The Phoenix Companies Q3 2008 Earnings Call Transcript

| About: The Phoenix (PNX)

The Phoenix Companies (NYSE:PNX)

Q3 2008 Earnings Call

October 30, 2008 12:00 pm ET


Dona Young - Chairman, President and Chief Executive Officer

Peter Hofmann - Senior executive Vice President

Phil Polkinghorn - President of Life and Annuity

George Aylward - President of Asset Management

Jim Wehr - Chief Investment Officer

Dave Pellerin - Chief Accounting Officer


Jukka Lipponen - KBW

Bob Glasspiegel - Langen McAlenney

Craig Crolasory - Matched Capital


Good afternoon. My name is Barbara and I will be your conference operator today. At this time, I would like to welcome everyone to the Phoenix third quarter 2008 conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator Instructions)

It’s now my pleasure to turn the floor over to your host, Mr. Peter Hofmann. Sir, you may begin your conference.

Peter Hofmann

Thank you very much. Good afternoon and thank you for joining us this afternoon. I’m going to start with the required disclosures and then turn it over to Dona Young, our Chairman, President and CEO for an overview of the quarter. After that, I will review the numbers and we’ll open it up to your questions.

Also joining us for the Q-and-A section are Phil Polkinghorn; President of Life and Annuity; George Aylward, President of Asset Management, Jim Wehr, our Chief Investment Officer; and Dave Pellerin, our Chief Accounting Officer. Our third quarter earnings release, our quarterly financial supplement and the third quarter earnings review presentation are available on our website at

Slide two of the presentation contains the important disclosures. We may make forward-looking statements on this call that are subject to certain risks and uncertainties. These risks and uncertainties are discussed in detail in our third quarter earnings release and our latest SEC filings. Our actual results may differ materially from such forward-looking statements.

In addition to Generally Accepted Accounting Principles, we use non-GAAP financial measures to evaluate our financial results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our press release and financial supplement. Now I will turn the call over to Donna.

Dona Young

Thank you, Peter and good afternoon. Thank you for joining us on this call. We have much to talk about, from the results themselves to the pending spin-off of Verdis Investment Partners, our asset management business and the equity stake that Harris Bancorp, a US subsidiary of the Bank of Montreal is taking in Verdis.

First, the quarter; clearly the third quarter was brutal for almost all companies and followed almost a year of falling markets. For Phoenix, the fallout showed up in the market sensitive portions of our business; notably annuities, investment income and investment portfolio. At the same time, we’ve been able to advance the spins is off of asset management and attract a significant investor in Harris.

As anticipated by the spin-off, but accelerated by market conditions, we evaluated our Verdis related good will and other intangibles at the end of the third quarter. As a result of this review, we chose significant non-cash charge this quarter, writing down good will and other intangibles in our asset management operations.

When you take away the noise of the impairment, our results held up well, particularly our core life results, which given the environment showed continued resilience. The fundamentals of our life business, mortality and persistency, once again were favorable in the quarter and the portfolio underlying the life company remained solid. I would also note that even in this very trying environment, we continue to have a strong capital and liquidity position, as well as a great deal of financial flexibility. I will talk about all of these in more detail in a few minutes.

As you saw in our press release, the non-cash impairment charge was $332.6 million. Several successive quarters of declining markets, significant reductions in market multiples for asset managers that are at almost unprecedented lows and other valuation data we have accumulated in advance of the spin-off triggered the impairment analysis and led us to this decision.

It’s important to remember that the impairment will have only a small impact on Phoenix’s future equity, because the asset management segment will be eliminated when the spin-off is completed. Excluding the write-down, we have operating income of $15 million and a net loss of $6.9 million. This is not a great quarter for us, but within the context of the large environment, it is a respectable outcome.

Before turning to specifics in the quarter for Life and Annuity, let me continue with Verdis, including an update on where we are in the spin process. Looking at asset management’s results excluding the write-down, the third quarter market challenges brought lower revenues and declines in assets under management that decreased EBITDA and pre-tax operating income from last year’s third quarter.

