual Insurance Company and
Philip R. McLoughlin*
10.49 Fifth Amendment to Nonqualified Supplemental Executive
Retirement Plan for Certain Employees of Phoenix Home Life
Mutual Insurance Company*
10.50 Credit Agreement, dated as of June 11, 2001, between The
Phoenix Companies, Inc., Phoenix Home Life Mutual Insurance
Company, Bank of America, N.A., and Fleet Bank, as
Syndication Agents, Bank of Montreal, as Administrative
Agent, Deutsche Bank AG and Key Bank National Association,
as Documentation Agents, Banc of America Securities LLC and
Fleet Securities, Inc., as Joint Lead Arrangers and Joint
Book Managers*
10.51 Subordination Agreement, dated as of June 11, 2001 between
Phoenix Home Life Mutual Insurance Company and Phoenix
Investment Partners, Ltd.*
10.52 Credit Agreement, dated as of June 15, 2001, between The
Phoenix Companies, Inc., The Financial Institutions Party
thereto, and Fleet National Bank, as Administrative Agent,
arranged by Fleet Securities, Inc.*
21.1 Subsidiaries of the Registrant*
</Table>
- ------------
* Previously filed.
(+) Portions subject to confidential treatment request.
56