Verdis had $2.3 million of expenses related to long-term cost reduction initiatives, including severance and lease abandonment. Flows in the third quarter were improved from a year ago, albeit still negative and were driven by mutual funds and managed accounts. In fact, retail outflows were the lowest in 19 quarters.

Short term relative performance improved significantly over the previous three quarters, although we focused on long term performance when assessing competitiveness. The percentage of all [OEM] in the top third of relative peer rankings was 58%, 65% and 59% for the one, three and five year periods respectively.

Now let me turn to the spin-off. Peter will walk you through the financial highlights of the transaction and I’ll review it from a strategic perspective. Our relationship with Harris goes back to 2006, when George Aylward established an alliance with Harris involving its insight funds. The fact that such a leading financial institution with strategic ties to the business is making this 23% investment underscores Verdis’s many strengths, including its management team, cash profitability, solid investment performance and broad distribution footprint.

The Verdis up to date which stands on a solid platform for growth is the direct result of the hard, hard work of the last few years to fundamentally restructure the organization from transforming the business model itself and building out mutual funds for a more balanced product portfolio to reshaping the operations and sales organizations to be more efficient and effective. This is a difficult, demanding, challenging undertaking.

While our actions over the years had one goal in mind, to create good options for this business, this is not always clear externally. We remain focused on turning the business around, which eventually gave us optioning, including the spin-off. The vast investment strength and the strategic partnership between Verdis and Harris, will allow them to deepen their products and distribution relationship to the benefit of both companies shareholders and we believe Verdis has good growth prospects because the markets should improve over time and Verdis will be well positioned when that happens.

We are on track to complete the spin-off this year when we share some recent activities and actions. On September 10, we filed a first amendment to the Form 10 with the SEC. We will file at least one more amendment to the Form 10 before the spin-off is complete. Verdis’s name change became effective on October 1, including new names to the mutual funds family and investment advisor. Verdis’s website is also live at After tomorrow, we will begin operating separately.

Administrative items such as payroll, employee benefits and many systems will be handled as if Verdis were already an independent company. We did this, so all of these areas would be up and running when the legal spin takes place to make the transition as smooth as possible, after the separation is declared effective.

Our board’s governance committee has led the process of assembling a Verdis Board of Directors and has identified six individuals with complementally skills and exposure to the asset management industry in the course of their professional careers. The six are eager to help such strategy and oversee Verdis as it is launched as an independent company. Verdis will also welcome two more board members to be nominated by Harris.

We should be making an announcement about the board membership soon, as well as the stock exchange where Verdis shares will be traded and the last point I will make on Verdis is the timing of the conference call with investors. George is aiming to schedule it right after the next Form 10 filing, which we expect to be in the next two weeks. We will issue a press release to confirm the date and time soon.

Now let’s look at what Phoenix will be after the spin. Essentially that’s our Life and Annuity segment and corporate and other excluding unusual items this year. As you know, we have been viewing the business this way since the beginning of the year.

Free cash operating income for these areas was $22.1 million compared with 37.2 million a year ago. The difference is almost entirely in the Annuity line. Annuity earnings were substantially lower because of the adverse markets and increased reserves for guaranteed minimum death benefits, as well as higher tax amortization.

Conversely we are finding shared resilience in the fundamental strength of this business by achieving results equal to last year’s third quarter. Once again, mortality was favorable in the quarter, with VO margins at 50% and UL at 61%. For the first nine months, mortality margins in the aggregate remained in line with our long-term expectations.

I’ll now turn to sales in the quarter. Overall Life and Annuity sales continued to slow, which is understandable. After all in this environment, the only decision people seem to be making is to postpone making a buying decision at all. Yet we are pleased by the growth in sales for State Farm for both Life and Annuity.

Annualized life sales were off 42% year-over-year and sales through independent channels were much slower, but sales to State Farm increased 35%. Annuity deposits rose 10% year-over-year, although they were lower than the last three quarters. State Farm continued to be the leading distribution channel accounting for 66% of total sales and showing 13% growth year-over-year. We also had the fourth consecutive quarter of positive annuity net flows.

Let me spend the next few minutes talking about our investment portfolio and more generally the strength and adequacy of our capital position. First, the investment portfolio: All along we have said we would not be immune to market stress; however, our disciplined approach has served us well.

Net realized investment losses of $60.6 million were driven primarily by impairments of certain corporate credits in the financial services industry, although they were comparable to losses in the first quarter. Growth credit impairments in the third quarter were $38.2 million compared to $5.3 million in the 2007 third quarter and were mostly in corporate securities, primarily holding to Washington Mutual and Lehman Brothers.

Net unrealized losses increased $429 million, which represents about a 4% price decline in the portfolio. No single index is a proxy for our portfolio, but as a point of reference investment grade corporate bonds declined 7.8% in the quarter, as represented in the Lehman Brothers aggregate bond index.

Now our capital position and liquidity: Here are a few facts. We remain well capitalized and have strong liquidity. Our liability profile is quite stable. We have no exposure to institutional funding agreements, no securities lending activities and strong persistency in our core business lines. We also have no debt maturities until 2032 and our leverage remains low at 18.1%. Post-spin, our leverage will be about 21% and finally, our investment portfolio provides the liquidity necessary for our business needs.

In recent years, we have also achieved a great deal of financial flexibility, which means we have more options to reinforce our capital position, including our sizable closed block. Let me say a word about expenses. As we previously indicated, we have been doing a fair amount of belt tightening in anticipation of the spin. It is essential for us to have the right expense and operational structure when we begin life as a Pure Play life and Annuity company. We will continue to work diligently to become even more efficient and examine every area of the business to reduce expenses further.

Before turning it over to Peter, let me sum up where we are. Like everyone else, we are experiencing the worst market cycle in decades, but we believe we have positioned ourselves well to withstand the tough times. Our focus now in going forward is on preserving capital, managing liquidity, maintaining discipline around expenses and serving our valued customers well to retain and deepen those relationships.

We believe that Phoenix post-spin will be well positioned operationally. Without the asset management business, Phoenix will be a more streamlined, more focused company delivering the innovative products and exceptional service our target market demands. Now, Peter.

Peter Hofmann

Thanks, Donna. I’m going to cover two topics; the investment and Verdis and our financial results and we’ve also included investments portfolio detail in an appendix to the presentation for your reference and we’re certainly prepared to address this in the Q-and-A.

Slide three of the deck gives an overview of the deal with Harris Bancorp. Harris will take a 23% equity position in Verdis in connection with the spin-off. They will purchase $45 million of preferred convertible stock and become a minority investor as a result. The preferred will carry 8% dividend and is convertible into 23%, which implies an aggregate equity value for Verdis of $195.6 million.

The securities are redeemable at the end of six years and putt able at the end of year seven. The transaction clearly has benefits for both Phoenix and Verdis as Donna discussed. For Phoenix, it supports successful subrogation of asset management, provides a valuation benchmark for current and future shareholders and provides further financial flexibility. For Verdis, it provides sponsorship in capital to support the launch of the new company. It also extends an important existing strategic relationship.

Now let me turn to the financials. Slide four shows the highlights of the quarter. As Donna already mentioned, the results are dominated by the impairment resulting in a loss of $2.97 per share. Excluding the impairment, operating earnings were $15 million, or $0.13 per share and the net loss was $6.9 million or $0.6 per share.

Stable life earnings were offset by the impact of the market on Annuity and Asset Management results. We had some transaction related costs, as well as severance in restructuring charges, which in total were $8.1 million pretax. Following the impairment, our post-impairment book value is $1.53 billion or $13.35 per share which includes $239 million of remaining good will and intangibles, the majority of which will be removed from the balance sheet sue to spin-offs. Net realized investment losses after offsets were at $21 million in the quarter.

Now looking at the results by line of business on Slide five, you can see that life insurance pretax earnings of $42.8 million were consistent with the prior year. The results reflect favorable mortality and persistency offset by lower net investment income. The pretax loss of $9.5 million in annuities reflects the effect of the weak stock market which largely came through lower fees, higher debt benefit reserves and accelerated amortization.

Corporate and other excluding the transaction related expenses had a loss of $11.2 million which is in line with our historical run rate. The current quarter had lower interest expense partially offset by lower corporate net investment income. Asset management had a pretax operating loss of $427.7 million reflecting the impairments. Excluding that impairment, asset management earnings were negative $6.0 million.

Slide six provides a bit more detail on the life insurance results. Core life earnings were $19.5 million in the quarter. Universal life earnings benefited from excellent mortality and lower expenses, partially offset by higher back amortizations. Variable universal life earnings were adversely affected by higher mortality, lower fees and lower investment income.

Traditional life earnings of $23.3 million were slightly above our expected range of $17 million to $23 million per quarter. Lower investment gains here were offset by lower expenses and favorable mortality. The slightly higher losses in the other lifeline reflect investments in our alternative retirement and Phoenix life solutions initiatives.

Slide seven shows the mortality trends in UL and VUL. As already discussed mortality overall was favorable in the third quarter with a margin of 61% for UL and 50% for VUL, excluding private placements and an aggregate mortality margins for the first nine months of the year in line with our long-term expectations.

Slide eight shows the detail on the sales that Donna discussed. Annualized life sales of $56 million down from both the second quarter and a year ago largely driven by the independent channel. Total life insurance in force however is up 9% over last year and the number of policies sold has also increased over the last quarter and last year.

Slide nine shows our annuity results in addition to the earnings which I already mentioned; you can see the impact of the market on funds under management. Funds are down by 9% over the last quarter and by 15% over the last year, reflecting market conditions. Deposits however are up 10% year-over-year driven by the strong sales at State Farm and as already mentioned net flows were $35 million and positive for the fourth consecutive quarter.

The market impact is also clear in asset management, as you can see on Slide 10. Assets under management fell by $4.7 billion or 14% to $28.7 billion in the quarter. The money market fund assets under management which can be very volatile dropped by more than $2 billion. Market performance accounted for 1.5 billion of the decline; however, overall net flows were negative 706, which is the lowest in several quarters. Notably, retail outflows were at their lowest level in 19 quarters.

Turning to the asset management income statement on Slide 11, the decline in AUM clearly affected revenues, which decreased $12 million from a year ago and $3 million sequentially and as a result EBITDA has declined over the last quarter in the year ago, but that also includes the $2.3 million related to long term cost reduction initiatives that were mentioned previously and that is part of the $8.1 million of transaction and restructuring expenses that I mentioned at the outset.

A couple of comments on our investment portfolio, on Slide 12, you’ll see our realized loss trend and growth impairments here of $38.2 million came from corporate securities within the financial services sector, specifically exposures we had to Lehman and WaMu, as well as structured impairments, but the level of structured impairments was lower than in previous quarters.

Slide 13 details our unrealized losses as of September 30. As you can see our unrealized losses have increased because of the widening credit spreads, but we do not believe that these losses are an indication of future impairments. Over 50% of the growths unrealized losses are in the closed block where they back very long duration, stable liabilities and where up to a point they are absorbed by the policy holder dividend obligation. After offsets, the percentage in the closed block goes up to nearly 60%.

Unrealized losses [Inaudible] in the context of liquidity, a strong liquidity position mitigates the risk of having to sell securities that are below book value and as Donna already mentioned and as pointed out on Slide 14, our liquidity profile is very strong. Not only do we have modest redemption liquidity risks as a result of not being in the gate or institutional funding business and really having no bank owned life insurance and we don’t engage in securities lending. We’ve also on the asset side of the balance sheet have been adding high quality liquid positions to our portfolio in the beginning of the year.

Turning to Slide 15, statutory surplus of $835 million was down 20% from the year end of 2007 and there are really three reasons for this decline. First, higher than expected credit impairments and investment losses in the life entities. Second, the fact that we paid dividends as planned to the parent company and third, sales-related surplus drain.

The estimated RBC at 9-30 was well above 325. We have a capital plan under way to reach our 375 to 400 target range by year end. The plan consists of a variety of options from risk repositioning to reinsurance, to looking at our sales and our product designs. Year-to-date statutory gains from operations was $20.7 million, leverage was 18.1% as of quarter end even after taking into account the asset management impairments.

Before turning it back to Donna, a reminder again that we have the appendix, which includes detailed information on our RMBS, CMBS, CDO and financial sector holdings. Overall, our portfolio continues to be of high quality and relatively well positioned in our view and this market environment and we are happy to address details with respect to the portfolio in the Q-and-A. With that, I’ll turn it back to Donna.

Dona Young

Thank you, Peter. At this time, I’m going to ask our operator Barbara to open up the lines. As a reminder, we ask that you limit your questions to two at a time as a courtesy to your fellow listeners on the call who want to pose questions. So again, two per caller and then you can get back into the queue. Barbara can you open it up please?

Question-and-Answer Session


(Operator Instructions) Your first question comes from Bob Glasspiegel - Langen McAlenney.

Bob Glasspiegel - Langen McAlenney

The capital plan, you say you’re going to get to your target of RBC by year end. Can you help us with some of the steps that you envision in the fourth quarter?

Dona Young

Bob, there are a number of steps. Peter alluded to in just a few minutes ago. The steps that we are pursuing to achieve the 375 by year end are steps that are internal steps. So, again, it’s a range of reinsurance, risk repositioning of certain assets in the portfolio and other strategies around product design that will enhance the capital of the company, but we’re referring to internal efforts that are well under way with an expectation that they will be concluded within the next four to six weeks.

Bob Glasspiegel - Langen McAlenney

Okay and the write-off of the securitization that had been there; can we read in that that’s no longer in the plans as an option?

Peter Hofmann

Bob, its Peter. The write-off relates to the fact that we were working on a specific structure that in the current market environment is not a tenable structure. That does not mean that we are not looking at options for the closed block.

Bob Glasspiegel - Langen McAlenney

Okay. I have a follow-up, but I’ll come back in the queue to ask you about that.


Our next question is coming from Jukka Lipponen - KBW.

Jukka Lipponen – KBW

First question, are there any reasons that potentially could prevent you from completing the asset management spend?

Dona Young

Well, the first and really most important requirement at this stage is for the SEC to declare the form 10 effective. We fully expect to conclude the spin by the end of the year. The way you worded your question, no one’s going to say “there’s absolutely zero probability and I spent too much over my adult life with actual to know there’s always a probability for something happening,” but this is a very good transaction with Paris and Bank of Montreal. We have the operational steps well underway and as I said, really effective tomorrow. Operationally the companies will be separate and we’re ready to go, subject to the SEC declaring it effective and then of course our board has to declare the dividend.

Bob Glasspiegel - Langen McAlenney

My second question is about the zero mortality margin. What am I doing wrong? If I take the 11.6 million over debt and divide it by the COI charges of 21.5, I’m getting 46%, not 50%.

Dona Young

Okay. That’s a pretty easy answer and I’ll let Phil just try that.

Phil Polkinghorn

I think you need to back out the private placement segment of universal life and you’ll get the numbers. The percentage quoted is ex private placement business.


(Operator Instructions) Your next question comes from [Craig Croasory - Matched Capital.]

Craig Crolasory - Matched Capital

What do you expect to do with the proceeds from your Harris sale, the $45 million?

Peter Hofmann

Yes, the investment is made into Verdis as part of the spin-off and we’ll represent capital to Verdis. So it is not currently contemplated to be capital to PNX.

Craig Crolasory - Matched Capital

Okay. Second question, what is your hold co-cash as of Q3, at the end of Q3 in your dividend capacity for the rest of the year?

Peter Hofmann

We have not disclosed intra quarter cash positions. I can tell you there’s no reason for concern around the cash position. Our dividend capacity is determined by the lesser of our statutory gain from operations for this year or the 10% of the surplus at the end of the year.

Even though we have, as you saw, lower gain from operations for the year that is related to a specific internal reinsurance transaction. We’re quite confident that in the fourth quarter, we will have a significant pickup in statutory GFO that will enable us to pay a dividend around the range of the 10% of surplus level.


Your next question comes from Bob Glasspiegel - Langen McAlenney

Bob Glasspiegel - Langen McAlenney

I was just wondering if you could expand just on the question on the securitization options that are still on the table, what are some of the things that you might want to pursue, post block rather.

Dona Young

Yes, more broadly, from a closed block standpoint, our review and discussions have led us to conclude that there are a number of options including reinsurance or other securitization transactions or structures that, again are not quite as we contemplated before with the wrap structure.

I want to comment that at least with respect to the internal capital options to get us to 375 between now and the end of the year, a closed block transaction is not contemplated, but what the close block represents is a very valuable block of business and it represents an enormous amount of flexibility to the company to use those proceeds to invest in higher growth businesses within Life and Annuity.

I don’t want to speculate as to what all of that might be or the timing, but it certainly is a very terrific asset, particularly at a time when there are strengths generally in the marketplace and that level of flexibility is a strength of the company.

Bob Glasspiegel - Langen McAlenney

Okay. Do the gross and realized losses that you have unrealized to date put any restrictions on either sort of fourth quarter repositioning?

Peter Hofmann

Not, not really, Bob, none that I can think of.


We have another follow-up question coming from Craig Crolasory - Matched Capital.

Craig Crolasory - Matched Capital

A couple more quick ones; on page 18 of your slide presentation, where you express your residential mortgage backed securities by rating, do you have or can you give us any color on subordination? I mean we’ve learned that all AAA aren’t created equal, so are these subordinated AAA are these mid tier or the top of the capital structures?

Dona Young

We agree with your comment that they are not all created equal and I'm going to let Jim Wehr give you some details regarding our positions.

James Wehr

Fortunately most of the more recent vintage are the most senior AAA or kind of the super-senior AAA and that’s really the case across the board and you got a sub-prime [inaudible] and the difference, because of the level or the amount of subordination, the amount of buffer you have against impairments in the underlying collateral has been a huge differentiator in terms of how those transactions have performed and I think it goes a long way to explain why our level of impairment in 2008 has been relatively modest where we look at the relative size of our portfolio compared to market indices or compared to what other folks are seeing.

Craig Crolasory - Matched Capital

Okay. So it’s fair to say just to sum up your comments, the vast majority of the, call it ‘05 to ‘07 vintages are that M 1 trench that very top?

James Wehr

Yes, that super-senior.

Craig Crolasory - Matched Capital

Second question; regarding your CDO holdings, could you give us any idea of vintage, kind of the data you provided for CMBS on all day. Just curious if these CDOs are ‘03, ’02 or we’re talking ’06, ’07 on a bank loan stuff.

James Wehr

The bank loan stuff is heavily concentrated in ‘04 and earlier. A ballpark on the bank loan side of things 75%, thereabouts.

Craig Crolasory - Matched Capital

Okay and what about your investment grade, your high yield, your CMBS, that stuff?

James Wehr

Pretty similar stories for the other guys. The investment grade, I will point out, if we look at the market values and I would not suggest that market values are the be-all and end-all in the marketplace right now, but the market value on the investment grade pieces is very close by the book. High yield would be about $0.95 on the dollar; the CMBS is about $0.70 on the dollar and that reflects the fact that those deals have been as a group in the marketplace has been under a lot of pressure. So I think that’s an important take away as well.


Our next follow-up question is coming from Jukka Lipponen – KBW.

Jukka Lipponen – KBW

How much the goodwill on intangible is going to be that will remain in the life company post spin.

Peter Hofmann

I’ll let Dave answer that because he knows the number exactly.

Dave Pellerin

After the impairment, our total goodwill and intangibles pre-spin will be $240 million and approximately three quarters of that will relate to Verdis.


Thank you. At this time, I would like to turn the floor back over to Dona Young.

Dona Young

Okay well, thank you. This concludes our third quarter earnings call. Thank you for your participation and interest and we look forward to reporting to you at the conclusion of the fourth quarter. Have a good day.


Thank you. This does conclude today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!